The Weekly Summary
You know it's been a wild couple of days on Wall Street when the monthly unemployment report is at best the fifth-biggest story of the week. The good news is that that closely watched gauge of the U.S. labor market (and by extension the consumer economy) remains roughly as robust as we expected. While Corporate America has gotten a little cautious about hiring more people until resolving questions about the global trade situation, mass layoffs remain rare enough to sustain full employment.
And with peak 2Q19 earnings now behind us (33% of the S&P 500 reported last week), it's clear that most companies have no reason to make dramatic payroll cuts. The numbers may not be great, but with the market as a whole tracking only a 1% earnings decline, they're far from awful or even distressing. If we were weighing in on the S&P 500, we wouldn't sell this quarter. At worst we'd holding on for better times later in the year or at worst early 2020, which is now not far away.
Apple was the biggest earnings headline of the week and its numbers weren't bad. Tim Cook worked his magic and engineered a slight revenue uptick where we thought iPhone sales would be too weak for other units of the company to pick up the slack. Investors cheered, at least initially.
However, the next afternoon the Fed came around to make us all forget about Apple. While some wanted a deeper rate cut or a promise of more loosening moves ahead, we aren't greedy. Even rolling rates back to September's level is a rare gift that the central bank rarely bestows on Wall Street, especially when the underlying economy is this strong. Lucky for us, inflation remains dormant and the dollar is if anything too strong for exporters like Apple to comfortably tolerate. We can afford a little rate relief. Now we have it.
On Wednesday, we thought that would be the biggest headline of the week and that we were looking at another rally. But then the trade war escalated, with reciprocal promises of massive tariffs on products coming out of China and going in. While it may simply be another negotiating tactic, we can't count on it. Either way, stocks dropped enough on Thursday and Friday to push the S&P 500 down 3% and leave the BMR universe with similar losses.
It's far from the end of the world. Our stocks are still up 35% YTD and the way the losses were highly correlated without respect to sector or economic sensitivity makes us think this is more of a short-term gesture of frustration than a long-term slump. So far trade hasn't come up a lot in corporate conference calls. They're more worried about the dollar, which the Fed can correct and no tariff can make worse. The fundamentals are getting better. Headlines come and go.
There’s always a bull market here at The Bull Market Report! Some huge quarterly beats force us to revise our ongoing earnings coverage in The Big Picture. Gary Jefferson looks at the economic strength going on behind the Fed's latest move, giving The High Yield Investor room to crunch the 2Q19 numbers from Vornado, New Residential and Equity Residential Trust.
And lest we forget, we’re wrapping up our tour of the Technology portfolio with reviews of recent earnings from Spotify, Shopify, Akamai and Facebook. CBRE, one of our favorite stocks, also merits an update, and as for previews, a look at Shutterstock is required to get you ahead of Tuesday morning's quarterly release.
Key Market Indicators
BMR Companies and Commentary
The Big Picture: A Great Season
We’ve talked a fair amount in the last few weeks about how BMR stocks are keeping earnings growth alive in an environment when fundamentals for the market as a whole have stalled. This week gave us even more evidence that on the whole, our recommendations are both robust enough to keep the cash flowing and resilient enough to weather the factors that have become a drag elsewhere.
Thanks to dramatic year-over-year expansion at Universal Display (OLED: $205, down 4% last week) and Shopify (SHOP: $332, down 1%), our universe is on track to deliver 30% earnings growth this quarter. We don’t want to brag or make it appear like we’re fudging the numbers, but even factoring out those two huge trends (respectively 300% and 600% above last year), we’re still looking for 13% more profit than we saw a year ago.
Admittedly, we’re factoring out companies where year-over-year comparisons are meaningless, often because they’re still burning cash or, like Spotify (SPOT: $153, down 1%) and Alteryx (AYX: $130, up 7%) nudging above breakeven. People who try to weigh a loss against a profit in percentage terms are really just juggling abstractions.
But where the math makes sense, we have a lot to work with. Taking just the BMR stocks that were profitable last year and are still profitable today, it will take at least a 13% rally to keep multiples from actively declining. And since we know investors are willing to buy these companies at these valuations, more earnings translate to rising stocks. Contrast that to the S&P 500, where all the upside surprises so far this season haven’t been enough to generate positive growth.
While we aren’t dead set against stocks with fundamentals going in reverse (as long as the deterioration is transitory and there’s a good reason), we’d much rather have the trend on our side, especially when the market as a whole is still this close to record territory. Experience tells us that other investors will inevitably agree. Besides, even on stocks like mighty Apple (AAPL: $204, down 2%) where profits are temporarily depressed, the results are generally better than anyone suspected a few months ago.
The Carlyle Group (CG: $23, down 8%) provides a great illustration of what we’re seeing. We were braced to see barely 60% of the profit the company last year, but management held onto 83% of that historical cash flow after all. While neither scenario is ideal, the more drastic one was already baked into the stock, so it’s no wonder we saw a relief rally here before the trade war took it away.
Or take Twilio (TWLO: $134, down 11%), where what initially looked like a slight year-over-year profit decline evaporated, leaving shareholders with massive revenue gains without having to sacrifice a single penny in earnings per share. No earnings erosion means no multiple pressure. When the market recovers its equilibrium, fundamentals like these get rewarded.
We’ll calculate our multiples when the season is over and we suspect the growth-adjusted results will argue that BMR stocks still have room to rally without straining the historical limits. But first there’s one more big week and a few stragglers beyond that to see.
CBRE Group (CBRE: $54, up 1% -- all returns are for the week)
We rarely talk about this Stock For Success because it simply isn’t controversial. Every major corporate entity still needs Real Estate. CBRE does all the strategic work finding the properties, managing the physical plant and, increasingly, advising global enterprise how to get the most from every branch office and warehouse. As a result, in some quarters this company generates more than half of all profit growth throughout the Real Estate sector.
Last quarter wasn’t quite so overwhelming but that’s more a factor of the REITs catching up than CBRE hitting a wall. Revenue hit $5.7 billion, beating our $5.6 billion target by over $100 million and proving that the top line here is still moving 12% a year. About half of it now comes from fees as opposed to the brokerage commissions that built the business but were too dependent on deal flow to count on.
The more recurring advisory and outsourced property management fees CBRE can lock in, the more stable its results become and, if the Software industry is any guide, the happier Wall Street gets. Margins are improving as cash flow patterns become more reliable and management can adjust operations to create efficiencies. This time around, that $5.7 billion in revenue only converted into $277 million in profit, so there’s still a lot of room to improve.
We’re eager to see cost discipline give those margins a little relief. In the meantime, it’s hard to be unhappy when we only wanted $0.77 per share in profit and CBRE gave us $0.81. That’s 11% above last year’s levels, and in a season where most stocks are struggling to produce any year-over-year improvement at all, this is clearly one of the hot spots in the economy right now.
BMR Take: Subscribers who established a position on CBRE when it was still obscure back in 2016 barely needed three years to double their money. Again, that would be extraordinary performance just about anywhere else . . . it’s only when you weigh it against so many truly hyperbolic winners in our world that it becomes just another trade on the list. From here, management says margins are improving, so we could see that 11% profit growth rate turn into 14% by the end of the year. That’s easily 7 times the dynamism the market as a whole can provide. Our current $60 Target is not the limit.
Akamai (AKAM: $88, up 5%)
Finishing out our High Tech portfolio which we touched on last week, Akamai had a big week after the earnings beat. Revenue was up 6% YoY to just over $700 million, and EPS came in at $1.07, beating the market’s expectations by a healthy 7%.
Breaking the company down by division makes it look even stronger. The Web Division and Media Division both beat expectations, as did Cloud Security Solutions which came in at $205 million, on consensus expectations of $193 million. That’s huge, because it proves the company’s go-forward strategy is indeed paying off.
Akamai’s management has been transitioning away from low-margin business lines into higher-margins outputs. Cloud Security is a key driver of their future success, so it’s wonderful to see such a large beat in such an important area of the company. Look for more of the same as management continues to double-down on what’s working best.
BMR Take: The stock is up 50% YTD and has some serious momentum. A strong beat all around proves management’s thesis that transitioning away from its Web Traffic business line, and into higher-growth and higher-margin businesses. We’ve still got that $100 Target Price in place which we’ll leave for now, but we are raising our Sell Price from $65 to $77.
Facebook (FB: $189, down 5%)
Facebook is up a healthy 42% YTD, and has reached the peak attained prior to all of that bad publicity which sent the stock into the gutter during 2Q18.
Daily active users for 2Q19 rose to 1.6 billion, a 9% YoY increase (it’s hard to increase any more than that when you’ve got 20% of the global population using your product every single day). Monthly active users reached 2.4 billion – a full 1/3 of planet earth – also a 9% increase. Revenue reached $17 billion for the quarter, representing 30% YoY growth. Average revenue per user topped $7, a 15% YoY increase. So Facebook is growing both its user base, and the amount of money it makes per user – simply phenomenal.
Even better news for Facebook, the bears are starting to fade into the distance (and taking their anxieties with them). RBC just reiterated its ‘Outperform’ rating for the stock, citing a $260 price target. That’s a full $40 more than our current Target Price. The only thing that kept the stock down during 3Q and 4Q18 was the PR debacle which led to a mini-panic attack from investors. But all of that has subsided. Zuckerberg and co. have steadied the ship, and headline risk is already baked into the price. So it should be smooth sailing to new all-time highs from here.
BMR Take: These growth numbers would be impressive for a mid-cap stock, but for a $540 billion company? Facebook is on the march, and our $220 Target Price isn’t looking so far-fetched anymore. In fact, one more strong quarter and we’ll likely be raising our target after the stock surpasses it. Our Sell Price of $165 is hereby raised to $177.
Shopify (SHOP: $332, down 1%)
Shopify has gone straight up this year, producing a 150% YTD gain, with no end in sight. The company posted yet another fantastic earnings report, with 2Q19 revenue coming in at $362 million, for a nearly 50% YoY increase. The EPS of $0.14 trounced the market consensus estimate of just $0.02. Needless to say, the stock soared on the news, and the stock cracked its 52-week high of $340.
Looking at the breakdown, Merchant Solutions rose 56% YoY to $210 million, and Subscription Solutions grew 40% to $153 million. Everything keeps going right for this company. Management even guided full-year revenue above consensus estimates of $1.51 billion, predicting $1.51 on the low end and $1.53 billion on the high end.
Is there any reason to doubt the stock will keep going higher? The bears have nothing to say here (if there are even any left). Shopify keeps setting new all-time highs, and that trend will continue for the rest of the year.
BMR Take: The company continues to expand its user base as more small and medium-sized businesses leverage its capabilities globally. That’s what’s driving the astounding growth. Our $315 Target Price was left in the dust (thank goodness!), so we’re raising to $365. The old target of $315 becomes the new Sell Price, up from $280 previously.
Spotify (SPOT: $153, down 1%)
Spotify missed its paid subscriber numbers, which sent the stock down temporarily (it quickly regained its footing). We’re up over 40% YTD, and even the slow subscriber growth yielded some hopeful signs for the future.
Premium (paid) subscribers came in at 108 million for the quarter, just 500,000 below Wall Street’s expectations, a small miss. Half a percent was all it took to rock the stock (albeit temporarily). The good news is that total subscribers grew to 232 million, a full 5 million above Wall Street’s expectations. That gives the company an even larger-than-expected pool of free subscribers to convert to paid over the coming years.
Remember, Spotify is mid-transition into a holistic audio provider. The company recently purchased a pair of podcast services – Gimlet Media and Parcast – and has inked licensing deals with two of the four major record labels. The deals provide Spotify some pricing flexibility, as it can now deliver new services that are free from royalty payments back to the labels. This is a major feat, and will drive new revenue streams for the company moving forward.
BMR Take: The current focus of the company is on the product shift, not necessarily paid subscriber growth. That will come once all of the dominoes are aligned. In the meantime, the company is moving steadily forward, even as it transitions its business model. We see big moves ahead for both the company and the stock.
A Word From Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
Even though the Fed found room to cut interest rates, the economy remains robust. The Commerce Department reported last week that gross domestic product grew at an annualized pace of 2.1% during the second quarter, down from 3.1% in the previous quarter but still significantly faster than the 1.9% many economists had expected.
Then, while a lot of investors missed it, the all-important non-farm payroll jobs report on Friday came in roughly on track with expectations, with U.S. employers adding another 166,000 paid positions in July. This is a very good sign that the economy is still in a growth mode and a recession isn't anywhere on the horizon. Likewise, Consumer Confidence has averaged roughly 130 in the past twelve months, and this is a 47-point improvement from the prior eight years.
If you examine the pillars of the market, psychology is complacent. Workers who have jobs and incomes naturally feel that things are good. Fundamentals are a little mixed, reflecting the decline in both GDP estimates and future earnings forecasts. However, unemployment and inflation remain under control. While the technical situation shows resistance for the major indices, that’s really a day trader’s short-term concern.
And then there’s monetary policy, which is now more supportive than it has been since last September. This “insurance” cut may be what the economy needs to alleviate some trade dispute uncertainty and put growth back on a positive and accelerating trajectory. If nothing else, it will help cushion any shocks we see. Low rates have been supportive of markets as companies can easily and cheaply finance dividend increases and share buybacks. It’s also good for exporters straining under the weight of a strong dollar.
Admittedly, this is a bearish time of year, but the thing about seasonal factors is they only need a little patience to resolve. August is the worst month for the Dow industrials, S&P 500, Nasdaq, Russell 1000 and Russell 2000 over the last three decades, with average declines ranging from 0.1% to 1.1%. In pre-election years, however, August has been better, with modest average gains
What does all this mean? In our worst Fed scenario, we were looking for a 10% correction. Now the Fed has delivered and tariff talk has taken it away. However, we still have not only a healthy market but one of the best in the world. Going back to pre-recession 2007, it is remarkable to compare the U.S. market against that of Europe, China and Japan. With emerging markets at literally the same level today that they were back in 2007, investors in these markets have made no money.
Europe is trading 30% below its best 2007 level. Japan has gained 27% in these past 12 years, averaging 2.25% per year. Chinese investors are down a whopping 50% from 2007 levels. But U.S. investors who stayed in the S&P 500 all this time are up 150%, averaging about 8.5% per year.
Things are not nearly as bad in the U.S. as the media would have you think and, although volatility should be expected to rise over the coming year, the best course of action is to simply "stay the course" and let earnings continue to do the heavy lifting. Wharton's Jeremy Siegel summed it up a week ago when he said, "No recession, no trade war and lower rates will drive stocks higher.” That’s as simple as it gets.
Earnings Preview: Shutterstock (SSTK: $38, down 4%)
Earnings Date: Tuesday, 8:00 AM ET
Revenue: $172 million
Net Profit: $13 million
Year Ago Quarter Results
Revenue: $157 million
Net Profit: $11 million
Implied Revenue Growth: 10%
Implied EPS Growth: 3%
Sell Price: $35
Date Added: January 16, 2018
BMR Performance: -15%
Key Things To Watch For in the Quarter
Photographers have already embraced Shutterstock as a way to monetize their images and protect their rights. Now the company is increasingly all about giving film makers the same power over their stock footage. In a world where the ability to produce streaming video is within reach of every consumer with a relatively recent phone, demand for background material and documentation is only going to expand.
As a result, we’re holding out for the video service Shutterstock Select to keep driving the parent company’s overall performance. While we don’t expect big gains here yet on either the top or the bottom line, we do have a sense that the business is accelerating. Last quarter brought in only 7% revenue growth, so if the company hits our target we’re looking at the upper end of management’s guidance for the year as a whole.
By that point, little Shutterstock looks like it will be able to sustain a $700 million run rate and throw off $0.90 per share in annualized profit within six months. And once the video service starts getting momentum and scale on its side, we’re looking for dramatic earnings growth ahead. After all, the money has been spent and capital expenditures are now relaxing (down 50% from last year) so the hard part is over. If Shutterstock hits our growth targets, Wall Street is going to take notice.
The High Yield Investor
By John Freund
VP of High Yield
The Bull Market Report
This week let’s take a look at some Real Estate, starting with Vornado (VNO: $63, flat, Yield = 4.2%, including 66 cent dividend on Friday.) The stock is up 5% YTD, after a very choppy year so far. 2Q19 reflects that choppiness, with a mixed report overall. FFO – the key measure of healthiness for a REIT – reached $0.91 per share, which beat the market consensus by a cool $0.05, and beat the prior quarter’s FFO/share by a healthy 16%. However, revenue slipped 15% YoY to $463 million. That’s also less than the $535 million brought in during 1Q19.
Both of those metrics are important, but we find the FFO/share growth to be more impactful, especially given that 1Q19’s FFO/share decreased 3% YoY (not including a one-time $16 million accelerated stock vesting expense). If you exclude one-time costs from 2Q19 – namely, the write-off of rent receivables and equity compensation to new management hired – then Vornado’s $0.91 FFO/share would have been $0.98/share, or right on par with 2Q18. For the company to bounce back from -3% to even in terms of FFO/share growth signals a positive trend, and one worth sticking around for.
Remember, the long-term story here is the sustained growth of the Commercial Real Estate market in New York City (where 90% of the company’s assets are located). New York is the #1 market for Real Estate in the world with a diverse economy, low unemployment, high occupancy rates (97% by end of 1Q19), and durable, high-end retail that is immune to the Amazon retail-apocalypse. Much of Vornado’s listings are in the toniest NY neighborhoods – Fifth Avenue, SoHo, and the Upper East Side – and the company boasts clients as prominent as Harry Winston, Google, HSBC and Bloomberg. These are brands that are far more likely to double-down on office/retail space than they are to abandon shop.
Vornado also has four property developments which are slated to come online in the next two years, as well as several other redevelopment opportunities (one which it has already received approval for) to meet the growing tenant demand.
Same-store sales for Vornado increased over 4% YoY for the quarter. This signals the underlying strength of the New York economy. Rents are increasing, and tenants are willing to pay to stay in the most culturally dynamic and business-friendly environment in the United States. It’s very telling that job growth in NYC has consistently outpaced the national average over the last 10 years. Does anyone thing the next 10 will be any different?
Now that the Fed has lowered rates, the broader economic outlook is improving. And this is especially true for Real Estate, given that mortgages are becoming more affordable by the month. There’s also the possibility of the Fed continuing to reduce rates (as some theorize they will again this year). Vornado is primed to benefit, and we’re looking forward to the stock crossing the $70 mark like it did in November of last year.
Now for a slightly better earnings call from another REIT holding of ours. Equity Residential (EQR: $80, up 3%, Yield = 2.9%) posted positive FFO and revenue numbers for 2Q19.
FFO/share came in at $0.86, which was a penny higher than the consensus estimate, and a 6% YoY increase. Revenue rose 5% YoY to $670 million, about $2 million higher than analyst expectations. Management also raised its 2019 FFO/share guidance to $3.46 from $3.39. That’s a solid raise that illustrates management’s confidence in their ability to keep the FFO strong throughout the rest of the year.
Occupancy rates were 97% for the quarter, and same-store sales grew 4% YoY. During the quarter, Equity Residential purchased three new apartment properties with a total of 1,065 units for $375 million. The company also sold two properties totaling 560 units for $400 million.
With a $30 billion market cap, Equity is either the largest or second-largest (depending on the day) residential REIT in existence (AvalonBay Communities is the other). Led by industry titan Sam Zell, the company is among the most renowned in the industry. Management’s strategy of targeting urban Millennials in up-market locales is paying off, as the aforementioned earnings results illustrate. The company has over 80,000 units in dense, walkable, urban or suburban areas thriving with both business and lifestyle opportunities. Equity has primarily focused on major urban metropolises like New York, Boston, Washington, D.C. and San Francisco, but recently also expanded to second-tier, up-and-coming cities like Denver, Stamford and Fort Lauderdale.
The genius of this strategy is that it targets a growing population of income-producing renters. Millennials are getting married later in life, and therefore renting for longer and longer periods. 40% of Equity’s residents are singles, and the median age for an Equity resident is 33. Only 15% of residents are over the age of 50. This youth-oriented focus builds brand loyalty as well. Equity’s services are top-notch, which is why their same-store sales were able to grow in an otherwise tepid Real Estate market. Much like Vornado, Equity focuses on premium-quality properties, which are relatively immune to the swings and sentiments of the broader Real Estate market.
The stock is up 27% YTD, and nearing its 2015 all-time high of $82. While the yield isn’t especially high, it still offers a nice buffer in case things turn south. But the stock has already surpassed its pre-4Q18 peak, and we’re nearing uncharted territory (that’s a good thing). We are expecting Equity to break through the all-time high ceiling any day now, and continue on its upward trajectory throughout the rest of 2019.
One final REIT we’re taking a look at this week is New Residential (NRZ: $15.37, down 1%, Yield = 12.9%). The stock is “only” up 7% YTD. We put “only” in quotes, because that’s typically not bad for a REIT midway through the year, however this year the industry has been crushing it (Equity Residential’s 27% YTD gain is a perfect example). That said, New Residential offers a 12.9% annual yield, which gives us a double-digit return so far in the year, so we’re not complaining.
New Residential is an interesting case, because the REIT actually performs better in a rising-rate environment. When interest rates are rising, people are loathe to refinance their homes, which means the company – as a mortgage servicing company – can extend the lifeline of its product (the right to service those mortgages). Now that rates have come down, the likelihood of a refinance increases, which is actually a bad thing for the company.
The earnings call wasn’t the best either. Net interest income decreased 30% YoY to $188 million, although core earnings increased about 7% from the prior quarter to $220 million. CEO Michael Nierenberg highlighted the focus on book value ($16.37) and originations. New Residential acquired the right to service $53 billion of unpaid principal balance during 2Q19 alone. The company is by far the largest non-bank holder of mortgage servicing rights (MSRs) in the world, and actually pioneered the space as a standalone business.
Given the Fed’s rate reduction, management is right to focus on book value and originations. Now is the time to consider adding to your position, since margins are being compressed by the rate reduction. And there’s no shortage of MSRs out there, as banks continue to offload this product year after year, in order to keep up with regulations imposed by Dodd-Frank.
The company has also been diversifying into traditional mortgage-backed securities (MBS). New Residential purchased $275 million of non-agency MBS during the quarter, and we expect this trend to continue as management seeks to diversify its holdings during this period of lower interest rates. Over 30% of the portfolio is comprised of call rights, which increase in value as interest rates decline, so this presents a nice hedge against the impact to the core business from a rate reduction.
And last but certainly not least, New Residential is among the best Mortgage REITs in the world when it comes to distribution coverage. The company paid 94% of its earnings out in dividends in 2Q19, the same as in 2Q18. That’s a nice 6% cushion of core earnings to cover shareholder obligations. The company has covered its dividend with core earnings in every single quarter over the last three years, and didn’t even need to cut the dividend when the yield curve inverted. Now that’s saying something.
Ultimately, New Residential faces some slight headwinds here, but a quarter-point reduction in the Fed funds rate isn’t enough to shake our confidence. Management is focused on the right go-forward strategy, and the core business is still a powerful one, and remains unmatched by any competitor. All of that, plus the enormous dividend is rock-solid. What more can you ask for?
Todd Shaver, Founder and CEO
The Bull Market Report