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: The Changing Mood of the Market

Weekly Issue: The Changing Mood of the Market

Over the last several days, volatility in the stock market has been rampant with wide swings taking place. Part and parcel of this has been a mood change in the stock market as high-flying stocks, including a number of technology ones, have come under pressure as investors re-think their growth prospects. That continued yesterday as shares of iPhone maker Apple (AAPL) became the latest one to dip into bear market territory with last night’s close following renewed concerns over the company’s device shipments in the near-term. This, in turn, has led to a few downgrades by Wall Street analysts, that at least in my view, are being somewhat short-sighted as the company continues to morph its business into one that is more reliant on high margin services rather than just the iPhone.

The same can be said with Amazon (AMZN), which has seen its shares tumble despite there being no slowdown in the shift to digital commerce as evidenced by the October Retail Sales Report. That report showed Nonstore retail sales for the month climbing just shy of 3x as fast as overall retail sales year over year. That was certainly confirmed in the latest earnings reports this week from Macy’s (M) and Walmart (WMT).  All indications, as well as expectations, have this aspect of our Digital Lifestyle investing theme accelerating into the all-important holiday shopping season. And yes, this keeps me bullish on our shares of United Parcel Service (UPS)

Now here’s the tough part to swallow – while we and our thematic way of investing are likely to be right in the medium to long-term, the mood in the stock market tends to prevail in the short-term. And with several of the concerns I’ve talked about here as well as in Tematica Investing and on our podcast, Cocktail Investing, rearing their heads odds are the stock market will continue to be a volatile one in the very near-term. This will likely see the current expectation resetting continue, especially for the sector-based investor view of “technology” stocks. Talk about a multi-headed sector that is simply a mish-mash of things – I’ll stick to our thematic lens approach, thank you very much. That said, with “tech” being in the doghouse, I’m using the time to evaluate a number of companies for the currently open Disruptive Innovators slot in our Thematic Leaders. Some of the current contenders include cloud-focused companies Dropbox (DBX), Instructure (INST) and Okata (OKT) among others.

This week

What’s been driving the latest round of roller coaster like thrills in the stock market can be found in the intersection of the latest earnings reports, economic data, and political developments. From sector investing perspective, we continue to get mixed results as evidenced by this week’s earnings reports as JC Penney (JCP) lagged expectations while Walmart (WMT) and Macy’s (M) beat them. From a thematic one, however, we see the dichotomy in those results as strong confirmation in our Digital Lifestyle investing theme as both Macy’s and Walmart delivered strong digital shopping performance in those quarterly reports, while JC Penney continues to struggle with its brick & mortar business.

Our Living the Life investing theme was also the recipient of positive confirmation this week as high-end outerwear company Canada Goose (GOOS) simply smashed top and bottom line expectations. Similarly, profits at luxury car company Aston Martin (AML.L) soared as its sales volume doubled year over year in the September quarter.

 

Sticking with Del Frisco’s

And while the Living the Lifestyle Thematic Leader that is Del Frisco’s (DFRG) reported a sloppy quarter following the disposal of its Sullivan’s business, the company shared a vibrant outlook, including the plan to grow its revenue and EBITDA to at least $700 million and $100 million by, respectively, by 2020 from the September quarter run rates of $420 million and $74 million, respectively. The intent on average will be to roll out two to three Double Eagles, two to three Barcelona Wine Bars and six bartacos restaurants each year, which is a measured move over the coming years and one that could be scaled back quickly should the domestic economy begin to falter several quarters out.

Near-term, Del Frisco’s should benefit from a pick-up in activity quarter to date following the arrival in the third quarter of its new chief marketing officer. On the earnings conference call, management shared Double Eagle’s private dining is up almost 20% in the first few weeks of the quarter and bookings for the rest of the quarter are up more than 20% compared to last year at this time.

The company also confirmed one of the key aspects of our investment thesis, which centers on margin improvement due in part to beef deflation. As discussed on the earnings call, the company’s total cost of sales as a percentage of revenue for the quarter decreased by 60 basis points to 27.3% from 27.9% in the year-ago period due to margin improvements at Double Eagle, Barcelona, and bartaco. This improvement and the year-over-year jump in bookings certainly point to the expected holiday inflection point panning out, which is also the most seasonally profitable time of year for Double Eagle and Grille. Cost-reduction efforts put in place earlier this year at these two brands should lead to visible margin improvement versus year-ago levels as the holiday volumes take effect.

  • For now, we’ll keep our long-term price target of $14 for Del Frisco’s (DFRG) shares intact, revisiting as needed should the company’s rollouts begin to slip.

 

Several headwinds remain in place

Despite these positive signals and happenings, we have to remember there are several headwinds blowing on the overall stock market. These include Italy standing firm with its latest budget, which puts it at odds with the European Union; Brexit limping forward; inflationary readings in both the October Producer Price Index and Consumer Price Index that will more than likely keep the Fed’s rate hike path intact, a looming concern for consumer debt and high levels of corporate debt; and the pending trade talks between the US and China at a time when more data shows a cooling in the global economy.

On a positive note, the NFIB Small Business Index’s October reading continued the near-two year string of record highs with more small businesses than not citing a bullish attitude toward the economy and expanding their businesses. A note of caution here as most businesses tend to exude such sentiment at or near the economic peak – few see the looming the downside. The NFIB’s report once again called out the lack of skilled workers with 53% of those surveyed reporting few or no qualified applicants.

This signals potential wage pressures ahead, however, the sharp fall in oil prices, which follows the notion of the slowing global economy and rising inventory levels, is poised to give some relief to both businesses and consumers as we head into the holiday shopping season. Yes, average gas prices have fallen to $2.68 per gallon from $2.89 a month ago, but they are still up vs. $2.56 per gallon this time last year. When it comes to gas prices, most consumers think sequentially, which means they are recognizing the drop in recent weeks, which in their minds offers some relief.

Noticed, I said some relief – consumers still face high debt levels with larger servicing costs vs. the year-ago levels. And let’s be honest, a consumer with a 12-gallon gas tank in his or her car that fills up twice a week is saving all of $4.80 per week compared to this time last month. In today’s world, that’s about enough to buy one pizza with some toppings a month. In other words, it will take more pronounced declines in gas prices to make a meaningful difference for those investors that resonate with our Middle-Class Squeeze investing theme.

 

What to watch next week

In looking at the calendar for next week, we have the Thanksgiving holiday, which long-time subscribers know is one of my favorites. While the stock market is only closed for that holiday, we do have shortened trading hours next Friday – better known as Black Friday – and that will kick off the race for holiday shopping. That means we can expect the litany of headlines over initial holiday shopping sales over the post-holiday weekend as we ease into Cyber Monday. And yes, I will be paying close attention to those results given our positions in Amazon and UPS.

Before we get to share our thankfulness with family and friends, we will have a few economic reports to chew through including October Housing Starts, Durable Orders and Existing Home Sales. This week even Fed Chair Powell recognized the softening housing market as a headwind to the economy, and in my view that sets the stage for yet another lackluster housing report next week. Inside the Durable Orders report, we’ll be watching the all-important core capital goods line, a proxy for business investment. The stronger that number, the better the prospects for the current quarter, which tends to benefit from “use it or lose it” capital spending budgets.

On the earnings front next week, we will continue to hear from retailers, such as Best Buy (BBY), Kohl’s (KSS), Ross Stores (ROST) and TJX Companies (TJX). With regard to our own Costco Wholesale (COST) shares, we’ll be paying close attention to results from competitor BJ Wholesale (BJ). Outside of those retailers, I’ll be listening to what Nuance Communications (NUAN) has to say about the adoption of voice interfaces and digital assistants next week.

Looking past this week’s market relief rally

Looking past this week’s market relief rally

As expected, the last few days in the market have been a proverbial see-saw, which culminated in the sharp market rally following the mid-term elections. The outcome, which saw the Democrats gain ground in Washington, was largely expected. We’ll see in the coming weeks and months the degree of gridlock to be had in Washington and what it means for the economy, but we have to remember several other concerning items remain ahead of us. To jog memories, these include the next round of budget talks between Italy and EU, which should occur next week; continued rate hikes by the Fed as it looks to stave off inflation and get more tools back for the next eventual recession; and upcoming trade talks between the US-China.

While we like the mid-week, market rebound and what it did for the Thematic Leaders as well as positions on the Select List, the upcoming events outlined above suggest near-term caution is still warranted. Shares of McCormick & Co. (MKC) International Flavors & Fragrances (IFF) as well as Altria (MO), AMN Healthcare (AMN) and Costco Wholesale (COST) have been on a tear of late. Earlier this week, Costco reported its October same-store sales results, which once again confirmed this Middle-class Squeeze company is taking wallet share.

Yesterday, mobile infrastructure company Ericsson (ERIC) held its annual Capital Markets event at which it spoke in a bullish tone over 5G rollouts, so much so that it raised its 2020 targets. I see that along with other similar comments in the last few weeks as very positive for our positions in Digital Infrastructure leader Dycom (DY) and Disruptive Innovator Nokia Corp. (NOK) as well as AXT Inc. (AXTI) shares.

 

Axon’s – September quarter earnings and an upgrade

Over the last few weeks, share of Safety & Security Thematic Leader Axon Enterprises (AAXN) have come under considerable pressure, but on Tuesday night the company reported September quarter earnings of $0.20 per share, crushing the consensus view of $0.13 per share as both revenue and earnings before interest, taxes, depreciation, and amortization (EBITDA) soared. Axon then reiterated its full-year guidance which hinged on the continued adoption of its Axon camera and cloud-storage business. Year over year, the number of cloud seats booked by customers rose to 325,200 exiting September up from 187,400 twelve months earlier. The combination of the 25% pullback in the shares quarter to date and that upbeat outlook led JPMorgan Chase to upgrade the shares to Overweight from Neutral.

Yes, we are down with the shares, but as the market settles out I’ll look to add to the position and improve our cost basis along the way. I continue to expect Axon will eventually acquire rival Digital Ally (DGLY) and its $31 million market cap, removing the current legal overhang on the shares. Our price target remains $90.

 

Disney earnings on deck tonight

After tonight’s market close, Disney (DIS) will report its quarterly results, and while we are not expecting any surprises for the September quarter, it’s the comments surrounding the company’s streaming strategy and integration of the Fox assets that will be in focus. Expectations for the September quarter are EPS of $1.34 on revenue of $13.73 billion. Our position on Disney has been and continues to be that based on the success of its streaming services, investors will need to revisit how they value DIS shares as it goes direct to the consumer with a cash-flow friendly subscription business model. Our price target for DIS shares remains $125.

 

Del Frisco’s earnings to follow next week

Monday morning, Del Frisco’s Restaurant Group (DFRG) also postponed its quarterly earnings report from until Tuesday, Nov. 13, citing “additional time required to finalize the accounting and tax treatment of our acquisition of Barteca Restaurant Group, disposition of Sullivan’s Steakhouse, a secondary offering of common stock and debt syndication.”

Coincidence? Perhaps, but it raises questions over the bench strength of these companies as they reshape their business. If you’ve ever been in a negotiation, you know things can slip, but following GNC’s postponement, we are at heightened alert levels with Del Frisco’s. We knew this was going to be a sloppy earnings report and we clearly have confirmation; our only question is why didn’t the management team wait to announce its earnings date until it had dotted its Is and crossed its Ts on all of these items?

To some extent, I am expecting a somewhat messy report in light of the sale of its Sullivan’s business and its common stock offering early in the quarter that raised more than $90 million. In parsing the company’s report, I will be focusing on revenue growth for the ongoing business as well as its profit generation considering that earnings-per-share comparisons could be challenging if not complicated versus the year-ago quarter. Nonetheless, the reported quarterly results will be gauged at least initially against the consensus view, which heading into the weekend sat at a loss per share of $0.25 on revenue of $120 million. For the December quarter, one of the company’s seasonally strongest, Del Frisco’s is expected to guide to EPS near $0.23 on revenue of $144 million.

So far this earnings season we’ve heard how restaurant companies including Bloomin’ Brands Inc. (BLMN), Ruth’s Hospitality Group (RUTH), Del Taco Restaurants Inc. (TACO), Chipotle Mexican Grill Inc. (CMG) and more recently Wingstop Inc. (WING) are seeing their margins benefitting from food deflation. Along with a pickup in average check size owing to prior price increases, these companies have delivered margin improvement and expanding EPS. I expect the same from Del Frisco’s. When coupled with an expected uptick in holiday spending and consumer sentiment running at high levels, we remain bullish on DFRG shares heading into Monday’s earnings report. Our price target on DFRG shares remains $14.

 

What to Watch Next Week

On the economic front, we’ll get more inflation data in the form of the October CPI report next week, which follows tomorrow’s October PPI one. In both we hear at Tematica will be scrutinizing the year over year comparisons and given the growing number of companies issuing price increases we expect to see those reflected in these October as well as November inflation reports. If the figures come in hotter than expected, expect that to reignite Fed rate hike concerns. Also, next week, we have the October reports for Retail Sales and Industrial Production as well as the first look at November with the Empire Manufacturing and Philly Fed indices.

With the October Retail Sales report, we’ll be once again parsing it to compare against the October same-store sales reported yesterday by Costco Wholesale (COST), which were up 8.6% year over year (+6.6% core). Odds are we will once again have formal confirmation that Costco is taking consumer wallet share.

Compared to the more than 1,200 earnings reports we had this week, the 345 or so next week will be a proverbial walk in the park. there will be several key reports to watch including Home Depot (HD), Macy’s (M), JC Penney (JCP), Williams Sonoma (WSM), and WalMart (WMT). We’ll be matching their forecasts for the current quarter up against the 2018 holiday shopping forecasts from the National Retail Federation, Adobe (ADBE) and others that call for overall holiday shopping to rise 4.0%-5.5% with online shopping climbing more than 15% year over year. I continue to see that as very positive for our shares in Amazon (AMZN), Costco and United Parcel Service (UPS) as well as McCormick & Co. (MKC).

Perhaps the biggest wild card next week will be the Italian budget and as we near the end of this week, things are already getting heated on that front. Today, the Italian government said it is sticking with its plan to rapidly increase public spending despite the budget dispute with the European Union, and it has no intention of revising its plan by next week. As background, Italy is the third largest economy in the EU, and if a joint resolution is not reached we expect this to reignite talk of “Italeave,” which will stoke once again questions over the durability of the EU. Given its size compared to Greece, the Italian situation is one we will be watching closely in the coming days.

Weekly Issue: Among the Volatility, We See Several Thematic Confirming Data Points

Weekly Issue: Among the Volatility, We See Several Thematic Confirming Data Points

Key points inside this issue:

  • As expected, news of the day is the driver behind the stock market swings
  • Data points inside the September Retail Sales Report keep us thematically bullish on the shares of Amazon (AMZN), United Parcel Service (UPS) and Costco Wholesale. Our price targets remain $$2,250, $130 and $250, respectively.
  • We use the recent pullback to scale further into our Del Frisco’s Restaurant Group (DFRG) shares at better prices, our price target remains $14.
  • Netflix crushes subscriber growth in the September quarter; Our price target on Netflix (NFLX) shares remains $500.
  • September quarter earnings from Ericsson (ERIC) and Taiwan Semiconductor (TSM) paint a favorable picture from upcoming reports from Nokia (NOK) and AXT Inc. Our price targets on Nokia and AXT shares remain $8.50 and $11, respectively.
  • Walmart embraces our Digital Innovators investment theme
  • Programming note: Much commentary in this week’s issue centers on the September Retail Sales Report. On this week’s Cocktail Investing podcast, we do a deep dive on that report from a thematic perspective. 

 

As expected, news of the day is the driver behind the stock market swings

If there is one thing we can say about the domestic stock market over the last week, it remains volatile. While there are other words that one might use to describe the down, up, down move over the last week, but volatile is probably the most fitting. Last week I shared the market would likely trade based on the data of the day — economic, earnings or political — and that seems to have been the case. While we’ve received several solid earnings reports, including one from Thematic Leader Netflix (NFLX), several banks and even a few airlines, the headline economic data came up soft for September Retail Sales and Housing.

And then there was yesterday’s FOMC minutes from the Fed’s September monetary policy meeting, which showed that even though the Fed expects to remain on its tightening path, subject to the data to be had, several members of the committee see “a period where the Fed even will need to go beyond normalization of rates and into a more restrictive stance.”

Odds are we can expect further tweets from President Trump on this given his prior comments that the Fed is one of his greatest risks. I also expect this to reignite concerns for the current expansion, particularly since the Fed has historically done a good job hiking interest rates into a recession. From a thematic perspective, continued rate hikes by the Fed is likely to put some added pressure on Middle-Class Squeeze consumers. Before you freak out, let’s check the data. The economy is still growing, adding jobs, benefiting from lower taxes and regulation. It’s not about to fall off a cliff in the near term, but yes, the longer the current expansion goes, the greater the risk of something more than just a slower economy. More reasons to keep watching the monthly data.

Here’s the good news, inside that data and elsewhere we continue to receive confirming signals for our 10 investing themes as well as favorable data points for the Thematic Leaders and other positions on the Tematica Investing Select List.

 

Several positives in the September Retail Sales report for AMZN, UPS & COST

Cocktail Investing Podcast September Retail Sales Report

With the consumer directly or indirectly accounting for nearly two-thirds of the domestic economy and the average consumer spending 31% of his or her paycheck on retails goods, this monthly report is one worth monitoring closely.

Let’s take a closer look at this week’s September 2018 Retail Sales report. First, let’s talk about the headline miss that was making the rounds yesterday. Yes, the month over month comparison Total Retail & Food Services excluding motor vehicles & parts fell 0.1%, but Retail rose 0.4% on the same basis. The thing is, most tend to focus on those sequential comparisons, but as investors, we examine year over year comparisons when it comes to measuring revenue, profit and EPS growth. On that basis, Total Retail & Food Services rose 5.7% year over year while Retail climbed 4.4% compared to September 2017. That sounds pretty solid if you ask me. Now, let’s dig into the meat of the report and what it means for several of our thematic holdings.

Right off the bat, we can’t ignore the 11.4% year over year increase in gas station sales during September, which capped off a 17.2% increase for the September 2018 quarter. With such an increase owing to the rise in oil and gas prices, we would expect to see weakness in several of the retail sales categories as the cost of filling up the car saps spending at the margin and confirms our Middle-Class Squeeze investing theme. And we saw just that. Department stores once again fell in September vs. year ago levels as did Sporting goods, hobby, musical instrument, & bookstores. Given recent construction as well as housing starts data, the Building material & garden eq. & supplies dealer category posted slower year over year growth, which was hardly surprising.

Other than gas station sales, the other big gainer was Nonstore retailers – Census Bureau speak for e-tailers and digital commerce that are part of Digital Lifestyle investing theme,  which saw an 11.4% increase in September retail sales vs. year ago levels. That strong level clearly confirms our investment thesis that digital shopping continues to take consumer wallet share, which bodes well for our Amazon (AMZN), United Parcel Service (UPS), and to a lesser extent our Costco Wholesale (COST). With consumers feeling the pressure of our Middle-Class Squeeze investing theme, I continue to see them embracing the Digital Lifestyle to ferret out deals and bargains to stretch their after-tax spending dollars, especially as we head into the holiday shopping season.

Sticking with Costco, the company recently reported its U.S. same-store-sales grew 7.7% for September excluding fuel and currency. Further evidence that Costco also continues to gain consumer wallet share compared to retail and food sales establishments as well as the General Merchandise Store category.

  • Data points inside the September Retail Sales Report keep us thematically bullish on the shares of Amazon (AMZN), United Parcel Service (UPS) and Costco Wholesale. Our price targets remain $2,250, $130 and $250, respectively.

 

Scaling deeper into Del Frisco’s shares

Now let’s dig into the report as it relates to Del Frisco Restaurant Group, our Thematic Leader for the Living the Life investing theme. Per the Census Bureau, retail sales at food services & drinking places rose 7.1% year over year in September, which brought its year-over-year comparison for the September quarter to 8.8%. Clearly, consumers are spending more at restaurants, than eating at home. Paired with beef price deflation that has been confirmed by Darden Restaurants (DRI), this bodes well for profit growth at Del Frisco.

Against those data points, I’m using the blended 12.5% drop in DFRG shares since we added them to our holdings to improve our costs basis.

  • We are using the recent pullback to scale further into our Del Frisco’s Restaurant Group (DFRG) shares at better prices, our price target remains $14.

 

Netflix crushes subscriber growth in the September quarter

Tuesday night Netflix (NFLX) delivered a crushing blow to skeptics as it served up an EPS and net subscriber adds beat that blew away expectations and guided December quarter net subscriber adds above Wall Street’s forecast. This led NFLX shares to pop rather nicely, which was followed by a number of Wall Street firms reiterating their Buy ratings and price targets.

Were there some investors that were somewhat unhappy with the continued investment spend on content? Yes, and I suppose there always will be, but as we are seeing its that content that is driving subscriber growth and in order to drive net new adds outside the US, Netflix will continue to invest in content. As we saw in the company’s September quarter results, year to date international net subscriber adds is 276% ahead of those in the US. Not surprising, given the service’s launch in international markets over the last several quarters and corresponding content ramp for those markets.

Where the content spending becomes an issue is when its subscriber growth flatlines, which will likely to happen at some point, but for now, the company has more runway to go. I say that because the content spend so far in 2018 is lining its pipeline for 2019 and beyond. With its international paid customer base totaling 73.5 million users, viewed against the global non-US population, it has a way to go before it approaches the 45% penetration rate it has among US households.  This very much keeps Netflix as the Thematic Leader for our Digital Lifestyle investing theme.

One other thing, as part of this earnings report Netflix said it plans to move away from reporting how many subscribers had signed up for free trials during the quarter and focus on paid subscriber growth. I have to say I am in favor of this. It’s the paying subscribers that matter and will be the key to the stock until the day comes when Netflix embraces advertising revenue. I’m not saying it will, but that would be when “free” matters. For now, it’s all about subscriber growth, retention, and any new price increases.

That said, I am closely watching all the new streaming services that are coming to market. Two of the risks I see are a recreation of the cable TV experience and the creep higher in streaming bill totals that wipe out any cord-cutting savings. Longer-term I do see consolidation among this disparate services playing out repeating what we saw in the internet space following the dot.com bubble burst.

  • Our price target on Netflix (NFLX) shares remains $500.

 

What earnings from Ericsson and Taiwan Semiconductor mean for Nokia and AXT

This morning mobile infrastructure company Ericsson (ERIC) and Taiwan Semiconductor (TSM) did what they said was positive for our shares of Nokia (NOK) and AXT Inc. (AXTI).

In its earnings comments, Ericsson shared that mobile operators around the globe are preparing for 5G network launches as evidenced by the high level of field trials that are expected to last at such levels over the next 12-18 months. Ericsson also noted that North America continues to lead the way in terms of network launches, which confirms the rough timetable laid out by AT&T (T), Verizon (VZ) and even T-Mobile USA (TMUS) with China undergoing large 5G field trials as well. In sum, Ericsson described the 5G momentum as strong, which helped drive the company’s first quarter of organic growth since 3Q 2014. That’s an inflection point folks, especially since the rollout of these mobile technologies span years, not quarters.

Turning to Taiwan Semiconductor, the company delivered a top and bottom line beat relative to expectations. Its reported revenue rose just shy of 12% quarter over quarter (3.3% year over year) led by a 24% increase in Communication chip demand followed by a 6% increase in Industrial/Standard chips. In our view, this confirms the strong ramp associated with Apple’s (AAPL) new iPhone models as well as the number of other new smartphone models and connected devices slated to hit shelves in the back half of 2018. From a guidance perspective, TSM is forecasting December quarter revenue of $9.35-$9.45 billion is well below the consensus expectation of $9.8 billion, but before we rush to judgement, we need to understand how the company is accounting for currency vs. slowing demand. Given the seasonal March quarter slowdown for smartphone demand vs. the December quarter and the lead time for chips for those and other devices, we’d rather not rush to judgement until we have more pieces of data to round out the picture.

In sum, the above comments set up what should be positive September quarter earnings from Nokia and AXT in the coming days. Nokia will issue its quarterly results on Oct. 25, while AXT will do the same on Oct. 31. There will be other companies whose results as well as their revised guidance and reasons for those changes will be important signs posts for these two as well as our other holdings. As those data points hit, we’ll be sure to absorb that information and position ourselves accordingly.

  • September quarter earnings from Ericsson (ERIC) and Taiwan Semiconductor (TSM) paint a favorable picture from upcoming reports from Nokia (NOK) and AXT Inc. Our price targets on Nokia and AXT shares remain $8.50 and $11, respectively.

 

Walmart embraces our Digital Innovators investment theme

Yesterday Walmart (WMT) held its annual Investor Conference and while much was discussed, one of the things that jumped out to me was how the company is transforming  itself to operate in the “dynamic, omni-channel retail world of the future.” What the company is doing to reposition itself is embracing a number of aspects of our Disruptive Innovators investing theme, including artificial intelligence, robotics, inventory scanners, automated unloading in the store receiving dock, and digital price tags.

As it does this, Walmart is also making a number of nip and tuck acquisitions to improve its footing with consumers that span our Middle-Class Squeeze and in some instances our Living the Life investing theme as well our Digital Lifestyle one.  Recent acquisitions include lingerie company Bare Essentials and plus-sized clothing startup Eloquii. Other acquisitions over the last few quarters have been e-commerce platform Shoebuy, outdoor apparel retailer Moosejaw, women’s wear site Modcloth, direct-to-consumer premium menswear brand Bonobos, and last-mile delivery startup Parcel in September.

If you’re thinking that these moves sound very similar to ones that Amazon (AMZN) has made over the years, I would quickly agree. The question percolating in my brain is how does this technology spending stack up against expectations and did management boost its IT spending forecast for the coming year? As that answer becomes clear, I’ll have some decisions to make about WMT shares and if we should be buyers as we move into the holiday shopping season.

 

Targeting the Middle-class Squeeze, Target unveils Smartly, but will it work?

Targeting the Middle-class Squeeze, Target unveils Smartly, but will it work?

 

When a company brings out a new product line, more than likely it is looking to tap into a demand channel in order to grow revenues, its consumer base or both. What we see with the new consumer staple brand, Smartly, that is being launched by Target is an attempt to catch the tailwind associated with our Middle-class Squeeze investing theme. That theme focuses on cash-strapped consumers that facing tepid wage gains or rising costs and pressured disposable income are changing where they buy the products they need and in some cases sacrificing well-known brands for more affordable prices. It’s what made the Dollar Shave Club such a thorn in the side of Proctor & Gamble’s Gillette razor and razor blade business.

With Target, odds are they are trying to use Smartly to lure cost-conscious shoppers back into their locations, hoping it can convert the traffic into buyers of other items. It sounds a lot like the loss leader strategies of yore, but even in those cases the question is will the traffic (if it comes) convert to buyers? The jury is out on that for now.

 

Target Corp. is wading into a new territory: $1 toiletries.

The Minneapolis-based retailer said it is planning to launch a new brand for consumer staples called Smartly with more than 70 products, including razors, toilet paper and dish soap, mostly priced under $2. The products will be offered at stores and online in mid-October.

Mark Tritton, Target’s chief merchandising officer, said the new line of consumer staples is an attempt to compete with generic brands at drugstores and discount chains. “It’s about showing people that I don’t have to go to Aldi or I don’t have to go to Dollar General to find what I’m looking for,” he said in an interview.

Meanwhile, the market for generic consumer staples has become more crowded. Last year, Brandless, a San Francisco-based startup, began selling staples such as fluoride-free toothpaste and dish soap, priced at $3. German grocer Aldi has also been opening more locations in the U.S. and gaining traction by selling a pared-down selection at rock-bottom prices.

The competition has forced players such as Walmart to revamp their brands. In 2016, the big-box chain scrapped a discount store brand in sparse blue packaging called Price First as part of a wider reworking of all its private-label products. The company now sells its lowest-priced groceries under Great Value and toiletries under Equate, with boxes and bottles more reminiscent of traditional brands.

Source: Target’s Answer to Discounters Is an Even Cheaper Store Brand – WSJ

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

Making thematic sense of the July Retail Sales report

Making thematic sense of the July Retail Sales report

Key points for this alert:

  • Our price target on Amazon (AMZN) remains $2,250.
  • Our price target on Costco Wholesale (COST) remains $230.
  • Our price target on Habit Restaurant (HABT) is getting a boost to $17 from $16.
  • We are also bumping our price target on McCormick & Co. (MKC) shares to $130 from $110 as we get ready for seasons eatings 2018.

 

Following on the heels of the July Retail Sales report we received Wednesday, this morning Walmart (WMT) reported stellar July quarter results led by stronger than expected same-store sales and a 40% year over year increase in its e-commerce sales. From our perch, we see both reports as positive for our positions in both Amazon (AMZN) and Costco Wholesale (COST) as well as Habit Restaurant (HABT) and McCormick & Co. (MKC) shares.

Digging into the better than expected July Retail Sales report that showed Retail up 0.4% month over month and 6.0% sequentially, top performers were Food Services & drinking places (up +9.7% year over year), Nonstore retailers (+8.7%) and Grocery Stores (+4.9%) year over year. In response to that report, as well as the news that China and the US are heading back to the trade negotiation tables, our Habit Restaurant shares continue to sizzle. That stellar showing in July for Food Services & drinking places brought the trailing 3-month comparison to up more than 8% year over year.

To me, this echoes the data we’ve seen of late that points to the rebound in monthly restaurant sales, which is due as much to price increases as it is to improving customer volume, particularly at Fast Casual restaurants like Habit. As evidenced by Habit’s recent blowout June quarter earnings report, the company continues to execute on the strategy that led us to add the shares to the portfolio back in May. On the heels of the July Retail Sales report, I find myself once again boosting our price target on HABT shares to $17 from $16 as the underlying strength is continuing into the current quarter.

With just over 6% upside to our new price target for Habit, it’s not enough to commit fresh capital to the position. Given the surge in HABT shares – more than 80% since we added them to the Tematica Investing Select List this past May – as well as their current technical picture (see the chart below), I’m inclined to opportunistically use the position as a source of funds in the coming weeks.

 

 

While one might think those gains have come at the expense of grocery stores, and in turn, a potential blow to McCormick’s, the July figure for grocery was also the best in the last three months. What this tells us is people are likely paying more for food at the grocery store and at restaurants, which reflects the combination of higher food prices as well as the shift to food, drinks, and snacks that are healthier for the consumer (and a bit more expensive in general). On that strength and the forward view that will soon have us waist deep in season’s eatings, we are boosting our price target for MCK to $130 from $110. That includes some post-June quarter earnings catch up on our part for McCormick and its ability to grow its top line as part of our Clean Living and Rise of the New Middle Class investing themes, as well as wring out cost synergies associated with acquired businesses. In the coming months, I expect we will once again see this Dividend Dynamo boost its quarterly dividend, keeping MKC shares as one to own, not trade.

Getting back to the July Retail Sales report, the Nonstore retail July figure bodes very well for continued share gains at Amazon and other retailers that are embracing our Digital Lifestyle investing theme as we head into the holiday shopping season. Moreover, I see the e-commerce sales gains at Walmart – up +40% in the July quarter as well as those by Costco Wholesale, up  33% year to date — serving to confirm the accelerating shift by consumers to that modality of shopping as more alternatives become available. Helping Walmart is the addition of over 1,100 brands year to date including Zwilling J. A. Henckels cutlery and cookware, Therm-a-Rest outdoor products, O’Neill surf and water apparel, Shimano cycling products and the brands available on the dedicated Lord & Taylor shop, like Steve Madden footwear. Let’s remember too that Amazon continues to pull the lever that is private label products across a growing array of categories, and those margins are superior to those for its Fulfilled by Amazon efforts.

Speaking of Costco, its July sales figures showed a 6.6% year over year increase in same-store sales, which as we learned by comparing that with the July Retail Sales report was magnitudes stronger than General Merchandise stores (+3.3% year over year) and Department Stores (+0.3% year over year). Yes, Costco was helped by its fresh foods business, but even there it topped Grocery sales for the month. The clear message is that Costco continues to win consumer wallet share, and more of that is likely to be had in the coming months as consumers contend with the seasonal spending pickup.

The big loser in the July Retail Sales report was the Sporting goods, hobby, musical instrument, & bookstores category, which is more than likely seeing its lunch eaten by Amazon, Walmart, and Costco. All three of these companies are embracing the increasing digital lifestyle, targeting rising incomes in the emerging markets and helping cash-strapped consumers in the US stretch those dollars. As we have said many times before, the only thing better than the tailwinds of one of our investing themes is the combination of several and these companies are benefitting from our Digital Lifestyle, Rise of the New Middle Class and Middle-Class Squeeze investing themes.

All in all, the last 24 or so hours as very positive for our AMZN, COST, HABT and MKC shares on the Tematica Investing Select List.

  • Our price target on Amazon (AMZN) remains $2,250.
  • Our price target on Costco Wholesale (COST) remains $230.
  • Our price target on Habit Restaurant (HABT) is getting a boost to $17 from $16.
  • We are also bumping our price target on McCormick & Co. (MKC) shares to $130 from $110 as we get ready for seasons eatings 2018.

 

Ikea open for the growing middle-class in India

Ikea open for the growing middle-class in India

We can now add Ikea to the throes of companies that are targeting the growing middle-class in India. We’ve acknowledged for some time that market in India is one of the drivers behind our Rise of the New Middle Class investing theme, and the latest data from the International Monetary Fund finds India to be the world’s fastest-growing major economy in 2018. With a household furniture market that is expected to be worth $2.7 billion by 2022, odds are other companies like Walmart and Amazon will be attacking this market as they look to expand their presence in India.

Ikea has finally opened its first store in India on Thursday, targeting the country’s growing middle-class in an environment that Chief Executive Jesper Brodin has described as “more committed to progress.”

India presents businesses with one of the world’s largest consumer markets. Its 1.3 billion citizens means that it is the world’s second most populous country after China. But, gross domestic product (GDP) per capita remains less than a quarter that of its fellow Asian giant.

Nonetheless, India is expected by the International Monetary Fund (IMF) to be the world’s fastest-growing major economy in 2018. The country’s household furniture market is expected to be worth $2.7 billion by 2022, according to The Economist Intelligence Unit.

Indian consumers are unused to traveling to stores to buy self-assemble furniture, Reuters reported. Instead, furniture is usually delivered to customers fully built. To solve this problem, Ikea has set up a 150-strong in-house team to help customers put products together.

According to one analyst, Ikea’s latest venture into India is likely to be a success — and this is not just down to the country’s economic fundamentals. “With high real estate prices forcing more and more Indians to live in small apartments, Ikea’s minimalist and multi-purpose furniture will be expected to register strong demand,” Barsali Bhattacharyya, deputy lead companies analyst at The Economist Intelligence Unit, told CNBC via email Thursday.

Chicken and vegetarian variations of Ikea’s famous meatballs are sold in the Hyderabad store to account for India’s prevailing religious beliefs.

Source: Ikea opens first India store in Hyderabad

Recasting Our Rise and Fall of the Middle Class and Cash-Strapped Consumer Themes

Recasting Our Rise and Fall of the Middle Class and Cash-Strapped Consumer Themes

 

KEY POINTS FROM THIS POST

  • As we recast our Rise & Fall of the Middle Class into two themes – the New Middle Class and the Middle-Class Squeeze, which also folds in our Cash-Strapped Consumer theme, we are calling out Costco Wholesale (COST) shares as a top Middle-Class Squeeze pick, reiterating our Buy rating on the shares, and bumping our price target from $210 to $220.

At the end of yesterday’s Tematica Investing issue, I mentioned how at Tematica we are in the process of reviewing the investing themes that we have in place to make sure they are still relevant and relatable. As part of that exercise and when appropriate, we’ll also rename a theme.  Our goal through this process is to streamline and simplify the full list of 17 themes.

Of course, first up is our Rise & Fall of the Middle-Class theme that we are splitting into two different themes — which I know doesn’t sound like an overall simplification, but trust me, it will make sense. As the current name suggests, there are two aspects of this theme — the “Rise” and the “Fall” part. It can be confusing to some, so we’re splitting it into two themes. The “Rise” portion will be “The New Global Middle Class” and will reflect the rapidly expanding middle-class markets particularly in Asia and South America. On the other hand, the “Fall” portion will be recast as “The Middle Class Squeeze” to reflect the shrinking middle class in the United States and the realities that it poses to our consumer-driven economy.

As we make that split, it’s not lost on us here at Tematica that there is bound to be some overlap between The Middle-Class Squeeze and our Cash-Strapped Consumer investing theme given that one of the more powerful drivers of both is disposable income pressure and a loss of purchasing power. As such, as we cleave apart The Middle-Class Squeeze we’re also incorporating Cash-Strapped Consumer into it. It’s repositionings like this that we’ll be making over coming weeks, and while I hate to spoil a surprise as we say good bye to one or two themes, we’ll be saying hello to new one or two as well.

 

 

Why America’s Middle Class are Feeling the Squeeze

As both I and Tematica’s Chief Macro Strategist, Lenore Hawkins, have been sharing in our writings as well as our collective media hits, we’re seeing increasing signs of inflation in the systems from both hard and soft data points and that recently prompted the Fed to boost its interest rate forecast to four hikes this year, up from three with additional rate hikes in 2019. That’s what’s in the front windshield of the investing car, while inside we are getting more data that points to an increasingly stretched consumer that is seeing his or her disposable income under pressure.

According to LendingTree’s May 2018 Consumer Debt Outlook, Americans owe more than 26% percent of their disposable personal income on consumer debt, up from 22% in 2010. And just so we are clear, LendingTree is defining consumer debt to include non-mortgage debts such as credit cards, personal loans, auto loans, and student loans. These outstanding balances of consumer credit, per LendingTree, have been growing at a steady rate of 5% to 6% annually over the last two years, and this has it to forecast total consumer debt to exceed $4 trillion by the end of 2018.

Part of the reason consumers have been turning to debt is the lack of wage growth. Even as tax reform related expectations have been running high for putting more money in consumer pockets data from the Bureau of Labor Statistics revealed compensation for civilian workers rose 2.4% year over year in the March quarter. By comparison, gas prices have risen more than 24% over the last 12 months, and the average home price in the US was up more than 11% in April 2018 vs. April 2017. So, while wages have moved up that move has paled in comparison to other costs faced by consumers.

Then there’s the data from Charles Schwab’s (SCHW) 2018 Modern Wealth Index that finds three in five Americans are living paycheck to paycheck. According to other data, consumers more than three months behind on their bills or considered otherwise in distress were behind on nearly $12 billion in credit card debt as of the beginning of the year — an 11.5 percent increase during Q4 alone.

And it’s not just the credit card debt — mortgage problem debt is up as well, 5.2% to $56.7 billion.

As that debt grows, it’s going to become even more expensive to service. On its recent quarterly earnings conference call, Lending Club’s (LC) CFO Tom Casey shared that “Borrowers are starting to see the increased cost of credit as most credit card debt is indexed to prime, which has moved up 75 basis points from a year ago…We have observed a number of lenders increase rates to borrowers…We know that consumers are feeling the increase in rates.”

And that’s before the Fed rate hikes that are to come.

The bottom line is it likely means more debt and higher interest payments that lead to less disposable income for consumers to spend.

 

More US consumers getting squeezed

All of this points to an already stretched consumer base that has increasingly turned to debt given that real wage growth has been tepid at best over the past decade. And this doesn’t even touch on the degree to which the American consumer is under-saved or has little in the way of an emergency fund to cover those unforeseen expenses. Per Northwestern Mutual’s 2018 Planning & Progress Study, which surveyed 2,003 adults:

  • 78% of Americans say they’re ‘extremely’ or ‘somewhat’ concerned about not having enough money for retirement. Another 66 percent believe that they’ll outlive their retirement savings.
  • 21% of Americans have nothing at all saved for the future, and another 10 percent have less than $5,000 saved or invested for their golden years.

Adding credence to this figures, Bankrate’s latest financial security index survey, showed that 34% of American households experienced a major unexpected expense over the past year. But, only 39% of survey respondents said they would be able to cover a $1,000 setback using their savings. Other findings from Bankrate, based on data from the Federal Reserve, showed that those Americans between the ages of 55 and 64 that have retirement savings only have a median of $120,000 socked away. A similar 2016 GOBankingRates survey found that 69 percent of Americans had less than $1,000 in total savings and 34 percent had no savings at all.

Nearly 51 million households don’t earn enough to afford a monthly budget that includes housing, food, childcare, healthcare, transportation and a cell phone, according to a study by the United Way ALICE Project. That’s 43% of households in the United States.

As the New Middle Class in the emerging economies like China, India and parts of South America continue to expand, it will drive competitive world-wide pressures for food, water, energy and other scarce resources that will drive prices higher given prospects for global supply-demand imbalances.

 

Middle-Class Squeeze pain brings opportunity with Costco and others

What this tells us is that there is a meaningful population of Americans that are in debt and are not prepared for their financial future. In our experience, pain points make for good investment opportunities. In the case of the Middle-Class Squeeze investment theme, it means consumers trading down when and where possible or looking to stretch the disposable dollars they do have.

It’s no coincidence that we’re seeing a growing move toward private label brands, not only at the grocery store for packaged foods and beverages but by the likes of Amazon (AMZN) as well. We’re also seeing casual dining and fine dining restaurant categories give way to fast casual, and as one might expect the data continues to show more Americans eating at home than eating out.

From my perspective, the best-positioned company for the Middle-Class Squeeze investing theme is Costco Wholesale (COST). By its very nature, the company’s warehouse business model aims to give consumers more for their dollar as Costco continues to improve and expand its offering both in-store and online. To me, one of the smartest moves the company made was focusing not only on perishable food but on organic and natural products as well. That combination keeps customers coming back on a more frequent basis.

Let’s remember too, the secret sauce baked into Costco’s business model – membership fees, which are high-margin in nature, and are responsible for a significant portion of the company’s income. As I’ve shared before, that is a key differentiator compared to other brick & mortar retailers. And Costco looks to further expand that footprint as it opens some 17 more warehouse locations in the coming months.

I’ll continue to monitor Costco’s monthly sales reports, which have clearly shown it taking consumer wallet share, and juxtaposing them against the monthly Retail Sales report to confirm those wallet share gains.

  • As we recast our Rise & Fall of the Middle Class into two themes – the New Middle Class and the Middle-Class Squeeze, we are calling out Costco Wholesale (COST) shares as a top Middle-Class Squeeze pick, reiterating our Buy rating on the shares, and bumping our price target from $210 to $220.

 

Examples of companies riding the Middle-Class Squeeze Tailwind

  • Walmart (WMT)
  • Amazon (AMZN)
  • McDonald’s (MCD)
  • Dollar Tree (DLTR)
  • TJX Companies (TJX)
  • Ross Stores (ROST)
  • Kohl’s (KSS)

Examples of companies facing the Middle-Class Squeeze Headwind

  • Dillard’s (DDS)
  • JC Penney (JCP)
  • Macy’s (M)
  • Target (TGT)
  • Gap (GPS)
  • Red Robin (RRGB)

Again, those are short lists of EXAMPLES, not a full list of the companies benefitting or getting hit.

Over the next several weeks, I’ll be revisiting our investment themes, both the ones being tweaked as well as the ones, like Safety & Security, that are fine as is.