by Scott Martin | Jun 2, 2024 | Weekly Newsletter 7pm Sunday
Market Summary
The Bull Market Report
The last two weeks were a tale of one stock. We spent a few days waiting for NVIDIA (NVDA) to release its quarterly results, leaving Wall Street almost literally breathless in the meantime. Then we watched money crowd into NVIDIA after the SEC filing, swelling the stock to lofty levels ($2.7 trillion, more than the entire German market). And finally, investors tired of scrutinizing this AI giant found a distraction in the form of a potentially threatening uptick in bond yields. We're happy we have NVIDIA in our High Technology portfolio. It's already soared close to 140% in the last six months for us.
But we'll never be satisfied with exposure to just one stock, no matter how strong it is in the moment. If that were the case, we'd have cut everything but Apple (AAPL) or Berkshire Hathaway (BRK-B) long ago, and had to live with the day-to-day consequences of that decision. In our world, a balanced portfolio of themes will win in the end. When Technology is triumphant, we have plenty of those stocks scattered around our universe. When Silicon Valley hits a wall, our Financials or Energy or Real Estate holdings tend to benefit as the pendulum of sentiment swings in their favor. And throughout the cycle, our High Yield recommendations keep paying dividends.
How has that paid out for us in the last two weeks? NVIDIA obviously did extremely well on its own, but its success sucked all the air out of the Technology portfolio and cut big holes into our results in the Stocks For Success and Long-Term Growth portfolios as well. Only mighty Apple managed to rise above the tide on the Stocks For Success side. First Solar (FSLR) was an absolute triumph and helped buoy Long-Term Growth. See below.
What's more interesting is the way the Early Stage recommendations were split between a 12% gain in the past two weeks for C3.ai (AI) and a 12% loss from Recursion Pharmaceuticals (RXRX), leaving the portfolio neutral for the period. A lot of our portfolios sat out the NVIDIA cycle close to neutral. This was a non-event as far as they were concerned. Now that Wall Street's attention has moved on, we expect them to recover their momentum and get back to work.
For now, this was a "rebuilding" period for our stocks. The Dow Industrials lost more ground but the Nasdaq, overweight NVIDIA as it is, held up better than the BMR universe in the aggregate. That's okay. Ordinarily our "equal weight" system for accounting for our performance plays out in our favor. This time, the single standout name was so strong (and nearly everything else was so tentative) that only portfolios that were heavily concentrated in NVIDIA managed to do well. One way or another, earnings season is over. It was a good one. We can afford to let the AI giant hog the spotlight. After all, we own it too.
In our view, bond yields are a sideshow. They sting, but the real story is what the Fed said two weeks ago. It's going to take serious pain in the Treasury market to feed back into our stocks. And get serious: that kind of pain in the Treasury market is not going to entice smart investors to pull their money out of stocks and flood into the "safety" of bonds paying less than 5% a year. That kind of pain is not enticing. It's scary. And it feeds on itself. Stocks like ours may even look defensive in that scenario. But in our view, the scenario is unlikely. The bond market corrects itself. When yields are attractive to the people who want bonds, you'll know. Otherwise, we focus on stocks.
There's always a bull market here at The Bull Market Report. With earnings season on the books, The Big Picture tackles the question of whether stocks have gotten ahead of their growth rates, while The Bull Market High Yield Investor sets the scene for the next Fed meeting And as always, we can't resist updating you on our latest thoughts on our favorite recommendations.
Key Market Indicators
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The Big Picture: Record Earnings, Record Stocks
Despite the persistent drag from the Fed on the short end of the yield curve and a weakening bond market on the long end, the economy remains resilient and the largest corporations in the world are making more money than ever. With 98% of S&P 500 companies reporting results, the index is on track for a healthy 6% growth in earnings per share. This surpasses analysts’ earlier forecasts of 3.2% growth, marking the biggest year-over-year increase since mid-2022 and quite the upside surprise. So far, nothing in the recent past has provided even a speed bump, and guidance suggests that things get even stronger in the current quarter and beyond.
When earnings hit records, stocks deserve to hit records too. That part is inevitable. The only question is how far investors' comfort zone will stretch to accommodate stronger fundamentals when valuations across the market are already on the high side of recent memory. After doing the math, we aren't especially worried that stocks have gotten ahead of their growth trend.
Think about it. Yes, the S&P 500 is currently priced at 20.3X forward earnings, which is significantly elevated when you consider that across the past decade the market only commanded a 17.8X multiple. However, it's barely a notch above where it's averaged out over the last five extreme bear-and-bull-and-bear-and-bull years. And because growth shows every sign of accelerating in the coming year, we wouldn't be shocked next summer to see the market as a whole at least 15% above where it is now. That's better than what stocks have historically delivered over the long haul. It's a boom.
And even in this 15% scenario, there's a strong argument that stocks will be strategically attractive at that point. The Fed will find an excuse to guide the short end of the yield curve down. That's a good thing for the market, giving valuations an excuse to reinflate as the "risk-free" return rate on cash drops. Long-term yields should drop far enough with it to take a lot of pressure off the economy and Wall Street alike.
Meanwhile, earnings expansion is on track to speed up from 11% for this year to 14% in 2025.
Those extra 3 percentage points bend the P/E calculations just enough to eliminate just about any rational fear that stocks are overvalued now. Remember, smart investors pay extra for faster growth because every additional percentage point on that side shortens the amount of time you need to wait in uncertainty and doubt to see your companies grow into what would otherwise look like high valuations. We wouldn't be shocked to recheck the numbers in 12 months and see the S&P 500 in the aggregate bringing in as much as $50 more per "share" (spread across all 500 stocks of course) than it's making now, and then at the end of 2025, adding another $35-$40 to that pool of cash takes the S&P 500 multiple down BELOW long-term historical averages if the market doesn't move appreciably in either direction in the meantime.
All you need to take advantage of that discounted future is buy stocks today and hold on until next summer. There will undoubtedly be volatility. Maybe it will take the market down, in which case the discount will be even more substantial a year from now. And maybe it will take the market up, in which case the route to positive returns pays off earlier. All in all, analysts collectively think the market can rally another 13% or so in the next 12 months. At that point, if all the projections line up with reality, the market looks LESS overheated on an earnings basis, even though investors would have reason to cheer with a better-than-average annual gain on the books.
We like the odds of executives continuing to outperform. They've already successfully weathered an earnings recession, a slowing global economy and just about everything inflation and interest rates can throw at them. Give them a little relief and the numbers will go through the roof. All we need to provide is that year of fortitude. It feels like a pretty good bet.
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BMR Companies and Commentary
C3.ai (AI: $30, up 23% last week)
Early Stage Portfolio
Enterprise AI company C3.ai released its fourth-quarter results last week, reporting $87 million in revenue, up 20% YoY, compared to $72 million a year ago. The company posted a loss of $14 million, or $0.11 per share, against $15 million, or $0.13, with a beat on estimates on the top and bottom lines, coupled with robust guidance for the new year bringing much-needed glad tidings for investors.
For the full year, the company posted $310 million in revenue, up 16% YoY, compared to $270 million a year ago, with a loss of $56 million, or $0.47, against $46 million, or $0.42. With demand for enterprise AI solutions continuing to intensify across industries, the company exceeded the top end of its guidance for the full year as well. It marked its fifth consecutive quarter of accelerating revenue growth.
During the quarter, the company signed 47 new agreements, including 32 new pilots, with marquee clients such as ExxonMobil, General Mills, BASF Petronas, and the US Navy, among others. This has resulted in subscription revenues rising 41% YoY, constituting 92% of its total revenue, giving the company much-needed stability and certainty regarding its cash flow position going forward.
C3’s focus on expanding its partner network has paid off well, with 91 of the 115 agreements closed last year from companies such as AWS, Google Cloud, and Microsoft Azure. The qualified opportunity pipeline with the partner network grew a huge 63% YoY. The company received a blockbuster response for its GenAI offerings, with 50,000 inquiries coming from 3,000 businesses during the fourth quarter; alone.
Some thoughts:
C3.ai's future holds promise, but it's definitely on the speculative side of the AI industry. Here's a breakdown of their potential and competition where it fits into the landscape of the AI revolution:
Strengths:
- Focus on Enterprise Applications: Unlike some AI companies targeting broad consumer markets, C3.ai focuses on developing enterprise-grade AI solutions for specific industries like manufacturing, energy, and healthcare. This targeted approach allows them to cater to specific needs and potentially achieve faster adoption.
- C3 AI Suite: Their core product, the C3 AI Suite, offers a comprehensive platform for developing, deploying, and managing AI applications. This can be attractive to businesses looking for an all-in-one solution.
- Partnerships: C3.ai has established partnerships with major technology players like Microsoft and Google. This gives them a leg up in terms of access to resources and market reach.
Challenges and Competition:
- Emerging Market: The enterprise AI market is still evolving, and it's not guaranteed that its approach will be the most successful in the long run. They face competition from established tech giants like Microsoft, Amazon (AWS), and IBM, all with significant resources and cloud computing expertise.
Profitability: C3.ai is not yet profitable, and it's unclear how quickly they can achieve profitability in this competitive landscape
The best choice for you depends on your risk tolerance and specific investment goals. The company offers a potentially high reward but also carries a higher risk due to the competitive landscape and its unproven track record of profitability.
The stock has had a fairly volatile year so far, but the recent rally following its fourth-quarter results has put it firmly in the green. As of now, the company is focused on growth, giving profitability a pass, but a pole position in the potentially $1 trillion enterprise AI market will ultimately will make it worthwhile. The company has sound financials, with $750 million in cash, and no debt. Our Target for this very speculative high-flyer is $50 with the Sell Price at $24. We added the stock at $22 in 2023, so we are up 34%. But is it worth the anguish or the volatility? Only YOU can decide that!
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The Trade Desk (TTD: $93, down 2%)
High Technology Portfolio
Pioneering ad tech company The Trade Desk released its first quarter results recently, reporting $490 million in revenue, up 28% YoY, compared to $380 million a year ago. It produced a profit of $130 million, or $0.26 per share, compared to $110 million, or $0.23, with a beat on consensus estimates on the top and bottom lines, coupled with an upbeat forecast for the second quarter. We are impressed by the profitability level – 27% after tax. That’s up there with some of the greatest companies in the market, like Apple, Google and Facebook.
During the quarter, the company was aided by continued penetration of connected TVs, with industry giants such as Disney, NBC Universal, and Roku making deeper pivots into this segment. This comes as the company’s UID2*, its alternative to the aging browser cookies, as it becomes more and more ubiquitous across the open internet, resulting in robust value for advertisers, and undeniably strong moats for Trade Desk. Unified ID 2.0 (UID2) is a non-proprietary, open standard accessible to constituents across the advertising ecosystem. It enables advertisers, agencies, ad technology companies, and ad publishers selling advertising to interoperate together in advertising workflows. The company struck a string of new collaborations and partnerships with its UID2 during the quarter, starting with Times Internet, a leading media conglomerate in India, followed by satellite TV giant, Dish Media, along with TF1 and M6, two of the largest broadcasters in France. As a result, the platform now has access to ad inventory in over 11,000 destinations across connected TV, display, mobile, and audio.
The Trade Desk isn't just another ad network; it provides a self-service, cloud-based platform for ad buyers. This platform allows businesses and agencies to plan, manage, and optimize their advertising campaigns across various channels and devices. Here's what makes them special:
- Independent and Open Platform: Unlike some ad networks that prioritize their own inventory, The Trade Desk offers an independent platform with access to a vast marketplace of ad inventory. This gives ad buyers more control and flexibility in reaching their target audience.
- Data-Driven Targeting: The Trade Desk leverages data and analytics to help ad buyers target specific audiences with greater precision. This can lead to more effective and efficient advertising campaigns.
- Programmatic Bidding: They automate the ad buying process, allowing advertisers to bid on ad impressions in real-time based on pre-defined criteria. This can help them secure better ad placements at more competitive prices.
Why They Are Leaders:
- Focus on Innovation: The Trade Desk is constantly innovating and developing new features to stay ahead of the curve in the fast-evolving advertising landscape.
- Transparency & Control: They prioritize transparency and control for advertisers. This builds trust and encourages long-term partnerships.
- Global Reach: The Trade Desk operates in a global marketplace, giving advertisers access to a vast audience.
The Trade Desk has strong secular tailwinds in its favor within the digital advertising market, which stood at $600 billion in 2023, expected to rise to over $870 billion by 2027. Global streaming giants are doubling down on advertising: Netflix with its 40 million ad-tier subscribers and Disney+ have already announced partnerships with the company to monetize their massive ad inventory.
The stock had a phenomenal year in 2023, up 60%, which has been extended this year with a YTD rally of 31%. While the valuation is anything but cheap, at 22 times sales and 120 times earnings, the massive addressable market and an impressive compound annual growth rate of 32% largely make up for it. The company ended the quarter with $1.4 billion in cash, just $240 million in debt, and $600 million in cash flow. Our Target is $100 and our Sell Price is $64. We’re raising both to $120 and $84 respectively. The stock hit $97 two weeks ago, not quite a new all-time high, as that was set in 2021 at $114. But we can see that number being broken later this year if the market holds steady and moves higher. If not, that is why we have such a tight stop. No matter how good a company is, if the overall market tanks hard, it will bring these high flyers down with it. Revenues are great – moving from $840 million in 2020 to $1.2 billion, to $1.6 billion to $1.95 billion in 2023. What worries us the most, is its low level of profitability. Watch this one closely.
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Workday (WDAY: $211, up 4%)
TERMINATING COVERAGE
Workday, a leading financial and human capital management solutions provider, released its first quarter results last week, reporting $2.0 billion in revenue, up 18% YoY, compared to $1.7 billion a year ago. It posted a profit of $103 million, or $0.38 per share, against -$10 million, or $0. The company beat on consensus estimates but lowered full-year guidance a bit. See below.
As always, subscription revenues led the way at $1.8 billion, up 19% YoY, with the rest coming from professional services at $180 million, up 12% YoY. The company’s 12-month subscription backlog now stands at $6.6 billion, up 18% YoY, followed by total subscription backlog at $21 billion, an increase of 24% YoY. The gross revenue retention rate came in at 95%, representing a churn of just 5% over the year.
During the quarter, the company onboarded several marquee new companies. This includes Asda, Electrolux, TopGolf, and LVHM, among others. In the public sector, the company acquired the Defense Intelligence Agency (DIA) as a customer for its Workday Government Cloud. It now counts 60% of the global Fortune 500 as customers and was named a leader in cloud Human Capital Management for 1,000+ employees by Gartner.
The company continues to double down on AI and now has 50 AI and 25 generative AI use cases in its roadmap. Workday completed the acquisition of HiredScore, an AI-powered talent acquisition and internal mobility solution. With 65 million users and 800 billion transactions on its platform each year, the company has a wealth of data to train its AI and leapfrog competitors.
Following a robust performance last year, the stock has had a rough start to 2024, and is down 21% YTD, mostly owing to its high valuation. We believe that this is unjustifiable, and overblown, considering the massive addressable market of $140 billion, and an impressive 5-year CAGR of 20%. Workday ended the quarter with $7.2 billion in cash, $3.3 billion in debt, and $2.2 billion in cash flow. Our Target is $325 and our Sell Price is $250.
We, that is, you and we have a decision to make. Do we let the company go here? Or do we buckle down and add more? We added the stock at $139 in 2018, so we are up over 50%. You, however, may have a higher entry price. Not that that makes any difference. It just feels better if you can sell and take a profit, even though the stock was at $311 in February. Revenues have been growing for the past four years, from $4.3 billion in 2020, to $5.1 billion, to $6.2 billion, to $7.3 billion in 2023. At the current rate it looks like $8.0 billion is probable for 2024. Growth appears to be slowing and we wonder: Is this 10% growth rate worth such a high valuation? The market just might have something here.
Here’s what occurred: When Workday reported quarterly earnings a week ago, it lowered its forecast for fiscal 2025 subscription revenue to between $7.7 billion to $7.725 billion from a prior call for $7.725 billion to $7.775 billion. That prompted a flurry of price-target cuts from Wall Street. This is a tiny lowering. It is such a small reduction, that you have to re-read the sentence to understand the difference. The stock was smashed. This is what the market is doing to great companies. We’re not happy about it, but it is reality. For this reason, and the slowdown in growth discussed in the previous paragraph, we are going to exit the stock. Tough decision, but the market is just destroying growth companies with slower growth in the forecast.
If you wish to stay in the stock, the knockdown of the stock by $52 a share (19%) since earnings a week ago, certainly creates a better valuation now. It’s down $100 (32%) since February. With cash of $7.2 billion and debt of $3.3 billion, the balance sheet is strong.
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First Solar (FSLR: $272, up 2%)
Long-Term Growth Portfolio
First Solar released its first quarter results recently, reporting $800 million in revenue, up 45% YoY, compared to $550 million a year ago. It posted a profit of $240 million, or $2.20 per share, against $42 million, or $0.40, with a beat on consensus estimates on the top and bottom lines, all driven by macro regulatory tailwinds, ever since the passing of the IRA Act in 2022.
The company has a sales backlog of 78.3 GW, up from 71.6 GW a year ago, with net YTD bookings at 2.7 GW, down from 12.1 GW. Its average selling price stands at 31.3 cents per watt, down from 31.8 cents a year ago. The company expects its bookings backlog to extend through 2030, as there is seemingly no stopping demand for rooftop solar and large-scale solar energy generation projects.
While much of the solar energy industry reels from the structural overcapacity in China, First Solar has circumvented this threat, with its focus on differentiation and its business model. The company’s cadmium telluride semiconductor technology is vastly better than the commoditized crystalline silicon modules coming from China, which are known to harbor various reliability and quality issues.
Beyond the regulatory tailwinds, the company stands to benefit from the rise of generative AI as tech giants look to transition towards green energy to operate their massive new data centers, with First Solar being the preferred choice. A typical query on ChatGPT consumes 50 times more energy than a Google Search, so the giants of AI must make this shift to solar if they want to save money and don’t want to come under criticism.
It is already up 58% YTD and is showing no signs of slowing with plenty of tailwinds in its favor, and a pole position in the market. First Solar ended the quarter with a robust balance sheet, with $2 billion in cash reserves, just $680 million in debt, and $900 million in cash flow.
Many leading analysts from UBS, Piper Sandler, and JP Morgan Chase have increased their Price Targets for the stock. UBS raised its target to $320, from $270, the highest on the Street. Our Target was destroyed in the last two weeks as the stock rallied from $187 on May 14th to its present level of $272. We’re up 40% in less than a year. At $215 it is time to raise. We love this company so we are going to best UBS and place a $325 Target on the stock. Our Sell Price of $140 is hereby raised to $240.
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iShares US Oil & Gas Exploration & Production ETF (IEO: $103, up 2%)
Energy Portfolio
A pure-play energy fund with concentrated exposure to oil and gas companies that are exclusively involved in exploration and production, this fund closely tracks global energy companies and is thus subject to the industry’s swings and volatility. So far this year, the fund is off to a flying start and is up 9% YTD, mainly owing to the recovery in natural gas prices following a prolonged slump over the past year.
Given a short to medium-term horizon, the oil and gas industry is always eventful, with plenty of geopolitics and macroeconomic factors coming into play. For example, right now there is the Red Sea crisis, a prolonged conflict in the Middle East, and Ukraine intensifying its attacks on Russian oil refineries, among a host of other things to factor in, that could lead to swings in global energy prices.
On the macro front, the demand from China is still weak, but a recovery is in the cards, which could push oil prices beyond the $85 mark. Apart from that, a rate cut by the Fed sometime later this year, and a recovery in demand from Europe this winter for space heating and other residential and commercial uses can all lead to a much-needed rally in natural gas prices, which remain at multi-year lows.
When taking a long-term view, there is a lot to be optimistic about oil and gas stocks. This might seem counterintuitive considering the growing environmental movements the world over, alongside new alternative energy sources, but we believe that natural gas and hydrogen will play an outsized role in this transition. This too will take anywhere from two to three decades to become a reality, and in the meantime, oil and gas giants will be reaping profits.
The Exchange Traded Fund allows investors to ride this trend with its highly concentrated portfolio, with 45% of its assets held in ConocoPhillips, EOG Resources, Marathon Petroleum, and Phillips 66. These are all companies with massive inventories and low production costs, helping generate outsized returns during bullish streaks in energy prices, while still outperforming when prices slump.
Our Target is $120 and our Sell Price is $95. This fund is a great way to own an assortment of energy companies in one transaction. We added the fund at $80 two years ago.
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Recursion Pharmaceuticals (RXRX: $8.28, down 10%)
Early Stage Portfolio
Recursion Pharmaceuticals, a leading AI and machine learning company in the biotech space, released its first quarter results a month ago, reporting $13.8 million in revenue, up 14% YoY, compared to $12.1 million a year ago. It posted a loss of $91 million, or $0.39 per share, as against a loss of $65 million, or $0.34 the prior year, but posted a beat on consensus estimates on the top and bottom lines.
Rising losses were largely the result of increasing R&D expenses, at $68 million, up from $47 million a year ago. This was followed by a similar rise in administrative expenses at $31 million, up from $23 million, as the company has been on a hiring spree. Revenues during the quarter were entirely from its partnership with Swiss life sciences company, Roche, which the company expects to scale further.
Recursion has plenty of value catalysts coming up over the next few quarters, which can be quite profitable for the company in a significant way. This includes five drugs in phase 2 clinical trials, each with over 100,000 potential patients worldwide, and no competitor. If the company can successfully commercialize just one of these five drugs, it can add significant value from current levels.
Its AI-enabled drug discovery platform continues to gain momentum, with potential new partnerships and the exercising of existing partnership options capable of driving top-line growth. The company’s 20 petabytes of data collected from real patients, when used with its internal AI software is a game changer for the industry, prompting Roche and Bayer to start working with Recursion.
The company’s AI play has been formidable enough to warrant a $50 million investment from Nvidia, and it has grand plans in this regard, including a next-generation supercomputer. The stock is down 16% YTD, and it stands to offer enormous value if catalysts start to align going forward from present levels. It has a robust balance sheet, with $300 million in cash, and just $50 million in debt. Our Target is $28 and our Sell Price is $8, which is getting tight. We added the stock at $10 just six months ago and it ran up to $17 in February but has since settled down. This is a speculative stock for sure. Enjoy the ride, but be careful.
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ARK Innovation ETF (ARKK: $42, down 4%)
TERMINATING COVERAGE
Cathie Wood's flagship Innovation ETF has had a rough start to the year and is down 16% YTD. This comes as the broader equity markets, including disruptive tech stocks, have posted a rally this year. The pullback can be attributed to its high exposure to Tesla, which has been a key detractor for the fund in recent quarters.
The fund’s overreliance on Tesla is clearly wearing it down, and alongside this, other key weak investments include Roku (down 88% from peak), Unity Software (down 90%), Pacific Biosciences (down 96$), and Teladoc, which is down 50% this year and over 95% from its peak in 2021. Ark attributes the weakness in Tesla to auto sales still being lower than pre-COVID levels, but we think the various controversies surrounding Tesla’s founder, Elon Musk, and his controversial $45 billion compensation package could have contributed just as much, not to mention his purchase of Twitter, spending half his time with SpaceX, and many other strange personal quirks that this genius brings to the table. In our opinion, the fund’s underperformance in recent quarters is largely due to it being underweight on market leaders and mega-cap stocks, which have led the rally in 2023 and this year so far.
Investors should start treating the Ark Innovation ETF like a venture capital or private equity fund, which often comes with a lock-in period lasting a few years, up to a decade. That’s how long it takes for disruptive innovations to pay off, and at current levels the stock offers robust value, making it perfect for value-seeking investors with a long enough time horizon.
We are asking ourselves some tough questions lately. Cathie Wood has clearly lost her magic. We added the stock in 2021 at $117, after it had hit an all-time high of $158. We thought it was overvalued and waited patiently for it to come down. Come down it did, but it has continued to erode for the past three years, going nowhere for the past two years, languishing in the low 40s. Why do we continue to hang on to this stock? That’s a good question. We have again been patient with this fund, but for far too long. We don’t have the time to wait any longer. There are much better places for our funds, than the many pie-in-the-sky investments she has made these past few years.
We are exiting the fund and moving on. We’d rather own more Nvidia, more Super Micro Computers, or Eli Lilly and Novo Nordisk.
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The Bull Market High Yield Investor
The clock is now ticking on the next Fed policy meeting on June 12. Nobody expects a rate cut or a rate hike at this point. We're more interested in seeing whether consumer inflation numbers due out that morning have any impact on Jay Powell's prepared marks: a soft or "cool" print could once again prompt a lot of talk about relaxing overnight lending rates when the moment is right, while anything hotter than expected could have the opposite effect. Whatever we see this month, it's unlikely to change the primary narrative around the Fed, which is that we'll probably be in a place where Powell and company can start relaxing in September and cut more aggressively after that.
We've been saying it for months and we were right. Short-term interest rates have peaked. People parked in money markets are unlikely to earn more on those accounts than they're making right now. And as the short end of the yield curve recedes, upward pressure on the long end will evaporate along with it. There simply won't be a reason for capital to keep flowing out of Treasury bonds into those money market accounts. And as the bond market stabilizes, long-term yields have less reason to keep climbing to the point where they spook us here in the stock market.
Add it all up and if you're looking for a relatively smooth income stream without the strain of life in the stock market, you need to lock in Treasury yields where they are. That means settling for 4-5% a year, which translates into 2-3% above where the Fed wants to guide inflation in the long term. Maybe a 2-3% real return is enough for you. We have a feeling most investors will want their money to work a little harder, which is why we're banging the drum on stocks and funds like these.
Arbor Realty (ABR: $13.68, up 2%. Yield=12.6%)
REIT Portfolio
Leading Mortgage REIT Arbor Realty released its first quarter results recently, reporting $104 million in revenue, down 5% YoY, compared to $109 million a year ago. It posted a profit or FFO of $58 million, or $0.31 per share, down from $84 million, or $0.46. This was a mixed quarter for the company, with a beat on the top line, but a miss at the bottom, largely owing to a big drop in loan originations across the board due to the tougher mortgage business, due to 7% 30-year loans.
Agency loan originations during the quarter stood at $850 million, down from $1.1 billion a year ago, which Arbor had warned against a couple of months back. The company believes that the first two quarters of this year will include peak stress, as interest rates remain higher, with a possibility of a rate cut in late 2024. Borrowers are deferring taking loans in anticipation of lower rates.
Arbor’s structured portfolio, however, continues to do well, albeit with a small YoY decline, with $256 million in originations, down from $266 million the prior year, with a total of 59 loans being originated, the same as last year. Similarly, the company’s servicing portfolio hit new highs during the quarter, at $31 billion, up 8% YoY, compared to $29 billion a year ago, with a net servicing revenue of $31 million.
The company has done remarkably well throughout the pandemic, and the volatile interest rates environment that followed. This was largely owing to its diversified business model with multiple countercyclical income streams. For instance, if interest rates continue to remain high, originations will take a hit, but the mortgage servicing rights portfolio will increase in value due to low refinancing rates. Who is going to refinance a 3-4% loan at today’s 7% level?
This has helped it maintain its distributable earnings in excess of dividends, and a payout ratio of at least 90% throughout, all the while maintaining its book value, currently at $13.02. Over the past few months, Arbor has held outsized reserves to hedge against delinquencies and has continued to shore up liquidity, resulting in a robust balance sheet, with $910 million in cash, $12 billion in debt, and $550 million in cash flow.
Realty Income Corporation (O: $53, up 2%. Yield=5.9%)
REIT Portfolio
Realty Income, "the Monthly Dividend Company," is one of the largest investors in commercial real estate across the globe and recently reported $1.2 billion in revenue, up 40% YoY, compared to $940 million a year ago. It posted a profit or FFO of $790 million, or $0.94 per share, against $680 million, or $1.03, with a beat on top-line estimates, but a miss at the bottom, making it a mixed performance.
The company is structured as a real estate investment trust, and its monthly dividends are supported by the cash flow from over 13,250 real estate properties owned under long-term lease agreements with commercial clients. During the quarter, the company invested $600 million across a wide range of properties, with a weighted average yield of 7.8%. A significant chunk of these investments, or $320 million was allocated towards assets in the UK and Europe, with an average yield of 8.2%. The company invested $38 million in a US-based data center joint venture, marking its first investment in the space.
Another big milestone during the quarter was the completion of the $9.2 billion acquisition of Spirit Realty Capital, with the new combined firm valued at $63 billion, and Spirit shareholders set to own 13% of it. The CEO of Arbor stated that the transaction is immediately accretive. This gives Realty Income significantly more size, scale, and diversification across asset, geographical, and demographic lines, along with the potential for realizing various cost and operational synergies.
This was an eventful quarter for the company in terms of capital activity, starting with a secondary offering to raise $550 million an at average price of $56.93 per share. Followed by $450 million in 4.750% senior unsecured notes due on February 2029, and $800 million worth of 5.125% senior unsecured notes due on February 2034, resulting in $4 billion in liquidity, to fund $2 billion in investments during the year.
The stock is down by nearly 10% so far this year, but there are a few key catalysts that could turn things around, most importantly a rate cut by the Fed, later this year. What makes this REIT truly impressive is its diversification across classes, assets, and geographies, leaving it well off in all market conditions. It ended the quarter with $680 million in cash, $26 billion in debt, and $3 billion in cash flow.
Invesco Municipal Trust (VKQ: $7.93, up 2%. Yield=5.1% tax free, or the equivalent of 7.8% taxable)
High Yield Portfolio
The Invesco Municipal Trust is a closed-end fund that invests in tax-free municipal bonds, with the aim of generating steady current income for investors, with limited volatility and downside risks given a long-term horizon. It is a perfect product for retirees and other conservative investors seeking consistent tax-free income, but don’t want to stomach any excessive market risks.
The fund posted a stellar rally starting in October when the Fed officially ended its hawkish stance, but as the anticipation of further rate cuts soured, it has been increasingly rangebound over this year. It is, however, making the most of the higher nominal yields in recent months.
Following two consecutive years of net outflows, $140 billion in 2022, and $8 billion in 2023, muni bonds are set for a turnaround this year. Bonds posted negative performance in April, mostly owing to the better-than-expected employment and inflation data, prompting a hawkish reaction from the Fed. New issuances, however, swelled to $45 billion, 29% over the 5-year average, and were oversubscribed 3.8 times. After several months of limited supply, this quarter presented an opportunity for funds to add yield to their portfolios at an attractive risk-reward proposition.
Despite its phenomenal 22% rally since mid-year 2023, the fund offers an attractive discount of 12% to book value, while providing tax-free yields of 5.15%. This makes for a very impressive proposition, not just for conservative, income-seeking investors, but for speculators seeking value as well. With its extensive 30-year track record and a low expense ratio of just 1.3%, this fund is for those who want no risk from equities.
Good Investing,
Todd Shaver, Founder and CEO
The Bull Market Report
Since 1998
by Scott Martin | May 5, 2024 | Weekly Newsletter 7pm Sunday
Market Summary
The Bull Market Report
A cruel April is over and our stocks are bouncing back fast. Attribute it to Fed dread turning into relief if you like, now that Wednesday's policy meeting is safely over with. It's also good to have most of the Big Tech earnings reports that matter on the books. Silicon Valley's giants are doing well on the whole, which is again enough to motivate relief that the results weren't truly terrible even when they weren't strong enough on their own to trigger a lot of fresh buying. And if elevated bond yields were worrying you, fear not: as we anticipated (and wrote about at length two weeks ago), they've already receded again.
We can discount any of these arguments but it really boils down to a classic situation. Anxiety got out of hand, creating a "wall of worry" that stocks and the economy as a whole needed to expend time and effort climbing. But sooner or later, every historical wall of worry has fallen, becoming just another failed obstacle on Wall Street's relentless road to record after record. Earnings were good enough. The Fed is dovish enough. We know from recent experience that bond yields at this level are survivable. If they weren't, none of us would be here worrying about market activity!
The only pain point in our results this issue is that while BMR stocks are rebounding fast, we're lagging the market as a whole. It's not the fault of our more aggressive portfolios: the Early Stage stocks are soaring while High Tech and Long-Term Growth are also outperforming. But this is simply one of those moments when healthy diversification can become a drag. Our Energy recommendations, which were such a source of comfort and upside in recent weeks, have stalled once again. They'll be back. Healthcare and the Financials are moving slower to the upside than the market as a whole. Guess what? That's what Big Banks and Big Pharma do. They move slower. In down markets, that's a comfort. When the bull is in control, these names hold us back. We aren't complaining. They're here for a reason and they're doing their job.
The great news is that now that the fear clouds have lifted, investors have a chance to go back and review stocks that delivered fantastic numbers but were shunned while the market was distracted by its own doubts. Our stocks have a longer way to go before we fully recover from April's storms. We'll catch up again. And that makes this a buying opportunity, especially on Energy and select names in the Special Opportunities portfolio. Even Berkshire Hathaway (BRK.B) is available now at a discount price!
There's always a bull market here at The Bull Market Report. Since lagging the market in the short term is never fun, we've dedicated The Big Picture to a discussion of our longer-term performance and the reasons for our continued conviction that our stocks are the best. The Bull Market High Yield Investor talks about the Fed: sometimes it's important to say there's no news, and sometimes no news is the best news of all. And as always, we're talking about a few of our favorite stocks as earnings season continues. Don't forget: if you'd like different coverage or more detail on any topic, you know how to reach us. (Todd@BullMarket.com 970.544.1707).
Key Market Indicators
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The Big Picture: A Longer View
We're never thrilled in these periods where our recommendations lag the big benchmarks, but over the years we've come to accept it as part of the larger market cycle. After all, if you dumped all your stocks the minute they started to underperform, you'd very quickly be left with a lot of cash earning prevailing money market rates. That's fine if your financial needs and ambition are satisfied with at most 4-5% a year, but for any hope of a higher return, you need to accept a little more risk along the way. Of course doing that gets a whole lot easier when you have a little confidence in your posture.
And few things are better for confidence than a track record of tangible success. That's why we informally track our own "index" in order to quantify how far ahead of the curve our recommendations are tracking from day to day and from year to year. When we're in high gear, we accumulate excess returns that a temporary reversal can reduce without eliminating completely.
(A lot of what superficially resembles idle boasting about how great BMR stocks have done over time really boils down to reminding you to keep checking that index at moments when your confidence would otherwise start to flag. While we love to brag, there's a behavioral reason for it here.)
So how high is our conviction that the stocks we cover can outrun the broad market in the long haul? Extremely high. The numbers are all the evidence we need. Take the last 4-1/2 years as an example . . . years of uninterrupted volatility and endless shocks punctuated with periods of extreme relief. From the end of 2019 to today, the impact of risk is clearer now than it has been since the 2008 crash. If our methodology broke down in that time frame, it clearly wasn't built to hold up to serious bad market weather. And on the other side of the coin, if our methodology held up throughout the pandemic era, we can trust it to not only survive the storms but keep making money.
Going back, the "BMR Index" weighed in at 1696 at the end of 2019, a few weeks before the world went crazy and "normal" practically ceased to exist on Wall Street. Back then, the S&P 500 closed at 3240 and the Nasdaq was barely holding 9000. Those indices have since rallied at an annualized rate of 13% and 18% . . . not bad at all for investors who had the nerve to keep their eyes fixed on the long-term goal. Believe it or not, these returns are actually a little elevated by historical standards that stretch back over a century, which means that those who swallowed the elevated risk received elevated rewards.
Since the BMR Index currently reads 3321, we've roughly doubled our starting stake across those wild rollercoaster years. That's an annualized return of almost 22%, enough to beat the high-flying Nasdaq by 4 percentage points a year and run literal rings around the market as a whole. Stretch that 4-point advantage across a few years and our lead becomes unassailable. Unless something dramatic shifts in the world (more dramatic than the pandemic and its impacts), it becomes increasingly unlikely that the benchmarks will ever have what it takes to catch up with us.
And in the meantime, the months and years go by. Beating the S&P 500 by 9 percentage points a year even in the stormiest part of the cycle means we're making far more efficient use of every day than index funds . . . and no investor can recover lost time. That's why we won't settle for an extended period of outperformance across our portfolios. When a company has clearly hit a permanent wall, we pull the plug and end active coverage. Otherwise, we take a deep breath and acknowledge that our methodology still picks enough winners to move the overall needle far enough in the right direction.
Of course some of our portfolios will outperform or underperform under various conditions. That's by design too. Maintaining significant exposure to multiple themes helps to raise the odds that something in the BMR universe will be working well in any given season. While diversification has mathematical benefits, the psychological power of a few strong points in a weak season shouldn't be understated either. It's good for morale. And what's good for morale helps investors keep their heads in the game and avoid folding their hands too early. Was the turmoil of the last four years so awful that you would sacrifice 17 percentage points a year to run for the safety of cash? In that scenario, we once again suggest parking your funds in our High Yield recommendations to squeeze as much income as you can without taking another ride on the market rollercoaster.
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BMR Companies and Commentary
Apple (AAPL: $183, up 8% last week)
Stocks For Success Portfolio
Tech giant Apple released its second-quarter results this week, reporting $91 billion in revenue, down 4% YoY, compared to $95 billion a year ago. The company posted a profit of $23.6 billion, or $1.53 per share, down slightly from $24.2 billion, or $1.52, with a beat on consensus estimates on the top and bottom lines.
Product revenue took a hit during the quarter, dropping nearly 10%, from $74 billion a year ago, to $67 billion. This was mostly owing to iPhone sales falling 10% YoY, to $46 billion, compared to $51 billion a year ago, followed by similar declines across iPad, plus wearables and accessories by 17% and 10% YoY, respectively. The Mac segment posted 4% YoY growth, at $7.5 billion.
The decline in hardware was, offset by a strong showing in the company’s burgeoning services business, posting $24 billion in revenue, up 15% YoY, compared to $21 billion a year ago. The segment includes subscriptions, advertising, search engine licensing fees, and payments, among others. Right now, it counts over 1 billion active subscriptions across its apps, third-party apps, services, and platforms.
Apple’s hardware performance during the quarter was hurt by persistent weakness in China, apart from tough YoY comparisons because the year-earlier period benefited from strong pent-up iPhone demand after supply constraints lessened. All of this is set to subside, especially with the company set to launch the new iPad this week, and its new blockbuster product, the Apple Vision Pro, already gaining traction.
Despite all of this, the spotlight was ultimately stolen by Apple’s mammoth new $110 billion stock buyback authorization, which will create remarkable value for investors. This unprecedented share repurchase program comes as no surprise. Boasting a war chest of $67 billion in cash, a manageable debt load of $104 billion, and a gushing cash flow of $110 billion annually, the company has been primed for a major buyback for quite some time.
Our Target is $200 and we would not sell Apple. The all-time high on the stock is $199 set right before Christmas last year. It’s had an 8% pullback since then and many are concerned. After all, the overall market was up 9% during this same time frame, so Apple is losing ground lately. Of course, it has been leading the overall market for years now, so it’s not the end of the world. We’re watching and waiting, and thinking about this stock all the time. Apple is slowly moving from a growth stock to a value stock. The company has historically found a way of finding new, massive products to make up for products that have plateaued. We are confident that they are working on many of them that we will see introduced this year and in the coming years, that will prove to be big winners.
The company is amazingly profitable producing $23.6 billion in profits on $91 billion in revenues. That’s 26% AFTER TAX – one of only two or three companies with this extraordinary level of profitability. This will provide plenty of cash in the future to buy back more and more stock, similar to what Exxon has been doing for 40 years.
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Johnson & Johnson (JNJ: $150, up 1%)
Healthcare Portfolio
Healthcare giant Johnson & Johnson released its first-quarter results recently, reporting $21.4 billion in revenue, up 2% YoY, compared to $20.9 billion a year ago. The company produced a profit of $6.6 billion, or $2.71 per share, against $6.3 billion, or $2.41, with a beat on consensus earnings estimates, but a slight miss on top-line figures.
During the quarter, the company was aided by a rebound in elective surgeries by older adults, which had been deferred due to COVID over the past few years. This has helped offset the company’s waning COVID-19 vaccine sales, which stood at a mere $25 million, as opposed to $750 million a year ago. The pharma operation reported $13.6 billion in sales, up by 1%.
The medical devices business saw $7.8 billion in revenue, up 4%, driven by the resurgence in elective procedures and a contraction in US distributor inventories for contact lenses. Wound closure products and devices used for orthopedic procedures contributed just as well, alongside serious injuries, and muscular and skeletal trauma, all of which are expected to see double-digit growth rates going forward.
The company was further aided by its acquisitions in this section, which include heart devices maker, Shockwave Medical for $13 billion, alongside Abiomed and Laminar, for $16 billion and $400 million, respectively. All of this is aimed at making J&J a leader in the cardiovascular devices and technologies space, helping offset the decline in sales from spinning off its consumer health segment, Kenvue.
The stock has been largely rangebound for the past four years, as the stock hit $150 at the beginning of the pandemic in 2020, but a few key catalysts could bring about a breakout in the coming months. The company currently trades at just 4 times sales and 14 times earnings, while offering a solid 3.3% annualized yield. It ended the quarter with $26 billion in cash, $34 billion in debt, and $23 billion in cash flow. The company is one of only two firms with a AAA credit rating, the other being Microsoft. Apple had a AAA rating but is now AA+.
Our Target is $188 and the stock hit $182 in 2022 as we had been expecting it to do so, but lately, the market had other ideas. The last time we reported on JNJ we said we were moving on out if it hit $150. Well, it did and we are still in. Look at it this way: This $360 billion company is not going away. It is here to stay and will hit that Target someday down the road. You know what Buffett would do in our position. He would put it away and never look back. You, on the other hand, can do the same, OR, find a replacement for it. But you have to pay capital gains tax and the reinvestment stock has to be better than JNJ. That could be Novo Nordisk. It could be Eli Lilly. But maybe you already have these two great companies. Of course, you can never have too much Novo Nordisk or Eli Lilly. SO YOU DECIDE! We just want you to think about it. Make your decision and stick with it.
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Novo Nordisk (NVO: $123, down 3%)
Healthcare Portfolio
Diabetes drug giant Novo Nordisk had another spectacular performance during its first quarter results this week, posting $9.4 billion in revenue, up 20% YoY, compared to $7.7 billion a year ago. It produced a profit of $3.7 billion, or $0.82 per share, against $2.9 billion, or $0.63, with a beat on consensus estimates on the top and bottom lines, coupled with a raise in its sales guidance for the full year.
The stock pulled back following the results, largely owing to the rising competition from Eli Lilly in the obesity drug market, prompting the Danish giant to cut prices of its wildly popular drugs Ozempic and Wegovy. The company sees no signs of customers moving to competing products such as Zepbound or Mounjaro, and projects double-digit sales growth for the next couple of years.
Wegovy sales more than doubled on a YoY basis, hitting $1.3 billion during the quarter, with the company now filling 130,000 weekly prescriptions in the US alone, with 25,000 fresh new weekly additions. [Focus on these numbers! If the numbers hold, we could see 325,000 new prescriptions in the next 90 days.] The company’s head start in the obesity drug market positions it to dominate as competition heats up. With a potentially $100 billion market on the horizon, their early mover advantage is a significant asset.
Novo Nordisk’s diabetes and obesity care operation, which encompasses its two blockbuster drugs, along with its top-selling insulin variants, among other products, hit $8.8 billion in sales during the quarter, up 25% YoY. The rare diseases segment didn’t fare too well, with $630 million in sales, down 4% YoY, owing to supply constraints on the one hand, and waning demand in key markets on the other.
With a mere 6.2% share of GLP-1 in the global diabetes prescription market, the company has a massive untapped addressable market and a long runway ahead. In addition to this, it has patent protection for Wegovy, extending all the way to 2032, creating massive competitive moats. Novo Nordisk ended the quarter with $9.3 billion in cash, $27 billion in debt, and $93 billion in cash flow. We’d love to see them pull their debt level down. Our Target is $145 and our Sell Price is $110. It hit $138 a short month ago and we fully expect it to hit this in the coming months. We can see this stock at $200 in 2025. Maybe higher. Look what Eli Lilly has done. There is no reason for Novo not to do the same thing.
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SPDR Gold Shares ETF (GLD: $213, down 2%)
Special Opportunities Portfolio
It’s hard to make a bearish case for gold in the short run, and the SPDR Gold Shares ETF is the best vehicle to ride this trend. Not only does it come with an extensive track record going back 20 years, but it also offers a low expense ratio, minimal tracking errors, and best-in-class liquidity, making it ideal for all types of funds, investors, and portfolios seeking exposure to the shiny yellow metal. Why? Because the fund actually owns gold and it trades on a 1 for 1 basis with the global price of gold. If gold goes up 4%, the Gold Shares ETF goes up 4%. Where is the gold held? In vaults in HSBC USA, NA Bank vault in London. Very safe and easy way to own gold.
With the possibility of further rate cuts looking quite slim this year, and global equities, particularly in the tech sector once again reaching what some investors feel are high valuations, gold offers much-needed cover for investors. Alongside this, several geopolitical risks are adding to the volatility in equity markets, which are expected to persist for the foreseeable future, making it important to hold gold.
Central banks for various nations have been buying gold hand over fist, with the most bullish nations being Turkey and China, with the latter buying the metal for the 17th consecutive month through March. Historically, demand for gold has been driven by jewelry and industry, but there has been a fundamental shift ever since the war in Ukraine started, with central banks finally capitalizing on the opportunity.
Apart from this, an extended slump in the Chinese real estate market, coupled with the lack of trust in its equity markets has made the commodity popular among retail investors in the country, who now represent a major source of demand. With many nations working to sidestep the dollar with unilateral trade agreements with each other, the role of gold in trade and settlements will be key going forward.
Following a 13% rally in 2023 and 12% YTD, the fund is showing no signs of slowing. We further believe that gold has been held back by a broken correlation with the US dollar, which seems to be ascending merely on the virtue of being more resilient than European and Japanese economies. In the near term, there will be a correction in this regard, resulting in a further rally in gold prices this year. Our Target is $215, hereby raised to $230. Our SP is being raised from $175 to $195.
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Walgreens Boots Alliance (WBA: $17.81, up 1%)
REMOVING FROM COVERAGE
We added this stock at $22 at the end of 2023 with the hope that it was so undervalued that the market would realize this and bid the stock up. We also felt that management had a handle on things and would move to raise profits and cut debt. We were wrong on all counts. The stock did move higher to $27 after we added it by the beginning of 2024, but it has faded to its current level. We’re tired of this one and we are moving on. Not too many of you wrote us about this stock so we are hoping it hasn’t caused too much pain.
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The Carlyle Group (CG: $41, down 11%)
Special Opportunities Portfolio
The private equity giant released its first quarter results last week, reporting $690 million in revenue, down 20% YoY, compared to $860 million a year ago. It reported a profit of $430 million, or $1.01 per share, up from $270 million, or $0.63, beating consensus estimates on the top and bottom lines, driven by robust asset sales and capital market activity across its private equity funds and portfolio. The stock got hammered. These numbers may look out of whack, with revenues dropping and profits rising so much, but year-over-year comparisons are very tough for any firm in the private equity sector. One could make an argument that these firms shouldn’t report year-over-year comparisons because they don’t operate like a normal growth company. A company like Carlyle might make five large transactions in a given year. And then the next year might do three. Then in the following year, they might do 10. See what we mean here? Private equity firms should be evaluated on their overall profit level over a longer period, say 3-5 years, and their asset base – how has it grown over the past few years. Metrics like these. More in the paragraphs that follow.
This was an eventful quarter for the firm, with $5 billion in fresh deployments, up from $3.8 billion a year ago, followed by proceeds of $5.9 billion, compared to $4.3 billion the prior year. This includes the company selling its stake in McDonald’s local Chinese business, and the UK-based oil firm Neptune Energy, helping Carlyle generate a net profit of $400 million, an increase from $165 million the prior year.
Despite a strong global equity market and a rebound in M&A activity, the firm’s corporate private equity portfolio ended the quarter flat, with its global credit funds appreciating 2%, real estate funds by 1%, and secondaries gaining a remarkable 5%, on a YoY-basis. The private equity fund came in lower than the broader industry, with peers such as Blackstone seeing a 3.4% growth during the quarter.
Carlyle raised $5.3 billion in capital during the quarter, as opposed to net outflows during the same period last year, bringing total assets under management (AUM) to $425 billion, up 12% YoY. Of this, $300 billion are fee-earning assets, $90 billion in perpetual fee-earning capital, and $76 billion in dry powder, capital available for investment, up 3% YoY, which is set to be deployed over the coming years.
Following a phenomenal 36% rally last year, and 6% this year so far, the stock is still fairly undervalued, trading at just over 6 times earnings. The company is amid strong tailwinds in favor of alternative asset management and is rewarding shareholders generously with $150 million in stock repurchases and an annualized yield of 3.4%. It ended with $1.7 billion in cash and $9.3 billion in debt.
Our Target is $53 and our Sell Price is $34. The current drop in price presents a buying opportunity for this excellent company, with a proven management team. The stock is trading at a discount compared to where we believe it should be. While it reached an all-time high of $60 in 2021, the company has grown significantly since then, with AUM increasing from $300 billion to $425 billion. We believe the stock will recover and reach this level again in the coming years. We’ve been with Carlyle since 2017 when we added it at $16.66, so we’re up 150%. We are quite pleased with this investment.
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Ally Financial (ALLY: $39, flat)
Financial Portfolio
Bank and leading auto finance company Ally Financial released its first quarter results recently, reporting $2.0 billion in revenue, down 5% YoY, compared to $2.1 billion a year ago. It delivered a profit of $140 million, or $0.45 per share, down from $250 million, or $0.82, but beat consensus estimates on the top and bottom lines, alongside a raise in its guidance for the full year.
The drop in profits during the quarter largely results from increased provisioning against credit losses and substantially higher non-interest expenses, which primarily pertain to its insurance segment. The company’s financing revenue stood at $1.5 billion, down $150 million compared to last year, owing to higher funding costs, which were mostly offset by favorable auto loan pricing and floating rate yields.
During the quarter, Ally received a record 3.8 million auto loan applications, up from 3.3 million a year ago, resulting in an origination volume of $10.0 billion, up from $9.5 billion the prior year. The yield stood at 10.9%, with 40% of new originations in the highest credit quality tier, mainly comprised of high-earning borrowers, and high-end cars with lower depreciation rates. As we research these numbers, we are quietly amazed at the large volume the firm is doing with what everyone seems to think are such high interest rates, curtailing business. Not in this case with Ally.
Ally’s model relies on its extensive partnership with car dealerships, which helps it generate retail loan originations at low costs, in addition to $350 million in insurance premiums. Alongside this, the company has garnered massive retail deposits, which have helped lower its financing costs, and during the quarter this number stood at $145 billion, from over 3.2 million depositors located all over the country.
The stock was up 43% in 2023, and a further 11% so far this year, owing to a resilient US auto market. Credit provisioning has hit profits, but should bounce back in the current quarter as the company continues to cut costs. In the meantime, the company offers an enviable 3% annualized dividend yield, made possible by a strong balance sheet, with $8 billion in cash and $17 billion in debt. Debt is high, of course, as the business model demands it. Our Target is $43 and our Sell Price is $31. We’re going to raise the Sell Price to $35 to protect profits. We added the stock at $27 in 2023, so we are up 46%.
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ServiceNow (NOW: $717, down 1%)
High Technology Portfolio
Enterprise digital workflows and cloud computing company ServiceNow released its first quarter results recently, reporting $2.6 billion in revenue, up 24% YoY, compared to $2.1 billion a year ago. The company posted a profit of $710 million, or $3.41 per share, against $480 million, or $2.37, up an incredible 48%, with a beat on consensus estimates on the top and bottom lines, alongside a raise in its guidance for the full-year.
As always, subscription revenues led the way at $2.5 billion, up 25% YoY, with the rest coming from professional services, at $80 million, up 11% YoY. Current remaining performance obligations, or contractual revenues that are set to be realized over the next 12 months hit $8.5 billion, up 21% YoY, owing to a string of new marquee client acquisitions and transactions.
During the quarter, the company onboarded 8 new clients with annual contract values (ACVs) over $5 million, an increase of 100% YoY. It now has over 1,900 customers with ACV over $1 million, up 15% YoY, making it an SAAS company for large enterprises through and through. It is, however, expected to move down-market to offer services to small businesses over the next few years.
ServiceNow has continued its relentless innovation on the product front, starting with its GenAI-powered Now Assist, which is already garnering massive ACV within a few short months of launch. In conjunction with Nvidia and Hugging Face, the company released StarCoder2, a set of open-access large language models (LLMs) for code generation, and was once again named a leader in Customer Service Solutions by Forrester Wave.
The stock posted an impressive 82% rally last year and is still up 4% YTD, which can be attributed to its valuations getting a bit stretched and a weak market for the past 5-6 weeks. Trading at 16 times sales and 53 times earnings, it is anything but cheap, but the company is supporting this with strong revenue and earnings, and $175 million in buybacks, made possible by its $5.1 billion in cash reserves, just $2.3 billion in debt, and $3.8 billion in cash flow.
Our Target is $800 which it hit in February, and a Sell Price of $650. This is no small company, clocking in at a market cap of $150 billion. With growth like this, we fully expect to see a new all-time high (currently $815), later this year or early next.
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Prologis (PLD: $106, up 2%)
REIT Portfolio
The leading warehousing REIT released its first quarter results recently, reporting $1.8 billion in revenue, up 12% YoY, compared to $1.6 billion a year ago. The company delivered a profit, or FFO of $1.2 billion, or $1.28 per share, against $1.1 billion, or $1.22, with a miss on consensus estimates on the top line, but a beat on the bottom, alongside a reduction in its full-year guidance impacting the stock.
The company maintained an average occupancy rate of 98.6% while commencing new leases on 48 million square feet, with an impressive retention rate of 74%. The firm’s net effective rent change was 67% YoY*, while its same-store net operating income increased 5.7% YoY. The company achieved this despite concerns of excess capacity post-COVID, and broader headwinds facing logistics and e-commerce.
*We double-checked this number and it came right from the company. An extraordinary increase.
Prologis made acquisitions of just $5 million during the quarter, followed by development stabilizations of $520 million, with an average yield of 5.7%, and $270 million in development starts, with 6.9% in average yields. The company disposed of assets worth over $250 million during the quarter, with an average cap rate of 4.8%, in line with its long-running capital recycling program.
Prologis has long been dubbed ‘Amazon’s Secret Weapon’, allowing the e-commerce giant to serve customers more effectively and efficiently with its 1.2 billion square feet of warehouse space. It is continuing along the same lines with the partnership with Amazon and is well-positioned to capitalize on the unrelenting growth in e-commerce and the new trend of reshoring across industries in recent years.
Following an 18% rally last year, the stock is down 21% so far this year, which can mostly be attributed to excess capacity, and the Fed’s higher-for-longer stance, which may cause consumer demand to take longer than expected to recover. The stock trades at 12 times sales and 30 times earnings, which isn’t cheap, and could have contributed to the pullback. The company ended the quarter with $500 million in cash and $5.3 billion in cash flow. Our Target is $160 and our Sell Price is $120. We added the stock at $128 in 2022 after it hit its all-time high of $174, and as recently as February, the stock was at $136. But it has been weak since then. We’re going to lower the Sell Price to $100 because we believe in the company and the business they are in. But if it hits, we are out.
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The Bull Market High Yield Investor
That was easy. Nobody seriously expected a rate cut this week in the face of stubborn recent inflation reports. But Jay Powell put a forceful stop to speculation that rates would swing in the opposite direction. There's no tightening move on the horizon. The short end of the yield curve has climbed as far as it can for the foreseeable future. As far as the Fed is concerned, the pressure has gotten as intense as it gets in this cycle. The only fear factor now is that the cycle will remain this intense for longer than the economy can bear.
We aren't especially worried. Neither is the market. While watching long-term Treasury yields edge back above 4.5% has been a bracing experience, the biggest impact on our investment posture has been psychological. The big institutions simply aren't pivoting big money out of cash or stocks into the bond market because locking in a 4.5% coupon yield is no long-term bargain when you subtract the impact of 2% inflation, assuming that the Fed succeeds in cooling prices that much. What we're seeing instead is banks trying as hard as they can to lighten their exposure to bonds, which is not compatible with the scenario that people who publicly fret about 4.5% yields enticing capital out of the stock market have predicted.
In our view, that's important enough to say twice so it sinks in. If the dangerous thing about bond yields is that they suck money out of stocks, then we would expect to see bond prices surge to lock in those yields. That is not happening. And if it isn't happening, then where is the threat to stocks? Remember, Wall Street and America have weathered 4-5% yields for most of history. This is not a magic tipping point that automatically turns stocks toxic. Instead, it's the past 15 years that were the aberration. Yields got artificially low after the 2008 crash and stayed there so long that people forgot how "normal" works.
"Normal" is Treasury yields trending 1-2 percentage points above inflation in order to compensate bondholders for the use of their money. Right now, that means 4.5% yields are on the low end of normal. We don't see those bond holders getting fair compensation at this point and as a result we do not consider Treasury debt appealing to anyone who isn't forced like the banks to own it. Unless the Fed tightens again, that's only going to change if bond prices drop. Who wants that?
And Powell remains committed to cutting rates one way or another. That could come when inflation weakens or the economy itself cracks. Naturally we prefer the former scenario, but either way the days of 5% cash are numbered. If you're looking for higher returns in the long term, our High Yield portfolio remains where it's at.
Ares Capital (ARCC: $21, down 1%. Yield=9.3%)
High Yield Portfolio
Ares Capital, a leading business development company and alternative asset manager, disclosed a strong first quarter performance, with $700 million in revenue, up 13% YoY, compared to $620 million a year ago. Profits were $325 million, or $0.59 per share, compared to $318 million, $0.57, with a beat on estimates on the top and bottom lines.
The rise in the investment income number during the quarter was driven by an increase in interest income, alongside capital restructuring service fees and dividends. The company had an eventful quarter in terms of portfolio activities, with $3.6 billion in fresh commitments, compared to $770 million a year ago, and $3.6 billion in commitments exited during the quarter, nearly doubling from $1.9 billion a year ago.
Ares has continued to pursue value by bolstering and diversifying its capital base, and during the quarter this involved issuing, amending, and renewing over $7 billion of financing at attractive rates. The company’s portfolio is now valued at $23.1 billion, up from $21.1 billion a year earlier, distributed across over 500 portfolio companies, 66% with floating rates, and 46% in first lien senior secured notes.
The company has done well to make the most of the rate cuts to refinance its debt, but with the possibility of further rate cuts being muted, owing to persistent inflation and a robust labor market, Ares stands to benefit substantially, given its high concentration of floating rate loans. The Fed is hedging on its plan to cut rates, leaving another 6-12 months of elevated interest rates.
Following an 8% rally last year, and 2% so far this year, the stock still trades at a little over 6 times sales and 9 times earnings, offering substantial value for investors. It offers an enviable annualized yield of 9.3% while maintaining sustainable coverage, making it perfect for conservative, income-seeking investors. The company ended the quarter with a strong balance sheet. Our Target is $22 and our Sell Price is $19. We added the stock at $17.22 in 2018 and are now up 20%, and have been collecting over 9% in dividends year in and year out. A very steady investment.
On that note, we know of a very wealthy Wall Street insider in his mid-70s who is a bit concerned about the economy and global uncertainty, and he is very happy to be sitting in 5% Treasuries for the time being. We don’t feel this way, as we are more optimists than he is, but it is certainly food for thought. Wall Street climbs a wall of worry as you know, and we wish to be fully invested in the 60 or so stocks we follow. And if you feel a bit anxious about the economy and other factors, we believe that you could consider moving into our High Yield Portfolio and REIT Portfolio stocks, most of which pay from 7-10% dividends. This is a good income in an inflationary world of 2-3%.
Rithm Capital (RITM: $11.32, up 1%. Yield=8.8%)
High Yield Portfolio
Leading alternative investment management company Rithm Capital released its first quarter results last week, reporting $1.3 billion in revenue, up 66% YoY, compared to $780 million a year ago. It reported a profit of $230 million, or $0.48 per share, against $250 million, or $0.51, with a beat on estimates on the top and bottom lines, aided by continued strong mortgage servicing revenues (MSR) during the quarter.
The company was firing on all cylinders during the quarter, (and continues to fire…) with origination volumes hitting $10.8 billion, up 54% YoY, as borrowers anticipate interest rates to remain higher for longer. This puts the company in a sweet spot, meaning it will see originations grow going forward, with the higher interest rates, while its massive MSR portfolio, at $860 billion will get more valuable, with lower repayments and refinancings. We’ve been saying this for years. Book value is $12.19 as of March 30th. Thus the stock is trading at a discount of 7% to book. With book growing in the future, this appeals to us greatly.
Rithm owns and operates a series of brands across the entire spectrum of the real estate value chain, ranging from its NewRez refinance company to Shellpoint, its mortgage servicing brand, having successfully encompassed the entire real estate financial system. This allows the company to hedge against market cycles, with low interest rates aiding with higher originations, and higher rates raising the value of its MSR business.
Similarly, the company has a presence in the single-family rental market, with 4,270 units across various markets, operating under the brand name Adoor. As a result of the high interest rates, the company is benefiting from higher rents as potential buyers put off home purchases. Rithm recently made its foray into private equity, with its $720 million acquisition of Sculptor, once again aimed at diversification.
Following a 30% rally last year, and 6% this year so far, the stock still trades at a 7% discount to book value (Price/Book of 0.93), a mere 2 times sales, and 7 times earnings, offering substantial value for conservative and speculative investors alike. Its extensive diversification offers protection against volatility, as does its robust balance sheet position, with $1.2 billion in cash and $1.2 billion in cash flow.
Our Target is $13 and our Sell Price is $10.35. The company is driven by a CEO who wants to build a much bigger company. He has been at the helm for 10 years and wants to stay for another 10 years, building the company into a $20 billion company, from its current level of $5 billion. Michael Nierenberg is on a mission and we want to be on the mission with him. While he is building and growing the company, we are enjoying a dividend of 8.8% which will have to be raised in the future, as a REIT must pay out 90% of its income to maintain its REIT status. Our Target is doable later this year or early next, but our secret target is $17. Don’t tell anyone.
Good Investing,
Todd Shaver, Founder and CEO
The Bull Market Report
Since 1998
by Scott Martin | Apr 21, 2024 | Weekly Newsletter 7pm Sunday
Market Summary
The Bull Market Report
While some investors are convinced that September and October are the cruelest months, this year we're seeing April play out as a stormy season. Our stocks have stepped a collective 6% back since the month started, giving back nearly all their once-substantial YTD gains. Likewise, the Nasdaq and the Dow Industrials have also seen their 1Q rally evaporate, leaving both indices along with us on the brink of breakeven. Only the S&P 500, as middle-of-the-road as it gets in the modern market, is showing the bears any resistance whatsoever, and it's still down 5% so far this month.
People can blame the bond market for this, but in our view the situation is both more complicated and so simple that it needs little explanation at all. The last time stocks shuddered like this, nobody knew whether the Fed was finally done raising short-term interest rates, which ensured that there was still enough anxiety circulating to keep investors off balance. We had a pretty good sense then that the Fed's "pause" would continue for the foreseeable future, but nobody had the confidence to say for sure. As a result, money flooded out of the Treasury market into higher-yielding cash, leaving bond prices reeling and pushing yields up to 5% in the process.
A similar dynamic has played out this time around. The mood around the Fed has gotten significantly softer, with investors who had once hoped for nothing better than an extended end to rate hikes starting to bet more confidently on active rate cuts in the coming year. However, even that improved attitude is vulnerable to second guessing and frustration when the economic numbers flow the wrong way. As long as inflation remains stubbornly persistent, the Fed's calculus around rate cuts in the near term will remain difficult, and the hope that dominated the market early in the year gives way again to doubt.
That's the complex narrative. But when you look at the way stocks and bonds have moved in the last six months, you'll see a much simpler pattern emerge. Bond yields got so high in November that they started to strain the statistical limits, triggering an inevitable bounce when conditions finally reached an unsustainable level. When that happened, yields dropped and stocks rebounded. There wasn't any deep narrative going on here. It was just statistics. And then, around the new year, yields had swung all the way from testing the statistical ceiling to crawling on the floor, pushing markets in the opposite direction in response.
Again, just statistics. Money followed its own cyclical tide and human beings scrambled to tell the tale. The Fed didn't get in the way. A few weeks ago, markets were in roughly the same position as they were back in November. The cycle played out again. The earnings reports we'll review in the next few weeks may accelerate the ongoing correction; or give investors a strong enough reason to defy statistics and start buying again. For now, however, we're resigned to see stocks drift a little while before regaining their equilibrium. All part of life on Wall Street.
At moments like this, we look for pockets of relative strength and weakness to make sure we're positioned the right way to exploit the market's next moves. The fact that the losses are relatively evenly distributed tells us that this is not a problem for the economy or any particular sector. Our Healthcare recommendations are down roughly as much as our High Yield stocks this month, and the REITs and Stocks For Success have also experienced roughly the same level of pain in the last few weeks. When such a large slice of the market drops at the same speed and correlations across otherwise unrelated industries converge, the normal pattern of distributed strength and weakness disintegrates. There's no shelter, in other words. Defense and offense, established companies and speculative ones are all moving together.
That's the kind of move that tends to reverse itself in the pattern we've watched since November. In the meantime, we appreciate our Energy portfolio more than ever, as well as our allocation to SPDR Gold Shares (GLD). Gold is a hedge when everything else is suffering. That's why we're happy to be in gold right now.
There's always a bull market here at The Bull Market Report. With earnings season just underway, The Big Picture lays out where the growth is across the market and where we can anticipate it. The Bull Market High Yield Investor is all about making sure the yields we've gotten in the past will continue, which is important when the Fed keeps rates higher than a lot of investors think they can stand. And as always, we're talking about a few of our favorite stocks, including a few that have the power to change the market's mood when they report over the next few days. Don't forget: if you'd like different coverage or more detail on any topic, you know how to reach us. (Todd@BullMarket.com 970.544.1707).
Key Market Indicators
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The Big Picture: Where The Growth Is
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BMR Companies and Commentary
Axcelis Technologies (ACLS: $95, down 9% last week)
High Technology Portfolio
Axcelis Technologies designs and manufactures critical equipment for the $550 billion global semiconductor industry. It recently released its fourth-quarter results, reporting $310 million in revenue, up 17% YoY, compared to $270 million a year ago. It posted a profit of $70 million, or $2.15 per share, against $65 million, or $1.99, with a beat on consensus estimates on the top and bottom lines.
As the global semiconductor boom accelerates, Axcelis continues to see strong demand for its Purion Power Series product family, hitting $1.2 billion in order backlogs to end the year 2024. This can largely be attributed to the semiconductor nationalism, aimed at reducing dependence on Taiwan and minimizing the supply chain risks that come with the same. In addition to this, Axcelis is currently riding on the coattails of many other tailwinds, ranging from the electrification of the automotive industry to the global rollout of 5G, IoT, IIoT, and AI, among others. The company generates 98% of its revenue from the ion implantation market, where it maintains a strong portfolio of products, alongside substantial blockades leaving it with very few worthy competitors.
The stock, alongside the company’s performance, cooled off substantially over the past year, and much of this can be attributed to the rationalization of capital expenditure in the industry. Apart from this, China, where Axcelis generates 46% of its revenues, was been hit with a prolonged slowdown. However, now that the country is starting to turn around once again, we expect robust demand going forward.
After surging 140% in the first half of 2023, the stock has shed more than half its value from its all-time high of $201 last summer, currently down 24% year-to-date. This creates an interesting situation: a growth stock with a compelling valuation, trading at under 3 times sales and 12 times earnings, especially as it begins returning capital to investors with $15 million in buybacks during the quarter. With $510 million in cash, just $45 million in debt, and $160 million in cash flow, the company is poised for strong future growth in this industry that is roaring on all engines. The Target is $200 with a Sell Price of $105, both of which should be adjusted today. The stock is sitting now where it was a little over a year ago. In 2021, the stock was at $30. So let’s look at revenues and earnings.
| Year |
Revenue |
Earnings |
| 2023 |
$1.15 billion |
$250 million |
| 2022 |
$920 million |
$180 million |
| 2021 |
$660 million |
$100 million |
Note that the company is still tiny compared with the big boys in the industry, with a market cap of just $3 billion. The company might just be on the buyout list of many companies in the business.
We are moving the Target to $150 and the Sell Price to $75.
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Bill Holdings (BILL: $60, down 3%)
High Technology Portfolio
Financial management platform for small and medium-sized businesses, Bill posted its second-quarter results recently, reporting $320 million in revenue, up 20% YoY, compared to $260 million a year ago. It posted a profit of $70 million, or $0.63 per share, against $50 million, or $0.42, with a beat on consensus figures on the top and bottom lines, coupled with robust guidance for the third quarter and full year.
The company generates the bulk of its revenues from subscriptions and transaction fees, at $275 million, up 19% YoY, followed by float revenue, which is interest earned on client deposits, at $43 million. The latter number was a significant increase in recent years owing to higher prevailing interest rates. During the quarter, the company processed $75 billion in payments, across 26 million transactions, up 11% and 23%, respectively. The platform now hosts 470,000 small and medium-sized businesses located all across the world, up 19% YoY, alongside 5.8 million network members, 7,000 accounting firms, and 7 out of the 10 largest financial institutions, resulting in a strong barrier to its competition.
The company saw a marked slowdown in its growth rate, from 65% YoY in 2023 to just 20% during this particular quarter. This is owing to its significant macro exposure, and the prevailing broader slowdown, coupled with the company hitting a saturation point in certain regards. Its next stage of growth will come internationally, where it has an addressable market of over 330 million businesses.
Despite an 82% pullback in the stock from its all-time high in 2021, it still features a fairly expensive valuation of 5 times sales and 21 times earnings. During the quarter, the company returned $200 million to investors in stock buybacks, made possible by its $2.6 billion in cash reserves, $1.9 billion in debt, and $250 million in cash flow. Our Target is $85 and our Sell Price is $50. The company produced strong growth in revenues, having done $240 million in fiscal 2021, $640 million in 2022, and $1.05 billion in 2023. It appears that revenue for the fiscal year that ends June 2024, will total about $1.2 billion, quite a slowdown, just 16-18% growth when we have been used to 50%+ growth.
Bill Holdings has a $6 billion market cap, quite a comedown from the $36 billion it hit in 2021. Do we want to hang with the company now after this comedown? That’s a good question and one that you have to ask yourself as well. We like companies that are growing 30% a year or more, but perhaps we are entering a different dynamic lately and should be pleased with 15-20% growth. We’re going to stick with the company for a little bit longer but watch it closely. If the stock moves to the $55 level, our new Sell Price, we are moving on.
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PayPal (PYPL: $62, down 4%)
Financial Portfolio
Global payments giant PayPal released its fourth quarter results recently, reporting $8.0 billion in revenues, up 9% YoY, compared to $7.4 billion a year ago. It posted a profit of $1.6 billion, or $1.48 per share, against $1.4 billion, or $1.24, beating consensus figures on the top and bottom lines. The company, however, disappointed some on Wall Street, with its guidance for the coming year, at 6.5% revenue growth, making us think long and hard about the future of this investment. For the year, the company did $30 billion in revenue, up 8%, up 75%(!), with $4.2 billion in profits. The is no small company, clocking in at $65 billion in market cap.
The numbers are certainly big. During the quarter, the company’s payment volumes hit a record $410 billion, up 15% YoY, and $1.5 trillion for the full year, up 13% YoY. This was driven by a 14% YoY rise in total transactions per account, at 59, helping offset a slight decline in the total active accounts on the platform at 426 million, down 2%. This was largely the result of the company ending its extensive promotions involving bonuses and cashbacks.
Two years ago, PayPal was forced to manually close over 4 million accounts in response to massive promo fraud and abuse. It marked a shift in the company’s marketing strategy, and the repercussions of this are being felt to this day. It is now focused on the quality of accounts, rather than merely focusing on fresh new accounts opened, and it seems to be working well given the positive metrics that have resulted.
PayPal introduced several new services and initiatives in recent months, the most promising of which is its PYUSD stablecoin, designed to make international payments a lot smoother. It allows users to transfer US dollars to over 160 countries, without incurring any transaction fees, marking the company’s biggest foray into cryptocurrencies, in the $150 billion stable currencies market.
Following an 80% pullback since its all-time high in 2021, the stock trades at an enticing valuation of just 2.3 times sales and 12 times earnings. With a string of new products, services, and initiatives around the corner, extensive restructuring, and $5 billion in buybacks, we expect strong value creation in the months ahead. It ended the quarter with $14 billion in cash, $12 billion in debt, and $5 billion in cash flow. Our Target is $75 and our Sell Price is $48, hereby raised to $54. We’ve been with this company a long time, having added it at $31 in 2016. We’re looking at a 100% return which is fair, but the return was a lot better by 2021, three years ago, when it hit $310. Will it ever return to its glory days? Tough question. At this level and valuation, we have a company that is growing (revenues of $21 billion in 2021, $30 billion in 2023), with strong profits each year. We like this company and would suggest you stick with it and add to it as it moves higher (or lower – either way a winning strategy). The company is a leader, is strong financially, and will come out on top as we move into the 2nd half of the roaring 2020s.
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Shopify (SHOP: $70, flat)
High Technology Portfolio
eCommerce platform Shopify had a phenomenal fourth quarter to cap off an impressive year, posting $2.1 billion in revenue, up 24% YoY, compared to $1.7 billion a year ago. The company posted a profit of $440 million, or $0.34 per share, against $93 million, or $0.07, beating consensus estimates on the top and bottom lines, yet investors were dismayed with the light guidance provided for the new year.
The company’s merchant solutions segment led the way with $1.6 billion in revenue, up 21% YoY, followed by subscription solutions at $525 million, up 31% YoY. This was driven by steady growth in gross merchandise volumes and payments, at $75 billion and $45 billion, up 23% and 32% YoY, respectively, as Shopify penetrates deeper into the commerce value chain while being aided by a resilient US economy.
Shopify unveiled many new products and services during the quarter, starting with Shopify Magic, its suite of new AI tools to help run stores more efficiently. This was followed by Sidekick, its AI-enabled commerce assistant, and its new ChatGPT-powered shopping assistant for consumers, all aimed at unlocking value for merchants on the platform, and helping them go toe-to-toe against larger retailers.
The platform now powers 11% of all e-commerce sales in the US, an amazing number when you concentrate on it, and has endless potential for further growth, both in the US and internationally. What began as a solution for small businesses to set up online storefronts with ease turned into the platform of choice for large B2B and consumer brands, including the likes of AllBirds, Mattel, and Carrier among others.
Let’s take a moment to discuss what makes Shopify such a great company:
Shopify's success stems from a combination of factors for both e-commerce businesses and investors. Here's a breakdown of its strengths:
Ease of Use and Scalability
Simple Interface: Shopify boasts a user-friendly platform that allows entrepreneurs with minimal technical expertise to set up and manage their online stores.
Scalability: As businesses grow, Shopify scales with them. They can adjust their plans and add features seamlessly to accommodate increasing needs.
Wide Range of Features and Integrations
Built-in Features: Shopify offers a comprehensive suite of features for managing products, inventory, payments, shipping, marketing, and analytics.
App Store: The Shopify App Store provides access to thousands of additional apps and integrations, allowing businesses to customize their stores and extend functionality.
Strong Ecommerce Ecosystem
App Developers: A thriving app developer community constantly creates new extensions and tools for the Shopify platform.
Payment Gateways: Integrates with various popular payment gateways, offering flexibility for customers.
Support Resources: Provides extensive documentation, tutorials, and a supportive community for troubleshooting and learning.
Focus on Merchants
Affordable Pricing: Offers tiered pricing plans to cater to businesses of all sizes, making it an attractive option for startups and growing companies.
Success Stories: Shopify showcases success stories of merchants who have thrived using their platform, inspiring new entrepreneurs.
App Marketplace Revenue Sharing: Shares a portion of revenue generated by third-party apps with Shopify merchants, incentivizing app development for the platform.
Market Leader and Growth Potential
Market Share: Shopify is a dominant player in the e-commerce platform market, attracting a large user base and benefiting from network effects.
Constant Innovation: They continuously invest in research and development, introducing new features and expanding their offerings to stay ahead of the curve.
Global Presence: Shopify operates in a vast market with significant growth potential, particularly in developing economies.
Despite a 120% rally last year, the stock is still down by nearly 60% from its all-time high of $176 in 2021, while featuring an undeniably expensive valuation of 13 times sales and 70 times earnings. These figures are, however, well justified given its 20%+ YoY growth, and a 5-year CAGR of 40%. The company ended the quarter with $5 billion in cash, just $1.2 billion in debt, and $1.0 billion in cash flow. Our Target is $100 and we would not sell Shopify. We would suggest an over-allocation of this company in your portfolio. We believe in Shopify big time.
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Airbnb (ABNB: $155, down 3%)
Long-Term Growth Portfolio
Vacation rental giant Airbnb ended the year on a high note, with its fourth-quarter results, reporting $2.2 billion in revenue, up 17% YoY, compared to $1.9 billion a year ago. The company posted a loss of $350 million, or $0.55 per share, against a profit of $320 million, or $0.48, with a miss on earnings, but a beat on top-line consensus estimates, with strong guidance bringing respite for investors. The loss during the quarter was the result of a $620 million tax settlement with the Italian government, which amounts to 41% of its net profits for the full year. This, of course, is a one-time expense, and the company will return to profitability in the coming quarters. Other operating metrics and Key Performance Indicators were impressive, to say the least, hinting at a rebound in global and domestic travel.
Gross booking values hit a fresh high of $15.5 billion in the quarter, up 15% YoY, and a mammoth 80% since 2019, driven by a total of 100 million nights booked on the platform, up 12% YoY. With its new initiatives aimed at helping hosts unlock more value, the platform added a record 1.1 million new listings during the past year, up 18% YoY, bringing its total active listings to 7.7 million located around the world.
Airbnb was been faced with a few challenges and headwinds in recent years, starting with regulatory scrutiny, the ban in New York City, and intensifying competition. It is, however, working hard and succeeding in differentiating itself, much of which involves its new focus on creating experiences, not just renting rooms. This, coupled with its new AI-assisted booking tools gives the company an upper hand against competitors.
Going forward, the company will be unlocking value across its massive landed base of hosts and guests. As of now, it is in a sound financial position, with $10 billion in cash reserves, $2.3 billion in debt, and $3.9 billion in cash flow. In light of this, the company announced a fresh $6 billion stock buyback program, adding further support to its 15% rally YTD. Our Target is $195 and our SP is $125. This company has been changing the world as we know it, and we are here to say that it will continue to change the world of travel and experiences. At $100 billion in market cap, this is no small company. We expect it to hit new all-time highs ($214) in 2025 or 2026. Many very intelligent minds on Wall Street have large positions in the stock. You should too.
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Netflix (NFLX: $555, down 11%)
Long-Term Growth Portfolio
Streaming giant Netflix released its first quarter results last week, reporting $9.4 billion in revenue, up 15% YoY, compared to $8.2 billion a year ago. The company posted a profit of $2.3 billion, or $5.28 per share, against $1.3 billion, or $2.88, while blowing past estimates on the top and bottom lines. The stock ran into a bad day on Wall Street Friday and fell with big boys – Microsoft, Google, Facebook, Nvidia, Super Micro Computers, and others. But let’s put this in perspective. The stock was at $328 a year ago. It was at $555, its current price, two months ago in February. So a little pullback doesn’t faze us in the slightest. The numbers that the company produced are really all that matters. Take a look, below, at the new subscribers the company added in the quarter.
The company did remarkably well across a host of other metrics, starting with net new subscribers at an amazing 9.3 million, up from just 1.8 million a year ago, driven by its crackdown on password sharing and other initiatives. Total memberships on the platform closed in on 270 million, up 16% YoY, and well ahead of Street estimates at 264 million. Netflix, however, believes that subscriber growth is no longer its primary focus as it was all this while, with revenue, margins, engagement, and customer satisfaction taking its place. The company plans to phase out the reporting of its quarterly membership figures, a plan that hasn’t gone over well with investors, but this pullback was an overreaction nonetheless. The move to stop sharing membership figures each quarter was done with the same in mind. We are disappointed about this decision, but we’ll have to live with it. We’ll just have to watch revenues and profits even more closely, which is really what it’s all about anyway.
Netflix’s next stage of growth will come from monetizing its massive landed base and network effects, and the launch of its ad-supported pricing tier. Its foray into live sports streaming and video games was done in pursuit of the same. Other avenues include theatrical releases of select content to recoup its investment, merchandising, and product placements which have remained underutilized.
Despite the pullback last week, the stock remains up 18% YTD and 70% over the past year, while trading at a valuation of under 8 times sales and 32 times earnings. During the quarter, the company repaid $400 million in debt, while repurchasing stock worth $2 billion, made possible by its increasingly robust balance sheet position with $7 billion in cash, $17 billion in debt, and $7.3 billion in cash flow. Our Target of $590 was hit after the stock ran up to $638 in early April. Have no fear – that number will be seen again in the coming months. We’re raising our Target to $650 and our Sell Price remains: we would not sell Netflix.
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Blackstone (BX: $118, down 4%)
Stocks For Success Portfolio
Private equity giant Blackstone released its first quarter results last week, reporting $2.6 billion in revenue, up 2.6% YoY, compared to $2.5 billion a year ago. The company posted a profit of $1.3 billion, or $0.98 per share, against $1.2 billion, or $0.97, with a marginal beat on earnings and a slight miss on the top line. Business as usual for the largest manager of assets in the world. Fee-related earnings during the quarter stood at $1.2 billion. Fresh inflows stood at $36 billion, down 36% from the prior quarter and 16% YoY, but impressive nonetheless, considering its size. Its uninvested capital has now reached $190 billion.
All of Blackstone’s core funds posted strong performances during the quarter, with its core and opportunistic real estate funds gaining 1.0%. This was followed by its corporate private equity and infrastructure funds, up by 3.4% and 4.8%, and finally, its credit and hedge funds appreciating by 4.1% and 4.6%, respectively, which are impressive figures. This performance has been driven by strong global equity markets, coupled with an end to the Fed’s hawkish stance, reigniting mergers and acquisition activities that had come to a standstill over the past 18 months. The central bank remains non-committal on further rate cuts, which should help the market move forward on the deal-making front going forward.
Why Blackstone is a Leader:
- Experienced Team: Blackstone has a team of seasoned professionals with deep expertise in various investment sectors. This expertise allows them to identify promising opportunities, manage risk, and generate strong returns for their clients.
- Strong Track Record: Their long history of success and consistent performance have earned them a reputation for excellence in the alternative investment industry.
- Scale and Resources: The sheer size of their AUM allows them to access exclusive deals, negotiate better terms, and attract top talent, further strengthening their position.
- Focus on Innovation: Blackstone actively explores new investment strategies and asset classes, staying ahead of the curve and adapting to evolving market trends.
- Client Focus: They prioritize understanding their clients' investment goals and risk tolerance, tailoring solutions that meet their specific needs.
Overall, Blackstone's combination of a diverse range of alternative investments, a highly experienced team, a stellar track record, immense resources, and a commitment to innovation makes it a dominant force in the alternative investment landscape.
The stock is down 8% YTD, following a 76% rally last year, but we cannot discount its potential for consistent fee income, from its $1.06 trillion in assets under management. Blackstone returned $1.2 billion to investors in buybacks, in addition to its annualized yield of 3.6%.
It’s been a good investment for us. We added the stock at $27 in 2016 and we have a Target of $150 on the stock. We would not sell Blackstone. The firm has the best asset managers in the world and that allows stockholders to sit back and let them do their thing.
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Alphabet (GOOG: $156, down 2%)
Stocks For Success Portfolio
Reporting Earnings This Week!
While revenues and profits continue to scale unabated, Google parent Alphabet has had an undeniably rough couple of months. On the heels of its first quarter results this week, some investors remain ill at ease, with the company firmly on the backfoot on the AI front, trailing behind competitors such as Microsoft, which is making massive strides in collaboration with OpenAI across its suite of products and services. Note that we at The Bull Market Report are not some of those investors who are ill at ease with this great company.
Google has introduced the world to Gemini, its generative Artificial Intelligence entry into the competition for the world’s eyeballs. Have you tried it yet? Powerful beyond words. Plus, the company still has remarkable moats, with integrations across platforms, browsers, and devices. Whether it is ChatGPT itself, or Microsoft’s Bing search engine with the new AI tool, Copilot, neither can build the kind of ecosystem that Google has painstakingly acquired over the years. Stay tuned for a NewsFlash on Alphabet after earnings are released on Thursday after the close.
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Microsoft (MSFT: $399, down 5%)
Stocks For Success Portfolio
Reporting Earnings This Week!
Tech giant Microsoft is doing everything right of late, and its market cap of $3 trillion at 30 times earnings reflects the same. Certain analysts and observers are concerned that this AI-driven exuberance is set to burst, but this is remarkable shortsightedness that comes from traditional valuation models which fail to factor in the remarkable disruptive and value creation potential of the latest advances in AI.
Just last week, the company released a research paper on AutoDev, its new framework for automated AI-driven coding. This framework will make manual coding a thing of the past, and bring application development to individual managers, as opposed to large teams. Software development jobs in the future will be more management and supervising of AI, rather than coding and development.
The company is set to release its third-quarter results after the close on Thursday, and more than its earnings and beat on consensus figures, we are looking forward to its next big exploits on the AI front. Microsoft made groundbreaking advances in AI in 2023, and we expect this momentum to continue unabated this year, as it unveils its growing prowess in this field across its massive portfolio of products and services. Stay tuned for a NewsFlash on Microsoft later this week after earnings are released.
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The Bull Market High Yield Investor
Concerns about persistently high inflation locking the Fed into high interest rates have rattled the bond market in particular but stocks are also feeling the pressure, seemingly confirming the common belief that once rates cross a certain threshold the environment gets toxic fast. But here's the reality: Going back across the past four decades, whenever 10-year Treasury yields spiked above 6%, the S&P 500 delivered an average annual return of 14.5%, compared to a less exuberant 7.7% return in years when bonds were paying less than 4%.
As it turns out, stocks performed better during periods of rising interest rates, with an average annual rolling one-year return of 13.9% as opposed to 6.5% in a falling rate environment. That probably isn't our world right now, but it supports the way the market has resisted its most bearish impulses as the economy adjusts to the Fed's most aggressive moves.
Remember, lower rates can often signal sluggish economic growth. The Fed cuts in the face of looming disaster and stays there until they’re 100% sure we’ve averted disaster. As a result, higher rates may actually reflect a stronger economy and the prospect of better corporate earnings, factors that usually bode well for the stock market. What's going on now?
Bond yields have been climbing since April, with the 10-year Treasury yield peaking near its highest level since November. This coincided with a decline in the S&P 500.
However, in our view, this anticipates a “return to normalization” with yields eventually settling around their 75-year average of 5%. You read that right. Rather than being some toxic frontier, 5% is average. It’s normal. And it’s really just about 2 percentage points above ambient inflation. If the Fed coaxes price pressure back down to its target, that translates to bond yields staying at or above 4%.
But the most important thing here is that the world didn't end in November, which is the last time long-term rates got this high. Unless something fundamental has broken in the last 5-6 months, the world is unlikely to end now. What matters to us is where the bond market starts paying a high enough yield to become a compelling alternative to dividend-paying stocks. Right now, we aren't especially impressed with anything less than 2 percentage points above ambient inflation, which eliminates just about the entire Treasury market from serious consideration.
Yields need to get higher to give stocks or even cash a run for their money. That means the bond market is in for more pain. And in that scenario, the risk-return calculations favor our High Yield recommendations as a place to park money and earn income at relatively low risk. They might not have the same near-zero risk profile as federal debt, but they make up for it by offering investors a chance to collect additional upside over time. Bond returns are fixed if you hold them to maturity. Stocks are always a work in progress, where we sacrifice certainty (nothing is "fixed") in exchange for a potentially richer long-term return.
However, our ability to say that with any degree of confidence requires some sense that dividends will keep coming. Congressional bickering aside, there's no threat that Treasury bonds will fail to pay the rate you lock in when you buy them. But if you can't count on your stocks to at least keep their dividends where they are, there's no clarity there at all. You want to know that your portfolio can pay the bills. If something starts to look like it isn't working, it needs to go. That's where we are now with one of our holdings.
BlackRock Income Trust (BKT: $11.37, up 1%. Yield=9.3%)
REMOVING FROM ACTIVE COVERAGE
A leading closed-end fund with exposures to mortgage-backed securities as well as US government treasuries, BlackRock Income Trust had been on an ascendant streak since the latter half of last year, but this momentum has since fizzled out. Yet, none of this should matter to conservative, income-seeking investors, with a long enough time horizon, given the fund’s remarkable yields.
The trust’s rally starting mid-last year was largely the result of the Fed ending its hawkish stance, and embarking on rate cuts for the first time in two years. Things, however, have changed in recent weeks, with the Federal Reserve now seemingly in no hurry to cut rates any further, resulting in a pullback in the stock, and leaving it down by 8% YTD.
The Trust invests in AAA-rated securities, backed by government agencies such as Fannie Mae and Freddie Mac. As interest rates rise, bond prices go down, and the stock trades at a discount to book value – currently 11%.
The trust is struggling to cover its distributions as of now, and analysts fear that a dividend cut is around the corner. This has put pressure on the stock and will put more pressure on the stock.
The stock has been a laggard for quite some time now. In the last 12 months, the stock is down 8% and there is some conjecture that the firm may have to cut its dividend. If that happens we can see the stock drop another 8% in the following month. We don’t want to take this risk so we would suggest a sale of the stock at this point. We are thus removing the stock from coverage. The investment hasn’t been a good one for us. We added the stock at $18.33 in 2019, and we should have gotten out a long time ago.
Good Investing,
Todd Shaver, Founder and CEO
The Bull Market Report
Since 1998
by Scott Martin | Feb 25, 2024 | Weekly Newsletter 7pm Sunday
Market Summary
The Bull Market Report
After the trauma and endless anxieties of the last few years, it's no shock that a lot of investors are still unwilling to accept the evidence that the Wall Street Journal headlines and our own account statements tell us every day: stocks have not only recovered their equilibrium but pushed past all historical peaks into record-breaking territory. That simply doesn't happen unless rational markets weigh the opportunities that corporate innovation can unlock against the threats we all face, and ultimately decide that it's better to bet on progress than hide on the sidelines. Money is flowing into stocks. Cash is getting back to work in pursuit of better outcomes than the yields money market accounts currently pay.
And since earnings provide a tangible sign of how well all that corporate innovation is working, it's clear now that the innovators have faced every challenge of the last few years and come up smiling. Across the corporate landscape as a whole, the situation is under control. The world hasn't ended yet because if it had, we wouldn't be here to write this and you wouldn't care enough to read it. Confidence in capitalism survives. After three bear markets in five years (ranging from the now-almost-forgotten 2018 Trade War meltdown to the 2022 Fed hangover, with the COVID crash in the middle), investors are willing and able to let hope and even a little greed drive their decisions.
(That bit about "greed" is important. With the S&P 500 up nearly 28% in the past 12 months, people who clung to a defensive position in those money markets might have slept well at night, but they're also susceptible to envy. They're falling behind their friends and relatives. As their fear swings toward FOMO - fear of missing out - they're going to join the party that we never left, but have quite a stretch to catch up.)
Earnings are moving higher again, despite the Fed raising rates, despite inflation, despite the perpetual certainty that there's always another recession lurking just over the economic horizon. Macro conditions have been a real drag on corporate results. Should any of those conditions improve, corporate results will register the relief. That's why people are so fixated on the Fed actively cutting interest rates. As far as we're concerned, the most important thing is that the Fed stopped actively making things worse months ago. Rates got as bad as they're going to get. Companies survived. They evolved. And now they're leaner, meaner and more dynamic than ever.
There's always a bull market here at The Bull Market Report. As another quarterly corporate confessions cycle winds up, we'd like to use The Big Picture to talk about where the season leaves us and what we see ahead, while the individual stock updates below provide more specific feedback on how well various recommendations have done and look to do in the future. The Bull Market High Yield Investor has a simpler mandate this time around: If interest rates have peaked, what income-oriented investments make sense? We hope you'll appreciate the conclusions. And as always, reach out if you'd like different coverage or more detail on any topic. You know how to reach us. (Todd@BullMarket.com).
Key Market Indicators
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The Big Picture: A Champion Earnings Season
Sometimes the investor's life boils down to knowing how to grit through the challenges until the moment comes when the world finally turns your way. That's the mindset Wall Street has had to maintain through the Fed's long war on inflation and the pressure that higher interest rates put on an economy that was otherwise on the verge of overheating. We all needed the conviction to see better times ahead. According to all the numbers we've been seeing this season, that pivot from anticipation to gratification is finally here.
The 4th quarter of 2023, has produced a great earnings season in the first two months of this year. The fundamentals are trending up faster than they have since mid-2022, when the Fed really started getting aggressive in its tightening campaign, and operations across the S&P 500 started to feel the sudden deceleration in the air. Back then, earnings growth across the market had slowed to a 2.5% crawl, which felt sluggish at the time. After that, things got worse, with "growth" shifting into reverse as inflation and interest rates squeezed margins from both sides. It took an entire year before the executives running these companies could make enough tough decisions to get the numbers moving back in the right direction.
Three months ago, we got our first hint that growth was back on the menu. Expectations were extremely low, but those executives managed to manufacture a few percentage points of positive progress. This earnings season started from a similar playbook and effectively ended on another high note last week. From a fundamental perspective, the bulls have won. Across the S&P 500, growth is on track to not only stay positive for the second quarter in a row but accelerate from a little over 2% to roughly 4%. With two data points on the books, Wall Street now feels a lot more confident in projecting that the current quarter will also show that companies are still expanding at a reasonable rate and not contracting at all.
Following earlier interest rate increases aimed at curbing inflation, the Fed has paused its tightening cycle for the past few months. While inflation remains above target, recent data indicates some moderation in price pressures. This provides the Fed with more leeway in its policy decisions, unless unforeseen circumstances cause a rapid resurgence in inflation. What we're left with is a sense that the future will be not only better than the present but the past as well. That's why year-over-year growth is so important. It means progress.
And progress is good. Companies that generate more cash than they did in the past deserve to have more valuable stocks. Record earnings support record-breaking markets like the one we're in now. That's the world where the bull is in control. You can see that story play out in the way stocks have responded to this season's quarterly reports. Since the big Banks started the cycle on January 13th (five weeks ago), the S&P 500 and Nasdaq have rallied close to 7%. Remember, in the long term it can take the market a full year to generate results like this. These are the boom times.
Bull Market Report stocks have outperformed the broader benchmarks. This season has handed our portfolios a gain of 7.5% across all recommendations, almost a full point ahead of the high-flying Nasdaq. The winners are easy to see. In the core Stocks For Success portfolio, Amazon (AMZN) and Berkshire Hathaway (BRK-B) have been superstars, rewarding shareholders at a rate more than double the Nasdaq. Meta (META), Netflix (NFLX), Snowflake (SNOW), The Trade Desk (TTD) and of course NVIDIA (NVDA) did even better than that. How about Super Micro Computer (SMCI), which more than earned its name with a 165% gain during this earnings season. Outside the Technology space, it's hard to ignore what The Carlyle Group (CG), Novo Nordisk (NVO), Eli Lilly (LLY) and Recursion Pharmaceuticals (RXRX) are doing. We'd like to single out Eli Lilly here. This was the season that the stock turned into a four-digit (1000%) win on our watch, since the initial Research Report back in 2016. That's more than 100% every year. Beat that, bond bulls!
This is not to even hint that every single one of our stocks spent this season cheering. There are a lot of pain points. But that's how life in the market always plays out. On any given day or in any given season, there are winners and there are losers. As long as your winners do well enough to compensate for the losses, you end up ahead. And leadership rotates. A lot of the champions this quarter may stall or even fumble three months from now. Some of the underdogs will come back fiercer than ever. We haven't given up on any of our current underdogs, although some of the decisions were extremely tough. They'll come back. Meanwhile, our champions will run the field as far as they can. Their quarterly reports gave them a lot of fuel, and the next season doesn't even start until mid-April, so there's plenty of time for a victory lap or two.
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BMR Companies and Commentary
NVIDIA (NVDA: $788, up 9% last week)
High Technology Portfolio
Another Blowout Quarter As AI Hits The Tipping Point
The most anticipated earnings call this season was an absolute blowout on Wednesday after the close, with chipmaker Nvidia soaring past consensus estimates across the board. The company posted $22 billion in revenue, up 265% YoY, REPEAT: 265% - that’s almost FOUR TIMES, compared to $6 billion a year ago, with a profit of $12.8 billion, or $5.16 per share, up from $2.2 billion, or $0.88 the prior year, as it rides on the coattails of an unprecedented global phenomenon.
Figures for the full year were just as impressive, with a mammoth $60 billion in revenue, up 125% YoY, compared to $27 billion a year ago, with a profit of $32.3 billion, or $12.96 per share, against $8.4 billion, or $3.34 – four times the year before. The stock popped 16% following the results, adding a record $272 billion to its market cap, the largest ever since Meta added $195 billion following its fourth-quarter results over two weeks ago. Some compared the one-day jump in market cap to Nvidia adding more than an Intel Corporation. In. One. Day. This is truly an incredible story. Oh – Here’s more. The founder, Jensen Huang got $10 billion richer on Nvidia’s share price surge that day. The Nvidia CEO saw his overall wealth increase to $69 billion after the stock in the California chip maker he founded in 1993 jumped more than 16% after it outstripped expectations in posting exceptional fourth-quarter results. The market cap increased by $280 billion on Thursday.
During the quarter, Nvidia’s data center division led the way with $18.4 billion in revenue, up 400% YoY, driven by massive new capex spending in the segment, with technologies like generative AI taking resource utilization to a whole new level.
Not one to rest on its laurels, the company has unveiled a string of new products, solutions, and collaborations during the quarter. This includes the Nvidia DGX SuperPod for drug discoveries; the MONAI API for cloud-based medical imaging; collaborations with Google, Cisco, Amgen, and many more, creating insurmountable network effects that no newer entrant or established player can match.
As it inches close to a $2 trillion market cap, ($1.96 trillion now) Nvidia’s more than 5X rally over the past 14 months is already the stuff of legends. There is no questioning the quality of this company, or the role it is set to play in the future. The only debate that continues to rage is relative to its valuation, and whether it can justify the same. This largely stems from the market’s inability to wrap its head around the coming age of AI.
A question asked on ChatGPT consumes much greater server resources than a traditional Google search. As people get accustomed to the new way of searching and finding information online, and while newer use cases and applications start cropping up, AI data and processing requirements will rise dramatically each passing year for the foreseeable future.
OpenAI’s Sam Altman recently had a lot of eyes rolling when he sought $7 trillion to develop silicon-chip manufacturing capacity that can power artificial intelligence. A figure that is two to three times the size of the global electronics industry is a bit hard to digest but doesn’t seem that off the mark considering that generative AI is set to add 7% to global GDP, or $6 trillion over the next 6 to 7 years alone, which we believe is a rather conservative estimate.
Trading at 32 times sales and 40 times earnings, Nvidia is anything but cheap but is certainly nowhere close to its peak given its pole position in the biggest tech story of this century. The company is already rewarding investors generously with $10 billion in dividends and buybacks this year, made possible by a strong balance sheet, with $26 billion in cash, $11 billion in debt, and $28 billion in cash flow. For them to raise another $5-10 billion in equity via a secondary would be easy as pie. Super Micro Computer (SMCI) just completed one last week, raising $1.7 billion in a convertible bond offering.
We added the stock at $460 in December. Our Target is currently $600 with the Sell Price of $400. We are changing the Target to $900 and the Sell Price to $700. We secretly think the stock could go to $1,500 or higher this year. Don’t tell anyone.
Listen, Artificial Intelligence is changing the world we live in. And we are guessing that you probably haven’t felt any of it yet, meaning that the ballgame is in the top of the 1st inning with just one out. There is a long, long road ahead and it is very exciting. All of Silicon Valley is working on AI as we speak. And again, AI is driving the stock market higher. It set an all-time high Friday. Dow, S&P and Nasdaq. But the story is LONG TERM. We believe Nvidia will be higher later this year and next. 2026? This company could be the largest in the world. It’s number 3 now; Microsoft at $3.04 trillion and Apple at $2.82 trillion look out!
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Ally Financial (ALLY: $36, up 1%)
Financial Portfolio
Leading auto finance company Ally Financial released its fourth quarter results recently, reporting $2.1 billion in revenues, down 6% YoY, compared to $2.2 billion a year ago. Profits of $140 million, or $0.45 per share, were down from $330 million, or $1.08, with a beat on consensus figures at the top and bottom lines, coupled with strong guidance.
For the full year, the company posted $8.2 billion in revenue, down 3%, compared to $8.4 billion a year ago, with a profit of $930 million, or $3.05 per share, against $1.9 billion, or $6.06. The drop in its performance during the past year was largely owing to rising provisions for bad debt, alongside fresh FDIC charges, both of which remain in line with the broader industry in recent quarters.
Despite a challenging year, the company continues to post strong operating metrics. While auto origination volumes dipped 14% to $40 billion for the full year, compared to $46 billion previously, the number of applications increased by 4% from 12.5 million to 13.0 million. Retail deposits have hit $142 billion across 3 million customers, up from $138 billion and 2.7 million during the year-ago period.
Ally earned insurance premiums of $1.3 billion during the quarter, its highest ever, made possible by its growing dealership network. Total active credit cardholders hit 1.2 million, up 20% YoY, offering a compelling return profile for the company, while its bread and butter auto loans hit an average yield of 10.8%, up 124 basis points over the past year, with negligible impact on originations.
Following a 43% rally in 2023, the stock still trades at 1.2 times sales and 9.8 times earnings, while offering an annualized yield of 3.3%. Ally is well positioned for an extended rally, with the low interest paid on deposits resulting in marked improvements in net interest margins. It ended the quarter with $7 billion in cash, $21 billion in debt, and $4.7 billion in cash flow. Our Target of $35 was breached late last month at $38 and it has been holding steady all this month. Our Sell Price is $27. We’re bullish on this one and are raising the Target to $43, and the SP to $31. At $11 billion, the company is fairly small in the world of finance and we can see strong growth ahead, through organic growth and future acquisitions.
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Financial Select Sector SPDR Fund (XLF: $40, up 2%)
Financial Portfolio
The Financial Select Sector SPDR Fund is a leading ETF for those looking for exposure to the Financial Services industry. The fund, like the banking and financial services sector that it tracks, had a roller coaster of a year in 2023, starting with the regional banking crisis in March, which saw massive pullbacks across the board, followed by a strong recovery leading it to end the year with a gain of 10%.
Several small banks shut down last year, and while the fund has escaped unscathed, largely owing to its focus on quality, blue chip securities in the industry, there are stressors in the sector that remain a challenge. Unrealized banking losses are now estimated between $1.5 to $2.0 trillion, and the US banking system is now somewhat reliant on the Federal Reserve stimulus to shore up and deal with liquidity issues.
This stimulus may not last forever, forcing banks to reckon with the crisis sometime over the course of this year. Fortunately, the Fed has officially ended its hawkish stance on interest rates and is expected to announce 1-3 rate cuts in 2024, offering banks and financial institutions much-needed respite. Rate cuts may not eliminate these unrealized losses, but can certainly provide a breather.
The Fund has escaped and remains insulated from the worst of this crisis, thanks to its extensive diversification. Its biggest holding has been, and still is Berkshire Hathaway, at nearly 14%, followed by JP Morgan Chase, Visa, Mastercard, Bank of America, and Wells Fargo, among others. Most of these banks have limited exposure to treasuries, or are well-capitalized to warehouse these underwater bonds.
The sector is set for a rebound in 2024, and few other funds are better suited to ride this trend. With an expense ratio of just 0.10%, an extensive track record going back decades, and a pedigreed management team, we expect strong value creation with the fund over the coming months. There certainly are risks, but the Fund, as well as the industry, are much better positioned today than they were a year ago. Our Target is $47 and our SP is $30, hereby raised to $35.
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The Carlyle Group (CG: $45, flat)
Special Opportunities Portfolio
This private equity giant released its fourth quarter results recently, reporting $900 million in revenue, down 15% YoY, compared to $1.1 billion a year ago. Profits were $400 million, or $0.86 per share, compared to $430 million, or $1.01, with a beat on consensus estimates on the top and bottom lines, coupled with strong guidance helped send the stock on an extended rally.
For the full year, the company produced $3.4 billion in revenue, down 30% YoY, compared to $4.4 billion a year ago. It posted a profit of $1.4 billion, or $3.24 per share, against $1.9 billion, or $4.34, owing to dropping asset sales and dealmaking across the board. The past year was undeniably challenging, but Carlyle ended on a high note and is set to carry forward strong momentum for the new year.
During the quarter, the firm realized $5.2 billion in proceeds from asset sales, and $20.6 billion for the full year, down from $8.6 billion, and $33.8 billion a year ago. It made fresh investments worth $7.2 billion, and $20.0 billion for the full year, compared to $6.8 billion, and $34.0 billion. Its total assets under management have hit a fresh high of $430 billion, up 14% YoY, with $76 billion in dry powder.
Carlyle’s private equity portfolio gained 2% during the quarter, followed by credit funds appreciating by 4%, but its real estate portfolio continues to struggle with a 2% decline, and its infrastructure and natural resources funds were largely flat during the quarter. Global real estate is currently in a state of flux, with a lot of changes taking place, not just in high-end commercial real estate, but in residential markets as well.
Despite a challenging year, the stock fared well in 2023, posting 36% in gains, which will and already is extending into the new year. With the Fed’s hawkish stance coming to an end, M&A transactions will start to pick up once again, boding well for fee revenues. Carlyle has authorized $1.4 billion in buybacks, made possible by its $1.8 billion in cash reserves, $9.3 billion in debt, and substantial cash flows.
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Exxon Mobil (XOM: $104, flat)
Energy Portfolio
Energy giant Exxon Mobil released its fourth quarter results early this month, reporting $84 billion in revenue, down 12% YoY, compared to $95 billion a year ago. It made a profit of $10.0 billion, or $2.43 per share, against $9.2 billion, or $2.27, with a beat on earnings, but a slight miss on top-line figures. This, however, didn’t dent the stock’s rally, owing to broader optimism surrounding the oil and gas industry.
For the full year, Exxon produced $345 billion in revenue, down 17% YoY, compared to $415 billion a year ago, with a profit of $40 billion, or $9.52 per share, against $60 billion, or $14.06. The drop in figures during the quarter and the full year are largely in line with expectations, owing to the fall in oil and gas prices YoY, as the elevated prices stemming from the wars in Ukraine and Gaza, normalized during the year.
During the quarter, the company produced 3.8 million barrels of oil equivalent per day, up 136,000 barrels compared to the prior year, owing to developments in the Permian Basin, as well as at its assets in Guyana. The company’s upstream profits took a $2 billion hit during the quarter, owing to regulatory issues at its Santa Ynez Unit assets in California, without which Exxon would have had a stellar beat.
A lot is happening around oil and gas prices at the moment, with a recovery in China, the Red Sea conflict, and a drawdown in US inventories, all creating short-term tailwinds. However, leaving all of this aside, what matters to us is Exxon’s remarkable execution over the years, which has seen its earnings power double from 2019 to 2023, totally irrespective of oil prices, margins, and other factors.
Exxon Mobil’s $60 billion acquisition of Pioneer Natural Resources is set to conclude halfway through this year, giving rise to substantial cost and operational synergies. The company has a lot going for it and yet it still trades at 1.3 times sales and 11 times earnings. The company returned $32 billion to investors and maintained a strong balance sheet with $32 billion in cash, $42 billion in debt, and $55 billion in cash flow. Our Target is $120 and our Sell Price is $85. We’re going to tighten the SP to $95 just in case.
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SPDR Gold Shares ETF (GLD: $189, up 1%)
Special Opportunities Portfolio
The SPDR Gold Shares ETF is the largest gold fund in the world by quite a margin. Its extensive track record, low expense ratio, minimal tracking errors and massive liquidity have made it the most sought-after instrument for most investors seeking a hassle-free option to gain exposure to gold. The fund had a great year in 2023, up 13%, and looks set to continue along the same lines this year, owing to several factors.
To start with, central banks across the globe have started buying gold heavily, with the World Gold Council expecting demand for the precious metal to hit a new record this year. With the Federal Reserve indicating 1-2 rate cuts in 2024, the US dollar will be vulnerable to outflows, prompting various country emerging and developed central banks to diversify their currency reserves with gold.
Historically, each time the Fed ends a hiking cycle, the gold charts a robust performance the following year, and we expect the same this year as well. This bullish cycle often lasts three to five years, but we expect something a lot more robust this year owing to the commodity being significantly undervalued relative to the S&P 500, with the ratio hitting the lowest levels in history.
Gold is still a safe haven during times of uncertainty, and given the increasing geopolitical risks and conflicts across the world, starting with Ukraine, the Middle East, and now a massive military build-up in China, there are plenty of catalysts in the near term. Given a long enough time frame, the commodity’s prospects are many times better, with several tailwinds aligning in its favor. This includes the Dollar being replaced as the world’s reserve currency, with many countries signing unilateral trade agreements that sidestep the currency altogether. (However, we don’t think this will happen anytime soon.) Besides this, the fact that the Fed printed 80% of all US dollars in existence during the course of COVID alone, clearly points to the fact that gold, and not US Treasuries are the ultimate hedge against the excesses of the US government.
Our Target is $215 and our Sell Price is $175. The current price of gold is $2,030, having peaked at $2,135 in December. Where is it headed? Only time will tell. But we’re leaning to “higher.” Remember, the SPDR GLD Trust actually holds gold in its vault, equal to its market cap which currently stands at $56 billion.
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CBRE Group (CBRE: $90, down 3%)
Stocks For Success Portfolio
Our favorite diversified real estate conglomerate released its fourth-quarter results a week ago, reporting $9.0 billion in revenue, up 9% YoY, compared to $8.2 billion a year ago. Profits came in at $430 million, or $1.38 per share, against $420 million, or $1.33, with a beat on consensus estimates at the top and bottom lines, coupled with a strong guidance for the full year leaving investors optimistic.
For the full year, the company hit $32 billion in revenue, up 3.6% YoY, compared to $31 billion a year ago. Profit came in at $1.2 billion, or $3.84 per share, down from $1.9 billion, or $5.69, largely owing to investment volumes dropping during the year, with high interest rates, and a fundamental realignment in the commercial real estate segment taking a toll on the company’s advisory business.
During the quarter, CBRE’s advisory services saw $2.59 billion in revenue, down 1%, compared to $2.61 billion, followed by its Global Workplace Solutions at $6.1 billion, up 15% YoY, compared to $5.3 billion. The Real Estate Investments segment, which includes its development solutions, as well as asset management, was down 10% at $260 million in revenue, compared to $290 million.
These figures are rather phenomenal, considering that commercial real estate investment volumes in the US dropped 44% YoY during the quarter. If anything, the company’s performance during this past year shows its resilience in the face of a remarkably tough macro environment and is a testament to its extensive diversification across services, asset classes, geographic locations, and more.
Following a 21% rally in 2023, CBRE still trades at a valuation of less than 1 times sales and 21 times earnings. Now that the Fed’s hawkish stance is slowly coming to an end, the stock is set for a rally this year, riding a long overdue recovery in the real estate market. The company has $1.5 billion in pending buyback authorizations, ending the year with $1.3 billion in cash, $4.9 billion in debt, and $500 million in cash flow. Our Target is $105 and our SP is $73, hereby raised to $85. Let’s play the SP tight, as there is some negativity surrounding commercial real estate at the moment, although CBRE makes money in good times and bad. In fact, companies need their services way more in tough times.
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Meta Platforms (META: $484, up 2%)
Long-Term Growth Portfolio
Social networking giant Meta Platforms ended the year on a high note, with a spectacular fourth-quarter performance early this month. The company posted $40 billion in revenue, up 25% YoY, compared to $32 billion a year ago, with a profit of $14 billion, or $5.33 per share, exactly triple YoY, from $4.7 billion, or $1.76 per share, with a beat on consensus sending the stock soaring following the results, jumping from $394 to $475.
The company’s figures for the full year were just as extraordinary, with $135 billion in revenue, up 16% YoY, compared to $117 billion a year ago. It posted a profit of $40 billion, or $14.87 per share, up from $23 billion, or $8.59. This can mostly be attributed to the rebound in digital ad spends, following a slump last year, and the year before, coupled with accelerating user growth across its family of apps.
Meta’s extensive family of apps, which includes the Facebook platform, WhatsApp, Instagram, Facebook Messenger, and now Threads, had 3.2 billion daily active users on average during the quarter, up 8% YoY. Monthly active users across the family were mere inches away from 4 billion, an increase of 6% YoY, driven by growing interest penetration, and the company’s efforts in retaining and engaging users.
Ad impressions during the quarter grew 21% YoY, with the average price per day increasing 2% YoY, which is rather impressive. This means that despite the supply of inventory increasing significantly, ad prices kept up, and this highlights a major rebound in global digital ad spending. Meta is now focused on unlocking other sources of revenue across its massive landed base, beyond its traditional advertising.
Despite the stock’s phenomenal 440% rally since mid-2022, it is still rather undervalued, and with its first dividend announcement and a potential stock split later this year, it is far from done. The company’s year of efficiency has been a phenomenal success, with significant improvements in its cost profile following layoffs, before ending the year with $65 billion in cash, $38 billion in debt, and $71 billion in cash flow.
Our Target was smashed at the beginning of the month, having blown by the $350 target late last year. We are raising it today to $550. Our Sell Price doesn’t exist. We would not sell META/Facebook. The market cap is now over $1 trillion, at $1.25 trillion. #6 in the country/world. Can you name them? Hint: MANAGM
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Recursion Pharmaceuticals (RXRX: $13.37, up 32% in the past two weeks)
Early Stage Portfolio
Recursion Pharmaceuticals is a pioneering biotech company that develops AI and machine learning-enabled platforms to aid in the process of drug development.
The company is a research company at this point, with revenues minimal. They have almost $400 million in cash in the bank, and debit of just $50 million. Many bigwigs of the tech and investment world are paying close attention to its massive potential in the world of new pharmaceuticals. When we first started coverage for this stock, we discussed how it had Cathie Woods’s stamp of approval, with ARK’s funds owning 4 million shares in the company, which we thought was pretty good. This figure has now gone up to its current level of 23 million shares in all of ARK’s funds. ARK INVEST now owns a sizable 8.5% stake in the company, valued at $300 million, which is enough to get analysts to pay attention to the stock. Now, just two months since our first report on the stock, semiconductor giant, Nvidia has announced that it has invested $76 million into this company, and this is in addition to the $50 million that it had already invested last year.
Recursion aims to industrialize drug discovery, and it plans to achieve this by building a massive library of chemical compounds and their reactions with gene types, before letting the forces of AI and ML work their magic. It has already partnered with Nvidia to power its supercomputer, BioHive-1*, and this partnership is set to grow deeper, with the two innovators playing off each other's strengths.
* BioHive-1 is Recursion’s supercomputer, one of the top 500 supercomputers in the world and the fastest supercomputer wholly owned and operated by any biopharma company
Key Points of the recent News Release from the company last week:
- Recursion announces a multi-year collaboration and $50 million investment from NVIDIA.
- This collaboration aims to accelerate the development of Recursion's AI foundation models for drug discovery.
- NVIDIA will provide computational power, expertise, and access to their BioNeMo platform for model training and distribution.
- Both companies share a vision to revolutionize drug discovery through AI.
Benefits of the collaboration:
- Faster development of advanced AI models.
- Wider reach and impact of Recursion's models through Nvidia’s BioNeMo, a generative AI platform that provides services to develop, customize and deploy foundation models for drug discovery.
- Improved data-driven strategy and model release for Recursion.
Significance:
- Marks a major step towards Recursion's goal of becoming a leading "techbio" company.
- The collaboration has the potential to significantly impact the development of new medicines.
Today, pretty much anything that Nvidia touches turns into gold, so as soon as its fresh investment was announced Recursion’s stock popped 20%. But note that Recursion is partnering with other companies like Roche/Genentech and Bayer on drug discovery efforts. Our Target is $18, hereby increased to $28. Our SP is $8. THIS STOCK IS VERY SPECULATIVE.
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The Bull Market High Yield Investor
Despite a few hot inflation prints earlier this month, the investors who really care about interest rates aren’t worried enough to vote with their wallets. There’s zero real money in the futures market riding on any more tightening moves from the Fed. Zero. Which cuts through a lot of the doomsday chatter. If anything, the odds of a significant number of rate CUTS this year remain high. Rate futures traders think we’ll see 2-4 loosening moves, enough to take overnight rates down 0.5% to a full percentage point. That’s real relief. It’s enough to take rates down to where they were a year ago or even lower.
The world did not end a year ago. Everyone now knows that the current level of monetary austerity is survivable. Sustainable. It might sting to pay that much interest, but we’ve seen that the economy has been able to bear it. And if the absolute level of interest isn’t toxic in itself, then the only thing to fear is time. Rates are likely to start going down before the end of the summer, but have they stayed too high for too long for borrowers to handle? We think the answer is no. For one thing, even borrowers who got into debt at the highest rates (last summer) will rush to refinance the minute the Fed relaxes. The more ground the Fed gives up, the more leeway they’ll have to refinance.
The relief spreads. Things feel better. All we need for that to happen is for inflation to show us real signs of improvement. The PCE will set the tone on Thursday morning. If it’s good, the futures market has the right idea and there’s no need to be afraid. It only gets complicated if the numbers come in as hot as the CPI and PPI did. In that scenario, rate relief will be elusive. But in the past, the economy has grown fast enough to power through higher borrowing costs. It evidently doesn’t take much. GDP is on track to expand about 2.5% in the current quarter. That’s a good sign.
Growth is the engine that keeps the economy moving forward. It’s the gas pedal. Rates are the brake. As long as the gas is pushing the car forward faster than the brake is slowing it down, the economy is in a good place for investors. It’s that simple. Whether the Fed gets its foot off the brake or not, the gas is flowing. But in a strong economy, stocks have what they need to outperform.
Bonds, meanwhile, are only attractive if you can lock in yields that you can be satisfied with over the long haul. That satisfaction is in the eye of the investor, but as far as we're concerned, locking in around 4% a year (or barely 2% above inflation, even if the Fed achieves its target) is not exactly a thrilling outcome. We'd rather chase higher income from corporate dividends, where growing companies end up with more cash to share with shareholders. Then there are chances to simply capture a higher current yield than anything the Treasury market can give you . . . and these opportunities often have other advantages as well. We profile one of each type of investmetn here for you.
Prologis (PLD: $133, flat. Yield=2.6% right now, but it could rise over time)
REIT Portfolio
Warehousing giant Prologis released its fourth quarter results recently, reporting $1.8 billion in revenue, up 10% YoY, compared to $1.6 billion a year ago. It created a profit, or FFO of $1.20 billion, or $1.26 per share, against $1.18 billion, or $1.24, which was broadly in line with estimates, and despite light guidance for the new year, the stock has been on an ascendant streak ever since the results.
The company’s full-year figures were impressive, with revenues at $6.8 billion, up 40% YoY, compared to $4.9 billion a year ago. Profits were $5.3 billion, or $5.61 per share, against $4.2 billion, or $5.16, driven by robust occupancy rates, at 97%, record new lease commences at 44 million square feet, and a retention rate of 73%, among many of other internal and macroeconomic factors.
It had an eventful quarter and year when it comes to fresh deployments, with $500 million worth of acquisitions during the fourth quarter alone, and $730 million for the full year. This was followed by $3.2 billion worth of development stabilizations, $3.4 billion in new development starts, and finally $1.6 billion in dispositions, all perfectly aligning with Prologis’ capital recycling initiatives.
Prologis currently remains right in the sweet spot amidst massive global tailwinds, with the e-commerce boom not showing any signs of slowing, and the supply constraints in recent years forcing merchants to maintain larger inventories. As a result, in the third quarter of 2023, it raised rents by a phenomenal 74% on all expiring leases, because it could, and there was plenty of demand from companies to pay for it.
Following a 19% rally last year, the stock is not cheap by any measure, trading at 16 times sales, and 40 times earnings. However, given its massive addressable market, it wouldn’t be wise to value it like any other REIT. This is a growth stock that pays a nice dividend and with a strong balance sheet ($530 million in cash, $30 billion in debt, and $5.4 billion in cash flow) has the potential to raise that distribution a lot more over time.
Guess what? We looked back a decade and saw that Prologis "only" paid $0.28 per share quarterly back then. Shareholders who locked in at that point have seen their payout soar to $0.87 in the intervening years. They paid about $40 for that income stream in 2014, which means that what was once a 2.8% current yield is now handing them 8.7% of their initial investment every year. If the trend continues, investors today who are willing to settle for less than 3% can ultimately enjoy a similar outcome.
Either way, our Target is $160 and our SP is $110, raised today to $120. This is no small company, with a $123 billion market cap. Solid as a rock.
Nuveen Municipal Credit Income Fund (NVG: $11.85, up 1%. Yield=4.6% tax free, or the equivalent of 7.7% taxable)
High Yield Portfolio
Since hitting its lowest levels in over a decade, the Nuveen Municipal Credit Income Fund has created a stellar rebound over the past four to five months. Following significant value erosion for over two years owing to the Fed’s hawkish stance, the possibility of multiple rate cuts in 2024 has reignited optimism in the Fund, presenting a once-in-a-decade opportunity for value investors and speculators alike.
Municipal bonds are now in a plum position, with the muted possibility of further rate hikes eliminating downside risks, and a higher for longer interest rate environment allowing for significant value creation and equity-like yields. Yields are at the highest point to start the year since 2011, and for the first time in over a decade, investors will enjoy attractive total returns from cash, a dynamic that has long been absent.
After the second consecutive year of net outflows in munis in 2023, at $19 billion, we expect demand to start rising soon, as tax loss harvesting starts to subside, and there is more clarity on the Fed’s interest rate strategy going forward. Higher yields and lessening volatility will compel mutual funds and other institutional investors to lock in yields by reallocating funds from other assets in favor of muni bonds.
Despite a net outflow in 2023, it is worth noting that much of it was driven by redemptions at short-term funds, whereas longer-term funds recorded a net inflow of $10 billion during the year. Portfolio managers should now start to pursue moderately longer duration profiles, aimed at creating enduring value as it becomes increasingly certain that rate hikes are coming to an end, with cuts on the horizon.
In addition to broad-based tailwinds in its favor, the Fund at a Book Value of $13.55 trades at a 14% discount, offering tax-free yields of nearly 4.6%. In this light, there are few better funds to ride this trend than the Nuveen Municipal Credit Income Fund. Our Target is $16 and our SP is $11.
Good Investing,
Todd Shaver, Founder and CEO
The Bull Market Report
Since 1998
by Scott Martin | Dec 17, 2023 | Weekly Newsletter 7pm Sunday
Market Summary
The Bull Market Report
We were feeling pretty good a few weeks ago. Now, the Fed has given us permission to openly cheer. The BMR universe is up 40% YTD, with portfolio after portfolio soaring faster this month than the Nasdaq and the S&P 500 put together. At this point, our stocks are poised to leave the market as a whole far behind, and it isn't hard to understand why. Investors are finally looking forward to a future that's tangibly better than the past. If there's a recession in 2024, the odds are good that it will be relatively mild. From a corporate perspective, the recession that matters has already come and gone. We're back in a world where the fundamentals are improving again instead of deteriorating as they did for much of this year. Yes, earnings are shifting back into record-breaking gear.
The Dow Industrials have responded by recovering their pre-bear-market highs and then moving even farther forward into record territory. While the Nasdaq and the S&P 500 aren't quite there yet, the pain we endured last year has almost entirely evaporated. The BMR universe, for example, is where it closed out 2021. That's an important milestone because it means that for the first time in months, investors who held on through the Fed's aggressive tightening cycle are on the verge of breaking even. They haven't lost appreciable money. The only thing they've lost is time. At the rate our stocks are moving, we're making up for that lost time fast. Sooner or later, we'll be back on our long-term trend, and the way statistics work means that after a period of underperformance, we can look forward to accelerated gains for at least a little while to come.
In other words, the best may be yet to come. The earnings cycle that starts next month will almost certainly be the strongest we've seen in the 12 months. After that, the year-over-year numbers can get even better as corporate executives shake off all the pressure on their operations and get back to work. Inflation has receded to something like "normal" historical levels. Profit margins remain robust. Supply chains have become far more resilient than they were before the pandemic. A new wave of technological innovation is already boosting productivity, enabling worker-starved companies to do more with the people they have. Mass layoffs like we saw in 2008 or 2020 look relatively remote at this stage.
Of course, additional shocks can create setbacks. But life is full of shocks and as we love to say, Wall Street has survived generations of shocks (world wars, social upheavals, oil embargos, pandemics, credit crashes, high and low bond yields, high and low taxes) and thrived. That's "normal." Something new emerges to worry about and investors find a way around or over that wall of worry. Stocks continue their long record-breaking trajectory. In a bear market, it's easy to forget that the S&P 500 has spent most of its life chasing from peak to peak, taking us all to levels of unprecedented wealth along the way. This isn't simply our optimism talking. It's historical fact.
Granted, the road is never smooth from day to day, week to week, or even year to year. But the ultimate direction is never really in doubt. Everyone at the Fed who votes on monetary policy currently thinks interest rates will go down in the coming year. Nobody seriously thinks rates will go up. The drag we feel from that direction is unlikely to increase. This is as bad as it gets in this cycle. And when you're already feeling the worst, those statistical rules tell us that things are going to get better. All we need to do is keep our eyes open and remain disciplined enough to stay in the market waiting for that reward. What we've weathered in the last few months was simply the bears struggling to reassert their relevance. We just saw the so-called "bond king" Jeffrey Gundlach try to argue that 10-year bonds yielding less than 4% is a red flag when two short months ago he was worried that 5% was going to poison the economy.
There's always a bull market here at The Bull Market Report. As always, we need to talk about several of our favorite stocks, leaving The Big Picture to delve into a few of the "defensive" themes we like a whole lot less in this environment. The Bull Market High Yield Investor dissects a few of the things Fed Chair Jay Powell said this week that resonate with our investment philosophy, as well as our thoughts on the economic landscape as a surprisingly great year winds up. The holidays are coming. Santa is here.
Key Market Indicators
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The Big Picture: Check Your Defense
A lot of investors stayed sidelined this year after the 2022 bear market crushed any confidence in the market they had left. After all, the pundits told them, a recession was imminent and exposure to stocks could only add to the pain. But sometimes a defensive posture is the surest way to fail. Start with the bond market. If you bought 1-year Treasury paper a year ago, it’s maturing now. You’ll get your money back, plus 4.65% interest. There was no risk there. However, the money you’re getting back is worth 3.1% less than it was at the end of 2022, thanks to inflation. The interest payments don’t stretch as far either. All in all, for every $100 you put in, you’re getting the equivalent of $101.40 back. And in the meantime, everyone else was passing you like you were standing still. The S&P 500 gained 22% in that same 12-month period. The Nasdaq jumped a staggering 48%.
Adjust for inflation all you want, but those investors are still significantly richer than they were when you parked that $100 in the bond market where it wasn’t vulnerable to much besides opportunity costs. Stock investors gritted their teeth, closed their eyes, and jumped. They were rewarded for that calculated risk, that leap of faith. And not every bond investor was foresighted enough to buy the actual bonds and hold to maturity. Long-term bond funds are down a net 6-7% in the last 12 months. Yes, it is possible to lose money in the Treasury market when other people are buying high and selling low on your behalf.
Likewise, investors who wanted to stay in the stock market but clung to the “defensive” sectors missed their shot at the dramatic recovery. In effect, those who were in aggressive areas of the market during the bear cycle locked in their losses while locking out the rebound that followed. Utilities are down 9% over the past year. They lost money. Cash is flowing into areas of the economy that are more vibrant and have the power to rally when the bulls are in charge. Defensive consumer stocks (think Big Food and grocery stores) are down. Don't get us wrong, we remain committed to our defensive line, but we aren't going near areas of the market that are clear losers. They rarely do well in an economic downturn. It’s just that they rarely drop hard. They preserve more value than other stocks when the market as a whole takes a dive.
In other words, there is rarely a way to make real money unless you can leverage them with options like some people try to do. What these sectors are all about is protecting existing capital. If you already have more capital than you need, a strong defense is a decent way to hold onto more of it for a longer period. But most of us want to build wealth. We want more than we have. That means a strong offense. Think technology, communications, and discretionary consumer stocks. Industrials. These companies have what it takes to grow. Sometimes that proposition falters, but over time, they run farther to the upside than the downswings take away.
Look at the Industrials. Say you bought the sector on the brink of the COVID crash. You made about 25% in the years that followed until the 2022 bear market got in the way. At the very worst moment of the bear cycle, your initial investment showed a slight loss. Today, about a year from that bear bottom, your initial investment has recovered all lost ground and more. You’re up 35% across the cycle. That’s a strong offense. The gains are bigger than the losses. You end up ahead. Cycle after cycle, you get farther ahead.
How about utilities? Down a net 9% across the same period. How about a bond fund? Down 20% counting dividends. Ouch. The defense was lethal. Gold did well, but gold is a hedge against inflation. And a lot of people were desperate for an inflationary shield in the last few years. We would have rather been in gold than bonds. Thanks to our SPDR Gold Shares ETF, we are. But then again, we are always happy to stay in stocks. To each their own. Feel free to tell us how you feel! Your feedback helps to guide our recommendations to fit your needs.
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BMR Companies and Commentary
The Carlyle Group (CG: $42, up 13% last week)
Special Opportunities Portfolio
Alternative assets manager The Carlyle Group posted a smaller-than-expected but tangible drop in earnings during its recent third-quarter results. The company posted $780 million in revenues, down 45% YoY, compared to $1.4 billion a year ago, with a profit of $370 million, or $0.87 per share, down from $640 million, or $1.42. It, however, posted a spectacular beat on consensus estimates during the quarter.
Private equity giants such as Carlyle have struggled in recent months owing to high interest rates, macro uncertainties, and geopolitical conflicts putting a dampener on M&A activities. This, however, didn’t stop the company from realizing proceeds worth $5.6 billion from asset dispositions during the quarter, as it deployed $4.1 billion towards new investments and acquisitions, bringing it to $12.6 billion YTD.
The Carlyle Group is a global investment firm that specializes in alternative asset management, primarily focusing on private equity, real assets, and private credit. They manage a staggering $380 billion in assets under management as of this moment, making them one of the world's largest private equity firms.
Here's a breakdown of their business, an IN-DEPTH LOOK:
1. Private Equity:
Carlyle's bread and butter. They invest in established companies across various industries like aerospace, consumer, defense, energy, healthcare, technology, and more. They typically acquire majority or controlling stakes in these companies, aiming to improve their operations and drive value creation before selling them later for a profit. Think of them as financial alchemists, turning underperforming companies into gold.
2. Real Assets:
This segment focuses on investments in infrastructure, real estate, and energy assets. They invest in things like airports, ports, pipelines, warehouses, renewable energy projects, and even student housing. Carlyle aims to generate stable income and long-term capital appreciation through these investments.
3. Private Credit:
This newer arm provides financing to mid-sized companies that often struggle to access traditional bank loans. Carlyle offers various debt solutions, including senior loans, mezzanine debt, and distressed debt, catering to different risk appetites.
What makes Carlyle so good at what they do? Here are some key factors:
Experienced Team: Founded in 1987 by a group of seasoned Wall Street veterans, Carlyle boasts a team with extensive expertise in finance, investing, and operations.
Global Reach: With offices in 28 cities across six continents, Carlyle has a deep understanding of different markets and economies, allowing them to identify promising investment opportunities worldwide.
Industry Focus: They have a strong track record in specific sectors like aerospace, consumer, and healthcare, giving them valuable insights and relationships within these industries.
Operational Expertise: Carlyle doesn't just invest money; they actively work with portfolio companies to improve their operations, streamline processes, and drive growth.
Strong Network: They have built strong relationships with investors, governments, and other industry players, giving them access to deal flow and valuable information.
The company is like a well-oiled machine, seamlessly navigating the complex world of alternative investments and generating significant returns for its investors. Carlyle’s funds have shown remarkable resilience in the face of headwinds. While capital market activity remains a bit weak, there has been a steady recovery during the third quarter, and this coupled with the Fed’s recent pivot on interest rates indicates a strong possibility of good times ahead.
The firm’s fundraising activity has slowed a bit with the new higher-interest-rate environment that we have been in this year, at $6.3 billion during the quarter, down from $8 billion a year ago, bringing total assets under management to $380 billion, up 3% YTD. It now has dry powder that is ready to be invested of over $70 billion, as it looks for new opportunities across private equity, real estate, and credit to unveil themselves.
Despite the challenging conditions, the stock is up by 40% YTD but is down 30% from its all-time high of $60 two years ago. It currently offers remarkable value, as well as an annualized yield of 3.3%. The company stands to unlock substantial value going forward. It has a strong balance sheet with $1.7 billion in cash and $9.2 billion in debt. Our Target is $45 which we are raising today to $53, and our Sell Price is $28 which we are raising today to $34.
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SPDR Gold Shares ETF (GLD: $187, up 1%)
Special Opportunities Portfolio
The largest gold ETF in the world by a wide margin, the SPDR Gold Shares ETF is looking more upbeat than ever heading into the new year. Gold briefly traded above $2,100 an ounce early this month, setting a new all-time high, before falling to its current level of $2,030. Following a mixed year, it is now up by 10% YTD since gold prices started to rally a few months ago. With prices near all-time highs, we expect this rally to continue into 2024, even as broader consensus anticipates a soft landing for the US economy.
Gold prices have seen significant volatility in recent weeks, mainly owing to the shift in investor sentiment, and the decline in post-pandemic inflation that has prompted the Fed to end its hawkish stance. That being said, there are still signs of weakness in the US economy. Gold is a vehicle for wealth preservation and hedging.
In addition to this, central banks across the world are increasingly stockpiling gold in response to the rising national debt in the US, along with a debt crisis brewing in the broader world economy. There is also the growing institutional demand, during this period of growing geopolitical tensions in several conflict regions.
During the upcoming year, many factors in play will decide the direction of precious metals. A hard landing or recession for the global economy would send investors running for cover, and prompt the Fed to cut rates, making gold more attractive. Similarly, while high interest rates have a negative correlation with gold, staying higher for longer can make the yellow metal a lot more attractive.
Following a disappointing show since the pandemic, gold is stirring once again, and there are few better ways to gain exposure to it, than the SPDR Gold Shares ETF. With a nearly two-decades-long track record, an expense ratio of just 0.4%, and robust liquidity (8 million shares a day on average), no other fund even comes close. We’re sure you know this, but in case you don’t, the SPDR Gold Shares ETF actually owns gold bars. The current level of assets owned (gold) is $57 billion. It is hidden away in HSBC Bank USA, London, as well as other undisclosed locations. Guess why they are not disclosing the locations! Our Target is $190 and our Sell Price is $160. We are raising both to $215 and $175.
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Visa (V: $258, up 1%)
Financial Portfolio
Global payments giant Visa released its fourth quarter results recently, reporting $8.6 billion in revenues, up 11% YoY, compared to $7.8 billion a year ago. The company posted a profit of $5.6 billion, or $2.27 per share, against $4.2 billion, or $1.93, with a beat on estimates on the top and bottom lines. It further posted an upbeat guidance for the new year, sending the stock on an extended rally ever since. Every time we write about Visa and mention their profits, we are in awe. Look at those numbers above. On $8.6 billion in revenues, they reported $5.6 billion in profits. We must say there are very few, if any more profitable companies on a percentage of revenues. Apple is good at 30%, but Visa is insanely good at 65%, after tax.
The company’s full-year figures were just as exceptional, with $33 billion in revenues, up 11% YoY, compared to $29 billion a year ago. It posted a profit of $17 billion, $8.29 per share, against $15 billion, or $7.01. Despite being faced with a wide variety of headwinds, the company has continued its ascendant streak, made possible by its growing partnerships and integrations across the ecosystem.
During the quarter, the company posted robust performances across core operational metrics, with total processed transactions at 56 billion, up 10% YoY. This was followed by a similar growth in payments volume and cross-border volumes at 9% and 16%, respectively. This was once again made possible by Visa’s growing penetration across geographies, use cases, and product classes.
Its value-added services are helping unlock substantial value for banks, merchants, and financial institutions, all the while creating substantial competitive moats for the company. Visa’s tap-to-pay, payment account tokenization, and business expense management tools are a few of the many products, services, and solutions that the company has unveiled in recent years, that have since gained traction.
The stock is up 24% YTD, scaling new heights each passing month, and perfectly justifies its valuation at 16 times sales and 26 times earnings, given the massive digital payments tailwinds in its favor. Visa rewards shareholders generously with $5 billion in dividends and buybacks during the quarter alone, made possible by its $20 billion treasure trove, just $21 billion in debt, and $21 billion in cash flow.
The stock hit a new all-time high Wednesday at $263. Our Target is $265 and We Would Never Sell Visa. The Target is hereby raised to $295. This $530 billion market company is heading higher, of that there is no doubt. We added the stock seven years ago in 2016 at $70. How are we doing? And where do you think the stock will be in another seven years? Let’s put it this way: If you don’t have any shares, get some in your portfolio!
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Eli Lilly (LLY: $572, down 4%)
Healthcare Portfolio
Pharmaceuticals giant Eli Lilly released its third quarter results recently, reporting $9.5 billion in revenues, up 37% YoY, compared to $7.3 billion a year ago. The company posted a profit of $3.1 billion, or $3.39 per share, against $1.8 billion, or $1.98. It was, however, hit with a $3.0 billion charge from acquiring in-process research and development during the quarter.
During the quarter, the company saw strong growth in its metastatic breast cancer drug, Verzanio, with sales hitting $1 billion, up 68% YoY, and the diabetic medication, Jardiance at $700 million, up 22% YoY. However, other blockbuster products such as Trulicity fell a bit, with a 10% drop in sales YoY, largely owing to the changes to estimates for rebates and discounts during the period in question.
The big news for the company and shareholders during the quarter is the US and EU approval for its anti-obesity drug Zepbound, with results showing a reduction in major cardiovascular events, in addition to substantial weight loss benefits. The drug will be available by the end of this month. Goldman Sachs expects this class of drugs to bring in $150 billion in additional revenues through 2030.
Eli saw strong progress on the pipeline front, with FDA approval for Omvoh, to treat adults with ulcerative colitis. These developments couldn’t have come at a better time, considering that it is set to lose exclusivity to Trulicity in the US by 2027, eating away a good chunk of its revenues.
Eli Lilly had a banner year for its pipeline in 2023. Here's a breakdown of the highlights:
Regulatory Approvals:
- Donanemab (Lecanemab): This Alzheimer's disease treatment received FDA approval in July, becoming the first anti-amyloid therapy to reach the market. This was a major milestone for Lilly and a promising development for Alzheimer's patients.
- Mirikizumab: This IL-23 inhibitor was approved in September for plaque psoriasis, offering a new option for patients.
- Lebrikizumab: This IL-13 inhibitor was approved in the US and EU in December for adults and adolescents with severe nasal polyposis, offering relief from a debilitating condition.
- Tirzepatide (Zepbound): This dual GLP-1 and GIP receptor agonist completed positive FDA approval came in November. It appears that it will become a blockbuster drug for weight management.
Late-Stage Pipeline Advancement:
- Pirtobrutinib: This BTK inhibitor demonstrated promising efficacy in Phase 3 trials for mantle cell lymphoma and chronic lymphocytic leukemia. On December 1, 2023, the Food and Drug Administration granted accelerated approval to pirtobrutinib for adults with chronic lymphocytic leukemia or small lymphocytic lymphoma.
Eli Lilly has done remarkably well this year, with the stock posting a YTD rally of 57%, and while its valuations might seem expensive at 16 times sales and 46 times earnings, they are perfectly justified given the potential of its new drugs in the obesity niche. The company ended the quarter with a strong balance sheet, comprising $2.6 billion in cash, $20 billion in debt, and $5.7 billion in cash flow. Our Target is $665 and We Would Not Sell Eli Lilly. We added the company at $69 in 2016. We like this company!
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ServiceNow (NOW: $698, flat)
High Technology Portfolio
Enterprise cloud computing giant ServiceNow released its third quarter results recently, reporting $2.3 billion in revenues, up 25% YoY, compared to $1.8 billion a year earlier. The company posted a profit of $240 million, or $1.18 per share, against $150 million, or $0.74, with a beat on estimates at the top and bottom lines, coupled with strong guidance for the full year resulting in an extended rally for the stock, rallying from $530 to its present level at $700. The stock hit a new all-time high this week at $720.
Subscription revenues led the way with $2.2 billion in revenues. Current remaining performance obligations stood at $7.4 billion, up 24% YoY, which is set to be realized over the next 12 months, largely the result of large multi-million dollar, multi-year commitments from leading organizations across the world. During the third quarter alone, the company inked 83 new deals with annual contract values over $1 million, an increase of 20% YoY. It currently boasts a total of 1,800 customers with annual spends in excess of $1 million, and 50 customers spending more than $20 million, an increase of 58% YoY. A few new additions included the US Air Force, Cleveland Clinic, and one of the world’s largest automakers.
As always, the company continues to go all-out when it comes to growing its base and executing plans. So far this year, it has unveiled 5,000 new capabilities, including a wide range of generative AI features to help its customers unlock value. The company has since embedded AI across all workflows, with text summarization, chat, and search being a few of the many new features available to customers.
The company is slowly, but surely turning its platform into a must-have for enterprise systems and workflows. If not for its extensive platform and features, the partnerships and integrations it has built over the years will create substantial moats to stave off competitors making it a strong value creator going forward. It ended the quarter with $4.1 billion in cash, $2.3 billion in debt, and $3 billion in cash flow.
This is no small company, clocking in at $143 billion in market cap. It’s certainly not cheap when you look at the P/S ratio – Price to Sales. 6-10 is high. ServiceNow checks in at 143/8.5 which equals 17. Revenues for the past few years were $4.5 billion, $5.9 billion, $7.2 billion in 2022, and what looks like $8.5 billion in 2023. If the company can hit $10 billion in 2024, that would bring the P/S ratio down to 14 – high but not killer high. Our Target is $650 and our Sell Price is $500. The stock blew through our Target in mid-November. Let’s do this: We are raising our Target to $800 and raising our Sell Price to $650. This is a high-flyer for sure. We love the company and believe they will continue to go places in the future. They are showing good growth in revenues, profits are good, but not stellar. But if the market turns sour, high flyers tend to fly lower, many times quickly. Watch your investment here closely.
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Occidental Petroleum (OXY: $59, up 4%)
Energy Portfolio
Hydrocarbon exploration company Occidental Petroleum released its third quarter results recently, reporting $7.4 billion in revenues, down 22% YoY, compared to $9.5 billion a year ago. It posted a profit of $1.1 billion, or $1.18 per share, down from $2.5 billion, or $2.44, but posted a beat on estimates on the top and bottom lines, coupled with a rise in its full-year guidance figures.
The drop in revenues and profits during the quarter is largely in line with the broader energy industry, which has been hit hard by falling global oil and gas prices after a run-up last year. The company, however, produced 1.22 million barrels of oil equivalent per day, above its estimates in August.
Its chemicals business, OxyChem, posted a profit of $370 million, down slightly from $440 million the prior quarter, owing to falling margins. The marketing segment posted a loss of $130 million, as against a loss of $30 million the prior quarter, as midstream margins started to get squeezed amidst falling global demand and prices.
During the quarter, the company announced that it wished to acquire the oil and gas producer CrownRock, in a deal estimated to be worth $12 billion. This will add 170,000 barrels of oil production per day, and 1,700 more undeveloped locations, with the potential to create substantial cost synergies going forward. Occidental is now diversifying into carbon capture, even as its fossil fuel business continues to go strong. Carbon capture has been in the news recently, especially at the Climate Change Conference that just ended in Dubai. Oxy is one of the first to invest in this potential big business.
The stock is down 4% YTD, trading at under 2 times sales and 12 times earnings, offering immense value to investors. It has made great use of the cash it generates each quarter, with $1.5 billion in YTD preferred stock redemptions, and it bought back $340 million of Berkshire Hathaway's preferred shares, bringing redemptions this year to 15% of the initial $10 billion investment by Warren Buffett's firm that was used by Occidental to fund its acquisition of Anadarko Petroleum in 2019. It has rapidly reduced debt, all the while continuing the $600 million in stock repurchases. Our Target is $90 and our Sell Price of $61 is lowered today to $50. We would be buyers of Oxy here at $59, rather than sellers. If Warren likes it, we like it. Not always, but certainly here. We can see Berkshire making an offer for the whole company at something north of $75 a share sometime in 2024 or 2025. This could be one of Warren’s last large legacy moves.
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C3.ai (AI: $31, up 10%)
Early Stage Portfolio
Enterprise AI startup C3.ai released its second quarter results last week, reporting $73 million in revenues, up 17% YoY, compared to $62 million a year ago. The company posted a loss of $15 million, or $0.13 per share, against a loss of $12 million, or $0.11, with a beat on earnings estimates, and a miss on the top line figures, despite which the stock posted a 15% rally following the results. The company’s subscription revenues now constitute 91% of total revenues. During the quarter, the company added a string of new marquee customers to its roster. This includes the likes of GlaxoSmithKline, Indorama, and First Business Bank. It expanded its agreements with Nucor, Hewlett Packard, Roche, and Con Edison, among others.
C3’s federal bookings continue to remain upbeat, with 20 new agreements signed, representing half of total new bookings during the quarter. It further expanded its agreements with Federal agencies such as the US Navy, the Office of The Director of National Intelligence, the Defense Logistics Agency, and the Department of Health & Human Services, among others.
In the sprawling landscape of digital innovation, C3.AI stands out as a beacon of practical intelligence. They haven't gone chasing the latest Artificial Intelligence whims; instead, they've chosen to forge a path through the dense jungle of business complexities, armed with the tools of artificial intuition. Their mission? To equip organizations with weapons, not of war but of optimization, growth, and informed decision-making. For example, oil and gas companies can now monitor the health of their assets with hawk-like precision, while manufacturers can produce optimized production lines. C3.AI software helps banks fight fraud by using algorithms to spot early warning signs, preventing major problems. The company focuses on solving specific industry problems, making its solutions relevant and accurate. Plus, their platform is easy to use, even for people without an AI background. C3.AI is making AI accessible and practical for everyday businesses, paving the way for a future where AI is a real tool for success.
Growth has slowed down in recent quarters largely owing to its pivot to a consumption-based pricing strategy, where it plans to implement a pricing model based on vCPU/Hour*, which it believes will be the standard for cloud software pricing going forward. This model brings C3’s solutions within the purview of small businesses and startups, as opposed to large government agencies and enterprises like it is today.
* Virtual central processing unit - A pricing model that refers to a cloud computing billing system where you pay for the vCPU resources you use per hour.
C3’s growing partner ecosystem has been its biggest achievement so far this year, having closed 40 agreements with the help of its partners such as AWS, Baker Hughes, Booz Allen, Google Cloud, and Microsoft. Despite the volatility, the stock is close to a triple YTD, and while profitability remains elusive, the company is well capitalized, with $760 million in cash, and no debt. Our Target is $50 and our Sell Price is $24.
Don’t forget how volatile this stock can be. The market cap is only $3.7 billion, so an influx of buy or sell orders can move this stock by 3-5 points a day and more. Be very careful with this speculative stock. It’s not profitable and Wall Street hasn’t liked non-profitable stocks for the last two years. (It never really has liked them, but has tolerated them in various periods over the past decades.) However, any sustained downward movement in the overall market will knock this stock for a loop. We can see it below $20 before you know what hit you. Be careful.
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Energy Transfer (ET: $13.71, up 3%. Yield=9.1%)
Energy Portfolio
Midstream giant Energy Transfer Partners reported its third quarter results recently, posting $21 billion in revenues, down 10% YoY, compared to $23 billion a year ago. Profits hit $470 million, or $0.15 per share, down from $900 million, or $0.29, owing to the sharp drop in the prices of natural gas and natural gas liquids over the past year and a half. The company hit record natural gas transportation, fractionation, and export volumes, up by 14%, 9%, and 20% on a YoY basis, respectively. Its intrastate and interstate transportation volumes were up by 2% and 15%, respectively, followed by crude transportation and terminal volumes posting growth of 23% and 15%, another significant record for the firm.
Energy Transfer is a midstream energy giant playing a crucial role in moving natural gas and natural gas liquids (NGLs) across North America.
What They Do:
- Transportation: ET owns and operates an extensive network of pipelines, spanning nearly 90,000 miles, that transport natural gas, natural gas liquids, and crude oil to processing facilities, storage areas, and ultimately, end-users.
- Processing: Through its network of processing facilities, (80 gas processing plants in Texas, Louisiana, Pennsylvania, Oklahoma, and Wyoming, among others, Energy Transfer removes impurities and separates NGLs from raw natural gas, unlocking their commercial value.
- Storage: ET boasts massive storage capacity for both natural gas and NGLs, enabling companies to manage supply fluctuations and optimize delivery.
- Marketing: ET acts as a matchmaker, connecting producers of natural gas and NGLs with buyers at the best price, earning fees for facilitating these transactions.
What They Own:
- NGL Fractionators: ET owns 8 fractionators with a total capacity of approximately 1.15 million barrels per day (mbpd).
- Some of their facilities combine fractionation and storage, so the total number of fractionation units might be slightly higher.
- NGL Fractionation & Storage Hubs: The exact number isn't publicly available, but:
- They mention "several" NGL fractionation and storage hubs in their project highlights.
- Given their focus on integrated facilities, a significant portion of their 8 fractionators may also function as hubs with storage capabilities.
- Export Terminals: They currently operate 3 export terminals:
- Nederland Terminal in Texas
- Marcus Hook Terminal in Pennsylvania
- AltaGas Liquids terminal in British Columbia, Canada
Energy Transfer remains resilient to challenging times largely owing to its extensive diversification and strong footprint across the midstream segment within the US. It remains committed to growing along the same lines, with $2 billion a year earmarked for capital spending, with 40% allocated to midstream projects, and the rest aimed at a wide variety of NGL, refined products, and interstate production projects.
The energy sector continues to see substantial headwinds from climate change activism, but Energy Transfer Partners remains insulated in this regard, owing to its focus on natural gas, as opposed to crude oil. Natural gas and natural gas liquids are believed to be a strong ally in the fight against climate change and are expected to play a key role in the global transition away from fossil fuels over the coming years.
The stock is up 18% YTD, and is still very attractively priced at a little over 0.50 times sales and 8 times earnings, all the while offering enticing dividend yields of 9.1%. In August, ET announced a $7 billion merger with Crestwood Equity Partners in a bid to take advantage of substantial cost-saving synergies*. The company has a mammoth $9.6 billion in cash flow. Our Target is $15 and our Sell Price is $12. Energy Transfer is no small company, clocking in at $46 billion. We believe in the Energy business in the United States, especially natural gas and liquids. ET keeps these fluids flowing 24 hours a day, 365 days a year. We can see this firm at $17 in a few years, all the while paying its fabulous 9% dividend.
* Crestwood Equity Partners includes gathering and processing assets located in the Williston, Delaware, and Powder River basins, including approximately 2.0 billion cubic feet per day of gas gathering capacity, 1.4 billion cubic feet per day of gas processing capacity, and 340 thousand barrels per day of crude gathering capacity. When consummated, this transaction would extend Energy Transfer’s position in the value chain deeper into the Williston and Delaware basins while also providing entry into the Powder River basin. These assets are expected to complement Energy Transfer’s downstream fractionation capacity at Mont Belvieu, as well as its hydrocarbon export capabilities from both its Nederland Terminal in Texas and the Marcus Hook Terminal in Philadelphia, Pennsylvania.
This transaction is also expected to provide benefits to Energy Transfer’s NGL & Refined Products and Crude Oil businesses with the addition of strategically located storage and terminal assets, including approximately 10 million barrels of storage capacity, as well as trucking and rail terminals. These systems are anchored by predominantly investment-grade producer customers with firm, long-term contracts, and significant acreage dedications.
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The Bull Market High Yield Investor
By now you know that everyone at the Fed who votes on monetary policy thinks interest rates are going down at least 0.5 percentage point in the coming year and some anticipate double that level of easing. But Jay Powell said two more things that should guide every investor’s strategic outlook. First, Powell “welcomes the progress” on inflation. That’s a crucial attitude if you’re committed to being invested throughout your life.
He isn’t banking on inflation continuing to drop at any particular rate or to any particular level across any particular timeline. But he isn’t asking a lot of questions about the trailing numbers either, hoping to somehow reveal a hidden problem. All the most powerful person in the global economy is doing is accepting the good data alongside the bad. Life is like that. There will be good numbers and bad ones. You can’t explain the bad beats away. Reality is reality. However, that also means you can’t close yourself off to the good beats when they hit.
As human beings, most of us fear the pain and try to avoid it. Go too far in that direction and you end up closing yourself off to the progress, and to the opportunities life also provides. When you’re closed off to the opportunities, you’re not an investor. At best, you’re watching somebody else’s experience and refusing to participate because you have a feeling it’s all a horror movie in the long run. If that’s your world, we can’t help you. Protect what you have as well as you can because you’re probably not open to the possibility of taking a calculated risk that pays off to put you ahead of where you are right now.
That’s not our world. We're invested. And it’s not Powell’s world either. When he sees progress, he doesn’t nitpick it into oblivion by interrogating how long it lasts or even if it’s real. He accepts it. Embraces it. “Welcomes” it when it comes. On Wall Street, we make money when it’s flowing. We've watched Jay Powell for years and he believes in calculated risk, which is another way of saying he’s motivated by a form of game theory. When making a move gives him a reasonable opportunity to change the game board in his favor, he’ll make the move. Otherwise, he’s content to conserve his resources for a better opening.
Of course, that move needs to make a real impact. It has to be meaningful. We’re lucky on Wall Street because our moves all have money attached and money is a number. If the move doesn’t move the money more than you’d get in the bond market, it isn’t worth making. But then there’s that second insight Powell made in the press conference. “There’s little basis for thinking the economy is in a recession now.” Every word there matters. He’s not blindly optimistic. He knows that you’re rarely more than 3 years away from the next recession and rarely more than 5 years from that cyclical moment of truth.
As he told the reporter, there’s always a chance that a recession is mere months from materializing. They can even come from thin air like the one in 2020 when the economy locked down hard and fast. However, you can’t plan for thin-air scenarios like a global pandemic. Investors and other human beings need to extrapolate from current conditions to shape our expectations about the future. Does the world look good or bad right now? Is it getting better or worse? At what rate?
A recession is nothing but a deterioration in economic conditions big enough to affect a broad segment of the population and lasting at least 5-6 months. That’s it. It doesn’t mean mass layoffs, bank crashes, bear markets, a bent yield curve or profound suffering. And the logical correlate of that is that mass layoffs, bank crashes, the yield curve, the market and profound suffering do not necessarily line up with every recession. They often come together but the causal relationship is more complicated. Bear markets and the yield curve tend to precede a recession. The Fed has a lot of power over the yield curve and markets fear the Fed.
But right now, nobody in the Fed expects GDP to decline in the coming year. Growth will slow to somewhere above 1 percent and below 2 percent, but that’s far from the end of the world. We’ve muddled through with less in the past. It doesn’t mean active economic destruction; or wealth destruction. At worst, the people who vote at the Fed think unemployment will edge up to 4.2% next year. Again, not the apocalypse. Closer to “normal” historically. Powell used the word “normalizing” a lot in that press conference. Going back to “normal” only feels awful when you’re addicted to abnormal, if not completely unsustainable conditions. And as far as he can see, there’s “little basis” for thinking things are all that terrible right now. He’s approaching this as an economist and Wall Street insider, not as a private person.
This economy can feel miserable. We get it. It’s been a long and exhausting couple of years. We’re all working harder just to keep up with inflation. But the numbers don’t support that misery. When that happens, economists and Wall Street insiders acknowledge their feeling but go with the numbers. We trade on numbers. Our feelings are our own. Powell doesn’t see much basis for thinking the economy is in a recession right “now,” here in the present where we're writing this and you’re reading it.
This is the time that matters. The past is dead. We can’t trade it or go back in any way to change it. The future is nebulous. None of us can predict it. All we can do is extrapolate on the conditions we see in the present. If they continue, the future will look like the present. If they change, the future will change in that direction. Powell and his cronies at the Fed don’t see the present as that bad. Wall Street agrees. The Dow and the Nasdaq (it's close) are hitting record highs. This is the best those indices have done in all of history.
Is this as good as it gets? The Fed thinks things get a little better next year. In that scenario, we’ve already lived through the worst. We welcome the progress. We hope you do as well. And with that in mind, we need to cut a stock that has been defensive one without giving us much progress. Time to let it go in order to focus on other recommendations that can actually embrace the gift the future provides.
Ventas (VTR: $49, up 6%)
REMOVING COVERAGE
We added Ventas to our portfolio in 2016 at $60 a share. On paper, this is a perfect stock to hold, as the company is one of the largest owners and operators of healthcare facilities across the world, being largely recession-proof with extensive diversification across locations, industries, and geographic locations. In addition to this, it has broad multi-decade-long secular tailwinds in its favor, with the potential to create substantial value.
Yet, since we added this REIT seven years ago, revenues have grown at a snail's pace of just 2.6% annually, and the stock languished. Despite being a high-quality company, it has consistently been dealt with a tough set of cards in recent years, and while it might seem rational to wait for a while longer as it finds its post-COVID heels, we are pretty done with this stock. We've cashed $17 in dividends so we haven't done badly . . . but there are many other good places for your capital.
Rithm Capital (RITM: $10.87, up 4%. Yield=9.1%)
High Yield Portfolio
Rithm Capital is a highly diversified asset management company, active in lending, financing, real estate investments, and more. The third quarter results, saw $1.1 billion in revenues, up 20% YoY, compared to $910 million a year ago. The company posted a profit of $280 million, or $0.58 per share, against $300 million, or $0.62, with a beat on consensus estimates at the top and bottom lines.
Rithm Capital is highly differentiated from other mortgage REITs and BDCs with its business diversified across various lines of business including but not limited to mortgage lending, consumer lending, mortgage servicing, single-family rentals, and with its recent acquisition, wealth management, creating a broadly covered and well-hedged portfolio for all market conditions.
During periods of higher interest rates such as the present, when originations witness a slowdown, the company’s $600 billion mortgage servicing rights portfolio comes to its aid, along with its single-family rentals with high interest rates making home ownership harder. During the quarter, its NewRez operating business generated funded originations to the tune of $11 billion, down from $13 billion a year ago.
The company completed its merger with Sculptor Capital Management in November, absorbing its $33 billion of assets under management, as it continues its foray into investment management, effectively putting it on the same lines as PE giants such as Blackstone, although it is nowhere as big just yet. Last year it acquired a 50% stake in Senlac Ridge Partners (now Greenbarn Investment Group), an investment management firm with a focus on commercial real estate, to expand its presence in this lucrative space.
The stock is up by a stellar 31% YTD, while still trading at a little over 2 times sales and 6 times earnings, and offering an annualized yield of 9.1%. Despite the run-up in recent months, it trades at a 12% discount to book value. Our Target is $13 and our Sell Price of $8.50 is a bit low, so we are raising it to $9.50. We are very high on Rithm Capital. Their commitment to innovation and recent acquisition spree hint at major expansion plans. CEO Michael Nierenberg's vision is clear – he wants to see this relatively small company ($5 billion market cap) become a much bigger player. While predicting the future is always tricky, reaching twice its current size in two years and crossing the $20 billion mark by 2030 are strong possibilities.
Nuveen AMT-Free Municipal Credit Income Fund (NVG: $11.97, up 3%. Yield=5.1% tax free, the equivalent of 7.8% taxable)
High Yield Portfolio
The Nuveen AMT-Free Income Fund has posted a remarkable rally since we last discussed the fund a couple of months ago. This rally isn’t surprising considering the strong favorable economic data emerging from across quarters, and the Fed finally pivoting from its hawkish position on interest rates, which means debt investors can finally see some value following months of testing newer lows.
While we may see some rate cuts over the coming months, interest rates in general will remain higher for longer. This leaves muni bonds at a rather attractive position, with less risk of value erosion owing to rising interest rates, while at the same time offering equity-like yields, and little-to-no downside risks. This will prompt steady inflows into municipal bonds and funds over the upcoming few months.
For the first time in years, there is compelling value to be found across the muni bond spectrum, as investors want to lock in on attractive yields by reallocating funds from elsewhere. Given that muni bonds are next to only treasuries when considering the risk of default, they are much better positioned when compared to corporate bonds which still have to deal with many more macro uncertainties.
We’ve seen a nice 20% rally in the past two months and the stock is now just down by 3% YTD, and continuing to trade at a 12% discount to book value. As we’ve mentioned many times in the past, for long-term, conservative investors all of this is just noise. If you’re looking for tax-free yields of 5.1% and a default rate that is less than 0.08%, there are no better funds than the Nuveen AMT-Free Municipal Credit Income Fund. Our Target is $16 and our Sell Price is $11.
Good Investing,
Todd Shaver, Founder and CEO
The Bull Market Report
Since 1998
by Scott Martin | Aug 25, 2023 | Weekly Newsletter 7pm Sunday
Market Summary
It's been a bumpy couple of weeks, but baby bull markets tend to sputter a little sometime between the 60- and 120-day mark. With that in mind, this test of investors' courage seems almost foreordained in terms of where it fits in the larger Wall Street cycle. Yes, things were going extremely well. Yes, stocks were racing back to the levels they comfortably commanded before the pandemic inflated and then deflated a bubble. And yes, that rebound is largely justified. We just need to test that justification in order to shake off our residual trauma from the bubble collapse; and the last few years in general.
This is how stocks normally behave. If the bull market has hit a wall this early, it will be the shortest significant rally in modern history. Bull markets generally run for 5-6 years and even in the depths of the Great Depression, the recovery was both more robust and more sustained. Granted, we live in unusually unsettled times, but sooner or later every statistical aberration reverts to the long-term trend. For the S&P 500 and large stocks in general, that means moving up 8-11% a year across the long term. And for Treasury yields, that means about 1% above inflation.
Keep that last part in the back of your head when people try to tell you that 4% bond yields are poison for the stock market. Across generations, inflation has averaged a little over 3% a year. Adding a full percentage point to that "normal" historical level gives you a number above 4%, which means this is where long-term yields should be. If anything, with the latest read on consumer prices coming in at 3.2%, both inflation and interest rates are exactly where they should be under normal circumstances.
Of course, accepting this argument means letting go of a lot of assumptions and expectations that have accumulated over the last 10-15 years. Extremely low interest rates were a historical aberration left over from the 2008 crisis. They needed to come back up, for a lot of reasons. Whether the trigger that gets them back on track is the Fed or a sudden Treasury credit downgrade is secondary. And stocks have historically rallied in the face of exactly this kind of interest rate environment. This is a market fact. Unless you think something fundamental has broken within the American psyche that will prevent us from rising above all current obstacles like we did in the wake of the 2008 crash, or the dotcom crash, or 911, or World War II, or the Great Depression itself for that matter, the numbers are on our side.
In the meantime, the numbers are not great, but they aren't terrible either. The S&P 500 is up 16% YTD, which is accelerated performance when you look at the statistics. Granted, a lot of investors still have wounds left to heal before they really start feeling good about their experience in the last few years, but things are still moving fast in the right direction. The Nasdaq is up a blistering 30% in barely 7 months. Our stocks, balanced between a strong defense and plenty of aggressive growth recommendations, are right in the middle. We've scored a 22% bounce so far this year. In just another 7 percentage points, we'll be back where we were at the end of 2021 ... right before the zero-rate bubble started to rupture.
The big market benchmarks are in a similar state. Even counting the recent pullback, Wall Street as a whole hasn't exactly fallen off a cliff. Stocks are within sight of record territory. And as you know, these relatively rarefied levels near all-time peaks tend to be a little precarious. Investors and traders challenge every move. The bulls need to fight for every inch. Sometimes we need a little time to build up our strength and go over each wall of worry in turn. But it happens. On average, the bulls run for 5-6 years before a real obstacle gets in the way and forces a major downswing. Across each multi-year run, the market as a whole tends to quadruple in value.
In other words, things look a long way from unsustainable or overheated. This is a pause, not a halt. Corporate earnings support this. This has been a mediocre earnings season but the mood has been more hopeful than depressed and a lot of investors have even showed signs of impatience. People can't wait to see the numbers on the current quarter and then guidance for the end of the year. There's a strong sense that by then, the Fed will be finished raising short-term interest rates, which means the pressure on the economy will not get much worse. And when things can't get much worse, they generally get better from there.
Inflation is no longer accelerating. The Fed is getting traction. Earnings across the S&P 500 are not great, but they aren't plunging either. At worst, the tone reads "stagnation," a stall instead of a swoon. That's not a hard landing. Unless the real cliff is coming, this is the soft landing we needed. The recession so mild that it barely even registers after years of disruption, upheaval and, most recently, an economy too strong for anyone's comfort. When investors run from signs of the job market running too hot, it's really a sign that we could all use a break. The economy needs to cool off. That's what the Fed is doing. The alternative is watching prices keep soaring indefinitely, which creates a vicious cycle in which the dollar ends up much lower. Nobody wants that. This is preferable. This is what normal feels like.
There's always a bull market here at The Bull Market Report. As earnings season winds down, the drama has shifted back to the bond market, which shifts The High Yield Investor into the spotlight as we work to explain how rising yields pushed our stocks back down 3% in the last two weeks. As a result, The Big Picture once again revolves around benchmarking the current stock market environment against history, and finds the results highly encouraging. And if you're still paying attention to earnings, we've got plenty of updates for you as always.
Key Market Indicators
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The Big Picture: From Baby Bull To Tempestuous Tot
If you’ve already written this bull market off for dead, we have to admit, you’ve given up on the stock market and we can’t help you. For this bull market to have been born in June and dead by August, the economic environment would need to be worse than it was in 1932, in the deepest depths of the Great Recession. That’s when the shortest bull market in modern memory happened. Back then, investors only got two months after rallying 20% from its peak before the bear recouped control of Wall Street. Those were truly bad times.
But even then, investors who bought the brief rally didn’t have a lot to complain about. That two-month rally sent the S&P 500 up a dizzying 91%. The brief but savage retreat that followed took about 30% off that peak, leaving the market roughly 55% off its low. Maybe you think the world is in worse shape now than it was 80 years ago and the market just no longer has what it takes to recover. In that scenario, you’ve effectively given up on stocks, the economy and the American people.
Because in every other crisis over the past eight decades, the bulls got years to run. Other than the 1932 shudder, the shortest modern bull market lasted 1.8 years, before the grim lead into World War II cut the rally short. Only the 2020-2021 pandemic bubble was anywhere near that truncated. It took real determination for the bulls to start running this time around. The mood bottomed out in October and it took eight months for the S&P 500 to recover 20% from that low point. During that period, it became clear that even the Fed’s aggressive rate hikes wouldn’t be severe enough to crash the economy immediately.
And in the absence of that crash, guess what? We survived. Corporations didn’t implode like people feared. A recession like the one we saw in 2008 didn’t happen this time around. We're thinking the recession is already well underway for corporations. Earnings are down from last year. But in the new third quarter, we’re looking for a slight uptick. Even if that doesn’t happen, the comparisons practically guarantee better times ahead for the end of the year. In that scenario, we’ve already lived through the worst of it. Things get better from here. In a few months, members of the S&P 500 will be getting bigger again in the aggregate. The economy will be growing.
That’s good for investors. It’s hard for stocks to go down for long when the economy is feeding more profit across big companies year after year, which is why bull markets are hard to kill once they get going. Admittedly, it isn’t a smooth ride. The first few months of any baby bull are the most intense. But then there’s generally a lull and a pause for the market to test its convictions. Things slow down. People get nervous and start second guessing themselves. But in history, the bull has never backed down this fast. History can bend, but it rarely breaks. If the bear takes over again, we'll be shocked.
Remember, bond yields move in the opposite direction from bond prices. If bonds are falling and rates rising, that means money is pouring out of that particular side of the global financial markets. Within the dollar sphere, money flowing out of bonds means money flows into cash or stocks. Cash is bad news as long as inflation remains high. You might be able to get 4% in money markets, but you’re probably going to lose it all from inflation. Only stocks can make enough right now to keep ahead of inflation. Some may go down instead but the right stocks have a fighting chance. When that’s the best bet you get, you take it. We have the right stocks.
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BMR Companies and Commentary
Moderna (MRNA: $101, down 6% last week)
Healthcare Portfolio
Get ready for a good long read on this extraordinary company. This is not a 1- or 2-minute read. It will be 5-10 minutes. So, hang on. Here we go.
Leading biotechnology company and mRNA pioneer, Moderna, released its second quarter results a week ago. The company posted $340 million in revenues, down by a colossal 94% YoY, compared to $4.7 billion a year ago. It further posted a loss of $1.4 billion, or $3.62 per share, against a profit of $2.2 billion, or $5.24. This was largely the result of the seasonal nature of its COVID-19 vaccine sales.
While this was expected as the world moves on from the pandemic, the company, however, expects $6 to $8 billion in revenues from its COVID shot this year, with the US alone expected to buy anywhere between 50 to 100 million doses for the fall. Its updated COVID vaccine, targeting the omicron subvariant XBB.1.5. Is still awaiting FDA approval, but will be ready for a rollout over the coming months.
The company is confident of seeing robust demand for the shot, not just in the US, but also in Europe, Japan, and other leading markets. With COVID-19 becoming ubiquitous, Moderna expects this great business to continue. Far from resting on its laurels, however, it has gone all out to ensure its pandemic windfall is used towards developing more sustainable products.
This includes a robust pipeline of vaccines targeting cancer, heart disease, and a slew of other conditions, and are all set to hit the market by 2030. This pipeline includes its experimental vaccine for respiratory syncytial virus, aimed at adults aged 60 and above, followed by its personalized cancer vaccine in partnership with Merck, which passed its first major clinical trial early last month, with flying colors.
The stock is down by 44% YTD and over 78% from its all-time high in 2021, and as such, is quite de-risked. It currently trades under 4 times sales and 35 times earnings, which might seem rich, but is perfectly justified for a growth stock such as this. It has since repurchased stock worth $1.5 billion and ended the quarter with $8.5 billion in cash, $1.2 billion in debt, and negative $230 million in cash flow. Our Target is $250 and our Sell Price is $150. SO, let’s discuss. These numbers are there for you to decide what to do. And each and every one of you has a different scenario of buying the stock. Some of you bought the stock in January 2023 when we added the stock at $193. Some of you bought the stock beforehand in February 2020 at $26. As the stock has come down from the all-time high of $464 in September of 2021, and more recently from the $218 level in January of this year, you have decisions to make on a day-to-day basis. And all of these decisions are personal, based on a myriad of things that are going on in your life. We could list them here, but you know what we mean here. It comes down to a decision that YOU have to make: Do I sell? Do I stay with it? Do I add more? Tough questions. We highly recommend GTC Stop Orders. Good-‘Til-Canceled orders are orders to sell a stock at a certain price. If it hits the number, the order executes and you are out of the stock. If you bought in January, you could have put a stop order in place to sell at say, $181. Or $171 or whatever price you picked. They used to call this order a Stop Loss order because that’s what it does. Now it is just called a Stop order.
We’re not real happy that the market has drubbed this company the way it has. But we believe in the firm long term, and since we are a long-term investment newsletter, we believe in the companies that we follow and if the stock moves lower, in many cases we like it even more than it was at the higher price. That is the case with Moderna. We would buy the stock here as they have a strong, diverse set of new products coming to market this year, in 2024 and 2025, and beyond.
The future looks bright for Moderna. The company has a strong pipeline of new products, including vaccines for influenza, respiratory syncytial virus (RSV), cytomegalovirus (CMV)*, and HIV. Moderna is also developing a personalized cancer vaccine that could revolutionize the treatment of cancer. The potential dollar size of these markets is enormous. The global market for influenza vaccines is estimated to be worth $8.5 billion, the RSV market is worth $2.5 billion, the CMV market is worth $1.5 billion, and the HIV market is worth $30 billion. Moderna could capture a significant share of these markets with its innovative products.
*CMV is related to the viruses that cause chickenpox, herpes simplex, and mononucleosis. CMV may cycle through periods when it lies dormant and then reactivates.
In addition to its new products, Moderna is also expanding its manufacturing capacity. This will allow the company to meet the growing demand for its vaccines and other products. Moderna is well-positioned to be a major player in the pharmaceutical industry for years to come.
Here are some specific examples of new products that Moderna has in the pipeline. The company is committed to using its mRNA technology to develop innovative new treatments for a wide range of diseases:
A bivalent influenza vaccine that protects against both influenza A and influenza B.
An RSV vaccine that is more effective than existing RSV vaccines.
A CMV vaccine that could prevent congenital CMV infection, which can lead to serious health problems in newborns.
A personalized cancer vaccine that is designed to target the specific mutations in a patient's cancer cells.
The company is worth $39 billion now. At its peak, it was worth $189 billion. Can it go there again in the future? We believe so.
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Axcelis Technologies (ACLS: $167, down 5%)
High Technology Portfolio
This company is one of the largest suppliers of capital equipment for the semiconductor industry, leading some industry observers to call it one of the most important companies in the world. During its second quarter, despite a glut in the Chip industry, the company has continued its strong streak, with $270 million in revenues, up 24% YoY, compared to $220 million a year ago. The company posted a profit of $62 million, or $1.86 per share, against $48 million, or $1.43, in addition to a beat on consensus estimates at the top and bottom lines. Its dominant position within this space, amid an industry that in many places has been turned upside down, has resulted in substantial tailwinds for Axcelis, something that is unlikely to subside even in the case of a glut in the market.
Axcelis Technologies ended the quarter with an order backlog of over $1.2 billion, including fresh orders of $200 million. This is largely the result of persistent demand for its Purion family of products, particularly from the silicon carbide power markets. These are semiconductors used in cars, particularly electric vehicles, which are growing fast around the world.
The company’s customers span markets of advanced logic chips, memory chips, and storage chips, all of which are set to witness robust demand, as a result of the unprecedented growth in AI, machine learning, and cloud computing. It is further the only ion implant company capable of providing full-recipe coverage for all power device applications, allowing for high-volume, low-cost manufacturing.
As a result, the company has increased its revenue forecast for the full year by $70 million, giving the stock that is already up by 115% YTD, more reason to rally. Axcelis has a strong balance sheet position with $450 million in cash, just $80 million in debt, and $250 million in cash flow. This puts many lucrative value-creation opportunities, such as dividends and stock repurchases on the horizon going forward. Our Target is $150 and our Sell Price is $125. We are raising the Target today to $195, and the Sell Price to $148.
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Roku (ROKU: $79, down 8%)
Early Stage Portfolio
Streaming giant Roku caught another break with its second quarter results a week ago. The company posted $850 million in revenues, up 11% YoY, compared to $760 million a year ago, with a loss of $110 million, or $0.76 per share, down from $112 million, or $0.82, in addition to a beat on consensus estimates on the top and bottom lines.
The company posted strong growth across key operational metrics, with total active accounts at 74 million, up 16% YoY, and reaching a level of 25 billion hours streamed on the platform during the quarter, up by 4 billion hours from last year. The Roku channel now accounts for 1.1% of total TV viewership, establishing it as a leading player in the global streaming space, with plenty of room to grow.
The platform’s average revenue per user slid 7% YoY, to $40.67, but this is mostly owing to a global advertising slowdown, which has since started to turn around, as recessionary fears abate. Roku is perfectly poised to reap rewards from this trend, given its dominance in the connected TV space with a market share of 50% in North America, and billions of dollars of unmonetized ad inventory.
Roku continues to face substantial challenges as a result of supply chain constraints and inflationary pressures, particularly when it comes to its hardware business. Its decision to not pass these additional costs onto customers is what led to the string of losses in recent quarters. This same strategy will pay off in the long run, as it faces stiff competition from the likes of Alphabet TV, Amazon, and Apple TV.
The stock is down by over 85% since its all-time high in 2021 but has posted a 95% rally YTD, amid substantial challenges and headwinds. It currently trades at under 3.5 times sales, which is very reasonable for a growth stock with a landed base and massive competitive moats. Roku ended the quarter with $1.8 billion in cash, just $650 million in debt, and $15 million in cash flow. Our Target is $110 and our Sell Price is $62.
With all of this said, we are not very happy about the fact that the company can’t make a profit. Yes, they have a ton of cash to tide them over the next year or two. But gee whiz, after all these years, WHY CAN’T THEY MAKE A PROFIT? We’ve always said to ourselves: When you are not happy about something, you have to take some action. We’re pretty darn tired of waiting for this one, so yes, their future looks bright, but the stock had better move higher, and if it doesn’t, we are going to move on. The way we like to do this is to set a Stop. We would suggest that you put a Sell Stop in place at $74. If it goes there, we are out. If it goes higher, we will move the stop up accordingly over time.
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PayPal (PYPL: $62, down 2%)
Financial Portfolio
PayPal released its second quarter results two weeks ago, reporting $7.3 billion in revenues, up 7% YoY, compared to $6.8 billion a year ago. The company posted a profit of $1.3 billion, or $1.16 per share, against $1.1 billion and $0.93. Despite posting in line with estimates, the stock witnessed a pullback following the results, owing to a slew of factors and operating metrics.
During the quarter, the company processed over $370 billion in payments, across 6.1 billion transactions, up 11% and 10% YoY, respectively. It processed 55 transactions per active account, an increase of 12% YoY, with total active accounts growing to 435 million, up marginally from 428 million during the same period a year ago. It is truly an astounding number of accounts.
PayPal is an online payment platform that facilitates payments between individuals and businesses. It is one of the most popular online payment platforms in the world. PayPal is successful because it is easy to use, secure, and trusted by businesses and consumers alike.
PayPal has a new deal with private-equity giant Kohlberg, Kravis & Roberts. According to this deal, the PE firm will be acquiring PayPal’s ‘Buy Now, Pay Later’ loans originated within the UK and other European countries, to the tune of $44 billion, with $1.8 billion in net proceeds to PayPal set to be realized over the next few months alone. This provides the fintech giant with much-needed liquidity and stability, as it forays deeper into the lucrative consumer credit markets. In addition to this, the company has seen enormous traction with its recent rollout of PayPal Complete Payments, onboarding big ticket channel partners, the likes of Adobe, WooCommerce, Shopify, Stack Payments, and LightSpeed among others.
As PayPal grows by leaps and bounds, it hasn’t lost sight of its promise to continue delivering exceptional value to shareholders, with $1.5 billion being returned via buybacks during the second quarter alone. It plans to scale past $5 billion in buybacks in 2023, giving strong support to the stock, while hardly denting its robust balance sheet, with $11 billion in cash, just $12 billion in debt, and $5.8 billion in cash flow. And the firm is quite profitable, as noted above in the first paragraph. The Target is $125 and we would not sell PayPal.
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The Trade Desk (TTD: $75, down 12%)
Early Stage Portfolio
One of the largest demand-side advertising platforms, The Trade Desk released its second quarter results last week, reporting $460 million in revenues, up 23% YoY, compared to $380 million a year ago. The company posted a profit of $140 million, or $0.28 per share, against $100 million, or $0.20, driven by its relentless streak of onboarding new brands, inventory, and partnerships throughout the past year.
Despite a beat on consensus estimates at the top and bottom lines, the market reaction following the results put a damper on the stock’s 100% YTD rally. The results themselves had nothing to warrant an adverse reaction, and in our opinion, this was everything to do with the company’s unjustifiably high valuations of 22 times sales and 290 times earnings, many times higher than the industry average.
The Trade Desk is a technology company that helps businesses buy and sell digital advertising. They are successful because they offer a platform that is easy to use, transparent, and effective. The company has a strong focus on data and analytics, which allows them to help businesses target their ads more effectively. While demand for advertising has hit a rough patch over the past few quarters, the company’s precision and transparency-driven platform has remained resilient nonetheless. Its business development initiatives have made its solutions indispensable for large brands, resulting in a 95% customer retention rate for the ninth consecutive year.
In a niche filled with walled gardens from the likes of Meta and Alphabet, The Trade Desk has succeeded by making this business more accessible to everyone. It has continually gained market share at the expense of its two major competitors, and while the threat of Alphabet’s renewed efforts in this space is substantial, TTD’s expansive moats, industry partnerships, and integrations will not be easy to breach.
The stock was upgraded by many firms on the Street, including Wells Fargo, raising their target to $100 from $82. Piper Sandler has a nice round $100 price target, with Morgan Stanley at $105. During the quarter the company repurchased stock worth over $40 million, with a further $360 million in pending authorizations. This should provide it with much-needed support during volatile times like the present. The Trade Desk ended the quarter with $1.4 billion in cash, a mere $250 million in debt, and $630 million in cash flow. Note: We wrote about The Trade Desk in The Bull Market Report of July 17th. Check it out on the website.
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HF Sinclair (DINO: $59, up 8%)
Energy Portfolio
Independent petroleum refiner HF Sinclair released its second quarter results two weeks ago, reporting $7.8 billion in revenues, down 30% YoY, compared to $11.2 billion a year ago. The company posted a profit of $500 million, or $2.60 per share, down from $1.3 billion, or $5.59, but the beat on consensus estimates at the top and bottom lines sent the stock on a strong rally from $51, and the $46 level in July. We added the stock at $61 in December, so the weakness this year has been put behind it.
During the quarter, the company was hurt by the drop in volumes due to the drop in energy prices and the economic slowdown globally, along with a slowdown in refining margins. The gross margin per barrel stood at $22, down 40% YoY, compared to $36 a year ago. This was coupled with lower production of 554,000 barrels of oil per day, down from 627,000 barrels during the second quarter of last year. This is in sharp contrast to the previous quarter, when the company looked upbeat as a result of increasing utilization rates, falling oil refining capacities, and a widening crack spread, owing to the normalization of global energy markets. (Crack Spread is the margin or pricing difference between a barrel of crude oil and the finished petroleum products.)
HF Sinclair is an energy company that produces and sells a variety of fuels, including gasoline, diesel, jet fuel, renewable diesel, specialty lubricant products, specialty chemicals, and specialty and modified asphalt. They have a long history in the energy industry, having been founded in 1916. They have a strong financial position and are committed to innovation. The company used its windfall gains over the past year exceptionally well, paring down debt to $3.6 billion, while offering a well-covered annualized dividend yield of 3%, ending the quarter with $1.6 billion in cash, and $2.5 billion in cash flow during the quarter. Our Target is at $72 and our Sell Price is at $51. This is a solid $11 billion company with a strong management team.
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Sunrun (RUN: $16.64, down 5%)
TERMINATING COVERAGE
Photovoltaic cells and energy storage solutions provider Sunrun is riding the post-IRA high life, as evidenced by its second quarter results two weeks ago. The company posted a profit of $55 million, or $0.25 per share, against a loss of $12 million, $0.06. This was still a fairly mixed quarter, with earnings blowing past estimates by a wide margin, with top-line figures coming in below expectations.
Market reactions aside, this was a spectacular quarter for the company, with 103 megawatt hours of fresh installations, up 35%. Total solar energy capacity installations reached 300 megawatts, exceeding the high-end of its guidance at the end of the quarter. Net subscriber value hit $12,320, up by $320 from the prior quarter. Much of this was made possible by the tax credits availed to consumers since the passing of the $700 billion Inflation Reduction Act last year. With tax credits now covering 30% of the installation costs, solar companies such as Sunrun are on a fiery streak.
The company unveiled a slew of new products and initiatives during the quarter, starting with the Sunrun Shift, a home solar subscription that aims at maximizing value under California’s new solar policy. It further signed a partnership with PG&E to develop a distributed power plant that turns home solar storage systems into resources during periods of peak demand, helping prevent blackouts.
Sunrun is an undisputed leader in an industry that is set to hit $400 billion by 2030, and following a 30% YTD pullback, and an 83% decline since its all-time high in 2021, it is trading at a mere 1.5 times sales. The company ended the quarter with $670 million in cash, and over $10 billion in debt which is concerning, but has the assets and is now generating sufficient cash flow to back this up.
With all of this said, we’re not happy with the performance of the firm. After thinking this through long and hard, we believe their marketing philosophy is skewed. The firm offers solar leases, solar loans, and purchase agreements where customers agree to buy the electricity generated by their solar panels for a fixed price over a set period. They don't have to pay upfront for the solar panels, and they don't have to worry about maintenance or repairs. This all sounds great at first glance, but the financing costs for the firm are exorbitant at $10 billion, which is WAY out of line. We added the stock at $29 and we reluctantly exit the stock here. We will be replacing this with a much better solar option in the coming weeks.
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Twilio (TWLO: $62, up 1%)
Long-Term Growth Portfolio
Twilio is the leading provider of cloud-based programmable communications solutions. It released its second quarter results last week, reporting $1.0 billion in revenues, up 10% YoY, compared to $940 million a year ago. It posted a profit of $120 million, or $0.54 per share, against a loss of $7 million, or $0.11, coupled with a beat on estimates for the next quarter sending the stock up from the $58 level following the results.
The company hit a rough patch over the past year, owing to persistent macro pressures, which in turn resulted in longer sales cycles, lower deal sizes, and a substantially lower dollar-based net expansion rate* at 103%, compared to 123% a year ago. The slowdown in the social, streaming, and crypto verticals has made things worse, yet Twilio has successfully managed to hold its ground as things start to turn around.
* Dollar-based net expansion rate (DBNER) is a measure of how much revenue you earned from existing customers due to add-ons, upselling, and cross-selling.
Twilio currently has 304,000 active customers on its platform, against 275,000 a year ago, which is largely in line with estimates. The company’s communications revenues led the way at $910 million, up 10% YoY, followed by data and applications at $125 million, up 12%.
Over the past few years, the company has made significant progress in offering a differentiated customer value proposition. It has done this via acquisitions, partnerships, and integrations, which have since resulted in wide, impenetrable moats. The tailwinds as a result of this are only just beginning to be realized and have since prompted a flurry of analyst rate hikes, with the high end of its target at $110.
The stock is up by 23% YTD, but is still off by 86% from its all-time high in 2021 at $457, while trading at a mere 2.8 times sales, making it a fairly priced growth stock. The company completed $500 million in stock repurchases during the quarter, from its $1 billion in authorizations at the beginning of this year. It ended the quarter with a strong balance sheet with $3.7 billion in cash, $1.2 billion in debt, and a stable cash flow position. Will the stock ever reach its all-time high again? We believe so, but certainly not for a few years. In the meantime, we see steady, profitable growth ahead and look forward to breaching our Target of $135. Our Sell Price is $65, with the stock under that price now, as you know, so if you are anxious, set a sell stop at your pain point, say $55 or so. We don’t believe this can happen, but a lot depends on the world economies and all of the potential negatives in the world. We are optimists, as the American economy and markets have grown through thick and thin, through war and viruses, and bull markets and bears, for 200 years. We’ll come through again, of that there is no doubt.
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The Bull Market High Yield Investor
It happened like clockwork. Something nudges long-term interest rates above 4% and a perfectly good rally in the stock market evaporates. This week, the trigger was a shock cut to the Treasury’s credit rating, a significant shift in the bond market but not necessarily anything the rest of Wall Street needs to worry about. Most of the big players blew off the downgrade. Warren Buffett, Jamie Dimon, Janet Yellen, everyone. The rating agency that pulled the trigger, Fitch, is relatively minor, with maybe 15% of the global heft in this space. Neither of the true giants spoke up.
And the timing of this downgrade is strange to say the least. It feels like a PR stunt, a desperate reach for relevance. But for now, that 15% of the world that pays attention now needs to adjust its bond portfolios to mirror this move, which means selling Treasury debt to make room for whatever this agency decides is still worth its top rating. Demand for Treasury bonds goes down a bit. And the laws of economics say that when demand for a thing suddenly drops, the price drops with it. When bond prices drop, yields go up. Suddenly yields on the 10-year are above 4%.
This is a historical pain point for the market. Round numbers scare people. The thought is that if you can lock in 4% a year on bonds for the foreseeable future, enough investors will pull their money out of stocks to buy those bonds. But wait a minute. Money flowing out of stocks into bonds means demand for bonds picks up again. Prices in this scenario firm up. And guess what, yields go down. The situation just resolved itself.
That’s how this works. It’s how it worked in 2011 and it’s how it’s going to work now. Yields have had trouble getting above 4% in this cycle. It’s going to take a massive shift in the landscape to get them permanently above that level now. If you’re worried about yields, buy bonds when they hit 4%. And if you’re unwilling to buy bonds at 4%, stick with the stocks that can deliver better under the right circumstances. Beyond that, 4% is just a number.
After all, there are two things here to keep in mind. First and foremost, when long bond yields are stuck at roughly 4% and the Fed has pushed short-term rates well above 5%, the system is showing dramatic signs of stress. That’s the inverted yield curve that tends to foreshadow a recession. The Fed controls the short end. The market decides the long end. When the market keeps buying so many Treasury bonds that long yields stay below short yields, the market is already so fixated on an economic downturn ahead that the prophecy becomes self fulfilling.
But if long-term Treasury yields were to rise back above the short end of the curve, that recession signal goes away. Keep that in mind when people talk about how lethal 4% really is. The only way this curve can heal is if those long yields climb well above 4% or if the Fed wakes up and decides there’s been a terrible mistake. You know the first scenario is the only plausible one. And that’s the second factor to watch. We remember back to 1994, when Treasury yields started at 5.92% and crossed 8% by November. They didn’t get back below 5.5% until 1998. That’s at least four years the world survived yields much higher than 4%, a period in which the S&P 500 doubled. It was the dotcom boom, one of the greatest rallies in history. And it happened in the face of those rates.
What’s lethal about 4% yields? Fear itself. We’ll get through this. Stocks will recover and get back to work. If yields stay above 4%, it’s going to be a lot harder to argue that there’s a recession looming. And if they fall below 4%, where does all that fear go? For now, if you're happy earning 4% a year, bonds are attractive. If you want more, you need to reach for a few of our higher-yield recommendations like the two profiled here.
Apollo Commercial Real Estate Finance (ARI: $10.74, flat. Yield=13.0%)
High Yield Portfolio
New York-based Apollo Commercial Real Estate Finance primarily invests in real estate-backed debt instruments, including senior mortgages and mezzanine loans. The company released its second quarter results recently, reporting $63 million in revenues, up 10% YoY, compared to $57 million a year ago, with a loss of $16 million, or $0.11 per share, against a profit of $50 million, or $0.35. The numbers were weighed down by net realized losses on investments of $82 million, or $0.61 per share, from a subordinate loan backed by an ultra-luxury residential property. This was a significant event, one that saw a $60 million increase to its special current expected credit loss allowance, bringing it to a total of $141 million. This includes an already realized loss of nearly $80 million on the same Manhattan-based ultra-luxurious residential property and is a reflection of the state of New York’s property market, which continues to struggle with a very tough post-COVID recovery.
The company continues to benefit from higher interest rates because 99% of its portfolio is held in floating debt. This led to another consistent quarter of strong distributable earnings of $0.51, well above the quarterly dividend of $0.35. There has been some talk of a dividend cut, but with the level of coverage, we are not concerned. We believe the likelihood of interest rates remaining high for the foreseeable future is quite high.
Leaving this aside, Apollo’s loan portfolio remains as sturdy as ever, with a total portfolio value of $8.3 billion, a weighted average yield of 8.6%, with nearly 94% of them being first mortgages, making this a good place to be in a high-interest rate environment. The trust further funded two first mortgage loans worth $170 million, and received repayments worth $600 million.
The stock is down by 1% YTD, trading at an enticing 27% discount to book value. Apollo ended the quarter with $370 million in cash, $7.0 billion in debt, and $330 million in cash flow.
BlackRock Income Trust (BKT: $11.82, down 2%. Yield=8.9%)
High Yield Portfolio
The BlackRock Income Trust, one of the leading investors in agency mortgage-backed securities and US Government securities offers plenty of value for conservative investors looking for capital preservation, alongside regular income. With its exposure to quality AAA-rated securities, its risk quotient is only a notch below treasuries and munis, while offering higher yields and avenues for capital appreciation.
Ever since the Fed began its hawkish stance, the fund has witnessed a steady pullback and is currently down 6% this year so far. As a result, it offers an enticing 9% dividend yield, all the while trading at a 5% discount to book. With inflation slowing down, and the Fed’s rate hikes finally coming to an end, this fund represents a stellar economic opportunity during the months ahead.
The thing about this fund is that while it may be affected by macroeconomic headwinds and market volatilities in the short term, for investors with a long enough time horizon, the risk of loss is very low. This is made possible thanks to its exposure to mortgage-backed securities, all insured by Fannie Mae, Freddie Mac, and Ginnie Mae, which while not explicitly guaranteed by the US government, we know for a fact that the latter will step in to keep these entities solvent.
The biggest drawback when it comes to investing in the BlackRock Income Trust is the lack of any significant hedges against interest rate risks. During a high-interest rate environment like the present, a portfolio of mortgage servicing rights offers much-needed cushioning against volatility, but they don’t own any, as Rithm Capital and others do. We feel that the company, at current levels, has limited downside risk as the current interest rate levels are very beneficial for the fund.
Good Investing,
Todd Shaver, Founder and CEO
The Bull Market Report
Since 1998
