The Week Ahead
It was a week of ups and downs last week, with the Nasdaq up big, due to Apple and other Tech, and two out of the three major indices ending flat. There is clear confusion. World class investors at the Delivering Alpha Conference hosted by CNBC in NYC this week could not even agree which way the market is heading. While volatility has started to rise, we believe the moderation that was seen toward week end reflects a wait and see attitude surrounding what the Fed will do next week at their meeting. The probability for a rate hike is only 20%, but we are bracing for a potential surprise, as the Fed needs to prove to the market that it will hike rates, counter to low market probabilities, in order to demonstrate that they are leading the market and not the other way around. With all the volatility and uncertainty, we continue to stress top quality stocks as the place to be.
Here is How Last Week Progressed:
Monday (9/12) – S&P 500 +1.8%
— Markets rallied after Friday’s big selloff. Goldman Sachs issued a report calling for last week’s bond market selloff, triggered by UK concerns and Japan monetary policy, to extend into the 4th quarter, with US Treasuries reaching 2% by year-end (currently 1.69%).
— In Energy, a ratings agency issued a new report discussing how recovery rates for 15 US exploration and production bankruptcies averaged a “catastrophic” 20% last year, well below the historical average of 60%. (So out of those that go bankrupt, lenders are getting back just 20 cents on the dollar vs. 60 cents. Not good.)
— In Financials, Wells Fargo (WFC: $45, down 7% last week)admitted to secretly creating millions of bank and credit card accounts over the past five years without their customers’ knowledge or consent. An entire arm of the bank was fired over the matter and the stock is down sharply.
Tuesday (9/13) – S&P 500 -1.5%
— Monday’s recovery turned wobbly as concerns of general global economic conditions are increasing.
— The Delivering Alpha Conference in NYC hosted some of the brightest and richest minds in investing. Billionaire Paul Singer issued cautionary words for the path ahead discussing how it’s a very dangerous time in the global economy and global financial markets, adding that gold was under-represented in investors’ portfolios. Billionaire Ray Dalio warned that the current environment is analogous to the 1935 to 1945 period in America where we reached the limits of central banking’s ability to stimulate the economy and raise global asset prices.
— A US think tank warned that Australia has about six weeks or so to turn their situation around or face a massive hit to property valuations.
— Another Fed president has decided to call it a day. President of the Atlanta Fed Dennis Lockhart announced he will be stepping down on February, 2017.
Wednesday (9/14) – S&P 500 -0.1%
— Markets stood still.
— Goldman Sachs issued reports reducing their odds for a hike next week to 25% from 40% previously.
— CNBC hosted numerous conversations about the volatile mechanics of the stock and bond markets simultaneously selling off over the past week.
— In Healthcare, an undercover investigation by the Government Accountability Office found that 100% of their fictitious enrollees were able to sign-up and maintain Obamacare coverage and taxpayer subsidies despite submitting fictitious documents and/or refusal to submit any documentation at all.
Thursday (9/15) – S&P 500 +1.1%
— The morning began with news of the biggest German M&A deal in history. Monsanto accepted Bayer’s takeover offer for $66 billion creating an agriculture giant.
— More concerns about markets soon followed. Former Fed Chairman Allen Greenspan made public comments discussing how this is the worst economic and political environment that he has ever been remotely related to, noting that the U.S. is headed toward stagflation. New data soon after the statement confirmed Greenspan’s concerns.
— Year-over-year growth in Retail Sales rose just 1.9%, which represented the weakest level since March’s plunge and is now worryingly in historical recession territory.
Friday (9/16) – S&P 500 -0.9%
— Market performance was soft into the weekend. In Autos, just weeks after warning that sales had reached a plateau, Ford is now warning investors that operating profit will fall in 2017 and as a result the company is relocating small car production to Mexico.
— In Transportation, bankrupt shipping giant Hanjin said that as of this morning it had 93 vessels, including 79 container ships, stranded at 51 ports in 26 countries.
— Gearing up for next week’s Fed meeting, former Fed leader Ben Bernanke was out with some noteworthy comments foreshadowing the future path of interest rates in the US – negative! Specifically, he said, “The fact that negative rates would be temporary and deployed only during severely adverse economic conditions, would be an advantage. Like quantitative easing, which was also unpopular in many quarters, a period of negative rates would probably be tolerated by politicians if properly motivated and explained.”
Bull Market Report Companies and Commentary
Microsoft (MSFT: $57) Microsoft is a high quality bellwether. Recent reports indicate that channel partners* see strong business trends for the company’s Cloud product, Azure. Azure is a key pillar of expected EPS growth embedded in consensus forecasts. Accordingly, it is a good sign to hear that Azure is on track with expectations.
* A channel partner is a company that partners with a manufacturer or producer to market and sell the manufacturer’s products, services, or technologies, usually done through a co-branding relationship. Channel partners may be distributors, vendors, retailers, consultants, systems integrators (SI), technology deployment consultancies, and value-added resellers (VARs) and other such organizations.
To be more specific, channel partners are seeing strong sustained growth for Microsoft Cloud products, with a couple of partners underscoring a pronounced uptick with respect to Azure. One partner recently observed a renewed push by Microsoft to make inroads into the federal government vertical with its government Cloud. Lastly, a few channel partners referred to overall softness in their legacy Microsoft practices, partially driven by a faster-than-expected transition into the Cloud. This should be read as good news. Basically, the use of office desktop products is slowing because companies are transitioning to the Cloud.
We like that trend. We are fine with the legacy Microsoft business declining if the customers are moving to the Microsoft Cloud. It’s quicker and better, and a higher valuation is applied by the Street for the Cloud versus the desktop business
While Microsoft’s Azure product faces fierce competition from Amazon’s comparable AWS offering, one channel partner noted that Microsoft’s head start in the market with Office 365, along with their inherent long term relationships in Enterprise IT gives Microsoft a slight advantage in the Cloud space as compared to Amazon.
In fact, there is currently talk of an enormous energy conglomerate that has physical data centers in multiple countries which they are finding incredibly difficult to manage and scale and hence is thinking of moving to a Cloud infrastructure model. While this company has engaged both Microsoft and Amazon, the company appears to have a preference to go with Microsoft Azure because of the long standing relationship with Microsoft. This case study reinforces the storyline that Microsoft has created enough of a reputation now so that Amazon doesn’t seem like the only company in the public Cloud space.
BMR Take: The Cloud business is booming. Microsoft’s Azure product is recording revenue growth of greater than 100% a year. Channel partners are suggesting momentum is building. We view Microsoft as a high quality portfolio holding with an attractive dividend yield and substantial upside ahead.
Facebook (FB: $128) Weak sentiment surrounding the stock presents a buying opportunity. Facebook has delivered three consecutive quarters of 60%+ ad revenue growth, with an acceleration in four of the past five quarters. Street estimates have an upward revision bias with the 2017 consensus EPS having increased 35% so far this year. The overall lack of enthusiasm is reflected in the lower forward PE multiple and creates an opportunity.
One debatable topic right now is ad growth. Despite management’s caution on the 2Q16 earnings call, ad loads still have room to increase. Ad loads are a less significant growth driver of EPS estimates than many appreciate. Street estimates now call for slowing ad load growth to around 10% this year and actually declining in 2017-2018. Though there are several levers for management to focus on to drive improvement. For example, the company is currently working on ad targeting, relevancy, formats, and profitability in ways that don’t alter the user experience. Facebook still has opportunity ahead for ad load growth despite the recent near term headwinds.
Another debatable topic right now is engagement. Despite a small sequential drop in 2Q16 daily and monthly active users across all regions, the overall ratio of daily to monthly active users remains steady at 66%, which highlights the stickiness of the customer base. Moreover, Facebook’s share of US mobile Internet time of 13% is 2x greater than Snapchat, Twitter, Instagram combined, which highlights how healthy engagement remains. Recent product changes such as prioritizing friends and family in the Facebook and Instagram feeds and the launch of Instagram Stories may acknowledge shifting usage and increased competition, at least in certain demographics, but we expect Facebook to remain innovative on products. We are not concerned about a slight slowing of engagement.
BMR Take: We think weak sentiment surrounding ad growth and engagement presents a buying opportunity. Street price targets are as high as $170, framing the compelling upside potential. We added the stock in February at $97, and we are approaching our Price Target of $140. We are pleased.
Tesla (TSLA: $206) Tesla released an Autopilot update announcing advanced signal processing capabilities for its radar, which can now act as a primary control sensor and does not require the camera to confirm visual image recognition. It is just another sign of the transformational shift in auto manufacturing, where Tesla is leading the way,
Digging into the new technology a bit, the software upgrade collects more data in order to better determine the risk of a collision and prevent unnecessary braking. All very exciting stuff. In fact, just in the past few days at Ford’s annual investor day, Chairman Bill Ford acknowledged that “the technology is here in the world of autonomous driving, but there are a lot of things to work through and we have something to learn from every competitor [inferring Tesla]”. This was quiet the notable endorsement for the direction Tesla is heading.
Note that Robert W. Baird set a $338 price target on Tesla on Monday. FBN Securities upped their price target from $260 to $275 and gave the stock an outperform rating. Morgan Stanley reaffirmed an equal weight rating and set a $245 price target. Six research analysts have rated the stock with a sell rating, 13 have a hold, 10 have a buy rating and two have assigned a strong buy to the company. The consensus target price is $253.
BMR Take: We view the AutoPilot announcement as a positive that shifts focus back to Tesla’s core competitive advantage as a leader in the development, distribution, and monetization of ground-breaking automotive technologies. With that said, we await more news of the Gigafactory progress; the progress of the integration of SolarCity into the future of Tesla; and how in the world they can deliver on the 400,000 orders for the new Model 3 (for which they received $400 million in cash from the down payments.) These are the big picture items. And again, Tesla is RISKY. The stock could go to $400 in the next year or two, or it could go to $70. Or both. This one is volatile and not for the faint of heart.
Visa (V: $82) We have seen some big headlines in the stock market in recent weeks, but this company just quietly continues to perform. We want to be sure this stock doesn’t fall off your radar.
There are several catalysts that appear to be pushing stronger top line revenue growth including improved cross-border volumes, new deal wins (Costco, USAA), price increases (adds 100 bps to the growth rate), and accretion from the Visa Europe deal.
On cross-border volume, Visa is optimistic about improving trends as oil and the stronger US dollar comparables ease. Visa isn’t seeing any pricing pressure on cross border fees and is seeing significant growth in online commerce (the growth of digital grows at double the rate of offline). Cross border is 6-7x more profitable than domestic transactions.
Another big opportunity coming out soon is their entering the China market. Although there is no specific timeline yet, there is a big future opportunity to process Chinese domestic volumes and more Chinese cross-border transactions. In fact, some analysts size the opportunity to be $3 billion of revenue by 2020. Currently, Visa is focused on adding-single branded Visa cards to the Chinese market, while the cobrand relationships move towards expiration.
BMR Take: Visa is a very steady business model and a proven stock. The global opportunity to convert cash to electronic forms of payments remains lucrative. We continue to view this stock as a long term core holding.
Qualcomm (QCOM: $63) With all the news out on the Apple iPhone 7 launch, we can’t overlook the implications to Qualcomm. Eyes are on the Intel baseband share of the iPhone 7 business because the remaining share falls to Qualcomm.
Multiple reports have surfaced claiming to be able to discern the amount of share that Intel has taken in the iPhone 7. It is a bit premature to make a pronouncement on this, given that Apple is likely only slowing letting Intel into their phones. Either way, the impact is confined to only a 65% subset of iPhones that are non-CDMA* capable. Moreover, it is very likely that Apple is very slowly introducing Intel into the product line, considering recent major disruptions others in the industry have experienced, like with Samsung’s recent migration to a new chip stumbled.
*CDMA stands for code division multiple access, which is a channel access method used by various radio communication technologies. It often determines what network (Verizon, AT&T, etc.) your iPhone will work on).
To be clear, Qualcomm is expected to continue to hold 100% share in CDMA capable smartphones. According to industry estimates, CDMA capable smartphones represented 30% of total iPhone unit volume over the past 12 months and 35% in the 2nd quarter. As referenced above, the 65% of 2Q unit volume that was not CDMA capable is where Intel is possibly taking share. Some more aggressive expectations presume Intel may take the lion’s share of this 65% bucket. However, more in-depth analysis from industry experts points out that it is entirely possible that even where Apple is using Intel they may also be using Qualcomm in the same model. Bottom line, the Intel versus Qualcomm market share discussion in the iPhone remains pure speculation at this point, but is a must-watch trend going forward.
The most important trend to watch, however, is overall smartphone demand which remains strong.
BMR Take: We continue to like the prospects for the Apple ecosystem, which includes Qualcomm. Moreover, shares look attractive here with a 3.3% dividend yield. Qualcomm is a cash machine riding the smartphone wave to higher levels.
Home Depot (HD: $126) Management was on the road these past two weeks meeting with investors. Several favorable takeaways on the business surfaced. The Western part of the US continues to see strength, as Home Depot attributes it to more than just a California story, with a mini Silicon Valley forming in the Northwest states and great momentum around this build out. Phoenix is also improving and they believe there is a strong upside to the market based on how much there is left for that housing market to appreciate to reach the prior peak. Home Depot generates 1/3rd of its sales in the West.
Management highlights that the Pros customer base (professionals) are a little less price conscious given that they want to be able to know their costs and seem to have less patience for following promotions. Recall that 40% of sales is generated by the Pro customer.
Lastly, management noted that their second half guidance is not just based on the strength of the housing market but also feedback from the Pro customer base; that the project pipeline is strong for at least the next six months. Management noted that the Pros are taking vacations for the first time in years based on the healthy labor market.
BMR Take: Solid trends are seen over at Home Depot. The implications are good for the broad economy and stock market. We continue to favor this blue chip.
Gilead Sciences (GILD: $79) We thought we would give you some news on recent upgrades and research reports have been issued on Gilead. A large bank in Germany issued a buy rating and a $112 price target on the stock. Barclays reaffirmed an overweight rating. RBC Capital Markets set a $105 target price on Gilead and gave the stock a buy rating. Morgan Stanley has a price target of $103. Nine research analysts rate the stock with a hold, 18 have a buy and two have issued a strong buy rating on the company. The company has a consensus rating of Buy and a consensus price target of $105.
Gilead last posted its earnings results on July 25th. They reported $3.08 EPS for the quarter with revenue of $7.8 billion. On average, equities analysts predict that Gilead Sciences will post $11.80 for the current year.
The business also recently announced a quarterly dividend, to be paid on September 29th. The $1.88 annualized dividend produces a yield of 2.4%, paying out just 17% of earnings. There is plenty of room for growth in the dividend here.
Hedge funds and other institutional investors have recently added to their stakes in the company. Norges Bank acquired a new position in Gilead valued at about $1.3 billion. Bank of Montreal acquired a new position in Gilead Sciences during the second quarter valued at $430 million. Capital World Investors boosted its position in Gilead Sciences by 28% in the second quarter. They now own stock valued at $1.3 billion. Investec Asset Management acquired a new position during the first quarter of $280 million. Finally, Parnassus Investments CA boosted its position by 45% in the second quarter. Parnassus now owns $700 million. 78% of the stock is owned by institutional investors and hedge funds.
BMR Take: The stock has a market cap of $102 billion and a price-to-earnings ratio of 7. The stock is grossly undervalued and we expect the stock to go back to the triple-digit level late this year or next.
Upcoming Economic News
It is a very light week for economic news. The focus will be on the FOMC statement out Wednesday. The probability of a rate hike is just 20% with >50% odds that a hike will not occur until December. But who knows! Yellen now has Bernanke in her corner prescribing possible negative rates.
Under Armour Update:
Kevin Plank, CEO and Founder of Under Armour (UA: $39) announced that he will be selling 2.1 million shares of stock starting in October. A subscriber wrote in and asked our opinion of the situation, as he thought this was a bad thing.
Here’s what we wrote back:
“Hi Samuel –
“We generally don’t mind if executives sell stock. Plank currently owns 34 million shares of the company’s Class B stock, 135,000 shares of Class A stock and 34 million shares of Class C stock, representing 65% of the voting power in the company. So 2 million shares is a small part of his holdings. He is just diversifying.”
That’s how we feel. Of course, we secretly wish we had 2 million shares to sell of our own, and we admire Plank and all the others that have created all of the amazing companies out there, like Amazon and Facebook and Google, and so on. This is America. The entrepreneurs and the risk takers shall reap the rewards. Again, we would not even blink a negative eye over this CEO selling a small part of his stake in the company. Bill Gates has been selling 20 million shares a quarter since 2002. Wow. And we still love Microsoft.
THE APPLE CORNER
Apple had a great week. The stock was up $12, or 11%, closing at $115. I hope you are listening to us here at The Bull Market Report as we’ve been pounding the table on Apple for months! The stock saw its strongest four-day streak in over two years and is destroying short sellers who bet against it. The newest fuel was Apple’s announcement that initial quantities of the iPhone 7 Plus have sold out globally. Sprint said sales set records, far out-pacing sales of the iPhone 6 two years ago. That sent the stock up 3% on Thursday, after a 3% rise on Wednesday.
It was the strongest 4-day percentage increase since 2014, when Apple shot 13% higher over four days after the company increased its share buybacks and announced better-than-expected quarterly result.
Apple was responsible for much of this week’s gains in the Dow Jones Industrial Average. If Apple had been unchanged this week, the Dow would have been down 0.1%, instead of the 0.2% gain it recorded.
Apple on Tuesday made available new software (at no charge) for iPads and iPhones bringing huge enhancements to Messages, Maps, Siri, Photos, Apple Music, News, and more. This is what customers love about the company. And this is what WE at The Bull Market Report love about the company.
BMR Take: The stock trades at a PE of 14 times its past 12 months of earnings compared with 20 for the S&P 500. Will we see new highs ($134) in the stock by Christmas?
Good Investing,
Todd Shaver
Editor in Chief