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Weekly Issue: Del Frisco’s Sends Strong Signals of Potential Take Over Bid

Weekly Issue: Del Frisco’s Sends Strong Signals of Potential Take Over Bid

Key points inside this issue

  • The stock market continues to move higher even as global growth slows and S&P 500 earnings prospects for the current quarter slump further.
  • Our long-term price target on Thematic King Amazon (AMZN) shares remains $2,250, which offers more than 35% upside following its December quarter earnings report.
  • As Living the Life Thematic Leader Del Frisco’s Restaurant Group (DFRG) gets serious with its strategic alternatives, our price target remains $14.
  • We are issuing a Buy on and adding the Del Frisco’s Restaurant Group (DFRG) September 20, 2019, 10.00 calls (DFRG 190920C00010000) that closed last night at 0.60 with a stop loss at 0.30.
  • On the housekeeping front, we were stopped out of the Nokia (NOK) July 2019 7.00 (NOK190719C00007000) calls last Friday (Feb. 1).

 

Stocks rebounded in a pronounced manner as we started off 2019, making it the best January showing since 1989. The data continues to point to a slowing global slowing economy, especially in China and in the eurozone with Italy in a recession and France not too far behind. The December-quarter concerns, however, have rolled back and propelled the market higher, especially during the last week of the month when the Fed signaled patience with its speed of further interest rate hikes. For the month in full, the S&P 500 finished up just shy of 8.0%, ahead of the Dow Jones Industrial Average’s 7.2% rise, but trailing the tech-heavy Nasdaq’s 9.7% surge.

On top of Friday’s blockbuster January Employment Report, a stronger-than-expected ISM Manufacturing Index reading for January came in, which showcased a rebound in new order activity. On the back of those two reports, the domestic stock market started February off in the green, as that data suggest the U.S. remains the brightest spot in the global economy. That view was supported by the January PMI data released Friday morning by IHS Markit, which showed the U.S. manufacturing economy picking up steam while that activity in the eurozone and Japan slowed, and China marked the second month in contraction territory.

 

Another positive inside the ISM Manufacturing Report was the month-over-month drop in the Prices component. Pairing that with falling prices in the eurozone data, it’s another reason the Federal Reserve can take its finger off the interest rate hike button for the time being. That patient stance, shared by the Fed this week after its latest FOMC meeting, has walked the dollar back some, but as we see in the chart below the greenback’s year-over-year strength will likely continue to be a headwind for companies during the first half of 2019.

 

The current mismatch between U.S. economic data and that for China has raised hopes for U.S.-China trade talks. Also lending a helping hand on that front were several positive tweets from President Trump exiting this week’s round of trade talks. I remain cautiously optimistic but will once again remind subscribers it’s the details that we’ll be focused on when they are released. 

As we move deeper into February, just over half of the S&P 500 companies have yet to report their quarterly results and given the slowing global economy and dollar headwinds we are likely to see further downward revisions to earnings expectations for the S&P 500 in the coming weeks. Along with the market’s push higher in January that has extended into February, should those revisions come to pass it means the market gets incrementally more expensive. This means we should continue to tread carefully in the near-term.

 

As we do this, known catalysts to watch in the coming weeks will be incremental developments on U.S.-China trade and potential moves by the European Central Bank. Following the weakening economic data in the eurozone, ECB President Mario Draghi said, “The European Central Bank is ready to use all its policy tools to support Europe’s softening economy, including by restarting a recently shelved bond-buying program.” There is also the possibility of another government shutdown should Congress fail to reach an agreement on immigration. Who said 2019 was likely to be boring?

 

Tematica Investing

As I have said numerous times, we do not buy the market, but rather invest in companies that are well positioned to capitalize on the tailwinds from our 10 investment themes. From time to time, we are given opportunities to scale into existing positions and in my view, we are seeing that now with Thematic King Amazon (AMZN). The reason for this latest bout of weakness in Amazon’s share price is management’s comments that it will once again investment more than Wall Street expected and the news over e-commerce regulations in India.

From time to time we’ve seen Amazon step up its investment spending and historically its been a great time to load up on the shares because those investments have paved the way for future growth. From opportunities in grocery, mobile payments, streaming video and gaming services, healthcare following its PillPack acquisition as well as expanding the scale and scope of its Amazon Prime service further in the US and abroad, there are ample thematic opportunities for the Amazon business. I also suspect that with FedEx (FDX) looking to collapse order times to under 24 hours for its retail partners, that Amazon too is working on growing its Prime Now offering at the same time.

Let’s turn to the new e-commerce regulations in India and their potential impact on Amazon. The issue is that while these new regulations permit full foreign ownership of ‘single brand’ retailers such as IKEA, restrictions are in place with ‘multibrand’ stores such as supermarkets from outside India. Odds are we will see a rebranding of sorts by the likes of Amazon, Walmart (WMT) and others that are looking to tap into this New Global Middle-Class market. Candidly, given Amazon’s growing private label business that spans apparel, furniture, food, electronics, and other categories, I’m not all that bothered by this. And let’s face it, not only are the folks at Amazon pretty smart, but we have yet to see a market that shuns two-day delivery. I doubt India and its growing middle-class will be the first.

The bottom line with this Thematic King is it is a stock to own as the company is poised to further disrupt other markets, sectors and other business models in the coming quarters.

  • Our long-term price target on Thematic King Amazon (AMZN) shares remains $2,250, which offers more than 35% upside following its December quarter earnings report.

 

 

Del Frisco’s gets serious about entertaining take out bids

After a few weeks of no big news from Living the Life company Del Frisco’s Restaurant Group Inc. (DFRG) after it pre-announced its fourth-quarter revenue in early January, we have a new development that in my view reinforces our belief that the company is putting itself up for sale. More specifically, Del Frisco’s announced on Monday that it has executed a cooperation agreement with its third-largest shareholder, Engaged Capital — the same shareholder that criticized the management team in late 2018 and suggested the company examine its strategic alternatives.

Included in the agreement is the appointment of Joe Reece not only to the Del Frisco’s board but also as the Chairman of the Transaction Committee that is overseeing the company’s previously announced review of strategic alternatives. There are other conditions with the cooperation agreement, but it is the naming of Reece and the comments contained inside the accompanying press release that gives us some insight into his background. The comments read in part:

Glenn W. Welling, the founder and Chief Investment Officer of Engaged Capital, said, “I am pleased to have reached this agreement as part of a constructive dialogue with Del Frisco’s. In addition to his decades of experience working inside boardrooms, Joe Reece brings exceptional experience in investment banking and the capital markets to Del Frisco’s which will be instrumental as the Board evaluates the various opportunities available to maximize value for all shareholders.”

 Joe Reece has over 30 years of experience as a business leader. His experience working with executives at corporations, financial sponsors, and institutional investors, as well as serving on several public company boards, will bring an added dimension to the Board.

Mr. Reece is the Founder and Chief Executive Officer of Helena Capital. Mr. Reece previously served as Executive Vice Chairman and Head of the Investment Bank for the Americas at UBS Group AG from 2017-2018 as well as serving on the board of UBS Securities, LLC.

 

More on Reece’s background is contained in the press release, but as the above excerpt notes, he has ample investment banking experience. In our view, the naming of Reece as chairman of the Del Frisco’s Transaction Committee means two things. First, the company is serious about examining alternatives to remaining a stand-alone company. Second, it is also serious about extracting the greatest value for its business and brands.

As shareholders, this news has increased my degree of confidence that a transaction, be it with private equity or a strategic partner, is likely to happen. As such, we will continue to keep DFRG shares as a Thematic Leader for the time being to capture these potential gains.

  • As Living the Life Thematic Leader Del Frisco’s Restaurant Group (DFRG) gets serious with its strategic alternatives, our price target remains $14.

 

WEEKLY ISSUE: Amid an air of uncertainty we revisit a Cashless Consumption player

WEEKLY ISSUE: Amid an air of uncertainty we revisit a Cashless Consumption player

 

KEY POINTS FROM THIS ALERT

  • We are issuing a Buy on USA Technologies (USAT) shares and adding them back to the Tematica Investing Select List with a $12 price target.
  • Our price target on LSI Industries (LYTS) shares remains $11
  • Our price target on Paccar (PCAR) shares remains $85 and offers 25% upside from current levels.

 

Despite the swings up and down that we’ve seen in the stock market over the last several weeks, it might surprise you know the S&P 500, my preferred barometer of the domestic stock market, has moved down all of 1.4% over the last two months. As you know during those weeks we shed shares in both Universal Display (OLED), which have gone on to fall further, and Facebook (FB), while we added GSV Capital (GSVC) shares to the Tematica Investing Select List with a Buy rating and an $11 price target.

As I wrote this past weekend in the Toronto Sun – yes, we are spreading the thematic word to our northern neighbors – I expect the air of uncertainty of the last few weeks to result in lukewarm guidance. This will likely cause a rethink by investors given the herd’s expectation for more than 18% EPS growth by the S&P 500 this year. To say that’s aggressive even in the face of tax reform benefits to be had is an understatement. I suspect we’ll have several opportunities for the Select List in the coming weeks. In the meantime, buckle up for the fun begins early next week.

 

 

Facebook’s Zuckerberg in the hot seat

Yesterday, Facebook was a hot topic given CEO Mark Zuckerberg’s testimony to the Senate. As expected, Zuck offered up his mea culpa, once again promised to “do more” to address the company’s shortcomings when it comes to user data and privacy. While FB shares have traded higher, parsing Zuck’s comments to add more security personnel and do more, what it means is higher costs to eliminate existing and potential bad actors from its content partners. I made this point on the Intelligence Report with Trish Regain on Fox Business yesterday. This point was hammered home in this week’s Cocktail Investing podcast, in which I spoke with Interos Solutions Jennifer Bisceglie (Ep 59: Exposing the Supply Chain Security Nightmare).

Given the privacy concerns, we’re apt to see another drop in the company’s US user metrics as well as a dip in its revenue stream as advertisers backed away from Facebook. Here’s the thing, over the last 30-60 days, we’ve seen no meaningful change in revenue and EPS expectations for 1Q 2018 and 2Q 2018 for Facebook. When the company reports its quarterly results on April 25th, however, more than likely we will see some hit to its metrics and hear about the need to ramp spending in order to restore user trust. The company also needs to show the resiliency of its advertising dominated revenue stream.

What this means is just because Facebook shares have rebounded since we scuttled them a few weeks ago, there is another shoe to drop. My recommendation is we remain on the sidelines until we have a far better understanding of the financial implications to be had.

 

 

Adding back USA Technologies shares to the Select List

Last October we exited half of our position in Cashless Consumption play USA Technologies (USAT), with an 81% win, and were stopped out of the balance in February with a 67% gain. As a reminder, USA Technologies provides wireless networking, cashless transactions, asset monitoring, and other value-added services in the United States and internationally primarily through kiosks and unattended retail. All in all, the position was in USAT shares was a great investment in 2017 and early 2018, especially since the returns crushed the move in the S&P 500. I’ve kept tabs on the shares given the continued growth to be had in mobile payments and USA’s potential to be a takeout candidate.

Recently it was announced that mFoundry was getting acquired by Fidelity National Information Services (FIS), a banking and payment provider that works with some 14,000 banks worldwide, for $120 million. Monday night it was announced that point-of-sale system company VeriFone (PAY) is being acquired in a $3.4 billion deal led by private equity firm Francisco Partners and Canada’s British Columbia Investment Management Corp. Under the terms of the deal, VeriFone shareholders would receive $23.04 in cash for each share, representing a roughly 54% premium to the company’s Monday closing price of $15.

M&A activity and consolidation is a sign that an industry is beginning to mature, with larger players and financial players gobbling up technologies and products to round out their capabilities and offerings. I’ve long seen USA Technologies as company prominently riding our Cashless Consumption investing theme, but one that is bound to show up on M&A radar screens. With its revenue slated to reach roughly $175 million next year, up from $104 million in 2017, with positive EPS, this could happen sooner than previously expected.

I suspect two recent publications will help spur on this likelihood. First is “Intelligent Vending Machine Market – Global Industry Analysis, Size, Share, Trends, Growth and Forecast 2018 – 2025” — that calls for the global intelligent vending machine market to increase at a CAGR (compound annual growth rate) of 38.24% during the period 2017-2021. The second is a forecast published by Statista that shows more than 140% per annum growth for mobile point of sales to $1.3 trillion in 2022 up from $230.8 billion in 2017. Digging into this forecast, we see it reflects a combination of rising consumer adoption over the coming years as well as solid growth in transaction value per user.

On the merits of my original $12 price target, I see more than 35% upside in the shares on a fundamental basis. As mobile payments activity continues to grow, and USAT continues to expand its install base across vending, kiosk and other retail applications, I’ll look to revise my price target. Any additional upside to be had from a takeout offer, well that would just be gravy.

  • We are issuing a Buy on USA Technologies (USAT) shares and adding them back to the Tematica Investing Select List with a $12 price target.

 

 

Checking in on LSI Industries and Paccar

Each month there is a plethora of data released, some of it industry specific and some of it company specific. Recent industry data for both the construction and the truck industry are bullish for our positions in LSI Industries (LYTS) and Paccar (PCAR). Let me explain…

Year to date, shares of LSI Industries are up more than 15%, well ahead of the major market indices. I chalk this up to the favorable monthly data we’ve got in the form of the Architectural Billings Index (ABI) and construction data. In the February ABI reading marked the fifth consecutive monthly increase and the 11th monthly increase in the last 12 months. As a reminder, the ABI is a leading indicator of construction activity. Add to that the favorable February construction report that showed nonresidential construction rebounded in January following several weeks of severe cold and winter weather. As we finally put the winter weather behind us, I expect to see a pickup in nonresidential construction that reflects the ABI index. I see this as setting a favorable base for LSI’s lighting solutions, which is benefitting from the added tailwind associated with green construction that favors light-emitting diode solutions.

  • Our price target on LSI Industries (LYTS) shares remains $11

 

On a year to date basis, shares of heavy and medium duty truck company Paccar (PCAR) are down slightly, and we’re essentially flat form our mid-February addition to the Select List. Here too, the data has been more than favorable. Last week,

Late Wednesday, it was reported by FTR Transportation Intelligence that first-quarter 2018 orders for heavy-duty trucks came in at 133,900 — a 98% gain year over year and the highest level since 2006. Orders for medium-duty Class 5-7 trucks topped 84,700 for the first quarter, a 20.4% increase compared with the same period a year ago.

I expect this to lead to not only a favorable 1Q 2018 earnings report for Paccar but an upbeat outlook as well. During the upcoming earnings season, I’ll be looking for re-affirming comments for Paccar in the form of rising freight costs due to tight truck industry capacity at food and other consumer-related companies.

  • Our price target on Paccar (PCAR) shares remains $85 and offers 25% upside from current levels.