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.

 

 

Adding two Middle-class Squeeze call option positions ahead of earnings this week

Adding two Middle-class Squeeze call option positions ahead of earnings this week

Key point inside this issue

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, but also to share a new call option trade with you. The timing on that trade is important because the underlying company will report its quarterly results after Tuesday’s (March 5) market close. With that said, let’s get to the issues at hand…

 

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.

 

Tematica Options+

One of the key takeaways over the last few issues has been the growing consumer spending headwind that has become increasingly evident across the December Retail Sales report, falling Personal Income data and increasing delinquencies. At the same time, we learned that despite mild December weather Home Depot (HD) missed earnings expectations and set the bar lower. Macy’s (M) reported uninspiring results and guidance while Nordstrom missed quarterly revenue expectations and L Brands (LB), the home of Victoria’s Secret and Bath & Body works.

Meanwhile, last week TJX Companies (TJX), the parent of TJ Maxx, Marshalls, HomeGoods, and HomeSense, reported same-store comp sales of 6% for its most recent quarter as store traffic surged. The company also boosted its quarterly dividend by 18% and announced plans to upsize its share buyback plan to $1.75-$2.25 billion.

Quite a different story. Also last week, the Gap (GPS), a company that in my view has been lost for quite some time, announced it was splitting into two companies. One will house its Gap and Banana Republic lines, while Old Navy, a business that fits the mold of our Middle-class Squeeze investing theme, will stand on its own.

Then there is Thematic Leader Costco Wholesale, which has been simply taking consumer wallet share as it opens additional warehouse locations. Excluding the impact of gas prices and foreign exchange, Costco’s US same store sales climbed 7.1% year over year in December and 7.3% in January.

In my view, all of this sets up very well for solid earnings reports from both Ross Stores, which will issue those results after the market close on Tuesday (March 5), and Costco, which reports after the close on Thursday (March 7). To capture the upside associated with these reports, we will add the following call option positions:

 

Note the corresponding stop losses. These are tighter than usual because these are earnings related trades, and as we’ve seen of late guidance is as important as the rear-view quarterly results. These stops will help us limit that downside risk.

With regard to our Del Frisco’s Restaurant Group (DFRG) September 20, 2019, 10.00 calls (DFRG190920C00010000) and Nokia Corp. (NOK) December 2019 7.00 calls (NOK191220C0000700), we will continue to hold them. The Del Frisco’s calls traded off last week and finished the week at 0.85, which is rather close to our 0.80 stop loss. This will bear watching and should we get stopped out, while we’ll net a 33% return should it happen soon than later, I may be inclined to jump back into a DFRG call position ahead of the company’s March 12 earnings report.

 

 

Weekly Issue: Verizon is bulls up on 5G, paving the way for a Disruptive Innovator Leader position

Weekly Issue: Verizon is bulls up on 5G, paving the way for a Disruptive Innovator Leader position

Key points in this issue:

  • As expected, more negative earnings revisions roll in
  • Verizon says “We’re heading into the 5G era”
  • Nokia gets several boosts ahead of its earnings report
  • USA Technologies gets an “interim” CFO
  • We are issuing a Buy on and adding the Nokia Corp. (NOK) April 2019 call options (NOK190208C00006500) that closed last night at 0.30 with a stop loss of 0.15 to our options playbook this week.
  • Treading carefully after stopping out of our Del Frisco’s call option

 

As expected, more negative earnings revisions roll in

In full, last week was one in which the domestic stock market indices were largely unchanged and we saw that reflected in many of our Thematic Leaders. Late Friday, a deal was reached to potentially only temporarily reopen the federal government should Congress fail to reach a deal on immigration. Given the subsequent bluster that we’ve seen from President Trump, it’s likely this deal could go either way. Perhaps, we’ll hear more on this during his next address, scheduled ahead of this weekend’s Super Bowl.

Yesterday, the Fed began its latest monetary policy meeting. It’s not expected to boost interest rates, but Fed watchers will be looking to see if there is any change to its plan to unwind its balance sheet. As the Fed’s meeting winds down, the next phase of US-China trade talks will be underway.

Last week I talked about the downward revisions to earnings expectations for the S&P 500 and warned that we were likely to see more of the same. So far this week, a number of high-profile earnings reports from the likes of Caterpillar (CAT), Whirlpool (WHR), Crane Co. (CR), AK Steel (AKS), 3M (MMM) and Pfizer (PFE) have revealed December-quarter misses and guidance for the near-term below consensus expectations. More of that same downward earnings pressure for the S&P 500 indeed. And yes, those misses and revisions reflect issues we have been discussing the last several months that are still playing out. At least for now, there doesn’t appear to be any significant reversal of those factors, which likely means those negative revisions are poised to continue over the next few weeks.

 

Tematica Investing

With the market essentially treading water over the last several days, so too did the Thematic Leaders.  Apple’s (AAPL) highly anticipated earnings report last night edged out consensus EPS expectations with guidance that was essentially in line. To be clear, the only reason the company’s EPS beat expectations was because of its lower tax rate year over year and the impact of its share buyback program. If we look at its operating profit year over year — our preferred metric here at Tematica — we find profits were down 11% year over year.

With today’s issue already running on the long side, we’ll dig deeper into that Apple report in a stand-alone post on TematicaResearch.com later today or tomorrow, but suffice it to say the market greeted the news from Apple with some relief that it wasn’t worse. That will drive the market higher today, but let’s remember we have several hundred companies yet to report and those along with the Fed’s comments later today and US-China trade comments later this week will determine where the stock market will go in the near-term.

As we wait for that sense of direction, I’ll continue to roll up my sleeves to fill the Guilty Pleasure void we have on the Thematic Leaders since we kicked Altria to the curb last week. Stay tuned!

 

Verizon says “We’re heading into the 5G era”

Yesterday and early this morning, both Verizon (VZ) and AT&T (T) reported their respective December quarter results and shared their outlook. Tucked inside those comments, there was a multitude of 5G related mentions, which perked our thematic ears up as it relates to our Disruptive Innovators investing theme.

As Verizon succinctly said, “…we’re heading to the 5G era and the beginning of what many see as the fourth industrial revolution.” No wonder it mentioned 5G 42 times during its earnings call yesterday and shared the majority of its $17-$18 billion in capital spending over the coming year will be spent on 5G. Verizon did stop short of sharing exactly when it would roll out its commercial 5G network, but did close out the earnings conference call with “…We’re going to see much more of 5G commercial, both mobility, and home during 2019.”

While we wait for AT&T’s 5G-related comments on its upcoming earnings conference call, odds are we will hear it spout favorably about 5G as well. Historically other mobile carriers have piled on once one has blazed the trail on technology, services or price. I strongly suspect 5G will fall into that camp as well, which means in the coming months we will begin to hear much more on the disruptive nature of 5G.

 

Nokia gets several boosts ahead of its earnings report

Friday morning one of Disruptive Innovator Leader Nokia’s (NOK) mobile network infrastructure competitors, Ericsson (ERIC), reported its December-quarter results. ERIC shares are trading up following the report, which showed the company’s revenue grew by 10% year over year due primarily to growth at its core Networks business. That strength was largely due to 5G activity in the North American market as mobile operators such as AT&T (T), Verizon (VZ) and others prepare to launch their 5G commercial networks later this year. And for anyone wondering how important 5G is to Ericsson, it was mentioned 26 times in the company’s earnings press release.

In short, I see Ericsson’s earnings report as extremely positive and confirming for our Nokia and 5G investment thesis.

One other item to mention is the growing consideration for the continued banning of Huawei mobile infrastructure equipment by countries around the world. Currently, those products and services are excluded in the U.S., but the U.K. and other countries in Europe are voicing concerns over Huawei as they look to confirm their national telecommunications infrastructure is secure.

Last week, one of the world’s largest mobile carriers, Vodafone (VOD) announced it would halt buying Huawei gear. BT Group, the British telecom giant, has plans to rip out part of Huawei’s existing network. Last year, Australia banned the use of equipment from Huawei and ZTE, another Chinese supplier of mobile infrastructure and smartphones.

In Monday’s New York Times, there was an article that speaks to the coming deployment of 5G networks both in the U.S. and around the globe, comparing the changes they will bring. Quoting Chris Lane, a telecom analyst with Sanford C. Bernstein in Hong Kong it says:

“This will be almost more important than electricity… Everything will be connected, and the central nervous system of these smart cities will be your 5G network.”

That sentiment certainly underscores why 5G technology is housed inside our Disruptive Innovators investing theme. One of the growing concerns following the arrest of two Huawei employees for espionage in Poland is cybersecurity. As the New York Times article points out:

“American and British officials had already grown concerned about Huawei’s abilities after cybersecurity experts, combing through the company’s source code to look for back doors, determined that Huawei could remotely access and control some networks from the company’s Shenzhen headquarters.”

From our perspective, this raises many questions when it comes to Huawei. As companies look to bring 5G networks to market, they are not inclined to wait for answers when other suppliers of 5G equipment stand at the ready, including Nokia.

Nokia will report its quarterly results this Thursday (Jan. 31) and as I write this, consensus expectations call for EPS of $0.14 on revenue of $7.6 billion. Given Ericsson’s quarterly results, I expect an upbeat report. Should that not come to pass, I’m inclined to be patient and hold the shares for some time as commercial 5G networks launches make their way around the globe. If the shares were to fall below our blended buy-in price of $5.55, I’d be inclined to once again scale into them.

  • Our long-term price target for NOK shares remains $8.50.

 

USA Technologies gets an “interim” CFO

Earlier this week, Digital Lifestyle company USA Technologies (USAT) announced it has appointed interim Chief Financial Officer (CFO) Glen Goold. According to LinkedIn, among Goold’s experience, he was CFO at private company Sutron Corp. from Nov 2012 to Feb 2018, an Associate Vice President at Carlyle Group from July 2005 to February 2012, and a Tax Manager at Ernst & Young between 1997-2005. We would say he has the background to be a solid CFO and should be able to clean up the accounting mess that was uncovered at USAT several months ago.

That said, we are intrigued by the “interim” aspect of Mr. Goold’s title — and to be frank, his lack of public company CFO experience. We suspect the “interim” title could fuel speculation that the company is cleaning itself up to be sold, something we touched on last week. As I have said before, we focus on fundamentals, not takeout speculation, but if a deal were to emerge, particularly at a favorable share price, we aren’t ones to fight it.

  • Our price target on USA Technologies (USAT) shares remains $10.

 

Tematica Options+

The positive developments associated with Disruptive Innovator leader Nokia outlined above strongly suggest the company will deliver an upbeat December quarter earnings report, and will likely guide at least if line, if not higher, for 2019 given the accelerating 5G deployments and improving competitive landscape. That’s why we are adding the Nokia Corp. (NOK) April 2019 call options (NOK190208C00006500) that closed last night at 0.30 to our options playbook this week.

Not only does the timing on these calls capture this Thursday’s earnings report, but it also includes the next major mobile industry conference, the 2019 Mobile World Congress (MWC) that will be held in Barcelona from Feb. 25-28. Historically, during times of new mobile technology rollouts, MWC has been a hotbed of announcements. As we stand on the cusp of commercial 5G network deployments, odds are high that history will once again repeat itself.

While signs are bullish for 5G and Nokia, we as investors will want to limit our downside, which is why I’m setting a stop loss at 0.15 for this position.

 

Treading carefully after stopping out of our Del Frisco’s call option

On the housekeeping front, last night we were stopped out of our Del Frisco’s Restaurant Group call option. With the company evaluating its strategic options, we’ll carefully look to revisit a call option position in this company. This extra sense of caution follows the 20+% drop in GameStop (GME) shares following its Board’s decision to forego being taken private by private equity investors and remain both public and independent.

I would note that GameStop is hitting the headwind of our Digital Lifestyle theme as gamers increasingly shed physical formats over downloading games to their devices and consoles. As if that weren’t enough, I’m hearing reports that Apple, Google (GOOGL), Amazon (AMZN) and Microsoft (MSFT) are eyeing a streaming game service similar to what Thematic Leader Netflix (NFLX) has done for TV and movie content. I see this as another potential nail in the GameStop coffin, which means GME shares are one to avoid… at least in a long position.

 

 

Weekly Issue: As earnings season continues, the market catches a positive breather

Weekly Issue: As earnings season continues, the market catches a positive breather

Key points in this issue:

  • As expected, more negative earnings revisions roll in
  • Verizon says “We’re heading into the 5G era”
  • Nokia gets several boosts ahead of its earnings report
  • USA Technologies gets an “interim” CFO

 

As expected, more negative earnings revisions roll in

In full, last week was one in which the domestic stock market indices were largely unchanged and we saw that reflected in many of our Thematic Leaders. Late Friday, a deal was reached to potentially only temporarily reopen the federal government should Congress fail to reach a deal on immigration. Given the subsequent bluster that we’ve seen from President Trump, it’s likely this deal could go either way. Perhaps, we’ll hear more on this during his next address, scheduled ahead of this weekend’s Super Bowl.

Yesterday, the Fed began its latest monetary policy meeting. It’s not expected to boost interest rates, but Fed watchers will be looking to see if there is any change to its plan to unwind its balance sheet. As the Fed’s meeting winds down, the next phase of US-China trade talks will be underway.

Last week I talked about the downward revisions to earnings expectations for the S&P 500 and warned that we were likely to see more of the same. So far this week, a number of high-profile earnings reports from the likes of Caterpillar (CAT), Whirlpool (WHR), Crane Co. (CR), AK Steel (AKS), 3M (MMM) and Pfizer (PFE) have revealed December-quarter misses and guidance for the near-term below consensus expectations. More of that same downward earnings pressure for the S&P 500 indeed. And yes, those misses and revisions reflect issues we have been discussing the last several months that are still playing out. At least for now, there doesn’t appear to be any significant reversal of those factors, which likely means those negative revisions are poised to continue over the next few weeks.

 

Tematica Investing

With the market essentially treading water over the last several days, so too did the Thematic Leaders.  Apple’s (AAPL) highly anticipated earnings report last night edged out consensus EPS expectations with guidance that was essentially in line. To be clear, the only reason the company’s EPS beat expectations was because of its lower tax rate year over year and the impact of its share buyback program. If we look at its operating profit year over year — our preferred metric here at Tematica — we find profits were down 11% year over year.

With today’s issue already running on the long side, we’ll dig deeper into that Apple report in a stand-alone post on TematicaResearch.com later today or tomorrow, but suffice it to say the market greeted the news from Apple with some relief that it wasn’t worse. That will drive the market higher today, but let’s remember we have several hundred companies yet to report and those along with the Fed’s comments later today and US-China trade comments later this week will determine where the stock market will go in the near-term.

As we wait for that sense of direction, I’ll continue to roll up my sleeves to fill the Guilty Pleasure void we have on the Thematic Leaders since we kicked Altria to the curb last week. Stay tuned!

 

Verizon says “We’re heading into the 5G era”

Yesterday and early this morning, both Verizon (VZ) and AT&T (T) reported their respective December quarter results and shared their outlook. Tucked inside those comments, there was a multitude of 5G related mentions, which perked our thematic ears up as it relates to our Disruptive Innovators investing theme.

As Verizon succinctly said, “…we’re heading to the 5G era and the beginning of what many see as the fourth industrial revolution.” No wonder it mentioned 5G 42 times during its earnings call yesterday and shared the majority of its $17-$18 billion in capital spending over the coming year will be spent on 5G. Verizon did stop short of sharing exactly when it would roll out its commercial 5G network, but did close out the earnings conference call with “…We’re going to see much more of 5G commercial, both mobility, and home during 2019.”

While we wait for AT&T’s 5G-related comments on its upcoming earnings conference call, odds are we will hear it spout favorably about 5G as well. Historically other mobile carriers have piled on once one has blazed the trail on technology, services or price. I strongly suspect 5G will fall into that camp as well, which means in the coming months we will begin to hear much more on the disruptive nature of 5G.

 

Nokia gets several boosts ahead of its earnings report

Friday morning one of Disruptive Innovator Leader Nokia’s (NOK) mobile network infrastructure competitors, Ericsson (ERIC), reported its December-quarter results. ERIC shares are trading up following the report, which showed the company’s revenue grew by 10% year over year due primarily to growth at its core Networks business. That strength was largely due to 5G activity in the North American market as mobile operators such as AT&T (T), Verizon (VZ) and others prepare to launch their 5G commercial networks later this year. And for anyone wondering how important 5G is to Ericsson, it was mentioned 26 times in the company’s earnings press release.

In short, I see Ericsson’s earnings report as extremely positive and confirming for our Nokia and 5G investment thesis.

One other item to mention is the growing consideration for the continued banning of Huawei mobile infrastructure equipment by countries around the world. Currently, those products and services are excluded in the U.S., but the U.K. and other countries in Europe are voicing concerns over Huawei as they look to confirm their national telecommunications infrastructure is secure.

Last week, one of the world’s largest mobile carriers, Vodafone (VOD) announced it would halt buying Huawei gear. BT Group, the British telecom giant, has plans to rip out part of Huawei’s existing network. Last year, Australia banned the use of equipment from Huawei and ZTE, another Chinese supplier of mobile infrastructure and smartphones.

In Monday’s New York Times, there was an article that speaks to the coming deployment of 5G networks both in the U.S. and around the globe, comparing the changes they will bring. Quoting Chris Lane, a telecom analyst with Sanford C. Bernstein in Hong Kong it says:

“This will be almost more important than electricity… Everything will be connected, and the central nervous system of these smart cities will be your 5G network.”

That sentiment certainly underscores why 5G technology is housed inside our Disruptive Innovators investing theme. One of the growing concerns following the arrest of two Huawei employees for espionage in Poland is cybersecurity. As the New York Times article points out:

“American and British officials had already grown concerned about Huawei’s abilities after cybersecurity experts, combing through the company’s source code to look for back doors, determined that Huawei could remotely access and control some networks from the company’s Shenzhen headquarters.”

From our perspective, this raises many questions when it comes to Huawei. As companies look to bring 5G networks to market, they are not inclined to wait for answers when other suppliers of 5G equipment stand at the ready, including Nokia.

Nokia will report its quarterly results this Thursday (Jan. 31) and as I write this, consensus expectations call for EPS of $0.14 on revenue of $7.6 billion. Given Ericsson’s quarterly results, I expect an upbeat report. Should that not come to pass, I’m inclined to be patient and hold the shares for some time as commercial 5G networks launches make their way around the globe. If the shares were to fall below our blended buy-in price of $5.55, I’d be inclined to once again scale into them.

  • Our long-term price target for NOK shares remains $8.50.

 

USA Technologies gets an “interim” CFO

Earlier this week, Digital Lifestyle company USA Technologies (USAT) announced it has appointed interim Chief Financial Officer (CFO) Glen Goold. According to LinkedIn, among Goold’s experience, he was CFO at private company Sutron Corp. from Nov 2012 to Feb 2018, an Associate Vice President at Carlyle Group from July 2005 to February 2012, and a Tax Manager at Ernst & Young between 1997-2005. We would say he has the background to be a solid CFO and should be able to clean up the accounting mess that was uncovered at USAT several months ago.

That said, we are intrigued by the “interim” aspect of Mr. Goold’s title — and to be frank, his lack of public company CFO experience. We suspect the “interim” title could fuel speculation that the company is cleaning itself up to be sold, something we touched on last week. As I have said before, we focus on fundamentals, not takeout speculation, but if a deal were to emerge, particularly at a favorable share price, we aren’t ones to fight it.

  • Our price target on USA Technologies (USAT) shares remains $10.

 

 

 

Tematica Investing: Thematic Tailwinds for 2019 and Scaling into AXON

Tematica Investing: Thematic Tailwinds for 2019 and Scaling into AXON

 

Key Points Inside this Issue:

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

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

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

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

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

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

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

 

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

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

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

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

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

 

Earnings expectations are being revised lower

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

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

 

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

 

 

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

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

 

Thematic tailwinds will continue to drive profits and stock prices

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

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

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

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

 

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

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

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

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

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

 

TEMATICA INVESTING 

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

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

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

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

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

 

New bowls at Chipotle signal the Big Fix continues

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

 

Adding to Axon Enterprises as EPS expectations move higher

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

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

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

 

Del Frisco’s shares jump on takeout speculation

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

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

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

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

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

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

 

 

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

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

 

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

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

 

Key Points Inside this Issue:

 

 

CONTEXT AND PERSPECTIVES

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

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

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

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

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

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

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

 

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

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

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

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

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

 

Earnings expectations are being revised lower

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

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

 

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

 

 

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

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

 

Thematic tailwinds will continue to drive profits and stock prices

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

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

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

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

 

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

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

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

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

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

 

TEMATICA INVESTING 

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

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

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

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

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

 

New bowls at Chipotle signal the Big Fix continues

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

 

Adding to Axon Enterprises as EPS expectations move higher

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

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

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

 

Del Frisco’s shares jump on takeout speculation

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

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

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

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

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

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

 

TEMATICA OPTIONS+

Adding a call position on Del Frisco’s Restaurant Group

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

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

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

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

 

 

 

Weekly Issue: Economic reality is catching up with the stock market

Weekly Issue: Economic reality is catching up with the stock market

 

Coming into this week I said it would likely be another volatile one, and as much as I would like to say I was wrong, I wasn’t. Over the last five days, the individual price charts of the major stock market indices resembled a roller coaster ride, finishing lower week over week. This trajectory continued what we’ve seen over the last few weeks, which has all the major market indices in the red for the last month and that has erased most of their year to date gains.

Stepping back, yes, the market is trading day to day as expected but while there are pockets of strength we are seeing a growing number of companies miss top-line expectations. Coupled with guidance that in some cases may be conservative, but in other reflects a syncing up with the economic and other data of the last few months, investors have become increasingly nervous. This is evidenced in the wide swing over the last month at the CNN Fear & Greed Index, which now sits at Extreme Fear (6) down from Greed (65) several weeks ago. Looking at the AAII Investor Sentiment Survey this week, bullish sentiment fell to 28% from 34%, the fourth weakest reading for bullish sentiment this year. Bearish sentiment rose from 35% to 41%, the highest reading since the last week of June.

What this tells us is pessimism over the near-term direction of the stock market is at its highest level in months, which in turn is likely giving way to what we call a “shoot first and ask questions later” mentality. As almost any seasoned investor will say, that is one of the biggest mistakes one can make as it tends to let emotion, not logic and fact, rule the day.

What times like this call for is stepping back, collecting data shared in earnings releases and corresponding conference calls and presentations, to update our investing mosaic. We’ve had several Thematic Leaders and residents on the Tematica Investing Select List, including Chipotle Mexican Grill (CMG), Amazon (AMZN), Altria (MO),  Alphabet/Google, and Nokia (NOK) report this week as well as a dozens of others, such as AT&T (T), Verizon (VZ), Lockheed Martin (LMT), McDonald’s (MCD), iRobot (IRBT), and Hilton (HLT) report this week. That’s why I’ll be spending the weekend pouring over earnings releases and conference call transcripts, using our thematic lens to update our investing mosaic as needed. It also means furnishing you with a number of updates very early next week.

As I revisit our investing mosaic, the questions being asked will include ones like “Are we seeing any slowdown in the shift to digital commerce, the cloud, streaming content, the move to foods that are better for you?” and so on. Odds are the answers to those and similar questions will be no, which means we will continue to sit on the sidelines as earnings expectations for the market are adjusted likely leading the risk to reward dynamics in share prices to become more favorable. As calmer waters emerge in the coming weeks, we will use one of our time-tested strategies and scale into our Thematic Leader positions as well as those in the Select List where it makes sense.

 

What to Watch Next Week

As we trade the end of October and Halloween for the start of November next week, we have another barn burner one ahead for September quarter earnings as more than 1,000 companies will report their results and update their outlooks. We also have a full plate of economic data coming at us, some of which will influence the second edition of the September quarter’s GDP reading while others will start to put some shape around the GDP reading for the current quarter. To set the table for that data following the initial September quarter GDP print of 3.5%, the New York Fed’s Nowcast model is looking for 2.4% while The Wall Street Journal’s Economic Forecast Survey of more than 60 economists is calling for 2.9%. Thus far we have yet to see any forecast from the Atlanta Fed’s Nowcast model for the December quarter, however, odds are it will once again start out overly bullish and find its way closer to the economic reality of the quarter. We like to kid the Atlanta Fed, but it did start out modeling September quarter GDP of 4.7%. Of course, we would have loved to have seen that, but we’re in the business of letting the economic data talk to us. The fact the Citibank Economic Surprise Index (CESI) has been negative for several months, meaning the data is coming in below expectations, was a clue the Atlanta Fed would have to refine its outlook.

So, what do we have on tap from an economic data perspective?

Monday will bring the September Personal Income and Spending report, one that will we will be watching closely to see if consumers continued to spend above wage gains. Tuesday has the October Consumer Confidence reading for October, and the recent stock market gyrations could take some wind out of the September confidence gains. As we gear into the holiday shopping season, we’ll be closely watching the Expectations component for signs of any softening. Also, on Tuesday, we have Apple’s (AAPL) latest event at which it is widely expected to unveil its latest iPad and Mac models. The ADP Employment Report for October, as well as the 3Q 2018 Employment Cost Index report, will be had on Wednesday, and we expect them to receive more than a passing scrutiny given the growing scarcity of workers with needed skillsets and wage gains.

Thursday we will get the October auto and truck sales and we’ll be looking to see if those sales continue to resemble what we’ve seen in the housing market of late – fewer unit sales, but ones with higher price tags. Also, in focus, that day will be the October ISM Manufacturing Index, where we will be eyeing its order and backlog data as well as employment metrics. Rounding out Thursday, we’ll get the September Construction Spending Report. The first Friday of the new month usually means it’s time for the employment report, and yes, we will indeed be getting the October Employment report one week from today. While we expect many to be focused on the speed of job creation, we’ll be digging into the qualitative factors of the jobs created and who is taking them as well as focusing on the degree of wage gains.

Turning to next week’s earnings calendar, it is simply chock full of reports and once again Thursday will be the day with the heaviest flow – just under 400 companies on that day alone.  Just like this week, among the sea of reports to be had, there will be several, including Facebook (FB) and Apple that will capture investor attention given the impact they could have on the market. As we move through the week, we’ll be adding to our investment mosaic along the way.

Enjoy the weekend, stock up on all those tricks and treats and get some rest for the week ahead. I’ll be back with more early next week.

 

Facebook’s Watch get the international treatment and amps the content arms race

Facebook’s Watch get the international treatment and amps the content arms race

Over the last few quarters, we’ve seen a growing number of streaming content services come to market to challenge the success had by Netflix and to a lesser extent Amazon’s Prime Video. And the new entrants are from over given the pending launch of Disney’s Disney Play, AT&T/Time Warner’s DC Universe, Walmart’s Vudu and of course the highly anticipated one from Apple. Core essentials include a wide array of original programming and a global reach, which is a twin focus at Netflix and increasingly Amazon.

It comes as little surprise then that Facebook is now expanding the reach of its Watch streaming video service to “everywhere” offering a global reach to its content partners and of course it advertising ones as well. The question is given the growing privacy concerns, will Watch help Facebook reinvigorate its stickiness in the US and other markets but drive average revenue per user outside of the US as well?

As we get the answer to that question, we continue to see a global content arms race that runs the risk of diluting the content offering as the streaming video service markets become increasingly crowded. If we’re right, it could be a repeat of cable TV channels, just not on your TV.

Facebook has announced the international rollout of Facebook Watch, its video destination for episodic content, which first launched in the U.S. a year ago this month. The social media giant said Wednesday that the VOD service would be “available everywhere” from Thursday, giving publishers and content creators a worldwide market for their videos.

“With the global launch of Watch, we are supporting publishers and creators globally in two critical areas: helping them to make money from their videos on Facebook and better understand how their content is performing,” the company said in a statement.

Watch launched in the U.S. in August 2017 with the goal of offering users a place on Facebook to discover shows and video creators and to start conversations with friends, other fans and even the creators themselves. The company said that, since the launch, it had made the experience more social, including making it easier to see which videos friends have liked or shared, and creating shows with audience participation at their core. In June, Facebook said it would  launch a slate of new shows boasting interactive features such as polls and quizzes to fulfill the platform’s goal of fostering a sense of community between creators and users.

Taking Watch global would also create new opportunities for content creators as the service expanded its video Ad Breaks program to enable more partners to monetize their videos, the company said. The Ad Breaks service officially launches Thursday in the U.K., Ireland, Australia and New Zealand, in addition to the U.S. It will launch in another 21 countries in September, including France, Germany, Spain, Argentina, Colombia, El Salvador, Guatemala, and Thailand. Facebook said the service would support both English-language content and content in various local languages. Further countries and language will be added in the coming months.

The company said it had lowered the threshold for publishers and creators to be eligible to make money from their videos. Those creating three-minute videos that have 10,000 followers, generate more than 30,000 one-minute views within a two-month period, or meet Facebook’s monetization eligibility standards would qualify.

Source: Facebook Watch Rolls Out Internationally – Variety

Nokia win with T-Mobile solidifies 5G infrastructure spending outlook

Nokia win with T-Mobile solidifies 5G infrastructure spending outlook

So far this earnings season we’ve heard positive comments for the outlook for 5G network spending, particularly in the US. That’s the forward view, but the for actual spending in 2Q 2018 was a little different as Digital Infrastructure companies that sell 5G components to mobile carriers didn’t deliver robust growth. As we’ve seen before, network construction is a bit of a slippery thing, but as we get closer to the publicized launch date, activity picks up big time. With a 5G network race in the offing inside the US, we see the 5G agreement between Nokia and T-Mobile US kicking off what is likely to be a series of similar announcements in the coming weeks and months. Odds are AT&T and Verizon will not want to be viewed as lagging behind T-Mobile. Good for 5G infrastructure-related companies and those who serve them as well as the ones that build the actual network.

T-Mobile US (TMUS.O) named Nokia (NOKIA.HE) to supply it with $3.5 billion in next-generation 5G network gear, the firms said on Monday, marking the world’s largest 5G deal so far and concrete evidence of a new wireless upgrade cycle taking root.

No.3 U.S. mobile carrier T-Mobile – which in April agreed to a merger with Sprint (S.N) to create a more formidable rival to U.S. telecom giants Verizon (VZ.N) and AT&T (T.N) – said the multiyear supply deal with Nokia will deliver the first nationwide 5G services.

5G networks promise to deliver faster speeds for mobile phone users and make networks more responsive and reliable for the eventual development of new industrial automation, medical monitoring, driverless car and other business uses.

Source: Nokia, T-Mobile US agree $3.5 billion deal, world’s first big 5G award

With new antennas, Qualcomm signals 5G smartphones are coming “soon”

With new antennas, Qualcomm signals 5G smartphones are coming “soon”

We’re also looking for confirming data points for our investment themes, especially those that are poised to disrupt existing business models. In the case of 5G mobile technology, one of the meaningful questions is when we will see commercial deployments of both 5G networks and 5G devices. After all, a 5G network is pretty hard for AT&T or Verizon to monetize unless it has a service offering and that hinges on having 5G devices to deploy on its 5G network.

Today’s news that Qualcomm is shipping 5G antennas to its customers for testing and stands ready for “large-scale commercialization” likely means 5G devices are just quarters away instead of years away. As we move through 2Q 2018 earnings season, we’ll look for more timing signals for the launch of commercial 5G networks and devices.

 

Qualcomm today unveiled what it says is the world’s “first fully-integrated 5G NR mmWave and sub-6 GHz RF modules for smartphones and other mobile devices.” These are the QTM052 mmWave antenna module family and the QPM56xx sub-6 GHz radio frequency (RF) module, and they’ll pair with the company’s previously announced Snapdragon X50 5G modem — making next-gen phone networks a reality very soon.

If you recall, a bunch of major smartphone makers, including Samsung, LG, Sony, HTC and Xiaomi already said they’ll be working with Qualcomm, and most of them commited to delivering X50-powered phones by the first half of 2019. Those devices will likely use the new antenna and RF modules announced today. Qualcomm told Engadget it has already shipped samples out to its device partners, and will be working with them to figure out the best placement to minimize signal interference due to hand blocking.

According to the company’s statement, “a working mobile mmWave solution … was previously thought unattainable.” Now, however, Qualcomm said it is “ready for large scale commercialization,” which means we are that much closer to seeing 5G devices in the real world soon.

Source: Qualcomm’s 5G antennas are primed for next year’s phones