The Weekly Summary
We've been watching and waiting for the Shanghai market to open again after the long Lunar New Year break but it's clearly going to take a little more time for global markets to recover their equilibrium as the ramifications of China's viral outbreak play out. Even with Shanghai shut down for the holiday, Western investors have been projecting their fears on Asian stocks that trade on Wall Street, sending the biggest China funds down 11% in the last two weeks.
Naturally, that fear hasn't been confined to Chinese stocks. Like viral outbreaks, market moods operate more on contagious principles than normal logic. Investors worried about a threat to one area of the global market tend to extrapolate worst-case scenarios. They're usually proved wrong. After every outbreak in modern history, global stocks went up after the initial shock. We see nothing to show that this time is any different.
Of course any sustained disruption will be a drag on the Chinese economy and pull the rest of the interconnected world along with it. U.S. companies that did business in China have had to temporarily shut down operations and in some cases retrieve their people before U.S. carriers stopped flying in or out of the country. After a protracted trade war, Beijing now has even stronger incentives to stimulate the domestic market and keep the long growth story intact. They're at least as reluctant to entertain a recession as our financial authorities.
But that's all for after this outbreak is successfully halted and global investors find new things to focus on. In the meantime, U.S. stocks have served as a proxy for the closed Shanghai market. Major U.S. indices fell significantly last week, with the Dow industrials and S&P 500 falling back into negative territory for the year so far. Yes, the "January Indicator" ultimately fizzled in 2020. That's all right. Statistics say there's still at least an 80% chance of the market gaining ground in the 11 months ahead.
And while BMR stocks were not immune to the contagious selling, we're holding onto a much bigger gain than the market as a whole. Our recommendations are still up 4% YTD. The Nasdaq can't even boast half that return and only specialized Utility sector funds can beat it. While it's not fun to watch your investment universe retreat 2% in a single week, there's still a healthy cushion of profit behind our stocks to support patience and even acceptance: life on Wall Street is all about taking a few steps back for every leap forward, and we've enjoyed plenty of leaps lately. Now it's time to endure a little downtime to let the fundamentals get ahead of where stocks have already gone.
And as we'll see, the fundamentals are better than anyone hoped. We'll address that in The Big Picture.
There’s always a bull market here at The Bull Market Report! We need to preview our thoughts on Alphabet's earnings tomorrow night as well as our latest thoughts on some of our highest-flying Technology recommendations.
Gary Jefferson draws on his own experience with the SARS outbreak to put this latest disease into a larger historical context . . . in case you were wondering, the world did not end in 1993 and is unlikely to end here. However, this is a great moment to check the income component of your portfolio, so we've turned this week's installment of The High Yield Investor to a few of our favorite Real Estate stocks available at discounts now.
Key Market Indicators
BMR Companies and Commentary
The Big Picture: Earnings Are Back
Last week was a great one for investors with an eye on the fundamentals. Apple, Microsoft and especially Amazon did exactly what they needed to do. These companies have weathered all economic tailwinds and are still growing their businesses. Any deterioration is receding fast in the rear view now, with guidance suggesting even better year-over-year comparisons ahead.
That's great news for BMR subscribers who hold those stocks. But it's also good for the market as a whole. A few weeks ago, we were resigned to see the S&P 500 spend another quarter spinning its gears only to generate negative earnings growth. Those companies were effectively going backward, which made any progress the stocks made precarious at best.
Now, thanks in large part to our winners (massive companies that they are), there's a chance that the 4Q19 earnings trend for the entire market will end up flat at worst and maybe even deliver a sliver of progress. And then when the first 1Q20 numbers come in two months from now, the window is open for earnings to start really moving in the right direction once again.
For investors who have been starved for growth for an entire year, that's going to feel amazing. And with the Fed poised to cut interest rates if necessary to fight any global shock, we see no reason to think that growth is not going to happen. Energy and Communications stocks will lead the way and Tech is also coming back strong, thanks to Apple and Microsoft. After that, Consumer and Industrial companies can have their day in the sun, feeding a broader-based boom.
We're looking for 10% earnings growth for the S&P 500 this year. That's enough to support at least "normal" rally conditions for the market as a whole, and with the trade war paused at least through November, there's a decent chance U.S. companies will perform even better than we currently expect. Naturally our stocks have even stronger potential. Unlike the market as a whole, the BMR universe never stopped raising the bottom line, quarter after quarter. That's what it's all about.
Roku (ROKU: $121, down 7% last week)
Roku hit $170 in early-September, an all-time high, before falling 41% during the month, to $100. What’s behind the move? Nothing more than profit-taking after the stock shot up from $30 at the start of 2019. It has subsequently rebounded to $121, a nice recovery even after Friday’s sharp selloff. We expect a rebound following a Friday agreement with Fox allowing Roku to keep the app ahead of the Super Bowl. The stock had sold off sharply on Friday after the company announced it would remove Fox’s app.
The company’s devices connect users to streaming content, growing revenue from the “cord-cutting” trend, that is, viewers dropping cable in favor of streaming services such as Netflix, Amazon Prime, and the new Disney+. These streaming players are sold for a low price and Roku receives a licensing fee when you buy a Roku TV that is manufactured by different brands.
Roku uses three metrics to measure how effectively it is turning its streaming players into revenue: active accounts, streaming hours, and average revenue per user (ARPU). These are all moving in the right direction. In the third quarter, the number of active accounts was 32 million, a 36% increase from a year ago. Streaming hours were 10.3 billion, 68% above last year’s figure, and ARPU was $23, 30% higher.
Third-quarter revenue grew year-over-year by an astounding 79%, from $100 million to $180 million. Roku’s loss widened from $10 million to $25 million due to higher expenses to support the top-line growth. This is not great, but we are not terribly concerned since there’s more revenue growth on the horizon with even more streaming services coming (e.g. HBO Max, Peacock).
Turning to the balance sheet, there is $390 million in cash with debt of $160 million.
BMR Take: This growth story is set to continue. All the factors are there with its easy and inexpensive solution offering consumers a way to navigate through the various streaming services. Our $205 Target Price reflects the strong revenue growth outlook.
Shopify (SHOP: $466, up 2%)
Shopify continues to reach new heights, trading at $477 on Thursday, a new all-time high, before dipping on Friday with the overall market. The rise since the end of 2018 has been nothing short of spectacular. The stock has quadrupled, from $122 to $472.
The company produces web-based and mobile-based software that allows merchants to create e-commerce sites and allow clients to run their business across all sales channels (e.g. web, mobile, social media, and physical stores). These enable businesses to better manage products, inventory, process orders and payments, ship orders, and use analytics.
The proof that this is resonating with customers is in the revenue numbers. In the third quarter, Shopify’s top-line growth was 45%, increasing from $270 million to $390 million. Its monthly recurring revenue continued to grow, $40 million a year ago, growing to $50 million. Losses widened from $25 million to $75 million - with strong growth on the horizon, costs will remain elevated for some time. Certainly, we would like to see the company in the black, and, we are confident that this growth will translate into profitability down the road.
In the meantime, Shopify has plenty of cash, $2.7 billion, and only $110 million of debt.
BMR Take: Shopify is moving ahead, including last October’s $390 million cash-and-stock deal to acquire 6 River Systems. This expanded their fulfillment capabilities. Shopify has blown through our $450 Target Price, and, we like the stock so much that we are raising it to $510. We are increasing our Sell Price from $315 to $435.
Splunk (SPLK: $155, down 1%)
Splunk is another stock that is soaring, reaching an all-time high of $160 set in January. On Thursday, Splunk closed at $159 before closing lower on Friday. The stock was certainly volatile during 2019 but broke out starting in mid-November when it traded at $117, rising 33%.
Our optimism never wavered during 2019’s bumpy ride and it still hasn’t with the stock near all-time highs. Companies are moving to utilize data in the decision-making process. This big data trend is Splunk’s sweet spot, with software offerings allowing its customers to manipulate machine data. In the third quarter, the company inked 440 new enterprise customers
The fiscal third quarter’s revenue (ended October 31) rose to $625 million from third-quarter 2018’s $480 million, a 30% increase. Splunk is ramping up operating costs at a faster rate, recording a $60 million loss versus a $55 million last year.
Free cash flow was negative $280 million in the nine-month 2019 period. Management is switching from perpetual licenses to renewable licenses, which hurt short-term cash flow. With this nearly complete, management expects this to improve.
Splunk continues to make investments in real-time data monitoring and cybersecurity. Right after the third quarter ended, Splunk acquired SignalFX, a leader in real-time monitoring for the cloud, for $1 billion in cash-and-stock.
Sometimes, you have to spend money to get a payoff down the road. We believe that is the case here.
BMR Take: Many companies are talking about using data and analytics. With Splunk a leader in this field, this bodes well for its future. We see more upside and are comfortable with our $182 Target Price. Let’s tighten up the Sell Price to $147.
Spotify Technology (SPOT: $141, down 4%)
After plummeting from $158 in early-August to $112 in late-September, Spotify rebounded sharply, currently trading at $141.
There was some concern about increased competition from Amazon expanding its music streaming service, and the popular app TikTok entering the field. This worry is overblown and Spotify, the Sweden-based company, has previously shown growth in the face of competition from the likes of Apple and Sirius XM.
That revenue growth has been nothing short of astounding. Spotify’s 2014 revenue was $1.2 billion, and this increased to $5.9 billion in 2018. The company did not show an annual profit, with a loss of $210 million in 2014 narrowing to $90 million. The higher revenue did translate into increased operating cash flow, growing from a $85 million deficit to a positive $385 million.
Spotify continued to expand its user base in 2019. For the first nine months of 2019, monthly active users increased from 190 million to 250 million, a 30% year-over-year rise. The higher number of users drove third-quarter revenue 28% higher, from $1.6 billion to $1.9 billion. Better still, Spotify’s third-quarter profit rose from last year’s $50 million to $265 million.
What about operating cash flow? It nearly doubled in the nine-month period, from $195 million to $370 million. Spotify is using part of this strong cash generation to repurchase shares, to the tune of $550 million since its $1 billion share repurchase program began in 2018.
BMR Take: True, the company is facing competition. That should not make investors too nervous since this is nothing new. Management has stuck to business and continues to perform well, even expanding into podcasts. We have a $160 Price Target and a Sell Price of $125.
Square (SQ: $75, up 5%)
Square had a rough couple of months in August and September, falling by 30%, from $81 to $57. The stock picked up towards the end of the year and never stopped. Even in a rough week for the market, Square was up by 5%. Strong.
The summer selloff was triggered after the company reported 2Q19 results. These were fine, but 3Q19 guidance was softer than some investors wanted to see. However we don’t see anything disappointing about 40% revenue growth!
Third-quarter results were even better than that “soft” expectation. Revenue grew 44% year-over-year, from $880 million to $1.3 billion. Profits were also better than management expected, rising from $20 million to $30 million.
This company has its roots in processing card payments to businesses. It has expanded into new areas, such as providing data to sellers and offering its Cash App that is used for peer-to-peer payments, among other things. Bitcoin is also a growing portion of its business, more than tripling third-quarter revenue from last year’s $45 million to $150 million.
Square decided to sell Caviar, a food delivery app. The $410 million sale was completed in October. The move allows management to focus solely on its payments business. From an investment standpoint, Square made 10x its initial $44 million investment over five years.
The company certainly didn’t sell the business because it needed the cash. There is plenty of liquidity, with $1.2 billion in cash and YTD operating cash flow of $405 million. Debt stands at $1.05 billion. We’d like to see that lower, to tell you the truth.
BMR Take: Square competes with the likes of PayPal, but there is plenty of room for both in this fast-growing space. Consumers continue to migrate their shopping online, including mobile. One way to pay for these purchases is through Square’s Cash App. The company is not standing still, expanding its offerings. For instance, you can use its Cash App to invest money. The summer selloff was a good opportunity to pick up shares, but we see plenty of upside at these levels. This is reflected in our $105 Target Price. Our Sell Price is currently $56 but we hereby raise it to $65.
Twilio (TWLO: $124, up 3%)
Twilio fell from its lofty all-time high of $150 set at the end of July, dropping to $93 in early November. Proving you can’t keep a good company down for long, the stock has rebounded nicely, rising 33% since then.
The stock sold off following Twilio’s 2Q19 results announcement. Quarterly revenue was up 83% from the prior year, from $150 million to $275 million. True, Twilio’s loss was wider, $95 million compared to $25 million, but this was because the company has ramped up hiring in all areas – R&D, sales and marketing, and G&A – to keep up with this growth. With such robust top-line growth, we are more than fine with it. It is simply good business to support revenue growth.
Fast forward to the 3Q19 earnings release, and strong revenue increases continued. Revenue was 75% higher, rising from $170 million to $295 million. The company reported a loss of $90 million versus a $25 million loss in the year-ago period.
This stem of red ink will turn black as the company’s rapid revenue growth continues. We are confident this is going to happen since Twilio is a leader in the Cloud Communications category. This fancy-sounding title means the company provides companies with the tools to build, scale, and operate communications within applications. So, developers download Twilio’s software to generate their company’s e-mail, voice, text, video messages. Once Twilio’s solution is obtained, the process is very quick and easy.
In the meantime, the balance sheet is healthy. There is $1.9 billion in cash and $625 million of debt.
BMR Take: Twilio’s leading position in a fast-growing market puts the company in an enviable position. With rapid revenue growth, we feel good about our $156 Target Price.
A Word From Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
Much of the media is now making comparisons to the SARS outbreak in 2003. We were around and recall that the impact on U.S. stocks back then was not even a 10% "correction," with markets here and globally rebounding fairly quickly.
For now, investors can only watch to see how this virus develops and how the world's health organizations and governments react. Today, markets around the world already seem to be shaking off the concern. However, history shows us these biological scares need more than a few days to evaporate. The SARS volatility lasted for five weeks while the zika scare (mosquito bites in 2015) dragged on for over two months. History simply doesn't support hopes that this will be a one- or two-day worry.
With the S&P 500 today at 3,225, near-term support comes in at the following levels: 3,205, which only represents a 1% pullback from here; then 3,150, which corresponds to the 100-day moving average and only represents a 4% pullback; and then 3,000, which is major support at the 200-day moving average and which represents about a 7% pullback. At that point, yes, investors will have absorbed a full 10% correction from the peak we saw barely a week ago.
Will we see any of those support levels break? We don't know until we see for ourselves. But from an investment standpoint, and with our economy geared for a stronger second half than the first, it should present a good place to buy the dip.
Earnings Preview: Alphabet (GOOG: $1,434, down 2%)
Earnings Date: Monday, 5:00 PM ET
Revenue: $46.9 billion
Net Profit: $8.7 billion
Year Ago Quarter Results
Revenue: $39.3 billion
Net Profit: $8.9 billion
Implied Revenue Growth: 20%
Implied EPS Decline: 2%
Sell Price: We would not sell Alphabet.
Date Added: February 2, 2016
BMR Performance: 164%
Key Things To Watch For in the Quarter
Alphabet is rarely eager to share detailed guidance, opting instead to focus on the long term instead of hitting quarter-to-quarter targets. As a result, we're largely on our own when it comes to projecting the numbers into any given reporting period . . . but because everyone else is in a similar position, expectations are less rigid here than they would be if management set our sights high and then failed to deliver.
What we know is simple. Alphabet has persistently engineered its operations to support roughly 20% revenue growth, year after year. For the last six months, that strategy has meant swallowing significant margin compression as money coming in gets diverted back to massive Artificial Intelligence projects that will in turn feed the next cycle of sales expansion. We know the routine well from Big Tech rivals like Amazon. As long as the cash keeps flowing, all management needs to do is decide when they've grabbed enough growth . . . and then pause new spending in order to give profit room to roll.
Right now, however, we're still in the revenue cycle. This is not a profit quarter. What we're looking for here is confirmation that earnings growth will pick up again in 2020. Maybe that happens in the current quarter, although our expectations aren't high. Maybe these A.I. projects will need until summer to start paying off. Either way, we won't argue with a trillion-dollar company that's still finding ways to grow 20% a year. The big get bigger and success feeds success.
The High Yield Investor
Just when you thought United States Treasury yields could not go any lower, they continued to plunge. Stock market investors ran scared, particularly on Friday, due to concerns about the coronavirus and the impact on the global economy. Notably, this selloff led to investors seeking the safety of the risk-free Treasuries. The higher demand pushed up prices and depressed yields, which move in inverse directions.
Not to be forgotten, there was also a Federal Reserve meeting. As expected, they kept the federal funds rate unchanged at 1.5%-1.75%. In its statement, the Fed noted continued labor market strength and moderate economic growth. Inflation is running below its 2% target, which we believe provides the central bank the latitude to keep rates low for an extended period of time.
The two-year yield contracted from 1.49% to 1.33%. At the same time, the 10-year yield dropped by 19 basis points to 1.51%. The moves continue to flatten the yield curve, with the 2-10 spread shrinking to just 18 basis points from last week’s 21 bps. Normal spreads are 100-200 bp higher. (The peak spread was 2.91 bps in 2011.)
This makes it difficult to find attractive yield investments. We don’t complain at The Bull Market Report. Instead, we roll up our sleeves and get to work looking for equities that offer good dividend yields. In this week’s High Yield Investor, we continue our analysis of REITs. This is a good sector for those seeking yield since the economy continues to hum along (2.1% in the fourth quarter) and low interest rates create attractive financing. The three we discuss below offer a 250-400 bp yield advantage over the 10-year Treasury. Plus, there is capital appreciation potential for patient investors.
Ventas (VTR: $58, down 2%, yield = 5.5%)
Ventas has a real estate portfolio across the Healthcare world. The 1,200 properties primarily consist of senior housing communities (independent and assisted living communities, 61% of the portfolio) and medical office buildings (30%). It also owns research centers, inpatient rehab and long-term acute facilities, and skilled nursing facilities. Ventas also has a strong degree of geographic diversity with locations in the United States, Canada, and the United Kingdom.
The senior and independent living facilities do not rely on Medicare and Medicaid for reimbursements. This is good since this limits Ventas’ exposure to government reimbursement. There are complex rules involved here that are subject to annual changes and typically result in lower rates when they are adjusted.
Around 35% of Ventas’ properties are leased on a triple-net lease basis where the tenant pays all the operating expenses and capital improvements.
Last year was challenging for Ventas due to the supply/demand imbalance that depressed occupancy and rental rates at its Senior Housing Operating Properties business. In the third quarter, occupancy dipped from last year’s 87.2% to 86.6%.
We remain undeterred. Market forces will play out over time. In the longer-term, with an aging population, these are good assets to own.
Even with the pressure on its senior properties, 3Q19 revenue rose 5% year-over-year, from $935 million to $985 million. Income fell from $105 million to $85 million.
Ventas still generates plenty of cash flow, an important barometer for REITs. Its operating cash flow for the first nine months of 2019 was $1.1 billion versus $1.0 billion in the comparable year-ago period. This is certainly a move in the right direction.
Ventas (Target Price: $72) currently pays an annual dividend of $3.17 increasing the payout by a penny a year ago, continuing a history of slow and steady raises. The stock sold off by 23% to the current $58 after reaching $75 in September, a 52-week high. They are part of the S&P 500 Index, giving it a level of support due to its inclusion in funds tracking the index.
Vornado Realty Trust (VNO: $66, down 2%, yield = 4.0%)
Vornado’s properties, geographically concentrated in New York City, but they have some diversification across property types.
The properties are attractive assets to own. They include 19 million square feet of Manhattan office space across 35 properties, plus the Hotel Pennsylvania (across the street from New York’s Penn Station); 69 Manhattan Retail properties encompassing 2.4 million square feet. They own 10 residential properties totaling 1.5 million square feet; and a third of Alexander’s, a REIT that owns seven properties in the metropolitan area, including Bloomberg’s Manhattan headquarters.
New York City is notoriously a difficult market to crack, creating barriers to entry and providing some protection to Vornado’s properties from the competition.
Meanwhile, the company is redeveloping New York Penn Station assets. These new buildings should have strong leasing characteristics given the good location and capital improvements Vornado is doing. We expect strong occupancy and leasing rates.
They own other marquee properties outside New York City, including Chicago’s theMART, and a 70% interest in the Bank of America Center, located in San Francisco. These have strong characteristics and the latter property is fully occupied.
Vornado’s properties already have strong occupancy rates. Its 10 properties in the “other” category have a 93% occupancy rate while its New York (97%), the MART (95%), and San Francisco (100%) assets were even stronger.
Third-quarter revenue fell by 14% year-over-year, from $540 million to $465 million. Income grew sharply, from $205 million to $335 million due to several property dispositions, including Fifth Avenue/Time Square JV, and 330 Madison Avenue. Plus there were redevelopments, and Retail bankruptcies that the company took advantage of. On a same-store basis, rental revenue increased by $4.5 million.
Management has been astute operators, selling properties in a hot market. Investors benefitted after receiving a nice bonus when Vornado (Target Price: $80) paid a special $1.95 dividend last month due to the profit realized from the sale of certain assets, including Fifth Avenue and Madison Avenue. Most of this, $1.74 per share, is considered a long-term capital gain. Excluding this payout, Vornado’s yield is 4%. At the end of the day, the three keys to success in real estate, location, location, and location, will continue to serve Vornado’s shareholders well.
Welltower (WELL: $85, down 2%, yield = 4.1%)
Welltower has commonalities with Ventas since it is another Healthcare-focused REIT tilted towards senior housing operating properties across the country, ranging from independent living to assisted living and Alzheimer/dementia care. These represented 71% of 9-month 2019 revenue, up from 59% in 2016. There are also long-term/post-acute facilities (part of the triple-net segment, which also includes some senior housing that is leased on this basis), and outpatient medical buildings.
As with Ventas, Welltower’s senior housing operating portfolio has exciting growth potential due to the Baby Boomer population aging. The triple-net business offers greater cash flow stability as the tenant pays operating expenses such as taxes, insurance, and maintenance.
Welltower has good international exposure, with the United Kingdom and Canada making up 7% and 8%, respectively, of Welltower’s total number of properties. Combined, California, Texas, and New Jersey account for 29%. The remaining 56% are in other places across the United States.
Welltower’s results have been under pressure due to the senior housing market oversupply. Despite this, 3Q19 revenue increased to $1.3 billion compared to $1.2 billion a year ago. Income was $650 million versus $85 million, with the increase driven by $570 million in gains from selling real estate. We are pleased that, despite market challenges, operating cash flow was flat, at $1.2 billion for the first nine months of 2019. This shows the resilience of Welltower’s properties and we expect results to markedly improve when the market returns to a normal state.
Welltower’s (Target Price: $89) dividend has been constant at $0.87 per quarter for the last three years. Before that, the REIT had a history of raising dividends, and we expect investors to benefit from resumed revenue and profitability growth and higher dividends in the future due to their properties continuing to attract quality tenants. This is another member of the S&P 500 Index.
Todd Shaver, Founder and CEO
The Bull Market Report