Apple’s WWDC17: An event lacking vision from a company without a visionary

Apple’s WWDC17: An event lacking vision from a company without a visionary

Yesterday, Apple (AAPL) held its annual World Wide Developer Conference (WWDC) at which CEO Tim Cook showcased a number of announcements. While we tend to be Apple devotees when it comes to the hardware and its ease of use, in taking a few steps back, our view is this year’s WWDC is it was one largely filled with refinements and incremental additions. Not entirely surprising, given the fact that Apple is now led by an expert operations manager, Tim Cook, and not a visionary like Steve Jobs. As we see it, Apple will either need to bring in some visionary expertise, or perhaps, and more likely, use it’s war chest of $250 billion to buy some vision in the form of acquisitions, but that’s another story.

We have not been buyers of Apple shares as of late — despite being avid fans, if not a lover of its products — given the transition-like nature of the product cycle that keeps Apple arguably reliant on the iPhone. Instead, for subscribers to our Tematica Research premium service, we’ve recognized the Apple-related opportunity from a different perspective – one that intersects with our tendency to “Buy the Bullets, Not the Guns” and several of our investing themes — Connected Society, Content is King, Cashless Consumption and Disruptive Technologies – with great success along the way. Examples include Universal Display (OLED), Nuance Communications (NUAN) and Applied Materials (AMAT), which are up more than 127 percent, 23 percent and 28 percent, respectively since being added to the Tematica Select List.

In our view, Apple is in a tough spot after setting the bar so high for so long. It too now has to compete with how it once wowed audiences and consumers as it updates existing products and tries to find its footing with new ones. Given its size, install base and the fact that its products are for the most part so simple to use, Apple isn’t likely to go the way of Kodak or Xerox anytime soon.

Getting back to the conference, on the smaller side, there were announcements like Amazon’s (AMZN) Prime Video coming to Apple TV and the upgrades to its Mac line. The real interest was in what the latest release of its mobile operating system iOS 11 brings, with a surprise in that this next iteration is likely to make the iPad a device to be embraced for both business as well as personal use. Perhaps the best worst kept secret heading into the event was Apple’s move into the connected speaker market, and yes Apple did take the wraps off HomePod, which looks to be Apple’s second if not a third potential hub in the home. The first two hubs being the iPhone and Apple TV, both of which connect with Apple’s HomeKit.

 

 

Interestingly, Apple is leading HomePod with music first and as a connected device with Siri second. Perhaps this is because if you’ve ever asked Siri the same questions as you might ask Amazon Alexa, one tends to realize that Siri isn’t the sharpest knife in the drawer, as it lacks the backing of Amazon’s Amazon Web Services and artificial intelligence. This strategy is also likely aiming to spur subscriptions to Apple’s Apple Music service; we can’t tell you how many times Apple shared it offers more than 40 million songs during the keynote presentations. Will this be a viable competitor to Sonos’s smart speakers when it comes to sound quality? Could the HomePod spur Amazon or Alphabet to acquire Sonos? Time will answer both of those questions.

Apple did tout Siri Intelligence several times during yesterday’s presentations, but this appears to be an area of continued investment as Apple catches up to Amazon and Google rather than leapfrogging them in the process and redefining the category. With Amazon’s strategy to make Alexa compatible with autos, the likes of Ford (F) and Volkswagen, as well as consumer appliance companies such as Whirlpool (WHR), it looks like the old OS war between Microsoft and Apple could be played out again in the voice digital assistant space. This raises several questions in our minds – Will Apple license Siri for use outside of Apple products? Will Amazon have the same issues Microsoft had with Windows and device compatibility? Fodder for thought and what it may mean for the future of these interfaces.

Yes, there was some cool new Apple stuff, like the Do Not Disturb While Driving feature, the ability to drag and drop with iOS 11, which in our view was sorely missing for the iPad and Apple’s foray into Virtual Reality (VR). But again, the head turning “wow” factor just wasn’t there. Even with HomePod, it will be interesting to see how it stacks up against Amazon’s Echo products as well as Alphabet’s (GOOGL) Google Home in the coming months. One would have to think these companies are prepping newer models, perhaps with better sound capabilities, ahead of the year-end holiday season.

The problem as we see it is Apple is trapped inside a near yearly refresh rate that makes it challenging to deliver breakthrough features each and every year. Even the new iOS name, iOS 11, is uninspiring.

Who has a blowout birthday when they turn 11?

Even the naming conventions for the new macOS and iMac were iterative in nature with Craig Federighi, Apple’s senior vice president of Software Engineering, getting a good nature laugh along the way.

Now with the WWDC keynote behind us, the next event to watch for Apple will be the unveiling of the much-discussed iPhone 8 model later this year. While Apple did sneak peek a few products yesterday, we heard nothing about the next iPhone model and as the news cycle turns away from WWDC we expect investor speculation to run rampant when it comes to this device later this summer. With 66 percent of Apple’s sales coming from the iPhone over the last two quarters, it’s the one product that Apple has to get right. Odds are it will, and that device will keep Apple as one of the key players in our Connected Society investing theme as its other initiatives – Virtual Reality, Apple Pay, Apple Watch and Apple TV – feel the lift of our Disruptive Technology, Cashless Consumption, Fountain of Youth and Content is King themes.

As these tailwinds blow, our Tematica Select List will surely continue to reap the benefits.

Revisiting Position Ratings as the Stock Market Grinds Higher

Revisiting Position Ratings as the Stock Market Grinds Higher

DOWNLOAD THIS WEEK’S ISSUE
The full content of Tematica Investing is below; however downloading the full issue provides detailed performance tables and charts.Click here to download.

Since our last issue, the stock market continued to move higher on the news that President Trump will soon be sharing his tax overhaul plan and Fed Chairwoman’s Yellen’s congressional testimony yesterday. We review Yellen’s comments below in greater detail, but the point is the Fed, in aggregate, sees enough oomph in the economy to keep its stated goal of up to three rate increase this year in the mix. Candidly, we didn’t expect Yellen to deviate from the script given the next Fed meeting is still several weeks away, and far more data will be had ahead of it.

With the market climbing, we had a number of strong performers on the Tematica Select List, including recently added Disruptive Technology company Nuance Communications (NUAN) and  Safety & Security play PureFunds ISE Cyber Security ETF (HACK). Both of those remain Buys at current levels. Several other positions are closing in fast on their respective price targets. Last week we trimmed back the position in Costco Wholesale (COST) and reduced it to a Hold from Buy. We’d note that’s a true Hold, not to be interpreted in the herd mindset as a loose Sell recommendation. We continue to see Costco benefitting from our Cash-strapped Consumer theme and its plan to open additional warehouse clubs, which boosts higher margin membership fee income.

Similarly, this morning we are reducing our ratings on both Universal Display (OLED) and PowerShares NASDAQ Internet Portfolio ETF (PNQI) from Buy to Hold. Both have enviable runs, the former as more talk of Apple’s next iPhone iteration heats up and the potential of OLED screen and the latter given the moves we’ve enjoyed in our Facebook (FB) and Alphabet (GOOGL) shares. As we adjust these ratings, we’re also going to layer in stop losses as well:

  • We will set the OLED stop loss at $60, which ensures a gain of at least 13 percent.
  • And set a stop loss at $88 for PNQI shares, which ensures a 5 percent gain.

Positions that we’ll be watching closely as they move closer to our price targets include AMN Healthcare (AMN), Facebook FB), Alphabet (GOOGL) and Disney (DIS) shares.

 


What’s all the Yellin’ About Yellen?

As we mentioned above, yesterday Fed Chairwoman Janet Yellen began her two day session in front of Congress for her semiannual testimony on monetary policy. Last night Tematica Chief Investment Officer, Chris Versace, joined CGTN’s Global Business to discuss the testimony, which was very much a non-surprise given the Fed Chair is not likely to tip the Fed’s policy hand in between meetings, particularly when we have ample economic data ahead and we’ve yet to get the particulars on several Trump policies. In her prepared speech to the Senate Banking Committee yesterday, Yellen said the central bank can continue to raise interest rates slowly although it would be “unwise” to wait too long. Pretty much more of the same if you ask us.

Over the last few months, the pace of manufacturing activity has picked up as evidenced by the monthly ISM manufacturing data and manufacturing PMI metrics from Markit Economics. And while it has us thinking another hike is in the cards, we agree with Yellen that with little meat on the Trump policy bone as yet, the Fed might hold out until more specifics are shared before boosting rates. This also means much more economic data to factor into their economic group-think. Odds are this means a rate hike is more likely at the May FOMC meeting than at the March one.

Today Yellen takes the stage in front of the House Financial Services Committee, and while it’s a bit mean to say we do tend to get a hearty chuckle out of watching some of those folks ask questions they don’t really understand. That good fun aside, we don’t expect Yellen to deviate from the Fed script anytime soon.


Updates, Updates, Updates

Over the last few days, there were several noteworthy items for a few of our Tematica Select List holdings. The following is a roundup of those developments.

The Walt Disney Co. (DIS)    Content is King

Disney raised admission prices for U.S. theme parks, by as much as $5 for certain one-day tickets at the Magic Kingdom theme park in Orlando and Disneyland. The cost of a regular ticket at the Magic Kingdom, effective yesterday, is now $115, while the same at Disneyland is now $110. The $124 peak price at Magic Kingdom, which includes many summer days and holidays, is unchanged.

As a consumer, we may cringe at the Disney’s ticket prices, but there is no denying its parks remain a key attraction, and new exhibits/rides, such as Frozen and eventually Star Wars, will only serve to keep people coming. From an investor perspective, price increases like these tend to drive margin expansion and profits, and that’s something we certainly like.

  • Our price target on Disney remains $125, and we continue to rate DIS shares a Buy. 

 

AT&T (T)  Connected Society

AT&T competitor Verizon (VZ) announced it was returning to unlimited data plans, in part to combat Sprint (S) and T-Mobile USA (TMUS). Typically, there tends to be a herd mentality when such programs are introduced, which means we’ll be watching to see if AT&T joins the fray — and if so, how the company tiers its product offering.

Also with AT&T, when asked about the pending merger with Time Warner (TWX), CEO Randall Stephenson said, “We still think we’ll be closed by the end of the year.” That matches recent comments from Time Warner, and likely means AT&T shares will be somewhat rangebound until the proposed merger clears its review by the Department of Justice. Time Warner shareholders will meet today to decide on the company’s proposed $86B merger with AT&T — a “yes” vote is expected.

  • We continue to rate T shares a Hold, with a $45 price target. All things being equal, we’d look to revisit our rating on the shares below $40.
Amazon (AMZN)    Connected Society

As it relates to our position in Amazon, over the weekend there was news that FedEx (FDX) has launched FedEx Fulfillment, a logistic network for small and medium businesses. Given the accelerating shift to digital commerce (one of our key investment pillars for AMZN shares), it comes as little surprise that FedEx would seek to replicate Amazon’s Fulfilled By Amazon (FBA) business. For FBA transactions, Amazon receives a portion of each sale, but could, at the same time, be competing with the vendor.

The differentiator, in our view, is Amazon’s Prime service, which offers “free” two-day delivery for the shopper, and a growing list of items/services. Given the overall shift to digital commerce, odds are this rising tide will lift several boats, but to us, the real question is how vendors will offset shipping costs paid by shoppers. If they stick it to shoppers, this effort by FedEx could be more sizzle than steak.

 

AMN Healthcare (AMN)    Aging of the Population

The December JOLTS report showed yet another month-over-month increase in health-care and social assistance jobs, which led to a 12 percent increase in December 2016 compared to December 2015. Meanwhile, hiring levels in December remained relatively unchanged, up only 2.1 percent year over year.

In our view, this confirms the difficulty in finding quality staff, which bodes well for AMN’s business. Longer term, by 2020, the U.S. is expected to need 1.6 million more direct-care workers than in 2010, which equates to a 48 percent increase for nursing, home-health and personal-care aides over the decade, due primarily to the aging of 78 million baby boomers.

Our intent remains to nibble on AMN shares closer to $35 to build out the position at better prices. AMN will report its quarterly earnings tomorrow (Feb. 16) and consensus expectations call for EPS of $0.54 and revenue of $476.4 million.

  • We have a $47 price target on AMN and at current levels, that leaves 21 percent upside; as such we will look to revisit the rating and the price target after the company’s earnings announcement.

 

Dycom Industries (DY)  Connected Society

Our shares of this Connected Society infrastructure play rose more than 2 percent since last week following the news that CenturyLink’s (CTL) 2017 capital spending will be $2.6 billion vs. $3.0 billion in 2016. While overall spending is ticking down, on its earnings call CenturyLink management shared that its “broadband investments for 2017 are expected to actually be a little higher than 2016 levels.” Combined with 2017 capital spending plans for AT&T, Verizon, and Comcast, it looks like total capital spending on broadband and wireless will be up modestly year over year with a greater portion of spending on network capacity and new technologies (5G, Gigabit fiber).

We continue to see Dycom as a prime beneficiary of that wireless and wireline capital spending. We are going to sit tight and be patient with the position given our view that, worst case, it’s only a matter of time for next-generation network technologies to be deployed.

  • We rate Dycom shares a Buy with a $115 price target.

 

International Flavors & Fragrances (IFF) Rise & Fall of the Middle Class

After today’s market close, IFF will report its December quarter earnings. Consensus expectations have the company delivering EPS of $1.16 on revenue of $752.3 million. As we’ve shared previously, flavor and fragrance competitor results set a sound footing for IFF’s quarterly earnings that will be reported this week (Feb. 15).

We remind subscribers that given IFF’s international exposure, currency is likely to weigh on its December-quarter results as well as its near-term outlook. But, as we have said before, we see that largely reflected in the share price over the last few months.

  • We continue to see ample upside to our $145 price target over the coming quarters fueled by rising disposable income, particularly in the emerging markets, but also from the shift in consumer preferences to natural/organic flavors.

 

Nuance Communications (NUAN)  Disruptive Technology

Following solid December-quarter earnings last week, shares of this voice technology company rose more than 6 percent over the last several days, bringing our return in the shares to roughly 9 percent. In our view, the performance in the most recent quarter shows that despite all the headway we are hearing about Amazon’s (AMZN) Alexa voice digital assistant and similar offerings from Alphabet (GOOGL), there is ample opportunity in this expanding voice technology market for Nuance and its offerings to the health-care, mobile/auto, enterprise and imaging markets.

During the conference call Nuance shared that while there has been growing interest in voice interface technology in the last few years, the arrival of Amazon and Alphabet products has accelerated the pace of investment across several Nuance customer verticals. These opportunities along with Nuance’s expanding solution set, which includes artificial intelligence and analytics, bodes well for the company’s competitive position in the coming quarters.

Longer term, Tractica forecasts total voice digital assistant revenue will grow from $1.6 billion in 2015 to $15.8 billion in 2021. That is also likely to put Nuance on the M&A contender list for those larger entities that need to expand their voice technology capabilities.

  • Our price target on the shares remains $21 and our rating a Buy. All things being equal, the line at which we will revisit that rating is around $19

DOWNLOAD THIS WEEK’S ISSUE
The full content of Tematica Investing is above; however downloading the full issue provides detailed performance tables and charts. Click here to download.

And the Hacking Continues!

And the Hacking Continues!

DOWNLOAD THIS WEEK’S ISSUE
The full content of Tematica Investing is below; however downloading the full issue provides detailed performance tables and charts.Click here to download.

After Gapping Up Following Friday’s January Employment Report, The Market Is Trading Sideways Again This Week

Over the last week, the S&P 500 rose 0.6 percent, with the bulk of that move coming on the heels of the January Employment Report. As we pointed out in this week’s Monday Morning Kickoff, the face of that report was mostly positive, and when paired with other January manufacturing reports out last week, it likely paves the way for the Fed heads to start jawboning about a potential rate hike at the March FOMC meeting.

Well, we heard just that when Philadelphia Federal Reserve Bank President Patrick Harker on Monday said an interest-rate hike should be on the table at the U.S. central bank’s next meeting, in March. Should other domestic economic data, like the aforementioned January manufacturing data, continue to improve month over month, we expect the herd view to skew toward a March rate hike.

Looking across the Atlantic, however, as expected we are indeed hearing more about Grexit and Frexit this week. Odds are, we have not heard the last of those rumblings as we head into the 7th inning with 4Q 2016 earnings reports. Given where we are in the current earnings season, we have several updates to share on the Amazon (AMZN), CalAmp Corp. (CAMP), Dycom Industries (DY), Facebook (FB), and International Flavors & Fragrances (IFF) positions on the Tematica Select List.

At the same time, we see not only cyber attacks once again taking over the headlines — or at least what non-President Trump headlines there are — but we see impressive order and booking metrics as cyber security companies report their quarterly results.

This sets us up with a new position for the Tematica Select List so without further ado…

And the Hacking Continues!

Issuing a Buy on PureFunds ISE Cyber Security ETF (HACK) shares
as part of our Safety & Security investing theme

Once again cyber hacking is back in the news on several fronts:

  • The hospitality giant InterContinental Hotels Group (IHG) has confirmed that payment systems of 12 US hotels were victims of a massive data breach between August and December 2016.
  • An anonymous attack took down web-hosting company Freedom Hosting II, which hosts dark websites — sites that require software to access. All told, thousands of dark websites were taken offline in the process.
  • Taiwan is investigating an unprecedented case of threats made to five brokerages by an alleged cyber-group seeking payment to avert an attack that could crash their websites.
  • Norway’s foreign ministry, army, and other institutions have been targeted in a cyber-attack by a group suspected of having links to Russian authorities, according to Norwegian intelligence.

And that’s just a sampling of the cyber attack related headlines over the last few days. When we add in the growing number of corporate cyber attacks as well as those against government institutions (remember those from last November?), we are reminded that a few years ago former Defense Secretary Leon E. Panetta warned that the United States was facing the possibility of a “cyber-Pearl Harbor” and was increasingly vulnerable to foreign computer hackers who could dismantle the nation’s power grid, transportation system, financial networks, and government.

This earnings season we’ve seen a pickup in orders at a number of cybersecurity companies ranging from Fortinet (FTNT) and Checkpoint Systems (CKP) to Proofpoint (PFPT). Sifting through those reports, we find several common items bubbling to the surface:

There is the secular trend in cybersecurity that includes not only adoption of cyber security solutions for Internet of Things and Cloud, but also customers migrating to integrated solutions over single-point ones.

That migration is driving vendor consolidation, which with hindsight explains some of the extended sales cycles we heard about in the back half of 2016.

One positive is companies like Fortinet are seeing a pronounced pick-up in larger deal size, even as they add more customers. With Fortinet, it added 10,000 customers during 4Q 2016, which left it total customer base to more than 300,000. Meanwhile, Fortinet experienced significant growth in its larger deal sizes, up 31-39 percent for deal sizes above $500,000 and $1 million respectively.

This tells us that corporations and other institutions are stepping up their game for this dark side of our Connected Society investing theme. That bodes very well for cybersecurity stocks, which represent a key aspect of our Safety & Security investing theme.

The issue is deciding which one to place our hard-earned capital in… in our view, the near constant one-upmanship between hacker & attackers and cyber security firms looks an awful lot like the gaming console “wars” from a few years ago. Every time there was a hot new game, gamers would flock to the new platform. As cyber attackers become more creative, we suspect we are likely to see some cyber security firms respond more quickly than others, leading to market share shifts and better revenue and profit growth.

 

While this may sound like a complex problem, the solution could not be simpler.

Rather than focus on any one or two cyber security companies, instead we’ll place a basket of them onto the Tematica Select List. That basket is PureFunds ISE Cyber Security ETF (HACK), which counts Fortinet, Checkpoint Software, Palo Alto Networks (PAWN), Proofpoint, Symantec (SYMC), Qualys (QLYS), CyberArk Software (CYB) and Imperva (IMPV) among its top holdings. In sum, those eight positions account for just under 41 percent of the ETF’s assets.

Over the last several months HACK shares have been on a tear, but as our Connected Society theme continues to expand to include more devices (the Connected Car, Connected Home, the Internet of Things) across more of the globe (see Facebook’s 4Q 2016 earnings results below for an example of this), odds are the demand for cyber security solutions will remain robust. Just take a look at how often people in restaurants and elsewhere are checking their smartphones — the Connected Society toothpaste is not going to go back into its tube.

  • As such, we see long legs ahead for the cybersecurity aspect of our Safety & Security investing theme, which to us makes HACK a core, long-term holding.
  • In keeping with that, we are issuing a Buy on PureFunds ISE Cyber Security ETF (HACK), with a long-term price target is $35.
  • We’re inclined to use pullbacks below $25 to improve our cost basis. 

We would point out that cyber security is one aspect of our Safety & Security investing theme, which also includes personal, homeland and corporate security. President Trump continues to speak about rebuilding the US military, which should spur demand for a variety of defense companies. As more clarity comes to these proposed plans, we’ll look to include the proper exposure should valuations offer a compelling entry point. Stay tuned.

 

 

Amazon (AMZN) Connected Society 

Since the calendar turned to 2017, Amazon shares have been on a nice trajectory. Following December-quarter results, however, which included weaker-than-expected guidance for the current quarter, largely due to foreign currency issues, Amazon shares slipped just over 3 percent this past week. Given the comments we’ve heard across the earnings spectrum this reporting season about foreign currency, Amazon was bound to disappoint. Excluding the $558 million unfavorable impact from year-over-year changes in foreign exchange rates throughout the quarter, net sales increased 24 percent compared with fourth quarter 2015 versus the reported 22 percent increase for the quarter.

We also continue to see the company investing for the long term as it builds out its streaming content, expands its Fulfilled By Amazon and other initiatives such as Alexa, its voice digital assistant. Even so, margin expansion at both the North American business, as well as Amazon Web Services, enabled Amazon to handily beat consensus EPS expectations of $1.42 with reported earnings of $1.54 for 4Q 2016. Year over year, EPS improved more than 50 percent despite the stepped-up level of investments in the second half of 2016 and revenue shortfall of nearly $1 billion in the December quarter. To us, this means those who have questioned Amazon’s ability to deliver profitable growth while continuing to invest are likely to rethink their position . . . or they should be.

As investors, our view tends to be skewed to the medium to longer term. It’s that view that recognizes Amazon continues to invest for future growth as it benefits from the accelerating shift to digital shopping and Cloud adoption that led Amazon Web Services (AWS) to grow 47 percent year over year in the December quarter. For 2016 in full, AWS revenue rose 55 percent to more than $12 billion, with margins rising to 30 percent from 23.6 percent in 2015. To put this into context, AWS accounted for just 9 percent of overall Amazon revenue in 2016 but was responsible for just over half of the company’s 2016 operating income.

Turning to Amazon’s North American business, revenues climbed 22 percent in the December quarter, but operating margins in that business rose to 4.7 percent. Doing some quick math, we’d note the incremental margin for the North American business clocked in at 6.8 percent, which tells us the company is indeed realizing volume benefits and other synergies in this business.

Amazon’s international business continues to be a drag on overall profits as it posted operating losses both for the December quarter and for 2016 in full. As we have seen in recent quarters, Amazon will continue to invest for future growth, but it has developed a more disciplined approach, and we suspect that approach will be utilized in the International business as well.

This brings us to the company’s guidance for the current quarter, which fell short of consensus expectations due in part to foreign exchange rates. As Apple (AAPL) CEO Tim Cook noted on that company’s earnings call, foreign exchange will be a “major negative” as the company moves from the December to the March quarter.

The same holds true for Amazon, which shared that it expects foreign currency to impact current quarter revenue by $730 million. Factoring that into the consensus view that expected revenue for the current quarter will land near $36 billion, Amazon’s guidance of $33.25 billion to $35.75 billion, up 14 percent-23 percent year over year, is far more understandable. Stepping back, that year-over-year guidance is in a very challenging retail environment and in our view implies continued share gains at both the North American and AWS businesses. On the operating income guidance, Amazon again offers a range that is wide enough to fly a 747 through.

Stepping back and looking at the company’s competitive positions poised to benefit from their respective Connected Society tailwinds — the shift to digital consumption (shopping, content streaming, grocery) and Cloud adoption — we continue to see favorable revenue and profit growth for AMZN over the long term.

  • We’ll continue to monitor retail sales data and Cloud adoption as well as other relevant data points, but for now, are keeping our $975 price target for Amazon shares as well as our Buy rating. 
  • To be blunt, Amazon is a stock to own, not trade. We’d suggest subscribers who are underweight in the shares use the recent pullback to their long-term advantage.

 

The Walt Disney Company (DIS) Content is King

Last night Content is King company Walt Disney reported December quarter earning of $1.55 per share, $0.06 per share better than consensus expectations. Offsetting that upside surprise, which was partly fueled by the company’s share buyback efforts given the near 4% drop in the share count year over year, revenue for the December quarter came in lighter than expected at $14.78 billion vs. the consensus that was looking for $15.29 billion.

In our view, even though revenue and earnings fell compared to the December 2015 quarter we have to remember the year-ago quarter was one for the record books due in part to the impact of Star Wars: the Force Awakens on several Disney businesses.

  • Given the tone of the underlying business, which should improve throughout the year, and prospects for Disney to further shrink its share count in the coming quarters thereby enhancing EPS metric in the process, we are keeping our $125 price target intact even as several Wall Street firms are boosting their price targets to levels higher or inline with ours.
  • We continue to rate the shares a Buy, but would advise subscribers that are underweight the shares to be more aggressive at price below $105 should they arise in the coming weeks. 

 

Let’s Dig into the Details of Disney’s Latest Quarter

For a year at the company that had been described as one starting off slow and building throughout the year, the December quarter was, in our view, a solid one, especially after factoring in the results from the latest installment of the Star Ware franchise, The Force Awakens.

Without question, the standout-out performance was had at the company’s Parks and Resorts business which delivered a 13% increase in operating income on “just” a 6% revenue increase year over year. That business continues to benefit from tight cost controls as well as price hikes taken during calendar 2016. As we get ready for spring break travel season, we’ll be watching for potential 2017 price hikes at the domestic parks. In late May, Pandora: The World of Avatar will open at Disney’s Animal Kingdom in Orlando, Florida. This follows the roll out of Frozen across several parks, and longer-term yet-to-be-named Star Wars-themed lands at Walt Disney World and Disneyland in 2019.

Near-term, the Parks business will benefit from an extra week in the current quarter, but with the Easter holiday falling later than usual this year and landing in the June quarter that timing issue is expected to weigh on current quarter prospects. Timing will also impact the Studio business, which has just one major release in the current quarter — Beauty & the Beast — which looks to be a strong performer, but will be forced into comparisons to The Force Awakens and Zootopia in the year ago quarter.

Moving past the current quarter, the Studio business has a number of Marvel, Pixar and Star Wars films in the pipeline that include a new Spider-Man movie, a sequel to the Cars film, Guardians of the Galaxy 2 and the next Star Wars installment, all of which makes for a very strong second half of the year.

That brings us to the company’s Media Networks business, which is composed of Cable Networks and Broadcasting. This segment has been one investors have been watching closely given the performance of ESPN over the last several quarters and questions about the broadcasting business as streaming alternative become more robust. Case in point, our own AT&T’s DirecTV Now and a similar service soon to be launched by Hulu. During the yesterday’s earnings conference call, Bob Iger reminded participants of initiatives to bring ESPN content to various streaming platforms (Sling TV, PlayStation Vue, DirecTV Now, and Hulu). After the call, The Wall Street Journal reported a new unannounced but signed deal with YouTube. Combined with its BAMTech acquisition, Disney continues to move in the right direction to reposition the Media Networks business to deliver content to consumers when and where they want it. We’ll be looking for additional color on the YouTube relationship, including advertising revenue potential.

Outside of the company’s performance and business outlook, the biggest news that likely has investor tongues wagging this morning is the news that CEO Bob Iger is open to staying after his contract expires in 2018. We see that helping to calm the transition concerns and reassures investors that Iger is likely to remain on board to groom his successor.

On the housekeeping front, Disney repurchased about 15 million shares for about $1.5 billion during the December quarter. Including the current quarter, Disney has bought back some 22 million shares for approximately $2.2 billion leaving $5-$6 billion to go on its announced plan to spend $7-$8 billion on buying back shares this year.

 

CalAmp (CAMP) Connected Society

CAMP shares rose modestly last week, bringing the year-to-date return to 5.0 percent, which is well ahead of the major market indices on the same basis. As we’ve shared, one of the key near-term catalysts for CAMP shares is the electronic logging device (ELD) mandate, which requires trucking companies to move from paper logbooks to electronic logs to record drivers’ hours of service by Dec. 18, 2017.

Last week, freight transportation companies Landstar (LSTR) and Hub Group (HUBG) reported quarterly earnings and inside those conference calls was some bullish commentary for CalAmp. Landstar shared that it has programs to migrate the non-complaint portion of its truck fleet to ELDs before year-end and it’s “beginning those conversations now in order to make that occur.” While Hub Group did not call out ELD spending specifically, it acknowledged that its capital spending would trend higher year over year in 2017 due in part to technology-related investments. Given the ELD mandate, we suspect there at least a portion of that spending will be to ensure its vehicles comply by the current deadline.

Industry estimates suggest more than one million ELDs will be deployed in the U.S. this year to comply with that mandate. This bodes very well for CalAmp’s core telematics systems business (57 percent of revenue) in the coming quarters. Longer term, we continue to see the company’s business model benefiting from the connected vehicle market, which includes autos, trucks and other equipment like that from customer Caterpillar (CAT).

  • We continue to rate CAMP shares a Buy with a $20 price target.

 

Dycom Industries (DY) Connected Society

As we noted in last week’s Tematica Investing, several of Dycom’s key customers recently reported quarterly earnings and the combined capital spending plans of those customers — AT&T, Verizon, and Comcast — look to be flat to up year over year, with a greater portion of spending on network capacity and new technologies (5G, Gigabit fiber). This week we’ll get quarterly results from CenturyLink (CTL) and given the prevailing trends we expect it, too, will offer a favorable capital spending outlook for 2017 and beyond. Having said that, we will listen for any positive or negative impact in CenturyLink’s $34 billion plan to buy Level 3 Communications (LVLT).

We continue to see Dycom as a prime beneficiary of that wireless and wireline capital spending required to keep feeding our data-hungry Connected Society investment theme. In our view, the current share price offers subscribers who are underweight in Dycom an excellent opportunity to pick up the shares at better prices than we’ve seen recently.

  • We continue to rate Dycom shares a Buy with a $110 price target.

 

Facebook (FB) Connected Society

Despite delivering better-than-expected December-quarter earnings with strong user metrics and average revenue per user (ARPU), FB traded modestly lower following those quarterly results. To us, the one statistic that jumped out at us was the company’s ability to get nearly 30 percent more revenue per user during the quarter.

  • With advertising dollars continuing to shift to digital platforms, we continue to see Facebook’s efforts paying off in the coming quarters. 
  • As such, we continue to rate shares a Buy. As we do this, we’re boosting our price target to $155 from $150.

 

Now onto the quarter results . . . 

Facebook reported December quarter EPS of $1.41, well ahead of the $1.31 per share consensus forecast. Revenue for the quarter climbed more than 50 percent, year over year, to $8.63 billion, besting revenue expectations of $8.49 billion. Sifting through the various metrics from daily active users to mobile daily active users, all the metrics were trending in the right direction with both up 17  to 18 percent year over year.

We continue to see the growing influence of mobile on Facebook’s business with 1.74 billion mobile monthly active users, roughly 93 percent of the company’s monthly active user base. As we mentioned above, we continue to see Facebook capturing advertising share, and it did just that in the December quarter as mobile advertising accounted for roughly 84 percent of its advertising revenue in the quarter. We chalk this up to Facebook monetizing more of its platforms (Facebook, Instagram and now Messenger) as well as the greater use of video. As the company continues to improve its ad targeting across users, we would expect some lift in pricing, which should benefit margins.

Part of our initial investment thesis for Facebook was not only the social network company’s ability to not only expand its reach across the globe, but also improve average revenue per user (ARPU) metrics as it does this. During the quarter, the company’s ARPU climbed more than 30 percent, year over year, on a global basis. As one might expect, ARPU remains skewed heavily to the U.S. and Canada, which clocked in at $80, up some 47 percent year over year. As a result, U.S. and Canada accounted for just over 50 percent of revenue followed by Europe (23 percent), Asia-Pac (15 percent) and Rest of World (10 percent). Even so, all geographies were up double-digits, year over year, from a low of 17 percent (Asia-Pac) to a high of 28.7 percent (Europe).

The bottom line is our thesis on the shares remains intact, and we continue to see the tailwinds blowing hard as advertisers continue to focus on digital advertising. We liken this to the shift to digital shopping by consumers that is benefiting our Amazon (AMZN), $839.40, 5.54 percent) shares. Much like that shift, we do not see the one behind Facebook slowing in the near-term.

 

International Flavors & Fragrances (IFF) 

Rise & Fall of the Middle Class

In a quiet week of trading, with no company-specific news, IFF shares were down 1.6 percent, keeping them in the same range they’ve been in over the last several weeks. We continue to see ample upside to our $145 price target over the coming quarters fueled by rising disposable income, particularly in the emerging markets, but also from the shift in consumer preferences to natural and organic flavors. We saw confirmation in this from competitor Givaudan, which as part of its December-quarter earnings report last week shared that, “Natural flavors have been going at an average of 8 percent over the last two years… and represent more than 40 percent of our flavor sales.”

For its fragrance business, Givaudan achieved double-digit growth in North America and a solid performance in Latin America and the Middle East. We see these results as a positive for IFF when it reports its quarterly results on Feb. 15, but we will remind subscribers that given IFF’s international exposure, currency is likely to weigh on its results as well as its near-term outlook. But as we have said before, we see that largely reflect in the share price. We continue to focus on the growing shift to organic flavors and fragrances, the former of which has soda companies such as Coca-Cola (KO) and PepsiCo (PEP) looking to reformulate their products to exclude sugar.

Longer term, the outlook remains bright for this market as the Freedonia Group’s forecast calls for global demand for flavors and fragrances to reach $26.3 billion by 2020, which would be a 21 percent increase from $21.7 billion in 2015.

  • We continue to rate IFF shares a Buy at current levels.

DOWNLOAD THIS WEEK’S ISSUE
The full content of Tematica Investing is above; however downloading the full issue provides detailed performance tables and charts. Click here to download.