May 7, 2017
by Todd Shaver | May 7, 2017 | Weekly Newsletter 7pm Sunday
The Week Ahead
Well, it’s graduation week. Class of 2017 graduates are hitting the stage to accept their diplomas, listen to a keynote speech, make one last party, and then head out into the great big world. What will they find? GDP growth moving to 4% or stalling out around 2%. Will geopolitical tensions escalate as early as this year or find a sustainable comfort zone? Can equity prices hold? How bad will rising rates hurt the bond market? Everybody from the newest participant in the labor force to the most experienced must wrestle with these questions in the year ahead. We at The Bull Market Report hope to help you with some good insights about what to make of it all—week in and week out.
There is always a bull market here at The Bull Market Report! This week we highlight the following securities: Eli Lilly, Home Depot, Netflix, Splunk, PayPal, and VMWare. And a few others!
Highlights From The Past Week
Federal government expanding investigation of Fox News. The aggression against the media continues. Current and former Fox News employees have been interviewed, as authorities try to determine how settlement payments for sexual-harassment allegations were structured and which executives played roles in the payments. One source tells the WSJ that the investigators seem to be interested in intimidation tactics that former CEO Roger Ailes signed off on. The investigators are in the securities unit of the US attorney’s office, and no prosecution will necessarily follow. What does this all mean? You need to find trusted sources of information in this world. We strive to make The Bull Market Report a reliable and honest source of information for you to rely on.
It's the strangest thing: A hedge-fund manager apologizing for bad calls. Wellington Management Sr. VP Nick Adams isn't just apologizing for his mistakes on Silicon Valley venture deals -- which differ from the bank stocks he has a proven record with -- he's refunding fees. Adams, who has lost money two out of the past three years, put hundreds of millions of dollars into Mozido and Powa Technologies, which are both financially distressed. Adams has promised he won't ever invest in similar private deals in his flagship fund again. People familiar with the firm's finances say that after investors including Blackstone (BX) withdrew their cash, Adams's portfolio at the start of 2017 was $6 billion, down 40% from 2014. Adams has now returned to investing in traditional lenders like Bank of America and Citi, and his main fund rose 12% in Q1. We think there are lots of lessons to learn from this situation. For instance, if you ever wonder why many of The Bull Market Report’s stock picks are in household names that are often large cap stocks, well, now you know why. Traditional investing is a proven money maker and we try to take you where you can make money.
Don't assume the Healthcare industry will be fine. We think the market is right to assume that the Republican replacement for Obamacare won't be passed in its current version, but anything that hurts earnings for the sector could bring prices down, and the failure to pass any sort of healthcare reform may make a tax reform harder to achieve, which will be a negative for stocks more broadly. We all must keep an eye on this important event unfolding in Washington in the weeks ahead.
BMR Companies and Commentary
Eli Lilly (LLY: $83, +0.5% - All changes are for the week) Eli Lilly has more growth drivers than all its peers, but its continued pledge of "at least 5% annual sales growth" for 2015-20 is being called into question because a big portion of growth comes from two drugs - Jardiance and Trulicity - that have recently faced setbacks. We think Eli Lilly is a topnotch franchise in Healthcare and will overcome these hurdles.
Jardiance is a drug for type 2 diabetes. Johnson & Johnson has a competing drug called, Invokana, which is set to release new trial data in June. Everybody is saying that if Johnson & Johnson’s drug has good data, then there will be more pricing competition in 2018 for Eli Lilly’s drug. We think this risk is widely known, already factored into the numbers, and not a reason to not own Eli Lilly’s common stock.
Trulicity is also used for type 2 diabetes. It faces risks from the FDA's decision last August on Novo Victoza, specifically that this drug had problematic heart effects. Will the FDA say the same thing about Trulicity? We will find out in 2018. For now, it is overly pessimistic to assume Trulicity faces serious FDA challenges.
Note that Lilly's drug unit accounted for 83% of 2016 sales, with the balance coming from animal health, so the story is not just all about drugs. Also, Eli Lilly's operating margin trails most of its peers, except Bayer, and by leveraging new-drug launches, it aims to reduce R&D and SG&A expenses to 50% or less of sales in 2018 versus 56% in 2015. This target is achievable by Pharma standards as Jardiance's new heart label drives growth and Trulicity, an established product, continues to add to margins.
Lilly investors may be relieved by the good set of results in 1Q following recent drug setbacks. Older drugs, such as Cymbalta and Strattera, beat consensus, lifting margins and feeding through to the 2% EPS beat. Diabetes was strong with both Trulicity and Humalog beating consensus, while Jardiance missed by a little. Jardiance is a key driver of growth and while the miss raised eyebrows we say stay the course.
BMR Take: Eli Lilly is a top franchise in Healthcare boasting a market cap of $91 billion. On track to clear $5 of EPS, the stock is a good value.
Home Depot (HD: $156, flat)
A lingering debit/credit card breach has kept a lid on shares of Home Depot. The bad news is that it is so sad to see some large-scale breaches at US companies like Target and now Home Depot. The good news is Home Depot has taken strong steps to remedy the situation. In any case the stock is $1 from an all-time high, fast approaching $200 billion in market cap.
Companies hit by data breaches often face class action complaints filed by consumers. They also face lawsuits from shareholders looking to thwart future breaches and restore financial stability to companies in which they have invested. Home Depot's willingness to take meaningful but financially limited remedial mitigating action achieves a mutually beneficial resolution that companies facing any kind of data breach lawsuits, such as Yahoo, may rely on to improve their corporate data governance.
Under the proposed settlement, Home Depot will change many of its cybersecurity corporate governance policies. Home Depot agreed to document the duties and responsibilities of the chief information security officer; conduct table top exercises; monitor computer networks; maintain a “Data Security and Privacy Governance Committee;” hire a “dark web mining service;” receive reports on the company's information technology budget; join an information sharing program; and authorize the board to retain its own IT and data security professionals. Home Depot also agreed to pay $1.1 million in attorney’s fees and and $1.5 million to the shareholder representatives. They agreed to the settlement because it saw the attorneys’ fees as a minimal money issue and it believed the actions “would restore trust” in the company.
BMR Take: Home Depot is on track to deliver $10 of EPS and $100+ billion of sales. Don’t sweat the small stuff. Sorry to see the cyber breach, but the core business is doing great.
Netflix (NFLX: $157, +3%)
What could be more exciting than a Netflix merger with Apple? The world continues to talk about the prospects. Let’s break down the potential reality.
There may be as good as 40% odds that Apple acquires Netflix. The research arm of the investment bank Citi released a report with seven potential merger and acquisition targets for Apple. Tops on the list is Netflix. Elon Musk's Tesla, on the other hand, is only 5% likely. The full list of acquisition targets includes three media firms, three game developers, and, of course, one car manufacturer. Disney and Hulu are the media firms joining Netflix, while Activision, Electronic Arts, and Take-Two are the gaming companies.
Netflix makes a ton of sense, of course, as the company dominates streaming media both domestically and abroad. Disney has a strong list of properties as well, but slightly more oriented to traditional media consumption, whereas Netflix is well-positioned to take advantage of the continuing trend to cut the cord (cord-cutting has jumped 5x). Plus, Disney is worth $177 billion, whereas Netflix is worth $67 billion.
BMR Take: The future of TV consumption swings in the balance as the world moves away from traditional cable to the internet. Netflix is the powerhouse making the company a coveted asset in media. On track to do $10 of EPS by 2020 we see compelling value in the shares as a standalone entity even at current levels. A take-out could offer huge upside.
PayPal (PYPL: $49, +3%)
The PayPal network effect is working like charm. Investors in PayPal had plenty of reason to cheer last week when the company reported earnings. Nearly every metric was up by a better-than-expected percentage, surpassing expectations of all but the most bullish on the company.
More exciting to long-term investors, however, was the account growth and increase in user engagement with the company's core platform. Six million active accounts were added during the quarter, increasing the total to 203 million for the digital payments company. These active accounts now average almost 32 transactions per year, a 12% increase year over year. More customers using the company's platforms more often was a winning combination that the market liked.
PayPal's growth is beginning to fuel a powerful network effect opening a new window for the company. The beauty of this type of growth is that it drives itself. The more users that sign up for the platform the more important the service becomes for retailers to adopt it and the more places that accept it, the more attractive it becomes to new users. Get it?
At the end of March, 16 million retailers were accepting PayPal's core platform as a method of payment. Management is well aware of this virtuous cycle. During the conference call, CEO Dan Schulman stated: “Our powerful two-sided network engages both consumers and merchants, and the larger our scale, the stronger our network effect becomes. We made meaningful progress in advancing merchant adoption of PayPal in the quarter. At the end of March, the number of active merchant accounts on our platform increased to 16 million. The size of our merchant base is a formidable competitive advantage and is extraordinarily difficult for others to replicate.”
BMR Take: We think PayPal is in the middle of a decade-plus growth cycle that will deliver real value for shareholders. Stick around. They are already closing in on $3 of EPS.
Splunk (SPLK: $67, +4%)
Progress at Splunk is happening. Splunk, a provider of the leading software platform for real-time Operational Intelligence, recently announced support for SaaS Contracts in AWS Marketplace. Working with Amazon is a big deal!
The new globally available API capability* enables seamless procurement and deployment of Splunk® Cloud. The automated and accelerated purchasing process for Splunk Cloud via AWS Marketplace ensures fast time-to-value for customers leveraging Splunk solutions to gain real-time security, operational and cost management insights across their Amazon Web Services (AWS) and hybrid environment.
* Application program interface (API) is a set of routines, protocols, and tools for building software applications
The University of San Francisco is home to an innovative academic community of more than 12,000 students, faculty and staff. “As a higher education institution, USF prides itself on being at the forefront of technology, which is why we turned to Splunk and AWS,” said the vice president of information technology and chief information technology officer, University of San Francisco.
BMR Take: Working with Amazon gives Splunk big growth potential. The EPS outlook calls for great than 3x growth from $0.41 of EPS in 2017 to $1.35 of EPS in 2020. Ride this growth wave!
VMware (VMW: $94, flat)
VMware is out with some good news. The company is the first mobile application management provider to manage and secure hundreds of Oracle business applications and custom applications. As such, enterprise IT organizations can manage their Oracle application suite on a single unified platform together with their other business-critical applications and devices. Users who count on Oracle's business applications to make better decisions, reduce costs and increase performance can benefit by being able to access these applications through a simple digital workspace environment – be it from a mobile device, laptop or desktop – with VMware Workspace ONE and AirWatch.
What does that mean? VMware is continuing to make end roads in the lucrative cloud business, where growth is driving real results for stockholders.
The Chief Operating Officer, customer operations, said: "Mobilizing critical business processes is at the core of both of our organizations' DNA and this collaboration will help us advance this shared vision for our customers and their end users alike. We're proud to come together with Oracle to make it easier for IT administrators to secure and manage these critical mobile apps and help their end users seamlessly access them from any endpoint.” VMware Workspace ONE is the industry's only integrated platform for application and access management and unified endpoint management that enables simple enterprise secure access to any app from any device, accelerating adoption of digital workspaces.
BMR Take: The company is working. EPS is on track for $4.90 this year with growth upside to $6 in the next few years led by the cloud business and partnerships like the one described above serving Oracle.
Economic Outlook for the Coming Week
Monday, May 08, 2017 10:00 AM ET
United States - Labor Market Conditions
Period: APR
Actual: N/A
Consensus: N/A
Prior: 0.40
Labor market conditions index is derived from a dynamic factor model that extracts the primary common variation from 19 labor market indicators. It measures the changes of condition in the labor market. We expect to continue to see signs of a healthy labor market.
Tuesday, May 09, 2017 6:00 AM ET
United States - NFIB Small Business Index
Period: APR
Actual: N/A
Consensus: N/A
Prior: -$176B
NFIB Research Foundation has collected Small Business Economic Trends data from a sample of members from the National Federation of Independent Business (NFIB). Data from quarterly surveys since 1973 is based on 10 survey indicators. We expect to see an improving small business economy.
Tuesday, May 09, 2017 10:00 AM ET
United States - JOLTS Job Openings
Period: MAR
Actual: N/A
Consensus: 5,750K
Prior: 5,740K
Part of the US Bureau of Labor Statistics, the Job Openings and Labor Turnover Survey (JOLTS) program produces a monthly study that has been developed to address the need for data on job openings, hires, and separations. With the release of 2003 data, the JOLTS program began publishing industry estimates. We expect to see the JOLTS figures reveal a healthy labor market.
Wednesday, May 10, 2017 2:00 PM ET
United States - Treasury Budget NSA
Period: APR
Consensus: $166B
The monthly U.S. government surplus/deficit is published in the Monthly Treasury Statement (MTS). The MTS is assembled from data in the central accounting system. The major sources of data include monthly accounting reports by Federal entities and disbursing officers, and daily reports from the Federal Reserve banks. These reports detail accounting transactions affecting receipts and outlays of the Federal Government and off-budget Federal entities, and their related effect on the assets and liabilities of the U.S. Government. It is very critical what happens with Trump now negotiating the government budget and we are excited to see if he can get it under control and address the national debt.
Friday, May 12, 2017 08:30 AM ET
United States - Retail Sales ex-Auto
Period: APR
Actual: N/A
Consensus: 0.45%
Prior: 0.0%
Retail and food service sales data excluding motor vehicle are included in the Advance Monthly Sales for Retail and Food Service report, which provides an early indication of sales of retail and food service companies. We are keenly concerned about brick and mortar Retail sales declines and look to this economic release to assess the damage and potential impact.
MORE COMMENTARY ON BULL MARKET REPORT STOCKS
First Solar (FSLR: $35, up 17%) reported first-quarter earnings of 25 cents a share. The Street was looking for a loss of 13 cents.
Revenues hit $890 million in the quarter destroying the estimate of $700 million. (Who are these analysts anyway?) Revenues grew slightly from last year, up 2%. Profit was $84 million, down from $275 million a year ago. Ouch, but expected.
First Solar has $1.65 billion in cash, up from $1.35 billion at the end of the previous quarter. Long-term debt is $265 million at the end of the first quarter.
The big news is guidance. The company raised its revenue guidance to $2.9 billion from $2.85 billion. This is minuscule, but the Street liked it, pushing the stock up big. Gross margins guidance was moved to 13.5% from 12%.
Full-year earnings are now expected in the range of 25−75 cents per share, compared with the prior guidance of a breakeven to 50 cents.
We’ve said many times that this company is innovative and successful and that the turnaround will take time. This is the first positive information we have seen publicly that good things are actually happening. If you have patience, stick with First Solar. If you don’t, now is the time to take it off the table after this nice 17% run-up.
Facebook (FB: $150, flat)
Monthly active users totaled 1.94 billion while daily active users hit 1.28 billion. Expectations were for these numbers to hit 1.90 billion and 1.26 billion, respectively.
Facebook reported earnings of $2.5 billion or $1.04 per share on revenue of $8.03 billion. Expectations were for earnings of $0.87 on revenue of $7.83 billion. Huge beat. “We had a good start to 2017,” Mark Zuckerberg, Facebook founder and CEO, said. “We’re continuing to build tools to support a strong global community.”
Mobile is big at the company, as advertising revenue on mobile represented 85% of total advertising revenue, up from 82% a year ago. Ad revenue grew 51% over last year to $7.85 billion.
As of the end of the first quarter, the company had $32 billion in cash, and had almost 19,000 employees, up 38% from last year.
As Facebook nears the 5-year anniversary of its initial public offering, note this: In 2012, Facebook was the world's 10th-biggest seller of ads behind a bunch of traditional media companies such as CBS and 21st Century Fox. It has trounced almost all of them to rise to number two in the rankings, surpassed only by Alphabet, the Google parent that dominates search ads. Together, these two companies controlled 20% of the $550 billion spent on ads last year, up from 10% in 2012.
Source: Zenith Media
Jefferies hiked its price target on Facebook to $192 from $175, JPMorgan to $182 from $170, RBC Capital to $185 from $175, and Cowen to $170 from $156.
BMR Take: Our Target is in reach at $165. We would add to our positions at every opportunity. Wait until they hit 2 billion users. There will be fireworks and articles about the company galore and we just might see this as early as July. When this happens we can predict new all-time highs hit left and right.
Shopify News
We Tweeted this out on Friday:
“Shopify is on fire! All-time high at $86, up 5%. Stock was $73 a week ago. STRONG REVENUES will do it! Will eBay make an offer?” [The stock closed at $86 on Friday, up 13% for the week!]
The stock (SHOP) closed at $86 on Friday. We’re up 18% since we added the stock a little over a month ago. Our Target is $90. We can’t wait for it to hit so we can raise it to $100 or higher. And wouldn’t it be nice to see a stock split soon? What ever happened to stock splits? The markets in the 80s and 90s LOVED splits. We could see a 10-1 split for Amazon, bringing the price down to $93, and Google could split 20-1 bringing the price down to $46. Now wouldn’t THAT shake things up on Wall Street! The market would go wild.
Square (SQ: $19.78, up 8%) had a super good week. Square makes credit-card readers that plug into mobile phones and tablets and we were happy to see Square swing to a profit in the first quarter and raise full-year revenue guidance.
Led by Twitter Chief Executive Jack Dorsey, the company posted a quarterly loss of 4 cents per share on a revenue jump of 22% of $460 million. Analysts had expected a loss of 8 cents per share on revenue of $450 million, so of course the market liked what they saw. Square has predicted 2017 total revenue of $2.14 billion.
The company's gross payment volume - the total dollar amount of all credit card payments processed by sellers - jumped 33% to about $14 billion. We like numbers like this.
Another subsidiary, Square Capital, which offers loans to customers in exchange for a fixed percentage of their daily card sales, originated $250 million in loans in the first quarter of 2017, up 64% from a year earlier. We like large percentage increases like this. (We sound like a broken record…)
Square continues to move towards bigger customers. They said that 44% of the money flowing through its systems came from merchants that have over $125,000 in volume on the company’s platform, up from 39% a year ago. CFO Sarah Friar said: “That ongoing shift is good to see because those folks are not new to the payments world.”
Citigroup upped its price target on Square to $23 from $21, and Pacific Crest to $21 from $19.
BMR Take: We’re looking for $24, and hereby raise our Sell Price from $14 to $17.
Apple (AAPL: $148, up 4%) announced that it has $257 billion in cash as of the end of the quarter. They added $10 billion in the quarter which equates to about $800 million a week, or over $150 million per work day! Repeat: $150 million per work day. The company said it will return more of that to shareholders, announcing $50 billion in new stock buybacks and a 63-cent quarterly dividend. The company had already announced $175 billion in repurchases, helping maintain the stock price in lulls between new products, so the upcoming total is now $225 billion. Take a look at this chart of their cash buildup over the years:
Twilio (TWLO: $24, down 27%) We reported via News Flash on Tuesday that despite strong revenues the market didn’t like the results. The biggest knockoff was the fact that one of their big customers, Uber, has decided to go it alone. Uber provides 12% of total revenue for the company, but Twilio grew revenue by 60% not including Uber. So ultimately, we are not that worried about future revenues. We believe they will continue strong. (We think they will come back to Twilio at some point.) WhatsApp, owned by Facebook is also a large customer, so some people are worried about this large concentration of revenue in one customer. We’re not. There is no word as to whether they are considering leaving. We would suggest that they are quite happy with the service they receive. And again, note that the company added 4,000 customers in the quarter – amazing really – giving them more than 41,000 customers, up from 29,000 at this time last year.
We had a letter from a reader about Twilio and we said this to him:
Bob -- Be prepared for anything that might happen. We could see $20 before we see $30. I hope this is not the case, but it could happen. Uber is slowly leaving as a customer and they had 12% of revenues. So, this will take some time to work out. They did add 4000 customers last quarter and are now over 40,000. They normally add 2800 a quarter. But unfortunately, like First Solar, this is going to take some time.
The Options Corner
We had mentioned in our News Flash about Twilio that we would do a column about options if anyone was interested. Well, we had a strong show of support for this. So here you go.
There are myriad of options strategies if you want to maintain a position in Twilio and you believe it will come back like we do. Of course, most options trades are risky except for selling covered calls, which are still risky but less so than buying options outright. The premiums on Twilio options are relatively high so that usually points to two types of options trades: doing covered calls, and selling naked puts or calls. The latter two are very dangerous.
Selling covered calls: Selling covered calls on Twilio is fairly straight forward. With the stock at $24 you can get about $1.80 for the January $30 call. If you have 1000 shares, you can sell 10 options and receive $1800 in your account that day. The downside is that you would be obligated to sell your stock at $30 if it goes higher than that. But, you can always buy back the option if the stock goes above $30. Depending on how long it takes the stock to get there will determine the price at which you have to buy back the options. If the stock goes to say $32 by January, then you could buy them back for about $2, losing about 20 cents, or $200. But with the stock at $32, you would feel good about that. The downside is that if someone buys Twilio out at $40 a share, you would be forced to sell your stock at $30. Not pretty.
If the stock stays below $30 until January, then you can turn around and sell another out-of-the-money option for a few dollars and wait for the stock to move higher and each time you do this you put cash into your account.
As you can see there are lots of scenarios that can happen so you have to watch carefully. Make sure you have the advice of your broker.
Buying options: If you think the stock can get to the $40 level or higher by say January 2019, you can buy out-of-the-money options inexpensively. But you could lose all of your money if the stock doesn’t reach the strike price that you choose. For example, you can buy 10 options, controlling 1000 shares, at a strike price of $40 expiring in January 2019 for about $2,300. If the stock goes to $45, these options would be worth at least $5,000. If it goes to $50, the options would be worth $10,000.
Or you could buy the January 2019 50s for about $1400 and if the stock goes to $55 they would be worth $5,000. BUT, if the stock doesn’t get to your strike price, they expire worthless.
Selling naked puts: YOU SHOULD ONLY DO THIS IF YOU WISH TO BUY THE STOCK and if you have the money to do so. You could sell the January 2019 $25 put for about $7, or $7,000 for 10 options. That would obligate you to buy the stock at some point between now and the expiration date at $25, BUT you got $7 per share so your net price is $18. You could do the same thing with a $20 put and get $4.30 per share, obligating you to buy the stock for a bit below $16. We like this latter strategy. Suffice it to say that selling naked puts on stocks you want to buy at a lower price, is a good thing. Again – very risky. Why? What if the stock goes to $10. You would be forced to buy the stock at $18 or $16 as described above. Not fun.
Send us your questions and comments please! Info@BullMarket.com.
Tesoro (TSO: $80, up 1%) moves in the wind with crude oil. Crude got down to $45 early Friday and bounced back to $46 by the close. We like the company but can’t be part of it if crude is headed to $40. If you know where crude is headed you’ll know what to do with your position in this fabulous refiner. Unfortunately, we don’t. If we knew, we could make $1 million trading crude oil futures. We added the stock at $85 in November and have a Sell Price of $75. But we would hate to have the stock go that low, so we are hereby raising our Sell Price to $78, which is two dollars below the current price. So, if Tesoro closes below $78 we are out.
Carlyle Group (CG: $18.10, up 2%) posted first quarter earnings that handily beat expectations on Wednesday, in line with its peers, after a strong stock market last quarter lifted investment returns. Carlyle's peer Blackstone Group (BX: $30, down 2%), a Bull Market Report favorite, reported first-quarter earnings that surpassed expectations.
Carlyle said it earned economic net income (ENI)* of $365 million after taxes, more than six times what it earned a year earlier. That translated into $1.09 EPS, well above analyst forecasts for 38 cents per share and the second-highest on record since the fourth quarter of 2013.
* ENI is a crucial performance measure for U.S. private equity firms as it accounts for unrealized gains or losses in investments.
Carlyle said its private equity investments appreciated 9% in the first three months, better than a 5% gain in the S&P 500 index in the same period. Carlyle Co-CEO William E. Conway, Jr. said, “We deployed capital at a strong pace in the first quarter, with $4.4 billion of capital invested despite a difficult environment. We believe we are well-positioned to continue this strong pace. We have already announced substantial new investments and almost $4 billion of exits that we expect to close in the coming quarters.”
BMR Take: Carlyle is still way undervalued but is paying you 4% while you wait. We’re waiting patiently for the market to recognize this situation. We are up 12% since March, but we sure would like to see our Target hit of $20.
The High Yield Corner
By Michael Foster
It’s finally started.
It’s a bit late, but we’re finally seeing a correction in the BDC world. The UBS BDC ETF (BDCS: $23, down 3%) got hammered in a week that was pretty humdrum for high yield and not bad for the stock market as a whole, despite a lot of drama. Yet BDCs are back to underperforming, as they should. Overstretched valuations and high premiums to NAV were unjustifiable before this week. Now that many companies have reported lackluster earnings, those premiums are even less justifiable.
Ironically, however, this isn’t hurting the most overvalued BDC of them all: Main Street Capital Corporation (MAIN: $40, up 1%), which closed the week strong as investors sighed relief following the company’s earnings. Net interest income rose 9% from a year ago to 61 cents per share and the company’s NAV rose nearly 2% to $22.44. There are two big implications for this: firstly, the company’s dividend coverage is 109% and there’s room for years of dividend growth to continue. We have a feeling Main Street management has the ultimate goal of becoming the first BDC Dividend Aristocrat*. We’ve still got about two decades until they can qualify, so it won’t be easy. But if that is their goal, Main Street is easily the best managed and most long-term focused BDC in the world.
* The Dividend Aristocrats are a select group of 51 S&P 500 stocks with 25+ years of consecutive dividend increases.
That doesn’t mean you should go out and buy. We at The Bull Market Report were happy with our pick and happy to see it rise. But we are not happy to pay an 80% premium to net asset value. Consider this: if you considered Main Street to be the best BDC in the world, you wouldn’t want to compare its premium valuation to the valuation of other BDCs. You’d probably want something safer, like a megabank like Bank of America, which not only lends to small and medium sized banks but also mega-corps and governments while diversifying in other banking activities like M&A advisory, retail deposits, and so on. Or at least you’d want your BDC valuation to be less than the valuation of these banks, right? But if you compare Main Street’s valuation to the price-to-book valuations of these big banks, Main Street is overvalued by 40% at a minimum. This just isn’t good enough for a very well-run but extremely undiversified asset.
The market has begun to realize just how silly BDC valuations were getting, but the market has made an exception for main Street largely due to the fact that just about every other BDC reported awful earnings. Net investment income fell for almost all BDCs that have reported so far, with Hercules Capital (HTGC: $13) seeing NII down 33% from the prior quarter. The dividend is now less than 100% covered. NAV fell a bit as well (over 1%). What happened? The market dumped shares, which fell over 16% in a week. This used to be considered one of the safest and best specialty BDCs out there, but the market can turn very quickly on this asset class. We’re not saying anything similar will happen to Main Street anytime soon, but it is a serious risk.
Then there’s Goldman Sachs’s BDC (GSBD: $24), which fell 3% this week due to a decline in net investment income and virtually flat NAV. The stock is still up 3% year-to-date so you’re paying a higher premium for shares, though. Now you’re paying 32% over what the underlying assets are worth. Of course, this BDC is up big over the past year, thanks in part to the secular bull market in BDCs and thanks in part to the Goldman brand. But, as we’ve written here previously, there is a complicated conflict of interest going on with this BDC that makes us extremely cautious. Goldman Sachs’s management is not duty bound to restrict their deal making just to this BDC, and so there’s a chance (although no evidence this is the case) that management can select better deals for the parent company and keep lesser deals for the BDC business. Without clearer governance resolutions, this makes us extremely cautious. And, at the end of the day, this demonstrates one of the structural problems with many BDCs: management and investors’ interests do not align.
Some of the BDCs in the business were loved for avoiding this trap. The big Ares Capital Corporation (ARCC: $16.60, down 6%) is a good example. But this stock tanked as well, after reporting earnings fell 50% from a quarter ago and NAV rose less than 1%. We don’t need to emphasize how bad those results are, and how they deserve a discounted valuation. But Ares is still trading at a slight premium to NAV.
Obviously, a bigger correction in the BDC market is coming, so where else can we look? REITs and municipal bonds remain our favorite corners of the high yield market. The iShares S&P National AMT-Free Municipal Bond Fund (MUB: $109, flat) remained sleepy due to the risk-on nature of the market encouraging more investors to avoid the asset class, despite the growing number of undervalued bonds and great opportunities to get low risk yield for fund managers. Bull Market Report favorites remained flat for the week, Invesco Municipal Trust (VKQ: $12.69, flat) and The Nuveen AMT-Free Fund (NVG: $14.79, flat) Buying more of either fund at this juncture would make a lot of sense.
And then as REITs go, the SPDR Dow Jones REIT ETF (RWR: $92, down 1%) fell slightly with investor apathy hitting the asset class on little news. This again is resulting in plenty of good deals among REITs, and The Bull Market Report continues to have high conviction for long-term sustainable yields from Digital Realty Trust (DLR: $114, down 1%), Omega Healthcare Investors (OHI: $32, down 2%), and Care Capital Properties (CCP: $27, flat) in particular. Looking forward, we will be looking closely at how REIT earnings results and more market responses from the BDC market causes a reset in high-yield land that offers an opportunity to rebalance the portfolio.
Good Investing,
Todd Shaver, Founder
The Bull Market Report
CEO and Editor in Chief
Founded 1998
April 23, 2017
by Todd Shaver | Apr 23, 2017 | Weekly Newsletter 7pm Sunday
The Week Ahead
Global tensions are escalating. Since the United States dropped the Mother of all Bombs (MOAB), the world has come to learn that President Trump’s words carry weight. The newspapers are filled with stories of military angling between Russia, North Korea, China and the US. Peace through strength will hopefully prevail, which will be a major boost to equity markets, but in the interim, we are seeing elevated volatility as fears run rampant. Economic fundamentals remain great as optimism is at record highs and many bankers such as JP Morgan and Wells Fargo expect the optimism to translate to real growth in the economy in the near-future.
There is always a bull market here at The Bull Market Report! This week we highlight the following securities: Mazor, PayPal, Shopify, Digital Realty Trust, Care Capital, and Amazon.
Highlights From The Past Week
More Executive Orders From Trump. As pressure mounts on Trump to post some victories within the totally arbitrary window of the "First 100 Days," the President this week joined Treasury Secretary Steven Mnuchin to sign a combination of executive orders and memos targeting the reduction of tax regulations and certain components of Dodd-Frank. The executive orders and memos signed are expected to 1) initiate a review and potential unwind of executive orders signed by Obama in 2016 to limit corporate inversions and 2) initiate a thorough review of the orderly liquidation authority granted to the Federal Deposit Insurance Corp under Dodd-Frank.
Government Shutdown Looms. The Trump administration is quietly preparing for the possibility of a government shutdown, even though the president and his staff believe one is unlikely to occur. We will know at the end on Friday if the government can reach a deal. We expect Washington to figure it out in the 11th hour as they usually do, but we admit the risk of the government’s potential inability to come to consensus on how to manage its finances poses a risk to the bull market and may present volatility next week. In fact, the Vix (^VIX) has risen from 11.42 on March 29th to 14.63 today.
Oil Recovery Update. Global oil inventories are falling because of OPEC and non-OPEC production cuts, but the road to market balance will be long. Production cuts have removed approximately 1.8 million barrels per day from the world market since November. The latest IEA Oil Market Report stated, “It can be argued confidently that the market is already very close to balance.” What does that mean? Market balance means that production and consumption are approximately equal. That is an important first step for a market in which production has exceeded consumption for most of the last 3 years, but it hardly means that $70 oil prices are around the corner.
BMR Companies and Commentary
Mazor Robotics (MZOR: $36, +15% - all percentage changes in this report are for the week.)
The CEO of Mazor Robotics, Ori Hadomi, our beloved surgical robotics maker was on TV on Thursday. Shares of Mazor jumped on the publicity, among other reasons.
Hadomi explained that Mazor derives revenue from three pillars. It sells the robots themselves for about $1.1 million each. It sells the disposables the robot consumes, and it offers service and support. The company has always been focused on the patient, he continued, which is why he's privileged to be in this business. Mazor machines are seeing six times fewer complications and 10 times lower numbers for repeated procedures, and the hospitals that have Mazor robots are promoting and marketing the fact that they can offer procedures that others can't, generating new business for them that they didn’t have before. Hadomi also spoke about his company's partnership with Medtronic (MDT: $80), saying there are many synergies in culture and mission, and both are the leaders in their respective areas.
Mazor announced that it has received the FDA clearance for its Mazor X Align software. Mazor X Align software is designed to assist surgeons in planning spinal deformity correction and spinal alignment for procedures performed with the Mazor X Surgical Assurance Platform.
The new software is being demonstrated this weekend at the 2017 American Association of Neurological Surgeons Annual Scientific Meeting in Los Angeles. Mazor X Align will be initially released to select customers in early May, followed by a widespread release in the second half of 2017.
Mazor X Surgical Assurance Platform is a transformative guidance system for simplifying spine surgeries. Strong demand for Mazor X systems during the first quarter brought the total number of its orders to 40 since its introduction in the second half of 2016. The company ended the first quarter with an order backlog of 14 Mazor X systems and will deliver these in 2017. It is slated to report financial results for the first quarter on May 10th.
BMR Take: The company is putting every penny into its growth strategy and is not profitable and won’t be this year. Street estimates call for the company’s earnings to turn positive in 2019. With the inflection point in sight, we think EPS growth is coming and are happy to participate in what is shaping up to be an exciting stock. The stock has reached our Price Target of $36. Since we added the stock at $16 in June we are up 128%. We are hereby raising our Price Target to $44 and raising our Sell Price from $28 to $32. We don’t want to give away these amazing gains.
PayPal (PYPL: $44, +3%)
Earlier this week, it was announced that PayPal and Google will be partnering to integrate PayPal’s mobile payment options into Google’s smartphone payment app, Android Pay. No specific details of the arrangements were revealed, but according to Fortune, “PayPal’s chief operating officer, Bill Ready, said that his company’s partnership with Google will be implemented in the coming weeks.”
Executives at both Google and PayPal hope that the addition of PayPal as a funding source for Android Pay will serve to increase the number of smartphone owners who actively use Google’s digital wallet, while also making PayPal a more common choice for consumers making in-store purchases.
For years, PayPal has led the industry. Last year, PayPal processed more than 6 billion mobile transactions worth more than $350 billion. PayPal holds a commanding lead in the mobile payments industry, with 76% of digital wallet users reporting that they used PayPal.
BMR Take: PayPal is a one of the biggest growth stories of our generation. The company has 200 million users compared to Facebook’s 1.9 billion users. That leaves room for 10x growth still!
Shopify (SHOP: $76, +8%)
Shopify announced its new free Chip and Swipe card reader for in-person selling. With EMV support, the new Chip and Swipe reader lets any merchant in the United States sell offline in a fast and secure way. The card reader was launched at Unite, Shopify’s annual partner and developer conference.
Shopify makes every aspect of starting, running and growing a business easier. With the new Chip and Swipe reader, business owners can have the full power of Shopify behind them when selling in-person. The reader seamlessly connects with a seller’s Shopify store, eliminating the need for multiple systems to run a single business. Merchants benefit from the ability to manage their entire business from just one place and do not need to spend hours updating in-person sales with those made on their online store.
The first piece of hardware created in-house by Shopify, the new reader’s design was created using extensive research and user-experience feedback from their merchants. The Chip and Swipe reader is made for selling at festivals, pop-ups and markets. Unlike other readers that must plug into a headphone jack, the reader features wireless functionality and an extra-long battery life. The card reader was also developed to grow with business owners as they move from casual selling to a permanent retail location.
BMR Take: What can we say, Shopify is plugged into the massive growth of online, mobile e-commerce. Street estimates see sales growing from $390 million last year to $600 million this year to $1.4 billion by 2020. We saw a new all-time high this week ($78) and expect a LOT more from this stock.
Digital Reality Trust (DLR: $113, +3%)
Digital Realty, a leading global provider of data center, colocation and interconnection solutions, announced its 10th consecutive year of "five nines" of uptime – with 99.999 percent availability throughout 2016.
We are thrilled that the company has reached this important milestone, which reflects a steadfast commitment to developing and delivering the world's most dependable data center solutions. The company’s data centers are built and operated to rigorous standards by the most talented and best-trained team in the industry, which allows the business to consistently deliver solutions that provide the reliability customers require to run their businesses.
Digital Realty has 145 properties, encompassing approximately 23 million square feet in 33 metropolitan areas around the world. The company's global portfolio and comprehensive solutions enable their customers to expand from a single cabinet to a multi-megawatt facility as their needs grow, with no change in providers and no interruption in service.
BMR Take: With a 3.3% dividend yield and EPS power of $2+, the stock is a stable performer we think that should add nice gains in your portfolio.
Care Capital Properties (CCP: $28, +3%)
Care Capital Properties announced that it has entered into a definitive agreement to acquire six behavioral health hospitals in a sale-leaseback transaction for $400 million and to fund up to $50 million in capital expenditures to finance expansion and improvements in the portfolio. The properties are currently owned by affiliates of Signature Healthcare Services, one of the largest privately owned behavioral health care providers in the United States.
Upon completion of the transaction, which is expected to occur in Q2 of 2017, Care Capital will lease the properties to affiliates of Signature on a 10-year triple-net basis, with five renewals of five years each. The initial yield on the transaction is just under 9%, which is fantastic considering the leverage used to finance the deal was modest.
The acquired portfolio is comprised of six behavioral health hospitals located in California, Arizona and Illinois. The properties contain a total of 712 beds, and all six properties either have recently been expanded or are currently in planning or under development to increase bed capacity. The whole company now has about 350 properties, which is a nice size already and could potentially be much larger.
BMR Take: With an 8% dividend yield and a visible EPS run rate of $1.68, we like the value we see here.
Amazon (AMZN: $899, +2%)
As delivery firms struggle to manage overwhelming numbers of parcels, e-commerce giant Amazon is expanding its same-day Prime Now delivery service to include cooked meals and other items.
Amazon Japan said Tuesday it teamed up with Mitsukoshi's flagship store in Tokyo's Nihonbashi district to deliver foods such as deli fare and Japanese wagashi confections sold at the store. The online retailer also announced it has teamed up with pharmacy chains Cocokara Fine and Matsumotokiyoshi Holdings to deliver cosmetics and other daily supplies within one hour after an order is placed.
The Prime Now service, launched in 2015, has been available to Amazon Prime members who pay an annual fee of $36. Customers may choose items via a smartphone app with a minimum purchase of at least $23. The service is currently available to customers in parts of Tokyo, and a few other prefectures.
Amazon is also reportedly considering a rollout of same-day delivery service of fresh food including fish and vegetables. Similar options already exist in other countries such as the United States and the United Kingdom.
Competition over same-day delivery of groceries via online shopping is heating up in Japan but when Amazon puts its mind to something, great things usually happen.
BMR Take: We seem to say this every week: The Amazon innovation machine did it again. With so many new services being launched like the latest in Japan, earnings are expected to go to $20 in 2020 from $7 this year. The ride is far from over.
US Economic Outlook
Industrial production will look decent on the surface; we forecast it to have risen 0.4% in March. Mining production will likely increase, consistent with rising rig counts, as noted above in the Key Market Measures chart. Manufacturing production will be weak and is forecast to have dropped 0.4% in March, held back by Autos.
Unseasonably warm weather in January and February likely boosted housing starts, but temperatures were more seasonably normal in March. Also, an East Coast snowstorm should have hurt starts temporarily. Other housing data will look better, as we expect existing-home sales to have risen from 5.48 million annualized units in February to 5.58 million in March.
The first two regional manufacturing surveys for April are expected to have weakened, generally consistent with other survey-based data that have begun to surrender some of their post-election gains.
Financial market conditions also bear watching. Long-term interest rates have slid, which is a positive for investment and housing. However, equity prices have struggled recently. Though the immediate implications are minor, further declines would lend more downside risk to our outlook for consumer spending. Volatility could continue to rise because of geopolitical tensions, particularly in North Korea. Tensions are building between there and our forecast does not include a military conflict. Odds favor this conflict being eased with China imposing economic sanctions on North Korea.
We wouldn’t be surprised if the VIX continues to climb. The VIX curve is strangely inverted. In other words, investors expect volatility to be higher in the near term but revert to lower levels in the longer term. Volatility is normal and the economic implications of the VIX rising to the level consistent with fundamentals are not significant at the moment. If there were a sudden, significant and persistent increase in the VIX, there would be economic costs which would weigh on hiring and investment.
Goldman Sachs (GS: $217) had another bad week, dropping $7 or 3%. We removed the stock from our portfolio on Jan 19th at $232. Weighing on the bank’s results was a 2.4% decline in trading revenue to $3.36 billion. But the overall numbers were surprisingly good in our opinion: Profits per share of $5.15 were higher than the $2.68 it earned during the same period of 2015, but below Wall Street’s expectation for $5.31 a share. Revenue, meanwhile, came in at $8.0 billion, 27% above the year ago period, but missed the Street’s target of $8.44 billion. Wall Street is just funny sometimes. Those numbers appear pretty good to us. If the stock gets down below $200 we would be buyers again. Goldman is a money minting machine and they had a little hiccup last quarter, but you can’t hold this company down for long.
Home Depot (HD: $150) sets a new all-time high this week. The market cap is now $180 billion. Huge. Our Target is $160 which we are keeping, but we are raising our sell price from $130 to $144. We don’t want to lose these gains. We added them at $118 over a year ago and are up 27% on this powerful company.
Microsoft (MSFT: $66) quietly set a new all-time high this week. Go Bill Gates! The stock is up 14% since the election. Not bad for a company worth over $510 billion. Our target is $70 which we would love to see this summer. Our Sell Price remains the same: “We would not sell Microsoft.”
Splunk (SPLK: $62) had another good week, up 5%, and it is approaching its 52-week high of $66. Our Target is $70. Earnings are coming up in the 3rd week of May and we are quite optimistic that we will see strong revenues and earnings to keep this stock going higher.
Visa (V: $91) sets a new all-time high this week. We love this $210 billion market cap company. Ah – the business of MONEY. How can you beat it? The company reported revenue of $4.48 billion, up from $3.63 billion from a year ago, a gain of 23%. Wow. Excluding one-time items, Visa earned 86 cents a share, beating analysts' average estimate of 79 cents. The company said total payments volume jumped 37% to $1.73 trillion in the second quarter. The growth in payments volume was helped by the addition to Visa's results of Visa Europe, a former subsidiary Visa bought in June last year in a deal worth $23 billion. Visa Europe made up nearly a fifth of total payments volume. This company is truly and international company. We can’t wait to raise our Price Target of $95 to $110 when it hits $95. We would not sell Visa.
This stuff scares us here at The Bull Market Report. What more can we say? Well, Herbert Stein had a few things to say about these types of things. Herbert Stein (August 27, 1916 – September 8, 1999) was an American economist, a senior fellow at the American Enterprise Institute. He was chairman of the Council of Economic Advisers under Richard Nixon and Gerald Ford. Stein was the formulator of "Herbert Stein's Law," which he expressed as "If something cannot go on forever, it will stop," by which he meant that if a trend cannot go on forever, there is no need for action or a program to make it stop, much less to make it stop immediately; it will stop of its own accord. It is often rephrased as: "Trends that can't continue, won't."
A Word From Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
The pundits are all hopping on the "sentiment-remains-depressed-by-geopolitical-risks" bandwagon. Maybe, but sabre rattling has never really been a reliable forecaster of market direction. It's more likely that sentiment is flattening out because the Atlanta Fed’s real GDP forecast for the first quarter of 2017 is a measly 0.6% as of April 7th. Everyone knows the Fed would prefer to have some additional leeway to combat future economic weakness, but with that paltry number it may need to reconsider its current projected pace of rate increases as 0.6% is not near enough "runaway growth” to use as an excuse for rate hikes. Nor does it indicate inflation is going to become an urgent issue anytime soon.
There are other things worrying the market besides geopolitical risks. Transports, which have always played a meaningful role in measuring market moods, have fallen from a high of around 6% in March to the low for the year of about -1.5%. And small cap stocks, which roared at the end of 2016, have completely stalled out so far this year.
Maybe the market will digress back into the "bad news is good news". Hopefully not. Many pundits are now talking up a gridlock scenario where all the Republican squabbling and Democratic grandstanding will create the type of gridlock that the market thrives on where Washington does little to interfere with the private sector. Again, hopefully not.
Another pause in rate hikes means earnings aren't there and the economy is still stuck in low gear. That would be a serious headwind against further market gains if you consider that in the first quarter the S&P 500 was up 5.5% versus that 0.6% GDP performance. That kind of stock market performance needs better GDP support. We still feel that, contrary to what the mainstream media would have you believe, the Trump growth agenda has not been derailed. Yes, corporate tax reform hasn't gone anywhere. Basically, it is not happening as fast as many hoped for, but what else is new in the world of politics and bureaucracies?
What we still see in the countless projected earnings reports we have read is that, even with a derailment of the growth agenda, earnings this year will beat last year. Earnings should remain the catalyst for a decent year in which stocks end up higher than they are today.
The High Yield Corner
Special to The Bull Market Report
by Michael Foster
There’s one data point that we find particularly worrisome: the 10-year Treasury constant maturity minus the 2-year Treasury constant maturity. This somewhat esoteric macroeconomic metric effectively measures the market’s expectations for government bond yields in the short and long term. By comparing the two side by side, we can see how the market expects economic growth, inflation, and bond yields to trend in the future.
This metric was in a constant decline from its peak in 2014 to the Trump election for one simple reason: Expectations about inflation were getting weaker and weaker. Of course this made sense in a world where oil prices seemed to be in a never-ending freefall, so it’s not surprising that the trend was virtually uninterrupted until November’s election. Then it jumped to its highest point in a year and has been steadily declining since.
Why does this matter? Because that short-term spike, combined with the inevitable decline afterwards, indicates that the bond market simply doesn’t really believe that inflation and economic growth are going to spike. What’s more, the bond market also doesn’t really believe the Federal Reserve is going to raise interest rates three times in 2017.
We have been somewhat agnostic on the matter. While the bond market has made this pronouncement loud and clear, the stock market has been saying the opposite. The S&P 500’s P/E ratio keeps climbing, and the rationale behind the higher valuations rests largely on a belief that price inflation and strong economic growth will boost earnings. We have recently written about the 12% EPS growth expectations for 2017; those expectations have not disappeared. Thus it’s no surprise that the S&P 500 is still up 5% even after the slight pullback following early March’s peak.
As high yield investors, we are constantly trying to reconcile the stock and bond markets. There are two reasons for this. Firstly, corporate bonds, BDCs, preferred stocks and convertible bonds are a tad schizophrenic. Sometimes they trade with equities, sometimes they trade with bonds. When both markets are in agreement, there’s no problem; when they disagree, however, there’s a chance for a major price correction. Since the run-up in stocks and in bonds has caused all of these instruments to perform strongly, the chance of a downside correction, if not a brief bear market, deserves serious attention.
The other reason we always try to reconcile both markets is because our high yield strategy involves an incorporation of stocks and bonds. Bull Market Report pick AGIC Equity and Convertible Income Fund (NIE: $19.51) is a perfect example of this strategy at work. This fund has both stocks and convertible bonds in it, and its net asset value can often fluctuate because of one or other side of the portfolio. The balanced approach means the fund has massively outperformed the market, rising 6% year-to-date while paying an 8% dividend. It also outperformed the broader market this week, with a 1.3% boost.
Compared to standalone bond funds, the AGIC fund has been a massive outperformer. Bull Market Report pick Invesco Municipal Trust (VKQ: $12.68) was flat for the week and is up a bit over 3% year-to-date. Here’s a question for us all: Why is the AGIC fund performing so much better, despite the fact that the Invesco fund and other municipal bonds had a major correction in 2016 and are in recovery mode, while AGIC had an awesome 2016?
The key to this puzzle is in conflating what’s going on in the bond markets and the stock markets. AGIC is doing better than bonds alone because it has both equities and bonds, and both markets are doing extremely well for different reasons. Stocks are strong because of higher earnings expectations, and bonds are strong because the market doesn’t believe the Fed’s threats to jack up yields several times in the near term. We don’t either!
Can we merge both of these hypotheses into a coherent market view that makes sense?
We can. Both markets seem to be telling us that company performance is going to be strong but this will not result in runaway inflation that will give the Federal Reserve the justification it needs to raise interest rates. How can stronger earnings and more sales NOT translate into inflation? This seems like economic gibberish from a micro or a macro perspective - but it actually makes a lot of sense if you synthesize the two. Stronger earnings and more sales on the micro level can easily be offset by weak population growth; keep in mind that the population growth rate in the U.S. has fallen from 1.0% in 2008 to 0.7% in 2013 and has fallen below 0.7% this year for the first time since the 1930s.
Of course, if Donald Trump’s promises to lower immigration and deport illegal/undocumented immigrants are fulfilled, this will put downward pressure on population growth even further. Regardless of your political beliefs on the topic, the economics of such a dynamic are quite simple: Fewer people will mean lower GDP growth. However, that doesn’t mean you’ll have lower GDP per capita growth or that companies won’t be able to make higher profits in U.S. dollar terms.
We actually have a historical precedent for such a trend: Japan. GDP per capita has been going up since the late 1990s to today despite the fact that total GDP has barely budged. In 1995, Japan’s GDP exceeded $5 trillion. Its GDP is $4.1 trillion as of the last reading in 2016. However, GDP per capita has gone from less than $40,000 in the middle 1990s to $45,000 as of the last reading. That’s not terribly great growth, but it is growth - whereas GDP in total has gone down.
We could see a similar situation in America: Fewer people but more GDP per person.
Of course this kind of GDP growth hasn’t really translated itself into strong earnings at Japanese companies because the country depends on exports and has faced growing competition from South Korea and China. And that’s where the comparison between Japan and America falls apart. America is a net importer, not exporter, so the loss of people could impact firms quite differently. As a consumption-focused economy, that higher GDP per person could result in higher consumption, thus higher sales and higher profits. Or it could give companies room to grow prices (thus increasing revenue per customer) without actually causing inflation (because there will be fewer customers, meaning total spending isn’t going up). Thus we would be in a world of weak inflation, weak aggregate growth, but strong growth per person and higher earnings. Good for bonds and good for stocks.
This kind of granular analysis is foreign to the talking heads, political pundits, and headline writers who are financially motivated to stir up controversy, anger, fear, and all sorts of portfolio-destroying emotions.
So the Fed is not going to face the kind of economic conditions that can justify raising interest rates significantly. At the same time, there is tremendous pressure on the Fed to raise interest rates, so we can’t expect them to lower rates either, unless the bond market shoots higher from here and rates collapse. In other words, a very slow pace of interest rate hikes alongside higher earnings is probably going to be the big macroeconomic story for the next couple of years.
Is this good or bad for high yield investors? We believe it’s very good for a number of reasons. Firstly, it means lower bankruptcies for junk bonds (default rates have been falling for quite some time). Secondly, it means higher earnings potential for companies (thus more bond issuances and more tolerance for higher interest rates on new issues). Thirdly, it means that big capital flows out of high yield investments and into safer Treasuries is unlikely to happen. (This was the big bear case for junk bonds in 2014, 2015, 2016 and it’s a tired thesis that has been proven wrong so many times that it’s no longer a big hindrance to high yield bond price growth).
Is there any reason this could be bad for high yield investors? Perhaps the biggest risk is of the market overpricing the upside of this high earnings/low interest rate paradox.
For that reason there’s good reason to remain cautiously optimistic and look closely at what happens in the bond and stock markets over the next few weeks. But that doesn’t mean it’s time to sell or start to worry.
Good investing,
Todd Shaver, Editor in Chief
Founder and CEO
The Bull Market Report
Since 1998
March 26, 2017
by Todd Shaver | Mar 26, 2017 | Weekly Newsletter 7pm Sunday
Highlights From the Past Week
The markets were a bit weaker last week. Friday’s close ended with uncertainty over Healthcare reform. Regardless of the outcome, some people are starting to ask tough questions. Is this Congress going to be able to deliver on the aggressive Trump agenda? Across the board, we are not just talking simply healthcare, but taxes, trade, regulations, the wall, and so on. This very first test for the new Congress will set the tone for the years ahead. And we are sure you heard what happened on Friday. No healthcare deal. Now what?
No matter what, there is always a bull market here! Week in and week out, we you can find it right here at The Bull Market Report. We currently see a bull market across many parts of the stock market. This week we highlight the following securities: Mazor Robotics, Apple, Google, Facebook, Home Depot, Celgene, and VMware.
Keystone XL Pipeline To Start Construction. The Trump administration announced on Friday that it would issue a permit for the construction of the Keystone XL pipeline, a long-disputed project that would link oil producers in Canada and North Dakota with refiners and export terminals on the Gulf Coast. The announcement by the State Department, reversed the position of the Obama administration. The pipeline has been the focus of a long fight between environmentalists and the project’s advocates, who say it would further the goals of energy independence and economic growth. The event marks a key inflection point for American’s refocusing on business.
The Markets Don't Care About Healthcare As Long As They Get Their Tax Cut. For the stock market, the drawn out effort to pass the healthcare bill may not matter after all. Regardless of whether Republicans can push the bill through (they didn’t), pro-growth and economic policies are next on the agenda. If so, markets win either way. They are not willing to hold economic growth/tax reform hostage to the Affordable Care Act reform any longer. This is a broad market-positive signal that bolsters the case for 2017 tax reform. Tax reform will start to take center stage this Spring.
Optimism Sweeps the Nation and Pulls Money Into Stocks. The surge in business and consumer sentiment reflects an assumption that is deeply rooted in the American psyche: that deregulation and tax cuts always unleash transformative pro-growth entrepreneurship. That is what we are seeing since late last year. Money has been flowing into exchange-traded funds like never before, helping to propel stocks higher. $130 billion has flowed into these index-tracking funds in the first two months of 2017. This follows a record-breaking year in 2016, when ETF managers gathered more than $390 billion in new cash. Moreover, the CBOE Volatility Index, the VIX, a popular gauge of market fear, is trading near historic lows. Even the somewhat pretentious term -- “animal spirits” -- has come back with a vengeance in the financial media.*
*People say "animal spirits" as in reference to optimism and capitalistic mentality. Additionally they mean there is business opportunity out there that is obvious, management has that and is going for it.
BMR Companies and Commentary
Mazor Robotics (MZOR: $29, +24% - all percentages in this letter are for the last week)
Mazor had a big week. Honestly, there was no specific news on the company. There doesn’t always have to be a “new” story. Sometime, people just get more comfortable with what’s happening at a business, and they start to accumulate the stock.
The latest public development at Mazor was the Hartford HealthCare news. Hartford HealthCare is Connecticut's most comprehensive healthcare network. A week or so ago Hartford announced it was joining forces with Mazor. The new partnership will bring unprecedented precision to surgeons performing spine surgery and the patients they serve. The Mazor X system was developed to enhance predictability and improve patient outcomes. It enables surgeons to be more precise, more efficient, and reduce the overall risk rate of spinal surgery.
Hartford is the first healthcare system in the state of Connecticut and throughout the Northeast to debut this technique. Physicians performed surgeries this week at the Bone & Joint Institute at Hartford Hospital and at MidState Medical Center.
BMR Take: Mazor is serving quite the niche - spine surgery - and doing a great job. We continue to like this stock pick. This week’s healthy stock performance reaffirms our conviction. The stock reached our Target Price of $29, and we are now up 70% since June when we added the stock at $16. What should you do? Obviously you could sell or you could hold from here. We are raising our Target to $36 and raising our Sell Price from $18 to $26.
Apple (AAPL: $141, +1%)
With Apple once again moving to record highs, it seems that all anyone talks about is the next big iPhone launch. Buzz surrounding the coming 10-year anniversary iPhone is growing ever louder. Sales of the iPhone 8 debut later this year will shatter expectations and help fuel estimate-beating profit growth.
Yet high hopes for the iPhone 8 aren’t the only reason to take a bigger bite out of Apple. Let’s not forget, it is one of the few technology companies that pays a cash dividend to shareholders. There is talk that the iPhone maker is poised to announce next month plans to significantly increase the capital it returns to shareholders with a $35 billion boost to its existing share buyback plan and a 15% dividend hike. (AND WAIT UNTIL TRUMP starts his tax reform plan with the cash repatriation proposal.)
Apple is a great value proposition. Warren Buffett’s Berkshire Hathaway became one of the company’s biggest shareholders late last year when it added the stock to its portfolio.
BMR Take: With the iPhone continuing to blow away its competition, and Apple’s high-margin services business continuing to race higher, there is just so much to like here.
Google (GOOG: $814, -4%)
Google has run into a bit of a rough patch here. We like it even more down here at this level.
Major advertisers are halting advertising on YouTube after Google said it was taking steps to protect its clients from inadvertently supporting hate. The controversy over ad placement, is now in its second week. We believe it to be way overblown. Chairman Eric Schmidt said Google could "get pretty close" to guaranteeing companies' ads won't be placed near hateful material.
Range Rover it was suspending its YouTube campaign in South Africa while it investigates. Nissan said it was "urgently reviewing" its campaign with Google. JP Morgan Chase and Ford suspended their YouTube ads on Thursday. AT&T, Johnson & Johnson, GlaxoSmithKline and Verizon Communications have joined the boycott in recent days, after the BBC, Volkswagen and Toyota said they had pulled ads in the UK.
BMR Take: We reiterate that we believe this is a good opportunity to buy more of one of the best technology companies on the planet. Admittedly, Google isn't yet fully addressing advertisers' concerns and needs to take stronger steps to regain the trust of brands. However, they will get it right, and when they do, it’s back to the great story we know - and a much higher stock price.
Facebook (FB: $141, flat)
According to one Wall Street analyst’s recent due diligence, they observed Facebook advertising spend volume growing 85% so far this year, from a year ago, across its client base and ahead of the company’s internal forecasts.
Why the strength? Facebook’s customer match offerings and the return on investment benefits of lower cost per click are driving demand strength. Remember, they have 1.9 billion customers. 1.9 billion customers!
Separately, Instagram continues to represent a larger share of Facebook’s overall revenue and is a key driver of growth. Higher engagement is being driven by increased video content. What does this mean? Very good things. Higher engagement means more opportunity to sell advertising. With ad pricing stable, this trend adds up to more and more revenue. You get it. More engagement doesn't just mean people are happier on the platform. More engagement triggers more advertising opportunities for the business model.
BMR Take: It always nice to hear about how the current quarter is going before the current quarter is reported. We sleep well at night thinking about the future for Facebook’s advertising revenue.
Home Depot (HD: $148, -1%)
The remodeling boom continues. Remodeling is so popular right now that homeowners are expected to spend nearly $325 billion dollars on remodeling and repairs this year, according to Harvard. Wow!
Usually you decide to remodel or renovate your home when you're ready to upgrade worn-out areas, want to add new features, or simply because you're ready for a change. But like any good investment, there are a few areas where you can make a nice return on the money you're spending.
The number one interior improvement that ups the value of a home is a kitchen remodel. This can run $20,000 to $50,000 and even much more.
When it comes to the outside of the home, buyers apparently value structural upgrades over decorative improvements to the interior. New roofs lately have been growing fast.
BMR Take: Home Depot is benefiting from this remodeling boom. Retailers like Sears and Macys may be coming under increased pressure from online retailers, but Home Depot is trucking along just fine.
VMware (VMW: $92, -1%)
VMware is in a unique situation in the escalating hybrid cloud war. The company has a strong presence in datacenters but needs large public cloud providers as partners, given the high capital requirements to offer these services in scale. In February 2016, VMware entered into a partnership with IBM to offer hybrid cloud products. In October, VMware announced an alliance with Amazon, the largest public cloud provider, to do the same.
Recent quarterly results from VMware showed rising interest by customers in these partnerships. Lately we’ve seen rising customer confidence in VMware's long-term cloud strategy and its future position in the technology industry.
IBM's large client base in IT outsourcing gives it a novel edge as the adoption of hybrid cloud grows. It also has the entire breadth of services required to move clients at their pace from a legacy architecture to the cloud. IBM is also the world's largest IT services vendor with expertise in design, consulting and re-engineering of legacy IT to cloud. IBM is a leading vendor of both software and IT services, unlike other major cloud providers that historically focused more on software. Its early move into cognitive products through Watson should also help it drive additional growth in hybrid cloud.
BMR Take: We continue to like this core story around the “hybrid” cloud for VMware. Amazon and IBM - what great companies to call your partners! We expect more good news about this business in the near-future.
Celgene (CELG: $123, -2%)
The Affordable Care Act saga in Washington has created a buying opportunity for Celgene. We describe the situation below. The bottom line is that Celgene is lumped into the conversation with other bad actors. The reality is Celgene will do just fine if drug prices come down. It’s the real bad actors like Mylan that will be hurt.
The ACA saga in Washington has created a buying opportunity for Celgene. We describe the situation below. The perception is that Celgene is lumped into the conversation with other bad actors. The reality is that Celgene will do just fine if drug prices come down. It’s the bad actors like Mylan that will be hurt.
When you rush any kind of massive project, you raise the risk that people get hurt. That's certainly the case with healthcare reform. As President Donald Trump and congressional Republicans have scrambled (and lost) to save their troubled attempt to repeal and replace the Affordable Care Act, they addressed Trump’s repeated rhetoric that drug pricing needs to be rationalized. This is such a broad statement; there is a lot of uncertainty about how lower drug prices will impact each player in the healthcare space. So many medicines carry massive price tags because most patients typically pay just a small fraction of those list prices, while insurers handle the rest. We are all in wait-and-see mode as to how the new insurance schemes will influence drug pricing.
BMR Take: Lower drug pricing does not ruin Celgene. This is actually an opportunity for you, with this lower stock price. Celgene is widely cited by Street analysts as a top pick in the space as the franchise is best in class. The company has a stacked pipeline of new drugs creating strong financial prospects.
Consensus Ratings for Celgene
Ratings Breakdown: 1 Sell Rating, 4 Hold Ratings, 23 Buy Ratings
Price Targets:
3/8/2017 Cowen and Company $150
3/6/2017 Oppenheimer Holdings $148
3/2/2017 Cann $148
2/28/2017 Jefferies Group $155
2/25/2017 Canaccord Genuity $156
2/18/2017 Cantor Fitzgerald $159
2/18/2017 Credit Suisse Group $148
2/17/2017 Robert W. Baird $162
Must be something the Street likes about Celgene!
Upcoming Economic News
TUESDAY, MARCH 28
S&P CoreLogic Case-Shiller Home Price Index – January
Time: 9:00 am
Forecast: 5.7% yearly change of 20-city index
Gains in home sales over the long-term amid tight supply can keep the Case-Shiller home price index rising in excess of 5% annually in January. Nationally home prices now lag their pre-crisis peak by 7%, as certain local markets are considered overvalued. Yet broadly, consistent price gains have greatly reduced the share of homeowners underwater on their mortgages, which allows the housing market to function more smoothly.
Conference Board Consumer Confidence – March
Time: 10:00 am
Forecast: 113.0
Consumer confidence as measured by the March Conference Board survey is forecast to remain strong, even if the index slips a bit from February’s 15-year high. In February, the share of survey participants anticipating rising incomes exceeded the share expecting their incomes to decline by 10% for only the second time in the past decade. That gap points to persistent wage gains and an upward bias to price growth.
WEDNESDAY, MARCH 29
Pending Home Sales Index – February
Time: 10:00 am
Forecast: 2.4%
The Pending Home Sales Index is expected to rise in February after sliding to the 12-month low in January. Though sales and home lending are on a long-term uptrend, the pace of gains has not been consistent. Those uneven results imply that further gains in mortgage rates can weigh negatively on housing activity after borrowing costs rose in recent weeks to the highest levels since 2014.
THURSDAY, MARCH 30
GDP – Fourth Quarter (Third Estimate)
Time: 8:30 am
Forecast: 2.0%
Though overall GDP growth slipped in the fourth quarter, output still found support from a hearty pace of consumer spending. That may not be the case in the current quarter after January’s 0.3% decline in real consumer spending equaled the largest shortfall since 2009. Though GDP growth may once again disappoint in the early months of the year, healthy gains in jobs and improved industrial production trends signal stronger underlying economic progress.
FRIDAY, MARCH 31
Personal Income & Spending – February
Time: 8:30 am
Forecast: 0.4% income, 0.2% spending
Personal income is projected to rise 0.4% for the second straight month in February, aided by somewhat faster wage growth. Annual income growth touched 4% in January for the first time in over a year, partly signaling increased labor market tightness. Further gains must be registered in order for real spending to keep ahead of the recent uptick in inflation.
University of Michigan Consumer Sentiment – March
Final Time: 10:00am
Forecast: 98.0
Sentiment in the final March reading of the Michigan survey is likely to continue to display the strong post-election bounce. The reading on current economic conditions reached the highest level in 17 years in the preliminary March survey. That points to ample consumer resources that can keep the aged economic expansion chugging along.
Apple Hits New High This Week at $142.80
Pacific Crest raised their bullish price target for Apple to $175 based on the prospect of a cash repatriation holiday. This is a common song on Wall Street these days, and as you know we have been pounding the table about this for some time now. There is $2.5 trillion of cash overseas. Bring a little more than half of that back and you have $1.5 trillion that would be set to go to work creating jobs and benefitting stockholders. We might see a huge increase in the dividend. Maybe even a large, special distribution of $10-20 a share.
Goldman Sachs reiterated their Buy rating and $150 price target on Apple, saying the iPhone 8 supply chain data points to higher-than-usual seasonality in February based on average sales from six of the company’s suppliers.
And note that Apple was upgraded to Buy by one of the biggest bears on the stock on Wall Street. Bernstein now has a price target of $175. Now THAT’S saying something.
You heard it here first. What price would Apple have to hit to be the first* trillion dollar company? $190. Sounds like it's pretty far away, doesn’t it? But when Apple hits $160, it will be a hop skip and a jump away. Food for thought...
*Alas, PetroChina (PTR) was the first trillion dollar company, hitting that number in 2007. It’s worth just $200 billion now. (So we’re not counting it!) Apple will be the first. Or maybe Google or Amazon or Tesla. The race is on!
Number of monthly active Facebook users worldwide as 4Q16
This statistic shows a timeline with the worldwide number of monthly active Facebook users from 2008 to 2016 in millions. As of the fourth quarter of 2016, Facebook had 1.86 billion monthly active users. Extrapolating, we'd say they are well over 1.9 billion. 2 billion look out!
Consensus Ratings for Facebook
Ratings Breakdown: 1 Sell Rating, 4 Hold Ratings, 39 Buy Ratings, 4 Strong Buy Ratings
Price Targets:
3/21/2017 BTIG Research $175
3/13/2017 Cantor Fitzgerald $175
3/6/2017 Royal Bank of Canada $170
3/3/2017 Nomura $155
3/3/2017 Citigroup $165
High Yield Corner
By Michael Foster
This was a particularly good week for many Bull Market Report picks even though the high yield markets were rather dull.
The SPDR Barclays High Yield Bond ETF (JNK: $37) ended the week flat despite some interesting excitement in the Treasury markets. The 10-year yield retreated throughout the week to 2.42%, a drop of over 8 bp from the start of the week. This is significant because that yield is a combination of economic growth and inflation expectations, and the yield has been driven higher by the Federal Reserve’s rate hike and forward guidance of more rate hikes throughout the year. With the 3-month Treasury yield up to 0.75% and market expectations of an end-of-year yield of 1.5%, the spread between short-term and long-term bonds has shrunk considerably in the last few months. This means the market does not believe rate hikes from the Fed will come hard and fast, but will happen very gradually over a longer time period.
Why does this matter? Rate hikes intrinsically sound like monetary tightening, which is particularly bad for bonds and other debt instruments. For high yield bonds, it’s especially bad because it suggests that yields need to go up to compensate for the risk as yields on Treasuries get bigger. Since yields and price are inverted, it also means high yield bonds currently issued will go down in price. That, in turn, would hit funds like the SPDR High Yield fund
However, the Federal Reserve is not tightening relative to expectations. That “relative” clause is key here. The Fed is making borrowing more expensive, but everyone in the market expects the Fed to do this. The real question is how fast and how often they do it. The market now thinks that the Fed will raise rates at a slower pace than the market used to think, which means the Fed is tightening less than expectations. This, paradoxically, is good for high yield bonds because it indicates the downside of a tight policy is already priced in.
Extraordinarily, that “priced in” moment came in 2015. We’re getting near the 2-year anniversary to that cycle of discounting corporate bonds for future rate hike action. And keep in mind that is after junk bonds were discounted for future rate hike action back in 2013. If you look at the price return for the SPDR fund over the last five years, the fund is down over 7%. In other words, junk bonds have been discounting the Fed’s future rate hikes for several years, and every time the rate hike schedule is delayed, it bolsters junk bonds’ value even further.
That doesn’t mean junk bonds have fully recovered, though. The market is still very cautious because of a lot of misunderstanding about what the rate hike really means for corporate bonds, causing money to be left on the sidelines. That makes junk still a good opportunity, although you can’t expect the 10% price returns on junk bonds that were so easy to get a year ago.
So with that in mind, there remain valuable funds with high yield and corporate bonds in them. BMR picks AGIC Equity and Convertible Income Fund (NIE: $19.11, down -1%) and the PIMCO Dynamic Income Fund (PDI: $29, flat) remain solid picks that are earning their dividends and have capital gains potential. Impressively, Pimco has already seen a 5% return in 2017 although we haven’t even gotten to spring yet! That doesn’t mean the performance will annualize at that rate by the end of the year, but it may. What it does mean is that the fund remains a market outperformer that can continue to pay out its current dividend in a market where many funds are cutting distributions.
The AGIC fund has not been as solid of a performer largely because of its equity holdings. The fund had a bad week, but has a 4% year-to-date performance when looking at its NAV. That lags the S&P 500, which is up 4.6% over the same period. That underperformance does not bother us for two reasons. Firstly, the fund has tremendous liquidity thanks to its high 8% yield. It also has maintained its 10%+ discount to NAV throughout the year because the market simply underappreciates this fund. Thanks to that discount, the fund’s management needs to get just a 7.1% return annualized to maintain payouts and not see NAV go down. Thanks to the market’s growth and high yields on convertible bonds, this not difficult for AGIC Equity to earn in the current market. While there are some other risk factors at hand, they aren’t significant enough at the moment for investors to be concerned with.
Elsewhere in the high yield world, things were quiet this week. The SPDR Dow Jones REIT ETF (RWR: $92, flat) saw little movement, but BMR picks fared far better. Digital Realty Trust (DLR: $104) and Kimco Realty (KIM: $23) ended the week flat alongside the broader market, but Omega Healthcare Investors (OHI: $32, up 3%), Government Properties Trust (GOV: $21, up 1%), and Care Capital Properties (CCP: $25, up 2%) fared significantly better than the index. We’re nowhere near overbought territory for these REITs, but we may get there if further price appreciation comes to these stocks.
One asset class was particularly hard hit this week, and it’s one that readers know we have been cautious about for several weeks now: BDCs. The UBS BDC ETF (BDCS: $23, down -1%) was one of the worst performers in the high yield world, but former BMR favorite Main Street Capital (MAIN: $37) did much worse, losing over 1% for the week. Now Main Street’s price is up only 1% for 2017, making it a market laggard. Nothing fundamentally has changed with Main Street, but the market has finally warmed up to this stock so much that it’s gotten far overpriced and thus is now a bad value. It trades at a tremendous premium to its NAV, as we’ve mentioned several times since The Bull Market Report pulled it from its High Yield portfolio. It remains a very high quality BDC with market dominance, but at a 6% yield excluding special dividends, it just doesn’t provide the income worth the risk of paying for such a high premium. We are happy for management to have earned a deserved price premium for the value they add for investors, but we are not willing to pay that premium. Main Street is fairly to slightly overvalued, which is what you would expect for a good company in a healthy stock market. We will wait to buy Main Street again if and when the market gets unhealthy.
Finally, a word on municipal bonds. In 2016 we were pounding the table aggressively on almost all high yield assets, but were tentative about municipal bonds. The asset class was overbought throughout 2016 and undersold before that run up, especially when compared to the more ridiculous panic selling elsewhere in REITs, junk bonds, and especially corporate bonds. We didn’t see muni bonds fairly priced until late 2016, and then they became near bargains a short time later. That is when we started to dip our toes in the asset class and see tremendous value in the market.
Slowly, the market is beginning to come our way. The iShares S&P National AMT-Free Municipal Bond Fund (MUB: $109, up 1%) had a very strong week, and that’s helped the fund return again to positive territory for 2017. BMR pick Nuveen AMT-Free Fund (NVG: $14.53, up 1%) had a similarly strong week and has a similar year-to-date performance. Yet its dividend yield is over twice the iShares fund and its capital gains potential is much greater as well. There is no reason to shy away from municipal bonds now, and we can only hope that the trend we saw last week will continue over the coming weeks. Muni bonds deserve more market demand - it’s only a question of when that market demand materializes.
Good Investing,
Todd Shaver
CEO, Editor and Founder
The Bull Market Report
Since 1998
February 20, 2017
by Todd Shaver | Feb 20, 2017 | Earnings Preview 6 PM
The Home Depot (HD: $143)
Bull Market Report Target Price: $160
Bull Market Report Sell Price: $130
Earnings Date: Tuesday, 9:00 AM ET
Consensus: 4Q2016
Revenues: $22B
EPS: $1.33
Year Ago Quarter Results
Revenues: $21B
EPS: $1.17
Key Things to Watch For in the Quarter
Analysts expect Home Depot to report a 5% increase in revenue to $22 billion and a 14% increase in EPS to $1.33 for 4Q16. In response to the company’s ability to outperform analyst estimates in the first three quarters of 2016, the stock has gained 16% since the middle of last February. Investors remained stagnant upon the immediate release of earnings in Q1 and Q2 of 2016, however shares climbed nearly 5% in the weeks following the earnings report in 3Q16. Most recent developments in Home Depot’s business include an investment in a wind-powered renewable energy project that will provide the company the ability to power 100 Home Depot stores along with providing $150,000 in local community benefits.
First Solar (FSLR: $35)
Bull Market Report Target Price: $55
Bull Market Report Sell Price: $28
Earnings Date: Tuesday, 4:30 PM ET
Consensus: 4Q2016
Revenues: $410M
EPS: $0.97
Year Ago Quarter Results
Revenues: $940M
EPS: $1.6
Key Things to Watch For in the Quarter
Analysts across Wall Street expect First Solar to report a sharp decrease in both revenue and EPS, (56% to $410 million and 39% to $0.97 respectively) for the fourth quarter of 2016. Although the stock has plummeted 45% over the past year, it has beaten analyst earnings estimates for the past three quarters, and continues to provide investors with an inexpensive buying opportunity (PE of 7).
Splunk (SPLK: $64)
Bull Market Report Target Price: $75
Bull Market Report Sell Price: $55
Earnings Date: Thursday, after market hours (exact time unavailable)
Consensus: 4Q2016
Revenues: $290M
EPS: $0.17
Year Ago Quarter Results
Revenues: $220M
EPS: $0.11
Key Things to Watch For in the Quarter
Wall Street analysts estimate that Splunk will report a 54% increase in EPS and a 30% increase in revenues. The first three quarters of 2016 proved the company’s ability to continue beating analyst estimates, driving up the stock by a healthy 76%. Splunk continues to grow its operations, now operating in 110 countries across the world. In addition, it has actively brought together 20 industry leading security domains through its Adaptive Response Initiative, expediting the response to advanced cyber-attacks. We remain bullish on Splunk as they continue to grow revenues and earnings, and lead the industry with their ability to form profitable relationships.
February 19, 2017
by Todd Shaver | Feb 19, 2017 | Weekly Newsletter 7pm Sunday
The Week Ahead
“Kraft Makes Surprise Bid For Rival” was the weekend’s front page Wall Street Journal headline. The deal would be one of the biggest ever valued around $150 billion, ranking 2nd. However, it was flat out rejected on the premise of not being enough. Analysts expect Kraft to up the ante, perhaps substantially, so we could soon see the biggest deal ever in the next week or so. The largest deal so far was Vodafone buying Mannesmann for $172 billion in 2000. The second largest deal was Verizon Communications buying Verizon Wireless for $130 billion.
Why is all this M&A monitoring so important? If this deal passes, we would now have seen four out of the top five deals of all-time occur in the past two years. This flurry of mega deals reaffirms the strength of today’s bull market, which is perhaps turning into the greatest bull market of all-time.
Ha. This just in as we go to press. Kraft has withdrawn its bid. Story over for now.
The reality is, no matter what, there is always a bull market somewhere and you can always find it here. This week we highlight evidence of a bull market in the following securities: PayPal, Apple, Kinder Morgan, Home Depot, and Eli Lilly.
Highlights From The Past Week
Auto Bubble Bursting? For years there has been concern that record auto sales have been propped up by (i) low interest rates, (ii) a perpetual loosening of auto lending standards with terms being stretched to the max, and (iii) a wave of leases. All of these factors have allowed the American consumer to trade up to more expensive vehicles while maintaining low monthly payments. A quick look at the 61+ day delinquencies in General Motors' subprime securitization book would seem to support the rather negative thesis on future auto sales. January 2017 delinquency rates soared to the highest levels since 2010.
Mark Zuckerberg Rejects "America First" Calling For Global Community. Take a few moments to read the internal memo that he sent out to all Facebook (FB: $133, flat) employees:
“On our journey to connect the world, we often discuss products we're building and updates on our business. Today I want to focus on the most important question of all: Are we building the world we all want? History is the story of how we've learned to come together in ever greater numbers -- from tribes to cities to nations. At each step, we built social infrastructure like communities, media and governments to empower us to achieve things we couldn't achieve on our own. Today we are close to taking our next step. Our greatest opportunities are now global -- like spreading prosperity and freedom, promoting peace and understanding, lifting people out of poverty, and accelerating science. Our greatest challenges also need global responses -- like ending terrorism, fighting climate change, and preventing pandemics.
“Progress now requires humanity coming together not just as cities or nations, but also as a global community. This is especially important right now. Facebook stands for bringing us closer together and building a global community. When we began, this idea was not controversial. Every year, the world got more connected and this was seen as a positive trend. Yet now, across the world there are people left behind by globalization, and movements for withdrawing from global connection. There are questions about whether we can make a global community that works for everyone, and whether the path ahead is to connect more or reverse course.
“This is a time when many of us around the world are reflecting on how we can have the most positive impact. I am reminded of my favorite saying about technology: "We always overestimate what we can do in two years, and we underestimate what we can do in ten years." We may not have the power to create the world we want immediately, but we can all start working on the long term today. In times like these, the most important thing we at Facebook can do is develop the social infrastructure to give people the power to build a global community that works for all of us.
“There are many of us who stand for bringing people together and connecting the world. I hope we have the focus to take the long view and build the new social infrastructure to create the world we want for generations to come.”
A $17 Billion Trade Gone Wrong. Many traders across the Street were talking all week about a multi-billion dollar forced short cover by Catalyst Funds' Hedged Futures Strategy Fund (HFXAX). The fund was short upwards of $17 billion of S&P 500 call options and got backed into a corner and had to cover the position. Many believe this event pushed the S&P 500 Index over 2,300.
BMR Companies and Commentary
PayPal (PYPL: $42, +3% for the week)
The European commission has quietly launched the next offensive in the war on cash. These unelected bureaucrats have boldly asserted their intention to crack down on paper transactions across the E.U. and solidify a trend that has been gaining momentum for years. The financial uncertainty amplified by Brexit has incentivized governments throughout Europe to seize further control over their banking systems. France and Spain have already criminalized cash transactions above a certain limit, but now the commission has unilaterally established new regulations that will affect the entire union. The fear of physical money flowing out of the trade bloc has manifested a draconian response from the State.
The European Action Plan doesn’t mention a specific dollar amount for restrictions, but as expected, their reasoning for the move is to thwart money laundering and the financing of terrorism. Border checks between countries have already been bolstered to help implement these new standards on hard assets.
The above event further reinforces the secular idea of a cashless economy. This environment would be terrific for a purely online payments service like PayPal, just terrific! We highlight some additional opinions from credible sources on the topic below.
Governments around the world have pushed forward their agendas towards a cashless society. Former Chief Economist at the International Monetary Fund (IMF), Kenneth Rogoff, published a paper last year advocating for the U.S. $100 bill to be removed. He wrote: “There is little debate among law-enforcement agencies that paper currency, especially large notes such as the U.S. $100 bill, facilitates crime: racketeering, extortion, money laundering, drug and human trafficking, the corruption of public officials, not to mention terrorism. There are substitutes for cash - cryptocurrencies, uncut diamonds, gold coins, prepaid cards - but for many kinds of criminal transactions, cash is still king. It delivers absolute anonymity, portability, liquidity and near-universal acceptance.”
Former Treasury Secretary Larry Summers wrote last year that the E.U. would likely be the trailblazer of the West towards this new digital model: “But a moratorium on printing new high denomination notes would make the world a better place. In terms of unilateral steps, the most important actor by far is the European Union. The €500 bill is almost six times as valuable as the $100. Some actors in Europe, notably the European Commission, have shown sympathy for the idea and European Central Bank chief Mario Draghi has shown interest as well.”
PayPal announced this past week that it is acquiring the bill payment firm TIO Networks, which serves as a major player in the North American bill pay market, for $230 million. This will continue to help PayPal become more embedded in all of our financial lives.
PayPal has 200 million customers now and TIO Networks will add another 15 million. The market is big for bill pay. In the US, 15 billion bills were paid online worth $4 trillion. PayPal wants in and with TIO processing $7 billion worth, this a strong step in the right direction. PayPal did over $350 billion in payment volume last year, so this acquisition is small by any standard, but the way PayPal operates we can see this business doubling and tripling in the next five years. PayPal is a patient company and this is just another step in the right direction.
BMR Take: We are keeping eye on government actions that accelerate the speed the world is traveling at towards a cashless economy. PayPal is a big beneficiary. We’re up 18% since we added PayPal last year. We think it is lagging a bit lately and would definitely overweight the stock here at $42. Our Target remains the same at $48 which we would hope to see sometime in the first half of this year.
Apple (AAPL: $136, +3%)
It’s 13-F season. The 13-F report is filed by all investment shops detailing their holdings. This is where anybody with a computer and the internet can peer into the investment portfolios of the best investors on the planet. Well, our curious mind traveled through quite a few of the filings. We were surprised – though not really – to see investor after investor had recently increased their stake in Apple. The list of famous investors includes Greenlight Capital, Berkshire Hathaway, and Third Point. Berkshire won the prize for the largest increase in the size of their position, +277%. We recall that Warren took a position in Apple in May, right at the lows. He now holds 57.4 million shares, worth $7.8 billion. (This is the influence of Warren’s new young bucks who are making many of the new decisions in the company as the founder is now 86.)
So something must be going very right. Big investors are buying. Goldman Sachs research raised their price target from $133 to $150. What is going on? It is slowly coming to light just how undervalued the Services business is. People still don’t widely appreciate that Apple’s Services business alone would be a Fortune 100 company. Services now contributes profit greater than all non-iPhone segments combined.
UBS research estimates that if Services were valued similarly to PayPal, shares would be at least 10% higher.
BMR Take: There are times to be a contrarian, but now sure does not look like one of those times. The Apple train is breaking new speed.
Consensus Ratings for Apple
1 Sell Rating, 10 Hold Ratings, 36 Buy Ratings, 2 Strong Buy Ratings
2/14/2017 Robert W. Baird Target: $145
2/13/2017 Goldman Sachs Target: $150
2/8/2017 Bank of America Target: $145
2/7/2017 Canaccord Genuity Target: $154
2/6/2017 RBC Capital Markets Target: $140
2/2/2017 Wells Fargo & Company Target: $117
Come on, Wells Fargo. Get with the program!
Apple set a new all-time high last week of a shade over $136. We hereby raise the Price Target from $140 to $155. Our Sell Price remains: “We would not sell Apple.”
Home Depot (HD: $143, +2%)
The Home Depot recently announced its first major investment in a wind-powered renewable energy project. The energy purchased from the wind farm is enough to power 100 Home Depot stores for a year while also providing $150,000 in local community benefits.
The Los Mirasoles Wind Farm, owned and operated by EDP Renewables North America, is located in Hidalgo and Starr Counties, near McAllen, Texas. Through a 20-year power purchase agreement, Home Depot's annual purchase of 50 megawatts (MW) is a fifth of the wind farm's 250 MW capacity. The farm utilizes Vestas V110 2.0 MW wind turbines and produces enough power to provide more than 70,000 average U.S. homes with clean electricity each year.
As a part of its renewable energy initiative, The Home Depot's goal is to procure 135 megawatts of various renewable energy sources, including solar and wind, by the end of 2020.
The company also procures energy from solar farms in Delaware and Massachusetts. More than 150 stores and distribution centers utilize on-site fuel cells that produce roughly 85% of the electricity each store needs to operate.
BMR Take: We are glad to see Home Depot acting more like Amazon by getting more deeply involved in all aspects of their business--even it has nothing to do with lumber. The behavior is likely to lead to many more good things to come for Home Depot. The stock hit a new all-time high last week and the company is now worth $175 billion. Management knows what they are doing and we see no reason why the stock can’t hit $160 sometime this year if the market stays steady to higher. We hereby raise our Price Target to $160 from $135 and raise the Sell Price from $105 to $130. We are up 20% on the stock since we added it a year ago.
Kinder Morgan (KMI $22, -3%, market cap $49 billion)
Kinder’s CFO John Edwards spoke to investors at the Credit Suisse conference on Wednesday. Some insightful perspective was shared. Below we review the key points.
Kinder has an unparalleled asset footprint. They are the largest Energy Infrastructure company in the United States. They are the leader in all of their business segments. They are the largest natural gas network in North America moving over 40% of the gas in the U.S. They are the largest independent transporter of petroleum products, moving a little over 2 million barrels a day. They are the largest transporter of CO2. They are the largest independent terminal operator with approximately 155 terminals. And in the Canadian segment, they are the only pipeline serving the West Coast. These assets make Kinder well-positioned to take advantage of growth in North American energy.
While it might not seem like it to the casual eye, Kinder Morgan has a much simpler structure now than a few years ago. There is one publicly traded equity security versus four a few years ago, and that security is very liquid. It trades over 15 million shares a day, and the management team that is aligned with investors. Management and directors, own about 14% of the outstanding shares, a good thing.
Having survived the latest energy downturn, management is more than ever focused on remaining cost conscious. They want to control costs. Some people refer to management as cheap, but they want to make sure that they are spending money where they need to spend money, and they are not spending money where they don't need to. They do want to spend money on their assets to keep them operating safely and efficiently. On 35 out of 36 of metrics, they rank better than the industry average. Wow.
There is a very deep pool of capital out there in terms of the Canadian pension funds, The company is currently considering a Canadian IPO to tap that money. The IPO would be attractive capital. It would be long term. It would allow for growth investments and balance sheet improvement (paying off debt).
BMR Take: Fellow shareholders, Kinder has the best assets in North American energy. They have a management team that could be flashy but is instead frugal. We may get access to a flood of Canadian pension money. Life is good.
Eli Lilly (LLY: $80, +3%)
Additional results from the pivotal RA-BEAM study were published in New England Journal of Medicine. The study on their arthritis drug is being done by Eli Lilly along with Incyte Corporation. The goal is to greatly improve treatments for arthritis.
The New England Journal of Medicine publication included supplementary data, which showed that starting as early as week 8, and sustained through week 52, a higher proportion of patients taking baricitinib (a drug fighting arthritis) achieved 50% and 70% improvement - compared to the old drug adalimumab. These improvements were statistically significant. A breakthrough!
Lilly and Incyte previously announced positive topline results of at least a 20% improvement.
This is an exciting time for rheumatology, with potential new treatments for arthritis. The RA-BEAM study of baricitinib is the first phase 3 trial showing that a once-daily, oral treatment significantly improved clinical outcomes compared with a current standard of care, injectable adalimumab used with background methotrexate therapy. These data demonstrate that baricitinib could provide another treatment option for people with arthritis.
BMR Take: Eli Lilly’s success with the arthritis drug just further shows the business has a healthy pipeline of new products and is not broken. The stock has had a big rally from $64 back in December to now $80. Between a favorable trial outcome and the big rally recently, the Lilly turnaround is manifesting.
Lilly has reached our Price Target of $80. We are up 18% from where we added it just two months ago. We hereby raise the Price Target to $88 and raise the Sell Price to $76.
Upcoming Economic News
WEDNESDAY, FEBRUARY 22
Existing Home Sales – January
Time: 10:00 am
Forecast: 5.55 million
Existing home sales look to move higher in January after sliding in December. Sales rose 7% year-over-year in the fourth quarter, keeping the housing recovery steadily on track. With only four months’ worth of inventory at the latest monthly sales pace, prices will continue to climb, encouraging more homeowners to sell.
FOMC Meeting Minutes
Time: 2:00 pm
The minutes from the uneventful February FOMC meeting will give some indications about what policymakers expect for growth and inflation. The outlook for the economy is clouded by the potential actions of the new administration. Yet some near-term upward pressure on prices and wages still keeps the Fed on track to lift its policy rate three times this year. SO THEY SAY. Who is they? The analysts and pundits. We at The Bull Market Report aren’t so sure. We are watching the 10-year note which is stuck at the 2.4% range. We are in the camp of LOWER interest rates ahead, not higher. Watching and waiting are we.
FRIDAY, FEBRUARY 24
New Home Sales – January
Time: 10:00 am
Forecast: 575,000
New home sales are projected to rebound sharply in January after slumping to a 10-month low in December. Even with the December setback, the sales pace remains exceptionally strong at 25% year-over-year in the fourth quarter. Growth in new home sales can continue to be stellar. The most recent monthly sales pace is 25% above the average of the past 20 years.
University of Michigan Consumer Sentiment – February
Final Time: 10:00 am
Forecast: 96.0
The preliminary value of the Michigan Sentiment Index showed above-average confidence despite slipping from January’s 12-year high. Consumers are starting to feel the bite of higher gasoline prices, as short-term inflation expectations rose to equal the 23-month high. But long-term inflation expectations are muted at just 2.5% annualized between five and ten years ahead, as a sustained acceleration in price growth is doubtful.
Our Favorite Warren Buffet Quote:
"You can't produce a baby in one month by getting nine women pregnant." -- Warren Buffett
Love it. Be patient out there.
More on Stocks We Love
CBRE (CBG: $36, up 5%)
CBRE set a new 52-week high this week and is within a whisker of the all-time high of $38.50 set in 2015. We see no reason why the stock can’t hit $40 this year. It hit our Price Target of $35 this week, so we hereby raise the Target to $40. We are changing the Sell Price to $32.
Annaly Capital Management (NLY: $10.82, up 5%). Why We Love Thee.
With an 11.1% dividend yield, it's one of the highest yielding stocks on the market today. It is a real estate investment trust and a Mortgage REIT, specializing in mortgage-backed securities, or MBS's. A REIT is simply an investment fund that owns income-producing real estate or real estate-related assets. Among other requirements, a REIT must invest at least 75% of its total assets in real estate assets and cash, and derive at least 75% of its gross income from real estate-related sources. And it has to pay out 90% of its income.
In Annaly's case, it doesn't invest directly in real estate, but rather in MBS's. These are fixed-income securities, much like bonds, that are backed by residential mortgages. Annaly invests in securities that are issued by Fannie Mae or Freddie Mac, and are thus backed by the full faith and credit of the United States government. It means that the risk that its assets will default is nil.
On Annaly's most recent balance sheet, for instance, agency MBS's accounted for $82 billion out of $88 billion in total assets.
Annaly's biggest task is to deal with the interest rate risk. Annaly uses leverage to buy assets. They borrow money at low short-term interest rates and invest that money in higher-yielding long-term assets - MBS's. The firm has $88 billion in assets, composed of $13 billion in equity and $75 billion in debt. Thus the leverage is about 5 to 1. In years past, this leverage has been as high as 10-1. We are pleased to see the leverage at this lower level. Annaly hedges the risk of rising short term rates by buying interest rate swaps. These are financial derivatives designed to lock in the cost of financing. Annaly has outstanding interest rate swaps of approximately $31 billion.
As we mentioned above, as a REIT Annaly must distribute at least 90% of its income to shareholders to qualify as a REIT. Thus, Annaly doesn't have to pay corporate income taxes on its earnings.
The dividend yield of Annaly is currently 11.1%. That's almost six times greater than the 1.95% yield on the S&P 500.
In order to grow its capital Annaly sells new shares of stock in secondary offerings. In the old days they used to do this as much as twice a year, each time raising $500 million to $1 billion in fresh equity. In the new Annaly world, they don’t do as many secondaries, as management is content with growing the NAV slowly, with the company now worth over $11 billion.
BMR Take: We are comfortable with the company growing NAV slowly, as we hope you are too. Patient investors can sit back contentedly and enjoy the 11% dividend and if the stock is up just 50 cents in a year, that’s another 5% in overall growth producing over 15% in a year. And note that last week the stock was up 30 cents!
The Yield Curve Today. Or, Where are Interest Rates Going?
“Everyone” thinks rates are going higher. Right? You feel this way too, don’t you! Well, we don’t think this way. We think rates might just decide to peter out here and fall back. The 10-year US Treasury Note is at 2.42% right now, up from the 1.8% level before the election. But note that rates around the world are in many cases much lower than what we have in this country. In fact, late last year over $11 trillion was paying ZERO interest.
Take a look at this chart, concentrating on the 10-year notes in gray:
Note that Germany, Switzerland and Japan are hovering around 0%. How could this be? The answer to that may take our writing a book, but suffice it to say that IT IS REAL. And if it can happen in Germany and Switzerland, can it happen here?
BMR Take: The short answer? Yes it can. It “could” happen here. Will it? We wish we knew, but with all the turmoil in the world economically, we think there is more likelihood of rates going down rather than up at this time. We are not convinced that Yellen will have the power to buck THE MARKET. The MARKET will dictate interest rates, not the Fed. We see interest rates going lower rather than higher. And when rates go down, bonds and bond-like funds go up. Food for thought.
The High Yield Report
By Michael Foster
Special to The Bull Market Report
Another week, another bull run for the S&P 500.
The action has certainly slowed, but a 1% gain for the index is still impressive considering the long stretch of strength we’ve seen since November. The strength came on the back of Janet Yellen’s surprisingly hawkish testimony to Congress, an increase to unemployment claims that surprised analysts, and inflation rising to near 2%.
There’s a lot to unpack here.
First, let’s address Yellen, because this is most important to high yield markets. The Fed Chairwoman made her intentions very clearly in this paragraph:
"The Committee's view that gradual increases in the federal funds rate will likely be appropriate reflects the expectation that the neutral federal funds rate- - that is, the interest rate that is neither expansionary nor contractionary and that keeps the economy operating on an even keel- - will rise somewhat over time. Current estimates of the neutral rate are well below pre-crisis levels - a phenomenon that may reflect slow productivity growth, subdued economic growth abroad, strong demand for safe longer-term assets, and other factors. The Committee anticipates that the depressing effect of these factors will diminish somewhat over time, raising the neutral funds rate, albeit to levels that are still low by historical standards.”
Keep in mind that Yellen’s job is to talk in complicated, confusing phrases. But Yellen is actually a lot clearer than Greenspan was back in his day. In this block of awkward verbosity, we interpret what Yellen had to say:
1. Interest rates are going to naturally rise over time.
2. The Federal Reserve needs to anticipate these natural rises, because the market isn’t anticipating improvements in productivity, global conditions, investment, etc.
3. The Fed is going to raise interest rates swiftly and frequently.
If Yellen said this in 2014, the market would have tanked. Saying this in 2017, though, the markets barely budged. This is good for the Fed and bad for interest rates. It clearly means the Fed feels that it has the room to raise interest rates often and will do so throughout 2017. (We at The Bull Market Report are not so sure. See the following chart on interest rates around the world. We are not convinced that Yellen will have the power to buck THE MARKET. The MARKET will dictate interest rates, not the Fed. We see interest rates going lower rather than higher. And when rates go down, bonds and bond-like funds go up. Food for thought.
Where does that leave high yield assets?
On the surface, higher interest rates are bad for BDCs, junk bonds, and REITs. But remember that raising interest rates has been expected for years now; much of this is already priced in. The market knows this and so has not sold high yield assets in a panic.
Just look at the indices for high yield assets. The UBS BDC ETF (BDCS: $23, up 1%) ended the week up solidly, while the SPDR Barclays High Yield Bond ETF (JNK: $37, flat) held its ground. REITs did better than both of these assets. The SPDR Dow Jones REIT ETF (RWR: $94, up 2%) had yet another strong week despite the fact that higher borrowing costs will negatively impact REIT profitability. The market knows this and has already priced it into the sector.
In other words, everyone knows Yellen is getting more hawkish; they just don’t care.
Does this mean the market is overconfident and we should panic? No, not exactly. It does mean that there aren’t as many “screaming buys” in today’s market as there were at the start of 2016, when it was a much less obvious call to say junk bonds were worth snapping up at current valuations. But it also doesn’t mean those assets are overbought, either.
We’re clearly making the transition from “fear” to “greed,” as Warren Buffett would put it. But we’re not exactly at greed quite yet. In a market where buying and selling aren’t obvious choices, what can an investor do?
Simple: be selective. When it comes to being selective, it means finding assets that aren’t moving with the broader market. Fortunately there are some great values out there that are not performing as well as they should be. This week offered some new ones.
The first is a BMR favorite: Care Capital Properties (CCP: $25, down -2%), which failed to track the REIT bull run. Likewise, Omega Healthcare Investors (OHI: $32, down -2%) stumbled this week. Both REITs are in the Healthcare sector, which is being hit by greater uncertainty than the REIT universe as a whole. We’ve discussed in previous reports why we like both REITs. They’re well-managed and fear is driving the Healthcare REIT industry, making it a rare value play in a swiftly appreciating asset class.
To demonstrate just how undervalued these REITs are getting, compare them to our other REIT favorites Kimco Realty (KIM: $24, up 2%) and Government Properties Trust (GOV: $20, up 3%). Both outperformed the REIT sector as a whole this week.
Two more funds are getting attractively valued: the AllianzGI Equity and Convertible Income Fund (NIE: $19.35, up 1%) and the PIMCO Dynamic Income Fund (PDI: $28, up -1%). The Allianz fund went up this week, but its NAV has been going up at a faster rate than its stock price; as a result, its discount to NAV has grown to over 11%, making it a stronger buy than it’s been for months. Similarly, the Pimco fund’s decline this week makes it another great buy.
One final word on a stock that’s been a pain for us for a long time: Astra-Zeneca (AZN: $29, up 5%) had a stellar week. We’re now just 3% off from a year ago. This is a stock that has proven the old adage: best things come to those who wait. We’re still holding strong after liking what we heard at the company’s earnings release. Now we’re just anticipating possible dividend growth in this best-of-breed Pharma stock.
Good Investing,
Todd Shaver
Founder, Editor and CEO
The Bull Market Report
Since 1998
