The Weekly Summary
We hope you had a happy Thanksgiving break. The market definitely gave us plenty of reasons for gratitude, with BMR stocks jumping nearly 2% across an abbreviated 3.5-day week. Once again, compared to the S&P 500, we're outperforming as the stocks Wall Street neglected over the autumn heat up again.
Technology gained close to 3%, as did our core Stocks For Success portfolio. Our Aggressive recommendations jumped about 4%. If not for Dollar Tree's post-earnings remorse, the Special Opportunities would have joined them in the scoring zone. (We still like Dollar Tree as we pointed out in our News Flash. It's simply the victim of rotation right now as our Aggressive stocks were three months ago.)
And every week of outperformance drives substantial long-term returns. The BMR universe is now up 42% YTD, a full 17 percentage points better than the S&P 500. Even counting the stocks we've removed along the way, our recommendations have soared 35% in the last 11 months. Put that in context: Every 10 percentage points represents a typical year of profit for the market as a whole. That's a literal victory lap and there are still four weeks left before 2020 rolls around.
There’s always a bull market here at The Bull Market Report! The High Yield Investor expresses our gratitude for a few of our favorite dividend stocks while Gary Jefferson fills in some numbers on how returns across Wall Street have been distributed . . . and why a great 2019 doesn't necessarily translate into happy investors. We also need to provide Earnings Previews for Salesforce and Workday, which report tomorrow afternoon. When they're done, our cycle is almost over.
The Big Picture looks ahead to the remainder of 2019 and the start of 2020. Finally, it's time to turn to the Healthcare portfolio for our quarterly review. While these stocks are normally considered "defensive," some have turned into true powerhouses. We're pleased with all of them.
Key Market Indicators
BMR Companies and Commentary
The Big Picture: Looking Forward
What are we excited about in these remaining weeks? For one thing, there's always the chance that we'll see a breakthrough on trade. While President Trump's support for dissidents in Hong Kong is unlikely to make Beijing happy, it's probably not going to make a trade deal any less likely. Negotiations simply need to continue in order to keep hope alive. As it is, simply delaying the next tariffs due to take effect on December 15 (just two weeks from now) will come as a huge relief.
But for now, the U.S. consumer is alive and well. Early numbers from Black Friday show that Retail is holding up better than we expected. The dollar is strong even as the Fed cuts interest rates. The yield curve has healed a bit.
Commodity prices remain subdued and the world is relatively quiet, minimizing the odds of an inflationary shock to the global system. We could even get additional tax relief in the new year. And we're three months closer to Corporate America's next chance to show us real year-over-year earnings expansion. Even though 2019 has been great for stocks, the rally has stretched valuations a little. More profit will help rectify that situation and give the market real room to rally.ga
AstraZeneca (AZN: $48, up 2% last week)
AstraZeneca has been on offense all year long. The stock is up close to 30% YTD, which is excellent for a Healthcare company with a market cap of $125 billion.
The company has been benefitting from a strong drug pipeline and consistently good news coming from the FDA and the company’s testing facilities. Recently, the FDA approved Calquence, a treatment for chronic lymphocytic leukemia in adults. After positive results from two phase-3 clinical trials, which showed that Calquence reduces the risk of disease progression, the drug became one of the first approved under the FDA’s new Project Orbis, whereby international partners can review and approve oncology medicines in tandem with the FDA. That means a much faster time-to-market globally for Calquence, which means accelerated top-line for AstraZeneca.
The FDA also recently approved a marketing application for Selumetinib, a drug that targets a rare pediatric disorder. AstraZeneca is on a roll here. Meanwhile, type-2 diabetes drug Qtrilmet was approved by the European Commission. Diabetes is a growing problem in the EU, and this drug was approved in the U.S. earlier this year, and is expected to perform well globally.
Looking deeper into the drug pipeline, Imfinzi and Farxiga each look like powerhouses in the making. The former achieved positive results from a Phase 3 clinical trial targeting patients with non-small-cell lung cancer. And the latter showed cardiovascular benefits after a Phase 3 clinical trial. So each of these drugs could be major winners for the company down the line.
On the financial front, the company had a stellar 3Q19. Revenue of $6.1 billion improved 16% YoY, with gross margins increasing by 1% to a very healthy 80%. EPS came in at $0.99, over 40% better than the $0.71 reported during 3Q18. Oncology led the way with sales growth of 50% YoY, including 82% overall sales growth for blockbuster drug Tagrisso, which ballooned in emerging markets, with over 100% YoY growth there.
On top of all of that, the company is launching a $1 billion fund aimed at investing in Chinese Healthcare startups. China is the world’s second-biggest market for Healthcare (and growing). The fund is a joint venture between AstraZeneca and China International Capital, and has already raised capital from significant investors like Sequoia Capital.
BMR Take: AstraZeneca has so much going for it, it’s difficult to pick just one bright spot. All of the FDA approvals and successful trials point to a strong drug pipeline. Tagrisso’s $2.3 billion in YTD sales, plus Imfinzi’s $1 billion+ in YTD sales are what’s driving current revenue. And with $850 million in sales, Lynparza is on the verge of becoming another blockbuster. The stock is creeping up on our $50 Target Price, so expect us to raise very shortly. We’re raising out Sell Price from $36 to $44.
Eli Lilly (LLY: $117, up 1%)
Lilly’s story this year has been much different from AstraZeneca’s. The stock reached an all-time high of $132 back in March, but tumbled after investors grew anxious the stock was overbought. Since the summer, the stock has been on a bumpy ride, but is now creeping back up again during 4Q19, and is back into positive territory (up 2% YTD).
There are some encouraging stories here, underscored by Taltz, the psoriasis treatment in pediatric patients. 90% of patients in a recent Phase-3 trial achieved at least a 75% improvement, and 80% achieved perfect or near perfect results. That positions the drug as superior to Abbvie’s Humira drug, which is a mega-blockbuster. Humira has generated $115 billion in global sales since its launch in 2010. If Taltz can outperform Humira, the sky is the limit for Eli Lilly.
The loss of Cialis patent exclusivity clearly hurts. The company’s U.S. sales was flat this past quarter at just over $3 billion, which has everything to do with Cialis copycats hitting the market. That said, Trulicity, Taltz, Emgality and others are still going strong, so the loss of Cialis’ exclusivity was offset, and didn’t create a drop in YoY U.S. sales. Total international sales grew 8% YoY to $2.4 billion. Trulicity, Taltz, Olumiant and Jardiance are all growing globally, which is lifting overseas sales.
On the financial front, 3Q19 was a mixed bag, with revenue of $5.5 billion coming up short of expectations by a mere $20 million. That said, at only a 3% YoY gain, we can see why there has been tepid buying from investors. EPS of $1.48 beat market estimates by $0.07, and is up 22% YoY. That includes an extra 2% in operating costs this past quarter, thanks to some increased investments in the late-stage drug pipeline. Net income rose nearly 10% to $1.2 billion.
BMR Take: All in all, 3Q19 wasn’t the best earnings report, thanks to the revenue miss, but not the worst either. Lilly has a lot going for it, including the aforementioned Taltz positive data, the global growth story, as well as U.S. approval for Reyvow, which treats migraines. The company is also investing $400 million into a manufacturing hub in Indianapolis, which will boost capacity for future drug production. While we’re not happy with the performance thus far, we are hopeful the stock will continue its upward swing throughout what’s left of this year. The 2.2% yield adds a little extra onto your return, but the real story is the future growth potential. With the Taltz news and continued international sales growth, there’s no reason Lilly can’t get back into the $130 range in 2020.
Exact Sciences (EXAS: $61, up 4%)
Although it’s off over 30% from the 52-week high, Exact Sciences is still up 30% YTD, which makes it a winner vs. the S&P. The company’s at-home colorectal screening product, Cologuard, was the first-ever FDA-approved stool screening DNA test for colon cancer. The Center for Medicare and Medicaid Services (CMS) even suggested a coverage determination on the same day FDA approval was granted, which is a first. That’s how innovative this product is.
3Q19 revenue of $220 million was up an astounding 85% YoY, and EPS of -$0.31 beat market estimates by 10 cents (the company is still operating at a loss, as the story here is market share and revenue growth). And what a growth story: Cologuard has already been used by over 3 million people globally, and the product has only been on the market for five years. 3Q19 also saw 12,000 new Healthcare providers order their first test of Cologuard. That brings the total since launch to 185,000.
The company recently announced a partnership with Mayo Clinic, in order to generate evidence of the real-world impact of Cologuard. 150,000 people will enroll in the Voyage study, which will make it one of the largest colorectal cancer screening studies ever conducted. We like this news, because the more people learn about Cologuard, the better. The product continues to fly off the shelves, and the company hasn’t even saturated market awareness yet. Plus, 95% of patients pay nothing out-of-pocket for the test, thanks to insurance coverage. We are a happy customer and were quite happy that Medicare picked up the bill. Cologuard is revolutionary and will only grow in popularity as the years progress.
The stock took a hit after the 3Q19 earnings release, simply because they kept full-year guidance in line with previous estimates, and the market had been expecting a bump higher. Essentially, there was so much enthusiasm for this stock that the second a single hole was poked, much of the air came rushing out and the balloon deflated. That said, we view this dip as a buying opportunity. The stock is back down to the same level it was at in late January! Does anyone really think – after the year Exact Sciences had – that this stock is where it is before the previous three earnings calls? We absolutely don’t think so. It’s only a matter of time before the stock bounces, and sends Exact Sciences back above the $100 mark.
BMR Take: It’s rare that you’re disappointed with a 30% YTD gain, but with Exact Sciences, we believe the stock should be much higher. The selloff boils down to investors getting antsy over the meteoric rise, coupled with some profit-taking. But we’re confident both the company and stock will continue to impress. Cologuard keeps growing in popularity, and it’s only a matter of time before the stock rebounds from the sell-off.
Johnson & Johnson (JNJ: $137, flat)
Like Eli Lilly, Johnson & Johnson has had an up-and-down year, ultimately landing at a disappointing 7% YTD return. Of course the 2.8% yield nearly puts you in double-digits for the year, but we were expecting much more from this Healthcare stalwart.
The stock did crack the $140 mark several times over the summer, but has struggled to regain its footing since. We believe the company has enough going for it that the stock can return to that level. A big factor holding it down at the moment is legal risk – with both the pelvic mesh and opioid claims causing downward pressure on the stock. The company has already agreed to pay out just over $100 million to settle multiple claims throughout the U.S., and just lost another pelvic mesh claim in Australia.
Meanwhile the company is on the hook for $465 million in the opioid claim, with potentially more probes and litigation on the way. While no one knows the final cost of all claims, the end result will more than likely be a small part of overall revenue. That said, the market is averse to uncertainty, so any legal risk here will weigh down on the stock in the short term.
There’s good news in the drug pipeline, where Darzalex was just approved by the European Commission for multiple myeloma treatment in the EU. Additionally, the company is looking to promote its Invokana drug to adults with heart failure. This comes on the heels of blockbuster drug Xarelto winning FDA approval to treat blood clot patients. Xarelto keeps expanding its sales and its reach, with recent FDA approvals expected to add as much as $1.5 billion in annual sales over the coming years.
3Q19 sales of $21 billion reflects 2% YoY growth, and while EPS decreased 54% to $0.66, that has everything to do with the aforementioned legal claims, which took a chunk out of earnings.
BMR Take: Johnson & Johnson is an industry stalwart, and one of the all-time great American companies. With a dividend as rock-solid as they come, the company represents the ultimate defensive play. In that sense, banking a 10% total return isn’t bad, considering the company is much more stable and dependable than most – even in the Healthcare space. That said, we’re always looking to beat the broader market’s return, and J&J won’t accomplish that this year. Regardless, every investor should own a piece of this company, as doing so protects one’s downside risk in case of a pullback or recession, and there is plenty of upside once the legal troubles are firmly in the rearview.
A Word From Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
Last week we alluded to the fact that, in spite of the daily "new highs" reported in the market, stocks still have room to keep moving higher without any real worry of reaching bubble territory. Still, we were very surprised to read the performance numbers for some of the largest and best known ETF index funds over the past one-year period ending this October.
It's been a great 2019 for stocks but the end of 2018 was such a precipitous correction that a lot of areas of the market are still recovering. Since last November through the end of October, the S&P 500 is up only 4.2%. Value stocks are up only 3.5%. Mid-Cap stocks are down 2.5%. The Russell 2000 is down 9.0%. The Healthcare sector is down 3.7% and Biotech stocks have plunged a whopping 22.0%.
In other words, if an equity investor owned anything other than the right large caps, it's likely their portfolio is still negative and has been for about a year. (However, November has shaped up to be one of the best in decades.) That is a long way away from entering bubble territory. Last year's stealth bear market took a giant bite out of overall market valuations and investors need to keep that in mind before believing any media commentary that stocks are way overvalued at today's levels.
As we head into yet another investing year, we like to remind ourselves about the importance of being a "long-term" investor. We heard from a Wall Street manager over the weekend who said, "I honestly can't think of a strategy I haven't experimented with, but now Wall Street is dominated by algorithms and high-frequency traders." He then went on to say, rather cynically, "The way I see it, there are only three ways to make money on Wall Street: trade on illegal insider information, hold for a trillionth of a second or hold forever." We all know the first two are jokes, but the last one has a lot of truth to it. The way we view it is that holding forever is tantamount to being a long-term investor who remains invested in the market to some degree at all times. History clearly shows that investors who remain in the market during their working careers have always made money.
While we are certainly not advocating a "buy it and forget about it" discipline, having a fully diversified portfolio and being a long-term investor is still the best strategy for achieving one's financial goals and objectives. Investors who panicked and sold out last year missed a strong bull move this year and are going to have a very difficult time trying to get back to "even."
Waiting for that "perfect" moment to get back into the market has never – and we submit will never – be a strategy that works. Thus, don't let the media or emotions affect your decision to be a long-term investor. Despite the inevitable disappointments and setbacks, we believe an investor who remains a "long-term" investor will ultimately end up a successful investor.
Earnings Preview: Workday (WDAY: $179, up 4%)
Earnings Date: Tuesday, 5:00 PM ET
Revenue: $920 million
Net Profit: $91 million
Year Ago Quarter Results
Revenue: $743 million
Net Profit: $74 million
Implied Revenue Growth: 24%
Implied EPS Growth: 20%
Sell Price: $197 (temporarily suspended)
Date Added: November 27, 2018
BMR Performance: 29%
Key Things To Watch For in the Quarter
Workday was a $226 stock in July and while it's recovered 17% in the last five weeks, there's still a lot of work left to do in terms of restoring investor appetite for high-growth stories. That's what this earnings report can do and it's why we've suspended our Sell Price in the meantime. We simply see zero reason to sell as long as management keeps delivering on all its promises.
On that level, the number we really want to see is subscription revenue, which forms the foundation of the company's business model because it's reliable and recurring. Once an enterprise customer becomes a subscriber, the money keeps coming in, month after month and quarter after quarter. Workday has told us to look for around $785 million on that side. As long as it hits that target, Wall Street will come around.
Earnings Preview: Salesforce (CRM: $163, flat)
Earnings Date: Tuesday, 5:00 PM ET
Revenue: $4.4 billion
Net Profit: $600 million
Year Ago Quarter Results
Revenue: $3.4 billion
Net Profit: $477 million
Implied Revenue Growth: 30%
Implied EPS Growth: 8%
Target: $190 (up from $170)
Sell Price: $145 (up from $135)
Date Added: October 11, 2018
BMR Performance: 16%
Key Things To Watch For in the Quarter
Salesforce is always a juggling act in terms of expectations. Management is usually conservative on guidance, especially on the revenue side, but the outlook never makes any assumption about how well the company's $1 billion strategic investment portfolio is doing. As a result, our targets are probably close to reality on the top line and low when it comes to earnings per share. This time around, the fact that management confirmed guidance (and even raised) a few weeks ago gives us added confidence.
All we need is a little upside from any of the 300 start-up companies in the Salesforce Ventures portfolio and the bottom line will give us a beat. Otherwise, we're looking for the MuleSoft software development acquisition to finally weigh in on year-over-year comparisons, which will slow the formal growth rates from that side of the company while giving us more clarity on what's really going on from unit to unit.
And "Remaining Performance Obligation" is the critical metric we look at in the long term. That's the amount of work Salesforce has contracted to perform but hasn't translated into revenue yet. It's the equivalent of a service-dominated company's order backlog or "pipeline," giving us a sense of how much cash is left to flow before the sales team needs to sign any new deals at all.
Salesforce has $25 billion coming to it. That's up 20% from last year and it gives us 18 months of clarity. Anything better will force us to raise our growth targets. That's why we love this company.
The High Yield Investor
By John Freund
VP of High Yield
The Bull Market Report
On this Thanksgiving weekend, let’s look at the three stocks in our High Yield Investor portfolio that we’re most thankful for.
The first two are no-brainers, and they’re both in the same industry, so we’ll cover them together. They are Blackstone and Carlyle Group They are two of the three largest Private Equity (PE) companies in the world – Blackstone is the clear industry leader, with Carlyle and KKR often swapping places for second and third-largest. Blackstone is up a sensational 80% YTD, and Carlyle is up an even more sensational 88% YTD. Those are fantastic returns for any stock, but especially fantastic for a pair of Financial Services companies, given that the sector typically doesn’t move that aggressively.
As we’ve written about before, PE is benefitting from the current climate of institutional capital fleeing the high risk and poor returns of the hedge fund world. All of that money has to go somewhere, and it’s flowing into PE at the moment, with beneficiaries like Blackstone and Carlyle raising record amounts of capital. One of the ways PE companies make money is by earning fees on their AUM, so the more money these firms can raise, the more revenue they earn in fees.
Blackstone (BX: $54, up 6%, Yield = 3.6%) management has a goal of $1 trillion in total AUM by 2026. And that goal is very much in reach. 3Q19’s AUM reached $550 billion, for a 21% YoY increase. That includes over $20 billion of new inflows for the quarter, spread across the companies four main business lines: Real Estate, Private Equity (PE), Credit and Hedge Fund Solutions. There are now 25 quarters left to the start of 2026 (including the current 4Q19), which means Blackstone only needs to take in $18 billion per quarter in net AUM (inflows minus outflows) to hit their $1 trillion target. This is very achievable, especially for a company of this size and scale, its experience and expertise, and with their level of brand awareness.
One of the ways Blackstone has been racking up 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 sectors. As Blackstone establishes a footprint in these emerging industries globally, it has room to deploy more capital, which means it can raise more assets. To that end, the company recently announced the purchase of a U.S.-based industrial warehouse network from a Singaporean company for nearly $19 billion. That constitutes the single largest private Real Estate transaction in history. Blackstone also recently announced a $400 million investment into a joint venture with Swiss Pharma company Ferring, to develop an experimental gene therapy for bladder cancer. That represents the company’s largest foray into drug development.
And Blackstone isn’t the only one making big bets. Carlyle (CG: $30, up 3%, Yield = 4.5%) is in the midst of a record $100 billion fundraise – the largest ever for a pure Private Equity fund. Management expects the fundraise to be oversubscribed by 20%, which means the company could end up with $120 billion to put to work. That’s a lot of fees, and plenty of opportunity for Carlyle to generate some serious returns going forward via its global investment strategy.
In 2013, Carlyle purchased Addison Lee Minicabs, a private taxi company based in the UK, for about $400 million. Management now values the company at over $1 billion, and is actively looking to take Addison public. The company also purchased Fortitude Re, a reinsurance company, from industry giant AIG. They have plans to make Fortitude a standalone, independent company. And not to be outdone by Blackstone, Carlyle is forming its own Healthcare joint venture – this one with Cannae Holdings. The JV will acquire and operate Healthcare service companies in the payer and provider sectors. With Carlyle in the midst of that mega-$100 billion fundraise, expect more of these types of strategic acquisitions in the near future.
The flight from hedge funds isn’t the only thing benefitting PE at the moment. With the Fed cutting interest rates, the broader economy is picking up steam (the stock market setting record highs is a perfect example), and that benefits these two companies because as PE firms, they own portfolio companies which rely on the strength of the broader economies of the world. The Fed is widely expected to continue its rate reductions, which means the private companies that both Blackstone and Carlyle invest in are operating in a promising economic environment.
There’s one more key issue that has benefitted both stocks markedly, and that’s the switch from a limited partnership structure to a C-Corp. That’s not an immaterial transformation, given that many investment entities like ETFs and certain endowments are prohibited from investing in partnerships. Switching over to C-Corp status enables more liquidity for the stocks, which many investors have long been waiting for. The companies hesitated, because it makes reporting trickier (and the switch is cost- and labor-intensive), but that said, the juice is certainly worth the squeeze as at least part of the stock surges this year for both companies can be chalked up to the C-Corp transition.
Both companies had a strong 3Q19. Blackstone posted revenue of $1.7 billion, which beat expectations by a cool $430 million. The revenue figure was 10% lower YoY, however PE is one of those rare industries where the YoY comparisons don’t really matter, because revenue generation is ‘lumpy,’ meaning one quarter the company can post an enormous revenue haul, and the next quarter can see revenue come in much smaller – that’s simply how the business model is designed. The key here is the consistent AUM growth, which we touched on earlier, and the fact that management is beating Wall Street’s expectations. The same is true of Carlyle, which posted $770 million in 3Q19 revenue, for a whopping $250 million beat (or about 30% higher than consensus expectations). For what it’s worth, 3Q19 revenue came in 13% higher YoY.
With all of the positive tailwinds that PE is currently riding, plus the terrific numbers being posted by both of these companies, it isn’t hard to see why Blackstone and Carlyle are the two stocks we’re most thankful for in this year’s High Yield Investor. The third stock we’re thankful for comes from a totally different industry – Healthcare REITs. Although not as impressive as our PE stocks, Omega Healthcare Investors (OHI: $41, up 3%, Yield = 6.3%) has had an excellent year, especially given that the company is coming off of a turnaround.
As we’ve written numerous times, two of Omega’s operators fell into financial distress last year, with one going bankrupt and the other needing a line of credit to stay afloat. Omega’s crack management team – arguably the best out of all global REITs – stepped into immediate action. They transferred the bankrupt operator’s properties to other sections in their portfolio, and sold off the remaining assets which were underperforming. They also leveraged their stellar credit history (Omega has been very conservatively run for years, with minimal debt/equity) to obtain favorable financing from their bank, thus enabling advantageous terms on the credit line to the struggling operator in need.
All told, management got the job done faster than anyone expected, and what many thought would be a rebuilding year turned into a proactive growth story. In early January, Omega announced the purchase of MedEquities Trust, and the deal closed in May for $620 million. It is rare for Omega to make a Healthcare REIT purchase – in fact, the company has only done so twice before. Omega’s management team has decades of experience, and is as rock-solid as they come, so if management went out and purchased MedEquities on the back of a restructuring year, we’re confident the company will see some serious accretion from this deal. CEO Taylor Pickett has already announced that the deal will provide Omega an opportunity to expand certain properties. That’s the advantage of being helmed by a terrific management team – they can tighten their belts when the going gets tough, then come out swinging as soon as opportunities present themselves.
Omega had a stellar 3Q19. Revenue came in at $233 million for a 5% YoY increase, and FFO/share met expectations at $0.76. The company also boosted its full-year FFO guidance by a penny to $3.06. With a 21% YTD gain, plus that over 6.3% annual yield, Omega has impressed this year with its turnaround effort and the stock is looking primed for continued upside with the new purchase and the strong financials.
Our overall Bull Market Report High Yield portfolio certainly gives us a lot to be thankful for this year, and when it comes to the High Yield Investor, Blackstone, Carlyle and Omega top our list of stocks we are most thankful for in 2019.
Todd Shaver, Founder and CEO
The Bull Market Report