Penn After Hours
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Headlines for the Month of December 2024
We, 11 Dec 2024
Food & Staples Retailing
Judge blocks Kroger/Albertsons deal
It began with the anti-business FTC suing to block the deal, and ended with a judge shooting the deal down. Kroger's bid to buy smaller grocer Albertsons has official gone down in flames, unlikely to be revived even after the inept FTC chair is gone. Albertsons is now suing Kroger, stating its suitor should have done more to push the deal through.
Semiconductors & Related Equipment
Apple reportedly working with Broadcom to develop AI chip
According to a report from The Information, Apple is working with chipmaker Broadcom (AVGO) to develop its first server chip designed for artificial intelligence.
Tu, 10 Dec 2024
Global Strategy: Southeast Asia
China is cutting off supply of drone components to Europe and the US
Drones have been an important player in Ukraine's battle against Russian invaders, and now the latter's ally is doing something to curb their use. Chinese manufacturers, upon orders from Beijing, are limiting the sale of key components needed to build unmanned aerial vehicles. Broader export restrictions are expected in the coming year. Disgraceful that the West would rely on parts from Communist China for any defense-related items.
Renewables
Google plans for giant energy parks to power nearby data centers
One aspect of the AI data center buildout is certain: these centers all require massive amounts of energy to operate. Alphabet's Google division is taking a unique approach to the problem. The company has entered into a partnership with Intersect Power LLC, an independent power producer, to design and build big energy plants next to its data center campuses to generate, store, and transmit the power needed at the facilities.
Economic Outlook
US small-business optimism hits three-year high
Small-business optimism surged in November to a more than three-year high on the heels of the US election. The National Federation of Independent Business optimism index spiked eight points—the most on record—to 101.7. Nine of the ten components of the index rose, led by a 41-point improvement in the outlook for business conditions. That was the biggest rise going back to 1986.
Mo, 09 Dec 2024
Global Strategy: Middle East
No matter what comes, Assad's fall in Syria is a disaster for Putin
After fifty years in power, after multiple uses of chemical weapons against their own citizens, the Assad family is finally done in Syria. With rebels closing in on the capital city, dictator and Russian proxy Bashar Assad has escaped to Moscow with his family. We don't know what is to come, but we can be sure it will not be good for Putin.
Fr, 06 Dec 2024
Economics: Work & Pay
Jobs report sustains green light for a December rate cut
The November jobs report came in a bit hotter than expected—227,000 new jobs created for the month versus 200,000 expected. The unemployment rate did rise one basis point, to 4.2%. Wages also came in a bit hotter than expected. Put this together and we see sustained odds for a December, 25-bps rate cut. All eyes on next week's CPI report.
We, 04 Dec 2024
Cryptocurrencies
With nightmare Gensler out, crypto gets an early Christmas gift with Trump pick
If the crypto industry could have chosen a dream candidate to head up the SEC after the nightmare of Gary Gensler, it would have been Patomak Global Partners founder and chief executive officer Paul Atkins. And that is precisely who President-Elect Trump selected, sending Bitcoin to over $100,000 per coin for the first time.
Mo, 02 Dec 2024
Semiconductors & Equipment
Gelsinger out at Intel
After nearly four years at the helm, a period which saw the company's stock drop by 61%, Intel has announced that CEO Pat Gelsinger is out, effective immediately. Shares rallied 5% pre-market on the news.
We, 11 Dec 2024
Food & Staples Retailing
Judge blocks Kroger/Albertsons deal
It began with the anti-business FTC suing to block the deal, and ended with a judge shooting the deal down. Kroger's bid to buy smaller grocer Albertsons has official gone down in flames, unlikely to be revived even after the inept FTC chair is gone. Albertsons is now suing Kroger, stating its suitor should have done more to push the deal through.
Semiconductors & Related Equipment
Apple reportedly working with Broadcom to develop AI chip
According to a report from The Information, Apple is working with chipmaker Broadcom (AVGO) to develop its first server chip designed for artificial intelligence.
Tu, 10 Dec 2024
Global Strategy: Southeast Asia
China is cutting off supply of drone components to Europe and the US
Drones have been an important player in Ukraine's battle against Russian invaders, and now the latter's ally is doing something to curb their use. Chinese manufacturers, upon orders from Beijing, are limiting the sale of key components needed to build unmanned aerial vehicles. Broader export restrictions are expected in the coming year. Disgraceful that the West would rely on parts from Communist China for any defense-related items.
Renewables
Google plans for giant energy parks to power nearby data centers
One aspect of the AI data center buildout is certain: these centers all require massive amounts of energy to operate. Alphabet's Google division is taking a unique approach to the problem. The company has entered into a partnership with Intersect Power LLC, an independent power producer, to design and build big energy plants next to its data center campuses to generate, store, and transmit the power needed at the facilities.
Economic Outlook
US small-business optimism hits three-year high
Small-business optimism surged in November to a more than three-year high on the heels of the US election. The National Federation of Independent Business optimism index spiked eight points—the most on record—to 101.7. Nine of the ten components of the index rose, led by a 41-point improvement in the outlook for business conditions. That was the biggest rise going back to 1986.
Mo, 09 Dec 2024
Global Strategy: Middle East
No matter what comes, Assad's fall in Syria is a disaster for Putin
After fifty years in power, after multiple uses of chemical weapons against their own citizens, the Assad family is finally done in Syria. With rebels closing in on the capital city, dictator and Russian proxy Bashar Assad has escaped to Moscow with his family. We don't know what is to come, but we can be sure it will not be good for Putin.
Fr, 06 Dec 2024
Economics: Work & Pay
Jobs report sustains green light for a December rate cut
The November jobs report came in a bit hotter than expected—227,000 new jobs created for the month versus 200,000 expected. The unemployment rate did rise one basis point, to 4.2%. Wages also came in a bit hotter than expected. Put this together and we see sustained odds for a December, 25-bps rate cut. All eyes on next week's CPI report.
We, 04 Dec 2024
Cryptocurrencies
With nightmare Gensler out, crypto gets an early Christmas gift with Trump pick
If the crypto industry could have chosen a dream candidate to head up the SEC after the nightmare of Gary Gensler, it would have been Patomak Global Partners founder and chief executive officer Paul Atkins. And that is precisely who President-Elect Trump selected, sending Bitcoin to over $100,000 per coin for the first time.
Mo, 02 Dec 2024
Semiconductors & Equipment
Gelsinger out at Intel
After nearly four years at the helm, a period which saw the company's stock drop by 61%, Intel has announced that CEO Pat Gelsinger is out, effective immediately. Shares rallied 5% pre-market on the news.
Headlines for the Month of November 2024
Tu, 26 Nov 2024
Happiness Index
Consumer confidence jumps to 16-month high
Based on November's index of consumer confidence, Americans are suddenly feeling rosy about the year ahead. The index hit a 16-month high of 111.7, beating expectations. This report also bodes well for the Christmas shopping season, as consumers tend to spend more on discretionary items when they feel good about the where the economy is headed.
Specialty Retail
Best Buy shares drop on Q3 miss and forecast cut
Best Buy (BBY $86) shares fell 7% on the open after the electronics retailer saw its revenue decline 3.2% y/y and its earnings decline 2% y/y, falling short of estimates. The company also slashed its guidance for the full year, citing "distraction during the run-up to the election" as one of the factors. We've heard some lame ones before, but that one might just take the cake. We might be tempted to be bullish on the shares considering the drop, but management isn't exactly instilling confidence that they have a sound solution.
Mo, 25 Nov 2024
Monetary Policy
Stocks rip higher on news that Trump will tap market-friendly deficit hawk Scott Bessent to head Treasury
Simply an excellent pick. Scott Bessent is a successful hedge fund manager and someone who is actually concerned about the national debt and deficit. Markets rallied on the news.
Sa, 23 Nov 2024
Market Pulse
Stocks are ripping into year end, with small caps leading the way
Gold and crude outperformed equities, however, and Bitcoin is now up nearly 50% in the two weeks since the election.
Fr, 22 Nov 2024
Capital Markets
A just-announced deal is about to make the CEO of Jersey Mike's a very wealthy man
Peter Cancro was a working-class kid when he went deep into debt to buy a struggling sandwich shop. Fifty years later, he is about to become one of the 500 richest people in the world.
We, 20 Nov 2024
Multiline Retail
If Walmart is the gift that keeps on giving, then Target is the Grinch
The juxtaposition of Target's earnings the day after Walmart's stellar results could not be any more stark; while WMT shares hit a new all-time high, TGT shares were plunging 22%.
Tu, 19 Nov 2024
Food & Staples Retailing
Walmart shares just hit a new high on earnings; other deep discounters have not been so lucky
The disparity over the past year between Walmart's performance and the performance of Dollar General and Dollar Tree is staggering. A lot has to do with income classes. Visit the story by selecting the link above.
Mo, 18 Nov 2024
Airlines & Air Freight
After judge shoots down merger, Spirit Airlines files for bankruptcy
Something we have seen coming for over a year. Spirit Airlines, after spurning an excellent merger offer from Frontier, took a competing offer from lousy JetBlue. A judge shot the merger down this past January, and now Spirit has announced it is filing for bankruptcy. Ineptness, mismanagement, arrogance, years of operating in the red, and now bankruptcy.
We, 13 Nov 2024
Supply, Demand, & Prices
Futures turned positive after inflation report hits expectations
Investors were concerned about the CPI report before its release. If it showed an uptick in inflation, it would give the Fed pause to pull the trigger on another rate cut at the December FOMC meeting. When the report hit, however, those fears were quelled. The consumer price index rose 0.2% in October, taking the 12-month inflation rate up to 2.6%, or precisely what economists had been predicting. There is now an 83% chance of another rate cut next month.
Tu, 12 Nov 2024
Aerospace & Defense
Elliott takes a stake in Honeywell, calls for the company to be broken in two
Elliott Investment Management has revealed it has taken a $5 billion stake in the industrial giant, market cap $152B, and is calling for the company to separate its two main entities into standalone companies—its aerospace business and its automation business. HON shares rose 4% on the news, hitting a new 52-week high. HON is one of the top holdings in our Aerospace and Defense ETF (PPA $123). We would probably be supportive of such an action, pending the details.
Mo, 04 Nov 2024
IT: Technology Hardware & Equipment
A lot of skeletons in Super Micro's closet
Shares of the Cali-based firm were riding high on the AI wave, hitting $122.90 this past March. Since then, it has been a nightmarish ride down.
Fr, 01 Nov 2024
Economics: Work & Pay
Disastrous jobs report for October
It is hard to imagine a weaker jobs report rolling in four days before the national election. Against expectations for a relatively weak 100,000 new jobs created, nonfarm payrolls in the US came in at just 12,000 new jobs. The unemployment level remained steady at 4.1%. Excuses centered around the hurricanes and the Boeing strike. This is the worst jobs report since December 2020, winter of the pandemic. The lousy report all but guarantees a 25-bps rate cut by the Fed in November.
We, 30 Oct 2024
Super Micro auditor Ernst & Young resigns, shares plunge...
Tu, 29 Oct 2024
Health Care Providers & Services
GeneDx skyrockets 45% on the back of first profitable quarter (WGS $83)
Small-cap genetics testing company GeneDx spiked 50% on Tuesday following stellar Q3 results. Against estimates for a lose of $0.19 per share, the company actually earned $0.04 per share—its first-ever profitable quarter. Shares were trading under $3 going into the year, equating to a year-to-date return of over 2,900% based on the current share price.
Automotive
Ford shares plunge after lousy quarterly report (F $10)
On the heels of great Tesla and strong GM quarterly earnings reports, Ford threw cold water on the party. Though the automaker beat slightly on top line revenue and bottom line net income, it reduced its forward guidance for adjusted EBIT down from $12 billion to $10 billion. CFO John Lawler blamed supply chain disruptions and higher costs for the downward-revised figures. Funny the other two automakers didn't mention either of these problems. Ford shares were trading down around 8% after the report, to $10.44/sh.
Th, 24 Oct 2024
Skecher's pops 10% after hours after earnings beat...
In rare win for FTC, judge blocks Tapestry deal with Capri, Capri shares fall 52%...
TSMC's Arizona chip facility yields better than plant in Taiwan...
Metals & Mining
Leading global gold mining company Newmont falls 14% on Q3 earnings report
Newmont, the world's largest gold miner, saw its shares slashed by 14% after missing expectations for the quarter—which may seem odd, considering gold is at a 5,000-year high price. Revenue came in at $4.61B ($4.67B est.) and earnings came in at $0.81/sh ($0.86/sh est.). The company blamed the poor performance on the increased cost of extraction, thought that doesn't really explain the revenue miss.
Aerospace & Defense
The 1970s are calling: Boeing's union workforce rejects company offer, demands a return to pensions
Ludicrous—it will not happen. Boeing's factory workers, 33,000 members of the International Association of Machinists and Aerospace Workers, voted down the company's latest offer of a 35% pay increase over four years. While not as decisive as the previous rejection, 64% of the union members voted against the deal. They are demanding a return to the defined benefits pension plan which has been gone for over a decade. Boeing shares are now off 40% YTD; Airbus shares are flat over that time frame. Striking Boeing workers are not being paid by the company while they strike; rather, they receive a $250/week stipend from the union's strike fund. Boeing workers in North Carolina continue their work, as they are non-unionized.
Automotive
Tesla shares spike 10% after hours on Q3 beat
Shares of EV-leader Tesla jumped 10% after the company announced impressive Q3 numbers, with the Cybertruck already becoming profitable. The company generated $25.2 billion in revenue over the quarter, an 8% uptick from the same quarter last year, while net income rose to $2.2 billion, for a 17% beat y/y.
We, 23 Oct 2024
Restaurants
Fallout from McDonald's E. coli outbreak
Dozens of McDonald's customers throughout the Mountain states came down sick due to an E. coli outbreak linked to the restaurant's Quarter Pounders, with one person dying from the illness. The company believes it has narrowed the problem down to sliced onions found in the burger, as this ingredient all stems from one supplier (unlike the beef at the restaurants, for example). Share of MCD have fallen around 5% over the past two trading sessions. We don't believe it is cheap enough to jump in on the slide.
Housing
Existing home sales drop to 14-year low
Somewhat bizarrely, post-Fed rate cut, the 30-year mortgage rate is headed back up near 7% (6.92% now) and it is causing the sale of existing homes to decline to levels not seen in fourteen years. Annualized rate of home sales dropped to 3.84 million in September, compared to a 25-year average of 5.26 million per year. This was the worst one-month sales figure going back to October 2010.
Mo, 21 Oct 2024
National Debt & Deficit
Our "leaders" spent $1.8 trillion more than they brought in last year
It was the third-largest deficit on record, trailing only the two years of the pandemic.
We, 09 Oct 2024
Cybersecurity
Another US critical infrastructure attack
This is getting old. The latest attack came against America's largest investor-owned water utility.
Mo, 07 Oct 2024
Pharmaceuticals
Something finally moved Pfizer's share price: an activist
Shares of the Penn member were trading up 4% on the news.
We, 02 Oct 2024
Global Strategy: East/Southeast Asia
Japan has a new leader, and China is none too happy about the choice
Shigeru Ishiba wants to confront Chinese aggression in the region, and he has called for a snap election this month. We are bullish on Japan, and he is yet another reason why.
Automotive
Stellantis's US sales are crushing it—the company, that is
Automaker Stellantis, the former Fiat Chrysler, announced a blistering 20% drop in US sales in the July through September period, the worst performance of any major automaker. Fiat was the only line which did not suffer a drop, while the Chrysler and Dodge likes were off some 40%. Jeep sales fall 6% year/year.
Textiles, Apparel, & Luxury Goods
Nike shares drop on quarterly sales figures
They are trying to place blame on the former CEO, but Nike shares fell some 7% (17% down year-to-date) after the company announced a 10% drop in quarterly sales from the same period last year; net income fell 28% for the same period. Last month the company parted ways with John Donahoe, naming retired exec Elliot Hill new CEO. We aren't touching the shares.
Health Care Providers & Services
Humana shares plunge 20% on ratings drop
Health insurance provider Humana suffered one of its worst one-day drops ever as it warns that changes in the government's quality ratings of Medicare plans could weigh heavily on its profits. The company has roughly 25% of its members enrolled in plans rated four- or five-stars for 2025, a 94% drop from 2024 enrollment.
Fr, 27 Sep 2024
Global Strategy: East/Southeast Asia
A stand against Chinese aggression: Japan has a new hawkish PM
Japan's ruling Liberal Democratic Party (LDP) selected China hawk Shigeru Ishiba to become the country's newest prime minister. The 67-year-old Ishiba is an advocate of an "Asian NATO," favoring ramped up and "obligatory" security arrangements in the region to fight Chinese aggression.
Th, 26 Sep 2024
Media & Entertainment
DirecTV and Dish are nearing merger agreement
Based on the changing television landscape, it only makes sense. The two remaining satellite pay-TV providers, DirecTV and Dish, are apparently close to signing a merger agreement. With cord cutting, will it matter?
Economics
US economy remains on strong footing
It was reaffirmed that the US economy grew at a robust 3% clip in the second quarter of the year, and projections are the same for Q3.
Oil Commodity
Oil prices plunge after Saudi Arabia announces plans to boost output
Crude oil fell below $68 per bbl after Saudi Arabia said it will scrap its $100/bbl price target and increase production.
Fr, 20 Sep 2024
Semiconductors & Equipment
Can Intel really create a successful foundry in the United States
We delve into this question; plus, a surprise offer to buy the company.
Textiles, Apparel, & Luxury Goods
Nike fires CEO John Donahoe
Elliott Hill, a longtime company veteran, will take over the role in October.
Three Mile Island to Reopen
A deal between Constellation Energy Group (CEG $223) and Microsoft (MSFT $437) will restart the Three Mile Island nuclear plant in PA, with all of the energy generated being used to power the tech giant's AI centers.
Th, 19 Sep 2024
Latvian President offers bold leadership against Russian aggression
In an interview with Bloomberg, Latvian President Edgars Rinkevics said that the shackles on Ukraine's ability to fight war must be removed. He said the only way to bring Putin to the negotiating table is through strength, which includes the unfettered ability of Ukraine to use its weapons within Russia. Bold—and true—words from the leader of a country which borders Putin's Russia.
We, 18 Sep 2024
Fed surprises markets with a bold 50-basis-point rate cut
Odds were for a more moderate, 25-bps cut. He reiterated that the economy is in a good place, however, assuaging fears that the larger cut was due to economic weakness.
Mo, 16 Sep 2024
Transportation Infrastructure
Uber shares spike on driverless ride deal with Waymo
In a sign of what the nation's streets may look like soon, Penn New Frontier Fund member Uber (UBER $72) has inked an exclusive deal with autonomous car company Waymo, a subsidiary of Alphabet (GOOG $159), to provide driverless transport to ride-hailers in Austin and Atlanta. The trips, which will begin in early 2025, can only be booked through the Uber app. Uber shares popped 7% on the announcement.
This approach is an interesting one which begs the question, why isn't Waymo going it alone? After all, the company's autonomous vehicles can already be seen on the streets of San Francisco 24/7, with around 50,000 paid rides per week. The answer has to do with Uber's massive infrastructure and dominance within the industry. The company has been rapidly expanding its global reach, with special emphasis on Latin America and Europe. With 150 million customers using the Uber app, its advanced platform sets it apart from the competition. Since replicating the platform would be a herculean task, it makes sense for a hardware/software company like Waymo to "plug into" the Uber app and simply take a cut of the revenue generated. Neither company has offered any glimpse into what the revenue-sharing structure looks like.
Another catalyst for the deal was probably the planned Tesla (TSLA $227) robotaxi event slated for mid October. Always the showman, Tesla's Elon Musk has billed the event as the company's most significant moment since the introduction of the Model 3 nearly a decade ago. Analysts are expecting an impressive demonstration of the full self-driving (FSD) capabilities of the vehicle. For its part, Uber sold its own self-driving division to start-up competitor Aurora Innovation for $4 billion in 2020.
We still don't believe analysts are fully grasping how FSD technology will reshape the transportation landscape over the coming decades. Despite their respective share prices, we are still buyers of Uber, Alphabet, and Tesla. Not so much the legacy domestic car companies, which continue to fumble the ball in this arena.
Mo, 09 Sep 2024
IT Software & Services
Palantir will be added to the S&P 500; share price soars
How wonderfully fitting: One of our favorite companies is knocking one of our least favorite companies out of the S&P 500. S&P Global has announced that software platforms and data mining company Palantir (PLTR $35) will replace American Airlines (AAL $11) in the benchmark index as of the 23rd of September. Palantir shares spiked 14% on the trading day following the news, and are now up 77% year to date. We have owned this stellar company within the Penn New Frontier Fund since the day it went public at $10 per share.
Along with the announcement on Palantir came news that Dell Technologies (DELL $106) would replace Etsy (ETSY $52) within the index, and Erie Indemnity (ERIE $504) would replace diagnostics and life sciences company Bio-Rad (BIO $323). Erie is an underwriter for insurance products such as personal liability, property, home, flood, and auto policies.
As for the company Palantir is knocking out of the index, American Airlines, one could make an argument that it is grossly undervalued at $11 per share. We are reminded of clients who would tell us, "The stock is near $10 per share, it has to be undervalued!" Of course, share price means absolutely nothing by itself. Yes, AAL was trading near $60 per share six years ago; it also lost $121 million on $50 billion in revenue over the trailing twelve months, has a horrendous customer service reputation, and a hapless management team. If you want to own an airline, buy the one airline in the Penn Global Leaders Club: United (UAL $49)—it actually turns a profit ($3B on $52B TTM).
For investors who didn't buy into Palantir in the early days, is $35 to rich to take a position? Not in our opinion. This cutting edge company (their proprietary technology helped identify the whereabouts of Osama bin Laden so that the United States military could take him out) has an exemplary management team, a new headquarters in Colorado (from Silicon Valley), and a very bright future ahead of it. We wouldn't hesitate picking up more shares at this price, with the realization that volatility will continue to whipsaw the shares.
Fr, 06 Sep 2024
Food Products
Candy bar maker Mars to buy snack maker Kellanova for $36 billion
From the start, we wrote disparagingly of cereal maker Kellogg's plans to split into multiple entities. Even before that strategic event, we had little respect for the company's management team, strongly favoring competitor General Mills (GIS $75) instead. Ultimately, the financial engineering feat took place last year, with WK Kellogg (KLG $18) retaining the $2 billion cereal business, and spin-off Kellanova (K $80) retaining the long-time stock symbol and the snacking business. Now, lo and behold, the latter entity has found a suitor willing to pony up big bucks to buy the firm.
Mars, one of the largest privately held companies in the US and maker of a vast line of confectionary snacks, has agreed to buy Kellanova for $36 billion, which includes the assumption of $6 billion worth of debt. That equates to about $84 per share, or a 40% premium to where the shares were trading prior to the announcement. With the acquisition, Mars will be buying such brands as Eggo, Pringles, Pop-Tarts, Cheez-Its, and dozens of other household names.
The packaged-food aisles of the grocery store have been under strain for the past several years, as consumers continue to gravitate toward healthier options. The size of the deal makes it one of the largest M&A moves in recent memory within this industry, and may well spur other similar deals. Recall that Kellogg CEO Gary Pilnick was the brilliant C-suite executive who recently suggested that families struggling with food inflation start eating cereal for dinner. ("Let them eat Froot Loops!"?) Meanwhile, Kellanova CEO Steve Cahillane is expected to leave that firm after the Mars deal is completed.
As we haven't invested in Kellogg's in decades, the deal really doesn't affect us, though we do believe Mars can make it work. The company's vast distribution network and strong management team will take this moribund (or at least lethargic) company and breathe new life into the brands. As for competitor General Mills, which also owns the Blue Buffalo pet food line, we have owned it within the Penn Global Leaders Club since 2017.
Tu, 26 Nov 2024
Happiness Index
Consumer confidence jumps to 16-month high
Based on November's index of consumer confidence, Americans are suddenly feeling rosy about the year ahead. The index hit a 16-month high of 111.7, beating expectations. This report also bodes well for the Christmas shopping season, as consumers tend to spend more on discretionary items when they feel good about the where the economy is headed.
Specialty Retail
Best Buy shares drop on Q3 miss and forecast cut
Best Buy (BBY $86) shares fell 7% on the open after the electronics retailer saw its revenue decline 3.2% y/y and its earnings decline 2% y/y, falling short of estimates. The company also slashed its guidance for the full year, citing "distraction during the run-up to the election" as one of the factors. We've heard some lame ones before, but that one might just take the cake. We might be tempted to be bullish on the shares considering the drop, but management isn't exactly instilling confidence that they have a sound solution.
Mo, 25 Nov 2024
Monetary Policy
Stocks rip higher on news that Trump will tap market-friendly deficit hawk Scott Bessent to head Treasury
Simply an excellent pick. Scott Bessent is a successful hedge fund manager and someone who is actually concerned about the national debt and deficit. Markets rallied on the news.
Sa, 23 Nov 2024
Market Pulse
Stocks are ripping into year end, with small caps leading the way
Gold and crude outperformed equities, however, and Bitcoin is now up nearly 50% in the two weeks since the election.
Fr, 22 Nov 2024
Capital Markets
A just-announced deal is about to make the CEO of Jersey Mike's a very wealthy man
Peter Cancro was a working-class kid when he went deep into debt to buy a struggling sandwich shop. Fifty years later, he is about to become one of the 500 richest people in the world.
We, 20 Nov 2024
Multiline Retail
If Walmart is the gift that keeps on giving, then Target is the Grinch
The juxtaposition of Target's earnings the day after Walmart's stellar results could not be any more stark; while WMT shares hit a new all-time high, TGT shares were plunging 22%.
Tu, 19 Nov 2024
Food & Staples Retailing
Walmart shares just hit a new high on earnings; other deep discounters have not been so lucky
The disparity over the past year between Walmart's performance and the performance of Dollar General and Dollar Tree is staggering. A lot has to do with income classes. Visit the story by selecting the link above.
Mo, 18 Nov 2024
Airlines & Air Freight
After judge shoots down merger, Spirit Airlines files for bankruptcy
Something we have seen coming for over a year. Spirit Airlines, after spurning an excellent merger offer from Frontier, took a competing offer from lousy JetBlue. A judge shot the merger down this past January, and now Spirit has announced it is filing for bankruptcy. Ineptness, mismanagement, arrogance, years of operating in the red, and now bankruptcy.
We, 13 Nov 2024
Supply, Demand, & Prices
Futures turned positive after inflation report hits expectations
Investors were concerned about the CPI report before its release. If it showed an uptick in inflation, it would give the Fed pause to pull the trigger on another rate cut at the December FOMC meeting. When the report hit, however, those fears were quelled. The consumer price index rose 0.2% in October, taking the 12-month inflation rate up to 2.6%, or precisely what economists had been predicting. There is now an 83% chance of another rate cut next month.
Tu, 12 Nov 2024
Aerospace & Defense
Elliott takes a stake in Honeywell, calls for the company to be broken in two
Elliott Investment Management has revealed it has taken a $5 billion stake in the industrial giant, market cap $152B, and is calling for the company to separate its two main entities into standalone companies—its aerospace business and its automation business. HON shares rose 4% on the news, hitting a new 52-week high. HON is one of the top holdings in our Aerospace and Defense ETF (PPA $123). We would probably be supportive of such an action, pending the details.
Mo, 04 Nov 2024
IT: Technology Hardware & Equipment
A lot of skeletons in Super Micro's closet
Shares of the Cali-based firm were riding high on the AI wave, hitting $122.90 this past March. Since then, it has been a nightmarish ride down.
Fr, 01 Nov 2024
Economics: Work & Pay
Disastrous jobs report for October
It is hard to imagine a weaker jobs report rolling in four days before the national election. Against expectations for a relatively weak 100,000 new jobs created, nonfarm payrolls in the US came in at just 12,000 new jobs. The unemployment level remained steady at 4.1%. Excuses centered around the hurricanes and the Boeing strike. This is the worst jobs report since December 2020, winter of the pandemic. The lousy report all but guarantees a 25-bps rate cut by the Fed in November.
We, 30 Oct 2024
Super Micro auditor Ernst & Young resigns, shares plunge...
Tu, 29 Oct 2024
Health Care Providers & Services
GeneDx skyrockets 45% on the back of first profitable quarter (WGS $83)
Small-cap genetics testing company GeneDx spiked 50% on Tuesday following stellar Q3 results. Against estimates for a lose of $0.19 per share, the company actually earned $0.04 per share—its first-ever profitable quarter. Shares were trading under $3 going into the year, equating to a year-to-date return of over 2,900% based on the current share price.
Automotive
Ford shares plunge after lousy quarterly report (F $10)
On the heels of great Tesla and strong GM quarterly earnings reports, Ford threw cold water on the party. Though the automaker beat slightly on top line revenue and bottom line net income, it reduced its forward guidance for adjusted EBIT down from $12 billion to $10 billion. CFO John Lawler blamed supply chain disruptions and higher costs for the downward-revised figures. Funny the other two automakers didn't mention either of these problems. Ford shares were trading down around 8% after the report, to $10.44/sh.
Th, 24 Oct 2024
Skecher's pops 10% after hours after earnings beat...
In rare win for FTC, judge blocks Tapestry deal with Capri, Capri shares fall 52%...
TSMC's Arizona chip facility yields better than plant in Taiwan...
Metals & Mining
Leading global gold mining company Newmont falls 14% on Q3 earnings report
Newmont, the world's largest gold miner, saw its shares slashed by 14% after missing expectations for the quarter—which may seem odd, considering gold is at a 5,000-year high price. Revenue came in at $4.61B ($4.67B est.) and earnings came in at $0.81/sh ($0.86/sh est.). The company blamed the poor performance on the increased cost of extraction, thought that doesn't really explain the revenue miss.
Aerospace & Defense
The 1970s are calling: Boeing's union workforce rejects company offer, demands a return to pensions
Ludicrous—it will not happen. Boeing's factory workers, 33,000 members of the International Association of Machinists and Aerospace Workers, voted down the company's latest offer of a 35% pay increase over four years. While not as decisive as the previous rejection, 64% of the union members voted against the deal. They are demanding a return to the defined benefits pension plan which has been gone for over a decade. Boeing shares are now off 40% YTD; Airbus shares are flat over that time frame. Striking Boeing workers are not being paid by the company while they strike; rather, they receive a $250/week stipend from the union's strike fund. Boeing workers in North Carolina continue their work, as they are non-unionized.
Automotive
Tesla shares spike 10% after hours on Q3 beat
Shares of EV-leader Tesla jumped 10% after the company announced impressive Q3 numbers, with the Cybertruck already becoming profitable. The company generated $25.2 billion in revenue over the quarter, an 8% uptick from the same quarter last year, while net income rose to $2.2 billion, for a 17% beat y/y.
We, 23 Oct 2024
Restaurants
Fallout from McDonald's E. coli outbreak
Dozens of McDonald's customers throughout the Mountain states came down sick due to an E. coli outbreak linked to the restaurant's Quarter Pounders, with one person dying from the illness. The company believes it has narrowed the problem down to sliced onions found in the burger, as this ingredient all stems from one supplier (unlike the beef at the restaurants, for example). Share of MCD have fallen around 5% over the past two trading sessions. We don't believe it is cheap enough to jump in on the slide.
Housing
Existing home sales drop to 14-year low
Somewhat bizarrely, post-Fed rate cut, the 30-year mortgage rate is headed back up near 7% (6.92% now) and it is causing the sale of existing homes to decline to levels not seen in fourteen years. Annualized rate of home sales dropped to 3.84 million in September, compared to a 25-year average of 5.26 million per year. This was the worst one-month sales figure going back to October 2010.
Mo, 21 Oct 2024
National Debt & Deficit
Our "leaders" spent $1.8 trillion more than they brought in last year
It was the third-largest deficit on record, trailing only the two years of the pandemic.
We, 09 Oct 2024
Cybersecurity
Another US critical infrastructure attack
This is getting old. The latest attack came against America's largest investor-owned water utility.
Mo, 07 Oct 2024
Pharmaceuticals
Something finally moved Pfizer's share price: an activist
Shares of the Penn member were trading up 4% on the news.
We, 02 Oct 2024
Global Strategy: East/Southeast Asia
Japan has a new leader, and China is none too happy about the choice
Shigeru Ishiba wants to confront Chinese aggression in the region, and he has called for a snap election this month. We are bullish on Japan, and he is yet another reason why.
Automotive
Stellantis's US sales are crushing it—the company, that is
Automaker Stellantis, the former Fiat Chrysler, announced a blistering 20% drop in US sales in the July through September period, the worst performance of any major automaker. Fiat was the only line which did not suffer a drop, while the Chrysler and Dodge likes were off some 40%. Jeep sales fall 6% year/year.
Textiles, Apparel, & Luxury Goods
Nike shares drop on quarterly sales figures
They are trying to place blame on the former CEO, but Nike shares fell some 7% (17% down year-to-date) after the company announced a 10% drop in quarterly sales from the same period last year; net income fell 28% for the same period. Last month the company parted ways with John Donahoe, naming retired exec Elliot Hill new CEO. We aren't touching the shares.
Health Care Providers & Services
Humana shares plunge 20% on ratings drop
Health insurance provider Humana suffered one of its worst one-day drops ever as it warns that changes in the government's quality ratings of Medicare plans could weigh heavily on its profits. The company has roughly 25% of its members enrolled in plans rated four- or five-stars for 2025, a 94% drop from 2024 enrollment.
Fr, 27 Sep 2024
Global Strategy: East/Southeast Asia
A stand against Chinese aggression: Japan has a new hawkish PM
Japan's ruling Liberal Democratic Party (LDP) selected China hawk Shigeru Ishiba to become the country's newest prime minister. The 67-year-old Ishiba is an advocate of an "Asian NATO," favoring ramped up and "obligatory" security arrangements in the region to fight Chinese aggression.
Th, 26 Sep 2024
Media & Entertainment
DirecTV and Dish are nearing merger agreement
Based on the changing television landscape, it only makes sense. The two remaining satellite pay-TV providers, DirecTV and Dish, are apparently close to signing a merger agreement. With cord cutting, will it matter?
Economics
US economy remains on strong footing
It was reaffirmed that the US economy grew at a robust 3% clip in the second quarter of the year, and projections are the same for Q3.
Oil Commodity
Oil prices plunge after Saudi Arabia announces plans to boost output
Crude oil fell below $68 per bbl after Saudi Arabia said it will scrap its $100/bbl price target and increase production.
Fr, 20 Sep 2024
Semiconductors & Equipment
Can Intel really create a successful foundry in the United States
We delve into this question; plus, a surprise offer to buy the company.
Textiles, Apparel, & Luxury Goods
Nike fires CEO John Donahoe
Elliott Hill, a longtime company veteran, will take over the role in October.
Three Mile Island to Reopen
A deal between Constellation Energy Group (CEG $223) and Microsoft (MSFT $437) will restart the Three Mile Island nuclear plant in PA, with all of the energy generated being used to power the tech giant's AI centers.
Th, 19 Sep 2024
Latvian President offers bold leadership against Russian aggression
In an interview with Bloomberg, Latvian President Edgars Rinkevics said that the shackles on Ukraine's ability to fight war must be removed. He said the only way to bring Putin to the negotiating table is through strength, which includes the unfettered ability of Ukraine to use its weapons within Russia. Bold—and true—words from the leader of a country which borders Putin's Russia.
We, 18 Sep 2024
Fed surprises markets with a bold 50-basis-point rate cut
Odds were for a more moderate, 25-bps cut. He reiterated that the economy is in a good place, however, assuaging fears that the larger cut was due to economic weakness.
Mo, 16 Sep 2024
Transportation Infrastructure
Uber shares spike on driverless ride deal with Waymo
In a sign of what the nation's streets may look like soon, Penn New Frontier Fund member Uber (UBER $72) has inked an exclusive deal with autonomous car company Waymo, a subsidiary of Alphabet (GOOG $159), to provide driverless transport to ride-hailers in Austin and Atlanta. The trips, which will begin in early 2025, can only be booked through the Uber app. Uber shares popped 7% on the announcement.
This approach is an interesting one which begs the question, why isn't Waymo going it alone? After all, the company's autonomous vehicles can already be seen on the streets of San Francisco 24/7, with around 50,000 paid rides per week. The answer has to do with Uber's massive infrastructure and dominance within the industry. The company has been rapidly expanding its global reach, with special emphasis on Latin America and Europe. With 150 million customers using the Uber app, its advanced platform sets it apart from the competition. Since replicating the platform would be a herculean task, it makes sense for a hardware/software company like Waymo to "plug into" the Uber app and simply take a cut of the revenue generated. Neither company has offered any glimpse into what the revenue-sharing structure looks like.
Another catalyst for the deal was probably the planned Tesla (TSLA $227) robotaxi event slated for mid October. Always the showman, Tesla's Elon Musk has billed the event as the company's most significant moment since the introduction of the Model 3 nearly a decade ago. Analysts are expecting an impressive demonstration of the full self-driving (FSD) capabilities of the vehicle. For its part, Uber sold its own self-driving division to start-up competitor Aurora Innovation for $4 billion in 2020.
We still don't believe analysts are fully grasping how FSD technology will reshape the transportation landscape over the coming decades. Despite their respective share prices, we are still buyers of Uber, Alphabet, and Tesla. Not so much the legacy domestic car companies, which continue to fumble the ball in this arena.
Mo, 09 Sep 2024
IT Software & Services
Palantir will be added to the S&P 500; share price soars
How wonderfully fitting: One of our favorite companies is knocking one of our least favorite companies out of the S&P 500. S&P Global has announced that software platforms and data mining company Palantir (PLTR $35) will replace American Airlines (AAL $11) in the benchmark index as of the 23rd of September. Palantir shares spiked 14% on the trading day following the news, and are now up 77% year to date. We have owned this stellar company within the Penn New Frontier Fund since the day it went public at $10 per share.
Along with the announcement on Palantir came news that Dell Technologies (DELL $106) would replace Etsy (ETSY $52) within the index, and Erie Indemnity (ERIE $504) would replace diagnostics and life sciences company Bio-Rad (BIO $323). Erie is an underwriter for insurance products such as personal liability, property, home, flood, and auto policies.
As for the company Palantir is knocking out of the index, American Airlines, one could make an argument that it is grossly undervalued at $11 per share. We are reminded of clients who would tell us, "The stock is near $10 per share, it has to be undervalued!" Of course, share price means absolutely nothing by itself. Yes, AAL was trading near $60 per share six years ago; it also lost $121 million on $50 billion in revenue over the trailing twelve months, has a horrendous customer service reputation, and a hapless management team. If you want to own an airline, buy the one airline in the Penn Global Leaders Club: United (UAL $49)—it actually turns a profit ($3B on $52B TTM).
For investors who didn't buy into Palantir in the early days, is $35 to rich to take a position? Not in our opinion. This cutting edge company (their proprietary technology helped identify the whereabouts of Osama bin Laden so that the United States military could take him out) has an exemplary management team, a new headquarters in Colorado (from Silicon Valley), and a very bright future ahead of it. We wouldn't hesitate picking up more shares at this price, with the realization that volatility will continue to whipsaw the shares.
Fr, 06 Sep 2024
Food Products
Candy bar maker Mars to buy snack maker Kellanova for $36 billion
From the start, we wrote disparagingly of cereal maker Kellogg's plans to split into multiple entities. Even before that strategic event, we had little respect for the company's management team, strongly favoring competitor General Mills (GIS $75) instead. Ultimately, the financial engineering feat took place last year, with WK Kellogg (KLG $18) retaining the $2 billion cereal business, and spin-off Kellanova (K $80) retaining the long-time stock symbol and the snacking business. Now, lo and behold, the latter entity has found a suitor willing to pony up big bucks to buy the firm.
Mars, one of the largest privately held companies in the US and maker of a vast line of confectionary snacks, has agreed to buy Kellanova for $36 billion, which includes the assumption of $6 billion worth of debt. That equates to about $84 per share, or a 40% premium to where the shares were trading prior to the announcement. With the acquisition, Mars will be buying such brands as Eggo, Pringles, Pop-Tarts, Cheez-Its, and dozens of other household names.
The packaged-food aisles of the grocery store have been under strain for the past several years, as consumers continue to gravitate toward healthier options. The size of the deal makes it one of the largest M&A moves in recent memory within this industry, and may well spur other similar deals. Recall that Kellogg CEO Gary Pilnick was the brilliant C-suite executive who recently suggested that families struggling with food inflation start eating cereal for dinner. ("Let them eat Froot Loops!"?) Meanwhile, Kellanova CEO Steve Cahillane is expected to leave that firm after the Mars deal is completed.
As we haven't invested in Kellogg's in decades, the deal really doesn't affect us, though we do believe Mars can make it work. The company's vast distribution network and strong management team will take this moribund (or at least lethargic) company and breathe new life into the brands. As for competitor General Mills, which also owns the Blue Buffalo pet food line, we have owned it within the Penn Global Leaders Club since 2017.
Headlines for the Month of July/Aug 2024
Mo, 26 Aug 2024
Aerospace & Defense
NASA makes a stunning announcement with respect to Boeing Starliner astronauts
It was supposed to be an eight-day mission, and a chance for Boeing (BA $174) to show it finally had its act together—at least on the space side of its business. When veteran NASA astronauts and former test pilots Suni Williams and Butch Wilmore were launched aboard the Boeing Starliner back in early June, it was following years of embarrassing setbacks for the program; a period which saw massive successes for SpaceX's own crewed space program. Now, nearly three months after the launch, the astronauts remain in space and NASA has made a stunning announcement.
Problems for the Starliner capsule began early after the craft entered orbit. It remains parked at the International Space Station with malfunctioning thrusters and leaking helium among other glitches. All Boeing had to do was complete this mission successfully to get certified by the space agency for crewed transport—a feat SpaceX accomplished four years ago. Now, NASA has made the decision to let the Starliner return to Earth empty, and has tasked a SpaceX Dragon capsule to bring the astronauts back home next February. A brief, eight-day mission has turned into a nine-month ordeal and another humiliation for Boeing.
Following years of tragic incidents involving Boeing aircraft, the company has finally hired a CEO with real-world aerospace experience. Kelly Ortberg, who replaced outgoing CEO Dave Calhoun, joined Rockwell Collins in 1987, working his way up to the top job at that company in 2013. After overseeing the United Technologies (now part of Raytheon) acquisition of Rockwell, Ortberg retired in 2021, but Boeing's highly qualified board chair, former Qualcomm CEO Steve Mollenkopf, convinced him to come out of retirement to lead the turnaround effort. Considering the myriad of problems plaguing the aerospace giant, from labor union issues to serious quality control deficiencies, the spry 64-year-old may end up regretting that decision.
At $173 per share (down from a high of $446/sh), investors may want to jump into a BA position based on the new CEO. We believe the stock is a value trap, however. Even if Ortberg lives up to expectations, it will take years for the company to get back in the good graces of regulators, customers, and the flying public. If the stock price looks enticing, investors should take a sober look at the company's current debt load and consider the fact that it hasn't turned a profit since 2018.
Mo, 29 Jul 2024
Aerospace & Defense
US State Department approves sale of over 1,000 loitering munitions to Taiwan
Drawing the usual response of outrage from Beijing, the US Department of State has approved the sale of over 1,000 loitering munitions to Taiwan as the island nation (yes, nation) faces growingly belligerent behavior from mainland China. The munitions are made by publicly traded defense contractor AeroVironment (AVAV $172) and privately held Unduril Industries—an American defense technology firm.
Under the Taiwan Relations Act of 1979, which was Jimmy Carter's watered-down version of the 1955 Mutual Defense Treaty between the United States and the Republic of China (Taiwan), the US is obligated to help the island defend itself from its communist neighbor some 100 miles to its northwest. In addition to the loitering munitions, which are designed to fly around a target area then attack the target by crashing into it, Taiwan also has a US Patriot surface-to-air missile system deployed, and approximately 150 F-16 General Dynamics (GD $290) Fighting Falcons.
The most recent sale of defensive weapons to Taiwan, worth about $360 million, comes on the heels of valuable lessons gleaned from the Ukranian battlefield. Both the AeroVironment Switchblade® 300 and the larger Unduril Altius 600M, which can carry multiple seeker and warhead options, have been used effectively in that conflict, both for attack and reconnaissance purposes. These armaments are part of a much larger cache of weapons which have been approved for sale but are still awaiting delivery to the island. Total value of the weapons the Taiwanese military waits for? $20 billion. The wheels of justice—and apparently defense—turn slowly.
AeroVironment is an interesting mid-cap ($5 billion) industrials play. While its forward P/E of 50 is a bit rich, it turns a profit and has virtually no debt on its books. As for privately held Unduril, the only way to buy in would be through a private equity fund like those available within the Penn strategies.
Mo, 22 Jul 2024
Multiline Retail
Macy's will go it alone, ends talk of sale to go private
Last December we wrote of Macy's (M $16) planned deal to sell itself to Arkhouse Management and Brigade Capital Management for approximately $6 billion, thus becoming a privately held retailer. Shares surged 20% higher on the news. Last week, the opposite took place. Shares of M plunged after the company's board unanimously agreed to walk away from what they perceived as an underwhelming proposal that came with a lack of certainty over financing. They punted despite the raised offer price of $7 billion from the would-be buyers.
Macy's has faced severe competition in recent years from not only traditional peers such as Nordstrom and Kohl's, but also from retail giants like Amazon, Walmart, and Target who have been encroaching on their turf with higher-quality clothing. As if the environment weren't challenging enough, Chinese online retailers like SHEIN are now eating into market share. JC Penney lost its battle to stay public after being forced into bankruptcy by a massive debt load, only to be purchased for the paltry amount of $800 million ($300 million in cash and the assumption of $500 million of debt) by two retail REITs. The same two REITs, Brookfield Asset Management and Simon Property Group, were on the verge of buying struggling retailer Kohl's for $8.6 billion back in 2022 until management downgraded its full-year outlook. Kohl's now has a market cap of $2.5 billion.
Macy's may not end up like its unfortunate peers, however. Not only does the company own massive real estate holdings (which Arkhouse and Brigade almost certainly would have sold off to gain capital), it also has a promising strategic initiative to be spearheaded by new CEO Tony Spring. Actions will include closing unprofitable locations, increasing the upscale Bloomingdale's brand, enhancing the customer shopping experience, and improving an already robust online presence. Had the firm gone private, the focus would have been squarely on cannibalizing the company's assets rather than maximizing potential.
We last owned Macy's in the Intrepid Trading Platform back in 2020. In November of that year, we closed the position for an 82% gain. While we don't currently plan on adding the company back into a strategy, we do believe the shares are worth north of $20.
Th, 11 May 2024
Technology Hardware & Equipment
The strange case of Microsoft ordering workers to carry iPhones
To be clear, this order only involves Microsoft's (MSFT $466) Chinese workforce, but on its face it does seem odd. After all, the iOS used in Apple's (AAPL $225) iPhones is a competitor to Microsoft's Windows operating system. So why the sudden mandate?
Android is an operating system created by Google (GOOGL $189) to power mobile devices such as smartphones. Currently, around 70% of the world's phones use this technology, despite the iPhone's dominance in the US market. Following a series of Russian-linked cyberattacks, Microsoft launched a cybersecurity program called Secure Future Initiative (SFI). Under this program, employees will soon be required to verify their identities upon logging into their devices, which necessitates the downloading of Microsoft's Authenticator password manager and Identity Pass app. While these apps are available on Google Play, that service isn't available in China thanks to the communist nation's Internet censorship system, known as the Great Firewall. This leaves Apple's App Store as the only viable download source in the country.
Obviously, authorities would like every citizen to use smartphones made by China's Huawei or Xiaomi, which have developed their own unique software platforms—migrating away from Android. Any Microsoft employee in China using Android phones, to include devices made by the two domestic firms, will be provided an iPhone 15 by the company. More and more Chinese firms and government agencies are banning foreign phones from the workplace, citing security concerns. Coming from the world's leading intellectual property (IP) thief, that is rich.
This case further spotlights the fine line American firms operating in China must walk. It also provides more evidence for the need to diversify away from the increasingly troublesome country. The guise of free and fair trade has been revealed for what it has always been: a sham.
Tu, 21 May 2024
Semiconductors & Equipment
Nvidia just had an incredible quarter; a stock split is on the way
Precisely three months ago to the day, we reported on AI chip designer Nvidia's (NVDA $1,035) "crazy-good quarter." We are running out of adjectives to use for this firm's performance on the heels of a quarter that just eclipsed the previous one. Sales jumped 262% (not a typo) in the fiscal first quarter from the previous year, to $26 billion, and earnings came in at $6.12 per share; both numbers handily beat Wall Street estimates. Guidance for the second fiscal quarter of the year calls for $28 billion in revenue, and we have little doubt that the number will be reached. Shares were trading up double digits at the open following the release.
Just a reminder of what Nvidia does. In macro terms, think of it as the engine of AI. It provides a complete hardware and software package for companies operating within this new realm. It is the world's leading designer of graphics processing units (GPUs) which were traditionally used in gaming platforms, but are now an integral part of artificial intelligence. No one single company benefits more from the adoption of AI than Nvidia.
Going into Thursday morning, Nvidia was a $2.3 trillion company sitting in size only behind Microsoft and Apple. By the day's close, it carried a market cap in excess of $2.6 trillion, just 10% below Apple's market cap. Putting its growth in perspective, the company's shares were selling for around $100 apiece back in October of 2022. Along with the blowout quarterly results and the $1,000+ share price came news that the company would execute a ten-for-one stock split as of market open on June 10th. This would put them back around the $100 range, making the company more attractive to many retail buyers (though the valuation doesn't change due to a split, of course). In other words, we don't see their share price or the company's 39 forward multiple dissuading new buyers from jumping in.
In addition to the obvious customers such as Amazon, Meta, Microsoft, and Google, Nvidia is also working with over 300 companies in the autonomous driving space. Cash rich, growing free cash flow, and accelerating revenue growth; it is difficult not to love this firm. Not only is Nvidia a member of the Penn New Frontier Fund, it is also a top holding in several ETFs within the Penn Dynamic Growth Strategy.
Tu, 21 May 2024
Latin America
Even with leftists, China is wearing out its welcome in Latin America
No matter the year, there are always a handful of leftist leaders sprinkled throughout Latin America who would gladly work hand-in-hand with China if for no other reason than their disdain for the United States. The current lineup includes AMLO of Mexico, Lula of Brazil, Boric of Chile, and Petro of Colombia. Lula regularly welcomes Chinese warships to dock at ports in Rio, not to mention "warships" of the Iranian navy. But the communist nation seems to be doing everything it can to spoil its simpatico relationship with our neighbors to the south by using the old and stale playbook of dumping—flooding a foreign market with goods at a price below which domestic producers can compete.
Two dozen years ago, China exported under 100,000 tons of steel to Latin America each year. Now, it is flooding the region with almost ten million tons of the metal alloy—worth around $8.5 billion—annually. The US and EU have already slapped massive penalties on steel emanating from China, and suddenly three of the four countries mentioned above are following suit with similar—though not near as stiff—tariffs. They must walk a fine line, however, as China is both the biggest buyer of raw materials from and a major investor in the region. There are many retribution levers in which to pull, and China has shown a willingness to wantonly use these tools in the past.
Argentina is a great example of how quickly the landscape can change. Just two short years ago, under the leadership of Peronist President Alberto Fernandez, the country became part of China's grand Belt and Road Initiative—otherwise known as the New Silk Road. With the election of outspoken capitalist Javier Milei came the worst possible outcome for China: a pro-American president who talks of the evils of communism. While China has done an excellent job of placing government officials in the smallest of South American provinces, it won't take much for the working class masses to see what is going on. As is always the case, socialist leaders will try to pin economic troubles on the US; but that argument is getting more and more tenuous. As a miner in Argentina's northwestern province of Jujuy ("who who EEH") put it, "The Chinese seem to be taking over everything." The best thing the United States can do in response is work diligently to strengthen ties throughout every corner of the region.
The United States has a comically bad strategy with respect to maintaining relations in Latin America. In fact, it really isn't a strategy at all. It is more to the discredit of America's hodge-podge approach to the region that it is to the credit of China's efforts. With each new US administration comes a new policy, much to the consternation of our true friends throughout Latin America. We are not going to win over the likes of a Lula in Brazil, but why alienate those who share our beliefs? It is time for a Monroe Doctrine 2.0; a warning shot fired over the head of communist China. But who is around to craft such a document?
Mo, 26 Aug 2024
Aerospace & Defense
NASA makes a stunning announcement with respect to Boeing Starliner astronauts
It was supposed to be an eight-day mission, and a chance for Boeing (BA $174) to show it finally had its act together—at least on the space side of its business. When veteran NASA astronauts and former test pilots Suni Williams and Butch Wilmore were launched aboard the Boeing Starliner back in early June, it was following years of embarrassing setbacks for the program; a period which saw massive successes for SpaceX's own crewed space program. Now, nearly three months after the launch, the astronauts remain in space and NASA has made a stunning announcement.
Problems for the Starliner capsule began early after the craft entered orbit. It remains parked at the International Space Station with malfunctioning thrusters and leaking helium among other glitches. All Boeing had to do was complete this mission successfully to get certified by the space agency for crewed transport—a feat SpaceX accomplished four years ago. Now, NASA has made the decision to let the Starliner return to Earth empty, and has tasked a SpaceX Dragon capsule to bring the astronauts back home next February. A brief, eight-day mission has turned into a nine-month ordeal and another humiliation for Boeing.
Following years of tragic incidents involving Boeing aircraft, the company has finally hired a CEO with real-world aerospace experience. Kelly Ortberg, who replaced outgoing CEO Dave Calhoun, joined Rockwell Collins in 1987, working his way up to the top job at that company in 2013. After overseeing the United Technologies (now part of Raytheon) acquisition of Rockwell, Ortberg retired in 2021, but Boeing's highly qualified board chair, former Qualcomm CEO Steve Mollenkopf, convinced him to come out of retirement to lead the turnaround effort. Considering the myriad of problems plaguing the aerospace giant, from labor union issues to serious quality control deficiencies, the spry 64-year-old may end up regretting that decision.
At $173 per share (down from a high of $446/sh), investors may want to jump into a BA position based on the new CEO. We believe the stock is a value trap, however. Even if Ortberg lives up to expectations, it will take years for the company to get back in the good graces of regulators, customers, and the flying public. If the stock price looks enticing, investors should take a sober look at the company's current debt load and consider the fact that it hasn't turned a profit since 2018.
Mo, 29 Jul 2024
Aerospace & Defense
US State Department approves sale of over 1,000 loitering munitions to Taiwan
Drawing the usual response of outrage from Beijing, the US Department of State has approved the sale of over 1,000 loitering munitions to Taiwan as the island nation (yes, nation) faces growingly belligerent behavior from mainland China. The munitions are made by publicly traded defense contractor AeroVironment (AVAV $172) and privately held Unduril Industries—an American defense technology firm.
Under the Taiwan Relations Act of 1979, which was Jimmy Carter's watered-down version of the 1955 Mutual Defense Treaty between the United States and the Republic of China (Taiwan), the US is obligated to help the island defend itself from its communist neighbor some 100 miles to its northwest. In addition to the loitering munitions, which are designed to fly around a target area then attack the target by crashing into it, Taiwan also has a US Patriot surface-to-air missile system deployed, and approximately 150 F-16 General Dynamics (GD $290) Fighting Falcons.
The most recent sale of defensive weapons to Taiwan, worth about $360 million, comes on the heels of valuable lessons gleaned from the Ukranian battlefield. Both the AeroVironment Switchblade® 300 and the larger Unduril Altius 600M, which can carry multiple seeker and warhead options, have been used effectively in that conflict, both for attack and reconnaissance purposes. These armaments are part of a much larger cache of weapons which have been approved for sale but are still awaiting delivery to the island. Total value of the weapons the Taiwanese military waits for? $20 billion. The wheels of justice—and apparently defense—turn slowly.
AeroVironment is an interesting mid-cap ($5 billion) industrials play. While its forward P/E of 50 is a bit rich, it turns a profit and has virtually no debt on its books. As for privately held Unduril, the only way to buy in would be through a private equity fund like those available within the Penn strategies.
Mo, 22 Jul 2024
Multiline Retail
Macy's will go it alone, ends talk of sale to go private
Last December we wrote of Macy's (M $16) planned deal to sell itself to Arkhouse Management and Brigade Capital Management for approximately $6 billion, thus becoming a privately held retailer. Shares surged 20% higher on the news. Last week, the opposite took place. Shares of M plunged after the company's board unanimously agreed to walk away from what they perceived as an underwhelming proposal that came with a lack of certainty over financing. They punted despite the raised offer price of $7 billion from the would-be buyers.
Macy's has faced severe competition in recent years from not only traditional peers such as Nordstrom and Kohl's, but also from retail giants like Amazon, Walmart, and Target who have been encroaching on their turf with higher-quality clothing. As if the environment weren't challenging enough, Chinese online retailers like SHEIN are now eating into market share. JC Penney lost its battle to stay public after being forced into bankruptcy by a massive debt load, only to be purchased for the paltry amount of $800 million ($300 million in cash and the assumption of $500 million of debt) by two retail REITs. The same two REITs, Brookfield Asset Management and Simon Property Group, were on the verge of buying struggling retailer Kohl's for $8.6 billion back in 2022 until management downgraded its full-year outlook. Kohl's now has a market cap of $2.5 billion.
Macy's may not end up like its unfortunate peers, however. Not only does the company own massive real estate holdings (which Arkhouse and Brigade almost certainly would have sold off to gain capital), it also has a promising strategic initiative to be spearheaded by new CEO Tony Spring. Actions will include closing unprofitable locations, increasing the upscale Bloomingdale's brand, enhancing the customer shopping experience, and improving an already robust online presence. Had the firm gone private, the focus would have been squarely on cannibalizing the company's assets rather than maximizing potential.
We last owned Macy's in the Intrepid Trading Platform back in 2020. In November of that year, we closed the position for an 82% gain. While we don't currently plan on adding the company back into a strategy, we do believe the shares are worth north of $20.
Th, 11 May 2024
Technology Hardware & Equipment
The strange case of Microsoft ordering workers to carry iPhones
To be clear, this order only involves Microsoft's (MSFT $466) Chinese workforce, but on its face it does seem odd. After all, the iOS used in Apple's (AAPL $225) iPhones is a competitor to Microsoft's Windows operating system. So why the sudden mandate?
Android is an operating system created by Google (GOOGL $189) to power mobile devices such as smartphones. Currently, around 70% of the world's phones use this technology, despite the iPhone's dominance in the US market. Following a series of Russian-linked cyberattacks, Microsoft launched a cybersecurity program called Secure Future Initiative (SFI). Under this program, employees will soon be required to verify their identities upon logging into their devices, which necessitates the downloading of Microsoft's Authenticator password manager and Identity Pass app. While these apps are available on Google Play, that service isn't available in China thanks to the communist nation's Internet censorship system, known as the Great Firewall. This leaves Apple's App Store as the only viable download source in the country.
Obviously, authorities would like every citizen to use smartphones made by China's Huawei or Xiaomi, which have developed their own unique software platforms—migrating away from Android. Any Microsoft employee in China using Android phones, to include devices made by the two domestic firms, will be provided an iPhone 15 by the company. More and more Chinese firms and government agencies are banning foreign phones from the workplace, citing security concerns. Coming from the world's leading intellectual property (IP) thief, that is rich.
This case further spotlights the fine line American firms operating in China must walk. It also provides more evidence for the need to diversify away from the increasingly troublesome country. The guise of free and fair trade has been revealed for what it has always been: a sham.
Tu, 21 May 2024
Semiconductors & Equipment
Nvidia just had an incredible quarter; a stock split is on the way
Precisely three months ago to the day, we reported on AI chip designer Nvidia's (NVDA $1,035) "crazy-good quarter." We are running out of adjectives to use for this firm's performance on the heels of a quarter that just eclipsed the previous one. Sales jumped 262% (not a typo) in the fiscal first quarter from the previous year, to $26 billion, and earnings came in at $6.12 per share; both numbers handily beat Wall Street estimates. Guidance for the second fiscal quarter of the year calls for $28 billion in revenue, and we have little doubt that the number will be reached. Shares were trading up double digits at the open following the release.
Just a reminder of what Nvidia does. In macro terms, think of it as the engine of AI. It provides a complete hardware and software package for companies operating within this new realm. It is the world's leading designer of graphics processing units (GPUs) which were traditionally used in gaming platforms, but are now an integral part of artificial intelligence. No one single company benefits more from the adoption of AI than Nvidia.
Going into Thursday morning, Nvidia was a $2.3 trillion company sitting in size only behind Microsoft and Apple. By the day's close, it carried a market cap in excess of $2.6 trillion, just 10% below Apple's market cap. Putting its growth in perspective, the company's shares were selling for around $100 apiece back in October of 2022. Along with the blowout quarterly results and the $1,000+ share price came news that the company would execute a ten-for-one stock split as of market open on June 10th. This would put them back around the $100 range, making the company more attractive to many retail buyers (though the valuation doesn't change due to a split, of course). In other words, we don't see their share price or the company's 39 forward multiple dissuading new buyers from jumping in.
In addition to the obvious customers such as Amazon, Meta, Microsoft, and Google, Nvidia is also working with over 300 companies in the autonomous driving space. Cash rich, growing free cash flow, and accelerating revenue growth; it is difficult not to love this firm. Not only is Nvidia a member of the Penn New Frontier Fund, it is also a top holding in several ETFs within the Penn Dynamic Growth Strategy.
Tu, 21 May 2024
Latin America
Even with leftists, China is wearing out its welcome in Latin America
No matter the year, there are always a handful of leftist leaders sprinkled throughout Latin America who would gladly work hand-in-hand with China if for no other reason than their disdain for the United States. The current lineup includes AMLO of Mexico, Lula of Brazil, Boric of Chile, and Petro of Colombia. Lula regularly welcomes Chinese warships to dock at ports in Rio, not to mention "warships" of the Iranian navy. But the communist nation seems to be doing everything it can to spoil its simpatico relationship with our neighbors to the south by using the old and stale playbook of dumping—flooding a foreign market with goods at a price below which domestic producers can compete.
Two dozen years ago, China exported under 100,000 tons of steel to Latin America each year. Now, it is flooding the region with almost ten million tons of the metal alloy—worth around $8.5 billion—annually. The US and EU have already slapped massive penalties on steel emanating from China, and suddenly three of the four countries mentioned above are following suit with similar—though not near as stiff—tariffs. They must walk a fine line, however, as China is both the biggest buyer of raw materials from and a major investor in the region. There are many retribution levers in which to pull, and China has shown a willingness to wantonly use these tools in the past.
Argentina is a great example of how quickly the landscape can change. Just two short years ago, under the leadership of Peronist President Alberto Fernandez, the country became part of China's grand Belt and Road Initiative—otherwise known as the New Silk Road. With the election of outspoken capitalist Javier Milei came the worst possible outcome for China: a pro-American president who talks of the evils of communism. While China has done an excellent job of placing government officials in the smallest of South American provinces, it won't take much for the working class masses to see what is going on. As is always the case, socialist leaders will try to pin economic troubles on the US; but that argument is getting more and more tenuous. As a miner in Argentina's northwestern province of Jujuy ("who who EEH") put it, "The Chinese seem to be taking over everything." The best thing the United States can do in response is work diligently to strengthen ties throughout every corner of the region.
The United States has a comically bad strategy with respect to maintaining relations in Latin America. In fact, it really isn't a strategy at all. It is more to the discredit of America's hodge-podge approach to the region that it is to the credit of China's efforts. With each new US administration comes a new policy, much to the consternation of our true friends throughout Latin America. We are not going to win over the likes of a Lula in Brazil, but why alienate those who share our beliefs? It is time for a Monroe Doctrine 2.0; a warning shot fired over the head of communist China. But who is around to craft such a document?
Headlines for the Month of April 2024
Th, 25 Apr 2024
Airlines & Air Freight
No more fighting for those refunds on canceled flights
It would be difficult for anyone to say, with a straight face, that the state of air travel in the US has improved over the past generation; in fact, one could easily argue that since 9/11 and the pandemic, it has gotten decidedly worse. Try to question that delayed or canceled flight and face the wrath of a ticket agent ready to call for airport security. You may be the paying customer, but they are the airline apparatchik.
Complaints surrounding air travel in general and difficulties in dealing with ticket agents specifically have reached an all-time high. Consider this disturbing statistic: one-third of all Spirit Airlines (SAVE $4), JetBlue Airways (JBLU $6), and Frontier Airlines (ULCC $6) flights end up being either delayed or canceled. Delta (DAL $48) has the best on-time record, but flyers still face a one-in-five chance of a delayed or canceled flight with that airline. And arguing for a refund has become a running joke. At least until now.
Under new Department of Transportation rules, airlines will now be required to give automatic refunds for canceled or significantly delayed flights, providing much needed consistency throughout the industry. Here's what the DOT considers a "significant change": delays of more than three hours for domestic flights and six hours for international travel; being downgraded to a lower class; a change of departure or arrival airport; and an increase in the number of connections. Any of these circumstances would trigger the auto-refund policy. Missing luggage not delivered back to passengers within a reasonable amount of time (12 hours max for domestic flights) would also trigger the new rule, which is set to be fully in place within the next six months. It is unfortunate that the government had to get involved with this situation, but in this specific case the airlines have no one to blame but themselves.
We own United Airlines (UAL $53) in the Penn Global Leaders Club and consider it best-in-class. We believe investors should completely steer clear of the low-cost carriers mentioned above, as their margins will continue to shrink based on this much-needed ruling. Recall that the FTC recently shot down the merger between Spirit and JetBlue, leaving these carriers inordinately vulnerable to the new policy.
Fr, 05 Apr 2024
Market Pulse
Not a pretty week, except for oil and gold bulls
Despite a Friday rally on a blowout jobs report, it was a down week in the market, with the small caps performing the worst—off 2.84%. Sadly, oil moved in the opposite direction with crude closing Friday at $86.73 per barrel. One other positive mover: gold. We made a big bet on the precious metal last year based on expected (eventual) rate cuts and the fiscally irresponsible politicians in D.C. That has paid off in spades: gold is now the largest position in our client portfolios, surpassing Microsoft (MSFT $426) last week. Both the S&P and the NASDAQ dropped close to 1% over the five sessions.
As mentioned, we did have a nice rally on Friday after the March jobs report showed payrolls rising by 303,000 for the month (214k was the estimate). The unemployment rate dropped from 3.9% to 3.8%. While this indicates a strong labor market, it certainly didn't add any bullet points to the rate cut argument. In fact, Powell reiterated that the Fed is in no hurry to move—which is a major reason why the week finished in the red. Expectations are now for two cuts by the end of the year, which would bring the federal funds rate down to a range of 4.75% to 5%. The long-term average rate is 4.6%.
Is the stock market overvalued? It depends on which corner you are looking at. The big tech names have driven the recent rally, leaving many reasonably priced gems sitting at reasonable valuations. The S&P 500 is a cap-weighted index, meaning the behemoths skew the results. There is an equal-weighted S&P 500 ETF (RSP $166) which looks a lot more attractive. Also, despite sticky rates, we are overweighting small-cap equities, which are just up 1.88% year to date. Back to the Fed: The Bureau of Labor Statistics releases its consumer price index next Wednesday, which will give us a good indication of which FOMC meeting will offer the first cut. Analysts are expecting a headline number around 3.5%, which is still well above the Fed's 2% inflation target. Time a little extra time this week to enjoy the beautiful (but probably windy) spring weather!
Mo, 01 Apr 2024
Restaurants
Add a Krispy Kreme doughnut to that Egg McMuffin order
In a rather brilliant move for both companies, Krispy Kreme (DNUT $15) will begin selling its doughnuts at McDonald's (MCD $280) locations across the country with a phased rollout beginning in the second half of this year. This follows a highly successful test of the program at 160 McDonald's restaurants in Lexington and Louisville, Kentucky—a dry run which exceeded expectations by both firms. Krispy Kreme already sells its doughnuts at thousands of grocery stores around the country using its hub-and-spoke model, delivering fresh-baked treats to stores within a certain mile radius of each bricks-and-mortar location.
There are just over 350 Krispy Kreme locations in the US, but there are around 14,000 McDonald's restaurants in the US, meaning the opportunity for the North Carolina-based firm is huge. The bakery also operates the Insomnia Cookies brand, which not only has 240 locations but also delivers "warm, delicious cookies right to your door daily until 3 AM." The ramp-up to handle daily McDonald's deliveries will be considerable, but the efficient assembly line system already in place should be up for the task. As for McDonald's, the "sweet" portion of their breakfast lineup has been sorely lacking, and this deal will mark a major improvement. The original glazed, chocolate iced with sprinkles, and chocolate iced cream-filled varieties will be offered throughout the day.
While both restaurants' stocks popped on the news, Krispy Kreme was the clear winner—jumping 40% in one day. The sugar high wore off quickly, however, with the shares giving back half of that gain over the ensuing days. McDonald's accounts for around one-third of all breakfast visits to fast-food restaurants, coffee shops, and bakeries, including the likes of Dunkin' and Starbucks.
Investors might be tempted to jump into Krispy Kreme shares on this news, but there are other factors which should be weighed—no pun intended. We have written about the farcical share structure of the company under which JAB Holding Company (think Caribou Coffee, Panera Bread, Keurig, and Peet's Coffee) retains 78% control. Furthermore, the company brought DNUT (former symbol KKD) public once again at $21 per share three years ago, and they have yet to regain that price. As for McDonald's, we have a $320 target share price, which would represent just a 14% jump from current levels.
Th, 25 Apr 2024
Airlines & Air Freight
No more fighting for those refunds on canceled flights
It would be difficult for anyone to say, with a straight face, that the state of air travel in the US has improved over the past generation; in fact, one could easily argue that since 9/11 and the pandemic, it has gotten decidedly worse. Try to question that delayed or canceled flight and face the wrath of a ticket agent ready to call for airport security. You may be the paying customer, but they are the airline apparatchik.
Complaints surrounding air travel in general and difficulties in dealing with ticket agents specifically have reached an all-time high. Consider this disturbing statistic: one-third of all Spirit Airlines (SAVE $4), JetBlue Airways (JBLU $6), and Frontier Airlines (ULCC $6) flights end up being either delayed or canceled. Delta (DAL $48) has the best on-time record, but flyers still face a one-in-five chance of a delayed or canceled flight with that airline. And arguing for a refund has become a running joke. At least until now.
Under new Department of Transportation rules, airlines will now be required to give automatic refunds for canceled or significantly delayed flights, providing much needed consistency throughout the industry. Here's what the DOT considers a "significant change": delays of more than three hours for domestic flights and six hours for international travel; being downgraded to a lower class; a change of departure or arrival airport; and an increase in the number of connections. Any of these circumstances would trigger the auto-refund policy. Missing luggage not delivered back to passengers within a reasonable amount of time (12 hours max for domestic flights) would also trigger the new rule, which is set to be fully in place within the next six months. It is unfortunate that the government had to get involved with this situation, but in this specific case the airlines have no one to blame but themselves.
We own United Airlines (UAL $53) in the Penn Global Leaders Club and consider it best-in-class. We believe investors should completely steer clear of the low-cost carriers mentioned above, as their margins will continue to shrink based on this much-needed ruling. Recall that the FTC recently shot down the merger between Spirit and JetBlue, leaving these carriers inordinately vulnerable to the new policy.
Fr, 05 Apr 2024
Market Pulse
Not a pretty week, except for oil and gold bulls
Despite a Friday rally on a blowout jobs report, it was a down week in the market, with the small caps performing the worst—off 2.84%. Sadly, oil moved in the opposite direction with crude closing Friday at $86.73 per barrel. One other positive mover: gold. We made a big bet on the precious metal last year based on expected (eventual) rate cuts and the fiscally irresponsible politicians in D.C. That has paid off in spades: gold is now the largest position in our client portfolios, surpassing Microsoft (MSFT $426) last week. Both the S&P and the NASDAQ dropped close to 1% over the five sessions.
As mentioned, we did have a nice rally on Friday after the March jobs report showed payrolls rising by 303,000 for the month (214k was the estimate). The unemployment rate dropped from 3.9% to 3.8%. While this indicates a strong labor market, it certainly didn't add any bullet points to the rate cut argument. In fact, Powell reiterated that the Fed is in no hurry to move—which is a major reason why the week finished in the red. Expectations are now for two cuts by the end of the year, which would bring the federal funds rate down to a range of 4.75% to 5%. The long-term average rate is 4.6%.
Is the stock market overvalued? It depends on which corner you are looking at. The big tech names have driven the recent rally, leaving many reasonably priced gems sitting at reasonable valuations. The S&P 500 is a cap-weighted index, meaning the behemoths skew the results. There is an equal-weighted S&P 500 ETF (RSP $166) which looks a lot more attractive. Also, despite sticky rates, we are overweighting small-cap equities, which are just up 1.88% year to date. Back to the Fed: The Bureau of Labor Statistics releases its consumer price index next Wednesday, which will give us a good indication of which FOMC meeting will offer the first cut. Analysts are expecting a headline number around 3.5%, which is still well above the Fed's 2% inflation target. Time a little extra time this week to enjoy the beautiful (but probably windy) spring weather!
Mo, 01 Apr 2024
Restaurants
Add a Krispy Kreme doughnut to that Egg McMuffin order
In a rather brilliant move for both companies, Krispy Kreme (DNUT $15) will begin selling its doughnuts at McDonald's (MCD $280) locations across the country with a phased rollout beginning in the second half of this year. This follows a highly successful test of the program at 160 McDonald's restaurants in Lexington and Louisville, Kentucky—a dry run which exceeded expectations by both firms. Krispy Kreme already sells its doughnuts at thousands of grocery stores around the country using its hub-and-spoke model, delivering fresh-baked treats to stores within a certain mile radius of each bricks-and-mortar location.
There are just over 350 Krispy Kreme locations in the US, but there are around 14,000 McDonald's restaurants in the US, meaning the opportunity for the North Carolina-based firm is huge. The bakery also operates the Insomnia Cookies brand, which not only has 240 locations but also delivers "warm, delicious cookies right to your door daily until 3 AM." The ramp-up to handle daily McDonald's deliveries will be considerable, but the efficient assembly line system already in place should be up for the task. As for McDonald's, the "sweet" portion of their breakfast lineup has been sorely lacking, and this deal will mark a major improvement. The original glazed, chocolate iced with sprinkles, and chocolate iced cream-filled varieties will be offered throughout the day.
While both restaurants' stocks popped on the news, Krispy Kreme was the clear winner—jumping 40% in one day. The sugar high wore off quickly, however, with the shares giving back half of that gain over the ensuing days. McDonald's accounts for around one-third of all breakfast visits to fast-food restaurants, coffee shops, and bakeries, including the likes of Dunkin' and Starbucks.
Investors might be tempted to jump into Krispy Kreme shares on this news, but there are other factors which should be weighed—no pun intended. We have written about the farcical share structure of the company under which JAB Holding Company (think Caribou Coffee, Panera Bread, Keurig, and Peet's Coffee) retains 78% control. Furthermore, the company brought DNUT (former symbol KKD) public once again at $21 per share three years ago, and they have yet to regain that price. As for McDonald's, we have a $320 target share price, which would represent just a 14% jump from current levels.
Headlines for the Month of March 2024
Th, 28 Mar 2024
Specialty Retail
Already a contractor favorite, Home Depot doubling down on bet
Our Home Depot (HD $383) position within the Penn Global Leaders Club is up roughly 250% since purchase, and we have no intention of taking our profits anytime soon. For several years we have favored this home improvement retailer over you-know-who, and its latest acquisition is a great example as to why. The $400 billion Atlanta-based firm, which Ken Langone forged from a sleepy hardware store into an industry leader, has agreed to purchase specialty trade distributor SRS Distribution Inc for $18.25 billion, including debt.
Home Depot is already the hands-down favorite retailer of construction professionals, with the pro business accounting for half of its revenue. That is double the percentage of competitor Lowe's. SRS, which has a fleet of 4,000 delivery vehicles and a 750-branch network spread across the United States, should bump that needle even higher. The company serves roofers, landscapers, pool contractors, and other professionals.
Home Depot will use a combination of cash on hand and new financing to fund the deal, which is expected to close later this year. The anti-business FTC always poses a legal threat, but this would be a hard acquisition to shoot down over monopoly concerns—nonetheless, we wouldn't be surprised to see them try. The specialty retailer earned $15 billion on $152 billion in sales last year and has turned an annual profit as far back as the eye can see.
We absolutely love this deal. Not only will it give Home Depot the ability to better serve their pros by making on-site delivery with a fleet of 4k vehicles, the company is also gaining the vast knowledge base of what its community of craftsmen and installers want from their supplier.
We, 27 Mar 2024
Global Strategy: East & Southeast Asia
A few years ago Xi was saber rattling; now he sips tea with US CEOs
It's amazing what dollar signs in one's eyes will do to cloud vision. After countless cases of IP theft, a chronically uneven playing field, the self-proclaimed narrative about taking over as the world's leading economy (how's that going, by the way?), we have Chief Antagonist Xi Jinping dining with American business executives, flashing his best Winnie the Pooh grin, begging them to bolster investments within his country. The meeting spoke volumes. Sadly, we suspect many of these "wise and seasoned" execs were totally taken in.
China's vice president told the group that "investing in China is to invest in the future," but foreign companies have been moving in the opposite direction for the past four years. Foreign direct investment began falling during the pandemic, and there is no sign that the exodus will end anytime soon. That drawdown has filtered through the economy, causing Chinese citizens to guard their pocketbook. A vicious cycle of reduced consumer spending at home and the dumping of excess goods abroad is underway, and Beijing looks flatfooted in its response. Two real-world examples: iPhone sales in China fell 24% y/y through the first six weeks of 2024; meanwhile, Brazil, India, and South Africa—three fellow BRICS members—have all lodged formal antidumping investigations on specific goods coming from China.
The Western world faced similar challenges with respect to Japan some forty years ago, but that democratic, pro-free-trade nation made changes to assuage concerns. China seems to be going in the opposite direction of increasing state control when things aren't going their way. It is the very definition of a command economy—one in which a centralized government tries to control all aspects of supply and demand. That is a fanciful concept which has never worked. As for the CEOs, many would no-doubt like to see the US ease restrictions placed on trade with China over the course of the past two administrations. But considering we have the same two players in the race this election cycle, odds of that happening are near zero. Expect China's economic woes to continue. Sadly, the Chinese people will bear the brunt while the communist government will simply double down.
With respect to China, an economic story always has a geopolitical component to it. Just as they stripped the golden goose that was Hong Kong, they are now looking at the incredible wealth and power of the Taiwanese economy with envy. If they see a United States tiring of its defense of Ukraine against a Russian aggressor, they will eventually calculate that an invasion of land they already claim as theirs is worth the risk. We can't believe there are Americans who would say this is not our business; then again, there were plenty of Americans before December 7th, 1941 who said we had no business getting into a war on the other side of the world.
Tu, 26 Mar 2024
Aerospace & Defense
Better late than never: Boeing brooms CEO and two other senior execs
So overdue. In the four years since Boeing's (BA $188) chairman of the board at the time, Dave Calhoun (who has a degree in finance, not engineering), anointed himself as the only guy who could fix the ailing aerospace giant, he has—or will have by the time he is gone—made around $80 million in total compensation. Since he took the helm, the company has lost $71 billion in market cap—or about 40% of its value. Over the same time period the company's only major airframe competitor, Airbus (EADSY $46), has grown by $27 billion—or 23%. Over Calhoun's tenure, multiple safety incidents involving Boeing aircraft have occurred, major aircraft orders have been cancelled out of frustration, and the FAA began an unprecedented oversight program. Now, after backroom pleas to the board by airline CEOs, Calhoun is gone, along with Chairman Larry Kellner and commercial airplanes head Stan Deal. Sadly, Calhoun will remain in his position through the end of the year.
Besides brooming these three, there was another move at the company we love: former Qualcomm CEO and all-around brilliant business mind Steve Mollenkopf was appointed as the new chairman of the board. Not only did he masterfully run the semiconductor firm, he holds a bachelor's degree in electrical engineering from Virginia Tech and a master's in electrical engineering from the University of Michigan. Someone with engineering credentials as chairman of a massive industrial firm—what a concept. While Mollenkopf essentially ruled himself out as the next CEO (too bad the former chairman didn't have such humility), he will lead the search committee for Calhoun's replacement.
One name at the top of that list is Patrick Shanahan, the current CEO of Spirit AeroSystems (SPR $35) and a former US Secretary of Defense. Boeing recently announced its intent to purchase Spirit—a company it spun off back in 2005. Shanahan has a Bachelor of Science degree in mechanical engineering from the University of Washington, a Master of Science degree in mechanical engineering from MIT, and an MBA from the MIT Sloan School of Management. While he may technically be considered an insider, we believe Shanahan would be an excellent choice to lead the company back to its former benchmark position in the industry. Larry Culp, who took over a similar situation at General Electric (GE $174) after the Calhoun-like Jeffrey Immelt was "retired," has also been named as a potential replacement, but he is slated to lead GE Aerospace when it becomes a standalone company next month. No matter who takes the helm, at least three problematic senior execs are gone.
With shares sitting just $12 above their 52-week low, is it too early to buy back into the company? We actually don't think so. Yes, we don't know the replacement yet; and yes, the debt load carried by the firm is now massive, but we believe it will stage a massive comeback over the next five years. It may be difficult to get in near this price once the pieces begin falling into place. (No, we are not ready to add Boeing back into the Global Leaders Club just yet.)
Fr, 22 Mar 2024
Interactive Media & Services
It's only fitting that Reddit should soar like a meme stock at open
After all, it was the subreddit r/wallstreetbets that helped push AMC Entertainment (AMC $4) up to $640 per share in the summer of '21, and Radio Shack-like GameStop (GME $13) up to $120 four months prior. Shares of social media platform Reddit (RDDT $49) were priced at $34 in the IPO market, but only the anointed few could have purchased them at that price: they began trading around $48 and the fan base was buying shares at $57.80 exactly six minutes later. When IPO day was complete, shares were sitting just shy of $50—a 48% premium to the IPO price.
It's not clear how soon Reddit can turn a profit (it lost $91 million on $800 million of revenue last year), but one financial tidbit which is known is the CEO's salary leading up to the launch. Steve Huffman, who founded the company with Alexis Ohanian while the two were roommates at the University of Virginia, had a salary of $193 million in 2023. Granted, the majority of that largesse was awarded through a complicated scheme that Rube Goldberg would be challenged to draw on paper. Another "known" is the share class structure. We loathe multiple share classes designed to favor the few—why not just stay private if you want to retain that level of control? (We all know the answer to that, of course.) Average, ordinary investors will only be allowed to buy Class A shares, which provide for one vote per share. In addition to owning some 400,000 of those himself, Huffman will also own over 4 million shares of Class B stock—which offer ten votes per share. Class B owners will control some 97% of the total voting power.
All of this isn't to say that Reddit won't turn a profit one of these days. Revenue is generated through advertising and ad-free premium memberships, and the company plans to use its IPO windfall to massively increase its advertising effort. But it enters a crowded market of social media giants, and it faced a mini revolt on its last money-making scheme: charging third-party apps fees to retain access. As of yet, we don't see an animal that will become Reddit's cash cow; only an appeal to the content provider's 72 million daily active users to keep buying stock.
We are so reminded of our Penn Wealth Report issue entitled "The Show Must Go On." It highlighted schemes like NFTs, SPACs, and meme stocks during their heyday. On that cover was the following warning: "This Will Not End Well."
Th, 21 Mar 2024
Beverages, Tobacco, & Cannabis
Is Boston Beer now so cheap that it is worthy of a look?
We had been raving fans of The Boston Beer Company (SAM $295), and not just because founder Jim Koch always showed up to CNBC interviews with a Sam Adams in hand. Not only had the brewer remained fiercely independent, unlike Anheuser-Busch, Coors, and Miller—all now foreign-owned entities, it simply brewed great beer. Then it went down the hard seltzer rabbit hole at the expense of its beer lineup, and the shares began to crater.
SAM shares have plunged 78% since April 2021, and Koch is brooming the firm's CEO, Dave Burwick, after six years at the helm. But was Burwick really the problem? His résumé, after all, was impressive: he spent time at Peet's Coffee, Deckers Outdoor, Weight Watchers International, and PepsiCo. And it was Koch himself who declared the company's commitment to its ill-fated hard seltzer push. Shipments declined from the previous year in every quarter of 2023, and Q4's results were disastrous. The company lost $18 million (-$1.46/share) on $417 million in revenue over the course of the fourth quarter.
Current board member Michael Spillane, a seventeen-year Nike vet, will take over the CEO role as of next month, but we don't see any strategic initiatives which would get us excited about owning the brand once again. Competition is fierce in both the seltzer and craft beer segments, and consumers of the latter generally gravitate toward local brewers rather than large, national brands. One bright spot: the company holds no debt on its books. With interest rates sitting close to two-decade highs, this is one small-cap that doesn't need to worry about refinancing.
We wouldn't touch SAM shares until there is some indication that the leadership change will make a positive impact on the company's future. Right now, we would value the shares around $350—hardly an undervalued gem.
Mo, 18 Mar 2024
Semiconductors & Equipment
"Friendshoring": India wants to become a global foundry leader
American companies may be at the forefront of semiconductor design, but the actual production of those designs takes place overwhelmingly outside of the United States at factories known as foundries. Nearly 50% of all chip production takes place in Taiwan—which China continues to claim as its own, 25% in mainland China, 15% in South Korea, 6% in the US, and 2% in Japan. India says it wants to shake up that mix within the next five years.
Why aren't there more foundries in the United States? Time, money, and cost effectiveness are three reasons. It takes somewhere between $10 billion and $15 billion to get a new plant up and running, and the process takes between three and five years. This is why companies from Intel to AMD to Apple design their chips in house but outsource production to companies such as Taiwan Semiconductor (TSM $141). India's minister of electronics and IT, meanwhile, believes his country can become one of the top global foundry destinations within the next five years. Citing tension between China and the West, he has been courting tech companies from around the world with a simple message: "India is a "trusted value chain partner" open for business and ready for investment. US chip designer Qualcomm (QCOM $169), which just opened a new factory in Chennai that will employ some 1,600 workers, is buying into that narrative. CEO Cristiano Amon said his company plans to double its investment in the country.
Even Asian fab giants are getting in on the act. Hon Hai Precision Industry, otherwise known as Apple chip supplier Foxconn, said it will invest over $1 billion in new operational facilities in India. The country certainly has a lot of catching up to do in the tech arena, but a dedicated effort over the next five years could certainly vault it into a top-tier producer—a push which the United States and other Western countries should fully support. Especially considering the fact that China will never give up its claim over Taiwan, and it is simply a matter of time before the communist country makes it move.
Through its aggressive actions and incendiary rhetoric over the past five years China has proven it cannot be relied upon as a trustworthy partner going forward. The genie is out of the bottle: countries will continue to diversify away from the Chinese mainland, and India, which just became the world's most populous country, will be one of the major beneficiaries of this seismic shift.
Tu, 05 Mar 2024
Cryptocurrencies
On the back of new bitcoin ETFs, cryptos are soaring once again
On 08 November 2021, bitcoin hit an all-time high price of $67,566. One year later, in November 2022, it was sitting at $15,814—a 77% drop. Much like meme stocks and NFTs, reality hit this "new asset class," and investors fled like rats from a sinking ship. All of the talk about cryptocurrencies serving as a hedge against a downturn in stocks suddenly looked silly, as bitcoin easily outpaced the horrendous losses equities were piling up for the year. Then, in the early days of 2024, came the SEC's begrudging move to approve spot bitcoin ETFs.
Ironically, based on SEC Chair Gary Gensler's total disdain for cryptos, his department's approval of eleven spot bitcoin ETFs in January led to a massive new rally in the digital currency. This past Tuesday, bitcoin hit a new all-time high, trading above $69,000 for the first time in its history. Nearly $20 billion has flowed into these new vehicles since the SEC ruling, with the iShares Bitcoin Trust (IBIT $38) growing from zero to $10 billion in under eight weeks, and there are more catalysts on the horizon.
Sticking with the ETFs, it should be noted that when the first gold exchange-traded funds were introduced a few decades ago, it led to a boon for the precious metal. Everyday investors flooded into the commodity, causing prices to soar. It is easy to make the case for bitcoin doing the same, as many institutional investors who were limited by charter—or by comfort level—from investing in crypto will now be able to buy into the likes of the iShares or Fidelity bitcoin products.
Yet another catalyst comes next month, when the next bitcoin halving will take place. Bitcoin has a cap of 21 million; at each halving, the reward for bitcoin miners is cut in half. This event happens after each 210,000 blocks are mined, up until the maximum supply is released. The last halving occurred in May 2020, after which bitcoin prices rose from around $9,000 per coin to over $60,000 in the subsequent twelve months. While few are calling for a repeat of that insane spike, many crypto experts believe the coin will hit $100,000 before the end of the year. Thanks, SEC.
Yes, we do believe crypto is here to stay; and yes, we even would go as far as calling it a new asset class. That said, we wouldn't recommend allocating more than 5% of a portfolio to the digital currency, or about half the amount we would feel comfortable placing in a gold ETF.
Th, 28 Mar 2024
Specialty Retail
Already a contractor favorite, Home Depot doubling down on bet
Our Home Depot (HD $383) position within the Penn Global Leaders Club is up roughly 250% since purchase, and we have no intention of taking our profits anytime soon. For several years we have favored this home improvement retailer over you-know-who, and its latest acquisition is a great example as to why. The $400 billion Atlanta-based firm, which Ken Langone forged from a sleepy hardware store into an industry leader, has agreed to purchase specialty trade distributor SRS Distribution Inc for $18.25 billion, including debt.
Home Depot is already the hands-down favorite retailer of construction professionals, with the pro business accounting for half of its revenue. That is double the percentage of competitor Lowe's. SRS, which has a fleet of 4,000 delivery vehicles and a 750-branch network spread across the United States, should bump that needle even higher. The company serves roofers, landscapers, pool contractors, and other professionals.
Home Depot will use a combination of cash on hand and new financing to fund the deal, which is expected to close later this year. The anti-business FTC always poses a legal threat, but this would be a hard acquisition to shoot down over monopoly concerns—nonetheless, we wouldn't be surprised to see them try. The specialty retailer earned $15 billion on $152 billion in sales last year and has turned an annual profit as far back as the eye can see.
We absolutely love this deal. Not only will it give Home Depot the ability to better serve their pros by making on-site delivery with a fleet of 4k vehicles, the company is also gaining the vast knowledge base of what its community of craftsmen and installers want from their supplier.
We, 27 Mar 2024
Global Strategy: East & Southeast Asia
A few years ago Xi was saber rattling; now he sips tea with US CEOs
It's amazing what dollar signs in one's eyes will do to cloud vision. After countless cases of IP theft, a chronically uneven playing field, the self-proclaimed narrative about taking over as the world's leading economy (how's that going, by the way?), we have Chief Antagonist Xi Jinping dining with American business executives, flashing his best Winnie the Pooh grin, begging them to bolster investments within his country. The meeting spoke volumes. Sadly, we suspect many of these "wise and seasoned" execs were totally taken in.
China's vice president told the group that "investing in China is to invest in the future," but foreign companies have been moving in the opposite direction for the past four years. Foreign direct investment began falling during the pandemic, and there is no sign that the exodus will end anytime soon. That drawdown has filtered through the economy, causing Chinese citizens to guard their pocketbook. A vicious cycle of reduced consumer spending at home and the dumping of excess goods abroad is underway, and Beijing looks flatfooted in its response. Two real-world examples: iPhone sales in China fell 24% y/y through the first six weeks of 2024; meanwhile, Brazil, India, and South Africa—three fellow BRICS members—have all lodged formal antidumping investigations on specific goods coming from China.
The Western world faced similar challenges with respect to Japan some forty years ago, but that democratic, pro-free-trade nation made changes to assuage concerns. China seems to be going in the opposite direction of increasing state control when things aren't going their way. It is the very definition of a command economy—one in which a centralized government tries to control all aspects of supply and demand. That is a fanciful concept which has never worked. As for the CEOs, many would no-doubt like to see the US ease restrictions placed on trade with China over the course of the past two administrations. But considering we have the same two players in the race this election cycle, odds of that happening are near zero. Expect China's economic woes to continue. Sadly, the Chinese people will bear the brunt while the communist government will simply double down.
With respect to China, an economic story always has a geopolitical component to it. Just as they stripped the golden goose that was Hong Kong, they are now looking at the incredible wealth and power of the Taiwanese economy with envy. If they see a United States tiring of its defense of Ukraine against a Russian aggressor, they will eventually calculate that an invasion of land they already claim as theirs is worth the risk. We can't believe there are Americans who would say this is not our business; then again, there were plenty of Americans before December 7th, 1941 who said we had no business getting into a war on the other side of the world.
Tu, 26 Mar 2024
Aerospace & Defense
Better late than never: Boeing brooms CEO and two other senior execs
So overdue. In the four years since Boeing's (BA $188) chairman of the board at the time, Dave Calhoun (who has a degree in finance, not engineering), anointed himself as the only guy who could fix the ailing aerospace giant, he has—or will have by the time he is gone—made around $80 million in total compensation. Since he took the helm, the company has lost $71 billion in market cap—or about 40% of its value. Over the same time period the company's only major airframe competitor, Airbus (EADSY $46), has grown by $27 billion—or 23%. Over Calhoun's tenure, multiple safety incidents involving Boeing aircraft have occurred, major aircraft orders have been cancelled out of frustration, and the FAA began an unprecedented oversight program. Now, after backroom pleas to the board by airline CEOs, Calhoun is gone, along with Chairman Larry Kellner and commercial airplanes head Stan Deal. Sadly, Calhoun will remain in his position through the end of the year.
Besides brooming these three, there was another move at the company we love: former Qualcomm CEO and all-around brilliant business mind Steve Mollenkopf was appointed as the new chairman of the board. Not only did he masterfully run the semiconductor firm, he holds a bachelor's degree in electrical engineering from Virginia Tech and a master's in electrical engineering from the University of Michigan. Someone with engineering credentials as chairman of a massive industrial firm—what a concept. While Mollenkopf essentially ruled himself out as the next CEO (too bad the former chairman didn't have such humility), he will lead the search committee for Calhoun's replacement.
One name at the top of that list is Patrick Shanahan, the current CEO of Spirit AeroSystems (SPR $35) and a former US Secretary of Defense. Boeing recently announced its intent to purchase Spirit—a company it spun off back in 2005. Shanahan has a Bachelor of Science degree in mechanical engineering from the University of Washington, a Master of Science degree in mechanical engineering from MIT, and an MBA from the MIT Sloan School of Management. While he may technically be considered an insider, we believe Shanahan would be an excellent choice to lead the company back to its former benchmark position in the industry. Larry Culp, who took over a similar situation at General Electric (GE $174) after the Calhoun-like Jeffrey Immelt was "retired," has also been named as a potential replacement, but he is slated to lead GE Aerospace when it becomes a standalone company next month. No matter who takes the helm, at least three problematic senior execs are gone.
With shares sitting just $12 above their 52-week low, is it too early to buy back into the company? We actually don't think so. Yes, we don't know the replacement yet; and yes, the debt load carried by the firm is now massive, but we believe it will stage a massive comeback over the next five years. It may be difficult to get in near this price once the pieces begin falling into place. (No, we are not ready to add Boeing back into the Global Leaders Club just yet.)
Fr, 22 Mar 2024
Interactive Media & Services
It's only fitting that Reddit should soar like a meme stock at open
After all, it was the subreddit r/wallstreetbets that helped push AMC Entertainment (AMC $4) up to $640 per share in the summer of '21, and Radio Shack-like GameStop (GME $13) up to $120 four months prior. Shares of social media platform Reddit (RDDT $49) were priced at $34 in the IPO market, but only the anointed few could have purchased them at that price: they began trading around $48 and the fan base was buying shares at $57.80 exactly six minutes later. When IPO day was complete, shares were sitting just shy of $50—a 48% premium to the IPO price.
It's not clear how soon Reddit can turn a profit (it lost $91 million on $800 million of revenue last year), but one financial tidbit which is known is the CEO's salary leading up to the launch. Steve Huffman, who founded the company with Alexis Ohanian while the two were roommates at the University of Virginia, had a salary of $193 million in 2023. Granted, the majority of that largesse was awarded through a complicated scheme that Rube Goldberg would be challenged to draw on paper. Another "known" is the share class structure. We loathe multiple share classes designed to favor the few—why not just stay private if you want to retain that level of control? (We all know the answer to that, of course.) Average, ordinary investors will only be allowed to buy Class A shares, which provide for one vote per share. In addition to owning some 400,000 of those himself, Huffman will also own over 4 million shares of Class B stock—which offer ten votes per share. Class B owners will control some 97% of the total voting power.
All of this isn't to say that Reddit won't turn a profit one of these days. Revenue is generated through advertising and ad-free premium memberships, and the company plans to use its IPO windfall to massively increase its advertising effort. But it enters a crowded market of social media giants, and it faced a mini revolt on its last money-making scheme: charging third-party apps fees to retain access. As of yet, we don't see an animal that will become Reddit's cash cow; only an appeal to the content provider's 72 million daily active users to keep buying stock.
We are so reminded of our Penn Wealth Report issue entitled "The Show Must Go On." It highlighted schemes like NFTs, SPACs, and meme stocks during their heyday. On that cover was the following warning: "This Will Not End Well."
Th, 21 Mar 2024
Beverages, Tobacco, & Cannabis
Is Boston Beer now so cheap that it is worthy of a look?
We had been raving fans of The Boston Beer Company (SAM $295), and not just because founder Jim Koch always showed up to CNBC interviews with a Sam Adams in hand. Not only had the brewer remained fiercely independent, unlike Anheuser-Busch, Coors, and Miller—all now foreign-owned entities, it simply brewed great beer. Then it went down the hard seltzer rabbit hole at the expense of its beer lineup, and the shares began to crater.
SAM shares have plunged 78% since April 2021, and Koch is brooming the firm's CEO, Dave Burwick, after six years at the helm. But was Burwick really the problem? His résumé, after all, was impressive: he spent time at Peet's Coffee, Deckers Outdoor, Weight Watchers International, and PepsiCo. And it was Koch himself who declared the company's commitment to its ill-fated hard seltzer push. Shipments declined from the previous year in every quarter of 2023, and Q4's results were disastrous. The company lost $18 million (-$1.46/share) on $417 million in revenue over the course of the fourth quarter.
Current board member Michael Spillane, a seventeen-year Nike vet, will take over the CEO role as of next month, but we don't see any strategic initiatives which would get us excited about owning the brand once again. Competition is fierce in both the seltzer and craft beer segments, and consumers of the latter generally gravitate toward local brewers rather than large, national brands. One bright spot: the company holds no debt on its books. With interest rates sitting close to two-decade highs, this is one small-cap that doesn't need to worry about refinancing.
We wouldn't touch SAM shares until there is some indication that the leadership change will make a positive impact on the company's future. Right now, we would value the shares around $350—hardly an undervalued gem.
Mo, 18 Mar 2024
Semiconductors & Equipment
"Friendshoring": India wants to become a global foundry leader
American companies may be at the forefront of semiconductor design, but the actual production of those designs takes place overwhelmingly outside of the United States at factories known as foundries. Nearly 50% of all chip production takes place in Taiwan—which China continues to claim as its own, 25% in mainland China, 15% in South Korea, 6% in the US, and 2% in Japan. India says it wants to shake up that mix within the next five years.
Why aren't there more foundries in the United States? Time, money, and cost effectiveness are three reasons. It takes somewhere between $10 billion and $15 billion to get a new plant up and running, and the process takes between three and five years. This is why companies from Intel to AMD to Apple design their chips in house but outsource production to companies such as Taiwan Semiconductor (TSM $141). India's minister of electronics and IT, meanwhile, believes his country can become one of the top global foundry destinations within the next five years. Citing tension between China and the West, he has been courting tech companies from around the world with a simple message: "India is a "trusted value chain partner" open for business and ready for investment. US chip designer Qualcomm (QCOM $169), which just opened a new factory in Chennai that will employ some 1,600 workers, is buying into that narrative. CEO Cristiano Amon said his company plans to double its investment in the country.
Even Asian fab giants are getting in on the act. Hon Hai Precision Industry, otherwise known as Apple chip supplier Foxconn, said it will invest over $1 billion in new operational facilities in India. The country certainly has a lot of catching up to do in the tech arena, but a dedicated effort over the next five years could certainly vault it into a top-tier producer—a push which the United States and other Western countries should fully support. Especially considering the fact that China will never give up its claim over Taiwan, and it is simply a matter of time before the communist country makes it move.
Through its aggressive actions and incendiary rhetoric over the past five years China has proven it cannot be relied upon as a trustworthy partner going forward. The genie is out of the bottle: countries will continue to diversify away from the Chinese mainland, and India, which just became the world's most populous country, will be one of the major beneficiaries of this seismic shift.
Tu, 05 Mar 2024
Cryptocurrencies
On the back of new bitcoin ETFs, cryptos are soaring once again
On 08 November 2021, bitcoin hit an all-time high price of $67,566. One year later, in November 2022, it was sitting at $15,814—a 77% drop. Much like meme stocks and NFTs, reality hit this "new asset class," and investors fled like rats from a sinking ship. All of the talk about cryptocurrencies serving as a hedge against a downturn in stocks suddenly looked silly, as bitcoin easily outpaced the horrendous losses equities were piling up for the year. Then, in the early days of 2024, came the SEC's begrudging move to approve spot bitcoin ETFs.
Ironically, based on SEC Chair Gary Gensler's total disdain for cryptos, his department's approval of eleven spot bitcoin ETFs in January led to a massive new rally in the digital currency. This past Tuesday, bitcoin hit a new all-time high, trading above $69,000 for the first time in its history. Nearly $20 billion has flowed into these new vehicles since the SEC ruling, with the iShares Bitcoin Trust (IBIT $38) growing from zero to $10 billion in under eight weeks, and there are more catalysts on the horizon.
Sticking with the ETFs, it should be noted that when the first gold exchange-traded funds were introduced a few decades ago, it led to a boon for the precious metal. Everyday investors flooded into the commodity, causing prices to soar. It is easy to make the case for bitcoin doing the same, as many institutional investors who were limited by charter—or by comfort level—from investing in crypto will now be able to buy into the likes of the iShares or Fidelity bitcoin products.
Yet another catalyst comes next month, when the next bitcoin halving will take place. Bitcoin has a cap of 21 million; at each halving, the reward for bitcoin miners is cut in half. This event happens after each 210,000 blocks are mined, up until the maximum supply is released. The last halving occurred in May 2020, after which bitcoin prices rose from around $9,000 per coin to over $60,000 in the subsequent twelve months. While few are calling for a repeat of that insane spike, many crypto experts believe the coin will hit $100,000 before the end of the year. Thanks, SEC.
Yes, we do believe crypto is here to stay; and yes, we even would go as far as calling it a new asset class. That said, we wouldn't recommend allocating more than 5% of a portfolio to the digital currency, or about half the amount we would feel comfortable placing in a gold ETF.
Headlines for the Month of Feb 2024
We, 28 Feb 2024
Technology Hardware & Equipment
Tim Cook is no Steve Jobs, but something needs to happen soon
Not that long ago, we were self-proclaimed "Apple cores"—we built our technology infrastructure around the company's (AAPL $183) products, from iPhones to MacBook Pros, iPads to wearables. That is still mostly the case, but our commitment just isn't the same.
We once again include PCs in the mix, because there are some things you simply cannot do as efficiently on a Mac (Excel, for example). Before he died in 2011, Apple's brilliant founder, Steve Jobs, proclaimed to have "cracked the code" with respect to the TV. Had he lived, we have no doubt that the company would have created something amazing in this arena. We recently threw one of our Apple remotes and its accompanying device in the trash out of frustration, purchasing a new Roku device in its place.
Mainly to assist with sleep, we recently purchased an Oura ring. A few days later we read that Apple was thinking about developing a ring tied to Apple Health, but it was still on the drawing board. The company recently lost a court battle to Massimo, forcing it to shut down the blood oxygen feature on its Apple Watch. We also purchased advanced Google Nest smoke and CO2 detectors and love them. Apple HomeKit, which is apparently now part of Apple Home, feels like an afterthought. Now comes the news that, after a decade of secretive research, the Apple car is dead. Steve Jobs would clean house.
Apple's car project was a moonshot expected to generate billions of dollars for the firm in the not-too-distant future. Now, the "ultimate mobile device" sits in a scrap heap, with the firm telling some 2,000 project workers that their mission is over. Instead, the next massive project will be built around the future of AI. There's only one problem: the company has to play a serious game of catch up against rivals like Microsoft and Google.
But how will that manifest? We don't see new AI products generating long lines in front of Apple stores like we saw for the first iPhones back in 2007. Will the focus be on putting the technology to work in the $3,500 Vision Pro? Whatever the answer, it won't manifest soon. Furthermore, we are not convinced Tim Cook really has an answer which he is committed to. We miss Steve Jobs' passion.
Apple is still the second-largest company in the world—behind Microsoft, but it needs to crystallize its vision. After watching a once-great American company like Boeing flounder under weak leadership, we don't want to see this happen at Apple. The company has been in the Penn Global Leaders Club for a long time, and we sit on massive long-term unrealized gains, but the same could have been said for Boeing right before we broomed the company—after two consecutive 737 crashes and a completely inept response.
Sa, 24 Feb 2024
Market Pulse
The market week could be summed up with one company name
This past week's market success could be boiled down to one word: NVIDIA (NVDA $788). The tech company's simply remarkable quarter fueled the chip industry, the NASDAQ, and the markets overall. With all the angst over the elections, a "higher for longer" Fed, and Russia launching a nuke into space, it was precisely the good news investors needed.
We don't talk about the Dow Jones Industrial Average much, as we believe it to be an antiquated index representing only 30 companies in a price-weighted manner. The press likes large numbers in their headlines, so they continue to report on the Dow, but the S&P 500 is the real gauge for the markets. Nonetheless, we feel duty-bound to report that top Penn holding Amazon (AMZN $175) has replaced faltering Walgreens Boots Alliance (WBA $22) in the Dow. Ironically, Walgreens was only added to the Dow six years ago, in 2018. See why this is ironic in our Q&A.
We had some exciting space news this week when the privately built and launched Odysseus lunar lander set down on the surface of the moon. Unfortunately, it ended up on its side, but the feat is still impressive. We applaud NASA's brilliant NextSTEP program, which seeks out American companies to work with for the advancement of the country's efforts in space. A publicly traded company, Intuitive Machines (LUNR $7), built the Odysseus and launched it aboard a SpaceX Falcon 9 rocket. Expect many more lunar landings by the US over the coming years.
For the holiday-shortened trading week, the S&P 500, the NASDAQ, and the All Cap World Index ex-US were all up about 1.5%. Small caps continue to struggle, with the Russell 2000 off 88 bps for the week and 41 bps for the year. We should get a little relief at the pumps soon, as oil dropped 3.35%—to $76.57 per barrel of WTI crude. This coming week will see Salesforce, TJX, Paramount, and Hewlett Packard all report earnings, and home price figures for December will drop on Tuesday the 27th.
Fr, 23 Feb 2024
Semiconductors & Equipment
NVIDIA's crazy-good quarter makes it third-largest company in the world
Just how good was NVIDIA's (NVDA $800) quarter? Consider this: The company added over $200 billion to its size after reporting its Q4 results—the largest one-day market cap spike in history; and it leapfrogged over Amazon and Alphabet to become the third-largest publicly traded company in the world—behind only Microsoft ($3T) and Apple ($2.9T). (Granted, an argument could be made that Saudi Aramco has the same $2T market cap.)
Consider NVIDIA the picks-and-shovels company for the AI revolution, providing both hardware and software solutions to virtually every company which boasts an AI presence. Business is so good at Jensen Huang's firm that it is scrambling to try and keep pace with demand. The seasoned CEO used terms like "tipping point" and "astronomical" to describe sales, and that was not hyperbole.
Sales more than tripled in the fourth quarter from a year earlier, and earnings surged over eightfold. That almost seems impossible. All results easily exceeded analysts' expectations, leading NVDA shares to surge 15% out of the gate on Thursday and fomenting a massive rally across the industry. The tech companies surrounding NVIDIA in size all require its hardware, leading to a virtuous cycle we don't see ending anytime soon.
What does NVIDIA's rocking quarter mean to the NASDAQ specifically and the markets overall? At the very least it was a shot in the arm, but Huang sees something much bigger. He believes that "a whole new industry is being formed" around AI. If that turns out to be the case, it is seismic. We remember getting prematurely excited about concepts from the metaverse to 5G to supercomputing, but this does feel different. The CEO sees a new wave of investments worth trillions of dollars kicking into gear, and a doubling in the number of data centers around the world over the next five years.
Then again, we remember firsthand this same kind of talk about the "new economy" we were entering into some twenty-five years ago. That period ended with 78% of the NASDAQ's market cap erased. However, right now NVIDIA has a quite respectable forward P/E of 33; back in 1999, Yahoo! (for example) had a P/E of 1,100, and Cisco (one of the largest companies in the world at the time) had a multiple of 230. So it is safe to say we are not quite at tech bubble levels. In other words, let's celebrate the quarter and enjoy the ride.
Speaking of data centers, if Huang's predictions are right it would behoove investors to look at three major data center REITs: Prologis (PLD $134), Digital Realty Trust (DLR $138), and Equinix (EQIX $882). We have owned all three in various Penn strategies.
Th, 22 Feb 2024
Consumer Electronics
Walmart to buy Vizio for $2.3 billion
To be honest, not only didn't we realize Vizio (VZIO $11) was a publicly traded company, we never would have guessed the firm is based in America (Irvine, CA). We discovered these facts after learning that Walmart (WMT $176) plans to buy the smart TV maker for $2.3 billion in cash.
Anyone who has been a regular customer of Walmart recognizes the name, having to walk by the giant Vizio boxes as they pass the electronics section which divides the grocery and consumer products sections of most supercenters. But why would the retailer buy this particular name?
First off, it should be noted that Vizio's books look great. The company holds zero debt on its balance sheet and sits on $335 million of cash and equivalents. But the real catalyst for the deal seems to revolve around advertising. You see, making and selling devices is only one side of the company's business. The other side is known as Platform+, which includes SmartCast, the TV operating system that enables owners to instantly access built-in apps and hundreds of free channels from their device. Consider it an integrated Roku, of sorts.
The reason SmartCast is important to Walmart has everything to do with controlled advertising. Three years ago, Walmart rebranded its media group as Walmart Connect, the conduit for advertisers to reach the company's customer base. SmartCast will greatly enhance this reach, allowing the firm to rake in advertising dollars while also gleaning incredible amounts of consumer data in the process—as they own the network.
With around 18 million current SmartCast users—a 400% increase from five years ago—paying $2.3 billion for this infrastructure seems like a steal. If the comical FTC tries to shoot this one down, they will lose.
Just as Target (TGT $149) is making missteps, Walmart appears to be in all-out growth mode once again. Nearing their all-time high, WMT shares aren't exactly cheap, but we still wouldn't hesitate to buy the company at this price. Walmart is one of the 40 companies in the Penn Global Leaders Club.
Tu, 20 Feb 2024
Consumer Finance
Why we are not excited about a Capital One, Discover merger
From a mergers and acquisitions standpoint, it is a big deal. Consumer and commercial lender Capital One Financial (COF $130) has agreed to buy credit card issuer Discover Financial Services (DFS $123) in a deal valued at $35 billion. The all-stock offer represents a 25% premium to Discover's previous week close, and is the biggest M&A deal of the year. Furthermore, the merger would create the largest US credit card company by loan volume. Yawn.
The deal does make sense for Capital One, which relies on Visa and Mastercard for credit card issuance. This will give the company its own payment network, which is quite different than simply being a card issuer. Furthermore, it would leapfrog over lending giants JP Morgan, Citigroup, and American Express to become the largest lender in the US. So why are we underwhelmed by the news? Let us count the ways.
Precisely one month ago, we wrote of Discover's share price drop—from $110 to $97—after the financial services provider reported a massive 62% plunge in profits in the fourth quarter. The company also set aside an extra $1 billion in preparation for net charge-offs, i.e., bad loans coming down the pike. Ironically, based on that added reserve for bad loans, it should be noted that Capital One's average customer has a significantly lower credit score than the typical Discover customer. It should also be noted that Discover's stated APR range is between 17.24% and 28.24%, which we consider appalling. Credit card debt is a scourge, and this deal will do nothing to alleviate it; it will merely "streamline" the collection process for the combined company. Does anyone believe those efficiencies will result in lower rates to the consumer?
Then we have the simple logistics of the deal. It isn't expected to close before late 2024 or early 2025, but we question whether or not it will close at all. There has never been a more hostile FTC (to business and enterprise) than the current cabal headed by the inept Lina Khan. And that is saying a lot, considering the commission was founded under the Woodrow Wilson administration. We put the odds of approval at 50%.
While we fully understand why Capital One wants to make this deal, we see no value in buying either company right now. Discover shares spiked to within about $4 billion of the offer price, so some may see a merger arbitrage opportunity, but that seems like a risky rationalization for buying the acquiree. As for Capital One, we consider it fairly valued. One more note: We may avoid a recession, but the $1.129 trillion Americans have racked up on credit cards—at an average current rate of 21.47%—is going to come back to haunt these companies. It is simply a matter of time.
We, 14 Feb 2024
Transportation Infrastructure
Penn member Uber jumps 15% after announcing first-ever buyback
Shares of Penn New Frontier Fund member Uber (UBER $79) jumped 15% after announcing the company's first-ever share buyback plan. The repurchase plan, which calls for buying back as much as $7 billion worth of stock, comes on the heels of Uber's profitable 2023; a year which saw consistently growing free cash flow. The ride-hailing firm now has a cash hoard of $5.4 billion on its balance sheet.
It was a stellar year for the firm, whose shares are now up 137% in the past fifty-two weeks. Not only did it achieve full-year profitability in 2023, it was also added to the S&P 500 in December. And while we call it a ride-hailing service, the company is really a technology-based services firm. Uber's delivery segment grew 6% y/y, to $3.1 billion in Q4, while gross bookings for the unit grew 19%.
The company continues to expand its delivery business, buying food delivery service Postmates a few years ago and, more recently, booze delivery service Drizly. The latter has been integrated into Uber Eats, though it also maintains a standalone app. Ironically, not that long after Domino's Pizza (DPZ $421) ran a series of tone-deaf ads slamming third-party delivery companies, the chain teamed up with Uber to allow customers to order pizza through both the Uber Eats and Drizly apps.
We are still strong believers that Uber will lead the way with respect to autonomous mobility and delivery options in the near future. Until this next massive growth driver manifests, the industry leader should continue to operate comfortably in the black.
One fundamental reason for our continued confidence in Uber is the firm's stellar CEO, Dara Khosrowshani. Before taking the helm at the company in 2017, he cut his teeth at Expedia Group as president and CEO, and has performed masterfully since taking over for embattled founder Travis Kalanick. While Uber has blown threw our initial price target of $70, we still consider it in the "Buy" range.
Sa, 10 Feb 2024
Market Pulse
The S&P 500 just closed above 5,000 for the first time ever
The Fed keeps getting more ammo for its argument to hold off on rate cuts, and suddenly investors don't seem to mind too much. After all, we got a January jobs report that was nearly double (353k vs 185k) what was expected, earnings are coming in hotter than expected, and inflation keeps dropping closer to that 2% magical rate. Instead of throwing a fit over more hawkish Fed talk, investors pushed the S&P 500 to record highs, with the benchmark index closing above 5,000 for the first time ever to cap off the week.
What we consider to be the most undervalued area of the market, small caps, led the charge this week, with the Russell 2000 index returning 2.54%; that rally was made even more impressive considering the index closed Monday down 1.3%. Small caps (companies $250M to $2B in size) are still down about 1% year to date, however, meaning they remain attractive—as do mid-cap stocks ($2B to $10B in size).
Another area which remains in the red for the year is international stocks, with the MSCI All Cap World Index ex-US off 69 bps in 2024. Rather amazingly, they are even negative looking back three years (-2% three-year return). Unlike small- and mid-cap US companies, however, we don't see much we like in developed economies outside of the US. We do have a lot of conviction in one emerging market, however: India. Not only did that country just overtake China as the world's most populous nation, we also expect its GDP to grow faster than the communist nation's in 2024. We recently added an India-focused ETF to the Penn International Investor to take advantage of this condition.
We will probably avoid a recession this year, but the geopolitical landscape is as ugly as the domestic political landscape. Without delving too deeply into the matter, suffice to say that the dysfunctional state of US politics should worry us all. We have never felt more uncomfortable about a national election than we do this year. Neither leading candidate seems concerned about the $34 trillion national debt (123% the size of our economy), and Congress appears to be frozen due to internecine battles. In short, while we are off to a strong start for 2024, there are a lot of powder kegs which could blow before the general election rolls around. At least we can once again find relative safety in the fixed income market.
Fr, 09 Feb 2024
Commercial Banks
Another regional bank plunges off a cliff
Over the course of five trading days, regional mid-cap lender New York Community Bancorp (NYCB $5) fell 62% in value. Intriguingly, we are coming up on the one-year anniversary of SVB, Silvergate, Signature, and First Republic. We were told the bank runs are over, and that the regionals now provide investors with a great value proposition. Hold that thought. Since the start of the year, the SPDR S&P Regional Banking ETF (KRE $48) has fallen double digits while the S&P 500 is up 5%. New York Regional was a top-ten holding of the fund.
So what happened this time? It should be noted that New York Community Bank is heavily invested in commercial New York real estate. That is an area which continues to struggle since the pandemic shifted the paradigm in a major way, and we see those troubles continuing to mount. Rent-regulated multifamily loans (think Seinfeld's apartment building) account for nearly one-quarter of the bank's lending, and we view that segment of the real estate market to be highly volatile. Values have fallen and interest rates have risen since most of these borrowers last took out loans, and refinancing when they come due is going to be a challenge.
A major reason for NYCB's 200% debt-to-equity ratio is a recent spending spree. Not only did it acquire Flagstar Bancorp in late 2022, it more recently picked up parts of defunct Signature Bank. Crossing over $100B in assets, it should be noted, brought with it increased scrutiny by regulators. In December, the bank swung to an unexpected loss and slashed its fat dividend—a major reason investors were in the name—from $0.17 to $0.05 per share. Add a management shakeup to the mix and both investors and depositors alike got very nervous, leading to the selloff. One major depositor who also had money in Signature commented that his "finger is on the trigger," ready to pull funds if needed.
The bank says it is fully ready to offload assets to raise more cash if needed, but that doesn't change the makeup of the bank's loans. Just as trouble in the crypto industry helped bring down Silvergate, focusing on the owners of rent-controlled assets could be equally troubling. By its very name, owners of these properties are limited by law on how much they can increase rents on units, constricting their cash flow. To that end, the bank lost $252 million last quarter on the back of $185 million in charge-offs. For customers of Signature who suddenly found themselves with accounts at New York Community Bancorp, it must feel as though they are living in the movie Groundhog Day, especially considering the season during which this keeps happening.
For investors thinking they can get in a regional at an incredible price, dig a little deeper. The bank's P/E ratio of one may seem too good to be true, and it probably is. While annual revenue is expected to grow by 11%, the estimated EPS growth rate is -66.2% per annum. Yet another reason we are underweighting the Financials sector right now.
Tu, 06 Feb 2024
IT Software & Services
Penn darling Palantir soars 31% in one session on monster quarter
Sometimes CNBC's Jim Cramer is just hard to listen to. On Tuesday morning, after one of our favorite companies—Palantir (PLTR $22)—spiked double digits on news of a blowout quarter, blowhard Cramer said, "No, they are reliant on fickle government contracts." I am paraphrasing just a bit, but that was the gist of his brilliant commentary. He would rather own dogs like Disney and Boeing in his "chair-ble" trust. Sorry, Jim, you yelling something at the screen doesn't make it true.
Dr. Alex Karp's masterful company, which builds and deploys ultra-sophisticated data platform systems for customers, has, in fact, been focusing its attention on civilian clients as of late. Has it been paying off? Here's what Karp had to say about the company's commercial business for the quarter: "...bombastic, baller, incomprehensibly good." While so many like Cramer doubted the company's ability to move into the civilian space, we never did. Companies need products and services like this, and nobody provides them more effectively than Palantir.
For the quarter, revenue rose 20%, to $608 million, while net income grew a whopping 202%. Breaking revenue down by segment, commercial sales within the US rose 70% from the same quarter last year. Despite the current fiscal challenges facing governments, that side of the business still managed to grow 11%. Palantir operated in the black each quarter of 2023.
Every company from every industry is throwing around the AI acronym these days, but Palantir is one of the few firms which will actually exceed expectations in this new realm. Keep in mind that this super-secretive firm was originally funded by the CIA's venture capital arm, and has been an outspoken advocate for America's interests around the world. Remaining on the cutting edge of advanced technologies is in its DNA. In a recent discussion with Wall Street analysts, Karp laid out his strategic plans on artificial intelligence: "Just take the whole market." If anyone can do it, it is Palantir.
We have owned Palantir in the New Frontier Fund since the day it went public, buying in at $10 per share. It is one of our strongest conviction companies going forward.
Tu, 06 Feb 2024
Life Sciences Tools & Services
After exploding out of the gate as a SPAC, 23AndMe shares are now trading under $1
There are a number of sub-plots to unpack in this story, so let's begin with the basics: 23andMe (ME $1) is a genetics testing firm which provides a suite of DNA reports to customers. The "hook" for would-be subscribers may be the ability to understand one's ancestry, but the company's main focus is on identifying potential genetic health risks and, ultimately, providing therapeutic solutions. That alone is controversial; knowledge may be power, but imagine the needless worry that comes with knowing a host of personal health risks which will probably never manifest.
23AndMe went public in 2021 through a Richard Branson-backed special-acquisition company (SPAC) called VG Acquisition Corp. Once valued at nearly $6 billion, the company's driven leader, Anne Wojcicki, promised a host of products and services on the horizon. With the incredible amount of data the firm was collecting from DNA testing, the plan was to create a stream of therapeutics delivered with unprecedented accuracy. The pandemic put the company into hyperdrive as Americans suddenly became keenly interested in how their immune systems work.
Before long, however, concerns over data security began denting sales. It is one thing for a bank account to get hacked, but what could be the ramifications if someone's personal DNA map suddenly showed up on the dark web? In fact, that danger came to the forefront this past December as the company announced that data on its customers had been compromised. Hackers were able to access names, birthdates, ancestry reports, and other information on some six million people. Cybersecurity expert Justin Sherman put it succinctly: "You can change your passwords, but you cannot change your DNA."
All of the concerns over data security and whether or not the company could meet its lofty goals without a massive inflow of new cash helped pound the stock price down to under $1 by the end of the year. It has already had one-quarter of its market cap shaved off in 2024 and now sits at just $323 million in size. The company's strong growth focus has morphed into layoffs and concerns over the speed at which it is burning through cash.
It is not an impossible proposition that this company will stage a turnaround, but it is going to be a herculean task. The latest fundraising effort garnered $1.4 billion, with 80% of it already spent. Wojcicki does have a star-studded list of personal friends and backers, from Sergey Brin to Alex Rodriguez, and her company sits on a treasure trove of 10 million DNA samples which could be used for research, but time appears to be running out on her grand plans.
Tu, 29 Jan 2024
SeaWorld Entertainment (SEAS $50) will change its corporate name to United Parks & Resorts and trade under the new ticker PRKS starting in mid-February. The company operates 12 parks in the US and just opened a new aquatic park in the UAE.
UPS (UPS $149) announced the layoff of 12,000 workers after a disappointing quarter; revenue declined from $27 billion in the same quarter last year to $24.9 billion this past quarter—a 7.8% decline. Workers are being asked to return to the office five days per week. Shares dropped 6% in pre-market.
We, 28 Feb 2024
Technology Hardware & Equipment
Tim Cook is no Steve Jobs, but something needs to happen soon
Not that long ago, we were self-proclaimed "Apple cores"—we built our technology infrastructure around the company's (AAPL $183) products, from iPhones to MacBook Pros, iPads to wearables. That is still mostly the case, but our commitment just isn't the same.
We once again include PCs in the mix, because there are some things you simply cannot do as efficiently on a Mac (Excel, for example). Before he died in 2011, Apple's brilliant founder, Steve Jobs, proclaimed to have "cracked the code" with respect to the TV. Had he lived, we have no doubt that the company would have created something amazing in this arena. We recently threw one of our Apple remotes and its accompanying device in the trash out of frustration, purchasing a new Roku device in its place.
Mainly to assist with sleep, we recently purchased an Oura ring. A few days later we read that Apple was thinking about developing a ring tied to Apple Health, but it was still on the drawing board. The company recently lost a court battle to Massimo, forcing it to shut down the blood oxygen feature on its Apple Watch. We also purchased advanced Google Nest smoke and CO2 detectors and love them. Apple HomeKit, which is apparently now part of Apple Home, feels like an afterthought. Now comes the news that, after a decade of secretive research, the Apple car is dead. Steve Jobs would clean house.
Apple's car project was a moonshot expected to generate billions of dollars for the firm in the not-too-distant future. Now, the "ultimate mobile device" sits in a scrap heap, with the firm telling some 2,000 project workers that their mission is over. Instead, the next massive project will be built around the future of AI. There's only one problem: the company has to play a serious game of catch up against rivals like Microsoft and Google.
But how will that manifest? We don't see new AI products generating long lines in front of Apple stores like we saw for the first iPhones back in 2007. Will the focus be on putting the technology to work in the $3,500 Vision Pro? Whatever the answer, it won't manifest soon. Furthermore, we are not convinced Tim Cook really has an answer which he is committed to. We miss Steve Jobs' passion.
Apple is still the second-largest company in the world—behind Microsoft, but it needs to crystallize its vision. After watching a once-great American company like Boeing flounder under weak leadership, we don't want to see this happen at Apple. The company has been in the Penn Global Leaders Club for a long time, and we sit on massive long-term unrealized gains, but the same could have been said for Boeing right before we broomed the company—after two consecutive 737 crashes and a completely inept response.
Sa, 24 Feb 2024
Market Pulse
The market week could be summed up with one company name
This past week's market success could be boiled down to one word: NVIDIA (NVDA $788). The tech company's simply remarkable quarter fueled the chip industry, the NASDAQ, and the markets overall. With all the angst over the elections, a "higher for longer" Fed, and Russia launching a nuke into space, it was precisely the good news investors needed.
We don't talk about the Dow Jones Industrial Average much, as we believe it to be an antiquated index representing only 30 companies in a price-weighted manner. The press likes large numbers in their headlines, so they continue to report on the Dow, but the S&P 500 is the real gauge for the markets. Nonetheless, we feel duty-bound to report that top Penn holding Amazon (AMZN $175) has replaced faltering Walgreens Boots Alliance (WBA $22) in the Dow. Ironically, Walgreens was only added to the Dow six years ago, in 2018. See why this is ironic in our Q&A.
We had some exciting space news this week when the privately built and launched Odysseus lunar lander set down on the surface of the moon. Unfortunately, it ended up on its side, but the feat is still impressive. We applaud NASA's brilliant NextSTEP program, which seeks out American companies to work with for the advancement of the country's efforts in space. A publicly traded company, Intuitive Machines (LUNR $7), built the Odysseus and launched it aboard a SpaceX Falcon 9 rocket. Expect many more lunar landings by the US over the coming years.
For the holiday-shortened trading week, the S&P 500, the NASDAQ, and the All Cap World Index ex-US were all up about 1.5%. Small caps continue to struggle, with the Russell 2000 off 88 bps for the week and 41 bps for the year. We should get a little relief at the pumps soon, as oil dropped 3.35%—to $76.57 per barrel of WTI crude. This coming week will see Salesforce, TJX, Paramount, and Hewlett Packard all report earnings, and home price figures for December will drop on Tuesday the 27th.
Fr, 23 Feb 2024
Semiconductors & Equipment
NVIDIA's crazy-good quarter makes it third-largest company in the world
Just how good was NVIDIA's (NVDA $800) quarter? Consider this: The company added over $200 billion to its size after reporting its Q4 results—the largest one-day market cap spike in history; and it leapfrogged over Amazon and Alphabet to become the third-largest publicly traded company in the world—behind only Microsoft ($3T) and Apple ($2.9T). (Granted, an argument could be made that Saudi Aramco has the same $2T market cap.)
Consider NVIDIA the picks-and-shovels company for the AI revolution, providing both hardware and software solutions to virtually every company which boasts an AI presence. Business is so good at Jensen Huang's firm that it is scrambling to try and keep pace with demand. The seasoned CEO used terms like "tipping point" and "astronomical" to describe sales, and that was not hyperbole.
Sales more than tripled in the fourth quarter from a year earlier, and earnings surged over eightfold. That almost seems impossible. All results easily exceeded analysts' expectations, leading NVDA shares to surge 15% out of the gate on Thursday and fomenting a massive rally across the industry. The tech companies surrounding NVIDIA in size all require its hardware, leading to a virtuous cycle we don't see ending anytime soon.
What does NVIDIA's rocking quarter mean to the NASDAQ specifically and the markets overall? At the very least it was a shot in the arm, but Huang sees something much bigger. He believes that "a whole new industry is being formed" around AI. If that turns out to be the case, it is seismic. We remember getting prematurely excited about concepts from the metaverse to 5G to supercomputing, but this does feel different. The CEO sees a new wave of investments worth trillions of dollars kicking into gear, and a doubling in the number of data centers around the world over the next five years.
Then again, we remember firsthand this same kind of talk about the "new economy" we were entering into some twenty-five years ago. That period ended with 78% of the NASDAQ's market cap erased. However, right now NVIDIA has a quite respectable forward P/E of 33; back in 1999, Yahoo! (for example) had a P/E of 1,100, and Cisco (one of the largest companies in the world at the time) had a multiple of 230. So it is safe to say we are not quite at tech bubble levels. In other words, let's celebrate the quarter and enjoy the ride.
Speaking of data centers, if Huang's predictions are right it would behoove investors to look at three major data center REITs: Prologis (PLD $134), Digital Realty Trust (DLR $138), and Equinix (EQIX $882). We have owned all three in various Penn strategies.
Th, 22 Feb 2024
Consumer Electronics
Walmart to buy Vizio for $2.3 billion
To be honest, not only didn't we realize Vizio (VZIO $11) was a publicly traded company, we never would have guessed the firm is based in America (Irvine, CA). We discovered these facts after learning that Walmart (WMT $176) plans to buy the smart TV maker for $2.3 billion in cash.
Anyone who has been a regular customer of Walmart recognizes the name, having to walk by the giant Vizio boxes as they pass the electronics section which divides the grocery and consumer products sections of most supercenters. But why would the retailer buy this particular name?
First off, it should be noted that Vizio's books look great. The company holds zero debt on its balance sheet and sits on $335 million of cash and equivalents. But the real catalyst for the deal seems to revolve around advertising. You see, making and selling devices is only one side of the company's business. The other side is known as Platform+, which includes SmartCast, the TV operating system that enables owners to instantly access built-in apps and hundreds of free channels from their device. Consider it an integrated Roku, of sorts.
The reason SmartCast is important to Walmart has everything to do with controlled advertising. Three years ago, Walmart rebranded its media group as Walmart Connect, the conduit for advertisers to reach the company's customer base. SmartCast will greatly enhance this reach, allowing the firm to rake in advertising dollars while also gleaning incredible amounts of consumer data in the process—as they own the network.
With around 18 million current SmartCast users—a 400% increase from five years ago—paying $2.3 billion for this infrastructure seems like a steal. If the comical FTC tries to shoot this one down, they will lose.
Just as Target (TGT $149) is making missteps, Walmart appears to be in all-out growth mode once again. Nearing their all-time high, WMT shares aren't exactly cheap, but we still wouldn't hesitate to buy the company at this price. Walmart is one of the 40 companies in the Penn Global Leaders Club.
Tu, 20 Feb 2024
Consumer Finance
Why we are not excited about a Capital One, Discover merger
From a mergers and acquisitions standpoint, it is a big deal. Consumer and commercial lender Capital One Financial (COF $130) has agreed to buy credit card issuer Discover Financial Services (DFS $123) in a deal valued at $35 billion. The all-stock offer represents a 25% premium to Discover's previous week close, and is the biggest M&A deal of the year. Furthermore, the merger would create the largest US credit card company by loan volume. Yawn.
The deal does make sense for Capital One, which relies on Visa and Mastercard for credit card issuance. This will give the company its own payment network, which is quite different than simply being a card issuer. Furthermore, it would leapfrog over lending giants JP Morgan, Citigroup, and American Express to become the largest lender in the US. So why are we underwhelmed by the news? Let us count the ways.
Precisely one month ago, we wrote of Discover's share price drop—from $110 to $97—after the financial services provider reported a massive 62% plunge in profits in the fourth quarter. The company also set aside an extra $1 billion in preparation for net charge-offs, i.e., bad loans coming down the pike. Ironically, based on that added reserve for bad loans, it should be noted that Capital One's average customer has a significantly lower credit score than the typical Discover customer. It should also be noted that Discover's stated APR range is between 17.24% and 28.24%, which we consider appalling. Credit card debt is a scourge, and this deal will do nothing to alleviate it; it will merely "streamline" the collection process for the combined company. Does anyone believe those efficiencies will result in lower rates to the consumer?
Then we have the simple logistics of the deal. It isn't expected to close before late 2024 or early 2025, but we question whether or not it will close at all. There has never been a more hostile FTC (to business and enterprise) than the current cabal headed by the inept Lina Khan. And that is saying a lot, considering the commission was founded under the Woodrow Wilson administration. We put the odds of approval at 50%.
While we fully understand why Capital One wants to make this deal, we see no value in buying either company right now. Discover shares spiked to within about $4 billion of the offer price, so some may see a merger arbitrage opportunity, but that seems like a risky rationalization for buying the acquiree. As for Capital One, we consider it fairly valued. One more note: We may avoid a recession, but the $1.129 trillion Americans have racked up on credit cards—at an average current rate of 21.47%—is going to come back to haunt these companies. It is simply a matter of time.
We, 14 Feb 2024
Transportation Infrastructure
Penn member Uber jumps 15% after announcing first-ever buyback
Shares of Penn New Frontier Fund member Uber (UBER $79) jumped 15% after announcing the company's first-ever share buyback plan. The repurchase plan, which calls for buying back as much as $7 billion worth of stock, comes on the heels of Uber's profitable 2023; a year which saw consistently growing free cash flow. The ride-hailing firm now has a cash hoard of $5.4 billion on its balance sheet.
It was a stellar year for the firm, whose shares are now up 137% in the past fifty-two weeks. Not only did it achieve full-year profitability in 2023, it was also added to the S&P 500 in December. And while we call it a ride-hailing service, the company is really a technology-based services firm. Uber's delivery segment grew 6% y/y, to $3.1 billion in Q4, while gross bookings for the unit grew 19%.
The company continues to expand its delivery business, buying food delivery service Postmates a few years ago and, more recently, booze delivery service Drizly. The latter has been integrated into Uber Eats, though it also maintains a standalone app. Ironically, not that long after Domino's Pizza (DPZ $421) ran a series of tone-deaf ads slamming third-party delivery companies, the chain teamed up with Uber to allow customers to order pizza through both the Uber Eats and Drizly apps.
We are still strong believers that Uber will lead the way with respect to autonomous mobility and delivery options in the near future. Until this next massive growth driver manifests, the industry leader should continue to operate comfortably in the black.
One fundamental reason for our continued confidence in Uber is the firm's stellar CEO, Dara Khosrowshani. Before taking the helm at the company in 2017, he cut his teeth at Expedia Group as president and CEO, and has performed masterfully since taking over for embattled founder Travis Kalanick. While Uber has blown threw our initial price target of $70, we still consider it in the "Buy" range.
Sa, 10 Feb 2024
Market Pulse
The S&P 500 just closed above 5,000 for the first time ever
The Fed keeps getting more ammo for its argument to hold off on rate cuts, and suddenly investors don't seem to mind too much. After all, we got a January jobs report that was nearly double (353k vs 185k) what was expected, earnings are coming in hotter than expected, and inflation keeps dropping closer to that 2% magical rate. Instead of throwing a fit over more hawkish Fed talk, investors pushed the S&P 500 to record highs, with the benchmark index closing above 5,000 for the first time ever to cap off the week.
What we consider to be the most undervalued area of the market, small caps, led the charge this week, with the Russell 2000 index returning 2.54%; that rally was made even more impressive considering the index closed Monday down 1.3%. Small caps (companies $250M to $2B in size) are still down about 1% year to date, however, meaning they remain attractive—as do mid-cap stocks ($2B to $10B in size).
Another area which remains in the red for the year is international stocks, with the MSCI All Cap World Index ex-US off 69 bps in 2024. Rather amazingly, they are even negative looking back three years (-2% three-year return). Unlike small- and mid-cap US companies, however, we don't see much we like in developed economies outside of the US. We do have a lot of conviction in one emerging market, however: India. Not only did that country just overtake China as the world's most populous nation, we also expect its GDP to grow faster than the communist nation's in 2024. We recently added an India-focused ETF to the Penn International Investor to take advantage of this condition.
We will probably avoid a recession this year, but the geopolitical landscape is as ugly as the domestic political landscape. Without delving too deeply into the matter, suffice to say that the dysfunctional state of US politics should worry us all. We have never felt more uncomfortable about a national election than we do this year. Neither leading candidate seems concerned about the $34 trillion national debt (123% the size of our economy), and Congress appears to be frozen due to internecine battles. In short, while we are off to a strong start for 2024, there are a lot of powder kegs which could blow before the general election rolls around. At least we can once again find relative safety in the fixed income market.
Fr, 09 Feb 2024
Commercial Banks
Another regional bank plunges off a cliff
Over the course of five trading days, regional mid-cap lender New York Community Bancorp (NYCB $5) fell 62% in value. Intriguingly, we are coming up on the one-year anniversary of SVB, Silvergate, Signature, and First Republic. We were told the bank runs are over, and that the regionals now provide investors with a great value proposition. Hold that thought. Since the start of the year, the SPDR S&P Regional Banking ETF (KRE $48) has fallen double digits while the S&P 500 is up 5%. New York Regional was a top-ten holding of the fund.
So what happened this time? It should be noted that New York Community Bank is heavily invested in commercial New York real estate. That is an area which continues to struggle since the pandemic shifted the paradigm in a major way, and we see those troubles continuing to mount. Rent-regulated multifamily loans (think Seinfeld's apartment building) account for nearly one-quarter of the bank's lending, and we view that segment of the real estate market to be highly volatile. Values have fallen and interest rates have risen since most of these borrowers last took out loans, and refinancing when they come due is going to be a challenge.
A major reason for NYCB's 200% debt-to-equity ratio is a recent spending spree. Not only did it acquire Flagstar Bancorp in late 2022, it more recently picked up parts of defunct Signature Bank. Crossing over $100B in assets, it should be noted, brought with it increased scrutiny by regulators. In December, the bank swung to an unexpected loss and slashed its fat dividend—a major reason investors were in the name—from $0.17 to $0.05 per share. Add a management shakeup to the mix and both investors and depositors alike got very nervous, leading to the selloff. One major depositor who also had money in Signature commented that his "finger is on the trigger," ready to pull funds if needed.
The bank says it is fully ready to offload assets to raise more cash if needed, but that doesn't change the makeup of the bank's loans. Just as trouble in the crypto industry helped bring down Silvergate, focusing on the owners of rent-controlled assets could be equally troubling. By its very name, owners of these properties are limited by law on how much they can increase rents on units, constricting their cash flow. To that end, the bank lost $252 million last quarter on the back of $185 million in charge-offs. For customers of Signature who suddenly found themselves with accounts at New York Community Bancorp, it must feel as though they are living in the movie Groundhog Day, especially considering the season during which this keeps happening.
For investors thinking they can get in a regional at an incredible price, dig a little deeper. The bank's P/E ratio of one may seem too good to be true, and it probably is. While annual revenue is expected to grow by 11%, the estimated EPS growth rate is -66.2% per annum. Yet another reason we are underweighting the Financials sector right now.
Tu, 06 Feb 2024
IT Software & Services
Penn darling Palantir soars 31% in one session on monster quarter
Sometimes CNBC's Jim Cramer is just hard to listen to. On Tuesday morning, after one of our favorite companies—Palantir (PLTR $22)—spiked double digits on news of a blowout quarter, blowhard Cramer said, "No, they are reliant on fickle government contracts." I am paraphrasing just a bit, but that was the gist of his brilliant commentary. He would rather own dogs like Disney and Boeing in his "chair-ble" trust. Sorry, Jim, you yelling something at the screen doesn't make it true.
Dr. Alex Karp's masterful company, which builds and deploys ultra-sophisticated data platform systems for customers, has, in fact, been focusing its attention on civilian clients as of late. Has it been paying off? Here's what Karp had to say about the company's commercial business for the quarter: "...bombastic, baller, incomprehensibly good." While so many like Cramer doubted the company's ability to move into the civilian space, we never did. Companies need products and services like this, and nobody provides them more effectively than Palantir.
For the quarter, revenue rose 20%, to $608 million, while net income grew a whopping 202%. Breaking revenue down by segment, commercial sales within the US rose 70% from the same quarter last year. Despite the current fiscal challenges facing governments, that side of the business still managed to grow 11%. Palantir operated in the black each quarter of 2023.
Every company from every industry is throwing around the AI acronym these days, but Palantir is one of the few firms which will actually exceed expectations in this new realm. Keep in mind that this super-secretive firm was originally funded by the CIA's venture capital arm, and has been an outspoken advocate for America's interests around the world. Remaining on the cutting edge of advanced technologies is in its DNA. In a recent discussion with Wall Street analysts, Karp laid out his strategic plans on artificial intelligence: "Just take the whole market." If anyone can do it, it is Palantir.
We have owned Palantir in the New Frontier Fund since the day it went public, buying in at $10 per share. It is one of our strongest conviction companies going forward.
Tu, 06 Feb 2024
Life Sciences Tools & Services
After exploding out of the gate as a SPAC, 23AndMe shares are now trading under $1
There are a number of sub-plots to unpack in this story, so let's begin with the basics: 23andMe (ME $1) is a genetics testing firm which provides a suite of DNA reports to customers. The "hook" for would-be subscribers may be the ability to understand one's ancestry, but the company's main focus is on identifying potential genetic health risks and, ultimately, providing therapeutic solutions. That alone is controversial; knowledge may be power, but imagine the needless worry that comes with knowing a host of personal health risks which will probably never manifest.
23AndMe went public in 2021 through a Richard Branson-backed special-acquisition company (SPAC) called VG Acquisition Corp. Once valued at nearly $6 billion, the company's driven leader, Anne Wojcicki, promised a host of products and services on the horizon. With the incredible amount of data the firm was collecting from DNA testing, the plan was to create a stream of therapeutics delivered with unprecedented accuracy. The pandemic put the company into hyperdrive as Americans suddenly became keenly interested in how their immune systems work.
Before long, however, concerns over data security began denting sales. It is one thing for a bank account to get hacked, but what could be the ramifications if someone's personal DNA map suddenly showed up on the dark web? In fact, that danger came to the forefront this past December as the company announced that data on its customers had been compromised. Hackers were able to access names, birthdates, ancestry reports, and other information on some six million people. Cybersecurity expert Justin Sherman put it succinctly: "You can change your passwords, but you cannot change your DNA."
All of the concerns over data security and whether or not the company could meet its lofty goals without a massive inflow of new cash helped pound the stock price down to under $1 by the end of the year. It has already had one-quarter of its market cap shaved off in 2024 and now sits at just $323 million in size. The company's strong growth focus has morphed into layoffs and concerns over the speed at which it is burning through cash.
It is not an impossible proposition that this company will stage a turnaround, but it is going to be a herculean task. The latest fundraising effort garnered $1.4 billion, with 80% of it already spent. Wojcicki does have a star-studded list of personal friends and backers, from Sergey Brin to Alex Rodriguez, and her company sits on a treasure trove of 10 million DNA samples which could be used for research, but time appears to be running out on her grand plans.
Tu, 29 Jan 2024
SeaWorld Entertainment (SEAS $50) will change its corporate name to United Parks & Resorts and trade under the new ticker PRKS starting in mid-February. The company operates 12 parks in the US and just opened a new aquatic park in the UAE.
UPS (UPS $149) announced the layoff of 12,000 workers after a disappointing quarter; revenue declined from $27 billion in the same quarter last year to $24.9 billion this past quarter—a 7.8% decline. Workers are being asked to return to the office five days per week. Shares dropped 6% in pre-market.
Headlines for the Month of Jan 2024
Tu, 29 Jan 2024
East & Southeast Asia
Another Chinese facade exposed: Evergrande ordered to liquidate
The Chinese real estate market accounts for approximately one-fourth of the communist country's economy. Just as Americans invest in the stock market, middle- and upper-class Chinese citizens invest in property, which is a serious status symbol amongst the culture. Some 70% of aggregate family wealth, in fact, is tied up in residential properties—the apartments they live in and investments in development communities built by the likes of Country Garden and Evergrande. The former has now defaulted on a chunk of its debt, and the latter has just been forced into liquidation by a Hong Kong court.
Just a few years ago, the world was being shown images of grand new cities being built in China by the country's first- and second-largest real estate development companies. That facade has now been exposed, and Chinese citizens are filled with both shock and anger. After a weekend deal fell through, the Evergrande liquidation order means that creditors will be given full control over the company and its properties. Bonds issued by the firm are trading for a few cents on the dollar, and its $240 billion in assets is overshadowed by its $300 billion debt load.
Much of the company's assets exist in the form of massive, unfinished high rise communities like the one shown below. About as far on the liquidity spectrum from cash as one can get, who would want to take over these concrete and steel nightmares? No wonder China's citizenry is in a funk; they watch helplessly as their investments become virtually worthless.
At the time of the liquidation order, Evergrande had pre-sold some 1.5 million residences which have never been delivered. The damage up and down the supply chain, from lending banks to steel and concrete companies, is hard to fathom. The epicenter of the disaster will be the ordinary Chinese household. Xi may be president for life, but history has taught us that massive change can often occur with lightning speed.
Tu, 29 Jan 2024
SeaWorld Entertainment (SEAS $50) will change its corporate name to United Parks & Resorts and trade under the new ticker PRKS starting in mid-February. The company operates 12 parks in the US and just opened a new aquatic park in the UAE.
UPS (UPS $149) announced the layoff of 12,000 workers after a disappointing quarter; revenue declined from $27 billion in the same quarter last year to $24.9 billion this past quarter—a 7.8% decline. Workers are being asked to return to the office five days per week. Shares dropped 6% in pre-market.
Mo, 28 Jan 2024
Consumer Electronics
Thanks, Europe: Amazon's purchase of iRobot is axed
Shares of consumer robotics company iRobot (IRBT $15) plunged double digits on Monday following the announcement that Amazon (AMZN $150) would be terminating its agreement to buy the firm for $1.7 billion. Shareholders can thank the European Union.
As deficient as American regulatory agencies have become over the past three years, notably the FTC, the European apparatchik is far worse. The notion that Amazon buying a small-cap electronics firm would stifle competition on the continent was laughable. But, after company representatives met with European Commission officials, it became clear that the deal would be dead on arrival. This doesn't have much of an impact on the $1.65 trillion online retailer but it is a body blow to the Mass-based iRobot.
Founder and Chief Executive Colin Angle will step down, with Chief Legal Officer Glen Weinstein stepping in as interim CEO. The company also announced a restructuring plan which includes letting nearly one-third of its workforce go by the end of the year. For years, iRobot operated virtually debt free; they now have $204 million in debt and will pay a $94 million termination fee, eating up half of the company's cash on hand. Chairman Andrew Miller said the company's focus now turns to the future, but we don't see it looking very bright.
It is a shame that a company which pioneered such unique robotic devices—devices which were quickly copied by other companies—and operated in the black for years now faces an uncertain future. Before agreeing to be acquired, smaller firms must rewrite the risk management script on what a government agency shoot-down would mean to the firm's finances and operations. It is a tough time to be in the M&A business.
Sa, 20 Jan 2024
Market Pulse
The Week in Review: Four trading days, two narratives
It started out as a rough holiday-shortened trading week, with virtually everything dropping in value on Tuesday and Wednesday except for oil. Based on some Fed speak, investors suddenly weren't feeling so sure about that March rate cut they had already baked into the cake; a cut we still don't believe will manifest. Atlanta Fed President Raphael Bostic made news when he posited the notion that we could see "a couple of rate hikes in the second half of the year." Investors didn't like three words in that sentence.
Bostic's remarks were buttressed by persistently-strong consumer spending and jobless claims below the figure analysts were expecting. In other words, why lower rates if the economy is swimming along? Ironically, that notion started to make investors feel better about the economy, leading to a two-day surge to cap the week off. Furthermore, the big tech stocks which had been hammered in the first two weeks of 2024 staged the biggest comeback. The NASDAQ rose 2.26% for the week. While the S&P 500 was up just over one percent on the week, that was enough for the index to notch a new all-time high.
Fourth-quarter earnings season kicks into overdrive this coming week, with a diverse list of industry leaders reporting. The first estimate of Q4 GDP comes in on Thursday, and key personal consumption data (core PCE) hits next Friday. Thanks to the late-week rally, the S&P 500, Dow, and NASDAQ are now positive on the year, while small caps and international stocks (as measured by the iShares MSCI ACWI ex-US) remain in the red; 4.13% and 2.72%, respectively.
Fr, 19 Jan 2024
Consumer Finance
Discover shares plunge on bad debt worries, weakening income
Shares of Discover Financial Services (DFS $97), one of the country's largest credit card issuers, fell double digits on Thursday after the company reported a 62% plunge in profits for the fourth quarter. The company also set aside an additional $1 billion (from the same quarter a year earlier) in preparation for net charge-offs. That's financial lingo for debt it doesn't believe will be repaid.
Revenue did increase 13% from the previous year and 3.7% from the previous quarter, but net income fell to a paltry $388 million on $4.2 billion of revenue. That's the company's slimmest margin in years, and a stark contrast to the $1 billion it made in the fourth quarter of 2022. The jump in revenue is due to an increase in net interest income, or the extra money the company earns from its ability to charge higher rates.
Charge-offs doubled in the fourth quarter, from around 2% to over 4%, and the company's increased provisions for credit losses show they expect that trend to continue. There is at least a two-fold reason for that. First, Americans have now racked up a record amount of credit card debt—$1.08 trillion. Secondly, interest rates on these cards have skyrocketed.
Discover advertises a standard purchase APR between 17.24% and 28.24%. That is staggering. Imagine the financial condition of the poor soul who has maxed out their Discover card and is paying 28.24% per year in interest! Odds are great that they have no idea that is their rate, as few check their statements. We know someone with an 850 credit score, no balance on their card, and a stated interest rate of 17.49% (29.24% for cash advances). With a 5.5% federal funds rate upper limit, that is highway robbery. Assuming the Federal Reserve lowers interest rates this year, which investors are banking on, how much do you think Discover will lower those confiscatory rates? We shed no tears for the 10.8% drop in its share price.
Americans have got to work their way out of consumer debt, and that begins with an understanding of their precise debt load each month and the interest they are paying on each bucket of that debt. The pain and anger of carrying that burden must be stronger than the desire to add something new on their credit card. A simple monthly budget is the first step to financial freedom.
We, 17 Jan 2024
Airlines & Air Freight
Spirit Airlines falls 60% after judge ends JetBlue merger
It is funny in a way; unless, that is, you happen to be a Spirit Airlines (SAVE $6) shareholder. Nearly two years ago we wrote about the great merger of the low-cost carriers: Frontier Group Holdings (ULCC $4) agreed to buy Spirit in a deal valued at $6.6 billion—a fat premium for Spirit shareholders. Apparently that wasn't good enough.
Greed and arrogance took over when JetBlue (JBLU $5) went hostile for Spirit and shareholders accepted the deal. In May of 2022 we wrote that "JetBlue going hostile for Spirit is a complete waste of time." Two years later, and we have been proven right: a federal judge just shot down the merger. JetBlue shares were unfazed; Spirit shares fell 60% in two days.
Granted, we have an incorrigible FTC right now which is intent on suing to stop seemingly every corporate merger, but we believe they would have lost going against the original deal. The judge ruled that a combined JetBlue/Spirit entity would harm the latter's consumer base. We will go further. JetBlue has an atrocious on-time rate and horrendous customer service; an abysmal record that would have been foisted upon Spirit flyers. This would not have been the case were the Frontier deal maintained.
We will never know for sure whether the original deal would have stood up in court, but we believe it would have. Instead, Spirit shareholders who had no problem reneging on a deal to gain a few extra dollars find themselves 60% poorer in their investment.
Airlines are going through a rough spell right now, and investing in any of the carriers is risky. While we wouldn't own any of the low-cost carriers, we do own United Airlines (UAL $38) in the Penn Global Leaders Club due to its exemplary management team and long-term strategic vision, which includes a return to supersonic travel for the industry.
Mo, 15 Jan 2024
East/Southeast Asia
Global democracy notches a win in Taiwan; what will China do?
Expected or not, it was still an incredible victory. Standing defiantly against the world's second-biggest bully (behind Russia under Putin), the people of Taiwan just elected the country's vice president, Lai Ching-te, to be their new leader. To say the Communist Party of China loathes this man is an understatement. It labeled this election a choice between war and peace, but the voters were unintimidated. Lai's Democratic Progressive Party just won its third consecutive four-year term.
China's horse in the race was KMT party candidate Hou Yu-ih; while promising voters that he wouldn't move toward unification with China, he was widely viewed as a Xi lackey. A spokesperson for the Chinese Taiwan Affairs Office said that the election does not represent "mainstream public opinion on the island," but gave no further details. Secretary of State Antony Blinken, meanwhile, said that the Taiwanese people had demonstrated the strength of their democratic system.
Despite the fact that he is detested by the CPC, Lai, a Harvard-educated former physician, said he can keep the peace across the Taiwan Strait. While in past statements the new president said that he would work for full independence, he has since tempered those remarks; he now simply argues that Taiwan is already a de facto state.
In addition to being a former doctor, when he was mayor of the southern city of Tainan, "William" Lai helped bring a Taiwan Semiconductor (TSM $101) plant to the region. Born into a coal mining family, the new president lost his father at age two. Despite being raised in poverty, he worked tirelessly to excel in school and ultimately earn his medical degree. The youthful 64-year-old Ching-te seems well suited to lead Taiwan through what is sure to be a contentious period in its history.
Beijing may be livid with the results of Taiwan's election, but we expect its response to be tempered. Cyberattacks will undoubtedly increase on the island, and Chinese warships will probably become more belligerent in the Strait, but the country's economic woes should keep Xi's attention focused on the mainland—for now, anyway.
Th, 11 Jan 2024
Cryptocurrencies
Backed into a corner by the courts, SEC finally approves Bitcoin ETFs
In a massive win for the crypto world, the US Securities and Exchange Commission finally approved the launch of spot Bitcoin ETFs, specifically giving the green light to eleven different funds. This represents a seismic shift for the nascent asset class, and will allow everyday investors to buy the digital currency directly.
It wasn't looking good for Bitcoin back in 2022. That summer, the SEC rejected Grayscale's proposal to convert its Grayscale Bitcoin Trust (GBTC $41) into a spot Bitcoin ETF. By late full, the price of Bitcoin had dropped to $15,742 from its high of over $68,000. But a year later, in October of 2023, a DC Court of Appeals ruled that the commission failed to "adequately explain its reasoning." That court decision essentially forced the SEC's hand, leading to this week's reluctant approval.
The global crypto market now sits at approximately $1.8 trillion in size, with Bitcoin representing half of that value. Putting that in perspective, the global stock market has a value of around $110 trillion, with 43% of that residing in the US. A fairer comparison would be gold, which has a global market cap of around $15 trillion; or money market funds, which hold approximately $6 trillion in assets. We can only speculate how big that $1.8 trillion will become now that the flood gates have opened, but it is certainly a bullish sign for the industry. And for the marketing firms representing the dozen or so companies vying for their share of the Bitcoin pie.
Despite its high expense ratio of 2%, Grayscale will be the benchmark issuer in the space. Other companies launching Bitcoin ETFs include: Fidelity, Franklin, iShares, VanEck, Invesco, Valkyrie, and Wisdom Tree. Interested investors need to consider fee structure, size, and ease of liquidity when choosing a firm. This is a volatile asset class to be sure, but one which is not going away.
We, 10 Jan 2024
Beverages, Tobacco, & Cannabis
Tilray's new craft beer lineup lit up the company's quarter
Remember all of the excitement surrounding cannabis stocks? To help jog your memory, it occurred about the same time you were buying that Oculus headset to prepare for your future in the metaverse. Our favorite player was, and remains, Canadian player Tilray (TLRY $2), which was acquired by Aphria in a reverse merger in 2021.
Last year we reported that Tilray was buying eight craft beer brands from troubled brewer AB InBev. It didn't take long for that acquisition to pay off: Tilray just reported its fiscal Q2 numbers, which included a stunning 117% spike in net revenue from the company's alcohol business. Overall, quarterly net revenue grew 34%, beating expectations.
We have long praised the acumen of Tilray CEO Irwin Simon, who has quite the eclectic style. As the firm awaits federal cannabis rulings from DC, its CEO is expanding into yet another complementary category: vegetables. The company will begin growing strawberries, cucumbers, eggplants, and tomatoes in its excess cultivation space in Quebec. One massive hothouse, for example, will have a mix of 20% marijuana and 80% fruits and vegetables in the soil. Tilray points to the big demand for agricultural food commodities in the province.
One thing is undeniable: Under Simon's leadership, Tilray will never be accused of being just another boring Canadian cannabis company waiting for legislation from south of the border.
Despite its high beta, Tilray remains on track for positive free cash flow, and its financial position is strong. For the aggressive portion of a portfolio, this unique player is worth a look—especially at $2 per share.
Tu, 09 Jan 2024
Aerospace & Defense
Yet another reason to avoid Boeing until management is broomed
There is no leadership team in place at Boeing (BA $229); only a chief manager by the name of Dave Calhoun, walking behind each subsequent mishap with a giant shovel. Sort of like the guy who walks behind the elephants at a circus parade. We keep waiting for someone to do something about the situation, but who will that be?
Will Calhoun suddenly admit that he is not up for the task? Will his sycophantic board ask him to step aside? Neither of these two scenarios are likely, leaving it up to the major shareholders to take action. The top three shareholders are: The Vanguard Group, The Boeing Company Employee Savings Plans Master Trust, and BlackRock. We have close to zero confidence in any of these entities to take action. As long as Boeing is checking its ESG boxes, Larry Fink's BlackRock is happy.
We are all familiar with the latest nightmare for air passengers—the door plug which blew out of the fuselage of a Boeing 737 Max 9 in mid air. A door plug is, in essence, a panel with a window in it which takes the place of an emergency exit on jets configured to hold less than the max 220 passengers. The panel was found in the backyard of a school teacher in Portland.
Since the subsequent grounding of Max 9s, both United Airlines (UAL $43) and Alaska Airlines (ALK $38), the two US carriers which fly this version, have discovered loose bolts on a number of door plugs within their respective fleets. SpiritAeroSystems (SPR $28) makes the assemblies and assists in the installation, but it is ultimately up to Boeing to assure its aircraft are safe to fly. The Max 9 is a more recent version than the 737 Max 8s which were involved in two horrifically deadly crashes in 2018 and 2019.
The Max 9 involved in the incident was virtually fresh off the assembly line. Furthermore, pilots aboard this very same jet reported three pressurization warnings from the cockpit between 07 December and 04 January, with at least one occurring in-flight. This incident never should have occurred. Does anyone trust Calhoun and the board to prevent another incident on yet another system in the near future? Investors certainly shouldn't.
Boeing has negative shareholder equity, which means its assets are insufficient to cover its liabilities. The company hasn't turned a profit since 2018. It is a sad state of affairs that the American half of the global aircraft duopoly continues to muddle through safety crises. China would love for this condition to continue, as it boasts its own nascent effort in the industry via the Commercial Aircraft Corp of China, Ltd (Comac, a state-owned enterprise). With every subsequent mishap, Comac's future viability grows. David Calhoun's total compensation package for 2022 was $22.48 million. The average compensation for CEOs of similar size companies in the US market is $12 million per year.
Sa, 06 Jan 2024
Market Pulse
It was a rough start to the new year; earnings season now in focus
There wasn't much to hang our hats on in the first week of 2024—about the only component of the markets in the black was crude, which rose from $71 to $74 per barrel. All of the so-called Magnificent Seven stocks—the big tech names that led the charge in 2023—fell this week, with the NASDAQ plunging 3.25%. Small caps, as represented by the Russell 2000 index, dropped 3.72%.
Even bonds fell in value as investors reassessed their bullish call for Fed rate cuts. On that last point, we continue to believe the Fed won't deliver near the cuts this year that the market is pricing in. Most analysts are calling for between five and seven cuts, with the federal funds rate dropping from a range of 5.25%/5.5% down to 3.75%/4% (lower/upper limits). We tend to believe the Fed's own projection for three cuts in 2024, and that those will come later in the year than most expect.
Now that the first week of the year is in the books, attention can turn to earnings season. We remember the old days when all eyes would be on Alcoa's (AA $32) results to get a feel for how the season would shape up; now, it will be the big banks which act as the barometer. Bank of America (BAC $34), Citigroup (C $54), JP Morgan (JPM $172), and Wells Fargo (WFC $50) all report before Friday's opening bell. Wall Street expects an aggregate 1.3% growth rate in the fourth quarter, and a meager 0.8% full-year earnings growth rate for 2023. That bar doesn't seem too high; we believe actual results will surpass expectations.
Historically, "as goes January, so goes the year." Corporate earnings will, we hope, be the catalyst needed to lift us out of this little pothole we dug in the first four trading days of 2024.
Fr, 05 Jan 2024
Oil & Gas Refining, Storage, & Transportation
The world has a new leader in the export of liquified natural gas
In 2022, as the accompanying graph indicates, Australia was the world's leading exporter of liquefied natural gas (LNG), selling some 87.6 million metric tons (MT) of the energy source to the global market. And the process is no easy task: natural gas must be cooled down to approximately -260°F to liquify it, allowing it to take up about 1/600th of the previous volume. It can then be efficiently transported and regasified at its destination for normal use. A fascinating process. And the world has a new leader in the export of this fuel.
In 2023, LNG exports from the United States rose over 20%, to 90 MT, allowing the country to leapfrog over both Qatar and Australia. In the wake of Russia's invasion of Ukraine and the subsequent embargo of gas from that country, many energy experts feared the worst for Europe heading into last winter. Instead, the US helped fill the void, with between 60% and 70% of LNG exports headed to the continent. Asia was the destination for roughly 25% of America's exports, with the remainder mostly going to Latin America.
Two main factors allowed the US to increase production by such a hefty amount: a Freeport LNG export facility which had been shuttered due to a 2022 fire restarted production, and Venture Global's Calcasieu Pass facility in Louisiana came online. In 2024, two more major LNG projects will begin production: Venture Global's Plaquemines facility in Louisiana, and a joint venture between Exxon Mobil (XOM $102) and QatarEnergy in Texas. Impressively, these two projects should, once online, add another 40 MT per year in US production. So, not only is the US the world's leading producer of oil, it will also retain the mantle as the world's largest exporter of LNG—despite all of the talk of the world moving on from fossil fuels.
While Freeport LNG (not to be confused with Penn member Freeport-McMoRan) is not publicly traded, investors could look to Cheniere Energy (LNG $168), the largest LNG exporter in the US. We prefer to play the industry with our Chevron Corp (CVX $150) investment; the gas giant is a top ten global exporter of the fuel, with expansion plans in the works.
Tu, 02 Jan 2024
Financial Planning: Education Funding Strategies
Massive new change to 529 Savings Plans just took effect
Not to date myself, but when I first got in the financial planning business, the only tax-favored savings plan for college was the Coverdell Education Savings Account ("Education IRA") with a maximum annual contribution limit of $500. Granted, that amount went up to $2,000 per year around the turn of the century (that does make me sound old), but considering the average cost of in-state tuition and room and board at a public college is now $24,000 per year, that seems like a drop in the bucket—even with the tax-protected growth.
Around the same time that the Education IRA contribution limit was going up, a truly remarkable college savings tool was being created by Congress: the Qualified Tuition Program, or 529 Plan. In short, each US state could operate its own version, which essentially had no contribution cap (though the annual gift tax exclusion is currently $18,000 per person), and the funds would grow tax free. Assuming the proceeds were used for qualified education expenses, even withdrawals were—and remain—tax free. As of 01 Jan 2024, the plan got even better.
Through a provision in the Secure 2.0 Act, any time after fifteen years following the Plan's initial setup, any unused portion—up to a total of $35,000—can be rolled into a tax-free Roth IRA for the beneficiary. Just for fun, we plugged $35k into our Wayback Machine, set the dial for the S&P 500 in 2014, and discovered that we now have a cool $222,000 of tax-free retirement savings. This really is a big deal.
As good as the concept of the 529 Plan has been in the past, investments have actually been on the decline recently. A lousy market return in 2022 played a role, but our biggest hangup has been the disparity in states' plans. To be blunt, some plans have simply awful, age-based options, as opposed to the freedom of choice we had with the old Education IRAs. Another drawback has been the convoluted rules with respect to the degree in which a 529 plan could affect financial aid and the expected family contribution (EFC) amount. Still, compared to the options available when saving for a kid's education, the best tool just got a lot better.
One of our arguments against the federal government attempting to pay off portions of student loans (besides our $33.8 trillion national debt) has been the fact that it disregards the most responsible savers, those who worked their way through school, and those who joined the armed services in-part for the education benefits. When student loan repayments resumed this past fall, only 60% of debt holders began making payments once again. Most of the other 40% are waiting for something magical to happen via the federal government. Odds are great they are in for an unpleasant surprise down the road.
Fr, 22 Dec 2023
Media & Entertainment
Live by the sword, die by the sword: Netflix releases viewer data
Boasting the largest streaming television subscriber base in the world, Netflix (NFLX $487) never really felt the need—nor had the desire—to give individual metrics on which shows its 250 million subscribers were watching. It kept such data very guarded. Why, then, is the company suddenly telling the world how many viewing hours there have been for every single one of its releases? It has to do with the Hollywood writers and actors strikes.
In the past, actors and writers were just fine with the company keeping mum on such data, as the bombs could remain hidden behind the curtain—unlike theater releases, which have their level of success defined by box office ticket sales. But one of the results of the long and heated negotiations between the major studios and labor unions revolves around how the talent is paid. Labor argued that the studios weren't fairly compensating writers, directors, and actors involved in blockbuster hits; of course, they didn't mention the other side of the coin: has anyone ever been asked to give a portion of their paycheck back because their video art bombed?
So now, Netflix is going all in, releasing hard viewership numbers for some 18,000 titles, and they will continue to issue their "What We Watched: A Netflix Engagement Report" semiannually. The big winners? Season one of The Night Agent was the streamer's biggest hit in the first half of the year, garnering 812 million hours of viewing. (Great show.) Coming in second was season two of Ginny & Georgia (never heard of it), with 665 million viewing hours; and in third place was season one of The Glory (never heard of it), with 623 million hours. One of our favorites, the first season of Wednesday, rounded out the top four with 508 million hours.
With their pay now hinging on these metrics, let's see how the writers and actors of poor-performing shows feel about this hard-won point of victory. Then again, we imagine it is much like major league sports: there will be a minimum guaranteed salary—an amount most Americans would give anything to earn—just for making the cut.
We are avoiding the content providers like the plague. Looking at the graph, which outlines total return over the past five-year period, every media outlet is negative except for Netflix. To reiterate, that is over a five-year period! The bottom two, Warner Bros. and Paramount, are now toying with a merger to help assure their survival (our words). Disney has its own problems under Der Comondante Iger. Comcast's customer service is a joke, which is inexcusable in a hyper-competitive market undergoing constant change. Just steer clear.
Th, 21 Dec 2023
Middle East
How deeply will the maritime attacks in the Red Sea affect the economy?
On the 19th of November, Iranian-backed Houthi rebels attacked a British-owned and Japanese-operated cargo ship, the Galaxy Leader, near the southern tip of the Red Sea. It remains anchored off the Hudaydah Port in Yemen, with the ship's 25 crew members being held hostage for over a month now. A few weeks after this brazen attack, the rebels struck three commercial ships traveling through the Bab el-Mandeb Strait with ballistic missiles while a US warship in the region destroyed three incoming drones. On Tuesday the 12th of December, a Norwegian tanker headed for Israel was struck by a missile fired from Yemen and caught fire. A Houthi spokesperson commented on social media that the ship had "refused to respond to warning." The group's slogan is "Death to America, Death to Israel, curse the Jews and victory to Islam."
These attacks are being perpetrated by an Iranian-backed terrorist group, but we cannot underestimate both Russia and China's involvement. In addition to being allies of the militant state of Iran, nothing would please Putin and Xi more than focus—and resources—shifting away from the war in Ukraine and the defense of Taiwan. Switching gears to the economic standpoint, how much will these increasingly audacious attacks affect the global economy?
About 12% of tanker traffic and 30% of shipping containers traverse the Red Sea. The shippers are increasingly rerouting their craft to avoid the region, which we believe will cause a number of headaches for a world economy finally shaking off the effects of a global pandemic. For the better part of a month, oil seemed to shrug off the troubles (we added a long oil ETF to the mix when crude dropped to a six-handle), but over the past week WTI has risen 7% in price.
Inflation is another concern. The bullish theme going into 2024 is for inflation to drop nearer the Fed's 2% target range, allowing the central bank to lower rates several times. If oil moves higher due to the turmoil and 30% of container shipments must be rerouted, that might renew upward pressure on prices—freight rates have already spiked and the longer trips can add up to $1 million per journey. We buy into the bullish oil story (sadly), but less so the general renewed-inflation narrative. The US will not simply stand by much longer and allow these attacks to continue.
This week, the US launched Operation Prosperity Guardian, a 39-member international coalition designed to defend Red Sea shipping lanes. Under the command of the US Navy Fifth Fleet, Task Force 153's mission is to "focus on international maritime security...in the Red Sea, Bab el-Mandeb, and the Gulf of Aden." While attempting to avoid an escalation in the conflict, such as an attack by Hezbollah—an Iran-backed Lebanese militia—along Israel's northern border, we can expect this task force to heavily suppress the Houthi threat to the narrow shipping lane. The alternative is an unacceptable disruption of global commerce with no end in sight.
Look to the Galaxy Leader for signs of where this conflict is headed. Will there be a rescue attempt or a negotiated release of the ship and its crew, or will the situation drag on akin to the Iranian hostage crisis of 1979? Sadly, we recall what happened during that rescue attempt. While there are no American crew members on the Galaxy, it has an eerily similar feel to the pre-election crisis of forty-four years ago.
Mo, 18 Dec 2023
Metals & Mining
Better Japan than China: Nippon Steel to acquire US Steel
It formed out of the merger between Carnegie Steel and Federal Steel 122 years ago, with James Pierpont Morgan structuring the deal. The company established its headquarters in the Empire State Building and remained a major tenant in the building for 75 years. It was, at one time, not only the largest steel producer in the world but also the largest company in the world—the first to reach one billion dollars in size. Alas, it resides in a hyper-competitive industry with plenty of lower-cost producers around the world, one of which will now own them. On Monday, US Steel (X $50) made the announcement that Japan's largest steel producer, Nippon Steel (NPSCY $7), will acquire the firm for $14.1 billion—$55 per share—in an all-cash deal.
Nostalgia doesn't travel very far in the modern business environment, and we must face the fact that US Steel had dropped in position to the world's 24th-largest producer of flat-rolled steel and tubular products. In the US, there were about 82 million metric tons of steel produced last year, with X accounting for just one quarter of that amount (Nucor is the largest producer in the country). By contrast, suitor Nippon produced around 45 million tons last year, and a Chinese firm (what a shocker) led production with 132 million metric tons. This is an industry well-poised for contraction via mergers.
Nippon has said that, post-merger, the company will retain its name, brand, and headquarters in Pittsburgh, and that it will keep in place all agreements forged with the United Steelworkers (USW) union. We wrote this past summer that the union not only demanded that all labor agreements be honored in any sale, but that it would have a say in who bought the firm (no, really). Despite this deal being twice the size of the $7 billion offered by US competitor Cleveland-Cliffs (CLF $20) in August, the USW doesn't seem happy about it. We imagine union lawyers have already placed calls to their good friend, Lena Khan, at the FTC, but we expect she will lose this fight in the courts should she try and nix the deal. Her legal record is a running joke in the business community. In the end, the deal gets done.
Steel prices have been all over the place over the past few years, rising and falling like the price of lumber. If we had to make an investment in the industry right now it would be in Ryerson Holdings (RYI $32), a US-based services company that processes and distributes metals. The company has a foothold in several key areas, from oil and gas, to industrial equipment, to transportation. Better the dealer than the maker.
Mo, 18 Dec 2023
Energy Commodities
Foiling OPEC: The United States hits new record production levels
At the start of 2023, the OPEC nations were pumping some 31 million barrels per day (bpd) of crude onto the market; oil was sitting at $80.51 per barrel. The cartel found that price too low, and announced a cut of one million bpd to pump up prices. The move appeared to have maximum impact by September, when crude hit $91.20 per barrel. But two factors would soon combine to foil our dear friends' effort: both of them positive for the US.
The first factor was a serious drop-off in China's rate of economic growth. Considering the percentage of oil used by the communist nation, it makes sense that a good level of demand destruction is Asia would force prices down. The second factor was the unexpected spike in US crude production, especially shale. At the start of the year, the US was pumping 12.1 million bpd of oil; by mid-December, that amount had risen by the precise amount of OPEC's cuts—one million bpd. Between the end of November and the second week of December, crude prices dropped from $80 per barrel to $70 per barrel. The US had retained its moniker as the world's number one energy producer. Gasoline prices in the US, in turn, returned to what we would consider a normal level: around $2.50 per gallon.
America's shale renaissance has been a nightmare for OPEC over the past decade. In 2014, the cartel tried to crush the movement by flooding the world with additional crude to undercut the US effort. At first, the plan seemed to be working, with WTI crude falling to $44 per barrel by March 2015 and all the way down to $28 per barrel a year later. In April 2020, as pandemic fear was at its height, crude infamously began trading in negative figures.
Below $50 per barrel, it is extremely difficult for shale producers to stay afloat, let alone remain profitable; and it really takes oil trading above $60 per barrel for these companies to thrive. We are certainly above that price now, and we don't see the Saudis pushing for OPEC to try its 2014 stunt again. In fact, the group's action forced these explorers to become more efficient, increasing production while reducing costs (drilling rig count is down 20% ytd despite the 1M bpd increase). Perhaps American shale producers should send a thank you card to the cartel.
Our challenge with investing in this industry is that most of the companies tend to be laden with debt. If we had to pick one player to invest in, it would be APA Corp (APA $35; formerly Apache). This $11 billion mid-cap driller boasts an enormous and geographically diverse reserve base, and it has nice free cash flow. Shares are probably worth around $50. To mitigate risk a bit, investors could buy the Invesco Energy Exploration & Production EFT (PXE $30), which owns 30 industry leaders (Phillips 66 is the largest holding).
Fr, 15 Dec 2023
Market Pulse
The Fed set the tone for the most awesome week in the markets
Everyone expected the Fed to hold steady at this week's FOMC meeting, but few expected the Christmas gift that Powell brought to the equity market.
It was the third "hold" meeting in a row, virtually assuring that the most recent tightening cycle is now behind us—following eleven hikes and a federal funds rate between 5.25% and 5.5%. One of the components of the meeting which we didn't predict was the Fed's projection for three quarter-point rate cuts in 2024. That sent markets flying higher; but the best part came from Powell's presser.
Based on some of the inane questions asked by the pool of reporters and how investors interpret his answers, the stock market can get whipped around furiously during this exchange. What we got was another shocker: Powell sounded downright dovish. He indicated that inflation is moving down closer to the 2% target range, economic growth was slowing, and that the Fed doesn't need to see unemployment go much higher to warrant rate cuts. Stunning. By the end of this extraordinary day, the Dow was up 512 points, small caps rose by a whopping 3.52%, and bonds rose (Bloomberg US Aggregate) by 1.31%. Oil even stayed below $70, capping off a picture-perfect Wednesday.
The euphoria carried into Thursday, and the markets ended the week with a flattish Friday. For the five-session period, the S&P was up 2.5%, the NASDAQ 2.85%, and the Russell 2000 gained 5.85%. Now we head into the final two weeks of the year, and hopefully a continuation of the early Santa Claus rally.
Th, 14 Dec 2023
National Security
House passes defense bill, leaving out controversial social issues
There are two annual fiscal actions which shape what the state of America's defense will look like for the coming year: the National Defense Authorization Act (NDAA, first passed in 1961), and defense appropriations bills. While the NDAA establishes funding levels and general guidelines for the various agencies responsible for defense, the appropriations bill provides the funding. One down, one to go.
The US House of Representatives fended off attempts to include language on social issues into the NDAA, passing it by a margin of 310-118. That may not seem close, but a two-thirds margin was required under the fast-track procedure; it passed with 72% of the votes. The US Senate had already voted 87-13 in favor of the legislation.
The Act increases the US military budget by 3% from last year, to $886 billion, and includes a 5.2% pay raise for service members. It also provides for training assistance to Taiwan to help the US ally defend itself against attack from Communist China. One "controversial" aspect survived in the NDAA: Section 702 of the Foreign Intelligence Surveillance Act. First passed in 2008, this provision allows the government to conduct targeted surveillance of "foreign persons located outside of the United States." Privacy advocates have long criticized the law, but it has been responsible for over half of the information contained in the Presidential Daily Briefing (PDB).
The legislation also allows for the sale of US nuclear submarines to staunch American ally Australia; this is part of the AUKUS security agreement between Australia, the United Kingdom, and the US. Initiatives to strengthen relations with allies in the Pacific region, such as joint military exercises, will also be funded. Around $150 billion will be allocated to research and development in such fields as high-energy lasers and mobile micronuclear reactors for use in the theater of operations. Hundreds of other issues are addressed in the Act, to include $300 million in additional funding for Ukraine's war effort against Putin.
While passage was a major step in the right direction, the items outlined in the NDAA must now be funded. Considering the vitriol in a closely divided Congress, the upcoming election year, and the fact that our elected officials spent $1.7 trillion more than was brought in last year, that should be an interesting show.
Transportation Infrastructure
Uber soars higher after inclusion into S&P 500 announced
In 2022 we added Uber (UBER $63) to the Penn New Frontier Fund and there has been a litany of good news on the company since. The latest positive tidbit comes from an index; the S&P 500, to be precise. As of Tuesday the 19th of December, the transportation services company will join the prestigious index, along with IT manufacturing firm Jabil (JBL $121) and Builder's FirstSource (BLDR $149), a building material company and another Penn favorite. Uber shares rallied on the news, and are now up 150% year to date.
Three companies not faring so well are the ones being knocked out of the index: Sealed Air (SEE $33), Alaska Air Group (ALK $37), and SolarEdge Technologies (SEDG $76). The middle name is interesting, as the airline recently announced its intent to buy competitor Hawaiian Airlines (HA $13) for $1.9 billion—a massive premium to the $231 million market cap it had going into December. As for SolarEdge, the solar power industry is down something like 40% year to date.
Uber's inclusion makes perfect sense. The company has the largest market cap ($129 billion) of any US firm not listed in the S&P 500, and its Q3 earnings report showed four consecutive quarters of profitability. As the benchmark player in the ride-sharing space, we see a number of catalysts driving growth over the next several years, to include its growing Uber Eats business.
Although our UBER position has nearly doubled in value from last year's purchase price, we would still be a buyer at its current level.
Mo, 11 Dec 2023
Multiline Retail
Macy's shares soar after buyout offer announced
In August we added a small Macy's (M $21) position to the Intrepid at $13.32 per share. Legacy, multiline retail is a tough business these days, but we saw Macy's and Nordstrom (JWN $18) as two of the survivors. While we knew Nordstrom would probably be taken private at some point (perhaps by the Nordstrom family), this one was a surprise. We simply saw Macy's as undervalued at its price at the time, not the potential target of a few private equity firms.
Shares of M flew some 20% higher on Monday after it was revealed that investment firm Arkhouse Management and asset manager Brigade Capital Management had submitted a $5.8 billion bid to take the company private. With a single-digit forward P/E, it still seems as though they are getting a good deal, especially considering the real prize: Macy's real estate portfolio. At a conservative estimate, the firm owns in excess of the offer price in real estate alone. It is unclear whether this was the impetus behind the bid, but we would guess it was the major factor.
No word on management's review of the offer, and they are certainly not desperate to make a sale. With about $3 billion in debt, the company has a respectable 50% debt-to-equity ratio after the spike in value. (For comparison, Nordstrom's debt-to-equity ratio is 393%.) Over the trailing twelve months, Macy's earned $685 million on $24 billion in sales. In other words, they continue to operate in the black—something that a lot of retailers (Kohl's comes to mind) cannot say.
To repeat ourselves, this is an ultra-tough industry in which to operate, specifically due to the mushrooming of online competition. We would be tempted to take the money and run. Without shareholders breathing down management's neck each quarter, a creative leadership team could shape a great new experience for shoppers. But in this climate, who knows if the deal will even get done.
Buy the rumor, sell the news. We took our profit and closed the position. But honestly, we didn't see this one coming.
Mo, 04 Dec 2023
Consumer Electronics
The EU cast doubt on Amazon’s purchase of iRobot; time to buy?
In August of 2022 we wrote of Amazon’s (AMZN $147) plan to purchase one of our favorite little stock plays over the past few decades: consumer robot company iRobot (IRBT $37) for $1.7 billion in an all-cash deal—or about $61 per share. IRBT shares spiked from $37 to $60 in short order. Investors were trying to cash in on something known as merger arbitrage, which involves buying an M&A target at a price below the offer and riding the gravy train through completion of the deal. It now appears that one of the world’s great party poopers, the EU, has derailed that train.
A few weeks ago, just days after it appeared the deal was set to win “unconditional EU antitrust approval,” the European Commission issued a “statement of objections” which outlined why the merger would restrict competition in the European market. Shares plunged 17% at the open. Really? Amazon’s purchase of a small-cap robotic vacuum cleaner company was a threat to the continent? Every time the US government does something completely idiotic (hello, FTC Chair Lena Khan), it is quickly outdone by the dolts in the EU. Shares have rebounded a bit, but they still sit 40% below the revised buyout price of $51.75 per share. So, is it time to put a little aggressive money to work by hopping on the arbitrage train once more?
We do still like the company, but its global market share in the robotic vacuum space has dropped from around 65% a decade ago to 45% today. Furthermore, after the pandemic hit, the company postponed its plans to launch Terra, the lawn mowing robot. Several other companies have now jumped successfully into that space. (We recently witnessed a few of the little guys scurrying around near the green on a golf course.) We don’t believe iRobot will ever rejuvenate the Terra program.
Founded in 1990 by a team of MIT roboticists, iRobot was certainly ahead of its time. But consumer electronics is a business rife with IP theft and lower-cost overseas competition. Through the first three quarters of 2023, in fact, units shipped dropped by a third and revenues by a similar amount. After operating in the black for years, iRobot began losing money in 2022. While these factors make the EU claims ludicrous, and we do believe the deal will ultimately go through, we wouldn’t be playing the risk arb game right now with the shares.
We last purchased shares of iRobot in the New Frontier Fund back in 2019 for $48.80, selling them in early 2022 when a stop loss hit at $64.95 per share. We do believe Amazon could breathe some life back into the firm, but we will watch from a distance as the legal drama plays out. Plus, Amazon is one of our top holdings in the Global Leaders Club.
Fr, 01 Dec 2023
Market Pulse
One of the two best Novembers since 1980
It was the best month of the year and one of the two best Novembers in the market since 1980; sweet relief after a horrendous three-month period. A plethora of good news led to the rally, but the general sense that the Fed is done raising rates was the key component. Corporate earnings accounted for the second nice surprise, with S&P EPS jumping 6.3% Y/Y (11.6% ex energy). That is the fastest growth clip since the second quarter of 2022, and well ahead of what analysts were calling for.
As if the 4.9% GDP reading for Q3 wasn't good enough, that figure was revised up to 5.2%. That would typically worry Fed watchers, as it gives hawks another argument for raising rates yet again. That didn't happen this time, however, as clear signs are emerging that the rate of inflation is slowly falling back down into the desired range (disinflation). We still don't believe there will be rate cuts in the first half of next year, but that expectation also helped buoy the markets.
Another good sign came from the housing market. It was just over a month ago that the 30-year average mortgage rate hit 8%; that figure has now dropped to 7.22% and appears to be heading back down to a six-handle. Home sales, which had fallen to a 13-year low in October, began picking up steam once again in the last few weeks of November.
With all of the good economic and market news, let's not forget about the bond market. After a bruising few years, bonds just posted their strongest rally since the 1980s. The 10-year Treasury, which topped out at 5% in October, finished Friday with a yield of 4.22%. We have been increasing our exposure to fixed income investments—and increasing duration—since spring, and it has paid off nicely. We also added a 20-year Treasury bond proxy to the Strategic Income Portfolio a few weeks ago—it has rallied 10% since (bond values go up as rates fall).
Will the early Santa Claus rally continue through the end of the year? We believe so. We also see small-caps making up for lost ground (the Russell 2000 was flat YTD going into November), and value stocks staging a comeback. One of our biggest calls of the year was for gold to have a huge rally: the precious metal hit a new all-time high on Friday of $2,092 per ounce, and we are bullish on it for the coming year as well.
After such a strong November, investors should use the month of December to assure they are allocated properly going into 2024, and to consider some tax-loss harvesting.
Fr, 01 Dec 2023
Aerospace & Defense
SpaceX news: A South Korean spy satellite and strange bedfellows
On Friday morning, out of Vandenberg Space Force Base, California, a SpaceX Falcon 9 rocket carrying South Korea’s first domestically made spy satellite in its capsule’s cargo bay completed a picture-perfect launch. For security purposes, the company ended its webcast before the satellite was deployed, but all signs indicate it is in orbit and will soon be operational. The launch comes shortly after North Korean dictator Kim Jong Un’s claim of its own spy satellite launch.
The difference in technological prowess between the two Koreas is stark, making Un’s claims of viewing images of the White House from that country’s craft rather dubious. Earlier this year, North Korea failed at an attempt to launch a satellite into orbit, with the debris being salvaged by South Korea. Their conclusion: the craft’s abilities would have been somewhere on the spectrum between useless to “rudimentary at best.” As for its own program, South Korea expects Friday’s launch to be the first in a series, with the goal of having five operational spy satellites in orbit within the next two years.
In other SpaceX news, something extraordinary has occurred: Amazon (AMZN $147) has inked a deal for at least three launches of its satellite constellation aboard the Falcon 9. Bezos and Musk aren’t exactly friendly rivals in the field of space, with both dishing out some harsh words for each other’s programs (Bezos owns Blue Origin) over the past several years. Up until this point, Amazon’s founder had planned to rely primarily on United Launch Alliance (ULA) craft to send its Project Kuiper satellites into orbit (only two have been launched thus far). Project Kuiper is designed to be a direct competitor to Musk’s Starlink program. That program just notched its first profitable quarter, and the company may be spun off as an IPO soon.
The fact that Bezos would sign a contract with SpaceX speaks volumes of Boeing’s (BA $234) ULA program, which has been plagued with problems for years. He is obviously feeling some of the same frustration that NASA has experienced; the agency continues to rely heavily on the Falcon series of rockets, which have proven to be remarkably efficient at launching both hardware and humans into space.
While SpaceX has declined to publicly comment on the Kuiper deal, Musk did tweet the following on Friday: “SpaceX launches competitor satellite systems without favor to its own satellites. Fair and square.” As of November, there were some 5,500 Starlink satellites in orbit, accounting for more than 50% of all active satellites in space.
Amazon is a member of the Penn Global Leaders Club. Will we pick up Starlink shares when the company goes public? Hard to say, as it depends on how they are priced and where they begin trading. As for SpaceX, a privately held firm, clients own it within the Private Shares Fund, a private-equity-like instrument which invests in firms poised to go public in the near future.
Tu, 29 Jan 2024
East & Southeast Asia
Another Chinese facade exposed: Evergrande ordered to liquidate
The Chinese real estate market accounts for approximately one-fourth of the communist country's economy. Just as Americans invest in the stock market, middle- and upper-class Chinese citizens invest in property, which is a serious status symbol amongst the culture. Some 70% of aggregate family wealth, in fact, is tied up in residential properties—the apartments they live in and investments in development communities built by the likes of Country Garden and Evergrande. The former has now defaulted on a chunk of its debt, and the latter has just been forced into liquidation by a Hong Kong court.
Just a few years ago, the world was being shown images of grand new cities being built in China by the country's first- and second-largest real estate development companies. That facade has now been exposed, and Chinese citizens are filled with both shock and anger. After a weekend deal fell through, the Evergrande liquidation order means that creditors will be given full control over the company and its properties. Bonds issued by the firm are trading for a few cents on the dollar, and its $240 billion in assets is overshadowed by its $300 billion debt load.
Much of the company's assets exist in the form of massive, unfinished high rise communities like the one shown below. About as far on the liquidity spectrum from cash as one can get, who would want to take over these concrete and steel nightmares? No wonder China's citizenry is in a funk; they watch helplessly as their investments become virtually worthless.
At the time of the liquidation order, Evergrande had pre-sold some 1.5 million residences which have never been delivered. The damage up and down the supply chain, from lending banks to steel and concrete companies, is hard to fathom. The epicenter of the disaster will be the ordinary Chinese household. Xi may be president for life, but history has taught us that massive change can often occur with lightning speed.
Tu, 29 Jan 2024
SeaWorld Entertainment (SEAS $50) will change its corporate name to United Parks & Resorts and trade under the new ticker PRKS starting in mid-February. The company operates 12 parks in the US and just opened a new aquatic park in the UAE.
UPS (UPS $149) announced the layoff of 12,000 workers after a disappointing quarter; revenue declined from $27 billion in the same quarter last year to $24.9 billion this past quarter—a 7.8% decline. Workers are being asked to return to the office five days per week. Shares dropped 6% in pre-market.
Mo, 28 Jan 2024
Consumer Electronics
Thanks, Europe: Amazon's purchase of iRobot is axed
Shares of consumer robotics company iRobot (IRBT $15) plunged double digits on Monday following the announcement that Amazon (AMZN $150) would be terminating its agreement to buy the firm for $1.7 billion. Shareholders can thank the European Union.
As deficient as American regulatory agencies have become over the past three years, notably the FTC, the European apparatchik is far worse. The notion that Amazon buying a small-cap electronics firm would stifle competition on the continent was laughable. But, after company representatives met with European Commission officials, it became clear that the deal would be dead on arrival. This doesn't have much of an impact on the $1.65 trillion online retailer but it is a body blow to the Mass-based iRobot.
Founder and Chief Executive Colin Angle will step down, with Chief Legal Officer Glen Weinstein stepping in as interim CEO. The company also announced a restructuring plan which includes letting nearly one-third of its workforce go by the end of the year. For years, iRobot operated virtually debt free; they now have $204 million in debt and will pay a $94 million termination fee, eating up half of the company's cash on hand. Chairman Andrew Miller said the company's focus now turns to the future, but we don't see it looking very bright.
It is a shame that a company which pioneered such unique robotic devices—devices which were quickly copied by other companies—and operated in the black for years now faces an uncertain future. Before agreeing to be acquired, smaller firms must rewrite the risk management script on what a government agency shoot-down would mean to the firm's finances and operations. It is a tough time to be in the M&A business.
Sa, 20 Jan 2024
Market Pulse
The Week in Review: Four trading days, two narratives
It started out as a rough holiday-shortened trading week, with virtually everything dropping in value on Tuesday and Wednesday except for oil. Based on some Fed speak, investors suddenly weren't feeling so sure about that March rate cut they had already baked into the cake; a cut we still don't believe will manifest. Atlanta Fed President Raphael Bostic made news when he posited the notion that we could see "a couple of rate hikes in the second half of the year." Investors didn't like three words in that sentence.
Bostic's remarks were buttressed by persistently-strong consumer spending and jobless claims below the figure analysts were expecting. In other words, why lower rates if the economy is swimming along? Ironically, that notion started to make investors feel better about the economy, leading to a two-day surge to cap the week off. Furthermore, the big tech stocks which had been hammered in the first two weeks of 2024 staged the biggest comeback. The NASDAQ rose 2.26% for the week. While the S&P 500 was up just over one percent on the week, that was enough for the index to notch a new all-time high.
Fourth-quarter earnings season kicks into overdrive this coming week, with a diverse list of industry leaders reporting. The first estimate of Q4 GDP comes in on Thursday, and key personal consumption data (core PCE) hits next Friday. Thanks to the late-week rally, the S&P 500, Dow, and NASDAQ are now positive on the year, while small caps and international stocks (as measured by the iShares MSCI ACWI ex-US) remain in the red; 4.13% and 2.72%, respectively.
Fr, 19 Jan 2024
Consumer Finance
Discover shares plunge on bad debt worries, weakening income
Shares of Discover Financial Services (DFS $97), one of the country's largest credit card issuers, fell double digits on Thursday after the company reported a 62% plunge in profits for the fourth quarter. The company also set aside an additional $1 billion (from the same quarter a year earlier) in preparation for net charge-offs. That's financial lingo for debt it doesn't believe will be repaid.
Revenue did increase 13% from the previous year and 3.7% from the previous quarter, but net income fell to a paltry $388 million on $4.2 billion of revenue. That's the company's slimmest margin in years, and a stark contrast to the $1 billion it made in the fourth quarter of 2022. The jump in revenue is due to an increase in net interest income, or the extra money the company earns from its ability to charge higher rates.
Charge-offs doubled in the fourth quarter, from around 2% to over 4%, and the company's increased provisions for credit losses show they expect that trend to continue. There is at least a two-fold reason for that. First, Americans have now racked up a record amount of credit card debt—$1.08 trillion. Secondly, interest rates on these cards have skyrocketed.
Discover advertises a standard purchase APR between 17.24% and 28.24%. That is staggering. Imagine the financial condition of the poor soul who has maxed out their Discover card and is paying 28.24% per year in interest! Odds are great that they have no idea that is their rate, as few check their statements. We know someone with an 850 credit score, no balance on their card, and a stated interest rate of 17.49% (29.24% for cash advances). With a 5.5% federal funds rate upper limit, that is highway robbery. Assuming the Federal Reserve lowers interest rates this year, which investors are banking on, how much do you think Discover will lower those confiscatory rates? We shed no tears for the 10.8% drop in its share price.
Americans have got to work their way out of consumer debt, and that begins with an understanding of their precise debt load each month and the interest they are paying on each bucket of that debt. The pain and anger of carrying that burden must be stronger than the desire to add something new on their credit card. A simple monthly budget is the first step to financial freedom.
We, 17 Jan 2024
Airlines & Air Freight
Spirit Airlines falls 60% after judge ends JetBlue merger
It is funny in a way; unless, that is, you happen to be a Spirit Airlines (SAVE $6) shareholder. Nearly two years ago we wrote about the great merger of the low-cost carriers: Frontier Group Holdings (ULCC $4) agreed to buy Spirit in a deal valued at $6.6 billion—a fat premium for Spirit shareholders. Apparently that wasn't good enough.
Greed and arrogance took over when JetBlue (JBLU $5) went hostile for Spirit and shareholders accepted the deal. In May of 2022 we wrote that "JetBlue going hostile for Spirit is a complete waste of time." Two years later, and we have been proven right: a federal judge just shot down the merger. JetBlue shares were unfazed; Spirit shares fell 60% in two days.
Granted, we have an incorrigible FTC right now which is intent on suing to stop seemingly every corporate merger, but we believe they would have lost going against the original deal. The judge ruled that a combined JetBlue/Spirit entity would harm the latter's consumer base. We will go further. JetBlue has an atrocious on-time rate and horrendous customer service; an abysmal record that would have been foisted upon Spirit flyers. This would not have been the case were the Frontier deal maintained.
We will never know for sure whether the original deal would have stood up in court, but we believe it would have. Instead, Spirit shareholders who had no problem reneging on a deal to gain a few extra dollars find themselves 60% poorer in their investment.
Airlines are going through a rough spell right now, and investing in any of the carriers is risky. While we wouldn't own any of the low-cost carriers, we do own United Airlines (UAL $38) in the Penn Global Leaders Club due to its exemplary management team and long-term strategic vision, which includes a return to supersonic travel for the industry.
Mo, 15 Jan 2024
East/Southeast Asia
Global democracy notches a win in Taiwan; what will China do?
Expected or not, it was still an incredible victory. Standing defiantly against the world's second-biggest bully (behind Russia under Putin), the people of Taiwan just elected the country's vice president, Lai Ching-te, to be their new leader. To say the Communist Party of China loathes this man is an understatement. It labeled this election a choice between war and peace, but the voters were unintimidated. Lai's Democratic Progressive Party just won its third consecutive four-year term.
China's horse in the race was KMT party candidate Hou Yu-ih; while promising voters that he wouldn't move toward unification with China, he was widely viewed as a Xi lackey. A spokesperson for the Chinese Taiwan Affairs Office said that the election does not represent "mainstream public opinion on the island," but gave no further details. Secretary of State Antony Blinken, meanwhile, said that the Taiwanese people had demonstrated the strength of their democratic system.
Despite the fact that he is detested by the CPC, Lai, a Harvard-educated former physician, said he can keep the peace across the Taiwan Strait. While in past statements the new president said that he would work for full independence, he has since tempered those remarks; he now simply argues that Taiwan is already a de facto state.
In addition to being a former doctor, when he was mayor of the southern city of Tainan, "William" Lai helped bring a Taiwan Semiconductor (TSM $101) plant to the region. Born into a coal mining family, the new president lost his father at age two. Despite being raised in poverty, he worked tirelessly to excel in school and ultimately earn his medical degree. The youthful 64-year-old Ching-te seems well suited to lead Taiwan through what is sure to be a contentious period in its history.
Beijing may be livid with the results of Taiwan's election, but we expect its response to be tempered. Cyberattacks will undoubtedly increase on the island, and Chinese warships will probably become more belligerent in the Strait, but the country's economic woes should keep Xi's attention focused on the mainland—for now, anyway.
Th, 11 Jan 2024
Cryptocurrencies
Backed into a corner by the courts, SEC finally approves Bitcoin ETFs
In a massive win for the crypto world, the US Securities and Exchange Commission finally approved the launch of spot Bitcoin ETFs, specifically giving the green light to eleven different funds. This represents a seismic shift for the nascent asset class, and will allow everyday investors to buy the digital currency directly.
It wasn't looking good for Bitcoin back in 2022. That summer, the SEC rejected Grayscale's proposal to convert its Grayscale Bitcoin Trust (GBTC $41) into a spot Bitcoin ETF. By late full, the price of Bitcoin had dropped to $15,742 from its high of over $68,000. But a year later, in October of 2023, a DC Court of Appeals ruled that the commission failed to "adequately explain its reasoning." That court decision essentially forced the SEC's hand, leading to this week's reluctant approval.
The global crypto market now sits at approximately $1.8 trillion in size, with Bitcoin representing half of that value. Putting that in perspective, the global stock market has a value of around $110 trillion, with 43% of that residing in the US. A fairer comparison would be gold, which has a global market cap of around $15 trillion; or money market funds, which hold approximately $6 trillion in assets. We can only speculate how big that $1.8 trillion will become now that the flood gates have opened, but it is certainly a bullish sign for the industry. And for the marketing firms representing the dozen or so companies vying for their share of the Bitcoin pie.
Despite its high expense ratio of 2%, Grayscale will be the benchmark issuer in the space. Other companies launching Bitcoin ETFs include: Fidelity, Franklin, iShares, VanEck, Invesco, Valkyrie, and Wisdom Tree. Interested investors need to consider fee structure, size, and ease of liquidity when choosing a firm. This is a volatile asset class to be sure, but one which is not going away.
We, 10 Jan 2024
Beverages, Tobacco, & Cannabis
Tilray's new craft beer lineup lit up the company's quarter
Remember all of the excitement surrounding cannabis stocks? To help jog your memory, it occurred about the same time you were buying that Oculus headset to prepare for your future in the metaverse. Our favorite player was, and remains, Canadian player Tilray (TLRY $2), which was acquired by Aphria in a reverse merger in 2021.
Last year we reported that Tilray was buying eight craft beer brands from troubled brewer AB InBev. It didn't take long for that acquisition to pay off: Tilray just reported its fiscal Q2 numbers, which included a stunning 117% spike in net revenue from the company's alcohol business. Overall, quarterly net revenue grew 34%, beating expectations.
We have long praised the acumen of Tilray CEO Irwin Simon, who has quite the eclectic style. As the firm awaits federal cannabis rulings from DC, its CEO is expanding into yet another complementary category: vegetables. The company will begin growing strawberries, cucumbers, eggplants, and tomatoes in its excess cultivation space in Quebec. One massive hothouse, for example, will have a mix of 20% marijuana and 80% fruits and vegetables in the soil. Tilray points to the big demand for agricultural food commodities in the province.
One thing is undeniable: Under Simon's leadership, Tilray will never be accused of being just another boring Canadian cannabis company waiting for legislation from south of the border.
Despite its high beta, Tilray remains on track for positive free cash flow, and its financial position is strong. For the aggressive portion of a portfolio, this unique player is worth a look—especially at $2 per share.
Tu, 09 Jan 2024
Aerospace & Defense
Yet another reason to avoid Boeing until management is broomed
There is no leadership team in place at Boeing (BA $229); only a chief manager by the name of Dave Calhoun, walking behind each subsequent mishap with a giant shovel. Sort of like the guy who walks behind the elephants at a circus parade. We keep waiting for someone to do something about the situation, but who will that be?
Will Calhoun suddenly admit that he is not up for the task? Will his sycophantic board ask him to step aside? Neither of these two scenarios are likely, leaving it up to the major shareholders to take action. The top three shareholders are: The Vanguard Group, The Boeing Company Employee Savings Plans Master Trust, and BlackRock. We have close to zero confidence in any of these entities to take action. As long as Boeing is checking its ESG boxes, Larry Fink's BlackRock is happy.
We are all familiar with the latest nightmare for air passengers—the door plug which blew out of the fuselage of a Boeing 737 Max 9 in mid air. A door plug is, in essence, a panel with a window in it which takes the place of an emergency exit on jets configured to hold less than the max 220 passengers. The panel was found in the backyard of a school teacher in Portland.
Since the subsequent grounding of Max 9s, both United Airlines (UAL $43) and Alaska Airlines (ALK $38), the two US carriers which fly this version, have discovered loose bolts on a number of door plugs within their respective fleets. SpiritAeroSystems (SPR $28) makes the assemblies and assists in the installation, but it is ultimately up to Boeing to assure its aircraft are safe to fly. The Max 9 is a more recent version than the 737 Max 8s which were involved in two horrifically deadly crashes in 2018 and 2019.
The Max 9 involved in the incident was virtually fresh off the assembly line. Furthermore, pilots aboard this very same jet reported three pressurization warnings from the cockpit between 07 December and 04 January, with at least one occurring in-flight. This incident never should have occurred. Does anyone trust Calhoun and the board to prevent another incident on yet another system in the near future? Investors certainly shouldn't.
Boeing has negative shareholder equity, which means its assets are insufficient to cover its liabilities. The company hasn't turned a profit since 2018. It is a sad state of affairs that the American half of the global aircraft duopoly continues to muddle through safety crises. China would love for this condition to continue, as it boasts its own nascent effort in the industry via the Commercial Aircraft Corp of China, Ltd (Comac, a state-owned enterprise). With every subsequent mishap, Comac's future viability grows. David Calhoun's total compensation package for 2022 was $22.48 million. The average compensation for CEOs of similar size companies in the US market is $12 million per year.
Sa, 06 Jan 2024
Market Pulse
It was a rough start to the new year; earnings season now in focus
There wasn't much to hang our hats on in the first week of 2024—about the only component of the markets in the black was crude, which rose from $71 to $74 per barrel. All of the so-called Magnificent Seven stocks—the big tech names that led the charge in 2023—fell this week, with the NASDAQ plunging 3.25%. Small caps, as represented by the Russell 2000 index, dropped 3.72%.
Even bonds fell in value as investors reassessed their bullish call for Fed rate cuts. On that last point, we continue to believe the Fed won't deliver near the cuts this year that the market is pricing in. Most analysts are calling for between five and seven cuts, with the federal funds rate dropping from a range of 5.25%/5.5% down to 3.75%/4% (lower/upper limits). We tend to believe the Fed's own projection for three cuts in 2024, and that those will come later in the year than most expect.
Now that the first week of the year is in the books, attention can turn to earnings season. We remember the old days when all eyes would be on Alcoa's (AA $32) results to get a feel for how the season would shape up; now, it will be the big banks which act as the barometer. Bank of America (BAC $34), Citigroup (C $54), JP Morgan (JPM $172), and Wells Fargo (WFC $50) all report before Friday's opening bell. Wall Street expects an aggregate 1.3% growth rate in the fourth quarter, and a meager 0.8% full-year earnings growth rate for 2023. That bar doesn't seem too high; we believe actual results will surpass expectations.
Historically, "as goes January, so goes the year." Corporate earnings will, we hope, be the catalyst needed to lift us out of this little pothole we dug in the first four trading days of 2024.
Fr, 05 Jan 2024
Oil & Gas Refining, Storage, & Transportation
The world has a new leader in the export of liquified natural gas
In 2022, as the accompanying graph indicates, Australia was the world's leading exporter of liquefied natural gas (LNG), selling some 87.6 million metric tons (MT) of the energy source to the global market. And the process is no easy task: natural gas must be cooled down to approximately -260°F to liquify it, allowing it to take up about 1/600th of the previous volume. It can then be efficiently transported and regasified at its destination for normal use. A fascinating process. And the world has a new leader in the export of this fuel.
In 2023, LNG exports from the United States rose over 20%, to 90 MT, allowing the country to leapfrog over both Qatar and Australia. In the wake of Russia's invasion of Ukraine and the subsequent embargo of gas from that country, many energy experts feared the worst for Europe heading into last winter. Instead, the US helped fill the void, with between 60% and 70% of LNG exports headed to the continent. Asia was the destination for roughly 25% of America's exports, with the remainder mostly going to Latin America.
Two main factors allowed the US to increase production by such a hefty amount: a Freeport LNG export facility which had been shuttered due to a 2022 fire restarted production, and Venture Global's Calcasieu Pass facility in Louisiana came online. In 2024, two more major LNG projects will begin production: Venture Global's Plaquemines facility in Louisiana, and a joint venture between Exxon Mobil (XOM $102) and QatarEnergy in Texas. Impressively, these two projects should, once online, add another 40 MT per year in US production. So, not only is the US the world's leading producer of oil, it will also retain the mantle as the world's largest exporter of LNG—despite all of the talk of the world moving on from fossil fuels.
While Freeport LNG (not to be confused with Penn member Freeport-McMoRan) is not publicly traded, investors could look to Cheniere Energy (LNG $168), the largest LNG exporter in the US. We prefer to play the industry with our Chevron Corp (CVX $150) investment; the gas giant is a top ten global exporter of the fuel, with expansion plans in the works.
Tu, 02 Jan 2024
Financial Planning: Education Funding Strategies
Massive new change to 529 Savings Plans just took effect
Not to date myself, but when I first got in the financial planning business, the only tax-favored savings plan for college was the Coverdell Education Savings Account ("Education IRA") with a maximum annual contribution limit of $500. Granted, that amount went up to $2,000 per year around the turn of the century (that does make me sound old), but considering the average cost of in-state tuition and room and board at a public college is now $24,000 per year, that seems like a drop in the bucket—even with the tax-protected growth.
Around the same time that the Education IRA contribution limit was going up, a truly remarkable college savings tool was being created by Congress: the Qualified Tuition Program, or 529 Plan. In short, each US state could operate its own version, which essentially had no contribution cap (though the annual gift tax exclusion is currently $18,000 per person), and the funds would grow tax free. Assuming the proceeds were used for qualified education expenses, even withdrawals were—and remain—tax free. As of 01 Jan 2024, the plan got even better.
Through a provision in the Secure 2.0 Act, any time after fifteen years following the Plan's initial setup, any unused portion—up to a total of $35,000—can be rolled into a tax-free Roth IRA for the beneficiary. Just for fun, we plugged $35k into our Wayback Machine, set the dial for the S&P 500 in 2014, and discovered that we now have a cool $222,000 of tax-free retirement savings. This really is a big deal.
As good as the concept of the 529 Plan has been in the past, investments have actually been on the decline recently. A lousy market return in 2022 played a role, but our biggest hangup has been the disparity in states' plans. To be blunt, some plans have simply awful, age-based options, as opposed to the freedom of choice we had with the old Education IRAs. Another drawback has been the convoluted rules with respect to the degree in which a 529 plan could affect financial aid and the expected family contribution (EFC) amount. Still, compared to the options available when saving for a kid's education, the best tool just got a lot better.
One of our arguments against the federal government attempting to pay off portions of student loans (besides our $33.8 trillion national debt) has been the fact that it disregards the most responsible savers, those who worked their way through school, and those who joined the armed services in-part for the education benefits. When student loan repayments resumed this past fall, only 60% of debt holders began making payments once again. Most of the other 40% are waiting for something magical to happen via the federal government. Odds are great they are in for an unpleasant surprise down the road.
Fr, 22 Dec 2023
Media & Entertainment
Live by the sword, die by the sword: Netflix releases viewer data
Boasting the largest streaming television subscriber base in the world, Netflix (NFLX $487) never really felt the need—nor had the desire—to give individual metrics on which shows its 250 million subscribers were watching. It kept such data very guarded. Why, then, is the company suddenly telling the world how many viewing hours there have been for every single one of its releases? It has to do with the Hollywood writers and actors strikes.
In the past, actors and writers were just fine with the company keeping mum on such data, as the bombs could remain hidden behind the curtain—unlike theater releases, which have their level of success defined by box office ticket sales. But one of the results of the long and heated negotiations between the major studios and labor unions revolves around how the talent is paid. Labor argued that the studios weren't fairly compensating writers, directors, and actors involved in blockbuster hits; of course, they didn't mention the other side of the coin: has anyone ever been asked to give a portion of their paycheck back because their video art bombed?
So now, Netflix is going all in, releasing hard viewership numbers for some 18,000 titles, and they will continue to issue their "What We Watched: A Netflix Engagement Report" semiannually. The big winners? Season one of The Night Agent was the streamer's biggest hit in the first half of the year, garnering 812 million hours of viewing. (Great show.) Coming in second was season two of Ginny & Georgia (never heard of it), with 665 million viewing hours; and in third place was season one of The Glory (never heard of it), with 623 million hours. One of our favorites, the first season of Wednesday, rounded out the top four with 508 million hours.
With their pay now hinging on these metrics, let's see how the writers and actors of poor-performing shows feel about this hard-won point of victory. Then again, we imagine it is much like major league sports: there will be a minimum guaranteed salary—an amount most Americans would give anything to earn—just for making the cut.
We are avoiding the content providers like the plague. Looking at the graph, which outlines total return over the past five-year period, every media outlet is negative except for Netflix. To reiterate, that is over a five-year period! The bottom two, Warner Bros. and Paramount, are now toying with a merger to help assure their survival (our words). Disney has its own problems under Der Comondante Iger. Comcast's customer service is a joke, which is inexcusable in a hyper-competitive market undergoing constant change. Just steer clear.
Th, 21 Dec 2023
Middle East
How deeply will the maritime attacks in the Red Sea affect the economy?
On the 19th of November, Iranian-backed Houthi rebels attacked a British-owned and Japanese-operated cargo ship, the Galaxy Leader, near the southern tip of the Red Sea. It remains anchored off the Hudaydah Port in Yemen, with the ship's 25 crew members being held hostage for over a month now. A few weeks after this brazen attack, the rebels struck three commercial ships traveling through the Bab el-Mandeb Strait with ballistic missiles while a US warship in the region destroyed three incoming drones. On Tuesday the 12th of December, a Norwegian tanker headed for Israel was struck by a missile fired from Yemen and caught fire. A Houthi spokesperson commented on social media that the ship had "refused to respond to warning." The group's slogan is "Death to America, Death to Israel, curse the Jews and victory to Islam."
These attacks are being perpetrated by an Iranian-backed terrorist group, but we cannot underestimate both Russia and China's involvement. In addition to being allies of the militant state of Iran, nothing would please Putin and Xi more than focus—and resources—shifting away from the war in Ukraine and the defense of Taiwan. Switching gears to the economic standpoint, how much will these increasingly audacious attacks affect the global economy?
About 12% of tanker traffic and 30% of shipping containers traverse the Red Sea. The shippers are increasingly rerouting their craft to avoid the region, which we believe will cause a number of headaches for a world economy finally shaking off the effects of a global pandemic. For the better part of a month, oil seemed to shrug off the troubles (we added a long oil ETF to the mix when crude dropped to a six-handle), but over the past week WTI has risen 7% in price.
Inflation is another concern. The bullish theme going into 2024 is for inflation to drop nearer the Fed's 2% target range, allowing the central bank to lower rates several times. If oil moves higher due to the turmoil and 30% of container shipments must be rerouted, that might renew upward pressure on prices—freight rates have already spiked and the longer trips can add up to $1 million per journey. We buy into the bullish oil story (sadly), but less so the general renewed-inflation narrative. The US will not simply stand by much longer and allow these attacks to continue.
This week, the US launched Operation Prosperity Guardian, a 39-member international coalition designed to defend Red Sea shipping lanes. Under the command of the US Navy Fifth Fleet, Task Force 153's mission is to "focus on international maritime security...in the Red Sea, Bab el-Mandeb, and the Gulf of Aden." While attempting to avoid an escalation in the conflict, such as an attack by Hezbollah—an Iran-backed Lebanese militia—along Israel's northern border, we can expect this task force to heavily suppress the Houthi threat to the narrow shipping lane. The alternative is an unacceptable disruption of global commerce with no end in sight.
Look to the Galaxy Leader for signs of where this conflict is headed. Will there be a rescue attempt or a negotiated release of the ship and its crew, or will the situation drag on akin to the Iranian hostage crisis of 1979? Sadly, we recall what happened during that rescue attempt. While there are no American crew members on the Galaxy, it has an eerily similar feel to the pre-election crisis of forty-four years ago.
Mo, 18 Dec 2023
Metals & Mining
Better Japan than China: Nippon Steel to acquire US Steel
It formed out of the merger between Carnegie Steel and Federal Steel 122 years ago, with James Pierpont Morgan structuring the deal. The company established its headquarters in the Empire State Building and remained a major tenant in the building for 75 years. It was, at one time, not only the largest steel producer in the world but also the largest company in the world—the first to reach one billion dollars in size. Alas, it resides in a hyper-competitive industry with plenty of lower-cost producers around the world, one of which will now own them. On Monday, US Steel (X $50) made the announcement that Japan's largest steel producer, Nippon Steel (NPSCY $7), will acquire the firm for $14.1 billion—$55 per share—in an all-cash deal.
Nostalgia doesn't travel very far in the modern business environment, and we must face the fact that US Steel had dropped in position to the world's 24th-largest producer of flat-rolled steel and tubular products. In the US, there were about 82 million metric tons of steel produced last year, with X accounting for just one quarter of that amount (Nucor is the largest producer in the country). By contrast, suitor Nippon produced around 45 million tons last year, and a Chinese firm (what a shocker) led production with 132 million metric tons. This is an industry well-poised for contraction via mergers.
Nippon has said that, post-merger, the company will retain its name, brand, and headquarters in Pittsburgh, and that it will keep in place all agreements forged with the United Steelworkers (USW) union. We wrote this past summer that the union not only demanded that all labor agreements be honored in any sale, but that it would have a say in who bought the firm (no, really). Despite this deal being twice the size of the $7 billion offered by US competitor Cleveland-Cliffs (CLF $20) in August, the USW doesn't seem happy about it. We imagine union lawyers have already placed calls to their good friend, Lena Khan, at the FTC, but we expect she will lose this fight in the courts should she try and nix the deal. Her legal record is a running joke in the business community. In the end, the deal gets done.
Steel prices have been all over the place over the past few years, rising and falling like the price of lumber. If we had to make an investment in the industry right now it would be in Ryerson Holdings (RYI $32), a US-based services company that processes and distributes metals. The company has a foothold in several key areas, from oil and gas, to industrial equipment, to transportation. Better the dealer than the maker.
Mo, 18 Dec 2023
Energy Commodities
Foiling OPEC: The United States hits new record production levels
At the start of 2023, the OPEC nations were pumping some 31 million barrels per day (bpd) of crude onto the market; oil was sitting at $80.51 per barrel. The cartel found that price too low, and announced a cut of one million bpd to pump up prices. The move appeared to have maximum impact by September, when crude hit $91.20 per barrel. But two factors would soon combine to foil our dear friends' effort: both of them positive for the US.
The first factor was a serious drop-off in China's rate of economic growth. Considering the percentage of oil used by the communist nation, it makes sense that a good level of demand destruction is Asia would force prices down. The second factor was the unexpected spike in US crude production, especially shale. At the start of the year, the US was pumping 12.1 million bpd of oil; by mid-December, that amount had risen by the precise amount of OPEC's cuts—one million bpd. Between the end of November and the second week of December, crude prices dropped from $80 per barrel to $70 per barrel. The US had retained its moniker as the world's number one energy producer. Gasoline prices in the US, in turn, returned to what we would consider a normal level: around $2.50 per gallon.
America's shale renaissance has been a nightmare for OPEC over the past decade. In 2014, the cartel tried to crush the movement by flooding the world with additional crude to undercut the US effort. At first, the plan seemed to be working, with WTI crude falling to $44 per barrel by March 2015 and all the way down to $28 per barrel a year later. In April 2020, as pandemic fear was at its height, crude infamously began trading in negative figures.
Below $50 per barrel, it is extremely difficult for shale producers to stay afloat, let alone remain profitable; and it really takes oil trading above $60 per barrel for these companies to thrive. We are certainly above that price now, and we don't see the Saudis pushing for OPEC to try its 2014 stunt again. In fact, the group's action forced these explorers to become more efficient, increasing production while reducing costs (drilling rig count is down 20% ytd despite the 1M bpd increase). Perhaps American shale producers should send a thank you card to the cartel.
Our challenge with investing in this industry is that most of the companies tend to be laden with debt. If we had to pick one player to invest in, it would be APA Corp (APA $35; formerly Apache). This $11 billion mid-cap driller boasts an enormous and geographically diverse reserve base, and it has nice free cash flow. Shares are probably worth around $50. To mitigate risk a bit, investors could buy the Invesco Energy Exploration & Production EFT (PXE $30), which owns 30 industry leaders (Phillips 66 is the largest holding).
Fr, 15 Dec 2023
Market Pulse
The Fed set the tone for the most awesome week in the markets
Everyone expected the Fed to hold steady at this week's FOMC meeting, but few expected the Christmas gift that Powell brought to the equity market.
It was the third "hold" meeting in a row, virtually assuring that the most recent tightening cycle is now behind us—following eleven hikes and a federal funds rate between 5.25% and 5.5%. One of the components of the meeting which we didn't predict was the Fed's projection for three quarter-point rate cuts in 2024. That sent markets flying higher; but the best part came from Powell's presser.
Based on some of the inane questions asked by the pool of reporters and how investors interpret his answers, the stock market can get whipped around furiously during this exchange. What we got was another shocker: Powell sounded downright dovish. He indicated that inflation is moving down closer to the 2% target range, economic growth was slowing, and that the Fed doesn't need to see unemployment go much higher to warrant rate cuts. Stunning. By the end of this extraordinary day, the Dow was up 512 points, small caps rose by a whopping 3.52%, and bonds rose (Bloomberg US Aggregate) by 1.31%. Oil even stayed below $70, capping off a picture-perfect Wednesday.
The euphoria carried into Thursday, and the markets ended the week with a flattish Friday. For the five-session period, the S&P was up 2.5%, the NASDAQ 2.85%, and the Russell 2000 gained 5.85%. Now we head into the final two weeks of the year, and hopefully a continuation of the early Santa Claus rally.
Th, 14 Dec 2023
National Security
House passes defense bill, leaving out controversial social issues
There are two annual fiscal actions which shape what the state of America's defense will look like for the coming year: the National Defense Authorization Act (NDAA, first passed in 1961), and defense appropriations bills. While the NDAA establishes funding levels and general guidelines for the various agencies responsible for defense, the appropriations bill provides the funding. One down, one to go.
The US House of Representatives fended off attempts to include language on social issues into the NDAA, passing it by a margin of 310-118. That may not seem close, but a two-thirds margin was required under the fast-track procedure; it passed with 72% of the votes. The US Senate had already voted 87-13 in favor of the legislation.
The Act increases the US military budget by 3% from last year, to $886 billion, and includes a 5.2% pay raise for service members. It also provides for training assistance to Taiwan to help the US ally defend itself against attack from Communist China. One "controversial" aspect survived in the NDAA: Section 702 of the Foreign Intelligence Surveillance Act. First passed in 2008, this provision allows the government to conduct targeted surveillance of "foreign persons located outside of the United States." Privacy advocates have long criticized the law, but it has been responsible for over half of the information contained in the Presidential Daily Briefing (PDB).
The legislation also allows for the sale of US nuclear submarines to staunch American ally Australia; this is part of the AUKUS security agreement between Australia, the United Kingdom, and the US. Initiatives to strengthen relations with allies in the Pacific region, such as joint military exercises, will also be funded. Around $150 billion will be allocated to research and development in such fields as high-energy lasers and mobile micronuclear reactors for use in the theater of operations. Hundreds of other issues are addressed in the Act, to include $300 million in additional funding for Ukraine's war effort against Putin.
While passage was a major step in the right direction, the items outlined in the NDAA must now be funded. Considering the vitriol in a closely divided Congress, the upcoming election year, and the fact that our elected officials spent $1.7 trillion more than was brought in last year, that should be an interesting show.
Transportation Infrastructure
Uber soars higher after inclusion into S&P 500 announced
In 2022 we added Uber (UBER $63) to the Penn New Frontier Fund and there has been a litany of good news on the company since. The latest positive tidbit comes from an index; the S&P 500, to be precise. As of Tuesday the 19th of December, the transportation services company will join the prestigious index, along with IT manufacturing firm Jabil (JBL $121) and Builder's FirstSource (BLDR $149), a building material company and another Penn favorite. Uber shares rallied on the news, and are now up 150% year to date.
Three companies not faring so well are the ones being knocked out of the index: Sealed Air (SEE $33), Alaska Air Group (ALK $37), and SolarEdge Technologies (SEDG $76). The middle name is interesting, as the airline recently announced its intent to buy competitor Hawaiian Airlines (HA $13) for $1.9 billion—a massive premium to the $231 million market cap it had going into December. As for SolarEdge, the solar power industry is down something like 40% year to date.
Uber's inclusion makes perfect sense. The company has the largest market cap ($129 billion) of any US firm not listed in the S&P 500, and its Q3 earnings report showed four consecutive quarters of profitability. As the benchmark player in the ride-sharing space, we see a number of catalysts driving growth over the next several years, to include its growing Uber Eats business.
Although our UBER position has nearly doubled in value from last year's purchase price, we would still be a buyer at its current level.
Mo, 11 Dec 2023
Multiline Retail
Macy's shares soar after buyout offer announced
In August we added a small Macy's (M $21) position to the Intrepid at $13.32 per share. Legacy, multiline retail is a tough business these days, but we saw Macy's and Nordstrom (JWN $18) as two of the survivors. While we knew Nordstrom would probably be taken private at some point (perhaps by the Nordstrom family), this one was a surprise. We simply saw Macy's as undervalued at its price at the time, not the potential target of a few private equity firms.
Shares of M flew some 20% higher on Monday after it was revealed that investment firm Arkhouse Management and asset manager Brigade Capital Management had submitted a $5.8 billion bid to take the company private. With a single-digit forward P/E, it still seems as though they are getting a good deal, especially considering the real prize: Macy's real estate portfolio. At a conservative estimate, the firm owns in excess of the offer price in real estate alone. It is unclear whether this was the impetus behind the bid, but we would guess it was the major factor.
No word on management's review of the offer, and they are certainly not desperate to make a sale. With about $3 billion in debt, the company has a respectable 50% debt-to-equity ratio after the spike in value. (For comparison, Nordstrom's debt-to-equity ratio is 393%.) Over the trailing twelve months, Macy's earned $685 million on $24 billion in sales. In other words, they continue to operate in the black—something that a lot of retailers (Kohl's comes to mind) cannot say.
To repeat ourselves, this is an ultra-tough industry in which to operate, specifically due to the mushrooming of online competition. We would be tempted to take the money and run. Without shareholders breathing down management's neck each quarter, a creative leadership team could shape a great new experience for shoppers. But in this climate, who knows if the deal will even get done.
Buy the rumor, sell the news. We took our profit and closed the position. But honestly, we didn't see this one coming.
Mo, 04 Dec 2023
Consumer Electronics
The EU cast doubt on Amazon’s purchase of iRobot; time to buy?
In August of 2022 we wrote of Amazon’s (AMZN $147) plan to purchase one of our favorite little stock plays over the past few decades: consumer robot company iRobot (IRBT $37) for $1.7 billion in an all-cash deal—or about $61 per share. IRBT shares spiked from $37 to $60 in short order. Investors were trying to cash in on something known as merger arbitrage, which involves buying an M&A target at a price below the offer and riding the gravy train through completion of the deal. It now appears that one of the world’s great party poopers, the EU, has derailed that train.
A few weeks ago, just days after it appeared the deal was set to win “unconditional EU antitrust approval,” the European Commission issued a “statement of objections” which outlined why the merger would restrict competition in the European market. Shares plunged 17% at the open. Really? Amazon’s purchase of a small-cap robotic vacuum cleaner company was a threat to the continent? Every time the US government does something completely idiotic (hello, FTC Chair Lena Khan), it is quickly outdone by the dolts in the EU. Shares have rebounded a bit, but they still sit 40% below the revised buyout price of $51.75 per share. So, is it time to put a little aggressive money to work by hopping on the arbitrage train once more?
We do still like the company, but its global market share in the robotic vacuum space has dropped from around 65% a decade ago to 45% today. Furthermore, after the pandemic hit, the company postponed its plans to launch Terra, the lawn mowing robot. Several other companies have now jumped successfully into that space. (We recently witnessed a few of the little guys scurrying around near the green on a golf course.) We don’t believe iRobot will ever rejuvenate the Terra program.
Founded in 1990 by a team of MIT roboticists, iRobot was certainly ahead of its time. But consumer electronics is a business rife with IP theft and lower-cost overseas competition. Through the first three quarters of 2023, in fact, units shipped dropped by a third and revenues by a similar amount. After operating in the black for years, iRobot began losing money in 2022. While these factors make the EU claims ludicrous, and we do believe the deal will ultimately go through, we wouldn’t be playing the risk arb game right now with the shares.
We last purchased shares of iRobot in the New Frontier Fund back in 2019 for $48.80, selling them in early 2022 when a stop loss hit at $64.95 per share. We do believe Amazon could breathe some life back into the firm, but we will watch from a distance as the legal drama plays out. Plus, Amazon is one of our top holdings in the Global Leaders Club.
Fr, 01 Dec 2023
Market Pulse
One of the two best Novembers since 1980
It was the best month of the year and one of the two best Novembers in the market since 1980; sweet relief after a horrendous three-month period. A plethora of good news led to the rally, but the general sense that the Fed is done raising rates was the key component. Corporate earnings accounted for the second nice surprise, with S&P EPS jumping 6.3% Y/Y (11.6% ex energy). That is the fastest growth clip since the second quarter of 2022, and well ahead of what analysts were calling for.
As if the 4.9% GDP reading for Q3 wasn't good enough, that figure was revised up to 5.2%. That would typically worry Fed watchers, as it gives hawks another argument for raising rates yet again. That didn't happen this time, however, as clear signs are emerging that the rate of inflation is slowly falling back down into the desired range (disinflation). We still don't believe there will be rate cuts in the first half of next year, but that expectation also helped buoy the markets.
Another good sign came from the housing market. It was just over a month ago that the 30-year average mortgage rate hit 8%; that figure has now dropped to 7.22% and appears to be heading back down to a six-handle. Home sales, which had fallen to a 13-year low in October, began picking up steam once again in the last few weeks of November.
With all of the good economic and market news, let's not forget about the bond market. After a bruising few years, bonds just posted their strongest rally since the 1980s. The 10-year Treasury, which topped out at 5% in October, finished Friday with a yield of 4.22%. We have been increasing our exposure to fixed income investments—and increasing duration—since spring, and it has paid off nicely. We also added a 20-year Treasury bond proxy to the Strategic Income Portfolio a few weeks ago—it has rallied 10% since (bond values go up as rates fall).
Will the early Santa Claus rally continue through the end of the year? We believe so. We also see small-caps making up for lost ground (the Russell 2000 was flat YTD going into November), and value stocks staging a comeback. One of our biggest calls of the year was for gold to have a huge rally: the precious metal hit a new all-time high on Friday of $2,092 per ounce, and we are bullish on it for the coming year as well.
After such a strong November, investors should use the month of December to assure they are allocated properly going into 2024, and to consider some tax-loss harvesting.
Fr, 01 Dec 2023
Aerospace & Defense
SpaceX news: A South Korean spy satellite and strange bedfellows
On Friday morning, out of Vandenberg Space Force Base, California, a SpaceX Falcon 9 rocket carrying South Korea’s first domestically made spy satellite in its capsule’s cargo bay completed a picture-perfect launch. For security purposes, the company ended its webcast before the satellite was deployed, but all signs indicate it is in orbit and will soon be operational. The launch comes shortly after North Korean dictator Kim Jong Un’s claim of its own spy satellite launch.
The difference in technological prowess between the two Koreas is stark, making Un’s claims of viewing images of the White House from that country’s craft rather dubious. Earlier this year, North Korea failed at an attempt to launch a satellite into orbit, with the debris being salvaged by South Korea. Their conclusion: the craft’s abilities would have been somewhere on the spectrum between useless to “rudimentary at best.” As for its own program, South Korea expects Friday’s launch to be the first in a series, with the goal of having five operational spy satellites in orbit within the next two years.
In other SpaceX news, something extraordinary has occurred: Amazon (AMZN $147) has inked a deal for at least three launches of its satellite constellation aboard the Falcon 9. Bezos and Musk aren’t exactly friendly rivals in the field of space, with both dishing out some harsh words for each other’s programs (Bezos owns Blue Origin) over the past several years. Up until this point, Amazon’s founder had planned to rely primarily on United Launch Alliance (ULA) craft to send its Project Kuiper satellites into orbit (only two have been launched thus far). Project Kuiper is designed to be a direct competitor to Musk’s Starlink program. That program just notched its first profitable quarter, and the company may be spun off as an IPO soon.
The fact that Bezos would sign a contract with SpaceX speaks volumes of Boeing’s (BA $234) ULA program, which has been plagued with problems for years. He is obviously feeling some of the same frustration that NASA has experienced; the agency continues to rely heavily on the Falcon series of rockets, which have proven to be remarkably efficient at launching both hardware and humans into space.
While SpaceX has declined to publicly comment on the Kuiper deal, Musk did tweet the following on Friday: “SpaceX launches competitor satellite systems without favor to its own satellites. Fair and square.” As of November, there were some 5,500 Starlink satellites in orbit, accounting for more than 50% of all active satellites in space.
Amazon is a member of the Penn Global Leaders Club. Will we pick up Starlink shares when the company goes public? Hard to say, as it depends on how they are priced and where they begin trading. As for SpaceX, a privately held firm, clients own it within the Private Shares Fund, a private-equity-like instrument which invests in firms poised to go public in the near future.
Headlines for the Month of Nov 2023
Mo, 20 Nov 2023
Latin America
To the chagrin of the left, a fervent, pro-American capitalist wins in Argentina
Just for fun, we went back four years into the PennEconomics way back machine and reviewed our notes on the recently held (at the time) Argentinian election in which leftist Alberto Fernandez and his anti-American running mate, Cristina Kirchner, rose to power. We posited the notion that they would leave the country's economy in shambles. Voilà, four years have passed and our analysis was spot on.
We have been irritated with the coverage of this year's election by the mainstream media, which has all but assured us that Economy Minister Sergio Massa would win, carrying on the Peronist legacy. This despite the country's 140% annualized inflation rate and crumbling economy. Lo and behold, to "everyone's shock," pro-American libertarian candidate Javier Milei (mih LAY), who looks somewhat like a young Benny Hill, stormed to victory with a 15-percentage-point landslide. We watched as a stunned Bloomberg host asked an expert, "How will Argentina's economy react to this surprise?" Let us answer that: "Um, Haidi, the Global X MSCI Argentina ETF (ARGT $47) surged over 11% the day following Milei's victory."
Even more upset that many in the press was Brazil's current leader and former prisoner Lula da Silva. Understandably, he had a cozy relationship with the Peronist government of Fernandez and was a big backer of Massa. Of course, it probably didn't help that Milei had labeled Lula a communist (accurate) with whom he wouldn't deal. The two countries are historically big trading partners.
As for Milei's plans to snap Argentina out of its funk, he has proposed such radical plans as ditching his country's peso and making the US dollar the national currency, as well as eliminating the country's central bank. He also said he will prioritize trade with the US over erstwhile partners such as Brazil, and will make a "spiritual journey" to the United States and Israel soon. Things are about to get very interesting in South America's second-largest economy.
Despite its nightmarish condition, we are excited to see what Milei will do with the Argentinian economy. He certainly has a mandate, along with the personality and passion to make seismic changes. None of this will sit well with the leftists of the region; hopefully, America will show a bit of gratitude—via increased trade—for his love of capitalism.
Tu, 14 Nov 2023
Supply, Demand, & Prices
A great inflation report virtually assures an end to rate hikes
Before the October CPI report was released, futures were flat. Minutes after the release, Dow futures spiked over 300 points, NASDAQ futures rallied 2%, and the small-cap Russell 2000 jumped 4%. Powerful report.
Here’s the headline number that gained the most attention: Inflation cooled to 3.2% in October, down from 3.7% in September and well below last October’s scorching 7.75% reading. This report provides clear evidence that inflation is heading back down towards the Fed’s 2% target, all but assuring the rate hike cycle is dead.
Core inflation, which removes volatile food and energy costs, fell to 4.02% in October, down from 6.3% a year earlier. Parsing out the energy component, gas prices fell from an average $3.81 per gallon at the start of the month to $3.46 by the end. We have come a long way from the 9% inflation rate we were experiencing in the summer of 2022.
Suddenly, talk on the Street has shifted from concern over tightening to how quickly the Fed will begin lowering rates. Could we just take a little time to relish this victory over runaway inflation before going there?
Here’s the new narrative being pushed by the likes of Morgan Stanley (a group we respect very little) and UBS: Slower growth, rising unemployment, and disinflation will force the Fed to cut its benchmark rate to a target range between 2.5% and 2.75% by the end of 2024, with the cuts beginning relatively early in the new year. We are currently in a range between 5.25% and 5.5%, meaning that would be the equivalent of eleven 25-basis-point cuts! We may be sliding into a minor recession in 2024, but we sure don’t buy that narrative. That said, rates have peaked so investors should continue picking up higher-yielding bonds to balance their portfolios.
Mo, 13 Nov 2023
Renewables
America's hydrogen darling, Plug Power, is in freefall
Remember when that cleanest of clean energies, hydrogen, was going to be the panacea for America's future energy needs? Investors poured billions of dollars into hydrogen power plays, with Plug Power (PLUG $3) leading the charge. Sure bet, right?
On Thursday the 9th of November, Plug issued its latest earnings report. It did not go well. The two words which typically spell doom for a company were uttered: "going concern." Management is pursuing a possible loan from the Department of Energy for as much as $1.5 billion, and it also needs the billions of dollars in subsidies from the government to continue. Neither of these mentioned bullet points gave warm and fuzzy feelings to investors: shares of PLUG plunged 43% the following day and are now down 95% since January 2021. Once a $36 billion firm, Plug's market cap is now $2 billion.
As could be expected, downgrades came flooding in after the earnings release. The average price target by analysts who follow the company fell from $12 to $5 per share, and even the biggest of hydrogen power bulls admitted that help may not come soon enough to save this industry leader.
For the quarter, Plug reported $200 million in sales and a net loss of $283.5 million. To meet its full-year sales forecast, it will need to record $500 million in sales in the fourth quarter. We don't see that happening.
Plug's stated objective is to build an end-to-end green hydrogen ecosystem, from production to storage and delivery to energy generation. It envisions green hydrogen highways crisscrossing North America and Europe. This may still happen, but it is looking less likely that Plug will be the company delivering the results.
Another great example of investors rushing into a promising field during its nascent stages, urged on by glowing news articles. Our recommendation: don't try to catch a falling knife. That goes not only for shares of PLUG, but also for shares of the Global X Hydrogen ETF (HYDR $6).
We, 08 Nov 2023
Biotechnology
Investors view Moderna as simply a COVID play; that is a mistake
A few months ago, we reported on a joint venture between American biotech Moderna (MRNA $73) and German biotech Immatics NV (IMTX $10) to develop a line of cancer vaccines and therapies using the former's revolutionary mRNA technology. Consider the impact such a development could have on humanity—not to mention Moderna's future in the industry. Investors, however, remain myopically focused on the company's COVID vaccine and its dwindling sales.
Granted, it was the coronavirus vaccine that transformed Moderna into one of the most profitable biotechs in the world (it is now debt free), but we are more excited about the future of mRNA technology than we are concerned about the precipitous drop in Spikevax (formerly known as COVID-19 Vaccine Moderna) sales. The world is ready to move on from the pandemic, and investors mistakenly view this firm as a one-trick pony.
The massive inflow of cash from the COVID vaccine has allowed the firm to greatly increase its R&D department, and at least fifteen new products—four for rare diseases—are set to launch over the coming several years. This past July, Moderna submitted its RSV vaccine for approval in the United States and Europe, and an enhanced formulation of the flu vaccine is geared for approval in 2024. Early-stage clinical studies have begun on vaccines for HIV, Lyme disease, and the Zika virus. There are as many as 50 new pipeline candidates which should be in the clinical development stage by 2028.
Moderna's intellectual property is strong, and we love the strategy of teaming with other biotechs and big pharma companies for the development of its products. For example, in a joint project with Merck (MRK $104), the company has a melanoma vaccine in phase 3 trials. From the treatment of cancer and rare diseases to a transformational new line of vaccines, Moderna's future looks bright.
Investing in biotech companies is not for the faint of heart, as trial results can send a company's shares soaring or make them crater. But this biotech, with its unique IP and no debt on its books, looks to be a standout. We would place a fair value of $200 on the shares.
Sa, 04 Nov 2023
Market Pulse
A refreshing start to the "best six months of the year"
Finally. After a brutal quarter in the stock market, three months in which the Dow fell an average of 1,000 points per month, we have signs of life. Ironically, this past week's strong gains came on the back of soft jobs data; well, that and the announcement that the Treasury will "only" need to borrow $776 billion in the final quarter of the year.
The Treasury Department news kicked the week off when it announced on Monday that it would be issuing $776 billion worth of debt in Q4 and $816 billion between January and March. This announcement came ten days after it was revealed that the government had spent $1.7 trillion more than it brought in for fiscal 2023. It is amazing what counts for good news these days. The market also liked the quarterly refunding report issued Wednesday morning. This report, which gives the specifics of what debt the Treasury Department will be issuing, showed a skewed issuance of shorter-maturity Treasuries as opposed to ten-year or longer maturities. By the laws of supply and demand, this helped bring the 10-year Treasury yield down, helping bonds to rally.
Then came the scheduled FOMC meeting on Wednesday. Not only did the Fed not hike rates again, Powell gave a relatively dovish press conference. Despite the effort of some journalists and their boneheaded questions almost begging Powell to be hawkish (Michael McKee of Bloomberg wins the booby prize for the dumbest), investors walked away believing that the current rate hike cycle is officially dead. Add a cooler-than-expected jobs report for October, and it was off to the races in the market.
By Friday's close, the markets had pieced together their best week since October 2022. The biggest winner was the Russell 2000 small-cap index, which had been down 7% year-to-date. It erased all of the year's losses and is now sitting up 7 basis points for 2023. The Nasdaq rose 6.6% for the week, followed by the S&P 500 (5.85%) and the Dow (5%). As if that weren't enough good news, oil fell 5% and bonds rallied 2% on the week.
A better script for the first week of the best six months of the year couldn't have been written.
Fr, 03 Nov 2023
Maritime: Shipping & Ports
Container shipping giant Maersk gives bleak outlook on trade
To get a good read on the state of global trade, we often look to the bellwether container shipping firms for clues. Four in particular we look at are Diana Shipping (Greece), Costamare (Greece), Nordic American Tankers (Bermuda), and A.P. Moller Maersk (Denmark; AMKBY $7). Shares of the latter plunged on rather dire comments—and actions—by the CEO.
Chief Executive Officer Vincent Clerc announced in an interview with Bloomberg that at least 10,000 workers (out of 88,000) would lose their jobs. In a rather poor choice of words, he said that "6,000 of those have already been executed." Shares fell 16% on the news, finding themselves 35% below where they started the year.
Clerc said he sees the global shipping business remaining "subdued and pressured" until about 2026. Container lines had been riding high with increased demand for consumer goods both during and in the immediate aftermath of the pandemic, leading to higher freight prices and record profits. In 2022, for example, Maersk netted $32 billion off of $82 billion in revenue. Third quarter revenue plunged to $12 billion, or about half that of the same quarter last year. Earnings fell to $1.88 billion.
Of course, this is good news for customers who saw their rates spike from about $2,000 per 40-foot container unit to over $10,000 between 2019 and 2022. Those rates have now plunged back down to their pre-pandemic levels (more good news on the inflation front, as those prices were passed along to consumers). Maersk, which hopes to save $600 million on the cost-saving measures, transports about one-sixth of the world's containers.
With the shippers tanking (no pun intended), is it time to buy before a rebound? Not quite. With the Chinese economy foundering, much of Europe in a technical recession, and the US possibly heading for recession in the first half of 2024, these stocks are too risky right now. Put them on your radar and revisit around the middle of next year.
Fr, 03 Nov 2023
Economics: Work & Pay
A weaker-than-expected jobs report spurs market rally
We were already having a strong week in the markets; now, if only the October jobs report could come in weaker-than-expected. Voilà, the markets got what they wanted and futures immediately shifted from mildly negative to nicely positive.
Against expectations for 180,000 new jobs created, the actual October number came in at a cooler 150,000 rate. The US unemployment rate ticked up from 3.8% to 3.9%, and September's disturbingly strong jobs number was revised downward by about 40,000. The labor force participation rate ticked down from 62.8% to 62.7%, and annualized average hourly earnings dropped from 4.3% to 4.1%. There were 35,000 manufacturing jobs lost, though most of them can be traced back to the rolling UAW strikes. In a normal world, such a report would put downward pressure on stocks; instead, the markets rallied.
Here is what investors extrapolated from the report: the Fed is done with its tightening cycle, meaning no more rate hikes. Just look at the ten-year Treasury. Its yield has fallen from 5% to around 4.6%, meaning bond watchers expect the next Fed move to be down, not up. Nearly all of the data points fell in line, capping off a week which had already seen four straight positive days in the market—mostly on the back of Fed expectations.
We fully expect to see the labor picture continue to weaken going into 2024, which should help ameliorate the inflation problem. Another "helpful" factor will be Americans' credit card hangover, which should hit in the early months of the year. That will put further downward pressure on inflation. Sticking with this year, however, we believe the Santa Claus rally has already begun.
The big wild card for the markets over the coming months won't be monetary policy; it will be fiscal policy. What will Congress do, if anything, to stop the profligate spending? There are a lot of hands out right now, and few seem concerned that the money simply isn't there. Actually, to say the money isn't there implies we have spent all of the income generated by taxpayers over the past year. In reality, we spent $1.7 trillion more than that. The interest payment on our national debt is now $675 billion per year, and rapidly heading to $1 trillion.
Th, 02 Nov 2023
IT Software & Services
Investors were worried about Palantir’s commercial business; we weren’t
There are few companies with which we have a stronger conviction than data analytics firm Palantir (PLTR $18). Analysts may have had their doubts (and still do), but we never have. This secretive, black box organization, which gained acclaim for its assistance in tracking down Osama Bin Laden, has garnered the trust of domestic intelligence agencies and friendly governments around the world (it won’t do business with countries it considers adversarial to the US) for years, but many didn’t believe they could bridge the gap in the private sector. The latest earnings report dispels that myth.
Shares of Palantir spiked 20% higher after the company beat Q3 expectations both on the top and bottom line. Revenue rose 17%, to $558 million, while EPS came in at seven cents versus one cent a year earlier. The source of that growth is what we find most interesting.
While government revenue rose a healthy 12%, commercial market revenue spiked nearly twice that amount, growing 23% for the quarter. This was the area which had so many doubters. Another standout: CEO Alex Karp cited the firm’s Artificial Intelligence Platform (AIP), which saw usage triple over the course of the quarter, as a growth driver going forward. He expects AIP’s revenue run rate to hit $1 billion by 2025. The company also raised its full year revenue outlook for 2023—something we don’t recall one other firm doing this year.
Palantir currently offers three advanced platforms: Gotham for government agency use, Metropolis for financial services firms, and Foundry for large non-financial companies. Additionally, the firm is expanding into the health care, energy, and manufacturing sectors. Palantir is based out of Denver, Colorado, moving its headquarters from a “less hospitable” Silicon Valley a few years ago.
The growth potential for Palantir, in our opinion, is nearly unlimited. Wonderfully (for astute investors), the company also has a lot of detractors in the analyst world who simply fail to recognize that potential. Efficient Market Hypothesis is a joke.
Th, 02 Nov 2023
Real Estate Services
Real estate services firms get pummeled following Missouri ruling
At the heart of the case was a National Association of Realtors (NAR) rule that requires sellers to make a blanket offer of compensation to buyers’ agents for the ability to have their homes listed on the Multiple Listing Service, or MLS. In other words, if you want to sell your home expeditiously, plan on paying your 6% commission, with the understanding that half of the fee will go to the buyers’ agent. Home sellers generated a class-action lawsuit (well, let’s face it, legal firms fomented the case to generate their own income) in an effort to dismantle that rule. A jury in the Western District court of Missouri agreed with them, ruling that the NAR and residential brokerages were in collusion to maintain the fee structure.
While it will take years for the case to wind its way through the legal system, investors wasted no time in dumping their real estate services holdings. Digital real estate broker Redfin (RDFN $5), for example, saw its share price drop double digits on the ruling. Shares of Zillow Group (Z $34), an Internet-based real estate company, fell by about 7%, their biggest one-day decline since the summer of 2022. Cloud-based real estate software provider Compass Inc (COMP $2) saw its shares hit a 52-week-low of $1.81 before rebounding slightly.
As could be fully expected within the current climate, the US Department of Justice is reportedly considering its own lawsuit to dismantle the lucrative real estate commission structure within the country. Arguing that home sellers in most other countries face fees of around 2%, the department finds the systemic scheme to be archaic and harmful to consumers. While the DoJ and the FTC have a embarrassing loss record with respect to their adjudicated cases over the past several years, this one could gain traction.
In an interesting twist, the department settled a case with the NAR during the Trump administration which forced the organization to increase price transparency. The Biden DoJ, however, walked away from that agreement, wanting the ability to pursue tougher penalties in a wider case. A federal judge ruled this past January that the DoJ cannot simply walk away from its settlement. No matter what shakes out, with mortgage rates floating around 16-year highs and a dearth of homes on the market, this was the last thing realtors wanted on their plate.
The Real Estate Operations industry is ranked in the bottom five of all industries right now (239 out of 251), as the segment has a lot more to be concerned with right now beyond this legal action. We would not be tempted to do any bottom fishing here.
We, 01 Nov 2023
Real Estate Management & Development
Once valued at $47 billion, WeWork prepares for bankruptcy
In August of 2019 we called WeWork (WE $1) “a ticking time bomb waiting to be offloaded to unsuspecting investors.” Over the course of the last four years, we have been proven right time after time. Once carrying an inflated valuation of $47 billion, the real estate services firm’s shares now sit slightly above $1, giving it a market cap of around $60 million. According to a report from The Wall Street Journal, the company will file for bankruptcy as soon as next week.
We like the concept behind the firm: lease properties from landowners, transform the space to give it a community business feel, and sublease it to startups, freelancers, and corporations in need of office space. The business model may be sound, but the wheels begin to fall off the cart after that point.
It all starts with WeWork’s wacky founder, Adam Neumann, who seemed to have an odd power to persuade certain ultra-wealthy individuals and financial institutions to give him money. SoftBank’s Masayoshi Son, for example, invested a whopping $17 billion of his Vision Fund into WeWork. Jamie Dimon’s JP Morgan (JPM $139) not only provided billions in loans to the firm, but had also extended Neumann a $100 million or so personal line of credit. But the founder’s biggest act was saved for the millions of investors who would plop down hard-earned money to buy into his house of cards. Never mind the fact that he rigged the share structure so that his super-voting-rights class would count as ten share votes apiece. The IPO fell apart in 2019 after concerns arose surrounding the founder’s questionable business dealings.
As Neumann’s façade was finally uncovered, he was forced out of the company—getting a golden parachute worth north of $1 billion. The company did finally go public via a SPAC (another financial side show) a few years later, but it was a downward slide from there, leading to $95 million worth of missed interest payments in early October.
WeWork still maintains around 800 locations spread across 39 countries (they don’t own any of the properties), with an estimated $10 billion in lease obligations due through the end of 2027. Last year the company had around $3 billion in sales and recorded a $2 billion loss.
Considering the company owns no real estate, it is hard to imagine anyone wanting to pick WeWork up in bankruptcy to keep such a soiled name. Masa’s SoftBank still owns 68% of the firm, so they could try to strike a deal with the holders of roughly $1.2 billion worth of debt (including BlackRock), which may include swapping debt for equity in the reorganized corporation.
There is another interesting scenario in which the landlords, who obviously don’t want to lose the leases, may take partial ownership in the new firm. Remember how property owners Simon Property Group (SPG $112) and Brookfield Asset Management (BAM $29) bought JC Penney out of bankruptcy? As for the tenants, or “members” as they are known by WeWork, the future is uncertain. In locations which have been somewhat profitable, they may be allowed to continue on as usual. In less profitable locations, the operation may be shut down with the tenants asked to leave, allowing the landlord to lease the space to new occupants. The winner in this drama may be competitor firms such as privately held Regus.
Fr, 27 Oct 2023
Renewables
Solar stocks have been in freefall this year; what gives?
SolarEdge (SEDG $78) is a major supplier to the solar power industry, offering power optimizers, inverters, and a cloud-based monitoring platform for residential, commercial, and small-scale utility installations. Shares of SEDG are down 72% year-to-date (YTD). Enphase Energy (ENPH $83) delivers solutions which manage solar generation, storage, and communication on one efficient platform. Shares of ENPH are down 69% YTD. Both of these hardware manufacturers are top holdings within TAN ($41), the Invesco Solar ETF which finds itself down 41% YTD. After so much hype in this arena, what gives?
For the most part, blame that holy grail of renewable resources, Europe. Americans may feel uneasy about their own economy, but Europe has been an actual economic disaster recently; especially the continent’s largest player—Germany. This has led the haughty governments of the region to do some soul searching about their energy needs, and this has culminated in mass cancellations and pushouts of solar projects. Crippled by huge inventories and slowing installations, solar companies are reeling.
Higher interest rates are another reason for the precipitous drop in the share price of solar companies. Clean energy tech firms require massive amounts of capital for their projects, and attracting ESG-friendly investors was relatively simple when rates were sitting near zero (an analogy would be the tech lending going on at now-defunct Silicon Valley Bank). But now these firms face the double whammy of higher rates and stricter lending standards. Combine these factors with the steep drop-off in demand, and the plunge makes more sense.
So, should investors begin nibbling at the higher-quality stocks in this industry? Enphase has an average price target of $171 right now, which would represent a 106% upside potential; SolarEdge’s average price target is $174, representing similar valuations. Both look interesting at these levels for investors sanguine on the American and European economies for the year ahead. However, SolarEdge has its own unique challenges (supply chain issues, higher raw material prices, and currency exchange risks) which would make us steer clear. The company is also based out of Israel, meaning serious geopolitical concerns may affect operations for some time. For the riskier portion of an investor’s portfolio, Enphase might be worth a look right now—just be sure and review the company’s debt load first.
We do not currently own any of the stocks or ETFs in this industry within our Penn portfolios. If we did, however, it would probably TAN (to somewhat mitigate our risk) in the Dynamic Growth Strategy.
Th, 26 Oct 2023
Goods & Services
The US economy grew at a scorching 4.9% rate in Q3; curb your enthusiasm
On its face, a review of economic growth in the United States over the course of the third quarter appears stellar. Beating expectations, the economy grew at a whopping 4.9% annualized rate, or the fastest pace since coming out of the pandemic and over double Q2’s 2.1% growth rate. But don’t let that rosy report, which helped erase pre-market losses, fool you: it was built upon a consumer which is over-spending and racking up massive amounts of credit card debt—and a government which is doing the same.
Some 70% of the headline number is tied to consumer spending, which rose 4% from the prior quarter. The remaining amount is tied to government outlays, which rose 4.6% in the quarter, increased inventories, and exports. The mantra from companies and talking heads is this: “The consumer continues to be remarkably resilient.” What a pleasant way to portray building up personal debt. Following the pandemic, Americans built a piggybank cushion of roughly $2 trillion. That figure has now dropped by 75%. The wanton spending cannot continue.
The 3.8% unemployment rate certainly helped fuel the buying spree, but that figure is also showing signs of aging. Jobless claims totaled 210,000 for the most recent week, above estimates. As spending begins to slow, companies will be forced to resort to layoffs or, at the very least, reduced hiring. That, we believe, will lead to a vicious cycle over the coming several quarters. Expect Q3 to represent peak GDP for a while.
Will this hot growth rate force the Fed to raise rates again next week? We don’t believe so. The slowing within the labor market—albeit minor right now—will help assuage concerns that the economy is growing too fast (thus keeping inflation elevated). We remain doubtful that there will be any more rate hikes this cycle.
We, 25 Oct 2023
Integrated Oil & Gas
With Hess purchase, Chevron gains massive South American oil patch
Chevron (CVX $157) has been, and remains, our number one play in the energy field. One of the reasons for its ongoing position in the Penn Global Leaders Club has been the astute leadership of CEO Mike Wirth. He just displayed his abilities once again with the masterful pickup of Hess Corp (HES $155)—an exploration and production (E&P) company with key assets in the Bakken Shale, Guyana, the Gulf of Mexico, and Southeast Asia. Chevron will pay $53 billion in an all-stock deal to acquire the driller, which we consider a steal (the $171 purchase price equates to just a 10% premium over where the shares have been trading).
The most exciting aspect to the acquisition revolves around Hess’ Guyana assets—arguably the hottest oil patch in the world. Guyana’s Stabroek Block is a 6.6-million-acre offshore area currently controlled by Hess, Exxon Mobil (XOM $108), and China’s CNOOC. It also happens to represent the world’s largest crude discovery of the past decade. Once the deal is finalized, Chevron will control 30% of the field, with Exxon controlling another 45% and CNOOC owning the remaining 25%. We believe this represents the growth driver going forward that Chevron has arguably been missing.
Chevron already controlled a large position in the Permian Basin, thanks in good measure to its recent acquisition of Noble Energy. That deal also gave the firm access to critical natural gas projects in the eastern Mediterranean—holdings which supply massive amounts of natural gas to Israel, Jordan, and Egypt. With a lack of available funding for new fossil fuel projects, acquisitions have been the leading strategy for growth, and Chevron has proven yet again how skilled it is in that arena.
As is typical in an acquisition, Chevron shares dropped a few percentage points on news of the deal while Hess shares rallied. Sitting at $157, off 10% for the year, Chevron looks very attractive once again. We would place a fair value of $200 on CVX shares. The 4% dividend yield is a nice bonus.
Mo, 23 Oct 2023
Government Report: National Debt & Deficit
In the Books: The US just dug itself another $1.7 trillion hole
It’s official: FY23 is behind us, and our government just spent $1.7 trillion more than it took in. That is the third-largest deficit in history, behind only fiscal years 2020 and 2021. Our national debt now sits at $33.66 trillion.
We cringe every time we read a story (by the usual suspects) that debt and deficits don’t matter. They sure as hell matter to households trying to stay afloat and maintain a decent credit rating. It really is bordering on criminal; to spend trillions more than you take in from taxpayers each year. Let’s consider the cost of servicing that debt.
Just as a household must pay finance charges on any credit card balance not paid off at the end of the statement period, the US government must pay finance charges on its $33.66 trillion of debt. The annual interest due on that debt is currently $671.3 billion, but that will only grow as debt matures and the Treasury is forced to refinance at higher rates. Put another way, a full 15% of the entire budget of the United States goes up in smoke as interest on the debt. Think of what could be done with an extra $671 billion per year. But that’s not the worst of it: Net interest payments on the national debt were $352 billion in 2021 and $475 billion in 2022. See a trend?
While few seem to care about this economic disaster waiting to blow, the “bond vigilantes” are sounding the warning sirens by unloading Treasuries at a record clip, thus forcing yields higher. Simple supply and demand: If supply is rising while demand is falling, higher yields are required to entice would-be buyers. The vigilantes are demanding fiscal responsibility, but does anyone believe they will find it in D.C?
A balanced budget amendment is needed to force politicians to act responsibly. And that will entail a grassroots movement, as we can’t think of one elected official calling for it. Right now, every state except Vermont (go figure) has some form of a balanced budget provision on the books; it is time to demand the same of our federal government. It is not hyperbole to say that there is a tipping point with respect to the national debt—an event horizon from which there is no coming back.
Genuine Parts crashing after sales miss (Th, 19 Oct)
Shares of automotive parts distributor Genuine Parts (GPC $130) fell double digits after the company failed to hit estimates for Q3 sales. While $5.82B was still better than the same quarter a year ago, it didn't hit analysts' mark of $5.91B. We would place a fair value of $175 on the shares.
We, 18 Oct 2023
Housing
It’s official: the average 30-year mortgage rate just hit 8%
Per industry outlet Mortgage News Daily, the average 30-year mortgage just hit a rate not seen since the summer of 2000: 8%. The news provides yet another hurdle for would-be buyers, who have been facing dwindling inventories, record-high home prices, and inflation around every corner.
Let’s put that rate in dollars and cents. The average new home price in America was $430,300 as of the first week of October. After plopping a fat 20% down ($86,060) and adding in the average cost of home insurance, property taxes, and HOA dues, the new owner would be facing a $3,000 monthly mortgage payment. The same house purchased two years ago at the prevailing rate would come with a monthly mortgage payment of $1,865—and that doesn’t even account for inflation over the past two years. In other words, the same home probably would have cost in the neighborhood of $350,000 two years ago, which would bring the payment down to $1,600! We are told that Americans are still flush with cash (a point many would argue), but an extra $1,400 per month for the typical family has got to hurt.
And the higher rates are showing up in loan demand. According to the Mortgage Bankers Association, loan applications fell 6% on a seasonally adjusted basis from the end of the first week of October to the end of the second week. Applications to either buy or refinance a home fell 6.9%—the weakest reading since the mid 1990s. Nonetheless, housing starts still rose 7% in September to a seasonally adjusted rate of 1.358 million homes per year. That increase, however, was largely due to an increase in multifamily projects. For renters, the picture isn’t much brighter. According to Rent.com, the national median rent price is now $2,011 per month.
Putting this in perspective, the average 30-year mortgage rate in October 1981 was 18.63%. That said, if we are not at or very near the peak for mortgage rates, expect the damage to start slowly creeping throughout the economy. And don’t even get us started on what the US government will have to pay in interest this year on the $33 trillion national debt it has racked up. Several small nations could be purchased for the same amount.
We, 18 Oct 2023
eCommerce
Amazon is revamping its fulfillment centers with AI-powered robots
According to the Wall Street Journal, $1.4 trillion online retailer Amazon (AMZN $131) is about to undertake a massive overhaul of its fulfillment centers to increase efficiency. Under the project name Sequoia, the program will deploy artificial intelligence and robotic arms to increase both speed and safety at the warehouses.
Sequoia will allow the company to place items on its website more quickly, reduce the time it takes to fulfill an order by 25%, and store inventory up to 75% faster. The project isn’t piecemeal: it is part of a major push to fully integrate advanced robotics into the workflow process, transforming the way workers and machines interact. The goal is to eliminate as many arduous and mundane tasks for humans as possible, while lowering operating costs and improving margins. The strategy will initially be centered around dozens of new same-day delivery sites but will methodically expand throughout the company’s vast warehouse system.
Last year, Amazon initiated a $1 billion fund to foster innovation in the logistics and supply chain process, with privately-held Agility Robotics being among the first recipients. Agility believes it will usher in “the next wave of robotic automation.” Additionally, Amazon acquired robotics firm Kiva Systems Inc., maker of the little orange robot workers zipping around fulfillment centers, about a decade ago for $775 million. The deal was the second-largest in the firm’s history, behind the $900 million purchase of Zappos.com in 2009. The message is clear: AI-powered automation is a cornerstone of Amazon’s business strategy going forward, and it intends to remain the undisputed leader in the efficient delivery of goods to the American consumer.
Amazon is a member of the Penn Global Leaders Club and one of the “Ten Stocks to Buy for 2023,” as outlined in our 2023 Market Outlook report.
Strike contagion in Detroit (Tu, 17 Oct)
Strike fever is spreading in the Motor City. Not only are UAW workers on strike against the Big Three automakers, thousands of casino workers in the city just went on strike. The catalyst was the Detroit Casino Council, which is made up of five unions—yep, including the UAW.
United Airlines beats concensus in Q3 (Tu, 17 Oct)
Shares of Penn Global Leaders Club member United Airlines (UAL $39) were trading down after hours despite beating estimates on both the top and bottom lines. The company earned $3.65 per share vs $3.35 expected. Management raised concerns over the cost per available seat mile (CASM) for the fourth quarter, giving estimates much higher than the Street was already baking in.
Homebuilder sentiment falls as rates near 8% (Tu, 17 Oct)
As the 30-year average mortgage rate hits 7.92%, builder confidence in the US has dropped to its lowest level since January: 40. Any number above a 50 represents a positive outlook, any number below 50 represents a negative outlook.
Wyndham rejects takeover bid from Choice Hotels (Tu, 17 Oct)
Shares of Wyndham Hotels & Resorts (WH $76) were trading up 10% after the company said it had rejected a $9.8 billion takeover offer from competitor Choice Hotels International (CHH $119).
Lululemon ascends to S&P 500 (Mo, 16 Oct)
Shares of athleisure retailer Lululemon (LULU $418) were trading 10% higher as the company prepares to enter the coveted S&P 500 benchmark on Wednesday. Shares of Hubbell (HUBB $303), which designs, manufactures, and sells electrical and electronic products, were also trading a bit higher preceeding that company's entrance into the benchmark. The two firms replace Activision Blizzard (ATVI) and Organon & Co (OGN) in the S&_ 500, respectively.
Rite Aid files for bankruptcy (Mo, 16 Oct)
Drugstore retail chain Rite Aid (RAD $0.64) has filed for Chapter 11 bankruptcy protection. The company said lenders had agreed to extend $3.45 billion in new funding to provide sufficient liquidity at it navigates through the restructuring process.
Vista Outdoor plunges 25% on plan to sell Outdoor unit (Mo, 16 Oct)
Vista Outdoor, maker of such brands as Federal (ammo), Remington, Bushnell, Bell, and Fox, has announced that it has sold its ammo brands to a Czech company for $1.91 billion in cash. The new entity will trade under the symbol GEAR. The market didn't like the move, pushing VSTO shares down 25% Monday morning. We don't see a reason to own VSTO any longer.
Pfizer gets upgrade (Mo, 16 Oct)
Jefferies upgrades Pfizer to Buy, raising their price target on the big pharma company to $39 per share. The company believes Pfizer is greatly undervalued based on investor misunderstanding of the firm's pipeline of therapies.
Fr, 13 Oct 2023
Aerospace & Defense
US sends first resupply of missiles to Israel for its Iron Dome system
The Iron Dome system deployed in Israel has a remarkable success rate of over 90% in intercepting incoming missiles; nonetheless, when a terrorist organization launches some 5,000 rockets in a coordinated assault, even a 10% failure rate can be disastrous. That is precisely what happened when Hamas attacked Israel last weekend.
To assure the system has enough ammo to continually defend against the threat, the United States announced that it has shipped the first resupply of Tamir missiles (known in the US as SkyHunter) to Israel, with more to come.
The Iron Dome system is a joint venture between US aerospace and defense firm RTX Corp (RTX $73, formerly Raytheon and United Technologies) and Israel’s Rafael Advanced Defense Systems. Roughly 55% of the system is built by Raytheon, primarily at its Space Systems Operations facility (aka the “Space Factory”) in the outskirts of Tucson, Arizona. The US-owned system is deployed in approximately ten locations throughout Israel, with each battery of three to four launchers able to defend sixty square miles of land. Each launcher can hold up to 20 Tamir missiles, with each missile costing between $40,000 and $50,000.
Separately, both the US Army and United States Marine Corps have been deploying Iron Dome batteries within this country. The Army has taken delivery of over 300 SkyHunter missiles, while the USMC has announced its intent to buy some 1,800 missiles and 44 launchers.
With bad actors like Iran and North Korea on the world stage, receiving at least tacit backing from Russia and China, air defense systems—both domestically and amongst our allies in Europe and the Middle East—will come to the forefront in a manner not seen since the most heated days of the Cold War.
RTX is a product of the merger between Raytheon and United Technologies, and the subsequent spinoff of its Otis (elevators) and Carrier (HVAC) divisions. The firm now has a roughly equal balance between its civilian aerospace units and its defense business. Its lines include Collins Aerospace, Pratt & Whitney engines, Raytheon Intelligence & Space, and Raytheon Missile & Defense.
UBS cuts Starbucks (Th, 12 Oct)
UBS has cut its price target on Starbucks (SBUX $91) from $110 to $100. The firm maintains its Neutral rating on the coffee house.
Bank of America upgrades Target to a buy on valuation (Th, 12 Oct)
Bank of America believes the selloff in Target (TGT $111) shares is overdone, and has changed its rating on the multiline retailer from Neutral to Buy. It also raised its price target on the shares, from $120 to $135. And that rating improvement assumes a 5% decline in comparable sales for the second half of the year.
UAW launches surprise strike at Ford truck plant in Kentucky (Th, 12 Oct)
Approximately 8,700 Ford workers walked off the job at a highly-profitable Ford plant in Kentucky which produces both SUVs and pickups. The move shows just how far apart the sides remain in negotiations to strike a new long-term contract between the US automakers and the UAW.
Social Security recipients will get a 3.2% cost-of-living increase in 2024 (Th, 12 Oct)
Last year, Social Security recipients received a whopping 8.7% cost-of-living increase in their "benefits"—the highest such jump in four decades; for 2024, the COLA will be a more typical 3.2% raise. Roughly 67 million Americans, or about one in every five, currently receive Social Security benefits, with about 20% of that number represented by younger Americans on disability.
Consumer prices rose a bit more than expected (Th, 12 Oct)
Investors were anxiously awaiting the latest Consumer Price Index (CPI) report, expecting to see a continued downward push in inflation. Instead, they got a slightly hotter-than-expected number. CPI rose 0.4% against expectations for a 0.3% jump; meanwhile, core CPI (discounts food and gas prices) 0.3% m/m and 4.1% y/y—both as expected. Futures were dampened a bit, but remained positive.
Clorox shares dive on impact of hack (Fr, 06 Oct)
Clorox said that the effects of a massive cyberattack on the firm would have a major impact on sales and profits for the quarter. The hack essentially shut down automated production lines for weeks. Shares of CLX are trading near a five-year low. The First Trust Nasdaq Cybersecurity ETF (CIBR) is one of our top five holdings for clients within the Penn Wealth Strategies.
Energy mega-deal? (Fr, 06 Oct)
Pioneer Resources jumped double digits on rumors that oil giant Exxon Mobil may be ready to acquire the E&P firm in a $60 billion blockbuster deal. Exxon has a market cap of $431 billion. We have mixed emotions about the deal, as it may lead to a difficult-to-manage clash of cultures. We own Chevron (CVX) within the Penn Global Leaders Club.
Jobs shocker (Fr, 06 Oct)
Against expectations for 150,000 new jobs created in September, the US economy actually added nearly double that amount: 336,000 new payrolls. The immediate reaction was a sharp downturn in equities as concern over a hot report might mean that the Fed would continue hiking. The silver lining was a rather muted increase in wages, which rose just 0.2% month-over-month. By the afternoon, however, something remarkable happened. Markets suddenly decided they liked the strong report and made a serious afternoon rally.
Mo, 20 Nov 2023
Latin America
To the chagrin of the left, a fervent, pro-American capitalist wins in Argentina
Just for fun, we went back four years into the PennEconomics way back machine and reviewed our notes on the recently held (at the time) Argentinian election in which leftist Alberto Fernandez and his anti-American running mate, Cristina Kirchner, rose to power. We posited the notion that they would leave the country's economy in shambles. Voilà, four years have passed and our analysis was spot on.
We have been irritated with the coverage of this year's election by the mainstream media, which has all but assured us that Economy Minister Sergio Massa would win, carrying on the Peronist legacy. This despite the country's 140% annualized inflation rate and crumbling economy. Lo and behold, to "everyone's shock," pro-American libertarian candidate Javier Milei (mih LAY), who looks somewhat like a young Benny Hill, stormed to victory with a 15-percentage-point landslide. We watched as a stunned Bloomberg host asked an expert, "How will Argentina's economy react to this surprise?" Let us answer that: "Um, Haidi, the Global X MSCI Argentina ETF (ARGT $47) surged over 11% the day following Milei's victory."
Even more upset that many in the press was Brazil's current leader and former prisoner Lula da Silva. Understandably, he had a cozy relationship with the Peronist government of Fernandez and was a big backer of Massa. Of course, it probably didn't help that Milei had labeled Lula a communist (accurate) with whom he wouldn't deal. The two countries are historically big trading partners.
As for Milei's plans to snap Argentina out of its funk, he has proposed such radical plans as ditching his country's peso and making the US dollar the national currency, as well as eliminating the country's central bank. He also said he will prioritize trade with the US over erstwhile partners such as Brazil, and will make a "spiritual journey" to the United States and Israel soon. Things are about to get very interesting in South America's second-largest economy.
Despite its nightmarish condition, we are excited to see what Milei will do with the Argentinian economy. He certainly has a mandate, along with the personality and passion to make seismic changes. None of this will sit well with the leftists of the region; hopefully, America will show a bit of gratitude—via increased trade—for his love of capitalism.
Tu, 14 Nov 2023
Supply, Demand, & Prices
A great inflation report virtually assures an end to rate hikes
Before the October CPI report was released, futures were flat. Minutes after the release, Dow futures spiked over 300 points, NASDAQ futures rallied 2%, and the small-cap Russell 2000 jumped 4%. Powerful report.
Here’s the headline number that gained the most attention: Inflation cooled to 3.2% in October, down from 3.7% in September and well below last October’s scorching 7.75% reading. This report provides clear evidence that inflation is heading back down towards the Fed’s 2% target, all but assuring the rate hike cycle is dead.
Core inflation, which removes volatile food and energy costs, fell to 4.02% in October, down from 6.3% a year earlier. Parsing out the energy component, gas prices fell from an average $3.81 per gallon at the start of the month to $3.46 by the end. We have come a long way from the 9% inflation rate we were experiencing in the summer of 2022.
Suddenly, talk on the Street has shifted from concern over tightening to how quickly the Fed will begin lowering rates. Could we just take a little time to relish this victory over runaway inflation before going there?
Here’s the new narrative being pushed by the likes of Morgan Stanley (a group we respect very little) and UBS: Slower growth, rising unemployment, and disinflation will force the Fed to cut its benchmark rate to a target range between 2.5% and 2.75% by the end of 2024, with the cuts beginning relatively early in the new year. We are currently in a range between 5.25% and 5.5%, meaning that would be the equivalent of eleven 25-basis-point cuts! We may be sliding into a minor recession in 2024, but we sure don’t buy that narrative. That said, rates have peaked so investors should continue picking up higher-yielding bonds to balance their portfolios.
Mo, 13 Nov 2023
Renewables
America's hydrogen darling, Plug Power, is in freefall
Remember when that cleanest of clean energies, hydrogen, was going to be the panacea for America's future energy needs? Investors poured billions of dollars into hydrogen power plays, with Plug Power (PLUG $3) leading the charge. Sure bet, right?
On Thursday the 9th of November, Plug issued its latest earnings report. It did not go well. The two words which typically spell doom for a company were uttered: "going concern." Management is pursuing a possible loan from the Department of Energy for as much as $1.5 billion, and it also needs the billions of dollars in subsidies from the government to continue. Neither of these mentioned bullet points gave warm and fuzzy feelings to investors: shares of PLUG plunged 43% the following day and are now down 95% since January 2021. Once a $36 billion firm, Plug's market cap is now $2 billion.
As could be expected, downgrades came flooding in after the earnings release. The average price target by analysts who follow the company fell from $12 to $5 per share, and even the biggest of hydrogen power bulls admitted that help may not come soon enough to save this industry leader.
For the quarter, Plug reported $200 million in sales and a net loss of $283.5 million. To meet its full-year sales forecast, it will need to record $500 million in sales in the fourth quarter. We don't see that happening.
Plug's stated objective is to build an end-to-end green hydrogen ecosystem, from production to storage and delivery to energy generation. It envisions green hydrogen highways crisscrossing North America and Europe. This may still happen, but it is looking less likely that Plug will be the company delivering the results.
Another great example of investors rushing into a promising field during its nascent stages, urged on by glowing news articles. Our recommendation: don't try to catch a falling knife. That goes not only for shares of PLUG, but also for shares of the Global X Hydrogen ETF (HYDR $6).
We, 08 Nov 2023
Biotechnology
Investors view Moderna as simply a COVID play; that is a mistake
A few months ago, we reported on a joint venture between American biotech Moderna (MRNA $73) and German biotech Immatics NV (IMTX $10) to develop a line of cancer vaccines and therapies using the former's revolutionary mRNA technology. Consider the impact such a development could have on humanity—not to mention Moderna's future in the industry. Investors, however, remain myopically focused on the company's COVID vaccine and its dwindling sales.
Granted, it was the coronavirus vaccine that transformed Moderna into one of the most profitable biotechs in the world (it is now debt free), but we are more excited about the future of mRNA technology than we are concerned about the precipitous drop in Spikevax (formerly known as COVID-19 Vaccine Moderna) sales. The world is ready to move on from the pandemic, and investors mistakenly view this firm as a one-trick pony.
The massive inflow of cash from the COVID vaccine has allowed the firm to greatly increase its R&D department, and at least fifteen new products—four for rare diseases—are set to launch over the coming several years. This past July, Moderna submitted its RSV vaccine for approval in the United States and Europe, and an enhanced formulation of the flu vaccine is geared for approval in 2024. Early-stage clinical studies have begun on vaccines for HIV, Lyme disease, and the Zika virus. There are as many as 50 new pipeline candidates which should be in the clinical development stage by 2028.
Moderna's intellectual property is strong, and we love the strategy of teaming with other biotechs and big pharma companies for the development of its products. For example, in a joint project with Merck (MRK $104), the company has a melanoma vaccine in phase 3 trials. From the treatment of cancer and rare diseases to a transformational new line of vaccines, Moderna's future looks bright.
Investing in biotech companies is not for the faint of heart, as trial results can send a company's shares soaring or make them crater. But this biotech, with its unique IP and no debt on its books, looks to be a standout. We would place a fair value of $200 on the shares.
Sa, 04 Nov 2023
Market Pulse
A refreshing start to the "best six months of the year"
Finally. After a brutal quarter in the stock market, three months in which the Dow fell an average of 1,000 points per month, we have signs of life. Ironically, this past week's strong gains came on the back of soft jobs data; well, that and the announcement that the Treasury will "only" need to borrow $776 billion in the final quarter of the year.
The Treasury Department news kicked the week off when it announced on Monday that it would be issuing $776 billion worth of debt in Q4 and $816 billion between January and March. This announcement came ten days after it was revealed that the government had spent $1.7 trillion more than it brought in for fiscal 2023. It is amazing what counts for good news these days. The market also liked the quarterly refunding report issued Wednesday morning. This report, which gives the specifics of what debt the Treasury Department will be issuing, showed a skewed issuance of shorter-maturity Treasuries as opposed to ten-year or longer maturities. By the laws of supply and demand, this helped bring the 10-year Treasury yield down, helping bonds to rally.
Then came the scheduled FOMC meeting on Wednesday. Not only did the Fed not hike rates again, Powell gave a relatively dovish press conference. Despite the effort of some journalists and their boneheaded questions almost begging Powell to be hawkish (Michael McKee of Bloomberg wins the booby prize for the dumbest), investors walked away believing that the current rate hike cycle is officially dead. Add a cooler-than-expected jobs report for October, and it was off to the races in the market.
By Friday's close, the markets had pieced together their best week since October 2022. The biggest winner was the Russell 2000 small-cap index, which had been down 7% year-to-date. It erased all of the year's losses and is now sitting up 7 basis points for 2023. The Nasdaq rose 6.6% for the week, followed by the S&P 500 (5.85%) and the Dow (5%). As if that weren't enough good news, oil fell 5% and bonds rallied 2% on the week.
A better script for the first week of the best six months of the year couldn't have been written.
Fr, 03 Nov 2023
Maritime: Shipping & Ports
Container shipping giant Maersk gives bleak outlook on trade
To get a good read on the state of global trade, we often look to the bellwether container shipping firms for clues. Four in particular we look at are Diana Shipping (Greece), Costamare (Greece), Nordic American Tankers (Bermuda), and A.P. Moller Maersk (Denmark; AMKBY $7). Shares of the latter plunged on rather dire comments—and actions—by the CEO.
Chief Executive Officer Vincent Clerc announced in an interview with Bloomberg that at least 10,000 workers (out of 88,000) would lose their jobs. In a rather poor choice of words, he said that "6,000 of those have already been executed." Shares fell 16% on the news, finding themselves 35% below where they started the year.
Clerc said he sees the global shipping business remaining "subdued and pressured" until about 2026. Container lines had been riding high with increased demand for consumer goods both during and in the immediate aftermath of the pandemic, leading to higher freight prices and record profits. In 2022, for example, Maersk netted $32 billion off of $82 billion in revenue. Third quarter revenue plunged to $12 billion, or about half that of the same quarter last year. Earnings fell to $1.88 billion.
Of course, this is good news for customers who saw their rates spike from about $2,000 per 40-foot container unit to over $10,000 between 2019 and 2022. Those rates have now plunged back down to their pre-pandemic levels (more good news on the inflation front, as those prices were passed along to consumers). Maersk, which hopes to save $600 million on the cost-saving measures, transports about one-sixth of the world's containers.
With the shippers tanking (no pun intended), is it time to buy before a rebound? Not quite. With the Chinese economy foundering, much of Europe in a technical recession, and the US possibly heading for recession in the first half of 2024, these stocks are too risky right now. Put them on your radar and revisit around the middle of next year.
Fr, 03 Nov 2023
Economics: Work & Pay
A weaker-than-expected jobs report spurs market rally
We were already having a strong week in the markets; now, if only the October jobs report could come in weaker-than-expected. Voilà, the markets got what they wanted and futures immediately shifted from mildly negative to nicely positive.
Against expectations for 180,000 new jobs created, the actual October number came in at a cooler 150,000 rate. The US unemployment rate ticked up from 3.8% to 3.9%, and September's disturbingly strong jobs number was revised downward by about 40,000. The labor force participation rate ticked down from 62.8% to 62.7%, and annualized average hourly earnings dropped from 4.3% to 4.1%. There were 35,000 manufacturing jobs lost, though most of them can be traced back to the rolling UAW strikes. In a normal world, such a report would put downward pressure on stocks; instead, the markets rallied.
Here is what investors extrapolated from the report: the Fed is done with its tightening cycle, meaning no more rate hikes. Just look at the ten-year Treasury. Its yield has fallen from 5% to around 4.6%, meaning bond watchers expect the next Fed move to be down, not up. Nearly all of the data points fell in line, capping off a week which had already seen four straight positive days in the market—mostly on the back of Fed expectations.
We fully expect to see the labor picture continue to weaken going into 2024, which should help ameliorate the inflation problem. Another "helpful" factor will be Americans' credit card hangover, which should hit in the early months of the year. That will put further downward pressure on inflation. Sticking with this year, however, we believe the Santa Claus rally has already begun.
The big wild card for the markets over the coming months won't be monetary policy; it will be fiscal policy. What will Congress do, if anything, to stop the profligate spending? There are a lot of hands out right now, and few seem concerned that the money simply isn't there. Actually, to say the money isn't there implies we have spent all of the income generated by taxpayers over the past year. In reality, we spent $1.7 trillion more than that. The interest payment on our national debt is now $675 billion per year, and rapidly heading to $1 trillion.
Th, 02 Nov 2023
IT Software & Services
Investors were worried about Palantir’s commercial business; we weren’t
There are few companies with which we have a stronger conviction than data analytics firm Palantir (PLTR $18). Analysts may have had their doubts (and still do), but we never have. This secretive, black box organization, which gained acclaim for its assistance in tracking down Osama Bin Laden, has garnered the trust of domestic intelligence agencies and friendly governments around the world (it won’t do business with countries it considers adversarial to the US) for years, but many didn’t believe they could bridge the gap in the private sector. The latest earnings report dispels that myth.
Shares of Palantir spiked 20% higher after the company beat Q3 expectations both on the top and bottom line. Revenue rose 17%, to $558 million, while EPS came in at seven cents versus one cent a year earlier. The source of that growth is what we find most interesting.
While government revenue rose a healthy 12%, commercial market revenue spiked nearly twice that amount, growing 23% for the quarter. This was the area which had so many doubters. Another standout: CEO Alex Karp cited the firm’s Artificial Intelligence Platform (AIP), which saw usage triple over the course of the quarter, as a growth driver going forward. He expects AIP’s revenue run rate to hit $1 billion by 2025. The company also raised its full year revenue outlook for 2023—something we don’t recall one other firm doing this year.
Palantir currently offers three advanced platforms: Gotham for government agency use, Metropolis for financial services firms, and Foundry for large non-financial companies. Additionally, the firm is expanding into the health care, energy, and manufacturing sectors. Palantir is based out of Denver, Colorado, moving its headquarters from a “less hospitable” Silicon Valley a few years ago.
The growth potential for Palantir, in our opinion, is nearly unlimited. Wonderfully (for astute investors), the company also has a lot of detractors in the analyst world who simply fail to recognize that potential. Efficient Market Hypothesis is a joke.
Th, 02 Nov 2023
Real Estate Services
Real estate services firms get pummeled following Missouri ruling
At the heart of the case was a National Association of Realtors (NAR) rule that requires sellers to make a blanket offer of compensation to buyers’ agents for the ability to have their homes listed on the Multiple Listing Service, or MLS. In other words, if you want to sell your home expeditiously, plan on paying your 6% commission, with the understanding that half of the fee will go to the buyers’ agent. Home sellers generated a class-action lawsuit (well, let’s face it, legal firms fomented the case to generate their own income) in an effort to dismantle that rule. A jury in the Western District court of Missouri agreed with them, ruling that the NAR and residential brokerages were in collusion to maintain the fee structure.
While it will take years for the case to wind its way through the legal system, investors wasted no time in dumping their real estate services holdings. Digital real estate broker Redfin (RDFN $5), for example, saw its share price drop double digits on the ruling. Shares of Zillow Group (Z $34), an Internet-based real estate company, fell by about 7%, their biggest one-day decline since the summer of 2022. Cloud-based real estate software provider Compass Inc (COMP $2) saw its shares hit a 52-week-low of $1.81 before rebounding slightly.
As could be fully expected within the current climate, the US Department of Justice is reportedly considering its own lawsuit to dismantle the lucrative real estate commission structure within the country. Arguing that home sellers in most other countries face fees of around 2%, the department finds the systemic scheme to be archaic and harmful to consumers. While the DoJ and the FTC have a embarrassing loss record with respect to their adjudicated cases over the past several years, this one could gain traction.
In an interesting twist, the department settled a case with the NAR during the Trump administration which forced the organization to increase price transparency. The Biden DoJ, however, walked away from that agreement, wanting the ability to pursue tougher penalties in a wider case. A federal judge ruled this past January that the DoJ cannot simply walk away from its settlement. No matter what shakes out, with mortgage rates floating around 16-year highs and a dearth of homes on the market, this was the last thing realtors wanted on their plate.
The Real Estate Operations industry is ranked in the bottom five of all industries right now (239 out of 251), as the segment has a lot more to be concerned with right now beyond this legal action. We would not be tempted to do any bottom fishing here.
We, 01 Nov 2023
Real Estate Management & Development
Once valued at $47 billion, WeWork prepares for bankruptcy
In August of 2019 we called WeWork (WE $1) “a ticking time bomb waiting to be offloaded to unsuspecting investors.” Over the course of the last four years, we have been proven right time after time. Once carrying an inflated valuation of $47 billion, the real estate services firm’s shares now sit slightly above $1, giving it a market cap of around $60 million. According to a report from The Wall Street Journal, the company will file for bankruptcy as soon as next week.
We like the concept behind the firm: lease properties from landowners, transform the space to give it a community business feel, and sublease it to startups, freelancers, and corporations in need of office space. The business model may be sound, but the wheels begin to fall off the cart after that point.
It all starts with WeWork’s wacky founder, Adam Neumann, who seemed to have an odd power to persuade certain ultra-wealthy individuals and financial institutions to give him money. SoftBank’s Masayoshi Son, for example, invested a whopping $17 billion of his Vision Fund into WeWork. Jamie Dimon’s JP Morgan (JPM $139) not only provided billions in loans to the firm, but had also extended Neumann a $100 million or so personal line of credit. But the founder’s biggest act was saved for the millions of investors who would plop down hard-earned money to buy into his house of cards. Never mind the fact that he rigged the share structure so that his super-voting-rights class would count as ten share votes apiece. The IPO fell apart in 2019 after concerns arose surrounding the founder’s questionable business dealings.
As Neumann’s façade was finally uncovered, he was forced out of the company—getting a golden parachute worth north of $1 billion. The company did finally go public via a SPAC (another financial side show) a few years later, but it was a downward slide from there, leading to $95 million worth of missed interest payments in early October.
WeWork still maintains around 800 locations spread across 39 countries (they don’t own any of the properties), with an estimated $10 billion in lease obligations due through the end of 2027. Last year the company had around $3 billion in sales and recorded a $2 billion loss.
Considering the company owns no real estate, it is hard to imagine anyone wanting to pick WeWork up in bankruptcy to keep such a soiled name. Masa’s SoftBank still owns 68% of the firm, so they could try to strike a deal with the holders of roughly $1.2 billion worth of debt (including BlackRock), which may include swapping debt for equity in the reorganized corporation.
There is another interesting scenario in which the landlords, who obviously don’t want to lose the leases, may take partial ownership in the new firm. Remember how property owners Simon Property Group (SPG $112) and Brookfield Asset Management (BAM $29) bought JC Penney out of bankruptcy? As for the tenants, or “members” as they are known by WeWork, the future is uncertain. In locations which have been somewhat profitable, they may be allowed to continue on as usual. In less profitable locations, the operation may be shut down with the tenants asked to leave, allowing the landlord to lease the space to new occupants. The winner in this drama may be competitor firms such as privately held Regus.
Fr, 27 Oct 2023
Renewables
Solar stocks have been in freefall this year; what gives?
SolarEdge (SEDG $78) is a major supplier to the solar power industry, offering power optimizers, inverters, and a cloud-based monitoring platform for residential, commercial, and small-scale utility installations. Shares of SEDG are down 72% year-to-date (YTD). Enphase Energy (ENPH $83) delivers solutions which manage solar generation, storage, and communication on one efficient platform. Shares of ENPH are down 69% YTD. Both of these hardware manufacturers are top holdings within TAN ($41), the Invesco Solar ETF which finds itself down 41% YTD. After so much hype in this arena, what gives?
For the most part, blame that holy grail of renewable resources, Europe. Americans may feel uneasy about their own economy, but Europe has been an actual economic disaster recently; especially the continent’s largest player—Germany. This has led the haughty governments of the region to do some soul searching about their energy needs, and this has culminated in mass cancellations and pushouts of solar projects. Crippled by huge inventories and slowing installations, solar companies are reeling.
Higher interest rates are another reason for the precipitous drop in the share price of solar companies. Clean energy tech firms require massive amounts of capital for their projects, and attracting ESG-friendly investors was relatively simple when rates were sitting near zero (an analogy would be the tech lending going on at now-defunct Silicon Valley Bank). But now these firms face the double whammy of higher rates and stricter lending standards. Combine these factors with the steep drop-off in demand, and the plunge makes more sense.
So, should investors begin nibbling at the higher-quality stocks in this industry? Enphase has an average price target of $171 right now, which would represent a 106% upside potential; SolarEdge’s average price target is $174, representing similar valuations. Both look interesting at these levels for investors sanguine on the American and European economies for the year ahead. However, SolarEdge has its own unique challenges (supply chain issues, higher raw material prices, and currency exchange risks) which would make us steer clear. The company is also based out of Israel, meaning serious geopolitical concerns may affect operations for some time. For the riskier portion of an investor’s portfolio, Enphase might be worth a look right now—just be sure and review the company’s debt load first.
We do not currently own any of the stocks or ETFs in this industry within our Penn portfolios. If we did, however, it would probably TAN (to somewhat mitigate our risk) in the Dynamic Growth Strategy.
Th, 26 Oct 2023
Goods & Services
The US economy grew at a scorching 4.9% rate in Q3; curb your enthusiasm
On its face, a review of economic growth in the United States over the course of the third quarter appears stellar. Beating expectations, the economy grew at a whopping 4.9% annualized rate, or the fastest pace since coming out of the pandemic and over double Q2’s 2.1% growth rate. But don’t let that rosy report, which helped erase pre-market losses, fool you: it was built upon a consumer which is over-spending and racking up massive amounts of credit card debt—and a government which is doing the same.
Some 70% of the headline number is tied to consumer spending, which rose 4% from the prior quarter. The remaining amount is tied to government outlays, which rose 4.6% in the quarter, increased inventories, and exports. The mantra from companies and talking heads is this: “The consumer continues to be remarkably resilient.” What a pleasant way to portray building up personal debt. Following the pandemic, Americans built a piggybank cushion of roughly $2 trillion. That figure has now dropped by 75%. The wanton spending cannot continue.
The 3.8% unemployment rate certainly helped fuel the buying spree, but that figure is also showing signs of aging. Jobless claims totaled 210,000 for the most recent week, above estimates. As spending begins to slow, companies will be forced to resort to layoffs or, at the very least, reduced hiring. That, we believe, will lead to a vicious cycle over the coming several quarters. Expect Q3 to represent peak GDP for a while.
Will this hot growth rate force the Fed to raise rates again next week? We don’t believe so. The slowing within the labor market—albeit minor right now—will help assuage concerns that the economy is growing too fast (thus keeping inflation elevated). We remain doubtful that there will be any more rate hikes this cycle.
We, 25 Oct 2023
Integrated Oil & Gas
With Hess purchase, Chevron gains massive South American oil patch
Chevron (CVX $157) has been, and remains, our number one play in the energy field. One of the reasons for its ongoing position in the Penn Global Leaders Club has been the astute leadership of CEO Mike Wirth. He just displayed his abilities once again with the masterful pickup of Hess Corp (HES $155)—an exploration and production (E&P) company with key assets in the Bakken Shale, Guyana, the Gulf of Mexico, and Southeast Asia. Chevron will pay $53 billion in an all-stock deal to acquire the driller, which we consider a steal (the $171 purchase price equates to just a 10% premium over where the shares have been trading).
The most exciting aspect to the acquisition revolves around Hess’ Guyana assets—arguably the hottest oil patch in the world. Guyana’s Stabroek Block is a 6.6-million-acre offshore area currently controlled by Hess, Exxon Mobil (XOM $108), and China’s CNOOC. It also happens to represent the world’s largest crude discovery of the past decade. Once the deal is finalized, Chevron will control 30% of the field, with Exxon controlling another 45% and CNOOC owning the remaining 25%. We believe this represents the growth driver going forward that Chevron has arguably been missing.
Chevron already controlled a large position in the Permian Basin, thanks in good measure to its recent acquisition of Noble Energy. That deal also gave the firm access to critical natural gas projects in the eastern Mediterranean—holdings which supply massive amounts of natural gas to Israel, Jordan, and Egypt. With a lack of available funding for new fossil fuel projects, acquisitions have been the leading strategy for growth, and Chevron has proven yet again how skilled it is in that arena.
As is typical in an acquisition, Chevron shares dropped a few percentage points on news of the deal while Hess shares rallied. Sitting at $157, off 10% for the year, Chevron looks very attractive once again. We would place a fair value of $200 on CVX shares. The 4% dividend yield is a nice bonus.
Mo, 23 Oct 2023
Government Report: National Debt & Deficit
In the Books: The US just dug itself another $1.7 trillion hole
It’s official: FY23 is behind us, and our government just spent $1.7 trillion more than it took in. That is the third-largest deficit in history, behind only fiscal years 2020 and 2021. Our national debt now sits at $33.66 trillion.
We cringe every time we read a story (by the usual suspects) that debt and deficits don’t matter. They sure as hell matter to households trying to stay afloat and maintain a decent credit rating. It really is bordering on criminal; to spend trillions more than you take in from taxpayers each year. Let’s consider the cost of servicing that debt.
Just as a household must pay finance charges on any credit card balance not paid off at the end of the statement period, the US government must pay finance charges on its $33.66 trillion of debt. The annual interest due on that debt is currently $671.3 billion, but that will only grow as debt matures and the Treasury is forced to refinance at higher rates. Put another way, a full 15% of the entire budget of the United States goes up in smoke as interest on the debt. Think of what could be done with an extra $671 billion per year. But that’s not the worst of it: Net interest payments on the national debt were $352 billion in 2021 and $475 billion in 2022. See a trend?
While few seem to care about this economic disaster waiting to blow, the “bond vigilantes” are sounding the warning sirens by unloading Treasuries at a record clip, thus forcing yields higher. Simple supply and demand: If supply is rising while demand is falling, higher yields are required to entice would-be buyers. The vigilantes are demanding fiscal responsibility, but does anyone believe they will find it in D.C?
A balanced budget amendment is needed to force politicians to act responsibly. And that will entail a grassroots movement, as we can’t think of one elected official calling for it. Right now, every state except Vermont (go figure) has some form of a balanced budget provision on the books; it is time to demand the same of our federal government. It is not hyperbole to say that there is a tipping point with respect to the national debt—an event horizon from which there is no coming back.
Genuine Parts crashing after sales miss (Th, 19 Oct)
Shares of automotive parts distributor Genuine Parts (GPC $130) fell double digits after the company failed to hit estimates for Q3 sales. While $5.82B was still better than the same quarter a year ago, it didn't hit analysts' mark of $5.91B. We would place a fair value of $175 on the shares.
We, 18 Oct 2023
Housing
It’s official: the average 30-year mortgage rate just hit 8%
Per industry outlet Mortgage News Daily, the average 30-year mortgage just hit a rate not seen since the summer of 2000: 8%. The news provides yet another hurdle for would-be buyers, who have been facing dwindling inventories, record-high home prices, and inflation around every corner.
Let’s put that rate in dollars and cents. The average new home price in America was $430,300 as of the first week of October. After plopping a fat 20% down ($86,060) and adding in the average cost of home insurance, property taxes, and HOA dues, the new owner would be facing a $3,000 monthly mortgage payment. The same house purchased two years ago at the prevailing rate would come with a monthly mortgage payment of $1,865—and that doesn’t even account for inflation over the past two years. In other words, the same home probably would have cost in the neighborhood of $350,000 two years ago, which would bring the payment down to $1,600! We are told that Americans are still flush with cash (a point many would argue), but an extra $1,400 per month for the typical family has got to hurt.
And the higher rates are showing up in loan demand. According to the Mortgage Bankers Association, loan applications fell 6% on a seasonally adjusted basis from the end of the first week of October to the end of the second week. Applications to either buy or refinance a home fell 6.9%—the weakest reading since the mid 1990s. Nonetheless, housing starts still rose 7% in September to a seasonally adjusted rate of 1.358 million homes per year. That increase, however, was largely due to an increase in multifamily projects. For renters, the picture isn’t much brighter. According to Rent.com, the national median rent price is now $2,011 per month.
Putting this in perspective, the average 30-year mortgage rate in October 1981 was 18.63%. That said, if we are not at or very near the peak for mortgage rates, expect the damage to start slowly creeping throughout the economy. And don’t even get us started on what the US government will have to pay in interest this year on the $33 trillion national debt it has racked up. Several small nations could be purchased for the same amount.
We, 18 Oct 2023
eCommerce
Amazon is revamping its fulfillment centers with AI-powered robots
According to the Wall Street Journal, $1.4 trillion online retailer Amazon (AMZN $131) is about to undertake a massive overhaul of its fulfillment centers to increase efficiency. Under the project name Sequoia, the program will deploy artificial intelligence and robotic arms to increase both speed and safety at the warehouses.
Sequoia will allow the company to place items on its website more quickly, reduce the time it takes to fulfill an order by 25%, and store inventory up to 75% faster. The project isn’t piecemeal: it is part of a major push to fully integrate advanced robotics into the workflow process, transforming the way workers and machines interact. The goal is to eliminate as many arduous and mundane tasks for humans as possible, while lowering operating costs and improving margins. The strategy will initially be centered around dozens of new same-day delivery sites but will methodically expand throughout the company’s vast warehouse system.
Last year, Amazon initiated a $1 billion fund to foster innovation in the logistics and supply chain process, with privately-held Agility Robotics being among the first recipients. Agility believes it will usher in “the next wave of robotic automation.” Additionally, Amazon acquired robotics firm Kiva Systems Inc., maker of the little orange robot workers zipping around fulfillment centers, about a decade ago for $775 million. The deal was the second-largest in the firm’s history, behind the $900 million purchase of Zappos.com in 2009. The message is clear: AI-powered automation is a cornerstone of Amazon’s business strategy going forward, and it intends to remain the undisputed leader in the efficient delivery of goods to the American consumer.
Amazon is a member of the Penn Global Leaders Club and one of the “Ten Stocks to Buy for 2023,” as outlined in our 2023 Market Outlook report.
Strike contagion in Detroit (Tu, 17 Oct)
Strike fever is spreading in the Motor City. Not only are UAW workers on strike against the Big Three automakers, thousands of casino workers in the city just went on strike. The catalyst was the Detroit Casino Council, which is made up of five unions—yep, including the UAW.
United Airlines beats concensus in Q3 (Tu, 17 Oct)
Shares of Penn Global Leaders Club member United Airlines (UAL $39) were trading down after hours despite beating estimates on both the top and bottom lines. The company earned $3.65 per share vs $3.35 expected. Management raised concerns over the cost per available seat mile (CASM) for the fourth quarter, giving estimates much higher than the Street was already baking in.
Homebuilder sentiment falls as rates near 8% (Tu, 17 Oct)
As the 30-year average mortgage rate hits 7.92%, builder confidence in the US has dropped to its lowest level since January: 40. Any number above a 50 represents a positive outlook, any number below 50 represents a negative outlook.
Wyndham rejects takeover bid from Choice Hotels (Tu, 17 Oct)
Shares of Wyndham Hotels & Resorts (WH $76) were trading up 10% after the company said it had rejected a $9.8 billion takeover offer from competitor Choice Hotels International (CHH $119).
Lululemon ascends to S&P 500 (Mo, 16 Oct)
Shares of athleisure retailer Lululemon (LULU $418) were trading 10% higher as the company prepares to enter the coveted S&P 500 benchmark on Wednesday. Shares of Hubbell (HUBB $303), which designs, manufactures, and sells electrical and electronic products, were also trading a bit higher preceeding that company's entrance into the benchmark. The two firms replace Activision Blizzard (ATVI) and Organon & Co (OGN) in the S&_ 500, respectively.
Rite Aid files for bankruptcy (Mo, 16 Oct)
Drugstore retail chain Rite Aid (RAD $0.64) has filed for Chapter 11 bankruptcy protection. The company said lenders had agreed to extend $3.45 billion in new funding to provide sufficient liquidity at it navigates through the restructuring process.
Vista Outdoor plunges 25% on plan to sell Outdoor unit (Mo, 16 Oct)
Vista Outdoor, maker of such brands as Federal (ammo), Remington, Bushnell, Bell, and Fox, has announced that it has sold its ammo brands to a Czech company for $1.91 billion in cash. The new entity will trade under the symbol GEAR. The market didn't like the move, pushing VSTO shares down 25% Monday morning. We don't see a reason to own VSTO any longer.
Pfizer gets upgrade (Mo, 16 Oct)
Jefferies upgrades Pfizer to Buy, raising their price target on the big pharma company to $39 per share. The company believes Pfizer is greatly undervalued based on investor misunderstanding of the firm's pipeline of therapies.
Fr, 13 Oct 2023
Aerospace & Defense
US sends first resupply of missiles to Israel for its Iron Dome system
The Iron Dome system deployed in Israel has a remarkable success rate of over 90% in intercepting incoming missiles; nonetheless, when a terrorist organization launches some 5,000 rockets in a coordinated assault, even a 10% failure rate can be disastrous. That is precisely what happened when Hamas attacked Israel last weekend.
To assure the system has enough ammo to continually defend against the threat, the United States announced that it has shipped the first resupply of Tamir missiles (known in the US as SkyHunter) to Israel, with more to come.
The Iron Dome system is a joint venture between US aerospace and defense firm RTX Corp (RTX $73, formerly Raytheon and United Technologies) and Israel’s Rafael Advanced Defense Systems. Roughly 55% of the system is built by Raytheon, primarily at its Space Systems Operations facility (aka the “Space Factory”) in the outskirts of Tucson, Arizona. The US-owned system is deployed in approximately ten locations throughout Israel, with each battery of three to four launchers able to defend sixty square miles of land. Each launcher can hold up to 20 Tamir missiles, with each missile costing between $40,000 and $50,000.
Separately, both the US Army and United States Marine Corps have been deploying Iron Dome batteries within this country. The Army has taken delivery of over 300 SkyHunter missiles, while the USMC has announced its intent to buy some 1,800 missiles and 44 launchers.
With bad actors like Iran and North Korea on the world stage, receiving at least tacit backing from Russia and China, air defense systems—both domestically and amongst our allies in Europe and the Middle East—will come to the forefront in a manner not seen since the most heated days of the Cold War.
RTX is a product of the merger between Raytheon and United Technologies, and the subsequent spinoff of its Otis (elevators) and Carrier (HVAC) divisions. The firm now has a roughly equal balance between its civilian aerospace units and its defense business. Its lines include Collins Aerospace, Pratt & Whitney engines, Raytheon Intelligence & Space, and Raytheon Missile & Defense.
UBS cuts Starbucks (Th, 12 Oct)
UBS has cut its price target on Starbucks (SBUX $91) from $110 to $100. The firm maintains its Neutral rating on the coffee house.
Bank of America upgrades Target to a buy on valuation (Th, 12 Oct)
Bank of America believes the selloff in Target (TGT $111) shares is overdone, and has changed its rating on the multiline retailer from Neutral to Buy. It also raised its price target on the shares, from $120 to $135. And that rating improvement assumes a 5% decline in comparable sales for the second half of the year.
UAW launches surprise strike at Ford truck plant in Kentucky (Th, 12 Oct)
Approximately 8,700 Ford workers walked off the job at a highly-profitable Ford plant in Kentucky which produces both SUVs and pickups. The move shows just how far apart the sides remain in negotiations to strike a new long-term contract between the US automakers and the UAW.
Social Security recipients will get a 3.2% cost-of-living increase in 2024 (Th, 12 Oct)
Last year, Social Security recipients received a whopping 8.7% cost-of-living increase in their "benefits"—the highest such jump in four decades; for 2024, the COLA will be a more typical 3.2% raise. Roughly 67 million Americans, or about one in every five, currently receive Social Security benefits, with about 20% of that number represented by younger Americans on disability.
Consumer prices rose a bit more than expected (Th, 12 Oct)
Investors were anxiously awaiting the latest Consumer Price Index (CPI) report, expecting to see a continued downward push in inflation. Instead, they got a slightly hotter-than-expected number. CPI rose 0.4% against expectations for a 0.3% jump; meanwhile, core CPI (discounts food and gas prices) 0.3% m/m and 4.1% y/y—both as expected. Futures were dampened a bit, but remained positive.
Clorox shares dive on impact of hack (Fr, 06 Oct)
Clorox said that the effects of a massive cyberattack on the firm would have a major impact on sales and profits for the quarter. The hack essentially shut down automated production lines for weeks. Shares of CLX are trading near a five-year low. The First Trust Nasdaq Cybersecurity ETF (CIBR) is one of our top five holdings for clients within the Penn Wealth Strategies.
Energy mega-deal? (Fr, 06 Oct)
Pioneer Resources jumped double digits on rumors that oil giant Exxon Mobil may be ready to acquire the E&P firm in a $60 billion blockbuster deal. Exxon has a market cap of $431 billion. We have mixed emotions about the deal, as it may lead to a difficult-to-manage clash of cultures. We own Chevron (CVX) within the Penn Global Leaders Club.
Jobs shocker (Fr, 06 Oct)
Against expectations for 150,000 new jobs created in September, the US economy actually added nearly double that amount: 336,000 new payrolls. The immediate reaction was a sharp downturn in equities as concern over a hot report might mean that the Fed would continue hiking. The silver lining was a rather muted increase in wages, which rose just 0.2% month-over-month. By the afternoon, however, something remarkable happened. Markets suddenly decided they liked the strong report and made a serious afternoon rally.
Headlines for the Month of Sep 2023
Energy Commodities
Yes, you are paying too much at the pump; just be glad you don’t live in Cali
The most recent price of gas in our neck of the woods is $3.59 at the local Casey’s (CASY $271). Since they are always about a dime per gallon more expensive than the local Murphy USA—attached to about 1,000 Walmart (WMT $160) stores around the country, let’s call it $3.50 per gallon. That’s with oil sitting at $90 per barrel. In our estimation, with Europe in the doldrums and Xi Jinping’s grand plans in the dumpster (at least for this year), oil should be in the $70 to $80 range, and we should be able to fill up our tanks for around $40. Oh well, at least we don’t live in California.
Unleaded gas, not that fancy premium stuff, now costs Californians an average of $6.05 per gallon—about $2 above the national average. In a feeble effort to give citizens of the Golden State “relief” at the pump, Governor Gavin Newsom ordered the state’s Air Resources Board (CARB) to allow winter-grade gas to be released a bit early this year. What a magnanimous ruler. The argument is that the winter-grade variety evaporates more rapidly in the sweltering summer heat, causing increased smog in the valleys; hence the typical November release. With any luck, gas will drop—perhaps—a buck per gallon thanks to this move. If drivers can just hold on until 2035 when Newsom’s ban on combustion engines takes effect and all of the state's energy problems disappear.
The truth is, if market forces were simply allowed to operate naturally in the state, Californians would be a lot better off in virtually every economic sense. Consider this: The cabal that is supposedly leading the national charge for clean air drove away the world’s greatest electric car company—at least to a large degree—due to onerous regulations and constant political and judicial attacks. It’s not about clean air, it is about winning on the political stage. And the poor citizens of California are the pawns on the board.
It is almost unfathomable to think that Ronald Reagan was once governor of California. How far that beautiful state has descended in two generations. If the citizens keep getting pushed around by Sacramento, however, the unthinkable might just happen once again.
Th, 28 Sep 2023
Aerospace & Defense
Lockheed Martin lands two big F-35 deals with Romania, Czech Republic
Two former Warsaw Pact nations, now both staunch US allies and members of NATO, have signed agreements to purchase advanced Lockheed Martin (LMT $411) F-35 Lightning II aircraft in an overhaul of their respect air forces. Romania will purchase 32 of the fifth-generation fighters for $6.5 billion, while the Czech Republic has approved the purchase of 24 F-35s for around $4.5 billion.
Romanian Defense Minister Angel Tîlvăr said the purchase will give the Romanian Air Force state-of-the-art capabilities “in the security architecture on NATO’s eastern flank and in the Black Sea region.” Following the purchase of these two 16-aircraft squadrons, the country also said it may pursue an acquisition of a third squadron.
As for the Czech Republic, the deal was a bit more controversial. The Czech Air Force’s top fighter is currently the Gripen, which it leases from Swedish aerospace and defense firm Saab AB (SAABY $27). After months of lobbying by the defense ministry, the government of Petr Pavel agreed to ditch renewing the lease—set to expire in 2027—in favor of the purchase, which will include simulators, pilot training, and a weapons package. Prime Minister Petr Fiala said the deal “is an effective solution” which will “solve the future of our tactical air force for decades to come, in contrast to (continuing to lease) older generations of fighter aircraft.” Prague is planning to rebuild its Caslav Air Base to accommodate the new fleet.
The F-35 is rapidly becoming the cutting-edge fighter of choice among Eastern European countries, with production of a previous order from Poland ramping up this year at Lockheed’s Fort Worth, Texas assembly lines.
We believe Lockheed Martin is the strongest player in the global aerospace and defense industry, not just within the United States. Boeing (BA $193) continues to prove it never should have been allowed to buy McDonnell Douglas, a fierce competitor in the space until the acquisition, as the company can’t seem to stop mucking up its military and civilian operations on both the aircraft and space sides of its business. We also believe that investors are underestimating Lockheed’s leadership role in the industry going forward. We would place a fair value on LMT shares at $550. Consider the recurring income stream from maintaining all of those F-35s around the world over the next several decades, and then consider that this is just one component of the company’s massive array of space and defense products and services.
We, 27 Sep 2023
Multiline Retail
Target announces the closure of nine stores in crime-ridden areas
It is a horrendous problem and a sad testament on the current state of American society. Organized crime has become so rampant at bricks-and-mortar stores that major American retailer Target (TGT $109) has announced the closure of nine locations in four states to protect their employees from physical harm. The affected stores are in New York City, Seattle, San Francisco, and Portland.
Target, which operates at 1,950 locations across the country, becomes the first retailer to specifically blame crime for the shuttering of stores. While many management teams have shied away from discussing the problem during quarterly conference calls, CEO Brian Cornell has been shining a spotlight on this disgraceful situation. While Target earned nearly $3 billion in profit during the most recent fiscal year, Cornell said he expects the company to take a $500 million hit this year due to theft.
The industry is pushing Congress to pass the Combating Organized Retail Crime Act, which would create an organization within the Department of Homeland Security to better align federal, state, and local law enforcement agencies engaged in the fight. It would also impose harsher penalties on offenders, and force online marketplaces to step up their vetting of vendors to help assure stolen goods stay off the sites. One major challenge has been the lack of willingness on the part of certain jurisdictions to prosecute the criminals nabbed by local law enforcement. Sinking some federal “teeth” into the problem would certainly reduce the effect of recalcitrance on the part of local officials.
Target has told its employees at the affected stores that they would have the opportunity to transfer to other locations within their respective areas.
This is lawlessness, plain and simple. While nearly a dozen states have passed laws imposing harsher penalties on these retail thieves (none of the four states listed above are included in that list), a coordinated and effective national effort is needed. Until such a program is implemented, the problem will persist. From an investment standpoint, we believe Target is trading at a 50% discount to its fair value.
Mo, 25 Sep 2023
Textiles, Apparel, & Luxury Goods
Jefferies downgrades Nike, sees student loan repayments impacting sales
We question the poll claiming 87% of student loan debt holders within their payback window will have trouble making those payments when they resume in October, but we do believe some discretionary companies will bear the brunt of the program’s resumption. Jefferies believes one of the most obvious targets will be footwear and athletic accessory maker Nike (NKE $91).
Then again, it’s not like the company hasn’t already been hammered. Floating around the $90-mark, Nike shares trade today where they traded in October 2019. In other words, your four-year investment would have had a negative real (inflation adjusted) return. Bulls may point to the fact that $90 puts the shares at a 50% discount to their November 2021 highs, but this is hardly a value play. Shares trade at a 28 multiple, and the forward P/E still clocks in at 25.
Jefferies downgraded Nike from Buy to Hold and lowered its price target from $140 to $100 per share. If they turn out to be right, a 10% gain would hardly be worth the risk.
The bullish calls on Nike over the past few years have revolved around the company’s growth in emerging markets, primarily China. With China and the US at interminable odds, we would cross through that bullet point. The strong US dollar poses a headwind, as it makes US goods more expensive for overseas buyers. Finally, the competitive landscape in the space is fierce, with Adidas, Under Armour, and a slew of newer entrants clawing away at market share. We agree with the Jefferies call and the analyst’s price target.
Th, 21 Sep 2023
Global Strategy: Middle East
Think a 5.5% US interest rate is high? Turkey just raised rates to 30%
We looked back on our previous comments on Turkey and found this quote from November 2021: “Despite the fact that his second five-year term, which will end in 2023, should make him ineligible from running again, any bets on who will still be the Turkish president in 2024?” We called it, as Recep Tayyip Erdogan recently won reelection to a third—and illegal—term as president. Perhaps it is the fabulous job he is doing with his country’s economy, such as the 60% annual inflation rate Turks are now facing.
To fight this nightmarish condition for the consumer, the Turkish central bank did something remarkable: it raised the benchmark rate from 25% to 30% at its latest meeting. The country has been trying to lure in foreign investment; maybe they can entice investors with their 18.79% ten-year government bond rate.
To say the economic situation in Turkey is dire is an understatement. Food costs have gone up 60% over the past year, while cafes, restaurants, and hotels have raised their prices by 83%. For Turks seeking a brief respite from domestic inflation by traveling abroad, more pain awaits. The lira has weakened substantially against the US dollar, losing one-third of its value this year alone. That makes exports from the Middle Eastern country cheaper for the world to buy, but that means little to the struggling consumer. At least their beloved leader is still in power.
Turkey is uninvestable and will remain so until Erdogan is gone. His latest power play is to hold Sweden’s NATO ambitions hostage until the European Union welcomes his country as a new member. That would be great for Turkey, not so much for the rest of the Union. The EU is already in the economic doldrums, and another big drag on the economy is the last thing it needs.
Th, 14 Sep 2023 Headlines
Arm opens at $56.10, 10% above IPO price; runs up to over $60/share
Tu, 12 Sep 2023
Biotechnology
Are cancer vaccines on the horizon? Moderna thinks so
It sounds like something straight out of science fiction, but Moderna (MRNA $105) is working to make it a reality. The $40 billion Cambridge, MA-based drug company has announced an agreement with German biotech firm Immatics NV (IMTX $12) to develop a line of cancer vaccines and therapies. The $1 billion small-cap will receive $120 million up front in a deal that could grow to nearly $2 billion, plus royalties.
For Moderna, the project represents the next stage in its revolutionary mRNA technology, which proved its efficacy during the pandemic. For its part, Immatics is engaged in the research and development of T-cell redirecting immunotherapies for the treatment of cancer. The collaboration will merge the two platforms with the goal of developing a line of novel oncology therapies.
Initially, cancer vaccines will be given to people who already have the disease, with the hopes that the body’s own immune system can be turned into a cancer-killing machine to prevent recurrence. By presenting tumor-specific antigens to the immune system, it will recognize them as a threat and destroy cells displaying the trait without harming healthy cells in the surrounding area. The ultimate goal would be the development of vaccines to be given to people with a high risk of the disease, but who are currently healthy. The combination of mRNA technology and the T-cell immunotherapy platform holds incredible promise in this area.
The agreement between these two firms is subject to antitrust clearance in the US. In the past, we would put the odds of approval at near 100%; in the current climate, however, we put those odds at around 80%.
While Immatics would be a purely speculative play on the part of investors (it brought in just $182 million in revenue last year, though $40 million did flow down as profit), Moderna looks extremely attractive at its current price. There has been an odd point of view that the company is overly reliant on its COVID vaccine for sales, which is extremely myopic. We believe many analysts cannot wrap their minds around the promise of mRNA technology and the potential growth it could bring to this company. Furthermore, Moderna operates with no debt on its books—a remarkable feat for a biotech. We would place a fair value of $210 on the shares.
Mo, 11 Sep 2023
Food Products
JM Smucker will buy iconic Twinkies brand for $5.6 billion
It seems hard to believe, but just over a decade ago there were no Twinkies to be found on any grocery shelves—well, except for really expired ones (actually, we don’t think they have an expiration date). The iconic little crème-filled delights, which began rolling off the Continental Baking Company assembly lines in 1930, went out of production in 2012 when Hostess Brands declared bankruptcy and liquidated. Sadly, Ding Dongs and Hostess CupCakes—that staple dessert in my brown lunch bag at Golden Oaks grade school, were also victims of the shutdown. As luck would have it, Private Equity Firm Apollo Global Management rode to the rescue, picking up Hostess for a song ($410 million), and taking the firm public once again in 2016.
Between 2016 and a few weeks ago, the market cap of Hostess (TWNK $33) rose from $450 million to around $3 billion. Then came the offer: JM Smucker (SJM $132), the famed sweets and jellies company which has been family run since 1897, would buy Hostess for $5.6 billion in cash and stock. Shareholders would receive $30 in cash and a fractional share of SJM for each TWNK share owned, which represented a whopping 54% premium to the recent stock price. The Wall Street Journal reported that Smucker beat out Penn Global Leaders Club member General Mills (GIS $66) with its winning bid.
The purchase caps an incredible comeback for the Twinkie, not to mention other Hostess brands such as the aforementioned Ding Dong and Hostess CupCakes, as well as Voortman brand cookies, Dolly Madison cakes, Donettes, HoHos, Zingers, and SnoBalls. The Lenexa, Kansas-based firm’s products will now join the likes of Folgers Coffee, Smucker’s jelly, Jiff peanut butter, and Milk Bone dog biscuits. Quite the coup.
We love the deal, but it will increase Smucker’s 60% debt-to-equity ratio substantially, which investors recognized by pounding the stock down 7% on the news. We continue to prefer General Mills in the space, and believe it remains at least 25% undervalued. In addition to its cereal line, General Mills owns such brands as Betty Crocker, Annie’s, Nature Valley, Pillsbury, Haagen-Dazs, and the Blue Buffalo line of premium pet food products.
Fr, 08 Sep 2023
Semiconductors & Equipment
The stage is set for the largest IPO in two years as Arm roadshow begins
If investors were excited about the recent Cava Group (CAVA $41) IPO (and they were), then they should really be excited about what is about to hit the market: shares of British semiconductor firm ARM Holdings. After all, one is a restaurant chain with enormous overhead and thin margins; the other designs and sells the most advanced semiconductors in the world.
Formerly trading under the symbol ARMH, the company was purchased and taken private by Masayoshi Son’s Softbank back in 2016 for $32 billion. Now, just over seven years later, the company is getting ready to public once again, this time under the symbol ARM and with a valuation north of $50 billion.
The firm will issue 95.5 million American depository receipts (ADRs), with each representing one ordinary share in a planned range of $47 to $51 apiece. Extrapolate that number out to the billion or so shares outstanding after the IPO, and we get a market cap in the $50 billion range. While that is just one-third the size of Intel (INTC $38) and nowhere near NVIDIA’s (NVDA $461) $1.1 trillion market cap, expect that fact to only amplify investor interest.
Arm Holdings does not make chips. Instead, it designs the cutting-edge processors which power nearly all smartphones in the world. It then licenses those designs to Intel, NVIDIA, AMD, Apple, Samsung, and virtually every other device-maker in the world, receiving royalties from every unit sold. And the designs aren’t limited to smartphones. It is estimated that nearly 70% of the world’s population uses an Arm-based device—from smartphones to servers to ordinary sensors. With the coming AI boom, the company’s reach will be nearly unprecedented. Expect to see the company trading on the NASDAQ as soon as this coming week.
We may be tempted to pick up shares of ARM out of the gate, but we expect demand to drive the price up as soon as the shares begin trading. If, for example, they shoot up to the $60s or higher, we would wait for the inevitable pullback to the $45 range. Expect this IPO to start a wave of other high-profile tech names going public—a welcome sign after two years of relative silence in the space.
Th, 07 Sep 2023
Global Strategy: East/Southeast Asia
Both Chinese export and import levels continue to fall as economic woes worsen
Ever since China became a member of the World Trade Organization in December 2001, countries—led by the United States—have been propping up the communist nation’s economy by rushing to buy the goods produced by its poorly paid but massive workforce. Now, following the pandemic and increasingly belligerent government words and actions, the fanciful growth rate envisaged by leader Xi and much of the American press is getting a reality check. Not only has the volume of exports dropped every month since April, but imports have also fallen every month this year as Chinese consumers face mounting economic challenges at home.
Goods leaving China fell by 8.78% in August from the prior year—a 9.5% drop with respect to the US—while imports fell by 7.34%. Factory activity in the country has been contracting since this past spring, and the youth jobless rate has been on such a steep incline that the government stopped reporting the figures to the public.
A major source of angst for consumers is the crumbling state of the domestic real estate market. The country’s largest homebuilder, Country Garden, just barely avoided default by making interest payments on outstanding bonds hours before the grace period ended. Investing in real estate projects has been the most favored method of building wealth for Chinese citizens, but as confidence in the sector continues to erode, new construction starts and property investments have plummeted. Millions of Chinese families have been boycotting payments on their mortgage loans due to unfinished projects and substandard construction. The government is trying to assuage borrowers by ordering state-owned banks to cut the interest rates on existing mortgages, but the effect has been minimal.
A telltale sign of who China blames for its economic problems—besides the United States, of course—is the country’s decision to skip the upcoming G20 summit in New Delhi. Russia, China’s new bestie, will also snub India by skipping the meeting. That is somewhat ironic since India has continued to enjoy a close trading relationship with Putin, to the chagrin of Washington. The weekend meeting will give Biden another chance to solidify America’s support of increased trade with India. If Prime Minister Narendra Modi can actually modernize India’s archaic business structure, that country could be the biggest threat to China’s growth rate going forward.
Remember when the “must-have” international investment was a BRICs vehicle? We do. Brazil is once again being led by far-leftist Lula after he spent time in the pokey. He has invited Chinese warships to dock at Brazilian ports. Russia is a global pariah led by a madman. China is a communist nation hell-bent on ruling the world. That leaves one “BRIC” in the wall intact: India. Yes, enormous challenges remain, but the country is a democracy, and the government will eventually straighten out its byzantine business structure. The largest ETF providing exposure to the Indian market is the iShares MSCI India ETF (INDA $44). The fund has rallied some 15% since March, while the iShares MSCI China ETF (MCHI $44) has fallen nearly 22% since the middle of January. Investors may not recognize many names among the 122 companies in the India ETF, but we expect that to change over the coming decade.
Tu, 05 Sep 2023
Global Exchanges & Indexes
Rebalancing season: Airbnb and Blackstone added to the S&P 500
Both travel services company Airbnb (ABNB $140) and alternative asset manager Blackstone (BX $108) rallied at the start of the week on news that they would be replacing Newell Brands (NWL $11) and Lincoln National (LNC $26) in the S&P 500 index. Meanwhile, troubled pharmacy retailer Walgreens (WBA $23), which just fired CEO Rosalind Brewer, will be replaced in the S&P 100 by ag equipment maker Deere (DE $417). The benchmark put it politely when it said the changes were taking place to “better represent its market cap range,” which simply means the deletions had lost too much of their size to remain viable members.
Moving down in cap size, Morningstar (MORN $246), Ally Financial (ALLY $29), Vail Resorts (MTN $243), and Weatherford International (WFRD $94) are some of the names we like which will be entering the S&P MidCap 400, replacing such companies as Energizer (ENR $36), Xerox (XRX $17), JetBlue Airways (JBLU $6), and Foot Locker (FL $19)—four names struggling for quite different reasons. JetBlue, for example, has been in a fierce battle with the Department of Justice and FTC over its planned acquisition of Spirit Airlines (SAVE $16). It didn’t help when court documents revealed that JetBlue might raise airfares on certain Spirit routes by as much as 40%. At $2 billion in size, the airline was knocked down to the S&P SmallCap 600.
All of this reshuffling will be concluded by market open on Monday the 18th of September.
We recently took profits on our Airbnb position at a level higher than where it is currently trading (though we may revisit a purchase if it falls below $120/share). Despite the removal of their CEO, who oversaw a 58% decline in the company’s size, we aren’t ready to touch Walgreens—mainly because a successor hasn’t been chosen yet, and CVS looks like a much better value. Vail Resorts is a name we have owned in the past, and it is still trading some 55% off of its high. The company also has a nice 3.62% dividend yield. From a cap size, we strongly favor the beaten-down small caps for the remainder of the year, as represented by our position in the Value Line Small Cap Opportunities Fund (VLEIX $51) and the Invesco S&P SmallCap 600 Revenue ETF (RWJ $39).
Energy Commodities
Yes, you are paying too much at the pump; just be glad you don’t live in Cali
The most recent price of gas in our neck of the woods is $3.59 at the local Casey’s (CASY $271). Since they are always about a dime per gallon more expensive than the local Murphy USA—attached to about 1,000 Walmart (WMT $160) stores around the country, let’s call it $3.50 per gallon. That’s with oil sitting at $90 per barrel. In our estimation, with Europe in the doldrums and Xi Jinping’s grand plans in the dumpster (at least for this year), oil should be in the $70 to $80 range, and we should be able to fill up our tanks for around $40. Oh well, at least we don’t live in California.
Unleaded gas, not that fancy premium stuff, now costs Californians an average of $6.05 per gallon—about $2 above the national average. In a feeble effort to give citizens of the Golden State “relief” at the pump, Governor Gavin Newsom ordered the state’s Air Resources Board (CARB) to allow winter-grade gas to be released a bit early this year. What a magnanimous ruler. The argument is that the winter-grade variety evaporates more rapidly in the sweltering summer heat, causing increased smog in the valleys; hence the typical November release. With any luck, gas will drop—perhaps—a buck per gallon thanks to this move. If drivers can just hold on until 2035 when Newsom’s ban on combustion engines takes effect and all of the state's energy problems disappear.
The truth is, if market forces were simply allowed to operate naturally in the state, Californians would be a lot better off in virtually every economic sense. Consider this: The cabal that is supposedly leading the national charge for clean air drove away the world’s greatest electric car company—at least to a large degree—due to onerous regulations and constant political and judicial attacks. It’s not about clean air, it is about winning on the political stage. And the poor citizens of California are the pawns on the board.
It is almost unfathomable to think that Ronald Reagan was once governor of California. How far that beautiful state has descended in two generations. If the citizens keep getting pushed around by Sacramento, however, the unthinkable might just happen once again.
Th, 28 Sep 2023
Aerospace & Defense
Lockheed Martin lands two big F-35 deals with Romania, Czech Republic
Two former Warsaw Pact nations, now both staunch US allies and members of NATO, have signed agreements to purchase advanced Lockheed Martin (LMT $411) F-35 Lightning II aircraft in an overhaul of their respect air forces. Romania will purchase 32 of the fifth-generation fighters for $6.5 billion, while the Czech Republic has approved the purchase of 24 F-35s for around $4.5 billion.
Romanian Defense Minister Angel Tîlvăr said the purchase will give the Romanian Air Force state-of-the-art capabilities “in the security architecture on NATO’s eastern flank and in the Black Sea region.” Following the purchase of these two 16-aircraft squadrons, the country also said it may pursue an acquisition of a third squadron.
As for the Czech Republic, the deal was a bit more controversial. The Czech Air Force’s top fighter is currently the Gripen, which it leases from Swedish aerospace and defense firm Saab AB (SAABY $27). After months of lobbying by the defense ministry, the government of Petr Pavel agreed to ditch renewing the lease—set to expire in 2027—in favor of the purchase, which will include simulators, pilot training, and a weapons package. Prime Minister Petr Fiala said the deal “is an effective solution” which will “solve the future of our tactical air force for decades to come, in contrast to (continuing to lease) older generations of fighter aircraft.” Prague is planning to rebuild its Caslav Air Base to accommodate the new fleet.
The F-35 is rapidly becoming the cutting-edge fighter of choice among Eastern European countries, with production of a previous order from Poland ramping up this year at Lockheed’s Fort Worth, Texas assembly lines.
We believe Lockheed Martin is the strongest player in the global aerospace and defense industry, not just within the United States. Boeing (BA $193) continues to prove it never should have been allowed to buy McDonnell Douglas, a fierce competitor in the space until the acquisition, as the company can’t seem to stop mucking up its military and civilian operations on both the aircraft and space sides of its business. We also believe that investors are underestimating Lockheed’s leadership role in the industry going forward. We would place a fair value on LMT shares at $550. Consider the recurring income stream from maintaining all of those F-35s around the world over the next several decades, and then consider that this is just one component of the company’s massive array of space and defense products and services.
We, 27 Sep 2023
Multiline Retail
Target announces the closure of nine stores in crime-ridden areas
It is a horrendous problem and a sad testament on the current state of American society. Organized crime has become so rampant at bricks-and-mortar stores that major American retailer Target (TGT $109) has announced the closure of nine locations in four states to protect their employees from physical harm. The affected stores are in New York City, Seattle, San Francisco, and Portland.
Target, which operates at 1,950 locations across the country, becomes the first retailer to specifically blame crime for the shuttering of stores. While many management teams have shied away from discussing the problem during quarterly conference calls, CEO Brian Cornell has been shining a spotlight on this disgraceful situation. While Target earned nearly $3 billion in profit during the most recent fiscal year, Cornell said he expects the company to take a $500 million hit this year due to theft.
The industry is pushing Congress to pass the Combating Organized Retail Crime Act, which would create an organization within the Department of Homeland Security to better align federal, state, and local law enforcement agencies engaged in the fight. It would also impose harsher penalties on offenders, and force online marketplaces to step up their vetting of vendors to help assure stolen goods stay off the sites. One major challenge has been the lack of willingness on the part of certain jurisdictions to prosecute the criminals nabbed by local law enforcement. Sinking some federal “teeth” into the problem would certainly reduce the effect of recalcitrance on the part of local officials.
Target has told its employees at the affected stores that they would have the opportunity to transfer to other locations within their respective areas.
This is lawlessness, plain and simple. While nearly a dozen states have passed laws imposing harsher penalties on these retail thieves (none of the four states listed above are included in that list), a coordinated and effective national effort is needed. Until such a program is implemented, the problem will persist. From an investment standpoint, we believe Target is trading at a 50% discount to its fair value.
Mo, 25 Sep 2023
Textiles, Apparel, & Luxury Goods
Jefferies downgrades Nike, sees student loan repayments impacting sales
We question the poll claiming 87% of student loan debt holders within their payback window will have trouble making those payments when they resume in October, but we do believe some discretionary companies will bear the brunt of the program’s resumption. Jefferies believes one of the most obvious targets will be footwear and athletic accessory maker Nike (NKE $91).
Then again, it’s not like the company hasn’t already been hammered. Floating around the $90-mark, Nike shares trade today where they traded in October 2019. In other words, your four-year investment would have had a negative real (inflation adjusted) return. Bulls may point to the fact that $90 puts the shares at a 50% discount to their November 2021 highs, but this is hardly a value play. Shares trade at a 28 multiple, and the forward P/E still clocks in at 25.
Jefferies downgraded Nike from Buy to Hold and lowered its price target from $140 to $100 per share. If they turn out to be right, a 10% gain would hardly be worth the risk.
The bullish calls on Nike over the past few years have revolved around the company’s growth in emerging markets, primarily China. With China and the US at interminable odds, we would cross through that bullet point. The strong US dollar poses a headwind, as it makes US goods more expensive for overseas buyers. Finally, the competitive landscape in the space is fierce, with Adidas, Under Armour, and a slew of newer entrants clawing away at market share. We agree with the Jefferies call and the analyst’s price target.
Th, 21 Sep 2023
Global Strategy: Middle East
Think a 5.5% US interest rate is high? Turkey just raised rates to 30%
We looked back on our previous comments on Turkey and found this quote from November 2021: “Despite the fact that his second five-year term, which will end in 2023, should make him ineligible from running again, any bets on who will still be the Turkish president in 2024?” We called it, as Recep Tayyip Erdogan recently won reelection to a third—and illegal—term as president. Perhaps it is the fabulous job he is doing with his country’s economy, such as the 60% annual inflation rate Turks are now facing.
To fight this nightmarish condition for the consumer, the Turkish central bank did something remarkable: it raised the benchmark rate from 25% to 30% at its latest meeting. The country has been trying to lure in foreign investment; maybe they can entice investors with their 18.79% ten-year government bond rate.
To say the economic situation in Turkey is dire is an understatement. Food costs have gone up 60% over the past year, while cafes, restaurants, and hotels have raised their prices by 83%. For Turks seeking a brief respite from domestic inflation by traveling abroad, more pain awaits. The lira has weakened substantially against the US dollar, losing one-third of its value this year alone. That makes exports from the Middle Eastern country cheaper for the world to buy, but that means little to the struggling consumer. At least their beloved leader is still in power.
Turkey is uninvestable and will remain so until Erdogan is gone. His latest power play is to hold Sweden’s NATO ambitions hostage until the European Union welcomes his country as a new member. That would be great for Turkey, not so much for the rest of the Union. The EU is already in the economic doldrums, and another big drag on the economy is the last thing it needs.
Th, 14 Sep 2023 Headlines
Arm opens at $56.10, 10% above IPO price; runs up to over $60/share
Tu, 12 Sep 2023
Biotechnology
Are cancer vaccines on the horizon? Moderna thinks so
It sounds like something straight out of science fiction, but Moderna (MRNA $105) is working to make it a reality. The $40 billion Cambridge, MA-based drug company has announced an agreement with German biotech firm Immatics NV (IMTX $12) to develop a line of cancer vaccines and therapies. The $1 billion small-cap will receive $120 million up front in a deal that could grow to nearly $2 billion, plus royalties.
For Moderna, the project represents the next stage in its revolutionary mRNA technology, which proved its efficacy during the pandemic. For its part, Immatics is engaged in the research and development of T-cell redirecting immunotherapies for the treatment of cancer. The collaboration will merge the two platforms with the goal of developing a line of novel oncology therapies.
Initially, cancer vaccines will be given to people who already have the disease, with the hopes that the body’s own immune system can be turned into a cancer-killing machine to prevent recurrence. By presenting tumor-specific antigens to the immune system, it will recognize them as a threat and destroy cells displaying the trait without harming healthy cells in the surrounding area. The ultimate goal would be the development of vaccines to be given to people with a high risk of the disease, but who are currently healthy. The combination of mRNA technology and the T-cell immunotherapy platform holds incredible promise in this area.
The agreement between these two firms is subject to antitrust clearance in the US. In the past, we would put the odds of approval at near 100%; in the current climate, however, we put those odds at around 80%.
While Immatics would be a purely speculative play on the part of investors (it brought in just $182 million in revenue last year, though $40 million did flow down as profit), Moderna looks extremely attractive at its current price. There has been an odd point of view that the company is overly reliant on its COVID vaccine for sales, which is extremely myopic. We believe many analysts cannot wrap their minds around the promise of mRNA technology and the potential growth it could bring to this company. Furthermore, Moderna operates with no debt on its books—a remarkable feat for a biotech. We would place a fair value of $210 on the shares.
Mo, 11 Sep 2023
Food Products
JM Smucker will buy iconic Twinkies brand for $5.6 billion
It seems hard to believe, but just over a decade ago there were no Twinkies to be found on any grocery shelves—well, except for really expired ones (actually, we don’t think they have an expiration date). The iconic little crème-filled delights, which began rolling off the Continental Baking Company assembly lines in 1930, went out of production in 2012 when Hostess Brands declared bankruptcy and liquidated. Sadly, Ding Dongs and Hostess CupCakes—that staple dessert in my brown lunch bag at Golden Oaks grade school, were also victims of the shutdown. As luck would have it, Private Equity Firm Apollo Global Management rode to the rescue, picking up Hostess for a song ($410 million), and taking the firm public once again in 2016.
Between 2016 and a few weeks ago, the market cap of Hostess (TWNK $33) rose from $450 million to around $3 billion. Then came the offer: JM Smucker (SJM $132), the famed sweets and jellies company which has been family run since 1897, would buy Hostess for $5.6 billion in cash and stock. Shareholders would receive $30 in cash and a fractional share of SJM for each TWNK share owned, which represented a whopping 54% premium to the recent stock price. The Wall Street Journal reported that Smucker beat out Penn Global Leaders Club member General Mills (GIS $66) with its winning bid.
The purchase caps an incredible comeback for the Twinkie, not to mention other Hostess brands such as the aforementioned Ding Dong and Hostess CupCakes, as well as Voortman brand cookies, Dolly Madison cakes, Donettes, HoHos, Zingers, and SnoBalls. The Lenexa, Kansas-based firm’s products will now join the likes of Folgers Coffee, Smucker’s jelly, Jiff peanut butter, and Milk Bone dog biscuits. Quite the coup.
We love the deal, but it will increase Smucker’s 60% debt-to-equity ratio substantially, which investors recognized by pounding the stock down 7% on the news. We continue to prefer General Mills in the space, and believe it remains at least 25% undervalued. In addition to its cereal line, General Mills owns such brands as Betty Crocker, Annie’s, Nature Valley, Pillsbury, Haagen-Dazs, and the Blue Buffalo line of premium pet food products.
Fr, 08 Sep 2023
Semiconductors & Equipment
The stage is set for the largest IPO in two years as Arm roadshow begins
If investors were excited about the recent Cava Group (CAVA $41) IPO (and they were), then they should really be excited about what is about to hit the market: shares of British semiconductor firm ARM Holdings. After all, one is a restaurant chain with enormous overhead and thin margins; the other designs and sells the most advanced semiconductors in the world.
Formerly trading under the symbol ARMH, the company was purchased and taken private by Masayoshi Son’s Softbank back in 2016 for $32 billion. Now, just over seven years later, the company is getting ready to public once again, this time under the symbol ARM and with a valuation north of $50 billion.
The firm will issue 95.5 million American depository receipts (ADRs), with each representing one ordinary share in a planned range of $47 to $51 apiece. Extrapolate that number out to the billion or so shares outstanding after the IPO, and we get a market cap in the $50 billion range. While that is just one-third the size of Intel (INTC $38) and nowhere near NVIDIA’s (NVDA $461) $1.1 trillion market cap, expect that fact to only amplify investor interest.
Arm Holdings does not make chips. Instead, it designs the cutting-edge processors which power nearly all smartphones in the world. It then licenses those designs to Intel, NVIDIA, AMD, Apple, Samsung, and virtually every other device-maker in the world, receiving royalties from every unit sold. And the designs aren’t limited to smartphones. It is estimated that nearly 70% of the world’s population uses an Arm-based device—from smartphones to servers to ordinary sensors. With the coming AI boom, the company’s reach will be nearly unprecedented. Expect to see the company trading on the NASDAQ as soon as this coming week.
We may be tempted to pick up shares of ARM out of the gate, but we expect demand to drive the price up as soon as the shares begin trading. If, for example, they shoot up to the $60s or higher, we would wait for the inevitable pullback to the $45 range. Expect this IPO to start a wave of other high-profile tech names going public—a welcome sign after two years of relative silence in the space.
Th, 07 Sep 2023
Global Strategy: East/Southeast Asia
Both Chinese export and import levels continue to fall as economic woes worsen
Ever since China became a member of the World Trade Organization in December 2001, countries—led by the United States—have been propping up the communist nation’s economy by rushing to buy the goods produced by its poorly paid but massive workforce. Now, following the pandemic and increasingly belligerent government words and actions, the fanciful growth rate envisaged by leader Xi and much of the American press is getting a reality check. Not only has the volume of exports dropped every month since April, but imports have also fallen every month this year as Chinese consumers face mounting economic challenges at home.
Goods leaving China fell by 8.78% in August from the prior year—a 9.5% drop with respect to the US—while imports fell by 7.34%. Factory activity in the country has been contracting since this past spring, and the youth jobless rate has been on such a steep incline that the government stopped reporting the figures to the public.
A major source of angst for consumers is the crumbling state of the domestic real estate market. The country’s largest homebuilder, Country Garden, just barely avoided default by making interest payments on outstanding bonds hours before the grace period ended. Investing in real estate projects has been the most favored method of building wealth for Chinese citizens, but as confidence in the sector continues to erode, new construction starts and property investments have plummeted. Millions of Chinese families have been boycotting payments on their mortgage loans due to unfinished projects and substandard construction. The government is trying to assuage borrowers by ordering state-owned banks to cut the interest rates on existing mortgages, but the effect has been minimal.
A telltale sign of who China blames for its economic problems—besides the United States, of course—is the country’s decision to skip the upcoming G20 summit in New Delhi. Russia, China’s new bestie, will also snub India by skipping the meeting. That is somewhat ironic since India has continued to enjoy a close trading relationship with Putin, to the chagrin of Washington. The weekend meeting will give Biden another chance to solidify America’s support of increased trade with India. If Prime Minister Narendra Modi can actually modernize India’s archaic business structure, that country could be the biggest threat to China’s growth rate going forward.
Remember when the “must-have” international investment was a BRICs vehicle? We do. Brazil is once again being led by far-leftist Lula after he spent time in the pokey. He has invited Chinese warships to dock at Brazilian ports. Russia is a global pariah led by a madman. China is a communist nation hell-bent on ruling the world. That leaves one “BRIC” in the wall intact: India. Yes, enormous challenges remain, but the country is a democracy, and the government will eventually straighten out its byzantine business structure. The largest ETF providing exposure to the Indian market is the iShares MSCI India ETF (INDA $44). The fund has rallied some 15% since March, while the iShares MSCI China ETF (MCHI $44) has fallen nearly 22% since the middle of January. Investors may not recognize many names among the 122 companies in the India ETF, but we expect that to change over the coming decade.
Tu, 05 Sep 2023
Global Exchanges & Indexes
Rebalancing season: Airbnb and Blackstone added to the S&P 500
Both travel services company Airbnb (ABNB $140) and alternative asset manager Blackstone (BX $108) rallied at the start of the week on news that they would be replacing Newell Brands (NWL $11) and Lincoln National (LNC $26) in the S&P 500 index. Meanwhile, troubled pharmacy retailer Walgreens (WBA $23), which just fired CEO Rosalind Brewer, will be replaced in the S&P 100 by ag equipment maker Deere (DE $417). The benchmark put it politely when it said the changes were taking place to “better represent its market cap range,” which simply means the deletions had lost too much of their size to remain viable members.
Moving down in cap size, Morningstar (MORN $246), Ally Financial (ALLY $29), Vail Resorts (MTN $243), and Weatherford International (WFRD $94) are some of the names we like which will be entering the S&P MidCap 400, replacing such companies as Energizer (ENR $36), Xerox (XRX $17), JetBlue Airways (JBLU $6), and Foot Locker (FL $19)—four names struggling for quite different reasons. JetBlue, for example, has been in a fierce battle with the Department of Justice and FTC over its planned acquisition of Spirit Airlines (SAVE $16). It didn’t help when court documents revealed that JetBlue might raise airfares on certain Spirit routes by as much as 40%. At $2 billion in size, the airline was knocked down to the S&P SmallCap 600.
All of this reshuffling will be concluded by market open on Monday the 18th of September.
We recently took profits on our Airbnb position at a level higher than where it is currently trading (though we may revisit a purchase if it falls below $120/share). Despite the removal of their CEO, who oversaw a 58% decline in the company’s size, we aren’t ready to touch Walgreens—mainly because a successor hasn’t been chosen yet, and CVS looks like a much better value. Vail Resorts is a name we have owned in the past, and it is still trading some 55% off of its high. The company also has a nice 3.62% dividend yield. From a cap size, we strongly favor the beaten-down small caps for the remainder of the year, as represented by our position in the Value Line Small Cap Opportunities Fund (VLEIX $51) and the Invesco S&P SmallCap 600 Revenue ETF (RWJ $39).
Headlines for the Month of Aug 2023
Tu, 29 Aug 2023
Specialty Retail
Best Buy beats, sees consumer demand for electronics troughing this year
We probably have more old investor notes on Best Buy (BBY $78) than just about any other company. That may seem strange, given its relatively small size and the industry it’s in, but we have always had an affinity for the consumer retailer. While we don’t currently own the $16 billion firm in any strategy right now, it does look compelling at $78 per share.
Best Buy released a good-looking Q2 earnings report early in the week, beating the Street’s expectations for both revenue and net income. Revenue came in at $9.58 billion versus the $9.52 billion expected, and the company posted earnings of $1.22 per share versus the $1.06 projected. CEO Corie Barry, at the helm for four years now, said that the industry still faces headwinds due to the “pull-forward in demand” in recent years (due to the pandemic), but that this year should reflect the low point. For the year, the company expects to earn around $6 to $6.40 from roughly $44 billion in sales.
Despite being the one remaining big-box electronics retailer left standing (remember Silo and Circuit City?), Best Buy has not been standing still. We like the company’s paid membership programs as a source of recurring revenue and a way to build stronger bonds with customers, and the ongoing redesign of stores to reflect the increase in digital sales. Roughly one-third of sales are now made online, and the physical stores are morphing into a mix of showroom, fulfillment center, and service area (Best Buy bought Geek Squad back in 2002).
Finally, Best Buy Health looks intriguing, but it is way too early to know if the program will be a success. The company has been forming alliances with health care providers to supply hardware and installation services to meet the medical needs of patients. Healthcare devices for remote monitoring are a key piece of the puzzle. If this unit can become profitable, it will be yet another reason to own the shares.
Best Buy has long attracted the attention of short sellers, but the firm continues to defy the haters. With its solid balance sheet, low multiple, and strong leader at the helm, we believe the shares are worth between $90 and $100.
Mo, 28 Aug 2023
Electric Utilities
Maui County sued Hawaiian Electric for the deadly wildfires; the utility is firing back
When I first got in the business, I recall making phone calls to clients or prospective clients about various investments. One broker I would often make these calls with began his greeting in a way that would make me put my hand over my eyes and shake my head: “Aloha, Mr./Ms. Smith! You may be wondering why I greeted you that way….” I still wince when I think of it. He was pushing shares of Hawaiian Electric (HE $13), provider of electricity for the five islands.
In addition to hoping the utility would conjure up images of the tropics in their minds, this broker sold the concept of owning a strong, regulated utility company with a fat (around 7% at the time), safe dividend yield. Who could argue with that logic? Unfortunately, nothing is certain in the world of investments. Case in point: Consider the breakup of the stalwart Bell System in the early 1980s and the tumult which ensued.
As for Hawaiian Electric, it had been a relatively stable performer for decades, with a rock-solid dividend. All of that changed virtually overnight with the tragic Maui wildfires. Before Maui County had even concluded its own investigation into the disaster, it sued the utility for negligence, claiming that power should have been shut down well before it was. In short, it blamed the company for the deaths which ensued. In a matter of days, HE’s share price dropped from $40 to $15; by Friday the 25th, shares had dropped to $9.06—their lowest level since 1985 and off 76% since the start of the year. The company immediately suspended its dividend, and a Forbes article opined that a Chapter 11 bankruptcy was “the most plausible path forward.”
By the following Monday, news hit that Hawaiian Electric did, in fact, “de-energize” its power lines in the region more than six hours before the fire which destroyed the town of Lahaina had begun. Furthermore, an earlier fire caused by a downed line had been quickly extinguished by the local fire department. The company turned the blame back to the county, and HE shares responded with a 40% surge within seconds of the open.
It's too early to predict what will ultimately happen in the courts, but the tragic incident should serve as a reminder to investors that even seemingly conservative investments can be hammered by unexpected events. Then again, anyone who had a large portion of their portfolios in the “safe” bond market in 2022 had already learned that lesson.
Utilities are the worst-performing sector over the past twelve months, off some 14%. When interest rates are relatively high, conservative investors tend to migrate out of utilities and into bonds for their income stream. However, virtually every portfolio should have at least a small portion allocated to this sector for proper diversification. We own several utility companies in the Strategic Income Portfolio and the Penn Global Leaders Club, and a 3% position in XLU, the Utilities Select Sector SPDR, within the Dynamic Growth Strategy.
Sa, 26 Aug 2023
Market Pulse
A bumpy five days marked by higher mortgage rates and Powell’s Jackson Hole comments
The S&P 500 vacillated between positive and negative returns this week, with each day closing in a different direction. Between mortgage rates hitting levels not seen since December 2000 and angst over what Fed Chair Jerome Powell would say at the Jackson Hole Symposium on Friday, investors were lucky to end the week relatively unscathed.
Tech stocks started out the week on fire after Softbank announced semiconductor giant Arm Holdings, formerly holding the symbol ARMH, would go public once again via an IPO. This time it will carry the symbol ARM. This company designs the architecture of chips which are found in nearly every single smartphone. While the exact valuation SoftBank will be seeking is not yet known, expect the company to open with a market cap of between $60 billion and $70 billion; also expect a flurry of IPO activity following this bombshell announcement. The NASDAQ finished up over 2% on the week, with most of the gains coming on Monday.
Boeing (BA $223) and Disney (DIS $83) held the Dow Jones Industrial Average in the red this week, with the latter dropping to price levels not seen since 2014. We have discussed ad nauseum what we think of both management teams. The small-cap Russell 2000 benchmark also finished in the red, while the S&P 500 managed to gain 82 basis points by Friday’s close.
As usual, investors didn’t know what to make of Powell’s presser, this one occurring at the Kansas City Fed’s Jackson Hole Economic Symposium. While they didn’t like the “we are not done yet (fighting inflation)” comments, his overall speech was relatively dovish. We continue to believe the Fed is done raising rates, but do not believe they will be in any hurry to lower rates in 2024. According to Mortgage News Daily, the average 30-year mortgage rate hit 7.48% this week before settling in around 7.23% on Friday. Oil closed Friday down about 1.66%, or $80.05 per barrel.
Next week’s big potential market movers will be the Case-Shiller Home Price Index on Tuesday, Salesforce’s results on Wednesday, and the August jobs report on Friday. Economists are looking for an additional 172,500 jobs for the month, down from 187,000 in July.
Fr, 25 Aug 2023
Electric Utilities
More than three decades later, a new nuclear power plant enters operation
It was seven years late and $17 billion over budget, but the first built-from-scratch domestic nuclear power plant in over thirty years is up and running. Georgia Power’s Plant Vogtle Unit 3, southeast of Augusta, will generate 1,100 megawatts of electricity, or enough to power 500,000 homes and businesses. Vogtle Unit 4 is also nearing completion, with expectations for a March 2024 production date.
Construction on the new plant began back in 2009 and has been marred by setbacks, including the 2017 bankruptcy of plant maker Westinghouse. The delays have taken a toll on Georgia Power’s parent company, utility giant Southern Co. (SO $68). That said, SO has outperformed the industry this year, down just 1.75% as compared to the Utilities Select Sector SPDR’s (XLU $64) 8.3% loss.
As for the future of nuclear power, while there are around 100 reactors planned or on order and another 300 proposed around the world, none are in the US. However, while there may not be any more of these massive Gen 3+ reactors built on US soil, the industry is betting on advanced, small modular reactors (SMR) known as Gen 4 units to carry it into the future. Oregon-based NuScale Power (SMR $6) has an agreement to build a first-of-its-kind modular reactor in Idaho, set to begin commercial operation by the end of the decade. Privately held TerraPower is working on another new reactor design, known as Natrium, which it is testing at a retired coal plant in Kemmerer, Wyoming.
While we expect Vogtle Units 3 and 4 to be the last of the traditional nuclear power plants built in the US, and the regulatory hurdles for the Gen 4 plants will be high, we still believe the industry has a critical role in the future of “green” energy in the country.
While an investment in SMR would be highly speculative, the Global X Uranium ETF (URA $23) is an interesting way to play the uranium-mining angle. It holds 49 of the world’s top uranium miners, with a 24% position in Cameco Corp (CCJ $36), arguably the world’s largest producer of the heavy metal. From a utilities standpoint, two companies with the largest exposure to nuclear power generation are Southern Co. and Entergy Corp (ETR $95), each with a 4.5% dividend yield.
Th, 24 Aug 2023
Metals & Mining
US Steel wants to be acquired; the steelworkers union wants to select the winning bidder
Sadly, the US steelmaking industry isn’t what it used to be. Take US Steel (X $31), which was trading around $200 per share in 2008 and bottomed out at $7.21 per share less than a decade later. Competition has become so keen in the industry—China now accounts for nearly half of the world’s output—that the storied US manufacturer, founded in 1901 by a group of potentates including Andrew Carnegie and J.P. Morgan, is actively searching for suitors.
This strategic review was fomented by multiple unsolicited bids, most notably Cleveland-Cliffs’ (CLF $15) $7.3 billion takeover offer; a proposal which was quickly rebuffed. All of this acquisition talk quickly drove up the share price of X from $22.50 to $32 in the matter of a week, but one other consideration needs to be factored in: the role of the United Steelworkers union (USW).
Esmark, an industrial conglomerate which made an all-cash bid for US Steel at a higher offering price than CLF, has already pulled its offer, citing the union’s support for the original bidder. An agreement between the company and the union specifies that if the USW supports one specific bidder, another company’s offer cannot be accepted unless the board of directors deems it superior. Furthermore, the buyer must either assume the existing labor contract or forge a new deal with the union before a transaction can take place. Needless to say, US Steel disagrees with this wide interpretation of the rules.
Yet another concern is the draconian FTC, headed by the anti-business activist Lina Khan. It is all but given that the agency would file lawsuits to stop a merger between two competing US steel companies—even if it meant a stronger hand against Chinese manufacturers. It appears that a deal will eventually get done, but the road ahead will be anything but smooth.
Investors who see value in this beaten-down industry (X has a multiple of 6) need to remember just how much the bottom line is affected by commodity prices, higher energy costs, competition from China, and economic conditions. As for US Steel, it is trading at or above fair market value due to the bidding war—in other words, an ultimate sale has already been baked into the price. As for the competitors mentioned, we don’t see any undervalued gems begging for investors to pounce. If we had to hold a position in the industry, it would be Japanese small-cap producer Yamato Kogyo Co Ltd (YMTKF $32, P/E ratio 4.4), which has major markets in Japan, South Korea, and Thailand. Consider any investment in the industry higher risk.
Tu, 22 Aug 2023
Leisure Equipment, Products, & Facilities
Dick’s Sporting Goods plunges by nearly 25%; it still doesn’t look cheap
It’s called “shrink,” but that’s just a politically correct way of saying theft. The condition was one of several reasons Dick’s Sporting Goods (DKS $112) gave for a disappointing earnings report; a report which caused shares to sink by nearly one-fourth in a matter of minutes.
On sales of $3.22 billion (analysts had been predicting $3.24B), the company earned $2.82 per share in the second quarter of the year. That is about 35% lighter than the Street expected. Management also reduced its full-year outlook, citing the resumption of student loan payments, a choppy economic environment, and the theft issue. Not showing up in this quarter’s results, the company will also have to shell out around $20 million in severance packets to recently laid off employees.
From our perspective, the biggest issues facing the retailer are increased competition in the space, a poor management team, discretionary cutbacks by consumers, and the lingering theft issue which few retailers have the courage to take on. And none of those issues are going to dissipate soon.
Consider the firm’s operating margin—the proportion of revenue left over after paying the variable costs of production. That measure of efficiency went from 16.5% in 2021 to 11.8% in 2022, and we expect the number to continue dropping as pricing power further erodes. Key vendors like Adidas and Nike have been strongly developing their own direct-to-consumer channels, reducing their dependence on third-party retailers such as Dick’s. Additionally, we see inflation continuing to constrict margins, as it is becoming more difficult to pass along higher prices on the type of elastic goods sold at the retailer. It may seem as though investors overreacted to this latest earnings report; considering the challenges ahead, however, we don’t think so.
With well-run competitors like Scheels (privately held) and Academy Sports and Outdoors (ASO $53) increasing market share, we see no reason to buy DKS on this hefty pullback; nor do we see any unique value proposition being presented by management.
Mo, 21 Aug 2023
Media & Entertainment
Iger’s tone-deaf response to falling subs: raise prices across the board
We had high hopes for entertainment powerhouse Disney (DIS $86) when the board finally gave Chapek the boot (shortly after extending his contract) and brought back former CEO Iger. We should have remembered our first thought after reading his autobiography: what an arrogant SOB. Indeed, Iger’s “I’m the greatest,” bull in a china shop approach has only wreaked more havoc on the company.
His latest misstep, fresh off the heels of ticking off Hollywood during a CNBC interview with David Faber, comes in his response to floundering Disney+ subscriptions. After giving mixed quarterly results for Q2, which included flatlining subscriber growth for the company’s streaming service, Iger announced that the ad-free version of Disney+ would now cost faithful subscribers 27% more. In addition to the $13.99 per month fee (up from $10.99), the company’s no-ad Hulu streaming service would jump 20%, from $14.99 to $17.99. Disney’s ad-supported service will remain $7.99 per month, but Iger even stepped in it with regards to that option. When pressed on the rate hikes, he flippantly indicated he would be just fine with subscribers dumping the ad model for the lower priced alternative, as the company would “make more via the ads.” Tone deaf.
An appropriate answer for slowing growth is never “let’s milk our faithful customers more for their current products and services,” but Iger doesn’t get it. While Disney’s streaming service has been a gamble from the start, the company always had its money-printing parks to serve as the cash cow, but even that is changing. Over the Independence Day weekend, wait times for rides at Disney’s US parks were the lowest they have been in over a decade—and no, that is not due to improvements in efficiency. It may, however, have something to do with the multiple price hikes implemented at the parks this year. Try this on for size: A one-person, one-day Park Hopper ticket for an adult (ten years or older) now costs up to $268.38. Happy sticking to one park for the day? Look to pay as much as $189.
We will always love the Disney experience, but something tells us Walt would clean house in the C-suite were he alive today. And who can blame him?
The first step to solving a problem is admitting you have one in the first place, and then accepting responsibility for it. Iger may say the right things (well, actually, not lately), but his arrogance will keep him from doing the right things. Until there are massive changes at the top, we don’t see owning this company in any of the Penn strategies.
We, 09 Aug 2023
Global Strategy: East/Southeast Asia
China’s economy continues to contract
As most of the developed world continues to grapple with inflation, China has quite a different challenge: fewer people—both at home and abroad—are buying Chinese goods, causing a serious case of deflation within the country.
China’s exports to the rest of the world fell 14.5% in July from the previous year, representing the sharpest downturn since February 2020—the earliest days of the pandemic. At home, real estate values are plunging, causing the average Chinese consumer to pull back on spending. Not only did consumer prices fall in July, producer prices fell for a tenth straight month, contracting 4.4% in July from the prior year.
As is always the case in a controlled economy, the Chinese Communist Party believes it can ride to the rescue with more government action. The People’s Bank of China is expected to reduce rates in an effort to spur economic activity, and the CCP has announced a new round of massive government spending. But even if it works at home (it won’t), how is that going to help reverse the contraction in exports? Chinese goods shipments to the US fell some 23% in July from the prior year, and shipments to the EU dropped around 20%.
After President for Life Xi announced his plans for global economic dominance while reiterating his support for Russia’s Putin, the Western world began scrambling to find alternate suppliers of goods to reduce reliance on the communist nation. While China’s exports to Russia have mushroomed since Putin’s invasion of Ukraine, that amounts to a drop in the bucket compared to the contracts which have been lost due to supply chain realignment. And China’s new exertion of control over quasi-private firms in the country will only exacerbate the problem. The only solution is a humble mea culpa by the regime and a distancing from Russia with respect to Ukraine, and there is zero chance that either of those actions will take place.
Chinese companies may seem appealing on the recent pull back, but investors should steer clear of the country for the international portion of their portfolios. Instead, consider India, Vietnam, Malaysia, and a host of other countries which are directly benefitting from the corporate migration away from China.
Tu, 08 Aug 2023
Beverages, Tobacco, & Cannabis
Cannabis company Tilray buying eight beer and beverage brands from Bud
It is no secret that our favorite Canadian cannabis company is Tilray (TLRY $2), run by the highly skilled beverage industry veteran Irwin Simon, founder of Hain Celestial Group. Despite the industry falling off the proverbial cliff over the past few years (Tilray shares topped out at $38 in February 2021), we still believe that a handful of players are destined to excel once they can legally operate in the US. In the meantime, Simon has been pursuing a bold path outside of the weed market—exemplified by this week’s news of a rather major acquisition.
Tilray has announced the purchase of eight beer and beverage brands from troubled brewer AB/InBev (BUD $56), to include Breckenridge Brewery, Redhook, and Shock Top. The all-cash acquisition, to be completed by the end of the year, will bring the breweries and all brewpubs associated with the brands under the Tilray name, joining Breckenridge Distillery, SweetWater Brewing, and the Alpine Beer Company.
The acquisition marks an interesting turn of events for Bud, which had been gobbling up formerly independent brewers at a breakneck pace. The company claims it remains committed to its craft beer portfolio, but recent layoffs and restructuring efforts bring those claims into question. With its $78 billion debt load (versus its market cap of $112 billion), it could certainly use the inflow of cash from the sale. As for Tilray, the purchase will make the company the fifth-largest craft brewer in the US.
When a company’s stock is selling for $2.50 per share, you tend to think wildly speculative name. While Tilray’s beta is extremely high (2.445), the company’s finances are actually quite strong (17.4% debt/equity ratio). Couple that with an intelligent strategic plan, and we could see the shares easily trading at $5 before long, which would be a 100% gain from here.
Tu, 29 Aug 2023
Specialty Retail
Best Buy beats, sees consumer demand for electronics troughing this year
We probably have more old investor notes on Best Buy (BBY $78) than just about any other company. That may seem strange, given its relatively small size and the industry it’s in, but we have always had an affinity for the consumer retailer. While we don’t currently own the $16 billion firm in any strategy right now, it does look compelling at $78 per share.
Best Buy released a good-looking Q2 earnings report early in the week, beating the Street’s expectations for both revenue and net income. Revenue came in at $9.58 billion versus the $9.52 billion expected, and the company posted earnings of $1.22 per share versus the $1.06 projected. CEO Corie Barry, at the helm for four years now, said that the industry still faces headwinds due to the “pull-forward in demand” in recent years (due to the pandemic), but that this year should reflect the low point. For the year, the company expects to earn around $6 to $6.40 from roughly $44 billion in sales.
Despite being the one remaining big-box electronics retailer left standing (remember Silo and Circuit City?), Best Buy has not been standing still. We like the company’s paid membership programs as a source of recurring revenue and a way to build stronger bonds with customers, and the ongoing redesign of stores to reflect the increase in digital sales. Roughly one-third of sales are now made online, and the physical stores are morphing into a mix of showroom, fulfillment center, and service area (Best Buy bought Geek Squad back in 2002).
Finally, Best Buy Health looks intriguing, but it is way too early to know if the program will be a success. The company has been forming alliances with health care providers to supply hardware and installation services to meet the medical needs of patients. Healthcare devices for remote monitoring are a key piece of the puzzle. If this unit can become profitable, it will be yet another reason to own the shares.
Best Buy has long attracted the attention of short sellers, but the firm continues to defy the haters. With its solid balance sheet, low multiple, and strong leader at the helm, we believe the shares are worth between $90 and $100.
Mo, 28 Aug 2023
Electric Utilities
Maui County sued Hawaiian Electric for the deadly wildfires; the utility is firing back
When I first got in the business, I recall making phone calls to clients or prospective clients about various investments. One broker I would often make these calls with began his greeting in a way that would make me put my hand over my eyes and shake my head: “Aloha, Mr./Ms. Smith! You may be wondering why I greeted you that way….” I still wince when I think of it. He was pushing shares of Hawaiian Electric (HE $13), provider of electricity for the five islands.
In addition to hoping the utility would conjure up images of the tropics in their minds, this broker sold the concept of owning a strong, regulated utility company with a fat (around 7% at the time), safe dividend yield. Who could argue with that logic? Unfortunately, nothing is certain in the world of investments. Case in point: Consider the breakup of the stalwart Bell System in the early 1980s and the tumult which ensued.
As for Hawaiian Electric, it had been a relatively stable performer for decades, with a rock-solid dividend. All of that changed virtually overnight with the tragic Maui wildfires. Before Maui County had even concluded its own investigation into the disaster, it sued the utility for negligence, claiming that power should have been shut down well before it was. In short, it blamed the company for the deaths which ensued. In a matter of days, HE’s share price dropped from $40 to $15; by Friday the 25th, shares had dropped to $9.06—their lowest level since 1985 and off 76% since the start of the year. The company immediately suspended its dividend, and a Forbes article opined that a Chapter 11 bankruptcy was “the most plausible path forward.”
By the following Monday, news hit that Hawaiian Electric did, in fact, “de-energize” its power lines in the region more than six hours before the fire which destroyed the town of Lahaina had begun. Furthermore, an earlier fire caused by a downed line had been quickly extinguished by the local fire department. The company turned the blame back to the county, and HE shares responded with a 40% surge within seconds of the open.
It's too early to predict what will ultimately happen in the courts, but the tragic incident should serve as a reminder to investors that even seemingly conservative investments can be hammered by unexpected events. Then again, anyone who had a large portion of their portfolios in the “safe” bond market in 2022 had already learned that lesson.
Utilities are the worst-performing sector over the past twelve months, off some 14%. When interest rates are relatively high, conservative investors tend to migrate out of utilities and into bonds for their income stream. However, virtually every portfolio should have at least a small portion allocated to this sector for proper diversification. We own several utility companies in the Strategic Income Portfolio and the Penn Global Leaders Club, and a 3% position in XLU, the Utilities Select Sector SPDR, within the Dynamic Growth Strategy.
Sa, 26 Aug 2023
Market Pulse
A bumpy five days marked by higher mortgage rates and Powell’s Jackson Hole comments
The S&P 500 vacillated between positive and negative returns this week, with each day closing in a different direction. Between mortgage rates hitting levels not seen since December 2000 and angst over what Fed Chair Jerome Powell would say at the Jackson Hole Symposium on Friday, investors were lucky to end the week relatively unscathed.
Tech stocks started out the week on fire after Softbank announced semiconductor giant Arm Holdings, formerly holding the symbol ARMH, would go public once again via an IPO. This time it will carry the symbol ARM. This company designs the architecture of chips which are found in nearly every single smartphone. While the exact valuation SoftBank will be seeking is not yet known, expect the company to open with a market cap of between $60 billion and $70 billion; also expect a flurry of IPO activity following this bombshell announcement. The NASDAQ finished up over 2% on the week, with most of the gains coming on Monday.
Boeing (BA $223) and Disney (DIS $83) held the Dow Jones Industrial Average in the red this week, with the latter dropping to price levels not seen since 2014. We have discussed ad nauseum what we think of both management teams. The small-cap Russell 2000 benchmark also finished in the red, while the S&P 500 managed to gain 82 basis points by Friday’s close.
As usual, investors didn’t know what to make of Powell’s presser, this one occurring at the Kansas City Fed’s Jackson Hole Economic Symposium. While they didn’t like the “we are not done yet (fighting inflation)” comments, his overall speech was relatively dovish. We continue to believe the Fed is done raising rates, but do not believe they will be in any hurry to lower rates in 2024. According to Mortgage News Daily, the average 30-year mortgage rate hit 7.48% this week before settling in around 7.23% on Friday. Oil closed Friday down about 1.66%, or $80.05 per barrel.
Next week’s big potential market movers will be the Case-Shiller Home Price Index on Tuesday, Salesforce’s results on Wednesday, and the August jobs report on Friday. Economists are looking for an additional 172,500 jobs for the month, down from 187,000 in July.
Fr, 25 Aug 2023
Electric Utilities
More than three decades later, a new nuclear power plant enters operation
It was seven years late and $17 billion over budget, but the first built-from-scratch domestic nuclear power plant in over thirty years is up and running. Georgia Power’s Plant Vogtle Unit 3, southeast of Augusta, will generate 1,100 megawatts of electricity, or enough to power 500,000 homes and businesses. Vogtle Unit 4 is also nearing completion, with expectations for a March 2024 production date.
Construction on the new plant began back in 2009 and has been marred by setbacks, including the 2017 bankruptcy of plant maker Westinghouse. The delays have taken a toll on Georgia Power’s parent company, utility giant Southern Co. (SO $68). That said, SO has outperformed the industry this year, down just 1.75% as compared to the Utilities Select Sector SPDR’s (XLU $64) 8.3% loss.
As for the future of nuclear power, while there are around 100 reactors planned or on order and another 300 proposed around the world, none are in the US. However, while there may not be any more of these massive Gen 3+ reactors built on US soil, the industry is betting on advanced, small modular reactors (SMR) known as Gen 4 units to carry it into the future. Oregon-based NuScale Power (SMR $6) has an agreement to build a first-of-its-kind modular reactor in Idaho, set to begin commercial operation by the end of the decade. Privately held TerraPower is working on another new reactor design, known as Natrium, which it is testing at a retired coal plant in Kemmerer, Wyoming.
While we expect Vogtle Units 3 and 4 to be the last of the traditional nuclear power plants built in the US, and the regulatory hurdles for the Gen 4 plants will be high, we still believe the industry has a critical role in the future of “green” energy in the country.
While an investment in SMR would be highly speculative, the Global X Uranium ETF (URA $23) is an interesting way to play the uranium-mining angle. It holds 49 of the world’s top uranium miners, with a 24% position in Cameco Corp (CCJ $36), arguably the world’s largest producer of the heavy metal. From a utilities standpoint, two companies with the largest exposure to nuclear power generation are Southern Co. and Entergy Corp (ETR $95), each with a 4.5% dividend yield.
Th, 24 Aug 2023
Metals & Mining
US Steel wants to be acquired; the steelworkers union wants to select the winning bidder
Sadly, the US steelmaking industry isn’t what it used to be. Take US Steel (X $31), which was trading around $200 per share in 2008 and bottomed out at $7.21 per share less than a decade later. Competition has become so keen in the industry—China now accounts for nearly half of the world’s output—that the storied US manufacturer, founded in 1901 by a group of potentates including Andrew Carnegie and J.P. Morgan, is actively searching for suitors.
This strategic review was fomented by multiple unsolicited bids, most notably Cleveland-Cliffs’ (CLF $15) $7.3 billion takeover offer; a proposal which was quickly rebuffed. All of this acquisition talk quickly drove up the share price of X from $22.50 to $32 in the matter of a week, but one other consideration needs to be factored in: the role of the United Steelworkers union (USW).
Esmark, an industrial conglomerate which made an all-cash bid for US Steel at a higher offering price than CLF, has already pulled its offer, citing the union’s support for the original bidder. An agreement between the company and the union specifies that if the USW supports one specific bidder, another company’s offer cannot be accepted unless the board of directors deems it superior. Furthermore, the buyer must either assume the existing labor contract or forge a new deal with the union before a transaction can take place. Needless to say, US Steel disagrees with this wide interpretation of the rules.
Yet another concern is the draconian FTC, headed by the anti-business activist Lina Khan. It is all but given that the agency would file lawsuits to stop a merger between two competing US steel companies—even if it meant a stronger hand against Chinese manufacturers. It appears that a deal will eventually get done, but the road ahead will be anything but smooth.
Investors who see value in this beaten-down industry (X has a multiple of 6) need to remember just how much the bottom line is affected by commodity prices, higher energy costs, competition from China, and economic conditions. As for US Steel, it is trading at or above fair market value due to the bidding war—in other words, an ultimate sale has already been baked into the price. As for the competitors mentioned, we don’t see any undervalued gems begging for investors to pounce. If we had to hold a position in the industry, it would be Japanese small-cap producer Yamato Kogyo Co Ltd (YMTKF $32, P/E ratio 4.4), which has major markets in Japan, South Korea, and Thailand. Consider any investment in the industry higher risk.
Tu, 22 Aug 2023
Leisure Equipment, Products, & Facilities
Dick’s Sporting Goods plunges by nearly 25%; it still doesn’t look cheap
It’s called “shrink,” but that’s just a politically correct way of saying theft. The condition was one of several reasons Dick’s Sporting Goods (DKS $112) gave for a disappointing earnings report; a report which caused shares to sink by nearly one-fourth in a matter of minutes.
On sales of $3.22 billion (analysts had been predicting $3.24B), the company earned $2.82 per share in the second quarter of the year. That is about 35% lighter than the Street expected. Management also reduced its full-year outlook, citing the resumption of student loan payments, a choppy economic environment, and the theft issue. Not showing up in this quarter’s results, the company will also have to shell out around $20 million in severance packets to recently laid off employees.
From our perspective, the biggest issues facing the retailer are increased competition in the space, a poor management team, discretionary cutbacks by consumers, and the lingering theft issue which few retailers have the courage to take on. And none of those issues are going to dissipate soon.
Consider the firm’s operating margin—the proportion of revenue left over after paying the variable costs of production. That measure of efficiency went from 16.5% in 2021 to 11.8% in 2022, and we expect the number to continue dropping as pricing power further erodes. Key vendors like Adidas and Nike have been strongly developing their own direct-to-consumer channels, reducing their dependence on third-party retailers such as Dick’s. Additionally, we see inflation continuing to constrict margins, as it is becoming more difficult to pass along higher prices on the type of elastic goods sold at the retailer. It may seem as though investors overreacted to this latest earnings report; considering the challenges ahead, however, we don’t think so.
With well-run competitors like Scheels (privately held) and Academy Sports and Outdoors (ASO $53) increasing market share, we see no reason to buy DKS on this hefty pullback; nor do we see any unique value proposition being presented by management.
Mo, 21 Aug 2023
Media & Entertainment
Iger’s tone-deaf response to falling subs: raise prices across the board
We had high hopes for entertainment powerhouse Disney (DIS $86) when the board finally gave Chapek the boot (shortly after extending his contract) and brought back former CEO Iger. We should have remembered our first thought after reading his autobiography: what an arrogant SOB. Indeed, Iger’s “I’m the greatest,” bull in a china shop approach has only wreaked more havoc on the company.
His latest misstep, fresh off the heels of ticking off Hollywood during a CNBC interview with David Faber, comes in his response to floundering Disney+ subscriptions. After giving mixed quarterly results for Q2, which included flatlining subscriber growth for the company’s streaming service, Iger announced that the ad-free version of Disney+ would now cost faithful subscribers 27% more. In addition to the $13.99 per month fee (up from $10.99), the company’s no-ad Hulu streaming service would jump 20%, from $14.99 to $17.99. Disney’s ad-supported service will remain $7.99 per month, but Iger even stepped in it with regards to that option. When pressed on the rate hikes, he flippantly indicated he would be just fine with subscribers dumping the ad model for the lower priced alternative, as the company would “make more via the ads.” Tone deaf.
An appropriate answer for slowing growth is never “let’s milk our faithful customers more for their current products and services,” but Iger doesn’t get it. While Disney’s streaming service has been a gamble from the start, the company always had its money-printing parks to serve as the cash cow, but even that is changing. Over the Independence Day weekend, wait times for rides at Disney’s US parks were the lowest they have been in over a decade—and no, that is not due to improvements in efficiency. It may, however, have something to do with the multiple price hikes implemented at the parks this year. Try this on for size: A one-person, one-day Park Hopper ticket for an adult (ten years or older) now costs up to $268.38. Happy sticking to one park for the day? Look to pay as much as $189.
We will always love the Disney experience, but something tells us Walt would clean house in the C-suite were he alive today. And who can blame him?
The first step to solving a problem is admitting you have one in the first place, and then accepting responsibility for it. Iger may say the right things (well, actually, not lately), but his arrogance will keep him from doing the right things. Until there are massive changes at the top, we don’t see owning this company in any of the Penn strategies.
We, 09 Aug 2023
Global Strategy: East/Southeast Asia
China’s economy continues to contract
As most of the developed world continues to grapple with inflation, China has quite a different challenge: fewer people—both at home and abroad—are buying Chinese goods, causing a serious case of deflation within the country.
China’s exports to the rest of the world fell 14.5% in July from the previous year, representing the sharpest downturn since February 2020—the earliest days of the pandemic. At home, real estate values are plunging, causing the average Chinese consumer to pull back on spending. Not only did consumer prices fall in July, producer prices fell for a tenth straight month, contracting 4.4% in July from the prior year.
As is always the case in a controlled economy, the Chinese Communist Party believes it can ride to the rescue with more government action. The People’s Bank of China is expected to reduce rates in an effort to spur economic activity, and the CCP has announced a new round of massive government spending. But even if it works at home (it won’t), how is that going to help reverse the contraction in exports? Chinese goods shipments to the US fell some 23% in July from the prior year, and shipments to the EU dropped around 20%.
After President for Life Xi announced his plans for global economic dominance while reiterating his support for Russia’s Putin, the Western world began scrambling to find alternate suppliers of goods to reduce reliance on the communist nation. While China’s exports to Russia have mushroomed since Putin’s invasion of Ukraine, that amounts to a drop in the bucket compared to the contracts which have been lost due to supply chain realignment. And China’s new exertion of control over quasi-private firms in the country will only exacerbate the problem. The only solution is a humble mea culpa by the regime and a distancing from Russia with respect to Ukraine, and there is zero chance that either of those actions will take place.
Chinese companies may seem appealing on the recent pull back, but investors should steer clear of the country for the international portion of their portfolios. Instead, consider India, Vietnam, Malaysia, and a host of other countries which are directly benefitting from the corporate migration away from China.
Tu, 08 Aug 2023
Beverages, Tobacco, & Cannabis
Cannabis company Tilray buying eight beer and beverage brands from Bud
It is no secret that our favorite Canadian cannabis company is Tilray (TLRY $2), run by the highly skilled beverage industry veteran Irwin Simon, founder of Hain Celestial Group. Despite the industry falling off the proverbial cliff over the past few years (Tilray shares topped out at $38 in February 2021), we still believe that a handful of players are destined to excel once they can legally operate in the US. In the meantime, Simon has been pursuing a bold path outside of the weed market—exemplified by this week’s news of a rather major acquisition.
Tilray has announced the purchase of eight beer and beverage brands from troubled brewer AB/InBev (BUD $56), to include Breckenridge Brewery, Redhook, and Shock Top. The all-cash acquisition, to be completed by the end of the year, will bring the breweries and all brewpubs associated with the brands under the Tilray name, joining Breckenridge Distillery, SweetWater Brewing, and the Alpine Beer Company.
The acquisition marks an interesting turn of events for Bud, which had been gobbling up formerly independent brewers at a breakneck pace. The company claims it remains committed to its craft beer portfolio, but recent layoffs and restructuring efforts bring those claims into question. With its $78 billion debt load (versus its market cap of $112 billion), it could certainly use the inflow of cash from the sale. As for Tilray, the purchase will make the company the fifth-largest craft brewer in the US.
When a company’s stock is selling for $2.50 per share, you tend to think wildly speculative name. While Tilray’s beta is extremely high (2.445), the company’s finances are actually quite strong (17.4% debt/equity ratio). Couple that with an intelligent strategic plan, and we could see the shares easily trading at $5 before long, which would be a 100% gain from here.
Headlines for the Month of July, 2023
Sa, 29 Jul 2023
Market Pulse
It was a busy—and generally positive—week in the markets
What a week. The fireworks began on Tuesday, when it appeared as though we were on the cusp of yet another regional bank failure. As quickly as the concern over California regional PacWest Bancorp (PACW $9) reared its ugly head, it dissipated with news that smaller regional Banc of California (BANC $14) would acquire it, maintaining the latter's name. It's a crazy world. Going into the year, PacWest had a market cap of just under $3 billion, while BANC's market cap was around $1 billion. Thank JP Morgan's Jamie Dimon—it's a long story. Anyway, crisis averted.
On Wednesday the Fed raised interest rates another 25 basis point, to 5.50%. That brings it up to a rate not seen since January of 2001. It had about a 100% chance of happening, so the markets shrugged off the move. Inflation is clearly coming down and credit card debt is at a new record high, so it is time to stop hiking. But will they?
Thursday brought an unexpectedly high GDP report for the second quarter. The US economy grew at 2.4%, handily beating expectations and coming on the heels of a 2% Q1 growth rate. Consumer spending also surprised analysts, and the labor market remains strong. Even housing prices resumed their upward trend, despite a 30-year mortgage rate near 7%. A dearth of homes on the market helped that metric; who wants to sell and lose their 3.5% mortgage rate?
Friday capped the week off with a stunning show of strength. The S&P 500 gained nearly 1%, the Nasdaq rose nearly 2%, and the Russell 2000 (small caps) gained 1.36%. Unfortunately, oil rose nearly 4% on the week, and the spike is definitely filtering through to the price of gas. At the start of the week, we saw prices floating around $3.11 per gallon; by the weekend, they were close to $3.60 per gallon—a 16% increase.
We are unsettled by the news that credit card debt just hit another record high, and we wonder how many people even realize they are paying around 22% in interest on their balances (the national average). Then again, US debt is about to hit $33 trillion—well above the size of the US economy, so why should the population be any more responsible than the people they elect? We will take the win in the markets for the week, and the risk of a recession is diminishing, but debt trouble is brewing. If a politician is blathering on about the need for more government spending but never mentions the national debt, they should be run out of D.C. on a rail. More evidence of the need for a balanced budget amendment to the US Constitution and term limits.
Tu, 25 Jul 2023
Specialty Retail: E-Commerce
Overstock.com will buy the intellectual property of Bed Bath & Beyond
It turns out Bed Bath & Beyond (BBBY $0.31) is not going away after all. Well, the 260 (down from 1,500 five years ago) remaining stores may be, but the name will live on. It seems that Overstock.com (OSTK $31) has been trying to break the stigma for years that it is nothing but a liquidator of goods. Considering that concept is literally in the name of the firm, the $1.4 billion online retailer has agreed to purchase BBBY’s intellectual property, customer lists, and website domain for $21.5 million in cash. Honestly, that seems like a real bargain if they can actually pull it off.
Investors are applauding the deal, pulling the shares up from just above $17 in June to just under $31 as we write this. In Canada, online shoppers who visit bedbathandbeyond.ca website will now be taken to the Overstock site, with the US rollout expected by the end of summer. The fit just seems right—the two companies’ sites look almost identical.
Despite the low cost of acquisition and the enormous name recognition of the acquired, one lingering question remains: Without a physical presence, what percentage of Bed Bath & Beyond bricks-and-mortar shoppers—most of whom armed with 20% coupons in hand as they lingered the aisles—will take to the online store? After all, if you can’t walk around and find in-store deals, isn’t it easier just to visit Amazon.com? Then again, couldn’t that have been said of Overstock.com before this deal?
For $21.5 million, Overstock made a smart move. For a fully online company, we could imagine them getting lost in ubiquity before long, looking a lot like most other home furnishings retailers. At least the new name will make them stand out a bit more. Another plus: the company’s balance sheet is very strong, with virtually no debt on the books. Imagine the overhead of those Bed Bath and Beyond behemoths, and it is easy to understand why they were awash in debt. Is OSTK (not sure whether they will change that ticker) worthy of an investment? With no dividend and a fair market value—in our opinion—of $35 per share, they seem close to fairly valued. Too bad we can’t use a 20% coupon on the stock price.
Tu, 18 Jul 2023
Telecom Services
AT&T shares fall to lowest level in three decades—Verizon not looking much better
Two years ago this October, we posed the question: “Over the course of twenty years, AT&T (T $13) shares have dropped 43%; is it time to buy?” We concluded that, based on the maladroit leadership team’s missteps, such as overpaying for ill-advised acquisitions instead of addressing a poor customer service problem, it was decidedly not time to buy, despite an enticing dividend yield. At the time, T shares were trading for $26 and offered a dividend yield north of 5%; in the two years since we wrote that article, they have fallen precisely 50%.
The telecom giant’s latest headache stems from a Wall Street Journal report claiming that the company—along with other industry players, chiefly Verizon (VZ $33)—left behind over 2,000 lead-encased cables which remain buried throughout the United States. The publication claims its testing showed toxic lead leaching into soil and waterways around the cables at levels exceeding government standards. This begs the question, what are the potential liabilities once the class action lawsuits begin—and we all know they will. The ultimate legal costs could be staggering.
Verizon shares were also affected by the report, falling over 7% on Monday and bringing them down to their lowest level since 2010. It should be noted that both T and VZ now have dividend yields around 8.25%, give or take five basis points. AT&T shot back to the contamination issue by stating that the Journal’s conclusion flies in the face of “long-standing science” regarding the safety of lead-clad cables. That position certainly won’t staunch the flood of litigation that is sure to come down the pike, but it does give us insight into the industry’s probable defense. New Street Research estimates that the removal of all remaining cables of this type would cost in the ballpark of $59 billion; of course, that is on top of any future legal costs. As of this writing, T has a market cap of just under $100 billion, while Verizon’s market cap sits just under $140 billion.
Forget the fat dividend yields; steer clear of these two telecom giants. For an industry holding, investors may want to consider T-Mobile (TMUS $140), with its 19 forward P/E. It doesn’t offer a yield, but it sure seems to offer more growth potential than T or VZ.
Mo, 17 Jul 2023
Government Watchdog
The FTC’s inept chairperson loses yet another case: Microsoft will buy Activision
Last December, when the FTC’s buffoonish leader, Lina Khan, sued Microsoft (MSFT $345) to stop them from buying video game publisher Activision Blizzard (ATVI $90) in a $69 billion deal, we predicted the case would be laughed out of court. That just happened, and it happened at the hands of a Biden-appointed judge. Making matters worse (for the American taxpayer), following this blistering rebuke of the FTC Khan ordered her organization to appeal the decision. On what possible grounds does she still have a job?
As we were writing about the case last December, we were struck by how cavalier the respective management teams had been about the lawsuit and the current state of the commission. They offered nothing to the government other than a promise to fight—and win—the case. There was, after all, nothing anticompetitive about the deal. In a show of good faith, Microsoft even agreed in writing to continue allowing Activision’s mammoth hit, “Call of Duty,” to remain on Sony’s (SONY $94) PlayStation with the same level of availability it enjoyed on the company’s own Xbox platform.
When she ascended to the spot—virtually straight out of law school, Khan sent shudders through the corporate world as many executives feared the FTC would grind M&A activity to a halt. She held up her end of the threat via the mountain of lawsuits filed by the FTC since she took the helm; they have just been shot down at a historic rate by the courts. The person they once feared is now seen as a paper tiger, and that is putting it kindly. This past February, one of the FTC commissioners resigned and expressed her dismay at Khan’s “disregard for the rule of law.” It appears the courts agree with that assessment.
Khan’s latest target is another member of the Penn Global Leaders Club, Amazon (AMZN $134). She is claiming that it is too difficult for Prime members to cancel their subscription. We are not going too far out on the limb by predicting another win for corporate America and yet another black mark on Khan’s record. But how many more taxpayer dollars will be lost on yet another frivolous lawsuit? When a nation is $32 trillion in debt, we suppose few are really counting any longer.
Th, 13 Jul 2023
Global Organizations & Accords
In surprising turn of events, Turkey agrees to Sweden’s NATO accession
For more than a year, Turkish President Recep Tayyip Erdogan has foiled Sweden’s bid to become NATO’s 32nd member, seemingly milking his Western allies for all he could get to support the move. Now, in a rather stunning turn of events, Erdogan has agreed to approve Sweden’s bid, making the alliance stronger than it has ever been.
For generations, Nordic countries Sweden and Finland shunned joining the alliance in an effort to assuage Russia’s security concerns; shortly after Putin’s wanton invasion of Ukraine, both countries applied for membership—with a majority of their respective citizenry supporting the move. To enter the alliance, all current member-states must vote to approve. After a hard-fought battle to win over Hungary and Turkey, Finland was formally invited in earlier this year. Erdogan’s seemingly insatiable demands made it appear that Sweden’s membership remained a long way off.
Just hours before a NATO summit was to begin in the Lithuanian capital of Vilnius, however, NATO Secretary-General Jens Stoltenberg made the surprise announcement that Turkey had formally approved Sweden’s bid to become a member “as soon as possible.” Concessions were no doubt made, but this is a huge move and a deeply troubling one for Putin, who now finds himself enveloped by the alliance on his northern, western, and southern flanks. With this latest move, hundreds of warplanes, tanks, and tens of thousands of additional troops will strengthen NATO’s dominant military position on the continent.
For Sweden’s part, the country agreed to Erdogan’s demands to crack down on members of the Kurdish Workers’ Party, or PKK, operating within Sweden. This Marxist group has been fighting Turkish forces since the 1980s. Ironically, Sweden was one of the first countries to label the group a terrorist organization, so it is unclear what further promises were made. As for the US, President Biden tied the sale to Turkey of $20 billion worth of General Dynamics/Lockheed Martin F-16 Fighting Falcons to Erdogan’s approval. While obstacles may remain in Congress, the deal will certainly now go through.
As for the EU, Erdogan wanted assurances that his country would become a member of the Union. While European leaders balked at a direct promise, they did agree to reevaluate Turkey’s bid “with a view to proceed in a strategic and forward-looking manner.” A lot of moving parts remain, but one thing is certain: it was an excellent day for Sweden and NATO, and another really bad day for the Russian menace.
Putin’s true friends are now limited to the likes of China, North Korea, Iran, Belarus, and Brazil—the latter only as long as the socialist Lula da Silva remains in power. Talk about a motley crew. As for the country he invaded, Ukraine continues to push for entry into the Western alliance, with an increasing number of members ready to support that move.
Th, 13 Jul 2023
Economics: Housing
Multifamily housing is going up at a clip not seen since 1986, meaning rental prices should continue to moderate
Something rather amazing happened over the course of the year through this past May: According to apartment search engine and online marketplace Rent.com, monthly rental prices fell 0.57%. That represents the first drop in prices since March 2022, and comes on the heels of a year in which the average renter paid 17.5% more than they did the previous year. Despite this good news, consider this: The national median rent is now $1,995 per month. Rents may finally be moderating, but that is still a lofty figure. More good news may be on the horizon, however.
After years of being underdeveloped, construction is soaring once again. In May, privately-owned multifamily unit starts hit 624,000, up from a trough of 234,000 in April 2020. That is the fastest clip of new units since April 1986. Meanwhile, Month-over-month (MoM) housing starts for May rose a robust 21.7%—the fastest pace since October 2016. In addition to supply ramping up, inflation is clearly moderating. One other factor should help put downward pressure on rent prices: the average American budget is getting tighter. Not only are the pandemic piggy banks running out of money after three years of wanton discretionary spending, the resumption of student loan payments this September will further crimp the budget of millions of American families. The supply and demand dynamic of multifamily housing is about to make a rather dramatic shift.
In the next issue of The Penn Wealth Report we will take a closer look at this topic and what it means not only for renters, but for developers and those who hold apartment REITs in their portfolios. One housing research firm sees apartment values dropping another 20% between now and the end of next year, meaning investors should pay special attention to this corner of the real estate market and consider placing stops on positions to help protect their principal.
Sa, 29 Jul 2023
Market Pulse
It was a busy—and generally positive—week in the markets
What a week. The fireworks began on Tuesday, when it appeared as though we were on the cusp of yet another regional bank failure. As quickly as the concern over California regional PacWest Bancorp (PACW $9) reared its ugly head, it dissipated with news that smaller regional Banc of California (BANC $14) would acquire it, maintaining the latter's name. It's a crazy world. Going into the year, PacWest had a market cap of just under $3 billion, while BANC's market cap was around $1 billion. Thank JP Morgan's Jamie Dimon—it's a long story. Anyway, crisis averted.
On Wednesday the Fed raised interest rates another 25 basis point, to 5.50%. That brings it up to a rate not seen since January of 2001. It had about a 100% chance of happening, so the markets shrugged off the move. Inflation is clearly coming down and credit card debt is at a new record high, so it is time to stop hiking. But will they?
Thursday brought an unexpectedly high GDP report for the second quarter. The US economy grew at 2.4%, handily beating expectations and coming on the heels of a 2% Q1 growth rate. Consumer spending also surprised analysts, and the labor market remains strong. Even housing prices resumed their upward trend, despite a 30-year mortgage rate near 7%. A dearth of homes on the market helped that metric; who wants to sell and lose their 3.5% mortgage rate?
Friday capped the week off with a stunning show of strength. The S&P 500 gained nearly 1%, the Nasdaq rose nearly 2%, and the Russell 2000 (small caps) gained 1.36%. Unfortunately, oil rose nearly 4% on the week, and the spike is definitely filtering through to the price of gas. At the start of the week, we saw prices floating around $3.11 per gallon; by the weekend, they were close to $3.60 per gallon—a 16% increase.
We are unsettled by the news that credit card debt just hit another record high, and we wonder how many people even realize they are paying around 22% in interest on their balances (the national average). Then again, US debt is about to hit $33 trillion—well above the size of the US economy, so why should the population be any more responsible than the people they elect? We will take the win in the markets for the week, and the risk of a recession is diminishing, but debt trouble is brewing. If a politician is blathering on about the need for more government spending but never mentions the national debt, they should be run out of D.C. on a rail. More evidence of the need for a balanced budget amendment to the US Constitution and term limits.
Tu, 25 Jul 2023
Specialty Retail: E-Commerce
Overstock.com will buy the intellectual property of Bed Bath & Beyond
It turns out Bed Bath & Beyond (BBBY $0.31) is not going away after all. Well, the 260 (down from 1,500 five years ago) remaining stores may be, but the name will live on. It seems that Overstock.com (OSTK $31) has been trying to break the stigma for years that it is nothing but a liquidator of goods. Considering that concept is literally in the name of the firm, the $1.4 billion online retailer has agreed to purchase BBBY’s intellectual property, customer lists, and website domain for $21.5 million in cash. Honestly, that seems like a real bargain if they can actually pull it off.
Investors are applauding the deal, pulling the shares up from just above $17 in June to just under $31 as we write this. In Canada, online shoppers who visit bedbathandbeyond.ca website will now be taken to the Overstock site, with the US rollout expected by the end of summer. The fit just seems right—the two companies’ sites look almost identical.
Despite the low cost of acquisition and the enormous name recognition of the acquired, one lingering question remains: Without a physical presence, what percentage of Bed Bath & Beyond bricks-and-mortar shoppers—most of whom armed with 20% coupons in hand as they lingered the aisles—will take to the online store? After all, if you can’t walk around and find in-store deals, isn’t it easier just to visit Amazon.com? Then again, couldn’t that have been said of Overstock.com before this deal?
For $21.5 million, Overstock made a smart move. For a fully online company, we could imagine them getting lost in ubiquity before long, looking a lot like most other home furnishings retailers. At least the new name will make them stand out a bit more. Another plus: the company’s balance sheet is very strong, with virtually no debt on the books. Imagine the overhead of those Bed Bath and Beyond behemoths, and it is easy to understand why they were awash in debt. Is OSTK (not sure whether they will change that ticker) worthy of an investment? With no dividend and a fair market value—in our opinion—of $35 per share, they seem close to fairly valued. Too bad we can’t use a 20% coupon on the stock price.
Tu, 18 Jul 2023
Telecom Services
AT&T shares fall to lowest level in three decades—Verizon not looking much better
Two years ago this October, we posed the question: “Over the course of twenty years, AT&T (T $13) shares have dropped 43%; is it time to buy?” We concluded that, based on the maladroit leadership team’s missteps, such as overpaying for ill-advised acquisitions instead of addressing a poor customer service problem, it was decidedly not time to buy, despite an enticing dividend yield. At the time, T shares were trading for $26 and offered a dividend yield north of 5%; in the two years since we wrote that article, they have fallen precisely 50%.
The telecom giant’s latest headache stems from a Wall Street Journal report claiming that the company—along with other industry players, chiefly Verizon (VZ $33)—left behind over 2,000 lead-encased cables which remain buried throughout the United States. The publication claims its testing showed toxic lead leaching into soil and waterways around the cables at levels exceeding government standards. This begs the question, what are the potential liabilities once the class action lawsuits begin—and we all know they will. The ultimate legal costs could be staggering.
Verizon shares were also affected by the report, falling over 7% on Monday and bringing them down to their lowest level since 2010. It should be noted that both T and VZ now have dividend yields around 8.25%, give or take five basis points. AT&T shot back to the contamination issue by stating that the Journal’s conclusion flies in the face of “long-standing science” regarding the safety of lead-clad cables. That position certainly won’t staunch the flood of litigation that is sure to come down the pike, but it does give us insight into the industry’s probable defense. New Street Research estimates that the removal of all remaining cables of this type would cost in the ballpark of $59 billion; of course, that is on top of any future legal costs. As of this writing, T has a market cap of just under $100 billion, while Verizon’s market cap sits just under $140 billion.
Forget the fat dividend yields; steer clear of these two telecom giants. For an industry holding, investors may want to consider T-Mobile (TMUS $140), with its 19 forward P/E. It doesn’t offer a yield, but it sure seems to offer more growth potential than T or VZ.
Mo, 17 Jul 2023
Government Watchdog
The FTC’s inept chairperson loses yet another case: Microsoft will buy Activision
Last December, when the FTC’s buffoonish leader, Lina Khan, sued Microsoft (MSFT $345) to stop them from buying video game publisher Activision Blizzard (ATVI $90) in a $69 billion deal, we predicted the case would be laughed out of court. That just happened, and it happened at the hands of a Biden-appointed judge. Making matters worse (for the American taxpayer), following this blistering rebuke of the FTC Khan ordered her organization to appeal the decision. On what possible grounds does she still have a job?
As we were writing about the case last December, we were struck by how cavalier the respective management teams had been about the lawsuit and the current state of the commission. They offered nothing to the government other than a promise to fight—and win—the case. There was, after all, nothing anticompetitive about the deal. In a show of good faith, Microsoft even agreed in writing to continue allowing Activision’s mammoth hit, “Call of Duty,” to remain on Sony’s (SONY $94) PlayStation with the same level of availability it enjoyed on the company’s own Xbox platform.
When she ascended to the spot—virtually straight out of law school, Khan sent shudders through the corporate world as many executives feared the FTC would grind M&A activity to a halt. She held up her end of the threat via the mountain of lawsuits filed by the FTC since she took the helm; they have just been shot down at a historic rate by the courts. The person they once feared is now seen as a paper tiger, and that is putting it kindly. This past February, one of the FTC commissioners resigned and expressed her dismay at Khan’s “disregard for the rule of law.” It appears the courts agree with that assessment.
Khan’s latest target is another member of the Penn Global Leaders Club, Amazon (AMZN $134). She is claiming that it is too difficult for Prime members to cancel their subscription. We are not going too far out on the limb by predicting another win for corporate America and yet another black mark on Khan’s record. But how many more taxpayer dollars will be lost on yet another frivolous lawsuit? When a nation is $32 trillion in debt, we suppose few are really counting any longer.
Th, 13 Jul 2023
Global Organizations & Accords
In surprising turn of events, Turkey agrees to Sweden’s NATO accession
For more than a year, Turkish President Recep Tayyip Erdogan has foiled Sweden’s bid to become NATO’s 32nd member, seemingly milking his Western allies for all he could get to support the move. Now, in a rather stunning turn of events, Erdogan has agreed to approve Sweden’s bid, making the alliance stronger than it has ever been.
For generations, Nordic countries Sweden and Finland shunned joining the alliance in an effort to assuage Russia’s security concerns; shortly after Putin’s wanton invasion of Ukraine, both countries applied for membership—with a majority of their respective citizenry supporting the move. To enter the alliance, all current member-states must vote to approve. After a hard-fought battle to win over Hungary and Turkey, Finland was formally invited in earlier this year. Erdogan’s seemingly insatiable demands made it appear that Sweden’s membership remained a long way off.
Just hours before a NATO summit was to begin in the Lithuanian capital of Vilnius, however, NATO Secretary-General Jens Stoltenberg made the surprise announcement that Turkey had formally approved Sweden’s bid to become a member “as soon as possible.” Concessions were no doubt made, but this is a huge move and a deeply troubling one for Putin, who now finds himself enveloped by the alliance on his northern, western, and southern flanks. With this latest move, hundreds of warplanes, tanks, and tens of thousands of additional troops will strengthen NATO’s dominant military position on the continent.
For Sweden’s part, the country agreed to Erdogan’s demands to crack down on members of the Kurdish Workers’ Party, or PKK, operating within Sweden. This Marxist group has been fighting Turkish forces since the 1980s. Ironically, Sweden was one of the first countries to label the group a terrorist organization, so it is unclear what further promises were made. As for the US, President Biden tied the sale to Turkey of $20 billion worth of General Dynamics/Lockheed Martin F-16 Fighting Falcons to Erdogan’s approval. While obstacles may remain in Congress, the deal will certainly now go through.
As for the EU, Erdogan wanted assurances that his country would become a member of the Union. While European leaders balked at a direct promise, they did agree to reevaluate Turkey’s bid “with a view to proceed in a strategic and forward-looking manner.” A lot of moving parts remain, but one thing is certain: it was an excellent day for Sweden and NATO, and another really bad day for the Russian menace.
Putin’s true friends are now limited to the likes of China, North Korea, Iran, Belarus, and Brazil—the latter only as long as the socialist Lula da Silva remains in power. Talk about a motley crew. As for the country he invaded, Ukraine continues to push for entry into the Western alliance, with an increasing number of members ready to support that move.
Th, 13 Jul 2023
Economics: Housing
Multifamily housing is going up at a clip not seen since 1986, meaning rental prices should continue to moderate
Something rather amazing happened over the course of the year through this past May: According to apartment search engine and online marketplace Rent.com, monthly rental prices fell 0.57%. That represents the first drop in prices since March 2022, and comes on the heels of a year in which the average renter paid 17.5% more than they did the previous year. Despite this good news, consider this: The national median rent is now $1,995 per month. Rents may finally be moderating, but that is still a lofty figure. More good news may be on the horizon, however.
After years of being underdeveloped, construction is soaring once again. In May, privately-owned multifamily unit starts hit 624,000, up from a trough of 234,000 in April 2020. That is the fastest clip of new units since April 1986. Meanwhile, Month-over-month (MoM) housing starts for May rose a robust 21.7%—the fastest pace since October 2016. In addition to supply ramping up, inflation is clearly moderating. One other factor should help put downward pressure on rent prices: the average American budget is getting tighter. Not only are the pandemic piggy banks running out of money after three years of wanton discretionary spending, the resumption of student loan payments this September will further crimp the budget of millions of American families. The supply and demand dynamic of multifamily housing is about to make a rather dramatic shift.
In the next issue of The Penn Wealth Report we will take a closer look at this topic and what it means not only for renters, but for developers and those who hold apartment REITs in their portfolios. One housing research firm sees apartment values dropping another 20% between now and the end of next year, meaning investors should pay special attention to this corner of the real estate market and consider placing stops on positions to help protect their principal.
Headlines for the Month of June, 2023
Tu, 27 Jun 2023
Drug Retail
Walgreens hasn’t traded this low since June 2010; what gives?
One would think that an enormous retail pharmacy chain would be relatively immune to a slowing economy and a pullback in consumer spending. Prescription drugs are pretty important, after all. Why, then, are shares of Walgreens Boots Alliance (WBA $29) sitting at their lowest point in precisely thirteen years? After reporting an abysmal fiscal third quarter and slashing its full-year guidance, management blamed “challenging consumer and macroeconomic conditions.” We don’t buy any of that.
Despite management’s comments, sales rose 8.65% from the same quarter last year, to $35.42 billion. The disconnect came in net income, which fell from $289 million in fiscal Q3 of 2022 to $118 million in the latest quarter—nearly a 60% plunge. The company reported a $3.72 billion loss two quarters ago after paying a massive opioid settlement, but that is in the rear-view mirror. We see the challenges driven more by increased competition than economic conditions or a “drop off in Covid-related sales.”
CEO Rosalind Brewer said the company will increase its cost-cutting initiative to $4.1 billion and take other steps to increase profitability in its health care segment, but with Amazon (AMZN $127) Pharmacy gaining momentum, and multiline retailers like Target (TGT $134) and Walmart (WMT $155) increasing market share, will that be enough? We don’t think so. Even at a thirteen-year low, the share price doesn’t look that attractive. It is going to take an intelligent strategic initiative to garner our interest once more, and we don’t see management bringing anything like that to the table.
We closed Walgreens from the Penn Global Leaders Club at $36 per share in November 2020. Up until that point, it had been a staple company in the portfolio.
Fr, 23 Jun 2023
Restaurants
The Cava IPO proves that (too) many haven’t gotten any smarter since the downturn
It felt like the old days; the New York Stock Exchange was all abuzz about a new IPO. Cava Group (CAVA $40), owner of CAVA Mediterranean restaurants and Zoe’s Kitchen, which the company bought back in 2018 and has been converting to CAVA locations ever since, was going public. How exciting. Never mind the fact that Zoe’s was publicly traded between 2014 and 2018 before agreeing to be bought out at a value below its IPO price, this time is different.
With the IPO priced at $22 per share for the Mr. Howells and Daddy Warbucks of the world, by the time us hoi polloi had a chance to buy in at the open the price had doubled—topping out at $47.89 within hours. Unlike Airbnb (ABNB $125) or CrowdStrike Holdings (CRWD $144), however, we weren’t the least bit bummed out that we weren’t part of the trading elite.
It seems as though the only carrot much of the investment community needs is a good story to forget their meme stock, crypto, and NFT losses, and pundits quickly offered them one: CAVA was going to be the next Chipotle (CMG $2,045). Cha-ching! Why let discounted cash flow models or actual profits get in the way of a good story? At least with respect to this IPO, it feels like the frothy days of a few years ago. Let the dumb money chase the flashy stories; we still see many unloved bargains sitting out there for astute and selective investors.
This is no disparagement of CAVA; in fact, we want to try the place now. However, investors who bought in on day one or who will buy in anywhere above the IPO price will lose on this one. Think Sweetgreen (SG $11), not Chipotle.
Fr, 23 Jun 2023
Aerospace & Defense
When your company is a perennial money loser, is it wise to go on strike?
That is a rhetorical question. Spirit AeroSystems (SPR $27), which was spun out of Boeing (BA $203) in 2005, designs and manufactures aerostructures—primarily fuselages—for commercial and military aircraft. Boeing and Airbus (EADSY $34) are the company’s two primary customers, with the former generating 80% of the firm’s revenue. In fact, the supplier is responsible for a majority of the Boeing 737’s airframe. The company lost $761 million over the trailing twelve months, $539 million in 2022, $555 million in 2021, and $1.1 billion in 2020. Unionized workers at Spirit just voted overwhelmingly to reject the company’s “best and final offer” and go on strike.
Analysts had considered the company’s last offer “steep but necessary,” as the industry faces mounting challenges even without a strike threat on the table. Spirit offered a 16% pay hike over four years, a $7,500 signing bonus, cost of living adjustments, and annual bonuses—adding up to an aggregate 34% increase over four years. An offer so generous that the the International Association of Machinists and Aerospace Workers (IAM) representatives at the bargaining table recommended its acceptance. At the vote, 79% of union workers rejected the offer, and 85% formally voted to go on strike. Spirit immediately told the organized workers not to report back to work for their shifts on the 22nd of June.
Shares of Spirit and Boeing fell sharply on the rejection, while Airbus shares remained largely unaffected.
Spirit has been losing money for three straight years; this type of manufacturing environment is ready-made for automation and a robotic workforce. The actions belie logic. As for Boeing, we wouldn’t consider touching the shares until their inept CEO, David Calhoun, and most of the board are shown the door.
Tu, 13 Jun 2023
Automotive
Tesla strikes deal with both Ford and GM for use of its Supercharger network
Over a decade ago, EV leader Tesla (TSLA $250) introduced its Supercharger network to overcome buyer angst over hitting the highways in an electric vehicle. In typical Tesla fashion, the company invited other American automakers to adopt their charging methods (NACS, or North American Charging Standard) to help grow the industry. They were rebuffed in a not-so-polite manner. Now, after a decade of Tesla dominance in the EV race, the competition’s haughty attitude has changed.
Drivers of non-Tesla EVs have been forced to use a rather spotty and unreliable system known as CCS, or Combined Charging System. With Ford (F $14) and GM (GM $37) planning on producing millions of electric vehicles per year, this condition has become unacceptable. That is why, over the course of a few weeks, both automakers have inked deals adopting Tesla’s Supercharger standard. Phase one will involve their vehicles coming equipped with an adapter allowing them to use Tesla’s network. Within a few years, compatible plugs will come standard on the vehicles.
What does this mean for Tesla? Naysayers argue the move only helps the company’s competitors sell more EVs and catch up to the leader. Baloney. What it really means is a great new source of revenue as Ford and GM vehicles roll up and plug in. It also highlights the leadership of Tesla within the industry. Tesla’s senior director of charging infrastructure, Rebecca Tinucci, reiterated the company’s mission to “accelerate the world’s transition to sustainable energy.” These new deals will help with that acceleration.
Tesla currently operates 45,000 Superchargers at over 5,000 locations, and the company’s pre-fab system means a new station can be up and running within eight days. Expect the explosive growth of these locations to continue until they are virtually everywhere on American roads. We own Tesla, which is up 103% year-to-date as of this writing, in the Penn New Frontier Fund.
Th, 08 Jun 2023
Economics: Work & Pay
The latest jobless report: another reason the Fed should stop hiking
The number of Americans who applied for unemployment benefits in early June spiked to 261,000, matching July 2022 figures and representing the highest rate since November 2021. The four-week moving average rose to 237,250, and we expect to see that average continue to climb in the face of a softening economy. While that’s bad news for workers, it is good news for those wishing the Fed would finally end its rate hike cycle, and for Americans looking for lower prices at the pump and in the grocery stores.
While the Labor Department didn’t cite specifics for the unexpected jump, the breakdown is interesting: Out of 53 states and territories 26 showed a decrease in claims, 27 had an increase, and two states—California and Ohio—saw a surge in claims. All of the tech layoffs almost certainly accounted for California’s job losses, in addition to companies exiting the state. Rising claims are a leading economic indicator for the economy and often a telltale sign we are nearing a recession. That said, other indicators—such as corporate earnings—point to a quite mild recession, assuming we have one at all.
Thanks to his hawkish—and quite unnecessary—recent comments, most analysts believe we will see another rate hike in July. We have changed our tune (thanks to Powell's rhetoric) and agree with that prediction. After either one or two more hikes, we see an elongated pause going well into 2024. We view the 5% federal funds rate as the sweet spot: not high enough to hurt the US economy, but robust enough to provide cash-starved investors with some real yield for the first time in a decade. Sadly, Powell doesn't want to seem to stop his tightening.
As for fixed-income maturities, we are moving out our duration sweet spot to 5-7 years. We will continue to buy on the shorter end as well, but now feel comfortable walking up a few more steps on the duration ladder.
Mo, 05 Jun 2023
South Asia
The expulsion of each other's journalists is just the latest flashpoint in the deteriorating relations between India and China
"The enemy of my enemy is my friend?" Sadly, considering India's tight relationship with Russia's Putin, that saying doesn't really apply with respect to India's ongoing Cold War (which is, at times, hot) with China, but it is fascinating to watch from a distance.
The latest flare-up comes after each country kicked out the other's journalists, with India denying visa renewals to Chinese state media personnel, and China quickly reciprocating. Tensions between the two neighbors, which share a 2,100-mile border, have been steadily growing over the past several years, marked by border conflicts and economic disputes.
Not long after the Chinese-borne pandemic began, a deadly clash took place in the Himalayan Mountains along a stretch of land claimed by both countries; specifically, the Aksai Chin region. Twenty Indian soldiers and an unknown number of Chinese troops were killed in the fighting, marking the lowest point in relations between the two countries in decades. According to a senior Indian military official, several of the soldiers were killed by clubs embedded with nails.
It doesn't take much for a hyper-sensitive China, emboldened by a growing economy, to react violently to perceived threats. In addition to aggressive behavior along the Indian border, the country has claimed a number of disputed islands in the South China Sea as its own, alienating southern and eastern neighbors in the region.
The CCP has also expressed outrage at the existence of the Quadrilateral Security Dialogue, a geopolitical group made up of the United States, Japan, India, and Australia. It claims the group's purpose is to encircle and isolate the country, though the stated goal of the Quad, as it is known, is to monitor illegal fishing, maritime militias, and the secret shipping of goods such as weapons.
China's inferiority complex with respect to its role on the world stage is troubling. The more it feels slighted, the more the country's military is apt to act in an irresponsible way, as highlighted by the recent border dispute. Unfortunately, India's close relationship with Russia illustrates the nuanced approach the US must take when forming strategic alliances in the region.
As China's economy matures, it will become impossible to maintain the high growth rate it displayed as an emerging market. The arrogance of the country's ruling class will prevent them from accepting that fact, which will lead to ever-growing tumult in the region. For the international portion of any investment portfolio, we see greener pastures outside of both China and India.
Mo, 05 Jun 2023
Leisure Equipment, Products, and Facilities
BofA: Reiterate bullish views on Topgolf Callaway
After meeting with senior executives, Bank of America reiterated its bullish outlook on Penn member (Intrepid Trading Platform) Topgolf Callaway (MODG $19). Analysts were especially impressed with Project PIE, the company's new digital bay inventory system, which should greatly increase the utilization rate at Topgolf—the unit responsible for 39% of sales. We have a $30 per share price target on MODG.
Tu, 27 Jun 2023
Drug Retail
Walgreens hasn’t traded this low since June 2010; what gives?
One would think that an enormous retail pharmacy chain would be relatively immune to a slowing economy and a pullback in consumer spending. Prescription drugs are pretty important, after all. Why, then, are shares of Walgreens Boots Alliance (WBA $29) sitting at their lowest point in precisely thirteen years? After reporting an abysmal fiscal third quarter and slashing its full-year guidance, management blamed “challenging consumer and macroeconomic conditions.” We don’t buy any of that.
Despite management’s comments, sales rose 8.65% from the same quarter last year, to $35.42 billion. The disconnect came in net income, which fell from $289 million in fiscal Q3 of 2022 to $118 million in the latest quarter—nearly a 60% plunge. The company reported a $3.72 billion loss two quarters ago after paying a massive opioid settlement, but that is in the rear-view mirror. We see the challenges driven more by increased competition than economic conditions or a “drop off in Covid-related sales.”
CEO Rosalind Brewer said the company will increase its cost-cutting initiative to $4.1 billion and take other steps to increase profitability in its health care segment, but with Amazon (AMZN $127) Pharmacy gaining momentum, and multiline retailers like Target (TGT $134) and Walmart (WMT $155) increasing market share, will that be enough? We don’t think so. Even at a thirteen-year low, the share price doesn’t look that attractive. It is going to take an intelligent strategic initiative to garner our interest once more, and we don’t see management bringing anything like that to the table.
We closed Walgreens from the Penn Global Leaders Club at $36 per share in November 2020. Up until that point, it had been a staple company in the portfolio.
Fr, 23 Jun 2023
Restaurants
The Cava IPO proves that (too) many haven’t gotten any smarter since the downturn
It felt like the old days; the New York Stock Exchange was all abuzz about a new IPO. Cava Group (CAVA $40), owner of CAVA Mediterranean restaurants and Zoe’s Kitchen, which the company bought back in 2018 and has been converting to CAVA locations ever since, was going public. How exciting. Never mind the fact that Zoe’s was publicly traded between 2014 and 2018 before agreeing to be bought out at a value below its IPO price, this time is different.
With the IPO priced at $22 per share for the Mr. Howells and Daddy Warbucks of the world, by the time us hoi polloi had a chance to buy in at the open the price had doubled—topping out at $47.89 within hours. Unlike Airbnb (ABNB $125) or CrowdStrike Holdings (CRWD $144), however, we weren’t the least bit bummed out that we weren’t part of the trading elite.
It seems as though the only carrot much of the investment community needs is a good story to forget their meme stock, crypto, and NFT losses, and pundits quickly offered them one: CAVA was going to be the next Chipotle (CMG $2,045). Cha-ching! Why let discounted cash flow models or actual profits get in the way of a good story? At least with respect to this IPO, it feels like the frothy days of a few years ago. Let the dumb money chase the flashy stories; we still see many unloved bargains sitting out there for astute and selective investors.
This is no disparagement of CAVA; in fact, we want to try the place now. However, investors who bought in on day one or who will buy in anywhere above the IPO price will lose on this one. Think Sweetgreen (SG $11), not Chipotle.
Fr, 23 Jun 2023
Aerospace & Defense
When your company is a perennial money loser, is it wise to go on strike?
That is a rhetorical question. Spirit AeroSystems (SPR $27), which was spun out of Boeing (BA $203) in 2005, designs and manufactures aerostructures—primarily fuselages—for commercial and military aircraft. Boeing and Airbus (EADSY $34) are the company’s two primary customers, with the former generating 80% of the firm’s revenue. In fact, the supplier is responsible for a majority of the Boeing 737’s airframe. The company lost $761 million over the trailing twelve months, $539 million in 2022, $555 million in 2021, and $1.1 billion in 2020. Unionized workers at Spirit just voted overwhelmingly to reject the company’s “best and final offer” and go on strike.
Analysts had considered the company’s last offer “steep but necessary,” as the industry faces mounting challenges even without a strike threat on the table. Spirit offered a 16% pay hike over four years, a $7,500 signing bonus, cost of living adjustments, and annual bonuses—adding up to an aggregate 34% increase over four years. An offer so generous that the the International Association of Machinists and Aerospace Workers (IAM) representatives at the bargaining table recommended its acceptance. At the vote, 79% of union workers rejected the offer, and 85% formally voted to go on strike. Spirit immediately told the organized workers not to report back to work for their shifts on the 22nd of June.
Shares of Spirit and Boeing fell sharply on the rejection, while Airbus shares remained largely unaffected.
Spirit has been losing money for three straight years; this type of manufacturing environment is ready-made for automation and a robotic workforce. The actions belie logic. As for Boeing, we wouldn’t consider touching the shares until their inept CEO, David Calhoun, and most of the board are shown the door.
Tu, 13 Jun 2023
Automotive
Tesla strikes deal with both Ford and GM for use of its Supercharger network
Over a decade ago, EV leader Tesla (TSLA $250) introduced its Supercharger network to overcome buyer angst over hitting the highways in an electric vehicle. In typical Tesla fashion, the company invited other American automakers to adopt their charging methods (NACS, or North American Charging Standard) to help grow the industry. They were rebuffed in a not-so-polite manner. Now, after a decade of Tesla dominance in the EV race, the competition’s haughty attitude has changed.
Drivers of non-Tesla EVs have been forced to use a rather spotty and unreliable system known as CCS, or Combined Charging System. With Ford (F $14) and GM (GM $37) planning on producing millions of electric vehicles per year, this condition has become unacceptable. That is why, over the course of a few weeks, both automakers have inked deals adopting Tesla’s Supercharger standard. Phase one will involve their vehicles coming equipped with an adapter allowing them to use Tesla’s network. Within a few years, compatible plugs will come standard on the vehicles.
What does this mean for Tesla? Naysayers argue the move only helps the company’s competitors sell more EVs and catch up to the leader. Baloney. What it really means is a great new source of revenue as Ford and GM vehicles roll up and plug in. It also highlights the leadership of Tesla within the industry. Tesla’s senior director of charging infrastructure, Rebecca Tinucci, reiterated the company’s mission to “accelerate the world’s transition to sustainable energy.” These new deals will help with that acceleration.
Tesla currently operates 45,000 Superchargers at over 5,000 locations, and the company’s pre-fab system means a new station can be up and running within eight days. Expect the explosive growth of these locations to continue until they are virtually everywhere on American roads. We own Tesla, which is up 103% year-to-date as of this writing, in the Penn New Frontier Fund.
Th, 08 Jun 2023
Economics: Work & Pay
The latest jobless report: another reason the Fed should stop hiking
The number of Americans who applied for unemployment benefits in early June spiked to 261,000, matching July 2022 figures and representing the highest rate since November 2021. The four-week moving average rose to 237,250, and we expect to see that average continue to climb in the face of a softening economy. While that’s bad news for workers, it is good news for those wishing the Fed would finally end its rate hike cycle, and for Americans looking for lower prices at the pump and in the grocery stores.
While the Labor Department didn’t cite specifics for the unexpected jump, the breakdown is interesting: Out of 53 states and territories 26 showed a decrease in claims, 27 had an increase, and two states—California and Ohio—saw a surge in claims. All of the tech layoffs almost certainly accounted for California’s job losses, in addition to companies exiting the state. Rising claims are a leading economic indicator for the economy and often a telltale sign we are nearing a recession. That said, other indicators—such as corporate earnings—point to a quite mild recession, assuming we have one at all.
Thanks to his hawkish—and quite unnecessary—recent comments, most analysts believe we will see another rate hike in July. We have changed our tune (thanks to Powell's rhetoric) and agree with that prediction. After either one or two more hikes, we see an elongated pause going well into 2024. We view the 5% federal funds rate as the sweet spot: not high enough to hurt the US economy, but robust enough to provide cash-starved investors with some real yield for the first time in a decade. Sadly, Powell doesn't want to seem to stop his tightening.
As for fixed-income maturities, we are moving out our duration sweet spot to 5-7 years. We will continue to buy on the shorter end as well, but now feel comfortable walking up a few more steps on the duration ladder.
Mo, 05 Jun 2023
South Asia
The expulsion of each other's journalists is just the latest flashpoint in the deteriorating relations between India and China
"The enemy of my enemy is my friend?" Sadly, considering India's tight relationship with Russia's Putin, that saying doesn't really apply with respect to India's ongoing Cold War (which is, at times, hot) with China, but it is fascinating to watch from a distance.
The latest flare-up comes after each country kicked out the other's journalists, with India denying visa renewals to Chinese state media personnel, and China quickly reciprocating. Tensions between the two neighbors, which share a 2,100-mile border, have been steadily growing over the past several years, marked by border conflicts and economic disputes.
Not long after the Chinese-borne pandemic began, a deadly clash took place in the Himalayan Mountains along a stretch of land claimed by both countries; specifically, the Aksai Chin region. Twenty Indian soldiers and an unknown number of Chinese troops were killed in the fighting, marking the lowest point in relations between the two countries in decades. According to a senior Indian military official, several of the soldiers were killed by clubs embedded with nails.
It doesn't take much for a hyper-sensitive China, emboldened by a growing economy, to react violently to perceived threats. In addition to aggressive behavior along the Indian border, the country has claimed a number of disputed islands in the South China Sea as its own, alienating southern and eastern neighbors in the region.
The CCP has also expressed outrage at the existence of the Quadrilateral Security Dialogue, a geopolitical group made up of the United States, Japan, India, and Australia. It claims the group's purpose is to encircle and isolate the country, though the stated goal of the Quad, as it is known, is to monitor illegal fishing, maritime militias, and the secret shipping of goods such as weapons.
China's inferiority complex with respect to its role on the world stage is troubling. The more it feels slighted, the more the country's military is apt to act in an irresponsible way, as highlighted by the recent border dispute. Unfortunately, India's close relationship with Russia illustrates the nuanced approach the US must take when forming strategic alliances in the region.
As China's economy matures, it will become impossible to maintain the high growth rate it displayed as an emerging market. The arrogance of the country's ruling class will prevent them from accepting that fact, which will lead to ever-growing tumult in the region. For the international portion of any investment portfolio, we see greener pastures outside of both China and India.
Mo, 05 Jun 2023
Leisure Equipment, Products, and Facilities
BofA: Reiterate bullish views on Topgolf Callaway
After meeting with senior executives, Bank of America reiterated its bullish outlook on Penn member (Intrepid Trading Platform) Topgolf Callaway (MODG $19). Analysts were especially impressed with Project PIE, the company's new digital bay inventory system, which should greatly increase the utilization rate at Topgolf—the unit responsible for 39% of sales. We have a $30 per share price target on MODG.
Headlines for the Month of May, 2023
Fr, 19 May 2023
Multiline Retail
Theft, plain and simple: Target expects over $1 billion worth of shrinkage this year
It is a sad testament to our society. Crimes being committed while the justice system looks the other way. Retailer Target (TGT $161) said it lost $763 million last fiscal year due to shrinkage, which is an industry term for the theft of goods. What’s more, the company expects that figure to increase by $500 million this year, bringing the total loss to over $1.2 billion. For a retailer which earned $2.8 billion in net income on $108 billion in sales over the trailing twelve months, that figure is substantial.
And Target is certainly not the only firm facing this problem. The National Retail Federation said that nearly $100 billion worth of goods were stolen in 2021, with the number of violent incidents on the rise. Target is battling the problem by installing more “protective fixtures” in its stores, which means inconvenience for paying customers. We were taken aback the first time we went into a CVS to buy shave blades, only to find them locked behind a plexiglass cover. Expect more items to be protected from theft in this manner. Also expect companies to continue closing locations in high-theft areas, meaning local residents will have to drive further to do their shopping.
Where there is a problem, there is also opportunity. Privately held OpenEye offers its OpenEye Web Services (OWS) system to clients to deter theft, reduce internal fraud, and generate valuable business intelligence for retail stores nationwide. Expect the rapid rise of AI to play a major role in theft prevention, with security companies rushing to apply the emerging technology to solutions for retailers. AI systems can be placed near checkout stands to account for every product in a customer’s possession. New Amazon (AMZN $118) Go convenience stores use advanced technology to scan all items in a cart and charge the customer automatically, negating the need for a checkout stand. Expect more retailers to adopt this technology within the next few years.
In an ideal world, all individuals would have the moral fiber required to not commit these crimes. As we don’t live in such a world, opportunities will be plentiful for creative security technology firms developing solutions for frustrated retailers.
Expect a slew of AI companies to go public over the next twelve to eighteen months; many of which will provide retail security solutions. In the meantime, our favorite pure automation company is Rockwell Automation (ROK $280), which provides intelligent devices and software to business clients, as well as consulting services. We own Rockwell in the Penn New Frontier Fund. For an interesting read on Amazon Go’s “just walk out” AI technology, visit here.
Mo, 15 May 2023
Capital Markets
The hunter becomes the prey: Icahn Enterprises falls 44% on short seller attack
We typically are about as much fans of short sellers as we are those bums who walk up to the “don’t come/don’t pass” line on the craps table. Get the pitchforks out. But now that Nathan Anderson has launched blistering attacks against both Jack Dorsey and Carl Icahn, we are quickly becoming admirers of his Hindenburg “forensic financial research firm.”
The attack on Icahn is poetic. Here is a man who bled TWA dry in the early 1990s, often attacks companies we love, and seemingly ignores the ones in true need of an overhaul. He doesn’t make companies better; he strips them of their value and leaves them for dead—along with their investors’ capital (in our humble opinion).
As for the Hindenburg attack, it is epic. The company’s report, entitled “The corporate raider throwing stones from his glass house,” likened Ichan’s company to a Ponzi scheme, able to survive only by getting new dupes, er, investors in at the bottom of the pyramid. Gutsy accusations against a man who has countless attack dog lawyers on speed dial. Icahn Enterprises LP (IEP $36) suffered its worst-ever day following the report, falling 20%. Icahn and his son own around 85% of the firm, which is now valued at $12 billion.
One particular focus of the report was a margin loan taken out by Icahn and backed by his ownership of IEP. This loan—or the lack of accounting for it—seemingly inflated the raider’s wealth by over $7 billion. When the loan and the market drop of IEP were taken into account, Icahn dropped from the 58th-wealthiest person in the world to the 119th.
Icahn’s response to the Hindenburg attack was two-pronged. He called the report “self-serving” and “generated simply to allow the company to profit from its short position on IEP shares.” He also changed his questionable practice of issuing dividends in the form of additional shares of stock, with 85% going to him and his son. The company declared a dividend distribution of $2 per unit for the first quarter of the year, giving holders the right to elect either a cash option or additional units.
IEP gives investors exposure to Icahn’s personal portfolio of public and private companies in a wide range of industries, from energy to automotive to real estate. Over the past decade, an investment in IEP would have resulted in a 57% unrealized loss for shareholders.
Icahn isn’t about making companies better; he is about financial engineering. Wise investors would steer clear of this limited partnership.
Tu, 09 May 2023
IT Software & Services
Palantir shares soar 25% after strong earnings report, new AI tool announcement
Super-secretive data mining company Palantir (PLTR $10) saw its shares rise 25% following two announcements: quarterly earnings beat estimates and the firm is launching a major new artificial intelligence platform.
As for the first-quarter earnings report, revenue came in at $525 million, an 18% jump over Q1 of 2022, while GAAP net income hit $17 million—the second quarter in a row of GAAP profitability. CEO Alex Karp told shareholders he is confident the company will remain profitable “each quarter throughout the end of the year.” Adjusted income from operations came in at $125 million, well ahead of management’s projections for $91 million to $95 million. Government revenue rose 20% year-on-year, while commercial revenue—a major strategic focus—rose 39% from the previous quarter (15% year-on-year).
Those figures should have been enough to give PLTR shares a nice bump, but the exciting news came with the announcement of the company’s new AI tool, dubbed “AIP,” or AI Platform. Karp said he hasn’t seen demand like this (for a new product) in his twenty years at the company. Imagine a battlefield commander able to access a tool which displays and analyzes intel on enemy targets, identifies potentially hostile situations, proposes battle plans, and sends those plans to combatants in the field for execution. If not revolutionary, it is certainly an enormous evolutionary step.
AIP isn’t just for the military, however. Imagine the manager of a major shipping warehouse which lies in the path of a hurricane. Using private company data, AIP can analyze distribution at the warehouse for areas which are most likely to be affected, decide whether to expedite, delay, or cancel orders, and forecast the impact to revenues based on likely scenarios. All without writing one line of code. Karp says that within days of having the tool, customers will be able to build their own “collaborative AI agent.” The potential is staggering. Investors seemed to agree.
We have owned Palantir in the New Frontier Fund since its IPO and have no intention of selling it when it hits (again) our first target price of $20/share. This is an exceptional company unmatched in its critically important industry.
Mo, 08 May 2023
Transportation Infrastructure
Penn member Uber’s most excellent quarter
We have been big believers in transportation infrastructure company Uber (UBER $38) from its early days, even while analysts were throwing the company under the bus. We were undeterred by various government agencies’ attacks, arguments that competitors would eat away at market share, and two sizeable downturns in its share price. The company’s latest earnings report was what we expected: Uber delivered a beat on both revenue and earnings.
The company generated revenue of $8.82 billion in the first quarter, a 33% jump from Q1 of the previous year, and gross bookings rose 22%, to $31.4 billion. Adjusted EBITDA rose to $761 million (beating the company’s own guidance of $660M to $700M) and should rise as high as $850 million in the second quarter. Shares spiked 11% on the report.
The Mobility segment (ride-hailing) led the first-quarter charge, with gross bookings climbing 43%, while Delivery gross bookings were up 12%. The Freight division, which the company is considering spinning off or selling, was the laggard, with gross bookings down 23%. Uber’s network effect continues to gain momentum at the expense of the competition, chiefly Lyft (LYFT $9), and the company’s total addressable market points to strong growth ahead. Uber currently controls about one-third of the global ride-sharing market, and its food delivery service—currently 40% of revenue—should be a major growth driver going forward.
We maintain our $70 target price on Uber, a member of the Penn New Frontier Fund. That would represent an 85% share price increase from here, even after the post-earnings bump.
Tu, 02 May 2023
Education & Training Services
Shares of education services company Chegg are nearly halved after earnings report
One year ago, almost to the day, we wrote about the market’s irrational response to education services company Chegg’s (CHGG $9) quarterly earnings report. On that day, despite beating on the top and bottom line, the company’s shares were plummeting. That had nothing to do with the quarterly results and everything to do with management’s dour guidance. As we write this, it is déjà vu all over again.
As the session opened following Chegg’s after-market report, shares were cut nearly in half, falling from $17.60 to as low as $8.72. Once again, the company beat expectations on the top ($187.6M revs) and bottom ($2.2M net income) lines. Once again, it was management’s post-report commentary which sank the shares.
Chegg is an online educational resource for students, providing digital and physical textbook rentals, online tutoring, 24/7 homework help, and other student services. The company has “sticky” revenue, in that it charges students a monthly fee (starting at $15.95/mo) for access. With nearly ten million subscribers, the math looks pretty good. Unfortunately, CEO Dan Rosensweig sees a major challenge to the company’s revenue stream on the horizon: AI. Specifically, he sees more students turning to ChatGPT for homework help, which eats directly into Chegg’s core business. In fact, he specifically stated that the artificial intelligence chatbot will have “a direct impact on our new customer growth rate.”
Chegg was a $15 billion company just two years ago; it now has a market cap of $1.1 billion. With a strong business model and a single-digit multiple, it should be fine going forward, but it is not for the faint-of-heart investor.
The average price target among analysts who cover this company is $18.67 per share, though many may amend those targets down following this recent bloodbath. ValueLine has an 18-month price target band between $13 and $51 per share, while Morningstar gives the company a fair value of $28.13 per share. The price swings have been too crazy for us to touch the company right now. That said, we both like the Chegg business model and believe the AI hype is being overplayed—at least with respect to its near-term disruptive power.
Fr, 19 May 2023
Multiline Retail
Theft, plain and simple: Target expects over $1 billion worth of shrinkage this year
It is a sad testament to our society. Crimes being committed while the justice system looks the other way. Retailer Target (TGT $161) said it lost $763 million last fiscal year due to shrinkage, which is an industry term for the theft of goods. What’s more, the company expects that figure to increase by $500 million this year, bringing the total loss to over $1.2 billion. For a retailer which earned $2.8 billion in net income on $108 billion in sales over the trailing twelve months, that figure is substantial.
And Target is certainly not the only firm facing this problem. The National Retail Federation said that nearly $100 billion worth of goods were stolen in 2021, with the number of violent incidents on the rise. Target is battling the problem by installing more “protective fixtures” in its stores, which means inconvenience for paying customers. We were taken aback the first time we went into a CVS to buy shave blades, only to find them locked behind a plexiglass cover. Expect more items to be protected from theft in this manner. Also expect companies to continue closing locations in high-theft areas, meaning local residents will have to drive further to do their shopping.
Where there is a problem, there is also opportunity. Privately held OpenEye offers its OpenEye Web Services (OWS) system to clients to deter theft, reduce internal fraud, and generate valuable business intelligence for retail stores nationwide. Expect the rapid rise of AI to play a major role in theft prevention, with security companies rushing to apply the emerging technology to solutions for retailers. AI systems can be placed near checkout stands to account for every product in a customer’s possession. New Amazon (AMZN $118) Go convenience stores use advanced technology to scan all items in a cart and charge the customer automatically, negating the need for a checkout stand. Expect more retailers to adopt this technology within the next few years.
In an ideal world, all individuals would have the moral fiber required to not commit these crimes. As we don’t live in such a world, opportunities will be plentiful for creative security technology firms developing solutions for frustrated retailers.
Expect a slew of AI companies to go public over the next twelve to eighteen months; many of which will provide retail security solutions. In the meantime, our favorite pure automation company is Rockwell Automation (ROK $280), which provides intelligent devices and software to business clients, as well as consulting services. We own Rockwell in the Penn New Frontier Fund. For an interesting read on Amazon Go’s “just walk out” AI technology, visit here.
Mo, 15 May 2023
Capital Markets
The hunter becomes the prey: Icahn Enterprises falls 44% on short seller attack
We typically are about as much fans of short sellers as we are those bums who walk up to the “don’t come/don’t pass” line on the craps table. Get the pitchforks out. But now that Nathan Anderson has launched blistering attacks against both Jack Dorsey and Carl Icahn, we are quickly becoming admirers of his Hindenburg “forensic financial research firm.”
The attack on Icahn is poetic. Here is a man who bled TWA dry in the early 1990s, often attacks companies we love, and seemingly ignores the ones in true need of an overhaul. He doesn’t make companies better; he strips them of their value and leaves them for dead—along with their investors’ capital (in our humble opinion).
As for the Hindenburg attack, it is epic. The company’s report, entitled “The corporate raider throwing stones from his glass house,” likened Ichan’s company to a Ponzi scheme, able to survive only by getting new dupes, er, investors in at the bottom of the pyramid. Gutsy accusations against a man who has countless attack dog lawyers on speed dial. Icahn Enterprises LP (IEP $36) suffered its worst-ever day following the report, falling 20%. Icahn and his son own around 85% of the firm, which is now valued at $12 billion.
One particular focus of the report was a margin loan taken out by Icahn and backed by his ownership of IEP. This loan—or the lack of accounting for it—seemingly inflated the raider’s wealth by over $7 billion. When the loan and the market drop of IEP were taken into account, Icahn dropped from the 58th-wealthiest person in the world to the 119th.
Icahn’s response to the Hindenburg attack was two-pronged. He called the report “self-serving” and “generated simply to allow the company to profit from its short position on IEP shares.” He also changed his questionable practice of issuing dividends in the form of additional shares of stock, with 85% going to him and his son. The company declared a dividend distribution of $2 per unit for the first quarter of the year, giving holders the right to elect either a cash option or additional units.
IEP gives investors exposure to Icahn’s personal portfolio of public and private companies in a wide range of industries, from energy to automotive to real estate. Over the past decade, an investment in IEP would have resulted in a 57% unrealized loss for shareholders.
Icahn isn’t about making companies better; he is about financial engineering. Wise investors would steer clear of this limited partnership.
Tu, 09 May 2023
IT Software & Services
Palantir shares soar 25% after strong earnings report, new AI tool announcement
Super-secretive data mining company Palantir (PLTR $10) saw its shares rise 25% following two announcements: quarterly earnings beat estimates and the firm is launching a major new artificial intelligence platform.
As for the first-quarter earnings report, revenue came in at $525 million, an 18% jump over Q1 of 2022, while GAAP net income hit $17 million—the second quarter in a row of GAAP profitability. CEO Alex Karp told shareholders he is confident the company will remain profitable “each quarter throughout the end of the year.” Adjusted income from operations came in at $125 million, well ahead of management’s projections for $91 million to $95 million. Government revenue rose 20% year-on-year, while commercial revenue—a major strategic focus—rose 39% from the previous quarter (15% year-on-year).
Those figures should have been enough to give PLTR shares a nice bump, but the exciting news came with the announcement of the company’s new AI tool, dubbed “AIP,” or AI Platform. Karp said he hasn’t seen demand like this (for a new product) in his twenty years at the company. Imagine a battlefield commander able to access a tool which displays and analyzes intel on enemy targets, identifies potentially hostile situations, proposes battle plans, and sends those plans to combatants in the field for execution. If not revolutionary, it is certainly an enormous evolutionary step.
AIP isn’t just for the military, however. Imagine the manager of a major shipping warehouse which lies in the path of a hurricane. Using private company data, AIP can analyze distribution at the warehouse for areas which are most likely to be affected, decide whether to expedite, delay, or cancel orders, and forecast the impact to revenues based on likely scenarios. All without writing one line of code. Karp says that within days of having the tool, customers will be able to build their own “collaborative AI agent.” The potential is staggering. Investors seemed to agree.
We have owned Palantir in the New Frontier Fund since its IPO and have no intention of selling it when it hits (again) our first target price of $20/share. This is an exceptional company unmatched in its critically important industry.
Mo, 08 May 2023
Transportation Infrastructure
Penn member Uber’s most excellent quarter
We have been big believers in transportation infrastructure company Uber (UBER $38) from its early days, even while analysts were throwing the company under the bus. We were undeterred by various government agencies’ attacks, arguments that competitors would eat away at market share, and two sizeable downturns in its share price. The company’s latest earnings report was what we expected: Uber delivered a beat on both revenue and earnings.
The company generated revenue of $8.82 billion in the first quarter, a 33% jump from Q1 of the previous year, and gross bookings rose 22%, to $31.4 billion. Adjusted EBITDA rose to $761 million (beating the company’s own guidance of $660M to $700M) and should rise as high as $850 million in the second quarter. Shares spiked 11% on the report.
The Mobility segment (ride-hailing) led the first-quarter charge, with gross bookings climbing 43%, while Delivery gross bookings were up 12%. The Freight division, which the company is considering spinning off or selling, was the laggard, with gross bookings down 23%. Uber’s network effect continues to gain momentum at the expense of the competition, chiefly Lyft (LYFT $9), and the company’s total addressable market points to strong growth ahead. Uber currently controls about one-third of the global ride-sharing market, and its food delivery service—currently 40% of revenue—should be a major growth driver going forward.
We maintain our $70 target price on Uber, a member of the Penn New Frontier Fund. That would represent an 85% share price increase from here, even after the post-earnings bump.
Tu, 02 May 2023
Education & Training Services
Shares of education services company Chegg are nearly halved after earnings report
One year ago, almost to the day, we wrote about the market’s irrational response to education services company Chegg’s (CHGG $9) quarterly earnings report. On that day, despite beating on the top and bottom line, the company’s shares were plummeting. That had nothing to do with the quarterly results and everything to do with management’s dour guidance. As we write this, it is déjà vu all over again.
As the session opened following Chegg’s after-market report, shares were cut nearly in half, falling from $17.60 to as low as $8.72. Once again, the company beat expectations on the top ($187.6M revs) and bottom ($2.2M net income) lines. Once again, it was management’s post-report commentary which sank the shares.
Chegg is an online educational resource for students, providing digital and physical textbook rentals, online tutoring, 24/7 homework help, and other student services. The company has “sticky” revenue, in that it charges students a monthly fee (starting at $15.95/mo) for access. With nearly ten million subscribers, the math looks pretty good. Unfortunately, CEO Dan Rosensweig sees a major challenge to the company’s revenue stream on the horizon: AI. Specifically, he sees more students turning to ChatGPT for homework help, which eats directly into Chegg’s core business. In fact, he specifically stated that the artificial intelligence chatbot will have “a direct impact on our new customer growth rate.”
Chegg was a $15 billion company just two years ago; it now has a market cap of $1.1 billion. With a strong business model and a single-digit multiple, it should be fine going forward, but it is not for the faint-of-heart investor.
The average price target among analysts who cover this company is $18.67 per share, though many may amend those targets down following this recent bloodbath. ValueLine has an 18-month price target band between $13 and $51 per share, while Morningstar gives the company a fair value of $28.13 per share. The price swings have been too crazy for us to touch the company right now. That said, we both like the Chegg business model and believe the AI hype is being overplayed—at least with respect to its near-term disruptive power.
Headlines for the Month of April, 2023
We, 26 Apr 2023
Personal Finance
SECURE 2.0 added an interesting twist to the 529 college savings plan
The SECURE 2.0 Act of 2022 brought some 92 provisions to the way Americans save for retirement. While a few high-profile changes made the headlines, a little digging led to an obscure change to the popular 529 college savings plan.
The 529 plan, established a generation ago, allows parents or grandparents to put money away to help cover the costs of their kids’ or grandkids’ education—primarily college, but the program later expanded in scope to include primary and secondary education costs. Although contributions are not tax deductible, not only do the funds grow free from taxation, disbursements made for qualified expenses are also tax-free for the entire portion—including growth. If there has been one major issue with the program, it has been the challenge of what to do with any excess funds not used for education by the beneficiary or another qualifying family member. That is about to change.
Until now, if 529 funds were not used for education, any withdrawals would incur a 10% penalty along with full taxation. Beginning in 2024, assuming the plan has been opened for at least fifteen years, tax- and penalty-free distributions can be made to fund a Roth IRA for the beneficiary. As with any IRA, the annual contribution limit must be honored, and the owner of the Roth must have earned income equal or greater than the amount moved. For example, if a beneficiary made $10,000 in earned income, the full $6,500 (based on 2023 limits) annual contribution could be made. If the beneficiary earned $2,000 in income for the year, that would be the maximum qualified to roll over. There is also a $35,000 lifetime cap placed on the aggregate rollovers made from any given plan. If the 529 plan has not been established for fifteen years, that threshold must be simply be met before the rollovers can be made.
We have come a long way with respect to education funding since the days of the $500 max-contribution Education IRAs. With the runaway cost of attending college, it is important to understand all of the options available to avoid—or at least mitigate—decades-long loan payback periods. Financial advisors and planners can help guide you through the maze of options and strategies.
For clients looking at 529 plans or other education savings vehicles for their kids or grandkids, the Education Analysis section of the Personal Financial Website contains some great information regarding funding higher education, to include updated figures for specific schools. Goals can be created, various scenarios can be run, and different strategies can be evaluated. Initial information can be added by going to Profile>Goals>Add Goal>Education. Various scenarios can be run by going to the Education tab and then selecting Action Items. Finally, existing student loans can be evaluated by going to the Dashboard and selecting the Student Loan sub-tab.
Tu, 25 Apr 2023
Metals & Mining
Chile’s radical leftist leader underscores the country risk involved with lithium miners
High-grade lithium is a critical component to the new generation of batteries which are “fueling” the EV movement, and we have outlined some of our favorite lithium miners in the recent past. However, Chile’s leftist president, Gabriel Boric, provides us a glaring reminder of the country risk involved with investing in this industry.
Take Albemarle (ALB $182), the world’s largest lithium miner and an investor darling in the space. This North Carolina-based company (hence, Albemarle) has extensive operations in Chile in the form of salt brine deposits—the source of the mineral—and a major lithium conversion plant. Shares of the company plunged double digits last week after the Chilean leader unveiled plans to create a state-owned lithium company and take a majority stake in private mining companies. That sounds ominously similar to the language we heard out of Venezuela under Chavez and Maduro with respect to private oil operations.
Albemarle’s CEO, Jerry Masters, tried to put a spin on the news, saying that existing mining operations wouldn’t be affected, and that the announcement presents an “opportunity to work with the administration” going forward. Yes, because leftist leaders make such great business partners. The company does have operations in Australia and the United States as well, but we see trouble brewing for their Chilean fields. While Australia is the leading lithium producer in the world, Chile holds the world’s largest known reserves of the mineral.
Our favorite lithium miner is Livent Corp (LTHM $22), which was spun out of FMC in 2018. The company has major mining operations in Argentina as well as conversion plants in the US, Canada, and China. Investors should keep an eye on Tesla (TSLA $161), as we could see the EV leader purchasing a small-cap player in the space over the next year or two. Brazil-based Sigma Lithium (SGML $34) has been a rumored target, but it is more a speculative play.
Mo, 24 Apr 2023
Beverages
What consumer slowdown? Penn member Coca-Cola rocks the quarter
We keep hearing anecdotal stories about how the American consumer is pumping the breaks on discretionary spending, and what’s more discretionary than soda pop? Of course, Coca-Cola (KO $65) sells a lot more than “Coke” these days, owning such brands as BodyArmor, Costa Coffee, Dasani, Minute Maid, and around 200 other brands, but we were still expecting a relatively muted quarter. Instead, the 137-year-old beverage maker gave us a blockbuster.
The company generated $11 billion in revenue, besting last year’s Q1 numbers and beating analyst estimates, and earned $0.68 per share versus estimates of $0.65. Management also reiterated its full-year outlook for growth between 4% and 5% at a time when most other consumer brands are dampening expectations for the remainder of the year. Most impressively, Coke put these numbers together in the face of an 11% average selling price increase during the quarter. So, not only are consumers still buying Coca-Cola products, they are paying more to do so.
Coke has invested heavily in modernizing its supply chain and leveraging its strong bottler relationships in high-growth emerging markets. It has also built an impressive empire of brands, which is paying off in spades around the world. While many investors are looking to add international positions to their portfolio, consider this: Coca-Cola generated 65% of its sales in international markets last year. Costa Coffee alone has some 4,000 retail outlets outside of the United States. While no consumer goods company is completely immune to economic conditions, Coke’s exemplary management team has built an all-weather stalwart.
We added shares of Coca-Cola to the Penn Global Leaders Club during the heart of the pandemic downturn—March of 2020—and it has risen substantially since. Although shares have hit our primary price target of $65, this is precisely the type of firm we wish to own in a choppy economic environment.
Fr, 21 Apr 2023
Media & Entertainment
Netflix is ending its DVD-by-mail business; we didn’t know it was still around
Wow does time ever fly. We were early adopters of Netflix’s (NFLX $322) DVD-by-mail business back in the day, getting rather excited when we opened the mailbox to discover one of little red and white envelopes waiting for us. Could that really have been back in the late 1990s? In this new world of streaming, we just assumed that the service had already been abandoned, but that was not the case—at least until now. During its most recent earnings call, Netflix’s management team announced that it would be mothballing the business that forced Blockbuster—except that one in Bend, Oregon—to shut its doors. Over the past decade, as streaming has taken off, Netflix’s DVD revenue has been steadily declining, from nearly $1 billion a decade ago to under $150 million last year. Those 2022 figures accounted for just 4.5% of the company’s revenue for the year.
While Netflix arguably ushered in the era of streaming, it didn’t get off to a pretty start. We recall being outraged—along with millions of other Americans—back in 2011 when the company split its DVD and streaming services into two separate units, effectively doubling the cost of a subscription from $8 to $16 per month. Investors showed their disdain for the move, driving the share price of NFLX stock down some 80% between summer and the end of the year. In hindsight, that obviously would have been a great time to jump in, as the shares ultimately rose from $9 to $700 between winter of 2011 and winter of 2021—a 7,700% increase if we did our quick math correctly.
Of course, timing is everything. Anyone not selling in December of 2021 at $700 watched as their shares fell to $162 over the ensuing six-month period. And Q1’s earnings report offered investors a mixed bag, at best. Revenue rose a paltry 4% from last year, while Q2’s guidance was weaker than expected. The Street did like two new initiatives, an ad-supported subscription model and a promise to crack down on password sharing, but we are waiting to see subscriber reaction when their kids away at college are no longer able to login (without another subscription). Considering the seemingly perennial rate hikes ($15.49 is the current price of a standard plan), we do like the ad-based $6.99 per month plan, which should widen the company’s subscriber net. According to the company, about 5% of shows available on the standard plan won’t be available on the ad-supported subscription for contractual reasons.
A few more reasons we are steering clear right now are the economic environment and increased competition in the streaming space. Americans don’t want to lose access to their favorite shows, but when household discretionary funds get constricted, turning off the subscription is an easy way to cut down on costs. Especially when nothing would be lost (e.g., recorded programs) like when we change providers.
At $327 per share and with a forward P/E of 30, we believe Netflix shares are fairly valued. Additionally, we see two potential headwinds (as mentioned above) on the immediate horizon: backlash over the password crackdown and a possible recession (job losses are a lagging indicator). While we don’t see a 2011-type meltdown in the share price, we could envision them falling by one-third at some point this year. That would put them in the $220 range, at which time we might be tempted to jump back in. Management has made plenty of missteps over the past quarter century, but the shares have been nothing if not resilient.
Tu, 18 Apr 2023
Commercial Banks
Goldman Sachs bucks the quarterly banking trend with a revenue miss
So far, it has been a pretty good quarter for the big banks. And that makes sense, considering how net interest income should increase as rates rise. That has held true for the likes of JP Morgan, Chase, Citi, Wells Fargo, and Bank of America. Not so much for Goldman Sachs (GS $334), however. The $112 billion global investment bank missed revenue expectations, raking in $12.22 billion as opposed to the $12.76 billion analysts were expecting. In addition to the 5% drop in revenue from the same quarter last year, net income also fell. The bank earned $3.23 billion for the quarter, or 18% less that last year.
A major reason for the miss stems from Goldman’s decision to jettison its Marcus personal loan unit. The fatter margins at the other big banks have been due in good measure to their consumer loans (they have been able to charge higher rates to customers); meanwhile, Goldman has been reducing its exposure to this segment. In addition to ridding itself of Marcus, management announced it would begin the process of selling off its GreenSky unit, a specialty lender it bought just over a year ago. GreenSky was, ironically, designed to be a bolt-on acquisition to Marcus.
Unlike the other big banks, Goldman generates most of its revenue from its Wall Street dealings; understandably, considering higher rates, recession concerns, and the market downturn, this activity has been muted. An area they should have done well in is fixed income, yet they also disappointed in that arena. Fixed income trading revenue dropped 17% from last year, while equity trading revenue fell 7%.
If there was one positive nugget to point to in the quarterly results it was the company’s asset and wealth management division, which notched a 24% revenue increase—to $3.22 billion. But CEO David Solomon’s about face on consumer finance should send up red flags for investors. After all, just a few short years ago they were told that this would be a major catalyst for the company’s growth going forward.
Full disclosure: Not only has Financials been one of our most underweighted sectors over the past two years, we haven’t owned Goldman Sachs for over a decade—and have no plans to add it to any strategy anytime soon. We see little for investors to get excited about here.
Tu, 18 Apr 2023
Energy Exploration & Production
With Exxon Mobil reportedly eyeing the driller, is Pioneer Natural Resources a good buy?
Shares of Scott Sheffield’s Pioneer Natural Resources (PXD $227) spiked last week on reports that $500 billion integrated energy giant Exxon Mobil (XOM $115) had begun informal talks to acquire the E&P firm. Add in the former’s fat dividend yield of 12% and the Saudi’s recent million-barrel-per-day oil cut, and the $53 billion driller becomes worthy of a closer look.
Pioneer works exclusively in the Permian Basin region of West Texas, with average daily production of around 650,000 barrels of oil equivalent (BOE) and 2.2 billion BOE worth of proven reserves. The company’s product mix is approximately 60% oil and 40% natural gas. The impressive 12% dividend yield is a result of management’s objective of returning 80% of operating cash flow minus capital spending back to shareholders. But how likely is an acquisition, and how sustainable is the double-digit yield?
Exxon itself happens to be the fourth-largest driller in the Permian region, and buying Pioneer would allow the company to leapfrog over Occidental Petroleum (OXY $62) to become the largest player. It could also easily fund the acquisition, even with a premium demand from Pioneer: Exxon’s trailing twelve months (TTM) net income is $55 billion, which is still larger than the market cap of Pioneer following the recent price spike. And, unlike Exxon’s rather disastrous 2009 purchase of XTO Energy for $41 billion, Pioneer’s assets are proven, and it operates with industry-leading efficiency.
Two major factors could reduce the firm’s double-digit dividend yield: lower oil prices and increased capital spending. The latter is almost assured, as capex is expected to climb 20% due to inflation and the acquisition of new oil rigs. As for the price of oil, we see it topping out in the mid-$80s range (crude futures sit at $80.68 as of this writing). The company projects it will be able to maintain a $19 per share dividend with WTI near $80, which would equal an 8.3% dividend at current prices.
Whether or not a deal manifests, Pioneer is a solid driller with an enviable balance sheet. Holding just $5 billion worth of debt, the firm’s debt-to-equity ratio is 0.2176, and it holds a cash hoard of $1.2 billion. And for all the lip service being given to renewables, expect the fossil fuel E&P industry to remain strong for years to come.
Investors buying Pioneer to receive a 12% dividend yield will end up being disappointed—it is bound to drop into the single-digit range before long. The price also seems a bit rich to us, especially if the Exxon deal falls through. Our favorite play in the industry is Diamondback Energy (FANG $144), with its dividend yield of 6.6%; one of our least favorite "popular" players is Occidental Petroleum.
Th, 06 Apr 2023
Media & Entertainment
A judge is stopping AMC’s chief financial engineer from performing his latest magic act
As much as we write about AMC Entertainment (AMC $5), it may seem as though we have it out for the Leawood, Kansas-based firm. Not at all. We have it out for the financial engineer posing as a CEO, Adam Aron. Let’s first consider the financials of the theater chain. Take a look at the blue line on the graph below; that line represents shareholder equity, or all of the firm’s assets minus its liabilities. That blue line should never, ever, ever be below zero. AMC has a negative shareholder equity of $2.624 billion and a market cap of $2 billion. For some perspective, the money-losing car company Nikola (NKLA $1.22), which has produced something like 100 vehicles in total, has positive shareholder equity. This leads us to the current scheme of chief Snake Oil Salesman Adam Aron.
Last year we wrote of AMC’s fiendish idea to keep cold, hard cash from entering shareholders’ pockets by issuing preferred shares in lieu of cash for the payment of dividends. These new instruments began trading around the $7 range last summer. As a refresher on preferred stock: it usually comes with a par price of $25 per share and serves up a fat dividend—not used as one. Aron used these preferreds as sweeteners to keep shareholders happy, as they would ultimately be able to convert them to common stock. Not so fast, says a Delaware judge.
In addition to the conversion issue, Aron also wanted a 10-to-1 reverse stock split, which would price AMC common around $50 per share. Delaware Chancery Court Vice Chancellor Morgan Zurn wrote in a letter this week that “the parties offer no good cause to lift the status quo order.” Allowing this plan to proceed, wrote Zurn, would prevent the court from effectively overseeing a class action suit brought about against the chain by the Allegheny County Employees’ Retirement System, which claimed this has all been part of a strategy to dilute the voting power of AMC’s Class A stockholders. You think? The bigger question is why a county pension system would invest in such a speculative stock in the first place?
When the judge’s ruling hit the wires, AMC shares rose double digits while APE shares dropped double digits. APE trades for $1.50 as we write this. Living up to its moniker, shouldn’t this be the catalyst for a new wave of Apesters to jump in? After all, if the judge were to reverse his ruling today, they would be sitting on a 333% gain. Sure, AMC common would immediately drop in price, but it seems fitting to use a little fuzzy math when talking about APE shares.
One of these days, the cult of AMC will end and it will become a normal company once more. Until then, go to the craps table to gamble. Actually, that’s not really a fair comparison—there is a good deal of strategy involved in craps.
Tu, 04 Apr 2023
Space Sciences & Exploration
SPAC meltdown continues: Virgin Orbit goes belly up, is Virgin Galactic next?
In August of 2021 we had a picture of a circus tent on the cover of The Penn Wealth Report. The title of the issue was “This Will Not End Well.” Alongside meme stocks and NFTs was the acronym SPAC, which stands for special purpose acquisition company. It was all the rage back in the summer of ‘21—companies taking the “easy” route to the public markets. As the title indicated, we knew it was just a matter of time before these financial engineering schemes blew up, leaving investors holding the bag. The latest case study comes to us courtesy of Sir Richard Branson’s Virgin Orbit (VORB $0.19).
January 7th of 2022 was a big day for Virgin Orbit. It had recently merged with a SPAC known as NextGen Acquisition Corp II, and executives at the firm were on the floor of the NASDAQ to ring the opening bell. The concept behind the company was unique: instead of launching customer satellites from launch pads, it would load them in a rocket known as LauncherOne which was subsequently loaded on the underbelly of a modified Boeing 747. After the aircraft attained an altitude of around 35,000 feet, the rocket would be released from its pylon and then roar into space. Brilliant idea. Sadly, two of the six missions ended in failure, forcing the company to seek additional funding to stay afloat. After a few potential funding deals fell through, Virgin Orbit executed its final maneuver this week: filing for Chapter 11 Bankruptcy.
So what about Sir Richard’s other SPAC-initiated enterprise, space tourism company Virgin Galactic (SPCE $4)? After rising from $10 per share in its early trading days all the way up to $62.80 per share in February of 2021, the great plunge began (discounting a failed rally back to $52 the following July). That investors turned this into a $14 billion company despite the fact that no space tourists have yet to be launched made us think of the Apple TV show Hello Tomorrow!, in which a slick marketer dupes wide-eyed customers into buying nonexistent homes on the moon. Virgin Galactic’s revenue comes from the sale of tickets to the edge of space with the launch dates coming at some point in the future.
The commercialization of space and the business of space travel will be an incredibly exciting and lucrative undertaking, but investors should do a little reading on the history of failed ventures which took place as Europeans were looking to the New World with visions of riches dancing through their heads. Success will come, but the road will be strewn with many abject failures along the way.
Is there a way to potentially take advantage of the burgeoning commercial space movement today? Yes, but it comes with a high degree of risk. Our favorite play is SpaceX, which we own through The Private Shares Fund—an investment vehicle which owns privately held companies. We are riding a fat profit on our Aerojet Rocketdyne (AJRD $56) position, but that company will soon be acquired near where it currently trades. Another potential investment is Cathy Wood’s ARK Space Exploration & Innovation ETF (ARKX $14), which owns around 35 space-themed companies. Investors should exercise caution and not invest any amount of money in this field they are not willing to lose.
Mo, 27 Mar 2023
Global Strategy: Australasia
Oh, the rich irony: China and Russia claim Australia sub deal threatens the peace of the South China Sea
If there is one clear piece of the geopolitical puzzle, it is China’s desire to portray itself as the new power broker on the world stage. Say it enough and perhaps the world will believe you. Well, the global press pool, anyway. Xi, however (and certainly his new best friend Putin), seems to have a serious case of insecurity. While Xi and Putin were displaying their deep love for one another in Moscow, Beijing was busy decrying the so-called AUKUS submarine deal. But, as with NATO’s latest expansion, the deal probably would have never happened without the aggressive behavior of these two players.
Under the terms of the deal hammered out by Australia, the UK, and the United States (hence, AUKUS), the former will purchase a new fleet of up to five Virginia-class nuclear-powered submarines. The impetus for the deal is China’s growing threat to the South China Sea region, specifically with respect to Taiwan. Beyond the sale of the powerful subs comes something even more exciting: the development and deployment of a next-generation vessel to be dubbed the SSN-Aukus.
While nuclear powered, the subs won’t carry nuclear-tipped missiles, which makes China’s claims duplicitous. Australia’s foreign minister, Penny Wong, said that China’s criticism was “not grounded in fact.” A very nice way to put it. Anyone familiar with the outstanding series Succession, which just returned for its final season, knows our two-word response to China and its demand that the program be scrapped.
The new capabilities will be rolled out in three phases: first, the US and UK will send a rotational force of subs to Australia, with Australian sailors and workers getting hands-on experience both on the subs and in the shipyards; second will be the sale of the Virginia-class weapons platform to Australia; and third will be the development and deployment of the next generation SSN-Aukus. It should be noted that General Dynamics (GD $225) Electric Boat, which built the US Navy’s first commissioned undersea warship in 1899, has the contract to build the subs.
With this deal, and for the first time ever, the United States will share some of its highly classified submarine technology with the two staunch allies. The new sub will be based on a UK design and will incorporate Virginia-class features and technologies, such as stealth. As an aside, the French were also furious with the AUKUS announcement, as Australia had previously planned to buy 12 diesel-powered subs from that country. French government officials called the move a “stab in the back.” Since the initial outrage, the UK government has worked diligently to smooth over the flap.
We, 26 Apr 2023
Personal Finance
SECURE 2.0 added an interesting twist to the 529 college savings plan
The SECURE 2.0 Act of 2022 brought some 92 provisions to the way Americans save for retirement. While a few high-profile changes made the headlines, a little digging led to an obscure change to the popular 529 college savings plan.
The 529 plan, established a generation ago, allows parents or grandparents to put money away to help cover the costs of their kids’ or grandkids’ education—primarily college, but the program later expanded in scope to include primary and secondary education costs. Although contributions are not tax deductible, not only do the funds grow free from taxation, disbursements made for qualified expenses are also tax-free for the entire portion—including growth. If there has been one major issue with the program, it has been the challenge of what to do with any excess funds not used for education by the beneficiary or another qualifying family member. That is about to change.
Until now, if 529 funds were not used for education, any withdrawals would incur a 10% penalty along with full taxation. Beginning in 2024, assuming the plan has been opened for at least fifteen years, tax- and penalty-free distributions can be made to fund a Roth IRA for the beneficiary. As with any IRA, the annual contribution limit must be honored, and the owner of the Roth must have earned income equal or greater than the amount moved. For example, if a beneficiary made $10,000 in earned income, the full $6,500 (based on 2023 limits) annual contribution could be made. If the beneficiary earned $2,000 in income for the year, that would be the maximum qualified to roll over. There is also a $35,000 lifetime cap placed on the aggregate rollovers made from any given plan. If the 529 plan has not been established for fifteen years, that threshold must be simply be met before the rollovers can be made.
We have come a long way with respect to education funding since the days of the $500 max-contribution Education IRAs. With the runaway cost of attending college, it is important to understand all of the options available to avoid—or at least mitigate—decades-long loan payback periods. Financial advisors and planners can help guide you through the maze of options and strategies.
For clients looking at 529 plans or other education savings vehicles for their kids or grandkids, the Education Analysis section of the Personal Financial Website contains some great information regarding funding higher education, to include updated figures for specific schools. Goals can be created, various scenarios can be run, and different strategies can be evaluated. Initial information can be added by going to Profile>Goals>Add Goal>Education. Various scenarios can be run by going to the Education tab and then selecting Action Items. Finally, existing student loans can be evaluated by going to the Dashboard and selecting the Student Loan sub-tab.
Tu, 25 Apr 2023
Metals & Mining
Chile’s radical leftist leader underscores the country risk involved with lithium miners
High-grade lithium is a critical component to the new generation of batteries which are “fueling” the EV movement, and we have outlined some of our favorite lithium miners in the recent past. However, Chile’s leftist president, Gabriel Boric, provides us a glaring reminder of the country risk involved with investing in this industry.
Take Albemarle (ALB $182), the world’s largest lithium miner and an investor darling in the space. This North Carolina-based company (hence, Albemarle) has extensive operations in Chile in the form of salt brine deposits—the source of the mineral—and a major lithium conversion plant. Shares of the company plunged double digits last week after the Chilean leader unveiled plans to create a state-owned lithium company and take a majority stake in private mining companies. That sounds ominously similar to the language we heard out of Venezuela under Chavez and Maduro with respect to private oil operations.
Albemarle’s CEO, Jerry Masters, tried to put a spin on the news, saying that existing mining operations wouldn’t be affected, and that the announcement presents an “opportunity to work with the administration” going forward. Yes, because leftist leaders make such great business partners. The company does have operations in Australia and the United States as well, but we see trouble brewing for their Chilean fields. While Australia is the leading lithium producer in the world, Chile holds the world’s largest known reserves of the mineral.
Our favorite lithium miner is Livent Corp (LTHM $22), which was spun out of FMC in 2018. The company has major mining operations in Argentina as well as conversion plants in the US, Canada, and China. Investors should keep an eye on Tesla (TSLA $161), as we could see the EV leader purchasing a small-cap player in the space over the next year or two. Brazil-based Sigma Lithium (SGML $34) has been a rumored target, but it is more a speculative play.
Mo, 24 Apr 2023
Beverages
What consumer slowdown? Penn member Coca-Cola rocks the quarter
We keep hearing anecdotal stories about how the American consumer is pumping the breaks on discretionary spending, and what’s more discretionary than soda pop? Of course, Coca-Cola (KO $65) sells a lot more than “Coke” these days, owning such brands as BodyArmor, Costa Coffee, Dasani, Minute Maid, and around 200 other brands, but we were still expecting a relatively muted quarter. Instead, the 137-year-old beverage maker gave us a blockbuster.
The company generated $11 billion in revenue, besting last year’s Q1 numbers and beating analyst estimates, and earned $0.68 per share versus estimates of $0.65. Management also reiterated its full-year outlook for growth between 4% and 5% at a time when most other consumer brands are dampening expectations for the remainder of the year. Most impressively, Coke put these numbers together in the face of an 11% average selling price increase during the quarter. So, not only are consumers still buying Coca-Cola products, they are paying more to do so.
Coke has invested heavily in modernizing its supply chain and leveraging its strong bottler relationships in high-growth emerging markets. It has also built an impressive empire of brands, which is paying off in spades around the world. While many investors are looking to add international positions to their portfolio, consider this: Coca-Cola generated 65% of its sales in international markets last year. Costa Coffee alone has some 4,000 retail outlets outside of the United States. While no consumer goods company is completely immune to economic conditions, Coke’s exemplary management team has built an all-weather stalwart.
We added shares of Coca-Cola to the Penn Global Leaders Club during the heart of the pandemic downturn—March of 2020—and it has risen substantially since. Although shares have hit our primary price target of $65, this is precisely the type of firm we wish to own in a choppy economic environment.
Fr, 21 Apr 2023
Media & Entertainment
Netflix is ending its DVD-by-mail business; we didn’t know it was still around
Wow does time ever fly. We were early adopters of Netflix’s (NFLX $322) DVD-by-mail business back in the day, getting rather excited when we opened the mailbox to discover one of little red and white envelopes waiting for us. Could that really have been back in the late 1990s? In this new world of streaming, we just assumed that the service had already been abandoned, but that was not the case—at least until now. During its most recent earnings call, Netflix’s management team announced that it would be mothballing the business that forced Blockbuster—except that one in Bend, Oregon—to shut its doors. Over the past decade, as streaming has taken off, Netflix’s DVD revenue has been steadily declining, from nearly $1 billion a decade ago to under $150 million last year. Those 2022 figures accounted for just 4.5% of the company’s revenue for the year.
While Netflix arguably ushered in the era of streaming, it didn’t get off to a pretty start. We recall being outraged—along with millions of other Americans—back in 2011 when the company split its DVD and streaming services into two separate units, effectively doubling the cost of a subscription from $8 to $16 per month. Investors showed their disdain for the move, driving the share price of NFLX stock down some 80% between summer and the end of the year. In hindsight, that obviously would have been a great time to jump in, as the shares ultimately rose from $9 to $700 between winter of 2011 and winter of 2021—a 7,700% increase if we did our quick math correctly.
Of course, timing is everything. Anyone not selling in December of 2021 at $700 watched as their shares fell to $162 over the ensuing six-month period. And Q1’s earnings report offered investors a mixed bag, at best. Revenue rose a paltry 4% from last year, while Q2’s guidance was weaker than expected. The Street did like two new initiatives, an ad-supported subscription model and a promise to crack down on password sharing, but we are waiting to see subscriber reaction when their kids away at college are no longer able to login (without another subscription). Considering the seemingly perennial rate hikes ($15.49 is the current price of a standard plan), we do like the ad-based $6.99 per month plan, which should widen the company’s subscriber net. According to the company, about 5% of shows available on the standard plan won’t be available on the ad-supported subscription for contractual reasons.
A few more reasons we are steering clear right now are the economic environment and increased competition in the streaming space. Americans don’t want to lose access to their favorite shows, but when household discretionary funds get constricted, turning off the subscription is an easy way to cut down on costs. Especially when nothing would be lost (e.g., recorded programs) like when we change providers.
At $327 per share and with a forward P/E of 30, we believe Netflix shares are fairly valued. Additionally, we see two potential headwinds (as mentioned above) on the immediate horizon: backlash over the password crackdown and a possible recession (job losses are a lagging indicator). While we don’t see a 2011-type meltdown in the share price, we could envision them falling by one-third at some point this year. That would put them in the $220 range, at which time we might be tempted to jump back in. Management has made plenty of missteps over the past quarter century, but the shares have been nothing if not resilient.
Tu, 18 Apr 2023
Commercial Banks
Goldman Sachs bucks the quarterly banking trend with a revenue miss
So far, it has been a pretty good quarter for the big banks. And that makes sense, considering how net interest income should increase as rates rise. That has held true for the likes of JP Morgan, Chase, Citi, Wells Fargo, and Bank of America. Not so much for Goldman Sachs (GS $334), however. The $112 billion global investment bank missed revenue expectations, raking in $12.22 billion as opposed to the $12.76 billion analysts were expecting. In addition to the 5% drop in revenue from the same quarter last year, net income also fell. The bank earned $3.23 billion for the quarter, or 18% less that last year.
A major reason for the miss stems from Goldman’s decision to jettison its Marcus personal loan unit. The fatter margins at the other big banks have been due in good measure to their consumer loans (they have been able to charge higher rates to customers); meanwhile, Goldman has been reducing its exposure to this segment. In addition to ridding itself of Marcus, management announced it would begin the process of selling off its GreenSky unit, a specialty lender it bought just over a year ago. GreenSky was, ironically, designed to be a bolt-on acquisition to Marcus.
Unlike the other big banks, Goldman generates most of its revenue from its Wall Street dealings; understandably, considering higher rates, recession concerns, and the market downturn, this activity has been muted. An area they should have done well in is fixed income, yet they also disappointed in that arena. Fixed income trading revenue dropped 17% from last year, while equity trading revenue fell 7%.
If there was one positive nugget to point to in the quarterly results it was the company’s asset and wealth management division, which notched a 24% revenue increase—to $3.22 billion. But CEO David Solomon’s about face on consumer finance should send up red flags for investors. After all, just a few short years ago they were told that this would be a major catalyst for the company’s growth going forward.
Full disclosure: Not only has Financials been one of our most underweighted sectors over the past two years, we haven’t owned Goldman Sachs for over a decade—and have no plans to add it to any strategy anytime soon. We see little for investors to get excited about here.
Tu, 18 Apr 2023
Energy Exploration & Production
With Exxon Mobil reportedly eyeing the driller, is Pioneer Natural Resources a good buy?
Shares of Scott Sheffield’s Pioneer Natural Resources (PXD $227) spiked last week on reports that $500 billion integrated energy giant Exxon Mobil (XOM $115) had begun informal talks to acquire the E&P firm. Add in the former’s fat dividend yield of 12% and the Saudi’s recent million-barrel-per-day oil cut, and the $53 billion driller becomes worthy of a closer look.
Pioneer works exclusively in the Permian Basin region of West Texas, with average daily production of around 650,000 barrels of oil equivalent (BOE) and 2.2 billion BOE worth of proven reserves. The company’s product mix is approximately 60% oil and 40% natural gas. The impressive 12% dividend yield is a result of management’s objective of returning 80% of operating cash flow minus capital spending back to shareholders. But how likely is an acquisition, and how sustainable is the double-digit yield?
Exxon itself happens to be the fourth-largest driller in the Permian region, and buying Pioneer would allow the company to leapfrog over Occidental Petroleum (OXY $62) to become the largest player. It could also easily fund the acquisition, even with a premium demand from Pioneer: Exxon’s trailing twelve months (TTM) net income is $55 billion, which is still larger than the market cap of Pioneer following the recent price spike. And, unlike Exxon’s rather disastrous 2009 purchase of XTO Energy for $41 billion, Pioneer’s assets are proven, and it operates with industry-leading efficiency.
Two major factors could reduce the firm’s double-digit dividend yield: lower oil prices and increased capital spending. The latter is almost assured, as capex is expected to climb 20% due to inflation and the acquisition of new oil rigs. As for the price of oil, we see it topping out in the mid-$80s range (crude futures sit at $80.68 as of this writing). The company projects it will be able to maintain a $19 per share dividend with WTI near $80, which would equal an 8.3% dividend at current prices.
Whether or not a deal manifests, Pioneer is a solid driller with an enviable balance sheet. Holding just $5 billion worth of debt, the firm’s debt-to-equity ratio is 0.2176, and it holds a cash hoard of $1.2 billion. And for all the lip service being given to renewables, expect the fossil fuel E&P industry to remain strong for years to come.
Investors buying Pioneer to receive a 12% dividend yield will end up being disappointed—it is bound to drop into the single-digit range before long. The price also seems a bit rich to us, especially if the Exxon deal falls through. Our favorite play in the industry is Diamondback Energy (FANG $144), with its dividend yield of 6.6%; one of our least favorite "popular" players is Occidental Petroleum.
Th, 06 Apr 2023
Media & Entertainment
A judge is stopping AMC’s chief financial engineer from performing his latest magic act
As much as we write about AMC Entertainment (AMC $5), it may seem as though we have it out for the Leawood, Kansas-based firm. Not at all. We have it out for the financial engineer posing as a CEO, Adam Aron. Let’s first consider the financials of the theater chain. Take a look at the blue line on the graph below; that line represents shareholder equity, or all of the firm’s assets minus its liabilities. That blue line should never, ever, ever be below zero. AMC has a negative shareholder equity of $2.624 billion and a market cap of $2 billion. For some perspective, the money-losing car company Nikola (NKLA $1.22), which has produced something like 100 vehicles in total, has positive shareholder equity. This leads us to the current scheme of chief Snake Oil Salesman Adam Aron.
Last year we wrote of AMC’s fiendish idea to keep cold, hard cash from entering shareholders’ pockets by issuing preferred shares in lieu of cash for the payment of dividends. These new instruments began trading around the $7 range last summer. As a refresher on preferred stock: it usually comes with a par price of $25 per share and serves up a fat dividend—not used as one. Aron used these preferreds as sweeteners to keep shareholders happy, as they would ultimately be able to convert them to common stock. Not so fast, says a Delaware judge.
In addition to the conversion issue, Aron also wanted a 10-to-1 reverse stock split, which would price AMC common around $50 per share. Delaware Chancery Court Vice Chancellor Morgan Zurn wrote in a letter this week that “the parties offer no good cause to lift the status quo order.” Allowing this plan to proceed, wrote Zurn, would prevent the court from effectively overseeing a class action suit brought about against the chain by the Allegheny County Employees’ Retirement System, which claimed this has all been part of a strategy to dilute the voting power of AMC’s Class A stockholders. You think? The bigger question is why a county pension system would invest in such a speculative stock in the first place?
When the judge’s ruling hit the wires, AMC shares rose double digits while APE shares dropped double digits. APE trades for $1.50 as we write this. Living up to its moniker, shouldn’t this be the catalyst for a new wave of Apesters to jump in? After all, if the judge were to reverse his ruling today, they would be sitting on a 333% gain. Sure, AMC common would immediately drop in price, but it seems fitting to use a little fuzzy math when talking about APE shares.
One of these days, the cult of AMC will end and it will become a normal company once more. Until then, go to the craps table to gamble. Actually, that’s not really a fair comparison—there is a good deal of strategy involved in craps.
Tu, 04 Apr 2023
Space Sciences & Exploration
SPAC meltdown continues: Virgin Orbit goes belly up, is Virgin Galactic next?
In August of 2021 we had a picture of a circus tent on the cover of The Penn Wealth Report. The title of the issue was “This Will Not End Well.” Alongside meme stocks and NFTs was the acronym SPAC, which stands for special purpose acquisition company. It was all the rage back in the summer of ‘21—companies taking the “easy” route to the public markets. As the title indicated, we knew it was just a matter of time before these financial engineering schemes blew up, leaving investors holding the bag. The latest case study comes to us courtesy of Sir Richard Branson’s Virgin Orbit (VORB $0.19).
January 7th of 2022 was a big day for Virgin Orbit. It had recently merged with a SPAC known as NextGen Acquisition Corp II, and executives at the firm were on the floor of the NASDAQ to ring the opening bell. The concept behind the company was unique: instead of launching customer satellites from launch pads, it would load them in a rocket known as LauncherOne which was subsequently loaded on the underbelly of a modified Boeing 747. After the aircraft attained an altitude of around 35,000 feet, the rocket would be released from its pylon and then roar into space. Brilliant idea. Sadly, two of the six missions ended in failure, forcing the company to seek additional funding to stay afloat. After a few potential funding deals fell through, Virgin Orbit executed its final maneuver this week: filing for Chapter 11 Bankruptcy.
So what about Sir Richard’s other SPAC-initiated enterprise, space tourism company Virgin Galactic (SPCE $4)? After rising from $10 per share in its early trading days all the way up to $62.80 per share in February of 2021, the great plunge began (discounting a failed rally back to $52 the following July). That investors turned this into a $14 billion company despite the fact that no space tourists have yet to be launched made us think of the Apple TV show Hello Tomorrow!, in which a slick marketer dupes wide-eyed customers into buying nonexistent homes on the moon. Virgin Galactic’s revenue comes from the sale of tickets to the edge of space with the launch dates coming at some point in the future.
The commercialization of space and the business of space travel will be an incredibly exciting and lucrative undertaking, but investors should do a little reading on the history of failed ventures which took place as Europeans were looking to the New World with visions of riches dancing through their heads. Success will come, but the road will be strewn with many abject failures along the way.
Is there a way to potentially take advantage of the burgeoning commercial space movement today? Yes, but it comes with a high degree of risk. Our favorite play is SpaceX, which we own through The Private Shares Fund—an investment vehicle which owns privately held companies. We are riding a fat profit on our Aerojet Rocketdyne (AJRD $56) position, but that company will soon be acquired near where it currently trades. Another potential investment is Cathy Wood’s ARK Space Exploration & Innovation ETF (ARKX $14), which owns around 35 space-themed companies. Investors should exercise caution and not invest any amount of money in this field they are not willing to lose.
Mo, 27 Mar 2023
Global Strategy: Australasia
Oh, the rich irony: China and Russia claim Australia sub deal threatens the peace of the South China Sea
If there is one clear piece of the geopolitical puzzle, it is China’s desire to portray itself as the new power broker on the world stage. Say it enough and perhaps the world will believe you. Well, the global press pool, anyway. Xi, however (and certainly his new best friend Putin), seems to have a serious case of insecurity. While Xi and Putin were displaying their deep love for one another in Moscow, Beijing was busy decrying the so-called AUKUS submarine deal. But, as with NATO’s latest expansion, the deal probably would have never happened without the aggressive behavior of these two players.
Under the terms of the deal hammered out by Australia, the UK, and the United States (hence, AUKUS), the former will purchase a new fleet of up to five Virginia-class nuclear-powered submarines. The impetus for the deal is China’s growing threat to the South China Sea region, specifically with respect to Taiwan. Beyond the sale of the powerful subs comes something even more exciting: the development and deployment of a next-generation vessel to be dubbed the SSN-Aukus.
While nuclear powered, the subs won’t carry nuclear-tipped missiles, which makes China’s claims duplicitous. Australia’s foreign minister, Penny Wong, said that China’s criticism was “not grounded in fact.” A very nice way to put it. Anyone familiar with the outstanding series Succession, which just returned for its final season, knows our two-word response to China and its demand that the program be scrapped.
The new capabilities will be rolled out in three phases: first, the US and UK will send a rotational force of subs to Australia, with Australian sailors and workers getting hands-on experience both on the subs and in the shipyards; second will be the sale of the Virginia-class weapons platform to Australia; and third will be the development and deployment of the next generation SSN-Aukus. It should be noted that General Dynamics (GD $225) Electric Boat, which built the US Navy’s first commissioned undersea warship in 1899, has the contract to build the subs.
With this deal, and for the first time ever, the United States will share some of its highly classified submarine technology with the two staunch allies. The new sub will be based on a UK design and will incorporate Virginia-class features and technologies, such as stealth. As an aside, the French were also furious with the AUKUS announcement, as Australia had previously planned to buy 12 diesel-powered subs from that country. French government officials called the move a “stab in the back.” Since the initial outrage, the UK government has worked diligently to smooth over the flap.
Headlines for the Month of March, 2023
Mo, 27 Mar 2023
Global Strategy: Australasia
Oh, the rich irony: China and Russia claim Australia sub deal threatens the peace of the South China Sea
If there is one clear piece of the geopolitical puzzle, it is China’s desire to portray itself as the new power broker on the world stage. Say it enough and perhaps the world will believe you. Well, the global press pool, anyway. Xi, however (and certainly his new best friend Putin), seems to have a serious case of insecurity. While Xi and Putin were displaying their deep love for one another in Moscow, Beijing was busy decrying the so-called AUKUS submarine deal. But, as with NATO’s latest expansion, the deal probably would have never happened without the aggressive behavior of these two players.
Under the terms of the deal hammered out by Australia, the UK, and the United States (hence, AUKUS), the former will purchase a new fleet of up to five Virginia-class nuclear-powered submarines. The impetus for the deal is China’s growing threat to the South China Sea region, specifically with respect to Taiwan. Beyond the sale of the powerful subs comes something even more exciting: the development and deployment of a next-generation vessel to be dubbed the SSN-Aukus.
While nuclear powered, the subs won’t carry nuclear-tipped missiles, which makes China’s claims duplicitous. Australia’s foreign minister, Penny Wong, said that China’s criticism was “not grounded in fact.” A very nice way to put it. Anyone familiar with the outstanding series Succession, which just returned for its final season, knows our two-word response to China and its demand that the program be scrapped.
The new capabilities will be rolled out in three phases: first, the US and UK will send a rotational force of subs to Australia, with Australian sailors and workers getting hands-on experience both on the subs and in the shipyards; second will be the sale of the Virginia-class weapons platform to Australia; and third will be the development and deployment of the next generation SSN-Aukus. It should be noted that General Dynamics (GD $225) Electric Boat, which built the US Navy’s first commissioned undersea warship in 1899, has the contract to build the subs.
With this deal, and for the first time ever, the United States will share some of its highly classified submarine technology with the two staunch allies. The new sub will be based on a UK design and will incorporate Virginia-class features and technologies, such as stealth. As an aside, the French were also furious with the AUKUS announcement, as Australia had previously planned to buy 12 diesel-powered subs from that country. French government officials called the move a “stab in the back.” Since the initial outrage, the UK government has worked diligently to smooth over the flap.
Mo, 27 Mar 2023
Energy Commodities
No more excuses: begin refilling the Strategic Petroleum Reserve
With a capacity of 714 million barrels, the Strategic Petroleum Reserve, or SPR, is the world’s largest stockpile of oil. Held in underground tanks in Louisiana and Texas, this Department of Energy-maintained stash was a direct result of the 1973 energy crisis when OPEC labeled the United States a “hostile entity” and embargoed all oil exports to the country. To any American who vividly remembers that time, the current state of the SPR is appalling.
Now sitting at its lowest level since 1983—a time at which our energy needs were much lower—the SPR is just over half full (372 million barrels). Over the course of the past two years, the Biden administration has authorized the release of a staggering 266 million barrels of crude for no strategic reason, simply the tactical reason of lowering the price at the pump. That was never what the program was intended for.
As for refilling the SPR, last October the administration cited high prices and further stated that a program would be put in place to begin refilling the reserve when oil fell into the $67 to $72 per barrel range. It dropped down to that range in the middle of March, leading to the latest round of excuses.
When questioned about the lack of action, Energy Secretary Jennifer Granholm said it would take years to replenish the tanks. All we could think of was Ronald Reagan’s classic response to the argument that his Star Wars program would take decades to implement: “Well, then let’s get started.” Granholm’s response was not exactly Reaganesque: “This year it will be difficult for us to take advantage of this low price.” She laid the blame on Congress and maintenance work being done at two of the four SPR sites. No more excuses; it is time to refill this critical component of America’s energy security.
The Saudis were reportedly irked by Granholm's comments that the administration would not begin refilling the SPR this year, directly leading to the OPEC+ announcement that it would cut 1.1 million barrels per day of production between May and the end of the year. That led to a sudden spike in the price of crude, which now sits at $80.54 per barrel. Complete and utter ineptness directly led to American consumers paying more at the pump. What's next, another massive release from the SPR?
We, 22 Mar 2023 Fed raises rates 25 bps
Fed raises rates 25 basis points, to a range of 4.75%-5% upper limit. Odds say 62% chance of another hike in May (next meeting), but we believe the Fed is done. Markets positive to flat while Powell is giving his briefer. By end of session, Dow falls 530 points because Powell did not indicate rate cuts on the horizon this year. Of course he didn't! Completely irrational markets. The US economy can handle these rates.
Tu, 21 Mar 2023
Consumer Finance
The end of easy money: auto loan rejection rate spikes
If the Fed is still looking for evidence that its tightening policy is working, look no further than the auto market. More and more consumers are being rejected for auto loans, with the 9.1% rate marking the highest level in six years. Furthermore, the trajectory has been steep: last October the rejection rate was 5.8%. Auto loan delinquency rates are also rising, going from roughly 2% at the end of 2021 to nearly 4% at the end of last year.
We never thought the 72-month loan was a good idea; now, with the average new vehicle going for nearly $50,000 and interest rates substantially higher, it may take some borrowers that long to pay off the loans. In fact, according to consumer finance services company Bankrate.com, the average payment for a new vehicle is $716 per month, with nearly one in five buyers paying over $1,000 per month. Not long ago, that was a house payment.
Sticker shock has sent many consumers to the used car lots, but that picture isn’t much rosier. The average used car price is $30,000 (substantially higher in many states), and the lack of new vehicles produced during the first year of the pandemic has added strain to the system. Most buyers prefer a late model used vehicle with under 50,000 miles of wear and tear. Of course, another reason for the dearth of vehicles—and higher used car prices—is the fact that would-be sellers realize they would have to pay a much higher interest rate for their new ride—the same challenge the housing market is facing right now. Perhaps it is time to take another look at the do-it-yourself auto repair retailers.
Eventually, this problem will work itself out. While rates will almost certainly stay higher for longer, the trajectory of inflation in this market is unsustainable. Our favorite used car dealership remains CarMax (KMX $59), which is down 62% from its high share price and trading at a reasonable multiple of seventeen. Our favorite DIY shop is Advance Auto Parts (AAP $120), which has a tiny forward P/E of ten, and a solid customer mix of 60% commercial and 40% consumer clients. By the way, the largest auto finance company is Ally Financial (ALLY $25).
Su, 19 Mar 2023
Bank failures and Fed speculation drove the markets this week
At the end of this frenzied trading week, it was fitting that the only green which would show up on Friday, St. Patrick's Day, was gold—it rose 6% over the course of five days. Rising gold prices are often in response to economic instability and concerns over monetary policy, so the precious metal's surge makes perfect sense.
The week began with news of Signature Bank's collapse, and the only thing standing in the way of a market rout was the government's promise that all depositors at the failed banks would be immediately made whole. The focus quickly turned to what Fed Chair Powell would do at the following week's FOMC meeting. We went from high odds for a 50 bps hike, to calls for an immediate pause while the damage was assessed, to expectations for a 25 bps hike (what we have been—and still are—expecting). Odds increased for the last option when ECB President Christine Lagarde stuck by her guns and raised rates in the EU by 50 bps. Any pause, the pundits argued, would signal fear that the government didn't believe it could contain the new banking crisis.
By late in the week, the domestic banking crisis made its way across the pond to a troubled European institution: Credit Suisse. After the company delayed its annual report and shades of SVB and Signature began gripping investors, the largest shareholder—the Saudi National Bank—said it would not come to the rescue with new funding. On Friday, the Financial Times reported that fellow Swiss bank UBS might be a reluctant suitor (earlier in the week, the $57 billion behemoth said it had little interest in buying the troubled bank). As we write this, UBS has offered $1 billion to take over Credit Suisse, which had a market cap of $35 billion just two years ago and $8 billion at the beginning of the month. Meanwhile, Switzerland is considering nationalizing the firm if the UBS deal fails. Stunning.
Considering everything that happened over the course of five days, it is rather impressive that the benchmarks were relatively unchanged. The NASDAQ, in fact, gained 4.4% on the week. One thing is certain: tech startups which had little trouble securing loans in the zero interest rate environment are going to face much higher hurdles—and debt servicing costs—going forward. Which makes it somewhat strange that the tech-laden benchmark put together a positive week.
The same issues that drove markets this past week will drive them this week: global concerns about the financial strength of middle market and regional banks, and how the Fed will balance battling inflation with these new banking concerns. Expect the Fed's balance sheet reduction program to be placed on pause just as it was beginning to show results.
Mo, 13 Mar 2023
Financial Services
One week, three bank failures; shades of 2008?
We all recall the nightmarish string of bank failures back in 2008 stemming from toxic mortgage-backed securities poisoning the capital of these doomed giants. While we are certainly not at that level of concern right now, the failure of three banks over the course of a few days has the markets on edge.
First came Silvergate Capital (SI $2), the premier lender to the cryptocurrency industry. The California state-chartered bank, which provided financial services such as commercial banking, business lending, and cash management to its customers, sent up red flags when it announced it was closing its Silvergate Exchange Network which served as a bridge between traditional banking services and the crypto world. Then the company said it would not be able to file its required 10-K to the SEC on time. That was all it took for a run on the bank: customers began pulling out some $8 billion worth of deposits, forcing Silvergate to secure a loan from the Home Bank Loan system. Furthermore, the bank was forced to sell the solid assets on its balance sheet such as Treasuries and securitized residential mortgage loans at discount prices to fund the customer withdrawals. These assets were discounted because of the Fed rate hikes—the bank simply didn’t have the luxury of waiting for the securities to mature at par. By late in the week, Silvergate announced it was winding down its operations. Sadly, the story did not end there.
Silicon Valley Bank, the major arm of SVB Financial Group (SVB, trading halted), collapsed on Friday, becoming the second-largest bank failure in US history (Washington Mutual, which failed during the financial crisis, was the largest). The FDIC quickly moved in to take control, creating a new entity called the Deposit Insurance National Bank of Santa Clara. SVB was the 16th largest bank in the country, with around $210 billion in assets, and was the go-to bank for tech startup firms—many of whom wouldn’t have been able to access funding otherwise.
As for cryptocurrency shops, the preferred lender behind Silvergate has been New York-based Signature bank (SBNY, trading halted). On Sunday, regulators closed the doors of this institution, which held nearly $100 billion on deposit. New York Governor Kathy Hochul said this did not amount to a taxpayer bailout, as the funds required to pay back depositors would come from "the fees assessed on all banks." She was referring to the Deposit Insurance Fund, which will guarantee money above and beyond the FDIC limit—or "uninsured" funds.
These closures lead many to wonder why companies would not have better risk management with respect to their deposits, spreading around their money to a number of different financial institutions. For example, streaming device company Roku said it had some $500 million—or 26% of its cash reserves—in an account at SVB. A who’s who list of prominent companies have already announced they are in a similar situation. Per one seasoned venture capitalist, if a tech startup received loans from a bank, that institution pretty much demanded that the bulk of their cash be kept at the firm. Furthermore, tech companies overwhelmingly trusted SVB, Silvergate, and Signature. They simply couldn't believe there would ever be a run on these banks.
In the wake of these meltdowns and with rates much higher rates than a year ago, these tech startups must now be wondering where they can possibly turn for new sources of funding. The troubles in Silicon Valley won't go away with the government's promised backstop.
Two thoughts come to mind. As the interest rate hike cycle began, we were told how this would help the major financial institutions, as their net interest income—the difference between what they could make on loans and what they had to pay on investors’ deposits—would increase greatly. We didn’t buy that argument this time around, and Financial Services remains our most underweighted sector. Second thought: Many experts have been saying for the past several months that the Fed would continue to raise rates until they “broke things.” Mission accomplished. If the hot jobs numbers and the recent inflation reports were pointing to a 50 bps hike at the March meeting, the broken pieces laying on the floor around them should give the Fed pause. We still believe a 25-bps hike will be announced on the 20th, but odds for an immediate pause are growing. And 50 bps is now all but off the table.
Th, 09 Mar 2023
Technology Hardware & Equipment
Exit, stage left: Apple is expediting its move out of China and into India
India just surpassed China as the world’s most populous nation, with 1.412 million citizens, but size is just a minor factor in Apple’s (AAPL $152) hurried exodus out of the communist nation and into the South Asian country. The world’s largest publicly traded company ($2.4 trillion as of this writing) had a rare contraction in sales of 5.5% in the last quarter of 2022 as compared to the prior year, but it posted record revenues in India. Couple that with China’s growing ties to Russia, a continuing Covid nightmare in the country, and saber-rattling against the West (especially the US), and it makes sense that Apple would be packing up, so to speak, and heading west. And where Apple goes, its suppliers are sure to follow.
Key suppliers to the Cupertino-based firm are increasingly being asked one question by their corporate customers: “When can you move out (of China)?” An executive at GoerTek, an AirPods manufacturer, said that 90% of his American tech firm clients are asking that question on a near-constant basis, and the pressure is growing. While Vietnam has been a major destination for many of these firms, India has been building momentum. For the first time ever, Apple has designated India as its own region, as opposed to simply being part of a larger geographic area including Middle Eastern, Eastern European, and African nations. Somewhat surprisingly, Apple still doesn’t have a physical footprint in India via retail outlets, but that will change beginning later this year. Apple recently created an online store dedicated to serving its Indian customers.
In addition to reading the writing on the wall with respect to increasingly strained US-China relations, Apple has faced tumult at its Chinese facilities recently. Late last year, at its massive Foxconn plant in Zhengzhou, violent protests broke out as workers rioted against low pay and Covid restrictions. Up to 85% of iPhone Pros had been produced at that facility. It appears as though Apple is finally getting the message.
Why did it take so long for American companies to wake up to the risks of concentrating operations in a state-controlled country? Quite simply, they were chasing profits and ignoring the obvious threats. A little over a generation ago, Americans could flip over common retail goods and read the “Made in Japan” label. Overwhelmingly, those labels now read “Made in China.” It will take some time to change that, but the exodus has begun—and we don’t see anything on the horizon that will derail the movement.
Tu, 07 Mar 2023
Housing
The Fed is raising rates to cool inflation, but one segment will remain immune
The long-term average 30-year mortgage rate is 7.75%; as of this writing—despite what the accompanying chart shows—we have retaken the 7% level. While 7.75% is the long-term average, the ten-year average mortgage rate sits at 4%; but, for a brief two-year period, we sat in a trench below that level. The typical American may make some poor financial decisions, but a large percentage of the US population did something brilliant over that spell: they either financed a new purchase at rock-bottom rates or they refinanced their existing home with a fixed-rate loan. While 10% of current home loans are the adjustable-rate (ARM) variety, that is well below the historic average (40% of mortgage loans were ARMs back in 2006, for example). For Americans locking in 2.65% to 4% rates, it is time to celebrate. For the Fed, not so much.
The Fed has a dual mandate: keep the unemployment rate reasonably low and keep inflation somewhere around the 2% rate. While the first mandate has obviously been met, the central bank continues to raise rates in an effort to bring down the stubbornly high level of inflation. Were they operating in most other countries (a 30-year fixed-rate home loan is a uniquely American experience), they would be having an easier time. However, the 40% of homeowners who took out those low-rate loans in either 2020 or 2021 are immune from the Fed’s actions—at least with respect to their largest expense. They may be locked into their existing home, but that extra purchasing power will remain intact for decades. Sadly, evidence is mounting that many Americans are once again spending beyond their means: credit card balances just hit a new record high. And for anyone who has looked at their credit card interest rates lately, it is clear that the banks wasted no time in spiking those very-adjustable rates.
With such a large percentage of homeowners locked into their current homes due to low mortgage rates, the housing industry will continue to be negatively impacted. In a warped sense, this is what the Fed wants to see—lower or stagnate home prices due to reduced demand, and higher unemployment in the industry due to a pullback in construction. Investors should keep in mind that the homebuilders reside in the Consumer Discretionary sector; a segment which is already facing headwinds due to the probable recession on the horizon. We have been underweighting this sector since the middle of last year.
Headlines for the Month of February, 2023
Mo, 27 Feb 2023
East/Southeast Asia
Xi tells China’s military establishment to be prepared for Taiwan invasion by 2027
According to CIA Director William Burns, Chinese President Xi Jinping has conveyed a strategic message to the People’s Liberation Army: Be prepared to invade and take control of Taiwan by 2027. To be clear, there is no possible scenario in Xi’s mind in which Taiwan is not fully under the thumb of Beijing. If anyone still believes that they don’t understand the mind of a communist like Xi and the history of Taiwan going back to 1949. Jimmy Carter certainly didn’t understand the mind of a Chinese communist, or he wouldn’t have cut ties with a democratic Taiwan in favor of improved relations with Beijing. But the myopia certainly hasn’t been limited to one party: both sides have been in power as the US became overly reliant on cheap goods and an enormous potential market in the East. Never mind that the Western values of individual liberty and personal freedom are anathema to communism. We wonder if anyone ever believed that the balance of trade between the US and China would be anything other than grossly lopsided?
Now, despite that country’s unwillingness to take any responsibility for the pandemic unleashed on the world, many want us to believe that Xi is sitting back, watching his buddy Putin sink in the quicksand that is Ukraine, and second-guessing his plans to invade Taiwan. He is probably furious at his friend for shining the spotlight on the similarities between Ukraine and Taiwan with respect to their bully neighbors, but he would be sending arms to Russia for use in the conflict right now if the world weren’t watching his actions so closely. Just before the start of the Olympics, Putin promised Xi two things: that he would wait to invade until after the games had concluded, and that war would be swift and victory assured. Xi must be taken aback by both the toughness of the Ukrainian people and the cohesion of the Western world against this horrific act.
The West must now make it clear that we are willing to defend Taiwan (and the president has said as much), and that a swift victory would not be possible. His mind may still be made up, but doubt has crept in—at least about going in before 2027.
Americans should pay attention to where the goods they buy are sourced and also have a basic understanding of the modern geopolitical world. For example, Vietnam has been a major recipient of US manufacturing deals as companies scramble to exit China; Vietnam has strained relations with China and continues to be a growing economic partner to the US. The same could be said of Malaysia, Bangladesh, Taiwan, and India—though the latter has ruffled feathers with its continued purchase of Russian energy. The United States played a major role in China’s economic growth over the past generation. Now, with a full understanding of that nation’s strategic plans, we have the power to impede that growth trajectory. But do we have the stomach for it?
Th, 23 Feb 2023
Metals & Mining
Two catalysts for lithium miners' recent volatility: Tesla and a Chinese battery company
In the mad dash to create more efficient batteries for electric vehicles, few elements, literally, are more important than high-grade lithium. Mining projects to produce this valuable element, however, are costly and can take years to get up and running. These factors should make current lithium miners extremely valuable; and, in fact, a look at the three year returns for the major players shows them far outpacing the performance of their respective benchmark indexes. But last Friday something odd happened: lithium miners got crushed, falling around 10% on average and leaving investors befuddled as to why.
It turns out that two companies on different sides of the planet led to the drop. In China, the world’s largest EV battery maker, Contemporary Amperex Technology (aka CATL), pulled a fast one. Without warning, the company changed its pricing structure on batteries to a lithium-based model, which had the effect of greatly reducing the price it charges per unit. Since CATL produces its own lithium from company-owned mines, it has the ability to reduce profit margins on the input side to virtually nothing—a luxury most EV battery makers don’t have.
With CATL’s actions in mind, it recently came to light that major US electric battery producer Tesla (TSLA $202) may be interested in acquiring mid-cap ($3.6B) miner Sigma Lithium Corp (SGML $35). This Vancouver-based company mines high-purity lithium from its enormous mining operation in Brazil. While the other miners were watching their shares plunge, SGML shares were busy spiking nearly 20%.
While Tesla said that Sigma is but one of many options being considered, it clearly wants to control its own mining operation. For a company with a clear history of vertical integration, the move makes perfect sense. Close to the port city of Corpus Christi, Tesla is in the process of building its own lithium processing plant, scheduled to be up and running by next year. Investors are betting that a company-owned mining firm won’t be far behind. If it doesn’t turn out to be Sigma, however, look for those shares to plunge back to earth.
Yes, Tesla shares have doubled in price since January 6th, but we still consider them a bargain. As for the miners, we prefer industry leader Albermarle (ALB $252, $35B market cap) and small-cap miner Lithium Americas Corp (LAC $23, $3.5B market cap). The latter is developing three new lithium production facilities—two in Argentina and one in Nevada—with the ultimate goal of splitting into two companies based on geography. The need to diversify away the risk of relying on China for critical elements and rare earth minerals has never been more evident, which should provide ample opportunity in the space for astute investors looking closer to home.
Th, 16 Feb 2023
Hotels, Resorts, & Cruise Lines
Airbnb stock soars after its first fully profitable year
On 07 December 2022, just over two months ago, Morgan Stanley downgraded travel services company Airbnb (ABNB $143) and slashed its price target to $80 per share. The shares immediately fell 5% on the news, and we immediately added the company to the Penn Global Leaders Club. We didn’t buy into the analyst’s narrative, but we did buy into CEO Brian Chesky’s intelligent strategic vision for the company. Our initial price target for ABNB shares was $145. Ten weeks later, the shares have moved 56% above our purchase price, and we still consider them a bargain.
The latest catalyst for the move higher was a stellar Q4 earnings report. Revenues rose 24%—to $1.9 billion—from the same period a year earlier, and profits came in nearly double what was expected ($0.48 vs $0.25). Most importantly, after losing $4.6 billion in 2020 (pandemic) and $300 million in 2021, the company just posted its first profitable year, bringing in $2 billion on $8.4 billion in revenue. That equates to an impressive 22.52% operating margin. While others (like Vrbo) enter the business and while the hotels try new tactics to emulate what Airbnb has created, Chesky’s company remains on the cutting edge of new technologies designed to increase its dominance in the space. Meanwhile, Airbnb sits on a $10 billion mountain of cash, a tiny relative debt load of $2 billion, and a demand backlog due to a record number of new bookings. Suddenly, the analysts are changing their tune.
Even though the shares have run up to near our price target in a matter of months, our Global Leaders Club purchases are designed to be longer-term holdings. In other words, we won’t be selling at $145. Airbnb is the only travel-related company we currently own in the Club—the hotels remain a bit too expensive, and the cruise lines (we prefer Royal Caribbean and Norwegian) could be further affected by softening economic conditions.
Tu, 14 Feb 2023
IT Software & Services
Palantir soars after the company announces its first profitable quarter
Shares of data software company and Penn New Frontier Fund member Palantir (PLTR $9) soared double digits after the company reported its first quarterly profit, earning $31 million in Q4. Revenues rose 18% from a year ago, to $509 million, with government revenue jumping 23% and commercial sales growing by 11%. CFO David Glazer said he expects that rate of growth to continue throughout 2023.
Denver-based Palantir aggregates massive amounts of data to produce usable, actionable information for its government and civilian clients. As our favorite example, the company was essential in collecting and analyzing the data which ultimately allowed US forces to track down and kill terrorist Osama bin Laden. Palantir’s customer mix is roughly 60% government and 40% civilian sector, respectively, with 43% of its revenues emanating from outside of the US. As a policy, the company will only deal with nation-states aligned with the values of the United States—no bad actors welcome. With cash on hand of $2.5 billion, Palantir holds no debt on its books.
The company’s three platforms, Palantir Gotham, Palantir Foundry, and Palantir Apollo, are unrivaled in the industry, and we fully expect the firm to maintain its benchmark position. We opened our position in the Penn New Frontier Fund within minutes of its IPO, purchasing shares roughly where they now sit. We maintain our $20 price target on the shares and would not be a seller once that level is reached.
Th, 09 Feb 2023
Media & Entertainment
Bob Iger’s return is already paying dividends for Disney
There was at least one person enamored with former Disney (DIS $116) Ceo Bob Chapek: Bob Chapek. Everyone else, not so much. After nearly three years of floundering under the woeful boss, Bob Iger is back; and, based on the first few months of his well-publicized return, the stock might be as well.
After plunging 44% in 2022, shares of Disney have already rebounded 35% in the first six weeks of 2023, buoyed by a strong earnings report and a $5.5 billion cost-cutting program laid out by Iger. First the numbers: Revenues rose 7.7% from Q1 of 2022, to $23.51 billion, while diluted earnings per share came in at $0.99, beating forecasts of $0.77. Disney+ subs disappointed, with the company losing some 2.4 million subscribers over the course of the quarter, though ESPN+ and Hulu—two Disney units—both gained subscribers. Parks revenue continues to impress, jumping 21% from last year—to $8.74 billion—and beating estimates.
What investors really applauded was Iger’s announced $5.5 billion cost savings plan, with $3 billion of that coming from content cuts. Iger also disclosed a headcount reduction of 7,000, or around 3% of the workforce. All of this apparently appeased activist investor Nelson Peltz of Trian Partners, who declared his proxy fight with the company officially over. Iger understands business and how to deal with activist investors; Chapek would have surely invited—and ultimately lost—this battle. Disney still has a lot of work to do (it has already lost the battle with the state of Florida over ownership of the land on which Walt Disney World sits), but we expect more intelligent leadership out of Iger.
We added Disney back into the Penn Global Leaders Club the same morning Chapek was fired (actually, he was fired over the weekend—to his shock—and we picked up shares at Monday’s open), and the shares are up substantially since that point. Recession or not, we anticipate the parks revenue to continue its post-Covid growth trajectory despite the recent price hikes. Our initial target price for the shares is $150.
Sa, 04 Feb 2023
Week in Review
Bookend bad days didn’t stop the market from plowing ahead this week
The week started off rough, with investors worrying about (potentially) bad earnings reports to come and a Fed which wasn’t prepared to stop raising rates. The latest hike did, indeed, come on Wednesday when Powell and the FOMC announced another 25-basis-point increase, bringing the upper band of target federal funds rate to 4.75%. There seemed to be something different about his press conference this time around, however. His typically hawkish tone seemed a bit mellower, which investors took as a good sign. After being down before and during the rate hike announcement, the market reversed course and finished higher.
Friday brought the real shocker. We are back in bizarro world where good economic news is bad for the markets, and did we ever get some good economic news via the jobs report. Economists were expecting to hear that 187,000 or so jobs had been created in January; the actual number came in at a scorching 517,000 new nonfarm payrolls. The unemployment rate, which many argue needs to be higher for the Fed to pause, dropped to its lowest level since 1969—3.4%. Leisure and hospitality posted huge jobs gains, as did professional and business services, government, and health care. Putting the aggregate number in perspective, it was almost twice as high as December’s strong gain of 260,000 new jobs.
Since the worrisome factor of a strong jobs report is the potential for a wage-price spiral (more people working means more money to spend which means higher prices), all eyes turned to wage growth in the report. For the month of January, wages increased at a 4.4% year-over-year clip. That may seem high, but the number has been steadily coming down since March of last year, and it is inching ever closer to the 2.96% long-term average. As the numbers were digested, they became more palatable. What could have been a lousy finish to the week turned into manageable losses. The only benchmark dropping for the week was the Dow, which only shed fifteen points over the five sessions. Small caps, as measured by the Russell 2000, gained nearly 4% on the week.
There is an old market expression: “As goes January, so goes the year.” We believe that will hold true this year, which would help erase a lot of 2022’s pain. The S&P 500 finished January up 6%, the Russell 2000 was up 10%, and the NASDAQ was up nearly 11%. Bonds, which were down double digits in aggregate last year, are up 3% thus far as represented by the Bloomberg US Aggregate Bond index. So far, so good.
Th, 02 Feb 2023
Energy Commodities
Remember when natural gas was going to be the investment of the decade?
Think back for a minute to last summer. There were a lot of nightmare scenarios dancing around the economic horizon, but few more haunting than Vlad Putin’s desire to make Europeans pay for their support of Ukraine in the war. His number one weapon was energy, and endless stories painted a dire picture of gas bills quadrupling on the continent and many being left without natural gas to heat their homes. For investors, this pointed to an incredible opportunity to invest in the energy commodity using instruments such as UNG ($8.50), the United States Natural Gas ETF.
Indeed, shares of UNG had risen from around $12 going into 2022 to $34.50 by August, a gain of some 187%. And that was during the warm days of summer; imagine (argued investors) how high they might go during the frigid European winter! Fast forward six months. UNG is sitting at $8.50, or 75% lower than it was in August. What happened? A prolonged spell of mild weather on the continent and stronger-than-expected supply inventories have combined to knock natural gas prices back down to pre-war levels. US natural gas production is hitting record highs (we are the world’s largest producer), and US LNG exporters increased shipments to Europe by nearly 150% year-over-year. Europe’s dependence on Russian gas has dropped from over 40% to near zero, yet Putin’s dream of exacting pain has failed to manifest. The pain to be felt in Russia by lost revenue due to his actions, however, is just beginning.
We distinctly remember the copious stories in the financial press about natural gas facilities being knocked offline by storms in the US, the hardship Europeans would face over the winter months, and the critical shortage of LNG. What seemed like a no-brainer of an investment turned into a nightmare for anyone buying into the hype. Yet another great lesson on behavioral finance and the false narratives so prevalent within the media. Always do your homework before investing, and have a specific exit strategy if events don’t play out as expected.
Mo, 27 Mar 2023
Global Strategy: Australasia
Oh, the rich irony: China and Russia claim Australia sub deal threatens the peace of the South China Sea
If there is one clear piece of the geopolitical puzzle, it is China’s desire to portray itself as the new power broker on the world stage. Say it enough and perhaps the world will believe you. Well, the global press pool, anyway. Xi, however (and certainly his new best friend Putin), seems to have a serious case of insecurity. While Xi and Putin were displaying their deep love for one another in Moscow, Beijing was busy decrying the so-called AUKUS submarine deal. But, as with NATO’s latest expansion, the deal probably would have never happened without the aggressive behavior of these two players.
Under the terms of the deal hammered out by Australia, the UK, and the United States (hence, AUKUS), the former will purchase a new fleet of up to five Virginia-class nuclear-powered submarines. The impetus for the deal is China’s growing threat to the South China Sea region, specifically with respect to Taiwan. Beyond the sale of the powerful subs comes something even more exciting: the development and deployment of a next-generation vessel to be dubbed the SSN-Aukus.
While nuclear powered, the subs won’t carry nuclear-tipped missiles, which makes China’s claims duplicitous. Australia’s foreign minister, Penny Wong, said that China’s criticism was “not grounded in fact.” A very nice way to put it. Anyone familiar with the outstanding series Succession, which just returned for its final season, knows our two-word response to China and its demand that the program be scrapped.
The new capabilities will be rolled out in three phases: first, the US and UK will send a rotational force of subs to Australia, with Australian sailors and workers getting hands-on experience both on the subs and in the shipyards; second will be the sale of the Virginia-class weapons platform to Australia; and third will be the development and deployment of the next generation SSN-Aukus. It should be noted that General Dynamics (GD $225) Electric Boat, which built the US Navy’s first commissioned undersea warship in 1899, has the contract to build the subs.
With this deal, and for the first time ever, the United States will share some of its highly classified submarine technology with the two staunch allies. The new sub will be based on a UK design and will incorporate Virginia-class features and technologies, such as stealth. As an aside, the French were also furious with the AUKUS announcement, as Australia had previously planned to buy 12 diesel-powered subs from that country. French government officials called the move a “stab in the back.” Since the initial outrage, the UK government has worked diligently to smooth over the flap.
Mo, 27 Mar 2023
Energy Commodities
No more excuses: begin refilling the Strategic Petroleum Reserve
With a capacity of 714 million barrels, the Strategic Petroleum Reserve, or SPR, is the world’s largest stockpile of oil. Held in underground tanks in Louisiana and Texas, this Department of Energy-maintained stash was a direct result of the 1973 energy crisis when OPEC labeled the United States a “hostile entity” and embargoed all oil exports to the country. To any American who vividly remembers that time, the current state of the SPR is appalling.
Now sitting at its lowest level since 1983—a time at which our energy needs were much lower—the SPR is just over half full (372 million barrels). Over the course of the past two years, the Biden administration has authorized the release of a staggering 266 million barrels of crude for no strategic reason, simply the tactical reason of lowering the price at the pump. That was never what the program was intended for.
As for refilling the SPR, last October the administration cited high prices and further stated that a program would be put in place to begin refilling the reserve when oil fell into the $67 to $72 per barrel range. It dropped down to that range in the middle of March, leading to the latest round of excuses.
When questioned about the lack of action, Energy Secretary Jennifer Granholm said it would take years to replenish the tanks. All we could think of was Ronald Reagan’s classic response to the argument that his Star Wars program would take decades to implement: “Well, then let’s get started.” Granholm’s response was not exactly Reaganesque: “This year it will be difficult for us to take advantage of this low price.” She laid the blame on Congress and maintenance work being done at two of the four SPR sites. No more excuses; it is time to refill this critical component of America’s energy security.
The Saudis were reportedly irked by Granholm's comments that the administration would not begin refilling the SPR this year, directly leading to the OPEC+ announcement that it would cut 1.1 million barrels per day of production between May and the end of the year. That led to a sudden spike in the price of crude, which now sits at $80.54 per barrel. Complete and utter ineptness directly led to American consumers paying more at the pump. What's next, another massive release from the SPR?
We, 22 Mar 2023 Fed raises rates 25 bps
Fed raises rates 25 basis points, to a range of 4.75%-5% upper limit. Odds say 62% chance of another hike in May (next meeting), but we believe the Fed is done. Markets positive to flat while Powell is giving his briefer. By end of session, Dow falls 530 points because Powell did not indicate rate cuts on the horizon this year. Of course he didn't! Completely irrational markets. The US economy can handle these rates.
Tu, 21 Mar 2023
Consumer Finance
The end of easy money: auto loan rejection rate spikes
If the Fed is still looking for evidence that its tightening policy is working, look no further than the auto market. More and more consumers are being rejected for auto loans, with the 9.1% rate marking the highest level in six years. Furthermore, the trajectory has been steep: last October the rejection rate was 5.8%. Auto loan delinquency rates are also rising, going from roughly 2% at the end of 2021 to nearly 4% at the end of last year.
We never thought the 72-month loan was a good idea; now, with the average new vehicle going for nearly $50,000 and interest rates substantially higher, it may take some borrowers that long to pay off the loans. In fact, according to consumer finance services company Bankrate.com, the average payment for a new vehicle is $716 per month, with nearly one in five buyers paying over $1,000 per month. Not long ago, that was a house payment.
Sticker shock has sent many consumers to the used car lots, but that picture isn’t much rosier. The average used car price is $30,000 (substantially higher in many states), and the lack of new vehicles produced during the first year of the pandemic has added strain to the system. Most buyers prefer a late model used vehicle with under 50,000 miles of wear and tear. Of course, another reason for the dearth of vehicles—and higher used car prices—is the fact that would-be sellers realize they would have to pay a much higher interest rate for their new ride—the same challenge the housing market is facing right now. Perhaps it is time to take another look at the do-it-yourself auto repair retailers.
Eventually, this problem will work itself out. While rates will almost certainly stay higher for longer, the trajectory of inflation in this market is unsustainable. Our favorite used car dealership remains CarMax (KMX $59), which is down 62% from its high share price and trading at a reasonable multiple of seventeen. Our favorite DIY shop is Advance Auto Parts (AAP $120), which has a tiny forward P/E of ten, and a solid customer mix of 60% commercial and 40% consumer clients. By the way, the largest auto finance company is Ally Financial (ALLY $25).
Su, 19 Mar 2023
Bank failures and Fed speculation drove the markets this week
At the end of this frenzied trading week, it was fitting that the only green which would show up on Friday, St. Patrick's Day, was gold—it rose 6% over the course of five days. Rising gold prices are often in response to economic instability and concerns over monetary policy, so the precious metal's surge makes perfect sense.
The week began with news of Signature Bank's collapse, and the only thing standing in the way of a market rout was the government's promise that all depositors at the failed banks would be immediately made whole. The focus quickly turned to what Fed Chair Powell would do at the following week's FOMC meeting. We went from high odds for a 50 bps hike, to calls for an immediate pause while the damage was assessed, to expectations for a 25 bps hike (what we have been—and still are—expecting). Odds increased for the last option when ECB President Christine Lagarde stuck by her guns and raised rates in the EU by 50 bps. Any pause, the pundits argued, would signal fear that the government didn't believe it could contain the new banking crisis.
By late in the week, the domestic banking crisis made its way across the pond to a troubled European institution: Credit Suisse. After the company delayed its annual report and shades of SVB and Signature began gripping investors, the largest shareholder—the Saudi National Bank—said it would not come to the rescue with new funding. On Friday, the Financial Times reported that fellow Swiss bank UBS might be a reluctant suitor (earlier in the week, the $57 billion behemoth said it had little interest in buying the troubled bank). As we write this, UBS has offered $1 billion to take over Credit Suisse, which had a market cap of $35 billion just two years ago and $8 billion at the beginning of the month. Meanwhile, Switzerland is considering nationalizing the firm if the UBS deal fails. Stunning.
Considering everything that happened over the course of five days, it is rather impressive that the benchmarks were relatively unchanged. The NASDAQ, in fact, gained 4.4% on the week. One thing is certain: tech startups which had little trouble securing loans in the zero interest rate environment are going to face much higher hurdles—and debt servicing costs—going forward. Which makes it somewhat strange that the tech-laden benchmark put together a positive week.
The same issues that drove markets this past week will drive them this week: global concerns about the financial strength of middle market and regional banks, and how the Fed will balance battling inflation with these new banking concerns. Expect the Fed's balance sheet reduction program to be placed on pause just as it was beginning to show results.
Mo, 13 Mar 2023
Financial Services
One week, three bank failures; shades of 2008?
We all recall the nightmarish string of bank failures back in 2008 stemming from toxic mortgage-backed securities poisoning the capital of these doomed giants. While we are certainly not at that level of concern right now, the failure of three banks over the course of a few days has the markets on edge.
First came Silvergate Capital (SI $2), the premier lender to the cryptocurrency industry. The California state-chartered bank, which provided financial services such as commercial banking, business lending, and cash management to its customers, sent up red flags when it announced it was closing its Silvergate Exchange Network which served as a bridge between traditional banking services and the crypto world. Then the company said it would not be able to file its required 10-K to the SEC on time. That was all it took for a run on the bank: customers began pulling out some $8 billion worth of deposits, forcing Silvergate to secure a loan from the Home Bank Loan system. Furthermore, the bank was forced to sell the solid assets on its balance sheet such as Treasuries and securitized residential mortgage loans at discount prices to fund the customer withdrawals. These assets were discounted because of the Fed rate hikes—the bank simply didn’t have the luxury of waiting for the securities to mature at par. By late in the week, Silvergate announced it was winding down its operations. Sadly, the story did not end there.
Silicon Valley Bank, the major arm of SVB Financial Group (SVB, trading halted), collapsed on Friday, becoming the second-largest bank failure in US history (Washington Mutual, which failed during the financial crisis, was the largest). The FDIC quickly moved in to take control, creating a new entity called the Deposit Insurance National Bank of Santa Clara. SVB was the 16th largest bank in the country, with around $210 billion in assets, and was the go-to bank for tech startup firms—many of whom wouldn’t have been able to access funding otherwise.
As for cryptocurrency shops, the preferred lender behind Silvergate has been New York-based Signature bank (SBNY, trading halted). On Sunday, regulators closed the doors of this institution, which held nearly $100 billion on deposit. New York Governor Kathy Hochul said this did not amount to a taxpayer bailout, as the funds required to pay back depositors would come from "the fees assessed on all banks." She was referring to the Deposit Insurance Fund, which will guarantee money above and beyond the FDIC limit—or "uninsured" funds.
These closures lead many to wonder why companies would not have better risk management with respect to their deposits, spreading around their money to a number of different financial institutions. For example, streaming device company Roku said it had some $500 million—or 26% of its cash reserves—in an account at SVB. A who’s who list of prominent companies have already announced they are in a similar situation. Per one seasoned venture capitalist, if a tech startup received loans from a bank, that institution pretty much demanded that the bulk of their cash be kept at the firm. Furthermore, tech companies overwhelmingly trusted SVB, Silvergate, and Signature. They simply couldn't believe there would ever be a run on these banks.
In the wake of these meltdowns and with rates much higher rates than a year ago, these tech startups must now be wondering where they can possibly turn for new sources of funding. The troubles in Silicon Valley won't go away with the government's promised backstop.
Two thoughts come to mind. As the interest rate hike cycle began, we were told how this would help the major financial institutions, as their net interest income—the difference between what they could make on loans and what they had to pay on investors’ deposits—would increase greatly. We didn’t buy that argument this time around, and Financial Services remains our most underweighted sector. Second thought: Many experts have been saying for the past several months that the Fed would continue to raise rates until they “broke things.” Mission accomplished. If the hot jobs numbers and the recent inflation reports were pointing to a 50 bps hike at the March meeting, the broken pieces laying on the floor around them should give the Fed pause. We still believe a 25-bps hike will be announced on the 20th, but odds for an immediate pause are growing. And 50 bps is now all but off the table.
Th, 09 Mar 2023
Technology Hardware & Equipment
Exit, stage left: Apple is expediting its move out of China and into India
India just surpassed China as the world’s most populous nation, with 1.412 million citizens, but size is just a minor factor in Apple’s (AAPL $152) hurried exodus out of the communist nation and into the South Asian country. The world’s largest publicly traded company ($2.4 trillion as of this writing) had a rare contraction in sales of 5.5% in the last quarter of 2022 as compared to the prior year, but it posted record revenues in India. Couple that with China’s growing ties to Russia, a continuing Covid nightmare in the country, and saber-rattling against the West (especially the US), and it makes sense that Apple would be packing up, so to speak, and heading west. And where Apple goes, its suppliers are sure to follow.
Key suppliers to the Cupertino-based firm are increasingly being asked one question by their corporate customers: “When can you move out (of China)?” An executive at GoerTek, an AirPods manufacturer, said that 90% of his American tech firm clients are asking that question on a near-constant basis, and the pressure is growing. While Vietnam has been a major destination for many of these firms, India has been building momentum. For the first time ever, Apple has designated India as its own region, as opposed to simply being part of a larger geographic area including Middle Eastern, Eastern European, and African nations. Somewhat surprisingly, Apple still doesn’t have a physical footprint in India via retail outlets, but that will change beginning later this year. Apple recently created an online store dedicated to serving its Indian customers.
In addition to reading the writing on the wall with respect to increasingly strained US-China relations, Apple has faced tumult at its Chinese facilities recently. Late last year, at its massive Foxconn plant in Zhengzhou, violent protests broke out as workers rioted against low pay and Covid restrictions. Up to 85% of iPhone Pros had been produced at that facility. It appears as though Apple is finally getting the message.
Why did it take so long for American companies to wake up to the risks of concentrating operations in a state-controlled country? Quite simply, they were chasing profits and ignoring the obvious threats. A little over a generation ago, Americans could flip over common retail goods and read the “Made in Japan” label. Overwhelmingly, those labels now read “Made in China.” It will take some time to change that, but the exodus has begun—and we don’t see anything on the horizon that will derail the movement.
Tu, 07 Mar 2023
Housing
The Fed is raising rates to cool inflation, but one segment will remain immune
The long-term average 30-year mortgage rate is 7.75%; as of this writing—despite what the accompanying chart shows—we have retaken the 7% level. While 7.75% is the long-term average, the ten-year average mortgage rate sits at 4%; but, for a brief two-year period, we sat in a trench below that level. The typical American may make some poor financial decisions, but a large percentage of the US population did something brilliant over that spell: they either financed a new purchase at rock-bottom rates or they refinanced their existing home with a fixed-rate loan. While 10% of current home loans are the adjustable-rate (ARM) variety, that is well below the historic average (40% of mortgage loans were ARMs back in 2006, for example). For Americans locking in 2.65% to 4% rates, it is time to celebrate. For the Fed, not so much.
The Fed has a dual mandate: keep the unemployment rate reasonably low and keep inflation somewhere around the 2% rate. While the first mandate has obviously been met, the central bank continues to raise rates in an effort to bring down the stubbornly high level of inflation. Were they operating in most other countries (a 30-year fixed-rate home loan is a uniquely American experience), they would be having an easier time. However, the 40% of homeowners who took out those low-rate loans in either 2020 or 2021 are immune from the Fed’s actions—at least with respect to their largest expense. They may be locked into their existing home, but that extra purchasing power will remain intact for decades. Sadly, evidence is mounting that many Americans are once again spending beyond their means: credit card balances just hit a new record high. And for anyone who has looked at their credit card interest rates lately, it is clear that the banks wasted no time in spiking those very-adjustable rates.
With such a large percentage of homeowners locked into their current homes due to low mortgage rates, the housing industry will continue to be negatively impacted. In a warped sense, this is what the Fed wants to see—lower or stagnate home prices due to reduced demand, and higher unemployment in the industry due to a pullback in construction. Investors should keep in mind that the homebuilders reside in the Consumer Discretionary sector; a segment which is already facing headwinds due to the probable recession on the horizon. We have been underweighting this sector since the middle of last year.
Headlines for the Month of February, 2023
Mo, 27 Feb 2023
East/Southeast Asia
Xi tells China’s military establishment to be prepared for Taiwan invasion by 2027
According to CIA Director William Burns, Chinese President Xi Jinping has conveyed a strategic message to the People’s Liberation Army: Be prepared to invade and take control of Taiwan by 2027. To be clear, there is no possible scenario in Xi’s mind in which Taiwan is not fully under the thumb of Beijing. If anyone still believes that they don’t understand the mind of a communist like Xi and the history of Taiwan going back to 1949. Jimmy Carter certainly didn’t understand the mind of a Chinese communist, or he wouldn’t have cut ties with a democratic Taiwan in favor of improved relations with Beijing. But the myopia certainly hasn’t been limited to one party: both sides have been in power as the US became overly reliant on cheap goods and an enormous potential market in the East. Never mind that the Western values of individual liberty and personal freedom are anathema to communism. We wonder if anyone ever believed that the balance of trade between the US and China would be anything other than grossly lopsided?
Now, despite that country’s unwillingness to take any responsibility for the pandemic unleashed on the world, many want us to believe that Xi is sitting back, watching his buddy Putin sink in the quicksand that is Ukraine, and second-guessing his plans to invade Taiwan. He is probably furious at his friend for shining the spotlight on the similarities between Ukraine and Taiwan with respect to their bully neighbors, but he would be sending arms to Russia for use in the conflict right now if the world weren’t watching his actions so closely. Just before the start of the Olympics, Putin promised Xi two things: that he would wait to invade until after the games had concluded, and that war would be swift and victory assured. Xi must be taken aback by both the toughness of the Ukrainian people and the cohesion of the Western world against this horrific act.
The West must now make it clear that we are willing to defend Taiwan (and the president has said as much), and that a swift victory would not be possible. His mind may still be made up, but doubt has crept in—at least about going in before 2027.
Americans should pay attention to where the goods they buy are sourced and also have a basic understanding of the modern geopolitical world. For example, Vietnam has been a major recipient of US manufacturing deals as companies scramble to exit China; Vietnam has strained relations with China and continues to be a growing economic partner to the US. The same could be said of Malaysia, Bangladesh, Taiwan, and India—though the latter has ruffled feathers with its continued purchase of Russian energy. The United States played a major role in China’s economic growth over the past generation. Now, with a full understanding of that nation’s strategic plans, we have the power to impede that growth trajectory. But do we have the stomach for it?
Th, 23 Feb 2023
Metals & Mining
Two catalysts for lithium miners' recent volatility: Tesla and a Chinese battery company
In the mad dash to create more efficient batteries for electric vehicles, few elements, literally, are more important than high-grade lithium. Mining projects to produce this valuable element, however, are costly and can take years to get up and running. These factors should make current lithium miners extremely valuable; and, in fact, a look at the three year returns for the major players shows them far outpacing the performance of their respective benchmark indexes. But last Friday something odd happened: lithium miners got crushed, falling around 10% on average and leaving investors befuddled as to why.
It turns out that two companies on different sides of the planet led to the drop. In China, the world’s largest EV battery maker, Contemporary Amperex Technology (aka CATL), pulled a fast one. Without warning, the company changed its pricing structure on batteries to a lithium-based model, which had the effect of greatly reducing the price it charges per unit. Since CATL produces its own lithium from company-owned mines, it has the ability to reduce profit margins on the input side to virtually nothing—a luxury most EV battery makers don’t have.
With CATL’s actions in mind, it recently came to light that major US electric battery producer Tesla (TSLA $202) may be interested in acquiring mid-cap ($3.6B) miner Sigma Lithium Corp (SGML $35). This Vancouver-based company mines high-purity lithium from its enormous mining operation in Brazil. While the other miners were watching their shares plunge, SGML shares were busy spiking nearly 20%.
While Tesla said that Sigma is but one of many options being considered, it clearly wants to control its own mining operation. For a company with a clear history of vertical integration, the move makes perfect sense. Close to the port city of Corpus Christi, Tesla is in the process of building its own lithium processing plant, scheduled to be up and running by next year. Investors are betting that a company-owned mining firm won’t be far behind. If it doesn’t turn out to be Sigma, however, look for those shares to plunge back to earth.
Yes, Tesla shares have doubled in price since January 6th, but we still consider them a bargain. As for the miners, we prefer industry leader Albermarle (ALB $252, $35B market cap) and small-cap miner Lithium Americas Corp (LAC $23, $3.5B market cap). The latter is developing three new lithium production facilities—two in Argentina and one in Nevada—with the ultimate goal of splitting into two companies based on geography. The need to diversify away the risk of relying on China for critical elements and rare earth minerals has never been more evident, which should provide ample opportunity in the space for astute investors looking closer to home.
Th, 16 Feb 2023
Hotels, Resorts, & Cruise Lines
Airbnb stock soars after its first fully profitable year
On 07 December 2022, just over two months ago, Morgan Stanley downgraded travel services company Airbnb (ABNB $143) and slashed its price target to $80 per share. The shares immediately fell 5% on the news, and we immediately added the company to the Penn Global Leaders Club. We didn’t buy into the analyst’s narrative, but we did buy into CEO Brian Chesky’s intelligent strategic vision for the company. Our initial price target for ABNB shares was $145. Ten weeks later, the shares have moved 56% above our purchase price, and we still consider them a bargain.
The latest catalyst for the move higher was a stellar Q4 earnings report. Revenues rose 24%—to $1.9 billion—from the same period a year earlier, and profits came in nearly double what was expected ($0.48 vs $0.25). Most importantly, after losing $4.6 billion in 2020 (pandemic) and $300 million in 2021, the company just posted its first profitable year, bringing in $2 billion on $8.4 billion in revenue. That equates to an impressive 22.52% operating margin. While others (like Vrbo) enter the business and while the hotels try new tactics to emulate what Airbnb has created, Chesky’s company remains on the cutting edge of new technologies designed to increase its dominance in the space. Meanwhile, Airbnb sits on a $10 billion mountain of cash, a tiny relative debt load of $2 billion, and a demand backlog due to a record number of new bookings. Suddenly, the analysts are changing their tune.
Even though the shares have run up to near our price target in a matter of months, our Global Leaders Club purchases are designed to be longer-term holdings. In other words, we won’t be selling at $145. Airbnb is the only travel-related company we currently own in the Club—the hotels remain a bit too expensive, and the cruise lines (we prefer Royal Caribbean and Norwegian) could be further affected by softening economic conditions.
Tu, 14 Feb 2023
IT Software & Services
Palantir soars after the company announces its first profitable quarter
Shares of data software company and Penn New Frontier Fund member Palantir (PLTR $9) soared double digits after the company reported its first quarterly profit, earning $31 million in Q4. Revenues rose 18% from a year ago, to $509 million, with government revenue jumping 23% and commercial sales growing by 11%. CFO David Glazer said he expects that rate of growth to continue throughout 2023.
Denver-based Palantir aggregates massive amounts of data to produce usable, actionable information for its government and civilian clients. As our favorite example, the company was essential in collecting and analyzing the data which ultimately allowed US forces to track down and kill terrorist Osama bin Laden. Palantir’s customer mix is roughly 60% government and 40% civilian sector, respectively, with 43% of its revenues emanating from outside of the US. As a policy, the company will only deal with nation-states aligned with the values of the United States—no bad actors welcome. With cash on hand of $2.5 billion, Palantir holds no debt on its books.
The company’s three platforms, Palantir Gotham, Palantir Foundry, and Palantir Apollo, are unrivaled in the industry, and we fully expect the firm to maintain its benchmark position. We opened our position in the Penn New Frontier Fund within minutes of its IPO, purchasing shares roughly where they now sit. We maintain our $20 price target on the shares and would not be a seller once that level is reached.
Th, 09 Feb 2023
Media & Entertainment
Bob Iger’s return is already paying dividends for Disney
There was at least one person enamored with former Disney (DIS $116) Ceo Bob Chapek: Bob Chapek. Everyone else, not so much. After nearly three years of floundering under the woeful boss, Bob Iger is back; and, based on the first few months of his well-publicized return, the stock might be as well.
After plunging 44% in 2022, shares of Disney have already rebounded 35% in the first six weeks of 2023, buoyed by a strong earnings report and a $5.5 billion cost-cutting program laid out by Iger. First the numbers: Revenues rose 7.7% from Q1 of 2022, to $23.51 billion, while diluted earnings per share came in at $0.99, beating forecasts of $0.77. Disney+ subs disappointed, with the company losing some 2.4 million subscribers over the course of the quarter, though ESPN+ and Hulu—two Disney units—both gained subscribers. Parks revenue continues to impress, jumping 21% from last year—to $8.74 billion—and beating estimates.
What investors really applauded was Iger’s announced $5.5 billion cost savings plan, with $3 billion of that coming from content cuts. Iger also disclosed a headcount reduction of 7,000, or around 3% of the workforce. All of this apparently appeased activist investor Nelson Peltz of Trian Partners, who declared his proxy fight with the company officially over. Iger understands business and how to deal with activist investors; Chapek would have surely invited—and ultimately lost—this battle. Disney still has a lot of work to do (it has already lost the battle with the state of Florida over ownership of the land on which Walt Disney World sits), but we expect more intelligent leadership out of Iger.
We added Disney back into the Penn Global Leaders Club the same morning Chapek was fired (actually, he was fired over the weekend—to his shock—and we picked up shares at Monday’s open), and the shares are up substantially since that point. Recession or not, we anticipate the parks revenue to continue its post-Covid growth trajectory despite the recent price hikes. Our initial target price for the shares is $150.
Sa, 04 Feb 2023
Week in Review
Bookend bad days didn’t stop the market from plowing ahead this week
The week started off rough, with investors worrying about (potentially) bad earnings reports to come and a Fed which wasn’t prepared to stop raising rates. The latest hike did, indeed, come on Wednesday when Powell and the FOMC announced another 25-basis-point increase, bringing the upper band of target federal funds rate to 4.75%. There seemed to be something different about his press conference this time around, however. His typically hawkish tone seemed a bit mellower, which investors took as a good sign. After being down before and during the rate hike announcement, the market reversed course and finished higher.
Friday brought the real shocker. We are back in bizarro world where good economic news is bad for the markets, and did we ever get some good economic news via the jobs report. Economists were expecting to hear that 187,000 or so jobs had been created in January; the actual number came in at a scorching 517,000 new nonfarm payrolls. The unemployment rate, which many argue needs to be higher for the Fed to pause, dropped to its lowest level since 1969—3.4%. Leisure and hospitality posted huge jobs gains, as did professional and business services, government, and health care. Putting the aggregate number in perspective, it was almost twice as high as December’s strong gain of 260,000 new jobs.
Since the worrisome factor of a strong jobs report is the potential for a wage-price spiral (more people working means more money to spend which means higher prices), all eyes turned to wage growth in the report. For the month of January, wages increased at a 4.4% year-over-year clip. That may seem high, but the number has been steadily coming down since March of last year, and it is inching ever closer to the 2.96% long-term average. As the numbers were digested, they became more palatable. What could have been a lousy finish to the week turned into manageable losses. The only benchmark dropping for the week was the Dow, which only shed fifteen points over the five sessions. Small caps, as measured by the Russell 2000, gained nearly 4% on the week.
There is an old market expression: “As goes January, so goes the year.” We believe that will hold true this year, which would help erase a lot of 2022’s pain. The S&P 500 finished January up 6%, the Russell 2000 was up 10%, and the NASDAQ was up nearly 11%. Bonds, which were down double digits in aggregate last year, are up 3% thus far as represented by the Bloomberg US Aggregate Bond index. So far, so good.
Th, 02 Feb 2023
Energy Commodities
Remember when natural gas was going to be the investment of the decade?
Think back for a minute to last summer. There were a lot of nightmare scenarios dancing around the economic horizon, but few more haunting than Vlad Putin’s desire to make Europeans pay for their support of Ukraine in the war. His number one weapon was energy, and endless stories painted a dire picture of gas bills quadrupling on the continent and many being left without natural gas to heat their homes. For investors, this pointed to an incredible opportunity to invest in the energy commodity using instruments such as UNG ($8.50), the United States Natural Gas ETF.
Indeed, shares of UNG had risen from around $12 going into 2022 to $34.50 by August, a gain of some 187%. And that was during the warm days of summer; imagine (argued investors) how high they might go during the frigid European winter! Fast forward six months. UNG is sitting at $8.50, or 75% lower than it was in August. What happened? A prolonged spell of mild weather on the continent and stronger-than-expected supply inventories have combined to knock natural gas prices back down to pre-war levels. US natural gas production is hitting record highs (we are the world’s largest producer), and US LNG exporters increased shipments to Europe by nearly 150% year-over-year. Europe’s dependence on Russian gas has dropped from over 40% to near zero, yet Putin’s dream of exacting pain has failed to manifest. The pain to be felt in Russia by lost revenue due to his actions, however, is just beginning.
We distinctly remember the copious stories in the financial press about natural gas facilities being knocked offline by storms in the US, the hardship Europeans would face over the winter months, and the critical shortage of LNG. What seemed like a no-brainer of an investment turned into a nightmare for anyone buying into the hype. Yet another great lesson on behavioral finance and the false narratives so prevalent within the media. Always do your homework before investing, and have a specific exit strategy if events don’t play out as expected.
Headlines for the Month of January, 2023
Tu, 31 Jan 2023
Automotive
After its best week in a decade, Tesla is delivering a message to perma-bears
Let’s face it, a rather large number of analysts have been hoping for Tesla’s (TSLA $172) demise just to vindicate their perma-bear positions on the EV maker. Last year provided them a great opportunity to crow, with Tesla shares falling some 65% in 2022. Going into 2023, they were all but writing the company’s epitaph, reminding us of falling production in China and the CEO’s preoccupation with another entity. There’s only one problem with that narrative: Tesla just posted a record quarterly profit.
Revenue jumped 37%, from $17.7B to $24.32B, with $3.69B flowing down as net income—a 40% spike from the same quarter last year. Both top-line revenue and bottom-line profits hit new records. Guidance was also strong, with management reiterating its goal of 50% CAGR in deliveries. For 2023, the company plans to produce—and sell—some 1.8 million vehicles, with a “potential” to hit the two million mark. The results were simply better than expected, but don’t expect the bears to change their tune.
Tesla is currently producing around 3,000 Model Y SUVs at its Austin plant alone, and is preparing that plant to begin producing the highly anticipated Cybertruck. The futuristic-looking all-electric pickup will begin rolling off the assembly line this month, with production ramping up to scale in 2024. While naysayers point to the company’s recent price reductions as evidence of waning demand, we would argue that the price cuts are possible because no other car company can produce electric vehicles at a lower cost, thanks to Tesla’s massive head start and unmatched production efficiencies. If other automakers try to reduce prices to keep pace, they will push their EV margins even further into the red. And that is exactly what we expect them to do—despite their insistence that Tesla has zero influence on their tactics or strategy.
Tesla is expected to generate over $12 billion in free cash flow this year, with the next closest car company (Toyota) coming in around $10 billion. With the Cybertruck coming online, as well as a lower-cost vehicle to widen its customer base, Tesla remains in the most enviable position of any car company. And that is not even accounting for the company’s renewable power and battery storage lines—also on the leading edge of their respective businesses. We maintain our $333 price target on TSLA shares, which we own in the Penn New Frontier Fund.
Mo, 30 Jan 2023
Restaurants
What layoffs? Chipotle hiring 15,000 new workers for “burrito season”
Every day brings new stories of layoffs, the rising cost of food items, and an impending recession. If one industry should be reeling from these conditions, it is the fast-food category, right? Fast-casual chain Chipotle Mexican Grill (CMG $1,614) begs to differ. Not only is the Penn Global Leaders Club member hiring 15,000 new workers ahead of spring “burrito season,” it is also in the early stages of a new expansion plan which would double its North American and European footprint—from around 3,000 restaurants to 7,000.
With nearly 100,000 employees currently, the new hires would represent a 15% increase in Chipotle’s workforce. How deeply is the company going into debt to fund its hiring and expansion plans? The $45 billion Mexican restaurant carries zero debt on its books and has a war chest of nearly $1 billion in cash and short-term equivalents. The restaurant business is notoriously tough, with enormous overhead, slim margins, and a fickle customer base; others in the industry should take note of what CEO Brian Niccol has been able to accomplish.
We added Chipotle to the Penn Global Leaders Club in March of 2020 at $590.85 per share. We would place a fair value on the company’s shares at around $1,700.
We, 25 Jan 2023
IT Software & Services
Microsoft had a strong quarter; it was the guidance which spooked investors
For the fiscal second quarter—ended 31 December—Microsoft (MSFT $242) posted revenues of $52.7 billion—a record high. Earnings (diluted) came in at $2.20 per share, or several cents above expectations. With everyone bracing for a disastrous earnings season with respect to tech stocks, investors breathed a sigh of relief, driving MSFT shares up 5% in after-hours trading. A rather sobering conference call and muted guidance quickly took those gains back, but we continue to see the software giant as an undervalued gem sitting at an attractive price.
Satya Nadella, who took charge of the company nearly a decade ago (hard to believe), immediately began reshaping Microsoft as a dominant cloud player, with Azure serving as the cornerstone. To say that strategy is paying off would be an understatement. Many other CEOs would have continued to rely on legacy moneymakers; in the case of Microsoft, that would have meant its More Personal Computing segment.
Overall, that segment was down 19% for the quarter (yes, currency headwinds did account for a few percentage points); Xbox revenues fell 12%, while device revenues (think Surface) fell a stunning 39%. It is a good thing Nadella came along a decade ago and began reshaping the company’s strategic vision. The Intelligence Cloud unit, which houses Azure, was up 18% in fiscal Q2, and would have been up 24% in constant currency (CC). The Productivity and Business Processes segment, which includes the massively successful Office 365 division as well as the LinkedIn unit, rose 7%. Finally, search and news ad revenue—minus traffic acquisition costs—was up 10%. Other than the weaker-than-expected March guidance and the fact that Microsoft will be laying off some 5% of its workforce (10,000 workers), it really wasn’t a bad quarter at all. Unless you happen to be one of those unfortunate workers, of course.
Microsoft remains a core holding within the Penn Global Leaders Club and is now up some 476% since we added it. Satya Nadella was the main catalyst for its addition to the Club. We would place a fair value on the shares at $320.
Th, 12 Jan 2023
Supply, Demand, & Prices
Enough data points are in: the Fed can (and will) take their foot of the gas
The never-ending blather in the press about the Fed’s tightening cycle has been painful to watch and listen to. We would argue that roughly half of the concerns expressed have been made up by the press itself. Had they simply chosen to adopt the real story (“Rates are at zero; the Fed must raise them to a responsible level to control inflation”) instead of crafting faulty narratives, we don’t believe the markets would have seen the same level of destruction in 2022. So, without regard to what the narrative du jour may be, let’s look at the facts with respect to inflation and rates.
Yet another strong data point came in with Thursday’s CPI report. The cost of living dropped 0.8%—a contraction not seen since April of 2020 during the early days of the pandemic—and the annual rate of inflation fell for a sixth-straight month—to 6.45% from a high of 9.1% last summer. If everyone knows that Fed adjustments have a lag, why has the press been freaking out investors since the hikes began? This downward pressure on inflation is precisely what we expected to see take place, and it is evidence that the hikes are having their desired effect. The unemployment rate may not be going up, but (wonderfully) that is not needed, as wages are finally cooling.
The price of groceries barely budged in December, and gas prices fell over 9%. The cost of shelter remains a major sticking point, as rents jumped 0.8% in the month and mortgage rates remain substantially higher than they were a year ago. Still, several Fed governors gave a nod to the positive report and indicated a slowing of hikes is probably warranted. That was enough to help the markets cobble together a steadily positive day.
Here is what we see happening: The Fed will hike rates just 25 basis points on the 1st of February, another 25 bps in the middle of March, and then halt—putting the upper band of the federal funds rate at 5%. Despite what investors may think, there will be no tightening due to any recession in 2023. Rather, the Fed will sit on that 5% rate for some time. That is not only what we expect, it is also what we want. It is time to start reining in wanton behavior and reduce the Fed’s balance sheet. Maybe we can even hold the $32 trillion national debt steady for a while (insert laugh track here).
Tu, 10 Jan 2023
Government Watchdog
The government is coming for your gas stove
Before you label this story hyperbole, consider this: the city of Los Angeles has already banned gas appliances from being placed in new homes, and the state of California is trying to pass the same law. Let’s consider what is going on at the federal level. You may be familiar with the name Richard Trumka. Before his death last year, Trumka was an organized labor leader and head of the AFL-CIO. In 2021, President Joe Biden appointed his son, Richard Trumka Jr., to head up the US Consumer Product Safety Commission. As with the partisan hack Lina Khan at the FTC, Trumka has turned the CPSC into a political tool, which leads us to the gas stove ban.
Under the ruse that gas stoves are a major source of indoor pollution and a health risk, Trumka told Bloomberg that “products that can’t be made safe can be banned.” Adding fuel to the fire, so to speak, senators Corey Booker and Elizabeth Warrant back the ban, arguing that Black, Latino, and low-income households bear the brunt of this national health crisis, as they do not have the means to properly ventilate their homes. Never mind the economic impact on these lower-income households, considering how much cheaper it is operate gas stoves as opposed to their electric counterparts.
This type of government overreach is both despicable and predictable. When government agencies are not held accountable by the people they supposedly represent, they are able to get away with outrageous acts. Hopefully, there will be a large enough outcry to stop this ban from taking place, but it clearly shows the arrogance of the elite ruling class. We would expect nothing less from a Trumka.
Oddly (not), the press has been quite mum on this topic. Since these individuals purport to be the spokespeople of the disenfranchised, why don’t we take a poll among ordinary Americans in the inner cities and ask them—without mentioning who proposed the ban—whether or not they support this decree? We are fairly sure how they would respond. (Around 35% of American households cook with gas stoves.)
Mo, 09 Jan 2023
Global Strategy: The Americas
Thawing of relations: Chevron shipping 500,000 barrels of oil from Venezuela
Any hopes of helping depose Hugo Chavez’ hand-picked successor in Venezuela, Nicolas Maduro, appear dashed; time to start exporting Venezuelan crude. The Biden administration granted an expanded license to oil giant Chevron (CVX $177) for the purpose of opening back up the supply of oil from Venezuela to the US and other western nations. The first tanker, in fact, has already picked up its load. After four years of sanctions which have done little to change the political dynamic in the country, the administration is trying another tack.
The amount of money Chevron might make out of the deal will be constricted due to the terms of the license; but, considering the billions of dollars owed by the PDVSA—Venezuela’s state-owned oil agency—to the company, it has little to lose. From the US government’s standpoint, the idea is to slowly increase ties with the nation in return for political reform and “free and fair” elections to be held later this year. As for the heavy crude, it is headed to refineries on the US Gulf Coast. The European Union has also been granted an exception for receiving Venezuelan oil to help offset the losses from the Russian embargo. The South American nation has the world’s largest proven oil reserves—some 35 billion more barrels, in fact, than Saudi Arabia.
The way the people of Venezuela are suffering, this is the best possible course of action for the US to take. Eventually, the citizenry will force change; the more draconian our approach to the country, the easier it will be for the Maduro administration to make the US a scapegoat for the economic turmoil.
Mo, 09 Jan 2023
Application & Systems Software
Lessons from Salesforce: If your company gets acquired, your job is not safe
In 2018, relationship management software company Salesforce (CRM $140) bought data integration firm MuleSoft for $6.5 billion. The following year it purchased data visualization company Tableau for $15.3 billion. Two years later, it purchased the business messaging platform Slack for a whopping $27.7 billion. Salesforce CEO Marc Benioff has an appetite as large as his ego, which should have served as a warning to the employees he gobbled up in the deals.
Salesforce has been crushed by the tech reckoning, with its shares trading down 55% from their bloated highs. Benioff, who made $28.6 million last year, is now taking it out on his staff by laying off 10% of the workforce—gutting the companies he accumulated on his wanton buying spree. In a memo to employees, Benioff said the company simply hired too many workers during the pandemic. That is no doubt true, but the ill-conceived acquisitions lie directly at the feet of Benioff, not an economic slowdown. As for those let go due to the CEO’s miscalculations, most were notified via blast emails stating that their positions had been eliminated. That is rich considering the company’s stated corporate culture revolves around the “concept of Ohana,” a Hawaiian term for taking care of one another through a family bond.
We have seen CEOs like Benioff many times over the past generation: blowhards who are never wrong and who run their company like a personal plaything. Workers at such firms must always be ready to face personal and professional upheaval.
Th, 05 Jan 2023
Specialty Retail
Bed Bath & Beyond expresses “substantial doubt” about future, shares plunge
Nine years ago, Bed Bath & Beyond (BBBY $2) was a $17 billion company with shares trading in the $80 range. Five short months ago, shares had rallied back into the $23 range as investors grew more optimistic that the company could pull out of its funk. Those hopes were dashed this week after the company said it was unable to file its Q3 report on time, expressing “substantial doubt about the company’s ability to continue.” That vote of no confidence from management sent shares tumbling 23% at the open, hitting an all-time low of $1.82.
What’s next for the specialty retailer, which now has a market cap of under $150 million? Bankruptcy protection, more than likely, will be the ultimate answer. The company could also attempt to restructure its debt, which might be difficult considering its 300% debt/equity ratio (it has some $1.7 billion in liabilities). Unaudited Q3 results point to sales of around $1.3 billion, down 33% from the same quarter last year, which the company attributes to slower traffic and reduced inventory levels. The latter is a real issue, as suppliers are reluctant to provide hard goods to a company which may not be able to pay them. Analysts had been expecting a net loss in the third quarter of $158 million; we can expect real losses to come in at more than double that figure. The more we look at the financials, the harder it becomes to see any exit strategy outside of bankruptcy protection.
It would be nice to see Bed Bath & Beyond purchased by a private equity firm and taken private, with a continued bricks-and-mortar footprint, but that may be wishful thinking. There is another aspect to this story for investors to be aware of: A dozen REITs report the company as a tenant, with Kimco Realty (KIM $21) holding a plurality of the leases. We have been warning investors about the challenges facing office and retail REITs going forward, and we believe the market is still underestimating the risk. Now is the time to review your real estate holdings.
Tu, 31 Jan 2023
Automotive
After its best week in a decade, Tesla is delivering a message to perma-bears
Let’s face it, a rather large number of analysts have been hoping for Tesla’s (TSLA $172) demise just to vindicate their perma-bear positions on the EV maker. Last year provided them a great opportunity to crow, with Tesla shares falling some 65% in 2022. Going into 2023, they were all but writing the company’s epitaph, reminding us of falling production in China and the CEO’s preoccupation with another entity. There’s only one problem with that narrative: Tesla just posted a record quarterly profit.
Revenue jumped 37%, from $17.7B to $24.32B, with $3.69B flowing down as net income—a 40% spike from the same quarter last year. Both top-line revenue and bottom-line profits hit new records. Guidance was also strong, with management reiterating its goal of 50% CAGR in deliveries. For 2023, the company plans to produce—and sell—some 1.8 million vehicles, with a “potential” to hit the two million mark. The results were simply better than expected, but don’t expect the bears to change their tune.
Tesla is currently producing around 3,000 Model Y SUVs at its Austin plant alone, and is preparing that plant to begin producing the highly anticipated Cybertruck. The futuristic-looking all-electric pickup will begin rolling off the assembly line this month, with production ramping up to scale in 2024. While naysayers point to the company’s recent price reductions as evidence of waning demand, we would argue that the price cuts are possible because no other car company can produce electric vehicles at a lower cost, thanks to Tesla’s massive head start and unmatched production efficiencies. If other automakers try to reduce prices to keep pace, they will push their EV margins even further into the red. And that is exactly what we expect them to do—despite their insistence that Tesla has zero influence on their tactics or strategy.
Tesla is expected to generate over $12 billion in free cash flow this year, with the next closest car company (Toyota) coming in around $10 billion. With the Cybertruck coming online, as well as a lower-cost vehicle to widen its customer base, Tesla remains in the most enviable position of any car company. And that is not even accounting for the company’s renewable power and battery storage lines—also on the leading edge of their respective businesses. We maintain our $333 price target on TSLA shares, which we own in the Penn New Frontier Fund.
Mo, 30 Jan 2023
Restaurants
What layoffs? Chipotle hiring 15,000 new workers for “burrito season”
Every day brings new stories of layoffs, the rising cost of food items, and an impending recession. If one industry should be reeling from these conditions, it is the fast-food category, right? Fast-casual chain Chipotle Mexican Grill (CMG $1,614) begs to differ. Not only is the Penn Global Leaders Club member hiring 15,000 new workers ahead of spring “burrito season,” it is also in the early stages of a new expansion plan which would double its North American and European footprint—from around 3,000 restaurants to 7,000.
With nearly 100,000 employees currently, the new hires would represent a 15% increase in Chipotle’s workforce. How deeply is the company going into debt to fund its hiring and expansion plans? The $45 billion Mexican restaurant carries zero debt on its books and has a war chest of nearly $1 billion in cash and short-term equivalents. The restaurant business is notoriously tough, with enormous overhead, slim margins, and a fickle customer base; others in the industry should take note of what CEO Brian Niccol has been able to accomplish.
We added Chipotle to the Penn Global Leaders Club in March of 2020 at $590.85 per share. We would place a fair value on the company’s shares at around $1,700.
We, 25 Jan 2023
IT Software & Services
Microsoft had a strong quarter; it was the guidance which spooked investors
For the fiscal second quarter—ended 31 December—Microsoft (MSFT $242) posted revenues of $52.7 billion—a record high. Earnings (diluted) came in at $2.20 per share, or several cents above expectations. With everyone bracing for a disastrous earnings season with respect to tech stocks, investors breathed a sigh of relief, driving MSFT shares up 5% in after-hours trading. A rather sobering conference call and muted guidance quickly took those gains back, but we continue to see the software giant as an undervalued gem sitting at an attractive price.
Satya Nadella, who took charge of the company nearly a decade ago (hard to believe), immediately began reshaping Microsoft as a dominant cloud player, with Azure serving as the cornerstone. To say that strategy is paying off would be an understatement. Many other CEOs would have continued to rely on legacy moneymakers; in the case of Microsoft, that would have meant its More Personal Computing segment.
Overall, that segment was down 19% for the quarter (yes, currency headwinds did account for a few percentage points); Xbox revenues fell 12%, while device revenues (think Surface) fell a stunning 39%. It is a good thing Nadella came along a decade ago and began reshaping the company’s strategic vision. The Intelligence Cloud unit, which houses Azure, was up 18% in fiscal Q2, and would have been up 24% in constant currency (CC). The Productivity and Business Processes segment, which includes the massively successful Office 365 division as well as the LinkedIn unit, rose 7%. Finally, search and news ad revenue—minus traffic acquisition costs—was up 10%. Other than the weaker-than-expected March guidance and the fact that Microsoft will be laying off some 5% of its workforce (10,000 workers), it really wasn’t a bad quarter at all. Unless you happen to be one of those unfortunate workers, of course.
Microsoft remains a core holding within the Penn Global Leaders Club and is now up some 476% since we added it. Satya Nadella was the main catalyst for its addition to the Club. We would place a fair value on the shares at $320.
Th, 12 Jan 2023
Supply, Demand, & Prices
Enough data points are in: the Fed can (and will) take their foot of the gas
The never-ending blather in the press about the Fed’s tightening cycle has been painful to watch and listen to. We would argue that roughly half of the concerns expressed have been made up by the press itself. Had they simply chosen to adopt the real story (“Rates are at zero; the Fed must raise them to a responsible level to control inflation”) instead of crafting faulty narratives, we don’t believe the markets would have seen the same level of destruction in 2022. So, without regard to what the narrative du jour may be, let’s look at the facts with respect to inflation and rates.
Yet another strong data point came in with Thursday’s CPI report. The cost of living dropped 0.8%—a contraction not seen since April of 2020 during the early days of the pandemic—and the annual rate of inflation fell for a sixth-straight month—to 6.45% from a high of 9.1% last summer. If everyone knows that Fed adjustments have a lag, why has the press been freaking out investors since the hikes began? This downward pressure on inflation is precisely what we expected to see take place, and it is evidence that the hikes are having their desired effect. The unemployment rate may not be going up, but (wonderfully) that is not needed, as wages are finally cooling.
The price of groceries barely budged in December, and gas prices fell over 9%. The cost of shelter remains a major sticking point, as rents jumped 0.8% in the month and mortgage rates remain substantially higher than they were a year ago. Still, several Fed governors gave a nod to the positive report and indicated a slowing of hikes is probably warranted. That was enough to help the markets cobble together a steadily positive day.
Here is what we see happening: The Fed will hike rates just 25 basis points on the 1st of February, another 25 bps in the middle of March, and then halt—putting the upper band of the federal funds rate at 5%. Despite what investors may think, there will be no tightening due to any recession in 2023. Rather, the Fed will sit on that 5% rate for some time. That is not only what we expect, it is also what we want. It is time to start reining in wanton behavior and reduce the Fed’s balance sheet. Maybe we can even hold the $32 trillion national debt steady for a while (insert laugh track here).
Tu, 10 Jan 2023
Government Watchdog
The government is coming for your gas stove
Before you label this story hyperbole, consider this: the city of Los Angeles has already banned gas appliances from being placed in new homes, and the state of California is trying to pass the same law. Let’s consider what is going on at the federal level. You may be familiar with the name Richard Trumka. Before his death last year, Trumka was an organized labor leader and head of the AFL-CIO. In 2021, President Joe Biden appointed his son, Richard Trumka Jr., to head up the US Consumer Product Safety Commission. As with the partisan hack Lina Khan at the FTC, Trumka has turned the CPSC into a political tool, which leads us to the gas stove ban.
Under the ruse that gas stoves are a major source of indoor pollution and a health risk, Trumka told Bloomberg that “products that can’t be made safe can be banned.” Adding fuel to the fire, so to speak, senators Corey Booker and Elizabeth Warrant back the ban, arguing that Black, Latino, and low-income households bear the brunt of this national health crisis, as they do not have the means to properly ventilate their homes. Never mind the economic impact on these lower-income households, considering how much cheaper it is operate gas stoves as opposed to their electric counterparts.
This type of government overreach is both despicable and predictable. When government agencies are not held accountable by the people they supposedly represent, they are able to get away with outrageous acts. Hopefully, there will be a large enough outcry to stop this ban from taking place, but it clearly shows the arrogance of the elite ruling class. We would expect nothing less from a Trumka.
Oddly (not), the press has been quite mum on this topic. Since these individuals purport to be the spokespeople of the disenfranchised, why don’t we take a poll among ordinary Americans in the inner cities and ask them—without mentioning who proposed the ban—whether or not they support this decree? We are fairly sure how they would respond. (Around 35% of American households cook with gas stoves.)
Mo, 09 Jan 2023
Global Strategy: The Americas
Thawing of relations: Chevron shipping 500,000 barrels of oil from Venezuela
Any hopes of helping depose Hugo Chavez’ hand-picked successor in Venezuela, Nicolas Maduro, appear dashed; time to start exporting Venezuelan crude. The Biden administration granted an expanded license to oil giant Chevron (CVX $177) for the purpose of opening back up the supply of oil from Venezuela to the US and other western nations. The first tanker, in fact, has already picked up its load. After four years of sanctions which have done little to change the political dynamic in the country, the administration is trying another tack.
The amount of money Chevron might make out of the deal will be constricted due to the terms of the license; but, considering the billions of dollars owed by the PDVSA—Venezuela’s state-owned oil agency—to the company, it has little to lose. From the US government’s standpoint, the idea is to slowly increase ties with the nation in return for political reform and “free and fair” elections to be held later this year. As for the heavy crude, it is headed to refineries on the US Gulf Coast. The European Union has also been granted an exception for receiving Venezuelan oil to help offset the losses from the Russian embargo. The South American nation has the world’s largest proven oil reserves—some 35 billion more barrels, in fact, than Saudi Arabia.
The way the people of Venezuela are suffering, this is the best possible course of action for the US to take. Eventually, the citizenry will force change; the more draconian our approach to the country, the easier it will be for the Maduro administration to make the US a scapegoat for the economic turmoil.
Mo, 09 Jan 2023
Application & Systems Software
Lessons from Salesforce: If your company gets acquired, your job is not safe
In 2018, relationship management software company Salesforce (CRM $140) bought data integration firm MuleSoft for $6.5 billion. The following year it purchased data visualization company Tableau for $15.3 billion. Two years later, it purchased the business messaging platform Slack for a whopping $27.7 billion. Salesforce CEO Marc Benioff has an appetite as large as his ego, which should have served as a warning to the employees he gobbled up in the deals.
Salesforce has been crushed by the tech reckoning, with its shares trading down 55% from their bloated highs. Benioff, who made $28.6 million last year, is now taking it out on his staff by laying off 10% of the workforce—gutting the companies he accumulated on his wanton buying spree. In a memo to employees, Benioff said the company simply hired too many workers during the pandemic. That is no doubt true, but the ill-conceived acquisitions lie directly at the feet of Benioff, not an economic slowdown. As for those let go due to the CEO’s miscalculations, most were notified via blast emails stating that their positions had been eliminated. That is rich considering the company’s stated corporate culture revolves around the “concept of Ohana,” a Hawaiian term for taking care of one another through a family bond.
We have seen CEOs like Benioff many times over the past generation: blowhards who are never wrong and who run their company like a personal plaything. Workers at such firms must always be ready to face personal and professional upheaval.
Th, 05 Jan 2023
Specialty Retail
Bed Bath & Beyond expresses “substantial doubt” about future, shares plunge
Nine years ago, Bed Bath & Beyond (BBBY $2) was a $17 billion company with shares trading in the $80 range. Five short months ago, shares had rallied back into the $23 range as investors grew more optimistic that the company could pull out of its funk. Those hopes were dashed this week after the company said it was unable to file its Q3 report on time, expressing “substantial doubt about the company’s ability to continue.” That vote of no confidence from management sent shares tumbling 23% at the open, hitting an all-time low of $1.82.
What’s next for the specialty retailer, which now has a market cap of under $150 million? Bankruptcy protection, more than likely, will be the ultimate answer. The company could also attempt to restructure its debt, which might be difficult considering its 300% debt/equity ratio (it has some $1.7 billion in liabilities). Unaudited Q3 results point to sales of around $1.3 billion, down 33% from the same quarter last year, which the company attributes to slower traffic and reduced inventory levels. The latter is a real issue, as suppliers are reluctant to provide hard goods to a company which may not be able to pay them. Analysts had been expecting a net loss in the third quarter of $158 million; we can expect real losses to come in at more than double that figure. The more we look at the financials, the harder it becomes to see any exit strategy outside of bankruptcy protection.
It would be nice to see Bed Bath & Beyond purchased by a private equity firm and taken private, with a continued bricks-and-mortar footprint, but that may be wishful thinking. There is another aspect to this story for investors to be aware of: A dozen REITs report the company as a tenant, with Kimco Realty (KIM $21) holding a plurality of the leases. We have been warning investors about the challenges facing office and retail REITs going forward, and we believe the market is still underestimating the risk. Now is the time to review your real estate holdings.
Headlines for the Month of December, 2022
Th, 22 Dec 2022
Goods & Services
Third quarter GDP revised up to 3.2% on the back of strong consumer spending
For all of the talk about recession, the third quarter of 2022 continues to look stronger in the rear-view mirror. The initial GDP figures showed a 2.6% growth rate, which was subsequently upgraded to 2.9%, and most recently to 3.2%. This is an especially welcome revision following a contraction in each of the first two quarters of the year. The Department of Commerce report reveals strong consumer spending—especially in services such as travel and recreation—over the three-month period, and stronger-than-expected nonresidential fixed investment (think expenditures by firms on capital such as commercial real estate, tools, machinery, and factories). Defense spending also helped grow the economy. An increase in exports and a decrease in imports led to a contraction in the US trade deficit, yet another positive factor. On the flipside, the higher price of both new and used cars constrained growth, as did a drop in new and used home sales.
Ironically, the upward revision in GDP led to a selloff in stocks, as investors see the report as another excuse for the Fed to keep raising rates. We don’t buy that, and still see two more 25-basis-point hikes (bringing the Fed funds rate to 5%) and then an elongated pause.
Th, 22 Dec 2022
Media & Entertainment
The chicanery rolls on at AMC, with an APE conversion and a reverse stock split
AMC Entertainment (AMC $5) is the gift that keeps on giving; well, unless you are an investor in the small-cap theater chain. Remember when Adam Aron’s company issued preferred shares under the apropos symbol APE this past August (at $6.95) and began handing them out to shareholders as dividends? How about when the company toyed with the idea of handing out NFTs as dividends? We sit about twenty minutes away from AMC’s international headquarters, yet Adam Aron, CEO and financial engineer extraordinaire, sits in his office some 1,100 miles away as the crow flies. That about sums it up.
Now, with APE trading at $1.20 (a 75% gain from the prior day) and AMC sitting at $4.50 per share (down 13% on the news), the company announced yet another capital raise ($110 million this time) and a one-for-ten reverse split proposal. Aron tweeted something to the effect of needing to attack the Wall Street haters who are determined to turn AMC into a penny stock. Um, that’s all you, buddy. Such a joke. Aron wanted to attract Apesters by offering a low stock price; now he supposedly wants to attract institutional investors by making the shares worth $50? What institutional investor in their right mind would buy into this horror show? He has turned AMC into his own personal Rube Goldberg machine. He ended his tweet with the sentence, “Simple arithmetic, if approved, the share count goes down so share price goes up.” Gee, thanks for that wonderful lesson in investment finance.
We have always wanted AMC to succeed, but this huckster needs to go. Investors simply need to look at the company’s financials to realize this fact. Stop the games and focus on new and creative ways to fill your theaters.
Mo, 19 Dec 2022
Aerospace & Defense
L3Harris wants to buy Aerojet Rocketdyne, but will the FTC’s Darth Vader kill the deal?
Recall back in February of this year that the FTC’s very own Darth Vader, the highly unqualified Lina Khan, killed Lockheed Martin’s (LMT $482) deal to buy rocket maker Aerojet Rocketdyne (AJRD $55) for $4.4 billion (we own both LMT and AJRD in Penn strategies). Now, US defense contractor L3Harris Technologies (LHX $208) has announced its own agreement to buy the company. L3 has offered $58 per share, or roughly $4.7 billion, to buy the El Segundo-based firm, with the firm’s CEO, Chris Kubasik, outlining a plan to become an alternative supplier to the Pentagon. Just a few months ago, L3 acquired Viasat’s military communications unit, creating the 6th-largest US defense contractor in the process.
While Khan probably would have wished for a foreign entity to buy this American jewel, she is going to have a tough time stopping this acquisition. Her FTC has already lost an inordinate number of battles in the courtroom (she received her law degree just five years ago), and she would have a tenuous argument that the merger would quell competition—though we still expect her to sue. As for the deal itself, we love it. As much as we wanted Lockheed to buy the company, Aerojet would be a great compliment to L3’s existing defense units.
While we don’t own L3Harris outright, it is the seventh-largest holding in our Invesco Aerospace & Defense ETF (PPA $77). With its 16 forward P/E and strong position in the military communications business, it would be a sold addition to a portfolio short on industrials. As could be expected, it is trading slightly down on the acquisition news.
Sa, 10 Dec 2022
Week in Review
Week in Review: The markets dropped on pure silliness
It is the question that just won't die: When will the Fed stop raising rates and what will the terminal rate be? Pure silliness. All of the major indexes fell this week on these concerns, capped off on Friday with a stronger-than-expected Producer Price Index (PPI) for November of 0.3% versus the 0.2% anticipated. The PPI measures inflation from the seller's perspective. There was only one positive day—Thursday—for the markets out of the five sessions.
Here's why we call this pure silliness: The Fed will probably raise rates another 50 basis points this coming week, followed by (in our estimate) two subsequent 25-basis-point hikes in early 2023. That would bring the upper band of the Fed funds rate to 5%. Not 12%, not 10%, not even 7%, but 5%! The economy can grow at a healthy clip with a 5% rate, period. In fact, the historical average of the Fed funds rate is 4.6%. And yes, all of these rate hikes will work their way through the system soon and cause inflation to drop and the unemployment rate to rise—probably closer to 5% from the current 3.7%. What does the Fed consider full employment? 4-6% or less. The markets have overreacted yet again.
Something did drop last week which brought welcome news. Crude oil futures began the week at $80.34 per barrel and ended the week at $71.58 per barrel, or an 11% slide. Astonishingly, considering the Russian oil embargo and OPEC+ production cuts, crude prices are now below where we started the year ($75.45/bbl).
Next week two big stories should dominate the markets: Tuesday's CPI report (what consumers pay for a basket of goods) and Wednesday's rate hike decision. Barring any major surprises in the CPI report, we stick with our 0.5% rate hike prediction. If Powell says the right things in the post-decision news conference, we might just be in for a three-week rally to close out an ugly, ugly year.
Fr, 09 Dec 2022
Government Watchdog
The imperial FTC will lose in court, Microsoft will buy Activision Blizzard
We cannot say enough rotten things about current chair of the Federal Trade Commission, Lina M. Khan. She is highly unqualified for her position, a political hack with a giant chip on her shoulder, a tool for progressives…we will stop there before we make it personal. The most recent target of the FTC, which is now as anti-capitalist as it has ever been, is Microsoft (MSFT $247); specifically, the company’s bid to acquire electronic gaming company Activision Blizzard (ATVI $75) for $69 billion.
Well before the agency announced its lawsuit against Microsoft to block the acquisition, we knew the legal action was coming—Khan is as transparent as cellophane wrap. Microsoft’s management team knew it as well and threw down the gauntlet earlier in the month. Instead of genuflecting before the mighty body the company did just the opposite: it offered nothing and promised a bloody fight. A smart move, as the lawsuit has no merit.
The FTC claims the acquisition would stifle the competition, which is laughable considering the level of creative genius within the world of content creators and the number of Activision’s competitors, to include: Electronic Arts, Take-Two Interactive, Epic Games, Ubiosoft, and Tencent Games. Activision CEO Bobby Kotick echoed Microsoft’s comments: “…I want to reinforce my confidence that this deal will close…we’ll win this challenge.” What do investors think? The day of the lawsuit’s announcement, ATVI shares were down just 1.54%.
The judicial system within the US is becoming so political that it is hard to know for sure what the ultimate outcome of this case will be, but if it is weighed by the merits of the case, the FTC’s lawsuit will be dismissed. We believe Microsoft, which is a member of the Penn Global Leaders Club, will win in court and this intelligent tactical acquisition will transpire—perhaps just a bit behind schedule.
Th, 08 Dec 2022
Judicial Watch
The despicable acts of Michael Avenatti
The first time we saw so-called celebrity lawyer Michael Avenatti we immediately thought, “arrogant (expletive).” At the time, he was considering gracing the country with a run for president. And why not? That seemed about par for the course. Now, several years later, we finally get a bit of schadenfreude. When this California-based legal professional wasn’t busy rushing to the cameras with the likes of porn star Stormy Daniels, he was hard at work defrauding helpless clients. And evading taxes. And trying to extort $25 million from Nike. And committing domestic violence. It now appears that if the reprobate wants to run for president again, it won’t be any sooner than the 2034 election cycle: US District Judge James Selna just threw a 14-year sentence at him, to run concurrently with the term he began serving in 2020. One of Avenatti’s lawyers proclaimed the sentence to be “off-the-charts harsh.”
This person committed so many unfathomable acts it would take a 500-page book to detail all of them, but let’s consider the case of paraplegic Geoffrey Johnson. Avenatti represented the mentally handicapped Johnson in a lawsuit against the County of Los Angeles, alleging that he garnered his injuries as a result of being denied his Constitutional rights (Johnson had jumped off a balcony at the Twin Towers Correctional Facility in LA, causing his injuries). Fearful of the lawsuit going to court, the county did precisely what Avenatti knew they would—pay a $4 million settlement to end the case. Within four months, the settlement funds—which had been placed in his law firm’s trust account—had been drained by the California lawyer. He even financed a new business venture, a coffee company, with the stolen money. Instead of simply taking his confiscatory fee from Johnson, he concealed the settlement from his client and magnanimously paid the man’s monthly assisted living expenses. He subsequently hid income from the government on his business, Tully’s Coffee, and impeded the IRS’s efforts to collect $3.2 million in unpaid payroll taxes.
There are dozens upon dozens of similar stories surrounding Avenatti, and we imagine he will demand payment for the movie which will ultimately be made about him. As for Stormy Daniels, she decided to write a memoir of her travails. In a case of aggravated identity theft, Avenatti stole the $300,000 book advance.
There is so much about the American justice system that has nothing to do with justice and everything to do with greed. In 2020, the State Bar of California finally yanked Avenatti’s license to practice law; where was that esteemed organization in the decades leading up to that point?
Th, 01 Dec 2022
Energy Commodities
License to pump oil in Venezuela is as farcical as tapping the Strategic Petroleum Reserve
The headline intrigued us: “Chevron Gets US License to Pump Oil in Venezuela.” Despite the despot Maduro running the country, we could certainly use more oil to counteract OPEC’s promise to reduce supply and the sanctions on Russian crude. It didn’t take very long, however, before we figured out that this was just another gimmick which would barely move the needle.
The United States produces some 11.7 million barrels per day (BPD) of crude—more than any other country on the planet. Granted, that is down 10% from what we were generating in 2019, but still mighty impressive. While Venezuela does have an enormous store of oil reserves beneath its surface (around 300 billion barrels, or 18% of the world’s known supply), it is only able to pump less than 700,000 BPD—down from 2.3 million BPD in 2016—due to its crumbling energy infrastructure. The deal to resume production, brokered by Norway and signed in Mexico City, is contingent upon the Maduro government implementing a $3 billion humanitarian relief program and holding talks on free elections in the country. Anyone holding their breath on either of those two requirements actually getting accomplished?
But here is where the deal gets really humorous. The Biden administration prohibits pdVSA, the Venezuelan state-owned oil and natural gas entity, from receiving any profits from the oil Chevron sells from the deal; instead, under the new license, all profits will be used to pay off the hundreds of millions of debt owed to Chevron by pdVSA. What, then, is the incentive for Maduro to abide by the agreement and allow Chevron to ramp production back up in the country? That is a good question. Watch for the old bait and switch routine to be pulled. Chevron provides infrastructure, and Venezuela delivers more to China.
Since we are talking oil supplies, let’s revisit the Strategic Petroleum Reserve, the emergency stockpile of oil maintained by the US Department of Energy. It is now down to a disgraceful 400 million barrels from its authorized 727 million barrels. The SPR is sitting there in case of a national emergency, not to reduce the price of oil. So far this year, the administration has released 165 million barrels from the reserve and has announced plans to allow another 15 million barrels to flow. A figurative drop in the bucket with respect to affecting oil prices, but a decision which will impact US readiness. Stop the release and rebuild the supply to authorized levels.
The aim of Venezuela in the Mexico City talks was to get American energy companies back to Venezuela; more specifically, their money, know-how, and equipment. Keep your eyes on this deal, as it will not turn out as expected by those who cobbled it together. Not that we are against more oil production in the Americas; there is nothing more we would like to see than an energy-independent Western hemisphere.
Th, 22 Dec 2022
Goods & Services
Third quarter GDP revised up to 3.2% on the back of strong consumer spending
For all of the talk about recession, the third quarter of 2022 continues to look stronger in the rear-view mirror. The initial GDP figures showed a 2.6% growth rate, which was subsequently upgraded to 2.9%, and most recently to 3.2%. This is an especially welcome revision following a contraction in each of the first two quarters of the year. The Department of Commerce report reveals strong consumer spending—especially in services such as travel and recreation—over the three-month period, and stronger-than-expected nonresidential fixed investment (think expenditures by firms on capital such as commercial real estate, tools, machinery, and factories). Defense spending also helped grow the economy. An increase in exports and a decrease in imports led to a contraction in the US trade deficit, yet another positive factor. On the flipside, the higher price of both new and used cars constrained growth, as did a drop in new and used home sales.
Ironically, the upward revision in GDP led to a selloff in stocks, as investors see the report as another excuse for the Fed to keep raising rates. We don’t buy that, and still see two more 25-basis-point hikes (bringing the Fed funds rate to 5%) and then an elongated pause.
Th, 22 Dec 2022
Media & Entertainment
The chicanery rolls on at AMC, with an APE conversion and a reverse stock split
AMC Entertainment (AMC $5) is the gift that keeps on giving; well, unless you are an investor in the small-cap theater chain. Remember when Adam Aron’s company issued preferred shares under the apropos symbol APE this past August (at $6.95) and began handing them out to shareholders as dividends? How about when the company toyed with the idea of handing out NFTs as dividends? We sit about twenty minutes away from AMC’s international headquarters, yet Adam Aron, CEO and financial engineer extraordinaire, sits in his office some 1,100 miles away as the crow flies. That about sums it up.
Now, with APE trading at $1.20 (a 75% gain from the prior day) and AMC sitting at $4.50 per share (down 13% on the news), the company announced yet another capital raise ($110 million this time) and a one-for-ten reverse split proposal. Aron tweeted something to the effect of needing to attack the Wall Street haters who are determined to turn AMC into a penny stock. Um, that’s all you, buddy. Such a joke. Aron wanted to attract Apesters by offering a low stock price; now he supposedly wants to attract institutional investors by making the shares worth $50? What institutional investor in their right mind would buy into this horror show? He has turned AMC into his own personal Rube Goldberg machine. He ended his tweet with the sentence, “Simple arithmetic, if approved, the share count goes down so share price goes up.” Gee, thanks for that wonderful lesson in investment finance.
We have always wanted AMC to succeed, but this huckster needs to go. Investors simply need to look at the company’s financials to realize this fact. Stop the games and focus on new and creative ways to fill your theaters.
Mo, 19 Dec 2022
Aerospace & Defense
L3Harris wants to buy Aerojet Rocketdyne, but will the FTC’s Darth Vader kill the deal?
Recall back in February of this year that the FTC’s very own Darth Vader, the highly unqualified Lina Khan, killed Lockheed Martin’s (LMT $482) deal to buy rocket maker Aerojet Rocketdyne (AJRD $55) for $4.4 billion (we own both LMT and AJRD in Penn strategies). Now, US defense contractor L3Harris Technologies (LHX $208) has announced its own agreement to buy the company. L3 has offered $58 per share, or roughly $4.7 billion, to buy the El Segundo-based firm, with the firm’s CEO, Chris Kubasik, outlining a plan to become an alternative supplier to the Pentagon. Just a few months ago, L3 acquired Viasat’s military communications unit, creating the 6th-largest US defense contractor in the process.
While Khan probably would have wished for a foreign entity to buy this American jewel, she is going to have a tough time stopping this acquisition. Her FTC has already lost an inordinate number of battles in the courtroom (she received her law degree just five years ago), and she would have a tenuous argument that the merger would quell competition—though we still expect her to sue. As for the deal itself, we love it. As much as we wanted Lockheed to buy the company, Aerojet would be a great compliment to L3’s existing defense units.
While we don’t own L3Harris outright, it is the seventh-largest holding in our Invesco Aerospace & Defense ETF (PPA $77). With its 16 forward P/E and strong position in the military communications business, it would be a sold addition to a portfolio short on industrials. As could be expected, it is trading slightly down on the acquisition news.
Sa, 10 Dec 2022
Week in Review
Week in Review: The markets dropped on pure silliness
It is the question that just won't die: When will the Fed stop raising rates and what will the terminal rate be? Pure silliness. All of the major indexes fell this week on these concerns, capped off on Friday with a stronger-than-expected Producer Price Index (PPI) for November of 0.3% versus the 0.2% anticipated. The PPI measures inflation from the seller's perspective. There was only one positive day—Thursday—for the markets out of the five sessions.
Here's why we call this pure silliness: The Fed will probably raise rates another 50 basis points this coming week, followed by (in our estimate) two subsequent 25-basis-point hikes in early 2023. That would bring the upper band of the Fed funds rate to 5%. Not 12%, not 10%, not even 7%, but 5%! The economy can grow at a healthy clip with a 5% rate, period. In fact, the historical average of the Fed funds rate is 4.6%. And yes, all of these rate hikes will work their way through the system soon and cause inflation to drop and the unemployment rate to rise—probably closer to 5% from the current 3.7%. What does the Fed consider full employment? 4-6% or less. The markets have overreacted yet again.
Something did drop last week which brought welcome news. Crude oil futures began the week at $80.34 per barrel and ended the week at $71.58 per barrel, or an 11% slide. Astonishingly, considering the Russian oil embargo and OPEC+ production cuts, crude prices are now below where we started the year ($75.45/bbl).
Next week two big stories should dominate the markets: Tuesday's CPI report (what consumers pay for a basket of goods) and Wednesday's rate hike decision. Barring any major surprises in the CPI report, we stick with our 0.5% rate hike prediction. If Powell says the right things in the post-decision news conference, we might just be in for a three-week rally to close out an ugly, ugly year.
Fr, 09 Dec 2022
Government Watchdog
The imperial FTC will lose in court, Microsoft will buy Activision Blizzard
We cannot say enough rotten things about current chair of the Federal Trade Commission, Lina M. Khan. She is highly unqualified for her position, a political hack with a giant chip on her shoulder, a tool for progressives…we will stop there before we make it personal. The most recent target of the FTC, which is now as anti-capitalist as it has ever been, is Microsoft (MSFT $247); specifically, the company’s bid to acquire electronic gaming company Activision Blizzard (ATVI $75) for $69 billion.
Well before the agency announced its lawsuit against Microsoft to block the acquisition, we knew the legal action was coming—Khan is as transparent as cellophane wrap. Microsoft’s management team knew it as well and threw down the gauntlet earlier in the month. Instead of genuflecting before the mighty body the company did just the opposite: it offered nothing and promised a bloody fight. A smart move, as the lawsuit has no merit.
The FTC claims the acquisition would stifle the competition, which is laughable considering the level of creative genius within the world of content creators and the number of Activision’s competitors, to include: Electronic Arts, Take-Two Interactive, Epic Games, Ubiosoft, and Tencent Games. Activision CEO Bobby Kotick echoed Microsoft’s comments: “…I want to reinforce my confidence that this deal will close…we’ll win this challenge.” What do investors think? The day of the lawsuit’s announcement, ATVI shares were down just 1.54%.
The judicial system within the US is becoming so political that it is hard to know for sure what the ultimate outcome of this case will be, but if it is weighed by the merits of the case, the FTC’s lawsuit will be dismissed. We believe Microsoft, which is a member of the Penn Global Leaders Club, will win in court and this intelligent tactical acquisition will transpire—perhaps just a bit behind schedule.
Th, 08 Dec 2022
Judicial Watch
The despicable acts of Michael Avenatti
The first time we saw so-called celebrity lawyer Michael Avenatti we immediately thought, “arrogant (expletive).” At the time, he was considering gracing the country with a run for president. And why not? That seemed about par for the course. Now, several years later, we finally get a bit of schadenfreude. When this California-based legal professional wasn’t busy rushing to the cameras with the likes of porn star Stormy Daniels, he was hard at work defrauding helpless clients. And evading taxes. And trying to extort $25 million from Nike. And committing domestic violence. It now appears that if the reprobate wants to run for president again, it won’t be any sooner than the 2034 election cycle: US District Judge James Selna just threw a 14-year sentence at him, to run concurrently with the term he began serving in 2020. One of Avenatti’s lawyers proclaimed the sentence to be “off-the-charts harsh.”
This person committed so many unfathomable acts it would take a 500-page book to detail all of them, but let’s consider the case of paraplegic Geoffrey Johnson. Avenatti represented the mentally handicapped Johnson in a lawsuit against the County of Los Angeles, alleging that he garnered his injuries as a result of being denied his Constitutional rights (Johnson had jumped off a balcony at the Twin Towers Correctional Facility in LA, causing his injuries). Fearful of the lawsuit going to court, the county did precisely what Avenatti knew they would—pay a $4 million settlement to end the case. Within four months, the settlement funds—which had been placed in his law firm’s trust account—had been drained by the California lawyer. He even financed a new business venture, a coffee company, with the stolen money. Instead of simply taking his confiscatory fee from Johnson, he concealed the settlement from his client and magnanimously paid the man’s monthly assisted living expenses. He subsequently hid income from the government on his business, Tully’s Coffee, and impeded the IRS’s efforts to collect $3.2 million in unpaid payroll taxes.
There are dozens upon dozens of similar stories surrounding Avenatti, and we imagine he will demand payment for the movie which will ultimately be made about him. As for Stormy Daniels, she decided to write a memoir of her travails. In a case of aggravated identity theft, Avenatti stole the $300,000 book advance.
There is so much about the American justice system that has nothing to do with justice and everything to do with greed. In 2020, the State Bar of California finally yanked Avenatti’s license to practice law; where was that esteemed organization in the decades leading up to that point?
Th, 01 Dec 2022
Energy Commodities
License to pump oil in Venezuela is as farcical as tapping the Strategic Petroleum Reserve
The headline intrigued us: “Chevron Gets US License to Pump Oil in Venezuela.” Despite the despot Maduro running the country, we could certainly use more oil to counteract OPEC’s promise to reduce supply and the sanctions on Russian crude. It didn’t take very long, however, before we figured out that this was just another gimmick which would barely move the needle.
The United States produces some 11.7 million barrels per day (BPD) of crude—more than any other country on the planet. Granted, that is down 10% from what we were generating in 2019, but still mighty impressive. While Venezuela does have an enormous store of oil reserves beneath its surface (around 300 billion barrels, or 18% of the world’s known supply), it is only able to pump less than 700,000 BPD—down from 2.3 million BPD in 2016—due to its crumbling energy infrastructure. The deal to resume production, brokered by Norway and signed in Mexico City, is contingent upon the Maduro government implementing a $3 billion humanitarian relief program and holding talks on free elections in the country. Anyone holding their breath on either of those two requirements actually getting accomplished?
But here is where the deal gets really humorous. The Biden administration prohibits pdVSA, the Venezuelan state-owned oil and natural gas entity, from receiving any profits from the oil Chevron sells from the deal; instead, under the new license, all profits will be used to pay off the hundreds of millions of debt owed to Chevron by pdVSA. What, then, is the incentive for Maduro to abide by the agreement and allow Chevron to ramp production back up in the country? That is a good question. Watch for the old bait and switch routine to be pulled. Chevron provides infrastructure, and Venezuela delivers more to China.
Since we are talking oil supplies, let’s revisit the Strategic Petroleum Reserve, the emergency stockpile of oil maintained by the US Department of Energy. It is now down to a disgraceful 400 million barrels from its authorized 727 million barrels. The SPR is sitting there in case of a national emergency, not to reduce the price of oil. So far this year, the administration has released 165 million barrels from the reserve and has announced plans to allow another 15 million barrels to flow. A figurative drop in the bucket with respect to affecting oil prices, but a decision which will impact US readiness. Stop the release and rebuild the supply to authorized levels.
The aim of Venezuela in the Mexico City talks was to get American energy companies back to Venezuela; more specifically, their money, know-how, and equipment. Keep your eyes on this deal, as it will not turn out as expected by those who cobbled it together. Not that we are against more oil production in the Americas; there is nothing more we would like to see than an energy-independent Western hemisphere.
Headlines for the Month of November, 2022
We, 30 Nov 2022
Global Organizations & Accords
Better late than never: NATO chief warns against repeating Russian mistake with China
NATO chief Jens Stoltenberg, perhaps the strongest alliance leader since General Alexander Haig back in the 1970s, warned member-states that the critical mistake of relying too heavily on Russia for necessary supplies must not be repeated with China. Of course, that ship has already sailed; for anyone who doubts it, go to the store of your choice and look at the labels on the goods. If it were possible to place an origin sticker on the active pharmaceutical ingredients (APIs) found in our lifesaving drugs, 86% of them would be stamped “Made in China.” Not the drugs, mind you, just the needed ingredients for the drugs. But at least someone in a leadership role is finally standing up and sounding the alarm.
On CNBC this week, the astute reporter Brian Sullivan made the following statement: “It is amazing how many CEOs of American companies have no problem wading into domestic politics but are completely silent with respect to (what is going on in) China. Amen, Brian. Stoltenberg told a group of foreign ministers that, “Over-dependence of resources on authoritarian regimes like Russia makes us vulnerable and we should not repeat that mistake with China. We should assess our vulnerabilities and reduce them.” US Secretary of State Antony Blinken echoed his comments following the meeting. The NATO chief went even further and brought up the topic China “forbids” being discussed. “China’s behavior toward Taiwan is aggressive, coercing, and threatening,” and “any conflict around Taiwan would be in nobody’s best interest.” Could we etch his words in stone and force American CEOs to hang them in their offices?
We have a high level of respect for the likes of Apple’s Cook, Walmart’s McMillon, and Nike’s Donahoe, but they can and should be doing more to migrate away from Chinese manufacturing facilities. Of course, they will tell you they are, but the shelves and the tags still tell a different story. Here’s to Stoltenberg—we will hunt down a Norwegian beer and drink a toast to his leadership.
Tu, 29 Nov 2022
Beverages, Tobacco, & Cannabis
Budweiser’s awesome response to Qatar’s classless move to ban beer
One might question the wisdom of Budweiser’s (BUD $58) decision to sponsor the World Cup in a nation which loathes alcohol, but the InBev unit paid $75 million for the rights. As could be expected, host nation Qatar—cash in hand—then banned all beer sales in and around World Cup stadiums, making the announcement just two days before the tourney began. They did, however, graciously announce that non-alcoholic Bud Zero would still be allowed. How magnanimous. Bud has been the exclusive beer distributor at FIFA World Cup games since 1986, and had previously renewed their contract after receiving assurances from Qatar that beer would be allowed when they hosted the games. Needless to say, InBev and beer drinking attendees were fuming.
We haven’t been the world’s biggest Budweiser fans since the Busch family—specifically Buschies III and IV—lost the company to a foreign entity (InBev) due to egregious mismanagement and stellar arrogance. Nonetheless, their response to Qatar’s slap in the face is worthy of a toast. The company has announced that all of the surplus beer banished from the Islamic state will be hauled to the nation which wins the 2022 World Cup and used as the centerpiece for a massive victory celebration. Bud tweeted: “They…get a victory celebration on us. It’s gonna be big.” Talk about turning a costly indignity into a massive, global PR stunt; brilliant! Trending on Twitter: #BringHomeTheBud. Long live beer!
With the proliferation of great craft beer companies since InBev acquired Anheuser-Busch back in 2008, competition within the industry has been fierce—even for the enormous players like Bud. We last owned BUD in the Penn Global Leaders Club back in 2008 and haven’t really considered adding it back since. Shares seem fairly valued around $65, or just 12% where they now trade. Still, we applaud the hilarious move following Qatar’s deceitful decision. An aside: An odds-on favorite to win the World Cup this year is Brazil, which happens to be one of the two countries (Belgium being the other) which control InBev.
Mo, 28 Nov 2022
Construction Materials
The ultimate contrarian play: Is Builders FirstSource worthy of a look?
Builders FirstSource (BLDR $60) is a pure play on one of the most (if not the most) distressed corners of the market: new home construction. The $9 billion Dallas-based company manufactures and supplies factory-built roof and floor trusses, wall panels and stairs, vinyl windows, custom millwork and trim, and engineered wood products to homebuilders of all sizes. When there is a housing boom underway, investing in the company makes perfect sense; but when the sector moves south, so does its share price. Case in point: Before the 2008 housing crisis, BLDR shares were trading around $25; in December of 2008, they hit $0.83.
While Builders FirstSource certainly isn’t under the strain it was back in 2008, consider this: at $60 per share, the stock has a tiny multiple of 3.7 and a forward P/E of 3.4. Over the trailing twelve months, the company earned $2.8 billion from $23 billion in revenue. Investors may be leery of jumping in, but management is not: the company just boosted its stock buyback program by $1 billion. Between August of last year and prior to this latest buyback, the firm spent a massive $3.8 billion buying back 61 million shares of stock (30% of shares outstanding) at an average price of $63.05. Talk about being bullish on your future.
With a presence in 85 of the top 100 metropolitan markets in the country, and with no single customer accounting for more than 6% of sales, it wouldn’t take much to move Builders FirstSource shares higher. While we don’t currently own the company in any Penn Strategy, we would place a fair value on the shares somewhere in the range of $80 to $100.
Sa, 26 Nov 2022
Market Pulse
Week in review: Markets gained some ground in thin trading
Trading was thin over the holiday-shortened week on Wall Street, but the major benchmarks still managed to pull out a win. The Nasdaq was the laggard, up 0.72% on the week; the S&P 500 was up just over twice that amount, or 1.53%. The one component we wanted to see fall on the week actually did just that: oil dropped 4.44% to $76.55 per barrel. Rather remarkable, considering all the recent talk of OPEC+ production cuts and the impending (05 Dec) full EU ban on Russian oil. Even more stunning is the fact that we are now just 1.46% above where crude started the year: $75.45. Keep in mind that Russia didn't invade Ukraine until February. China announced major lockdowns due to new outbreaks of the pandemic this past week, and we are now just over two weeks from a potential rail strike. Perhaps we are finally witnessing seller exhaustion. The S&P 500 remains 15.5% below where it started the year, while the Nasdaq remains down 28.24%.
We, 23 Nov 2022
Farm & Heavy Construction Machinery
High tech down on the farm: Deere sees ‘total autonomy’ by 2030
Shares of farming construction equipment leader Deere & Company (DE $438) rose 5% on Wednesday following a sterling earnings report. Revenue surged 37% year-over-year, to $15.5 billion, with all major business lines notching big sales increases. With booming commodity prices, farmers are reaping increased cash yields, and they are putting much of that money to work in new equipment. The big sales gains flowed directly down to the bottom line, with profits soaring 75%—to $2.2 billion. As if the actual numbers weren’t enough to make investors swoon, management followed up with strong 2023 projections. CEO John May sees increased investment in infrastructure next year—despite high odds of a recession—and a “healthy demand for our equipment.” Rachel Bach, manager of investor communications, said dealers “remain on allocation” for the year, with the order books already filled into the third quarter.
The company also sees a transformational trend taking root in the industry over the next decade with respect to automation. Deere believes we could see “total autonomy” in corn and soybean production within the US by 2030. Not only does that mean increased sales of new, high-tech equipment, it also means new recurring revenue models. Imagine farmers calling on the company’s AI to identify weeds in the field and spray nutrients with pinpoint accuracy. Consider how important that ability becomes with the sky-high price of agriculture inputs like nitrogen, phosphate, and potash. Deere plans to grow their recurring revenue streams by 10% before the end of the decade—we believe those estimates are conservative.
It's hard to believe it has been two years since we wrote about Deere’s impressive comeback following the brutal downturn during the initial days of the pandemic. At the time, Deere shares were trading for $256, and Morningstar had a fair value of $183 on them along with a one-star (“Sell”) rating. We didn’t agree with their thesis. Today, Deere shares are sitting at $438 and Morningstar has raised its weighting to two stars (“Underweight”) and placed a $354 fair value on the shares. Ditto what we said precisely two years ago—we ardently disagree. Maybe the company should do a 10-for-1 stock split; after all, doesn’t $44 per share sound more appealing to many investors than $438? (We are being facetious, but—sadly—that is how too many investors scour for “undervalued” stocks.)
Mo, 21 Nov 2022
Media & Entertainment
Disney shocker: Hapless Chapek fired as Iger returns to lead the company
It was the move we have been waiting for, but one we thought wouldn’t happen for at least another year. Despite foolishly extending CEO Bob Chapek’s contract by three years, the Walt Disney Company (DIS $100) board did an abrupt about face and fired him. Chapek was clearly in over his head, but the board was stubbornly defiant on the matter. So, why the sudden change of heart? The most recent earnings report, which we wrote about in our last After Hours, was almost certainly the final straw. A revenue miss, an earnings miss, and massive streaming losses pushed Chapek out the door—with no doubt some help from a few Iger phone calls we will never know about. Yes, Iger’s ego is enormous, but who cares? He is probably the one person who can choreograph a quick turnaround. The move was music to our ears. Investors didn’t mind, either: shares were trading up nearly 10% in the pre-market following the announcement.
After leading the company for fifteen years, Bob Iger has “agreed” (more like demanded) to come back for another two years, effective immediately. Despite hand-selecting Chapek to succeed him, one could sense the disdain between the two as of late. Under Iger’s tenure, Disney grew from a theme park juggernaut into a media empire, thanks to four astute acquisitions and the launch of the Disney+ streaming service. Now, instead of resuming his acquisition strategy, he will set about mending the fences in Hollywood which Chapek tore down and maximizing the post-pandemic comeback in his parks and resorts.
There are no systemic reasons why Disney cannot stage an impressive comeback with the right leadership. Streaming may be mega-competitive, but that should worry Netflix (NFLX $291) more than Disney, as the former is a one-trick pony. Despite hefty price increases at the parks, we expect visitors to continue flooding back; and with the company’s impressive media franchises (Pixar, Marvel, Lucasfilm, and 21st Century Fox), the content possibilities seem endless. It is simply time for Iger to perform damage control using a tool Chapek didn’t have: charisma.
We have said repeatedly that we would never re-add Disney to any Penn portfolio while Chapek was CEO. Well, now he is gone. Let the comeback begin.
Th, 17 Nov 2022
Personal Finance
As we near a possible recession, Americans hit a new record of household debt
Let’s put some gargantuan numbers in perspective. The annual US GDP, or the total value of all goods produced and services provided within the country, is currently $25.66 trillion—far and away the largest in the world. Sadly, like the talented athlete with a fat new contract but little financial control, the country is currently $31.26 trillion in debt. The next-largest number is reserved for the US consumer, otherwise known as the world’s golden goose. Despite concerns over a coming recession, household debt in the US just rose at its fastest pace since 2007, bringing the figure up to a whopping $16.5 trillion.
Most disturbingly, credit card balances rose more than 15% from last year, the biggest spike in two decades. Despite the Fed funds rate sitting at 4%, the average credit card carries a 20% interest rate, with the average store-branded credit card charging 26.72%. Total debt jumped $351 billion during the July-through-September period alone—the largest quarterly increase since 2007 as well. Interestingly, the 8.3% year-over-year jump in total debt exactly matches August’s inflation read. While the rate of inflation cooled to 7.7% according to October’s CPI report, something tells us the $16.5 trillion figure will not drop.
In fairness, outstanding mortgage balances account for some $11.7 trillion of the aggregate debt, followed by $1.5 trillion in both auto loan and student loan debt, and $1 trillion worth of credit card balances. The remaining amount consists of mortgage originations, or loans taken out against the value of one’s home. Sadly, many of these loans are initiated to pay down credit card debt; balances which have a tendency to build right back up. These are not good data points going into a turbulent economic period.
As interest rates were low and student loan interest was placed on hold, Americans had the perfect opportunity to draw down their personal debt levels. Many did just that, but too many others decided to wantonly spend despite rising prices. And why not? The government has no problem spending money it does not have.
We, 16 Nov 2022
Space Sciences & Exploration
Furthering US dominance in spaceflight, NASA launches Artemis to the moon
Fifty years almost to the month after Gene Cernan and Harrison Schmitt became the last humans to walk on the moon, NASA is ready to send a new generation of Americans to the lunar surface. At 1:47 a.m. EST the largest and most powerful rocket ever launched lifted off from the Kennedy Space Center, sending the Lockheed Martin-built (LMT $468) Orion crew capsule on its 25-day journey around the moon and back. The Space Launch System (SLS)—part of the Artemis Moon program—has been a massive effort involving a number of aerospace companies, to include Lockheed, Boeing (BA $173), Northrop Grumman (NOC $502), Aerojet Rocketdyne (AJRD $50), and Airbus (EADSY $30).
Orion should reach the moon within six days, passing within sixty miles of the lunar surface before settling into its deep retrograde orbit—a looping route that extends 40,000 miles beyond the moon. That will set a record for the furthest distance from the Earth for any crew-capable ship in the history of human spaceflight. After spending two weeks in orbit, the craft will return home on 11 December with a Pacific Ocean splashdown.
Much like the one-person Mercury, two-person Gemini, and three-person Apollo craft, NASA is taking a step-by-step approach with this program. Artemis 1 will show that the craft can safely ferry astronauts back to the moon; Artemis 2 will carry a crew of astronauts to lunar orbit; Artemis 3 will place Americans back on the moon’s surface. It should be noted that Artemis, in Greek mythology, is the twin sister of Apollo. While remaining on schedule with any crewed space program is always extremely challenging, NASA’s plans call for a landing to take place on the lunar surface as soon as 2025.
The Apollo missions completed one of the greatest achievements in human history; in some ways, however, the Artemis program is even more important. Like our ancestral explorers, the earliest journeys always pave the way for trips designed to settle new lands. Between the six-person Orion capsule and Elon Musk’s Starship, which can be configured to carry a crew of up to 100, it is fair to say that we are entering the most exciting phase of our nascent journey into space. NASA has, in fact, already tapped SpaceX and its Starship for the second lunar landing program. We own all of the companies listed in this story other than Boeing. Despite SpaceX being privately held, we own that company via a private equity fund within the Penn Dynamic Growth Strategy.
Mo, 14 Nov 2022
Homebuilding
Lennar is building a 3D-printed community in the suburbs of Austin, Texas
It seems like something out of a science fiction novel, but it is happening in our own backyard right now. America’s second-largest homebuilder, Lennar (LEN $87), in partnership with 3D printing company ICON, is developing a 100-home community near Austin, Texas consisting entirely of 3D-printed homes. The community will offer buyers a selection of eight floorplans and 24 unique elevations ranging from 1,574 to 2,112 square feet of living space. The three to four bedroom, two to three bath homes will be partially powered by rooftop solar panels and come with a price tag starting in the mid-$400,000 range.
The 3D printers creating the homes are nothing short of remarkable. Designed to operate 24 hours per day, they are fully automated with just three workers needed at each home site. The ICON machines build the entire wall system of the house, to include electrical and plumbing, three times faster than traditional methods and at around half the cost. The walls are made of concrete, meaning increased strength and excellent energy efficiency. It takes the massive printer about two weeks to “build” (picture toothpaste coming out of a tube) one home. This is the first 3D housing development project to be completed fully on site, but we expect it to be the start of a revolutionary transformation in the homebuilding industry.
There are many fascinating facets to this story, from the innovative robotics involved, to the possible effect of reducing housing inflation, to the impact on the price of building materials (think of the reduction in lumber use within these sites). Lennar remains on the cutting edge of homebuilding innovation, and is our favorite player in the space.
Sa, 12 Nov 2022
Market Pulse
Week in Review: Markets dropped after the election, soared on inflation data
There were two big potential catalysts for the stock market this past week: the mid-term elections and the CPI report. Following Tuesday’s mixed election results, investors decided it was time to sell; the major benchmarks all dropped in the 2% range. We were worried that Thursday’s CPI report, which gauges the rate of inflation in the US, would provide another excuse to keep the risk-off train moving. Instead, the rate of growth of inflation actually slowed to levels not seen since January, and it was off to the races. While led by the Nasdaq and small-cap Russell 2000, which were up 7.35% and 6.11% on the day, respectively, the S&P 500 and Dow also roared into the close. For the S&P 500 to move 5.54% in any given session is mighty impressive. Instead of taking some profit off the tables on Friday, investors followed up with another nice move higher. Everyone who finally threw the towel in on big tech names like Apple (AAPL), Microsoft (MSFT), and Google (GOOGL) paid a steep price this week: all were up nicely, with the latter two jumping 11.5% on the week. Good news also came with the price of crude, which fell 4% over the five sessions, dropping to an eight-handle. Both the ten-year and two-year Treasury yields fell more than 8% on the week.
Of all the market statistics from this past week, we find the Treasury rate change most interesting. The 2-year tends to predict what the Fed will do next, while the 10-year is more tethered to the 30-year mortgage rate. The plunge in the 2-year Treasury yield, from around 4.7% on Monday to 4.324% on Thursday (the bond market was closed on Veterans Day), signals a smaller rate hike might be in the cards for December’s FOMC meeting—at least in the minds of investors. We shall see—there remains a hawkish tone among the Fed governors.
Fr, 11 Nov 2022
Cryptocurrencies
Once called the JP Morgan of crypto, Sam Bankman-Fried’s wealth evaporates
Sam Bankman-Fried, the wonder boy of the crypto world who built the world’s second-largest crypto exchange, is finished. Were his FTX publicly traded, it would have probably garnered a market cap in the $20 billion ballpark a few weeks ago; now, the company has announced bankruptcy plans and Fried has resigned as CEO. The FTX token, which was selling for $80.50 in September of last year, is now going for $2.77 (down 60% in one day) and is probably worth a lot less than that. The wunderkind who went in front of Congress earlier in the year to explain the 2008 financial crisis—and how his exchange is completely different—was apparently using customer assets to fund ultra-high-risk bets by Alameda Research, a now-defunct quant trading firm majority-owned by Fried. High profile investment entities, from Softbank to Sequoia Capital to the Ontario Teachers’ Pension Plan, will lose virtually all the money they entrusted to FTX. Of course, their investment losses pale in comparison to Bankman-Fried’s personal erosion of wealth, which has dissolved from a high of around $16 billion to well under $1 billion today. But if a loss of wealth is all he suffers in the end, the JP Morgan of crypto should thank his lucky stars.
Highly sophisticated investors—and millions of everyday Joes—were wantonly pumping money into speculative vehicles which weren’t quite as transparent as the likes of Fried led them to believe. This was gambling, not investing. Ironically, Fried was seen as crypto’s white knight, riding to the rescue of “weaker” players. It appears he was doing so with money that didn’t belong to him. If this had to happen (and it did), it is a good thing that it came to light now—crypto had already been so pummeled that the contagion effect is relatively muted. Except, that is, for the investment houses like Softbank, which reportedly will lose some $100 million on the liquidation.
Th, 10 Nov 2022
Supply, Demand, & Prices
Finally! Inflation shows signs of cooling and the market’s reaction is intense
In normal times, a 7.7% year-over-year inflation reading would send the markets reeling. Instead, the latest CPI report led directly to a 1,201-point-gain in the Dow (3.7%), a 208-point-gain in the S&P 500 (5.54%), and an explosive 761-point-gain in the Nasdaq (7.35%). Those remarkable, one-session returns occurred thanks to slowest y/y inflation rate since January. This past June, the 9.1% reading marked the highest rate of inflation in the US in four decades. September’s report wasn’t much better, coming in at 8.2%. Breaking the report down, core CPI—which excludes food and energy—came in at 6.3%, which signaled another slowdown in growth from the previous months. October’s jobs numbers also gave the doves a ray of hope that the current hiking cycle may be on its last legs: the US unemployment rate rose from 3.5% to 3.7%. Wage growth is also easing, going from 5% y/y in September to 4.7% in October. No Fed officials came out and applauded the CPI report, but investors certainly celebrated by giving the market its best day in over two years.
While a 75-bps-hike is still expected at the December FOMC meeting, the odds of a smaller, 50-bps-hike are rising. Were the latter to happen, it would probably spell a serious Santa Claus rally going into the last few weeks of the year.
We, 09 Nov 2022
Media & Entertainment
Disney falls another 11% after dismal earnings report
We wrote a scathing indictment of Disney’s (DIS $88) management team this past spring, stating that CEO Bob Chapek must go. At the time, Disney shares had plunged to $138, down from $203. The latest drop—11% at the open—came in response to another bad earnings report. Revenues were a miss; earnings were a miss; streaming losses widened. While Disney+ added 12.1 million new accounts in the quarter, that business lost a whopping $1.47 billion. Since it launched back in 2019, the streaming service has now lost some $8 billion in aggregate. The parks have been doing great, but that is a huge deficit to keep covering. After spending $30 billion on content over the past twelve months alone, management announced cuts were coming to the content and marketing budgets but gave no specifics. Disney’s bottom-line numbers for the quarter say it all: Against expectations for $788 million in net income, the company made just $162 million. At least they remained in the black.
Analysts have overwhelmingly been bullish on this stock all year, projecting a big comeback in the share price. Considering Chapek just received a three-year contract extension, even $88 per share does not look attractive to us. What was the board thinking?
Th, 03 Nov 2022
Hotels, Resorts, & Cruise Lines
Airbnb is trading in double-digits again; is the stock worth a look?
Despite pricing its initial public offering shares at $68, the typical Joe had to buy Airbnb (ABNB $94) shares on the open market back in December of 2020. For anyone who wanted to jump into this highly touted travel name at the open (like us), the price was steep: shares opened at $146 and remained in triple digits for over a year. Now, investors can get in for the “bargain price” of just $94 per share—36% cheaper than the opening-day price. But are the shares actually cheap?
The company just had its “biggest and most profitable quarter ever,” with revenue of $2.9 billion and adjusted earnings of $1.5 billion. Gross bookings rose 31% in the quarter, beating estimates. Why, then, did ABNB shares plunge nearly 20% this week? It all revolves around guidance. For Q4, management expects revenue in the $1.85 billion range and growth of around 25%, “consistent with historical seasonality.” CEO Brian Chesky said the company is well positioned for the road ahead and has taken steps to reduce costs in preparation for a tougher economic environment. As with Powell’s comments on rate hikes, investors seemed to contort the words to paint a darker view of what’s to come. Hence, the major price drop.
In its “Airbnb 2022 Summer Release,” the company announced a slew of enhancements which would amount to “the biggest change to Airbnb in a decade,” according to Chesky. From an enhanced app experience to new protections for both guests and hosts, these upgrades should keep the company well ahead of its competitors in the space. While they are being attacked from both sides—the online travel agencies (to include Booking and Expedia) and the major hotel chains (primarily Hilton and Marriott)—the $60 billion firm controls approximately one-fifth of the entire vacation rental market. Considering the value of that market is projected to exceed $100 billion within five years, simply maintaining their ratio would spell strong growth ahead for the company. Investors are not in the mood, however, to give any consumer discretionary name a benefit of the doubt right now. Shares have fallen 43% year to date.
With its forward P/E of 32, Airbnb’s valuation remains richer than its online travel competitors and roughly in line with the major hotel chains. While we aren’t ready to add the company to a portfolio, the price seems to be at the upper end of the “fair” range. Should the shares fall closer to the IPO offering price of $68, we would almost certainly jump in.
We, 02 Nov 2022
Interactive Media & Services
Monetizing Twitter: Elon announces a new price plan for Twitter Blue
We were familiar with the blue checkmark symbol next to the name of Twitter users, but we never really gave much thought to who gets one and who does not. Introduced in 2009, this verification system was meant to provide a level of validity to notable account holders, such as celebrities, brands, and organizations. Sort of a caste system on the platform to separate the gentry from the hoi polloi, or unwashed masses. Elon Musk, self-proclaimed Chief Twit, is not a fan of such hierarchies, and he sent out a great tweet indicating what he thought of the policy: “Twitter’s current lords and peasants system for who has or doesn’t have a blue checkmark is bulls***. Power to the people! Blue for $8/month.”
Twitter Blue has been a subscription-based service which allows users to edit tweets, organize them into folders, and access other member-only perks. While Twitter has some 300 million daily active users and generated $5 billion in revenue last year, only around 424,000 accounts hold the coveted blue checkmark. Elon Musk has a grand vision for Twitter, and monetizing the platform is paramount. While the fee would go up to $8 per month, qualified users would be virtually guaranteed of receiving the verification stamp, and we can certainly expect Musk to roll out more perks in the months to come. His ultimate goal is to create what he calls “X, the everything app.” This “super app” would include social media interaction, messaging, payments, and even the ability to order food and drinks. Doubters abound, just as they did with Tesla in the early days, and some companies are indicating they may stop advertising on the platform. They will end up on the wrong side of this story after Musk is done writing it.
This past Friday, we saw a tweet which read: “Twitter hasn’t been this much fun in years.” Despite the naysayers, we fully expect Musk to transform what the platform is today into something quite different—and much more powerful. Some users and advertisers won’t come back, but we doubt the new owner, with his “move fast and break things” mentality, will give them a second’s worth of thought.
Tu, 01 Nov 2022
Transportation Infrastructure
Uber shares spike after the company reports beat on sales, strong ridership growth
A few weeks ago, shares of Penn New Frontier Fund member Uber (UBER $31) fell sharply on news that the Biden administration wanted to force gig economy companies to reclassify drivers as employees rather than freelancers. At the time, we believed that drop was a mistake, as there is very little chance the plan would ever see the light of day. That would have been a good time to get into the ridesharing company. Shares spiked over 15% mid-week as the company reported a staggering 72% jump in sales—to $8.34 billion—from the same quarter in 2021. Gross bookings rose 26%, to $29.1 billion, and adjusted EBITDA came in at $516 million—another beat. Uber Eats, the food-delivery unit of the company, now accounts for one-third of Uber’s total revenue mix.
In addition to the sales beat, Uber CEO Dara Khosrowshahi said he is quite optimistic about the fourth quarter, adding that even lower-income riders are increasing their ridership despite looming recession fears. He projects $600 million in adjusted earnings over the course of the quarter. As for the worker shortage, Uber’s global driver base is now back to pre-pandemic levels.
We have stuck with Uber through the horrendous 2022 downturn because we believe in the company’s growth trajectory. By building out a suite of delivery services, the company has insulated its business (to a good degree) from cyclical economic downturns. Additionally, the industry has a rather wide moat, and Uber is the clear leader in the space. We maintain our $70 price target on the shares.
We, 30 Nov 2022
Global Organizations & Accords
Better late than never: NATO chief warns against repeating Russian mistake with China
NATO chief Jens Stoltenberg, perhaps the strongest alliance leader since General Alexander Haig back in the 1970s, warned member-states that the critical mistake of relying too heavily on Russia for necessary supplies must not be repeated with China. Of course, that ship has already sailed; for anyone who doubts it, go to the store of your choice and look at the labels on the goods. If it were possible to place an origin sticker on the active pharmaceutical ingredients (APIs) found in our lifesaving drugs, 86% of them would be stamped “Made in China.” Not the drugs, mind you, just the needed ingredients for the drugs. But at least someone in a leadership role is finally standing up and sounding the alarm.
On CNBC this week, the astute reporter Brian Sullivan made the following statement: “It is amazing how many CEOs of American companies have no problem wading into domestic politics but are completely silent with respect to (what is going on in) China. Amen, Brian. Stoltenberg told a group of foreign ministers that, “Over-dependence of resources on authoritarian regimes like Russia makes us vulnerable and we should not repeat that mistake with China. We should assess our vulnerabilities and reduce them.” US Secretary of State Antony Blinken echoed his comments following the meeting. The NATO chief went even further and brought up the topic China “forbids” being discussed. “China’s behavior toward Taiwan is aggressive, coercing, and threatening,” and “any conflict around Taiwan would be in nobody’s best interest.” Could we etch his words in stone and force American CEOs to hang them in their offices?
We have a high level of respect for the likes of Apple’s Cook, Walmart’s McMillon, and Nike’s Donahoe, but they can and should be doing more to migrate away from Chinese manufacturing facilities. Of course, they will tell you they are, but the shelves and the tags still tell a different story. Here’s to Stoltenberg—we will hunt down a Norwegian beer and drink a toast to his leadership.
Tu, 29 Nov 2022
Beverages, Tobacco, & Cannabis
Budweiser’s awesome response to Qatar’s classless move to ban beer
One might question the wisdom of Budweiser’s (BUD $58) decision to sponsor the World Cup in a nation which loathes alcohol, but the InBev unit paid $75 million for the rights. As could be expected, host nation Qatar—cash in hand—then banned all beer sales in and around World Cup stadiums, making the announcement just two days before the tourney began. They did, however, graciously announce that non-alcoholic Bud Zero would still be allowed. How magnanimous. Bud has been the exclusive beer distributor at FIFA World Cup games since 1986, and had previously renewed their contract after receiving assurances from Qatar that beer would be allowed when they hosted the games. Needless to say, InBev and beer drinking attendees were fuming.
We haven’t been the world’s biggest Budweiser fans since the Busch family—specifically Buschies III and IV—lost the company to a foreign entity (InBev) due to egregious mismanagement and stellar arrogance. Nonetheless, their response to Qatar’s slap in the face is worthy of a toast. The company has announced that all of the surplus beer banished from the Islamic state will be hauled to the nation which wins the 2022 World Cup and used as the centerpiece for a massive victory celebration. Bud tweeted: “They…get a victory celebration on us. It’s gonna be big.” Talk about turning a costly indignity into a massive, global PR stunt; brilliant! Trending on Twitter: #BringHomeTheBud. Long live beer!
With the proliferation of great craft beer companies since InBev acquired Anheuser-Busch back in 2008, competition within the industry has been fierce—even for the enormous players like Bud. We last owned BUD in the Penn Global Leaders Club back in 2008 and haven’t really considered adding it back since. Shares seem fairly valued around $65, or just 12% where they now trade. Still, we applaud the hilarious move following Qatar’s deceitful decision. An aside: An odds-on favorite to win the World Cup this year is Brazil, which happens to be one of the two countries (Belgium being the other) which control InBev.
Mo, 28 Nov 2022
Construction Materials
The ultimate contrarian play: Is Builders FirstSource worthy of a look?
Builders FirstSource (BLDR $60) is a pure play on one of the most (if not the most) distressed corners of the market: new home construction. The $9 billion Dallas-based company manufactures and supplies factory-built roof and floor trusses, wall panels and stairs, vinyl windows, custom millwork and trim, and engineered wood products to homebuilders of all sizes. When there is a housing boom underway, investing in the company makes perfect sense; but when the sector moves south, so does its share price. Case in point: Before the 2008 housing crisis, BLDR shares were trading around $25; in December of 2008, they hit $0.83.
While Builders FirstSource certainly isn’t under the strain it was back in 2008, consider this: at $60 per share, the stock has a tiny multiple of 3.7 and a forward P/E of 3.4. Over the trailing twelve months, the company earned $2.8 billion from $23 billion in revenue. Investors may be leery of jumping in, but management is not: the company just boosted its stock buyback program by $1 billion. Between August of last year and prior to this latest buyback, the firm spent a massive $3.8 billion buying back 61 million shares of stock (30% of shares outstanding) at an average price of $63.05. Talk about being bullish on your future.
With a presence in 85 of the top 100 metropolitan markets in the country, and with no single customer accounting for more than 6% of sales, it wouldn’t take much to move Builders FirstSource shares higher. While we don’t currently own the company in any Penn Strategy, we would place a fair value on the shares somewhere in the range of $80 to $100.
Sa, 26 Nov 2022
Market Pulse
Week in review: Markets gained some ground in thin trading
Trading was thin over the holiday-shortened week on Wall Street, but the major benchmarks still managed to pull out a win. The Nasdaq was the laggard, up 0.72% on the week; the S&P 500 was up just over twice that amount, or 1.53%. The one component we wanted to see fall on the week actually did just that: oil dropped 4.44% to $76.55 per barrel. Rather remarkable, considering all the recent talk of OPEC+ production cuts and the impending (05 Dec) full EU ban on Russian oil. Even more stunning is the fact that we are now just 1.46% above where crude started the year: $75.45. Keep in mind that Russia didn't invade Ukraine until February. China announced major lockdowns due to new outbreaks of the pandemic this past week, and we are now just over two weeks from a potential rail strike. Perhaps we are finally witnessing seller exhaustion. The S&P 500 remains 15.5% below where it started the year, while the Nasdaq remains down 28.24%.
We, 23 Nov 2022
Farm & Heavy Construction Machinery
High tech down on the farm: Deere sees ‘total autonomy’ by 2030
Shares of farming construction equipment leader Deere & Company (DE $438) rose 5% on Wednesday following a sterling earnings report. Revenue surged 37% year-over-year, to $15.5 billion, with all major business lines notching big sales increases. With booming commodity prices, farmers are reaping increased cash yields, and they are putting much of that money to work in new equipment. The big sales gains flowed directly down to the bottom line, with profits soaring 75%—to $2.2 billion. As if the actual numbers weren’t enough to make investors swoon, management followed up with strong 2023 projections. CEO John May sees increased investment in infrastructure next year—despite high odds of a recession—and a “healthy demand for our equipment.” Rachel Bach, manager of investor communications, said dealers “remain on allocation” for the year, with the order books already filled into the third quarter.
The company also sees a transformational trend taking root in the industry over the next decade with respect to automation. Deere believes we could see “total autonomy” in corn and soybean production within the US by 2030. Not only does that mean increased sales of new, high-tech equipment, it also means new recurring revenue models. Imagine farmers calling on the company’s AI to identify weeds in the field and spray nutrients with pinpoint accuracy. Consider how important that ability becomes with the sky-high price of agriculture inputs like nitrogen, phosphate, and potash. Deere plans to grow their recurring revenue streams by 10% before the end of the decade—we believe those estimates are conservative.
It's hard to believe it has been two years since we wrote about Deere’s impressive comeback following the brutal downturn during the initial days of the pandemic. At the time, Deere shares were trading for $256, and Morningstar had a fair value of $183 on them along with a one-star (“Sell”) rating. We didn’t agree with their thesis. Today, Deere shares are sitting at $438 and Morningstar has raised its weighting to two stars (“Underweight”) and placed a $354 fair value on the shares. Ditto what we said precisely two years ago—we ardently disagree. Maybe the company should do a 10-for-1 stock split; after all, doesn’t $44 per share sound more appealing to many investors than $438? (We are being facetious, but—sadly—that is how too many investors scour for “undervalued” stocks.)
Mo, 21 Nov 2022
Media & Entertainment
Disney shocker: Hapless Chapek fired as Iger returns to lead the company
It was the move we have been waiting for, but one we thought wouldn’t happen for at least another year. Despite foolishly extending CEO Bob Chapek’s contract by three years, the Walt Disney Company (DIS $100) board did an abrupt about face and fired him. Chapek was clearly in over his head, but the board was stubbornly defiant on the matter. So, why the sudden change of heart? The most recent earnings report, which we wrote about in our last After Hours, was almost certainly the final straw. A revenue miss, an earnings miss, and massive streaming losses pushed Chapek out the door—with no doubt some help from a few Iger phone calls we will never know about. Yes, Iger’s ego is enormous, but who cares? He is probably the one person who can choreograph a quick turnaround. The move was music to our ears. Investors didn’t mind, either: shares were trading up nearly 10% in the pre-market following the announcement.
After leading the company for fifteen years, Bob Iger has “agreed” (more like demanded) to come back for another two years, effective immediately. Despite hand-selecting Chapek to succeed him, one could sense the disdain between the two as of late. Under Iger’s tenure, Disney grew from a theme park juggernaut into a media empire, thanks to four astute acquisitions and the launch of the Disney+ streaming service. Now, instead of resuming his acquisition strategy, he will set about mending the fences in Hollywood which Chapek tore down and maximizing the post-pandemic comeback in his parks and resorts.
There are no systemic reasons why Disney cannot stage an impressive comeback with the right leadership. Streaming may be mega-competitive, but that should worry Netflix (NFLX $291) more than Disney, as the former is a one-trick pony. Despite hefty price increases at the parks, we expect visitors to continue flooding back; and with the company’s impressive media franchises (Pixar, Marvel, Lucasfilm, and 21st Century Fox), the content possibilities seem endless. It is simply time for Iger to perform damage control using a tool Chapek didn’t have: charisma.
We have said repeatedly that we would never re-add Disney to any Penn portfolio while Chapek was CEO. Well, now he is gone. Let the comeback begin.
Th, 17 Nov 2022
Personal Finance
As we near a possible recession, Americans hit a new record of household debt
Let’s put some gargantuan numbers in perspective. The annual US GDP, or the total value of all goods produced and services provided within the country, is currently $25.66 trillion—far and away the largest in the world. Sadly, like the talented athlete with a fat new contract but little financial control, the country is currently $31.26 trillion in debt. The next-largest number is reserved for the US consumer, otherwise known as the world’s golden goose. Despite concerns over a coming recession, household debt in the US just rose at its fastest pace since 2007, bringing the figure up to a whopping $16.5 trillion.
Most disturbingly, credit card balances rose more than 15% from last year, the biggest spike in two decades. Despite the Fed funds rate sitting at 4%, the average credit card carries a 20% interest rate, with the average store-branded credit card charging 26.72%. Total debt jumped $351 billion during the July-through-September period alone—the largest quarterly increase since 2007 as well. Interestingly, the 8.3% year-over-year jump in total debt exactly matches August’s inflation read. While the rate of inflation cooled to 7.7% according to October’s CPI report, something tells us the $16.5 trillion figure will not drop.
In fairness, outstanding mortgage balances account for some $11.7 trillion of the aggregate debt, followed by $1.5 trillion in both auto loan and student loan debt, and $1 trillion worth of credit card balances. The remaining amount consists of mortgage originations, or loans taken out against the value of one’s home. Sadly, many of these loans are initiated to pay down credit card debt; balances which have a tendency to build right back up. These are not good data points going into a turbulent economic period.
As interest rates were low and student loan interest was placed on hold, Americans had the perfect opportunity to draw down their personal debt levels. Many did just that, but too many others decided to wantonly spend despite rising prices. And why not? The government has no problem spending money it does not have.
We, 16 Nov 2022
Space Sciences & Exploration
Furthering US dominance in spaceflight, NASA launches Artemis to the moon
Fifty years almost to the month after Gene Cernan and Harrison Schmitt became the last humans to walk on the moon, NASA is ready to send a new generation of Americans to the lunar surface. At 1:47 a.m. EST the largest and most powerful rocket ever launched lifted off from the Kennedy Space Center, sending the Lockheed Martin-built (LMT $468) Orion crew capsule on its 25-day journey around the moon and back. The Space Launch System (SLS)—part of the Artemis Moon program—has been a massive effort involving a number of aerospace companies, to include Lockheed, Boeing (BA $173), Northrop Grumman (NOC $502), Aerojet Rocketdyne (AJRD $50), and Airbus (EADSY $30).
Orion should reach the moon within six days, passing within sixty miles of the lunar surface before settling into its deep retrograde orbit—a looping route that extends 40,000 miles beyond the moon. That will set a record for the furthest distance from the Earth for any crew-capable ship in the history of human spaceflight. After spending two weeks in orbit, the craft will return home on 11 December with a Pacific Ocean splashdown.
Much like the one-person Mercury, two-person Gemini, and three-person Apollo craft, NASA is taking a step-by-step approach with this program. Artemis 1 will show that the craft can safely ferry astronauts back to the moon; Artemis 2 will carry a crew of astronauts to lunar orbit; Artemis 3 will place Americans back on the moon’s surface. It should be noted that Artemis, in Greek mythology, is the twin sister of Apollo. While remaining on schedule with any crewed space program is always extremely challenging, NASA’s plans call for a landing to take place on the lunar surface as soon as 2025.
The Apollo missions completed one of the greatest achievements in human history; in some ways, however, the Artemis program is even more important. Like our ancestral explorers, the earliest journeys always pave the way for trips designed to settle new lands. Between the six-person Orion capsule and Elon Musk’s Starship, which can be configured to carry a crew of up to 100, it is fair to say that we are entering the most exciting phase of our nascent journey into space. NASA has, in fact, already tapped SpaceX and its Starship for the second lunar landing program. We own all of the companies listed in this story other than Boeing. Despite SpaceX being privately held, we own that company via a private equity fund within the Penn Dynamic Growth Strategy.
Mo, 14 Nov 2022
Homebuilding
Lennar is building a 3D-printed community in the suburbs of Austin, Texas
It seems like something out of a science fiction novel, but it is happening in our own backyard right now. America’s second-largest homebuilder, Lennar (LEN $87), in partnership with 3D printing company ICON, is developing a 100-home community near Austin, Texas consisting entirely of 3D-printed homes. The community will offer buyers a selection of eight floorplans and 24 unique elevations ranging from 1,574 to 2,112 square feet of living space. The three to four bedroom, two to three bath homes will be partially powered by rooftop solar panels and come with a price tag starting in the mid-$400,000 range.
The 3D printers creating the homes are nothing short of remarkable. Designed to operate 24 hours per day, they are fully automated with just three workers needed at each home site. The ICON machines build the entire wall system of the house, to include electrical and plumbing, three times faster than traditional methods and at around half the cost. The walls are made of concrete, meaning increased strength and excellent energy efficiency. It takes the massive printer about two weeks to “build” (picture toothpaste coming out of a tube) one home. This is the first 3D housing development project to be completed fully on site, but we expect it to be the start of a revolutionary transformation in the homebuilding industry.
There are many fascinating facets to this story, from the innovative robotics involved, to the possible effect of reducing housing inflation, to the impact on the price of building materials (think of the reduction in lumber use within these sites). Lennar remains on the cutting edge of homebuilding innovation, and is our favorite player in the space.
Sa, 12 Nov 2022
Market Pulse
Week in Review: Markets dropped after the election, soared on inflation data
There were two big potential catalysts for the stock market this past week: the mid-term elections and the CPI report. Following Tuesday’s mixed election results, investors decided it was time to sell; the major benchmarks all dropped in the 2% range. We were worried that Thursday’s CPI report, which gauges the rate of inflation in the US, would provide another excuse to keep the risk-off train moving. Instead, the rate of growth of inflation actually slowed to levels not seen since January, and it was off to the races. While led by the Nasdaq and small-cap Russell 2000, which were up 7.35% and 6.11% on the day, respectively, the S&P 500 and Dow also roared into the close. For the S&P 500 to move 5.54% in any given session is mighty impressive. Instead of taking some profit off the tables on Friday, investors followed up with another nice move higher. Everyone who finally threw the towel in on big tech names like Apple (AAPL), Microsoft (MSFT), and Google (GOOGL) paid a steep price this week: all were up nicely, with the latter two jumping 11.5% on the week. Good news also came with the price of crude, which fell 4% over the five sessions, dropping to an eight-handle. Both the ten-year and two-year Treasury yields fell more than 8% on the week.
Of all the market statistics from this past week, we find the Treasury rate change most interesting. The 2-year tends to predict what the Fed will do next, while the 10-year is more tethered to the 30-year mortgage rate. The plunge in the 2-year Treasury yield, from around 4.7% on Monday to 4.324% on Thursday (the bond market was closed on Veterans Day), signals a smaller rate hike might be in the cards for December’s FOMC meeting—at least in the minds of investors. We shall see—there remains a hawkish tone among the Fed governors.
Fr, 11 Nov 2022
Cryptocurrencies
Once called the JP Morgan of crypto, Sam Bankman-Fried’s wealth evaporates
Sam Bankman-Fried, the wonder boy of the crypto world who built the world’s second-largest crypto exchange, is finished. Were his FTX publicly traded, it would have probably garnered a market cap in the $20 billion ballpark a few weeks ago; now, the company has announced bankruptcy plans and Fried has resigned as CEO. The FTX token, which was selling for $80.50 in September of last year, is now going for $2.77 (down 60% in one day) and is probably worth a lot less than that. The wunderkind who went in front of Congress earlier in the year to explain the 2008 financial crisis—and how his exchange is completely different—was apparently using customer assets to fund ultra-high-risk bets by Alameda Research, a now-defunct quant trading firm majority-owned by Fried. High profile investment entities, from Softbank to Sequoia Capital to the Ontario Teachers’ Pension Plan, will lose virtually all the money they entrusted to FTX. Of course, their investment losses pale in comparison to Bankman-Fried’s personal erosion of wealth, which has dissolved from a high of around $16 billion to well under $1 billion today. But if a loss of wealth is all he suffers in the end, the JP Morgan of crypto should thank his lucky stars.
Highly sophisticated investors—and millions of everyday Joes—were wantonly pumping money into speculative vehicles which weren’t quite as transparent as the likes of Fried led them to believe. This was gambling, not investing. Ironically, Fried was seen as crypto’s white knight, riding to the rescue of “weaker” players. It appears he was doing so with money that didn’t belong to him. If this had to happen (and it did), it is a good thing that it came to light now—crypto had already been so pummeled that the contagion effect is relatively muted. Except, that is, for the investment houses like Softbank, which reportedly will lose some $100 million on the liquidation.
Th, 10 Nov 2022
Supply, Demand, & Prices
Finally! Inflation shows signs of cooling and the market’s reaction is intense
In normal times, a 7.7% year-over-year inflation reading would send the markets reeling. Instead, the latest CPI report led directly to a 1,201-point-gain in the Dow (3.7%), a 208-point-gain in the S&P 500 (5.54%), and an explosive 761-point-gain in the Nasdaq (7.35%). Those remarkable, one-session returns occurred thanks to slowest y/y inflation rate since January. This past June, the 9.1% reading marked the highest rate of inflation in the US in four decades. September’s report wasn’t much better, coming in at 8.2%. Breaking the report down, core CPI—which excludes food and energy—came in at 6.3%, which signaled another slowdown in growth from the previous months. October’s jobs numbers also gave the doves a ray of hope that the current hiking cycle may be on its last legs: the US unemployment rate rose from 3.5% to 3.7%. Wage growth is also easing, going from 5% y/y in September to 4.7% in October. No Fed officials came out and applauded the CPI report, but investors certainly celebrated by giving the market its best day in over two years.
While a 75-bps-hike is still expected at the December FOMC meeting, the odds of a smaller, 50-bps-hike are rising. Were the latter to happen, it would probably spell a serious Santa Claus rally going into the last few weeks of the year.
We, 09 Nov 2022
Media & Entertainment
Disney falls another 11% after dismal earnings report
We wrote a scathing indictment of Disney’s (DIS $88) management team this past spring, stating that CEO Bob Chapek must go. At the time, Disney shares had plunged to $138, down from $203. The latest drop—11% at the open—came in response to another bad earnings report. Revenues were a miss; earnings were a miss; streaming losses widened. While Disney+ added 12.1 million new accounts in the quarter, that business lost a whopping $1.47 billion. Since it launched back in 2019, the streaming service has now lost some $8 billion in aggregate. The parks have been doing great, but that is a huge deficit to keep covering. After spending $30 billion on content over the past twelve months alone, management announced cuts were coming to the content and marketing budgets but gave no specifics. Disney’s bottom-line numbers for the quarter say it all: Against expectations for $788 million in net income, the company made just $162 million. At least they remained in the black.
Analysts have overwhelmingly been bullish on this stock all year, projecting a big comeback in the share price. Considering Chapek just received a three-year contract extension, even $88 per share does not look attractive to us. What was the board thinking?
Th, 03 Nov 2022
Hotels, Resorts, & Cruise Lines
Airbnb is trading in double-digits again; is the stock worth a look?
Despite pricing its initial public offering shares at $68, the typical Joe had to buy Airbnb (ABNB $94) shares on the open market back in December of 2020. For anyone who wanted to jump into this highly touted travel name at the open (like us), the price was steep: shares opened at $146 and remained in triple digits for over a year. Now, investors can get in for the “bargain price” of just $94 per share—36% cheaper than the opening-day price. But are the shares actually cheap?
The company just had its “biggest and most profitable quarter ever,” with revenue of $2.9 billion and adjusted earnings of $1.5 billion. Gross bookings rose 31% in the quarter, beating estimates. Why, then, did ABNB shares plunge nearly 20% this week? It all revolves around guidance. For Q4, management expects revenue in the $1.85 billion range and growth of around 25%, “consistent with historical seasonality.” CEO Brian Chesky said the company is well positioned for the road ahead and has taken steps to reduce costs in preparation for a tougher economic environment. As with Powell’s comments on rate hikes, investors seemed to contort the words to paint a darker view of what’s to come. Hence, the major price drop.
In its “Airbnb 2022 Summer Release,” the company announced a slew of enhancements which would amount to “the biggest change to Airbnb in a decade,” according to Chesky. From an enhanced app experience to new protections for both guests and hosts, these upgrades should keep the company well ahead of its competitors in the space. While they are being attacked from both sides—the online travel agencies (to include Booking and Expedia) and the major hotel chains (primarily Hilton and Marriott)—the $60 billion firm controls approximately one-fifth of the entire vacation rental market. Considering the value of that market is projected to exceed $100 billion within five years, simply maintaining their ratio would spell strong growth ahead for the company. Investors are not in the mood, however, to give any consumer discretionary name a benefit of the doubt right now. Shares have fallen 43% year to date.
With its forward P/E of 32, Airbnb’s valuation remains richer than its online travel competitors and roughly in line with the major hotel chains. While we aren’t ready to add the company to a portfolio, the price seems to be at the upper end of the “fair” range. Should the shares fall closer to the IPO offering price of $68, we would almost certainly jump in.
We, 02 Nov 2022
Interactive Media & Services
Monetizing Twitter: Elon announces a new price plan for Twitter Blue
We were familiar with the blue checkmark symbol next to the name of Twitter users, but we never really gave much thought to who gets one and who does not. Introduced in 2009, this verification system was meant to provide a level of validity to notable account holders, such as celebrities, brands, and organizations. Sort of a caste system on the platform to separate the gentry from the hoi polloi, or unwashed masses. Elon Musk, self-proclaimed Chief Twit, is not a fan of such hierarchies, and he sent out a great tweet indicating what he thought of the policy: “Twitter’s current lords and peasants system for who has or doesn’t have a blue checkmark is bulls***. Power to the people! Blue for $8/month.”
Twitter Blue has been a subscription-based service which allows users to edit tweets, organize them into folders, and access other member-only perks. While Twitter has some 300 million daily active users and generated $5 billion in revenue last year, only around 424,000 accounts hold the coveted blue checkmark. Elon Musk has a grand vision for Twitter, and monetizing the platform is paramount. While the fee would go up to $8 per month, qualified users would be virtually guaranteed of receiving the verification stamp, and we can certainly expect Musk to roll out more perks in the months to come. His ultimate goal is to create what he calls “X, the everything app.” This “super app” would include social media interaction, messaging, payments, and even the ability to order food and drinks. Doubters abound, just as they did with Tesla in the early days, and some companies are indicating they may stop advertising on the platform. They will end up on the wrong side of this story after Musk is done writing it.
This past Friday, we saw a tweet which read: “Twitter hasn’t been this much fun in years.” Despite the naysayers, we fully expect Musk to transform what the platform is today into something quite different—and much more powerful. Some users and advertisers won’t come back, but we doubt the new owner, with his “move fast and break things” mentality, will give them a second’s worth of thought.
Tu, 01 Nov 2022
Transportation Infrastructure
Uber shares spike after the company reports beat on sales, strong ridership growth
A few weeks ago, shares of Penn New Frontier Fund member Uber (UBER $31) fell sharply on news that the Biden administration wanted to force gig economy companies to reclassify drivers as employees rather than freelancers. At the time, we believed that drop was a mistake, as there is very little chance the plan would ever see the light of day. That would have been a good time to get into the ridesharing company. Shares spiked over 15% mid-week as the company reported a staggering 72% jump in sales—to $8.34 billion—from the same quarter in 2021. Gross bookings rose 26%, to $29.1 billion, and adjusted EBITDA came in at $516 million—another beat. Uber Eats, the food-delivery unit of the company, now accounts for one-third of Uber’s total revenue mix.
In addition to the sales beat, Uber CEO Dara Khosrowshahi said he is quite optimistic about the fourth quarter, adding that even lower-income riders are increasing their ridership despite looming recession fears. He projects $600 million in adjusted earnings over the course of the quarter. As for the worker shortage, Uber’s global driver base is now back to pre-pandemic levels.
We have stuck with Uber through the horrendous 2022 downturn because we believe in the company’s growth trajectory. By building out a suite of delivery services, the company has insulated its business (to a good degree) from cyclical economic downturns. Additionally, the industry has a rather wide moat, and Uber is the clear leader in the space. We maintain our $70 price target on the shares.
Headlines for the Month of October, 2022
Sa, 29 Oct 2022
Market Pulse
The foolishness of the mainstream media was on full display this week
Back in July, as the market was rebounding from its June lows, CNBC’s Jim Cramer frantically declared, “The market hit its bottom on June 16th!” Of course, he was proven wrong just a few months later. After the September bloodbath, Jim Cramer told his viewers that he had been talking to a lot of “big investors,” and they were all telling him the S&P 500 would take out 3,000 on the way down, and that the fed funds rate wouldn’t stop until it hit 6%. At the time, the S&P 500 was at 3,657 (we looked at the ticker the minute he made his rant). This was before what is shaping up as the best October in decades.
Yes, big tech got hit this week on weaker-than-expected earnings and some sobering guidance. But let’s take Apple (AAPL $156) as an example of just how reactionary the press really is. The minute the Cupertino-based giant announced a miss on iPhone 14 sales, and that revenue growth could slow during the coming holiday season, AAPL futures dropped some 8%. Immediately, the panel of esteemed hosts on a certain business channel began falling all over themselves to explain why the stock was down, how they saw this coming, and the bad things it portended for Apple as a company. The next day, instead of following through on the 8% drop, Apple shares climbed 8%—a 16% swing from the post-earnings futures. You would think these individuals would stay mum based on their previous afternoon’s comments. No, instead they doubled down on their dumb comments.
We find it highly impressive that, following some rather glum reports and guidance, all the major benchmarks were up this past week—including the Nasdaq (where the tech giants live). While we still haven’t clawed back September’s brutal losses, we are making good progress. This tells us investors believe a couple of things: that the Fed is going to do another 75-basis-point hike next week but then indicate a slowdown of the rate of increases; and that earnings are not coming in nearly as bad as feared, despite the FAANG disappointments. We believe they are correct on both counts. Too late to go back and declare another market bottom in September, Cramer, that ship has sailed.
We believe we are in the early stages of a Santa Claus rally, buttressed by a Fed slowing its pace and by the mid-term elections. Who will lead the charge? Probably the small caps, which have been severely beaten down and are spring-loaded for a comeback.
Fr, 28 Oct 2022
Aerospace & Defense
Boeing, led by its inept management team, fumbled yet another quarter away
The once-great American aerospace giant Boeing (BA $135), led by bumbling CEO Dave Calhoun, has announced yet another lousy quarter. Against expectations for $17.8 billion in sales, the company brought in just $16 billion; from that $16 billion, the company managed to lose $3.275 billion along the way. Put another way, the Street was expecting earnings per share of $0.10, instead it delivered a $5.49 per share loss.
While the bottom-line net income still would have been negative, the enormous loss was overwhelmingly a result of a $2.76 billion hit the company took on the aggregate of five fixed-price development programs, to include the (nightmarish) KC-46 tanker program and the (long delayed) Commercial Crew program. The KC-46 USAF tanker program alone accounted for a $1.17 billion loss. Are you ready for the “leader’s” response? CEO Dave Calhoun said the charges were driven by macroeconomic forces beyond Boing’s control. Way to take ownership, Dave.
The concept of the learning curve with respect to huge companies building complex systems states that costs go down with the repetition of a smooth-running assembly line. Calhoun said, “We don’t have any baked-in learning curves anymore.” True, you obviously don’t. What you didn’t say was that it is all management’s fault. It is hard to BS your way through the publicly traded landscape: Boeing has lost 70% of its value since 01 March 2019. How about an apples-to-apples comparison: Boeing’s disastrous finances are reflected in its -3.25 debt/equity ratio; Airbus (EADSY $26) has a debt/equity ratio of 1.32. We suppose the “macroeconomic environment” is rosier in Europe?
There is a fiefdom at Boeing, with Calhoun having anointed himself king and the jesters on the board facing little pushback from the poor citizens (shareholders). Until the autocratic regime is overthrown, there is no reason to own shares of this once-great company.
We, 26 Oct 2022
Interactive Media & Services
Snap continues to disappoint the Street; is the stock now cheap enough to buy?
It is becoming a quarterly ritual: Snap (SNAP $10) reports earnings, and we report the company’s double-digit share price drop. It just happened again. Last Thursday, for the third consecutive quarter, Snap missed on both revenues and net income, generating $1.128 billion in sales and losing $359.5 million in the process. Management then proceeded to give an outlook so lousy that the company’s shares gapped down some 28% on the day. While they have climbed back a bit from their new 52-week low of $7.33, investors shouldn’t be too eager to jump in at these “bargain basement” prices (shares remain down 80% for the year).
Snap has an impressive base of 158 million daily active users, but the company generates nearly all its revenue from advertising; and 88% of those ad dollars emanate from US companies. After surprisingly bad numbers from much larger competitor Alphabet (GOOG $105), particularly in its Snap-like YouTube unit, expect a rough year ahead as the US muddles through a recession. Digital ad spends are among the easiest cuts made by corporations as they hunker down in preparation for an economic downturn, and Snap would be an easier advertising cut to justify as opposed to a pullback in online ads at Google, for example. In short, we fail to see any near-term catalysts that would drive the shares substantially higher from here.
We have discussed the comically skewed share class structure (in favor of management) at Snap, so no reason to rehash it now. Suffice to say investors looking for deals among the tech carnage can find better opportunities elsewhere.
Mo, 24 Oct 2022
Global Strategy: Europe
Labour will have a much tougher time trying to discredit the new UK prime minister
Including the one just selected, there have been eight prime ministers of the United Kingdom since Maggie Thatcher left that post in 1990; seven have been Tories (Conservative Party), and one has been a member of Labour. The newest resident of 10 Downing Street, Rishi Sunak, has made it clear who he most idolizes: Margaret Thatcher.
On its face, the optics of having been through four Conservative Party PMs within the last three years and three within the past seven weeks should bode well for Labour going into the next general election, which must be held no later than early 2025 (the last, held in December of 2019, was a landslide victory for the Tories). But Rishi Sunak is no Theresa May, nor is he a Liz Truss; the left will be in for a bit of a surprise as they feign insult at every turn and begin their interminable attacks.
At age 42, Sunak will be the youngest prime minister since William Pitt the Younger assumed office—at age 24—in 1783. Indian by heritage, Sunak’s mother was a pharmacist and his father was a general practitioner in the National Health Service. After graduating from Oxford, he received his MBA from Stanford while living in the United States. Although he was Boris Johnson’s chancellor of the Exchequer (think Treasury secretary), he resigned this past summer after questioning his boss’ ethics. He has experience in the world of investment banking, working at Goldman Sachs and as a hedge fund manager in the US.
Following in his idol’s footsteps, Sunak believes in lower taxes and controlled government spending; though he did oversee the massive furlough program which made payments to the millions of Britons who lost their jobs during the pandemic. He enters office at a critical period, as economic conditions in Great Britain continue to deteriorate. Facing the twin culprits of weak economic growth and rampant inflation (stagflation), his honeymoon period will be short. However, his real-world experience in finance should serve him well, despite the loud and obnoxious voices of his critics.
Rishi Sunak may never breathe the rarefied air of the Iron Lady, but we expect him to be a highly effective PM—to the chagrin of his haters. We will also make the bold prediction that he will still be in power for the next general election, which he will proceed to win. For investors wishing to take advantage of an economic rebound in the UK, look at EWU, the iShares MSCI United Kingdom ETF. One of its top holdings—Diageo PLC (DEO $165)—is an inaugural member of the new Penn International Investor fund.
We, 19 Oct 2022
Commercial Banks
Credit Suisse looks a lot like Lehman in 2008; could the global bank really fail?
Credit Suisse Group AG (CS $5), founded in 1856, is one of the two major Swiss banks and an important player in global finance; the Zurich-based firm maintains offices in all major financial centers around the world. Going into the 2008 global financial crisis, the bank had a market cap of $90 billion; today, it is a shell of its former self, boasting a market cap of just $12 billion. While it survived the global banking crisis, recent scandals have driven investors away and have some analysts handicapping a nightmare scenario: insolvency.
The recent scandals began when British financial services firm Greensill Capital, in which Credit Suisse had some $10 billion invested, went belly up, causing CS clients to lose around $3 billion. Then came the Archegos Capital (Bill Hwang) debacle. While the privately held company primarily managed the assets of family office group trader Hwang, CS was a major lender to the firm. As Archegos was imploding and before Hwang was arrested for securities and wire fraud, the company lost $20 billion in a matter of days. Credit Suisse itself was out $4.7 billion, causing a half-dozen executives at the bank to lose their jobs. In February of this year, the bank was charged with money laundering (it was later found guilty by a Swiss court) in connection with a Bulgarian drug ring. Shortly after that, details of approximately 30,000 customer accounts at the bank—worth over 100 billion Swiss francs in aggregate—were leaked to a German newspaper. The leaks exposed customers involved in all types of lurid behavior, from human trafficking to torture. Finally, and most recently, it was discovered that executives at the bank urged certain investor-customers to destroy documents linked to Russian oligarchs who had been sanctioned following the invasion of Ukraine.
This past summer, Credit Suisse Chairman Axel Lehmann replaced the bank’s CEO with its head of asset management, Ulrich Koerner, and announced a strategic review of its investment banking unit. The bank’s upcoming earnings release—slated for 27 October—is expected to show a reduction in the bleeding from Q2, but that will not be enough to quell investors. A comprehensive restructuring plan is needed, but we doubt the current management hierarchy is up for the job. That said, we don’t believe the bank faces any real threat of insolvency—it is “too big to fail.”
There has been some intriguing speculation recently that the other major Swiss bank, UBS (UBS $15), with its $52 billion market cap, could swoop in and save Credit Suisse via a merger. While we don’t see that scenario playing out (Swiss regulators would not be keen on the idea), a positive upside surprise on the 27th could move the shares higher. Analysts run the spectrum of expectations, from CFRA’s $3.50 price target to Morningstar’s $10.60 fair value. While it may be fair to say the company is not going the way of Lehman, the risk of it languishing while management tries to clean up its mess is too great to justify an investment—even at $4.58 per share.
Tu, 18 Oct 2022
Social Security, Medicare, & Medicaid
Social Security recipients will receive their largest increase in four decades next year
In the face of soaring inflation, the Social Security Administration has announced that beneficiaries will receive an 8.7% cost of living increase in 2023—the largest adjustment since 1981’s 11.2% bump. This move comes on the heels of a 5.9% upward adjustment in 2022. On average, next year’s rate increase will amount to $146 more per month in recipients’ bank accounts. Additionally, Medicare Part B premiums, which are generally deducted from Social Security benefit payments, will be lowered next year from $170.10 to $164.90. Approximately 50 million Americans receive Social Security each month, with another ten million receiving disability payments and six million receiving survivor payments. The average payment for retired workers in 2022 is $1,670, while survivors average $1,328 per month. Per Social Security Administration figures, total income collected for the Social Security Trust Fund last year was $1.088 trillion, with $1.145 trillion going out in the form of payments—a $56 billion deficit. At the end of last year, the Fund had $2.852 trillion in asset reserves.
In early 1968, President Lyndon Baines Johnson moved the Social Security Trust Fund “on-budget,” meaning it would be considered part of the unified budget of the United States. In 1990, under President George H.W. Bush, this action was reversed, moving the Fund back “off-budget.” To see income, outflow, and reserve levels of the Fund, readers can visit the Social Security Administration website.
Tu, 11 Oct 2022
Government Watchdog
The rotten law that California voters rejected is about to be shoved down America’s throat
Think of how the likes of Uber (UBER $25) and Lyft (LYFT $12) have radically transformed—for the better—transportation in this country. Bargoers who wouldn’t have considered calling for a Yellow Taxi at two in the morning routinely hail rides on their app. Elderly shoppers in suburban regions can now get a convenient and reasonably priced ride to and from the grocery store. Apparently, that is a transformation which must not be allowed to stand.
The subversive movement to halt this positive trend began, fittingly, in California. Assembly Bill 5 (AB5) said that all workers, to include drivers for ride-hailing services, had to be considered employees of the company rather than freelance “gig” workers. Never mind the fact that most of these drivers did not wish to be considered employees. Then came Proposition 22, passed by a majority of California voters, which exempted these workers from being classified as employees rather than independent contractors. Understandably, Prop 22 was a major win for the industry.
Since such an important issue cannot be left to the masses to decide, the results immediately came under fire. A California judge ruled the measure unconstitutional. The battle rages on, but now the White House has chosen to take a stand on the issue. President Joe Biden has ordered his Department of Labor to review how workers are classified. In short, the administration wishes to codify, on a national level, California’s AB5. As this move would cause operating costs in the industry to skyrocket, shares of Uber and Lyft plunged on the news. Other companies in industries from trucking to construction also dropped on the DOL proposal. An attorney for the department said the move was “not intended to target any particular industry or business model.” Is anyone dense enough to believe that?
As we are on the precipice of a recession, what an incredibly thickheaded time to go forward with such anti-business nonsense. There will be an endless stream of legal challenges to the coming decree, and we expect the final decision to be made by the US Supreme Court. In the meantime, we have yet another roadblock in the way of getting our economy back on track.
Tu, 11 Oct 2022
Automotive
It has been a rough road for Rivian since its IPO, and that was before the massive recall
Talk about lousy timing. Last November, one year ago next month, signaled the peak in the stock market, and it has been a bumpy downhill slog from there. Last November was also when EV maker Rivian (RIVN $31) presented itself to the investment world via an IPO. Initially priced at $78, shares quickly soared to $179.47 on 16 November, just six days after the IPO. Woe to any investor who jumped in then: the current stock price represents an 83% drop from that all-time high.
In a tough economic environment, marred by supply chain issues and rising input costs, Rivian has been consistently missing its own production targets; now, on top of that, the company is being forced to recall nearly all its vehicles on the road for steering control issues. While there have been no reported injuries and the fix is relatively straightforward, the problem will divert precious resources away from production at a time when the startup is already under intense scrutiny for over-promising and under-delivering.
The first Rivian rolled off the assembly line in September of 2021, and the company has produced just 15,000 vehicles to date. The 2022 full-year production target is 25,000 vehicles, which is all but guaranteed to be another miss. Rivian has a market cap of $28 billion, down from a November high of $153 billion. The company's R1S electric pickup has a price range between $72,500 and $90,000, while the longer-range R1T, fully loaded, will set a buyer back around $100,000.
For those who believe Rivian is the next Tesla, $31 per share may seem like a great point at which to buy the stock. While the company has enough cash on hand to weather the production and recall problems, the potential for further price erosion is too great to justify an investment right now. For those willing to take the risk in the automotive industry, Ford (F $11) looks a lot more attractive with its 5.668 forward multiple.
Sa, 08 Oct 2022
Market Pulse
It was a positive week in the markets, so why didn’t it feel that way?
The week began with the best two-day rally since April of 2020, with the S&P jumping some 5.6%. A few signs arose which gave the market hope that inflation was starting to be tamed, which might lead to the end of rate hikes. Wednesday was flat, Thursday investors began to worry, and Friday’s strong jobs report capped the U-turn. The unemployment rate fell from 3.7% to 3.5%, the labor force participation rate remained steady at 62.3% (we need more workers rejoining the labor force), and 263,000 new jobs were created—more than anticipated. We are back to the bizarre world where good news is bad news. This all but assured more rate hikes, with odds strong for a 75-basis-point hike in November, followed by a 50- and then 25-bps hike in December and January, respectively. That would put the upper limit of the fed funds rate at 4.75%, at which time Powell and company should be able to put the tightening on hold.
That probable scenario spooked the Dow into a 630-point selloff on Friday, which is absolute silliness. A 4.75% rate is not economy crushing, as we have weathered much higher rates in the past. The average 30-year mortgage loan now comes with a 7% APR, which has certainly dissuaded homebuyers and seized up the refinance business; but runaway home values are beginning to level out—an important component to controlling inflation. Another big weight on the markets this week came courtesy of OPEC, which promised to curb oil production by two million barrels per day. The cartel’s aim is to stick it to Biden while getting oil prices closer to triple digits, and it seems to be working: the price for a barrel of crude rose from $79.74 before Monday’s open to $93.20 by Friday’s close.
By the end of the week the Dow had actually pulled off a 1.99% gain, followed by the S&P 500 at +1.5% and the NASDAQ at +0.72%. Market emotions were on full display over the five-session period, going from hopeful anticipation on Monday to depressed capitulation on Friday. It may seem odd, but these kinds of wild swings are often the precursor of something good waiting around the corner.
It has been a painful year, but we are now in the bottoming-out process. When the market senses that the Fed is near the end of tightening, there will be a rally akin to the one we experienced during the vaccine phase of the pandemic. Barring, of course, a cornered Russian thug doing something even more horrific than he already has.
Th, 06 Oct 2022
Beverages, Tobacco, & Cannabis
Cannabis stocks rocket after Biden requests drug classification changes
It was one of the moves North American cannabis producers have been anxiously awaiting: President Biden has formally requested a review of how marijuana is classified under US law. He further requested that governors move to pardon anyone in a state prison solely for marijuana possession (there are fewer than 10,000 incarcerated in federal prisons under these circumstances). Despite wild success in Canada and much of the rest of the world, leading producers such as Tilray (TLRY $4), Curaleaf Holdings (CURLF $6), and Canopy Growth (CGC $4) have been waiting for the mother lode of being able to freely sell their products in the richest market in the world. That dream is coming closer to fruition. While it will still be a largely states’-rights issue, a change in federal law would allow cannabis companies to access full banking services and list on US exchanges.
How did the publicly traded cannabis companies respond to the news? Our favorite, Tilray, run by the highly skilled Irwin Simon (founder of Celestial Seasonings), popped 31% in one session; the AdvisorShares Pure US Cannabis ETF (MSOS $12) surpassed even that performance, jumping 35% on the day. Granted, there is a long way to go before our laws on marijuana resemble those of our neighbor to the north, but investors should also keep in mind that this group has been absolutely hammered over the past year. The cannabis ETF, for example, is still down 65% year to date despite the enormous untapped potential of an open US market.
We mentioned Tilray, which is actually the result of a merger between the namesake company and Aphria. Not only did Simon oversee the purchase of SweetWater Brewing Company, he also spearheaded the purchase of Breckenridge Distillery, maker of the high-end line of Breckenridge bourbon whiskeys. We see cannabis-infused booze coming in the not-to-distant future.
Th, 06 Oct 2022
Energy Commodities
OPEC’s win-win solution: take a jab at Biden and get a spike in oil prices
To say there is no love lost between the Biden administration and the Kingdom of Saudi Arabia is quite an understatement. When Biden flew to Saudi Arabia this past summer in an effort to get the titular head of OPEC to raise production, the country responded with a slap-in-the-face promise to boost output by a paltry 100,000 barrels per day. Now that the administration is getting what it wants before the upcoming mid-term elections—lower prices at the pump—OPEC+ holds a meeting in which it announces a two million BPD production cut. Oil futures, which had dropped to the upper-$70s/bbl range recently, surged back into the upper-$80s. This was a win for not only Russia, which has navigated the oil ban by selling crude to its nation-state buddies China and India, but also for Saudi Arabia, which got another chance to poke Biden in the eye and get the price of oil closer to its target $100/bbl range.
The administration, clearly miffed, is responding in the feeblest of ways: promising to tap the US Strategic Petroleum Reserve yet again and discussing the possibility of easing sanctions on Maduro’s Venezuela. That is akin to a sweater-clad Jimmy Carter holding a fireside chat and encouraging Americans to turn down their thermostats in winter. The administration seems unwilling to take the correct course of action, which is to encourage—in deeds not words—increased production at home.
The two million BPD cut by OPEC will probably only amount to an increase of one million barrels, as many members of the oil cartel are not currently meeting their quota; that amount could be countered were the US to begin pumping the same amount it did back in early 2020. But the love affair between the US energy complex and the Biden administration is on par with the Kingdom’s affection for the president. Additionally, with the litany of recent regulations thrown against “big oil” and the cancellation of the Keystone pipeline, getting back to 13 million BPD would be extremely challenging in the short run. That leaves the greatest “hope” for reduced prices at the pump being a global economic slowdown—something nobody wants. With respect to energy prices, the US finds itself between a rock and a hard place, and American consumers will be the ones getting crushed.
The path of least resistance with respect to reining in oil prices seems to be a global economic slowdown. The regulations which have hampered oil production in this country will remain largely intact, and getting Venezuela back up to speed would take years. Also, consider the fact that there have been no new refineries built within the US for three decades, and the ongoing ESG battle against companies in the fossil fuels industry. That being said, if there is a marked slowdown in global growth we could see oil dropping back into the mid-$70s range this winter.
Tu, 04 Oct 2022
Interactive Media & Services
Twitter pops after Elon says he will buy the company under original terms
There have been a lot of crazy twists and turns in the Musk/Twitter (TWTR $52) saga, but we didn’t see this one coming. In a surprise move, Musk has said he will buy the social media platform under the original terms agreed upon: $54.20 per share, or $44 billion. Odds were stacked against him in the pending non-jury trial, slated to begin later this month, but it is rather strange that he did not come in with a lower offer. While it may not have been enough of a “smoking gun” to get him out of an ultimate deal, his argument that the company was hiding the enormity of the spam bots and fake accounts problem was substantiated by Twitter’s fired head of security—Musk’s key witness. While Twitter shares spiked 13% on the news and 20% in the ensuing days, the market cap still sits about $5 billion below the offer price. The press is making it sound as though Tesla (TSLA $242) shareholders hated the deal, but shares of the EV maker fell very little after the bombshell announcement. In the next issue of the Penn Wealth Report, we will delve into what Musk hopes to accomplish with his new platform. Hint: think indispensable “super app.”
We believe Musk can create a turnaround story at Twitter, a company which was never effectively monetized by erratic found Jack Dorsey and his hand-picked successor, Parag Agrawal. Of course, that will all take place (post deal) with Twitter as a privately held company. As for publicly traded Tesla, shares look like a steal at $242, and we maintain our $333 price target. We own Tesla in the Penn New Frontier Fund.
Th, 29 Sep 2022
Biotechnology
Biogen was down 18% year to date, then some good news sent shares soaring 40%
We are having a serious case of déjà vu with respect to $40 billion biotech firm Biogen (BIIB $277). Last summer, shares of the firm spiked some 55% on the back of positive news regarding its experimental Alzheimer’s drug, aducanumab. In the ensuing year, shares plunged 50%—from over $400 to under $200—on doubts about the therapy’s efficacy, despite FDA approval. This week it was a new Alzheimer’s drug from the firm, lecanemab, which moved shares of the firm back up some 40% in one session. Lecanemab, which was co-developed with Japanese biotech firm Eisai (ESALY $58), slowed cognitive decline in early-stage sufferers who were enrolled in the companies’ Phase 3 Clarity trials. Unlike the prior drug’s trials, which brought a good dose of skepticism from critics, these most recent results were universally hailed by the medical community. With the drug’s potential blockbuster status over the coming years, analysts were quick to upgrade shares of Biogen, though price targets remained relatively close to the day’s trading range. Among the 32 major houses covering the stock, 18 have Outperform or Buy ratings, while the other 14 have a Hold rating. The median price target on the shares is now $267.
Advances in the field of Alzheimer’s have been few and far between for the past two decades. Lecanemab holds a lot of promise, though we must now wait and see what type of support, via Medicare and insurance coverage, it will receive. We do believe, however, that the drug has the potential to generate over $1 billion in annual sales for Biogen.
We, 28 Sep 2022
Capital Markets
2021 was a banner year for IPOs, but most are not faring so well
There were some 400 companies that went public last year via the traditional route, with capital raised coming close to $300 billion. Add SPACs (special purpose acquisition companies) to the mix, and the number hits 1,000 new listings. So, how have these newly-publicly-traded entities been doing lately? The answer isn’t pretty. The Renaissance IPO Index is a basket of the largest, most liquid, newly-listed US public companies. Names like Snowflake (SNOW), Rivian (RIVN), Roblox (RBLX), and Coinbase Global (COIN) top the list. This index has an exchange traded fund, the Renaissance IPO ETF (IPO $29), which allows investors to buy into this basket with ease. Year to date, the fund’s value has been slashed in half, with the shares dropping from $60 to $30 in price. That represents more than twice the S&P 500’s plunge over the same time period. Here’s another staggering statistic: only about one in ten of the class of 2021 are trading above their IPO price. Market volatility due to inflation, rate hikes, supply chain issues, and fear of recession has pounded this group and dissuaded a lot of would-be players from going public this year. According to StockAnalysis.com, only 159 companies have gone public on US exchanges so far this year, or 79% less than the 767 IPOs which had taken place by the same time in 2021. As could be expected, this group has faced a similar fate. For anyone interested in scanning the list for possible value plays, the companies and their “since-IPO” returns are listed on the page.
What about getting into the IPO ETF with the fund sitting down at $30 per share? We wouldn’t recommend it—there are too many wildcards on the list. Some holdings do look promising going forward, however. Names like Palantir (PLTR), Snowflake (SNOW), Airbnb (ABNB), and DoorDash (DASH) have all seen their share prices pummeled, and these are companies which will still be around when the markets regain lost ground.
Tu, 27 Sep 2022
Food Products
Bucking the trend: Penn member General Mills has rallied 20% this year
Virtually all asset classes, sectors, and industries are in the red this year with the exception of energy stocks, and even they have been tumbling recently as crude oil has dropped back to where it began the year—the mid-$70s-per-barrel range. One consumer defensive name has been bucking the trend, however: General Mills (GIS $79) has rallied 20% so far in 2022—hitting an all-time high price last Thursday—and is up some 34% over the past year. Not only did the century-old food products firm report higher-than-expected profits over the past quarter, management also lifted its forecast for the year. Sales in the fiscal first quarter, which ended 28 August, rose 4% (to $4.72B), while net income jumped 31% from the same period last year—to $820 million.
While inflation has raised input and shipping costs for General Mills, the company has been able to pass along some of those higher prices to a consumer which is suddenly eating out less and cooking more meals at home. The stellar management team, led by 55-year-old Jeff Harmening, has also been making some astute strategic moves recently. In an effort to focus on more profitable units, the company recently sold its “Helper” line and Suddenly Salad packaged food division for $607 million, while acquiring St. Louis-based TNT Crust for $253 million. While consumers have been shifting away from higher-priced labels in favor of generic brands, General Mills products remain in the sweet spot. Harmening’s team also placed some well-timed hedge positions on grain inputs, cushioning the blow of rising agriculture prices. For the fiscal year, the company expects to grow net sales by 6-7%.
One of our favorite moves General Mills made a few years ago was the purchase of the rapidly growing Blue Buffalo line of pet foods. In fact, that was a catalyst for our purchase of GIS shares back in 2018. The company is the only packaged food name within the Penn Global Leaders Club.
Fr, 23 Sep 2022
Market Pulse
Another bruiser: markets have now given up two full years of gains
For the past two weeks in particular, the markets have had a myopic fixation on what the Fed’s next moves will be. The Tuesday before last, the Dow Jones Industrial Average lost 1,276 points after a hot August inflation read all but guaranteed a three-quarter-point rate hike in September. This Wednesday, when the Fed delivered, it dropped another 522 points. With the NASDAQ and Russell (small caps) leading the retreat, the major indexes all dropped around 10% over the past ten trading sessions, falling back to October of 2020 levels. So much for the June lows—those were taken out Friday intraday before bouncing slightly. It wasn’t only the Fed, though that was the big catalyst. The other concern markets seem to be stewing about is the strong US dollar, which is at its highest level in precisely two decades. That makes imports and overseas travel cheaper for Americans, but our exports more expensive for the world. But the strong dollar shouldn’t affect US small-cap companies much, as most rely on the domestic marketplace for the lion’s share of their revenues. It has been a brutal year thus far, but if our economy cannot handle a dollar at parity with the euro and a potential 5% federal funds rate, then that is a sad testament to American exceptionalism.
In reality, the US economy can and will be able to deal with these two conditions—a strong dollar and higher rates; it is investors who seem unable to come to terms with the situation. Great American companies, flush with cash and on strong growth trajectories, have not been spared during this latest selloff, which makes little sense. Until the madness abates, we are taking advantage of the dislocation in short-term rates by buying Treasuries, agencies, and quality corporate bonds.
Fr, 23 Sep 2022
Transportation Infrastructure
FedEx shares just suffered their worst day ever; are they now worth looking at?
When FedEx (FDX $148) shares were trading at $245.63 this past February, we removed the company from the Penn Global Leaders Club to make room for another holding. We had lost a good degree of confidence in the management team, and labor costs were suddenly becoming a major drag on the firm. That move was fortuitous, as FedEx just experienced its worst day as a publicly traded company—losing nearly one-quarter of its market cap—after a disastrous earnings call. After giving a rosy outlook in June, management did a 180-degree turn in September, reducing guidance by 50% and predicting a bruising global recession. Analysts were quick to point out that the major issues were not macro in nature, but directly related to this integrated freight and logistics giant. Q1 earnings per share fell 21% from the year prior, against expectations for an 18% gain; revenues rose 5%, but that number missed estimates as well. The company pulled its 2023 guidance altogether, citing a gloomy and uncertain global outlook. To round out the ugly report, FedEx said it plans to raise shipping rates this coming January by an average of 6.9% across the board. Shares are now down over 42% year to date.
With shares trading where they were back in June of 2020, are they now a buy? While the $2.7 billion in cost-cutting measures will help, and customers will probably just accept the shipping rate hikes, we don’t see the shares worth much more than $200 right now; and the risk to get that possible 33% return is still too high in our opinion.
Fr, 23 Sep 2022
Monetary Policy
Powell’s words left little doubt: rate hikes until inflation is under control
For anyone who still believes the stock market is rational and efficient, consider this: Going into the Fed’s rate decision, the Dow was trading up a few hundred points; within seconds of the fully-expected 75-basis-point rate hike, the Dow was down a few hundred points; during Powell’s post-decision speech, the Dow rallied into the green by several hundred points, only to close the session down 522 points.
No matter how late investors or pundits may believe Powell was to the party, his message has been crystal clear: Rates will go up until inflation is brought down to acceptable levels. While the official “acceptable” level is 2%, he said something very telling in his news conference: “The ultimate goal is to have positive real rates across the yield curve.” To us, that was meaningful. By “real rates” he means inflation adjusted, so if the 2-year Treasury is yielding 4% then inflation must be below that. They say markets don’t like uncertainty; well, we now have full clarity with respect to what the Fed plans on doing next.
Of course, we still don’t know how many rate hikes and other shocks to the system it will take to tame inflation. Furthermore, it will take time for the hikes to have their full effect on economic conditions as Fed actions typically have a lot of lag. The central bank forecasts a funds rate of 4.4% by the end of the year, which would point to one more 75-bps hike in November (there is no October meeting) plus a 50-bps hike in December. From there, we may see a few quarter-point hikes before the Fed pauses. We thought it would take a lot to get the fed funds rate to 4%; odds are now in favor of a 5% terminal point. That’s high, but not disastrous for the economy. For historical perspective, we were sitting at a 6.5% rate in August of 2000 and a 5.25% rate in May of 2008. Despite the market tantrums, the economy will weather these rates just fine.
A combination of two catalysts will fuel the coming market rally: signs that inflation is finally coming down, and the Fed’s indication that a pause in hikes is near. We see both of these indicators appearing within the next four months. In the meantime, own quality equities and load up on fat-yielding, shorter-maturity bonds.
Mo, 19 Sep 2022
Fixed Income Desk
The sudden and unusual opportunity in short-term bonds
Every now and again, bizarre things happen in the bond market which provide unique opportunities for investors. When we buy fixed income vehicles, from CDs to Treasuries to corporate bonds, we expect to get a higher yield for taking on the risk of going further out on the time horizon—assuming parity with respect to issuer safety, of course. For example, we expect a 30-year Treasury bond to have a higher yield than a 10-year Treasury note, and that 10-year should be paying more than a 2-year issue. The benchmark spread is the difference between the 10-year and 2-year yield. When the shorter maturity issue has a higher yield than its longer-maturity counterpart, we get a condition known as a yield curve inversion—generally a sign that a recession is on the way.
Right now, we have a quite rare situation: the 2-year Treasury carries a yield higher than all of the longer-maturity issues. Since the 2-year is considered a proxy for what the Fed will do next and the 30-year gauges investor sentiment about the economy, all bets are now on rates continuing to rise until the Fed hits a wall and is forced to pivot. Considering money markets are still yielding close to nothing, and bond values have been dropping in investors’ portfolios, now is a golden opportunity to pick up higher-yielding bonds with shorter maturities and low duration (duration measures sensitivity to changes in the interest rate).
And this opportunity is not limited to government-issued securities. While the 2-year Treasury is currently yielding just shy of 4%, corporate issuers are forced to offer even higher rates (either through new issues or thanks to discounted prices on current bonds in the secondary market) to compete with the risk-free nature of vehicles backed by the full faith and credit of the US government. It has been hard to get excited about bonds for some time; right now, at least with respect to the lower end of the ladder, that is not the case. Investors should strike before conditions change.
We are loading up on low-duration bonds issued by quality companies to take advantage of current conditions. Even bank-issued CDs with maturities of two years are offering rates around 4%. Due to the unique challenges facing Europe and Asia right now, we are sticking primarily to debt issued by domestic firms and financial institutions.
Tu, 13 Sep 2022
Government Watchdog
California dreaming: burger flippers could soon have a $22 per hour minimum wage
On Labor Day, fittingly, California Governor Gavin Newsom signed a stunningly egregious law into effect. While its official name is the Fast Food Accountability and Standards Recovery Act, that is about as accurate as calling a trillion dollar spending bill an Inflation Reduction Act. We have a more accurate name we would like to propose: The $22 Per Hour Minimum Wage Act for Burger Flippers. There are no cutesy acronyms politicians are so fond of, but it clearly spells out the intent.
The law will create a Fast Food Council in Cali, made up of a 10-person cabal of workers, state officials, and management—the latter to make it look credible. This cabal will set the “living wage” for fast-food workers employed at companies which operate at least 100 locations around the country (not the state). Clearly, the target is McDonald’s, Chick-fil-A (the one they really hate), Burger King, Chipotle, and a number of other “fat cats.” The ruling council will have the power to create a new $22 per hour minimum wage for all fast-food workers, beginning next year. The law was strongly supported by the Service Employees International Union, which has been advocating a nationwide, $15 per hour minimum wage. Since California is already set to raise the minimum wage to $15.50 per hour in 2023, we suppose $22 would be the next common sense target.
Of course, there is nothing common sense about this act or the politburo-like body it has created. Two unintended consequences immediately come to mind: $15 hamburgers and a more automated workforce. One will punish consumers who are already reeling from runaway inflation, and the other will punish the very workers who are supposed to be helped by this act. From California, which had attempted to place a cancer warning on every of coffee sold, this move is par for the course. We just can’t understand why so many companies are heading for the exits.
The brilliance of our Founding Fathers in giving so much power to the states (rather than a central government) is once again on full display. Newsom can deny the fact that companies are fleeing his hammer and sickle mentality, and the Chicago mayor can proclaim that the city’s economy has never been stronger, but the evidence proves otherwise. Maybe the voters who keep them in power will see the light one of these days. But we doubt it.
Tu, 13 Sep 2022
Economics: Supply, Demand, & Prices
A hot August CPI report gives the Fed the green light for another 75-bps hike
The seemingly major contingent of investors who believe the Fed is on the cusp of pivoting—moving from rate hikes to a pause to potential rate cuts due to an economic slowdown—befuddles us. In what realm are they living? What metrics possibly back up such a pivot? It is nonsense. With this contingent in mind, it really shouldn’t come as a surprise that Dow futures swung some 700 points, from up over 200 to down over 500, on the back of a higher-than-expected August inflation report. The consumer price index, or CPI, which tracks the price of a large basket of goods and services, rose 8.3% from last year—despite the sharp decline in gas prices for the month. Food, shelter, and medical care costs drove the spike in prices, while the average price for a gallon of gas fell 10.6%. A couple examples of food inflation: eggs are up 40% from last year, while bread is up over 16%. In the auto space, the average price of a new vehicle rose by 0.8% for the month, or 10% annualized. Medical care costs have risen 5.6% from the same period last year. The two-year Treasury note, a proxy for what the Fed might do next, surged from 3.358% to 3.704%, driving bond values down. We have been expecting the Fed to raise rates by 75 basis points at this month’s FOMC meeting; this report all but guarantees that taking place.
The August CPI report and subsequent market drop created a great opportunity for investors. The responsible behavior of the Fed will ultimately lead to a reduction in the rate of inflation, a healthier economy, and a stronger stock market. And it won’t take long for that theory to play out. The closer the Fed gets to 4%, the closer a major rally is to manifesting.
Mo, 12 Sep 2022
Economics: Housing
Mortgage rates hit highest level since 2008
This past week, the average interest rate for a 30-year mortgage did something it hasn’t done since November of 2008: hit the 6% mark. Considering rates topped out about three times that level back in the 1980s, the current rate may not seem too daunting, but that figure reflects a 130% spike from just over two years ago. As the Fed works to get inflation under control, this is certainly one of the intended consequences of the tightening cycle. As mortgage rates rise, it should cool the housing market and, hence, runaway home prices. Unfortunately for would-be buyers, that has not happened, leaving them at the mercy of higher rates and higher prices. For those putting their homebuying plans on hold, there is another problem: rents are rising just as fast. We did a double take when we saw this figure, but the national average for renting a single-family home in the US rose 13.4% from 2021 to 2022, to $2,495 per month. For apartment dwellers the picture is nearly as bad: the monthly rent for a multifamily dwelling in the US rose 12.6% from July of 2021 to this past July, to $1,717. And occupancy rates remain high for rental housing, hovering around 96%. It may seem warped, but this is precisely why the Fed must continue to raise rates. Ultimately, something must put downward pressure on home prices.
It may seem counterintuitive to look at buying the homebuilders now, but their prices have been so beaten down by the fear of rate hikes and a coming recession that they are beginning to look very attractive. While the builders of lower-end homes will face more difficulty, names like Toll Brothers (TOLL $45) and D.R. Horton (DHI $74, Emerald Homes is its luxury division) look attractive. Both companies have ultra-low P/E ratios—both current and forward—in the 4-6 range, and both have plenty of cash on hand to weather any coming housing storm.
Th, 08 Sep 2022
Global Strategy: Europe
Despite severe recession risks, the European Central Bank raises rates 75 bps
Typically, in the face of a potentially severe economic downturn, a country’s (or region’s) central bank will begin lowering interest rates in response. In an illustration of just how wrongheaded the ECB’s decision was to go negative with interest rates back in 2014, Europe’s central bank has been forced to do just the opposite: raise rates. It began back in July, when the ECB raised its deposit facility interest rate from -0.5% to 0.00%—a 50-basis-point hike. Now, due to runaway inflation (primarily caused by the energy crisis), the bank has been forced to match the Fed’s most recent action and raise rates another 75 basis points, to 0.75%. In addition to putting downward pressure on inflation, this move should also shore up the euro, which recently dipped to parity with the strengthening US dollar.
The irony of the ECB’s needed move is that the European Union is simultaneously pumping hundreds of billions of euros into the economy to help families deal with skyrocketing energy costs. Basic economics says that when a central government pumps money into an economy, inflation naturally increases. Eurozone inflation rose to 9.1% in August and is expected to hit double digits in September. The ECB, like the Fed, has an inflation target rate of 2%. It has a long way to go before getting anywhere near that number, unless a severe recession grinds the European economy to a halt.
It has been a full decade now since the key European rate has been above zero. ECB President Christine Lagarde, meanwhile, has signaled more hikes to come. These hikes are needed, but they will only increase the likelihood of a deep recession hitting the continent this winter.
Fr, 02 Sep 2022
Economics: Work & Pay
Two key positive takeaways from the August jobs report: unemployment and labor force participation
Here was the conventional thinking as investors awaited the August jobs numbers: if the report was strong, the Fed would continue hiking rates and stocks would be punished; if the report was weak, the Fed might start tapping on the brakes and stocks would celebrate. We ended up with something in the middle, and that was the best possible outcome.
First the headline number. There were 315,000 new nonfarm jobs added in the month of August, or slightly fewer than the 318,000 expected. Wages rose 5.2% from a year ago—not a positive sign for inflation, but not as much as expected. There were two key components of the report that helped turn futures from flat to positive. The first was the unemployment rate, which surprised analysts by ticking up from 3.5% to 3.7%. The second was the reason for that jump: the labor force participation rate rose an impressive 0.3%, to 62.4%. That may not seem like much, but it meant another 800,000 Americans began looking for work.
One of the biggest causes of inflation has been the scarcity of workers, forcing employers to pay more to attract new help. That pool of workers just got a lot bigger, which should help dampen the recent wage spikes. The prime-age labor force participation rate—workers between 25 and 54—surged to 82.8%, which is great news on that front. Overall, it is hard to imagine a much better report rolling in right now.
We still want—and expect—to see a 75-basis-point rate hike coming in September, which would bring the upper band of the Fed funds rate up to 3.25%. We still need to see any combination in subsequent months pushing that rate up to 4%. Then, it will be time to pause until inflation moves back down to an acceptable level. The Fed will also be reducing its $9 trillion balance sheet over the coming year. To be clear, this scenario is what needs to happen, not what the market wants to see.
Mo, 29 Aug 2022
Industrial Conglomerates
3M wanted bankruptcy court for one of its subsidiaries; a judge denied the request
Between 2003 and 2015 a 3M (MMM $126) subsidiary by the name of Aearo Technologies manufactured and supplied earplugs to the United States military for troop training and for troops stationed in a combat environment. Production of the earplugs, which were unique in their two-sided design, ceased in 2015. In 2016, a competitor filed a whistleblower lawsuit claiming that 3M knew the plugs were defective, causing hearing loss and tinnitus in scores of soldiers. Two years later, the company agreed to pay over $9 million in a victims’ fund. After that tiny amount was paid, some 230,000 service members began filing lawsuits against the firm; the suits were ultimately consolidated through multidistrict litigation (MDL, somewhat akin to a class action lawsuit but more personalized) and handed off to a bankruptcy court in the Northern District of Florida.
In an effort to limit its own liability, 3M declared bankruptcy for its Aearo Technologies unit and threw a gauntlet down to the judge, arguing that it was not within his power to interfere with the proceedings. The judge did not share that opinion. Shares of the company plunged nearly 10% after Judge Jeffrey Graham denied 3M’s attempt to offload the company’s problems in such a manner, keeping the parent company on the hook for a potentially enormous payout. While the cases which have already gone to trial present a mixed picture, it is easy to imagine the ultimate payout to a large percentage of 230,000 plaintiffs dwarfing the $1 billion amount the company has since set aside for settlement. For example, in ten cases which have already been decided, five were won and five were lost by the company, with the successful plaintiffs being awarded between $1.7 million and $22 million each. Here’s a staggering fact to consider: If one out of every three plaintiffs in the case were awarded $1 million, the dollar amount would be roughly equivalent to 3M’s market cap.
Over the course of the past nine years, 3M shares are flat. They were trading at $126 back in 2013, and they trade at $126 right now. The company is trying to pull a General Electric (GE $76) move by spinning off its healthcare business (the current GE shouldn't be used as a model for anything, except what not to do), arguing that long-term shareholder value will be created. We don’t buy it. As for the stock, we offer the same recommendation—don’t buy it.
Fr, 26 Aug 2022
Market Week in Review
There are well-founded market drops, and then there are the type that happened Friday
Did investors really believe Jerome Powell was about to pivot and become a dove? Perhaps they were expecting him to come out in front of the gorgeous mountain range at Jackson Hole and proclaim, “Inflation is no longer a threat or a problem, we must get rates back to zero!” Complete silliness. Instead, he did what everyone should have fully expected: In front of some wood paneling straight out of the ‘70s (fitting), he said that the Fed will continue to do everything it must to tame inflation. It was short and sweet…and correct. For us, that means the terminal Fed funds rate will be at least 3.5%, but we are hoping for 4%. If the markets can’t handle a 4% rate, then we have really dumbed down our economy.
Think of the trillions of dollars pumped into the economy by the Fed and the US Congress over the past few years. Does anyone other than a full-blooded, card-carrying Keynesian believe that is healthy for a country, an economy, the stock market, or individuals? No! Sure, we had to take extraordinary steps in response to the pandemic from China, but did it need to continue for two years? Furthermore, what about the $23 trillion worth of debt the government had built up before it added $7 trillion more post pandemic?
The market should have cheered a responsible Fed Chair following in Alan Greenspan’s footsteps and telling us he will do whatever it takes to staunch inflation. Instead, the Dow lost 1,008 points on the session, or 3%. In fact, all four major benchmarks (to include the Russell 2000) lost over 3%. Something to worry about? We believe just the opposite. Investors are myopic. Powell gave then exactly what they needed (a responsible policy), not what they wanted (a shiny early Christmas present), and after the temper tantrum we will be back on the upswing. Friday wasn’t a day to worry; it was a day to identify strong companies which have been senselessly beaten down.
Th, 25 Aug 2022
Global Strategy: Europe
Europeans face a harsh winter thanks to skyrocketing energy prices
Americans have certainly noticed their energy bills rising this year, and the problem will be exacerbated this winter when most households switch from their electricity-powered a/c to natural gas-powered heating systems. In fact, one in six American households now have overdue utility bills—the largest percentage on record. But Americans’ problem is nothing compared to that of their European counterparts, who now face an astronomical spike in energy prices.
The long-term average price in US dollars for one million British thermal units (MMBtu) of natural gas imported into Europe is $4.20. Today, that figure has skyrocketed some 718%—to $34.35—from its average. Electricity rates in Germany are now six times higher than they were last year, while the French are facing €900/megawatt-hour energy prices—ten times the cost as last year. France’s issue has been magnified due to its nuclear energy problems—over half of the country’s reactors are offline due to maintenance, repair needs, or river issues (reactors need massive amounts of river water for cooling; water levels are low right now, and temperatures are unusually high). While governments grapple with how to best help their citizenry with out-of-control prices, there are no easy answers. The long, hot summer in Europe will morph into a frigid and painful winter, much to Putin’s delight.
We have been underweighting both developed and emerging markets in Europe due to a host of economic issues. First and foremost is the continent’s massive energy crisis; a problem which came about due to an overreliance on Russia for its needs. Perhaps France and Germany will learn from this, but it will take years for the problem to be resolved.
Th, 25 Aug 2022
Specialty Retail
“Diamond hands” traders just got screwed over by mentor on Bed Bath & Beyond
By now, we all know who and what “diamond hand” traders are: people who follow social media sites like r/wallstreetbets, buy the flailing companies touted in an effort to crush short sellers, and then hang onto the shares no matter what. One of their recent champions has been Ryan Cohen, the activist investor who took a major stake in Bed Bath & Beyond (BBBY $10) back in March through his RC Ventures hedge fund. Shares of the home retailer rocketed from $15 to $30 as diamond hands piled in. Subsequently, however, as it became clear just how bad the financials were for the company, negative headlines and downgrades pushed the shares down to the $4 range. Cohen was sitting on a huge loss (he owned about 10% of the shares at that point). His firm then purchased call options on nearly 1.7 million shares of BBBY, driving the price back up to the $30 range. Then, Cohen did what no self-respecting diamond hands trader would do: he sold his entire position. This caused the shares to tumble 52% over the course of two days, leaving the hedge fund manager with a $68 million profit and his followers with enormous unrealized losses. Cohen’s investment firm had no comment.
Will Cohen’s actions at BBBY make many meme stock traders reconsider their “strategy?” Probably not. For investors who are serious about their portfolios, however, this story buttresses an important tenet: Understand the companies you are buying, what their unique value proposition is, and whether or not they will have the financial wherewithal to navigate any economic environment. And never have diamond hands—never hesitate to take profits and minimize losses.
Tu, 23 Aug 2022
National Debt & Deficit
Your government spent $2.775 trillion more than it collected last year
If we talk about enormous sums of money too often the brain begins to accept them; or, at least, gloss over them. That is not good. We need to understand the fiscal irresponsibility of our elected officials to have any hope of changing their actions. So, instead of simply saying that this country is currently $30.7 trillion in debt, let’s try this fact: If each US taxpayer were directly responsible for their portion of America’s debt, we would owe $244,315 apiece. Want to add your kids and other non-taxpayers into the mix? In that case, every US citizen owes $92,272.
Keeping in mind that 2020—not 2021—was the year we bore the brunt of the pandemic from an economic standpoint, consider how much the US government collected and spent last year. Revenue collected came in at $4.045 trillion. Last year the government spent $6.820 trillion. The difference, or deficit, is how much we grew the national debt last year: $2.775 trillion. At the risk of being redundant, our government spent $2.775 trillion more than it took in last year, in the midst of a rip-roaring economy. What is even more disgusting is that Social Security inflows and outflows are wantonly thrown into the mix rather than being physically separated, as they should have been from the start, from the general funds. Were your company to do that with your 401(k) plan, it would be a criminal act.
Understandably, the largest deficit on record took place in 2020. There is no excuse, however, for 2021’s budget-busting numbers. And as interest rates rise, it is going to take a bigger and bigger portion of revenue to simply service the interest on the national debt each year. Right now, a “paltry” ten cents out of every dollar collected goes toward interest payments. Imagine ten cents out of every dollar you earn going towards the interest on your credit card debt! Madness.
There are two ways this slow-moving (actually, not-so-slow-moving) train wreck can be avoided: the positive way via a balanced budget amendment and term limits added to the US Constitution, or the negative way through a fiscal meltdown. The fallout from the latter is hard to fathom.
Mo, 22 Aug 2022
Work & Pay
A wave of layoffs are probably coming soon; how will that affect unionization efforts?
Consulting firm PwC polled over 700 executives from US firms in all industries and of all sizes, and they found that over half plan to reduce headcount and implement hiring freezes within the coming months. While it may seem counterintuitive, many also said they plan on simultaneously increasing their number of contract workers and freelancers. Dig a bit deeper, however, and that makes perfect sense. With a slowing economy, higher inflation, and supply chain issues, many firms suddenly find themselves dealing with a renewed unionization push. And this time around, it is not just industrial names which are in the crosshairs. Consumer discretionary companies like Starbucks (SBUX $87), which are known for their generous benefits like tuition assistance, are bearing the brunt of the push. That is illogical, and we fully expect the inevitable increase in the 3.5% unemployment rate to help quell the movement.
Technology will also play a role in dampening successful activism, as advances allow firms to be more productive with a smaller headcount. A McDonald’s (MCD $266) restaurant, for example, might add new ordering kiosks, while an Apple (AAPL $169) might reduce its physical footprint in favor of an enhanced online presence. This is not the 1970s: Companies now have levers to pull in order to maintain their productivity levels—tools which were simply not available back then.
Speaking of productivity, it has been going down recently for the first time in a long time, and new studies are indicating that work-from-home is playing a role in the drop. This is one of the reasons why companies such as Apple are now demanding their workers return to the office at least two or three days per week. Right now, that mandate is limited to the area around Apple’s Cupertino headquarters, but we expect the requirement to expand into other areas soon. The back-to-work request has been a hard one to enforce with the low unemployment rate, but now that stimulus funds are depleted—and as the unemployment rate rises—expect more of these policies to come down the pike. We imagine a large percentage of those 700 executives will be watching Apple’s initiative with interest.
There is a natural ebb and flow to the unionization movement in America, with undercurrents such as the political environment and economics (the unemployment rate) affecting the efforts. Right now, corporations appear to be up against the ropes, but time and technology are on their side. This is especially true for the companies who treat their employees as fellow stakeholders rather than simply a line on a balance sheet.
Tu, 16 Aug 2022
Food & Staples Retailing
Walmart shares pop 5% after the company tops estimates and sticks to full-year guidance
It was just under a month ago that Walmart (WMT $140) shares plunged following dire management warnings on crimped profit margins due to inflation and a consumer who was cutting back on discretionary spending. The shock waves from those comments were felt throughout the industry. This week, we received a different story line. Walmart shares gained over 5% on Tuesday’s open following a revenue beat ($153B vs exp. $151B), an earnings beat ($1.77EPS vs exp. $1.63), and an improved outlook for the full year. Same-store sales at its flagship stores rose 6.5% in the quarter, while Sam’s Club saw a 9.5% gain. CEO Doug McMillon said that the company is now effectively working through the inventory problems which were at the heart of July’s lowered guidance. McMillon also said that behavior changes due to inflation are driving higher-income households into Walmart stores. Whatever the reason, the Street remain generally bullish on the company: out of 39 analysts, 20 have a buy rating and none have an underperform or sell rating on the shares.
Walmart is one of the 40 companies within the Penn Global Leaders Club.
Tu, 16 Aug 2022
Global Strategy: East/Southeast Asia
China cuts rates as economy slowing on nearly all fronts
Consider this: The US economy is slowing and layoffs are increasing, but the Fed remains committed (correctly so) to rate hikes; the European Union faces an even more severe economic slowdown and a brutal coming winter due to a Russian-fomented energy crisis, and the ECB is raising rates; China’s economic growth rate is slowing on nearly all fronts, and the People’s Bank of China just cut rates. That unexpected action by China’s central bank highlights the dichotomy between how the West and the East are dealing with an unwelcome mix of high inflation and probable recession.
While China didn’t cut its interest rates by much (the main rate at which it provides liquidity to banks dropped from 2.1% to 2%), the government simultaneously announced it was pumping an additional $60 billion into its financial system to spur lending. The challenge with both of those moves is the fact that Chinese citizens are very reluctant to borrow right now due to angst over lockdowns, an economic slowdown, and a nightmarish real estate market. (The government is placing strict controls over the sale of properties by homeowners, adding to the apprehensiveness of would-be buyers.) For a communist party which bases its very existence on control, the inability to get its people to act in a certain way must be maddening.
As for the economic slowdown in the country, economists are rushing to downgrade expected rates of growth. TD Securities, for example, just lowered its full-year GDP expectations to 2.9%, while UBS admitted to seeing “downside risks” to its 3% full-year growth forecast. Unlike the American consumer, which has been full steam ahead, Chinese consumers have purchased around half of the retail goods economists had expected by this point in the year. And there are scant indications that the situation will get better anytime soon.
Of course, US retailers who became overly reliant on Chinese sales will also be hurt by the country’s economic slowdown. That fact, combined with the strong US dollar, should have investors searching for small- and mid-cap consumer cyclicals which receive the lion’s share of their revenues from domestic sales.
Mo, 15 Aug 2022
Media & Entertainment
Clown company: You couldn’t give us shares of Getty Images Holdings
How fitting that Getty Images Holdings (GETY $31) went public via a SPAC—it certainly would have been a humorous roadshow full of fanciful tales of projected growth had they been forced to use the traditional process. It is also fitting—and sad—that “investors” pumped the value of the shares up from $10 to $31 since this joke of a company went public late last month. Getty, whose shares are worth—in our opinion—about $1 apiece, now has a market cap of $11 billion. Do people literally have money to burn?
As the name implies, Getty Images sells stock images to creative professionals, the media, and corporations. Protecting copyright infringement is serious business, but Getty has turned it into a nefarious source of revenue. Examples of the firm’s abuse of power are too numerous to mention, but here is a rather typical scenario: A photographer uses one of their own digital photographs on a website. Not long after, the photographer receives a demand of payment from Getty for using the photograph; the demand comes with a threat of legal action unless the confiscatory amount requested is paid immediately. The photographer takes legal action to get the threats stopped, as they created the very image in question! The company also uses embedded technology within images to “go fishing” for people who might use the images, thus initiating the demands for payment.
The last thing Getty wants is for people to call their bluff and demand that a court decide an outcome—the company has lost a string of cases, drawing rebukes from the courts. Getty also has a well-documented history of taking images in the public domain (“free use”) and leasing them to unsuspecting customers for up to $5,000 for a six-month term.
For any investors believing they will own a piece of a growing enterprise, consider the fact that this is not the first time Getty has been publicly traded, and that only twelve shareholders own nearly 80% of the company. It may be legal, but it is a scam in our books.
Getty is the sort of company that would love to sue anyone with a disparaging view of their operations. The New York Stock Exchange should have steered clear of this listing, and investors should run the other way.
Th, 11 Aug 2022
Economics: Supply, Demand, & Prices
At long last, the steep inflation trajectory is beginning to moderate
Within seconds of the report’s release, Dow futures soared more than 400 points—led by consumer discretionary names. Finally, after months of ever-growing rates, inflation cooled in July. Following June’s 9.06% YoY rate and 1.32% MoM rate, and against expectations for an 8.7% annual increase, the price of goods and services in the US rose by “only” 8.5% in July. The MoM number, which was expected to rise by 0.2%, actually fell by that precise amount. While the 7.7% drop in gas prices in July helped drive that number down, even when energy and food prices are excluded core CPI still rose less than expected: 5.9% versus the 6.1% expected. Housing costs, which make up around one-third of the CPI, rose 5.7% from a year ago.
The report brought a sigh of relief to investors, as the Fed has indicated it will continue raising rates until it tames inflation. Any number above consensus would have increased the odds for an even greater rate hike at the September FOMC meeting. Another 75-basis-point hike is still expected, followed by two or three smaller hikes before the end of 2022. Buttressing the good news on the consumer side of the inflation front, the producer price index (PPI)—a reflection of what producers of goods and services must pay—also fell in July. Instead of the expected 0.2% jump MoM, prices actually fell 0.5% from June.
One month does not a trend make, but we believe peak inflation is now behind us. Now, the move downward must be gradual enough so as to not create a more dovish Fed before rates get back up to where they should be. We need decent bond yields in order to build well-balanced portfolios.
We, 10 Aug 2022
Consumer Electronics
Amazon is buying iRobot for $1.7 billion
We were early investors in consumer robot company iRobot (IRBT $59), initially buying shares of the company shortly after they went public. It has been a wild, seventeen-year ride for those shares, coming out of the gate around $24, rising all the way to $197.40 in the spring of 2021, and then falling back to $35.41 a few months ago. We actually took our profits around $65 per share (we owned the company in the Penn New Frontier Fund) when a stop loss hit. Now, the maker of those cute little Roomba autonomous vacuums, Braava robot mops, and (coming soon to a backyard near you) Terra robot mowers is being acquired by Penn member Amazon (AMZN $138) for $1.7 billion in cash—around $61 per share. We love the deal.
Amazon’s Alexa already supports iRobot devices (“Alexa, ask Roomba to start vacuuming”), and now the enormous, $1.4 trillion e-commerce company can provide the needed cash inflow for the development of new devices. iRobot has faced a number of headwinds lately, to include tariffs (it is now moving a large portion of its manufacturing operations from China to Malaysia), rising input costs, supply chain issues, and an unanticipated drop in demand due to deteriorating global economic conditions. While the firm has generally operated in the black over the past decade, Amazon’s deep pockets will assure the company is able to weather a recession and come out stronger during the next recovery phase. The deal is expected to be completed by the end of the year.
Talk about a great marketing platform for iRobot: being highlighted by the world’s largest e-commerce company should provide a great catalyst for future sales. As for Amazon, it remains one of our highest-conviction holdings. We added to the position following the stock split (when shares were trading around $100) and have a price target of $200 on the shares. Amazon is one of the 40 holdings within the Penn Global Leaders Club.
Fr, 05 Aug 2022
Market Pulse
At first, the market hated the
Sa, 29 Oct 2022
Market Pulse
The foolishness of the mainstream media was on full display this week
Back in July, as the market was rebounding from its June lows, CNBC’s Jim Cramer frantically declared, “The market hit its bottom on June 16th!” Of course, he was proven wrong just a few months later. After the September bloodbath, Jim Cramer told his viewers that he had been talking to a lot of “big investors,” and they were all telling him the S&P 500 would take out 3,000 on the way down, and that the fed funds rate wouldn’t stop until it hit 6%. At the time, the S&P 500 was at 3,657 (we looked at the ticker the minute he made his rant). This was before what is shaping up as the best October in decades.
Yes, big tech got hit this week on weaker-than-expected earnings and some sobering guidance. But let’s take Apple (AAPL $156) as an example of just how reactionary the press really is. The minute the Cupertino-based giant announced a miss on iPhone 14 sales, and that revenue growth could slow during the coming holiday season, AAPL futures dropped some 8%. Immediately, the panel of esteemed hosts on a certain business channel began falling all over themselves to explain why the stock was down, how they saw this coming, and the bad things it portended for Apple as a company. The next day, instead of following through on the 8% drop, Apple shares climbed 8%—a 16% swing from the post-earnings futures. You would think these individuals would stay mum based on their previous afternoon’s comments. No, instead they doubled down on their dumb comments.
We find it highly impressive that, following some rather glum reports and guidance, all the major benchmarks were up this past week—including the Nasdaq (where the tech giants live). While we still haven’t clawed back September’s brutal losses, we are making good progress. This tells us investors believe a couple of things: that the Fed is going to do another 75-basis-point hike next week but then indicate a slowdown of the rate of increases; and that earnings are not coming in nearly as bad as feared, despite the FAANG disappointments. We believe they are correct on both counts. Too late to go back and declare another market bottom in September, Cramer, that ship has sailed.
We believe we are in the early stages of a Santa Claus rally, buttressed by a Fed slowing its pace and by the mid-term elections. Who will lead the charge? Probably the small caps, which have been severely beaten down and are spring-loaded for a comeback.
Fr, 28 Oct 2022
Aerospace & Defense
Boeing, led by its inept management team, fumbled yet another quarter away
The once-great American aerospace giant Boeing (BA $135), led by bumbling CEO Dave Calhoun, has announced yet another lousy quarter. Against expectations for $17.8 billion in sales, the company brought in just $16 billion; from that $16 billion, the company managed to lose $3.275 billion along the way. Put another way, the Street was expecting earnings per share of $0.10, instead it delivered a $5.49 per share loss.
While the bottom-line net income still would have been negative, the enormous loss was overwhelmingly a result of a $2.76 billion hit the company took on the aggregate of five fixed-price development programs, to include the (nightmarish) KC-46 tanker program and the (long delayed) Commercial Crew program. The KC-46 USAF tanker program alone accounted for a $1.17 billion loss. Are you ready for the “leader’s” response? CEO Dave Calhoun said the charges were driven by macroeconomic forces beyond Boing’s control. Way to take ownership, Dave.
The concept of the learning curve with respect to huge companies building complex systems states that costs go down with the repetition of a smooth-running assembly line. Calhoun said, “We don’t have any baked-in learning curves anymore.” True, you obviously don’t. What you didn’t say was that it is all management’s fault. It is hard to BS your way through the publicly traded landscape: Boeing has lost 70% of its value since 01 March 2019. How about an apples-to-apples comparison: Boeing’s disastrous finances are reflected in its -3.25 debt/equity ratio; Airbus (EADSY $26) has a debt/equity ratio of 1.32. We suppose the “macroeconomic environment” is rosier in Europe?
There is a fiefdom at Boeing, with Calhoun having anointed himself king and the jesters on the board facing little pushback from the poor citizens (shareholders). Until the autocratic regime is overthrown, there is no reason to own shares of this once-great company.
We, 26 Oct 2022
Interactive Media & Services
Snap continues to disappoint the Street; is the stock now cheap enough to buy?
It is becoming a quarterly ritual: Snap (SNAP $10) reports earnings, and we report the company’s double-digit share price drop. It just happened again. Last Thursday, for the third consecutive quarter, Snap missed on both revenues and net income, generating $1.128 billion in sales and losing $359.5 million in the process. Management then proceeded to give an outlook so lousy that the company’s shares gapped down some 28% on the day. While they have climbed back a bit from their new 52-week low of $7.33, investors shouldn’t be too eager to jump in at these “bargain basement” prices (shares remain down 80% for the year).
Snap has an impressive base of 158 million daily active users, but the company generates nearly all its revenue from advertising; and 88% of those ad dollars emanate from US companies. After surprisingly bad numbers from much larger competitor Alphabet (GOOG $105), particularly in its Snap-like YouTube unit, expect a rough year ahead as the US muddles through a recession. Digital ad spends are among the easiest cuts made by corporations as they hunker down in preparation for an economic downturn, and Snap would be an easier advertising cut to justify as opposed to a pullback in online ads at Google, for example. In short, we fail to see any near-term catalysts that would drive the shares substantially higher from here.
We have discussed the comically skewed share class structure (in favor of management) at Snap, so no reason to rehash it now. Suffice to say investors looking for deals among the tech carnage can find better opportunities elsewhere.
Mo, 24 Oct 2022
Global Strategy: Europe
Labour will have a much tougher time trying to discredit the new UK prime minister
Including the one just selected, there have been eight prime ministers of the United Kingdom since Maggie Thatcher left that post in 1990; seven have been Tories (Conservative Party), and one has been a member of Labour. The newest resident of 10 Downing Street, Rishi Sunak, has made it clear who he most idolizes: Margaret Thatcher.
On its face, the optics of having been through four Conservative Party PMs within the last three years and three within the past seven weeks should bode well for Labour going into the next general election, which must be held no later than early 2025 (the last, held in December of 2019, was a landslide victory for the Tories). But Rishi Sunak is no Theresa May, nor is he a Liz Truss; the left will be in for a bit of a surprise as they feign insult at every turn and begin their interminable attacks.
At age 42, Sunak will be the youngest prime minister since William Pitt the Younger assumed office—at age 24—in 1783. Indian by heritage, Sunak’s mother was a pharmacist and his father was a general practitioner in the National Health Service. After graduating from Oxford, he received his MBA from Stanford while living in the United States. Although he was Boris Johnson’s chancellor of the Exchequer (think Treasury secretary), he resigned this past summer after questioning his boss’ ethics. He has experience in the world of investment banking, working at Goldman Sachs and as a hedge fund manager in the US.
Following in his idol’s footsteps, Sunak believes in lower taxes and controlled government spending; though he did oversee the massive furlough program which made payments to the millions of Britons who lost their jobs during the pandemic. He enters office at a critical period, as economic conditions in Great Britain continue to deteriorate. Facing the twin culprits of weak economic growth and rampant inflation (stagflation), his honeymoon period will be short. However, his real-world experience in finance should serve him well, despite the loud and obnoxious voices of his critics.
Rishi Sunak may never breathe the rarefied air of the Iron Lady, but we expect him to be a highly effective PM—to the chagrin of his haters. We will also make the bold prediction that he will still be in power for the next general election, which he will proceed to win. For investors wishing to take advantage of an economic rebound in the UK, look at EWU, the iShares MSCI United Kingdom ETF. One of its top holdings—Diageo PLC (DEO $165)—is an inaugural member of the new Penn International Investor fund.
We, 19 Oct 2022
Commercial Banks
Credit Suisse looks a lot like Lehman in 2008; could the global bank really fail?
Credit Suisse Group AG (CS $5), founded in 1856, is one of the two major Swiss banks and an important player in global finance; the Zurich-based firm maintains offices in all major financial centers around the world. Going into the 2008 global financial crisis, the bank had a market cap of $90 billion; today, it is a shell of its former self, boasting a market cap of just $12 billion. While it survived the global banking crisis, recent scandals have driven investors away and have some analysts handicapping a nightmare scenario: insolvency.
The recent scandals began when British financial services firm Greensill Capital, in which Credit Suisse had some $10 billion invested, went belly up, causing CS clients to lose around $3 billion. Then came the Archegos Capital (Bill Hwang) debacle. While the privately held company primarily managed the assets of family office group trader Hwang, CS was a major lender to the firm. As Archegos was imploding and before Hwang was arrested for securities and wire fraud, the company lost $20 billion in a matter of days. Credit Suisse itself was out $4.7 billion, causing a half-dozen executives at the bank to lose their jobs. In February of this year, the bank was charged with money laundering (it was later found guilty by a Swiss court) in connection with a Bulgarian drug ring. Shortly after that, details of approximately 30,000 customer accounts at the bank—worth over 100 billion Swiss francs in aggregate—were leaked to a German newspaper. The leaks exposed customers involved in all types of lurid behavior, from human trafficking to torture. Finally, and most recently, it was discovered that executives at the bank urged certain investor-customers to destroy documents linked to Russian oligarchs who had been sanctioned following the invasion of Ukraine.
This past summer, Credit Suisse Chairman Axel Lehmann replaced the bank’s CEO with its head of asset management, Ulrich Koerner, and announced a strategic review of its investment banking unit. The bank’s upcoming earnings release—slated for 27 October—is expected to show a reduction in the bleeding from Q2, but that will not be enough to quell investors. A comprehensive restructuring plan is needed, but we doubt the current management hierarchy is up for the job. That said, we don’t believe the bank faces any real threat of insolvency—it is “too big to fail.”
There has been some intriguing speculation recently that the other major Swiss bank, UBS (UBS $15), with its $52 billion market cap, could swoop in and save Credit Suisse via a merger. While we don’t see that scenario playing out (Swiss regulators would not be keen on the idea), a positive upside surprise on the 27th could move the shares higher. Analysts run the spectrum of expectations, from CFRA’s $3.50 price target to Morningstar’s $10.60 fair value. While it may be fair to say the company is not going the way of Lehman, the risk of it languishing while management tries to clean up its mess is too great to justify an investment—even at $4.58 per share.
Tu, 18 Oct 2022
Social Security, Medicare, & Medicaid
Social Security recipients will receive their largest increase in four decades next year
In the face of soaring inflation, the Social Security Administration has announced that beneficiaries will receive an 8.7% cost of living increase in 2023—the largest adjustment since 1981’s 11.2% bump. This move comes on the heels of a 5.9% upward adjustment in 2022. On average, next year’s rate increase will amount to $146 more per month in recipients’ bank accounts. Additionally, Medicare Part B premiums, which are generally deducted from Social Security benefit payments, will be lowered next year from $170.10 to $164.90. Approximately 50 million Americans receive Social Security each month, with another ten million receiving disability payments and six million receiving survivor payments. The average payment for retired workers in 2022 is $1,670, while survivors average $1,328 per month. Per Social Security Administration figures, total income collected for the Social Security Trust Fund last year was $1.088 trillion, with $1.145 trillion going out in the form of payments—a $56 billion deficit. At the end of last year, the Fund had $2.852 trillion in asset reserves.
In early 1968, President Lyndon Baines Johnson moved the Social Security Trust Fund “on-budget,” meaning it would be considered part of the unified budget of the United States. In 1990, under President George H.W. Bush, this action was reversed, moving the Fund back “off-budget.” To see income, outflow, and reserve levels of the Fund, readers can visit the Social Security Administration website.
Tu, 11 Oct 2022
Government Watchdog
The rotten law that California voters rejected is about to be shoved down America’s throat
Think of how the likes of Uber (UBER $25) and Lyft (LYFT $12) have radically transformed—for the better—transportation in this country. Bargoers who wouldn’t have considered calling for a Yellow Taxi at two in the morning routinely hail rides on their app. Elderly shoppers in suburban regions can now get a convenient and reasonably priced ride to and from the grocery store. Apparently, that is a transformation which must not be allowed to stand.
The subversive movement to halt this positive trend began, fittingly, in California. Assembly Bill 5 (AB5) said that all workers, to include drivers for ride-hailing services, had to be considered employees of the company rather than freelance “gig” workers. Never mind the fact that most of these drivers did not wish to be considered employees. Then came Proposition 22, passed by a majority of California voters, which exempted these workers from being classified as employees rather than independent contractors. Understandably, Prop 22 was a major win for the industry.
Since such an important issue cannot be left to the masses to decide, the results immediately came under fire. A California judge ruled the measure unconstitutional. The battle rages on, but now the White House has chosen to take a stand on the issue. President Joe Biden has ordered his Department of Labor to review how workers are classified. In short, the administration wishes to codify, on a national level, California’s AB5. As this move would cause operating costs in the industry to skyrocket, shares of Uber and Lyft plunged on the news. Other companies in industries from trucking to construction also dropped on the DOL proposal. An attorney for the department said the move was “not intended to target any particular industry or business model.” Is anyone dense enough to believe that?
As we are on the precipice of a recession, what an incredibly thickheaded time to go forward with such anti-business nonsense. There will be an endless stream of legal challenges to the coming decree, and we expect the final decision to be made by the US Supreme Court. In the meantime, we have yet another roadblock in the way of getting our economy back on track.
Tu, 11 Oct 2022
Automotive
It has been a rough road for Rivian since its IPO, and that was before the massive recall
Talk about lousy timing. Last November, one year ago next month, signaled the peak in the stock market, and it has been a bumpy downhill slog from there. Last November was also when EV maker Rivian (RIVN $31) presented itself to the investment world via an IPO. Initially priced at $78, shares quickly soared to $179.47 on 16 November, just six days after the IPO. Woe to any investor who jumped in then: the current stock price represents an 83% drop from that all-time high.
In a tough economic environment, marred by supply chain issues and rising input costs, Rivian has been consistently missing its own production targets; now, on top of that, the company is being forced to recall nearly all its vehicles on the road for steering control issues. While there have been no reported injuries and the fix is relatively straightforward, the problem will divert precious resources away from production at a time when the startup is already under intense scrutiny for over-promising and under-delivering.
The first Rivian rolled off the assembly line in September of 2021, and the company has produced just 15,000 vehicles to date. The 2022 full-year production target is 25,000 vehicles, which is all but guaranteed to be another miss. Rivian has a market cap of $28 billion, down from a November high of $153 billion. The company's R1S electric pickup has a price range between $72,500 and $90,000, while the longer-range R1T, fully loaded, will set a buyer back around $100,000.
For those who believe Rivian is the next Tesla, $31 per share may seem like a great point at which to buy the stock. While the company has enough cash on hand to weather the production and recall problems, the potential for further price erosion is too great to justify an investment right now. For those willing to take the risk in the automotive industry, Ford (F $11) looks a lot more attractive with its 5.668 forward multiple.
Sa, 08 Oct 2022
Market Pulse
It was a positive week in the markets, so why didn’t it feel that way?
The week began with the best two-day rally since April of 2020, with the S&P jumping some 5.6%. A few signs arose which gave the market hope that inflation was starting to be tamed, which might lead to the end of rate hikes. Wednesday was flat, Thursday investors began to worry, and Friday’s strong jobs report capped the U-turn. The unemployment rate fell from 3.7% to 3.5%, the labor force participation rate remained steady at 62.3% (we need more workers rejoining the labor force), and 263,000 new jobs were created—more than anticipated. We are back to the bizarre world where good news is bad news. This all but assured more rate hikes, with odds strong for a 75-basis-point hike in November, followed by a 50- and then 25-bps hike in December and January, respectively. That would put the upper limit of the fed funds rate at 4.75%, at which time Powell and company should be able to put the tightening on hold.
That probable scenario spooked the Dow into a 630-point selloff on Friday, which is absolute silliness. A 4.75% rate is not economy crushing, as we have weathered much higher rates in the past. The average 30-year mortgage loan now comes with a 7% APR, which has certainly dissuaded homebuyers and seized up the refinance business; but runaway home values are beginning to level out—an important component to controlling inflation. Another big weight on the markets this week came courtesy of OPEC, which promised to curb oil production by two million barrels per day. The cartel’s aim is to stick it to Biden while getting oil prices closer to triple digits, and it seems to be working: the price for a barrel of crude rose from $79.74 before Monday’s open to $93.20 by Friday’s close.
By the end of the week the Dow had actually pulled off a 1.99% gain, followed by the S&P 500 at +1.5% and the NASDAQ at +0.72%. Market emotions were on full display over the five-session period, going from hopeful anticipation on Monday to depressed capitulation on Friday. It may seem odd, but these kinds of wild swings are often the precursor of something good waiting around the corner.
It has been a painful year, but we are now in the bottoming-out process. When the market senses that the Fed is near the end of tightening, there will be a rally akin to the one we experienced during the vaccine phase of the pandemic. Barring, of course, a cornered Russian thug doing something even more horrific than he already has.
Th, 06 Oct 2022
Beverages, Tobacco, & Cannabis
Cannabis stocks rocket after Biden requests drug classification changes
It was one of the moves North American cannabis producers have been anxiously awaiting: President Biden has formally requested a review of how marijuana is classified under US law. He further requested that governors move to pardon anyone in a state prison solely for marijuana possession (there are fewer than 10,000 incarcerated in federal prisons under these circumstances). Despite wild success in Canada and much of the rest of the world, leading producers such as Tilray (TLRY $4), Curaleaf Holdings (CURLF $6), and Canopy Growth (CGC $4) have been waiting for the mother lode of being able to freely sell their products in the richest market in the world. That dream is coming closer to fruition. While it will still be a largely states’-rights issue, a change in federal law would allow cannabis companies to access full banking services and list on US exchanges.
How did the publicly traded cannabis companies respond to the news? Our favorite, Tilray, run by the highly skilled Irwin Simon (founder of Celestial Seasonings), popped 31% in one session; the AdvisorShares Pure US Cannabis ETF (MSOS $12) surpassed even that performance, jumping 35% on the day. Granted, there is a long way to go before our laws on marijuana resemble those of our neighbor to the north, but investors should also keep in mind that this group has been absolutely hammered over the past year. The cannabis ETF, for example, is still down 65% year to date despite the enormous untapped potential of an open US market.
We mentioned Tilray, which is actually the result of a merger between the namesake company and Aphria. Not only did Simon oversee the purchase of SweetWater Brewing Company, he also spearheaded the purchase of Breckenridge Distillery, maker of the high-end line of Breckenridge bourbon whiskeys. We see cannabis-infused booze coming in the not-to-distant future.
Th, 06 Oct 2022
Energy Commodities
OPEC’s win-win solution: take a jab at Biden and get a spike in oil prices
To say there is no love lost between the Biden administration and the Kingdom of Saudi Arabia is quite an understatement. When Biden flew to Saudi Arabia this past summer in an effort to get the titular head of OPEC to raise production, the country responded with a slap-in-the-face promise to boost output by a paltry 100,000 barrels per day. Now that the administration is getting what it wants before the upcoming mid-term elections—lower prices at the pump—OPEC+ holds a meeting in which it announces a two million BPD production cut. Oil futures, which had dropped to the upper-$70s/bbl range recently, surged back into the upper-$80s. This was a win for not only Russia, which has navigated the oil ban by selling crude to its nation-state buddies China and India, but also for Saudi Arabia, which got another chance to poke Biden in the eye and get the price of oil closer to its target $100/bbl range.
The administration, clearly miffed, is responding in the feeblest of ways: promising to tap the US Strategic Petroleum Reserve yet again and discussing the possibility of easing sanctions on Maduro’s Venezuela. That is akin to a sweater-clad Jimmy Carter holding a fireside chat and encouraging Americans to turn down their thermostats in winter. The administration seems unwilling to take the correct course of action, which is to encourage—in deeds not words—increased production at home.
The two million BPD cut by OPEC will probably only amount to an increase of one million barrels, as many members of the oil cartel are not currently meeting their quota; that amount could be countered were the US to begin pumping the same amount it did back in early 2020. But the love affair between the US energy complex and the Biden administration is on par with the Kingdom’s affection for the president. Additionally, with the litany of recent regulations thrown against “big oil” and the cancellation of the Keystone pipeline, getting back to 13 million BPD would be extremely challenging in the short run. That leaves the greatest “hope” for reduced prices at the pump being a global economic slowdown—something nobody wants. With respect to energy prices, the US finds itself between a rock and a hard place, and American consumers will be the ones getting crushed.
The path of least resistance with respect to reining in oil prices seems to be a global economic slowdown. The regulations which have hampered oil production in this country will remain largely intact, and getting Venezuela back up to speed would take years. Also, consider the fact that there have been no new refineries built within the US for three decades, and the ongoing ESG battle against companies in the fossil fuels industry. That being said, if there is a marked slowdown in global growth we could see oil dropping back into the mid-$70s range this winter.
Tu, 04 Oct 2022
Interactive Media & Services
Twitter pops after Elon says he will buy the company under original terms
There have been a lot of crazy twists and turns in the Musk/Twitter (TWTR $52) saga, but we didn’t see this one coming. In a surprise move, Musk has said he will buy the social media platform under the original terms agreed upon: $54.20 per share, or $44 billion. Odds were stacked against him in the pending non-jury trial, slated to begin later this month, but it is rather strange that he did not come in with a lower offer. While it may not have been enough of a “smoking gun” to get him out of an ultimate deal, his argument that the company was hiding the enormity of the spam bots and fake accounts problem was substantiated by Twitter’s fired head of security—Musk’s key witness. While Twitter shares spiked 13% on the news and 20% in the ensuing days, the market cap still sits about $5 billion below the offer price. The press is making it sound as though Tesla (TSLA $242) shareholders hated the deal, but shares of the EV maker fell very little after the bombshell announcement. In the next issue of the Penn Wealth Report, we will delve into what Musk hopes to accomplish with his new platform. Hint: think indispensable “super app.”
We believe Musk can create a turnaround story at Twitter, a company which was never effectively monetized by erratic found Jack Dorsey and his hand-picked successor, Parag Agrawal. Of course, that will all take place (post deal) with Twitter as a privately held company. As for publicly traded Tesla, shares look like a steal at $242, and we maintain our $333 price target. We own Tesla in the Penn New Frontier Fund.
Th, 29 Sep 2022
Biotechnology
Biogen was down 18% year to date, then some good news sent shares soaring 40%
We are having a serious case of déjà vu with respect to $40 billion biotech firm Biogen (BIIB $277). Last summer, shares of the firm spiked some 55% on the back of positive news regarding its experimental Alzheimer’s drug, aducanumab. In the ensuing year, shares plunged 50%—from over $400 to under $200—on doubts about the therapy’s efficacy, despite FDA approval. This week it was a new Alzheimer’s drug from the firm, lecanemab, which moved shares of the firm back up some 40% in one session. Lecanemab, which was co-developed with Japanese biotech firm Eisai (ESALY $58), slowed cognitive decline in early-stage sufferers who were enrolled in the companies’ Phase 3 Clarity trials. Unlike the prior drug’s trials, which brought a good dose of skepticism from critics, these most recent results were universally hailed by the medical community. With the drug’s potential blockbuster status over the coming years, analysts were quick to upgrade shares of Biogen, though price targets remained relatively close to the day’s trading range. Among the 32 major houses covering the stock, 18 have Outperform or Buy ratings, while the other 14 have a Hold rating. The median price target on the shares is now $267.
Advances in the field of Alzheimer’s have been few and far between for the past two decades. Lecanemab holds a lot of promise, though we must now wait and see what type of support, via Medicare and insurance coverage, it will receive. We do believe, however, that the drug has the potential to generate over $1 billion in annual sales for Biogen.
We, 28 Sep 2022
Capital Markets
2021 was a banner year for IPOs, but most are not faring so well
There were some 400 companies that went public last year via the traditional route, with capital raised coming close to $300 billion. Add SPACs (special purpose acquisition companies) to the mix, and the number hits 1,000 new listings. So, how have these newly-publicly-traded entities been doing lately? The answer isn’t pretty. The Renaissance IPO Index is a basket of the largest, most liquid, newly-listed US public companies. Names like Snowflake (SNOW), Rivian (RIVN), Roblox (RBLX), and Coinbase Global (COIN) top the list. This index has an exchange traded fund, the Renaissance IPO ETF (IPO $29), which allows investors to buy into this basket with ease. Year to date, the fund’s value has been slashed in half, with the shares dropping from $60 to $30 in price. That represents more than twice the S&P 500’s plunge over the same time period. Here’s another staggering statistic: only about one in ten of the class of 2021 are trading above their IPO price. Market volatility due to inflation, rate hikes, supply chain issues, and fear of recession has pounded this group and dissuaded a lot of would-be players from going public this year. According to StockAnalysis.com, only 159 companies have gone public on US exchanges so far this year, or 79% less than the 767 IPOs which had taken place by the same time in 2021. As could be expected, this group has faced a similar fate. For anyone interested in scanning the list for possible value plays, the companies and their “since-IPO” returns are listed on the page.
What about getting into the IPO ETF with the fund sitting down at $30 per share? We wouldn’t recommend it—there are too many wildcards on the list. Some holdings do look promising going forward, however. Names like Palantir (PLTR), Snowflake (SNOW), Airbnb (ABNB), and DoorDash (DASH) have all seen their share prices pummeled, and these are companies which will still be around when the markets regain lost ground.
Tu, 27 Sep 2022
Food Products
Bucking the trend: Penn member General Mills has rallied 20% this year
Virtually all asset classes, sectors, and industries are in the red this year with the exception of energy stocks, and even they have been tumbling recently as crude oil has dropped back to where it began the year—the mid-$70s-per-barrel range. One consumer defensive name has been bucking the trend, however: General Mills (GIS $79) has rallied 20% so far in 2022—hitting an all-time high price last Thursday—and is up some 34% over the past year. Not only did the century-old food products firm report higher-than-expected profits over the past quarter, management also lifted its forecast for the year. Sales in the fiscal first quarter, which ended 28 August, rose 4% (to $4.72B), while net income jumped 31% from the same period last year—to $820 million.
While inflation has raised input and shipping costs for General Mills, the company has been able to pass along some of those higher prices to a consumer which is suddenly eating out less and cooking more meals at home. The stellar management team, led by 55-year-old Jeff Harmening, has also been making some astute strategic moves recently. In an effort to focus on more profitable units, the company recently sold its “Helper” line and Suddenly Salad packaged food division for $607 million, while acquiring St. Louis-based TNT Crust for $253 million. While consumers have been shifting away from higher-priced labels in favor of generic brands, General Mills products remain in the sweet spot. Harmening’s team also placed some well-timed hedge positions on grain inputs, cushioning the blow of rising agriculture prices. For the fiscal year, the company expects to grow net sales by 6-7%.
One of our favorite moves General Mills made a few years ago was the purchase of the rapidly growing Blue Buffalo line of pet foods. In fact, that was a catalyst for our purchase of GIS shares back in 2018. The company is the only packaged food name within the Penn Global Leaders Club.
Fr, 23 Sep 2022
Market Pulse
Another bruiser: markets have now given up two full years of gains
For the past two weeks in particular, the markets have had a myopic fixation on what the Fed’s next moves will be. The Tuesday before last, the Dow Jones Industrial Average lost 1,276 points after a hot August inflation read all but guaranteed a three-quarter-point rate hike in September. This Wednesday, when the Fed delivered, it dropped another 522 points. With the NASDAQ and Russell (small caps) leading the retreat, the major indexes all dropped around 10% over the past ten trading sessions, falling back to October of 2020 levels. So much for the June lows—those were taken out Friday intraday before bouncing slightly. It wasn’t only the Fed, though that was the big catalyst. The other concern markets seem to be stewing about is the strong US dollar, which is at its highest level in precisely two decades. That makes imports and overseas travel cheaper for Americans, but our exports more expensive for the world. But the strong dollar shouldn’t affect US small-cap companies much, as most rely on the domestic marketplace for the lion’s share of their revenues. It has been a brutal year thus far, but if our economy cannot handle a dollar at parity with the euro and a potential 5% federal funds rate, then that is a sad testament to American exceptionalism.
In reality, the US economy can and will be able to deal with these two conditions—a strong dollar and higher rates; it is investors who seem unable to come to terms with the situation. Great American companies, flush with cash and on strong growth trajectories, have not been spared during this latest selloff, which makes little sense. Until the madness abates, we are taking advantage of the dislocation in short-term rates by buying Treasuries, agencies, and quality corporate bonds.
Fr, 23 Sep 2022
Transportation Infrastructure
FedEx shares just suffered their worst day ever; are they now worth looking at?
When FedEx (FDX $148) shares were trading at $245.63 this past February, we removed the company from the Penn Global Leaders Club to make room for another holding. We had lost a good degree of confidence in the management team, and labor costs were suddenly becoming a major drag on the firm. That move was fortuitous, as FedEx just experienced its worst day as a publicly traded company—losing nearly one-quarter of its market cap—after a disastrous earnings call. After giving a rosy outlook in June, management did a 180-degree turn in September, reducing guidance by 50% and predicting a bruising global recession. Analysts were quick to point out that the major issues were not macro in nature, but directly related to this integrated freight and logistics giant. Q1 earnings per share fell 21% from the year prior, against expectations for an 18% gain; revenues rose 5%, but that number missed estimates as well. The company pulled its 2023 guidance altogether, citing a gloomy and uncertain global outlook. To round out the ugly report, FedEx said it plans to raise shipping rates this coming January by an average of 6.9% across the board. Shares are now down over 42% year to date.
With shares trading where they were back in June of 2020, are they now a buy? While the $2.7 billion in cost-cutting measures will help, and customers will probably just accept the shipping rate hikes, we don’t see the shares worth much more than $200 right now; and the risk to get that possible 33% return is still too high in our opinion.
Fr, 23 Sep 2022
Monetary Policy
Powell’s words left little doubt: rate hikes until inflation is under control
For anyone who still believes the stock market is rational and efficient, consider this: Going into the Fed’s rate decision, the Dow was trading up a few hundred points; within seconds of the fully-expected 75-basis-point rate hike, the Dow was down a few hundred points; during Powell’s post-decision speech, the Dow rallied into the green by several hundred points, only to close the session down 522 points.
No matter how late investors or pundits may believe Powell was to the party, his message has been crystal clear: Rates will go up until inflation is brought down to acceptable levels. While the official “acceptable” level is 2%, he said something very telling in his news conference: “The ultimate goal is to have positive real rates across the yield curve.” To us, that was meaningful. By “real rates” he means inflation adjusted, so if the 2-year Treasury is yielding 4% then inflation must be below that. They say markets don’t like uncertainty; well, we now have full clarity with respect to what the Fed plans on doing next.
Of course, we still don’t know how many rate hikes and other shocks to the system it will take to tame inflation. Furthermore, it will take time for the hikes to have their full effect on economic conditions as Fed actions typically have a lot of lag. The central bank forecasts a funds rate of 4.4% by the end of the year, which would point to one more 75-bps hike in November (there is no October meeting) plus a 50-bps hike in December. From there, we may see a few quarter-point hikes before the Fed pauses. We thought it would take a lot to get the fed funds rate to 4%; odds are now in favor of a 5% terminal point. That’s high, but not disastrous for the economy. For historical perspective, we were sitting at a 6.5% rate in August of 2000 and a 5.25% rate in May of 2008. Despite the market tantrums, the economy will weather these rates just fine.
A combination of two catalysts will fuel the coming market rally: signs that inflation is finally coming down, and the Fed’s indication that a pause in hikes is near. We see both of these indicators appearing within the next four months. In the meantime, own quality equities and load up on fat-yielding, shorter-maturity bonds.
Mo, 19 Sep 2022
Fixed Income Desk
The sudden and unusual opportunity in short-term bonds
Every now and again, bizarre things happen in the bond market which provide unique opportunities for investors. When we buy fixed income vehicles, from CDs to Treasuries to corporate bonds, we expect to get a higher yield for taking on the risk of going further out on the time horizon—assuming parity with respect to issuer safety, of course. For example, we expect a 30-year Treasury bond to have a higher yield than a 10-year Treasury note, and that 10-year should be paying more than a 2-year issue. The benchmark spread is the difference between the 10-year and 2-year yield. When the shorter maturity issue has a higher yield than its longer-maturity counterpart, we get a condition known as a yield curve inversion—generally a sign that a recession is on the way.
Right now, we have a quite rare situation: the 2-year Treasury carries a yield higher than all of the longer-maturity issues. Since the 2-year is considered a proxy for what the Fed will do next and the 30-year gauges investor sentiment about the economy, all bets are now on rates continuing to rise until the Fed hits a wall and is forced to pivot. Considering money markets are still yielding close to nothing, and bond values have been dropping in investors’ portfolios, now is a golden opportunity to pick up higher-yielding bonds with shorter maturities and low duration (duration measures sensitivity to changes in the interest rate).
And this opportunity is not limited to government-issued securities. While the 2-year Treasury is currently yielding just shy of 4%, corporate issuers are forced to offer even higher rates (either through new issues or thanks to discounted prices on current bonds in the secondary market) to compete with the risk-free nature of vehicles backed by the full faith and credit of the US government. It has been hard to get excited about bonds for some time; right now, at least with respect to the lower end of the ladder, that is not the case. Investors should strike before conditions change.
We are loading up on low-duration bonds issued by quality companies to take advantage of current conditions. Even bank-issued CDs with maturities of two years are offering rates around 4%. Due to the unique challenges facing Europe and Asia right now, we are sticking primarily to debt issued by domestic firms and financial institutions.
Tu, 13 Sep 2022
Government Watchdog
California dreaming: burger flippers could soon have a $22 per hour minimum wage
On Labor Day, fittingly, California Governor Gavin Newsom signed a stunningly egregious law into effect. While its official name is the Fast Food Accountability and Standards Recovery Act, that is about as accurate as calling a trillion dollar spending bill an Inflation Reduction Act. We have a more accurate name we would like to propose: The $22 Per Hour Minimum Wage Act for Burger Flippers. There are no cutesy acronyms politicians are so fond of, but it clearly spells out the intent.
The law will create a Fast Food Council in Cali, made up of a 10-person cabal of workers, state officials, and management—the latter to make it look credible. This cabal will set the “living wage” for fast-food workers employed at companies which operate at least 100 locations around the country (not the state). Clearly, the target is McDonald’s, Chick-fil-A (the one they really hate), Burger King, Chipotle, and a number of other “fat cats.” The ruling council will have the power to create a new $22 per hour minimum wage for all fast-food workers, beginning next year. The law was strongly supported by the Service Employees International Union, which has been advocating a nationwide, $15 per hour minimum wage. Since California is already set to raise the minimum wage to $15.50 per hour in 2023, we suppose $22 would be the next common sense target.
Of course, there is nothing common sense about this act or the politburo-like body it has created. Two unintended consequences immediately come to mind: $15 hamburgers and a more automated workforce. One will punish consumers who are already reeling from runaway inflation, and the other will punish the very workers who are supposed to be helped by this act. From California, which had attempted to place a cancer warning on every of coffee sold, this move is par for the course. We just can’t understand why so many companies are heading for the exits.
The brilliance of our Founding Fathers in giving so much power to the states (rather than a central government) is once again on full display. Newsom can deny the fact that companies are fleeing his hammer and sickle mentality, and the Chicago mayor can proclaim that the city’s economy has never been stronger, but the evidence proves otherwise. Maybe the voters who keep them in power will see the light one of these days. But we doubt it.
Tu, 13 Sep 2022
Economics: Supply, Demand, & Prices
A hot August CPI report gives the Fed the green light for another 75-bps hike
The seemingly major contingent of investors who believe the Fed is on the cusp of pivoting—moving from rate hikes to a pause to potential rate cuts due to an economic slowdown—befuddles us. In what realm are they living? What metrics possibly back up such a pivot? It is nonsense. With this contingent in mind, it really shouldn’t come as a surprise that Dow futures swung some 700 points, from up over 200 to down over 500, on the back of a higher-than-expected August inflation report. The consumer price index, or CPI, which tracks the price of a large basket of goods and services, rose 8.3% from last year—despite the sharp decline in gas prices for the month. Food, shelter, and medical care costs drove the spike in prices, while the average price for a gallon of gas fell 10.6%. A couple examples of food inflation: eggs are up 40% from last year, while bread is up over 16%. In the auto space, the average price of a new vehicle rose by 0.8% for the month, or 10% annualized. Medical care costs have risen 5.6% from the same period last year. The two-year Treasury note, a proxy for what the Fed might do next, surged from 3.358% to 3.704%, driving bond values down. We have been expecting the Fed to raise rates by 75 basis points at this month’s FOMC meeting; this report all but guarantees that taking place.
The August CPI report and subsequent market drop created a great opportunity for investors. The responsible behavior of the Fed will ultimately lead to a reduction in the rate of inflation, a healthier economy, and a stronger stock market. And it won’t take long for that theory to play out. The closer the Fed gets to 4%, the closer a major rally is to manifesting.
Mo, 12 Sep 2022
Economics: Housing
Mortgage rates hit highest level since 2008
This past week, the average interest rate for a 30-year mortgage did something it hasn’t done since November of 2008: hit the 6% mark. Considering rates topped out about three times that level back in the 1980s, the current rate may not seem too daunting, but that figure reflects a 130% spike from just over two years ago. As the Fed works to get inflation under control, this is certainly one of the intended consequences of the tightening cycle. As mortgage rates rise, it should cool the housing market and, hence, runaway home prices. Unfortunately for would-be buyers, that has not happened, leaving them at the mercy of higher rates and higher prices. For those putting their homebuying plans on hold, there is another problem: rents are rising just as fast. We did a double take when we saw this figure, but the national average for renting a single-family home in the US rose 13.4% from 2021 to 2022, to $2,495 per month. For apartment dwellers the picture is nearly as bad: the monthly rent for a multifamily dwelling in the US rose 12.6% from July of 2021 to this past July, to $1,717. And occupancy rates remain high for rental housing, hovering around 96%. It may seem warped, but this is precisely why the Fed must continue to raise rates. Ultimately, something must put downward pressure on home prices.
It may seem counterintuitive to look at buying the homebuilders now, but their prices have been so beaten down by the fear of rate hikes and a coming recession that they are beginning to look very attractive. While the builders of lower-end homes will face more difficulty, names like Toll Brothers (TOLL $45) and D.R. Horton (DHI $74, Emerald Homes is its luxury division) look attractive. Both companies have ultra-low P/E ratios—both current and forward—in the 4-6 range, and both have plenty of cash on hand to weather any coming housing storm.
Th, 08 Sep 2022
Global Strategy: Europe
Despite severe recession risks, the European Central Bank raises rates 75 bps
Typically, in the face of a potentially severe economic downturn, a country’s (or region’s) central bank will begin lowering interest rates in response. In an illustration of just how wrongheaded the ECB’s decision was to go negative with interest rates back in 2014, Europe’s central bank has been forced to do just the opposite: raise rates. It began back in July, when the ECB raised its deposit facility interest rate from -0.5% to 0.00%—a 50-basis-point hike. Now, due to runaway inflation (primarily caused by the energy crisis), the bank has been forced to match the Fed’s most recent action and raise rates another 75 basis points, to 0.75%. In addition to putting downward pressure on inflation, this move should also shore up the euro, which recently dipped to parity with the strengthening US dollar.
The irony of the ECB’s needed move is that the European Union is simultaneously pumping hundreds of billions of euros into the economy to help families deal with skyrocketing energy costs. Basic economics says that when a central government pumps money into an economy, inflation naturally increases. Eurozone inflation rose to 9.1% in August and is expected to hit double digits in September. The ECB, like the Fed, has an inflation target rate of 2%. It has a long way to go before getting anywhere near that number, unless a severe recession grinds the European economy to a halt.
It has been a full decade now since the key European rate has been above zero. ECB President Christine Lagarde, meanwhile, has signaled more hikes to come. These hikes are needed, but they will only increase the likelihood of a deep recession hitting the continent this winter.
Fr, 02 Sep 2022
Economics: Work & Pay
Two key positive takeaways from the August jobs report: unemployment and labor force participation
Here was the conventional thinking as investors awaited the August jobs numbers: if the report was strong, the Fed would continue hiking rates and stocks would be punished; if the report was weak, the Fed might start tapping on the brakes and stocks would celebrate. We ended up with something in the middle, and that was the best possible outcome.
First the headline number. There were 315,000 new nonfarm jobs added in the month of August, or slightly fewer than the 318,000 expected. Wages rose 5.2% from a year ago—not a positive sign for inflation, but not as much as expected. There were two key components of the report that helped turn futures from flat to positive. The first was the unemployment rate, which surprised analysts by ticking up from 3.5% to 3.7%. The second was the reason for that jump: the labor force participation rate rose an impressive 0.3%, to 62.4%. That may not seem like much, but it meant another 800,000 Americans began looking for work.
One of the biggest causes of inflation has been the scarcity of workers, forcing employers to pay more to attract new help. That pool of workers just got a lot bigger, which should help dampen the recent wage spikes. The prime-age labor force participation rate—workers between 25 and 54—surged to 82.8%, which is great news on that front. Overall, it is hard to imagine a much better report rolling in right now.
We still want—and expect—to see a 75-basis-point rate hike coming in September, which would bring the upper band of the Fed funds rate up to 3.25%. We still need to see any combination in subsequent months pushing that rate up to 4%. Then, it will be time to pause until inflation moves back down to an acceptable level. The Fed will also be reducing its $9 trillion balance sheet over the coming year. To be clear, this scenario is what needs to happen, not what the market wants to see.
Mo, 29 Aug 2022
Industrial Conglomerates
3M wanted bankruptcy court for one of its subsidiaries; a judge denied the request
Between 2003 and 2015 a 3M (MMM $126) subsidiary by the name of Aearo Technologies manufactured and supplied earplugs to the United States military for troop training and for troops stationed in a combat environment. Production of the earplugs, which were unique in their two-sided design, ceased in 2015. In 2016, a competitor filed a whistleblower lawsuit claiming that 3M knew the plugs were defective, causing hearing loss and tinnitus in scores of soldiers. Two years later, the company agreed to pay over $9 million in a victims’ fund. After that tiny amount was paid, some 230,000 service members began filing lawsuits against the firm; the suits were ultimately consolidated through multidistrict litigation (MDL, somewhat akin to a class action lawsuit but more personalized) and handed off to a bankruptcy court in the Northern District of Florida.
In an effort to limit its own liability, 3M declared bankruptcy for its Aearo Technologies unit and threw a gauntlet down to the judge, arguing that it was not within his power to interfere with the proceedings. The judge did not share that opinion. Shares of the company plunged nearly 10% after Judge Jeffrey Graham denied 3M’s attempt to offload the company’s problems in such a manner, keeping the parent company on the hook for a potentially enormous payout. While the cases which have already gone to trial present a mixed picture, it is easy to imagine the ultimate payout to a large percentage of 230,000 plaintiffs dwarfing the $1 billion amount the company has since set aside for settlement. For example, in ten cases which have already been decided, five were won and five were lost by the company, with the successful plaintiffs being awarded between $1.7 million and $22 million each. Here’s a staggering fact to consider: If one out of every three plaintiffs in the case were awarded $1 million, the dollar amount would be roughly equivalent to 3M’s market cap.
Over the course of the past nine years, 3M shares are flat. They were trading at $126 back in 2013, and they trade at $126 right now. The company is trying to pull a General Electric (GE $76) move by spinning off its healthcare business (the current GE shouldn't be used as a model for anything, except what not to do), arguing that long-term shareholder value will be created. We don’t buy it. As for the stock, we offer the same recommendation—don’t buy it.
Fr, 26 Aug 2022
Market Week in Review
There are well-founded market drops, and then there are the type that happened Friday
Did investors really believe Jerome Powell was about to pivot and become a dove? Perhaps they were expecting him to come out in front of the gorgeous mountain range at Jackson Hole and proclaim, “Inflation is no longer a threat or a problem, we must get rates back to zero!” Complete silliness. Instead, he did what everyone should have fully expected: In front of some wood paneling straight out of the ‘70s (fitting), he said that the Fed will continue to do everything it must to tame inflation. It was short and sweet…and correct. For us, that means the terminal Fed funds rate will be at least 3.5%, but we are hoping for 4%. If the markets can’t handle a 4% rate, then we have really dumbed down our economy.
Think of the trillions of dollars pumped into the economy by the Fed and the US Congress over the past few years. Does anyone other than a full-blooded, card-carrying Keynesian believe that is healthy for a country, an economy, the stock market, or individuals? No! Sure, we had to take extraordinary steps in response to the pandemic from China, but did it need to continue for two years? Furthermore, what about the $23 trillion worth of debt the government had built up before it added $7 trillion more post pandemic?
The market should have cheered a responsible Fed Chair following in Alan Greenspan’s footsteps and telling us he will do whatever it takes to staunch inflation. Instead, the Dow lost 1,008 points on the session, or 3%. In fact, all four major benchmarks (to include the Russell 2000) lost over 3%. Something to worry about? We believe just the opposite. Investors are myopic. Powell gave then exactly what they needed (a responsible policy), not what they wanted (a shiny early Christmas present), and after the temper tantrum we will be back on the upswing. Friday wasn’t a day to worry; it was a day to identify strong companies which have been senselessly beaten down.
Th, 25 Aug 2022
Global Strategy: Europe
Europeans face a harsh winter thanks to skyrocketing energy prices
Americans have certainly noticed their energy bills rising this year, and the problem will be exacerbated this winter when most households switch from their electricity-powered a/c to natural gas-powered heating systems. In fact, one in six American households now have overdue utility bills—the largest percentage on record. But Americans’ problem is nothing compared to that of their European counterparts, who now face an astronomical spike in energy prices.
The long-term average price in US dollars for one million British thermal units (MMBtu) of natural gas imported into Europe is $4.20. Today, that figure has skyrocketed some 718%—to $34.35—from its average. Electricity rates in Germany are now six times higher than they were last year, while the French are facing €900/megawatt-hour energy prices—ten times the cost as last year. France’s issue has been magnified due to its nuclear energy problems—over half of the country’s reactors are offline due to maintenance, repair needs, or river issues (reactors need massive amounts of river water for cooling; water levels are low right now, and temperatures are unusually high). While governments grapple with how to best help their citizenry with out-of-control prices, there are no easy answers. The long, hot summer in Europe will morph into a frigid and painful winter, much to Putin’s delight.
We have been underweighting both developed and emerging markets in Europe due to a host of economic issues. First and foremost is the continent’s massive energy crisis; a problem which came about due to an overreliance on Russia for its needs. Perhaps France and Germany will learn from this, but it will take years for the problem to be resolved.
Th, 25 Aug 2022
Specialty Retail
“Diamond hands” traders just got screwed over by mentor on Bed Bath & Beyond
By now, we all know who and what “diamond hand” traders are: people who follow social media sites like r/wallstreetbets, buy the flailing companies touted in an effort to crush short sellers, and then hang onto the shares no matter what. One of their recent champions has been Ryan Cohen, the activist investor who took a major stake in Bed Bath & Beyond (BBBY $10) back in March through his RC Ventures hedge fund. Shares of the home retailer rocketed from $15 to $30 as diamond hands piled in. Subsequently, however, as it became clear just how bad the financials were for the company, negative headlines and downgrades pushed the shares down to the $4 range. Cohen was sitting on a huge loss (he owned about 10% of the shares at that point). His firm then purchased call options on nearly 1.7 million shares of BBBY, driving the price back up to the $30 range. Then, Cohen did what no self-respecting diamond hands trader would do: he sold his entire position. This caused the shares to tumble 52% over the course of two days, leaving the hedge fund manager with a $68 million profit and his followers with enormous unrealized losses. Cohen’s investment firm had no comment.
Will Cohen’s actions at BBBY make many meme stock traders reconsider their “strategy?” Probably not. For investors who are serious about their portfolios, however, this story buttresses an important tenet: Understand the companies you are buying, what their unique value proposition is, and whether or not they will have the financial wherewithal to navigate any economic environment. And never have diamond hands—never hesitate to take profits and minimize losses.
Tu, 23 Aug 2022
National Debt & Deficit
Your government spent $2.775 trillion more than it collected last year
If we talk about enormous sums of money too often the brain begins to accept them; or, at least, gloss over them. That is not good. We need to understand the fiscal irresponsibility of our elected officials to have any hope of changing their actions. So, instead of simply saying that this country is currently $30.7 trillion in debt, let’s try this fact: If each US taxpayer were directly responsible for their portion of America’s debt, we would owe $244,315 apiece. Want to add your kids and other non-taxpayers into the mix? In that case, every US citizen owes $92,272.
Keeping in mind that 2020—not 2021—was the year we bore the brunt of the pandemic from an economic standpoint, consider how much the US government collected and spent last year. Revenue collected came in at $4.045 trillion. Last year the government spent $6.820 trillion. The difference, or deficit, is how much we grew the national debt last year: $2.775 trillion. At the risk of being redundant, our government spent $2.775 trillion more than it took in last year, in the midst of a rip-roaring economy. What is even more disgusting is that Social Security inflows and outflows are wantonly thrown into the mix rather than being physically separated, as they should have been from the start, from the general funds. Were your company to do that with your 401(k) plan, it would be a criminal act.
Understandably, the largest deficit on record took place in 2020. There is no excuse, however, for 2021’s budget-busting numbers. And as interest rates rise, it is going to take a bigger and bigger portion of revenue to simply service the interest on the national debt each year. Right now, a “paltry” ten cents out of every dollar collected goes toward interest payments. Imagine ten cents out of every dollar you earn going towards the interest on your credit card debt! Madness.
There are two ways this slow-moving (actually, not-so-slow-moving) train wreck can be avoided: the positive way via a balanced budget amendment and term limits added to the US Constitution, or the negative way through a fiscal meltdown. The fallout from the latter is hard to fathom.
Mo, 22 Aug 2022
Work & Pay
A wave of layoffs are probably coming soon; how will that affect unionization efforts?
Consulting firm PwC polled over 700 executives from US firms in all industries and of all sizes, and they found that over half plan to reduce headcount and implement hiring freezes within the coming months. While it may seem counterintuitive, many also said they plan on simultaneously increasing their number of contract workers and freelancers. Dig a bit deeper, however, and that makes perfect sense. With a slowing economy, higher inflation, and supply chain issues, many firms suddenly find themselves dealing with a renewed unionization push. And this time around, it is not just industrial names which are in the crosshairs. Consumer discretionary companies like Starbucks (SBUX $87), which are known for their generous benefits like tuition assistance, are bearing the brunt of the push. That is illogical, and we fully expect the inevitable increase in the 3.5% unemployment rate to help quell the movement.
Technology will also play a role in dampening successful activism, as advances allow firms to be more productive with a smaller headcount. A McDonald’s (MCD $266) restaurant, for example, might add new ordering kiosks, while an Apple (AAPL $169) might reduce its physical footprint in favor of an enhanced online presence. This is not the 1970s: Companies now have levers to pull in order to maintain their productivity levels—tools which were simply not available back then.
Speaking of productivity, it has been going down recently for the first time in a long time, and new studies are indicating that work-from-home is playing a role in the drop. This is one of the reasons why companies such as Apple are now demanding their workers return to the office at least two or three days per week. Right now, that mandate is limited to the area around Apple’s Cupertino headquarters, but we expect the requirement to expand into other areas soon. The back-to-work request has been a hard one to enforce with the low unemployment rate, but now that stimulus funds are depleted—and as the unemployment rate rises—expect more of these policies to come down the pike. We imagine a large percentage of those 700 executives will be watching Apple’s initiative with interest.
There is a natural ebb and flow to the unionization movement in America, with undercurrents such as the political environment and economics (the unemployment rate) affecting the efforts. Right now, corporations appear to be up against the ropes, but time and technology are on their side. This is especially true for the companies who treat their employees as fellow stakeholders rather than simply a line on a balance sheet.
Tu, 16 Aug 2022
Food & Staples Retailing
Walmart shares pop 5% after the company tops estimates and sticks to full-year guidance
It was just under a month ago that Walmart (WMT $140) shares plunged following dire management warnings on crimped profit margins due to inflation and a consumer who was cutting back on discretionary spending. The shock waves from those comments were felt throughout the industry. This week, we received a different story line. Walmart shares gained over 5% on Tuesday’s open following a revenue beat ($153B vs exp. $151B), an earnings beat ($1.77EPS vs exp. $1.63), and an improved outlook for the full year. Same-store sales at its flagship stores rose 6.5% in the quarter, while Sam’s Club saw a 9.5% gain. CEO Doug McMillon said that the company is now effectively working through the inventory problems which were at the heart of July’s lowered guidance. McMillon also said that behavior changes due to inflation are driving higher-income households into Walmart stores. Whatever the reason, the Street remain generally bullish on the company: out of 39 analysts, 20 have a buy rating and none have an underperform or sell rating on the shares.
Walmart is one of the 40 companies within the Penn Global Leaders Club.
Tu, 16 Aug 2022
Global Strategy: East/Southeast Asia
China cuts rates as economy slowing on nearly all fronts
Consider this: The US economy is slowing and layoffs are increasing, but the Fed remains committed (correctly so) to rate hikes; the European Union faces an even more severe economic slowdown and a brutal coming winter due to a Russian-fomented energy crisis, and the ECB is raising rates; China’s economic growth rate is slowing on nearly all fronts, and the People’s Bank of China just cut rates. That unexpected action by China’s central bank highlights the dichotomy between how the West and the East are dealing with an unwelcome mix of high inflation and probable recession.
While China didn’t cut its interest rates by much (the main rate at which it provides liquidity to banks dropped from 2.1% to 2%), the government simultaneously announced it was pumping an additional $60 billion into its financial system to spur lending. The challenge with both of those moves is the fact that Chinese citizens are very reluctant to borrow right now due to angst over lockdowns, an economic slowdown, and a nightmarish real estate market. (The government is placing strict controls over the sale of properties by homeowners, adding to the apprehensiveness of would-be buyers.) For a communist party which bases its very existence on control, the inability to get its people to act in a certain way must be maddening.
As for the economic slowdown in the country, economists are rushing to downgrade expected rates of growth. TD Securities, for example, just lowered its full-year GDP expectations to 2.9%, while UBS admitted to seeing “downside risks” to its 3% full-year growth forecast. Unlike the American consumer, which has been full steam ahead, Chinese consumers have purchased around half of the retail goods economists had expected by this point in the year. And there are scant indications that the situation will get better anytime soon.
Of course, US retailers who became overly reliant on Chinese sales will also be hurt by the country’s economic slowdown. That fact, combined with the strong US dollar, should have investors searching for small- and mid-cap consumer cyclicals which receive the lion’s share of their revenues from domestic sales.
Mo, 15 Aug 2022
Media & Entertainment
Clown company: You couldn’t give us shares of Getty Images Holdings
How fitting that Getty Images Holdings (GETY $31) went public via a SPAC—it certainly would have been a humorous roadshow full of fanciful tales of projected growth had they been forced to use the traditional process. It is also fitting—and sad—that “investors” pumped the value of the shares up from $10 to $31 since this joke of a company went public late last month. Getty, whose shares are worth—in our opinion—about $1 apiece, now has a market cap of $11 billion. Do people literally have money to burn?
As the name implies, Getty Images sells stock images to creative professionals, the media, and corporations. Protecting copyright infringement is serious business, but Getty has turned it into a nefarious source of revenue. Examples of the firm’s abuse of power are too numerous to mention, but here is a rather typical scenario: A photographer uses one of their own digital photographs on a website. Not long after, the photographer receives a demand of payment from Getty for using the photograph; the demand comes with a threat of legal action unless the confiscatory amount requested is paid immediately. The photographer takes legal action to get the threats stopped, as they created the very image in question! The company also uses embedded technology within images to “go fishing” for people who might use the images, thus initiating the demands for payment.
The last thing Getty wants is for people to call their bluff and demand that a court decide an outcome—the company has lost a string of cases, drawing rebukes from the courts. Getty also has a well-documented history of taking images in the public domain (“free use”) and leasing them to unsuspecting customers for up to $5,000 for a six-month term.
For any investors believing they will own a piece of a growing enterprise, consider the fact that this is not the first time Getty has been publicly traded, and that only twelve shareholders own nearly 80% of the company. It may be legal, but it is a scam in our books.
Getty is the sort of company that would love to sue anyone with a disparaging view of their operations. The New York Stock Exchange should have steered clear of this listing, and investors should run the other way.
Th, 11 Aug 2022
Economics: Supply, Demand, & Prices
At long last, the steep inflation trajectory is beginning to moderate
Within seconds of the report’s release, Dow futures soared more than 400 points—led by consumer discretionary names. Finally, after months of ever-growing rates, inflation cooled in July. Following June’s 9.06% YoY rate and 1.32% MoM rate, and against expectations for an 8.7% annual increase, the price of goods and services in the US rose by “only” 8.5% in July. The MoM number, which was expected to rise by 0.2%, actually fell by that precise amount. While the 7.7% drop in gas prices in July helped drive that number down, even when energy and food prices are excluded core CPI still rose less than expected: 5.9% versus the 6.1% expected. Housing costs, which make up around one-third of the CPI, rose 5.7% from a year ago.
The report brought a sigh of relief to investors, as the Fed has indicated it will continue raising rates until it tames inflation. Any number above consensus would have increased the odds for an even greater rate hike at the September FOMC meeting. Another 75-basis-point hike is still expected, followed by two or three smaller hikes before the end of 2022. Buttressing the good news on the consumer side of the inflation front, the producer price index (PPI)—a reflection of what producers of goods and services must pay—also fell in July. Instead of the expected 0.2% jump MoM, prices actually fell 0.5% from June.
One month does not a trend make, but we believe peak inflation is now behind us. Now, the move downward must be gradual enough so as to not create a more dovish Fed before rates get back up to where they should be. We need decent bond yields in order to build well-balanced portfolios.
We, 10 Aug 2022
Consumer Electronics
Amazon is buying iRobot for $1.7 billion
We were early investors in consumer robot company iRobot (IRBT $59), initially buying shares of the company shortly after they went public. It has been a wild, seventeen-year ride for those shares, coming out of the gate around $24, rising all the way to $197.40 in the spring of 2021, and then falling back to $35.41 a few months ago. We actually took our profits around $65 per share (we owned the company in the Penn New Frontier Fund) when a stop loss hit. Now, the maker of those cute little Roomba autonomous vacuums, Braava robot mops, and (coming soon to a backyard near you) Terra robot mowers is being acquired by Penn member Amazon (AMZN $138) for $1.7 billion in cash—around $61 per share. We love the deal.
Amazon’s Alexa already supports iRobot devices (“Alexa, ask Roomba to start vacuuming”), and now the enormous, $1.4 trillion e-commerce company can provide the needed cash inflow for the development of new devices. iRobot has faced a number of headwinds lately, to include tariffs (it is now moving a large portion of its manufacturing operations from China to Malaysia), rising input costs, supply chain issues, and an unanticipated drop in demand due to deteriorating global economic conditions. While the firm has generally operated in the black over the past decade, Amazon’s deep pockets will assure the company is able to weather a recession and come out stronger during the next recovery phase. The deal is expected to be completed by the end of the year.
Talk about a great marketing platform for iRobot: being highlighted by the world’s largest e-commerce company should provide a great catalyst for future sales. As for Amazon, it remains one of our highest-conviction holdings. We added to the position following the stock split (when shares were trading around $100) and have a price target of $200 on the shares. Amazon is one of the 40 holdings within the Penn Global Leaders Club.
Fr, 05 Aug 2022
Market Pulse
At first, the market hated the
Th, 28 Jul 2022
Airlines & Air Freight
Shocker: Spirit terminates Frontier bid, agrees to JetBlue merger
We have written about the ongoing saga between three small-cap airlines, Spirit (SAVE $25), Frontier (ULCC $11), and JetBlue (JBLU $9), each approximately $2.5 billion in size, for the past several months. Despite JetBlue’s hostile takeover push for Spirit, it looked as though a Spirit/Frontier merger was as good as done. In fact, two major shareholder advisory firms were recommending that the deal be approved. The CEO of Spirit, Ted Christie, had argued that the Federal Trade Commission and the Department of Justice would never approve a merger with JetBlue. Suddenly, in a rather shocking reversal, Spirit announced that it was terminating its deal with Frontier—scheduled to be voted on within weeks—and embracing JetBlue’s offer. Something stinks. We will never know what went on behind closed doors, but it would probably be worthy of a book. JetBlue, it should be noted, has the worst on-time record in the industry, with nearly 10,000 canceled or delayed flights (39%!) in the month of June alone. The deal would give Spirit shareholders $33.50 per share in cash, an aggregate equity value of $3.8 billion, and carry with it a breakup fee of $400 million if it is shot down by regulators.
There is a lot of baggage to unpack here. First and foremost, we believe the feds will not approve the merger on anticompetitive grounds. Beyond that, what happens to Frontier, our personal favorite of the three, now that they are left to fend for themselves in an industry dominated by the four large players—United, American, Delta, and Southwest? And what magic panacea will allow JetBlue to improve its horrendous on-time record? Our advice? Don’t touch any of the low-cost carriers. And avoid flying JetBlue.
We, 27 Jul 2022
E-Commerce
Shopify drops another 14% after booting one-tenth of its workforce out the door
At one time we were intrigued with Canadian e-commerce platform Shopify (SHOP $32); now, we find ourselves repelled by the firm. Back in spring, we wrote of two big decisions by the board: the initiation of a ten-for-one stock split, and the creation of a new share class (the Founder share) which would increase CEO Tobi Lutke’s voting power to 40%. Why not just decree him ruler for life? That was an outrageous move, made even more distasteful by the company’s decision on Tuesday to boot 10% of the workforce out the door “by the end of the day.” Lutke admitted to misreading the strength of online shopping post pandemic, but words are cheap. The proper action would have been to join the 10% of fired workers and leave the building with his little brown shipping box.
Since the company’s ten-for-one stock split muddied the waters with respect to just how much the shares have fallen, consider this: In November of 2021 SHOP had a market cap of $212 billion; it is now worth $40 billion, or 81% smaller than it was nine months ago. We often talk about how the Nasdaq fell 78% between 2000 and 2002. Astonishingly, we now have a growing list of companies on that exchange which have dropped further than that in under a year. Certainly, some will come roaring back, but others will flounder for years. We can’t say in which camp Shopify will find itself, but we can say we wouldn’t invest in a firm where one person controls 40% of the voting rights.
Tu, 26 Jul 2022
Food & Staples Retailing
Walmart shares drop 8% after the retailer slashed its profit outlook
The good news: America’s largest retailer, Walmart (WMT $120), said it expects same store sales, ex-fuel, to rise 6% in Q2 over the same time period last year. The bad news: profit margins are being crushed by inflation and a pullback by consumers in discretionary spending. Put another way, the bottom 40% of wage earners, being harder hit by higher fuel costs and grocery bills, have little left over for apparel and other discretionary items. Unfortunately for Walmart, that is where the fattest profit margins reside. Although the retailer won’t formally report Q2 earnings until the 16th of August, management announced that an oversupply of merchandise (inventories rose some 33% in Q1) at both Walmart and its Sam’s Club locations was forcing it to cut prices, thereby reducing net income. The company is projecting an 8% to 9% decrease in EPS for the quarter, and an 11% to 13% drop in earnings for the full year.
Despite the move lower, Walmart is still holding up better than most of its peers. The company’s warning portends rough sailing ahead for lower-priced merchandisers which, unlike Walmart, do not have the luxury of relying on staples to help stabilize sales. Dick’s Sporting Goods (DKS $90), Kohls (KSS $27), and Bed Bath & Beyond (BBBY $5) all moved sharply lower after the announcement. Potential safety plays in the sector? We like well-run, dedicated grocers like The Kroger Company (KR $45) and Grocery Outlet (GO $44).
Mo, 25 Jul 2022
Metals & Mining
Newmont Mining just had its worst day since 2008
Despite gold’s recent drop, we remain quite bullish on the precious metal going forward. If we are in some time-warped 1970s redux, keep this in mind: Gold entered the 1970s around $40 per ounce and exited the decade around $500 per ounce; over that same time period, the Dow Jones Industrial Average grew from 800 to 839 (5%)! While not quite as bullish on the gold miners (due to a host of threats, from rising costs to geopolitical trouble around many of the world’s mines), we did see opportunity among the most well-run players.
On that note, we added Newmont Mining (NEM $44) to the Penn Global Leaders Club last year and it immediately began trading higher. Wishing to maintain our gains, we placed a stop on the shares. Fortunately, the stop price hit and the position was closed when Newmont shares dropped to a recent price of $60. Highlighting the importance of having protection in place on volatile holdings, the company just had its worst day since 2008, falling some 14% on the heels of the Q2 earnings release. While revenue remained steady YoY at $3.06 billion for the quarter, earnings per share (EPS) tumbled to $0.46 from $0.81 in the same quarter last year. Management reported a 23% increase in costs, to $932 per ounce mined. Furthermore, the company had an all-in sustaining cost of $1,150 per ounce due to inflationary pressures. While gold is off just over 5% thus far in 2022, Newmont finds itself down 27% year-to-date and nearly 50% below its April intraday high of $86.37.
Our three favorite gold mining stocks are all presently getting crushed. In addition to Newmont, shares of Barrick Gold Corp (GOLD) have dropped from $26 to $15, while shares of Kinross Gold Corp (KGC) have plunged from $7 to $3. While we are not ready to touch any of them right now, they should all see a nice rebound as costs return to normal. Of course, we can only speculate as to when that might be.
Mo, 25 Jul 2022
Aerospace & Defense
Boeing workers plan to strike; wait till you see what they deem as “inadequate”
(Update: Workers at the three Boeing plants in question approved a sweetened deal by the company, averting the strike) Pretty much every aspect of Boeing (BA $158) makes us uncomfortable right now. This critical American aerospace company, which never should have been allowed to knock out rival McDonnell Douglas, has a completely inept management team. The disgusting way in which two deadly 737-MAX crashes were handled is inexcusable. The chairman, who announced his wholehearted support for the former CEO right before the latter was fired, decided that he was the only person who could fix the company. Um, weren’t you the chairman of the board when the crashes occurred? Seemingly nothing is going right for the company, on either the aircraft or space side of the business. The company tells us that manned spaceflight is tough, and they can’t cut corners. Meanwhile, SpaceX is proving that the job isn’t too tough to get done. It is a Boeing problem.
Now, amidst all the self-inflicted problems at the firm, let’s throw in one for which we don’t really blame the company. Workers at three St. Louis plants, some 2,500 members of the machinists’ union, plan to go on strike in August. The tired old union arguments are really hard to swallow in this case—even more so than normal. They first feigned outrage that Boeing no longer has a pension plan. Who does these days?! They then complained about the “inadequate compensation” to the employees’ 401(k) retirement plans. This is where it gets comical. Right now, Boeing offers a 75% match on the first eight percent that a worker puts into his or her 401(k). Inadequate? That sounds like a gold-plated plan to us. But it gets better. In the negotiations, the company said it would increase the company match to dollar for dollar on the first ten percent. The response? A flat refusal, with the union stating that “the company continues to make billions of dollars each year off the backs of our hardworking members.”
Take a trip to nearly any corner of the world and read that statement to workers making a fraction of what Boeing workers make and gauge the response. As for the silly “billions of dollars” comment, the union had better check the company’s financials: Boeing lost $4.2 billion in 2021, $12 billion in 2020, and $636 million in 2019.
For the better part of 25 years Boeing was a staple holding for our clients. Now, until a complete board overhaul takes place, we couldn’t imagine owning the company. Sad. As we say, virtually every aspect of the company’s business model makes us uncomfortable right now.
Airlines & Air Freight
Shocker: Spirit terminates Frontier bid, agrees to JetBlue merger
We have written about the ongoing saga between three small-cap airlines, Spirit (SAVE $25), Frontier (ULCC $11), and JetBlue (JBLU $9), each approximately $2.5 billion in size, for the past several months. Despite JetBlue’s hostile takeover push for Spirit, it looked as though a Spirit/Frontier merger was as good as done. In fact, two major shareholder advisory firms were recommending that the deal be approved. The CEO of Spirit, Ted Christie, had argued that the Federal Trade Commission and the Department of Justice would never approve a merger with JetBlue. Suddenly, in a rather shocking reversal, Spirit announced that it was terminating its deal with Frontier—scheduled to be voted on within weeks—and embracing JetBlue’s offer. Something stinks. We will never know what went on behind closed doors, but it would probably be worthy of a book. JetBlue, it should be noted, has the worst on-time record in the industry, with nearly 10,000 canceled or delayed flights (39%!) in the month of June alone. The deal would give Spirit shareholders $33.50 per share in cash, an aggregate equity value of $3.8 billion, and carry with it a breakup fee of $400 million if it is shot down by regulators.
There is a lot of baggage to unpack here. First and foremost, we believe the feds will not approve the merger on anticompetitive grounds. Beyond that, what happens to Frontier, our personal favorite of the three, now that they are left to fend for themselves in an industry dominated by the four large players—United, American, Delta, and Southwest? And what magic panacea will allow JetBlue to improve its horrendous on-time record? Our advice? Don’t touch any of the low-cost carriers. And avoid flying JetBlue.
We, 27 Jul 2022
E-Commerce
Shopify drops another 14% after booting one-tenth of its workforce out the door
At one time we were intrigued with Canadian e-commerce platform Shopify (SHOP $32); now, we find ourselves repelled by the firm. Back in spring, we wrote of two big decisions by the board: the initiation of a ten-for-one stock split, and the creation of a new share class (the Founder share) which would increase CEO Tobi Lutke’s voting power to 40%. Why not just decree him ruler for life? That was an outrageous move, made even more distasteful by the company’s decision on Tuesday to boot 10% of the workforce out the door “by the end of the day.” Lutke admitted to misreading the strength of online shopping post pandemic, but words are cheap. The proper action would have been to join the 10% of fired workers and leave the building with his little brown shipping box.
Since the company’s ten-for-one stock split muddied the waters with respect to just how much the shares have fallen, consider this: In November of 2021 SHOP had a market cap of $212 billion; it is now worth $40 billion, or 81% smaller than it was nine months ago. We often talk about how the Nasdaq fell 78% between 2000 and 2002. Astonishingly, we now have a growing list of companies on that exchange which have dropped further than that in under a year. Certainly, some will come roaring back, but others will flounder for years. We can’t say in which camp Shopify will find itself, but we can say we wouldn’t invest in a firm where one person controls 40% of the voting rights.
Tu, 26 Jul 2022
Food & Staples Retailing
Walmart shares drop 8% after the retailer slashed its profit outlook
The good news: America’s largest retailer, Walmart (WMT $120), said it expects same store sales, ex-fuel, to rise 6% in Q2 over the same time period last year. The bad news: profit margins are being crushed by inflation and a pullback by consumers in discretionary spending. Put another way, the bottom 40% of wage earners, being harder hit by higher fuel costs and grocery bills, have little left over for apparel and other discretionary items. Unfortunately for Walmart, that is where the fattest profit margins reside. Although the retailer won’t formally report Q2 earnings until the 16th of August, management announced that an oversupply of merchandise (inventories rose some 33% in Q1) at both Walmart and its Sam’s Club locations was forcing it to cut prices, thereby reducing net income. The company is projecting an 8% to 9% decrease in EPS for the quarter, and an 11% to 13% drop in earnings for the full year.
Despite the move lower, Walmart is still holding up better than most of its peers. The company’s warning portends rough sailing ahead for lower-priced merchandisers which, unlike Walmart, do not have the luxury of relying on staples to help stabilize sales. Dick’s Sporting Goods (DKS $90), Kohls (KSS $27), and Bed Bath & Beyond (BBBY $5) all moved sharply lower after the announcement. Potential safety plays in the sector? We like well-run, dedicated grocers like The Kroger Company (KR $45) and Grocery Outlet (GO $44).
Mo, 25 Jul 2022
Metals & Mining
Newmont Mining just had its worst day since 2008
Despite gold’s recent drop, we remain quite bullish on the precious metal going forward. If we are in some time-warped 1970s redux, keep this in mind: Gold entered the 1970s around $40 per ounce and exited the decade around $500 per ounce; over that same time period, the Dow Jones Industrial Average grew from 800 to 839 (5%)! While not quite as bullish on the gold miners (due to a host of threats, from rising costs to geopolitical trouble around many of the world’s mines), we did see opportunity among the most well-run players.
On that note, we added Newmont Mining (NEM $44) to the Penn Global Leaders Club last year and it immediately began trading higher. Wishing to maintain our gains, we placed a stop on the shares. Fortunately, the stop price hit and the position was closed when Newmont shares dropped to a recent price of $60. Highlighting the importance of having protection in place on volatile holdings, the company just had its worst day since 2008, falling some 14% on the heels of the Q2 earnings release. While revenue remained steady YoY at $3.06 billion for the quarter, earnings per share (EPS) tumbled to $0.46 from $0.81 in the same quarter last year. Management reported a 23% increase in costs, to $932 per ounce mined. Furthermore, the company had an all-in sustaining cost of $1,150 per ounce due to inflationary pressures. While gold is off just over 5% thus far in 2022, Newmont finds itself down 27% year-to-date and nearly 50% below its April intraday high of $86.37.
Our three favorite gold mining stocks are all presently getting crushed. In addition to Newmont, shares of Barrick Gold Corp (GOLD) have dropped from $26 to $15, while shares of Kinross Gold Corp (KGC) have plunged from $7 to $3. While we are not ready to touch any of them right now, they should all see a nice rebound as costs return to normal. Of course, we can only speculate as to when that might be.
Mo, 25 Jul 2022
Aerospace & Defense
Boeing workers plan to strike; wait till you see what they deem as “inadequate”
(Update: Workers at the three Boeing plants in question approved a sweetened deal by the company, averting the strike) Pretty much every aspect of Boeing (BA $158) makes us uncomfortable right now. This critical American aerospace company, which never should have been allowed to knock out rival McDonnell Douglas, has a completely inept management team. The disgusting way in which two deadly 737-MAX crashes were handled is inexcusable. The chairman, who announced his wholehearted support for the former CEO right before the latter was fired, decided that he was the only person who could fix the company. Um, weren’t you the chairman of the board when the crashes occurred? Seemingly nothing is going right for the company, on either the aircraft or space side of the business. The company tells us that manned spaceflight is tough, and they can’t cut corners. Meanwhile, SpaceX is proving that the job isn’t too tough to get done. It is a Boeing problem.
Now, amidst all the self-inflicted problems at the firm, let’s throw in one for which we don’t really blame the company. Workers at three St. Louis plants, some 2,500 members of the machinists’ union, plan to go on strike in August. The tired old union arguments are really hard to swallow in this case—even more so than normal. They first feigned outrage that Boeing no longer has a pension plan. Who does these days?! They then complained about the “inadequate compensation” to the employees’ 401(k) retirement plans. This is where it gets comical. Right now, Boeing offers a 75% match on the first eight percent that a worker puts into his or her 401(k). Inadequate? That sounds like a gold-plated plan to us. But it gets better. In the negotiations, the company said it would increase the company match to dollar for dollar on the first ten percent. The response? A flat refusal, with the union stating that “the company continues to make billions of dollars each year off the backs of our hardworking members.”
Take a trip to nearly any corner of the world and read that statement to workers making a fraction of what Boeing workers make and gauge the response. As for the silly “billions of dollars” comment, the union had better check the company’s financials: Boeing lost $4.2 billion in 2021, $12 billion in 2020, and $636 million in 2019.
For the better part of 25 years Boeing was a staple holding for our clients. Now, until a complete board overhaul takes place, we couldn’t imagine owning the company. Sad. As we say, virtually every aspect of the company’s business model makes us uncomfortable right now.
Fr, 22 Jul 2022
Market Pulse
Despite Friday’s fizzled rally, all of the major benchmarks finished the week strong
Remember the chart of 1970’s wild S&P 500 ride we reviewed in the last issue of After Hours? Obviously, we are still very early in the second half of 2022, but our prediction of mirroring those results have been encouraging thus far. Friday’s shift from rally to fade wasn’t what we were hoping for to finish out a strong week, but it didn’t stop the S&P 500 from posting a 2.56% gain for the five sessions, surpassed only by the Nasdaq (+3.34%) and the small-cap Russell 2000 (+3.61%). There were two classes we wanted to see drop, oil and the 10-year Treasury, and both did precisely that. The gains this past week stemmed largely from the fact that earnings weren’t as bad as feared; well, except for some notable exceptions like Snapchat (SNAP $10), which was punished to the tune of a 40% drop on Friday.
Next week is huge. We know what the Fed is going to do, barring any surprises: raise rates by 75 basis points to an upper limit of 2.5%. We still need to get to a 4% rate (in our opinion), but investors are now banking on the fact that the velocity of hikes will begin to slow after the July FOMC meeting. In fact, many see rate cuts coming in 2023 due to a recession. Yet another reason we had better make it to 4% by then, coupled with a sizeable reduction in the Fed’s $9 trillion balance sheet. Second quarter’s initial GDP read comes out next week, which may show a second straight contraction—signaling a technical recession using an archaic metric. And talk about some critical earnings reports: Apple, Microsoft, and Alphabet all report next week. Our prediction? Except for some poorly run companies, earnings won’t be as bad as feared with the major players. We’re not really going out on the limb with that prediction: 75% of the S&P 500 firms which have already reported beat analysts’ dour estimates. Yes, the economy is cooling, but that is what happens with a normal economic cycle. Based on the bear market we entered with all of the major benchmarks except the least important one (the Dow), we are set up nicely for a second half rally.
We, 20 Jul 2022
Global Strategy: East & Southeast Asia
Latest Chinese reality check: a mortgage boycott sweeps the nation
For decades, the communist-controlled Chinese media has poured forth an endless stream of rosy stories about the country’s growth trajectory and the general happiness of ordinary Chinese citizens. Too often, a sycophantic Western press has “dutifully” regurgitated these propaganda-filled fairy tales. One such yarn revolves around the millions of housing units being built for the rising middle class in the country, and the excited would-be homeowners happily making mortgage payments on properties not yet built—a typical practice in China. Now, despite the iron-clad control over social media in the country, a darker image is coming into focus.
There is a revolt taking place among a large number of Chinese homebuyers who have stopped making mortgage payments—or are threatening to—on their unfinished properties. Despite the censors’ best efforts, online petitions are circulating urging citizens to boycott making payments until they see results. With nearly $7 trillion worth of outstanding mortgage loans, the real estate industry accounts for nearly one quarter of China’s economy; these boycotts threaten to spread like wildfire, further dampening a recovery marred by renewed Covid lockdowns. Rising loan defaults are already spooking investors, which have driven down both bank and developer stocks by double digits over the past few weeks.
How bad is the crisis? Analysts at Nomura Holdings, a Japanese financial holding company, estimate that just 60% of homes pre-sold to Chinese households over the past decade have been delivered. A slowing growth rate in the country’s economy will only exacerbate the problem.
China’s wanton real estate boom was built upon unsustainable projections of forward growth—growth levels which couldn’t possibly be sustained as its economy matured. With Xi Jinping about to become ruler for life, the problem will be exacerbated by the government’s draconian response to economic challenges.
Tu, 19 Jul 2022
Capital Markets
Another black (SPAC) eye: Electric Last Mile Solutions to be delisted
During SPACmania, 2021, companies which couldn’t dream of going public on their own joined with so-called blank check SPACs, or special purpose acquisition companies, to sneak in through the back door. The fact that investors were flocking to these creatures with force was one of the major red flags of the year, along with NFTs and meme stocks (see Feeding Frenzy, Penn Wealth Report, Vol. 9 Issue 03). Electric Last Mile Solutions (ELMSQ $0.14), yet another EV startup, was one such firm. The company became publicly traded in June of last year by joining with blank check firm Forum Merger III, initially trading at $10 per share. Now, after what the company is blaming on an SEC investigation which ultimately forced the CEO and chairman to resign, Electric Last Mile has initiated bankruptcy proceedings. On the company’s investor page, Interim CEO Shauna McIntyre assures all stakeholders that ELMS is “dedicated to the company’s ongoing business and mission.” At $0.14 per share, this “ongoing business” now has a market cap of $15.5 million, down from $1.3 billion. Management has quite the mountain to climb to make good on its current set of promises.
It is a sad testament that so many small investors would see “EV startup” and “$10 per share” and jump in with hard-earned money. No due diligence, not a modicum of research, just pure silliness. It reminds us of the guy featured on a CNBC special who declared that he spent “an entire day researching the stock market before jumping in.” Now, instead of a sober evaluation of mistakes made and an intelligent progression, how many will simply throw in the towel—until the next major rally is long in the tooth?
Tu, 19 Jul 2022
Aerospace & Defense
With shares trading around $9, Embraer looks tempting on heels of new aircraft order
Back in a 2017 article within The Penn Wealth Report, we wrote a rather glowing commentary on Brazilian aircraft maker Embraer (ERJ $9). Purchasing the company within the Intrepid Trading Platform for $20.50 per share at the time, we took a fat short-term profit (the nature of the ITP) just two months later when Boeing (BA $155) agreed to buy the $3.777 billion small-cap industrial. Since then, Boeing has pulled out of the deal and Embraer’s share price has dropped from a five-year high of $27.50 to a recent low of $8. The company, which has been around since 1969, manufactures regional and business jets as well as a host of defense and security products. Through its services and support division, the company generates a solid stream of recurring revenue.
This week, Canada’s Porter Airlines announced that it would be buying an additional 20 E195-E2 aircraft from Embraer on top of the 30 it has already ordered. The carrier also purchased the rights to buy another 50 as needed. Somewhat a slap in the face to Canada’s own business jet manufacturer, Bombardier (BDRAF $20). So, with the shares trading below $10, is it time to buy back into this now $1.645 billion foreign aerospace player? It is tempting. We have no doubt that Embraer will continue to be a viable player in the industry for decades, and it is trading almost 85% below its all-time high share price. Alas, it was a review of the income statement that kept us from pulling the trigger. While several issues jumped out, the fact that the company has not turned a profit since 2017 is certainly one of the biggest red flags. For a riskier portion of an investment portfolio, however, the potential reward might just be worth the risk.
If we did purchase Embraer, we would do so with a tight stop loss in place—probably around $8 per share—to minimize potential losses. It should be noted that every year for the past decade ERJ shares have reached the $20s to $30s range.
Mo, 18 Jul 2022
Automotive
EV maker Canoo spikes on Walmart and US Army interest; don’t be fooled
We can imagine a certain group of investors licking their chops now: EV maker Canoo (GOEV $4) is a dirt-cheap stock in a promising industry with sudden interest from both Walmart (WMT $129) and the US Army. Shares, in fact, were trading around $1.88 when America’s largest retailer said it has plans to buy 4,500 Canoo EVs with an option to buy up to 10,000. The vehicles are to be used for the store’s “last-mile delivery” to customers’ homes. A few days after the Walmart announcement, the US Army selected a Canoo vehicle for analysis and demonstration. Is the company about to have a major breakout?
Before jumping in to buy shares at the “low price” of $4.28 (where they trade as we write this), investors should dig a little deeper into the stories. As for Walmart, which stipulated in its deal that Canoo cannot provide competitor Amazon (AMZN $114) with EVs, the company has similar deals with Nikola, Daimler, and Cummins. Furthermore, Canoo has yet to deliver on any vehicles—to anyone. All of the existing vehicles are prototypes. Another major concern we have is that the company is only publicly traded because it is part of a SPAC deal. It never would have been able to go public (anytime soon) through the traditional IPO route.
On the financial front, it is common for a young company to have negative earnings, but Canoo’s top-line revenue is zero. Something that made us think back to Nikola’s slick founder, Trevor Milton, was the company’s pie-in-the-sky projections. Canoo told investors it could generate over $300 million in revenue in 2022 and produce 3,000 to 6,000 vehicles this year. The assembly lines are not yet rolling. Two years ago, the company offered revenue projections of $4.13 billion in 2026 alongside profits of $1.18 billion. These “creative” projections are raising some eyebrows in the regulatory community. Walmart and the US Army aside, $4 doesn’t seem cheap considering the potential share price of $0.00.
Headlines can spur positive actions by investors, but not always in the way one might imagine. With so many misleading narratives floating around, the ability to think like a contrarian can pay off handsomely. If something doesn’t pass the smell test, a deeper dive might uncover a real opportunity to take advantage of a misguidedly negative sentiment. In the case of the recent Canoo news, a little emotional discipline and some basic research might keep one from joining the lemmings who think they have uncovered a bargain.
Market Pulse
Despite Friday’s fizzled rally, all of the major benchmarks finished the week strong
Remember the chart of 1970’s wild S&P 500 ride we reviewed in the last issue of After Hours? Obviously, we are still very early in the second half of 2022, but our prediction of mirroring those results have been encouraging thus far. Friday’s shift from rally to fade wasn’t what we were hoping for to finish out a strong week, but it didn’t stop the S&P 500 from posting a 2.56% gain for the five sessions, surpassed only by the Nasdaq (+3.34%) and the small-cap Russell 2000 (+3.61%). There were two classes we wanted to see drop, oil and the 10-year Treasury, and both did precisely that. The gains this past week stemmed largely from the fact that earnings weren’t as bad as feared; well, except for some notable exceptions like Snapchat (SNAP $10), which was punished to the tune of a 40% drop on Friday.
Next week is huge. We know what the Fed is going to do, barring any surprises: raise rates by 75 basis points to an upper limit of 2.5%. We still need to get to a 4% rate (in our opinion), but investors are now banking on the fact that the velocity of hikes will begin to slow after the July FOMC meeting. In fact, many see rate cuts coming in 2023 due to a recession. Yet another reason we had better make it to 4% by then, coupled with a sizeable reduction in the Fed’s $9 trillion balance sheet. Second quarter’s initial GDP read comes out next week, which may show a second straight contraction—signaling a technical recession using an archaic metric. And talk about some critical earnings reports: Apple, Microsoft, and Alphabet all report next week. Our prediction? Except for some poorly run companies, earnings won’t be as bad as feared with the major players. We’re not really going out on the limb with that prediction: 75% of the S&P 500 firms which have already reported beat analysts’ dour estimates. Yes, the economy is cooling, but that is what happens with a normal economic cycle. Based on the bear market we entered with all of the major benchmarks except the least important one (the Dow), we are set up nicely for a second half rally.
We, 20 Jul 2022
Global Strategy: East & Southeast Asia
Latest Chinese reality check: a mortgage boycott sweeps the nation
For decades, the communist-controlled Chinese media has poured forth an endless stream of rosy stories about the country’s growth trajectory and the general happiness of ordinary Chinese citizens. Too often, a sycophantic Western press has “dutifully” regurgitated these propaganda-filled fairy tales. One such yarn revolves around the millions of housing units being built for the rising middle class in the country, and the excited would-be homeowners happily making mortgage payments on properties not yet built—a typical practice in China. Now, despite the iron-clad control over social media in the country, a darker image is coming into focus.
There is a revolt taking place among a large number of Chinese homebuyers who have stopped making mortgage payments—or are threatening to—on their unfinished properties. Despite the censors’ best efforts, online petitions are circulating urging citizens to boycott making payments until they see results. With nearly $7 trillion worth of outstanding mortgage loans, the real estate industry accounts for nearly one quarter of China’s economy; these boycotts threaten to spread like wildfire, further dampening a recovery marred by renewed Covid lockdowns. Rising loan defaults are already spooking investors, which have driven down both bank and developer stocks by double digits over the past few weeks.
How bad is the crisis? Analysts at Nomura Holdings, a Japanese financial holding company, estimate that just 60% of homes pre-sold to Chinese households over the past decade have been delivered. A slowing growth rate in the country’s economy will only exacerbate the problem.
China’s wanton real estate boom was built upon unsustainable projections of forward growth—growth levels which couldn’t possibly be sustained as its economy matured. With Xi Jinping about to become ruler for life, the problem will be exacerbated by the government’s draconian response to economic challenges.
Tu, 19 Jul 2022
Capital Markets
Another black (SPAC) eye: Electric Last Mile Solutions to be delisted
During SPACmania, 2021, companies which couldn’t dream of going public on their own joined with so-called blank check SPACs, or special purpose acquisition companies, to sneak in through the back door. The fact that investors were flocking to these creatures with force was one of the major red flags of the year, along with NFTs and meme stocks (see Feeding Frenzy, Penn Wealth Report, Vol. 9 Issue 03). Electric Last Mile Solutions (ELMSQ $0.14), yet another EV startup, was one such firm. The company became publicly traded in June of last year by joining with blank check firm Forum Merger III, initially trading at $10 per share. Now, after what the company is blaming on an SEC investigation which ultimately forced the CEO and chairman to resign, Electric Last Mile has initiated bankruptcy proceedings. On the company’s investor page, Interim CEO Shauna McIntyre assures all stakeholders that ELMS is “dedicated to the company’s ongoing business and mission.” At $0.14 per share, this “ongoing business” now has a market cap of $15.5 million, down from $1.3 billion. Management has quite the mountain to climb to make good on its current set of promises.
It is a sad testament that so many small investors would see “EV startup” and “$10 per share” and jump in with hard-earned money. No due diligence, not a modicum of research, just pure silliness. It reminds us of the guy featured on a CNBC special who declared that he spent “an entire day researching the stock market before jumping in.” Now, instead of a sober evaluation of mistakes made and an intelligent progression, how many will simply throw in the towel—until the next major rally is long in the tooth?
Tu, 19 Jul 2022
Aerospace & Defense
With shares trading around $9, Embraer looks tempting on heels of new aircraft order
Back in a 2017 article within The Penn Wealth Report, we wrote a rather glowing commentary on Brazilian aircraft maker Embraer (ERJ $9). Purchasing the company within the Intrepid Trading Platform for $20.50 per share at the time, we took a fat short-term profit (the nature of the ITP) just two months later when Boeing (BA $155) agreed to buy the $3.777 billion small-cap industrial. Since then, Boeing has pulled out of the deal and Embraer’s share price has dropped from a five-year high of $27.50 to a recent low of $8. The company, which has been around since 1969, manufactures regional and business jets as well as a host of defense and security products. Through its services and support division, the company generates a solid stream of recurring revenue.
This week, Canada’s Porter Airlines announced that it would be buying an additional 20 E195-E2 aircraft from Embraer on top of the 30 it has already ordered. The carrier also purchased the rights to buy another 50 as needed. Somewhat a slap in the face to Canada’s own business jet manufacturer, Bombardier (BDRAF $20). So, with the shares trading below $10, is it time to buy back into this now $1.645 billion foreign aerospace player? It is tempting. We have no doubt that Embraer will continue to be a viable player in the industry for decades, and it is trading almost 85% below its all-time high share price. Alas, it was a review of the income statement that kept us from pulling the trigger. While several issues jumped out, the fact that the company has not turned a profit since 2017 is certainly one of the biggest red flags. For a riskier portion of an investment portfolio, however, the potential reward might just be worth the risk.
If we did purchase Embraer, we would do so with a tight stop loss in place—probably around $8 per share—to minimize potential losses. It should be noted that every year for the past decade ERJ shares have reached the $20s to $30s range.
Mo, 18 Jul 2022
Automotive
EV maker Canoo spikes on Walmart and US Army interest; don’t be fooled
We can imagine a certain group of investors licking their chops now: EV maker Canoo (GOEV $4) is a dirt-cheap stock in a promising industry with sudden interest from both Walmart (WMT $129) and the US Army. Shares, in fact, were trading around $1.88 when America’s largest retailer said it has plans to buy 4,500 Canoo EVs with an option to buy up to 10,000. The vehicles are to be used for the store’s “last-mile delivery” to customers’ homes. A few days after the Walmart announcement, the US Army selected a Canoo vehicle for analysis and demonstration. Is the company about to have a major breakout?
Before jumping in to buy shares at the “low price” of $4.28 (where they trade as we write this), investors should dig a little deeper into the stories. As for Walmart, which stipulated in its deal that Canoo cannot provide competitor Amazon (AMZN $114) with EVs, the company has similar deals with Nikola, Daimler, and Cummins. Furthermore, Canoo has yet to deliver on any vehicles—to anyone. All of the existing vehicles are prototypes. Another major concern we have is that the company is only publicly traded because it is part of a SPAC deal. It never would have been able to go public (anytime soon) through the traditional IPO route.
On the financial front, it is common for a young company to have negative earnings, but Canoo’s top-line revenue is zero. Something that made us think back to Nikola’s slick founder, Trevor Milton, was the company’s pie-in-the-sky projections. Canoo told investors it could generate over $300 million in revenue in 2022 and produce 3,000 to 6,000 vehicles this year. The assembly lines are not yet rolling. Two years ago, the company offered revenue projections of $4.13 billion in 2026 alongside profits of $1.18 billion. These “creative” projections are raising some eyebrows in the regulatory community. Walmart and the US Army aside, $4 doesn’t seem cheap considering the potential share price of $0.00.
Headlines can spur positive actions by investors, but not always in the way one might imagine. With so many misleading narratives floating around, the ability to think like a contrarian can pay off handsomely. If something doesn’t pass the smell test, a deeper dive might uncover a real opportunity to take advantage of a misguidedly negative sentiment. In the case of the recent Canoo news, a little emotional discipline and some basic research might keep one from joining the lemmings who think they have uncovered a bargain.
We, 13 Jul 2022
Economics: Supply, Demand, & Prices
June inflation came in red hot, but the market drop was misguided
On Wednesday the 13th, June’s inflation numbers rolled in. They were expected to be high, but investors discounted the spike and futures were up. Within seconds of the scorching 9.1% year-over-year number being released, futures took a U-turn and tumbled some 400 points on the Dow and 200 points (-1.8%) on the Nasdaq. A 75-basis-point rate hike was already expected for July; after the report, odds of another 75-basis-point hike in September (there is no August FOMC meeting) more than doubled to around 78%. Keeping this in perspective, these two probable hikes would just put the upper limit of the Fed funds rate at 3.25%. For all the comparisons to the 1970s and 1980s, consumers could only dream about such low rates back then. The Fed should—must—make these moves.
As for the market’s immediate reaction, it was misguided. We believe that peak inflation has now hit, and that prices should begin to stabilize. Commodity prices, which have been on a steep trajectory for the past nine months or so, have turned the corner and are now pulling back at a rapid clip. Auto repossessions are exploding as an inordinate number of Americans who purchased vehicles during the pandemic have suddenly stopped making payments. Buyers and renters are pushing back against the high price of homes and 14% increase in leases by holding off on making a move—or, in the case of younger renters, moving back home. Companies of all sizes, expecting a recession, have begun to pull back on capital expenditures. Smaller companies are really feeling the pinch. Forget the American consumer for a moment: if companies start to pull back on spending, inflation will begin to subside.
Copper, a fundamental industrial-use metal, has lost one-third of its value since April. Wheat, corn, and other ag products have also dropped precipitously over the past few months. Even oil has dropped back below the $100 per barrel rate. These are signs that inflation is starting to return to more normal levels. Add a price-wary consumer to the mix, and suddenly the headline narrative begins to deflate, no pun intended. Mild recession or not, the second half of the year could hold some pleasant surprise for investors. At least the ones who resisted the urge to panic.
By “resisting the urge to panic,” we mean sticking to one’s proper portfolio diversification. On that front, we are excited by the Fed’s rate hikes as they signal some great bond issues are on the horizon. In the meantime, investors should remember that cash truly is an asset class, and a 20% allocation to that class is not excessively high right now. Dry powder to take advantage of the coming opportunities.
We, 06 Jul 2022
Airlines & Air Freight
JetBlue just can’t win: FAA awards coveted Newark slots to Spirit alone
Three miles south of downtown Newark and nine short miles from Manhattan lies Newark Liberty International Airport. Serving some 40 million passengers annually prior to the pandemic, the airport remains one of the busiest in the world. Back in 2019, Southwest Airlines (LUV $36) pulled out of the airport due to falling revenue amidst the grounding of Boeing’s (BA $135) 737-MAX fleet. This week, the FAA awarded all sixteen open slots at Newark to low-cost carrier Spirit Airlines (SAVE $25). JetBlue (JBLU $8), which has already been rebuffed twice by Spirit as a takeover target, had also been vying for the slots. A spokesperson for the FAA’s parent organization, the Department of Transportation, said that awarding all slots to Spirit would improve competition and secure more low-cost flights for Newark passengers.
A few weeks ago, JetBlue sweetened its takeover offer for Spirit, offering shareholders $30 at close and $1.50 per share in prepayment (from a raised reverse break-up fee). Spirit’s management team, however, remains committed to Frontier’s (ULCC $10) takeover offer, arguing that the deal will not face the same level of government scrutiny. (They are correct: we don’t see the respective government agencies approving a JetBlue/Spirit merger due to routing and competition issues.) Two major shareholder advisory firms, Glass Lewis and Institutional Shareholder Services (ISS), are now urging approval of the Frontier bid during this month’s shareholder vote.
It is difficult to find any airline we like right now due to inflation, a slow-moving economic slowdown, and chronic flight cancellations. We have one carrier in the Global Leaders Club, United (UAL $37), but we have a tight stop loss order on the shares. As for the airline in the direst straits (in our opinion): we wouldn’t touch shares of JetBlue.
We, 06 Jul 2022
Currencies & Forex
For the first time since 2002, the dollar is reaching parity with the euro
We always found it bizarre that certain politicians and leading economists would express a desire for a weak US dollar. Yes, our lopsided balance of trade can be aided by a weaker domestic currency, as it makes US goods cheaper for the world to buy, but the root causes of this condition are almost always troublesome. Furthermore, it harms the American consumer because their money doesn’t go as far. In essence, it is a signal that “our economy is weaker than yours.” Hardly bragging rights. For example, as the US was in the midst of the Financial Crisis of 2008/09, the euro, which was created in 1999, hit a high of €1.60 to one greenback. Many Europhiles have since predicted that parity would never be reached again. Lo and behold, the two currencies are now skirting near that level right now, with the euro hitting a two-decade low. This is due to the Fed’s willingness to raise rates until inflation is quelled, while the ECB begrudgingly signaled that it would finally raise rates by 25 basis points in July. The responsible actions on the part of the Fed add to the dollar’s strength, as global investors seek safe haven for their lowest-risk assets. While the US will probably have to battle a recession early next year, at least the Fed will have some fresh ammo; not so much the case in Europe, which is facing a deeper economic trough.
US multinational corporations do like a weaker dollar, as it makes their goods cheaper for the world to buy. The best way for an investor to take advantage of a strengthening dollar is through a bullish dollar ETF, such as the Invesco DB US Dollar Bullish fund (UUP $28), or by adjusting their portfolio toward small-cap US companies, most of whom sell overwhelmingly to domestic customers. In this space we use the Invesco S&P SmallCap 600 Revenue ETF (RWJ $103), a value/core fund which owns top revenue-producing smaller US companies.
Fr, 01 Jul 2022
Market Pulse
Worst first half of the year since 1970, but where do we go from here?
There have been a lot of comparisons to the 1970s floating around recently, and for good cause. After all, many of the same antagonists we faced fifty years ago haunt us today: China, Russia, inflation, high oil prices, and general economic malaise. Then there are the market comparisons. Yes, we have just closed out the worst first half of any year for the S&P 500 since 1970, and for the Dow Jones Industrial Average since 1962. Furthermore, the Nasdaq and Russell 2000 (small caps) just had their worst start to a year--ever. Anyone listening to the doom and gloom in the press and among economists certainly don’t feel much like buying. It is as if the all-but-guaranteed recession at our doorstep will mean the end to life as we know it. The negativism is palpable.
As we have recently noted, the entire decade of the 1970s was not kind to the markets; however, it was not just one big ten-year decline for the indexes. After dropping around 25% in the first half of 1970—eerily similar to 2022—the S&P 500 actually gained back nearly all of its losses on the back half, finishing the year down under 1%. While the Nasdaq didn’t come about until 1971, the same could be said of many of its would-be components back then.
At the end of the first half of this year, the S&P, Nasdaq, and Russell 2000 all found themselves in bear market territory, as defined by at least a 20% drop. The Nasdaq got hit the hardest, falling 30%. Bonds, which are supposed to provide a hedge to market losses, dropped 10.7% in aggregate over the past six months. Investors now seem certain on more rate hikes, a recession, terrible corporate earnings, a continuing war in Ukraine, and stubbornly persistent higher oil and gas prices. In other words, the stock market now reflects the worst of all possible outcomes for the second half.
This has created a condition in which large tech names like Microsoft, Apple, Adobe, and Amazon appear as though they are value plays. And large cap core/value names like Dollar General, Target, Pfizer, Home Depot, and Lockheed Martin have multiples that would have made investors drool last summer. All of these companies have rock solid balance sheets and strong fundamentals, it should be noted. The last time we remember solid companies selling off like this was March of 2020. June, it just so happens, was the worst month in the market since (you guessed it) March of 2020. Fear and gloom have taken over. Historically, with respect to equities, that has nearly always been the time to buy; never the time to panic.
Will the second half of the year be an encore to the second half of 1970? While we can’t say for sure, it wouldn’t surprise us a bit. Nonetheless, protection on positions and a larger allocation to cash (as we await higher rates which will lead to better bond values) are certainly prudent measures to maintain right now.
We, 29 Jun 2022
Hotels, Resorts, & Cruise Lines
Morgan Stanley analyst: Carnival Cruise Lines could go to $0 in worst-case scenario
Every time we write about Carnival Corp (CCL $9), we begin with the disclaimer that we have disliked the company and its shares for some time. A year ago, we wrote about members of senior management talking up the company’s great growth prospects while simultaneously offloading their own shares—at a much higher price than they are today, we might add. CCL shares were selling for $19 at the time. Morgan Stanley analysts have apparently had enough as well. The company maintained its “underweight” rating on the stock (why not “sell”?) while lowering the price target to $7. This helped drive the stock down some 15% at the open, to under $9 per share. Even more disconcerting was the analyst’s bear case scenario for the cruise line: the price of the shares could possibly go to $0. The catalyst for that stunningly bearish call is, primarily, the company’s debt load. Carnival holds some $11 billion worth of short-term debt and $32 billion worth of long-term debt. It has a current market cap of $10 billion. Should an upcoming recession trigger another “demand shock,” it could spell the end of the line as the company would find it very difficult to secure even more funding (at higher rates, we might add). Not everyone is so bearish, however. Six of the 24 major analysts covering the stock have a “buy” rating on the shares. Count us in the Morgan Stanley camp.
Both Royal Caribbean (RCL $36) and Norwegian Cruise Lines ($12) fell nearly double digits in sympathy with Carnival on Wednesday. For investors betting on a cruise line comeback, either of those names would offer a much better play on the industry in our opinion. (Penn does not own any cruise lines within the five portfolios.)
We, 29 Jun 2022
Global Organizations & Accords
Obstacle falls: Turkey agrees to full NATO membership for Sweden and Finland
Considering his deranged mental capacity, Vladimir Putin will never admit to the enormous tactical error he made by invading Ukraine, but it is clearly evident to the rest of the world. Based on the false narrative that Ukraine posed a threat to Russia, he invaded with the expectation of killing the country’s leader, Volodymyr Zelenskyy, and installing his own puppet regime. He has obviously failed in that attempt, but the unintended consequences of his barbaric act can be summed up with one stunning development: NATO is coming to Russia’s northwestern doorstep.
The one obstacle holding back Sweden and Finland’s membership into the military alliance was Turkey, which has been in the group since 1952. Based on the group’s bylaws, any expansion required approval by all member-states. Turkey had opposed the Nordic countries’ ambitions to join due to their respective governments’ support for Kurdish “terrorists” allegedly residing within the two nations. Now, according to Turkish President Recep Tayyip Erdogan, those concerns have been assuaged, leaving a clear path toward membership. Erdogan’s announcement came at the alliance’s Madrid Summit, which can now focus on its plan to rebuild forces in Europe to counter the increased Russian threat. That country has threatened to station nuclear weapons along its border with Finland if the nations were admitted to NATO.
Back in the 1990s, following the fall of the Soviet Union, many misguided critics questioned the need for NATO to remain in existence. Today, it is once again as important as it was during the height of the Cold War.
The final straw which ultimately brought about the fall of the Soviet Union was Ronald Reagan’s Strategic Defense Initiative and the communist nation’s attempt to counter the program. History may well repeat itself: Russia is ill-equipped to counter a strengthened NATO on its border, but Putin will spend critical capital trying to do just that.
We, 22 Jun 2022
Municipal Bonds
Alabama finds underwriters for $725 million worth of tax-free prison bonds
Breaking down a rather complicated series of events, here is what is going on in Alabama with respect to the improvement of conditions for prisoners, and the funding of these upgrades. The state faced a lawsuit from the DoJ which alleged that inmates housed in the state’s prisons were being exposed to “cruel and unusual punishment” due to dilapidated conditions. One such building, the Draper Correction Facility, had been in operation since 1939. To answer these concerns, the state contracted with CoreCivic Inc (CXW $12), a specialty REIT, to build and operate newer facilities, leasing them back to the Alabama Department of Corrections.
To fund the projects the state planned to offer municipal bonds, with the debt being backed by annual appropriations to the Department of Corrections. After backlash over the privately built and managed facilities, Barclays Plc and KeyBanc Capital Markets, the primary underwriters, dropped out of the deal. A CoreCivic spokesperson called the activists “reckless and irresponsible” for (apparently) preferring to have inmates remain in the outdated facilities rather than support a public-private enterprise.
Now, the deal has a new set of underwriters: Alabama-based Stephens Inc and The Frazer Lanier Company will co-manage the sale, along with help from Raymond James, Wells Fargo, and several other backers. The bonds will carry an Aa2 rating by Moody’s and a AA- rating by S&P Global. The yield on these tax-free general obligation (GO) bonds has yet to be announced, but they should hit the muni bond marketplace within the next month.
As rates bottomed out and the world was in the midst of the pandemic, there was a dearth of new muni bond issues. While the US faces a probable recession early next year, higher rates and the need to rebuild the American infrastructure should present investors with a huge wave of new tax-free bonds. Who knows, they may even get close to the 5% range many of them offered income-oriented investors back in the early years of the century. We would settle for a 3% tax free rate.
We, 22 Jun 2022
Beverages, Tobacco, & Cannabis
In blow to Altria, the FDA is poised to order Juul e-cigarettes off the market
In a rather stunning turn of events, the Food and Drug Administration is preparing an order that would force Juul Labs to take its popular e-cigarettes off American shelves. This follows a two-year review of the products, specifically the fruit flavored blends. The FDA’s ruling serves as a capstone to the great downfall of Juul, which was flying high back in 2018 as its products soared to the top of a frenzied market. In what turned out to be a critical miscalculation, 2018 also happens to be the year that tobacco giant Altria (MO $41) decided to take a 35% stake in the company. What might have seemed like a reasonable move to diversify away from its traditional cigarette products (Altria owns the popular Marlboro brand, among others), the company bought in at the worst possible time. Shares of MO had been holding up quite well in 2022 thus far, sitting at where they were trading going into the year. As soon as the news was announced, shares fell 10% and remained stuck there. The 2018 deal valued Juul at around $35 billion; just prior to the FDA decision, the company had a valuation of roughly $5 billion. Adding insult to injury, the FDA also indicated that e-cigarettes made by rivals Reynolds American and NJOY Holdings would be allowed to continue selling their tobacco-flavored vaping devices. Juul lost around $259 million on sales of $1.3 billion in 2021.
Somewhat surprisingly, there are still some Altria bulls out there. In addition to a fat 7.88% dividend yield, the company has maintained annual revenues of between $24 billion and $26 billion per year for the past ten years and has generated positive net income in all but one (2019) of those years. We wouldn’t touch the stock, especially considering the firm spun off its international division—Philip Morris International (PM $99)—back in 2008.
Tu, 21 Jun 2022
Currencies & Forex
Japanese yen falls to a 24-year low against the dollar
If you have been considering a Japanese getaway, now might be the time to book that trip. As of this week, one US dollar will buy 135 yen, up from slightly over 100 at the start of the year. Why does the world’s third-most-traded currency continue to plummet? Because the Bank of Japan’s governor, Haruhiko Kuroda, stands firmly by his commitment to maintain a -0.1% short-term interest rate while the rest of the developed world is raising rates to tamp down runaway inflation. Angering the Japanese public with his recent comments that consumers were becoming more tolerant of higher prices, nearly 60% of the country’s residents now find him unfit for the job. A weak currency due to an easy money policy means that goods and services cost a lot more for consumers within that country, and a lot cheaper for foreign visitors thanks to the generous exchange rate. Yes, a weak currency promotes stronger exports because the goods are less expensive for the world to buy, but the tradeoff can be brutal for the family budget. For a country which imports 94% of its energy, soaring prices and a weaker yen have most cheering the fact that Kuroda is in the final year of his second term as governor of the central bank.
For investors, the yen’s weakness also makes the Japanese stock market look more attractive thanks to the currency disparity. One way to potentially take advantage of this weakness is through the WisdomTree Japan Hedged Equity Fund (DXJ $64), which is up 2.35% in value this year against the backdrop of an 18% decline in the MSCI All-Cap World Index, Ex-US. Some of the fund’s top holdings are Toyota Motor Corp, Nintendo, Mitsubishi, and Canon.
Tu, 21 Jun 2022
Food Products
Kellogg to break into three companies; does anybody care?
Five years ago, we wrote a brief piece on Kellogg’s (K $69) hiring of a new CEO after floundering for years under chief executive John Bryant. We expressed doubt that Steven Cahillane would be any different. At the time, K was sitting around $70 per share. Confirming our concerns, the shares have barely budged since.
So, what does a mediocre company do to move the needle on its share price? Announce a plan to split into multiple entities, of course. Sure enough, shares of Kellogg opened the week up nearly 4% after management announced it would break into three pieces: a global snacking company, a North American cereal company, and a plant-based food company, names to be decided at a later date. We are not talking about GM spinning off its financing unit (remember GMAC?) or GE spinning off its jet-leasing unit; we are talking about a food company spinning off…food companies. Aren’t all three units within the core competencies of a packaged food manufacturer?
Right out of the mediocre manager playbook, CEO Cahillane said that the standalone companies will now be able to “direct their resources toward their distinct strategic priorities…and create more value for all stakeholders….” What a bunch of gobbledygook. Milquetoast executives throw out terms like “unlock value” as if a split would magically open corporate treasure chests which the crackerjack team had just been unable to open in the past. Really? All of the talent at your fingertips and you just couldn’t crack the code, but now you will be able to? What will be fun to watch next is how many middling analysts get excited by this move and upgrade the shares. Insert eye roll emoji here.
Full disclosure: We own Kellogg’s chief competitor, General Mills (GIS $68), in the Penn Global Leaders Club.
Th, 09 Jun 2022
Aerospace & Defense
BWX Technologies wins DoD contract to build first advanced microreactor in US
Aerospace & Defense firm BWX Technologies (BWXT $54) has been awarded a contract by the United States Department of Defense to build a first-of-its-kind advanced nuclear microreactor. Under codename Project Pele, these reactors, which can be transported by modules aboard trucks, trains, aircraft, or ship, are designed to be assembled on-site and operational within 72 hours. The reactors can provide a resilient power source for a variety of operational needs, eliminating the need for fossil fuels delivered by often extensive supply lines. The possibilities are endless, from immediate power needs at remote locations, to disaster response and recovery around the world. The prototype will be built under a contract valued at around $300 million and should be completed and delivered by 2024 for multiyear testing at the Idaho National Laboratory.
As we move away from fossil fuels, these advanced concepts are going to come to fruition, and the industry is full of potential going forward. A lack of understanding and a fear of the word “nuclear” may slow the process, but the safety attributes of these devices will eventually allow them to become embraced by politicians and the general population. BWX Technologies is a $5 billion specialty manufacturer and service provider of nuclear components. Additionally, the Lynchburg, Virginia-based firm provides uranium processing, environmental site restoration services, and other solutions to the nuclear power industry. With average annual revenues around $2 billion, the company is perennially profitable.
We, 08 Jun 2022
Renewables
Solar stocks surge on Biden’s decision to hold off on new solar tariffs for two years
Investing in the solar energy movement has always been fraught with danger, with the slightest shift in sentiment or any new legislative (or executive) actions generally causing an oversized reaction by investors in the industry. The latest news on the latter front, however, had solar enthusiasts cheering. The Biden administration announced there would be no new tariffs placed on solar panel imports for the next two years. There had been a major push underway by the US Department of Commerce to investigate whether global solar panel suppliers were using deceptive tactics to avoid getting hit with tariffs on goods emanating from China. That push, along with supply chain constraints, led to a major slowdown in solar panel installation in the US. In a decision we find more impactful on the US economy, the president also signed three executive orders designed to increase domestic production of solar panels. Tesla, which had been in partnership with Panasonic to produce such panels at a Buffalo, New York facility, has since exited the production side of the business and now focuses solely on installation of the systems.
The Invesco Solar ETF (TAN $78) has been on a roller coaster ride this year, dropping 25% before rebounding to flat YTD. The new legislation, along with soaring energy prices, could provide a catalyst for the companies within this fund in the second half of the year. Enphase Energy (ENPH $214) is the largest of the fund’s 42 holdings, with a 12% weighting.
While we do not currently own any direct solar plays in the Penn strategies, we do own Tesla (TSLA $737), a major renewables player and lithium-ion battery manufacturer, in the New Frontier Fund.
We, 01 Jun 2022
Monetary Policy
The Fed will finally start reducing its $9 trillion balance sheet this month
It is hard to imagine, but just nineteen years ago, in 2003, the Federal Reserve had around $700 billion of assets on its balance sheet. That amount, it should be noted, is one component of the national debt. After the financial crisis of 2008-09, the balance sheet more than tripled, hitting $2.25 trillion. At the time, those figures were hard to fathom. Quadruple that amount and we have the current size of the Fed balance sheet. June is the month the figure finally begins going down.
Four large Treasury securities held by the Fed, worth $48.25 billion, are maturing this month. In previous months, the Fed would have reinvested the proceeds, purchasing an equal amount of new securities. Instead, it will let $47.5 billion simply run off the balance sheet, only reinvesting the final $1 billion or so. It will continue this process until September, at which time it will double the amount allowed to mature without reinvestment, reducing the balance sheet by $95 billion per month. This may seem like a rapid pace, but it will only amount to a $522 billion reduction by the end of this year, and an additional $1.1 trillion by the end of 2023. If the downward trajectory continues, the Fed balance sheet will be back to pre-pandemic levels by the summer of 2026.
That date may seem far in the future, but there is something even more unsettling about the entire process: we will probably never get there. The continued reduction is contingent upon the economy humming along between now and June of 2026. Does anyone really believe that yet another “urgent crisis” will fail to manifest? Our best hope is that the balance sheet is reduced by a few trillion dollars before the Fed is forced to go on its next buying spree.
Rarely are two of the Fed’s three main tools used in tandem, at least to this degree: an increase in short-term rates plus a simultaneous reduction of the balance sheet through open market operations. These two actions will undoubtedly have an impact on the housing market specifically, and the overall economy in general. Hence, the doubt expressed by economists that the Fed can execute a “soft landing” as opposed to fomenting a recession. A fascinating case study to watch.
Tu, 31 May 2022
Food & Staples Retailing
The dollar stores provide a much-needed positive catalyst for the markets
Certainly with respect to retailers, it seems all we have been hearing about lately is margin contraction. Consumer Staples companies, which sell the goods people need under all economic conditions, have been maintaining their gross sales levels, but their net profits have shrunk due to higher input, labor, and transportation costs, as well as disruptions in the supply chain. In other words, inflation is killing their bottom line.
Assuming the so-called dollar stores (Dollar General and Dollar Tree primarily) would suffer the same fate at their larger brethren such as Walmart and Target, these companies had their respective share prices hammered in sympathy. All the bad news was priced in before the numbers ever came out. This was true more so for Dollar Tree (DLTR $164), which carries a larger percentage of discretionary items than does Dollar General (DG $228).
Lo and behold, both companies surprised to the upside, sending shares of DG and DLTR up by double digits. Dollar General announced revenue of $8.8 billion, earnings per share of $2.41, and a negligible decline in same-store sales. The company also raised its full year sales guidance and maintained its bottom-line income projections. Dollar Tree posted revenues of $6.9 billion and earnings per share of $2.37, also beating analysts’ predictions, and raised its full year guidance.
How are these low-cost darlings able to withstand inflation better than their larger competitors? Primarily, the answer revolves around management’s effective use of inventory tactics to preserve profits. Dollar General CEO Todd Vasos, for example, explained that the company can shift to substitutes when certain goods go up in price. They have also added self-checkout lanes to over 8,000 stores and have plans to turn another 200 locations into self-checkout only, thus reducing labor costs. For its part, Dollar Tree’s decision to raise the price of its $1 items to $1.25 hasn’t had any detrimental effect on sales. Finally, as could be expected, higher prices are driving more and more Americans to visit these stores; names which they may have shunned in the past. Expect this trend to continue through next year, as the US faces a probable recession.
We have long regarded Dollar General as one of our most defensive plays in the Penn Global Leaders Club. Even after the economy troughs in 2023 or 2024 and begins a new expansion phase, the unique value proposition of the company—such as where the stores are located—means it will probably remain a core holding in the strategy.
We, 25 May 2022
Fintech
AI-powered ETF is facing its first major test, and the results have not been pretty
We recall being intrigued about five years ago when we heard of the AI Powered Equity ETF (AIEQ $32), the so-called robot-managed exchange traded fund. This automated, data-driven fund would “harness the power of IBM Watson to equal a team of 1,000 research analysts, traders, and quants working around the clock.” Using artificial intelligence instead of human brainpower, predictive models would be built on some 6,000 US companies. These models would analyze millions of data points across news, social media, financial statements, and analyst reports to build a more efficient fund. Between 30 and 200 companies with the greatest growth potential over the following twelve months would be purchased, with adjustments being made constantly. Truly a fascinating concept.
It is always a good idea to let concepts prove themselves before jumping in, so we held off on adding AIEQ to the Penn Dynamic Growth Strategy—our ETF portfolio. Watson is certainly an incredibly powerful tool which may enhance a plethora of different industries, but wasn’t it the machine behind our weather app which we were less-than-impressed with? Perhaps Watson could have even predicted how AIEQ would perform in a downturn, but we wanted to find out the old-fashioned way.
Unfortunately, the fund got a chance to prove itself following the worst market start to a year since 1970. Based on the rather impressive breakdown of holdings (roughly an equal representation in Health Care, Industrials, Technology, and Consumer Cyclicals, followed by Financial Services, Consumer Defensives, and Basic Materials companies), the benchmark for the fund would be the S&P 500. While that key market benchmark has given up around 17% year-to-date as of this writing, AIEQ is down 23.84%. We expanded the scope of our comparison to include the Dow Jones Industrial Average (30 holdings), the NASDAQ (primarily tech names), and the Russell 2000 (small-cap proxy). Only the NASDAQ composite, with its 27% loss, underperformed the fund. The narrative was excellent; unfortunately, the results were not. Back to the drawing board.
The Penn Dynamic Growth Strategy (PDGS) is currently comprised of 25 holdings; overwhelmingly ETFs (due to their intraday liquidity, lower general costs, and other factors), and a couple of open-end mutual funds which we rate as exemplary. The Strategy uses a core/satellite approach, with the satellite funds being more tactical in nature (Invesco DBA Agriculture ETF is a great example). The PDGS is actively managed, with changes being made based on the economic, investment, and geopolitical environment.
We, 25 May 2022
Interactive Media & Services
Snap shares just fell 43% in one day; in 2017, we called the company’s share class structure a sham
After social media company Snap (SNAP $13) lowered its outlook for the year—ultimately causing shares of Snapchat’s parent company to fall 43.08% in one day—we immediately began perusing our past notes on the firm. Our first comments came in February of 2017 as the company was about to begin its IPO roadshow. Setting a price target of between $14 and $16 per share, the company would immediately have a $20 billion market cap in what would be the largest US tech offering since Alibaba (BABA $82) went public in 2014. We urged investors not to bite. The roadshow was such a success that the IPO shares were more than ten times oversubscribed. They ultimately priced at $17.
Our next note on Snap came just a month later, in March of 2017. This time we said that investors were getting a raw deal with respect to the share class structure. Get this scheme: The company would sell schmucks like us Class A shares, which came with no voting rights but did “entitle” buyers to attend the annual shareholders’ meeting and “ask questions.” Gee, thanks. Executives of the company could acquire Class B shares, which came with one vote each, while Snap’s founders would own the coveted Class C shares which came with ten votes apiece. Talk about some fancy financial engineering.
The catalysts for our other notes on Snap were earnings reports. In all but one case, shares had plummeted on lower-than-expected numbers or worse-than-expected guidance. The latter was the cause for Tuesday’s 43.08% drop, taking the shares down to $12.79, or 25% lower than the $17 per share initial offering price. What a mess.
SNAP shares now sit 85% off their September 2021 highs. Some might see a bargain; we still see an aristocracy in which the company’s rulers have no idea what they are doing.
Mo, 23 May 2022
Market Pulse
Consumer staples fell dramatically last week, but the Dow is attempting a comeback
If there was one positive sign in this five-month-long anxiety-riddled market tumble, it had been the fact that consumer staples—those stolid, earnings-rich companies that sell goods people need under all economic conditions—were holding their own. That changed last Wednesday after Target (TGT $155) shocked the market with news that profit margins were getting seriously crimped by high inflation—from higher fuel costs to a spike in commodity prices. This exemplary company, which was up around 300% since we added it to the Global Leaders Club, lost one quarter of its value in one day; its worst one-day hit since 1987. And it wasn’t just a Target problem. The prior day, Walmart’s (WMT $122) earnings showed the same challenges, pushing WMT shares down 11%. Ironically (or not), that was also their worst single day since 1987.
We all know what happened in 1987. I was in the US Air Force rather than a cushy chair at an investment firm back then, but I remember the fear being palpable. There really wasn’t a single major catalyst that would explain away the massive market drop, which was part of the problem. Investors feel better if they can point to a viable reason for a system shock, and there wasn’t one in October of 1987 (though there was a confluence of events, much like today). Many investors made the worst possible mistake that month: they began selling even their best positions. Over the course of the next six months or so, the Russell 2000 (small caps) had rallied 37%, the NASDAQ was up 32%, and both the S&P 500 and Dow were up 20%. Those who sold in October missed a remarkable rally right around the corner.
This is not March of 2000. The current bear market much more closely resembles the one which occurred in the fall of 1987. Inflation is real, and the Fed will do what it takes to get it under control (raise rates and reduce the balance sheet), which may push the economy into a mild recession next year. But we wouldn’t be surprised to see the same type of rally occur in the second half of this year that began on 7 December 1987. Friday afternoon and Monday’s follow through may portend that coming rally: the Dow was down over 600 points with a few trading hours left in the week, only to rally into a positive close. That rally continued Monday, with the Dow finishing up 618 points—or more than 1,200 points higher than Friday afternoon’s low. Of course, we have no way of knowing whether the bottom of this current market downturn is in, but it is refreshing to see buyers jumping back in after being pummeled for seven straight weeks.
We, 18 May 2022
Editor's Corner
Don't wave the American flag while watching your cargo ships roll in...
We have preached repeatedly about the irresponsible manner in which so many American companies became overly reliant on a communist nation with respect to trade; how executives became seduced by a massive population for the sale of their goods, and a dirt cheap labor force for the production of those goods. Distressingly, it took a global pandemic originating from that country for many of these companies to (finally) look at reducing their country risk. Still, the narrative these firms weave for public consumption is enough to make us choke.
One major US retailer has a "Made in America" campaign running to proudly proclaim how the goods they sell are made in the US. They use a flower grower as an example. Try finding a flashlight or a can opener at this retailer made anywhere around the globe other than China. You won't.
We are not xenophobes by any stretch, and we still support companies which source from factories in virtually any country outside of China, Russia, North Korea, or Iran. That being said, more can and should be produced domestically. Especially with the Fourth Industrial Revolution at our doorstep, with many American technology firms and universities leading the charge. What can we, as consumers, do to help the process along? We can get in the habit of checking where the goods we buy are actually produced, and providing feedback via direct contact and social media when we don't like what we see.
Tu, 17 May 2022
Construction Materials
Armstrong Flooring paid out $4.8 million in bonuses to execs—then declared bankruptcy
The world of home flooring is one of those murky, opaque realms in which performing due diligence is extremely difficult—often by design. Take, for instance, a home buyer who wants to assure their builder uses wood flooring sourced from anywhere but China. Good luck. The company may be American, and their final products may be designed and even produced in the US, but that doesn’t mean the “cores” of factory-made materials didn’t come from the communist nation. Which leads us to a recent story about Armstrong Flooring (AFI $0.32).
While we couldn’t readily determine what percentage of the company’s wood flooring materials emanated from China, at least they had the courage to admit—clearly on their website—that they do have a flooring plant in the Jiang Su Province of that country—in addition to plants in the US and Australia. We point this out because the company cited supply disruptions and higher transportation costs as two of the reasons it was forced to declare bankruptcy this past week. Never fear, though, as the company fully plans to continue operating while in bankruptcy while it devises plans to emerge. Armstrong told the Delaware court that it owed some $300 million to creditors and has roughly $500 million worth of assets, giving it a debt-to-equity ratio of 61.5%—up from 28.3% in March of 2020 and 17% in September of 2018.
We are happy for the employees of Armstrong, but we must wonder how happy they were to learn that senior executives received some $4.8 million worth of annual incentives just before the company declared bankruptcy; incentives that would have almost certainly been disallowed by the courts. An Armstrong attorney told US Bankruptcy Judge Mary Walrath that these execs (the CEO and at least three others) were key in securing funding, but aren’t the employees key as well? It should be noted that the company’s CEO was the “chief sustainability officer” at Mohawk Industries between 2017 and 2019. It should also be noted that Armstrong had 1,600 employees as of the end of 2021. That $4.8 million would have meant a nice bonus of $3,000 for each, and we will even include the top executives in that package.
We love American free enterprise, which is why we must hold all companies to the highest possible standard. We are not accusing Armstrong of doing anything illegal or even unethical, but companies that wave the American flag and wax eloquent about sustainability had better make sure they are practicing the ethics they preach. The last year Armstrong Flooring turned a profit was 2016, which happens to also be the year that Armstrong World Industries (AWI $84) offloaded the firm as its own publicly traded company, trading in the $19 range. These decisions don’t happen in a vacuum, and it behooves investors to look well beyond the glossy ads and company websites when reviewing a company for possible purchase. Pull up the rug and see what’s underneath, so to speak.
Tu, 17 May 2022
Global Organizations & Accords
Turkey’s objection to Sweden and Finland joining NATO is all about personal gain
Turkey has never been a faithful ally to the West. While desiring to be considered a mainstream Western European country, it has acted in the best interest of the Middle East. While demanding arms from the United States, it gladly accepts a missile defense system from Russia. President Recep Erdogan “massages” the country’s constitution to remain firmly ensconced in power while political opponents are dealt with swiftly and harshly. Now, as two truly European countries, Sweden and Finland, begin their application for formal membership into NATO, Erdogan runs interference, knowing full well that all current members must approve their entry.
Erdogan’s position, as usual, has nothing to do with the common good and everything to do with his own greed and self-enrichment. While claiming that the two Nordic countries need to clamp down on “Kurdish terrorist activities” in the region, he has no problem inciting—or outright approving—terrorist activities at home. Knowing full well that his approval is needed, expect this would-be dictator to successfully milk a host of concessions out of Europe before bestowing his magnanimous blessing on a strengthened NATO. While his good friend Putin won’t be happy with this ultimate decision, Erdogan will have enriched himself, yet again, by playing the dirty merchant of Europe.
On a scale of 1-9 on the democracy meter, Turkey has an abysmal rating of 4.35—more in the proximity of a Russia or a China as opposed to those of its Western neighbors. This won’t change as long as Erdogan is in power, and we don’t see him loosening his grip on that power any time soon.
Tu, 17 May 2022
Airlines
JetBlue is going hostile for Spirit, and it is a complete waste of time
We know how much the big four US-based airlines—American, United, Southwest, and Delta—were financially impacted by the pandemic, and quite understandably so. It follows, then, that the smaller players would be in even rougher shape following the two-year nightmare. Consolidation within the industry among these smaller players makes sense, and we reported this past February of Frontier’s (ULCC $9) plans to acquire Spirit Airlines (SAVE $19) in a deal valued at $2.9 billion ($6.6 billion with debt added in). Another small-cap player, JetBlue (JBLU $10), felt threatened by this move (rightfully so), and made its own offer to buy Spirit for $3.6 billion in an all-cash offer. Interesting, as the market cap of JBLU is just $3 billion. Not seeing a path toward regulatory approval, Spirit said thanks, but no thanks.
Which leads us to JetBlue’s current tactic: going hostile. Denouncing Spirit’s management team for refusing to perform due diligence with its offer, the company said it will actively pressure SAVE shareholders to reject the Frontier bid at a 10 June meeting. Bizarrely, JetBlue said that it would raise its $30 per share offer to $33 per share if management comes back to the table and provides the financial information being requested. That does nothing to alleviate the real problem: we see no circumstances under which the antitrust forces at the Department of Justice and the Federal Trade Commission will allow the JetBlue/Spirit deal to go through. In fact, Spirit CEO Ted Christie has explicitly stated that this may simply be about foiling the Frontier deal. We believe his argument will carry the day with shareholders. A combination of any two of these players would create the country’s fifth-largest airline, leapfrogging over Alaska Air Group (ALK $47).
JetBlue has a host of problems which Spirit wants nothing to do with, to include a worst-in-class, 62% on-time rate. Furthermore, the carrier is already in the Justice Department’s crosshairs, as the agency sued to block the airline’s regional partnership with American Airlines last year. Ultimately, we see the original Frontier acquisition getting approved, which will make JetBlue’s position in the industry even more tenuous.
Mo, 16 May 2022
Aerospace & Defense
Ryanair’s fiery Irish CEO loves Boeing, but “management is a group of headless chickens”
We love CEOs who are true leaders, are interesting characters in their own right, and who don’t feel the need to insert themselves into the political arena to score sycophantic points with super-sensitive stakeholders. Irish low-cost carrier Ryanair’s (RYAAY $81) fiery CEO, Michael “Mick” O’Leary, easily checks all three boxes. When Boeing’s (BA $126) hapless CEO, David Calhoun, is on one of the business networks, we mute the TV to avoid hearing the canned hot air delivered with a strained jumpiness; when we see O’Leary’s face, we always listen with rapt attention. A little background on Ryanair’s history with Boeing: the company has always been one of the aircraft maker’s most loyal customers. A European airliner with a fleet of 471 Boeing aircraft, 145 more on order, and just 29 Airbus (European) aircraft. That made us applaud all the louder when, during a Ryanair earnings call, O’Leary blasted Boeing’s management team and its inability to make good on orders. Saying they need to “bloody well improve on what they’ve been doing…,” he added that, “At the moment, we think the Boeing management (team) is running around like headless chickens.” Hey, that’s just what we have been saying ever since Calhoun anointed himself—with the Board’s blessing—CEO! Hear, hear! How refreshing to have a leader who tells it like it is. We could quickly list a dozen major US companies which could use someone like O’Leary at the helm.
Our minuscule impact on Boeing is limited to not owning it in any of the Penn strategies. We have to believe that the words of a Boeing cheerleader and major customer would have some major sway in the industry. Then again, Boeing has proven itself to be quite tone deaf since Jim McNerney left the firm in 2015, so who knows. It is probably the customer’s fault, right?
Mo, 16 May 2022
East & Southeast Asia
For the US, there was only one direction to go in the Philippines after Duterte
Many of us vividly recall the presidency of Ferdinand Marcos, and the endless stories written by the American press about his wife Imelda’s shoe collection. We thought back to his regime, which ended with a thud in 1986, this past week as his son, Ferdinand “Bongbong” Marcos Jr., notched a landslide election victory to become the next president of the Republic of the Philippines. For the United States, the importance of having a strong ally in this strategically critical region of the world cannot be overstated. Once one of America’s staunchest advocates in Southeast Asia, the country moved decidedly away from its old friend—and toward China—under President Rodrigo Duterte’s six-year rule. Until a last-minute change of heart, in fact, Duterte had all but cut military ties with the US by threatening to end the longstanding Philippines-United States Visiting Forces Agreement (VFA).
Along with the election of Marcos Jr., Filipinos sent a clear message that they do not wish to be subservient to their would-be Chinese masters. Overwhelmingly, voters expressed their unease with Duterte’s cozying up to China’s Xi Jinping. For its part, American military exercises in the South China Sea have enraged China, and the country’s ruling communist party has done everything it could to poison the relationship—not a difficult task with the mercurial Duterte in power. Now, with a huge favorability rating he does not wish to squander, we can expect Marcos to govern in a manner more conducive to overall stability in the region, and that is not what China had been hoping for.
Even though Duterte’s own daughter is the vice president-elect, this election was a clear victory for America’s interests in the region; as much of a victory, in fact, as the March election of Yoon Seok-youl in South Korea. Controlling the South and East China Sea regions are a linchpin to China’s grand ambitions, and the citizens of South Korea and the Philippines have indicated precisely what they think of those plans.
We, 11 May 2022
Automotive
Before a meme stock-like comeback, Carvana shares dropped 92% in nine months
Back in August of last year, used auto platform Carvana (CVNA $30) could do no wrong. Despite a lack of positive net income in any given year over its ten-year history, the company’s sales growth was spectacular, growing from $42 million in 2014 to $11.77 billion in 2021. Investors rewarded the competitor to such names as Carmax (our favorite in the space), Cars.com, and Autotrader by driving CVNA shares up to an intraday high of $376.83 on 10 August 2021. Fast forward precisely nine months, and traders are fleeing the maker of the highly unique Carvana Vending Machines. Shares hit a new 52-week low of $29.13 on the 11th of May after management announced a 12% reduction in its workforce; that price represents a 92% drop from the August highs. Another reason investors soured on the company was news of its acquisition of Adesa US, the wholesale vehicle auction division of KAR Auction Services, for $2.2 billion. Not due the acquisition itself, but the financing scheme: Carvana would be issuing $3.3 billion in junk bonds carrying a yield of 10.25%. In decades gone by, that might seem fine for a junk bond rate; today, it seems too good to be true (for bond buyers). Longtime Carvana investor Apollo Capital Management agreed to secure some $1.6 billion of that paper. As for the layoffs, which equate to roughly 2,500 employees, the company told the SEC that senior management would not collect any salaries for the remainder of the year to help fund the severance packages.
We feel for the investors who bought shares in the company last August. Price targets now range from $40 to $470 among analysts on the Street, but we wouldn’t touch the shares right now—or the 10.25% bonds. The company’s cash burn rate will be hard to sustain, even with the new round of funding.
Fr, 06 May 2022
Week in Review
Despite a hopeful FOMC day, markets suffered their fifth straight week of losses
It would be nice just to focus on Wednesday. Yes, that was the day the FOMC raised rates 50 basis points, the most since May of 2000, but the markets cheered when the Fed Chairman took a 75 basis point rate hike off the table. Between that comment and his belief that the Fed can pull off a “softish” landing, markets took to rallying: the Dow Jones Industrial Average gained 932 points and the NASDAQ rose 3.19%. Unfortunately, there were four other days in the trading week. Like the happy partygoer who wakes up the next day and asks, “what the * was I thinking?” the major benchmarks all made a swift change in directions. The Dow, in fact, shed over 1,000 points for the first time since the spring of 2020. Even a really strong Friday jobs report seemed to irritate the markets. The week’s drop signified the fifth straight down week for the benchmarks, and the worst start to a year since 1970. And that is not a decade we wish to see repeated. We said to expect wild market fluctuations and plenty of volatility during the rate hike cycle, and that certainly manifested itself this past week. The good news? Plenty of great, revenue-generating, industry-dominating American tech giants are now selling at bargain basement valuations. And for the record, we believe investors will be pleased with where the major indexes end the year—especially from the current vantage point.
Fr, 06 May 2022
Under the Radar
Hanesbrands Inc (HBI $12)
I rediscovered Hanes while on a search for socks, t-shirts, and briefs that were actually manufactured somewhere other than China. Sadly, that is a lot harder task that one would assume. In the end, Hanes was the one brand which came shining through. Channeling my inner Peter Lynch, I decided to do a deeper dive into HBI stock. Founded in 1901 and based out of Salem, North Carolina, Hanesbrands includes the Hanes, Champion, Playtex, Maidenform, Bali, and Bonds (Australia) labels. Importantly, this company is vertically integrated: it produces over 70% of its goods in company-controlled factories across some three dozen countries. Unlike a troubling percentage of other American manufacturing firms, it never hitched its wagon to communist-controlled China. In addition to its vertical integration (a major plus considering current supply chain issues), management has successfully created a vibrant omnichannel network. The company sells wholesale to discount, midmarket, department store, and direct to consumer via an impressive online and digital presence. At $12 per share (down from a high of $34.80 and sitting at a 52-week low), this $4.4 billion small-cap value company has a forward P/E of 7.5, a tiny price-to-sales ratio of 0.6520, and a fat dividend yield of 4.72% based on current share price. With a new strategic plan called Full Potential, CEO Steve Bratspies—formerly an Executive Vice President and the Chief Merchandising Officer at Walmart—has a clear vision of where he wants to take the company. We are betting he succeeds. We would conservatively value HBI shares at $24 apiece.
Th, 05 May 2022
Monetary Policy
Fed raises rates most in one meeting since May of 2000; let’s hope the trend continues
In May of 1999, twenty-three years ago this month, the upper limit of the federal funds rate (FFR) was sitting at 4.75%. In an effort to prevent runaway inflation and cool the scorching-hot US economy, the Fed began raising interest rates. It capped that effort one year later, in May of 2000, when it raised rates 50 basis points, from 6% to 6.5%. Why is that history lesson important? Because, to staunch already-runaway inflation, the Fed just made its biggest move since that meeting twenty-two years ago: the Committee spiked rates (upper limit) from 0.50% to 1%. The history lesson also brings home another point. When rates topped out at 6.5%, the central bank had an enormous amount of room to tighten as it worked to avoid recession, which it did (lowering rates) between 2001 and 2003. The accompanying graph provides a wonderful visual for the difference between then and now. Rates must continue to go higher. At the very least, we need to get back to the average FFR of 2.5%. To do so in a timely manner would entail another 50 basis point hike at both the June and July meetings, respectively, and a 25 basis point hike in both September and November. Unless inflation shows real signs of cooling, that is the scenario we can expect to play out. We can also expect a few hikes in 2023, bringing the FFR up to 3% or higher.
In addition to the hike, Fed Chair Jerome Powell also announced a systematic paring back of the Fed balance sheet, which remains just shy of $9 trillion. More perspective: that debt load sat well below $1 trillion back in 2000. Starting in June, that astronomical figure will be reduced by $95 billion per month, equaling a $1.1 trillion reduction by May of 2023. Again, a good start.
With any luck at all, inflation can be tamed without the rate hikes pulling us into a recession until 2024—though the latter scenario may well play out in 2023. The longer we can keep a recession at bay, the more ammo the Fed will have leading into the next tightening cycle.
We, 04 May 2022
Education & Training Services
Textbook company Chegg’s market drop following its earnings release was irrational
Despite the fact that we like Education and Training Services company Chegg (CHGG $17), we knew it was overvalued when the shares were trading north of $100. Now, after falling some 85%—yes, you read that right—the shares are decidedly undervalued. In fact, one would almost have to assume the company were ready to go out of business to still be bearish at this level, and we expect the company to be around for a long time to come. The catalyst for the pummeling wasn’t rotten numbers for the quarter, it was forward guidance. In fact, Chegg’s revenue rose 2% year-over-year, to $202.2 million in the quarter; and adjusted net income rose 8%, to $50.1 million. Earnings per share easily beat the Street’s estimate of $0.24, coming in at $0.32. Finally, subscriber growth—that wonderful, “sticky” revenue stream—rose by 12%. The problems began to appear when management began talking. Claiming that more people were now focusing on “earning over learning,” CEO Dan Rosensweig warned of rough quarters ahead, lowering full-year revenue guidance from the $830M-$850M range to $740M-$770M. Those figures, and a similar reduction in expected earnings, helped the stock crater to a new 52-week low, falling 30% in one day.
Chegg has been aggressively growing its international footprint, offering a direct-to-student learning platform which should continue to increase its market share in a solid industry: education services. While we don’t currently own the company, we believe the shares could easily fetch $35 before long. That would give investors a 100% reward for taking on the risk of owning this small-cap name.
Tu, 04 May 2022
Trading Desk
Opening industrial automation leader within the New Frontier Fund
This current market downturn has been indiscriminate: it has taken some fine companies down to valuations not seen since spring of 2020. We are adding a great but beaten down industrial company to the New Frontier Fund. When you think of automation and the factory of the future, this mid-cap gem should come to mind. Members, log into the Trading Desk for details.
Mo, 01 May 2022
Economics: Goods & Services
Yes, the US economy contracted in the first quarter of the year; but no, it won't become a trend just yet
Technically, a recession is defined as two consecutive quarters of economic contraction within an economy. How concerned should we be, then, that the US economy shrunk by 1.4% in the first quarter? In our opinion, not very. While the headline number is concerning, some comfort can be found by reviewing the internal components of the Commerce Department's report, which was released last week. Government spending actually slowed, which may not be a good thing in the eyes of economists, but in the "real world," it signals at least a modicum of fiscal responsibility. The trade deficit soared in the first quarter on a surge in imports; certainly not a desirable condition, but one which shows the American consumer is still flush with cash and willing to spend. Visualize all of those cargo ships stuck at US ports finally offloading their goods. For all of the concern over inflation, higher prices didn't seem to mute consumer spending last quarter. Fixed investment—economic jargon for the purchase of physical assets such as machinery, land, buildings, and other hard assets—grew a whopping 7.3% in Q1, versus a 2.7% growth rate in the same quarter of last year. Hardly a sign that businesses are buckling down in anticipation of a pending recession. In short, don't expect a consecutive contraction when the Q2 GDP numbers are released in July.
In the past, slowing GDP figures would have certainly played a major role in the Fed's decisions on rates. However, with runaway inflation taking center stage, we still expect a slew of rate hikes this year. By the time the next recession rolls around, probably at some point in 2023, expect more normalized long-term interest rates—which we would anticipate being in the 4.50% range. That is a good thing, as it would give the Fed something to work with should it need to begin loosening once again.
We, 27 Apr 2022
Aerospace & Defense
David Calhoun will never run out of excuses for Boeing's problems; will shareholders ever run out of patience with him?
It was yet another disastrous quarter for formerly-great American aerospace giant Boeing (BA $152). Against underwhelming expectations for $15.9 billion in sales and a $0.15 per share loss, the company brought in just $14 billion in revenue (a 12% decline from the same quarter last year) and had a loss of $2.75 per share (an 80% larger loss than the same quarter last year). Boeing shares proceeded to drop some 14%, to their lowest level since October of 2020, giving the company a smaller market cap than European rival Airbus (EADSY $27) for the first time ever. Even the cash burn was worse than expected, with Boeing blowing through some $3.6 billion versus expectations for a $3 billion cash burn. The company has now missed analysts’ expectations in nine out of the last twelve quarters. Watching hapless CEO David Calhoun being interviewed by CNBC’s Phil LeBeau was painful. With an unsure, shaky voice, he blamed the quarter on everything but the management team—even citing the company’s last Air Force One deal as a reason for the horrible quarter. (If it were so bad, why did you make it?) We knew Calhoun, who was Chairman during the company’s two ill-fated 737-MAX crashes, was the wrong selection for CEO from the start. But he placed himself in the position shortly after telling us how much confidence the board had in then-CEO Dennis Muilenburg. He gave himself the role as the other board members nodded their sycophantic approval like Governor William J. LePetomane’s staff in Blazing Saddles. It should be noted that Calhoun’s compensation last year was $21 million, while the company lost some $4 billion over that time frame. With serious failures on both the aircraft and spacecraft side of the business, when will the madness end?
We sold our BA shares shortly after the second MAX crash—after holding them in one of the Penn portfolios for over a decade. With all the activist investors out there, often going after good management teams, where is the shareholder uprising at Boeing?
Tu, 26 Apr 2022
Random thought: Are we the only ones who find it a bit insincere for investment houses to "adjust" their S&P 500 predictions for the full year? If you are going to change your prediction, why make one in the first place? It is like placing a bet in March on a team to win the Super Bowl, then asking for your money back when October rolls around and your team is 1-4. We made our predictions in December that the S&P 500 would be at 5,100 by the end of the year; wouldn't changing that prediction (which we still stand by) be a bit deceptive?
Tu, 26 Apr 2022
Capital Markets
Fidelity plans to bring cryptocurrencies to your 401(k) plan; we applaud the move
Whatever you may think of Bitcoin, cryptocurrency is now its own asset class and it is here to stay. While this digital money has certainly not shown itself to be a hedge against inflation, nor an inversely correlated (to equities) asset class, it will be of growing importance to the capital markets. That is why we were happy to see Fidelity Investments, a major retirement plan provider, announce plans to include Bitcoin as a core option within its 401(k) plans. It won't be offered as a mutual fund or ETF, such as the Grayscale Bitcoin Trust (GBTC $29), but rather a dedicated asset account just like a plan's money market option. Fidelity would custody the assets on its own digital assets platform, charging between 75 and 90 basis points for administration. Employees' allocation to the crypto portion of their retirement plan would be limited to 20%, though individual employers could place further limitations on that percentage. How big is this move? Of a roughly $8 trillion 401(k) plan market, Fidelity controls approximately $3 trillion of that amount. Expect others to follow the company's lead.
We imagine Jack Bogle, the curmudgeonly old founder of Vanguard, is rolling over in his grave at this news. We recall him once arguing that employees were given too many options in their retirement plans, and that more controls (i.e., limitations) needed to be put in place by the government. Of course, that would have meant more assets under management for his company's less-than-stellar target-date funds.
Mo, 25 Apr 2022
Media & Entertainment
The rise and demise of CNN+ (a 30-day tale)
When we first heard that CNN was going to package a standalone streaming subscription service, our immediate thought was, "subscription overload time." We figured the effort would ultimately fail; we had no idea it would do so in under a month. The Warner Bros. Discovery (WBD $20) creation seemed doomed from the start, based on the fanciful wishes of WarnerMedia's management team to build CNN+ into a digital version of the New York Times. The faulty premise was the (arrogant) notion that millions of cord cutters who had previously viewed CNN as part of their respective cable package would suddenly be willing to subscribe to a standalone CNN news network. They threw out a "conservative" estimate of two million new subscribers by the end of the operation's first year. After all, that was a mere one-third of the six million subscriptions that the Times boasts. (The New York Times actually claims it just passed the ten million paid subscribers mark with its acquisition of The Athletic, but that involves some seriously creative math.) The management team even considered putting a paywall around the entire cnn.com site; as we say, arrogance. When AT&T (T $20) completed its WarnerMedia spin-off more quickly than expected, placing industry veteran David Zaslav at the helm, the end was at hand. We have a lot of respect for Zaslav, who has little tolerance for BS. The dream of milking off of AT&T and its deep pockets (and lack of good financial decision making based on past acquisitions) turned into a nightmare. Immediately after WBD began trading as a standalone, CNN+'s marketing budget was adjusted to zero. Chris Licht, former executive producer of Stephen Colbert's show, had just been brought in to run the new operation. One of his first duties was to tell the staff that the unit was defunct, and that they could try and get reassigned to other departments, but that most would be losing their jobs. Licht, himself, will be looking for other work soon. "This is a uniquely shitty situation," Licht told his stunned audience.
Is AT&T a worthy investment now that they have spun off WarnerMedia? No. Is Warner Bros. Discovery a good investment now that they are a standalone? No.
Fr, 22 Apr 2022
Market Pulse
There are different strains of downturns; investors should not sweat this week's garden variety
Investors are going to have to accept this simple fact: the markets will throw a number of tantrums during the Fed's tightening cycle, despite the irrationality of doing so. Quite often, there are very good reasons for a market selloff. March of 2020's downturn, based on the uncertain nature of a global health threat, was a good reason. When markets are vastly overvalued, like they were in March of 2000, that becomes another good reason for a big drawdown. Sometimes, however, the market sells off for very inane, irrational reasons. Chalk this week's downturn up to the latter. It was another one of those weeks when nothing worked: all of the major equity benchmarks fell, as did gold and oil. Bonds typically go up as equities go down; this past week, headline after headline read: "The Global Bond Market Rout." And it was, indeed, the bond market which drove equities lower. If anyone doesn't expect the Fed to raise rates 50 basis points at the May meeting, they have had their head in the sand. Let's be clear: fear of rate hikes is a really dumb reason for a market selloff. Even if Powell and company raise rates at every single meeting for the next year, we will still be below the historical average. The markets can withstand this course of events, despite the investor fits which will be thrown along the way. Here's why we are actually excited about the coming hikes: we will finally be able to pick up some decent-yielding bonds once again, which will mean stronger portfolio allocations. And at some point in 2023, when the Fed will be forced to reverse course due to a looming recession, those bonds are going to look mighty good sitting in our portfolios.
Tech stocks and small-caps have been hit the hardest this year, with both areas not far away from bear market territory. Scan some of the P/E ratios of strong tech/small-cap holdings; you might be surprised at how cheap they are. Want an example? Coinbase Global (COIN $132), a company we hold in the New Frontier Fund, had a P/E ratio of 172 one year ago; it currently holds a multiple of ten. Bargains abound, just choose wisely.
Fr, 22 Apr 2022
Leisure Equipment, Products, & Facilities
Floundering Peloton has one viable option remaining: get acquired and let the new owner broom the C-suite
We were early investors in Peloton (PTON $20), a company which brought a little life back into the languid fitness products market. We stood by the company when they were being attacked by thin-skinned viewers over a Christmas ad which we found to be highly effective—and not at all offensive. Even with the steep price for its products (the Tread+ was selling for around $5k with warranty), we liked the company's business model. Then, following a tragic accident involving a child as well as scores of other incidents, cracks began to appear in the management team's facade. After briefly trying to go on offense against the feds, Co-Founder and then-CEO John Foley was forced to strike a deal with the Consumer Product Safety Commission (CPSC), agreeing to offer a full refund for the 125,000 or so customers who purchased the pricey tread. Furthermore, the machine could be returned for a full refund at any point in time up until 06 November, 2022.
Since then (the agreement was announced last May), John Foley has stepped down as CEO, but the management missteps continue. As if a $39 monthly fee for the Peloton membership was not enough, the company announced it would be raising prices to $44 this June. Here's the insult to injury part (truly, no pun intended): The company's safety "fix," which was also part of the CPSC agreement, made it virtually impossible to use the tread without a membership! What a stupid move, considering the fact that users now have a full six months to think about that slap-in-the-face before deciding whether or not to get their full refund. Membership prices should have been reduced to $30 per month, and customers who willingly paid out a whopping amount of money should retain the ability to run on their tread without a monthly membership fee. That would have been an easy software fix, but that ship has now sailed.
The only remaining viable option for the company is to court suitors, such as Apple (it would be a great fit), and agree to be acquired. With a market cap of under $7 billion (it was a $50 billion company in January of 2021), that would be a win-win outcome. With an obtuse management team, however, that crystal clear option is probably not even being considered.
When PTON shares fell to $50, we said they may be worth a look—though we did not own them at the time. We obviously underestimated the management team's ability to make dumb decisions. Ultimately, we imagine the company will be backed into a corner and have no choice but to sell—or liquidate. As for us, we will continue paying the confiscatory monthly fees through the summer, then turn that fancy puppy in for a full refund and buy another company's tread. With the leftover dough, maybe we will buy a nice television to hang in front of the device; one that offers more than a single, captive, expensive channel. (For Peloton owners, go here for the CPSC recall info, plus the company's contact info; deadline for full refund is 06 Nov 2022.)
We, 20 Apr 2022
Under the Radar
Lundin Mining Corp (LUN.TO $14)
Lundin Mining Corp is a diversified Canadian base metals miner with operations in the United States, Brazil, Chile, Portugal, and Sweden. Copper production is the company's main source of revenue, with about 70% of last year's sales being generated by the base metal. That being said, gold, zinc, and nickel mining are also important components to the company's continued profitability. Not only do we like the miner's geographic footprint—which steers clear of geopolitical hotspots, we also like its mix of products: copper plays a critical role in electronics, power generation and transmission (especially renewables), industrial machinery, and construction. While the risk level is a bit high (3-year beta 1.750), owning the shares have been worth it (3-year alpha 5.090). Lundin has a strong balance sheet, little debt, and a 3.16% dividend yield for income-oriented investors.
We would place a fair value of $20 on LUN.TO shares; the company is appropriate for investors looking for income, a global commodities play, and a willingness to hold a higher-risk name.
We, 20 Apr 2022
Media & Entertainment
The Netflix nightmare continues: shares plunged 35% in one day
Admittedly, we have never been fans of Netflix (NFLX $218) the stock, which means we have missed out on some stunning growth in the past. It also means, however, that we avoided the 69% plunge in the shares between last November and this week. Unlike activist investor (and someone we like about as much as Netflix stock) Bill Ackman, who made an enormous bet on the company three months ago, buying some 3.1 million shares. A full 35% of the stock's decline occurred on Wednesday, following the release of an awful quarterly earnings report. Instead of gaining subscribers, as the company has done every quarter going back to 2011, Netflix actually lost 200,000 subscribers over the three month period. In guidance which stunned analysts even more than Q1's figures, the company said it now expects to lose two million more subscribers in the second quarter. Analysts had been predicting a pick-up of two million subs in the current quarter. While management pointed to the company's retreat from Russia as one explanation for the drop, we would argue that yet another increase in the subscription rate—to $15.49 per month—certainly drove some customers away. Tesla CEO Elon Musk tweeted his own rationale for the streaming service's troubles: "The woke mind virus is making Netflix unwatchable." As for Ackman, he just sold his 3.1 million shares for a huge short-term loss. At least that should help him at tax time next year.
Following the abysmal results, analysts began lowering their price targets for NFLX shares at breakneck speed. Even after their 69% drop, we still wouldn't touch the shares.
Tu, 19 Apr 2022
Airlines
To the delight of the carriers, federal judge in Florida rules CDC overstepped its bounds with airline mask mandate
On Monday, a federal judge in Florida ruled that the CDC had overstepped its authority when it decreed that masks were required to be worn by all passengers on aircraft and other means of public transportation. Shortly after the judge's ruling, the TSA announced that it would no longer enforce the mandate. By Tuesday, all of the major airlines lifted the requirement. In her ruling, US District Judge Kathryn Kimball Mizelle said that the Centers for Disease Control had failed to adequately give the rationale for its mandate, and did not allow for the normal procedure of public comment before issuing its decree. The United States Department of Justice is reviewing the decision and deciding whether or not it will appeal. In addition to the airlines, Amtrak has officially removed its mask requirement, as has private ride-hailing service Uber (UBER $33).
With vaccines and therapies now available, lifting the mask mandate was the common sense next step in our return to some semblance of normalcy. While many health experts are predicting strains of the disease will re-emerge with force when the weather turns colder this coming fall and winter, we don't see a return of either lockdowns or widespread mask requirements. In other words, the disease has become an endemic which must be managed by the health care system for the foreseeable future. As for the airlines specifically, we expect pent up demand for travel to fuel strong earnings over the coming quarters. We own United Airlines Holdings (UAL $45) in the Penn Global Leaders Club.
Tu, 19 Apr 2022
Capital Markets
Schwab gaps down nearly 9% on earnings miss
Retail financial services firm Charles Schwab (SCHW $76) lost nearly 9% of its value on Monday following a first quarter miss on both revenue and earnings. Analysts were looking for $4.83 billion in revenue and earnings per share of $0.84; instead, they got $4.67 billion in revenue and $0.77 in EPS. While retail activity has surged in recent years on the back of commission-free trading, daily trading volume at the firm actually dropped 22% from the same period last year. Increased volatility, new competition, and a return to normal activities following the pandemic all played a role in the company's challenges for the quarter. As for the earnings miss, the high costs associated with the TD Ameritrade acquisition and higher general expenses helped explain the lackluster quarter. Expenses for the three-month period came in $56 million above what Piper Sandler had projected, and 4% above last year's figures. Monday's drop represents the largest one-day decline in SCHW shares since March of 2020.
The company won't admit it, but the TD Ameritrade acquisition has brought about a good deal of unexpected headaches. These will eventually be worked through, but with its P/E ratio of 27 and its rather high price-to-sales ratio of 8, investors shouldn't be in a hurry to take advantage of this most recent drop in the share price.
Tu, 19 Apr 2022
Latin America
AMLO tried to nationalize Mexico's electrical grid; the lower house of congress short-circuited his plans
The state oil company of Mexico, Pemex, is the most indebted oil company in the world. This makes perfect sense, as it is owned and operated by a government rather than private enterprise. What Mexico accomplished through Pemex, President AMLO had hoped to do for the country's electrical grid: nationalize it. To that end, his allies in the Congress of the Union attempted to push through a bill restoring government control over the electrical sector. Fortunately for the Mexican people, the body's lower house refused to deliver. Needing a two-thirds majority to amend the constitution, only 55% of the lower chamber's members voted for the scheme, handing AMLO a rare legislative defeat. AMLO lashed out, calling critics of the bill betrayers of Mexico and defenders of foreign interests. Considering the bill's passage would have greatly diminished foreign investment in Mexico's energy sector, it sounds like these members were acting in the best interest of the citizenry.
This is yet another example of a country's leadership wishing to have it both ways: they want foreign money but wish to keep full control of the entities. It simply doesn't work that way. One of these days, Mexico will offer a great opportunity for investors. That day won't come, however, until elected officials understand and accept how a free market works. The easiest way to invest in the Mexican economy is through the iShares MSCI Mexico ETF (EWW $53). The fund lost 46% of its value in spring of 2020 during the early days of the pandemic, and has a one-year fund outflow of $518 million, leaving just $900 million in total assets under management.
Economics: Supply, Demand, & Prices
June inflation came in red hot, but the market drop was misguided
On Wednesday the 13th, June’s inflation numbers rolled in. They were expected to be high, but investors discounted the spike and futures were up. Within seconds of the scorching 9.1% year-over-year number being released, futures took a U-turn and tumbled some 400 points on the Dow and 200 points (-1.8%) on the Nasdaq. A 75-basis-point rate hike was already expected for July; after the report, odds of another 75-basis-point hike in September (there is no August FOMC meeting) more than doubled to around 78%. Keeping this in perspective, these two probable hikes would just put the upper limit of the Fed funds rate at 3.25%. For all the comparisons to the 1970s and 1980s, consumers could only dream about such low rates back then. The Fed should—must—make these moves.
As for the market’s immediate reaction, it was misguided. We believe that peak inflation has now hit, and that prices should begin to stabilize. Commodity prices, which have been on a steep trajectory for the past nine months or so, have turned the corner and are now pulling back at a rapid clip. Auto repossessions are exploding as an inordinate number of Americans who purchased vehicles during the pandemic have suddenly stopped making payments. Buyers and renters are pushing back against the high price of homes and 14% increase in leases by holding off on making a move—or, in the case of younger renters, moving back home. Companies of all sizes, expecting a recession, have begun to pull back on capital expenditures. Smaller companies are really feeling the pinch. Forget the American consumer for a moment: if companies start to pull back on spending, inflation will begin to subside.
Copper, a fundamental industrial-use metal, has lost one-third of its value since April. Wheat, corn, and other ag products have also dropped precipitously over the past few months. Even oil has dropped back below the $100 per barrel rate. These are signs that inflation is starting to return to more normal levels. Add a price-wary consumer to the mix, and suddenly the headline narrative begins to deflate, no pun intended. Mild recession or not, the second half of the year could hold some pleasant surprise for investors. At least the ones who resisted the urge to panic.
By “resisting the urge to panic,” we mean sticking to one’s proper portfolio diversification. On that front, we are excited by the Fed’s rate hikes as they signal some great bond issues are on the horizon. In the meantime, investors should remember that cash truly is an asset class, and a 20% allocation to that class is not excessively high right now. Dry powder to take advantage of the coming opportunities.
We, 06 Jul 2022
Airlines & Air Freight
JetBlue just can’t win: FAA awards coveted Newark slots to Spirit alone
Three miles south of downtown Newark and nine short miles from Manhattan lies Newark Liberty International Airport. Serving some 40 million passengers annually prior to the pandemic, the airport remains one of the busiest in the world. Back in 2019, Southwest Airlines (LUV $36) pulled out of the airport due to falling revenue amidst the grounding of Boeing’s (BA $135) 737-MAX fleet. This week, the FAA awarded all sixteen open slots at Newark to low-cost carrier Spirit Airlines (SAVE $25). JetBlue (JBLU $8), which has already been rebuffed twice by Spirit as a takeover target, had also been vying for the slots. A spokesperson for the FAA’s parent organization, the Department of Transportation, said that awarding all slots to Spirit would improve competition and secure more low-cost flights for Newark passengers.
A few weeks ago, JetBlue sweetened its takeover offer for Spirit, offering shareholders $30 at close and $1.50 per share in prepayment (from a raised reverse break-up fee). Spirit’s management team, however, remains committed to Frontier’s (ULCC $10) takeover offer, arguing that the deal will not face the same level of government scrutiny. (They are correct: we don’t see the respective government agencies approving a JetBlue/Spirit merger due to routing and competition issues.) Two major shareholder advisory firms, Glass Lewis and Institutional Shareholder Services (ISS), are now urging approval of the Frontier bid during this month’s shareholder vote.
It is difficult to find any airline we like right now due to inflation, a slow-moving economic slowdown, and chronic flight cancellations. We have one carrier in the Global Leaders Club, United (UAL $37), but we have a tight stop loss order on the shares. As for the airline in the direst straits (in our opinion): we wouldn’t touch shares of JetBlue.
We, 06 Jul 2022
Currencies & Forex
For the first time since 2002, the dollar is reaching parity with the euro
We always found it bizarre that certain politicians and leading economists would express a desire for a weak US dollar. Yes, our lopsided balance of trade can be aided by a weaker domestic currency, as it makes US goods cheaper for the world to buy, but the root causes of this condition are almost always troublesome. Furthermore, it harms the American consumer because their money doesn’t go as far. In essence, it is a signal that “our economy is weaker than yours.” Hardly bragging rights. For example, as the US was in the midst of the Financial Crisis of 2008/09, the euro, which was created in 1999, hit a high of €1.60 to one greenback. Many Europhiles have since predicted that parity would never be reached again. Lo and behold, the two currencies are now skirting near that level right now, with the euro hitting a two-decade low. This is due to the Fed’s willingness to raise rates until inflation is quelled, while the ECB begrudgingly signaled that it would finally raise rates by 25 basis points in July. The responsible actions on the part of the Fed add to the dollar’s strength, as global investors seek safe haven for their lowest-risk assets. While the US will probably have to battle a recession early next year, at least the Fed will have some fresh ammo; not so much the case in Europe, which is facing a deeper economic trough.
US multinational corporations do like a weaker dollar, as it makes their goods cheaper for the world to buy. The best way for an investor to take advantage of a strengthening dollar is through a bullish dollar ETF, such as the Invesco DB US Dollar Bullish fund (UUP $28), or by adjusting their portfolio toward small-cap US companies, most of whom sell overwhelmingly to domestic customers. In this space we use the Invesco S&P SmallCap 600 Revenue ETF (RWJ $103), a value/core fund which owns top revenue-producing smaller US companies.
Fr, 01 Jul 2022
Market Pulse
Worst first half of the year since 1970, but where do we go from here?
There have been a lot of comparisons to the 1970s floating around recently, and for good cause. After all, many of the same antagonists we faced fifty years ago haunt us today: China, Russia, inflation, high oil prices, and general economic malaise. Then there are the market comparisons. Yes, we have just closed out the worst first half of any year for the S&P 500 since 1970, and for the Dow Jones Industrial Average since 1962. Furthermore, the Nasdaq and Russell 2000 (small caps) just had their worst start to a year--ever. Anyone listening to the doom and gloom in the press and among economists certainly don’t feel much like buying. It is as if the all-but-guaranteed recession at our doorstep will mean the end to life as we know it. The negativism is palpable.
As we have recently noted, the entire decade of the 1970s was not kind to the markets; however, it was not just one big ten-year decline for the indexes. After dropping around 25% in the first half of 1970—eerily similar to 2022—the S&P 500 actually gained back nearly all of its losses on the back half, finishing the year down under 1%. While the Nasdaq didn’t come about until 1971, the same could be said of many of its would-be components back then.
At the end of the first half of this year, the S&P, Nasdaq, and Russell 2000 all found themselves in bear market territory, as defined by at least a 20% drop. The Nasdaq got hit the hardest, falling 30%. Bonds, which are supposed to provide a hedge to market losses, dropped 10.7% in aggregate over the past six months. Investors now seem certain on more rate hikes, a recession, terrible corporate earnings, a continuing war in Ukraine, and stubbornly persistent higher oil and gas prices. In other words, the stock market now reflects the worst of all possible outcomes for the second half.
This has created a condition in which large tech names like Microsoft, Apple, Adobe, and Amazon appear as though they are value plays. And large cap core/value names like Dollar General, Target, Pfizer, Home Depot, and Lockheed Martin have multiples that would have made investors drool last summer. All of these companies have rock solid balance sheets and strong fundamentals, it should be noted. The last time we remember solid companies selling off like this was March of 2020. June, it just so happens, was the worst month in the market since (you guessed it) March of 2020. Fear and gloom have taken over. Historically, with respect to equities, that has nearly always been the time to buy; never the time to panic.
Will the second half of the year be an encore to the second half of 1970? While we can’t say for sure, it wouldn’t surprise us a bit. Nonetheless, protection on positions and a larger allocation to cash (as we await higher rates which will lead to better bond values) are certainly prudent measures to maintain right now.
We, 29 Jun 2022
Hotels, Resorts, & Cruise Lines
Morgan Stanley analyst: Carnival Cruise Lines could go to $0 in worst-case scenario
Every time we write about Carnival Corp (CCL $9), we begin with the disclaimer that we have disliked the company and its shares for some time. A year ago, we wrote about members of senior management talking up the company’s great growth prospects while simultaneously offloading their own shares—at a much higher price than they are today, we might add. CCL shares were selling for $19 at the time. Morgan Stanley analysts have apparently had enough as well. The company maintained its “underweight” rating on the stock (why not “sell”?) while lowering the price target to $7. This helped drive the stock down some 15% at the open, to under $9 per share. Even more disconcerting was the analyst’s bear case scenario for the cruise line: the price of the shares could possibly go to $0. The catalyst for that stunningly bearish call is, primarily, the company’s debt load. Carnival holds some $11 billion worth of short-term debt and $32 billion worth of long-term debt. It has a current market cap of $10 billion. Should an upcoming recession trigger another “demand shock,” it could spell the end of the line as the company would find it very difficult to secure even more funding (at higher rates, we might add). Not everyone is so bearish, however. Six of the 24 major analysts covering the stock have a “buy” rating on the shares. Count us in the Morgan Stanley camp.
Both Royal Caribbean (RCL $36) and Norwegian Cruise Lines ($12) fell nearly double digits in sympathy with Carnival on Wednesday. For investors betting on a cruise line comeback, either of those names would offer a much better play on the industry in our opinion. (Penn does not own any cruise lines within the five portfolios.)
We, 29 Jun 2022
Global Organizations & Accords
Obstacle falls: Turkey agrees to full NATO membership for Sweden and Finland
Considering his deranged mental capacity, Vladimir Putin will never admit to the enormous tactical error he made by invading Ukraine, but it is clearly evident to the rest of the world. Based on the false narrative that Ukraine posed a threat to Russia, he invaded with the expectation of killing the country’s leader, Volodymyr Zelenskyy, and installing his own puppet regime. He has obviously failed in that attempt, but the unintended consequences of his barbaric act can be summed up with one stunning development: NATO is coming to Russia’s northwestern doorstep.
The one obstacle holding back Sweden and Finland’s membership into the military alliance was Turkey, which has been in the group since 1952. Based on the group’s bylaws, any expansion required approval by all member-states. Turkey had opposed the Nordic countries’ ambitions to join due to their respective governments’ support for Kurdish “terrorists” allegedly residing within the two nations. Now, according to Turkish President Recep Tayyip Erdogan, those concerns have been assuaged, leaving a clear path toward membership. Erdogan’s announcement came at the alliance’s Madrid Summit, which can now focus on its plan to rebuild forces in Europe to counter the increased Russian threat. That country has threatened to station nuclear weapons along its border with Finland if the nations were admitted to NATO.
Back in the 1990s, following the fall of the Soviet Union, many misguided critics questioned the need for NATO to remain in existence. Today, it is once again as important as it was during the height of the Cold War.
The final straw which ultimately brought about the fall of the Soviet Union was Ronald Reagan’s Strategic Defense Initiative and the communist nation’s attempt to counter the program. History may well repeat itself: Russia is ill-equipped to counter a strengthened NATO on its border, but Putin will spend critical capital trying to do just that.
We, 22 Jun 2022
Municipal Bonds
Alabama finds underwriters for $725 million worth of tax-free prison bonds
Breaking down a rather complicated series of events, here is what is going on in Alabama with respect to the improvement of conditions for prisoners, and the funding of these upgrades. The state faced a lawsuit from the DoJ which alleged that inmates housed in the state’s prisons were being exposed to “cruel and unusual punishment” due to dilapidated conditions. One such building, the Draper Correction Facility, had been in operation since 1939. To answer these concerns, the state contracted with CoreCivic Inc (CXW $12), a specialty REIT, to build and operate newer facilities, leasing them back to the Alabama Department of Corrections.
To fund the projects the state planned to offer municipal bonds, with the debt being backed by annual appropriations to the Department of Corrections. After backlash over the privately built and managed facilities, Barclays Plc and KeyBanc Capital Markets, the primary underwriters, dropped out of the deal. A CoreCivic spokesperson called the activists “reckless and irresponsible” for (apparently) preferring to have inmates remain in the outdated facilities rather than support a public-private enterprise.
Now, the deal has a new set of underwriters: Alabama-based Stephens Inc and The Frazer Lanier Company will co-manage the sale, along with help from Raymond James, Wells Fargo, and several other backers. The bonds will carry an Aa2 rating by Moody’s and a AA- rating by S&P Global. The yield on these tax-free general obligation (GO) bonds has yet to be announced, but they should hit the muni bond marketplace within the next month.
As rates bottomed out and the world was in the midst of the pandemic, there was a dearth of new muni bond issues. While the US faces a probable recession early next year, higher rates and the need to rebuild the American infrastructure should present investors with a huge wave of new tax-free bonds. Who knows, they may even get close to the 5% range many of them offered income-oriented investors back in the early years of the century. We would settle for a 3% tax free rate.
We, 22 Jun 2022
Beverages, Tobacco, & Cannabis
In blow to Altria, the FDA is poised to order Juul e-cigarettes off the market
In a rather stunning turn of events, the Food and Drug Administration is preparing an order that would force Juul Labs to take its popular e-cigarettes off American shelves. This follows a two-year review of the products, specifically the fruit flavored blends. The FDA’s ruling serves as a capstone to the great downfall of Juul, which was flying high back in 2018 as its products soared to the top of a frenzied market. In what turned out to be a critical miscalculation, 2018 also happens to be the year that tobacco giant Altria (MO $41) decided to take a 35% stake in the company. What might have seemed like a reasonable move to diversify away from its traditional cigarette products (Altria owns the popular Marlboro brand, among others), the company bought in at the worst possible time. Shares of MO had been holding up quite well in 2022 thus far, sitting at where they were trading going into the year. As soon as the news was announced, shares fell 10% and remained stuck there. The 2018 deal valued Juul at around $35 billion; just prior to the FDA decision, the company had a valuation of roughly $5 billion. Adding insult to injury, the FDA also indicated that e-cigarettes made by rivals Reynolds American and NJOY Holdings would be allowed to continue selling their tobacco-flavored vaping devices. Juul lost around $259 million on sales of $1.3 billion in 2021.
Somewhat surprisingly, there are still some Altria bulls out there. In addition to a fat 7.88% dividend yield, the company has maintained annual revenues of between $24 billion and $26 billion per year for the past ten years and has generated positive net income in all but one (2019) of those years. We wouldn’t touch the stock, especially considering the firm spun off its international division—Philip Morris International (PM $99)—back in 2008.
Tu, 21 Jun 2022
Currencies & Forex
Japanese yen falls to a 24-year low against the dollar
If you have been considering a Japanese getaway, now might be the time to book that trip. As of this week, one US dollar will buy 135 yen, up from slightly over 100 at the start of the year. Why does the world’s third-most-traded currency continue to plummet? Because the Bank of Japan’s governor, Haruhiko Kuroda, stands firmly by his commitment to maintain a -0.1% short-term interest rate while the rest of the developed world is raising rates to tamp down runaway inflation. Angering the Japanese public with his recent comments that consumers were becoming more tolerant of higher prices, nearly 60% of the country’s residents now find him unfit for the job. A weak currency due to an easy money policy means that goods and services cost a lot more for consumers within that country, and a lot cheaper for foreign visitors thanks to the generous exchange rate. Yes, a weak currency promotes stronger exports because the goods are less expensive for the world to buy, but the tradeoff can be brutal for the family budget. For a country which imports 94% of its energy, soaring prices and a weaker yen have most cheering the fact that Kuroda is in the final year of his second term as governor of the central bank.
For investors, the yen’s weakness also makes the Japanese stock market look more attractive thanks to the currency disparity. One way to potentially take advantage of this weakness is through the WisdomTree Japan Hedged Equity Fund (DXJ $64), which is up 2.35% in value this year against the backdrop of an 18% decline in the MSCI All-Cap World Index, Ex-US. Some of the fund’s top holdings are Toyota Motor Corp, Nintendo, Mitsubishi, and Canon.
Tu, 21 Jun 2022
Food Products
Kellogg to break into three companies; does anybody care?
Five years ago, we wrote a brief piece on Kellogg’s (K $69) hiring of a new CEO after floundering for years under chief executive John Bryant. We expressed doubt that Steven Cahillane would be any different. At the time, K was sitting around $70 per share. Confirming our concerns, the shares have barely budged since.
So, what does a mediocre company do to move the needle on its share price? Announce a plan to split into multiple entities, of course. Sure enough, shares of Kellogg opened the week up nearly 4% after management announced it would break into three pieces: a global snacking company, a North American cereal company, and a plant-based food company, names to be decided at a later date. We are not talking about GM spinning off its financing unit (remember GMAC?) or GE spinning off its jet-leasing unit; we are talking about a food company spinning off…food companies. Aren’t all three units within the core competencies of a packaged food manufacturer?
Right out of the mediocre manager playbook, CEO Cahillane said that the standalone companies will now be able to “direct their resources toward their distinct strategic priorities…and create more value for all stakeholders….” What a bunch of gobbledygook. Milquetoast executives throw out terms like “unlock value” as if a split would magically open corporate treasure chests which the crackerjack team had just been unable to open in the past. Really? All of the talent at your fingertips and you just couldn’t crack the code, but now you will be able to? What will be fun to watch next is how many middling analysts get excited by this move and upgrade the shares. Insert eye roll emoji here.
Full disclosure: We own Kellogg’s chief competitor, General Mills (GIS $68), in the Penn Global Leaders Club.
Th, 09 Jun 2022
Aerospace & Defense
BWX Technologies wins DoD contract to build first advanced microreactor in US
Aerospace & Defense firm BWX Technologies (BWXT $54) has been awarded a contract by the United States Department of Defense to build a first-of-its-kind advanced nuclear microreactor. Under codename Project Pele, these reactors, which can be transported by modules aboard trucks, trains, aircraft, or ship, are designed to be assembled on-site and operational within 72 hours. The reactors can provide a resilient power source for a variety of operational needs, eliminating the need for fossil fuels delivered by often extensive supply lines. The possibilities are endless, from immediate power needs at remote locations, to disaster response and recovery around the world. The prototype will be built under a contract valued at around $300 million and should be completed and delivered by 2024 for multiyear testing at the Idaho National Laboratory.
As we move away from fossil fuels, these advanced concepts are going to come to fruition, and the industry is full of potential going forward. A lack of understanding and a fear of the word “nuclear” may slow the process, but the safety attributes of these devices will eventually allow them to become embraced by politicians and the general population. BWX Technologies is a $5 billion specialty manufacturer and service provider of nuclear components. Additionally, the Lynchburg, Virginia-based firm provides uranium processing, environmental site restoration services, and other solutions to the nuclear power industry. With average annual revenues around $2 billion, the company is perennially profitable.
We, 08 Jun 2022
Renewables
Solar stocks surge on Biden’s decision to hold off on new solar tariffs for two years
Investing in the solar energy movement has always been fraught with danger, with the slightest shift in sentiment or any new legislative (or executive) actions generally causing an oversized reaction by investors in the industry. The latest news on the latter front, however, had solar enthusiasts cheering. The Biden administration announced there would be no new tariffs placed on solar panel imports for the next two years. There had been a major push underway by the US Department of Commerce to investigate whether global solar panel suppliers were using deceptive tactics to avoid getting hit with tariffs on goods emanating from China. That push, along with supply chain constraints, led to a major slowdown in solar panel installation in the US. In a decision we find more impactful on the US economy, the president also signed three executive orders designed to increase domestic production of solar panels. Tesla, which had been in partnership with Panasonic to produce such panels at a Buffalo, New York facility, has since exited the production side of the business and now focuses solely on installation of the systems.
The Invesco Solar ETF (TAN $78) has been on a roller coaster ride this year, dropping 25% before rebounding to flat YTD. The new legislation, along with soaring energy prices, could provide a catalyst for the companies within this fund in the second half of the year. Enphase Energy (ENPH $214) is the largest of the fund’s 42 holdings, with a 12% weighting.
While we do not currently own any direct solar plays in the Penn strategies, we do own Tesla (TSLA $737), a major renewables player and lithium-ion battery manufacturer, in the New Frontier Fund.
We, 01 Jun 2022
Monetary Policy
The Fed will finally start reducing its $9 trillion balance sheet this month
It is hard to imagine, but just nineteen years ago, in 2003, the Federal Reserve had around $700 billion of assets on its balance sheet. That amount, it should be noted, is one component of the national debt. After the financial crisis of 2008-09, the balance sheet more than tripled, hitting $2.25 trillion. At the time, those figures were hard to fathom. Quadruple that amount and we have the current size of the Fed balance sheet. June is the month the figure finally begins going down.
Four large Treasury securities held by the Fed, worth $48.25 billion, are maturing this month. In previous months, the Fed would have reinvested the proceeds, purchasing an equal amount of new securities. Instead, it will let $47.5 billion simply run off the balance sheet, only reinvesting the final $1 billion or so. It will continue this process until September, at which time it will double the amount allowed to mature without reinvestment, reducing the balance sheet by $95 billion per month. This may seem like a rapid pace, but it will only amount to a $522 billion reduction by the end of this year, and an additional $1.1 trillion by the end of 2023. If the downward trajectory continues, the Fed balance sheet will be back to pre-pandemic levels by the summer of 2026.
That date may seem far in the future, but there is something even more unsettling about the entire process: we will probably never get there. The continued reduction is contingent upon the economy humming along between now and June of 2026. Does anyone really believe that yet another “urgent crisis” will fail to manifest? Our best hope is that the balance sheet is reduced by a few trillion dollars before the Fed is forced to go on its next buying spree.
Rarely are two of the Fed’s three main tools used in tandem, at least to this degree: an increase in short-term rates plus a simultaneous reduction of the balance sheet through open market operations. These two actions will undoubtedly have an impact on the housing market specifically, and the overall economy in general. Hence, the doubt expressed by economists that the Fed can execute a “soft landing” as opposed to fomenting a recession. A fascinating case study to watch.
Tu, 31 May 2022
Food & Staples Retailing
The dollar stores provide a much-needed positive catalyst for the markets
Certainly with respect to retailers, it seems all we have been hearing about lately is margin contraction. Consumer Staples companies, which sell the goods people need under all economic conditions, have been maintaining their gross sales levels, but their net profits have shrunk due to higher input, labor, and transportation costs, as well as disruptions in the supply chain. In other words, inflation is killing their bottom line.
Assuming the so-called dollar stores (Dollar General and Dollar Tree primarily) would suffer the same fate at their larger brethren such as Walmart and Target, these companies had their respective share prices hammered in sympathy. All the bad news was priced in before the numbers ever came out. This was true more so for Dollar Tree (DLTR $164), which carries a larger percentage of discretionary items than does Dollar General (DG $228).
Lo and behold, both companies surprised to the upside, sending shares of DG and DLTR up by double digits. Dollar General announced revenue of $8.8 billion, earnings per share of $2.41, and a negligible decline in same-store sales. The company also raised its full year sales guidance and maintained its bottom-line income projections. Dollar Tree posted revenues of $6.9 billion and earnings per share of $2.37, also beating analysts’ predictions, and raised its full year guidance.
How are these low-cost darlings able to withstand inflation better than their larger competitors? Primarily, the answer revolves around management’s effective use of inventory tactics to preserve profits. Dollar General CEO Todd Vasos, for example, explained that the company can shift to substitutes when certain goods go up in price. They have also added self-checkout lanes to over 8,000 stores and have plans to turn another 200 locations into self-checkout only, thus reducing labor costs. For its part, Dollar Tree’s decision to raise the price of its $1 items to $1.25 hasn’t had any detrimental effect on sales. Finally, as could be expected, higher prices are driving more and more Americans to visit these stores; names which they may have shunned in the past. Expect this trend to continue through next year, as the US faces a probable recession.
We have long regarded Dollar General as one of our most defensive plays in the Penn Global Leaders Club. Even after the economy troughs in 2023 or 2024 and begins a new expansion phase, the unique value proposition of the company—such as where the stores are located—means it will probably remain a core holding in the strategy.
We, 25 May 2022
Fintech
AI-powered ETF is facing its first major test, and the results have not been pretty
We recall being intrigued about five years ago when we heard of the AI Powered Equity ETF (AIEQ $32), the so-called robot-managed exchange traded fund. This automated, data-driven fund would “harness the power of IBM Watson to equal a team of 1,000 research analysts, traders, and quants working around the clock.” Using artificial intelligence instead of human brainpower, predictive models would be built on some 6,000 US companies. These models would analyze millions of data points across news, social media, financial statements, and analyst reports to build a more efficient fund. Between 30 and 200 companies with the greatest growth potential over the following twelve months would be purchased, with adjustments being made constantly. Truly a fascinating concept.
It is always a good idea to let concepts prove themselves before jumping in, so we held off on adding AIEQ to the Penn Dynamic Growth Strategy—our ETF portfolio. Watson is certainly an incredibly powerful tool which may enhance a plethora of different industries, but wasn’t it the machine behind our weather app which we were less-than-impressed with? Perhaps Watson could have even predicted how AIEQ would perform in a downturn, but we wanted to find out the old-fashioned way.
Unfortunately, the fund got a chance to prove itself following the worst market start to a year since 1970. Based on the rather impressive breakdown of holdings (roughly an equal representation in Health Care, Industrials, Technology, and Consumer Cyclicals, followed by Financial Services, Consumer Defensives, and Basic Materials companies), the benchmark for the fund would be the S&P 500. While that key market benchmark has given up around 17% year-to-date as of this writing, AIEQ is down 23.84%. We expanded the scope of our comparison to include the Dow Jones Industrial Average (30 holdings), the NASDAQ (primarily tech names), and the Russell 2000 (small-cap proxy). Only the NASDAQ composite, with its 27% loss, underperformed the fund. The narrative was excellent; unfortunately, the results were not. Back to the drawing board.
The Penn Dynamic Growth Strategy (PDGS) is currently comprised of 25 holdings; overwhelmingly ETFs (due to their intraday liquidity, lower general costs, and other factors), and a couple of open-end mutual funds which we rate as exemplary. The Strategy uses a core/satellite approach, with the satellite funds being more tactical in nature (Invesco DBA Agriculture ETF is a great example). The PDGS is actively managed, with changes being made based on the economic, investment, and geopolitical environment.
We, 25 May 2022
Interactive Media & Services
Snap shares just fell 43% in one day; in 2017, we called the company’s share class structure a sham
After social media company Snap (SNAP $13) lowered its outlook for the year—ultimately causing shares of Snapchat’s parent company to fall 43.08% in one day—we immediately began perusing our past notes on the firm. Our first comments came in February of 2017 as the company was about to begin its IPO roadshow. Setting a price target of between $14 and $16 per share, the company would immediately have a $20 billion market cap in what would be the largest US tech offering since Alibaba (BABA $82) went public in 2014. We urged investors not to bite. The roadshow was such a success that the IPO shares were more than ten times oversubscribed. They ultimately priced at $17.
Our next note on Snap came just a month later, in March of 2017. This time we said that investors were getting a raw deal with respect to the share class structure. Get this scheme: The company would sell schmucks like us Class A shares, which came with no voting rights but did “entitle” buyers to attend the annual shareholders’ meeting and “ask questions.” Gee, thanks. Executives of the company could acquire Class B shares, which came with one vote each, while Snap’s founders would own the coveted Class C shares which came with ten votes apiece. Talk about some fancy financial engineering.
The catalysts for our other notes on Snap were earnings reports. In all but one case, shares had plummeted on lower-than-expected numbers or worse-than-expected guidance. The latter was the cause for Tuesday’s 43.08% drop, taking the shares down to $12.79, or 25% lower than the $17 per share initial offering price. What a mess.
SNAP shares now sit 85% off their September 2021 highs. Some might see a bargain; we still see an aristocracy in which the company’s rulers have no idea what they are doing.
Mo, 23 May 2022
Market Pulse
Consumer staples fell dramatically last week, but the Dow is attempting a comeback
If there was one positive sign in this five-month-long anxiety-riddled market tumble, it had been the fact that consumer staples—those stolid, earnings-rich companies that sell goods people need under all economic conditions—were holding their own. That changed last Wednesday after Target (TGT $155) shocked the market with news that profit margins were getting seriously crimped by high inflation—from higher fuel costs to a spike in commodity prices. This exemplary company, which was up around 300% since we added it to the Global Leaders Club, lost one quarter of its value in one day; its worst one-day hit since 1987. And it wasn’t just a Target problem. The prior day, Walmart’s (WMT $122) earnings showed the same challenges, pushing WMT shares down 11%. Ironically (or not), that was also their worst single day since 1987.
We all know what happened in 1987. I was in the US Air Force rather than a cushy chair at an investment firm back then, but I remember the fear being palpable. There really wasn’t a single major catalyst that would explain away the massive market drop, which was part of the problem. Investors feel better if they can point to a viable reason for a system shock, and there wasn’t one in October of 1987 (though there was a confluence of events, much like today). Many investors made the worst possible mistake that month: they began selling even their best positions. Over the course of the next six months or so, the Russell 2000 (small caps) had rallied 37%, the NASDAQ was up 32%, and both the S&P 500 and Dow were up 20%. Those who sold in October missed a remarkable rally right around the corner.
This is not March of 2000. The current bear market much more closely resembles the one which occurred in the fall of 1987. Inflation is real, and the Fed will do what it takes to get it under control (raise rates and reduce the balance sheet), which may push the economy into a mild recession next year. But we wouldn’t be surprised to see the same type of rally occur in the second half of this year that began on 7 December 1987. Friday afternoon and Monday’s follow through may portend that coming rally: the Dow was down over 600 points with a few trading hours left in the week, only to rally into a positive close. That rally continued Monday, with the Dow finishing up 618 points—or more than 1,200 points higher than Friday afternoon’s low. Of course, we have no way of knowing whether the bottom of this current market downturn is in, but it is refreshing to see buyers jumping back in after being pummeled for seven straight weeks.
We, 18 May 2022
Editor's Corner
Don't wave the American flag while watching your cargo ships roll in...
We have preached repeatedly about the irresponsible manner in which so many American companies became overly reliant on a communist nation with respect to trade; how executives became seduced by a massive population for the sale of their goods, and a dirt cheap labor force for the production of those goods. Distressingly, it took a global pandemic originating from that country for many of these companies to (finally) look at reducing their country risk. Still, the narrative these firms weave for public consumption is enough to make us choke.
One major US retailer has a "Made in America" campaign running to proudly proclaim how the goods they sell are made in the US. They use a flower grower as an example. Try finding a flashlight or a can opener at this retailer made anywhere around the globe other than China. You won't.
We are not xenophobes by any stretch, and we still support companies which source from factories in virtually any country outside of China, Russia, North Korea, or Iran. That being said, more can and should be produced domestically. Especially with the Fourth Industrial Revolution at our doorstep, with many American technology firms and universities leading the charge. What can we, as consumers, do to help the process along? We can get in the habit of checking where the goods we buy are actually produced, and providing feedback via direct contact and social media when we don't like what we see.
Tu, 17 May 2022
Construction Materials
Armstrong Flooring paid out $4.8 million in bonuses to execs—then declared bankruptcy
The world of home flooring is one of those murky, opaque realms in which performing due diligence is extremely difficult—often by design. Take, for instance, a home buyer who wants to assure their builder uses wood flooring sourced from anywhere but China. Good luck. The company may be American, and their final products may be designed and even produced in the US, but that doesn’t mean the “cores” of factory-made materials didn’t come from the communist nation. Which leads us to a recent story about Armstrong Flooring (AFI $0.32).
While we couldn’t readily determine what percentage of the company’s wood flooring materials emanated from China, at least they had the courage to admit—clearly on their website—that they do have a flooring plant in the Jiang Su Province of that country—in addition to plants in the US and Australia. We point this out because the company cited supply disruptions and higher transportation costs as two of the reasons it was forced to declare bankruptcy this past week. Never fear, though, as the company fully plans to continue operating while in bankruptcy while it devises plans to emerge. Armstrong told the Delaware court that it owed some $300 million to creditors and has roughly $500 million worth of assets, giving it a debt-to-equity ratio of 61.5%—up from 28.3% in March of 2020 and 17% in September of 2018.
We are happy for the employees of Armstrong, but we must wonder how happy they were to learn that senior executives received some $4.8 million worth of annual incentives just before the company declared bankruptcy; incentives that would have almost certainly been disallowed by the courts. An Armstrong attorney told US Bankruptcy Judge Mary Walrath that these execs (the CEO and at least three others) were key in securing funding, but aren’t the employees key as well? It should be noted that the company’s CEO was the “chief sustainability officer” at Mohawk Industries between 2017 and 2019. It should also be noted that Armstrong had 1,600 employees as of the end of 2021. That $4.8 million would have meant a nice bonus of $3,000 for each, and we will even include the top executives in that package.
We love American free enterprise, which is why we must hold all companies to the highest possible standard. We are not accusing Armstrong of doing anything illegal or even unethical, but companies that wave the American flag and wax eloquent about sustainability had better make sure they are practicing the ethics they preach. The last year Armstrong Flooring turned a profit was 2016, which happens to also be the year that Armstrong World Industries (AWI $84) offloaded the firm as its own publicly traded company, trading in the $19 range. These decisions don’t happen in a vacuum, and it behooves investors to look well beyond the glossy ads and company websites when reviewing a company for possible purchase. Pull up the rug and see what’s underneath, so to speak.
Tu, 17 May 2022
Global Organizations & Accords
Turkey’s objection to Sweden and Finland joining NATO is all about personal gain
Turkey has never been a faithful ally to the West. While desiring to be considered a mainstream Western European country, it has acted in the best interest of the Middle East. While demanding arms from the United States, it gladly accepts a missile defense system from Russia. President Recep Erdogan “massages” the country’s constitution to remain firmly ensconced in power while political opponents are dealt with swiftly and harshly. Now, as two truly European countries, Sweden and Finland, begin their application for formal membership into NATO, Erdogan runs interference, knowing full well that all current members must approve their entry.
Erdogan’s position, as usual, has nothing to do with the common good and everything to do with his own greed and self-enrichment. While claiming that the two Nordic countries need to clamp down on “Kurdish terrorist activities” in the region, he has no problem inciting—or outright approving—terrorist activities at home. Knowing full well that his approval is needed, expect this would-be dictator to successfully milk a host of concessions out of Europe before bestowing his magnanimous blessing on a strengthened NATO. While his good friend Putin won’t be happy with this ultimate decision, Erdogan will have enriched himself, yet again, by playing the dirty merchant of Europe.
On a scale of 1-9 on the democracy meter, Turkey has an abysmal rating of 4.35—more in the proximity of a Russia or a China as opposed to those of its Western neighbors. This won’t change as long as Erdogan is in power, and we don’t see him loosening his grip on that power any time soon.
Tu, 17 May 2022
Airlines
JetBlue is going hostile for Spirit, and it is a complete waste of time
We know how much the big four US-based airlines—American, United, Southwest, and Delta—were financially impacted by the pandemic, and quite understandably so. It follows, then, that the smaller players would be in even rougher shape following the two-year nightmare. Consolidation within the industry among these smaller players makes sense, and we reported this past February of Frontier’s (ULCC $9) plans to acquire Spirit Airlines (SAVE $19) in a deal valued at $2.9 billion ($6.6 billion with debt added in). Another small-cap player, JetBlue (JBLU $10), felt threatened by this move (rightfully so), and made its own offer to buy Spirit for $3.6 billion in an all-cash offer. Interesting, as the market cap of JBLU is just $3 billion. Not seeing a path toward regulatory approval, Spirit said thanks, but no thanks.
Which leads us to JetBlue’s current tactic: going hostile. Denouncing Spirit’s management team for refusing to perform due diligence with its offer, the company said it will actively pressure SAVE shareholders to reject the Frontier bid at a 10 June meeting. Bizarrely, JetBlue said that it would raise its $30 per share offer to $33 per share if management comes back to the table and provides the financial information being requested. That does nothing to alleviate the real problem: we see no circumstances under which the antitrust forces at the Department of Justice and the Federal Trade Commission will allow the JetBlue/Spirit deal to go through. In fact, Spirit CEO Ted Christie has explicitly stated that this may simply be about foiling the Frontier deal. We believe his argument will carry the day with shareholders. A combination of any two of these players would create the country’s fifth-largest airline, leapfrogging over Alaska Air Group (ALK $47).
JetBlue has a host of problems which Spirit wants nothing to do with, to include a worst-in-class, 62% on-time rate. Furthermore, the carrier is already in the Justice Department’s crosshairs, as the agency sued to block the airline’s regional partnership with American Airlines last year. Ultimately, we see the original Frontier acquisition getting approved, which will make JetBlue’s position in the industry even more tenuous.
Mo, 16 May 2022
Aerospace & Defense
Ryanair’s fiery Irish CEO loves Boeing, but “management is a group of headless chickens”
We love CEOs who are true leaders, are interesting characters in their own right, and who don’t feel the need to insert themselves into the political arena to score sycophantic points with super-sensitive stakeholders. Irish low-cost carrier Ryanair’s (RYAAY $81) fiery CEO, Michael “Mick” O’Leary, easily checks all three boxes. When Boeing’s (BA $126) hapless CEO, David Calhoun, is on one of the business networks, we mute the TV to avoid hearing the canned hot air delivered with a strained jumpiness; when we see O’Leary’s face, we always listen with rapt attention. A little background on Ryanair’s history with Boeing: the company has always been one of the aircraft maker’s most loyal customers. A European airliner with a fleet of 471 Boeing aircraft, 145 more on order, and just 29 Airbus (European) aircraft. That made us applaud all the louder when, during a Ryanair earnings call, O’Leary blasted Boeing’s management team and its inability to make good on orders. Saying they need to “bloody well improve on what they’ve been doing…,” he added that, “At the moment, we think the Boeing management (team) is running around like headless chickens.” Hey, that’s just what we have been saying ever since Calhoun anointed himself—with the Board’s blessing—CEO! Hear, hear! How refreshing to have a leader who tells it like it is. We could quickly list a dozen major US companies which could use someone like O’Leary at the helm.
Our minuscule impact on Boeing is limited to not owning it in any of the Penn strategies. We have to believe that the words of a Boeing cheerleader and major customer would have some major sway in the industry. Then again, Boeing has proven itself to be quite tone deaf since Jim McNerney left the firm in 2015, so who knows. It is probably the customer’s fault, right?
Mo, 16 May 2022
East & Southeast Asia
For the US, there was only one direction to go in the Philippines after Duterte
Many of us vividly recall the presidency of Ferdinand Marcos, and the endless stories written by the American press about his wife Imelda’s shoe collection. We thought back to his regime, which ended with a thud in 1986, this past week as his son, Ferdinand “Bongbong” Marcos Jr., notched a landslide election victory to become the next president of the Republic of the Philippines. For the United States, the importance of having a strong ally in this strategically critical region of the world cannot be overstated. Once one of America’s staunchest advocates in Southeast Asia, the country moved decidedly away from its old friend—and toward China—under President Rodrigo Duterte’s six-year rule. Until a last-minute change of heart, in fact, Duterte had all but cut military ties with the US by threatening to end the longstanding Philippines-United States Visiting Forces Agreement (VFA).
Along with the election of Marcos Jr., Filipinos sent a clear message that they do not wish to be subservient to their would-be Chinese masters. Overwhelmingly, voters expressed their unease with Duterte’s cozying up to China’s Xi Jinping. For its part, American military exercises in the South China Sea have enraged China, and the country’s ruling communist party has done everything it could to poison the relationship—not a difficult task with the mercurial Duterte in power. Now, with a huge favorability rating he does not wish to squander, we can expect Marcos to govern in a manner more conducive to overall stability in the region, and that is not what China had been hoping for.
Even though Duterte’s own daughter is the vice president-elect, this election was a clear victory for America’s interests in the region; as much of a victory, in fact, as the March election of Yoon Seok-youl in South Korea. Controlling the South and East China Sea regions are a linchpin to China’s grand ambitions, and the citizens of South Korea and the Philippines have indicated precisely what they think of those plans.
We, 11 May 2022
Automotive
Before a meme stock-like comeback, Carvana shares dropped 92% in nine months
Back in August of last year, used auto platform Carvana (CVNA $30) could do no wrong. Despite a lack of positive net income in any given year over its ten-year history, the company’s sales growth was spectacular, growing from $42 million in 2014 to $11.77 billion in 2021. Investors rewarded the competitor to such names as Carmax (our favorite in the space), Cars.com, and Autotrader by driving CVNA shares up to an intraday high of $376.83 on 10 August 2021. Fast forward precisely nine months, and traders are fleeing the maker of the highly unique Carvana Vending Machines. Shares hit a new 52-week low of $29.13 on the 11th of May after management announced a 12% reduction in its workforce; that price represents a 92% drop from the August highs. Another reason investors soured on the company was news of its acquisition of Adesa US, the wholesale vehicle auction division of KAR Auction Services, for $2.2 billion. Not due the acquisition itself, but the financing scheme: Carvana would be issuing $3.3 billion in junk bonds carrying a yield of 10.25%. In decades gone by, that might seem fine for a junk bond rate; today, it seems too good to be true (for bond buyers). Longtime Carvana investor Apollo Capital Management agreed to secure some $1.6 billion of that paper. As for the layoffs, which equate to roughly 2,500 employees, the company told the SEC that senior management would not collect any salaries for the remainder of the year to help fund the severance packages.
We feel for the investors who bought shares in the company last August. Price targets now range from $40 to $470 among analysts on the Street, but we wouldn’t touch the shares right now—or the 10.25% bonds. The company’s cash burn rate will be hard to sustain, even with the new round of funding.
Fr, 06 May 2022
Week in Review
Despite a hopeful FOMC day, markets suffered their fifth straight week of losses
It would be nice just to focus on Wednesday. Yes, that was the day the FOMC raised rates 50 basis points, the most since May of 2000, but the markets cheered when the Fed Chairman took a 75 basis point rate hike off the table. Between that comment and his belief that the Fed can pull off a “softish” landing, markets took to rallying: the Dow Jones Industrial Average gained 932 points and the NASDAQ rose 3.19%. Unfortunately, there were four other days in the trading week. Like the happy partygoer who wakes up the next day and asks, “what the * was I thinking?” the major benchmarks all made a swift change in directions. The Dow, in fact, shed over 1,000 points for the first time since the spring of 2020. Even a really strong Friday jobs report seemed to irritate the markets. The week’s drop signified the fifth straight down week for the benchmarks, and the worst start to a year since 1970. And that is not a decade we wish to see repeated. We said to expect wild market fluctuations and plenty of volatility during the rate hike cycle, and that certainly manifested itself this past week. The good news? Plenty of great, revenue-generating, industry-dominating American tech giants are now selling at bargain basement valuations. And for the record, we believe investors will be pleased with where the major indexes end the year—especially from the current vantage point.
Fr, 06 May 2022
Under the Radar
Hanesbrands Inc (HBI $12)
I rediscovered Hanes while on a search for socks, t-shirts, and briefs that were actually manufactured somewhere other than China. Sadly, that is a lot harder task that one would assume. In the end, Hanes was the one brand which came shining through. Channeling my inner Peter Lynch, I decided to do a deeper dive into HBI stock. Founded in 1901 and based out of Salem, North Carolina, Hanesbrands includes the Hanes, Champion, Playtex, Maidenform, Bali, and Bonds (Australia) labels. Importantly, this company is vertically integrated: it produces over 70% of its goods in company-controlled factories across some three dozen countries. Unlike a troubling percentage of other American manufacturing firms, it never hitched its wagon to communist-controlled China. In addition to its vertical integration (a major plus considering current supply chain issues), management has successfully created a vibrant omnichannel network. The company sells wholesale to discount, midmarket, department store, and direct to consumer via an impressive online and digital presence. At $12 per share (down from a high of $34.80 and sitting at a 52-week low), this $4.4 billion small-cap value company has a forward P/E of 7.5, a tiny price-to-sales ratio of 0.6520, and a fat dividend yield of 4.72% based on current share price. With a new strategic plan called Full Potential, CEO Steve Bratspies—formerly an Executive Vice President and the Chief Merchandising Officer at Walmart—has a clear vision of where he wants to take the company. We are betting he succeeds. We would conservatively value HBI shares at $24 apiece.
Th, 05 May 2022
Monetary Policy
Fed raises rates most in one meeting since May of 2000; let’s hope the trend continues
In May of 1999, twenty-three years ago this month, the upper limit of the federal funds rate (FFR) was sitting at 4.75%. In an effort to prevent runaway inflation and cool the scorching-hot US economy, the Fed began raising interest rates. It capped that effort one year later, in May of 2000, when it raised rates 50 basis points, from 6% to 6.5%. Why is that history lesson important? Because, to staunch already-runaway inflation, the Fed just made its biggest move since that meeting twenty-two years ago: the Committee spiked rates (upper limit) from 0.50% to 1%. The history lesson also brings home another point. When rates topped out at 6.5%, the central bank had an enormous amount of room to tighten as it worked to avoid recession, which it did (lowering rates) between 2001 and 2003. The accompanying graph provides a wonderful visual for the difference between then and now. Rates must continue to go higher. At the very least, we need to get back to the average FFR of 2.5%. To do so in a timely manner would entail another 50 basis point hike at both the June and July meetings, respectively, and a 25 basis point hike in both September and November. Unless inflation shows real signs of cooling, that is the scenario we can expect to play out. We can also expect a few hikes in 2023, bringing the FFR up to 3% or higher.
In addition to the hike, Fed Chair Jerome Powell also announced a systematic paring back of the Fed balance sheet, which remains just shy of $9 trillion. More perspective: that debt load sat well below $1 trillion back in 2000. Starting in June, that astronomical figure will be reduced by $95 billion per month, equaling a $1.1 trillion reduction by May of 2023. Again, a good start.
With any luck at all, inflation can be tamed without the rate hikes pulling us into a recession until 2024—though the latter scenario may well play out in 2023. The longer we can keep a recession at bay, the more ammo the Fed will have leading into the next tightening cycle.
We, 04 May 2022
Education & Training Services
Textbook company Chegg’s market drop following its earnings release was irrational
Despite the fact that we like Education and Training Services company Chegg (CHGG $17), we knew it was overvalued when the shares were trading north of $100. Now, after falling some 85%—yes, you read that right—the shares are decidedly undervalued. In fact, one would almost have to assume the company were ready to go out of business to still be bearish at this level, and we expect the company to be around for a long time to come. The catalyst for the pummeling wasn’t rotten numbers for the quarter, it was forward guidance. In fact, Chegg’s revenue rose 2% year-over-year, to $202.2 million in the quarter; and adjusted net income rose 8%, to $50.1 million. Earnings per share easily beat the Street’s estimate of $0.24, coming in at $0.32. Finally, subscriber growth—that wonderful, “sticky” revenue stream—rose by 12%. The problems began to appear when management began talking. Claiming that more people were now focusing on “earning over learning,” CEO Dan Rosensweig warned of rough quarters ahead, lowering full-year revenue guidance from the $830M-$850M range to $740M-$770M. Those figures, and a similar reduction in expected earnings, helped the stock crater to a new 52-week low, falling 30% in one day.
Chegg has been aggressively growing its international footprint, offering a direct-to-student learning platform which should continue to increase its market share in a solid industry: education services. While we don’t currently own the company, we believe the shares could easily fetch $35 before long. That would give investors a 100% reward for taking on the risk of owning this small-cap name.
Tu, 04 May 2022
Trading Desk
Opening industrial automation leader within the New Frontier Fund
This current market downturn has been indiscriminate: it has taken some fine companies down to valuations not seen since spring of 2020. We are adding a great but beaten down industrial company to the New Frontier Fund. When you think of automation and the factory of the future, this mid-cap gem should come to mind. Members, log into the Trading Desk for details.
Mo, 01 May 2022
Economics: Goods & Services
Yes, the US economy contracted in the first quarter of the year; but no, it won't become a trend just yet
Technically, a recession is defined as two consecutive quarters of economic contraction within an economy. How concerned should we be, then, that the US economy shrunk by 1.4% in the first quarter? In our opinion, not very. While the headline number is concerning, some comfort can be found by reviewing the internal components of the Commerce Department's report, which was released last week. Government spending actually slowed, which may not be a good thing in the eyes of economists, but in the "real world," it signals at least a modicum of fiscal responsibility. The trade deficit soared in the first quarter on a surge in imports; certainly not a desirable condition, but one which shows the American consumer is still flush with cash and willing to spend. Visualize all of those cargo ships stuck at US ports finally offloading their goods. For all of the concern over inflation, higher prices didn't seem to mute consumer spending last quarter. Fixed investment—economic jargon for the purchase of physical assets such as machinery, land, buildings, and other hard assets—grew a whopping 7.3% in Q1, versus a 2.7% growth rate in the same quarter of last year. Hardly a sign that businesses are buckling down in anticipation of a pending recession. In short, don't expect a consecutive contraction when the Q2 GDP numbers are released in July.
In the past, slowing GDP figures would have certainly played a major role in the Fed's decisions on rates. However, with runaway inflation taking center stage, we still expect a slew of rate hikes this year. By the time the next recession rolls around, probably at some point in 2023, expect more normalized long-term interest rates—which we would anticipate being in the 4.50% range. That is a good thing, as it would give the Fed something to work with should it need to begin loosening once again.
We, 27 Apr 2022
Aerospace & Defense
David Calhoun will never run out of excuses for Boeing's problems; will shareholders ever run out of patience with him?
It was yet another disastrous quarter for formerly-great American aerospace giant Boeing (BA $152). Against underwhelming expectations for $15.9 billion in sales and a $0.15 per share loss, the company brought in just $14 billion in revenue (a 12% decline from the same quarter last year) and had a loss of $2.75 per share (an 80% larger loss than the same quarter last year). Boeing shares proceeded to drop some 14%, to their lowest level since October of 2020, giving the company a smaller market cap than European rival Airbus (EADSY $27) for the first time ever. Even the cash burn was worse than expected, with Boeing blowing through some $3.6 billion versus expectations for a $3 billion cash burn. The company has now missed analysts’ expectations in nine out of the last twelve quarters. Watching hapless CEO David Calhoun being interviewed by CNBC’s Phil LeBeau was painful. With an unsure, shaky voice, he blamed the quarter on everything but the management team—even citing the company’s last Air Force One deal as a reason for the horrible quarter. (If it were so bad, why did you make it?) We knew Calhoun, who was Chairman during the company’s two ill-fated 737-MAX crashes, was the wrong selection for CEO from the start. But he placed himself in the position shortly after telling us how much confidence the board had in then-CEO Dennis Muilenburg. He gave himself the role as the other board members nodded their sycophantic approval like Governor William J. LePetomane’s staff in Blazing Saddles. It should be noted that Calhoun’s compensation last year was $21 million, while the company lost some $4 billion over that time frame. With serious failures on both the aircraft and spacecraft side of the business, when will the madness end?
We sold our BA shares shortly after the second MAX crash—after holding them in one of the Penn portfolios for over a decade. With all the activist investors out there, often going after good management teams, where is the shareholder uprising at Boeing?
Tu, 26 Apr 2022
Random thought: Are we the only ones who find it a bit insincere for investment houses to "adjust" their S&P 500 predictions for the full year? If you are going to change your prediction, why make one in the first place? It is like placing a bet in March on a team to win the Super Bowl, then asking for your money back when October rolls around and your team is 1-4. We made our predictions in December that the S&P 500 would be at 5,100 by the end of the year; wouldn't changing that prediction (which we still stand by) be a bit deceptive?
Tu, 26 Apr 2022
Capital Markets
Fidelity plans to bring cryptocurrencies to your 401(k) plan; we applaud the move
Whatever you may think of Bitcoin, cryptocurrency is now its own asset class and it is here to stay. While this digital money has certainly not shown itself to be a hedge against inflation, nor an inversely correlated (to equities) asset class, it will be of growing importance to the capital markets. That is why we were happy to see Fidelity Investments, a major retirement plan provider, announce plans to include Bitcoin as a core option within its 401(k) plans. It won't be offered as a mutual fund or ETF, such as the Grayscale Bitcoin Trust (GBTC $29), but rather a dedicated asset account just like a plan's money market option. Fidelity would custody the assets on its own digital assets platform, charging between 75 and 90 basis points for administration. Employees' allocation to the crypto portion of their retirement plan would be limited to 20%, though individual employers could place further limitations on that percentage. How big is this move? Of a roughly $8 trillion 401(k) plan market, Fidelity controls approximately $3 trillion of that amount. Expect others to follow the company's lead.
We imagine Jack Bogle, the curmudgeonly old founder of Vanguard, is rolling over in his grave at this news. We recall him once arguing that employees were given too many options in their retirement plans, and that more controls (i.e., limitations) needed to be put in place by the government. Of course, that would have meant more assets under management for his company's less-than-stellar target-date funds.
Mo, 25 Apr 2022
Media & Entertainment
The rise and demise of CNN+ (a 30-day tale)
When we first heard that CNN was going to package a standalone streaming subscription service, our immediate thought was, "subscription overload time." We figured the effort would ultimately fail; we had no idea it would do so in under a month. The Warner Bros. Discovery (WBD $20) creation seemed doomed from the start, based on the fanciful wishes of WarnerMedia's management team to build CNN+ into a digital version of the New York Times. The faulty premise was the (arrogant) notion that millions of cord cutters who had previously viewed CNN as part of their respective cable package would suddenly be willing to subscribe to a standalone CNN news network. They threw out a "conservative" estimate of two million new subscribers by the end of the operation's first year. After all, that was a mere one-third of the six million subscriptions that the Times boasts. (The New York Times actually claims it just passed the ten million paid subscribers mark with its acquisition of The Athletic, but that involves some seriously creative math.) The management team even considered putting a paywall around the entire cnn.com site; as we say, arrogance. When AT&T (T $20) completed its WarnerMedia spin-off more quickly than expected, placing industry veteran David Zaslav at the helm, the end was at hand. We have a lot of respect for Zaslav, who has little tolerance for BS. The dream of milking off of AT&T and its deep pockets (and lack of good financial decision making based on past acquisitions) turned into a nightmare. Immediately after WBD began trading as a standalone, CNN+'s marketing budget was adjusted to zero. Chris Licht, former executive producer of Stephen Colbert's show, had just been brought in to run the new operation. One of his first duties was to tell the staff that the unit was defunct, and that they could try and get reassigned to other departments, but that most would be losing their jobs. Licht, himself, will be looking for other work soon. "This is a uniquely shitty situation," Licht told his stunned audience.
Is AT&T a worthy investment now that they have spun off WarnerMedia? No. Is Warner Bros. Discovery a good investment now that they are a standalone? No.
Fr, 22 Apr 2022
Market Pulse
There are different strains of downturns; investors should not sweat this week's garden variety
Investors are going to have to accept this simple fact: the markets will throw a number of tantrums during the Fed's tightening cycle, despite the irrationality of doing so. Quite often, there are very good reasons for a market selloff. March of 2020's downturn, based on the uncertain nature of a global health threat, was a good reason. When markets are vastly overvalued, like they were in March of 2000, that becomes another good reason for a big drawdown. Sometimes, however, the market sells off for very inane, irrational reasons. Chalk this week's downturn up to the latter. It was another one of those weeks when nothing worked: all of the major equity benchmarks fell, as did gold and oil. Bonds typically go up as equities go down; this past week, headline after headline read: "The Global Bond Market Rout." And it was, indeed, the bond market which drove equities lower. If anyone doesn't expect the Fed to raise rates 50 basis points at the May meeting, they have had their head in the sand. Let's be clear: fear of rate hikes is a really dumb reason for a market selloff. Even if Powell and company raise rates at every single meeting for the next year, we will still be below the historical average. The markets can withstand this course of events, despite the investor fits which will be thrown along the way. Here's why we are actually excited about the coming hikes: we will finally be able to pick up some decent-yielding bonds once again, which will mean stronger portfolio allocations. And at some point in 2023, when the Fed will be forced to reverse course due to a looming recession, those bonds are going to look mighty good sitting in our portfolios.
Tech stocks and small-caps have been hit the hardest this year, with both areas not far away from bear market territory. Scan some of the P/E ratios of strong tech/small-cap holdings; you might be surprised at how cheap they are. Want an example? Coinbase Global (COIN $132), a company we hold in the New Frontier Fund, had a P/E ratio of 172 one year ago; it currently holds a multiple of ten. Bargains abound, just choose wisely.
Fr, 22 Apr 2022
Leisure Equipment, Products, & Facilities
Floundering Peloton has one viable option remaining: get acquired and let the new owner broom the C-suite
We were early investors in Peloton (PTON $20), a company which brought a little life back into the languid fitness products market. We stood by the company when they were being attacked by thin-skinned viewers over a Christmas ad which we found to be highly effective—and not at all offensive. Even with the steep price for its products (the Tread+ was selling for around $5k with warranty), we liked the company's business model. Then, following a tragic accident involving a child as well as scores of other incidents, cracks began to appear in the management team's facade. After briefly trying to go on offense against the feds, Co-Founder and then-CEO John Foley was forced to strike a deal with the Consumer Product Safety Commission (CPSC), agreeing to offer a full refund for the 125,000 or so customers who purchased the pricey tread. Furthermore, the machine could be returned for a full refund at any point in time up until 06 November, 2022.
Since then (the agreement was announced last May), John Foley has stepped down as CEO, but the management missteps continue. As if a $39 monthly fee for the Peloton membership was not enough, the company announced it would be raising prices to $44 this June. Here's the insult to injury part (truly, no pun intended): The company's safety "fix," which was also part of the CPSC agreement, made it virtually impossible to use the tread without a membership! What a stupid move, considering the fact that users now have a full six months to think about that slap-in-the-face before deciding whether or not to get their full refund. Membership prices should have been reduced to $30 per month, and customers who willingly paid out a whopping amount of money should retain the ability to run on their tread without a monthly membership fee. That would have been an easy software fix, but that ship has now sailed.
The only remaining viable option for the company is to court suitors, such as Apple (it would be a great fit), and agree to be acquired. With a market cap of under $7 billion (it was a $50 billion company in January of 2021), that would be a win-win outcome. With an obtuse management team, however, that crystal clear option is probably not even being considered.
When PTON shares fell to $50, we said they may be worth a look—though we did not own them at the time. We obviously underestimated the management team's ability to make dumb decisions. Ultimately, we imagine the company will be backed into a corner and have no choice but to sell—or liquidate. As for us, we will continue paying the confiscatory monthly fees through the summer, then turn that fancy puppy in for a full refund and buy another company's tread. With the leftover dough, maybe we will buy a nice television to hang in front of the device; one that offers more than a single, captive, expensive channel. (For Peloton owners, go here for the CPSC recall info, plus the company's contact info; deadline for full refund is 06 Nov 2022.)
We, 20 Apr 2022
Under the Radar
Lundin Mining Corp (LUN.TO $14)
Lundin Mining Corp is a diversified Canadian base metals miner with operations in the United States, Brazil, Chile, Portugal, and Sweden. Copper production is the company's main source of revenue, with about 70% of last year's sales being generated by the base metal. That being said, gold, zinc, and nickel mining are also important components to the company's continued profitability. Not only do we like the miner's geographic footprint—which steers clear of geopolitical hotspots, we also like its mix of products: copper plays a critical role in electronics, power generation and transmission (especially renewables), industrial machinery, and construction. While the risk level is a bit high (3-year beta 1.750), owning the shares have been worth it (3-year alpha 5.090). Lundin has a strong balance sheet, little debt, and a 3.16% dividend yield for income-oriented investors.
We would place a fair value of $20 on LUN.TO shares; the company is appropriate for investors looking for income, a global commodities play, and a willingness to hold a higher-risk name.
We, 20 Apr 2022
Media & Entertainment
The Netflix nightmare continues: shares plunged 35% in one day
Admittedly, we have never been fans of Netflix (NFLX $218) the stock, which means we have missed out on some stunning growth in the past. It also means, however, that we avoided the 69% plunge in the shares between last November and this week. Unlike activist investor (and someone we like about as much as Netflix stock) Bill Ackman, who made an enormous bet on the company three months ago, buying some 3.1 million shares. A full 35% of the stock's decline occurred on Wednesday, following the release of an awful quarterly earnings report. Instead of gaining subscribers, as the company has done every quarter going back to 2011, Netflix actually lost 200,000 subscribers over the three month period. In guidance which stunned analysts even more than Q1's figures, the company said it now expects to lose two million more subscribers in the second quarter. Analysts had been predicting a pick-up of two million subs in the current quarter. While management pointed to the company's retreat from Russia as one explanation for the drop, we would argue that yet another increase in the subscription rate—to $15.49 per month—certainly drove some customers away. Tesla CEO Elon Musk tweeted his own rationale for the streaming service's troubles: "The woke mind virus is making Netflix unwatchable." As for Ackman, he just sold his 3.1 million shares for a huge short-term loss. At least that should help him at tax time next year.
Following the abysmal results, analysts began lowering their price targets for NFLX shares at breakneck speed. Even after their 69% drop, we still wouldn't touch the shares.
Tu, 19 Apr 2022
Airlines
To the delight of the carriers, federal judge in Florida rules CDC overstepped its bounds with airline mask mandate
On Monday, a federal judge in Florida ruled that the CDC had overstepped its authority when it decreed that masks were required to be worn by all passengers on aircraft and other means of public transportation. Shortly after the judge's ruling, the TSA announced that it would no longer enforce the mandate. By Tuesday, all of the major airlines lifted the requirement. In her ruling, US District Judge Kathryn Kimball Mizelle said that the Centers for Disease Control had failed to adequately give the rationale for its mandate, and did not allow for the normal procedure of public comment before issuing its decree. The United States Department of Justice is reviewing the decision and deciding whether or not it will appeal. In addition to the airlines, Amtrak has officially removed its mask requirement, as has private ride-hailing service Uber (UBER $33).
With vaccines and therapies now available, lifting the mask mandate was the common sense next step in our return to some semblance of normalcy. While many health experts are predicting strains of the disease will re-emerge with force when the weather turns colder this coming fall and winter, we don't see a return of either lockdowns or widespread mask requirements. In other words, the disease has become an endemic which must be managed by the health care system for the foreseeable future. As for the airlines specifically, we expect pent up demand for travel to fuel strong earnings over the coming quarters. We own United Airlines Holdings (UAL $45) in the Penn Global Leaders Club.
Tu, 19 Apr 2022
Capital Markets
Schwab gaps down nearly 9% on earnings miss
Retail financial services firm Charles Schwab (SCHW $76) lost nearly 9% of its value on Monday following a first quarter miss on both revenue and earnings. Analysts were looking for $4.83 billion in revenue and earnings per share of $0.84; instead, they got $4.67 billion in revenue and $0.77 in EPS. While retail activity has surged in recent years on the back of commission-free trading, daily trading volume at the firm actually dropped 22% from the same period last year. Increased volatility, new competition, and a return to normal activities following the pandemic all played a role in the company's challenges for the quarter. As for the earnings miss, the high costs associated with the TD Ameritrade acquisition and higher general expenses helped explain the lackluster quarter. Expenses for the three-month period came in $56 million above what Piper Sandler had projected, and 4% above last year's figures. Monday's drop represents the largest one-day decline in SCHW shares since March of 2020.
The company won't admit it, but the TD Ameritrade acquisition has brought about a good deal of unexpected headaches. These will eventually be worked through, but with its P/E ratio of 27 and its rather high price-to-sales ratio of 8, investors shouldn't be in a hurry to take advantage of this most recent drop in the share price.
Tu, 19 Apr 2022
Latin America
AMLO tried to nationalize Mexico's electrical grid; the lower house of congress short-circuited his plans
The state oil company of Mexico, Pemex, is the most indebted oil company in the world. This makes perfect sense, as it is owned and operated by a government rather than private enterprise. What Mexico accomplished through Pemex, President AMLO had hoped to do for the country's electrical grid: nationalize it. To that end, his allies in the Congress of the Union attempted to push through a bill restoring government control over the electrical sector. Fortunately for the Mexican people, the body's lower house refused to deliver. Needing a two-thirds majority to amend the constitution, only 55% of the lower chamber's members voted for the scheme, handing AMLO a rare legislative defeat. AMLO lashed out, calling critics of the bill betrayers of Mexico and defenders of foreign interests. Considering the bill's passage would have greatly diminished foreign investment in Mexico's energy sector, it sounds like these members were acting in the best interest of the citizenry.
This is yet another example of a country's leadership wishing to have it both ways: they want foreign money but wish to keep full control of the entities. It simply doesn't work that way. One of these days, Mexico will offer a great opportunity for investors. That day won't come, however, until elected officials understand and accept how a free market works. The easiest way to invest in the Mexican economy is through the iShares MSCI Mexico ETF (EWW $53). The fund lost 46% of its value in spring of 2020 during the early days of the pandemic, and has a one-year fund outflow of $518 million, leaving just $900 million in total assets under management.
Th, 14 Apr 2022
Flagship vessel of the Russian Black Sea fleet, the missile cruiser Moskva (Moscow), has been so badly damaged that the crew has been forced to evacuate. At least, it is out of commission; at most, it will sink into the Black Sea. Yet again, Putin has overestimated his military and underestimated the adroitness and resolve of the Ukrainians.
UPDATE: It sunk. Russia (falsely) claims ammo exploded on the vessel; Ukraine (correctly) explains that its Neptune missiles successfully struck and destroyed the Moskva.
Th, 14 Apr 2022
The Twitter board views Musk's takeover offer as a distraction. Distraction from what? Losing money? That seems to be their strongest skillset. As for the prince from Saudi Arabia "rejecting" Musk's offer, his sovereign wealth fund owns roughly half as many TWTR shares as Musk. I would create a competing platform and take my 80 million followers (we are among them) to a better platform. As for Twitter's supposed "poison pill" to keep Musk at bay, considering their debt load and the amount of money they are losing, it appears they have already deployed it.
Th, 14 Apr 2022
Trading Desk
Opening new international semiconductor play in the New Frontier Fund
As the world continues to ween itself off of semiconductors made in China, this European company should benefit nicely. It provides thousands of products to companies in industries such as telecom, automotive, industrials, and consumer products. And yes, Tesla is a customer. See the Trading Desk for details.
Flagship vessel of the Russian Black Sea fleet, the missile cruiser Moskva (Moscow), has been so badly damaged that the crew has been forced to evacuate. At least, it is out of commission; at most, it will sink into the Black Sea. Yet again, Putin has overestimated his military and underestimated the adroitness and resolve of the Ukrainians.
UPDATE: It sunk. Russia (falsely) claims ammo exploded on the vessel; Ukraine (correctly) explains that its Neptune missiles successfully struck and destroyed the Moskva.
Th, 14 Apr 2022
The Twitter board views Musk's takeover offer as a distraction. Distraction from what? Losing money? That seems to be their strongest skillset. As for the prince from Saudi Arabia "rejecting" Musk's offer, his sovereign wealth fund owns roughly half as many TWTR shares as Musk. I would create a competing platform and take my 80 million followers (we are among them) to a better platform. As for Twitter's supposed "poison pill" to keep Musk at bay, considering their debt load and the amount of money they are losing, it appears they have already deployed it.
Th, 14 Apr 2022
Trading Desk
Opening new international semiconductor play in the New Frontier Fund
As the world continues to ween itself off of semiconductors made in China, this European company should benefit nicely. It provides thousands of products to companies in industries such as telecom, automotive, industrials, and consumer products. And yes, Tesla is a customer. See the Trading Desk for details.
Mo, 18 Apr 2022
Global Organizations & Accords
Putin, his own worst enemy, is pushing historically-neutral Finland and Sweden into the arms of a welcoming NATO
While Norway has been a member of NATO since its inception in 1949, neighboring Nordic countries Sweden and Finland have historically and steadfastly remained nonaligned with any military organization or group. It appears that is all about to change. Especially with respect to Finland, which borders Russia to its east, it is easy to understand this geopolitical balancing act. For Finnish Prime Minister Sanna Marin, however, "Everything changed when Russia invaded Ukraine." Prime Minister Magdalena Andersson of Sweden was just as succinct with her analysis: "There is a before and after the 24th of February." Both women lead countries on the verge of deciding whether or not to apply for NATO membership, with its "an invasion of one is an invasion of all" canon. Finland has paved its path toward membership with a new security-policy report clearly outlining the threat posed by its eastern neighbor. For the fiercely-independent citizens of both countries, Putin's aggressive actions have had a clear impact, with majorities now favoring membership. With decisions from both countries imminent, the autocratic leader of Russia has already issued an ultimatum. Dmitry Medvedev, once Putin's puppet president and now the country's prime minister, has said that a nuclear-free Baltic region would no longer be possible if Finland and Sweden become NATO member-states. Lithuanian Prime Minister Ingrida Simonyte dismissed the threats, noting that Russia has already armed the region with nuclear weapons. The death and destruction brought about by the invasion has been a tragedy for Europe and for the civilized world. At least it appears to be crystallizing the resolve of Europe to a rare degree.
We would put money on Finland and Sweden joining the alliance, which will lead to more saber-rattling by Putin. We applaud the leadership being exercised in the region, which will certainly manifest itself through larger defense budgets.
Global Organizations & Accords
Putin, his own worst enemy, is pushing historically-neutral Finland and Sweden into the arms of a welcoming NATO
While Norway has been a member of NATO since its inception in 1949, neighboring Nordic countries Sweden and Finland have historically and steadfastly remained nonaligned with any military organization or group. It appears that is all about to change. Especially with respect to Finland, which borders Russia to its east, it is easy to understand this geopolitical balancing act. For Finnish Prime Minister Sanna Marin, however, "Everything changed when Russia invaded Ukraine." Prime Minister Magdalena Andersson of Sweden was just as succinct with her analysis: "There is a before and after the 24th of February." Both women lead countries on the verge of deciding whether or not to apply for NATO membership, with its "an invasion of one is an invasion of all" canon. Finland has paved its path toward membership with a new security-policy report clearly outlining the threat posed by its eastern neighbor. For the fiercely-independent citizens of both countries, Putin's aggressive actions have had a clear impact, with majorities now favoring membership. With decisions from both countries imminent, the autocratic leader of Russia has already issued an ultimatum. Dmitry Medvedev, once Putin's puppet president and now the country's prime minister, has said that a nuclear-free Baltic region would no longer be possible if Finland and Sweden become NATO member-states. Lithuanian Prime Minister Ingrida Simonyte dismissed the threats, noting that Russia has already armed the region with nuclear weapons. The death and destruction brought about by the invasion has been a tragedy for Europe and for the civilized world. At least it appears to be crystallizing the resolve of Europe to a rare degree.
We would put money on Finland and Sweden joining the alliance, which will lead to more saber-rattling by Putin. We applaud the leadership being exercised in the region, which will certainly manifest itself through larger defense budgets.
Mo, 11 Apr 2022
E-Commerce
We are fine with Shopify's ten-for-one stock split decision; it is the other planned move which has us concerned
Ten-for-one stock splits have been the financial activity du jour for tech companies recently, with the likes of Amazon, Google, and Tesla undertaking such moves. E-commerce platform Shopify (SHOP $601) just joined the pack. We began seriously looking at this e-commerce platform, which is a hugely popular choice for small- and medium-sized businesses wishing to expand their digital footprint, after its share price plunged some 70% in the four-month period between last November and this past March. Around $600 per share, it seems undervalued. The company just announced a move we fully support: it will undergo a ten-for-one stock split, which would bring the current share price to around $60. At first, share futures rallied on the news; but then, another announcement was made which gave investors pause for concern. A new share class would be created, the Founder share, which would be given to founder and CEO Tobi Lutke in order to increase his voting power in excess of 40%. We have made clear our disdain for dual share class structures (or more than dual in many cases), which is little short of financial engineering designed to give elite stakeholders power over us ordinary shlub owners, the hoi polloi who dare to expect some modicum of power simply because we put our hard-earned money into an ownership stake. Granted, Lutke has been a fine—even dynamic—leader for the firm, but he is well compensated for his skills through a generous, $15 million per year pay structure and a 6.27% ownership stake. If he wants so much power over the firm he began, shouldn't he take it private? Shopify really is an excellent platform for small- and mid-sized businesses, but the competition is too keen for the company to turn off would-be investors with this scheme.
We put together the accompanying graph in February, asking if shares were undervalued at $657. If they were then, they certainly are now, with shares floating around the $600 level. Still, we are having trouble accepting this Founder share class maneuver. For investors who have a high risk appetite and are comfortable with the move, we could easily make the argument that the shares are worth between $750 and $1,000. We just can't justify pulling the trigger right now.
E-Commerce
We are fine with Shopify's ten-for-one stock split decision; it is the other planned move which has us concerned
Ten-for-one stock splits have been the financial activity du jour for tech companies recently, with the likes of Amazon, Google, and Tesla undertaking such moves. E-commerce platform Shopify (SHOP $601) just joined the pack. We began seriously looking at this e-commerce platform, which is a hugely popular choice for small- and medium-sized businesses wishing to expand their digital footprint, after its share price plunged some 70% in the four-month period between last November and this past March. Around $600 per share, it seems undervalued. The company just announced a move we fully support: it will undergo a ten-for-one stock split, which would bring the current share price to around $60. At first, share futures rallied on the news; but then, another announcement was made which gave investors pause for concern. A new share class would be created, the Founder share, which would be given to founder and CEO Tobi Lutke in order to increase his voting power in excess of 40%. We have made clear our disdain for dual share class structures (or more than dual in many cases), which is little short of financial engineering designed to give elite stakeholders power over us ordinary shlub owners, the hoi polloi who dare to expect some modicum of power simply because we put our hard-earned money into an ownership stake. Granted, Lutke has been a fine—even dynamic—leader for the firm, but he is well compensated for his skills through a generous, $15 million per year pay structure and a 6.27% ownership stake. If he wants so much power over the firm he began, shouldn't he take it private? Shopify really is an excellent platform for small- and mid-sized businesses, but the competition is too keen for the company to turn off would-be investors with this scheme.
We put together the accompanying graph in February, asking if shares were undervalued at $657. If they were then, they certainly are now, with shares floating around the $600 level. Still, we are having trouble accepting this Founder share class maneuver. For investors who have a high risk appetite and are comfortable with the move, we could easily make the argument that the shares are worth between $750 and $1,000. We just can't justify pulling the trigger right now.
Tu, 05 Apr 2022
Economic Outlook
The yield curve is inverted once again, so does that really mean a recession is rapidly approaching?
The "normal" yield curve makes sense: an investor expects to receive better compensation for longer maturity instruments, as uncertainty understandably increases with time. So, a 5-year Treasury should pay more than a 2-year, a 10-year Treasury should pay more than a 5-year, and so on. This is known as the risk premium—investors expect to be rewarded for taking more risk by going further out on the time horizon. The yield curve inverts when something unusual happens: shorter-maturity instruments begin offering a better yield than their longer-term counterparts, with the difference being known as the spread. The most common comparison economists look at for an indication of economic health is the 2-10 year spread, and it just so happens that the spread in question has inverted.
Why would fixed-income investors be willing to accept a 2.42% rate on a 10-year Treasury right now as opposed to a 2.43% rate on a 2-year? Because they believe that economic conditions will worsen to the point at which the Fed must begin easing in the not-too-distant future. If events unfold in this manner, the value of that 10-year, 2.42% note will rise in value quicker (or at least hold up better) than its shorter-term counterpart. It may seem crazy to be talking about easing when we are just one, 25-basis-point hike into a tightening cycle expected to last a year or so, but that is where we are. As for the time frame, the last five recessions (not counting the one induced by COVID in early 2020) came between 10 and 34 months after the yield curve inverted. This has many economists looking out to mid- to late-2023 for the next one.
Others are splashing cold water on this prognosis, pointing out that foreign demand for 10-year US Treasuries has been elevated and sustained. Per the laws of supply and demand, the issuer—the US government in this case—is able to offer lower rates and still attract buyers. Another factor is duration of the inverted curve. While it has fluttered between negative and positive, there has yet to be a persistent inversion. Throwing a third factor into the mix, the S&P 500 has historically been strong in the period between inversion of the yield curve and the beginning of a recession. In other words, don't panic just yet.
Not counting 2020's mini recession induced by the pandemic, the US has endured twelve recessions since the end of World War II, with the last occurring between 2007 and 2009. It is too simple to say we are "due" a recession, as so many variables conspire to cause the event. Nonetheless, proper asset allocation is paramount when preparing for the next economic downturn—whenever it comes.
Economic Outlook
The yield curve is inverted once again, so does that really mean a recession is rapidly approaching?
The "normal" yield curve makes sense: an investor expects to receive better compensation for longer maturity instruments, as uncertainty understandably increases with time. So, a 5-year Treasury should pay more than a 2-year, a 10-year Treasury should pay more than a 5-year, and so on. This is known as the risk premium—investors expect to be rewarded for taking more risk by going further out on the time horizon. The yield curve inverts when something unusual happens: shorter-maturity instruments begin offering a better yield than their longer-term counterparts, with the difference being known as the spread. The most common comparison economists look at for an indication of economic health is the 2-10 year spread, and it just so happens that the spread in question has inverted.
Why would fixed-income investors be willing to accept a 2.42% rate on a 10-year Treasury right now as opposed to a 2.43% rate on a 2-year? Because they believe that economic conditions will worsen to the point at which the Fed must begin easing in the not-too-distant future. If events unfold in this manner, the value of that 10-year, 2.42% note will rise in value quicker (or at least hold up better) than its shorter-term counterpart. It may seem crazy to be talking about easing when we are just one, 25-basis-point hike into a tightening cycle expected to last a year or so, but that is where we are. As for the time frame, the last five recessions (not counting the one induced by COVID in early 2020) came between 10 and 34 months after the yield curve inverted. This has many economists looking out to mid- to late-2023 for the next one.
Others are splashing cold water on this prognosis, pointing out that foreign demand for 10-year US Treasuries has been elevated and sustained. Per the laws of supply and demand, the issuer—the US government in this case—is able to offer lower rates and still attract buyers. Another factor is duration of the inverted curve. While it has fluttered between negative and positive, there has yet to be a persistent inversion. Throwing a third factor into the mix, the S&P 500 has historically been strong in the period between inversion of the yield curve and the beginning of a recession. In other words, don't panic just yet.
Not counting 2020's mini recession induced by the pandemic, the US has endured twelve recessions since the end of World War II, with the last occurring between 2007 and 2009. It is too simple to say we are "due" a recession, as so many variables conspire to cause the event. Nonetheless, proper asset allocation is paramount when preparing for the next economic downturn—whenever it comes.
Mo, 04 Apr 2022
Interactive Media & Services
Twitter rockets higher after Elon Musk takes 9% stake in the social media platform
A few weeks ago, Elon Musk took to Twitter (TWTR $50) to throw some shade the company's way. After calling the social media platform the "de facto public town square (for the exchange of ideas)," he asked his 80 million followers, "Do you believe Twitter rigorously adheres to this principle (of free speech)?" For the record, the response was 70% to 30% in the negative. Several months before positing this question, Musk tweeted an altered image of CEO Parag Agrawal seemingly doing away with founder and former CEO Jack Dorsey by pushing him into a river. Our opinion is that the tweet was more of a joke than anything (it was funny), but analysts began questioning whether he had it out for Twitter's new boss. On Monday came the news that, around mid March, Musk had made himself the firm's largest shareholder, with a 9% stake worth around $3 billion. News of the stake sent TWTR shares rocketing 27% higher—to $50—in Monday's session. While his position is classified as a passive stake per his 13G filing, it is hard to imagine Musk making his first major investment in a publicly-traded company (outside of one which he controls) without having a say in how the company is managed going forward. Especially given his record of tweeting what is on his mind. The simple fact that he is the largest shareholder gives him more sway over the company than The Vanguard Group or Morgan Stanley Investment Management—the second and third largest shareholders, respectively. The interesting questions become, what will he do with this power, how might (his chronic nemesis) the SEC respond, and what are his larger designs? Stay tuned.
With Twitter shares still down nearly 40% from their highs, even after the Musk bounce, is the platform a buying opportunity? To say we weren't fans of Jack Dorsey would be an understatement, but we have about as much confidence in Agrawal as Musk seems to place in him. Perhaps this new shareholder can be the catalyst the company needs to better monetize its business and actually become the "de facto public town square for the exchange of ideas." Until Musk's plans are a little more clear, we still wouldn't be buyers.
Interactive Media & Services
Twitter rockets higher after Elon Musk takes 9% stake in the social media platform
A few weeks ago, Elon Musk took to Twitter (TWTR $50) to throw some shade the company's way. After calling the social media platform the "de facto public town square (for the exchange of ideas)," he asked his 80 million followers, "Do you believe Twitter rigorously adheres to this principle (of free speech)?" For the record, the response was 70% to 30% in the negative. Several months before positing this question, Musk tweeted an altered image of CEO Parag Agrawal seemingly doing away with founder and former CEO Jack Dorsey by pushing him into a river. Our opinion is that the tweet was more of a joke than anything (it was funny), but analysts began questioning whether he had it out for Twitter's new boss. On Monday came the news that, around mid March, Musk had made himself the firm's largest shareholder, with a 9% stake worth around $3 billion. News of the stake sent TWTR shares rocketing 27% higher—to $50—in Monday's session. While his position is classified as a passive stake per his 13G filing, it is hard to imagine Musk making his first major investment in a publicly-traded company (outside of one which he controls) without having a say in how the company is managed going forward. Especially given his record of tweeting what is on his mind. The simple fact that he is the largest shareholder gives him more sway over the company than The Vanguard Group or Morgan Stanley Investment Management—the second and third largest shareholders, respectively. The interesting questions become, what will he do with this power, how might (his chronic nemesis) the SEC respond, and what are his larger designs? Stay tuned.
With Twitter shares still down nearly 40% from their highs, even after the Musk bounce, is the platform a buying opportunity? To say we weren't fans of Jack Dorsey would be an understatement, but we have about as much confidence in Agrawal as Musk seems to place in him. Perhaps this new shareholder can be the catalyst the company needs to better monetize its business and actually become the "de facto public town square for the exchange of ideas." Until Musk's plans are a little more clear, we still wouldn't be buyers.
Tu, 29 Mar 2022
Real Estate Management & Development
Following a pandemic-driven office exodus, One World Trade Center is bucking the trend with its 95% occupancy rate
Despite what big-city politicians are telling us about the great worker return of 2022, the pandemic—and subsequent advances in telecom technology—helped generate a seismic shift in the corporate real estate environment. Companies which never gave a thought to allowing any of their employees to work remotely have suddenly embraced the hybrid, home/office work model. As financial managers gaze at their leases, which continue to become more costly thanks to inflation, they are even more inclined to change their ways. On top of this transformation, many big financial firms have been fleeing NYC for greener pastures in Florida, despite the fact that the self-proclaimed socialist mayor (DeBlasio) is finally gone. Even as COVID-19 cases continue to subside, the city is still facing 40-year high vacancy rates.
Against that backdrop, we have One World Trade Center, the 104-story "tallest building in the Western Hemisphere." After an existing tenant, Germany's Celonis (data processing), expanded its footprint to the entire 70th floor of the building, the skyscraper is now at 95% occupancy. Considering its 3.1 million square feet of space garners some $75 to $85 per rentable square foot, that is impressive. Breaking that down, and assuming Celonis is paying $80 per square foot, that comes to $3.28 million per year for the 70th floor alone.
With additional space hitting the market, and with financial firms still pulling out, we can expect a dichotomy to form between the high-tech, glass-imbued modern skyscrapers and the clusters of older, less energy efficient buildings in need of constant repair and renovation. The older buildings also lack many of the amenities and features workers are looking for today, including state-of-the-art gyms, plenty of large windows, higher ceiling heights, and outdoor spaces. In many cases, it is structurally impossible to transform a 1970s-era building into one which can compete with its newly-built counterparts. And that will continue to be a major source of consternation for landlords and office property REITs relying on contract renewals and a steady stream of new tenants.
While many office property REITs will struggle with the new hybrid work model, investors should remember that this is an industry full of opportunities in areas outside of office and retail space. Digital Realty Trust (DLR $144), for example, owns and operates 300 data centers worldwide. American Tower Corp (AMT $250) is a specialty REIT which owns a quarter of a million cell towers around the world. Both of these companies are members of the Penn Global Leaders Club.
Real Estate Management & Development
Following a pandemic-driven office exodus, One World Trade Center is bucking the trend with its 95% occupancy rate
Despite what big-city politicians are telling us about the great worker return of 2022, the pandemic—and subsequent advances in telecom technology—helped generate a seismic shift in the corporate real estate environment. Companies which never gave a thought to allowing any of their employees to work remotely have suddenly embraced the hybrid, home/office work model. As financial managers gaze at their leases, which continue to become more costly thanks to inflation, they are even more inclined to change their ways. On top of this transformation, many big financial firms have been fleeing NYC for greener pastures in Florida, despite the fact that the self-proclaimed socialist mayor (DeBlasio) is finally gone. Even as COVID-19 cases continue to subside, the city is still facing 40-year high vacancy rates.
Against that backdrop, we have One World Trade Center, the 104-story "tallest building in the Western Hemisphere." After an existing tenant, Germany's Celonis (data processing), expanded its footprint to the entire 70th floor of the building, the skyscraper is now at 95% occupancy. Considering its 3.1 million square feet of space garners some $75 to $85 per rentable square foot, that is impressive. Breaking that down, and assuming Celonis is paying $80 per square foot, that comes to $3.28 million per year for the 70th floor alone.
With additional space hitting the market, and with financial firms still pulling out, we can expect a dichotomy to form between the high-tech, glass-imbued modern skyscrapers and the clusters of older, less energy efficient buildings in need of constant repair and renovation. The older buildings also lack many of the amenities and features workers are looking for today, including state-of-the-art gyms, plenty of large windows, higher ceiling heights, and outdoor spaces. In many cases, it is structurally impossible to transform a 1970s-era building into one which can compete with its newly-built counterparts. And that will continue to be a major source of consternation for landlords and office property REITs relying on contract renewals and a steady stream of new tenants.
While many office property REITs will struggle with the new hybrid work model, investors should remember that this is an industry full of opportunities in areas outside of office and retail space. Digital Realty Trust (DLR $144), for example, owns and operates 300 data centers worldwide. American Tower Corp (AMT $250) is a specialty REIT which owns a quarter of a million cell towers around the world. Both of these companies are members of the Penn Global Leaders Club.
Tu, 29 Mar 2022
Aerospace & Defense
Lockheed Martin scores two big wins in one month as both Canada and Germany select the company's fighters
Aerospace giant Lockheed Martin (LMT $430) remains one of our strongest conviction holdings for a number of reasons: leadership, geopolitical tensions, style profile, product mix, and growth potential just to name a few. This month we received a couple of other reasons to appreciate this undervalued gem. A few weeks ago Germany, under new Chancellor Olaf Scholz, announced it would be purchasing 35 of the company's F-35 Lightning II "Panther" fighter aircraft to replace its aging fleet of Tornado combat aircraft—a European-built fighter which has been in service since the early 1980s. This was a slap in the face to France, which had argued for a next-generation, European-built fighter to be the focus of the continent's air defenses. This past week, Lockheed beat out yet another European aerospace company as Canada announced it would buy 88 F-35s instead of Saab's (Sweden) Gripen fighters. Boeing had previously been knocked out of the competition. There is some humor in this story, as Saab had complained about a "politically influenced" decision by Finland to buy 64 F-35s, with the company "looking forward to an impartial Canada (to select the Gripen over the Panther)." The Canadian deal alone could equate to an additional $1 billion per year in sales for Lockheed beginning in 2025. The company should consider sending Putin a thank you card for awakening the Western world to the real and present danger of an aggressive Russia and its communist neighbor to the south.
While Boeing flounders under the arrogant leadership of David Calhoun, Lockheed CEO (and former Air Force pilot) Jim Taiclet pushes quietly forward, gaining market share and building bridges to our NATO allies. Leadership matters.
Aerospace & Defense
Lockheed Martin scores two big wins in one month as both Canada and Germany select the company's fighters
Aerospace giant Lockheed Martin (LMT $430) remains one of our strongest conviction holdings for a number of reasons: leadership, geopolitical tensions, style profile, product mix, and growth potential just to name a few. This month we received a couple of other reasons to appreciate this undervalued gem. A few weeks ago Germany, under new Chancellor Olaf Scholz, announced it would be purchasing 35 of the company's F-35 Lightning II "Panther" fighter aircraft to replace its aging fleet of Tornado combat aircraft—a European-built fighter which has been in service since the early 1980s. This was a slap in the face to France, which had argued for a next-generation, European-built fighter to be the focus of the continent's air defenses. This past week, Lockheed beat out yet another European aerospace company as Canada announced it would buy 88 F-35s instead of Saab's (Sweden) Gripen fighters. Boeing had previously been knocked out of the competition. There is some humor in this story, as Saab had complained about a "politically influenced" decision by Finland to buy 64 F-35s, with the company "looking forward to an impartial Canada (to select the Gripen over the Panther)." The Canadian deal alone could equate to an additional $1 billion per year in sales for Lockheed beginning in 2025. The company should consider sending Putin a thank you card for awakening the Western world to the real and present danger of an aggressive Russia and its communist neighbor to the south.
While Boeing flounders under the arrogant leadership of David Calhoun, Lockheed CEO (and former Air Force pilot) Jim Taiclet pushes quietly forward, gaining market share and building bridges to our NATO allies. Leadership matters.
F-35 Lightning II "Panther"; Image courtesy of Lockheed Martin
Mo, 28 Mar 2022
Automotive
With one announcement, and in one session, Tesla gains more in value than Ford Motor Company is worth
Ahh the law of large numbers. It is one thing to say that Tesla (TSLA $1,091) has a market cap of $1.128 trillion versus Ford Motor Company's (F $17) $66 billion, but let's compare their respective sizes with this stunning fact: Tesla's one day change in value is greater than Ford's total value. The reason for the EV maker's 8% gain on the day? The company announced it would perform another stock split to make the shares more accessible to retail investors. Shareholders still need to approve the move, but that is almost a given, and we can assume another 5-1 division is in the works, as was the case with the 2020 split. Speaking of that past event, it led to a 40% rally by Tesla shares and an inclusion in the S&P 500 by year's end.
Just as we liked both Google and Amazon's 20-1 stock split, we like this move as well. Of course, the act of splitting a stock doesn't add or subtract one penny of value in and of itself, but it generally garners excitement by the investment community. This is as opposed to GE's financial engineering in which eight shares suddenly became one share, eight times more expensive. That stunt back in the Summer of 2020 has led to an 11% drop in the almost two years since it happened. We own Tesla in the Penn New Frontier Fund, where it continues to perform as expected. Naysayers point to the flood of EVs about to inundate the market; we point to Tesla's growing lead over the pack, and their massive lead in the world of fuel cell technology.
Automotive
With one announcement, and in one session, Tesla gains more in value than Ford Motor Company is worth
Ahh the law of large numbers. It is one thing to say that Tesla (TSLA $1,091) has a market cap of $1.128 trillion versus Ford Motor Company's (F $17) $66 billion, but let's compare their respective sizes with this stunning fact: Tesla's one day change in value is greater than Ford's total value. The reason for the EV maker's 8% gain on the day? The company announced it would perform another stock split to make the shares more accessible to retail investors. Shareholders still need to approve the move, but that is almost a given, and we can assume another 5-1 division is in the works, as was the case with the 2020 split. Speaking of that past event, it led to a 40% rally by Tesla shares and an inclusion in the S&P 500 by year's end.
Just as we liked both Google and Amazon's 20-1 stock split, we like this move as well. Of course, the act of splitting a stock doesn't add or subtract one penny of value in and of itself, but it generally garners excitement by the investment community. This is as opposed to GE's financial engineering in which eight shares suddenly became one share, eight times more expensive. That stunt back in the Summer of 2020 has led to an 11% drop in the almost two years since it happened. We own Tesla in the Penn New Frontier Fund, where it continues to perform as expected. Naysayers point to the flood of EVs about to inundate the market; we point to Tesla's growing lead over the pack, and their massive lead in the world of fuel cell technology.
Sa, 26 Mar 2022
Beverages, Tobacco, & Cannabis
Tilray Brands gains 55% for the week on positive cannabis news, deal with competitor
A major reason why we added Canadian cannabis player Tilray Brands (TLRY $9) to the Intrepid Trading Platform was its management team: CEO Irwin Simon is the adroit businessman who founded Hain Celestial back in 1993. While the industry's performance has been lacking as of late, to put it mildly, the company had a big turn of luck this past week. First, it announced an alliance with smaller rival Hexo (HEXO $0.74) in which it would help the company straighten out its finances in return for a generous share of the company. Tilray made a similar deal with California-based cannabis player MedMen last year (though the terms of that deal are more convoluted, as a Canadian cannabis firm cannot own a stake in a US-based one as of yet). The market approved of the company's "white knight" approach, pushing shares higher. Then came news that the US House of Representatives would consider a bill to decriminalize marijuana on a national level. Of course, there is no guarantee this one will make it further than previous bills, but it feels as if the movement is getting closer to the finish line. Shares of Tilray rose 55.35% on the week.
We own TLRY in the Intrepid with an initial target price of $14 per share. We expect to see major consolidation in the industry, with Tilray becoming one of the industry leaders. Tilray merged with larger industry player Aphria back in December of 2020.
Beverages, Tobacco, & Cannabis
Tilray Brands gains 55% for the week on positive cannabis news, deal with competitor
A major reason why we added Canadian cannabis player Tilray Brands (TLRY $9) to the Intrepid Trading Platform was its management team: CEO Irwin Simon is the adroit businessman who founded Hain Celestial back in 1993. While the industry's performance has been lacking as of late, to put it mildly, the company had a big turn of luck this past week. First, it announced an alliance with smaller rival Hexo (HEXO $0.74) in which it would help the company straighten out its finances in return for a generous share of the company. Tilray made a similar deal with California-based cannabis player MedMen last year (though the terms of that deal are more convoluted, as a Canadian cannabis firm cannot own a stake in a US-based one as of yet). The market approved of the company's "white knight" approach, pushing shares higher. Then came news that the US House of Representatives would consider a bill to decriminalize marijuana on a national level. Of course, there is no guarantee this one will make it further than previous bills, but it feels as if the movement is getting closer to the finish line. Shares of Tilray rose 55.35% on the week.
We own TLRY in the Intrepid with an initial target price of $14 per share. We expect to see major consolidation in the industry, with Tilray becoming one of the industry leaders. Tilray merged with larger industry player Aphria back in December of 2020.
Sa, 26 Mar 2022
Market Pulse
Thanks to a few good weeks, the ugly quarter is starting to look brighter
When the month hit its midway point, things weren't looking good for the stock market. By session close on Friday the 11th, the S&P 500 had fallen 12% and the NASDAQ was still hanging around bear market territory for the year, down 18%. At that point, investors had little to look forward to: the war in Ukraine was raging—along with inflation in the US—and the Fed was suddenly talking about seven consecutive rate hikes. In the midst of all the worry and few positive catalysts, the major benchmarks strung together two impressive weeks. With just four trading days remaining in Q1, the S&P 500 is off less than 5% for the year, while the NASDAQ and Russell 2000 (small caps) are only off by single digits. This flurry of positive activity took place as bonds continued to lose ground as Treasury yields rose. The 10-year is now yielding just shy of 2.5%—a 15% increase from where it started the week. That spike is understandable considering talk is now swirling around 50-basis-point rate hikes instead of the formerly-baked-in 25 bps. As the real yield on money markets is still deeply in the red thanks to inflation, and as bond values continue to drop due to the tightening cycle we are (finally) in, US equities seem to be the beneficiary. Even cryptos punched their way out of a deep recent funk, with ethereum and bitcoin jumping 10% and 8% on the week, respectively. We are sticking with our year-end target of 5,100 for the S&P 500, which would represent a 12% gain from here. Our year-end target for the upper band of the Fed funds rate is 2%, or 1.5% higher than its current rate. We also expect the Fed to begin substantially lowering its $9T balance sheet by selling some of the $2.6 trillion worth of mortgage-backed securities and Treasuries it holds—or, at least, letting existing ones fall off the balance sheet without reinvesting the proceeds. The market should be able to handle these moves, but expect some tantrums along the way.
Sa, 26 Mar 2022
Under the Radar
Silgan Holdings Inc (SLGN $46)
There are some points in the market cycle at which it pays to be loaded up with boring old defensive plays; the companies that quietly churn out profits, growing their top line revenue and earnings per share quarter after quarter. There is a strong argument being made that the Fed will have to raise rates so rapidly to tame inflation that it will push the US into recession by some point in 2023. If that is the case, now is the time to load up on such companies. For instance: Silgan ("SEAL gun") Holdings (SLGN $46) manufactures roughly half of all metal food containers in North America, with customers such as Campbell Soup, Nestle, and Del Monte. An astute acquirer, the company is currently searching for opportunities to increase its footprint in the European metal and plastic packaging market. Based out of Stamford, Connecticut, this small-cap value gem has a market cap of $5 billion, a forward P/E ratio of 12, and a relative strength rating of 86. We would place a fair value on SLGN shares at $65.
Th, 24 Mar 2022
Media & Entertainment
Trouble in the House of Mouse: Steer clear of Disney due to Iger's ego, Chapek's inability, workers' activism
So many companies we thought would always have a role in the Penn portfolios, so many disappointments. General Electric, Boeing, Starbucks...Disney. The latter, The Walt Disney Company (DIS $138), is now facing a serious crisis of confidence swirling around its leadership team. First we have Bob Iger, the golden CEO who spent fifteen years running the company. Iger was the central figure in the transformation of Disney into the world's largest media company. Unfortunately, the only thing greater than his ability was—and is—his stratospheric ego. After reading his autobiography, The Ride of a Lifetime, the first thing that came to mind was, "Strong leader, complete a**." Perhaps it was Iger's ego—his desire to go out on top—that led him to resign his role as CEO at the worst possible time: just as businesses were shutting down due to the pandemic. It was bad enough that his hand-picked successor, Disney Parks President Bob Chapek, had to receive a baptism by fire, but Iger's refusal to ride off into the sunset compounded the problem. Just a few months after Chapek took the helm, Iger was loudly announcing his plans to help lead Disney through this troubled period. What a punk move. As could be expected, Chapek was furious. That incident caused the couple to become estranged.
To be clear, we were never happy with Iger's pick of Chapek. We felt he was a capable manager, but not the leader Disney would need for its next two decades of growth. That is becoming clear in his handling of what should be a non-issue for the company. As is increasingly the case in America, employees are demanding their companies, the entities which place money in these employees' respective bank accounts, make political stands. Companies should be, by nature, apolitical. That level of corporate maturity doesn't fit into the zeitgeist of today's "pay attention to me!" society, apparently. When the Florida legislature took up a bill which would disallow schools from discussing sexual orientation in grades kindergarten through third, there was a call to arms by certain groups. The fact that Disney would not immediately denounce the bill put them in the crosshairs. In no way, shape, or form did the company come out in support of the bill, it should be noted. Employees were called upon to walk off the job and protest in front of Disney headquarters—iPhone cameras at the ready, no doubt. Chapek quickly did a mea culpa and came out against the bill. The obligatory "listening tour" and "equality task force" quickly manifested.
Before this latest "incident" (which never should have been an incident at all), Chapek made some questionable moves. By picking a fight with Black Widow star Scarlett Johansson—a fight he ultimately lost—he risked alienating the Hollywood community. By centralizing budget control (P&L power) for all movie and TV deals to a key ally, he alienated high level managers in the field who previously held a good deal of such authority. By snubbing Iger instead of stroking his giant ego until he was ultimately out the door, he forced company executives to choose sides. (Iger had remained on as chairman of the board after stepping down as CEO.) None of these were wise moves by a CEO whose contract is up for renewal in eleven months. Disney will weather this latest storm, but something tells us many more are to follow.
In a way we almost feel bad for Chapek, who clearly does not have Iger's charm-on-demand. Furthermore, his strategic vision for the company and its digital future make a lot of sense, but he cannot seem to make the personal connections needed to drive that point home. When Chapek was first announced by Iger as his hand-picked replacement, we sold our Disney stake. That was a wise move, and one we don't plan on reversing until the storm clouds hovering above the Magic Kingdom show signs of subsiding.
Market Pulse
Thanks to a few good weeks, the ugly quarter is starting to look brighter
When the month hit its midway point, things weren't looking good for the stock market. By session close on Friday the 11th, the S&P 500 had fallen 12% and the NASDAQ was still hanging around bear market territory for the year, down 18%. At that point, investors had little to look forward to: the war in Ukraine was raging—along with inflation in the US—and the Fed was suddenly talking about seven consecutive rate hikes. In the midst of all the worry and few positive catalysts, the major benchmarks strung together two impressive weeks. With just four trading days remaining in Q1, the S&P 500 is off less than 5% for the year, while the NASDAQ and Russell 2000 (small caps) are only off by single digits. This flurry of positive activity took place as bonds continued to lose ground as Treasury yields rose. The 10-year is now yielding just shy of 2.5%—a 15% increase from where it started the week. That spike is understandable considering talk is now swirling around 50-basis-point rate hikes instead of the formerly-baked-in 25 bps. As the real yield on money markets is still deeply in the red thanks to inflation, and as bond values continue to drop due to the tightening cycle we are (finally) in, US equities seem to be the beneficiary. Even cryptos punched their way out of a deep recent funk, with ethereum and bitcoin jumping 10% and 8% on the week, respectively. We are sticking with our year-end target of 5,100 for the S&P 500, which would represent a 12% gain from here. Our year-end target for the upper band of the Fed funds rate is 2%, or 1.5% higher than its current rate. We also expect the Fed to begin substantially lowering its $9T balance sheet by selling some of the $2.6 trillion worth of mortgage-backed securities and Treasuries it holds—or, at least, letting existing ones fall off the balance sheet without reinvesting the proceeds. The market should be able to handle these moves, but expect some tantrums along the way.
Sa, 26 Mar 2022
Under the Radar
Silgan Holdings Inc (SLGN $46)
There are some points in the market cycle at which it pays to be loaded up with boring old defensive plays; the companies that quietly churn out profits, growing their top line revenue and earnings per share quarter after quarter. There is a strong argument being made that the Fed will have to raise rates so rapidly to tame inflation that it will push the US into recession by some point in 2023. If that is the case, now is the time to load up on such companies. For instance: Silgan ("SEAL gun") Holdings (SLGN $46) manufactures roughly half of all metal food containers in North America, with customers such as Campbell Soup, Nestle, and Del Monte. An astute acquirer, the company is currently searching for opportunities to increase its footprint in the European metal and plastic packaging market. Based out of Stamford, Connecticut, this small-cap value gem has a market cap of $5 billion, a forward P/E ratio of 12, and a relative strength rating of 86. We would place a fair value on SLGN shares at $65.
Th, 24 Mar 2022
Media & Entertainment
Trouble in the House of Mouse: Steer clear of Disney due to Iger's ego, Chapek's inability, workers' activism
So many companies we thought would always have a role in the Penn portfolios, so many disappointments. General Electric, Boeing, Starbucks...Disney. The latter, The Walt Disney Company (DIS $138), is now facing a serious crisis of confidence swirling around its leadership team. First we have Bob Iger, the golden CEO who spent fifteen years running the company. Iger was the central figure in the transformation of Disney into the world's largest media company. Unfortunately, the only thing greater than his ability was—and is—his stratospheric ego. After reading his autobiography, The Ride of a Lifetime, the first thing that came to mind was, "Strong leader, complete a**." Perhaps it was Iger's ego—his desire to go out on top—that led him to resign his role as CEO at the worst possible time: just as businesses were shutting down due to the pandemic. It was bad enough that his hand-picked successor, Disney Parks President Bob Chapek, had to receive a baptism by fire, but Iger's refusal to ride off into the sunset compounded the problem. Just a few months after Chapek took the helm, Iger was loudly announcing his plans to help lead Disney through this troubled period. What a punk move. As could be expected, Chapek was furious. That incident caused the couple to become estranged.
To be clear, we were never happy with Iger's pick of Chapek. We felt he was a capable manager, but not the leader Disney would need for its next two decades of growth. That is becoming clear in his handling of what should be a non-issue for the company. As is increasingly the case in America, employees are demanding their companies, the entities which place money in these employees' respective bank accounts, make political stands. Companies should be, by nature, apolitical. That level of corporate maturity doesn't fit into the zeitgeist of today's "pay attention to me!" society, apparently. When the Florida legislature took up a bill which would disallow schools from discussing sexual orientation in grades kindergarten through third, there was a call to arms by certain groups. The fact that Disney would not immediately denounce the bill put them in the crosshairs. In no way, shape, or form did the company come out in support of the bill, it should be noted. Employees were called upon to walk off the job and protest in front of Disney headquarters—iPhone cameras at the ready, no doubt. Chapek quickly did a mea culpa and came out against the bill. The obligatory "listening tour" and "equality task force" quickly manifested.
Before this latest "incident" (which never should have been an incident at all), Chapek made some questionable moves. By picking a fight with Black Widow star Scarlett Johansson—a fight he ultimately lost—he risked alienating the Hollywood community. By centralizing budget control (P&L power) for all movie and TV deals to a key ally, he alienated high level managers in the field who previously held a good deal of such authority. By snubbing Iger instead of stroking his giant ego until he was ultimately out the door, he forced company executives to choose sides. (Iger had remained on as chairman of the board after stepping down as CEO.) None of these were wise moves by a CEO whose contract is up for renewal in eleven months. Disney will weather this latest storm, but something tells us many more are to follow.
In a way we almost feel bad for Chapek, who clearly does not have Iger's charm-on-demand. Furthermore, his strategic vision for the company and its digital future make a lot of sense, but he cannot seem to make the personal connections needed to drive that point home. When Chapek was first announced by Iger as his hand-picked replacement, we sold our Disney stake. That was a wise move, and one we don't plan on reversing until the storm clouds hovering above the Magic Kingdom show signs of subsiding.
We, 23 Mar 2022
Fixed Income Desk
Looking to bonds to help protect your portfolio from a market downturn? You may want to take a closer look
We've talked extensively on this subject, but to reiterate: the days of a passive, 60/40 mix of stocks to bonds have passed. Yet another argument for professional money management as opposed to buying a generic mixed basket of Vanguard funds and believing your portfolio is safe. With inflation surging, and with the Fed finally sending in the troops (via rate hikes and a planned balance sheet reduction), the global bond market is in the midst of its largest drawdown on record. How bad is it? The Bloomberg Global Aggregate Index is the benchmark for measuring the universe of fixed income vehicles, to include government, corporate, mortgage-backed, and other debt instruments from both developed and emerging markets. That index is now sitting at a peak-to-trough drawdown of over 11%. In dollar terms, that equates to a loss of over $2.5 trillion. For perspective, during the drawdown brought on by the financial meltdown of 2008-09, the bond market lost roughly $2 trillion of value. With the Fed signaling a total of seven rate hikes this year alone, fixed income investors know full well that they will be able to get a better yield on bonds purchased next year, hence the drop in value of current bond holdings. For further evidence, consider the yield on the 10-year Treasury note, which moves in the opposite direction of bond values. The 10-year now offers a yield of 2.381%, which represents a 57% increase over the 1.514% rate it offered going into 2022. Why wouldn't bond investors keep their money safe and sound in cash until they can get an even better rate? This in spite of the fact that their cash bucket has a current real yield (i.e., adjusted for inflation) of around -7.5%. It's tough being a conservative investor right now.
When selecting fixed income vehicles for our clients, the first metric we look at is duration—a representation of how sensitive the instrument is to changes in interest rates. The lower the duration, the less the vehicle will be affected by rising rates. Right now, we prefer fixed income investments with a duration of five or less. For example, one of our strongest recommendations right now is the SPDR Blackstone Senior Loan ETF (SRLN $45), which has a yield of 4.55% and a tiny duration of 0.301.
Fixed Income Desk
Looking to bonds to help protect your portfolio from a market downturn? You may want to take a closer look
We've talked extensively on this subject, but to reiterate: the days of a passive, 60/40 mix of stocks to bonds have passed. Yet another argument for professional money management as opposed to buying a generic mixed basket of Vanguard funds and believing your portfolio is safe. With inflation surging, and with the Fed finally sending in the troops (via rate hikes and a planned balance sheet reduction), the global bond market is in the midst of its largest drawdown on record. How bad is it? The Bloomberg Global Aggregate Index is the benchmark for measuring the universe of fixed income vehicles, to include government, corporate, mortgage-backed, and other debt instruments from both developed and emerging markets. That index is now sitting at a peak-to-trough drawdown of over 11%. In dollar terms, that equates to a loss of over $2.5 trillion. For perspective, during the drawdown brought on by the financial meltdown of 2008-09, the bond market lost roughly $2 trillion of value. With the Fed signaling a total of seven rate hikes this year alone, fixed income investors know full well that they will be able to get a better yield on bonds purchased next year, hence the drop in value of current bond holdings. For further evidence, consider the yield on the 10-year Treasury note, which moves in the opposite direction of bond values. The 10-year now offers a yield of 2.381%, which represents a 57% increase over the 1.514% rate it offered going into 2022. Why wouldn't bond investors keep their money safe and sound in cash until they can get an even better rate? This in spite of the fact that their cash bucket has a current real yield (i.e., adjusted for inflation) of around -7.5%. It's tough being a conservative investor right now.
When selecting fixed income vehicles for our clients, the first metric we look at is duration—a representation of how sensitive the instrument is to changes in interest rates. The lower the duration, the less the vehicle will be affected by rising rates. Right now, we prefer fixed income investments with a duration of five or less. For example, one of our strongest recommendations right now is the SPDR Blackstone Senior Loan ETF (SRLN $45), which has a yield of 4.55% and a tiny duration of 0.301.
Mo, 21 Mar 2022
Trading Desk
Closed out a big pharma company in Global Leaders to make room for a Materials play
We have a strict rule of only carrying 40 great companies in our Penn Global Leaders Club, so when an addition is made, it must take the place of another. In this case, we let our GlaxoSmithKline (GSK $43) go. Actually, to give it more room for potential growth, we closed it from the strategy and simply placed a $40 stop loss on client positions to preserve double-digit gains. To see our undervalued "Materials: Specialty Chemicals" pick up, clients and members can check out the Penn Trading Desk.
Mo, 21 Mar 2022
East & Southeast Asia
Victory for the US and the Western world: South Korea's surprise election results equal a stronger ally in the region
It was a white-knuckler of a race, but when the dust settled South Korea had a new leader. Few expected Yoon Suk-yeol of the Conservative People Power Party to pull off the upset victory, but his win represents the growing angst in South Korea over Kim Jong-un's incessant saber-rattling and China's growing threat to the stability of the region. It also points to the failure of North Korea's decades-long policy of subterfuge; a policy which involves planting false stories and placing North Korean spies in the country to foment a distrust of the government. It has always been Kim Jong-un's (and his father, Kim Jong-il's) master plan to reunite the peninsula not in the name of peace, but in the name of communist rule. Yoon Suk-yeol's victory has splashed cold water on those plans. Not only has this charismatic leader spoken out against the rampant human rights violations in North Korea and China, he has also made it clear that he wants his country to become a "global pivotal state" on the world stage for the cause of freedom. Such language is anathema to Xi Jingping and his dear friend Kim Jong-un. Yoon's victory means he will lead the fourth-largest economy in Asia for at least the next five years. Over that period of time, we can expect much warmer relations between the US and South Korea, a demand that North Korea give up its nuclear ambitions as a basis for negotiations, and an upgrade to the US THAAD anti-missile system in the country—a system which China vehemently opposes. China and North Korea will seek to undermine his rule in every way imaginable, but something tells us this former prosecutor (of nearly three decades) is up for the task.
The pandemic hit South Korea hard, with the country's GDP shrinking by 1% in 2020 before rebounding to 4% in 2021—an eleven-year high. There are three main ETFs to take advantage of South Korea's explosive potential. The Direxion Daily South Korea Bull 3X ETF (KORU $18) we would steer clear of unless conviction is very strong (due to its triple leverage). The Franklin FTSE South Korea ETF (FLKR $25) is run by—in our opinion—the best global investment team in the world (Franklin). and the iShares MSCI South Korea ETF (EWY $71) is the largest, with $4.5 billion AUM. Our personal choice? Go with the Franklin name, FLKR. In addition to Samsung, Kia, Hyundai, and LG, the fund is full of names which few would recognize—hence the importance of the management team.
Fr, 18 Mar 2022
Media & Entertainment
AMC, the movie we can't pull ourselves away from, just took another odd twist: it bought a debt-laden, floundering gold mine
We have always rooted for underdog AMC Entertainment (AMC $16), although our support began to erode when China's Dalian Wanda Group became controlling owner, and further when CEO Adam Aron remained in his hometown of Philly to run the Leawood, Kansas-based theater chain. We can almost picture the images that popped into the head of the Harvard grad when he found out where it was headquartered. Probably cornfields and rolling tumbleweeds. But, as the likes of Radio Shack, Toys R Us, and Borders (books) began succumbing to the march of time, we really wanted AMC to survive. Of course, we all know what happened next. When the AMC apes first began moving the share price of the stock from $2 to $73, Aron had that deer-in-the-headlights look—he wasn't quite sure what to make of it. As his personal wealth began to grow exponentially thanks to this odd phenomenon, he suddenly got on the bandwagon. Imagine that. Now, he is exhibiting an ape behavior of his very own: his company just took a 22% stake in a floundering, debt-laden gold mining firm. In spite of the obvious connection between a theater chain and a gold mining company, who did the due diligence on this purchase? Shares of the company in question, Hycroft Mining Holding Corp (HYMC), were selling for about $0.30 apiece going into March, which certainly tracks the ape mentality. AMC purchased 23.4 million units, with each unit consisting of one common share of HYMC and one purchase warrant. The units were priced at $1.19 per share, and the warrants are priced around $1.07 and carry a five-year term. Certainly a good deal for Hycroft. If we can say one nice thing about the purchase, it is this: at least the mining company isn't headquartered in the metaverse.
We are ambivalent about virtually every aspect of this story. On the one hand, we want AMC to thrive, as we are not fans of the short sellers, and the Dalian Wanda Group is now out of the picture. On the other hand, the company was never worth anywhere near where the shares were pushed (we still argue they are worth $5 to $10). Likewise, we would like to see Hycroft make it; but Aron is not running a special purpose acquisition company, he is supposed to be running a theater chain. The whole thing seems, as so many analysts have rightly put it, bizarre.
We, 16 Mar 2022
Monetary Policy
Fed's fully-telegraphed move to raise interest rates sent the markets on a crazy afternoon ride
Not only did everyone know an interest rate hike was coming at the Fed's March FOMC meeting, the widely-accepted terminal point—the point at which the hikes would probably cease—was somewhere between 2.5% and 2.75%. That is precisely the script Fed Chair Jerome Powell followed as he announced the 25-basis-point hike and hinted at one more for each of the six remaining meetings for 2022. That would be a total of seven hikes this year, bringing the target band of the Federal funds rate between 1.75% and 2.00%. For no rational reason, the Dow, which had been up as much as 500 points on the day, suddenly went negative. Did the "every meeting will be a live meeting" comment spook the markets? That makes little sense. Powell did seem to calm nerves during his press briefing and Q&A session, and the markets began their second major turnaround of the day. He mentioned the need to begin reducing the Fed's balance sheet beginning "at a coming meeting," which was also expected (The prior $120 billion per month Treasury/MBS buying program finally ended a few weeks ago.) On one hand, we are being told that inflation is out of control due to the Fed's slowness to act; on the other hand, we are being told that too many rate hikes will all but guarantee a recession. Fortunately, Powell and the voting members of the Committee will ignore the chatter and do what they think is right. By the end of the day, the markets applauded the day's events, with the Dow finishing the session up 519 points.
It still amazes us that certain high-ranking individuals (at the time) thought that Powell was too slow to lower rates a few years back, and that rates should essentially stay at zero for the foreseeable future. With the lower band of the FFR at zero, the Fed balance sheet at a stuffed $9 trillion, and inflation at 7.5%, we believe a rate hike at each meeting this year would be a responsible course of action. Now we are being told by a number of high profile economists that a soft landing of the economy will prove to be near impossible, no matter what the Fed does. We don't buy that theory at all, assuming the Ukraine crisis doesn't mushroom into something much larger.
Th, 10 Mar 2022
E-Commerce
Amazon will pursue a 20-for-1 stock split as well as a share buyback program—investors applaud the moves
When I tell people that stock splits are pure financial engineering, and that not one dollar of value is created, I typically hear something like, "But at least the shares will be cheaper for me to buy!" As Charlie Brown says, "Good grief." That being said, I finally heard it put in the perfect way, courtesy of Barron's: "(A stock split) is no different than swapping your $20 bill for 20 singles. Your wallet might be a little fatter, but you aren't any richer." Precisely! Nonetheless, in the case of Amazon (AMZN $2,960), we do support the 20-for-1 stock split they just announced. Why fight the psychology of a $150 share price sounding more appealing to a stock buyer than a $3,000 share price, despite the fact that traders can now buy fractional shares? Another de minimis act was the company's announcement of a $10 billion stock repurchase plan. To you or I, $10B sounds like a lofty sum; to a $1.5 trillion company, it is pocket change. Nonetheless, investors cheered the two moves by pushing Amazon shares up over 6% after the news was released. One tangible benefit the company might receive due to its actions: it is much more likely to be included in the Dow Jones Industrial Average post-split. The DJIA is a price-weighted index, meaning the higher the share price of a member the more its price swings can affect the Dow's swings—not a good thing. Alphabet (GOOG $2,657) announced the exact same stock split plans last month, so the interesting question is which company will get the first invite. Our money is on Google, though we imagine both will eventually earn their way into the rather archaic index.
We said what we thought of Google last month, so what about Amazon shares? They are a bargain, and probably worth in the $4,000 range ($200 post split). Love 'em or hate 'em, this company is only going to get stronger, and the recent tech wreck has the shares trading down about 21% from their recent highs—historically a good sign that it is time to take a position. Amazon is one of the 40 members of the Penn Global Leaders Club.
Trading Desk
Closed out a big pharma company in Global Leaders to make room for a Materials play
We have a strict rule of only carrying 40 great companies in our Penn Global Leaders Club, so when an addition is made, it must take the place of another. In this case, we let our GlaxoSmithKline (GSK $43) go. Actually, to give it more room for potential growth, we closed it from the strategy and simply placed a $40 stop loss on client positions to preserve double-digit gains. To see our undervalued "Materials: Specialty Chemicals" pick up, clients and members can check out the Penn Trading Desk.
Mo, 21 Mar 2022
East & Southeast Asia
Victory for the US and the Western world: South Korea's surprise election results equal a stronger ally in the region
It was a white-knuckler of a race, but when the dust settled South Korea had a new leader. Few expected Yoon Suk-yeol of the Conservative People Power Party to pull off the upset victory, but his win represents the growing angst in South Korea over Kim Jong-un's incessant saber-rattling and China's growing threat to the stability of the region. It also points to the failure of North Korea's decades-long policy of subterfuge; a policy which involves planting false stories and placing North Korean spies in the country to foment a distrust of the government. It has always been Kim Jong-un's (and his father, Kim Jong-il's) master plan to reunite the peninsula not in the name of peace, but in the name of communist rule. Yoon Suk-yeol's victory has splashed cold water on those plans. Not only has this charismatic leader spoken out against the rampant human rights violations in North Korea and China, he has also made it clear that he wants his country to become a "global pivotal state" on the world stage for the cause of freedom. Such language is anathema to Xi Jingping and his dear friend Kim Jong-un. Yoon's victory means he will lead the fourth-largest economy in Asia for at least the next five years. Over that period of time, we can expect much warmer relations between the US and South Korea, a demand that North Korea give up its nuclear ambitions as a basis for negotiations, and an upgrade to the US THAAD anti-missile system in the country—a system which China vehemently opposes. China and North Korea will seek to undermine his rule in every way imaginable, but something tells us this former prosecutor (of nearly three decades) is up for the task.
The pandemic hit South Korea hard, with the country's GDP shrinking by 1% in 2020 before rebounding to 4% in 2021—an eleven-year high. There are three main ETFs to take advantage of South Korea's explosive potential. The Direxion Daily South Korea Bull 3X ETF (KORU $18) we would steer clear of unless conviction is very strong (due to its triple leverage). The Franklin FTSE South Korea ETF (FLKR $25) is run by—in our opinion—the best global investment team in the world (Franklin). and the iShares MSCI South Korea ETF (EWY $71) is the largest, with $4.5 billion AUM. Our personal choice? Go with the Franklin name, FLKR. In addition to Samsung, Kia, Hyundai, and LG, the fund is full of names which few would recognize—hence the importance of the management team.
Fr, 18 Mar 2022
Media & Entertainment
AMC, the movie we can't pull ourselves away from, just took another odd twist: it bought a debt-laden, floundering gold mine
We have always rooted for underdog AMC Entertainment (AMC $16), although our support began to erode when China's Dalian Wanda Group became controlling owner, and further when CEO Adam Aron remained in his hometown of Philly to run the Leawood, Kansas-based theater chain. We can almost picture the images that popped into the head of the Harvard grad when he found out where it was headquartered. Probably cornfields and rolling tumbleweeds. But, as the likes of Radio Shack, Toys R Us, and Borders (books) began succumbing to the march of time, we really wanted AMC to survive. Of course, we all know what happened next. When the AMC apes first began moving the share price of the stock from $2 to $73, Aron had that deer-in-the-headlights look—he wasn't quite sure what to make of it. As his personal wealth began to grow exponentially thanks to this odd phenomenon, he suddenly got on the bandwagon. Imagine that. Now, he is exhibiting an ape behavior of his very own: his company just took a 22% stake in a floundering, debt-laden gold mining firm. In spite of the obvious connection between a theater chain and a gold mining company, who did the due diligence on this purchase? Shares of the company in question, Hycroft Mining Holding Corp (HYMC), were selling for about $0.30 apiece going into March, which certainly tracks the ape mentality. AMC purchased 23.4 million units, with each unit consisting of one common share of HYMC and one purchase warrant. The units were priced at $1.19 per share, and the warrants are priced around $1.07 and carry a five-year term. Certainly a good deal for Hycroft. If we can say one nice thing about the purchase, it is this: at least the mining company isn't headquartered in the metaverse.
We are ambivalent about virtually every aspect of this story. On the one hand, we want AMC to thrive, as we are not fans of the short sellers, and the Dalian Wanda Group is now out of the picture. On the other hand, the company was never worth anywhere near where the shares were pushed (we still argue they are worth $5 to $10). Likewise, we would like to see Hycroft make it; but Aron is not running a special purpose acquisition company, he is supposed to be running a theater chain. The whole thing seems, as so many analysts have rightly put it, bizarre.
We, 16 Mar 2022
Monetary Policy
Fed's fully-telegraphed move to raise interest rates sent the markets on a crazy afternoon ride
Not only did everyone know an interest rate hike was coming at the Fed's March FOMC meeting, the widely-accepted terminal point—the point at which the hikes would probably cease—was somewhere between 2.5% and 2.75%. That is precisely the script Fed Chair Jerome Powell followed as he announced the 25-basis-point hike and hinted at one more for each of the six remaining meetings for 2022. That would be a total of seven hikes this year, bringing the target band of the Federal funds rate between 1.75% and 2.00%. For no rational reason, the Dow, which had been up as much as 500 points on the day, suddenly went negative. Did the "every meeting will be a live meeting" comment spook the markets? That makes little sense. Powell did seem to calm nerves during his press briefing and Q&A session, and the markets began their second major turnaround of the day. He mentioned the need to begin reducing the Fed's balance sheet beginning "at a coming meeting," which was also expected (The prior $120 billion per month Treasury/MBS buying program finally ended a few weeks ago.) On one hand, we are being told that inflation is out of control due to the Fed's slowness to act; on the other hand, we are being told that too many rate hikes will all but guarantee a recession. Fortunately, Powell and the voting members of the Committee will ignore the chatter and do what they think is right. By the end of the day, the markets applauded the day's events, with the Dow finishing the session up 519 points.
It still amazes us that certain high-ranking individuals (at the time) thought that Powell was too slow to lower rates a few years back, and that rates should essentially stay at zero for the foreseeable future. With the lower band of the FFR at zero, the Fed balance sheet at a stuffed $9 trillion, and inflation at 7.5%, we believe a rate hike at each meeting this year would be a responsible course of action. Now we are being told by a number of high profile economists that a soft landing of the economy will prove to be near impossible, no matter what the Fed does. We don't buy that theory at all, assuming the Ukraine crisis doesn't mushroom into something much larger.
Th, 10 Mar 2022
E-Commerce
Amazon will pursue a 20-for-1 stock split as well as a share buyback program—investors applaud the moves
When I tell people that stock splits are pure financial engineering, and that not one dollar of value is created, I typically hear something like, "But at least the shares will be cheaper for me to buy!" As Charlie Brown says, "Good grief." That being said, I finally heard it put in the perfect way, courtesy of Barron's: "(A stock split) is no different than swapping your $20 bill for 20 singles. Your wallet might be a little fatter, but you aren't any richer." Precisely! Nonetheless, in the case of Amazon (AMZN $2,960), we do support the 20-for-1 stock split they just announced. Why fight the psychology of a $150 share price sounding more appealing to a stock buyer than a $3,000 share price, despite the fact that traders can now buy fractional shares? Another de minimis act was the company's announcement of a $10 billion stock repurchase plan. To you or I, $10B sounds like a lofty sum; to a $1.5 trillion company, it is pocket change. Nonetheless, investors cheered the two moves by pushing Amazon shares up over 6% after the news was released. One tangible benefit the company might receive due to its actions: it is much more likely to be included in the Dow Jones Industrial Average post-split. The DJIA is a price-weighted index, meaning the higher the share price of a member the more its price swings can affect the Dow's swings—not a good thing. Alphabet (GOOG $2,657) announced the exact same stock split plans last month, so the interesting question is which company will get the first invite. Our money is on Google, though we imagine both will eventually earn their way into the rather archaic index.
We said what we thought of Google last month, so what about Amazon shares? They are a bargain, and probably worth in the $4,000 range ($200 post split). Love 'em or hate 'em, this company is only going to get stronger, and the recent tech wreck has the shares trading down about 21% from their recent highs—historically a good sign that it is time to take a position. Amazon is one of the 40 members of the Penn Global Leaders Club.
We, 09 Mar 2022
Global Strategy: Latin America
Strange bedfellows: Invasion of Ukraine has opened up a doorway to Venezuela, with Maduro talking capitalism
"Misery acquaints a man with strange bedfellows," as Shakespeare posited in his play, The Tempest, and what is going on between the United States and Venezuela right now underscores that point. President Nicolas Maduro, whose leadership seemed to be hanging from a thread as hyperinflation inundated his country, has to be looking on in satisfaction as Putin's invasion of Ukraine has diverted the world's attention. Now, it appears that the Russian energy embargo in the US has opened up an opportunity for trade to resume between the two nations. Officials from the Biden administration headed into a secret meeting last weekend in Caracas; when it was over, Maduro had agreed to release two political prisoners from the United States in return for discussions over lifting some trade sanctions. Holding some 17.8% of the world's proven oil reserves, and with the Keystone pipeline from Canada having been killed by the administration, the truth is we could sorely use oil from our erstwhile political opponent in South America. For his part, Maduro seems to be almost embracing capitalism in an effort to staunch the mass exodus of citizens and bring a halt to hyperinflation. Most socialists tend to double down on the failed philosophy of Marx when backed into a corner, so this is a hopeful sign.
In its heyday, Venezuela produced around 3 million barrels of oil per day; thanks to sanctions and infrastructure issues, that figure is now down to around 800,000. By comparison, the US produces nearly 12 million barrels of oil per day—more than Russia and more than Saudi Arabia. With its vast store of reserves and some technical support, Venezuela could (relatively) quickly double its output. If Maduro is truly interested in bringing his country back from the brink, he must make a host of pro-free-market moves for this to happen. He just made one: he will allow US dollars to flow freely throughout the country once again, meaning workers can be paid with the greenback instead of the virtually worthless bolivar, and companies will be allowed to issue debt in foreign currencies. In another hopeful sign, a recent poll showed only 38% of Venezuelans wish to flee their country. In a sad commentary, that is a dramatic improvement from a similar poll taken a few years ago. The ball is in Maduro's court.
We are not under any false impression that Venezuela is suddenly going to become a Chile, Colombia, or even Mexico with respect to the country's relationship with the US, but even a small thawing of relations should equate to the open flow of oil once again. And that is something which would benefit both economies—and certainly buttress Maduro's grip on power.
Global Strategy: Latin America
Strange bedfellows: Invasion of Ukraine has opened up a doorway to Venezuela, with Maduro talking capitalism
"Misery acquaints a man with strange bedfellows," as Shakespeare posited in his play, The Tempest, and what is going on between the United States and Venezuela right now underscores that point. President Nicolas Maduro, whose leadership seemed to be hanging from a thread as hyperinflation inundated his country, has to be looking on in satisfaction as Putin's invasion of Ukraine has diverted the world's attention. Now, it appears that the Russian energy embargo in the US has opened up an opportunity for trade to resume between the two nations. Officials from the Biden administration headed into a secret meeting last weekend in Caracas; when it was over, Maduro had agreed to release two political prisoners from the United States in return for discussions over lifting some trade sanctions. Holding some 17.8% of the world's proven oil reserves, and with the Keystone pipeline from Canada having been killed by the administration, the truth is we could sorely use oil from our erstwhile political opponent in South America. For his part, Maduro seems to be almost embracing capitalism in an effort to staunch the mass exodus of citizens and bring a halt to hyperinflation. Most socialists tend to double down on the failed philosophy of Marx when backed into a corner, so this is a hopeful sign.
In its heyday, Venezuela produced around 3 million barrels of oil per day; thanks to sanctions and infrastructure issues, that figure is now down to around 800,000. By comparison, the US produces nearly 12 million barrels of oil per day—more than Russia and more than Saudi Arabia. With its vast store of reserves and some technical support, Venezuela could (relatively) quickly double its output. If Maduro is truly interested in bringing his country back from the brink, he must make a host of pro-free-market moves for this to happen. He just made one: he will allow US dollars to flow freely throughout the country once again, meaning workers can be paid with the greenback instead of the virtually worthless bolivar, and companies will be allowed to issue debt in foreign currencies. In another hopeful sign, a recent poll showed only 38% of Venezuelans wish to flee their country. In a sad commentary, that is a dramatic improvement from a similar poll taken a few years ago. The ball is in Maduro's court.
We are not under any false impression that Venezuela is suddenly going to become a Chile, Colombia, or even Mexico with respect to the country's relationship with the US, but even a small thawing of relations should equate to the open flow of oil once again. And that is something which would benefit both economies—and certainly buttress Maduro's grip on power.
On the bright side, Venezuela's inflation rate is back down below 2,000%; Weimar Republic, anyone?
Tu, 08 Mar 2022
Global Strategy: Eastern Europe
As tech companies from around the world end shipments to Russia, Chinese firms are licking their chops
Last week, Apple (AAPL $159) stopped selling its products in Russia and removed state-controlled RT News from its App Store. Although the company doesn't have a physical footprint in Russia, visitors to the online Apple store would get the message that products are "unavailable for purchase or delivery." No problem, right? Russians can simply turn to the Samsung Galaxy. Not so fast. South Korea's Samsung, which holds a larger market share than Apple in the country, just announced that it, too, would halt all shipments of phones to Russia, in addition to consumer electronics and chips. On the tech front, similar moves have been made by the likes of Microsoft, Electronic Arts, Nintendo, IBM, Intel, and Sony. The united global front against Russia's invasion of Ukraine has been nothing short of remarkable. Sadly, this united front does not extend to that country's neighbor to the south: China. China-based Xiaomi is the second-largest phone seller in Russia, while Hong Kong-based Lenovo holds that distinction in the PC market (behind HP, which is also halting sales). Huawei Technologies, based out of Shenzhen, China, is already Russia's top telecom equipment provider, and the company has been battling Sweden's Ericsson for 5G contracts in the country. The latter announced back on 28 Feb that it would suspend deliveries until Russia ends its war against Ukraine. There is no doubt a stronger economic and even military alliance forming between Communist China and the former communist state of Russia—birds of a feather, but the worldwide condemnation of Russia's military actions will make the new love affair tenuous for Xi Jinping and the ruling CCP. Especially in the year when Xi hopes to cement his role as "ruler for life." And that last factor is really all we need to know about China and Russia to understand the nature of the threat the West faces going forward.
Despite their love affair, both Xi and Putin have undoubtedly been shocked by the level of global cohesiveness against Russian aggression. China has so much as telegraphed that this is all about Taiwan, a nation which will one day face the same fate as Ukraine. The greatest weapon the West has against these leaders is their own hubris. "Leader for life" may look great on paper, but maintaining order and controlling the narrative in this new world of smartphones, communication satellites, and Internet access will be a Herculean task—especially as the civilized world continues to wake up to the threat both pose on the world scene. Two years and two disasters later, no sane mind could argue that those threats aren't clear and present.
Global Strategy: Eastern Europe
As tech companies from around the world end shipments to Russia, Chinese firms are licking their chops
Last week, Apple (AAPL $159) stopped selling its products in Russia and removed state-controlled RT News from its App Store. Although the company doesn't have a physical footprint in Russia, visitors to the online Apple store would get the message that products are "unavailable for purchase or delivery." No problem, right? Russians can simply turn to the Samsung Galaxy. Not so fast. South Korea's Samsung, which holds a larger market share than Apple in the country, just announced that it, too, would halt all shipments of phones to Russia, in addition to consumer electronics and chips. On the tech front, similar moves have been made by the likes of Microsoft, Electronic Arts, Nintendo, IBM, Intel, and Sony. The united global front against Russia's invasion of Ukraine has been nothing short of remarkable. Sadly, this united front does not extend to that country's neighbor to the south: China. China-based Xiaomi is the second-largest phone seller in Russia, while Hong Kong-based Lenovo holds that distinction in the PC market (behind HP, which is also halting sales). Huawei Technologies, based out of Shenzhen, China, is already Russia's top telecom equipment provider, and the company has been battling Sweden's Ericsson for 5G contracts in the country. The latter announced back on 28 Feb that it would suspend deliveries until Russia ends its war against Ukraine. There is no doubt a stronger economic and even military alliance forming between Communist China and the former communist state of Russia—birds of a feather, but the worldwide condemnation of Russia's military actions will make the new love affair tenuous for Xi Jinping and the ruling CCP. Especially in the year when Xi hopes to cement his role as "ruler for life." And that last factor is really all we need to know about China and Russia to understand the nature of the threat the West faces going forward.
Despite their love affair, both Xi and Putin have undoubtedly been shocked by the level of global cohesiveness against Russian aggression. China has so much as telegraphed that this is all about Taiwan, a nation which will one day face the same fate as Ukraine. The greatest weapon the West has against these leaders is their own hubris. "Leader for life" may look great on paper, but maintaining order and controlling the narrative in this new world of smartphones, communication satellites, and Internet access will be a Herculean task—especially as the civilized world continues to wake up to the threat both pose on the world scene. Two years and two disasters later, no sane mind could argue that those threats aren't clear and present.
Mo, 07 Mar 2022
Trading Desk
Adding two Application & Systems Software companies to the Intrepid Trading Platform
Two companies which helped transform their respective industries during the pandemic; two companies which will continue to dominate their respective space and gain market share; two companies whose shares are off roughly 75% from their 2021 highs. We added both to the Intrepid Trading Platform in the midst of the current tech wreck. Great companies are being pilloried, making for great bargains in the market. Members can see the trade by logging into the Trading Desk.
Fr, 04 Mar 2022
Work & Pay
Huge jobs number: 678,000 new positions created in February
The US added a whopping 678,000 new payrolls in the month of February, with the unemployment rate dropping down from 4% to 3.8%. Wall Street had been expecting those figures to come in at 440,000 and 3.9%, respectively. This amounts to the best jobs report since last July, before the Omicron variant of the virus hit US shores. Indications that inflation could be starting to cool a bit came from the wage figures in the report: hourly wages grew just $0.01 per hour, or roughly half of what was expected. Year-over-year wage growth is now 5.13%, also below expectations. In a sign that the economy is back on its reopening path, the leisure and hospitality industries led the gains, with 179,000 new jobs created, with the unemployment rate in those two areas dropping from 8.2% to 6.6%. Other areas showing strong gains for the month include professional and business services, health care, construction, and transportation.
Not that anyone is expecting the Fed to hold off on rate hikes starting this month, but this report certainly adds fuel to the fire for a normalization of rates, with the terminal number floating somewhere around 2.5% (the lower band sits at 0% right now). Unfortunately, the strong jobs numbers were overshadowed by Russia's attack on the nuclear facility in Ukraine. That story continues to be at center stage.
Trading Desk
Adding two Application & Systems Software companies to the Intrepid Trading Platform
Two companies which helped transform their respective industries during the pandemic; two companies which will continue to dominate their respective space and gain market share; two companies whose shares are off roughly 75% from their 2021 highs. We added both to the Intrepid Trading Platform in the midst of the current tech wreck. Great companies are being pilloried, making for great bargains in the market. Members can see the trade by logging into the Trading Desk.
Fr, 04 Mar 2022
Work & Pay
Huge jobs number: 678,000 new positions created in February
The US added a whopping 678,000 new payrolls in the month of February, with the unemployment rate dropping down from 4% to 3.8%. Wall Street had been expecting those figures to come in at 440,000 and 3.9%, respectively. This amounts to the best jobs report since last July, before the Omicron variant of the virus hit US shores. Indications that inflation could be starting to cool a bit came from the wage figures in the report: hourly wages grew just $0.01 per hour, or roughly half of what was expected. Year-over-year wage growth is now 5.13%, also below expectations. In a sign that the economy is back on its reopening path, the leisure and hospitality industries led the gains, with 179,000 new jobs created, with the unemployment rate in those two areas dropping from 8.2% to 6.6%. Other areas showing strong gains for the month include professional and business services, health care, construction, and transportation.
Not that anyone is expecting the Fed to hold off on rate hikes starting this month, but this report certainly adds fuel to the fire for a normalization of rates, with the terminal number floating somewhere around 2.5% (the lower band sits at 0% right now). Unfortunately, the strong jobs numbers were overshadowed by Russia's attack on the nuclear facility in Ukraine. That story continues to be at center stage.
Headlines for the Week of 20 Feb 2022 — 26 Feb 2022
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The Incredible National Gift of Mount Rushmore...
America boasts some incredible national monuments, but few hold the natural beauty and grandeur of Mount Rushmore. While South Dakota historian Doane Robinson dreamed up the concept, it was Danish-American sculptor Gutzon Borglum, a good friend of the French sculptor Rodin, who brought the glorious monument to life. Borglum and his son, Lincoln, thought that the monument should have a national focus around four cornerstone concepts of American freedom. We all know the presidents represented in the carving, but what are the concepts each represent?
Penn Trading Desk:
Penn: Swap Aerospace & Defense funds within Dynamic Growth Strategy
We are overweighting Industrials in 2022, especially within the Aerospace & Defense industries. Within our ETF-based Penn Dynamic Growth Strategy we are replacing our long-term iShares US Aerospace & Defense ETF (ITA $108) holding with another specialty player in the category. ITA has remained faithful to Boeing (BA $201) for far too long, and the company's 17.5% representation in the fund is unacceptable. The top two holdings in the fund—one of which is Boeing—account for a 40% weighting. We have replaced ITA with a more well-balanced fund comprised of 52 strong holdings in the aerospace and defense arenas.
Penn: Open agriculture play in Dynamic Growth Strategy
A confluence of events has created a very favorable environment for commodities, particularly agriculture products. Within the Penn Dynamics Growth Strategy, we have replaced our 4% position in ROBO—a robotics and automation ETF—with a well-managed commodities vehicle focused on agriculture. Investors are seeking instruments with a low to inverse correlation to stocks and bonds right now, and commodities have historically filled the bill.
Penn: Close BCE and Open Premium Income Fund Within the Strategic Income Portfolio
It is a nightmare scenario for fixed-income investors: rates are at historic lows (meaning you're getting paltry income from your bonds), and the Fed is signaling at least six rate hikes (meaning the value of your bonds will probably go down). We have added one potential solution within the Strategic Income Portfolio: We have replaced Canadian telecom company BCE with a premium income ETF which provides a 7% income stream to investors. Members can read about this unique strategy in the upcoming Penn Wealth Report, and see the trade details now at the Penn Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Market Pulse
Invasion Day: What we can learn from the Dow's near-1,000 point swing last Thursday
Considering the headline, "Russia invades Ukraine," last Thursday's early session bloodbath certainly seemed to make sense. The Dow was in the red by 859 points in short order, causing us to have flashbacks to the multiple 2,000-point-drop days in March of 2020, almost two years ago to the month. All of the major indexes were off by 2.5% or more. Then, something remarkable happened: the markets staged their great comeback. Led by the NASDAQ, then followed by the S&P 500 and—grudgingly—the Dow, all of the indexes ended the day in the green. For the Dow, that represented a 963-point swing from bottom to close. The S&P 500 ended the day up 1.56% while the NASDAQ was in the green by 3.34%, with many recent "opening trade punching bags" moving higher by double digits.
The knee-jerk reaction coming from analysts was that the market liked President Biden's new round of measured sanctions—just enough to potentially make Putin think twice about his course of action, but not so draconian as to hurt Western allies (like limiting the flow of Russian gas and oil, or cutting Russia out of the Swift global payment system). But the rebound, we believe, goes a bit deeper than that. In the first place, it all but assured a more measured pace of Fed rate hikes and balance sheet reduction, as opposed to the 50-basis-point March hike and seven rate hikes that the likes of Bank of America had been calling for (we never believed that would happen). Additionally, we felt a real sense that many investors who had been waiting for the bottoming of the recent market trough decided that this was the moment to get back in. That notion was buttressed by Friday's 835-point Dow follow through. Time will tell whether or not this represented a turnaround from the brutal past few months, but the rapid shift in market sentiment was heartening. CNBC's Bob Pisani perhaps put it best when he said, "I've been on the (trading) floor for twenty-five years; you don't see many weeks like this."
If we are on the happy side of a bottoming out, here is a tempting morsel for would-be buyers: 51% of S&P 500 stocks and 76% of NASDAQ stocks are still in bear market territory. Many quality NASDAQ names (strong revenues, needed products and services) remain 50% or more below their 52-week highs.
Textiles, Apparel, & Luxury Goods
Foot Locker gaps down by a third as management gives sobering guidance, outlines Nike problems
Shares of retailer Foot Locker (FL $29) plunged over 30% last Friday after management said it expects weaker sales and earnings this year due to supply chain issues and economic factors such as raging inflation. Furthermore, the company admitted that Nike's (NKE $137) decision to focus on direct-to-consumer sales at the expense of its third-party sellers (such as Foot Locker) will have a deleterious effect on the company, at least in the short term. To put that statement in perspective, nearly 70% of Foot Locker sales in 2021 were of Nike products. How much of a hit does management expect to take in 2022? The company is projecting a sales decline of between 8% and 10% this year. As for the quarterly earnings, the numbers were a mixed bag: Sales grew from $2.19 billion in the same quarter of the previous year to $2.34 billion this past quarter; however, thanks to higher supply-chain costs, net income for the quarter fell 16% from the previous year, to $103 million. Foot locker has nearly 3,000 retail stores around the world, with management expecting to trim that figure by roughly 3% this year.
We could easily make a convincing argument for a $50 fair value on FL shares, which would equate to a 67% gain in the share price. The company's financial health is strong, it has a tiny P/E ratio of 3.4, and a price-to-sales ratio of 0.36. A $3 billion small cap in the specialty retail space is not for the faint of heart at this moment in time, but it has a nice risk/reward profile for more "aggressive money." We would recommend a stop loss around $27.60 on any purchase of the shares.
Europe
Trump couldn't get Germany to raise its defense spending; Putin just did
Just how mentally stable Vladimir Putin is right now is open for debate, but one component of his unprovoked invasion of neighboring Ukraine is crystal clear: he is taken aback by the cohesion of the Western world against his actions; specifically, Germany. Germany has become irresponsibly reliant on Russia, a condition going back at least as far as Angela Merkel's ascension to power in 2005. This has always seemed strange to us, as she was raised in East Germany under the thumb of the Soviet empire. She is also highly intelligent, earning her doctorate in quantum chemistry and working as a research scientist before the fall of the Berlin Wall. It is hard to imagine anyone more acutely aware of Russia's tactics than Merkel. Nonetheless, as the country phased out coal and nuclear energy, Germany's leadership allowed itself to become more and more reliant on Russian commodities, especially in the energy sector.
Chancellor Merkel's party recently suffered its worst defeat since it was founded in the aftermath of World War II in 1945. The country's new leader is Olaf Scholz, head of the center-left Social Democratic Party (SPD). His party, and the Greens who have formed an alliance with the SPD, have never been fond of the already-built Nord Stream 2 pipeline, but Putin was angered (and surprised, we would argue) when Germany actually halted approval of the pipeline for operational status due to the invasion. Now, they are taking steps which have surprised even us: they are planning on a massive boost in defense spending.
That is something Germany is not known for doing, to put it mildly. Just ask former President Donald Trump, who vociferously and unsuccessfully argued that our European allies needed to at least hit NATO's 2% of GDP target for defense spending. Now, thanks to Putin's aggression on the continent, Scholz has announced that his government will funnel 100 billion euros ($113B USD) into a modernization fund for Germany's military. Additionally, he announced that the country would allot at least the 2% target on defense spending by 2024. On a related note, Germany even said it would supply weapons to Ukrainian fighters—a dramatic change in posture for the nation, and certainly the SPD, which has a history of warm ties to Moscow.
Germany's moves are great news for the cause of freedom. The wild card, however, remains Putin's state of mind. It is rather disturbing to consider just how far this mercurial autocrat will go to prevent his image from being damaged or ego from being bruised. Sadly, we cannot rely on the Chinese government to coerce its ally into pulling back. Winnie the Pooh's evil doppelganger is trying to portray an image of China being above the fray, but it is evident which side his country supports. Birds of a feather....
Interactive Media and Services
More trouble for Facebook: Google just pulled an Apple
Last year, Apple (AAPL $171) made changes to its operating system, iOS, which had a dramatic effect on Meta Platform's (FB $214) Facebook unit. Specifically, thanks to Apple's App Tracking Transparency feature, iPhone users could essentially cut off the wealth of data previously shared with Facebook advertisers to help them reach their target audience. For example, if an iPhone user happened to make regular shoe purchases through various apps, a footwear advertiser on Facebook could reach this potential customer with targeted ads. Now, iPhone users must opt in to having their activities on any given app tracked in such a manner. As could be expected, this is already having an effect on ad spends within the platform. In a stark admission, Facebook said that the changes would be responsible for a roughly $10 billion decrease in revenue this year. That equates to nearly a 10% hit.
Now, the second shoe has dropped. Alphabet's (GOOG $2,703) Google unit just announced that it will be rolling out its "Privacy Sandbox" for Android-based devices which will limit cross-site and cross-app tracking. While not quite as draconian as Apple's forced "opt in" measures, these steps will certainly have a negative impact on Facebook's ad business. This move follows a previous Google decision to phase out third-party tracking cookies on its Google Chrome browser. This gives Google Ads, the company's online advertising platform formerly known as Google AdWords, a definitive leg up in the battle for ad dollars. After all, the simple act of searching for goods or services via the browser gives the company user information in an "organic" manner (i.e., no third-party tracking apps required). As if Meta didn't have enough on its plate already.
After its shares fell sharply, we re-added Meta Platforms to the Penn Global Leaders Club. Despite its perpetual headwinds, keep in mind that it still controls the world's largest online social network, with nearly 3 billion monthly active users. We also believe the metaverse will be a transformational movement which will reshape both entertainment and business as we know it (we recall many rolling their eyes at the Internet as well), and that Meta Platforms will be a major player. We retain our $442 initial price target on the shares.
Media & Entertainment
Roku didn't miss revenue expectations by all that much, but investors fled; we've seen this movie before
Back in September of 2019, we wrote of streaming device maker Roku's (ROKU $112) really bad day. Shares had just fallen 20%, to $108, on the back of a scathing analyst call arguing that the company wouldn't be able to stand up to new competition from the likes of Apple, Comcast, Facebook (Portal), and the slew of new smart TVs; the latter of which which would ultimately make its device obsolete. Eighteen months after that drop, the pandemic came along and helped Roku shares skyrocket, topping out at $491. We have missed out on every one of the company's meteoric price spikes because we simply can't explain its long-term growth story. It was September of 2019 all over again this week, as Roku shares fell 22.3% in one day—closing the week at $112—after a slight revenue miss led to a slew of price target downgrades. Shares have now fallen 76.55% since the summer of 2021. There is some comedy to inject in this story. Our 2019 commentary mentioned that a major catalyst for the price drop (to $108) was Pivotal Research initiating coverage with a "Sell" rating and a $60 per share price target. What makes this so humorous is that Pivotal, following this past Friday's drop, once again lowered their rating to "Sell." This time they moved their price target on Roku shares down from $350 to $95. Now that's funny. Wouldn't it have been better to just not say anything after their 2019 commentary? Yet another reason we have never pulled the trigger on adding this company to one of our strategies—its price gyrations tend to make analysts look silly. As for the earnings report which sparked this latest price drop, Roku reported Q4 revenues of $865 million (+33% YoY), which fell short of analysts' expectations for $894 million in sales. On the bright side, the company reported net earnings of $23.7 million, representing its sixth-straight quarter of profitability.
Bulls argue that Roku is no longer just a one-trick (the Roku Stick) pony. The company now has its own ad-sponsored channel to supplement a service-neutral platform which allows customers to access Netflix, Disney+, Hulu, and a host of others providers. They also argue that enormous growth potential outside of a saturated US market should provide 30%+ annual revenue growth for years to come. We remain skeptical, just as we did the last time it sat near $100 per share.
Industrial Machinery
We added Generac to the Global Leaders Club this month; its earnings and guidance support our Strong Buy thesis
Companies listed on the NASDAQ have, overwhelmingly, seen their share prices crushed over the past few months, with some big names falling 50% or more from their 52-week highs. For many, based on their nonexistent earnings, the drop is understandable. For others, the pullback has been irrational. Power generation equipment maker Generac Holdings (GNRC $295) certainly falls in the latter camp. After falling 50% from its November high of $524, we added shares of this great American company to the Penn Global Leaders Club on the fourth of this month. The company just reported earnings and gave guidance for 2022: both sides of the coin were stellar. Revenues for the fourth quarter came in at just over $1 billion, representing a 40% spike from the same quarter of the previous year. Earnings per share (EPS) was $2.51 versus expectations for $2.42. For the fiscal year, sales hit a record $3.75 billion, a 50% increase over the previous year. As for guidance, management expects net sales in 2022 to increase somewhere in the 35% range, based on strong global demand—especially in clean energy markets—and increased home standby production capacity. The team also cited recent acquisitions as a catalyst. Shares spiked 16% on the report, and then proceeded to fall back down with the rest of the index. Generac is in an incredible position right now: the company is generating huge profits from its existing business line, but is also poised to be an industry leader in the renewable energy market. Investors seem to be missing that point.
We removed FedEx (FDX $222) from the Penn Global Leaders Club to make room for Generac, picking up shares of the company at $280. Our target price is $550.
E-Commerce
Another e-commerce company plummets on earnings, sentiment
While we have never owned e-commerce platform Shopify (SHOP $657), it was certainly one of the investor darlings during the pandemic. Furthermore, we love the story. Consider the company an Amazon for the rest of us. It provides everything a small- or mid-sized business needs to set up shop on the Internet, make sales, ship goods (fast), and help with bookkeeping and marketing. All for a quite reasonable price, we might add. If that wasn't enough of a sales pitch, consider this: you can now pick up shares at a 63% discount to their 52-week high of $1,763. But should you? This is yet another case of a company reporting strong earnings, but issuing guidance which spooked the market. Against expectations for $1.34 billion in sales for the quarter, the company reported revenue of $1.38 billion. Earnings also beat, with the company netting a profit of $1.36 per share (yes, they are actually operating in the black). For the full year, Shopify generated $4.6 billion in revenue, improving on 2020's sales by 57%. Impressive. Two concerns weighed on investor sentiment, however. First, can the company possibly keep up the impressive rate of growth it enjoyed during the pandemic? Secondly, investors are concerned about how much it is going to cost to build the company's massive American distribution system, known as the Shopify Fulfillment Network. The ultimate goal is to deliver good from its merchants to their respective customers within two days, competing head-to-head with Amazon Prime. The company is expected to spend around $1 billion over the next two years to build out key warehouse hubs in the United States (Shopify is a Canadian company). The key question is whether or not management can effectively deploy the capital needed to complete the project. Dour investors voted with their capital this past week, sending the shares reeling.
Again, we don't currently own the company right now. That being said, we do believe in the management team, and we could see the shares doubling in price if 2022 shapes up like we expect it to. The financials look exceptional, and the company is sitting on a war chest of nearly $8 billion. A conservative fair value of $1,000 per share seems appropriate.
Strategies & Tactics: Behavioral Finance
The Russia/Ukraine brouhaha is a rallying cry for Ukrainians, a wake-up call to Europeans, and an opportunity for investors
Will they? Won't they? That is the question being asked incessantly on the news channels. The question is missing the point: Russia has, in essence, already invaded Ukraine. After all, the country forcefully took the almost-island (it is connected to Ukraine by a tiny isthmus) of Crimea back in 2014, annexing it as Russian territory; it is fomenting constant fighting in the Donbas region of southeastern Ukraine; and it has unleashed a cyberwar on its western neighbor. Yes, a ground invasion would bring about a multitude of deaths (14,000 have already died in the Donbas region of Donetsk and Luhansk, where Russian-speaking separatists—provided with Russian arms—have been fighting government forces), but the real threat is to Putin himself, not the markets. The dictator has painted himself into a corner, despite his belief that he holds all the cards.
Germany, thanks to Merkel's full-throated and myopic cheerleading for Russian gas flowing into the country (roughly 50% of demand), is certainly in a precarious situation as it scrambles for new suppliers. And the sanctions which would follow a ground invasion would send oil above $100 per barrel. But from a US market perspective, this threat is far less ominous than the one posed by a global pandemic we knew little about back in March of 2020. That spring turned out to be one of the best buying opportunities since the fall and winter of 1987. The press is doing its best to keep anxiety high, but Putin will be the real loser in this game of chicken, not the US stock market.
The major indexes finished the week down—their fifth losing week of the last seven, and the downturn has created some real opportunities to pick up some of those wish list stocks on the cheap. Granted, many tech names were strongly overvalued, but the likes of Adobe (ADBE), Uber (UBER), PayPal (PYPL), and Generac (GNRC) fell to levels investors would have drooled over last fall. Now is the time to discount the headlines and search for some premium names to buy.
Just as we did in March and April of 2020, we pulled out our own wish list of stocks which have dropped below our target buy price. Take a look at portfolio allocations and see which promising sectors and industries have become underweighted and plug in some good names. Let the headlines rattle others into wanton selling; the crisis in Eastern Europe does not pose a major threat to fundamentally sound, cash-flow-generating American companies—it has created a tactical opportunity which will become clear to others over the coming months.
Under the Radar Investment
Rogers Sugar (RSI.TO $6)
We were not picky, we just wanted a: small-cap defensive stock with a great dividend yield and low risk level (as measured by beta) to add to our international opportunities fund. Simple, right? We actually found what we were looking for in Vancover-based Rogers Sugar Inc. This $607 million company was established in 1890 by B.T. Rogers, who was trying to solve the problem of the high cost of transporting refined sugar by rail from Montreal to Vancouver. Strategically located to access raw sugar shipments from the Pacific and send refined sugar to Canada's western population centers, the company was the first major non-logging or fishing industry in the region. Today, the company refines, packages, and markets sugar and maple products to industrial customers and consumers throughout Canada and the United States. Rogers has a P/E ratio of 12, a tiny price-to-sales ratio of 0.761, and a dividend yield of 6.15%. Shares closed the week at $5.85.
Answer
The four presidents were chosen for their significant contribution to the founding, expansion, preservation, and unification of the United States:
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The Incredible National Gift of Mount Rushmore...
America boasts some incredible national monuments, but few hold the natural beauty and grandeur of Mount Rushmore. While South Dakota historian Doane Robinson dreamed up the concept, it was Danish-American sculptor Gutzon Borglum, a good friend of the French sculptor Rodin, who brought the glorious monument to life. Borglum and his son, Lincoln, thought that the monument should have a national focus around four cornerstone concepts of American freedom. We all know the presidents represented in the carving, but what are the concepts each represent?
Penn Trading Desk:
Penn: Swap Aerospace & Defense funds within Dynamic Growth Strategy
We are overweighting Industrials in 2022, especially within the Aerospace & Defense industries. Within our ETF-based Penn Dynamic Growth Strategy we are replacing our long-term iShares US Aerospace & Defense ETF (ITA $108) holding with another specialty player in the category. ITA has remained faithful to Boeing (BA $201) for far too long, and the company's 17.5% representation in the fund is unacceptable. The top two holdings in the fund—one of which is Boeing—account for a 40% weighting. We have replaced ITA with a more well-balanced fund comprised of 52 strong holdings in the aerospace and defense arenas.
Penn: Open agriculture play in Dynamic Growth Strategy
A confluence of events has created a very favorable environment for commodities, particularly agriculture products. Within the Penn Dynamics Growth Strategy, we have replaced our 4% position in ROBO—a robotics and automation ETF—with a well-managed commodities vehicle focused on agriculture. Investors are seeking instruments with a low to inverse correlation to stocks and bonds right now, and commodities have historically filled the bill.
Penn: Close BCE and Open Premium Income Fund Within the Strategic Income Portfolio
It is a nightmare scenario for fixed-income investors: rates are at historic lows (meaning you're getting paltry income from your bonds), and the Fed is signaling at least six rate hikes (meaning the value of your bonds will probably go down). We have added one potential solution within the Strategic Income Portfolio: We have replaced Canadian telecom company BCE with a premium income ETF which provides a 7% income stream to investors. Members can read about this unique strategy in the upcoming Penn Wealth Report, and see the trade details now at the Penn Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Market Pulse
Invasion Day: What we can learn from the Dow's near-1,000 point swing last Thursday
Considering the headline, "Russia invades Ukraine," last Thursday's early session bloodbath certainly seemed to make sense. The Dow was in the red by 859 points in short order, causing us to have flashbacks to the multiple 2,000-point-drop days in March of 2020, almost two years ago to the month. All of the major indexes were off by 2.5% or more. Then, something remarkable happened: the markets staged their great comeback. Led by the NASDAQ, then followed by the S&P 500 and—grudgingly—the Dow, all of the indexes ended the day in the green. For the Dow, that represented a 963-point swing from bottom to close. The S&P 500 ended the day up 1.56% while the NASDAQ was in the green by 3.34%, with many recent "opening trade punching bags" moving higher by double digits.
The knee-jerk reaction coming from analysts was that the market liked President Biden's new round of measured sanctions—just enough to potentially make Putin think twice about his course of action, but not so draconian as to hurt Western allies (like limiting the flow of Russian gas and oil, or cutting Russia out of the Swift global payment system). But the rebound, we believe, goes a bit deeper than that. In the first place, it all but assured a more measured pace of Fed rate hikes and balance sheet reduction, as opposed to the 50-basis-point March hike and seven rate hikes that the likes of Bank of America had been calling for (we never believed that would happen). Additionally, we felt a real sense that many investors who had been waiting for the bottoming of the recent market trough decided that this was the moment to get back in. That notion was buttressed by Friday's 835-point Dow follow through. Time will tell whether or not this represented a turnaround from the brutal past few months, but the rapid shift in market sentiment was heartening. CNBC's Bob Pisani perhaps put it best when he said, "I've been on the (trading) floor for twenty-five years; you don't see many weeks like this."
If we are on the happy side of a bottoming out, here is a tempting morsel for would-be buyers: 51% of S&P 500 stocks and 76% of NASDAQ stocks are still in bear market territory. Many quality NASDAQ names (strong revenues, needed products and services) remain 50% or more below their 52-week highs.
Textiles, Apparel, & Luxury Goods
Foot Locker gaps down by a third as management gives sobering guidance, outlines Nike problems
Shares of retailer Foot Locker (FL $29) plunged over 30% last Friday after management said it expects weaker sales and earnings this year due to supply chain issues and economic factors such as raging inflation. Furthermore, the company admitted that Nike's (NKE $137) decision to focus on direct-to-consumer sales at the expense of its third-party sellers (such as Foot Locker) will have a deleterious effect on the company, at least in the short term. To put that statement in perspective, nearly 70% of Foot Locker sales in 2021 were of Nike products. How much of a hit does management expect to take in 2022? The company is projecting a sales decline of between 8% and 10% this year. As for the quarterly earnings, the numbers were a mixed bag: Sales grew from $2.19 billion in the same quarter of the previous year to $2.34 billion this past quarter; however, thanks to higher supply-chain costs, net income for the quarter fell 16% from the previous year, to $103 million. Foot locker has nearly 3,000 retail stores around the world, with management expecting to trim that figure by roughly 3% this year.
We could easily make a convincing argument for a $50 fair value on FL shares, which would equate to a 67% gain in the share price. The company's financial health is strong, it has a tiny P/E ratio of 3.4, and a price-to-sales ratio of 0.36. A $3 billion small cap in the specialty retail space is not for the faint of heart at this moment in time, but it has a nice risk/reward profile for more "aggressive money." We would recommend a stop loss around $27.60 on any purchase of the shares.
Europe
Trump couldn't get Germany to raise its defense spending; Putin just did
Just how mentally stable Vladimir Putin is right now is open for debate, but one component of his unprovoked invasion of neighboring Ukraine is crystal clear: he is taken aback by the cohesion of the Western world against his actions; specifically, Germany. Germany has become irresponsibly reliant on Russia, a condition going back at least as far as Angela Merkel's ascension to power in 2005. This has always seemed strange to us, as she was raised in East Germany under the thumb of the Soviet empire. She is also highly intelligent, earning her doctorate in quantum chemistry and working as a research scientist before the fall of the Berlin Wall. It is hard to imagine anyone more acutely aware of Russia's tactics than Merkel. Nonetheless, as the country phased out coal and nuclear energy, Germany's leadership allowed itself to become more and more reliant on Russian commodities, especially in the energy sector.
Chancellor Merkel's party recently suffered its worst defeat since it was founded in the aftermath of World War II in 1945. The country's new leader is Olaf Scholz, head of the center-left Social Democratic Party (SPD). His party, and the Greens who have formed an alliance with the SPD, have never been fond of the already-built Nord Stream 2 pipeline, but Putin was angered (and surprised, we would argue) when Germany actually halted approval of the pipeline for operational status due to the invasion. Now, they are taking steps which have surprised even us: they are planning on a massive boost in defense spending.
That is something Germany is not known for doing, to put it mildly. Just ask former President Donald Trump, who vociferously and unsuccessfully argued that our European allies needed to at least hit NATO's 2% of GDP target for defense spending. Now, thanks to Putin's aggression on the continent, Scholz has announced that his government will funnel 100 billion euros ($113B USD) into a modernization fund for Germany's military. Additionally, he announced that the country would allot at least the 2% target on defense spending by 2024. On a related note, Germany even said it would supply weapons to Ukrainian fighters—a dramatic change in posture for the nation, and certainly the SPD, which has a history of warm ties to Moscow.
Germany's moves are great news for the cause of freedom. The wild card, however, remains Putin's state of mind. It is rather disturbing to consider just how far this mercurial autocrat will go to prevent his image from being damaged or ego from being bruised. Sadly, we cannot rely on the Chinese government to coerce its ally into pulling back. Winnie the Pooh's evil doppelganger is trying to portray an image of China being above the fray, but it is evident which side his country supports. Birds of a feather....
Interactive Media and Services
More trouble for Facebook: Google just pulled an Apple
Last year, Apple (AAPL $171) made changes to its operating system, iOS, which had a dramatic effect on Meta Platform's (FB $214) Facebook unit. Specifically, thanks to Apple's App Tracking Transparency feature, iPhone users could essentially cut off the wealth of data previously shared with Facebook advertisers to help them reach their target audience. For example, if an iPhone user happened to make regular shoe purchases through various apps, a footwear advertiser on Facebook could reach this potential customer with targeted ads. Now, iPhone users must opt in to having their activities on any given app tracked in such a manner. As could be expected, this is already having an effect on ad spends within the platform. In a stark admission, Facebook said that the changes would be responsible for a roughly $10 billion decrease in revenue this year. That equates to nearly a 10% hit.
Now, the second shoe has dropped. Alphabet's (GOOG $2,703) Google unit just announced that it will be rolling out its "Privacy Sandbox" for Android-based devices which will limit cross-site and cross-app tracking. While not quite as draconian as Apple's forced "opt in" measures, these steps will certainly have a negative impact on Facebook's ad business. This move follows a previous Google decision to phase out third-party tracking cookies on its Google Chrome browser. This gives Google Ads, the company's online advertising platform formerly known as Google AdWords, a definitive leg up in the battle for ad dollars. After all, the simple act of searching for goods or services via the browser gives the company user information in an "organic" manner (i.e., no third-party tracking apps required). As if Meta didn't have enough on its plate already.
After its shares fell sharply, we re-added Meta Platforms to the Penn Global Leaders Club. Despite its perpetual headwinds, keep in mind that it still controls the world's largest online social network, with nearly 3 billion monthly active users. We also believe the metaverse will be a transformational movement which will reshape both entertainment and business as we know it (we recall many rolling their eyes at the Internet as well), and that Meta Platforms will be a major player. We retain our $442 initial price target on the shares.
Media & Entertainment
Roku didn't miss revenue expectations by all that much, but investors fled; we've seen this movie before
Back in September of 2019, we wrote of streaming device maker Roku's (ROKU $112) really bad day. Shares had just fallen 20%, to $108, on the back of a scathing analyst call arguing that the company wouldn't be able to stand up to new competition from the likes of Apple, Comcast, Facebook (Portal), and the slew of new smart TVs; the latter of which which would ultimately make its device obsolete. Eighteen months after that drop, the pandemic came along and helped Roku shares skyrocket, topping out at $491. We have missed out on every one of the company's meteoric price spikes because we simply can't explain its long-term growth story. It was September of 2019 all over again this week, as Roku shares fell 22.3% in one day—closing the week at $112—after a slight revenue miss led to a slew of price target downgrades. Shares have now fallen 76.55% since the summer of 2021. There is some comedy to inject in this story. Our 2019 commentary mentioned that a major catalyst for the price drop (to $108) was Pivotal Research initiating coverage with a "Sell" rating and a $60 per share price target. What makes this so humorous is that Pivotal, following this past Friday's drop, once again lowered their rating to "Sell." This time they moved their price target on Roku shares down from $350 to $95. Now that's funny. Wouldn't it have been better to just not say anything after their 2019 commentary? Yet another reason we have never pulled the trigger on adding this company to one of our strategies—its price gyrations tend to make analysts look silly. As for the earnings report which sparked this latest price drop, Roku reported Q4 revenues of $865 million (+33% YoY), which fell short of analysts' expectations for $894 million in sales. On the bright side, the company reported net earnings of $23.7 million, representing its sixth-straight quarter of profitability.
Bulls argue that Roku is no longer just a one-trick (the Roku Stick) pony. The company now has its own ad-sponsored channel to supplement a service-neutral platform which allows customers to access Netflix, Disney+, Hulu, and a host of others providers. They also argue that enormous growth potential outside of a saturated US market should provide 30%+ annual revenue growth for years to come. We remain skeptical, just as we did the last time it sat near $100 per share.
Industrial Machinery
We added Generac to the Global Leaders Club this month; its earnings and guidance support our Strong Buy thesis
Companies listed on the NASDAQ have, overwhelmingly, seen their share prices crushed over the past few months, with some big names falling 50% or more from their 52-week highs. For many, based on their nonexistent earnings, the drop is understandable. For others, the pullback has been irrational. Power generation equipment maker Generac Holdings (GNRC $295) certainly falls in the latter camp. After falling 50% from its November high of $524, we added shares of this great American company to the Penn Global Leaders Club on the fourth of this month. The company just reported earnings and gave guidance for 2022: both sides of the coin were stellar. Revenues for the fourth quarter came in at just over $1 billion, representing a 40% spike from the same quarter of the previous year. Earnings per share (EPS) was $2.51 versus expectations for $2.42. For the fiscal year, sales hit a record $3.75 billion, a 50% increase over the previous year. As for guidance, management expects net sales in 2022 to increase somewhere in the 35% range, based on strong global demand—especially in clean energy markets—and increased home standby production capacity. The team also cited recent acquisitions as a catalyst. Shares spiked 16% on the report, and then proceeded to fall back down with the rest of the index. Generac is in an incredible position right now: the company is generating huge profits from its existing business line, but is also poised to be an industry leader in the renewable energy market. Investors seem to be missing that point.
We removed FedEx (FDX $222) from the Penn Global Leaders Club to make room for Generac, picking up shares of the company at $280. Our target price is $550.
E-Commerce
Another e-commerce company plummets on earnings, sentiment
While we have never owned e-commerce platform Shopify (SHOP $657), it was certainly one of the investor darlings during the pandemic. Furthermore, we love the story. Consider the company an Amazon for the rest of us. It provides everything a small- or mid-sized business needs to set up shop on the Internet, make sales, ship goods (fast), and help with bookkeeping and marketing. All for a quite reasonable price, we might add. If that wasn't enough of a sales pitch, consider this: you can now pick up shares at a 63% discount to their 52-week high of $1,763. But should you? This is yet another case of a company reporting strong earnings, but issuing guidance which spooked the market. Against expectations for $1.34 billion in sales for the quarter, the company reported revenue of $1.38 billion. Earnings also beat, with the company netting a profit of $1.36 per share (yes, they are actually operating in the black). For the full year, Shopify generated $4.6 billion in revenue, improving on 2020's sales by 57%. Impressive. Two concerns weighed on investor sentiment, however. First, can the company possibly keep up the impressive rate of growth it enjoyed during the pandemic? Secondly, investors are concerned about how much it is going to cost to build the company's massive American distribution system, known as the Shopify Fulfillment Network. The ultimate goal is to deliver good from its merchants to their respective customers within two days, competing head-to-head with Amazon Prime. The company is expected to spend around $1 billion over the next two years to build out key warehouse hubs in the United States (Shopify is a Canadian company). The key question is whether or not management can effectively deploy the capital needed to complete the project. Dour investors voted with their capital this past week, sending the shares reeling.
Again, we don't currently own the company right now. That being said, we do believe in the management team, and we could see the shares doubling in price if 2022 shapes up like we expect it to. The financials look exceptional, and the company is sitting on a war chest of nearly $8 billion. A conservative fair value of $1,000 per share seems appropriate.
Strategies & Tactics: Behavioral Finance
The Russia/Ukraine brouhaha is a rallying cry for Ukrainians, a wake-up call to Europeans, and an opportunity for investors
Will they? Won't they? That is the question being asked incessantly on the news channels. The question is missing the point: Russia has, in essence, already invaded Ukraine. After all, the country forcefully took the almost-island (it is connected to Ukraine by a tiny isthmus) of Crimea back in 2014, annexing it as Russian territory; it is fomenting constant fighting in the Donbas region of southeastern Ukraine; and it has unleashed a cyberwar on its western neighbor. Yes, a ground invasion would bring about a multitude of deaths (14,000 have already died in the Donbas region of Donetsk and Luhansk, where Russian-speaking separatists—provided with Russian arms—have been fighting government forces), but the real threat is to Putin himself, not the markets. The dictator has painted himself into a corner, despite his belief that he holds all the cards.
Germany, thanks to Merkel's full-throated and myopic cheerleading for Russian gas flowing into the country (roughly 50% of demand), is certainly in a precarious situation as it scrambles for new suppliers. And the sanctions which would follow a ground invasion would send oil above $100 per barrel. But from a US market perspective, this threat is far less ominous than the one posed by a global pandemic we knew little about back in March of 2020. That spring turned out to be one of the best buying opportunities since the fall and winter of 1987. The press is doing its best to keep anxiety high, but Putin will be the real loser in this game of chicken, not the US stock market.
The major indexes finished the week down—their fifth losing week of the last seven, and the downturn has created some real opportunities to pick up some of those wish list stocks on the cheap. Granted, many tech names were strongly overvalued, but the likes of Adobe (ADBE), Uber (UBER), PayPal (PYPL), and Generac (GNRC) fell to levels investors would have drooled over last fall. Now is the time to discount the headlines and search for some premium names to buy.
Just as we did in March and April of 2020, we pulled out our own wish list of stocks which have dropped below our target buy price. Take a look at portfolio allocations and see which promising sectors and industries have become underweighted and plug in some good names. Let the headlines rattle others into wanton selling; the crisis in Eastern Europe does not pose a major threat to fundamentally sound, cash-flow-generating American companies—it has created a tactical opportunity which will become clear to others over the coming months.
Under the Radar Investment
Rogers Sugar (RSI.TO $6)
We were not picky, we just wanted a: small-cap defensive stock with a great dividend yield and low risk level (as measured by beta) to add to our international opportunities fund. Simple, right? We actually found what we were looking for in Vancover-based Rogers Sugar Inc. This $607 million company was established in 1890 by B.T. Rogers, who was trying to solve the problem of the high cost of transporting refined sugar by rail from Montreal to Vancouver. Strategically located to access raw sugar shipments from the Pacific and send refined sugar to Canada's western population centers, the company was the first major non-logging or fishing industry in the region. Today, the company refines, packages, and markets sugar and maple products to industrial customers and consumers throughout Canada and the United States. Rogers has a P/E ratio of 12, a tiny price-to-sales ratio of 0.761, and a dividend yield of 6.15%. Shares closed the week at $5.85.
Answer
The four presidents were chosen for their significant contribution to the founding, expansion, preservation, and unification of the United States:
- George Washington was chosen as he was the Founding Father of the nation
- Thomas Jefferson was chosen to represent expansion, as the author of the Declaration of Independence and the promoter/signer of the Louisiana Purchase (which doubled the size of the US)
- Theodore Roosevelt was chosen because he represented conservation (he established 150 national forests, 50 federal bird reserves, 4 national game preserves, 5 national parks, and 18 national monuments on over 230 million acres of newly-protected land)
- Abraham Lincoln was chosen for leading the United States through the bloody Civil War and his belief that the nation "must be preserved at any cost."
Headlines for the Week of 13 Feb 2022 — 19 Feb 2022
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The Incredible National Gift of Mount Rushmore...
America boasts some incredible national monuments, but few hold the natural beauty and grandeur of Mount Rushmore. While South Dakota historian Doane Robinson dreamed up the concept, it was Danish-American sculptor Gutzon Borglum, a good friend of the French sculptor Rodin, who brought the glorious monument to life. Borglum and his son, Lincoln, thought that the monument should have a national focus around four cornerstone concepts of American freedom. We all know the presidents represented in the carving, but what are the concepts each represent?
Penn Trading Desk:
Penn: Open immersive gaming platform in New Frontier Fund
We have been waiting for a catalyst to bring shares of this forward-looking media and entertainment company down within our price range; we got it in the form of Market reaction to an earnings report. Added to the Penn New Frontier Fund with an initial price target 79% higher than our purchase price, though we have no plans to sell it when that first target is hit.
Penn: Open Application Software company in the New Frontier Fund
When you see the name, you may scratch your head as to why it is listed as an Application & Systems Software company, but it is. We added this industry leader to the New Frontier Fund with a target price 101% above our purchase price. We believe the market has grossly misjudged this company.
Penn: Close BCE and Open Premium Income Fund Within the Strategic Income Portfolio
It is a nightmare scenario for fixed-income investors: rates are at historic lows (meaning you're getting paltry income from your bonds), and the Fed is signaling at least six rate hikes (meaning the value of your bonds will probably go down). We have added one potential solution within the Strategic Income Portfolio: We have replaced Canadian telecom company BCE with a premium income ETF which provides a 7% income stream to investors. Members can read about this unique strategy in the upcoming Penn Wealth Report, and see the trade details now at the Penn Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Airlines
Merger of the low-cost carriers: Frontier to buy Spirit Airlines in $6.6 billion deal
Denver-based Frontier (ULCC $12) is a $2.6 billion ultra-low-cost carrier serving 90 destinations with a fleet of 60 single-aisle Airbus aircraft. Florida-based Spirit Airlines (SAVE $24) is a $2.3 billion ultra-low-cost carrier serving 78 destinations with a fleet of 157 single-aisle Airbus aircraft. Both small cap airlines have lost money since the pandemic. With so much in common, it makes sense that these two airlines, both focused on leisure travel, would join forces. Our only question is the price-tag: Frontier has agreed to buy Spirit in a deal valued at $6.6 billion—or around $1.7 billion more than the combined companies' market cap at the end of last week. If the merger is approved (it should be, but with the current DoJ, who knows), it would create the country's fifth-largest airline, behind American, Delta, Southwest, and United. We know that Frontier would control 51.5% of the merged company, with Spirit shareholders owning the other 48.5%. What has yet to be determined is who will be the CEO, what the entity will be called, and where it will be headquartered. Bill Franke, the current chair of Frontier and managing partner of parent company Indigo Parters, will remain in his role, however. Although its IPO was delayed due to the pandemic, Frontier finally went public on the NASDAQ last April, opening around $19 per share.
We like this deal a lot. In fact, it is fair to say that it needed to be done for the long-term viability of both companies. Both carriers have aggressive growth plans, and the combined entity should begin operations before the end of this year, just as leisure travel begins to take off once again. We wouldn't touch shares of either company, however, before the DoT/DoJ appear ready to give the green light to the merger. We own United Airlines Holdings (UAL $44) in the Penn Global Leaders Club.
Bear Market Chatter
The economy—and the markets—should be able to withstand the coming tightening cycle
Want an idea of how the markets might react to a multi-year series of rate hikes? Look no further than 2015 through 2018. In the three-year period between December of 2015 and December of 2018, the Fed initiated a total of nine, 25-basis-point hikes, taking the lower band of the Fed funds rate from 0% to 2.25%. That same scenario seems completely plausible this time around. Common sense test: It is rather difficult to imagine would-be home buyers proclaiming, "A 6% mortgage rate? That's it, we're out!" (6% is probably the max rates would spike to; they peaked at 4.94% during the last tightening cycle.)
Just as the last series of hikes didn't chase away buyers, it also didn't run off investors. Sure, we had that ugly fourth-quarter downturn in 2018 which culminated in a negative year, but that was the result of trade tensions, D.C.'s battle with big tech, and a host of other concerning headlines. By April of 2019, the Q4 losses had been erased, and the markets were off to the races once again—at least until a global pandemic entered the field.
Yes, piloting a so-called "soft landing" of the economy is going to require some finesse by the Fed, but we don't buy the current narrative that inflation is so out of control that it cannot be subdued. Supply chain issues will abate this year, higher rates will help dampen the unbridled enthusiasm which has pushed up the cost of new and used vehicles and homes, and technology will continue to put downward pressure on prices. Add needed tightening to the mix and we can make a good argument for a decent year ahead, especially after the market's recent pullback. We retain our 5,100 target price for the S&P 500 (which is suddenly sounding a lot better), with the caveat that we are due a negative year—much like the one we had in 2018.
Quantitative tightening will probably continue into 2023 and then end at some point in the year. The Fed should be able to whittle its balance sheet down to a more manageable (yet still unacceptable) $7 trillion or so. We do see a recession on the horizon, but that will most likely come to pass in the second half of 2023 or in the election year of 2024.
Monetary Policy
The Bank of America analyst who predicted seven rate hikes this year isn't too concerned about the tightening yield curve
We just explained why investors shouldn't be overly concerned with a series of rate hikes, but what about concern over the flattening yield curve? Many economists are wringing their hands over the tightening spread between the 2-year Treasury and the 10-year Treasury, with some seemingly wired to believe that an inverted curve (the blue line on the chart going below 0.00%) signals a recession is all but guaranteed. Ironically, we turn to someone whose rate hike predictions we don't buy to explain why this is not necessarily the case. There's an old joke—at the expense of economists—which says, "The yield curve has predicted eight out of the last four recessions." Funny. Bank of America's head of global economics, who is calling for seven hikes in 2022 and another four in 2023, made an interesting observation about the tightening curve. He argues that foreign investors are flooding in to buy 10-year US Treasuries because they are faced with zero—or even negative—rates back home. That is a great point. As demand goes up for the longer notes, the law of supply and demand says prices will naturally go up. In Bond World, high demand and higher prices means yields will naturally fall. Picture the teeter-totter rule of bonds. The longer the maturity, the further out on the teeter-totter the bonds sit. On the opposite side of price for any given maturity sits yield. In other words, as prices go up, yields come down, and the longer the duration or maturity, the faster this takes place. Yes, the Fed will raise rates, but they can only affect the short end, sitting nearest the fulcrum on our imaginary piece of playground equipment. This is certainly one strong explanation for the tightening curve. For the record, the B of A analyst, Ethan Harris, also believes that inflation will come down naturally to the 3% range or so in the not-too-distant future as a result of supply constraints easing and the economy getting back to more normal levels. So, we agree with everything he is espousing except for the eleven rate hikes.
We are sticking with our prediction of four, 25-basis-point hikes this year, and four more in 2023; this would place the Fed funds rate at a quite accommodative 2%. If that rate freaks the market out, we have bigger concerns about the psyche of investors.
Interactive Media and Services
More trouble for Facebook: Google just pulled an Apple
Last year, Apple (AAPL $171) made changes to its operating system, iOS, which had a dramatic effect on Meta Platform's (FB $214) Facebook unit. Specifically, thanks to Apple's App Tracking Transparency feature, iPhone users could essentially cut off the wealth of data previously shared with Facebook advertisers to help them reach their target audience. For example, if an iPhone user happened to make regular shoe purchases through various apps, a footwear advertiser on Facebook could reach this potential customer with targeted ads. Now, iPhone users must opt in to having their activities on any given app tracked in such a manner. As could be expected, this is already having an effect on ad spends within the platform. In a stark admission, Facebook said that the changes would be responsible for a roughly $10 billion decrease in revenue this year. That equates to nearly a 10% hit.
Now, the second shoe has dropped. Alphabet's (GOOG $2,703) Google unit just announced that it will be rolling out its "Privacy Sandbox" for Android-based devices which will limit cross-site and cross-app tracking. While not quite as draconian as Apple's forced "opt in" measures, these steps will certainly have a negative impact on Facebook's ad business. This move follows a previous Google decision to phase out third-party tracking cookies on its Google Chrome browser. This gives Google Ads, the company's online advertising platform formerly known as Google AdWords, a definitive leg up in the battle for ad dollars. After all, the simple act of searching for goods or services via the browser gives the company user information in an "organic" manner (i.e., no third-party tracking apps required). As if Meta didn't have enough on its plate already.
After its shares fell sharply, we re-added Meta Platforms to the Penn Global Leaders Club. Despite its perpetual headwinds, keep in mind that it still controls the world's largest online social network, with nearly 3 billion monthly active users. We also believe the metaverse will be a transformational movement which will reshape both entertainment and business as we know it (we recall many rolling their eyes at the Internet as well), and that Meta Platforms will be a major player. We retain our $442 initial price target on the shares.
Media & Entertainment
Roku didn't miss revenue expectations by all that much, but investors fled; we've seen this movie before
Back in September of 2019, we wrote of streaming device maker Roku's (ROKU $112) really bad day. Shares had just fallen 20%, to $108, on the back of a scathing analyst call arguing that the company wouldn't be able to stand up to new competition from the likes of Apple, Comcast, Facebook (Portal), and the slew of new smart TVs; the latter of which which would ultimately make its device obsolete. Eighteen months after that drop, the pandemic came along and helped Roku shares skyrocket, topping out at $491. We have missed out on every one of the company's meteoric price spikes because we simply can't explain its long-term growth story. It was September of 2019 all over again this week, as Roku shares fell 22.3% in one day—closing the week at $112—after a slight revenue miss led to a slew of price target downgrades. Shares have now fallen 76.55% since the summer of 2021. There is some comedy to inject in this story. Our 2019 commentary mentioned that a major catalyst for the price drop (to $108) was Pivotal Research initiating coverage with a "Sell" rating and a $60 per share price target. What makes this so humorous is that Pivotal, following this past Friday's drop, once again lowered their rating to "Sell." This time they moved their price target on Roku shares down from $350 to $95. Now that's funny. Wouldn't it have been better to just not say anything after their 2019 commentary? Yet another reason we have never pulled the trigger on adding this company to one of our strategies—its price gyrations tend to make analysts look silly. As for the earnings report which sparked this latest price drop, Roku reported Q4 revenues of $865 million (+33% YoY), which fell short of analysts' expectations for $894 million in sales. On the bright side, the company reported net earnings of $23.7 million, representing its sixth-straight quarter of profitability.
Bulls argue that Roku is no longer just a one-trick (the Roku Stick) pony. The company now has its own ad-sponsored channel to supplement a service-neutral platform which allows customers to access Netflix, Disney+, Hulu, and a host of others providers. They also argue that enormous growth potential outside of a saturated US market should provide 30%+ annual revenue growth for years to come. We remain skeptical, just as we did the last time it sat near $100 per share.
Industrial Machinery
We added Generac to the Global Leaders Club this month; its earnings and guidance support our Strong Buy thesis
Companies listed on the NASDAQ have, overwhelmingly, seen their share prices crushed over the past few months, with some big names falling 50% or more from their 52-week highs. For many, based on their nonexistent earnings, the drop is understandable. For others, the pullback has been irrational. Power generation equipment maker Generac Holdings (GNRC $295) certainly falls in the latter camp. After falling 50% from its November high of $524, we added shares of this great American company to the Penn Global Leaders Club on the fourth of this month. The company just reported earnings and gave guidance for 2022: both sides of the coin were stellar. Revenues for the fourth quarter came in at just over $1 billion, representing a 40% spike from the same quarter of the previous year. Earnings per share (EPS) was $2.51 versus expectations for $2.42. For the fiscal year, sales hit a record $3.75 billion, a 50% increase over the previous year. As for guidance, management expects net sales in 2022 to increase somewhere in the 35% range, based on strong global demand—especially in clean energy markets—and increased home standby production capacity. The team also cited recent acquisitions as a catalyst. Shares spiked 16% on the report, and then proceeded to fall back down with the rest of the index. Generac is in an incredible position right now: the company is generating huge profits from its existing business line, but is also poised to be an industry leader in the renewable energy market. Investors seem to be missing that point.
We removed FedEx (FDX $222) from the Penn Global Leaders Club to make room for Generac, picking up shares of the company at $280. Our target price is $550.
E-Commerce
Another e-commerce company plummets on earnings, sentiment
While we have never owned e-commerce platform Shopify (SHOP $657), it was certainly one of the investor darlings during the pandemic. Furthermore, we love the story. Consider the company an Amazon for the rest of us. It provides everything a small- or mid-sized business needs to set up shop on the Internet, make sales, ship goods (fast), and help with bookkeeping and marketing. All for a quite reasonable price, we might add. If that wasn't enough of a sales pitch, consider this: you can now pick up shares at a 63% discount to their 52-week high of $1,763. But should you? This is yet another case of a company reporting strong earnings, but issuing guidance which spooked the market. Against expectations for $1.34 billion in sales for the quarter, the company reported revenue of $1.38 billion. Earnings also beat, with the company netting a profit of $1.36 per share (yes, they are actually operating in the black). For the full year, Shopify generated $4.6 billion in revenue, improving on 2020's sales by 57%. Impressive. Two concerns weighed on investor sentiment, however. First, can the company possibly keep up the impressive rate of growth it enjoyed during the pandemic? Secondly, investors are concerned about how much it is going to cost to build the company's massive American distribution system, known as the Shopify Fulfillment Network. The ultimate goal is to deliver good from its merchants to their respective customers within two days, competing head-to-head with Amazon Prime. The company is expected to spend around $1 billion over the next two years to build out key warehouse hubs in the United States (Shopify is a Canadian company). The key question is whether or not management can effectively deploy the capital needed to complete the project. Dour investors voted with their capital this past week, sending the shares reeling.
Again, we don't currently own the company right now. That being said, we do believe in the management team, and we could see the shares doubling in price if 2022 shapes up like we expect it to. The financials look exceptional, and the company is sitting on a war chest of nearly $8 billion. A conservative fair value of $1,000 per share seems appropriate.
Strategies & Tactics: Behavioral Finance
The Russia/Ukraine brouhaha is a rallying cry for Ukrainians, a wake-up call to Europeans, and an opportunity for investors
Will they? Won't they? That is the question being asked incessantly on the news channels. The question is missing the point: Russia has, in essence, already invaded Ukraine. After all, the country forcefully took the almost-island (it is connected to Ukraine by a tiny isthmus) of Crimea back in 2014, annexing it as Russian territory; it is fomenting constant fighting in the Donbas region of southeastern Ukraine; and it has unleashed a cyberwar on its western neighbor. Yes, a ground invasion would bring about a multitude of deaths (14,000 have already died in the Donbas region of Donetsk and Luhansk, where Russian-speaking separatists—provided with Russian arms—have been fighting government forces), but the real threat is to Putin himself, not the markets. The dictator has painted himself into a corner, despite his belief that he holds all the cards.
Germany, thanks to Merkel's full-throated and myopic cheerleading for Russian gas flowing into the country (roughly 50% of demand), is certainly in a precarious situation as it scrambles for new suppliers. And the sanctions which would follow a ground invasion would send oil above $100 per barrel. But from a US market perspective, this threat is far less ominous than the one posed by a global pandemic we knew little about back in March of 2020. That spring turned out to be one of the best buying opportunities since the fall and winter of 1987. The press is doing its best to keep anxiety high, but Putin will be the real loser in this game of chicken, not the US stock market.
The major indexes finished the week down—their fifth losing week of the last seven, and the downturn has created some real opportunities to pick up some of those wish list stocks on the cheap. Granted, many tech names were strongly overvalued, but the likes of Adobe (ADBE), Uber (UBER), PayPal (PYPL), and Generac (GNRC) fell to levels investors would have drooled over last fall. Now is the time to discount the headlines and search for some premium names to buy.
Just as we did in March and April of 2020, we pulled out our own wish list of stocks which have dropped below our target buy price. Take a look at portfolio allocations and see which promising sectors and industries have become underweighted and plug in some good names. Let the headlines rattle others into wanton selling; the crisis in Eastern Europe does not pose a major threat to fundamentally sound, cash-flow-generating American companies—it has created a tactical opportunity which will become clear to others over the coming months.
Under the Radar Investment
Rogers Sugar (RSI.TO $6)
We were not picky, we just wanted a: small-cap defensive stock with a great dividend yield and low risk level (as measured by beta) to add to our international opportunities fund. Simple, right? We actually found what we were looking for in Vancover-based Rogers Sugar Inc. This $607 million company was established in 1890 by B.T. Rogers, who was trying to solve the problem of the high cost of transporting refined sugar by rail from Montreal to Vancouver. Strategically located to access raw sugar shipments from the Pacific and send refined sugar to Canada's western population centers, the company was the first major non-logging or fishing industry in the region. Today, the company refines, packages, and markets sugar and maple products to industrial customers and consumers throughout Canada and the United States. Rogers has a P/E ratio of 12, a tiny price-to-sales ratio of 0.761, and a dividend yield of 6.15%. Shares closed the week at $5.85.
Answer
The four presidents were chosen for their significant contribution to the founding, expansion, preservation, and unification of the United States:
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The Incredible National Gift of Mount Rushmore...
America boasts some incredible national monuments, but few hold the natural beauty and grandeur of Mount Rushmore. While South Dakota historian Doane Robinson dreamed up the concept, it was Danish-American sculptor Gutzon Borglum, a good friend of the French sculptor Rodin, who brought the glorious monument to life. Borglum and his son, Lincoln, thought that the monument should have a national focus around four cornerstone concepts of American freedom. We all know the presidents represented in the carving, but what are the concepts each represent?
Penn Trading Desk:
Penn: Open immersive gaming platform in New Frontier Fund
We have been waiting for a catalyst to bring shares of this forward-looking media and entertainment company down within our price range; we got it in the form of Market reaction to an earnings report. Added to the Penn New Frontier Fund with an initial price target 79% higher than our purchase price, though we have no plans to sell it when that first target is hit.
Penn: Open Application Software company in the New Frontier Fund
When you see the name, you may scratch your head as to why it is listed as an Application & Systems Software company, but it is. We added this industry leader to the New Frontier Fund with a target price 101% above our purchase price. We believe the market has grossly misjudged this company.
Penn: Close BCE and Open Premium Income Fund Within the Strategic Income Portfolio
It is a nightmare scenario for fixed-income investors: rates are at historic lows (meaning you're getting paltry income from your bonds), and the Fed is signaling at least six rate hikes (meaning the value of your bonds will probably go down). We have added one potential solution within the Strategic Income Portfolio: We have replaced Canadian telecom company BCE with a premium income ETF which provides a 7% income stream to investors. Members can read about this unique strategy in the upcoming Penn Wealth Report, and see the trade details now at the Penn Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Airlines
Merger of the low-cost carriers: Frontier to buy Spirit Airlines in $6.6 billion deal
Denver-based Frontier (ULCC $12) is a $2.6 billion ultra-low-cost carrier serving 90 destinations with a fleet of 60 single-aisle Airbus aircraft. Florida-based Spirit Airlines (SAVE $24) is a $2.3 billion ultra-low-cost carrier serving 78 destinations with a fleet of 157 single-aisle Airbus aircraft. Both small cap airlines have lost money since the pandemic. With so much in common, it makes sense that these two airlines, both focused on leisure travel, would join forces. Our only question is the price-tag: Frontier has agreed to buy Spirit in a deal valued at $6.6 billion—or around $1.7 billion more than the combined companies' market cap at the end of last week. If the merger is approved (it should be, but with the current DoJ, who knows), it would create the country's fifth-largest airline, behind American, Delta, Southwest, and United. We know that Frontier would control 51.5% of the merged company, with Spirit shareholders owning the other 48.5%. What has yet to be determined is who will be the CEO, what the entity will be called, and where it will be headquartered. Bill Franke, the current chair of Frontier and managing partner of parent company Indigo Parters, will remain in his role, however. Although its IPO was delayed due to the pandemic, Frontier finally went public on the NASDAQ last April, opening around $19 per share.
We like this deal a lot. In fact, it is fair to say that it needed to be done for the long-term viability of both companies. Both carriers have aggressive growth plans, and the combined entity should begin operations before the end of this year, just as leisure travel begins to take off once again. We wouldn't touch shares of either company, however, before the DoT/DoJ appear ready to give the green light to the merger. We own United Airlines Holdings (UAL $44) in the Penn Global Leaders Club.
Bear Market Chatter
The economy—and the markets—should be able to withstand the coming tightening cycle
Want an idea of how the markets might react to a multi-year series of rate hikes? Look no further than 2015 through 2018. In the three-year period between December of 2015 and December of 2018, the Fed initiated a total of nine, 25-basis-point hikes, taking the lower band of the Fed funds rate from 0% to 2.25%. That same scenario seems completely plausible this time around. Common sense test: It is rather difficult to imagine would-be home buyers proclaiming, "A 6% mortgage rate? That's it, we're out!" (6% is probably the max rates would spike to; they peaked at 4.94% during the last tightening cycle.)
Just as the last series of hikes didn't chase away buyers, it also didn't run off investors. Sure, we had that ugly fourth-quarter downturn in 2018 which culminated in a negative year, but that was the result of trade tensions, D.C.'s battle with big tech, and a host of other concerning headlines. By April of 2019, the Q4 losses had been erased, and the markets were off to the races once again—at least until a global pandemic entered the field.
Yes, piloting a so-called "soft landing" of the economy is going to require some finesse by the Fed, but we don't buy the current narrative that inflation is so out of control that it cannot be subdued. Supply chain issues will abate this year, higher rates will help dampen the unbridled enthusiasm which has pushed up the cost of new and used vehicles and homes, and technology will continue to put downward pressure on prices. Add needed tightening to the mix and we can make a good argument for a decent year ahead, especially after the market's recent pullback. We retain our 5,100 target price for the S&P 500 (which is suddenly sounding a lot better), with the caveat that we are due a negative year—much like the one we had in 2018.
Quantitative tightening will probably continue into 2023 and then end at some point in the year. The Fed should be able to whittle its balance sheet down to a more manageable (yet still unacceptable) $7 trillion or so. We do see a recession on the horizon, but that will most likely come to pass in the second half of 2023 or in the election year of 2024.
Monetary Policy
The Bank of America analyst who predicted seven rate hikes this year isn't too concerned about the tightening yield curve
We just explained why investors shouldn't be overly concerned with a series of rate hikes, but what about concern over the flattening yield curve? Many economists are wringing their hands over the tightening spread between the 2-year Treasury and the 10-year Treasury, with some seemingly wired to believe that an inverted curve (the blue line on the chart going below 0.00%) signals a recession is all but guaranteed. Ironically, we turn to someone whose rate hike predictions we don't buy to explain why this is not necessarily the case. There's an old joke—at the expense of economists—which says, "The yield curve has predicted eight out of the last four recessions." Funny. Bank of America's head of global economics, who is calling for seven hikes in 2022 and another four in 2023, made an interesting observation about the tightening curve. He argues that foreign investors are flooding in to buy 10-year US Treasuries because they are faced with zero—or even negative—rates back home. That is a great point. As demand goes up for the longer notes, the law of supply and demand says prices will naturally go up. In Bond World, high demand and higher prices means yields will naturally fall. Picture the teeter-totter rule of bonds. The longer the maturity, the further out on the teeter-totter the bonds sit. On the opposite side of price for any given maturity sits yield. In other words, as prices go up, yields come down, and the longer the duration or maturity, the faster this takes place. Yes, the Fed will raise rates, but they can only affect the short end, sitting nearest the fulcrum on our imaginary piece of playground equipment. This is certainly one strong explanation for the tightening curve. For the record, the B of A analyst, Ethan Harris, also believes that inflation will come down naturally to the 3% range or so in the not-too-distant future as a result of supply constraints easing and the economy getting back to more normal levels. So, we agree with everything he is espousing except for the eleven rate hikes.
We are sticking with our prediction of four, 25-basis-point hikes this year, and four more in 2023; this would place the Fed funds rate at a quite accommodative 2%. If that rate freaks the market out, we have bigger concerns about the psyche of investors.
Interactive Media and Services
More trouble for Facebook: Google just pulled an Apple
Last year, Apple (AAPL $171) made changes to its operating system, iOS, which had a dramatic effect on Meta Platform's (FB $214) Facebook unit. Specifically, thanks to Apple's App Tracking Transparency feature, iPhone users could essentially cut off the wealth of data previously shared with Facebook advertisers to help them reach their target audience. For example, if an iPhone user happened to make regular shoe purchases through various apps, a footwear advertiser on Facebook could reach this potential customer with targeted ads. Now, iPhone users must opt in to having their activities on any given app tracked in such a manner. As could be expected, this is already having an effect on ad spends within the platform. In a stark admission, Facebook said that the changes would be responsible for a roughly $10 billion decrease in revenue this year. That equates to nearly a 10% hit.
Now, the second shoe has dropped. Alphabet's (GOOG $2,703) Google unit just announced that it will be rolling out its "Privacy Sandbox" for Android-based devices which will limit cross-site and cross-app tracking. While not quite as draconian as Apple's forced "opt in" measures, these steps will certainly have a negative impact on Facebook's ad business. This move follows a previous Google decision to phase out third-party tracking cookies on its Google Chrome browser. This gives Google Ads, the company's online advertising platform formerly known as Google AdWords, a definitive leg up in the battle for ad dollars. After all, the simple act of searching for goods or services via the browser gives the company user information in an "organic" manner (i.e., no third-party tracking apps required). As if Meta didn't have enough on its plate already.
After its shares fell sharply, we re-added Meta Platforms to the Penn Global Leaders Club. Despite its perpetual headwinds, keep in mind that it still controls the world's largest online social network, with nearly 3 billion monthly active users. We also believe the metaverse will be a transformational movement which will reshape both entertainment and business as we know it (we recall many rolling their eyes at the Internet as well), and that Meta Platforms will be a major player. We retain our $442 initial price target on the shares.
Media & Entertainment
Roku didn't miss revenue expectations by all that much, but investors fled; we've seen this movie before
Back in September of 2019, we wrote of streaming device maker Roku's (ROKU $112) really bad day. Shares had just fallen 20%, to $108, on the back of a scathing analyst call arguing that the company wouldn't be able to stand up to new competition from the likes of Apple, Comcast, Facebook (Portal), and the slew of new smart TVs; the latter of which which would ultimately make its device obsolete. Eighteen months after that drop, the pandemic came along and helped Roku shares skyrocket, topping out at $491. We have missed out on every one of the company's meteoric price spikes because we simply can't explain its long-term growth story. It was September of 2019 all over again this week, as Roku shares fell 22.3% in one day—closing the week at $112—after a slight revenue miss led to a slew of price target downgrades. Shares have now fallen 76.55% since the summer of 2021. There is some comedy to inject in this story. Our 2019 commentary mentioned that a major catalyst for the price drop (to $108) was Pivotal Research initiating coverage with a "Sell" rating and a $60 per share price target. What makes this so humorous is that Pivotal, following this past Friday's drop, once again lowered their rating to "Sell." This time they moved their price target on Roku shares down from $350 to $95. Now that's funny. Wouldn't it have been better to just not say anything after their 2019 commentary? Yet another reason we have never pulled the trigger on adding this company to one of our strategies—its price gyrations tend to make analysts look silly. As for the earnings report which sparked this latest price drop, Roku reported Q4 revenues of $865 million (+33% YoY), which fell short of analysts' expectations for $894 million in sales. On the bright side, the company reported net earnings of $23.7 million, representing its sixth-straight quarter of profitability.
Bulls argue that Roku is no longer just a one-trick (the Roku Stick) pony. The company now has its own ad-sponsored channel to supplement a service-neutral platform which allows customers to access Netflix, Disney+, Hulu, and a host of others providers. They also argue that enormous growth potential outside of a saturated US market should provide 30%+ annual revenue growth for years to come. We remain skeptical, just as we did the last time it sat near $100 per share.
Industrial Machinery
We added Generac to the Global Leaders Club this month; its earnings and guidance support our Strong Buy thesis
Companies listed on the NASDAQ have, overwhelmingly, seen their share prices crushed over the past few months, with some big names falling 50% or more from their 52-week highs. For many, based on their nonexistent earnings, the drop is understandable. For others, the pullback has been irrational. Power generation equipment maker Generac Holdings (GNRC $295) certainly falls in the latter camp. After falling 50% from its November high of $524, we added shares of this great American company to the Penn Global Leaders Club on the fourth of this month. The company just reported earnings and gave guidance for 2022: both sides of the coin were stellar. Revenues for the fourth quarter came in at just over $1 billion, representing a 40% spike from the same quarter of the previous year. Earnings per share (EPS) was $2.51 versus expectations for $2.42. For the fiscal year, sales hit a record $3.75 billion, a 50% increase over the previous year. As for guidance, management expects net sales in 2022 to increase somewhere in the 35% range, based on strong global demand—especially in clean energy markets—and increased home standby production capacity. The team also cited recent acquisitions as a catalyst. Shares spiked 16% on the report, and then proceeded to fall back down with the rest of the index. Generac is in an incredible position right now: the company is generating huge profits from its existing business line, but is also poised to be an industry leader in the renewable energy market. Investors seem to be missing that point.
We removed FedEx (FDX $222) from the Penn Global Leaders Club to make room for Generac, picking up shares of the company at $280. Our target price is $550.
E-Commerce
Another e-commerce company plummets on earnings, sentiment
While we have never owned e-commerce platform Shopify (SHOP $657), it was certainly one of the investor darlings during the pandemic. Furthermore, we love the story. Consider the company an Amazon for the rest of us. It provides everything a small- or mid-sized business needs to set up shop on the Internet, make sales, ship goods (fast), and help with bookkeeping and marketing. All for a quite reasonable price, we might add. If that wasn't enough of a sales pitch, consider this: you can now pick up shares at a 63% discount to their 52-week high of $1,763. But should you? This is yet another case of a company reporting strong earnings, but issuing guidance which spooked the market. Against expectations for $1.34 billion in sales for the quarter, the company reported revenue of $1.38 billion. Earnings also beat, with the company netting a profit of $1.36 per share (yes, they are actually operating in the black). For the full year, Shopify generated $4.6 billion in revenue, improving on 2020's sales by 57%. Impressive. Two concerns weighed on investor sentiment, however. First, can the company possibly keep up the impressive rate of growth it enjoyed during the pandemic? Secondly, investors are concerned about how much it is going to cost to build the company's massive American distribution system, known as the Shopify Fulfillment Network. The ultimate goal is to deliver good from its merchants to their respective customers within two days, competing head-to-head with Amazon Prime. The company is expected to spend around $1 billion over the next two years to build out key warehouse hubs in the United States (Shopify is a Canadian company). The key question is whether or not management can effectively deploy the capital needed to complete the project. Dour investors voted with their capital this past week, sending the shares reeling.
Again, we don't currently own the company right now. That being said, we do believe in the management team, and we could see the shares doubling in price if 2022 shapes up like we expect it to. The financials look exceptional, and the company is sitting on a war chest of nearly $8 billion. A conservative fair value of $1,000 per share seems appropriate.
Strategies & Tactics: Behavioral Finance
The Russia/Ukraine brouhaha is a rallying cry for Ukrainians, a wake-up call to Europeans, and an opportunity for investors
Will they? Won't they? That is the question being asked incessantly on the news channels. The question is missing the point: Russia has, in essence, already invaded Ukraine. After all, the country forcefully took the almost-island (it is connected to Ukraine by a tiny isthmus) of Crimea back in 2014, annexing it as Russian territory; it is fomenting constant fighting in the Donbas region of southeastern Ukraine; and it has unleashed a cyberwar on its western neighbor. Yes, a ground invasion would bring about a multitude of deaths (14,000 have already died in the Donbas region of Donetsk and Luhansk, where Russian-speaking separatists—provided with Russian arms—have been fighting government forces), but the real threat is to Putin himself, not the markets. The dictator has painted himself into a corner, despite his belief that he holds all the cards.
Germany, thanks to Merkel's full-throated and myopic cheerleading for Russian gas flowing into the country (roughly 50% of demand), is certainly in a precarious situation as it scrambles for new suppliers. And the sanctions which would follow a ground invasion would send oil above $100 per barrel. But from a US market perspective, this threat is far less ominous than the one posed by a global pandemic we knew little about back in March of 2020. That spring turned out to be one of the best buying opportunities since the fall and winter of 1987. The press is doing its best to keep anxiety high, but Putin will be the real loser in this game of chicken, not the US stock market.
The major indexes finished the week down—their fifth losing week of the last seven, and the downturn has created some real opportunities to pick up some of those wish list stocks on the cheap. Granted, many tech names were strongly overvalued, but the likes of Adobe (ADBE), Uber (UBER), PayPal (PYPL), and Generac (GNRC) fell to levels investors would have drooled over last fall. Now is the time to discount the headlines and search for some premium names to buy.
Just as we did in March and April of 2020, we pulled out our own wish list of stocks which have dropped below our target buy price. Take a look at portfolio allocations and see which promising sectors and industries have become underweighted and plug in some good names. Let the headlines rattle others into wanton selling; the crisis in Eastern Europe does not pose a major threat to fundamentally sound, cash-flow-generating American companies—it has created a tactical opportunity which will become clear to others over the coming months.
Under the Radar Investment
Rogers Sugar (RSI.TO $6)
We were not picky, we just wanted a: small-cap defensive stock with a great dividend yield and low risk level (as measured by beta) to add to our international opportunities fund. Simple, right? We actually found what we were looking for in Vancover-based Rogers Sugar Inc. This $607 million company was established in 1890 by B.T. Rogers, who was trying to solve the problem of the high cost of transporting refined sugar by rail from Montreal to Vancouver. Strategically located to access raw sugar shipments from the Pacific and send refined sugar to Canada's western population centers, the company was the first major non-logging or fishing industry in the region. Today, the company refines, packages, and markets sugar and maple products to industrial customers and consumers throughout Canada and the United States. Rogers has a P/E ratio of 12, a tiny price-to-sales ratio of 0.761, and a dividend yield of 6.15%. Shares closed the week at $5.85.
Answer
The four presidents were chosen for their significant contribution to the founding, expansion, preservation, and unification of the United States:
- George Washington was chosen as he was the Founding Father of the nation
- Thomas Jefferson was chosen to represent expansion, as the author of the Declaration of Independence and the promoter/signer of the Louisiana Purchase (which doubled the size of the US)
- Theodore Roosevelt was chosen because he represented conservation (he established 150 national forests, 50 federal bird reserves, 4 national game preserves, 5 national parks, and 18 national monuments on over 230 million acres of newly-protected land)
- Abraham Lincoln was chosen for leading the United States through the bloody Civil War and his belief that the nation "must be preserved at any cost."
Headlines for the Week of 30 Jan 2022 — 05 Feb 2022
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Whose GDP is this anyway?..
America has, far and away, the world's largest GDP, currently at $23 trillion. China comes in second, at $17 trillion. But there is an interesting aspect to a nation's gross domestic product which we seldom take into consideration. Consider this question: If an American firm has $100 billion in revenue in one year, but $50 billion worth of that firm's products were sourced, assembled, and packaged in China, is the full $100 billion still added to US GDP? Hint: it doesn't matter where the products were sold.
Penn Trading Desk:
Penn: Power generation: The past meets the future in one company
We have removed FedEx (FDX $246) from the Penn Global Leaders Club and added a legacy power generation company which is embracing the future of the industry. We are very bullish on this well-known mid-cap stalwart, and have placed a price target on the shares 96% above our purchase price.
Penn: Add lower beta telecom player to the Strategic Income Portfolio
We continue to make moves in preparation for six to eight inevitable rate hikes over the next two years. To that end, we have replaced a bond fund in the Strategic Income Portfolio with a fat-yielding and undervalued equity position. Guard your fixed income holdings carefully in this environment.
Penn: Close Baird Aggregate Bond Fund in Strategic Income Portfolio
The Baird Aggregate Bond Fund (BAGSX $12) is the fund referenced above which we have liquidated. With around 1,500 securities, allocated about equally between government, corporate, and securitized notes, it is well diversified; however, its intermediate nature and effective duration of seven concerns us as we move into an interest rate hike cycle. Closed to purchase new position.
Penn: Add Natural Resources Fund to Dynamic Growth Strategy
Executing on one of our themes for 2022, the need to own "real assets" in the face of growing inflation, we have added a global upstream natural resources ETF to the Dynamic Growth Strategy. This investment focuses on real assets within five upstream industries: Energy, Metals, Agriculture, Timber, and Water.
Penn: Close XLC in Dynamic Growth Strategy
To make room for our natural resources holding, we closed our 3% position in XLC, the Communication Services Select Sector SPDR, and shaved 1% from each of our two health care positions, placing 5% in the new holding.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Media & Entertainment
10. Microsoft is making an enormous bet on the future of gaming, and it aims to be the dominant player*
We are not sure how many times the world’s second largest company (by market cap), Microsoft (MSFT $295), can successfully reinvent itself, but all we can say is thank goodness Satya Nadella is at the helm rather than the “scholarly” Bill Gates. Not one to rest on its laurels or legacy products and services, the $2.3 trillion company just made its biggest purchase ever, and signaled its intent to embrace the future of gaming and the metaverse. With its $95 per share ($68.7B) purchase of Activision Blizzard (ATVI $81), Microsoft will leapfrog over a number of players to become the third-largest gaming company in the world by revenue, behind only Tencent Holdings and Sony (SONY $112). Once the deal is complete, Microsoft plans to fold as many of Activision's hugely-popular games into its Game Pass subscription, which boasts some 25 million paying subscribers. These include: World of Warcraft, Call of Duty, and Candy Crush. While the Game Pass numbers are impressive, they pale in comparison to Activision Blizzard's 400 million monthly active users; talk about a lucrative prospect list. Yes, the deal is going to face headwinds via a suddenly hostile FTC and DoJ, not to mention the always-hostile (against US firms) EU regulators, but we expect it to ultimately be approved.
Sony may end up being the odd player out, as the company's main console competitor will take ownership of PlayStation's most popular content, like Call of Duty. Accordingly, Sony shares plunged double digits following the announcement. Microsoft is a longstanding member of the Penn Global Leaders Club. (Update: Sony has subsequently announced its plans to acquire Halo and Destiny creator Bungie in a $3.6 billion deal. It should be noted that the Halo franchise itself is owned by Microsoft and is not available on the PlayStation.)
Media & Entertainment
09. Take-Two Interactive Software to buy Zynga in a $12.7 billion deal
Take-Two Interactive Software (TTWO $143), the $16 billion maker of such online games as "Grand Theft Auto" and "Red Dead Redemption," announced plans to buy mobile gaming developer Zynga (ZNGA $8) in a $12.7 billion deal. Zynga shareholders will receive $3.50 in cash and $6.36 in stock, or just shy of $10 per share. Not bad, considering Zynga shares were trading at $6 prior to the deal's announcement. The acquisition is part of a major push by Take-Two's outstanding CEO, Strauss Zelnick, to increase the company's footprint in the lucrative world of mobile gaming. According to WedBush analyst Michael Pachter, the deal should move the company's product mix from 10% mobile (gaming) to over 50% mobile, making it a major player in the space for the first time. Zynga generated $2 billion in revenue in 2020 and $2.7 billion in revenue over the trailing twelve months, yet it recorded a net loss of $90 million TTM.
With the deal, Take-Two should find itself in a better position to compete with larger rivals like Electronic Arts (EA $129). While we like the move, opinions on the Street are quite mixed. We would value TTWO shares at $200, or 40% higher from here, while our favorite player was Activision Blizzard, which we will soon own (pending approval) via our Microsoft holding.
Bear Market Chatter
08. Permabear Jeremy Grantham says stocks are in a superbubble, sees benchmark falling nearly 50%*
We are not a fan of permabears—individuals who chronically predict that the stock market sky is falling. We liken them to the man who had engraved on his tombstone, “I told you I was sick.” When major corrections do manifest, they are always there to take credit for “bravely” making the calls while the world fiddled. This leads us to Jeremy Grantham, the British billionaire investor and co-founder of GMO, a Boston-based asset management firm. Grantham has reissued his proclamation, first expressed before last year’s massive market run-up, that we are in the fourth superbubble of the past 100 years—the last three being the Stock Market Crash of 1929, the dot-com bubble of 2000, and the financial meltdown of 2008. Just how much does Grantham predict the markets will fall? For the S&P 500, on which we have a year-end price target of 5,100, he is calling for a level around 2,500. That would represent just shy of a 50% drop from its early January peak. As was the case with the tech bubble burst, he believes the drop could be substantially greater for the NASDAQ. In dollars and cents, Grantham notes, this could equate to the loss of some $35 trillion worth of wealth. While we actually agree with some of the rationale for his doomsday call (irresponsible fiscal and investor behavior, for the most part), we don't agree with his conclusion. Corrections have a way of sobering investor sentiment, and the lack of pullbacks since March of 2020 have led to overconfidence in high-flying equities with little to show in the way of earnings. We are due a normal, natural, garden variety downturn—the kind we used to get quadrennially; but nothing to the extent which Grantham is predicting.
America’s $30 trillion national debt and annual budget-busting deficits are another story. In that respect, we do believe the piper will have to be paid one of these days; just not in 2022.
National Debt
07. The national debt, Fed balance sheet, budget deficit, and GDP: a quick and dirty guide
When the terms national debt, budget deficit, Fed balance sheet, and GDP are thrown around, we suspect that many Americans' eyes tend to gloss over. However, just as every American family should know its financial position at any point in time, it is our duty to understand the basics of how the government is spending our money. Spoiler alert: it is not pretty. Let's start with the national debt, the most eye-popping of figures. As of right now, per USDebtClock.org, the United States is indebted to the tune of $30 trillion. We have been hearing a lot about the Fed's balance sheet lately, which currently adds up to just shy of $9 trillion. The "good news" is that this amount, which is a combination of mostly Treasuries and mortgage-backed securities, is included in the $30 trillion national debt. The Fed has already begun tapering its massive spending program, and aims to actually begin reducing that $9 trillion this year. Per a recent CNBC business survey, the general consensus is that the Fed should be able to reduce its balance sheet by $2.8 trillion over three years, which would bring the total down to roughly $6 trillion. Sadly, that is still well ahead of the $4.3 trillion on its books just prior to the pandemic.
So, this means that our federal debt should be reduced by $3 trillion as well, right? Not exactly. The government has estimated that it will receive $4.2 trillion in revenue in fiscal 2022. Unfortunately, the nonpartisan Congressional Budget Office predicts that, out of the $4.2 trillion in revenue, the government will actually spend approximately $6 trillion. This is fully legal, as there is no "balanced budget" amendment in the US Constitution. This means that, in one single year, the United States will have a budget deficit of $1.8 trillion, more that offsetting the Fed's planned balance sheet reduction. Of course, interest must be paid on any debt load ("servicing the debt"). A full 7.3% of all revenue collected by the US government, or some $305 billion, will be needed to service the national debt this year. And that is with historically-low interest rates. As interest rates rise, that 7.3% will grow, and grow, and grow.
Gross Domestic Product, or GDP, measures the total value of goods and services produced in a country in a single year. For the United States, that figure is sitting right at $23 trillion—far ahead of second place you-know-who, and certainly the envy of the world. The debt-to-GDP ratio is easily determined by dividing the amount of debt a country owes by the amount of its GDP in a given year. For historical perspective, America's debt-to-GDP ratio at the time of the Stock Market Crash of 1929 was 16%; upon entering World War II it was 44%; during the 1973 oil embargo it was 33%; and during the 9/11 attacks it was 55%. In 2012, something ominous happened; an economic "death cross," if you will. That is the year our national debt overtook—chronically and perennially—our GDP. Right now, America's debt-to-GDP ratio sits at 130%, and projections have that figure steadily rising over the coming years. For comparison, Venezuela's ratio is 214% and the United Kingdom's is 85%. China's debt-to-GDP ratio in 2021, according to the IMF, was roughly 70%. That country has responded by growing its spending by the weakest rate (0.3% y/y) in nearly two decades—a feat much more easily accomplished in a one-party communist dictatorship than in a representative republic.
And there we have it: a quick and dirty guide to federal debt, balance sheets, budget deficits, and GDP. Understanding these numbers and ratios is the first step in solving the problem. The next step is actually admitting that these numbers represent an unacceptable condition and will ultimately lead to an existential national threat. The third and fourth steps involve brainstorming for solutions and then implementing actions which will increase income and reduce expenditures. It is time to hold those in charge of the national credit cards accountable for their actions, and to demand more responsible behavior. But that would take yet another "stick" (in addition to a balanced budget amendment) in the form of mandatory term limits.
Consumer Electronics
06. A shot in the arm to a battered market: Apple delivers a blowout quarter
It has certainly been an ugly month for stocks, especially the formerly high-flying NASDAQ. That benchmark suddenly finds itself in correction territory and just three percentage points away from a bear market—down 17% from its November, 2021 highs. Fortunately, the index's top holding, Apple (AAPL $168), just came riding to the rescue. Despite facing severe parts shortages which have hampered production, the company shattered its old record by generating $123.9 billion in revenue in the last quarter of 2021, with $34.6 billion of that flowing down as pure profit. Analysts had lofty goals for the company's quarter; those estimates were easily surpassed. Apple's leading revenue generator, the iPhone, accounted for $71.6 billion of revenue—up 9.2% from the same period last year, while services revenue rose 23.8%, to $19.5 billion. Perhaps the biggest surprise came from Mac sales, which grew 25% from a year ago. While Mac accounts for just 10% of revenue, the move to an internally-produced M1 chip (dumping Intel's products) seems to have been a brilliant move. Geographically, sales grew robustly in every region. Despite America's ongoing trade disputes with China, Apple's $25.8 billion in sales from that country represented a 21% jump from last year. Morningstar analysts must have been impressed, as they raised their fair value on AAPL shares from $124 to $130 (insert eye rolling emoji here).
There are very few remaining "buy and hold" companies out there, as lackluster "managers" have taken over many of the offices where visionaries once sat. (Boeing, McDonald's, and Disney immediately come to mind.) Granted, were Steve Jobs still around we might have a few more super-cool gadgets to play with right now, but Tim Cook has been masterful at the helm. While Jobs wouldn't be happy with the Apple TV in its current form (he claimed to have "broken the TV code" shortly before his demise), the company is working on a number of exciting projects—like AR/VR hardware—which will help fuel future growth. A recurring stream of revenue from the company's 785 million subscribers (up 165 million from a year ago) doesn't hurt, either. Don't listen to the vacillating analysts—hold your Apple shares.
Application & Systems Software
05. Bakkt Holdings: Talk about a really, really bad time to go public
In August of 2018, the Intercontinental Exchange (ICE $124) formed a new company called Bakkt (pron. "backed," as in asset-backed securities) designed to give consumers, businesses, and institutions the ability to make transactions with digital assets such as cryptos, airline miles, and gift cards. The idea made sense: one simple digital wallet to securely transact with and store one's digital assets on an advanced app. ICE decided to take its creation public via a SPAC (uh oh, first sign of trouble) back in October of last year under the symbol BKKT. Before the month was up, a deal was announced between Mastercard (MA $383) and Bakkt Holdings which would allow the second-largest payments processor in the world to offer and accept crypto payments using the tech company's platform. BKKT shares skyrocketed over 500% virtually overnight, from around $8 to an intraday high of $50.80 on the first day of November. Investors should have taken that insane spike as an excuse to put a stop-loss on their position, if not selling it outright and waiting for it to fall back to earth. And fall back it did, riding the tech correction all the way down. The $2 billion company is now worth $195 million, and its shares have "rallied" back up to $3.61 as of Friday's close. The chart, quite frankly, looks like something out of the 1999 to 2001 timeframe. One difference: we do expect this tech company to stick around, unlike so many from that era.
For anyone just discovering this micro-cap tech infrastructure play, is it worth nibbling at after its massive fall? Only with money that wouldn't be missed, and certainly with a stop-loss order in place. Morningstar has a fair value of $6.41 on the shares.
Goods & Services
04. Another argument for rate hikes and Fed balance sheet reduction: Q4's strong GDP figures
Much of January's market correction could be placed at the feet of the Fed's well-telegraphed pending rate hikes, but does the American economy really need near-zero interest rates any longer to sustain growth? Not according to one very important economic metric. Fourth quarter GDP numbers are in, and they easily surpassed all expectations. Against economists' predictions calling for a growth rate of 5.5% annualized in Q4, the aggregate of all goods and services produced in the US for the last three months of the year actually grew by 6.9%. With four quarters now in the books, we have our preliminary read on 2021's US GDP: 5.7%. How good is that? The figure is over double the ten-year average growth rate of 2.47%, and represents the strongest full year growth since 1984. Impressively, the gains were brought about by a dual springboard of higher consumer activity and increased business spending—all while government spending decreased. Considering the supply chain issues which hampered growth in the fourth quarter, we see economic growth remaining strong throughout 2022 as these issues slowly abate.
The United States accounts for 25% of the world's $95 trillion economy, with China coming in second place at 17% (See graph). It is interesting to note that we have passed the date by which many economists and business journalists told us that China would surpass America as the world's largest economy. Of course, they made these projections based on the faulty logic that an emerging market economy could sustain a double-digit growth rate as its economy grew. Additionally, with global companies finally diversifying their country risk away from China, that imaginary no-later-than date has been moved out even further.
Aerospace & Defense
03. Now that the heavy hand of the government has come down on the deal, what happens to Aerojet Rocketdyne?
We are invested in this story, literally. Lockheed Martin (LMT $387) is a longstanding member of the Penn Global Leaders Club and one of our top picks for 2022; Aerojet Rocketdyne (AJRD $38) is a member of the Penn New Frontier Fund and a key US supplier of aerospace and defense systems—to include highly-advanced hypersonic propulsion technology. In a move that made brilliant sense, the former agreed to buy the latter back in December of 2020 for the equivalent of $56 per share, or $4.4 billion. Now, the Darth Vader of American business, the Federal Trade Commission's Lina Khan, is suing to block the deal. (Well, the FTC is suing, but this was obviously spearheaded by the anti-business—in our opinion—new chair of the Commission). Khan, who received her J.D. from Yale just five years ago and was a law professor at Columbia University before accepting the FTC position, has clearly signaled her disdain for large American corporations. The FTC claims that Lockheed would use its control of Aerojet to hurt its rivals, but can the purchase of one small-cap rocket maker really put the industry in tumult? Of course not. Furthermore, it is highly likely that a European firm would swoop in and buy AJRD without the FTC lifting a finger. If Lockheed's ownership of the company would affect the competitive landscape for the defense industry, wouldn't foreign ownership be even worse? We knew Khan would do her best to wreak havoc on the American business landscape; consider this the first shot of many more to come.
We would like to say that the combination of Aerojet Rocketdyne's critical technology and recent share price plummet equates to a unique opportunity for investors, but something else is going on within the company which concerns us. There is a battle forming between the company's innovative leadership team, led by CEO Eileen Drake, and an activist movement spearheaded by private equity investor and Executive Chairman Warren Lichtenstein. We believe that Drake, a distinguished graduate of the US Army Aviation Officer School, is intent on maintaining industry leadership for a standalone Aerojet, while Lichtenstein, true to his nature, is intent on engineering a takeover of the firm by another player. Our hopes are that Drake prevails, but the internecine battle could cause further damage to the share price.
Interactive Media & Services
02. Alphabet's blowout quarter and a 20-for-1 stock split makes the company look even more attractive
The $2 trillion holding company of Google, Alphabet (GOOG $2,961), just announced its best quarter ever, easily blowing away pretty hefty expectations for the period. Analysts had predicted revenues of $72.3 billion and earnings of $27.68 per share; instead, the company reported Q4 revenues of $75.3 billion and EPS of $30.69. As if that weren't enough, CFO Ruth Porat announced plans for a 20-for-1 stock split, making the company more attractive to a wider swath of investors and raising the odds that it will soon be included in the Dow Jones Industrial Average. The revenue windfall amounted to a 32% increase from the same quarter last year, and was buoyed by advertising sales of $61 billion. The company's YouTube business, which boasts some 15 billion views per day, accounted for $8.63 billion in sales. The company is far and away the hottest destination for digital advertising dollars, which accounts for some 80% of total revenue, but it also wants to diversify its offerings. Although it barely makes a mark in the lucrative cloud computing business, an area dominated by Amazon Web Services and Microsoft Azure, the company is investing heavily to grow its 6% stake. Google has tapped into its over $140 billion stash of cash, for example, to buy an equity stake in Chicago-based exchange CME Group (CME $241) in return for the company's long-term cloud contracts. This seems like a natural arena for the Internet media giant, and the cloud services pie is only getting bigger. As for other opportunities to widen its scope, recall that Google changed its name to Alphabet for a reason. From the metaverse to self-driving vehicles (it bought autonomous driving tech company Waymo in 2016), we expect the skilled team of CEO Sundar Pichai and CFO Ruth Porat to continue generating stunning quarterly results for investors.
We have figuratively banged our heads against the wall trying to explain to certain clients over the years that just because a stock is priced at $10 per share, it is no more undervalued (all other facets being equal) than if the shares were selling for $10,000 apiece. Nonetheless, while the stock split will not add one cent of value, we do applaud the move. Psychology is a powerful tool to use when analyzing investor behavior. Based on the company's current share price, it would be trading around $150 per share were the split completed today. Rather than saying Google shares are worth $6,000 each, let's just say we could see them growing from $150 to $300 in a reasonable amount of time post split.
Market Pulse
01. As goes January, so goes the year? Hopefully not
Even with a nice rally on the final trading day of the month, January was messy. In fact, it turned out to be the worst start to a year since the global financial crisis. For tech stocks, as benchmarked by the NASDAQ, it was even worse: the index had its second-poorest opening month of the year since its inception. But even the NASDAQ performed better than the small caps, which briefly entered bear market territory with their 20.94% drop from November highs. (The NASDAQ skirted a bear market, missing by three percentage points.) It was not quite as bad for the Dow and S&P 500, which fell as much as 7% and 10% from their highs, respectively. Was the month just a blip following a strong year, or do we believe the old "as goes January, so goes the month" adage?
Let's begin by analyzing the catalysts—other than a strong preceding year—for the downturn. Overwhelmingly, it was the Fed (rate hikes), the Russians (potential invasion of the Ukraine), and concerns over weakening earnings. For the tech stocks which were pandemic darlings, sky-high valuations are being reevaluated as the global workforce moves back, albeit slowly, into the office environment. We know what has happened to the Peloton's of the market, but consider this: shares of DocuSign (DOCU $125) fell 60% from their high price, while Zoom Video (ZM $151) fell 76% from October highs. It was the worst overall month for the markets since March of 2020, which investors recall all too well. That period, however, turned out to be one of the best buying opportunities in the past decade. Time will tell whether or not January will have provided a similar opportunity.
While our buying spree is nothing like that of late spring/early summer of 2020, we have been picking up some deeply undervalued names. The selling was relatively indiscriminate, as witnessed by drops in the likes of Microsoft and Apple. While scouring for deals, look for companies with fat earnings, pricing and staying power, and nice dividend yields. Also, scan small-cap equities which are domestically focused; the drop in the Russell 2000 has presented some excellent buying opportunities. Finally, don't be afraid to put stop-loss orders on positions to protect gains or limit losses—there will be other chances to pick these companies back up at lower levels if warranted. And remember, cash is an asset class in which every investor should be allocated.
Under the Radar Investment
Mitsubishi Electric (MIELY $24)
We are bullish on Japanese equities in 2022, and have begun a top-down review of sectors, industries, and—subsequently—individual names based out of that country which we find attractive. One clear opportunity presents itself in $25 billion industrial firm Mitsubishi Electric. Think of the firm as the Japanese version of General Electric, without the milquetoast leadership (well, lack thereof) of the American firm. Founded 101 years ago, Mitsubishi is an electrical industrials conglomerate that develops, manufactures, distributes, and sells electrical equipment worldwide. With a low P/E ratio and beta, the company has annual sales of around $40 billion and perennially yields a fat net income. Going forward, we especially like the company's industrial automation systems division, which should play a major role in the global automation renaissance picking up steam. Mitsubishi also offers investors a decent dividend yield of 3%. We would give MIELY shares a fair value of $30.
Answer
Gross domestic product is the value of all goods and services produced in a country during one year. Therefore, if an American company produces goods at a foreign factory, the value of those goods adds to that country's GDP, not America's. Of course, the global supply chain is a complicated matter, as is clearly evident right now. An iPhone, for example, might be assembled in China, but with parts from around the world. Nonetheless, here is the point: Consider China's $17 trillion economy, and then consider what China's GDP would look like without foreign companies manufacturing their products within the country. The number is somewhat of an illusion.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Whose GDP is this anyway?..
America has, far and away, the world's largest GDP, currently at $23 trillion. China comes in second, at $17 trillion. But there is an interesting aspect to a nation's gross domestic product which we seldom take into consideration. Consider this question: If an American firm has $100 billion in revenue in one year, but $50 billion worth of that firm's products were sourced, assembled, and packaged in China, is the full $100 billion still added to US GDP? Hint: it doesn't matter where the products were sold.
Penn Trading Desk:
Penn: Power generation: The past meets the future in one company
We have removed FedEx (FDX $246) from the Penn Global Leaders Club and added a legacy power generation company which is embracing the future of the industry. We are very bullish on this well-known mid-cap stalwart, and have placed a price target on the shares 96% above our purchase price.
Penn: Add lower beta telecom player to the Strategic Income Portfolio
We continue to make moves in preparation for six to eight inevitable rate hikes over the next two years. To that end, we have replaced a bond fund in the Strategic Income Portfolio with a fat-yielding and undervalued equity position. Guard your fixed income holdings carefully in this environment.
Penn: Close Baird Aggregate Bond Fund in Strategic Income Portfolio
The Baird Aggregate Bond Fund (BAGSX $12) is the fund referenced above which we have liquidated. With around 1,500 securities, allocated about equally between government, corporate, and securitized notes, it is well diversified; however, its intermediate nature and effective duration of seven concerns us as we move into an interest rate hike cycle. Closed to purchase new position.
Penn: Add Natural Resources Fund to Dynamic Growth Strategy
Executing on one of our themes for 2022, the need to own "real assets" in the face of growing inflation, we have added a global upstream natural resources ETF to the Dynamic Growth Strategy. This investment focuses on real assets within five upstream industries: Energy, Metals, Agriculture, Timber, and Water.
Penn: Close XLC in Dynamic Growth Strategy
To make room for our natural resources holding, we closed our 3% position in XLC, the Communication Services Select Sector SPDR, and shaved 1% from each of our two health care positions, placing 5% in the new holding.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Media & Entertainment
10. Microsoft is making an enormous bet on the future of gaming, and it aims to be the dominant player*
We are not sure how many times the world’s second largest company (by market cap), Microsoft (MSFT $295), can successfully reinvent itself, but all we can say is thank goodness Satya Nadella is at the helm rather than the “scholarly” Bill Gates. Not one to rest on its laurels or legacy products and services, the $2.3 trillion company just made its biggest purchase ever, and signaled its intent to embrace the future of gaming and the metaverse. With its $95 per share ($68.7B) purchase of Activision Blizzard (ATVI $81), Microsoft will leapfrog over a number of players to become the third-largest gaming company in the world by revenue, behind only Tencent Holdings and Sony (SONY $112). Once the deal is complete, Microsoft plans to fold as many of Activision's hugely-popular games into its Game Pass subscription, which boasts some 25 million paying subscribers. These include: World of Warcraft, Call of Duty, and Candy Crush. While the Game Pass numbers are impressive, they pale in comparison to Activision Blizzard's 400 million monthly active users; talk about a lucrative prospect list. Yes, the deal is going to face headwinds via a suddenly hostile FTC and DoJ, not to mention the always-hostile (against US firms) EU regulators, but we expect it to ultimately be approved.
Sony may end up being the odd player out, as the company's main console competitor will take ownership of PlayStation's most popular content, like Call of Duty. Accordingly, Sony shares plunged double digits following the announcement. Microsoft is a longstanding member of the Penn Global Leaders Club. (Update: Sony has subsequently announced its plans to acquire Halo and Destiny creator Bungie in a $3.6 billion deal. It should be noted that the Halo franchise itself is owned by Microsoft and is not available on the PlayStation.)
Media & Entertainment
09. Take-Two Interactive Software to buy Zynga in a $12.7 billion deal
Take-Two Interactive Software (TTWO $143), the $16 billion maker of such online games as "Grand Theft Auto" and "Red Dead Redemption," announced plans to buy mobile gaming developer Zynga (ZNGA $8) in a $12.7 billion deal. Zynga shareholders will receive $3.50 in cash and $6.36 in stock, or just shy of $10 per share. Not bad, considering Zynga shares were trading at $6 prior to the deal's announcement. The acquisition is part of a major push by Take-Two's outstanding CEO, Strauss Zelnick, to increase the company's footprint in the lucrative world of mobile gaming. According to WedBush analyst Michael Pachter, the deal should move the company's product mix from 10% mobile (gaming) to over 50% mobile, making it a major player in the space for the first time. Zynga generated $2 billion in revenue in 2020 and $2.7 billion in revenue over the trailing twelve months, yet it recorded a net loss of $90 million TTM.
With the deal, Take-Two should find itself in a better position to compete with larger rivals like Electronic Arts (EA $129). While we like the move, opinions on the Street are quite mixed. We would value TTWO shares at $200, or 40% higher from here, while our favorite player was Activision Blizzard, which we will soon own (pending approval) via our Microsoft holding.
Bear Market Chatter
08. Permabear Jeremy Grantham says stocks are in a superbubble, sees benchmark falling nearly 50%*
We are not a fan of permabears—individuals who chronically predict that the stock market sky is falling. We liken them to the man who had engraved on his tombstone, “I told you I was sick.” When major corrections do manifest, they are always there to take credit for “bravely” making the calls while the world fiddled. This leads us to Jeremy Grantham, the British billionaire investor and co-founder of GMO, a Boston-based asset management firm. Grantham has reissued his proclamation, first expressed before last year’s massive market run-up, that we are in the fourth superbubble of the past 100 years—the last three being the Stock Market Crash of 1929, the dot-com bubble of 2000, and the financial meltdown of 2008. Just how much does Grantham predict the markets will fall? For the S&P 500, on which we have a year-end price target of 5,100, he is calling for a level around 2,500. That would represent just shy of a 50% drop from its early January peak. As was the case with the tech bubble burst, he believes the drop could be substantially greater for the NASDAQ. In dollars and cents, Grantham notes, this could equate to the loss of some $35 trillion worth of wealth. While we actually agree with some of the rationale for his doomsday call (irresponsible fiscal and investor behavior, for the most part), we don't agree with his conclusion. Corrections have a way of sobering investor sentiment, and the lack of pullbacks since March of 2020 have led to overconfidence in high-flying equities with little to show in the way of earnings. We are due a normal, natural, garden variety downturn—the kind we used to get quadrennially; but nothing to the extent which Grantham is predicting.
America’s $30 trillion national debt and annual budget-busting deficits are another story. In that respect, we do believe the piper will have to be paid one of these days; just not in 2022.
National Debt
07. The national debt, Fed balance sheet, budget deficit, and GDP: a quick and dirty guide
When the terms national debt, budget deficit, Fed balance sheet, and GDP are thrown around, we suspect that many Americans' eyes tend to gloss over. However, just as every American family should know its financial position at any point in time, it is our duty to understand the basics of how the government is spending our money. Spoiler alert: it is not pretty. Let's start with the national debt, the most eye-popping of figures. As of right now, per USDebtClock.org, the United States is indebted to the tune of $30 trillion. We have been hearing a lot about the Fed's balance sheet lately, which currently adds up to just shy of $9 trillion. The "good news" is that this amount, which is a combination of mostly Treasuries and mortgage-backed securities, is included in the $30 trillion national debt. The Fed has already begun tapering its massive spending program, and aims to actually begin reducing that $9 trillion this year. Per a recent CNBC business survey, the general consensus is that the Fed should be able to reduce its balance sheet by $2.8 trillion over three years, which would bring the total down to roughly $6 trillion. Sadly, that is still well ahead of the $4.3 trillion on its books just prior to the pandemic.
So, this means that our federal debt should be reduced by $3 trillion as well, right? Not exactly. The government has estimated that it will receive $4.2 trillion in revenue in fiscal 2022. Unfortunately, the nonpartisan Congressional Budget Office predicts that, out of the $4.2 trillion in revenue, the government will actually spend approximately $6 trillion. This is fully legal, as there is no "balanced budget" amendment in the US Constitution. This means that, in one single year, the United States will have a budget deficit of $1.8 trillion, more that offsetting the Fed's planned balance sheet reduction. Of course, interest must be paid on any debt load ("servicing the debt"). A full 7.3% of all revenue collected by the US government, or some $305 billion, will be needed to service the national debt this year. And that is with historically-low interest rates. As interest rates rise, that 7.3% will grow, and grow, and grow.
Gross Domestic Product, or GDP, measures the total value of goods and services produced in a country in a single year. For the United States, that figure is sitting right at $23 trillion—far ahead of second place you-know-who, and certainly the envy of the world. The debt-to-GDP ratio is easily determined by dividing the amount of debt a country owes by the amount of its GDP in a given year. For historical perspective, America's debt-to-GDP ratio at the time of the Stock Market Crash of 1929 was 16%; upon entering World War II it was 44%; during the 1973 oil embargo it was 33%; and during the 9/11 attacks it was 55%. In 2012, something ominous happened; an economic "death cross," if you will. That is the year our national debt overtook—chronically and perennially—our GDP. Right now, America's debt-to-GDP ratio sits at 130%, and projections have that figure steadily rising over the coming years. For comparison, Venezuela's ratio is 214% and the United Kingdom's is 85%. China's debt-to-GDP ratio in 2021, according to the IMF, was roughly 70%. That country has responded by growing its spending by the weakest rate (0.3% y/y) in nearly two decades—a feat much more easily accomplished in a one-party communist dictatorship than in a representative republic.
And there we have it: a quick and dirty guide to federal debt, balance sheets, budget deficits, and GDP. Understanding these numbers and ratios is the first step in solving the problem. The next step is actually admitting that these numbers represent an unacceptable condition and will ultimately lead to an existential national threat. The third and fourth steps involve brainstorming for solutions and then implementing actions which will increase income and reduce expenditures. It is time to hold those in charge of the national credit cards accountable for their actions, and to demand more responsible behavior. But that would take yet another "stick" (in addition to a balanced budget amendment) in the form of mandatory term limits.
Consumer Electronics
06. A shot in the arm to a battered market: Apple delivers a blowout quarter
It has certainly been an ugly month for stocks, especially the formerly high-flying NASDAQ. That benchmark suddenly finds itself in correction territory and just three percentage points away from a bear market—down 17% from its November, 2021 highs. Fortunately, the index's top holding, Apple (AAPL $168), just came riding to the rescue. Despite facing severe parts shortages which have hampered production, the company shattered its old record by generating $123.9 billion in revenue in the last quarter of 2021, with $34.6 billion of that flowing down as pure profit. Analysts had lofty goals for the company's quarter; those estimates were easily surpassed. Apple's leading revenue generator, the iPhone, accounted for $71.6 billion of revenue—up 9.2% from the same period last year, while services revenue rose 23.8%, to $19.5 billion. Perhaps the biggest surprise came from Mac sales, which grew 25% from a year ago. While Mac accounts for just 10% of revenue, the move to an internally-produced M1 chip (dumping Intel's products) seems to have been a brilliant move. Geographically, sales grew robustly in every region. Despite America's ongoing trade disputes with China, Apple's $25.8 billion in sales from that country represented a 21% jump from last year. Morningstar analysts must have been impressed, as they raised their fair value on AAPL shares from $124 to $130 (insert eye rolling emoji here).
There are very few remaining "buy and hold" companies out there, as lackluster "managers" have taken over many of the offices where visionaries once sat. (Boeing, McDonald's, and Disney immediately come to mind.) Granted, were Steve Jobs still around we might have a few more super-cool gadgets to play with right now, but Tim Cook has been masterful at the helm. While Jobs wouldn't be happy with the Apple TV in its current form (he claimed to have "broken the TV code" shortly before his demise), the company is working on a number of exciting projects—like AR/VR hardware—which will help fuel future growth. A recurring stream of revenue from the company's 785 million subscribers (up 165 million from a year ago) doesn't hurt, either. Don't listen to the vacillating analysts—hold your Apple shares.
Application & Systems Software
05. Bakkt Holdings: Talk about a really, really bad time to go public
In August of 2018, the Intercontinental Exchange (ICE $124) formed a new company called Bakkt (pron. "backed," as in asset-backed securities) designed to give consumers, businesses, and institutions the ability to make transactions with digital assets such as cryptos, airline miles, and gift cards. The idea made sense: one simple digital wallet to securely transact with and store one's digital assets on an advanced app. ICE decided to take its creation public via a SPAC (uh oh, first sign of trouble) back in October of last year under the symbol BKKT. Before the month was up, a deal was announced between Mastercard (MA $383) and Bakkt Holdings which would allow the second-largest payments processor in the world to offer and accept crypto payments using the tech company's platform. BKKT shares skyrocketed over 500% virtually overnight, from around $8 to an intraday high of $50.80 on the first day of November. Investors should have taken that insane spike as an excuse to put a stop-loss on their position, if not selling it outright and waiting for it to fall back to earth. And fall back it did, riding the tech correction all the way down. The $2 billion company is now worth $195 million, and its shares have "rallied" back up to $3.61 as of Friday's close. The chart, quite frankly, looks like something out of the 1999 to 2001 timeframe. One difference: we do expect this tech company to stick around, unlike so many from that era.
For anyone just discovering this micro-cap tech infrastructure play, is it worth nibbling at after its massive fall? Only with money that wouldn't be missed, and certainly with a stop-loss order in place. Morningstar has a fair value of $6.41 on the shares.
Goods & Services
04. Another argument for rate hikes and Fed balance sheet reduction: Q4's strong GDP figures
Much of January's market correction could be placed at the feet of the Fed's well-telegraphed pending rate hikes, but does the American economy really need near-zero interest rates any longer to sustain growth? Not according to one very important economic metric. Fourth quarter GDP numbers are in, and they easily surpassed all expectations. Against economists' predictions calling for a growth rate of 5.5% annualized in Q4, the aggregate of all goods and services produced in the US for the last three months of the year actually grew by 6.9%. With four quarters now in the books, we have our preliminary read on 2021's US GDP: 5.7%. How good is that? The figure is over double the ten-year average growth rate of 2.47%, and represents the strongest full year growth since 1984. Impressively, the gains were brought about by a dual springboard of higher consumer activity and increased business spending—all while government spending decreased. Considering the supply chain issues which hampered growth in the fourth quarter, we see economic growth remaining strong throughout 2022 as these issues slowly abate.
The United States accounts for 25% of the world's $95 trillion economy, with China coming in second place at 17% (See graph). It is interesting to note that we have passed the date by which many economists and business journalists told us that China would surpass America as the world's largest economy. Of course, they made these projections based on the faulty logic that an emerging market economy could sustain a double-digit growth rate as its economy grew. Additionally, with global companies finally diversifying their country risk away from China, that imaginary no-later-than date has been moved out even further.
Aerospace & Defense
03. Now that the heavy hand of the government has come down on the deal, what happens to Aerojet Rocketdyne?
We are invested in this story, literally. Lockheed Martin (LMT $387) is a longstanding member of the Penn Global Leaders Club and one of our top picks for 2022; Aerojet Rocketdyne (AJRD $38) is a member of the Penn New Frontier Fund and a key US supplier of aerospace and defense systems—to include highly-advanced hypersonic propulsion technology. In a move that made brilliant sense, the former agreed to buy the latter back in December of 2020 for the equivalent of $56 per share, or $4.4 billion. Now, the Darth Vader of American business, the Federal Trade Commission's Lina Khan, is suing to block the deal. (Well, the FTC is suing, but this was obviously spearheaded by the anti-business—in our opinion—new chair of the Commission). Khan, who received her J.D. from Yale just five years ago and was a law professor at Columbia University before accepting the FTC position, has clearly signaled her disdain for large American corporations. The FTC claims that Lockheed would use its control of Aerojet to hurt its rivals, but can the purchase of one small-cap rocket maker really put the industry in tumult? Of course not. Furthermore, it is highly likely that a European firm would swoop in and buy AJRD without the FTC lifting a finger. If Lockheed's ownership of the company would affect the competitive landscape for the defense industry, wouldn't foreign ownership be even worse? We knew Khan would do her best to wreak havoc on the American business landscape; consider this the first shot of many more to come.
We would like to say that the combination of Aerojet Rocketdyne's critical technology and recent share price plummet equates to a unique opportunity for investors, but something else is going on within the company which concerns us. There is a battle forming between the company's innovative leadership team, led by CEO Eileen Drake, and an activist movement spearheaded by private equity investor and Executive Chairman Warren Lichtenstein. We believe that Drake, a distinguished graduate of the US Army Aviation Officer School, is intent on maintaining industry leadership for a standalone Aerojet, while Lichtenstein, true to his nature, is intent on engineering a takeover of the firm by another player. Our hopes are that Drake prevails, but the internecine battle could cause further damage to the share price.
Interactive Media & Services
02. Alphabet's blowout quarter and a 20-for-1 stock split makes the company look even more attractive
The $2 trillion holding company of Google, Alphabet (GOOG $2,961), just announced its best quarter ever, easily blowing away pretty hefty expectations for the period. Analysts had predicted revenues of $72.3 billion and earnings of $27.68 per share; instead, the company reported Q4 revenues of $75.3 billion and EPS of $30.69. As if that weren't enough, CFO Ruth Porat announced plans for a 20-for-1 stock split, making the company more attractive to a wider swath of investors and raising the odds that it will soon be included in the Dow Jones Industrial Average. The revenue windfall amounted to a 32% increase from the same quarter last year, and was buoyed by advertising sales of $61 billion. The company's YouTube business, which boasts some 15 billion views per day, accounted for $8.63 billion in sales. The company is far and away the hottest destination for digital advertising dollars, which accounts for some 80% of total revenue, but it also wants to diversify its offerings. Although it barely makes a mark in the lucrative cloud computing business, an area dominated by Amazon Web Services and Microsoft Azure, the company is investing heavily to grow its 6% stake. Google has tapped into its over $140 billion stash of cash, for example, to buy an equity stake in Chicago-based exchange CME Group (CME $241) in return for the company's long-term cloud contracts. This seems like a natural arena for the Internet media giant, and the cloud services pie is only getting bigger. As for other opportunities to widen its scope, recall that Google changed its name to Alphabet for a reason. From the metaverse to self-driving vehicles (it bought autonomous driving tech company Waymo in 2016), we expect the skilled team of CEO Sundar Pichai and CFO Ruth Porat to continue generating stunning quarterly results for investors.
We have figuratively banged our heads against the wall trying to explain to certain clients over the years that just because a stock is priced at $10 per share, it is no more undervalued (all other facets being equal) than if the shares were selling for $10,000 apiece. Nonetheless, while the stock split will not add one cent of value, we do applaud the move. Psychology is a powerful tool to use when analyzing investor behavior. Based on the company's current share price, it would be trading around $150 per share were the split completed today. Rather than saying Google shares are worth $6,000 each, let's just say we could see them growing from $150 to $300 in a reasonable amount of time post split.
Market Pulse
01. As goes January, so goes the year? Hopefully not
Even with a nice rally on the final trading day of the month, January was messy. In fact, it turned out to be the worst start to a year since the global financial crisis. For tech stocks, as benchmarked by the NASDAQ, it was even worse: the index had its second-poorest opening month of the year since its inception. But even the NASDAQ performed better than the small caps, which briefly entered bear market territory with their 20.94% drop from November highs. (The NASDAQ skirted a bear market, missing by three percentage points.) It was not quite as bad for the Dow and S&P 500, which fell as much as 7% and 10% from their highs, respectively. Was the month just a blip following a strong year, or do we believe the old "as goes January, so goes the month" adage?
Let's begin by analyzing the catalysts—other than a strong preceding year—for the downturn. Overwhelmingly, it was the Fed (rate hikes), the Russians (potential invasion of the Ukraine), and concerns over weakening earnings. For the tech stocks which were pandemic darlings, sky-high valuations are being reevaluated as the global workforce moves back, albeit slowly, into the office environment. We know what has happened to the Peloton's of the market, but consider this: shares of DocuSign (DOCU $125) fell 60% from their high price, while Zoom Video (ZM $151) fell 76% from October highs. It was the worst overall month for the markets since March of 2020, which investors recall all too well. That period, however, turned out to be one of the best buying opportunities in the past decade. Time will tell whether or not January will have provided a similar opportunity.
While our buying spree is nothing like that of late spring/early summer of 2020, we have been picking up some deeply undervalued names. The selling was relatively indiscriminate, as witnessed by drops in the likes of Microsoft and Apple. While scouring for deals, look for companies with fat earnings, pricing and staying power, and nice dividend yields. Also, scan small-cap equities which are domestically focused; the drop in the Russell 2000 has presented some excellent buying opportunities. Finally, don't be afraid to put stop-loss orders on positions to protect gains or limit losses—there will be other chances to pick these companies back up at lower levels if warranted. And remember, cash is an asset class in which every investor should be allocated.
Under the Radar Investment
Mitsubishi Electric (MIELY $24)
We are bullish on Japanese equities in 2022, and have begun a top-down review of sectors, industries, and—subsequently—individual names based out of that country which we find attractive. One clear opportunity presents itself in $25 billion industrial firm Mitsubishi Electric. Think of the firm as the Japanese version of General Electric, without the milquetoast leadership (well, lack thereof) of the American firm. Founded 101 years ago, Mitsubishi is an electrical industrials conglomerate that develops, manufactures, distributes, and sells electrical equipment worldwide. With a low P/E ratio and beta, the company has annual sales of around $40 billion and perennially yields a fat net income. Going forward, we especially like the company's industrial automation systems division, which should play a major role in the global automation renaissance picking up steam. Mitsubishi also offers investors a decent dividend yield of 3%. We would give MIELY shares a fair value of $30.
Answer
Gross domestic product is the value of all goods and services produced in a country during one year. Therefore, if an American company produces goods at a foreign factory, the value of those goods adds to that country's GDP, not America's. Of course, the global supply chain is a complicated matter, as is clearly evident right now. An iPhone, for example, might be assembled in China, but with parts from around the world. Nonetheless, here is the point: Consider China's $17 trillion economy, and then consider what China's GDP would look like without foreign companies manufacturing their products within the country. The number is somewhat of an illusion.
Headlines for the Week of 19 Dec — 25 Dec 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Best stock of 1999...
In some ways, 2021 reminds us of 1999. High-tech companies with a lack of profitability as far as the eye can see, speculative investments which seem impervious to fundamental analysis, new platforms bringing trading to the masses. Looking back to 1999, what would have been the best investment (outside of some goofy answer, like the Puerto Rican Cement Company—a high-flying penny stock back in the day) of that year? Hint: it not only still exists, but we own it within our strategies.
Penn Trading Desk:
Oppenheimer: Coinbase listed as a top stock pick for 2022
Oppenheimer has named Penn strategies member Coinbase (COIN $250) as one of its top picks for 2022. The company cited continued and widespread adoption of digital assets as a form of payment, both by retailers and institutions, as rationale for their rating. Coinbase, which is a member of the Penn Intrepid Trading Platform, is a major cryptocurrency exchange allowing for the purchase of hundreds of different cryptocurrencies, as well as the ability to make transactions with these currencies directly from the platform's digital wallet. Oppenheimer has an Outperform rating on the company with a price target of $444 on COIN shares—or 77% higher from here.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Telecommunication Services
10. US recommends approval of a massive Meta/Google undersea cable project in Asia; China is not amused
The Biden administration has recommended that the FCC grant Meta (FB $334) and Alphabet (GOOG $2,856) licenses to build a 12,000-kilometer-long (7,500 miles) network of undersea fiber optic cables spanning a number of Asian countries—sans China. The effort, known as Project Apricot, will connect Singapore, Japan, Guam, the Philippines, Taiwan, and Indonesia in an effort to bring reliable, high-speed Internet access to portions of the world both underserved and over-reliant on Communist China for their connectivity. The Apricot project will compliment Project Echo, connecting the US with Singapore, Guam, and Indonesia. The ultimate goal, according to Google VP of Global Networking Bikash Koley, is to create multiple (digital) paths in and out of Asia, and "increased resilience in connectivity between Southeast Asia, North Asia, and the United States." A previous joint project to build an undersea cable connecting California and Hong Kong was scrapped by Google and Meta—upon a US Department of Justice recommendation—due to US/Sino tensions. Technology, coupled with gutsy leadership, is making it harder for repressive regimes to constrict the free flow of information, thus controlling the narrative. Needless to say, Beijing is not happy with this project, which is slated to be completed by 2023.
The more China is backed into a corner, the more evident it will become to the free world precisely what the CCP's long-term goals are, and how incompatible they are with the pursuit of human freedom. The West may have a short memory, but we can count on China's ruling communist elites to keep stoking the fire. In the end, freedom always wins.
Renewables
09. Solar stocks are getting crushed on the back of new California proposals
Interesting, coming from the state which claims to be on the vanguard of societal evolution (smirk). The once-darling solar stocks, names like Sunrun (RUN $32), First Solar (FSLR $86), EnPhase Energy (ENPH $180), and SolarEdge Technologies (SEDG $263), have been plummeting since California proposed new rules which would make it more costly for families to put solar panels on their roofs. At the heart of the issue are the California utilities, which don't like the competition from the bourgeois middle class of the state who dare to generate their own household power. These utility concerns, working through the California Public Utilities Commission, wish to extort a monthly "grid fee" from anyone with the panels on their roofs, and they want to reduce the amount of payout for the power coming back to the grid from solar sources. While these recommendations must still be codified by state legislators, the threat was enough to sink the shares of major players. California-based Sunrun, for example, has seen its share price drop by two-thirds since January. One hopeful sign: the commissioner who penned the proposal will be leaving his post soon and won't be around to help bring it to fruition.
Here is the solution for homeowners: get off the grid by storing the solar power your panels collect in your own storage system. True, the needed efficiencies are not quite there yet, but we believe power storage will be the golden ticket for investors in this industry, and the nightmare for utility companies. In the energy storage space, Tesla's (TSLA $900) systems are hard to beat. We also like Johnson Controls (JCI $76), Enphase Energy, and Generac (GNRC $346). To take advantage of the industry without placing a big bet on any one player, the Invesco Solar ETF (TAN $74) may be the way to go. The ETF holds an eclectic group of 49 companies engaged in solar power production, storage, and infrastructure.
Semiconductors & Related Equipment
08. Our Micron position spikes nearly double digits on strong earnings report
We added leading US semiconductor and component maker Micron Technology (MU $90) to the Penn New Frontier Fund just under two months ago at $69.35, with an initial price target of $90. It didn't take long to reach that mark: shares of MU spiked nearly double digits on the morning following a stellar quarterly earnings report. Revenues rose 33% from a year ago, to $7.69 billion, while net income rose from $803 million in the fiscal first quarter of last year to $2.31 billion in the same quarter of this year. The company reported that revenue from dynamic random access memory chips, or DRAM, was up 38% from last year. DRAM chips, which provide low-cost and high-capacity memory, accounted for 73% of total revenue in the quarter; these are the critical chips which will power devices in the world of 5G and the Internet of Things. Chief Business Officer Sumit Sadana was highly bullish on Micron's future in the metaverse, which he said should provide the company with a "tremendous potential demand" going forward. Founded in 1978, Micron employs 43,000 workers and is headquartered in Boise, Idaho.
While it reached our target price much quicker than we expected, we are not considering trimming our position. With the global chip shortage, unprecedented demand on the horizon, and a domestic manufacturing capability, we expect Micron to be a shining star in the portfolio going forward.
Media & Entertainment
07. "Spider-Man: No Way Home" just had a blockbuster weekend; now, who will take home the profits?
When the dust settled, it was the second-largest opening weekend for a movie in cinematic history: "Spider-Man: Now Way Home" brought in $260 million in North American ticket sales alone, placing it behind only "Avengers: Endgame" in the record books. Globally, the news was equally good, with the film grossing $601 million in ticket sales around the world. Industry experts are now expecting the film to hit the $1 billion mark by the end of Christmas weekend. As for who gets the profits, recall that Sony (SONY $121) struck a deal with Marvel back in 1998 to buy the rights to the Spider-Man character, over a decade before Disney (DIS $151) paid $4 billion for the Marvel Cinematic Universe. Through a contorted series of moves since that deal, Sony and Disney came to the agreement—at least for this film—that the latter would provide 25% of the financing in return for 25% of the film's profits, in addition to the merchandising rights. To further muddy the waters, Sony has a previous deal with Netflix (NFLX $606) still in effect, meaning "No Way Home"—or any other Spider-Man movie—probably won't be coming to Disney+ until 2023. Nonetheless, both Sony and Disney should be pleased with their respective share of the profits on this third installment of the latest trilogy. And despite the word "trilogy," a fourth "Spider-Man" is already being planned.
Trying to sift through all of the legal wrangling between Sony and Disney over the years is enough to bring on a headache. Sadly, Disney is now being led by a CEO who is not, shall we say, a world-class negotiator. From an investment standpoint, we would rather own Sony, with its 18 P/E. As lovers of all things Disney, we await regime change at the firm.
Application & Systems Software
06. The Street was generally negative on Oracle's $28 billion purchase of Cerner, but we see potential
From a personal perspective, we hate to see another home-grown company get gobbled up by a much bigger competitor, but from an investment standpoint, does Oracle's (ORCL $92) $28.3 billion acquisition of Kansas City-based Cerner Corp (CERN $90) make sense? At first blush, the integration seems to have plenty of potential synergies. Cerner is a leading electronic health records company, operating in an industry—health information systems—which needs a serious dose of technology. We need look no further than our little white vaccination cards to figure that one out. (At least technology would have made it more difficult for Aaron Rodgers to "alter" his medical history.) Oracle is a $245 billion enterprise software company which developed the first commercial SQL-based relational database management system. It would make perfect sense that this pioneering company would want to buy the established leader in an industry with enormous growth potential. Investors may agree with that premise, but they apparently balked at the $95 per share price-tag, which represents a 25% premium to Cerner's recent trading range. In fact, prior to the announcement Cerner shares were trading around the same price they sat at four years ago, in October of 2017, when we sold them from the Global Leaders Club. Larry Ellison, the brilliant co-founder of Oracle and the company's chief technology officer, is clearly excited about the deal, which makes us feel even stronger about the potential for growth. "With this acquisition," Ellison said, "Oracle's corporate mission expands to...providing our overworked medical professionals with a new generation of easier-to-use digital tools...lowering the administrative workload, improving patient privacy and outcomes, and lowering overall health care costs." Noble goals, indeed.
With Oracle off nearly 10% on news of the acquisition, they are worth a look. We would place a fair value of $100 on the shares, but they should easily grow north of that if the company's plans for Cerner pan out. And for the record, we believe they will.
Capital Markets
05. Blackstone continues to collect real estate assets with purchase of Bluerock Group
There may a Flintstones joke somewhere in the headline, "Blackstone to buy Bluerock," but the $93 billion alternative asset manager has been on a serious mission to increase its real estate holdings recently, and few understand valuations better than Steve Schwarzman and his team. The company's latest acquisition involves a $3.6 billion deal to buy apartment REIT Bluerock Residential Growth, which owns some 30 multifamily rental communities with 11,000 units throughout the Sun Belt—hot growth areas such as Austin, Orlando, and Phoenix. It should be noted that Bluerock also has a portfolio of single-family rentals, which it will spin off to shareholders in the form of the Bluerock Homes Trust. In addition to this deal, Blackstone has already made three other buys thus far in 2021, all in areas we love going forward: industrial REIT WPT, data center REIT QTS Realty Trust, and a collection of student housing properties. Blackstone is one of the world's largest alternative asset managers, with $730 billion in assets under management, including $530 billion in fee-earning assets. The company has a reasonable P/E ratio of 18, and a nice yield of 2.89%—or 100 basis points higher than the current 30-year US Treasury yield.
The sale of Blackstone from the Strategic Income Portfolio several years ago turned out to be one of our most frustrating moves. We liquidated the position due to its status as a limited partnership, meaning it generated K-1s that clients often shy away from. Within months of our selling the position, Blackstone announced that it was converting from a partnership to a corporation. Perhaps we should have re-purchased at that time, but we didn't. At $130, BX shares seem fairly valued, and we expect them to hold up relatively well in what we predict will be a very choppy 2022.
Pharmaceuticals
04. Huge news in the fight against the pandemic: FDA clears two at-home Covid treatments
First it was Pfizer's (PFE $59) Paxlovid, then it was Merck's (MRK $76) molnupiravir, developed in partnership with Ridgeback Biotherapeutics. In the same week, the FDA gave us the news we have been waiting for: two at-home, anti-Covid therapies have been given emergency use authorization for use by Americans who have tested positive for the disease. In clinical trials, Pfizer's Paxlovid reduced the risk of Covid-related hospitalization or death by an impressive 89% if taken within the first three days of symptoms appearing; that percentage is reduced just one point—to 88%—if taken within the first five days. Despite lackluster results on Merck's antiviral treatment, which has been show to reduce hospitalizations and deaths by 30%, the FDA narrowly granted authorization to that treatment as well. Pfizer's treatment consists of three pills twice daily for five days (30 pills), while Merck's therapy consists of four pills twice daily for five days (40 pills). In a related story, France has cancelled a pre-order it had in for Merck's drug based on the disappointing trial results. While it will take time to ramp up production of Pfizer's Paxlovid, the Biden administration has already placed an order for ten million courses of the treatment.
Pfizer is a member of the Penn Global Leaders Club and one of our strongest-conviction stocks for 2022.
Global GDP & Debt
03. The world's $94 trillion economy, in one stunning graphic
Few things paint the story like a good visual, and this stunning graphic from Visual Capitalist proves that point. Here, in one snapshot, is a breakdown of which countries are most responsible for the world's production of goods and offering of services. Note that, despite the fact that we are several years beyond the forecast date (from the press) of China's economy surpassing that of America's, the United States still enjoys an economy that is one-third larger than its second-place rival. Pretty amazing, considering that virtually every item we pick up in the store has "Made in China" stamped somewhere on the packaging. In fact, the US accounts for nearly one-quarter of the world's GDP. While the US dominates the North American, China, to a lesser degree, dominates Asia. There are a number of factors we find of interest in the red section. Note how small India's GDP appears in relation to that of China's, despite the fact that both countries have approximately equal natural resources and populations (1.3 billion Indians vs 1.4 billion Chinese). It was just eleven years ago, in 2010, that China's economic might surpassed Japan's, despite the fact that the latter has a much smaller land mass and one-tenth the population of the former. China claims it controls the nation in the lower left portion of the red, Taiwan, and its $790 billion economy; it is a matter of time before they make a move on that country, forcing some type of American/global response. In the green section of the graphic, one notes how small Russia's economy looks, despite Putin's saber-rattling. Furthermore, around one-third of Russia's economy is energy based (and 60% of its exports), making it vulnerable to price fluctuations in related commodities such as gas and oil. Germany has the continent's largest economy, at $4.23 trillion, followed closely by the UK, France, and Italy. As geopolitical events occur around the world, it is useful to think back to this visual, as what it represents almost certainly plays the major role in the action taking place.
The world is slowly beginning to wake up to the danger of a Communist China playing such a major role in the world, both economically and militarily (though American military might—and Russian, for that matter—still dwarfs that country's arsenal). China's growth rate is already slowing, and we expect that to continue as the world's companies continue to mitigate country risk by building their factories in other Asian countries. Internal issues are the only reason that the world's largest democracy, India, cannot seem to gain more economic traction, but that is slowly changing. We also expect Latin America to have an expanded economic role in the world over the coming decades.
Market Pulse
02. Six companies which played an outsized role in the headlines this past year
To break the year down by headlines in the business media, six companies dominated the news. It is hard to believe, but the meme stock craze just started back in January of this year when the reddit brigade drove the price of GameStop (GME $152) up from around $20 per share to a stratospheric $483 per share on the 28th of the month. In a coordinated effort to attack the shorts, AMC Entertainment (AMC $29) and several other heavily-shorted names became meme stocks shortly thereafter. The beneficiary of this craze, at least initially, was a new trading platform for the masses: Robinhood (HOOD $19), which went public in late July and attained an $85 share price a week later. The company has since lost three-quarters of its market cap. The crypto craze hit full stride by late spring when the Coinbase (COIN $268) platform went public. Nearly 100 cryptos can be easily traded on the platform, and users can make payments from the app using the coin of their choosing—or the US dollar. Coinbase is in the Penn Intrepid Trading Platform and remains one of our favorite plays going into 2022. Pfizer (PFE $59) has been the corporate hero of the pandemic, providing the world's best vaccine to prevent Covid, and the first approved therapy to treat the disease. Tesla (TSLA $1,067), which is in the Penn New Frontier Fund, has been in the headlines throughout the year for a number of reasons, from Elon Musk's entertaining tweets to the company's remarkable production levels to the fact that it became a $1 trillion company this year—one of only a handful. Meta Platforms, yet another Penn name, has been in the headlines for mostly negative reasons this year (via incessant attacks by elected officials), though investors have largely brushed off these headlines. The company, which changed its name from Facebook in October, is up 25% year-to-date. Finally, we have TikTok. We have nothing to say about TikTok.
Several of these companies will remain solidly in the headlines throughout 2022, but new and unexpected additions will certainly arise. For a number of tech darlings which have yet to turn a profit, many of the headlines will be anything but positive. Investors need to watch their high-beta positions diligently, as volatility will rule the year.
Market Pulse
01. A true Santa Claus began to take shape in the markets this week
After an "uh oh" sort of Monday, it was all "ho ho ho" in the markets this Christmas-shortened trading week. Virtually every asset class other than cryptos gained ground, from stocks to commodities to bond yields. The tech-heavy NASDAQ led the charge this week, finishing up 3.19%; followed by the small-cap Russell 2000 (+3.11%), the S&P 500 (+2.28%), and the Dow (+1.65%). Oil closed the week at $73.76, or 5% higher, while gold regained the $1,800 mark, closing at $1,810. With investors now fully bracing for two to three rate hikes next year, the 10-year Treasury hit a yield of 1.495%, meaning that bond values fell. AGG, the iShares Core Aggregate Bond ETF, was off 0.26%.
A Santa Claus rally happens when stocks climb higher in the final seven trading days of a year plus the first two trading days of the new year. So far, so good.
Under the Radar Investment
International Paper (IP $46)
Have you ever stopped to wonder who makes all of those cardboard boxes being dropped off at your front door each week? Odds are good that they were produced by Tennessee-based International Paper. The company accounts for nearly one-third of all corrugated packaging in North America, though it also has major operations in Brazil, Russia, India, and China. This industry could be considered an oligopoly, as it is dominated by three major players: International Paper, WestRock (WR $43), and Packaging Corp. of America (PKG $131). While we actually find all three companies nice value plays, we especially like the new efficiencies IP has put in place over the past several years, its low multiple (10), and the company's growth potential in emerging markets. We would place a fair value of $65 on the shares, which would bring them back up to their summer levels. Oh, and the 4% dividend could be considered the icing on the cake.
Answer
John and Henry Churchill leased 80 acres of land in Louisville, Kentucky to their nephew, Colonel Meriwether Lewis Clark Jr., grandson of explorer William Clark, in 1874. Clark happened to be president of the Louisville Jockey Club and Driving Park Association, and proceeded to build Churchill Downs, which opened in 1875. The first Kentucky Derby was held that same year at the field. With the infield open for the race, capacity at Churchill Downs is roughly 170,000.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Best stock of 1999...
In some ways, 2021 reminds us of 1999. High-tech companies with a lack of profitability as far as the eye can see, speculative investments which seem impervious to fundamental analysis, new platforms bringing trading to the masses. Looking back to 1999, what would have been the best investment (outside of some goofy answer, like the Puerto Rican Cement Company—a high-flying penny stock back in the day) of that year? Hint: it not only still exists, but we own it within our strategies.
Penn Trading Desk:
Oppenheimer: Coinbase listed as a top stock pick for 2022
Oppenheimer has named Penn strategies member Coinbase (COIN $250) as one of its top picks for 2022. The company cited continued and widespread adoption of digital assets as a form of payment, both by retailers and institutions, as rationale for their rating. Coinbase, which is a member of the Penn Intrepid Trading Platform, is a major cryptocurrency exchange allowing for the purchase of hundreds of different cryptocurrencies, as well as the ability to make transactions with these currencies directly from the platform's digital wallet. Oppenheimer has an Outperform rating on the company with a price target of $444 on COIN shares—or 77% higher from here.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Telecommunication Services
10. US recommends approval of a massive Meta/Google undersea cable project in Asia; China is not amused
The Biden administration has recommended that the FCC grant Meta (FB $334) and Alphabet (GOOG $2,856) licenses to build a 12,000-kilometer-long (7,500 miles) network of undersea fiber optic cables spanning a number of Asian countries—sans China. The effort, known as Project Apricot, will connect Singapore, Japan, Guam, the Philippines, Taiwan, and Indonesia in an effort to bring reliable, high-speed Internet access to portions of the world both underserved and over-reliant on Communist China for their connectivity. The Apricot project will compliment Project Echo, connecting the US with Singapore, Guam, and Indonesia. The ultimate goal, according to Google VP of Global Networking Bikash Koley, is to create multiple (digital) paths in and out of Asia, and "increased resilience in connectivity between Southeast Asia, North Asia, and the United States." A previous joint project to build an undersea cable connecting California and Hong Kong was scrapped by Google and Meta—upon a US Department of Justice recommendation—due to US/Sino tensions. Technology, coupled with gutsy leadership, is making it harder for repressive regimes to constrict the free flow of information, thus controlling the narrative. Needless to say, Beijing is not happy with this project, which is slated to be completed by 2023.
The more China is backed into a corner, the more evident it will become to the free world precisely what the CCP's long-term goals are, and how incompatible they are with the pursuit of human freedom. The West may have a short memory, but we can count on China's ruling communist elites to keep stoking the fire. In the end, freedom always wins.
Renewables
09. Solar stocks are getting crushed on the back of new California proposals
Interesting, coming from the state which claims to be on the vanguard of societal evolution (smirk). The once-darling solar stocks, names like Sunrun (RUN $32), First Solar (FSLR $86), EnPhase Energy (ENPH $180), and SolarEdge Technologies (SEDG $263), have been plummeting since California proposed new rules which would make it more costly for families to put solar panels on their roofs. At the heart of the issue are the California utilities, which don't like the competition from the bourgeois middle class of the state who dare to generate their own household power. These utility concerns, working through the California Public Utilities Commission, wish to extort a monthly "grid fee" from anyone with the panels on their roofs, and they want to reduce the amount of payout for the power coming back to the grid from solar sources. While these recommendations must still be codified by state legislators, the threat was enough to sink the shares of major players. California-based Sunrun, for example, has seen its share price drop by two-thirds since January. One hopeful sign: the commissioner who penned the proposal will be leaving his post soon and won't be around to help bring it to fruition.
Here is the solution for homeowners: get off the grid by storing the solar power your panels collect in your own storage system. True, the needed efficiencies are not quite there yet, but we believe power storage will be the golden ticket for investors in this industry, and the nightmare for utility companies. In the energy storage space, Tesla's (TSLA $900) systems are hard to beat. We also like Johnson Controls (JCI $76), Enphase Energy, and Generac (GNRC $346). To take advantage of the industry without placing a big bet on any one player, the Invesco Solar ETF (TAN $74) may be the way to go. The ETF holds an eclectic group of 49 companies engaged in solar power production, storage, and infrastructure.
Semiconductors & Related Equipment
08. Our Micron position spikes nearly double digits on strong earnings report
We added leading US semiconductor and component maker Micron Technology (MU $90) to the Penn New Frontier Fund just under two months ago at $69.35, with an initial price target of $90. It didn't take long to reach that mark: shares of MU spiked nearly double digits on the morning following a stellar quarterly earnings report. Revenues rose 33% from a year ago, to $7.69 billion, while net income rose from $803 million in the fiscal first quarter of last year to $2.31 billion in the same quarter of this year. The company reported that revenue from dynamic random access memory chips, or DRAM, was up 38% from last year. DRAM chips, which provide low-cost and high-capacity memory, accounted for 73% of total revenue in the quarter; these are the critical chips which will power devices in the world of 5G and the Internet of Things. Chief Business Officer Sumit Sadana was highly bullish on Micron's future in the metaverse, which he said should provide the company with a "tremendous potential demand" going forward. Founded in 1978, Micron employs 43,000 workers and is headquartered in Boise, Idaho.
While it reached our target price much quicker than we expected, we are not considering trimming our position. With the global chip shortage, unprecedented demand on the horizon, and a domestic manufacturing capability, we expect Micron to be a shining star in the portfolio going forward.
Media & Entertainment
07. "Spider-Man: No Way Home" just had a blockbuster weekend; now, who will take home the profits?
When the dust settled, it was the second-largest opening weekend for a movie in cinematic history: "Spider-Man: Now Way Home" brought in $260 million in North American ticket sales alone, placing it behind only "Avengers: Endgame" in the record books. Globally, the news was equally good, with the film grossing $601 million in ticket sales around the world. Industry experts are now expecting the film to hit the $1 billion mark by the end of Christmas weekend. As for who gets the profits, recall that Sony (SONY $121) struck a deal with Marvel back in 1998 to buy the rights to the Spider-Man character, over a decade before Disney (DIS $151) paid $4 billion for the Marvel Cinematic Universe. Through a contorted series of moves since that deal, Sony and Disney came to the agreement—at least for this film—that the latter would provide 25% of the financing in return for 25% of the film's profits, in addition to the merchandising rights. To further muddy the waters, Sony has a previous deal with Netflix (NFLX $606) still in effect, meaning "No Way Home"—or any other Spider-Man movie—probably won't be coming to Disney+ until 2023. Nonetheless, both Sony and Disney should be pleased with their respective share of the profits on this third installment of the latest trilogy. And despite the word "trilogy," a fourth "Spider-Man" is already being planned.
Trying to sift through all of the legal wrangling between Sony and Disney over the years is enough to bring on a headache. Sadly, Disney is now being led by a CEO who is not, shall we say, a world-class negotiator. From an investment standpoint, we would rather own Sony, with its 18 P/E. As lovers of all things Disney, we await regime change at the firm.
Application & Systems Software
06. The Street was generally negative on Oracle's $28 billion purchase of Cerner, but we see potential
From a personal perspective, we hate to see another home-grown company get gobbled up by a much bigger competitor, but from an investment standpoint, does Oracle's (ORCL $92) $28.3 billion acquisition of Kansas City-based Cerner Corp (CERN $90) make sense? At first blush, the integration seems to have plenty of potential synergies. Cerner is a leading electronic health records company, operating in an industry—health information systems—which needs a serious dose of technology. We need look no further than our little white vaccination cards to figure that one out. (At least technology would have made it more difficult for Aaron Rodgers to "alter" his medical history.) Oracle is a $245 billion enterprise software company which developed the first commercial SQL-based relational database management system. It would make perfect sense that this pioneering company would want to buy the established leader in an industry with enormous growth potential. Investors may agree with that premise, but they apparently balked at the $95 per share price-tag, which represents a 25% premium to Cerner's recent trading range. In fact, prior to the announcement Cerner shares were trading around the same price they sat at four years ago, in October of 2017, when we sold them from the Global Leaders Club. Larry Ellison, the brilliant co-founder of Oracle and the company's chief technology officer, is clearly excited about the deal, which makes us feel even stronger about the potential for growth. "With this acquisition," Ellison said, "Oracle's corporate mission expands to...providing our overworked medical professionals with a new generation of easier-to-use digital tools...lowering the administrative workload, improving patient privacy and outcomes, and lowering overall health care costs." Noble goals, indeed.
With Oracle off nearly 10% on news of the acquisition, they are worth a look. We would place a fair value of $100 on the shares, but they should easily grow north of that if the company's plans for Cerner pan out. And for the record, we believe they will.
Capital Markets
05. Blackstone continues to collect real estate assets with purchase of Bluerock Group
There may a Flintstones joke somewhere in the headline, "Blackstone to buy Bluerock," but the $93 billion alternative asset manager has been on a serious mission to increase its real estate holdings recently, and few understand valuations better than Steve Schwarzman and his team. The company's latest acquisition involves a $3.6 billion deal to buy apartment REIT Bluerock Residential Growth, which owns some 30 multifamily rental communities with 11,000 units throughout the Sun Belt—hot growth areas such as Austin, Orlando, and Phoenix. It should be noted that Bluerock also has a portfolio of single-family rentals, which it will spin off to shareholders in the form of the Bluerock Homes Trust. In addition to this deal, Blackstone has already made three other buys thus far in 2021, all in areas we love going forward: industrial REIT WPT, data center REIT QTS Realty Trust, and a collection of student housing properties. Blackstone is one of the world's largest alternative asset managers, with $730 billion in assets under management, including $530 billion in fee-earning assets. The company has a reasonable P/E ratio of 18, and a nice yield of 2.89%—or 100 basis points higher than the current 30-year US Treasury yield.
The sale of Blackstone from the Strategic Income Portfolio several years ago turned out to be one of our most frustrating moves. We liquidated the position due to its status as a limited partnership, meaning it generated K-1s that clients often shy away from. Within months of our selling the position, Blackstone announced that it was converting from a partnership to a corporation. Perhaps we should have re-purchased at that time, but we didn't. At $130, BX shares seem fairly valued, and we expect them to hold up relatively well in what we predict will be a very choppy 2022.
Pharmaceuticals
04. Huge news in the fight against the pandemic: FDA clears two at-home Covid treatments
First it was Pfizer's (PFE $59) Paxlovid, then it was Merck's (MRK $76) molnupiravir, developed in partnership with Ridgeback Biotherapeutics. In the same week, the FDA gave us the news we have been waiting for: two at-home, anti-Covid therapies have been given emergency use authorization for use by Americans who have tested positive for the disease. In clinical trials, Pfizer's Paxlovid reduced the risk of Covid-related hospitalization or death by an impressive 89% if taken within the first three days of symptoms appearing; that percentage is reduced just one point—to 88%—if taken within the first five days. Despite lackluster results on Merck's antiviral treatment, which has been show to reduce hospitalizations and deaths by 30%, the FDA narrowly granted authorization to that treatment as well. Pfizer's treatment consists of three pills twice daily for five days (30 pills), while Merck's therapy consists of four pills twice daily for five days (40 pills). In a related story, France has cancelled a pre-order it had in for Merck's drug based on the disappointing trial results. While it will take time to ramp up production of Pfizer's Paxlovid, the Biden administration has already placed an order for ten million courses of the treatment.
Pfizer is a member of the Penn Global Leaders Club and one of our strongest-conviction stocks for 2022.
Global GDP & Debt
03. The world's $94 trillion economy, in one stunning graphic
Few things paint the story like a good visual, and this stunning graphic from Visual Capitalist proves that point. Here, in one snapshot, is a breakdown of which countries are most responsible for the world's production of goods and offering of services. Note that, despite the fact that we are several years beyond the forecast date (from the press) of China's economy surpassing that of America's, the United States still enjoys an economy that is one-third larger than its second-place rival. Pretty amazing, considering that virtually every item we pick up in the store has "Made in China" stamped somewhere on the packaging. In fact, the US accounts for nearly one-quarter of the world's GDP. While the US dominates the North American, China, to a lesser degree, dominates Asia. There are a number of factors we find of interest in the red section. Note how small India's GDP appears in relation to that of China's, despite the fact that both countries have approximately equal natural resources and populations (1.3 billion Indians vs 1.4 billion Chinese). It was just eleven years ago, in 2010, that China's economic might surpassed Japan's, despite the fact that the latter has a much smaller land mass and one-tenth the population of the former. China claims it controls the nation in the lower left portion of the red, Taiwan, and its $790 billion economy; it is a matter of time before they make a move on that country, forcing some type of American/global response. In the green section of the graphic, one notes how small Russia's economy looks, despite Putin's saber-rattling. Furthermore, around one-third of Russia's economy is energy based (and 60% of its exports), making it vulnerable to price fluctuations in related commodities such as gas and oil. Germany has the continent's largest economy, at $4.23 trillion, followed closely by the UK, France, and Italy. As geopolitical events occur around the world, it is useful to think back to this visual, as what it represents almost certainly plays the major role in the action taking place.
The world is slowly beginning to wake up to the danger of a Communist China playing such a major role in the world, both economically and militarily (though American military might—and Russian, for that matter—still dwarfs that country's arsenal). China's growth rate is already slowing, and we expect that to continue as the world's companies continue to mitigate country risk by building their factories in other Asian countries. Internal issues are the only reason that the world's largest democracy, India, cannot seem to gain more economic traction, but that is slowly changing. We also expect Latin America to have an expanded economic role in the world over the coming decades.
Market Pulse
02. Six companies which played an outsized role in the headlines this past year
To break the year down by headlines in the business media, six companies dominated the news. It is hard to believe, but the meme stock craze just started back in January of this year when the reddit brigade drove the price of GameStop (GME $152) up from around $20 per share to a stratospheric $483 per share on the 28th of the month. In a coordinated effort to attack the shorts, AMC Entertainment (AMC $29) and several other heavily-shorted names became meme stocks shortly thereafter. The beneficiary of this craze, at least initially, was a new trading platform for the masses: Robinhood (HOOD $19), which went public in late July and attained an $85 share price a week later. The company has since lost three-quarters of its market cap. The crypto craze hit full stride by late spring when the Coinbase (COIN $268) platform went public. Nearly 100 cryptos can be easily traded on the platform, and users can make payments from the app using the coin of their choosing—or the US dollar. Coinbase is in the Penn Intrepid Trading Platform and remains one of our favorite plays going into 2022. Pfizer (PFE $59) has been the corporate hero of the pandemic, providing the world's best vaccine to prevent Covid, and the first approved therapy to treat the disease. Tesla (TSLA $1,067), which is in the Penn New Frontier Fund, has been in the headlines throughout the year for a number of reasons, from Elon Musk's entertaining tweets to the company's remarkable production levels to the fact that it became a $1 trillion company this year—one of only a handful. Meta Platforms, yet another Penn name, has been in the headlines for mostly negative reasons this year (via incessant attacks by elected officials), though investors have largely brushed off these headlines. The company, which changed its name from Facebook in October, is up 25% year-to-date. Finally, we have TikTok. We have nothing to say about TikTok.
Several of these companies will remain solidly in the headlines throughout 2022, but new and unexpected additions will certainly arise. For a number of tech darlings which have yet to turn a profit, many of the headlines will be anything but positive. Investors need to watch their high-beta positions diligently, as volatility will rule the year.
Market Pulse
01. A true Santa Claus began to take shape in the markets this week
After an "uh oh" sort of Monday, it was all "ho ho ho" in the markets this Christmas-shortened trading week. Virtually every asset class other than cryptos gained ground, from stocks to commodities to bond yields. The tech-heavy NASDAQ led the charge this week, finishing up 3.19%; followed by the small-cap Russell 2000 (+3.11%), the S&P 500 (+2.28%), and the Dow (+1.65%). Oil closed the week at $73.76, or 5% higher, while gold regained the $1,800 mark, closing at $1,810. With investors now fully bracing for two to three rate hikes next year, the 10-year Treasury hit a yield of 1.495%, meaning that bond values fell. AGG, the iShares Core Aggregate Bond ETF, was off 0.26%.
A Santa Claus rally happens when stocks climb higher in the final seven trading days of a year plus the first two trading days of the new year. So far, so good.
Under the Radar Investment
International Paper (IP $46)
Have you ever stopped to wonder who makes all of those cardboard boxes being dropped off at your front door each week? Odds are good that they were produced by Tennessee-based International Paper. The company accounts for nearly one-third of all corrugated packaging in North America, though it also has major operations in Brazil, Russia, India, and China. This industry could be considered an oligopoly, as it is dominated by three major players: International Paper, WestRock (WR $43), and Packaging Corp. of America (PKG $131). While we actually find all three companies nice value plays, we especially like the new efficiencies IP has put in place over the past several years, its low multiple (10), and the company's growth potential in emerging markets. We would place a fair value of $65 on the shares, which would bring them back up to their summer levels. Oh, and the 4% dividend could be considered the icing on the cake.
Answer
John and Henry Churchill leased 80 acres of land in Louisville, Kentucky to their nephew, Colonel Meriwether Lewis Clark Jr., grandson of explorer William Clark, in 1874. Clark happened to be president of the Louisville Jockey Club and Driving Park Association, and proceeded to build Churchill Downs, which opened in 1875. The first Kentucky Derby was held that same year at the field. With the infield open for the race, capacity at Churchill Downs is roughly 170,000.
Headlines for the Week of 05 Dec — 11 Dec 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Talk about paying for yourself many times over...
On Christmas Day, the Staples Center in Los Angeles, which was built in 1999, will become the Crypto.com Arena. Twenty-two years old may seem "seasoned," but it can't hold a candle to another arena in the country. What is the oldest sports stadium/arena still in use in the United States, and when was it established?
Penn Trading Desk:
Penn: Open Canadian cannabis player in the Intrepid
We believe that one Canadian cannabis firm is well poised to be the industry leader in the US once the drug is legalized at the federal level. Exemplary management, a just-announced acquisition which we love, and a discounted price (to our fair value) led to our decision to add the mid-cap growth company to the Intrepid Trading Platform. Our first price target is 50% above current price, while our second target is nearly double current price.
Penn: Open airline in the Global Leaders Club
Having written glowingly about one particular airline in a recent issue of The Penn Wealth Report, it is only fitting that we would pick it up as one of the 40 positions within the Penn Global Leaders Club, especially after the Omicron scare drove shares down near a 52-week low. Our initial price target is 57% above our purchase price, but we expect to own this forward-looking company well beyond its shares hitting our first target.
Penn: Open fintech giant in Global Leaders Club
Using some contorted logic (proving that efficient market hypothesis is bunk), investors have decided to place a dynamic fintech company in the "old financials" category. The Street's disinterest—or sheer disdain—has driven the price down on this excellent credit services company to the golden ticket range. Additionally, we have been actively searching for strong financial services firms at a reasonable price now that we are overweighting the sector. To see this latest addition to the Penn Global Leaders Club, which carries just 40 members, sign into the Penn Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cryptocurrencies
10. Come watch the Lakers play at the...Crypto.com Arena?
The meteoric rise of the nascent cryptocurrency market, already $2 trillion in size, has been remarkable. With each passing day, fewer experts seem willing to write the movement off as some sort of fad which will eventually implode. The latest evidence of which comes from California, where the crypto world is about to get some serious signage: Effective Christmas Day, the Staples Center will be renamed Crypto.com Arena. The marketing coup comes at a steep price for the privately-held company. We recall naming rights for stadiums in the $3 million per year price range, which always seemed a bit steep to us. Crypto.com will reportedly pay $700 million for a 20-year contract, which equates to $35 million per year. If those numbers are correct, this would be the second-largest naming rights deal in history, behind 2017's Scotiabank Arena deal in Toronto, which was valued at $800 million for 20 years. Keeping it closer to home, Staples paid $116 million for the previous 20-year deal with The Anschutz Entertainment Group, owner of the arena which has carried its name since 1999. Crypto.com is a low-cost cryptocurrency exchange, much like publicly-traded Coinbase Global (COIN $255), a member of the Penn Intrepid Trading Platform.
Yes, cryptocurrencies are here to stay, but it can be very difficult to separate the long-term winners from the inevitable multitude of losers. We purchased shares in the Coinbase exchange in June at $230 per share—well off of their $429.54 near-IPO price and below their current trading range. We can see why the Coinbase wallet is so attractive to crypto traders, and believe in the company's fundamental story. Our biggest concern about privately-held Crypto.com, despite the pretty cool Matt Damon advertisements, is country risk: it is headquartered in Hong Kong, which is now under the full control of the Communist Party of China.
Consumer Staples
09. Penn member Dollar General announces plans to open 1,000 new Popshelf stores to attract a wealthier clientele
We added Dollar General (DG $222) to the Penn Global Leaders Club—the home for holdings we expect to own for years—when shares of the discount retailer were discount priced themselves, at $71.06. It has been a relatively straight trajectory up from there: shares of the $51 billion Tennessee-based retailer are now trading north of $220. With more than 18,000 stores across the United States, the company's bread-and-butter customer base has been households with annual incomes of 40,000 or less, and we consider the investment an excellent defensive play for any economic downturn. Now, Dollar General has an interesting plan to widen its total addressable market. The company has been testing a concept store called Popshelf which is designed to attract a younger, wealthier group of shoppers. The roughly 9,000 square foot stores have been so popular that management has announced an aggressive plan to open 1,000 Popshelf locations by the end of fiscal 2025. Targeting suburban women with household incomes of between $50,000 and $125,000, the stores will present a bright and lively image, with the mix of goods changing frequently to create a "treasure hunt" vibe. Shoppers searching for unique gifts, holiday decorations, or party supplies should be able to find what they are looking for, all at a reasonable price. We applaud the move, and look forward to checking out one of the new locations. For the first time in its 80-year history, Dollar General also announced it would be delving into the international market, opening ten stores in Mexico by the end of FY 2022.
Despite our success in the position, Dollar General continues to be an overlooked gem by so many retail analysts. That is simply a mistake on their part. For all of its tremendous growth within the Club, it carries a tiny price-to-earnings ratio of seven and an enviable financial position. While others chase multiples that don't exist (because they won't turn a profit for years—if ever), give us an income-generating machine like DG any day.
Multiline Retail
08. Our favorite retailer, Target, gives an early Christmas gift to both customers and employees
Retail juggernaut Target (TGT $248), whose shares have risen 295% in value since we added it as a Consumer Defensive play within the Penn Global Leaders Club under three years ago, has faced two catalysts over the past week which have sent shares lower. Ironically, we love both of them. The first came in the statement following last Wednesday's earnings release. Masterful CEO Brian Cornell, such a different leader than the hapless Gregg Steinhafel, said that the $120 billion retailer was in a "strong inventory position heading into the peak of the holiday season...." Investors were fine with that statement, but when Cornell warned of higher expenses and trimmed gross margins due to inflation and supply constraints, and asserted that Target could "tolerate lower margins if it meant keeping prices (lower for consumers)," which would be fine with him, that was simply too much. A retailer putting customers above fatter margins when those costs could quite easily be passed along? That simply did not compute for investors, which sent the shares down 4% in the pre-market, despite healthy year-on-year revenue and earnings growth. The second share drop within a week came after the company announced that not only was it going to be closed this Thanksgiving, it will remain closed on the holiday in future years as well. What century does Cornell think he is living in? That shaved another 4% or so off of the share price. Two excellent decisions met with derision. That sounds about right.
Some days we watch and listen to an endless stream of malleable, weak, milquetoast CEOs as they contort themselves into odd shapes to prove how enlightened they are. And other days we come in and see something refreshing: true leadership. Cornell's skill at the helm is a major reason why Target remains a shining star in the Penn Global Leaders Club.
Global Strategy: Middle East
07. "Insanity" is how Erdogan's demanded rate cuts in the face of 20% Turkish inflation is being described
To set the stage: Turkey is not a US ally, despite that country's longstanding NATO membership. Under the mercurial leadership of President Recep Tayyip Erdogan, Russia seems to have more influence than does the West, despite Turkey's desire to be seen as part of the EU rather than the Middle East. Under that backdrop comes the bizarre economic situation going on in the country of 85 million people. The main reason that the central bank in the US will probably raise rates at least twice next year is to dampen the rate of inflation, which is currently well above the 2% target range. In Turkey, inflation is running at a nightmarish (for consumers) pace of 20%, so what does Erdogan do? He orders the country's central bank to lower rates. Hence the claims of insanity. And for anyone who believes that the president didn't order the cuts consider this: he has fired three central bank chiefs in the past two years for daring to question his monetary views. Erdogan's defense is that he is waging "an economic war of independence." His strange war has had quite the impact on the Turkish lira, which is now trading at 13:1 versus the US dollar. So, for the unfortunate Turkish worker, this means that their paycheck is being watered down on a daily basis while prices at the local bazar or supermarket are simultaneously going up on a daily basis. A recipe for disaster. Somehow, despite the economic nightmare, Erdogan has still managed to finance the expensive purchase of a Russian-made S-400 missile defense system—a system designed to thwart the most advanced US fighters. To counter the move, the US has removed Turkey from the F-35 joint strike fighter program at a cost of half a billion dollars. The only good news about the economic situation Erdogan is causing within his country is that he will be forced to play defense, taking time away from his mental musings on how to foment more trouble in the region.
It is going to take an uprising by the Turkish people to remove Recep Tayyip Erdogan from power. Despite the fact that his second five-year term, which will end in 2023, should make him ineligible for running again, any bets on who will still be the Turkish president in 2024 and beyond? While that country's constitution prohibits a third term, when has a legal document ever stopped a dictator? Look no further than Vlad Putin. As for a Turkish uprising, sadly, look no further than Venezuela for evidence that those odds, despite the human suffering, are slim to none.
Economics: Work & Pay
06. Trying to dissect the Rorschach test that was the November jobs report
It is always difficult to gauge how investors will react to any given monthly jobs release: a positive report often results in a market downturn, while a lousy one can be a catalyst for gains. Go figure. Even by those standards, November's results and subsequent investor response was a bit strange. Immediately after the release of the jobs survey, which showed a paltry 210,000 new jobs being created in the country against expectations for gains of 550,000, futures rose. This was based on the assumption that the Fed would back off of their threat to end their bond buying program quicker than the current reduction of $15 billion per month. Within the details of the report, however, came some good news: the labor force participation rate—the percentage of Americans of working age either already employed or looking for work—rose to 61.80%, which is the highest level since pre-pandemic. That equates to 600,000 or so Americans re-entering the workforce. Buttressing that point was the household survey section of the report showing that payrolls actually rose by 1.1 million in November. Why the discrepancy? The headline figure represents employers reporting how many hires they had in the month, while the household survey includes individuals moving to self-employed status. In other words, a record number of Americans just started working for themselves. This would also explain why the unemployment rate fell more than expected, to 4.2%. The internals were enough to bring back investors' fear of the Fed tightening quicker than expected to help quell inflation, leading to a 500-point intra-day swing in the Dow. But the Dow's reversal was nothing compared to the NASDAQ and Russell 2000 small-cap index, with each benchmark losing around 2% on the day. It was one of those odd weeks where everything fell in tandem: stocks, bonds, gold, cryptos, and the 10-year Treasury all ended the week in the red.
Following a negative third quarter of the year, a down November for the markets, and a rough start to December, we revisited our January 1st prediction for the year-end S&P 500: 4,300. That would have represented a healthy 14.5% gain on the year. On the Friday of the jobs report, the S&P 500 closed at 4,538, or 238 points above our projection for the year. Granted, anything can happen in any given market week, but we are still looking at a quite strong 2021. The big question for next year will be how investors digest the end of tapering and two to three probable rate hikes.
Interactive Media & Services
05. A visual of the world's largest social media networks and who owns them
Thanks to Visual Capitalist for providing this rather stunning graphic of who actually dominates the explosive world of social media. Shortly before they changed their name to Meta (FB $317), we added shares of $900 billion Facebook back into the Penn Global Leaders Club after a hiatus. Looking beyond the ceaseless attacks by politicians on both sides of the aisle, we believe this company's embrace of the metaverse will lead to a long-term growth trajectory beyond the scope of most analysts' imagination. From a social media usage standpoint, nobody comes close: Meta companies (Facebook, Instagram, WhatsApp, and Messenger) have an aggregate 7.5 billion monthly active users (MAUs), which equates to advertising pricing power miles ahead of the competition. (To be clear, if one person uses all four platforms, as we do, they would be counted four times; still, those numbers are remarkable.) From an individual platform standpoint, Alphabet's (GOOG $2,882) YouTube comes in second to Facebook, with 2.3 billion MAUs. We already own the third largest controlling company on the list, Microsoft (MSFT $326; Skype, LinkedIn, Teams), which continues to be one of our highest conviction names. Skipping over Snap (SNAP $48), which we have never been fond of from an investment standpoint, we come to Twitter (TWTR $45) and its 463M MAUs. Now that Dorsey is gone, we are actually considering picking up some shares of TWTR for the Intrepid Trading Platform. We believe the promotion of Chief Technology Officer Parag Agrawal to the CEO role makes sense for a company which hasn't been able to effectively monetize its business model. Then again, we also thought it made sense for JC Penney to hire Ron Johnson—the guy who created the Apple store model—as CEO, so it is always prudent to wait for evidence of leadership abilities before jumping in. As for the red balls on the list, the Asian names, we wouldn't touch any of them.
At the risk of being labeled a metaverse fanatic, most truly don't understand how the two-dimensional world of social media will morph over the coming years into something truly interactive. Facebook is proven it is all in, which is why it is our number one play in the interactive media and services space.
Application & Systems Software
04. DocuSign shares plunged over 40% in a day; are they a screaming buy right now?
For obvious reasons, shares of DocuSign (DOCU $144), the benchmark in remote document signing technology, skyrocketed during the pandemic-forced lockdown, climbing from $90 in February of last year to $314.76 per share by summer. After a billings miss and a guide-down in the latest quarter, however, the company is now valued at less than half of what is was last year. So, at $144, should investors buy into the story? Although DocuSign has yet to turn a profit, and competing products such as Adobe Sign are gaining traction, the company still posted an impressive revenue growth rate of 50% last quarter. Subscriptions, which give the company a recurring income stream, rose 44% year over year, and over one million customers are now using the e-Signature suite of products. With mass adoption of electronic signatures in virtually every industry, from financial services to health care to government agencies, we tend to agree with management's assessment of a $50 billion total addressable market (TAM), meaning there is still enormous growth potential ahead. Will DocuSign continue to be the company eating away at most of that TAM? Despite so many throwing in the towel after the latest earnings report, we believe they will.
While we do not currently own DocuSign in any of the Penn Portfolios (we do own competitor Adobe in the Global Leaders Club), we do believe the shares will rise back to the $250 range before long. That would signify a 70% jump from the current share price.
Textiles, Apparel, & Luxury Goods
03. Allbirds was overpriced from the start, which is one reason its shares have been slashed in half
We are constantly scanning the IPO calendar, looking for under-the-radar names that won't be devoured by investors at the initial open, driving prices to outrageous levels. Allbirds (BIRD $16) seemed like it had potential; after all, who would get too excited about an athletic footwear maker going public? After pricing 20 million shares at $15 apiece the night before the big debut, we decided to buy in if they fell to the $10-$12 range after trading began. Instead, retail investors gobbled BIRD shares up right out of the gate, driving the price up to an intraday high of $32.44 on the third of November. So much for that trade. One month later, on the 3rd of December, shares had dropped to $13.91 intraday—a 57% course correction. So, are we entertaining the trade once again? Not really. Allbirds shoes are pretty cool, and sales continue to be strong despite the fact they don't believe in discounting the price. The company's self-proclaimed raison d'être is to bring the world eco-friendly and environmentally-sourced shoes. It is hard to go a paragraph deep into any of their ads or press releases without reading the word "sustainability." While management's efforts in this area may be commendable, their words might carry more weight if such a large percentage of Allbirds products weren't made in China—not exactly the ESG capital of the world. In the company's first earnings report since going public, sales came in at $63 million for the quarter funneling down to a net loss of $14 million. For comparison's sake, in its latest quarter $1.1 billion footwear retailer Designer Brands (DBI $16) notched sales of $817 million and had a positive net income of $43 million. Despite its current "discount" from highs, Allbirds seems ripe for another turn downward in the next general market correction.
IPO days for companies we are interested in can be stressful. Trading volatility is high, and the stock price can literally double on the first tick out of the gate. Patience is paramount; if you are priced out (based on your mental buy price) immediately, be patient, as you will have another chance to buy in at a lower price. Even with companies such as Facebook and Tesla, this has always been the case. Use the emotions of others to create wealth in the markets rather than letting your own cloud your judgment.
Pharmaceuticals
02. Pfizer lab studies show third dose of vaccine (the booster) effectively neutralizes the omicron variant of disease
Futures went from negative to positive on Wednesday after pharma giant Pfizer (PFE $51) announced that its lab studies have shown a third dose of the company's Covid-19 vaccine, otherwise known as the booster shot, effectively neutralizes the highly-transmissible omicron strain of the disease. Uncertainty about and fear over the strain helped wreak havoc on markets over the prior two weeks. Researchers at the New Jersey-based firm observed a massive drop in effectiveness of just two doses of the vaccine against this latest strain, yet those who received the booster showed a restored level of protection. Nonetheless, Pfizer continues work on an omicron-targeted shot which may be ready as soon as early spring. More good news: it now appears that the current variant spreading throughout the world, despite its rate of transmission, is less virulent than prior strains, meaning fewer deaths and hospitalizations. On the heels of the Pfizer test results, Cantor Fitzgerald reiterated its Overweight rating on the company and $61 price target on the shares, noting that "...Pfizer's vaccine sales for Covid-19 remain underappreciated by the Street." We couldn't agree more.
Presently, there are some real bargains in the pharmaceutical and biotech space. It is as though investors believe that the entire industry rests on what happens next with respect to Covid-19. Meanwhile, the pipeline of therapies being developed for other life-threatening diseases and maladies has never been deeper. IBB, a cap-weighted ETF of biotech companies, is down 1% on the year, while XBI, an equal-weighted basket of 188 biotechs (and our preferred vehicle in the space) is down over 17% year-to-date. That smells like opportunity.
Economics: Supply, Demand, & Prices
01. The highest inflation rate in forty years didn't dampen the markets
We expected the CPI numbers for November to be bad, and they were. Hitting a rate not seen since 1982, the US Department of Labor announced that the consumer price index (CPI), which measures what consumers pay for a wide swath of goods and services, rose 6.8% annualized in November—the sixth-straight month in which the inflation rate was above 5%. For reference, the Fed's inflation target sits at 2%, and we all recall how "stubbornly low," to use Powell's own words, it was not that long ago. Even stripping food and energy out of the mix, the rate still climbed to 4.9%. What is leading the inflationary charge? Homes are up nearly 20% year-on-year, new vehicles 11%, used vehicles 27%, and fast food prices 8%—just to give a few examples. Unfortunately, while wages have climbed, they are not matching the jump in the price of goods. The Atlanta Fed reported that wage growth was 4.3% in November, annualized.
Oddly enough, the markets largely ignored Friday's CPI release, with the three major indexes (the small caps did not participate) gaining ground on the day. For the week, even the beaten-down Russell 2000 pulled out a gain of 0.76%. Meanwhile, the S&P 500, the DJIA, and the NASDAQ all reclaimed ground not seen since before the prior two week market downturn. We have three weeks left in the month, but December is suddenly looking like it might bring its usual dose of holiday cheer to investors. Of course, next week's Fed meeting could throw a monkey wrench into the works: Fed Chair Powell is highly expected to speed up the rate of taper, perhaps from $15 billion per month to $30 billion per month, which would end the bond buying program by March. Stay tuned.
With the taper now expected to end by next March, economists are raising their expectations for rate hikes next year. The general consensus is one hike by early summer, and two beyond that in 2022. Where will it end? When the target Fed funds rate gets to 2% to 2.5% (the upper band is at 0.25% now), we expect the Fed to halt. Of course, anything can happen between now and that point in time.
Under the Radar Investment
Zimmer Biomet Holdings (ZBH $124)
Zimmer Biomet designs, manufactures, and markets orthopedic reconstructive implants, as well as needed supplies and surgical equipment for orthopedic surgery. The hands-down leader in the field, not only in the United States, but also in Europe and Japan, Zimmer owns some 4,500 patents and applications worldwide. With a highly motivated salesforce and under the strong leadership of CEO Bryan Hanson, we believe the company will continue to solidify its benchmark position. Over the trailing twelve months, Zimmer had sales of $7.9 billion and a net profit of $819 million. We believe the shares of this recession-resistant company are worth $200, or 61% more than their current trading price.
Answer
John and Henry Churchill leased 80 acres of land in Louisville, Kentucky to their nephew, Colonel Meriwether Lewis Clark Jr., grandson of explorer William Clark, in 1874. Clark happened to be president of the Louisville Jockey Club and Driving Park Association, and proceeded to build Churchill Downs, which opened in 1875. The first Kentucky Derby was held that same year at the field. With the infield open for the race, capacity at Churchill Downs is roughly 170,000.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Talk about paying for yourself many times over...
On Christmas Day, the Staples Center in Los Angeles, which was built in 1999, will become the Crypto.com Arena. Twenty-two years old may seem "seasoned," but it can't hold a candle to another arena in the country. What is the oldest sports stadium/arena still in use in the United States, and when was it established?
Penn Trading Desk:
Penn: Open Canadian cannabis player in the Intrepid
We believe that one Canadian cannabis firm is well poised to be the industry leader in the US once the drug is legalized at the federal level. Exemplary management, a just-announced acquisition which we love, and a discounted price (to our fair value) led to our decision to add the mid-cap growth company to the Intrepid Trading Platform. Our first price target is 50% above current price, while our second target is nearly double current price.
Penn: Open airline in the Global Leaders Club
Having written glowingly about one particular airline in a recent issue of The Penn Wealth Report, it is only fitting that we would pick it up as one of the 40 positions within the Penn Global Leaders Club, especially after the Omicron scare drove shares down near a 52-week low. Our initial price target is 57% above our purchase price, but we expect to own this forward-looking company well beyond its shares hitting our first target.
Penn: Open fintech giant in Global Leaders Club
Using some contorted logic (proving that efficient market hypothesis is bunk), investors have decided to place a dynamic fintech company in the "old financials" category. The Street's disinterest—or sheer disdain—has driven the price down on this excellent credit services company to the golden ticket range. Additionally, we have been actively searching for strong financial services firms at a reasonable price now that we are overweighting the sector. To see this latest addition to the Penn Global Leaders Club, which carries just 40 members, sign into the Penn Trading Desk.
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Cryptocurrencies
10. Come watch the Lakers play at the...Crypto.com Arena?
The meteoric rise of the nascent cryptocurrency market, already $2 trillion in size, has been remarkable. With each passing day, fewer experts seem willing to write the movement off as some sort of fad which will eventually implode. The latest evidence of which comes from California, where the crypto world is about to get some serious signage: Effective Christmas Day, the Staples Center will be renamed Crypto.com Arena. The marketing coup comes at a steep price for the privately-held company. We recall naming rights for stadiums in the $3 million per year price range, which always seemed a bit steep to us. Crypto.com will reportedly pay $700 million for a 20-year contract, which equates to $35 million per year. If those numbers are correct, this would be the second-largest naming rights deal in history, behind 2017's Scotiabank Arena deal in Toronto, which was valued at $800 million for 20 years. Keeping it closer to home, Staples paid $116 million for the previous 20-year deal with The Anschutz Entertainment Group, owner of the arena which has carried its name since 1999. Crypto.com is a low-cost cryptocurrency exchange, much like publicly-traded Coinbase Global (COIN $255), a member of the Penn Intrepid Trading Platform.
Yes, cryptocurrencies are here to stay, but it can be very difficult to separate the long-term winners from the inevitable multitude of losers. We purchased shares in the Coinbase exchange in June at $230 per share—well off of their $429.54 near-IPO price and below their current trading range. We can see why the Coinbase wallet is so attractive to crypto traders, and believe in the company's fundamental story. Our biggest concern about privately-held Crypto.com, despite the pretty cool Matt Damon advertisements, is country risk: it is headquartered in Hong Kong, which is now under the full control of the Communist Party of China.
Consumer Staples
09. Penn member Dollar General announces plans to open 1,000 new Popshelf stores to attract a wealthier clientele
We added Dollar General (DG $222) to the Penn Global Leaders Club—the home for holdings we expect to own for years—when shares of the discount retailer were discount priced themselves, at $71.06. It has been a relatively straight trajectory up from there: shares of the $51 billion Tennessee-based retailer are now trading north of $220. With more than 18,000 stores across the United States, the company's bread-and-butter customer base has been households with annual incomes of 40,000 or less, and we consider the investment an excellent defensive play for any economic downturn. Now, Dollar General has an interesting plan to widen its total addressable market. The company has been testing a concept store called Popshelf which is designed to attract a younger, wealthier group of shoppers. The roughly 9,000 square foot stores have been so popular that management has announced an aggressive plan to open 1,000 Popshelf locations by the end of fiscal 2025. Targeting suburban women with household incomes of between $50,000 and $125,000, the stores will present a bright and lively image, with the mix of goods changing frequently to create a "treasure hunt" vibe. Shoppers searching for unique gifts, holiday decorations, or party supplies should be able to find what they are looking for, all at a reasonable price. We applaud the move, and look forward to checking out one of the new locations. For the first time in its 80-year history, Dollar General also announced it would be delving into the international market, opening ten stores in Mexico by the end of FY 2022.
Despite our success in the position, Dollar General continues to be an overlooked gem by so many retail analysts. That is simply a mistake on their part. For all of its tremendous growth within the Club, it carries a tiny price-to-earnings ratio of seven and an enviable financial position. While others chase multiples that don't exist (because they won't turn a profit for years—if ever), give us an income-generating machine like DG any day.
Multiline Retail
08. Our favorite retailer, Target, gives an early Christmas gift to both customers and employees
Retail juggernaut Target (TGT $248), whose shares have risen 295% in value since we added it as a Consumer Defensive play within the Penn Global Leaders Club under three years ago, has faced two catalysts over the past week which have sent shares lower. Ironically, we love both of them. The first came in the statement following last Wednesday's earnings release. Masterful CEO Brian Cornell, such a different leader than the hapless Gregg Steinhafel, said that the $120 billion retailer was in a "strong inventory position heading into the peak of the holiday season...." Investors were fine with that statement, but when Cornell warned of higher expenses and trimmed gross margins due to inflation and supply constraints, and asserted that Target could "tolerate lower margins if it meant keeping prices (lower for consumers)," which would be fine with him, that was simply too much. A retailer putting customers above fatter margins when those costs could quite easily be passed along? That simply did not compute for investors, which sent the shares down 4% in the pre-market, despite healthy year-on-year revenue and earnings growth. The second share drop within a week came after the company announced that not only was it going to be closed this Thanksgiving, it will remain closed on the holiday in future years as well. What century does Cornell think he is living in? That shaved another 4% or so off of the share price. Two excellent decisions met with derision. That sounds about right.
Some days we watch and listen to an endless stream of malleable, weak, milquetoast CEOs as they contort themselves into odd shapes to prove how enlightened they are. And other days we come in and see something refreshing: true leadership. Cornell's skill at the helm is a major reason why Target remains a shining star in the Penn Global Leaders Club.
Global Strategy: Middle East
07. "Insanity" is how Erdogan's demanded rate cuts in the face of 20% Turkish inflation is being described
To set the stage: Turkey is not a US ally, despite that country's longstanding NATO membership. Under the mercurial leadership of President Recep Tayyip Erdogan, Russia seems to have more influence than does the West, despite Turkey's desire to be seen as part of the EU rather than the Middle East. Under that backdrop comes the bizarre economic situation going on in the country of 85 million people. The main reason that the central bank in the US will probably raise rates at least twice next year is to dampen the rate of inflation, which is currently well above the 2% target range. In Turkey, inflation is running at a nightmarish (for consumers) pace of 20%, so what does Erdogan do? He orders the country's central bank to lower rates. Hence the claims of insanity. And for anyone who believes that the president didn't order the cuts consider this: he has fired three central bank chiefs in the past two years for daring to question his monetary views. Erdogan's defense is that he is waging "an economic war of independence." His strange war has had quite the impact on the Turkish lira, which is now trading at 13:1 versus the US dollar. So, for the unfortunate Turkish worker, this means that their paycheck is being watered down on a daily basis while prices at the local bazar or supermarket are simultaneously going up on a daily basis. A recipe for disaster. Somehow, despite the economic nightmare, Erdogan has still managed to finance the expensive purchase of a Russian-made S-400 missile defense system—a system designed to thwart the most advanced US fighters. To counter the move, the US has removed Turkey from the F-35 joint strike fighter program at a cost of half a billion dollars. The only good news about the economic situation Erdogan is causing within his country is that he will be forced to play defense, taking time away from his mental musings on how to foment more trouble in the region.
It is going to take an uprising by the Turkish people to remove Recep Tayyip Erdogan from power. Despite the fact that his second five-year term, which will end in 2023, should make him ineligible for running again, any bets on who will still be the Turkish president in 2024 and beyond? While that country's constitution prohibits a third term, when has a legal document ever stopped a dictator? Look no further than Vlad Putin. As for a Turkish uprising, sadly, look no further than Venezuela for evidence that those odds, despite the human suffering, are slim to none.
Economics: Work & Pay
06. Trying to dissect the Rorschach test that was the November jobs report
It is always difficult to gauge how investors will react to any given monthly jobs release: a positive report often results in a market downturn, while a lousy one can be a catalyst for gains. Go figure. Even by those standards, November's results and subsequent investor response was a bit strange. Immediately after the release of the jobs survey, which showed a paltry 210,000 new jobs being created in the country against expectations for gains of 550,000, futures rose. This was based on the assumption that the Fed would back off of their threat to end their bond buying program quicker than the current reduction of $15 billion per month. Within the details of the report, however, came some good news: the labor force participation rate—the percentage of Americans of working age either already employed or looking for work—rose to 61.80%, which is the highest level since pre-pandemic. That equates to 600,000 or so Americans re-entering the workforce. Buttressing that point was the household survey section of the report showing that payrolls actually rose by 1.1 million in November. Why the discrepancy? The headline figure represents employers reporting how many hires they had in the month, while the household survey includes individuals moving to self-employed status. In other words, a record number of Americans just started working for themselves. This would also explain why the unemployment rate fell more than expected, to 4.2%. The internals were enough to bring back investors' fear of the Fed tightening quicker than expected to help quell inflation, leading to a 500-point intra-day swing in the Dow. But the Dow's reversal was nothing compared to the NASDAQ and Russell 2000 small-cap index, with each benchmark losing around 2% on the day. It was one of those odd weeks where everything fell in tandem: stocks, bonds, gold, cryptos, and the 10-year Treasury all ended the week in the red.
Following a negative third quarter of the year, a down November for the markets, and a rough start to December, we revisited our January 1st prediction for the year-end S&P 500: 4,300. That would have represented a healthy 14.5% gain on the year. On the Friday of the jobs report, the S&P 500 closed at 4,538, or 238 points above our projection for the year. Granted, anything can happen in any given market week, but we are still looking at a quite strong 2021. The big question for next year will be how investors digest the end of tapering and two to three probable rate hikes.
Interactive Media & Services
05. A visual of the world's largest social media networks and who owns them
Thanks to Visual Capitalist for providing this rather stunning graphic of who actually dominates the explosive world of social media. Shortly before they changed their name to Meta (FB $317), we added shares of $900 billion Facebook back into the Penn Global Leaders Club after a hiatus. Looking beyond the ceaseless attacks by politicians on both sides of the aisle, we believe this company's embrace of the metaverse will lead to a long-term growth trajectory beyond the scope of most analysts' imagination. From a social media usage standpoint, nobody comes close: Meta companies (Facebook, Instagram, WhatsApp, and Messenger) have an aggregate 7.5 billion monthly active users (MAUs), which equates to advertising pricing power miles ahead of the competition. (To be clear, if one person uses all four platforms, as we do, they would be counted four times; still, those numbers are remarkable.) From an individual platform standpoint, Alphabet's (GOOG $2,882) YouTube comes in second to Facebook, with 2.3 billion MAUs. We already own the third largest controlling company on the list, Microsoft (MSFT $326; Skype, LinkedIn, Teams), which continues to be one of our highest conviction names. Skipping over Snap (SNAP $48), which we have never been fond of from an investment standpoint, we come to Twitter (TWTR $45) and its 463M MAUs. Now that Dorsey is gone, we are actually considering picking up some shares of TWTR for the Intrepid Trading Platform. We believe the promotion of Chief Technology Officer Parag Agrawal to the CEO role makes sense for a company which hasn't been able to effectively monetize its business model. Then again, we also thought it made sense for JC Penney to hire Ron Johnson—the guy who created the Apple store model—as CEO, so it is always prudent to wait for evidence of leadership abilities before jumping in. As for the red balls on the list, the Asian names, we wouldn't touch any of them.
At the risk of being labeled a metaverse fanatic, most truly don't understand how the two-dimensional world of social media will morph over the coming years into something truly interactive. Facebook is proven it is all in, which is why it is our number one play in the interactive media and services space.
Application & Systems Software
04. DocuSign shares plunged over 40% in a day; are they a screaming buy right now?
For obvious reasons, shares of DocuSign (DOCU $144), the benchmark in remote document signing technology, skyrocketed during the pandemic-forced lockdown, climbing from $90 in February of last year to $314.76 per share by summer. After a billings miss and a guide-down in the latest quarter, however, the company is now valued at less than half of what is was last year. So, at $144, should investors buy into the story? Although DocuSign has yet to turn a profit, and competing products such as Adobe Sign are gaining traction, the company still posted an impressive revenue growth rate of 50% last quarter. Subscriptions, which give the company a recurring income stream, rose 44% year over year, and over one million customers are now using the e-Signature suite of products. With mass adoption of electronic signatures in virtually every industry, from financial services to health care to government agencies, we tend to agree with management's assessment of a $50 billion total addressable market (TAM), meaning there is still enormous growth potential ahead. Will DocuSign continue to be the company eating away at most of that TAM? Despite so many throwing in the towel after the latest earnings report, we believe they will.
While we do not currently own DocuSign in any of the Penn Portfolios (we do own competitor Adobe in the Global Leaders Club), we do believe the shares will rise back to the $250 range before long. That would signify a 70% jump from the current share price.
Textiles, Apparel, & Luxury Goods
03. Allbirds was overpriced from the start, which is one reason its shares have been slashed in half
We are constantly scanning the IPO calendar, looking for under-the-radar names that won't be devoured by investors at the initial open, driving prices to outrageous levels. Allbirds (BIRD $16) seemed like it had potential; after all, who would get too excited about an athletic footwear maker going public? After pricing 20 million shares at $15 apiece the night before the big debut, we decided to buy in if they fell to the $10-$12 range after trading began. Instead, retail investors gobbled BIRD shares up right out of the gate, driving the price up to an intraday high of $32.44 on the third of November. So much for that trade. One month later, on the 3rd of December, shares had dropped to $13.91 intraday—a 57% course correction. So, are we entertaining the trade once again? Not really. Allbirds shoes are pretty cool, and sales continue to be strong despite the fact they don't believe in discounting the price. The company's self-proclaimed raison d'être is to bring the world eco-friendly and environmentally-sourced shoes. It is hard to go a paragraph deep into any of their ads or press releases without reading the word "sustainability." While management's efforts in this area may be commendable, their words might carry more weight if such a large percentage of Allbirds products weren't made in China—not exactly the ESG capital of the world. In the company's first earnings report since going public, sales came in at $63 million for the quarter funneling down to a net loss of $14 million. For comparison's sake, in its latest quarter $1.1 billion footwear retailer Designer Brands (DBI $16) notched sales of $817 million and had a positive net income of $43 million. Despite its current "discount" from highs, Allbirds seems ripe for another turn downward in the next general market correction.
IPO days for companies we are interested in can be stressful. Trading volatility is high, and the stock price can literally double on the first tick out of the gate. Patience is paramount; if you are priced out (based on your mental buy price) immediately, be patient, as you will have another chance to buy in at a lower price. Even with companies such as Facebook and Tesla, this has always been the case. Use the emotions of others to create wealth in the markets rather than letting your own cloud your judgment.
Pharmaceuticals
02. Pfizer lab studies show third dose of vaccine (the booster) effectively neutralizes the omicron variant of disease
Futures went from negative to positive on Wednesday after pharma giant Pfizer (PFE $51) announced that its lab studies have shown a third dose of the company's Covid-19 vaccine, otherwise known as the booster shot, effectively neutralizes the highly-transmissible omicron strain of the disease. Uncertainty about and fear over the strain helped wreak havoc on markets over the prior two weeks. Researchers at the New Jersey-based firm observed a massive drop in effectiveness of just two doses of the vaccine against this latest strain, yet those who received the booster showed a restored level of protection. Nonetheless, Pfizer continues work on an omicron-targeted shot which may be ready as soon as early spring. More good news: it now appears that the current variant spreading throughout the world, despite its rate of transmission, is less virulent than prior strains, meaning fewer deaths and hospitalizations. On the heels of the Pfizer test results, Cantor Fitzgerald reiterated its Overweight rating on the company and $61 price target on the shares, noting that "...Pfizer's vaccine sales for Covid-19 remain underappreciated by the Street." We couldn't agree more.
Presently, there are some real bargains in the pharmaceutical and biotech space. It is as though investors believe that the entire industry rests on what happens next with respect to Covid-19. Meanwhile, the pipeline of therapies being developed for other life-threatening diseases and maladies has never been deeper. IBB, a cap-weighted ETF of biotech companies, is down 1% on the year, while XBI, an equal-weighted basket of 188 biotechs (and our preferred vehicle in the space) is down over 17% year-to-date. That smells like opportunity.
Economics: Supply, Demand, & Prices
01. The highest inflation rate in forty years didn't dampen the markets
We expected the CPI numbers for November to be bad, and they were. Hitting a rate not seen since 1982, the US Department of Labor announced that the consumer price index (CPI), which measures what consumers pay for a wide swath of goods and services, rose 6.8% annualized in November—the sixth-straight month in which the inflation rate was above 5%. For reference, the Fed's inflation target sits at 2%, and we all recall how "stubbornly low," to use Powell's own words, it was not that long ago. Even stripping food and energy out of the mix, the rate still climbed to 4.9%. What is leading the inflationary charge? Homes are up nearly 20% year-on-year, new vehicles 11%, used vehicles 27%, and fast food prices 8%—just to give a few examples. Unfortunately, while wages have climbed, they are not matching the jump in the price of goods. The Atlanta Fed reported that wage growth was 4.3% in November, annualized.
Oddly enough, the markets largely ignored Friday's CPI release, with the three major indexes (the small caps did not participate) gaining ground on the day. For the week, even the beaten-down Russell 2000 pulled out a gain of 0.76%. Meanwhile, the S&P 500, the DJIA, and the NASDAQ all reclaimed ground not seen since before the prior two week market downturn. We have three weeks left in the month, but December is suddenly looking like it might bring its usual dose of holiday cheer to investors. Of course, next week's Fed meeting could throw a monkey wrench into the works: Fed Chair Powell is highly expected to speed up the rate of taper, perhaps from $15 billion per month to $30 billion per month, which would end the bond buying program by March. Stay tuned.
With the taper now expected to end by next March, economists are raising their expectations for rate hikes next year. The general consensus is one hike by early summer, and two beyond that in 2022. Where will it end? When the target Fed funds rate gets to 2% to 2.5% (the upper band is at 0.25% now), we expect the Fed to halt. Of course, anything can happen between now and that point in time.
Under the Radar Investment
Zimmer Biomet Holdings (ZBH $124)
Zimmer Biomet designs, manufactures, and markets orthopedic reconstructive implants, as well as needed supplies and surgical equipment for orthopedic surgery. The hands-down leader in the field, not only in the United States, but also in Europe and Japan, Zimmer owns some 4,500 patents and applications worldwide. With a highly motivated salesforce and under the strong leadership of CEO Bryan Hanson, we believe the company will continue to solidify its benchmark position. Over the trailing twelve months, Zimmer had sales of $7.9 billion and a net profit of $819 million. We believe the shares of this recession-resistant company are worth $200, or 61% more than their current trading price.
Answer
John and Henry Churchill leased 80 acres of land in Louisville, Kentucky to their nephew, Colonel Meriwether Lewis Clark Jr., grandson of explorer William Clark, in 1874. Clark happened to be president of the Louisville Jockey Club and Driving Park Association, and proceeded to build Churchill Downs, which opened in 1875. The first Kentucky Derby was held that same year at the field. With the infield open for the race, capacity at Churchill Downs is roughly 170,000.
Headlines for the Week of 07 Nov — 13 Nov 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The last time inflation was this hot...
With inflation at its highest level since December of 1990, let's take a trip down memory lane. What was the top-grossing movie in that month, 31 years ago? Hint: It had somewhat of a Christmas-related theme.
Penn Trading Desk:
Penn: Close American Campus Communities in the Strategic Income Portfolio
In the summer of 2020, rumors of kids not returning to dorm rooms in fall began circulating throughout the financial press. These concerns hammered our favorite student housing REIT, American Campus Communities (ACC $54). We never bought into the hype, and added ACC to the Strategic Income Portfolio (it had a dividend around 5%) at $34.43 per share. Now, with shares sitting near their 52-week high and carrying a lofty valuation, we took our 57% profit off the table. We still believe in the company, but the shares seem a bit rich to us at this level. Additionally, we are building our cash position.
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Leisure Equipment, Products, & Facilities
10. If you were upset that you missed Peloton's massive share price run-up, you have been given a second chance
We added exercise equipment company Peloton (PTON $50) to the Intrepid Trading Platform way back in February of 2020 (which seems like a lifetime ago) at $29.11 per share. While we had a nice gain in the position, we certainly missed the majority of the run-up as it rocketed all the way to $167.42 in the early days of the pandemic. The company makes the best-selling treads and stationary bikes on the market, but we have had misgivings about its rather mandatory subscription service—it costs $39 per month and the hardware/software interface makes it difficult to do without. As could be expected, the return to some semblance of normalcy has led to a resurgence in gym memberships and a slew of lowered price targets for this "stay-at-home" play. The company has also dealt with recalls following the well-publicized safety issues of its pricey Tread+ and an ongoing battle with the Consumer Product Safety Commission. The company's problems hit a crescendo last week when Peloton's management team lowered full-year guidance and reported a net loss of $376 million for the latest quarter. With most analysts slashing their price targets nearly in half, and the shares falling 70% from their intraday highs of 14 Jan 2021, is the damage done or does this portend more pain ahead? That will depend on how management responds to its three imminent threats: increased competition in the space, safety issues, and a consumer base ready to get back out into the world.
As we write this, PTON shares have fallen to the $50 range. The company, for all of its challenges, is not going anywhere, and we believe it will effectively deal with its issues. It should be noted that the company sells a large percentage of its equipment to health clubs, universities, and hotels—though it doesn't give investors a breakout of its commercial sales. Additionally, Peloton just completed its $$420 million acquisition of Precor, an exercise equipment manufacturer which primarily sells to commercial entities such as hotel chains, picking up 625,000 square feet of manufacturing space in the process. While we don't currently own PTON in any Penn strategy, $50 seems like a tempting buy point.
Fintech
09. PayPal's Venmo unit strikes deal with Amazon to become a payment option at checkout; we remain bullish
Just last month we were talking about PayPal's (PYPL $229) supposed $40 billion acquisition of Pinterest (PINS $47). While the company quickly quelled those rumors, we do believe they were actually interested in buying the social media platform. Feeling the heat from competitors such as Square (SQ $237), which recently paid $29 billion for buy now-pay later firm Afterpay, the company desperately wants to expand its fintech offerings. While that transaction never happened, the company's Venmo unit did just notch a big victory: it inked a deal with online behemoth Amazon (AMZN $3,489) to become a checkout option for customers at Amazon.com. Considering Amazon is responsible for over 40% of online purchases, that is a pretty big deal. PayPal made the announcement during its mixed-quarter earnings report. While revenues in Q3 rose from $5.46 billion to $6.18 billion year-on-year, that 13% increase fell slightly below analyst expectations. Profits, however, did beat expectations of $1.07/share, with net revenue actually jumping to $1.11/share. Shares were little changed after hours following the earnings report and the announcement. PayPal was spun off from eBay six years ago and has 377 million active accounts, including 29 million merchant accounts.
For some reason, PayPal has been portrayed by many as "old school" fintech. That is simply inaccurate. It is a $270 billion fintech giant, and the leader in the secure online payment space. While we were sorry to see the Pinterest deal fail to manifest, management is not done searching for a good fit. CEO Dan Schulman will not sit idly by while new upstarts eat into his company's market share. We place a fair value on PYPL shares at $300, but investors may want to see if continued Wall Street pessimism pushes them down to the $200 range before considering a purchase.
Industrial Conglomerates
08. Following 1-8 reverse split, GE now says it will split into three firms
Just three months ago, storied industrial giant General Electric (GE $116) performed a 1-8 reverse split, making its shares magically go from $13 to $105 in an instant. Now, GE's management team has announced another split: the company itself will be divided into three parts. The GE name will live on in the new aviation company, while the healthcare and energy units will become separate entities. All of these moves, however, won't allow the disparate companies to escape from the aggregate debt racked up by years of mismanagement; debt which could not be erased by the continual fire-sale of units, such as the 2016 sale of GE Appliances to Chinese conglomerate Haier for $5.6 billion, or the sale of GE lighting to Savant Systems in 2020 for an undisclosed amount. At least Savant is manufacturing the light bulbs in the US (as evidenced by an old package of GE bulbs which reads, "Made in China," versus a newer package we found which reads, "Made in USA"). While the spinoff of the healthcare unit won't take place until the end of 2023, and the energy spinoff won't happen until the end of 2024, investors cheered the move by driving GE shares up 6% in the pre-market following the announcement. CEO Larry Culp told Barron's, "It is a wow sort of day." That is about the response we would have expected. At least we didn't have to listen to Jeffrey Immelt bloviating some long-winded response from the cabin of one of his two personal corporate jets.
What would we do if we still held GE shares in any of the Penn strategies? Take the spike in price as an opportunity to exit the position. We certainly wouldn't wait around three years for the completion of the spinoffs. As for GE, with Culp running one company, perhaps the board should invite the other two post-Jack Welch CEOs—Immelt and Flannery—to take the respective helm of the other firms.
Hotels, Resorts, & Cruise Lines
07. Airbnb prepares for "golden age of travel" with new tools built around the hybrid work environment
We fully planned to add shares of Airbnb (ABNB $195) to one of the Penn strategies on its long-anticipated IPO day. Alas, it shot out of the gate so quickly that we could not justify the rich valuation. The company has inarguably changed the travel landscape, with its platform boasting some 5.6 million active accommodation listings worldwide. While the major hotel chains have effectively fought back to avoid losing market share, and a number of competitors have since tried to replicate their business model, we remain bullish on the company's long-term strategy. To that end, the $124 billion travel/tech firm has announced the rollout of some 50 new features designed to take advantage of the new, post-covid world; a world in which remote work is no longer the exception, and a large percentage of travel has morphed into a business/leisure affair. The company is placing a greater focus on its customers who book long-term stays of four weeks or longer, as that is now its fastest-growing segment. The suite of new tools will include the ability to verify wi-fi speeds to assure an effective work environment, and a listings search which will now go out a year into the future. For hosts, Airbnb is rolling out AirCover, an insurance program which offers $1 million in both damage protection and liability coverage, as well as "deep-cleaning" protection. As for the company's third-quarter earnings, they were off the charts. Revenues came in at $2.24 billion versus $1.34 billion in the same quarter of 2020 (+67%), and profits rose 280% y/y for the quarter, to $834 million. The company gave bullish guidance for Q4, with expectations that the rosy projections will carry into 2022.
Morningstar places the fair value of ABNB shares at $102. While we don't buy into that valuation, a price floating around $200 per share is still too rich for us. Looking elsewhere in the industry, our favorite hotel chain—Hilton Worldwide (HLT)—also seems richly priced at $147 per share (1,200 P/E). Ditto online travel agency Booking Holdings (BKNG $2,641), with its 288 multiple. Our advice? Wait for the inevitable pullback in these travel names.
Economics: Supply, Demand, & Prices
06. Inflation on the price of consumer goods just came in scorchingly hot; is it a blip or cause for serious concern?
Anyone who fills their tank, shops for groceries, pays their rent, or—gulp—needs a new or used car knows that inflation is a reality. Forget the anecdotal stories, here is the data: the US Department of Labor just announced that consumer prices surged 0.9% from September to October, driving the y/y rate up to 6.2%. That marks the highest rate since December of 1990, and the fastest pace of inflation since the summer of 1982. The rate even exceeded the 5.4% spike economists had projected. As for the ten million missing workers in the US, expect the price of goods to drive them back to their well-paying jobs soon. Serious supply chain issues certainly play a major role in the price spike, but the upward pressure on wages is another major factor; industries across all sectors are being forced to pay their workers more. While the supply chain issues should begin to subside by early next year, the higher wages are probably here to stay, which is good news in itself, but tempered by the fact that inflation is eating away at those wages. Management teams have been echoing the same sentiment: price increases must be passed along to the consumer, and the pricing power is in place to allow those increases without facing much pushback. In other words, Americans seem willing to pay more for lumber, autos, travel, and Christmas gifts this year. The Fed has already implemented its plan to reduce bond buying by $15 billion per month until it hits zero, and telegraphed plans to begin raising interest rates by late next year. If inflation reports keep coming in hot, however, they may need to quicken their pace. And that is a specter investors may not be prepared to handle with aplomb.
Products such as gasoline may be inelastic, but we believe inflation across the board will cause shoppers to become more sensitive to higher prices on easily-substituted goods and services. And the online shopping genie is out of the bottle, meaning consumers can perform their due diligence with ease. While the days of the Fed worrying about sub-2% inflation may be gone, the fears of long-lasting and severe price jumps have been overblown. This is not the 1970s all over again. From an investment standpoint, we have increased our allocation to the financial sector, which will be one of the areas poised to gain by higher interest rates.
Automotive
05. Making sense of Elon Musk's tweet asking followers whether or not he should sell 10% of his Tesla shares
Last Saturday, Elon Musk posed the following question to his 63.3 million Twitter followers: "Much is made lately of unrealized gains being a means of tax avoidance, so I propose selling 10% of my Tesla stock. Do you support this?" In a roughly 60/40 split, with 3.5 million voters (including us, we voted in the affirmative), the answer was "yes." While we wouldn't label the tweet as a gimmick, as many business journalists have, it is true that Musk really has no choice but to sell a good portion of his shares. Due to Tesla's achievement of some remarkably high targets, Musk has around 23 million vested stock options from 2012 with a strike price of roughly $6 per share. These options will expire next year, so he must exercise them and take the ordinary income (not realized gain) tax hit on the difference between $6 and the share price when he sells. Considering the shares are currently trading around $1,082, that tax bill we be enormous. In fact, it will probably be the largest single tax bill paid by an individual in history. (Though we doubt he will get a thank you card from the IRS or any politicians on the Hill.) Tesla also hit challenging targets which gave Musk options to purchase another 101 million shares at around $70 per share. These were issued in 2018, and represent about 5% of all outstanding shares.
In trading action this week, Musk sold approximately 5 million of his Tesla shares, grossing him around $5 billion. Between the federal government and the state of California, and between ordinary income tax and capital gains, about 54% of that amount will disappear in the form of taxes. Musk, who has never taken a salary from Tesla, once famously quipped to his brother Kimbal, who had asked him for a loan, "You do know that I don't actually have any cash, right? I have to borrow." While his trades this week will certainly put some cash in his pocket, we fully expect him to make good on his promise to live by the results of the twitter poll; if for no other reason than to pay the $7 billion or so the IRS will soon come calling for due to his remaining options. Even after all of the sales are complete, Musk will still own around 15% of outstanding TSLA shares, or more than double the amount of the next largest shareholder, Vanguard Group. Last month, Elon Musk became the first person in the world to achieve a net worth in excess of $300 billion, eclipsing that of the second-place Jeff Bezos, who is worth around $200 billion.
Even at $1,085 per share, we still consider Tesla, which we own in the Penn New Frontier Fund, a buy. All of the critics who argue that Ford, GM, Volkswagen, and a slew of startups will end up dooming the company seem to assume that Tesla will simply stand still. As usual, they will be proven grossly wrong. We would place the current fair value of TSLA shares at $1,800.
Media & Entertainment
04. Disney shares hit a ten-month low following an unexpectedly-rough quarter
Our lack of confidence in Disney's (DIS $162) new management team has been well articulated. It has been clear in our writings that we have little confidence in the company's new CEO, former parks head Bob Chapek, to lead the American icon going forward. Perhaps we received the first hard evidence of that view via the company's fiscal Q4 earnings report. The company missed on both the top and bottom lines, and it was downhill from there. While revenues grew 26% y/y for the quarter, to $18.5 billion, analysts were expecting more, especially considering the park restrictions due to covid in the same quarter of last year. Earnings per share came in a whopping 73% below estimates, at $0.37 adjusted. But the worst news, perhaps, came in the subs figure for the Disney+ streaming service. After adding 12 million new subscribers in the previous quarter, the company added just 2.1 million new subs in fiscal Q4. That is around 9.4 million fewer than analysts were expecting. The average monthly revenue per subscriber (ARPS) for Disney+ also dropped year-on-year, to $4.12, thanks to special bundle pricing for the Indonesia and India markets. Certainly, the return to the office for millions of Americans had an impact on the muted numbers, and park activity will continue to pick up, but investors gave a thumbs-down to the earnings report: Disney shares fell 7% in the following session, hitting a new ten-month low.
Disney was a company we never wanted to remove from the Penn Global Leaders Club; but, like Boeing, General Electric, and McDonald's, concerns over management forced us to make the move. After the big drop, are the shares undervalued? We don't believe so. Perhaps we will take another look if they get down below their 52-week low of $134.
Global Strategy: Eastern Europe
03. The US has warned Europe to be prepared for a potential Russian invasion of Ukraine
Russia's mercurial de facto dictator, Vladimir Putin, doesn't need an excuse to cause problems and wreak havoc, but he currently has two: a migrant issue and a pipeline issue. And, according to the Biden administration, Ukraine might be the battleground. The US has warned its Western allies in Europe that Russia is building up its forces near the Ukrainian border, and some level of military operations in the country—to include a possible invasion, may be in the cards. On the energy front, tensions have been heated between Western Europe and Russia, which provides nearly half of the natural gas to countries such as Germany. (Poland, it should be noted, receives most of its natural gas from the United States, after shunning Russia's Gazprom.) Putin is demanding that European regulators immediately approve the already-built Nord Stream 2 gas pipeline which runs between Russia and Germany. Despite Europe's severe gas crunch and skyrocketing LNG prices, the pipeline is in limbo due to Germany's new left-leaning government which is currently being formed. The US and Ukraine have vehemently opposed the pipeline. On the migrant front, thousands of Belarus refugees have flocked to that Russian ally's border with Poland in an attempt to get into Western Europe. Poland, a staunch US ally, has held firm on the issue, with full backing from the EU. This has enraged the president of Belarus, Alexander Lukashenko, who is now threatening to cut off LNG supples from another pipeline which travels from Russia to the West. All of this comes at a time when energy prices are at multi-year highs, meaning Russia, which has an energy-based economy, is suddenly feeling even more emboldened than usual.
For all of America's challenges, Europe is currently getting hit with crises on all sides of the economic spectrum, from a new wave of the pandemic to the severe energy problems. Granted, many of these challenges are from self-inflicted wounds, but the best course of action they could take right now is to make Putin understand that military action on his western front will not be tolerated. Sadly, the historical record of Europe standing up to bullies is spotty, at best.
Specialty REITs
02. Penn member American Tower to buy data center REIT CoreSite Realty in $10 billion deal
We purchased specialty REIT American Tower Corp (AMT $261), owner and operator of over 185,000 cell towers around the world, back in March of this year. The addition took advantage of two of our favorite themes: real estate and 5G technology. After hitting our initial target price within eight months, the company made a move we fully embrace: it will acquire data center REIT CoreSite Realty for $170 per share in cash—roughly $8.3 billion—plus the assumption of its $2 billion or so of debt. We believe it was a smart move by a skilled management team, led by AMT CEO Tom Bartlett. With the bolt-on acquisition of CoreSite, AMT will add data and cloud management capabilities to its offering mix, fully complimenting its wireless communications business. We suddenly find ourselves with two of our favorite growth drivers in the REIT world—5G towers and data centers—morphed into one position within the Penn Global Leaders Club. Furthermore, the company's reach is truly global, with 75,000 towers in Asia/Pacific, 43,000 in North America, 42,000 in Latin America, 20,000 in Africa, and 5,000 in Europe. For its part, CoreSite operates 24 data centers in major urban hubs such as Boston, New York, Miami, Chicago, and Los Angeles.
AMT shares are down about 4% on the news, as is typical for an acquiring company immediately after a deal has been announced. For investors who have missed the run-up to this point, we believe the shares remain in an attractive buy range. REITs are an important part of a portfolio, but we are highly concerned about the rapidly-changing landscape for retail and office REITs. Data centers and towers, as mentioned, will be two of the strongest growth drivers for the industry going forward.
Food Products
01. Oatly shares just plummeted another 21% in one session, now down 68% from their high
We first wrote about oat milk products company Oatly Group AB (OTLY $9) when the Swedish firm went public back in May. After the IPO priced at $17, shares rose 37% almost immediately. By the 16th of June, they had topped out at an intra-day high of $29 per share. We believed they were overvalued from day one, and reminded investors of the competition in the space. Just because a company appears to be in the stream of a fast moving theme—like plant-based products, they are not automatically good investment candidates. That is a story we have seen in constant reruns for the past 25 years. Alas, reality just hit OTLY shares after the company reported a revenue miss, greater losses than expected, and a warning from management with respect to the full-year's guidance. On top of the dismal financials, it was also reported that a quality issue in one of Oatly's production facilities will result in destroyed product and lost sales in the EMEA (Europe, Middle East, Africa) region. Perhaps the worst news of all: arch-competitor Chobani has officially filed to go public, and Danone, owner of the Silk brand of plant-based "milks," announced it is doubling-down on its "Oat-Yeah" product line. Oatly had a rough summer; it appears that the company is headed for an ugly winter.
When we first wrote of Oatly's debut, we said the shares were overvalued but might be worth a look if they dropped below $20. They are now sitting at $9.36 and still don't seem like a bargain. We can't figure out what the company's unique value proposition is, and even its commitment to the ESG (the most overused acronym in the global corporate environment) movement is being questioned by the environment police. Shares may seem cheap, but we wouldn't touch them.
Under the Radar Investment
Callaway Golf (ELY $29)
Callaway Golf Company is a mid-cap ($5.5B) leisure products firm dedicated to the game of golf. The company's golf equipment segment manufactures golf balls and clubs, while its apparel and gear segment manufactures golf shoes, clothing, bags, and practice aids. Just a few years ago, articles were written of the sport's imminent demise in the United States, and advice was given on how to extend its lifespan by silly actions such as doubling the size of the hole to make the game easier for inexperienced players. What nonsense. As is so often the case, the self-proclaimed experts were dead wrong, and the 270-year-old sport is going through a renaissance in this country—thanks in part to the pandemic. Another reason for the game's resurgence and popularity among a younger demographic base is a company called Topgolf, a global sports entertainment venue headquartered in Dallas, Texas. With seventy locations throughout the world, these tech-driven operations have created a new generation of golf enthusiasts. Imagine morphing a video game, nightclub, and personal sports experience into one, and you get an idea of why the facilities are so popular. This year, Callaway Golf completed its acquisition of Topgolf for $2.6 billion in stock and announced aggressive—but methodical—expansion plans. At $29 per share, Callaway has a near-single-digit multiple, a strong balance sheet, and a viable growth strategy. Not many leisure companies can boast those attributes. We would put a fair value on ELY shares at $40.
Answer
In December of 1990, America was still in the midst of Operation Desert Shield—it wouldn't turn into a "Storm" until the following month. The top grossing film in December was Home Alone, which grossed $90 million throughout 2,173 theaters, followed by Dances with Wolves, Misery, and Kindergarten Cop.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The last time inflation was this hot...
With inflation at its highest level since December of 1990, let's take a trip down memory lane. What was the top-grossing movie in that month, 31 years ago? Hint: It had somewhat of a Christmas-related theme.
Penn Trading Desk:
Penn: Close American Campus Communities in the Strategic Income Portfolio
In the summer of 2020, rumors of kids not returning to dorm rooms in fall began circulating throughout the financial press. These concerns hammered our favorite student housing REIT, American Campus Communities (ACC $54). We never bought into the hype, and added ACC to the Strategic Income Portfolio (it had a dividend around 5%) at $34.43 per share. Now, with shares sitting near their 52-week high and carrying a lofty valuation, we took our 57% profit off the table. We still believe in the company, but the shares seem a bit rich to us at this level. Additionally, we are building our cash position.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Leisure Equipment, Products, & Facilities
10. If you were upset that you missed Peloton's massive share price run-up, you have been given a second chance
We added exercise equipment company Peloton (PTON $50) to the Intrepid Trading Platform way back in February of 2020 (which seems like a lifetime ago) at $29.11 per share. While we had a nice gain in the position, we certainly missed the majority of the run-up as it rocketed all the way to $167.42 in the early days of the pandemic. The company makes the best-selling treads and stationary bikes on the market, but we have had misgivings about its rather mandatory subscription service—it costs $39 per month and the hardware/software interface makes it difficult to do without. As could be expected, the return to some semblance of normalcy has led to a resurgence in gym memberships and a slew of lowered price targets for this "stay-at-home" play. The company has also dealt with recalls following the well-publicized safety issues of its pricey Tread+ and an ongoing battle with the Consumer Product Safety Commission. The company's problems hit a crescendo last week when Peloton's management team lowered full-year guidance and reported a net loss of $376 million for the latest quarter. With most analysts slashing their price targets nearly in half, and the shares falling 70% from their intraday highs of 14 Jan 2021, is the damage done or does this portend more pain ahead? That will depend on how management responds to its three imminent threats: increased competition in the space, safety issues, and a consumer base ready to get back out into the world.
As we write this, PTON shares have fallen to the $50 range. The company, for all of its challenges, is not going anywhere, and we believe it will effectively deal with its issues. It should be noted that the company sells a large percentage of its equipment to health clubs, universities, and hotels—though it doesn't give investors a breakout of its commercial sales. Additionally, Peloton just completed its $$420 million acquisition of Precor, an exercise equipment manufacturer which primarily sells to commercial entities such as hotel chains, picking up 625,000 square feet of manufacturing space in the process. While we don't currently own PTON in any Penn strategy, $50 seems like a tempting buy point.
Fintech
09. PayPal's Venmo unit strikes deal with Amazon to become a payment option at checkout; we remain bullish
Just last month we were talking about PayPal's (PYPL $229) supposed $40 billion acquisition of Pinterest (PINS $47). While the company quickly quelled those rumors, we do believe they were actually interested in buying the social media platform. Feeling the heat from competitors such as Square (SQ $237), which recently paid $29 billion for buy now-pay later firm Afterpay, the company desperately wants to expand its fintech offerings. While that transaction never happened, the company's Venmo unit did just notch a big victory: it inked a deal with online behemoth Amazon (AMZN $3,489) to become a checkout option for customers at Amazon.com. Considering Amazon is responsible for over 40% of online purchases, that is a pretty big deal. PayPal made the announcement during its mixed-quarter earnings report. While revenues in Q3 rose from $5.46 billion to $6.18 billion year-on-year, that 13% increase fell slightly below analyst expectations. Profits, however, did beat expectations of $1.07/share, with net revenue actually jumping to $1.11/share. Shares were little changed after hours following the earnings report and the announcement. PayPal was spun off from eBay six years ago and has 377 million active accounts, including 29 million merchant accounts.
For some reason, PayPal has been portrayed by many as "old school" fintech. That is simply inaccurate. It is a $270 billion fintech giant, and the leader in the secure online payment space. While we were sorry to see the Pinterest deal fail to manifest, management is not done searching for a good fit. CEO Dan Schulman will not sit idly by while new upstarts eat into his company's market share. We place a fair value on PYPL shares at $300, but investors may want to see if continued Wall Street pessimism pushes them down to the $200 range before considering a purchase.
Industrial Conglomerates
08. Following 1-8 reverse split, GE now says it will split into three firms
Just three months ago, storied industrial giant General Electric (GE $116) performed a 1-8 reverse split, making its shares magically go from $13 to $105 in an instant. Now, GE's management team has announced another split: the company itself will be divided into three parts. The GE name will live on in the new aviation company, while the healthcare and energy units will become separate entities. All of these moves, however, won't allow the disparate companies to escape from the aggregate debt racked up by years of mismanagement; debt which could not be erased by the continual fire-sale of units, such as the 2016 sale of GE Appliances to Chinese conglomerate Haier for $5.6 billion, or the sale of GE lighting to Savant Systems in 2020 for an undisclosed amount. At least Savant is manufacturing the light bulbs in the US (as evidenced by an old package of GE bulbs which reads, "Made in China," versus a newer package we found which reads, "Made in USA"). While the spinoff of the healthcare unit won't take place until the end of 2023, and the energy spinoff won't happen until the end of 2024, investors cheered the move by driving GE shares up 6% in the pre-market following the announcement. CEO Larry Culp told Barron's, "It is a wow sort of day." That is about the response we would have expected. At least we didn't have to listen to Jeffrey Immelt bloviating some long-winded response from the cabin of one of his two personal corporate jets.
What would we do if we still held GE shares in any of the Penn strategies? Take the spike in price as an opportunity to exit the position. We certainly wouldn't wait around three years for the completion of the spinoffs. As for GE, with Culp running one company, perhaps the board should invite the other two post-Jack Welch CEOs—Immelt and Flannery—to take the respective helm of the other firms.
Hotels, Resorts, & Cruise Lines
07. Airbnb prepares for "golden age of travel" with new tools built around the hybrid work environment
We fully planned to add shares of Airbnb (ABNB $195) to one of the Penn strategies on its long-anticipated IPO day. Alas, it shot out of the gate so quickly that we could not justify the rich valuation. The company has inarguably changed the travel landscape, with its platform boasting some 5.6 million active accommodation listings worldwide. While the major hotel chains have effectively fought back to avoid losing market share, and a number of competitors have since tried to replicate their business model, we remain bullish on the company's long-term strategy. To that end, the $124 billion travel/tech firm has announced the rollout of some 50 new features designed to take advantage of the new, post-covid world; a world in which remote work is no longer the exception, and a large percentage of travel has morphed into a business/leisure affair. The company is placing a greater focus on its customers who book long-term stays of four weeks or longer, as that is now its fastest-growing segment. The suite of new tools will include the ability to verify wi-fi speeds to assure an effective work environment, and a listings search which will now go out a year into the future. For hosts, Airbnb is rolling out AirCover, an insurance program which offers $1 million in both damage protection and liability coverage, as well as "deep-cleaning" protection. As for the company's third-quarter earnings, they were off the charts. Revenues came in at $2.24 billion versus $1.34 billion in the same quarter of 2020 (+67%), and profits rose 280% y/y for the quarter, to $834 million. The company gave bullish guidance for Q4, with expectations that the rosy projections will carry into 2022.
Morningstar places the fair value of ABNB shares at $102. While we don't buy into that valuation, a price floating around $200 per share is still too rich for us. Looking elsewhere in the industry, our favorite hotel chain—Hilton Worldwide (HLT)—also seems richly priced at $147 per share (1,200 P/E). Ditto online travel agency Booking Holdings (BKNG $2,641), with its 288 multiple. Our advice? Wait for the inevitable pullback in these travel names.
Economics: Supply, Demand, & Prices
06. Inflation on the price of consumer goods just came in scorchingly hot; is it a blip or cause for serious concern?
Anyone who fills their tank, shops for groceries, pays their rent, or—gulp—needs a new or used car knows that inflation is a reality. Forget the anecdotal stories, here is the data: the US Department of Labor just announced that consumer prices surged 0.9% from September to October, driving the y/y rate up to 6.2%. That marks the highest rate since December of 1990, and the fastest pace of inflation since the summer of 1982. The rate even exceeded the 5.4% spike economists had projected. As for the ten million missing workers in the US, expect the price of goods to drive them back to their well-paying jobs soon. Serious supply chain issues certainly play a major role in the price spike, but the upward pressure on wages is another major factor; industries across all sectors are being forced to pay their workers more. While the supply chain issues should begin to subside by early next year, the higher wages are probably here to stay, which is good news in itself, but tempered by the fact that inflation is eating away at those wages. Management teams have been echoing the same sentiment: price increases must be passed along to the consumer, and the pricing power is in place to allow those increases without facing much pushback. In other words, Americans seem willing to pay more for lumber, autos, travel, and Christmas gifts this year. The Fed has already implemented its plan to reduce bond buying by $15 billion per month until it hits zero, and telegraphed plans to begin raising interest rates by late next year. If inflation reports keep coming in hot, however, they may need to quicken their pace. And that is a specter investors may not be prepared to handle with aplomb.
Products such as gasoline may be inelastic, but we believe inflation across the board will cause shoppers to become more sensitive to higher prices on easily-substituted goods and services. And the online shopping genie is out of the bottle, meaning consumers can perform their due diligence with ease. While the days of the Fed worrying about sub-2% inflation may be gone, the fears of long-lasting and severe price jumps have been overblown. This is not the 1970s all over again. From an investment standpoint, we have increased our allocation to the financial sector, which will be one of the areas poised to gain by higher interest rates.
Automotive
05. Making sense of Elon Musk's tweet asking followers whether or not he should sell 10% of his Tesla shares
Last Saturday, Elon Musk posed the following question to his 63.3 million Twitter followers: "Much is made lately of unrealized gains being a means of tax avoidance, so I propose selling 10% of my Tesla stock. Do you support this?" In a roughly 60/40 split, with 3.5 million voters (including us, we voted in the affirmative), the answer was "yes." While we wouldn't label the tweet as a gimmick, as many business journalists have, it is true that Musk really has no choice but to sell a good portion of his shares. Due to Tesla's achievement of some remarkably high targets, Musk has around 23 million vested stock options from 2012 with a strike price of roughly $6 per share. These options will expire next year, so he must exercise them and take the ordinary income (not realized gain) tax hit on the difference between $6 and the share price when he sells. Considering the shares are currently trading around $1,082, that tax bill we be enormous. In fact, it will probably be the largest single tax bill paid by an individual in history. (Though we doubt he will get a thank you card from the IRS or any politicians on the Hill.) Tesla also hit challenging targets which gave Musk options to purchase another 101 million shares at around $70 per share. These were issued in 2018, and represent about 5% of all outstanding shares.
In trading action this week, Musk sold approximately 5 million of his Tesla shares, grossing him around $5 billion. Between the federal government and the state of California, and between ordinary income tax and capital gains, about 54% of that amount will disappear in the form of taxes. Musk, who has never taken a salary from Tesla, once famously quipped to his brother Kimbal, who had asked him for a loan, "You do know that I don't actually have any cash, right? I have to borrow." While his trades this week will certainly put some cash in his pocket, we fully expect him to make good on his promise to live by the results of the twitter poll; if for no other reason than to pay the $7 billion or so the IRS will soon come calling for due to his remaining options. Even after all of the sales are complete, Musk will still own around 15% of outstanding TSLA shares, or more than double the amount of the next largest shareholder, Vanguard Group. Last month, Elon Musk became the first person in the world to achieve a net worth in excess of $300 billion, eclipsing that of the second-place Jeff Bezos, who is worth around $200 billion.
Even at $1,085 per share, we still consider Tesla, which we own in the Penn New Frontier Fund, a buy. All of the critics who argue that Ford, GM, Volkswagen, and a slew of startups will end up dooming the company seem to assume that Tesla will simply stand still. As usual, they will be proven grossly wrong. We would place the current fair value of TSLA shares at $1,800.
Media & Entertainment
04. Disney shares hit a ten-month low following an unexpectedly-rough quarter
Our lack of confidence in Disney's (DIS $162) new management team has been well articulated. It has been clear in our writings that we have little confidence in the company's new CEO, former parks head Bob Chapek, to lead the American icon going forward. Perhaps we received the first hard evidence of that view via the company's fiscal Q4 earnings report. The company missed on both the top and bottom lines, and it was downhill from there. While revenues grew 26% y/y for the quarter, to $18.5 billion, analysts were expecting more, especially considering the park restrictions due to covid in the same quarter of last year. Earnings per share came in a whopping 73% below estimates, at $0.37 adjusted. But the worst news, perhaps, came in the subs figure for the Disney+ streaming service. After adding 12 million new subscribers in the previous quarter, the company added just 2.1 million new subs in fiscal Q4. That is around 9.4 million fewer than analysts were expecting. The average monthly revenue per subscriber (ARPS) for Disney+ also dropped year-on-year, to $4.12, thanks to special bundle pricing for the Indonesia and India markets. Certainly, the return to the office for millions of Americans had an impact on the muted numbers, and park activity will continue to pick up, but investors gave a thumbs-down to the earnings report: Disney shares fell 7% in the following session, hitting a new ten-month low.
Disney was a company we never wanted to remove from the Penn Global Leaders Club; but, like Boeing, General Electric, and McDonald's, concerns over management forced us to make the move. After the big drop, are the shares undervalued? We don't believe so. Perhaps we will take another look if they get down below their 52-week low of $134.
Global Strategy: Eastern Europe
03. The US has warned Europe to be prepared for a potential Russian invasion of Ukraine
Russia's mercurial de facto dictator, Vladimir Putin, doesn't need an excuse to cause problems and wreak havoc, but he currently has two: a migrant issue and a pipeline issue. And, according to the Biden administration, Ukraine might be the battleground. The US has warned its Western allies in Europe that Russia is building up its forces near the Ukrainian border, and some level of military operations in the country—to include a possible invasion, may be in the cards. On the energy front, tensions have been heated between Western Europe and Russia, which provides nearly half of the natural gas to countries such as Germany. (Poland, it should be noted, receives most of its natural gas from the United States, after shunning Russia's Gazprom.) Putin is demanding that European regulators immediately approve the already-built Nord Stream 2 gas pipeline which runs between Russia and Germany. Despite Europe's severe gas crunch and skyrocketing LNG prices, the pipeline is in limbo due to Germany's new left-leaning government which is currently being formed. The US and Ukraine have vehemently opposed the pipeline. On the migrant front, thousands of Belarus refugees have flocked to that Russian ally's border with Poland in an attempt to get into Western Europe. Poland, a staunch US ally, has held firm on the issue, with full backing from the EU. This has enraged the president of Belarus, Alexander Lukashenko, who is now threatening to cut off LNG supples from another pipeline which travels from Russia to the West. All of this comes at a time when energy prices are at multi-year highs, meaning Russia, which has an energy-based economy, is suddenly feeling even more emboldened than usual.
For all of America's challenges, Europe is currently getting hit with crises on all sides of the economic spectrum, from a new wave of the pandemic to the severe energy problems. Granted, many of these challenges are from self-inflicted wounds, but the best course of action they could take right now is to make Putin understand that military action on his western front will not be tolerated. Sadly, the historical record of Europe standing up to bullies is spotty, at best.
Specialty REITs
02. Penn member American Tower to buy data center REIT CoreSite Realty in $10 billion deal
We purchased specialty REIT American Tower Corp (AMT $261), owner and operator of over 185,000 cell towers around the world, back in March of this year. The addition took advantage of two of our favorite themes: real estate and 5G technology. After hitting our initial target price within eight months, the company made a move we fully embrace: it will acquire data center REIT CoreSite Realty for $170 per share in cash—roughly $8.3 billion—plus the assumption of its $2 billion or so of debt. We believe it was a smart move by a skilled management team, led by AMT CEO Tom Bartlett. With the bolt-on acquisition of CoreSite, AMT will add data and cloud management capabilities to its offering mix, fully complimenting its wireless communications business. We suddenly find ourselves with two of our favorite growth drivers in the REIT world—5G towers and data centers—morphed into one position within the Penn Global Leaders Club. Furthermore, the company's reach is truly global, with 75,000 towers in Asia/Pacific, 43,000 in North America, 42,000 in Latin America, 20,000 in Africa, and 5,000 in Europe. For its part, CoreSite operates 24 data centers in major urban hubs such as Boston, New York, Miami, Chicago, and Los Angeles.
AMT shares are down about 4% on the news, as is typical for an acquiring company immediately after a deal has been announced. For investors who have missed the run-up to this point, we believe the shares remain in an attractive buy range. REITs are an important part of a portfolio, but we are highly concerned about the rapidly-changing landscape for retail and office REITs. Data centers and towers, as mentioned, will be two of the strongest growth drivers for the industry going forward.
Food Products
01. Oatly shares just plummeted another 21% in one session, now down 68% from their high
We first wrote about oat milk products company Oatly Group AB (OTLY $9) when the Swedish firm went public back in May. After the IPO priced at $17, shares rose 37% almost immediately. By the 16th of June, they had topped out at an intra-day high of $29 per share. We believed they were overvalued from day one, and reminded investors of the competition in the space. Just because a company appears to be in the stream of a fast moving theme—like plant-based products, they are not automatically good investment candidates. That is a story we have seen in constant reruns for the past 25 years. Alas, reality just hit OTLY shares after the company reported a revenue miss, greater losses than expected, and a warning from management with respect to the full-year's guidance. On top of the dismal financials, it was also reported that a quality issue in one of Oatly's production facilities will result in destroyed product and lost sales in the EMEA (Europe, Middle East, Africa) region. Perhaps the worst news of all: arch-competitor Chobani has officially filed to go public, and Danone, owner of the Silk brand of plant-based "milks," announced it is doubling-down on its "Oat-Yeah" product line. Oatly had a rough summer; it appears that the company is headed for an ugly winter.
When we first wrote of Oatly's debut, we said the shares were overvalued but might be worth a look if they dropped below $20. They are now sitting at $9.36 and still don't seem like a bargain. We can't figure out what the company's unique value proposition is, and even its commitment to the ESG (the most overused acronym in the global corporate environment) movement is being questioned by the environment police. Shares may seem cheap, but we wouldn't touch them.
Under the Radar Investment
Callaway Golf (ELY $29)
Callaway Golf Company is a mid-cap ($5.5B) leisure products firm dedicated to the game of golf. The company's golf equipment segment manufactures golf balls and clubs, while its apparel and gear segment manufactures golf shoes, clothing, bags, and practice aids. Just a few years ago, articles were written of the sport's imminent demise in the United States, and advice was given on how to extend its lifespan by silly actions such as doubling the size of the hole to make the game easier for inexperienced players. What nonsense. As is so often the case, the self-proclaimed experts were dead wrong, and the 270-year-old sport is going through a renaissance in this country—thanks in part to the pandemic. Another reason for the game's resurgence and popularity among a younger demographic base is a company called Topgolf, a global sports entertainment venue headquartered in Dallas, Texas. With seventy locations throughout the world, these tech-driven operations have created a new generation of golf enthusiasts. Imagine morphing a video game, nightclub, and personal sports experience into one, and you get an idea of why the facilities are so popular. This year, Callaway Golf completed its acquisition of Topgolf for $2.6 billion in stock and announced aggressive—but methodical—expansion plans. At $29 per share, Callaway has a near-single-digit multiple, a strong balance sheet, and a viable growth strategy. Not many leisure companies can boast those attributes. We would put a fair value on ELY shares at $40.
Answer
In December of 1990, America was still in the midst of Operation Desert Shield—it wouldn't turn into a "Storm" until the following month. The top grossing film in December was Home Alone, which grossed $90 million throughout 2,173 theaters, followed by Dances with Wolves, Misery, and Kindergarten Cop.
Headlines for the Week of 31 Oct — 06 Nov 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Purpose-driven spending...
You just purchased a new home and need to select the appliances—refrigerator, washer and dryer, range, dishwasher, microwave—for the joint. You would like to buy products made in North America, Europe, Japan, or South Korea; four regions known for making quality consumer durables. You decide upon the GE Appliances line based on their century-old reputation. Did you meet your objective?
Penn Trading Desk:
Penn: Open educational services company in the Intrepid
We have followed this major American educational services company for the past five years and, while we found it overvalued at recent levels, found it irresistible after lowered guidance and an analyst cut sent shares plummeting. We added this mid-cap growth company to the Intrepid Trading Platform with an initial price target 53% higher than our purchase price, and a secondary price target double our purchase price.
Penn: Open communication services firm in the Global Leaders Club
Oddly enough, we haven't recently held any firms from the Communication Services sector in the Penn Global Leaders Club—a rare condition. We rectified that with a pickup of one of the most controversial companies in America. Here's the way we see it: this behemoth is an income-generating machine, dominates its segment, and has a bold strategic plan for its future. Political correctness be damned, we added this juggernaut to the portfolio with high expectations for future growth.
Penn: Open a US semiconductor powerhouse (not Intel) to the New Frontier Fund
There is a major (and much needed) push underway for increased domestic production of high-tech semiconductor devices and components. We added a US-based manufacturer which will play a major role in the Internet of Things (IoT), 5G, autonomous vehicles, and AI/VR to the New Frontier Fund.
Penn: Open a hammered booze company in the Intrepid
We have watched investors analyze booze companies incorrectly more times than we can count, and our most recent addition to the Penn Intrepid Trading Program is a glaring example. Making a few poor decisions, one on hard seltzer and another on a new beer launch, made investors lose faith; but management matters, and we fully expect this company's exemplary chairman of the board to right his ship.
Penn: Open a regional bank in the Strategic Income Portfolio
Based on the specter of rising rates and not-so-transitory inflation, we have increased our allocation within the Financials sector. To that end, we added a regional bank (Northeastern US) with a clean balance sheet and a hefty dividend yield to our income portfolio. Members, see the Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
eCommerce
10. Netflix is teaming up with Walmart to create a dedicated digital storefront on the retailing giant's website
As Netflix's (NFLX $624) subscriber growth cools, it continues to search for new revenue streams in an effort to become less reliant on the one metric analysts focus on each quarter. To that end, the company has announced a new deal with Walmart (WMT $141) which will result in a dedicated 'Netflix Hub' on the giant retailer's website. The shop will include themed merchandise from its wildly-successful "Squid Game" as well as other recent hits on the streaming service, such as "Stranger Things." Right now, Netflix receives the vast majority of its revenue from the $13.99 paid monthly (more or less, depending on subscription plan) by its 200 million subscribers around the world. The growth of that subscriber base has been leveling out, however, due to saturation and a host of new entrants in the space, from Disney+ to Amazon Prime Video. While CEO Reed Hastings said he doesn't expect the new venture to have a major impact on the company's top line, he believes the real value comes in building user engagement with and excitement for the provider's Netflix Originals, for which it currently spends over $5 billion per year developing. Netflix licenses its intellectual property to select manufacturers in exchange for a cut of the profit. As for Walmart, this deal is part of an overall strategy to increase its online Walmart Marketplace presence by teaming up with brands held in high esteem by consumers. Like the recent deal with Gap, the company hopes to broaden its customer base by attracting a new generation of consumers; primarily younger customers who might have avoided the company's site in the past.
Based on valuations and our current tilt toward more conservative names, we believe Walmart shares look more attractive right now than those of its new marketing partner, Netflix. When another downturn hits the market, we could see NFLX shares falling back into the $400s—at which time they would be worthy of another look.
Communication Services
09. Over the course of twenty years, AT&T shares have dropped 43%; is it time to buy?
Our stop-loss order on AT&T (T $26) shares finally hit this past May at $32, ending a miserable period of holding the once-great telecom company. That stop was fortuitous, as shares have dropped to $26 since we dumped them. At least we had the fat dividend yield (now at 8% based on the share price, though it will be adjusted down after spinoffs), but that is about the only positive aspect of owning the shares since we picked them up. Our super-long-term 26% gain was not worth the wait; the opportunity cost was tremendous. In fact, an investment in the S&P 500 twenty years ago would have given investors just shy of a 500% return, while the same investment in T shares would have lost nearly 50% after two decades, sans the dividend.
Enormous missteps by management—like overpaying for acquisitions they could never quite make fit into the T puzzle, and ignoring serious problems with customer service due to sheer arrogance—have brought us to this point. Other telecom companies have proven that industry flux is not the issue; poor management is the root cause. So, with the shares "dirt cheap," as some analysts have called them, is it time to bet on the storied company? The argument for purchase revolves around the company's plan to slim down and focus its efforts exclusively on telecom services, mainly its 5G wireless network. It already ditched its wildly-expensive DirecTV unit and is about to spinoff its WarnerMedia division, which will become Warner Bros. Discovery. But we have three major arguments against the bull case. First, the company still has a massive debt load of $180 billion, which will only be negligibly alleviated by the Warner spinoff. Second, the company's area of focus going forward is going to be hyper-competitive thanks to new technologies and entrants. Finally, we have about as much faith in the management team at T as we do in the team at Boeing.
It is certainly tempting to pick up shares of T at $26, but we have seen the stock languish for too long to get excited here. It may end up being a multiyear low price, but there are simply too many obstacles facing the lackluster leadership team.
Homes & Durables
08. Zillow falls double digits as it presses pause on its home buying program; competitor Opendoor Technologies jumps*
(UPDATE: Zillow has announced it has exited the home flipping business altogether, sending shares tumbling another 25% on Wednesday. Considering the percentage of revenues generated by the unit, we are even more concerned now than when we wrote this piece on Monday.)
It didn't strike us as a viable reason for the company's shares to fall over 10%, but Zillow's (Z $65) announcement that it would hold off on buying any more homes while it works through a backlog of properties caused the shares to tumble on Monday. Zillow Offers, the company's high-tech buying and flipping unit, purchased nearly 4,000 homes in the second quarter of the year. And the unit is hardly an afterthought: it produced $772 million of the $1.31 billion—or 60%—in total revenue generated over the three-month period. With that in mind, why would management bring buying to a screeching halt? The answer, according to management, revolves around what the company does after purchasing the properties.
One of the biggest headaches for sellers involves evaluating what needs to be repaired or replaced in a home before it is listed. Using its proprietary home value algorithms, Zillow will make homeowners an offer on the spot—no repair or staging required. This means that the company must perform the repairs and prepare the house for sale. While it won't invest in homes with extensive damage or with major needed repairs, COO Jeremy Wacksman told investors that labor and supply constraints have been the major issue. At the end of Q2, the company still had over 3,100 unsold homes with an aggregate value north of $1 billion in its inventory. Competitor Opendoor Technologies (OPEN $24), meanwhile, purchased over 8,000 homes in Q2 and has contracts on another 8,000 or so. It should be noted that Opendoor just went public last December, and is using the infusion of cash from its IPO to help purchase the large number of homes.
There are a number of different aspects to this story (to include how these iBuyers get paid), which we will delve into deeper in the next Penn Wealth Report. In short, we don't necessarily believe the pullback presents a good buying opportunity. Investors clearly thought the pause was a negative, shedding Z shares and buying OPEN shares on the news. Opendoor, which has yet to turn a profit, suddenly finds itself with a market cap of nearly $15 billion. It takes some creative math to justify that valuation, especially if the specter of higher rates coupled with skyrocketing home prices begin to keep would-be buyers at bay.
Cryptocurrencies
07. You may love bitcoin, but that doesn't mean you should buy into BITO, the first bitcoin-focused ETF
Crypto enthusiasts may be thrilled that a bitcoin-centric exchange traded fund has finally arrived, but there are a few things to consider about the ProShares Bitcoin Strategy ETF (BITO $43) before taking a bite. First and foremost, this is not an investment in the crypto itself; rather, it is a derivative which makes a bet on bitcoin futures. Each month, the futures contracts held by the ETF will expire, forcing them to roll into the following month's contracts. This gets into a potentially disastrous situation known as contango—a condition in which the future price of a commodity is higher than the spot (current) price. That is exactly where we sit right now with respect to bitcoin. Of course, the opposite condition, known as backwardation, could also come into play; this is where the spot price of the asset is higher than the its futures price. Another reason crypto investors may want to steer clear is the fact that crypto bears will be able to short BITO, dragging down its price despite the current value of the underlying asset. For sure, the ETF's successful first day (it rose 5% from its $40 initial NAV) helped bitcoin prices rise to new highs, but don't expect the crypto to return the favor for investors in this volatile new vehicle.
The cleanest way to buy bitcoin is to open a digital wallet via an app such as Coinbase. Or, better yet in our opinion, buy some Coinbase (COIN $314) itself, and take advantage of the moves in other cryptos. While the Grayscale Bitcoin Trust (GBTC $52) may seem like a common sense solution, this is also a derivative tracking vehicle for the coin, not a direct investment. That being said, Grayscale has filed to turn the biggest bitcoin fund into an ETF, but that is dependent upon the good graces of one of the biggest crypto critics out there: Gary Gensler's SEC. Once again, we would steer would-be crypto bugs to Coinbase.
Automotive
06. After landing enormous Hertz deal, Tesla officially reaches the rarified air of the $1T market cap club
Our favorite graph of EV leader Tesla (TSLA $1,025), surprisingly, isn't the company's share price; rather, it is the percentage of shares held short. In other words, a visual of the percentage of investors betting against the company. We can almost hear the ghost of CNBC's Mark Haines blathering, "Why the hell would anyone want to own this company?" Back in May of 2019, one out of every four shares of Tesla were held short; today, that number is under 3%. You can lose only so many hands before you are forced to walk away from the table. The latest news, which made Musk's vehicle technology firm one of only five American companies with a market cap exceeding $1 trillion (Apple, Microsoft, Alphabet, and Amazon are the others), was the announcement that car rental company Hertz (HTZZ $27) would buy a staggering 100,000 Teslas for nearly full price. Putting that in some perspective, that order would account for one out of every five vehicles the company sold in 2020. The news drove Tesla's share price up 12.66% on Monday, to a new high of $1,024.86, and brought its market cap up to $1.029 trillion. For Hertz, the deal represents a major strategic push to electrify its rental car fleet, to include building out its own charging infrastructure. The order, which will transpire over the next fourteen months, will add roughly $4.2 billion to Tesla's top line, meaning Hertz will pay around $42,000 for each vehicle. Tesla Model 3 sedans should be available to Hertz customers in the US and areas of Western Europe as soon as next month. Ironically, the interim CEO of Hertz is Mark Fields, the former CEO of Ford Motor Company (F $16).
For investors, this massive deal represents yet another reason to own shares of Tesla. The news also drove Hertz shares up 10% on the day, but recall that the firm was driven into bankruptcy during the height of the pandemic, just recently emerging. We love the company's strategic push to electrify its fleet, but the $27 share price seems a bit rich. They may be worth another look should they fall back into the teens.
Capital Markets
05. After quickly doubling in price, Robinhood shares come tumbling back to earth on earnings, forward guidance
The "trading platform for the masses," Robinhood (HOOD $34), has been on quite the ride since its summer IPO. After immediately falling 12% from its $38 IPO price, it ended up hitting an intra-day high (not reflected in the graph, which represents closing prices) of $85 per share on the 4th of August. It has been pretty much been of a downhill slide since then. The latest negative catalyst, which resulted in shares once again falling below their IPO price, was a brutal Q3 earnings report and dark forward guidance from management. Consider these headline numbers representing the difference between Q2 and Q3: Revenues fell from $565M to $365M; crypto-based revenues fell from $233M to $51M; net losses were $2.06/sh versus estimates of -$1.37/sh; monthly active users (MAU) fell from 21.3M to 18.9M. The icing on this rather ugly cake came in the form of forward guidance from management: "...factors may result in quarterly revenues no greater than $325M in the fourth quarter." As if the numbers weren't bad enough, there are other potential negative surprises waiting in the wings. A full 73% of the company's revenues emanated from payment for order flow (PFOF) in Q3, something the SEC is seriously considering placing a ban on. Only seven cryptos are available on the platform, as opposed to 50+ (and growing) on the Coinbase platform. On the first of December the lock-up period will expire for all shares, meaning insiders will be able to sell at will. At least management took a conservative approach on the conference call, giving a refreshingly sober review of the company's outlook—as opposed to using the typical hyperbole so common in many quarterly earnings releases.
Management freely admitted that two major events, the meme stock craze and the explosion in cryptos, helped fuel the company's success in the first two quarters of the year, and that it is virtually impossible to predict the next big event that will drive trading. Again, points for being honest, but we would stick with Coinbase (COIN $319) for anyone wishing to invest in a new exchange platform. Shares of the company are up 40% since we added it to the Intrepid Trading Platform—with a target price of $300.
Interactive Media & Services
04. What's in a name? Perhaps we are in the minority, but we are thrilled about Facebook morphing to Meta
Listening to David Faber (Little Lord Fauntleroy) of CNBC talk about Facebook's (FB $323) push into the metaverse reminded us of his mentor, the late Mark Haines, bashing Apple's new iPad back in 2014. There are creative souls who design and build the future, and then there are the naysayers telling us—every step along the way—all of the reasons failure is inevitable. As for Facebook's grand plans for its future, it all begins with a name change. On the 1st of December, the company Meta, formerly known as Facebook, will begin trading under the symbol MVRS. Predictably, the jeers began immediately after Zuckerberg announced the change, with many (if not most) claiming this was just an attempt to distract the focus away from the endless political attacks on the firm. We simply don't buy that. Already an owner of Oculus, the leading maker of virtual reality hardware, Facebook is ready to embrace the "next evolution of social technology," as the firm labels the metaverse. Imagine communicating and interacting with others not in the 2D environment of a Facebook app, but in a computer-generated digital environment. A "face-to-face" game of golf, a board meeting, "visiting" a digital clothing store—it will all be possible in this new virtual world. While a Faber or a Haines (were he still alive) could never generate the sparks of creativity required to envision such a place, the opportunities will be endless—for participants, involved companies, and investors. Zuckerberg said that the company will now be a "metaverse-first, not a Facebook-first, firm." To that end, Meta has already committed $10 billion to its Reality Labs division, and will begin breaking out the financial results for the two sides of the company. Our bet? As profitable and dominant a player Facebook has become, its metaverse division will, ultimately, eclipse its traditional business. There will be plenty of competition along the way, and we expect Apple (AAPL $150) to roll out its own metaverse hardware soon, but Facebook will be a major player in this nascent industry.
We vividly recall the ascent of the personal computer and, subsequently, the Internet. Both of these massive disruptors began as something of a gimmick in the minds of journalists and the business community. Consider how these two "gimmicks" have changed the way we live. Consider living and working through the pandemic without them. The potential of the metaverse is enormous; now is the time for astute investors to begin understanding what it is, and how it will weave its way into the fabric of society. As for MVRS, we can officially say we owned while it was still just a social media platform.
Supply, Demand, & Prices
03. Twitter's Jack Dorsey says hyperinflation is coming; we say he is not playing with a full deck
For anyone who hasn't seen a recent picture of Twitter (TWTR $54) and Square (SQ $255) CEO Jack Dorsey, picture a younger version of Howard Hughes shortly before his death. This brilliant economic mind has been studying the US and global landscape and has issued an edict from on high: "Hyperinflation is going to change everything. It's happening." Really? Yes, inflation is here, and for some very specific reasons—from a seemingly endless supply of new money to the temporarily-broken global supply chain; but hyperinflation? The textbook definition of the term is the persistent, rapidly-rising cost of goods and services, to the tune of over 50% per month. A textbook example of hyperinflation would be the conditions in the Weimar Republic in the 1920s, when the German government ran their printing presses nonstop. A loaf of bread that cost a shopper 250 marks in January of 1923 had risen to a price of 200 billion marks by November of that same year (a US dollar was worth roughly 1 trillion marks going into the month). Wages for German workers were renegotiated daily, as their pay was typically worthless by the following day. We doubt it is still taught in school, but many of us remember seeing the photos of German homeowners wallpapering their houses with worthless currency. That, Mr. Dorsey, is hyperinflation. What you are spewing is called hyperbole. To be sure, the Fed—and the Treasury Department and the politicians—should be concerned about the 5% inflation rate we have witnessed for the past three months. Instead of making silly claims, Mr. Dorsey (leave that to the real economists), focus on how you can better monetize your social media platform.
Speaking of Germany, inflation in that country just hit its highest mark in three decades: 4%. Perhaps the specter of inflation, which Germans are hypersensitive to considering past events, is the reason the 10-year German Bund is nearing 0%—on the way up, that is. Monetary policy around the world is in a state of wanton madness. Tightening needs to occur, but the markets won't like it when it finally happens. While the first rate hike may still be a year away, we could see the Fed tapering its $120B per month spending spree within the next three months. It will be fascinating to gauge how the markets react when it does.
Consumer Durables
02. Whirlpool is getting squeezed by higher input costs and supply chain troubles; is it time to buy?
"Elevated supply constraints" was the term management used during Whirlpool's (WHR $214) Q3 earnings conference call. Shares of America's largest consumer appliance maker fell more than 4% on the heels of the release, or about 22% off of their May highs. While revenues for the quarter ($5.5B) missed analyst expectations by 2%, they were still up 4% from the same quarter in 2020, and the company is still on pace to exceed—or at least match—its pre-pandemic annual revenues of $21 billion. As for net income, which was constricted due to higher wages and input costs, the company still made $471 in profit versus $392 million in Q3 of 2020. So, with its tiny multiple of 6.8, is the domestic maker of Whirlpool, KitchenAid, and Maytag appliances a buy? Arguably, yes. The housing market is still hot, and the strong demand for appliances has allowed the company to raise prices between 5% and 12% across the board to make up for the higher cost of raw materials. The company has also increased its stock repurchase program—a sign that management believes the shares are cheap—and maintained its healthy $1.40 per share dividend. Additionally, the Whirlpool name is highly respected throughout much of Latin America, a region which should be a nice driver for increased sales for years to come. The company's largest competitor in the Americas is GE Appliances, but that unit continues to struggle since General Electric (GE $106) sold it to a Chinese conglomerate five years ago. Despite investors' reaction to the Q3 earnings report, the future looks pretty bright for this 110-year-old Michigan-based company.
With its $13 billion market cap, Whirlpool is nestled snugly in the mid-cap value space—an area we are enamored with right now. Furthermore, we believe the company will retain its pricing power even as the supply chain issues abate, meaning expanded margins. We would place a fair value of WHR shares at $300, or 40% higher than where they trade right now.
Monetary Policy
01. The Fed just announced a refreshing move; even more refreshing was the market's muted reaction to the news
In June of 2020, we wrote of the Fed's announcement to continue buying $120 billion in bonds ($80 billion in Treasuries and $40 billion in mortgage-backed securities, or MBS) until the economic situation had stabilized to the point at which they could begin tapering those purchases. At the time, the Fed's balance sheet—which is part of our $28.9 trillion national debt—had already mushroomed from $4 trillion to $7 trillion. Today, as the Fed's balance sheet sits at $8.6 trillion, the big moment has arrived: Fed Chair Jerome Powell announced on Wednesday that the purchase program would be reduced by $15 billion ($10B Treasuries, $5B MBS) per month, beginning immediately. At this clip, the program would end entirely by June of 2022. Investors breathlessly awaited the market's reaction. Impressively, neither the stock market nor the bond market did much of anything in response. In fact, the major indexes actually began to strengthen into the close as Powell conducted his press briefing. It is refreshing to see that the move did not cause any type of "taper tantrum," as a similar move did back in 2013. Credit to the Fed for masterfully telegraphing the inevitability of this action. Now, let's see how the market reacts when rates begin to inch up, probably in the second half of next year.
It is depressing to look at America's national debt, especially knowing full well that it will ultimately have an enormous negative impact on this country's economy. While the Fed's move won't help reduce that load (at least until the program ends and some of the bonds begin to "fall off" of the balance sheet), it is somewhat comforting to know that it won't grow it at a guaranteed rate of $120 billion per month. Just as every family should be able to rattle off their total debt in an instant, every American should know how much debt their government holds. After all, we are all ultimately responsible for outstanding bill and its ever-accruing interest.
Under the Radar Investment
BorgWarner Inc (BWA $46)
BorgWarner is a mid-cap value company operating in the auto parts supply chain. It is a Tier 1 supplier, meaning it provides parts directly to the OEMs (original equipment manufacturers) such as Ford, Volkswagen, and Hyundai—its three main customers. The company has a masterful geographic diversification, with about one third of revenues coming from each: North America, Europe, and Asia. Due to its mix of products, innovative design team, and recent acquisition of Delphi Automotive, BorgWarner is very well positioned to take advantage of the industry trends toward lower emissions and a "greener" environment. It makes a number of parts and components for hybrid and electric vehicles. With its low multiple of 14 and excellent financial health, we find the company as attractive now as we did when we added it to the Penn Global Leaders Club precisely one year ago, 03 Nov 2020, at $36.57 per share.
Answer
Not only didn't you meet your objective, you didn't even buy from an American company which happens to produce its goods outside of the US. In 2016, General Electric sold their GE Appliances unit to Haier, a Chinese company. (Sidebar: We once purchased a Haier mini-fridge which failed to operate immediately upon removal from the shipping container.) A consumer visiting geappliances.com would be hard pressed to determine that these were not American-made goods.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Purpose-driven spending...
You just purchased a new home and need to select the appliances—refrigerator, washer and dryer, range, dishwasher, microwave—for the joint. You would like to buy products made in North America, Europe, Japan, or South Korea; four regions known for making quality consumer durables. You decide upon the GE Appliances line based on their century-old reputation. Did you meet your objective?
Penn Trading Desk:
Penn: Open educational services company in the Intrepid
We have followed this major American educational services company for the past five years and, while we found it overvalued at recent levels, found it irresistible after lowered guidance and an analyst cut sent shares plummeting. We added this mid-cap growth company to the Intrepid Trading Platform with an initial price target 53% higher than our purchase price, and a secondary price target double our purchase price.
Penn: Open communication services firm in the Global Leaders Club
Oddly enough, we haven't recently held any firms from the Communication Services sector in the Penn Global Leaders Club—a rare condition. We rectified that with a pickup of one of the most controversial companies in America. Here's the way we see it: this behemoth is an income-generating machine, dominates its segment, and has a bold strategic plan for its future. Political correctness be damned, we added this juggernaut to the portfolio with high expectations for future growth.
Penn: Open a US semiconductor powerhouse (not Intel) to the New Frontier Fund
There is a major (and much needed) push underway for increased domestic production of high-tech semiconductor devices and components. We added a US-based manufacturer which will play a major role in the Internet of Things (IoT), 5G, autonomous vehicles, and AI/VR to the New Frontier Fund.
Penn: Open a hammered booze company in the Intrepid
We have watched investors analyze booze companies incorrectly more times than we can count, and our most recent addition to the Penn Intrepid Trading Program is a glaring example. Making a few poor decisions, one on hard seltzer and another on a new beer launch, made investors lose faith; but management matters, and we fully expect this company's exemplary chairman of the board to right his ship.
Penn: Open a regional bank in the Strategic Income Portfolio
Based on the specter of rising rates and not-so-transitory inflation, we have increased our allocation within the Financials sector. To that end, we added a regional bank (Northeastern US) with a clean balance sheet and a hefty dividend yield to our income portfolio. Members, see the Trading Desk.
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eCommerce
10. Netflix is teaming up with Walmart to create a dedicated digital storefront on the retailing giant's website
As Netflix's (NFLX $624) subscriber growth cools, it continues to search for new revenue streams in an effort to become less reliant on the one metric analysts focus on each quarter. To that end, the company has announced a new deal with Walmart (WMT $141) which will result in a dedicated 'Netflix Hub' on the giant retailer's website. The shop will include themed merchandise from its wildly-successful "Squid Game" as well as other recent hits on the streaming service, such as "Stranger Things." Right now, Netflix receives the vast majority of its revenue from the $13.99 paid monthly (more or less, depending on subscription plan) by its 200 million subscribers around the world. The growth of that subscriber base has been leveling out, however, due to saturation and a host of new entrants in the space, from Disney+ to Amazon Prime Video. While CEO Reed Hastings said he doesn't expect the new venture to have a major impact on the company's top line, he believes the real value comes in building user engagement with and excitement for the provider's Netflix Originals, for which it currently spends over $5 billion per year developing. Netflix licenses its intellectual property to select manufacturers in exchange for a cut of the profit. As for Walmart, this deal is part of an overall strategy to increase its online Walmart Marketplace presence by teaming up with brands held in high esteem by consumers. Like the recent deal with Gap, the company hopes to broaden its customer base by attracting a new generation of consumers; primarily younger customers who might have avoided the company's site in the past.
Based on valuations and our current tilt toward more conservative names, we believe Walmart shares look more attractive right now than those of its new marketing partner, Netflix. When another downturn hits the market, we could see NFLX shares falling back into the $400s—at which time they would be worthy of another look.
Communication Services
09. Over the course of twenty years, AT&T shares have dropped 43%; is it time to buy?
Our stop-loss order on AT&T (T $26) shares finally hit this past May at $32, ending a miserable period of holding the once-great telecom company. That stop was fortuitous, as shares have dropped to $26 since we dumped them. At least we had the fat dividend yield (now at 8% based on the share price, though it will be adjusted down after spinoffs), but that is about the only positive aspect of owning the shares since we picked them up. Our super-long-term 26% gain was not worth the wait; the opportunity cost was tremendous. In fact, an investment in the S&P 500 twenty years ago would have given investors just shy of a 500% return, while the same investment in T shares would have lost nearly 50% after two decades, sans the dividend.
Enormous missteps by management—like overpaying for acquisitions they could never quite make fit into the T puzzle, and ignoring serious problems with customer service due to sheer arrogance—have brought us to this point. Other telecom companies have proven that industry flux is not the issue; poor management is the root cause. So, with the shares "dirt cheap," as some analysts have called them, is it time to bet on the storied company? The argument for purchase revolves around the company's plan to slim down and focus its efforts exclusively on telecom services, mainly its 5G wireless network. It already ditched its wildly-expensive DirecTV unit and is about to spinoff its WarnerMedia division, which will become Warner Bros. Discovery. But we have three major arguments against the bull case. First, the company still has a massive debt load of $180 billion, which will only be negligibly alleviated by the Warner spinoff. Second, the company's area of focus going forward is going to be hyper-competitive thanks to new technologies and entrants. Finally, we have about as much faith in the management team at T as we do in the team at Boeing.
It is certainly tempting to pick up shares of T at $26, but we have seen the stock languish for too long to get excited here. It may end up being a multiyear low price, but there are simply too many obstacles facing the lackluster leadership team.
Homes & Durables
08. Zillow falls double digits as it presses pause on its home buying program; competitor Opendoor Technologies jumps*
(UPDATE: Zillow has announced it has exited the home flipping business altogether, sending shares tumbling another 25% on Wednesday. Considering the percentage of revenues generated by the unit, we are even more concerned now than when we wrote this piece on Monday.)
It didn't strike us as a viable reason for the company's shares to fall over 10%, but Zillow's (Z $65) announcement that it would hold off on buying any more homes while it works through a backlog of properties caused the shares to tumble on Monday. Zillow Offers, the company's high-tech buying and flipping unit, purchased nearly 4,000 homes in the second quarter of the year. And the unit is hardly an afterthought: it produced $772 million of the $1.31 billion—or 60%—in total revenue generated over the three-month period. With that in mind, why would management bring buying to a screeching halt? The answer, according to management, revolves around what the company does after purchasing the properties.
One of the biggest headaches for sellers involves evaluating what needs to be repaired or replaced in a home before it is listed. Using its proprietary home value algorithms, Zillow will make homeowners an offer on the spot—no repair or staging required. This means that the company must perform the repairs and prepare the house for sale. While it won't invest in homes with extensive damage or with major needed repairs, COO Jeremy Wacksman told investors that labor and supply constraints have been the major issue. At the end of Q2, the company still had over 3,100 unsold homes with an aggregate value north of $1 billion in its inventory. Competitor Opendoor Technologies (OPEN $24), meanwhile, purchased over 8,000 homes in Q2 and has contracts on another 8,000 or so. It should be noted that Opendoor just went public last December, and is using the infusion of cash from its IPO to help purchase the large number of homes.
There are a number of different aspects to this story (to include how these iBuyers get paid), which we will delve into deeper in the next Penn Wealth Report. In short, we don't necessarily believe the pullback presents a good buying opportunity. Investors clearly thought the pause was a negative, shedding Z shares and buying OPEN shares on the news. Opendoor, which has yet to turn a profit, suddenly finds itself with a market cap of nearly $15 billion. It takes some creative math to justify that valuation, especially if the specter of higher rates coupled with skyrocketing home prices begin to keep would-be buyers at bay.
Cryptocurrencies
07. You may love bitcoin, but that doesn't mean you should buy into BITO, the first bitcoin-focused ETF
Crypto enthusiasts may be thrilled that a bitcoin-centric exchange traded fund has finally arrived, but there are a few things to consider about the ProShares Bitcoin Strategy ETF (BITO $43) before taking a bite. First and foremost, this is not an investment in the crypto itself; rather, it is a derivative which makes a bet on bitcoin futures. Each month, the futures contracts held by the ETF will expire, forcing them to roll into the following month's contracts. This gets into a potentially disastrous situation known as contango—a condition in which the future price of a commodity is higher than the spot (current) price. That is exactly where we sit right now with respect to bitcoin. Of course, the opposite condition, known as backwardation, could also come into play; this is where the spot price of the asset is higher than the its futures price. Another reason crypto investors may want to steer clear is the fact that crypto bears will be able to short BITO, dragging down its price despite the current value of the underlying asset. For sure, the ETF's successful first day (it rose 5% from its $40 initial NAV) helped bitcoin prices rise to new highs, but don't expect the crypto to return the favor for investors in this volatile new vehicle.
The cleanest way to buy bitcoin is to open a digital wallet via an app such as Coinbase. Or, better yet in our opinion, buy some Coinbase (COIN $314) itself, and take advantage of the moves in other cryptos. While the Grayscale Bitcoin Trust (GBTC $52) may seem like a common sense solution, this is also a derivative tracking vehicle for the coin, not a direct investment. That being said, Grayscale has filed to turn the biggest bitcoin fund into an ETF, but that is dependent upon the good graces of one of the biggest crypto critics out there: Gary Gensler's SEC. Once again, we would steer would-be crypto bugs to Coinbase.
Automotive
06. After landing enormous Hertz deal, Tesla officially reaches the rarified air of the $1T market cap club
Our favorite graph of EV leader Tesla (TSLA $1,025), surprisingly, isn't the company's share price; rather, it is the percentage of shares held short. In other words, a visual of the percentage of investors betting against the company. We can almost hear the ghost of CNBC's Mark Haines blathering, "Why the hell would anyone want to own this company?" Back in May of 2019, one out of every four shares of Tesla were held short; today, that number is under 3%. You can lose only so many hands before you are forced to walk away from the table. The latest news, which made Musk's vehicle technology firm one of only five American companies with a market cap exceeding $1 trillion (Apple, Microsoft, Alphabet, and Amazon are the others), was the announcement that car rental company Hertz (HTZZ $27) would buy a staggering 100,000 Teslas for nearly full price. Putting that in some perspective, that order would account for one out of every five vehicles the company sold in 2020. The news drove Tesla's share price up 12.66% on Monday, to a new high of $1,024.86, and brought its market cap up to $1.029 trillion. For Hertz, the deal represents a major strategic push to electrify its rental car fleet, to include building out its own charging infrastructure. The order, which will transpire over the next fourteen months, will add roughly $4.2 billion to Tesla's top line, meaning Hertz will pay around $42,000 for each vehicle. Tesla Model 3 sedans should be available to Hertz customers in the US and areas of Western Europe as soon as next month. Ironically, the interim CEO of Hertz is Mark Fields, the former CEO of Ford Motor Company (F $16).
For investors, this massive deal represents yet another reason to own shares of Tesla. The news also drove Hertz shares up 10% on the day, but recall that the firm was driven into bankruptcy during the height of the pandemic, just recently emerging. We love the company's strategic push to electrify its fleet, but the $27 share price seems a bit rich. They may be worth another look should they fall back into the teens.
Capital Markets
05. After quickly doubling in price, Robinhood shares come tumbling back to earth on earnings, forward guidance
The "trading platform for the masses," Robinhood (HOOD $34), has been on quite the ride since its summer IPO. After immediately falling 12% from its $38 IPO price, it ended up hitting an intra-day high (not reflected in the graph, which represents closing prices) of $85 per share on the 4th of August. It has been pretty much been of a downhill slide since then. The latest negative catalyst, which resulted in shares once again falling below their IPO price, was a brutal Q3 earnings report and dark forward guidance from management. Consider these headline numbers representing the difference between Q2 and Q3: Revenues fell from $565M to $365M; crypto-based revenues fell from $233M to $51M; net losses were $2.06/sh versus estimates of -$1.37/sh; monthly active users (MAU) fell from 21.3M to 18.9M. The icing on this rather ugly cake came in the form of forward guidance from management: "...factors may result in quarterly revenues no greater than $325M in the fourth quarter." As if the numbers weren't bad enough, there are other potential negative surprises waiting in the wings. A full 73% of the company's revenues emanated from payment for order flow (PFOF) in Q3, something the SEC is seriously considering placing a ban on. Only seven cryptos are available on the platform, as opposed to 50+ (and growing) on the Coinbase platform. On the first of December the lock-up period will expire for all shares, meaning insiders will be able to sell at will. At least management took a conservative approach on the conference call, giving a refreshingly sober review of the company's outlook—as opposed to using the typical hyperbole so common in many quarterly earnings releases.
Management freely admitted that two major events, the meme stock craze and the explosion in cryptos, helped fuel the company's success in the first two quarters of the year, and that it is virtually impossible to predict the next big event that will drive trading. Again, points for being honest, but we would stick with Coinbase (COIN $319) for anyone wishing to invest in a new exchange platform. Shares of the company are up 40% since we added it to the Intrepid Trading Platform—with a target price of $300.
Interactive Media & Services
04. What's in a name? Perhaps we are in the minority, but we are thrilled about Facebook morphing to Meta
Listening to David Faber (Little Lord Fauntleroy) of CNBC talk about Facebook's (FB $323) push into the metaverse reminded us of his mentor, the late Mark Haines, bashing Apple's new iPad back in 2014. There are creative souls who design and build the future, and then there are the naysayers telling us—every step along the way—all of the reasons failure is inevitable. As for Facebook's grand plans for its future, it all begins with a name change. On the 1st of December, the company Meta, formerly known as Facebook, will begin trading under the symbol MVRS. Predictably, the jeers began immediately after Zuckerberg announced the change, with many (if not most) claiming this was just an attempt to distract the focus away from the endless political attacks on the firm. We simply don't buy that. Already an owner of Oculus, the leading maker of virtual reality hardware, Facebook is ready to embrace the "next evolution of social technology," as the firm labels the metaverse. Imagine communicating and interacting with others not in the 2D environment of a Facebook app, but in a computer-generated digital environment. A "face-to-face" game of golf, a board meeting, "visiting" a digital clothing store—it will all be possible in this new virtual world. While a Faber or a Haines (were he still alive) could never generate the sparks of creativity required to envision such a place, the opportunities will be endless—for participants, involved companies, and investors. Zuckerberg said that the company will now be a "metaverse-first, not a Facebook-first, firm." To that end, Meta has already committed $10 billion to its Reality Labs division, and will begin breaking out the financial results for the two sides of the company. Our bet? As profitable and dominant a player Facebook has become, its metaverse division will, ultimately, eclipse its traditional business. There will be plenty of competition along the way, and we expect Apple (AAPL $150) to roll out its own metaverse hardware soon, but Facebook will be a major player in this nascent industry.
We vividly recall the ascent of the personal computer and, subsequently, the Internet. Both of these massive disruptors began as something of a gimmick in the minds of journalists and the business community. Consider how these two "gimmicks" have changed the way we live. Consider living and working through the pandemic without them. The potential of the metaverse is enormous; now is the time for astute investors to begin understanding what it is, and how it will weave its way into the fabric of society. As for MVRS, we can officially say we owned while it was still just a social media platform.
Supply, Demand, & Prices
03. Twitter's Jack Dorsey says hyperinflation is coming; we say he is not playing with a full deck
For anyone who hasn't seen a recent picture of Twitter (TWTR $54) and Square (SQ $255) CEO Jack Dorsey, picture a younger version of Howard Hughes shortly before his death. This brilliant economic mind has been studying the US and global landscape and has issued an edict from on high: "Hyperinflation is going to change everything. It's happening." Really? Yes, inflation is here, and for some very specific reasons—from a seemingly endless supply of new money to the temporarily-broken global supply chain; but hyperinflation? The textbook definition of the term is the persistent, rapidly-rising cost of goods and services, to the tune of over 50% per month. A textbook example of hyperinflation would be the conditions in the Weimar Republic in the 1920s, when the German government ran their printing presses nonstop. A loaf of bread that cost a shopper 250 marks in January of 1923 had risen to a price of 200 billion marks by November of that same year (a US dollar was worth roughly 1 trillion marks going into the month). Wages for German workers were renegotiated daily, as their pay was typically worthless by the following day. We doubt it is still taught in school, but many of us remember seeing the photos of German homeowners wallpapering their houses with worthless currency. That, Mr. Dorsey, is hyperinflation. What you are spewing is called hyperbole. To be sure, the Fed—and the Treasury Department and the politicians—should be concerned about the 5% inflation rate we have witnessed for the past three months. Instead of making silly claims, Mr. Dorsey (leave that to the real economists), focus on how you can better monetize your social media platform.
Speaking of Germany, inflation in that country just hit its highest mark in three decades: 4%. Perhaps the specter of inflation, which Germans are hypersensitive to considering past events, is the reason the 10-year German Bund is nearing 0%—on the way up, that is. Monetary policy around the world is in a state of wanton madness. Tightening needs to occur, but the markets won't like it when it finally happens. While the first rate hike may still be a year away, we could see the Fed tapering its $120B per month spending spree within the next three months. It will be fascinating to gauge how the markets react when it does.
Consumer Durables
02. Whirlpool is getting squeezed by higher input costs and supply chain troubles; is it time to buy?
"Elevated supply constraints" was the term management used during Whirlpool's (WHR $214) Q3 earnings conference call. Shares of America's largest consumer appliance maker fell more than 4% on the heels of the release, or about 22% off of their May highs. While revenues for the quarter ($5.5B) missed analyst expectations by 2%, they were still up 4% from the same quarter in 2020, and the company is still on pace to exceed—or at least match—its pre-pandemic annual revenues of $21 billion. As for net income, which was constricted due to higher wages and input costs, the company still made $471 in profit versus $392 million in Q3 of 2020. So, with its tiny multiple of 6.8, is the domestic maker of Whirlpool, KitchenAid, and Maytag appliances a buy? Arguably, yes. The housing market is still hot, and the strong demand for appliances has allowed the company to raise prices between 5% and 12% across the board to make up for the higher cost of raw materials. The company has also increased its stock repurchase program—a sign that management believes the shares are cheap—and maintained its healthy $1.40 per share dividend. Additionally, the Whirlpool name is highly respected throughout much of Latin America, a region which should be a nice driver for increased sales for years to come. The company's largest competitor in the Americas is GE Appliances, but that unit continues to struggle since General Electric (GE $106) sold it to a Chinese conglomerate five years ago. Despite investors' reaction to the Q3 earnings report, the future looks pretty bright for this 110-year-old Michigan-based company.
With its $13 billion market cap, Whirlpool is nestled snugly in the mid-cap value space—an area we are enamored with right now. Furthermore, we believe the company will retain its pricing power even as the supply chain issues abate, meaning expanded margins. We would place a fair value of WHR shares at $300, or 40% higher than where they trade right now.
Monetary Policy
01. The Fed just announced a refreshing move; even more refreshing was the market's muted reaction to the news
In June of 2020, we wrote of the Fed's announcement to continue buying $120 billion in bonds ($80 billion in Treasuries and $40 billion in mortgage-backed securities, or MBS) until the economic situation had stabilized to the point at which they could begin tapering those purchases. At the time, the Fed's balance sheet—which is part of our $28.9 trillion national debt—had already mushroomed from $4 trillion to $7 trillion. Today, as the Fed's balance sheet sits at $8.6 trillion, the big moment has arrived: Fed Chair Jerome Powell announced on Wednesday that the purchase program would be reduced by $15 billion ($10B Treasuries, $5B MBS) per month, beginning immediately. At this clip, the program would end entirely by June of 2022. Investors breathlessly awaited the market's reaction. Impressively, neither the stock market nor the bond market did much of anything in response. In fact, the major indexes actually began to strengthen into the close as Powell conducted his press briefing. It is refreshing to see that the move did not cause any type of "taper tantrum," as a similar move did back in 2013. Credit to the Fed for masterfully telegraphing the inevitability of this action. Now, let's see how the market reacts when rates begin to inch up, probably in the second half of next year.
It is depressing to look at America's national debt, especially knowing full well that it will ultimately have an enormous negative impact on this country's economy. While the Fed's move won't help reduce that load (at least until the program ends and some of the bonds begin to "fall off" of the balance sheet), it is somewhat comforting to know that it won't grow it at a guaranteed rate of $120 billion per month. Just as every family should be able to rattle off their total debt in an instant, every American should know how much debt their government holds. After all, we are all ultimately responsible for outstanding bill and its ever-accruing interest.
Under the Radar Investment
BorgWarner Inc (BWA $46)
BorgWarner is a mid-cap value company operating in the auto parts supply chain. It is a Tier 1 supplier, meaning it provides parts directly to the OEMs (original equipment manufacturers) such as Ford, Volkswagen, and Hyundai—its three main customers. The company has a masterful geographic diversification, with about one third of revenues coming from each: North America, Europe, and Asia. Due to its mix of products, innovative design team, and recent acquisition of Delphi Automotive, BorgWarner is very well positioned to take advantage of the industry trends toward lower emissions and a "greener" environment. It makes a number of parts and components for hybrid and electric vehicles. With its low multiple of 14 and excellent financial health, we find the company as attractive now as we did when we added it to the Penn Global Leaders Club precisely one year ago, 03 Nov 2020, at $36.57 per share.
Answer
Not only didn't you meet your objective, you didn't even buy from an American company which happens to produce its goods outside of the US. In 2016, General Electric sold their GE Appliances unit to Haier, a Chinese company. (Sidebar: We once purchased a Haier mini-fridge which failed to operate immediately upon removal from the shipping container.) A consumer visiting geappliances.com would be hard pressed to determine that these were not American-made goods.
Headlines for the Week of 29 Aug—04 Sep 2021
Important Disclaimer: This report has been compiled and produced by Penn Wealth Publishing, LLC, a legally separate entity from Penn Wealth Management, our registered investment advisory service. It is for informational purposes only, and should not be construed as investment advice. Always consult with your professional financial advisor before making any investment decision.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Turning point of the American Revolution...
Despite Washington's impressive Revolutionary War victory against the German Hessians on December 26th, 1776 in the town of Trenton, there wasn't much to celebrate during the brutal months to come. What stunning victory began to turn the tide in favor of the Americans and convinced the French to join the fight against their longstanding nemesis, Great Britain?
Penn Trading Desk:
Penn: Changes to mining companies within the Global Leaders Club
After performing a review of the Metals & Mining industry, we are removing the two gold miners currently in the Penn Global Leaders Club and replacing them with an alternate name. Instead of an outright sell order, we recommend placing stops on the current positions slightly below their current respective prices. Members, see the Trading Desk for specific instructions. As always, clients of Penn Wealth Management, our Registered Investment Advisory service and a separate entity, will automatically have these actions taken.
JP Morgan: Add Sunrun to "U.S. Analyst Focus List"
JP Morgan just added $10 billion solar energy and storage company Sunrun (RUN $47) to its highest conviction group of names, the U.S. Analyst Focus List. Analyst Mark Strouse likes the fundamentals for the industry over the medium and long term, and believes supply constraints will ease in the second half of the year. While the risk, as measured by beta, is a quite large 2.089, the median target share price among analysts covering the stock is $76.53, or 62% higher from here. We listed some of our favorite clean energy plays in a recent Penn Wealth Report.
Cowen: Raise rating and price target on Textron
Citing a strong comeback in the demand for business jets and the nascent civilian VTOL (vertical take-off and landing) movement, Cowen has raised its rating on aviation firm Textron from Market Perform to Outperform, and has adjusted its target price for TXT shares from $75 to $95. That is a street high, with Morningstar taking the opposite side of the bet with its one-star rating and $42 per share target price. The average price target among the eleven analysts weighing in on the Rhode Island-based firm is $78 per share.
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Cryptocurrencies
10. In a refreshing twist, Coinbase's CEO fires back at SEC
We are ambivalent with respect to cryptos: their future as a means of exchange feels certain, but the industry is going through its Wild West phase right now, with plenty of risks and opportunities for investors. We are equally ambivalent about the SEC (and most other government agencies as well): they enforce needed guardrails, yet they too often create more problems than they resolve. Which leads to the brouhaha going on right now between the SEC and Coinbase (COIN $257), the leading crypto exchange platform in the United States and a current member of the Penn Intrepid Trading Platform. Shares of the exchange fell sharply this week as the SEC warned that it planned to sue if the company forged ahead with plans to allow its users—of which it currently boasts some 68 million—to earn interest by lending crypto assets. Apparently the SEC believes that privilege should rest solely in the hands of the banks. It is crystal clear that current SEC Chairman Gary Gensler plans on doing battle with a host of financial services companies during his reign, with cryptos, perhaps, being his number one target.
When a company receives a Wells Notice, a formal notice from the SEC informing the recipient that the agency is preparing enforcement actions, it is traditional to stay relatively mum; certainly not to stir the pot. Apparently, Coinbase CEO Brian Armstrong is taking a page from Elon Musk's playbook, as he remained anything but mum following the announcement. In what Bloomberg described as "a rant" and "a fit" (it was neither, Bloomberg), Armstrong unloaded on the commission. In one tweet, the dynamic CEO noted "Some really sketchy behavior coming out of the SEC recently. Story time...." Ironically, it was Coinbase's willingness to share its plans for the new lending platform with the SEC—instead of pushing ahead and implementing the plan—which instigated the threats from the government body. Instead of a few polite questions to delve further into how the process would work, the SEC, i.e. Gensler, took the very public action of issuing the Wells Notice. Not cool, SEC. Jesse Powell, co-founder of the crypto exchange Kraken, came to Armstrong's defense in his own series of tweets: "We won't tell you why we think your product is illegal but we will tell you that there is no path to making it legal. Disagree? Go ahead and see what happens." CEOs daring to fight back against government regulators? Brilliant! While the zeitgeist seems to consist of corporate heads cowardly genuflecting to any and all social movements looking their way, it is refreshing to see a little gutsy pushback against the tactics of bullies. That used to be called The American Spirit.
Despite the SEC-caused downturn in the stock, our COIN position is still up 10% since purchase. We fully expect the firm to weather this storm. We doubt the SEC fully understands how the crypto exchanges even work, so it will buy some time while the government attorneys attempt to get up to speed. After that, let the lengthy court battles begin.
Beverages & Tobacco
09. Tilray's convoluted effort to get its foot in the door of the US cannabis market
We have mentioned before our deep respect for Irwin Simon, founder of Hain Celestial (HAIN $40) and current CEO of Canadian cannabis company Tilray (TLRY $14). That being said, we do not currently own any specific cannabis names within any of the Penn portfolios. It's not that we don't believe in the future of the industry from an investment standpoint; we are simply waiting for the winners to break free from the inevitable losers. We expect Tilray to be a long-term player, but it doesn't yet have the ability to crack the lucrative US market. The company is trying to change that. As a Canadian cannabis company dual listed on the Toronto Exchange and the Nasdaq, the fact that cannabis is still illegal in the US at the federal level precludes Tilray from setting up operations south of their current border. So, in a complex, circuitous route, management just made a very interesting move. They acquired around $170 million of convertible MedMen (MMNFF $0.29) debt through a new limited partnership, with the debt's maturity date being extended out through August of 2028. MedMen is the preeminent cannabis player in the US, with access to roughly 50% of the total addressable (legal) market. The firm has major operations in California, Nevada, and New York. What does this mean for Tilray? The company's CEO made it pretty clear in recent comments: he believes that his Canadian entity will be able to acquire control of MedMen once cannabis is legalized at the federal level. Acquiring $170 million in debt for a micro-cap player in the US may not seem that big of a deal, but we fully expect the adroit Simon to leverage it into a major piece of the action as the domestic market for cannabis expands.
While we have played with positions in Tilray as well as Canopy Growth Corp (CGC $18), another major Canadian player, we have yet to add a cannabis company to a portfolio. MedMen may look attractive to some investors, but its current $0.29 share price represents a dramatic fall from the high of $1.47 it hit in February of this year. All of these firms remain huge money losers, though the space is worth keeping an eye on.
Aerospace & Defense
08. The last major aviation market refusing to lift ban on 737 MAX should come as no surprise
We have certainly given aircraft maker Boeing (BA $218) a lot of grief over the past two years, but this is a story more about politics than aviation prowess. Most other major aviation markets lifted the ban on the Boeing 737 MAX late last year or early in 2021, with two notable exceptions: India and China. This week, India's Directorate General of Civil Aviation announced that the model has received the green light to resume operations in that country, leaving only China's ban in place. Boeing's management team clearly believes the Chinese market is crucial for the company's growth story going forward, with one-fifth of the firm's aircraft deliveries since 2017 heading to the communist nation. But the trade war, the pandemic, and China's own economic ambitions have strongly constricted sales, leaving primarily Airbus (EADSY $34) to pick up the slack. China wants that situation to change as well, touting its own manufacturer, the Commercial Aircraft Corporation of China, or Comac. The company's nascent efforts, the ARJ21 and the C919—the latter of which it hopes can go head to head with the 737 MAX and the Airbus A320, have been riddled with defects and delays. The problems have kept would-be buyers at bay, despite the C919 selling for about half as much ($50 million) as the Airbus A320neo. Nonetheless, China, through its Belt and Road infrastructure initiative, will pump as much money as needed into Comac until it shows signs of life. As for the MAX, China would love to have Comac's C919 step in to fill the void, but it is unlikely that will happen anytime soon. Expect a lift on the ban to come—out of pure necessity—by the end of the year.
Boeing is facing a host of serious problems; a new competitor in the form of a state-sponsored Chinese aircraft manufacturer is one we haven't even touched on before. CEO David Calhoun is actively pushing the Biden administration to urge China to lift its ban on the MAX, but what really needs to be taking place is more activism in the ranks of BA shareholders to force an overhaul of Boeing's board of directors—including its president and CEO—Calhoun.
Demographics & Lifestyle
07. China limits videogame usage to three hours per week for minors, no play Monday through Thursday
Our first thought was, "Imagine trying to implement such a law in the U.S." China, as part of its latest salvo against industries it deems harmful to the collective cause, has issued a rather remarkable decree: minors—we are assuming that means youth under the age of eighteen—are hereby forbidden from playing videogames Monday through Thursday, and will limit their play to a maximum of one hour per day on Fridays, weekends, and public holidays, between the hours of 8 p.m. and 9 p.m. The ruling communist party claims that the "youth videogame addiction" is distracting young people from their responsibilities to school and family. How on earth does the government plan on enforcing this new dictate? Since the government controls the tech companies which operate in China, and these companies can control users via login credentials, the task isn't as herculean as it may seem. Just how granular is the government willing to get with respect to controlling its population? A few years back, videogame players between the ages of 16 and 18 were told that they could not spend over 400 yuan (about $60) per month on the purchase of new games.
At first blush, we imagine many Americans applaud such a move to restrict the brain-numbing play of videogames by a country's youth. However, a government which can and will control such a mundane aspect of life will never reach a level of satisfaction; lines in the sand will be just that, and they will be redrawn at the whim of the ruling members of the party. Personal freedoms will continue to wither away until an inevitable clash occurs between the masses being controlled and the elites who are imposing the draconian standards. China believes it can simultaneously control and feast off of the golden goose of economic prosperity. That faulty logic stems from the incredible level of arrogance and hubris which communism foments among its ruling class. The short-term pain we so often experience in a democracy is allowed to mushroom out of control within a closed society. Despite the lessons of the past, this is a condition lost on many within the financial media; journalists who eagerly regurgitate what the state-controlled media in China feeds them. As for the Chinese Internet companies which so many investors have been wantonly rushing into, many are now sitting 50% below their February highs on the heels of this latest government crackdown.
Application & Systems Software
06. Skittish investors drive Zoom Video shares down 25% in August
It is hard to believe, but it was just one year ago that investors were betting the farm on the future of Zoom Video Communications (ZM $289), driving shares up to astronomical valuations. After all, the company just happened to offer the exact right services at precisely the right time: a way for teachers to connect with students and for management to collaborate with workers in a world where schools and offices had been shut down due to the pandemic. It's not as though the company won't continue to excel, or that the health threat is behind us; it's more a case of investors' euphoria giving way to the reality of kids and workers going back to their respective schools and offices. Tuesday accounted for the second-largest one-day drop in Zoom's short history, with shares falling 17%, but August has been particularly brutal as the company lost about one-quarter of its market cap. But was it ever really deserving of the $160 billion market cap it held in October of last year, and does $86 billion signal a golden buying opportunity? The answer to both questions is, in our opinion, "no." Putting its size in perspective, ZM is nestled between banking stalwart US Bancorp (USB) and aerospace giant Lockheed Marti
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Turning point of the American Revolution...
Despite Washington's impressive Revolutionary War victory against the German Hessians on December 26th, 1776 in the town of Trenton, there wasn't much to celebrate during the brutal months to come. What stunning victory began to turn the tide in favor of the Americans and convinced the French to join the fight against their longstanding nemesis, Great Britain?
Penn Trading Desk:
Penn: Changes to mining companies within the Global Leaders Club
After performing a review of the Metals & Mining industry, we are removing the two gold miners currently in the Penn Global Leaders Club and replacing them with an alternate name. Instead of an outright sell order, we recommend placing stops on the current positions slightly below their current respective prices. Members, see the Trading Desk for specific instructions. As always, clients of Penn Wealth Management, our Registered Investment Advisory service and a separate entity, will automatically have these actions taken.
JP Morgan: Add Sunrun to "U.S. Analyst Focus List"
JP Morgan just added $10 billion solar energy and storage company Sunrun (RUN $47) to its highest conviction group of names, the U.S. Analyst Focus List. Analyst Mark Strouse likes the fundamentals for the industry over the medium and long term, and believes supply constraints will ease in the second half of the year. While the risk, as measured by beta, is a quite large 2.089, the median target share price among analysts covering the stock is $76.53, or 62% higher from here. We listed some of our favorite clean energy plays in a recent Penn Wealth Report.
Cowen: Raise rating and price target on Textron
Citing a strong comeback in the demand for business jets and the nascent civilian VTOL (vertical take-off and landing) movement, Cowen has raised its rating on aviation firm Textron from Market Perform to Outperform, and has adjusted its target price for TXT shares from $75 to $95. That is a street high, with Morningstar taking the opposite side of the bet with its one-star rating and $42 per share target price. The average price target among the eleven analysts weighing in on the Rhode Island-based firm is $78 per share.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cryptocurrencies
10. In a refreshing twist, Coinbase's CEO fires back at SEC
We are ambivalent with respect to cryptos: their future as a means of exchange feels certain, but the industry is going through its Wild West phase right now, with plenty of risks and opportunities for investors. We are equally ambivalent about the SEC (and most other government agencies as well): they enforce needed guardrails, yet they too often create more problems than they resolve. Which leads to the brouhaha going on right now between the SEC and Coinbase (COIN $257), the leading crypto exchange platform in the United States and a current member of the Penn Intrepid Trading Platform. Shares of the exchange fell sharply this week as the SEC warned that it planned to sue if the company forged ahead with plans to allow its users—of which it currently boasts some 68 million—to earn interest by lending crypto assets. Apparently the SEC believes that privilege should rest solely in the hands of the banks. It is crystal clear that current SEC Chairman Gary Gensler plans on doing battle with a host of financial services companies during his reign, with cryptos, perhaps, being his number one target.
When a company receives a Wells Notice, a formal notice from the SEC informing the recipient that the agency is preparing enforcement actions, it is traditional to stay relatively mum; certainly not to stir the pot. Apparently, Coinbase CEO Brian Armstrong is taking a page from Elon Musk's playbook, as he remained anything but mum following the announcement. In what Bloomberg described as "a rant" and "a fit" (it was neither, Bloomberg), Armstrong unloaded on the commission. In one tweet, the dynamic CEO noted "Some really sketchy behavior coming out of the SEC recently. Story time...." Ironically, it was Coinbase's willingness to share its plans for the new lending platform with the SEC—instead of pushing ahead and implementing the plan—which instigated the threats from the government body. Instead of a few polite questions to delve further into how the process would work, the SEC, i.e. Gensler, took the very public action of issuing the Wells Notice. Not cool, SEC. Jesse Powell, co-founder of the crypto exchange Kraken, came to Armstrong's defense in his own series of tweets: "We won't tell you why we think your product is illegal but we will tell you that there is no path to making it legal. Disagree? Go ahead and see what happens." CEOs daring to fight back against government regulators? Brilliant! While the zeitgeist seems to consist of corporate heads cowardly genuflecting to any and all social movements looking their way, it is refreshing to see a little gutsy pushback against the tactics of bullies. That used to be called The American Spirit.
Despite the SEC-caused downturn in the stock, our COIN position is still up 10% since purchase. We fully expect the firm to weather this storm. We doubt the SEC fully understands how the crypto exchanges even work, so it will buy some time while the government attorneys attempt to get up to speed. After that, let the lengthy court battles begin.
Beverages & Tobacco
09. Tilray's convoluted effort to get its foot in the door of the US cannabis market
We have mentioned before our deep respect for Irwin Simon, founder of Hain Celestial (HAIN $40) and current CEO of Canadian cannabis company Tilray (TLRY $14). That being said, we do not currently own any specific cannabis names within any of the Penn portfolios. It's not that we don't believe in the future of the industry from an investment standpoint; we are simply waiting for the winners to break free from the inevitable losers. We expect Tilray to be a long-term player, but it doesn't yet have the ability to crack the lucrative US market. The company is trying to change that. As a Canadian cannabis company dual listed on the Toronto Exchange and the Nasdaq, the fact that cannabis is still illegal in the US at the federal level precludes Tilray from setting up operations south of their current border. So, in a complex, circuitous route, management just made a very interesting move. They acquired around $170 million of convertible MedMen (MMNFF $0.29) debt through a new limited partnership, with the debt's maturity date being extended out through August of 2028. MedMen is the preeminent cannabis player in the US, with access to roughly 50% of the total addressable (legal) market. The firm has major operations in California, Nevada, and New York. What does this mean for Tilray? The company's CEO made it pretty clear in recent comments: he believes that his Canadian entity will be able to acquire control of MedMen once cannabis is legalized at the federal level. Acquiring $170 million in debt for a micro-cap player in the US may not seem that big of a deal, but we fully expect the adroit Simon to leverage it into a major piece of the action as the domestic market for cannabis expands.
While we have played with positions in Tilray as well as Canopy Growth Corp (CGC $18), another major Canadian player, we have yet to add a cannabis company to a portfolio. MedMen may look attractive to some investors, but its current $0.29 share price represents a dramatic fall from the high of $1.47 it hit in February of this year. All of these firms remain huge money losers, though the space is worth keeping an eye on.
Aerospace & Defense
08. The last major aviation market refusing to lift ban on 737 MAX should come as no surprise
We have certainly given aircraft maker Boeing (BA $218) a lot of grief over the past two years, but this is a story more about politics than aviation prowess. Most other major aviation markets lifted the ban on the Boeing 737 MAX late last year or early in 2021, with two notable exceptions: India and China. This week, India's Directorate General of Civil Aviation announced that the model has received the green light to resume operations in that country, leaving only China's ban in place. Boeing's management team clearly believes the Chinese market is crucial for the company's growth story going forward, with one-fifth of the firm's aircraft deliveries since 2017 heading to the communist nation. But the trade war, the pandemic, and China's own economic ambitions have strongly constricted sales, leaving primarily Airbus (EADSY $34) to pick up the slack. China wants that situation to change as well, touting its own manufacturer, the Commercial Aircraft Corporation of China, or Comac. The company's nascent efforts, the ARJ21 and the C919—the latter of which it hopes can go head to head with the 737 MAX and the Airbus A320, have been riddled with defects and delays. The problems have kept would-be buyers at bay, despite the C919 selling for about half as much ($50 million) as the Airbus A320neo. Nonetheless, China, through its Belt and Road infrastructure initiative, will pump as much money as needed into Comac until it shows signs of life. As for the MAX, China would love to have Comac's C919 step in to fill the void, but it is unlikely that will happen anytime soon. Expect a lift on the ban to come—out of pure necessity—by the end of the year.
Boeing is facing a host of serious problems; a new competitor in the form of a state-sponsored Chinese aircraft manufacturer is one we haven't even touched on before. CEO David Calhoun is actively pushing the Biden administration to urge China to lift its ban on the MAX, but what really needs to be taking place is more activism in the ranks of BA shareholders to force an overhaul of Boeing's board of directors—including its president and CEO—Calhoun.
Demographics & Lifestyle
07. China limits videogame usage to three hours per week for minors, no play Monday through Thursday
Our first thought was, "Imagine trying to implement such a law in the U.S." China, as part of its latest salvo against industries it deems harmful to the collective cause, has issued a rather remarkable decree: minors—we are assuming that means youth under the age of eighteen—are hereby forbidden from playing videogames Monday through Thursday, and will limit their play to a maximum of one hour per day on Fridays, weekends, and public holidays, between the hours of 8 p.m. and 9 p.m. The ruling communist party claims that the "youth videogame addiction" is distracting young people from their responsibilities to school and family. How on earth does the government plan on enforcing this new dictate? Since the government controls the tech companies which operate in China, and these companies can control users via login credentials, the task isn't as herculean as it may seem. Just how granular is the government willing to get with respect to controlling its population? A few years back, videogame players between the ages of 16 and 18 were told that they could not spend over 400 yuan (about $60) per month on the purchase of new games.
At first blush, we imagine many Americans applaud such a move to restrict the brain-numbing play of videogames by a country's youth. However, a government which can and will control such a mundane aspect of life will never reach a level of satisfaction; lines in the sand will be just that, and they will be redrawn at the whim of the ruling members of the party. Personal freedoms will continue to wither away until an inevitable clash occurs between the masses being controlled and the elites who are imposing the draconian standards. China believes it can simultaneously control and feast off of the golden goose of economic prosperity. That faulty logic stems from the incredible level of arrogance and hubris which communism foments among its ruling class. The short-term pain we so often experience in a democracy is allowed to mushroom out of control within a closed society. Despite the lessons of the past, this is a condition lost on many within the financial media; journalists who eagerly regurgitate what the state-controlled media in China feeds them. As for the Chinese Internet companies which so many investors have been wantonly rushing into, many are now sitting 50% below their February highs on the heels of this latest government crackdown.
Application & Systems Software
06. Skittish investors drive Zoom Video shares down 25% in August
It is hard to believe, but it was just one year ago that investors were betting the farm on the future of Zoom Video Communications (ZM $289), driving shares up to astronomical valuations. After all, the company just happened to offer the exact right services at precisely the right time: a way for teachers to connect with students and for management to collaborate with workers in a world where schools and offices had been shut down due to the pandemic. It's not as though the company won't continue to excel, or that the health threat is behind us; it's more a case of investors' euphoria giving way to the reality of kids and workers going back to their respective schools and offices. Tuesday accounted for the second-largest one-day drop in Zoom's short history, with shares falling 17%, but August has been particularly brutal as the company lost about one-quarter of its market cap. But was it ever really deserving of the $160 billion market cap it held in October of last year, and does $86 billion signal a golden buying opportunity? The answer to both questions is, in our opinion, "no." Putting its size in perspective, ZM is nestled between banking stalwart US Bancorp (USB) and aerospace giant Lockheed Marti