May 21, 2017
by Todd Shaver | May 21, 2017 | Weekly Newsletter 7pm Sunday
Let's Get Started
The President took Air Force One for an international tour to promote peace, justice, and stability. His first stop is in Saudi Arabia to meet with over 50 Muslim leaders to discuss a shared fight against radical beliefs and terrorism. He will make his way next to Jerusalem and Bethlehem to re-build relationships that deteriorated under the last administration. Thereafter, he will spend time with the Pope at the Vatican strategizing on how Christian beliefs can bring about more peace in the world. We learned Saturday morning that Trump was greeted on his first stop in Saudi Arabia with $110 billion of deals for US companies in the region, in particular for General Electric and Halliburton. This one of the reasons why America voted for the man? But we’ll see if anything comes of it.
There is always a bull market here at The Bull Market Report! This week we highlight the following stocks: Athenahealth, Home Depot, Amazon, Facebook VMware, and Kinder Morgan.
Highlights From The Past Week
Why have stocks bounced? We see no one specific factor behind a stock market bounce that followed the biggest selloff since last September on Wednesday. Some are focused on the pervasive buy-the-dip mentality since the financial crisis bottom in 2009. The initial flurry of Trump impeachment talk following the Comey memo leak seems overdone. Trump heading overseas may shift some of the focus away from recent controversies toward foreign policy (and dampen his more combative tone). A stabilizing influence is Robert Mueller’s appointment as special counsel in the Russia investigation which brings credibility amid the chaos. Despite all the talk about the threat to Republicans’ legislative agenda, policy expectations have already been meaningfully dialed back. There is little change in a fairly upbeat fundamental narrative that has revolved around expectations for an upswing in global growth. In addition, central banks are still in an easy money stance.
Bullard says Fed’s path may be “overly aggressive”. At an address at Washington University, St Louis Fed President James Bullard noted that in the wake of the Fed’s March rate hike, financial markets saw declining long-term yields and weakening inflation expectations. He observed that this may suggest that the FOMC’s contemplated policy rate path is overly aggressive relative to actual incoming data on US macroeconomic performance. Bullard noted that labor market improvements have slowed over the last two years, and that inflation and inflation expectations have surprised to the downsize in recent months. Note that Bullard has been quite dovish in the past relative to rates, saying in January that there was no reason to move rates dramatically and standing by his forecast for a single rate hike in 2017. In statements following his presentation, Bullard reiterated his call that the Fed should shrink its balance sheet to gain policy space, and said the central bank should retain the option for future quantitative easing should it be necessary.
Oil supported by deal extension headlines. Oil posted a nice gain this week on growing expectations exporters will extend output cuts to curb a persistent glut in inventories at next week’s OPEC meeting. This follows headlines earlier this week that Saudi Arabia and non-OPEC Russia agreed to a 9-month extension. Reuters, citing OPEC sources, said the cartel’s panel reviewing scenarios for the 25-May meeting is looking at the option of deepening and extending the deal to reduce oil output. No agreement has been made on final scenarios. Some say a deeper cut in output is an option depending on estimated growth in supply from non-OPEC producers and US shale oil.
BMR Companies & Commentary
Athenahealth (ATHN: $130, +19% - all price changes are for the week)
Top-notch hedge fund Elliott Associates disclosed a 9.2% stake in Athenahealth this week sending the stock soaring.
Elliot believes the company operates in a highly strategic area at the intersection of technology and healthcare with a disruptive value proposition, a leading competitive position, and a compelling product set, the value of which is not reflected in the company's current market value. Interpretation: The stock is cheap. Elliot believes that there are numerous operational and strategic opportunities to maximize shareholder value. Elliot will engage in a dialogue with the company's board regarding these matters.
Elliot may consider and develop plans and make proposals with respect to operations and management, and all types of other changes that will add value to the stock.
Looking at the software landscape, IBM and Inuit have expressed a desire to break into Healthcare. Reports have also speculated that Aetna and UnitedHealth may also be interested.
BMR Take: Elliot Associates is the real deal as highlighted by Athena’s 19% move higher last week. We hit our Target of $125, having added the stock at $101 in November, so we are up 30% in six months. Not bad. We definitely would stick around to see what happens here. We could see another big move higher should the company be sold. We hereby Raise the Target Price to $140, and the Sell Price which was originally at $90, is now at $105, to $125. We don’t want to lose any of these massive gains.
Home Depot: (HD: $156, down 2%, but up from $144 a month ago)
Home Depot just blew earnings out of the water while the rest of Retail keeps falling apart. With mall retailers such as Sears and J.C. Penney seemingly on their deathbed, Home Depot once again proves why it pays to sell lumber and nails.
Last week, the home improvement retailer delivered first quarter results. EPS of $1.67 beat consensus of $1.61 on revenue of $23.9 billion versus consensus of $23.7 billion. Management reaffirmed full year sales growth guidance of +5% and lifted expectations for EPS growth 11% to $7.15. In February they announced an increase to $15 billion in the stock buyback program.
All merchandise departments delivered sales increases. Sales from contractors were stronger than those from typical consumers. Online sales surged 23%. "The housing market is very strong", Home Depot CFO Carol Tome said, adding that sales in May have been "very good."
So far, the U.S. housing market has withstood the rising interest rate environment (which we see as very insignificant). In turn, home improvement retailers such as Home Depot have continued to thrive as existing homeowners renovate their homes -- which are rising in value -- and builders try quickly to bring on badly needed supply.
Home improvement spending still remains healthier than most areas in retail. Trends remain strong as building materials, hardware and garden supply sales have grown 6.4% year over year.
BMR Take: Stick with this blue chip. Many analysts see the EPS outlook as conservative. Despite its impressive $95 billion sales base, Home Depot has ample opportunity to grow, especially in eCommerce. The company will continue to benefit from healthy home improvement spending, market share gains, and strong execution. The home improvement sector remains well-positioned to benefit from continued modest GDP growth, home price appreciation, and solid household formation. Our Target is $160 – getting close. We can’t wait to raise the Target soon.
Amazon (AMZN: $960, flat)
Amazon cut the price of the Echo to the lowest level in 2017. For a limited time users can purchase two Amazon Echos with the promo code ECHO2PACK effectively dropping the price to $140 each. The normal price is $180.
Why do we care?
Echo is Amazon’s ticket into a massive Home Services Market. It lets Amazon gather data for what is happening in the house as it records everything. It also provides a door for instant on-demand ordering. We have one and we love it!
Amazon, which launched its Home Services unit in 2015, now offers 1,200 services in more than 50 U.S. cities. Customers can select assembly or installation services, which will compete against those offered by retailers like Home Depot or Best Buy, in addition to other services like house cleaning, home repair and yard work, which will compete with Angie’s List. Throughout its 20-year history, Amazon has continued to explore areas of commerce that it believes it could disrupt and this is one ripe for disruption. In March, Amazon estimated that the on-demand Home Services market was valued between $500 and $700 billion.
BMR Take: Amazon is a serial monopolist company that picks markets to enter, disrupts them entirely, and runs away with market share. Home Services looks like the next target. Amazon is really expensive at 145x this year’s earnings, but Amazon doesn’t trade like a normal company. Bezos has said profits will come in due time. Lately they have been knocking out much bigger profits and the Street is content to wait and wait as the stock goes up and up. There remains a ton of upside to Amazon long term as the company is investing massively for growth and future earnings power more than supports the current valuation.
Facebook (FB: $148, -1.5%)
Facebook and Major League Baseball struck a deal to live stream games. The move is the latest initiative by Facebook to expand into the world of live programming. Facebook said that it would stream one game a week beginning immediately and the broadcasts would be available to everyone on Facebook in the U.S.
What does this mean? More engagement. More engagement means more advertising opportunities and more revenue. It’s great news.
MLB Commissioner Rob Manfred said at a news conference in New York, "Probably the most important single announcement is we've done an agreement with Facebook. It's really important for us in terms of experimenting with a new partner in this area. We are really excited about this."
"It's pretty cool," Ian Desmond of the Rockies said. "It's an opportunity to provide the game to everybody. That's what we're trying to do -- expand the game and make it more diverse. It's a step in the right direction. They're doing a good job with that."
BMR Take: The stock is having a great year so far, and we see so much more potential still. Consensus estimates call for EPS near $10 by 2020. At the current PE multiple or 27 where the stock is today, this implies shares can double.
VMware (VMW: $93, -1%)
VMware, a global leader in cloud infrastructure and business mobility, announced it will deliver VMware Horizon Cloud on Microsoft Azure. The integration helps customers accelerate the move to Windows 10 and brings VMware virtual desktops and applications to the increasing global presence of Azure in the enterprise -- available in 38 regions globally.
This is a great news item! Microsoft Azure is connected to so many of the world’s enterprises (large, medium and small) it is mind boggling. By becoming integrated with Microsoft Azure, VMware is now able to tap into all of these customer relationships. What a revenue opportunity.
BMR Take: The addition of a major cloud platform such as Microsoft Azure to VMware’s customer database has the potential to accelerate the growth of the company. VMware is expected to generate $5-6 of EPS consistently for the foreseeable future. Putting it all together, the outlook suggests the stock should continue to do well. We have a Target of $95 on the stock. We can’t wait to raise this Target when hit.
Kinder Morgan (KMI: $20, -2%)
Kinder Morgan had a rough week on some news about more obstacles surfacing. The Alberta Securities Commission is reviewing an environmental group’s request to halt a $1.28 billion share sale that Kinder Morgan needs to help finance the expansion of its Trans Mountain pipeline.
Earlier this month, Greenpeace Canada sent a letter to the Alberta commission, saying Kinder Morgan may have used outdated oil projections in its IPO prospectus. The Alberta commission acknowledged receiving the challenge and will give it "consideration.”
Kinder Morgan had been running a dual-track process, exploring both an IPO and a joint venture to finance the Trans Mountain expansion. In a regulatory filing earlier this month, the company said it was no longer looking into a joint venture.
BMR Take: Kinder Morgan needs to get this together and do so fast. With EPS in recovery mode from $0.66 this year back to $1.00 by 2020, this coincides with more normalized earnings levels prior to the recent drop in oil prices. We don’t need any hiccups to the business plans that push out earnings, especially as oil prices remain volatile.
You know what? The more we think about this company the more we think it is time to move on. $1.00 of earnings (previous paragraph) by 2020? That’s a long time to wait. We’ve got a LOT BETTER places to put our money than this one. Just take a look at any one of our High Yield portfolio stocks, or the REIT portfolio. We are just tired of waiting and waiting – it’s been over a year. We added the company in early 2016 at $18 and exit here at $20.
Upcoming Economic News
Tuesday, May 23, 2017 10:00 AM
New Home Sales
Period: APR
Consensus: 610,000
Prior: 620,000
Wednesday, May 24, 2017 10:00 AM
Existing Home Sales
Period: APR
Consensus: 5,650,000
Prior: 5,710,000
Thursday, May 25, 2017 08:30 AM
Initial Jobless Claims
Period: 5/20
Actual: N/A
Previous: 232,000
Consensus: 237,000
Friday, May 26, 2017 08:30 AM
GDP
Period: Q1
Actual: N/A
Consensus: 1.9%
Prior: 1.9%
A Word from Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
Friday the 12th marked the 13th straight day in which the S&P 500 failed to move more than 0.5% in either direction on a closing basis, the longest such streak since 1995.
Q1 results from 95% of S&P 500 members show earnings are up +14% from the same period last year on +8% higher revenues, with 72% beating EPS estimates and 66% beating revenue estimates. The proportion of companies beating both EPS and revenue estimates is 52%.
Importantly, the growth performance is broad-based and not narrowly concentrated. We had the leadership from the Finance space earlier in the reporting cycle, but the baton has since shifted to Tech and other areas, including Industrials, Basic Materials, and Energy. The big disappointment – you guessed it: brick and mortar retail stores. While brick and mortar stores may be ailing, however, online sales are doing great.
Here is the important takeaway: When looking at the last three quarters, the overall strong Q1 showing represents a notable acceleration in the growth momentum. We have never seen a bad market during a period when it was in the midst of an accelerating growth trend. It could happen of course as wild cards such as oil or geopolitical risks are always present, but if there was ever a silver bullet for the market, it is an accelerating earnings momentum. We do not expect to have a slew of 2nd quarter earnings revisions to the downside begin cropping up over the next few weeks. Rather, with any kind of good news from D.C. such as healthcare reform, tax reform or infrastructure programs, we expect the growth momentum to continue to accelerate on a year-over-year comparison.
Bottom line: Earnings are strong, rates should rise in conjunction with a tightening labor market and we believe stocks still offer greater upside than bonds or cash. Here are the numbers that we feel support this opinion:
The Q1 earnings season was better than expected, and it’s resulted in 2018 S&P 500 earnings estimates bumping up $1 from $134 to $137. (Source UBS) At the higher end of that range, the S&P 500 is trading at 17X next year’s earnings. That’s high historically to be sure, but it’s not "crazy" as some of the doom and gloomers are arguing, especially given low Treasury yield levels and expected macro-economic fundamentals. On the downside, if the S&P 500 were to drop to 2300, then the market would be trading at 16.7X 2018 earnings. In this environment (low yields, stable macro environment), the market could easily be considered fairly valued and a buying opportunity.
Right now, it’s more likely earnings expectations get revised higher in the future, not lower, and that will make the market cheaper.
Sectors which have strong momentum currently include Financials, Healthcare, Technology (including cyber security, which is in the forefront as "ransomware" attacks go worldwide) and Energy.
Square Announces a Debit Product
Square Cash, the mobile peer-to-peer (P2P) payment offering from Square, will launch a physical prepaid debit product. The card is funded by customers’ Square Cash balance, and can be used anywhere that accepts Visa.
Square (SQ: $20, flat) wants to get a bigger piece of the P2P space. Mobile P2P payments are growing fast. That’s increasing competition in an industry where no one player holds a true market majority. Square Cash is an important player, but it's not as well-positioned as market leader Venmo, owned by PayPal (a Bull Market Report favorite) or Zelle, which will have access to up to 85 million customers and is backed by Bank of America, U.S. Bank, and Wells Fargo and 17 other banks. Zelle Network Banks Processed 170 million P2P Payments, Totaling $55 billion in 2016. The market is BIG!
Cash and checks have historically dominated the P2P world. But as smartphones become a primary computing device, top digital platforms, like Venmo and Google Wallet, have enabled customers to turn away from cash and make those payments digitally with ease. A shift to mobile payments across the board and increased spending power from the digital-savvy younger generation will cause the mobile P2P industry to skyrocket.
Consumers want mobile P2P services, and they’re turning to them. As smartphones are increasingly used as computing devices, these consumers look to such services for fast and easy ways to pay.
Monetizing P2P is more important than ever. As volume grows and user bases scale fast, finding ways to monetize quickly should be a priority for firms looking to stay ahead. We believe Square has a good shot of winning a good piece of this market.
In-store card payments are still substantially more popular than any form of P2P transfer. A physical card could help Square stand out. Gaining access to a traditional card could help users form habits and encourage customers to run a Square Cash balance, thus engaging them more with the product and increasing volume.
Our Target is $24. We can see this getting hit and our having to raise the Target to $34 and beyond. Square could be a big one.
And this just in:
Washington, D.C., is enlisting Square’s help as its taxi commission tries to help the city’s cabbies compete with Uber drivers. By the end of August, all of the taxis in Washington have to tear out their traditional meters and start using smartphones or tablets. The Department announced that Square will process the payments going through those mobile devices.
Wow – that’s good news. Our takeaway is that this is a great PR move that will get more and more people to use Square. We use it. We love it. You will too. And the more customers the better. AND a higher stock price.
Annaly Keeps Chugging Along
Annaly Capital Management (NLY, $11.50) was up 2% this week and showed us a nice bounce back from recent lows after trading in the high 11s in early May. We have said this many times – the stock has its ups and downs and they are not anything to be worried about. The “interest-raising-talk” will accelerate in the press in the next few weeks, as the Fed prepares to raise in June or July, so buckle up your seat belts and sit back and watch Annaly handle all the bumps in the air. We are not worried. We’re quite content to sit back and collect the fabulous 10.4% yield.
Mazor Keeps Chugging Along
Mazor (MZOR: $43) had a stellar week, closing up 7%. Pretty volatile little stock, isn’t it? It hit $45 on Thursday and closed at $43. Crazy. We think it better to watch this stock on a weekly basis instead of daily!
Amazon Keeps Chugging Along
Amazon (AMZN: $960) was flat for the week, even after dropping $22 on nasty Wednesday. It bounced right back on Thursday. Love this company. Are you still hung up on the stock PRICE? Well, don’t be. Get some shares on Monday. On May 22, 2018 you will be ONE HAPPY CAMPER!
The High Yield Corner
By Michael Foster
The financial press was particularly amusing this week. On Wednesday we had a market correction that was called a disaster, a sign of turmoil, and a harbinger for a market crash. What caused the crash? Depends on who you read. We’ve seen explanations range from algorithmic trading going haywire, bank unwinding, bad earnings (really?), and, of course, geopolitical turmoil because of the Russia scandals. None of these really make any sense, and some are just plain wrong (earnings growth has accelerated, making S&P 500s forward P/E ratio relatively low), but the media keeps clutching for a narrative.
What are the facts? [No FAKE NEWS here at The Bull Market Report!] The Fed announced industrial production rose 1% in April, the largest gain since 2014 and near its all-time high. Unemployment claims fell to 232,000, maintaining levels lower than what we saw in the 1990s and early 2000s. Mortgage rates also fell to less than 4% (mortgage rates have been falling for a few weeks), and some analysts expect this to go lower. [We do.]
This is all good news and better than expected. Macroeconomically, there’s little to worry about in the U.S. And that may explain why the VIX dipped into single-digit territory, which created its own kind of paradoxical panic as many fretted that people aren’t scared enough. But the slew of good news indicates there is little to be afraid of.
That brings us to the most important but most controversial data point: household debt and credit. The Federal Reserve’s Household Debt and Credit Report announced that total household debt reached its highest point since 2008 ($12.7 trillion). While this may ring alarm bells to debt conscious individuals, from a macroeconomic perspective this is a good thing.
Here’s why. American consumers, for the most part, will take on credit only when they feel reasonably confident in their ability to earn money in the future. That’s not to say people are innately responsible with credit, but rather that they will to a certain extent take credit only when they feel confident about their own personal economies. The massive decline in debt following the 2008 crisis is an indication of this, especially when you look into the details. It wasn’t just mortgage debt that fell during the housing crash - it was credit card debt, auto loan debt, and personal loan debt. People just stopped borrowing money during the crisis. This was partly because banks stopped lending, of course, but not entirely. For a large part of America, it was time to tighten belts and weather the storm.
What did this mean for companies? Declining sales. Weaker profits. The need to cut costs, which often meant layoffs which in turn meant more belt tightening and thus even lower sales and weaker profits. This is the "deflationary spiral” economists warn about, and it is the reason why government stimulus is used during a recession.
The opposite of this deflationary spiral is a winding up of credit across the board. Americans are confident of their ability to pay back loans, so they borrow more, and then use that money to spend more. That results in higher sales and bigger profits for U.S. firms. That, in turn, results in firms hiring more people, thus creating a cycle of spending begetting spending and helping GDP rise across the board.
This has several implications for all kinds of investors. For stocks broadly, the news is good: it means higher sales and higher earnings (the S&P 500 has already reported both for the start of 2017). For other sectors, the news is also good but for different reasons.
For business development corporations (BDCs), it’s good because it means small and medium-sized businesses will have much higher demand for credit as they expand operations. This is partly why BDCs have been on a tear for the last couple of years - the market anticipated this expansionary climate. So the UBS BDC ETF (BDCS: $22) is up 10% from a year ago.
There’s just one problem: BDCs aren’t actually better investments.
The distributions that this ETF pays out have fallen in the past year as a result of yields on loans falling for individual BDCs. We’ve seen both NAVs and distributions fall for many BDCs, both big and small, over the last few months. As a result, the BDC ETF is down year to date and the BDC sector is by no means as attractive as it seemed a year ago. But if the macroeconomic climate is better for BDCs, why is this happening?
As we’ve said repeatedly at The Bull Market Report, BDCs are getting squeezed because of the better environment. This is attracting more competition from banks and leveraged lending firms. We’re also seeing smaller BDCs set up shop and compete with big guys like Main Street Capital Corporation (MAIN: $38), making its 70%-ish premium to NAV untenable. That’s why we cut Main Street from the Bull Market Report High Yield portfolio a few months ago, and that decision is finally getting vindicated: Main Street is now 7% off its all-time high reached just a few weeks ago at $41 and is down for the week. We are keeping a close look on the BDC sector and are looking for a company that has a reasonable market price and a strong income-producing portfolio. Until that shows up, we recommend caution.
Better options exist in municipal bonds for income. This sector has lost market favor for a very long time due to its more risk-hungry approach, and that’s caused yields on many muni funds to rise. Bull Market Report favorites Invesco Municipal Trust (VKQ: $12.64, flat) and the Nuveen AMT-Free Fund (NVG: $14.81, up 1%) are now yielding near 6%, tax free. These funds have risen slightly (about 3%) in 2017 but remain down from a year ago. There is still time to jump into these funds, although it appears that the window to get munis at a discount is shrinking.
Over the coming weeks we are going to get more macroeconomic data to determine exactly where we are in the economic cycle. During that time, holding high yield investments and doubling down on munis makes a lot of sense for income-hungry investors. There is a strong chance that the Federal Reserve will raise interest rates next month, and we may see second quarter GDP numbers that are strong. Neither of these are bad for high yield investments, because both signal a market in which people are spending and companies and municipalities can repay their loans. While the market is obsessed over a one-day drop on Wednesday, we will keep our eyes focused on the data to tease out what is really going on beyond popular distractions.
Good Investing,
Todd Shaver, Founder, CEO and Editor
The Bull Market Report
Since 1998
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 30, 2017
by Todd Shaver | Apr 30, 2017 | Weekly Newsletter 7pm Sunday
The Week Ahead
Tax season came to a close two weeks ago. We filed an extension of course. Now Tax Reform is front and center. A new plan released by the Trump Administration got the market excited about the prospects. The bull in us hopes to see the corporate tax rate dropped to 15% from 35% and tax repatriation bring home the bacon from overseas – they are talking 10% for this cash that totals $2.6 trillion. We personally are excited about that prospect. We look for more progress in the weeks ahead to drive continued improvement in sentiment and higher stock market prices.
There is always a bull market here at The Bull Market Report! This week we highlight the following securities: Amazon, PayPal, CBRE Group, UPS, Google, Celgene and Athenahealth.
Highlights From The Past Week
The biggest tax cut in US history? The announcement outlined the general principles of proposed US tax cuts and reform. The proposals outline the lowering of the marginal corporate tax rate to 15% from 35%. This rate will be applied to a simplified tax code. Border tax adjustments have been said not to work in their current form but discussions are continuing. Overseas cash will be repatriated at a one-time lower tax rate, although this rate is yet to be determined. The timeline for US tax reform is still unclear. The budget neutrality of these proposals has not been outlined in detail. Secretary Mnuchin stated that the reform would pay for itself with economic growth. But we know this is just impossible. Arthur Laffer would be laughing from the grave. Oh wait – he is still around – a healthy 76 years old.
Remember the Laffer Curve? Google it. It has come to be remembered as the concept of lowering taxes (thus cutting tax revenue to the government) causing so much growth that the increased tax revenues pays for the tax cut. Again – this has been completely debunked over the past four decades.
Cash repatriation a big deal for the Technology sector. In recent years, US companies have accumulated estimated overseas cash balances of $2.6 trillion on their balance sheets. Overseas cash holdings are dominated by the Information Technology sector. Companies such as Apple ($255 billion), Microsoft ($110 billion) and Google ($75 billion) have significant cash holdings well in excess of their working capital requirement. If this cash starts coming back we think it will be a boost to the economy and the stock market.
No healthcare vote this past week. The latest House attempt to pass a revised Obamacare replacement bill seems to have stalled. Despite continued pressure from the White House and recent speculation that a vote could take place over the weekend, House Speaker Ryan and his top lieutenants decided during a late-night meeting on Thursday that they still do not have the votes to pass the legislation. Note that at least 15 House Republicans remain firmly opposed to the bill, while at least another 20 are leaning towards no or are still undecided. Recall that Republicans can lose only 22 votes. The Hill recently reported that at least 21 Republicans have said they would vote no on the bill.
Big inflows to equities. Dampened risk aversion surrounding the French election, tax reform back in the headlines, and better earnings sentiment all are reflected in the latest flow data. Equities saw $21 billion of inflows this week, the largest since the US election. US equities saw inflows of $14 billion, the largest in 19 weeks. Inflows to European equities were $2.4 billion, the most since December 2015. Emerging market equities saw its sixth straight week of inflows. US value has now seen outflows in five of the last six weeks. At the same time, we saw the biggest inflows to small caps in 23 weeks, the biggest inflows to Financials in seven weeks and outflows from bond proxies like real estate, utilities and telecom. Investment grade bond funds attracted funds for an 18th straight week. At the same time, the biggest inflows to Treasury/government bond funds in 13 weeks occurred.
BMR Companies and Commentary
Amazon (AMZN: $925, up 3% - but being up $27 sounds better!)
Amazon reported better than expected 1Q17 results, whereby revenue came in 1% above consensus and operating income was 10% above consensus despite a continued ramp in investments globally. All around it was a great quarter. Check out the News Flash from Thursday.
While Amazon continues to invest globally with a focus on content and fulfillment center expansion, in addition to starting up newer markets, like India, and services such as Prime in Mexico, we believe it is increasingly attracting a greater share of consumer wallets globally as a result of these investments and is focused on cost discipline and efficiency where possible. It’s a great strategy – one that is working and working well.
Amazon remains in investment mode globally, and we believe margins can be sustained as the company continues to focus on cost discipline, as earlier projects become increasingly efficient. As an example, most fulfillment centers typically need to go through three peak periods before reaching sustained efficiency levels. To this end, the maturing of existing fulfillment centers helped Amazon’s operating margin of 5.2% in 1Q17 beat projections. This is great news. Recall, a few quarters ago the stock sank on weak operating margin.
Internationally, Amazon is investing in newer markets and is rolling out many of its products and Prime benefits globally sooner than prior, pressuring profitability in the short term as international losses reached $1.5 billion over the prior three quarters alone. We note that Prime recently launched in Mexico with 20 million eligible items. We believe these member benefits should result in greater adoption of Amazon’s services globally.
Amazon Web Services (AWS) revenue of $3.7 billion increased 44% from last year and was largely in line with projections. AWS continues to launch newer products and we note recent customer additions, Snap, Dunkin Brands, and Liberty Mutual, among others.
BMR Take: Our $1,000 price target is quickly approaching. We expect around $19 of EPS in 2018 versus the $13 in 2017. We believe Bezos will be focusing on earnings as the company moves forward and with nearly 50% EPS growth in the cards, Amazon moving to $1,000 is not a stretch at all.
PayPal (PYPL: $48, up 9%)
PayPal delivered a solid set of results and raised its revenue and earnings outlook modestly by around 3%. The metrics were quite robust all around, starting with acceleration in active accounts (partly helped by consumer choice), robust transaction growth, healthy growth in total payment volume, a lower deceleration in take rate and numerous partnership announcements in the quarter highlighting business momentum.
In particular, we love to see big growth as that confirms a bull market is alive and well. On this front, PayPal delivered through mobile. Mobile volume growth was +50% overall with Venmo doing +115%.
First-quarter revenue of $3.0 billion (up 17% annually) and EPS of $0.44 (up from $0.37), beat estimates of $2.94 billion and $0.41. PayPal expects second quarter revenue of $3.1 billion and EPS of $0.42; and full-year revenue of $12.6 billion (up 16%) and EPS of $1.76. Over $2.7 billion in free cash flow is expected this year. Wow.
Number of PayPal's total active registered user accounts from 1Q10 to 1Q17 (in millions)
And check this out:
PayPal's annual mobile payment volume from 2008 to 2016 (in $billions)
PayPal announced a new $5 billion stock repurchase authorization. This news caught investor’s attention and was one of the key drivers to send the shares up 7% in the trading session the day after posting results.
One noteworthy ongoing debate is the option to move to more of an “asset light” model, which should increase the valuation the business receives from the market. This strategy would require selling PayPal Credit so the company doesn’t do any lending but only runs technology and processing operations. We would be pleased to see this catalyst occur.
BMR Take: EPS estimates call for around 15% growth to upwards of $2.50 in 2019. With all fundamentals looking great, this freight train is rolling, baby! Our Price Target is $48. Since it hit this price on Thursday, we hereby raise our Target to $56. With a market cap of $57 billion now, if it reaches this new target we will see the cap reach $67 billion. Now THAT’S a story.
Oh – our Sell Price? It remains the same: We would not sell PayPal.
Google (GOOG: $906, +8%, or $63 a share)
Results were better than expected in 1Q17. Gross revenue of $24.8 billion grew a nice 24% from a year ago and was 2% above consensus. The results reflected continued strength from mobile search, YouTube, and programmatic ads as paid clicks growth accelerated 53% from a year ago.
What is really exciting? There is a belief that it remains relatively early days for “mobile search monetization”. To this end, we saw local shopping queries increase by 45% from a year ago and the company achieved 2 billion app installs since September 2016. What does this all mean? More and more people are on their phones searching for stuff as they walk through malls, sit in their cars, and do whatever they do every day. This trend is unlocking “mobile search monetization” we described above. Bottom line, mobile search continues to lead to good results for Google for the foreseeable future.
YouTube did great. YouTube usage was 1+ billion hours of video watched daily in February. Holy cow! This might be the best asset in all of video media. During the quarter, we saw large brand advertisers increasingly come back to the platform after some recent mishaps around inappropriate video uploads being attached to the marketing campaigns of some advertisers on the platform. Very nice to see the recovery unfold here.
BMR Take: We continue to believe Google is among the best-positioned Internet companies due to its leadership position in artificial intelligence, mobile, search, video, and programming, all of which are core Internet growth drivers. With EPS on track to do over $50 in 2018, you just have to own this one.
CBRE Group (CBG: $36, up 4%)
Another Bull Market Report stock delivered a good quarter. It was a clean beat for CBRE. EPS of $0.43 came in well-ahead of the $0.33 consensus, as expenses trended materially below expectations.
CBRE Group’s resilient first quarter result validated the persistent strength of the commercial real estate cycle and the company’s first-rate global platform.
EMEA* and Asia stood out for the company. Asia posted 10% revenue growth.
*Europe, Middle East and Africa
The company has a strong outlook. Management commented that it was not making any adjustments to its 2017 earnings outlook of $2.40. The backdrop remains favorable as rates have retreated, the election fallout has stabilized, global economies are growing and new construction remains strong.
M&A is emerging again. This could be a big boost for the company. The company closed two investments in the quarter, and an additional one at quarter end. Management suggested that after a year of remaining mostly absent from the acquisition markets, pricing was becoming more rational again, suggesting we could see slightly more activity from the company. With a balance sheet that remains healthy, with in excess of $3 billion of dry powder on hand, management could step on the gas if they choose to.
BMR Take: CBRE Group is the Rolls Royce of real estate. With nearly $3.00 in EPS due in 2018 with upside from possible M&A, the current price in the mid $30s sure looks like a cheap value to us.
Celgene (CELG: $124, up 1%)
Celgene reported 1Q17 light on revenues, but modestly ahead of Street consensus on lower spending, and provided positive 2017 guidance. EPS of $1.68 was above Street consensus of $1.64. Revenues of $2.95 billion were slightly below consensus of $3.05 billion.
The modest revenue softness was largely due to weakness in sales of Otezla, which were negatively affected by a greater than anticipated contraction in U.S. prescriptions for psoriasis/psoriatic arthritis, and a modest inventory draw-down through 1Q17. Other products - namely Revlimid and Pomalyst - were also negatively affected by Medicare prescription problems.
We note that previous guidance of $1.5-$1.7 billion in net Otezla sales for 2017 remains intact despite this soft quarter. Further, the contracts negotiated with large payers have significantly broadened access to Otezla for up to 100 million covered lives, intimating future tailwinds for the asset.
BMR Take: We remain bullish on Celgene and forecast total revenues to rise strongly. We expect Celgene’s four drugs (Revlimid, Abraxane, Otezla, and Pomalyst) to drive revenues to over $13 billion by 2017, and over $21 billion by 2020. Note that revenues were $7.7 billion in 2014, $9.3 billion in 2015, and $11.2 billion 2016. Now that’s growth. Recent acquisitions of Receptos and Delinia along with investments in collaborators such as Acceleron, Epizyme, Agios, and others likely ensure growth from 2017 and beyond. We continue to view Celgene as a top large cap pick in healthcare. The market cap is at $96 billion now.
United Parcel Services (UPS: $107, +2%)
UPS pleased investors with earnings results too, mainly on the top line. Total revenue climbed 6.2%. Revenue grew in all segments and in all major product categories, as balanced market demand occurred across the company’s broad product portfolio.
There was a wave of other good news to report. Total fuel expense increased $187 million or 43% over Q1 2016. The fuel surcharge revenue lagged expense, however a February 2017 surcharge change mitigates this variance for future periods. Capital expenditures to support network enhancements were $938 million during the quarter, demonstrating a run-rate at the annualized guidance level.
UPS paid dividends of $775 million, an increase of 6% per share over the prior year, rewarding shareowners with continued strong dividend yield. The company repurchased 4.2 million shares for approximately $450 million in line with the company’s capital allocation policy.
What is exciting? The company is accelerating investments to create the industry's leading smart global logistics network and value-creating portfolio. UPS customers are benefiting from expanded capacity, choice and improved time-in-transit, while technology solutions continue to deliver efficiencies. One example of expanded service is the company's new Saturday delivery program, which began rolling out this year. While the roll-out cost the company $35 million this quarter, UPS is hoping it will give the company a leg up on competitors. The service is now in 15 metro areas. By the holiday season, the company hopes to have Saturday delivery capability in 4,700 cities.
BMR Take: UPS is without question a top logistics franchise globally. With projections pushing towards strong EPS growth and nearly $8 of EPS potential in a few years, we expect the company to deliver. The stock is slowly making a comeback from the sharp drop we saw from $117 to $103 in early February. We wouldn’t be surprised to see $110 soon and $115 again in a month or so. This $93 billion market cap company is a well-oiled machine and with more and more people buying online instead in malls, their business is assure of growth in the future.
US Economic Outlook
The first quarter can be full of surprises. During the existing expansion, first quarter GDP growth has come in short of consensus expectations every time, with an average absolute forecast error of 0.5%. Initially, disappointing first quarter GDP growth led some to question the durability of the expansion, but that should fade now that the issue of residual seasonality has come to the forefront.
Residual seasonality in GDP implies that there is a predictable seasonal pattern. This is clear in the first quarter, as GDP tends to be noticeably weaker than in the subsequent three quarters. The differences are frequent and large enough that they are unlikely a fluke. Also, residual seasonality is evident across many of the major components of GDP, including parts of services spending, exports, federal and state and local government expenditures, and nonresidential structures.
The Bureau of Economic Analysis has made adjustments to correct some of the issues related to residual seasonality, but it likely remains a sizable weight on GDP growth. GDP came in weak in the first quarter, rising 0.7% at an annualized rate. Residual seasonality appears to be shaving 0.5% off first quarter GDP growth. There are other reasons for the weakness in the first quarter, including weather and possibly the delay in tax refunds.
We believe the Fed will look through the poor start of the year, as GDP is inconsistent with other hard data, including employment. Still, sub-1% GDP growth could create a challenge for the Fed, since we still expect it to raise rates in June. Though GDP is heavily scrutinized, the employment cost index for the first quarter could have greater influence on monetary policy. The Fed is worried that the tight job market will lead to a sudden acceleration in wages that would then boost inflation.
Federal Reserve policy makers are set to meet next week, and while there is little expectation that an interest-rate increase will be announced when the meeting ends on Wednesday, the latest economic reading could sway the Fed’s outlook. The monthly report on job creation is due next Friday, and a strong showing could ease some of the concern over the lack of vigor in the first quarter.
Reaffirming its recent findings, the University of Michigan said its consumer sentiment index finished April with a decidedly bullish reading of 97, up from 87 just before the election.
A Word from Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.
Viva Le Pen! Laissez les bon temps roulez! But wait a minute……..the market wants Macron to win and therefore is acting as though his election is a foregone conclusion. Does that ring a bell? Remember how Clinton was a "foregone conclusion" and how that night the market absolutely crashed……but made a miraculous recovery after the Trump victory. As far as we can tell, US stocks shouldn't be materially affected one way or the other and we view this as a "sideshow" to the earnings season that is under way here at home. Or, as Alfred E. Neuman might comment on the whole French thing, "What, me worry?"
President Trump announced a new tax plan which he called "bigger, I believe, than any tax cut ever". This news is, in our humble opinion, of much greater interest to the US investor than the French election. We are seeing a plan that is pro-growth and nothing but pro-growth, and which has a realistic chance of garnering enough support to get passed. If that happens, we expect a nice rally. If it doesn't, then we would expect the market to react with some sort of displeasure.
Earnings update: Thomson Reuters is reporting that earnings are expected to grow by more than 11% in the first quarter. 76% of the earnings reports have already come in above estimates. 62% of companies have beat revenue forecasts, and revenues are expected to be up just under 7% on the quarter. These are good, solid numbers. Numbers like these should provide durable support for the market.
Blackstone (BX: $31) killed in the first quarter of 2017. They earned 82 cents a share on revenue that rose 108% year over year to $1.94 billion. Analysts were looking for 68 cents on revenue of $1.6 billion. Total assets under management climbed to a record $368 billion. The company said that realizations totaled $16.6 billion, a company record. The bulk of the realizations came from the firm’s flagship private equity and real estate strategies, with an average multiple on invested capital of 2.6 times.
Underlying portfolio company fundamentals appear strong. Management noted its private equity portfolio companies are experiencing high single-digit EBITDA growth and in real estate, both rents and occupancy continue to improve.
BMR Take: And the stock took off this week. It was up 5%, counting the fabulous 87 cent dividend that it paid a few days ago. You know, we are always looking for new companies to invest in that will give you above-average gains. We will tell you this: There is going to come a time when this stock will skyrocket. We can see it hitting $40 down the road and it just might come sooner rather than later. Why? Because this stock has been undervalued so long that investors have given up on it. But don’t forget that Stephen Allen Schwarzman has NOT given up on it. From what we can gather he has 230 million shares. WOW. That’s 45% of the company, worth north of $15 billion. He thinks the stock is WAY undervalued and is working on a million ways to get the stock higher. We’re going with Steve on this one. We’re up 25% on Blackstone since early 2016, but our Target is $36 and we think hitting this is quite possible in the next few months.
Athenahealth (ATHN: $98) got hammered on Friday, dropping $23, all of our gains since we added the stock in November at $103. We’re down 5% now, not pretty, but not bad in the whole scheme of things. We just hate to see these overreactions. Look at this: revenues for the past three years are $750 million in 2014, $925 million in 2015, and $1.1 billion for 2016. The company reported revenue of $285 million in the quarter up from $255 million in the year ago quarter. And the company stated last week that they expect full-year revenue of $1.23 billion. So really, if you look at the numbers, everything is still solid. Earnings were $22 million, down from $24 million. Yes, earnings were a bit weaker, but revenue growth is key in our book.
We are going to stick with this company for now. We can see the overreaction continuing a bit, taking the stock down to $95 or even a little lower, so you have to make a decision – stick with it or bail. These are always tough decisions and of course, it is impossible to predict what will happen. Many investors say to cut your losses and move on. Others say, like we are saying here, that this great company is being punished by the market for a silly little miss on the earnings front.
Trump’s Repatriation Initiative
Credit Suisse told investors to buy high tech shares because the companies will thrive under President Donald Trump's tax reform, saying it will enable an increase to its shareholder return program and allow for more strategic acquisitions.
The firm raised its rating on one of the giant tech companies two notches, to outperform from underperform, a rare "double upgrade."
"We believe the possibility of an upcoming repatriation and balanced approach towards M&A [mergers and acquisitions] and capital return could drive long term earnings power," they said.
There is over $2.6 trillion of cash offshore, which can be "unleashed" under tax repatriation reform, at least half of which is controlled by Tech firms. If Trump's tax plan is passed, Credit Suisse estimated that about half of this ($650 billion) can return to shareholders during the next five years and another $500 billion could be used for mergers and acquisitions.
"The combination of a potential buyback combined with accretion from M&A, has the capacity to drive these firms’ earnings materially higher in the coming years," they wrote.
BMR Take: The firms with the largest hordes of cash are Apple with over $255 billion, Facebook, Google and Oracle, so we expect them to be the biggest beneficiaries of this tax cut if it every happens.
AstraZeneca (AZN: $30, flat) went up and down after reporting earnings. Revenue of $5.4 billion fell 12% from a year ago and EPS of 99 cents was 4 cents up from a year ago. The company’s ability to grow earnings with falling sales is impressive, and partly justifies the 24 P/E ratio. Most impressive was the company’s ability to lower core SG&A costs by 14% - greater than the sales decline, suggesting greater operational efficiency.
Why were sales down so much? Really this is a one-story issue: Crestor. This drug lost its patent in the U.S. and is a big hit to sales. The company still has plenty of cancer and diabetes drugs in the pipeline, indicating upside is still possible. We will be paying close attention to the company’s pipeline in the months ahead.
Shopify (SHOP: $76) hit an all-time high on Monday. Two weeks ago the stock surged from the $70 level to the $76 level and last week the gains were sustained. The market cap is still a tiny $7 billion and we continue to maintain that a firm could come in a make a $90 or $100 offer for them and it wouldn’t make a dent on the acquirer’s balance sheet. Apple with $255 billion in cash, or Oracle (ORCL: $45) worth $185 billion with $60 billion in cash are just two possible buyers. Don’t get me started on Google or Facebook or Amazon! With over 300,000 websites using Shopify software we expect great things for this company in the future.
The High Yield Corner
By Michael Foster
Special to The Bull Market Report
Of all the high yield sectors as a whole, junk bonds performed the best. The SPDR Barclays High Yield Bond ETF (JNK: $37, up 1%) closed the week stronger despite slightly disappointing GDP news, with the trend starting last Monday at its strongest and continuing throughout the week. The asset class did far better than U.S. Treasuries, especially on the long-term end of the curve, where yields slipped this week, although that slip began before the GDP data. This trend is not sustainable in the long term; junk bond yields cannot keep falling and U.S. Treasury yields cannot keep rising at the same time. At one point or another the gap between the two would narrow and there would be no risk premium for investing in assets that can and do default a lot (junk bonds), versus an asset that cannot default, outside of a major apocalyptic event (U.S. Treasury).
While junk had a good week, BDCs have had a good year so far. The UBS BDC ETF (BDCS: $24, up 1%) is up over 4% year-to-date versus junk bonds’ 1%, with the more popular BDCs becoming an increasingly popular trade. Main Street Capital Corporation (MAIN: $40) is now up 9% year-to-date after another 1% gain this week. But note that Friday was a peak that very swiftly and steeply fell, causing the stock to lose 1% in a day. With a premium to net asset value of 80% by the end of the week, we cannot expect this trend to continue. Of course, we have been saying this ever since we removed Main Street from the high yield portfolio and while we haven’t seen a correction, we have seen the stock’s run up stalling slightly. Timing a top exactly is impossible, but recognizing that we’re at or near a top is easy. This is the case with Main Street as well as several other popular BDCs. While we suspect a correction in the junk bond market to be uncomfortable, we expect a similar trend in BDCs to be much more severe. That may come next week or next year, but these 80% premium valuations cannot last forever.
We’ve given a similar word of caution regarding REITs. Last year, especially the start of the year, was a stellar time for the asset class, with post-August proving much more challenging and post-Trump proving even more difficult. The SPDR Dow Jones REIT ETF (RWR: $92, down 2%) had yet another rough week. Despite the problems surrounding REITs, we have not recommended exiting the sector entirely as we found most prudent with BDCs. The reason for that was simple: REIT valuations remained modest and much less efficient than in BDCs. Part of this is due to the greater ease of valuing BDCs in terms of the market value of their debt portfolio. Due to the strategy of accounting for depreciation with REITs, this sector is much more complicated. As a result, valuing these assets in terms of their book value is largely useless or must be done with extreme care. For this reason, many investors prefer to focus on price to FFO as a ratio - in other words, determining how much you’re paying for income instead of paying for the underlying assets producing this income. This of course is unwise because FFO and asset values can be extremely divorced from each other as a result of a variety of market factors.
Ultimately, this means a closer analysis of the underlying business is necessary when analyzing REITs, and in doing so investors can find amazing deals. This is the back story of our REIT picks, and is why Digital Realty Trust (DLR: $115, up 3%) has remained a major pick for a long time. This income stock is now up over 33% in the last year and the dividend has grown 6%, with more dividend hikes inevitable thanks to its strong and growing FFO. The market has no qualms giving this REIT a high valuation, so it’s no surprise that it jumped this week despite weakness in REITs elsewhere.
That weakness, however, impacted several other Bull Market Report picks. Omega Healthcare Investors (OHI: $33, down 4%), Kimco Realty (KIM: $20, down 6%), Government Properties Trust (GOV: $21, down 2%), and Care Capital Properties (CCP: $27, down 4%) fell with the broader market. These are extremely big movements, largely a result of market panic in the sector. It has also created tremendous opportunities, especially with the very safe Kimco Realty, which has an amazing track record and solid dividend coverage. This is a “buy the dip” opportunity.
A Note on Facebook’s Growth:
Facebook (FB: $150) has four operations that have over one billion users. There is Facebook itself with 1.9 billion. Messenger is at 1.2 billion, as is WhatsApp at 1.2 billion. Then there is Instagram. Listen to this: Since inception, the company has been adding 100 million users about every nine months. But something happened when they hit 500 million. Going from 500 million to 600 million took just six months. And getting to 700 million took just FOUR months. This is unreal growth. When will Instagram reach 1 billion? Good question, but at this rate it just might be in early 2018. And people wonder why the stock hit $150 this week, up 5%. Repeat – Facebook has FOUR operations with over 1 billion users. One billion. That’s 1000 millions. We are just in shock.
OK – the stock hit our Target of $150 Friday and we are now up 55% since we added it in January last year. The stock is going a lot higher folks, so we hereby raise our Price Target to $165 and our Sell Price from $125 to $140.
Good Investing,
Todd Shaver, CEO and Editor
The Bull Market Report
Since 1998
April 10, 2017
by Todd Shaver | Apr 10, 2017 | 1pm News Flash
By Michael Foster
(Michael was under the weather yesterday but has made a remarkable recovery!)
Let’s start our retrospective with junk bonds. The SPDR Barclays High Yield Bond ETF (JNK: $37, 6% yield) ended the week mostly flat after going ex-dividend (17 cents each month) last Monday, showing another period of surprising restraint from a tightly-wound up market. Back in early 2016 when we were recommending junk bonds most aggressively, funds like this started a bull run that was steep and long lasting, hindered only by a correction at the end of the election cycle that reversed course shortly after Trump won. Junk bonds returned to their 52-week high by February, and since then have reversed course slightly. The market is about 2% off its recent high, with the correction happening mostly over the last month or so.
This is good news for the junk bond market because of two big pressures happening to the market. First is the yield spread issue. U.S. Treasury yields have been climbing higher although recently stalling, and yields on junk bonds needed to either go higher or stay where they were lest the spread between Treasury and junk bond yields get too small and thus disincentivize investors from buying junk bonds. Since bond yields and prices are inversely related, this meant junk bond prices had to go down a little or a lot. The market decided on a little, and spread the pain out over several weeks. This is a restrained move, indicating a market awareness that junk bonds can’t go up in price significantly, but there’s no justification for a crash either.
This conclusion is particularly surprising because of the second big pressure on the market: Retail. You may have read the news of Retail giants going bankrupt and closing stores. Go to your neighborhood mall and you’ll see it yourself. If you’re old enough to remember the mall’s heyday, going to one of these shopping centers today is cripplingly sad. But don’t feel bad for the retailers - feel bad for their creditors. Retail shops rely on junk bonds and middle market lenders to give them liquidity, so the crash in this market impacts the bond and debt markets too. Yet the intense store closings have done some damage to the bond market without causing them to implode like oil’s crash in 2014 did. This again indicates an awareness of building risks and a restrained response. It’s a laudable market response.
These kinds of risks should hit BDCs as well, which arguably are exposed to lower quality mall retailers. We’re still waiting for the bottom to fall out in the BDC universe. The UBS BDC ETF (BDCS: $24) was mostly flat this past week on little news, although we were disturbed to see insider selling at Main Street Capital Corporation (MAIN: $38), one of BMR’s former favorites. COO Jason Beauvais sold 4,300 shares, or 5% of his pre-sales stake, for six-figure proceeds. While share compensation meant he was a net buyer of stock, Beauvais’s sale of already-owned shares rings claxons in our ears, especially since Main Street still sells at its highest premium in history - a premium of 75%. That’s just too much for us no matter how attractive the stock is, and one can’t help but wonder if it’s too high for Beauvais too.
Triangle Capital Corporation (TCAP: $18.70) is another big BDC with a solid track record and insider selling. Director McComb Dunwoody sold 32% of his stake for $930,000 in cash. Of course, Triangle Capital is one of those paradoxes that portends safety with a steady portfolio of debts to reliable middle market companies. Not that that has resulted in reliable income to cover growing expenses, which is partly why the firm cut its dividend in 2016. That wasn’t enough reason for us to be cautious of the company back then, and there are fundamental strengths in the portfolio. But that’s not enough to justify buying in where dividend coverage remains uncertain. Dunwoody’s sale makes sense and, coupled with Beauvais’s, indicates something particularly distressing about BDCs: Insiders are getting less confident of the industry. This leads us to continue our caution about BDCs.
What’s more, we think investors need to try to understand what exactly BDCs are. They are an alternative investment, and that means risk. Alternative investments serve two purposes, both equally important. The first is to provide a diversified portfolio so that you get exposure to different asset classes in case one of those asset classes really does well one year. The other, arguably more common, raison d’etre for alternative investments is non-correlated returns. This is a complex concept but the basic idea is that you want to try to invest in things that don’t necessarily track your main equity investments, so in case that tanks you have something else going up while you wait for your main investments to recover.
The problem is that BDCs fail miserably on that measure for retail investors - their prime target investor group. Triangle Capital has a beta of 0.87 and Main Street has one of 1.1 - both suggest a close correlation to the S&P 500, versus the -0.38 beta of the iShares 20+ Year Treasury Bond Fund (TLT: $121), a fund that is truly non-correlated with the S&P 500. Investors get duped into BDCs because they think this isn’t correlated to the S&P 500 because it’s such a different kind of investment vehicle. That’s sadly not the case. That doesn’t mean this alternative investment should never be bought - it should, but only when it’s undervalued. And with massive premiums like Main Street’s, this is hardly an asset class that’s gone undervalued in recent months.
So what has? In all honesty, the most undervalued asset class right now may still be municipal bonds. We have been pounding the table on munis since December and we get more emphatic with this recommendation every week that we see the S&P 500 climb and junk bond values go higher. Muni bonds are one of the safest income producing asset classes on Earth, yet they’re priced as if they had a much higher risk than they really do. Yet the biggest risks facing munis - rate hikes in particular - are much bigger risks to BDCs and junk bonds, yet those asset classes are doing much better than munis. Why? Muni investors are an easily frightened bunch, and they’re still terrified about a rate hike that they don’t realize won’t hurt them. That makes for viciously underpriced bonds and a buyer’s market.
How to get into munis? Bull Market Report’s two picks - Invesco Municipal Trust (VKQ: $12.60) and Nuveen AMT-Free Fund (NVG: $14.78) - remain solid choices for getting into this market. You’re getting a near 6% tax free yield and we’ve already seen 4% capital gains since the start of December. There’s still room for these funds to climb as the risk-averse tiptoe back in. It’s a very easy cyclical price trend to follow, and we’re happy to ride it for the short term.
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
