WEEKLY ISSUE: Trade Concerns and Tariffs Continue to Hold Center Stage

WEEKLY ISSUE: Trade Concerns and Tariffs Continue to Hold Center Stage

Key Points From This Week’s Issue

  • News from Harley Davidson (HOG) and Universal Stainless & Alloy Products Inc. (USAP) confirm tariffs and rising costs will be a hotbed of conversation in the upcoming earnings season.
  • That conversation is likely to lead to a major re-think on earnings growth expectations for the back half of 2018.
  • We are closing out our position in Corning (GLW) shares;
  • We are closing out our position in LSI Industries (LYTS) shares;
  • We are closing out our position in shares of Universal Display (OLED).

 

Trade concerns and tariffs taking center stage

As we saw in Monday’s stock market, where the four major U.S. market indices fell from 1.3% to 2.1%, trade wars and escalating tariffs increasingly are on the minds of investors. Something that at first was thought would be short-lived has grown into something far more pronounced and widespread, with tariffs potentially being exchanged among the U.S., China, the European Union, Mexico and Canada.

In last week’s issue of Tematica Investing, shared how the Tematica Investing Select List has a number of domestically focused business, such as Costco Wholesale (COST), Habit Restaurants (HABT) and recently added Farmland Partners (FPI) to name a few. While the majority of stocks on the Select List traded down with the market, those domestic-focused ones are, generally speaking, higher week over week. Hardly a surprise as that escalating tariff talk is leading investors to safer stocks like a horse to water.

I cautioned this would likely be a longer than expected road to trade renegotiations, with more than a helping of uncertainty along the way that would likely see the stock market gyrate like a roller coaster. That’s exactly what we’ve been seeing these last few weeks, and like any good roller coaster, there tends to be an unexpected drop that scares its riders. For us as investors that could be the upcoming June quarter earnings season.

As we prepare to exit the current quarter, there tend to be a handful or more of companies that report their quarterly results. These tend to offer some insight into what we’re likely going to hear over the ensuing months. In my view, the growing question in investors’ minds is likely to center on the potential impact in the second half of 2018 from these tariffs if they are enacted for something longer than a short period.

Remember that earlier this year, investors were expecting earnings to rise as the benefits of tax reform were thought to jumpstart the economy. While GDP expectations for the current quarter have climbed, the growing concern of late is the cost side of the equation for both companies and consumers. We saw this rear its head during first-quarter earnings season and the widening of inflationary pressures is likely to make this a key topic in the back half of 2018, especially as interest costs for businesses and consumers creep higher.

 

Harley Davidson spills the tariff beans

Well, we didn’t need to wait too long to hear companies talk on those tariff and inflation cost concerns. Earlier this week Harley-Davidson Inc. (HOG) shared that its motorcycle business will be whacked by President Trump’s decision to impose a new 25% tariff on steel imports from the EU and a 10% tariff on imported aluminum.

For Harley-Davidson, its duty paid on imported steel and aluminum from the EU will be 31%, up from 6%. The impact is not small potatoes, considering that the EU has been Harley’s second-largest market, accounting for roughly 16% of total sales last year. On an annualized basis, the company estimates the new tariffs will translate into $90 million to $100 million in incremental costs. That would be a big hit to the company’s overall operating profit, as its annualized March quarter operating income was $254.3 million. With news like that it’s a wonder that HOG shares are down only 6.5% or so this week.

Meanwhile, Universal Stainless & Alloy Products Inc. (USAP), a company that makes semi-finished and finished specialty steel products that include stainless steel, tool steel and aircraft-quality low-alloy steels, announced this week it would increase prices on all specialty and premium products by 3% to 7%. Universal Steel also said all current material and energy surcharges will remain in effect.

 

What does it mean for earnings in the 2Q 2018 quarterly reporting season?

What these two companies have done is set the stage for what we’re likely to hear in the coming weeks about challenges from prolonged tariffs and the need to boost prices to contend with rising input costs, which we’ve been tracking in the monthly economic data. In our view here at team Tematica, this combination is likely to make for a challenging June quarter earnings season, which kicks off in just a few weeks, as costs and trade take over the spotlight from tax cuts and buybacks.

Here’s the thing – even as trade and tariff talk has taken center stage, we have yet to see any meaningful change to the 2018 consensus earnings forecast for the S&P 500 this year, which currently sits around $160.85 per share, up roughly 12% year over year. With up to $50 billion in additional tariffs being placed on Chinese goods after July 6, continued tariff retaliation by China and others could lead to a major reset of earnings expectations in the back half of 2018.

If we get more comments like those from Harley Davidson and Universal Stainless, and odds are that we will, we could very well see those results and comments lead to expectation changes that run the risk of weighing on the market.  We could see management teams offer “everything and the kitchen sink” explanations should they rejigger their outlooks to factor in potential tariff implications, and their words are likely to be met with a “shoot first, ask questions later” mentality by investors. That’s especially likely with the CNN Money Fear & Greed Index back in the Fear zone from Greed just a week ago.

I’m not the only one paying attention to this, as it was reported that Federal Reserve Chairman Jay Powell remarked that some business had put plans to hire or invest on hold because of trade worries and that “those concerns seem to be rising.”

Now there is a silver lining of sorts. Given the upsizing of corporate buyback programs over the last few months due in part to tax reform, any potential pullback in the stock market could be muted as companies scoop up shares and pave the way for further EPS growth as they shrink their share count.

I’ll continue to be vigilant with the Select List in the coming days so we’ll be at the ready to make moves as needed.

 

Doing some further Select List pruning

As we get ready for the 2Q 2018 earnings season that will commence with some fervor after the July 4th holiday, I’m going to take out the pruning shears and put them to work on the Tematica Investing Select List. As I mentioned above, odds are we will see some unexpected cautionary tales to be had in the coming weeks, and my thinking is that we should get ahead of it, remove some of the weaker positions and return some capital to subscribers that we can put to work during 3Q 2018. With that in mind, I am removing Corning (GLW), LSI Industries (LYTS), and Universal Display (OLED) from the Select List. in closing out these positions, I recognize they’ve been a drag on the Select List’s performance of late but we’ll also likely eliminate any further weight on the rest of the Select List.

  • We are closing out our position in Corning (GLW) shares;
  • We are closing out our position in LSI Industries (LYTS) shares;
  • We are closing out our position in shares of Universal Display (OLED).

 

WEEKLY ISSUE: Trade and Tariffs, the Words of the Week

WEEKLY ISSUE: Trade and Tariffs, the Words of the Week

 

KEY POINTS FROM THIS WEEK’S ISSUE:

  • We are issuing a Sell on the shares of MGM Resorts (MGM) and removing them from the Tematica Investing Select List.
  • While the markets are reacting mainly in a “shoot first and ask questions later” nature, given the widening nature of the recent tariffs there are several safe havens that patient investors must consider.
  • We are recasting several of our Investment Themes to better reflect the changing winds.

 

Investor Reaction to All the Tariff Talk

Over the last two days, the domestic stock market has sold off some 16.7 points for the S&P 500, roughly 0.6%. That’s far less than the talking heads would suggest as they focus on the Dow Jones Industrial Average that has fallen more than 390 points since Friday’s close, roughly 1.6%. Those moves pushed the Dow into negative territory for 2018 and dragged the returns for the other major market indices lower. Those retreats in the major market indices are due to escalating tariff announcements, which are raising uncertainty in the markets and prompting investors to shoot first and ask questions later. We’ve seen this before, but we grant you the causing agent behind it this time is rather different.

What makes the current environment more challenging is not only the escalating and widening nature of the tariffs on more countries than just China, but also the impact they will have on supply chain part of the equation. So, the “pain” will be felt not just on the end product, but rather where a company sources its parts and components. That means the implications are wider spread than “just” steel and aluminum. One example is NXP Semiconductor (NXPI), whose chips are used in a variety of smartphone and other applications – the shares are down some 3.7% over the last two days.

With trade and tariffs being the words of the day, if not the week, we have seen investors bid up small-cap stocks, especially ones that are domestically focused. While the other major domestic stock market indices have fallen over the last few days, as we noted above, the small-cap, domestic-heavy Russell 2000 is actually up since last Friday’s close, rising roughly 8.5 points or 0.5% as of last night’s market close. Tracing that index back, as trade and tariff talk has grown over the last several weeks, it’s quietly become the best performing market index.

 

A Run-Down of the Select List Amid These Changing Trade Winds

On the Tematica Investing Select List, we have more than a few companies whose business models are heavily focused on the domestic market and should see some benefit from the added tailwinds the international trade and tariff talk is providing. These include:

  • Costco Wholesale (COST)
  • Dycom Industries (DY)
  • Habit Restaurants (HABT)
  • Farmland Partners (FPI)
  • LSI Industries (LYTS)
  • Paccar (PCAR)
  • United Parcel Services (UPS)

We’ve also seen our shares of McCormick & Co. (MKC) rise as the tariff back-and-forth has picked up. We attribute this to the inelastic nature of the McCormick’s products — people need to eat no matter what — and the company’s rising dividend policy, which helps make it a safe-haven port in a storm.

Based on the latest global economic data, it once again appears that the US is becoming the best market in the market. Based on the findings of the May NFIB Small Business Optimism Index, that looks to continue. Per the NFIB, that index increased in May to the second highest level in the NFIB survey’s 45-year history. Inside the report, the percentage of business owners reporting capital outlays rose to 62%, with 47% spending on new equipment, 24% acquiring vehicles, and 16% improving expanded facilities. Moreover, 30% plan capital outlays in the next few months, which also bodes well for our Rockwell Automation (ROK) shares.

Last night’s May reading for the American Trucking Association’s Truck Tonnage Index also supports this view. That May reading increased slightly from the previous month, but on a year over year basis, it was up 7.8%. A more robust figure for North American freight volumes was had with the May data for the Cass Freight Index, which reported an 11.9% year over year increase in shipments for the month. Given the report’s comment that “demand is exceeding capacity in most modes of transportation,” I’ll continue to keep shares of heavy and medium duty truck manufacturer Paccar (PCAR) on the select list.

The ones to watch

With all of that said, we do have several positions that we are closely monitoring amid the escalating trade and tariff landscape, including

  • Apple (AAPL),
  • Applied Materials (AMAT)
  • AXT Inc. (AXTI)
  • MGM Resorts (MGM)
  • Nokia (NOK)
  • Universal Display (OLED)

With Apple we have the growing services business and the eventual 5G upgrade cycle as well as the company’s capital return program that will help buoy the shares in the near-term. Reports that it will be spared from the tariffs are also helping. With Applied, China is looking to grow its in-country semi-cap capacity, which means semi- cap companies could see their businesses as a bargaining chip in the short-term. Longer- term, if China wants to grow that capacity it means an eventual pick up in business is likely in the cards. Other drivers such as 5G, Internet of Things, AR, VR, and more will spur incremental demand for chips as well. It’s pretty much a timing issue in our minds, and Applied’s increased dividend and buyback program will help shield the shares from the worst of it.

Both AXT and Nokia serve US-based companies, but also foreign ones, including ones in China given the global nature of smartphone component building blocks as well as mobile infrastructure equipment. Over the last few weeks, the case for 5G continues to strengthen, but if these tariffs go into effect and last, they could lead to a short-term disruption in their business models. Last week, Nokia announced a multi-year business services deal with Wipro (WIT) and alongside Nokia, Verizon (VZ) announced several 5G milestones with Verizon remaining committed to launching residential 5G in four markets during the back half of 2018. That follows the prior week’s news of a successful 5G test for Nokia with T-Mobile USA (TMUS) that paves the way for the commercial deployment of that network.

In those cases, I’ll continue to monitor the trade and tariff developments, and take action when are where necessary.

 

Pulling the plug on MGM shares

With MGM, however, I’m concerned about the potential impact to be had not only in Macau but also on China tourism to the US, which could hamper activity on the Las Vegas strip. While we’re down modestly in this Guilty Pleasure company, as the saying goes, better safe than sorry and that has us cutting MGM shares from the Select List.

  • We are issuing a Sell on the shares of MGM Resorts (MGM) and removing them from the Tematica Investing Select List

 

Sticking with the thematic program

On a somewhat positive note, as the market pulls back we will likely see well-positioned companies at better prices. Yes, we’ll have to navigate the tariffs and understand if and how a company may be impacted, but to us, it’s all part of identifying the right companies, with the right drivers at the right prices for the medium to long-term. That’s served us well thus far, and we’ll continue to follow the guiding light, our North Star, that is our thematic lens. It’s that lens that has led to returns like the following in the active Tematica Investing Select List.

  • Alphabet (GOOGL): 60%
  • Amazon (AMZN): 133%
  • Costco Wholesale (COST) : 30%
  • ETFMG Prime Cyber Security ETF (HACK): 34%
  • USA Technologies (USAT): 62%

Over the last several weeks, we’ve added several new positions – Farmland Partners (FPI), Dycom Industries (DY), Habit Restaurant (HABT) and AXT Inc. (AXTI) to the active select list as well as Universal Display (OLED) shares. As of last night’s, market close the first three are up nicely, but our OLED shares are once again under pressure amid rumor and speculation over the mix of upcoming iPhone models that will use organic light emitting diode displays. When I added the shares back to the Select List, it hinged not on the 2018 models but the ones for 2019. Let’s be patient and prepare to use incremental weakness to our long-term advantage.

 

Recasting Several of our investment themes

Inside Tematica, not only are we constantly examining data points as they relate to our investment themes we are also reviewing the investing themes that we have in place to make sure they are still relevant and relatable. As part of that exercise and when appropriate, we’ll also rename a theme.

Over the next several weeks, I’ll be sharing these repositions and renamings with you, and then providing a cheat sheet that will sum up all the changes. As I run through these I’ll also be calling out the best-positioned company as well as supplying some examples of the ones benefitting from the theme’s tailwinds and ones marching headlong into the headwinds.

First up, will be a recasting of our Rise & Fall of the Middle-Class theme.  As the current name suggests, there are two aspects of this theme — the “Rise” and the “Fall” part. It can be confusing to some, so we’re splitting it into two themes.  The “Rise” portion will be “The New Global Middle Class” and will reflect the rapidly expanding middle class markets particularly in Asia and South America. On the other hand, the “Fall” portion will be recast as “The Middle Class Squeeze” to reflect the shrinking middle class in the United States and the realities that poses to our consumer-driven economy.

We’ll have a detailed report to you in the coming days on the recasting of these two themes, how it impacts the current Select List as well as other companies we see as well-positioned given the tailwinds of each theme.

 

 

WEEKLY ISSUE: The Cherry on Top of Apple’s Quarter Earnings Beat

WEEKLY ISSUE: The Cherry on Top of Apple’s Quarter Earnings Beat

 

Key Points from this Alert:

  • After March quarter earnings that shut down the doomsayers, an upsized capital return program and ahead of the upcoming WWDC 2018 event in June, our price target on Apple (AAPL) shares remains $200.
  • What’s the Fed likely to say later today?
  • We are scaling into AXT (AXTI) shares on the Tematica Investing Select List at current levels and keeping our long-term $11 price target intact.
  • We are also adding to our position in LSI Industries (LYTS) shares at current levels, and our price target remains $11.

 

Apple delivers for the March quarter and upsizes its capital return program

Last night in aftermarket trading, Apple (AAPL) shares popped more than 3% after closing the day more than 2% higher as Apple delivered a March quarter that was a sigh of relief to many investors. More specifically Apple served up results on the top and bottom line that were ahead of expectations, guided current quarter revenue ahead of expectations and upsized not only its share repurchase program, but its dividend as well. Heading into the earnings report, investors had become increasingly concerned over iPhone shipments for the quarter, particularly for the iPhone X, following recent comments on high-end smartphone demand from Taiwan Semiconductor (TSM), Samsung and others. That set a low sentiment bar, which the company once again walked over.

What Apple delivered included iPhone shipments modestly ahead of expectations – 52.2 million vs. 52.0 million – and an average selling price that fell $70 to $729. Down but certainly not the disaster that many had fretted for the iPhone X. iPad shipments were also stronger than expected and Apple continued to grow its Services business with Mac sales in line with analyst forecasts. Looking at the Services business, Apple is well on track to deliver on its $50 billion revenue target by 2021 and that’s before we factor in what’s to come from its recent acquisitions of Shazam and Texture as well as its burgeoning original content moves. In my view, that original content move, which replicates a strategy employed by Netflix (NFLX) and Amazon (AMZN), will make Apple’s already incredibly sticky devices even more so.

Think of it as Tematica’s Content is King investing theme meets Connected Society and Cashless Consumption… and yes, I need a better name for that three-pronged tailwind combination.

On the guidance, Apple put revenue ahead of consensus expectations and signaled a modest dip in gross margins due to the memory pricing environment. Even so, the sequential comparison for revenue equates to a quarter over quarter drop of 12.5%-15.5%, which likely reflects a mix shift in iPhones toward non-iPhone models. Pretty much as expected and far better than the doomsayers were predicting.

The bottom line on the March quarter results and June quarter outlook was investors fretted about the iPhone X to an extreme degree… an overreactive degree… forgetting the company has a portfolio of iPhone products as well as other products and services. Some may see the report as giving investors a sigh of relief, but I see it more as a reminder that investors should not count Apple out as we move into an increasingly digital lifestyle.

Is the company still primarily tied to the iPhone? Yes, but it is more than just the iPhone and that is something that will become more apparent in the coming year. We’re apt to see more of that in a month’s time at the company’s annual World-Wide Developer Conference, which several months later will be followed by what continues to sound like an iPhone product line up with refresh with several models at favorable price points.

The added cherry on top of the company’s meet to beat quarter and outlook was the incremental $100 billion share repurchase program and the 16% increase in the dividend. That dividend boost brings the company’s annual dividend to $2.92 per share, which equates to a dividend yield of 1.7%. Looking at dividend yields over the last few years applied to the new dividend supports our $200 price target for Apple shares.

  • After March quarter earnings and ahead of the upcoming WWDC 2018 event in June, our price target on Apple (AAPL) shares remains $200.

 

What’s the Fed likely to say later today?

While many were focused on Apple’s earnings, others, like myself, were also getting ready for the Fed’s latest monetary- policy meeting, which concludes today. Market watchers expect the FOMC to leave interest rates unchanged, but recent data (as well as some comments that company executives have made this earnings season) suggest that we’re seeing a pickup in U.S. inflation.

For example, Caterpillar (CAT) last week shared that its margins likely peaked during the first quarter due to rising commodity prices, most notably steel. Meanwhile, the April IHS Markit Flash U.S. Composite Purchasing Managers Index report last week showed that average prices for goods and services “increased solidly. The rate of input price inflation was the quickest since July 2013.”

And on the manufacturing side, the report noted that “price pressures within the factory sector intensified, with the rate of input-cost inflation picking up to the fastest since June 2011.” Markit also wrote that the services sector “witnessed its average cost burdens climbing month over month as well.”

We also learned just this week that the U.S. Personal Consumption Expenditures Price Index (which happens to be the Fed’s preferred inflation metric) rose 2.4% year over year. While that’s down a few ticks from February’s 2.7%, the PCE came in well above the Fed’s 2% inflation target for the second month in a row.

And lastly, the April ISM Manufacturing Index’s price component edged up to 79.3 from 78.1 in March, easily marking 2018’s highest level so far.

All of these figures have likely caught the Fed’s eyes and ears. Make no mistake about it — the central bank will review them with a fine-toothed comb. The FOMC came out of its last policy meeting rather divided as to the number of rate hikes it expects for 2018. Some FOMC members preferring the three hikes that markets widely expect, but others on the committee increasingly leaned toward four.

In the grand scheme of things, four vs. three rate hikes isn’t a “yuge deal” (as President Donald Trump would say). In fact, more investors are likely expecting the higher numbers of hikes given the recent inflationary economic data. But that’s just the investor base. Odds are that any language in the FOMC’s post-meeting communique that points to an upsized pace of rate hikes is bound to catch the mainstream media and others off-guard.

And one way or another, the Fed’s comments are bound to make the wage data that we’ll be getting in this Friday’s U.S. April jobs report a key focus. A hotter-than- expected headline number will boost the odds that we’ll see a fourth rate hike this year.

But between now and then, expect to see lower-than-usual trading volumes as investors wait to see the latest economic figures while also digesting this week’s litany of earnings reports. Things could get a little wonky, as investors reset expectations for corporate earnings and FOMC hikes, but I’ll continue to let our thematic tailwinds be our guide.

 

Scaling into AXTI (AXTI) shares …

Last week was a challenging one for shares of AXT Inc. (AXTI) and LSI Industries (LYTS), and while that is painful and frustrating in the near-term, I view this as an opportunity to scale deeper into both positions at better prices. The silver lining is this will improve our cost basis for the longer term.

With regard to AXT, the smartphone industry has been currently transfixed on comments from Taiwan Semiconductor (TSM), Samsung and SK Hynix that all warned on demand for high-end smartphones. As we saw last night, those comments were not necessarily indicative of Apple’s iPhone shipments for the March quarter and as I pointed out above Apple has a portfolio of smartphones and a growing services business. Also, given comments from mobile infrastructure company Ericsson (ERIC) and chip-supplier Qualcomm (QCOM), 5G smartphones should be hitting in 2019, which we see fostering the beginning of a major upgrade cycle for the iPhone and other vendors.

This is a great example of focusing on the long-term drivers rather than short-term share-price movement. Later this week two of AXT’s customers — Skyworks Solutions (SWKS) and Qorvo (QRVO) — will report their quarterly results. I expect those reports to reflect the short-term concerns as well as the longer-term opportunity as wireless connectivity continues to move past smartphones. With AXT’s substrates an essential building block for the RF semiconductors, let’s remain patient as I keep our long-term price target at $11, following the company’s first-quarter 2018 results that beat expectations but also call for sequential improvement in both revenue and earnings per share.

  • We are scaling into AXT (AXTI) shares on the Tematica Investing Select List at current levels and keeping our long-term $11 price target intact.

 

… and buying more shares of LSI Industries (LYTS) as well

Now let’s turn to LSI Industries. Concerns about a sudden management change last week, just days ahead of the company’s quarterly earnings report, led LYTS shares to plummet 20% but rebound a bit later in the week even as LSI reported March-quarter results that missed both top-line and bottom-line expectations. While the search for a new CEO is underway, what was said during the earnings conference call was favorable, in my opinion, and supports my thesis on the shares.

First, let’s tackle the elephant in the room that is the sudden CEO departure. As one might expect, such a late in the quarterly reporting game resignation is bound to jar investors, but the near 29% move lower over the ensuing few days was more than extreme. That said, a sudden CEO departure raises many questions, and when it’s in a market that has been registering Fear on the CNNMoney Fear & Greed Index, investors tend to a shoot first and ask questions later mentality.

What I saw on the earnings conference call was a calm management team that is looking for a next-generation CEO. What I mean by that is one that understands the changes that are happening in the lighting market with increasing connectivity in lighting systems and signage. This to me says the desired CEO will be one with a technology background vs. one with a legacy lighting background. Much the way the lighting technology being used is being disrupted with LEDs and soon OLEDs, LSI needs a forward-thinking CEO, not one that only thinks of traditional light bulbs.

Second, the company’s lighting business is nearing the end of its transition to light- emitting diodes (LEDs) from traditional lighting solutions. During the March quarter, LSI’s LED business grew 14% year over year to account for 92% of the segment vs. roughly 80% in the year-ago quarter. Despite that success, the legacy lighting business continues to decline, with sales of those products falling by more than 55% year over year in the March quarter.

With one more quarter left in its transition to LEDs, the weight of the legacy lighting business likely won’t be a factor much longer, and that should allow the power of the LED business to benefit the bottom line. The LED business is riding the combined tailwinds of both environmentally friendly green technology as well as the improving nonresidential landscape.

Alongside its earnings report, LSI’s Board of Directors declared a regular quarterly cash dividend of $0.05 per share that is payable May 15 to shareholders of record as of May 7. The annualized dividend equates to LYTS shares offering a dividend yield of 3.4% at recent levels, well above its historical range of 1.5%-2.5% over the 2015-2017 period. Applying those historical dividend yields to the current annualized dividend yields a share price between $8-$13. The stock market liked this as LYTS shares rallied some 10% over the last several days, but we still have ample upside to my long-term $11 price target.

This tells me that there is much further to go fro LYTS shares in the coming months as LSI finds a CEO and gets its story back on track. Let’s remain patient with this one.Helping with that patient attitude was yesterday’s March Construction Spending Report, which revealed private nonresidential construction rose 3.8% year over year for the month on a non-seasonally adjusted basis.

  • We are adding to our position in LSI Industries (LYTS) shares at current levels, and our price target remains $11.

 

 

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.

 

 

Boosting our price target on LSI Industries

Boosting our price target on LSI Industries

 

Our shares of LSI Industries (LYTS) on the Tematica Investing Select List are popping today following a solid earnings beat for the companies December quarter and raised bottom line expectations for the coming year due in part to the benefits of tax reform. With that benefit, which is based on a consolidated tax rate of 29% vs. 34% for 2017, we are boosting our price target on LYTS shares to $11 from $10, which keeps the shares a Buy rating despite this morning’s 15% move higher. We’re more than happy to take that 15% move as it brings the return thus far on LYTS shares to just under 14%.

As I mentioned above, the earnings beat was partly due to tax reform. The other part was the stronger than expected operating performance as revenue for the quarter rose 7.7% year over year to $92.3 million, well ahead of the $88.5 million “consensus” expectation formulated by all two of the Wall Street analysts that follow the shares. More impressive was the sharp improvement in operating profit that rose significantly higher year over year as its operating margins climbed to roughly 4.9%, up from 3.3% in the year-ago quarter. This continues the trend of year over year margin improvement, which bodes well for incremental EPS growth in the coming quarters, even before we factor in the company’s new tax rate.

Once again, we are seeing that stocks under covered by Wall Street analysts offer opportunity, provided the fundamentals and other data points support the investment thesis. As a reminder, LSI remains well-positioned with its lighting solutions as non-residential construction activity continues to rise in the coming quarters. Comments from construction equipment heavy weight Caterpillar (CAT) are certainly comforting in this regard as it “expects improvement in North American residential, non-residential and infrastructure. The outlook does not include any impact from a potential U.S. infrastructure bill.”

I continue to see the rebuilding of US infrastructure as pouring gasoline on non-residential contraction and LSI’s business. I continue to wait for more formal details to emerge out of Washington on this, but between now and then, I’ll continue to look for additional confirming data points as the December quarter earnings season heats up.

  • We are boosting our price target on LSI Industries (LYTS) to $11 from $10

 

November construction spend and ABI index data are positives for LSI Industries

November construction spend and ABI index data are positives for LSI Industries

Yesterday we received a rather favorable November Construction Spending report. I continue to see the overall improvement in nonresidential spending, — due in part to post-hurricane rebuilding efforts — benefiting the shares of Tematica Investing Select List resident LSI Industries (LYTS) in the weeks to come. Also in the coming weeks, President Trump is set to unveil his rebuilding US infrastructure framework and in my view, this is a likely catalyst to drive LYTS shares higher.

Now let’s recap yesterday’s report from the Census Bureau…

Per the report, November Construction Spending rose 0.8% month over month and 2.4% year over year, continuing the string of improvement that began in August. Breaking the report down, private residential construction rose 1.0% month over month while private nonresidential construction rose 0.6%, a sharp tick higher compared to the modest contraction in October due primarily to a boost in commercial spending (+4.6% month over month. Turning to public construction, nonresidential spending increased 0.9% in November as office spending grew 5.5% and transportation spending rose 3.7%.

Aside from the upbeat view on nonresidential construction offered by this report, I also like that it backs up the recent Architecture Billings Index (ABI) reading for November that hit 55.0 for the month, its strongest reading for 2017. I look at a number of these indices, and it always helps to understand what each’s particular reference scoring system in mind. In the case of ABI, an index score of 50 represents no change in firm billings from the previous month, a score above 50 indicates an increase in firm billings from the previous month, and a score below 50 indicates a decline in firm billings from the previous month.

  • Our price target on LSI Industries (LYTS) shares remains $10.

 

The November retail sales report is great news for the Tematica Investing Select List

The November retail sales report is great news for the Tematica Investing Select List

Today we received a better than expected print for the November Retail Sales report, which rose 0.8% month over month compared to the 0.3% expected increase. Viewed on a year over year basis, the headline November figure, which includes retail and food sales, climbed 5.8%. Backing out food, motor vehicles and parts, retail sales in the month soared 6.3% year over year. While we’re going to focus on the retail aspect of the report, we’d note the downtick in food sales bodes rather well for our position in McCormick & Co. (MKC) shares.

In a nutshell, the overall November report was rather bullish for a number of Connected Society and Cash-Strapped Consumer positions on the Tematica Investing Select List as well as several others. With that said, let’s get to the nitty-gritty…

The three standouts in the November retail data were:

  • Gasoline Stations (up 12.2%)
  • Building Materials (up 10.7% year over year)
  • Nonstore Retailers (up10.4% year over year)

The fact that Building Materials and Nonstore Retailers were stalwarts was not a surprise, given post-hurricane building efforts and the digital shopping data for the Thanksgiving – Cyber Monday holiday shopping period. We see these data points as rather confirming and positive for our positions in LSI Industries (LYTS), Amazon (AMZN), and United Parcel Service (UPS) and to a lesser extent Alphabet (GOOGL) shares.

The 3.6% year over year increase in general merchandise stores is, in our view, another reason to expect an upbeat earnings report from Costco Wholesale (COST) after today’s market close. As a reminder, with the shares bumping up against our $190 price target, we are in the process of reviewing additional upside. Today’s earnings report will be a factor in that analysis.

Despite the favorable November results for Sporting good, book and music stores (up 2.9% year over year), it wasn’t enough to bring the trailing 3-month total into the black. We continue to see a tough road ahead for these categories in the traditional brick & mortar environment as they feel the one-two punch of not only our Connected Society investment theme, but also Amazon flexing its muscles in an effort into private label products such as exercise and sports apparel.

Finally, electronics & appliance stores experienced a 6.4% bump year over year, clearly the strongest period in the trailing three-month period. While some of this is likely due to post-hurricane rebuilding efforts, we would note Apple’s (AAPL) iPhone X went on sale early in November and electronics was a big contributor to the holiday shopping spend.

  • Our price target on McCormick & Co.  (MKC) shares is $110
  • Our price target on LSI Industries (LYTS) shares is $10
  • Our price target on Amazon (AMZN) shares is $1,400
  • Our price target on United Parcel Service (UPS) shares is $130
  • Our price target on Alphabet (GOOGL) shares is $1,150
  • Our $190 price target for Costco Wholesale (COST) shares is under review.
  • Our price target on Apple (AAPL) shares is $200.
WEEKLY ISSUE: Business as usual ahead of the Fed’s September policy meeting

WEEKLY ISSUE: Business as usual ahead of the Fed’s September policy meeting

Stocks continued to inch higher over the last several days ahead of today’s next Fed policy meeting. Over the last few days, we’ve seen GDP expectations for the current quarter revised lower from economists, regional Fed banks and even companies like FedEx (FDX), which sees GDP hitting all of 2.2% this year. I continue to see the Fed taking yet another pass on boosting interest rates later today, and given the impact from the recent hurricanes, the team Tematica view is that while next potential interest rate hike could come late this year, it’s more likely going to be in 1Q 2018.

The more closely watched item in the Fed’s comments will be timing for its balance sheet unwinding, and that means parsing the Fed-speak out this afternoon. Much like interest rates, I suspect the Fed will take a pass this month on kicking that initiative off and revisit the strength of the economy at its October/November meeting, but again, more on that once we have parsed the Fed’s words. We’ll have the Tematica take and what it means for the markets as well as the Tematica Investing Select List tomorrow morning.

Keeping the market somewhat in check yesterday was President Trump’s address to the United Nations General Assembly at which he shared he will take a hard line, vowing to “totally destroy” North Korea if it threatened the United States or its allies. Nothing keeps uncertainty alive lately quite like political drama in DC. Such drams also now includes questions over the potential benefits to the domestic economy with corporate tax reform at a time when the federal budget deficit continues to climb. Let’s also remember we are on the cusp of the 2017 election season, and even as President Trump reaches across the aisle, odds are it won’t be an all “cookies and warm milk” as politicians are vying for their own jobs.  For this reason, I see tax reform more likely toward the end of 2017, which happens to be when the debt ceiling conversation will be resumed.

 

Earnings this week, set the stage for coming 3Q 2107 season

Over the next week and a half we will close the books on 3Q 2017 and face quarterly earnings. Before too long the year-end holidays will be upon us. Last night we had a few earnings reports from FedEx, Bed Bath & Beyond (BBBY) and Adobe Systems (ADBE), and today all three stocks are trending lower. Part of the reason for FedEx missing expectations last night was the disruption it faced due to its recent cyber attack. Such attacks are yet another reminder that the cybersecurity aspect of our Safety & Security theme is a form of insurance in our Connected Society. This keeps us long-term bullish on PureFunds ISE Cyber Security ETF (HACK) shares.

Despite a beat at Adobe, the company signaled softer than expected growth for its cloud business. When paired with revenue guidance that was in line with expectations and the stocks sky-high valuation near 40x 2017 earnings per share, it’s not surprising to see ADBE shares trading off today. I point this out because it is another example of good news being ill-received on Wall Street — another reason to think the next few weeks will continue to be volatile.

  • Our price target on PureFunds ISE Cyber Security ETF (HACK) shares remains $35.

 

 

Another brick & mortar retailer looks to leverage Amazon

While earnings reports from FDX, BBBY and ADBE will factor into our larger thinking, what I found far more interesting was the new partnership announced between thematic investing poster child Amazon (AMZN) and retailer Kohl’s (KSS), which includes Kohl’s offering to accept returns for Amazon customers at 82 stores in Los Angeles and Chicago. This is yet another example of a retail-facing company looking to partner with Amazon, and to me, it speaks to the logistics power that is one of Amazon’s core strengths.

Perhaps the management team at Kohl’s saw what I did in the last week’s August Retail Sales Report –  continued pain at department stores as shoppers continue to shift spending to digital platforms. As much pain as we here at Tematica see for brick & mortar retailers in the upcoming year-end holiday shopping season, we see a similar amount of opportunity for Amazon given its footprint expansion over the last year.

  • Our price target on Amazon (AMZN) shares remains $1,150, which keeps the shares a Buy on the Tematica Investing Select List.

 

 

Results at United Natural Foods offer comfort for Amplify Snacks

One of the positions that has been lagging this market move higher is Food with Integrity company Amplify Snacks (BETR), and we used August pullback to improve our cost basis. Since that scaling, BETR shares have once again languished, but commentary last week from United Natural Foods (UNFI) offered a confirming perspective. In United Natural’s earnings report it shared its supernatural net sales were up approximately 6.8% year over year and its supermarket channel net sales increased 8.3% year over year in the quarter. To me, that points to consumers continuing to embrace food that is good for you and bodes rather well for healthy snacking options offered by Amplify. Anecdotally, after visiting several Whole Foods locations over the weekend we can attest to a rebound in traffic and shopping bags.

We will continue to be patient with Amplify Snacks (BETR) shares as the company expands its product offering as well as its reach beyond the U.S. As we have said, we see Amplify as a potential acquisition candidate for PepsiCo (PEP), Snyder’s-Lance (LNCE), Post Holdings (POST), General Mills (GIS) or another snack-food company as they look to expand their presence in the “better for you food” snacking category.

  • Our price target on Amplify Snacks (BETR) shares remains $11

 

 

Recapping moves made earlier this week

As we get ready for what lies ahead over the coming weeks, we made some maneuverings with the Tematica Select List earlier this week. Those moves included adding two new Buy rated positions – LSI Industries (LYTS) and Nokia Corp. (NOK) – and we exited shares of CalAmp Corp. (CAMP). I’d note that one day after we added NOK shares to the Select List, UBS unveiled a “buy” rating on the shares.

Also, this week, our shares of Applied Materials (AMAT) were upgraded to “outperform” at RBC Capital Markets with a new $55 price target; if you’re thinking “that $55 price target sounds familiar” it’s because it has been our AMAT price target for months. As a reminder, Applied will host its 2017 Analyst Day on Sept. 27, and I see that offering an upbeat dialog for both its display  semiconductor capital equipment businesses

  • Our price target on LSI Industries (LYTS) remains $10
    Our price target on Nokia Corp. (NOK) remains $8.50
    Our price target on Applied Materials (AMAT) remains $55

 

Speaking of displays and price targets, yesterday we increased our price target on Universal Display (OLED) shares to $175 from $135, and we are evaluating potential stop loss levels for this position.

As we close this week’s issue, we’d suggest subscribers that missed yesterday’s comments on the current corn harvest as well as a potential longer-term disruptor to corn supply-demand dynamics and what it means for the Teucrium Corn Fund (CORN) shares on the Select List give them a whirl.

  • Our long-term price target on Teucrium Corn Fund (CORN) shares remains $25.
SPECIAL ALERT – Adding LSI Industries to the Tematica Investing Select List

SPECIAL ALERT – Adding LSI Industries to the Tematica Investing Select List

  • We issuing a Buy rating on shares of LSI Industries (LYTS) as we add them to the Tematica Investing Select List with a $10 price target.

  • LSI Industries is poised to benefit from post-hurricane rebuilding as well as the overall shift to light emitting diode (LED) lighting vs. conventional lighting technologies.

  • Given the sharp move higher last week – more than 17% – we would not chase the shares much past $7.25; rather we will be patient and look to improve our cost basis should the shares fall back to Earth near $6.00

 

Yes, we’re in a buying mood this morning. After issuing a Buy rating on Nokia (NOK) earlier this morning, we’re back again with a second new Buy rating, this time on a firm poised to see a surge in demand as the rebuilding process takes hold in Florida and Texas.

Over the last few weeks, we’ve heard quite a bit about the destruction following the one-two punch of Hurricanes Harvey and Irma. People are without electricity, water, food and other essentials and we’re starting to see the economic impact reflected in GDP forecasts for the current quarter. Late last week, the Atlanta Fed joined with forecasters from Bank of America (BAC) and Barclays (BCS) in reducing their GDP estimates by 0.8 percentage points. The dourest is Goldman Sachs (GS), which lowered its forecast by 0.4 percentage points, to 1.6% growth in the quarter.

The somewhat silver lining in all of this is the flooding and other damage means having to replace homes, offices, cars, clothing, and electronics as well as rebuilding affected infrastructure. We’re hearing reports of damage to wastewater systems, which means a shift in capital spending there as water utilities aim to bring clean drinking water back online. The same rebuilding spending will include lighting both in homes, offices and other nonresidential construction as well as signage and other lighting applications.

 

This brings us to LSI Industries

LSI Industries (LYTS) derives the bulk of its revenue from its lighting and graphics businesses. Its lighting segment manufactures and markets outdoor and indoor lighting and lighting controls for the commercial, industrial and multi-site retail markets, including the quick-service and automotive markets. The Graphics segment manufactures and sells exterior and interior visual image elements related to signage and graphics, including integrated digital solutions. Markets served include automotive, grocery, quick service restaurant, parking garage, banking, petroleum retail stores, and retail among others. Representative customers include Burger King (QSR), Wendy’s (WEN), Costco Wholesale (COST), Walmart (WMT), Kohl’s (KSS), Lowe’s (LOW), Chevron (CVX), Toyota (TMC), US Bank (USB), Nasdaq (NDAQ) and Coca-Cola (KO). While we acknowledge the long-term prospects for a number of retailers is questionable given headwinds associated with our Connected Society theme, near-term rebuilding by these and other customers bodes well for LSI in the coming quarters.

Across those two businesses, LSI utilizes light emitting diode (LED) technology that is far more power efficient than other forms of lighting (incandescent, cathode ray tube), is solid state (which reduces breakage and offers a far longer life than other lighting technologies) and emits far less heat. Applications for the technology range from signage to general illumination and others that have long life cycle requirements. Even though the technology has been around for years, it is still disrupting the existing lighting market and will continue to do so as LED prices continue to come down. Those price erosions drive lower replacement costs compared to those other lighting technologies. We’ve mentioned this disruption to subscribers before in comparing the expected adoption of organic light emitting diodes that is driving our Universal Display (OLED) and Applied Materials (AMAT) shares. Near-term OLEDs will disrupt smartphones, TVs, wearables and interior automotive applications, but it will be some time before the technology matches the brightness strides that have been made with LEDs.

As you might be thinking, LEDs are a far more “green” friendly form of lighting. We’ve seen massive investment in LED technology over the last several years, including ramping manufacturing capacity in China. This has led to significant price erosion for LED lighting, which has opened up a number of applications as LED pricing approaches parity with other lighting technologies. This bodes well for LSI’s project input costs, margins, and EPS.

 

Why We Think the Timing is Right for LYTS Shares

What makes this an even more interesting addition to the portfolio is the recent hit to LYTS shares following disappointing guidance. But here’s the thing, the company missed EPS by 2 cents a share and revenue by less than 4% relative to expectations. It still delivered positive growth year over year. The result, as we’ve come to expect was a clobbering in the shares, which fell to nearly $5 from almost $9 several weeks prior. We’ve seen the shares rebound of late, and we attribute that not only to the potential hurricane spending to be had, but also LSI’s quarterly dividend. Historically LSI shares bottomed out near a dividend yield of 2.6% over the last four years. The current dividend yield is 3.0%, which in our view confirms the recent fall off is more than overdone and the eventual post-hurricane rebuilding should serve as a positive catalyst for the shares.

As such, we are beginning this position today with a $10 price target. That figure equates to a dividend yield of 2% vs. the 1.5%-2.0% dividend yield the shares have peaked at over the last several years. In our view, the looming pick-up in rebuilding activity as well as the overall shift to LED lighting bodes well for the company’s business and should leave it well positioned to deliver meaningful EPS growth in the coming quarters. As such, we are adding LYTS shares to the Tematica Select List with a Buy rating. Given the sharp move higher last week – more than 17% – we would not chase the shares much past $7.25; rather we will be patient and look to improve our cost basis should the shares fall back to Earth near $6.00.