Weekly Issue: We aren’t out of the woods just yet

Weekly Issue: We aren’t out of the woods just yet

Key Points from this Issue:

  • We are downgrading Universal Display (OLED) shares from the Thematic Leaders to the Select List and cutting our price target to $125 from $150. In the coming days, we will name a new Thematic Leader for our Disruptive Innovators investing theme.
  • Given the widespread pain the market endured in October, Thematic Leaders Chipotle Mexican Grill (CMG), Del Frisco’s (DFRG), Axon Enterprises (AXXN), Alibaba (BABA) and Netflix (NFLX) were hit hard; however, the hardest hit was Amazon (AMZN).

 

This week we closed the books on the month of October, and what a month it was for the stock market. In today’s short-term focused society, some will focus on the rebound over the last few days in the major domestic stock market indices, but even those cannot hide the fact that October was one of the most challenging months for stocks in recent memory. In short, the month of October wiped out most the market’s year to date gains as investors digested both September quarter earnings and updated guidance that spurred a re-think in top and bottom line expectations.

All told, the Dow Jones Industrial Average fell 5.1% for the month, making it the best performer of the major market indices. By comparison, the S&P 500 fell 6.9% in October led by declines in eight of its ten subgroups. The technology-heavy Nasdaq Composite Index dropped 9.2% and the small-cap focused Russell 2000 plummeted 10.9%. That marked the Nasdaq’s steepest monthly drop since it posted a 10.8% fall in November 2008. The month’s move pulled the Russell 2000 into negative territory year to date while for the same time period both the Dow and S&P 500 closed last night up around 1.5%.

We are just over halfway through the September quarter earnings season, which means there are ample companies left to report and issue updated guidance. Candidly, those reports could push or pull the market either higher or continue the October pain. There are still ample risks in the market to be had as the current earnings season winds down. These include the mid-term elections; Italy’s next round of budget talks with Brussels; upcoming Trump-China trade talks, which have led to another round of tariff preparations; and Fed rate hikes vs. the slowing speed of the global economy.

Despite the very recent rebound in the stock market, CNN’s Fear & Greed Index remains at Extreme Fear (7) as I write this – little changed from last week. What this likely means is we are seeing a nervous rebound in the market, and it will likely some positive reinforcement to make the late October rebound stick. As we navigate that pathway to the end of the year, we will also be entering the 2018 holiday shopping season, which per the National Retail Federation’s annual consumer spending survey should rise more than 4% year over year.

This combination of upcoming events and sentiment likely means we aren’t out of the woods just yet even though we are seeing a reprieve from the majority of October. As is shared below, next week has even more companies reporting than this week as well as the midterm elections. The strategy of sitting on the sidelines until the calmer waters emerge as stock prices come to us is what we’ll be doing. At the right time, we’ll be adding to existing positions on the Thematic Leaders and Thematic Select List as well as introducing new ones.

Speaking of the Thematic Leaders and the Select List, as the mood shifts from Halloween to the year-end shopping season,  we have several companies including Amazon (AMZN), United Parcel Service (UPS), Costco Wholesale (COST), Del Frisco’s Restaurant Group (DFRG), McCormick & Co. (MKC) and Apple (AAPL) among others that should benefit from that uptick in holiday spending as well as our Digital Lifestyle, Living the Life and Middle-class Squeeze investing themes in the next few months.

 

UPDATES TO The Thematic Leaders and Select List

Given the widespread pain the market endured in October, we were not immune to it with the Thematic Leaders or companies on the Tematica Select List. Given the volatility, investor’s nerves it was a time of shoot first, ask questions later with the market – as expected – trading day to day based on the most recent news. I expect this to continue at least for the next few weeks.

The hardest hit was Amazon, which despite simply destroying September quarter expectations served up what can only be called a conservative forecast for the current quarter. For those that didn’t tune in to the company’s related earnings conference call, Amazon management flat out admitted that it was being conservative because it is too hard to call the second half of the quarter, which is when it does the bulk of its business during the frenetic holiday shopping season. I have long said that Amazon shares are one to hold not trade, and with the move to expand its private label product, move into the online pharmacy space as well as continued growth at Amazon Web Services, we will do just that. That conservative guidance also hit United Parcel Service (UPS) shares, but we see that as a rising tide this holiday season as digital shopping continues to take consumer wallet share this holiday shopping season.

Both Chipotle Mexican Grill (CMG), Del Frisco’s (DFRG), Axon Enterprises (AXXN), Alibaba (BABA) and Netflix (NFLX) have also been hit hard, and I’m waiting for the market to stabilize before scaling into these Thematic Leader positions. As we’ve moved through the current earnings season, comments from Bloomin’ Brands (BLMN), Del Taco (TACO), Wingstop (WING), Habit Restaurant (HABT) and others, including Chipotle, have all pointed to the benefit of food deflation. Chipotle’s Big Fix continues with progress had in the September quarter and more to be had in the coming ones. Del Frisco’s will soon report its quarterly results and it too should benefit from a consumer with high sentiment and lower food costs.

With Axon, the shares remain trapped in the legal volley with Digital Ally (DGLY), but as I pointed out when we added it to the Leaders, Axon continues to expand its safety business with law enforcement and at some point, I suspect it will simply acquire Digital Ally given its $30 million market cap. Turning to Alibaba (BABA) and Netflix (NFLX), both have been hit hard by the downdraft in technology stocks, with Alibaba also serving as a proxy for the current US-China trade war. In my opinion, there is no slowing down the shift to digital streaming that is driving Netflix’s business and its proprietary content strategy is paying off, especially outside the US where it is garnering subscriber growth at price points that are above last year’s levels. This is one we will add to as things settle down.

The same is true with Alibaba – there is no slowing down the shift to the Digital Lifestyle inside of China, and as Alibaba’s other business turn from operating losses to operating profits, I expect a repeat of what we saw with Amazon shares. For now, however, the shares are likely to trade sideways until we see signs of positive developments on trade talks. Again, let’s hang tight and make our move when the time is right.

 

Downgrading Universal Display shares to the Select List

Last night Thematic Leader Universal Display (OLED) reported rather disappointing September quarter results that fell well short of expectations and guided the current quarter below expectations given that the expected rebound in organic light emitting diode materials sales wasn’t ramping as expected despite a number of new smartphones using organic light emitting diode displays. On the earnings call, the company pointed out the strides being had with the technology in other markets, such as TV and automotive that we’ve been discussing these last few months but at least for the near-term the volume application has been smartphones. In short, with that ramp failing to live up to expectations for the seasonally strongest part of the year for smartphones, it speaks volumes about what is in store for OLED shares.

By the numbers, Universal now expected 2018 revenue in the range of $240-$250, which implies $63-$73 million for the December quarter vs. $77.5 million for the September quarter and $88.3 million in the year-ago one. To frame it another way, that new revenue forecast of $240-$250 million compares to the company’s prior one of $315- $325 million and translates into a meaningful fall off vs. 2017 revenues of $335.6 million. A clear sign that the expected upkeep is not happening as fast as was expected by the Universal management team. Also, too, the first half of the calendar year tends to be a quiet one for new smartphone models hitting shelves. And yes, there will be tech and consumer product industry events like CES, CEBIT, and others in 2019 that will showcase new smartphone models, but candidly we see these new models with organic light emitting diode displays as becoming a show-me story given their premium price points. Even with Apple (AAPL) and its September quarter earnings last night, its iPhone volumes were flat year over year at 46.9 million units falling short of the 48.0 million consensus forecast.

In my view, all of this means the best case scenario in the near-term is OLED shares will be dead money. Odds are once Wall Street computes the new revenue numbers and margin impact, EPS numbers for the next few quarters will be taken down and will hang on the shares like an anchor. Given our cost basis in the shares near $101, and where the shares are likely to open up tomorrow – after market trading indicates $95-$100, down from last night’s closing price of $129.65 – we have modest downside ahead. Not bad, but again, near-term the shares are likely range bound.

Given our long-term investing style and the prospects in markets outside of the smartphone, we’re inclined to remain long-term investors. That said, given the near-term headwinds, we are demoting Universal Display shares from the Thematic Leaders to the Select List. Based on revised expectations, we are cutting our price target from $150 to $125, fully recognizing the shares are likely to rangebound for the next 1-2 quarters.

  • We are downgrading Universal Display (OLED) shares from the Thematic Leaders to the Select List and cutting our price target to $125 from $150. In the coming days, we will name a new Thematic Leader for our Disruptive Innovators investing theme.

 

Clean Living signals abound

As we hang tight, I will continue to pour through the latest thematic signals that we see day in, day out throughout the year, but I’ll also be collecting ones from the sea of earnings reports around us.

If I had just read that it would prompt me to wonder what some of the recent signals have been. As you know we post them on the Tematica Research website but during the earnings season, they can get a tad overwhelming, which is why on this week’s Cocktail Investing podcast, Lenore Hawkins (Tematica’s Chief Macro Strategist) and I ran through a number of them. I encourage you to give it a listen.

Some of the signals that stood out of late center on our Clean Living investing theme. Not only did Coca-Cola (KO) chalk up its September quarter performance to its water and non-sugary beverage businesses, but this week PepsiCo (PEP) acquired plant-based nutrition bar maker Health Warrior as it continues to move into good for you products. Mondelez International (MDLZ), the company behind my personal fav Oreos as well as other cookies and snacks is launching SnackFutures, a forward-thinking innovation hub that will focus on well-being snacks and ingredients. Yep, it too is embracing our Clean Living investing theme.

Stepping outside of the food aspect of Clean Living, there has been much talk in recent months about the banning of plastic straws. Now MasterCard (MA) is looking to go one further with as it looks to develop an alternative for those plastic debit and credit cards. Some 6 billion are pushed into consumer’s hands each year. The issue is that thin, durable card is also packed with a fair amount of technology that enables transactions to occur and do so securely. A looming intersection of our Clean Living, Digital Infrastructure and Safety & Security themes to watch.

 

Turning to next week

During the week, the Atlanta Fed published its initial GDP forecast of 2.6% for the current quarter, which is essentially in line with the same forecast provided by the NY Fed’s Nowcast, and a sharp step down from the initial GDP print of 3.5% for the September quarter. Following the October Employment Report due later this week, where wage growth is likely to be more on investor minds that job gains as they contemplate the velocity of the Fed’s interest rate hikes, next week brings several additional pieces of October data. These include the October ISM Services reading and the October PPI figure. Inside the former, we’ll be assessing jobs data as well as pricing data, comparing it vs. the prior months for hints pointing to a pickup in inflation. That will set the stage for the October PPI and given the growing number of companies that have announced price increases odds are we will some hotter pricing data and that could refocus the investor spotlight back on the Fed.

Next week also brings the September JOLTS report as well as the September Consumer Credit report. Inside those data points, we expect more data on the continued mismatch between employer needs and available worker skills that is expected to spur more competitive wages.  As we examine the latest credit data, we will keep in mind that smaller banks reporting higher credit card delinquency rates while Discover Financial (DFS) and Capital One (COF) have shared they have started dialing back credit spending limits. That could put an extra layer of hurt on Middle-class Squeeze consumers this holiday season.

Also, next week, the Fed has its next FOMC meeting, and while it’s not expected to boost rates at that meeting, we can expect much investor attention to be focused on subsequent Fed head comments as well as the eventual publication of the meeting’s minutes in the coming weeks ahead of the December meeting.

On the earnings front, following this week’s more than 1,000 earnings reports next week bring another 1,100 plus reports. What this means is more than half of the S&P 500 group of companies will have issued September quarter results and shared their revised guidance. As these reports are had, we can expect consensus expectations for those companies to be refined for the balance of the year. Thus far, roughly 63% of the companies that have issued EPS guidance for the current quarter have issued negative guidance, but we have yet to see any meaningful negative revisions overall EPS expectations for the S&P 500.

Outside the economic data and corporate earnings flow next week, we also have US midterm elections. While we wait for the outcome, we would note if the Republicans maintain control of the House and Senate, it likely means a path of less resistance for President Trump’s agenda for the coming two years. Should the Democrats gain ground, which has historically been the case following a Republican presidential win, it could very well mean an even more contentious 24 months are to be had in Washington with more gridlock than not. Should that be the case, expectations for much of anything getting done in Washington in the medium-term are likely to fall.

Yes, next week will be another busy one that could challenge the recent market rebound. We’ll continue to ferret out signals for our thematic lens as we remain investors focused on the long-term opportunities to be had with thematic investing.

 

 

 

 

WEEKLY ISSUE: Booking more Habit gains and redeploying into another Digital Lifestyle investment

WEEKLY ISSUE: Booking more Habit gains and redeploying into another Digital Lifestyle investment

Key points in this issue

  • We are issuing a Sell on Habit Restaurant (HABT) shares and removing them from the Tematica Investing Select List. As we say goodbye to Habit, we’d note the position generated a blended return of more than 80% over the last four months.
  • We are issuing a Buy on Alibaba (BABA) shares as part of our Digital Lifestyle investing theme with a $230 price target.
  • Chatter over Apple’s (AAPL) potential new products begins to swell ahead of its upcoming Fall event, and it’s looking for our Universal Display (OLED) shares as well. Our price targets for AAPL and OLED shares remain $225 and $150, respectively.

 

Exiting Habit Restaurant Shares

A few weeks ago we took some of our Habit Restaurant (HABT) shares off the table, which gave us a tasty 68% profit on that half of the position. In the ensuing weeks, Habit shares have continued their climb higher and with last night’s close, the remaining portion of our HABTshares were up almost 89% from our early May buy. Not only is that a hefty profit, but it equates to a very rich valuation as well.

As of last night’s close, HABTshares were trading at 278x expected 2019 EPS of $0.06 vs. a PE range of 16-80 for peers that that range from El Poll Loco (LOCO) to Shake Shack (SHAK). On a price to sales basis, HABTshares are trading near 1.15x expected 2018 sales, well ahead of the 0.9x takeout multiple at which Zoe’s Kitchen is being acquired by Cava Mezza Grill.

As we often hear, it pays not to fall in love with the stock one owns, lest we are tempted to not do the prudent thing. I still like the Habit Restaurant story, and that goes for its Ahi Tuna burger as well. That said, given the phenomenal run and rich valuation, I’m calling it a day and removing HABTshares from the Tematica Investing Select List. I’ll be keeping tabs on the company and its geographic expansion in the coming months, but I’d be more inclined to revisit the shares at a more reasonable set of valuation metrics.

  • We are issuing a Sell on Habit Restaurant (HABT) shares and removing them from the Tematica Investing Select List. As we say goodbye to Habit, we’d note the position generated a blended return of more than 80% over the last four months.

Gearing into Alibaba Shares

One of the shortcomings in the perspective for most investors is they tend to be focused on the geographic region in which they reside. Given the global nature of our investment themes, I try to keep an open mind and look for thematic opportunities no matter where they are. One such company that sits at the crossroads of our Digital Lifestyle and Rise of the New Middle-Class investments, and has a dash of Disruptive Innovators and Digital Infrastructure is Alibaba (BABA). Alibaba has long been heralded as the Amazon (AMZN) of China given its position in digital shopping (84% of revenue) but that’s about where the similarities end…. For now.

Last week Alibaba reported its latest quarterly results, in which revenue hit $12.23 billion for the quarter, beating consensus expectations of $12.02 billion. Paired with double-digit earnings before interest, tax, depreciation, and amortization (EBITDA) growth is more than overshadowing a $0.02 per share miss on the company’s bottom line, which came in at $1.22 per share.

At Alibaba, all the company’s operating profit is derived from its core commerce business with the remaining 16% of its revenue stream spread across cloud, digital media and innovation initiatives all weighing on that profit stream. By comparison, Amazon’s Amazon Web Services (AWS) is the company’s profit and cash flow secret weapon as I like to call it.

That’s the negative, but if we look at the year over year comparisons of the non-core commerce businesses, not only are they growing quickly, but year over year Alibaba is shrinking their losses across the board.

In many respects this is similar to one of the key concerns investors once had with Amazon not too long ago — can it turn a consistent profit? We have seen Amazon do just that for a number of quarters in a row, and investors have removed that objection, which has sent AMZN shares significantly higher.

With Alibaba, the question is not whether those businesses become profitable, but rather when. Yes, much like Amazon, Alibaba continues to invest for future growth as evidenced by the level of capital spending in the June quarter vs. the year ago and declining cash on the balance sheet.

Both of these reflect investments to — much like Amazon — move past its core commerce platforms, into physical retail and food-delivery services, as well as expanding its footprint in areas such as logistics and in overseas markets.

That said, the company is benefiting from the continued tailwinds of the Digital Lifestyle investment theme. This is evidenced by the continued growth in both active consumers on its retail marketplace as well as mobile monthly active users. Exiting June, the company’s annual active consumers reached 576 million, up nearly 24% year over year, while its mobile monthly active users hit 634 million, up 20% year over year.

Much like Amazon’s Prime business, as Alibaba expands its scope of product and services, at least in the near-term, it should continue to win new users and retain existing ones. Also much like Amazon, Alibaba will continue to grab incremental consumer wallet share. The combination should continue to drive top-line growth and pull its non-core commerce businesses into the black.

Following last week’s earnings report, consensus EPS sits at $5.71 per share, up from the $4.78 achieved in 2017, with expectations of $7.75 in 2019. What the math shows is an expectation for roughly 27% EPS growth over the 2017-2019 time frame, and against that backdrop BABA shares are trading at a PEG ratio of 0.85 based on 2019 EPS expectations.

In coming months, odds are we will see continued growth in China digital commerce as China consumers build up for the year-end holidays and Chinese New Year. That along with other gains in its cloud and digital media businesses should see Alibaba closing the profit gap leading to not only more comparisons to Amazon but to multiple expansion to a PEG ratio of 1.1x that offers upside to $230, if not more.

The one obvious risk is the impact of trade and tariffs between the U.S. and China, which stepped up today. My thinking is given the slowing economic data of late from China and potential mid-term election risk, President Trump could be angling for an October-early November trade win. Not only would that send the overall U.S. stock market higher, but it would remove the trade concerns from BABA shares as well.

  • We are issuing a Buy on Alibaba (BABA) shares as part of our Digital Lifestyle investing theme with a $230 price target.

 

Apple ChatterCcontinues to Build Ahead of its 2018 Product Launch

With Apple’s (AAPL) annual fall event inching closer, chatter about new products is increasing and the internet is filling up with speculation over the number of iPhones and other products that the company could ship later this year. The current buzz has three new models being released:

  • an iPhone X successor
  • a new 6.5-inch iPhone X Plus
  • a mass-market 6.1-inch LCD iPhone with thin bezels and Face ID just like the iPhone X

Accompanying this chatter is speculation concerning the impact on Apple shipments, with DigiTimes saying “new iPhone shipments should hit 70-75 million units through the end of the year, the highest level since the iPhone 6/6 Plus super cycle. This number is purely on new 2018 iPhone shipments, it does not include sales of older generations.”

These happenings help explain the favorable move higher in Apple shares registered in recent days as well as for fellow Select List holding Universal Display (OLED).

Based on the rumblings, it looks like Apple will have two iPhone models utilizing organic light-emitting diode display technologies, up from just one last year, a positive for Universal’s chemical and IP business, especially as shipments of those model will likely continue to grow in 2019. Remember, too, that some months ago Apple was expected to fully transition its iPhone lineup to organic light-emitting diode displays with its 2019 lineup. Going from one model to two or three of its new models appears to be a confirming step as organic light emitting diode capacity expands and display prices come down.

I continue to see an improving outlook for OLED shares as smartphone competitors follow suit and adopt the organic light-emitting diode technology, and its uses expand into other markets (interior automotive lighting, specialty lighting and eventually general illumination, much the way light emitting diodes did). Our price target on OLED shares remains $150.

With Apple, I expect the shares to continue to melt up ahead of its rumored mid- September event and look to revisit our $225 price target based on products the company does announce, not rumors.

  • Chatter over Apple’s (AAPL) potential new products begins to swell ahead of its upcoming Fall event, and it’s looking for our Universal Display (OLED) shares as well. Our price targets for AAPL and OLED shares remain $225 and $150, respectively.

WEEKLY ISSUE: Taking Positions Off the Board and Reallocating Into Existing Positions

WEEKLY ISSUE: Taking Positions Off the Board and Reallocating Into Existing Positions

Key points from this issue

  • We are exiting the shares of Paccar (PCAR), which had an essentially neutral impact on the Select List;
  • We are exiting the shares of Rockwell Automation (ROK), which were a drag of more than 11% on the Select List;
  • We are exiting the shares of GSV Capital (GSVC), which in full returned a modest decline since we added the shares back in April.
  • We are scaling into shares of Applied Materials (AMAT) at current levels and keeping our long-term price target of $70 intact.
  • We are scaling into shares of Netflix (NFLX) at current levels and keeping our long-term price target of $500 in place.

 

After the S&P 500 hit an all-time high yesterday, if the stock market finishes higher today it will mean the current bull market will be 3,453 days old, which will make it the longest on record by most definitions. For those market history buffs, as of last night’s market close, it tied the one that ran from October 1990 to March 2000.

Even as the S&P 500 hit an all-time high yesterday thus far in 2018 it’s up 7.1%. By comparison, we have a number of positions on the Tematica Investing Select List that are up considerably more. Among them are Amazon (AMZN), Apple (AAPL), Costco Wholesale (COST), ETFMG Prime Cyber Security ETF (HACK), Habit Restaurant (HABT), McCormick & Co. (MKC), and USA Technologies (USAT). Not that I’m prone to bragging, rather I’m offering a gentle reminder of the power to be had with thematic investing vs. the herd and sector-based investing.

Over the last few weeks, I’ve been recasting our investing themes, which in some cases has given rise to a new theme like Digital Infrastructure, combined a few prior themes into the more cohesive Digital Lifestyle and Middle-Class Squeeze ones, and expanded the scope of our Clean Living theme. In the next few weeks, I’ll finish the task at hand as well as ensure we have a stock recommendation for each of what will be our 10 investment themes.

As part of that effort, I’m re-classifying USA Technologies (USAT) shares as part of our Digital Infrastructure investing theme. The shares join Dycom Industries (DY) in this theme.

 

Pruning PCAR, ROK and GSVC shares

Once we pass the approaching Labor Day holiday, we will be off to the races with the usual end of the year sprint. For that reason, we’re going to take what is normally the last two relatively quiet weeks of August to do some pruning. This will go hand in hand with the ongoing investment theme reconstitution that will eliminate the stand-alone Economic Acceleration/Deceleration and Tooling & Re-tooling investment themes. As such, we’re saying goodbye to shares of Paccar (PCAR) and Rockwell Collins (ROK). We’ll also shed the shares of GSV Capital (GSVC), which are going to be largely driven by share price movements in Spotify (SPOT) and Dropbox (DBX). As the lock-up period with both of those newly public companies come and go, I’ll look to revisit both of them with an eye to our Digital Lifestyle and Digital Infrastructure investing themes.

  • We are exiting the shares of Paccar (PCAR), which had an essentially neutral impact on the Select List;
  • We are exiting the shares of Rockwell Automation (ROK), which were a drag of more than 11% on the Select List;
  • We are exiting the shares of GSV Capital (GSVC), which in full returned a modest decline since we added the shares back in April.

 

Scaling into Applied Materials and Netflix shares

We’ll use a portion of that returned capital to scale into shares of Applied Materials (AMAT), which approached their 52-week low late last week following the company’s quarterly earnings report that included an earnings beat but served up a softer than expected outlook.

Applied’s guidance called for sales of $3.85-$4.15 billion vs. analyst consensus outlook of $4.45 billion. On the company’s earnings conference call, CEO Gary Dickerson confirmed worries that slower smartphone growth could cause chipmakers to rein in capital spending and reduce demand for chipmaking equipment in the near- term. That’s the bad news, the good news is Applied sees double-digit growth in 2019 for each of its businesses and remains comfortable with its 2020 EPS forecast of $5.08.

From my perspective, I continue to see the several aspects of our Disruptive Innovators investing theme – augmented and virtual reality, 5G, artificial intelligence, Big Data and others – as well as growing storage and memory demands for connected devices driving semiconductor capital equipment demands. There is also the rising install base of semiconductor capital equipment inside China, and with Apple turning to China suppliers over Taiwanese ones to contain costs it likely means a rebound in China demand when the current US-China trade imbroglio ends.

As we wait for that, I suspect Applied will continue to use its stock buyback program During its recently closed quarter, Applied repurchased $1.25 billion or 25 million shares of stock and the company has about $5 billion remaining in buyback authorization. Applied’s next quarterly dividend of $0.20 per share will be paid on Sept. 13 to shareholders of record on Aug. 23.

  • We are scaling into shares of Applied Materials (AMAT) at current levels and keeping our long-term price target remains $70 intact.

Turning to Netflix (NFLX) shares, they are down some just under 20% from where I first added them to the Select List several weeks ago. My thesis on the shares remains unchanged, and I continue to see its streaming video service and original content as one of the cornerstones of our Digital Lifestyle investing theme. Adding to the shares at current levels will serve to reduce our cost basis from just under $420 to just under $380.

  • We are scaling into shares of Netflix (NFLX) at current levels and keeping our long-term price target of $500 in place.

 

 

Making thematic sense of the July Retail Sales report

Making thematic sense of the July Retail Sales report

Key points for this alert:

  • Our price target on Amazon (AMZN) remains $2,250.
  • Our price target on Costco Wholesale (COST) remains $230.
  • Our price target on Habit Restaurant (HABT) is getting a boost to $17 from $16.
  • We are also bumping our price target on McCormick & Co. (MKC) shares to $130 from $110 as we get ready for seasons eatings 2018.

 

Following on the heels of the July Retail Sales report we received Wednesday, this morning Walmart (WMT) reported stellar July quarter results led by stronger than expected same-store sales and a 40% year over year increase in its e-commerce sales. From our perch, we see both reports as positive for our positions in both Amazon (AMZN) and Costco Wholesale (COST) as well as Habit Restaurant (HABT) and McCormick & Co. (MKC) shares.

Digging into the better than expected July Retail Sales report that showed Retail up 0.4% month over month and 6.0% sequentially, top performers were Food Services & drinking places (up +9.7% year over year), Nonstore retailers (+8.7%) and Grocery Stores (+4.9%) year over year. In response to that report, as well as the news that China and the US are heading back to the trade negotiation tables, our Habit Restaurant shares continue to sizzle. That stellar showing in July for Food Services & drinking places brought the trailing 3-month comparison to up more than 8% year over year.

To me, this echoes the data we’ve seen of late that points to the rebound in monthly restaurant sales, which is due as much to price increases as it is to improving customer volume, particularly at Fast Casual restaurants like Habit. As evidenced by Habit’s recent blowout June quarter earnings report, the company continues to execute on the strategy that led us to add the shares to the portfolio back in May. On the heels of the July Retail Sales report, I find myself once again boosting our price target on HABT shares to $17 from $16 as the underlying strength is continuing into the current quarter.

With just over 6% upside to our new price target for Habit, it’s not enough to commit fresh capital to the position. Given the surge in HABT shares – more than 80% since we added them to the Tematica Investing Select List this past May – as well as their current technical picture (see the chart below), I’m inclined to opportunistically use the position as a source of funds in the coming weeks.

 

 

While one might think those gains have come at the expense of grocery stores, and in turn, a potential blow to McCormick’s, the July figure for grocery was also the best in the last three months. What this tells us is people are likely paying more for food at the grocery store and at restaurants, which reflects the combination of higher food prices as well as the shift to food, drinks, and snacks that are healthier for the consumer (and a bit more expensive in general). On that strength and the forward view that will soon have us waist deep in season’s eatings, we are boosting our price target for MCK to $130 from $110. That includes some post-June quarter earnings catch up on our part for McCormick and its ability to grow its top line as part of our Clean Living and Rise of the New Middle Class investing themes, as well as wring out cost synergies associated with acquired businesses. In the coming months, I expect we will once again see this Dividend Dynamo boost its quarterly dividend, keeping MKC shares as one to own, not trade.

Getting back to the July Retail Sales report, the Nonstore retail July figure bodes very well for continued share gains at Amazon and other retailers that are embracing our Digital Lifestyle investing theme as we head into the holiday shopping season. Moreover, I see the e-commerce sales gains at Walmart – up +40% in the July quarter as well as those by Costco Wholesale, up  33% year to date — serving to confirm the accelerating shift by consumers to that modality of shopping as more alternatives become available. Helping Walmart is the addition of over 1,100 brands year to date including Zwilling J. A. Henckels cutlery and cookware, Therm-a-Rest outdoor products, O’Neill surf and water apparel, Shimano cycling products and the brands available on the dedicated Lord & Taylor shop, like Steve Madden footwear. Let’s remember too that Amazon continues to pull the lever that is private label products across a growing array of categories, and those margins are superior to those for its Fulfilled by Amazon efforts.

Speaking of Costco, its July sales figures showed a 6.6% year over year increase in same-store sales, which as we learned by comparing that with the July Retail Sales report was magnitudes stronger than General Merchandise stores (+3.3% year over year) and Department Stores (+0.3% year over year). Yes, Costco was helped by its fresh foods business, but even there it topped Grocery sales for the month. The clear message is that Costco continues to win consumer wallet share, and more of that is likely to be had in the coming months as consumers contend with the seasonal spending pickup.

The big loser in the July Retail Sales report was the Sporting goods, hobby, musical instrument, & bookstores category, which is more than likely seeing its lunch eaten by Amazon, Walmart, and Costco. All three of these companies are embracing the increasing digital lifestyle, targeting rising incomes in the emerging markets and helping cash-strapped consumers in the US stretch those dollars. As we have said many times before, the only thing better than the tailwinds of one of our investing themes is the combination of several and these companies are benefitting from our Digital Lifestyle, Rise of the New Middle Class and Middle-Class Squeeze investing themes.

All in all, the last 24 or so hours as very positive for our AMZN, COST, HABT and MKC shares on the Tematica Investing Select List.

  • Our price target on Amazon (AMZN) remains $2,250.
  • Our price target on Costco Wholesale (COST) remains $230.
  • Our price target on Habit Restaurant (HABT) is getting a boost to $17 from $16.
  • We are also bumping our price target on McCormick & Co. (MKC) shares to $130 from $110 as we get ready for seasons eatings 2018.

 

WEEKLY ISSUE: Scaling deeper into Dycom shares

WEEKLY ISSUE: Scaling deeper into Dycom shares

Key points from this issue:

  • We are halfway through the current quarter, and we’ve got a number of holdings on the Tematica Investing Select List that are trouncing the major market indices.
  • We are using this week’s pain to improve our long-term cost basis in Dycom Industries (DY) shares as we ratchet back our price target to $100 from $125.
  • Examining our Middle-Class Squeeze investing theme and housing.
  • A Digital Lifestyle company that we plan on avoiding as Facebook attacks its key market.

 

As the velocity of June quarter earnings reports slows, in this issue of Tematica Investing we’re going to examine how our Middle-Class Squeeze investing theme is impacting the housing market and showcase a Digital Lifestyle theme company that I think subscribers would be smart to avoid. I’m also keeping my eyes open regarding the recent concerns surrounding Turkey and the lira. Thus far, signs of contagion appear to be limited but in the coming days, I suspect we’ll have a much better sense of the situation and exposure to be had.

With today’s issue, we are halfway through the current quarter. While the major market indices are up 2%-4% so far in the quarter, by comparison, we’ve had a number of strong thematic outperformers. These include Alphabet (GOOGL), Amazon (AMZN), Apple (AAPL), AXT Inc. (AXTI), Costco Wholesale (COST),  Habit Restaurant (HABT), Walt Disney (DIS), United Parcel Service (UPS), Universal Display (OLED) and USA Technologies (USAT).  That’s an impressive roster to be sure, but there are several positions that have lagged the market quarter to date including GSV Capital (GSVC), Nokia (NOK), Netflix (NFLX), Paccar (PCAR) and Rockwell Automation (ROK). We’ve also experienced some pain with Dycom (DY) shares, which we will get to in a moment.

Last week jettisoned shares of Farmland Partners (FPI) following the company taking it’s 3Q 2018 dividend payment and shooting it behind the woodshed. We also scaled into GSVC shares following GSV’s thesis-confirming June quarter earnings report, and I’m closely watching NFLX shares with a similar strategy in mind given the double-digit drop since adding them to the Tematica Investing Select List just over a month ago.

 

Scaling into Dycom share to improve our position for the longer-term

Last week we unveiled our latest investing theme here at Tematica – Digital Infrastructure. Earlier this week, Dycom Industries (DY), our first Digital Infrastructure selection slashed its outlook for the next few quarters despite a sharp rise in its backlog. Those shared revisions are as follows:

  • For its soon to be reported quarter, the company now sees EPS of $1.05-$1.08 from its previous guidance of $1.13-$1.28 vs. $1.19 analyst consensus estimate and revenues of $799.5 million from the prior $830-$860 million vs. the $843 million consensus.
  • For its full year ending this upcoming January, Dycom now sees EPS of $2.62-$3.07 from $4.26-$5.15 vs. the $4.63 consensus estimate and revenues of $3.01-$3.11 billion from $3.23-$3.43 billion and the $3.33 billion consensus.

 

What caught my eyes was the big disparity between the modest top line cuts and the rather sharp ones to the bottom line. Dycom attributed the revenue shortfall to slower large-scale deployments at key customers and margin pressure due to the under absorption of labor and field costs – the same issues that plagued it in its April quarter. Given some of the June quarter comments from mobile infrastructure companies like Ericsson (ERIC) and Nokia (NOK), Dycom’s comments regarding customer timing is not that surprising, even though the magnitude to its bottom line is. I chalk this up to the operating leverage that is inherent in its construction services business, and that cuts both ways – great when things are ramping, and to the downside when activity is less than expected.

We also know from Ericsson and Dycom that the North American market will be the most active when it comes to 5G deployments in the coming quarters, which helps explain why Dycom’s backlog rose to $7.9 billion exiting July up from $5.9 billion at the end of April and $5.9 billion exiting the July 2017 quarter. As that backlog across Comcast, Verizon, AT&T, Windstream and others is deployed in calendar 2019, we should see a snapback in margins and EPS compared to 2018.

With that in mind, the strategy will be to turn lemons – Monday’s 24% drop in DY’s share price – into long-term lemonade. To do this, we are adding to our DY position at current levels, which should drop our blended cost basis to roughly $80 from just under $92. Not bad, but I’ll be inclined to scale further into the position to enhance that blended cost basis in the coming weeks and months on confirmation that 5G is moving from concept to physical network. Like I said in our Digital Infrastructure overview, no 5G network means no 5G services, plain and simple. As we scale into the shares and factor in the revised near-term outlook, I’m also cutting our price target on DY shares to $100 from $125.

  • We are using this week’s pain to improve our long-term cost basis in Dycom Industries (DY) shares as we ratchet back our price target to $100 from $125.

 

Now, let’s get to how our Middle-Class Squeeze investing theme is hitting the housing market, and review that Digital Lifestyle company that we’re going to steer clear of because of Facebook (FB). Here we go…

 

If not single-family homes, where are the squeezed middle-class going?

To own a home was once considered one of the cornerstones of the American dream. If we look at the year to date move in the SPDR S&P Homebuilders ETF (XHB), which is down nearly 16% this year, one might have some concerns about the tone of the housing market. Yes, there is the specter of increasing inflation that has and likely will prompt the Federal Reserve to boost interest rates, and that will inch mortgage rates further from the near record lows enjoyed just a few years ago.

Here’s the thing:

  • Higher mortgage rates will make the cost of buying a home more expensive at a time when real wage growth is not accelerating, and consumers will be facing higher priced goods as inflation winds its way through the economic system leading to higher prices. During the current earnings season, we’ve heard from a number of companies including Cinemark Holdings (CNK), Hostess Brands (TWNK), Otter Tail (OTTR), and Diodes Inc. (DIOD) that are expected to pass on rising costs to consumers in the form of price increases.
  • Consumers debt loads have already climbed higher in recent years and as interest rates rise that will get costlier to service sapping disposable income and the ability to build a mortgage down payment

 

 

And let’s keep in mind, homes prices are already the most expensive they have been in over a decade due to a combination of tight housing supply and rising raw material costs. According to the National Association of Home Builders, higher wood costs have added almost $9,000 to the price of the average new single-family since January 2017.

 

 

Already new home sales have been significantly lower than over a decade ago, and as these forces come together it likely means the recent slowdown in new home sales that has emerged in 2018 is likely to get worse.

 

Yet our population continues to grow, and new households are being formed.

 

This prompts the question as to where are these new households living and where are they likely to in the coming quarters as homeownership costs are likely to rise further?

The answer is rental properties, including apartments, which are enjoying low vacancy rates and a positive slope in the consumer price index paid of rent paid for a primary residence.

 

There are several real estate investment trusts (REITs) that focus on the apartment and rental market including Preferred Apartment Communities, Inc. (APTS) and Independence Realty Trust (IRT). I’ll be looking at these and others to determine potential upside to be had in the coming quarters, which includes looking at their attractive dividend yields to ensure the underlying dividend stream is sustainable. More on this to come.

 

A Digital Lifestyle company that we plan on avoiding as Facebook attacks its key market

As important as it is to find well-positioned companies that are poised to ride prevailing thematic tailwinds that will drive revenue and profits as well as the share price higher, it’s also important to sidestep those that are running headlong into pronounced headwinds. These headwinds can take several forms, but one of the more common ones of late is the expanding footprint of companies like Alphabet (GOOGL), Amazon (AMZN) and Facebook (FB) among others.

We’ve seen the impact on shares of Blue Apron (APRN) fall apart over the last year following the entrance of Kroger (KR) into the meal kit business with its acquisition of Home Chef and investor concerns over Amazon entering the space following its acquisition of Whole Foods Market. That changing landscape highlighted one of the major flaws in Blue Apron’s subscription-based business model –  very high customer acquisition costs and high customer churn rates. While we warned investors to avoid APRN shares back last October when they were trading at north of $5, those who didn’t heed our advice are now enjoying APRN shares below $2.20. Ouch!

Now let’s take a look at the shares of Meet Group (MEET), which have been on a tear lately rising to $4.20 from just under $3 coming into 2018. The question to answer is this more like a Blue Apron or more like USA Technologies (USAT) or Habit Restaurant (HABT). In other words, one that is headed for destination @#$%^& or a bona fide opportunity.

According to its description, Meet offers  applications designed to meet the “universal need for human connection” and keep its users “entertained and engaged, and originate untold numbers of casual chats, friendships, dates, and marriages.” That sound you heard was the collective eye-rolling across Team Tematica. If you’re thinking this sounds similar to online and mobile dating sites like Tinder, Match, PlentyOfFish, Meetic, OkCupid, OurTime, and Pairs that are all part of Match Group (MTCH) and eHarmony, we here at Tematica are inclined to agree. And yes, dating has clearly moved into the digital age and that falls under the purview of our Digital Lifestyle investing theme.

Right off the bat, the fact that Meet’s expected EPS in 2018 and 2019 are slated to come in below the $0.39 per share Meet earned in 2017 despite consensus revenue expectations of $181 in 2019 vs. just under $124 million in 2017 is a red flag. So too is the lack of positive cash flow and fall off in cash on the balance sheet from $74.5 million exiting March 2017 to less than $21 million at the close of the June 2018 quarter. A sizable chunk of that cash was used to buy Lovoo, a popular dating app in Europe as well as develop the ability to monetize live video on several of its apps.

Then there is the decline in the company’s average total daily active users to 4.75 million in the June 2018 quarter from 4.95 million exiting 2017. Looking at average mobile daily active users as well as average monthly active user metrics we see the same downward trend over the last two quarters. Not good, not good at all.

And then there is Facebook, which at its 2018 F8 developer conference in early May, shared it was internally testing its dating product with employees. While it’s true the social media giant is contending with privacy concerns, CEO Mark Zuckerberg shared the company will continue to build new features and applications and this one was focused on building real, long-term relationships — not just for hookups…” Clearly a swipe at Match Group’s Tinder.

Given the size of Facebook’s global reach – 1.47 billion daily active users and 2.23 billion monthly active users – it has the scope and scale to be a force in digital dating even with modest user adoption. While Meet is enjoying the monetization benefits of its live video offering, Facebook has had voice and video calling as well as other chat capabilities that could spur adoption and converts from Meet’s platforms.

As I see it, Meet Group have enjoyed a nice run thus far in 2018, but as Facebook gears into the digital dating and moves from internal beta to open to the public, Meet will likely see further declines in user metrics. So, go user metrics to go advertising revenue and that means the best days for MEET shares could be in the rearview mirror. To me this makes MEET shares look more like those from Blue Apron than Habit or USA Technologies. In other words, I plan on steering clear of MEET shares and so should you.

 

 

A Middle-class Squeeze recipe: Flat real wage growth with prices poised to move higher

A Middle-class Squeeze recipe: Flat real wage growth with prices poised to move higher

We’ve been witnessing inflationary pressures in the monthly economic data over the last several months. Some of this has been higher raw material due in part to trade tariffs and other input costs, such as climbing freight costs, as well as the impact of increased minimum wages in certain states. Habit Restaurant (HABT) noticeably called out the impact of wage gains as one of the primary drivers in its recent menu price increase.

This June 2018 earnings season, we’ve heard from a growing number of companies – from materials and food to semiconductor and restaurants –  that contending with inflationary pressures are looking to pass it through to consumers in the form of higher prices as best they can. The thing is, wage growth has been elusive for the vast majority of workers, especially on an inflation-adjusted basis. Keep in mind that is before we factor in the inflationary effect to be had if these escalating rounds of trade tariffs are in effect longer than expected.

As these price increases take hold and interest rates creep higher, it means consumer spending dollars will not stretch as far as they did previously.  Not good for consumers and not good for the economy but it offers support for the Fed to boost rates in the coming quarters and keeps our Middle-Class Squeeze investing theme in vogue.

 

U.S. average hourly earnings adjusted for inflation fell 0.2 percent in July from a year earlier, data released on Friday showed, notching the lowest reading since 2012. While inflation isn’t high in historical terms, after years of being too low following the 2007-2009 recession, its recent gains are taking a bigger bite out of U.S. paychecks.

“Inflation has been climbing and wage growth, meanwhile, has been flat as a pancake,” said Laura Rosner, senior economist at MacroPolicy Perspectives LLC in New York. “In a very tight labor market you would expect that workers would negotiate their wages to at least keep up with the cost of living, and the picture tells you that they’re not.”

Source: American Workers Just Got a Pay Cut in Economy Trump Calls Great – Bloomberg

Silver Screen

Coming soon to theaters: higher prices. Movie theater operator Cinemark Holdings Inc. plans to pass costs along to customers, partly due to seating upgrades.

“Our average ticket price also increased 3.7 percent to $8.08, largely as a result of inflation, incremental pricing opportunities associated with recliner conversions, and favorable adult-versus-child ticket type mix,” said Chief Financial Officer Sean Gamble. “As we’ve continued to roll out recliners, our general tactic has been to go forward with limited pricing upfront and then when we see the demand opportunity increase there, and I’d say there’s still — we still believe there is further opportunity as we look to the back half of this year and forward in that regard.”

To be fair, movie ticket prices have been marching steadily higher in recent years. But theaters aren’t the only ones planning to pass on costs.

Sugar Boost

The maker of Twinkies and Ding Dongs wants to charge more for its sugary snacks.

“We will implement a retail price increase and incremental retailer programs to help offset the inflationary headwinds we and others in the industry are experiencing,” Hostess Brands Inc. Chief Executive Officer Andrew Callahan said on a call, explaining that the company is researching how to do so without choking off growth. The majority of the change will come in 2019, he said.

Bubble Wrap

Sealed Air Corp., the maker of Bubble Wrap and other packaging materials, is trying “to do everything we can operationally to keep our freight costs low,” Chief Financial Officer William Stiehl said in apresentation. “Where I’ve been very happy with the company’s success is our ability to pass along price increases to our customers for our relevant input cost.”

Steel Prices

Tariffs are hitting home at Otter Tail Corp.’s metal fabrication unit BTD, but leadership doesn’t sound especially concerned. Thank pricing power.

“We do not anticipate higher steel prices from tariffs having a significant impact on BTD’s margins as steel costs are largely passed through to customers,” Chief Executive Officer Charles MacFarlane said on a call. “BTD is working to enhance productivity in a period of increased volume and tight labor markets.”

Tariff Tag

The trade impact pass-through is equally real at semiconductor device maker Diodes Inc.

“Products that we import into the U.S. from China, all of those products are going to be ultimately affected by the tariffs,” Chief Financial Officer Richard White said on a call. Between U.S. levies that began July 6 and additional rounds planned to follow, “it’s about $3.6 million per quarter, but we plan to pass these tariff charges on to our customers.”

Home Costs

Housing developer LGI Homes Inc. is “consistently” seeing sales price increases as costs bump higher — a sign that pricing power exists even in big-ticket markets like housing.

“We’re able to and need to raise our prices to keep our gross margins consistent,” Chairman Eric Lipar said on a call. “In the market that we’re in, which I’d characterize as a good, solid, strong demand market with a tight supply of houses and the labor challenges, the material challenges that we all face, we see at least for the next couple quarters, that trend continuing. Prices are going to have to increase on a same-store basis if you will in order to offset increased costs.”

“We’re dealing with a higher monthly payment for the buyer now because of the rising interest rates from nine months ago. Demand seems to be there,” he said, adding that the company may need to examine ways to address the situation. “Rather than reducing the price, we may have to look at smaller square footages. The buyer may have to choose.”

People Problems

Not everyone is finding opportunities to pass along costs: Civitas Solutions Inc., a health and human services provider that caters to those with disabilities and youth with behavioral or medical challenges, is seeing slimmer margins.

“The number of people that are exiting the company are still a concern to us and I think it’s driven largely by the full, robust economy,” Chairman Bruce Nardella said on a call, citing workers seeing opportunities to leave to get higher wages. “Over the last two years, our margins have eroded because of that labor pressure.”

Pizza Pain

As if a leadership feud and sales slump weren’t problematic enough, pizza chain Papa John’s International Inc. also has to deal with wage pressures and rising costs. It’s responding by attempting to eke out efficiency gains, rather than by raising prices, to defend its margins.

“We have employed third party efficiency experts to review the potential for improvements within our restaurants,” Chief Executive Officer Steve Ritchie said on a call. “They are also conducting time and motion studies. Their work will directly supplement the work we are doing within our restaurant design of the future.”

Addressing Pressures

As some companies maintain profits by pushing costs to customers, Flowers Foods Inc., the maker of Tastykake pastries and Mi Casa tortillas, is finding work-arounds. It increased prices in the first quarter to help offset input inflation, but has also eaten some of the cost.

“Our margins were impacted by inflationary pressures from higher transportation cost, a tight labor market, and increasingly volatile commodity markets,” Chief Executive Officer Allen Shiver said on a call. “To address these inflationary pressures, we are aggressively working to capture greater efficiencies and cost reductions.”

 

Source: Inflation Is Coming to Theater Near You as U.S. Companies Flex Pricing Power – Bloomberg

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

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

Key points inside this issue

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

 

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

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

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

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

 

Taking some profits in Habit after a smoking run

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

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

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

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

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

Costco shares get another boost

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

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

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

 

UPS keeps on trucking

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

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

 

WEEKLY ISSUE: Confirming Thematic Data Points Continue to Pour In

WEEKLY ISSUE: Confirming Thematic Data Points Continue to Pour In

Key points inside this issue:

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

 

Oh how the stock market has diverged over the last week

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

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

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

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

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

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

 

Apple delivers and boosting our price target in response

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

Nokia scores the biggest 5G contract win thus far

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

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

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

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

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

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

 

Here come earnings from Habit

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

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

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

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

 

Weekly Issue: Amazon Prime Day, Netflix Earnings, Controversy at Farmland Partners and June Retail Sales

Weekly Issue: Amazon Prime Day, Netflix Earnings, Controversy at Farmland Partners and June Retail Sales

Key points from this week’s issue:

  • Amazon (AMZN): What to watch as Amazon Prime Day 2018 comes and goes; Following the strong run in Amazon (AMZN) shares over the last several weeks, our $1,900 price target is under review.
  • Habit Restaurants (HABT): Our price target on Habit shares remains $11.50
  • Costco (COST): We are once again boosting our price target on Costco Wholesale (COST) shares to $230 from $220.
  • Netflix (NFLX): Despite 2Q 2018 earnings results, I continue to see Netflix shares rising further in the coming quarters as investors become increasingly comfortable with the company’s ability to deliver compelling content that will attract net new users, driving cash flow and bottom line profits. Our NFLX price target remains $525.
  • Farmland Partners (FPI): While credibility questions will keep Farmland in the penalty box in the short term, we continue to favor the longer-term business fundamentals. Our price target on FPI shares remains $12.

 

 

Catching up with the stock market

Last week we saw a change in the domestic stock market. After being led by the technology-heavy Nasdaq Composite Index and the small-cap-laden Russell 2000 during much of 2Q 2018, last week we saw the Dow Jones Industrial Average take the pole position, handily beating the other three major market indices. As all investors know, individual stocks, as well as the overall market, fluctuate week to week, but with just over two weeks under our belt in the current quarter, all four major market indices have moved higher, shrugging off trade concerns at least for now.

Of course, those mini market rallies occurred in the calm period before the 2Q 2018 earnings storm, which kicks off in earnest tomorrow when more than 84 companies will issue their report card for the quarter. Last week’s initial earnings reports for 2Q 2018 were positive for the market as was the latest Small Business Optimism Index reported by the NFIB. Despite those positive NFIB findings, which marked the sixth highest reading in the survey’s 45-year history, business owners continue to have challenges finding qualified workers. The challenge to fill open positions is not only a headwind for growth, but also increases the prospects for wage inflation.

For context, that NFIB survey reading matched the record high set in November 2000, which helps explain the survey’s findings for more companies planning to increase compensation. That adds to the findings from the June PPI report that showed headline inflation rising to 3.4% year over year and the 2.9% year-over-year increase in the June CPI report, all of which gives the Fed ample room to continue increasing interest rates in the coming months. Granted, a portion of that inflation is due to the impact of higher oil prices, but also higher metal and other commodity costs in anticipation of tariffs being installed are contributing. Again, these data points give the Fed the cover fire it will need when it comes to raising interest rates, which at the margin means borrowing costs will inch their way higher. Here’s the thing — all of that data reflects the time-period before the tariffs.

The focus over the next few weeks will be on corporate earnings, particularly how they stack up against expectations calling for more than 20% year-over-year EPS growth for the S&P 500 companies in the back half of 2018. So far, in aggregate, the reports we’ve received give little reason to worry, but to be fair we’ve only had a few dozen in recent weeks, with several hundred to be had. But… ah you knew there was a but coming… with companies like truck freight company JB Hunt blowing the doors off expectations but keeping its full-year 2018 guidance intact… a flag is raised. Another flag raised in the earnings results thus far was the consecutive slowdown in loan growth seen at JPMorgan Chase (JPM), Citigroup (C), PNC (PMC) and Wells Fargo (WFC), which came down to 2.1% year-over-year on an aggregate basis from 3% in the March quarter.

If earnings expectations come up short, we will likely see the market trade-off. How much depends on the discrepancy between reality and projections. Also, keep in mind, the current market multiple is ahead of the market’s historical average, and a resetting of EPS expectations could trigger something similar in the market multiple. What this means is at least as we go through the next few weeks there is a greater risk to be had in the market. As we move into the back half of the September quarter, if Trump can show some progress on the trade front we could have a market rally toward the end of the year. Needless to say, I’ll continue to keep one eye on all of this while the other ferrets out signals for our thematic investing lens.

 

It’s that Prime Day time of year

As I write this, we have passed the 24-hour mark in what is one of if not the largest self-created holidays. Better known as Amazon (AMZN) Prime Day, this made-up holiday strategically falls during one of the seasonally slowest times of the year for retailers. For those uninitiated with the day, or those who have not seen the litany of websites touting the evolving number of deals and retail steals being served up by Amazon throughout the day, Prime Day is roughly a day and a half push by Amazon to goose it sales by serving up compelling offerings and enticing non-Prime members to become ones. To put some context around it, Coresight Research forecasts Prime Day 2018 will generate $3.4 billion in sales in 36 hours — roughly 6% of the $58.06 billion Amazon is expected to report in revenue for the entire September quarter.

What separates this year’s Prime Day from prior ones isn’t the prospect for record-breaking sales, but rather the increased arsenal of private label products had by Amazon. Over the last few quarters, Amazon has expanded its reach into private label apparel and athletic wear as well as others like shoes and jewelry. All told, Amazon now sells more than 70 of its own brands, which it can price aggressively on Prime Day helping it win incremental consumer wallet share. Prime Day is also a deal bonanza for Amazon’s own line of electronic devices, ranging from FireTV products to Kindle e-readers and Echo powered digital assistants. The thing with each of those devices is they help remove friction to other Amazon products, such as its streaming TV and music services, Audible and of course its digital book service.

Unlike last year, this year’s Prime Day started off with a hitch in that soon after it began shoppers were met with the company’s standard error page because it was overwhelmed with deal seekers. Not a bad problem and certainly a great marketing story, but it raises the question as to whether Amazon will hit that $3.4 billion figure.

To me, the allure of Prime Day is the inherent stickiness it brings to Amazon as the best deals are offered only to Prime members, which historically has made converts of the previously unsubscribed. Those new additions pay their annual fee and that drives cash flow during a seasonally slow time of year for the company, while also expanding the base of users as we head into the year-end holiday shopping season before too long. Very smart, Amazon. But then again, I have long said Amazon is a company that knows how to reduce if not remove transaction friction. Two-day free Prime delivery, Amazon Alexa and Echo devices, Kindle digital downloads, and Amazon Pay are just some of the examples to be had.

Thus far in 2018, Amazon shares are up more than 58%, making them one of the best performers on the Tematica Investing Select List – hardly surprising given the number of thematic tailwinds pushing on its businesses. Even before we got to Prime Day, we’ve seen Amazon expanding its reach on a geographic and product basis, winning new business for its Amazon Web Services unit along the way. More recently, Amazon is angling to disrupt the pharmacy business with its acquisition of online pharmacy PillPack, a move that has already taken a bite out of CVS Health (CVS) and Walgreen Boots Alliance (WAB) shares. Odds are there will be more to come from Amazon on the healthcare front, and it has the potential to add to its business in a meaningful way as it once again looks to reduce transaction friction.So, what am I looking for from Amazon coming out of Prime Day 2018? Aside from maybe a few of mine own purchases, like a new Echo Spot for my desk, on the company data front, I am going to be looking for the reported number of new Prime subscribers Amazon adds to the fold. Sticking with that, I’m even more interested in the number of non-US Prime subscribers it adds, given the efforts by Amazon of late to bring 2-day Prime delivery to parts of Europe. As we here in the US have learned, once you have Prime, there is no going back.

  • Following the strong run in Amazon (AMZN) shares over the last several weeks, our $1,900 price target is under review.

 

June Retail Sales Report is good for Habit Restaurant and Costco shares

Inside this week’s June Retail Sales Report there were several reasons for investors to take a bullish stance on consumer spending in light of the headline increase of 0.5% month-over-month. On a year-over-year basis, the June figure was an impressive 6.6%, but to get to the heart of it we need to exclude several line items that include “motor vehicles & parts” and “gas stations.” In doing so, we find June retail sales rose 6.4% year-over-year, which continues the acceleration that began in May. The strong retail sales numbers likely means upward revisions to second-quarter GDP expectations by the Atlanta Fed and N.Y. Fed. Despite the positive impact had on 2Q 2018 GDP, odds are this spending has only added to consumer debt levels which means more pressure on disposable income in the coming months as the Fed ticks interest rates higher.

Now let’s examine the meat of the June retail report and determine what it means for the Tematica Select List, in particular, our positions in Habit Restaurants Inc. (HABT) and Costco Wholesale (COST).

Digging into the report, we find retail sales at food services and drinking places rose 8.0% year-over-year in June — clearly the strongest increase over the last three months. How strong? Strong enough that it brought the quarter’s year-over-year increase to 6.1% for the category, more than double the year-over-year increase registered in the March quarter.

People clearly are back eating out and this was confirmed by the June findings from TDn2K’s Black Box Intelligence. Those findings showed that while overall restaurant sales rose 1.1% year over year in June, one of the stronger categories was the fast casual category, which benefitted from robust to-go sales. That restaurant category is the one in which Habit Restaurant competes, and the combination of these two June data points along with new store openings and higher prices increases our confidence in Habit’s second-quarter consensus revenue expectations.

  • Our price target on Habit Restaurants (HABT) remains $11.50

Now let’s turn to Costco – earlier this month the warehouse retailer reported net sales of $13.55 billion for the retail month of June an increase of 11.7% from $12.13 billion last year. Compared to the June Retail Sales Report, we can easily say Costco continues to take consumer wallet share. Even after removing the influences of gas sales and foreign currency, Costco’s June sales in the US rose 7.7% year over year and not to be left out its e-commerce sales jumped nearly 28% year over year as well. Those are great metrics, but exiting June, Costco has 752 warehouse locations opened with plans to further expand its footprint in the coming months. New warehouses means new members, which should continue to drive the very profitable membership fee income in the coming months, a key driver of EPS for the company.

Over the last few weeks, COST shares have been a strong performer. After several months in which it has clearly taken consumer wallet share and continued to expand its physical locations, I’m boosting our price target on COST shares to $230 from $220, which offers roughly 7% upside from current levels before factoring in the dividend. Subscribers should not commit fresh capital at current levels but should continue to enjoy the additional melt up to be had in the shares.

  • We are once again boosting our price target on Costco Wholesale (COST) shares to $230 from $220.

 

What to make of earnings from Netflix

Last week we added shares of Netflix (NFLX) to the Tematica Investing Select List given its leading position in streaming as well as original content, which makes it a natural for our newly recasted Digital Lifestyle investing theme, and robust upside in the share price even after climbing nearly 100% so far in 2018. As a reminder, our price target for NFLX is $525.

Earlier this week, Netflix reported its June quarter results and I had the pleasure of appearing on Cheddar to discuss the results as they hit the tape. What we learned was even though the company delivered better than expected EPS for the quarter, it missed on two key fronts for the quarter – revenue and subscriber growth. The company also lowered the bar on September quarter expectations. While NFLX shares plunged in

While NFLX shares plunged in after-market trading immediately after its earnings were announced on Monday, sliding down some 14%, yesterday the shares rallied back some to closed down a little more than 5% at the end of Tuesday’s trading session. Trading volume in NFLX shares was nearly 6x its normal levels, as the shares received several rating upgrades as well as a few downgrades and a few price target changes.

Here’s the thing, even though the company fell short of new subscriber targets for the quarter, it still grew its membership by more than 5 million in the quarter to hit 130 million memberships, an increase of 26% year over year. Combined with a 14% increase in average sales price, revenue in the quarter grew 43% year over year. Tight expense control led to the company’s operating margin to reach 11.8% in 2Q 2018, up from 4.6% in the year-ago quarter.

In recent quarters, the number of Netflix’s international subscribers outgrew the number of domestic ones, and that has a two-fold impact on the business. First, the company’s exposure to non-US currencies has grown to just over half of its streaming revenue and the strengthening dollar during 2Q 2018 weighed on the company’s international results. With its content production in 80 countries and expanding, Netflix will move more of its operating costs to non-US dollar currencies to put a more natural hedging strategy in place. Second, continued growth in its international markets means continuing to develop and acquire programming for those markets, which was confirmed by the company’s comments that its content cash spending will be weighted to the second half of this year.

From my perspective, the Netflix story is very much intact and the drivers we outlined have not changed in a week’s time. I continue to see Netflix shares rising further in the coming quarters as investors become increasingly comfortable with the company’s ability to deliver compelling content that will attract net new users, driving cash flow and bottom line profits.

  • Despite Netflix’s (NFLX) 2Q 2018 earnings results, I continue to see Netflix shares rising further in the coming quarters as investors become increasingly comfortable with the company’s ability to deliver compelling content that will attract net new users, driving cash flow and bottom line profits. Our NFLX price target remains $525.

 

 

Checking in on Farmland Partners

Last week we saw some wide swings in shares of Farmland Partners (FPI), and given its lack of analyst coverage I wanted to tackle this head-on. Before we get underway, let’s remember that Farmland Partners is a REIT that invests in farmland and looks to increase rents over time, which means paying close attention to farmer income and trends in certain agricultural prices such as corn, wheat and soybeans.

So what happened?

Two things really. First, a bearish opinion piece on FPI shares ran on Seeking Alpha last week, which accused FPI of “artificially increasing revenues by making loans to related-party tenants who round-trip the cash back to FPI as rent; 310% of 2017 earnings could be made-up.” Also according to the article FPI “has not disclosed that most of its loans have been made to two members of the management team” and it has “significantly overpaid for properties.”

As one might suspect, that article hit FPI shares hard to the gut, dropping them some 38%. Odds are that article caught ample attention, something it was designed to do. Soon thereafter, Farmland Partners responded with the following data:

  • The total notes and interest receivable under the Company’s loan program was $11.6 million, or 1.0% of the Company’s total assets, as of March 31, 2018.
  • The program generated $0.5 million in net revenues, or 1.1% of total revenue, in the year ended December 31, 2017.
  • The program is directed at farmers, including, as previously disclosed, tenants. It was publicly announced in August 2015, and included in the Company’s public disclosures since then. None of the borrowers under the program as of March 31, 2018 were related parties, or have other business relationships with the Company, other than as borrowers and, in some cases, tenants.

Those clarifications helped prop FPI shares up, but odds are it will take more work on the part of Farmland’s management team to fully reverse the drop in the shares.

In over two decades of investing, I’ve seen my fair share of bears extrapolate from a few, or less than few, data points to make a sweeping case against a company. When that happens, it tends to be short-lived with the effect fleeting as the company delivers in the ensuing quarters. Given the long-term prospects we discussed when we added FPI shares to the Select List, I’m rather confident over the long-term. In the short-term, the real issue we have to contend with is falling commodity prices and that brings us to our second topic of conversation.

As trade and tariffs have continued to escalate, we’ve seen corn, wheat and soybean prices come under pressure. Because these are key drivers of farmer income, we can understand FPI shares coming under some pressure. However, here’s the thing –  on the podcast, Lenore and I recently spoke with Sal Gilbertie of commodity trading firm Teucrium Trading, and he pointed out that not only are these commodity prices below production costs, something that historically is short-lived, but the demographic and production dynamics make the recent moves unsustainable. In short, China’s share of the global population is multiples ahead of its portion of the world’s arable land, which means that China will be forced to import corn, wheat and soybeans to not only feed its people but to feed its livestock as well. While China may be able to import from others, given the US is among the top exporters for those commodities, that can only last for a period of time.

Longer-term, the rising new middle class in China, India and other parts of greater Asia will continue to drive incremental demand for these commodities, which in the long-term view bodes well for FPI shares.

What I found rather interesting in Farmland’s press release was the following –  “We are evaluating what avenues are available to the Company and its stockholders to remedy the damage inflicted.” Looks like there could be some continued drama to be had.

  • While credibility questions will keep Farmland Partners (FPI) in the penalty box in the short term, we continue to favor the longer-term business fundamentals. Our price target on FPI shares remains $12.

 

WEEKLY ISSUE: The Potential Impact Tariffs Will Have on 2nd Half Earnings

WEEKLY ISSUE: The Potential Impact Tariffs Will Have on 2nd Half Earnings

 

Given the way the Fourth of July holiday falls this year, we strongly suspect the back of the week will be quieter than usual. For those reasons, we’re coming at you earlier than usual this week. And while we have your attention, Tematica will be dark next week as we recharge our batteries ahead of the 2Q 2018 earnings onslaught that kicks off on July 16.

With the housekeeping stuff out of the way, let’s get to this week’s issue…

Closing the bookS on 1Q 2018

Last Friday, we closed the books on the second quarter, and while it’s true all four major US stock market indices delivered positive returns, the last three months were far more volatile than most expected back in January. Year to date, the Dow Jones Industrial Average remains modestly in the red and the S&P 500 modestly in the green. By comparison, despite being overshadowed in the second quarter by the small-cap heavy Russell 2000, the Nasdaq Composite Index finished the first half of the year with a 9% gain.

From a Tematica Investing Select List perspective, there we a number of outperformers to be had including Alphabet (GOOGL), Amazon (AMZN), Apple (AAPL), Costco Wholesale (COST), ETFMG Prime Cyber Security ETF (HACK), McCormick & Co. (MKC), USA Technologies (USAT). To paraphrase one of team Tematica’s favorite movies, Star Wards, our themes are strong with those companies. As much as we like the accolades to be had with performing positions, there are ones such as Dycom Industries (DY), Nokia (NOK), AXT Inc. (AXTI) and Applied Materials (AMAT) that had a challenging few months but they too should be seeing the benefits of thematic tailwinds in the coming months.

During the quarter, we did some fine tuning with the Select List, adding shares of GSV Capital (GSVC), Habit Restaurant (HABT) and Farmland Partners (FPI). We also shed our positions in Starbucks (SBUX), LSI Industries (LYTS), Corning (GLW) and International Flavors & Fragrances (IFF) during the second quarter. In making those moves, we’ve enhanced the Select List’s position for the back half of 2018 as the focus for investors centers on the impact of trade and tariffs on revenue and earnings. Let’s discuss…

 

First Harley Davidson, then BMW and General Motors

Last week we were reminded that trade wars and escalating tariffs increasingly are on the minds of investors. Something that at first was thought would be short-lived has grown into something far more pronounced and widespread, with tariffs potentially being exchanged among the U.S., China, the European Union, Mexico and Canada. As we discussed Harley-Davidson (HOG) shared that its motorcycle business will be whacked by President Trump’s decision to impose a new 25% tariff on steel imports from the EU and a 10% tariff on imported aluminum.

We soon heard from BMW (BMWG) that U.S. tariffs on imported cars could lead it to reduce investment and cut jobs in the United States due to the large number of cars it exports from its South Carolina plant. Soon thereafter, General Motors (GM) warned that if President Trump pushed ahead with another wave of tariffs, the move could backfire, leading to “less investment, fewer jobs and lower wages” for its employees. Then yesterday, citing a state-by-state analysis, the new campaign argues that Trump is risking a global trade war that will hit the wallets of U.S. consumers,  the U.S. Chamber of Commerce shared it would launch a campaign to oppose Trump’s trade tariff policies.

With up to $50 billion in additional tariffs being placed on Chinese goods after July 6, continued tariff retaliation by China and others could lead to a major reset of earnings expectations in the back half of 2018. And ahead of that potential phase-in date, Canada’s foreign minister announced plans to impose about $12.6 billion worth of retaliatory tariffs on U.S. goods beginning yesterday. Not all companies may swallow the tariffs the way Harley Davidson is choosing to, which likely means consumers and business will be paying higher prices in the coming months. That will show up in the inflation metrics, and most likely lead to the Fed being more aggressive on interest rate hikes than previously thought.

As part of our Middle-Class Squeeze investing theme, a growing number of consumers are already seeing their buying power erode, and if the gaming out of what could come it means more folks will be shopping with Amazon (AMZN) and Costco Wholesale (COST) and consumer McCormick & Co. (MKC) products.

 

Falling investor sentiment sets the stage for 2Q 2018 earnings

All of this, is weighing on the market mood and investor sentiment as we get ready for the 2Q 2018 earnings season. Remember that earlier this year, investors were expecting earnings to rise as the benefits of tax reform were thought to jumpstart the economy and if Harley Davidson is the canary in the coal mine, we are likely going to see those expectations reset lower. We could see management teams offer “everything and the kitchen sink” explanations should they rejigger their outlooks to factor in potential tariff implications, and their words are likely to be met with a “shoot first, ask questions later” mentality by investors.

Helping fan the flames of that investor mindset, the Citibank Economic Surprise Index (CESI) has dropped into negative territory. We’ve discussed this indicator before as has Tematica’s Chief Macro Strategist Lenore Hawkins, but as a quick reminder CESI tracks the rate that U.S. economic indicators come in better or worse than estimates over a rolling three-month period. When indicators are better than expected, the CESI is in positive territory and when indicators disappoint, it is negative.

As Lenore pointed out in last week’s Weekly Wrap:

While the CESI has just dropped into negative territory, let’s add some context and perspective — the index has had an impressive run of 188 trading days of positive readings, the longest such streak by 37 days in the 15-year history of the index. Now some of that reflects the enthusiasm surrounding tax reform and its economic prospects from the start of the year, but economic reality is now hitting those earlier expectations. Odds are the reality as seen through the trade and tariff glasses will continue to weigh on the CESI in the coming weeks, adding to investor anxiety.

I’d point out the level of anxiety hit Fear last week on the CNNMoney Fear & Greed Index, down from Neutral a month ago. But there is reason to think it will not rebound quite so quickly…

 

Here’s the question investors are pondering

The growing question in investors’ minds is likely to center on the potential impact in the second half of 2018 from these tariffs if they are enacted for something longer than a short period. While GDP expectations for the current quarter have climbed, the concern we have is the cost side of the equation for both companies and consumers, thanks in part to Harley-Davidson’s recent comments.

We have yet to see any meaningful change to the 2018 consensus earnings forecast for the S&P 500 this year, which currently sits around $160.85 per share, up roughly 12% year over year. But we will soon be entering second-quarter earnings season and could very well see results and comments lead to expectation changes that run the risk of weighing on the market. Given the upsizing of corporate buyback programs over the last few months due in part to tax reform, any potential pullback could be muted as companies scoop up shares and pave the way for further EPS growth as they shrink their share count. That means we’ll be increasingly focused on the internals of earnings reports as well as new order and backlog metrics.

There are roughly a handful of companies reporting this week, and next week sees a modest pick-up in reports, with roughly 25 companies issuing their latest quarterly results. It’s the week after, that sees the number of earnings reports mushroom to more than 220. We’ll enjoy the slower pace over the next two weeks as we get ready for that onslaught, but we will be paying close attention to comments on potential tariff impacts in the second half of 2018 and what that means for earnings expectations for both the market as well as companies on the Select List.