The Weekly Summary
The week after a market holiday is usually frenetic and this one was no exception, packing at least five days of volatility into an abbreviated calendar. Relief was the strongest note driving the S&P 500 and our stocks up close to 2%, with news that China has agreed to participate in trade negotiations in October cutting through the global clouds.
Closer to home, August job creation numbers were decent . . . a little lower than some hoped, but well within the range that usually reflects an ongoing economic expansion. We're a long way from recession territory even though corporate hiring plans remain on hold while the world waits for the trade war to resolve. In the meantime, any slippage in the job market will strengthen the Federal Reserve's argument to keep lowering interest rates in the absence of inflation.
We're less than 10 days from the next Fed meeting now. If we get the 0.25% cut most investors expect, it probably translates into roughly a 3.5% bump up for the S&P 500. Catch the market mood in the right place and that's going to take stocks back to record levels. It's hard to complain about that.
There’s always a bull market here at The Bull Market Report! The Big Picture this week provides more detail on which sectors are getting all the money on Wall Street these days. (Hint: it isn't about growth or value.) Gary Jefferson of UBS takes a contrarian posture this week by wondering about the recession triggers the China-obsessed media doesn't see, while The High Yield Investor digs into developments at our Private Equity recommendations.
Our tour of the BMR universe finishes the Special Opportunities (Dollar Tree and the US Energy ETF) and moves on to Technology, where some of our most spectacular successes are worth a second look. That's right, this week we need to raise a few Target Prices as stocks like Roku, Shopify, Akamai and Facebook defy the flat market mood. Who said Technology was dead money these days? Finally, we wrap up 2Q19 earnings season with a preview of what Zscaler will bring us Tuesday night.
Key Market Indicators
BMR Companies and Commentary
The Big Picture: The Sector Map Spins
With earnings stalled across the S&P 500 as a whole for the past nine months, most of the market activity this year is best interpreted as Wall Street’s effort to pivot to match changing investment priorities. Popular growth sectors are currently out of favor as their expansion hits a wall. And with defensive themes already looking rich, there isn’t a lot of “value” around in the traditional sense.
However, a month from now the pendulum can easily swing again, pulling cash away from today’s hot spots and pushing it back into areas of the market that don’t look attractive at all. We’ve seen it play out again and again over the year so far and will undoubtedly see the cycle continue until clear leadership emerges.
Cut through the cycle and one thing is clear. Investors fleeing declining yields in the bond market are hunting replacements for lost income, parking money in dividend-paying stocks instead of rolling it into newly issued Treasury debt. They don’t want to take on a lot of additional risk in the process, so only the safest economic havens have benefited.
Over the last 12 months, the Utilities are up 15%, which is a staggering rally for a sector that rarely moves at all. We haven’t bothered with these stocks for two reasons. First, our more growth-oriented recommendations have done much better. Second, the Utilities don’t actually pay much. Dividends across the sector only added up to 4% a year ago and now that the stocks have rallied they don’t even pay 3% a year. That’s not worth locking in.
Similar logic carries to the Consumer Staples and Real Estate sectors, both of which have rallied 13% over the last 12 months. We love Real Estate because the yields tend to be much higher and a year ago the stocks were deeply depressed. Where are the REIT bears now? We don’t hear them.
Otherwise, it’s been a dull year for the market. Technology has gained ground because that’s where the long-term growth is. Consumer Discretionary stocks have also done well because that’s where Amazon is. And Communications is all about Social Media stocks recovering from a terrible 1H18. Healthcare, Materials, Industrials, Financials and especially Energy have all suffered.
Again, this isn’t about relative growth or value. Healthcare, for example, had a huge 2Q19, with the sector as a whole reporting 9% stronger earnings than what we saw the previous year. That’s usually a catalyst to push the stocks into a rally. This time around, the group went nowhere. The Financials told a similar story.
For the long term, the Financials are also extremely attractive on a pure earnings basis. The big Banks and Insurance carriers are still growing at a healthy 5% rate, but as long as the yield curve is unsettled few investors want to go near the stocks. The sector barely commands a 13X earnings multiple now, half what we see in most other areas of the market. Energy doesn’t look much stronger. They’ll recover, but until they do, we see little point in widening our sector-weight Special Opportunities exposure to either group, no matter how “cheap” they look today. (We’re not fond of that word.)
So what does this mean? If you tried to capture growth this year on a sector level, you’ve been disappointed. Our strategy of selecting the right stocks regardless of sector has paid off a lot better. BMR recommendations have climbed 20% over the past 12 months. And while we're heavy on Technology, that sector as a whole has been no prize. Going all over the market map has given us the freedom to outperform. We're looking forward to more, even if the market as a whole keeps grinding its gears.
Dollar Tree (DLTR: $110, up 8% -- all returns are for the week)
Finishing off our Special Opportunities portfolio from last week, Dollar Tree has had its ups and downs over the last year but 2Q19 was very strong. Revenue ticked up 4% YoY to $5.75 billion, which was $20 million more than we expected. EPS beat expectations by a penny, coming in at $0.76. And perhaps most tellingly, comparable (same store) sales rose 2.5% for the quarter, with both the Dollar Tree and Family Dollar brands turning in positive performance.
The story with Dollar Tree has been the lack of turnaround for Family Dollar. Management has insisted that restructuring is on the verge of turning that pivotal quarter, and with the latest comp sales news for Family Dollar, this finally looks to be the case. Same-store sales were a full 25% above market expectations, which illustrates that the Family Dollar turnaround is moving quicker than anticipated.
Management accomplished that goal by adding a $1 Dollar Tree-style section to 550 of its Family Dollar stores. Called the ‘H2 Model,’ management attributes a 10% increase in year-over-year sales at Family Dollar to this rollout. The company will now roll out H2 to 1,000 of its nearly 8,000 Family Dollar stores by the end of the year.
BMR Take: While the China trade war does impact the company, management is working hard to avoid passing on higher costs to the consumer. That said, there is actually a silver lining here. As prices at other Retailers rise, it will drive more customers to Dollar Tree in search of bargains. So Dollar Tree is primed for continued success in any economic environment going forward. Now that the Family Dollar turnaround is in full swing, expect the stock (already up 21% YTD) to continue its upward trajectory for the year.
US Energy ETF (IYE: $32, up 3%)
The final stock to cover in our Special Opportunities portfolio is up only 4% YTD, which actually isn’t bad considering the heavy hit the Energy industry has taken this year thanks to the dual headwinds of heavy supply and anxiety over a global economic slowdown. While we want all positions to make money all the time, diversifying into an Energy ETF protects our downside risk while still providing us exposure to the sector should things manage to turn around. The 3.2% yield helps a lot.
Domestic oil production is rising, which is sending crude prices lower. Throw in the China trade dispute and anxiety over a recession (we think overblown), and you have some serious downward pressure on prices. That said, all of this has been baked into the cake for some time, which is why this fund is currently trading at a five-year low. It would take a massive economic shock to send it any lower, which is why we are comfortable looking ahead to what will eventually be rosier times for the sector.
BMR Take: We want to maintain exposure to Energy in case the China trade war ends abruptly. (Very possible, the two sides are on the edge of negotiating as we speak.) Plus, any drawdown or disruption in production from either OPEC or Russia will impact prices, as will any positive news for the global economy. Essentially, the market has priced in a worst case scenario. Anything above that low bar will put the stock in positive territory for the year.
Akamai (AKAM: $92, up 3%)
Now let’s move on to our High Tech portfolio, which has been experiencing some equally impressive gains for the year. Akamai is up a sensational 50% YTD.
Akamai operates a Content Delivery Network (CDN) that helps businesses reduce the time it takes to deliver Web Pages to their customers worldwide. Roughly 20-25% of all Internet traffic globally is delivered through an Akamai CDN. However, over the last several years, the company has been ramping up its Cloud Security business line, which now makes up nearly 1/3 of its annual revenue. Data security is a hot sector at the moment, and one that BMR highly recommends. (Our picks such as Splunk, Okta and Zscaler illustrate our commitment to this growing space.)
And Akamai is also committed to growing its Cyber Security portfolio. The company recently acquired cloud identity management platform Janrain, which will help bolster its product line. During 2Q19, cloud security revenue increased over 30% for the company, to $205 million. Core products such as Kona and Prolexic are holding up well and new offerings such as Bot Manager are making an impression with customers.
Overall, the company produced 6% YoY revenue growth during 2Q19 to $705 million. All of the various divisions produced positive YoY increases, and operating margin also impressed us by coming in at 29%, one percentage point higher than we expected.
BMR Take: The stock is at its all-time high for a reason. We are reiterating our $100 Target Price here. With a strong spate of products, diversification into cloud security, and a dominant foundation in its core CDN business line, Akamai is a stock worth investing in for the long run.
Facebook (FB: $187, up 1%)
Speaking of companies of the future, there’s Facebook, which is actually both a company of the present and future, as the $520 billion company has rebounded a phenomenal 40% YTD. With about 1/3 of the world on the platform, Mark Zuckerberg can make a serious dent in any industry he chooses to operate in. Take this week’s announcement that the company plans to diversify into the Online Dating space. Users already have a platform that connects their likes, hobbies, political leanings, geographic locations and everything else that a matchmaker might take into account. Don't forget, Facebook owns Instagram, where users can swap photos easily before even meeting on their first date. It’s small wonder, then, that the top Online Dating stocks all plummeted on news of Facebook’s entrance into the market.
Meanwhile, lost in the above news was the announcement of Facebook’s partnerships with European publishers looking to put out video content. Facebook also has a video-friendly platform, which it hasn’t yet even attempted to accelerate. But why couldn’t Facebook target YouTube with content sharing? The company seems to be inching in that direction as well.
And of course, Facebook is looking to turn the cryptocurrency market on its head with the introduction of its own token, Libra. The company just hired a pair of powerful lobbyists to work wonders in Washington and beyond. Again, with its vast user base, Facebook can disrupt any industry it touches. So why not touch Finance and Banking? If Libra is even remotely successful, it could send this company into the stratosphere.
BMR Take: A year ago, Facebook was facing a host of PR concerns over privacy and user data. While still very much an issue, it’s no longer top of mind for investors. Zuckerberg and company have done a magnificent job of assuaging user anxiety while at the same time diversifying into an array of industries that will help shift the business model away from advertising and pure data collection. We’re expecting the stock to crack that $200 mark again soon and we’re reiterating our $220 Target Price.
Roku (ROKU: $170, up 12%)
It’s not often we can say that a stock has returned nearly 500% YTD, but that’s exactly what we can say about Roku. This stock has been everything we imagined and more as investors flock to this company which sits primed to take advantage of the ‘cord-cutting’ revolution.
Roku provides access to the various digital content providers like Netflix, Hulu, Amazon Prime and even its own proprietary programming. With Millennials cutting the cord on cable TV at record rates, Roku sits at the forefront of a content delivery revolution. Last quarter, the company reported over 30 million active users, up 40% YoY.
2Q19 was another fabulous one, with revenue coming in at $250 million for a 60% YoY gain. EBITDA rose 56% to $11 million and average revenue per user increased $2.00 from the prior quarter to over $21.00. The company also added 1.5 million new subscribers during the quarter.
Remember, Roku provides access to multiple content providers, so the more that enter the space, the merrier. In fact, the more cluttered the space gets, the more valuable Roku becomes as a standalone device which can access every major content provider. Who wants to surf their Internet browser and go from Amazon to Netflix to HBO Go to Hulu when you can find them all on one single platform? That's Roku.
BMR Take: Roku has been our best-performing stock all year and there’s no reason to see that changing by year-end. We can’t seem to raise our Target Price fast enough with this stock, so here we go again, raising our Target from $125 to $205. And the Sell Price moves up from $95 to $130.
Shopify (SHOP: $380, down 1%)
Last but not least, this E-Commerce platform is up nearly 175% YTD and a full 385% for BMR subscribers who have been here since early 2017. We see very reason for the good times to continue through the end of the year.
Management made some big announcements recently. First, there was the launch of Shopify Business Chat and Apple Pay. This allowed merchants to respond to customer questions via a button on their page while customers can now pay directly through the chat bot. Then the company followed that up with the launch of their first native chat feature. Shopify now offers its merchants a free means of communication with their client base via Android, IOS device or laptop. This makes it that much easier for businesses to sell to clients and retain new customers, which in turn boosts Shopify’s own sales and retention rates.
Not that sales need any sort of boost at the moment. 2Q19 revenue was up nearly 50% YoY to $360 million. EPS came in at $0.14, a full $0.12 above analyst expectations. Is it any wonder the stock keeps setting new all-time highs?
Both subscription solutions and merchant solutions grew YoY, the former by nearly 40% and the latter by 56%. And that subscription growth was driven by a monthly recurring revenue increase of 34% YoY to $47 million. This is a company that knows how to acquire new customers while retaining and upselling the ones it currently has. Shopify even raised its 3Q19 revenue guidance to $377-$382 million, well above the $374 million we expected. The full-year forecast was also raised to $1.51-$1.53 billion, which beats our $1.47 billion estimate.
BMR Take: In addition to the new product features, the company is expanding geographically. Shopify Payments is now available in 13 countries and Shopify Admin just added 11 new languages, for a total of 18. The company also has plans to invest $1 billion in a network of fulfillment centers across the U.S. There’s growth across the board here, not least of all with the stock. Our $365 Target Price has been surpassed. (Love it when that happens.) We’re raising it to $450 and maintaining our $315 Sell Price. Shopify has been one of our best stocks of the year and we’re confident that will continue through the remainder of 2019.
A Word From Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
Looking back for the past year ending in August, the DOW is up about 1%, the NASDAQ down about 1% and the Russell 3000 is up about 1%. That’s not a great year, but at least the numbers are positive. The S&P Small Cap 600 and S&P Midcap 300 are down 15% and-6.5% respectively.
Even if you only owned the S&P 500, you are up a mere 2.9%. We think a major reason for this "lost" year is that the market priced in the "tariff war" that began last year with China, Japan, Mexico, Canada and Europe. Favorable agreements have been struck with all these trading partners except for China and the market has acted positively so far this year albeit it with an extreme amount of volatility.
We don't expect a communist dictatorship will act anything like the other democratic world trading partners and, if we had to speculate, China's trading strategy revolves around waiting out President Trump's term. Thus, it seem to us that the tariff conflict has been priced into this market for quite some time and is only stirred up when the media decides that China, alone, should be a ball and chain on every attempt to rally stocks.
The market knows this. It is important to remember that all of this tariff turmoil has been priced in against a backdrop of a strong economy, with full year GDP on pace for 2.6%, which is stronger than the average annual GDP of this entire decade-long expansion. So where does this leave everything? At the moment, credible arguments can be made for both a strengthening economy as well as a weakening economy.
There is a very distinct and palatable difference between a recession-caused bear market and a stock market correction unrelated to a recession. At this point a recession will be the most telegraphed slowdown in history, with every investor preparing for it even as we speak. That's not good news for them. Most of the time, when most of the experts and investors are all on the same side, they get it wrong.
This is why remain alert for possible triggers of a recession or serious trouble for stocks that are not at the top of everyone’s talking points. While we have been keenly aware of the non-farm payroll and ISM Producers Index numbers, as well as the consumer confidence number and yield curve inversion, we will also be watching a few other scenarios that have contributed to past recessions like government regulation and risky mortgages.
What? Worry about government regulation when President Trump has cut more regulations than the past four presidents combined that literally helped jump start this economy? It would be the regulation of the Technology giants that would worry us. Microsoft, Alphabet, Apple, Facebook and Amazon make up 50% of the tech sector and about a quarter of the entire U.S. stock market. That's a huge amount of clout.
But there is rising concern and skepticism about ways Tech companies make money by collecting data on your daily activity, interests and even movements. They've already started regulating the sector in Europe with the enactment of the General Data Protection Regulation, or GDPR, that sets all kinds of controls, standards and fines on tech companies. This is an area we will keep an eye on and, fortunately, there doesn't seem to be a gathering storm in the U.S. quite yet.
Another worry would be a repeat of the ridiculous subprime " NINJA" mortgage loan fiasco that triggered the 2008 financial crises. Borrowers took out $45 billion in subprime loans last year, the highest number since just before the 2008 crises, and in the 1st quarter of this year took out double the amount taken during the same time last year. This is a trend to watch.
Bottom Line: With the China trade war so widely discussed, we think the risk is priced into asset prices, so we want to be alert to little known or discussed factors that could harm the economy if they got materially worse. Regulation of tech and subprime loans are on our radar. China is priced in.
Earnings Preview: Zscaler (ZS: $64, down 7%)
Earnings Date: Tuesday, 5:00 PM ET
Revenue: $82 million
Net Profit: $2 million
Year Ago Quarter Results
Revenue: $56 million
Net Loss: $1 million
Implied Revenue Growth: 46%
Implied EPS Growth: flip from loss to profit
Sell Price: $68 (temporarily relaxed)
Date Added: July 30, 2019
BMR Performance: -25%
Key Things To Watch For in the Quarter
As far as we’re concerned, this stock has been a victim of investors’ rotating appetites and not any fundamental weakness in its business model. Enterprise data networks remain congested and prone to opportunistic intrusion, which feeds demand for next-generation security and speed. Since Zscaler has one of the most sophisticated Cloud Computing security platforms, it’s no shock to see a lot of that demand going in this direction.
Management’s guidance remains robust. They told us three months ago that revenue was tracking at around $82 million for the quarter, so that’s reasonable place to set the bar. We’re happy to see the top line moving 46% over the past year, but realistically speaking anything better than $80 million keeps the company above the breakeven point. Zscaler has already proved that the business can generate profit at this scale. Now it’s simply a matter of reaching for larger scale and the efficiencies that come with it.
Furthermore, management made a great observation on the previous conference call, noting that Zscaler wins customers looking generate immediate return on investment on the cost side. These solutions help companies stretch their computing budgets, which makes them a natural fit for a less confident economic environment. As the world slows down, this business actually speeds up.
But in a cloudier world, investors aren’t letting hope write a lot of checks. Little companies like Zscaler (and most of our Aggressive recommendations) look like miracles when the S&P 500 as a whole has stalled. Their growth rates provoke a healthy level of skepticism . . . we need proof that management can back up their cheerful talk. Over and over last quarter, we saw these companies deliver that proof, only to suffer when the news hit Wall Street in a fragile twist in the trade war.
When even perfection isn’t good enough, the only thing to do is circle your wagons and wait for the mood to improve. That’s why we kept Zscaler around below what would ordinarily be our $68 Sell Price. Unless we see that the fundamentals truly support the recent slide, this stock will rise again when Wall Street is ready to think rationally about some of the fastest-growing companies around.
After all, Zscaler isn’t burning cash at this stage. This is no speculative story that will take years to achieve sustainable profitability. All we need here is for revenue to remain steady and the company can operate for the foreseeable future. Given the subscription-based business model, we suspect very few accounts will drop out from month to month. The sales team will be able to replace those that do or get remaining customers to spend more money. Retention is tracking just under 120%, which means that once you’re on the platform, you’re more likely to allocate more of your budget to Zscaler than quit.
This quarter also presents that sales team with unusually difficult year-over-year comparisons. Last year Zscaler booked a $16 million deal out of nowhere. That success is unlikely to be repeated this time around, although it if happened, we’d be among the first to cheer.
The High Yield Investor
By John Freund
VP of High Yield
The Bull Market Report
This week, we’re going to take a look at a pair of Private Equity stocks that have been outperforming the broader Finance sector. Both stocks have already been benefitting from the flight of institutional capital away from Hedge Funds shuttering their doors after years of lackluster returns coupled with extremely high fees. All of that institutional capital has to move somewhere, and as the Fed slashes rates, Private Equity firms that directly invest in the economy are the logical place for the money to go.
Blackstone Group (BX: $50, up 1%, Yield = 3.8%) has had a fabulous year, up 74% YTD. The company is a $60 billion fund complex with four main business lines: Real Estate, Private Equity, Credit and Hedge Fund Solutions. The long-awaited conversion into a C-Corp from a limited partnership structure is huge. Many mutual funds and institutions are prohibited from investing in partnerships, which means the shareholder base has been artificially limited here. Granted, it’s much easier and less costly to report as a limited partnership, but breaking down shareholder walls naturally increases demand for Blackstone stock.
Earnings have grown 14% over the last five years, which is just enough to keep the dividend intact and rising. Five years ago, Blackstone distributed $1.39 per share across a 12-month period. Last year that payout came in at $2.07. Assets Under Management (AUM) is the key to this business. Firms like Blackstone earn fees on money other investors place with them, so the bigger the assets, the more cash gets captured. Management has a goal of running $1 trillion in total outside assets by 2026. That goal is looking more and more realistic as the years progress.
The company already has $550 billion in AUM, which is a 24% YoY increase for 2Q19, and with $45 billion coming in during the quarter, the math tells us that management is right on track to meet its goal. There are 26 quarters left until the start of 2026, so Blackstone would only need to take in a little over $17 billion more per quarter than goes out to hit the $1 trillion target. The company has brought in a record $150 billion over the trailing 12 months, and as the pace picks up we expect continued massive flows for several more quarters. We wouldn’t be surprised if Blackstone is sitting on $700 billion in outside capital by the start of 2021.
One of the ways Blackstone has been racking up the AUM is by generating new, forward-looking business lines. The company has aggressively diversified into industries such as Insurance, Life Sciences, Infrastructure and numerous Real Estate segments. As Blackstone establishes a footprint in these emerging industries globally, it has room to deploy more capital, which means it can raise more money from outside. One of the challenges of Private Equity is properly deploying capital in portfolio companies. You can’t simply raise money and have it just sit on the sidelines. So new markets create more flexibility in terms of deployment. As an example, the company recently announced the purchase of a U.S.-based industrial warehouse network from a Singaporean company for nearly $19 billion, the single largest private Real Estate transaction in history.
Don't get anxious over the fact that the stock is currently trading at its all-time high. This is a fundamentally solid company riding a wave of industry and macroeconomic tailwinds that give investors every reason to be excited about the future. We are reiterating our $52 Target Price and are on the verge of raising it once Blackstone crosses the mark. With the Fed on the cusp of another rate cut, that should happen sooner rather than later.
Much of what we just said about Blackstone applies to The Carlyle Group (CG: $25, up 8%, Yield = 6.0%). Carlyle also benefits from the flight of institutional capital from Hedge Funds as well as from the Fed’s impending rate cut. And given that the company is in the midst of a record $100 billion fund-raising round that management expects to actually be oversubscribed by 20%, shareholders will benefit from a fee income surge in the foreseeable future.
Carlyle is much smaller than Blackstone at only $8 billion in market cap and $223 billion under management. However, AUM is climbing fast and much like Blackstone, Carlyle also recently announced its C-Corp conversion, which will be fully implemented by 2020. The company also sold $425 million in debt to buy back preferred stock. Interest on the note is 3.5% and at a yield of 6% the decision to borrow to retire dividend-paying stock immediately makes sense.
Like Blackstone, the company has its fingers in a lot of pies globally. One example is Addison Lee Minicabs, a private taxi company based in the UK. Carlyle purchased Addison for under $400 million in 2013 and now values the company at over $1 billion. An IPO could be on the horizon. These are the kinds of big moves that major funds can make. They spot opportunities to pick up valuable companies globally, enhance their value through excellent managerial decision-making and then either sell the company or take it public, capturing internal cash flow in the meantime.
The stock is up 62% YTD. Not quite as much as Blackstone, but who’s complaining when the yield is so much higher? A 6% yield is awfully hard to come by when you're dealing with companies this large and mature.
At a time when the rest of the Finance sector has been struggling, Blackstone and Carlyle have been crushing the market. The S&P index is up 19% YTD. Carlyle more than doubles that, Blackstone more than triples it. Both stocks have been very good to us and we suspect the rest of 2019 will be more of the same. Strong fundamentals plus heavy tailwinds equals every reason to stay invested here.
Todd Shaver, Founder and CEO
The Bull Market Report