Doubling Down on Digital Infrastructure Thematic Leader

Doubling Down on Digital Infrastructure Thematic Leader

Key point inside this issue

  • We are doubling down on Dycom (DY) shares on the Thematic Leader board and adjusting our price target to $80 from $100, which still offers significant upside from our new cost basis as the 5G and gigabit fiber buildout continues over the coming quarters.

We are coming at you earlier than usual this week in part to share my thoughts on all of the economic data we received late last week.


Last week’s data confirms the US economy is slowing

With two-thirds of the current quarter behind now in the books, the continued move higher in the markets has all the major indices up double-digits year to date, ranging from around 11.5-12.0%% for the Dow Jones Industrial Average and the S&P 500 to nearly 18% for the small-cap heavy Russell 2000. In recent weeks we have discussed my growing concerns that the market’s melt-up hinges primarily on U.S.-China trade deal prospects as earnings expectations for this year have been moving lower, dividend cuts have been growing and the global economy continues to slow. The U.S. continues to look like the best economic house on the block even though it, too, is slowing.

On Friday, a round of IHS Markit February PMI reports showed that three of the four global economic horsemen — Japan, China, and the eurozone — were in contraction territory for the month. New orders in Japan and China improved but fell in the eurozone, which likely means those economies will continue to slug it out in the near-term especially since export orders across all three regions fell month over month. December-quarter GDP was revealed to be 2.6% sequentially, which equates to a 3.1% improvement year over year but is down compared to the 3.5% GDP reading of the September quarter and 4.2% in the June one.  Slower growth to be sure, but still growing in the December quarter.

Before we break out the bubbly, though, the IHS Markit February U.S. Manufacturing PMI fell to its lowest reading in 18 months as rates of output and new order growth softened as did inflationary pressures. This data suggest the U.S. manufacturing sector is growing at its slowest rate in several quarters, as did the February ISM Manufacturing Index reading, which slipped month over month and missed expectations. Declines were seen almost across the board for that ISM index save for new export orders, which grew modestly month over month. The new order component of the February ISM Manufacturing Index dropped to 55.5 from 58.2 in January, but candidly this line item has been all over the place the last few months. The January figure rebounded nicely from 51.3 in December, which was down sharply from 61.8 in November. This zig-zag pattern likely reflects growing uncertainty in the manufacturing economy given the pace of the global economy and uncertainty on the trade front. Generally speaking though, falling orders translate into a slower production and this means carefully watching both the ISM and IHS Markit data over the coming months.

In sum, the manufacturing economy across the four key economies continued to slow in February. On a wider, more global scale, J.P. Morgan’s Global Manufacturing PMI fell to 50.6 in February, its lowest level since June 2016. Per J.P. Morgan’s findings, “the rate of expansion in new orders stayed close to the stagnation mark,” which suggests we are not likely to see a pronounced rebound in the near-term. We see this as allowing the Fed to keep its dovish view, and as we discuss below odds are it will be joined by the European Central Bank this week.

Other data out Friday included the December readings for Personal Income & Spending and the January take on Personal Income. The key takeaway was personal income fell for the first time in more than three years during January, easily coming in below the gains expected by economists. Those pieces of data not only help explain the recent December Retail Sales miss but alongside reports of consumer credit card debt topping $1 trillion and record delinquencies for auto and student loans, point to more tepid consumer spending ahead. As I’ve shared before, that is a headwind for the overall US economy but also a tailwind for those companies, like Middle-class Squeeze Thematic Leader Costco Wholesale (COST), that help consumers stretch the disposable income they do have.

We have talked quite a bit in recent Tematica Investing issues about revisions to S&P 500 2019 EPS estimates, which at last count stood at +4.7% year over year, down significantly from over +11% at the start of the December quarter. Given the rash of reports last week – more than 750 in total –  we will likely see that expected rate of growth tweaked a bit lower.

Putting it all together, we have a slowing U.S. and global economy, EPS cuts that are making the stock market incrementally more expensive as it has moved higher in recent weeks, and a growing number of dividend cuts. Clearly, the stock market has been melting up over the last several weeks on increasing hopes over a favorable trade deal with China, but last week we saw President Trump abruptly end the summit with North Korea’s Kim Jong Un with no joint agreement after Kim insisted all U.S. sanctions be lifted on his country. This action spooked the market, leading some to revisit the potential for a favorable trade deal between the U.S. and China.

Measuring the success of any trade agreement will hinge on the details. Should it fail to live up to expectations, which is a distinct possibility, we could very well see a “buy the rumor, sell the news” situation arise in the stock market. As I watch for these developments to unfold, given the mismatch in the stock market between earnings and dividends vs. the market’s move thus far in 2019 I will also be watching insider selling in general but also for those companies on the Thematic Leader Board as well as the Tematica Select List. While insiders can be sellers for a variety of reasons, should we see a pronounced and somewhat across the board pick up in such activity, it could be another warning sign.


What to Watch This Week

This week we will see a noticeable drop in the velocity of earnings reports, but we will still get a number of data points that investors and economists will use to triangulate the speed of the current quarter’s GDP relative to the 2.6% print for the December quarter. The consensus GDP forecast for the current quarter is for a slower economy at +2.0%, but we have started to see some economists trim their forecasts as more economic data rolls in. Because that data has fallen shy of expectations, it has led the Citibank Economic Surprise Index (CESI) to once again move into negative territory and the Atlanta Fed’s GDPNow current quarter forecast now sat at 0.3% as of Friday.

On the economic docket this week, we have December Construction Spending, ISM’s February Non-Manufacturing Index reading, the latest consumer credit figures and the February reports on job creation and unemployment from ADP (ADP) and the Bureau of Labor Statistics. With Home Depot (HD) reporting relatively mild December weather, any pronounced shortfall in December Construction Spending will likely serve to confirm the economy is on a slowing vector. Much like we did above with ISM’s February Manufacturing Index we’ll be looking into the Non-Manufacturing data to determine demand and inflation dynamics as well as the tone of the services economy.

On the jobs front, while we will be watching the numbers created, including any aberration owing to the recent federal government shutdown, it will be the wage and hours worked data that we’ll be focusing on. Wage data will show signs of any inflationary pressures, while hours worked will indicate how much labor slack there is in the economy. The consumer is in a tighter spot financially speaking, which was reflected in recent retail sales and personal spending data. Recognizing the role consumer spending plays in the overall speed of the U.S. economy, we will be scrutinizing the upcoming consumer credit data rather closely.

In addition to the hard data, we’ll also get the Fed’s latest Beige Book, which should provide a feel for how the regional economies are faring thus far in 2019. Speaking of central bankers, next Wednesday will bring the results of the next European Central Bank meeting. Given the data depicted in the February IHS Markit reports we discussed above, the probability is high the ECB will join the Fed in a more dovish tone.

While the velocity of earnings reports does indeed drop dramatically next week, there will still be several reports worth digging into, including Ross Stores (ROST), Kohl’s (KSS), Target (TGT), BJ’s Wholesale (BJ), and Middle-class Squeeze Thematic Leader Costco Wholesale (COST) will also issue their latest quarterly results. Those reports combined with the ones this week, including solid results from TJX Companies (TJX) last week should offer a more complete look at consumer spending, and where that spending is occurring. Given the discussion several paragraphs above, TJX’s results last week, and the monthly sales reports from Costco, odds are quite good that Costco should serve up yet another report showcasing consumer wallet share gains.

Outside of apparel and home, reports from United Natural Foods (UNFI) and National Beverage (FIZZ) should corroborate the accelerating shift toward food and beverages that are part of our Cleaner Living investing theme. In that vein, I’ll be intrigued to see what Tematica Select List resident International Flavors & Fragrances (IFF) has to say about the demand for its line of organic and natural solutions.

The same can be said with Kroger (KR) as well as its efforts to fend off Thematic King Amazon (AMZN) and Walmart (WMT). Tucked inside of Kroger’s comments, we will be curious to see what the company says about digital grocery shopping and delivery. On Kroger’s last earnings conference call, Chairman and CEO Rodney McMullen shared the following, “We are aggressively investing to build digital platforms because they give our customers the ability to have anything, anytime, anywhere from Kroger, and because they’re a catalyst to grow our business and improve margins in the future.” Now to see what progress has been achieved over the last 90 or so days and what Kroger has to say about the late-Friday report that Amazon will launch its own chain of supermarkets.


Tematica Investing

As you can see in the chart above, for the most part, our Thematic Leaders have been delivering solid performance. Shares of Costco Wholesale (COST) and Nokia (NOK) are notable laggards, but with Costco’s earnings report later this week which will also include its February same-store sales, I see the company’s business and the shares once again coming back into investor favor as it continues to win consumer wallet share. That was clearly evident in its December and January same-store sales reports. With Nokia, coming out of Mobile World Congress 2019 last week, we have confirmation that 5G is progressing, with more network launches coming and more devices coming as well in the coming quarters. We’ll continue to be patient with NOK shares.


Adding significantly to our position in Thematic Leader Dycom Industries

There are two positions on the leader board – Aging of the Population AMN Healthcare (AMN) and Digital Infrastructure Dycom Industries (DY) – that are in the red. The recent and sharp drop in Dycom shares follows the company’s disappointing quarterly report in which costs grew faster than 14.3% year over year increase in revenue, pressuring margins and the company’s bottom line. As we’ve come to expect this alongside the near-term continuation of those margin pressures, as you can see below, simply whacked DY shares last week, dropping them into oversold territory.


When we first discussed Dycom’s business, I pointed out the seasonal tendencies of its business, and that likely means some of the February winter weather brought some added disruptions as will the winter weather that is hitting parts of the country as you read this. Yet, we know that Dycom’s top customers – AT&T (T), Verizon (VZ), Comcast (CMCSA) and CenturyLink (CTL) are busy expanding the footprint of their connective networks. That’s especially true with the 5G buildout efforts at AT&T and Verizon, which on a combined basis accounted for 42% of Dycom’s January quarter revenue.

Above I shared that coming out of Mobile World Congress 2019, commercial 5G deployments are likely to be a 2020 event but as we know the networks, base stations, and backhaul capabilities will need to be installed ahead of those launches. To me, this strongly suggests that Dycom’s business will improve in the coming quarters, and as that happens, it’s bound to move down the cost curve as efficiencies and other aspects of higher utilization are had. For that reason, we are using last week’s 26% drop in DY shares to double our position size in DY shares on the Thematic Leader board. This will reduce our blended cost basis to roughly $64 from the prior $82. As we buy up the shares, I’m also resetting our price target on DY shares to $80, down from the prior $100, which offers significant upside from the current share price and our blended cost basis.

If you’re having second thoughts on this decision, think of it this way – doesn’t it seem rather strange that DY shares would fall by such a degree given the coming buildout that we know is going to occur over the coming quarters? If Dycom’s customers were some small, regional operators I would have some concerns, but that isn’t the case. These customers will build out those networks, and it means Dycom will be put to work in the coming quarters, generating revenue, profits, and cash flow along the way.

In last week’s Tematica Investing I dished on Warren Buffett’s latest letter to Berkshire Hathaway (BRK.A) shareholders. In thinking about Dycom, another Buffett-ism comes to mind – “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.” Since this is a multi-quarter buildout for Dycom, we will need to be patient, but as we know for the famous encounter between the tortoise and the hare, slow and steady wins the race.

  • We are doubling down on Dycom (DY) shares on the Thematic Leader board and adjusting our price target to $80 from $100, which still offers significant upside from our new cost basis as the 5G and gigabit fiber buildout continues over the coming quarters.


As the pace of earnings slows, over the next few weeks I’ll not only be revisiting the recent 25% drop in Aging of the Population Thematic Leader AMN Healthcare to determine if we should make a similar move like the one we are doing with Dycom, but I’ll also be taking closer looks at wireless charging company Energous Corp. (WATT) and The Alkaline Water Company (WTER). Those two respectively fall under our Disruptive Innovators and Cleaner Living investing themes. Are they worthy of making it onto the Select List or bumping one of our Thematic Leaders? We’ll see…. And as I examine these two, I’m also pouring over some candidates to fill the Guilty Pleasure vacancy on the leader board.



Weekly Issue: Looking Around the Bend of the Current Rebound Rally

Weekly Issue: Looking Around the Bend of the Current Rebound Rally


Stock futures are surging this morning in a move that has all the major domestic stock market indices pointing up between 1.5% for the S&P 500 to 2.2% for the Nasdaq Composite Index. This surge follows the G20 Summit meeting of President Trump and Chinese President Xi Jinping news that the US and China will hold off on additional tariffs on each other’s goods at the start of 2019 with trade talks to continue. What this means is for a period of time as the two countries look to hammer out a trade deal during the March quarter, the US will leave existing tariffs of 10% on more than $200 million worth of Chinese products in place rather than increase them to 25%.  If after 90 days the two countries are unable to reach an agreement, the tariff rate will be raised to 25% percent.

In my view, what we are seeing this morning is in our view similar to what we saw last week when Fed Chair Powell served up some dovish comments regarding the speed of interest rate hikes over the coming year – a sigh of relief in the stock market as expected drags on the economy may not be the headwinds previously expected. On the trade front, it’s that tariffs won’t escalate at the end of 2018 and at least for now it means one less negative revision to 2019 EPS expectations. In recent weeks, we’ve started to see the market price in the slowing economy and potential tariff hikes as 2019 EPS expectations for the S&P 500 slipped over the last two months from 10%+ EPS growth in 2019 to “just” 8.7% year over year. That’s down considerably from the now expected EPS growth of 21.6% this year vs. 2017, but we have to remember the benefit of tax reform will fade as it anniversaries. I expect this to ignite a question of what the appropriate market multiple should be for the 2019 rate of EPS growth as investors look past trade and the Fed in the coming weeks. More on that as it develops.

For now, I’ll take the positive performance these two events will have on the Thematic Leaders and the Select List; however, it should not be lost on us that issues remain. These include the slowing global economy that is allowing the Fed more breathing room in the pace of interest rate hikes as well as pending Brexit issues and the ongoing Italy-EU drama. New findings from Lending Tree (TREE) point to consumer debt hitting $4 trillion by the end of 2018, $1 trillion higher than less five years ago and at interest rates that are higher than five years ago. Talk about a confirming data point for our Middle-class Squeeze investing theme. And while oil prices have collapsed, offering a respite at the gas pump, we are seeing more signs of wage inflation that along with other input and freight costs will put a crimp in margins in the coming quarters. In other words, headwinds to the economy and corporate earnings persist.

On the US-China trade front, the new timeline equates to three months to negotiate a number of issues that have proved difficult in the past. These include forced technology transfer by U.S. companies doing business in China; intellectual-property protection that the U.S. wants China to strengthen; nontariff barriers that impede U.S. access to Chinese markets; and cyberespionage.

So, while the market gaps up today in its second sigh of relief in as many weeks, I’ll continue to be prudent with the portfolio and deploying capital in the near-term.  At the end of the day, what we need to see on the trade front is results – that better deal President Trump keeps talking about – rather than promises and platitudes. Until then, the existing tariffs will remain, and we run the risk of their eventual escalation if promises and platitudes do not progress into results.


The Stock Market Last Week

Last week we closed the books on November, and as we did that the stock market received a life preserver from Federal Reserve Chair Powell, which rescued them from turning in a largely across-the-board negative performance for the month. Powell’s comments eased the market’s concern over the pace of rate hikes in 2019 and the subsequent Fed November FOMC meeting minutes served to reaffirm that. As we shared Thursday, we see recent economic data, which has painted a picture of a slowing domestic as well as global economy, giving the Fed ample room to slow its pace of rate hikes. 

While expectations still call for a rate increase later this month, for 2019 the consensus is now looking for one to two hikes compared to the prior expectation of up to four. As we watch the velocity of the economy, we’ll also continue to watch the inflation front carefully given recent declines in the PCE Price Index on a year-over-year basis vs. wage growth and other areas that are ripe for inflation.

Despite Powell’s late-month “rescue,” quarter to date, the stock market is still well in the red no matter which major market index one chooses to look at. And as much as we like the action of the past week, the decline this quarter has erased much of the 2018 year-to-date gains. 


Holiday Shopping 2018 embraces the Digital Lifestyle

Also last week, we had the conclusion of the official kickoff to the 2018 holiday shopping season that spanned Thanksgiving to Cyber Monday, and in some cases “extended Tuesday.” The short version is consumers did open their wallets over those several days, but as expected, there was a pronounced shift to online and mobile shopping this year, while bricks-and-mortar traffic continued to suffer. 

According to ShopperTrak, shopper visits were down 1% for the two-day period compared to last year, with a 1.7% decline in traffic on Black Friday and versus 2017. Another firm, RetailNext, found traffic to U.S. stores fell between 5% and 9% during Thanksgiving and Black Friday compared with the same days last year. For the Thanksgiving to Sunday 2018 period, RetailNext’s traffic tally fell 6.6% year over year. 

Where were shoppers? Sitting at home or elsewhere as they shopped on their computers, tablets and increasingly their mobile devices. According to the National Retail Federation, 41.4 million people shopped only online from Thanksgiving Day to Cyber Monday. That’s 6.4 million more than the 34.7 million who shopped exclusively in stores. Thanksgiving 2018 was also the first day in 2018 to see $1 billion in sales from smartphones, according to Adobe, with shoppers spending 8% more online on Thursday compared with a year ago. Per Adobe, Black Friday online sales hit $6.22 billion, an increase of 23.7% from 2017, of which roughly 33% were made on smartphones, up from 29% in 2017.

The most popular day to shop online was Cyber Monday, cited by 67.4 million shoppers, followed by Black Friday with 65.2 million shoppers. On Cyber Monday alone, mobile transactions surged more than 55%, helping make the day the single largest online shopping day of all time in the United States at $7.9 billion, up 19% year over year. It also smashed the smartphone shopping record set on Thanksgiving as sales coming from smartphones hit $2 billion.

As Lenore Hawkins, Tematica’s Chief Macro Strategist, and I discussed on last week’s Cocktail Investing podcast, the holiday shopping happenings were very confirming for our Digital Lifestyle investing theme. It was also served to deliver positive data points for several positions on the Select List and the Thematic Leader that is Amazon (AMZN). These include United Parcel Service (UPS), which I have long viewed as a “second derivative” play on the shift to digital shopping, but also Costco Wholesale (COST) and Alphabet/Google (GOOGL). Let’s remember that while we love McCormick & Co. (MKC) for “season’s eatings” the same can be said for Costco given its food offering, both fresh and packaged, as well as its beer and wine selection. For Google, as more consumers shop online it means utilizing its search features that also drive its core advertising business.

As we inch toward the Christmas holiday, I expect more data points to emerge as well as more deals from brick & mortar retailers in a bid to capture what consumer spending they can. The risk I see for those is profitless sales given rising labor and freight costs but also the investments in digital commerce they have made to fend off Amazon. Sales are great, but it has to translate into profits, which are the mother’s milk of EPS, and that as we know is one of the core drivers to stock prices.


Marriott hack reminds of cyber spending needs

Also last week, we learned of one of the larger cyber attacks in recent history as Marriott (MAR) shared that up to 500 million guests saw their personal information ranging from passport numbers, travel details and payment card data hacked at its Starwood business. As I wrote in the Thematic Signal in which I discussed this attack, it is the latest reminder in the need for companies to continually beef up their cybersecurity, and this is a profound tailwind for our Safety & Security investing theme as well as the  ETFMG Prime Cyber Security ETF (HACK) shares that are on the Select List.


The Week Ahead

Today, we enter the final month of 2018, and given the performance of the stock market so far in the December quarter it could very well be a photo finish to determine how the market finishes for the year. Helping determine that will not only be the outcome of the weekend’s G-20 summit, but the start of November economic data that begins with today’s ISM Manufacturing Index and the IHS Markit PMI data, and ends the week with the monthly Employment Report. Inside those two reports, we here at Tematica be assessing the speed of the economy in terms of order growth and job creation, as well as inflation in the form of wage growth. These data points and the others to be had in the coming weeks will help firm up current quarter consensus GDP expectations of 2.6%, per The Wall Street Journal’s Economic Forecasting Survey that is based on more than 60 economists, vs. 3.5% in the September quarter.

Ahead of Wednesday’s testimony by Federal Reserve Chair Powell on “The Economic Outlook” before Congress’s Joint Economic Committee, we’ll have several Fed heads making the rounds and giving speeches. Odds are they will reinforce the comments made by Powell and the November Fed FOMC meeting minutes that we talked about above. During Powell’s testimony, we can expect investors to parse his words in order to have a clear sense as to what the Fed’s view is on the speed of the economy, inflation and the need to adjust monetary policy, in terms of both the speed of future rate hikes and unwinding its balance sheet. Based on what we learn, Powell’s comments could either lead the market higher or douse this week’s sharp move higher in the stock market with cold water.

On the earnings front this week, we have no Thematic Leaders or Select List companies reporting but I’ll be monitoring results from Toll Brothers (TOL), American Eagle (AEO), Lululemon Athletica (LULU), Broadcom (AVGO) and Kroger (KR), among others. Toll Brothers should help us understand the demand for higher-end homes, something to watch relating to our Living the Life investing theme, while American Eagle and lululemon’s comments will no doubt offer some insight to the holiday shopping season. With Broadcom, we’ll be looking at its demand outlook to get a better handle on smartphone demand as well as the timing of 5G infrastructure deployments that are part of our Disruptive Innovators investing theme. Finally, with Kroger, it’s all about our Clean Living investing theme and to what degree Kroger is capturing that tailwind.


Our Costco thesis remains intact

Our Costco thesis remains intact

Last night Costco Wholesale (COST) reported quarterly results that in our view are being misinterpreted by investors. While the company reported EPS for the quarter came in at $1.59 per share that included a $0.17 per share tax benefit that resulted from tax legislation passed by Congress vs. the expected $1.45 per share, it’s top line results continue to show Costco making wallet and market share gains. Net sales for the quarter came in at $32.3 billion, a 10.8% increase over the $29.1 billion achieved in the year-ago quarter. Excluding the impact of FX and gas, Costco sales rose 5.4% year over year for the quarter.

In our view, context is key and pitting Costco top-line results vs. those for Target (TGT) or Kroger (KR) confirm those share gains. For their latest quarters, Target reported adjusted top-line growth of 3.6% year over year, while this morning Kroger reported year over year sales growth of 2.7% excluding fuel. Also, scrutinizing Costco’s internal metrics confirm those share gains.  These include membership renewal rates (90.1% in the U.S. for the quarter) and membership growth (50.4 million member households vs. 49.9 million at the end of the prior quarter).

From a geographic perspective, U.S. sales rose 7.1% (5.7% ex-gas and FX); Canada + 8.7% (2.5% ex gas and FX); and Other/International up 15.7% (7.4% ex gas and FX) for the quarter with E-commerce sales up more than 28% year over year. Those share gains were also reflected in the February same-store sales data that was shared last night as well. For the month, net sales rose 12.8% to $10.21 billion with:

  • US up 9.0% (7.5% ex-FX and gas)
  • Canada +8.4% (up 3.2% ex-FX and gas)
  • Other/International up 22.2% (14.1% ex-FX and gas)
  • E-commerce +38% (up 37% ex-FX and gas)

In addition to the brick & mortar wallet share gains being had, we’d also note the reported E-commerce growth metrics. Management has continued to focus on improving its digital offering while also improving its search capabilities and checkout experience. I also suspect its relationship with Instacart and others is driving digital grocery, which should alleviate bearish concerns over Amazon as it relates to Costco’s business.

On a side note, I was at a local Costco this past weekend when it opened, and it was not only packed to the gills, but the checkout lines were several people deep as was the new membership line.

From a fundamental perspective, we see the company has benefitted and continues to do so from the lack of domestic wage growth for roughly 80% of the workforce over the last year that is prompting debt-laden consumers to stretch disposable spending dollars where they can. The latest data from the Federal Reserve showing a gap up in credit card charge-offs in 4Q 2017 vs. 4Q 2016 serves as a confirming point and sets the stage for more should the Fed boost interest rates as expected. The bottom line is given economic constraints, Cash-Strapped Consumers will continue to flock to Costco be it in person or online as the company continues to expand its offering.

As we have discussed previously, one of the key differentiators for Costco is its high margin membership fee business, which accounts for more than 70% of the company’s pre-tax income. During the quarter Costco slowed its pace of new warehouse openings to 1 from 5 in the prior quarter but shared it aims to open two in the current quarter followed by 18 openings and three relocations in the subsequent quarter. All told, Costco will open 22-23 new locations during the current fiscal year, which sets the stage for continued membership fee income growth in the coming quarters.

Understanding these two perspectives keeps us bullish on COST shares.

  • Our price target on Costco Wholesale (COST) shares remains $200



Kicking the tires on Rite Aid shares

Kicking the tires on Rite Aid shares

There are several facets to our Aging of the Population investment theme, ranging from the obvious — assisted living, pharmaceuticals, financial services and vitamins and supplements — to the not so obvious such as online shopping, disruptive technology and artificial intelligence which can help maintain independence as the physical realities of an aging body take hold.

We as a people are also living longer, and statistics tabulated by Milliman show an encouraging pattern of increased life expectancy which will trigger increased consumption patterns in the population for medical services and pharmaceuticals. This should be a positive tailwind to pharmacy companies, such as CVS Health (CVS), Walgreen Boots (WBA) and Rite Aid (RAD) that are also pivoting their businesses toward health and wellness offerings. This tailwind also bodes well for the pharmacy businesses at Tematica Select List holding Costco Wholesale (COST) and other companies, like Kroger (KR) and other grocery chains, that have pharmacies.

Looking back over 2017, it was a painful year for Rite Aid, as its shares fell around 75%. Part of that reflects regulators blocking the acquisition of Rite Aid by Walgreens Boots Alliance for some $9.4 billion. After attempts to structure a deal that would placate regulators, this past September the two companies announced that Rite Aid would instead sell off more than 1,900 stores and three distribution centers to Walgreens for $4.375 billion in cash. Rite Aid is in the process of transferring those stores and facilities over to Walgreens, a process that’s expected to span through most of 2018. In exchange, Rite Aid will be receiving an influx of cash, which it has earmarked to primarily reduce the outstanding debt on its balance sheet. That debt reduction should drive a favorable decline in interest expense, enabling the company to drop more to its bottom line in the coming quarters.

Current Wall Street expectations call for Rite Aid to post losses of $0.06 per share in 2018 and $0.03 per share in 2019. Those consensus figures are tallied from six active analysts following Rite Aid and their consensus price target is $2.07, with a consensus view of “Hold.”

As I mentioned above, we here at Tematica see the aging of the U.S. population unfolding as more baby boomers pass 70 years of age, making it a multi-year tailwind to the pharmacy business, particularly as people are living longer. That’s not to say it will be easy peasy for Rite Aid considering the pharmacy businesses at CVS Health, Walgreens, Walmart (WMT)Kroger (KR), Costco Wholesale and others. Note, we haven’t even mentioned the rumblings of bricks and mortar crusher Amazon’s (AMZN) potential entry into the category.

I’m not going to sugar coat it, folks. What all of this tells me is Rite Aid is a turnaround story, and expectations are low, which also makes it a “show-me story.”

The hope/opportunity is that the Rite Aid management team is able to transform the company quicker than expected by leveraging the 20.7 million customers in its loyalty program, improving its offerings and shrinking its operating costs as it looks to offset reimbursement pressure. Management has already identified some $96 million in administrative cost savings, and I suspect there could be more savings to be had in the coming quarters as Rite Aid continues to right size itself.

I also see the company’s predominantly domestic footprint making it a solid beneficiary in terms of tax reform. As I shared in yesterday’s weekly issue of Tematica Investing, tax reform related EPS benefits are arguably all over the map, but Rite Aid should see some lift to its 2018 EPS forecast – the question is how much? More than likely this combination will lead to better-than-expected EPS performance over the coming quarters, and with the current low expectations that would likely move RAD shares, especially if its analyst following became either more bullish or less bearish on the company.

The question is one of magnitude in terms of tax reform benefits vs. expectations, and for that reason, I’m inclined to hold off on adding RAD shares to the Select List until we have some clarity on this key issue, especially since Rite Aid has been received income tax benefits in recent quarters. With the company’s next earnings report likely to occur in early April, we can look at results from CVS Health and Walgreens to get a handle on the potential tax reform impact to be had at Rite Aid. CVS shared that as a result of tax reform it sees its effective tax rate to run near 27% this year, which should increase its cash flow by roughly $1.2 billion, but Walgreen’s recent guidance did not factor in any impact from tax legislation.

Not very helpful, and rather than jump the gun on this, I’ll continue to assess the potential benefit on Rite Aid’s business and what it could mean for its shares. Until that clarity arrives, I’m adding Rite Aid shares to the Tematica Contender List as part of our Aging of the Population investment theme.

No need to catch the falling knife that is Blue Apron, we have Amazon

No need to catch the falling knife that is Blue Apron, we have Amazon

This year we’ve seen several busted initial public offerings, and one of them is Blue Apron (APRN), which came public at near $10 and been essentially cut in half over the last four months. As was joked in the business pages, that is “less than the price of one of its meals.”

Such a sharp drop raises the question, “Could the fall in the stock be overdone?”

That’s a fair question as one of the tools in the investing kit is picking off undervalued stocks. The keyword that makes all of the difference is “undervalued” as it relies on the notion that at a certain point, other investors and the market will recognize the potential value to be had in the underlying business.

Let’s remember the impetus that led to Blue Apron landing on the busted IPO list: Amazon’s (AMZN) intent to acquire Whole Foods and trademarking its own meal kit offering. This made Blue Apron, along with Kroger (KR) and other grocery stores, the latest company to be upended by Amazon. Last week we saw Amazon add eMeals to AmazonFresh. Through the program, eMeals subscribers can now send their shopping list, which is automatically generated for all meals selected each week, to AmazonFresh as well as Walmart (WMT) Grocery and Kroger ClickList. Another thorn in the side of Blue Apron.

There was more news for Blue Apron last week as the company announced a “company-wide realignment” to “focus the company on future growth and achieving profitability…” As part of that realignment, Blue Apron said it would be cutting 6% of its workforce. Let’s remember that this comes less than a handful of months after the company went public!

But it gets worse.

Current consensus expectations have Blue Apron losing $1.56 per share this year, with bottom-line losses narrowing to -$0.73 per share in 2018. Keep in mind the company botched its first quarter as a public company when it posted a second-quarter loss of $0.47 per share vs. the expected $0.30 per share loss. That’s a huge miss out of the gate as a newly public company.

Put that out of the box earnings miss together with its headcount reductions and we have a pretty clear credibility problem with the management team, which is likely to be outclassed and out-muscled by Amazon and other grocery chains. And that raises the question as to what is Blue Apron’s competitive advantage? Recipes? Ingredients? Those can both be replicated by Amazon, especially with Whole Foods, and others as they scale up their natural and organic offerings to ride our Food with Integrity investment theme tailwind.

As we ponder that, let’s not forget that Blue Apron closed its June 2017 quarter with $63.3 million in cash on its balance sheet. That compares to the net loss of $83.8 million during the first half of 2017 and the expected net loss of that is expected to grow in the second half of the year. Simple math tells us, the company is poised to face a cash crunch or do a painful secondary offering to bring in additional cash. We’ve seen this movie before and it never has a happy ending.

The bottom line is APRN shares are cheap, and they are cheap for a reason – they are running headlong into the headwind of our Connected Society and Food with Integrity investment themes. My advice is to move along and not be tempted by the falling knife that is APRN. Better to focus on a well-positioned company that has an enviable or defendable competitive advantage. To us here at Tematica, that is Amazon (AMZN) in spades.

  • Our price target on Amazon (AMZN) shares is $1,150.
Initial observations of the Amazon-Whole Foods marraige

Initial observations of the Amazon-Whole Foods marraige

With the official closing of the Amazon (AMZN) acquisition of Whole Foods Market (WFM) yesterday, I made a point of visiting two locations near me outside of Washington, D.C. The traffic in the store was greater than usual for a Monday, as were the length of the lines at the checkout counters. There were a number of prices that were better as has been reported, and there was a pop-up stand for Amazon Echo devices.

What was missing, however, were the appropriate Amazon’s private label brands that are slated to hit shelves at Whole Foods locations, as well as the lockers that will allow for both delivery of items as well as returns.

I say appropriate items because Amazon has quietly expanded the scope of its private label products from food (Happy Belly, Mama Bear and Wickedly Prime) and supplements (Amazon Elements) to fashion, electronics, household items, cosmetics, lingerie, and furniture to name a several. Conversations with the store managers confirmed Amazon private label products will be turning over in the store “over time” where appropriate. That hasn’t slowed Amazon from including Whole Foods’ private label brand, 365 Everyday Value, on its website although based on some basic searching 365 Everyday Value has yet to be offered under Amazon Fresh.

Like many large acquisitions, integration and the targeted synergies come over time, and I are still in the very early days of these two companies being under one roof. I expect the rollout of Amazon private label products to be had at the 470 Whole Foods locations in the U.S. and the U.K. over the coming quarters with added benefits coming (Amazon Fresh, Amazon meal kits and the instillation of Amazon Prime as the new membership rewards program).

As the combined entity flexes its product and logistical offering, I suspect before too long the conversation will shift from “death of the mall” to “death of the grocery store.” One of the “secret weapons” that Amazon has over its grocery and other competitors that range from Kroger (KR) to Wal-Mart (WMT) is the high margin Amazon Web Services, which continues to be embraced by corporate America as it increasingly migrates to the cloud.

One thing I am pondering is based on the number of Whole Foods locations, will Amazon look to make other grocery acquisitions in a bid to reach key markets that have a high concentration of Amazon Prime customers? If so, this could quickly turn the conversation from “the death of the mall” to the “death of the grocery store.”


  • We continue to rate Amazon (AMZN) shares a Buy with a $1,150 price target.

Source: Whole Foods prices cheaper with Amazon – Business Insider

WEEKLY ISSUE: Doubling down on COST as yet another cyber attack provides support for our HACK position

WEEKLY ISSUE: Doubling down on COST as yet another cyber attack provides support for our HACK position


In this Week’s Issue:

  • Doubling Down on Costco Shares
  • More Cyber Attacks, Mean It’s a Good Time to Own HACK Shares
  • Alphabet Gets Wrapped on the Knuckles


We’re moving deeper into summer with more schools across the country finishing out the academic year. Most would expect that would mean a slower go of things, but that’s hardly been the case. True, the only economic data point to be had this week was the May Durable Orders report, which simply isn’t going to speed up anyone’s 2Q 2017 GDP forecast. Nondefense capital goods orders excluding aircraft — a proxy for business spending — declined 0.2 percent, while shipments of these same goods, which factor into the GDP computation, also declined 0.2 percent. We continue to think businesses are sitting on the sidelines as the Trump Slump is likely to continue through the summer months and into the fall.

At the same time, we’ve also had commentary from some of the Fed heads about the stock market including this from yesterday from San Francisco Federal Reserve Bank President John Williams:

 “The stock market seems to be running pretty much on fumes.”

He’s not alone in thinking the market is overvalued. A record 44 percent of fund managers polled in a monthly survey from Bank of America Merrill Lynch saw equities as overvalued this month, up from 37 percent last month. The surveyed body included 200 panelists with a combined $596 billion under management participated in the survey.

With the S&P 500 trading at roughly 18x 2017 expectations that have more downside risk than upside surprise potential as we discussed in this week’s Monday Morning Kickoff, we suspect we are likely to see more announcements like the one yesterday from General Motors (GM). If you missed it, GM now expects U.S. new vehicle sales in 2017 will be in the “low 17 million” unit range, versus last year’s record of 17.55 million units. Keep in mind, GM has been hard hit lately and seen its US inventory creep up to 110 days of supply in June, up from 100 in May. As GM said, “the market is definitely slowing” and that means we’re going to see more widespread pressure on the likes of Ford Motor Company (F), Honda Motor Company (HMC) and other auto manufactures. Lower production volume also means reduced demand at key suppliers like Federal Mogul (FDML), Dana Corp. (DAN), Delphi Automotive (DLPH) and similar companies. Pair this with the May Durable Orders report, and it’s another reason to see a step down in GDP for the back half of the year.

At the same time, yesterday also brought the news of the Petya ransomware, which in our view not only serves to reinforce our Safety & Security investing theme as well as our position in PureFunds ISE Cyber Security ETF (HACK)shares (more on that below), but also reminds us of the tailwinds powering all of our investing themes here at Tematica. We don’t look to own sectors, but rather companies that are benefitting from multi-year thematic tailwinds – that has been and will continue to be our guiding light, and if we have the opportunity to improve our cost basis in the coming weeks we’ll aim to take it.

In fact, we’re doing that today with shares of Costco Wholesale (COST) right now…


Doubling Down on Costco Shares

Last week we added back shares of Costco Wholesale (COST) to the Tematica Select List given what we saw (and continue to see) as an overreaction to the Amazon (AMZN)Whole Foods (WFM) tie up. Not only hasn’t the transaction closed yet, and it won’t for several months until that occurs. It will be deep into 2018 before any Whole Foods integration is even close to being done. This tells us the market is shooting first and asking questions later… potentially much later.

With COST shares falling another 2 percent over the last week, bringing the two-week drop to more than 11 percent, we’ll use the current share price to improve the position’s cost basis and grow the respective position size to the overall Select List. As we’ve shared before, the real key to Costco’s profits and EPS is its membership fee income, and with more locations set to open in the coming quarters plus a recent membership price hike, we remain bullish on COST shares.

  • With COST shares closing last night at $159.26, we’re going to use the continued drop in share price to lower our cost basis by adding a second position in the shares as of this morning.
  • Our price target on Costco Wholesale (COST) shares remains $190
  • As we scale into the position today, we are setting a stop loss at $135, but we’ll look to move that higher as COST shares rebound.




More Cyber Attacks, Mean It’s a Good Time to Own HACK Shares

When we added PureFunds ISE Cyber Security ETF (HACK) shares back in February this year to the Select List as part of our Safety & Security investing theme, we acknowledge the frequency of cyber attacks would be a likely catalyst for the shares. Simply put, a higher frequency of attacks would not only spur cybersecurity spending, but odds are it would also act as a rising tide as media attention shifts to these attacks lifting all cyber security boats including our HACK shares.

We recently witnessed the WannaCry ransomware attacks, and as we learned during our Cocktail Investing Podcast conversation with Yong-Gon Chon, CEO of cyber security company Focal Point, following attacks were going to get bigger and bolder. That’s exactly what we saw yesterday with “Petya” ransomware that hit firms both large and small with ransomware in Europe and now the US. The attack was first reported in Ukraine, where the government, banks, state power utility and Kiev’s airport and metro system were all affected. It soon spread to including the advertising giant WPP, French construction materials company Saint-Gobain and Russian steel and oil firms Evraz and Rosneft. The new malware uses an exploit called EternalBlue to spread by taking advantage of vulnerabilities in Microsoft Corp.’s Windows operating system, similar to WannaCry and the infected computers display a message demanding a Bitcoin ransom worth $300. Those who pay are asked to send confirmation of payment to an email address.

According to a study by IBM (IBM), the amount of spam containing ransomware surged to 40 percent by the end of 2016 from just 0.6 percent in 2015. While many ransomware attacks are blocked by security software, the number of infections getting through is growing. Symantec (SYMC) said it detected 463,000 ransomware infections in 2016, 36 percent higher than the year before. Odds are that figure is only to go higher in 2017 and 2018.

  • We continue to have a Buy on PureFunds ISE Cyber Security ETF (HACK) with a price target of $35.




Alphabet Gets Wrapped on the Knuckles

Alphabet (GOOGL) is one of the building blocks of our Connected Societyinvesting theme due primarily, but not entirely to the company’s market share leading position in digital search. We define digital search much the way we do digital commerce – it comprises both desktop and mobile activity. Alphabet is also home to some of the most widely used apps across the various smartphone operating systems including YouTube (#2), Google Search (#4), Google Maps (#5), Google Play (#6), Gmail (#8) and Google Calendar (#11).

Google’s YouTube is expanding not only into original content with YouTube Red, but recently copped to targeting TV advertising dollars as well as eventually creating video content with “big name stars.” Alphabet is also bringing a YouTube TV service to market that will stream broadcast TV much the way AT&T’s (T) DirectTV Now and Hulu do. Let’s not forget Google Wallet or Android Wallet.

Putting it all together, Alphabet has several thematic tailwinds pushing its respective businesses as well as burgeoning ones like its Waymo self-driving car initiative that recently partnered with Avis Budget Group (CAR).

One of the items we’ve been watching and waiting for with Alphabet (GOOGL)has been the pending fine from EU antitrust regulators following the ruling that Alphabet had abused its “search engine” power and promoted its own shopping service in search results. Following several years of investigation, yesterday that EU body hit Alphabet with a decision that included a record $2.71 billion (€2.4 billion) fine and “ordered the search giant to apply the same methods to rivals as its own when displaying their services.” Google has 90 days to end the conduct and explain how it will implement the decision, or face additional penalties of up to 5 percent of average daily global revenue.

On its face, the $2.7 billion is a drop in the cash bucket for Alphabet, which ended the March quarter with $92.5 billion in cash. Alphabet could simply swallow the fine, but the implication of the decision could reshape how Google presents search results in Europe if not eventually elsewhere. As such, we expect the company will review the decision and consider an appeal, thereby dragging this out for another few months.

In the short-term the fine is a bump in the road for Alphabet, but we’ll continue to see how this situation develops further and what its implications are for not only Google, but other dominant technology firms such as Amazon (AMZN)that also rely on displayed search results, but also offer their own proprietary products. As we monitor these and other developments, we continue to Alphabet shares as ones to own not trade as we continue to migrate deeper into an increasingly connected society. The same goes for Amazon shares.

  • Our price targets on AMZN and GOOGL shares remain $1,150 and $1,050, respectively.


Costco vs Amazon? We see opportunity for both

Costco vs Amazon? We see opportunity for both


In this Week’s Issue:

  • Amazon (AMZN) to Buy Whole Foods (WFM) and We Add Costco Wholesale (COST) Shares Back to the Tematica Select List
  • Investor Short-Sightedness Triggers United Natural Foods (UNFI) Stop-Loss
  • Checking in on Dycom (DY) Shares
  • While Disney’s (DIS) Summer Movie Slate Hasn’t Lived Up to Expectations, We Still See Some Bright Spots



We’ve given each other some hard lessons lately, but we ain’t learnin’

The quote above is a lyric by Bruce Springsteen, and it came to mind as we look at this week’s market.  So far, we took one step up on Monday, and then one step back on Tuesday, essentially wiping out any gains. Let’s hope we don’t end up following Springsteen’s full lyrics and taking “one step up and two steps back” as the rest of the week plays out.

The biggest hit so far this week was had in the energy “sector” as oil prices continued their move down, officially moving into bearish territory. Crude’s slide is due not only to growing supply, but also weak demand. Not to sound like a know it all, but supply-demand dynamics are pretty much economics 101, and when we see ramping US supply alongside a slowing domestic economy, it hasn’t been hard to guess where the price of oil is headed.

The proverbial second shoe to watch is earnings. We mention this because according to FactSet the energy sector is expected to be the biggest contributor to EPS growth for the S&P 500 in the current quarter. Oil, however, closed last night at $43.34, well below the $51 level it averaged in 1Q 2017 and the $52 mean estimate for the average price of oil for Q2 2017.

What this likely means is we are going to see negative revisions for energy earnings if not for the current quarter then for the back half of 2017. As those revisions happen, the ripple effect will bring down expected earnings growth for the S&P 500 as well. And that’s before we share the New York Fed’s Nowcast for 2Q 2017 GDP hit 1.9 percent this week with 3Q 2017 falling to 1.5 percent.

Then there is the upcoming health care battle in the Senate and the rest of the Trump agenda (repatriation, tax reform, infrastructure), which as we’ve been saying is far more likely to begin anew after the 2017 elections.

The bottom line is, it looks like the market is bound to have a bout of indigestion come 2Q 2017 earnings season that kicks off soon after the July 4th holiday. Of course, here at Tematica, we don’t “buy the market,” but rather capitalize on our multi-year thematic tailwinds. With that in mind, in this week’s issue of Tematica Investing we’re bringing an old favorite back into the fold – Cash-Strapped Consumer play Costco Wholesale (COST). We also share our thoughts on Amazon (AMZN) buying Whole Foods Market (WFM), and check in on both Dycom (DY) and Disney (DIS).



Amazon (AMZN) to Buy Whole Foods (WFM) and We Add Costco Wholesale (COST) Shares Back to the Tematica Select List

If you were pulling an abbreviated Rip Van Winkle over the last few days and missed the headlines, Amazon (AMZN) is back in the news as it once again looks to implement what we can only be viewed as an amping up of its creative destruction on the grocery industry. Friday morning the company announced it has a definitive agreement to acquire Whole Foods Market (WFM) for $42 per share in all cash transaction valued at $13.7 billion. With $21.5 billion in cash and just $7.7 billion in total debt on a balance sheet with $21.7 billion in equity, we see little if any financing challenges for Amazon.

Per usual, Amazon was scant on details, but we see this acquisition catapulting its position in grocery, particularly organic and natural that continues to be one of the fastest growing grocery categories. Amazon should also be able to utilize Whole Foods warehouse and stores to expand the reach of its Amazon Fresh business at a time when more consumers are embracing online grocery delivery. With companies like Panera Bread (PNRA) sharing that 26% of its weekly orders are now generated digitally, we suspect we are at or near the tipping point for digital grocery. For those unfamiliar with Whole Foods’s existing online delivery offering, it currently offers delivery in under 1 hour from a growing number of locations, which strategically fits with Amazon’s Prime Now offering.

According to the “The Digitally Engaged Food Shopper” report from Nielsen (NLSN), currently a quarter of American households buy some groceries online, up from 19% in 2014. The report goes on to forecast that more than 70 percent will engage with online food shopping within 10 years resulting in online grocery capturing 20 percent share up from 4.3 percent in 2016. When dealing with percentages, we prefer to consider the actual dollar amounts and in this case, it means online grocery jumping to more than $100 billion by 2025, up from $20.5 billion in 2016.

Now, a quick word on this decade forecasts. We tend to ignore the actual numbers, preferring instead to note the vector, which in this case is solidly higher and fits with our increasingly connected society. That said, we know Amazon tends to play the long game, and we see them once again doing this by entering into this transaction with Whole Foods, a deal that offers a solid base from which to flex its logistical muscles. We find this move far more appealing than if Amazon opted to build it from scratch, given the existing infrastructure as well as the simple fact that for the duration Whole Foods management team will continue to run the chain after the deal closes and stores will continue to operate under the Whole Foods brand.

In a nutshell, we see this as a win-win for Amazon as it looks to battle Kroger (KR), Sprouts Farmer (SFM), Wal-Mart (WMT) and others that have ventured into the grocery space like Target (TGT) for consumer wallet share.

We would point out that we are not as negative as some over the potential impact on Costco Wholesale (COST), which derives a significant percentage of its operating profit from membership fees. Costco continues to expand its warehouse footprint, which bodes well for growing its all-important membership fee income.

Following the Amazon-Whole Foods news, Costco shares are off roughly 9 percent and we see this as more than just an overreaction. Rather we see this as an opportunity to get back into COST shares, as the company continues to both expand its footprint as well as continue to help the Cash-Strapped Consumer stretch their disposable income. For those subscribers that have been with us a while, you’ll remember Costco was added to the Tematica Select List last September and we ended up selling half the shares and were stopped out of the second half on a dip of the shares. All told, our positions generated a 14.6 percent return and given the recent dip in the shares, we’re ready to add another batch of shares to our cart:

  • We are adding back shares of Costco Wholesale (COST) back to the Tematica Select List with a price target of $190.
  • As we will look to opportunistically improve the cost basis of this position, there is no recommended stop loss at this time.

Getting back to Amazon, there has been no shortage of headlines speculating what may or may not happen in the grocery sector with the move. Our position is we see Amazon using Whole Foods as a platform that not only expands its Amazon Fresh footprint, it also improves Amazon’s position within our Food with Integrity investing theme. That brings the number of thematic tailwinds pushing on Amazon to 6 – Connected Society, Cash-Strapped Consumer, Content is King, Cashless Consumption, Rise & Fall of the Middle Class and now Food with Integrity. As we share this we once again we find ourselves once again thinking Amazon is business and a stock to own, not trade as it continues to be a disruptor to be reckoned with.

  • We are boosting our price targets on Amazon (AMZN) shares to $1,150 from $1,100 to factor in the existing Whole Foods business.
  • We continue to rate AMZN shares a Buy.



Investor Short-Sightedness Triggers UNFI Stop-Loss

From time to time, we say our goodbyes to a position on the Tematica Select List. The reasons can be a position has reached its price target, original thematic tailwinds may give way to headwinds or the stop-loss gets triggered.

This last one is what happened with United Natural Foods (UNFI) when the shares crossed below the $38.50 stop loss that was set last week. Interestingly enough, they passed through that stop loss level on the news of Amazon (AMZN) acquiring Whole Foods Market (WFM), which would likely do more good for UNFI’s business than harm. This isn’t the first nor is it likely to be the last of the herd shooting first and asking questions later.

  • We’ll place UFNI shares on the Thematic Contender’s list, and look for a compelling re-entry point should one emerge like it did with Costco shares.



Checking in on Dycom Shares

We remained patient with shares of Dycom (DY) after the company offered weaker than expected guidance inside its March quarter earnings. Over the last few weeks, we have been rewarded for that patience as DY shares have rebounded 15 percent to current levels. Granted, we’re still a ways off the $105-$100 level high we saw prior to the dip, but flipping that around, it is still an opportunity for subscribers that missed out on Dycom’s sharp move higher from late March through most of April to add to their position. We say this because, over the last few weeks, Dycom and other specialty contractors have been making the conference rounds sharing upbeat comments regarding the accelerating deployment of 5G wireless technologies and gigabit Ethernet over the coming years.

From a thematic perspective, we see the increasing amount of screen time we are all accumulating across our desktops, tablets and smartphones, as well as other burgeoning connected applications (car, home, Internet of Things) choking network capacity. Part of the solution is to roll out these next generation solutions, but also for the carriers to expand existing network capacity – all of which bodes well for Dycom, given its customer base that includes AT&T (T), Comcast (CMCSA), Verizon (VZ) and CenturyLink (CTL).

Hindsight being 20/20, DY shares were more than likely overextended, and odds are no matter what the management had provided as an outlook for the current quarter, it would have fallen short of expectations. That’s the downside of a quick rocket ride higher like the one we’ve enjoyed in Dycom shares, but we recognized this when we opted to keep the position on the Tematica Select List and now we’re reaping the rewards of that decision.

  • Our price target on DY remains $115, which offers more than 25% upside from current levels.



While Disney’s Summer Movie Slate Hasn’t Lived Up to Expectations, We Still See Some Bright Spots

Since peaking in late April, shares of Walt Disney (DIS) have fallen 10 percent as some of the company’s movies fell short of expectations, especially the new installment of the Pirates of the Caribbean franchise. Granted, Guardians 2 still took the box office, and we’re still determining how successful the latest Pixar film, Cars 3, will be, but it is probably safe to say that Disney’s not hitting it out of the park like it has in recent years. That reflects the thin by comparison movie slate the company has this year and with no new films until Thor: Ragnarok (Oct. 21), Coco (Nov. 22) and Star Wars: The Last Jedi (Dec. 22) it means a relatively quiet summer for Disney’s film business.

The next major event to watch is the Disney-run D23 Expo from July 14-16 at the Anaheim Convention Center in California, which should provide a number of updates on the company’s various businesses. Historically, it’s been a showcase for Disney’s films, including clips of those soon to be released. This year, we expect more details on its extended Marvel and Star Wars franchise plans as well as likely timing for Frozen 2 and The Incredibles 2 from Pixar. After D23 Expo, however, as we mentioned above, it’s likely to be a relatively quiet summer for Disney. With a $10 billion buyback in place and declining capital spending, we see support for the stock near current levels, with upside likely nearing the last few months of the year as Disney returns to the box office.

As we remain patient with this Content is King company, we’ll continue to monitor ongoing at ESPN as well as the parks business. The Parks & Resorts segments is one of Disney’s most profitable business segments and while the business tends to benefit from price increases, there is another reason we see better margins ahead. The factor behind this is Disney’s Shanghai theme park, after 11 million visitors, is close to breaking even after its first full year of operations. Based on performance at other non-US parks, this is far faster than anyone expected and also serves to confirm the power of Disney’s content. As that drag on profitability continues to fade, we see it becoming a positive contributor to Disney’s bottom line and increases confidence in current consensus expectations for the company to deliver EPS of $5.94 this year and $6.75 next year.

  • Our price target on Walt Disney (DIS) share remains $125, which at current levels keeps the shares a Buy.
  • We would be buyers of DIS shares up to $108, which leaves 15 percent upside to our price target.



Woeful Earnings from Kroger Has Us Tightening Position in UNFI

Woeful Earnings from Kroger Has Us Tightening Position in UNFI

While many have been focused on the retail environment —and we count ourselves among them here at Tematica — we’ve also been watching the painful restaurant environment over the past few months. It’s been one characterized by falling same-store-sales and declining traffic – not a harbinger of good things when paired with rising minimum wages.

For those that are data nut jobs like we are, per TDn2K, same-store sales for restaurants fell 1.1 percent in May, a decline of 0.1 percentage points from April. In May, same-store traffic growth was -3.0 percent. Now for the perspective, the industry has not reported a month of positive sales since February 2016 – that’s 15 months! One month shy of the bad streak the May Retail Sales Report has been on. Clearly not a good operating environment, nor one that is bound to be friendly when it comes to growing revenue and earnings.

Reading those tea leaves, we’ve avoided that the restaurant aspect of our Fattening of the Population investing theme, and with Ignite Restaurant Group filing bankruptcy, Cheesecake Factory (CAKE) warning about its current quarter outlook we confident we’ve made the right decision.

But people still need to eat, and we’ve seen consumers increasingly flock back to grocery stores in 2017. Year to date, grocery retail sales are up 1.7 percent through May. Breaking down the data, we find that in recent months those sales have accelerated, with March to May 2017 grocery sales up 2.8 percent year over year and standalone May grocery store sales up 2.2 percent year over year.

Yet, when grocery company Kroger (KR) reported in-line earnings for its latest quarter, it lowered its 2017 EPS outlook, cutting in the process to $2.00-$2.05 from the prior $2.21-$2.25, with the current quarter to be down year over year. Aside from price deflation in the protein complex and fresh foods, the company cited its results continue to be pressured by rising health care and pension costs for employees, as well as the need to defend market share amid “upheaval” in the food retailing industry. We see that as company-speak for Kroger and its grocery store competitors having to contend with our

We see that as company-speak for Kroger and its grocery store competitors having to contend with our Connected Society investment theme that is bringing in not only Amazon (AMZN), MyFresh, and FreshDirect into the fray, but also leading Wal-Mart (WMT), Target (TGT), and Safeway among others to expand their online shopping capabilities, which in some cases includes delivery. Another reason not to get off the couch when shopping.

Candidly, we’re bigger fans of companies that focus on profits over market share given that short-term market share led strategies, often times with aggressive pricing, tend to sacrifice margins, but focusing on profits tends to lead to better market-share over the long-term. We’ve seen the “strategy” that Kroger is adopting many times in the past and while it may have short-term benefits, increasing prices later on, runs the risk of alienating customers.

Getting back to Kroger’s guidance cut, that news sent Kroger’s shares down almost 20 percent on Thursday and led to United Natural Foods (UNFI) shares to fall more than 3.5 percent, while Amplify Snacks (BETR) slumped by 2 percent. In our view, most of Kroger’s bad news was likely priced into UNFI’s mixed guidance last week when it reported its own quarterly earnings. Without question, 2017 has been a rough ride for UNIF shares despite the Food with Integrity tailwind, but despite Kroger’s guidance cut, management shared on the company earnings call that it continues “to focus on the areas of highest growth like natural and organic products.” Even Costco Wholesale (COST) recently shared it has room to grow in packaged organic food items, excluding fresh), which plays to the strengths at both United Natural Foods and Amplify Snacks.


Tightening Our Position in UNFI, But Staying the Course with BETR

With our Food with Integrity thematic tailwind still blowing and UNFI shares down just 7.5 percent relative to our blended cost basis on the Tematica Select List, we’ll remain patient with the position. That said, from a technical perspective the shares are near support levels and if they break through $38.50 the next likely stop is between $33 and $34. Therefore, to manage potential downside risk, we’re instilling a stop loss on UNFI shares at $38.50. As we do this, we’ll acknowledge the tougher operating environment and reduce our UNFI price target to $50 from $65, which still offers upside of just over 25 percent from current levels.

  • We are keeping our Buy rating on United Natural Foods, but trimming our price target back to $50 from $65.
  • We are instilling a stop loss at $38.50 to manage additional downside risk near-term.

With regard to Amplify Snacks, with today’s close the shares are down just 6 percent from our late April Buy recommendation. Generally speaking, these single digit stocks tend to be volatile and require some extra patience, and that’s the tact will take with BETR shares. Our price target remains $11.

  • We continue to have a Buy on Amplify Snacks (BETR) shares and our price target remains $11.




Shifting Consumer Preferences Favor Food with Integrity Bullets Not Restaurant Shares

Shifting Consumer Preferences Favor Food with Integrity Bullets Not Restaurant Shares

It’s no secret the restaurant industry is having a tough time given restaurant traffic data and less-than-flattering industry articles as it grapples with several consumer-centric issues. We received yet another indication of that restaurant pain last week when Sonic Corp. (SONC) reported a 7.4 percent decline in same-store-sales. The company’s management team chalked up the drop to “a sluggish consumer environment, weather headwinds and share losses…” amid a “very intense” competitive environment. Predictably, the company is retooling its menu offering and even though it’s late to the party, it is also jumping on the smartphone bandwagon.

Stepping back there is a larger issue that Sonic and other restaurants have to contend with – declining restaurant traffic that is due not only to lower prices at grocery stores but also to the shift in consumer preferences to healthier foods. That preference shift is toward natural and organic offerings as well as paleo, gluten-free and others and that’s one of the reason’s we’ve favored shares of United Natural Foods (UNFI) as grocers expand their offering to meet that demand.

Even as companies like Coca-Cola (KO) and PepsiCo (PEP) tinker with their carbonated soft drink formulas to reduce sugar, the new enemy, they have to do so without sacrificing taste. Some investors may remember the whole New Coke thing back in 1985 that was ultimately a failure given the different taste. As Coca-Cola, PepsiCo and even Dr. Pepper Snapple (DPS) look to reformulate to ride either the lower sugar or better-for-you shift, it bodes rather well for flavor companies like International Flavors & Fragrances (IFF) or Sensient Tech (SXT).

That shifting preference has led several restaurant companies such as Panera Bread (PNRA) and Darden’s (DRI) Olive Garden to change up their menus in order to lure eaters. Over the last several years, Panera has been working to eliminate artificial additives in its food to make it “cleaner” for consumers and in 2015 it released a “no-no” list of more than 96 ingredients that it vowed to either remove from or never use in food. Darden is shifting to lighter fare recipes that have far fewer calories than prior ones. Even Chipotle (CMG), the one-time poster child for our Food with Integrity investing theme until its food safety woes last year, has come to fulfill its pledge of using no added colors, flavors or preservatives of any kind in any of its ingredients.

These are all confirming signs of our Food with Integrity investing theme that Lenore Hawkins and I talked about on last week’s podcast. Here too with these new menu offerings, it’s a question of how can restaurants offer healthier alternatives without sacrificing flavor? To us, the answer is found in  International Flavors & Fragrances, McCormick & Co. (MKC) and Sensient shares as well as other flavor companies.

Against that backdrop — – the shift to eating not only at home but eating food that is better for you – we have serious doubts when it comes to the quick service restaurant industry. According to the data research firm Sense360, which analyzed data from 140 chains and 5 million limited-service visits, 38% of heavy quick-service restaurant users reduced their visits in February, compared with the period before Christmas. Not exactly an inspiring reason to revisit shares of Sonic or several other QSR (Quick Service Restaurant) chains like McDonald’s  (MCD) or Wendy’s (WEN) at a time when bank card delinquency rates are climbing, subprime auto issues are doing the same, student debt levels loom over consumers and real wage growth has been meager at best.

While more people eating at home is a positive for Kroger (KR) and Wal-Mart (WMT), our “buy the bullets not the gun” approach continues to favor shares of McCormick and International Flavors & Fragrances in particular.  For those unfamiliar with “buy the bullets, not the gun” it’s a strategy that looks to capitalize on select industry suppliers that serve the majority of the industry with key components or other inputs. Shining examples of this strategy have included Intel (INTC), Qualcomm (QCOM) and recently acquired ARM Holdings. Common traits among them include a diverse customers base and strong competitive position with a leading market position for their products. The same holds true for both McCormick and International Flavors & Fragrances, which are also benefitting from our Rise & Fall of the Middle Class investing theme.