The Weekly Summary
It's been a wild couple of weeks on Wall Street, but in general the superlatives remain completely disconnected from the stocks. Even after soaring 27% from its pandemic bottom, the S&P 500 is still down 14% YTD. Likewise, the blue-chip Dow industrials have rebounded 30% but are still 17% in the hole, while the NASDAQ has rallied 21% back from its own post-viral low. We've seen a lot of recovery fueled by trillions of dollars of Congressional stimulus and Federal Reserve support. The impact on our stocks has yet to be determined.
That's why we've taken a step back from the market in the last few weeks. To be completely frank, there's zero fundamental reason to report on individual stocks until we can start gauging the impact of the outbreak in medical and economic terms. This quarter has dropped into limbo as far as corporate performance is concerned. Whatever results we see over the next few weeks that line up with previously established trends will be practically impossible to project into a post-outbreak future. Sooner or later, things will get back to normal, but that time is not now.
Likewise, even though the market mood over the next few weeks will revolve around corporate guidance for the current quarter, all the best forecasts executives can provide are hypothetical at this stage. Nobody knows when the viral cloud will lift or when the economy will reopen. While there are a few encouraging signs that the infection "curve" is flattening out in various parts of the world, cases are still being reported nationwide at an exponentially increasing rate. Once the tests start coming back negative, people can literally breathe easier and get back to work. We are not there yet.
We remain confident that we will be there in a few months or even weeks. For now, however, we don't want to waste your time musing on the vagaries of a stalled market running entirely on algorithmic day-to-day currents. Any updates we could provide are predictions written in sand. Washington and the virus are calling the tune and roughly 95% of all stocks are dancing in unison. There's a reason nearly all stocks are somewhere between 10% correction and 40% rout right now. The only question is which of these companies truly deserves to take that big step back and which ones will recover their confidence first and fastest.
In the meantime, volatility remains elevated with the CBOE Volatility Index (^VIX) at 40 even after the last few weeks of recovery. Ordinarily we would start feeling complacent with the VIX somewhere in a 9-12 range, so this is still extremely unsettled market weather. If anything, the wild swings to the upside we've seen on the back of the Fed's superhuman efforts to keep markets liquid only confirm that this is not about corporate fundamentals. This is purely about confidence: how good investors feel about the long-term future and the role U.S. companies play in it.
As far as we're concerned, you should already know how you feel. Our experience and the weight of a century of market data tell us that investors will get through this and that the future will ultimately be better than the past. Every recession in history has ended with stronger companies creating bigger and more dynamic markets, ultimately generating more wealth for everyone. Sometimes it takes months to recover, as we saw in the 2008 crash, the dot-com bust or the 1987 slump. Occasionally it takes years, as investors had to accept in the 1970s or the Great Depression. But every single time, the long trend always pointed up . . . and the right stocks shook off the shocks and got back to work faster than the rest.
We suspect that we are still in the right stocks. But until we know for sure, you have better things than hypotheticals to think about.
In the meantime, there's always a long-term bull market here at The Bull Market Report! While earnings season is on the horizon, we do not see much sense in reviewing the numbers except as a formality. Our recommendations were poised to outperform before the virus hit and all things being equal, they're likely to outperform through the outbreak and beyond. However, we have a few brief comments in The Big Picture.
What really interests us right now is making sure that our recommendations have not materially changed. In all humility, it's unlikely that the core Stocks For Success have weakened significantly more than anything else in the market as a whole. If anything, these stocks are a source of strength and inspiration for investors around the world. Several like Microsoft and Amazon have actually made money for shareholders YTD. Many others like Apple, Alphabet, Johnson & Johnson and Visa are still well above where they were a year ago. We'd like to devote most of this issue to checking in on these core holdings. Our view on them really hasn't changed, but it's important to communicate that.
The High Yield Investor, on the other hand, demonstrates the power of conviction when sentiment turns around. Several of our most battered holdings rocketed back to reality last week and while the chance to lock in once-in-a-lifetime yields seems to have receded for now, they still present attractive long-term income opportunities. We'd like to spotlight a few here.
Finally, we'd like to repeat: Reach out to us at any time. We will do our best to address your concerns and answer your questions. We are truly all in this together. And if you don't hear back fast, reach out again. These weeks have been a drain on everyone attention and we are watching a lot of things changing every day.
Key Market Indicators
BMR Companies and Commentary
The Big Picture: Earnings In Limbo
We saw a great headline a few days ago: consensus "no longer exists." Nobody with any real sense at all is predicting what we see in the coming earnings cycle. All the best analysts in the world can do is plug hypothetical economic variables into their models and lower their expectations accordingly on a company-by-company basis.
Some people suspect U.S. GDP dropped 6% in the first quarter of the year and will deteriorate a harrowing 24% more between now and June. We think that's excessive, but these are all just placeholder numbers. The real calculations will revolve around what corporate managers can confirm as the virus rolls away and we see where "the new normal" begins.
We are currently braced for 10% earnings decline across the S&P 500 when 1Q20 numbers start coming in. Again, that's a placeholder. Some companies will see minimal viral impact. Amazon and other Online Retailers, for example, are probably looking at record revenue, better than anything we saw coming before the virus unhinged consumption habits. Companies like Apple, on the other hand, are clearly struggling to support the top line. And then expectations for Energy, Financial stocks and the Industrials have cratered. The OPEC price war continues. Interest rates are at zero. And factories aren't open. Meanwhile, 17 million Americans have filed for unemployment benefits.
There will be bright spots, as we've mentioned with companies like Amazon. But the important thing this season is not about beating gloomy expectations. We want to see our recommendations reveal that the 2Q20 environment is not as bad as we think . . . at least, not as far as their executives can see right now. While guidance will be provisional at best, the outlook is everything as we all try to rebuild our sense of how well companies are doing and what their stocks are worth. That will take a few months. But it will happen.
And investors who pick the most resilient and robust stocks will see their money get back to work fastest. On the other hand, stocks that will need more time to recover simply aren't worth holding for the long term now. This is a time to hold your positions until you see that something else is poised to do better in the post-viral world. When that happens, we'll rotate.
Alphabet (GOOG: $1,211, up 10% last week)
Google has recovered nicely over the past couple of weeks. It is well above $1,014, the 52-week low that the stock hit in late March, although the company is still 21% off the 52-week high of $1,532 reached in February. When investors are indiscriminately selling, great companies like Alphabet drop in price. It is good to see some sense of normalcy return.
We’ve discussed its merits, how it is involved in various businesses, and its strong financial results. (See The Bull Market Report for March 23, 2020 for details). In the aftermath of the coronavirus, the company’s Search, Android, Maps, etc., will not see a drop in demand, except Maps since people are staying at home right now. Advertising revenue, which generates 83% of its top line, will feel the effects of the economic slowdown. The company has shifted away a bit from an advertising-based model with products like Google Cloud, Google Play, and YouTube, which will offset some softness. We expect revenue growth to pick up after a hiccup. The balance sheet is incredibly strong, with $120 billion in cash and $16 billion of debt. It will get through this crisis just fine.
BMR Take: We have lowered our Target Price from $1,600 to $1,360 to reflect the current economic environment and market. Just to be clear, we have not changed our opinion of the company. Our faith in the business remains so strong that we don’t have a Sell Price. That being said, as with any investment, there are risks. Most immediate is the slowdown in advertising revenue. The company continually looks to grow, which is positive. Even better, we like its track record when it enters new markets.
Amazon.com (AMZN: $2,043, up 7%)
Shareholders were feeling the pain when the stock fell from $2,185 on February 19 all the way down to $1,626 on March 16, a painful 26% loss in only a month. The good news is the stock has rebounded sharply to $2,043. The stock is now 7% off the all-time high of $2,086, which should have you feeling a lot better. These times require patience. It is not only a virtue, exercising it with this company will make you a lot wealthier.
We won’t rehash the company’s strong sales and profit growth. You can re-read The Bull Market Report for March 30, 2020 if you want to see the details. We will say the ability to buy grocery goods and other everyday items (including masks, disinfectants, and toilet paper) along with streaming content from Amazon Prime* will serve the company well during these times, driving revenue growth. We also expect that people who never used Amazon for shopping, or limited their use, along with those who signed up for Prime, will stay on as customers. Once people realize how easy it is to shop for groceries and how much they like the movies and television shows, they won’t give it up.
*There are 130 million households in America. 112 million have Prime!
BMR Take: We have a $2,200 Target Price and don’t have a Sell Price. We believe the company has shown you why by rebounding so quickly in the face of the pandemic. The company has gained new customers, but an immediate risk is an economic slowdown that results in less consumer spending. This could result in people canceling Prime or buying fewer Kindles. Selling so many items (including groceries) at different price points mitigates this risk but note that it continued growing sales and profits through the last recession. Amazon Web Services, an on-demand cloud computing service, which has been growing quickly, may see a dip in sales. This generated $35 billion in sales last year, or 12% of the top line, but a huge proportion of profits. A fast-growing business (37% year-over-year sales growth last year), this will only be temporary.
Apple (AAPL: $268, up 11%)
Closing at $324 on February 19, the stock swooned $100 or 31%, to $224 on March 23. The good news is that Apple has recovered to $268. At least the stock is heading in the right direction.
Management warned investors in mid-February that it wouldn’t meet their fiscal 2Q20 (ended March 28, 2020) revenue guidance due to iPhone supply constraints and weaker demand in China. Obviously, with the coronavirus spreading across Europe and North America, it is not a stretch to say that fiscal 2Q20 revenue was weaker than they expected and fiscal 3Q20 sales will also get affected. That’s the bad news. The good news is that iPhone sales (55% of FY19 sales) will continue strong. So will the other products like the iPad and AirPods. You can reference The Bull Market Report for March 30, 2020 to see how well the company was doing before the pandemic. Is there any reason to doubt the company’s prowess? We certainly don’t.
BMR Take: The iPhone 12 is on the horizon. Typically shrouded in secrecy, there were some details that leaked about four new models, including 5G connectivity. The company traditionally releases new models in September, but with the uncertainty created by the coronavirus, that could easily get pushed back. If the economy recovers fairly quickly, sales merely get pushed back rather than canceled. We can live with that scenario. Of course, if the economy remains in the doldrums, the company may have to delay the launch. Those are the biggest risks we see – delayed sales rather than lost sales. With the stock at these levels, we are lowering our $375 Target Price to $300. We would not sell; hence, we don’t have a Sell Price.
Berkshire Hathaway (BRK.B: $194, up 9%)
The world was a different place when the stock closed at $229 on February 21. Subsequently, cities across North America shut down and all of Italy was locked down, among other things. The stock fell 30%, plummeting to a52-week low of $160. Now trading at $194, the company is making its way back. We have examined the company and view the selloff as a buying opportunity.
For its major investments and company holdings, you can read The Bull Market Report for March 30, 2020. Some are economically sensitive, such as railroad Burlington Northern Santa Fe and a host of consumer product companies like Clayton Homes and Benjamin Moore, and 80% of the portfolio is invested in five companies (American Express, Apple, Bank of America, Coca-Cola, and Wells Fargo), some of which are economically sensitive. These will feel the impact from an economy slowdown and sluggish economic growth when stay-at-home orders are lifted. With Warren Buffett’s ability to pick long-term winners and management teams, we don’t doubt that the portfolio will bounce back in a big way.
BMR Take: Based on the current price, we have lowered our Target Price from $255 to $220 The major risks are that the economy enters a long period in the doldrums, which would hurt the underlying companies’ profits. We are not overly concerned by this prospect given Buffett’s track record. We would expect him to use the company’s $128 billion cash hoard to bargain hunt. There is even more at the company’s disposal since it took advantage of low rates by issuing $1.8 billion worth of yen-denominated notes. To us, the biggest concern is Warren Buffett’s and partner Charlie Munger’s age, which is 89 and 96 respectively. He has mentioned a non-public succession plan and he has hired portfolio managers, Todd Combs and Ted Weschler. Weschler now runs the important GEICO subsidiary. To us, the rewards far outweigh the risks, which is why we do not have a Sell Price in place.
Microsoft (MSFT: $165, up 7%)
The stock closed at $187 on February 19, close to the $191 all-time high reached earlier in February. The next month’s market doldrums hit the company, and the stock fell 27% to $136 in late March. Over the following few weeks, the company has rebounded 21%. We hope you have stuck with the company during this wild ride and we believe you should keep holding on.
Before the coronavirus hit, results were strong. You can read about fiscal 2Q20’s (ended December 31, 2019) revenue and profit growth in our newsletter for March 30, 2020. Since then, management withdrew their $11 billion fiscal 3Q20 revenue guidance for the More Personal Computing business that consists of Windows, Devices, Gaming, and Search. This business generates 35% of revenue. The other segments are Productivity (Consumer and Commercial Office products, LinkedIn, and cloud applications) and Intelligence Cloud (Server Products and Cloud Services and Enterprise Services). Management stated these two businesses were unaffected at the time. With the breadth of strong products in place there is no doubt that the company will get through these tough times
BMR Take: Some of the companies’ products are sold via licenses, providing more stability to revenue and earnings. We expect a strong rebound driven by the company’s dominant market position. Its diversity across sectors and company size also help to cushion results. There is $134 billion in cash and $87 billion of debt for the AAA-rated company, another point in its favor. Merely due to the current trading levels, we are amending our $200 Target Price down to $190. While the chief risk is from competitive products, nobody has been able to knock Microsoft off its lofty perch in key areas like Windows. No surprise, this is another company that we wouldn’t sell.
Visa (V: $174, up 14%)
Visa hit a record, $214, on February 19. There wasn’t much time to celebrate, with the stock dropping to $134 on March 23, a 52-week low. Since then it has sharply rebounded, up 30% and we still have high hopes for further gains.
The company’s results are tied to consumer spending, which may feel some pressure given the state of the economy. There is the $2 trillion stimulus package that puts money directly into people’s hands, which will help offset job weakness. Over the long-term, there is no doubt spending will rebound. In the meantime, Visa’s results are also affected by people shifting payments away from cash. Here, the company’s long history and global platform help in the long run. Last year, it focused on growing digital payments by investing in the core businesses of credit, debit, and prepaid cards. We discussed the opportunity and fiscal 1Q20 results (ended December 31, 2019) in The Bull Market Report for February 18, 2020. Visa’s strong business model hasn’t been altered even as the world changed drastically since then. Visa, a AA-rated credit, has $12.7 billion of cash and $17.3 billion of debt. Just last week it issued $4 billion worth of notes, adding liquidity. They will pay around 2.0% for ¾ of it and just 2.5% for $1 billion due in 2040. Good timing! Adjusted for this issuance, debt/total capital was a reasonable 33%
BMR Take: A chief risk is a sustained economic slowdown that results in high unemployment and depressed spending. We don’t expect this to happen, especially in an election year where the government is motivated to provide additional stimulus measures. But with the virus still untamed, keep your eyes wide open. The other principal risk is from the competition even though Visa is a large and established player. New entrants, especially as technology evolves, could eat into its share. With the stock at this level, we are lowering our Target Price to $200 from $230. Our Sell Price? Quite simply, we wouldn’t sell.
PayPal (PYPL: $106, up 15%)
Yes, this is another stock that reached a record high in February, going to $124 on February 19. You know the story – the company went down to $82, a 52-week low, on March 23. By now, you also know that you can’t keep a good company down for too long. Over the next few weeks, the stock shot up to $106.
For a discussion on 4Q19 results, you can read The Bull Market Report for February 18, 2020. Even though 4Q19 revenue disappointed the Street, it grew 15% year-over-year. For an “off” quarter, that is not too shabby! Looking forward, the company will feel the impact of slower consumer spending. Rest assured that this is temporary. It will continue to grow as payments continue moving to a digital platform – even without the coronavirus. Actually, the trend will accelerate with more people using the platform to order goods and transfer money since they can’t exchange cash in person. The core products are the namesake PayPal and Venmo, which appeal to a younger clientele. PayPal, with $10.8 billion in cash and $5.5 billion of debt, has a strong balance sheet to ride out this economic storm.
BMR Take: We’re watching the current economic slowdown closely, but we believe the major risk is competition. This doesn’t overly frighten us since there is plenty of business to go around with the market is expanding rapidly. This stock is a core holding, which is why we don’t have a Sell Price. Our $140 Target Price is too high in the current market, so we are lowering it to $122. We would not sell PayPal.
Salesforce.com (CRM: $155, up 15%)
The stock market has played with our emotions over the last six weeks or so, taking a great company like this from an all-time high of $196 on February 20 down to a $115 a month later, a 52-week low. Hopefully, you avoided panic-selling since the stock zoomed up 35% in the next few weeks.
The company is a leader in customer relationship technology, with offerings including Sales Cloud (stores data, keeps track of leads, uses analytics, etc.), Service Cloud (improves customer service), and Marketing and Commerce Cloud (e.g. personalizes marketing). Even in an economic slowdown, its Subscriptions ($16 billion of revenue) and Product Services ($1.1 billion) are mostly contractual, providing stability. You can read our take on the company’s strong fiscal 4Q19 (ended January 31, 2020) revenue growth (see The Bull Market Report for March 2, 2020).
BMR Take: The company’s backlog and business model provide short-term visibility into the company’s revenue. Down the line, revenue would feel the effects of a prolonged downturn if it were to occur. Salesforce is the market leader, which lessens our concern about competition. Turning to pre-coronavirus concerns, management surprised the Street and not in a good way, including co-CEO Keith Block’s resignation and the $1.3 billion Vlocity acquisition. We are not overly concerned. Block’s departure leaves the company in Marc Benioff’s fine hands. The acquisition makes a lot of sense since management is very familiar with the company since its applications are built on Salesforce’s platform. They have also promised to pause acquisitions to focus on integrations, which should calm investors’ nerves. We are hereby lowering our Target Price to $175 from $190. Our Sell Price is $145.
Occidental Petroleum (OXY: $15.36, up 18%)
Well, this stock hasn’t gone the way we thought since we recommended it in mid-January at $47. On February 20, the company was at $43 before dropping to $9 on March 18, a 52-week low. There is some solace in the nice bounce back to the current level.
It is worth reviewing to see where things from here. The coronavirus affected China and spread to the rest of the world, crushing energy demand as people were forced to stay at home. To pour salt on the wound, supply had been going up with OPEC (particularly Saudi Arabia) and Russia engaged in a price war with each opening the spigot. Occidental, in what has proved to be poor timing, completed the $55 billion acquisition of Anadarko last year.
BMR Take: So far, we have presented a grim picture of the Energy sector and Occidental. There is good news, though. Russia and OPEC, have hammered out an agreement, cutting production by 10 million barrels a day. Not everyone agreed, with Mexico holding out, and with demand down 20% to 35% from the typical 100 million barrels a day, more cuts are needed. It is a good start in restoring balance though.
Crude is at $23 now. It hit $20 in late March and went as high as $28 Thursday before falling sharply in the afternoon. This is below the $40 price (since lowered to $30) the company previously stated it needed to break even. There are also a couple of smart investors involved. Carl Icahn has built a 20% stake and has two board members now. Icahn won’t go away quietly and all shareholders stand to benefit. Warren Buffett’s $10 billion preferred stock investment should also comfort shareholders and in fact may be converted to equity in the next few weeks. They have slashed the dividend on common shares from 79 cents per quarter to 11 cents, for an annual savings of $2.4 billion. Oxy will also reduce capital spending this year by about $1.7 billion.
We are lowering our Target Price to $18 from $59 and our Sell Price to $12 versus $41.
One further note. If crude heads to $40, Oxy will move higher, perhaps way higher from here. However, we are still quite concerned about the effects of the virus on the world of Energy. Crude is currently at $23, and if it stays here this will cause massive disruption here in this country and around the world, with work stoppages and bankruptcies. If crude heads to $15, watch out.
Shopify (SHOP: $418, up 17%)
The stock lost 43% from February 19 to March 16, falling from $543 to $322. Bouncing around since then, the company recovered nicely, ending the week at $418.
Revenue growth was strong before the coronavirus pandemic. If you wish, you can re-read the details in The Bull Market Report from March 16, 2020. The question is what happens going forward. This is a company that builds web-and-mobile-based software that lets merchants set up “online storefronts” that allow them to do so much more than selling goods online – e.g. manage inventory, process orders and payments, ship orders, and use analytics, to name a few. We like the steps management has taken in the immediate aftermath, which includes extending 90-day trials, supporting curbside pickup, and supporting merchants via online resources. The company is also providing data analytics to show how COVID-19 is affecting merchants’ businesses. This shows that consumers are shifting towards online shopping, which is hardly surprising, and this will benefit Shopify in the long run. Additionally, at year-end, the company had over one million merchants in 175 countries using its platform, with 52% in the U.S., 7% in the U.K., 6% each in Canada and Australia, and 29% from the rest of the world. This geographic diversity will help Shopify’s results recover since different regions will improve economically at different rates.
BMR Take: The biggest risk is that high unemployment is sustained for a long time, depressing consumer spending and having merchants cut back initiatives or even go out of business. We believe a different scenario plays out where the online shopping trend accelerates and businesses that had been slow in setting up an e-commerce site are pushed into it. The company has a strong balance sheet to weather these challenging times. There is $2.5 billion of cash and only $150 million of debt. We are lowering our Target Price and Sell Price to $480 and $370 from $510 and $435, respectively.
Square (SQ: $59, up 35%)
When a stock gains 35%, all we can say is, what a week! Square was at $87 on February 20, a 52-week high, and then dropped to $32 on March 18, a 52-week low. Rising 83% off this level should have you feeling better.
It was doing fine before the coronavirus spread, with 4Q19’s 40% year-over-year revenue growth (see The Bull Market Report for March 16, 2020). The company’s momentum continued in 1Q20, with revenue 51% higher for the first two months of the quarter. Then, COVID-19 hurt economic growth in March and management lowered 1Q20 guidance. With two-thirds of its top-line generated from transaction-based revenue, businesses shutting down has had an impact on the company’s results, naturally. They now expect revenue of $1.3 billion compared to their prior $1.35 billion guidance, and gross profit of $515 million, down from their original $550 million estimate. This isn’t too bad, all things considered. They have withdrawn their 2020 guidance due to the uncertainty. This company has been around for more than a decade, and it didn’t survive by standing still. Rather, it has adopted and expanded product offerings. There is good geographic and sector diversity which will help Square recover.
BMR Take: Tied to spending, this year’s results will feel the effects of COVID-19. The faster the economy recovers, the quicker Square’s prospects improve. Of course, the government and Fed are trying to give it a lift. We are lowering our Target Price from $105 to $66 and our Sell Price by $13 to $52.
Twilio (TWLO: $95, up 18%)
The stock tumbled from $128 on February 19 all the way down to $68 on March 16, a 52-week low, or a whopping 47% loss. The 40% recovery to $95 should boost your spirits.
The business of the company is to allow communications like text, text-to-speech, transcription, video and e-mail. These are used by applications like WhatsApp and Facebook Messenger. Do you think this business will disappear? We don’t either. It has contracts with large companies like Lyft and Twitter. What we have here is a revenue growth story (see The Bull Market Report for March 16, 2020). It hasn’t translated into profitability yet, but it will. Our long-term thesis that the trend towards these types of communication is unmistakable and unstoppable. In the meantime, you can take comfort in the company’s healthy balance sheet that allows it to ride out the storm. There is $1.9 billion of cash and $640 million of debt.
BMR Take: A market leader, the company faces competition and there is always the risk that its customers bring the business in house. As long as Twilio provides a good, cost-efficient solution, this is minimized. Our new Target Price is $120, down from $156. We are also lowering our Sell Price from $111 to $75.
Facebook (FB: $175, up 14%)
This company got caught up in the market downturn. We understand how frustrating it is to watch the stock fall from $217 on February 19 down to $137 in just a month. The stock is now at $175, a nice comeback.
This company is simply a juggernaut that can’t be stopped right now. More than just its namesake brand, it also includes products like WhatsApp, Instagram, and Messenger, each with over one billion users. Its family of products have 2.5 billion monthly active users. With the world’s population at 7.7 billion, that’s an incredible one out of three people across the globe. Naturally, this generates a large amount of revenue, profit, and cash flow (see The Bull Market Report for March 9, 2020). Its advertising model will dent revenue growth temporarily before resuming with a better economy. There is a mountain of cash, $55 billion, and only $11 billion of debt.
BMR Take: The biggest near-term risk is a slowdown in advertising, which doesn’t concern us much since this is a short-term phenomenon. Long-term, possible government regulations concerning privacy are a greater risk, although management has taken steps to address these issues. Still, there is always a target on your back when you are as large and successful as Facebook and you should be aware that increased regulations could hurt its revenue. For us, the rewards far outweigh the risks. We are lowering our Target Price from $250 to $200 due to the price drop and our new Sell Price is $155, down from $206.
Johnson & Johnson (JNJ: $141, up 5%)
On February 21, the stock closed at $150, near the all-time high of $155 reached a couple of weeks earlier. What a difference a month makes, with the company plunging to $109 on March 23, a 52-week low. From there, the stock shot back up, to $141 this week.
Pharmaceuticals have continued to show steady growth while the other two businesses, Consumer and Medical Devices, saw year-over-year sales growth accelerate in 4Q19 (see The Bull Market Report for March 23, 2020). The company is devoting resources on a coronavirus vaccine. The company is a major contender in the early stages of the race. With 49% of the company’s revenue generated from outside the U.S., this global presence will also help results. Additionally, if you are looking for a strong balance sheet, this company fits the bill since it carries a AAA-rated credit ($20 billion of cash and $29 billion of debt). You can also enjoy the dividend, which has increased yearly for nearly six decades. Talk about impressive! Currently, it pays a $0.95 quarterly rate, which is a 2.7% yield.
BMR Take: There is litigation risk from opioid lawsuits, which is fading as states settle. Lawsuits from talc in baby powder remains a potentially large risk. Here’s the upshot: A company with necessary products (how long can people stop taking a life-saving drug?), a highly rated credit, and stable dividends add up to an attractive investment, particularly in this environment. This is why we don’t have a Sell Price - we can’t see getting rid of a great company. Our Target Price remains $168.
The High Yield Investor
By Larry Rothman
VP High Yield Investments
The Bull Market Report
A holiday-shortened week saw equity markets moving up and Treasury yields generally climbing across the board. The two-year yield remained the same, 0.23%, while the 10-year yield rose 11 basis points to 0.73%. The 2/10 spread is 50 basis points compared to 39 basis points a week ago.
In terms of economic data, it paints a pretty grim picture right now. The Consumer Sentiment Index Plummeted to 71 from 89 and unemployment claims for the week were 6.6 million.
Unemployment rolls have been climbing for a while, with 15 million filing new claims over the last few weeks. We credit the Federal Reserve with doing its part to pump liquidity into the economy. Its early actions included slashing interest rates, purchasing asset classes (Treasuries, mortgage securities), and establishing a Term-Asset Backed Securities Loan Facility to allow the issuance of asset-backed securities such as student loans. This past week, the Fed took additional steps to support up to $2.3 trillion in loans. These include providing liquidity to banks that are participating in the Small Business Administration’s Paycheck Protection Program, purchasing up to $600 billion of loans through the Main Street Lending Program to support small-and-mid-sized business lending, and establishing a Municipal Liquidity Facility offering up to $500 billion to states and municipalities.
The recent steadying of the ship, with a big hand from the Fed, gives us more confidence that we are not catching a falling knife. In this context, The Bull Market Report presents three high-yield investments: New Residential Investment, Nuveen AMT-Free Municipal Credit Income, and PIMCO Dynamic Income Fund.
New Residential Investment (NRZ: $5.75, up 73%, yield = 3.5%)
A lot has changed since we last wrote about this REIT (see The Bull Market Report for February 24, 2020). The company invests in mortgage-related assets. These include mortgage serving rights (receiving a 0.25% to 0.50% fee) and residential mortgage-backed securities (RMBS) and loans, along with consumer loans.
At year end, the face value of its real estate portfolio was $36 billion, with $11 billion placed in agency RMBS, which are guaranteed by the U.S. government or an agency (i.e. Ginnie Mae, Fannie Mae, or Freddie Mac), and hence have lower risk in the event the borrower defaults. This leaves the other $25 billion invested in the higher risk non-agency RMBS. Management is trying to de-risk the portfolio, recently selling non-agency residential securities, which had a face value of $6.1 billion, for $3.3 billion.
We are lowering our Target Price from $18 to $7 and our Sell Price is $5. The company slashed its quarterly dividend from $0.50 to $0.05, which equates to a 3.5% yield. The market felt better about New Residential this week, with the stock skyrocketing from $3.33. At the end of March, management estimated its book value per share had fallen 25% to 30% from the year-end’s $16.21. This would place it at around $11.75, meaning the stock is selling at a 50% discount. Of course, in these times, things are fluctuating very quickly, and we advise exercising caution with these valuations. Those of you that are more risk tolerant may wish to invest at this level, cautiously. We have also discussed the preferred securities for those of you that want to take a more conservative approach (see our April 1 News Flash).
Nuveen AMT-Free Municipal Credit Income (NVG: $14.89, up 10%, yield = 5.3%)
This fund invests in municipal securities that are tax-exempt from federal income tax. The managers employ leverage (39% as of the end of March), raising the risk profile. At the end of 1Q20, 54% of the fund is invested in A-rated securities or higher, and 75% when BBB-rated bonds are included. Anything below BBB- is considered high yield and thus high risk.
The top five states (Illinois, California, Texas, Colorado, and Ohio) comprise 45% of the funds’ assets at the end of 1Q20. Broken out by sector, the largest allocations are Healthcare (20%) and Transportation (12%). Limited and General Municipal Obligations comprise 28%. It also has 9% of the fund in U.S. guaranteed bonds.
It is important to remember that municipal debt is not the same as U.S. Treasury notes and bonds, which are considered risk free. Many municipalities are required to balance their budgets, which can place stress on their economies by forcing them to cut spending and/or raising taxes during an economic slowdown. State and local governments are going to have to confront this situation due to the fallout from the coronavirus pandemic. The federal government provided some relief for state and local governments with the stimulus package and this past week the Fed established a fund that will lend money directly to the municipalities. We believe further aid is on the way since the federal government wants to avoid economic disaster for municipalities. Additionally, this fund minimizes risk by investing in higher-quality bonds and diversifying across sectors.
Nuveen AMT-Free Municipal Credit Income’s 5.3% yield needs an adjustment to compare it to taxable investments. To do that, calculate your tax-equivalent yield: the yield divided by 1 minus your tax rate. Naturally, the higher your tax bracket, the greater your advantage in tax-free investments. So, if you are in the 37% bracket, your tax-equivalent yield is 8.4%.
PIMCO Dynamic Income Fund (PDI: $25, up 22%, yield = 10.7%)
This closed-end fund invests its assets across Fixed Income to generate current income, tending towards the riskier end of the spectrum. Typically, it will invest at least 25% in non-agency mortgage-related securities (remember, these are not guaranteed by the U.S. government or an agency). It can invest up to 40% in emerging market countries (currently 5% of assets).
At the end of 1Q20, 53% of its assets were invested in mortgages, with 97% of this amount in non-agency securities. High yield bonds were another major investment area, representing 17% of the assets.
PIMCO Dynamic Income Fund (Target Price: $33) takes on more risk, and rewards investors with a higher yield, 10.7%. Three-quarters of the portfolio matures within five years, with 31% due within a year and another 25% maturing between one and three years. With shorter-term Treasury yields rates below 1%, the fund offers a 10% advantage over treasuries. For risk-oriented investors, this is intriguing since you get a diversified portfolio of fixed-income securities.
Todd Shaver, Founder and CEO
The Bull Market Report