October 23, 2016
by Todd Shaver | Oct 23, 2016 | Weekly Newsletter 7pm Sunday
The Week Ahead
Year to date the S&P 500 is up 5%. The train keeps on rolling. Weak GDP in the US - no problem. Energy industry falls apart - no big deal. Lack of middle class household income growth doesn’t matter. Troubling student debt burden is what it is. With low rates and bond prices and record low levels, the only game in town is equities. There is a record amount of cash sitting on the sidelines waiting to go into stocks.
Wall Street enters the thick of earnings in week three of the season with Apple (Tuesday) and Alphabet (Thursday) reporting this week (see our Earnings Preview to be sent out Monday morning). Instead of a widely expected earnings decline, Thomson Reuters now anticipates 1% growth in the S&P 500 companies the quarter, reversing previous expectations of a decline. This could be the first time we see an increase since the second quarter of last year. So far this quarter, 20% of S&P 500 companies have reported on their recent quarters with 80% beating estimates.
It has been a good not great year for stocks, though we are coming to an inflection point. They say if Republicans win the White House the market will sell off. They say if Democrats win the White House the Fed will raise rates in December and the markets will sell off. So brace for some turbulence, but don’t stop investing in great stocks. This week we highlight Facebook, Google, First Solar, Microsoft, Qualcomm, Amazon, and PayPal, among others.
Highlights From The Past Week
Record Cash Levels. Investor cash levels jump to levels not last seen since 9/11. Fund managers are now holding 5.8% of their portfolios in cash, up from 5.5% last month. The current level was a bit higher than what happened right after Brexit. We haven’t seen cash levels this high since 2001, shortly after the terrorist attacks in the US. It’s hard to get a total reading on cash levels, but some say there is $1.5 trillion in corporate cash on the sidelines. What is driving the caution? The commonly cited reasons are an EU breakup, a bond market crash, and a certain Republican winning the White House.
What Junk Bonds Are Saying About Risk. High yield bonds, also known as Junk Bonds, are a key indicator of appetite for risk. There are two things occurring providing insight into market sentiment. First, the interest rate spread of junk over treasuries has compressed to the point where history suggests there is not much further to go. This could predict a reversal soon coming. In other words, investors are so thirsty for yield they are overpaying for risk assets, where all it will take is a little turbulence to rattle confidence. Second, actual defaults on junk bonds are decelerating. This is due to the improving Energy sector. The key point is that while we might see more risk start to get priced into the market there is still little evidence of a recession happening in the next 12 months based on default rates.
European Taper Tantrum. European Central Bank President Mario Draghi came out this week and said he will not be scaling back bond purchases prior to March. After March there is risk of doing so, but for right now the window for bond purchases is ongoing. Recall that in the US when the Fed started scaling back bond purchases, interest rates spiked impacting various sectors. For instance, Mortgage REITs went down as much as 50% and banks rose, as the steepness of the yield curve hurt/helped the respective business models. Accordingly, all eyes are on Draghi and the ECB for a European Taper Tantrum and any flow-through effect to US markets.
BMR Companies and Commentary
Alphabet (GOOG: $799, up 3% for the week)
The stock hit an all-time high Wednesday at $804. Alphabet is schedule to release its earnings on Thursday after the market closes. The Street is looking for $8.62 of EPS on $18.2 billion of revenue.
We expect to see Google's search revenue growth momentum be sustained. We understand that expectations for search budget growth earlier this year were around the 12-15% level, but now these expectations have been ratcheted higher to the 15-20% range. In particular, we understand that feedback from advertisers suggests that budget deployment into search started to accelerate over the course of the quarter as the market gears up for the crucial holiday period. Advertisers are specifically citing the newly-released Expanded Text Ads feature as one of the reasons for their pick-up in spend.
Outside of search, we like Google Cloud and we like YouTube. Neither business is the size or impact of Search. But we like that they are heading in the right direction. The larger and larger contribution from YouTube is particularly exciting. There have been some rumors of YouTube soon doing large deals with content providers like Disney. This could be very exciting and we want to see more. By owning Google, we own the best asset in all of media - YouTube.
BMR Take: We expect a very strong quarter and will look to be revising our $850 price target higher.
Amazon (AMZN: $819, flat)
The long term Amazon Web Services (AWS) operating margin expansion potential remains a controversial topic for Amazon. Let’s discuss it.
We are in the camp that expects to ultimately see a 40% long term operating margin in the AWS division. This outlook includes the fact that they have aggressive expense growth projections, specifically an incremental $1.5 billion over the next five years versus the historical ramp of $600 million to $1.0 billion. What we are saying is that it's not like they need to stop spending money. In fact, they can spend a lot. That's okay. They are bringing in the revenue – and ultimately profits.
Many are concerned about all the competition in the space, namely Microsoft Azure, Google Cloud, Oracle, and so on. Right now there is no evidence of a price war but there certainly is the possibility as these three giants fight it out. We will keep a close eye out for any change.
Why is all this talk of AWS operating margin important? Within five years, AWS will account for roughly 40% of the company’s consolidated free cash flow, if the profitability ramp plays out. Given the total addressable market of $1 trillion for AWS, it is very likely the 40% figure proves conservative. Free cash flow is the basis for how most analysts are valuing the stock. Some valuation models are inferring a price target of $1,600 for Amazon should we see the free cash flow production really start to ramp. Now that would be interesting, $1,600! We aren’t ready to place our rational expectation for the stock there yet, but there is real potential and we are watching closely.
BMR Take: Amazon is an invention machine and the latest breakthrough is AWS. AWS has the potential to unlock substantial value for shareholders. So we care about its prospects and free cash flow contribution. We think the stock has tremendous value here at this price.
Facebook (FB: $132, up 3%)
FB shares are currently trading at 25x and 20x our 2017 and 2018 earnings estimates respectively. This is versus expectations of 26% EPS growth per year over the next five years. What value! In fact, the stock hit an all-time high Friday and is now worth $380 billion, just behind Amazon at $390 billion, Microsoft at $465 billion and Google at $560 billion. All we can say is Wow.
Investors are overcoming concerns around two things - tougher comparisons beginning in 4Q16, and moderation of ad load growth. While the former is a mathematic reality as the company gets bigger (you can’t grow revenues at 40% forever), we expect the latter to become less of a concern as Facebook has taken steps to modify existing ad units and release new products.
Why is slowing ad load growth not an issue? Did you hear during the Presidential debates the constant reference to “on Facebook over 100 million people are saying…”
Additionally, we believe Facebook is taking steps to introduce a new prospecting product to help advertisers find new customers, as well as to monetize Messenger in 2017. Recent feedback from advertisers suggest that the company continues to innovate on product development.
BMR Take: Now is a great time to buy this technology blue chip. Our $140 price target is a layup with many analysts already pushing the bar much higher. We hereby raise our price target to $150.
First Solar (FSLR: $42, up 7%)
Whoa! The stock has a pulse! Momentum has shifted and a turnaround appears underway.
We look forward to First Solar’s Q3 earnings report on Thursday. We continue to believe the company’s financial position and product technology are second to none. We expect the company to emerge stronger and more dominant following the industry’s latest capacity shakeout, but we also expect it to use its competitive strength to apply pressure in the marketplace during the coming year.
What is all the fuss? First Solar goes into 2017 with the lowest backlog coverage in several years, and with utility-scale project pricing hitting new lows. The company has reiterated its determination to keep its factories running at full capacity in order to be ready for the 2018 turn. We cheer them on! Though it means operating losses in 2017.
The 2017 revenue outlook by consensus is $2.9 billion, down from $3.8 billion this year. There is not much debate about the revenue picture. All the debate is over how bad operating margins will be in 2017. The tricky part is due to the fact that the company doesn’t provide a great detail about the mix of variable versus fixed costs.
BMR Take: Why are we talking about 2017 margins? The Street is looking for EPS of $2.00+, but some estimates are much lower, running through rougher margins. You need to be prepared for a worse 2017 EPS figure than $2.00. Look it doesn’t matter because there is a turnaround already underway and it’s all about 2018. But the shares could go down before going up much higher should this margin issue surface. We see shares on a recovery path back to $55. Momentum is turning in our favor, though let’s be ready for possible turbulence around margins in 2017.
Microsoft (MSFT: $60, up 4%)
Microsoft had a fantastic quarter. The stock hit a new all-time high Friday. The stock is trading above the high set in 1999, following 1Q17 results that outpaced consensus metrics across-the-board. Guidance for the second quarter at the midpoint fell short of existing consensus numbers; however, management reiterated its focus on cloud-based services, including investments to position its product and services for long-term growth.
Analysts viewed the results positively, with the majority impressed with the organic growth results, particularly focusing on the +120% growth of Azure, the firms cloud service, re-accelerating sequentially. Commercial Cloud and Office 365 growth led the bulk of analysts to increase conviction that the organic growth trends are sustainable.
Guidance for 2Q was the main sticking point in the quarter, with some analysts seeing the initial guidance as typical management practice, citing consistently lower-than-consensus out-quarter estimates followed by outperforming results. However, others pointed to increasing underlying operating expense trends, suggesting any meaningful acceleration of gross margins over the medium-term may not materialize.
BMR Take: Microsoft is expected to generate $25+ billion of free cash flow this year. The free cash flow per share forecast for next year is $4.00 supporting a bull case of $80 based on 20x. We love what we are seeing from the company, in particular the Azure segment. Our current $66 price target is conservative.
PayPal (PYPL: $44, up 13%)
Blowout quarter. Revenues were $2.67 billion vs. $2.3 billion last year, with EPS of 35 cents vs. 31 cents last year. The stock hit a new all-time high of a shade under $45 and the company hit the $50 billion market cap goalpost level, closing at $53 billion. Management discussion of the results centered on the updated outlook, with the commitment to stable margins perhaps the most well-received item given recent debate around the long-term trajectory. Also some upbeat commentary around increased revenue growth over the medium term and continued strong user metrics, especially for Venmo - the mobile payment technology business that was recently acquired.
PayPal demonstrated another strong quarter of customer acquisition, adding new consumers and merchants to the platform. The company grew its active customer accounts by 11%, ending the quarter with 192 million active customer accounts.
The move to customer choice (see next sentence) is also allowing PayPal to forge valuable, new strategic partnerships across the ecosystem. During the quarter, PayPal announced major agreements with Visa and MasterCard. In addition, as an extension of previous agreements with Alibaba, PayPal launched the first stages of becoming a payment option on Alibaba's global retail marketplace, AliExpress.
Note that PayPal was upgraded by investment banker Stifel Nicolaus from a hold rating to a buy. They now have a $49 price target on the stock, up previously from $43.
BMR Take: PayPal is a business with sustainable competitive advantages, long growth runways, and strategically-minded management. There was nothing shocking about this quarter. Instead, we all got a reminder that revenue and profit trends are sustainable and PayPal is going to be kicking butt for a long time to come. We’re up 44% since we added the stock this year at $31. Our target is hereby raised from $48 to $52. We would hope to see this number later this year or early next.
Qualcomm (QCOM: $68, up 3%)
Bloomberg is saying that a Qualcomm deal to acquire $34 billion NXP Semiconductors (NXPI: $102) could be announced next week. Apparently the price is around $110 per share for NXP, which will likely be paid in cash. NXP is due to release earnings on Wednesday so perhaps we will see the news break officially right after earnings.
What does the deal mean for Qualcomm? It’s great news if it happens. In short, this deal would be 25% accretive assuming Qualcomm utilizes its offshore cash pile of approximately $29 billion. Qualcomm and NXP together strategically makes sense. NXP has a strong automotive presence, boosting Qualcomm’s presence in an market that management has frequently said they want to target. We note that management has mentioned on a number of occasions that they gravitate toward smaller, tuck-in acquisitions, so NXP, not being a small company, is certainly a transformational situation.
BMR Take: The NXP Semiconductors acquisition is a powerful catalyst for Qualcomm as it will be materially accretive to EPS. We expect Qualcomm shares to rise considering the improved EPS outlook, on their way to our $72 price target.
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Upcoming Economic News
Tuesday, October 25th
S&P Case-Shiller Home Price Index – August
Time: 9:00 am
Forecast: 5.0% yearly change in 20-city index
Tight housing supply will keep prices advancing solidly. Nationally, home prices have risen 42% since bottoming in 2012, yet still trail their boom-era high by 8%. The 1.9 million existing homes available for sale in August is the least in 15 years, as the historically low pace of homebuilding and increased rental activity has limited housing inventory.
Conference Board Consumer Confidence – October
Time: 10:00 am
Forecast: 100.5
Consumer Confidence is projected to step back in October after jumping to the 9-year high in September. Expectations about the future hold at merely average levels. Steady job growth persisting beyond the election, should help.
Wednesday, October 26th
New Home Sales – September
Time: 10:00 am
Forecast: 604,000
New home sales are forecast to be little changed in September, contributing to continued rapid annual growth. Such sales rose 25% year-over-year in the three months ending August, the fastest advance in three years. Demand for newly constructed homes remains stout. The NAHB survey measure of builder expectations for future sales rose to the highest level of the past year in October.
Thursday, October 27th
Durable Goods Orders – September
Time: 8:30 am
Forecast: 0.0% overall, 0.2% ex-transportation
Core durable goods orders will potentially rise in September after slipping in the previous month. Recent orders data hint of some uplift in business investment spending despite continuing to decline on an annual basis. Reversing a contractionary trend throughout this year, core capital goods orders rose 2% annualized in the three months ending August.
Pending Home Sales – September
Time: 10:00 am
Forecast: 1.4%
The Pending Home Sales Index looks to advance in September, yet not by enough to undo August’s 2.4% drop. The index has fallen in three of the past four months as home lending volume fails to expand. Mortgage application volume for home purchases fell 6% sequentially in the last quarter.
Friday, October 28th
GDP – Third Quarter (Advance Estimate)
Time: 8:30 am
Forecast: 2.5%
GDP growth is slated to improve significantly in the third quarter as the drag from slower inventory growth fades out. But the underlying economic lift from consumer spending is sliding after rising 4.3% annualized in the second quarter. With auto sales flattening out and growth in housing activity falling short of expectations, broad economic activity has limited potential to reach 3% real growth over the medium-term. This is an unfavorable outcome. Our GDP prospects of 1-2% are dismal and highlight a stagnant economy.
University of Michigan Consumer Sentiment – October Final
Time: 10:00 am
Forecast: 88.0
Historically low consumer inflation expectations can have serious policy implications. The initial October reading of 2.4% annualized expected inflation between five and ten years from now is at an all-time low. That muted price outlook justifies very infrequent moves from the Federal Reserve to lift the Fed Funds rate.
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A Word from Gary Jefferson
First Vice-President, Investments
Jefferson Financial Group
UBS Financial Services, Inc.
Early disappointing corporate earnings and weaker economic data from China weighed on the markets and October is off to a poor start. That was expected, especially since we believe the market is beginning to price in a December hike in interest rates.
Earnings season really kicked off last week with more than 80 S&P 500 companies having reported. Some of the big names include Bank of America, IBM, J&J, United Health, Intel, Microsoft, Verizon, Travelers, GE, Honeywell and McDonald's (just to name a few). Nearly 400 more of the S&P 500 companies will report over the next three weeks.
But herein lies the problem - third quarter earnings reports have started to come in and analysts are expecting yet another period of negative earnings growth. According to Thomson Reuters, estimates for Q3 profits and revenues declined over the last several weeks. Overall, they are reporting that S&P 500 company earnings are expected to be down -3% over Q315, though revenues are expected to be up +1%. These numbers are still "guesses" and we can expect plenty of surprises and individual success or "miss" stories as earnings season progresses.
We really need some decent earnings and guidance for the 4th quarter in order to get a year-end rally jumpstarted. That said, this is the view from UBS: "The third quarter should be an important one for investors. We expect that S&P 500 EPS will rise on a year-over-year basis for the first time since 2Q15. Perhaps just as important, S&P 500 companies should guide for a sustained profit recovery, with earnings growth accelerating in the fourth quarter and remaining squarely in positive territory in 2017. When all is said and done, we expect 3Q16 S&P 500 EPS to rise by 3%, a healthy improvement from the 6% decline in the first quarter and the 1.4% decline in the second quarter of the year."
Those are two views which certainly are not compatible – the former represents the 6th down quarter for year-over-year earnings comparisons while the latter gives the green light to the long-awaited year-end rally for the market.
Basically, UBS is saying earnings growth numbers have not really been that terrible but rather have been skewed downward due to the Energy factor. The next three weeks should tell the tale.
Meantime, the news ("noise") in the weeks ahead will likely be dominated by the upcoming November elections. As election uncertainty continues to resolve itself, attention should rightfully turn to the Fed's December meeting and year-end economic data. Earnings will become ever more important to a successful Santa Clause rally.
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Aetna Update (AET: $111, up 1%)
The stock is being penalized for the uncertainty of the pending transaction with Humana (HUM: $176). We think the stock will move higher if the deal goes through. And if the deal doesn’t go through we think it will trade higher as well. It looks like win-win to us. Earnings are solid for the 3rd quarter as we look to Thursday morning before the market opens when they report.
The pending Humana deal continues to be a drag on the stock. The market is putting a low probability on the deal getting approved. Either way, we are fond of this company. We maintain our Price Target of $135.
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High Yield Report
This was the week when markets breathed a sigh of relief. The S&P 500’s slightly positive performance for the week helped reverse recent weakness and fears that a major correction is imminent. At the same time, most high yield assets outperformed the market slightly as income continues to remain a key motivator for buyers in the market.
Energy was a top performer this week, especially when we look at the High Yield space. The Alerian MLP fund (AMLP: $12.70) rose 1% this week, helping it reach a 5% year-to-date return excluding its dividend. (13%+ return so far YTD.) That’s a healthy return, but many MLPs are still struggling against weak energy prices, and oil’s close of the week around the $51 mark suggests the weaker firms will still struggle to produce positive cash flow.
When it comes to oil and gas exposure, we are still most positive about Kinder Morgan Inc. (KMI: $21), which soared 4% this week. The stock got a boost after reporting strong cash flow. It’s true that revenue and earnings disappointed, with negative EPS of 10 cents, with lower oil and gas volumes contributing to the results. However, the fact that Kinder Morgan is able to deliver strong cash flow that will exceed dividend payouts “for the foreseeable futures,” as management put it, indicates the firm’s resilience in the face of weak energy prices. That helped the company get three upgrades this week from Credit Suisse, Stifel Nicolaus, and Wolfe Research. We remain positive on the stock and expect it to continue to outperform.
The junk bond market saw a weaker but still strong performance, as the SPDR High Yield Fund (JNK: $37) rose nearly 1% this week, bringing the year-to-date price return up to over 8%. That’s double the S&P 500, indicating that the corporate bond market is continuing to enjoy its protracted correction after the panic of late 2015. That panic was driven by a fear that the Federal Reserve’s interest rate hike would decimate corporate bonds, and it’s true that we have seen a steady increase in corporate defaults throughout 2016. But those defaults seem largely priced into the market. So junk bonds remain risky but not riskier than the market had been expecting.
If junk bonds remain risky but still provide opportunities, investors need to avoid an index approach to the market and diversify among corporate bonds and other high yield instruments. That’s why we continue to like Pimco Dynamic Income Fund (PDI: $29), which rose nearly 1% this week and is currently yielding 50% higher (at 9.2%) than the JNK SPDR fund. That higher yield implies greater risk, but since the Pimco fund diversifies between mortgage-backed securities and high yield corporate bonds, we see it as a much less risky alternative to a junk bond index fund. Additionally, the fund’s undistributed net income has hit a one-year high and December is just around the corner: Pimco will announce its special dividend, and we are confident it will be over $1. That will bring its annual dividend to over 12%, making it one of the highest yielding funds out there, especially when considering its risk profile (fairly low) and its dividend stability (high). Since inception, PDI has both grown dividend payouts and never cut distributions. It’s impossible to find such a performance elsewhere.
Let’s turn to REITs. These investments have been interesting to look at this year. Changes to indexes have meant a reclassification of REITs away from other Financials, which the market interpreted as higher demand for REITs from index funds. That helped many of these stocks soar throughout 2016, but now the indexes have completed their restructuring and the last few weeks saw a correction in REIT prices as investors felt there was no further growth to come. Yet this week the SPDR Dow Jones REIT ETF (RWR: $93, flat) remains up 2% year-to-date.
Let’s compare our REIT picks. Kimco Realty (KIM: $28, paying 3.6%) is up 6% year-to-date and remains a low volatile and low risk REIT that still has the potential for dividend growth for years to come. Digital Realty Trust (DLR: $96) is up 27% year-to-date and continues to benefit from demand for server space thanks to the explosion in cloud computing. Government Properties Trust (GOV: $21) is up 30% year-to-date and remains the most controversial of our picks. Some people are worried about the company’s shift in strategy towards moving beyond its leases to government agencies, which is partly why the fund is still yielding 8% (although it was yielding 11% when we first recommended it). It’s still covering its dividend by 140%, suggesting dividend growth is easily obtainable. Or, if the bears contend, the company cannot grow funds from operations, it should still be able to manage payouts for quite some time.
We continue to recommend holding these three REITs instead of indexing the market both for a higher yield and for sustainable dividends. These picks, in addition to our bond, energy, and other high yield picks, provide a portfolio of 8% yields on average and sustainable payouts. This is not easy to do in a market where Treasuries are yielding less than 2%, but these great companies deliver it and are capable of continuing to deliver it for quite some time.
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Apple Corner
We read a lot of research each and every day, seven days a week. Here are some highlights of some recent Apple research reports from a few of the top firms on the Street.
--- It's all about expectations over the coming year – the iPhone 8 produce cycle.
--- The iPhone 8 cycle could be reflected in stock as early as the first two months of 2018.
--- So all you have to do is correctly predict Apple's next 12-month sales relative to
expectations. [Boy these guys are smart! Not.]
--- Consensus for iPhone unit growth in 2017 is 8%.
--- A few firms forecast a 16% unit increase. Given the 12-month lead, the stock could begin to discount the iPhone 8 cycle in early 2017.
--- Apple's discount to the market is 30%, which should narrow closer to its 5-year average of 20%. [Of course, we think there should be NO discount, but we can’t change that even though we feel it should be trading at a premium.]
--- Apple had its price target raised by analysts at Cowen and Company from $125 to $135 on Friday.
BMR Take: We think Apple is doing just fine and that earnings coming up on Tuesday after the close will be solid. They still have $40 per share in cash which is unprecedented in global financial history, and that number should grow when they report. Yes, the Samsung tragedy has helped Apple, big time. Who would want to buy a product from this $260 billion market cap company? So this will continue to drive the world to buy the iPhone as we move forward into 2017 and beyond.
Good Investing,
Todd Shaver
Editor in Chief
The Bull Market Report
October 16, 2016
by Todd Shaver | Oct 16, 2016 | Weekly Newsletter 7pm Sunday
The Week Ahead
We are a little over three weeks away from election day. So much is in the balance for the stock market. Clinton represents the status quo of US monetary, fiscal, and foreign policy. Trump is heading in a different direction with billionaire brainpower. We know from what happened with Brexit that the numbers out of the polls are just guesses, and uncertainty will linger until the final vote is cast and counted. Whatever happens will matter, a lot. The US is an economic giant in the world. Our interest rates aren’t negative. Our trade policies influence nations. The impact of Trump or Clinton will reverberate across the globe. All eyes are glued the United States and who we vote to lead our country for the next four years.
The Week Just Past
US fiscal position deteriorating as deficit grows. One week after the US Treasury revealed that total US debt in fiscal 2016 rose by $1.4 trillion, the third highest annual increase in history, and hitting an all-time high of $19.6 trillion, this week it also revealed that in the fiscal year ended September 30, the US budget deficit grew by $590 billion, a 34% spike compared to the post-crisis low of $440 billion in fiscal 2015, despite the Treasury enjoying a healthy surplus of $33 billion in the month of September. The latest figures show that the government is borrowing 15 cents of every dollar it spends.
US deficit widening due to out of control spending. Government spending went up almost 5% to $3.9 trillion in fiscal 2016, but revenues stayed flat at $3.3 trillion. Of the $3.9 trillion in outlays, Social Security was by far the biggest spending item, at $915 billion. But more importantly, in fiscal 2016 the deficit was 3.2% of GDP, compared to a deficit of 2.5% of GDP a year earlier, which was the first increase in the deficit as a share of GDP since 2009.
US GDP outlook is not good. There was much excitement when just two months ago, the Atlanta Fed revealed that its original Q3 GDP "nowcast" was showing an economy growing at a whopping 3.8% - a welcome reprieve for an economy which has barely been able to rise above a stall speed 1% GDP in the first half. Alas, since then things have deteriorated, and quite rapidly in recent days, because just one week after the Atlanta Fed slashed its GDP estimate to a low of 2.1%, this week it took it down to even less, or the lowest it has been to date, a paltry 1.9% and 50% lower than the original estimate. So taking all the data we have on hand as of this moment, we get that the US will grow at just 1.4% in 2016. Never in history have stock prices been able to go up while GDP growth rates decelerated for very long.
Billionaire investor Ray Dalio is warning of a major bond market bubble. The thesis is that since interest rates are so low, bond prices are at the far end of the upper bound. Dalio’s point is this: “It would only take a 100 basis point rise in Treasury bond yields to trigger the worst price decline in bonds since the 1981 bond market crash. The 100 basis point rise would drive bond’s to lose roughly $2.4 trillion of market value.” Whoa! Mrs. Yellen is between a rock and a hard place.
BMR Companies and Commentary
Facebook (FB: $128, flat for the week)
Facebook Workplace has arrived. Facebook announced the official launch of Workplace (formerly Facebook at Work), now available to any company or organization. Workplace is a communications network platform for work focused on facilitating interaction, collaboration, and sharing. Workplace includes core Facebook features such as News Feed, Groups, Live, Reactions, Search, and Trending posts, as well as new Workplace-only features such as a dashboard with analytics and integration, multi-company Groups, and identity providers to enable integration with existing IT systems.
While Facebook dominates the social segment, the enterprise network segment has yet to crown a clear leader. LinkedIn could be considered a competitor to some extent given the enterprise/social crossover, though LinkedIn has more of a public networking focus than a specific internal product for enterprises.
While Facebook is new to the segment, Workplace already has 1,000+ organizations and 100,000+ user-created groups in the testing phase, and Facebook’s 1.7+ billion underlying social user-base provides a broad canvas to encourage more enterprise adoption.
BMR Take: While it is unlikely Workplace moves the needle any time soon, Facebook has already disclosed that companies such as Starbucks have embraced the technology. This all fits into our longer term thesis that there are multiple untapped potential revenue sources in opportunities like Messenger, WhatsApp, Live Streaming, Search, and Workplace to name a few. $140 price target.
PayPal (PYPL: $39, down 1%)
PayPal reports 3Q16 results on October 20th. We expect good results. To be specific, we expect PayPal to report revenue growth of at least 17% and EPS of $0.34. In addition to a good 3Q16 performance, we anticipate a positive outlook for the holiday season.
We expect positive results to be driven by strength in payment volume (that is, the amount of money people are sending through PayPal’s network). And we see continued strong mobile growth, driven largely by the recent acquisitions of Braintree and Venmo, which are each focused on delivering innovative mobile technologies in payments.
One focus area that continues to get attention from investors is the financial implications of new agreements with Visa and MasterCard. The new agreement with Visa was announced along with last quarter’s earnings. In between now and then, the MasterCard agreement has been finalized. Investors want to hear about how much higher the costs will be for PayPal in the new contracts. What we mean is that PayPal has to pay Visa and MasterCard when PayPal users send money using their Visa or MasterCard plastic. Contracts just renegotiated with Visa and MasterCard raised costs for PayPal. Specifically, each transaction is now a higher fee. Investors also want to know if margins are still going to be acceptable. We think so. We just need management to say it so that the overhang goes away. We’re not really concerned because having access to Visa and MasterCard business could be absolutely huge for the company.
BMR Take: We like PayPal’s exposure to the rapidly growing online payments landscape, and believe it is positioned well to sustain mid-teens revenue growth. We believe PayPal’s scale and mobile transaction trajectory can sustain a growing network effect. The company is generating $2.5+ billion of free cash flow per year available for M&A and other value-driving initiatives. We find the stock compelling at this level as we look for the stock to get to our $50+ price target.
Netflix (NFLX: $101, down 3%)
We think Netflix is ultimately heading to $200 based on 20x a 2020 EPS outlook of $10. However, Deutsche Bank initiated the stock with a Sell rating and a $90 price target this week. We recap their call below so you have all the information. We believe you should side with us because there is a lot of money to make if we are right.
The report admits to be positive on the business and but cautious on the stock. Netflix has a long runway for growth due to its first mover advantage and self-reinforcing model.* They say and we agree, that increasing content and user experience investment drives subscriber growth and pricing power, which funds further content and user experience investment. The report doesn’t take issue with the business model, but only the valuation on the stock, saying this is a very long duration, high multiple investment with market expectations that appear too high through 2020.
* The self-reinforcing model entails increasing content, and user experience investment drives subscriber growth and pricing power, which funds further content and user experience investment in an endless loop of growth.
Folks, they have been saying this same thing about Netflix’s valuation for years. The business is doing so well, that is why the valuation is high, unless you are telling us the business is turning south. In our view the valuation is going to stay where it is. The business is heading in a healthy direction.
The report argues there is no take-out value*, specifically citing that nobody on the speculative list of buyers would have an interest. This list includes among others Disney, Amazon, and 21st Century Fox. They say severe economic/earnings dilution would be a major obstacle to a potential combination. They say there would be 25% EPS dilution for Disney. This is all true we must admit. But we don’t really care. You don’t need a take-out to do well in your investment as we like Netflix on a standalone basis.
* The estimated value of a company if it were to be taken private or acquired.
Netflix’s pivot to original programming, the development of its own in-house studio, the growth in aggregate studio output, and the size of Netflix’s programming budget all mitigate the apparent risk from Amazon, Hulu, and local international players increasing their subscription video on demand programming spend. This is the sell report’s argument not ours. This seems like a reason to own the stock not sell it, don’t you agree?
BMR Take: Netflix has a long runway for growth due to its first mover advantage and self-reinforcing model. The business is firing on all cylinders. Don’t pass on this just because it’s not a thrift store cheap stock. We like Netflix and have a $133 target price on the stock.
Welltower (HCN: $70, up 1%)
Welltower has pulled back from highs, but we like the shares still. The company owns one of the largest portfolios of healthcare real estate in the country and has established a track record as good operators.
Acquisitions are propelling earnings higher. Welltower has been one of the largest acquirers in the healthcare space, purchasing almost $25 billion of assets since 2007, or about $2.5 billion annually. So far this year, Welltower has closed or announced another $1.6 billion of acquisitions. Management’s agreement to acquire $1.15 billion of senior housing assets
Senior housing has rebounded, and as the company continues to invest in the this market, concerns about supply growth around the country seems to have paused. After putting up below-average growth in 2015, Welltower has delivered same store net operating income growth of 4.8% year-to-date in its portfolio. Moreover, Welltower’s portfolio has outperformed its peers in the space as the top 25 markets have only 2.4% inventory growth.
BMR Take: Welltower is on track to deliver EPS of $4.60 this year heading modestly higher over the next several years. This more than supports the current dividend of $3.44, which offers an attractive 5% dividend yield. Accordingly, we see compelling value here. We have an $84 price target on the stock. And note that this is no small company – the market cap is $25 billion. Very solid.
Mazor Robotics (MZOR, +7%)
Mazor reported earnings this week. There is a lot to like. Below we recap some specifics.
Mazor is at a key inflection point. While revenue in the 3rd quarter was a little light versus some estimates, the 25 orders received in the quarter represent a significant increase. To put this in perspective, the company sold 25 systems worldwide in 2015.
While quarterly revenue still remains a bit lumpy, this phenomenon now relates to easily explainable facets of the company's transition to its next stage of growth with Mazor X and the Medtronics partnership.
Customers are already beginning to pre-order the Mazor X system based on positive experiences during early training events. Medtronic ordered 15 Mazor X systems during the quarter. Four were delivered and revenue was recognized on three systems. Importantly, these are training systems that sell roughly at cost, which impacts revenue this quarter, but is a planned part of fully developing the Medtronic partnership.
The installed base increased to 130, from 96 in the prior year, up 35%. The majority of growth was driven in the U.S., where the installed base of 80 systems grew over 40% YoY from 56 systems in 3Q15. The international installed base grew 30%, to 52 systems.
The Mazor X system will be commercially launched at the North American Spine Society (NASS) meeting later this month in Boston. The meeting will be held from October 26-29.
BMR Take: This quarter’s results tell the story. The business is doing very well with upcoming catalysts. $27 price target.
Apple (AAPL: $117, up 3%)
We bet you didn’t hear the news: Batteries in the Samsung Galaxy Note 7 phone are exploding. Seriously, they are blowing up. Customers are returning the device and new orders have stopped. In fact, the company has discontinued the Note 7.
This is good news for Apple. As large carriers in the US like AT&T, T-Mobile, and Verizon stop replacing Galaxy Note 7 phones with new ones, Apple stands to gain incremental market share.
AT&T is offering to replace Note 7 phones with different models. T-Mobile is allowing customers to exchange their phones for a different model or get a refund. Verizon also stopped offering replacement Note 7s to customers.
Whether Samsung’s woes with the Note 7 turn out to be a significant increment to Apple’s earnings depends on how quickly the battery charging issue can be resolved. Third party estimates had called for 14 million Note 7 phones to be sold between August and December before the battery issue emerged. With the damage to Samsung’s brand, it sure seems like users may prefer to switch over to the Apple ecosystem.
BMR Take: The Samsung event is just icing on the cake. We like Apple for the potential upside from 1) continued long-term opportunity in China, 2) potential share gains from the release of a lower-end iPhone, 3) strength in the upcoming iPhone 7 cycle, and 4) optionality in cash balance. We like Apple at this level. $140 price target.
AmerisourceBergen (ABC: $80, up 1%)
Shares have been lagging. A number of pressures in recent quarters caused this year’s EPS guidance to be reduced. There is no more meaningful concern than the epidemic of concern over pricing throughout the Healthcare ecosystem (Think Mylan – down to $37 from where we removed it at $45).
There are still concerns about EPS risk linked to deteriorating pricing power for each of the major three pharmaceutical distributors. Specifically, at one point, AmerisourceBergen had indicated that it assumed 10-12% price increases in 2017 similar to 2016 levels. However, recent commentary indicates that all manufacturers, not just AmerisourceBergen, are showing a bit more caution in the way they approach pricing. In fact, there has also been some evidence of manufacturers deferring price increases at this point in the year versus what they might have seen in other years. Ouch!
BMR Take: The company still holds firm in aiming to meet its long term aspirational goal of 15% EPS growth of which 10% is organic. Though the timeline is not until 2018. The 2017 EPS outlook only calls for 4-6% growth. So be patient! $125 price target.
Upcoming Economic News
MONDAY, OCTOBER 17
Industrial Production & Capacity Utilization – September
Time: 9:15 am
Forecast: 0.2% industrial production, 75.6% capacity utilization
Industrial production is forecast to expand in September after declining by the most in five months in August. Both the production and new orders components of the September ISM Manufacturing Index turned positive after sliding in the previous month, an indication that both current output and demand are moving higher. Further positive monthly results will be needed to confirm an industrial sector rebound after manufacturing output fell year-over-year in both July and August.
TUESDAY, OCTOBER 18
Consumer Price Index – September
Time: 8:30 am
Forecast: 0.3% overall, 0.2% core
Rising gasoline costs can lead the September Consumer Price Index to its largest gain in five months. Though potential supply cuts from OPEC nations are pressuring fuel costs, gasoline at the recent $2.24 per gallon trails the current expansion’s high by 43%. One area where consumers have faced consistently rising prices is housing; the cost of shelter rose 3.4% year-over-year in August.
THURSDAY, OCTOBER 20
Existing Home Sales – September
Time: 10:00 am
Forecast: 5.33 million
The pace of existing home sales may show little change in September as limited supply is holding back transactions. Declines in the Pending Home Sales Index in three of the past four months warn that momentum for homes sales will not form in the near-term. The inventory of existing homes available for sale is equivalent to 4.3 months at August’s sales pace, well behind the historical average of 6.1.
Leading Indicators Index – September
Time: 10:00 am
Forecast: 0.2%
The large increase in the ISM Manufacturing Survey’s reading on new orders can lift the Leading Indicators Index in September. Both the Manufacturing and Non-Manufacturing indices from the ISM posted sharp turnarounds last month, easing concerns about potential slowdowns in hiring and output. An economic expansion of consistent but not overly rapid growth can support sporadic moves to tighten monetary policy.
The Options Corner
Here’s a simple option purchase that you might find interesting. With Bristol Myers-Squibb (BMY: $50, down 10%) down from recent highs, and the selling way overdone in our opinion, you might be interested in a way to take a position in the company without having to put up much capital. Or if you already have the stock you might want to average down a little. Additionally, there is great leverage in options as you will see in a minute, but also note, that there is risk.
You can do this by buying the January 2018 option, also known as a LEAP. The $45 option is selling for $8.50 and this gives you the right to buy the stock at $45. Thus if the stock goes to $53.50 you break even on the trade. We like the company expect to see the stock at $60 sometime next year and if the stock were to go to $62, you would double your money.
The risk is if the stock stays where it is or goes to $45 or lower by the end of the life of the option. If that happens, your investment goes to zero.
So, there you have it: a short and sweet option example for you.
A few words from Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services
Last week the Jobs report came in a little low and we also had the third revision of 2nd Qtr economic growth – it showed that the economy grew 1.4% in the second quarter. We have been told daily that economists expect to see stronger growth return in the third quarter. Two unofficial projections of GDP show that the economy may have grown 2.2% in the 3rd Qtr. However, forecasts have come down steadily in recent weeks, and it's possible the official growth numbers could be a disappointment. (Source: Thomson Reuters)
So once again the question is, "What can we expect in the coming weeks?"
Volatility and more volatility seems a fairly safe answer. The markets are grappling with a lot of uncertainty, especially ahead of the November election. We also know that the Fed wants to raise rates before the end of the year. We now believe that will happen unless 3rd and 4th Qtr earnings completely disappoint. On top of that are concerns about oil prices and the global effects of Great Britain's exit from the European Union.
Overall, we can expect markets to remain on edge until these uncertainties sort themselves out, and be somewhat comforted in the sense that there still does not appear to be a recession on the horizon. One market expert recently described it like this: "Adding it all up I see a long term bull market that is being interrupted by a too close to call Presidential election. It says more range bound action until the election results are final. Then the bull market gets rolling into year-end with a touch of Santa Claus rally mixed in for good measure."
The Market still seems to be expecting a stocking stuffed with goodies instead of coal.
Under Armour (UA: $38.50, up 2%) was upgraded by analysts at Wells Fargo from a "market perform" rating to an "outperform" rating. They now have a $45 price target on the stock, up previously from $40.
Twilio (TWLO: $46, down 11%) We added the stock on Monday after the stock dropped from $60 to $52 due to some selling stockholders announcing that they would sell about $350 million of stock. It is a bit unclear but it appears that the company will be selling just $50 million of new stock to raise capital. Both of these announcements are not bad things. Selling stockholders do this all the time. The stock will just change hands and it is actually a positive, since the stock will be in new hands. The company selling stock is nothing new either. And in this case, $50 million is just a tiny amount.
So the selling is way overdone. Yes, the company is new but they are on a trajectory to becoming one of the fastest growing firms on the Street. They have 30,000 customers, which we think is quite an accomplishment. We would recommend buying more slowly at these new, lower prices, averaging down if you bought at the $50 level. The stock could go to $40 before the selling stops, but we expect the stock to be a lot higher in early 2017 as the world sees how fast the company is growing.
Brookdale Senior Living (BKD: $15.30, down 5%) hasn’t been acting well. We have a $15 Sell Price on the stock and things are getting tight here. If it hits $15 we are removing the stock from our Special Opportunities Portfolio and would suggest you move into Welltower (HCN: $69, flat). Welltower’s market cap is $25 billion compared to Brookdale’s $3 billion. Welltower has 1400 properties and is paying 4.9% in a dividend. We were looking for Brookdale to be a turnaround situation for us, but they haven’t turned, and in fact have changed our opinion on them recently as they continue to disappoint.
North Dakota Crude Production Falls Below 1 Million Barrels a Day
North Dakota oil production dropped 4.7% in August on a commodity price slump, falling below the one-million-barrel-a-day mark for the first time in more than two years, according to the latest data from the state’s Department of Mineral Resources.
Crude production dropped to 980,000 barrels a day in August, the lowest level since March 2014.
Most oil in North Dakota is extracted from shale rock formations by hydraulic fracturing, or fracking, where a mixture of water, sand and chemicals is pumped into rock formations to push oil out. The state’s production has become an important barometer for how U.S. shale producers are faring during a period of low oil prices
High Yield Corner
We’re getting closer and closer to the Fed’s long-awaited rate hike, and the markets don’t like it.
The S&P 500 fell 1% this week as investors geared up for December, where the rate hike is looking increasingly likely. We’re seeing the fallout already in interest rates, with the 10-year Treasury already yielding 1.8% - far above its recent historic lows, but still far below the 52-week high of 2.4% reached just about a year ago. We still have a long way for Treasury yields to rise, and with it some pressure on stocks broadly.
Broadly - but not entirely. The Financial sector is poised to benefit, and the benefit seems to already be rolling in. Wells Fargo (WFC: $45, down 1%) reported earnings above expectations and a 2% increase in revenue despite the scandals that have caused the stock to plunge. Initially the stock surged on the news Friday, but erased those gains later in the day on broad market-wide weakness. It closed flat, and this should be instructive; a crisis-plagued financial firm is still able to deliver strong earnings with rising interest rates, and earnings are likely to go up for Wells Fargo and other financial firms. The opportunity to lend more aggressively with rising interest rates means these banks will be able to expand their operations and take on more risk. In short, if the Fed delivers on those rising interest rates, the Financial sector - currently one of the most beat up sectors in the market - will provide superior returns despite current low valuations.
This has a direct impact on one part of the high yield market: BDCs. It’s no surprise that this market was down a bit this week, but many people don’t understand why this happened. The UBS E-Tracs BDC ETF (BDCS: $22) fell 1% this week. The BDC universe is a diverse and complicated sector with many underperformers, which comprise the index that makes up BDCS. These underperformers are likely to do even worse in the future, because they will increasingly be competing with banks as interest rates go up. When rates rise, banks will lend more to small and medium businesses, thus competing in the Business Development Companies’ wheelhouse.
This dynamic is why we continue to like Main Street Capital (MAIN: $34, down 2.5%) even after its recent decline. We maintain our target price of $40 on the stock and recommend holding the stock even if it slides further with the BDC world. Our confidence remains steadfast that management is well-positioned and competent, and will be able to help make new deals that are profitable, and allow net investment income to pass through to investors through dividends. The 8% yield including special dividends and regular dividends is far from threatened, but the higher yield of some more risky BDCs is at much greater risk with the new competition from banks. So stay long Main Street Capital and avoid other BDCs.
Similarly, we remain constructive in selective parts of the junk bond market. Rising yields can have a bad impact on junk bonds and corporate bonds more generally, although we didn’t see that happening this week. The SPDR High Yield Bond Fund (JNK: $37) was flat this week and remains up 7% year-to-date. The junk bond market provides selective opportunities even as yields rise. We have seen bankruptcies rise considerably throughout 2016 and the market has priced this risk in, which means the risk of buying junk bonds now relative to the rising default rate is quite limited. (Most of the defaults have already happened and the risk was priced in a year ago. Buying at this level is less risky than in the past.) However, one needs to be selective about bonds, since indexes will include a lot of high-risk debt that actively managed funds can avoid.
This is the rationale behind our choice to buy Pimco Dynamic Income Fund (PDI: $28), although it must be admitted that this fund sees much greater volatility than the index fund. This is why the Pimco fund fell 1% this week and more declines may be forthcoming. But as we have repeatedly stated in this newsletter, this fund is poised to pay over $1 in a special dividend in December. The announcement is coming very soon, since November is just around the corner (the fund usually announces its special dividends in November), so we urge anyone long this fund to continue holding it even if it continues to underperform the index on a short-term basis.
Finally, to REITs. These have been a volatile roller coaster in 2016, providing strong outperformance followed by a sharp correction beginning this summer. Now the correction seems to have stopped, with the SPDR Dow Jones REIT Fund (RWR: $93) up 1% in the past week. Will this strength continue? Many are worried that rising rates will pressure REITs, but a lot of that happened in recent weeks and may already be played out. We don’t foresee great strength in the REIT universe, nor weakness either. In a market with limited market-wide buying or selling pressure, outperformers will be more desirable. This is why we continue to recommend holding Kimco Realty (KIM: $28, up 1%) and Digital Realty Trust (DLR: $92, up 3%), as the buying pressure for these stocks in particular is likely to prop them up no matter what happens to REITs more broadly.
Good Investing,
Todd Shaver
Editor in Chief
The Bull Market Report
October 11, 2016
by Todd Shaver | Oct 11, 2016 | 11am News Flash
Twilio: (TWLO: $52, down 14% yesterday)
Twilio fell the most since it started trading in June after the mobile and web-applications maker said the company and select shareholders will sell more stock. Despite Monday’s drop, Twilio is still up more than 250% since its IPO at $15 in June, closing up at $29, up 92% the first day. Now is the opportunity we’ve been waiting for to invest.
Twilio is a rare opportunity to invest in the only pure-play Platform-as-a-Service (“PaaS”) provider that is taking large slices of the Communications Software market, which IDC estimates to reach $46 billion in 2017. This new greenfield opportunity is being called Communications-Platform-as-a-Service (“CPaaS”). Twilio is known as the cloud-based category leader in CPaaS.
Riding the wave of the app and developer economy is a great place to invest. The clear growth in cloud computing is widely recognized. High-growth trajectories from Amazon Web Services (AWS), Microsoft Azure, Google Cloud, and Salesforce.com’s PaaS reflect the paradigm shift in how developers are building applications.
What does all that PaaS and CPaaS jargon mean in layman terms? The Information Technology (IT) department across Corporate America is undergoing a massive transformation. Historically, companies used to build out internal IT departments with staff and equipment. Right now, everything is shifting to the cloud. Instead of purchasing all the equipment to store data, the process is being run through massive data storage centers made available through the cloud for a simple license fee that scales up and down with volume. Instead of hiring a team of mobile software developers, the process is taking place through open sourcing the projects through the cloud, again on a pay-as-you-go basis. Twilio is leading the trend with a tight grip on communication services. Specifically, Twilio enables developers to build, scale, and operate real-time communications within software applications – to include SMS (texting), voice, video, and authentication.
The company is led by Jeff Lawson who is low-key and personable, but high in engineering intensity and entrepreneurial discipline. He is brilliant, and we at The Bull Market Report believe in him and hold him in high regard. You WILL hear more from this man and this company in the future.
Why is Twilio’s platform considered to be the leader? Listen to this: Twilio has 30,000 customers - from small developers to large enterprises - who use Twilio to power some 75 billion annual connections that reach 1 billion devices. Match.com makes matches without revealing phone numbers; Airbnb sends rental notifications, and the American Red Cross deploys volunteers, all through Twilio. ING, the European banking giant, recently announced it was closing down 17 hardware and software systems across its global call centers and replacing all of it with Twilio. Twilio’s largest customer, WhatsApp, uses them to verify customer accounts and logins. Apps from Lyft, Expedia, Netflix, Coca-Cola, Salesforce and the New York Times all have Twilio inside. The company saw 70% growth last quarter.
Here is more about the business model. The revenue model is transactional. Twilio largely prices its products on a transactional usage-based model. For example, its voice business is priced on a per-minute basis, while its message business is on a per-message sent basis. Programmable video is priced per gigabit. The reality is that Corporate America wants a scale-up/scale-down service on a pay-as-you-go basis, so the entire technology industry is just going to have to get used to no longer having the degree of revenue visibility that once existed.
Due to the nature of the business model, we look at revenue growth as the key indicator of business momentum. The outlook is exciting. There is substantial growth opportunity ahead through international expansion, adding other enterprise customers, and the roll-out of new products. While Twilio has been experiencing high revenue growth running 80-90%, there is strong likelihood for continued explosive growth, primarily via expanding the business internationally, which accounted for just 14% of revenue in 2015. Twilio began investing in Europe only in 2014 and Asia just in 2015 and has already yielded strong results. These geographic regions are just getting going. Additionally, Twilio is gearing its sales force to pursue business with a greater number of enterprise customers such as ING and Nike, where the more big names the company can win the more likely we are to see trickle-through effects in terms of enterprise-level retention rates.
The financial picture calls for the major inflection point to come in 2018. Twilio did $167 million in sales last year, up from $90 million the year before. At its current growth rate Twilio would hit a $1 billion annual run rate in the second half of 2018. Lawson calls telecommunications services a trillion-dollar market, with big portions of it poised to migrate from hardware to software. Following Twilio’s total revenue growth of 88% YoY in 2015, consensus estimates call for growth to decelerate to 50% per year in 2016-2018 but we think they can outdo these estimates. By 2018, management has committed to be EPS, operating cash flow, and free cash flow positive. This inflection point considers ongoing investments to build out partnerships that will support the future of the company.
Customer concentration risk* is among the single biggest concerns investors currently have. In 2015, Twilio’s 10 largest customers contributed 32% of total revenue. A meaningful though undisclosed revenue contribution came from just two customers – WhatsApp and Uber. These two customers, however, have very different profiles and it is important to understand the nuances. The bottom line is that investors will just have to live with the customer concentration until the business can grow out of it. WhatsApp is a mobile instant messaging platform with approximately 1 billion users globally and was acquired by Facebook in 2014. WhatsApp has been a Twilio customer for about four years and was a customer before Facebook purchased it. WhatsApp uses Twilio for both voice and messaging.
Uber uses Twilio’s Programmable Voice products to enable voice calls between the driver and the rider, uses Twilio’s Programmable Messaging products to notify riders of an approaching ride or to engage drivers during increasing demand, and finally uses Twilio’s Authy product to authenticate phone numbers of new users.. Overall, both the relationships with WhatsApp and Uber appear to be on solid footing.
The other main concern is the long-term competitive threat of Amazon’s AWS. However, AWS, the leading cloud platform, is not currently a competitor. Should AWS decide to provide a competitive cloud platform for communications, it would pose a threat to Twilio’s business but that talk is just speculative. Twilio has noted that it has a “great” relationship with Amazon, which is an investor in Twilio. In July, Twilio announced that it now “helps AWS extend text message delivery for SNS customers.” AWS VP of Mobile and IoT Marco Argenti commented, "AWS believes in the value of efficient, scalable technology solutions that can elevate the developers' role to concentrate on building great applications, rather than managing infrastructure. We are thrilled to be working with Twilio, and we'll continue to work together to help empower developers to communicate with their users seamlessly across devices." All in all, we find some comfort in the close relationship the two companies currently share.
BMR Take: Twilio is not cheap, trading at 12x 2017 sales, relative to its peer group average of around 4x. However, Twilio is better positioned than all its peers by a large distance as a pure play in CPaaS, an explosive growth opportunity. We believe Twilio is on the path to ultimately produce annual sales greater than the current market cap of $4.4 billion with sales this year of $315 million. The timeline is a ways out, but the recent sell-off is an opportunity to invest in this powerful, explosive company.
*Note that we at The Bull Market Report do not view the customer concentration as a worrisome issue. With growth as noted above, we don’t see it as a threat to the well-being of the company.
And one more thing. The world is always looking for The Next Big Thing. Twilio just might be a candidate for this exciting category.
October 9, 2016
by Todd Shaver | Oct 9, 2016 | Weekly Newsletter 7pm Sunday
The Week Ahead
What uncertainty! Confusion is seemingly everywhere we look. The Presidential debates are underway and the future direction of the country is in the balance. Both candidates are staying far away from discussing any meaningful fiscal reform. Trump’s plan for a $1 trillion infrastructure stimulus is 4 times greater than Clinton’s. Monetary policy is clear as mud. Markets were pricing a 63% chance of a December rate hike prior to the Jobs report, which missed badly, but I guess it didn’t matter because by the end of the day odds of the rate hike were 69%.
Many investment professionals are calling this moment among the most treacherous periods they’ve ever faced. After all, a 5-year certificate of deposit yields 1.80% or above many of the highest quality investment grade corporate bonds - how does that make sense? Bond bubble? We continue to stress to stay selective and disciplined with your investments, with good stock picks being the best opportunity for making money.
The newsletter was delayed today - we normally like to get this to you by 6 PM Eastern. Now you’ll just have to read this during the debate!
Highlights From The Past Week
Oil Recovery. The United States saw three new oil rigs brought online, bringing the total count to 428, according to Baker Hughes. The number of rigs marks the highest number of oil rigs in production since February, and with 15 straight weeks of increases in the rig count, we are in the middle of one of the biggest recoveries in US oil.
Labor market. The US added 156,000 new jobs in September, which missed the whisper number of 200,000 many were hoping for. Worse, the number was far weaker when observed from a quality standpoint – a surge in part-time jobs, the dip in full-time jobs, and the jump in multiple jobholders to the highest since the financial crisis.
Consumer credit. The latest consumer credit report revealed that in August, total US credit surged by $26 billion, smashing expectations of a $16 billion increase, and marking the third biggest monthly jump since 2001. This is not good. This borrowing is a byproduct of lack of savings and soaring healthcare costs.
Bank of Japan. In a fresh new move to counteract failing monetary policy, the BOJ announced it will now be targeting a 10-year interest rate of 0%. This is a new move for central banks called permanent "yield curve targeting." Markets have not experienced this before from any central bank and are having to learn quickly what it means. One conclusion everybody is worried about is that the BOJ is one step ahead of Europe’s ECB, which is one step ahead of Yellen at the Fed here in the US. This means if BOJ’s decade+ of extremely easy monetary policies have failed to the point of having to prop up their 10-year government rate from dangerous negative levels, then logic follows that Mrs. Yellen at the Fed here in the US is in for an ordeal of ultimately having to admit failed inflation targeting and is not far behind from having to deal with similar issues.
BMR Companies and Commentary
Facebook (FB: $129, +1%)
Facebook launched a local Marketplace this week. The Marketplace is a mobile app feature that connects local buyers and sellers – a Craigslist competitor. The new feature enables classified listings on Facebook that include a photo, title, description and asking price that are then viewable by the public. The Marketplace landing page shows a mesh of photos (with pricing) of local postings with complete search and filter functionality. Postings include Make Offer and Message Seller buttons, which are managed in the “Your Items” section. Facebook does not execute the final transaction, but instead focuses on making the connections and managing interactions between buyer and seller.
This is not the first time Facebook has tried a local shopping service. The difference this time is emphasis on mobile. In 2007, Facebook launched a Facebook App also called Marketplace with similar functionality of classified postings for friends and networks, but was desktop-centric. The service never gained meaningful traction and was eventually off-loaded. The new Marketplace is mobile-centric in terms of user-interface, ease of posting, and ability to manage posts and interactions on your phone.
Why does this matter? Marketplace ads are another feature to drive engagement, with positive benefit to usage if the feature gains transaction. Among the main bear cases about Facebook is that the company is unable to find new ways to sustain and grow user engagement. Well, Marketplace directly addresses this issue.
BMR Take: We remain positive on Facebook heading into the third quarter, as we believe strong engagement, pricing tailwinds, and underlying growth in advertisers position the company well for a potential EPS beat. Longer term, we are positive given the attractive revenue growth outlook supported by growth in global users.
Goldman Sachs (GS: $170, +5%)
Improving operating conditions should help Goldman Sachs. Investment Banking activity started percolating in 3Q16 after a slow start to the year, which could have bigger revenue implications into 4Q16. According to Morgan Stanley’s CFO at a recent conference, “It’s the first time in a long time we had real good breadth in terms of deal backlog for the industry.”
It has been a tough year for Mergers and Acquisitions (M&A). So far the trend has carried into 3Q16 according to analysis that track announced deals in real-time. The number of announced M&A deals declined 18% from a year ago in 3Q16. Worse, global announced M&A volumes for 3Q16 declined 27% from a year ago, as the deals we did see were of smaller size. The M&A business has always been boom and bust. While we aren't seeing the record activity experienced a year ago, we are fortunately still seeing a steady flow of business. We also point out that expectations were arguably too high for this year as last year's string of "mega" deals was not likely to be repeated.
Equity and debt capital markets businesses have been in a sluggish downtrend for a while. Encouragingly, we are seeing some pockets of strength. Global equity issuance activity during 3Q16 improved modestly from 2Q16 and global debt underwriting experienced another solid quarter as volume increased 21% from last year.
BMR Take: While M&A is having a tough year, the indications of improving backlog are welcomed. Global equity issuance and debt underwriting have improved slightly in recent months. With the stock trading at 91% of book value, we think valuation is compelling and continue to look for signs of an Return on Equity breakout to skew the risk/reward profile upwards.
Alphabet (GOOG: $775, flat)
This past week Google announced five new or updated hardware products, including a new flagship phone and Home device that are connected to Google’s updated Google Assistant* as it transitions from mobile first to artificial intelligence (AI) first**. While many of these new devices were expected and pre-announced at the company’s recent conference, the news is still a positive for the company.
* If you want to know all the details about Google Assistant, go here:
http://www.pocket-lint.com/news/137722-what-is-google-assistant-how-does-it-work-and-when-can-you-use-it
** "Mobile first" used to be the focus. Now it is “AI first.” It's how Tech looks at product cycles and where the world is going. They are saying that before, they would build everything with the primary focus on how to integrate Mobile. Now the focus is how to integrate AI.
The importance of Machine Learning, AI, and Voice are increasingly hard to ignore. These technologies are being embedded across products as digital is playing an increasingly larger role in our lives as connected devices proliferate. In many ways, we now view Voice as the new on-ramp to the Internet. Google’s voice activated Assistant is a central feature across devices, such as the new Pixel and Google Home. Strategically, at least 20% of Google’s queries are now voice enabled and we think of these new devices as an extension of Google’s reach that now includes the connected home.
Other product launches include Google’s VR headset, Daydream, Google Wi-Fi, and an updated Chromecast capable of streaming 4K video. While we view many of the announcements as a catch-up of sorts to devices currently on the market and as an extension of Search beyond laptops/tablets/phones, we believe they position Google well going forward as engagement expands across devices and increasingly through voice and AI.
BMR Take: The ecosystem Google is building is enviable. The intersection of hardware with new technologies like AI, voice, and machine learning, leveraged through an ecosystem of products creates a remarkable business. We think the stock is worth a lot more. Some analysts' price targets based on sum of the parts analysis suggest a value near $950/share.
First Solar (FSLR: $38, -5%)
We want to circle back to an industry we think has a great future, solar and wind power. There has been a lot of positive news flow for the industry in the past week. A summary is below. We continue to see compelling value in First Solar.
Solar and wind power plant deals are getting done at remarkably low prices. We conducted an analysis of recently released data for newly awarded wind and solar power plant projects around the world. Prices for power from new projects are plummeting to remarkable levels. We see the transition away from coal-fired power plants to renewable energy exceeding expectations. At this point, prices are now below the cost for power from new gas plants, according to Energy Information Agency analysis.
New deals in Mexico, Chile, and Dubai are coming in at less than $30/MWh (million watts/hour.) The second power auction from Mexico’s state-owned utility was completed last week with record low pricing for any technology type. According to analysis of the 56 winning bids, a 300MW solar farm was bid in at $27/MWh, which bests previous pricing records set in Chile and Dubai earlier this year.
Markets with a high preference for renewable energy (think lots of people who are on the "green living" train) - like Germany or California – are still struggling with striking the right balance between renewable and fossil fuel energy consumption. Why? Storage of renewable energy has been an issue. Fortunately, the trend toward lower prices means that these markets are more likely to soon start making the expensive investments in storage, in order to solve the problem. We see a dramatic increase in energy storage investments on the horizon which is ultimately a good thing for companies like First Solar.
BMR Take: We see well-capitalized, well-run companies like First Solar winning the long run opportunity in this market. We think concerns about the transitional 2017 year present an exceptional buying opportunity.
Brookdale Senior Living (BKD: $16, -8%)
Following our review of the 3Q16 senior housing market segment data, our thesis remains that inventory increases will outweigh demand, presenting pressure on earnings for operators. We think that secondary markets will experience more pain than the top 31 major metro markets. Fortunately, Brookdale’s geographic reach and scale is well-positioned to weather these trends.
Does the operating backdrop even matter for the stock though? Not so much in this case as expectations are already very low. With the stock trading well below real estate value, the market is clearly indicating little confidence in operational improvements. In other words, the weak operating backdrop is already priced.
What matters more to the stock is simply confidence in management’s ability to execute and a few one-off items. For the stock to work we need to see investors re-gain confidence is a few particularly concerning areas, specifically: 1) what the plan is for additional facility sales; 2) how much government reimbursement exposure can be reduced; 3) if further G&A and operating expense savings are possible; 4) more clarity about the ideal long-term leverage levels; and 5) more specifics about the plans for use of additional free cash flow for a stock buyback program. Answers to these questions can take the stock much higher.
BMR Take: Analysis suggests a real estate value of $6-7 billion versus the current market value of $3 billion. We are watching for management to focus on rebuilding investor confidence over a few key concerning areas, primarily leverage and the stock buyback. We expect operating conditions to remain tough, but with the stock trading so far under real estate value this critique is a moot point.
Gilead Sciences (GILD: $75, down 5%) had its price target raised by analysts at Royal Bank Of Canada from $95 to $105 on Monday. They now have an "outperform" rating on the stock. This is good news despite some negative news about their patent in Europe. The key patent for the Sovaldi drug has come under the scanner of the European Patent Office (EPO). The news from the EPO office confirms that part of the Gilead-held patent is already nixed by the officials. This development could mean that generic versions of the drug could hit the market four years earlier than expected, in 2024 rather than 2028. Revenues could be severely impacted. But these things can be challenged in patent court, all of which will take years, so we are not overly concerned.
Opko Health (OPK: $9.91, down 6%) The stock had a rough week as medical claims-processing firm Palmetto posted a no-coverage decision on Opko’s 4Kscore prostate cancer test. The 4Kscore had been widely perceived as a growth driver for this Medicare Processing firm. The company said this: “Opko believes there is more than enough scientific and clinical data to justify a positive local coverage decision by Medicare administrative contractors, and intends to work closely with these organizations to demonstrate the value of the 4Kscore test to improve individual patient care as well as the efficiency of healthcare systems.”
We feel that this is just a small bump in the road and that it will have little impact on the company going forward.
Upcoming Economic News
Wednesday, October 12th
FOMC Meeting Minutes
Time: 2:00 pm
Minutes from the September FOMC meeting will clarify how eager policymakers are to hike rates before the year is through. Fed Chair Janet Yellen has noted that labor market slack has proven to be greater than anticipated, which reduces the urgency to tighten policy. A December Fed Funds increase is likely.
Friday, October 14th
Retail Sales – September
Time: 8:30 am
Forecast: 0.4% overall, 0.5% ex auto
Retail sales are projected to rebound solidly in September after falling for the first time in five months in August. Steady job and income gains provide reassurance that August’s shortfall was only a temporary blip. But as the long-term boom in auto sales swings into reverse, the broad vigor of retail sales will be limited.
University of Michigan Consumer Sentiment – October Preliminary
Time: 10:00 am
Forecast: 92.1
The first reading on sentiment in the October Michigan survey is forecast to reach the highest level in four months as expectations about the future are on the rise. Yet the assessment of current conditions fell to a year-to-date low in September, perhaps as concerns about the election build. Getting past the election would remove a major source of uncertainty for both consumers and financial markets.
A Few Words from Gary Jefferson
First Vice-President, Investments
Jefferson Financial Group
We believe The Stock Trader's Almanac (STA) is without question the foremost historian of the U.S. stock markets. It has chronicled just about every conceivable stat that has to do with stock market patterns such as the 4-year presidential cycle; the best six months; sector seasons; the best and worst months, just to name a very few. STA has charted and identified a clear pattern of the market "predicting" a presidential win by an incumbent party or a win by the non-incumbent party going all the way back to 1950.
Last week, STA wrote, "As of today’s close S&P 500 is down 0.8% and appears to be casting its vote early against the incumbent party’s candidate. Admittedly it is too early in October to make such a call. However; it is notable that S&P 500 has already deviated from its typical path in October compared to past incumbent party victories. Should S&P 500 continue to track the Incumbent Party Defeat pattern, weakness is likely to persist until near the end of October before a modest rally ensues. This presidential election has been unique, and an unusual response from the market is not out of the question.
Recent weakness likely has more to do with the IMF lowering its growth forecast for the U.S., and an increasingly hawkish tone from the Fed. Brexit fears are also weighing with the British pound trading at its lowest level in decades today. These are all legitimate concerns, but nothing exactly new. The Fed has been a pendulum swinging between yes and no since the start of the year and U.S. (and global) growth has been tepid for years now while an actual Brexit is still unsorted. Earnings season just around the corner will either confirm concerns and fears or alleviate them."
That's the key – “Earnings season will either confirm concerns and fears or alleviate them.” With regard to your investment portfolio, forget about all the political noise (we know - it is almost impossible to do) because, at least historically, we are in somewhat of a win-win. If the market votes incumbent, STA's research shows that the market will trend up throughout October. If not, the market should still begin to rally near the end of the month possibly giving investors another good entry point for the anticipated year-end rally.
But it is still all about earnings. The broad NYSE Composite Index is at a lower level than it set more than two years ago, in 2014. Including dividends, the index has gained hardly 2%. Over the past two years, the behavior of the stock market is hardly an ongoing bull market
In other words, the broad stock market has basically gone nowhere in over two years. A well-diversified portfolio that included foreign stocks, gold and energy (commodities) and emerging markets like China did much worse. It's been a tough two years, and guess what? Earnings growth rates have been revised downward for six straight quarters. The market is clearly saying, "Show me the money". If we finally get the long expected bump up in earnings growth this 3rd and 4th quarter, that should alleviate fear that the recovery has stalled as well as concerns about recession. And that will trump emotions every time (no pun intended).
HIGH YIELD CORNER
The biggest news of the last week was the Jobs report from the Bureau of Labor Statistics. Nonfarm payrolls rose by 156,000, a big disappointment that drove the unemployment rate up a tick to 5%, a marginal rise, but any increase is bad news right now. The market is hoping for stronger demand from consumers to help companies’ revenues and earnings rise, but weak employment will not help that.
There are two macroeconomic theories going around right now regarding the future of the S&P 500. On the one hand, there is the “bad news is good news” crowd who are hoping that weak economic conditions force the Federal Reserve to slow or even halt its interest rate hikes, thus keeping more money in the stock market and bolstering the S&P. On the other hand, there is the “good news is good news” crowd who think the Fed is facing too much pressure to raise rates, and they cannot delay rate hikes much longer.
The latter crowd seems to be winning, and the proof is in Treasury futures that predict the Federal Reserve’s next move. These futures are predicting a 69% chance of a rate hike in December - even after the weak Jobs report. The market seems to have accepted that the Fed needs to move, no matter what happens to the labor market. With that in mind, we need fundamental strength to boost stocks.
We didn’t get that, which is why the S&P 500 fell nearly 1% last week. We’re still up over 5% year-to-date, so it isn’t all bad. Which brings us to High Yield.
Corporate bonds are still outperforming the S&P 500. The SPDR High Yield Bond ETF (JNK: $37) was flat for the week and is up over 8% year-to-date, excluding dividends. The market seems to have accepted the rising tide of default rates and isn’t worried too much that the weak Jobs report is going to increase defaults beyond the current clip. Since most defaults are still in the Energy sector, this makes sense, especially when we consider that oil rose this week on surprisingly low supplies in the U.S. Corporate balance sheets, especially in the Energy world, will not get worse even with the disappointing Jobs report - and that means corporate bonds are safe.
It’s no surprise that the Pimco Dynamic Income Fund (PDI: $29) had another good week. Rising over 1%, the fund is now up over 5% year-to-date and its dividend is safer than it’s ever been this year thanks to continually rising undistributed net investment income. This is an important point as we get nearer the end of the year. Investors may be tempted to sell, especially since the fund is over our initial target price of $28. However, investors need to wait and heed our new target price of $31. The reason for this is that a special dividend is going to come soon, and it is likely to be in excess of $1. The buying pressure to capture that special dividend plus the cash payout itself values the fund much higher than its current price point, which is why we recommend holding the stock until the end of the year unless the price surges - which is not entirely impossible.
Now let’s look at BDCs, since this industry was closely tied to oil at the beginning of the year and throughout almost all of 2015. That correlation seems to be breaking, as the UBS Etracs BDC ETF (BDCS: $22) was down slightly (less than 1%) for the week despite oil’s surge. BDCs have had an excellent year, with this fund rising over 8% year-to-date. Comparable metrics from the prior year are quite easy, and many BDCs have beaten the low expectations that were set in 2015. This has helped this sector rise. Additionally, oil-related defaults don’t seem to be increasing for most BDCs anymore, so a sigh of relief is blowing over the entire market.
This is why we still like Main Street Capital (MAIN: $34), which is up 19% year-to-date and actually went up slightly in the last week while the BDC market as a whole went down. This continued outperformance has caused a hefty premium for Main Street shares, which is why we recommend holding the stock with our new target price of $38. There are two reasons for this upgrade. Firstly, the company’s NAV is set to rise organically, which will close the gap between its premium pricing and its book value. Secondly, competition in the BDC world is not a threat to Main Street. This company is known for its high quality dealmaking among both investors and lenders, and that will reinforce the company’s business as it encourages more companies to seek out Main Street for loans. We see good reasons to benefit from this virtuous cycle by keeping our shares.
Finally, a quick word on REITs. The market has been extremely volatile, and last week was frankly a disaster for the sector. The SPDR Dow Jones REIT ETF (RWR: $92) plunged 5% last week. This is a diversified fund with “safe” REITs, so this decline is astounding. Popular low-yielding REITs like Realty Income (O: $61, down 8% this week) saw huge declines after big run-ups earlier this year. We have warned readers that a correction in REITs is likely to come soon, and we are in the midst of it. No one knows where the bottom will be, which is why we recommend adding slowly to REIT positions to capture the income these companies provide.
Our favorite REIT picks remain Digital Realty Trust (DLR: $92, down 6%), Kimco Realty (KIM: $28, down 3% - dividend paid of 25 cents), and Government Properties Income Trust (GOV: $20, down 10%). Each of these companies saw big declines last week along with the entire REIT market. Expect more declines to come, but see these as opportunities to get good quality high dividend payers at a discount. And don’t worry - after the market realizes its mistake, REITs will go back up again.
Note that Government Properties is below our Sell Price of $21 which we raised from $11 last week. If you are the nervous type you may wish to sell here, but as noted above we are still believers in the company. We are lowering our Sell Price to $17.
One more favorite, Annaly Capital Management (NLY: $10.02, down 5%) had another rough week. A reader wrote us this week:
Good morning Todd,
What a difference a week makes. I still cannot believe the pullback in REITs. Take for example, Annaly - wow. Do you consider NLY at $9.90 still a "buy"? The obvious follow up is the dividend safety. It seems with the share price drop, NLY is even more of a bargain.
Even if the Fed decides to increase in "any" upcoming month, a 0.25% increase should not be a negative. I wonder what the market is really trying to price in with these types of moves?
Thanks.
Vince Kostoff
We answered him here:
Hi Vince -
We have said this countless times. The market gets nervous when there is a hint of a rate rise. So Annaly has been knocked down more than 10% because of it. And this presents an amazing buying opportunity. The stock has done this countless times over the past 20 years and I am quite sure that the stock will be at $10.50 or higher sometime in the next 3-6 months.
The stock market is up 40 points as we publish this Sunday evening and the 10-year Treasury is down 2 basis points. Gold is coming back too – it’s up $11. Let this be the start of a good week in the markets.
Good Investing,
Todd Shaver
Editor in Chief
September 19, 2016
by Todd Shaver | Sep 19, 2016 | Monthly Newsletter Daily 6am if new
The Week Ahead
It was a week of ups and downs last week, with the Nasdaq up big, due to Apple and other Tech, and two out of the three major indices ending flat. There is clear confusion. World class investors at the Delivering Alpha Conference hosted by CNBC in NYC this week could not even agree which way the market is heading. While volatility has started to rise, we believe the moderation that was seen toward week end reflects a wait and see attitude surrounding what the Fed will do next week at their meeting. The probability for a rate hike is only 20%, but we are bracing for a potential surprise, as the Fed needs to prove to the market that it will hike rates, counter to low market probabilities, in order to demonstrate that they are leading the market and not the other way around. With all the volatility and uncertainty, we continue to stress top quality stocks as the place to be.
Here is How Last Week Progressed:
Monday (9/12) – S&P 500 +1.8%
— Markets rallied after Friday’s big selloff. Goldman Sachs issued a report calling for last week’s bond market selloff, triggered by UK concerns and Japan monetary policy, to extend into the 4th quarter, with US Treasuries reaching 2% by year-end (currently 1.69%).
— In Energy, a ratings agency issued a new report discussing how recovery rates for 15 US exploration and production bankruptcies averaged a “catastrophic” 20% last year, well below the historical average of 60%. (So out of those that go bankrupt, lenders are getting back just 20 cents on the dollar vs. 60 cents. Not good.)
— In Financials, Wells Fargo (WFC: $45, down 7% last week)admitted to secretly creating millions of bank and credit card accounts over the past five years without their customers’ knowledge or consent. An entire arm of the bank was fired over the matter and the stock is down sharply.
Tuesday (9/13) – S&P 500 -1.5%
— Monday’s recovery turned wobbly as concerns of general global economic conditions are increasing.
— The Delivering Alpha Conference in NYC hosted some of the brightest and richest minds in investing. Billionaire Paul Singer issued cautionary words for the path ahead discussing how it’s a very dangerous time in the global economy and global financial markets, adding that gold was under-represented in investors’ portfolios. Billionaire Ray Dalio warned that the current environment is analogous to the 1935 to 1945 period in America where we reached the limits of central banking’s ability to stimulate the economy and raise global asset prices.
— A US think tank warned that Australia has about six weeks or so to turn their situation around or face a massive hit to property valuations.
— Another Fed president has decided to call it a day. President of the Atlanta Fed Dennis Lockhart announced he will be stepping down on February, 2017.
Wednesday (9/14) – S&P 500 -0.1%
— Markets stood still.
— Goldman Sachs issued reports reducing their odds for a hike next week to 25% from 40% previously.
— CNBC hosted numerous conversations about the volatile mechanics of the stock and bond markets simultaneously selling off over the past week.
— In Healthcare, an undercover investigation by the Government Accountability Office found that 100% of their fictitious enrollees were able to sign-up and maintain Obamacare coverage and taxpayer subsidies despite submitting fictitious documents and/or refusal to submit any documentation at all.
Thursday (9/15) – S&P 500 +1.1%
— The morning began with news of the biggest German M&A deal in history. Monsanto accepted Bayer’s takeover offer for $66 billion creating an agriculture giant.
— More concerns about markets soon followed. Former Fed Chairman Allen Greenspan made public comments discussing how this is the worst economic and political environment that he has ever been remotely related to, noting that the U.S. is headed toward stagflation. New data soon after the statement confirmed Greenspan’s concerns.
— Year-over-year growth in Retail Sales rose just 1.9%, which represented the weakest level since March’s plunge and is now worryingly in historical recession territory.
Friday (9/16) – S&P 500 -0.9%
— Market performance was soft into the weekend. In Autos, just weeks after warning that sales had reached a plateau, Ford is now warning investors that operating profit will fall in 2017 and as a result the company is relocating small car production to Mexico.
— In Transportation, bankrupt shipping giant Hanjin said that as of this morning it had 93 vessels, including 79 container ships, stranded at 51 ports in 26 countries.
— Gearing up for next week’s Fed meeting, former Fed leader Ben Bernanke was out with some noteworthy comments foreshadowing the future path of interest rates in the US – negative! Specifically, he said, “The fact that negative rates would be temporary and deployed only during severely adverse economic conditions, would be an advantage. Like quantitative easing, which was also unpopular in many quarters, a period of negative rates would probably be tolerated by politicians if properly motivated and explained.”
Bull Market Report Companies and Commentary
Microsoft (MSFT: $57) Microsoft is a high quality bellwether. Recent reports indicate that channel partners* see strong business trends for the company’s Cloud product, Azure. Azure is a key pillar of expected EPS growth embedded in consensus forecasts. Accordingly, it is a good sign to hear that Azure is on track with expectations.
* A channel partner is a company that partners with a manufacturer or producer to market and sell the manufacturer’s products, services, or technologies, usually done through a co-branding relationship. Channel partners may be distributors, vendors, retailers, consultants, systems integrators (SI), technology deployment consultancies, and value-added resellers (VARs) and other such organizations.
To be more specific, channel partners are seeing strong sustained growth for Microsoft Cloud products, with a couple of partners underscoring a pronounced uptick with respect to Azure. One partner recently observed a renewed push by Microsoft to make inroads into the federal government vertical with its government Cloud. Lastly, a few channel partners referred to overall softness in their legacy Microsoft practices, partially driven by a faster-than-expected transition into the Cloud. This should be read as good news. Basically, the use of office desktop products is slowing because companies are transitioning to the Cloud.
We like that trend. We are fine with the legacy Microsoft business declining if the customers are moving to the Microsoft Cloud. It’s quicker and better, and a higher valuation is applied by the Street for the Cloud versus the desktop business
While Microsoft’s Azure product faces fierce competition from Amazon’s comparable AWS offering, one channel partner noted that Microsoft’s head start in the market with Office 365, along with their inherent long term relationships in Enterprise IT gives Microsoft a slight advantage in the Cloud space as compared to Amazon.
In fact, there is currently talk of an enormous energy conglomerate that has physical data centers in multiple countries which they are finding incredibly difficult to manage and scale and hence is thinking of moving to a Cloud infrastructure model. While this company has engaged both Microsoft and Amazon, the company appears to have a preference to go with Microsoft Azure because of the long standing relationship with Microsoft. This case study reinforces the storyline that Microsoft has created enough of a reputation now so that Amazon doesn’t seem like the only company in the public Cloud space.
BMR Take: The Cloud business is booming. Microsoft’s Azure product is recording revenue growth of greater than 100% a year. Channel partners are suggesting momentum is building. We view Microsoft as a high quality portfolio holding with an attractive dividend yield and substantial upside ahead.
Facebook (FB: $128) Weak sentiment surrounding the stock presents a buying opportunity. Facebook has delivered three consecutive quarters of 60%+ ad revenue growth, with an acceleration in four of the past five quarters. Street estimates have an upward revision bias with the 2017 consensus EPS having increased 35% so far this year. The overall lack of enthusiasm is reflected in the lower forward PE multiple and creates an opportunity.
One debatable topic right now is ad growth. Despite management’s caution on the 2Q16 earnings call, ad loads still have room to increase. Ad loads are a less significant growth driver of EPS estimates than many appreciate. Street estimates now call for slowing ad load growth to around 10% this year and actually declining in 2017-2018. Though there are several levers for management to focus on to drive improvement. For example, the company is currently working on ad targeting, relevancy, formats, and profitability in ways that don’t alter the user experience. Facebook still has opportunity ahead for ad load growth despite the recent near term headwinds.
Another debatable topic right now is engagement. Despite a small sequential drop in 2Q16 daily and monthly active users across all regions, the overall ratio of daily to monthly active users remains steady at 66%, which highlights the stickiness of the customer base. Moreover, Facebook’s share of US mobile Internet time of 13% is 2x greater than Snapchat, Twitter, Instagram combined, which highlights how healthy engagement remains. Recent product changes such as prioritizing friends and family in the Facebook and Instagram feeds and the launch of Instagram Stories may acknowledge shifting usage and increased competition, at least in certain demographics, but we expect Facebook to remain innovative on products. We are not concerned about a slight slowing of engagement.
BMR Take: We think weak sentiment surrounding ad growth and engagement presents a buying opportunity. Street price targets are as high as $170, framing the compelling upside potential. We added the stock in February at $97, and we are approaching our Price Target of $140. We are pleased.
Tesla (TSLA: $206) Tesla released an Autopilot update announcing advanced signal processing capabilities for its radar, which can now act as a primary control sensor and does not require the camera to confirm visual image recognition. It is just another sign of the transformational shift in auto manufacturing, where Tesla is leading the way,
Digging into the new technology a bit, the software upgrade collects more data in order to better determine the risk of a collision and prevent unnecessary braking. All very exciting stuff. In fact, just in the past few days at Ford’s annual investor day, Chairman Bill Ford acknowledged that “the technology is here in the world of autonomous driving, but there are a lot of things to work through and we have something to learn from every competitor [inferring Tesla]”. This was quiet the notable endorsement for the direction Tesla is heading.
Note that Robert W. Baird set a $338 price target on Tesla on Monday. FBN Securities upped their price target from $260 to $275 and gave the stock an outperform rating. Morgan Stanley reaffirmed an equal weight rating and set a $245 price target. Six research analysts have rated the stock with a sell rating, 13 have a hold, 10 have a buy rating and two have assigned a strong buy to the company. The consensus target price is $253.
BMR Take: We view the AutoPilot announcement as a positive that shifts focus back to Tesla’s core competitive advantage as a leader in the development, distribution, and monetization of ground-breaking automotive technologies. With that said, we await more news of the Gigafactory progress; the progress of the integration of SolarCity into the future of Tesla; and how in the world they can deliver on the 400,000 orders for the new Model 3 (for which they received $400 million in cash from the down payments.) These are the big picture items. And again, Tesla is RISKY. The stock could go to $400 in the next year or two, or it could go to $70. Or both. This one is volatile and not for the faint of heart.
Visa (V: $82) We have seen some big headlines in the stock market in recent weeks, but this company just quietly continues to perform. We want to be sure this stock doesn’t fall off your radar.
There are several catalysts that appear to be pushing stronger top line revenue growth including improved cross-border volumes, new deal wins (Costco, USAA), price increases (adds 100 bps to the growth rate), and accretion from the Visa Europe deal.
On cross-border volume, Visa is optimistic about improving trends as oil and the stronger US dollar comparables ease. Visa isn’t seeing any pricing pressure on cross border fees and is seeing significant growth in online commerce (the growth of digital grows at double the rate of offline). Cross border is 6-7x more profitable than domestic transactions.
Another big opportunity coming out soon is their entering the China market. Although there is no specific timeline yet, there is a big future opportunity to process Chinese domestic volumes and more Chinese cross-border transactions. In fact, some analysts size the opportunity to be $3 billion of revenue by 2020. Currently, Visa is focused on adding-single branded Visa cards to the Chinese market, while the cobrand relationships move towards expiration.
BMR Take: Visa is a very steady business model and a proven stock. The global opportunity to convert cash to electronic forms of payments remains lucrative. We continue to view this stock as a long term core holding.
Qualcomm (QCOM: $63) With all the news out on the Apple iPhone 7 launch, we can’t overlook the implications to Qualcomm. Eyes are on the Intel baseband share of the iPhone 7 business because the remaining share falls to Qualcomm.
Multiple reports have surfaced claiming to be able to discern the amount of share that Intel has taken in the iPhone 7. It is a bit premature to make a pronouncement on this, given that Apple is likely only slowing letting Intel into their phones. Either way, the impact is confined to only a 65% subset of iPhones that are non-CDMA* capable. Moreover, it is very likely that Apple is very slowly introducing Intel into the product line, considering recent major disruptions others in the industry have experienced, like with Samsung’s recent migration to a new chip stumbled.
*CDMA stands for code division multiple access, which is a channel access method used by various radio communication technologies. It often determines what network (Verizon, AT&T, etc.) your iPhone will work on).
To be clear, Qualcomm is expected to continue to hold 100% share in CDMA capable smartphones. According to industry estimates, CDMA capable smartphones represented 30% of total iPhone unit volume over the past 12 months and 35% in the 2nd quarter. As referenced above, the 65% of 2Q unit volume that was not CDMA capable is where Intel is possibly taking share. Some more aggressive expectations presume Intel may take the lion’s share of this 65% bucket. However, more in-depth analysis from industry experts points out that it is entirely possible that even where Apple is using Intel they may also be using Qualcomm in the same model. Bottom line, the Intel versus Qualcomm market share discussion in the iPhone remains pure speculation at this point, but is a must-watch trend going forward.
The most important trend to watch, however, is overall smartphone demand which remains strong.
BMR Take: We continue to like the prospects for the Apple ecosystem, which includes Qualcomm. Moreover, shares look attractive here with a 3.3% dividend yield. Qualcomm is a cash machine riding the smartphone wave to higher levels.
Home Depot (HD: $126) Management was on the road these past two weeks meeting with investors. Several favorable takeaways on the business surfaced. The Western part of the US continues to see strength, as Home Depot attributes it to more than just a California story, with a mini Silicon Valley forming in the Northwest states and great momentum around this build out. Phoenix is also improving and they believe there is a strong upside to the market based on how much there is left for that housing market to appreciate to reach the prior peak. Home Depot generates 1/3rd of its sales in the West.
Management highlights that the Pros customer base (professionals) are a little less price conscious given that they want to be able to know their costs and seem to have less patience for following promotions. Recall that 40% of sales is generated by the Pro customer.
Lastly, management noted that their second half guidance is not just based on the strength of the housing market but also feedback from the Pro customer base; that the project pipeline is strong for at least the next six months. Management noted that the Pros are taking vacations for the first time in years based on the healthy labor market.
BMR Take: Solid trends are seen over at Home Depot. The implications are good for the broad economy and stock market. We continue to favor this blue chip.
Gilead Sciences (GILD: $79) We thought we would give you some news on recent upgrades and research reports have been issued on Gilead. A large bank in Germany issued a buy rating and a $112 price target on the stock. Barclays reaffirmed an overweight rating. RBC Capital Markets set a $105 target price on Gilead and gave the stock a buy rating. Morgan Stanley has a price target of $103. Nine research analysts rate the stock with a hold, 18 have a buy and two have issued a strong buy rating on the company. The company has a consensus rating of Buy and a consensus price target of $105.
Gilead last posted its earnings results on July 25th. They reported $3.08 EPS for the quarter with revenue of $7.8 billion. On average, equities analysts predict that Gilead Sciences will post $11.80 for the current year.
The business also recently announced a quarterly dividend, to be paid on September 29th. The $1.88 annualized dividend produces a yield of 2.4%, paying out just 17% of earnings. There is plenty of room for growth in the dividend here.
Hedge funds and other institutional investors have recently added to their stakes in the company. Norges Bank acquired a new position in Gilead valued at about $1.3 billion. Bank of Montreal acquired a new position in Gilead Sciences during the second quarter valued at $430 million. Capital World Investors boosted its position in Gilead Sciences by 28% in the second quarter. They now own stock valued at $1.3 billion. Investec Asset Management acquired a new position during the first quarter of $280 million. Finally, Parnassus Investments CA boosted its position by 45% in the second quarter. Parnassus now owns $700 million. 78% of the stock is owned by institutional investors and hedge funds.
BMR Take: The stock has a market cap of $102 billion and a price-to-earnings ratio of 7. The stock is grossly undervalued and we expect the stock to go back to the triple-digit level late this year or next.
Upcoming Economic News
It is a very light week for economic news. The focus will be on the FOMC statement out Wednesday. The probability of a rate hike is just 20% with >50% odds that a hike will not occur until December. But who knows! Yellen now has Bernanke in her corner prescribing possible negative rates.
Under Armour Update:
Kevin Plank, CEO and Founder of Under Armour (UA: $39) announced that he will be selling 2.1 million shares of stock starting in October. A subscriber wrote in and asked our opinion of the situation, as he thought this was a bad thing.
Here’s what we wrote back:
“Hi Samuel –
“We generally don’t mind if executives sell stock. Plank currently owns 34 million shares of the company’s Class B stock, 135,000 shares of Class A stock and 34 million shares of Class C stock, representing 65% of the voting power in the company. So 2 million shares is a small part of his holdings. He is just diversifying.”
That’s how we feel. Of course, we secretly wish we had 2 million shares to sell of our own, and we admire Plank and all the others that have created all of the amazing companies out there, like Amazon and Facebook and Google, and so on. This is America. The entrepreneurs and the risk takers shall reap the rewards. Again, we would not even blink a negative eye over this CEO selling a small part of his stake in the company. Bill Gates has been selling 20 million shares a quarter since 2002. Wow. And we still love Microsoft.
THE APPLE CORNER
Apple had a great week. The stock was up $12, or 11%, closing at $115. I hope you are listening to us here at The Bull Market Report as we’ve been pounding the table on Apple for months! The stock saw its strongest four-day streak in over two years and is destroying short sellers who bet against it. The newest fuel was Apple’s announcement that initial quantities of the iPhone 7 Plus have sold out globally. Sprint said sales set records, far out-pacing sales of the iPhone 6 two years ago. That sent the stock up 3% on Thursday, after a 3% rise on Wednesday.
It was the strongest 4-day percentage increase since 2014, when Apple shot 13% higher over four days after the company increased its share buybacks and announced better-than-expected quarterly result.
Apple was responsible for much of this week’s gains in the Dow Jones Industrial Average. If Apple had been unchanged this week, the Dow would have been down 0.1%, instead of the 0.2% gain it recorded.
Apple on Tuesday made available new software (at no charge) for iPads and iPhones bringing huge enhancements to Messages, Maps, Siri, Photos, Apple Music, News, and more. This is what customers love about the company. And this is what WE at The Bull Market Report love about the company.
BMR Take: The stock trades at a PE of 14 times its past 12 months of earnings compared with 20 for the S&P 500. Will we see new highs ($134) in the stock by Christmas?
Good Investing,
Todd Shaver
Editor in Chief
