2019 Marks an Inflection Point in Media Consumption 

2019 Marks an Inflection Point in Media Consumption 

On the one hand, it’s official; on the other hand it comes as no surprise to us here at Tematica that “internet consumption,” which of course includes video streaming be it on Netflix, Google’s YouTube or some of the newer platforms, such as Disney+, given our Digital Lifestyle investing theme. With more streaming services from Apple and AT&T to be had plus the looming launch of 5G networks, before too long we could see “TV viewing” go the way of newspapers and magazines. Again, no real surprise, just a matter of time.

According to Zenith, daily mobile internet consumption will amount to 130 minutes per day, up from just 80 minutes in 2015. Adding 40 minutes of desktop internet use, total internet use is expected to amount to 170 minutes per day this year, compared to 167 minutes of daily TV viewing. In line with the old advertising adage “money follows eyeballs”, online advertising expenditure is also on the rise and, according to Zenith, surpassed TV ad spending for the first time in 2017.

Source: • Chart: 2019 Marks an Inflection Point in Media Consumption | Statista

Weekly Issue: As Global Economy Slows, Investors Switch into Fear Mode

Weekly Issue: As Global Economy Slows, Investors Switch into Fear Mode


Key points inside this issue

  • The global economy continued to slow in August
  • Uncertainty has investors in Extreme Fear mode
  • Trade remains the focus of the stock market
  • Boosting our Disney (DIS) price target following D23’s Disney+ focus
  • Items to watch this week


The stock market has been a more volatile than usual over the last few weeks as investors:

  • Contend with the latest global economic data
  • Eye the yield curve
  • Question what the Fed will do next
  • Brace for the next round of trade talks

As if that wasn’t enough, we’ve also witnessed mixed June quarter retail earnings, which are now getting factored into second half of 2019 earnings-per-share expectations for the S&P 500. At the same time, the velocity of corporate buybacks has slowed, Washington is scrutinizing tech companies, and consumer confidence is waning. 

All in all, these issues weighing on investors minds have led to swings in the market based on the most recent headlines, and that can make for a challenging time in the market and for investors.


The global economy continued to slow in August

Last Thursday morning, we received the first meaningful piece of August economic data in the form of the IHS Markit Flash PMI data for the month, and in aggregate, it confirms the global economic slowdown. To date, the U.S. has been the best house on the slowing economic block, but Thursday’s data, which showed the domestic manufacturing sector contracting for the first time in a decade means the trade war and uncertain environment are weighing on the economy. 

During periods of uncertainty, whether we’re talking about companies or people, the natural instinct is to pull back, wait and assess the situation. For both people and companies, dialing back spending is an arguable course of action when faced with uncertainty, but from an economic perspective that translates into a headwind for growth. We’re seeing that headwind in the day’s Flash PMI data.

Aside from the headline, U.S. Flash Manufacturing PMI hit 49.9, marking a 119-month low; the index’s new orders component put in its weakest reading since 2009. Per the report, “Survey respondents often cited subdued corporate spending in response to softer business conditions and concerns about the global economic outlook.” 

But as we saw with the July Retail Sales report, consumers continue to spend, despite rising debt levels and banks are starting to report a pick-up in delinquency rates. The question that is coming to the forefront of investor minds is whether consumers will be able to spend and keep the economy chugging along during the all- important holiday shopping season that will soon be upon us? Given the continued increase in consumer debt levels and news that Citibank (C), JPMorgan Chase (JPM), Bank of America (BAC) and other banks are reporting rising credit card delinquency rates we could be starting to see the consumer spending breaking point. 

Looking at the August Flash PMI data for the eurozone, the slowdown continued as well, but the report also registered a “sizeable drop in confidence regarding the 12-month outlook” with sentiment down to its lowest level since May 2013. Digging into that report we find new order growth in Germany, the largest economy in the eurozone, falling to its weakest levels since early 2013. The August data for the region confirms current forecasts the region is likely to hit just 0.1%-0.2% Gross Domestic Product in the current quarter. Another round of weak data, and odds are we’ll soon see recession fears rising ahead of the European Central Banks upcoming mid-September monetary policy meeting.


Uncertainty has investors in Extreme Fear mode

If we were to step back and look at the data, what we are seeing is data that points to a continued slowdown with some bright spots. Granted those bright spots are also somewhat mixed and there are reasons to be concerned over the sustainability of those bright spots. Is it any wonder then that the CNN Money Fear & Greed Index has been firmly in “Extreme Fear” for the last week? In a word, no.

During periods of Extreme Fear, the jittery market is bound to overreact. Add in the fact that we are in one of the seasonally slowest times of the year for trading volumes means market reactions will be even more extreme one way or another. The danger for investors is to get caught up in the turbulence, and it can be rather easy to do, especially if one is looking to pile onto a money-making trade, be it a long or short one. This makes headline-grabbing, bold assertions increasingly digestible, like the one from hedge fund hired-gun Harry Markopolos on General Electric (GE) or rumormongering like the recent one that drove the recent pop in shares of Tesla Motors (TSLA).

Rumors and assertions are tricky things, and while some may turn out to be true, others may only have a whisper of truth, if any at all. In the case of Markopolos, he’s working with an unnamed hedge fund partner, and while it would be wrong to cast wide dispersion on the industry, the reality is it is hurting. In 2018, eVestment hedge fund performance data showed the overall hedge fund industry returned negative 5.08%. While the industry is in positive territory on a year-to-date basis this year, it still meaningfully lags the major market indexes.

The bottom line is that in a market environment that is teaming with uncertainty on several sides, it is even more important that investors continue to focus on the data rather than be led astray by rumors and conjecture. Whether it is digging into a company’s financial filings; cross referencing conference call transcripts across a company’s competitors, customers and suppliers; or wading deep into the economic data, now more than ever it is important to do the homework rather than simply piling onto an idea that could simply be one person talking his or her trade book.  In our case, we’ll continue to assess and revisit the tailwinds that powers each of our investing themes each week through Thematic Signals and our Thematic Reading as well as our Thematic Signals podcast. 

Along the way, we may find something that helps put some of those potentially over-the- top assertions into perspective. One such example is found in the work by Bronte Capital that took Markopolos’ assertion that GE’s industrial margins near 15% are “too good to be true” to task by comparing them with similar margins at Honeywell (HON), Emerson Electric (EMR) and others. Once again, digging into the data adds that layer of context and perspective that is both helpful and insightful to investors.

In my experience, making a trade without doing the homework first and getting conviction on the thesis rarely yields the hopium expected. If the homework checks out, it offers confidence and conviction in the position. Periodically checking the data to determine if that thesis remains on track can either keep one’s conviction running high or alert to a potential issue. Not doing the homework leaves one vulnerable to a change they might not even known was coming.


Trade remains the focus on the stock market

As we approached the end of last week, the stock market was poised to move higher week over week, but as we saw it finished up on a very different note given all of Friday’s news. That news spanned from China threatening countermeasures on tariffs set to be instilled on Sept. 1, to the Fed being ready to extend the current recovery even though it remains upbeat about the domestic economy, to President Trump “ordering” U.S. companies to look for “alternative to China” and then raising tariffs on China after the market close. 

There was little question, we were once again seeing U.S.-China trade tensions escalate, raising questions as to what it could mean for the next round of trade talks. In other words, as we headed into one of the last summer weekends, U.S.-China trade uncertainty continued. While the market absorbed China’s escalation and Fed Chair Powell’s “at the ready when needed” comment, it was Trump’s latest trade salvo that reversed the market’s direction for the week leading all the major stock indices to finish down for the week. Trump said he would raise existing duties on $250 billion in Chinese products to 30% from 25% on October 1 and increase the 10% tariff on another $300 billion of Chinese goods set to take effect on September 1 to 15%.

The trade drama at the G-7 meeting continued over the weekend, and it appeared the market was going to start this week off with more than a whimper given that last night US stock market futures were down more than 1%. However, like any good drama that has a number of twists, this morning President Trump shared that China wants to make a trade deal, which served to walk back last week’s jump in trade tensions. 

My stance on the trade war has been a combination of hope, patience and details. Hope for a trade deal, patience realizing it would take time to come together and that the details of any trade agreement matter. Despite the purported trade related developments today, my stance remains unchanged. 


Boosting our Disney price target following D23’s Disney+ focus

While many were watching the political and trade events unfold at the G-7 meeting over the weekend, there was another gathering of note – D23 2019 at which Walt Disney (DIS) shared quite a bit about its upcoming Disney+ service that is set to launch on November 12. As I’ve said before, that service not only grows Disney’s exposure to our Digital Lifestyle investing theme, it’s also going to change how Wall Street values both DIS shares as well as those for Netflix (NFLX)

On its own Disney+ will cost users $6.99 a month, or $69.99 for a full year, but together with ESPN+ and ad-supported Hulu the bundle will run customers $12.99 per month, which is on par with the standard plan offered by Netflix that allows for two screens to be watching at the same time. The starter price for Disney+ allows for up to support for four simultaneous streams with 4K included. That’s quite a difference, and one that runs the risk of eating into Netflix’s business, particularly at the margin as Middle-class Squeeze consumers tally up how much they are spending on all of their streaming video and music as well as other subscription services

During D23 Disney showcased a plethora of Disney+ exclusive content ranging from its Star Wars to Marvel universes. On the Marvel front, Disney+ will include seven live action programs that are expected to tie into the active Marvel Cinematic Universe (MCU) that span existing characters and introduce new ones as well. While some may be missing the original Marvel streaming content that was found on Netflix, the upcoming Marvel content on Disney+ will continue the interlocking nature of the box office films that culminated in this summer’s blockbuster Avengers: Endgame. 

The original programming will be dribbled out over the coming quarters, but at launch Disney+ is expected to contain approximately 7,000 episodes of television series and 400 to 500 movies. According to Disney CEO Bob Iger, almost every single movie in the Disney catalog will eventually be available on the service. That is expected to pale in comparison to the sheer volume of content found on Netflix, which according to Ampere Analysis will be roughly eight times bigger than Disney+’s launch lineup. That may help explain the initial price point for Disney+ but what the service has going for it is it will be the only place one can find some of the biggest franchises in entertainment. That’s very much a page out of the Disney park playbook, and the odds are certainly high that Disney will leverage the content found on Disney+ across its merchandising and park businesses. It was also revealed that Disney and Target (TGT) will partner to open Disney shops inside Target locations, which should only add to the Disney merchandizing business. 

The looming question is to what degree will Disney+ attract subscribers? A far better sense will be had once the service goes live, but that hasn’t stopped Wall Street for putting forth expectations. Wedbush expects Disney to add between 10 million and 15 million subscribers to its service each year until they reach around 45 million. For context, that compares to roughly 60 million Netflix US subscribers and other firms are calling for a faster sign-up rate at Disney+ given the combination of cost and content. 

  • With details surrounding Disney+ becoming clearer, we are boosting our price target on Walt Disney (DIS) shares to $150 from $125. As subscriber data for Disney+ is shared, we’ll continue to refine our price target. 


What to watch this week

On the corporate earnings front this week, the parade of retail earnings will continue with J.Jill (JILL), Chico’s FAS (CHS), Tiffany & Co. (TIF), Best Buy (BBY), Ulta Beauty (ULTA), and Dollar Tree (DLTR) on tap to report, among others. In each of those reports, I’ll be looking for signals relating to our Living the Life, Digital Lifestyle, Aging of the Population, and Middle-class Squeeze investing themes. 

Beyond that cohort, we also have Sanderson Farms (SAFM) reporting and it will be interesting to see what it says about the growing prevalence of meat alternatives that are part of our Cleaner Living investing theme. . Yesterday, Cleaner Living Index company Beyond Meat (BYND) announced it will start testing plant-based fried chicken with YUM Brand’s (YUM) KFC in Atlanta beginning today, August 27. In keeping with that theme, we’ll be comparing and contrasting results at Campbell Soup (CPG) and Hain Celestial (HAIN) given the shifting preference among consumers for healthier foods and snacks. 

Also this week, specialty contractor and one-time Digital Infrastructure Thematic Leader Dycom Industries (DY) will issue its quarterly results and guidance, both of which should offer a view on 5G network buildout for its key customers that include AT&T (T) and Verizon (VZ). Given that Nokia (NOK) shares on the Select List, this will be a report worth digging into.   

While the number of economic data release last week were relatively light, they did pack quite a punch and that continued today with the July Durable Orders Report. While its headline figure showed a better than expected increase, excluding transportation, aircraft and defense to focus on core capital goods the data revealed a 0.4% increase in July, which followed the 0.9% increase in June. Sucking some of the air out of that improvement, core capital goods shipments in July dropped 0.7%, which will weigh on September quarter GDP forecasts. Over the coming days, we’ll get several other pieces of economic July data including trade inventories and Personal Income & Spending reports. 

Coming off a better-than-expected July Retail Sales report, we expect investors will be closely watching the July Personal Income & Spending report to gauge the degree to which consumers can be counted on to power the economy in the second half of the year. In addition to the usual monthly economic data, this week will also bring us the second GDP estimate for the June quarter. As focused as some might be on that revision, we here at Tematica far more focused on what the continued slowdown in the current quarter means for the market and investors. 

Weekly Issue: Factors making the stock market melt up a head-scratcher

Weekly Issue: Factors making the stock market melt up a head-scratcher

Key points inside this issue

  • Our long-term price target on Disruptive Innovator leader Nokia (NOK) shares remains $8.50.
  • We will continue to be long-term shareholders with Disruptive Innovator Select List resident Universal Display (OLED). Given the improving outlooks, our near-term price target for OLED shares is getting lifted to $150 from $125, and I will revisit that target as we move through the balance of 2019.

 

Reading the latest from the Oracle of Omaha

Over the weekend, the Oracle of Omaha, Warren Buffett, released his annual letter to shareholders of Berkshire Hathaway (BRK.A). This letter has become a must-read among institutional and individual investors alike because it not only reveals changes in Berkshire’s top investment portfolio positions, but it also has contained ample comments on the economy and markets as well as an investing lesson or two.

Out of the gate, we learned that once again Team Buffett outperformed the major stock market indices in 2018. As Buffett got underway, he casually reminded readers to be buyers of “ably managed businesses, in whole or part, that possess favorable and durable economic characteristics” and to do so at sensible prices. While it may seem somewhat self-serving this sounds very much like our thematic investing strategy that looks to identify companies benefitting from structural economic, demographic, psychographic and technological changes at prices that offer commanding upside vs. potential downside.

In the past, Buffett has commented that stocks are akin to pieces of paper and it’s the businesses behind them that are the drivers of revenue and profits. It’s an idea we are very much in tune with as we view ourselves as buyers of thematically well-positioned business first, their shares second. No matter how attractive a stock’s price may be, if its business is troubled or facing thematic headwinds, it can be a tough pill to swallow.

As Buffett later noted, “On occasion, a ridiculously high purchase price for a given stock will cause a splendid business to become a poor investment — if not permanently, at least for a painfully long period.” I certainly agree with that statement because buying a stock at the wrong price can make for a painful experience. There are times, to be patient, but there are also times when the thesis behind owning a stock changes. In those times, it makes far more sense to cut bait in favor of better-positioned companies.

Buffett then shared that “prices are sky-high for businesses possessing decent long- term prospects,” which is something we’ve commented on several times in recent weeks as the stock market continued to melt up even as earnings expectations for the near term have moved lower. We’ll continue to take the advice of Buffett and focus on “calculating whether a portion of an attractive business is worth more than its market price,” for much like Buffett and his team work for Berkshire shareholders, Tematica and I work for you, our subscribers.

Mixed in among the rest of the letter are some on Buffett’s investing history, which is always an informative read, and a quick mention that “At Berkshire, we hope to invest significant sums across borders” and that it continues to “hope for an elephant-sized acquisition.” While I can’t speak to any acquisition, especially after the debacle that is now recognized as Kraft Heinz (KHC), the focus on investing across borders potentially speaks to our New Global Middle-class and Living the Life investing themes. Given Buffett’s style, I suspect Team Buffett is more likely to tap into the rising middle-class over luxury and travel.

Several times Buffett touched on his age, 88 years, as well as that of its key partner Charlie Munger, who is 95. There was no meaningful revelation on how they plan to transition the management team, but odds are that will be a topic of conversation, as will Kraft Heinz Co. (KHC) at the annual shareholder meeting that is scheduled for Saturday, May 4. More details on that can be found at the bottom of the 2018 shareholder letter.

If I had to describe the overall letter, it was a very solid one, but candidly not one of the more memorable ones. Perhaps that reflects 2018 as a whole, a year in which all major market indices fell into the red during the last quarter of the year, and a current environment that is characterized by slowing global growth.

 

More signs that the domestic economy is a-slowin’

In recent issues of Tematica Investing and in the recent Context & Perspectives pieces penned by Tematica’s Chief Macro Strategist Lenore Hawkins, we’ve shared how even though the U.S. economy looks like the best one on the global block, it is showing signs of slowing. We had further confirmation of that in the recent December Retail Sales Report as well as the January Industrial Production data that showed a drop in manufacturing activity. The December Durable Orders report that showed orders for non-defense capital goods excluding aircraft dropped 0.7% added further confirmation. Moreover, the report showed a downward November revision for the category to a fall of 1.0% vs. the prior 0.6% decline.

Much the way we focus on the order data inside the monthly ISM and IHS Markit PMI reports, the order data contained inside the monthly Durable Orders report gives us a sense of what is likely to come in near-term. These declining orders combined with the January declines in Industrial Production suggest slack is growing in the manufacturing economy, which means orders for new production equipment are likely to remain soft in the near-term. 

This past Monday we received another set of data that point to a slowing U.S. economy. We learned the Chicago Fed National Activity Index (CFNAI) fell to -0.43 in January from +0.05 in December. This index tracks 85 indicators; we’d note that in January, 35 of those indicators made positive contributions to the index, but that 50 made negative contributions, which produced the month-over-month decline.

Before we get all nervous over that negative January reading for the CFNAI, periods of economic expansion have been associated with index values above -0.70, which means the economy continued to expand in January, just at a much slower pace compared to December. Should the CFNAI reading fall below -0.70 in February or another coming month, it would signal a contraction in the domestic economy.

In response, Buffett likely would say that he and the team will continue to manage the portfolio for the long term, and that’s very much in sync with our thematic investing time frame.

 

Watch those dividends… for increases and for cuts!

Ahead of Buffett’s shareholder letter, shares of Kraft Heinz (KHC) tumbled in a  pronounced manner following several announcements, one of which included the 35% cut in its quarterly dividend to $0.40 per share from $0.625 per share. That’s a huge disappointment given the commonplace expectation that a company is expected to pay its dividend in perpetuity. It can increase its dividend or from time to time declare a special dividend, but as we’ve seen time and time again, the cutting of a company’s dividend is a disaster its stock price. We’ve seen this when General Motors (GM) and General Electric (GE) cut their respective dividends and again last week when Kraft made a similar announcement.

Those three are rather high profile and well-owned stocks, but they aren’t the only ones that have cut quarterly dividend payments to their shareholders. In December, L Brands (LB), the company behind Victoria’s Secret and Bath & Body Works, clipped its annual dividend by 50% to $1.20 per share from $2.40 per share and its shares dropped from $35 to $24 before rebounding modestly. On the company’s fourth-quarter earnings conference call, management of Century Link (CTL)  disclosed it would be cutting the telecom service provider’s annual dividend from $2.16 to $1.00 per share. Earlier this month, postal meter and office equipment company Pitney Bowes (PBI) declared a quarterly dividend of $0.05 per share, more than 73% fall from the prior dividend of $0.1875 per share. Other dividend cuts in recent weeks were had at Owens & Minor (OMI), Manning & Napier (MN), Unique Fabricating (UFAB), County Bancorp (ICBK), and Fresh Del Monte (FDP).

What the majority of these dividend cuts have in common is a challenged business, and in some cases like that for Pitney Bowes, the management team and Board have opted to carve out a new path for its capital allocation policy. For Pitney, it means shifting the mix to favor its share buyback program over dividends given the additional $100 million authorization that was announced which upsized its program to $121 million.

As I see it, there are several lessons to be had from these dividends:

One, outsized dividend yields as was the case back in September with L Brands can signal an opportunity for dividend income-seeking investors, but it can also represent a warning sign as investors exit shares in businesses that look to have operating and/or cash flow pressures.

This means that Two, we as investors always need to do the homework to determine what the prospects for the company’s business. As we discussed above, Buffett’s latest shareholder letter reminds investors to be buyers of “ably-managed businesses, in whole or part, that possess favorable and durable economic characteristics” and to do so at sensible prices. Through our thematic lens, it’s no surprise that L Brands and Pitney Bowes are hitting the headwinds of our Digital Lifestyle investing theme, while Kraft Heinz is in the grips of the consumer shift to Cleaner Living. Perhaps Kraft should have focused on something other than cost cuts to grow its bottom line.

Third, investors make mistakes and as we saw with the plummet in the share price at Kraft Heinz, it can happen to Buffett as well. There’s no shame in making a mistake, so long as we can learn from it.

Fourth and perhaps most important, while some may look at the growing number of dividend cuts on a company by company basis, if we look at them in aggregate the pace is greater than the number of such cuts, we saw in all of 2018. While we try not to overly excited one way or another, the pace of dividend cuts is likely to spur questions over the economy and where we are in the business cycle.

 

Putting it all together

As we move into March, more than 90% of the S&P 500 group of companies will have reported their quarterly results. As those results have been increasingly tallied over the last few weeks, we’ve seen EPS expectations move lower for the coming quarters and as of Friday’ stock market close the consensus view is 2019 EPS growth for the S&P 500 will be around 4.7%. That is significantly lower than the more than 11% EPS growth that was forecasted back at the start of the December quarter.

For those keeping score, the consensus for the current quarter points to a 2% growth rate. However, we’re starting to see more analysts cut their outlooks as more figures are reported. For example, JPMorgan (JPM) now sees the current quarter clocking in at 1.5% due to slower business investment spending. For now, JP sees a pick-up in the June quarter to a 2.25% forecast. But in our view, this will hinge on what we see in the coming order data.

Putting it all together, we have a slowing economy, EPS cuts that are making the stock market incrementally more expensive as has moved higher over the last 9 weeks, marking one of the best runs it has had in more than 20 years, and a growing number of dividend cuts. Sounds like a disconnect in the making to me.

Clearly, the stock market has been melting up over the last several weeks on increasing hopes over a favorable trade deal with China, but as I’ve been saying for some time, measuring the success of any trade agreement will hinge on the details. Should it fail to live up to expectations, which is a distinct possibility, we could very well see a “buy the rumor, sell the news” situation arise in the stock market.

We will continue to tread carefully in the near-term, especially given the likelihood that following the disappointing December Retail Sales report and consumer-facing data, retailers are likely to deliver underwhelming quarterly results. Despite favorable weather in December, we saw that yesterday with Home Depot (HD),  and historically it’s been a pretty good yardstick for the consumer. In all likelihood as the remaining 10% of the S&P 500 companies report, we’re going to see further negative revisions to that current 4.7% EPS growth rate for this year I talked about.

 

Tematica Investing

A few paragraphs above, I touched on the strength of the stock market thus far in 2019, and even though concerns are mounting, we have seen pronounced moves higher in a number of the Thematic Leaders as you can see in the chart below. We’ll continue to monitor the changing landscapes and what they may bring. For example, in the coming weeks both Apple and Disney (DIS) are expected to unveil their respective streaming services, and I’ll be listening closely for to determine what this means for Digital Lifestyle leader Netflix (NFLX).

Nokia and Mobile World Congress 2019

We are two days into Mobile World Congress 2019, arguably THE mobile industry event of the year and one to watch for our Digital Lifestyle, Digital Infrastructure, and Disruptive Innovator themes. Thus far, we’ve received a number of different device and network announcements from the event.

On the device side, more 5G capable handsets have been announced as well as a number of foldable smartphones that appear to be a hybrid between a large format smartphone and a tablet. Those foldable smartphones are sporting some hefty price tags as evidenced by the $2,600 one for Huawei’s model. Interesting, but given the size of the device as well as the price point, one has to question if this is a commercially viable product or simply a concept one. Given the pushback that we are seeing with big-ticket smartphones that is resulting in consumers not upgrading their smartphones as quickly as they have in the past, odds are some of these device announcements fall more into the concept category.

On the network side, the news to center on comes from Verizon (VZ), which said it expects to have its 5G network in 30 U.S. cities by the end of 2019. That’s hardly what one would call a vibrant, national 5G network, and makes those commercial 5G launches really a 2020 event for the mobile carriers and consumers. It does mean that over the next several quarters, those mobile operators will continue to build out their 5G networks, which is positive for our shares of Nokia (NOK). As the 5G buildout moves beyond the U.S. into Europe and Asia, this tailwind bodes rather well for the company and helps back its longer-term targets. 

This 5G timetable was also confirmed by comments from Intel (INTC) about the timing of 5G chipsets, which are now expected to be available by the end of 2019 and are not likely to hit devices until 2020. Given the timing of CES in early January and the Mobile World Congress 2020 in February, odds are it means we will see a number of device announcements in early 2020 that will hit shelves in the second half of the year. Many have been wondering when Apple (AAPL) will have a 5G powered iPhone, and based on the various chipset and network comments, odds are the first time we’ll hear about such a device is September-October 2020. 

If history is to be repeated, we are likely to see something similar to what we saw with the first 3G and 4G handsets. By that, we mean a poor consumer experience at least until the 5G networks are truly national in scale and the chipsets become more efficient. One of the issues with each additional layer of mobile technology is it requires additional radio frequency (RF) chips, which in turn not only consume more power but also present internal design issues that out of the gate could limit the size of the battery. Generally speaking, early versions of these new smartphones tend to have less than desirable up-times. This is another reason to think Apple will not be one of those out of the gate 5G smartphone companies, but rather it will repeat its past strategy of bringing its product to market at the tipping point for the chipsets and network deployments. 

Circling back to our Nokia shares, while there are just over a handful of 5G smartphones that have been announced, some of which are expected to become available later this year, over the coming 18 months we will see a far greater number of 5G devices. This should drive Nokia’s high margin, IP licensing business in the coming quarters. As this occurs, Nokia’s mobile infrastructure should continue to benefit from the growing number of 5G networks being built out, not only here in the US but elsewhere as well.

  • Our long-term price target on Disruptive Innovator leader Nokia (NOK) shares remains $8.50

 

Universal Display shares get lit up

Last week I previewed the upcoming earnings report from Select List resident Universal Display (OLED) and following that news the shares were off with a bang! Universal posted earnings of $0.40 per share, $0.08 per share better than the consensus expectations, on revenue that matched the Wall Street consensus of $70 million. Considering the tone of the smartphone market, I view the company’s quarterly results as “not as bad a feared” and, no surprise, the guidance reflects the continued adoption of organic light-emitting displays across a growing number of devices and vendors. For the current year, Universal has guided revenue to $325 million-$350 million, which is likely to be a step function higher as we move through the coming quarters reflecting the traditional year-end debut of new smartphones, TVs and other devices.

Longer-term, we know Apple (AAPL) and others are looking to migrate more of their product portfolios to organic light-emitting diode displays. This shift will drive capacity increases in the coming several quarters — and recent reports on China’s next round of display investing seems to confirm this happening per its latest Five-Year Plan. As we have seen in the past, this can lead to periods of oversupply and pricing issues for the displays, but the longer-term path as witnessed with light-emitting diodes (LEDs) is one of greater adoption. 

As display pricing improves as capacity grows, new applications for the technology tend to arise. Remember that while we are focused on smartphones and TVs in the near-term, other applications include automotive lighting and general lighting. Again, just like we saw with LEDs.

  • We will continue to be long-term shareholders with Disruptive Innovator Select List resident Universal Display (OLED). Given the improving outlooks, our near-term price target for OLED shares is getting lifted to $150 from $125, and I will revisit that target as we move through the balance of 2019.

 

 

Weekly Issue: Favorable signposts have us adding a call option position

Weekly Issue: Favorable signposts have us adding a call option position

Key points inside this issue

  • We will continue to be long-term shareholders with Disruptive Innovator Select List resident Universal Display (OLED). Given the improving outlooks, our near-term price target for OLED shares is getting lifted to $150 from $125, and I will revisit that target as we move through the balance of 2019.
  • We are issuing a Buy on and adding the Nokia Corp. (NOK) December 2019 7.00 calls (NOK191220C0000700) that closed last night at 0.38 to the Options+ Select List with 0.20 stop loss.
  • We will continue to hold the Del Frisco’s Restaurant Group (DFRG) September 20, 2019, 10.00 calls (DFRG190920C00010000) that closed last night at 1.00, but we will boost our stop loss to 0.80, which will ensure a minimum return of 33% based on our 0.60 entry point.

 

Reading the latest from the Oracle of Omaha

Over the weekend, the Oracle of Omaha, Warren Buffett, released his annual letter to shareholders of Berkshire Hathaway (BRK.A). This letter has become a must-read among institutional and individual investors alike because it not only reveals changes in Berkshire’s top investment portfolio positions, but it also has contained ample comments on the economy and markets as well as an investing lesson or two.

Out of the gate, we learned that once again Team Buffett outperformed the major stock market indices in 2018. As Buffett got underway, he casually reminded readers to be buyers of “ably managed businesses, in whole or part, that possess favorable and durable economic characteristics” and to do so at sensible prices. While it may seem somewhat self-serving this sounds very much like our thematic investing strategy that looks to identify companies benefitting from structural economic, demographic, psychographic and technological changes at prices that offer commanding upside vs. potential downside.

In the past, Buffett has commented that stocks are akin to pieces of paper and it’s the businesses behind them that are the drivers of revenue and profits. It’s an idea we are very much in tune with as we view ourselves as buyers of thematically well-positioned business first, their shares second. No matter how attractive a stock’s price may be, if its business is troubled or facing thematic headwinds, it can be a tough pill to swallow.

As Buffett later noted, “On occasion, a ridiculously high purchase price for a given stock will cause a splendid business to become a poor investment — if not permanently, at least for a painfully long period.” I certainly agree with that statement because buying a stock at the wrong price can make for a painful experience. There are times, to be patient, but there are also times when the thesis behind owning a stock changes. In those times, it makes far more sense to cut bait in favor of better-positioned companies.

Buffett then shared that “prices are sky-high for businesses possessing decent long- term prospects,” which is something we’ve commented on several times in recent weeks as the stock market continued to melt up even as earnings expectations for the near term have moved lower. We’ll continue to take the advice of Buffett and focus on “calculating whether a portion of an attractive business is worth more than its market price,” for much like Buffett and his team work for Berkshire shareholders, Tematica and I work for you, our subscribers.

Mixed in among the rest of the letter are some on Buffett’s investing history, which is always an informative read, and a quick mention that “At Berkshire, we hope to invest significant sums across borders” and that it continues to “hope for an elephant-sized acquisition.” While I can’t speak to any acquisition, especially after the debacle that is now recognized as Kraft Heinz (KHC), the focus on investing across borders potentially speaks to our New Global Middle-class and Living the Life investing themes. Given Buffett’s style, I suspect Team Buffett is more likely to tap into the rising middle-class over luxury and travel.

Several times Buffett touched on his age, 88 years, as well as that of its key partner Charlie Munger, who is 95. There was no meaningful revelation on how they plan to transition the management team, but odds are that will be a topic of conversation, as will Kraft Heinz Co. (KHC) at the annual shareholder meeting that is scheduled for Saturday, May 4. More details on that can be found at the bottom of the 2018 shareholder letter.

If I had to describe the overall letter, it was a very solid one, but candidly not one of the more memorable ones. Perhaps that reflects 2018 as a whole, a year in which all major market indices fell into the red during the last quarter of the year, and a current environment that is characterized by slowing global growth.

 

More signs that the domestic economy is a-slowin’

In recent issues of Tematica Investing and in the recent Context & Perspectives pieces penned by Tematica’s Chief Macro Strategist Lenore Hawkins, we’ve shared how even though the U.S. economy looks like the best one on the global block, it is showing signs of slowing. We had further confirmation of that in the recent December Retail Sales Report as well as the January Industrial Production data that showed a drop in manufacturing activity. The December Durable Orders report that showed orders for non-defense capital goods excluding aircraft dropped 0.7% added further confirmation. Moreover, the report showed a downward November revision for the category to a fall of 1.0% vs. the prior 0.6% decline.

Much the way we focus on the order data inside the monthly ISM and IHS Markit PMI reports, the order data contained inside the monthly Durable Orders report gives us a sense of what is likely to come in near-term. These declining orders combined with the January declines in Industrial Production suggest slack is growing in the manufacturing economy, which means orders for new production equipment are likely to remain soft in the near-term. 

This past Monday we received another set of data that point to a slowing U.S. economy. We learned the Chicago Fed National Activity Index (CFNAI) fell to -0.43 in January from +0.05 in December. This index tracks 85 indicators; we’d note that in January, 35 of those indicators made positive contributions to the index, but that 50 made negative contributions, which produced the month-over-month decline.

Before we get all nervous over that negative January reading for the CFNAI, periods of economic expansion have been associated with index values above -0.70, which means the economy continued to expand in January, just at a much slower pace compared to December. Should the CFNAI reading fall below -0.70 in February or another coming month, it would signal a contraction in the domestic economy.

In response, Buffett likely would say that he and the team will continue to manage the portfolio for the long term, and that’s very much in sync with our thematic investing time frame.

 

Watch those dividends… for increases and for cuts!

Ahead of Buffett’s shareholder letter, shares of Kraft Heinz (KHC) tumbled in a  pronounced manner following several announcements, one of which included the 35% cut in its quarterly dividend to $0.40 per share from $0.625 per share. That’s a huge disappointment given the commonplace expectation that a company is expected to pay its dividend in perpetuity. It can increase its dividend or from time to time declare a special dividend, but as we’ve seen time and time again, the cutting of a company’s dividend is a disaster its stock price. We’ve seen this when General Motors (GM) and General Electric (GE) cut their respective dividends and again last week when Kraft made a similar announcement.

Those three are rather high profile and well-owned stocks, but they aren’t the only ones that have cut quarterly dividend payments to their shareholders. In December, L Brands (LB), the company behind Victoria’s Secret and Bath & Body Works, clipped its annual dividend by 50% to $1.20 per share from $2.40 per share and its shares dropped from $35 to $24 before rebounding modestly. On the company’s fourth-quarter earnings conference call, management of Century Link (CTL)  disclosed it would be cutting the telecom service provider’s annual dividend from $2.16 to $1.00 per share. Earlier this month, postal meter and office equipment company Pitney Bowes (PBI) declared a quarterly dividend of $0.05 per share, more than 73% fall from the prior dividend of $0.1875 per share. Other dividend cuts in recent weeks were had at Owens & Minor (OMI), Manning & Napier (MN), Unique Fabricating (UFAB), County Bancorp (ICBK), and Fresh Del Monte (FDP).

What the majority of these dividend cuts have in common is a challenged business, and in some cases like that for Pitney Bowes, the management team and Board have opted to carve out a new path for its capital allocation policy. For Pitney, it means shifting the mix to favor its share buyback program over dividends given the additional $100 million authorization that was announced which upsized its program to $121 million.

As I see it, there are several lessons to be had from these dividends:

One, outsized dividend yields as was the case back in September with L Brands can signal an opportunity for dividend income-seeking investors, but it can also represent a warning sign as investors exit shares in businesses that look to have operating and/or cash flow pressures.

This means that Two, we as investors always need to do the homework to determine what the prospects for the company’s business. As we discussed above, Buffett’s latest shareholder letter reminds investors to be buyers of “ably-managed businesses, in whole or part, that possess favorable and durable economic characteristics” and to do so at sensible prices. Through our thematic lens, it’s no surprise that L Brands and Pitney Bowes are hitting the headwinds of our Digital Lifestyle investing theme, while Kraft Heinz is in the grips of the consumer shift to Cleaner Living. Perhaps Kraft should have focused on something other than cost cuts to grow its bottom line.

Third, investors make mistakes and as we saw with the plummet in the share price at Kraft Heinz, it can happen to Buffett as well. There’s no shame in making a mistake, so long as we can learn from it.

Fourth and perhaps most important, while some may look at the growing number of dividend cuts on a company by company basis, if we look at them in aggregate the pace is greater than the number of such cuts, we saw in all of 2018. While we try not to overly excited one way or another, the pace of dividend cuts is likely to spur questions over the economy and where we are in the business cycle.

 

Putting it all together

As we move into March, more than 90% of the S&P 500 group of companies will have reported their quarterly results. As those results have been increasingly tallied over the last few weeks, we’ve seen EPS expectations move lower for the coming quarters and as of Friday’ stock market close the consensus view is 2019 EPS growth for the S&P 500 will be around 4.7%. That is significantly lower than the more than 11% EPS growth that was forecasted back at the start of the December quarter.

For those keeping score, the consensus for the current quarter points to a 2% growth rate. However, we’re starting to see more analysts cut their outlooks as more figures are reported. For example, JPMorgan (JPM) now sees the current quarter clocking in at 1.5% due to slower business investment spending. For now, JP sees a pick-up in the June quarter to a 2.25% forecast. But in our view, this will hinge on what we see in the coming order data.

Putting it all together, we have a slowing economy, EPS cuts that are making the stock market incrementally more expensive as has moved higher over the last 9 weeks, marking one of the best runs it has had in more than 20 years, and a growing number of dividend cuts. Sounds like a disconnect in the making to me.

Clearly, the stock market has been melting up over the last several weeks on increasing hopes over a favorable trade deal with China, but as I’ve been saying for some time, measuring the success of any trade agreement will hinge on the details. Should it fail to live up to expectations, which is a distinct possibility, we could very well see a “buy the rumor, sell the news” situation arise in the stock market.

We will continue to tread carefully in the near-term, especially given the likelihood that following the disappointing December Retail Sales report and consumer-facing data, retailers are likely to deliver underwhelming quarterly results. Despite favorable weather in December, we saw that yesterday with Home Depot (HD),  and historically it’s been a pretty good yardstick for the consumer. In all likelihood as the remaining 10% of the S&P 500 companies report, we’re going to see further negative revisions to that current 4.7% EPS growth rate for this year I talked about.

 

Tematica Investing

A few paragraphs above, I touched on the strength of the stock market thus far in 2019, and even though concerns are mounting, we have seen pronounced moves higher in a number of the Thematic Leaders as you can see in the chart below. We’ll continue to monitor the changing landscapes and what they may bring. For example, in the coming weeks both Apple and Disney (DIS) are expected to unveil their respective streaming services, and I’ll be listening closely for to determine what this means for Digital Lifestyle leader Netflix (NFLX).

Nokia and Mobile World Congress 2019

We are two days into Mobile World Congress 2019, arguably THE mobile industry event of the year and one to watch for our Digital Lifestyle, Digital Infrastructure, and Disruptive Innovator themes. Thus far, we’ve received a number of different device and network announcements from the event.

On the device side, more 5G capable handsets have been announced as well as a number of foldable smartphones that appear to be a hybrid between a large format smartphone and a tablet. Those foldable smartphones are sporting some hefty price tags as evidenced by the $2,600 one for Huawei’s model. Interesting, but given the size of the device as well as the price point, one has to question if this is a commercially viable product or simply a concept one. Given the pushback that we are seeing with big-ticket smartphones that is resulting in consumers not upgrading their smartphones as quickly as they have in the past, odds are some of these device announcements fall more into the concept category.

On the network side, the news to center on comes from Verizon (VZ), which said it expects to have its 5G network in 30 U.S. cities by the end of 2019. That’s hardly what one would call a vibrant, national 5G network, and makes those commercial 5G launches really a 2020 event for the mobile carriers and consumers. It does mean that over the next several quarters, those mobile operators will continue to build out their 5G networks, which is positive for our shares of Nokia (NOK). As the 5G buildout moves beyond the U.S. into Europe and Asia, this tailwind bodes rather well for the company and helps back its longer-term targets. 

This 5G timetable was also confirmed by comments from Intel (INTC) about the timing of 5G chipsets, which are now expected to be available by the end of 2019 and are not likely to hit devices until 2020. Given the timing of CES in early January and the Mobile World Congress 2020 in February, odds are it means we will see a number of device announcements in early 2020 that will hit shelves in the second half of the year. Many have been wondering when Apple (AAPL) will have a 5G powered iPhone, and based on the various chipset and network comments, odds are the first time we’ll hear about such a device is September-October 2020. 

If history is to be repeated, we are likely to see something similar to what we saw with the first 3G and 4G handsets. By that, we mean a poor consumer experience at least until the 5G networks are truly national in scale and the chipsets become more efficient. One of the issues with each additional layer of mobile technology is it requires additional radio frequency (RF) chips, which in turn not only consume more power but also present internal design issues that out of the gate could limit the size of the battery. Generally speaking, early versions of these new smartphones tend to have less than desirable up-times. This is another reason to think Apple will not be one of those out of the gate 5G smartphone companies, but rather it will repeat its past strategy of bringing its product to market at the tipping point for the chipsets and network deployments. 

Circling back to our Nokia shares, while there are just over a handful of 5G smartphones that have been announced, some of which are expected to become available later this year, over the coming 18 months we will see a far greater number of 5G devices. This should drive Nokia’s high margin, IP licensing business in the coming quarters. As this occurs, Nokia’s mobile infrastructure should continue to benefit from the growing number of 5G networks being built out, not only here in the US but elsewhere as well.

  • Our long-term price target on Disruptive Innovator leader Nokia (NOK) shares remains $8.50

 

Universal Display shares get lit up

Last week I previewed the upcoming earnings report from Select List resident Universal Display (OLED) and following that news the shares were off with a bang! Universal posted earnings of $0.40 per share, $0.08 per share better than the consensus expectations, on revenue that matched the Wall Street consensus of $70 million. Considering the tone of the smartphone market, I view the company’s quarterly results as “not as bad a feared” and, no surprise, the guidance reflects the continued adoption of organic light-emitting displays across a growing number of devices and vendors. For the current year, Universal has guided revenue to $325 million-$350 million, which is likely to be a step function higher as we move through the coming quarters reflecting the traditional year-end debut of new smartphones, TVs and other devices.

Longer-term, we know Apple (AAPL) and others are looking to migrate more of their product portfolios to organic light-emitting diode displays. This shift will drive capacity increases in the coming several quarters — and recent reports on China’s next round of display investing seems to confirm this happening per its latest Five-Year Plan. As we have seen in the past, this can lead to periods of oversupply and pricing issues for the displays, but the longer-term path as witnessed with light-emitting diodes (LEDs) is one of greater adoption. 

As display pricing improves as capacity grows, new applications for the technology tend to arise. Remember that while we are focused on smartphones and TVs in the near-term, other applications include automotive lighting and general lighting. Again, just like we saw with LEDs.

  • We will continue to be long-term shareholders with Disruptive Innovator Select List resident Universal Display (OLED). Given the improving outlooks, our near-term price target for OLED shares is getting lifted to $150 from $125, and I will revisit that target as we move through the balance of 2019.

 

Tematica Options+

It would have been wonderful to have been long Universal Display (OLED) calls, but again given what we’ve heard in recent weeks about the tone of the smartphone market, its results were far more “not as bad as feared” and I suspect in the short-term drove a fair amount of short covering. I still like the long-term prospects for the adoption of the technology, and it’s something to watch as adoption heats up.

By comparison, after months of what seemed like modest forward progress coming out of Mobile World Congress, the pace of 5G is about to get into gear from both a device and network perspective. As we move through 2019, that pace is poised to accelerate even further, which should bring favorable operating leverage to both businesses tucked inside Nokia.

For that reason, I am adding the Nokia Corp. (NOK) December 2019 7.00 calls (NOK191220C0000700) that closed last night at 0.38 to the Options+ Select List. The duration should capture that expected swell in 5G activity, and as we move through the coming months, I’ll consider a layered strategy that could include adding 2020 calls to the mix. Given the time span, we’ll set a wider stop loss berth than usual at 0.20.

 

 

Weekly Issue: Streaming Services and the Middle Class Squeeze

Weekly Issue: Streaming Services and the Middle Class Squeeze

Key points inside this issue

  • Stocks continue to melt higher on hopes, but details will matter in the end
  • Our price target on Middle-Class Squeeze company Costco Wholesale (COST) remains $250.
  • Netflix: Mark your calendars for Apple and Disney events
  • Taking a look at LendingClub (LC) shares as consumer debt climbs

 

Sorry, we’re a day late with your weekly issue. I’m just back from InsideETFs 2019, the industry event for the exchange-traded (ETF) industry. This isn’t the first time I’ve attended the event, and attendees continue to hear about the uptake of ETFs, as well as the growing number of differentiated strategies to be had. Some, in my opinion, are faddish in nature, looking to capture assets even though their strategies may not be ones that survive more than a few years. We’ve got a long issue this week, so I’ll suffice to say that such ETFs are not thematic investing, but rather trend investing and we’re already starting to see several of those older trend products being repositioned to something else.

As we close out this week, we’ll be halfway through the first quarter of 2019. Hard to believe, as we have yet to go through the swarm earnings reports from retailers, but it’s true. Given what appears to be the rollbacking of items that weighed on the stock market during the last few months of 2018, we’ve seen all the major stock market indices rebound hard, even though the global economy continues to slow. Once again, this has made the US the best house in the neighborhood, which has likely bid up assets and made the dollar a headwind to multinational companies in the process. As we are fonding of saying, the devil is in the details and that includes any would be progress on US-China trade and Congress with immigration reform. We remain cautiously optimistic, especially on the China trade front, but recognize that more time is likely to be needed until a Trump-sized “big deal” can be reached.

As we get set for the second half of the quarter, we here at Tematica will continue to not only watch the data and our Thematic Signals to assess what’s the next likely step for the market from here, but also the happenings in Washington on trade and infrastructure.

 

Tematica Investing

Odds are, the Thematic Leaders have seen some lift from the sharp rebound in the market thus far in 2019. As we can see in the chart above, several of them are going gangbusters, including Chipotle Mexican Grill (CMG), Netflix (NFLX), Alibaba (BABA) and Axon Enterprises (AXXN). This morning we’ll get the first Retail Sales report since before the federal government shutdown, and in my view, it will more than likely continue to show what it did during all of 2018 – digital shopping taking share and Middle-Class Squeeze leader Costco Warehouse (COST) continuing to win consumer wallet share.

On a reported basis, Costco’s January same-store sales rose 6.6% (7.3% excluding the impact of gasoline prices and foreign exchange). Exiting the month, Costco operated 768 warehouse locations vs. 746 this time last year, a 3% year over year, which reflects its stated path to open more locations in 2019, allowing for the steady growth of its high margin membership fee revenue stream. In my view, this lays the groundwork for a favorable earnings report from Costco on March 7, which is also when it will publish its February sales results.

  • Our price target on Middle-Class Squeeze company Costco Wholesale (COST) remains $250.

 

Netflix: Mark your calendars for Apple and Disney

While we have our calendars out and are marking them for that upcoming Costco date I mentioned early, let’s also circle March 25th, which is the rumored date of Apple’s next event. Per the Apple rumor mill, the company will not only showcase its new news subscription service (say that three times), but also unveil its video service as well. This video service falls into the category of one of the best, worst kept secrets, given the number of deals it has inked for original shows and movies. The news subscription service, which is expected to be called Apple News Magazines, comes after Apple acquired Texture, the would-be Netflix (NFLX) of magazines last year.

While we could see a new device or two, this event will be focused primarily on Apple’s Services business, which it is using to further its position inside our Digital Lifestyle investing theme.  Much like Proctor & Gamble’s (PG) Gillette razor blade business, I would not be surprised if Apple adopts a similar mindset with its devices being the razor that gets replaced periodically, while its far more profitable Services business is the one that people consume on a frequent basis.

Soon after Apple’s event, Disney will hold its annual Investor Day on April 11th at which it is expected to unveil its much discussed, but yet to be seen Disney streaming service dubbed Disney+. Given its robust library of films, content, and characters, Disney should not be underestimated on this front, and in my view much like Apple and its Services business, success with Disney+ could change the way Wall Street values DIS shares. Key items to watch will be the Disney+ price point, original content rollout, and subscriber growth.

Stepping back, if one were to argue that we are on the path to a crowd of streaming services between Netflix, Amazon (AMZN), Hulu, CBS, NBC, AT&T (T), and now Apple and Disney, I would have to agree. In many ways, we’re heading for cable-TV without the cable box, but on an ala carte basis. While we’ve argued that consumers will go to where there is great content, the more streaming services there are the more likely we see the proliferation of good or not so good content. The risk they run is that just like cable channels that need to be filled with content, so too will their streaming services. Also too, one unknown is how many services will a person subscribe to? Past a certain point, consumers will balk, especially if all they’ve succeeded in doing is replicating that high cable bill they sought to originally sought to escape.

Needless to say, I’ll be watching the unveiling and uptake of these new services from Apple and Disney with an eye for what it may mean for Digital Lifestyle company Netflix (NFLX). One interesting item to watch will be to see what is actually included in the Disney and Apple services at launch and over time. Both companies are rumored to be working on streaming gaming services as are Microsoft (MSFT) and Alphabet (GOOGL), which to date is something Netflix has resisted at least publicly. If Apple were to bundle a gaming, video and news service along with Apple Music into one digital content bundle, that would offer some consumer wallet leverage over other single, stand-alone services.

 

Taking a look at LendingClub shares

Earlier this week, Tematica’s Chief Macro Strategist Lenore Hawkins posted a Thematic Signal for our Middle-Class Squeeze investing theme following the news that a record 7 million Americans are 90 days or more behind on their auto loan payments. Lenore went on to show some additional data that consumer loans from banks are in contraction mode, which as we know is a sign the US economy is not going gangbusters.

What we are seeing is the consumer looking to get their financial house in order, most likely after ringing up credit card, auto loan and student debt over the last several quarters. A new report from LendingTree (TREE) points to total credit card debt having climbed to more than $1 trillion in under five years, with more people using personal loans to manage existing debt. This has led the amount owed on personal loans to double what it was five years ago and the number of outstanding loans to rise some 50% in the last three years. According to the report’s findings, managing existing debt was the most popular reason for a personal loan, representing 61% of all loan requests in 2018. Of that percentage, 39% of borrowers plan to use their loans to consolidate debt, while 22% planned to use it to refinance credit cards.

From a stock detective’s point of view, the question to ask is what company is poised to benefit from this aspect of our Middle-Class Squeeze investing theme?

One candidate is LendingClub (LC), which operates an online credit marketplace that connects borrowers and investors in the US. It went public a few years ago and was heralded as a disruptive business for consumers and businesses to obtain credit based on its digital product offering. That marketplace facilitates various types of loan products for consumers and small businesses, including unsecured personal loans, unsecured education and patient finance loans, auto refinance loans, and unsecured small business loans. The company also provides an opportunity to the investor to invest in a range of loans based on term and credit.

Last year 78% of its $575 million in revenue was derived from loan origination transaction fees derived from its platform’s role in accepting and deciding on applications on behalf of the company’s bank partners. More than 50 banks—ranging in total assets of less than $100 million to more than $100 billion—have taken advantage of LendingClub’s partnership program.

LendingClub’s second largest revenue stream is derived from investors fees, which include servicing fees for various services, including servicing and collection efforts and matching available loans with capital and management fees from investment funds and other managed accounts, gains on sales of whole loans, interest income earned and fair value gains/losses from loans held on the company’s balance sheet.

In the past LendingClub was tainted with uncertainty given several investigations, but in mid-December, it settled with the SEC and DOJ, with the SEC stating:

“The SEC’s Enforcement Division determined not to recommend charges against LendingClub Corporation, which promptly self-reported its executives’ misconduct following a review initiated by its board of directors, thoroughly remediated, and provided extraordinary cooperation with the agency’s investigation.”

The SEC’s comments are a positive affirmation of the company’s internal procedures and policies, which also helps reduce the potential negative impact from the still-remaining Federal Trade Commission complaint. The FTC’s complaint against LendingClub charged it has misled consumers and has been deducting hidden fees from loan proceeds issued to borrowers.

Those recent developments have improved the company’s risk profile at a time when its core business has been growing given Middle-Class Squeeze pains being felt by more consumers. According to data TransUnion, subprime personal loan balances have been climbing since 2014 and are forecast to increase 20% this year to a record $156.3 billion.

Here’s the thing, the year-end shopping season isn’t just for shopping,  it’s also the seasonally strongest time of year for subprime loan originations, which according to TransUnion rose to 5 million loans at the end of 2018. That sets up what is likely to be a favorable December quarter earnings report from LendingClub when it issues those results next week (Tuesday, Feb. 19). The thing is I continue to see far more upside to be had with Middle-Class Squeeze Thematic Leader Costco Wholesale, which is not only growing its very profitable membership fee income stream the company is also a dividend payer.

 

Weekly Issue: Another company poised to benefit from the Middle Class Squeeze

Weekly Issue: Another company poised to benefit from the Middle Class Squeeze

Key points inside this issue

Sorry, we’re a day late with your weekly issue. I’m just back from InsideETFs 2019, the industry event for the exchange-traded (ETF) industry. This isn’t the first time I’ve attended the event, and attendees continue to hear about the uptake of ETFs, as well as the growing number of differentiated strategies to be had. Some, in my opinion, are faddish in nature, looking to capture assets even though their strategies may not be ones that survive more than a few years. We’ve got a long issue this week, so I’ll suffice to say that such ETFs are not thematic investing, but rather trend investing and we’re already starting to see several of those older trend products being repositioned to something else.

As we close out this week, we’ll be halfway through the first quarter of 2019. Hard to believe, as we have yet to go through the swarm earnings reports from retailers, but it’s true. Given what appears to be the rollbacking of items that weighed on the stock market during the last few months of 2018, we’ve seen all the major stock market indices rebound hard, even though the global economy continues to slow. Once again, this has made the US the best house in the neighborhood, which has likely bid up assets and made the dollar a headwind to multinational companies in the process. As we are fonding of saying, the devil is in the details and that includes any would be progress on US-China trade and Congress with immigration reform. We remain cautiously optimistic, especially on the China trade front, but recognize that more time is likely to be needed until a Trump-sized “big deal” can be reached.

As we get set for the second half of the quarter, we here at Tematica will continue to not only watch the data and our Thematic Signals to assess what’s the next likely step for the market from here, but also the happenings in Washington on trade and infrastructure.

 

Tematica Investing

Odds are, the Thematic Leaders have seen some lift from the sharp rebound in the market thus far in 2019. As we can see in the chart above, several of them are going gangbusters, including Chipotle Mexican Grill (CMG), Netflix (NFLX), Alibaba (BABA) and Axon Enterprises (AXXN). This morning we’ll get the first Retail Sales report since before the federal government shutdown, and in my view, it will more than likely continue to show what it did during all of 2018 – digital shopping taking share and Middle-Class Squeeze leader Costco Warehouse (COST) continuing to win consumer wallet share.

On a reported basis, Costco’s January same-store sales rose 6.6% (7.3% excluding the impact of gasoline prices and foreign exchange). Exiting the month, Costco operated 768 warehouse locations vs. 746 this time last year, a 3% year over year, which reflects its stated path to open more locations in 2019, allowing for the steady growth of its high margin membership fee revenue stream. In my view, this lays the groundwork for a favorable earnings report from Costco on March 7, which is also when it will publish its February sales results.

  • Our price target on Middle-Class Squeeze company Costco Wholesale (COST) remains $250.

 

Netflix: Mark your calendars for Apple and Disney

While we have our calendars out and are marking them for that upcoming Costco date I mentioned early, let’s also circle March 25th, which is the rumored date of Apple’s next event. Per the Apple rumor mill, the company will not only showcase its new news subscription service (say that three times), but also unveil its video service as well. This video service falls into the category of one of the best, worst kept secrets, given the number of deals it has inked for original shows and movies. The news subscription service, which is expected to be called Apple News Magazines, comes after Apple acquired Texture, the would-be Netflix (NFLX) of magazines last year.

While we could see a new device or two, this event will be focused primarily on Apple’s Services business, which it is using to further its position inside our Digital Lifestyle investing theme.  Much like Proctor & Gamble’s (PG) Gillette razor blade business, I would not be surprised if Apple adopts a similar mindset with its devices being the razor that gets replaced periodically, while its far more profitable Services business is the one that people consume on a frequent basis.

Soon after Apple’s event, Disney will hold its annual Investor Day on April 11th at which it is expected to unveil its much discussed, but yet to be seen Disney streaming service dubbed Disney+. Given its robust library of films, content, and characters, Disney should not be underestimated on this front, and in my view much like Apple and its Services business, success with Disney+ could change the way Wall Street values DIS shares. Key items to watch will be the Disney+ price point, original content rollout, and subscriber growth.

Stepping back, if one were to argue that we are on the path to a crowd of streaming services between Netflix, Amazon (AMZN), Hulu, CBS, NBC, AT&T (T), and now Apple and Disney, I would have to agree. In many ways, we’re heading for cable-TV without the cable box, but on an ala carte basis. While we’ve argued that consumers will go to where there is great content, the more streaming services there are the more likely we see the proliferation of good or not so good content. The risk they run is that just like cable channels that need to be filled with content, so too will their streaming services. Also too, one unknown is how many services will a person subscribe to? Past a certain point, consumers will balk, especially if all they’ve succeeded in doing is replicating that high cable bill they sought to originally sought to escape.

Needless to say, I’ll be watching the unveiling and uptake of these new services from Apple and Disney with an eye for what it may mean for Digital Lifestyle company Netflix (NFLX). One interesting item to watch will be to see what is actually included in the Disney and Apple services at launch and over time. Both companies are rumored to be working on streaming gaming services as are Microsoft (MSFT) and Alphabet (GOOGL), which to date is something Netflix has resisted at least publicly. If Apple were to bundle a gaming, video and news service along with Apple Music into one digital content bundle, that would offer some consumer wallet leverage over other single, stand-alone services.

 

Taking a look at LendingClub shares

Earlier this week, Tematica’s Chief Macro Strategist Lenore Hawkins posted a Thematic Signal for our Middle-Class Squeeze investing theme following the news that a record 7 million Americans are 90 days or more behind on their auto loan payments. Lenore went on to show some additional data that consumer loans from banks are in contraction mode, which as we know is a sign the US economy is not going gangbusters.

What we are seeing is the consumer looking to get their financial house in order, most likely after ringing up credit card, auto loan and student debt over the last several quarters. A new report from LendingTree (TREE) points to total credit card debt having climbed to more than $1 trillion in under five years, with more people using personal loans to manage existing debt. This has led the amount owed on personal loans to double what it was five years ago and the number of outstanding loans to rise some 50% in the last three years. According to the report’s findings, managing existing debt was the most popular reason for a personal loan, representing 61% of all loan requests in 2018. Of that percentage, 39% of borrowers plan to use their loans to consolidate debt, while 22% planned to use it to refinance credit cards.

From a stock detective’s point of view, the question to ask is what company is poised to benefit from this aspect of our Middle-Class Squeeze investing theme?

One candidate is LendingClub (LC), which operates an online credit marketplace that connects borrowers and investors in the US. It went public a few years ago and was heralded as a disruptive business for consumers and businesses to obtain credit based on its digital product offering. That marketplace facilitates various types of loan products for consumers and small businesses, including unsecured personal loans, unsecured education and patient finance loans, auto refinance loans, and unsecured small business loans. The company also provides an opportunity to the investor to invest in a range of loans based on term and credit.

Last year 78% of its $575 million in revenue was derived from loan origination transaction fees derived from its platform’s role in accepting and deciding on applications on behalf of the company’s bank partners. More than 50 banks—ranging in total assets of less than $100 million to more than $100 billion—have taken advantage of LendingClub’s partnership program.

LendingClub’s second largest revenue stream is derived from investors fees, which include servicing fees for various services, including servicing and collection efforts and matching available loans with capital and management fees from investment funds and other managed accounts, gains on sales of whole loans, interest income earned and fair value gains/losses from loans held on the company’s balance sheet.

In the past LendingClub was tainted with uncertainty given several investigations, but in mid-December, it settled with the SEC and DOJ, with the SEC stating:

“The SEC’s Enforcement Division determined not to recommend charges against LendingClub Corporation, which promptly self-reported its executives’ misconduct following a review initiated by its board of directors, thoroughly remediated, and provided extraordinary cooperation with the agency’s investigation.”

The SEC’s comments are a positive affirmation of the company’s internal procedures and policies, which also helps reduce the potential negative impact from the still-remaining Federal Trade Commission complaint. The FTC’s complaint against LendingClub charged it has misled consumers and has been deducting hidden fees from loan proceeds issued to borrowers.

Those recent developments have improved the company’s risk profile at a time when its core business has been growing given Middle-class Squeeze pains being felt by more consumers. According to data TransUnion, subprime personal loan balances have been climbing since 2014 and are forecast to increase 20% this year to a record $156.3 billion.

Here’s the thing, the year-end shopping season isn’t just for shopping,  it’s also the seasonally strongest time of year for subprime loan originations, which according to TransUnion rose to 5 million loans at the end of 2018. That sets up what is likely to be a favorable December quarter earnings report from LendingClub when it issues those results next week (Tuesday, Feb. 19). The thing is I continue to see far more upside to be had with Middle-Class Squeeze Thematic Leader Costco Wholesale, which is not only growing its very profitable membership fee income stream the company is also a a dividend payer.

 

Tematica Options+

 

Adding a call option play on Lending Club

While we aren’t adding Lending Club shares to the Thematic Leaders, we will look to capitalize on the opportunity ahead of the company’s December quarter earnings report by adding the Lending Club (LC) March 2019 4.00 calls (LC 190315C0000400)that closed last night at 0.10. Given the tight trading pattern of these calls, I’m not recommending a stop loss level just yet, but as they trend higher I plan to do so.

 

Boosting the stop loss on our Del Frisco’s calls

The September 2019 10.00 calls for Del Frisco’s Restaurant Group (DFRG) calls that we added last week climbed more than 58% over the last several trading sessions. While we’ll continue to hold these calls as Del Frisco’s continues to review potential takeout bids, we will boost our stop loss on the calls from 0.30 to 0.60, which also happens to be our entry point.

 

A live concert in Fortnite shows why Netflix is right to be worried

A live concert in Fortnite shows why Netflix is right to be worried

We recently published a Thematic Signal in which we discussed the comment from Netflix management why it isn’t so worried about HBO, but rather Fortnite. If there was any doubt it was put to rest in the form a recent live concert held inside Fortnite that drew “25 times as many people that attended Woodstock in 1969.”

According to reports, that four-day music event that spanned August 15-18, 1969 in the Catskill Mountains attracted more than 400,000 people. Some simple math suggests the live concert in Fortnite attracted roughly 10 million people.

10 million!

Watching a concert inside a game!

What were those 10 million people not doing?

Watching Netflix, HBO, Hulu or another streaming video service.

Yes, Netflix is right to be worried over competitive streaming services that take eyeballs away from its content.

This makes the much-rumored streaming gaming services from Apple, Amazon, Google, and Microsoft even more interesting as it could alter the Digital LIfestyle market shares and make for an even more challenging landscape for the existing video streaming services as well as those that are forthcoming from Disney, NBC, and Apple.

 

The wildly popular video game “Fortnite” made history yesterday with a live show by EDM artist Marshmello that reportedly drew millions of viewers — which, for context, would be 25 times as many people as attended Woodstock in 1969.

“It truly felt like a glimpse into the future of interactive entertainment,” wrote Nick Statt for The Verge, “where the worlds of gaming, music, and celebrity combined to create a virtual experience we’ve never quite seen before.

Source: Live Concert Inside “Fortnite” Drew More Viewers Than Woodstock

Tematica Investing: Thematic Tailwinds for 2019 and Scaling into AXON

Tematica Investing: Thematic Tailwinds for 2019 and Scaling into AXON

 

Key Points Inside this Issue:

Last Friday’s favorable December Employment Report showed the domestic economy is not falling off a cliff and comments by Fed Chair Jay Powell reflected that the central bank will be patient with monetary policy as it watches how the economy performs. Those two things kicked the market off on its most recent three-day winning streak as of last night’s close. In many ways, Powell gave the market what it was looking for when he shared the Fed will remain data dependent when it looks at the economy and its next step with monetary policy.

Taking a few steps back, we’ve all experienced the market volatility over the last several weeks as it contends with a host of issues that we here at Tematica have laid out through much of the December quarter. These include:

  • U.S.-China trade issues
  • The slowing economy
  • A Fed that could boost rates twice in 2019 and continues to unwind its balance sheet
  • Brexit and political uncertainty in the Eurozone
  • And more recently the government shutdown.

These factors have led investors to question growth prospects for the global as well as the domestic economy and earnings in 2019.

Powell’s comments potentially take one of those issues off the table at least in the short-term. If the economy continues to deliver job creation as we saw in December, with some of the best year-over-year wage gains we’ve seen in years, before too long the Fed-related conversation could very well turn from two rate hikes to three.

Currently, that isn’t what the market is expecting.

The reason it isn’t is that outside of the December jobs report, data from ISM and IHS Markit continued to show a decelerating global and U.S. economy. With new orders and backlog levels falling, as well as pricing-related data, it likely means we won’t see a pronounced pickup in the January data. The JPMorgan Global Composite Output Index for December delivered its lowest reading since September 2016 due principally to the slowdown in the eurozone. Rates of expansion slowed in Germany (66-month low) and Spain (three-month low), while Italy stagnated. China, the UK, and Brazil all saw modest growth accelerations.

 

Despite the month over month declines in the December data for the US, it was the best performer on a relative basis even though the IHS Markit Composite PMI reading for the month hit a 15-month low. A more sobering view was shared by Chris Williamson, Chief Business Economist at IHS Markit who said:

“Manufacturers reported a weakened pace of expansion at the end of 2018, and grew less upbeat about prospects for 2019. Output and order books grew at the slowest rates for over a year and optimism about the outlook slumped to its gloomiest for over two years.”

That should give the Fed some room to hold off boosting rates, but it also confirms the economy is decelerating, which will likely have revenue and earnings guidance repercussions in the upcoming December-quarter earnings season.

There are several catalysts that could drive both the economy and the stock market higher in the coming months. These include a “good deal” resolution to the U.S.-China trade situation and forward movement in Washington on infrastructure spending. This week, the US and China have met on trade and it appears those conversations have paved the way for further discussions in the coming weeks. A modest positive that has helped drive the stock market higher this week, but thus far concrete details remain scant.

Such details are not likely to emerge for at least several weeks, which means the next major catalyst for the stock market will be the upcoming December quarter earnings season that begins in nine trading days.

 

Earnings expectations are being revised lower

Facing a number of risks and uncertainties over the last several weeks, investors have once again questioned growth prospects for both the economy and earnings growth for 2019. The following two charts – one of the Citibank Economic Surprise Index and one showing the aggregate profit margin for the S&P 500 companies – depict what investors are grappling with weaker than expected economic data at a time when corporate operating margins have hit the highest levels in over 20 years.

While expectations for growth in both the domestic economy and earnings for the S&P 500 have come in compared to forecasts from just a few months ago, the current view per The Wall Street Journal’s Economic Forecasting Survey calls for 2019 GDP near 2.3% (down from 3.0% in 2018) with the S&P 500 group of companies growing their collective EPS by 7.4% year over year in 2019.

 

Here’s the thing, in recent weeks, analysts lowered their earnings estimates for companies in the S&P 500 for the December quarter by roughly 4% to $40.93. The Q4 bottom-up EPS estimate (which is an aggregation of the median EPS estimates of all the companies in the index) dropped by 4.5% to $40.63. In the chart below, you can see this means quarter over quarter, December quarter earnings are expected to drop breaking the typical pattern of earnings growth into the last quarter of the year. What you can’t see is that marks the largest cut to quarterly S&P 500 EPS estimates in over a year.

 

 

Getting back to that 7.4% rate of earnings growth that is currently forecasted for 2019, I’d call out that it too has been revised down from 9% earlier in the December quarter. That new earnings forecast is a far cry from 21.7% in 2018, which was in part fueled by a stronger economy as well as the benefits of tax reform that was passed in late 2017. As we all know, there that was a one-time bump to corporate bottom lines that will not be repeated this year or in subsequent ones. The conundrum that investors are facing is with the market barometer that is the S&P 500 currently trading at 15.9x consensus 2018 EPS of $161.54, the factors listed above have investors asking what the right market multiple based on 2019’s consensus EPS of $173.45 should be?

And while most investors don’t “buy the market,” its valuation and earnings growth are a yardstick by which investors judge individual stocks.

 

Thematic tailwinds will continue to drive profits and stock prices

One of the key principles to valuing stocks is that companies delivering stronger EPS growth warrant a premium valuation. Of course, in today’s stock buyback rampant world, that means ferreting out those companies that are growing their net income. My preference has been to zero in on what is going on with a company’s operating profit and operating margins given that their vector and velocity are the prime drivers of earnings. That was especially needed last year given the widespread bottom-line benefits of tax reform.

At the heart of it, the question is what is driving the business?

As I’ve shared before, sector classifications don’t speak to that as they are a grouping of companies by certain characteristics rather than the catalysts that are driving their businesses. As we’ve seen before, some companies, such as Amazon (AMZN) or Apple (AAPL) capitalize on those catalysts, while others fail to do so in a timely manner if at all. Sears (SHLD), JC Penney (JCP) are easy call outs, but so are Toys R Us, Bon-Ton Stores, Sports Authority, Blue Apron (APRN), and Snap (SNAP) to name just over a handful.

Very different, and we can see the difference in comparing revenue and profit growth as well as stock prices. The ones that are performing are responding to the changing landscapes across the economic, demographic, psychographic, technological, regulatory and other playing fields they face. In short, they are riding the thematic tailwinds that we here at Tematica have identified. As a reminder those themes are:

 

As we move into 2019, I continue to see the tailwinds associated with those themes continuing to blow hard. Despite all the vain attempts to fight it temporarily, there is no slowing down the aging process. Consumers continue to flock to better for you alternatives, and as you’ll see below that has led Thematic Leader Chipotle Mexican Grill (CMG) to bring a new offering to market.

As we saw this past holiday shopping season, consumers are flocking more and more to digital shopping while hours spent streaming content continue to thwart broadcast TV and the box office. This year 5G networks and devices will become a reality as AT&T (T), Verizon (VZ) and others launch those commercial networks. The legalization of cannabis continues, and consumers continue to consume chocolate, alcohol and other Guilty Pleasures.

Whether you are Marriott International (MAR), Facebook (FB), British Airways or the Bridgeport School System, cyber threats continue to grow and as we saw last night during the presidential address and Democratic response, border security be it through a wall, technology or other means is a pain point that needs to be addressed. While the last two monthly Employment Reports have shown some of the best wage gains in years, Middle-class Squeeze consumers continue to face a combination of higher debt and interest rates as well as rising healthcare costs and the need to save for their golden years that will weigh on the ability to spend.

Like any set of winds, there will be times when some blow harder than others. For example, as we peer into the coming year the launch of 5G networks and gigabit ethernet will likely see the Digital Infrastructure tailwind accelerate in the first half of the year as network and data center operators utilize the services of companies like Thematic Leader Dycom Industries (DY) to build the physical networks. Some tailwinds, such as those associated with Aging of the Population, Clean Living and Middle-class Squeeze are likely to be more persistent over the coming year. Other tailwinds will gust hard at times almost seemingly out of nowhere reminding that they have been there all along. Given the nature of high profile cyber attacks and other threats, that’s likely to once again be the case with Safety & Security.

The bottom line is this – the impact to be had of the tailwinds associated with our 10 investment themes will continue to be felt in 2019. They will continue to influence consumer and business behavior, altering the playing field and forcing companies to either respond or not. The ones that are capitalizing on that changing playing field and are delivering pronounced profit growth are the ones investors should be focusing on.

 

TEMATICA INVESTING 

Scaling into AAXN, and updates on NFLX, CMG, and DFRG

As I discussed above, the December quarter was one of the most challenging periods for the stock market in some time. Even though we are just over a handful of days into 2019, we’re seeing the thematic tailwinds blow again on the Thematic Leaders with 9 of the 11 positions ahead of the S&P 500. Yes, we’re looking pretty good so far but it’s too early in the year to start patting our backs, especially with the upcoming earnings season. Odds are Apple’s (AAPL) negative preannouncement last week won’t be the only sign of misery to be had, and that’s why I’m keeping the ProShares Short S&P 500 ETF (SH) active for the time being. As I shared with you last week, while Apple and others are contending with a maturing smartphone market, I continue to like the long-term Digital Lifestyle aspects as it moves into streaming content and subscription-related businesses.

Of those 9 companies that are ahead of the S&P 500, as you can see in the table above, there are several that are significantly outperforming the market in the brief time that is 2019. These include Netflix (NFLX) shares, Axon Enterprises (AAXN), and Chipotle Mexican Grill (CMG)  as well as Del Frisco’s (DFRG).

After falling just over 28% in the December quarter as investors gave up on the FANG stocks, as of last night’s market close Netflix shares are up 20% so far for the new year. Spurring them along have been favorable comments and a few upgrades from the likes of Piper Jaffray, Barclays, Sun Trust, and several other investment banks. From my perspective, even though Netflix will face a more competitive landscape as AT&T (T), Disney (DIS), Hulu, Amazon (AMZN), Google (GOOGL), Facebook (FB), and Apple (AAPL), it has a substantial lead in the original content race over the likes of Facebook, Apple, Google and Amazon.

Candidly, only AT&T given its acquisition of Time Warner, and Disney, especially once it formally acquires with the movie, TV and other content from 21stCentury Fox (FOXA), will be streaming content contenders in the near term. And Disney is starting from scratch while AT&T lags meaningfully behind Netflix in terms of not only overall subscribers but domestic ones as well. For now, the digital streaming horse to play remains Netflix, especially as it brings more content to its service for both the US and international markets, which should drive its global subscriber base higher.

 

New bowls at Chipotle signal the Big Fix continues

Since its beginnings, Chipotle has been at the forefront of our Clean Living investing theme, but last week it took another step to attract those who are aiming to eat healthier when it introduced a line of Lifestyle Bowls. These included Keto, Paleo, Whole30, and Double Protein versions are only available through the company’s mobile app and the Chipotle website. Clearly, the new management team that arrived last year understands the powerful tailwind associated with our Digital Lifestyle investing theme. More on those new bowls can be found here, and we expect to hear more on the management team’s Big Fix initiatives when the company presents at the ICR Conference on Jan. 15.

 

Adding to Axon Enterprises as EPS expectations move higher

When we added shares of Axon Enterprises to the Thematic Leaders for the Safety & Security slot, we noted the company’s long reach into US police departments and other venues that should drive adoption of its newer Taser units but more importantly its body cameras and digital storage businesses. In the company’s November earnings report we saw that positive impact as its Axon Cloud revenue rose 47% year over year to $24 million, roughly $24 million or 23% of revenue vs. 18% in the year-ago quarter. Even better, the gross margin associated with that business has been running in the mid 70% range over the last few quarters, well above the corporate gross margin average of 36%-37%. Over the last 90 days, we’ve seen Wall Street boost its EPS forecasts for the company to $0.77 for 2018, up from $0.52, and to $0.92 for 2019 up from $0.73.

Even though we AAXN shares are on a roll thus far in 2019, the position is still in the red since joining the Thematic Leaders. Against the favorable tailwind of our Safety & Security investing theme and rising EPS expectations, we will scale into AAXN shares at current levels, which will drop our cost basis to around $61 from just under $73. Our $90 price target remains intact.

  • We are scaling into shares of Safety & Security Thematic Leader Axon Enterprises (AXON) at current levels, which will dramatically improve our cost basis. Our $90 price target remains intact.

 

Del Frisco’s shares jump on takeout speculation

Over the last few weeks, there has a sizable rebound in the shares of high-end restaurant name Del Frisco’s Restaurant Group. Ahead of the year-end 2018 holidays, the company’s board of directors was the recipient of activist investor action from Engaged Capital. During the holiday weeks, the company shared it has hired investment firm Piper Jaffray to “review and consider a full range of options focused on maximizing shareholder value, including a possible sale of the Company or any of its dining concepts.”

In other words, Del Frisco’s is putting itself in play. Often this can result in a company being taken out either by strategic investors, private equity or a combination of the two. There is also the chance a company going through this process is not acquired due primarily to a mismatch between the potential buyer(s) and the board on price as well as underlying financing.

From my perspective, 2018 was a challenging year for Del Frisco’s as it repositioned its branded portfolio. This included the sale of Sullivan’s Steakhouse and the acquisition of Barteca Restaurant Group, the parent of both Bartaco and Barcelona restaurants.

Transitions such as these can be challenging, and in some cases, the benefits of the transformation may take longer to emerge than planned. That said, given the data we’ve discussed previously on the recession-resistant nature of high-end dining, such as at Del Frisco’s core Double Eagle Steakhouse and Grille, we do think the company would be a feather in the cap for another restaurant group. As we noted when we added DFRG shares to the Thematic Leaders, there are very few standalone public steakhouse companies left — the vast majority of them have been scooped up by names such as Landry’s or Darden Restaurants (DRI).

From a fundamental perspective, the reasons why we are bullish on Del Frisco’s are the same ones that make it a takeout candidate. While we wait and see what emerges on the bid front, I’ll be looking over other positions to fill DFRG’s slot on the Thematic Leaders should a viable bid emerge.  Given the company’s restaurant portfolio, the continued spending on high-end dining and its recession-resistant nature, odds are rather high of that happening.

  • Our price target on Del Frisco’s Restaurant Group (DFRG) remains $14.

 

 

Tematica Options+: A Thematic Look at 2019 and a New Option Trade

Tematica Options+: A Thematic Look at 2019 and a New Option Trade

 

We’re kicking off 2019 trying something different with Tematica Investing and Tematica Options+. Instead of sending two separate reports each week and asking you to flip it back and forth to weave it all together, we’re going to try and combine it all together for you in a single report. On top of that, we’re going to lay the groundwork upfront on what’s going on from a market and macroeconomic standpoint, something we call Context and Perspectives. You’ll see a truncated version of this report posted on the Tematica Investing section of our website without the Options+ content, but rest assured that it’s the same as what’s included in this report. If you’re simply looking for the option trade for the week, which we do have this week, you can scroll down to the bottom on a new call position with Del Frisco’s (DFRG).

We hope this simplifies things for you. If you want to take a moment and let me know what you think, just email me at cversace@tematicaresearch.com . I always love to hear from subscribers!

 

Key Points Inside this Issue:

 

 

CONTEXT AND PERSPECTIVES

Last Friday’s favorable December Employment Report showed the domestic economy is not falling off a cliff and comments by Fed Chair Jay Powell reflected that the central bank will be patient with monetary policy as it watches how the economy performs. Those two things kicked the market off on its most recent three-day winning streak as of last night’s close. In many ways, Powell gave the market what it was looking for when he shared the Fed will remain data dependent when it looks at the economy and its next step with monetary policy.

Taking a few steps back, we’ve all experienced the market volatility over the last several weeks as it contends with a host of issues that we here at Tematica have laid out through much of the December quarter. These include:

  • U.S.-China trade issues
  • The slowing economy
  • A Fed that could boost rates twice in 2019 and continues to unwind its balance sheet
  • Brexit and political uncertainty in the Eurozone
  • And more recently the government shutdown.

These factors have led investors to question growth prospects for the global as well as the domestic economy and earnings in 2019.

Powell’s comments potentially take one of those issues off the table at least in the short-term. If the economy continues to deliver job creation as we saw in December, with some of the best year-over-year wage gains we’ve seen in years, before too long the Fed-related conversation could very well turn from two rate hikes to three.

Currently, that isn’t what the market is expecting.

The reason it isn’t is that outside of the December jobs report, data from ISM and IHS Markit continued to show a decelerating global and U.S. economy. With new orders and backlog levels falling, as well as pricing-related data, it likely means we won’t see a pronounced pickup in the January data. The JPMorgan Global Composite Output Index for December delivered its lowest reading since September 2016 due principally to the slowdown in the eurozone. Rates of expansion slowed in Germany (66-month low) and Spain (three-month low), while Italy stagnated. China, the UK, and Brazil all saw modest growth accelerations.

 

Despite the month over month declines in the December data for the US, it was the best performer on a relative basis even though the IHS Markit Composite PMI reading for the month hit a 15-month low. A more sobering view was shared by Chris Williamson, Chief Business Economist at IHS Markit who said:

“Manufacturers reported a weakened pace of expansion at the end of 2018, and grew less upbeat about prospects for 2019. Output and order books grew at the slowest rates for over a year and optimism about the outlook slumped to its gloomiest for over two years.”

That should give the Fed some room to hold off boosting rates, but it also confirms the economy is decelerating, which will likely have revenue and earnings guidance repercussions in the upcoming December-quarter earnings season.

There are several catalysts that could drive both the economy and the stock market higher in the coming months. These include a “good deal” resolution to the U.S.-China trade situation and forward movement in Washington on infrastructure spending. This week, the US and China have met on trade and it appears those conversations have paved the way for further discussions in the coming weeks. A modest positive that has helped drive the stock market higher this week, but thus far concrete details remain scant.

Such details are not likely to emerge for at least several weeks, which means the next major catalyst for the stock market will be the upcoming December quarter earnings season that begins in nine trading days.

 

Earnings expectations are being revised lower

Facing a number of risks and uncertainties over the last several weeks, investors have once again questioned growth prospects for both the economy and earnings growth for 2019. The following two charts – one of the Citibank Economic Surprise Index and one showing the aggregate profit margin for the S&P 500 companies – depict what investors are grappling with weaker than expected economic data at a time when corporate operating margins have hit the highest levels in over 20 years.

While expectations for growth in both the domestic economy and earnings for the S&P 500 have come in compared to forecasts from just a few months ago, the current view per The Wall Street Journal’s Economic Forecasting Survey calls for 2019 GDP near 2.3% (down from 3.0% in 2018) with the S&P 500 group of companies growing their collective EPS by 7.4% year over year in 2019.

 

Here’s the thing, in recent weeks, analysts lowered their earnings estimates for companies in the S&P 500 for the December quarter by roughly 4% to $40.93. The Q4 bottom-up EPS estimate (which is an aggregation of the median EPS estimates of all the companies in the index) dropped by 4.5% to $40.63. In the chart below, you can see this means quarter over quarter, December quarter earnings are expected to drop breaking the typical pattern of earnings growth into the last quarter of the year. What you can’t see is that marks the largest cut to quarterly S&P 500 EPS estimates in over a year.

 

 

Getting back to that 7.4% rate of earnings growth that is currently forecasted for 2019, I’d call out that it too has been revised down from 9% earlier in the December quarter. That new earnings forecast is a far cry from 21.7% in 2018, which was in part fueled by a stronger economy as well as the benefits of tax reform that was passed in late 2017. As we all know, there that was a one-time bump to corporate bottom lines that will not be repeated this year or in subsequent ones. The conundrum that investors are facing is with the market barometer that is the S&P 500 currently trading at 15.9x consensus 2018 EPS of $161.54, the factors listed above have investors asking what the right market multiple based on 2019’s consensus EPS of $173.45 should be?

And while most investors don’t “buy the market,” its valuation and earnings growth are a yardstick by which investors judge individual stocks.

 

Thematic tailwinds will continue to drive profits and stock prices

One of the key principles to valuing stocks is that companies delivering stronger EPS growth warrant a premium valuation. Of course, in today’s stock buyback rampant world, that means ferreting out those companies that are growing their net income. My preference has been to zero in on what is going on with a company’s operating profit and operating margins given that their vector and velocity are the prime drivers of earnings. That was especially needed last year given the widespread bottom-line benefits of tax reform.

At the heart of it, the question is what is driving the business?

As I’ve shared before, sector classifications don’t speak to that as they are a grouping of companies by certain characteristics rather than the catalysts that are driving their businesses. As we’ve seen before, some companies, such as Amazon (AMZN) or Apple (AAPL) capitalize on those catalysts, while others fail to do so in a timely manner if at all. Sears (SHLD), JC Penney (JCP) are easy call outs, but so are Toys R Us, Bon-Ton Stores, Sports Authority, Blue Apron (APRN), and Snap (SNAP) to name just over a handful.

Very different, and we can see the difference in comparing revenue and profit growth as well as stock prices. The ones that are performing are responding to the changing landscapes across the economic, demographic, psychographic, technological, regulatory and other playing fields they face. In short, they are riding the thematic tailwinds that we here at Tematica have identified. As a reminder those themes are:

 

As we move into 2019, I continue to see the tailwinds associated with those themes continuing to blow hard. Despite all the vain attempts to fight it temporarily, there is no slowing down the aging process. Consumers continue to flock to better for you alternatives, and as you’ll see below that has led Thematic Leader Chipotle Mexican Grill (CMG) to bring a new offering to market.

As we saw this past holiday shopping season, consumers are flocking more and more to digital shopping while hours spent streaming content continue to thwart broadcast TV and the box office. This year 5G networks and devices will become a reality as AT&T (T), Verizon (VZ) and others launch those commercial networks. The legalization of cannabis continues, and consumers continue to consume chocolate, alcohol and other Guilty Pleasures.

Whether you are Marriott International (MAR), Facebook (FB), British Airways or the Bridgeport School System, cyber threats continue to grow and as we saw last night during the presidential address and Democratic response, border security be it through a wall, technology or other means is a pain point that needs to be addressed. While the last two monthly Employment Reports have shown some of the best wage gains in years, Middle-class Squeeze consumers continue to face a combination of higher debt and interest rates as well as rising healthcare costs and the need to save for their golden years that will weigh on the ability to spend.

Like any set of winds, there will be times when some blow harder than others. For example, as we peer into the coming year the launch of 5G networks and gigabit ethernet will likely see the Digital Infrastructure tailwind accelerate in the first half of the year as network and data center operators utilize the services of companies like Thematic Leader Dycom Industries (DY) to build the physical networks. Some tailwinds, such as those associated with Aging of the Population, Clean Living and Middle-class Squeeze are likely to be more persistent over the coming year. Other tailwinds will gust hard at times almost seemingly out of nowhere reminding that they have been there all along. Given the nature of high profile cyber attacks and other threats, that’s likely to once again be the case with Safety & Security.

The bottom line is this – the impact to be had of the tailwinds associated with our 10 investment themes will continue to be felt in 2019. They will continue to influence consumer and business behavior, altering the playing field and forcing companies to either respond or not. The ones that are capitalizing on that changing playing field and are delivering pronounced profit growth are the ones investors should be focusing on.

 

TEMATICA INVESTING 

Scaling into AAXN, and updates on NFLX, CMG, and DFRG

As I discussed above, the December quarter was one of the most challenging periods for the stock market in some time. Even though we are just over a handful of days into 2019, we’re seeing the thematic tailwinds blow again on the Thematic Leaders with 9 of the 11 positions ahead of the S&P 500. Yes, we’re looking pretty good so far but it’s too early in the year to start patting our backs, especially with the upcoming earnings season. Odds are Apple’s (AAPL) negative preannouncement last week won’t be the only sign of misery to be had, and that’s why I’m keeping the ProShares Short S&P 500 ETF (SH) active for the time being. As I shared with you last week, while Apple and others are contending with a maturing smartphone market, I continue to like the long-term Digital Lifestyle aspects as it moves into streaming content and subscription-related businesses.

Of those 9 companies that are ahead of the S&P 500, as you can see in the table above, there are several that are significantly outperforming the market in the brief time that is 2019. These include Netflix (NFLX) shares, Axon Enterprises (AAXN), and Chipotle Mexican Grill (CMG)  as well as Del Frisco’s (DFRG).

After falling just over 28% in the December quarter as investors gave up on the FANG stocks, as of last night’s market close Netflix shares are up 20% so far for the new year. Spurring them along have been favorable comments and a few upgrades from the likes of Piper Jaffray, Barclays, Sun Trust, and several other investment banks. From my perspective, even though Netflix will face a more competitive landscape as AT&T (T), Disney (DIS), Hulu, Amazon (AMZN), Google (GOOGL), Facebook (FB), and Apple (AAPL), it has a substantial lead in the original content race over the likes of Facebook, Apple, Google and Amazon.

Candidly, only AT&T given its acquisition of Time Warner, and Disney, especially once it formally acquires with the movie, TV and other content from 21stCentury Fox (FOXA), will be streaming content contenders in the near term. And Disney is starting from scratch while AT&T lags meaningfully behind Netflix in terms of not only overall subscribers but domestic ones as well. For now, the digital streaming horse to play remains Netflix, especially as it brings more content to its service for both the US and international markets, which should drive its global subscriber base higher.

 

New bowls at Chipotle signal the Big Fix continues

Since its beginnings, Chipotle has been at the forefront of our Clean Living investing theme, but last week it took another step to attract those who are aiming to eat healthier when it introduced a line of Lifestyle Bowls. These included Keto, Paleo, Whole30, and Double Protein versions are only available through the company’s mobile app and the Chipotle website. Clearly, the new management team that arrived last year understands the powerful tailwind associated with our Digital Lifestyle investing theme. More on those new bowls can be found here, and we expect to hear more on the management team’s Big Fix initiatives when the company presents at the ICR Conference on Jan. 15.

 

Adding to Axon Enterprises as EPS expectations move higher

When we added shares of Axon Enterprises to the Thematic Leaders for the Safety & Security slot, we noted the company’s long reach into US police departments and other venues that should drive adoption of its newer Taser units but more importantly its body cameras and digital storage businesses. In the company’s November earnings report we saw that positive impact as its Axon Cloud revenue rose 47% year over year to $24 million, roughly $24 million or 23% of revenue vs. 18% in the year-ago quarter. Even better, the gross margin associated with that business has been running in the mid 70% range over the last few quarters, well above the corporate gross margin average of 36%-37%. Over the last 90 days, we’ve seen Wall Street boost its EPS forecasts for the company to $0.77 for 2018, up from $0.52, and to $0.92 for 2019 up from $0.73.

Even though we AAXN shares are on a roll thus far in 2019, the position is still in the red since joining the Thematic Leaders. Against the favorable tailwind of our Safety & Security investing theme and rising EPS expectations, we will scale into AAXN shares at current levels, which will drop our cost basis to around $61 from just under $73. Our $90 price target remains intact.

  • We are scaling into shares of Safety & Security Thematic Leader Axon Enterprises (AXON) at current levels, which will dramatically improve our cost basis. Our $90 price target remains intact.

 

Del Frisco’s shares jump on takeout speculation

Over the last few weeks, there has a sizable rebound in the shares of high-end restaurant name Del Frisco’s Restaurant Group. Ahead of the year-end 2018 holidays, the company’s board of directors was the recipient of activist investor action from Engaged Capital. During the holiday weeks, the company shared it has hired investment firm Piper Jaffray to “review and consider a full range of options focused on maximizing shareholder value, including a possible sale of the Company or any of its dining concepts.”

In other words, Del Frisco’s is putting itself in play. Often this can result in a company being taken out either by strategic investors, private equity or a combination of the two. There is also the chance a company going through this process is not acquired due primarily to a mismatch between the potential buyer(s) and the board on price as well as underlying financing.

From my perspective, 2018 was a challenging year for Del Frisco’s as it repositioned its branded portfolio. This included the sale of Sullivan’s Steakhouse and the acquisition of Barteca Restaurant Group, the parent of both Bartaco and Barcelona restaurants.

Transitions such as these can be challenging, and in some cases, the benefits of the transformation may take longer to emerge than planned. That said, given the data we’ve discussed previously on the recession-resistant nature of high-end dining, such as at Del Frisco’s core Double Eagle Steakhouse and Grille, we do think the company would be a feather in the cap for another restaurant group. As we noted when we added DFRG shares to the Thematic Leaders, there are very few standalone public steakhouse companies left — the vast majority of them have been scooped up by names such as Landry’s or Darden Restaurants (DRI).

From a fundamental perspective, the reasons why we are bullish on Del Frisco’s are the same ones that make it a takeout candidate. While we wait and see what emerges on the bid front, I’ll be looking over other positions to fill DFRG’s slot on the Thematic Leaders should a viable bid emerge.  Given the company’s restaurant portfolio, the continued spending on high-end dining and its recession-resistant nature, odds are rather high of that happening.

  • Our price target on Del Frisco’s Restaurant Group (DFRG) remains $14.

 

TEMATICA OPTIONS+

Adding a call position on Del Frisco’s Restaurant Group

That combination of solid fundamentals and a prospective takeout bid are prompting me to add a call option position on the shares of Del Frisco’s. Given the nature of the “up for acquisition” process, bidders have to emerge, the company’s advisors and Board have to review the bids, and there could be a second round of bidding. All of this takes time. For that reason, we’re going to go out several months longer than usual with the strike date to June. Given our preference for out of the money calls, that brings us to the June 10.00. calls.

One potential risk with any prospective acquisition play is that a viable bid fails to emerge. It could be a lack of bidders, which in this case is rather unlikely, or it could be because the negotiating parties aren’t able to agree on a transaction price. That has happened in the past, and while it’s likely a low probability in this instance, it is a risk to consider. For that reason, we want to set a rather tight stop loss.

Putting all of these factors together, we are adding the Del Frisco’s Restaurant Group (DFRG) June 2019 10.00 (DFRG190621C00010000) calls that closed last night at 0.47 to the Select List with a stop loss of 0.35

As we gear up for the upcoming earnings season that will kick off in earnest the week of Jan. 21, which currently has more than 250 companies reporting quarterly results and offering a fresh look at 2019, we will continue to keep the ProShares Short S&P 500 Jan 2019 30.00 calls (SH190118C00030000) position intact for now.

 

 

 

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