Financial Research
Signal from Noise
- Signal from Noise
– Our base case is U.S. virus peak in May and SPX bottoms around 2200-2400 – Now market doesn’t care that pandemic growth seems to be slowing in some places – PMs seem to have written off 2020 and look to 2021, but EPS visibility low Source: FSInsight, Bloomberg Having lived through three bad bear markets, I thought I’d seen everything. But the rapid demise of stock prices in this one is nothing short of astounding. These are historic times. There are two things investors are afraid of, both of which remain hard to handicap, the extent of the coronavirus spread and the eventual knock on economic effects. The S&P 500 index is down over 29% since the Feb. 19 high of 3386. What’s been baffling is that there are incipient signs the COVID-19 virus is coming under control in many of the hardest hit places. As I’ve noted before, China, where the virus originated, is already showing lower infection and death rates, as is South Korea. While you won’t see that in the screaming headlines, there are some who think the pandemic will slow. For example, Israeli Nobel Laureate Michael Levitt said recently that “the end of the pandemic is near.” Now increasing talk like that should stabilize the stock market—eventually. However, and this is a big however, there’s been significant damage to the investor psyche—no matter how obvious it becomes that the pandemic is over—and that could go on for a while. That is worrying short term. Investors should look dispassionately at the market, but that is hard to do and at times like these when often sentiment wins out. There’s an old Wall Street saying about bear markets, “When you should be buying, you won’t.” I’m convinced that in the three to five-year time frame this is a buying opportunity, but the fear factor is too high for many to overcome. And that’s understandable. I believe the coronavirus scare, though serious, has been overhyped and that in a few month’s time we will all be wondering why the market took it so badly. That doesn’t mean the broad market will recover and old high of 3386 on the SPX certainly looks a long way off now. Unfortunately, the knock effects—again something I’ve written about previously—have already become a self-fulfilling prophecy in the oil market, where crude prices have plunged to $25 per barrel from over $60 a few months ago, on fears of a glut and lower energy consumption globally. While that might help consumers, it won’t help an already beaten up oil sector or their creditors, or employment levels. That will begin to affect the industries that sell to oil companies and car companies, and so on and so on, until the economy as a whole is hurt. Not to sound callous but stock prices probably reflect a declining profit growth much more than coronavirus itself, even though the latter started the whole thing rolling downhill. The market just wants it all to stop and no one knows when that’s going to happen. There could be a negative wealth effect. People have lost gobs of money in their stock accounts and 401ks. That hurts and could put a damper on consumer activity for a while, particularly if the market doesn’t stabilize. The bears are piling on as for the first time in many years—for most of them—their predictions have come true. The market is desperately trying to estimate what this means for the global and U.S. economic growth, as well as profits. Here again there’s little data that can be said definitive, particularly as the outbreak hasn’t completely finished. The estimates vary widely. Goldman Sachs, the investment bank, for example said Monday that its U.S. GDP growth forecast for the 1H20 was reduced to zero, with a decline of 5.0% for the second quarter. Ian Shepherdson, chief economist at Pantheon Macroeconomics, in a note to clients on Monday night said a 10% drop in possible in 2Q20 after a 2% drop in 1Q20. Ouch. Others, however, don’t see it that bad. For example, The Wall Street Journal recently reported that its monthly economists’ survey expects, on average, gross domestic product to contract to 0.1% in 2Q vs a previous projection of 1.9%. They see growth of 1.2% this year, down from 1.9% Annual growth was 2.3% in 2019. Just for comparison, Bespoke Investment Group says 5% declines are rare. Since 1950, there have only been six prior quarters where GDP declined by 5% or more with the most recent being back in December 2008. Moreover, all those six quarters contractions of 5% or more were either immediately preceded or followed by another quarter of negative growth averaging a decline of over 2%. My colleague Tom Lee has a base case that sees 65% probability of a U.S. peak case rate in May with a 2%-3% hit to 2Q GDP. That suggests an SPX level of 2200-2400, roughly where we are now. Source: FSInsight, Bloomberg It’s difficult to estimate what this means for EPS of the SPX in 2020. It will likely be lower than the $163 last year. But how much lower? Guidance is coming down and that will continue. One silver lining is that smart managements will take the opportunity to kitchen sink any and all corporate problems into 1Q and 2Q EPS, corona related or not. But I’m getting ahead of myself. Given the over 30% drop, it seems to me the market has already discounted a terrible 2020 earnings. History suggests a permanent 30% drop in EPS isn’t rationale. Likely, institution al investors are already looking at 2021 EPS. If COVID-19 continues to be a serious pandemic with a long trajectory then here are some stocks whose businesses I think could outperform in terms of EPS and perhaps their stock prices as well. They run from healthcare to videogames. (See chart nearby.) (The writer currently owns GILD shares.) Where I could be wrong: The coronavirus spread is unpredictable and its mortality rate could worsen appreciably. It could take much longer than expected to be contained. Bottom Line: The stock market has taken a hammer blow and it will stabilize when coronavirus cases peak and when we have a clearer idea of 2020-21 SPX EPS. Prior “Signals” Date Topic Subject / Ticker The Signal 3/11/20 Market COVID-19 COVID-19 Worry Overblown; Market Discounts Recession 3/4/20 Stock iHeartMedia (IHRT) iHeartMedia Stock Could Rise on Cost Cuts, Digital Revenue 2/26/20 Market South Korean Stock Market When Virus Fears Ease, Hard Hit Korean Stocks Look Cheap 2/19/20 Q&A Atlantic Investment Management Atlantic’s Concentrated Approach Yields Strong Returns 2/12/20 Stock Casper Sleep (CSPR) Casper Stock Might Not Let You Get a Whole Lot of Sleep 2/5/20 Stock Arch Coal (ARCH) After Sentiment Plunge, Arch Coal Stock Looks Inexpensive 1/29/20 Sector Healthcare Healthcare Looks Inexpensive; Some Healthy ETFs to Play 1/22/20 Stock Spirit Airlines (SAVE) Why Spirit Airlines Shares Could Take Off in 2020 1/15/20 Market 4Q19 EPS Season Market to Focus on SPX EPS Growth after 4Q19 EPS Season 1/8/20 Stock Alibaba (BABA), Tencent (700 HK) Alibaba, Tencent Look Attractive on Strong Growth Potential 1/2/20 Stock 2019 Report Card Signal From Noise 2019 Picks: 74% Win Rate, Beat SPX 12/26/19 Market Stock Market 2020 2020 Could Be the Year “Animal Spirits” Return to Equities 12/18/19 Stock Ulta Beauty (ULTA) Ulta Beauty Shares Whacked 35%; Stock Looks Cheap 12/11/19 Market UK Stock Market Conservative Election Win Should Boost Lagging UK Stocks 12/4/19 Stock Capri Holdings (CPRI) Capri Holdings Recovery, Makeover Could Send Stock Higher 11/27/19 Style Value When a Value Stock Is a Value Trap
- Signal from Noise
Report Card: Signal From Noise '19 Picks: 74% Win Rate, Beat SPX
– SFN picks average return 11% from publication date, beat SPX by 30 bps – Winners: TGT +46%; WW +67%; CAT and OSK + over 20%; ARCO +27%; SKX +21% – Losing stocks include BYND, ZS, EYPT, GWPH. Bull market helps The turn of the new year is report card time for those of us foolish (brave?) enough to handicap the market and stocks. I won’t keep you waiting: the average return of our calls since the relevant publication date is 11%. Outperformance versus the SPX, again from date of publication, is 30 bps. Since the end of May SFN made 24 calls of which 19 are evaluated. The win rate is 74%. It’s too early to tell on the remaining five calls. Signal from Noise (SFN) and use data, history, fundamental and technical analysis and common sense to publish a view of which stocks might—or might not—do well and why, over the intermediate term. I try to incorporate the known risk factors. Gains are what we want, but preservation of capital is just as important. SFN inaugurated May 31 last year, and if I might be allowed to say, it was a good year for SFN. I list the specific picks made into three buckets: Winners, Losers and Too Early to Tell. I will focus on those that did spectacularly well—or badly—and leave the middling returns for readers to see in the table below. Not every single SFN column has been evaluated numerically as some, like “Low Rates Could Spur M&A Surge,” Aug. 14, are not directly amenable to a return calculation. Even so, according to a recent article in The Wall Street Journal, the value of U.S. deals rose 12% to $1.8 trillion in 2019. Let’s say it here, up front: Yes, a strong bull market in the second half of 2019 aided my picks, for obvious reasons. But, hey, I also wrote that 2H19 would be better than the first: “After a Strong 1H ’19, Potential Is For More Gains in 2H,” June 26. Since then the SPX is up 10.6%. My picks went across many different industries. (Returns priced from publication date to close on Dec. 30.) Winners: Thinking about both return and the bigger picture, our positive call on Target (TGT) was gratifying, not only because the stock is up 46% since then but because I like to point out that Target gets it. The management and culture at this “bricks and mortar” store is successfully battling Amazon (AMZN) and the online threat. It is an online threat itself. The cloud software picks outperformed (June 5), with an average rise of 31% for four of the five stocks that went up but one stock fell 36%. (See nearby table.) I repeat: software is eating the world and those companies in the cloud computing sector, though still richly-valued, are growing like weeds. Cloud investments will be very important for the corporate world. WW International (WW), formerly known as Weight Watchers, was actually a very typical pick with an atypical rebound, up 67%. I like finding stocks where Mr. Market concludes that a near-term problem is fatal. I look out a year or two. But Mr. Market can get overemotional in the short term and knee cap a stock far beyond what the problem portends. The market regularly throws out the baby with the bathwater. In the case of WW it was, among other things, the latest diet craze, ketogenic, that did the shares in. But that’s exactly what it was: a fad. Meanwhile, WW has been around a long time and offers a proven weight loss program. Turns out the entire world isn’t moving to keto. Similar, the call on both Caterpillar (CAT), up 22%, and Oshkosh, (OSK), up 24%, both heavy industry companies, was straightforward. As a firm, we believe that a recession in 2020 is unlikely and that the battering such stocks took in 2019 would turn out to be a buying opportunity when our view won out. Moving on to a completely different animal: Arcos Dorados, (ARCO) the biggest McDonald’s franchisor in the world, was up 27% since publication. It’s a turnaround story and I pointed out there are budding signs of improvement. Mr. Market now believes us. It was an interesting year for IPOs, especially the one that didn’t happen: We Work. SFN was negative on it, but perhaps not negative enough. Nevertheless, it affected IPO pricing. I was and remain positive on Peloton (PTON) for the next few quarters but the stock is down a bit. My report that suggested UK stocks would run hot if the Tories won the Dec. 12 election was a simple matter. The Conservatives had the lead and it was logical that a market friendly party would help British stocks more than the Stalinists in the U.K. Labor Party. Still, elections are funny things and it could have been a surprise, as Brexit itself was. Losers: The Beyond Meat (BYND) IPO was interesting for several reasons. The company is the first of its kind to go public and true comps were not available. SFN said basically not to short the shares at $98, as it was too much of a story stock. Technically, the stock is down 29% since our report’s publication, so I was wrong. However, in between those periods the stock went from $98 to $240 eventually before falling back to $78, so if you did short it you would have enormous paper losses at one point. I’m guessing that you might have thrown in the towel. It was better just to leave it alone. I didn’t do well in the healthcare sector. Shares of Eyepoint (EYPT) fell 38%. EYPT missed third quarter numbers and investors are worried about bond covenants. However, I still think EYPT will prove a winner. GW Pharmaceuticals (GWPH) keeps getting buffeted by unrelated bad marijuana news but as I pointed out in the report, GWPH is at a big remove from that market. I still think the stock goes up longer term. To Early To Tell: This concerns November and December reports, as generally there hasn’t been enough time passing for these ideas to play out. Let’s check back later this year. I also point out that is a team effort, with input by Tom Lee, head of research, and by Robert Sluymer, our technical analyst. Bottom Line: SFN’s picks did well and in the inherently self-interested act of grading our own picks, I give SFN an A-. Feel free to write in your own views to me at vito. racanelli@fsinsight. com. Prior “Signals” Date Topic Subject / Ticker The Signal 12/26/19 Market Stock Market 2020 2020 Could Be the Year “Animal Spirits” Return to Equities 12/18/19 Stock Ulta Beauty (ULTA) Ulta Beauty Shares Whacked 35%; Stock Looks Cheap 12/11/19 Market UK Stock Market Conservative Election Win Should Boost Lagging UK Stocks 12/4/19 Stock Capri Holdings (CPRI) Capri Holdings Recovery, Makeover Could Send Stock Higher 11/27/19 Style Value When a Value Stock Is a Value Trap 11/20/19 Stock Aaron’s (AAN) Roughed Up Aaron’s (AAN) Stock Looks Undervalued 11/13/19 Stock Bed Bath & Beyond (BBBY) Bed Bath & Beyond Fixable; More Best Buy Than Blockbuster 10/30/19 Stock GH Pharmaceuticals (GWPH) Undeservedly Caught Up in the Volatile Marijuana Stock Fad 10/23/19 Stock Sherwin Williams (SHW) Sherwin Williams Paints a Pretty Profile 10/16/19 Stock Eyepoint (EYPT), Sonova (SONVY) Both cater to the increasing vision, hearing needs of seniors 10/9/19 Stock Skechers U.S.A (SKX) Volatile Skechers stock could be ready to roll higher 10/2/19 Stock Arcos Dorados (ARCO) Arcos Dorados Shares Undervalued; Turnaround In Sight 9/25/19 Stock Peloton (PTON) Peloton IPO Offers Growth, Scarcity Value—For Now 9/18/19 Stock Oshkosh (OSK) For investors with a long term horizon, OSK looks cheap. 9/5/19 Market BBB bond mkt implosion overdone Don’t sweat the BBB market so long as market chugs along
- Signal from Noise
Despite Gyrating Markets, This Manager Returned 40% in 2019
Signal from Noise Question & Answer articles are published occasionally as we run across investment themes and stock ideas relevant to subscribers. It’s our intention to familiarize you, if briefly, with the views of successful investment managers or analysts, some you might have read about, but, more importantly perhaps, some you might not have. This week’s Q&A was conducted recently with Marshall Kaplan, Senior Vice President at Ingalls & Snyder, an NYC-based investment advisor and broker dealer with $4 billion in AUM. He has 39 years of investment industry experience and leads the Fundamental Equity Advisors (FEA), an investment management team formed in October 2010 at Morgan Stanley. FEA joined Ingalls & Snyder in 2018. Marshall joined Smith Barney in 1983 as a Portfolio Analyst, where he created and managed that firm’s Equity High Net Worth and Portfolio Management programs and served on its Global Investment Committee and Global Portfolio Committee. Please describe briefly the history of FEA. The Ingalls & Snyder (FEA) team consists of lead portfolio manager Marshall Kaplan, Rochelle Wagenheim and Michael Nelson. Prior to our tenure at Morgan Stanley, FEA managed model portfolios at Citigroup from 2002 through September 2010. What has been your performance this year vs. peers and the market? For 2019 the Ingalls & Snyder Fundamental Equity Advisors All-Cap portfolio was up 40.47% gross of fees, +38.75% net, versus the Russell 3000’s return of 31.02%. The Ingalls & Snyder FEA SMID Core portfolio increased by 36.82% gross of fees, +35.24% net, versus the Russell 2500’s return of 27.77%. Through 3Q 2020, the All-Cap strategy has gained 5.96% gross of fees, +5.0% net, versus 5.41% for the benchmark. The weak performance of Small/Mid-Cap stocks has caused our SMID strategy to decline by 6.54% gross of fees, -7.37% net, versus a drop of 5.82% for the benchmark. Over the last three years, gross of fees, our All-Cap strategy is up 11.24%, +10% net, and our SMID strategy has advanced by 5.79%, +4.6% net, on an annualized basis. Smaller capitalization issues have underperformed their larger cap brethren over this period. What are the main contributors to that 2019 performance? In recent years, particularly in 2019, we’ve had success in the Information Technology and Healthcare sectors. For example, in Healthcare, critically important products and services offered by life science and diagnostic companies have recorded impressive organic growth. In the IT sector, we’ve had strong interest and success in the Payments & Processing space. Software and service companies also had stellar performance last year. From time to time, we discover “special situations” that meet our investment criteria, and last year a manufacturer/seller of mechanical and electronic security products and solutions helped our performance. Describe briefly the fund’s investment stock picking thesis? We use a bottom-up fundamental approach focusing on risk management and capital preservation. We seek to identify undervalued equities by focusing on companies possessing strong or positively inflecting free cash flow, attractive valuations, changing internal dynamics, potential for expanding profit margins, market share growth opportunities, and strong management. We analyze a company’s financial flexibility, earnings quality, valuation, business model and competitive position. Broader industry trends, relative growth, and investor sentiment are also evaluated. We utilize an independent forensic accounting firm to evaluate a company’s earnings quality and validate the team’s internal analysis. Each FEA team member brings unique industry experience and skills to the process, while leveraging a common, time-tested approach to investing. We’re all generalists, and potential investments are analyzed by all team members. Our team is unconstrained by style boxes and ideas may come from a variety of resources including industry conferences, contacts, proprietary screens, Street research, management calls, etc. Investor sentiment also plays an important role in our overall process. How does this method distinguish itself from conventional methods? Marshall Kaplan We employ a multi-faceted approach to managing risk. Our intense focus on risk management utilizes a premier independent forensic accounting firm as well as the use of a partial-position strategy. This sets us apart from other managers. In addition, the close monitoring of individual securities and sectors (and weightings), and liquidity management all help support our goal of creating an “all-weather” portfolio. Each member of the team is personally invested in our strategies, ensuring that we are aligned with our clients’ interests How about a few stock picks? Vertiv Holdings (VRT) is a structural winner, we think. It is a global leader in design, manufacturing, and servicing of critical digital infrastructure that cools and maintains electronics that process, store, and transmit data. We view Vertiv as a mission-critical partner to data centers, communication networks, and commercial & industrial companies worldwide. Our outlook is driven by the secular uptrend in global data usage, a sticky customer base (switching costs are high) and material margin expansion potential. We like the company’s recurring revenue stream, more than 60% of sales, and strong management team. At approximately 15x consensus estimates of $1.15 a share for 2021, the shares trade at a modest P/E to Growth (PEG) ratio of 0.34. Evercore Inc. (EVR) has been a core holding for several years. The company is an independent investment bank with 80% of revenue from Merger & Acquisitions advisory fees and the remainder from Investment Management. We believe the stock will benefit from stronger M&A activity next year, driven by economic recovery and strong demand for restructuring activity. We view the shares as attractively valued, and the recent dividend hike gives us increased conviction that business trends are poised to improve. The shares trade at only 11x consensus 2021 EPS estimates of $7.23. Teleflex (TFX) is another core holding for us. The company develops, manufactures, and supplies single-use medical devices. Teleflex has consistently delivered impressive organic growth, maintains strong cost controls, and has a healthy balance sheet. Management has a strong track record of making accretive acquisitions while also divesting lower growth businesses, driving a favorable mix shift in margins. We believe growth prospects for the company’s Urolift and Vascular Solutions businesses remain compelling and expect upside to current estimates. In our view, Teleflex represents an attractive candidate for a larger medtech company. With forecast growth of 22% and 17%, respectively, for 2021 and 2022, the shares trade at 24.7x consensus 2021 estimates, a slight discount to its historical median. Disclosure: Any FEA opinions expressed in this material are only current opinions and while the information contained is believed to be reliable there is no representation that it is accurate or complete. Members of FEA own shares of the companies specifically mentioned in this material. Gross returns do not reflect the deduction of any expenses. Net returns reflect returns after deduction of expenses such as charges for transaction costs, investment management/advisory fees, custody and applicable administrative expenses or wrap fees that may incorporate such expenses.
- Signal from Noise
Playing the Seniors Cohort: EyePoint, Sonova Look Tempting
– EYPT, SONVY cater to the increasing vision, hearing needs of seniors, a growing cohort – EYPT in wide open, fast growing mkts, offers advanced post-cataract surgery products – SONVY: the big kahuna in hearing aids, boasts advanced sound filtering technology If you’re one of those investors who watches the news 24/7, hoping to stay ahead of the next Trump tweet, stop here. Read further if you’re interested in a couple of stocks that have the potential to rise independently of what President Trump tweets, a trade deal, or even the direction of interest rates. We’re going to talk fundamentals here, no national emotions or global politics. Long-lived investment themes are a good place to start looking for stocks, and one that’s been written about in these pages before is how to play the Millennial generation. Let’s go to the other end of the population curve: seniors. They too have lots of needs, and it’s a growing population cohort globally. According to a 2019 UN Population Division report, the number of persons aged 65 years or older is projected to double to 1.5 billion by 2050 from 703 million now. The share of seniors globally rose to 9% today from 6% in 1990. That’s projected to rise to 16% by 2050, or 1/6 from 1/11. Virtually all countries will participate in this rise. Supplying seniors is a trend of the same quality as cyber security, a relentless need, argues Peter Andersen, the founder of Andersen Capital Management. As folks around the world live longer, this will create demand for more medical devices, particularly vision and hearing aids. These are products and services that are relatively inelastic and not dependent on economic conditions. From a health care perspective, eyesight and hearing are low lying fruit, he says. Let’s consider vision. Unfortunately, many of you reading this will develop cataracts. Some 50% of folks over 80 will develop this vision problem, and surgery is the only way to remove them. Annually, roughly 5 million Americans undergo this surgery, making it the most common in the U.S. Worldwide, there are about 10 million performed. Eyepoint (EYPT) is a small cap company specializing in sustained-release drug delivery to treat various eye diseases and chronic conditions, and has 6 FDA approvals for such treatments, such as post cataract surgery care (DEXYCU, dexamethasone intraocular suspension 9%), among others. For example, EYPT’s products replace the patients’ need for 100 eye drops to a single, tiny time-release implant administered during the surgery, to prevent post-surgical inflammation and other complications. This same technology is used to administer therapies for various sight-threatening eye diseases. EYPT’s patents don’t expire until 2034, giving the company plenty of time to capture a large market share. Shares of mega-cap pharma healthcare companies continually move on “patent cliff” worries. Andersen estimates that every 1% market share in U.S. cataract surgery market bolsters annual revenue $30 million and every 1% capture in the eye disease market adds another $8 million to the EYPT top line. Given its latest 12-month revenue was $12 million, a 1% market gain in both segments would triple revenue. And, trade wars and impeachment have little or no impact on EYPT’s fundamentals. Strong growth is possible, says Andersen. Let’s consider hearing: More than 50% of people over 75 years old—now 16 million people in the U.S.—will develop disabling hearing loss. The hearing aids market is an obvious opportunity. Sonova Holding (ADR: SONVY, $45) “is a pure play on hearing in the age of Alexa,” and technologically it’s way ahead, Andersen says. One of the largest manufacturers and distributors of hearing aids, the Swiss-based firm distributes its product in more than 90 countries and also sells cochlear implants. The other big competitor is Demant (ADR: WILYY), a Danish company whose shares are controlled by a charitable trust. Each has roughly 20% of the world hearing aid market. SONVY focuses on higher end devices, with strong sales and distribution channels. It trades at a price/earnings (P/E) of about 26 times 2020 estimated EPS, a fair valuation given the potential long term. It’s not apples to apples, but when Hershey’s trades at 27 P/E for about 2% sales growth, the choice seems stark. Demant, which grows similarly but isn’t a pure play, is smaller and majority controlled by a trust, trades at 20 times. In the financial year ended March 31, 2019, Sonova’s second-half results showed material sequential improvement, largely due to a successful launch of its Marvel platform, according to a Morningstar report. Sonova benefits from an aging population, increasing noise pollution, fairly low penetration rates for hearing aids in the developed world, and “virtually untapped” patient populations in emerging markets, the report said. Its broad product offerings should allow the company to capitalize on these trends, while its strong brand and superior technological know-how should yield market share gains, Morningstar wrote. Where could I be wrong: EYPT is a small ($235 million market cap) and still unprofitable company that isn’t widely followed on Wall Street and faces bigger competition in some product areas. It has a limited history and relatively new products. As a $2.44 stock, many institutions can’t own it and it can be volatile. The much bigger Sonova, $14.5 billion market cap, faces lots of well-armed rivals and has to spend significantly on R&D to keep up. The competition is heating up at the bottom end of the device market. Bottom Line: Both EYPT and SONVY offer strong long-term growth potential thanks to favorable demographic tailwinds. I believe the shares, much less affected by the volatile macro concerns that seem to dominate equity markets in 2019, could give significantly better than market returns over the next few years. Prior “Signals” Date Topic Subject / Ticker The Signal 10/9/19 Stock Skechers U.S.A (SKX) Volatile Skechers stock could be ready to roll higher 10/2/19 Stock Arcos Dorados (ARCO) Arcos Dorados Shares Undervalued; Turnaround In Sight 9/25/19 Stock Peloton (PTON) Peloton IPO Offers Growth, Scarcity Value—For Now 9/18/19 Stock Oshkosh (OSK) For investors with a long term horizon, OSK looks cheap. 9/5/19 Market BBB bond market implosion overdone Don’t sweat the BBB market so long as market chugs along 8/29/19 Industry Soybean/Tariff Impact on Trump 2020 If tariff wars continue, auto – not farm – states could hurt Trump 8/21/19 Stock We Co. (WE) Fast growing company but poor governance 8/14/19 Market M&A to Accelerate? Ultra-low rates could spur accelerated M&A 8/7/19 Stock Caterpillar (CAT) Cyclical stock could benefit from recovering growth 7/24/19 Stock Mowi (MHGVY) Salmon fish farmer could benefit from BYND trends 7/17/19 Market Earnings Recession Look Through the EPS Recession to 2020 EPS 7/10/19 Stock Weight Watcher (WW) Battered Weight Watchers Stock Looks Cheap 7/3/19 Industry Why SaaS Isn’t Cheap SaaS stocks improved models create value 6/26/19 Market 2H Mkt Gains After Strong 1H19, Potential for More Gains 6/19/19 Market What’s Worth Knowing Don’t Heed the Bearish Market Herd 6/12/19 Stock Target Corp (TGT) Bricks and Mortar TGT Thriving in E-Commerce
- Signal from Noise
Other Voices: Why Reading 10K Filings Is Crucial; Part 3
(This report is part of our occasional Other Voices format, as we run across interesting investment ideas or practices from outside our firm. Today’s piece is written by David Zion, founder of the Zion Research Group, an independent research firm focused on accounting and tax issues, and his colleagues Ravi Gomatam and Ben Wechter. This report is excerpted in part from Zion’s annual 10-K Checklist, which includes tricks of the trade, potential red flags, questions to ask and common-sense tips to help you navigate the 10-K filings.) They aren’t fun to read, but SEC documents are crucial to a complete understanding of the company whose shares you are considering. Buying a stock without reading the 10-K is like driving to an unknown destination without a map. You can do it, but it’s better with navigation. Zion Research Group is expert at deciphering corporate SEC filings. To help you navigate this thicket, we are running excerpts from Zion’s reports about 10-Ks. This is the third of three. Footnotes Financial statements are a good place to start your analysis, but you need to dig deeper to make sense out of them and that's where the footnotes come in to provide more context and detail. Remember that when you are going through the footnotes, keep asking yourself if the company's disclosures are clear and in plain English or are they confusing and complex. If a company wants a premium valuation, it needs to provide you with premium disclosures. The following is what to look for. Significant Accounting Policies: We’ve started year three of the “Three Great Years of Accounting Changes”. Revenue recognition (2018), leases and hedge accounting (2019), followed by credit losses (2020). As companies get closer to applying a new rule, they should provide better info (i.e., SAB 74 disclosures) about the potential impact. In our view, the biggest impact of an accounting rule change is the potential changes in behavior it can spark. Investors may gain some new insight about the risks, growth and claims on future cash flow, which could change how they view the underlying economics of the business and how they value the company. Corporates might do things differently, too. Watch out for changes in accounting policy... Of course, companies may change how they account for things even when not forced to by the FASB. Pay extra close attention to these types of changes: did the company get more/less aggressive, did they pull closer/farther away from their peers, will their results more/less closely track the underlying economics? Red Flag: Not understanding a footnote after reading it three times. Instead of ignoring accounting rule changes, we’d suggest asking yourself eight questions, The Ocho. (See below.) 1. Does the new rule better reflect the underlying economics? Does that affect how you view the business? 2. What adjustments (if any) do you need to make to your model? Are you looking at minor tweaks or a major rebuild? 3. Were you already factoring this issue into your analysis (e.g., leases)? Does the new rule change your approach? 4. Will non-GAAP numbers change as a result? Will the Street look at the company any differently? 5. Do you need to fix your quant screen so that it’s not sending misleading signals? 6. Does the change make it easier/harder to compare companies both within the U.S and around the world? 7. What changes in corporate behavior do you expect because of the new rule (are those good business decisions or just meant to paint a prettier picture)? Will that change the underlying economics of the business? 8. Are the debt covenants based on frozen GAAP or floating GAAP? If a change in GAAP sparks a covenant default (possible under floating GAAP), would it create an event of default or does it require the covenant to be renegotiated? Below is an abbreviated list of potential footnote items that Zion Research Group recommends that investors study closely. Space doesn’t allow us to list them in their entirety, but readers can get the full picture at Tax Are today’s low tax rates sustainable? Probably not. How to value NOLs. Post TCJA, the net operating loss (NOL) related tax shield is less valuable due to the lower tax rate. How does the company make money? You need to determine if the revenue recognition pattern matches up with how the company does business with its customers. Questionable Judgement Calls: New revenue recognition rules provide plenty of room for management judgment which could be used to manage earnings. Do those judgments match the economics of the business?. Financial Instruments When stock prices fall, there’s some accounting consequences. For example, changes in the fair value of equity securities (typically less than 20% stakes) now run through earnings. Foreign Currency FX risk, FX hedging, FX accounting are all complex. Focus on two things (1) impact of FX on business fundamentals and (2) impact of FX on the value of the business. Leases Most leases are now on balance sheet but they might present surprises. Pensions/OPEB When analyzing pensions, take three steps: (1) Health (2) Cost and (3) Risk. M&A There are lots of games companies can play with purchase accounting. For example, watch out for large chunks of purchase price allocated to goodwill, is that what they are buying or an attempt to make the transaction appear more accretive. Derivatives & Hedging Hedging costs are worth keeping an eye on. Stock Comp Make sure you capture two things in your analysis: (1) options and restricted stock are a claim and (2) future grants are a cost of doing business. Don’t ignore the stock comp cost, especially when management tells you to. Shareholder's Equity Buying back stock to offset earnings dilution is not always a great idea. In theory, companies should buy back stock when it's cheap, but in reality, they tend to buy back the most shares when stock prices are at their highs. EPS There are a few different share counts. If you are looking for the shares outstanding, check the front page of the 10-K. Keep in mind that's not the same as the basic share count, which is the weighted average of the shares outstanding for a period (quarter, year). The company will provide a table that takes you from basic to diluted shares. Inventory Companies don't disclose too much about inventory nowadays. We'd suggest monitoring the components (raw materials, work-in-process, finished goods). For example, rising finished goods might signal an expected increase in demand or the company is stuck with inventory it can’t sell. PP&E Don't ignore impairment charges. Sure, there's no impact on current period cash flows, but it does reflect management's expectations for lower future cash flows (does that change your expectations?). Prior “Signals” DateTopicSubject / TickerThe Signal8/19/20Stock10-K Filings Part 2Other Voices: Why Reading 10-K Filings Is Crucial; Part 28/6/20StockTruist Financial (TFC)Never Heard of Truist? This Bank Stock Could Rise Up to 30%7/29/20StockWeight Watchers (WW)Weight Watchers Can Continue to Outperform Post COVID-197/22/20StockXilinx (XLNX)If EPS Rises to Pre-Covid-19 Level, XLNX Could See Old Highs7/15/20StockMarket ConcentrationNarrow Mkt Rally Fuels Worry; We Expect Cyclicals To Join7/8/20StockSEC FilingsOther Voices: Why Reading 10-K Filings Is Crucial; Part 17/1/20StockSimply Good Foods (SMPL)Post-COVID-19, Simply Good Foods Stock Looks Appetizing6/24/20StockLam Research, Applied MaterialsLam Research, Applied Materials Set to Reap IoT Harvest6/17/20StockNordic Semiconductor (Nod. NO)Continued IoT Growth Good News for Nordic Semiconductor6/10/20StockHelmerich & Payne (HP)Helmerich & Payne Stock Could Energize Your Portfolio6/3/20OptionsVan Hulzen Asset ManagementFor Income Seekers, Why Covered Calls Top Junk Bond ETFs5/27/20StockJP Morgan Chase (JPM)Why JPMorgan Chase Belongs in Portfolios Post-COVID-195/20/20StockHorizon (HZNP)Horizon Therapeutics Is Inexpensive; 2 Drugs Show Promise5/13/20StockBank OZK (OZK)‘Plain Vanilla’ Bank OZK Could Be Long Term Opportunity Disclosures This research is for the clients of FS Insight only. For additional information, please contact your sales representative or FS Insight at /. Conflicts of Interest This research contains the views, opinions and recommendations of FS Insight. At the time of publication of this report, FS Insight does not know of, or have reason to know of any material conflicts of interest. General Disclosures FS Insight is an independent research company and is not a registered investment advisor and is not acting as a broker dealer under any federal or state securities laws. FS Insight is a member of IRC Securities’ Research Prime Services Platform. IRC Securities is a FINRA registered broker-dealer that is focused on supporting the independent research industry. Certain personnel of FS Insight (i.e. Research Analysts) are registered representatives of IRC Securities, a FINRA member firm registered as a broker-dealer with the Securities and Exchange Commission and certain state securities regulators. As registered representatives and independent contractors of IRC Securities, such personnel may receive commissions paid to or shared with IRC Securities for transactions placed by FS Insight clients directly with IRC Securities or with securities firms that may share commissions with IRC Securities in accordance with applicable SEC and FINRA requirements. 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Information has been obtained from sources believed to be reliable, but FS Insight does not warrant its completeness or accuracy except with respect to any disclosures relative to FS Insight and the analyst's involvement (if any) with any of the subject companies of the research. All pricing is as of the market close for the securities discussed, unless otherwise stated. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and recommendations herein do not take into account individual client circumstances, risk tolerance, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies. 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- Signal from Noise
Other Voices: Why Reading 10-K Filings Is Crucial; Part 2
(This report is part of our occasional Other Voices format, as we run across interesting investment ideas or practices from outside our firm. Today’s piece is written by David Zion, founder of the Zion Research Group, an independent research firm focused on accounting and tax issues, and his colleagues Ravi Gomatam and Ben Wechter. It is excerpted from Zion’s annual 10-K Checklist, which includes tricks of the trade, potential red flags, questions to ask and common-sense tips to help you navigate the 10-K filings.) Few investors other than Warren Buffett, perhaps, enjoy reading SEC documents, but they are crucial to a complete understanding of the company whose shares you are considering. Buying a stock without reading the 10-K is like driving to an unknown destination without a map. You can do it, but it’s better with navigation. Zion Research Group is expert at deciphering corporate SEC filings. To help you navigate this thicket, we are running excerpts from Zion’s reports about 10-Ks. This is the second of three. Financial Statement Analysis, Just Do It. When the team at Zion Research Group are doing a Deep Dive on a company, they'll read the 10-K from start to finish. If you want to narrow your focus, old fashioned financial statement analysis is a good place to start (e.g., common size financial statements, free cash conversion, working capital trends, etc.). Zion uses a variety of tools to evaluate earnings quality. But they always start with their Red Flag Finder. Give them a shout if you’d like to see it for your portfolio or coverage universe. Look for changes in financial statements (out with the bad in with the good). Did a line item suddenly appear or disappear? Keep an eye out for reclassifications. Are bad things getting shifted out of the line items that the Street pays attention to while good things are getting shifted in? Name that auditor. A change in auditor is a potential red flag, especially if the company is just shopping around for a better audit opinion. Remember, auditors now file Form AP (Auditor Reporting of Certain Audit Participants) with the Public Company Accounting Oversight Board (PCAOB). The form discloses the name of the engagement partner for audit reports of public companies and information about other firms that helped-out on the audit. So, the next time you see a company run into some accounting trouble, find out who signed that audit report. He/she may have also done work on the audit of a company in your portfolio. Critical audit matters (CAM) will make their debut for most large accelerated filers in the 2019 10-K’s. As discussed in their September 6, 2019 blog post, Critical Audit Matters: CAMtastic Stuff Coming Soon to an Audit Report Near You, CAMs are matters communicated to the audit committee that “relate to accounts or disclosures that are material to the financial statements and involve especially challenging, subjective or complex audit judgment.” Zion suggests comparing CAMs to the company’s disclosures (e.g., critical accounting estimate); differences could be red flags. Balance Sheet Looking for a high-quality balance sheet. In Zion’s view, a high-quality balance sheet is when the assets and liabilities are fairly stated, the company has enough liquidity, manageable asset/liability mismatches, a straightforward capital structure and not too much leverage. Simple ratios like the current ratio (current assets / current liabilities) and debt to equity are a good start. ✓ Asset/liability mismatches can be a problem. Zion suggests monitoring them especially when no one else is. For example, short-duration liabilities funding long duration assets may not cause too many problems during a normal economic environment but come crisis time, they could be crippling (if you know about a mismatch beforehand, you can be nimble and act accordingly before crisis strikes). Quant alert: Growing liabilities (debt). The new lease rules resulted in balance sheet growth in 2019, as both assets (right to use leased asset) and liabilities (lease obligation) landed on balance sheet. A bit further down the road (in 2022), the FASB’s project to “simplify” accounting for converts will increase the amount of debt on the balance sheet and reduce interest expense (bringing it closer to cash interest but further from economic cost); see Accounting Ch-Ch-Changes. Income Statement Earnings quality is key. High quality earnings are sustainable and generated by the core business (low quality are not). Look out for disconnects, like earnings growing faster than cash flows, receivables growing faster than sales, gross margins falling but operating margins are growing, earnings not being converted into cash, etc. ✓ Higher quality = higher multiple. Is the market paying more/less for the earnings stream relative to peers, does that reflect higher/lower quality earnings? If you adjust earnings to better reflect economic reality (e.g., strip out the impact of more aggressive accounting), what type of multiple does the stock price imply? Does the stock still look cheap? Cash Flow Statement Focus on cash flow quality. Are the cash flows driven by recurring operating activities core to the underlying business or is it non-operating, non-recurring stuff? For example, is the cash flow growth coming from selling more widgets or is the company just putting off paying its bills or has it stepped up receivable sales (there's only so long that can last)? ✓ Sources and uses of cash. Zion would prefer that companies provide direct method cash flow statements where you would see sources and uses of cash by different types of business activity. That might provide a better view of whether or not the cash flows are being generated by those areas where the company has a competitive advantage. While you’re waiting for a direct method cash flow statement (don’t hold your breath), you need to do some work to get at the real operating cash inflows and outflows (e.g., strip out financing and tax related items that currently show up in cash flow from operations). ✓ Will the real free cash flow please stand up? What's the real free cash flow after adjusting for stock comp related buybacks and acquisition spend? What appears to be strong free cash flow on the surface may look quite a bit weaker after making a few adjustments. Statement of Changes in Shareholder's Equity It’s the forgotten financial statement. Use it to track changes in the underlying components of equity (i.e., book value), like additional paid in capital, retained earnings, treasury stock, accumulated other comprehensive income (AOCI), etc. ✓ But look elsewhere. If you want more information on share buybacks, check out Item 5 (Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities) under Part II of the 10-K.
- Signal from Noise
Norway's Mowi Could Profit From Beyond Meat Trends
-Trend away from meat products should help benefit Mowi’s big salmon business -Salmon demand growing 7% but supply only 3% -Stock could rise 40% or more One of the biggest surprises in the U.S. stock market this year was the IPO for Beyond Meat (BYND), which I wrote about on this website May 30th. From the IPO price of $25 that stock has soared to over $200 per share, confounding skeptics and burning shorts. BYND is a pure play on the idea that consumers, particularly young ones, are moving to a diet that is low on or avoids meat products. The reasons usually are environmental or health-based. I doubt there will be another BYND-like jump for any stock in that space as the secret is out. But what about adjoining spaces? For example, the trends supporting the craze for BYND products don’t necessarily stop at meat, as I’ll explain below. Another company that could exploit some of those trends—albeit at a different level—is Mowi ASA, a Norwegian seafood processor and fish farming company. This stock, which admittedly has done pretty well in the past five years—up 150% in local currency terms—could do well in the next few years if trends away from meat are sustainable. Mowi (MOWI NO) trades on the Oslo Exchange and as an OTC ADR (MHGVY) in the US, which is 1:1 with the ordinary shares. Norway supplies roughly 50% of the world’s salmon meat and Mowi provides about half of that, so it’s a dominant provider inside the dominant country. The other big country is Chile, with roughly 30%. With a $13 billion market cap, Mowi is global and no small fry. From an anecdotal basis, in the past five years there are an increasing number of vegetarian restaurants opening, while supermarkets have upped their offerings of alternatives to meat, BYND being just the most recognized. Depending on which survey you consult, some 5% of Americans are vegetarians, that is, non-meat eaters. It’s probably a higher percentage outside North America. The trend toward avoiding red meat—epitomized starkly by BYND—is there, particularly among younger demographics. It will probably continue to grow. According to MOWI, food consumption habits are changing: 36% of consumers want to reduce their meat consumption and 32% want to increase their fish consumption. So what’s good about salmon? Well it’s high in Omega 3, a fatty acid essential to good health and the highest concentrations in fish can be found in salmon. Moreover, from an ESG point of view, salmon farm fishing has about 10% the carbon footprint of meat production, and supplies about 3-5 times the edible meat relative to a kilogram of feed. So there’s that. There are significant barriers to entry. Salmon farming can only be done in a few places, such as the waters of Norway, Chile and Nova Scotia, and supply is key, says Frederick A. Brimberg, a savvy investor and award-winning portfolio manager. He’s a fan and notes that demand is growing about 7% but supply—thanks to the peculiarities of fish farming and regulations—is growing mostly at 3%, so there’s a natural boost to results there. The Mowi analyst community, most of whom are in Europe, isn’t especially enthusiastic, with just 40% bullish, a good contrarian sign. Even after a big run, the stock looks cheap compared to other slower growing packaged food companies, which are typically awarded price earnings ratios of 20 times, and higher in some cases. Granted, MOWI is smaller but it’s growing earnings per share faster at 10% or higher with a ROE of 22%, notes Brimberg. MOWI’s P/E is less than 14 times 2022 projected EPS of 1.87 euros. (It reports in euros but the stock is priced in Norwegin krone.) Moreover, like BYND, Mowi is a unique global company, where public market comparables are few on the ground. Given the potential growth and possibility of expanded P/E towards the group level, the stock could reach over 300 krone (NOK) from 221 currently (EUR/NOK at 9.6). MOWI has growth plans: With processing facilities in 24 countries around the world, Mowi is also working on branding its salmon, which should help protect margins in cases of lower consumer demand or excess supply. The branding effort launched this year in Europe and will roll out in North America and Asia next year. It’s aiming for 100 million euros additional EBIT by 2022. (See nearby chart.) Where could I be wrong: Salmon prices could decline sharply if land-based fish farming ever took off or if a plant-based fish substitute became popular. And like cattle, salmon are susceptible to occasional disease outbreaks, though this would tend to drive salmon prices up and could prove a good entry point in the long run. Bottom Line: If MOWI were to get just a fraction of the rating investors give BYND, it would lead to a big rise in the stock.
- Signal from Noise
A Generation of Investors in Europe Have Lost Out Since 1999
If I told you that an asset made up of a balanced array of many different sectors—and large capitalization stocks global in nature—had delivered a 4% price drop over nearly 20 years, it’s a good guess you’d be mighty surprised. Guess what well known major global asset has managed this ignominious feat? The Stoxx Europe 600 index, that’s what. This index, made up of 600 large, mid and small capitalization stocks across 17 countries of the European region—not all of them participants in the euro—isn’t an exact analog to the Standard & Poor’s 500 index, but it is a reference index for the region. It’s the cream of Europe’s publicly-traded companies. Nestle, Barclays, BMW, etc., are part of it. Since 1999, the Stoxx 600, which closed around 391 recently, is up 3% in euro terms and 15% in dollars. Yes, up just 3%. The S&P 500 index is up over 100% over that time. Even worse, the Stoxx 600 remains down 4% below March 2000 highs of 407, in the middle of the dot. com boom. There are several long-term lessons here, but it isn’t to avoid Europe altogether. There are growing companies in Europe, and the trick is to find them. Moreover, avoiding Europe might be inadvisable in terms of putting together a diverse group of assets. The broader message is this: European companies, even the global ones that get much of the revenue outside the Old World, fight with one hand tied behind their back. Regulations in general, and on labor in particular, are onerous compared to the U.S. and the rest of the world. The EU’s many other business strictures are well known and curtail the ability to grow profits. For example, the anti-trust approach in the EU measures the effect of a merger on the competition. To me, that’s simply odd. In the U.S. anti-trust is based on the effects on the consumer. That sounds more conducive to free markets. Unfortunately, Brussels doesn’t understand this and is likely to create an even tougher business climate in the near future. The euro, which launched in 1999, has made it difficult for European companies outside of Germany to contend with German companies. In particular, the euro has really shackled Italy with higher costs and made it hard for their firms to compete. In the past, the lira would devalue and give them breathing room. Now this isn’t possible. The story is similar elsewhere in Europe. Look at the historical GDP numbers for each country. According to the World Bank, Italy’s 2017 GDP in current dollars was $1.9 trillion, up just 52% from $1.25 trillion in 1999. In the previous twenty years, it rose 218%. The numbers for France and the U.K. are comparable. Indeed, the argument for Brexit is strong when you consider the UK’s GDP rose 280% in the twenty years before the euro was born and Brussels started down a high regulatory track, but just 58% since—even though the UK isn’t part of the common currency. Corporate profits don’t directly correlate to GDP growth but the direction is similar. A whole generation of investors has grown up since the dotcom bust and probably doesn’t know that Europe is sick. If you didn’t, you do now.
- Signal from Noise
Never Heard of Truist? This Bank Stock Could Rise Up to 30%
-6th biggest US bank that few have heard of; born of a merger of 2 strong, large regionals-Low interest rates, COVID-19 have delayed merger synergies, raised loan loss fears -Footprint in fast growing Southeast; As economy recovers, stock could rise up to 30%What is Truist Financial (TFC) you might ask? It is the ungainly new name of a promising merger between the old BB&T and SunTrust, each of them well-known, big regional banks. The deal closed last December and the resulting entity has some 3,000 branches, mostly in the fast-growing southeast US, and assets of $504 billion, making it the sixth biggest bank in the US. Source: FSInsight, Bloomberg I forgive that name change, because I do think it’s a relatively cheap stock, a well-run bank with a good track record, and one worth examining closer, particularly if you need a little financial ballast in your portfolio. Both predecessor banks were among the faster growing regional banks in the US. Unlike the broad market, now near its all-time highs, Truist shares since the March lows are around $38—up from $24 at the low—but nowhere near the $55 previous pre-coronavirus (COVID-19) high. If our view is right, the stock can approach $50, up to a 30% rise. Here’s what I believe the market is concerned with. First, banks generally aren’t popular, as I’ve written before. On an industry level, interest rates continue to be low and will likely stay that way for a while, continuing to pressure net interest income margins for the foreseeable future. While this is not to be ignored, TFC has been dealing with this for years and their results have been strong. We’ll get to that. This is a legitimate issue, but I don’t think investors should be unduly concerned. As is the case with most other companies, COVID-19 hit TFC’s 2020 results, mainly on the reduced business and branch activity in the U.S.—loans, insurance, etc.—and the stock also suffers from worries about future loan losses and nonperforming assets. Again, this is not particular to TFC. More on this too below. Thirdly, and perhaps most importantly, because the stock fell sharply on the news, the bank said Jan. 30 that it would reach 30% of its expected $1.6 billion merger-related savings in 2020, instead of the 50% target. That represents significant cost savings. However, I think they will eventually come and investors should consider that. Truist chairman and CEO Kelly King said he was still confident in the bank’s ability to fully realize the anticipated cost savings by its original target of 2022. Given the company’s strong track record of cost cuts and good efficiency ratios, I believe it. In the second quarter of 2020, the efficiency ratio was a robust 55.8%, up from 55.1% in the year ago quarter. One thing well run banks—like TFC—have been able to rely on in this extraordinarily low rate environment is self-help, so investors were upset with that. Much of this, however, can be blamed on regulators, who asked the bank to defer closing 740 branches that are within 2 miles of one another until one year after the deal closes. Source: Truist TFC’s footprint is in the fastest growing part of the US by far, says a bullish Joe Terril, who runs money manager Terril & Co., which owns TFC shares for clients. “If you believe that we are going to come out of the other side of this virus, then this is the epitome of stocks to like.”If COVID-19 goes away as a serious problem, TFC should resume its growth. However, if COVID-19 has changed the world permanently, then the trend of folks moving to low tax, warm weather states, like Texas and South Caroline and Florida will intensify, Terril notes, and TFC home and business loans will grow faster than investors think. According to the Bureau of Economic Analysis, the southeast region plus Texas, the footprint of TFC’s banks, make up about 30% of US GDP and as of the fourth quarter—pre-COVID-19—nearly all the states included were growing faster than the US. Besides banking, TFC has a fast-growing insurance business: property, life, employee benefits, title, professional liability; and wealth management and capital markets. Looking at 2019’s results is helpful, but it was messy with merger-related and other one-time costs obfuscating TFC’s long-term earnings power. For example, TFC net income fell to $3.03 billion or $3.71 (including nearly $300 million or roughly 39 cents) in one-time merger costs, or from $3.06 billion or $3.91 in 2018. Yet from 2015 to 2018, pre-merger, TFC’s EPS (the old BB&T) rose over 50% from $2.56. Pro forma, as if SunTrust had been a part of TFC Jan. 1, 2018, last year’s net income was $6.0 billion, down from $6.3 billion. I think if you also throw in the potential synergies from Sun Trust, TFC can produce strong earnings growth again. In the virus-afflicted second quarter, revenue rose to $5.9 billion from $5.6 billion in the first quarter, the first full period of the merged company. The net interest margin, however, fell 45 basis points to 3.13%, from the first quarter. Half of that is attributable to COVID-19 and one-time reserve or accounting changes. Moreover, it was partially offset by an 8.1% sequential quarter increase in average earning assets. The bank is introducing measures to combat this. Nothing new here. Additionally, Terril likes the growing and more stable non-interest related income, like fees, now 41.3% of the bank’s total income vs 34.9% in 1Q and 38.6% in 4Q19. Fee income is benefitting from robust capital markets and residential mortgage performance as well as record insurance income. The balance sheet is robust, too, with coverage of nonperforming loans and leases at 5.24 times, he says. TFC continues to lower its cost of capital. TFC’s valuation is relatively cheap compared to its history. It trades at about 11 times consensus 2021 EPS of $3.26, compared to a median of 12-13 times. However, Terril says $4 per share—about what it earned in 2018 pre-merger—is achievable in 2022, and something investors will be looking at 12 months from now. He applies a 12.5 PE to that to come up with a $50 per share valuation. It trades at about 0.8 of book value, versus a mean of 1.2 times. TFC sports a robust balance sheet with strong capital ratios and a nearly 5% dividend. “What’s not to like?” He says, and I agree. Where I could be wrong: In the event TFC’s synergies don’t materialize as expected, the stock will likely suffer. Bottom Line: TFC stock represents a chance to buy a well-run, large US bank with a good track record at a low valuation. As things return to normal, and TFC effects synergies, the valuation should re-approach the historical mean. Prior Signals: 7/29/20: Weight Watchers Can Continue to Outperform Post COVID-19 7/22/20: If EPS Rises to Pre-COVID-19 Level, XLNX Could See Old Highs 7/15/20: Narrow Mkt Rise Fuels Worry; We Expect Cyclicals To Join 7/8/20: Other Voices: Why Reading 10K Filings Is Crucial; Part 1 7/1/20: Post-COVID-19, Simply Good Foods Stock Looks Appetizing 6/24/20: Lam Research, Applied Materials Set To Reap IoT Harvest 6/17/20: Continued IoT Growth Good News for Nordic Semiconductor 6/10/20: Helmerich & Payne Stock Could Energize Your Portfolio 6/3/20: For Income Seekers, Why Covered Calls Top Junk Bond ETFs 5/27/20: Why JPMorgan Chase Belongs in Portfolios Post-COVID-19 5/20/20: Horizon Therapeutics Is Inexpensive; 2 Drugs Show Promise 5/13/20: ‘Plain Vanilla’ Bank OZK Could Be Long Term Opportunity 5/6/20: Post COVID-19, Graham Holdings Could Return to Growth 4/29/20: Pacira To Benefit from Surgery Trend Away from Opioids 4/22/20: Avalara Stock Could Benefit from Catalysts Boosting Amazon
- Signal from Noise
Weight Watchers Can Continue to Outperform Post COVID-19
-Since our report ran 12 months ago WW’s stock has sharply outperformed the market -COVID-19 is accelerating WW move to digital subscriptions, which could help margins As US economy recovers, if subscribers continue to rise; WW stock could rise 30%-40% A year has passed since I wrote about WW International (WW), formerly Weight Watchers (A Battered Weight Watchers Stock Looks Inexpensive, July 10, 2019). I’m happy to report that since our piece was published its stock is up 20% to $25.73 recently, outperforming the Standard & Poor’s 500 index, up 8% over the same period. Of course, the 12 months in between has been hair raising. While the broad market, down 35% in March, has recovered most of its losses, WW hasn’t. It is off 45%, mostly on COVID-19 fear, from $47 in January. I should have taken a victory lap then! Source: FSInsight. com, Bloomberg I still favor WW shares and it could return to the mid $30s, or up 30%-40%. (More on the valuation below.) The company continues to make slow but steady progress under CEO Mindy Grossman, who came aboard three years ago and is modernizing WW to a “wellness” firm from an old-fashioned “diet” company. WW was already moving to a big emphasis on a digital approach from the traditional studio approach—where customers would physically come in—even before coronavirus hit. Here are WW’s latest results: The company finished 2019 with 4.2 million subscribers, a record level for a year-end and up 8% from the end of 2018, with subscriber growth in all its major geographic markets. Revenues in fiscal 2019 were $1.4 billion, down 5%, while net income was $120 million or $1.72, down from $224 million or $3.19 in 2018. The profit comp is skewed by a higher tax rate, 21% in 2019 vs 8% in 2018, and one-time benefits/charges swing of 55 cents favoring 2018. Slow and steady improvements are seen in the first quarter, as subs rose 9% year-over-year to 5 million, an all-time Q1 high. Revenues rose 10% from the year ago quarter to $400 million. Operating income rose 14% to $25 million, primarily driven by leverage on higher revenues from digital subscriptions. The net loss narrowed to $6.1 million, or 9 cents, from to $10.7 million, or 16 cents, in the prior year period. Debt net of cash was $1.4 billion at March end and adjusted Ebitda for the past 12 months was $358 million. Debt/Ebitda leverage has fallen to about 4 times from 4.5 and will likely drop further. WW is introducing cost cuts of $100 million in reaction to COVID-19. As you might expect, COVID-19 is not helping WW’s studio/store business, as is plain from this statistic: in the first quarter digital subscribers rose 16%, but studio plus digital subscribers, fell 5%. The unforeseeable spread of COVID-19 put a small dent in my thesis, at least to the extent that studio visits and attendant product sales are down. It forced the company to withdraw its previous February 2020 guidance of revenues approaching $1.6 billion and EPS range of $2.15 to $2.40. However, I think the guidance—even withdrawn—is instructive for an investor who wants to get a fix on WW post COVID-19. Indeed, I think that COVID-19 will speed up the move to digital at WW and more quickly improve results long term. For example, Zacks Investment Research, in a June 16 report, pointed out that WW “robust” digital business is courtesy of the social distancing and the focus on digital transformation. On June 15, WW said that it had 4.9 million subscribers as of June 6, up 7% from June 8, 2019, consisting of 3.8 million digital subs and 1.1 million studio plus digital subs. (Please note WW’s business is seasonal, with results trailing down from the typically strongest 1Q.) The company also said that starting mid-April, digital recruitment trends returned to growth and have accelerated, and are now trending ahead of the first quarter, prior to the escalation of COVID-19 mid-March. Approximately 90% of recruits since mid-March come from the digital business. Though the studio business continues to see significant declines, WW has begun reopening locations in a phased manner and anticipates 400 reopened in the U.S. last month. WW is increasingly transforming into a capital light business, with three main tailwinds, says Marshall Kaplan, who leads the Fundamental Equity Advisors, a team at Ingalls & Snyder, LLC, which recently bought WW shares. It’s a timely idea because the pandemic has focused Americans on health and weight control, he notes. As I wrote last year, obesity is a worldwide problem and getting worse. The Centers for Disease Control and Prevention estimates over 36% of US adults are obese. Source: Company reports Kaplan’s view is seconded by a recent report from Morgan Stanley, which said the accelerating digital business is driven by consumers’ increasing wellness focus post COVID-19 restrictions. It cited a Nutrisystem-sponsored survey of 2,000 Americans, which found 63% of people place more of a priority on improving their diet and 76% of Americans say they gained up to 16 pounds during isolation. Wow! Second, adds Kaplan, WW’s focus on its digital business shows. 2Q is usually a slower period for WW, and the 3Q might be difficult too, given COVID-19, yet the company’s recent update shows downloads of its app are strong. Thirdly, Kaplan likes the company’s plans to launch virtual group coaching worldwide, probably in the fourth quarter. If it significantly supersedes full time studio coaches, it could improve margins through higher utilization of coaching and potentially significant savings in real estate, if fewer physical locations are needed. Though the stock is up from a year ago, the valuation is not. It trades at 11.7 times consensus EPS of $2.21 next year (vs $1.73 this year), compared to a 12 times PE one year ago. If the company progresses on its plans, its PE could approach its historical PE median of 14-15 times. If applied to the EPS consensus of $2.46 in 2022, that could yield a $35 stock price longer term. Meanwhile, shares of weight loss product distributor Medifast (MED) have tripled since March lows, but WW’s have only doubled from lows. Then there is the not so secret weapon Oprah Winfrey, who actively markets WW and will likely continue that. She is a director with about an 8% stake. Our head of global portfolio analysis, Brian Rauscher, says his Analyst Sentiment Measure (ASM) at WW has positively inflected, and analyst EPS reductions continue to get smaller. The combination of these two metrics historically has boded well for a stock. Where I could be wrong: No one can predict how the COVID-19 spread will play out or when it will end. Even with strong cash flow, WW remains somewhat leveraged. Bottom Line: COVID-19 is accelerating a move to digital subscriptions. As WW continues its modernization to a “wellness” and digital company, the EPS should rise and the share price along with it. Prior “Signals” DateTopicSubject / TickerThe Signal7/22/20StockXilinx (XLNX)If EPS Rises to Pre-Covid-19 Level, XLNX Could See Old Highs7/15/20StockMarket ConcentrationNarrow Mkt Rally Fuels Worry; We Expect Cyclicals To Join7/8/20StockSEC FilingsOther Voices: Why Reading 10K Filings Is Crucial; Part 17/1/20StockSimply Good Foods (SMPL)Post-COVID-19, Simply Good Foods Stock Looks Appetizing6/24/20StockLam Research, Applied MaterialsLam Research, Applied Materials Set to Reap IoT Harvest6/17/20StockNordic Semiconductor (Nod. 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- Signal from Noise
If EPS Rises to Pre-Covid-19 Level, XLNX Could See Old Highs
– XLNX stock recovery from March lagging tech and cyclical stocks; we think unjustified – Huawei, slowing 5G rollout fear has dented sentiment; in our Granny Shots portfolio – As sales approach pre-COVID-19 levels, stock could rise to old high, up to 40% rise Xilinx (XLNX), which designs and develops programmable chips, has seen its share price rise about 50% to around $103 in the recent rally from the March lows, as the market broadly discounts a lessening of the COVID-19 spread, and a reopening of global economies. Source: FSInsight. com, Bloomberg XLNX is basically one of two big players (the other being Intel’s (INTC) Altera unit) in the field of integrated circuits (ICs) in the form of programmable logic devices (PLDs), including programmable System on Chips (SoCs), and other devices. They have end markets ranging from aerospace/defense to communications/data centers to automotive and testing. It’s complicated stuff, requiring a lot of R&D. It’s is a competitive environment, but XLNX is recognized as a leader, having invented field programmable gate arrays (FPGA), ICs designed to be configured by a customer after manufacturing. A standard application specific chip (ASIC), which is cheaper than FPGAs, cannot be programmed. The latter are typically more expensive but also flexible, so a user can change the hardware circuit as needed. Investors unfamiliar with XLNX might find this interesting: while many other high-quality tech—and even cyclical—companies have surpassed their old highs in this rebound since March, XLNX has not. For example, both Apple (AAPL) and Microsoft (MSFT) have made new highs and even truck equipment and parts maker Paccar (PCCR) has, too. Not XLNX, whose all-time high was $142 back in April, 2019. What gives? There are a few issues investors are grappling with (more on this below) but there are also reasons to be cheerful about the stock. As the COVID-19 outbreak continues to ease and economies around the world ramp up, I think XLNX’s results will return to pre-Covid levels faster than Wall Street analysts are expecting. That could lead to the shares approaching the old high in a year or two, a possible 40% rise. There is a pathway with high probability of returning to peak earnings but the stock has only reflected the broad market’s recovery, says a bullish Paul Latta, principal and portfolio manager at Cedar River Capital, which owns XLNX shares for clients. While not all XLNX end markets are “bulletproof,” other companies with worse outlooks have stocks that have recovered back to highs, he notes. Additionally, XLNX is in our very own Granny Shots portfolio, which has beaten the market by over 3,490 basis points since inception on January 10, 2019. (See nearby table.) The San Jose, CA-based tech company is expected to benefit from improving purchase-manager index trends; from growing use of artificial intelligence; and from our expectation of higher inflation in the long term. For more on Granny Shots, click here. The issues: as with most companies, COVID-19 has dented sentiment, though the company has said the coronavirus hasn’t generally disrupted its business. Nevertheless, car sales were already softening (in China, in particular) pre-COVID-19, so that end market has suffered. Source: FSInsight. com, Bloomberg Second, the ongoing US-China trade war, with reference to Huawei, has hurt sales. Huawei, reportedly 6%-8% of total XLNX revenue, was placed on the US restricted “entities list” in May, 2019. The UK recently did the same. Last year, XLNX removed Huawei from its forecasts but it is still getting some sales and recently restrictions were eased a bit. Latta points out that XLNX quarterly EPS has dropped to a run rate of 65-70 cents lately from about 95 cents in 2018-2019 before COVID-19 and the ruckus with Huawei began in May of 2019. Yet, the good news, he adds, is that Nokia (NOK) and Ericcson (ERIXF) are stepping into the breach. Secondly, their products use higher XLNX content than Huawei, which is attempting to source supply in China. Clearly XLNX will benefit eventually from the continuing rollout of 5G as well as AI, he says. In the year ended March 28, 2020, XLNX sales rose 3% to $3.2 billion from 2019, when revenues rose 24%. What XLNX terms its advanced products rose 15% in 2020 but core products fell 17%. Europe and Japan were weak, while North America and Asia Pacific grew nicely. Gross margins were 66.9% vs 68.9% EPS $3.11 vs $3.47, respectively. XLNX expects for the first fiscal quarter ended June 29, to be reported July 30, sales of $720 million to $734 million, up from previous guidance of $660 million to $720 million with gross margins of 67%-68%. The company said it is seeing stronger than expected revenues in its Wired and Wireless Group and Data Center Group, more than offsetting weaker than expected revenues in consumer-oriented end markets, including automotive, broadcast, and consumer. Robert Sluymer, our head of technical analysis, notes that XLNX crossed above its declining 200-dma in June, and has continued to trend higher above its rising 50-day moving average. Unlike other peer firms at or near new highs, XLNX appears to be in the early stages of a new bull cycle. He recommends accumulating. According to Brian Rauscher, our head of global portfolio analysis, XLNX is screening favorably in his single stock ERM model as his proprietary analyst sentiment measure (ASM) for the stock has bottomed and is now rising, which is historically a bullish sign. XLNX isn’t standing still either. It has said it intends to continue to displace ASICs and traditional PLDs in next generation electronic systems. Latta believes that in the future, programmable chips will likely take share from ASIC. The company has a strong balance sheet with a cash position net of long-term debt of near $1 billion. Analysts’ consensus is near $4 in EPS in fiscal 2023, which suggests they believe it can get back to peak revenues eventually. If it does, Latta thinks the stock could re-approach its all-time high of $140 in early 2019, when Wall Street last thought $4 EPS was within reach, before COVID-19 and the Huawei issues arose. Where I could be wrong: The US-China trade war could worsen. XLNX gets most of its chip supply from Taiwan Semiconductor (TSMC). Bottom Line: XLNX stock is at a level where the market is not expecting recovery of its end markets. If that happens, as we believe, the stock should rise. Prior “Signals” DateTopicSubject / TickerThe Signal7/15/20StockMarket ConcentrationNarrow Mkt Rally Fuels Worry; We Expect Cyclicals To Join7/8/20StockSEC FilingsOther Voices: Why Reading 10K Filings Is Crucial; Part 17/1/20StockSimply Good Foods (SMPL)Post-COVID-19, Simply Good Foods Stock Looks Appetizing6/24/20StockLam Research, Applied MaterialsLam Research, Applied Materials Set to Reap IoT Harvest6/17/20StockNordic Semiconductor (Nod. 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