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The Weekly Summary

 

The last few days have been extreme by any stretch of investors' imagination and now that the Fed has cut short-term interest rates to zero we are almost guaranteed more volatility ahead. It's a good thing we spent time last week discussing the circuit breakers that buffer Wall Street's biggest swings because after a full decade avoiding those automated curbs the S&P 500 hit the limit three times in the last five days: twice on the way down and then in Friday's shock rebound.

 

People who obsess over statistical anomalies and "black swan events" have plenty to chatter about. The CBOE Volatility Index (^VIX) hit one of its highest levels in history on Friday and is now within 4% of the all-time peak recorded in the days leading up to the 2008 implosion of Lehman Brothers. The Fed committed $5 trillion to make sure the credit markets avoid repeating that scenario in the foreseeable future. A few hours ago, the Fed also cut interest rates for the second time in two weeks, once again in an emergency meeting . . . this time, mere days before the scheduled Wednesday afternoon policy statement. In fact, as we publish this at 9 PM eastern, the circuit breakers have halted trading in futures with the Dow down 1040 points

 

Evidently the central bankers are watching the pressure of the global viral outbreak on the world economies and they don't like what they see. Between widespread business closures, millions of people stepping away from the workplace and an Oil price war, the Fed is right to be wary. They're doing all they can to shield the market from the worst-case scenarios. Congress, meanwhile, has passed a significant emergency stimulus package to keep U.S. households from immediate strain. Additional budget measures are likely as long as the disease remains a factor.

 

That's all constructive. We are unlikely to see a wave of debt defaults strangle any of the "too big to fail" financial institutions that can now count on the Fed for support. The Banks, in turn, have an incentive to keep pumping cash into the economy to keep businesses and consumers afloat. All they need is confidence to take the government's money and look out for each other. What the Fed is hoping to do is eliminate the extreme defensive postures that crashed the credit market back in 2008. If anyone can do it, Jay Powell and his colleagues at the Federal Reserve can.

 

However, Main Street and Wall Street don't always see eye to eye. While the underlying economy is now wrapped up tight to prevent shocks, investors do not like knowing that the horizon has gotten cloudy enough to force the Fed to act in the first place. Everyone who gets a vote on monetary policy wanted to cut interest rates at least 0.25%. The majority opted for a full 1.0 % cut, taking the overnight federal funds rate back to a range that starts at zero and goes all the way to 0.25%. Rates have been cut from 2.25% in September to zero - in six months. Unprecedented.

 

We're now back in the 2008-15 low-rate world and that's giving investors flashbacks to the disasters of a decade ago. Stocks will need to swing on their own to express that remembered trauma. The important thing for the long term is the economy and the people who interact with it. As we always say, sentiment is a pendulum given to extremes. The fundamentals provide the signal. Everything else is just noise.

 

There's going to be a lot more noise in the weeks to come. On one hand, the Fed sees "risks to the economic outlook" as the virus shuts down whole cities. Most recently, the New York City school system and all Chicago restaurants are now closed. You've undoubtedly seen plenty of institutions and offices disrupted in the wake of Friday's national emergency declaration. The Fed has seen all of it. The silver lining is the stress on the Energy sector, which has pushed inflation well below the Fed's 2% target. Powell probably would have been arguing that interest rates should come down anyway. This way, declining Oil and lower rates balance out.

 

What we're left with is a world awash in free money and as yet not generating serious inflation. We'll have to see where the cycle ends. For now, the Fed has demonstrated awareness and backbone. All it needs now is time for the viral storm to blow over. And we know from history that it always blows over. In China, there are now fewer than 12,000 active coronavirus patients, three months after the outbreak was first sighted, barely 0.0008% of the population is now sick with this disease. That's not an economic disaster. It's a rounding error.

 

At this point more people have the disease in Italy, which is another way the outbreak could go here. That's an infection rate of 0.035% so far, the equivalent of 115,000 Americans catching the disease. Either way, once we see new cases peak, we'll need to wait a few weeks before the world starts getting back to normal. We'll be able to gauge the corporate impact when the 1Q20 earnings cycle starts about a month from now. We are truly hoping that by the time we see the first 2Q20 numbers in July, the outbreak will be over and receding in the rear view.

 

Stay careful out there. Don't take unnecessary health risks, but don't give in to fear or anxiety either. Focus on the long term. There isn't a lot of urgency in "buying the dip" here. There may be more time ahead to buy lower. When we can measure the impacts, we'll know which stocks deserved to drop and which ones are true bargains. But that isn't a strong sell signal either. Unless you truly need cash, don't let the market force you to liquidate into weakness. That's what "staying the course" really means.

 

There’s always a bull market here at The Bull Market Report! Gary Jefferson has a lot to say about the way fear itself has taken over from what's otherwise a strong economy fed by low interest rates and what's happening in the Energy market. The High Yield Investor has anticipated a zero-rate world and as always has our latest thoughts on a few of the Real Estate companies that have been (in our view, guided by the fundamentals) unfairly beaten down in the current rout.

 

The Big Picture puts some of the extreme market moves we've seen into a larger context. Nearly all stocks are down over the past month and many of them are down a lot. When they all step back to this degree, their comparative merits still apply. We saw something similar play out in 2014 when the entire global risk environment took a step up and we're seeing it now. That's why we are still committed to our recommendations, which we consider the best positions in any economic environment . . . even if the economy as a whole weakens across the board. We'll update you on a few of the BMR names that have fallen the fastest in recent weeks.

 

Tomorrow looks like it will be another wild day. Don't hesitate to reach out if you get nervous, but remember: we still like all our positions. If we thought this storm would blow them over, we'd cut coverage and go. For now, with no real way to know where the worst gusts are, there's no clear sell signal anywhere. Hang in there.

 

Key Market Indicators

 

 

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BMR Companies and Commentary

 

The Big Picture: We're Not Alone In Our Pain

 

When 95% of all stocks move down in a single month, every portfolio suffers. What complicates this particular downswing is the speed and depth of the typical stock's decline. Since every investor's initial impulse in an environment like this is to second guess the logic that put those stocks in the portfolio in the first place, it's worth investigating whether any 60-stock universe like ours would have fared much better in this storm.

 

Most of the scattered companies that have gained any ground at all over the past month are tiny Healthcare plays running on a combination of fumes, speculation and hope. They have very narrow shareholder bases and once people started to reach for ways to make money on the outbreak the stocks surged far beyond sustainable levels. When the outbreak is over, these stocks will fall hard and fast.

 

Among the more substantial stocks that have done well, Gilead Sciences (GILD) and Regeneron Pharmaceuticals (REGN) have sucked all the life out of Biotech and the broader Healthcare field. Hospitals, Insurance groups and traditional Big Pharma have all suffered along with the rest of the market. We're happy for companies that might be able to concoct a coronavirus cure or vaccine, but we recognize that the gains here are going to be transient at best. US health officials suggest that 18-24 months is the earliest a vaccine might be available. Essentially people are speculating that curing one disease a few years down the road will move the needle on $50-100 billion companies. In our view, that is not a proposition that ends well.

 

Then there are the ultra-defensive Consumer companies: Sprint (S), General Mills (GIS), Kroger (KR), Clorox (CLX), Campbell Soup (CPB). Dominos Pizza (DPZ) is benefiting from every other Restaurant stock's pain as households stuck at home opt for delivery. After that, the field of substantial investment opportunities drops below $15 billion in market capitalization, which is not a zone we really like to focus on unless we see a really great opportunity on the go.

 

Just about every other major U.S. company has fallen at least 10% in the last month. A harrowing 70% of them are down 20% or more over that period, effectively entering a flash bear market in a matter of weeks. These are linchpins of Wall Street, stocks familiar to BMR subscribers: Alphabet (GOOG), all the big Banks that dominate the Financial Select Sector ETF (XLF), Big Oil. All in all, 9 out of 10 stocks are in bear territory and more than half have retraced 40% or more from their 52-week peaks.

 

Here's the map of the last month:

 

 

 

We aren't thrilled to say that a few of our recommendations are in the 40% decline cohort, but when you're looking at half of all U.S. stocks plunging to that extent, the odds are stacked against you. We aren't convinced that Welltower (WELL), MetLife (MET) and Ventas (VTR) deserve to be as battered as Travel stocks or most of Big Oil. (Yes, we still love Occidental Petroleum (OXY) for the long term but would not go near ExxonMobil (XOM) now.)

 

A 40% decline on a stock of this size amounts to investors betting on catastrophe. They're thinking the odds of these companies heading for oblivion have gone up substantially in the last few weeks. We aren't convinced. Any catastrophe that can swallow a giant like MetLife will wreak much wider havoc on the global economy. Right now, we don't see that happening . . . and even if it does, there's safety and strength in scale. Big companies with global footprints will fare much better in a broad-based downturn than small and specialized ones.

 

And if there's no broad-based downturn, these big companies are priced for a catastrophe that will never come. We like our odds here. It will take time to convince nervous investors to come back, but ultimately the market is where truth is made.

 

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Shopify (SHOP: $391, down 17% last week)

 

Over the last three weeks, the stock has dropped 28% from $543. Even with this slump, the company is still up 90% over the last year. We’ll take that anytime. When the illness passes and normal economic activity resumes, we expect the company to rebound.

 

The firm’s web-and-mobile-based software allows retailers to set up e-commerce sites, allowing merchants to sell their goods online. This is an integrated approach that allows retailers to sell merchandise across channels (e.g. online and physical stores) while managing inventory and processing orders, payments, and shipments. The platform is also used to build data that the retailers can use (e.g. targeted advertising).

 

A month ago, the company reported 4Q19 results. Anyone unhappy with 47% year-over-year revenue growth? To say we are pleased is a gross understatement. Revenue was $505 million versus $345 million.  There are two ways the company generates revenue: Subscription Solutions and Merchant Solutions. The former (36% of 4Q19 revenue) consists of revenue from subscription sales. This grew 37% year-over-year, from $135 million to $185 million. It generates a much higher gross margin (80% in 4Q19). Merchant Solutions (64% of 4Q19 revenue, 37% gross margin) experienced 53% top-line growth, to $320 million. Management is trying to grow this segment by offering new services, such as point-of-sale card readers and cash advances

 

Turning to the bottom line, income was $770,000 compared to a $1.5 million loss last year, still pretty small relative to sales. We would like to see much bigger profits in the future. In an ideal world, this kind of revenue growth would generate ever-increasing amounts of profits. We believe that will be the case, eventually. Right now, management is supporting the growth by increasing operating expenses (Sales & Marketing, R&D, G&A), which rose from $195 million to $295 million.

 

There is $2.5 billion of cash and only $150 million of debt. Now this is what we call a strong balance sheet. A healthy balance always provides a company with more financial flexibility.

 

BMR Take: We remain optimistic about Shopify. In fact, if the virus gets worse and people stay home, we believe there will be explosion of online development in the world of commerce. Guess who will benefit? The markets aren’t cooperating at the moment. Hence, the stock is below our $435 Sell Price. Our view notwithstanding, that means you have a decision to make. Our Target Price remains $510.

 

 

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Splunk (SPLK: $115, down 17%)

 

Like so many others, the last month has not been kind to the company. Less than a month ago the stock hit an all-time high of $176. Since then, 35% has been wiped out. We are used to this volatility with this company. In late-October, the stock traded at $110 before going on a big run for the next four months. Yes, we’re used to it, but not particularly happy about it.

 

Its software offerings allow companies to use data in real time. Addressing a mass array of data sets, “big data” is being used by more companies to improve decision making. This trend is set to accelerate.

 

The company’s fiscal 4Q20 (ended January 31, 2020) revenue grew by 27% year-over-year, to $790 million. There was a $25 million loss compared to about breakeven last year. Operating expenses jumped by 33% to $670 million.

 

Management’s FY21 guidance calls for 10% revenue growth, from $2.4 billion to $2.6 billion. This is disappointing, although, if things go according to their plan, top-line growth will accelerate in the latter part of the year. The shifting focus towards cloud products does create challenges in making year-over-year comparisons. They believe annual recurring revenue is a better metric. After growing 54% last year, management is targeting a 40% compounded annual growth rate over the next three years.

 

Admittedly, the company’s balance sheet isn’t in great shape. There is $1.8 billion of cash and $2.0 billion of debt. With management changing the business model, operating cash flow, which was negative $290 million for FY20, should recover. It generated $295 million the prior year.

 

BMR Take: The combination of lukewarm guidance and the overall market selloff have left the stock below our $147 Sell Price, and you may very well choose to exit your position. If you can ride out the current storm, there is big upside potential, reflected in our $182 Target Price. You have to decide if this is a risk worth taking.

 

 

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Spotify Technology (SPOT: $132, down 9%)

 

Since early February, the stock is down 15%, holding up better than many others. Last year, it has gone from $145 down to $112 at the end of September. Then, it zoomed up to $156 in January. Currently, the stock has been roughed up a bit, trading at $132. The market’s uncertainty has created angst with a lot of stocks. Predicting the short-term is impossible even in calm waters. We so say we believe firmly in the company’s prospects.

 

Revenue grew 24% in 4Q19, to $2.1 billion versus 4Q18’s $1.7 billion. This was driven by a 31% increase in monthly active users (MAUs), from 207 million to 271 million. It lost $235 million compared to income of $495 million. The turnaround from a profit was due to higher operating expenses ($615 million versus $340 million).

 

Spotify is known for its music platform, successfully competing against behemoths like Apple and Amazon. The company is pushing into podcasts, a promising area. This is why we are willing to show patience with the company’s losses. Currently, 16% of its MAUs use podcasts. This is another avenue to attract subscribers and convert users from an ad-supported subscription to a premium one. The early data is promising, providing positive evidence, which we always like to see. After all, talk is cheap (pardon the pun).

 

This year, management expects MAUs to grow to 285 million and a 20% revenue increase to $9.3 billion.

 

BMR Take: We would feel more concerned about the company’s loss if it wasn’t generating increasing amounts of cash flow. For 4Q19, cash flow was $225 million, nearly triple 4Q18’s $80 million. It was $640 million for the entire year, 67% higher than in 2018. We have a $160 Target Price and our Sell Price is $125.

 

 

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Square (SQ: $58, down 21%)

 

The first half of March has been brutal for the company, with the stock falling from $83, 31% since the end of February. This is ugly. There is no other way to describe this move. And this is on no company-specific news. It isn't unique, of course. About 1 in 10 stocks are in a similar position right now.

 

That’s not to say the company will skate free unaffected by the coronavirus. We expect an impact from lower economic activity hurting payment activity. This will bounce back once the illness passes, although the timing remains uncertain. Remember, we are in uncharted territory. When it does, we expect spending to rebound from pent-up demand, provided, of course, that the coronavirus does not lead to mass layoffs and high unemployment.

 

We are long-term investors and Square fits the bill. It recently celebrated its 11th anniversary. That may not seem too impressive, but it is quite a feat for the Tech sector. The key is the ability of the company to evolve to meet the market’s needs. Initially started to allow businesses to accept card payments, it has 30 different products. Sellers can now use Square’s products to grow their businesses. On the individual side, its Cash App used to only allow the sending and receiving of money. Presently, users can spend or invest money, among other things.

 

Quarterly revenue grew to $1.3 billion from 4Q18’s $930 million, and, we are pleased that the company reported a $390 profit compared to a $30 million loss. Last year’s free cash flow was $400 million, much higher than the $235 million generated in 2018.

 

There is $1.5 billion in cash and $2.1 billion but $1 billion convertible note was issued earlier this month. We would expect this to be converted to stock in the next few years. With markets going haywire, this turned out to be fortuitous timing. Remember the old Wall Street adage: it is better to raise money when you can and not when you need the funds.

 

BMR Take: The stock is well below our $65 Sell Price. What does this mean? You know how we feel about the company. But this is irrelevant to your decision. We completely understand that it is not easy to hang in under the current circumstances. We only ask that you make a well-informed, rational decision that is not guided by your emotions. Our Target Price is $105 and if the virus clears up and the market gets back to normal, we fully expect to see this number later in the year or sometime next year.

 

 

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Twilio (TWLO: $80, down 21%)

 

When a stock falls by 38% in a month, that is not a lot of fun for shareholders. We know that we are masters of the obvious. We also believe that these are times that test long-term investors’ mettle. It is also a good time to re-examine the situation. We’ve done so and after careful analysis, our long-term thesis remains unchanged.

 

This is a phenomenal revenue growth story. Who could ask for more than 62% year-over-year revenue growth, which is what the company achieved in 4Q19? Its top line rose from $205 million to $330 million, partly aided by an acquisition. This hasn’t translated in profitability – yet. Losses widened from $45 million to $90 million as management is ramping up expenses, particularly R&D and Sales & Marketing. Combined, these more than doubled, rising to $215 million versus $110 million, supporting future revenue growth.

 

Its solutions are aimed at developers so they can build, scale, and operate real-time communications within software applications. These allow all kinds of communications that most of us just for granted. Things like text, text-to-speech, transcription, video, e-mail – you get the idea. The technology is used in popular, everyday applications like WhatsApp and Facebook Messenger.

 

The effects of the coronavirus will no doubt slow down growth, but the company’s train cannot get derailed. It gets revenue via contracts from the likes of Lyft and Twitter. The balance sheet, with $1.9 billion of cash and $640 million of debt, is in good shape. That’s always nice to see, especially when we are going through a challenging time.

 

BMR Take: These levels are awfully tempting to us. The swoon has left the stock at half our $156 Target Price. We remind you that the stock closed at $150 in late-July, an all-time high. Of course, the tailspin has left Twilio well below our $111 Sell Price. We are obviously enthusiastic about the company’s prospects but it is certainly understandable if you don’t want to continue the ride.

 

 

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Workday (WDAY: $138, down 13%)

  

In July, the stock hit an all-time high of $227 before falling 40%. Most of that move downward has come within the last month. Ouch! We don’t take this lightly, naturally. We do believe the company is going to be just fine. More than merely okay, actually.

 

The company, founded in 2005, made it through the tough 2008-2009 period as a fairly new entity, providing some comfort. Over the last five years, revenue has tripled from $1.2 billion to $3.6 billion. It is more than history that gives us a sense of comfort. This revenue machine provides cloud applications to companies’ human resource and finance functions, as well as to medium and large businesses, including companies that are part of the Fortune 50. Their customers are from a diverse array of industries, such as Financial Services, Healthcare, Education, and Government. This provides diversification benefits, especially as we head towards rougher seas (although, we expect the coronavirus to have a temporary effect).

 

Fiscal 4Q20 (ended January 31, 2020) revenue rose 24% compared to the year-ago period, to $975 million. The company is not profitable, reporting a $130 million loss versus $105 million. We believe, with its leading market position and revenue growth, it is only a matter of time before the company achieves sustained profitability. This doesn’t mean it doesn’t generate cash flow. Operating cash flow (OCF) has increased for several years, in fact. FY20’s OCF was $865 million. In FY18 and FY19, we saw $460 million and $600 million, respectively.

 

 

BMR Take: This is another company that is below our Sell Price ($150), after a rough week that impacted so many stocks. This is a good point to ask yourself whether you want to remain invested. We believe that indiscriminate selling is affecting most companies. When the market rebounds, the cream rises to the top. You know where we stand regarding Workday.

 

 

 

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A Word From Gary Jefferson

Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.

 

The media has gone into total shock and awe mode, even comparing the coronavirus fears to the great financial crises of 2008. We don’t believe there is any comparison at all between what caused the 2008 financial crises and the fear that a new flu-like virus will cause a slowdown in overall market activity. Columnist Mike Bird has recently discussed how the world's financial system is less fragile today than during the financial crisis, and we believe he makes a very important distinction between 2008 and today:

 

"Investors have some reasons to temper their fears, if not to turn optimistic. The world’s major banking institutions are far better able to weather shocks than they were in 2008, and the underlying plumbing that keeps markets moving has yet to show the signs of seizure that characterized the global financial crisis. Large banks are less than half as heavily leveraged as they were in 2008, according to the Financial Stability Board. The current crisis is still evolving, but the relative strength of the world’s major banks could end up making this selloff look more like Black Monday than the global financial crisis. The defining quality of the latter was the total arrest of the banking system. Better defenses against a similar outcome today should assuage some of the worst fears in markets right now."

 

Last week, U.S. futures triggered the 5% circuit breaker three times: once to the upside and twice to the downside. At the opening bell, the S&P declined 7% on two separate occasions and regular trading was paused for 15 minutes. And now the Fed has cut interest rates a full 1 percentage point in the past two weeks. This is new territory we are confronting, a perfect storm of uncertainty.  We know the negatives: slower or no growth, unemployment, possible changes to daily life style.  However, there are also many positives: interest rates are already priced as though they are going to zero, gas will soon be much cheaper, and the financial system is prepared for these wild rides. Looking out a few quarters, it has been our experience that these low rates will drive money back into equities. There just isn't any other place to go.

 

Volatility will persist as long as there is an America living in "fear of infection" and a media establishment with a virus and oil shocks to work with. We can add 1 + 1, but it doesn't quite add up to 2 just yet. As of today, we still don't have good numbers on the global economic slowdown effects of contagion and we have a long way to go before election day. More importantly, we have no idea what changes there will be to consumer consumption, the real driver of our current solid economic growth.

 

Yet doom and gloom reigns supreme even though the collapse in oil prices along with the implosion in fixed income benchmarks, such as the 10-year Treasury, has also gifted most of those consumers an implicit tax break.  Consumption therefore could rebound smartly upon a release of this potential source of pent up demand among consumers. What started as a slight decline because of an expectation that the outbreak would dent global demand is morphing into a major crash in oil prices from over $40 per barrel to $30.

 

Lower oil prices are generally seen as a tailwind for the economy because of reduced prices at the gas pump for consumers as well as lower shipping and transportation costs for businesses. Thus, notwithstanding a terrible market, there are many benefits for the U.S. consumer: lower taxes, lower interest rates and lower gas prices. We still believe they are a long way away from shutting down their normal lifestyles and spending habits.

 

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The High Yield Investor
By Larry Rothman
VP High Yield Investments
The Bull Market Report 

 

What a week! Those hoping for a return to normalcy were sorely disappointed. Just to make things interesting, oil prices spiraled downward since Russia and Saudi Arabia are intent on waging a price war. The President’s midweek speech addressing the coronavirus was not well received, although Friday afternoon’s press conference went better.

 

There wasn’t much in the way of economic data last week. The limited information was good. With weekly jobless claims remaining in the low-200,000 range (211,000 last week), there is no sign that the coronavirus is leading to mass layoffs. As long as that is the case, businesses may absorb the short-term hit to profitability and the current circumstances will not lead to a full-blown, severe recession. The Consumer Sentiment Index, a measure of confidence, fell to 95.9 from 101. Right now, we are not too concerned about the drop. We view this as a perfectly natural response to all the negative news circulating. It is worth keeping an eye on since consumer spending is a large driver of the U.S. economy. Not to be forgotten, inflation remains contained with the Producer Price Index, after jumping 0.5% last month, dropped 0.6% in February. Consumer prices rose just 0.2%.

 

To help keep the lending markets functioning, the Fed intervened multiple times. The central bank initially made $1.5 trillion available, followed by $1 trillion weekly, to ensure the short-term “repo” market works. The idea is to keep financial markets and institutions solvent against any possible disruption. The Fed is also purchasing a broader maturity range of Treasury securities . . . and not just short-term bills. We're looking at $750 billion in "quantitative easing" at least. Central bankers are willing to use the balance sheet to add liquidity to the market. We welcome the relief.

 

At the shorter end of the Treasury yield curve, yields were lower, while rising at the longer end. The two-year yield was the dividing line, with its yield remaining at 0.49%. With the 10-year yield climbing 20 basis points to 0.94%, the 2-10 spread widened to 45 basis points from 25 basis points a week earlier.

 

We are in this together. The Bull Market Report is not abandoning you just because the markets have gone haywire. We analyze three REITs in this week’s report. Vornado, holding high-quality properties, mostly in New York City, offers a 505-basis point yield advantage over the 10-year Treasury yield. Turning to Healthcare, we discuss Welltower (590 basis point yield advantage) and Ventas (860-basis point yield advantage), with each having different risk/reward characteristics.

 

Vornado (VNO: $44, down 16%, yield = 6.0%)

 

This REIT actively manages its real estate portfolio, developing and selling properties. Its core holdings are in New York City. These include 35 Office properties, 70 Retail properties, 10 Residential properties, along with the Hotel Pennsylvania (located right across the street from Madison Square Garden and Penn Station) and a 32% interest in Alexander’s (a REIT that owns seven properties in greater New York City, including Bloomberg’s headquarters).

 

The other holdings, such as theMART in Chicago and a controlling interest in a San Francisco office building, are also impressive.

 

Last year, Vornado sold a bunch of assets, garnering $3.3 billion in proceeds. Part of this was contributing seven New York City properties to a joint venture and transferring a 48.5% interest in the JV (the company still owns the balance).

 

Meanwhile, the company is investing in redeveloping the Penn District (PENN1 and PENN2, two office buildings close to New York’s Penn Station) and developing a condo tower at 220 Central Park South (a prestigious address).

 

Other than a full-blown, long-lasting recession, Vornado’s properties are going to do fine. For the record, we don’t expect one. Coronavirus will undoubtedly have an economic impact. It’s just that we expect it to be shallow and short-term.

 

With fewer properties, 4Q19 revenue fell by 15%, to $460 million from 4Q18’s $545 million. Profit grew to $160 million from $100 million.

 

A REIT’s key metric is Funds from Operations, a proxy for cash flow. Vornado continued to perform well, with FFO increasing by 48%, from $210 million to $310 million.

 

Obviously, we remain optimistic (Target Price: $80). Over the past month, the yield has risen by 210 basis points, from 3.9% to 6.0%. With U.S. Treasury yields falling precipitously, the spread over the 10-year is an appealing 505 basis points. The stock has fallen below our $50 Sell Price, so you may decide this is the time to exit your position, depending on your own viewpoint.

 

 

Welltower (WELL: $51, down 31%, yield = 6.8%)

 

Welltower invests in Senior Housing and Health Care. Senior Housing Operating properties include Seniors Apartments, Independent Living, Continuing Care Retirement Communities, Assisted Living, and Alzheimer’s/Dementia Care (a specialized type of Assisted Living). The second category is triple-net properties. These include many of the same property types that we just mentioned plus Long-Term/Post-Acute Care. Lastly, there are Outpatient Medical Buildings.

 

Cash flow can be volatile since 67% of the company’s 2019 revenue was generated from Senior Housing. This segment has been under pressure due to oversupply. The good news is that the company has a solid portfolio of real estate which has historically outperformed the industry. Over the long haul, demographics are on its side since the population is aging. Triple-net, which provides more stability, accounted for 19% of revenue. Outpatient medical generated the remaining 13% of the company’s 2019 top line. With more procedures done outside large hospitals, this is a potential growth area.

 

Revenue grew 3% in 4Q19, to $1.6 billion from 4Q18’s $1.2 billion, in a challenging environment. Income, meanwhile, nearly doubled to $240 million from $125 million. That's great progress that we suspect the coronavirus and instinctive fear of an epidemic clearing Senior Housing occupancy will not eliminate. Yes, the virus is the culprit in our Senior REITs' precipitous decline this week. They will recover. We still need places where medically infirm people can live, especially if the hospitals fill up.

 

Welltower (Target Price: $89) now has a 6.8% dividend yield. Just a week ago, it was yielding 4.7%. Of course, this also means the stock has dropped dramatically. So much so that the company has fallen below our $72 Sell Price. What you do next is up to you. We still believe in it.

 

 

Ventas (VTR: $33, down 33%, yield = 9.5%)

 

We discussed this REIT a couple of weeks ago. It is worth refreshing since the yield has increased by 60% from 5.9% in that short period of time.

 

The company has a similar portfolio to Welltower. Its 1,200 properties are comprised of Seniors Housing Communities, Medical Office Buildings, Research/Innovation Centers, Inpatient Rehabilitation Facilities, and Long-term Acute Facilities. Approximately one-third of its properties are under the more stable triple-net leases.

 

The majority, 68%, of its revenue is derived from Senior Housing Communities. Medical Office Buildings (15%) and Research/Innovation Centers (7%) are also significant top-line drivers.

 

Its 4Q19 revenue was 8% higher than the year-ago period, from $925 million to $995 million. Resident Fees and Services, the largest component, rose from $515 million to $570 million. Income fell from $65 million to $15 million, with Depreciation and Amortization more than $100 million higher, at $350 million.

 

The Triple-Net Lease and Office properties are doing fine. Senior Housing Operating Properties have been under pressure. We don’t expect this to last since the current excess supply will get soaked up over time, particularly as the Baby Boomers age.

 

Ventas (Target Price: $72) offers a compelling yield for patient investors. This is well under our $53 Sell Price. Just to be clear, we are not bailing. That doesn’t mean if you are a risk-averse investor that you should feel compelled to remain invested. It is understandable if you decide this is the time to sell.

 

 

Good Investing,
Todd Shaver, Founder and CEO
The Bull Market Report
Since 1998