THE BULL MARKET REPORT for October 16, 2017

by Todd Shaver | Oct 15, 2017 | Weekly Newsletter 7pm Sunday

The Weekly Summary

Tulip Mania was a period in the Dutch Golden Age when the price of bulbs reach ridiculously high levels in a craze only to eventually have the price crash badly in 1637. While we are not seeing broad-based craze in today’s markets, we must be mindful that there are pockets of risk out there, and that while market prices today haven’t reached “ridiculously high levels” they have still come a long way, raising the bar for how much risk lingers around out there. For example, this week the mainstream news media extensively covered Wall Street’s junk market bond binge. Junk rated companies are raising debt at the fastest pace since 2012. Not just is the issuance up a lot, but the terms of the deals (i.e. the debt covenants) are getting looser and looser, and thus easier to borrow money. We only raise these points to say, please be mindful of the risks, but there remains plenty of opportunity for future profits!

No matter what is happening out there, there is always a bull market here at The Bull Market Report! This week we highlight some of our favorite stocks/funds where we think you can still make good money, including: Athenahealth, Nutanix, Cloudera , Opko, Apple, Annaly and BlackRock.

BMR Companies & Commentary

Another week, another all-time record high. Does this scare you? Not us. Why should it scare you? The economy is strong. We have 325 million people who are trying to better themselves by starting companies, by investing in real estate, by buying equities and bonds. No one thing or no one event can bring down the entrepreneurial nature of this country. The market is climbing a wall of worry. Trump, North Korea, breaking the Iran deal, the Taliban, our war in Afghanistan (that Trump is escalating now – ouch), Trump – oh wait, we just said that above. Yes, climbing a wall of worry. But the stock market has been doing this for over 100 years. Seriously. Look what it has been through and look where it is now. Look where our economy is now. Amazing. So Dow 23,000 look out and who knows, maybe in a year or two we will be saying “Dow 30,000 look out.”

If you really are worried and/or if things do get worse, sell your growth stocks and buy some income producing stocks from our REIT portfolio or our High Yield portfolio. Annaly Capital Mortgage (NLY: $12.22, up 1%) has been paying over 10% for over 20 years. I am going to repeat this for you here: Annaly Capital Mortgage has been paying over 10% for over 20 years. Since 1997 they have operated through bull and bear markets in stocks and bonds and they have survived and thrived. You’re worried about the stock market? Buy some Annaly – it is non-correlated with the market.*

*It has a beta of 0.30. A beta of 1 means it follows the overall stock market equally – if the market is up 1%, Annaly is up 1%. But no, Annaly has a beta of 0.30% meaning little to no correlation. The beta of an investment indicates whether the investment is more or less volatile than the market as a whole. In general, a beta less than 1 indicates that the investment is less volatile than the market, while a beta more than 1 indicates that the investment is more volatile than the market Beta can be zero. Some zero-beta assets are risk-free, such as treasury bonds and cash.

You want diversification? There are many other stocks in those two portfolios that pay from 4% to 9% dividends. Buy a basket of them and sit back and sleep like a baby at night!

Athenahealth (ATHN: $115, down 7%)

While Athenahealth didn’t perform well this week, as far as we can tell the issues are just some pre-earnings jitters, not anything serious. The company is scheduled to report earnings on Friday. The consensus is looking for EPS of $0.50 on $310 million of revenue.

We expect all the key fundamentals to remain solid. Recall, the company recently committed to several key initiatives, including: (i) targeting approximately $100 million in cost-savings to increase profitability and drive growth; (ii) committing to significant operating margin expansion; (iii) launching a search to recruit a seasoned independent chairman of the board and additional independent director; and (iv) augmenting the senior management structure to establish the role of president, in addition to an ongoing CFO search.

We do note that the interim CFO sold 4,000 shares this week. Sometimes this news spooks people, but in this case we see no reasons to be concerned about it.

BMR Take: With Elliott Management in there shaking things up, there is a lot of excitement ahead. We love this company but believe now is the time to take profits. For those of you who bought on our recommendation, we made a fair amount of money since we added the stock at $103 in November. While we already officially removed the stock from our portfolio on 8/7/17, we once more reiterate taking profits. Why again? We know some of you out there may have stayed the course selling calls, as that’s what we recommended to do at the time if you weren’t ready to get out. Well, we want to be sure to now say without any hedging - time to exit completely! Let’s buy this one back below $100.

Nutanix (NTNX: $27, up 15%)

Goldman Sachs called Nutanix the investment opportunity of a decade. Why?

The demand pendulum appears to be swinging toward emerging, best-of-breed vendors with more modern approaches, and away from traditional, one-stop shop vendors that are often viewed to be out-of-step with the latest trends.

The proof is in the success or failure of new clients. Just this past quarter Nutanix had a strong quarter for large deals, including multiple deals in the high seven-figure range (several of these in the public sector). Nutanix is now working with a big chunk of the Fortune 500.

The big exciting part about Nutanix is that the company has doubled the number of clients in the past year. The typical client starts with a small contract, but then increases the amount of business they do, often 3x, 5x, or even 10x within a few years. So if Nutanix does nothing else but take care of the clients it already has, we should see strong growth in the years ahead.

BMR Take: We think Nutanix is a must-buy at current levels. Don't be worried about the current valuation. Let's look at why. This year the consensus is for EPS of $0.07, which is nothing much. However, the company is plowing money into sales and marketing to grow the business. Did you know they could save a few hundred million dollars tomorrow generating $1.50+ of EPS if they wanted to stop investing for growth? You see this analysis reveals the serious earnings power embedded in the business model, which is why we like the company so much.

Cloudera (CLDR: $15.72, down 6%)

Remember the company we really like just mentioned above, Nutanix? Well they are doing great things with Cloudera, which means there is more than one way to make money here.

Nutanix, a leader in enterprise cloud computing, announced that its Enterprise Cloud Platform software has been certified to run Cloudera Enterprise workloads. Through this certification, joint customers can reduce management complexity and derive more value by deploying and managing their Cloudera analytics workloads on the market’s leading hyperconverged software platform.

For big data deployments, choosing the right hardware and software is critical to success but often challenging for IT teams balancing ambitious corporate goals with smaller budgets and fewer resources. Joint customers can now run Cloudera workloads on an on-premises, elastic, software-driven infrastructure that can scale on-demand, one node at a time. And because Cloudera workloads can run on the same shared infrastructure as other workloads, IT teams can reduce costs and focus their attention on strategic projects, rather than managing multiple silos of underutilized infrastructure. Great news!

BMR Take: With $360 million of sales projected this year, a growth of 40%, Cloudera is an emerging growth stock worth keeping an eye on. With acquisitions building out the product suite and accelerating revenue growth, momentum is undeniably picking up. A $2 billion market cap, this company is a pipsqueak in the world of commerce. But given its high growth rate, in 2-3 years, the firm can be a major factor (if the company doesn’t get taken out by the big boys.)

Wall Street Consensus Ratings for Cloudera
Ratings Breakdown: 5 Hold Ratings, 4 Buy Ratings
Consensus Price Target: $22.40

10/11/2017 Mizuho $18
9/8/2017    J P Morgan Chase $24
9/8/2017    Morgan Stanley $19
9/8/2017    Stifel Nicolaus $24
5/24/2017  Bank of America $23
5/23/2017  Raymond James Financial $23
5/23/2017  Citigroup $23
5/23/2017  Deutsche Bank $25

Opko Health (OPK: $6.95, flat)

Opko is a diversified healthcare company that seeks to establish industry leading positions in large, rapidly growing markets. The diagnostics business includes BioReference Laboratories, the nation's third largest clinical laboratory with a core genetic testing business and a 400 person sales and marketing team to drive growth and leverage new products, including the 4Kscore® prostate cancer test and the Claros® 1 in-office immunoassay platform. The pharmaceutical business features Rayaldee, an FDA approved treatment for Secondary hyperparathyroidism in stage 3-4 chronic kidney disease (CKD) patients with vitamin D insufficiency.

Opko recently announced that it has entered into an exclusive agreement with Japan Tobacco (JT) for the development and commercialization in Japan of Rayaldee for the treatment of SHPT in dialysis patients with chronic kidney disease. This is great news for growth!

Under the terms of the agreement, JT will make an upfront payment to Opko of $6 million with another $6 million payment to be made upon initiation of Opko’s planned phase 2 study of Rayaldee in US dialysis patients. In addition, Opko will be eligible to receive up to an additional $31 million in development and regulatory milestones and $75 million in sales-based milestones. JT will also pay Opko tiered, double digit royalties on net product sales. Wow!

BMR Take: Consensus calls for about $1.2 billion of revenue for the company this year heading to $2 billion in a few years. We could be in for some major upside to estimates. Now wouldn’t that be nice, after being so patient with this little $3.9 billion company.

Apple (AAPL: $157, up 1%)

Apple could be disrupting more industries soon.

Barclays, the British bank, will need to defend its advantages in the payments business from encroachment by technology companies including Amazon and Apple, according to Barclay’s CEO Jes Staley.

There are some tectonic shifts going on, driven by tech and the geopolitical environment. The banks are very focused on the payments space and that may be where the battleground of finance is fought over the next 15 years. Could you imagine if Apple started taking share of the banking business from the world’s largest banks (like Barclays, JP Morgan, and Wells Fargo) as well as the world’s largest payments companies (like Visa and MasterCard). This would be another huge long-term growth driver.

BMR Take: Note that Apple has $260 billion in cash now, and with a market cap of $810 billion cash is 32% of the stock price. So more than $50 of the stock price is in cash. This is UNPRECEDENTED in the history of Wall Street. Apple remains an exciting investment opportunity. The services business is projected to double in revenue to $50 billion over the next several years. The Services business is much more profitable than hardware so the impact to earnings is even better. Don’t sell a share. We believe Apple has a lot more room to go on the upside.

BlackRock (BLK: $475, up 3%)

BlackRock, the world's largest money manager with $5.7 trillion in assets under management, reported better-than-expected earnings on Wednesday, which sent its stock to a record high.

And shares could go even higher, according to Credit Suisse (and us!) Following 3Q17 results, BlackRock remains the best-positioned traditional asset manager in the world with EPS growth expected to run 15-20% through 2019.

Most of the company's growth has come from its wildly successful exchange-traded fund business, known as iShares, which now accounts for half of all US investments in the products. There continues to be strong demand for iShares's ETFs driven by the evolution of the US retail channel (from commission-based to fee-based) and increased adoption by institutional clients and pricing reductions in its core series. Year to date, iShares accounted for about 50% of total ETF flows in the US.

Passive investments, like ETFs and other products that track a weighted index rather than a single equity, have steadily eaten away at active managers' portfolios in recent years.

BMR Take: BlackRock is among the best-positioned companies in investment management owning the top ETF franchise that is growing rapidly due to passive investing, as well as an increasing product portfolio of technology. Recall, there are several top hedge funds on the list of shareholders in BlackRock. With EPS set to approach $30 over the next 3 years, this stock pick is among our favorites.

Upcoming Economic News

Industrial Production
Tuesday, October 17, 2017 09:15 AM
Period: September
Consensus: 0.30%
Prior: -0.90%

Housing Starts
Wednesday, October 18th, 8:30 AM
Period: September
Consensus: 1,180,000
Prior: 1,180,000

Continuing Jobless Claims
Thursday, October 19th, 8:30 AM
Period: October
Consensus: 1,895,000
Prior: 1,889,000

A Word from Gary Jefferson
Jefferson Financial Group
First Vice-President, Investments
UBS Financial Services, Inc.

The 4th quarter is off and running strongly, which is not uncommon. Even though it includes October (Octoberphobia), Q4 has historically been the strongest quarter of the year for the S&P 500. Since 1950, the S&P 500 has gained 4% on average in the fourth quarter, advancing 79% of the time. Oil dipped back under $50 per barrel and gold has fallen over 7% in just the last month because the US Dollar has strengthened due to the belief that the Fed will hike rates again in December. Maybe or maybe not. We still think tax reform is a bigger wild card than another Fed hike. The expectation of tax reform has resulted in just about everything with the exception of energy being up for the year, but even energy has some building tailwinds.

According to Boone Pickens Advisors, worldwide demand is soaring and set to hit 100 million barrels per day next year – a feat that was only expected around 2025 by most long-term forecasts including those from OPEC and Exxon. Growing energy demand is normally associated with growing economies, so this continues to be good news for future market gains based on earnings growth. The point being made is that if the market suffers a setback due to the failure of tax reform, it should not develop into a real bear market because of the support to be found in continued earnings growth. If Boone Pickens Advisors is right about soaring demand for energy, there is plenty of upside left in this bull.

General Electric (GE: $23, down 10% this week, and down from $32 in December - wow)

The drop in the stock in the last 10 months is almost 30%. With a market cap of $200 billion GE is not going away. But they are the Dog of the Dow. You know what the Dogs of the Dow are, right? They are the five worst performing stocks of the 30 Dow stocks. GE is gunning for THE DOG of the Dow this year. Many value money managers love this stuff. They buy the Dogs and historically, they have been big winners the following year and years.

We are thinking of adding GE to our Stocks For Success portfolio, not just because of the thinking in the above paragraph but for a host of other reasons. It has just had a shakeup in management, which will continue for the next few months. Old CEO out (Immelt), new CEO in (John Flannery). Lots of executives leaving or getting pushed out. Dividend is 4% which is pretty darn good for a Dow stock. 100+ year history of success as a global business leader. Lots going on with this huge company.

A note about the dividend. Some analysts think the dividend could get cut in order to conserve cash. This would be bad and good news. The stock would probably get nailed by another 10% down to $21 or even lower, but that would most likely mark the bottom. So if you are thinking of taking a position, keep this in mind. In other words, keep some cash around (keep your powder dry) in order to buy more at a lower price. If this dividend cut doesn’t happen, then buy some more as the stock moves up over the coming 24 months as it gets back into the $30s. The all-time high is about $58 back in 2000, right after the bubble started bursting in the dotcoms. It dropped to $24 in 2002 and then rallied to $41 in 2007. It got whacked to $12 in 2009 in the financial crisis and has moved straight up for eight years to $32 in 2016. We think there is a good possibility of seeing $30 and $40 in this great franchise as we move into the latter stages of the twenty teens.

Again, we are thinking of writing a research piece on GE soon. We believe it is a long term winner for the super conservative investor.

Update on Shopify
As you know, we love Shopify (SHOP: $94, down 4%) but along came Andrew Left and his firm Citron announcing that he was short the stock, that it was going way down, and that the company was fraudulent, among other silly claims. Many analysts jumped in this past week on the story. Here’s what one of them said:

"Citron’s Argument is Weak
"Let’s call a spade a spade - Shopify is selling a dream.

"So, is the Shopify stock news on-point? Is Shopify using illegal marketing tactics in selling that dream? That’s a gray area to be sure, but is the marketing message remarkably more misleading than the TV commercials inviting consumers to participate in class action lawsuits that mostly enrich attorneys, but rarely pan out as well as expected for the actual plaintiffs?

"Is a vision of a healthy cancer patient within a television commercial for a cancer drug some sort of unspoken guarantee of long-term survival? Does a young man that uses the Axe brand of personal-hygiene products actually expect to be besieged by young women, as depicted in Axe’s television commercials?

"The answer to all these questions is, of course, no. The FTC tolerates the imagery simply because it knows it has to give consumers at least a modicum of credit in distinguishing the difference between a contract and a commercial.

"And as for Shopify’s lack of profits, Shopify is in good company. Most young companies don’t turn a profit until after they’ve matured, but savvy investors know the time to get into some of them is before, not after, that fact. Look at Amazon, the most prominent of the rags-to-riches stories. It’s been one of the best long-term investments anyone could have made over the course of the past couple of decades. Investors don’t care where a company is, they care about where it’s going.

"Looking Ahead for SHOP Stock
"Don’t misread the message. The FTC might crack down on Shopify’s advertising. The company might never turn a profit. The market might not care if Shopify does eventually turn a profit. Nobody really knows the future. That’s the speculative nature of stock-picking.

"Andrew Left, however, seems to be grasping at straws with this one. Though he certainly rattled shareholders by generating some rather alarming Shopify stock news headlines, this time his claims are more bark than bite.

"If your gut is telling you this may be a time to scoop up shares at bargain prices, you may want to trust your gut."

BMR Take: Again, this was an opinion of a consensus of Wall Street analysts. But we certainly concur. We think this guy Left is out in left field. Here’s a chart of the last six months. You can see that the stock is where it was in August, just two short months ago. In April it was $71. We think there is tremendous value here with this company and believe Andrew Left will be left high and dry.

Update on Cloudera (CLDR: $15.72, down 6%)
Nothing new this week, just a lower stock price, giving the stock even more value for the investor.

Here’s what we said three weeks ago on September 24th.

Cloudera (CLDR: $16.90, down 8%)
Cloudera is issuing new stock, diluting existing stockholders, hence why the stock is down. Specifically, Cloudera announced that it has filed a registration statement with the U.S. Securities and Exchange Commission relating to a proposed follow-on public offering of its common stock. A portion of the shares to be sold in the offering will be sold by existing stockholders of Cloudera, and a portion of the shares will be sold by the company. Cloudera will not retain any proceeds from the shares sold by existing stockholders. The number of shares to be sold and the allocation of the shares between existing stockholders and the company have not yet been determined.

Morgan Stanley, J.P. Morgan, and Allen & Company are acting as lead bookrunners for the offering. Merrill Lynch, Citigroup, and Deutsche Bank Securities are acting as book-running managers and Stifel, JMP Securities, and Raymond James are acting as co-managers.

BMR Take: Two weeks ago they reported this:
Recent Business and Financial Highlights:
Subscription revenue was up 46% year-over-year to $74 million
Subscription revenue represented 82% of total revenue, up from 79% in year-ago period
Subscription gross margin for the quarter was 85%, 200 basis points higher than second quarter fiscal 2017
Dollar-based net expansion rate was 140% for the quarter
45 net new Global 8000 customers added

And they have $500 million in the bank. Yes, they aren’t profitable yet, but remember, revenues tell all.

Taking a step back, companies do what Cloudera just did all the time — raise equity and use the proceeds for corporate purposes. It is not a reason for us to sell the stock or for the stock to be down as much as it is. The fundamental business has not changed one iota on this development. So it makes sense for us to stay invested. We will certainly keep a close eye on this management team though. For the time being, we are sticking with the company.

The High Yield Corner
By Michael Foster

Remember the slight volatility we recently saw in REITs? That’s gone. Instead, 4 of the 6 REITs in the High Yield portfolio were up this week, while two were flat. While not rising the most, Omega Healthcare Investors, Inc (OHI: $32, up 1%) is the most important and interesting story of the week. Extremely cautious, risk-averse investors dislike this stock because of its high yield (8%) and relative youth. Having been around since the late 1990s, it lacks the history of many dividend growth stocks. It also had a pretty disastrous collapse in its dividend back in 2000. However, that’s all long history by now. More recently, Omega Healthcare has devoted itself to a penny-per-quarter dividend hike that makes it a uniquely high yielding dividend growth stock. Some will warn that these dividend increases are unsustainable, and that may be true. But if the hikes last 10 years instead of 2 quarters and you avoid it because it won’t last forever, you’re giving up some extreme gains over a decade. This is how risk averse behavior cuts into returns.

The more aggressive investors who own Omega realize this, which is why they look at both the firm’s FFO and its dividend growth rate like a hawk. Last week, Omega yet again gave investors a penny-per-share raise. At the new payout, FFO covers the dividend pretty well - at a 125% rate. Bear in mind that that’s below the 130% threshold that we frequently write about here, which makes us cautious about the longevity of the rate hikes. We need to see FFO per share slow significantly before that dividend coverage ratio gets hurt and a cut becomes a mathematical necessity.

But how long could that take? Our best guess is that we have at least three years until a cut becomes necessary, but there are two factors that could grossly change that estimate. For one, shares outstanding growth. The more shares Omega releases, the more dividends it has to pay, which makes its FFO less powerful in covering payouts. Total shares outstanding have risen to 197 million from 196 million in the last year - a pretty small jump. But shares were just 68 million a decade ago, meaning an 11% annualized growth rate in total shares outstanding. That brings us to our second factor: FFO - funds from operations. During that same decade, FFO has risen 22% annualized over the same period. So you can see how Omega has been able to grow far beyond its obligations to shareholders and keep that growth rate going!

Can Omega continue? The real answer is no one knows, but there is reason to be concerned. The growth rate has slowed significantly in recent years, especially since Omega was smart to expand during the post-2009 years when all real estate was on sale. Deals are harder to find now, making growth a lot harder.

There’s another lever Omega can pull, though: Getting strong rent hikes. Keep in mind that Omega’s wheelhouse is a customer base that struggles with inflation, which makes rent hikes particularly challenging. For that reason, we think the long term trend of strong growth at Omega is definitely a thing of the past, and the penny-per-quarter hike cannot continue forever. But selling now and missing out on years of high yield dividend growth would be folly. Instead, we need to keep our positions and look closely at the numbers before jumping out. Now is not the time.

Our strongest REIT of the week is in many ways the exact opposite of Omega. Digital Realty Trust (DLR: $122, up 3%) saw a really strong week without too much relevant news. Last week the firm announced it would expand its Silicon Valley Connected Campus, with a new six-megawatt facility planned for 1Q18 delivery. This is a really small part of Digital Realty’s portfolio, comprising just a $75 million investment, so it isn’t enough to move the needle. Also, as counterintuitive as it sounds, Digital Realty’s strength isn’t in the Valley but in its distributed presence around the country. The company has many retail-facing clients, as well as the U.S. government, where the need is to have many hubs where human beings who use the Valley’s services are located.

Digital Realty is on track to grow that business, but the real story of last week’s price movement is more technical than fundamental. The stock has retreated from its 52-week high hit last month ($127), and after this week’s gains is approaching it yet again. The dividend yield is also nearing the sub-3% level, which it hit in September briefly before rising. We fear we may have a repeat of that in the short term - but that’s hardly a cause for concern. It simply means that Digital Realty is for the most part range bound right now, and we need to content ourselves with that while we wait for the company to aggressively ramp up its dividend. The last rate hike was in March, and another one by the end of the year would be nice. In reality, this company’s management has settled itself into a predictable pattern of one-per-year dividend hikes despite a rapid acceleration in FFO growth. FFO per share is now over double payouts - an absurd ratio to say the least! We would like to see Digital Realty aggressively ramp up its dividend hike schedule.

We doubt we’ll see it anytime soon, but we do think it’s an inevitability with this company. Simply put, it cannot stop making money, and its business is growing too rapidly for it to be at risk anytime soon. Eventually, Digital Realty will need to start increasing its dividend more frequently or doing much more aggressive dividend hikes. Either way, its 3% yield at current prices is destined to turn into more of a 5% yield in the next 3-5 years. For that reason, investors long the stock should stay tight even if you’ve been in it for the past year and are sitting on some attractive capital gains.

Good Investing,
Todd Shaver, CEO, Founder and Editor
The Bull Market Report
Since 1998