Menu

Category Archives: Tematica Investing

Lord & Taylor’s owner Hudson Bay increasingy focused on digital

Lord & Taylor’s owner Hudson Bay increasingy focused on digital

What can we say other than it’s the latest sign of the woes faced by traditional brick & mortar retailers – the closing of once iconic flagship locations as they are caught between the push-pull of our investment themes. In this case it’s the accelerating shift toward digital shopping that is part of our Connected Society or Digital Lifestyle investing theme as well as our Cash-strapped Consumer one.

While Hudson Bay once expected to keep a scaled down version of the iconic Lord & Taylor location on Fifth Avenue, it has since decided to throw in the towel all together. Future generations may never know the beauty of Lord & Taylor’s Holiday Windows… unless Hudson Bay gives them a digital makeover as well.

 

Hudson’s Bay (HBAYF), the Canadian-based owner of Lord & Taylor and Saks Fifth Avenue, agreed last October to sell the Fifth Avenue store to WeWork for $850 million. The iconic store is located between 38th and 39th Streets and not far from Times Square.

The original plan was for the store to become WeWork’s New York headquarters after the 2018 holiday season. After that, approximately 150,000 square feet of the building would continue to be run as a scaled-down Lord & Taylor.

But that is no longer the case. Hudson’s Bay said late Monday that it “has decided not to maintain a presence at [the Fifth Avenue] location following turnover of the building to WeWork.”

The company said that “exiting this iconic space” — which first opened in 1914 — is a reflection of “Lord & Taylor’s increasing focus on its digital opportunity and [Hudson’s Bay] commitment to improving profitability.”

Hudson’s Bay is turning to Amazon rival Walmart (WMT) for assistance in the digital shopping arena. Walmart announced last November that Lord & Taylor will have a flagship store on Walmart.com.

The companies added last month that the online store is set to launch in the coming weeks with more than 125 brands and will feature free two-day shipping for orders over $35.

Source: Lord & Taylor is closing its 5th Ave store

WEEKLY ISSUE: Taking a Last Sip from Our Venti Latte as We Head into the Summer

WEEKLY ISSUE: Taking a Last Sip from Our Venti Latte as We Head into the Summer

KEY POINTS FROM THIS ALERT:

  • We are issuing a Sell on Starbucks (SBUX) shares and removing them from the Tematica Investing Select List.
  • We are trimming our position in USA Technologies (USAT) shares, selling half the position on the Tematica Investing Select List and keeping the other half in play to capture any potential additional upside.
  • Heading into this week’s Costco (COST) earnings call, our price target is $210.
  • Heading into Apples 2018 WWDC event next week, our price target on Apple (AAPL) shares remains $200.
  • While we watch for a potential Las Vegas strike, our longer-term price target for MGM remains $39.
  • We continue to have a Buy rating and an $85 target for Paccar (PCAR) shares
  • With data points confirming a pick-up in business investment, we continue to have a Buy rating and a $235 price target for Rockwell Collins (ROK) shares.

 

Coming into this shortened week for the stock market following the Memorial Day holiday, we’ve seemingly traded one concern for another. I’m talking about the shift in investor focus that has moved from the pending June 12 meeting between the US and North Korea to renewed concerns over Italy and what it could mean for the eurozone and the euro as well as the overall stock market and the dollar. In last week’s Weekly Wrap, I thought Tematica’s Chief Macro Strategist, Lenore Hawkins, did a bang-up job summing up the situation but as we entered this week it pivoted once again, pointing to the likelihood of new elections that could pave the way for anti-euro forces.

This fresh round of uncertainty led the market lower this week, pulling the CNN Money Fear & Greed Index back into Fear territory from Neutral last week. Not surprising, but as investors assess the situation odds are US stocks, as well as the dollar and US Treasuries, will be viewed as ports of safety. That realization likely means the short-term turbulence will give way to higher stock prices, especially for US focused ones. Multinational ones will likely see a renewed currency headwind given the rebound in the dollar as well as the new fall in the euro.

I’ll continue to keep close tabs on these developments and what they mean for not only our thematic lens, but also for the Tematica Investing Select List. Expect to hear more about this on our Cocktail Investing podcast as well.

 

Cutting Starbucks shares from the Tematica Investing Select List

Given our thematic bent, we tend to be investors with a long-term view and that means it takes quite a bit for me to remove a company from the Tematica Investing Select List. Today, we are doing that with Starbucks (SBUX) and for several reasons. As I just mentioned above, this multinational company will likely see currency headwinds return that will weigh on its income statement.

At the same time, the company has been underperforming of late in same-store sales comparisons, which have slipped to the low single digits from mid-single digits in 2013-2016. The decline has occurred as Starbucks has reaped the benefits of its improved food offering over the last several quarters, and its new beverage offerings of late have underwhelmed. In the March quarter, if it weren’t for price increases, its same-store sales would have been negative.

While I still go to Starbucks as does the rest of team Tematica, the reality is that we are not spending incremental dollars compared to last year outside of a price increase for our latte or cappuccino. Said a different way, Starbucks needs to reinvigorate its product line up to win incremental consumer wallet share. In the past, the company had new beverages and then the addition of an expanded food and snack offering to deliver favorable same-store comparisons. Now with a full array of beverages, food and snacks, the question facing Starbucks is what’s next?

It’s this question as well as the simple fact that the closure of its stores yesterday to deliver racial tolerance training to its employees will weigh not only on same-store sales comps for the current quarter but hit profits as well. Keep in mind too that we are heading into the seasonally slower part of the year for the company.

Taking stock of Starbucks stock, my view is let’s take the modest profit and dividends we’ve collected over the last 24 months and move on.

  • We are issuing a Sell on Starbucks (SBUX) shares and removing them from the Tematica Investing Select List.

 

Trimming back our position in USA Technologies

Since adding shares of USA Technologies (USAT) back to the Tematica Investing Select List in early April, they have risen more than 50%, making them one of the best performers thus far in 2018. While the prospects for mobile payments remains vibrant and we are starting to see some consolidation in the space, I’m reminded of the old Wall Street adage – bulls make money, bears make money and pigs get slaughtered.

Therefore, we will do the prudent thing given the sharp rise in our USAT shares in roughly a handful of weeks – we will trim the position back, selling half the position on the Tematica Investing Select List and keep the other half in play to capture the additional upside. As we do this, we are placing our $12 price target under review with an upward bias. That said, we would need to see upside near $16 to warrant placing fresh capital into the shares.

  • We are trimming our position in USA Technologies (USAT) shares, selling half the position on the Tematica Investing Select List and keeping the other half in play to capture the additional upside.

 

Prepping for Costco earnings later this week

After the market close on Thursday (May 31), Costco Wholesale (COST) will report its latest quarterly earnings. Consensus Wall Street expectations are for EPS of $1.68 on revenue of $31.59 billion.

Over the last several months, the company’s same-store sales show it gaining consumer wallet share as it continued to open additional warehouse locations, which sets the stage for favorable membership fee income comparisons year over year. Exiting April, Costco operated 749 warehouse locations around the globe, the bulk of which are in the U.S. and that compares to 729 warehouses exiting April 2017. The number of Costco locations should climb by another 17 by the end of August and paves the way for continued EPS growth in the coming quarters.

  • Heading into this week’s earnings call, our price target is $210 for Costco (COST) shares

 

Updates, updates, updates, updates

Apple (AAPL)                                                                       
Connected Society

Next Monday Apple will hold its 2018 World-Wide Developer Conference (WWDC), which historically has been a showcase for the company’s various software platforms. This year it’s expected to feature iOS 12, the next evolution in its smartphone and tablet software. Recently it was hinted that Apple will unleash the full power of Near Field Communication capabilities found in those chipsets, which have been inside the iPhone since the iPhone 6 model.

In my view, this is likely to be but one of the improvements shared at the event. Those hoping for a hardware announcement are likely to be disappointed, but we never know if we’ll get “one more thing.”

  • Heading into next week’s 2018 WWDC event, our price target on Apple (AAPL) shares remains $200.

 

MGM Resorts International (MGM)
Guilty Pleasure

Quarter to date, shares of gaming-and-resort company MGM have come under pressure but our position in them is down only modestly. I’m putting MGM shares on watch this week following a vote by Las Vegas casino workers to strike when their contract expires at the end of May. I see that vote as a negotiating tactic with dozens of casino and resort operators, akin to what we’ve been seeing emanating from Washington these last few months.

I’ll continue to watch for a potential resolution and what it could mean for margins and EPS expectations. We’ve been patient with MGM shares, but if a strike ensues I’m apt to exit the position and fish in more fruitful waters for this investment theme of ours.

  • While we watch for a potential Las Vegas strike, our longer-term price target remains $39.

 

Paccar (PCAR)
Economic Acceleration/Deceleration

Over the last month, shares of this heavy-duty and medium-duty truck manufacturer have traded sideways. According to the most recent data point from the Cass Freight Index, shipment rose just over 10% year over year in April. That sets the stage for a favorable April reading for the American Trucking Associations’s For-Hire Truck Tonnage Index that rose 6.3% year over year after increasing 7.7% in February on the same basis.

At the same time, we continue to hear from a growing array of companies that they are facing rising costs due in part to surging trucking rates. Coca-Cola (KO) recently reported a 20% year-over-year increase in freight expense. Procter & Gamble (PG), Hasbro, Inc. (HAS), Danone SA, and Nestle SA also reported higher transportation costs and Unilever (UL) expects high-single-digit to high-teens increases in U.S. freight costs in the coming quarters. All of this confirms the current truck shortage that is fueling robust year-over-year growth in new orders for medium and heavy-duty trucks. Next week, we should get the May data and I expect the favorable year over year comparisons to continue.

As production rises to meet demand, we see a positive impact on Paccar’s business on both the top and bottom lines. Our $85 price target equates to just under 15x current estimated 2018 EPS, which has crept up by a few pennies over the last several weeks to $5.69 per share vs. $4.26 in 2017.

  • We continue to have a Buy rating and an $85 target for Paccar (PCAR) shares

 

Rockwell Automation (ROK)
Tooling & Re-Tooling

Our thesis on Rockwell Automation has focused on the expected pick-up in business investment and capital spending following tax reform last year. As the March quarter earnings season winds down, data collected by Credit Suisse reveals spending on factories, equipment and other capital goods by companies in the S&P 500 is expected to have risen to $166 billion during the quarter, up 24% year over year. That’s the fastest pick-up in capital spending since 2011 and marks a March-quarter record since Credit Suisse started collecting the data in 1995.

That year over year increase is roughly in line with the year over year increase in March 2018 U.S. manufacturing technology orders according to data published in the U.S. Manufacturing Technology Orders report from The Association For Manufacturing Technology (AMT). For March quarter in full, AMT’s data points to a 25% year over year improvement, which is in line with Credit Suisse’s capital spending assessment.

Based on these prospects, as well as statistics for the average age of private fixed assets that reveal the average age of U.S. factory stock is near 60 years old, it appears AMT’s 2018 forecast that calls for a 12% increase in US orders of manufacturing equipment compared to 2017 is looking somewhat conservative.

I’ve also noticed that over the last several weeks 2018 EPS expectations for Rockwell have inched up to $7.87 per share from $7.79, while 2019 expectations have moved higher to $8.81 per share from $8.73. I see those upward movements as increasing our confidence in our $235 price target for ROK shares.

  • With data points confirming a pick-up in business investment, we continue to have a Buy rating and a $235 price target for Rockwell Collins (ROK) shares.

 

SPECIAL ALERT: Calling this Disruptive Technology Company back up to the Select List

SPECIAL ALERT: Calling this Disruptive Technology Company back up to the Select List

 

  • We are issuing a Buy on shares of Universal Display (OLED), a Disruptive Technology company, with a $175 price target.

This morning I am calling shares of Universal Display (OLED) back up to the Tematica Investing Select List on reports from South Korea’s ETNews that Apple (AAPL) intends to fully transition its iPhone line up to organic light emitting diode displays with its 2019 models. As the organic light emitting diode  industry continues to ramp capacity in order to meet full demand by Apple and others, I expect to see pricing become more favorable for Apple and others, which should help restrain iPhone price creep in 2019 and beyond. As a reminder, the price of the iPhone X is one of the most cited reasons for its high price point, with one of the key reasons for that price tag being the cost of the organic light emitting diode display that is currently sole sources from Samsung.

As a reminder, Tematica’s Disruptive Technology investment theme focuses on companies that upend existing business models as new technologies come to market. I see Universal Display and its organic light emitting diode technology doing just that to the display industry and eventually the lighting industry as well, just the way light emitting diode displays did. These disruptions can take time and are often filled with setbacks that punish stock prices, much like we have seen with OLED shares over the last several months. As those setbacks fade, however, the adoption resumes and the Apple news suggests that is about to happen for organic light emitting diode displays, a major positive for OLED shares.

Being cautious as OLED shares may get ahead of themselves in the near-term

I expect OLED shares to jump on this news, perhaps even get a tad ahead of themselves in the near-term, but I will keep in mind the ramp for Apple’s 2019 iPhone models will begin in earnest in roughly 12 months from now. During that time, I expect current industry capacity issues to be digested and additional capacity added, which will also be a positive for the display equipment business at our Applied Materials (AMAT) shares.

I point this out because it’s still widely expected that Apple will introduce three new iPhone models this year with some combination of organic light emitting diode and liquid crystal displays (LCDs). Some reports suggest Apple has scaled back volume expectations for iPhone models with organic light emitting diode displays this year in favor of lower cost LCD ones, likely to help it regain share with more affordable models.  In my view, the push-pull between the lineup display choices between this year and 2019 likely reflects a combination of sufficient organic light emitting diode capacity for Apple’s full iPhone lineup and near-term pricing for the displays.

What this means is there are likely to be fits and starts for Universal Display along the way as other smartphone and device manufacturers incrementally chew up existing industry ahead of the 2019 Apple ramp. Should this pan out, it will give us the opportunity to scale into this OLED position, potentially at better prices.

In terms of sign posts I’ll be watching over the coming quarters, organic light emitting diode industry capacity utilization data, new order metrics from Applied and smartphone display choices by other top competitors such as Samsung, Huawei and others.

A conservative price target… for now

With the add back of OLED shares, I am instilling a price target of $175, but as we did before I will continue to monitor the speed of organic light emitting diode adoption and adjust that target accordingly in the coming months.

While some may ask questions over that 51x price to earnings multiple on currently expected 2019 EPS of $3.42 per share I offer two thoughts. First, as the Apple ramp unfolds, odds are 2019 EPS expectations will move higher. Second, even if those 2019 expectations don’t move higher, which is unlikely, OLED shares are currently trading at a price to earnings growth (PEG) ratio of 0.35 based on the compound annual earnings growth rate of 82% over the 2015-2019 period. My $175 target equates to a PEG ratio of 0.6 on current 2019 EPS expectations. In my view, the Apple news is the catalyst that will move shares higher, but it will take the expected ramp becoming a reality that will push the shares closer to a PEG ratio of 1.0 over the coming several quarters.

  • We are issuing a Buy on shares of Universal Display (OLED), a Disruptive Technology company, with a $175 price target.

 

WEEKLY ISSUE: Adding back a specialty contractor to Select List

WEEKLY ISSUE: Adding back a specialty contractor to Select List

 

  • We are issuing a Buy on Dycom Industries (DY) shares with a $125 price target as part of our Connected Society investing theme.
  • We are adding LendingClub (LC) shares to the Tematica Investing Contender List and will revisit the shares following the resolution of the current FTC complaint.
  • Our price target on Costco Wholesale (COST) and Amazon (AMZN) shares remain $210 and $1,750, respectively.
  • Our long-term price target on shares of Applied Materials (AMAT) remains $70.

As we inch along in the second half of the current quarter, the stock market is once again dealing with the flip-flopping on foreign trade. Last week there appeared to be modest progress between China and the US but following comments from President Trump on the pending summit with North Korea and “no deal” regarding China’s bankrupt ZTE, trade uncertainty is once again gripping the markets. Several weeks ago, I cautioned we were likely in for some turbulent weeks – some up some down – as these negotiations got underway. In my view, there will be much back and forth, which will keep the stock market on edge. I’ll continue to utilize our thematic lens and look for compelling long-term opportunities in the coming weeks, just like the one we are about to discuss…

 

Adding back shares of Dycom (DY) to the Tematica Investing Select List

Late last summer, we exited our position in specialty contractor and Connected Society food chain company Dycom Industries (DY) that serves the mobile and broadband infrastructure markets. Yesterday, following an earnings miss and reduced guidance from the company, its share dropped 20% to $92.64. The reason for the miss and outlook revisions stemmed from weather-related concerns during the February and March months as well as protracted timing associated with key next-gen network buildouts.

Clearly disappointing, but we have seen such timing issues before in the buildouts of both 3G and 4G/LTE networks before. In today’s stock market that double disappointment hit DY shares, no different than it has other companies that have come up short this earnings season.

We’ve often used pronounced pullbacks in existing positions to sweeten our average cost basis, and today we’re going to use this drop in DY shares to add them back to the Tematica Investing Select List.

Why?

Two reasons.

First, the inevitability of 5G network deployments from key customers (AT&T) and Verizon (VZ). Those two alongside their competitors have Sprint (S) and T-Mobile (TMUS) have committed to launching 5G networks by year-end, with a buildout to a national footprint to follow over the ensuing quarters. AT&T and Verizon accounted for 24% and 16% of the quarter’s revenue with Comcast (CMCSA) clocking in at just under 22% and Centurylink (CTL:NYSE) around 12%. This positions Dycom extremely well not only for the pending 5G buildout, but also the gigabit fiber one that is underway at cable operators like Comcast. Amid the timing disruptions with AT&T and Centurylink that led to the earnings disappointment and outlook cut, Dycom called out solid progress with Verizon, as its revenue rose more than 80% year over year. There’s also an added bonus – Dycom has little exposure to Sprint and T-Mobile, which are planning to merge and based on what we’ve seen in the past that means spending cuts are likely to be had as they consolidate existing assets and capital expansion plans.

Here’s the thing, while it is easy to get caught up in yesterday’s DY share price drop, it’s akin to missing the forest for the trees given the network upgrades and next-gen buildouts that will occur not over the coming months, but over the coming quarters.

Dissecting Dycom’s quarterly earnings and revised outlook that calls for EPS of $1.78-$1.93 in the first half of the year, to hit its new full-year target EPS of $4.26-$5.15 it means delivering EPS of $2.98-$3.22 in the back half of the year. In other words, a pronounced pick up in business activity that likely hinges on a pickup in network buildout activity from its customers.

I do expect Wall Street price target revisions and analyst commentary to weigh on DY shares in the near-term. Even I am cutting my once $140 price target for the shares to $125. That $140 target was based on 2019 EPS of $7.10 per share and given the company’s comments yesterday I expect 2019 EPS forecasts to be revised down to the $6.00-$6.50 range.

As the 5G buildout gets under way, the reality is that several quarters from now, such EPS and price target cuts could prove to be conservative, but I’d rather be in the position to raise our price target as the company beats EPS expectations. That revised 2019 EPS range derives a price target for DY shares of $120-$130. For now, we’ll split the difference at $125, which still offers almost 35% upside from current share price levels.

  • We are issuing a Buy on Dycom Industries (DY) shares with a $125 price target as part of our Connected Society investing theme.

 

Putting LendingClub shares onto the Contender List

As team Tematica has been discussing over the last several weeks in our writings and on our Cocktail Investing Podcast, we’re seeing increasing signs of inflation in the systems from both hard and soft data points. This likely means the Fed will boost rates four not three times in 2018 with additional rate hikes to be had 2019. That’s what’s in the front windshield of the investing car, while inside we are getting more data that points to a stretched consumer.

  • Per the May 2018 Consumer Debt Outlook report from Lending Tree (TREE), Americans are on pace to amass a collective $4 trillion in consumer debt by the end of 2018. This means Americans are spending more than 26% of their income on consumer debt, up from 22% in 2010 with the bulk of that increase due to non-house related borrowing.
  • The Charles Schwab’s (SCHW) 2018 Modern Wealth Index that reveals three in five Americans are living paycheck to paycheck.
  • A new report from the Federal Reserve finds that 40% of Americans could not cover an unexpected $400 expense and 25% of Americans have no retirement savings.

 

As consumer debt grows, it’s going to become even more expensive to service as the Fed further increases interest rates. On its recent quarterly earnings conference call, LendingClub’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.”

Again, 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. Unfortunately, we see this as a tailwind for our Cash-strapped Consumer investing theme as well as a headwind for consumer spending and the economy. We’ve seen the power of this tailwind in monthly retail same store sales from Costco Wholesale (COST), which have simply been off the charts, and in monthly Retail Sales reports that show departments stores, sporting goods stores and others continue to lose consumer wallet share at the expense of non-store retailers like Amazon (AMZN). The drive is the need to stretch what disposable spending dollars a consumer has.

The reality is, however, that those that lack sufficient funds will seek out alternatives. In some cases that means adding to their borrowings, often times at less than attractive rates.

With that in mind, above I mentioned LendingClub. For those unfamiliar with the company, it operates an online credit marketplace that connects borrowers and investors in the US. It went public a few years ago and was heralded as a disruptive business for consumers and businesses to obtain credit based on its digital product platform. That marketplace facilitates various types of loan products for consumers and small businesses, including unsecured personal loans, unsecured education and patient finance loans, auto refinance loans, and unsecured small business loans. The company also provides an opportunity to the investor to invest in a range of loans based on term and credit.

Last year 78% of its $575 million in revenue was derived from loan origination transaction fees derived from its platform’s role in accepting and decisioning applications on behalf of the company’s bank partners. More than 50 banks—ranging in total assets of less than $100 million to more than $100 billion—have taken advantage LendingClub’s partnership program.

LendingClub’s second largest revenue stream is derived from investor fees, which include servicing fees for various services, including servicing and collection efforts and matching available loans with capital and management fees from investment funds and other managed accounts, gains on sales of whole loans, interest income earned and fair value gains/losses from loans held on the company’s balance sheet.

The core loan origination transaction fee business along with the consensus price target of $5.00, which offers compelling upside from the current share prices, has caught my interest. However, there is one very good reason for why I am recommending we wait on LC shares.

It’s because the Federal Trade Commission (FTC) has filed a complaint against LendingClub, charging that it has misled consumers and has been deducting hidden fees from loan proceeds issued to borrowers. Moreover, as stated in the FTC’s complaint, Lending Club recognized that its hidden fee was a significant problem for consumers, and an internal review by the company noted that its claims about the fee and the amount consumers would receive “could be perceived as deceptive as it is likely to mislead the consumer.”

Given the potential fallout, which could pressure LC shares, we’ll sit on the sidelines with LendingClub and look for other companies that are positioned to capitalize on this particular Cash-strapped Consumer pain point.

  • We are adding LendingClub (LC) shares to the Tematica Investing Contender List and will revisit the shares following the resolution of the current FTC complaint.
  • Our price target on Costco Wholesale (COST) and Amazon (AMZN) shares remain $210 and $1,750, respectively.

 

Sticking with shares of Applied Materials

Last week Disruptive Technology company Applied Materials (AMAT) reported quarterly results that once again topped expectations but guided the current quarter below expectations. As I mentioned above with Dycom shares, the current market mood is less than forgiving in these situations and that led AMAT shares to give back much of the gains made in the first half of May.

The shortfall relative to expectations reflected reported weakness in high end smartphones, which is slowing capital additions for both chips and organic light-emitting diode display equipment. This is the latest in a growing number of red flags on smartphone demand, which in my view is likely to be the latest transition period in the world of smartphones. For those wondering about our Apple (AAPL) shares, the company already issued a sequentially down iPhone forecast when it reported its own earnings several weeks back as it upsized its own buyback program.

Again, looking back on my Dycom comments above, mobile carriers are about to embark on building out their 5G networks, which will drive incremental RF semiconductor chip demand as well as drive demand for new applications, such as semi-autonomous and autonomous cars. I see 5G devices with near broadband data speeds driving the next smartphone upgrade cycle. When that happens, there are also other technologies, such as artificial intelligence, augmented reality, and virtual reality that will be moving into a greater number of these and other devices. On its earnings call, Applied shared it’s starting to see ramping demand for artificial intelligence, big data a cloud related applications. I see more of this happening in the coming quarters… again, the long-term forest vs. the quarterly tree… and I haven’t even mentioned the internet of things (IoT).

Another driver I’m watching for Applied’s semi-cap business is the ongoing buildout of in-China semiconductor capacity. The item to watch for this is The National Integrated Circuitry Investment Fund, which represents the Chinese government’s primary vehicle to develop the domestic semiconductor supply chain and become competitive with the U.S.  chip industry leader the US. That fund is reportedly closing in on an upsized 300 billion-yuan fund ($47.4 billion) fund vs. the expected 120 billion-yuan ($18.98 billion) to support the domestic chip sector. As we have seen in the headlines with ZTE as well as the Broadcom (AVGO) bid for Qualcomm (QCOM), the semiconductor industry has taken a leading role in the current U.S.-China trade conflict. As I continue to watch these trade discussions play out, I’ll only be assessing implications for the National Integrated Circuitry Investment Fund and our Applied Materials shares.

In terms of organic light emitting diode displays and revisiting shares of Universal Display (OLED), the industry is still in a digestion period given the capacity ramp for that technology and the smartphone transition I touched on above. We’ve got OLED shares on the Tematica Investing Contender List and I’ll be watching them and signs of ramping demand as we move through the summer months.

While we wait, I expect Applied will continue to put its robust share repurchase program to use. As we learned in its quarterly earnings report last week, during the quarter, Applied used $2.5 billion of its $8.8 billion share repurchase authorization to repurchase 44 million shares, roughly 4% of the outstanding share count coming into the quarter. I suspect that once the post-earnings quiet period is over, Applied will be putting more of that program to work. I see that as limiting downside from current levels.

Finally, a quick reminder that come June, Applied will be paying its first $0.20 per share dividend.

  • Our long-term price target on shares of Applied Materials (AMAT) remains $70.
  • As we monitor signs of organic light emitting diode display demand, we continue to have shares of Universal Display on the Tematica Investing Contender List

 

 

Weekly Issue: Many Confirming Data Points from Retail Sales Report

Weekly Issue: Many Confirming Data Points from Retail Sales Report

 

KEY POINTS FROM THIS ISSUE:

  • Our price target on Amazon (AMZN) shares remains $1,750
  • Our price target on United Parcel Service (UPS) remains $130
  • Our price target on Costco Wholesale (COST) remains $210.
  • Our price target on Habit Restaurant (HABT) shares remains $11.50
  • Our price target on Applied Materials (AMAT) shares remains $65.
  • Our price target on Apple (AAPL) shares remains $200.

 

Yesterday, we received the latest monthly Retail Sales report and it once again confirmed not only several of our investing themes, but also several of our Tematica Investing Select List holdings as well. While I and others at Team Tematica put these and other such reports through the grinder to ensure we understand what the data is telling us, I have to say some reports are more of a pleasure to read than others. In this case, it was a great read. First, let’s dig into the actual report and then follow up with some thematic insight and commentary. 

April Retail Sales – the data and comments

Per the Census Bureau, April total Retail Sales & Food Services rose 4.7% year over year, with the core Retail Sales ex-auto parts and food services up 4.8% compared to April 2017. A modest downtick compared to the year over year growth registered in March, but a tad higher than the February comparison.

Subscribers will not be bowled over to learn the two key retail drivers were gas stations (up 11.7% year over year) followed by Nonstore retailers (9.6%). The two categories that have been a drag on the overall retail comparisons – Sporting goods, hobby, book & music stores and Department Stores – continued to do the same in April falling  1.1% and 1.6%, respectively. Scanning the last few months, the data tells us things have gotten tougher for those two categories as the last three months have happened.

With gas stations sales up nearly 11% over the last three months compared to 2017, real hourly earning’s barely up per the latest from the Bureau of Labor Statistics and consumer debt up to 26% of average disposable income (vs. 22% during the financial crisis per the latest LendingTree Consumer Debt Outlook) there’s no way to sugar coat it – something had to give and those two continue to take the brunt of the pain. As gas prices look to move even higher as we switch over to more costly summer gas blends and interest rates poised to move higher, it means consumers will continue to see discretionary spending dollars under pressure.

In keeping with our Connected Society and Cash-strapped consumer investing themes, consumers are turning to digital shopping to hunt down bargains and deals, while also saving a few extra bucks by not heading to the mall. That is, of course, positive confirmation for our position in Amazon (AMZN) shares as well as United Parcel Service (UPS) shares, which have had a quiet resurgence thus far in 2018. That move serves to remind us that connecting the dots can lead to some very profitable investments, and as I like to say – no matter what you order from Amazon or other online shopping locations, the goods still need to get to you or the person for which they are intended. I continue to see UPS as a natural beneficiary of the accelerating shift toward digital commerce.

  • Our price target on Amazon (AMZN) shares remains $1,750
  • Our price target on United Parcel Service (UPS) remains $130

 

April retail sales confirms our bullish stance on Costco

Costco Wholesale (COST) shares have been on a tear since their February bottom, and in my view each month we get a positive confirmation when Costco reports its monthly sales data as increasingly Cash-strapped Consumers look to stretch their disposable dollars was had in Costco Wholesale’s (COST) April same-store-sales report. For the month, Costco’s US sales excluding gas and foreign exchange rose 7.9%, once again showing the company continues to take consumer wallet share. As for the critics over how, late Costco had been to digital commerce, over the last few months its e-commerce sales have been up 31%-41% each month. While still an overall small part of Costco’s revenue stream, the management team continues to expand its digital offerings putting it ahead of many traditional brick & mortar focused retailers.

Finally, we need to touch on one of the key profit generators at Costco – membership fee revenue, which is tied to new warehouse openings.  If we look at the company’s recent quarterly earnings report we find that 73% of its operating profit is tied to that line item. As part of its monthly sale report, Costco provides an updated warehouse location count as well. Exiting April Costco operated 749 warehouse locations around the globe, the bulk of which are in the U.S. and that compares to 729 warehouses exiting April 2017. That number should climb by another 17 new locations by the end of August and paves the way for continued EPS growth in the coming quarters.

  • Our price target on Costco Wholesale (COST) remains $210.

 

Two favorable data points for recently added Habit Restaurant shares

Last week, we added shares of Habit Restaurant (HABT) to the Tematica Investing Select List with an $11.50 price target. Since then, we’ve had two positive data points, including one found in yesterday’s Retail Sales report. The first data point was from TDn2K, a firm that closely watches monthly restaurant sales. For the month of April, TDN2K reported same-store sales for the month rose 1.5%, the best showing in over 30 months. The April Retail Sales report showed year over year April retail sales at Food services & drinking places rose 3.8%, bringing the trailing 3-month total to up 3.6% on a year over year basis.

While our investment thesis on HABT centers on the company’s geographic expansion, these data points point to an improving business for its existing locations. Paired with the pending menu price increase, we see this data pointing a stronger operating environment in the coming quarters.

  • Our price target on Habit Restaurant (HABT) shares remains $11.50

 

Gearing up for earnings from Applied Materials

After tomorrow night’s close Disruptive Technologies company Applied Materials (AMAT) will report its quarterly earnings. Expectations call for it to deliver EPS of $1.14 on revenue of $4.45 billion. For those at home keeping score, those figures are up 44% and 26%, respectively, on a year over year basis.

As the current earnings season got underway, we heard very positive commentary on the semiconductor capital equipment market from several competitors, including Lam Research (LRCX). This lays the groundwork for an upbeat report despite the softness we are seeing in the organic light emitting diode display market. With more smartphone models poised to adopt that display technology, including more favorably priced ones from Apple (AAPL), Applied’s outlook for its Display business tomorrow night could be the canary in the coal mine for shares of Universal Display (OLED).

With regard to the core semiconductor capital equipment business, I continue to see longer-term opportunities for it associated with a number of emerging technologies and applications (growing memory demand, 5G chips sets, 3D sensing, smarter automobiles and homes, and augmented reality to virtual reality and the Internet of Things) that will drive incremental chip demand in the coming years. I’m also hearing that China’s state-backed semiconductor fund, The National Integrated Circuitry Investment Fund, is closing in on an upsized 300 billion-yuan fund ($47.4 billion) fund vs. the expected 120 billion-yuan ($18.98 billion) to support the domestic chip sector. This buildout was one of my focal points behind adding AMAT shares to the Select List over a year ago.

Since then AMAT shares are up more than 50%, and this upsized demand from China is poised to drive them even higher in my view. Before that can happen, however, the semiconductor industry has taken a leading role in the current U.S.-China trade conflict. This means I’ll continue to monitor this development closely.

As we get ready for the upcoming earnings report, let’s also remember Applied buyback program. I suspect the company was in buying shares during the April lows. We’ll get a better sense when we compare year over year share counts once I have the earnings report in my hands.

  • Our price target on Applied Materials (AMAT) shares remains $65.

 

Tim Cook confirms Apple’s move into original content

Apple’s move into original content has to be one of the worst-kept secrets in some time. There have been hiring’s of key people for key roles as well as content partners that have spilled the beans, but now Apple CEO Tim Cook quietly confirmed the move while appearing on “The David Rubenstein Show: Peer-to-Peer Conversations” on Bloomberg Television by saying

“We are very interested in the content business. We will be playing in a way that is consistent with our brand,” Cook told Bloomberg. “We’re not ready to give any details on it yet. But it’s clearly an area of interest.”

A summary of that conversation can be found here, and my $0.02 on this is Apple will be looking to leverage original content to increase the sticky factor for its devices as well as attract new customers for those devices. This is similar to the strategy behind its services business that includes iCloud, Apple Music, Apple Pay and other offerings. We could hear more of this in a few weeks at Apple’s 2018 World Wide Developer Conference but given the expectation for its content to roll out after March 2019 odds are we won’t hear much just yet.

  • Our price target on Apple (AAPL) shares remains $200.

 

 

 

Disney continues to execute as it preps its streaming services

Disney continues to execute as it preps its streaming services

 

After Tuesday’s market close, Content is King investment theme company Walt Disney (DIS) reported stronger than expected March quarter results with EPS besting expectations by $0.14 per share. For the quarter, Disney reported EPS of $1.84 vs the consensus forecast of $1.70 and the $1.50 delivered in the year-ago quarter, which means year over year EPS improved 23%. While better than expected revenue of $14.5 billion for the quarter, up 9% year over year and ahead of the expected $14.1 billion for the quarter, aided the EPS beat so too did the 5% decline in the outstanding share count and the lower tax rate (20.7% vs. 32.3%) in the year-ago quarter.

That revenue and buyback combination offset overall operating profit margin declines that reflected softer margins at the Media Networks (42% of sales, 49% of operating profit) and Consumer Products & Interactive Media (7% of sales, 8% of operating profit) despite solid margin improvement at both Parks & Resorts (34% of sales, 23% of operating profit) and Studio Entertainment (17% of sales, 20% of operating profit).

Sifting through all of the segment results and assessing the below the operating line influences, we find that year over year Disney’s operating profit rose 6% with the business spitting out free cash flow of $3.5 billion, up nearly 50% year over year.

 

More high profile movies are on the way…

It’s pretty much business as usual for Disney, and during the earnings conference call CEO Bob Iger shared an upbeat outlook across the Studio Entertainment and the Parks and Resorts businesses. More specifically for the Studio Entertainment business, on the heels of the newest Avengers film that is breaking box office records, Solo: A Star Wars Story, is generating a lot of interest and strong buzz ahead of its Memorial Day weekend opening. Disney will follow that with a dozen high profile movies over the next 18 months, including Incredibles 2, Ant-Man and the Wasp, Ralph Breaks the Internet, Mary Poppins Returns, Captain Marvel, Dumbo, Avengers 4, Aladdin, Toy Story 4, The Lion King, Frozen 2 and Star Wars Episode IX.

 

…that will drive Disney’s other businesses

With Disney merging its Parks & Resorts business with its Consumer Products business, the new combined entity stands to benefit from the coming onslaught in content from Studio Entertainment across its licensing business as well as new attractions at the Parks. Those new attractions include the Toy Story Land that’s about to open in Florida next month, the one that just opened in Shanghai, updated cruise ships, Star Wars: Galaxy’s Edge will open in both Disneyland and Disney World by the end of calendar 2019 plus multiple hotels around the world and new lands in the Paris and Tokyo parks. I see that as more reasons for people to return to the Disney Parks in the coming years.

 

ESPN Plus has launched

Turning to ESPN, the company recently launched its ESPN Plus Service, a streaming sports service, and while it was mum on details given the brief time it’s been in the marketplace, management said it was encouraged by initial results. The team also noted that it recently inked a deal to add UFC content to the Plus service and that it will continue to both invest and license sports content for both live and non-live sports.

 

And about that pending transaction with FOX

In terms of the pending transaction with 21st Century Fox (FOXA), Disney shared that it is still deep in the process, including on the regulatory front, and it could not add more at this time. Even so, Iger went on to share some high-level synergies to be had, particularly from a content side when describing ESPN Plus, Disney’s own direct to consumer streaming service that will launch in late 2019 as well as Hulu of which it will own some 60%. As part of those comments, Iger also answered a lingering question over that Disney branded streaming service – that it will be anchored by Disney, Marvel, Pixar and Star Wars content.

In recent days, Comcast (CMCSA) appears to have thrown its hat back into the ring for the Fox business. I’ll be watching the developments, and what it means for a Disney-Fox combination, which in my view would serve to improve Disney’s content and character library, serving to quickly build a formidable set of direct to consumer streaming services. Next to this is we are waiting to see if the U.S. government approves AT&T’s (T) acquisition of Time Warner (TWX).

Viewing these pending transactions together, we continue to see a transformation when it comes to content creation as well as transmission. I see it as a coming together of our Connected Society investing theme with Content is King to form a new theme in and around our growing digital lifestyle. More on that as I flesh that thought out further in the coming weeks.

 

Bottom line – Disney is doing what it does

To sum it up, Disney is doing what it does – generating tentpole franchise content at the box office and then using that same content to increasingly fueling its consumer products and parks business. As Disney continues to do this, in the coming quarter Disney will look to expand its streaming services, and if successful those subscription businesses are successful, it will add greater visibility and predictability to the company’s revenue and earnings stream as well as cash generation that will be used to buyback shares and re-invest in the company’s businesses. Should that come to pass, Disney will be tapping into our Connected Society investing theme in a way similar to Netflix (NFLX) and I suspect investors will look to re-think valuation multiples for the shares vs. the current multiple of 14.5x 2018 earnings that are poised to grow 21% year over year.

  • Our long-term price target on DIS shares remains $120.

 

 

WEEKLY ISSUE: A Guilty Pleasure or a Habit? In this case it’s the same

WEEKLY ISSUE: A Guilty Pleasure or a Habit? In this case it’s the same

 

KEY POINTS FROM THIS ALERT:

  • We are adding shares of Habit Restaurant (HABT) to the Tematica Investing Select List as part of our Guilty Pleasure investing theme with an $11.50 price target.
  • We are boosting our price target on USA Technologies (USAT) shares to $12 from $11 following robust margin performance in the March quarter and strong prospects for more realized synergies with its Cantaloupe acquisition and new Ingenico relationship.
  • After reporting March quarter earnings that saw its net asset value per share continue to climb, we continue to rate GSV Capital (GSVC) shares a Buy with an $11 price target.

 

After formally adding shares of Disruptive Technology company AXT Inc. (AXTI) back to the Tematica Investing fold earlier this week, we’ve got a jam-packed issue this week that includes a new recommendation that brings an active position in our Guilty Pleasure investing theme onto the Tematica Investing Select List. Let’s get to it…

Adding Habit Restaurant shares to the Tematica Investing Select List

People need to eat. That’s a pretty recognizable fact. Some may eat more than others, some may eat less; some may eat meat, others may not. But at the end of the day, we need food.

As investors, we recognize this and that means considering where and what consumers eat, and also identifying companies that are poised to benefit from other opportunities. One such opportunity is geographic expansion, and with restaurants it often means expanding across the United States.

Typically, expansion is driven by new store openings, which in turn drive sales. Tracing back its expansion over the last several years, Chipotle Mexican Grill (CMG) had to build up to 2,363 locations. Even with that number of locations, per Chipotle’s recently filed 10-K, the company still expects to “open between 130 and 150 new restaurants in 2018.” At that pace, it would take quite a while before Chipotle has as many locations as McDonald’s (MCD) (more than 14,000) or Starbucks (SBUX) (just under 14,000) in the U.S. exiting last year.

A little over a year ago, Restaurant Brands (QSR), the company behind Tim Hortons and Burger King, acquired Popeye’s in part for food-related synergies but also the opportunity to grow Popeye’s through geographic expansion. In 2016, Popeye’s had some 2,600 locations compared to more than 7,500 Burger Kings in the U.S. For those wondering, that’s greater than the 2,251 locations Jack in the Box (JACK) had in 2017.

And that brings us to a quick service with a California char-grill twist restaurant that is Habit Restaurant (HABT). With just 209 Habit Burger Grill fast casual locations in 11 states spread between the two coasts, Habit has ample room to expand its concept serving flame char-grilled burgers and sandwiches, fries, salads and shakes. And if you’re wondering how good Habit is, I took the liberty of trying its products and sampling its friendly service at one of the few East coast locations — it’s work, someone had to do it. I can certainly understand why this Guilty Pleasure company was named “best tasting burger in America” in July 2014.

In 2017, the company recorded revenue of $331.7 million from which it generated EPS of $0.16. For this year, consensus expectations have it serving up revenue near $393 million, up around 18% year over year, but EPS of $0.05 — a sharp drop from 2017.

What we’re seeing is Habit hitting an inflection point as it engages a national advertising agency, opens 30 new locations this year and contends with higher wage costs (up 6%-7% vs. 2017), as well as test markets breakfast. Inflection point stocks can be tricky largely because even as things go right there can be mishaps along the way. With the company expected to open the greatest number of new locations during the March quarter, I put the shares on the back burner in early March when they were near $10 with a note to follow up after the company reported the March quarter.

Last week, Habit issued its quarterly results with year over year revenue growth near 17%, but still out of reach compared to consensus expectations, and it also missed on the bottom line. Following that report, HABT shares fell x%, bottoming our near $8.20 before settling at $8.60.

What led to the shortfall?

During the March quarter, Habit opened 11 new company-owned locations – more than the expected 7-10 for the quarter — more than one-third of its targeted new openings for 2018. Another factor was rising costs in the form of inputs (beef and chicken in the protein complex and French fries) as well as higher labor costs, particularly in California, during its peak promotional activity.

Now for the positive developments. First, to offset those higher costs the company is implementing a 3.9% menu price hike at the end of May. Second, its expansion plans – with another 20 or so company restaurants this year and 6-8 franchised locations  —remain on track with but at a slower open rate compared to the March quarter.

This expansion should help improve the company’s geographic footprint further as it follows the three new east coast locations openings (Maryland, New Jersey) opened during the March quarter. During the earnings call, the company shared that roughly 20% of its company-operated growth will be on the east coast and about 50% will be drive through locations. On another note, the company is testing a breakfast menu, which in our view is a long-term positive given that per NPD Group findings, breakfast is the fastest growing meal with 80% of that growing being had a quick service restaurants.

Now here’s the thing – no matter what metric you look at for the shares OTHER than P/E they are cheap.  The shares are currently trading at 8.0x on an enterprise value to 2018 earnings before interest, taxes, depreciation and amortization (EBITDA) basis, which is more than 40% discount to the peer group that includes Jack in the Box (JACK), Wendy’s (WEN) and other quick-service restaurants. Some of that discount is warranted as Habit has to wind its way through some likely growing pains, but as I shared above the longer-term driver of the company’s success will be geographic expansion. It bears repeating — we’ve seen this time and time again with restaurant companies ranging from Dunkin’ Donuts to Starbucks (SBUX), Chipotle (CMG) back in the day and Del Taco (TACO) more recently. There is also the chance that another quick service chain will pull a Restaurant Brands-Popeye’s move to jumpstart its own growth metrics.

With more than 25% upside to our $11.50 price target, which is still a discount to the quick service peer group, and modest downside following the news of the March quarter, the risk to reward profile in HABT shares is rather tasty. As the company continues to expand its footprint East, I’ll continue to review the impact on the business – good and bad — as well as the bottom line and what it means for our price target.

  • We are adding shares of Habit Restaurant (HABT) to the Tematica Investing Select List as part of our Guilty Pleasure investing theme with an $11.50 price target.

 

Robust margins lead us to boost our price target for USAT shares

Yesterday morning USA Technologies (USAT) reported March quarter results that pushed the shares higher in morning trading, and has us nudging our price target to $12 from $11 in response. For the quarter, USA achieved EPS of $0.04, beating the consensus by $0.03, despite missing revenue expectations for the period by just over 6%, as the company’s gross margin rose to more than 33% vs. 25.0% in the year-ago quarter.

That jump in profitability reflects continued growth in USA’s total mobile payment connection base as well as sustained growth in the dollar transaction volume carried over those connections. Exiting the quarter, USA’s total connection base stood at 969,000 across 15,600 customers (up from 504,000 and 12,400, respectively exiting March 2017), with transaction volume climbing to $318 million, up 57% higher year over year.  USA’s margins also benefitted from realized synergies from its November 2017 acquisition of Cantaloupe Systems. As a reminder, Cantaloupe utilizes cloud-based, mobile technologies to offer an integrated end-to-end vending and payment solution for cashless vending, dynamic route scheduling, automated pre-kitting and merchandising and inventory management.

We continue to see that as extremely synergistic with USA’s mobile payment platform for vending and other unattended retail applications, with more incremental revenue and profit synergies to be had in the coming quarters. Central among those synergies is new customer engagements, which should drive additional mobile payment connections and customer growth. Also adding to that is the recently inked multi-year with payment processing firm Ingenico that pairs Ingenico’s hardware, software, security and services products with USA’s mobile payment services platform. As the company’s results and guidance, including the margin commentary, are digested, we expect 2018 EPS to move higher from the pre-earnings report consensus of $0.06 for this year and $0.13 next year.

Do we continue to think that USAT will emerge as a potential takeout candidate as the mobile payment industry continues to grow and mature? Yes, but that does not factor into our new price target of $12.

  • We are boosting our price target on USA Technologies (USAT) shares to $12 from $11 following robust margin performance in the March quarter and strong prospects for more realized synergies with its Cantaloupe acquisition and new Ingenico relationship.

 

Net asset value per share continues to climb at GSV Capital

Last night shares of Asset-lite company GSV Capital (GSVC) reported mixed March quarter results with a beat on the bottom line and a miss on the top line. As I’ve shared before, the real driver of GSV’s shares price is not revenue or earnings, but the trajectory of its investment portfolio, which we measure through its net asset value per share. Exiting the March quarter, that portfolio’s net assets across 29 positions totaled approximately $210.5 million, or $9.99 per share up from to $9.64 per share at the end of 2017, and $8.83 per share exiting the March 2017 quarter.

The company’s top five holdings, which included privately held Palantir Technologies, Spotify (SPOT), Dropbox (DBX), private company Coursera and NESTGVS, accounted for 58% of GSV’s investment portfolio exiting March vs. 39% in the year ago quarter. With consensus price targets of $157 and $33 for Spotify and Dropbox shares, respectively, we continue to see added lift in the company’s net asset value per share. Should the company’s largest holding in Palantir Technologies go public as is widely postulated or be acquired, we would have a third leg to the stool driving GSV’s net asset value growth higher.

Helping the net asset value per share comparisons, GSV repurchased 1.1 million shares during the quarter for $6.2 million, which reduced the shares outstanding by 5% year over year. Following the upsizing of the company’s share repurchase program by an additional $5 million, GSV has roughly $8.8 million remaining. At current levels, the company could repurchase another 1.25 million shares, shrinking its outstanding share count by 6%.

  • After reporting March quarter earnings that saw its net asset value per share continue to climb, we continue to rate GSV Capital (GSVC) shares a Buy with an $11 price target.

 

SPECIAL ALERT – Adding AXT Inc. shares back to the Select List

SPECIAL ALERT – Adding AXT Inc. shares back to the Select List

 

  • We are adding shares of AXT (AXTI) back to the Tematica Investing Select List as part of our Disruptive Technology investing theme. Our price target is $11.

Like the saying says, “To make a mistake is human” and last week I did just that – I made a mistake by saying we were scaling into shares of compound semiconductor substrate company AXT (AXTI). I had forgotten that we had been stopped out of AXTI shares back in late January with a 27% gain. While I could blame it on the crazy week of economic data and earnings reports, the bottom line is I made a mistake.

The silver lining is that as we formally add back AXTI shares to the Tematica Investing Select List, we are doing so at an even better share price – roughly $6.50 vs. the $8.25 price at which we were stopped out. Over the last few weeks of earnings season, we’ve heard a growing number of companies point to the launch of 5G networks and devices in the coming quarters. I expect more confirmation at the upcoming 5G North America conference that will be held May 14-16 in Austin, Tex. Based on the list of speakers for the event, I expect a number of data points surrounding the timing of 5G but also ensuing applications to be had spinning out of the event.

Also, I am hearing more about rising demand for vertical cavity surface emitting lasers (VCSELs for short) that are a crucial light source component for 3D sensors which increasingly being adopted into smartphones and other consumer electronics devices. This should help drive incremental substrate demand for AXT in the back half of 2018 and beyond.

At current levels, the longer-term reward to be had with AXTI shares easily outweighs incremental downside, and this has us adding AXTI shares back to the Tematica Investing Select List with an $11 price target.

 

 

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

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

 

Key Points from this Alert:

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

 

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

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

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

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

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

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

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

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

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

 

What’s the Fed likely to say later today?

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

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

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

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

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

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

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

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

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

 

Scaling into AXTI (AXTI) shares …

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

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

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

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

 

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

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

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

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

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

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

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

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

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

 

 

WEEKLY ISSUE: Earnings Season is Not What Was Expected

WEEKLY ISSUE: Earnings Season is Not What Was Expected

 

Key Points from this Issue: 

  • Our rating on Applied Materials (AMAT) remains Buy and our price target is $70
  • Our rating on LSI Industries (LYTS) remains Buy and our price target is $11
  • Our rating on Paccar (PCAR) remains Buy and our price target is $85
  • Our price target on Amazon shares remains $1,750, and a win, whole or partial of the pending Pentagon cloud contract would lead to a reassessment of that target.
  • Our long-term price target on AXT Inc (AXTI) and Nokia (NOK) shares remain $11 and $8.50, respectively.

 

The benchmark 10-year Treasury bond rate went over 3% yesterday for the first time since 2014, sending stock prices down sharply in response. We saw that reverberate through the Tematica Investing Select List as the stock market continues to shoot first and ask questions later. Not surprising given that CNNMoney’s Fear & Greed Index has vacillated between Extreme Fear and Fear over the last month, and commentary thus far this earnings season is aggravating things. Last week it was United Rentals (URI) beating expectations largely due to the impact of tax reform. Yesterday it was Caterpillar (CAT), which after delivering a stellar 1Q 2018 earnings report warned that its margins may have peaked in 1Q 2018 due to rising manufacturing costs. 3M (MMM) also reduced its 2018 outlook and Lockheed Martin’s (LMT) raised outlook included almost all key metrics for the company save the closely watch operating cash flow line.

Stepping back, what we’re seeing is an earnings season that developing far from what was expected. As a reminder, the S&P 500 group of companies were expected to deliver 17%-18% EPS growth year over year in 1Q 2018 and reaffirm the outlook that would equate to at least 18% EPS growth in 2018 vs. 2017. The commentary that we’ve gotten over the last week, raises some questions about those growth expectations as the 10-year Treasury bond rate has inched up, which is likely stoking interest rate hike concerns.

This skittish mentality has hit our Applied Materials (AMAT) shares last week despite a solid earnings report from competitor Lam Research (LRCX) and the vibrant outlook for chip demand over the next several years. We saw it again in our LSI Industries (LYTS) and Paccar (PCAR) shares this week – the former getting gut-punched lower amid a sudden CEO exit, and the later despite a rip-roaring 1Q 2018 earnings report that crushed expectations. With 1Q 2018 truck orders surging to levels last seen more than a decade ago, prospects for Paccar to deliver further margin leverage look rather favorable in my view. With the underlying data pointing to a favorable nonresidential construction market and a continued truck shortage, I remain bullish on LYTS and PCAR shares, especially at current levels.

The current market environment will call for patience, but that’s in keeping with our long-term, thematic perspective. Complicating matters in the short-term is the inability of companies to step in with their share repurchase programs, which would normally help backstop share prices. Until a company reports its results and clears its quiet period window, it’s in a holding pattern with its share repurchase plan. This likely means if the current market mood persists, odds are the market will trade sidewise at best and likely lower in the near-term as investors recalibrate expectations.

As we navigate through the rest of 1Q 2018 earnings season, odds are we will get a few opportunities to improve our cost basis, and odds are LYTS shares and PCAR shares will be among them unless the data suddenly turns sharply lower. As yet there are no signs indicating that is on the horizon.

  • Our rating on Applied Materials (AMAT) remains a Buy and our price target is $70
  • Our rating on LSI Industries (LYTS) remains a Buy and our price target is $11
  • Our rating on Paccar (PCAR) remains a Buy and our price target is $85

 

Amazon: A looming boost for Amazon Web Services as the Pentagon gets connected

Shares of Amazon (AMZN) have been on a tear this year, up 25% thus far this year even after yesterday’s market. That makes them the best performer on the Tematica Investing Select List over the last year as well. For those wondering if my outlook for the shares of what I affectionally call the poster child company for thematic investing remains vibrant, my response would be a firm yes!

As we learned last week in Jeff Bezos’s annual shareholder letter, Amazon has 100 million Prime members – to put that in perspective that’s 1 member out of every 3.3 people in the U.S. alone – and garnered for the eighth consecutive year the top slot in the American Customer Satisfaction Index. As Bezos discusses the achievements across Amazon’s various business lines, he gives credit to the 560,000 Amazon employees and the “2 million sellers, hundreds of thousands of authors, millions of AWS developers, and hundreds of millions of divinely discontent customers around.”

Across Amazon’s various businesses it has positioned itself not only with the thematic tailwind that is the accelerating shift toward a digital lifestyle but at nearly every turn it has looked to remove friction for its customers be they consumers, enterprise or other institutions. According to data from Statista, e-commerce sales accounted for 9.1% of total U.S. retail sales in 4Q 2017, up sharply from 4.6% in 4Q 2010. The combination of Amazon’s Prime service, which in my view was the beginning of the end for the mall and brick & mortar retail, paired with a still-expanding array of products and services has led Amazon to take consumer wallet share as it disrupts existing business models and industries. As Bezos pointed out, one of Amazons’ not so subtle strategies is to tap into consumer discontent. I see that as a different way to say, Amazon is riding the thematic tailwinds associated with our Connected Society, Disruptive Technology, Cashless Consumption and other investing themes.

What many don’t realize, however, is the secret weapon that is Amazon Web Services (AWS), the company’s cloud business that accounted for 10% of its 2017 revenue but virtually all of its operating profit for the year. I see the cloud as a disruptive force in how companies are conducting their business, and for individuals, a new method to save files of various types, and this means AWS is on the receiving end of a Disruptive Technologies tailwind.

On the one hand, enables Amazon to invest in its other initiatives while more often than not beating EPS expectations over the last several quarters. On the other, this means investors need to pay close attention to AWS and its ability to continue to grow, thwart competition and maintain if not further expand its operating margins.

This brings us to one of the larger known opportunities for AWS – in March, the Department of Defense announced it would select one cloud vendor for a multibillion-dollar cloud services contract to support its 3.4 million users, 4 million devices and some 1,700 data centers. Likely competitors for this include Microsoft (MSFT), IBM (IBM), Alphabet (GOOGL), Oracle (ORCL) and yes, AWS.

This raises the question of market share and here’s the answer. According to data from research firm Gartner, AWS has 44% percent of the public cloud market, followed by Microsoft’s Azure with 7% percent, China’s Alibaba Group with 3% and both Google and Rackspace at just over 2%. Outside those top 5, the remaining 41% of the 2017 $22 billion infrastructure as a service public cloud market was spread across a number of competitors.

For those wondering, AWS has already cracked the government cloud market with the $600 million contract it received from the CIA back in 2013, beating IBM out in the process. What makes all of this interesting is that in February, the U.S. Department of Defense awarded a $950 million cloud contract to REAN Cloud LLC, an Amazon Web Services LLC consulting partner and reseller.

While the Pentagon is not slated to make any formal announcement as to the winner of the contract until September, there is pushback on the decision to go with one vendor. Understandable as even companies like Apple (AAPL) loath to be tied to just one supplier. In this case, there is the obvious risk that just one cloud vendor for the entire Pentagon would more than likely make that vendor the world’s largest target for hackers and other digital malcontents. But there are other business reasons for the Pentagon to consider multiple vendors including competitive pricing and innovation as well as limiting complacency.

As an investor, would I like to see Amazon win the Pentagon contract? Absolutely. But given the increasing frequency of cyber-attacks and a bloating government budget, the smarter business decision looks to be having at least a few cloud vendors. As the American author, Nancy Pearcey summed up rather nicely, “Competition is a good thing, it forces us to do our best.” And let’s remember, any slice of the Pentagon contract is a win for all of these potential cloud suppliers.

  • Our price target on Amazon shares remains $1,750, and a win, whole or partial of the pending Pentagon cloud contract would lead to a reassessment of that target.

 

AXTI and NOK: Checking the 5G news

On Friday, Ericsson (ERIC) one of the leading mobile infrastructure companies reported better-than-expected results, which contained positive comments on the North American market that reflect investments in network expansions and in 5G readiness. This bodes very well not only for our Nokia (NOK) shares but also our AXT Inc. (AXTI) ones as well. It also happens that both companies are reporting later this week – AXT after Wednesday’s market close and Nokia before the market open on Thursday.

Here’s the thing – Ericsson wasn’t the only company to paint a favorable picture for these two companies when it comes to 5G. AT&T (T) recently shared that it will expand its “5G Evolution” wireless technology to more than 140 U.S. markets, which lays the groundwork for its planned mobile 5G service launch later this year. For those that are unfamiliar with AT&T’s 5G Evolution technology, it can deliver theoretical peak speeds for capable devices of up to 400 megabits per second. By the end of 2018, AT&T targets having 5G Evolution in more than 500 markets “including major cities like Baltimore, Cleveland, Denver, Detroit, Las Vegas, New York City, Philadelphia, Seattle and Washington D.C.” Alongside that announcement, AT&T also shared it is making its LTE-LAA technology available in parts of 3 new markets, bringing the total number of markets served to 7. AT&T’s LTE-LAA technologies can deliver theoretical peak speeds for capable devices of up to 1 gigabit per second.

Again, those rollouts are paving the way for AT&T 5G service. The company has been running test trials of 5G service in preparation for deployment in 12 US markets later this year. The carrier shared its speed test results and a few other notes on Tuesday. AT&T has been testing 5G with small businesses over the last year in three separate cities: Waco, Texas; Kalamazoo, Michigan; and South Bend, Indiana. Here are some of its findings:

  • Waco’s 5G speeds were 1.2Gbps from 500 feet over a 400MHz channel, with 9-12 millisecond latency. That was with “hundreds of simultaneous connected users,” according to AT&T.
  • Kalamazoo had 1Gbps speeds at 900 feet in “line of sight” conditions, and no negative impact from rain or snow. AT&T noted the signals could penetrate “significant foliage, glass, and even walls” better than expected, but it’s unclear what that specifically means.
  • South Bend didn’t report specific speeds but claimed “gigabit wireless speeds” in the line of sight and “some non-line of sight” conditions. To put that in perspective, my home’s Wi-Fi speed is around 100Mbps and my phone on AT&T LTE averages around 25Mbps.

Putting aside the technical mumbo-jumbo, an analogy from RF semiconductor company Skyworks Solutions (SWKS) and AXT customer drives home the data speed differential – downloading a full-length HD movie in 3G took one day, in 4G, the same file took minutes. On a 5G network, this content will be downloaded in mere seconds. Talk about the next disruptive iteration in mobile technology. Given its move to acquire Time Warner (TWX), I’d argue that AT&T has a vested interest in scaling its 5G network.

In January, AT&T shared that it plans to launch its mobile 5G network in a dozen markets in late 2018, along with a phone that will actually be able to use it. When AT&T reports its 1Q 2018 results after Wednesday’s close and then holds its annual shareholder meeting on Friday (Apr. 27), we’ll be looking for confirmation of those plans and possibly either an upsizing or pulling forward of them as well. We would view any of those scenarios as positive for our AXT and Nokia shares.

  • Our long-term price target on AXT Inc (AXTI) and Nokia (NOK) shares remain $11 and $8.50, respectively.