Penn After Hours
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Headlines for the Month of March 2025
Fr 14 Mar 2025
Market Pulse
Another down week in the markets
Six weeks have passed since the first of February; five of those weeks have been down. The S&P 500 joined the NASDAQ in correction territory before slightly pulling out of it on Friday. Tariffs have been the main downward driver for US equities—domestic averages are all down for the year, while the All Cap World Index is up over 8%.
Beverages, Tobacco, & Cannabis
Pepsi is on the cusp of buying healthier-soda company Poppi
The $1.5 billion deal would insert the company firmly in this popular new category. Though we still like another company better.
We 12 Mar 2025
Consumer Electronics
iRobot's days may be numbered
And we can thank the heavy-handed EU apparatchik for hastening the company's decline.
Economics: Supply, Demand, & Prices
A cool inflation report sends futures higher
After a scorching 0.5% inflation rate in January, investors got some good news with February's number: The consumer Price Index ticked up 0.2%, putting the annual inflation rate at 2.8%. Economists had been looking for a 0.3% rate. Futures added to their pre-market gains on the report.
Tu 11 Mar 2025
Global Strategy: Latin America
Lula will not win next year's election in Brazil
He's a socialist in Latin America at a time when countries are lurching to the right, as evidenced by Argentina. Not only that, Lula da Silva has lost the support of his main voting base: blue collar workers.
Fr 07 Mar 2025
Drug Retail
Sycamore Partners will take Walgreens private for $10 billion
No more Walgreens, at least for investors at least for now. The flailing drug retailer has been in freefall for the better part of a decade for a host of reasons, from pharmacy provider headwinds to shrinkage (theft). Shares have dropped from $100 a decade ago to $10 today. The $10 billion price tag represents a 9% premium to recent share price.
Economics: Work & Pay
February jobs report in line
Economists were expecting 160k new jobs created in Feb, the real number came in at 151,000. The unemployment rate rose from 4% to 4.1%. Earnings rose 0.3%, as expected, for an annualized rate of 3.6%. All pretty much in line. The biz journalists are telling us this is the last decent jobs report; is that really what they believe, or is politics seeping into their comments? Time will tell. Markets rose on the report.
Fr 14 Mar 2025
Market Pulse
Another down week in the markets
Six weeks have passed since the first of February; five of those weeks have been down. The S&P 500 joined the NASDAQ in correction territory before slightly pulling out of it on Friday. Tariffs have been the main downward driver for US equities—domestic averages are all down for the year, while the All Cap World Index is up over 8%.
Beverages, Tobacco, & Cannabis
Pepsi is on the cusp of buying healthier-soda company Poppi
The $1.5 billion deal would insert the company firmly in this popular new category. Though we still like another company better.
We 12 Mar 2025
Consumer Electronics
iRobot's days may be numbered
And we can thank the heavy-handed EU apparatchik for hastening the company's decline.
Economics: Supply, Demand, & Prices
A cool inflation report sends futures higher
After a scorching 0.5% inflation rate in January, investors got some good news with February's number: The consumer Price Index ticked up 0.2%, putting the annual inflation rate at 2.8%. Economists had been looking for a 0.3% rate. Futures added to their pre-market gains on the report.
Tu 11 Mar 2025
Global Strategy: Latin America
Lula will not win next year's election in Brazil
He's a socialist in Latin America at a time when countries are lurching to the right, as evidenced by Argentina. Not only that, Lula da Silva has lost the support of his main voting base: blue collar workers.
Fr 07 Mar 2025
Drug Retail
Sycamore Partners will take Walgreens private for $10 billion
No more Walgreens, at least for investors at least for now. The flailing drug retailer has been in freefall for the better part of a decade for a host of reasons, from pharmacy provider headwinds to shrinkage (theft). Shares have dropped from $100 a decade ago to $10 today. The $10 billion price tag represents a 9% premium to recent share price.
Economics: Work & Pay
February jobs report in line
Economists were expecting 160k new jobs created in Feb, the real number came in at 151,000. The unemployment rate rose from 4% to 4.1%. Earnings rose 0.3%, as expected, for an annualized rate of 3.6%. All pretty much in line. The biz journalists are telling us this is the last decent jobs report; is that really what they believe, or is politics seeping into their comments? Time will tell. Markets rose on the report.
Headlines for the Month of February 2025
Tu 25 Feb 2025
Specialty Retail
Home Depot beats on earnings
Shares of Penn stalwart Home Depot (HD $397) were trading up about 4% following an earnings report which saw both revenue and earnings beat estimates for Q4. The company generated $40 billion in sales and $3.02 in earnings per share. Notably, comparable sales rose 0.8% for the quarter following eight straight quarters of declines. Online sales rose 9% in Q4 from the same quarter last year. Shares remain attractive at this level.
Education & Training Services
Chegg sues Google for hurting traffic with AI
Two years ago this May, we reported on shares of education services company (think educational material and online study aids) Chegg (CHGG $1) dropping 50%—from $18 to $9—on an earnings report. Now, $9 per share seems like a dream. Shares are down 30% this morning on reports that the company is suing Google on the grounds that the search engine's AI summaries are hurting traffic. The company is said to be exploring options with Goldman Sachs, to include being acquired or going private.
Restaurants
Krispy Kreme falls 25% at open on quarter which saw serious cyber attack
Krispy Kreme (DNUT $7) shares fell some 25% on Tuesday's open after sales and profit guidance missed analysts' expectations. For Q4, total revenue dropped 10% from the same quarter last year, or from $451M to $404M. The iconic donut maker hit a major roadblock last quarter, with a massive cyber attack disrupting online orders and even forcing some stores to temporarily close. The company took a $10M hit to its earnings from this disruption, dropping adjusted core income 28% ($45.9M). We love the company's product, but recall that we have railed against the comical share structure which allows JAB Holdings to retain 78% control of the firm.
Mo 24 Feb 2025
Hotels, Resorts, & Cruise Lines
Vail Resorts is having a rough season
We have followed Vail Resorts (MTN $159), the $6 billion resorts and casinos company, for decades. At first glance, its shares look tempting right now: they are trading near a 52-week low and offer a fat 5.6% dividend. But in investing, you must always look under the hood. The company's famed Epic Pass, which allows skiers to hit the slopes from Whistler, Canada to the Swiss Alps, seems to be in a rut, selling fewer passes from the previous season for the first time ever. As if that weren't enough, a 12-day ski patrol strike closed most of the runs at Park City, Utah—its largest US resort. Value investors may desire to do some bottom fishing, but we would see what unfolds before considering the shares.
Restaurants
Domino's disastrous quarter
The pizza company we love to hate, Domino's (DPZ $455) was trading down after a triple miss for the quarter. The pizza chain fell short on revenue, profit, and same-store sales in the US. Of course, the blame-game company mentioned potential tariffs on the earnings call. Tariffs, for a pizza chain? OK.
Global Strategy: EU
Left dealt serious blow in German elections
The governing left party in Germany, the SPD, just lost at the polls so badly that German Chancellor Olaf Scholz was even kicked out as the leader of his party. Two huge winners emerged: the right-leaning CDU/CSU and the further right AfD. Those two groups garnered nearly 50% of the votes. The SPD, Greens, and Left parties received about 35% of the vote in aggregate. It was a wake up call to woke politicians in Europe.
Mo 10 Feb 2025
Industrial Conglomerates
Following GE's lead, Honeywell will split into three distinct companies
GE has had success since the split, but can the Elliott-forced move at Honeywell really unlock value for shareholders, or is it simply rearranging the deck chairs?
We 05 Feb 2025
IT Software & Services
Palantir just had the mother of all quarters; shares rocketed 25% higher
Ever since the company's IPO, doubters and haters have ruled the analysts' pool. We never doubted the firm's future, and are now sitting on a 1,000% gain due to that prescience.
Tu 25 Feb 2025
Specialty Retail
Home Depot beats on earnings
Shares of Penn stalwart Home Depot (HD $397) were trading up about 4% following an earnings report which saw both revenue and earnings beat estimates for Q4. The company generated $40 billion in sales and $3.02 in earnings per share. Notably, comparable sales rose 0.8% for the quarter following eight straight quarters of declines. Online sales rose 9% in Q4 from the same quarter last year. Shares remain attractive at this level.
Education & Training Services
Chegg sues Google for hurting traffic with AI
Two years ago this May, we reported on shares of education services company (think educational material and online study aids) Chegg (CHGG $1) dropping 50%—from $18 to $9—on an earnings report. Now, $9 per share seems like a dream. Shares are down 30% this morning on reports that the company is suing Google on the grounds that the search engine's AI summaries are hurting traffic. The company is said to be exploring options with Goldman Sachs, to include being acquired or going private.
Restaurants
Krispy Kreme falls 25% at open on quarter which saw serious cyber attack
Krispy Kreme (DNUT $7) shares fell some 25% on Tuesday's open after sales and profit guidance missed analysts' expectations. For Q4, total revenue dropped 10% from the same quarter last year, or from $451M to $404M. The iconic donut maker hit a major roadblock last quarter, with a massive cyber attack disrupting online orders and even forcing some stores to temporarily close. The company took a $10M hit to its earnings from this disruption, dropping adjusted core income 28% ($45.9M). We love the company's product, but recall that we have railed against the comical share structure which allows JAB Holdings to retain 78% control of the firm.
Mo 24 Feb 2025
Hotels, Resorts, & Cruise Lines
Vail Resorts is having a rough season
We have followed Vail Resorts (MTN $159), the $6 billion resorts and casinos company, for decades. At first glance, its shares look tempting right now: they are trading near a 52-week low and offer a fat 5.6% dividend. But in investing, you must always look under the hood. The company's famed Epic Pass, which allows skiers to hit the slopes from Whistler, Canada to the Swiss Alps, seems to be in a rut, selling fewer passes from the previous season for the first time ever. As if that weren't enough, a 12-day ski patrol strike closed most of the runs at Park City, Utah—its largest US resort. Value investors may desire to do some bottom fishing, but we would see what unfolds before considering the shares.
Restaurants
Domino's disastrous quarter
The pizza company we love to hate, Domino's (DPZ $455) was trading down after a triple miss for the quarter. The pizza chain fell short on revenue, profit, and same-store sales in the US. Of course, the blame-game company mentioned potential tariffs on the earnings call. Tariffs, for a pizza chain? OK.
Global Strategy: EU
Left dealt serious blow in German elections
The governing left party in Germany, the SPD, just lost at the polls so badly that German Chancellor Olaf Scholz was even kicked out as the leader of his party. Two huge winners emerged: the right-leaning CDU/CSU and the further right AfD. Those two groups garnered nearly 50% of the votes. The SPD, Greens, and Left parties received about 35% of the vote in aggregate. It was a wake up call to woke politicians in Europe.
Mo 10 Feb 2025
Industrial Conglomerates
Following GE's lead, Honeywell will split into three distinct companies
GE has had success since the split, but can the Elliott-forced move at Honeywell really unlock value for shareholders, or is it simply rearranging the deck chairs?
We 05 Feb 2025
IT Software & Services
Palantir just had the mother of all quarters; shares rocketed 25% higher
Ever since the company's IPO, doubters and haters have ruled the analysts' pool. We never doubted the firm's future, and are now sitting on a 1,000% gain due to that prescience.
Headlines for the Month of January 2025
Th 30 Jan 2025
Semiconductors & Related Equipment
Chevron and GE Vernova team up to power AI data centers
It will be a massive undertaking, generating some 4 gigawatts of power, and it will fuel the power-hungry AI data centers about to be built throughout the United States.
Mo 26 Jan 2025
Semiconductors & Related Equipment
Fear of a Chinese AI model sinks stocks
Ahh, the irrational markets. Last week tech stocks were ripping higher on Project Stargate and the billions which would be spent on the AI buildout; on Monday morning NASDAQ futures were trading down 4% on fear of a Chinese AI project known as DeepSeek could do the job on the cheap (the program was supposedly developed in two months for a paltry $6 million). We suspect the markets are deeply overreacting to the news.
We 22 Jan 2025
Media & Entertainment
Netflix surges as streaming giant adds 18.9 million subs
Shares of streaming giant Netflix (NFLX $974) were trading up 12% Wednesday morning after the company announced that it had added 18.9 million new subs in Q4. The company also raised its FY25 revenue forecast to a range of $43.5B to $44.5B. Of course, this will be partially fueled by yet another round of subscription price hikes, which never seem to end.
Semiconductors & Related Equipment
DJT launches Operation Stargate
The president called it a "new American company which will invest $500 billion or more in AI infrastructure in the United States." Think of it as a Project Manhattan for artificial intelligence. The major players will be Larry Ellison's Oracle, Sam Altman's OpenAI, and Masayoshi Son's Softbank, but expect a massive supporting cast of players like Nvidia, Microsoft, and Broadcom. Exciting times ahead, and it is about time America takes the lead on such an effort.
Drug Retail
Walgreens continues its downward slide
A ten-year look at Walgreens stock is not a pretty sight, with the share price marching steadily downward from around $100 to its current $11 range. The latest downward pressure came from a DoJ lawsuit accusing the drug retailer of contributing to drug abuse. Additionally, theft continues to force more and more items behind locked plexiglass (now shampoo, deodorant, and toothpaste) and another round of store closures in high-crime areas. Not good.
Fr. 17 Jan 2025
Insurance
Affect of the Cali fires on the insur
For all of the human tragedy we have been witnessing in California, we cannot forget the impact the disaster will have economically, and the impact for insurers and homeowners.
Mo. 13 Jan 2025
Airlines
Ryanair's nanny state answer
From our X feed: Old Granny Airlines, AKA @Ryanair, is demanding airports (airports, NOT airlines) limit drinks to two per traveler. Typical nanny state answer. Better idea: Take part of CEO Michael O'Leary's €2.7M annual comp and increase your own damned security.
Metals & Mining
US Steel may have a new suitor
After the Biden administration shot down Nippon's (NISTF $20) purchase of US Steel (X $37) because the suitor is a Japanese firm (aren't they a US ally? Didn't Obama allow a Chinese firm to acquire Smithfield Foods, the largest pork producer in the world?), a new potential buyer is emerging. Cleveland Cliffs (CLF $10) and Nucor (NUE $123) are apparently readying a proposal.
Domestic Economics
California Wildfires
$250 billion. That is the current estimate of damages thus far from the LA fires, according to Accuweather. The three publicly traded companies most exposed are Allstate (ALL $183), Chubb (CB $260), and Travelers (TRV $234). The California FAIR Plan, essentially the insurer of last resort for homeowners unable to find insurance in the traditional marketplace, is facing an economic disaster.
We. 08 Jan 2025
Economics: Monetary Policy
If the Fed is lowering rates, why do they keep rising?
It seems to belie logic, that the federal funds rate would be coming down while key interest rates like the 10-year Treasury and the 30-year mortgage would be rising. One major answer for the divergence lies with our elected representatives.
Mo. 06 Jan 2025
Global Strategy: Europe
Austria's Freedom Party wins right to form government
For the first time since World War II, a right-leaning government is coming to Austria. The Freedom Party, which is trying to stem illegal immigration in the European nation, won parliamentary elections this past September. Austria joins a growing number of Western European nations lurching to the right after populist uprisings surrounding illegal immigration.
Metals & Mining
US Steel and Nippon file lawsuits against blocked merger
US Steel (X $32) and Japan's Nippon Steet (NPSCY $7) have filed joint lawsuits in an effort to overturn Biden's blocking of the firms' $14 billion merger. The two also filed suits against American steel company Cleveland-Cliffs (CLF $10) and the United Steelworkers Union for conspiring to doom the deal. Our advice to investors? Stay out of the fray.
Th. 02 Jan 2025
Automotive
Hindenburg shorts Carvana
Carvana (CVNA $207) shares were shaking off a scathing report from Hindenburg Research, which called the company's turnaround effort a "mirage." The short seller accused the used car vendor of all kinds of nefarious accounting activity. Carvana was all but dead a year ago before a stupid-crazy comeback in the share price, jumping from around $6 to $268. Hindenburg may or may not be accurate, but we wouldn't touch the shares anywhere near this level.
Th 30 Jan 2025
Semiconductors & Related Equipment
Chevron and GE Vernova team up to power AI data centers
It will be a massive undertaking, generating some 4 gigawatts of power, and it will fuel the power-hungry AI data centers about to be built throughout the United States.
Mo 26 Jan 2025
Semiconductors & Related Equipment
Fear of a Chinese AI model sinks stocks
Ahh, the irrational markets. Last week tech stocks were ripping higher on Project Stargate and the billions which would be spent on the AI buildout; on Monday morning NASDAQ futures were trading down 4% on fear of a Chinese AI project known as DeepSeek could do the job on the cheap (the program was supposedly developed in two months for a paltry $6 million). We suspect the markets are deeply overreacting to the news.
We 22 Jan 2025
Media & Entertainment
Netflix surges as streaming giant adds 18.9 million subs
Shares of streaming giant Netflix (NFLX $974) were trading up 12% Wednesday morning after the company announced that it had added 18.9 million new subs in Q4. The company also raised its FY25 revenue forecast to a range of $43.5B to $44.5B. Of course, this will be partially fueled by yet another round of subscription price hikes, which never seem to end.
Semiconductors & Related Equipment
DJT launches Operation Stargate
The president called it a "new American company which will invest $500 billion or more in AI infrastructure in the United States." Think of it as a Project Manhattan for artificial intelligence. The major players will be Larry Ellison's Oracle, Sam Altman's OpenAI, and Masayoshi Son's Softbank, but expect a massive supporting cast of players like Nvidia, Microsoft, and Broadcom. Exciting times ahead, and it is about time America takes the lead on such an effort.
Drug Retail
Walgreens continues its downward slide
A ten-year look at Walgreens stock is not a pretty sight, with the share price marching steadily downward from around $100 to its current $11 range. The latest downward pressure came from a DoJ lawsuit accusing the drug retailer of contributing to drug abuse. Additionally, theft continues to force more and more items behind locked plexiglass (now shampoo, deodorant, and toothpaste) and another round of store closures in high-crime areas. Not good.
Fr. 17 Jan 2025
Insurance
Affect of the Cali fires on the insur
For all of the human tragedy we have been witnessing in California, we cannot forget the impact the disaster will have economically, and the impact for insurers and homeowners.
Mo. 13 Jan 2025
Airlines
Ryanair's nanny state answer
From our X feed: Old Granny Airlines, AKA @Ryanair, is demanding airports (airports, NOT airlines) limit drinks to two per traveler. Typical nanny state answer. Better idea: Take part of CEO Michael O'Leary's €2.7M annual comp and increase your own damned security.
Metals & Mining
US Steel may have a new suitor
After the Biden administration shot down Nippon's (NISTF $20) purchase of US Steel (X $37) because the suitor is a Japanese firm (aren't they a US ally? Didn't Obama allow a Chinese firm to acquire Smithfield Foods, the largest pork producer in the world?), a new potential buyer is emerging. Cleveland Cliffs (CLF $10) and Nucor (NUE $123) are apparently readying a proposal.
Domestic Economics
California Wildfires
$250 billion. That is the current estimate of damages thus far from the LA fires, according to Accuweather. The three publicly traded companies most exposed are Allstate (ALL $183), Chubb (CB $260), and Travelers (TRV $234). The California FAIR Plan, essentially the insurer of last resort for homeowners unable to find insurance in the traditional marketplace, is facing an economic disaster.
We. 08 Jan 2025
Economics: Monetary Policy
If the Fed is lowering rates, why do they keep rising?
It seems to belie logic, that the federal funds rate would be coming down while key interest rates like the 10-year Treasury and the 30-year mortgage would be rising. One major answer for the divergence lies with our elected representatives.
Mo. 06 Jan 2025
Global Strategy: Europe
Austria's Freedom Party wins right to form government
For the first time since World War II, a right-leaning government is coming to Austria. The Freedom Party, which is trying to stem illegal immigration in the European nation, won parliamentary elections this past September. Austria joins a growing number of Western European nations lurching to the right after populist uprisings surrounding illegal immigration.
Metals & Mining
US Steel and Nippon file lawsuits against blocked merger
US Steel (X $32) and Japan's Nippon Steet (NPSCY $7) have filed joint lawsuits in an effort to overturn Biden's blocking of the firms' $14 billion merger. The two also filed suits against American steel company Cleveland-Cliffs (CLF $10) and the United Steelworkers Union for conspiring to doom the deal. Our advice to investors? Stay out of the fray.
Th. 02 Jan 2025
Automotive
Hindenburg shorts Carvana
Carvana (CVNA $207) shares were shaking off a scathing report from Hindenburg Research, which called the company's turnaround effort a "mirage." The short seller accused the used car vendor of all kinds of nefarious accounting activity. Carvana was all but dead a year ago before a stupid-crazy comeback in the share price, jumping from around $6 to $268. Hindenburg may or may not be accurate, but we wouldn't touch the shares anywhere near this level.
Headlines for the Month of December 2024
Fr, 20 Dec 2024
Pharmaceuticals
GLP-1 leader plummets on disappointing drug results
Novo Nordisk was a darling of the weight-loss drug movement. Now, after its next-gen GLP-1 therapy failed to live up to expectations, its share price is crashing down.
We, 18 Dec 2024
Monetary Policy
The Fed did what was expected, so why did the Dow plunge over 1,000 points?
It was the largest percentage drop in the Dow caused by an FOMC meeting since 2001. After the Fed made its expected 25-bps cut, to a lower limit of 4.25%, the Dow proceeded to drop 1,123 points, or 2.58%, as Fed Chair Powell sent signals that there may only be a few cuts in the coming year. That drop was relatively mild compared to small caps, which fell 4.39% on the "news." Gold and Treasuries got hammered as well, while Treasury yields and the dollar gained strength. Such an overreaction. But, after the non-stop run up we have had in the markets this year, perhaps we should have seen it coming. Inflation concerns continue to linger, so it makes sense that Powell would not commit to bringing rates down much more.
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.
Fr, 20 Dec 2024
Pharmaceuticals
GLP-1 leader plummets on disappointing drug results
Novo Nordisk was a darling of the weight-loss drug movement. Now, after its next-gen GLP-1 therapy failed to live up to expectations, its share price is crashing down.
We, 18 Dec 2024
Monetary Policy
The Fed did what was expected, so why did the Dow plunge over 1,000 points?
It was the largest percentage drop in the Dow caused by an FOMC meeting since 2001. After the Fed made its expected 25-bps cut, to a lower limit of 4.25%, the Dow proceeded to drop 1,123 points, or 2.58%, as Fed Chair Powell sent signals that there may only be a few cuts in the coming year. That drop was relatively mild compared to small caps, which fell 4.39% on the "news." Gold and Treasuries got hammered as well, while Treasury yields and the dollar gained strength. Such an overreaction. But, after the non-stop run up we have had in the markets this year, perhaps we should have seen it coming. Inflation concerns continue to linger, so it makes sense that Powell would not commit to bringing rates down much more.
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.
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.
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.
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.
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.
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 Martin (LMT). That's hard to justify; but, then again, it makes more sense that AMC Entertainment (AMC) having a $24 billion market cap. (The latter was a $450 million company teetering on the brink of bankruptcy going into this year.)
Ironically, Zoom's big drop came after the company reported revenue of over $1 billion in the second quarter of the year, handily topping estimates. That figure represents a 54% gain over the same quarter last year, and a 700% gain over the same quarter in 2019. It was the guidance, however, that spooked investors. Subscribers are dropping off at an unexpected rate, and management warned that revenues would probably remain flat through the end of the year. Even after the August drop, Zoom's P/E ratio is still a lofty 100, but at least it has a multiple—unlike AMC.
We have a lot of respect for Zoom and its management team, and the company's long-term viability is not in question. However, there are so many other massive competitors getting into the space—from Microsoft to Google to Cisco—that it will be a street fight going forward. As the firm rolls out new services, such as Zoom Phone, it will grow into its multiple, but that would indicate it is rather fairly valued right around where it sits today.
Capital Markets
05. Robinhood investors should be concerned about recent comments made by the new SEC chairman
I recall would-be clients, early in my career, telling me that "we own American Century no-load mutual funds, so we don't pay any fees." My retort was always the same: "I wonder how they paid for those two beautiful towers where their headquarters is located, or how they pay their staff?" In reality, despite the flowery ads designed to make us think that a company's sole existence is to help others, it's always about the money. I thought of those comments, made to me in the late 1990s, as I read about the latest threat to newly-public Robinhood Markets (HOOD $44). As the financial services platform offers customers commission-free trading, where does the revenue come from? Overwhelmingly, the answer lies in something called payments for order flow (PFOF).
When a customer wishes to buy or sell shares of a company or to trade options, the broker—be it Robinhood, Schwab, or a host of others—forwards the trade to a market maker. Historically, these intermediaries were at the major exchanges, such as the New York Stock Exchange. More recently, however, a slew of off-exchange market makers have popped up and are now responsible for over half of all retail trades placed. They make their money off of the difference between what they pay to buy the requested shares and what they sell them for seconds later—the spread. Understandably, the higher the volume of orders flowing through a market maker, the more profit to be made. Since companies like Robinhood can choose who handles a given trade, these third-party market makers have been offering to share a percentage of the spread with the brokers; hence, payments for order flow. In one month alone, Robinhood reportedly generated $100 million in revenue via this practice.
Many of the larger brokerages, such as Fidelity and Interactive Brokers, generally refuse to accept PFOF. In fact, countries like Canada, Australia, and the U.K. have gone so far as to ban the practice altogether. Enter SEC Chairman Gary Gensler. In a Barron's interview, Gensler said that a ban on PFOF is "on the table." Transparency seems to be the term du jour in the financial services world, which means an ultimate U.S. ban is quite possible. For Robinhood, which makes a majority of its revenue from PFOF, this would be a disastrous course of events.
With HOOD shares trading nearly 50% off of their August high of $85, investors might be tempted to jump in. We are sticking by our previous comments, however, and would wait to see a price in the mid-$20s range before considering a new stake.
Media & Entertainment
04. Joke of the Week: GameStop headed back to the S&P 500?
It doesn't take much news, if any, to make a meme stock gyrate wildly in price, but the reason behind the most recent leg up in shares of GameStop (GME $214) is rather humorous. It seems a rumor began circulating that the reddit darling may be headed back to the S&P 500, the index which gave the company the boot back in 2016 due to deteriorating fundamentals. Granted, five years ago the videogame consumer retailer had dropped in size to $2.5 billion (it is now comically valued at $15 billion), but it was also generating over $9 billion in revenue and was operating in the black. Now, the company's sales are about half that amount and it hasn't turned a profit in over three years. That in itself should keep it out of the index, which requires an entrant to have positive earnings for not only the most recent quarter (GME lost $67 million), but also for the most recent four quarters in aggregate (GME lost $116 million TTM). Membership into the S&P 500 is not a matter of quant calculations; ultimately, an index committee made up of staffers at S&P Dow Jones Indices decide a company's fate. Bloggers and reddit users can speculate all they want, generally driving the price up as they do, but the odds of seeing ticker GME in the S&P 500 ever again are slim to none.
Forget the term "new paradigm" or the theory that new, young investors will keep the meme stocks supported; we heard the same false narratives back in 1999. Fundamentals always matter in the long run, and the correction to these money-burning companies will eventually arrive. Diamonds may be forged by fire and high pressure, but it will be entertaining to watch how "diamond hands" hold up when these two conditions come calling.
Economics: Work & Pay
03. Payroll growth hit the skids in August, coming up half-a-million jobs short
It's always thrilling to watch the monthly US Nonfarm Payrolls report roll in, as we never know what kind of surprises it has in store. Take August's figures, released by the US Labor Department Friday morning: Against economists' estimates for 720,000 new jobs, just 235,000 were created over the course of the month. That miss of nearly half-a-million jobs immediately sent the major indexes from positive to negative territory in the pre-market. The only thing that tempered investors' concern was the "bad news equals good news" phenomenon: they calculated that this report will force the Fed to hold off on any potential September tapering of the $120 billion per month T-bill/MBS spending spree. The Delta variant was, most believe, behind the anemic jobs growth for the month, but few believe we are heading back to lockdowns or other draconian measures. In other words, the business world is learning to adapt to a new era in which these variants are, sadly, always going to be around. Buttressing the Delta argument were the internals of the report, showing the biggest misses in industries directly affected by a pandemic resurgence, such as leisure and hospitality. On the bright side, the unemployment rate did drop 20 basis points, to 5.2%. The last time the US economy hit that number—on the way down, that is—was July of 2015.
We're not overly concerned about the August jobs report, as it truly does seem to be a direct result of the latest major variant of the disease. Infection rates and hospitalizations have generally peaked in the US and are coming back down, so we expect the robust hiring to pick back up through the remainder of the year. As the extra unemployment benefits fall off, more Americans will be incentivized into going back to work. The major push to create more in-home test kits and, more importantly, develop Covid therapies which can be administered at home should continue to mitigate the economic damage to the economy.
Capital Markets
02. Renaissance Capital: Get ready for a cascade of new IPOs this fall
If a new report issued by Renaissance Capital is correct, investors are going to have a dream autumn as the IPO market will see its busiest season since the peak of the Internet craze of 2000. Around 100 public offerings are expected to take place over the coming months, to include the likes of: Warby Parker, Allbirds, Authentic Brands (Nautica, Eddie Bauer), Impossible Foods, Chobani, Flipkart, Instacart, mobile payments processor Stripe, and social media darling Reddit. When the dust settles on 2021, Renaissance believes we will be looking back on 375 deals raising roughly $125 billion. There is no doubt the appetite is there, with new investors on the Robinhood platform willing to buy into companies not showing even a modicum of profits and, in a number of instances, scant revenue. As opposed to most of the names brought to market via the recent SPAC craze, however, we do like most of the companies anticipated to go public this fall. One, Warby Parker, will go the direct listing route due to its name recognition. While SPACs have been on a horrendous downturn throughout the summer due to their excessively-overpriced debuts (just because an IPO launches at $10 per share doesn't make it a good deal), expect some relatively reasonable valuations with this new crop. In fact, investors will be chasing so many new tickers that a few golden opportunities are bound to present themselves in a number of these new issues. Get ready for a whirlwind season.
Our advice? Prepare to make a few additions to the portfolio by looking at current sector weightings to identify underweight sectors and industries. Other than Stripe and Reddit, the names mentioned above are outside of the recent new-tech-stock craze. And that is a good thing.
Energy Commodities
01. As we head into sweater weather and beyond, beware the trajectory of natural gas prices
For anyone paying the family bills and living in a home which utilizes both gas and electric utilities, the cooler months generally meant a nice cost savings as the AC was turned off and the gas-powered heat came on. It always boggled our minds that homeowners would willingly go to an all-electric house, considering the spread between the price of the two commodities. That spread hasn't completely vanished, but the natural gas advantage is being rapidly diminished. In fact, the Henry Hub Natural Gas Spot Price has risen a remarkable 78%, from $2.43 to $4.33 per million British thermal units (MMBtu), just since this past April. A confluence of events have led to the dramatic price increase, from Europe's war on fossil fuels to an especially cold winter last year to a mysterious supply shortage in Russia. Whatever the mix of reasons, over which we have little to no control, expect higher gas bills this winter. Ironically, the spike in LNG prices has led to a semi-resurgence in the "dirtiest" of all fossil fuels, coal, as the price of the latter is substantially less than the former. Adding insult to injury is the fact that the hybrid work-from-home model means that families, not the companies they work for, will shoulder a higher percentage of the burden as they tap into more energy for their domestic work requirements.
Our pocketbooks may be hurting this winter, but the vilified fossil fuel producers have provided a nice opportunity for high-risk-tolerance investors. Cheniere Energy (LNG $89), a major exporter of liquified natural gas (no easy task, by the way), is up 50% ytd; while the hated coal company, Peabody Energy Corp (BTU $19), is up a whopping 670%. For a basket of LNG holdings, investors can consider the United States 12 Month Natural Gas ETF (UNL $12), the United States Natural Gas ETF (UNG $16), and the iPath Bloomberg Natural Gas ETN (GAZ $25).
Under the Radar Investment
Agnico Eagle Mines Ltd (AEM $57)
We have a strong thesis with respect to the current price of gold: it is undervalued. While the SPDR® Gold Shares ETF (GLD $168) is certainly one good method for playing the coming price increase of the precious metal, don't forget the gold miners as well. One of our perennial favorites—or at least a historical favorite when the price of gold has appeared undervalued—is Agnico Eagle Mines (AEM $57). The company is on pace to produce two million ounces of gold this year through its cornerstone mines in Canada, Mexico, and Finland. AEM is continually working to make its mining processes more efficient, reducing its all-in sustaining costs (AISC) by 10% this year, to $1,021 per ounce. The company believes it is on pace to reduce that figure to $950 per ounce in the very near future. The AISC is an industry-specific standard which portrays the true cost of mining an ounce of a given metal. With gold currently sitting at $1,789 per ounce, AEM shares are sitting near their 52-week low. With a market cap of $14B, the company has an eighteen multiple and a solid balance sheet (L/T assets/liabilities=$8.6B/$3.35B). Conservatively, we place AEM's fair value at $75/share, or 32% above where they currently trade.
Answer
The Battle of Saratoga consisted of two crucial battles, eighteen days apart. The Battle of Freeman's Farm, which took place 19 September 1777 on the abandoned farm of loyalist John Freeman, ended up being a pyrrhic victory for General John Burgoyne, as the British forced the Americans to retreat, but lost twice as many men in the process. This prevented the British from continuing their drive to Albany. Then, on 17 October 1777, two American officers, Major General Benedict Arnold and Brigadier General Daniel Morgan, fought savagely to deal Burgoyne a humiliating defeat. Their commanding officer, Major General Horatio "Granny" Gates, took credit for the victory, despite remaining safely in his tent during the battle and excoriating Arnold for his "reckless" actions. This incident, among others, would ultimately push Benedict Arnold, whose leg was severely mangled during the fighting, to become a traitor to the cause and a spy for the British.
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 Martin (LMT). That's hard to justify; but, then again, it makes more sense that AMC Entertainment (AMC) having a $24 billion market cap. (The latter was a $450 million company teetering on the brink of bankruptcy going into this year.)
Ironically, Zoom's big drop came after the company reported revenue of over $1 billion in the second quarter of the year, handily topping estimates. That figure represents a 54% gain over the same quarter last year, and a 700% gain over the same quarter in 2019. It was the guidance, however, that spooked investors. Subscribers are dropping off at an unexpected rate, and management warned that revenues would probably remain flat through the end of the year. Even after the August drop, Zoom's P/E ratio is still a lofty 100, but at least it has a multiple—unlike AMC.
We have a lot of respect for Zoom and its management team, and the company's long-term viability is not in question. However, there are so many other massive competitors getting into the space—from Microsoft to Google to Cisco—that it will be a street fight going forward. As the firm rolls out new services, such as Zoom Phone, it will grow into its multiple, but that would indicate it is rather fairly valued right around where it sits today.
Capital Markets
05. Robinhood investors should be concerned about recent comments made by the new SEC chairman
I recall would-be clients, early in my career, telling me that "we own American Century no-load mutual funds, so we don't pay any fees." My retort was always the same: "I wonder how they paid for those two beautiful towers where their headquarters is located, or how they pay their staff?" In reality, despite the flowery ads designed to make us think that a company's sole existence is to help others, it's always about the money. I thought of those comments, made to me in the late 1990s, as I read about the latest threat to newly-public Robinhood Markets (HOOD $44). As the financial services platform offers customers commission-free trading, where does the revenue come from? Overwhelmingly, the answer lies in something called payments for order flow (PFOF).
When a customer wishes to buy or sell shares of a company or to trade options, the broker—be it Robinhood, Schwab, or a host of others—forwards the trade to a market maker. Historically, these intermediaries were at the major exchanges, such as the New York Stock Exchange. More recently, however, a slew of off-exchange market makers have popped up and are now responsible for over half of all retail trades placed. They make their money off of the difference between what they pay to buy the requested shares and what they sell them for seconds later—the spread. Understandably, the higher the volume of orders flowing through a market maker, the more profit to be made. Since companies like Robinhood can choose who handles a given trade, these third-party market makers have been offering to share a percentage of the spread with the brokers; hence, payments for order flow. In one month alone, Robinhood reportedly generated $100 million in revenue via this practice.
Many of the larger brokerages, such as Fidelity and Interactive Brokers, generally refuse to accept PFOF. In fact, countries like Canada, Australia, and the U.K. have gone so far as to ban the practice altogether. Enter SEC Chairman Gary Gensler. In a Barron's interview, Gensler said that a ban on PFOF is "on the table." Transparency seems to be the term du jour in the financial services world, which means an ultimate U.S. ban is quite possible. For Robinhood, which makes a majority of its revenue from PFOF, this would be a disastrous course of events.
With HOOD shares trading nearly 50% off of their August high of $85, investors might be tempted to jump in. We are sticking by our previous comments, however, and would wait to see a price in the mid-$20s range before considering a new stake.
Media & Entertainment
04. Joke of the Week: GameStop headed back to the S&P 500?
It doesn't take much news, if any, to make a meme stock gyrate wildly in price, but the reason behind the most recent leg up in shares of GameStop (GME $214) is rather humorous. It seems a rumor began circulating that the reddit darling may be headed back to the S&P 500, the index which gave the company the boot back in 2016 due to deteriorating fundamentals. Granted, five years ago the videogame consumer retailer had dropped in size to $2.5 billion (it is now comically valued at $15 billion), but it was also generating over $9 billion in revenue and was operating in the black. Now, the company's sales are about half that amount and it hasn't turned a profit in over three years. That in itself should keep it out of the index, which requires an entrant to have positive earnings for not only the most recent quarter (GME lost $67 million), but also for the most recent four quarters in aggregate (GME lost $116 million TTM). Membership into the S&P 500 is not a matter of quant calculations; ultimately, an index committee made up of staffers at S&P Dow Jones Indices decide a company's fate. Bloggers and reddit users can speculate all they want, generally driving the price up as they do, but the odds of seeing ticker GME in the S&P 500 ever again are slim to none.
Forget the term "new paradigm" or the theory that new, young investors will keep the meme stocks supported; we heard the same false narratives back in 1999. Fundamentals always matter in the long run, and the correction to these money-burning companies will eventually arrive. Diamonds may be forged by fire and high pressure, but it will be entertaining to watch how "diamond hands" hold up when these two conditions come calling.
Economics: Work & Pay
03. Payroll growth hit the skids in August, coming up half-a-million jobs short
It's always thrilling to watch the monthly US Nonfarm Payrolls report roll in, as we never know what kind of surprises it has in store. Take August's figures, released by the US Labor Department Friday morning: Against economists' estimates for 720,000 new jobs, just 235,000 were created over the course of the month. That miss of nearly half-a-million jobs immediately sent the major indexes from positive to negative territory in the pre-market. The only thing that tempered investors' concern was the "bad news equals good news" phenomenon: they calculated that this report will force the Fed to hold off on any potential September tapering of the $120 billion per month T-bill/MBS spending spree. The Delta variant was, most believe, behind the anemic jobs growth for the month, but few believe we are heading back to lockdowns or other draconian measures. In other words, the business world is learning to adapt to a new era in which these variants are, sadly, always going to be around. Buttressing the Delta argument were the internals of the report, showing the biggest misses in industries directly affected by a pandemic resurgence, such as leisure and hospitality. On the bright side, the unemployment rate did drop 20 basis points, to 5.2%. The last time the US economy hit that number—on the way down, that is—was July of 2015.
We're not overly concerned about the August jobs report, as it truly does seem to be a direct result of the latest major variant of the disease. Infection rates and hospitalizations have generally peaked in the US and are coming back down, so we expect the robust hiring to pick back up through the remainder of the year. As the extra unemployment benefits fall off, more Americans will be incentivized into going back to work. The major push to create more in-home test kits and, more importantly, develop Covid therapies which can be administered at home should continue to mitigate the economic damage to the economy.
Capital Markets
02. Renaissance Capital: Get ready for a cascade of new IPOs this fall
If a new report issued by Renaissance Capital is correct, investors are going to have a dream autumn as the IPO market will see its busiest season since the peak of the Internet craze of 2000. Around 100 public offerings are expected to take place over the coming months, to include the likes of: Warby Parker, Allbirds, Authentic Brands (Nautica, Eddie Bauer), Impossible Foods, Chobani, Flipkart, Instacart, mobile payments processor Stripe, and social media darling Reddit. When the dust settles on 2021, Renaissance believes we will be looking back on 375 deals raising roughly $125 billion. There is no doubt the appetite is there, with new investors on the Robinhood platform willing to buy into companies not showing even a modicum of profits and, in a number of instances, scant revenue. As opposed to most of the names brought to market via the recent SPAC craze, however, we do like most of the companies anticipated to go public this fall. One, Warby Parker, will go the direct listing route due to its name recognition. While SPACs have been on a horrendous downturn throughout the summer due to their excessively-overpriced debuts (just because an IPO launches at $10 per share doesn't make it a good deal), expect some relatively reasonable valuations with this new crop. In fact, investors will be chasing so many new tickers that a few golden opportunities are bound to present themselves in a number of these new issues. Get ready for a whirlwind season.
Our advice? Prepare to make a few additions to the portfolio by looking at current sector weightings to identify underweight sectors and industries. Other than Stripe and Reddit, the names mentioned above are outside of the recent new-tech-stock craze. And that is a good thing.
Energy Commodities
01. As we head into sweater weather and beyond, beware the trajectory of natural gas prices
For anyone paying the family bills and living in a home which utilizes both gas and electric utilities, the cooler months generally meant a nice cost savings as the AC was turned off and the gas-powered heat came on. It always boggled our minds that homeowners would willingly go to an all-electric house, considering the spread between the price of the two commodities. That spread hasn't completely vanished, but the natural gas advantage is being rapidly diminished. In fact, the Henry Hub Natural Gas Spot Price has risen a remarkable 78%, from $2.43 to $4.33 per million British thermal units (MMBtu), just since this past April. A confluence of events have led to the dramatic price increase, from Europe's war on fossil fuels to an especially cold winter last year to a mysterious supply shortage in Russia. Whatever the mix of reasons, over which we have little to no control, expect higher gas bills this winter. Ironically, the spike in LNG prices has led to a semi-resurgence in the "dirtiest" of all fossil fuels, coal, as the price of the latter is substantially less than the former. Adding insult to injury is the fact that the hybrid work-from-home model means that families, not the companies they work for, will shoulder a higher percentage of the burden as they tap into more energy for their domestic work requirements.
Our pocketbooks may be hurting this winter, but the vilified fossil fuel producers have provided a nice opportunity for high-risk-tolerance investors. Cheniere Energy (LNG $89), a major exporter of liquified natural gas (no easy task, by the way), is up 50% ytd; while the hated coal company, Peabody Energy Corp (BTU $19), is up a whopping 670%. For a basket of LNG holdings, investors can consider the United States 12 Month Natural Gas ETF (UNL $12), the United States Natural Gas ETF (UNG $16), and the iPath Bloomberg Natural Gas ETN (GAZ $25).
Under the Radar Investment
Agnico Eagle Mines Ltd (AEM $57)
We have a strong thesis with respect to the current price of gold: it is undervalued. While the SPDR® Gold Shares ETF (GLD $168) is certainly one good method for playing the coming price increase of the precious metal, don't forget the gold miners as well. One of our perennial favorites—or at least a historical favorite when the price of gold has appeared undervalued—is Agnico Eagle Mines (AEM $57). The company is on pace to produce two million ounces of gold this year through its cornerstone mines in Canada, Mexico, and Finland. AEM is continually working to make its mining processes more efficient, reducing its all-in sustaining costs (AISC) by 10% this year, to $1,021 per ounce. The company believes it is on pace to reduce that figure to $950 per ounce in the very near future. The AISC is an industry-specific standard which portrays the true cost of mining an ounce of a given metal. With gold currently sitting at $1,789 per ounce, AEM shares are sitting near their 52-week low. With a market cap of $14B, the company has an eighteen multiple and a solid balance sheet (L/T assets/liabilities=$8.6B/$3.35B). Conservatively, we place AEM's fair value at $75/share, or 32% above where they currently trade.
Answer
The Battle of Saratoga consisted of two crucial battles, eighteen days apart. The Battle of Freeman's Farm, which took place 19 September 1777 on the abandoned farm of loyalist John Freeman, ended up being a pyrrhic victory for General John Burgoyne, as the British forced the Americans to retreat, but lost twice as many men in the process. This prevented the British from continuing their drive to Albany. Then, on 17 October 1777, two American officers, Major General Benedict Arnold and Brigadier General Daniel Morgan, fought savagely to deal Burgoyne a humiliating defeat. Their commanding officer, Major General Horatio "Granny" Gates, took credit for the victory, despite remaining safely in his tent during the battle and excoriating Arnold for his "reckless" actions. This incident, among others, would ultimately push Benedict Arnold, whose leg was severely mangled during the fighting, to become a traitor to the cause and a spy for the British.
Headlines for the Week of 01 Aug—07 Aug 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 communist party declares open season on domestic Internet companies...
Since February, when China began ramping up its attack on Net-based companies under its domain, the affected stocks have been plummeting. Since that time, what percentage have they, as a group, dropped in price?
Penn Trading Desk:
Penn: Purchased a play on the surging demand for outdoor recreational activities
Americans want to get out and explore their country to an extent not seen in a century. We added an undervalued name to the Intrepid Trading Platform which is well poised to take advantage of this trend, and one which happens to be on an aggressive acquisition spree to increase its breadth in the arena.
Penn: Placing a stop loss to protect our American Campus Communities gains
We purchased student housing REIT American Campus Communities right as analysts were predicting a dire situation for students returning to their respective colleges in the fall of 2020. We never bought into the "mass closings of dormitories" thesis and saw a great opportunity in the shares. In addition to strong growth potential, we were drawn to the company's 5.41% dividend yield. ACC has blown past our $40 initial price target and we are protecting our gains with a $47 stop loss on the shares.
Penn: Placing a stop loss to protect our MGM gains
We added the Las Vegas Strip's largest resort casino operator, MGM Resorts International, to the Penn Global Leaders Club last year as the industry was reeling from the pandemic. MGM shares surpassed our target price, are now up 130% from our purchase price, and have been falling back recently due to the Delta variant. We still believe in the company's long-term vision, but are not willing to fall below a triple-digit gain. We have placed a stop on the shares at $34, or $2 above our target price.
Penn: Placing a stop loss to protect our AVB gains
We opened our position in AvalonBay Communities (AVB $227) within the Strategic Income Portfolio in July of 2020, and this owner of 275 apartment communities—with 74,000 units—has seen its share price rise well above our initial price target of $182. Valuations seem a bit stretched, and with the share price hovering near an all-time high, we are putting protection on our position with a $218 stop loss.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cybersecurity
10. Use diligence before clicking on that "unsubscribe" button at the bottom of spam emails
Remember when it was actually fun to find new emails waiting to be opened in your inbox? A few of us even remember AOL's iconic "you've got mail" notification. How times have changed. Americans are now inundated with mountains of new emails each and every day, and trying to cull the weeds from the garden can be challenging, to say the least. Instead of just whacking away by deleting them, knowing they are destined to return, many of us have tried to eradicate them using the mandatory (at least we thought it was) "Unsubscribe" button located in microscopic print somewhere near the bottom of each piece. We recently began to wonder, though, if the sage advice of not clicking on any link we're not extremely familiar with also held true for this innocuous little "opt out" key.
In fact, it turns out that malicious emails can, indeed, have unsubscribe links that lead to dangerous sites which can compromise or even infect your system with a virus. According to cybersecurity firm McAfee, following a few simple rules can help keep your system—and the treasure trove of data it probably holds—safe(r) from the dark web. If the email is from a legitimate company with which you are familiar, it should be safe to take a minute of your valuable time and go through the unsubscribe process. (Most are simple, others are purposefully irritating, making you put in the email address where they sent their junk!) If the email is from a company you don't recognize or one that seems a bit fishy, do not hit the unsubscribe link, just delete the email. For nefarious individuals and the algorithms they devise, this verifies that they have made a successful hit on a "validated" email address. If this is the case, the best scenario is more unwanted email heading your way. An uglier possibility is that the simple act of clicking on an unsubscribe button or link can lead to a virus being downloaded to your system. Another reason it pays to have good antivirus software protecting your system at all times.
Bottom line: simply delete or move to spam/junk any email that appears suspicious. In addition to having a strong web protection system installed on all of your devices, be sure and have it run scans on your system on a regular basis. Always keep your operating system up-to-date as well, as new malicious efforts are constantly being identified by software developers.
Beverages & Tobacco
09. Boston Beer's big bet on seltzer hits a wall, shares plummet
Boston Beer (SAM $716), maker of Sam Adams, has been our favorite name in booze/brewers for a number of years. Fiercely independent (as opposed to the big three, which are all now owned by foreign entities), the company simply makes an excellent product and has an exemplary management team, led by founder and Chairman of the Board Jim Koch. The sheen began to come off the name, however, when SAM started pushing a mediocre beer called Sam 76. That misstep was followed by another: the company bet big on hard seltzers—the modern version of Zima or Bartles & Jaymes wine coolers—at the expense (in our opinion) of their staple beer business. Hopefully they received the message investors sent them last week. After missing Q2 earnings badly ($4.75/sh vs the $6.60/sh expected), management admitted to increasing production of Truly hard seltzer to meet a summer demand which never fully manifested. For the quarter, SAM generated $602.8M in revenue versus expectations for $675.7M. To make matters worse, the firm cut its guidance for the remainder of the year. All of this was enough to pound SAM shares down 26% in one day and 31% from the week's peak to trough price.
We haven't owned SAM shares within the Penn portfolios since our disappointment over the capital expended on the ill-fated Sam 76 campaign, and the hard push into hard seltzers only reinforced our decision. Even if the company does pivot back to its staple, high-end beer business, the field is now crowded with new competitors. Analysts seem to be gravitating toward an average price target of $1,000, but we are waiting to see evidence that management fully understands the problem and is willing to make a mea culpa on their recent moves.
Automotive
08. Tesla earned over $1 billion this past quarter, ten times more than it made in the second quarter of 2020
EV maker Tesla (TSLA $658) just achieved its eighth-straight quarter with positive cash flow, earning $1.14 billion in profit between April and June. As if that wasn't impressive enough, the figure represents a ten-fold increase over the $104 million it earned in the same quarter last year. Revenue in Q2 doubled from last year, from $6.04 billion to $11.96 billion. It is difficult to find any flaws in the earnings report, but that didn't stop the chronic naysayers from pointing out why this level of growth is unsustainable. Those comments are rather ironic, considering the company had to weather recalls, a backlash from Chinese consumers, and a chip shortage over the course of the quarter. As for Musk, he hinted that this may be the last earnings conference call he would be taking part in, let alone leading. We can fully understand that decision.
Too many analysts continue to view Tesla as just another car company. Granted, were that the case, the multiples for the company are excessively high. We don't buy the premise, however. Tesla earned nearly $1 billion from its energy business last quarter, installing 60% more energy storage systems in homes than it did the previous quarter. Furthermore, we are most excited about the FSD (full self-driving) subscription service that should mushroom after future system upgrades make the company's vehicles fully autonomous. Then there is the company's advanced battery production facilities and its benchmark Supercharger DC fast-charting stations, which it will soon open to non-Tesla vehicles. We believe the Tesla growth story remains fully intact.
Global Exchanges & Indexes
07. The high risks associated with investing in Chinese tech companies
There have always been outsized risks associated with investing in Internet companies; when those companies happen to be based out of Communist China, those risks are compounded. For evidence, consider the popular KraneShares CSI China Internet ETF (KWEB $52). This fund holds fifty of the largest Chinese Internet companies listed on exchanges outside of Mainland China (presumably to mitigate risk). Alibaba and Tencent Holdings are the two largest positions within the fund. On 17 February, shares of KWEB hit $104.94; now, just five months later, they have been sliced precisely in half. Put another way, a $10,000 investment in the fund five months ago would now be worth $5,000.
China's general crackdown on publicly-traded companies and the more recent rules handed down to rein in for-profit education companies—such as the $4 billion New Oriental Education & Technology Group (EDU $2)—have been the major catalyst for the plummet. EDU has been a popular bet for investors looking to ring up profits in Chinese companies, with the shares jumping from $5 in 2019 to a peak of $20 this past February, before settling back down to their current $2 range. Why would China, which is bent on becoming the world's largest economy in short order, create a host of new rules designed to stifle the growth of their own companies? Note that KWEB focuses on shares of companies listed outside of the country; China wants to promote those listing on domestic exchanges—the largest being the Shanghai Stock Exchange. These rules are a shot across the bow to home-grown companies daring to list outside of the country. As has always been the case, investors are at the mercy of the all-powerful Chinese Communist Party.
There are so many wonderful opportunities right now across the globe, both in frontier/emerging and developed markets, that we urge investors to focus on areas which promote democratic values and offer citizens a high level of personal freedom. We don't believe it is worth the risk to have direct exposure to individual Chinese companies. The KWEB example shows how much risk is involved even in owning a basket of the largest publicly-traded companies based out of Mainland China.
Aerospace & Defense
06. Brain drain at Boeing: engineers and technicians are leaving the firm at an alarming rate
Bloomberg recently published an interesting and rather in-depth story on the flight of disillusioned engineers and technicians out of the exits at Boeing (BA $233). Certainly, the dual tragedies of recent 737 MAX crashes have impacted morale at the firm, but the problem has more to do with a management team wandering aimlessly in search of a strategic mission than it does with any specific events. When a former Boeing CEO announced, "no more 'moon shots,' it might as well have become the new company slogan. For young engineers, the excitement which once swirled around working for the world's largest aerospace and defense company has been replaced by, "well, at least it will look good on my résumé." Those workers have been taking their résumés to competing firms in droves as of late. And the recipients of this talent pool are not just the usual suspects such as SpaceX, Blue Origin, and Virgin Galactic.
Since the beginning of last year, over 3,200 engineers and technicians have bolted from the firm—a figure which accounts for nearly one-fifth of the 18,000 Boeing workers represented by the Society of Professional Engineering Employees in Aerospace (SPEEA) union. While many have been attracted to SpaceX's stunning recent successes and Elon Musk's bold vision for the future of humanity in space, Amazon has also been a major destination for these skilled workers. The idea of remaining in the Seattle area with a nice pay bump has been the major selling point for the latter. Amazon employs these specialists to increase the efficiency at their warehouses, much like they did with the Boeing factory floors.
The airliner catastrophes and a lack of a new generation passenger aircraft on the drawing boards at Boeing have not been the only forces driving workers away. On the space side of the equation, the company's recent Starliner failures stand in stark comparison to the stunning SpaceX successes. The company will have another chance to prove itself with the upcoming crew capsule test slated for this weekend, but even with a glaring success the firm has a long way to go. Meanwhile, European nemesis Airbus is increasingly outpacing Boeing with respect to both orders and deliveries. In the first quarter of 2021, Boeing delivered 77 aircraft versus 125 jets for Airbus—a 62% differential. By the end of Q1, Airbus reported a backlog of nearly 6,000 jets, while Boeing's backlog amounted to just shy of 5,000 aircraft. Furthermore, with no exciting new designs to show potential buyers, we are not sure what will be the catalyst for a comeback.
In our opinion, there is a horrendous vacuum leadership at Boeing, and the company's great turnaround cannot occur until a nearly clean sweep is made at the top. Unfortunately, the entire leadership team would disagree with that assessment. It will take major activist investor push to force the change required, but there hasn't been much action on that front either. At least we have SpaceX around to spearhead America's great return to manned spaceflight.
Media & Entertainment
05. Scarlett Johansson sues Disney over streaming release of Black Widow, Disney fires back with scathing retort
Our immediate thought was, "poor Scarlett, $20 million for one movie wasn't enough?" However, the more we delved into the story, the more it appears this will be one heck of a court battle. Actor Scarlett Johansson, number seven on the list of IMDb's hottest female actors of 2021, is suing Disney (DIS $ 176) for simultaneously releasing Black Widow, in which she plays the eponymous lead role, in theaters and on the Disney+ streaming service for a fee. Johansson's beef is this: the better the movie does at the box office, the more she will stand to make for her role. According to her attorney, the streaming release was done primarily for Disney to add subscribers, and a large number of viewers decided to forego the theater and stream instead. The figures show that Disney did, indeed, fatten its wallet by charging $30 for Disney+ members to stream the movie. Over the course of its opening weekend, Black Widow raked in $80 million at the US box office, $78 million at the worldwide box office, and a whopping $60 million from its Disney+ platform.
Disney shot back directly at Johansson, saying that "the lawsuit is especially sad and distressing in its callous disregard for the horrific and prolonged global effects of the COVID-19 pandemic." Yes, Disney, we are sure you released the movie on your streaming service as a public service, which is why you charged paying subscribers an additional $30 a pop. Actually, the more we mull the situation over, the more we tend to side with Johansson. Based on other movies released during the pandemic and the way in which other studios compensated their talent, she probably would have made around $25 million more for the movie than she did. In addition to a probable loss in the courts, Disney will suffer a real black eye in Hollywood over this one.
When Bob Chapek took over at Disney, we cashed out—despite having owned the company in the Penn Global Leaders Club for years. It appears we made the right call. Nothing matters like management.
Capital Markets
04. HOOD's wild ride: platform for the meme stocks turns into one itself
By most accounts, it was a lackluster debut. The much-anticipated IPO of financial services platform Robinhood (HOOD $55) finally occurred last week, but shares ended up tumbling 12% from their $38 initial offering price almost immediately. Considering the platform boasts some 20 million accounts, one would have expected fireworks out of the gate, akin to an Airbnb ($145) or a DoorDash (DASH $176). But, alas, the WallStreetBets/reddit monster ended up harming the very company which fomented the movement, with some on the social media sites even calling on members to short the stock on day one. That is rich, considering users' raison d'être seemed to be destroying the shorts. ARK Investment's Cathie Wood, someone whom we respect a lot, may have played a part in the turnaround which occurred after day one by buying 1.85 million shares below the IPO price. Despite Wood's buy, we tend to agree with Morningstar's fair value of $30 on the shares, meaning they have some additional falling to do before we are interested.
When the reckoning does hit the markets, and it will, expect HOOD to get pounded. The world where an AMC, which is worth $5 per share, trades at $38 per share will eventually come crumbling down, and some semblance of sanity will return. At that point, there will be a lot of formerly-overvalued stocks worth picking up, and plenty we still wouldn't touch. As for HOOD, if the $30 fair value is accurate that means $25 per share might be a good point to jump in.
Automotive
03. We called it: Nikola's founder, Trevor Milton indicted on fraud charges
We have been calling EV maker Nikola (NKLA $11) little short of a sham for a couple of years now. Our opinion was cemented after we saw the company's founder, Trevor Milton, in several interviews. Based on decades of CEO-watching, we got a really bad feeling about the founder and his alleged product lineup. While the company was spared in the indictment, the US government has just charged the founder with three counts of fraud, stating that he lied to investors "about nearly all aspects of the business." We may have had a bad feeling about the firm, but investors certainly didn't: NKLA shares went from $10 in March of 2020 to $80 three months later, since dropping back to the $12 range. While at their high, Milton had a paper net worth of roughly $9 billion; that figure is now floating around $1 billion, but we imagine there is plenty more pain ahead. The wheels became to come off the cart last September after Hindenburg Research published a scathing article on the EV firm, pretty much echoing the government case—or vice versa. Shortly after the report was released, Milton was out at the firm he started and a deal the company cobbled together with General Motors fell apart (we excoriated GM when it made the deal). If we want to ignore the company's financials (basically zero revenue) and focus on production, try this on for size: the company has produced zero vehicles for public sale.
Tesla was enormously successful, so we should just jump into an EV maker that sounds like the next Tesla, right? Heck, this company even took the famous inventor's first name! Madness. It is understandable that the financials wouldn't look stellar on a nascent company trying to break into an industry with a pretty tall barrier to entry, but we are talking about a company that went public without having one vehicle roll off of an assembly line. NKLA may not have been a meme stock, but the same level of (ir)rational thought went into the purchase of the shares.
Industrial Conglomerates
02. A sure sign of desperation: financial engineering has replaced cutting-edge engineering at General Electric
I feel bad for General Electric (GE $105); embarrassed for this once-great American powerhouse. Has Edison's firm really been reduced to this? Some companies have a "move fast and break things" mentality. GE's grand strategic vision is "let's do a reverse stock split at just the right level to move our share price into triple digits like our competition." I mean, that's simply embarrassing. The move is tantamount to an admission that the company can't get its stock price to triple digits the old fashioned way, through hard work, relentless creativity, and a stellar sales force. Instead, management performed the corporate version of breaking into the school's server to change a grade from a C- to an A+. Here's a question: name the last company that regained a leadership role in an industry after performing a reverse stock split? Good luck—we couldn't think of any. General Electric, once a "move fast and break things" company, now makes most of its profits from servicing the equipment it had previously sold to customers. Unlike an Apple, however, the firm isn't introducing the new products necessary to feed an ever-growing services business. When it finds itself in need of a new supply of cash, it simply sells one of its legacy businesses. Jeffrey Immelt, who spent too much time flying around on one of his two corporate jets (the other would travel behind in case of mechanical problems), started the great downturn at General Electric; unfortunately, Larry Culp doesn't seem to be the dynamic disruptor so desperately needed at the firm. Maybe he and Boeing's David Calhoun can have a few adult beverages one of these days and reminisce about the good old days at their respective firms.
General Electric was one of those global leaders which always had a place in our portfolios. No longer. GE is a case study in the importance of understanding what you own and why. We have a neighbor who had a gorgeous and enormous white pine in his back yard. One day we noticed that the needles at the top of the tree began turning brown. Instead of calling in a tree expert at the first sign of trouble, he figured the problem would take care of itself. Needless to say, the problem rapidly spread and the tree met its demise. A company used to be able to rest on its laurels and simply weather some boneheaded tactical or even strategic errors by upper management. Those days are gone, but the entrenched members of the board at a company like GE seem content to collect their pay and stay the course. Good luck. Pardon us if we choose not to board your next flight.
Market Week in Review
01. Yet another solid jobs report helps cobble together a positive week for the markets
It was difficult to find much wrong with the employment situation in America for the month of July, except for the fact that employers couldn't find enough workers to fill the open slots. Against expectations for 862,500 new nonfarm jobs for the month, companies actually hired 943,000 workers; June's 850,000 figure was also revised higher, to 938,000. The unemployment rate was, perhaps, the most pleasant surprise of all: it ticked down a whopping 50 basis points, from 5.9% to 5.4%. We are slowly but steadily getting back to the pre-pandemic unemployment rate of 3.5%, recorded in the halcyon days of February, 2020. The jobs report helped sway two market conditions: the 10-year Treasury rose from 1.228% to 1.303%, and all of the major indexes recorded gains for the week. Another five days of strong earnings releases also helped strengthen the stock market—especially the small caps. The Russell 2000 rose 1.46% on the week. On Monday, an interesting figure from the Bureau of Labor Statistics will be released: the Job Openings and Labor Turnover Survey, or JOLTS. Economists are predicting a near-record 9.1 million new job openings for the last business day of June. Quite a different story from a year ago.
Under the Radar Investment
Afry AB
Afry AB (AFXXF $17) is a $1.9 billion Swedish-Finnish engineering and consulting firm with projects in the energy, industrial, and infrastructure markets. On the infrastructure front, Afry provides sustainable technology solutions for railways, roads, and other transportation networks. In the energy sector, the firm constructs plants and provides market analysis for power generation, manufacturing facilities, and chemical refining plants. This is a play on a European recovery, as the overwhelming percentage of sales emanate from that continent. With a 15 P/E ratio and a 3.57% dividend yield, the company generated revenues of $2.07 billion in 2020 and $2.238 billion TTM, signaling a nice growth trajectory. Afry was founded in 1895 and trades on the Nasdaq Stockholm AB, formerly known as the Stockholm Stock Exchange.
Answer
Since February 16th, the Dow Jones Internet ETF hasn't been too impressive, with the aggregate shares down 0.47%. Those results appear stellar, however, when compared to a group of Chinese Internet stocks, which are down 53% in the same period. Alibaba, Tencent, and JD.com are the top three holdings in the group.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The communist party declares open season on domestic Internet companies...
Since February, when China began ramping up its attack on Net-based companies under its domain, the affected stocks have been plummeting. Since that time, what percentage have they, as a group, dropped in price?
Penn Trading Desk:
Penn: Purchased a play on the surging demand for outdoor recreational activities
Americans want to get out and explore their country to an extent not seen in a century. We added an undervalued name to the Intrepid Trading Platform which is well poised to take advantage of this trend, and one which happens to be on an aggressive acquisition spree to increase its breadth in the arena.
Penn: Placing a stop loss to protect our American Campus Communities gains
We purchased student housing REIT American Campus Communities right as analysts were predicting a dire situation for students returning to their respective colleges in the fall of 2020. We never bought into the "mass closings of dormitories" thesis and saw a great opportunity in the shares. In addition to strong growth potential, we were drawn to the company's 5.41% dividend yield. ACC has blown past our $40 initial price target and we are protecting our gains with a $47 stop loss on the shares.
Penn: Placing a stop loss to protect our MGM gains
We added the Las Vegas Strip's largest resort casino operator, MGM Resorts International, to the Penn Global Leaders Club last year as the industry was reeling from the pandemic. MGM shares surpassed our target price, are now up 130% from our purchase price, and have been falling back recently due to the Delta variant. We still believe in the company's long-term vision, but are not willing to fall below a triple-digit gain. We have placed a stop on the shares at $34, or $2 above our target price.
Penn: Placing a stop loss to protect our AVB gains
We opened our position in AvalonBay Communities (AVB $227) within the Strategic Income Portfolio in July of 2020, and this owner of 275 apartment communities—with 74,000 units—has seen its share price rise well above our initial price target of $182. Valuations seem a bit stretched, and with the share price hovering near an all-time high, we are putting protection on our position with a $218 stop loss.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cybersecurity
10. Use diligence before clicking on that "unsubscribe" button at the bottom of spam emails
Remember when it was actually fun to find new emails waiting to be opened in your inbox? A few of us even remember AOL's iconic "you've got mail" notification. How times have changed. Americans are now inundated with mountains of new emails each and every day, and trying to cull the weeds from the garden can be challenging, to say the least. Instead of just whacking away by deleting them, knowing they are destined to return, many of us have tried to eradicate them using the mandatory (at least we thought it was) "Unsubscribe" button located in microscopic print somewhere near the bottom of each piece. We recently began to wonder, though, if the sage advice of not clicking on any link we're not extremely familiar with also held true for this innocuous little "opt out" key.
In fact, it turns out that malicious emails can, indeed, have unsubscribe links that lead to dangerous sites which can compromise or even infect your system with a virus. According to cybersecurity firm McAfee, following a few simple rules can help keep your system—and the treasure trove of data it probably holds—safe(r) from the dark web. If the email is from a legitimate company with which you are familiar, it should be safe to take a minute of your valuable time and go through the unsubscribe process. (Most are simple, others are purposefully irritating, making you put in the email address where they sent their junk!) If the email is from a company you don't recognize or one that seems a bit fishy, do not hit the unsubscribe link, just delete the email. For nefarious individuals and the algorithms they devise, this verifies that they have made a successful hit on a "validated" email address. If this is the case, the best scenario is more unwanted email heading your way. An uglier possibility is that the simple act of clicking on an unsubscribe button or link can lead to a virus being downloaded to your system. Another reason it pays to have good antivirus software protecting your system at all times.
Bottom line: simply delete or move to spam/junk any email that appears suspicious. In addition to having a strong web protection system installed on all of your devices, be sure and have it run scans on your system on a regular basis. Always keep your operating system up-to-date as well, as new malicious efforts are constantly being identified by software developers.
Beverages & Tobacco
09. Boston Beer's big bet on seltzer hits a wall, shares plummet
Boston Beer (SAM $716), maker of Sam Adams, has been our favorite name in booze/brewers for a number of years. Fiercely independent (as opposed to the big three, which are all now owned by foreign entities), the company simply makes an excellent product and has an exemplary management team, led by founder and Chairman of the Board Jim Koch. The sheen began to come off the name, however, when SAM started pushing a mediocre beer called Sam 76. That misstep was followed by another: the company bet big on hard seltzers—the modern version of Zima or Bartles & Jaymes wine coolers—at the expense (in our opinion) of their staple beer business. Hopefully they received the message investors sent them last week. After missing Q2 earnings badly ($4.75/sh vs the $6.60/sh expected), management admitted to increasing production of Truly hard seltzer to meet a summer demand which never fully manifested. For the quarter, SAM generated $602.8M in revenue versus expectations for $675.7M. To make matters worse, the firm cut its guidance for the remainder of the year. All of this was enough to pound SAM shares down 26% in one day and 31% from the week's peak to trough price.
We haven't owned SAM shares within the Penn portfolios since our disappointment over the capital expended on the ill-fated Sam 76 campaign, and the hard push into hard seltzers only reinforced our decision. Even if the company does pivot back to its staple, high-end beer business, the field is now crowded with new competitors. Analysts seem to be gravitating toward an average price target of $1,000, but we are waiting to see evidence that management fully understands the problem and is willing to make a mea culpa on their recent moves.
Automotive
08. Tesla earned over $1 billion this past quarter, ten times more than it made in the second quarter of 2020
EV maker Tesla (TSLA $658) just achieved its eighth-straight quarter with positive cash flow, earning $1.14 billion in profit between April and June. As if that wasn't impressive enough, the figure represents a ten-fold increase over the $104 million it earned in the same quarter last year. Revenue in Q2 doubled from last year, from $6.04 billion to $11.96 billion. It is difficult to find any flaws in the earnings report, but that didn't stop the chronic naysayers from pointing out why this level of growth is unsustainable. Those comments are rather ironic, considering the company had to weather recalls, a backlash from Chinese consumers, and a chip shortage over the course of the quarter. As for Musk, he hinted that this may be the last earnings conference call he would be taking part in, let alone leading. We can fully understand that decision.
Too many analysts continue to view Tesla as just another car company. Granted, were that the case, the multiples for the company are excessively high. We don't buy the premise, however. Tesla earned nearly $1 billion from its energy business last quarter, installing 60% more energy storage systems in homes than it did the previous quarter. Furthermore, we are most excited about the FSD (full self-driving) subscription service that should mushroom after future system upgrades make the company's vehicles fully autonomous. Then there is the company's advanced battery production facilities and its benchmark Supercharger DC fast-charting stations, which it will soon open to non-Tesla vehicles. We believe the Tesla growth story remains fully intact.
Global Exchanges & Indexes
07. The high risks associated with investing in Chinese tech companies
There have always been outsized risks associated with investing in Internet companies; when those companies happen to be based out of Communist China, those risks are compounded. For evidence, consider the popular KraneShares CSI China Internet ETF (KWEB $52). This fund holds fifty of the largest Chinese Internet companies listed on exchanges outside of Mainland China (presumably to mitigate risk). Alibaba and Tencent Holdings are the two largest positions within the fund. On 17 February, shares of KWEB hit $104.94; now, just five months later, they have been sliced precisely in half. Put another way, a $10,000 investment in the fund five months ago would now be worth $5,000.
China's general crackdown on publicly-traded companies and the more recent rules handed down to rein in for-profit education companies—such as the $4 billion New Oriental Education & Technology Group (EDU $2)—have been the major catalyst for the plummet. EDU has been a popular bet for investors looking to ring up profits in Chinese companies, with the shares jumping from $5 in 2019 to a peak of $20 this past February, before settling back down to their current $2 range. Why would China, which is bent on becoming the world's largest economy in short order, create a host of new rules designed to stifle the growth of their own companies? Note that KWEB focuses on shares of companies listed outside of the country; China wants to promote those listing on domestic exchanges—the largest being the Shanghai Stock Exchange. These rules are a shot across the bow to home-grown companies daring to list outside of the country. As has always been the case, investors are at the mercy of the all-powerful Chinese Communist Party.
There are so many wonderful opportunities right now across the globe, both in frontier/emerging and developed markets, that we urge investors to focus on areas which promote democratic values and offer citizens a high level of personal freedom. We don't believe it is worth the risk to have direct exposure to individual Chinese companies. The KWEB example shows how much risk is involved even in owning a basket of the largest publicly-traded companies based out of Mainland China.
Aerospace & Defense
06. Brain drain at Boeing: engineers and technicians are leaving the firm at an alarming rate
Bloomberg recently published an interesting and rather in-depth story on the flight of disillusioned engineers and technicians out of the exits at Boeing (BA $233). Certainly, the dual tragedies of recent 737 MAX crashes have impacted morale at the firm, but the problem has more to do with a management team wandering aimlessly in search of a strategic mission than it does with any specific events. When a former Boeing CEO announced, "no more 'moon shots,' it might as well have become the new company slogan. For young engineers, the excitement which once swirled around working for the world's largest aerospace and defense company has been replaced by, "well, at least it will look good on my résumé." Those workers have been taking their résumés to competing firms in droves as of late. And the recipients of this talent pool are not just the usual suspects such as SpaceX, Blue Origin, and Virgin Galactic.
Since the beginning of last year, over 3,200 engineers and technicians have bolted from the firm—a figure which accounts for nearly one-fifth of the 18,000 Boeing workers represented by the Society of Professional Engineering Employees in Aerospace (SPEEA) union. While many have been attracted to SpaceX's stunning recent successes and Elon Musk's bold vision for the future of humanity in space, Amazon has also been a major destination for these skilled workers. The idea of remaining in the Seattle area with a nice pay bump has been the major selling point for the latter. Amazon employs these specialists to increase the efficiency at their warehouses, much like they did with the Boeing factory floors.
The airliner catastrophes and a lack of a new generation passenger aircraft on the drawing boards at Boeing have not been the only forces driving workers away. On the space side of the equation, the company's recent Starliner failures stand in stark comparison to the stunning SpaceX successes. The company will have another chance to prove itself with the upcoming crew capsule test slated for this weekend, but even with a glaring success the firm has a long way to go. Meanwhile, European nemesis Airbus is increasingly outpacing Boeing with respect to both orders and deliveries. In the first quarter of 2021, Boeing delivered 77 aircraft versus 125 jets for Airbus—a 62% differential. By the end of Q1, Airbus reported a backlog of nearly 6,000 jets, while Boeing's backlog amounted to just shy of 5,000 aircraft. Furthermore, with no exciting new designs to show potential buyers, we are not sure what will be the catalyst for a comeback.
In our opinion, there is a horrendous vacuum leadership at Boeing, and the company's great turnaround cannot occur until a nearly clean sweep is made at the top. Unfortunately, the entire leadership team would disagree with that assessment. It will take major activist investor push to force the change required, but there hasn't been much action on that front either. At least we have SpaceX around to spearhead America's great return to manned spaceflight.
Media & Entertainment
05. Scarlett Johansson sues Disney over streaming release of Black Widow, Disney fires back with scathing retort
Our immediate thought was, "poor Scarlett, $20 million for one movie wasn't enough?" However, the more we delved into the story, the more it appears this will be one heck of a court battle. Actor Scarlett Johansson, number seven on the list of IMDb's hottest female actors of 2021, is suing Disney (DIS $ 176) for simultaneously releasing Black Widow, in which she plays the eponymous lead role, in theaters and on the Disney+ streaming service for a fee. Johansson's beef is this: the better the movie does at the box office, the more she will stand to make for her role. According to her attorney, the streaming release was done primarily for Disney to add subscribers, and a large number of viewers decided to forego the theater and stream instead. The figures show that Disney did, indeed, fatten its wallet by charging $30 for Disney+ members to stream the movie. Over the course of its opening weekend, Black Widow raked in $80 million at the US box office, $78 million at the worldwide box office, and a whopping $60 million from its Disney+ platform.
Disney shot back directly at Johansson, saying that "the lawsuit is especially sad and distressing in its callous disregard for the horrific and prolonged global effects of the COVID-19 pandemic." Yes, Disney, we are sure you released the movie on your streaming service as a public service, which is why you charged paying subscribers an additional $30 a pop. Actually, the more we mull the situation over, the more we tend to side with Johansson. Based on other movies released during the pandemic and the way in which other studios compensated their talent, she probably would have made around $25 million more for the movie than she did. In addition to a probable loss in the courts, Disney will suffer a real black eye in Hollywood over this one.
When Bob Chapek took over at Disney, we cashed out—despite having owned the company in the Penn Global Leaders Club for years. It appears we made the right call. Nothing matters like management.
Capital Markets
04. HOOD's wild ride: platform for the meme stocks turns into one itself
By most accounts, it was a lackluster debut. The much-anticipated IPO of financial services platform Robinhood (HOOD $55) finally occurred last week, but shares ended up tumbling 12% from their $38 initial offering price almost immediately. Considering the platform boasts some 20 million accounts, one would have expected fireworks out of the gate, akin to an Airbnb ($145) or a DoorDash (DASH $176). But, alas, the WallStreetBets/reddit monster ended up harming the very company which fomented the movement, with some on the social media sites even calling on members to short the stock on day one. That is rich, considering users' raison d'être seemed to be destroying the shorts. ARK Investment's Cathie Wood, someone whom we respect a lot, may have played a part in the turnaround which occurred after day one by buying 1.85 million shares below the IPO price. Despite Wood's buy, we tend to agree with Morningstar's fair value of $30 on the shares, meaning they have some additional falling to do before we are interested.
When the reckoning does hit the markets, and it will, expect HOOD to get pounded. The world where an AMC, which is worth $5 per share, trades at $38 per share will eventually come crumbling down, and some semblance of sanity will return. At that point, there will be a lot of formerly-overvalued stocks worth picking up, and plenty we still wouldn't touch. As for HOOD, if the $30 fair value is accurate that means $25 per share might be a good point to jump in.
Automotive
03. We called it: Nikola's founder, Trevor Milton indicted on fraud charges
We have been calling EV maker Nikola (NKLA $11) little short of a sham for a couple of years now. Our opinion was cemented after we saw the company's founder, Trevor Milton, in several interviews. Based on decades of CEO-watching, we got a really bad feeling about the founder and his alleged product lineup. While the company was spared in the indictment, the US government has just charged the founder with three counts of fraud, stating that he lied to investors "about nearly all aspects of the business." We may have had a bad feeling about the firm, but investors certainly didn't: NKLA shares went from $10 in March of 2020 to $80 three months later, since dropping back to the $12 range. While at their high, Milton had a paper net worth of roughly $9 billion; that figure is now floating around $1 billion, but we imagine there is plenty more pain ahead. The wheels became to come off the cart last September after Hindenburg Research published a scathing article on the EV firm, pretty much echoing the government case—or vice versa. Shortly after the report was released, Milton was out at the firm he started and a deal the company cobbled together with General Motors fell apart (we excoriated GM when it made the deal). If we want to ignore the company's financials (basically zero revenue) and focus on production, try this on for size: the company has produced zero vehicles for public sale.
Tesla was enormously successful, so we should just jump into an EV maker that sounds like the next Tesla, right? Heck, this company even took the famous inventor's first name! Madness. It is understandable that the financials wouldn't look stellar on a nascent company trying to break into an industry with a pretty tall barrier to entry, but we are talking about a company that went public without having one vehicle roll off of an assembly line. NKLA may not have been a meme stock, but the same level of (ir)rational thought went into the purchase of the shares.
Industrial Conglomerates
02. A sure sign of desperation: financial engineering has replaced cutting-edge engineering at General Electric
I feel bad for General Electric (GE $105); embarrassed for this once-great American powerhouse. Has Edison's firm really been reduced to this? Some companies have a "move fast and break things" mentality. GE's grand strategic vision is "let's do a reverse stock split at just the right level to move our share price into triple digits like our competition." I mean, that's simply embarrassing. The move is tantamount to an admission that the company can't get its stock price to triple digits the old fashioned way, through hard work, relentless creativity, and a stellar sales force. Instead, management performed the corporate version of breaking into the school's server to change a grade from a C- to an A+. Here's a question: name the last company that regained a leadership role in an industry after performing a reverse stock split? Good luck—we couldn't think of any. General Electric, once a "move fast and break things" company, now makes most of its profits from servicing the equipment it had previously sold to customers. Unlike an Apple, however, the firm isn't introducing the new products necessary to feed an ever-growing services business. When it finds itself in need of a new supply of cash, it simply sells one of its legacy businesses. Jeffrey Immelt, who spent too much time flying around on one of his two corporate jets (the other would travel behind in case of mechanical problems), started the great downturn at General Electric; unfortunately, Larry Culp doesn't seem to be the dynamic disruptor so desperately needed at the firm. Maybe he and Boeing's David Calhoun can have a few adult beverages one of these days and reminisce about the good old days at their respective firms.
General Electric was one of those global leaders which always had a place in our portfolios. No longer. GE is a case study in the importance of understanding what you own and why. We have a neighbor who had a gorgeous and enormous white pine in his back yard. One day we noticed that the needles at the top of the tree began turning brown. Instead of calling in a tree expert at the first sign of trouble, he figured the problem would take care of itself. Needless to say, the problem rapidly spread and the tree met its demise. A company used to be able to rest on its laurels and simply weather some boneheaded tactical or even strategic errors by upper management. Those days are gone, but the entrenched members of the board at a company like GE seem content to collect their pay and stay the course. Good luck. Pardon us if we choose not to board your next flight.
Market Week in Review
01. Yet another solid jobs report helps cobble together a positive week for the markets
It was difficult to find much wrong with the employment situation in America for the month of July, except for the fact that employers couldn't find enough workers to fill the open slots. Against expectations for 862,500 new nonfarm jobs for the month, companies actually hired 943,000 workers; June's 850,000 figure was also revised higher, to 938,000. The unemployment rate was, perhaps, the most pleasant surprise of all: it ticked down a whopping 50 basis points, from 5.9% to 5.4%. We are slowly but steadily getting back to the pre-pandemic unemployment rate of 3.5%, recorded in the halcyon days of February, 2020. The jobs report helped sway two market conditions: the 10-year Treasury rose from 1.228% to 1.303%, and all of the major indexes recorded gains for the week. Another five days of strong earnings releases also helped strengthen the stock market—especially the small caps. The Russell 2000 rose 1.46% on the week. On Monday, an interesting figure from the Bureau of Labor Statistics will be released: the Job Openings and Labor Turnover Survey, or JOLTS. Economists are predicting a near-record 9.1 million new job openings for the last business day of June. Quite a different story from a year ago.
Under the Radar Investment
Afry AB
Afry AB (AFXXF $17) is a $1.9 billion Swedish-Finnish engineering and consulting firm with projects in the energy, industrial, and infrastructure markets. On the infrastructure front, Afry provides sustainable technology solutions for railways, roads, and other transportation networks. In the energy sector, the firm constructs plants and provides market analysis for power generation, manufacturing facilities, and chemical refining plants. This is a play on a European recovery, as the overwhelming percentage of sales emanate from that continent. With a 15 P/E ratio and a 3.57% dividend yield, the company generated revenues of $2.07 billion in 2020 and $2.238 billion TTM, signaling a nice growth trajectory. Afry was founded in 1895 and trades on the Nasdaq Stockholm AB, formerly known as the Stockholm Stock Exchange.
Answer
Since February 16th, the Dow Jones Internet ETF hasn't been too impressive, with the aggregate shares down 0.47%. Those results appear stellar, however, when compared to a group of Chinese Internet stocks, which are down 53% in the same period. Alibaba, Tencent, and JD.com are the top three holdings in the group.
Headlines for the Week of 27 Jun—03 Jul 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 movement was set in motion well before the Declaration of Independence...
While the final wording of the American Declaration of Independence was approved by the Second Continental Congress on 04 July 1776, the die had already been cast. What battle served as the demarcation point, the event from which there was no turning back?
Penn Trading Desk:
Cowen: Under Armour is "best idea"
Shares of sports apparel manufacturer Under Armour (UA $19, UAA $21) shot up around 4% following an upgrade by investment research firm Cowen, which put it on its "best idea" list. Analysts at the firm believe that UA is well poised to take advantage of the return of team sports and a back to school season which will be largely free from mask requirements. Cowen has an overweight rating on the company with a price target of $31 per share. We are not as bullish, as Under Armour is heavily dependent on sales in the Asia Pacific region, and tensions remain high (rightfully so) between China and the US. We also don't like the multi-share-class gimmick. An investor can buy Class A shares under the ticker UA and have one vote per share. The same investor could buy Class C shares under the ticker UAA and have no voting rights. Of course, the anointed company insiders like Kevin Plank own Class B shares, which the hoi polloi cannot touch—and which carry around ten votes per share. Gimmickry. For the record, six years ago UAA was trading above $51 per share.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Business & Professional Services
10. DoorDash is ramping up its grocery delivery business with Albertsons partnership
With over 450,000 merchants, 20 million consumer/customers, and one million dashers on its platform, DoorDash (DASH $175) is already the largest food delivery service in the United States—despite just going public late last year. How far the company has come in seven years, from back when it was known as Palo Alto Delivery, Inc. Now, the San Fran-based firm is entering the competitive grocery delivery business, inking a deal with grocer Albertsons (ACI $20) to offer delivery of the chain's goods on its marketplace app. DashPass customers will be able to order grocery and household items from nearly 2,000 Albertsons-owned stores, which include Safeway, Jewel-Osco, and Vons. For a monthly subscription fee of $9.99, members receive free deliveries and reduced fees from thousands of restaurants, grocery stores, and convenience stores, according to the DoorDash website. Over 40,000 grocery items will be available on the marketplace app. DoorDash has also recently entered into delivery agreements with PetSmart and Bed Bath & Beyond, in addition to making a major international move into Japan. In 2020, DASH generated revenues of $2.9 billion, an increase of 229% over 2019 revenues (which, themselves, were up 310% from the prior year).
There are going to be a handful of big, long-term winners in this new niche industry. In addition to the obvious mega-cap players (Amazon, Walmart), we see DoorDash and Uber increasing their market share for years to come. Actually, it would be relatively safe to bet on any of these four names going forward, assuming the fit is right for the respective portfolio.
Cryptocurrencies
09. The real reason China is cracking down on cryptos
Oh, the naive press. If only they would give esteemed American establishments the same deference they show to the Chinese Communist Party. The big price drop in cryptos at the start of the week came on the heels of a major Chinese crackdown; the press got that part of the story right, but what they missed was the real catalyst behind the move. Absurdly, one major business publication said, "Concerns about the environmental impact (of the computers that mine Bitcoin) continue to swirl." Yep, they nailed it. The greatest polluter in the world is suddenly concerned that Bitcoin mining might make the air over Xinjiang a little bit browner.
The real reason the CCP ordered the People's Bank of China to warn lenders to cease using cryptocurrencies, and for the major provinces where mining takes place to crack down on production, is two-fold. First, by their very nature, digital coins are hard to control, and the CCP is all about control. Once the coins have been mined they can travel freely through the ether, generally untouchable by a central power. The second reason has to do with China's own ambitions in the arena. As we have mentioned before, the country wants to create a digital yuan that will ultimately (in the eyes of the party) become the world's leading currency, supplanting the dollar. The incredible amount of hydropower used for mining should be reserved for the state's own coinage, not the free market's. Don't believe anything you hear about the government's sudden concern over the environment, or the need to preserve electricity for the Chinese people—only journalists are gullible enough to fall for that straw man.
When Bitcoin rose above $64,000, the experts were pointing to $100,000 as the next major stop. On Tuesday, the coins broke below $29,000 and there isn't much clarity on where prices are headed from here. The China-induced drop is interesting; if Chinese mining goes offline, shouldn't that bode well for the price of the commodity? For those with FOMO, we recommend opening a Coinbase account and buying a few of the fifty or so cryptos available on the platform.
Consumer Finance
08. And the world's dumbest new idea goes to...drumroll, please...the credit card designed to pay your rent*
I love history. Reading about the brilliant successes and colorful failures of the past and considering how their lessons can be applied to current, real-world situations. This can be an effective tool in separating the right course of action from the wrong, or the smart from incredibly stupid. In the latter camp, fintech startup Kairos just launched a new loyalty program, Bilt Rewards, tied to its co-branded Bilt Mastercard which is being affectionately labeled "the renter's credit card." Kairos founder and CEO Ankur Jain said it's not fair that credit card users gain rewards for traveling or shopping (paraphrasing), but that renters haven't been able to earn rewards on their largest expenditure, their rent payment. That is some stunningly convoluted thinking.
The concept is straightforward: pay your rent using your Bilt Mastercard and start earning 250 rewards points per rent payment, along with any other perks your landlord wants to throw in. And don't worry about checking whether or not your apartment is a qualifying property; if it is, you should automatically receive an email within the next six months informing you of your eligibility. And the more you use your card, the higher you can climb in the membership levels of Blue, Silver, Gold, and Platinum status. Bilt Rewards can be redeemed for such things as travel, fitness classes, even art purchases through the Bilt Collection. When pressed on the credit card's interest rate, Jain said that it should be in the "14-22% range...it's standard."
Remember when it was a sign of prestige to carry an American Express card that had to be paid off each month? This card is not that. The idea of putting rent on a credit card is one of the most irresponsible concepts to manifest as of late, and that is saying a lot. Rewarding people for doing the wrong thing, encouraging them to put their rent on a credit card when odds are strong they don't even have an IRA set up, is sickening. Shame on the founder of this company, and on Mastercard for going along with the deal. And the same goes for the Bilt Rewards Alliance of property owners participating in this scheme.
Global Strategy: East & Southeast Asia
07. Communist China forces shutdown of Hong Kong's last remaining pro-democracy newspaper
We recall, back in the late 1990s, how silly the argument seemed: although sovereignty over the British colony of Hong Kong was being passed to China, many so-called experts were telling us that the communist nation wouldn't dare kill their golden goose. Granted, it took a few decades to quell the basic hallmarks of a free society, but this week pretty much sealed the deal. Apple Daily, the wealthy island's last remaining pro-democracy newspaper, has been killed. It began with the (second) jailing of the paper's majority owner, Jimmy Lai. Then, Hong Kong's puppet regime froze the company's assets and seized its journalists' computers. The final straw was the arrest of two top executives under a new national security law Beijing imposed on the island to stifle dissent. Following that move, Apple Daily reported that both its print edition and website would cease operations. It is the beginning of a full-scale collapse of freedom in Hong Kong, which begs the question: how much longer can Taiwan remain a free country? Furthermore, what will the United States, which is bound by agreement to protect the nation from Chinese attack, do when the inevitable begins to unfold.
America wouldn't have dreamed of accepting wave after wave of goods-laden shipping containers from the Soviet Union during the Cold War, yet we are funding the insatiable appetite of Communist China, and its dreams of global domination, by welcoming in some $500 billion per year of goods from that country, even though China only imports around $130 billion per year of US goods. This situation must change. If US companies are unwilling to break the deadly cycle and search elsewhere around the world for imports, they must be strongly coerced by the federal government to do so. Better yet, they should consider saving on the shipping costs by manufacturing domestically—or at least within the USMCA region.
Pharmaceuticals
06. More exciting news on the Alzheimer's front
For such a horrible and deadly disease which hasn't seen much progress on the therapies front over the past two decades, researchers may finally be rounding the corner with respect to Alzheimer's. Last week was the exciting news that Biogen's (BIIB $351) aducanumab (trade name Aduhelm) had been given the green light by the FDA; now, the organization has granted breakthrough therapy designation to Eli Lilly's (LLY $234) Alzheimer's therapy donanemab. This designation will speed along the drug's approval process, the application for which Lilly plans to submit later this year. Despite the naysayers' multi-faceted complaints about these drugs, the FDA is doing the right thing by allowing them to go forward. These positive rulings will help speed along the development of other drugs to treat the disease, and ultimately the exorbitant prices for the therapies will fall. The FDA has smoothed the way for pharma and biotech companies to pump increased R&D spending into the category, giving hope to the families of the six million Americans suffering with this horrendous condition.
We continue to overweight the Health Care sector and a number of industries within the space. On the back of stunning advances in medical technology, we can expect to see a biotech and pharma boom over the next decade, with new therapies for diseases which have stymied researchers for decades. The greatest threat to this boom would be increased government regulatory control over the industry, but we see that as an unlikely scenario. We hold a number of health care companies and ETFs in the Dynamic Growth Strategy, Penn Global Leaders Club, and Penn New Frontier Fund.
Space Tourism
05. Virgin Galactic gets OK from FAA to fly passengers into space
Virgin Galactic (SPCE $54) shares were soaring 34% higher on Friday following news that the FAA granted approval for the company to begin sending people into space aboard its spaceplanes. The full commercial space-launch license opens the door for space tourism, the firm's only immediate source of revenues. It is interesting to note that Blue Origin, which is owned by Jeff Bezos, has yet to receive this FAA stamp of approval, despite Bezos recently announcing that he would be a part of the company's first manned flight scheduled for July. When pressed about the Blue Origin certification, an FAA spokesperson said that the agency would "make a decision when and if all regulatory requirements are met." As for Virgin, the company said it has already sold over 600 tickets for rides aboard its SpaceShipTwo spaceplanes, with each one going for around $250,000. The company plans to have a fleet of five craft launching from its Spaceport America launch site in New Mexico. Ultimately, the plans call for launches taking place from multiple sites around the country, with destinations ranging from major cities around the world, to space-based hotels in orbit. Regarding the FAA certification, it is interesting to note that the agency has no authority over spacecraft operating above the atmosphere, but they do control the safety of the airways traversed by the spacecraft between launch and orbit.
At $54 per share, SPCE seems to have a pretty lofty valuation—even though we are excited about the company's strategic plans. It is normal for a nascent growth company to have no P/E ratio, as they often have no earnings. What is unique about Virgin Galactic is its $13 billion market cap on a foundation of virtually zero revenues as well—other than the 250-large they collected for each ticket sold for the promise of a future flight.
Textiles, Apparel, & Luxury Goods
04. PVH is selling its legacy clothing lines to Authentic Brands
Apparel manufacturing firm PVH (PVH $109) is selling four of its legacy brands, or what they call their Heritage Brands, to Authentic for $220 million. Why would the company want to part ways with prominent names Izod, Van Heusen, Arrow, and Geoffrey Beene? Management says it is doing so to "drive the next chapter of sustainable, profitable, growth," which will be built on a foundation of the Calvin Kline and Tommy Hilfiger brands. The company also said it plans on "supercharging" its e-commerce channel. That actually makes sense in this new world of hybrid workers buying fewer suits and more work-casual clothing. It is also interesting to note that this is the first major move by new CEO (Feb, 2021) Stefan Larsson—though longtime CEO and well-respected industry insider Manny Chirico did take on the role of Chairman of the Board. Not counting Chirico, the average tenure of PVH's management team is just 1.5 years. As for the buyer of these brands, privately-held Authentic is collecting quite the portfolio. In addition to these four names, the company owns Forever 21, Lucky Brand, Nine West, and part of Brooks Brothers—which it helped buy out of bankruptcy last year. Before the pandemic, PVH had an annual revenue of approximately $10 billion and a net income which was perennially in the black. Last year, the firm notched $7 billion in sales and lost $1.16 billion.
We actually like the move by $7.7 billion PVH to sell off these legacy brands, but is the stock a buy? We don't think so. It is estimated that the company will generate $6.73 in earnings per share in FY2022, which is about what it generated in FY2017. The share price ranged from $84 to $139 that year, and we wouldn't touch it above $75 per share. Perhaps the fledgling management team will impress, but this single move is really all we have to go on thus far.
Interactive Media & Services
03. Facebook joins the Trillion Dollar Club after judge throws out the FTC's complaint
Talk about some rarified air: Facebook (FB $356) joined an elite group of companies carrying a market cap of over one trillion dollars after a US District Court judge threw out the antitrust complaints against the company filed by the Federal Trade Commission and virtually all states' attorneys general. That dismissal led to a 4.25% pop in the company's share price, giving it a $1.009 trillion valuation. Facebook joins Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), and Alphabet (GOOGL) in the tiny group of companies which can boast of a $1 trillion size. While Judge James Boasberg disputed the FTC's claim that Facebook was a monopoly, he did leave the door open for the agency to amend its complaint and submit a revised filing. Had it been successful, the complaint could have forced Facebook to divest itself of both the WhatsApp and Instagram platforms. The court seemed to excoriate the plaintiffs' lack of effort, at one point in the ruling saying that the allegations "do not even provide an estimated figure or range for Facebook's market share at any point over the past ten years...." Ouch. It seems as though the judge felt there was some hubris involved in the suit, with an "expectation" that the court would find fault in Facebook's business practices. Arrogance and hubris among government officials? Shocking.
Despite all the bluster among elected officials about cutting these big social media companies down to size, we think very little gets accomplished (to that end) in the near future. As a matter of fact, a 20% investment in each of these five behemoths—beginning today—would probably yield some impressive results if we were to go forward five years in time and gauge the investment bucket's return.
Restaurants
02. Krispy Kreme: Love the doughnuts, hate the stock
More technically, love the doughnuts, hate the financial engineering firm that is bringing the company public...again. Krispy Kreme, former symbol KKD, used to be one of our favorite trading stocks. We actually had a client at A.G. Edwards who would only trade two stocks, KKD and WMT, based on whether the economy was in an expansionary period or a contraction phase. Fast forward to 2016, when KKD was taken private by the powerful German Reimann family, via their JAB Holding Company. JAB had also gobbled up the likes of Peet's Coffee, Panera Bread, Keurig Dr. Pepper, Einstein Bros. Bagels, and a host of other fast food and consumer goods companies. As with all financial engineering firms, the strategy is to make as much money as possible with as little effort as possible, and one popular tactic is the repackaging of companies to bring public once again under a shiny new symbol. That is precisely what JAB did with Krispy Kreme, which now trades under the new—admittedly catchier—symbol DNUT ($19). Perhaps the most insulting aspect of this game of smoke and mirrors is the fact that JAB will retain 78% control of the firm, so suckers...er, investors...beware. Investors did appear to be leery of the game: after planning to offer $26.7 million shares in the range of $21 to $24, soft demand led to the holding company selling 29.4 million shares at $17. While they did rocket up 24% from the offering price on IPO day, the shares steadily declined from there. DNUT shares closed out their first week at $19.12.
We have to wonder how many DNUT investors were aware of the company's back story as opposed to just thinking, "cool, Krispy Kreme is going public and the shares are cheap." They are actually not cheap. In fact, Amazon shares at $3,510 are "cheaper" than DNUT at $19. But none of that seems to matter in these days of meme stocks and SPACs. If shares are $25 or less, it must be a good deal, so let's buy in and watch the confetti fall on our iPhone screen.
Market Week in Review
01. Strong June jobs report leads to weekly gains across the board
All of the major indexes—along with the price of crude—rose over 1% this week on the back of a solid June jobs report. The economy added 850,000 new jobs for the month, and while the unemployment rate ticked up 10 basis points (to 5.9%), that was simply due to more Americans re-entering the job market. Investors actually liked the small uptick, as it lessens the odds of the Fed tightening sooner than expected. In a sign that employers are having a difficult time filling open spots, hourly wages in the private sector rose a robust 3.6% from a year ago. Among the sectors and market caps, big tech names led the week's rally, with the NASDAQ jumping 1.94%. Crude oil rose 1.62% on the week, trading a whopping 55% higher on the year. The first two months of the "worst six months of the year" have come and gone, and we are impressed at how well the markets have held up thus far.
Under the Radar Investment
Kratos Defense & Security Solutions
Kratos Defense & Security Solutions Inc (KTOS $28), despite its small size ($3.7B), is a key player in America's defense and aerospace infrastructure. The company develops and fields advanced systems and platforms for national security and communications needs. Its Skyborg program is focused on expanding the envelope of unmanned aircraft use, especially as related to artificial intelligence; while its Defense and Rocket Support Services (DRSS) division develops hypersonic test vehicles for America's missile defense initiative. Civilian and government satellite operators, meanwhile, rely on Kratos as their strategic supplier of end-to-end enterprise products. We especially like the company's size and financial health, and believe the company will continue along its strong growth trajectory.
Answer
While the battles of Lexington and Concord, which were fought on 19 April 1775, technically kicked off the American Revolution, it was the Battle of Bunker Hill, which was actually fought on Breed's Hill on 17 June 1775, that made both sides in the fight realize there was no turning back. While the British won the battle, it was a Pyrrhic victory: the number of British killed or wounded (1,054, including 89 officers) was over twice that suffered on the American side. The King's troops and their loyalist allies in Boston were left stunned and shocked, while the "loss" served as a rallying cry for the patriots' cause. George Washington, who had been appointed commander of the Continental Army just three days prior, arrived shortly after the conclusion of the battle. Soon, the disparate militias of the various colonies would be forged into one American force.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The movement was set in motion well before the Declaration of Independence...
While the final wording of the American Declaration of Independence was approved by the Second Continental Congress on 04 July 1776, the die had already been cast. What battle served as the demarcation point, the event from which there was no turning back?
Penn Trading Desk:
Cowen: Under Armour is "best idea"
Shares of sports apparel manufacturer Under Armour (UA $19, UAA $21) shot up around 4% following an upgrade by investment research firm Cowen, which put it on its "best idea" list. Analysts at the firm believe that UA is well poised to take advantage of the return of team sports and a back to school season which will be largely free from mask requirements. Cowen has an overweight rating on the company with a price target of $31 per share. We are not as bullish, as Under Armour is heavily dependent on sales in the Asia Pacific region, and tensions remain high (rightfully so) between China and the US. We also don't like the multi-share-class gimmick. An investor can buy Class A shares under the ticker UA and have one vote per share. The same investor could buy Class C shares under the ticker UAA and have no voting rights. Of course, the anointed company insiders like Kevin Plank own Class B shares, which the hoi polloi cannot touch—and which carry around ten votes per share. Gimmickry. For the record, six years ago UAA was trading above $51 per share.
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Business & Professional Services
10. DoorDash is ramping up its grocery delivery business with Albertsons partnership
With over 450,000 merchants, 20 million consumer/customers, and one million dashers on its platform, DoorDash (DASH $175) is already the largest food delivery service in the United States—despite just going public late last year. How far the company has come in seven years, from back when it was known as Palo Alto Delivery, Inc. Now, the San Fran-based firm is entering the competitive grocery delivery business, inking a deal with grocer Albertsons (ACI $20) to offer delivery of the chain's goods on its marketplace app. DashPass customers will be able to order grocery and household items from nearly 2,000 Albertsons-owned stores, which include Safeway, Jewel-Osco, and Vons. For a monthly subscription fee of $9.99, members receive free deliveries and reduced fees from thousands of restaurants, grocery stores, and convenience stores, according to the DoorDash website. Over 40,000 grocery items will be available on the marketplace app. DoorDash has also recently entered into delivery agreements with PetSmart and Bed Bath & Beyond, in addition to making a major international move into Japan. In 2020, DASH generated revenues of $2.9 billion, an increase of 229% over 2019 revenues (which, themselves, were up 310% from the prior year).
There are going to be a handful of big, long-term winners in this new niche industry. In addition to the obvious mega-cap players (Amazon, Walmart), we see DoorDash and Uber increasing their market share for years to come. Actually, it would be relatively safe to bet on any of these four names going forward, assuming the fit is right for the respective portfolio.
Cryptocurrencies
09. The real reason China is cracking down on cryptos
Oh, the naive press. If only they would give esteemed American establishments the same deference they show to the Chinese Communist Party. The big price drop in cryptos at the start of the week came on the heels of a major Chinese crackdown; the press got that part of the story right, but what they missed was the real catalyst behind the move. Absurdly, one major business publication said, "Concerns about the environmental impact (of the computers that mine Bitcoin) continue to swirl." Yep, they nailed it. The greatest polluter in the world is suddenly concerned that Bitcoin mining might make the air over Xinjiang a little bit browner.
The real reason the CCP ordered the People's Bank of China to warn lenders to cease using cryptocurrencies, and for the major provinces where mining takes place to crack down on production, is two-fold. First, by their very nature, digital coins are hard to control, and the CCP is all about control. Once the coins have been mined they can travel freely through the ether, generally untouchable by a central power. The second reason has to do with China's own ambitions in the arena. As we have mentioned before, the country wants to create a digital yuan that will ultimately (in the eyes of the party) become the world's leading currency, supplanting the dollar. The incredible amount of hydropower used for mining should be reserved for the state's own coinage, not the free market's. Don't believe anything you hear about the government's sudden concern over the environment, or the need to preserve electricity for the Chinese people—only journalists are gullible enough to fall for that straw man.
When Bitcoin rose above $64,000, the experts were pointing to $100,000 as the next major stop. On Tuesday, the coins broke below $29,000 and there isn't much clarity on where prices are headed from here. The China-induced drop is interesting; if Chinese mining goes offline, shouldn't that bode well for the price of the commodity? For those with FOMO, we recommend opening a Coinbase account and buying a few of the fifty or so cryptos available on the platform.
Consumer Finance
08. And the world's dumbest new idea goes to...drumroll, please...the credit card designed to pay your rent*
I love history. Reading about the brilliant successes and colorful failures of the past and considering how their lessons can be applied to current, real-world situations. This can be an effective tool in separating the right course of action from the wrong, or the smart from incredibly stupid. In the latter camp, fintech startup Kairos just launched a new loyalty program, Bilt Rewards, tied to its co-branded Bilt Mastercard which is being affectionately labeled "the renter's credit card." Kairos founder and CEO Ankur Jain said it's not fair that credit card users gain rewards for traveling or shopping (paraphrasing), but that renters haven't been able to earn rewards on their largest expenditure, their rent payment. That is some stunningly convoluted thinking.
The concept is straightforward: pay your rent using your Bilt Mastercard and start earning 250 rewards points per rent payment, along with any other perks your landlord wants to throw in. And don't worry about checking whether or not your apartment is a qualifying property; if it is, you should automatically receive an email within the next six months informing you of your eligibility. And the more you use your card, the higher you can climb in the membership levels of Blue, Silver, Gold, and Platinum status. Bilt Rewards can be redeemed for such things as travel, fitness classes, even art purchases through the Bilt Collection. When pressed on the credit card's interest rate, Jain said that it should be in the "14-22% range...it's standard."
Remember when it was a sign of prestige to carry an American Express card that had to be paid off each month? This card is not that. The idea of putting rent on a credit card is one of the most irresponsible concepts to manifest as of late, and that is saying a lot. Rewarding people for doing the wrong thing, encouraging them to put their rent on a credit card when odds are strong they don't even have an IRA set up, is sickening. Shame on the founder of this company, and on Mastercard for going along with the deal. And the same goes for the Bilt Rewards Alliance of property owners participating in this scheme.
Global Strategy: East & Southeast Asia
07. Communist China forces shutdown of Hong Kong's last remaining pro-democracy newspaper
We recall, back in the late 1990s, how silly the argument seemed: although sovereignty over the British colony of Hong Kong was being passed to China, many so-called experts were telling us that the communist nation wouldn't dare kill their golden goose. Granted, it took a few decades to quell the basic hallmarks of a free society, but this week pretty much sealed the deal. Apple Daily, the wealthy island's last remaining pro-democracy newspaper, has been killed. It began with the (second) jailing of the paper's majority owner, Jimmy Lai. Then, Hong Kong's puppet regime froze the company's assets and seized its journalists' computers. The final straw was the arrest of two top executives under a new national security law Beijing imposed on the island to stifle dissent. Following that move, Apple Daily reported that both its print edition and website would cease operations. It is the beginning of a full-scale collapse of freedom in Hong Kong, which begs the question: how much longer can Taiwan remain a free country? Furthermore, what will the United States, which is bound by agreement to protect the nation from Chinese attack, do when the inevitable begins to unfold.
America wouldn't have dreamed of accepting wave after wave of goods-laden shipping containers from the Soviet Union during the Cold War, yet we are funding the insatiable appetite of Communist China, and its dreams of global domination, by welcoming in some $500 billion per year of goods from that country, even though China only imports around $130 billion per year of US goods. This situation must change. If US companies are unwilling to break the deadly cycle and search elsewhere around the world for imports, they must be strongly coerced by the federal government to do so. Better yet, they should consider saving on the shipping costs by manufacturing domestically—or at least within the USMCA region.
Pharmaceuticals
06. More exciting news on the Alzheimer's front
For such a horrible and deadly disease which hasn't seen much progress on the therapies front over the past two decades, researchers may finally be rounding the corner with respect to Alzheimer's. Last week was the exciting news that Biogen's (BIIB $351) aducanumab (trade name Aduhelm) had been given the green light by the FDA; now, the organization has granted breakthrough therapy designation to Eli Lilly's (LLY $234) Alzheimer's therapy donanemab. This designation will speed along the drug's approval process, the application for which Lilly plans to submit later this year. Despite the naysayers' multi-faceted complaints about these drugs, the FDA is doing the right thing by allowing them to go forward. These positive rulings will help speed along the development of other drugs to treat the disease, and ultimately the exorbitant prices for the therapies will fall. The FDA has smoothed the way for pharma and biotech companies to pump increased R&D spending into the category, giving hope to the families of the six million Americans suffering with this horrendous condition.
We continue to overweight the Health Care sector and a number of industries within the space. On the back of stunning advances in medical technology, we can expect to see a biotech and pharma boom over the next decade, with new therapies for diseases which have stymied researchers for decades. The greatest threat to this boom would be increased government regulatory control over the industry, but we see that as an unlikely scenario. We hold a number of health care companies and ETFs in the Dynamic Growth Strategy, Penn Global Leaders Club, and Penn New Frontier Fund.
Space Tourism
05. Virgin Galactic gets OK from FAA to fly passengers into space
Virgin Galactic (SPCE $54) shares were soaring 34% higher on Friday following news that the FAA granted approval for the company to begin sending people into space aboard its spaceplanes. The full commercial space-launch license opens the door for space tourism, the firm's only immediate source of revenues. It is interesting to note that Blue Origin, which is owned by Jeff Bezos, has yet to receive this FAA stamp of approval, despite Bezos recently announcing that he would be a part of the company's first manned flight scheduled for July. When pressed about the Blue Origin certification, an FAA spokesperson said that the agency would "make a decision when and if all regulatory requirements are met." As for Virgin, the company said it has already sold over 600 tickets for rides aboard its SpaceShipTwo spaceplanes, with each one going for around $250,000. The company plans to have a fleet of five craft launching from its Spaceport America launch site in New Mexico. Ultimately, the plans call for launches taking place from multiple sites around the country, with destinations ranging from major cities around the world, to space-based hotels in orbit. Regarding the FAA certification, it is interesting to note that the agency has no authority over spacecraft operating above the atmosphere, but they do control the safety of the airways traversed by the spacecraft between launch and orbit.
At $54 per share, SPCE seems to have a pretty lofty valuation—even though we are excited about the company's strategic plans. It is normal for a nascent growth company to have no P/E ratio, as they often have no earnings. What is unique about Virgin Galactic is its $13 billion market cap on a foundation of virtually zero revenues as well—other than the 250-large they collected for each ticket sold for the promise of a future flight.
Textiles, Apparel, & Luxury Goods
04. PVH is selling its legacy clothing lines to Authentic Brands
Apparel manufacturing firm PVH (PVH $109) is selling four of its legacy brands, or what they call their Heritage Brands, to Authentic for $220 million. Why would the company want to part ways with prominent names Izod, Van Heusen, Arrow, and Geoffrey Beene? Management says it is doing so to "drive the next chapter of sustainable, profitable, growth," which will be built on a foundation of the Calvin Kline and Tommy Hilfiger brands. The company also said it plans on "supercharging" its e-commerce channel. That actually makes sense in this new world of hybrid workers buying fewer suits and more work-casual clothing. It is also interesting to note that this is the first major move by new CEO (Feb, 2021) Stefan Larsson—though longtime CEO and well-respected industry insider Manny Chirico did take on the role of Chairman of the Board. Not counting Chirico, the average tenure of PVH's management team is just 1.5 years. As for the buyer of these brands, privately-held Authentic is collecting quite the portfolio. In addition to these four names, the company owns Forever 21, Lucky Brand, Nine West, and part of Brooks Brothers—which it helped buy out of bankruptcy last year. Before the pandemic, PVH had an annual revenue of approximately $10 billion and a net income which was perennially in the black. Last year, the firm notched $7 billion in sales and lost $1.16 billion.
We actually like the move by $7.7 billion PVH to sell off these legacy brands, but is the stock a buy? We don't think so. It is estimated that the company will generate $6.73 in earnings per share in FY2022, which is about what it generated in FY2017. The share price ranged from $84 to $139 that year, and we wouldn't touch it above $75 per share. Perhaps the fledgling management team will impress, but this single move is really all we have to go on thus far.
Interactive Media & Services
03. Facebook joins the Trillion Dollar Club after judge throws out the FTC's complaint
Talk about some rarified air: Facebook (FB $356) joined an elite group of companies carrying a market cap of over one trillion dollars after a US District Court judge threw out the antitrust complaints against the company filed by the Federal Trade Commission and virtually all states' attorneys general. That dismissal led to a 4.25% pop in the company's share price, giving it a $1.009 trillion valuation. Facebook joins Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), and Alphabet (GOOGL) in the tiny group of companies which can boast of a $1 trillion size. While Judge James Boasberg disputed the FTC's claim that Facebook was a monopoly, he did leave the door open for the agency to amend its complaint and submit a revised filing. Had it been successful, the complaint could have forced Facebook to divest itself of both the WhatsApp and Instagram platforms. The court seemed to excoriate the plaintiffs' lack of effort, at one point in the ruling saying that the allegations "do not even provide an estimated figure or range for Facebook's market share at any point over the past ten years...." Ouch. It seems as though the judge felt there was some hubris involved in the suit, with an "expectation" that the court would find fault in Facebook's business practices. Arrogance and hubris among government officials? Shocking.
Despite all the bluster among elected officials about cutting these big social media companies down to size, we think very little gets accomplished (to that end) in the near future. As a matter of fact, a 20% investment in each of these five behemoths—beginning today—would probably yield some impressive results if we were to go forward five years in time and gauge the investment bucket's return.
Restaurants
02. Krispy Kreme: Love the doughnuts, hate the stock
More technically, love the doughnuts, hate the financial engineering firm that is bringing the company public...again. Krispy Kreme, former symbol KKD, used to be one of our favorite trading stocks. We actually had a client at A.G. Edwards who would only trade two stocks, KKD and WMT, based on whether the economy was in an expansionary period or a contraction phase. Fast forward to 2016, when KKD was taken private by the powerful German Reimann family, via their JAB Holding Company. JAB had also gobbled up the likes of Peet's Coffee, Panera Bread, Keurig Dr. Pepper, Einstein Bros. Bagels, and a host of other fast food and consumer goods companies. As with all financial engineering firms, the strategy is to make as much money as possible with as little effort as possible, and one popular tactic is the repackaging of companies to bring public once again under a shiny new symbol. That is precisely what JAB did with Krispy Kreme, which now trades under the new—admittedly catchier—symbol DNUT ($19). Perhaps the most insulting aspect of this game of smoke and mirrors is the fact that JAB will retain 78% control of the firm, so suckers...er, investors...beware. Investors did appear to be leery of the game: after planning to offer $26.7 million shares in the range of $21 to $24, soft demand led to the holding company selling 29.4 million shares at $17. While they did rocket up 24% from the offering price on IPO day, the shares steadily declined from there. DNUT shares closed out their first week at $19.12.
We have to wonder how many DNUT investors were aware of the company's back story as opposed to just thinking, "cool, Krispy Kreme is going public and the shares are cheap." They are actually not cheap. In fact, Amazon shares at $3,510 are "cheaper" than DNUT at $19. But none of that seems to matter in these days of meme stocks and SPACs. If shares are $25 or less, it must be a good deal, so let's buy in and watch the confetti fall on our iPhone screen.
Market Week in Review
01. Strong June jobs report leads to weekly gains across the board
All of the major indexes—along with the price of crude—rose over 1% this week on the back of a solid June jobs report. The economy added 850,000 new jobs for the month, and while the unemployment rate ticked up 10 basis points (to 5.9%), that was simply due to more Americans re-entering the job market. Investors actually liked the small uptick, as it lessens the odds of the Fed tightening sooner than expected. In a sign that employers are having a difficult time filling open spots, hourly wages in the private sector rose a robust 3.6% from a year ago. Among the sectors and market caps, big tech names led the week's rally, with the NASDAQ jumping 1.94%. Crude oil rose 1.62% on the week, trading a whopping 55% higher on the year. The first two months of the "worst six months of the year" have come and gone, and we are impressed at how well the markets have held up thus far.
Under the Radar Investment
Kratos Defense & Security Solutions
Kratos Defense & Security Solutions Inc (KTOS $28), despite its small size ($3.7B), is a key player in America's defense and aerospace infrastructure. The company develops and fields advanced systems and platforms for national security and communications needs. Its Skyborg program is focused on expanding the envelope of unmanned aircraft use, especially as related to artificial intelligence; while its Defense and Rocket Support Services (DRSS) division develops hypersonic test vehicles for America's missile defense initiative. Civilian and government satellite operators, meanwhile, rely on Kratos as their strategic supplier of end-to-end enterprise products. We especially like the company's size and financial health, and believe the company will continue along its strong growth trajectory.
Answer
While the battles of Lexington and Concord, which were fought on 19 April 1775, technically kicked off the American Revolution, it was the Battle of Bunker Hill, which was actually fought on Breed's Hill on 17 June 1775, that made both sides in the fight realize there was no turning back. While the British won the battle, it was a Pyrrhic victory: the number of British killed or wounded (1,054, including 89 officers) was over twice that suffered on the American side. The King's troops and their loyalist allies in Boston were left stunned and shocked, while the "loss" served as a rallying cry for the patriots' cause. George Washington, who had been appointed commander of the Continental Army just three days prior, arrived shortly after the conclusion of the battle. Soon, the disparate militias of the various colonies would be forged into one American force.
Headlines for the Week of 13 Jun—19 Jun 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 mighty American economy...
At $22 trillion, the US has—by far—the largest economy in the world. The great growth trajectory began at the end of the Second World War, when the US had an economy of around $240 billion. How long did it take the country's economy to reach $1 trillion in size?
Penn Trading Desk:
Penn: Add a crypto play to the Intrepid
We have made the comparison between the Gold Rush of the mid-19th century and the crypto craze unfolding right now. We have urged investors to "invest in the companies supplying the tools rather than in the miners themselves." Taking our own advice, we just added a cryptocurrency infrastructure play to the Intrepid Trading Platform. Members, sign into the Penn Trading Desk for details.
Goldman: Double downgrade Ferrari
At $205 per share ($210 before the downgrade) and a price-to-earnings ratio of 50, Italian automaker Ferrari (RACE) does seem a bit expensive. Furthermore, its reliance on Formula One racing and its recent drought in that arena could be damaging the brand's reputation. At least that is what Goldman Sachs analyst George Galliers said as part of the rationale for his double downgrade of the company's shares, from Buy to Sell. Galliers, who reduced the Goldman target price on RACE from $227 to $207, also said that the firm is facing higher capital spending as it invests in EV battery technology, with little assurance of its success in that arena.
Penn: Added foreign telecom play to Strategic Income Portfolio
One never knows for certain how any given individual stock will perform going forward, but we found a telecom services company that checks three of our boxes for the Strategic Income Portfolio: a great yield, a foreign play (which we are chronically short on), and a smart strategic vision which embraces the future of the industry. Added to the SIP. Members, sign into the Penn Trading Desk for details.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Industrials: Airlines
10. America is entering a new era of supersonic air travel—and Boeing is not building the aircraft
When I was growing up in the 1970s, with an avid fascination in all things air and space, there were dozens of major, publicly-traded, aerospace and defense contractors. Sadly, due to mergers and acquisitions (the largest being Boeing's 1997 purchase of McDonnell Douglas), the numbers dwindled to a few. As competition helps assure that companies continue to operate at peak performance, we knew that the seemingly-endless acquisitions would lead to complacency. And indeed, based on Boeing's (BA $ 250) string of recent high-profile failures, it did. Fortunately, a new breed of young upstarts has entered the industry, and they are fearless when it comes to putting bold plans into action. While SpaceX is the first name that comes to mind, another, lesser-known company is about to make a major splash.
United Airlines Holdings (UAL $57) just announced plans to buy a fleet of 15 supersonic passenger aircraft, capable of traveling at Mach 1.7, from Denver-based Boom Technology. The Boom Overture, which can carry up to 88 passengers and will have a cruising altitude of 60,000 feet, is slated to begin ferrying United passengers by the end of the decade. Using sustainable aviation fuel (SAF), the aircraft is made with advanced composite materials and will be propelled by much quieter—by supersonic standards—Rolls Royce twin engines. It is interesting to note that Boeing CEO, David Calhoun, said that an investment in supersonic travel didn't make sense for his company's business right now.
Currently, United is the only US carrier which has signed an agreement with Boom for the Overture, but Japan Airlines (JAPSY $12) has been a major backer of the US firm, investing $10 million in the company and signing a nonbinding option to buy 20 of the aircraft. Putting the speed of the craft in some context, a flight from New York to London will be reduced in travel time by roughly half: from 6:30H to 3:30H. United CEO Scott Kirby stated that "United continues on its trajectory to build a more innovative, sustainable airline and today's advancements in technology are making it more viable for that to include supersonic planes." Well said.
In the zeitgeist of too many CEOs focused more on "not offending" than on their own strategic visions, we salute Kirby and his leadership. We also salute yet another startup boldly going where the old, established players fear to tread. Perhaps the latter group needs a little history lesson in what made their respective companies great in the first place.
Cryptocurrencies
09. Bitcoin drops following FBI's successful clawback of ransom
It always struck us as odd that so many cryptophiles—the unabashed cheerleaders of all digital "currencies"—consider these creatures completely secure from outside forces. Granted, we have heard stories of Bitcoin owners forgetting their digital wallet passcodes, thus losing their coins forever, but we are talking about something which exists purely in the digital realm. Perhaps that realization hit home for some this week following the FBI's successful recovery of $2.3 million worth of bitcoins paid to the Russian-backed hacker group DarkSide by Colonial Pipeline. The ransom was apparently retrieved after investigators either uncovered the complex key code for the hackers' digital wallet, or somehow took control of the server which held the coins. However it was done, the specter of a third party being able to reach in and take bitcoins out lacking the permission of the wallet's owner sent the price of Bitcoin down around 8%. The FBI recently launched its Ransomware and Digital Extortion Task Force, which was responsible for the recovery. The price of Bitcoin has been reeling as of late, falling from its high of $64,000 in the middle of April to $32,800 following news of the ransom recovery.
As we've mentioned before, anyone wishing to get in on the crypto craze would be better off buying into the underlying blockchain technology rather than amassing the actual coins. Coinbase (COIN $227), the platform on which a number of major cryptos trade, might be a good place to start.
Automotive
08. Two words investors never want to see in an SEC filing
Looking at a company's actual financials can be a great way to spot trends, but we love a more nebulous measure as well: watching a CEO in live interviews. That is how we first got an inkling that the likes of bumbling Ron Johnson (JCP), Bernie Ebbers (WCOM), and Jeffrey Immelt (GE) were either blowing smoke or out of their league—to put it nicely. As we watched interviews of EV startup Lordstown Motors' (RIDE $10) CEO Steve Burns on the business networks, we had an uneasy feeling. He came across as a super-nice guy, but one who was banking on hope, not facts. As the meme stock groupies drove RIDE shares up from the $10 range—where they had languished for years—to $31.40, we shook our heads. Here is a company offering a ton of promises and not one vehicle in production. CNBC's Phil Lebeau pressed Burns on the massive number of pre-orders supposedly on the books, and the response was an embarrassing shuffle that made us grimace.
Fast forward to this week and the company's required quarterly filing; a filing which was submitted late, and only after the threat of a delisting notice from the Nasdaq. There was a lot of disconcerting language in the filing, but investors' jaws dropped on two words nestled in one ugly sentence: "These conditions raise substantial doubt regarding our ability to continue as a going concern for a period of at least one year...." Going concern. That means staying in business. The company came out and admitted that, failing to raise massive new amounts of capital, it would simply cease to be. RIDE shares plunged after hours on the report. At $10 per share once again, and with a major short interest, isn't it time for the WallStreetBets crowd to pile back in and stick it to "the man" yet again?
Such a joke. And emblematic of the ugliness that will soon unfold before our very eyes with a number of other profitless companies. Meme groupie money may staunch the bleeding for awhile, but the inflows only prolong the inevitable. As for Lordstown, we would be surprised if one unit of one product ever leaves the actual assembly line.
Economics
07. Inflation just hit its highest rate since 2008; here's why the Fed isn't worried
The average price of goods purchased by Americans rose 0.6% month-over-month in May, following a 0.8% jump in April. That may not sound like much, but May's Consumer Price Index number equates to a 7.2% annualized rate. The MoM figures represent the fastest rate of inflation since August of 2008. Leading the charge was the price of used cars and trucks, which rose a whopping 7.2% in May on the heels of a double-digit price jump in April.
Why doesn't Jerome Powell's Fed, which has a 2% target inflation range, seem worried by these numbers? One major reason is a phenomenon known as the base effect. Simply put, this condition argues that if inflation was too low in the same period a year earlier, even a small rise in CPI will mathematically show a high current rate of inflation. Indeed, the pandemic put a short-term clamp on economic activity, so it is understandable that the rate of inflation would appear worrisome at the moment. Here's the real question on the mind of economists, however: as we work through this blip, will the rate stabilize or continue to grow?
Another factor to consider is wage growth. Wage push inflation is an overall jump in inflation as a result of companies needing to pay more to their workforce. Evidence of wage push inflation is everywhere, with the latest example coming from Chipotle. The fast casual chain said it must hike menu prices by around 4% to cover the higher cost of paying its employees. By the end of the month, the average hourly wage for employees at the restaurant will hit $15. With a record number of job openings, this condition will certainly gain momentum as companies struggle to find the workers they need to handle the growing demand for their products and services.
While the Fed has indicated it probably won't raise rates until 2023, we expect the central bank to begin signaling a slowdown in its bond buying program at some point in the second half of the year—a very important step to help staunch the unsustainable level of federal spending. The Fed has been buying $120 billion per month worth of treasuries and mortgage-backed securities, leading to its bloated $8 trillion balance sheet. The market should be prepared for this step, but expect at least a short-term fit when the tapering is announced.
Media & Entertainment
06. Yet another reason to avoid GameStop shares: Microsoft is about to make a major gaming push
Not that true investors needed yet another reason to avoid a stock that is overvalued by 90%, but Microsoft's (MSFT $259) announcement that it will bring its Xbox games directly to smart TVs reveals just how antiquated bricks and mortar video game retailers—namely, GameStop (GME $235)—are becoming. Microsoft CEO Satya Nadella's strategy is straightforward: he wants gamers to be able to go from device to device and enjoy an incredible gaming experience, without the need to buy the latest—often outrageously-priced and sold out—gaming equipment. That means developing the cloud-based infrastructure required to efficiently stream Xbox games on computers, hand-held devices, and TVs. The company is already in talks with smart TV makers and streaming device providers like Roku (ROKU $347) to bring the strategy to fruition. The ultimate goal for Microsoft is to increase its Game Pass subscription business, which currently has about 23 million users, giving the company another steady stream of monthly income. If Nadella can replicate the incredible success of Microsoft 365, a subscription-based service for the company's software suite, it will continue to gobble up market share in the world of online gaming. And that spells trouble for an old video game retailer trying to transform itself into a digital player.
We may be dedicated Apple users, but Microsoft remains one of our strongest conviction holdings in the Penn Global Leaders Club. We also happen to be one of the 240 million or so users of Microsoft Office 365, paying the company a steady stream of recurring monthly income so we can operate Microsoft software on our MacBook Pros. We may curse our lonely PC on a weekly basis (some software still doesn't play nice with macOS), but Satya Nadella is one of the best CEOs in corporate America. As for GameStop, we are still waiting for incoming chairman Ryan Cohen's great strategic turnaround plan for GameStop (not).
Aerospace & Defense
05. Northrop Grumman just successfully launched a US Space Force satellite into orbit aboard its Pegasus XL launch vehicle
At 1:11 in the morning, a Northrop Grumman (NOC $371) L-1011 "Stargazer" took off from the newly renamed Vandenberg Space Force Base in California. After achieving 40,000 feet over the Pacific Ocean, its special cargo launched from the underbelly: a solid fuel Pegasus XL rocket carrying a secretive United States Space Force satellite. Last Sunday's launch represented the 45th deployment for the Pegasus, which Northrop Grumman was able to design, integrate, test, and place into service within a whirlwind four month period following the contract award. The rocket, which was built under the USSF's tactically responsive launch concept, is the world's first privately-developed commercial space launch vehicle. It has the ability to launch payloads from virtually anywhere on Earth at a moment's notice and with minimal ground support. The rocket is quickly becoming a favorite tool of the nascent US Space Force.
While Lockheed Martin (LMT $390) is the primary defense contractor within our Penn Global Leaders Club, Northrop Grumman is high on our list of the most respected industry players—easily ahead of Boeing. The $60 billion company (what a great size—well poised to become a $100 billion firm) netted a $3.2 billion profit on $37 billion in revenues last year.
Cryptocurrencies
04. Finally, a crypto that acts like a currency: Tether now the third-largest digital coin in the world
We have laughed off any comparison of cryptocurrencies such as Bitcoin to actual currencies; they are actually commodities with wild volatility. Well, that is true for most of them. All of a sudden, a digital currency known as a stablecoin has roared into third place—behind Bitcoin and Ether—on the list of the world's largest cryptocurrencies. Tether, which was originally known as Realcoin, is—as the name implies—tethered to an actual currency. Tether USDT is tied to the price of a US dollar, EURT to the euro, CHNT to the Chinese yuan, and XAUT to the price of an ounce of gold. So, at least in theory, one Tether USDT will always be worth one US dollar. As one could imagine, that makes it a lot easier for owners to buy goods with their USDTs, as they won't be worried that they could buy the same goods for a lot less in the future (due to fluctuation). The cryptocurrency got a big boost in May when the largest US digital exchange, Coinbase (COIN $232), announced that Tether USDT would be available on its platform. Tether is not without its share of controversy, however. It got in some hot water a few years back by implying that it was fully backed by the dollar. In actuality, a breakdown of the coin's reserves shows that it is 75%-backed by cash and cash equivalents; 13%-backed by secured loans; and 12%-backed by corporate bonds, precious metals, and other digital tokens. Nonetheless, it has traded at or near $1 throughout its seven year history. Another thing we like about this coin: For foreign nationals who don't have access to US bank accounts but want the stability of the US dollar, Tether has proved to be a popular solution.
Tether's market cap surpassed $60 billion last month, and we expect it to maintain its steep growth trajectory. Considering the Communist Party of China is hell-bent on creating a digital currency to supplant the US dollar as the world's reserve currency, perhaps the United States Treasury should study Tether as it slowly prepares to roll out its own fiat digital currency. In the meantime, Tether is one of the only digital coins whose future value we can confidently predict.
Financial Services
03. American Express has a new hybrid work model we can get behind
We have all witnessed how the pandemic has uprooted the traditional work/office relationship in a dramatic fashion. Companies which would never would have considered allowing a meaningful percentage of their workforce to perform their duties at home are suddenly rethinking those policies—and discovering just how much they can save in overhead through a reduced real estate footprint. One of our favorite new hybrid models comes to us from American Express (AXP $158), a global financial services firm operating in 130 countries. Most of the company's US and UK workers will be required to show up at the office just three days a week, Tuesday through Thursday, with the choice to work from home every Monday and Friday. Thinking back on some past jobs, that seems like a dream scenario to us. The new AmEx policy, which will begin this fall, stands in stark contrast to Goldman Sachs' (GS $349) demand that all employees return to the office by the 14th of July. Goldman Sachs CEO David Solomon (of which we have never been a fan) went so far as to call remote work "an aberration," and harmful to productivity. Based on some rather ugly employee feedback over the past few years, neither the company's policy nor the CEO's imperious comments surprise us. In a memo to employees, AmEx CEO Steve Squeri said that the new hybrid model will allow for both in-office collaboration and an increased work-life balance. Between the two firms, we know who we would rather work for.
Goldman Sachs has a notorious history of corporate arrogance. Thanks to technology and a shifting demographic landscape, the company is facing increased competition in areas it used to dominate, such as mergers and acquisition and securities underwriting. Counter that with American Express (granted, not exactly an apples-to-apples comparison), whose strong position within the small business community should provide a nice tailwind going forward.
Pharmaceuticals
02. AstraZeneca has another fail
Precisely one quarter ago we were writing of AstraZeneca's (AZN $58) vaccine fail—due to blood clot complications among some recipients—and management's unswerving denial that there was anything wrong with the drug; even hinting that a political hit job was in play. European countries went from halting the vaccine's use, to (under pressure) resuming its use, to halting it once again. This quarter the Swedish/UK conglomerate is facing yet another setback: its antibody drug is proving to be just 33% effective in preventing symptomatic Covid-19 in those exposed to the virus. Meanwhile, both Regeneron and Eli Lilly each have successful antibody cocktails already in use under emergency authorization. The US had already ordered 700,000 doses of the AstraZeneca therapy for delivery this year, while the UK had ordered one million doses. Odds are strong that the US will ultimately cancel the order, and it will be fascinating to watch what the company's home country ends up doing with respect to the one-million-dose order.
We are constantly on the lookout for strong pharmaceutical stocks and sound international companies in which to invest. Unfortunately, AZN doesn't fit the bill—in our opinion—for either category. Meanwhile, AZN shares are trading as if both therapies were a rousing success.
Market Week in Review
01. In a week to be expected—both based on the calendar and an FOMC meeting—stocks retreat
It wasn't a pretty week for the markets. After all, the Dow lost over 1,000 points (down 3.45%) and the S&P gave up nearly 2%. If there was a "bright spot" it was the tech-laden NASDAQ, which just gave back 28 basis points over the five-day period. We have no problem with the pullback: nothing makes us more nervous than built-in investor expectations for weekly gains. What bothers us is the rationale for the pullback. Investors (apparently) got spooked by the Fed's "more hawkish" tone after the week's FOMC meeting. Hawkish tone? You've got to be kidding. Did Chairman Powell even talk about ending the $120 billion monthly purchase of Treasuries and mortgage-backed securities? Nope. Did the Fed signal an imminent interest rate hike? Nope. St Louis Fed President James Bullard, who will be a voting member of the FOMC next year, said he could see a rate hike coming before 2022 is done. Katy, bar the door! You mean, we might actually move off of a target fed funds rate of zero?! Sure, there is also the fear of inflation running hotter than Powell expects, but we had to hear the word "transitory" at least one hundred times over the course of the week with respect to that particular market threat. In fact, the anemic yield of the 10-year Treasury actually fell this week, showing how little bond investors are worried about inflation forcing the Fed's hand. In all, this was simply a rather welcome pressure relief for a stock market that seemed to forget what a downturn was—despite the nightmare it was emerging from precisely one year ago. We went into the week with the Dow sitting above 34,000; we can handle an 1,190-point giveback. In fact, investors need to be mentally prepared for more summer volatility ahead.
Under the Radar Investment
POSCO
POSCO (PKX $73) is the largest steel producer in South Korea and one of the top steel producers in the world. The company is exposed to the auto, shipbuilding, home appliance, engineering, and machinery industries. The firm controls 40% of the domestic market share and exports roughly 50% of its steel products overseas, primarily to Asian countries. POSCO netted $1.3 billion in profit on $48 billion in revenues last year, and we expect the firm to play a major role in Asia's post-pandemic rebound. We believe the shares, which carry a 3% dividend yield and a P/E ratio of 12, could fetch $100 relatively soon.
Answer
It took just one generation, from the end of World War II to approximately the time we were landing astronauts on the lunar surface in 1969, for the American economy to grow from around $240 billion to $1 trillion—a fourfold increase.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The mighty American economy...
At $22 trillion, the US has—by far—the largest economy in the world. The great growth trajectory began at the end of the Second World War, when the US had an economy of around $240 billion. How long did it take the country's economy to reach $1 trillion in size?
Penn Trading Desk:
Penn: Add a crypto play to the Intrepid
We have made the comparison between the Gold Rush of the mid-19th century and the crypto craze unfolding right now. We have urged investors to "invest in the companies supplying the tools rather than in the miners themselves." Taking our own advice, we just added a cryptocurrency infrastructure play to the Intrepid Trading Platform. Members, sign into the Penn Trading Desk for details.
Goldman: Double downgrade Ferrari
At $205 per share ($210 before the downgrade) and a price-to-earnings ratio of 50, Italian automaker Ferrari (RACE) does seem a bit expensive. Furthermore, its reliance on Formula One racing and its recent drought in that arena could be damaging the brand's reputation. At least that is what Goldman Sachs analyst George Galliers said as part of the rationale for his double downgrade of the company's shares, from Buy to Sell. Galliers, who reduced the Goldman target price on RACE from $227 to $207, also said that the firm is facing higher capital spending as it invests in EV battery technology, with little assurance of its success in that arena.
Penn: Added foreign telecom play to Strategic Income Portfolio
One never knows for certain how any given individual stock will perform going forward, but we found a telecom services company that checks three of our boxes for the Strategic Income Portfolio: a great yield, a foreign play (which we are chronically short on), and a smart strategic vision which embraces the future of the industry. Added to the SIP. Members, sign into the Penn Trading Desk for details.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Industrials: Airlines
10. America is entering a new era of supersonic air travel—and Boeing is not building the aircraft
When I was growing up in the 1970s, with an avid fascination in all things air and space, there were dozens of major, publicly-traded, aerospace and defense contractors. Sadly, due to mergers and acquisitions (the largest being Boeing's 1997 purchase of McDonnell Douglas), the numbers dwindled to a few. As competition helps assure that companies continue to operate at peak performance, we knew that the seemingly-endless acquisitions would lead to complacency. And indeed, based on Boeing's (BA $ 250) string of recent high-profile failures, it did. Fortunately, a new breed of young upstarts has entered the industry, and they are fearless when it comes to putting bold plans into action. While SpaceX is the first name that comes to mind, another, lesser-known company is about to make a major splash.
United Airlines Holdings (UAL $57) just announced plans to buy a fleet of 15 supersonic passenger aircraft, capable of traveling at Mach 1.7, from Denver-based Boom Technology. The Boom Overture, which can carry up to 88 passengers and will have a cruising altitude of 60,000 feet, is slated to begin ferrying United passengers by the end of the decade. Using sustainable aviation fuel (SAF), the aircraft is made with advanced composite materials and will be propelled by much quieter—by supersonic standards—Rolls Royce twin engines. It is interesting to note that Boeing CEO, David Calhoun, said that an investment in supersonic travel didn't make sense for his company's business right now.
Currently, United is the only US carrier which has signed an agreement with Boom for the Overture, but Japan Airlines (JAPSY $12) has been a major backer of the US firm, investing $10 million in the company and signing a nonbinding option to buy 20 of the aircraft. Putting the speed of the craft in some context, a flight from New York to London will be reduced in travel time by roughly half: from 6:30H to 3:30H. United CEO Scott Kirby stated that "United continues on its trajectory to build a more innovative, sustainable airline and today's advancements in technology are making it more viable for that to include supersonic planes." Well said.
In the zeitgeist of too many CEOs focused more on "not offending" than on their own strategic visions, we salute Kirby and his leadership. We also salute yet another startup boldly going where the old, established players fear to tread. Perhaps the latter group needs a little history lesson in what made their respective companies great in the first place.
Cryptocurrencies
09. Bitcoin drops following FBI's successful clawback of ransom
It always struck us as odd that so many cryptophiles—the unabashed cheerleaders of all digital "currencies"—consider these creatures completely secure from outside forces. Granted, we have heard stories of Bitcoin owners forgetting their digital wallet passcodes, thus losing their coins forever, but we are talking about something which exists purely in the digital realm. Perhaps that realization hit home for some this week following the FBI's successful recovery of $2.3 million worth of bitcoins paid to the Russian-backed hacker group DarkSide by Colonial Pipeline. The ransom was apparently retrieved after investigators either uncovered the complex key code for the hackers' digital wallet, or somehow took control of the server which held the coins. However it was done, the specter of a third party being able to reach in and take bitcoins out lacking the permission of the wallet's owner sent the price of Bitcoin down around 8%. The FBI recently launched its Ransomware and Digital Extortion Task Force, which was responsible for the recovery. The price of Bitcoin has been reeling as of late, falling from its high of $64,000 in the middle of April to $32,800 following news of the ransom recovery.
As we've mentioned before, anyone wishing to get in on the crypto craze would be better off buying into the underlying blockchain technology rather than amassing the actual coins. Coinbase (COIN $227), the platform on which a number of major cryptos trade, might be a good place to start.
Automotive
08. Two words investors never want to see in an SEC filing
Looking at a company's actual financials can be a great way to spot trends, but we love a more nebulous measure as well: watching a CEO in live interviews. That is how we first got an inkling that the likes of bumbling Ron Johnson (JCP), Bernie Ebbers (WCOM), and Jeffrey Immelt (GE) were either blowing smoke or out of their league—to put it nicely. As we watched interviews of EV startup Lordstown Motors' (RIDE $10) CEO Steve Burns on the business networks, we had an uneasy feeling. He came across as a super-nice guy, but one who was banking on hope, not facts. As the meme stock groupies drove RIDE shares up from the $10 range—where they had languished for years—to $31.40, we shook our heads. Here is a company offering a ton of promises and not one vehicle in production. CNBC's Phil Lebeau pressed Burns on the massive number of pre-orders supposedly on the books, and the response was an embarrassing shuffle that made us grimace.
Fast forward to this week and the company's required quarterly filing; a filing which was submitted late, and only after the threat of a delisting notice from the Nasdaq. There was a lot of disconcerting language in the filing, but investors' jaws dropped on two words nestled in one ugly sentence: "These conditions raise substantial doubt regarding our ability to continue as a going concern for a period of at least one year...." Going concern. That means staying in business. The company came out and admitted that, failing to raise massive new amounts of capital, it would simply cease to be. RIDE shares plunged after hours on the report. At $10 per share once again, and with a major short interest, isn't it time for the WallStreetBets crowd to pile back in and stick it to "the man" yet again?
Such a joke. And emblematic of the ugliness that will soon unfold before our very eyes with a number of other profitless companies. Meme groupie money may staunch the bleeding for awhile, but the inflows only prolong the inevitable. As for Lordstown, we would be surprised if one unit of one product ever leaves the actual assembly line.
Economics
07. Inflation just hit its highest rate since 2008; here's why the Fed isn't worried
The average price of goods purchased by Americans rose 0.6% month-over-month in May, following a 0.8% jump in April. That may not sound like much, but May's Consumer Price Index number equates to a 7.2% annualized rate. The MoM figures represent the fastest rate of inflation since August of 2008. Leading the charge was the price of used cars and trucks, which rose a whopping 7.2% in May on the heels of a double-digit price jump in April.
Why doesn't Jerome Powell's Fed, which has a 2% target inflation range, seem worried by these numbers? One major reason is a phenomenon known as the base effect. Simply put, this condition argues that if inflation was too low in the same period a year earlier, even a small rise in CPI will mathematically show a high current rate of inflation. Indeed, the pandemic put a short-term clamp on economic activity, so it is understandable that the rate of inflation would appear worrisome at the moment. Here's the real question on the mind of economists, however: as we work through this blip, will the rate stabilize or continue to grow?
Another factor to consider is wage growth. Wage push inflation is an overall jump in inflation as a result of companies needing to pay more to their workforce. Evidence of wage push inflation is everywhere, with the latest example coming from Chipotle. The fast casual chain said it must hike menu prices by around 4% to cover the higher cost of paying its employees. By the end of the month, the average hourly wage for employees at the restaurant will hit $15. With a record number of job openings, this condition will certainly gain momentum as companies struggle to find the workers they need to handle the growing demand for their products and services.
While the Fed has indicated it probably won't raise rates until 2023, we expect the central bank to begin signaling a slowdown in its bond buying program at some point in the second half of the year—a very important step to help staunch the unsustainable level of federal spending. The Fed has been buying $120 billion per month worth of treasuries and mortgage-backed securities, leading to its bloated $8 trillion balance sheet. The market should be prepared for this step, but expect at least a short-term fit when the tapering is announced.
Media & Entertainment
06. Yet another reason to avoid GameStop shares: Microsoft is about to make a major gaming push
Not that true investors needed yet another reason to avoid a stock that is overvalued by 90%, but Microsoft's (MSFT $259) announcement that it will bring its Xbox games directly to smart TVs reveals just how antiquated bricks and mortar video game retailers—namely, GameStop (GME $235)—are becoming. Microsoft CEO Satya Nadella's strategy is straightforward: he wants gamers to be able to go from device to device and enjoy an incredible gaming experience, without the need to buy the latest—often outrageously-priced and sold out—gaming equipment. That means developing the cloud-based infrastructure required to efficiently stream Xbox games on computers, hand-held devices, and TVs. The company is already in talks with smart TV makers and streaming device providers like Roku (ROKU $347) to bring the strategy to fruition. The ultimate goal for Microsoft is to increase its Game Pass subscription business, which currently has about 23 million users, giving the company another steady stream of monthly income. If Nadella can replicate the incredible success of Microsoft 365, a subscription-based service for the company's software suite, it will continue to gobble up market share in the world of online gaming. And that spells trouble for an old video game retailer trying to transform itself into a digital player.
We may be dedicated Apple users, but Microsoft remains one of our strongest conviction holdings in the Penn Global Leaders Club. We also happen to be one of the 240 million or so users of Microsoft Office 365, paying the company a steady stream of recurring monthly income so we can operate Microsoft software on our MacBook Pros. We may curse our lonely PC on a weekly basis (some software still doesn't play nice with macOS), but Satya Nadella is one of the best CEOs in corporate America. As for GameStop, we are still waiting for incoming chairman Ryan Cohen's great strategic turnaround plan for GameStop (not).
Aerospace & Defense
05. Northrop Grumman just successfully launched a US Space Force satellite into orbit aboard its Pegasus XL launch vehicle
At 1:11 in the morning, a Northrop Grumman (NOC $371) L-1011 "Stargazer" took off from the newly renamed Vandenberg Space Force Base in California. After achieving 40,000 feet over the Pacific Ocean, its special cargo launched from the underbelly: a solid fuel Pegasus XL rocket carrying a secretive United States Space Force satellite. Last Sunday's launch represented the 45th deployment for the Pegasus, which Northrop Grumman was able to design, integrate, test, and place into service within a whirlwind four month period following the contract award. The rocket, which was built under the USSF's tactically responsive launch concept, is the world's first privately-developed commercial space launch vehicle. It has the ability to launch payloads from virtually anywhere on Earth at a moment's notice and with minimal ground support. The rocket is quickly becoming a favorite tool of the nascent US Space Force.
While Lockheed Martin (LMT $390) is the primary defense contractor within our Penn Global Leaders Club, Northrop Grumman is high on our list of the most respected industry players—easily ahead of Boeing. The $60 billion company (what a great size—well poised to become a $100 billion firm) netted a $3.2 billion profit on $37 billion in revenues last year.
Cryptocurrencies
04. Finally, a crypto that acts like a currency: Tether now the third-largest digital coin in the world
We have laughed off any comparison of cryptocurrencies such as Bitcoin to actual currencies; they are actually commodities with wild volatility. Well, that is true for most of them. All of a sudden, a digital currency known as a stablecoin has roared into third place—behind Bitcoin and Ether—on the list of the world's largest cryptocurrencies. Tether, which was originally known as Realcoin, is—as the name implies—tethered to an actual currency. Tether USDT is tied to the price of a US dollar, EURT to the euro, CHNT to the Chinese yuan, and XAUT to the price of an ounce of gold. So, at least in theory, one Tether USDT will always be worth one US dollar. As one could imagine, that makes it a lot easier for owners to buy goods with their USDTs, as they won't be worried that they could buy the same goods for a lot less in the future (due to fluctuation). The cryptocurrency got a big boost in May when the largest US digital exchange, Coinbase (COIN $232), announced that Tether USDT would be available on its platform. Tether is not without its share of controversy, however. It got in some hot water a few years back by implying that it was fully backed by the dollar. In actuality, a breakdown of the coin's reserves shows that it is 75%-backed by cash and cash equivalents; 13%-backed by secured loans; and 12%-backed by corporate bonds, precious metals, and other digital tokens. Nonetheless, it has traded at or near $1 throughout its seven year history. Another thing we like about this coin: For foreign nationals who don't have access to US bank accounts but want the stability of the US dollar, Tether has proved to be a popular solution.
Tether's market cap surpassed $60 billion last month, and we expect it to maintain its steep growth trajectory. Considering the Communist Party of China is hell-bent on creating a digital currency to supplant the US dollar as the world's reserve currency, perhaps the United States Treasury should study Tether as it slowly prepares to roll out its own fiat digital currency. In the meantime, Tether is one of the only digital coins whose future value we can confidently predict.
Financial Services
03. American Express has a new hybrid work model we can get behind
We have all witnessed how the pandemic has uprooted the traditional work/office relationship in a dramatic fashion. Companies which would never would have considered allowing a meaningful percentage of their workforce to perform their duties at home are suddenly rethinking those policies—and discovering just how much they can save in overhead through a reduced real estate footprint. One of our favorite new hybrid models comes to us from American Express (AXP $158), a global financial services firm operating in 130 countries. Most of the company's US and UK workers will be required to show up at the office just three days a week, Tuesday through Thursday, with the choice to work from home every Monday and Friday. Thinking back on some past jobs, that seems like a dream scenario to us. The new AmEx policy, which will begin this fall, stands in stark contrast to Goldman Sachs' (GS $349) demand that all employees return to the office by the 14th of July. Goldman Sachs CEO David Solomon (of which we have never been a fan) went so far as to call remote work "an aberration," and harmful to productivity. Based on some rather ugly employee feedback over the past few years, neither the company's policy nor the CEO's imperious comments surprise us. In a memo to employees, AmEx CEO Steve Squeri said that the new hybrid model will allow for both in-office collaboration and an increased work-life balance. Between the two firms, we know who we would rather work for.
Goldman Sachs has a notorious history of corporate arrogance. Thanks to technology and a shifting demographic landscape, the company is facing increased competition in areas it used to dominate, such as mergers and acquisition and securities underwriting. Counter that with American Express (granted, not exactly an apples-to-apples comparison), whose strong position within the small business community should provide a nice tailwind going forward.
Pharmaceuticals
02. AstraZeneca has another fail
Precisely one quarter ago we were writing of AstraZeneca's (AZN $58) vaccine fail—due to blood clot complications among some recipients—and management's unswerving denial that there was anything wrong with the drug; even hinting that a political hit job was in play. European countries went from halting the vaccine's use, to (under pressure) resuming its use, to halting it once again. This quarter the Swedish/UK conglomerate is facing yet another setback: its antibody drug is proving to be just 33% effective in preventing symptomatic Covid-19 in those exposed to the virus. Meanwhile, both Regeneron and Eli Lilly each have successful antibody cocktails already in use under emergency authorization. The US had already ordered 700,000 doses of the AstraZeneca therapy for delivery this year, while the UK had ordered one million doses. Odds are strong that the US will ultimately cancel the order, and it will be fascinating to watch what the company's home country ends up doing with respect to the one-million-dose order.
We are constantly on the lookout for strong pharmaceutical stocks and sound international companies in which to invest. Unfortunately, AZN doesn't fit the bill—in our opinion—for either category. Meanwhile, AZN shares are trading as if both therapies were a rousing success.
Market Week in Review
01. In a week to be expected—both based on the calendar and an FOMC meeting—stocks retreat
It wasn't a pretty week for the markets. After all, the Dow lost over 1,000 points (down 3.45%) and the S&P gave up nearly 2%. If there was a "bright spot" it was the tech-laden NASDAQ, which just gave back 28 basis points over the five-day period. We have no problem with the pullback: nothing makes us more nervous than built-in investor expectations for weekly gains. What bothers us is the rationale for the pullback. Investors (apparently) got spooked by the Fed's "more hawkish" tone after the week's FOMC meeting. Hawkish tone? You've got to be kidding. Did Chairman Powell even talk about ending the $120 billion monthly purchase of Treasuries and mortgage-backed securities? Nope. Did the Fed signal an imminent interest rate hike? Nope. St Louis Fed President James Bullard, who will be a voting member of the FOMC next year, said he could see a rate hike coming before 2022 is done. Katy, bar the door! You mean, we might actually move off of a target fed funds rate of zero?! Sure, there is also the fear of inflation running hotter than Powell expects, but we had to hear the word "transitory" at least one hundred times over the course of the week with respect to that particular market threat. In fact, the anemic yield of the 10-year Treasury actually fell this week, showing how little bond investors are worried about inflation forcing the Fed's hand. In all, this was simply a rather welcome pressure relief for a stock market that seemed to forget what a downturn was—despite the nightmare it was emerging from precisely one year ago. We went into the week with the Dow sitting above 34,000; we can handle an 1,190-point giveback. In fact, investors need to be mentally prepared for more summer volatility ahead.
Under the Radar Investment
POSCO
POSCO (PKX $73) is the largest steel producer in South Korea and one of the top steel producers in the world. The company is exposed to the auto, shipbuilding, home appliance, engineering, and machinery industries. The firm controls 40% of the domestic market share and exports roughly 50% of its steel products overseas, primarily to Asian countries. POSCO netted $1.3 billion in profit on $48 billion in revenues last year, and we expect the firm to play a major role in Asia's post-pandemic rebound. We believe the shares, which carry a 3% dividend yield and a P/E ratio of 12, could fetch $100 relatively soon.
Answer
It took just one generation, from the end of World War II to approximately the time we were landing astronauts on the lunar surface in 1969, for the American economy to grow from around $240 billion to $1 trillion—a fourfold increase.
Headlines for the Week of 23 May—29 May 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 growing power of the plant-based food industry...
The plant-based food business is red-hot, and don't expect it to cool anytime soon. It is not a novelty or a niche corner of the market; it is quickly becoming a mainstream staple. For evidence of that, just look at the growing space dedicated to the products in your local supermarket. What is the size of this industry, based on revenue, and how rapidly did it grow last year over 2019?
Penn Trading Desk:
Penn: AT&T Stopped Out in Strategic Income Portfolio
AT&T CEO John Stankey, earlier this spring: "HBO Max is a pillar of the company's long-term strategy." This week: HBO Max is being spun-off so the company can focus on its "core competencies" of wireless and broadband. What a joke. We placed a stop on T @ $32, and it filled the same day, 17 May, at $31.98. A position we have held since 2010 is officially gone.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Media & Entertainment
10. AT&T and Discovery to combine media assets, creating a new entertainment behemoth (i.e., AT&T admits defeat)
While we have owned telecom services giant AT&T (T $33) for years, either in the Penn Global Leaders Club or—most recently—in the Strategic Income Portfolio (it carries a 6.5% dividend yield), we've had a strong sense as of late that the company is not quite sure of its own strategic vision. After all, T bought DirecTV in 2015 for $67 billion (with debt) only to spin it off six years later for one-fourth of that value; and it paid $85 billion to acquire Time Warner a few years after the DirecTV deal only, now, to spin that company off for $43 billion. Someone needs to explain the concept of "buy low and sell high" to the AT&T board.
With respect to the latter, AT&T and Discovery (DISCA $38) have announced plans to combine their media assets, which include the likes of HBO Max, CNN, TBS, Warner Brothers, TLC, and HGTV, into a new publicly-traded company—name to be determined. T shareholders will own 71% of the new entity, with Discovery shareholders getting the remaining 29%. Well-known media executive David Zaslav, current CEO of Discovery, will lead the new business. While Zaslav envisions the new firm becoming the dominant streaming service in the world (Netflix might disagree with that boast), here's what won't be said: this move represents a 180-degree turn for AT&T, which is now throwing in the towel on its lofty media aspirations. Going forward, the company will focus on its 5G buildout and its broadband service. The $43 billion will certainly help the firm pay for the $23 billion worth of 5G spectrum it committed to buying in its bidding war with Verizon (VZ $59). As for that 6.5% dividend yield which has kept many investors around, it will almost certainly be cut when this deal closes.
AT&T popped over 4% on news of this spinoff, jumping to over $33 per share. We know the dividend is going to get cut, and we question how much growth can be squeezed out of the wireless and broadband businesses—considering the fierce competition—over the coming years. We also feel like we got suckered into believing the company's line about creating a new media empire. We are placing a stop on our T position at $32. In short, we have lost almost all confidence in T's management team. Update: T changed direction on the day the deal was announced and went below $32, triggering our stop loss. Update: T changed direction on the day the deal was announced and went below $32, triggering our stop loss.
Restaurants
09. Dine Brands' restaurant IHOP to launch fast-casual spinoff Flip'd this summer
It was a plan put on hold due to the pandemic, but Dine Brands' (DIN $95) restaurant IHOP is finally ready to unveil its new fast-casual chain known as Flip'd. The concept is simple: lure on-the-go customers who want to grab some good food fast. Visitors will be able to order the likes of signature pancake bowls, made-to-order egg sandwiches, and a host of other pastry, drink, and food items at either a digital kiosk or the counter, generally taking their food to go. Picture a Chipotle, but breakfast-based. All of the Flip'd locations will be franchise-owned, with IHOP offering $150,000 to each of the first ten franchisees to get them up and running. A few of the very first Flip'd restaurants will be located in Manhattan; Lawrence, Kansas; and several cities in Ohio. A number of restaurants have tried to launch spin-off versions of themselves with a unique twist, but most have had limited success. We will go ahead and predict it: Flip'd will be an overwhelming success.
IHOP is owned by Dine Brands, which also owns Applebee's. Dine was under an enormous amount of financial stress during the pandemic, as could be imagined. While we picked up hotel chains, retail stores, an airline, and even a major gambling resort precisely twelve months ago during the heat of the market free-fall, we didn't pick up any restaurants. That was a mistake: Dine Brands is up 132% since then. Fair value would probably be in the $125 per share range.
Media & Entertainment
08. Amazon poised to make its second-largest acquisition ever: a storied movie studio
Formed in 1924, MGM dominated Hollywood for over a generation. While the studio has had a number of interesting owners over the past century, none have been quite like its next probable owner: Internet retailer Amazon (AMZN $3,245). Back in 2017, when reports surfaced that Amazon was about to buy food retailer Whole Foods for $13.7 billion, there were many of doubters. We believed the move was brilliant, and that opinion has been borne out in an impressively short period of time (Whole Foods now delivers food to the doorstep of Prime members with Amazon-like efficiency). The Whole Foods acquisition remains the company's largest to date; but, with its reported $8.45 billion price tag, MGM will easily hold the second position.
Amazon has been investing heavily in its streaming service, recently inking a deal with the NFL to stream Thursday night games for around $1.2 billion per year. The recent merger of AT&T's Warner Media with Discovery may well have been the catalyst for MGM and the retailer to get this deal inked. It is interesting to note that MGM's former CEO, Gary Barber, was fired by the board after he reportedly engaged in talks with Apple surrounding a possible $6 billion deal. So, with a cost 40% higher than the purported range during the Apple talks, is Amazon overpaying for this asset? Probably. But in the end, they will make the premium look like chump change.
Amazon is a long-standing member of the Penn Global Leaders Club, and we have a fair value on the shares of around $4,250. The most concerning aspect of the company's growth trajectory revolves around government intervention. The company already had a target on its back from an antitrust standpoint; this will only add fuel to the fire of those who wish to see it forcibly broken up.
Food Products
07. Swedish oat milk company Oatly comes out of the gate hot, but established food players are stepping up the pressure
It's an age old story: established players bash a new concept, consumers embrace the new products, and the established players suddenly enter the fray, claiming they were always on board. EVs are perhaps the best example of this, and we remember the Fords and GMs of the world impugning Tesla on a chronic basis...until they suddenly embraced EVs as if it were their idea in the first place. The same is true in the plant-based foods business. Oatly Group AB (OTLY $21), maker of the happy little cartons of "milk" you have probably seen in the dairy section of the grocery store, went public last week. Despite the IPO price of $17, shares shot out of the gate, jumping 37%—to $23.25—within a day. While they have cooled off a bit since, their $21 price still values the company at $12.5 billion—about 50% larger than our favorite plant-based company, Beyond Meat (BYND $123). At $21, are the new shares worth picking up? Plant-based food sales rose an impressive 27%—to $7 billion—in 2020, and the upward trajectory will continue. Silk, which is now owned by Danone (DANOY $15), will probably be the company's chief competitor going forward, but we see Oatly growing its rather faithful consumer base. While it will be a few years before the company is profitable (it lost $60 million in 2020), its revenues doubled last year from the previous year. If shares go below $20, they are worth looking at for investors needing an international play in the consumer staples sector (which you probably do).
We believe a lot of investors are not fully grasping just how big the plant-based food movement will become over the next decade. Consider this frontier investing: there will be massive gains to be had, but choose your vehicles carefully. Oatly is a pretty safe bet.
Pharmaceuticals
06. Just another example of why this company is underrated: Pfizer's Covid pill should be out by year's end
By definition, we believe in all 100 or so investments within the five Penn Wealth strategies; put another way, if we lose faith, we have no qualms jettisoning any of them. That said, at any particular point in time we have our favorites. Typically, these are companies in which we see something dynamic going on, but ones that seem to be flying under the radar of the Street. Penn Global Leaders Club member Pfizer (PFE $38) is a perfect example. We believe this company, which also happens to have a fat 4% dividend yield, is the global benchmark for the pharmaceuticals industry. As if it weren't enough that Pfizer has the most effective vaccine for Covid on the market (which it developed in record time), it now plans to have a pill for the treatment of the deadly virus on the market before the end of the year. Currently in a phase 1 clinical trial, this protease inhibitor (a protease is an enzyme which allows the virus to break down proteins so it can make copies of itself and multiply) could be taken at home by those having positive test results, effectively treating the disease and helping to keep patients out of the hospital. The first protease inhibitor was approved by the FDA a generation ago to treat HIV. As for the various strains of the disease, Pfizer believes the therapy, currently known simply as PF-07321332, should effectively tackle all of them with strong efficacy.
Pfizer has a healthy balance sheet, a strong drug pipeline, a top-tier sales force, and a simply great R&D team. Let others follow meme stocks that are infinitesimally overvalued (i.e., really worth nothing), we will stick with beautiful workhorses like Pfizer. When the next correction comes, washing the silliness away, this 172-year-old stalwart will still be standing.
Global Trade
05. Parity must be the US goal with respect to trade with China
The press keeps telling us that China is about to reach economic parity with the United States, so here's our question to the collective press: why are we importing over four times as much from China as we export to China? If the economies are of equal scale, shouldn't our trade deficit with the communist nation be relatively balanced? In reality, the United States has a $22 trillion economy compared to China's $15 trillion or so, meaning we could even accept a 50% differential in the transfer of goods; but 400%? Something doesn't smell right.
In March, the most recent month on record, we exported $11.27 billion worth of goods to China and imported $48.21 billion worth of goods from China. While those figures are both depressing and outrageous, there is some good news: the US tariffs on Chinese goods are finally forcing US companies to look elsewhere for their purchases. One of the biggest beneficiaries in this shift has been Vietnam, which is now the eighth-largest exporter to the US, moving ahead of India. Vietnam, as we have noted in the past, is no friend to China, with the ongoing South China Sea dispute just the latest bone of contention between the two. The peak in our level of imports from China was $539 billion in 2018; as of the trailing twelve months (TTM) ended 31 March, that figure has dropped to $472 billion. A 12% drop doesn't sound like much, and the pandemic certainly skewed the results to some extent, but at least the needle is moving in the right direction.
Fortunately, the Biden administration has shown little inclination toward removing the tariffs on Chinese goods, much to the consternation of the CPC. Americans must keep up the pressure on companies to persuade them to look elsewhere for the wholesale purchase of products and building of new plants. If that pressure continues, China's five-year plan to overtake the US economically will face a much larger hurdle—despite the cheerleading from much of the press.
Technology is going to be, far and away, our greatest ally in the fight to curb Chinese imports. From 3D printing to vastly increased efficiency for manufacturing firms, technology is the great disruptor with respect to the balance of trade. Investors should keep a close eye on opportunities in the small- and mid-cap industrials space, those tech-heavy firms which almost always travel under the radar. We will continue to highlight individual names for readers.
Global Strategy: Europe
04. America is roaring out of the pandemic; that is not so much the case in Europe
Over the course of the last two quarters, covering the end of 2020 and the beginning of 2021, the US economy grew at an impressive clip of 4.3% and 6.4%, respectively, thanks to a herculean vaccination effort and a subsequent loosening of Covid restrictions. Sadly, this has not been the case across the pond. The latest metric comes from France, which just re-entered a recession. The French economy shrank by 0.1% in the first quarter of 2021, following a 1.5% contraction in Q4 of 2020. But Europe's second-largest economy has some good company: Germany, the eurozone's largest economy, has seen its economy shrink for five straight quarters, with Q1 GDP coming in at -3.10%. To be sure, the pandemic and a chaotic subsequent vaccine rollout have been the catalysts for the recession that Europe can't seem to shake, but there were other factors which prepared the field for these conditions.
While US deficit spending has been a sad, running joke for a number of years, Europe's fiscal policy almost makes America's economic house look enviable. After the Great Recession, Brussels, led by the erudite wonks primarily from France and Germany, spent with reckless abandon to help the poorer nations in the southern region shake off record levels of unemployment—like 28% in Greece and 26% in Spain. Austerity measures were then forced upon these borrowers which only served to exacerbate the problem and create resentment among the citizens of these beleaguered southern nations. Going into the pandemic, unemployment levels remained stubbornly high in Portugal, Italy, Greece, and Spain. In essence, the eurozone never shook off the effects of the 2008-2009 crisis when the global pandemic hit. The ECB's only answer seems to be throwing more money at the problem until it goes away. Eventually, Europe's vaccination rate will subdue the nightmarish pandemic and growth will return to the region. But the economic scars caused by the handling of two massive crises will remain, as will the bitter divide between the northern and southern regions of the continent.
We continue to underweight the eurozone—with the exception of a few emerging markets in Eastern Europe—as the region grapples with its reopening efforts. The UK is the wild card, as the 2017 Brexit outcome appears more and more prescient with each passing month. Goldman Sachs recently issued a glowing outlook for the British economy, anticipating a "striking" 7.8% GDP growth rate for the year. One way to play the anticipated rebound is with the iShares MSCI United Kingdom ETF (EWU $34), which holds 88 large-cap positions; names such as Unilever PLC and London Stock Exchange Group PLC. For investors looking for more growth potential there is the iShares MSCI United Kingdom Small-Cap ETF (EWUS $50), which holds several hundred small- and mid-cap names.
Road & Rail
03. The latest developments in the Kansas City Southern saga
When Canadian National Railway (CNI $113) stunned the industry with its $30 billion bid for Kansas City Southern (KSU $298), we fully expected rival Canadian Pacific Railway (CP $81) to up its prior $25 billion bid. Instead, the rail—which arguably needs the American north-south tracks of KSC more than Canadian National—stuck by its original offer. It also sent a message to Kansas City Southern: take our deal or lose the regulatory battle in the US. The Kansas City-based rail responded by telling Canadian Pacific to take a hike—and eat the $700 million deal breakup fee. At the heart of the issue are overlapping routes (Canadian National Railway has more) and stricter merger standards adopted in 2001 by the Surface Transportation Board (STB). The agency, which must approve or deny the merger, now states that railway mergers must be in the public interest; the older standard simply stated that a deal must not hinder competition. Canadian Pacific's plans? Wait out the ruling, which it expects to be negative, then swoop back in with its original deal.
This is a really tough call, as we see a 50/50 chance for ultimate approval by the STB. In the meantime, KSC seems too expensive (its price has risen to within 9% of the acquisition offer price), we don't like Canadian Pacific's tactics (and it seems fairly valued), and Canadian National will probably take a share price hit if the deal is shot down. That being said, we do like Canadian National's reach, which extends throughout Canada and all the way south to the Mexican border. It agreed to sell some of its southern-most lines to acquire KSC, but that would be a moot point if the deal fails. Of the major rails, CNI at $112.57 seems like the best bet right now for investors.
Biotechnology
02. In the war against Alzheimer's, a momentous day is coming
After a 12-month span in which most well-known health care stocks notched some impressive gains, one well-respected drug manufacturer seems to have been left behind. Biogen (BIIB $267), which has a solid bench of proven performers—like Tysabri for MS and Rituxan for cancer—and a decent pipeline of new therapies, is down 12.90% over the course of the past year. Something big is about to happen, however, that will (probably) move the shares sharply one way or the other, and send a critically-important signal on where we stand in the fight against Alzheimer's. Next Monday, the 7th of June, the US Food and Drug Administration will decide whether or not to approve the use of Biogen's Alzheimer's therapy, aducanumab. It is not just Biogen which will be watching the decision closely, it is also the families of the over six million sufferers of this terrible disease. Considering it has been nearly twenty years since an Alzheimer's therapy has been approved, a positive ruling would be an enormous win against what has been a very elusive disease.
There have been some oddly positive indicators that this drug will finally win approval, such as the very unique step of the FDA preparing a briefing document alongside Biogen on aducanumab. The stakes are high: generics have been slowly eating away at the company's anchor drugs, while approval of this Alzheimer's therapy would add immensely to the company's sales outlook for years to come. Our best guess? Investors should consider buying some shares at their current price of $267 in anticipation of a huge win.
Market Week in Review
01. In a stunning turnaround, two of the three major indexes actually cobbled together a positive May
It wasn't looking very good a few weeks into the new month. In fact, the "Sell in May..." adage seemed destined to, once again, prove true. However, after hammering out a solid second half of the month, both the S&P 500 and the Dow Jones Industrial Average ended May in the green—though not by much. While the NASDAQ couldn't make that happen, it did end up paring its earlier losses, finishing down just 1.53% on the month. Inflation fears seemed to grip the stock market in the first two weeks of May, while plenty of expert witnesses helped to effectively allay those fears during the second half of the month. For crypto investors, the story was more dour. Bitcoin lost one-third of its value in May. Bring on the dog days of summer, and strap in for a wild ride.
Under the Radar Investment
Kongsberg Gruppen ASA (NSKFF $25)
Kongsberg Gruppen ASA is a $4.5 billion Norwegian mid-cap industrials firm (try and find one of those in your portfolio). The company operates primarily in the Maritime and the Aerospace & Defense industries. The company's maritime unit makes navigation, automation, and positioning products for commercial ships and offshore industries. The aerospace unit provides an array of defense- and space-related products and services. Kongsberg has perennially-positive cash flow and a sound balance sheet. The company, which was founded in 1814, is based out of the Buskerud region of Norway.
Answer
According to the food industry publication Supermarket News, in 2018 US plant-based food sales sat at an impressive $4.5 billion. A year later, that figure grew to $5 billion—an 11% YoY growth rate compared to the 2.2% growth rate in total US retail food sales. In 2020, sales in the industry surged a whopping 27%, to $7 billion. Granted, overall retail food sales rose 15% (to $760 billion) due to closed restaurants and lockdowns, but to nearly double that rate says a lot about shifting dietary habits in the country. (And no, we are not knocking the summer delight that is a sizzling T-bone on the grill; it will be some time before that experience can be replicated.) 2021's figures, when they come out next April, will be a fascinating dot to add to the chart, as the lockdowns are essentially over in this country. What do we expect? Another surprisingly-high growth rate.*
*Granted, at 0.92% of overall food sales, the plant-based industry may seem like an afterthought from a sales standpoint. However, to us it simply portrays how much room the industry has to grow. Food products used to be a relatively boring corner of the consumer staples sector; thanks to visionaries like Beyond Meat's Ethan Brown, that is no longer the case...and we love it.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The growing power of the plant-based food industry...
The plant-based food business is red-hot, and don't expect it to cool anytime soon. It is not a novelty or a niche corner of the market; it is quickly becoming a mainstream staple. For evidence of that, just look at the growing space dedicated to the products in your local supermarket. What is the size of this industry, based on revenue, and how rapidly did it grow last year over 2019?
Penn Trading Desk:
Penn: AT&T Stopped Out in Strategic Income Portfolio
AT&T CEO John Stankey, earlier this spring: "HBO Max is a pillar of the company's long-term strategy." This week: HBO Max is being spun-off so the company can focus on its "core competencies" of wireless and broadband. What a joke. We placed a stop on T @ $32, and it filled the same day, 17 May, at $31.98. A position we have held since 2010 is officially gone.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Media & Entertainment
10. AT&T and Discovery to combine media assets, creating a new entertainment behemoth (i.e., AT&T admits defeat)
While we have owned telecom services giant AT&T (T $33) for years, either in the Penn Global Leaders Club or—most recently—in the Strategic Income Portfolio (it carries a 6.5% dividend yield), we've had a strong sense as of late that the company is not quite sure of its own strategic vision. After all, T bought DirecTV in 2015 for $67 billion (with debt) only to spin it off six years later for one-fourth of that value; and it paid $85 billion to acquire Time Warner a few years after the DirecTV deal only, now, to spin that company off for $43 billion. Someone needs to explain the concept of "buy low and sell high" to the AT&T board.
With respect to the latter, AT&T and Discovery (DISCA $38) have announced plans to combine their media assets, which include the likes of HBO Max, CNN, TBS, Warner Brothers, TLC, and HGTV, into a new publicly-traded company—name to be determined. T shareholders will own 71% of the new entity, with Discovery shareholders getting the remaining 29%. Well-known media executive David Zaslav, current CEO of Discovery, will lead the new business. While Zaslav envisions the new firm becoming the dominant streaming service in the world (Netflix might disagree with that boast), here's what won't be said: this move represents a 180-degree turn for AT&T, which is now throwing in the towel on its lofty media aspirations. Going forward, the company will focus on its 5G buildout and its broadband service. The $43 billion will certainly help the firm pay for the $23 billion worth of 5G spectrum it committed to buying in its bidding war with Verizon (VZ $59). As for that 6.5% dividend yield which has kept many investors around, it will almost certainly be cut when this deal closes.
AT&T popped over 4% on news of this spinoff, jumping to over $33 per share. We know the dividend is going to get cut, and we question how much growth can be squeezed out of the wireless and broadband businesses—considering the fierce competition—over the coming years. We also feel like we got suckered into believing the company's line about creating a new media empire. We are placing a stop on our T position at $32. In short, we have lost almost all confidence in T's management team. Update: T changed direction on the day the deal was announced and went below $32, triggering our stop loss. Update: T changed direction on the day the deal was announced and went below $32, triggering our stop loss.
Restaurants
09. Dine Brands' restaurant IHOP to launch fast-casual spinoff Flip'd this summer
It was a plan put on hold due to the pandemic, but Dine Brands' (DIN $95) restaurant IHOP is finally ready to unveil its new fast-casual chain known as Flip'd. The concept is simple: lure on-the-go customers who want to grab some good food fast. Visitors will be able to order the likes of signature pancake bowls, made-to-order egg sandwiches, and a host of other pastry, drink, and food items at either a digital kiosk or the counter, generally taking their food to go. Picture a Chipotle, but breakfast-based. All of the Flip'd locations will be franchise-owned, with IHOP offering $150,000 to each of the first ten franchisees to get them up and running. A few of the very first Flip'd restaurants will be located in Manhattan; Lawrence, Kansas; and several cities in Ohio. A number of restaurants have tried to launch spin-off versions of themselves with a unique twist, but most have had limited success. We will go ahead and predict it: Flip'd will be an overwhelming success.
IHOP is owned by Dine Brands, which also owns Applebee's. Dine was under an enormous amount of financial stress during the pandemic, as could be imagined. While we picked up hotel chains, retail stores, an airline, and even a major gambling resort precisely twelve months ago during the heat of the market free-fall, we didn't pick up any restaurants. That was a mistake: Dine Brands is up 132% since then. Fair value would probably be in the $125 per share range.
Media & Entertainment
08. Amazon poised to make its second-largest acquisition ever: a storied movie studio
Formed in 1924, MGM dominated Hollywood for over a generation. While the studio has had a number of interesting owners over the past century, none have been quite like its next probable owner: Internet retailer Amazon (AMZN $3,245). Back in 2017, when reports surfaced that Amazon was about to buy food retailer Whole Foods for $13.7 billion, there were many of doubters. We believed the move was brilliant, and that opinion has been borne out in an impressively short period of time (Whole Foods now delivers food to the doorstep of Prime members with Amazon-like efficiency). The Whole Foods acquisition remains the company's largest to date; but, with its reported $8.45 billion price tag, MGM will easily hold the second position.
Amazon has been investing heavily in its streaming service, recently inking a deal with the NFL to stream Thursday night games for around $1.2 billion per year. The recent merger of AT&T's Warner Media with Discovery may well have been the catalyst for MGM and the retailer to get this deal inked. It is interesting to note that MGM's former CEO, Gary Barber, was fired by the board after he reportedly engaged in talks with Apple surrounding a possible $6 billion deal. So, with a cost 40% higher than the purported range during the Apple talks, is Amazon overpaying for this asset? Probably. But in the end, they will make the premium look like chump change.
Amazon is a long-standing member of the Penn Global Leaders Club, and we have a fair value on the shares of around $4,250. The most concerning aspect of the company's growth trajectory revolves around government intervention. The company already had a target on its back from an antitrust standpoint; this will only add fuel to the fire of those who wish to see it forcibly broken up.
Food Products
07. Swedish oat milk company Oatly comes out of the gate hot, but established food players are stepping up the pressure
It's an age old story: established players bash a new concept, consumers embrace the new products, and the established players suddenly enter the fray, claiming they were always on board. EVs are perhaps the best example of this, and we remember the Fords and GMs of the world impugning Tesla on a chronic basis...until they suddenly embraced EVs as if it were their idea in the first place. The same is true in the plant-based foods business. Oatly Group AB (OTLY $21), maker of the happy little cartons of "milk" you have probably seen in the dairy section of the grocery store, went public last week. Despite the IPO price of $17, shares shot out of the gate, jumping 37%—to $23.25—within a day. While they have cooled off a bit since, their $21 price still values the company at $12.5 billion—about 50% larger than our favorite plant-based company, Beyond Meat (BYND $123). At $21, are the new shares worth picking up? Plant-based food sales rose an impressive 27%—to $7 billion—in 2020, and the upward trajectory will continue. Silk, which is now owned by Danone (DANOY $15), will probably be the company's chief competitor going forward, but we see Oatly growing its rather faithful consumer base. While it will be a few years before the company is profitable (it lost $60 million in 2020), its revenues doubled last year from the previous year. If shares go below $20, they are worth looking at for investors needing an international play in the consumer staples sector (which you probably do).
We believe a lot of investors are not fully grasping just how big the plant-based food movement will become over the next decade. Consider this frontier investing: there will be massive gains to be had, but choose your vehicles carefully. Oatly is a pretty safe bet.
Pharmaceuticals
06. Just another example of why this company is underrated: Pfizer's Covid pill should be out by year's end
By definition, we believe in all 100 or so investments within the five Penn Wealth strategies; put another way, if we lose faith, we have no qualms jettisoning any of them. That said, at any particular point in time we have our favorites. Typically, these are companies in which we see something dynamic going on, but ones that seem to be flying under the radar of the Street. Penn Global Leaders Club member Pfizer (PFE $38) is a perfect example. We believe this company, which also happens to have a fat 4% dividend yield, is the global benchmark for the pharmaceuticals industry. As if it weren't enough that Pfizer has the most effective vaccine for Covid on the market (which it developed in record time), it now plans to have a pill for the treatment of the deadly virus on the market before the end of the year. Currently in a phase 1 clinical trial, this protease inhibitor (a protease is an enzyme which allows the virus to break down proteins so it can make copies of itself and multiply) could be taken at home by those having positive test results, effectively treating the disease and helping to keep patients out of the hospital. The first protease inhibitor was approved by the FDA a generation ago to treat HIV. As for the various strains of the disease, Pfizer believes the therapy, currently known simply as PF-07321332, should effectively tackle all of them with strong efficacy.
Pfizer has a healthy balance sheet, a strong drug pipeline, a top-tier sales force, and a simply great R&D team. Let others follow meme stocks that are infinitesimally overvalued (i.e., really worth nothing), we will stick with beautiful workhorses like Pfizer. When the next correction comes, washing the silliness away, this 172-year-old stalwart will still be standing.
Global Trade
05. Parity must be the US goal with respect to trade with China
The press keeps telling us that China is about to reach economic parity with the United States, so here's our question to the collective press: why are we importing over four times as much from China as we export to China? If the economies are of equal scale, shouldn't our trade deficit with the communist nation be relatively balanced? In reality, the United States has a $22 trillion economy compared to China's $15 trillion or so, meaning we could even accept a 50% differential in the transfer of goods; but 400%? Something doesn't smell right.
In March, the most recent month on record, we exported $11.27 billion worth of goods to China and imported $48.21 billion worth of goods from China. While those figures are both depressing and outrageous, there is some good news: the US tariffs on Chinese goods are finally forcing US companies to look elsewhere for their purchases. One of the biggest beneficiaries in this shift has been Vietnam, which is now the eighth-largest exporter to the US, moving ahead of India. Vietnam, as we have noted in the past, is no friend to China, with the ongoing South China Sea dispute just the latest bone of contention between the two. The peak in our level of imports from China was $539 billion in 2018; as of the trailing twelve months (TTM) ended 31 March, that figure has dropped to $472 billion. A 12% drop doesn't sound like much, and the pandemic certainly skewed the results to some extent, but at least the needle is moving in the right direction.
Fortunately, the Biden administration has shown little inclination toward removing the tariffs on Chinese goods, much to the consternation of the CPC. Americans must keep up the pressure on companies to persuade them to look elsewhere for the wholesale purchase of products and building of new plants. If that pressure continues, China's five-year plan to overtake the US economically will face a much larger hurdle—despite the cheerleading from much of the press.
Technology is going to be, far and away, our greatest ally in the fight to curb Chinese imports. From 3D printing to vastly increased efficiency for manufacturing firms, technology is the great disruptor with respect to the balance of trade. Investors should keep a close eye on opportunities in the small- and mid-cap industrials space, those tech-heavy firms which almost always travel under the radar. We will continue to highlight individual names for readers.
Global Strategy: Europe
04. America is roaring out of the pandemic; that is not so much the case in Europe
Over the course of the last two quarters, covering the end of 2020 and the beginning of 2021, the US economy grew at an impressive clip of 4.3% and 6.4%, respectively, thanks to a herculean vaccination effort and a subsequent loosening of Covid restrictions. Sadly, this has not been the case across the pond. The latest metric comes from France, which just re-entered a recession. The French economy shrank by 0.1% in the first quarter of 2021, following a 1.5% contraction in Q4 of 2020. But Europe's second-largest economy has some good company: Germany, the eurozone's largest economy, has seen its economy shrink for five straight quarters, with Q1 GDP coming in at -3.10%. To be sure, the pandemic and a chaotic subsequent vaccine rollout have been the catalysts for the recession that Europe can't seem to shake, but there were other factors which prepared the field for these conditions.
While US deficit spending has been a sad, running joke for a number of years, Europe's fiscal policy almost makes America's economic house look enviable. After the Great Recession, Brussels, led by the erudite wonks primarily from France and Germany, spent with reckless abandon to help the poorer nations in the southern region shake off record levels of unemployment—like 28% in Greece and 26% in Spain. Austerity measures were then forced upon these borrowers which only served to exacerbate the problem and create resentment among the citizens of these beleaguered southern nations. Going into the pandemic, unemployment levels remained stubbornly high in Portugal, Italy, Greece, and Spain. In essence, the eurozone never shook off the effects of the 2008-2009 crisis when the global pandemic hit. The ECB's only answer seems to be throwing more money at the problem until it goes away. Eventually, Europe's vaccination rate will subdue the nightmarish pandemic and growth will return to the region. But the economic scars caused by the handling of two massive crises will remain, as will the bitter divide between the northern and southern regions of the continent.
We continue to underweight the eurozone—with the exception of a few emerging markets in Eastern Europe—as the region grapples with its reopening efforts. The UK is the wild card, as the 2017 Brexit outcome appears more and more prescient with each passing month. Goldman Sachs recently issued a glowing outlook for the British economy, anticipating a "striking" 7.8% GDP growth rate for the year. One way to play the anticipated rebound is with the iShares MSCI United Kingdom ETF (EWU $34), which holds 88 large-cap positions; names such as Unilever PLC and London Stock Exchange Group PLC. For investors looking for more growth potential there is the iShares MSCI United Kingdom Small-Cap ETF (EWUS $50), which holds several hundred small- and mid-cap names.
Road & Rail
03. The latest developments in the Kansas City Southern saga
When Canadian National Railway (CNI $113) stunned the industry with its $30 billion bid for Kansas City Southern (KSU $298), we fully expected rival Canadian Pacific Railway (CP $81) to up its prior $25 billion bid. Instead, the rail—which arguably needs the American north-south tracks of KSC more than Canadian National—stuck by its original offer. It also sent a message to Kansas City Southern: take our deal or lose the regulatory battle in the US. The Kansas City-based rail responded by telling Canadian Pacific to take a hike—and eat the $700 million deal breakup fee. At the heart of the issue are overlapping routes (Canadian National Railway has more) and stricter merger standards adopted in 2001 by the Surface Transportation Board (STB). The agency, which must approve or deny the merger, now states that railway mergers must be in the public interest; the older standard simply stated that a deal must not hinder competition. Canadian Pacific's plans? Wait out the ruling, which it expects to be negative, then swoop back in with its original deal.
This is a really tough call, as we see a 50/50 chance for ultimate approval by the STB. In the meantime, KSC seems too expensive (its price has risen to within 9% of the acquisition offer price), we don't like Canadian Pacific's tactics (and it seems fairly valued), and Canadian National will probably take a share price hit if the deal is shot down. That being said, we do like Canadian National's reach, which extends throughout Canada and all the way south to the Mexican border. It agreed to sell some of its southern-most lines to acquire KSC, but that would be a moot point if the deal fails. Of the major rails, CNI at $112.57 seems like the best bet right now for investors.
Biotechnology
02. In the war against Alzheimer's, a momentous day is coming
After a 12-month span in which most well-known health care stocks notched some impressive gains, one well-respected drug manufacturer seems to have been left behind. Biogen (BIIB $267), which has a solid bench of proven performers—like Tysabri for MS and Rituxan for cancer—and a decent pipeline of new therapies, is down 12.90% over the course of the past year. Something big is about to happen, however, that will (probably) move the shares sharply one way or the other, and send a critically-important signal on where we stand in the fight against Alzheimer's. Next Monday, the 7th of June, the US Food and Drug Administration will decide whether or not to approve the use of Biogen's Alzheimer's therapy, aducanumab. It is not just Biogen which will be watching the decision closely, it is also the families of the over six million sufferers of this terrible disease. Considering it has been nearly twenty years since an Alzheimer's therapy has been approved, a positive ruling would be an enormous win against what has been a very elusive disease.
There have been some oddly positive indicators that this drug will finally win approval, such as the very unique step of the FDA preparing a briefing document alongside Biogen on aducanumab. The stakes are high: generics have been slowly eating away at the company's anchor drugs, while approval of this Alzheimer's therapy would add immensely to the company's sales outlook for years to come. Our best guess? Investors should consider buying some shares at their current price of $267 in anticipation of a huge win.
Market Week in Review
01. In a stunning turnaround, two of the three major indexes actually cobbled together a positive May
It wasn't looking very good a few weeks into the new month. In fact, the "Sell in May..." adage seemed destined to, once again, prove true. However, after hammering out a solid second half of the month, both the S&P 500 and the Dow Jones Industrial Average ended May in the green—though not by much. While the NASDAQ couldn't make that happen, it did end up paring its earlier losses, finishing down just 1.53% on the month. Inflation fears seemed to grip the stock market in the first two weeks of May, while plenty of expert witnesses helped to effectively allay those fears during the second half of the month. For crypto investors, the story was more dour. Bitcoin lost one-third of its value in May. Bring on the dog days of summer, and strap in for a wild ride.
Under the Radar Investment
Kongsberg Gruppen ASA (NSKFF $25)
Kongsberg Gruppen ASA is a $4.5 billion Norwegian mid-cap industrials firm (try and find one of those in your portfolio). The company operates primarily in the Maritime and the Aerospace & Defense industries. The company's maritime unit makes navigation, automation, and positioning products for commercial ships and offshore industries. The aerospace unit provides an array of defense- and space-related products and services. Kongsberg has perennially-positive cash flow and a sound balance sheet. The company, which was founded in 1814, is based out of the Buskerud region of Norway.
Answer
According to the food industry publication Supermarket News, in 2018 US plant-based food sales sat at an impressive $4.5 billion. A year later, that figure grew to $5 billion—an 11% YoY growth rate compared to the 2.2% growth rate in total US retail food sales. In 2020, sales in the industry surged a whopping 27%, to $7 billion. Granted, overall retail food sales rose 15% (to $760 billion) due to closed restaurants and lockdowns, but to nearly double that rate says a lot about shifting dietary habits in the country. (And no, we are not knocking the summer delight that is a sizzling T-bone on the grill; it will be some time before that experience can be replicated.) 2021's figures, when they come out next April, will be a fascinating dot to add to the chart, as the lockdowns are essentially over in this country. What do we expect? Another surprisingly-high growth rate.*
*Granted, at 0.92% of overall food sales, the plant-based industry may seem like an afterthought from a sales standpoint. However, to us it simply portrays how much room the industry has to grow. Food products used to be a relatively boring corner of the consumer staples sector; thanks to visionaries like Beyond Meat's Ethan Brown, that is no longer the case...and we love it.
Headlines for the Week of 09 May—15 May 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
No putting that genie back in its bottle...
While Bank of America issued the first card using the concept of "revolving credit" back in 1958, what was the first credit card that could boast of widespread use?
Penn Trading Desk:
Penn: Add potential inflation hedge to the Dynamic Growth Strategy
It used to be so easy to hedge against inflation, just like it was easy to reduce beta in a portfolio by increasing the percentage of bonds in a portfolio. Ah, the good old days. We don't believe the current line that "inflation is transitory," and we are continually searching for creative hedges against this condition. To that end, we have added a position to the Penn Dynamic Growth Strategy, our ETF portfolio, which invests in companies that are expected to benefit from rising prices of real assets, i.e., inflation. Looking down the list of 40 or so holdings was like looking down one of our equity wish lists. A quite creative mix. Members can see the new addition by visiting the Penn Trading Desk and signing in.
Evercore ISI: Upgrade Simon Property Group to Outperform
We've talked relatively disparagingly about retail REIT Simon Property Group (SPG $120) in the past, but Evercore ISI has become a believer. The analyst firm upgraded their rating on SPG to Outperform, lifting their target price on the shares from $121 to $128. The analyst gave relatively generic rationale for the upgrade, to include a post-pandemic return to normalcy, improved rent collections, lower tenant fallout, and potential upside surprises to net operating income by the likes of JC Penney, Brooks Brothers, and other mall anchors.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cybersecurity
10. Private equity firm Thoma Bravo makes bid for cybersecurity firm Proofpoint, sending shares soaring
Going into last week, Proofpoint (PFPT $173) was a $7.5 billion cloud-based cybersecurity firm with a suite of offerings for mid- to large-sized companies. After the following Monday's open, the company's offerings remained the same but its market cap was suddenly sitting near $11 billion thanks to an unsolicited bid by private equity firm Thoma Bravo. The deal, which would take the firm private, is worth $12.3 billion, or $176 per share, and comes with a 45-day "go-shop" provision which would allow other bids to be reviewed. Thoma Bravo, which specializes in software and cybersecurity acquisitions, just completed a $10 billion deal to buy RealPage, a provider of property management software for the commercial, single-family, and vacation rental housing industries. Barring any other offers, the Proofpoint deal should close in the third quarter.
Proofpoint is one of the top holdings in the First Trust NASDAQ Cybersecurity ETF (CIBR $45), a satellite holding within the Penn Dynamic Growth Strategy. While selecting individual cybersecurity names can be challenging for investors, we maintain that the best way to take part in this ever-growing industry is through a strong exchange traded fund, such as CIBR.
Automotive
09. Tesla's revenues surged 74% in the first quarter, leading to a record net income for the global EV leader
We remember listening to CNBC's David Faber ad nauseam: "Yes, Jim, but you do realize the company has never turned a profit, right?" We've never considered Mr. Brooks Brothers a lofty thinker, but his stale comments do make it all the more enjoyable to report that Tesla (TSLA $723) just notched its seventh-straight profitable quarter on the back of blowout numbers. For Q1 of 2021, Tesla generated $10.39 billion in revenue, with a record $438 million of that flowing down as net income. Addressing the new greatest threat to the automakers, the chip shortage, management said it has addressed the issue by moving to new microcontrollers for its vehicles and by developing the firmware required to work with the new chips made by different suppliers. Granted (we can hear Faber now), the company did make over $100 million by selling roughly 10% of its bitcoin stash at a profit, and another $500 million by the sale of tax credits, but the ever-increasing efficiency within their plants is undeniable. Tesla delivered a record 184,800 Model 3 and Model Y vehicles in Q1, and expects a 50% delivery growth rate this year over 2020. On the technical side of the business, Musk sees cameras replacing radar on its full self-driving (FSD) vehicles when they roll out, and expects to completely eliminate the old (radar-based) systems soon. In the earnings conference call, Musk also reiterated his aggressive plans to put more Tesla solar roofs on homes across America, supported by the company's home energy storage system known as Powerwall. The goal is to create a "giant distributed utility" which will ultimately make one's house energy self-sufficient.
There are always going to be naysaying journalists and analysts chronically pointing out why Tesla will ultimately fail. Their latest narrative is that increased competition within the EV and autonomous-driving space, along with the end of tax subsidies, will doom the company. Tesla is doing everything right to remain in the pole position going forward, however, and we consider its nationwide Supercharger network to be an enormous advantage over the competition. It should be noted that Tesla offered this technology to other automakers several years ago, but the offer was flatly declined.
Investment Vehicles: ETFs
08. Talk of raising the capital gains tax rate points to yet another reason we prefer ETFs over mutual funds
There are a number of reasons we migrated away from mutual funds in favor of exchange traded funds (ETFs) some years back, but the current tax rate discussion emanating from D.C. points to one specific benefit of the latter: their tax efficiency. As a young broker, one perennial pain came from the collection of mutual fund capital gains distribution figures for clients. Even if a client held a mutual fund throughout the entire year, they still had to pay taxes on the capital gains generated by the internal trades of the portfolio managers (PMs)—assuming the funds weren't held in an IRA, of course. For example, in the late 1990s the largest position held in client accounts was the venerable Growth Fund of America (AGTHX). The estimated capital gains distribution at year-end 2020 for AGTHX is 9-11%. Counter that with the 2020 capital gains distribution on the largest equity ETF, the SPDR S&P 500 ETF Trust (SPY): 0.00%. By law, open-end mutual funds must pass along capital gains to shareholders each year; there is no such requirement for ETFs. While the Biden administration is discussing a 39.6% capital gains tax rate on only the wealthiest of shareholders, does anyone really believe that the current rates for the rest of us will stay where they are now (0% to 20%, depending on the shareholder's tax bracket)? Yet another reason to favor ETFs in the taxable portion of your investment portfolio.
In the Penn Dynamic Growth Strategy, our ETF portfolio, we own a number of core funds designed to be held for the long haul, and satellite positions, designed to take advantage of current market and economic conditions. This is an excellent strategy for taxable accounts due to its relative tax efficiency. There are currently 23 funds (yes, one is an open-end fund we consider to be a stellar performer) in the Strategy.
Technology Hardware, Storage, & Peripherals
07. Apple vows to invest $430 billion and hire 20,000 new workers in the US over the next five years
Claiming that the company blew past its 2018 promise to invest $350 billion in the US, Apple's (AAPL $135) Tim Cook just announced bold new plans that would have the Cupertino-based firm adding another 20,000 US workers to the rolls (a 21% increase) and investing $430 billion in projects around the country. One of those projects will be a brand new campus and engineering hub in North Carolina which will create at least 3,000 AI, machine learning, software engineering, and other technical positions. Recall that the company just spent $1 billion on a new campus in Austin, Texas, which will be move-in ready next year. The new expenditures will focus on American suppliers, data center growth and enhancements, and Apple TV productions. Cook also added some very interesting comments following the investment announcements: he said that Apple was the largest taxpayer in the US, having paid over $45 billion in corporate income taxes over the past five years. That was a not-so-subtle message to D.C. that the big growth engines of the country—the large companies which each employ tens of thousands of American workers—are paying their fair share. We would like to add to the inference: the small- and medium-sized American companies which employ 65% of the US workforce are also paying their fair share.
Apple remains one of our strongest conviction stocks within the Penn Global Leaders Club. When a short seller or analyst comes along and attempts to besmirch the bright future of this company, investors should be prepared to pounce on any negative reaction within the share price.
Metals & Mining
06. Outcome of Peruvian national election highlights the country risk associated with precious metals and mining stocks
Trying to root out socialism from Latin America is a monumental challenge at best, an exercise in futility at worst. For evidence of this, just look to Venezuela. Despite the nightmarish economic situation for Venezuelans (like five hours in line for a few rolls of toilet paper), Hugo Chavez wannabe Nicolas Maduro remains in power, despite having the personality of a single-ply square of...Venezuelan toilet paper. Heading further down the South American continent we have the Republic of Peru: a relative bastion of free trade in the region—at least up until this point. The rather shocking results of the national elections held earlier this month set up socialist candidate Pedro Castillo to coast into the presidency following a June runoff (he holds a 20-point lead over his opponent, the market-friendly Keiko Fujimori). Which leads us to mining companies in general, and Southern Copper (SCCO $72) specifically.
Thanks to the global rebound, the outlook for metals—especially those with heavy industrial usage such as copper—is bright. Peru is the world's second-largest source of copper, and a majority of Southern Copper's mining operations reside within that country. While Castillo is trying to temper the harshness of his message leading into the runoff, his talk of nationalizing private companies operating inside the country has spooked investors. His party's platform, in fact, talks of "taking control" of the nation's natural resources. For $57 billion Souther Copper, which recently announced $8 billion in new Peruvian projects, there should be cause for concern. In fact, considering the remainder of their operations are in Mexico, which has been methodically moving left, there should be cause for extreme concern.
We remain very bullish on both precious metals/minerals as well as those used for industrial purposes. In fact, if the new Peruvian government were to nationalize the miners (not beyond the realms of possibility), copper prices would shoot even higher than they already are. Great for commodity investors; not so much for those who took a chance on individual miners like Southern Copper. While we do own two gold miners in the Penn Global Leaders Club, it is a safer bet to own sector or thematic ETFs to take advantage of anticipated growth. A few worth looking at are the US Global GO Gold and Precious Metal Miners ETF (GOAU $20), and the SPDR Gold Shares ETF (GLD $165). We own the latter in the Penn Dynamic Growth Strategy as a satellite position, and the current price of gold $1,777) makes it an attractive opportunity right now—in our opinion.
There are some excellent mining stocks in which to invest, and they are often in the small- to mid-cap sweet spot. However, investors need to perform their due diligence and understand exactly where the respective company's mines are located, and what the geopolitical risks are within that country or region.
Household & Personal Products
05. Jessica Alba's Honest Company is open for trading, but can it compete with the likes of Procter & Gamble and Kimberly-Clark?
Hollywood star Jessica Alba was plagued by asthma and allergies as a child to the point of being hospitalized on several occasions due to her maladies. Those experiences helped shape her thoughts on personal health, ultimately leading to her decision to launch The Honest Company (HNST $15) a decade ago. The Honest Company is a consumer products firm which offers a growing line of eco-friendly baby supplies (primarily diapers), bath and skincare products, and home cleaning solutions. There are over 2,500 chemicals and materials the company excludes from its products due to their potentially harmful effects on either the body or the environment.
How has Alba's concept resonated with consumers? Overall, pretty well. The company's products are now available at 32,000 various retailers throughout the US and Canada, including big players like Target (TGT) and Walgreens Boots Alliance (WBA). While still operating in the red, the company's revenues rose from $235M in 2019 to $300M in 2020 (+28%) and losses were stanched from -$31M to -$14M (a 55% improvement) over the same time frame. Leading into Wednesday's IPO, HNST shares were priced in the $14 to $17 range. They shot out of the gate at $23 per share and have fallen precipitously ever since. The company's valuation now sits at $1.4 billion, but is it worth even that much?
There is a mountain of competition in this space—both the personal care products industry in general and the eco-friendly corner specifically. Having Jessica Alba's sway certainly helps, but facing down the market caps of Procter ($330B), Unilever PLC ($155B), Kimberly-Clark ($46B), and an army of "green" players will be a herculean task. Furthermore, the aforementioned stocks all come with nice dividend yields, while HNST will need to plow its capital back into its strategic growth efforts.
Nonetheless, we do see a faithful and growing customer base. Honest estimates it currently holds about 5% market share in its space, and 55% of revenues are generated online. We believe it could easily double its market share in the short term, generating in excess of $500 million in revenues by 2023; maybe even becoming profitable by that point. The company is worth keeping an eye on, and the products are also worth a look.
HNST shares have now lost about one-third of their value since IPO day. If they drop to the $10/share range, we believe they will be undervalued and worth looking at for a potential purchase.
Global Strategy: East & Southeast Asia
04. Why do we care what Covid vaccine Philippine President Rodrigo Duterte chose to receive?
Roughly 20,000 American soldiers died defending the Philippines during World War II; about half were lost in battle while the other half succumbed to disease. The United States has enjoyed—actually, earned—an incredibly good relationship with the Southeast Asian country ever since General Douglas MacArthur uttered the infamous words in 1942: "I came through...and I shall return." To say that the Philippines sits in an important region of the world is an understatement. About one-fifth of global trade passes through the South China Sea, and trillions of dollars’ worth of oil and gas resources reside beneath its waves. The US military regularly patrols the region, with the Theodore Roosevelt and Nimitz Carrier Strike Groups conducting joint exercises in the waters this past February.
China has continued to make outrageous claims on enormous swaths of the South China Sea—as shown by the red dashed line on the accompanying map—much to the consternation of its neighbors in the region. Now, the communist nation seems to be strongly wooing the mercurial and dictatorial leader of the Philippines, Rodrigo Duterte. The latest sign of the love affair came with Duterte’s decision to receive the underwhelming Chinese Covid vaccine known as Sinovac. Recent results from Brazil show a 50% effectiveness rate for the Chinese product. The Philippines’ Covid rate is the second highest in Southeast Asia, behind only Indonesia.
While the choice of a vaccine is certainly anecdotal (though he did also praise Russia’s near-comical vaccine, Sputnik V), there is little doubt that Duterte is an iron-fisted leader who is on the outs with the United States right now, and that China would love to count on him as an ally in the region. The South China Sea seems to be quickly replacing the Persian Gulf as the most troublesome hot spot in the world.
Outside of the Philippines, all other nations in the region have serious disagreements with China. That nation’s ham-handed approach to diplomacy will not serve them well over the coming years, but more countries need to follow Australia’s lead and refuse to be bullied by the ruling Communist Party of China. America, through its military presence in the region, must make it clear that a massive land grab by fiat is unacceptable.
Demographics & Lifestyle
03. A most excellent problem: credit card issuers concerned as Americans continue to pay down their debt
We've often wondered what the overall economic health of the typical American household would look like if revolving debt did not exist. After all, it wasn't until Bank of America (BAC $42) issued the first credit card with a "revolving credit" feature in 1958 that Americans began racking up debt not backed by any tangible property, such as a home or an auto. Before then, money borrowed on a card had to be paid off at the end of each month. And despite the near-zero Fed funds rate, many cardholders are still being charged confiscatory interest rates of 16.99% to 19.99% on their balances, or even higher.
Now for the good news. Much to the chagrin of the card-issuing banks, which toughen their standards when people need the money the most and loosen them when they don't, borrowers are paying down their debt at impressive levels. During the company's most recent earnings call, card issuer Discover Financial Services (DFS $115) said that balances paid off recently have hit levels not seen since 2000. All of the top card issuers, in fact, have reported significant declines in the aggregate balance of revolving debt owed. While Americans put nearly $4 trillion on their cards in 2020, the total US credit card debt outstanding now sits at $819 billion--a significant decrease from pre-pandemic levels. It's hard to say whether this will turn into a healthy, long-term trend, but more and more people are becoming cognizant of just how much they owe, and what they have been paying for the "privilege" of buying on credit.
Once Americans get their own fiscal house in order, perhaps they will look at the $28.3 trillion of outstanding debt their government has racked up and demand accountability. The current rationale for spending trillions more than what is brought in via taxation is the pandemic. But what's the excuse for the reckless and wanton spending before the crippling disaster hit?
Cybersecurity
02. Despite the company's original denials, Colonial Pipeline reportedly paid hackers $5 million in ransom
A few months ago, we reported about a hack on a municipal water treatment plant in Florida. The hacker was attempting to adjust the chlorine level in the city’s water supply to toxic levels. That attack was thwarted by an attentive city worker who noticed a mouse cursor mysteriously moving on his computer screen. This past week brought us news of a successful hack on the Colonial Pipeline, the largest pipeline for refined oil products in the US. The 5,500-mile-long system, which carries 3 million barrels of fuel per day between Texas and New York, was shut down for days, causing massive gas lines along the East Coast.
While the company initially denied paying ransom to the hackers, it now appears that $5 million was, indeed, paid to a group known as DarkSide shortly after the attack occurred. DarkSide is a highly sophisticated criminal organization based out of Eastern Europe, with definite Russian connections. The cybercriminals use ransomware to lock a victim’s system, promising to provide the digital “keys” to unlock the system once the monetary demands are met. Experts are surprised that the amount demanded in this case was so low; normally, with a company of this size and services with such a broad scope, a $30 million demand would not be out of the ordinary.
Ransomware attacks on firms of all sizes more than tripled in 2020, with victims ponying up over $350 million in crypto ransoms. As is typical following such an attack, the US government said it would be setting up a task force to counter these threats. Sadly, these promises always seem to come along after the damage is done. This is yet another sobering reminder of just how vulnerable American companies and individuals are to cybercriminals, and how disruptive a simple digital act of aggression can become, literally overnight. While it is up to the government to go after the bad actors and nation-states involved in these crimes, it is up to each American to take all possible measures to assure their own system’s security profile is as robust as possible.
On the personal defense front, we have found Bitdefender to be one of the best cybersecurity suites on the market, for both PCs and MacBooks. Kaspersky ranks highly on most lists, but it is headquartered in Russia, which makes us immediately suspicious. From an investment standpoint, we believe the First Trust NASDAQ Cybersecurity ETF (CIBR $43) is an effective way to invest in the growing need for digital protection. We own CIBR as a satellite position within the Penn Dynamic Growth Strategy.
Market Week in Review
01. Inflation fears brought an ugly first half to the week for the markets, followed by an impressive comeback effort
The extent to which investors have been indifferent about inflation concerns is rather remarkable, considering the grand economic reopening which is in its nascent stage and the mounting evidence that the concern is real—as evidenced by the price of everything from used cars to commodities. Perhaps they were taking solace in Jerome Powell's nonchalant attitude, with the Fed Chair almost daring inflation to try and stir trouble. That changed this past Wednesday when, following two previous down days, the major indexes threw a major fit over the latest Consumer Price Index (CPI) report. The CPI, which measures the rate of change in the price of a basket of consumer goods, spiked 4.2% YoY, above the lofty expectations for a 3.6% reading. That jump represents the sharpest spike since September of 2008. By Wednesday's close, the major indexes were off between 2% and 2.67%, with the NASDAQ getting hit the hardest. Fears that the Fed would have to act sooner rather than later to rein in inflation seemed to abate after the mid-week bloodbath, with the Dow gaining nearly 1,000 points during the last two sessions, and the S&P gaining 110 points. Stocks typically face a higher level of volatility in May, as investors seem intent on proving the "Sell in May..." adage. What is the right course of action after such a volatile week? Take a good look at your portfolio's allocation to assure the fast-growing tech positions didn't knock it out of whack; also, position more toward the value side of the equation. On that note, take a look at our latest addition to the Dynamic Growth Strategy by visiting the Penn Trading Desk.
Under the Radar Investment
Masimo Corp (MASI $220)
Masimo is a US-based medical device company which focuses on noninvasive patient monitoring. For individuals, the firm offers state-of-the-art pulse oximeters for measuring oxygen saturation levels and pulse rates, wearable "smart" thermometers which allow parents to keep a constant eye on a sick child's temperature level, and sleep improvement devices. For medical facilities, Masimo offers a comprehensive patient monitoring and connectivity platform. Sadly, due to the global pandemic millions of people are now familiar with the company's products. Demand and name recognition helped drive MASI shares up to $285 this past January, but they have since pulled back into a nice buying range. While we don't currently own the company within the Penn strategies, we believe a fair value for the shares is around $300.
Answer
The Diners Club Card was created in 1950 after businessman Frank McNamara forgot his wallet while attending a business dinner in New York. By 1951, there were 20,000 Diners Club members. For its part, American Express introduced the first plastic credit card in 1959, with over one million in use by the mid 1960s.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
No putting that genie back in its bottle...
While Bank of America issued the first card using the concept of "revolving credit" back in 1958, what was the first credit card that could boast of widespread use?
Penn Trading Desk:
Penn: Add potential inflation hedge to the Dynamic Growth Strategy
It used to be so easy to hedge against inflation, just like it was easy to reduce beta in a portfolio by increasing the percentage of bonds in a portfolio. Ah, the good old days. We don't believe the current line that "inflation is transitory," and we are continually searching for creative hedges against this condition. To that end, we have added a position to the Penn Dynamic Growth Strategy, our ETF portfolio, which invests in companies that are expected to benefit from rising prices of real assets, i.e., inflation. Looking down the list of 40 or so holdings was like looking down one of our equity wish lists. A quite creative mix. Members can see the new addition by visiting the Penn Trading Desk and signing in.
Evercore ISI: Upgrade Simon Property Group to Outperform
We've talked relatively disparagingly about retail REIT Simon Property Group (SPG $120) in the past, but Evercore ISI has become a believer. The analyst firm upgraded their rating on SPG to Outperform, lifting their target price on the shares from $121 to $128. The analyst gave relatively generic rationale for the upgrade, to include a post-pandemic return to normalcy, improved rent collections, lower tenant fallout, and potential upside surprises to net operating income by the likes of JC Penney, Brooks Brothers, and other mall anchors.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cybersecurity
10. Private equity firm Thoma Bravo makes bid for cybersecurity firm Proofpoint, sending shares soaring
Going into last week, Proofpoint (PFPT $173) was a $7.5 billion cloud-based cybersecurity firm with a suite of offerings for mid- to large-sized companies. After the following Monday's open, the company's offerings remained the same but its market cap was suddenly sitting near $11 billion thanks to an unsolicited bid by private equity firm Thoma Bravo. The deal, which would take the firm private, is worth $12.3 billion, or $176 per share, and comes with a 45-day "go-shop" provision which would allow other bids to be reviewed. Thoma Bravo, which specializes in software and cybersecurity acquisitions, just completed a $10 billion deal to buy RealPage, a provider of property management software for the commercial, single-family, and vacation rental housing industries. Barring any other offers, the Proofpoint deal should close in the third quarter.
Proofpoint is one of the top holdings in the First Trust NASDAQ Cybersecurity ETF (CIBR $45), a satellite holding within the Penn Dynamic Growth Strategy. While selecting individual cybersecurity names can be challenging for investors, we maintain that the best way to take part in this ever-growing industry is through a strong exchange traded fund, such as CIBR.
Automotive
09. Tesla's revenues surged 74% in the first quarter, leading to a record net income for the global EV leader
We remember listening to CNBC's David Faber ad nauseam: "Yes, Jim, but you do realize the company has never turned a profit, right?" We've never considered Mr. Brooks Brothers a lofty thinker, but his stale comments do make it all the more enjoyable to report that Tesla (TSLA $723) just notched its seventh-straight profitable quarter on the back of blowout numbers. For Q1 of 2021, Tesla generated $10.39 billion in revenue, with a record $438 million of that flowing down as net income. Addressing the new greatest threat to the automakers, the chip shortage, management said it has addressed the issue by moving to new microcontrollers for its vehicles and by developing the firmware required to work with the new chips made by different suppliers. Granted (we can hear Faber now), the company did make over $100 million by selling roughly 10% of its bitcoin stash at a profit, and another $500 million by the sale of tax credits, but the ever-increasing efficiency within their plants is undeniable. Tesla delivered a record 184,800 Model 3 and Model Y vehicles in Q1, and expects a 50% delivery growth rate this year over 2020. On the technical side of the business, Musk sees cameras replacing radar on its full self-driving (FSD) vehicles when they roll out, and expects to completely eliminate the old (radar-based) systems soon. In the earnings conference call, Musk also reiterated his aggressive plans to put more Tesla solar roofs on homes across America, supported by the company's home energy storage system known as Powerwall. The goal is to create a "giant distributed utility" which will ultimately make one's house energy self-sufficient.
There are always going to be naysaying journalists and analysts chronically pointing out why Tesla will ultimately fail. Their latest narrative is that increased competition within the EV and autonomous-driving space, along with the end of tax subsidies, will doom the company. Tesla is doing everything right to remain in the pole position going forward, however, and we consider its nationwide Supercharger network to be an enormous advantage over the competition. It should be noted that Tesla offered this technology to other automakers several years ago, but the offer was flatly declined.
Investment Vehicles: ETFs
08. Talk of raising the capital gains tax rate points to yet another reason we prefer ETFs over mutual funds
There are a number of reasons we migrated away from mutual funds in favor of exchange traded funds (ETFs) some years back, but the current tax rate discussion emanating from D.C. points to one specific benefit of the latter: their tax efficiency. As a young broker, one perennial pain came from the collection of mutual fund capital gains distribution figures for clients. Even if a client held a mutual fund throughout the entire year, they still had to pay taxes on the capital gains generated by the internal trades of the portfolio managers (PMs)—assuming the funds weren't held in an IRA, of course. For example, in the late 1990s the largest position held in client accounts was the venerable Growth Fund of America (AGTHX). The estimated capital gains distribution at year-end 2020 for AGTHX is 9-11%. Counter that with the 2020 capital gains distribution on the largest equity ETF, the SPDR S&P 500 ETF Trust (SPY): 0.00%. By law, open-end mutual funds must pass along capital gains to shareholders each year; there is no such requirement for ETFs. While the Biden administration is discussing a 39.6% capital gains tax rate on only the wealthiest of shareholders, does anyone really believe that the current rates for the rest of us will stay where they are now (0% to 20%, depending on the shareholder's tax bracket)? Yet another reason to favor ETFs in the taxable portion of your investment portfolio.
In the Penn Dynamic Growth Strategy, our ETF portfolio, we own a number of core funds designed to be held for the long haul, and satellite positions, designed to take advantage of current market and economic conditions. This is an excellent strategy for taxable accounts due to its relative tax efficiency. There are currently 23 funds (yes, one is an open-end fund we consider to be a stellar performer) in the Strategy.
Technology Hardware, Storage, & Peripherals
07. Apple vows to invest $430 billion and hire 20,000 new workers in the US over the next five years
Claiming that the company blew past its 2018 promise to invest $350 billion in the US, Apple's (AAPL $135) Tim Cook just announced bold new plans that would have the Cupertino-based firm adding another 20,000 US workers to the rolls (a 21% increase) and investing $430 billion in projects around the country. One of those projects will be a brand new campus and engineering hub in North Carolina which will create at least 3,000 AI, machine learning, software engineering, and other technical positions. Recall that the company just spent $1 billion on a new campus in Austin, Texas, which will be move-in ready next year. The new expenditures will focus on American suppliers, data center growth and enhancements, and Apple TV productions. Cook also added some very interesting comments following the investment announcements: he said that Apple was the largest taxpayer in the US, having paid over $45 billion in corporate income taxes over the past five years. That was a not-so-subtle message to D.C. that the big growth engines of the country—the large companies which each employ tens of thousands of American workers—are paying their fair share. We would like to add to the inference: the small- and medium-sized American companies which employ 65% of the US workforce are also paying their fair share.
Apple remains one of our strongest conviction stocks within the Penn Global Leaders Club. When a short seller or analyst comes along and attempts to besmirch the bright future of this company, investors should be prepared to pounce on any negative reaction within the share price.
Metals & Mining
06. Outcome of Peruvian national election highlights the country risk associated with precious metals and mining stocks
Trying to root out socialism from Latin America is a monumental challenge at best, an exercise in futility at worst. For evidence of this, just look to Venezuela. Despite the nightmarish economic situation for Venezuelans (like five hours in line for a few rolls of toilet paper), Hugo Chavez wannabe Nicolas Maduro remains in power, despite having the personality of a single-ply square of...Venezuelan toilet paper. Heading further down the South American continent we have the Republic of Peru: a relative bastion of free trade in the region—at least up until this point. The rather shocking results of the national elections held earlier this month set up socialist candidate Pedro Castillo to coast into the presidency following a June runoff (he holds a 20-point lead over his opponent, the market-friendly Keiko Fujimori). Which leads us to mining companies in general, and Southern Copper (SCCO $72) specifically.
Thanks to the global rebound, the outlook for metals—especially those with heavy industrial usage such as copper—is bright. Peru is the world's second-largest source of copper, and a majority of Southern Copper's mining operations reside within that country. While Castillo is trying to temper the harshness of his message leading into the runoff, his talk of nationalizing private companies operating inside the country has spooked investors. His party's platform, in fact, talks of "taking control" of the nation's natural resources. For $57 billion Souther Copper, which recently announced $8 billion in new Peruvian projects, there should be cause for concern. In fact, considering the remainder of their operations are in Mexico, which has been methodically moving left, there should be cause for extreme concern.
We remain very bullish on both precious metals/minerals as well as those used for industrial purposes. In fact, if the new Peruvian government were to nationalize the miners (not beyond the realms of possibility), copper prices would shoot even higher than they already are. Great for commodity investors; not so much for those who took a chance on individual miners like Southern Copper. While we do own two gold miners in the Penn Global Leaders Club, it is a safer bet to own sector or thematic ETFs to take advantage of anticipated growth. A few worth looking at are the US Global GO Gold and Precious Metal Miners ETF (GOAU $20), and the SPDR Gold Shares ETF (GLD $165). We own the latter in the Penn Dynamic Growth Strategy as a satellite position, and the current price of gold $1,777) makes it an attractive opportunity right now—in our opinion.
There are some excellent mining stocks in which to invest, and they are often in the small- to mid-cap sweet spot. However, investors need to perform their due diligence and understand exactly where the respective company's mines are located, and what the geopolitical risks are within that country or region.
Household & Personal Products
05. Jessica Alba's Honest Company is open for trading, but can it compete with the likes of Procter & Gamble and Kimberly-Clark?
Hollywood star Jessica Alba was plagued by asthma and allergies as a child to the point of being hospitalized on several occasions due to her maladies. Those experiences helped shape her thoughts on personal health, ultimately leading to her decision to launch The Honest Company (HNST $15) a decade ago. The Honest Company is a consumer products firm which offers a growing line of eco-friendly baby supplies (primarily diapers), bath and skincare products, and home cleaning solutions. There are over 2,500 chemicals and materials the company excludes from its products due to their potentially harmful effects on either the body or the environment.
How has Alba's concept resonated with consumers? Overall, pretty well. The company's products are now available at 32,000 various retailers throughout the US and Canada, including big players like Target (TGT) and Walgreens Boots Alliance (WBA). While still operating in the red, the company's revenues rose from $235M in 2019 to $300M in 2020 (+28%) and losses were stanched from -$31M to -$14M (a 55% improvement) over the same time frame. Leading into Wednesday's IPO, HNST shares were priced in the $14 to $17 range. They shot out of the gate at $23 per share and have fallen precipitously ever since. The company's valuation now sits at $1.4 billion, but is it worth even that much?
There is a mountain of competition in this space—both the personal care products industry in general and the eco-friendly corner specifically. Having Jessica Alba's sway certainly helps, but facing down the market caps of Procter ($330B), Unilever PLC ($155B), Kimberly-Clark ($46B), and an army of "green" players will be a herculean task. Furthermore, the aforementioned stocks all come with nice dividend yields, while HNST will need to plow its capital back into its strategic growth efforts.
Nonetheless, we do see a faithful and growing customer base. Honest estimates it currently holds about 5% market share in its space, and 55% of revenues are generated online. We believe it could easily double its market share in the short term, generating in excess of $500 million in revenues by 2023; maybe even becoming profitable by that point. The company is worth keeping an eye on, and the products are also worth a look.
HNST shares have now lost about one-third of their value since IPO day. If they drop to the $10/share range, we believe they will be undervalued and worth looking at for a potential purchase.
Global Strategy: East & Southeast Asia
04. Why do we care what Covid vaccine Philippine President Rodrigo Duterte chose to receive?
Roughly 20,000 American soldiers died defending the Philippines during World War II; about half were lost in battle while the other half succumbed to disease. The United States has enjoyed—actually, earned—an incredibly good relationship with the Southeast Asian country ever since General Douglas MacArthur uttered the infamous words in 1942: "I came through...and I shall return." To say that the Philippines sits in an important region of the world is an understatement. About one-fifth of global trade passes through the South China Sea, and trillions of dollars’ worth of oil and gas resources reside beneath its waves. The US military regularly patrols the region, with the Theodore Roosevelt and Nimitz Carrier Strike Groups conducting joint exercises in the waters this past February.
China has continued to make outrageous claims on enormous swaths of the South China Sea—as shown by the red dashed line on the accompanying map—much to the consternation of its neighbors in the region. Now, the communist nation seems to be strongly wooing the mercurial and dictatorial leader of the Philippines, Rodrigo Duterte. The latest sign of the love affair came with Duterte’s decision to receive the underwhelming Chinese Covid vaccine known as Sinovac. Recent results from Brazil show a 50% effectiveness rate for the Chinese product. The Philippines’ Covid rate is the second highest in Southeast Asia, behind only Indonesia.
While the choice of a vaccine is certainly anecdotal (though he did also praise Russia’s near-comical vaccine, Sputnik V), there is little doubt that Duterte is an iron-fisted leader who is on the outs with the United States right now, and that China would love to count on him as an ally in the region. The South China Sea seems to be quickly replacing the Persian Gulf as the most troublesome hot spot in the world.
Outside of the Philippines, all other nations in the region have serious disagreements with China. That nation’s ham-handed approach to diplomacy will not serve them well over the coming years, but more countries need to follow Australia’s lead and refuse to be bullied by the ruling Communist Party of China. America, through its military presence in the region, must make it clear that a massive land grab by fiat is unacceptable.
Demographics & Lifestyle
03. A most excellent problem: credit card issuers concerned as Americans continue to pay down their debt
We've often wondered what the overall economic health of the typical American household would look like if revolving debt did not exist. After all, it wasn't until Bank of America (BAC $42) issued the first credit card with a "revolving credit" feature in 1958 that Americans began racking up debt not backed by any tangible property, such as a home or an auto. Before then, money borrowed on a card had to be paid off at the end of each month. And despite the near-zero Fed funds rate, many cardholders are still being charged confiscatory interest rates of 16.99% to 19.99% on their balances, or even higher.
Now for the good news. Much to the chagrin of the card-issuing banks, which toughen their standards when people need the money the most and loosen them when they don't, borrowers are paying down their debt at impressive levels. During the company's most recent earnings call, card issuer Discover Financial Services (DFS $115) said that balances paid off recently have hit levels not seen since 2000. All of the top card issuers, in fact, have reported significant declines in the aggregate balance of revolving debt owed. While Americans put nearly $4 trillion on their cards in 2020, the total US credit card debt outstanding now sits at $819 billion--a significant decrease from pre-pandemic levels. It's hard to say whether this will turn into a healthy, long-term trend, but more and more people are becoming cognizant of just how much they owe, and what they have been paying for the "privilege" of buying on credit.
Once Americans get their own fiscal house in order, perhaps they will look at the $28.3 trillion of outstanding debt their government has racked up and demand accountability. The current rationale for spending trillions more than what is brought in via taxation is the pandemic. But what's the excuse for the reckless and wanton spending before the crippling disaster hit?
Cybersecurity
02. Despite the company's original denials, Colonial Pipeline reportedly paid hackers $5 million in ransom
A few months ago, we reported about a hack on a municipal water treatment plant in Florida. The hacker was attempting to adjust the chlorine level in the city’s water supply to toxic levels. That attack was thwarted by an attentive city worker who noticed a mouse cursor mysteriously moving on his computer screen. This past week brought us news of a successful hack on the Colonial Pipeline, the largest pipeline for refined oil products in the US. The 5,500-mile-long system, which carries 3 million barrels of fuel per day between Texas and New York, was shut down for days, causing massive gas lines along the East Coast.
While the company initially denied paying ransom to the hackers, it now appears that $5 million was, indeed, paid to a group known as DarkSide shortly after the attack occurred. DarkSide is a highly sophisticated criminal organization based out of Eastern Europe, with definite Russian connections. The cybercriminals use ransomware to lock a victim’s system, promising to provide the digital “keys” to unlock the system once the monetary demands are met. Experts are surprised that the amount demanded in this case was so low; normally, with a company of this size and services with such a broad scope, a $30 million demand would not be out of the ordinary.
Ransomware attacks on firms of all sizes more than tripled in 2020, with victims ponying up over $350 million in crypto ransoms. As is typical following such an attack, the US government said it would be setting up a task force to counter these threats. Sadly, these promises always seem to come along after the damage is done. This is yet another sobering reminder of just how vulnerable American companies and individuals are to cybercriminals, and how disruptive a simple digital act of aggression can become, literally overnight. While it is up to the government to go after the bad actors and nation-states involved in these crimes, it is up to each American to take all possible measures to assure their own system’s security profile is as robust as possible.
On the personal defense front, we have found Bitdefender to be one of the best cybersecurity suites on the market, for both PCs and MacBooks. Kaspersky ranks highly on most lists, but it is headquartered in Russia, which makes us immediately suspicious. From an investment standpoint, we believe the First Trust NASDAQ Cybersecurity ETF (CIBR $43) is an effective way to invest in the growing need for digital protection. We own CIBR as a satellite position within the Penn Dynamic Growth Strategy.
Market Week in Review
01. Inflation fears brought an ugly first half to the week for the markets, followed by an impressive comeback effort
The extent to which investors have been indifferent about inflation concerns is rather remarkable, considering the grand economic reopening which is in its nascent stage and the mounting evidence that the concern is real—as evidenced by the price of everything from used cars to commodities. Perhaps they were taking solace in Jerome Powell's nonchalant attitude, with the Fed Chair almost daring inflation to try and stir trouble. That changed this past Wednesday when, following two previous down days, the major indexes threw a major fit over the latest Consumer Price Index (CPI) report. The CPI, which measures the rate of change in the price of a basket of consumer goods, spiked 4.2% YoY, above the lofty expectations for a 3.6% reading. That jump represents the sharpest spike since September of 2008. By Wednesday's close, the major indexes were off between 2% and 2.67%, with the NASDAQ getting hit the hardest. Fears that the Fed would have to act sooner rather than later to rein in inflation seemed to abate after the mid-week bloodbath, with the Dow gaining nearly 1,000 points during the last two sessions, and the S&P gaining 110 points. Stocks typically face a higher level of volatility in May, as investors seem intent on proving the "Sell in May..." adage. What is the right course of action after such a volatile week? Take a good look at your portfolio's allocation to assure the fast-growing tech positions didn't knock it out of whack; also, position more toward the value side of the equation. On that note, take a look at our latest addition to the Dynamic Growth Strategy by visiting the Penn Trading Desk.
Under the Radar Investment
Masimo Corp (MASI $220)
Masimo is a US-based medical device company which focuses on noninvasive patient monitoring. For individuals, the firm offers state-of-the-art pulse oximeters for measuring oxygen saturation levels and pulse rates, wearable "smart" thermometers which allow parents to keep a constant eye on a sick child's temperature level, and sleep improvement devices. For medical facilities, Masimo offers a comprehensive patient monitoring and connectivity platform. Sadly, due to the global pandemic millions of people are now familiar with the company's products. Demand and name recognition helped drive MASI shares up to $285 this past January, but they have since pulled back into a nice buying range. While we don't currently own the company within the Penn strategies, we believe a fair value for the shares is around $300.
Answer
The Diners Club Card was created in 1950 after businessman Frank McNamara forgot his wallet while attending a business dinner in New York. By 1951, there were 20,000 Diners Club members. For its part, American Express introduced the first plastic credit card in 1959, with over one million in use by the mid 1960s.
Headlines for the Week of 18 Apr—24 Apr 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
American leadership in human spaceflight is back. Thank you Elon...
America willingly—and disgustingly—gave up its ability to launch astronauts into orbit back in 2011. After a decade of no manned launches from American soil, how many astronauts have been launched into space since last June aboard SpaceX rockets?
Penn Trading Desk:
Bank of America/Citi: Upgrade First Solar
One of our favorite renewable energy companies, First Solar (FSLR $84), popped over 5% following an upgrade at both Bank of America and Citi. The BofA analyst cited a green infrastructure plan coming from Washington and accelerated near-term bookings momentum as catalysts for the upgrade. Citi, which upgraded FSLR shares from Hold to Buy, cited tailwinds from US tax and trade policies. We place the fair value of FSLR shares at $100.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cryptocurrencies
10. As expected, Coinbase shot out of the gate in its debut trading day; then something interesting happened
Despite an initial pricing range of around $250 per share, cryptocurrency exchange Coinbase (COIN $288) opened on the Nasdaq at $381 then quickly rocketed to nearly $430 per share. That mark put a sky-high valuation on the firm at $112 billion, but woe to the investors who wantonly bought in within the first few minutes of trading. Unlike many other recent IPOs with similar levels of rabid interest, shares of COIN began faltering almost immediately, falling all the way back to $311 within two hours of the company's first trade. Shares closed the day at $335.90, or 22% off of their high. While the closing price gave the exchange a more reasonable market cap, we believe it is still overvalued. We do like the fact that Coinbase is a play not on one particular cyrpto, but on a number of reasonably solid players. In fact, it acts as something of a gatekeeper, keeping more questionable digital currencies from being traded on the platform. Bitcoin and Ethereum trading generated nearly 60% of the firm's revenue in 2020. One clear winner on the day was the Nasdaq exchange, with Coinbase representing its first direct listing. At its size, in fact, COIN became the largest company to ever take the direct listing route. There was a heated competition between the NYSE and the Nasdaq to land the deal, but Coinbase's CFO said the fact that the latter had the symbol "COIN" played a part in the company's decision to go with that exchange. Here's what worries us most about Coinbase: there are few barriers to entry for would-be competitors. In fact, the fat fees the exchange charges almost begs the competition to come flooding in with the promise of lower costs to the customer. Nonetheless, the company has grand strategic plans of building out a complete suite of financial services over the coming years. They will, more than likely, succeed with those plans.
So, we are relatively bullish on Coinbase, but believe COIN shares are overvalued and that the industry has few barriers to entry. With all of that in the mix, what's an intriguing price point for a buying opportunity? We would say anywhere around $250 per share, which is where we set our own price alert.
Space Sciences & Exploration
09. NASA awards SpaceX contract to build the spacecraft which will take astronauts back to the moon
It was initially whittled down to three companies—Musk's SpaceX, Bezos' Blue Origin, and Dynetics—but we had our hunch as to who would walk away with the prize; the prize being a coveted NASA contract to develop the craft which will take astronauts back to the moon. Blue Origin tried to stack the deck in their favor by teaming up with the likes of Lockheed Martin (LMT) and Northrop Grumman (NOC) and by calling their group a "national team." In the end, however, SpaceX was awarded the $2.9 billion contract. And why not? While other companies have fiddled or floundered, SpaceX has been busy sending astronauts and cargo to the International Space Station (ISS). Real feats, funded with real revenue. Most importantly, in the extreme-risk arena of human spaceflight, SpaceX has won the trust of America's space agency. The United States launched the Artemis program back in 2017 with the express goal of landing men and women on the moon by 2024, fifty-two years after Gene Cernan and Harrison Schmitt crawled back into their lunar module and gently lifted off from the moon's surface as part of their Apollo 17 mission. Who could have imagined back in 1972 that it would take us so long to return. While the 2024 target might have to be pushed out, by nominating former astronaut and US Senator Bill Nelson to head up the space agency, President Biden has signaled his support for a strong US manned space program; quite a different story from his Democratic predecessor, Barrack Obama.
SpaceX's Crew Dragon Endeavour spacecraft is slated to launch on its next mission to the ISS this coming Thursday. On board will be mission commander Shane Kimbrough, pilot Megan McArthur, Japanese astronaut Akihiko Hoshide, and European Space Agency mission specialist Thomas Pesquet.
Internet Retail
08. Amazon set to test furniture and appliance assembly service
Amazon (AMZN $3,411) appears poised to encroach on more turf, and this time the likes of Home Depot, Lowe's, and Wayfair could be affected. The $1.7 trillion Internet retailer will begin testing a product assembly service in several markets this summer, with drivers delivering, unpacking, and assembling everything from beds to treadmills, taking away all of the packing material when done. Customers will even have the option of sending the items back on the spot if dissatisfied with a product once assembled. While the furniture assembly service would most affect the likes of a Wayfair (W $324), moving into the setup of appliances such as washing machines, dishwashers, and ceiling fans would impact the likes of Home Depot (HD $328) and Lowe's (LOW $206). Taking it a step further, ordering big-screen televisions through Amazon and having the price include mounting and setup would affect electronics retailers such as Best Buy (BBY $120). Behind the scenes, however, Amazon is already facing pushback from drivers and delivery workers who fear getting bogged down by the inevitable in-home challenges. Concerns include having customers hover over them during the assembly process, and the company not taking into account any delays caused by unique in-home circumstances such as space constraints.
Our first inclination was to disregard any employee grumblings—Amazon tends to get its way in such matters. However, there are so many unique challenges bound to arise for a non-specialty company such as Amazon trying to train its delivery specialists on the assembly of a multitude of products that the success of this program is far from given. We will keep an eye out for the anecdotal—yet highly entertaining—stories which are sure to make their rounds on social media.
Industrials: Road & Rail
07. A new twist—and a new Canadian player—in the Kansas City Southern saga
Last month we reported on the probable loss of one of America's storied railroads—Kansas City Southern (KSU $298)—as it agreed to be acquired by larger rival to the north, Canadian Pacific (CP $357). The plan called for the $47 billion Canadian rail to buy the north/south American rail for $25 billion plus the assumption of another $4 billion in debt (equivalent to roughly $275/sh). We also noted that last fall KSU rejected a bid by the Blackstone Group (BX $80) to pay shareholders $208/sh to take the firm private. We thought the CP deal was a fait accompli until this week's shocker from an even larger Canadian rail.
Canadian National Railway (CNI $110), which has a market cap of nearly $80 billion, has made a $30 billion bid for KSU, valuing the deal at $325/share and promising to keep KSU's headquarters in Kansas City. While the terms are more favorable for KSU shareholders, there is another factor which will almost certainly come into play: due to a bit more overlap, Canadian National will face a higher regulatory hurdle, with no guarantee of ultimate approval on either side of the border. Despite its smaller size, Kansas City Southern is a coveted jewel of the industry, operating as the only rail going into both Canada to the north and Mexico to the south. As USMCA picks up steam, the importance of one company's ability to transport raw materials from Canada, American farm goods to Mexico, and autos and industrial products back from Mexico cannot be overstated. It even operates a rail link along one side of the Panama Canal. Executives at KSU said they are reviewing the deal and would respond to CP in due course, but shareholders are already cheering the offer: KSU shares were trading up 16% after terms of the deal were announced.
While we would like to see KSU remain independent, odds are very high that one of these deals will ultimately be approved. And, quite frankly, the powerhouse which would be created from a merger is exciting to ponder. Our gut instinct, based on over two decades of following the rail stocks, tells us that the Canadian National Railway merger would offer the best comprehensive outcome—except for Canadian Pacific, of course.
Furnishings, Fixtures, & Appliances
06. Herman Miller and Knoll to merge, creating office furnishings powerhouse
We first highlighted office furnishings company Knoll (KNL $24) in our June, 2015 issue of The Penn Wealth Report. At the time, we were fully engrossed in the final season of the hit AMC television series Mad Men. Knoll, which epitomized the modernist design movement stemming from Munich in the early 20th century, could have easily been responsible for every office scene from the fictional Sterling Cooper ad agency. Quite understandably, the company took a huge hit as offices around the world began shutting their doors last March, with KNL shares falling from nearly $30 going into the year to $9.05 by that terrible week in late March. The same was true for one of Knoll's prime competitors, 116-year-old interior furnishings company Herman Miller (MLHR $41), whose shares fell from near $50 to $15.15 in March of 2020. While both of these small-cap cyclicals rode out the storm and have witnessed a strong comeback in their respective share price, they have made the very intelligent decision to join forces. In a cash-and-stock deal valued at $1.8 billion, the two companies plan to morph into a global leader of modern design not only for the corporate office world, but also to serve the needs of the growing throng of workers who will operate either full- or part-time within their homes. In a joint statement issued by the firms, a strategic plan for "transforming the home and office sectors at a time of unprecedented disruption" was outlined. As Herman Miller was the larger of the two companies, each Knoll shareholder will receive $11 in cash and 0.32 shares of Herman Miller for each share owned, while current MLHR shareholders will end up owning around 78% of the combined entity. The two companies have, in aggregate, a presence in over 100 countries, and both have developed strong e-commerce platforms. Heading into the pandemic, the two had combined annual revenues of $4 billion.
We love the deal, and we expect to see these two American companies pull off a relatively smooth integration. It is not easy to be an American manufacturing firm making high-quality products in a world of cheaper imports, but we fully believe the combined entity will skillfully carry out its bold new strategy. The deal should close by the end of the third quarter.
Government Watchdog
05. So you desire to have a home in New Jersey? Be prepared to pay confiscatory property taxes
We have long espoused the view that property taxes assessed on single-family homes should be capped at 1% per year. After all, in addition to every other tax Americans must pay, isn't $5,000 per year on a $500,000 home enough income for a homeowner's state and local government, on top of the other tax revenues generated? But in many states, the effective property tax rate is much higher than our proposed cap. Take New Jersey, for example, which happens to have the highest property tax rate in the nation. While the state's marginal rate is a sky-high 2.2%, the effective real estate tax rate is 2.47%. That equates to a $5,064 tax bill on a very modest $205,000 home. The effective taxes on a home priced at $327,900, the state's median home value, is $8,104. Perhaps what shocked us the most as we looked at each state's 2020 property tax figures was California's number: the Golden State actually capped the rate at 1% of assessed value, with a 2% annual cap on value increases. Of course, Californians must also contend with a 9.3% income tax rate (on income between $58.6k and $299.5k—it goes up from there) and a 7.25% tax on goods purchased. The opposite end of the spectrum from New Jersey, at least with respect to property taxes, is Hawaii with its 0.28% rate. That would equate to just a $1,715 tax bill on a home valued at $615,300, the median home value in the state.
While moving isn't always an option—for any number of reasons—all Americans should be aware of their individual state's property tax rate, income tax rate, and sales tax rate (the last will fluctuate within various parts of the state). Combined, these three figures represent one's overall tax burden for living where they do. Of interest: Alaska has the lowest overall tax burden of any state in the union, at roughly 5.8% (the state has no sales tax); while Illinois comes in with the most burdensome rate in the country, at 15%.
Global Strategy: Europe
04. The weaker candidate won the primary battle in Germany; may now lose the war to the Greens
Last week we outlined the internal struggles going on behind the scenes among the two leading center-right political parties in Germany, Merkel's Christian Democratic Union and Markus Söder's Christian Social Union of Bavaria. The wildly popular Söder agreed to step aside if the CDU voted to support Merkel's candidate, the unpopular Armin Laschet. Despite the latter's weakness in the polls, that is exactly what her party did, and Söder, true to his word, stepped aside. While we said that the bloc's main competition would come from the center-left Social Democratic Party of Germany (SPD), a new frontrunner has emerged: the far-left Green party's Annalena Baerbock. The 40-year-old former champion trampolinist is promising Germans a "new start" for the country, with a focus on green energy and increased spending on eduction. A poll of German business leaders (a poll we highly question, it should be noted) favors Baerbock over Laschet by a comfortable margin. Clouding the outlook—and probably fracturing the vote in the general elections—are the two candidates from the SPD and the pro-business Free Democrats Party (FDP), Olaf Scholz and Christian Lindner, respectively. The general elections are precisely five months away.
With the best candidate for Germany's future (in our opinion) officially out of the race, the outcome is a flip of the coin. Our instincts tell us that Armin Laschet will come out on top, which will lead to a ho-hum period for the German economy. In a tantalizing twist of fate, that would probably tip the economic scales in Europe in favor of the breakaway "troublemaker," Great Britain. While it is brutally painful going through a domestic election, we have a deep sense of schadenfreude watching the "wise and sapient" Europeans squirm through theirs.
Semiconductors & Related Equipment
03. For true believers, Intel shares seem to be sitting at a decent buy-in point; we remain cautious
While we have talked glowingly about Intel's (INTC $59) new wonkish CEO, Pat Gelsinger, we still haven't pulled the trigger on re-adding the semiconductor maker to any of our portfolios. Management is saying the right things, and we applaud the company's decision to expand their own US manufacturing footprint, but we want to see some results first. A new data point did just roll in; unfortunately, it was not on the bullish side of the scatter plot. Shares of the $242 billion firm were off over 5% on Friday after announcing a strong drop in data center revenue—its most profitable segment—and a decline in gross profit margin. Sales from the Data Center Group fell 20% in the first quarter, year-over-year, well below what analysts were expecting. One anecdotal yet disturbing sign for the group came last month from tech giant Amazon (AMZN $3,370): the company announced that it would begin designing its own data center chips in-house.
Intel has made a string of very smart acquisitions over the past several years to take market share in the AI and EV segments, but it is going to take precision execution on management's part for the company to become a vibrant player in those nascent areas. If played correctly, the severe supply chain disruptions which led to the global chip shortage could provide Intel a nice tailwind. We will remain on the sideline while a few more chapters are written.
Market Pulse
02. Some rather volatile moves, but a flat week in the end; except for the cryptos
There were some wild gyrations in the markets this week, to include a tantrum over the specter of a doubling (for some) of the capital gains tax rate, but when the dust settled we ended up pretty close to where we began. All of the major indexes finished the five session period down, but not by much. Gold finished the week precisely where it started—$1,777 per ounce—and crude futures were off just a buck, to $62.04. The big story of the week was in cryptocurrencies. After prices began tumbling over the weekend, JP Morgan issued a rather dire warning that Bitcoin was due for some further weakness. After topping out at nearly $65,000 on the 14th of April, the digital currency had a steep decline over the weekend. When massively-leveraged bets are made on an investment vehicle, it doesn't take much of a catalyst to begin a massive selloff. As of Friday's close, Bitcoin was trading just shy of $52,000—a 20% drop from its high. The highly-touted Coinbase exchange (COIN $292) didn't fare much better; it was down 14% on the week. For those not willing to do the basic work (some Robinhood customers are claiming they didn't understand the concept of margin, though they had been using it in their accounts), it may be a long year indeed.
Cryptos are here to stay, but that doesn't mean a lack of extreme pullbacks in their respective prices on a regular basis. Some of them, in fact, won't survive. A wanton, meme-driven "strategy" for investing is a dangerous game to play. And that is not even taking margin into account.
Under the Radar Investment
01. Asseco Poland SA (ASOZY $18)
You know the international slice of your portfolio is sorely lacking, as is—more than likely—your small-cap allocation. Take a look at this financially sound, small-cap systems software company from one of our favorite countries in Europe. Asseco Poland SA is a $1.5 billion developer of sector-specific software for banking and finance, and manager of large IT projects in the fields of healthcare, telecom, and security services. With 27,000 employees, the company has a major presence in Europe and Israel, and generates the majority of its (nicely recurring) revenue from proprietary software licenses. With a tiny beta of 0.4181, a very reasonable P/E ratio of 14, and positive net income for the past decade, the company could be a nice play on the economic comeback in Europe. It also comes with a fat, 4.18% dividend yield. We believe that Poland, a staunchly-democratic, anti-communist country, has enormous economic potential over the coming years. It was recently upgraded from an emerging market to a developed market within the FTSE Country Classification framework. Asseco Poland was founded in 1989 and is headquartered in the southeastern Polish city of Rzeszów.
Answer
After the first manned test flight of the Dragon capsule last June with two astronauts onboard, two operational crew launches have taken place—each with a four-person crew. So, ten astronauts have now made the trip from American soil to the International Space Station within the past year.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
American leadership in human spaceflight is back. Thank you Elon...
America willingly—and disgustingly—gave up its ability to launch astronauts into orbit back in 2011. After a decade of no manned launches from American soil, how many astronauts have been launched into space since last June aboard SpaceX rockets?
Penn Trading Desk:
Bank of America/Citi: Upgrade First Solar
One of our favorite renewable energy companies, First Solar (FSLR $84), popped over 5% following an upgrade at both Bank of America and Citi. The BofA analyst cited a green infrastructure plan coming from Washington and accelerated near-term bookings momentum as catalysts for the upgrade. Citi, which upgraded FSLR shares from Hold to Buy, cited tailwinds from US tax and trade policies. We place the fair value of FSLR shares at $100.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Cryptocurrencies
10. As expected, Coinbase shot out of the gate in its debut trading day; then something interesting happened
Despite an initial pricing range of around $250 per share, cryptocurrency exchange Coinbase (COIN $288) opened on the Nasdaq at $381 then quickly rocketed to nearly $430 per share. That mark put a sky-high valuation on the firm at $112 billion, but woe to the investors who wantonly bought in within the first few minutes of trading. Unlike many other recent IPOs with similar levels of rabid interest, shares of COIN began faltering almost immediately, falling all the way back to $311 within two hours of the company's first trade. Shares closed the day at $335.90, or 22% off of their high. While the closing price gave the exchange a more reasonable market cap, we believe it is still overvalued. We do like the fact that Coinbase is a play not on one particular cyrpto, but on a number of reasonably solid players. In fact, it acts as something of a gatekeeper, keeping more questionable digital currencies from being traded on the platform. Bitcoin and Ethereum trading generated nearly 60% of the firm's revenue in 2020. One clear winner on the day was the Nasdaq exchange, with Coinbase representing its first direct listing. At its size, in fact, COIN became the largest company to ever take the direct listing route. There was a heated competition between the NYSE and the Nasdaq to land the deal, but Coinbase's CFO said the fact that the latter had the symbol "COIN" played a part in the company's decision to go with that exchange. Here's what worries us most about Coinbase: there are few barriers to entry for would-be competitors. In fact, the fat fees the exchange charges almost begs the competition to come flooding in with the promise of lower costs to the customer. Nonetheless, the company has grand strategic plans of building out a complete suite of financial services over the coming years. They will, more than likely, succeed with those plans.
So, we are relatively bullish on Coinbase, but believe COIN shares are overvalued and that the industry has few barriers to entry. With all of that in the mix, what's an intriguing price point for a buying opportunity? We would say anywhere around $250 per share, which is where we set our own price alert.
Space Sciences & Exploration
09. NASA awards SpaceX contract to build the spacecraft which will take astronauts back to the moon
It was initially whittled down to three companies—Musk's SpaceX, Bezos' Blue Origin, and Dynetics—but we had our hunch as to who would walk away with the prize; the prize being a coveted NASA contract to develop the craft which will take astronauts back to the moon. Blue Origin tried to stack the deck in their favor by teaming up with the likes of Lockheed Martin (LMT) and Northrop Grumman (NOC) and by calling their group a "national team." In the end, however, SpaceX was awarded the $2.9 billion contract. And why not? While other companies have fiddled or floundered, SpaceX has been busy sending astronauts and cargo to the International Space Station (ISS). Real feats, funded with real revenue. Most importantly, in the extreme-risk arena of human spaceflight, SpaceX has won the trust of America's space agency. The United States launched the Artemis program back in 2017 with the express goal of landing men and women on the moon by 2024, fifty-two years after Gene Cernan and Harrison Schmitt crawled back into their lunar module and gently lifted off from the moon's surface as part of their Apollo 17 mission. Who could have imagined back in 1972 that it would take us so long to return. While the 2024 target might have to be pushed out, by nominating former astronaut and US Senator Bill Nelson to head up the space agency, President Biden has signaled his support for a strong US manned space program; quite a different story from his Democratic predecessor, Barrack Obama.
SpaceX's Crew Dragon Endeavour spacecraft is slated to launch on its next mission to the ISS this coming Thursday. On board will be mission commander Shane Kimbrough, pilot Megan McArthur, Japanese astronaut Akihiko Hoshide, and European Space Agency mission specialist Thomas Pesquet.
Internet Retail
08. Amazon set to test furniture and appliance assembly service
Amazon (AMZN $3,411) appears poised to encroach on more turf, and this time the likes of Home Depot, Lowe's, and Wayfair could be affected. The $1.7 trillion Internet retailer will begin testing a product assembly service in several markets this summer, with drivers delivering, unpacking, and assembling everything from beds to treadmills, taking away all of the packing material when done. Customers will even have the option of sending the items back on the spot if dissatisfied with a product once assembled. While the furniture assembly service would most affect the likes of a Wayfair (W $324), moving into the setup of appliances such as washing machines, dishwashers, and ceiling fans would impact the likes of Home Depot (HD $328) and Lowe's (LOW $206). Taking it a step further, ordering big-screen televisions through Amazon and having the price include mounting and setup would affect electronics retailers such as Best Buy (BBY $120). Behind the scenes, however, Amazon is already facing pushback from drivers and delivery workers who fear getting bogged down by the inevitable in-home challenges. Concerns include having customers hover over them during the assembly process, and the company not taking into account any delays caused by unique in-home circumstances such as space constraints.
Our first inclination was to disregard any employee grumblings—Amazon tends to get its way in such matters. However, there are so many unique challenges bound to arise for a non-specialty company such as Amazon trying to train its delivery specialists on the assembly of a multitude of products that the success of this program is far from given. We will keep an eye out for the anecdotal—yet highly entertaining—stories which are sure to make their rounds on social media.
Industrials: Road & Rail
07. A new twist—and a new Canadian player—in the Kansas City Southern saga
Last month we reported on the probable loss of one of America's storied railroads—Kansas City Southern (KSU $298)—as it agreed to be acquired by larger rival to the north, Canadian Pacific (CP $357). The plan called for the $47 billion Canadian rail to buy the north/south American rail for $25 billion plus the assumption of another $4 billion in debt (equivalent to roughly $275/sh). We also noted that last fall KSU rejected a bid by the Blackstone Group (BX $80) to pay shareholders $208/sh to take the firm private. We thought the CP deal was a fait accompli until this week's shocker from an even larger Canadian rail.
Canadian National Railway (CNI $110), which has a market cap of nearly $80 billion, has made a $30 billion bid for KSU, valuing the deal at $325/share and promising to keep KSU's headquarters in Kansas City. While the terms are more favorable for KSU shareholders, there is another factor which will almost certainly come into play: due to a bit more overlap, Canadian National will face a higher regulatory hurdle, with no guarantee of ultimate approval on either side of the border. Despite its smaller size, Kansas City Southern is a coveted jewel of the industry, operating as the only rail going into both Canada to the north and Mexico to the south. As USMCA picks up steam, the importance of one company's ability to transport raw materials from Canada, American farm goods to Mexico, and autos and industrial products back from Mexico cannot be overstated. It even operates a rail link along one side of the Panama Canal. Executives at KSU said they are reviewing the deal and would respond to CP in due course, but shareholders are already cheering the offer: KSU shares were trading up 16% after terms of the deal were announced.
While we would like to see KSU remain independent, odds are very high that one of these deals will ultimately be approved. And, quite frankly, the powerhouse which would be created from a merger is exciting to ponder. Our gut instinct, based on over two decades of following the rail stocks, tells us that the Canadian National Railway merger would offer the best comprehensive outcome—except for Canadian Pacific, of course.
Furnishings, Fixtures, & Appliances
06. Herman Miller and Knoll to merge, creating office furnishings powerhouse
We first highlighted office furnishings company Knoll (KNL $24) in our June, 2015 issue of The Penn Wealth Report. At the time, we were fully engrossed in the final season of the hit AMC television series Mad Men. Knoll, which epitomized the modernist design movement stemming from Munich in the early 20th century, could have easily been responsible for every office scene from the fictional Sterling Cooper ad agency. Quite understandably, the company took a huge hit as offices around the world began shutting their doors last March, with KNL shares falling from nearly $30 going into the year to $9.05 by that terrible week in late March. The same was true for one of Knoll's prime competitors, 116-year-old interior furnishings company Herman Miller (MLHR $41), whose shares fell from near $50 to $15.15 in March of 2020. While both of these small-cap cyclicals rode out the storm and have witnessed a strong comeback in their respective share price, they have made the very intelligent decision to join forces. In a cash-and-stock deal valued at $1.8 billion, the two companies plan to morph into a global leader of modern design not only for the corporate office world, but also to serve the needs of the growing throng of workers who will operate either full- or part-time within their homes. In a joint statement issued by the firms, a strategic plan for "transforming the home and office sectors at a time of unprecedented disruption" was outlined. As Herman Miller was the larger of the two companies, each Knoll shareholder will receive $11 in cash and 0.32 shares of Herman Miller for each share owned, while current MLHR shareholders will end up owning around 78% of the combined entity. The two companies have, in aggregate, a presence in over 100 countries, and both have developed strong e-commerce platforms. Heading into the pandemic, the two had combined annual revenues of $4 billion.
We love the deal, and we expect to see these two American companies pull off a relatively smooth integration. It is not easy to be an American manufacturing firm making high-quality products in a world of cheaper imports, but we fully believe the combined entity will skillfully carry out its bold new strategy. The deal should close by the end of the third quarter.
Government Watchdog
05. So you desire to have a home in New Jersey? Be prepared to pay confiscatory property taxes
We have long espoused the view that property taxes assessed on single-family homes should be capped at 1% per year. After all, in addition to every other tax Americans must pay, isn't $5,000 per year on a $500,000 home enough income for a homeowner's state and local government, on top of the other tax revenues generated? But in many states, the effective property tax rate is much higher than our proposed cap. Take New Jersey, for example, which happens to have the highest property tax rate in the nation. While the state's marginal rate is a sky-high 2.2%, the effective real estate tax rate is 2.47%. That equates to a $5,064 tax bill on a very modest $205,000 home. The effective taxes on a home priced at $327,900, the state's median home value, is $8,104. Perhaps what shocked us the most as we looked at each state's 2020 property tax figures was California's number: the Golden State actually capped the rate at 1% of assessed value, with a 2% annual cap on value increases. Of course, Californians must also contend with a 9.3% income tax rate (on income between $58.6k and $299.5k—it goes up from there) and a 7.25% tax on goods purchased. The opposite end of the spectrum from New Jersey, at least with respect to property taxes, is Hawaii with its 0.28% rate. That would equate to just a $1,715 tax bill on a home valued at $615,300, the median home value in the state.
While moving isn't always an option—for any number of reasons—all Americans should be aware of their individual state's property tax rate, income tax rate, and sales tax rate (the last will fluctuate within various parts of the state). Combined, these three figures represent one's overall tax burden for living where they do. Of interest: Alaska has the lowest overall tax burden of any state in the union, at roughly 5.8% (the state has no sales tax); while Illinois comes in with the most burdensome rate in the country, at 15%.
Global Strategy: Europe
04. The weaker candidate won the primary battle in Germany; may now lose the war to the Greens
Last week we outlined the internal struggles going on behind the scenes among the two leading center-right political parties in Germany, Merkel's Christian Democratic Union and Markus Söder's Christian Social Union of Bavaria. The wildly popular Söder agreed to step aside if the CDU voted to support Merkel's candidate, the unpopular Armin Laschet. Despite the latter's weakness in the polls, that is exactly what her party did, and Söder, true to his word, stepped aside. While we said that the bloc's main competition would come from the center-left Social Democratic Party of Germany (SPD), a new frontrunner has emerged: the far-left Green party's Annalena Baerbock. The 40-year-old former champion trampolinist is promising Germans a "new start" for the country, with a focus on green energy and increased spending on eduction. A poll of German business leaders (a poll we highly question, it should be noted) favors Baerbock over Laschet by a comfortable margin. Clouding the outlook—and probably fracturing the vote in the general elections—are the two candidates from the SPD and the pro-business Free Democrats Party (FDP), Olaf Scholz and Christian Lindner, respectively. The general elections are precisely five months away.
With the best candidate for Germany's future (in our opinion) officially out of the race, the outcome is a flip of the coin. Our instincts tell us that Armin Laschet will come out on top, which will lead to a ho-hum period for the German economy. In a tantalizing twist of fate, that would probably tip the economic scales in Europe in favor of the breakaway "troublemaker," Great Britain. While it is brutally painful going through a domestic election, we have a deep sense of schadenfreude watching the "wise and sapient" Europeans squirm through theirs.
Semiconductors & Related Equipment
03. For true believers, Intel shares seem to be sitting at a decent buy-in point; we remain cautious
While we have talked glowingly about Intel's (INTC $59) new wonkish CEO, Pat Gelsinger, we still haven't pulled the trigger on re-adding the semiconductor maker to any of our portfolios. Management is saying the right things, and we applaud the company's decision to expand their own US manufacturing footprint, but we want to see some results first. A new data point did just roll in; unfortunately, it was not on the bullish side of the scatter plot. Shares of the $242 billion firm were off over 5% on Friday after announcing a strong drop in data center revenue—its most profitable segment—and a decline in gross profit margin. Sales from the Data Center Group fell 20% in the first quarter, year-over-year, well below what analysts were expecting. One anecdotal yet disturbing sign for the group came last month from tech giant Amazon (AMZN $3,370): the company announced that it would begin designing its own data center chips in-house.
Intel has made a string of very smart acquisitions over the past several years to take market share in the AI and EV segments, but it is going to take precision execution on management's part for the company to become a vibrant player in those nascent areas. If played correctly, the severe supply chain disruptions which led to the global chip shortage could provide Intel a nice tailwind. We will remain on the sideline while a few more chapters are written.
Market Pulse
02. Some rather volatile moves, but a flat week in the end; except for the cryptos
There were some wild gyrations in the markets this week, to include a tantrum over the specter of a doubling (for some) of the capital gains tax rate, but when the dust settled we ended up pretty close to where we began. All of the major indexes finished the five session period down, but not by much. Gold finished the week precisely where it started—$1,777 per ounce—and crude futures were off just a buck, to $62.04. The big story of the week was in cryptocurrencies. After prices began tumbling over the weekend, JP Morgan issued a rather dire warning that Bitcoin was due for some further weakness. After topping out at nearly $65,000 on the 14th of April, the digital currency had a steep decline over the weekend. When massively-leveraged bets are made on an investment vehicle, it doesn't take much of a catalyst to begin a massive selloff. As of Friday's close, Bitcoin was trading just shy of $52,000—a 20% drop from its high. The highly-touted Coinbase exchange (COIN $292) didn't fare much better; it was down 14% on the week. For those not willing to do the basic work (some Robinhood customers are claiming they didn't understand the concept of margin, though they had been using it in their accounts), it may be a long year indeed.
Cryptos are here to stay, but that doesn't mean a lack of extreme pullbacks in their respective prices on a regular basis. Some of them, in fact, won't survive. A wanton, meme-driven "strategy" for investing is a dangerous game to play. And that is not even taking margin into account.
Under the Radar Investment
01. Asseco Poland SA (ASOZY $18)
You know the international slice of your portfolio is sorely lacking, as is—more than likely—your small-cap allocation. Take a look at this financially sound, small-cap systems software company from one of our favorite countries in Europe. Asseco Poland SA is a $1.5 billion developer of sector-specific software for banking and finance, and manager of large IT projects in the fields of healthcare, telecom, and security services. With 27,000 employees, the company has a major presence in Europe and Israel, and generates the majority of its (nicely recurring) revenue from proprietary software licenses. With a tiny beta of 0.4181, a very reasonable P/E ratio of 14, and positive net income for the past decade, the company could be a nice play on the economic comeback in Europe. It also comes with a fat, 4.18% dividend yield. We believe that Poland, a staunchly-democratic, anti-communist country, has enormous economic potential over the coming years. It was recently upgraded from an emerging market to a developed market within the FTSE Country Classification framework. Asseco Poland was founded in 1989 and is headquartered in the southeastern Polish city of Rzeszów.
Answer
After the first manned test flight of the Dragon capsule last June with two astronauts onboard, two operational crew launches have taken place—each with a four-person crew. So, ten astronauts have now made the trip from American soil to the International Space Station within the past year.
Headlines for the Week of 11 Apr—17 Apr 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
Hasbro's first hit toy...
Hasbro can trace its roots back to 1923, but its first major hit rolled along in 1952. What was that beloved toy?
Penn Trading Desk:
Penn: Add media conglomerate to the Intrepid
Just because we are not fans of a company doesn't mean we can't make money off of it. That is the scenario under which we picked up shares of a media giant whose price rose too quickly, then fell too sharply. The ideal place for a company we don't love—or even necessarily like? Anyone following the five Penn strategies knows there is only one good fit: the Penn Intrepid Trading Platform. Our target price is precisely 50% above where we purchased the shares. For details of the trade, sign into the Penn Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Global Strategy: Southeast Asia
10. In a refreshing move, Western companies are finally speaking out against China's horrendous human rights abuses
In the current zeitgeist, many large American companies seem to have no problem wading into domestic politics—a taboo policy until quite recently. Now, in a refreshing move, some surprising players are finally willing to shine a light on the human rights abuses committed by the Communist Party of China. The largest footwear and athletic apparel brand in the world, Nike (NKE $133), saw its shares take a hit last week after the company denounced the forced labor of Chinese Uyghers and other ethnic minorities throughout various parts of China. Swedish fashion conglomerate H&M (HMRZF $24) announced that it would stop buying cotton from the Xinjiang region of northwest China after confirmed reports of forced labor. Burberry, Adidas, and New Balance have issued similar statements condemning the conditions. In another refreshing move, the governments of the EU, the UK, the US, and Canada jointly issued a statement denouncing the treatment of minorities in China. Now, as could be expected, calls to boycott Nike and H&M have sprung up across China. As the communist party controls virtually every aspect of media—to include social media—within China, the boycotts could have been easily predicted. How badly could these companies be hurt by a boycott? Considering that 36% of Nike's production and 22% of the company's sales emanate from China, there will be some pain felt. However, this should serve as an excellent wake up call for organizations which have become overly reliant on one closed society's cheap labor and growing middle class. Perhaps they will now consider China's more open-society neighbors to the south and east as a location for new plants and for new sources of revenue.
It has been widely reported that China is turning more towards Russia and North Korea as it faces ever-increasing blowback for its unacceptable actions. That shouldn't come as a surprise, considering the similar nature of all three governments. The importance of US leadership in building an international alliance against human rights atrocities cannot be overstated. As the world's largest economy, America must counter China's Belt and Road Initiative (BRI), which will serve as a spreader for these practices, by building stronger economic and political alliances with countries around the world instead of acting unilaterally.
Capital Markets
09. We knew several major media and entertainment stocks fell sharply, now we begin to see the formerly-unknown fallout
In the matter of a week, former high-flying media darlings Discovery (DISCA $42) and ViacomCBS (VIAC $46) saw there share prices slashed roughly in half, without any clear-cut catalyst. Investors saw that bloodbath unfold in real time, but something else was going on behind the scenes which was neither clear nor transparent. One family office group (FOG), Archegos Capital, founded by former Tiger Management analyst Bill Hwang, had amassed major stakes in both of these firms and a number of Chinese Internet ADRs. As the shares began to crater, margin calls began rolling in from Archegos lenders, primarily Credit Suisse and Nomura, forcing the FOG to sell shares—thus exacerbating the initial drop. Both of these foreign lenders warned of big losses after announcing that "a significant US-based hedge fund had defaulted on margin calls," causing the shares of each to drop around 13%. It is too early to tell just how much Archegos and its lenders have lost in this nightmarish downward spiral, but it will certainly be in the billions of dollars for each of the players. Of interesting note: Goldman Sachs, Morgan Stanley, and Deutsche Bank rapidly unloaded big blocks of shares last week which were tied to Archegos. In other words, they got out before incurring the losses felt by Credit Suisse and Nomura. The incident is especially troubling for Credit Suisse, which already faced massive losses from the collapse of UK investment partner Greensill Capital, and a reported February loss of over $1 billion stemming from a US court case over questionable securities.
Here is what's most disturbing about this case: Neither Credit Suisse nor Nomura shareholders were wise to the banks' dealings with Archegos or the extent to which the hedge fund had leveraged its media holdings. This is due to an exclusion made for family office groups in Dodd-Frank legislation, exempting them from the the same level of SEC reporting with which non-FOGs must comply. Odds are extremely high that by the time the dust settles on this saga these rules will have been "amended."
Science & Technology Investor
08. Cathie Wood's ARK Space Exploration & Innovation ETF makes its debut
To say that Cathie Wood, founder, CEO, and CIO of ARK Investment Management, has made a big splash in the investment world is an understatement. Her skills at uncovering and investing in primarily small- and mid-cap tech and innovation companies (and increased marketing, of course) have led to a stunning inflow of funds during a horrendously tough year—her firm's assets under management (AUM) went from around $2.6 billion to over $50 billion. This week, Wood launched her latest gem: the ARK Space Exploration and Innovation ETF (ARKX $20). The fund, according to ARK, will invest in companies operating under one of four areas: orbital aerospace, suborbital aerospace, enabling technologies, and aerospace beneficiaries (e.g. Internet access). The top holding (of around 50) is scientific and technical instruments maker Trimble (TRMB $78); others in the top-ten list include Kratos Defense & Security (KTOS), L3 Harris Technologies (LHX), and Iridium Communications (IRDM). It would be safe to assume that SpaceX will be among the holdings when that company ultimately goes public. I must admit to being excited about this fund, and appreciate the company's complete transparency with respect to buys and sells—what a refreshing concept.
Based on the explosive growth in all things tech and space related as of late, is this fund overvalued out of the gate? I don't believe so. Looking through the holdings, many are industrial or tech names which are not on most investors' radar screens. It is an impressive lineup.
Economics: Work & Pay
07. A spectacular jobs report pushes equities higher
Yes, yes, we know it will take like ten more jobs reports similar to the one we got for March to get us back anywhere near where we were in February of 2020, but let's take some time and savor this one. While the markets were closed on Good Friday, futures shot up nonetheless on news that the US added 916,000 new jobs in the month of March against economists' expectations for 618,000. Even better, the hiring was broad-based, spread out among virtually every corner of the private sector. Notable strength was seen in leisure and hospitality (the group hit hardest during the heart of the pandemic), education, health care, and construction. The US unemployment rate dropped from 6.2% to 6%, while the more comprehensive U-6 rate (which includes all persons marginally attached to the labor force) dropped from 11.1% to 10.7%. Even better than simply a stunning report, the areas of weakness (such as wages) gave investors confidence that the Fed wouldn't accelerate plans to raise rates. Even after digesting the news for three days, investors were still applauding the report on Monday morning, as all major indexes rose in excess of 1% out of the gates.
Warmer weather, more vaccines, strong hiring—we can feel the momentum building. Out litmus test for the great economic comeback will be full NFL stadiums this fall; and yes, we expect that to be the case. Our dual goals, post-pandemic? More "shop local," and less "Made in China."
Market Pulse
06. Jamie Dimon sees economic boom continuing into 2023, but also sees challenges to address
In his annual letter to JP Morgan (JPM $153) shareholders, CEO Jamie Dimon said he sees strong growth for the American economy "easily running into 2023." Dimon, one of the most astute watchers of the market, listed a host of factors for his bullish sentiment on the world's largest economy: the remarkable speed at which a vaccine was developed, excess savings for the typical American family after being homebound for much of the past year, huge deficit spending, more quantitative easing by the Fed, a new infrastructure bill, and general euphoria that the long global nightmare may finally be coming to an end. His letter wasn't all rosy, however. Dimon sees a real possibility that inflation "will not be just temporary," and he expressed his concerns that our international rivals see a nation "torn and crippled by politics...." "The good news," Dimon concluded, "is that this is fixable."
There have always been fomenters of discord and division in this country. There is no doubt that our adversaries, such as China and Russia, are stealthily acting to support such hatred and division. America is, by far, the strongest nation on earth, both economically and militarily—that is a statistically provable fact, not hyperbole. The best weapon our enemies have to harm our standing in the world is to help balkanize the country into groups pitted against one another. Their efforts will fail if we refuse to play their game.
Application & Systems Software
05. Another smart move by Satya Nadella: Microsoft to buy AI firm Nuance in $19.7 billion deal
CEO Satya Nadella continues to aggressively transform Microsoft (MSFT $255), with his latest move being the acquisition of pioneering speech-recognition ("conversational AI") company Nuance (NUAN) for $19.7 billion ($16 billion plus assumption of debt). The all-cash deal values Nuance at $56 per share, or a 23% premium over Friday's close. The move should give Microsoft a greater presence in the growing field of health information services, and should also be cause for concern for the likes of $22 billion, Missouri-based Cerner (CERN $73). Nuance offers health care professionals the tools to recognize and transcribe speech during doctor's visits, both in-person and digital (telemedicine). Appointment management, patient support, and the efficient creation and maintenance of complete medical records are a few of Nuance's extensive list of offerings. While health care is the leading source the firm's revenues, it also operates in the financial services, telecom, retail, and government sectors. The deal would represent Microsoft's second-largest ever, behind only the 2016 acquisition of LinkedIn for $27 billion.
Microsoft is one of the forty holdings within the Penn Global Leaders Club, and remains one of our strongest-conviction buys at its current price.
Global Strategy: Europe
04. Could an internecine battle in Germany help bring about a major regime change?
For some reason, it seems as though it has been about five years since Angela Merkel announced that she would be stepping down from her role as Chancellor of Germany—a position (stepping down, that is) rather forced upon her by the party she led between 2000 and 2018, the Christian Democratic Union (CDU). In what seems to be dragging on longer than Brexit, the battle for her successor just took a dramatic turn.
While there are roughly a dozen political parties in the country, the ruling alliance between the center-right CDU and the center-right Christian Social Union in Bavaria (CSU) has been a stabilizing factor in the country since nearly the end of World War II. Generally, the leader of the larger CDU, Merkel's party, gets the nod to represent the alliance in the national election. And, indeed, Merkel has backed her party's leader, Armin Laschet, to succeed her. However, the more charismatic Markus Söder, head of the CSU, believes that he is the right person for the job, and his party just sent a shocking snub to Merkel's pick. Söder points out how far the CDU has fallen in the polls since the former journalist took the reins of the party from Merkel three years ago. He is correct on both counts: that the party has fallen from grace since 2018, and that he could energize the electorate more than Laschet.
Of course, this battle has the center-left Social Democratic Party of Germany (SPD) licking its chops. It sees its own nominee, Olaf Scholz, gaining from the disarray. To further complicate the matter, Scholz is not only Merkel's deputy vice chancellor, he actually lost the race to be the leader of his own party. We won't even get into the far-left Green Party, or the far-right Alternative for Germany (AfD), or even the Pirate Party, which opposes the EU's data retention policies. It should be fun to watch (from across the ocean) as battles play out over the next five months—the country has set its official federal election date as 26 September 2021.
The ugliness could spiral out of control, with a real possibility that Scholz could pull out a victory. Considering the gargantuan problems facing Germany right now, perhaps the real question should be why would anyone want to be chancellor?
Cryptocurrencies
03. There is an enormous crypto opportunity coming Wednesday via direct listing; should you buy?
If we ever had any doubts about the long-term viability of cryptos, that ended when it became clear that China has plans to create its own global reserve currency (dollar envy). It has decided to do that in the form of a government-backed digital currency, a sovereign Bitcoin if you will. Technically called the Digital Currency Electronic Payment, or DCEP, the currency will allow the Communist Party of China to further control the entire banking system in China and, in the hopes and dreams of the master planners, create a tool to overtake the dollar as the world's reserve currency. Will it work? Probably not—at least not to the extent China hopes. However, it points to the critical importance of the American government both understanding and embracing cryptos.
On that note, Something big will happen in the crypto world on Wednesday: Coinbase will go public via a direct listing. As the largest cryptocurrency exchange, the San Fran-based company (though it has no official physical headquarters) acts as a secure online platform for buying, selling, transferring, and storing digital currency. The fact that it is part of the support structure, rather than an entity tied to the success of any one single crypto such as Bitcoin, makes the company extremely interesting. Not only that, it is (get ready) already profitable! The firm had a blowout Q1, with earning of around $800 million on revenues of $7.2 billion. And that revenue base represented an 850% spike from the same quarter a year earlier. There is only one problem with this intriguing investment. With the rabid interest circulating around cryptos and the millions of new myopic retail investors now in the game, Coinbase will probably come out of the chute with a market cap in excess of $100 billion, and some will be willing to jump in at any price ("diamond hands, baby"). We will be watching the action closely, and if the price is too expensive on its first day of trading we recommend investors wait for the shares to come down and settle within a reasonable range.
Cryptos, despite what we said about their inevitable future, still operate in a normal market cycle of peaks, contractions, troughs, and expansions. Don't get too caught up in the hype: when everyone is jumping into the water with their eyes closed, it is always wise advice to wait until the sharks send them fleeing for safety.
Media & Entertainment
02. Physical games meet digital gaming as Roblox and Hasbro team up
Last month we wrote about the exciting new (to the markets) online entertainment platform Roblox (RBLX $83), which allows users to code their own games and share them for other gamers to play—often earning a little profit in the process. One 98-year-old gaming company which few associate with technology, Hasbro (HAS $99), is hoping to breathe some new life into its lineup by joining forces with the online platform. Specifically, the toy and game company's Nerf and Monopoly lines will soon include codes for Roblox players to redeem for virtual items. Additionally, a number of Roblox games will be created around the iconic products. For example, buy a Nerf Blaster and receive a code to score an online Nerf Blaster to use in games such as Jailbreak and Arsenal. A new version of Monopoly, to be available later this year, will include Roblox characters and come with codes to acquire other online items. We're not sure which company came up with the brainstorm, but if it was Hasbro's idea, it is the latest in a series of smart moves. Recall that five years ago the company scored a major coup in taking the Disney line away from Mattel (MAT $20) after a sixty year relationship was fractured. For an old-school toy company living in a digital world, Hasbro continues to impress.
The ten-year chart of Hasbro vs Mattel highlights the great struggle between the two iconic brands. Some analysts still believe that $14 billion Hasbro should acquire Mattel, half its size. There is little doubt that the former is leading the latter in digital acumen; plus, who wouldn't want to own the coveted Barbie and American Girl lines?
Under the Radar Investment
01. Accolade Inc
There are many corners of the health care market with which investors are enamored, from big pharma to biotech to medical devices and testing, but one area which remains relatively ignored is the health information services arena. The industry made news this week with Microsoft's announcement that it would buy Nuance in a nearly $20 billion deal, but a firm much deeper under the radar screen of investors is $2.8 billion Accolade Inc (ACCD $48). Accolade is a tech-based firm which helps employers provide individualized health care "advocacy" for their employees, to include putting them in touch with nurses and specialists on demand, coordinating their care, and providing the best resources for their individual needs. Mention "company health care plan" to most employees and they will picture a byzantine system which includes long lines on hold and inexplicable bills arriving in the mail. Accolade turns that model on its head. We place a fair value of $60 on the shares. At $2.8 billion in size, the firm has plenty of room to grow.
Answer
Three Polish-Jewish siblings founded Hassenfeld Brothers in 1923, selling textile remnants, then school supplies, then—ultimately—toys. They would later shorten the name to Hasbro. The brothers' first hit toy came along in 1952 in the form of a lumpy brownish potato; included in the kit were hands, feet, ears, two mouths, two pairs of eyes, four noses, three hats, eyeglasses, a pipe, and some felt which resembled facial hair.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Hasbro's first hit toy...
Hasbro can trace its roots back to 1923, but its first major hit rolled along in 1952. What was that beloved toy?
Penn Trading Desk:
Penn: Add media conglomerate to the Intrepid
Just because we are not fans of a company doesn't mean we can't make money off of it. That is the scenario under which we picked up shares of a media giant whose price rose too quickly, then fell too sharply. The ideal place for a company we don't love—or even necessarily like? Anyone following the five Penn strategies knows there is only one good fit: the Penn Intrepid Trading Platform. Our target price is precisely 50% above where we purchased the shares. For details of the trade, sign into the Penn Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Global Strategy: Southeast Asia
10. In a refreshing move, Western companies are finally speaking out against China's horrendous human rights abuses
In the current zeitgeist, many large American companies seem to have no problem wading into domestic politics—a taboo policy until quite recently. Now, in a refreshing move, some surprising players are finally willing to shine a light on the human rights abuses committed by the Communist Party of China. The largest footwear and athletic apparel brand in the world, Nike (NKE $133), saw its shares take a hit last week after the company denounced the forced labor of Chinese Uyghers and other ethnic minorities throughout various parts of China. Swedish fashion conglomerate H&M (HMRZF $24) announced that it would stop buying cotton from the Xinjiang region of northwest China after confirmed reports of forced labor. Burberry, Adidas, and New Balance have issued similar statements condemning the conditions. In another refreshing move, the governments of the EU, the UK, the US, and Canada jointly issued a statement denouncing the treatment of minorities in China. Now, as could be expected, calls to boycott Nike and H&M have sprung up across China. As the communist party controls virtually every aspect of media—to include social media—within China, the boycotts could have been easily predicted. How badly could these companies be hurt by a boycott? Considering that 36% of Nike's production and 22% of the company's sales emanate from China, there will be some pain felt. However, this should serve as an excellent wake up call for organizations which have become overly reliant on one closed society's cheap labor and growing middle class. Perhaps they will now consider China's more open-society neighbors to the south and east as a location for new plants and for new sources of revenue.
It has been widely reported that China is turning more towards Russia and North Korea as it faces ever-increasing blowback for its unacceptable actions. That shouldn't come as a surprise, considering the similar nature of all three governments. The importance of US leadership in building an international alliance against human rights atrocities cannot be overstated. As the world's largest economy, America must counter China's Belt and Road Initiative (BRI), which will serve as a spreader for these practices, by building stronger economic and political alliances with countries around the world instead of acting unilaterally.
Capital Markets
09. We knew several major media and entertainment stocks fell sharply, now we begin to see the formerly-unknown fallout
In the matter of a week, former high-flying media darlings Discovery (DISCA $42) and ViacomCBS (VIAC $46) saw there share prices slashed roughly in half, without any clear-cut catalyst. Investors saw that bloodbath unfold in real time, but something else was going on behind the scenes which was neither clear nor transparent. One family office group (FOG), Archegos Capital, founded by former Tiger Management analyst Bill Hwang, had amassed major stakes in both of these firms and a number of Chinese Internet ADRs. As the shares began to crater, margin calls began rolling in from Archegos lenders, primarily Credit Suisse and Nomura, forcing the FOG to sell shares—thus exacerbating the initial drop. Both of these foreign lenders warned of big losses after announcing that "a significant US-based hedge fund had defaulted on margin calls," causing the shares of each to drop around 13%. It is too early to tell just how much Archegos and its lenders have lost in this nightmarish downward spiral, but it will certainly be in the billions of dollars for each of the players. Of interesting note: Goldman Sachs, Morgan Stanley, and Deutsche Bank rapidly unloaded big blocks of shares last week which were tied to Archegos. In other words, they got out before incurring the losses felt by Credit Suisse and Nomura. The incident is especially troubling for Credit Suisse, which already faced massive losses from the collapse of UK investment partner Greensill Capital, and a reported February loss of over $1 billion stemming from a US court case over questionable securities.
Here is what's most disturbing about this case: Neither Credit Suisse nor Nomura shareholders were wise to the banks' dealings with Archegos or the extent to which the hedge fund had leveraged its media holdings. This is due to an exclusion made for family office groups in Dodd-Frank legislation, exempting them from the the same level of SEC reporting with which non-FOGs must comply. Odds are extremely high that by the time the dust settles on this saga these rules will have been "amended."
Science & Technology Investor
08. Cathie Wood's ARK Space Exploration & Innovation ETF makes its debut
To say that Cathie Wood, founder, CEO, and CIO of ARK Investment Management, has made a big splash in the investment world is an understatement. Her skills at uncovering and investing in primarily small- and mid-cap tech and innovation companies (and increased marketing, of course) have led to a stunning inflow of funds during a horrendously tough year—her firm's assets under management (AUM) went from around $2.6 billion to over $50 billion. This week, Wood launched her latest gem: the ARK Space Exploration and Innovation ETF (ARKX $20). The fund, according to ARK, will invest in companies operating under one of four areas: orbital aerospace, suborbital aerospace, enabling technologies, and aerospace beneficiaries (e.g. Internet access). The top holding (of around 50) is scientific and technical instruments maker Trimble (TRMB $78); others in the top-ten list include Kratos Defense & Security (KTOS), L3 Harris Technologies (LHX), and Iridium Communications (IRDM). It would be safe to assume that SpaceX will be among the holdings when that company ultimately goes public. I must admit to being excited about this fund, and appreciate the company's complete transparency with respect to buys and sells—what a refreshing concept.
Based on the explosive growth in all things tech and space related as of late, is this fund overvalued out of the gate? I don't believe so. Looking through the holdings, many are industrial or tech names which are not on most investors' radar screens. It is an impressive lineup.
Economics: Work & Pay
07. A spectacular jobs report pushes equities higher
Yes, yes, we know it will take like ten more jobs reports similar to the one we got for March to get us back anywhere near where we were in February of 2020, but let's take some time and savor this one. While the markets were closed on Good Friday, futures shot up nonetheless on news that the US added 916,000 new jobs in the month of March against economists' expectations for 618,000. Even better, the hiring was broad-based, spread out among virtually every corner of the private sector. Notable strength was seen in leisure and hospitality (the group hit hardest during the heart of the pandemic), education, health care, and construction. The US unemployment rate dropped from 6.2% to 6%, while the more comprehensive U-6 rate (which includes all persons marginally attached to the labor force) dropped from 11.1% to 10.7%. Even better than simply a stunning report, the areas of weakness (such as wages) gave investors confidence that the Fed wouldn't accelerate plans to raise rates. Even after digesting the news for three days, investors were still applauding the report on Monday morning, as all major indexes rose in excess of 1% out of the gates.
Warmer weather, more vaccines, strong hiring—we can feel the momentum building. Out litmus test for the great economic comeback will be full NFL stadiums this fall; and yes, we expect that to be the case. Our dual goals, post-pandemic? More "shop local," and less "Made in China."
Market Pulse
06. Jamie Dimon sees economic boom continuing into 2023, but also sees challenges to address
In his annual letter to JP Morgan (JPM $153) shareholders, CEO Jamie Dimon said he sees strong growth for the American economy "easily running into 2023." Dimon, one of the most astute watchers of the market, listed a host of factors for his bullish sentiment on the world's largest economy: the remarkable speed at which a vaccine was developed, excess savings for the typical American family after being homebound for much of the past year, huge deficit spending, more quantitative easing by the Fed, a new infrastructure bill, and general euphoria that the long global nightmare may finally be coming to an end. His letter wasn't all rosy, however. Dimon sees a real possibility that inflation "will not be just temporary," and he expressed his concerns that our international rivals see a nation "torn and crippled by politics...." "The good news," Dimon concluded, "is that this is fixable."
There have always been fomenters of discord and division in this country. There is no doubt that our adversaries, such as China and Russia, are stealthily acting to support such hatred and division. America is, by far, the strongest nation on earth, both economically and militarily—that is a statistically provable fact, not hyperbole. The best weapon our enemies have to harm our standing in the world is to help balkanize the country into groups pitted against one another. Their efforts will fail if we refuse to play their game.
Application & Systems Software
05. Another smart move by Satya Nadella: Microsoft to buy AI firm Nuance in $19.7 billion deal
CEO Satya Nadella continues to aggressively transform Microsoft (MSFT $255), with his latest move being the acquisition of pioneering speech-recognition ("conversational AI") company Nuance (NUAN) for $19.7 billion ($16 billion plus assumption of debt). The all-cash deal values Nuance at $56 per share, or a 23% premium over Friday's close. The move should give Microsoft a greater presence in the growing field of health information services, and should also be cause for concern for the likes of $22 billion, Missouri-based Cerner (CERN $73). Nuance offers health care professionals the tools to recognize and transcribe speech during doctor's visits, both in-person and digital (telemedicine). Appointment management, patient support, and the efficient creation and maintenance of complete medical records are a few of Nuance's extensive list of offerings. While health care is the leading source the firm's revenues, it also operates in the financial services, telecom, retail, and government sectors. The deal would represent Microsoft's second-largest ever, behind only the 2016 acquisition of LinkedIn for $27 billion.
Microsoft is one of the forty holdings within the Penn Global Leaders Club, and remains one of our strongest-conviction buys at its current price.
Global Strategy: Europe
04. Could an internecine battle in Germany help bring about a major regime change?
For some reason, it seems as though it has been about five years since Angela Merkel announced that she would be stepping down from her role as Chancellor of Germany—a position (stepping down, that is) rather forced upon her by the party she led between 2000 and 2018, the Christian Democratic Union (CDU). In what seems to be dragging on longer than Brexit, the battle for her successor just took a dramatic turn.
While there are roughly a dozen political parties in the country, the ruling alliance between the center-right CDU and the center-right Christian Social Union in Bavaria (CSU) has been a stabilizing factor in the country since nearly the end of World War II. Generally, the leader of the larger CDU, Merkel's party, gets the nod to represent the alliance in the national election. And, indeed, Merkel has backed her party's leader, Armin Laschet, to succeed her. However, the more charismatic Markus Söder, head of the CSU, believes that he is the right person for the job, and his party just sent a shocking snub to Merkel's pick. Söder points out how far the CDU has fallen in the polls since the former journalist took the reins of the party from Merkel three years ago. He is correct on both counts: that the party has fallen from grace since 2018, and that he could energize the electorate more than Laschet.
Of course, this battle has the center-left Social Democratic Party of Germany (SPD) licking its chops. It sees its own nominee, Olaf Scholz, gaining from the disarray. To further complicate the matter, Scholz is not only Merkel's deputy vice chancellor, he actually lost the race to be the leader of his own party. We won't even get into the far-left Green Party, or the far-right Alternative for Germany (AfD), or even the Pirate Party, which opposes the EU's data retention policies. It should be fun to watch (from across the ocean) as battles play out over the next five months—the country has set its official federal election date as 26 September 2021.
The ugliness could spiral out of control, with a real possibility that Scholz could pull out a victory. Considering the gargantuan problems facing Germany right now, perhaps the real question should be why would anyone want to be chancellor?
Cryptocurrencies
03. There is an enormous crypto opportunity coming Wednesday via direct listing; should you buy?
If we ever had any doubts about the long-term viability of cryptos, that ended when it became clear that China has plans to create its own global reserve currency (dollar envy). It has decided to do that in the form of a government-backed digital currency, a sovereign Bitcoin if you will. Technically called the Digital Currency Electronic Payment, or DCEP, the currency will allow the Communist Party of China to further control the entire banking system in China and, in the hopes and dreams of the master planners, create a tool to overtake the dollar as the world's reserve currency. Will it work? Probably not—at least not to the extent China hopes. However, it points to the critical importance of the American government both understanding and embracing cryptos.
On that note, Something big will happen in the crypto world on Wednesday: Coinbase will go public via a direct listing. As the largest cryptocurrency exchange, the San Fran-based company (though it has no official physical headquarters) acts as a secure online platform for buying, selling, transferring, and storing digital currency. The fact that it is part of the support structure, rather than an entity tied to the success of any one single crypto such as Bitcoin, makes the company extremely interesting. Not only that, it is (get ready) already profitable! The firm had a blowout Q1, with earning of around $800 million on revenues of $7.2 billion. And that revenue base represented an 850% spike from the same quarter a year earlier. There is only one problem with this intriguing investment. With the rabid interest circulating around cryptos and the millions of new myopic retail investors now in the game, Coinbase will probably come out of the chute with a market cap in excess of $100 billion, and some will be willing to jump in at any price ("diamond hands, baby"). We will be watching the action closely, and if the price is too expensive on its first day of trading we recommend investors wait for the shares to come down and settle within a reasonable range.
Cryptos, despite what we said about their inevitable future, still operate in a normal market cycle of peaks, contractions, troughs, and expansions. Don't get too caught up in the hype: when everyone is jumping into the water with their eyes closed, it is always wise advice to wait until the sharks send them fleeing for safety.
Media & Entertainment
02. Physical games meet digital gaming as Roblox and Hasbro team up
Last month we wrote about the exciting new (to the markets) online entertainment platform Roblox (RBLX $83), which allows users to code their own games and share them for other gamers to play—often earning a little profit in the process. One 98-year-old gaming company which few associate with technology, Hasbro (HAS $99), is hoping to breathe some new life into its lineup by joining forces with the online platform. Specifically, the toy and game company's Nerf and Monopoly lines will soon include codes for Roblox players to redeem for virtual items. Additionally, a number of Roblox games will be created around the iconic products. For example, buy a Nerf Blaster and receive a code to score an online Nerf Blaster to use in games such as Jailbreak and Arsenal. A new version of Monopoly, to be available later this year, will include Roblox characters and come with codes to acquire other online items. We're not sure which company came up with the brainstorm, but if it was Hasbro's idea, it is the latest in a series of smart moves. Recall that five years ago the company scored a major coup in taking the Disney line away from Mattel (MAT $20) after a sixty year relationship was fractured. For an old-school toy company living in a digital world, Hasbro continues to impress.
The ten-year chart of Hasbro vs Mattel highlights the great struggle between the two iconic brands. Some analysts still believe that $14 billion Hasbro should acquire Mattel, half its size. There is little doubt that the former is leading the latter in digital acumen; plus, who wouldn't want to own the coveted Barbie and American Girl lines?
Under the Radar Investment
01. Accolade Inc
There are many corners of the health care market with which investors are enamored, from big pharma to biotech to medical devices and testing, but one area which remains relatively ignored is the health information services arena. The industry made news this week with Microsoft's announcement that it would buy Nuance in a nearly $20 billion deal, but a firm much deeper under the radar screen of investors is $2.8 billion Accolade Inc (ACCD $48). Accolade is a tech-based firm which helps employers provide individualized health care "advocacy" for their employees, to include putting them in touch with nurses and specialists on demand, coordinating their care, and providing the best resources for their individual needs. Mention "company health care plan" to most employees and they will picture a byzantine system which includes long lines on hold and inexplicable bills arriving in the mail. Accolade turns that model on its head. We place a fair value of $60 on the shares. At $2.8 billion in size, the firm has plenty of room to grow.
Answer
Three Polish-Jewish siblings founded Hassenfeld Brothers in 1923, selling textile remnants, then school supplies, then—ultimately—toys. They would later shorten the name to Hasbro. The brothers' first hit toy came along in 1952 in the form of a lumpy brownish potato; included in the kit were hands, feet, ears, two mouths, two pairs of eyes, four noses, three hats, eyeglasses, a pipe, and some felt which resembled facial hair.
Headlines for the Week of 21 Mar—27 Mar 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...
Correction: The Penn Wealth Report, Vol. 9 Issue 02
In the "From the Editor" section of the latest Penn Wealth Report it was mistakenly noted that the Nasdaq began its massive 78% drop sixteen years ago this month. This should have read "twenty-one years ago this month." The publication has been updated.
Question
The first video blockbuster...
For some reason, the Roblox image made us think of the early days of video games. On that note, what was the first blockbuster video game (which seemed so futuristic at the time), and when was it released?
Penn Trading Desk:
ARK Invest: Tesla going to $3,000
Cathie Wood's ARK Invest ETFs have taken the investment world by storm. From the ARK Industrial Innovation fund to the ARK Genomic Revolution, she has quickly built a reputation of being an oracle for emerging technologies. Her bold call this week on where Tesla (TSLA $670) is headed raised some eyebrows, along with the price of the shares. She sees the leading EV maker's shares headed to $3,000 by 2025, which would give the firm a market cap in the neighborhood of $3.5 trillion. While $3,000 is ARK's base case for TSLA, they did list a 2025 bear case price of $1,500 per share. One big catalyst for the price jump, Wood argues, is the potential for a large fleet of robotaxis hitting the streets over the coming five years, which she sees Tesla spearheading. With the shares off around 5% for the year, at $670, true believers should probably see this as an opportunity to jump in—or add to their position.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Telecom Services
10. AT&T is finally spinning off its satellite and cable TV services
Back in 2015, telecom giant AT&T (T $30) acquired satellite television service provider DirecTV for $66 billion ($49B plus debt), thus beginning a comical boondoggle for the firm. Finally, six years later, T is offloading the albatross for a fraction of what it paid. More accurately, the company is spinning off its satellite and cable operations into a new company with the help of private equity group TPG Capital, which will pay nearly $8 billion in cash to become a minority owner. The new entity will hold DirecTV, AT&T TV (the firm's cord-cutting attempt), and U-Verse (which it left on the vine to die when it bought DirecTV). Fair value of the company sits somewhere around $16 billion, with T owning 70% and TPG owning the remaining 30%. What will management do with the $8 billion windfall? The company said it plans to pay down debt; based on the fact that this $210 billion telecom has approximately $346 billion in short- and long-term debt, that is probably not a bad idea. CEO John Stankey said the move will allow AT&T to focus on "connectivity and content," meaning the 5G wireless, fiber internet, and HBO Max businesses. The deal should close in the second half of this year.
We purchased AT&T in the Penn Strategic Income Portfolio years ago, based primarily on its fat dividend yield and seemingly reasonable price. The dividend yield now sits at 7% and the share price remains flat from where we bought in. Management continues to disappoint, but we still believe a fair value of the shares is around $35, or roughly 20% higher from here.
Cybersecurity
09. A massive Chinese hack hits Microsoft...and some 60,000 of its organizational and corporate customers
While there may not be a "hot" war raging between the United States and both China and Russia, the actions of these two nation-states clearly indicate that they are at battle with this country. What it will take for the United States to get on a war footing is unclear, as thousands of victims continue to fall prey to these adversaries. The latest attack took place within the Microsoft Exchange—a mail and calendar server used by some 200 million individuals and corporations. Unlike the cowardly stance taken by Amazon (AMZN), at least Microsoft has been forthcoming with respect to the attacks made on its systems, and has been willing to identify the culprits to help other companies better protect their customer data.
This latest attack, according to the company, was perpetrated by a Chinese-sponsored group known as Hafnium. This group typically targets infectious disease researchers, defense contractors, and other critical agencies in an effort to both steal knowledge and cause general disruption. Adding insult to injury, the group gets its guidance from the Chinese government but uses servers it leases within the United States. The hackers first gained access to the Exchange by exploiting previously-unknown vulnerabilities, then created a malicious web-based interface to take control of the compromised servers remotely. Finally, they used this remote access to steal data from the targeted individuals and organizations. While Microsoft has identified and patched the vulnerability, the perpetrators already in the "body" may still operate untouched. In other words, they were already on the inside when the patch was put in place.
While a serious federal response is needed, which includes an ongoing series of counterstrikes to send a message, companies and individuals must take responsibility and adopt next-level security practices such as multi-factor authentication and deployment of the highest possible level of cybersecurity protection. Unfortunately, these measures will be irritating and costly, but it sure beats the alternative.
We praise Microsoft for having the guts to be transparent with regard to these attacks, and encourage timid firms like Amazon to follow suit. For investors, cybersecurity—sadly—will be one of the hottest industries for the foreseeable future. We recommend scanning the Penn holding CIBR, the First Trust NASDAQ Cybersecurity ETF, for individual names to consider.
Computer Software/Gaming
08. Roblox is not just another gaming stock, but should you invest?
Admittedly, online gaming stocks don't typically get us very excited from an investment standpoint. Roblox (RBLX $67), however, may just prove to be the exception. Granted, the company came out of the gate with a crazy valuation—it lost $253M on a paltry $924M in revenues in 2020, yet the GameStop crowd made it a $40 billion company by the end of its first day of trading. Want some perspective on that? Ford (F) has a market cap of $49 billion. This particular online entertainment platform, however, has a very unique story. More than just a place to play around (over half of the company's 33 million daily users are 13 or younger), users actually program games and play games created by other users. And it doesn't take a degree in programming to participate: Roblox offers even the youngest of users online tutorials to teach them how to create. "We offer free resources to teach students of all ages real coding, game design, digital civility, and entrepreneurial skills," reads a lead-in to one of their education pages.
Game developers on the platform earn "robux," digital currency which can be created to cold, hard cash. Over 1,250 developers/gamers earned at least $10,000 in robux last year, with several hundred earning over $100,000. Two British teens, who produced their first Roblox game when they were just 13, made a splash in the BBC when it was reported that they paid off their parents mortgage using their converted robux. It doesn't take much to get a large percentage of the younger generation hooked on gaming; imagine what happens when potential to make money is added to the mix. We also appreciate the fact that these young developers are actually learning analytical skills along the way. The shares may seem pricey now (they have dropped back from a high of $79.10), but the company is for real, and it comes with a unique value proposition for investors—unlike GameStop.
There is going to be a substantial tech pullback this year, and we can expect the gaming stocks which are not generating a profit to get hit hard. Where would a decent buy point for RBLX shares reside? If they drop back to $60 or lower, and they fit the respective portfolio mix, it would be wise to take a deeper dive and considering picking some up. In the meantime, why not "sign up and start having fun?" You might even earn some robux while waiting for the shares to become more attractive.
Pharmaceuticals
07. Vaccine Spring: All along, there was only one Covid-19 vaccine we said we would not take
Long before the world knew anything about the Wuhan-borne virus which would rapidly escalate into a global pandemic, we were highly bullish on American pharmaceutical and biotech companies. The more politicians bashed these companies, which create the life-saving medications hundreds of millions of people use annually, the angrier we got. If these politicians had their way, cutting-edge research and development within the pharmaceutical industry would take a major hit—as would the overall health of Americans. Before we work ourselves into a lather once again, let's focus on the incredible progress researchers at these firms made with respect to uncovering a vaccine for the pandemic. With Manhattan Project-like speed, the men and women at these pharma and biotech companies developed, tested, produced, and delivered highly effective therapies to prevent the deadly disease (535,000 Americans have died from Covid as of this writing).
While we would feel comfortable receiving the Pfizer-BioNTech (PFE/BNTX), Moderna (MRNA), or Johnson & Johnson (JNJ) vaccines, we have held serious reservations about one company's efforts from the start. Since early testing began, AstraZeneca PLC's (AZN) vaccine seemed to generate more questions than it answered, and we didn't like the answers management was doling out. Thankfully, the AZN vaccine was never approved for emergency use in the United States, as it was in Europe. Now, three major European countries, Germany, France, and Italy, are joining a rapidly-growing list of nations which have suspended the vaccine following reports of blood clots in the legs and/or lungs of a number of recipients. True to form, the company quickly blasted the suspensions, claiming that the percentage of those vaccinated who developed clots were in line with what could be expected within the general population. It should be noted that a number of those coming down with the conditions resided in younger age groups; i.e., below the age these maladies would typically develop.
The company's objections were reminiscent—at least to us—of their response following the questionable trial results. There never seemed to be a sense of "let's make absolutely sure of this..." so much as "nothing to see here, move along." And that makes us uncomfortable. A lot of nations now seem to feeling ill at ease with the company's vaccine as well. UPDATE: It appears that most of the nations which put a halt on the AstraZeneca vaccines are now willing to lift the temporary bans, mainly due to external pressure. We would still not feel comfortable taking the product, especially as the J&J vaccine begins to flood the market.
AstraZeneca was the result of a 1999 merger between Sweden's Astra and the UK's Zeneca Group. Pfizer's partner BioNTech, it should be noted, is based in Mainz, Germany. We own Pfizer in the Penn Global Leaders Club, and it remains one of our highest-conviction buys.
Global Strategy: Southeast Asia
06. The new administration took a tough stance with China in first official meeting; now, let's look for continuity
Thankfully, John Kerry was nowhere near the Captain Cook Hotel in Anchorage this past week. The first official meeting between the Biden administration and the Communist Party of China was anything but a love-fest, and that gives us encouragement that the US won't get rolled over the next four years. In what was to be a brief photo-op, US Secretary of State Anthony Blinken and US National Security Advisor Jake Sullivan gave their Chinese counterparts an earful, expressing concern over issues from Hong Kong to questionable trade practices to cybersecurity. Secretary Blinken: "...the US relationship with China will be competitive where it should be, collaborative where it can be, adversarial where it must be." He went on to express the concerns raised (about China) from allies such as Japan and South Korea: "I have to tell you what I'm hearing is very different from what you described." Surprisingly stark language for an audience that wanted to hear sycophantic praise for the Chinese people and the ruling communist party. The frustration was revealed in a response by Chinese Director of the Central Foreign Affairs Commission, Yang Jiechi: "...the United States does not have the qualification to say that it wants to speak to China from a position of strength...this is not the way to deal with the Chinese people." A nerve was touched, to put it mildly.
Of course, what really matters is how the Biden administration actually deals with the communist nation going forward. Nonetheless, neither the spirit of Neville Chamberlain nor John Kerry seemed to be present in the room—which gives us quite a bit of comfort.
One of our biggest beefs with the Trump administration was the lack of willingness to join with our allies in a united front against unacceptable Chinese behavior. We are virtually certain that will not be the case with the new administration. China also made a major miscalculation by unleashing the massive cyber strike against Microsoft so early in Biden's term, leaving him almost no choice but to take a tough stance against our major global nemesis. Russia is trying to join forces with China against the US on several fronts, such as a planned Sino-Russian moon base, but Russia remains a shell of its former self, with an economy fueled—no pun intended—overwhelmingly by fossil fuels. A full 82% of the world's population does not reside in China, and a majority of that percentage hold animosity for—or, at least, a deep mistrust of—China. The US must work to garner a true global coalition against the CCP's global ambitions. We can't think of any more important strategic US focus over the coming years.
Road & Rail
05. America is losing one of its great and storied railroads as Canadian Pacific set to acquire Kansas City Southern
It has been twelve years since Warren Buffett's "affinity for railroads as a kid" led him to take a great American rail, Burlington Northern Santa Fe, private, and we still aren't over it—BNI was one of our favorite holdings in the Penn Global Leaders Club. Now, investors are about to lose another great name in the space: Canadian Pacific (CP $370) plans to acquire Kansas City Southern (KSU $260) for $25 billion plus the assumption of roughly $4 billion in debt. As a north-south rail, Kansas City Southern has been a major play on trade between the United States and Mexico: the firm owns 3,400 route miles in the US, and an interest in 3,300 miles of rail in Mexico. Canadian Pacific is a $50 billion rail which operates 12,500 miles of track throughout most of Canada and into parts of the Northeastern and Midwestern US. While it will be tough to say goodbye to KSU, the deal actually makes a lot of sense. As Canada became the last nation to approve the new USMCA trade pact last March, the new rail will be a beast, controlling a north-south route throughout the pact's domain. For the first time ever, one rail will connect all three nations. Current CP CEO Keith Creel will head up the new giant, which will be based out of Calgary, Alberta. At least investors will still have the ability to own Kansas City Southern, albeit through CP shares—last fall the rail rejected a $208/share bid from the Blackstone Group which would have taken the firm private.
Although there will be a regulatory fight, this acquisition will ultimately be approved. If the USMCA lives up to its potential, Canadian Pacific will be in a great position to streamline its operations, improve profitability, and grow its market share. While we don't own CP, we are bullish on the shares, which currently sit around $370.
Monetary Policy
04. The Fed calmed market fears last week, but its growing balance sheet is concerning
Fed Chair Jerome Powell said just about everything right at his Q&A following last week's FOMC meeting. The Fed upgraded its US GDP expectations for the year from 4.2% to 6.5%; inflation may well go above 2% in the short-term, but that was OK; and the central bank would continue buying bonds at a clip of $120 billion per month. The markets may have cheered the news, but the rising debt load of the Fed, which is part of the nation's $28 trillion overall debt load, is concerning. Before the 2008 financial crisis, the Fed's balance sheet was below $1 trillion. It more than doubled due to the crisis, then plateaued around $2.8 trillion before mushrooming again in 2013 and 2014. Steady at about $4.5 trillion for several years, it did something few would expect: it began falling—all the way back down to $3.6 trillion in September of 2019. Of course, we know what hit the world six months later, causing the balance sheet to more than double. Just shy of $8 trillion now, we can expect (based on Powell's comments) that it will hit $9 trillion before any talk of tapering. Of major note at the FOMC meeting was the fact that only four members saw rates rising in 2022 and another eight (of the eighteen) saw rates coming off of zero in 2023. That is remarkable, at least until we consider that every tick up in rates makes servicing our $28 trillion national debt all the costlier. At least we are not alone in the boat; governments around the world are awash in debt, with few showing signs of hiking rates. In the meantime, let the party continue.
For the first time in a year, the pandemic is not the market's biggest concern—and that is wonderful news. Right now, investors have turned their attention to inflation and Treasury rates creeping up. Our biggest concern right now is none of the above. We see valuations reaching crazy levels on some high-flying tech names which won't turn a profit for years. There will be a tech reckoning at some point this year, which is one reason we have been maneuvering toward a value tilt. Also, portfolios simply got overweighted in growth names due to the run-up. This spring is certainly a good time for a portfolio tune-up.
Auto Parts
03. Goodyear to buy Cooper Tire & Rubber Company for $2.8 billion
There aren't many tire manufacturers based in the United States these days, so the two biggest might as well join forces. Goodyear Tire & Rubber Company (GT $17) has announced its plans to acquire smaller US rival Cooper Tire (CTB) for $2.8 billion in cash and stock. Goodyear, which trails only France's Michelin and Japan's Bridgestone by sales, will suddenly have a much larger global footprint: 50 factories and 72,000 employees around the world, and sales volume of 64 million replacement tires in the US. With demand for replacement tires expected to grow rapidly in the coming years, the move should allow the new entity to grow market share substantially in both the US and China—the industry's two largest markets. Both companies are based out of Ohio.
Obviously, the commodity price of rubber plays a major role in a tire manufacturer's bottom line. Fortunately, global rubber prices have dropped precipitously over the past decade. We would put a fair value on the price of Goodyear shares, post-merger, at $20.
Business & Professional Services
02. Will GoPuff be the poster child for the coming post-pandemic market reality check?
For anyone not familiar with SoftBank, it is the Masayoshi Son-run business that tried to bring WeWork public with founder and walking nightmare Adam Neumann still at the helm (at least originally). For anyone not familiar with GoPuff, it is yet another delivery service which brings products from the store to your home. The latter is being financially backed, in good measure, by the former. Why, you might ask, does America need another delivery service with established competitors such as Amazon, DoorDash, Uber Eats, GrubHub, Walmart, Drizly, Instacart, and an army of grocery stores which are getting into the game? We wish we had the answer. As for their unique value proposition (UVP), the delivery service brings household items such as OTC medicines, snacks, and household essentials to your doorstep. In essence, you are saved that pesky trip to Walgreens. (Actually, don't some of these competitors already do that?)
Forget the viability—or lack thereof—of the company's UVP; we are more concerned about the valuation. In October of 2020, the company raised funds which valued the enterprise at just under $4 billion. Now, fueled with a new round of funding, it is valued at just shy of $9 billion. Keep this in mind as well: GoPuff will probably go public this year, and we have all seen what happens to these novelty (our word) startups out of the gate—many see their shares double or even triple before the dust settles. So, we have a company that may be worth $4 billion (doubt it), it is now valued at $9 billion, and it may be at $20 billion after the IPO. Does that make sense? We love DoorDash, but how many DASH investors even realize that the firm, which has never turned a profit, has a $44 billion market cap as of this writing? There is a house of cards being built, and every house of cards eventually comes crashing down.
Forget the hype being pushed by the old media or on social media with respect to these companies. Do the research, figure out whether they actually do have a UVP, take a look at the numbers, consider the management team in place, and make wise investment decisions based on the easily-accessible research available to virtually everyone. Maybe it is FOMO, or maybe we are simply going stir-crazy in our homes, but there is a whole lot of gambling going on within the markets right now.
Under the Radar Investment
01. Adaptive Biotechnologies Corp
Adaptive Biotechnology Corp (ADPT $42) is a $6 billion biotech firm working in the field of what they refer to as Immune Medicine. By harnessing the power of the adaptive immune system, a subsystem which contains processes that eliminate pathogens or prevent their growth, the company believes it can transform the diagnosis and treatment of disease. The company's clinical diagnostic product, clonoSEQ, is an FDA-authorized test for the detection and monitoring of minimal residual disease in patients with blood cancers. The cornerstone of Adaptive's Immune Medicine platform, immunoSEQ, serves as its underlying R&D engine and generates revenue from academic and biopharmaceutical customers. Shares have dropped from their $71.25 high reached on 25 Jan 2021.
Answer
Space Invaders, created in 1978 by Tomohiro Nishikado, was licensed in the US by the Midway division of Bally. By 1982, the game had grossed nearly $4 billion, making it both the best-selling and highest-grossing (adjusted for inflation) video game of all time.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Correction: The Penn Wealth Report, Vol. 9 Issue 02
In the "From the Editor" section of the latest Penn Wealth Report it was mistakenly noted that the Nasdaq began its massive 78% drop sixteen years ago this month. This should have read "twenty-one years ago this month." The publication has been updated.
Question
The first video blockbuster...
For some reason, the Roblox image made us think of the early days of video games. On that note, what was the first blockbuster video game (which seemed so futuristic at the time), and when was it released?
Penn Trading Desk:
ARK Invest: Tesla going to $3,000
Cathie Wood's ARK Invest ETFs have taken the investment world by storm. From the ARK Industrial Innovation fund to the ARK Genomic Revolution, she has quickly built a reputation of being an oracle for emerging technologies. Her bold call this week on where Tesla (TSLA $670) is headed raised some eyebrows, along with the price of the shares. She sees the leading EV maker's shares headed to $3,000 by 2025, which would give the firm a market cap in the neighborhood of $3.5 trillion. While $3,000 is ARK's base case for TSLA, they did list a 2025 bear case price of $1,500 per share. One big catalyst for the price jump, Wood argues, is the potential for a large fleet of robotaxis hitting the streets over the coming five years, which she sees Tesla spearheading. With the shares off around 5% for the year, at $670, true believers should probably see this as an opportunity to jump in—or add to their position.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Telecom Services
10. AT&T is finally spinning off its satellite and cable TV services
Back in 2015, telecom giant AT&T (T $30) acquired satellite television service provider DirecTV for $66 billion ($49B plus debt), thus beginning a comical boondoggle for the firm. Finally, six years later, T is offloading the albatross for a fraction of what it paid. More accurately, the company is spinning off its satellite and cable operations into a new company with the help of private equity group TPG Capital, which will pay nearly $8 billion in cash to become a minority owner. The new entity will hold DirecTV, AT&T TV (the firm's cord-cutting attempt), and U-Verse (which it left on the vine to die when it bought DirecTV). Fair value of the company sits somewhere around $16 billion, with T owning 70% and TPG owning the remaining 30%. What will management do with the $8 billion windfall? The company said it plans to pay down debt; based on the fact that this $210 billion telecom has approximately $346 billion in short- and long-term debt, that is probably not a bad idea. CEO John Stankey said the move will allow AT&T to focus on "connectivity and content," meaning the 5G wireless, fiber internet, and HBO Max businesses. The deal should close in the second half of this year.
We purchased AT&T in the Penn Strategic Income Portfolio years ago, based primarily on its fat dividend yield and seemingly reasonable price. The dividend yield now sits at 7% and the share price remains flat from where we bought in. Management continues to disappoint, but we still believe a fair value of the shares is around $35, or roughly 20% higher from here.
Cybersecurity
09. A massive Chinese hack hits Microsoft...and some 60,000 of its organizational and corporate customers
While there may not be a "hot" war raging between the United States and both China and Russia, the actions of these two nation-states clearly indicate that they are at battle with this country. What it will take for the United States to get on a war footing is unclear, as thousands of victims continue to fall prey to these adversaries. The latest attack took place within the Microsoft Exchange—a mail and calendar server used by some 200 million individuals and corporations. Unlike the cowardly stance taken by Amazon (AMZN), at least Microsoft has been forthcoming with respect to the attacks made on its systems, and has been willing to identify the culprits to help other companies better protect their customer data.
This latest attack, according to the company, was perpetrated by a Chinese-sponsored group known as Hafnium. This group typically targets infectious disease researchers, defense contractors, and other critical agencies in an effort to both steal knowledge and cause general disruption. Adding insult to injury, the group gets its guidance from the Chinese government but uses servers it leases within the United States. The hackers first gained access to the Exchange by exploiting previously-unknown vulnerabilities, then created a malicious web-based interface to take control of the compromised servers remotely. Finally, they used this remote access to steal data from the targeted individuals and organizations. While Microsoft has identified and patched the vulnerability, the perpetrators already in the "body" may still operate untouched. In other words, they were already on the inside when the patch was put in place.
While a serious federal response is needed, which includes an ongoing series of counterstrikes to send a message, companies and individuals must take responsibility and adopt next-level security practices such as multi-factor authentication and deployment of the highest possible level of cybersecurity protection. Unfortunately, these measures will be irritating and costly, but it sure beats the alternative.
We praise Microsoft for having the guts to be transparent with regard to these attacks, and encourage timid firms like Amazon to follow suit. For investors, cybersecurity—sadly—will be one of the hottest industries for the foreseeable future. We recommend scanning the Penn holding CIBR, the First Trust NASDAQ Cybersecurity ETF, for individual names to consider.
Computer Software/Gaming
08. Roblox is not just another gaming stock, but should you invest?
Admittedly, online gaming stocks don't typically get us very excited from an investment standpoint. Roblox (RBLX $67), however, may just prove to be the exception. Granted, the company came out of the gate with a crazy valuation—it lost $253M on a paltry $924M in revenues in 2020, yet the GameStop crowd made it a $40 billion company by the end of its first day of trading. Want some perspective on that? Ford (F) has a market cap of $49 billion. This particular online entertainment platform, however, has a very unique story. More than just a place to play around (over half of the company's 33 million daily users are 13 or younger), users actually program games and play games created by other users. And it doesn't take a degree in programming to participate: Roblox offers even the youngest of users online tutorials to teach them how to create. "We offer free resources to teach students of all ages real coding, game design, digital civility, and entrepreneurial skills," reads a lead-in to one of their education pages.
Game developers on the platform earn "robux," digital currency which can be created to cold, hard cash. Over 1,250 developers/gamers earned at least $10,000 in robux last year, with several hundred earning over $100,000. Two British teens, who produced their first Roblox game when they were just 13, made a splash in the BBC when it was reported that they paid off their parents mortgage using their converted robux. It doesn't take much to get a large percentage of the younger generation hooked on gaming; imagine what happens when potential to make money is added to the mix. We also appreciate the fact that these young developers are actually learning analytical skills along the way. The shares may seem pricey now (they have dropped back from a high of $79.10), but the company is for real, and it comes with a unique value proposition for investors—unlike GameStop.
There is going to be a substantial tech pullback this year, and we can expect the gaming stocks which are not generating a profit to get hit hard. Where would a decent buy point for RBLX shares reside? If they drop back to $60 or lower, and they fit the respective portfolio mix, it would be wise to take a deeper dive and considering picking some up. In the meantime, why not "sign up and start having fun?" You might even earn some robux while waiting for the shares to become more attractive.
Pharmaceuticals
07. Vaccine Spring: All along, there was only one Covid-19 vaccine we said we would not take
Long before the world knew anything about the Wuhan-borne virus which would rapidly escalate into a global pandemic, we were highly bullish on American pharmaceutical and biotech companies. The more politicians bashed these companies, which create the life-saving medications hundreds of millions of people use annually, the angrier we got. If these politicians had their way, cutting-edge research and development within the pharmaceutical industry would take a major hit—as would the overall health of Americans. Before we work ourselves into a lather once again, let's focus on the incredible progress researchers at these firms made with respect to uncovering a vaccine for the pandemic. With Manhattan Project-like speed, the men and women at these pharma and biotech companies developed, tested, produced, and delivered highly effective therapies to prevent the deadly disease (535,000 Americans have died from Covid as of this writing).
While we would feel comfortable receiving the Pfizer-BioNTech (PFE/BNTX), Moderna (MRNA), or Johnson & Johnson (JNJ) vaccines, we have held serious reservations about one company's efforts from the start. Since early testing began, AstraZeneca PLC's (AZN) vaccine seemed to generate more questions than it answered, and we didn't like the answers management was doling out. Thankfully, the AZN vaccine was never approved for emergency use in the United States, as it was in Europe. Now, three major European countries, Germany, France, and Italy, are joining a rapidly-growing list of nations which have suspended the vaccine following reports of blood clots in the legs and/or lungs of a number of recipients. True to form, the company quickly blasted the suspensions, claiming that the percentage of those vaccinated who developed clots were in line with what could be expected within the general population. It should be noted that a number of those coming down with the conditions resided in younger age groups; i.e., below the age these maladies would typically develop.
The company's objections were reminiscent—at least to us—of their response following the questionable trial results. There never seemed to be a sense of "let's make absolutely sure of this..." so much as "nothing to see here, move along." And that makes us uncomfortable. A lot of nations now seem to feeling ill at ease with the company's vaccine as well. UPDATE: It appears that most of the nations which put a halt on the AstraZeneca vaccines are now willing to lift the temporary bans, mainly due to external pressure. We would still not feel comfortable taking the product, especially as the J&J vaccine begins to flood the market.
AstraZeneca was the result of a 1999 merger between Sweden's Astra and the UK's Zeneca Group. Pfizer's partner BioNTech, it should be noted, is based in Mainz, Germany. We own Pfizer in the Penn Global Leaders Club, and it remains one of our highest-conviction buys.
Global Strategy: Southeast Asia
06. The new administration took a tough stance with China in first official meeting; now, let's look for continuity
Thankfully, John Kerry was nowhere near the Captain Cook Hotel in Anchorage this past week. The first official meeting between the Biden administration and the Communist Party of China was anything but a love-fest, and that gives us encouragement that the US won't get rolled over the next four years. In what was to be a brief photo-op, US Secretary of State Anthony Blinken and US National Security Advisor Jake Sullivan gave their Chinese counterparts an earful, expressing concern over issues from Hong Kong to questionable trade practices to cybersecurity. Secretary Blinken: "...the US relationship with China will be competitive where it should be, collaborative where it can be, adversarial where it must be." He went on to express the concerns raised (about China) from allies such as Japan and South Korea: "I have to tell you what I'm hearing is very different from what you described." Surprisingly stark language for an audience that wanted to hear sycophantic praise for the Chinese people and the ruling communist party. The frustration was revealed in a response by Chinese Director of the Central Foreign Affairs Commission, Yang Jiechi: "...the United States does not have the qualification to say that it wants to speak to China from a position of strength...this is not the way to deal with the Chinese people." A nerve was touched, to put it mildly.
Of course, what really matters is how the Biden administration actually deals with the communist nation going forward. Nonetheless, neither the spirit of Neville Chamberlain nor John Kerry seemed to be present in the room—which gives us quite a bit of comfort.
One of our biggest beefs with the Trump administration was the lack of willingness to join with our allies in a united front against unacceptable Chinese behavior. We are virtually certain that will not be the case with the new administration. China also made a major miscalculation by unleashing the massive cyber strike against Microsoft so early in Biden's term, leaving him almost no choice but to take a tough stance against our major global nemesis. Russia is trying to join forces with China against the US on several fronts, such as a planned Sino-Russian moon base, but Russia remains a shell of its former self, with an economy fueled—no pun intended—overwhelmingly by fossil fuels. A full 82% of the world's population does not reside in China, and a majority of that percentage hold animosity for—or, at least, a deep mistrust of—China. The US must work to garner a true global coalition against the CCP's global ambitions. We can't think of any more important strategic US focus over the coming years.
Road & Rail
05. America is losing one of its great and storied railroads as Canadian Pacific set to acquire Kansas City Southern
It has been twelve years since Warren Buffett's "affinity for railroads as a kid" led him to take a great American rail, Burlington Northern Santa Fe, private, and we still aren't over it—BNI was one of our favorite holdings in the Penn Global Leaders Club. Now, investors are about to lose another great name in the space: Canadian Pacific (CP $370) plans to acquire Kansas City Southern (KSU $260) for $25 billion plus the assumption of roughly $4 billion in debt. As a north-south rail, Kansas City Southern has been a major play on trade between the United States and Mexico: the firm owns 3,400 route miles in the US, and an interest in 3,300 miles of rail in Mexico. Canadian Pacific is a $50 billion rail which operates 12,500 miles of track throughout most of Canada and into parts of the Northeastern and Midwestern US. While it will be tough to say goodbye to KSU, the deal actually makes a lot of sense. As Canada became the last nation to approve the new USMCA trade pact last March, the new rail will be a beast, controlling a north-south route throughout the pact's domain. For the first time ever, one rail will connect all three nations. Current CP CEO Keith Creel will head up the new giant, which will be based out of Calgary, Alberta. At least investors will still have the ability to own Kansas City Southern, albeit through CP shares—last fall the rail rejected a $208/share bid from the Blackstone Group which would have taken the firm private.
Although there will be a regulatory fight, this acquisition will ultimately be approved. If the USMCA lives up to its potential, Canadian Pacific will be in a great position to streamline its operations, improve profitability, and grow its market share. While we don't own CP, we are bullish on the shares, which currently sit around $370.
Monetary Policy
04. The Fed calmed market fears last week, but its growing balance sheet is concerning
Fed Chair Jerome Powell said just about everything right at his Q&A following last week's FOMC meeting. The Fed upgraded its US GDP expectations for the year from 4.2% to 6.5%; inflation may well go above 2% in the short-term, but that was OK; and the central bank would continue buying bonds at a clip of $120 billion per month. The markets may have cheered the news, but the rising debt load of the Fed, which is part of the nation's $28 trillion overall debt load, is concerning. Before the 2008 financial crisis, the Fed's balance sheet was below $1 trillion. It more than doubled due to the crisis, then plateaued around $2.8 trillion before mushrooming again in 2013 and 2014. Steady at about $4.5 trillion for several years, it did something few would expect: it began falling—all the way back down to $3.6 trillion in September of 2019. Of course, we know what hit the world six months later, causing the balance sheet to more than double. Just shy of $8 trillion now, we can expect (based on Powell's comments) that it will hit $9 trillion before any talk of tapering. Of major note at the FOMC meeting was the fact that only four members saw rates rising in 2022 and another eight (of the eighteen) saw rates coming off of zero in 2023. That is remarkable, at least until we consider that every tick up in rates makes servicing our $28 trillion national debt all the costlier. At least we are not alone in the boat; governments around the world are awash in debt, with few showing signs of hiking rates. In the meantime, let the party continue.
For the first time in a year, the pandemic is not the market's biggest concern—and that is wonderful news. Right now, investors have turned their attention to inflation and Treasury rates creeping up. Our biggest concern right now is none of the above. We see valuations reaching crazy levels on some high-flying tech names which won't turn a profit for years. There will be a tech reckoning at some point this year, which is one reason we have been maneuvering toward a value tilt. Also, portfolios simply got overweighted in growth names due to the run-up. This spring is certainly a good time for a portfolio tune-up.
Auto Parts
03. Goodyear to buy Cooper Tire & Rubber Company for $2.8 billion
There aren't many tire manufacturers based in the United States these days, so the two biggest might as well join forces. Goodyear Tire & Rubber Company (GT $17) has announced its plans to acquire smaller US rival Cooper Tire (CTB) for $2.8 billion in cash and stock. Goodyear, which trails only France's Michelin and Japan's Bridgestone by sales, will suddenly have a much larger global footprint: 50 factories and 72,000 employees around the world, and sales volume of 64 million replacement tires in the US. With demand for replacement tires expected to grow rapidly in the coming years, the move should allow the new entity to grow market share substantially in both the US and China—the industry's two largest markets. Both companies are based out of Ohio.
Obviously, the commodity price of rubber plays a major role in a tire manufacturer's bottom line. Fortunately, global rubber prices have dropped precipitously over the past decade. We would put a fair value on the price of Goodyear shares, post-merger, at $20.
Business & Professional Services
02. Will GoPuff be the poster child for the coming post-pandemic market reality check?
For anyone not familiar with SoftBank, it is the Masayoshi Son-run business that tried to bring WeWork public with founder and walking nightmare Adam Neumann still at the helm (at least originally). For anyone not familiar with GoPuff, it is yet another delivery service which brings products from the store to your home. The latter is being financially backed, in good measure, by the former. Why, you might ask, does America need another delivery service with established competitors such as Amazon, DoorDash, Uber Eats, GrubHub, Walmart, Drizly, Instacart, and an army of grocery stores which are getting into the game? We wish we had the answer. As for their unique value proposition (UVP), the delivery service brings household items such as OTC medicines, snacks, and household essentials to your doorstep. In essence, you are saved that pesky trip to Walgreens. (Actually, don't some of these competitors already do that?)
Forget the viability—or lack thereof—of the company's UVP; we are more concerned about the valuation. In October of 2020, the company raised funds which valued the enterprise at just under $4 billion. Now, fueled with a new round of funding, it is valued at just shy of $9 billion. Keep this in mind as well: GoPuff will probably go public this year, and we have all seen what happens to these novelty (our word) startups out of the gate—many see their shares double or even triple before the dust settles. So, we have a company that may be worth $4 billion (doubt it), it is now valued at $9 billion, and it may be at $20 billion after the IPO. Does that make sense? We love DoorDash, but how many DASH investors even realize that the firm, which has never turned a profit, has a $44 billion market cap as of this writing? There is a house of cards being built, and every house of cards eventually comes crashing down.
Forget the hype being pushed by the old media or on social media with respect to these companies. Do the research, figure out whether they actually do have a UVP, take a look at the numbers, consider the management team in place, and make wise investment decisions based on the easily-accessible research available to virtually everyone. Maybe it is FOMO, or maybe we are simply going stir-crazy in our homes, but there is a whole lot of gambling going on within the markets right now.
Under the Radar Investment
01. Adaptive Biotechnologies Corp
Adaptive Biotechnology Corp (ADPT $42) is a $6 billion biotech firm working in the field of what they refer to as Immune Medicine. By harnessing the power of the adaptive immune system, a subsystem which contains processes that eliminate pathogens or prevent their growth, the company believes it can transform the diagnosis and treatment of disease. The company's clinical diagnostic product, clonoSEQ, is an FDA-authorized test for the detection and monitoring of minimal residual disease in patients with blood cancers. The cornerstone of Adaptive's Immune Medicine platform, immunoSEQ, serves as its underlying R&D engine and generates revenue from academic and biopharmaceutical customers. Shares have dropped from their $71.25 high reached on 25 Jan 2021.
Answer
Space Invaders, created in 1978 by Tomohiro Nishikado, was licensed in the US by the Midway division of Bally. By 1982, the game had grossed nearly $4 billion, making it both the best-selling and highest-grossing (adjusted for inflation) video game of all time.
Headlines for the Week of 21 Feb—27 Feb 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 three worst months...
Going back to 1950, only three months of the year have averaged negative returns for the S&P 500. What are they, and which month is historically the worst?
Penn Trading Desk:
Penn: Open a "new energy" ETF in the New Frontier Fund
We are extremely bullish on the future of renewable energy, especially as it is virtually being mandated by governments around the world. It is a tricky area for investors to navigate, which is why we just added a new ETF to the Penn New Frontier Fund that invests equally in all five areas of this dynamic field: e-mobility, energy storage, performance materials, energy distribution, and energy generation. To see the specific action, Members can log into the Penn Trading Desk.
America is (finally) attempting a comeback in the rare earth arena; we opened a position in the company at the center of the battle
We have discussed, ad nauseam, how America willingly turned over the role of dominant rare earth miner to China, despite the national security risk of doing so. Now, one company plans to restore order in this critical corner of the market, and we have added that company to the Intrepid Trading Platform. Members, see the Penn Trading Desk.
Penn: Open Mid-Cap Gold and Silver Miner in Penn Global Leaders Club
We remain bullish on gold going forward, especially considering the world's perpetually-running currency printing presses. We are very bullish on silver for more industrial reasons. With that in mind, we acquired a Canadian mid-cap gold and silver miner with 30 million ounces of proven/probable gold reserves, and 60 million ounces of proven/probable silver reserves. Our first target price is 53% above the company's current price. Members, see the Penn Trading Desk.
Penn: Closed Aphria in Intrepid after massive run-up
We purchased Canadian pot stock Aphria for $4.63 on 13 Aug 2020 in large part because Irwin Simon took over as CEO. While we expected a longer hold time, the massive run-up in price couldn’t be ignored. We took our 440%, short-term gain, stopping out at $25 per share.
Wedbush: Raise price target on Microsoft
Analysts at Wedbush have raised their price target on Microsoft (MSFT $243) from $285 to $300, maintaining their Outperform rating. They argue that the tide is shifting in the cloud arms race—away from Amazon (AMZN) Web Services and towards Microsoft. We agree.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Transportation Infrastructure
10. Uber jumps on news it is buying booze delivery company Drizly
Approximately 22% of ride-sharing platform Uber's (UBER $57) revenue emanates from food and drink delivery, with its Uber Eats division lagging well behind the likes of DoorDash, Postmates, and Grubhub. The company is making an aggressive move to change that with its $1.1 billion purchase of Drizly, a services firm which currently offers beer, wine, and hard liquor deliveries in over 1,400 cities. The deal will be funded with a mix of Uber stock (90%) and cash (10%), and is expected to close in the first of of this year. While Uber will maintain a separate Drizly app for customers, it will integrate the Drizly marketplace into its existing Uber Eats app. Uber shares were up 7% on the day of the announcement.
This was a smart move, and we continue to see Uber as the dominant player in the industry. That being said, the company lost $7 billion on $12.8 billion in revenues over the trailing twelve months, with the pandemic doing immense harm to its business model. We see UBER shares fairly priced around $60, just $3 above where they currently sit.
Biotechnology
09. Jazz Pharmaceuticals PLC to acquire medical cannabis company GW Pharma for $7B
Jazz Pharmaceuticals (JAZZ $150) is an $8 billion biotech focused in the neurosciences, including sleep disorders, and oncology, including hematologic and solid tumors. The company has a solid and growing revenue stream, and positive net income going back ten years—no small feat for a mid-cap biotech. GW Pharmaceuticals PLC (GWPH $214) is a $6.7 billion biopharma company which develops and markets cannabis-based therapies, such as the first epilepsy drug derived from the marijuana plant. This past week, the Ireland-based Jazz announced it would be acquiring the UK-based GW for approximately $7 billion in a mix of cash, debt, and newly-issued Jazz stock. This is a bold move for the company, considering the deal is worth about 90% of its own market cap and that GW hasn't turned a profit since 2012, but management believes that GW's Epidiolex drug for the treatment of epilepsy will be a billion-dollar blockbuster. Shares of Jazz were trading off about 8% on the news, while the deal sent GW Pharma shares soaring nearly 45% based on the premium paid for the acquisition.
It's a bold bet, but one we like—a lot. The drop in price of JAZZ shares makes the stock even more attractive. In a crazy market where investors are bidding up to buy companies which have never turned a profit, here is a company with explosive potential that has operated in the black for a decade.
Behavioral Finance
08. Sticking it to the man? Koss family cashes in as Reddit army targets the shorts
Readers may be vaguely familiar with the name Koss, but certainly not to the same extent as Bose, Beats, or Sony. To say the Wisconsin-based headphone maker was struggling is an understatement. In fact, going into this year the company was worth about $20 million—the most micro of micro-caps. Then the Reddit army discovered how many short sellers were betting on the company to fail, and sprang into action. Despite minuscule sales and a dearth of profits, they jacked the shares up from around $3 in early January to an intra-day high exceeding $120 per share on the 28th of the month. Corporate executives and the Koss family, which together control 75% of the shares, also sprang into action: they sold $44 million worth of shares of a company that had a market cap of $20 million going into the year. Who can blame them? When you know your company is worth about $3 per share and a group of retail investors suddenly make it worth 40 times that amount, why not rake in the dough? SEC filings show these insiders sold between approximately $20 and $60 per share. Among the family, president and CEO Michael Koss sold around $13 million worth of stock, while John Koss Jr., vice president of sales, sold almost exactly the same amount. The company had a short interest of around 35% before the madness began, putting it on the Reddit army's radar. Shares have since fallen back to $20, only about four times what we value them being worth.
Who knows, maybe the insiders sold the shares to raise cash for a new strategic push, though we doubt it. In the meantime, we would like to meet the "investors" who bought into a company with horrendous fundamentals while the share price was between $100 and $120. We would like to simply ask them "why?"
Cryptocurrencies
07. Tesla shifts $1.5 billion of its cash reserve to Bitcoin, will accept the crypto as a payment source soon
Going into the new year, $800 billion EV juggernaut Tesla (TSLA $854) had about $19 billion sitting in cash reserves. In a move that GM or Ford would never consider making, the firm revealed—via an SEC filing—that it has placed about $1.5 billion of that amount, or roughly 8%, in the cryptocurrency Bitcoin. Let there be no doubt, Bitcoin is not a currency; rather, it is a commodity. Forget the comparisons to the US dollar, compare it to gold or silver instead. The dollar is worth a dollar today, yesterday, and (hopefully) tomorrow. Certainly, its value will fluctuate, but it will not go up 60% in one month like Bitcoin has. Governments can print currencies 24/7, effectively reducing their value, but only 21 million bitcoins can be mined—and 18.6 million digital coins already exist. So, is there anything wrong with Tesla's cash management experts shifting 8% of the company's reserves into the commodity? We don't believe so. After all, they could also buy (based on their SEC filings) gold or silver as a store of cash. Given Elon Musk's belief in the future of cryptos, the move shouldn't be surprising. Furthermore, investors applauded the move: both Bitcoin and TSLA were trading higher following the announcement. The company also announced plans to accept Bitcoin as a means of payment in the near future.
We were true Bitcoin skeptics at first, but as soon as big payment processors like PayPal and Venmo got in the game, and as soon as we started looking a the non-physical product as a commodity rather than a currency, we warmed up to the crypto. Our biggest concern is this: Although only 21 million bitcoins will be mined, nothing will stop new, competing cryptocurrencies from being "discovered" in the digital world.
Maritime Shipping & Ports
06. Our maritime shipper spikes on the growing concern over container shortage
For anyone who believes that America, or the world in general, is ready to stand up to China's trade practices, try this one on for size: the communist nation ended 2020 with a record trade surplus. The demand for Chinese goods is now so great that the world is facing a shipping container crisis. Just how bad is it? Because the shippers can make so much more money on the goods leaving China as opposed to the goods entering the country—like grain from the United States—they are literally rushing back empty containers to China to alleviate the backlog of goods waiting at Chinese ports. Spot freight rates are up nearly 300% from a year ago. While that is a sick testament to the state of global trade, one industry is certainly reaping the rewards: the maritime shippers which had been crushed during the trade war and subsequent pandemic. We have been fascinated by this highly-cyclical industry for decades, and when one of our favorites, Nordic American Tankers (NAT $4), saw its share price drop to $2.80 this past October, we jumped in, adding the Bermuda-based shipper to the Penn Intrepid Trading Platform. NAT jumped 14% in one day on news of the container shortage. Think the run will be short-lived or that the shippers are now overvalued? Take a look at the accompanying chart on NAT. Despite the fact that there are nearly 200 million intermodal freight containers around the world, the rapid increase in demand caught nearly everyone off guard. Ready for the icing on the cake? 97% of these containers are now made in, you guessed it, China.
For a brief refresher on the shipping industry, visit our 2018 Penn Wealth Report story on The State of Global Shipping. We see the upswing continuing to gain momentum as global economies revive.
Global Health Threats
05. Hackers tried to poison the water supply of a small Florida town; is this the beginning of a new global health threat?*
Two days before the Super Bowl, in the Tampa suburb of Oldsmar, a technician at the Haddock Water Treatment Plant noticed something odd: the cursor was moving across his computer screen while his mouse sat idle. At first he assumed his supervisor was remotely logged in and simply checking out the systems of the plant, which provides drinking water to 15,000 local residents. His curiosity changed to panic when, a few hours later, the mysterious cursor began adjusting the level of chemicals being added to the water supply. Specifically, the level of sodium hydroxide (caustic soda) was being moved from the ordinary setting of 100 parts per million (ppm) to 11,100 ppm. At low levels, sodium hydroxide regulates PH levels; at high levels, it will damage human tissue. Officials at the plant quickly adjusted the settings back to normal, and they pointed out that PH testing mechanisms would have caught the problem before any contaminated water ever got to the taps, but does that make anyone feel at ease? The attack on the Oldsmar plant is eerily similar to a number of 2020 attacks on Israel's water supply, almost certainly the work of Iranian hackers. A disturbing new threat appears to be emerging; and, with over 100,000 water treatment facilities in the US, it is a threat which cannot be ignored.
In the next issue of The Penn Wealth Report, we will take a look at the threat to America's water supply and how we can prepare for an attack; we also take a look at some viable investment choices in the water utilities sector.
Aerospace & Defense
04. The weekend engine failure points to Raytheon's Pratt & Whitney unit, but we still point a finger at Boeing
It was the last thing Boeing (BA $212) needed (how many times have we said that over the past three years?): A Boeing 777, leaving Denver for Hawaii, had one of its two engines suffer an "uncontained failure," with fire and smoke visible to passengers, and with debris dropping down on a Denver suburb. Thankfully, the aircraft was able to make it back to the airport on one good engine and with no passenger injuries—unlike a very similar incident in 2018 which involved the death of a passenger following engine debris striking a window. That incident occurred just two months after a United Airlines 777 suffered engine failure, with a cracked fan blade forcing the aircraft to make an emergency landing in Honolulu. This is an extremely disturbing trend, and one which certainly places Raytheon's (RTX $73) Pratt & Whitney unit in the hot seat. But aircraft maker Boeing shares some blame, as problems continue to mount for the Chicago-based firm. First there were the deadly 737 crashes which grounded the fleet for the better part of two years. Then came the 787 Dreamliner "design flaws" and canceled orders. Now the 777 faces grounding in the US—and probably around the world. And the situation isn't looking much better on the space side of the business, with the company's problem-laden Starliner capsule and its high profile recent failures. In each case, Boeing can point fingers at suppliers or partners, but there is a point at which all fingers will point back to them. A sad state of affairs for a formerly-great American company.
The entire Boeing board of directors, along with its C-suite executives, should be broomed. The company needs a clean sweep if it has any chance of returning to its position of aerospace and defense dominance. Unfortunately, the very individuals which need to be fired are all part of the mutual admiration society which controls the decisions on leadership. If ever a company needed an aggressive activist investor to come along and force change, it is right now, and it is at Boeing. Even then, the company's downward flight path may be too steep to pull out of.
Automobiles
03. Investor darling Workhorse has its shares cut in half after losing USPS contract
It has been one of those "new investor" cult stocks with one of the key buzz phrases, or acronym in this case, that the new wave of retail money flocks to: EV. The company is Workhorse (WKHS $16), which has seen its stock price go from $2 per share a year ago to $43 per share a few weeks ago—all on the back of microscopic revenues and chronic annual losses. The financials didn't matter; pie-in-the-sky promises were enough to bring money flooding into the stock. The latest promise was the imminent contract by the United States Postal Service to replace its fleet of 150,000+ outdated vehicles. To Workhorse devotees, it was a foregone conclusion that their company would be the recipient. When the contract was awarded to the defense unit of $8 billion industrial firm Oshkosh (OSK $117), WKHS shares nosedived more than 50% in one day. The drop was so rapid that any stop order to protect gains would have been essentially worthless: investors would have been stopped-out at the bottom.
There are some great lessons in this story. Investors need to understand what they are buying, and they need do have at least some inkling as to a company's fundamentals. Forget the fact that Workhorse had never turned an annual profit, how about the fact that they were barely generating sales? As for "boring" old Oshkosh, the company has a pristine balance sheet and generates solid revenues—and profits—year after year. But who wants boring?
Anyone willing to take a little time to do some basic research can be greatly rewarded by the flow of "dumb money" right now. Don't get caught up in the hype and follow the lemmings off the cliff; use their moves to help uncover the value plays present in the market.
Market Pulse
02. Despite a bruising few weeks, February was a winner in the markets
It may be hard to believe based on the past two weeks, but equities actually hammered out a win in February. Not so for the week: each of the major benchmarks fell on the specter of rising rates. In a sign of just how the (fixed income) world has changed, the biggest hit came when the 10-year Treasury moved above the 1.5% mark on Thursday. It actually settled back down to 1.415% by Friday's close, but the rapid upward move spooked investors who are banking on ultra-low rates supporting further advances in the market. Even talk of another $1.9 trillion in government "stimulus" couldn't help—the NASDAQ was off just shy of 5% for the week, followed by the S&P 500 (-2.46%), and the Dow (-1.78%).
Nonetheless, the Dow closed out February with a healthy gain (3.17%), followed by the S&P 500 (2.61%), and the NASDAQ (0.93%). This is a far cry from one year ago as the new reality of the pandemic began to take hold. In February of 2020, the Dow was down 10.08%. Of course, those losses were nothing compared to what would follow in March. We never really know what's ahead, but it feels a lot better watching the effective Pfizer, Moderna, and (starting next week) Johnson & Johnson vaccines begin to eradicate this terrible virus than it did a year ago, facing insane toilet paper shortages and spiking hospitalization rates. If our biggest concern becomes a rising 10-year, then we really don't have much to complain about. One of these days, the realization that we now have a $30 trillion national debt will creep into our psyche, but let's focus on getting rid of the masks first.
Personally speaking, our biggest concern is actually not the rising 10-year; it is the madness going on with a bunch of stocks that couldn't turn a profit if their corporate lives depended on it. When falling confetti on an iPhone screen is all it takes to lure someone into buying an overpriced dog, something wicked this way comes. Yet another reason we are tilting toward the low-multiple, deep value names this year.
Under the Radar Investment
01. United Security Bancshares
Headquartered in Fresno, United Security Bancshares (UBFO $7) was formed in 2001 as a bank holding company to provide commercial banking services through its wholly-owned subsidiary, United Security Bank. The company's two primary sources of revenue are interest income from outstanding loans, and investment securities. With a p/e ratio of 14, UBFO has annual operating revenues of $37 million, and net income of $9 million (2020 full-year figures). The company has a cash dividend payout ratio of 60% and a dividend yield of $5.91%. As rates begin to creep higher, we are becoming more bullish on the financial sector, especially the regional banks with sound balance sheets.
Answer
Going back to 1950, only three months have resulted in negative average returns for the S&P 500: February, August, and September. Over that span of time, September has been the bleakest month, averaging a -0.62% return for the benchmark index.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The three worst months...
Going back to 1950, only three months of the year have averaged negative returns for the S&P 500. What are they, and which month is historically the worst?
Penn Trading Desk:
Penn: Open a "new energy" ETF in the New Frontier Fund
We are extremely bullish on the future of renewable energy, especially as it is virtually being mandated by governments around the world. It is a tricky area for investors to navigate, which is why we just added a new ETF to the Penn New Frontier Fund that invests equally in all five areas of this dynamic field: e-mobility, energy storage, performance materials, energy distribution, and energy generation. To see the specific action, Members can log into the Penn Trading Desk.
America is (finally) attempting a comeback in the rare earth arena; we opened a position in the company at the center of the battle
We have discussed, ad nauseam, how America willingly turned over the role of dominant rare earth miner to China, despite the national security risk of doing so. Now, one company plans to restore order in this critical corner of the market, and we have added that company to the Intrepid Trading Platform. Members, see the Penn Trading Desk.
Penn: Open Mid-Cap Gold and Silver Miner in Penn Global Leaders Club
We remain bullish on gold going forward, especially considering the world's perpetually-running currency printing presses. We are very bullish on silver for more industrial reasons. With that in mind, we acquired a Canadian mid-cap gold and silver miner with 30 million ounces of proven/probable gold reserves, and 60 million ounces of proven/probable silver reserves. Our first target price is 53% above the company's current price. Members, see the Penn Trading Desk.
Penn: Closed Aphria in Intrepid after massive run-up
We purchased Canadian pot stock Aphria for $4.63 on 13 Aug 2020 in large part because Irwin Simon took over as CEO. While we expected a longer hold time, the massive run-up in price couldn’t be ignored. We took our 440%, short-term gain, stopping out at $25 per share.
Wedbush: Raise price target on Microsoft
Analysts at Wedbush have raised their price target on Microsoft (MSFT $243) from $285 to $300, maintaining their Outperform rating. They argue that the tide is shifting in the cloud arms race—away from Amazon (AMZN) Web Services and towards Microsoft. We agree.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Transportation Infrastructure
10. Uber jumps on news it is buying booze delivery company Drizly
Approximately 22% of ride-sharing platform Uber's (UBER $57) revenue emanates from food and drink delivery, with its Uber Eats division lagging well behind the likes of DoorDash, Postmates, and Grubhub. The company is making an aggressive move to change that with its $1.1 billion purchase of Drizly, a services firm which currently offers beer, wine, and hard liquor deliveries in over 1,400 cities. The deal will be funded with a mix of Uber stock (90%) and cash (10%), and is expected to close in the first of of this year. While Uber will maintain a separate Drizly app for customers, it will integrate the Drizly marketplace into its existing Uber Eats app. Uber shares were up 7% on the day of the announcement.
This was a smart move, and we continue to see Uber as the dominant player in the industry. That being said, the company lost $7 billion on $12.8 billion in revenues over the trailing twelve months, with the pandemic doing immense harm to its business model. We see UBER shares fairly priced around $60, just $3 above where they currently sit.
Biotechnology
09. Jazz Pharmaceuticals PLC to acquire medical cannabis company GW Pharma for $7B
Jazz Pharmaceuticals (JAZZ $150) is an $8 billion biotech focused in the neurosciences, including sleep disorders, and oncology, including hematologic and solid tumors. The company has a solid and growing revenue stream, and positive net income going back ten years—no small feat for a mid-cap biotech. GW Pharmaceuticals PLC (GWPH $214) is a $6.7 billion biopharma company which develops and markets cannabis-based therapies, such as the first epilepsy drug derived from the marijuana plant. This past week, the Ireland-based Jazz announced it would be acquiring the UK-based GW for approximately $7 billion in a mix of cash, debt, and newly-issued Jazz stock. This is a bold move for the company, considering the deal is worth about 90% of its own market cap and that GW hasn't turned a profit since 2012, but management believes that GW's Epidiolex drug for the treatment of epilepsy will be a billion-dollar blockbuster. Shares of Jazz were trading off about 8% on the news, while the deal sent GW Pharma shares soaring nearly 45% based on the premium paid for the acquisition.
It's a bold bet, but one we like—a lot. The drop in price of JAZZ shares makes the stock even more attractive. In a crazy market where investors are bidding up to buy companies which have never turned a profit, here is a company with explosive potential that has operated in the black for a decade.
Behavioral Finance
08. Sticking it to the man? Koss family cashes in as Reddit army targets the shorts
Readers may be vaguely familiar with the name Koss, but certainly not to the same extent as Bose, Beats, or Sony. To say the Wisconsin-based headphone maker was struggling is an understatement. In fact, going into this year the company was worth about $20 million—the most micro of micro-caps. Then the Reddit army discovered how many short sellers were betting on the company to fail, and sprang into action. Despite minuscule sales and a dearth of profits, they jacked the shares up from around $3 in early January to an intra-day high exceeding $120 per share on the 28th of the month. Corporate executives and the Koss family, which together control 75% of the shares, also sprang into action: they sold $44 million worth of shares of a company that had a market cap of $20 million going into the year. Who can blame them? When you know your company is worth about $3 per share and a group of retail investors suddenly make it worth 40 times that amount, why not rake in the dough? SEC filings show these insiders sold between approximately $20 and $60 per share. Among the family, president and CEO Michael Koss sold around $13 million worth of stock, while John Koss Jr., vice president of sales, sold almost exactly the same amount. The company had a short interest of around 35% before the madness began, putting it on the Reddit army's radar. Shares have since fallen back to $20, only about four times what we value them being worth.
Who knows, maybe the insiders sold the shares to raise cash for a new strategic push, though we doubt it. In the meantime, we would like to meet the "investors" who bought into a company with horrendous fundamentals while the share price was between $100 and $120. We would like to simply ask them "why?"
Cryptocurrencies
07. Tesla shifts $1.5 billion of its cash reserve to Bitcoin, will accept the crypto as a payment source soon
Going into the new year, $800 billion EV juggernaut Tesla (TSLA $854) had about $19 billion sitting in cash reserves. In a move that GM or Ford would never consider making, the firm revealed—via an SEC filing—that it has placed about $1.5 billion of that amount, or roughly 8%, in the cryptocurrency Bitcoin. Let there be no doubt, Bitcoin is not a currency; rather, it is a commodity. Forget the comparisons to the US dollar, compare it to gold or silver instead. The dollar is worth a dollar today, yesterday, and (hopefully) tomorrow. Certainly, its value will fluctuate, but it will not go up 60% in one month like Bitcoin has. Governments can print currencies 24/7, effectively reducing their value, but only 21 million bitcoins can be mined—and 18.6 million digital coins already exist. So, is there anything wrong with Tesla's cash management experts shifting 8% of the company's reserves into the commodity? We don't believe so. After all, they could also buy (based on their SEC filings) gold or silver as a store of cash. Given Elon Musk's belief in the future of cryptos, the move shouldn't be surprising. Furthermore, investors applauded the move: both Bitcoin and TSLA were trading higher following the announcement. The company also announced plans to accept Bitcoin as a means of payment in the near future.
We were true Bitcoin skeptics at first, but as soon as big payment processors like PayPal and Venmo got in the game, and as soon as we started looking a the non-physical product as a commodity rather than a currency, we warmed up to the crypto. Our biggest concern is this: Although only 21 million bitcoins will be mined, nothing will stop new, competing cryptocurrencies from being "discovered" in the digital world.
Maritime Shipping & Ports
06. Our maritime shipper spikes on the growing concern over container shortage
For anyone who believes that America, or the world in general, is ready to stand up to China's trade practices, try this one on for size: the communist nation ended 2020 with a record trade surplus. The demand for Chinese goods is now so great that the world is facing a shipping container crisis. Just how bad is it? Because the shippers can make so much more money on the goods leaving China as opposed to the goods entering the country—like grain from the United States—they are literally rushing back empty containers to China to alleviate the backlog of goods waiting at Chinese ports. Spot freight rates are up nearly 300% from a year ago. While that is a sick testament to the state of global trade, one industry is certainly reaping the rewards: the maritime shippers which had been crushed during the trade war and subsequent pandemic. We have been fascinated by this highly-cyclical industry for decades, and when one of our favorites, Nordic American Tankers (NAT $4), saw its share price drop to $2.80 this past October, we jumped in, adding the Bermuda-based shipper to the Penn Intrepid Trading Platform. NAT jumped 14% in one day on news of the container shortage. Think the run will be short-lived or that the shippers are now overvalued? Take a look at the accompanying chart on NAT. Despite the fact that there are nearly 200 million intermodal freight containers around the world, the rapid increase in demand caught nearly everyone off guard. Ready for the icing on the cake? 97% of these containers are now made in, you guessed it, China.
For a brief refresher on the shipping industry, visit our 2018 Penn Wealth Report story on The State of Global Shipping. We see the upswing continuing to gain momentum as global economies revive.
Global Health Threats
05. Hackers tried to poison the water supply of a small Florida town; is this the beginning of a new global health threat?*
Two days before the Super Bowl, in the Tampa suburb of Oldsmar, a technician at the Haddock Water Treatment Plant noticed something odd: the cursor was moving across his computer screen while his mouse sat idle. At first he assumed his supervisor was remotely logged in and simply checking out the systems of the plant, which provides drinking water to 15,000 local residents. His curiosity changed to panic when, a few hours later, the mysterious cursor began adjusting the level of chemicals being added to the water supply. Specifically, the level of sodium hydroxide (caustic soda) was being moved from the ordinary setting of 100 parts per million (ppm) to 11,100 ppm. At low levels, sodium hydroxide regulates PH levels; at high levels, it will damage human tissue. Officials at the plant quickly adjusted the settings back to normal, and they pointed out that PH testing mechanisms would have caught the problem before any contaminated water ever got to the taps, but does that make anyone feel at ease? The attack on the Oldsmar plant is eerily similar to a number of 2020 attacks on Israel's water supply, almost certainly the work of Iranian hackers. A disturbing new threat appears to be emerging; and, with over 100,000 water treatment facilities in the US, it is a threat which cannot be ignored.
In the next issue of The Penn Wealth Report, we will take a look at the threat to America's water supply and how we can prepare for an attack; we also take a look at some viable investment choices in the water utilities sector.
Aerospace & Defense
04. The weekend engine failure points to Raytheon's Pratt & Whitney unit, but we still point a finger at Boeing
It was the last thing Boeing (BA $212) needed (how many times have we said that over the past three years?): A Boeing 777, leaving Denver for Hawaii, had one of its two engines suffer an "uncontained failure," with fire and smoke visible to passengers, and with debris dropping down on a Denver suburb. Thankfully, the aircraft was able to make it back to the airport on one good engine and with no passenger injuries—unlike a very similar incident in 2018 which involved the death of a passenger following engine debris striking a window. That incident occurred just two months after a United Airlines 777 suffered engine failure, with a cracked fan blade forcing the aircraft to make an emergency landing in Honolulu. This is an extremely disturbing trend, and one which certainly places Raytheon's (RTX $73) Pratt & Whitney unit in the hot seat. But aircraft maker Boeing shares some blame, as problems continue to mount for the Chicago-based firm. First there were the deadly 737 crashes which grounded the fleet for the better part of two years. Then came the 787 Dreamliner "design flaws" and canceled orders. Now the 777 faces grounding in the US—and probably around the world. And the situation isn't looking much better on the space side of the business, with the company's problem-laden Starliner capsule and its high profile recent failures. In each case, Boeing can point fingers at suppliers or partners, but there is a point at which all fingers will point back to them. A sad state of affairs for a formerly-great American company.
The entire Boeing board of directors, along with its C-suite executives, should be broomed. The company needs a clean sweep if it has any chance of returning to its position of aerospace and defense dominance. Unfortunately, the very individuals which need to be fired are all part of the mutual admiration society which controls the decisions on leadership. If ever a company needed an aggressive activist investor to come along and force change, it is right now, and it is at Boeing. Even then, the company's downward flight path may be too steep to pull out of.
Automobiles
03. Investor darling Workhorse has its shares cut in half after losing USPS contract
It has been one of those "new investor" cult stocks with one of the key buzz phrases, or acronym in this case, that the new wave of retail money flocks to: EV. The company is Workhorse (WKHS $16), which has seen its stock price go from $2 per share a year ago to $43 per share a few weeks ago—all on the back of microscopic revenues and chronic annual losses. The financials didn't matter; pie-in-the-sky promises were enough to bring money flooding into the stock. The latest promise was the imminent contract by the United States Postal Service to replace its fleet of 150,000+ outdated vehicles. To Workhorse devotees, it was a foregone conclusion that their company would be the recipient. When the contract was awarded to the defense unit of $8 billion industrial firm Oshkosh (OSK $117), WKHS shares nosedived more than 50% in one day. The drop was so rapid that any stop order to protect gains would have been essentially worthless: investors would have been stopped-out at the bottom.
There are some great lessons in this story. Investors need to understand what they are buying, and they need do have at least some inkling as to a company's fundamentals. Forget the fact that Workhorse had never turned an annual profit, how about the fact that they were barely generating sales? As for "boring" old Oshkosh, the company has a pristine balance sheet and generates solid revenues—and profits—year after year. But who wants boring?
Anyone willing to take a little time to do some basic research can be greatly rewarded by the flow of "dumb money" right now. Don't get caught up in the hype and follow the lemmings off the cliff; use their moves to help uncover the value plays present in the market.
Market Pulse
02. Despite a bruising few weeks, February was a winner in the markets
It may be hard to believe based on the past two weeks, but equities actually hammered out a win in February. Not so for the week: each of the major benchmarks fell on the specter of rising rates. In a sign of just how the (fixed income) world has changed, the biggest hit came when the 10-year Treasury moved above the 1.5% mark on Thursday. It actually settled back down to 1.415% by Friday's close, but the rapid upward move spooked investors who are banking on ultra-low rates supporting further advances in the market. Even talk of another $1.9 trillion in government "stimulus" couldn't help—the NASDAQ was off just shy of 5% for the week, followed by the S&P 500 (-2.46%), and the Dow (-1.78%).
Nonetheless, the Dow closed out February with a healthy gain (3.17%), followed by the S&P 500 (2.61%), and the NASDAQ (0.93%). This is a far cry from one year ago as the new reality of the pandemic began to take hold. In February of 2020, the Dow was down 10.08%. Of course, those losses were nothing compared to what would follow in March. We never really know what's ahead, but it feels a lot better watching the effective Pfizer, Moderna, and (starting next week) Johnson & Johnson vaccines begin to eradicate this terrible virus than it did a year ago, facing insane toilet paper shortages and spiking hospitalization rates. If our biggest concern becomes a rising 10-year, then we really don't have much to complain about. One of these days, the realization that we now have a $30 trillion national debt will creep into our psyche, but let's focus on getting rid of the masks first.
Personally speaking, our biggest concern is actually not the rising 10-year; it is the madness going on with a bunch of stocks that couldn't turn a profit if their corporate lives depended on it. When falling confetti on an iPhone screen is all it takes to lure someone into buying an overpriced dog, something wicked this way comes. Yet another reason we are tilting toward the low-multiple, deep value names this year.
Under the Radar Investment
01. United Security Bancshares
Headquartered in Fresno, United Security Bancshares (UBFO $7) was formed in 2001 as a bank holding company to provide commercial banking services through its wholly-owned subsidiary, United Security Bank. The company's two primary sources of revenue are interest income from outstanding loans, and investment securities. With a p/e ratio of 14, UBFO has annual operating revenues of $37 million, and net income of $9 million (2020 full-year figures). The company has a cash dividend payout ratio of 60% and a dividend yield of $5.91%. As rates begin to creep higher, we are becoming more bullish on the financial sector, especially the regional banks with sound balance sheets.
Answer
Going back to 1950, only three months have resulted in negative average returns for the S&P 500: February, August, and September. Over that span of time, September has been the bleakest month, averaging a -0.62% return for the benchmark index.
Headlines for the Week of 24 Jan—30 Jan 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 dot-com bubble...
The proliferation of personal computers in the mid-1990s and the unprecedented growth of the Internet thanks to new web browsers led to millions of Americans having access to stock market trading platforms. Wishing to take advantage of the technology of the "New Economy," they piled into dot-com stocks with no earnings but stratospheric promises. How much did the Nasdaq Composite, which housed these new companies, go up between January of 1995 and March of 2000, and how much did the index fall between March of 2000 and the end of 2002?
Penn Trading Desk:
Opened Infrastructure Play in the Penn Dynamic Growth Strategy
Massive infrastructure spending over the next two years is now all but guaranteed. Fortuitously, we found an investment that should not only take advantage of this condition, but also contains a number of our best small- and mid-cap industrial ideas—one of our overweight sectors for the year ahead. See the new position in our ETF portfolio, the Penn Dynamic Growth Strategy.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Biotechnology
10. One disappointing clinical trial highlights the risks of biotech investing
Going into the new year, Serepta Therapeutics (SRPT $87) was a $14 billion biotech darling trading around $180 per share. With a pipeline of 40 or so therapies in various stages of development, the company is a holding in a number of top biotech funds. Then came disappointing—not disastrous—clinical trial data for SRP-9001, an experimental gene therapy for Duchenne muscular dystrophy (DMD), a genetic disorder that progressively weakens the muscles of children—generally boys, with symptoms usually appearing before age five. One might expect a small pullback in the share price from the news; instead, SRPT shares plunged over 50% in one session. It should be noted that Sarepta markets and sells two other DMD treatments which are unaffected by the SRP-9001 trial, and remains the only company with approved treatments for certain DMD patients. One noted biotech analyst lowered his price target for SRPT shares from $200 to $143, but maintained his Outperform rating on the company. Another investment firm we track places a fair value of $357 on the shares. The company, which saw a meteoric rise in sales from $5 million in 2016 to $500 million TTM, has yet to turn a quarterly profit. While a lack of income is not uncommon for early-stage biotechs, this case does point to the need for investors to perform their own fundamental research rather than relying on the number of stars in a stock report or an analyst's lofty price targets.
One of the many screeners we use is designed to highlight stocks with certain characteristics which have sudden drops in share price. This has been a great contrarian tool for identifying sound companies at undervalued prices. A big price drop, however, must be accompanied by a number of positive attributes which portray a good buying opportunity. Those attributes are not in place with Sarepta, at least based on the metrics in our screener. If an investor does not wish to perform the research, the best way to take advantage of a promising industry is through a thematic or industry-specific ETF. For biotechs, we use the SPDR S&P Biotech ETF (XBI $147), which is one of the 21 holdings in the Penn Dynamic Growth Strategy.
Risk Management
09. Shades of '99: An Elon Musk tweet about one company leads to a 6,450% gain in another
On the 6th of January, Signal Advance (SIGL $39) was a $6 million micro-cap consulting firm for emerging technologies. Putting its size in perspective, it would need to grow by about 50 times to be considered a small-cap. The company has never turned a profit, and there is nothing to indicate that it ever will. An investor would have to have a screw loose to place even the smallest amount of money in SIGL shares. And then came Elon Musk’s tweet. The tweet was succinct: “Use Signal.” Musk was talking about a cross-platform encrypted messaging service he uses. Unfortunately, a certain group of gamers decided that Musk was talking about Signal Advance, and they began gobbling up SIGL shares on their Robinhood or other trading apps, driving the price from $0.60 to $38.70 per share in the matter of two trading days. Signal, the app company, is a privately-held entity. Not one modicum of rational thought or the most basic of research, just jump in like Pac Man gobbling up ghosts. It must be nice having money to throw into the abyss.
The reckoning is coming, and the laziest of investors will pay the biggest price. Back in 1999, we remember getting calls about a tech company named InfoSpace (INSP at the time). The company is still around, though now under the name Blucora (BCOR). It would be an enlightening exercise to check out a long-term chart of those shares.
Semiconductors
08. Intel hires a wonkish tech guy as the company's new CEO...and the move was a brilliant one
For at least the past year we have been hearing about Intel's (INTC $59) imminent demise, and for at least the past year we have poked holes in that narrative. In fact, we have said that Intel is one of the unloved, undervalued darlings ready to take off in 2021. In the most recent move supporting our premise (besides the impressive jump in the share price year-to-date), the company has announced that CEO Bob Swan would be replaced next month by wonkish tech veteran Pat Gelsinger. Gelsinger, considered a brilliant semiconductor engineer, is currently the CEO of VMware (VMW $133), and the perfect fit for Intel going forward. Somewhat ironically, Gelsinger left Intel eleven years ago when it became clear that he would not be tapped for the lead role at the company; Brian Krzanich ultimately got that spot. When Bob Swan replaced Krzanich in 2019, pundits were worried. Swan was a financials guy, not the tech guru the company needed to pull itself out of a nosedive. But analysts are singing a different tune this time, with some even comparing Gelsinger's return to Intel with Steve Jobs' return to Apple. That comparison comes with some stratospheric expectations, but we believe the move will at least be comparable to Microsoft's hiring of Satya Nadella in 2014; and that would be good enough for us.
Not everyone is convinced that this move can turn the giant battleship around, especially with the likes of NVIDIA (NVDA) and Advanced Micro Devices (AMD) snatching up market share. We point to the difference in multiples, however (INTC's 11 vs NVDA's 88 and AMD's 123), and remain faithful to the notion that Intel will gain the most ground (among these three) in 2021.
Automotive
07. After a century of operations in the country, Ford will close its Brazil plants, taking $4.1 billion in charges
There are a lot of moving parts at Ford right now, but the jury is still out on whether those machinations will create something bold, new, and profitable, or simply offer up new opportunities for massive breakdowns. The latest twist in the company's $11 billion turnaround effort, put in motion by former (and lackluster) CEO Jim Hackett, is the closure of its three assembly line plants in Brazil—ending a century of operations in the country. The move earned some rather acrimonious comments from Brazilian President Jair Bolsonaro—whom we have a lot of respect for—but the 5,000 unionized workers at the three plants have been turning out a paltry number of new vehicles per year, with the company netting a loss of $700 million in South America in 2019, and nearly $400 million through the first three quarters of 2020. The company will take a write-down of $4.1 billion related to the closures, mostly to give the workers a severance package. While we don't know what that will look like, the company offered workers at its shuttered plant in Russia the equivalent of one-year's salary, though it is unclear whether or not the Brazilian workers' union will accept the terms. Ford claims it is ready to embrace the future of electric and autonomous vehicles, but that is what we were told when Hackett, who headed up the firm's Smart Mobility unit, took the top spot in 2017. What a disappointment his tenure turned out to be. Jim Farley took over for Hackett this past October, but readily embraced his predecessor's turnaround plan. We're not sure what will be different with the automaker under new management.
Pardon us if we don't buy what Ford management is trying to sell us; we have been here before with this company, and have heard the same tired lines. We used to at least get a big fat dividend yield for buying shares in the company, but those were suspended last March.
IT Software & Services
06. Palantir spikes on news of its partnership with PG&E to help manage California's electric grid
We bought data mining firm Palantir (PLTR $27) on IPO day as a long-term investment, not a short-term trade. To the chagrin of the short-sellers and naysayers, that investment continues to grow. One of the knocks we have heard leveled at the company is that they rely too heavily on too few major clients for a bulk of their revenues. Lose any of these government agencies or corporate clients, the story goes, and the company is in dire straits. We see just the opposite happening: Palantir will continue to widen out its customer base, attracting new companies across a wide array of industries and market caps with its incredibly powerful, outcome-driven software platform; a platform which sifts through enormous amounts of raw data and produces actionable information. Case in point, the Denver-based firm (they moved out of California late last year) just inked a deal with regulated California utilities provider PG&E (PCG $12), the company at the epicenter of the fire-induced outages plaguing the state over the past few years. The goal is straightforward: enhance the safety and reliability of California's power grid. Palantir's Foundry software platform will allow managers at the utility, which provides power to 5.3 million California households, the ability to view and navigate a real-time visual of the power grid, enabling them to act on a moment's notice. Fires sparked by PG&E's power lines have led to payouts for damages in excess of $25 billion over the past four years. Think PG&E didn't do its due diligence before hiring Palantir?
There are a lot of tech companies with valuations in the stratosphere; and there are a lot of tech companies which will come crashing back to earth this year. When the tech correction hits, PLTR shares will probably get caught in the crossfire, but we would probably view that as a great opportunity to add to our holding.
Aerospace & Defense
05. Just as the 737-MAX flies again, Boeing must contend with its trouble-laden space business
If it weren't for SpaceX's remarkable recent accomplishments, Boeing (BA $211) might have been able to quietly get away with its problem-plagued Space Launch System (SLS). Alas, not long after the failed test flight of its unmanned Starliner capsule, SpaceX had its own successful manned flight, with the Crew Dragon transporting astronauts into space from American soil for the first time since the final Space Shuttle launch in 2011. This past weekend, Boeing had a chance to redeem itself just a bit with the test firing of the engines on the SLS's core stage. The powerful engines were to remain ignited for eight minutes; instead, they shut down shortly after one minute. It's too early to tell what caused the malfunction, and it could certainly be a simple component failure, but for a program that is already far behind schedule and billions of dollars over budget, it is yet another black eye. Assuming the test had been successful, the core stage would have been prepped for delivery to the Kennedy Space Center for final assembly with the Lockheed Martin (LMT $342) Orion spacecraft, followed by another test flight to make up for the failed, December 2019 mission. Instead, Boeing faces more delays and more costly test firings.
In normal times, we would say that Boeing is a huge bargain at $211 per share, down from its March, 2019 high of $441 per share. Instead, the company seems fairly valued right where the shares sit. Investors can't even collect dividends while the company figures out its future—payouts were halted "until further notice" in the middle of last year. The investment is about as exciting as the Boeing management team is dynamic.
Pharmaceuticals
04. Lackluster Merck shuts down its Covid-19 vaccine effort
We are bullish on the Health Care sector in 2021, but we remain bearish on one particular drug giant: Merck (MRK $80). CEO Ken Frazier seems to be—in our opinion—a lackluster leader simply going along for the ride. The latest piece of evidence supporting our bearish stance came on Monday morning, when the $200 billion drug manufacturer announced it would be shutting down its Covid-19 vaccine effort due to poor trial results. The company said it will retool its vaccine manufacturing facilities to produce antiviral therapies for patients suffering from the disease, one of which could be available for use in the middle of the year—about the time the vaccines should be kicking in.
We look at Merck's drug pipeline and see a dearth of therapies in late-stage trials. While most analysts see MRK shares hitting $100 within the next twelve months, we see more growth opportunities in our Penn Global Leaders Club holdings: Pfizer (PFE), GlaxoSmithKline (GSK), and Bristol-Myers Squibb (BMY). We also hold a number of higher-risk biotechs in our Penn New Frontier Fund, to include Biomarin (BMRN), Vertex (VRTX), and Nektar Therapeutics (NKTR).
Hotels, Resorts, & Cruise Lines
03. Look who else is jumping ship from Carnival Cruise Lines: senior management
Admittedly, we have never liked Carnival Cruise Lines (CCL $19). With great cruise lines to choose from like Royal Caribbean (RCL) and Norwegian Cruise Line Holdings (NCLH), why would investors choose the K-Mart (simply our opinion) of operators? Even before the pandemic, the charts were reflecting our negative view of the company. Now, with CCL shares so cheap, wouldn't it be a great time for management to step up and buy shares in an effort to reaffirm their post-pandemic comeback plans? Apparently not. In the middle of January, CEO Arnold Donald sold 62,639 shares of his company at $21.12 per share, netting him a cool $1.3 million. On the same day, CFO David Bernstein shed 49,000 shares for a total of $1 million, and Arnaldo Perez, the company's general counsel, sold 14,215 shares for $300,000. No notable insider buying has taken place since the start of the year. When your CEO, CFO, and general counsel jump ship (or at least head for the nearest dinghy), it is hard to get too excited about the company's great comeback plan.
We use insider buying and selling transactions as one metric to gauge where a company is headed, and how much confidence management has in its own strategic plans. While we use Simply Wall Street to locate this information, investors can find it on any number of sites free of charge.
Market Risk Management
02. GameStop brouhaha helps drag the markets down for the week
There are so many moving parts with respect to the GameStop (GME $325) story, each one fascinating in its own right, that we need to focus on the issue in bite-sized pieces. The latest turn of events has to do with trading app Robinhood tapping into its $1 billion lifeline and putting its IPO on hold. In an effort to maximize potential revenue, especially since the firm's customers trade fee and commission free, Robinhood cut out the intermediary, acting as custodian for accountholder funds. Considering the massive amount of losses that could potentially pile up in trading the types of options offered on the platform, and because of recent volatility in the likes of GME, the Depository Trust & Clearing Corp (DTCC) and other clearinghouses raised their capital requirements, forcing Robinhood to scramble for the additional funding. A frustrated Vlad Tenev, CEO and founder of the platform, explained that compliance with the firm's financial obligations was not open for negotiation, leading to the decision to limit trading on fifty stocks (as of Friday afternoon). This angered everyone, from the Reddit army responsible for going after the short sellers to the likes of AOC and Ted Cruz on Capitol Hill—the unlikeliest of allies on any issue. We actually feel kind of bad for Robinhood, which quickly turned from hero to villain. As for the GameStop trading—the irrationality that drove a stock worth about $10 up to $483 in a matter of a few weeks, it helped the market turn negative for the week, the month, and (hence) the year.
Our biggest fear is not spillover into the broader markets, it is how the ham-handed government will decide to regulate the actors, which really means regulating the rest of us innocent bystanders. In the next issue of The Penn Wealth Report we will take an in-depth look at how the GameStop story began, and where it will almost certainly end.
Under the Radar Investment
01. Under the Radar: Air Water Inc
Air Water Inc (AWTRF $15) is a Japanese-based mid-cap ($3.3 billion) specialty chemicals company founded in 1929. The firm manufactures and sells a variety of chemical-based products and operates in five segments: industrial gas, chemicals, medical gases, and agricultural/food products. This under-the-radar gem has a tiny five-year beta of 0.14, a P/E ratio of 12, and a 3% dividend yield. In fiscal 2020, the firm generated $7.4 billion in revenues and $268 million in profits. A cash cow in a steady industry, it hasn't had an unprofitable year for as far back as the eye can see.
Answer
Between 01 January 1995 and 10 March 2000, the Nasdaq Composite soared 571%. Between March of 2000 and October of 2002, it had fallen 78%. It wasn't until April of 2015 that the index regained its former high. Fifteen years from peak to peak.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The dot-com bubble...
The proliferation of personal computers in the mid-1990s and the unprecedented growth of the Internet thanks to new web browsers led to millions of Americans having access to stock market trading platforms. Wishing to take advantage of the technology of the "New Economy," they piled into dot-com stocks with no earnings but stratospheric promises. How much did the Nasdaq Composite, which housed these new companies, go up between January of 1995 and March of 2000, and how much did the index fall between March of 2000 and the end of 2002?
Penn Trading Desk:
Opened Infrastructure Play in the Penn Dynamic Growth Strategy
Massive infrastructure spending over the next two years is now all but guaranteed. Fortuitously, we found an investment that should not only take advantage of this condition, but also contains a number of our best small- and mid-cap industrial ideas—one of our overweight sectors for the year ahead. See the new position in our ETF portfolio, the Penn Dynamic Growth Strategy.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Biotechnology
10. One disappointing clinical trial highlights the risks of biotech investing
Going into the new year, Serepta Therapeutics (SRPT $87) was a $14 billion biotech darling trading around $180 per share. With a pipeline of 40 or so therapies in various stages of development, the company is a holding in a number of top biotech funds. Then came disappointing—not disastrous—clinical trial data for SRP-9001, an experimental gene therapy for Duchenne muscular dystrophy (DMD), a genetic disorder that progressively weakens the muscles of children—generally boys, with symptoms usually appearing before age five. One might expect a small pullback in the share price from the news; instead, SRPT shares plunged over 50% in one session. It should be noted that Sarepta markets and sells two other DMD treatments which are unaffected by the SRP-9001 trial, and remains the only company with approved treatments for certain DMD patients. One noted biotech analyst lowered his price target for SRPT shares from $200 to $143, but maintained his Outperform rating on the company. Another investment firm we track places a fair value of $357 on the shares. The company, which saw a meteoric rise in sales from $5 million in 2016 to $500 million TTM, has yet to turn a quarterly profit. While a lack of income is not uncommon for early-stage biotechs, this case does point to the need for investors to perform their own fundamental research rather than relying on the number of stars in a stock report or an analyst's lofty price targets.
One of the many screeners we use is designed to highlight stocks with certain characteristics which have sudden drops in share price. This has been a great contrarian tool for identifying sound companies at undervalued prices. A big price drop, however, must be accompanied by a number of positive attributes which portray a good buying opportunity. Those attributes are not in place with Sarepta, at least based on the metrics in our screener. If an investor does not wish to perform the research, the best way to take advantage of a promising industry is through a thematic or industry-specific ETF. For biotechs, we use the SPDR S&P Biotech ETF (XBI $147), which is one of the 21 holdings in the Penn Dynamic Growth Strategy.
Risk Management
09. Shades of '99: An Elon Musk tweet about one company leads to a 6,450% gain in another
On the 6th of January, Signal Advance (SIGL $39) was a $6 million micro-cap consulting firm for emerging technologies. Putting its size in perspective, it would need to grow by about 50 times to be considered a small-cap. The company has never turned a profit, and there is nothing to indicate that it ever will. An investor would have to have a screw loose to place even the smallest amount of money in SIGL shares. And then came Elon Musk’s tweet. The tweet was succinct: “Use Signal.” Musk was talking about a cross-platform encrypted messaging service he uses. Unfortunately, a certain group of gamers decided that Musk was talking about Signal Advance, and they began gobbling up SIGL shares on their Robinhood or other trading apps, driving the price from $0.60 to $38.70 per share in the matter of two trading days. Signal, the app company, is a privately-held entity. Not one modicum of rational thought or the most basic of research, just jump in like Pac Man gobbling up ghosts. It must be nice having money to throw into the abyss.
The reckoning is coming, and the laziest of investors will pay the biggest price. Back in 1999, we remember getting calls about a tech company named InfoSpace (INSP at the time). The company is still around, though now under the name Blucora (BCOR). It would be an enlightening exercise to check out a long-term chart of those shares.
Semiconductors
08. Intel hires a wonkish tech guy as the company's new CEO...and the move was a brilliant one
For at least the past year we have been hearing about Intel's (INTC $59) imminent demise, and for at least the past year we have poked holes in that narrative. In fact, we have said that Intel is one of the unloved, undervalued darlings ready to take off in 2021. In the most recent move supporting our premise (besides the impressive jump in the share price year-to-date), the company has announced that CEO Bob Swan would be replaced next month by wonkish tech veteran Pat Gelsinger. Gelsinger, considered a brilliant semiconductor engineer, is currently the CEO of VMware (VMW $133), and the perfect fit for Intel going forward. Somewhat ironically, Gelsinger left Intel eleven years ago when it became clear that he would not be tapped for the lead role at the company; Brian Krzanich ultimately got that spot. When Bob Swan replaced Krzanich in 2019, pundits were worried. Swan was a financials guy, not the tech guru the company needed to pull itself out of a nosedive. But analysts are singing a different tune this time, with some even comparing Gelsinger's return to Intel with Steve Jobs' return to Apple. That comparison comes with some stratospheric expectations, but we believe the move will at least be comparable to Microsoft's hiring of Satya Nadella in 2014; and that would be good enough for us.
Not everyone is convinced that this move can turn the giant battleship around, especially with the likes of NVIDIA (NVDA) and Advanced Micro Devices (AMD) snatching up market share. We point to the difference in multiples, however (INTC's 11 vs NVDA's 88 and AMD's 123), and remain faithful to the notion that Intel will gain the most ground (among these three) in 2021.
Automotive
07. After a century of operations in the country, Ford will close its Brazil plants, taking $4.1 billion in charges
There are a lot of moving parts at Ford right now, but the jury is still out on whether those machinations will create something bold, new, and profitable, or simply offer up new opportunities for massive breakdowns. The latest twist in the company's $11 billion turnaround effort, put in motion by former (and lackluster) CEO Jim Hackett, is the closure of its three assembly line plants in Brazil—ending a century of operations in the country. The move earned some rather acrimonious comments from Brazilian President Jair Bolsonaro—whom we have a lot of respect for—but the 5,000 unionized workers at the three plants have been turning out a paltry number of new vehicles per year, with the company netting a loss of $700 million in South America in 2019, and nearly $400 million through the first three quarters of 2020. The company will take a write-down of $4.1 billion related to the closures, mostly to give the workers a severance package. While we don't know what that will look like, the company offered workers at its shuttered plant in Russia the equivalent of one-year's salary, though it is unclear whether or not the Brazilian workers' union will accept the terms. Ford claims it is ready to embrace the future of electric and autonomous vehicles, but that is what we were told when Hackett, who headed up the firm's Smart Mobility unit, took the top spot in 2017. What a disappointment his tenure turned out to be. Jim Farley took over for Hackett this past October, but readily embraced his predecessor's turnaround plan. We're not sure what will be different with the automaker under new management.
Pardon us if we don't buy what Ford management is trying to sell us; we have been here before with this company, and have heard the same tired lines. We used to at least get a big fat dividend yield for buying shares in the company, but those were suspended last March.
IT Software & Services
06. Palantir spikes on news of its partnership with PG&E to help manage California's electric grid
We bought data mining firm Palantir (PLTR $27) on IPO day as a long-term investment, not a short-term trade. To the chagrin of the short-sellers and naysayers, that investment continues to grow. One of the knocks we have heard leveled at the company is that they rely too heavily on too few major clients for a bulk of their revenues. Lose any of these government agencies or corporate clients, the story goes, and the company is in dire straits. We see just the opposite happening: Palantir will continue to widen out its customer base, attracting new companies across a wide array of industries and market caps with its incredibly powerful, outcome-driven software platform; a platform which sifts through enormous amounts of raw data and produces actionable information. Case in point, the Denver-based firm (they moved out of California late last year) just inked a deal with regulated California utilities provider PG&E (PCG $12), the company at the epicenter of the fire-induced outages plaguing the state over the past few years. The goal is straightforward: enhance the safety and reliability of California's power grid. Palantir's Foundry software platform will allow managers at the utility, which provides power to 5.3 million California households, the ability to view and navigate a real-time visual of the power grid, enabling them to act on a moment's notice. Fires sparked by PG&E's power lines have led to payouts for damages in excess of $25 billion over the past four years. Think PG&E didn't do its due diligence before hiring Palantir?
There are a lot of tech companies with valuations in the stratosphere; and there are a lot of tech companies which will come crashing back to earth this year. When the tech correction hits, PLTR shares will probably get caught in the crossfire, but we would probably view that as a great opportunity to add to our holding.
Aerospace & Defense
05. Just as the 737-MAX flies again, Boeing must contend with its trouble-laden space business
If it weren't for SpaceX's remarkable recent accomplishments, Boeing (BA $211) might have been able to quietly get away with its problem-plagued Space Launch System (SLS). Alas, not long after the failed test flight of its unmanned Starliner capsule, SpaceX had its own successful manned flight, with the Crew Dragon transporting astronauts into space from American soil for the first time since the final Space Shuttle launch in 2011. This past weekend, Boeing had a chance to redeem itself just a bit with the test firing of the engines on the SLS's core stage. The powerful engines were to remain ignited for eight minutes; instead, they shut down shortly after one minute. It's too early to tell what caused the malfunction, and it could certainly be a simple component failure, but for a program that is already far behind schedule and billions of dollars over budget, it is yet another black eye. Assuming the test had been successful, the core stage would have been prepped for delivery to the Kennedy Space Center for final assembly with the Lockheed Martin (LMT $342) Orion spacecraft, followed by another test flight to make up for the failed, December 2019 mission. Instead, Boeing faces more delays and more costly test firings.
In normal times, we would say that Boeing is a huge bargain at $211 per share, down from its March, 2019 high of $441 per share. Instead, the company seems fairly valued right where the shares sit. Investors can't even collect dividends while the company figures out its future—payouts were halted "until further notice" in the middle of last year. The investment is about as exciting as the Boeing management team is dynamic.
Pharmaceuticals
04. Lackluster Merck shuts down its Covid-19 vaccine effort
We are bullish on the Health Care sector in 2021, but we remain bearish on one particular drug giant: Merck (MRK $80). CEO Ken Frazier seems to be—in our opinion—a lackluster leader simply going along for the ride. The latest piece of evidence supporting our bearish stance came on Monday morning, when the $200 billion drug manufacturer announced it would be shutting down its Covid-19 vaccine effort due to poor trial results. The company said it will retool its vaccine manufacturing facilities to produce antiviral therapies for patients suffering from the disease, one of which could be available for use in the middle of the year—about the time the vaccines should be kicking in.
We look at Merck's drug pipeline and see a dearth of therapies in late-stage trials. While most analysts see MRK shares hitting $100 within the next twelve months, we see more growth opportunities in our Penn Global Leaders Club holdings: Pfizer (PFE), GlaxoSmithKline (GSK), and Bristol-Myers Squibb (BMY). We also hold a number of higher-risk biotechs in our Penn New Frontier Fund, to include Biomarin (BMRN), Vertex (VRTX), and Nektar Therapeutics (NKTR).
Hotels, Resorts, & Cruise Lines
03. Look who else is jumping ship from Carnival Cruise Lines: senior management
Admittedly, we have never liked Carnival Cruise Lines (CCL $19). With great cruise lines to choose from like Royal Caribbean (RCL) and Norwegian Cruise Line Holdings (NCLH), why would investors choose the K-Mart (simply our opinion) of operators? Even before the pandemic, the charts were reflecting our negative view of the company. Now, with CCL shares so cheap, wouldn't it be a great time for management to step up and buy shares in an effort to reaffirm their post-pandemic comeback plans? Apparently not. In the middle of January, CEO Arnold Donald sold 62,639 shares of his company at $21.12 per share, netting him a cool $1.3 million. On the same day, CFO David Bernstein shed 49,000 shares for a total of $1 million, and Arnaldo Perez, the company's general counsel, sold 14,215 shares for $300,000. No notable insider buying has taken place since the start of the year. When your CEO, CFO, and general counsel jump ship (or at least head for the nearest dinghy), it is hard to get too excited about the company's great comeback plan.
We use insider buying and selling transactions as one metric to gauge where a company is headed, and how much confidence management has in its own strategic plans. While we use Simply Wall Street to locate this information, investors can find it on any number of sites free of charge.
Market Risk Management
02. GameStop brouhaha helps drag the markets down for the week
There are so many moving parts with respect to the GameStop (GME $325) story, each one fascinating in its own right, that we need to focus on the issue in bite-sized pieces. The latest turn of events has to do with trading app Robinhood tapping into its $1 billion lifeline and putting its IPO on hold. In an effort to maximize potential revenue, especially since the firm's customers trade fee and commission free, Robinhood cut out the intermediary, acting as custodian for accountholder funds. Considering the massive amount of losses that could potentially pile up in trading the types of options offered on the platform, and because of recent volatility in the likes of GME, the Depository Trust & Clearing Corp (DTCC) and other clearinghouses raised their capital requirements, forcing Robinhood to scramble for the additional funding. A frustrated Vlad Tenev, CEO and founder of the platform, explained that compliance with the firm's financial obligations was not open for negotiation, leading to the decision to limit trading on fifty stocks (as of Friday afternoon). This angered everyone, from the Reddit army responsible for going after the short sellers to the likes of AOC and Ted Cruz on Capitol Hill—the unlikeliest of allies on any issue. We actually feel kind of bad for Robinhood, which quickly turned from hero to villain. As for the GameStop trading—the irrationality that drove a stock worth about $10 up to $483 in a matter of a few weeks, it helped the market turn negative for the week, the month, and (hence) the year.
Our biggest fear is not spillover into the broader markets, it is how the ham-handed government will decide to regulate the actors, which really means regulating the rest of us innocent bystanders. In the next issue of The Penn Wealth Report we will take an in-depth look at how the GameStop story began, and where it will almost certainly end.
Under the Radar Investment
01. Under the Radar: Air Water Inc
Air Water Inc (AWTRF $15) is a Japanese-based mid-cap ($3.3 billion) specialty chemicals company founded in 1929. The firm manufactures and sells a variety of chemical-based products and operates in five segments: industrial gas, chemicals, medical gases, and agricultural/food products. This under-the-radar gem has a tiny five-year beta of 0.14, a P/E ratio of 12, and a 3% dividend yield. In fiscal 2020, the firm generated $7.4 billion in revenues and $268 million in profits. A cash cow in a steady industry, it hasn't had an unprofitable year for as far back as the eye can see.
Answer
Between 01 January 1995 and 10 March 2000, the Nasdaq Composite soared 571%. Between March of 2000 and October of 2002, it had fallen 78%. It wasn't until April of 2015 that the index regained its former high. Fifteen years from peak to peak.
Headlines for the Week of 03 Jan—09 Jan 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 Economies of Scale...
Tesla, which was formed in 2003 as Tesla Motors, now has a market cap of $835 billion. Is that larger than the combined market caps of General Motors, Ford, and Fiat Chrysler?
Penn Trading Desk:
Simon completes Taubman deal, proceeds flow to cash
Simon Property Group's deal to buy Taubman Centers closes, TCO owners paid $34 per share in cash. See story below.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Aerospace & Defense
10. Two Penn Members Merging: Lockheed Martin will Buy Aerojet Rocketdyne for $4.4 billion
We purchased mid-cap rocket engine maker Aerojet Rocketdyne (AJRD $53) in the Penn New Frontier Fund as a pure play on the burgeoning private space movement. We own aerospace and defense giant Lockheed Martin (LMT $355) in the Penn Global Leaders Club due to its dominance in that industry—and our negative opinion of Boeing's (BA $219) hapless management team. In a move that illustrates the savvy of Lockheed's own leadership, that company announced it will acquire Aerojet for the equivalent of $56 per share, or $4.4 billion. Just over one-third of Aerojet's revenue comes from Lockheed, meaning the $100 billion Maryland-based firm will now own a key supplier. As a major defense supplier to the United States government, one cutting-edge arena that certainly hastened the purchase was hypersonic technology. With Putin bragging about Russia's new generation of hypersonic weapons and China making similar claims, it is imperative for the United States to remain in the lead with respect to these weapon systems. Hypersonic weapons can travel five times the speed of sound, and Aerojet is the world leader in the engine technology which makes these speeds possible. The all-cash deal should close in the first quarter of 2021.
While we don't like losing a pure-play space investment, Lockheed looks even more undervalued after announcement of the deal. With a 15 PE ratio, solid financials, and a growing revenue stream, investors seem to be ignoring a very compelling growth story.
Media & Entertainment
09. "Wonder Woman 1984" had an abysmal opening weekend, but all the news was not bad
Three years ago, the first new installment of the "Wonder Woman" franchise brought in over $400 million domestically, with one-quarter of that amount coming from its opening weekend. Add another $400 million in international ticket sales, and one could proclaim the $150 million film a rousing financial success. Based on those metrics, the second installment's $16.7 US draw in its opening weekend does not portend good things ahead. True, another $36 million was pulled in from around the world, but odds are strong that the film—with its $200 million budget—will struggle to become cash flow positive. But all of the news is not bad. The pandemic has forced movie studios to get creative with distribution, which is exactly what AT&T's (T $29) Warner Bros. Pictures did with this film. Expecting light theater attendance from a germ-wary public, the studio also debuted the movie on Christmas Day through its HBO Max streaming platform. Viewership was record-shattering. Granted, subscribers did not have to pay an extra fee to watch the flick, but the move thrilled current members and led to increased December subs—there were over 550,000 downloads of the HBO app over the weekend. The tactic worked so well that Warner has already decided to rapidly develop the third "Wonder Woman" installment. Vaccine or not, any guess as to whether or not that one will be simultaneously streamed as well?
Despite its fat dividend yield, AT&T has certainly been a disappointment in the Penn Strategic Income Portfolio. However, we remain bullish on its filmmaking and distribution channels—to include HBO Max. Unfortunately, our bullishness does not extend to the big movie theater chains, such as AMC Entertainment (AMC $2) and Cinemark Holdings (CNK $17). To be sure, home-bound Americans will rush back to the theaters once vaccines are readily available, but these cash-strapped chains will find themselves even more beholden to the parent companies of the production studios who are betting a lot on their competing streaming services.
Retail REITs
08. Our Taubman Centers investment pays off as Simon Property Group finalizes its cash acquisition
Back on the 10th of June we wrote of Simon Property Group's (SPG $83) termination of a deal to buy much smaller competitor Taubman Centers (TCO $43). The rationale they gave in a subsequent lawsuit was ludicrous: Taubman hadn't taken appropriate steps to keep business humming along during the pandemic, giving them (Simon) the right to walk away from the deal. The silly argument might have carried a bit more weight had Simon's own malls not been closed over the timeframe in question. Of course, the real issue was Taubman's understandable drop in market cap due to the global health crisis. On the day that Simon balked, Taubman fell to an intraday low of $34.75 and we pounced, buying shares of the battered, ultra-high-end mall owner. Now, six months later, the deal has finally been inked: Simon Property Group will pay Taubman shareholders $43 per share in cash to take an 80% stake in the firm—the Taubman family will retain a 20% minority stake. Not a bad return for a six-month investment.
While we certainly expected Simon to ultimately acquire Taubman, we were prepared to own the small- to mid-cap REIT regardless. We knew its luxury retail properties, such as the Country Club Plaza in Kansas City, would come roaring back to life in 2021. As for Simon Property Group, we wouldn't touch the shares.
Multiline Retail
07. The JC Penney CEO carousel continues as the firm begins search for its sixth leader in the span of a decade
To keep one of their major anchor stores from shutting down, mall owners Simon Property Group (SPG $86) and Brookfield Property Partners agreed to rescue JC Penney (OTC: JCPNQ $0.15) from bankruptcy in an $800 million deal—$300 million in cash and $500 million in debt assumption. While this may have been comforting news for most of the 80,000 or so remaining employees of the beleaguered retailer, one particular employee is probably not too happy: the new owners just fired CEO Jill Soltau. Sadly, the news doesn't mean much for a company seeking its sixth leader in the span of a decade. Soltau, the former head of Jo-Ann Fabrics, probably had the best shot of any of the firm's recent leaders to bring about positive change; at least until the pandemic forced the company to declare bankruptcy this past May. Now, with Simon's chief investment officer, Stanley Shashoua, temporarily in charge, the new owners begin the search for someone who can bring yet another new vision to the 119-year-old retailer. The right person is out there, we just have no faith in Simon to find that individual. Maybe they can woo the hapless Ron Johnson back.
We are rooting for the retailer, which now has a market cap of just $48 million, and we do believe that a creative leader could still turn the ship around. Even with the shares sitting at fifteen cents on the OTC exchange, however, we are not willing to place money on that bet.
Automotive
06. Tesla misses gargantuan 2020 delivery goal—by 450 vehicles
It was an insanely-high goal, and the usual suspects scoffed at Elon Musk for even throwing the figure out there. Tesla (TSLA $730) projected it would deliver half-a-million electric vehicles in 2020. At the time of the forecast, the company was producing around 100,000 vehicles per year. As the naysayers predicted, the goal was not reached: just 499,550 vehicles were delivered. Not surprisingly, some pundits actually pointed out the miss. The less than one-tenth of one percent miss. The ramp-up in production is beyond impressive, and it points to one of the reasons why Elon Musk is now the second-richest person in the world, adding roughly $150 billion of wealth to his net worth last year. Analysts are scrambling to raise their 2021 projections for Tesla vehicle deliveries, with the average now calling for 750,000 units to roll off of the assembly lines. Major new plants in Austin, Brandenburg, and Shanghai should make that happen. (Update: With a net worth of $188 billion as of Thursday, Musk has surpassed Jeff Bezos as the world's richest person.)
For any investor wishing to get in on the relative ground floor of a Musk entity, look for SpaceX to go public at some point this year. Hopefully the "throw money at anything cool" crowd will not drive the price up to astronomical levels on IPO day, as we plan to buy.
Sovereign Debt & Global Fixed Income
05. Danish banks offering home buyers a mortgage rate that is hard to pass up: 0.0%
From the country that first introduced the novel concept of negative interest rates comes a new gimmick: the zero percent mortgage loan. Beginning this week, customers of Nordea Bank can get 20-year home loans at 0.0%, and other banks in Denmark have signaled their willingness to follow suit. The country has a pass-through system in which mortgages are directly correlated with the bonds covering the loans. Denmark began issuing 20-year government bonds with a zero percent interest rate a few years ago; hence, the new mortgage loan creatures. For Danish borrowers, this may seem like a dream condition, but it is a symptom of a much bigger problem that few in Europe are willing to grapple with—a mountain of government debt which has become completely unmanageable.
While the focus here is on Europe, the situation in the US is not much different. The dirty truth is this: Governments around the world have created so much debt that the central banks cannot afford to raise interest rates—they can barely pay the principal on their aggregate debt load, let alone any servicing costs. This problem will not simply go away, and when it ultimately comes to a head, the shock waves will be massive throughout the economic, fiscal, and political systems.
eCommerce
04. Amazon grows its fleet with purchase of eleven 767-class aircraft
Business is good for $1.6 trillion Internet retail firm Amazon (AMZN $3,166). So good, in fact, that the company is doing something it hasn't done before: buying cargo aircraft. While the firm has a fleet of leased jets, the purchase of eleven Boeing 767-300s from Delta (DAL) and WestJet Airlines gives an indication of Amazon's booming business, and a further indication that it will continue to reduce its reliance on United Parcel Service (UPS $161) for deliveries in favor of its own integrated fleet. Recall that back in 2019 FedEx (FDX $251) refused to renew its contract with Amazon due to draconian demands and thinning margins. The company's delivery operation now includes tens of thousands of cargo vans, and management has expressed a desire to control 200 aircraft in the coming years. By comparison, UPS operates roughly 500 aircraft, and FedEx roughly 700.
Remember when so many industry analysts were poking fun at an investment in Amazon due to the company's lack of profit? That wasn't very long ago. Granted, shares still hold a rich multiple of 95, but we believe that is justified. AMZN is one of the forty holdings in the Penn Global Leaders Club.
Semiconductors & Equipment
03. Should we sell our rocketing Qualcomm now that one of our favorite CEOs is abruptly stepping down?
Fundamental analysis, as opposed to technical analysis, is at the heart of selecting the right investments for a portfolio (though chartists would certainly disagree). And fundamental analysis goes beyond the financial statements; a wise investor must consider the strategic vision of a company, and the tactics being employed to achieve that vision. Weak or mediocre management teams have an excuse at the ready for every problem that arises. Strong teams, led by a true leader at the helm, create the right strategy, deploy the right tactics, and embolden the workforce to excel.
American semiconductor giant Qualcomm (QCOM $155), led by the analytically-minded Steve Mollenkopf, certainly fits the template of the latter. While an engineer by training (he holds two electrical engineering degrees), Mollenkopf is one of those rare individuals who is equally at ease with semiconductor schematics and boardroom meetings. He is the quintessential leader. That is why we were shocked to hear that the 52-year-old CEO of the San Diego-based firm would be retiring this year. He will be replaced this coming June by the company's president, Cristiano Amon, who also hails from an engineering background.
The challenges that Mollenkopf faced in his tenure were massive, from a hostile takeover bid by Broadcom to a licensing fight with Apple to regulatory scrutiny from numerous countries. He handled all of them masterfully, but how will Amon face the similar challenges which are sure to arise in this cutthroat industry? The 50-year-old has been with Qualcomm most of his career and has worked directly under Mollenkopf for the past several years, so he certainly has his bona fides in place. Only time will tell how adept he will be at navigating through crises, but the company is on the right course to take full advantage of the coming 5G revolution.
Qualcomm collects royalties on the majority of 3G, 4G, and 5G handsets sold, holding the essential patents for the components used in these networks. All major handset OEMs are under license, with a total of 110 5G deals on the books.
Our Qualcomm holding, which is in the Penn New Frontier Fund, is up triple digits from its purchase, and we see plenty of growth ahead. That being said, we are putting the company on our watchlist simply due to the change in leadership.
Market Pulse
02. Despite the disconcerting events of the week, the indexes rally to new highs
The image was so mind-blowing that I had to take a screenshot. The picture behind the chyron was that of the capitol building being overrun by protestors. The text on the screen read: Breaking News: House, Senate Evacuated as US Capitol Breached . In the lower right of the screen were the green numbers: DOW +465.40, % Change +1.53%. My mind raced back to one week in December of 2018 when the Dow dropped 1,884 points in four sessions due to seemingly benign interest rate comments by Fed Chair Jerome Powell. And now, the capitol is being stormed and the Dow is rallying. By the time the trading week was up, the Dow, the S&P 500, and the NASDAQ had all rallied approximately 2%. Not a bad start to 2021. Perhaps it was a rosy jobs report? Nope. There were 140,000 jobs lost in December versus an expected 50,000 gain. It was the first drop since April during the heart of the pandemic. While investors are certainly hopeful on the vaccine front, Thursday brought the deadliest day since the pandemic began, with 4,000 American lives lost. On the political front, we were told that divided government would be great for the markets, as nothing radical would take place in Congress. Instead, two special elections in Georgia brought about a blue wave. While we are still of the mindset that economies around the world will come roaring back this year as the vaccines begin to quell the deadly virus, the best word we can use to describe this week in the markets is "odd." And that is not an adjective which instills much confidence.
Under the Radar Investment
01. Under the Radar: The Kroger Co.
It may come as a surprise to many, but The Kroger Co. (KR $32) is the nation's largest grocery store chain based on sales ($122B in 2020), with the company operating nearly 3,000 supermarkets throughout the country. And CEO Rodney McMullen has kept his 138-year-old firm looking fresh, with online ordering and curbside pick up at 72% of the stores, and home delivery options for 97% of the customer base. Kroger Ship, which launched last year, marks a major new push into eCommerce. The program provides online customers access to over 50,000 items in categories such as organic foods, international foods, housewares, and toys. Two new highly-automated fulfillment centers are slated to open this spring, which should further reduce the company's cost of fulfilling online orders. With a tiny multiple of 8.5 and a pullback in the share price, this consumer defensive value play truly appears to be an under-the-radar gem ripe for the picking.
Answer
Slightly. The aggregate market cap of General Motors, Ford, and Fiat Chrysler as of 08 Jan 2021 is $133 billion, or less than 16% the market cap of Tesla.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The Economies of Scale...
Tesla, which was formed in 2003 as Tesla Motors, now has a market cap of $835 billion. Is that larger than the combined market caps of General Motors, Ford, and Fiat Chrysler?
Penn Trading Desk:
Simon completes Taubman deal, proceeds flow to cash
Simon Property Group's deal to buy Taubman Centers closes, TCO owners paid $34 per share in cash. See story below.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Aerospace & Defense
10. Two Penn Members Merging: Lockheed Martin will Buy Aerojet Rocketdyne for $4.4 billion
We purchased mid-cap rocket engine maker Aerojet Rocketdyne (AJRD $53) in the Penn New Frontier Fund as a pure play on the burgeoning private space movement. We own aerospace and defense giant Lockheed Martin (LMT $355) in the Penn Global Leaders Club due to its dominance in that industry—and our negative opinion of Boeing's (BA $219) hapless management team. In a move that illustrates the savvy of Lockheed's own leadership, that company announced it will acquire Aerojet for the equivalent of $56 per share, or $4.4 billion. Just over one-third of Aerojet's revenue comes from Lockheed, meaning the $100 billion Maryland-based firm will now own a key supplier. As a major defense supplier to the United States government, one cutting-edge arena that certainly hastened the purchase was hypersonic technology. With Putin bragging about Russia's new generation of hypersonic weapons and China making similar claims, it is imperative for the United States to remain in the lead with respect to these weapon systems. Hypersonic weapons can travel five times the speed of sound, and Aerojet is the world leader in the engine technology which makes these speeds possible. The all-cash deal should close in the first quarter of 2021.
While we don't like losing a pure-play space investment, Lockheed looks even more undervalued after announcement of the deal. With a 15 PE ratio, solid financials, and a growing revenue stream, investors seem to be ignoring a very compelling growth story.
Media & Entertainment
09. "Wonder Woman 1984" had an abysmal opening weekend, but all the news was not bad
Three years ago, the first new installment of the "Wonder Woman" franchise brought in over $400 million domestically, with one-quarter of that amount coming from its opening weekend. Add another $400 million in international ticket sales, and one could proclaim the $150 million film a rousing financial success. Based on those metrics, the second installment's $16.7 US draw in its opening weekend does not portend good things ahead. True, another $36 million was pulled in from around the world, but odds are strong that the film—with its $200 million budget—will struggle to become cash flow positive. But all of the news is not bad. The pandemic has forced movie studios to get creative with distribution, which is exactly what AT&T's (T $29) Warner Bros. Pictures did with this film. Expecting light theater attendance from a germ-wary public, the studio also debuted the movie on Christmas Day through its HBO Max streaming platform. Viewership was record-shattering. Granted, subscribers did not have to pay an extra fee to watch the flick, but the move thrilled current members and led to increased December subs—there were over 550,000 downloads of the HBO app over the weekend. The tactic worked so well that Warner has already decided to rapidly develop the third "Wonder Woman" installment. Vaccine or not, any guess as to whether or not that one will be simultaneously streamed as well?
Despite its fat dividend yield, AT&T has certainly been a disappointment in the Penn Strategic Income Portfolio. However, we remain bullish on its filmmaking and distribution channels—to include HBO Max. Unfortunately, our bullishness does not extend to the big movie theater chains, such as AMC Entertainment (AMC $2) and Cinemark Holdings (CNK $17). To be sure, home-bound Americans will rush back to the theaters once vaccines are readily available, but these cash-strapped chains will find themselves even more beholden to the parent companies of the production studios who are betting a lot on their competing streaming services.
Retail REITs
08. Our Taubman Centers investment pays off as Simon Property Group finalizes its cash acquisition
Back on the 10th of June we wrote of Simon Property Group's (SPG $83) termination of a deal to buy much smaller competitor Taubman Centers (TCO $43). The rationale they gave in a subsequent lawsuit was ludicrous: Taubman hadn't taken appropriate steps to keep business humming along during the pandemic, giving them (Simon) the right to walk away from the deal. The silly argument might have carried a bit more weight had Simon's own malls not been closed over the timeframe in question. Of course, the real issue was Taubman's understandable drop in market cap due to the global health crisis. On the day that Simon balked, Taubman fell to an intraday low of $34.75 and we pounced, buying shares of the battered, ultra-high-end mall owner. Now, six months later, the deal has finally been inked: Simon Property Group will pay Taubman shareholders $43 per share in cash to take an 80% stake in the firm—the Taubman family will retain a 20% minority stake. Not a bad return for a six-month investment.
While we certainly expected Simon to ultimately acquire Taubman, we were prepared to own the small- to mid-cap REIT regardless. We knew its luxury retail properties, such as the Country Club Plaza in Kansas City, would come roaring back to life in 2021. As for Simon Property Group, we wouldn't touch the shares.
Multiline Retail
07. The JC Penney CEO carousel continues as the firm begins search for its sixth leader in the span of a decade
To keep one of their major anchor stores from shutting down, mall owners Simon Property Group (SPG $86) and Brookfield Property Partners agreed to rescue JC Penney (OTC: JCPNQ $0.15) from bankruptcy in an $800 million deal—$300 million in cash and $500 million in debt assumption. While this may have been comforting news for most of the 80,000 or so remaining employees of the beleaguered retailer, one particular employee is probably not too happy: the new owners just fired CEO Jill Soltau. Sadly, the news doesn't mean much for a company seeking its sixth leader in the span of a decade. Soltau, the former head of Jo-Ann Fabrics, probably had the best shot of any of the firm's recent leaders to bring about positive change; at least until the pandemic forced the company to declare bankruptcy this past May. Now, with Simon's chief investment officer, Stanley Shashoua, temporarily in charge, the new owners begin the search for someone who can bring yet another new vision to the 119-year-old retailer. The right person is out there, we just have no faith in Simon to find that individual. Maybe they can woo the hapless Ron Johnson back.
We are rooting for the retailer, which now has a market cap of just $48 million, and we do believe that a creative leader could still turn the ship around. Even with the shares sitting at fifteen cents on the OTC exchange, however, we are not willing to place money on that bet.
Automotive
06. Tesla misses gargantuan 2020 delivery goal—by 450 vehicles
It was an insanely-high goal, and the usual suspects scoffed at Elon Musk for even throwing the figure out there. Tesla (TSLA $730) projected it would deliver half-a-million electric vehicles in 2020. At the time of the forecast, the company was producing around 100,000 vehicles per year. As the naysayers predicted, the goal was not reached: just 499,550 vehicles were delivered. Not surprisingly, some pundits actually pointed out the miss. The less than one-tenth of one percent miss. The ramp-up in production is beyond impressive, and it points to one of the reasons why Elon Musk is now the second-richest person in the world, adding roughly $150 billion of wealth to his net worth last year. Analysts are scrambling to raise their 2021 projections for Tesla vehicle deliveries, with the average now calling for 750,000 units to roll off of the assembly lines. Major new plants in Austin, Brandenburg, and Shanghai should make that happen. (Update: With a net worth of $188 billion as of Thursday, Musk has surpassed Jeff Bezos as the world's richest person.)
For any investor wishing to get in on the relative ground floor of a Musk entity, look for SpaceX to go public at some point this year. Hopefully the "throw money at anything cool" crowd will not drive the price up to astronomical levels on IPO day, as we plan to buy.
Sovereign Debt & Global Fixed Income
05. Danish banks offering home buyers a mortgage rate that is hard to pass up: 0.0%
From the country that first introduced the novel concept of negative interest rates comes a new gimmick: the zero percent mortgage loan. Beginning this week, customers of Nordea Bank can get 20-year home loans at 0.0%, and other banks in Denmark have signaled their willingness to follow suit. The country has a pass-through system in which mortgages are directly correlated with the bonds covering the loans. Denmark began issuing 20-year government bonds with a zero percent interest rate a few years ago; hence, the new mortgage loan creatures. For Danish borrowers, this may seem like a dream condition, but it is a symptom of a much bigger problem that few in Europe are willing to grapple with—a mountain of government debt which has become completely unmanageable.
While the focus here is on Europe, the situation in the US is not much different. The dirty truth is this: Governments around the world have created so much debt that the central banks cannot afford to raise interest rates—they can barely pay the principal on their aggregate debt load, let alone any servicing costs. This problem will not simply go away, and when it ultimately comes to a head, the shock waves will be massive throughout the economic, fiscal, and political systems.
eCommerce
04. Amazon grows its fleet with purchase of eleven 767-class aircraft
Business is good for $1.6 trillion Internet retail firm Amazon (AMZN $3,166). So good, in fact, that the company is doing something it hasn't done before: buying cargo aircraft. While the firm has a fleet of leased jets, the purchase of eleven Boeing 767-300s from Delta (DAL) and WestJet Airlines gives an indication of Amazon's booming business, and a further indication that it will continue to reduce its reliance on United Parcel Service (UPS $161) for deliveries in favor of its own integrated fleet. Recall that back in 2019 FedEx (FDX $251) refused to renew its contract with Amazon due to draconian demands and thinning margins. The company's delivery operation now includes tens of thousands of cargo vans, and management has expressed a desire to control 200 aircraft in the coming years. By comparison, UPS operates roughly 500 aircraft, and FedEx roughly 700.
Remember when so many industry analysts were poking fun at an investment in Amazon due to the company's lack of profit? That wasn't very long ago. Granted, shares still hold a rich multiple of 95, but we believe that is justified. AMZN is one of the forty holdings in the Penn Global Leaders Club.
Semiconductors & Equipment
03. Should we sell our rocketing Qualcomm now that one of our favorite CEOs is abruptly stepping down?
Fundamental analysis, as opposed to technical analysis, is at the heart of selecting the right investments for a portfolio (though chartists would certainly disagree). And fundamental analysis goes beyond the financial statements; a wise investor must consider the strategic vision of a company, and the tactics being employed to achieve that vision. Weak or mediocre management teams have an excuse at the ready for every problem that arises. Strong teams, led by a true leader at the helm, create the right strategy, deploy the right tactics, and embolden the workforce to excel.
American semiconductor giant Qualcomm (QCOM $155), led by the analytically-minded Steve Mollenkopf, certainly fits the template of the latter. While an engineer by training (he holds two electrical engineering degrees), Mollenkopf is one of those rare individuals who is equally at ease with semiconductor schematics and boardroom meetings. He is the quintessential leader. That is why we were shocked to hear that the 52-year-old CEO of the San Diego-based firm would be retiring this year. He will be replaced this coming June by the company's president, Cristiano Amon, who also hails from an engineering background.
The challenges that Mollenkopf faced in his tenure were massive, from a hostile takeover bid by Broadcom to a licensing fight with Apple to regulatory scrutiny from numerous countries. He handled all of them masterfully, but how will Amon face the similar challenges which are sure to arise in this cutthroat industry? The 50-year-old has been with Qualcomm most of his career and has worked directly under Mollenkopf for the past several years, so he certainly has his bona fides in place. Only time will tell how adept he will be at navigating through crises, but the company is on the right course to take full advantage of the coming 5G revolution.
Qualcomm collects royalties on the majority of 3G, 4G, and 5G handsets sold, holding the essential patents for the components used in these networks. All major handset OEMs are under license, with a total of 110 5G deals on the books.
Our Qualcomm holding, which is in the Penn New Frontier Fund, is up triple digits from its purchase, and we see plenty of growth ahead. That being said, we are putting the company on our watchlist simply due to the change in leadership.
Market Pulse
02. Despite the disconcerting events of the week, the indexes rally to new highs
The image was so mind-blowing that I had to take a screenshot. The picture behind the chyron was that of the capitol building being overrun by protestors. The text on the screen read: Breaking News: House, Senate Evacuated as US Capitol Breached . In the lower right of the screen were the green numbers: DOW +465.40, % Change +1.53%. My mind raced back to one week in December of 2018 when the Dow dropped 1,884 points in four sessions due to seemingly benign interest rate comments by Fed Chair Jerome Powell. And now, the capitol is being stormed and the Dow is rallying. By the time the trading week was up, the Dow, the S&P 500, and the NASDAQ had all rallied approximately 2%. Not a bad start to 2021. Perhaps it was a rosy jobs report? Nope. There were 140,000 jobs lost in December versus an expected 50,000 gain. It was the first drop since April during the heart of the pandemic. While investors are certainly hopeful on the vaccine front, Thursday brought the deadliest day since the pandemic began, with 4,000 American lives lost. On the political front, we were told that divided government would be great for the markets, as nothing radical would take place in Congress. Instead, two special elections in Georgia brought about a blue wave. While we are still of the mindset that economies around the world will come roaring back this year as the vaccines begin to quell the deadly virus, the best word we can use to describe this week in the markets is "odd." And that is not an adjective which instills much confidence.
Under the Radar Investment
01. Under the Radar: The Kroger Co.
It may come as a surprise to many, but The Kroger Co. (KR $32) is the nation's largest grocery store chain based on sales ($122B in 2020), with the company operating nearly 3,000 supermarkets throughout the country. And CEO Rodney McMullen has kept his 138-year-old firm looking fresh, with online ordering and curbside pick up at 72% of the stores, and home delivery options for 97% of the customer base. Kroger Ship, which launched last year, marks a major new push into eCommerce. The program provides online customers access to over 50,000 items in categories such as organic foods, international foods, housewares, and toys. Two new highly-automated fulfillment centers are slated to open this spring, which should further reduce the company's cost of fulfilling online orders. With a tiny multiple of 8.5 and a pullback in the share price, this consumer defensive value play truly appears to be an under-the-radar gem ripe for the picking.
Answer
Slightly. The aggregate market cap of General Motors, Ford, and Fiat Chrysler as of 08 Jan 2021 is $133 billion, or less than 16% the market cap of Tesla.
Headlines for the Week of 06 Dec—12 Dec 2020
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
Roots of a historic theater...
Grauman's Chinese Theatre, now a custom-designed IMAX experience, opened to much acclaim on 18 May 1927. It was built following the success of what nearby Hollywood theater with a similar Exotic Revival architecture style?
Penn Trading Desk:
(01 Dec 20) FedEx upgraded at Barclays due to "abundance of growth opportunities"
Shares of Penn Global Leaders Club member FedEx (FDX $287) hit an all-time high of $297.66 on Monday following an upgrade and rosy comments from analyst Brandon Oglenski at Barclays. Oglenski cited "an abundance of growth opportunities" for the firm due to the explosion of e-commerce this year. He raised the firm's rating from equal weight to overweight and moved his target price on FDX shares from $240 to $360.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Global Strategy: Latin America
10. Money is flooding out of Bolivia as socialists regain power
Sadly, a large percentage of Latin Americans seem have a loving adoration of socialism, despite its history of bringing misery to the masses. There is a constant battle raging between economic freedom and leftist tyranny in the region, with the latter often winning the war for the hearts and minds of the people. The latest example comes from Bolivia, where socialist Luis "Lucho" Arce (pron. "ARE say"), a staunch advocate of exiled former socialist president Evo Morales, just won a landslide victory in the presidential race. The nation's poorest citizens may adore Arce, but the country's wealthy are sending a different message. Bolivia's international cash reserves have plunged from $6.4 billion to $5.1 billion since the election, as both citizens and corporations in the country have been converting their bolivianos to US dollars and sending the cash abroad. One of Arce's key planks was the promise to implement a wealth tax on the country's richest citizens. Bolivia has a population of 11.7 million and a per capita GDP of approximately $4,000. For comparison, Bolivia's more "investment friendly" neighbor to the east—Brazil—has a per capita GDP of $10,400. The country's primary exports are natural gas, metals (mainly silver and zinc), and soybean products.
As is well documented in the region, socialists who gain power in Latin America tend to hold onto their position with a firm grip despite any ruling constitution. Evo Morales came to power in January of 2006 and was forced into exile in Argentina only after civil unrest following a disputed election in 2019. If Arce learned anything from his mentor, expect him to be the grand leader of Bolivia for some time to come—despite the exodus of wealth from the country.
Metals & Mining
09. Positive vaccine news and calmer political waters have pushed gold prices down; time to look at adding to our position
We took a hefty position in gold, via the SPDR Gold Shares ETF (GLD $167), back in January of 2019 when the metal was sitting at $1,290 per ounce. After topping out around $2,067 per ounce this summer, prices began falling precipitously when positive Covid vaccine news began flowing in, and the US election was in the rear-view mirror. Scott Wren, now a senior analyst at Wells Fargo, was once our favorite analyst at A.G. Edwards & Sons, and we have tremendous respect for his typically spot-on outlook. When asked about the falling price of gold, he questioned—rhetorically—whether or not central banks around the world would continue to wantonly print money, or if fiscal constraint was suddenly going to supplant massive government spending. The obvious answer to those questions support his thesis that gold will regain its footing and head to $2,150 by the end of next year. He also sees another $100 drop in the price as a good entry point for more investment dollars. Right now, gold is sitting at $1,780 per share.
The recent selloff in gold shows, in our opinion, that investors are playing the short game. The precise conditions that led to gold's rise over the past few years will still be in place post-pandemic. In fact, countries around the world are now about $15 trillion deeper in debt thanks to China and the virus which emanated from the country's shores. We remain very bullish on gold.
Automotive
08. Nikola shares fall 54% after deal with General Motors is scaled back
Anyone who has read our columns on a regular basis knows our personal opinion of EV automaker Nikola (NKLA $17)—that the company is a total sham. Nonetheless, "traders" went flooding in, driving the shares up from $10 in March to $94 just three months later. Research be damned, this was going to be the next Tesla (TSLA $585)! Not quite. We mocked General Motors (GM $45) for even considering taking a stake in the firm; a move that only emboldened neophyte traders. It seems as though GM's Mary Barra has seen the light, as the company has backed out of its plan to take an 11% stake in Nikola and will no longer work with the firm to build the Badger, an EV pickup for consumers. Perhaps to keep a little pride intact, GM did rework the deal to keep a fuel cell partnership in place, but this non-binding agreement will probably wither on the vine. In just five sessions, NKLA shares fell from $37.62 to $17.37—a 54% drop. Oh well, at least it is back on the radar screen for those whose investment strategy consists of buying stocks trading for under $25 per share.
Shades of 1999. Americans are piling into flashy stocks based on headlines, not research. For astute investors, this will create huge opportunities—especially in the boring value companies which don't garner many headlines, but which generate fat annual profits year after year. 2021 will mark the year of the great rotation back into value.
East & Southeast Asia
07. In hopeful sign, Apple is reportedly shifting some production from China to Vietnam
Country Risk: the uncertainty associated with investing in a particular country and the degree to which that uncertainty can lead to losses for stakeholders. This risk can be mitigated by assuring a company is not overly reliant on one particular country, especially those with undemocratic forms of government. This is Economics 101, yet how many management teams flouted this basic lesson because of the glittering jewel they saw in China's 1.3 billion potential consumers? We can't undo the past, but we can hold these companies accountable. In a hopeful sign that the zeitgeist is shifting, Apple (AAPL $123) is reportedly moving iPad production out of China and into Vietnam—a country with a large degree of animosity towards the communist state. More specifically, key Apple supplier Foxconn is shifting the production—both for iPads and some MacBooks—from their Chinese facilities to the Vietnamese factories they began building back in 2007. The company is setting up new assembly lines for both the tablets and the laptops at their plant in Bac Giang, a northeastern province of Vietnam, "at the request of Apple." Other than that admission, both companies are mum on the details.
In yet another hopeful sign, Apple is planning a $1 billion spend to expand its manufacturing presence in the democratic country of India. For its part, Foxconn is looking at building a new set of plants in Mexico. Slowly but surely, companies are waking up to the level of country risk involved with communist China. If the Western world can actually present a united front, the China 2025 plan may be dealt a hefty blow.
Media & Entertainment
06. Theater chains get pummeled after surprise Warner Brothers announcement
AMC Entertainment (AMC $4) was off 20%, as was Cinemark Holdings (CNK $13). Imax (IMAX $14) fared a little bit better, dropping just 7%. After the nightmare of having their theaters closed due to the pandemic, the news from AT&T's (T $29) Warner Brothers unit was quite unwelcome: the filmmaker would release all of its 2021 movies simultaneously on both the big screen and via streaming through WarnerMedia's HBO Max. In other words, zero exclusivity for the big movie chains. The relationship between the movie houses and the film studios was already strained. Back in April we reported on AMC's ban of Comcast's (CMCSA $52) Universal Pictures' films after the latter announced it would also pull the simultaneous release stunt. This "breaking of the theatrical window" is terrible news for an industry already struggling to stay afloat. WarnerMedia CEO Jason Kilar made the rather cocky comment that the theater chains need to "take a breather," adding that the new releases will be pulled from HBO Max after thirty days. His comments only added fuel to the fire.
The movie chains are in somewhat the same position as many shopping malls throughout America. Dealing with decreased foot traffic due to the online shopping renaissance, these malls were forced to reinvent themselves as "experience destinations." The theaters are slowly adopting this philosophy, with AMC experimenting with NFL games on the big screen to attract fans. At $4 per share, AMC may look attractive, but we wouldn't be in a hurry to invest—there is still scant evidence that the darkest days are behind these companies.
Restaurants
05. Already strained, McDonald's just made its relationship with franchisees even worse
McDonald's (MCD $211) was one of those stalwarts we expected to own in the Penn Global Leaders Club for some time to come. That changed when the board of directors fired one of the best—and most loyal—CEOs in the industry. We took our profits and ran. In a sign that things are returning to normal (not a compliment; rather, a reference to the way things were under Don Thompson), the company has been telegraphing warnings to franchisees about hard times ahead. While the parent company does have about $40 million earmarked for aid to restaurants hardest hit by the pandemic (which seems paltry compared to its $5B in TTM net income), it warned that owners may need to look at selling locations or finding financial assistance elsewhere. Management also announced that it would be ending the $300 monthly Happy Meal subsidy which has been around for decades, and that it expects franchisees to start sharing the costs of the firm's tuition program. To be sure, all of these moves could be justified by corporate, but that doesn't change the perception by franchisees that they are getting nickel-and-dimed by the controlling entity. Yet another reason we continue to steer clear of the restaurant.
Jeff Easterbrook knew how to deal with people. Growing up in London, he was a constant customer of the local McDonald's, and his love for the company was evident in the way he treated employees and franchisees. The current management team in place may know numbers, but they sure don't seem to know how to deal with the people on the front line of the restaurant's revenue stream.
Business & Professional Services
04. EMH debunked yet again with laughable spike in Kodak shares
Efficient market hypothesis (EMH): the theory that a stock is always fairly valued based on all the available information at the time, making it impossible to "beat the market" on a consistent basis since share prices only react to new information. What a load of bull. Shares of Eastman Kodak (KODK $13), the lovable yet archaic camera company which was founded in 1888, have fluctuated between $1.50 (23 Mar) and $60 (29 Jul) this year. On Monday, shares spiked 77% in one session, driving them all the way back up to $13.30. What led to this latest unreal jump? Exoneration from the SEC regarding accusations that the company leaked news about a potential $765 million loan by the government to help it—Kodak—begin making active pharmaceutical ingredients (APIs) for drugs—a job the US disgracefully outsourced to China years ago. So, leaked news of a $765 million loan turned a $96 million flounder into a $1.65 billion shark virtually overnight? Yep. Maybe it wasn't just the news that drove "investors" back into the shares; maybe it was the financials. Over the trailing twelve months (TTM), Kodak lost $623 million on $1.06 billion in sales. That seems almost difficult to accomplish. Yet another story reminiscent of the 1999/2000 time period: Throw good money into companies that will show losses as far as the eye can see. Some "investors" don't recall that period, but we do.
There is a true dichotomy in the markets right now. We see a lot of great investment opportunities and a bright horizon for the year ahead. We also see a lot of companies with insane valuations thanks to dumb money chasing quick returns. Even more so than in 1999, many of the people pumping money into these companies couldn't explain what these firms do if their lives depended on it. That is certainly true with respect to Kodak, the camera company turned drug ingredient supplier.
Hotels, Restaurants, & Cruise Lines
03. We had every intention of buying Airbnb on its IPO—and then it priced
Sorry, but we have one more 1999 analogy. Granted, Airbnb (ABNB $139) is no pets.com (remember the hand puppet?), but what happened on the former's IPO day is insane. To be clear, we fully believe in Airbnb's business model, and have no doubt that it will be highly successful going forward—precisely why we expected to buy shares of the firm on day one. So, what happened? The IPO was finally priced at $68 per share. Of note: the CEO said he wanted the IPO price to reflect what he considered to be fair value of the company. When the stock finally began trading, its first price was $146, or 116% above what senior management considered fair value. There is a new breed of investor hitting the markets right now, and facts be damned; if they want a company because it has a cool name (Nikola comes to mind) they will pay any price to own it. How bad is it right now? Many investors complained that they didn't get the IPO price of $68, having no idea that it doesn't work that way. Want another example? There was a flurry of options action in ABB Ltd (ABB), an electrical equipment and parts maker based in Zurich, leading up to the ABNB IPO. It seems as though many "investors" thought they were buying calls on Airbnb. Let the red flags go up. When we were figuring where we might get the shares of the firm on day one, we initially thought $35 to $50 seemed reasonable, though $50 was stretching it. So, a company that was valued at $18 billion this summer now has a market cap of $150 billion. Like we say, insane.
We're bummed that we don't own ABNB, but we expect to pick the shares up when they come crashing back to reality at some point in 2021. And that is not a slam against the company, it is a slam on the knuckleheads who bought in at $146 or higher (shares went up as high as $165 on day one).
Market Pulse
02. Despite the wild IPO ride, markets fall on the week
Based on what happened in the IPO market over the course of five sessions, it might seem surprising that the three major indexes were all down for the week, but DoorDash (DASH $175), Airbnb (ABNB $139), and C3.ai Inc (AI $120) all turned out to be red herrings—shiny objects which distracted investors from the big picture. The markets falling for the week (S&P -0.96%, Dow -0.57%, NASDAQ -0.69%) was actually a healthy respite from the big run-up we've had over the past month. Counter that with the facts-be-damned trading we had in three IPO stocks, and 2021 is shaping up to be a tale of the haves and the have-nots. The haves will be the thoughtful investors looking for value, earnings, and sound business models. The have-nots will be the shiny object crowd: those using their Robinhood app like a video game to gobble up the fun-sounding names. How fitting that Goldman will bring that company public next year. A reckoning is coming, but it will be—thankfully—more discerning than the 2000-2002 variety. This one will hammer the dumb money and provide opportunity for the smart money. Bring on the new year.
2021 will be the year of the great re-build. The global economy will come roaring back with a vengeance, and GDP—both domestically and globally—will surprise to the upside. It will also be the year that tech companies with no earnings and fat valuations come crashing back to reality. Where can the smart money go? Look for opportunities in health care and industrials—boring companies that simply turn a profit year-in and year-out.
Under the Radar Investment
01. Under the Radar: Embotelladora Andina SA
Embotelladora Andina (AKO.B $15) is a Chilean-based Coca-Cola bottler serving the Latin American region. Together with its subsidiaries, the company produces, markets, and distributes Coca-Cola trademark products, to include fruit juices, sports drinks, purified waters, and flavored waters. The firm also sells and distributes beer under the Amstel, Bavaria, Heineken, and Sol brands. On $2.5 billion in sales last year, the company brought in $248 million in profit. AKO.B offers investors a 5.61% dividend yield based on the current share price of $15. Yet another consideration for globally-diversifying a portfolio.
Answer
Grauman's Chinese Theatre was built following the success of the nearby Grauman's Egyptian Theatre, which opened on Hollywood Boulevard in 1922. In May of this year, Netflix purchased that historic property.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Roots of a historic theater...
Grauman's Chinese Theatre, now a custom-designed IMAX experience, opened to much acclaim on 18 May 1927. It was built following the success of what nearby Hollywood theater with a similar Exotic Revival architecture style?
Penn Trading Desk:
(01 Dec 20) FedEx upgraded at Barclays due to "abundance of growth opportunities"
Shares of Penn Global Leaders Club member FedEx (FDX $287) hit an all-time high of $297.66 on Monday following an upgrade and rosy comments from analyst Brandon Oglenski at Barclays. Oglenski cited "an abundance of growth opportunities" for the firm due to the explosion of e-commerce this year. He raised the firm's rating from equal weight to overweight and moved his target price on FDX shares from $240 to $360.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Global Strategy: Latin America
10. Money is flooding out of Bolivia as socialists regain power
Sadly, a large percentage of Latin Americans seem have a loving adoration of socialism, despite its history of bringing misery to the masses. There is a constant battle raging between economic freedom and leftist tyranny in the region, with the latter often winning the war for the hearts and minds of the people. The latest example comes from Bolivia, where socialist Luis "Lucho" Arce (pron. "ARE say"), a staunch advocate of exiled former socialist president Evo Morales, just won a landslide victory in the presidential race. The nation's poorest citizens may adore Arce, but the country's wealthy are sending a different message. Bolivia's international cash reserves have plunged from $6.4 billion to $5.1 billion since the election, as both citizens and corporations in the country have been converting their bolivianos to US dollars and sending the cash abroad. One of Arce's key planks was the promise to implement a wealth tax on the country's richest citizens. Bolivia has a population of 11.7 million and a per capita GDP of approximately $4,000. For comparison, Bolivia's more "investment friendly" neighbor to the east—Brazil—has a per capita GDP of $10,400. The country's primary exports are natural gas, metals (mainly silver and zinc), and soybean products.
As is well documented in the region, socialists who gain power in Latin America tend to hold onto their position with a firm grip despite any ruling constitution. Evo Morales came to power in January of 2006 and was forced into exile in Argentina only after civil unrest following a disputed election in 2019. If Arce learned anything from his mentor, expect him to be the grand leader of Bolivia for some time to come—despite the exodus of wealth from the country.
Metals & Mining
09. Positive vaccine news and calmer political waters have pushed gold prices down; time to look at adding to our position
We took a hefty position in gold, via the SPDR Gold Shares ETF (GLD $167), back in January of 2019 when the metal was sitting at $1,290 per ounce. After topping out around $2,067 per ounce this summer, prices began falling precipitously when positive Covid vaccine news began flowing in, and the US election was in the rear-view mirror. Scott Wren, now a senior analyst at Wells Fargo, was once our favorite analyst at A.G. Edwards & Sons, and we have tremendous respect for his typically spot-on outlook. When asked about the falling price of gold, he questioned—rhetorically—whether or not central banks around the world would continue to wantonly print money, or if fiscal constraint was suddenly going to supplant massive government spending. The obvious answer to those questions support his thesis that gold will regain its footing and head to $2,150 by the end of next year. He also sees another $100 drop in the price as a good entry point for more investment dollars. Right now, gold is sitting at $1,780 per share.
The recent selloff in gold shows, in our opinion, that investors are playing the short game. The precise conditions that led to gold's rise over the past few years will still be in place post-pandemic. In fact, countries around the world are now about $15 trillion deeper in debt thanks to China and the virus which emanated from the country's shores. We remain very bullish on gold.
Automotive
08. Nikola shares fall 54% after deal with General Motors is scaled back
Anyone who has read our columns on a regular basis knows our personal opinion of EV automaker Nikola (NKLA $17)—that the company is a total sham. Nonetheless, "traders" went flooding in, driving the shares up from $10 in March to $94 just three months later. Research be damned, this was going to be the next Tesla (TSLA $585)! Not quite. We mocked General Motors (GM $45) for even considering taking a stake in the firm; a move that only emboldened neophyte traders. It seems as though GM's Mary Barra has seen the light, as the company has backed out of its plan to take an 11% stake in Nikola and will no longer work with the firm to build the Badger, an EV pickup for consumers. Perhaps to keep a little pride intact, GM did rework the deal to keep a fuel cell partnership in place, but this non-binding agreement will probably wither on the vine. In just five sessions, NKLA shares fell from $37.62 to $17.37—a 54% drop. Oh well, at least it is back on the radar screen for those whose investment strategy consists of buying stocks trading for under $25 per share.
Shades of 1999. Americans are piling into flashy stocks based on headlines, not research. For astute investors, this will create huge opportunities—especially in the boring value companies which don't garner many headlines, but which generate fat annual profits year after year. 2021 will mark the year of the great rotation back into value.
East & Southeast Asia
07. In hopeful sign, Apple is reportedly shifting some production from China to Vietnam
Country Risk: the uncertainty associated with investing in a particular country and the degree to which that uncertainty can lead to losses for stakeholders. This risk can be mitigated by assuring a company is not overly reliant on one particular country, especially those with undemocratic forms of government. This is Economics 101, yet how many management teams flouted this basic lesson because of the glittering jewel they saw in China's 1.3 billion potential consumers? We can't undo the past, but we can hold these companies accountable. In a hopeful sign that the zeitgeist is shifting, Apple (AAPL $123) is reportedly moving iPad production out of China and into Vietnam—a country with a large degree of animosity towards the communist state. More specifically, key Apple supplier Foxconn is shifting the production—both for iPads and some MacBooks—from their Chinese facilities to the Vietnamese factories they began building back in 2007. The company is setting up new assembly lines for both the tablets and the laptops at their plant in Bac Giang, a northeastern province of Vietnam, "at the request of Apple." Other than that admission, both companies are mum on the details.
In yet another hopeful sign, Apple is planning a $1 billion spend to expand its manufacturing presence in the democratic country of India. For its part, Foxconn is looking at building a new set of plants in Mexico. Slowly but surely, companies are waking up to the level of country risk involved with communist China. If the Western world can actually present a united front, the China 2025 plan may be dealt a hefty blow.
Media & Entertainment
06. Theater chains get pummeled after surprise Warner Brothers announcement
AMC Entertainment (AMC $4) was off 20%, as was Cinemark Holdings (CNK $13). Imax (IMAX $14) fared a little bit better, dropping just 7%. After the nightmare of having their theaters closed due to the pandemic, the news from AT&T's (T $29) Warner Brothers unit was quite unwelcome: the filmmaker would release all of its 2021 movies simultaneously on both the big screen and via streaming through WarnerMedia's HBO Max. In other words, zero exclusivity for the big movie chains. The relationship between the movie houses and the film studios was already strained. Back in April we reported on AMC's ban of Comcast's (CMCSA $52) Universal Pictures' films after the latter announced it would also pull the simultaneous release stunt. This "breaking of the theatrical window" is terrible news for an industry already struggling to stay afloat. WarnerMedia CEO Jason Kilar made the rather cocky comment that the theater chains need to "take a breather," adding that the new releases will be pulled from HBO Max after thirty days. His comments only added fuel to the fire.
The movie chains are in somewhat the same position as many shopping malls throughout America. Dealing with decreased foot traffic due to the online shopping renaissance, these malls were forced to reinvent themselves as "experience destinations." The theaters are slowly adopting this philosophy, with AMC experimenting with NFL games on the big screen to attract fans. At $4 per share, AMC may look attractive, but we wouldn't be in a hurry to invest—there is still scant evidence that the darkest days are behind these companies.
Restaurants
05. Already strained, McDonald's just made its relationship with franchisees even worse
McDonald's (MCD $211) was one of those stalwarts we expected to own in the Penn Global Leaders Club for some time to come. That changed when the board of directors fired one of the best—and most loyal—CEOs in the industry. We took our profits and ran. In a sign that things are returning to normal (not a compliment; rather, a reference to the way things were under Don Thompson), the company has been telegraphing warnings to franchisees about hard times ahead. While the parent company does have about $40 million earmarked for aid to restaurants hardest hit by the pandemic (which seems paltry compared to its $5B in TTM net income), it warned that owners may need to look at selling locations or finding financial assistance elsewhere. Management also announced that it would be ending the $300 monthly Happy Meal subsidy which has been around for decades, and that it expects franchisees to start sharing the costs of the firm's tuition program. To be sure, all of these moves could be justified by corporate, but that doesn't change the perception by franchisees that they are getting nickel-and-dimed by the controlling entity. Yet another reason we continue to steer clear of the restaurant.
Jeff Easterbrook knew how to deal with people. Growing up in London, he was a constant customer of the local McDonald's, and his love for the company was evident in the way he treated employees and franchisees. The current management team in place may know numbers, but they sure don't seem to know how to deal with the people on the front line of the restaurant's revenue stream.
Business & Professional Services
04. EMH debunked yet again with laughable spike in Kodak shares
Efficient market hypothesis (EMH): the theory that a stock is always fairly valued based on all the available information at the time, making it impossible to "beat the market" on a consistent basis since share prices only react to new information. What a load of bull. Shares of Eastman Kodak (KODK $13), the lovable yet archaic camera company which was founded in 1888, have fluctuated between $1.50 (23 Mar) and $60 (29 Jul) this year. On Monday, shares spiked 77% in one session, driving them all the way back up to $13.30. What led to this latest unreal jump? Exoneration from the SEC regarding accusations that the company leaked news about a potential $765 million loan by the government to help it—Kodak—begin making active pharmaceutical ingredients (APIs) for drugs—a job the US disgracefully outsourced to China years ago. So, leaked news of a $765 million loan turned a $96 million flounder into a $1.65 billion shark virtually overnight? Yep. Maybe it wasn't just the news that drove "investors" back into the shares; maybe it was the financials. Over the trailing twelve months (TTM), Kodak lost $623 million on $1.06 billion in sales. That seems almost difficult to accomplish. Yet another story reminiscent of the 1999/2000 time period: Throw good money into companies that will show losses as far as the eye can see. Some "investors" don't recall that period, but we do.
There is a true dichotomy in the markets right now. We see a lot of great investment opportunities and a bright horizon for the year ahead. We also see a lot of companies with insane valuations thanks to dumb money chasing quick returns. Even more so than in 1999, many of the people pumping money into these companies couldn't explain what these firms do if their lives depended on it. That is certainly true with respect to Kodak, the camera company turned drug ingredient supplier.
Hotels, Restaurants, & Cruise Lines
03. We had every intention of buying Airbnb on its IPO—and then it priced
Sorry, but we have one more 1999 analogy. Granted, Airbnb (ABNB $139) is no pets.com (remember the hand puppet?), but what happened on the former's IPO day is insane. To be clear, we fully believe in Airbnb's business model, and have no doubt that it will be highly successful going forward—precisely why we expected to buy shares of the firm on day one. So, what happened? The IPO was finally priced at $68 per share. Of note: the CEO said he wanted the IPO price to reflect what he considered to be fair value of the company. When the stock finally began trading, its first price was $146, or 116% above what senior management considered fair value. There is a new breed of investor hitting the markets right now, and facts be damned; if they want a company because it has a cool name (Nikola comes to mind) they will pay any price to own it. How bad is it right now? Many investors complained that they didn't get the IPO price of $68, having no idea that it doesn't work that way. Want another example? There was a flurry of options action in ABB Ltd (ABB), an electrical equipment and parts maker based in Zurich, leading up to the ABNB IPO. It seems as though many "investors" thought they were buying calls on Airbnb. Let the red flags go up. When we were figuring where we might get the shares of the firm on day one, we initially thought $35 to $50 seemed reasonable, though $50 was stretching it. So, a company that was valued at $18 billion this summer now has a market cap of $150 billion. Like we say, insane.
We're bummed that we don't own ABNB, but we expect to pick the shares up when they come crashing back to reality at some point in 2021. And that is not a slam against the company, it is a slam on the knuckleheads who bought in at $146 or higher (shares went up as high as $165 on day one).
Market Pulse
02. Despite the wild IPO ride, markets fall on the week
Based on what happened in the IPO market over the course of five sessions, it might seem surprising that the three major indexes were all down for the week, but DoorDash (DASH $175), Airbnb (ABNB $139), and C3.ai Inc (AI $120) all turned out to be red herrings—shiny objects which distracted investors from the big picture. The markets falling for the week (S&P -0.96%, Dow -0.57%, NASDAQ -0.69%) was actually a healthy respite from the big run-up we've had over the past month. Counter that with the facts-be-damned trading we had in three IPO stocks, and 2021 is shaping up to be a tale of the haves and the have-nots. The haves will be the thoughtful investors looking for value, earnings, and sound business models. The have-nots will be the shiny object crowd: those using their Robinhood app like a video game to gobble up the fun-sounding names. How fitting that Goldman will bring that company public next year. A reckoning is coming, but it will be—thankfully—more discerning than the 2000-2002 variety. This one will hammer the dumb money and provide opportunity for the smart money. Bring on the new year.
2021 will be the year of the great re-build. The global economy will come roaring back with a vengeance, and GDP—both domestically and globally—will surprise to the upside. It will also be the year that tech companies with no earnings and fat valuations come crashing back to reality. Where can the smart money go? Look for opportunities in health care and industrials—boring companies that simply turn a profit year-in and year-out.
Under the Radar Investment
01. Under the Radar: Embotelladora Andina SA
Embotelladora Andina (AKO.B $15) is a Chilean-based Coca-Cola bottler serving the Latin American region. Together with its subsidiaries, the company produces, markets, and distributes Coca-Cola trademark products, to include fruit juices, sports drinks, purified waters, and flavored waters. The firm also sells and distributes beer under the Amstel, Bavaria, Heineken, and Sol brands. On $2.5 billion in sales last year, the company brought in $248 million in profit. AKO.B offers investors a 5.61% dividend yield based on the current share price of $15. Yet another consideration for globally-diversifying a portfolio.
Answer
Grauman's Chinese Theatre was built following the success of the nearby Grauman's Egyptian Theatre, which opened on Hollywood Boulevard in 1922. In May of this year, Netflix purchased that historic property.
Headlines for the Week of 22 Nov—28 Nov 2020
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
"They knew they were Pilgrims..."
In the perilous transatlantic crossing of the Mayflower, a storm of epic proportions threw separatist John Howland overboard into the turbulent waters below. What ultimately happened to Howland?
Penn Trading Desk:
(23 Nov 20) Take 82% short-term gains on Macy's
On 18 May we added Macy's (M $10) to the Intrepid @ $5.55/share. We took advantage of a double-digit jump on 23 Nov to close our position @ 10.09/share for an 82% short-term gain. It may well go higher, but we want to redeploy the capital elsewhere.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Pharmaceuticals
10. For the third week in a row, good vaccine news drives the market higher
Two weeks ago it was Pfizer (PFE). Last week it was Moderna (MRNA). This week, AstraZeneca (AZN $55) became the third drugmaker to drive the market higher with news of a successful Covid-19 vaccine trial. Initial analysis of the company's Phase 3 clinical trial showed its candidate, which is being developed with the University of Oxford, was as much as 90% effective in preventing infection from the virus after both of the doses were administered. Meanwhile, Regeneron (REGN $537) became the second company (Gilead was the first with remdesivir/Veklury) to receive Emergency Use Authorization from the FDA for its therapy to treat the virus. Unlike Veklury, which is typically administered once a patient is hospitalized, Regeneron's therapy is designed to be used to help prevent Covid-19 victims from deteriorating to the point in which they need to be hospitalized. The remarkable progress on this deadly virus continues to impress.
Investors have been paying a lot more attention to the vaccine developers than they have the the biotech companies making actual therapies to treat the disease. We think that's a mistake. Both Gilead (GILD $60)—which is in the Penn Global Leaders Club—and Regeneron look cheap from a valuation standpoint.
Leadership
09. With Tesla's share price on the rise, Elon Musk is suddenly the world's second-richest person
According to the Bloomberg Billionaire Index, Tesla (TSLA $522) and SpaceX founder Elon Musk is now worth $128 billion. He can thank the S&P 500 Index committee in a way: their decision to admit Tesla to the benchmark index has pushed that stock noticeably higher in recent days; in fact, Musk's net worth increased by $7.2 billion on Monday alone. But that's comparative peanuts: So far in 2020, Musk's net worth has risen by $100 billion, moving him from the number 35 spot of the world's richest people to the number two spot this week, knocking Microsoft founder Bill Gates to the number three position.
We imagine the prestige of being the world's second-richest person doesn't mean too much to Musk; his passion for what he does and his grand strategic vision of "making life multiplanetary" drives his thought process. Those who want to get the most out of life should take this lesson to heart with respect to uncovering and following their own unique passions. Another lesson we can learn from Musk: As all of the critics and naysayers were impugning both him and his audacious goals, he forged ahead relentlessly.
Washington Report
08. Investors are comforted by Biden's early cabinet picks
It certainly could have gone in a different direction, but that is not what we were expecting. In an attempt to assuage the radical wing of his party, President-Elect Joe Biden could have offered plum positions to the likes of Elizabeth Warren and Bernie Sanders—moves that would have sent the markets reeling. Instead, the stock market rallied on the news that he would nominate former Fed Chair Janet Yellen as Secretary of the Treasury, and Antony Blinken as Secretary of State. Yellen has a proven and well-known history after serving as an effective Fed Chair, and Blinken's work in the corporate world (as opposed to the fanciful world of "what-ifs" at a think tank) points to a sober domestic and foreign policy approach by the new administration. The far left wing of the party won't celebrate the moves, but the markets sure did.
With a divided government, we are hoping for enough bipartisanship to get the needed work done, but a lack of votes to pass any earth-shattering agenda items. That would be a Goldilocks scenario for the stock market and, dare we say, the economy. Maybe we will even get an infrastructure-light bill drafted and implemented.
Construction & Farm Equipment
07. Farm equipment companies are gearing up for a blowout 2021; Deere's most recent quarter supports that thesis
John Deere (DE $256), the world's leading manufacturer of agricultural equipment, got hit especially hard when the pandemic seized up global economic activity this past spring. That made perfect sense, as CFOs turned on a dime to an ultra-defensive attitude. Considering the premium price attached to Deere equipment (a new 95-series tractor might cost upwards of half-a-million dollars), companies made due with the equipment on hand. Following the sharpest economic decline in US history in Q2, all eyes turned to the third quarter, and especially to the farm and heavy construction machinery industry. To say Deere did not disappoint is putting it mildly. In the company's fiscal fourth quarter, which ended 31 October, equipment sales came in at $8.7 billion—against $7.7B expected, and earnings per share hit $2.39—against $1.49 expected. As if those blowout numbers weren't good enough for the analysts, the company raised its full-year 2021 guidance, citing an expected 5% to 10% jump in equipment sales in virtually every region of the globe.
It is always enlightening to look at the various analyst ratings on a company surrounding an earnings release or any other major news item. For example, Morningstar has a one-star (sell) rating on DE shares with a fair value of $183. Most analysts are bullish to neutral on the $80 billion firm, however. We think the shares of both Deere and Cat (CAT $175), each with a PE ratio of 29, seem fairly valued where they are at.
Specialty Retail
06. Despite their 20% drop in a matter of days, we suspect Gap shares are not done falling
Shares of specialty retailer Gap (GPS $22) dropped 20% following the release of a less-than-stellar third quarter earning report. On sales of $3.99 billion—the exact same as Q3 of 2019—the company earned $0.25 per share. That EPS figure missed analysts' expectations by about 22%. Gap markets its retail apparel primarily under four names: its eponymous stores, Old Navy, Banana Republic, and Athleta, with the Old Navy brand accounting for nearly one-half of the firm's revenues. The Athleta unit, as could be expected, had the biggest jump in sales for the quarter—up 37% from the previous year. Old Navy came in second, with a 17% increase. The Gap and Banana Republic brands, however, served as the anchor, with revenues declining 5% and 30%, respectively. While online sales for the combined units rose 61% from last year, management doesn't seem to have a concrete plan in place for the post-pandemic world. Gap stores have clearly lost the "cool factor" they once had, and Athleta will be competing with the likes of Lululemon (LULU) and Nike (NKE). The San Francisco-based retailer has an enormous footprint in malls across America, with roughly 3,500 company-operated stores and 600 franchise stores. As one could imagine, the aggregate overhead on these stores is enormous, and the company made news this past April when it stopped making lease payments on its shuttered locations. Management did not provide a full-year forecast in the earnings release.
It is difficult for us to imagine what is going to drive shoppers, en masse, back to Gap's branded stores next year. Of course, as the pandemic restrictions are lifted and the malls become hubs of activity once again, sales will improve. But shoppers will have a lot of great stores to choose from, and we don't see Gap eliciting the excitement it used to be able to generate. The mall landlords, meanwhile, will have no problem playing the role of Scrooge in litigating their demands for back rent. And Gap is not exactly sitting on a mountain of cash.
Global Strategy: Mideast
05. Top Iranian nuclear scientist killed near Tehran
Iran's "peaceful" nuclear power program was dealt a major blow on Friday when the alleged head of the unit was killed in a small city east of Tehran. Witnesses describe hearing an explosion followed by the sound of automatic rifles being fired; when the dust settled, Moshen Fakhrizadeh was dead and his bodyguards were either killed or wounded. State-controlled Iranian media outlets wasted no time in pointing the finger at Israel. An advisor to Ali Khamenei, Iran's "supreme leader," responded to the attack: "We will descend like lightning on the killers of this oppressed martyr and we will make them regret their actions!"
Of course, Iran has no need for "peaceful" nuclear power, based on its abundance of fossil fuels. The ability to intimidate its enemies and the capability to actually launch nuclear weapons against those enemies—namely Israel—is at the core of its nuclear development program.
E-Commerce
04. Americans were doing a lot more than eating on Thanksgiving, according to Adobe
According to Adobe Analytics, Americans spent a record $5.1 billion shopping online this Thanksgiving Day, a 21.4% increase from last year's $4.2 billion spent. With consumers understandably avoiding the malls this year, they turned to online shopping via their smartphones—the devices accounted for nearly one half of all purchases made. The marketing analytics arm of Adobe is also projecting a record-shattering $10.3 billion in online sales for Black Friday, and a staggering $189 billion for the entire holiday shopping season. Some of the top-selling items so far? Family games (especially chess boards), video games (especially Just Dance 2021), and electronic learning toys from vTech. Top online destinations? Amazon, Walmart, and Target.
It is hard to fathom the demand destruction which would have taken place this Christmas shopping season were it not for e-commerce. Companies that were embracing the trend before the health crisis, such as Walmart and Target, have been richly rewarded for their foresight and their tenacity in taking on Amazon. Retailers who failed to recognize this inevitable trend, such as now-defunct Sears, have paid dearly.
Application & Systems Software
03. Shares of Slack Technologies have risen nearly 40% this week on a rumor that Salesforce may want to buy the firm
Slack Technologies (WORK $41) is a Software as a Services (SaaS) firm which provides electronic communications tools for employees at small- and medium-sized businesses. Think of messaging on your smartphone or laptop, but for secure collaboration between you and your fellow employees. It is quite like Microsoft (MSFT) Teams, which some argue came out as a direct competitor to the Slack platform. The company went public in April of 2019, immediately trading around $37 per share. Shares fell all the way to $15.10 this past March as tech stocks (and stocks in every other industry) were searching for a bottom. By June, shares had risen back to $40, only to drop back down to $24 on the 10th of this month. Then came the rumor, reported by The Wall Street Journal, that SaaS relationship management software giant Salesforce (CRM $247) was in talks to buy the firm. That was all it took for traders to drive the shares up 40% in a matter of days and 69% since the 10th of November. Here's a company, now worth $23 billion thanks to traders, which has never had a profitable quarter and probably won't until the middle of the decade. A company late to the party with respect to video conferencing—a segment now dominated by Zoom (ZM $472). A company relying on one simple product, facing a dominant competitor in the form of Microsoft Teams. Our advice to traders: sell on the rumor.
Slack has a perfectly fine offering; one which we wouldn't mind using. But our Microsoft subscription comes with Teams built in, and we are just one of about 60 million monthly active users. This is an industry with few barriers to entry, and one dominated by the tech giants. Slack's best strategic plan is to pray the deal with Salesforce goes through.
Market Pulse
02. Markets manage to knock out some pretty good gains on a shortened trading week
It would be hard for investors to wish for much more on a holiday-shortened trading week—periods of time which are often anything but calm (remember the ugly week preceding Christmas, 2018?). In the four trading days surrounding Thanksgiving, all three major indexes were up in excess of 2%, and the gains were relatively methodical. The technology and health care sectors led the drive, pushing both the S&P 500 and Nasdaq to new highs. While the Dow couldn't maintain the historic 30,000 mark it hit on Tuesday, it still managed to climb 647 points on the week. Two clear drivers moved the markets this week: a virtual guarantee that Covid vaccines will be available in short order, and more clarity on the political front. Considering the relatively ugly jobs report we got mid-week (778,000 new claims), we're happy to head into December with these gains on the books.
Considering where we were in mid-March, it is remarkable to consider where we are at right now in the markets. We offered a rosy prediction for the remainder of the year back around the first of April, but even our projections ("S&P at 3,500") have been surpassed. December should be a relatively strong month on the back of vaccine rollouts and increased consumer spending, and the sky is the limit for 2021 as we slowly move beyond the pandemic. One of these days we will need to contend with our near-$30 trillion national debt, but odds are it won't be at the top of investors' minds in the coming year.
Under the Radar Investment
01. Under the Radar: Yara International ASA
Yara International ASA (YARIY $21) is a crop nutrition company based out of Oslo, Norway. The $10 billion agricultural inputs firm produces nitrogen-based fertilizers, raw material for feed products, and a broad base of other ag input products for farms and co-ops. Most of Yara's $12 billion in annual sales emanates from Europe and Brazil, where the company has built a large and relatively "sticky" customer base. Founded in 1905, Yara has a strong financial position, a reasonable PE ratio of 17, an unusually-steady stock price, and a dividend yield of 8.28%.
Answer
At the time of the incident, Howland would have been in his early twenties. Incredibly, as he was tumbling into the sea in the midst of a terrible storm and a ship that was bobbing up and down like a cork, Howland was somehow able to grab onto the Mayflower's trailing rope, giving the crew enough time to rescue him with a boat hook. A few years after arriving at Plymouth, Howland married fellow passenger Elizabeth Tilley, and the two went on to have ten children and millions of descendants. Howland lived into his eighties—quite a feat for anyone living in the 17th century.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
"They knew they were Pilgrims..."
In the perilous transatlantic crossing of the Mayflower, a storm of epic proportions threw separatist John Howland overboard into the turbulent waters below. What ultimately happened to Howland?
Penn Trading Desk:
(23 Nov 20) Take 82% short-term gains on Macy's
On 18 May we added Macy's (M $10) to the Intrepid @ $5.55/share. We took advantage of a double-digit jump on 23 Nov to close our position @ 10.09/share for an 82% short-term gain. It may well go higher, but we want to redeploy the capital elsewhere.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Pharmaceuticals
10. For the third week in a row, good vaccine news drives the market higher
Two weeks ago it was Pfizer (PFE). Last week it was Moderna (MRNA). This week, AstraZeneca (AZN $55) became the third drugmaker to drive the market higher with news of a successful Covid-19 vaccine trial. Initial analysis of the company's Phase 3 clinical trial showed its candidate, which is being developed with the University of Oxford, was as much as 90% effective in preventing infection from the virus after both of the doses were administered. Meanwhile, Regeneron (REGN $537) became the second company (Gilead was the first with remdesivir/Veklury) to receive Emergency Use Authorization from the FDA for its therapy to treat the virus. Unlike Veklury, which is typically administered once a patient is hospitalized, Regeneron's therapy is designed to be used to help prevent Covid-19 victims from deteriorating to the point in which they need to be hospitalized. The remarkable progress on this deadly virus continues to impress.
Investors have been paying a lot more attention to the vaccine developers than they have the the biotech companies making actual therapies to treat the disease. We think that's a mistake. Both Gilead (GILD $60)—which is in the Penn Global Leaders Club—and Regeneron look cheap from a valuation standpoint.
Leadership
09. With Tesla's share price on the rise, Elon Musk is suddenly the world's second-richest person
According to the Bloomberg Billionaire Index, Tesla (TSLA $522) and SpaceX founder Elon Musk is now worth $128 billion. He can thank the S&P 500 Index committee in a way: their decision to admit Tesla to the benchmark index has pushed that stock noticeably higher in recent days; in fact, Musk's net worth increased by $7.2 billion on Monday alone. But that's comparative peanuts: So far in 2020, Musk's net worth has risen by $100 billion, moving him from the number 35 spot of the world's richest people to the number two spot this week, knocking Microsoft founder Bill Gates to the number three position.
We imagine the prestige of being the world's second-richest person doesn't mean too much to Musk; his passion for what he does and his grand strategic vision of "making life multiplanetary" drives his thought process. Those who want to get the most out of life should take this lesson to heart with respect to uncovering and following their own unique passions. Another lesson we can learn from Musk: As all of the critics and naysayers were impugning both him and his audacious goals, he forged ahead relentlessly.
Washington Report
08. Investors are comforted by Biden's early cabinet picks
It certainly could have gone in a different direction, but that is not what we were expecting. In an attempt to assuage the radical wing of his party, President-Elect Joe Biden could have offered plum positions to the likes of Elizabeth Warren and Bernie Sanders—moves that would have sent the markets reeling. Instead, the stock market rallied on the news that he would nominate former Fed Chair Janet Yellen as Secretary of the Treasury, and Antony Blinken as Secretary of State. Yellen has a proven and well-known history after serving as an effective Fed Chair, and Blinken's work in the corporate world (as opposed to the fanciful world of "what-ifs" at a think tank) points to a sober domestic and foreign policy approach by the new administration. The far left wing of the party won't celebrate the moves, but the markets sure did.
With a divided government, we are hoping for enough bipartisanship to get the needed work done, but a lack of votes to pass any earth-shattering agenda items. That would be a Goldilocks scenario for the stock market and, dare we say, the economy. Maybe we will even get an infrastructure-light bill drafted and implemented.
Construction & Farm Equipment
07. Farm equipment companies are gearing up for a blowout 2021; Deere's most recent quarter supports that thesis
John Deere (DE $256), the world's leading manufacturer of agricultural equipment, got hit especially hard when the pandemic seized up global economic activity this past spring. That made perfect sense, as CFOs turned on a dime to an ultra-defensive attitude. Considering the premium price attached to Deere equipment (a new 95-series tractor might cost upwards of half-a-million dollars), companies made due with the equipment on hand. Following the sharpest economic decline in US history in Q2, all eyes turned to the third quarter, and especially to the farm and heavy construction machinery industry. To say Deere did not disappoint is putting it mildly. In the company's fiscal fourth quarter, which ended 31 October, equipment sales came in at $8.7 billion—against $7.7B expected, and earnings per share hit $2.39—against $1.49 expected. As if those blowout numbers weren't good enough for the analysts, the company raised its full-year 2021 guidance, citing an expected 5% to 10% jump in equipment sales in virtually every region of the globe.
It is always enlightening to look at the various analyst ratings on a company surrounding an earnings release or any other major news item. For example, Morningstar has a one-star (sell) rating on DE shares with a fair value of $183. Most analysts are bullish to neutral on the $80 billion firm, however. We think the shares of both Deere and Cat (CAT $175), each with a PE ratio of 29, seem fairly valued where they are at.
Specialty Retail
06. Despite their 20% drop in a matter of days, we suspect Gap shares are not done falling
Shares of specialty retailer Gap (GPS $22) dropped 20% following the release of a less-than-stellar third quarter earning report. On sales of $3.99 billion—the exact same as Q3 of 2019—the company earned $0.25 per share. That EPS figure missed analysts' expectations by about 22%. Gap markets its retail apparel primarily under four names: its eponymous stores, Old Navy, Banana Republic, and Athleta, with the Old Navy brand accounting for nearly one-half of the firm's revenues. The Athleta unit, as could be expected, had the biggest jump in sales for the quarter—up 37% from the previous year. Old Navy came in second, with a 17% increase. The Gap and Banana Republic brands, however, served as the anchor, with revenues declining 5% and 30%, respectively. While online sales for the combined units rose 61% from last year, management doesn't seem to have a concrete plan in place for the post-pandemic world. Gap stores have clearly lost the "cool factor" they once had, and Athleta will be competing with the likes of Lululemon (LULU) and Nike (NKE). The San Francisco-based retailer has an enormous footprint in malls across America, with roughly 3,500 company-operated stores and 600 franchise stores. As one could imagine, the aggregate overhead on these stores is enormous, and the company made news this past April when it stopped making lease payments on its shuttered locations. Management did not provide a full-year forecast in the earnings release.
It is difficult for us to imagine what is going to drive shoppers, en masse, back to Gap's branded stores next year. Of course, as the pandemic restrictions are lifted and the malls become hubs of activity once again, sales will improve. But shoppers will have a lot of great stores to choose from, and we don't see Gap eliciting the excitement it used to be able to generate. The mall landlords, meanwhile, will have no problem playing the role of Scrooge in litigating their demands for back rent. And Gap is not exactly sitting on a mountain of cash.
Global Strategy: Mideast
05. Top Iranian nuclear scientist killed near Tehran
Iran's "peaceful" nuclear power program was dealt a major blow on Friday when the alleged head of the unit was killed in a small city east of Tehran. Witnesses describe hearing an explosion followed by the sound of automatic rifles being fired; when the dust settled, Moshen Fakhrizadeh was dead and his bodyguards were either killed or wounded. State-controlled Iranian media outlets wasted no time in pointing the finger at Israel. An advisor to Ali Khamenei, Iran's "supreme leader," responded to the attack: "We will descend like lightning on the killers of this oppressed martyr and we will make them regret their actions!"
Of course, Iran has no need for "peaceful" nuclear power, based on its abundance of fossil fuels. The ability to intimidate its enemies and the capability to actually launch nuclear weapons against those enemies—namely Israel—is at the core of its nuclear development program.
E-Commerce
04. Americans were doing a lot more than eating on Thanksgiving, according to Adobe
According to Adobe Analytics, Americans spent a record $5.1 billion shopping online this Thanksgiving Day, a 21.4% increase from last year's $4.2 billion spent. With consumers understandably avoiding the malls this year, they turned to online shopping via their smartphones—the devices accounted for nearly one half of all purchases made. The marketing analytics arm of Adobe is also projecting a record-shattering $10.3 billion in online sales for Black Friday, and a staggering $189 billion for the entire holiday shopping season. Some of the top-selling items so far? Family games (especially chess boards), video games (especially Just Dance 2021), and electronic learning toys from vTech. Top online destinations? Amazon, Walmart, and Target.
It is hard to fathom the demand destruction which would have taken place this Christmas shopping season were it not for e-commerce. Companies that were embracing the trend before the health crisis, such as Walmart and Target, have been richly rewarded for their foresight and their tenacity in taking on Amazon. Retailers who failed to recognize this inevitable trend, such as now-defunct Sears, have paid dearly.
Application & Systems Software
03. Shares of Slack Technologies have risen nearly 40% this week on a rumor that Salesforce may want to buy the firm
Slack Technologies (WORK $41) is a Software as a Services (SaaS) firm which provides electronic communications tools for employees at small- and medium-sized businesses. Think of messaging on your smartphone or laptop, but for secure collaboration between you and your fellow employees. It is quite like Microsoft (MSFT) Teams, which some argue came out as a direct competitor to the Slack platform. The company went public in April of 2019, immediately trading around $37 per share. Shares fell all the way to $15.10 this past March as tech stocks (and stocks in every other industry) were searching for a bottom. By June, shares had risen back to $40, only to drop back down to $24 on the 10th of this month. Then came the rumor, reported by The Wall Street Journal, that SaaS relationship management software giant Salesforce (CRM $247) was in talks to buy the firm. That was all it took for traders to drive the shares up 40% in a matter of days and 69% since the 10th of November. Here's a company, now worth $23 billion thanks to traders, which has never had a profitable quarter and probably won't until the middle of the decade. A company late to the party with respect to video conferencing—a segment now dominated by Zoom (ZM $472). A company relying on one simple product, facing a dominant competitor in the form of Microsoft Teams. Our advice to traders: sell on the rumor.
Slack has a perfectly fine offering; one which we wouldn't mind using. But our Microsoft subscription comes with Teams built in, and we are just one of about 60 million monthly active users. This is an industry with few barriers to entry, and one dominated by the tech giants. Slack's best strategic plan is to pray the deal with Salesforce goes through.
Market Pulse
02. Markets manage to knock out some pretty good gains on a shortened trading week
It would be hard for investors to wish for much more on a holiday-shortened trading week—periods of time which are often anything but calm (remember the ugly week preceding Christmas, 2018?). In the four trading days surrounding Thanksgiving, all three major indexes were up in excess of 2%, and the gains were relatively methodical. The technology and health care sectors led the drive, pushing both the S&P 500 and Nasdaq to new highs. While the Dow couldn't maintain the historic 30,000 mark it hit on Tuesday, it still managed to climb 647 points on the week. Two clear drivers moved the markets this week: a virtual guarantee that Covid vaccines will be available in short order, and more clarity on the political front. Considering the relatively ugly jobs report we got mid-week (778,000 new claims), we're happy to head into December with these gains on the books.
Considering where we were in mid-March, it is remarkable to consider where we are at right now in the markets. We offered a rosy prediction for the remainder of the year back around the first of April, but even our projections ("S&P at 3,500") have been surpassed. December should be a relatively strong month on the back of vaccine rollouts and increased consumer spending, and the sky is the limit for 2021 as we slowly move beyond the pandemic. One of these days we will need to contend with our near-$30 trillion national debt, but odds are it won't be at the top of investors' minds in the coming year.
Under the Radar Investment
01. Under the Radar: Yara International ASA
Yara International ASA (YARIY $21) is a crop nutrition company based out of Oslo, Norway. The $10 billion agricultural inputs firm produces nitrogen-based fertilizers, raw material for feed products, and a broad base of other ag input products for farms and co-ops. Most of Yara's $12 billion in annual sales emanates from Europe and Brazil, where the company has built a large and relatively "sticky" customer base. Founded in 1905, Yara has a strong financial position, a reasonable PE ratio of 17, an unusually-steady stock price, and a dividend yield of 8.28%.
Answer
At the time of the incident, Howland would have been in his early twenties. Incredibly, as he was tumbling into the sea in the midst of a terrible storm and a ship that was bobbing up and down like a cork, Howland was somehow able to grab onto the Mayflower's trailing rope, giving the crew enough time to rescue him with a boat hook. A few years after arriving at Plymouth, Howland married fellow passenger Elizabeth Tilley, and the two went on to have ten children and millions of descendants. Howland lived into his eighties—quite a feat for anyone living in the 17th century.
Headlines for the Week of 15 Nov—21 Nov 2020
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
Pandemic winter will give way to vaccine spring...
The world is focused on the race to get safe, effective vaccines into the arms of the public as quickly as possible to help put an end to the pandemic. Odds are strong that by this coming April the vaccines will be widely available. When was the first laboratory vaccine created, and what disease did it prevent?
Penn Trading Desk:
(12 Nov 20) Replacing AbbVie with pharma powerhouse in Global Leaders
It's not so much that we wanted to sell AbbVie in the Penn Global Leaders Club but rather that we wanted to add this foreign pharma powerhouse to the mix, and we were at our self-imposed limit of Health Care holdings within the strategy. A leader in the respiratory, oncology, antiviral, and vaccine arenas, a 5%+ yield, undervalued, and a chance to add to the international portion (which is probably lacking) of a portfolio. It was the right time to strike.
(19 Nov 20) Citi releases its 2021 outlook for gold
Right now, Gold is sitting around $1,865 per ounce. One of our favorite investments since the middle of 2019, we see global fiscal spending only driving the price higher. Citigroup seems to agree, at least with respect to 2021. Analysts at the firm released their guidance for the yellow metal over the coming year: they see the price rising to $2,500 by year-end, or about 35% higher than current levels. We agree.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Biotechnology
10. Following in Pfizer's footsteps, Moderna brings us another step closer to controlling the pandemic
It truly is remarkable when you think about it. Biotech Moderna (MRNA $99) enrolled 30,000 participants one month ago for a Phase 3 trial on a vaccine to prevent a virus the world didn't know about a year ago. The group of 30,000 was split in two, with half receiving a placebo and half receiving the vaccine. There were 95 confirmed cases of Covid among the participants during the trial period: 90 in the placebo group and five in the vaccine group. Those stunning results led to Moderna's claim of a 94.5% efficacy rate and its application to the FDA for emergency use of the therapy. Shares had a double-digit rally on the news, and the week opened with a bang—just as it had done on the previous Monday thanks to Pfizer's equally-stunning results. As could be expected, the naysayers tried to throw cold water on the incredible advance, reminding us that we have a long way to go from a trial to a vaccine waiting for us in our physician's office. We disagree. Yes, there is a tragic second wave of the virus straining our health care system and killing Americans. But the same lightning-speed urgency that is bringing us these vaccines in record time will also be in place with respect to the creation and delivery of hundreds of millions of their doses. By this coming spring, we expect virtually every American who wants to get the double-dose vaccine (and that number needs to be around 60% or more of the population) to be able to set an appointment and do so. And despite the focus on vaccines, Gilead's Veklury (remdesivir) was just approved by the FDA as a Covid treatment, with a number of other therapies going through the trial stage. Expect a flourishing US economy to return by the middle of next year as the lockdowns and closures become a thing of the past.
In the next issue of The Penn Wealth Report, we discuss the latest on the vaccine front, plus a look at some of the ancillary players in the battle which are not being given the credit they are due.
Automotive
09. A major milestone for Tesla: it will be added to the S&P 500 Index
After five consecutive quarters of net profit, Tesla (TSLA $458) is headed to the S&P 500 Index. While the $434 billion EV maker technically became eligible for the benchmark index this past summer, following its fourth consecutive quarterly profit, the Index committee passed, offering no rationale for their decision. On the 21st of December, however, Tesla will officially become the largest company ever added to the Index, smoothing the way for more investment dollars to flow into Elon Musk's firm. We think of all the Tesla skeptics, many of whom have already expressed their anger over the inclusion, and all of the TSLA short sellers who seem to lose money at every turn. One sour grapes analyst proclaimed that "S&P is making a big mistake and adding lots of downside risk to the index...." Pardon us if we don't put much weight behind the words of an analyst who has proven to be chronically wrong.
Despite Ford and GM's push into the EV market, Tesla will maintain its dominant market position for decades to come. As the company's advanced Supercharger network continues its buildout, expect to see an ever-increasing number of Teslas on the road. Projections for vehicle deliveries in 2020 have increased from 800,000 to 950,000, and for 2021 projections have risen from 1.15 million to 1.6 million new vehicles. New plants are nearing completion in Texas, Berlin, and Shanghai. And don't forget about the company's massive battery gigafactories and its growing solar business.
Business & Professional Services
08. In a nod to the current state of many Americans' fiscal condition, PayPal will give employees immediate access to pay
Recent studies show that nearly one-half of all working Americans are living paycheck to paycheck, meaning they would not have the liquid assets available to pay living expenses were their next paycheck not to come in. Even among households making more than $100,000 per year, the number is a staggering one-third. Against that backdrop, $227 billion financial services firm PayPal (PYPL $194) has announced that it will give its US-based employees access to their pay as soon as they earn it, rather than having to wait for their twice-monthly deposit. To make this happen, the company is teaming up with privately-held Even Responsible Finance, an on-demand pay platform. Members of PayPal's management team, led by CEO Dan Schulman, identified the problem when they set up an emergency relief fund for employees who found themselves in a cash crunch. The request for assistance was much greater than expected, leading to the current arrangement with Even. Users of the app are also able to move money into savings and access basic budgetary tools. PayPal has approximately 20,000 employees, with the vast majority based in the U.S.
Expect more and more employers to begin offering such tools and services to their employees going forward. The historically-low rate of savings among a majority of Americans has been a chronic problem for the past two generations, and it must be addressed.
IT Software & Services
07. Penn member Palantir surges double digits after news of big hedge fund purchases
It is fair to say that super-secret data mining firm Palantir (PLTR $18) was our most highly-anticipated IPO ever, as we were writing about the company—whose data fingered the precise location of Osama bin Laden for the DoD—eighteen months before it went public. Within five minutes of the IPO, we had secured PLTR for clients and placed the firm in the Penn New Frontier Fund. Now, less than seven weeks later, our position is trading about 70% higher with plenty of growth potential ahead. Shares spiked another 12% in one session this week after it was disclosed that Steve Cohen's hedge fund, Point72 Asset Management LP, purchased nearly 30 million shares in the third quarter. Another fund, Anchorage Capital Group, acquired 3 million shares in Q3. Palantir offers highly-sophisticated data mining services to government agencies and corporations around the world. Management has a strict policy, however, of only doing business with staunch US allies; e.g., the company would not do business with Chinese entities. Naysaying analysts expressed doubts around the time of the IPO that the firm could expand their customer base substantially considering the amount government agencies pay for the sensitive information, and the company's reliance on its biggest clients for revenue. Those arguments were muted after Palantir's first earnings report as a publicly-traded entity: revenues grew 52% and full-year guidance was raised to $1.072 billion—a 44% growth rate from a year earlier. PLTR holds Position #6 (out of 24) in the Penn New Frontier Fund, our emerging technologies portfolio.
Drug Retail
06. Drug retailers hit the skids after Amazon launches its new pharmacy
Rite Aid got hit the hardest, down 15%, followed by Walgreens (-10%), CVS (-8%), and even retail giant Walmart (-2%). What caused these one-day drops in the shares of major drug retailers? The announcement that Amazon (AMZN $3,136) would finally be adding a pharmacy counter to its site. Rite Aid tried to throw cold water on the announcement, with the COO arguing that getting prescription drugs involves a lot more than does a typical shopping transaction. Really? We think of the hassles we have had in the past simply getting prescriptions filled in a timely manner, and it makes perfect sense as to why these drug retailers fell so much in a day. We don't recall, however, any extensive conversations with the pharmacist at the local Walmart. "Name? Date of Birth? You have one prescription ready." That's about the extent of it. And is it really the business of the person behind me in line as to what year I was born? When filling scripts online directly through our PBM (Cigna), we wonder how long it will actually take the post office to deliver the goods. Like them or not, we have full faith in Amazon's ability to deliver meds to our home in one or two days, which is what Amazon Pharmacy is promising for its 80 million or so Prime members. Walgreens CEO Stefano Pessina said he is not particularly worried about Amazon's move into the space. Does anyone believe that? Amazon Pharmacy will be a major disruptor in the prescription drug space. Investors need to take a renewed look at their holdings in the drug retail and medical distribution (think McKesson and Cardinal Health) industries. We can't stand Jeff Bezos, but owning Amazon in the Penn Global Leaders Club has certainly paid off.
Government Watchdog
05. Nightmarish New York fiscal situation: MTA may issue low-denomination bonds to raise more cash
Who should be held accountable for the freakishly-mismanaged New York Metropolitan Transportation Authority: New York or taxpayers across the country? The organization can blame the pandemic all they want, but their financial situation was dire long before the Wuhan-borne virus ever came along. Now, the largest public transportation agency in the country said it will cut 9,400 jobs and drastically reduce its subway, train, and bus services in New York if the federal government doesn't send them $12 billion immediately. That won't happen, at least not this year, so the agency has announced plans to potentially issue $3 billion in "deficit bonds." To attract everyday commuters, they will even (potentially) come in $1,000 denominations so all can participate. Just last month the agency sold $257 million of "green bonds" (how did the environment get involved?), with the proceeds going to pay down bonds that are maturing now. Apply this situation to the common American household. It is akin to maxing out the credit cards, getting a home equity line-of-credit to pay off the balances, re-maxing out the cards, and then demanding that mom and dad (the federal government using taxpayer funds) pony up! Yikes. Our only question is who the hell would invest in these Frankenstein bonds?
New York, like Chicago, like San Francisco, like any other ineptly-run major city government in the US, was on tenuous ice before the pandemic, and they will learn nothing from the hell they are going through. It will always be someone else's fault, and they will always be the victim of circumstances. The federal government needs to stop enabling and demand these cities fix their own problems.
Textiles, Apparel, & Luxury Goods
04. Bath & Body Works, Victoria's Secret parent jumps 16% on unexpected earnings beat
We have traded L Brands (LB $39) on and off for decades, but steered clear after the longest-serving CEO of any company in the S&P 500, Les Wexner, began to show signs that things weren't clicking upstairs like they once were. The fact that he was also ensnared in the Jeffrey Epstein brouhaha didn't help, either. When Wexner indicated this past January that he may be willing to let go of the company he founded in 1962, we almost bit once again on LB shares. We should have—they were trading for $23. In a logic-defying earnings report, the company's Bath & Body Works unit posted a 55% jump in quarterly sales, with L Brands turning a profit of $330 million versus a loss of $252 million in the same quarter last year. When we think of L Brands' flagship names, with think bricks-and-mortar stores; the fact that the company was able to perform so strongly during the heart of the pandemic is remarkable. It also portends good things to come for the company under new leadership: longtime retail specialist Andrew Meslow took the reins from Wexner this past May. The founder made a lot of boneheaded moves in his waning months, like ditching swimsuits, stopping catalog mailings, and shunning digital sales to focus on his physical stores (he told the WSJ that he had 5,000 years of history on his side). The company still has a lot of debt, and the price seems rich at $38 after their 16% spike on the earnings release, but it feels like they won't need to be going the Chapter 11 route anytime soon. While we don't own LB, we did pick up shares of Macy's (M) and Nordstrom (JWN) in the Intrepid during the darkest days of the downturn. Those positions have paid off nicely.
Pharmaceuticals
03. Pfizer shareholders get an early Christmas gift: Viatris
Pfizer (PFE $37) has completed its spinoff of the firm's Upjohn business, combining it with Mylan NV to form Viatris, Inc (VTRS $17). The newly-formed pharma company, $20 billion in size, will be largely led by Pfizer executives and will focus its efforts on generic and biosimilar compounds. Shareholders of Pfizer, a member of the Penn Global Leaders Club, will receive 0.125 shares of Viatris for every one share of PFE owned. So far, the deal has already paid off: shares are up 21% from the basis price. The generic drug market is huge, and Viatris is an immediate leader in the space. We believe the shares are worth $25, nearly a 50% upside from where they are currently trading.
Hotels, Resorts, & Cruise Lines
02. Airbnb: the next big IPO investors need to consider owning
There are a handful of IPOs we get excited about each year. The last one was Palantir (PLTR $18), which is up 70% since we purchased it on the last day of September. The next one will be Airbnb, which will trade on the Nasdaq under the symbol ABNB. Understandably, the pandemic hammered the vacation rental company, with revenues in Q2 of this year plummeting 72% from the same quarter in 2019. What does that mean for investors? They can expect to pick up shares a lot cheaper than they could have were there no pandemic. Airbnb's model is sound; nothing about the global health disaster changed that, and we expect a full rebound by the company as vaccines and therapies come online. In fact, one could make the argument that travelers will feel safer in the type of single-unit rentals the company typically hosts, rather than the crowded lobbies of the major hotel chains. Expect ABNB to begin trading in mid-December with an immediate market cap of roughly $30 billion. Like Palantir, we will own ABNB shares within minutes of the first trade.
Under the Radar Investment
01. Under the Radar: The GEO Group
The GEO Group (GEO $9) is a real estate investment trust specializing in detention facilities and community-reentry facilities. The company leases and oversees secure detention centers, rehab facilities, and service centers for troubled youth. Services include counseling, education, drug abuse treatment, tech-based supervision, and detainee transportation. Most of GEO's revenue comes from the leasing and management of these facilities in the US, Australia, South Africa, and the UK. The company had a net income of $167 million last year on $2.5 billion in revenue. Private prison stocks have stumbled since the election under the assumption that a Democrat in the White House would spell trouble for non-government entities in this arena. With the nature of GEO's work, however, we think investors miscalculated on this one. If shares climb back to their 2020 high, it would mean a 100% profit for investors.
Answer
In 1879, Louis Pasteur was studying fowl cholera by injecting chickens with the live bacteria and recording their subsequent deterioration. Before a holiday, he gave instructions to an assistant to make injections into the chickens with a fresh culture, as he would be away from his lab. The assistant forgot to do so. Upon return to the lab, Pasteur found the chickens still alive, suffering only mild symptoms of the disease. When injected with a full dose of the bacteria once again, he discovered that the chickens had developed immunity. He correctly deduced that a weakened form of the bacteria would allow the body to develop resistance to the disease. He immediately turned his attention to an anthrax epidemic which was raging in France. He successfully applied what he had learned in his lab from the chicken cholera experiment to develop an anthrax vaccine.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Pandemic winter will give way to vaccine spring...
The world is focused on the race to get safe, effective vaccines into the arms of the public as quickly as possible to help put an end to the pandemic. Odds are strong that by this coming April the vaccines will be widely available. When was the first laboratory vaccine created, and what disease did it prevent?
Penn Trading Desk:
(12 Nov 20) Replacing AbbVie with pharma powerhouse in Global Leaders
It's not so much that we wanted to sell AbbVie in the Penn Global Leaders Club but rather that we wanted to add this foreign pharma powerhouse to the mix, and we were at our self-imposed limit of Health Care holdings within the strategy. A leader in the respiratory, oncology, antiviral, and vaccine arenas, a 5%+ yield, undervalued, and a chance to add to the international portion (which is probably lacking) of a portfolio. It was the right time to strike.
(19 Nov 20) Citi releases its 2021 outlook for gold
Right now, Gold is sitting around $1,865 per ounce. One of our favorite investments since the middle of 2019, we see global fiscal spending only driving the price higher. Citigroup seems to agree, at least with respect to 2021. Analysts at the firm released their guidance for the yellow metal over the coming year: they see the price rising to $2,500 by year-end, or about 35% higher than current levels. We agree.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Biotechnology
10. Following in Pfizer's footsteps, Moderna brings us another step closer to controlling the pandemic
It truly is remarkable when you think about it. Biotech Moderna (MRNA $99) enrolled 30,000 participants one month ago for a Phase 3 trial on a vaccine to prevent a virus the world didn't know about a year ago. The group of 30,000 was split in two, with half receiving a placebo and half receiving the vaccine. There were 95 confirmed cases of Covid among the participants during the trial period: 90 in the placebo group and five in the vaccine group. Those stunning results led to Moderna's claim of a 94.5% efficacy rate and its application to the FDA for emergency use of the therapy. Shares had a double-digit rally on the news, and the week opened with a bang—just as it had done on the previous Monday thanks to Pfizer's equally-stunning results. As could be expected, the naysayers tried to throw cold water on the incredible advance, reminding us that we have a long way to go from a trial to a vaccine waiting for us in our physician's office. We disagree. Yes, there is a tragic second wave of the virus straining our health care system and killing Americans. But the same lightning-speed urgency that is bringing us these vaccines in record time will also be in place with respect to the creation and delivery of hundreds of millions of their doses. By this coming spring, we expect virtually every American who wants to get the double-dose vaccine (and that number needs to be around 60% or more of the population) to be able to set an appointment and do so. And despite the focus on vaccines, Gilead's Veklury (remdesivir) was just approved by the FDA as a Covid treatment, with a number of other therapies going through the trial stage. Expect a flourishing US economy to return by the middle of next year as the lockdowns and closures become a thing of the past.
In the next issue of The Penn Wealth Report, we discuss the latest on the vaccine front, plus a look at some of the ancillary players in the battle which are not being given the credit they are due.
Automotive
09. A major milestone for Tesla: it will be added to the S&P 500 Index
After five consecutive quarters of net profit, Tesla (TSLA $458) is headed to the S&P 500 Index. While the $434 billion EV maker technically became eligible for the benchmark index this past summer, following its fourth consecutive quarterly profit, the Index committee passed, offering no rationale for their decision. On the 21st of December, however, Tesla will officially become the largest company ever added to the Index, smoothing the way for more investment dollars to flow into Elon Musk's firm. We think of all the Tesla skeptics, many of whom have already expressed their anger over the inclusion, and all of the TSLA short sellers who seem to lose money at every turn. One sour grapes analyst proclaimed that "S&P is making a big mistake and adding lots of downside risk to the index...." Pardon us if we don't put much weight behind the words of an analyst who has proven to be chronically wrong.
Despite Ford and GM's push into the EV market, Tesla will maintain its dominant market position for decades to come. As the company's advanced Supercharger network continues its buildout, expect to see an ever-increasing number of Teslas on the road. Projections for vehicle deliveries in 2020 have increased from 800,000 to 950,000, and for 2021 projections have risen from 1.15 million to 1.6 million new vehicles. New plants are nearing completion in Texas, Berlin, and Shanghai. And don't forget about the company's massive battery gigafactories and its growing solar business.
Business & Professional Services
08. In a nod to the current state of many Americans' fiscal condition, PayPal will give employees immediate access to pay
Recent studies show that nearly one-half of all working Americans are living paycheck to paycheck, meaning they would not have the liquid assets available to pay living expenses were their next paycheck not to come in. Even among households making more than $100,000 per year, the number is a staggering one-third. Against that backdrop, $227 billion financial services firm PayPal (PYPL $194) has announced that it will give its US-based employees access to their pay as soon as they earn it, rather than having to wait for their twice-monthly deposit. To make this happen, the company is teaming up with privately-held Even Responsible Finance, an on-demand pay platform. Members of PayPal's management team, led by CEO Dan Schulman, identified the problem when they set up an emergency relief fund for employees who found themselves in a cash crunch. The request for assistance was much greater than expected, leading to the current arrangement with Even. Users of the app are also able to move money into savings and access basic budgetary tools. PayPal has approximately 20,000 employees, with the vast majority based in the U.S.
Expect more and more employers to begin offering such tools and services to their employees going forward. The historically-low rate of savings among a majority of Americans has been a chronic problem for the past two generations, and it must be addressed.
IT Software & Services
07. Penn member Palantir surges double digits after news of big hedge fund purchases
It is fair to say that super-secret data mining firm Palantir (PLTR $18) was our most highly-anticipated IPO ever, as we were writing about the company—whose data fingered the precise location of Osama bin Laden for the DoD—eighteen months before it went public. Within five minutes of the IPO, we had secured PLTR for clients and placed the firm in the Penn New Frontier Fund. Now, less than seven weeks later, our position is trading about 70% higher with plenty of growth potential ahead. Shares spiked another 12% in one session this week after it was disclosed that Steve Cohen's hedge fund, Point72 Asset Management LP, purchased nearly 30 million shares in the third quarter. Another fund, Anchorage Capital Group, acquired 3 million shares in Q3. Palantir offers highly-sophisticated data mining services to government agencies and corporations around the world. Management has a strict policy, however, of only doing business with staunch US allies; e.g., the company would not do business with Chinese entities. Naysaying analysts expressed doubts around the time of the IPO that the firm could expand their customer base substantially considering the amount government agencies pay for the sensitive information, and the company's reliance on its biggest clients for revenue. Those arguments were muted after Palantir's first earnings report as a publicly-traded entity: revenues grew 52% and full-year guidance was raised to $1.072 billion—a 44% growth rate from a year earlier. PLTR holds Position #6 (out of 24) in the Penn New Frontier Fund, our emerging technologies portfolio.
Drug Retail
06. Drug retailers hit the skids after Amazon launches its new pharmacy
Rite Aid got hit the hardest, down 15%, followed by Walgreens (-10%), CVS (-8%), and even retail giant Walmart (-2%). What caused these one-day drops in the shares of major drug retailers? The announcement that Amazon (AMZN $3,136) would finally be adding a pharmacy counter to its site. Rite Aid tried to throw cold water on the announcement, with the COO arguing that getting prescription drugs involves a lot more than does a typical shopping transaction. Really? We think of the hassles we have had in the past simply getting prescriptions filled in a timely manner, and it makes perfect sense as to why these drug retailers fell so much in a day. We don't recall, however, any extensive conversations with the pharmacist at the local Walmart. "Name? Date of Birth? You have one prescription ready." That's about the extent of it. And is it really the business of the person behind me in line as to what year I was born? When filling scripts online directly through our PBM (Cigna), we wonder how long it will actually take the post office to deliver the goods. Like them or not, we have full faith in Amazon's ability to deliver meds to our home in one or two days, which is what Amazon Pharmacy is promising for its 80 million or so Prime members. Walgreens CEO Stefano Pessina said he is not particularly worried about Amazon's move into the space. Does anyone believe that? Amazon Pharmacy will be a major disruptor in the prescription drug space. Investors need to take a renewed look at their holdings in the drug retail and medical distribution (think McKesson and Cardinal Health) industries. We can't stand Jeff Bezos, but owning Amazon in the Penn Global Leaders Club has certainly paid off.
Government Watchdog
05. Nightmarish New York fiscal situation: MTA may issue low-denomination bonds to raise more cash
Who should be held accountable for the freakishly-mismanaged New York Metropolitan Transportation Authority: New York or taxpayers across the country? The organization can blame the pandemic all they want, but their financial situation was dire long before the Wuhan-borne virus ever came along. Now, the largest public transportation agency in the country said it will cut 9,400 jobs and drastically reduce its subway, train, and bus services in New York if the federal government doesn't send them $12 billion immediately. That won't happen, at least not this year, so the agency has announced plans to potentially issue $3 billion in "deficit bonds." To attract everyday commuters, they will even (potentially) come in $1,000 denominations so all can participate. Just last month the agency sold $257 million of "green bonds" (how did the environment get involved?), with the proceeds going to pay down bonds that are maturing now. Apply this situation to the common American household. It is akin to maxing out the credit cards, getting a home equity line-of-credit to pay off the balances, re-maxing out the cards, and then demanding that mom and dad (the federal government using taxpayer funds) pony up! Yikes. Our only question is who the hell would invest in these Frankenstein bonds?
New York, like Chicago, like San Francisco, like any other ineptly-run major city government in the US, was on tenuous ice before the pandemic, and they will learn nothing from the hell they are going through. It will always be someone else's fault, and they will always be the victim of circumstances. The federal government needs to stop enabling and demand these cities fix their own problems.
Textiles, Apparel, & Luxury Goods
04. Bath & Body Works, Victoria's Secret parent jumps 16% on unexpected earnings beat
We have traded L Brands (LB $39) on and off for decades, but steered clear after the longest-serving CEO of any company in the S&P 500, Les Wexner, began to show signs that things weren't clicking upstairs like they once were. The fact that he was also ensnared in the Jeffrey Epstein brouhaha didn't help, either. When Wexner indicated this past January that he may be willing to let go of the company he founded in 1962, we almost bit once again on LB shares. We should have—they were trading for $23. In a logic-defying earnings report, the company's Bath & Body Works unit posted a 55% jump in quarterly sales, with L Brands turning a profit of $330 million versus a loss of $252 million in the same quarter last year. When we think of L Brands' flagship names, with think bricks-and-mortar stores; the fact that the company was able to perform so strongly during the heart of the pandemic is remarkable. It also portends good things to come for the company under new leadership: longtime retail specialist Andrew Meslow took the reins from Wexner this past May. The founder made a lot of boneheaded moves in his waning months, like ditching swimsuits, stopping catalog mailings, and shunning digital sales to focus on his physical stores (he told the WSJ that he had 5,000 years of history on his side). The company still has a lot of debt, and the price seems rich at $38 after their 16% spike on the earnings release, but it feels like they won't need to be going the Chapter 11 route anytime soon. While we don't own LB, we did pick up shares of Macy's (M) and Nordstrom (JWN) in the Intrepid during the darkest days of the downturn. Those positions have paid off nicely.
Pharmaceuticals
03. Pfizer shareholders get an early Christmas gift: Viatris
Pfizer (PFE $37) has completed its spinoff of the firm's Upjohn business, combining it with Mylan NV to form Viatris, Inc (VTRS $17). The newly-formed pharma company, $20 billion in size, will be largely led by Pfizer executives and will focus its efforts on generic and biosimilar compounds. Shareholders of Pfizer, a member of the Penn Global Leaders Club, will receive 0.125 shares of Viatris for every one share of PFE owned. So far, the deal has already paid off: shares are up 21% from the basis price. The generic drug market is huge, and Viatris is an immediate leader in the space. We believe the shares are worth $25, nearly a 50% upside from where they are currently trading.
Hotels, Resorts, & Cruise Lines
02. Airbnb: the next big IPO investors need to consider owning
There are a handful of IPOs we get excited about each year. The last one was Palantir (PLTR $18), which is up 70% since we purchased it on the last day of September. The next one will be Airbnb, which will trade on the Nasdaq under the symbol ABNB. Understandably, the pandemic hammered the vacation rental company, with revenues in Q2 of this year plummeting 72% from the same quarter in 2019. What does that mean for investors? They can expect to pick up shares a lot cheaper than they could have were there no pandemic. Airbnb's model is sound; nothing about the global health disaster changed that, and we expect a full rebound by the company as vaccines and therapies come online. In fact, one could make the argument that travelers will feel safer in the type of single-unit rentals the company typically hosts, rather than the crowded lobbies of the major hotel chains. Expect ABNB to begin trading in mid-December with an immediate market cap of roughly $30 billion. Like Palantir, we will own ABNB shares within minutes of the first trade.
Under the Radar Investment
01. Under the Radar: The GEO Group
The GEO Group (GEO $9) is a real estate investment trust specializing in detention facilities and community-reentry facilities. The company leases and oversees secure detention centers, rehab facilities, and service centers for troubled youth. Services include counseling, education, drug abuse treatment, tech-based supervision, and detainee transportation. Most of GEO's revenue comes from the leasing and management of these facilities in the US, Australia, South Africa, and the UK. The company had a net income of $167 million last year on $2.5 billion in revenue. Private prison stocks have stumbled since the election under the assumption that a Democrat in the White House would spell trouble for non-government entities in this arena. With the nature of GEO's work, however, we think investors miscalculated on this one. If shares climb back to their 2020 high, it would mean a 100% profit for investors.
Answer
In 1879, Louis Pasteur was studying fowl cholera by injecting chickens with the live bacteria and recording their subsequent deterioration. Before a holiday, he gave instructions to an assistant to make injections into the chickens with a fresh culture, as he would be away from his lab. The assistant forgot to do so. Upon return to the lab, Pasteur found the chickens still alive, suffering only mild symptoms of the disease. When injected with a full dose of the bacteria once again, he discovered that the chickens had developed immunity. He correctly deduced that a weakened form of the bacteria would allow the body to develop resistance to the disease. He immediately turned his attention to an anthrax epidemic which was raging in France. He successfully applied what he had learned in his lab from the chicken cholera experiment to develop an anthrax vaccine.
Headlines for the Week of 01 Nov—07 Nov 2020
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 once-dominant fossil fuels market continues its decline...
With an aggregate market cap of $1.67 trillion, the Energy sector now accounts for a paltry 2% of the S&P 500 (by contrast, the Information Technology sector accounts for 27% of the benchmark index). What was the sector's weighting in mid-1990 as America was preparing for Operation Desert Shield/Storm?
Penn Trading Desk:
(29 Oct 20) Adding a shipping powerhouse to Intrepid at a deep discount to FV
We began trading this maritime shipper in the late 1990s and have an excellent sense for when it is undervalued. We believe it is currently undervalued by 78%—conservatively. We have re-added the Bermuda-based shipper to the Intrepid Trading Platform.
(30 Oct 20) Added Aerospace & Defense firm to Intrepid
Actually, this small-cap American company could be listed in either the Aerospace & Defense industry or the Leisure Equipment industry. Either way, sales are through the roof based in good measure on the political environment.
(03 Nov 20) Added cutting-edge auto parts maker to the Global Leaders Club
This $9 billion auto parts manufacturer is making all the right moves to generate increased market share in our clean air/electric vehicle environment, to include a very smart recent acquisition. Increased vehicle efficiency is its forte, and its "sticky" customer base proves the strategy is working.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Application & Systems Software
10. German software giant SAP has biggest drop since 1996 on slashed outlook
In the stock's worst day in nearly a quarter-century, shares of $150 billion German software giant SAP (SAP $118) dropped over 21% after the company slashed its outlook for 2020, blaming the pandemic for putting the brakes on new corporate spending. Bad news for the company, but here's what investors need to know: is this train wreck company-centric, or does it portend bad news for the industry? The company, which sells a broad range of enterprise software products and services to corporations, government agencies, and educational institutions, generates approximately 40% of its revenues from the Americas, 40% from Europe, and 20% from Asia. We know that Europe is still reeling from the pandemic, with much of the continent back in lockdown mode. The US has been ramping up its corporate engine at a faster clip, and many parts of Asia are clawing their way back to pre-pandemic business activity levels. Looking at comparable offerings from the competition, Amazon's Web Services, Microsoft's Azure, and Oracle's suite of cloud infrastructure offerings have all held up relatively well this year. Software as a service (SaaS) providers such as Workday and Salesforce have actually been increasing market share—to the detriment of SAP. So, as bad as the news was for the company, the damage doesn't seem to be bleeding over to the competition.
Our favorite systems software company continues to be Microsoft (MSFT $212), and our favorite specialty applications firm is Adobe (ADBE $475). We own both in the Penn Global Leaders Club and, at their current prices, both offer a better value than SAP. We have no confidence in SAP's management team following Bill McDermott's departure for ServiceNow (NOW $504—another great industry player, but too rich with its 137 multiple).
Semiconductors & Related Equipment
09. AMD to buy Xilinx in another shot at rival Intel, but who is under greater pressure to perform?
When evaluating stocks, one of the most useful methods involves comparing a company's key stats to those of other companies in the same industry. Typically, the numbers are relatively aligned, but every now and again one notes a glaring discrepancy. Take two semiconductor giants: AMD (AMD $82) and Intel (INTC $46). The former has a market cap of around $90 billion, and the latter's size is over double that. The big discrepancy comes in the multiple investors have placed on each. While AMD carries an enormous PE of 150, Intel's multiple is just 9! That seems crazy for two companies which do, basically, the same thing. In essence, investors have no confidence in Intel's ability to pull out of its funk, while they are willing to give AMD's quite effective CEO Lisa Su every benefit of the doubt.
Su's most recent move, announced this week, is the acquisition of data center and cloud computing semiconductor maker Xilinx (XLNX) for $35 billion. At face value, the move appears brilliant, as the acquisition will complement—not duplicate—AMD's current chip focus and will allow the firm to yank market share away from Intel. In an effort to expand its own chip lineup, Intel purchased cloud chipmakers Altera and Mobileye (think autonomous vehicles) back in 2015 and 2017, respectively, but those acquisitions have yet to bear much fruit. Xilinx, which makes field-programmable gate arrays (FGPAs can be reprogrammed after they are manufactured), makes chips for the automotive and aerospace industry in addition to its data center business.
We say the move by AMD appears brilliant but it will also be very expensive, considering the $35 billion price tag equates to 38% of AMD's market cap. The firm must execute the integration with precision, as it has very little room for error. On the flip-side, investors have written off deep-valued Intel. This will be interesting to watch play out.
Call it the contrarian in us, or simply our recollection of what happened to high-flyers in 2000, but we would buy Intel right now (at $45) over AMD. Some would argue that Intel is a value trap, but the firm still controls the lion's share of the PC and server market, and it is investing in R&D like a nimble startup. It wouldn't take much for its shares to pop 50% and still appear cheap.
Life Sciences Tools & Services
08. Exact Sciences is expanding its cancer screening lineup with Thrive acquisition
Few technological advances are as exciting as noninvasive medical diagnostics—the ability to be screened for everything from colon cancer to heart problems without the specter of being knocked out with drugs and probed with instruments. We're not exactly at the Bones McCoy stage yet, but we are rapidly getting there. One of the companies on the frontline of noninvasive medical diagnostics is Exact Sciences (EXAS $129), which most people might recognize by the little blue talking Cologuard box in TV ads. While the company's claim to fame has been its at-home colorectal cancer screening kits, it is about to make a huge leap forward with its $2.15 billion acquisition of privately-held Thrive Earlier Detection. Thrive has developed a blood screening test for the early detection of a number of different cancers, and the potential market for such products is astronomical. Interestingly, the company's blood tests—assuming the advances continue—would probably start encroaching on Cologuard's turf soon. Another reason the acquisition makes sense. For all its promise, Exact Sciences has yet to turn a profit. While its shares are grossly overvalued at $129, keep an eye on the firm—eventual profitability and a more reasonable share price will equal a nice buy point.
Goods & Services
07. Following the sharpest economic decline in US history, the sharpest expansion
In the second quarter of 2020, the US economy recorded an almost unfathomable decline of 31.4% (thanks, China). Now, one quarter later, we have the strongest economic growth, quarter-over-quarter, in US history. Against expectations for a 32% expansion, Q3 GDP came in at 33.1% annualized clip according to the Commerce Department. GDP measures the total goods and services produced within a country over a one-quarter period. Putting that number in perspective, the previous record high GDP came in the first quarter of 1950 when the US economy expanded at a 16.7% annualized rate. Even more encouraging than the whopping headline number is where the growth came from. Strong exports, increased business investment, and residential purchases of durable goods all fueled the quarter's growth. These three components don't grow if businesses and consumers are hunkering down in anticipation of bad times ahead. Certainly, the massive new wave of Covid cases has spooked the markets, but confidence remains strong that we are on the tail end of the pandemic's wrath. As for the markets, expect positive vaccine news over the course of the quarter to fuel a year-end rally. We stand by our 2020 S&P target of 3,500, which we set in May of this year.
Market Pulse
06. Goldman Sachs: The Wrongway Feldman of the investment world
Any true Gilligan's Island fan remembers Wrongway Feldman, the former World War I pilot known for going the wrong way and bombing his own airfield. We view Goldman Sachs as the Wrongway Feldman of the investment world. If they say it is time to short oil, our tendency is to buy. If they say buy, it is probably time to sell. Which leads us to Goldman analyst Rod Hall and his "Sell" rating on Apple, which he issued this past April. At the time, adjusting for the four-for-one stock split, AAPL shares were going for $69, and Hall's expectation was for them to drop to $58.25 (again, adjusting for the split). As of this writing, Apple shares are sitting at $110, and Hall is doubling down on his silliness, reiterating his "Sell" rating and proclaiming shares will fall to $80. Considering the stock has rallied over 70% since his last brilliant call, sounds like it is time to add to our holding. So much money can be made in the stock market by taking advantage of terrible calls and any resulting share price moves. We celebrate companies like Goldman Sachs—they have helped us create a good deal of wealth.
Restaurants
05. Another great trading stock—Dunkin' Brands—gets gobbled up by a private equity firm
Back when I was in the broker-dealer world (as opposed to the RIA world with its accompanying fiduciary responsibility) I had a client who only traded two stocks in his portfolio: Walmart (WMT) and Krispy Kreme Doughnuts (KKD at the time). He had a trading system based on the location of the US economy along the economic cycle. Sadly, Krispy Kreme was ultimately taken private by Luxembourg-based JAB Holdings, which also took the likes of Panera Bread (formerly PNRA) and Green Mountain Coffee (formerly GMCR) private. We thought of that client after hearing that another great trading company, Dunkin' Brands (DNKN $106), was being taken out by private equity firm Inspire Brands in an $11.3 billion deal.
In our humble opinion, the financial engineers at these firms typically have no interest in the heart and soul of classic American companies; no, it is all about turning a buck and then moving on. Often, that involves squeezing every dime they can out of an entity and then repackaging the rubble as an IPO to a bunch of sucker investors (one reason we strongly avoid warmed-over publicly-traded companies). Inspire is a master at taking out companies we used to like trading: they also own Arby's, Buffalo Wild Wings, and Sonic. There is certainly no crime in a company selling itself to a private buyer, but that doesn't mean we need to like it. At least the members sitting on the acquired company's board will probably turn a nice personal profit in the deal.
Back when I had my Walmart/Krispy Kreme client, I worked at a well-respected, century-old firm called A.G. Edwards (ticker was AGE). While it wasn't taken private, top executives at the St. Louis-based mid-cap brokerage decided to sell the firm to Wachovia (and get fat paychecks—we assume—in the process) about fifteen years ago. This occurred shortly after the company placed the first non-Edwards family member in the CEO role. We remember his name with disdain, but it's not worth mentioning. Great due diligence there: Wachovia went belly-up soon after the acquisition and its assets were purchased by Wells Fargo (WFC)—a company with a whole host of its own problems.
So, we now say adios to ticker symbol DNKN. You will probably be repackaged and brought back to (public) life one of these days, but we won't be interested.
Individual shareholders need to begin taking a more active role in monitoring executives' behavior at publicly-traded companies. The first step in that process is understanding the ties these individuals have to the company. If they have no experience in the industry and a history of moving from one firm to the next using M&A stepping stones, investors beware—or sell on the rumor (and probable spike in share price) of an acquisition.
Business & Professional Services
04. In blow to the California political apparatchik, voters side with Uber and Lyft
You live in California and you want a part-time gig to supplement your income (and pay your confiscatory tax rate), so you begin driving for Uber (UBER $39). Of course, you are the epitome of an independent contractor. Common sense to most of the world, but not to the activist state government of California. No, to those blowhards you are an employee of Uber, despite your pleas to remain a contract worker. Refusing to bow to the power-hungry, micromanaging politicians in charge, Uber and Lyft fought back. They organized Proposition 22 in the state, which would allow ride-sharing firms and other gig economy companies (like Doordash and Postmates) to continue listing these part-time workers as contractors. They also announced that, barring the passage of Prop 22, they were ready to leave the state entirely. It looks like that won't be necessary, as voters in the once-Golden State handed them a resounding victory—nearly 60% to 40%. Never count an activist, overbearing government out, however; we are certain they will come at these companies in another way. We are reminded of Ronald Reagan's great quip on an overbearing central authority: "Government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. If it stops moving, subsidize it." On the morning after the victory, shares of Uber were trading up over 12% and Lyft shares were up 11%. Looks like a victory for shareholders as well.
Media Malpractice
03. Another election, another massive false narrative is blown to bits
I have the business networks—typically CNBC and Bloomberg—turned on in the office between six in the morning and six at night. I constantly scan the business news sites to keep abreast of what is going on, and have for too many years to count. I recall the MANTRA four years ago: "Trump win = massive stock market drop." It was drummed into viewers' heads like gospel. Trump won, and the markets exploded (in a good way). Fast forward four years and a new mantra emerged: "A blue wave would launch the markets higher, while a contested election and/or divided government would be disastrous for the markets." Lo and behold, we got the latter and the markets began hammering out their best period in a long time. Another false narrative blown to bits. At least Bloomberg had the guts to run the following headline the day after the election: "Doomsday Market Predictions Give Way to Never-Ending Rally." Meanwhile, CNBC ran the following headline on the chyron: :US Stocks, Bonds Rally as Blue Wave Fades." No mention of the fact that they told us blue wave would be the next great catalyst for the market. Journalism has a long and storied history of creating narratives that are anything but true and then packaging them as fact. Consumers of news need to accept that condition and figure out the best way to take advantage of the garbage the journalists are often peddling to their audience. There are some great and fair-minded journalists in the business; sadly, there are also many who just can't help tainting their stories based on personal prejudices. The key is to have a critical eye and discern the former from the latter.
Semiconductors
02. New Frontier Fund Member Qualcomm surges double-digits on earnings, 5G prospects
When we added $165 billion semiconductor maker Qualcomm (QCOM $145) to the Penn New Frontier Fund it had a market cap of $80 billion and was generally being ignored by the analysts. We had two major theses for our purchase: 1. the company would dominate in the era of 5G; 2. Steve Mollenkopf was one of the best CEOs in America. After a 100% run-up in the share price, analysts are suddenly paying attention. The latest one-day, double-digit price spike of QCOM shares came on the heels of the firm's fiscal Q4 results. Revenue climbed an impressive 73% from one year ago, from $4.81 billion to $8.45 billion, and net income spiked from $506 million in the same quarter last year to $2.96 billion (a good portion of which came from an IP settlement with Huawei) this past quarter. Mollenkopf's comments also helped the share price: the CEO said the company was poised to sell millions of chips for 5G mobile devices as consumers upgrade their smartphones. Despite the massive run-up in share price, QCOM has a lot of room to run. The company will be one of the dominant players in the nascent world of 5G technology.
Under the Radar Investment
01. Under the Radar: UGI Corp
UGI Corp (UGI $32) is a $6.7 billion regulated gas utility providing natural gas and electricity to over 650,000 households in Pennsylvania and Maryland. The company owns AmeriGas Propane, the largest US propane marketer, which serves over one million users throughout all 50 states. Within its energy services unit, UGI owns thermal power plants as well as processing, storage, and pipeline facilities. At $32 per share, the company offers an attractive 4.05% dividend yield. Our fair value estimation on UGI is $40 per share.
Answer
Back in 1990, there were only ten sectors in the S&P 500; meaning, were they all equal weighted, each would represent 10% of the benchmark. Energy, however, held a hefty 16% weighting in the index. The sector's fall to a current weight of 2% within the S&P 500 is nothing short of remarkable, and underlines the importance of proactive portfolio construction.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The once-dominant fossil fuels market continues its decline...
With an aggregate market cap of $1.67 trillion, the Energy sector now accounts for a paltry 2% of the S&P 500 (by contrast, the Information Technology sector accounts for 27% of the benchmark index). What was the sector's weighting in mid-1990 as America was preparing for Operation Desert Shield/Storm?
Penn Trading Desk:
(29 Oct 20) Adding a shipping powerhouse to Intrepid at a deep discount to FV
We began trading this maritime shipper in the late 1990s and have an excellent sense for when it is undervalued. We believe it is currently undervalued by 78%—conservatively. We have re-added the Bermuda-based shipper to the Intrepid Trading Platform.
(30 Oct 20) Added Aerospace & Defense firm to Intrepid
Actually, this small-cap American company could be listed in either the Aerospace & Defense industry or the Leisure Equipment industry. Either way, sales are through the roof based in good measure on the political environment.
(03 Nov 20) Added cutting-edge auto parts maker to the Global Leaders Club
This $9 billion auto parts manufacturer is making all the right moves to generate increased market share in our clean air/electric vehicle environment, to include a very smart recent acquisition. Increased vehicle efficiency is its forte, and its "sticky" customer base proves the strategy is working.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Application & Systems Software
10. German software giant SAP has biggest drop since 1996 on slashed outlook
In the stock's worst day in nearly a quarter-century, shares of $150 billion German software giant SAP (SAP $118) dropped over 21% after the company slashed its outlook for 2020, blaming the pandemic for putting the brakes on new corporate spending. Bad news for the company, but here's what investors need to know: is this train wreck company-centric, or does it portend bad news for the industry? The company, which sells a broad range of enterprise software products and services to corporations, government agencies, and educational institutions, generates approximately 40% of its revenues from the Americas, 40% from Europe, and 20% from Asia. We know that Europe is still reeling from the pandemic, with much of the continent back in lockdown mode. The US has been ramping up its corporate engine at a faster clip, and many parts of Asia are clawing their way back to pre-pandemic business activity levels. Looking at comparable offerings from the competition, Amazon's Web Services, Microsoft's Azure, and Oracle's suite of cloud infrastructure offerings have all held up relatively well this year. Software as a service (SaaS) providers such as Workday and Salesforce have actually been increasing market share—to the detriment of SAP. So, as bad as the news was for the company, the damage doesn't seem to be bleeding over to the competition.
Our favorite systems software company continues to be Microsoft (MSFT $212), and our favorite specialty applications firm is Adobe (ADBE $475). We own both in the Penn Global Leaders Club and, at their current prices, both offer a better value than SAP. We have no confidence in SAP's management team following Bill McDermott's departure for ServiceNow (NOW $504—another great industry player, but too rich with its 137 multiple).
Semiconductors & Related Equipment
09. AMD to buy Xilinx in another shot at rival Intel, but who is under greater pressure to perform?
When evaluating stocks, one of the most useful methods involves comparing a company's key stats to those of other companies in the same industry. Typically, the numbers are relatively aligned, but every now and again one notes a glaring discrepancy. Take two semiconductor giants: AMD (AMD $82) and Intel (INTC $46). The former has a market cap of around $90 billion, and the latter's size is over double that. The big discrepancy comes in the multiple investors have placed on each. While AMD carries an enormous PE of 150, Intel's multiple is just 9! That seems crazy for two companies which do, basically, the same thing. In essence, investors have no confidence in Intel's ability to pull out of its funk, while they are willing to give AMD's quite effective CEO Lisa Su every benefit of the doubt.
Su's most recent move, announced this week, is the acquisition of data center and cloud computing semiconductor maker Xilinx (XLNX) for $35 billion. At face value, the move appears brilliant, as the acquisition will complement—not duplicate—AMD's current chip focus and will allow the firm to yank market share away from Intel. In an effort to expand its own chip lineup, Intel purchased cloud chipmakers Altera and Mobileye (think autonomous vehicles) back in 2015 and 2017, respectively, but those acquisitions have yet to bear much fruit. Xilinx, which makes field-programmable gate arrays (FGPAs can be reprogrammed after they are manufactured), makes chips for the automotive and aerospace industry in addition to its data center business.
We say the move by AMD appears brilliant but it will also be very expensive, considering the $35 billion price tag equates to 38% of AMD's market cap. The firm must execute the integration with precision, as it has very little room for error. On the flip-side, investors have written off deep-valued Intel. This will be interesting to watch play out.
Call it the contrarian in us, or simply our recollection of what happened to high-flyers in 2000, but we would buy Intel right now (at $45) over AMD. Some would argue that Intel is a value trap, but the firm still controls the lion's share of the PC and server market, and it is investing in R&D like a nimble startup. It wouldn't take much for its shares to pop 50% and still appear cheap.
Life Sciences Tools & Services
08. Exact Sciences is expanding its cancer screening lineup with Thrive acquisition
Few technological advances are as exciting as noninvasive medical diagnostics—the ability to be screened for everything from colon cancer to heart problems without the specter of being knocked out with drugs and probed with instruments. We're not exactly at the Bones McCoy stage yet, but we are rapidly getting there. One of the companies on the frontline of noninvasive medical diagnostics is Exact Sciences (EXAS $129), which most people might recognize by the little blue talking Cologuard box in TV ads. While the company's claim to fame has been its at-home colorectal cancer screening kits, it is about to make a huge leap forward with its $2.15 billion acquisition of privately-held Thrive Earlier Detection. Thrive has developed a blood screening test for the early detection of a number of different cancers, and the potential market for such products is astronomical. Interestingly, the company's blood tests—assuming the advances continue—would probably start encroaching on Cologuard's turf soon. Another reason the acquisition makes sense. For all its promise, Exact Sciences has yet to turn a profit. While its shares are grossly overvalued at $129, keep an eye on the firm—eventual profitability and a more reasonable share price will equal a nice buy point.
Goods & Services
07. Following the sharpest economic decline in US history, the sharpest expansion
In the second quarter of 2020, the US economy recorded an almost unfathomable decline of 31.4% (thanks, China). Now, one quarter later, we have the strongest economic growth, quarter-over-quarter, in US history. Against expectations for a 32% expansion, Q3 GDP came in at 33.1% annualized clip according to the Commerce Department. GDP measures the total goods and services produced within a country over a one-quarter period. Putting that number in perspective, the previous record high GDP came in the first quarter of 1950 when the US economy expanded at a 16.7% annualized rate. Even more encouraging than the whopping headline number is where the growth came from. Strong exports, increased business investment, and residential purchases of durable goods all fueled the quarter's growth. These three components don't grow if businesses and consumers are hunkering down in anticipation of bad times ahead. Certainly, the massive new wave of Covid cases has spooked the markets, but confidence remains strong that we are on the tail end of the pandemic's wrath. As for the markets, expect positive vaccine news over the course of the quarter to fuel a year-end rally. We stand by our 2020 S&P target of 3,500, which we set in May of this year.
Market Pulse
06. Goldman Sachs: The Wrongway Feldman of the investment world
Any true Gilligan's Island fan remembers Wrongway Feldman, the former World War I pilot known for going the wrong way and bombing his own airfield. We view Goldman Sachs as the Wrongway Feldman of the investment world. If they say it is time to short oil, our tendency is to buy. If they say buy, it is probably time to sell. Which leads us to Goldman analyst Rod Hall and his "Sell" rating on Apple, which he issued this past April. At the time, adjusting for the four-for-one stock split, AAPL shares were going for $69, and Hall's expectation was for them to drop to $58.25 (again, adjusting for the split). As of this writing, Apple shares are sitting at $110, and Hall is doubling down on his silliness, reiterating his "Sell" rating and proclaiming shares will fall to $80. Considering the stock has rallied over 70% since his last brilliant call, sounds like it is time to add to our holding. So much money can be made in the stock market by taking advantage of terrible calls and any resulting share price moves. We celebrate companies like Goldman Sachs—they have helped us create a good deal of wealth.
Restaurants
05. Another great trading stock—Dunkin' Brands—gets gobbled up by a private equity firm
Back when I was in the broker-dealer world (as opposed to the RIA world with its accompanying fiduciary responsibility) I had a client who only traded two stocks in his portfolio: Walmart (WMT) and Krispy Kreme Doughnuts (KKD at the time). He had a trading system based on the location of the US economy along the economic cycle. Sadly, Krispy Kreme was ultimately taken private by Luxembourg-based JAB Holdings, which also took the likes of Panera Bread (formerly PNRA) and Green Mountain Coffee (formerly GMCR) private. We thought of that client after hearing that another great trading company, Dunkin' Brands (DNKN $106), was being taken out by private equity firm Inspire Brands in an $11.3 billion deal.
In our humble opinion, the financial engineers at these firms typically have no interest in the heart and soul of classic American companies; no, it is all about turning a buck and then moving on. Often, that involves squeezing every dime they can out of an entity and then repackaging the rubble as an IPO to a bunch of sucker investors (one reason we strongly avoid warmed-over publicly-traded companies). Inspire is a master at taking out companies we used to like trading: they also own Arby's, Buffalo Wild Wings, and Sonic. There is certainly no crime in a company selling itself to a private buyer, but that doesn't mean we need to like it. At least the members sitting on the acquired company's board will probably turn a nice personal profit in the deal.
Back when I had my Walmart/Krispy Kreme client, I worked at a well-respected, century-old firm called A.G. Edwards (ticker was AGE). While it wasn't taken private, top executives at the St. Louis-based mid-cap brokerage decided to sell the firm to Wachovia (and get fat paychecks—we assume—in the process) about fifteen years ago. This occurred shortly after the company placed the first non-Edwards family member in the CEO role. We remember his name with disdain, but it's not worth mentioning. Great due diligence there: Wachovia went belly-up soon after the acquisition and its assets were purchased by Wells Fargo (WFC)—a company with a whole host of its own problems.
So, we now say adios to ticker symbol DNKN. You will probably be repackaged and brought back to (public) life one of these days, but we won't be interested.
Individual shareholders need to begin taking a more active role in monitoring executives' behavior at publicly-traded companies. The first step in that process is understanding the ties these individuals have to the company. If they have no experience in the industry and a history of moving from one firm to the next using M&A stepping stones, investors beware—or sell on the rumor (and probable spike in share price) of an acquisition.
Business & Professional Services
04. In blow to the California political apparatchik, voters side with Uber and Lyft
You live in California and you want a part-time gig to supplement your income (and pay your confiscatory tax rate), so you begin driving for Uber (UBER $39). Of course, you are the epitome of an independent contractor. Common sense to most of the world, but not to the activist state government of California. No, to those blowhards you are an employee of Uber, despite your pleas to remain a contract worker. Refusing to bow to the power-hungry, micromanaging politicians in charge, Uber and Lyft fought back. They organized Proposition 22 in the state, which would allow ride-sharing firms and other gig economy companies (like Doordash and Postmates) to continue listing these part-time workers as contractors. They also announced that, barring the passage of Prop 22, they were ready to leave the state entirely. It looks like that won't be necessary, as voters in the once-Golden State handed them a resounding victory—nearly 60% to 40%. Never count an activist, overbearing government out, however; we are certain they will come at these companies in another way. We are reminded of Ronald Reagan's great quip on an overbearing central authority: "Government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. If it stops moving, subsidize it." On the morning after the victory, shares of Uber were trading up over 12% and Lyft shares were up 11%. Looks like a victory for shareholders as well.
Media Malpractice
03. Another election, another massive false narrative is blown to bits
I have the business networks—typically CNBC and Bloomberg—turned on in the office between six in the morning and six at night. I constantly scan the business news sites to keep abreast of what is going on, and have for too many years to count. I recall the MANTRA four years ago: "Trump win = massive stock market drop." It was drummed into viewers' heads like gospel. Trump won, and the markets exploded (in a good way). Fast forward four years and a new mantra emerged: "A blue wave would launch the markets higher, while a contested election and/or divided government would be disastrous for the markets." Lo and behold, we got the latter and the markets began hammering out their best period in a long time. Another false narrative blown to bits. At least Bloomberg had the guts to run the following headline the day after the election: "Doomsday Market Predictions Give Way to Never-Ending Rally." Meanwhile, CNBC ran the following headline on the chyron: :US Stocks, Bonds Rally as Blue Wave Fades." No mention of the fact that they told us blue wave would be the next great catalyst for the market. Journalism has a long and storied history of creating narratives that are anything but true and then packaging them as fact. Consumers of news need to accept that condition and figure out the best way to take advantage of the garbage the journalists are often peddling to their audience. There are some great and fair-minded journalists in the business; sadly, there are also many who just can't help tainting their stories based on personal prejudices. The key is to have a critical eye and discern the former from the latter.
Semiconductors
02. New Frontier Fund Member Qualcomm surges double-digits on earnings, 5G prospects
When we added $165 billion semiconductor maker Qualcomm (QCOM $145) to the Penn New Frontier Fund it had a market cap of $80 billion and was generally being ignored by the analysts. We had two major theses for our purchase: 1. the company would dominate in the era of 5G; 2. Steve Mollenkopf was one of the best CEOs in America. After a 100% run-up in the share price, analysts are suddenly paying attention. The latest one-day, double-digit price spike of QCOM shares came on the heels of the firm's fiscal Q4 results. Revenue climbed an impressive 73% from one year ago, from $4.81 billion to $8.45 billion, and net income spiked from $506 million in the same quarter last year to $2.96 billion (a good portion of which came from an IP settlement with Huawei) this past quarter. Mollenkopf's comments also helped the share price: the CEO said the company was poised to sell millions of chips for 5G mobile devices as consumers upgrade their smartphones. Despite the massive run-up in share price, QCOM has a lot of room to run. The company will be one of the dominant players in the nascent world of 5G technology.
Under the Radar Investment
01. Under the Radar: UGI Corp
UGI Corp (UGI $32) is a $6.7 billion regulated gas utility providing natural gas and electricity to over 650,000 households in Pennsylvania and Maryland. The company owns AmeriGas Propane, the largest US propane marketer, which serves over one million users throughout all 50 states. Within its energy services unit, UGI owns thermal power plants as well as processing, storage, and pipeline facilities. At $32 per share, the company offers an attractive 4.05% dividend yield. Our fair value estimation on UGI is $40 per share.
Answer
Back in 1990, there were only ten sectors in the S&P 500; meaning, were they all equal weighted, each would represent 10% of the benchmark. Energy, however, held a hefty 16% weighting in the index. The sector's fall to a current weight of 2% within the S&P 500 is nothing short of remarkable, and underlines the importance of proactive portfolio construction.
Headlines for the Week of 18 Oct—24 Oct 2020
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
History of the Dow Jones Industrial Average...
Though we label it "irrelevant" below, the Dow Jones Industrial Average does have an illustrious history. Who started the index and what was the publication which introduced it to the investing community? Also, one of the original twelve stocks on the Dow is still in existence—what company is it?
Penn Trading Desk:
(21 Aug 20) Adding Thematic Fund to Dynamic Growth Strategy
We have added a robotics fund to the DGS to take advantage of the coming boom in automation—the movement will be transformational for society. This fund is full of dynamic small- and mid-cap names. Members, see the trading desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Media & Entertainment
10. Disney's restructuring plans do not assuage our concerns
There really are no "buy and forget" companies out there anymore. The idea of owning a static group of blue chip stocks to hold for the long term is a relic of the past. Take three of our historic favorites: General Electric (GE), Boeing (BA), and Walt Disney (DIS). There was a time not that long ago when we couldn't imagine not owning these three juggernauts in our core portfolio. It's amazing how complacency and poor management can ravage a company virtually overnight.
While that condition has certainly gripped the former two names, what about Disney? We wrote disparagingly about Bob Iger's decision to step down after he assured investors he would remain on as CEO at least until 2021. Then we found out that Disney employees (who are now 28,000 fewer in number) had to hear the news from an interview Iger gave to a business network. Not cool, Bob. Taking over Iger's role would be Bob Chapek, the former head of Disney's parks. Based on our underwhelming early view of Chapek and Iger's cavalier attitude toward employees, we took our huge DIS profits earlier this year when we closed our position.
Now comes word that Disney will make a major structural shift in its operations. With an eye on direct-to-consumer, the $235 billion firm will create a new unit focused on the marketing and distribution of content, separating that function from the content creation unit. It is clear that the move is designed to foster migration away from the company's 100-year-old relationship with movie theaters and toward the direct-to-consumer model. Perhaps the first test of this new unit was the decision to charge Disney+ users $30 to stream the production of Mulan. Not a great first step. There is no doubt that Disney+ was a brilliant move; one that helped the company maintain critical revenue while the parks were being shuttered due to the pandemic. That being said, we are still not sold on the new leadership team and still question the strategic vision of the company going forward.
In fairness, it isn't the company's fault that Disneyland in California remains closed—that condition is the result of an inept government in Sacramento. We continue to watch DIS stock closely, as there will come a time, hopefully by the end of 2021, when the company's major revenue drivers—the parks—are back at full capacity.
Consumer Electronics
09. Sorry Apple haters, the iPhone 12 will indeed launch a new super-cycle for the company
It is a bizarre state of affairs. Rarely do you hear any of the 100 million Apple (AAPL $120) iPhone users in the US take to social media to bash the device's main competition—the Samsung Galaxy, but an odd number of Galaxy users seem to be preoccupied with hating on the iPhone. One petulant Galaxy-phile took to Twitter following the iPhone 12 event to proclaim, "We're like on Galaxy 24 now." It would probably take a clinical psychologist to explain their hatred for Apple, but the only thing that matters to us is this: Apple continues to innovate, and the launch of the iPhone 12 5G device lineup will bring about a new super-cycle for the company.
Forget all of the talk about limited 5G coverage. To be sure, it will take years to put up the millions of little devices throughout the country needed to bring this hyper-speed technology to everyone, but the train has left the station—and soon enough, everyone will be clamoring for it. Furthermore, millions of Americans have held off on upgrading their iPhones until 5G devices became available. Finally, many countries around the world, especially in Asia, have built out a larger 5G infrastructure than the US. This makes sense when we consider the state and local government impediments in the US versus the lack of such challenges in "less free" countries. Trade wars and anti-American sentiment aside, Apple will sell hundreds of millions of iPhone 12s globally.
So, let the Apple haters continue to throw their tantrums; we remain focused on what the $2 trillion Cupertino-based company has in store for us next. Remember, it will require new devices to take advantage of 5G technology, and that holds true for the iPad and Mac lineups as well as the iPhone. Stay tuned.
At $120 per share, Apple remains a buy. It currently holds the distinction of being our largest portfolio position, and we don't see that changing anytime soon.
Application & Systems Software
08. Tech traders beware: What just happened to Fastly is a sign of things to come
2020 has been a banner year for Internet-based tech companies which have yet to turn a profit—Robinhood traders can't scoop up their shares fast enough. Take cloud platform provider Fastly (FSLY $85), for example. Traders turned this $1 billion startup into a $10 billion player virtually overnight despite the company's lack of net income—ever. All of that changed after the firm's latest earnings report, however. After a slight revenue miss (the company's Q3 revenue came in around $70 million versus analyst expectations for $75 million), FSLY shares began their rapid 33% decline. Let's back up and think about this: Here we have a company generating a paltry $70 million per quarter, earning zero net income, and traders were still piling in when its market cap hit $10 billion. Insanity. This is precisely the type of plunge we witnessed—ad nauseam—in early 2000. Let this be a warning shot to traders piling into unprofitable companies with reckless abandon. We've seen this movie before, and it does not end well. Here's what bothers us the most about the Fastly case study: We are willing to bet that the majority of "investors" who jumped in to buy shares couldn't explain what the company actually does if their lives depended on it. Here's a really simple basic rule to follow: Don't invest in any company before understanding what they do and what their unique value proposition is for customers. Then, it sure wouldn't hurt to actually look at the financials.
Oil & Gas Exploration & Production
07. ConocoPhillips will acquire shale E&P firm Concho Resources for $9.7 billion
Considering the market cap of Permian Basin operator Concho Resources (CXO $49) was $32 billion precisely two years ago, it seems like a golden opportunity for ConocoPhillips (COP $34): the latter will acquire the former for $9.7 billion in an all-stock deal. In a sign of just how hard the energy sector has fallen over the past two years, COP's market cap has dropped from $90 billion two years ago to just $36 billion today. For many shale producers facing chronic $40 per barrel oil, it is simply a case of be acquired or face possible bankruptcy. Does the deal make sense for Conoco? Our guess is that in two years it will look as brilliant as the 2019 Occidental (OXY $10) takeover of Anadarko for $38 billion looked stupid (Occidental's market cap now sits below $10 billion—yikes). The global economy will surge forward when the pandemic is behind us, and the rumors of oil's death as the world's leading energy source have been greatly exaggerated—at least the timeline of its demise. We continue to underweight the energy sector, with Chevron (CVX) remaining the one integrated oil company we own. At $33 per share, however, and with a 5% dividend yield, COP seems quite undervalued.
Application & Systems Software
06. SpaceX selects Microsoft (not Amazon) to run its space-based cloud computing network
It is almost embarrassing to watch Jeff Bezos pretend to compete with Elon Musk for commercial space dominance. He's like a little kid donning an astronaut costume and proclaiming, "take that Neil Armstrong!" In his own mind, Bezos's Blue Origin is right up there with SpaceX; hell, maybe better. Of course, in reality Blue Origin continues to be the pet project of the world's richest man while SpaceX is busy launching astronauts into orbit and building out a massive fleet of satellites which will provide high-speed Internet service to even the most remote parts of the globe. (Right on cue, Bezos stated that Blue Origin is going to build an even better satellite system—despite the lack of even one satellite in orbit.) In a move that should come as no surprise, SpaceX just selected Microsoft's (MSFT $214) Azure service to operate and manage its cloud computing needs for the Starlink system, barely considering Amazon (AMZN $3,226) Web Services (AWS) as an option. Considering the scope of the project, which will consist of linking cloud, space, and ground capabilities, crunching almost unfathomable amounts of data, and helping to control the orbits of SpaceX satellites, this was a huge win for Microsoft. Beyond the Starlink project, Musk's SpaceX also landed a demo contract from the Pentagon for a new generation missile warning system. Assuming the demo leads to deployment, Microsoft would certainly get that contract as well. Recall that Amazon is currently suing the US government for the Pentagon's decision to go with Azure for its $10 billion JEDI program, snubbing AWS. We see very little chance of the lawsuit changing the outcome of the JEDI contract, though we wonder how it might have poisoned the well for Amazon's hopes of landing government contracts in the future. For its core business of online retailing, no other company can compete with Amazon—which is why we own it within the Penn Global Leaders Club. We just wish Bezos would shut up and let someone else run the company. Maybe he could run Blue Origin full time and work on landing one single contract.
Global Strategy: Europe
05. While the pandemic rages in Europe, parliament focuses on what to call a veggie burger
One of our favorite pastimes is making fun of the European government. Let's face it, the only reason a "European Union" even exists is because of that continent's envy of the United States. The level of arrogance permeating the halls of the EU parliament in Brussels is stratospheric, which makes them such an easy target for ridicule. The latest? While the pandemic rages across the continent, EU lawmakers are focused on a critical issue: Whether or not to ban the likes of Beyond Meat (BYND $176) from calling their plant-based patties "burgers." Lawmakers will debate and vote on an amendment this month which would force these companies to label their burgers "discs" and their sausages "tubes." i.e. Beyond Burgers would become "veggie discs," and Beyond Breakfast Sausage would become "plant-based tubes." Parliamentarians will vote on another amendment, pushed by the European dairy union, which would ban the use of the word "creamy" when describing a non-dairy item. And we make fun of our government. Is it any wonder Brits voted to pull out of this dysfunctional entity?
Business & Professional Services
04. Bitcoin pops after PayPal announces it will allow customers to trade in cryptocurrencies
The value of Bitcoin "shares" surged to $13,000 following news that credit services provider PayPal (PYPL $213) will begin allowing its customers to use the digital currency on its platform. The firm said Bitcoins can be used for purchases with its 26 million merchants around the world, and the currency will soon be allowed on Venmo, now a PayPal company. That being said, the firm will not hold cryptos on its balance sheet; instead, it will partner with cryptocurrency services firm Paxos Trust Company to assist in completing the transactions. This means that merchants won't have to actually deal with the digital currency, as Paxos will serve as the intermediary. Nonetheless, considering PayPal has some 300 million customers around the globe, Bitcoin advocates are celebrating the move. Shares of the digital currency have been extremely volatile this year, falling from around $10,000 in February to $5,000 in March, then climbing back to $13,000 this past week. The high value mark of the currency was $20,000 back in 2017. Investing in Bitcoin has been—and will continue to be—a complete gamble. Keep in mind that this currency does not exist in "hard" form, it only exists virtually. Considering the high level of sophistication of hackers around the world, expect to hear more stories in the near future of accounts being drained of Bitcoin. As for PayPal, we like the firm but don't like the 100 multiple on the share price.
Media & Entertainment
03. In blow to Katzenberg and Whitman, Quibi is already being shut down
Based on some of their questionable business decisions in the past, our respect for Jeffrey Katzenberg and Meg Whitman was already pretty low coming into this most recent foray; now it is virtually nonexistent. It was just this past April when Whitman, the former CEO of eBay and HP, came on-air to brag about her and Katzenberg's new streaming service known as Quibi. Not only wouldn't the pandemic hurt the new service, it may even enhance its value, claimed Whitman. Now, six months and billions of dollars later, Quibi is shutting down. Katzenberg cited the pandemic as one of the major factors in its demise. Wow. All of the great ideas out there waiting to be funded, and this duo was actually able to attract $2 billion for a questionable business proposition (Quibi's unique value proposition was that it would feature short-form news and entertainment videos of ten minutes or less—yawn). The power of name recognition. We've said it before and we'll say it again: There are so many mediocre to downright bad CEOs out there that it boggles the mind. Before buying shares in a company, investors need to perform some level of due diligence on that company's management team.
Cybersecurity
02. Cybersecurity firm McAfee goes public—again
We are always on the lookout for a promising IPO, so when we heard that well-known cybersecurity firm McAfee (MCFE $19) was going public, it piqued our interest. We even like the firm's anything-but-dull founder, John McAfee (OK, despite the libertarian's recent arrest in Spain over tax evasion charges; it should be noted that McAfee has not been affiliated with the eponymous company since 1994). However, there was one major obstacle keeping us from investing in MCFE shares, which began trading on Thursday the 22nd: it was the company's second trip to the public equity markets—Intel acquired the firm and took it private in 2011. Despite having eighteen underwriters working on the deal, the IPO turned out to be a bust. After raising $740 million on Wednesday (the company sold 37 million Class A shares at $20 apiece), shares began trading at $18.60, got as high as $19.34, and then spent most of the session declining. A late-session rally brought them back up to $18.68 at the close. Our largest concern is the company's hefty debt load, which will still sit around $4 billion after some of it is paid off with the IPO proceeds. To put that in perspective, $21 billion cybersecurity firm Fortinet (FTNT $128), which we own in the Penn New Frontier Fund, has an aggregate short- and long-term debt load of just $2.7 billion. With so many hands in the pie and a share structure that would be hard for an SEC lawyer to decipher, we would steer clear of this warmed-over offering.
Under the Radar Investment
01. Under the Radar: SPDR® Blackstone / GSO Senior Loan ETF
To say it is difficult finding "good" fixed income investments right now is the understatement of the century. Ten-year Treasuries are yielding just above one-half of one percent, and the 30-year T Bond is yielding 1.375%. Challenging times. That being said, one of our current favorites in the Penn Strategic Income Portfolio is our senior loan fund, the SPDR Blackstone GSO Senior Loan ETF (SRLN). Senior loans are debt instruments issued by a bank to a company to fund any number of projects or to retire existing debt with higher interest rates. Note the term "senior." This means that, in the case of bankruptcy, owners of senior bank loans will be paid first as assets are liquidated—before creditors, preferred shareholders, and stockholders. SRLN currently owns around 220 such senior loans outstanding to companies such as: Bass Pro Shop, Petsmart, Athena Health, and Rackspace Technology. The average maturity of these loans is a comforting 4.72 years, and the beta (risk level on a scale of zero to one, with one equaling the risk of the S&P 500) is 0.0859. Our favorite aspect of the fund in these days of ultra-low rates? It yields 5%.
Answer
Business journalist Charles Dow, founder of financial news bureau Dow, Jones & Co., created the Dow Jones Industrial Average back in 1896. Prominent business newspaper The Wall Street Journal introduced the DJIA on 26 May of that same year. Of the twelve original component companies of the Dow, only General Electric is still in existence as a publicly-traded company. It was jettisoned from the index in 2018. In 1928, the DJIA was expanded to include 30 companies.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
History of the Dow Jones Industrial Average...
Though we label it "irrelevant" below, the Dow Jones Industrial Average does have an illustrious history. Who started the index and what was the publication which introduced it to the investing community? Also, one of the original twelve stocks on the Dow is still in existence—what company is it?
Penn Trading Desk:
(21 Aug 20) Adding Thematic Fund to Dynamic Growth Strategy
We have added a robotics fund to the DGS to take advantage of the coming boom in automation—the movement will be transformational for society. This fund is full of dynamic small- and mid-cap names. Members, see the trading desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Media & Entertainment
10. Disney's restructuring plans do not assuage our concerns
There really are no "buy and forget" companies out there anymore. The idea of owning a static group of blue chip stocks to hold for the long term is a relic of the past. Take three of our historic favorites: General Electric (GE), Boeing (BA), and Walt Disney (DIS). There was a time not that long ago when we couldn't imagine not owning these three juggernauts in our core portfolio. It's amazing how complacency and poor management can ravage a company virtually overnight.
While that condition has certainly gripped the former two names, what about Disney? We wrote disparagingly about Bob Iger's decision to step down after he assured investors he would remain on as CEO at least until 2021. Then we found out that Disney employees (who are now 28,000 fewer in number) had to hear the news from an interview Iger gave to a business network. Not cool, Bob. Taking over Iger's role would be Bob Chapek, the former head of Disney's parks. Based on our underwhelming early view of Chapek and Iger's cavalier attitude toward employees, we took our huge DIS profits earlier this year when we closed our position.
Now comes word that Disney will make a major structural shift in its operations. With an eye on direct-to-consumer, the $235 billion firm will create a new unit focused on the marketing and distribution of content, separating that function from the content creation unit. It is clear that the move is designed to foster migration away from the company's 100-year-old relationship with movie theaters and toward the direct-to-consumer model. Perhaps the first test of this new unit was the decision to charge Disney+ users $30 to stream the production of Mulan. Not a great first step. There is no doubt that Disney+ was a brilliant move; one that helped the company maintain critical revenue while the parks were being shuttered due to the pandemic. That being said, we are still not sold on the new leadership team and still question the strategic vision of the company going forward.
In fairness, it isn't the company's fault that Disneyland in California remains closed—that condition is the result of an inept government in Sacramento. We continue to watch DIS stock closely, as there will come a time, hopefully by the end of 2021, when the company's major revenue drivers—the parks—are back at full capacity.
Consumer Electronics
09. Sorry Apple haters, the iPhone 12 will indeed launch a new super-cycle for the company
It is a bizarre state of affairs. Rarely do you hear any of the 100 million Apple (AAPL $120) iPhone users in the US take to social media to bash the device's main competition—the Samsung Galaxy, but an odd number of Galaxy users seem to be preoccupied with hating on the iPhone. One petulant Galaxy-phile took to Twitter following the iPhone 12 event to proclaim, "We're like on Galaxy 24 now." It would probably take a clinical psychologist to explain their hatred for Apple, but the only thing that matters to us is this: Apple continues to innovate, and the launch of the iPhone 12 5G device lineup will bring about a new super-cycle for the company.
Forget all of the talk about limited 5G coverage. To be sure, it will take years to put up the millions of little devices throughout the country needed to bring this hyper-speed technology to everyone, but the train has left the station—and soon enough, everyone will be clamoring for it. Furthermore, millions of Americans have held off on upgrading their iPhones until 5G devices became available. Finally, many countries around the world, especially in Asia, have built out a larger 5G infrastructure than the US. This makes sense when we consider the state and local government impediments in the US versus the lack of such challenges in "less free" countries. Trade wars and anti-American sentiment aside, Apple will sell hundreds of millions of iPhone 12s globally.
So, let the Apple haters continue to throw their tantrums; we remain focused on what the $2 trillion Cupertino-based company has in store for us next. Remember, it will require new devices to take advantage of 5G technology, and that holds true for the iPad and Mac lineups as well as the iPhone. Stay tuned.
At $120 per share, Apple remains a buy. It currently holds the distinction of being our largest portfolio position, and we don't see that changing anytime soon.
Application & Systems Software
08. Tech traders beware: What just happened to Fastly is a sign of things to come
2020 has been a banner year for Internet-based tech companies which have yet to turn a profit—Robinhood traders can't scoop up their shares fast enough. Take cloud platform provider Fastly (FSLY $85), for example. Traders turned this $1 billion startup into a $10 billion player virtually overnight despite the company's lack of net income—ever. All of that changed after the firm's latest earnings report, however. After a slight revenue miss (the company's Q3 revenue came in around $70 million versus analyst expectations for $75 million), FSLY shares began their rapid 33% decline. Let's back up and think about this: Here we have a company generating a paltry $70 million per quarter, earning zero net income, and traders were still piling in when its market cap hit $10 billion. Insanity. This is precisely the type of plunge we witnessed—ad nauseam—in early 2000. Let this be a warning shot to traders piling into unprofitable companies with reckless abandon. We've seen this movie before, and it does not end well. Here's what bothers us the most about the Fastly case study: We are willing to bet that the majority of "investors" who jumped in to buy shares couldn't explain what the company actually does if their lives depended on it. Here's a really simple basic rule to follow: Don't invest in any company before understanding what they do and what their unique value proposition is for customers. Then, it sure wouldn't hurt to actually look at the financials.
Oil & Gas Exploration & Production
07. ConocoPhillips will acquire shale E&P firm Concho Resources for $9.7 billion
Considering the market cap of Permian Basin operator Concho Resources (CXO $49) was $32 billion precisely two years ago, it seems like a golden opportunity for ConocoPhillips (COP $34): the latter will acquire the former for $9.7 billion in an all-stock deal. In a sign of just how hard the energy sector has fallen over the past two years, COP's market cap has dropped from $90 billion two years ago to just $36 billion today. For many shale producers facing chronic $40 per barrel oil, it is simply a case of be acquired or face possible bankruptcy. Does the deal make sense for Conoco? Our guess is that in two years it will look as brilliant as the 2019 Occidental (OXY $10) takeover of Anadarko for $38 billion looked stupid (Occidental's market cap now sits below $10 billion—yikes). The global economy will surge forward when the pandemic is behind us, and the rumors of oil's death as the world's leading energy source have been greatly exaggerated—at least the timeline of its demise. We continue to underweight the energy sector, with Chevron (CVX) remaining the one integrated oil company we own. At $33 per share, however, and with a 5% dividend yield, COP seems quite undervalued.
Application & Systems Software
06. SpaceX selects Microsoft (not Amazon) to run its space-based cloud computing network
It is almost embarrassing to watch Jeff Bezos pretend to compete with Elon Musk for commercial space dominance. He's like a little kid donning an astronaut costume and proclaiming, "take that Neil Armstrong!" In his own mind, Bezos's Blue Origin is right up there with SpaceX; hell, maybe better. Of course, in reality Blue Origin continues to be the pet project of the world's richest man while SpaceX is busy launching astronauts into orbit and building out a massive fleet of satellites which will provide high-speed Internet service to even the most remote parts of the globe. (Right on cue, Bezos stated that Blue Origin is going to build an even better satellite system—despite the lack of even one satellite in orbit.) In a move that should come as no surprise, SpaceX just selected Microsoft's (MSFT $214) Azure service to operate and manage its cloud computing needs for the Starlink system, barely considering Amazon (AMZN $3,226) Web Services (AWS) as an option. Considering the scope of the project, which will consist of linking cloud, space, and ground capabilities, crunching almost unfathomable amounts of data, and helping to control the orbits of SpaceX satellites, this was a huge win for Microsoft. Beyond the Starlink project, Musk's SpaceX also landed a demo contract from the Pentagon for a new generation missile warning system. Assuming the demo leads to deployment, Microsoft would certainly get that contract as well. Recall that Amazon is currently suing the US government for the Pentagon's decision to go with Azure for its $10 billion JEDI program, snubbing AWS. We see very little chance of the lawsuit changing the outcome of the JEDI contract, though we wonder how it might have poisoned the well for Amazon's hopes of landing government contracts in the future. For its core business of online retailing, no other company can compete with Amazon—which is why we own it within the Penn Global Leaders Club. We just wish Bezos would shut up and let someone else run the company. Maybe he could run Blue Origin full time and work on landing one single contract.
Global Strategy: Europe
05. While the pandemic rages in Europe, parliament focuses on what to call a veggie burger
One of our favorite pastimes is making fun of the European government. Let's face it, the only reason a "European Union" even exists is because of that continent's envy of the United States. The level of arrogance permeating the halls of the EU parliament in Brussels is stratospheric, which makes them such an easy target for ridicule. The latest? While the pandemic rages across the continent, EU lawmakers are focused on a critical issue: Whether or not to ban the likes of Beyond Meat (BYND $176) from calling their plant-based patties "burgers." Lawmakers will debate and vote on an amendment this month which would force these companies to label their burgers "discs" and their sausages "tubes." i.e. Beyond Burgers would become "veggie discs," and Beyond Breakfast Sausage would become "plant-based tubes." Parliamentarians will vote on another amendment, pushed by the European dairy union, which would ban the use of the word "creamy" when describing a non-dairy item. And we make fun of our government. Is it any wonder Brits voted to pull out of this dysfunctional entity?
Business & Professional Services
04. Bitcoin pops after PayPal announces it will allow customers to trade in cryptocurrencies
The value of Bitcoin "shares" surged to $13,000 following news that credit services provider PayPal (PYPL $213) will begin allowing its customers to use the digital currency on its platform. The firm said Bitcoins can be used for purchases with its 26 million merchants around the world, and the currency will soon be allowed on Venmo, now a PayPal company. That being said, the firm will not hold cryptos on its balance sheet; instead, it will partner with cryptocurrency services firm Paxos Trust Company to assist in completing the transactions. This means that merchants won't have to actually deal with the digital currency, as Paxos will serve as the intermediary. Nonetheless, considering PayPal has some 300 million customers around the globe, Bitcoin advocates are celebrating the move. Shares of the digital currency have been extremely volatile this year, falling from around $10,000 in February to $5,000 in March, then climbing back to $13,000 this past week. The high value mark of the currency was $20,000 back in 2017. Investing in Bitcoin has been—and will continue to be—a complete gamble. Keep in mind that this currency does not exist in "hard" form, it only exists virtually. Considering the high level of sophistication of hackers around the world, expect to hear more stories in the near future of accounts being drained of Bitcoin. As for PayPal, we like the firm but don't like the 100 multiple on the share price.
Media & Entertainment
03. In blow to Katzenberg and Whitman, Quibi is already being shut down
Based on some of their questionable business decisions in the past, our respect for Jeffrey Katzenberg and Meg Whitman was already pretty low coming into this most recent foray; now it is virtually nonexistent. It was just this past April when Whitman, the former CEO of eBay and HP, came on-air to brag about her and Katzenberg's new streaming service known as Quibi. Not only wouldn't the pandemic hurt the new service, it may even enhance its value, claimed Whitman. Now, six months and billions of dollars later, Quibi is shutting down. Katzenberg cited the pandemic as one of the major factors in its demise. Wow. All of the great ideas out there waiting to be funded, and this duo was actually able to attract $2 billion for a questionable business proposition (Quibi's unique value proposition was that it would feature short-form news and entertainment videos of ten minutes or less—yawn). The power of name recognition. We've said it before and we'll say it again: There are so many mediocre to downright bad CEOs out there that it boggles the mind. Before buying shares in a company, investors need to perform some level of due diligence on that company's management team.
Cybersecurity
02. Cybersecurity firm McAfee goes public—again
We are always on the lookout for a promising IPO, so when we heard that well-known cybersecurity firm McAfee (MCFE $19) was going public, it piqued our interest. We even like the firm's anything-but-dull founder, John McAfee (OK, despite the libertarian's recent arrest in Spain over tax evasion charges; it should be noted that McAfee has not been affiliated with the eponymous company since 1994). However, there was one major obstacle keeping us from investing in MCFE shares, which began trading on Thursday the 22nd: it was the company's second trip to the public equity markets—Intel acquired the firm and took it private in 2011. Despite having eighteen underwriters working on the deal, the IPO turned out to be a bust. After raising $740 million on Wednesday (the company sold 37 million Class A shares at $20 apiece), shares began trading at $18.60, got as high as $19.34, and then spent most of the session declining. A late-session rally brought them back up to $18.68 at the close. Our largest concern is the company's hefty debt load, which will still sit around $4 billion after some of it is paid off with the IPO proceeds. To put that in perspective, $21 billion cybersecurity firm Fortinet (FTNT $128), which we own in the Penn New Frontier Fund, has an aggregate short- and long-term debt load of just $2.7 billion. With so many hands in the pie and a share structure that would be hard for an SEC lawyer to decipher, we would steer clear of this warmed-over offering.
Under the Radar Investment
01. Under the Radar: SPDR® Blackstone / GSO Senior Loan ETF
To say it is difficult finding "good" fixed income investments right now is the understatement of the century. Ten-year Treasuries are yielding just above one-half of one percent, and the 30-year T Bond is yielding 1.375%. Challenging times. That being said, one of our current favorites in the Penn Strategic Income Portfolio is our senior loan fund, the SPDR Blackstone GSO Senior Loan ETF (SRLN). Senior loans are debt instruments issued by a bank to a company to fund any number of projects or to retire existing debt with higher interest rates. Note the term "senior." This means that, in the case of bankruptcy, owners of senior bank loans will be paid first as assets are liquidated—before creditors, preferred shareholders, and stockholders. SRLN currently owns around 220 such senior loans outstanding to companies such as: Bass Pro Shop, Petsmart, Athena Health, and Rackspace Technology. The average maturity of these loans is a comforting 4.72 years, and the beta (risk level on a scale of zero to one, with one equaling the risk of the S&P 500) is 0.0859. Our favorite aspect of the fund in these days of ultra-low rates? It yields 5%.
Answer
Business journalist Charles Dow, founder of financial news bureau Dow, Jones & Co., created the Dow Jones Industrial Average back in 1896. Prominent business newspaper The Wall Street Journal introduced the DJIA on 26 May of that same year. Of the twelve original component companies of the Dow, only General Electric is still in existence as a publicly-traded company. It was jettisoned from the index in 2018. In 1928, the DJIA was expanded to include 30 companies.
Headlines for the Week of 30 Aug—05 Sep 2020
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
History of the Dow Jones Industrial Average...
Though we label it "irrelevant" below, the Dow Jones Industrial Average does have an illustrious history. Who started the index and what was the publication which introduced it to the investing community? Also, one of the original twelve stocks on the Dow is still in existence—what company is it?
Penn Trading Desk:
(21 Aug 20) Adding Thematic Fund to Dynamic Growth Strategy
We have added a robotics fund to the DGS to take advantage of the coming boom in automation—the movement will be transformational for society. This fund is full of dynamic small- and mid-cap names. Members, see the trading desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Consumer Finance
10. Kick 'em when they're down: Capital One cuts credit card limits
We closed credit card company Capital One (COF $38-$71-$108) on 17 Jan of this year from the Penn Global Leaders Club at $104.13, taking our double digit gains. We took issue with some moves that management had been making. Our timing was spot-on—shares began tumbling to $38 a few months later. This week, the company made a move that buttresses our decision: As Americans are struggling due to the pandemic, Capital One began slashing the credit card limits of a large number of customers. And these customers have been expressing their outrage on social media. Many saw their credit limits cut by one-third or even two-thirds, with the effect of damaging their loan balance to limit ratio and, in turn, dragging down their credit scores. The company said the move was simply part of a periodic review of accounts it performs on a regular basis, but the timing certainly seems suspect. Capital One is the third-largest credit card issuer behind JP Morgan (JPM) and Citigroup (C). For their part, investors liked the move, pushing shares up just shy of 2%. We are currently underweighting Financials, and COF certainly isn't on our radar screen.
Multiline Retail
09. Penn Global Leader Target Corp. notches a blowout quarter
As if they weren't already on a tear, shares of Penn Global Leaders Club member Target Corp (TGT $149) popped another 9%—reaching yet another record high—after the retailer posted a simply stunning quarter. Overall, online and in-store sales were up 24.3% for the quarter, with the company attracting ten million new customers to its digital platform. Earnings per share blew past the expected $1.62, hitting $3.38, and profits rose by 80%, to $1.7 billion. Target breaks its merchandise down into five categories—all five showed strong growth. The company's electronics line was up 70% year-over-year, with the other six categories—to include beauty and apparel—rising by about 20% each. Despite launching just a year ago, Good & Gather, the firm's private label grocery brand, rose above the $1 billion in total sales mark. When a company reports surprise earnings, either to the upside or the downside, we like to review what the analysts were saying leading into the announcement. Our favorite came from Morningstar: the investment research firm had a one-star (sell) rating on TGT with a fair value of $98/share. Oops. We bought TGT shares during that nightmarish week before Christmas, 2018.
Biotechnology
08. Johnson & Johnson to buy biotech Momenta Pharma for $6.5 billion
One year ago, Momenta Pharmaceuticals (MNTA $12-$52-$40) was a $1.2 billion small-cap biotech with few standout therapies which might attract investors' attention. The company's work, however, did catch the eye of a much larger competitor: pharma giant Johnson & Johnson (JNJ $151) just agreed to buy the firm for $6.5 billion in cash. The catalyst for the acquisition was Momenta's experimental drug nipocalimab, a potential therapy for use in a number of autoimmune diseases. These disorders, which include type 1 diabetes, multiple sclerosis, and rheumatoid arthritis, cause either abnormally low or high activity within a person's immune system. Specifically, nipocalimab has shown promise in treating a rare blood disorder affecting fetuses and newborns. Despite the current focus on finding vaccines and therapies for Covid-19, big pharma has put a high priority on tackling autoimmune diseases, as this deal demonstrates. Somewhat surprisingly, this is the biggest acquisition in the pharma industry year-to-date, with Sanofi's recent $3.4 billion acquisition of US biotech Principia Biopharma coming in second. For investors, selecting the right micro- or small-cap biotech can be like finding a needle in a haystack, as unsuccessful trials often result in massive drops in a firm's share price. For investors looking for the next potential small- or mid-cap biotech to be acquired, the best bet is generally a focused biotech ETF with good management and a penchant for lower market caps. The SPDR® S&P Biotech ETF (XBI $112), a member of the Penn Dynamic Growth Strategy, is a good example.
Pharmaceuticals
07. AstraZeneca's novel approach: a combination vaccine and treatment
AstraZeneca (AZN $36-$57-$65), Britain's $150B drug powerhouse, has begun testing an exciting new therapy: AZD7442 is designed to not only prevent Covid-19, but also serve as a therapy for those already afflicted with the virus. The drug uses a combination of two monoclonal antibodies (mAbs), harvested antibodies made by identical immune cells which specifically bind to that substance, to create a cocktail to fight off and guard against a specific infection. The Phase 1 clinical trial, which is now underway in the UK, is being funded by the US Department of Defense and the Biomedical Advanced Research and Development Authority (BARDA). Leading infectious disease scientists have endorsed this mAb approach, which has been used successfully in the treatment of a number of cancer types. If the AZD7442 trials go as hoped, expect the therapy to receive fast-track designation by the FDA. Based on current valuations, shares of AZN may seem expensive, but success with AZD7442 could propel them higher.
Airlines
06. Delta to furlough 1,900 pilots, American to reduce staff by 19,000
Delta's (DAL $18-$30-$62) head of flight operations put it succinctly: "We are six months into this pandemic and only 25% of our revenues have been recovered." American Airlines Group (AAL $8-$13-$32) CEO Doug Parker echoed similar sentiments, stating that long-haul trips in Q4 of this year will equal about 25% of last year's Q4 rate. Against that backdrop, both companies have announced a new round of furloughs to take effect when government stimulus aid to the airlines ends on 30 Sep. Delta, which we purchased within the Intrepid Trading Platform at a steep discount back in May, said it will furlough 1,941 pilots—out of the 11,200 or so on the books—unless pilots take a 15% cut in pay. The Air Line Pilots Association, which represents the unionized group, has balked at that request. American Airlines announced even more draconian cuts, saying that 19,000 employees will be involuntarily furloughed after the government relief ends. Incredibly, American Airlines has lost 77.7% of its value since January of 2018, versus a 50% loss for Delta and a 23% gain in the S&P 500. Our Delta position is up 15% since we purchased it, and we see plenty of growth ahead as the pandemic subsides.
Global Exchanges & Indexes
05. The Dow's latest moves won't make the outdated index more relevant
It always amazes us how much attention is given to the level of the Dow Jones Industrial Average on any trading day as opposed to the much more reflective S&P 500. After all, out of roughly 2,500 listed companies on the New York Stock Exchange and another 3,300 on the Nasdaq, only 30 select entrants make up the DJIA. And these holdings are price-weighted, meaning companies are weighted in proportion to their share price, not market cap. In other words, another great day for Apple (AAPL $500)—and there have been plenty of those recently—probably means a strong day for the Dow. Compare this to the cap-weighted S&P 500 Index, which means the bigger a company, the more impact it can have on the S&P's return. No matter how big a company, it is still weighted against 499 others.
Let's stick with the Apple example, since the tech giant is about to undergo a four-for-one stock split. Right now, despite its $2 trillion size, Apple still makes up a little over 7% of the S&P 500 Index. After the split, nothing will change (its market cap won't change just because it split). In the Dow, however, where Apple also finds a home, it will suddenly become one-quarter as relevant to the daily returns. That's crazy. Or how about leaving entire industries virtually unrepresented, such as utilities! Also crazy.
We delve into this subject because the Dow is about to jettison three stocks and add three others in their place. Salesforce (CRM) will replace Exxon Mobil (XOM), Amgen (AMGN) will replace Pfizer (PFE), and Honeywell (HON) will replace Raytheon Technologies (RTX). The last two swaps are real head-scratchers. Even the first: Is Salesforce the most relevant tech company to infuse new blood into the Dow? What about Facebook (FB)?
Perhaps the Dow is still the financial press' favorite benchmark because it sounds more sensational to say, "DOW LOSES 1,000 POINTS" than it does to say, "S&P OFF 100." Irrespective, back during the bloodbath that was March, when the S&P 500 had plunged to below 2,500, we made our year-end prediction: "The index will rise to 3,500 by December 31st." It sits at 3,436 right now. We didn't bother making a prediction for the Dow.
Food Products
04. Boring old JM Smucker just knocked Q1 earnings out of the park
We should have seen it coming: In the midst of a lockdown and a mass migration of employees from their office buildings to their new in-home offices, packaged foods sales skyrocketed. Nothing made that more evident than the latest quarterly results from staid old JM Smucker (SJM $92-$121-$126), the 123-year-old, $14 billion packaged foods company. Best known for products such as Smucker's, Folgers, Jif, Crisco, and the like, the Ohio-based company increased earnings-per-share by 50% from the same quarter last year, and overall revenues by 11% from the same period in 2019. While their biggest category, Retail Pet Foods, increased by just 3% year-over-year (after all, the pets have always been at home), the Retail Consumer Foods division saw a 22% jump in sales. President and CEO Mark Smucker also said the firm had raised its fiscal 2021 guidance, now expecting between $8.20 and $8.60 in EPS and nearly $1 billion in free cash flow. Smucker said he expects the momentum to continue post-pandemic as Americans fell back in love with old brands, and as the company rolls out a large new marketing campaign. Time will tell, but the Q1 report was enough to drive the shares up over 7%. The company has a relatively decent P/E ratio of 18 (same as Penn holdings General Mills and B&G Foods), and we would put a fair value on the shares at around $125. That may not seem like much upside, but with its 3% dividend yield and very strong pet foods business, it is a pretty safe bet.
Multiline Retail
03. At $15, Nordstrom shares may be the retail deal of the decade, but...
Precisely one year ago, we made note of Nordstrom's (JWN $12-$15-$43) rather odd 16% one-day spike in price—to $31. Odd because it came on the heels of an earnings report that showed a 5% drop in revenue from Q2 of 2018. The spike apparently took place because analysts were expecting a much deeper drop. Here we are a year later and, with a pandemic added to the mix, analysts were really bracing for the worst. In fact, betting odds called for a 39% drop in sales from 2019. It wasn't even close. JWN shares were trading down around 6%—to $14.66—following news of a ghastly 53% drop in sales for the quarter. Even online sales, the bright spot for most retailers as customers were stuck at home behind their computers, dropped 5%. Nordstrom's earnings report even made the Kohl's quarter look good, and that was no easy feat.
Despite the reasons management gave for the drop, here's our biggest concern: Nordstrom makes its living off of selling higher-end clothing and accessories to an upscale workforce that wants to look nice in the office. When the family dog, Scruffy, becomes the only one needed to impress, Milk Bones—not fancy clothing—becomes the go-to purchase. (Milk Bones are a JM Smucker name brand, by the way.) For the quarter, Nordstrom had just shy of $2 billion in sales (down from roughly $4 billion in the same quarter last year) and a net loss of $255 million. The company doesn't have many money-losing quarters, however, and despite the lack of a P/E ratio due to that loss, its multiple had been as low as 4.1 the first week of April. Yes, the company's short-term and long-term liabilities to assets don't look great (roughly $4B/$4B and $6B/$6B, respectively), but odds are great that the company isn't going the way of JC Penney.
When the inevitable return to normalcy does come, we could easily see the shares trading at twice their current price.
Robotics & Industrial Machinery
02. 3D printing firm Desktop Metal to go public with a "blank check"
It seems to be all the rave on Wall Street this year: the SPAC, or Special Purpose Acquisition Company. A SPAC is a blank-check company that either does not have its own business plan or builds one around a merger with another company. In an upcoming issue of the Penn Wealth Report, for example, we discuss the SPAC Fortress Value Acquisition Corp (FVAC $12) funding America's return to rare earth mining via its "blank check" to MP Materials, owner of the Mountain Pass mining operation in California. Now, another SPAC, Trine Acquisition Corp, will provide advanced 3D printing "unicorn" (a startup valued at over $1B) Desktop Metal $575 million to go public under the symbol DM within the next few months.
Desktop is a leader in 3D printing, producing stainless steel, aluminum, and other metal alloy parts in large quantities at an assembly line rate. CEO Ric Fulop said the company's latest machines will be able to "print" critical components for the aerospace industry at 100-times the speed of current high-end printers at about one-twentieth the cost. He gives the example of a water impeller pump for a BMW auto; it would typically cost $80 to produce the pump, but one of Fulop's machines created it for $5. Desktop Metal may truly usher in the 3D world promised by advocates for years. Forget the low cost of labor in countries like China, imagine Fulop's machines pumping out intricate metal parts en masse here in the United States. That could bring about a transformational shift in global economics, greatly reducing America's reliance on cheap overseas labor.
Think that is a pie-in-the-sky promise? Remember how we were once at the mercy of OPEC for our energy needs? Keep an eye out for DM when it goes public later this year.
Under the Radar Investment
01. Under the Radar: Black Hills Corp
Black Hills Corp (BKH $48-$54-$87) is a mid-cap ($3.8B) diversified utility which provides regulated gas and electric power to states in the Midwest and mountain regions. The firm also runs a mining operation via its Wyodak Resources division. With steady revenue of roughly $1.7 billion annually, the firm had $200 million in net income last year and cash flow of $7.02 per share. BKH has fallen out of favor with hedge funds recently, dragging its share price down from $87 to $48, before the shares rebounded to their current level of $54. With an ultra-low beta of 0.3049 (5Y) and a dividend yield of 4%, the shares are worth a look for income-oriented investors.
Answer
Business journalist Charles Dow, founder of financial news bureau Dow, Jones & Co., created the Dow Jones Industrial Average back in 1896. Prominent business newspaper The Wall Street Journal introduced the DJIA on 26 May of that same year. Of the twelve original component companies of the Dow, only General Electric is still in existence as a publicly-traded company. It was jettisoned from the index in 2018. In 1928, the DJIA was expanded to include 30 companies.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
History of the Dow Jones Industrial Average...
Though we label it "irrelevant" below, the Dow Jones Industrial Average does have an illustrious history. Who started the index and what was the publication which introduced it to the investing community? Also, one of the original twelve stocks on the Dow is still in existence—what company is it?
Penn Trading Desk:
(21 Aug 20) Adding Thematic Fund to Dynamic Growth Strategy
We have added a robotics fund to the DGS to take advantage of the coming boom in automation—the movement will be transformational for society. This fund is full of dynamic small- and mid-cap names. Members, see the trading desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Consumer Finance
10. Kick 'em when they're down: Capital One cuts credit card limits
We closed credit card company Capital One (COF $38-$71-$108) on 17 Jan of this year from the Penn Global Leaders Club at $104.13, taking our double digit gains. We took issue with some moves that management had been making. Our timing was spot-on—shares began tumbling to $38 a few months later. This week, the company made a move that buttresses our decision: As Americans are struggling due to the pandemic, Capital One began slashing the credit card limits of a large number of customers. And these customers have been expressing their outrage on social media. Many saw their credit limits cut by one-third or even two-thirds, with the effect of damaging their loan balance to limit ratio and, in turn, dragging down their credit scores. The company said the move was simply part of a periodic review of accounts it performs on a regular basis, but the timing certainly seems suspect. Capital One is the third-largest credit card issuer behind JP Morgan (JPM) and Citigroup (C). For their part, investors liked the move, pushing shares up just shy of 2%. We are currently underweighting Financials, and COF certainly isn't on our radar screen.
Multiline Retail
09. Penn Global Leader Target Corp. notches a blowout quarter
As if they weren't already on a tear, shares of Penn Global Leaders Club member Target Corp (TGT $149) popped another 9%—reaching yet another record high—after the retailer posted a simply stunning quarter. Overall, online and in-store sales were up 24.3% for the quarter, with the company attracting ten million new customers to its digital platform. Earnings per share blew past the expected $1.62, hitting $3.38, and profits rose by 80%, to $1.7 billion. Target breaks its merchandise down into five categories—all five showed strong growth. The company's electronics line was up 70% year-over-year, with the other six categories—to include beauty and apparel—rising by about 20% each. Despite launching just a year ago, Good & Gather, the firm's private label grocery brand, rose above the $1 billion in total sales mark. When a company reports surprise earnings, either to the upside or the downside, we like to review what the analysts were saying leading into the announcement. Our favorite came from Morningstar: the investment research firm had a one-star (sell) rating on TGT with a fair value of $98/share. Oops. We bought TGT shares during that nightmarish week before Christmas, 2018.
Biotechnology
08. Johnson & Johnson to buy biotech Momenta Pharma for $6.5 billion
One year ago, Momenta Pharmaceuticals (MNTA $12-$52-$40) was a $1.2 billion small-cap biotech with few standout therapies which might attract investors' attention. The company's work, however, did catch the eye of a much larger competitor: pharma giant Johnson & Johnson (JNJ $151) just agreed to buy the firm for $6.5 billion in cash. The catalyst for the acquisition was Momenta's experimental drug nipocalimab, a potential therapy for use in a number of autoimmune diseases. These disorders, which include type 1 diabetes, multiple sclerosis, and rheumatoid arthritis, cause either abnormally low or high activity within a person's immune system. Specifically, nipocalimab has shown promise in treating a rare blood disorder affecting fetuses and newborns. Despite the current focus on finding vaccines and therapies for Covid-19, big pharma has put a high priority on tackling autoimmune diseases, as this deal demonstrates. Somewhat surprisingly, this is the biggest acquisition in the pharma industry year-to-date, with Sanofi's recent $3.4 billion acquisition of US biotech Principia Biopharma coming in second. For investors, selecting the right micro- or small-cap biotech can be like finding a needle in a haystack, as unsuccessful trials often result in massive drops in a firm's share price. For investors looking for the next potential small- or mid-cap biotech to be acquired, the best bet is generally a focused biotech ETF with good management and a penchant for lower market caps. The SPDR® S&P Biotech ETF (XBI $112), a member of the Penn Dynamic Growth Strategy, is a good example.
Pharmaceuticals
07. AstraZeneca's novel approach: a combination vaccine and treatment
AstraZeneca (AZN $36-$57-$65), Britain's $150B drug powerhouse, has begun testing an exciting new therapy: AZD7442 is designed to not only prevent Covid-19, but also serve as a therapy for those already afflicted with the virus. The drug uses a combination of two monoclonal antibodies (mAbs), harvested antibodies made by identical immune cells which specifically bind to that substance, to create a cocktail to fight off and guard against a specific infection. The Phase 1 clinical trial, which is now underway in the UK, is being funded by the US Department of Defense and the Biomedical Advanced Research and Development Authority (BARDA). Leading infectious disease scientists have endorsed this mAb approach, which has been used successfully in the treatment of a number of cancer types. If the AZD7442 trials go as hoped, expect the therapy to receive fast-track designation by the FDA. Based on current valuations, shares of AZN may seem expensive, but success with AZD7442 could propel them higher.
Airlines
06. Delta to furlough 1,900 pilots, American to reduce staff by 19,000
Delta's (DAL $18-$30-$62) head of flight operations put it succinctly: "We are six months into this pandemic and only 25% of our revenues have been recovered." American Airlines Group (AAL $8-$13-$32) CEO Doug Parker echoed similar sentiments, stating that long-haul trips in Q4 of this year will equal about 25% of last year's Q4 rate. Against that backdrop, both companies have announced a new round of furloughs to take effect when government stimulus aid to the airlines ends on 30 Sep. Delta, which we purchased within the Intrepid Trading Platform at a steep discount back in May, said it will furlough 1,941 pilots—out of the 11,200 or so on the books—unless pilots take a 15% cut in pay. The Air Line Pilots Association, which represents the unionized group, has balked at that request. American Airlines announced even more draconian cuts, saying that 19,000 employees will be involuntarily furloughed after the government relief ends. Incredibly, American Airlines has lost 77.7% of its value since January of 2018, versus a 50% loss for Delta and a 23% gain in the S&P 500. Our Delta position is up 15% since we purchased it, and we see plenty of growth ahead as the pandemic subsides.
Global Exchanges & Indexes
05. The Dow's latest moves won't make the outdated index more relevant
It always amazes us how much attention is given to the level of the Dow Jones Industrial Average on any trading day as opposed to the much more reflective S&P 500. After all, out of roughly 2,500 listed companies on the New York Stock Exchange and another 3,300 on the Nasdaq, only 30 select entrants make up the DJIA. And these holdings are price-weighted, meaning companies are weighted in proportion to their share price, not market cap. In other words, another great day for Apple (AAPL $500)—and there have been plenty of those recently—probably means a strong day for the Dow. Compare this to the cap-weighted S&P 500 Index, which means the bigger a company, the more impact it can have on the S&P's return. No matter how big a company, it is still weighted against 499 others.
Let's stick with the Apple example, since the tech giant is about to undergo a four-for-one stock split. Right now, despite its $2 trillion size, Apple still makes up a little over 7% of the S&P 500 Index. After the split, nothing will change (its market cap won't change just because it split). In the Dow, however, where Apple also finds a home, it will suddenly become one-quarter as relevant to the daily returns. That's crazy. Or how about leaving entire industries virtually unrepresented, such as utilities! Also crazy.
We delve into this subject because the Dow is about to jettison three stocks and add three others in their place. Salesforce (CRM) will replace Exxon Mobil (XOM), Amgen (AMGN) will replace Pfizer (PFE), and Honeywell (HON) will replace Raytheon Technologies (RTX). The last two swaps are real head-scratchers. Even the first: Is Salesforce the most relevant tech company to infuse new blood into the Dow? What about Facebook (FB)?
Perhaps the Dow is still the financial press' favorite benchmark because it sounds more sensational to say, "DOW LOSES 1,000 POINTS" than it does to say, "S&P OFF 100." Irrespective, back during the bloodbath that was March, when the S&P 500 had plunged to below 2,500, we made our year-end prediction: "The index will rise to 3,500 by December 31st." It sits at 3,436 right now. We didn't bother making a prediction for the Dow.
Food Products
04. Boring old JM Smucker just knocked Q1 earnings out of the park
We should have seen it coming: In the midst of a lockdown and a mass migration of employees from their office buildings to their new in-home offices, packaged foods sales skyrocketed. Nothing made that more evident than the latest quarterly results from staid old JM Smucker (SJM $92-$121-$126), the 123-year-old, $14 billion packaged foods company. Best known for products such as Smucker's, Folgers, Jif, Crisco, and the like, the Ohio-based company increased earnings-per-share by 50% from the same quarter last year, and overall revenues by 11% from the same period in 2019. While their biggest category, Retail Pet Foods, increased by just 3% year-over-year (after all, the pets have always been at home), the Retail Consumer Foods division saw a 22% jump in sales. President and CEO Mark Smucker also said the firm had raised its fiscal 2021 guidance, now expecting between $8.20 and $8.60 in EPS and nearly $1 billion in free cash flow. Smucker said he expects the momentum to continue post-pandemic as Americans fell back in love with old brands, and as the company rolls out a large new marketing campaign. Time will tell, but the Q1 report was enough to drive the shares up over 7%. The company has a relatively decent P/E ratio of 18 (same as Penn holdings General Mills and B&G Foods), and we would put a fair value on the shares at around $125. That may not seem like much upside, but with its 3% dividend yield and very strong pet foods business, it is a pretty safe bet.
Multiline Retail
03. At $15, Nordstrom shares may be the retail deal of the decade, but...
Precisely one year ago, we made note of Nordstrom's (JWN $12-$15-$43) rather odd 16% one-day spike in price—to $31. Odd because it came on the heels of an earnings report that showed a 5% drop in revenue from Q2 of 2018. The spike apparently took place because analysts were expecting a much deeper drop. Here we are a year later and, with a pandemic added to the mix, analysts were really bracing for the worst. In fact, betting odds called for a 39% drop in sales from 2019. It wasn't even close. JWN shares were trading down around 6%—to $14.66—following news of a ghastly 53% drop in sales for the quarter. Even online sales, the bright spot for most retailers as customers were stuck at home behind their computers, dropped 5%. Nordstrom's earnings report even made the Kohl's quarter look good, and that was no easy feat.
Despite the reasons management gave for the drop, here's our biggest concern: Nordstrom makes its living off of selling higher-end clothing and accessories to an upscale workforce that wants to look nice in the office. When the family dog, Scruffy, becomes the only one needed to impress, Milk Bones—not fancy clothing—becomes the go-to purchase. (Milk Bones are a JM Smucker name brand, by the way.) For the quarter, Nordstrom had just shy of $2 billion in sales (down from roughly $4 billion in the same quarter last year) and a net loss of $255 million. The company doesn't have many money-losing quarters, however, and despite the lack of a P/E ratio due to that loss, its multiple had been as low as 4.1 the first week of April. Yes, the company's short-term and long-term liabilities to assets don't look great (roughly $4B/$4B and $6B/$6B, respectively), but odds are great that the company isn't going the way of JC Penney.
When the inevitable return to normalcy does come, we could easily see the shares trading at twice their current price.
Robotics & Industrial Machinery
02. 3D printing firm Desktop Metal to go public with a "blank check"
It seems to be all the rave on Wall Street this year: the SPAC, or Special Purpose Acquisition Company. A SPAC is a blank-check company that either does not have its own business plan or builds one around a merger with another company. In an upcoming issue of the Penn Wealth Report, for example, we discuss the SPAC Fortress Value Acquisition Corp (FVAC $12) funding America's return to rare earth mining via its "blank check" to MP Materials, owner of the Mountain Pass mining operation in California. Now, another SPAC, Trine Acquisition Corp, will provide advanced 3D printing "unicorn" (a startup valued at over $1B) Desktop Metal $575 million to go public under the symbol DM within the next few months.
Desktop is a leader in 3D printing, producing stainless steel, aluminum, and other metal alloy parts in large quantities at an assembly line rate. CEO Ric Fulop said the company's latest machines will be able to "print" critical components for the aerospace industry at 100-times the speed of current high-end printers at about one-twentieth the cost. He gives the example of a water impeller pump for a BMW auto; it would typically cost $80 to produce the pump, but one of Fulop's machines created it for $5. Desktop Metal may truly usher in the 3D world promised by advocates for years. Forget the low cost of labor in countries like China, imagine Fulop's machines pumping out intricate metal parts en masse here in the United States. That could bring about a transformational shift in global economics, greatly reducing America's reliance on cheap overseas labor.
Think that is a pie-in-the-sky promise? Remember how we were once at the mercy of OPEC for our energy needs? Keep an eye out for DM when it goes public later this year.
Under the Radar Investment
01. Under the Radar: Black Hills Corp
Black Hills Corp (BKH $48-$54-$87) is a mid-cap ($3.8B) diversified utility which provides regulated gas and electric power to states in the Midwest and mountain regions. The firm also runs a mining operation via its Wyodak Resources division. With steady revenue of roughly $1.7 billion annually, the firm had $200 million in net income last year and cash flow of $7.02 per share. BKH has fallen out of favor with hedge funds recently, dragging its share price down from $87 to $48, before the shares rebounded to their current level of $54. With an ultra-low beta of 0.3049 (5Y) and a dividend yield of 4%, the shares are worth a look for income-oriented investors.
Answer
Business journalist Charles Dow, founder of financial news bureau Dow, Jones & Co., created the Dow Jones Industrial Average back in 1896. Prominent business newspaper The Wall Street Journal introduced the DJIA on 26 May of that same year. Of the twelve original component companies of the Dow, only General Electric is still in existence as a publicly-traded company. It was jettisoned from the index in 2018. In 1928, the DJIA was expanded to include 30 companies.
Headlines for the Week of 23 Aug—29 Aug 2020
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
History of the Dow Jones Industrial Average...
Though we label it "irrelevant" below, the Dow Jones Industrial Average does have an illustrious history. Who started the index and what was the publication which introduced it to the investing community? Also, one of the original twelve stocks on the Dow is still in existence—what company is it?
Penn Trading Desk:
(21 Aug 20) Adding Thematic Fund to Dynamic Growth Strategy
We have added a robotics fund to the DGS to take advantage of the coming boom in automation—the movement will be transformational for society. This fund is full of dynamic small- and mid-cap names. Members, see the trading desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
IT Software & Services
10. Why does Amazon want to buy warmed-over Rackspace shares?
Rackspace (RXT $15-$20-$20) is an end-to-end cloud services provider for companies of all sizes. From web hosting to managing a firm's cloud experience—to include cybersecurity—RXT works across the various platforms (Amazon Web Services, Azure, OpenStack) to create a seamless digital experience for customers. When the firm IPO'd on 05 August, tumbling 20% on the first day, it must have felt a sense of déjà vu, as it had a nearly identical experience the last time it went public—in August of 2008. Four years ago, private-equity group Apollo Global Management took Rackspace private in a deal valued at north of $4 billion, then unloaded all of that debt off on the company it just brought back to the public market. As of right now, RXT has a market cap of $3.8 billion and long-term debt of $4.8 billion, and that market cap is so high only due to a 22% one-week run-up in the share price.
Which leads us to the real story. RXT shares rose from around $16 to above $20 on news that Amazon is in talks to invest in the tech services provider. Why would Amazon, a competitor in one sense and a partner in another, want to become a minority shareholder in Rackspace? The only answer that makes sense to us is that Amazon may feel it can steer Rackspace customers away from using Microsoft Azure, the Google Cloud, and other platforms and toward AWS. The legality of that seems questionable. From a strictly fiscal standpoint, looking at RXT's financials, the move doesn't make much sense. Let's see if Amazon's chief cloud competitors have anything to say about the deal.
Multiline Retail
09. Penn Global Leader Target Corp. notches a blowout quarter
As if they weren't already on a tear, shares of Penn Global Leaders Club member Target Corp (TGT $149) popped another 9%—reaching yet another record high—after the retailer posted a simply stunning quarter. Overall, online and in-store sales were up 24.3% for the quarter, with the company attracting ten million new customers to its digital platform. Earnings per share blew past the expected $1.62, hitting $3.38, and profits rose by 80%, to $1.7 billion. Target breaks its merchandise down into five categories—all five showed strong growth. The company's electronics line was up 70% year-over-year, with the other six categories—to include beauty and apparel—rising by about 20% each. Despite launching just a year ago, Good & Gather, the firm's private label grocery brand, rose above the $1 billion in total sales mark. When a company reports surprise earnings, either to the upside or the downside, we like to review what the analysts were saying leading into the announcement. Our favorite came from Morningstar: the investment research firm had a one-star (sell) rating on TGT with a fair value of $98/share. Oops. We bought TGT shares during that nightmarish week before Christmas, 2018.
Biotechnology
08. Johnson & Johnson to buy biotech Momenta Pharma for $6.5 billion
One year ago, Momenta Pharmaceuticals (MNTA $12-$52-$40) was a $1.2 billion small-cap biotech with few standout therapies which might attract investors' attention. The company's work, however, did catch the eye of a much larger competitor: pharma giant Johnson & Johnson (JNJ $151) just agreed to buy the firm for $6.5 billion in cash. The catalyst for the acquisition was Momenta's experimental drug nipocalimab, a potential therapy for use in a number of autoimmune diseases. These disorders, which include type 1 diabetes, multiple sclerosis, and rheumatoid arthritis, cause either abnormally low or high activity within a person's immune system. Specifically, nipocalimab has shown promise in treating a rare blood disorder affecting fetuses and newborns. Despite the current focus on finding vaccines and therapies for Covid-19, big pharma has put a high priority on tackling autoimmune diseases, as this deal demonstrates. Somewhat surprisingly, this is the biggest acquisition in the pharma industry year-to-date, with Sanofi's recent $3.4 billion acquisition of US biotech Principia Biopharma coming in second. For investors, selecting the right micro- or small-cap biotech can be like finding a needle in a haystack, as unsuccessful trials often result in massive drops in a firm's share price. For investors looking for the next potential small- or mid-cap biotech to be acquired, the best bet is generally a focused biotech ETF with good management and a penchant for lower market caps. The SPDR® S&P Biotech ETF (XBI $112), a member of the Penn Dynamic Growth Strategy, is a good example.
Pharmaceuticals
07. AstraZeneca's novel approach: a combination vaccine and treatment
AstraZeneca (AZN $36-$57-$65), Britain's $150B drug powerhouse, has begun testing an exciting new therapy: AZD7442 is designed to not only prevent Covid-19, but also serve as a therapy for those already afflicted with the virus. The drug uses a combination of two monoclonal antibodies (mAbs), harvested antibodies made by identical immune cells which specifically bind to that substance, to create a cocktail to fight off and guard against a specific infection. The Phase 1 clinical trial, which is now underway in the UK, is being funded by the US Department of Defense and the Biomedical Advanced Research and Development Authority (BARDA). Leading infectious disease scientists have endorsed this mAb approach, which has been used successfully in the treatment of a number of cancer types. If the AZD7442 trials go as hoped, expect the therapy to receive fast-track designation by the FDA. Based on current valuations, shares of AZN may seem expensive, but success with AZD7442 could propel them higher.
Airlines
06. Delta to furlough 1,900 pilots, American to reduce staff by 19,000
Delta's (DAL $18-$30-$62) head of flight operations put it succinctly: "We are six months into this pandemic and only 25% of our revenues have been recovered." American Airlines Group (AAL $8-$13-$32) CEO Doug Parker echoed similar sentiments, stating that long-haul trips in Q4 of this year will equal about 25% of last year's Q4 rate. Against that backdrop, both companies have announced a new round of furloughs to take effect when government stimulus aid to the airlines ends on 30 Sep. Delta, which we purchased within the Intrepid Trading Platform at a steep discount back in May, said it will furlough 1,941 pilots—out of the 11,200 or so on the books—unless pilots take a 15% cut in pay. The Air Line Pilots Association, which represents the unionized group, has balked at that request. American Airlines announced even more draconian cuts, saying that 19,000 employees will be involuntarily furloughed after the government relief ends. Incredibly, American Airlines has lost 77.7% of its value since January of 2018, versus a 50% loss for Delta and a 23% gain in the S&P 500. Our Delta position is up 15% since we purchased it, and we see plenty of growth ahead as the pandemic subsides.
Global Exchanges & Indexes
05. The Dow's latest moves won't make the outdated index more relevant
It always amazes us how much attention is given to the level of the Dow Jones Industrial Average on any trading day as opposed to the much more reflective S&P 500. After all, out of roughly 2,500 listed companies on the New York Stock Exchange and another 3,300 on the Nasdaq, only 30 select entrants make up the DJIA. And these holdings are price-weighted, meaning companies are weighted in proportion to their share price, not market cap. In other words, another great day for Apple (AAPL $500)—and there have been plenty of those recently—probably means a strong day for the Dow. Compare this to the cap-weighted S&P 500 Index, which means the bigger a company, the more impact it can have on the S&P's return. No matter how big a company, it is still weighted against 499 others.
Let's stick with the Apple example, since the tech giant is about to undergo a four-for-one stock split. Right now, despite its $2 trillion size, Apple still makes up a little over 7% of the S&P 500 Index. After the split, nothing will change (its market cap won't change just because it split). In the Dow, however, where Apple also finds a home, it will suddenly become one-quarter as relevant to the daily returns. That's crazy. Or how about leaving entire industries virtually unrepresented, such as utilities! Also crazy.
We delve into this subject because the Dow is about to jettison three stocks and add three others in their place. Salesforce (CRM) will replace Exxon Mobil (XOM), Amgen (AMGN) will replace Pfizer (PFE), and Honeywell (HON) will replace Raytheon Technologies (RTX). The last two swaps are real head-scratchers. Even the first: Is Salesforce the most relevant tech company to infuse new blood into the Dow? What about Facebook (FB)?
Perhaps the Dow is still the financial press' favorite benchmark because it sounds more sensational to say, "DOW LOSES 1,000 POINTS" than it does to say, "S&P OFF 100." Irrespective, back during the bloodbath that was March, when the S&P 500 had plunged to below 2,500, we made our year-end prediction: "The index will rise to 3,500 by December 31st." It sits at 3,436 right now. We didn't bother making a prediction for the Dow.
Food Products
04. Boring old JM Smucker just knocked Q1 earnings out of the park
We should have seen it coming: In the midst of a lockdown and a mass migration of employees from their office buildings to their new in-home offices, packaged foods sales skyrocketed. Nothing made that more evident than the latest quarterly results from staid old JM Smucker (SJM $92-$121-$126), the 123-year-old, $14 billion packaged foods company. Best known for products such as Smucker's, Folgers, Jif, Crisco, and the like, the Ohio-based company increased earnings-per-share by 50% from the same quarter last year, and overall revenues by 11% from the same period in 2019. While their biggest category, Retail Pet Foods, increased by just 3% year-over-year (after all, the pets have always been at home), the Retail Consumer Foods division saw a 22% jump in sales. President and CEO Mark Smucker also said the firm had raised its fiscal 2021 guidance, now expecting between $8.20 and $8.60 in EPS and nearly $1 billion in free cash flow. Smucker said he expects the momentum to continue post-pandemic as Americans fell back in love with old brands, and as the company rolls out a large new marketing campaign. Time will tell, but the Q1 report was enough to drive the shares up over 7%. The company has a relatively decent P/E ratio of 18 (same as Penn holdings General Mills and B&G Foods), and we would put a fair value on the shares at around $125. That may not seem like much upside, but with its 3% dividend yield and very strong pet foods business, it is a pretty safe bet.
Multiline Retail
03. At $15, Nordstrom shares may be the retail deal of the decade, but...
Precisely one year ago, we made note of Nordstrom's (JWN $12-$15-$43) rather odd 16% one-day spike in price—to $31. Odd because it came on the heels of an earnings report that showed a 5% drop in revenue from Q2 of 2018. The spike apparently took place because analysts were expecting a much deeper drop. Here we are a year later and, with a pandemic added to the mix, analysts were really bracing for the worst. In fact, betting odds called for a 39% drop in sales from 2019. It wasn't even close. JWN shares were trading down around 6%—to $14.66—following news of a ghastly 53% drop in sales for the quarter. Even online sales, the bright spot for most retailers as customers were stuck at home behind their computers, dropped 5%. Nordstrom's earnings report even made the Kohl's quarter look good, and that was no easy feat.
Despite the reasons management gave for the drop, here's our biggest concern: Nordstrom makes its living off of selling higher-end clothing and accessories to an upscale workforce that wants to look nice in the office. When the family dog, Scruffy, becomes the only one needed to impress, Milk Bones—not fancy clothing—becomes the go-to purchase. (Milk Bones are a JM Smucker name brand, by the way.) For the quarter, Nordstrom had just shy of $2 billion in sales (down from roughly $4 billion in the same quarter last year) and a net loss of $255 million. The company doesn't have many money-losing quarters, however, and despite the lack of a P/E ratio due to that loss, its multiple had been as low as 4.1 the first week of April. Yes, the company's short-term and long-term liabilities to assets don't look great (roughly $4B/$4B and $6B/$6B, respectively), but odds are great that the company isn't going the way of JC Penney.
When the inevitable return to normalcy does come, we could easily see the shares trading at twice their current price.
Robotics & Industrial Machinery
02. 3D printing firm Desktop Metal to go public with a "blank check"
It seems to be all the rave on Wall Street this year: the SPAC, or Special Purpose Acquisition Company. A SPAC is a blank-check company that either does not have its own business plan or builds one around a merger with another company. In an upcoming issue of the Penn Wealth Report, for example, we discuss the SPAC Fortress Value Acquisition Corp (FVAC $12) funding America's return to rare earth mining via its "blank check" to MP Materials, owner of the Mountain Pass mining operation in California. Now, another SPAC, Trine Acquisition Corp, will provide advanced 3D printing "unicorn" (a startup valued at over $1B) Desktop Metal $575 million to go public under the symbol DM within the next few months.
Desktop is a leader in 3D printing, producing stainless steel, aluminum, and other metal alloy parts in large quantities at an assembly line rate. CEO Ric Fulop said the company's latest machines will be able to "print" critical components for the aerospace industry at 100-times the speed of current high-end printers at about one-twentieth the cost. He gives the example of a water impeller pump for a BMW auto; it would typically cost $80 to produce the pump, but one of Fulop's machines created it for $5. Desktop Metal may truly usher in the 3D world promised by advocates for years. Forget the low cost of labor in countries like China, imagine Fulop's machines pumping out intricate metal parts en masse here in the United States. That could bring about a transformational shift in global economics, greatly reducing America's reliance on cheap overseas labor.
Think that is a pie-in-the-sky promise? Remember how we were once at the mercy of OPEC for our energy needs? Keep an eye out for DM when it goes public later this year.
Under the Radar Investment
01. Under the Radar: Black Hills Corp
Black Hills Corp (BKH $48-$54-$87) is a mid-cap ($3.8B) diversified utility which provides regulated gas and electric power to states in the Midwest and mountain regions. The firm also runs a mining operation via its Wyodak Resources division. With steady revenue of roughly $1.7 billion annually, the firm had $200 million in net income last year and cash flow of $7.02 per share. BKH has fallen out of favor with hedge funds recently, dragging its share price down from $87 to $48, before the shares rebounded to their current level of $54. With an ultra-low beta of 0.3049 (5Y) and a dividend yield of 4%, the shares are worth a look for income-oriented investors.
Answer
Business journalist Charles Dow, founder of financial news bureau Dow, Jones & Co., created the Dow Jones Industrial Average back in 1896. Prominent business newspaper The Wall Street Journal introduced the DJIA on 26 May of that same year. Of the twelve original component companies of the Dow, only General Electric is still in existence as a publicly-traded company. It was jettisoned from the index in 2018. In 1928, the DJIA was expanded to include 30 companies.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
History of the Dow Jones Industrial Average...
Though we label it "irrelevant" below, the Dow Jones Industrial Average does have an illustrious history. Who started the index and what was the publication which introduced it to the investing community? Also, one of the original twelve stocks on the Dow is still in existence—what company is it?
Penn Trading Desk:
(21 Aug 20) Adding Thematic Fund to Dynamic Growth Strategy
We have added a robotics fund to the DGS to take advantage of the coming boom in automation—the movement will be transformational for society. This fund is full of dynamic small- and mid-cap names. Members, see the trading desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
IT Software & Services
10. Why does Amazon want to buy warmed-over Rackspace shares?
Rackspace (RXT $15-$20-$20) is an end-to-end cloud services provider for companies of all sizes. From web hosting to managing a firm's cloud experience—to include cybersecurity—RXT works across the various platforms (Amazon Web Services, Azure, OpenStack) to create a seamless digital experience for customers. When the firm IPO'd on 05 August, tumbling 20% on the first day, it must have felt a sense of déjà vu, as it had a nearly identical experience the last time it went public—in August of 2008. Four years ago, private-equity group Apollo Global Management took Rackspace private in a deal valued at north of $4 billion, then unloaded all of that debt off on the company it just brought back to the public market. As of right now, RXT has a market cap of $3.8 billion and long-term debt of $4.8 billion, and that market cap is so high only due to a 22% one-week run-up in the share price.
Which leads us to the real story. RXT shares rose from around $16 to above $20 on news that Amazon is in talks to invest in the tech services provider. Why would Amazon, a competitor in one sense and a partner in another, want to become a minority shareholder in Rackspace? The only answer that makes sense to us is that Amazon may feel it can steer Rackspace customers away from using Microsoft Azure, the Google Cloud, and other platforms and toward AWS. The legality of that seems questionable. From a strictly fiscal standpoint, looking at RXT's financials, the move doesn't make much sense. Let's see if Amazon's chief cloud competitors have anything to say about the deal.
Multiline Retail
09. Penn Global Leader Target Corp. notches a blowout quarter
As if they weren't already on a tear, shares of Penn Global Leaders Club member Target Corp (TGT $149) popped another 9%—reaching yet another record high—after the retailer posted a simply stunning quarter. Overall, online and in-store sales were up 24.3% for the quarter, with the company attracting ten million new customers to its digital platform. Earnings per share blew past the expected $1.62, hitting $3.38, and profits rose by 80%, to $1.7 billion. Target breaks its merchandise down into five categories—all five showed strong growth. The company's electronics line was up 70% year-over-year, with the other six categories—to include beauty and apparel—rising by about 20% each. Despite launching just a year ago, Good & Gather, the firm's private label grocery brand, rose above the $1 billion in total sales mark. When a company reports surprise earnings, either to the upside or the downside, we like to review what the analysts were saying leading into the announcement. Our favorite came from Morningstar: the investment research firm had a one-star (sell) rating on TGT with a fair value of $98/share. Oops. We bought TGT shares during that nightmarish week before Christmas, 2018.
Biotechnology
08. Johnson & Johnson to buy biotech Momenta Pharma for $6.5 billion
One year ago, Momenta Pharmaceuticals (MNTA $12-$52-$40) was a $1.2 billion small-cap biotech with few standout therapies which might attract investors' attention. The company's work, however, did catch the eye of a much larger competitor: pharma giant Johnson & Johnson (JNJ $151) just agreed to buy the firm for $6.5 billion in cash. The catalyst for the acquisition was Momenta's experimental drug nipocalimab, a potential therapy for use in a number of autoimmune diseases. These disorders, which include type 1 diabetes, multiple sclerosis, and rheumatoid arthritis, cause either abnormally low or high activity within a person's immune system. Specifically, nipocalimab has shown promise in treating a rare blood disorder affecting fetuses and newborns. Despite the current focus on finding vaccines and therapies for Covid-19, big pharma has put a high priority on tackling autoimmune diseases, as this deal demonstrates. Somewhat surprisingly, this is the biggest acquisition in the pharma industry year-to-date, with Sanofi's recent $3.4 billion acquisition of US biotech Principia Biopharma coming in second. For investors, selecting the right micro- or small-cap biotech can be like finding a needle in a haystack, as unsuccessful trials often result in massive drops in a firm's share price. For investors looking for the next potential small- or mid-cap biotech to be acquired, the best bet is generally a focused biotech ETF with good management and a penchant for lower market caps. The SPDR® S&P Biotech ETF (XBI $112), a member of the Penn Dynamic Growth Strategy, is a good example.
Pharmaceuticals
07. AstraZeneca's novel approach: a combination vaccine and treatment
AstraZeneca (AZN $36-$57-$65), Britain's $150B drug powerhouse, has begun testing an exciting new therapy: AZD7442 is designed to not only prevent Covid-19, but also serve as a therapy for those already afflicted with the virus. The drug uses a combination of two monoclonal antibodies (mAbs), harvested antibodies made by identical immune cells which specifically bind to that substance, to create a cocktail to fight off and guard against a specific infection. The Phase 1 clinical trial, which is now underway in the UK, is being funded by the US Department of Defense and the Biomedical Advanced Research and Development Authority (BARDA). Leading infectious disease scientists have endorsed this mAb approach, which has been used successfully in the treatment of a number of cancer types. If the AZD7442 trials go as hoped, expect the therapy to receive fast-track designation by the FDA. Based on current valuations, shares of AZN may seem expensive, but success with AZD7442 could propel them higher.
Airlines
06. Delta to furlough 1,900 pilots, American to reduce staff by 19,000
Delta's (DAL $18-$30-$62) head of flight operations put it succinctly: "We are six months into this pandemic and only 25% of our revenues have been recovered." American Airlines Group (AAL $8-$13-$32) CEO Doug Parker echoed similar sentiments, stating that long-haul trips in Q4 of this year will equal about 25% of last year's Q4 rate. Against that backdrop, both companies have announced a new round of furloughs to take effect when government stimulus aid to the airlines ends on 30 Sep. Delta, which we purchased within the Intrepid Trading Platform at a steep discount back in May, said it will furlough 1,941 pilots—out of the 11,200 or so on the books—unless pilots take a 15% cut in pay. The Air Line Pilots Association, which represents the unionized group, has balked at that request. American Airlines announced even more draconian cuts, saying that 19,000 employees will be involuntarily furloughed after the government relief ends. Incredibly, American Airlines has lost 77.7% of its value since January of 2018, versus a 50% loss for Delta and a 23% gain in the S&P 500. Our Delta position is up 15% since we purchased it, and we see plenty of growth ahead as the pandemic subsides.
Global Exchanges & Indexes
05. The Dow's latest moves won't make the outdated index more relevant
It always amazes us how much attention is given to the level of the Dow Jones Industrial Average on any trading day as opposed to the much more reflective S&P 500. After all, out of roughly 2,500 listed companies on the New York Stock Exchange and another 3,300 on the Nasdaq, only 30 select entrants make up the DJIA. And these holdings are price-weighted, meaning companies are weighted in proportion to their share price, not market cap. In other words, another great day for Apple (AAPL $500)—and there have been plenty of those recently—probably means a strong day for the Dow. Compare this to the cap-weighted S&P 500 Index, which means the bigger a company, the more impact it can have on the S&P's return. No matter how big a company, it is still weighted against 499 others.
Let's stick with the Apple example, since the tech giant is about to undergo a four-for-one stock split. Right now, despite its $2 trillion size, Apple still makes up a little over 7% of the S&P 500 Index. After the split, nothing will change (its market cap won't change just because it split). In the Dow, however, where Apple also finds a home, it will suddenly become one-quarter as relevant to the daily returns. That's crazy. Or how about leaving entire industries virtually unrepresented, such as utilities! Also crazy.
We delve into this subject because the Dow is about to jettison three stocks and add three others in their place. Salesforce (CRM) will replace Exxon Mobil (XOM), Amgen (AMGN) will replace Pfizer (PFE), and Honeywell (HON) will replace Raytheon Technologies (RTX). The last two swaps are real head-scratchers. Even the first: Is Salesforce the most relevant tech company to infuse new blood into the Dow? What about Facebook (FB)?
Perhaps the Dow is still the financial press' favorite benchmark because it sounds more sensational to say, "DOW LOSES 1,000 POINTS" than it does to say, "S&P OFF 100." Irrespective, back during the bloodbath that was March, when the S&P 500 had plunged to below 2,500, we made our year-end prediction: "The index will rise to 3,500 by December 31st." It sits at 3,436 right now. We didn't bother making a prediction for the Dow.
Food Products
04. Boring old JM Smucker just knocked Q1 earnings out of the park
We should have seen it coming: In the midst of a lockdown and a mass migration of employees from their office buildings to their new in-home offices, packaged foods sales skyrocketed. Nothing made that more evident than the latest quarterly results from staid old JM Smucker (SJM $92-$121-$126), the 123-year-old, $14 billion packaged foods company. Best known for products such as Smucker's, Folgers, Jif, Crisco, and the like, the Ohio-based company increased earnings-per-share by 50% from the same quarter last year, and overall revenues by 11% from the same period in 2019. While their biggest category, Retail Pet Foods, increased by just 3% year-over-year (after all, the pets have always been at home), the Retail Consumer Foods division saw a 22% jump in sales. President and CEO Mark Smucker also said the firm had raised its fiscal 2021 guidance, now expecting between $8.20 and $8.60 in EPS and nearly $1 billion in free cash flow. Smucker said he expects the momentum to continue post-pandemic as Americans fell back in love with old brands, and as the company rolls out a large new marketing campaign. Time will tell, but the Q1 report was enough to drive the shares up over 7%. The company has a relatively decent P/E ratio of 18 (same as Penn holdings General Mills and B&G Foods), and we would put a fair value on the shares at around $125. That may not seem like much upside, but with its 3% dividend yield and very strong pet foods business, it is a pretty safe bet.
Multiline Retail
03. At $15, Nordstrom shares may be the retail deal of the decade, but...
Precisely one year ago, we made note of Nordstrom's (JWN $12-$15-$43) rather odd 16% one-day spike in price—to $31. Odd because it came on the heels of an earnings report that showed a 5% drop in revenue from Q2 of 2018. The spike apparently took place because analysts were expecting a much deeper drop. Here we are a year later and, with a pandemic added to the mix, analysts were really bracing for the worst. In fact, betting odds called for a 39% drop in sales from 2019. It wasn't even close. JWN shares were trading down around 6%—to $14.66—following news of a ghastly 53% drop in sales for the quarter. Even online sales, the bright spot for most retailers as customers were stuck at home behind their computers, dropped 5%. Nordstrom's earnings report even made the Kohl's quarter look good, and that was no easy feat.
Despite the reasons management gave for the drop, here's our biggest concern: Nordstrom makes its living off of selling higher-end clothing and accessories to an upscale workforce that wants to look nice in the office. When the family dog, Scruffy, becomes the only one needed to impress, Milk Bones—not fancy clothing—becomes the go-to purchase. (Milk Bones are a JM Smucker name brand, by the way.) For the quarter, Nordstrom had just shy of $2 billion in sales (down from roughly $4 billion in the same quarter last year) and a net loss of $255 million. The company doesn't have many money-losing quarters, however, and despite the lack of a P/E ratio due to that loss, its multiple had been as low as 4.1 the first week of April. Yes, the company's short-term and long-term liabilities to assets don't look great (roughly $4B/$4B and $6B/$6B, respectively), but odds are great that the company isn't going the way of JC Penney.
When the inevitable return to normalcy does come, we could easily see the shares trading at twice their current price.
Robotics & Industrial Machinery
02. 3D printing firm Desktop Metal to go public with a "blank check"
It seems to be all the rave on Wall Street this year: the SPAC, or Special Purpose Acquisition Company. A SPAC is a blank-check company that either does not have its own business plan or builds one around a merger with another company. In an upcoming issue of the Penn Wealth Report, for example, we discuss the SPAC Fortress Value Acquisition Corp (FVAC $12) funding America's return to rare earth mining via its "blank check" to MP Materials, owner of the Mountain Pass mining operation in California. Now, another SPAC, Trine Acquisition Corp, will provide advanced 3D printing "unicorn" (a startup valued at over $1B) Desktop Metal $575 million to go public under the symbol DM within the next few months.
Desktop is a leader in 3D printing, producing stainless steel, aluminum, and other metal alloy parts in large quantities at an assembly line rate. CEO Ric Fulop said the company's latest machines will be able to "print" critical components for the aerospace industry at 100-times the speed of current high-end printers at about one-twentieth the cost. He gives the example of a water impeller pump for a BMW auto; it would typically cost $80 to produce the pump, but one of Fulop's machines created it for $5. Desktop Metal may truly usher in the 3D world promised by advocates for years. Forget the low cost of labor in countries like China, imagine Fulop's machines pumping out intricate metal parts en masse here in the United States. That could bring about a transformational shift in global economics, greatly reducing America's reliance on cheap overseas labor.
Think that is a pie-in-the-sky promise? Remember how we were once at the mercy of OPEC for our energy needs? Keep an eye out for DM when it goes public later this year.
Under the Radar Investment
01. Under the Radar: Black Hills Corp
Black Hills Corp (BKH $48-$54-$87) is a mid-cap ($3.8B) diversified utility which provides regulated gas and electric power to states in the Midwest and mountain regions. The firm also runs a mining operation via its Wyodak Resources division. With steady revenue of roughly $1.7 billion annually, the firm had $200 million in net income last year and cash flow of $7.02 per share. BKH has fallen out of favor with hedge funds recently, dragging its share price down from $87 to $48, before the shares rebounded to their current level of $54. With an ultra-low beta of 0.3049 (5Y) and a dividend yield of 4%, the shares are worth a look for income-oriented investors.
Answer
Business journalist Charles Dow, founder of financial news bureau Dow, Jones & Co., created the Dow Jones Industrial Average back in 1896. Prominent business newspaper The Wall Street Journal introduced the DJIA on 26 May of that same year. Of the twelve original component companies of the Dow, only General Electric is still in existence as a publicly-traded company. It was jettisoned from the index in 2018. In 1928, the DJIA was expanded to include 30 companies.
Headlines for the Week of 09 Aug—15 Aug 2020
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 First Casino-Resort on the Strip...
The first casino in Vegas (located in what would become downtown Vegas) was the Pair-o-Dice Club, which opened in 1931. What was the first casino-resort to be built on the Las Vegas Strip and when did it open?
Penn Trading Desk:
(13 Aug 20) Adding Canadian Cannabis Position to Intrepid Trading Platform
To say we are extremely cautious with respect to cannabis companies is an understatement. Nonetheless, as soon as we saw who was running this $1 billion firm, and upon doing some further analysis, we were in. Target price is 116% above purchase price. Members, see the trading desk.
(05 Aug 20) New Large-Cap Position in Dynamic Growth Strategy
We have replaced the AMG Yacktman Fund (YACKX) with a quite unique large-cap blend ETF in the Dynamic Growth Strategy. About 50 different companies from a host of sectors, but all with one very important thing in common. Members, see the trading desk.
(05 Aug 20) Raise BBBY Stop
Our Bed Bath & Beyond position in the Intrepid is now up in excess of 58% since last month's purchase, raise stop to $11/share to protect gains.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Automotive
10. Ford desperately needed new blood, instead they pulled from within
Let's take a sobering trip down memory lane from the standpoint of Ford Motor Co (F $4-$7-$10), beginning near the start of this century. Between 2001 and 2006, shares of the car company, founded in 1903, fell 50% under Bill Ford Jr., great-grandson of founder Henry Ford. Then came the company's last successful CEO, Alan Mulally, who presided over a 178% rise in the shares. In July of 2014, Mulally retired and handed the reins over to Mark Fields. By the time Fields was ushered out in 2016, shares had dropped another 35%. Finally, we had Jim "Buddy" Hackett, who became CEO in 2017. We had high hopes for this pick, as he had been the head of Ford's Smart Mobility subsidiary, the company's self-driving car initiative. Another 38% drop later, Hackett is gone. Reasonable business minds would fully grasp the need to find new blood to reinvent the car company, which managed to lose $2.123 billion over the trailing twelve months on $130 billion in revenues. So, what dynamic pick did the the board of directors make? They elevated the firm's chief operating officer, Jim Farley, to the CEO role. In a comment apparently designed to instill confidence, Chairman Bill Ford said that Hackett will remain in an advisory role to Farley until next spring. Whew, glad to hear that. Of interesting note: one component of the $2.123 billion in losses was the higher warranty costs (around $5 billion) incurred by the company due to quality control issues on their late model vehicles. Not a comforting sign for an automaker operating in a hyper-competitive industry. Much like Boeing, this once-great company has buried its head in the sand and refuses to accept what needs to be done. What should we expect when the same people who ran the companies into a ditch are the ones responsible for hiring the new blood?
Government Watchdog
09. In intriguing turn of events, the CalPERS CIO abruptly resigns
The California Public Employees' Retirement System, or CalPERS, is the state-run pension and health benefits agency of California, responsible for the retirement plans of nearly 2 million California public employees, retirees, and there families. The organization manages roughly $400 billion in assets. Based on the nature of the business and the state in which it sits, one can only imagine the level to which politics permeates the body.
Against that backdrop, we have Chief Investment Officer Ben Meng, who has served in that role for the past two years. It wasn't his first stint at the organization, however, as he worked at the agency from 2008 to 2015—before leaving to become deputy chief investment officer for China's State Administration of Foreign Exchange, in charge of China's $3 trillion or so in foreign reserves. Meng abruptly "resigned" his CIO role this week, citing a desire to spend more time with his family. California State Controller Betty Yee, however, said in a statement that she was "incredibly disappointed" to hear about Meng's lapse in judgment and failure to adhere to standard conflict-of-interest policies.
While that cryptic message tells us Meng didn't leave on his own accord, it certainly raises more questions than it answers. Adding to the intrigue, Indiana Rep. Jim Banks recently wrote a letter to California Governor Gavin Newsom requesting a thorough investigation into Meng's relationship to the Chinese Communist Party. CalPERS added roughly 100 Chinese firms to the stock portion of its portfolio over the past year. Against a stated target return of 7% per year, the fund has underperformed under Meng, notching a return of just 4.7% for the 2019-20 fiscal year. As of now, CalPERS has just 71% of the assets it needs to meet the pension requirements of its members.
Hotels, Resorts, & Cruise Lines
08. Wynn's revenue fell a staggering 95% in Q2
The casinos, especially those with large exposure to Asia, could be considered the poster children for the pandemic, and the latest results from our favorite pick in the group, Wynn Resorts (WYNN $36-$77-$153) illustrate why. In the second quarter of 2019, Wynn generated $1.65 billion in revenues; in Q2 of this year, the company brought in just $85.7 million--gross. That is a staggering 95% reduction, all before the company paid one cent in expenses. As a matter of fact, net income in Q2 of 2019—$94.55 million—was higher than last quarter's gross revenues. In the first six months of the year, Wynn has lost over $1 billion. So, with WYNN shares being down nearly 50% ytd, doesn't that mean they will snap back as we slowly put the virus behind us? Perhaps, but there is one important factor investors need to be aware of: 76% of the company's revenues over the past four quarters emanated from operations in Macau. Talk about some serious geographic risk. Despite all the bluster coming from the state-run media in communist China, we believe that country is in serious economic trouble. The idea that it will simply resume its pre-pandemic growth trajectory over the coming months—or even years—is a fallacy. As for Wynn, we would value the shares at roughly $100, but the company's reliance on Macau as a revenue source has us steering clear.
Economics: Work & Pay
07. A strong jobs report for July and increased retail hiring
Handily beating estimates, the highly-anticipated July jobs report provided more evidence that the US economy is returning to normal—despite the dire warnings of record Covid-19 cases foisted upon us daily by the media. After peaking at a 14.7%, the unemployment rate in the US fell to 10.2% in July—certainly still unacceptably high, but better than the 10.6% rate expected. A staggering 1.763 million new jobs were created in the month, with the labor force participation remaining relatively steady, at 61.2%. The leisure and hospitality industries accounted for a plurality of the new jobs created, adding 592,000 positions in the month, with government and retail coming in second and third, respectively. Big restaurant chains are about to embark on a massive hiring spree as well, with Chipotle (CMG) announcing it will hire 10,000 new employees in the coming months. McDonald's, Starbucks, Yum Brands (Taco Bell), Papa Johns, and Dunkin Brands announced similar plans. Meanwhile, after Congress failed to reach a new deal on pandemic relief, President Trump signed an executive order extending unemployment benefits to include an extra $400 per week (down from the extra $600, which expired on 31 Jul), deferring student loans through 2020, and extending the moratorium on evictions. The next big litmus test for the economy will come over the next several weeks as students—at least some of them—head back to school.
Hotels, Resorts, & Cruise Lines
06. Penn member MGM jumps on Barry Diller investment
We opened gaming and resort giant MGM (MGM $22) at $16 per share on 10 July within the Penn Global Leaders Club, and commented: "Did we really get it at that price?" Now, precisely one month later, our position is up 37%—helped along the way by Barry Diller's $1 billion investment in the firm. Shares were trading up around 15% on Monday after the InteractiveCorp (IAC $131) chairman said he was "energized and excited to make this investment in MGM." Why did an Internet media company want 12% ownership in the largest operator on the Las Vegas Strip? The new shareholder said that he believes his firm can help MGM expand its online gambling business and create other "digital first" experiences for guests. As for our price target, we're not quite there yet: we placed it at $32 per share, or 100% higher than our purchase price. Heading in the right direction.
Aerospace & Defense
05. Sorry Bezos: SpaceX, United Launch Alliance win big Pentagon deal
We've mentioned it before, but Amazon (AMZN) CEO Jeff Bezos showed his child-like petulance when he sent out a tweet following the first successful landing of SpaceX's first-stage boosters. The tweet said simply, "Congratulations...welcome to the club." (Bezos' Blue Origin had previously landed its New Shepard rocket in a similar fashion.) We thought of that tweet once again after hearing the news that the Pentagon has awarded billions in rocket contracts to SpaceX and United Launch Alliance (Boeing and Lockheed) to launch national security missions for a five-year period, while rejecting the Blue Origin and Northrop Grumman (NOC $342) bids. The contracts call for nearly three dozen launches over that period, valued at around $1 billion per year. SpaceX has its proven Falcon 9 and Falcon Heavy, while ULA is building the new Vulcan rocket to replace its decades-old Atlas fleet—which now relies on Russian rockets for propulsion. Blue Origin said it will continue to build its New Glenn rocket, despite the lack of any buyers thus far. Northrop Grumman's OmegA rocket's future is definitely in doubt after losing the bid.
Semiconductors
04. On a roll: FTC case against Qualcomm is thrown out by appeals court
Just a few weeks ago, Penn New Frontier Fund member Qualcomm (QCOM $109) announced it had struck a deal with Huawei, ending a time-consuming patent dispute and putting $1.8 billion in its pocket. This week the company received more good news: an appeals court overturned the FTC's antitrust ruling against the company. At the heart of the issue was Qualcomm's ability to charge licensing fees to handset makers, a practice the FTC said was anti-competitive. Had the appeals court not struck down the ruling, the company would have been forced to renegotiate licensing deals with hundreds of corporate customers, license its patents to rival chipmakers, and stop asking customers to sign exclusive agreements for its chips. The $123 billion San Diego-based firm would have also had to put up with seven years of FTC monitoring—a legal and monetary nightmare. All of that is swept away with this reversal, allowing the company to remain focused on its goal of dominating the 5G chip market. QCOM shares are up 40% since we purchased for the Penn New Frontier Fund three months ago.
Transportation Infrastructure
03. Uber threatens to suspend operations in Cali after new ruling
Is there any wonder companies are leaving the not-so-Golden State in droves? Last year the California legislature passed Assembly Bill 5 (AB5), which would force ride-sharing companies such as Uber (UBER $31) and Lyft (LYFT $31) to stop classifying their drivers as contractors (which is what they are) and begin classifying them as employees of the company (which is what they are not—by design). The bill was on hold pending appeal, but this week San Francisco County Superior Court Judge Ethan Schulman upheld that law and ordered the firms to make the changes. This simply won't happen. For Uber, that would mean suddenly making 100,000 contract workers employees of the company. The typically mild-mannered and restrained CEO, Dara Khosrowshahi, was blunt: the firm may be forced to shut down temporarily in California if enforcement of this law is initiated. Perhaps he said "temporarily" because the gig economy companies affected, which also include food delivery services like DoorDash, are pushing for Proposition 22, a measure on November's ballot which would exempt these companies from the very law which targeted them in the first place. California has designed a nightmarish and byzantine legal system designed to stymie productive companies and benefit the state's litigators. Until that changes, companies will continue to flee. As for Uber and Lyft, the ruling comes right as the companies are trying to pull out of the fiscal nosedive caused by the pandemic. UPDATE: Impressively, Lyft followed suit with a statement mirroring Dara's comments.
Market Pulse
02. Weekly jobless claims drop under 1M for first time since spring
US initial claims for unemployment dropped to below the one million mark for the first time since the pandemic came slamming into the global economy this past spring. While 963,000 new claims might not seem like much to celebrate, it is a far cry from the 6.867 million claims initiated in the last week of March. This most recent decline, coupled with the better-than-expected jobs number for July, points to an economy that is slowly returning to normal, despite the lack of a vaccine or a therapy for the virus. The markets remain hopeful: the S&P 500 just notched its third-straight week of gains. Our favorite anecdotal sign? The chronic, daily, in-our-face headlines telling us that Covid levels are hitting new highs have suddenly disappeared.
Under the Radar Investment
01. Under the Radar: iCAD Inc
iCAD Inc (ICAD $10) is a micro-cap ($238M) growth company in the Life Sciences Tools & Services industry. The New Hampshire-based firm, which has been in business since 1984, provides cancer detection and radiation therapy solutions and services. The company offers a range of upgradeable computer aided detection (CAD) solutions for the detection of breast, prostate, and colorectal cancers. Its Xoft Axxent system delivers high dose rate, low energy radiation to target cancer while minimizing exposure to surrounding healthy tissue. Based on its success, the Axxent system is now additionally being deployed for the treatment of non-melanoma skin cancer. Shares of ICAD topped out at $15.31 in March, leading into the pandemic-driven downturn.
Answer
The first casino-resort to be built on the Las Vegas Strip was the El Rancho Vegas, which opened in 1941. Sporting 63 rooms, its success spawned the building of a second resort, the Hotel Last Frontier, the following year. The success of these two casinos stirred the interest of organized crime, which planted its flag in Vegas when Bugsy Siegel funded the Flamingo, which opened four years later.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The First Casino-Resort on the Strip...
The first casino in Vegas (located in what would become downtown Vegas) was the Pair-o-Dice Club, which opened in 1931. What was the first casino-resort to be built on the Las Vegas Strip and when did it open?
Penn Trading Desk:
(13 Aug 20) Adding Canadian Cannabis Position to Intrepid Trading Platform
To say we are extremely cautious with respect to cannabis companies is an understatement. Nonetheless, as soon as we saw who was running this $1 billion firm, and upon doing some further analysis, we were in. Target price is 116% above purchase price. Members, see the trading desk.
(05 Aug 20) New Large-Cap Position in Dynamic Growth Strategy
We have replaced the AMG Yacktman Fund (YACKX) with a quite unique large-cap blend ETF in the Dynamic Growth Strategy. About 50 different companies from a host of sectors, but all with one very important thing in common. Members, see the trading desk.
(05 Aug 20) Raise BBBY Stop
Our Bed Bath & Beyond position in the Intrepid is now up in excess of 58% since last month's purchase, raise stop to $11/share to protect gains.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Automotive
10. Ford desperately needed new blood, instead they pulled from within
Let's take a sobering trip down memory lane from the standpoint of Ford Motor Co (F $4-$7-$10), beginning near the start of this century. Between 2001 and 2006, shares of the car company, founded in 1903, fell 50% under Bill Ford Jr., great-grandson of founder Henry Ford. Then came the company's last successful CEO, Alan Mulally, who presided over a 178% rise in the shares. In July of 2014, Mulally retired and handed the reins over to Mark Fields. By the time Fields was ushered out in 2016, shares had dropped another 35%. Finally, we had Jim "Buddy" Hackett, who became CEO in 2017. We had high hopes for this pick, as he had been the head of Ford's Smart Mobility subsidiary, the company's self-driving car initiative. Another 38% drop later, Hackett is gone. Reasonable business minds would fully grasp the need to find new blood to reinvent the car company, which managed to lose $2.123 billion over the trailing twelve months on $130 billion in revenues. So, what dynamic pick did the the board of directors make? They elevated the firm's chief operating officer, Jim Farley, to the CEO role. In a comment apparently designed to instill confidence, Chairman Bill Ford said that Hackett will remain in an advisory role to Farley until next spring. Whew, glad to hear that. Of interesting note: one component of the $2.123 billion in losses was the higher warranty costs (around $5 billion) incurred by the company due to quality control issues on their late model vehicles. Not a comforting sign for an automaker operating in a hyper-competitive industry. Much like Boeing, this once-great company has buried its head in the sand and refuses to accept what needs to be done. What should we expect when the same people who ran the companies into a ditch are the ones responsible for hiring the new blood?
Government Watchdog
09. In intriguing turn of events, the CalPERS CIO abruptly resigns
The California Public Employees' Retirement System, or CalPERS, is the state-run pension and health benefits agency of California, responsible for the retirement plans of nearly 2 million California public employees, retirees, and there families. The organization manages roughly $400 billion in assets. Based on the nature of the business and the state in which it sits, one can only imagine the level to which politics permeates the body.
Against that backdrop, we have Chief Investment Officer Ben Meng, who has served in that role for the past two years. It wasn't his first stint at the organization, however, as he worked at the agency from 2008 to 2015—before leaving to become deputy chief investment officer for China's State Administration of Foreign Exchange, in charge of China's $3 trillion or so in foreign reserves. Meng abruptly "resigned" his CIO role this week, citing a desire to spend more time with his family. California State Controller Betty Yee, however, said in a statement that she was "incredibly disappointed" to hear about Meng's lapse in judgment and failure to adhere to standard conflict-of-interest policies.
While that cryptic message tells us Meng didn't leave on his own accord, it certainly raises more questions than it answers. Adding to the intrigue, Indiana Rep. Jim Banks recently wrote a letter to California Governor Gavin Newsom requesting a thorough investigation into Meng's relationship to the Chinese Communist Party. CalPERS added roughly 100 Chinese firms to the stock portion of its portfolio over the past year. Against a stated target return of 7% per year, the fund has underperformed under Meng, notching a return of just 4.7% for the 2019-20 fiscal year. As of now, CalPERS has just 71% of the assets it needs to meet the pension requirements of its members.
Hotels, Resorts, & Cruise Lines
08. Wynn's revenue fell a staggering 95% in Q2
The casinos, especially those with large exposure to Asia, could be considered the poster children for the pandemic, and the latest results from our favorite pick in the group, Wynn Resorts (WYNN $36-$77-$153) illustrate why. In the second quarter of 2019, Wynn generated $1.65 billion in revenues; in Q2 of this year, the company brought in just $85.7 million--gross. That is a staggering 95% reduction, all before the company paid one cent in expenses. As a matter of fact, net income in Q2 of 2019—$94.55 million—was higher than last quarter's gross revenues. In the first six months of the year, Wynn has lost over $1 billion. So, with WYNN shares being down nearly 50% ytd, doesn't that mean they will snap back as we slowly put the virus behind us? Perhaps, but there is one important factor investors need to be aware of: 76% of the company's revenues over the past four quarters emanated from operations in Macau. Talk about some serious geographic risk. Despite all the bluster coming from the state-run media in communist China, we believe that country is in serious economic trouble. The idea that it will simply resume its pre-pandemic growth trajectory over the coming months—or even years—is a fallacy. As for Wynn, we would value the shares at roughly $100, but the company's reliance on Macau as a revenue source has us steering clear.
Economics: Work & Pay
07. A strong jobs report for July and increased retail hiring
Handily beating estimates, the highly-anticipated July jobs report provided more evidence that the US economy is returning to normal—despite the dire warnings of record Covid-19 cases foisted upon us daily by the media. After peaking at a 14.7%, the unemployment rate in the US fell to 10.2% in July—certainly still unacceptably high, but better than the 10.6% rate expected. A staggering 1.763 million new jobs were created in the month, with the labor force participation remaining relatively steady, at 61.2%. The leisure and hospitality industries accounted for a plurality of the new jobs created, adding 592,000 positions in the month, with government and retail coming in second and third, respectively. Big restaurant chains are about to embark on a massive hiring spree as well, with Chipotle (CMG) announcing it will hire 10,000 new employees in the coming months. McDonald's, Starbucks, Yum Brands (Taco Bell), Papa Johns, and Dunkin Brands announced similar plans. Meanwhile, after Congress failed to reach a new deal on pandemic relief, President Trump signed an executive order extending unemployment benefits to include an extra $400 per week (down from the extra $600, which expired on 31 Jul), deferring student loans through 2020, and extending the moratorium on evictions. The next big litmus test for the economy will come over the next several weeks as students—at least some of them—head back to school.
Hotels, Resorts, & Cruise Lines
06. Penn member MGM jumps on Barry Diller investment
We opened gaming and resort giant MGM (MGM $22) at $16 per share on 10 July within the Penn Global Leaders Club, and commented: "Did we really get it at that price?" Now, precisely one month later, our position is up 37%—helped along the way by Barry Diller's $1 billion investment in the firm. Shares were trading up around 15% on Monday after the InteractiveCorp (IAC $131) chairman said he was "energized and excited to make this investment in MGM." Why did an Internet media company want 12% ownership in the largest operator on the Las Vegas Strip? The new shareholder said that he believes his firm can help MGM expand its online gambling business and create other "digital first" experiences for guests. As for our price target, we're not quite there yet: we placed it at $32 per share, or 100% higher than our purchase price. Heading in the right direction.
Aerospace & Defense
05. Sorry Bezos: SpaceX, United Launch Alliance win big Pentagon deal
We've mentioned it before, but Amazon (AMZN) CEO Jeff Bezos showed his child-like petulance when he sent out a tweet following the first successful landing of SpaceX's first-stage boosters. The tweet said simply, "Congratulations...welcome to the club." (Bezos' Blue Origin had previously landed its New Shepard rocket in a similar fashion.) We thought of that tweet once again after hearing the news that the Pentagon has awarded billions in rocket contracts to SpaceX and United Launch Alliance (Boeing and Lockheed) to launch national security missions for a five-year period, while rejecting the Blue Origin and Northrop Grumman (NOC $342) bids. The contracts call for nearly three dozen launches over that period, valued at around $1 billion per year. SpaceX has its proven Falcon 9 and Falcon Heavy, while ULA is building the new Vulcan rocket to replace its decades-old Atlas fleet—which now relies on Russian rockets for propulsion. Blue Origin said it will continue to build its New Glenn rocket, despite the lack of any buyers thus far. Northrop Grumman's OmegA rocket's future is definitely in doubt after losing the bid.
Semiconductors
04. On a roll: FTC case against Qualcomm is thrown out by appeals court
Just a few weeks ago, Penn New Frontier Fund member Qualcomm (QCOM $109) announced it had struck a deal with Huawei, ending a time-consuming patent dispute and putting $1.8 billion in its pocket. This week the company received more good news: an appeals court overturned the FTC's antitrust ruling against the company. At the heart of the issue was Qualcomm's ability to charge licensing fees to handset makers, a practice the FTC said was anti-competitive. Had the appeals court not struck down the ruling, the company would have been forced to renegotiate licensing deals with hundreds of corporate customers, license its patents to rival chipmakers, and stop asking customers to sign exclusive agreements for its chips. The $123 billion San Diego-based firm would have also had to put up with seven years of FTC monitoring—a legal and monetary nightmare. All of that is swept away with this reversal, allowing the company to remain focused on its goal of dominating the 5G chip market. QCOM shares are up 40% since we purchased for the Penn New Frontier Fund three months ago.
Transportation Infrastructure
03. Uber threatens to suspend operations in Cali after new ruling
Is there any wonder companies are leaving the not-so-Golden State in droves? Last year the California legislature passed Assembly Bill 5 (AB5), which would force ride-sharing companies such as Uber (UBER $31) and Lyft (LYFT $31) to stop classifying their drivers as contractors (which is what they are) and begin classifying them as employees of the company (which is what they are not—by design). The bill was on hold pending appeal, but this week San Francisco County Superior Court Judge Ethan Schulman upheld that law and ordered the firms to make the changes. This simply won't happen. For Uber, that would mean suddenly making 100,000 contract workers employees of the company. The typically mild-mannered and restrained CEO, Dara Khosrowshahi, was blunt: the firm may be forced to shut down temporarily in California if enforcement of this law is initiated. Perhaps he said "temporarily" because the gig economy companies affected, which also include food delivery services like DoorDash, are pushing for Proposition 22, a measure on November's ballot which would exempt these companies from the very law which targeted them in the first place. California has designed a nightmarish and byzantine legal system designed to stymie productive companies and benefit the state's litigators. Until that changes, companies will continue to flee. As for Uber and Lyft, the ruling comes right as the companies are trying to pull out of the fiscal nosedive caused by the pandemic. UPDATE: Impressively, Lyft followed suit with a statement mirroring Dara's comments.
Market Pulse
02. Weekly jobless claims drop under 1M for first time since spring
US initial claims for unemployment dropped to below the one million mark for the first time since the pandemic came slamming into the global economy this past spring. While 963,000 new claims might not seem like much to celebrate, it is a far cry from the 6.867 million claims initiated in the last week of March. This most recent decline, coupled with the better-than-expected jobs number for July, points to an economy that is slowly returning to normal, despite the lack of a vaccine or a therapy for the virus. The markets remain hopeful: the S&P 500 just notched its third-straight week of gains. Our favorite anecdotal sign? The chronic, daily, in-our-face headlines telling us that Covid levels are hitting new highs have suddenly disappeared.
Under the Radar Investment
01. Under the Radar: iCAD Inc
iCAD Inc (ICAD $10) is a micro-cap ($238M) growth company in the Life Sciences Tools & Services industry. The New Hampshire-based firm, which has been in business since 1984, provides cancer detection and radiation therapy solutions and services. The company offers a range of upgradeable computer aided detection (CAD) solutions for the detection of breast, prostate, and colorectal cancers. Its Xoft Axxent system delivers high dose rate, low energy radiation to target cancer while minimizing exposure to surrounding healthy tissue. Based on its success, the Axxent system is now additionally being deployed for the treatment of non-melanoma skin cancer. Shares of ICAD topped out at $15.31 in March, leading into the pandemic-driven downturn.
Answer
The first casino-resort to be built on the Las Vegas Strip was the El Rancho Vegas, which opened in 1941. Sporting 63 rooms, its success spawned the building of a second resort, the Hotel Last Frontier, the following year. The success of these two casinos stirred the interest of organized crime, which planted its flag in Vegas when Bugsy Siegel funded the Flamingo, which opened four years later.
Headlines for the Week of 26 Jul—01 Aug 2020
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 first commercial airline service...
We mention in an article below that the airline industry is currently suffering through the biggest shock to its system in 100 years, even more so than during the 9/11 shutdowns. The industry is actually over 100 years old; when did commercial airline travel begin and what was the first official route?
Penn Trading Desk:
(30 Jul 20) Six Flags stops out
Six Flags (SIX) made a run at it after we purchased, but it could not hold its gains. The stock hit its stop loss at $17.47 and closed out of the Intrepid for a 9.15% loss in one month.
(24 Jul 20) Raise stop on Bed Bath & Beyond after quick run-up
On 09 July we added Bed Bath & Beyond (BBBY $10) to the Intrepid Trading Platform at $7.75, with a $10 price target. Shares of the specialty retailer have risen 40% since purchase, and we are raising the stop to $9.50 to protect gains.
(23 Jul 20) Open Residential REIT in Strategic Income Portfolio
We have opened a $5 billion residential REIT with a 5.4% dividend yield and a very unique story within the Penn Strategic Income Portfolio. We purchased it for several reasons: It has been unfairly beaten down due to specific concerns over the pandemic, it is highly undervalued, it holds the top spot in its niche market, and it has a great dividend yield at a time of horrendous bond rates. Members, visit the Trading Desk for more details.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Food & Staples Retailing
10. Analysts are giddy over newly-IPO'd Albertsons; are they right to be?
This isn't the first rodeo for the firm, as Albertsons Companies (ACI $16) was publicly traded up until 2006, when the debt-laden grocer was forced to sell assets and become acquired by SuperValu and hedge fund Cerberus. So why did the second-largest North American grocer (behind Kroger—KR) decide to become a publicly-traded entity yet again? Actually, Cerberus has been looking to offload the company for some time, even planning an IPO back in 2015. Back then, however, a soft retail environment forced management to hold off on the plans. Today, as grocery chains are benefiting from increased business due to the lockdown and restaurant closures, management decided to forge ahead with the offering. It was less than spectacular. Despite looking for an initial share price between $18 and $20, the market priced the shares at $16—and they proceeded to fall 3.44% on the day, closing at $15.45. So why are a dozen or so major analysts suddenly initiating coverage with a "Buy" rating, especially with privately-held German rival Aldi about to go on a US building spree? The comments range from "positive macro-trends as more Americans work from home," to "expanded curbside pickup." Yawn. Here's what we see: A debt-to-equity ratio (leverage of debt holders over equity holders) of 3.825, compared to Kroger's 1.440 and Walmart's 0.777, and a non-distinct business strategy with no moat. The price targets range from $18 to $21 per share, but we wouldn't touch the shares, even below their IPO price.
Food & Staples Retailing
09. Walmart to close on Thanksgiving this year, give staff another bonus
We recall the days when about the only store open on Thanksgiving and Christmas was Walgreen (WBA). Heck, we even remember the Blue laws, which kept nearly all stores closed on Sundays! How times have changed. One thing is changing back to the old ways, at least for one season: $375 billion mega-retailer Walmart (WMT $132) has announced it will remain closed for Thanksgiving this year. The move makes sense. Not only will social distancing make holiday shopping more challenging, the pandemic will also force management teams to change the way they market and execute sales for the busiest season of the year. Walmart, a member of the Penn Global Leaders Club, is simply taking the lead, and we can expect many more retailers to follow. In addition to the closure, the company also announced a new round of bonuses for employees to thank them for their efforts during the pandemic. The company will spend $428 million for the latest round of bonuses, bringing the total 2020 aggregate bonus spend up to $1.1 billion. Something tells us that this year's online shopping activity on Thanksgiving Day will make up for the missed in-store experience.
Pharmaceuticals
08. US government places massive vaccine order with Pfizer
Earlier in the week we reported that shares of Penn member Pfizer (PFE $38) were spiking due to the British government's order for 30 million doses of its yet-to-be-approved Covid-19 vaccine. The US government just upped the ante, ordering 100 million doses from the company for a price of $1.95 billion. In addition to that order, it also acquired the right to buy 500 million additional doses. These governments would not be placing billion dollar orders for a therapy unless they felt very confident in the drug's ultimate success in trials. In the case of Pfizer's drug, divide the amount paid by the number of doses and we come up with a per-dose cost of $19.50, though the Department of Health and Human Services has announced that Americans will not be charged to get the vaccine once it is approved. It is absolutely feasible that these vaccines could hit doctors' offices by December. When that happens, watch the economy launch once again.
Global Health Threats
07. China busted trying to steal Covid-19 vaccine data from Moderna
China, the communist-controlled nation which unleashed a pandemic on the world, is now trying to steal the potential vaccine for the virus from the men and women working tirelessly to develop the therapy. The United States Department of Justice announced last week the indictment of two government-backed Chinese hackers who had targeted Massachusetts-based biotech firm Moderna (MRNA $12-$75-$95) in an attempt to access classified data surrounding a Covid-19 vaccine in late-state trials. Cybersecurity experts working with the firm uncovered the criminal activities and alerted the FBI, who were able to ultimately finger the perps. The DoJ also mentioned breaches at two other biotech firms, one in California and another in Maryland, stemming from China. Last week the United States ordered the Chinese consulate in Houston closed due to a number of national security threats emanating from members of the consulate—such as providing fake passports and credentials to Chinese nationals attempting to gain employment at medical research facilities. China has denied all charges, labeling them "baseless accusations." Moderna's most promising vaccine, with the help of a $483 million government contract, has entered a Phase 3 trial with 30,000 participants.
Automotive
06. Tesla will build gigafactory, new production facility in Austin, Texas
If the location of the new site wasn't telegraphed, it was sure hinted at. Electric vehicle maker Tesla (TSLA $1,415) announced that it would build a new gigafactory and second production facility on 2,000 acres just outside of Austin in what will be one of the biggest economic development programs in the city's history. The $1.1 billion facility will be used to build the Tesla Cybertruck, its Semi, and both the Models 3 and Y for the eastern part of the United States. A few months ago, as California officials were trying to keep Tesla's Fremont location closed due to the pandemic, Musk angrily tweeted out that he may move everything to Texas. While that fight has dissipated, there is clearly a love affair between Musk, whose net worth is now valued at $70 billion, and the state of Texas. Ultimately, the new plant, which will be built along the Colorado River, will employ 5,000 workers with wages starting at $35,000 per year. As for keeping the area pristine, Musk said the factory will be an "ecological paradise," with a boardwalk and a hiking/biking trail.
Behavioral Finance
05. The insane trading of Eastman Kodak shares should raise concern
Quick, what comes to mind when you hear the word Kodak (KODK $2-$18-$33)? Maybe an old camera you or your parents used to take on vacations in the 1970s? Or maybe that workhorse inkjet printer sitting in your home office? Perhaps even a classic Paul Simon song from 1973? Chances are, the name doesn't make you think of active pharmaceutical ingredients (APIs) for use in drugs. Nonetheless, that last category has been the catalyst for frenetic movement in the company's share price over the past two weeks. It began when the iconic camera maker landed a $765 million government loan under the new Defense Production Act—authorized by President Trump back in May—to help fix America's medical supply chain problem; specifically, our reliance upon communist China for about 85% of our drug ingredients. While the shift from photos and printers to drug production may seem like a radical departure for the 132-year-old company, the firm has a long history of working with chemicals and advanced materials. But the real story is the stock's crazy price movement. This company went from having a $95 million market cap in June to a $1.5 billion market cap at the end of July. Now wait a minute. Even if the government loan (which can be paid back over 25 years) were an outright gift, that would still just bring the market cap up to $860 million. Here's the magic formula that made KODK an overnight darling among Robinhood users: it was selling for under $10 per share, and there was a nice story to tell with the DPA loan. Bammo! Price goes from $2 to $33 to $18 all in the matter of ten trading days. Now the reality: This deal will help energize a company that was floundering badly, but it is not a magical panacea that will suddenly make it investment-worthy.
Semiconductors
04. Qualcomm spikes 15% after reaching settlement with Huawei
Shares of Penn New Frontier Fund member Qualcomm (QCOM $45-$107-$96) punched through their 52-week high of $96.17 after the company announced it had reached a settlement with Chinese telecom giant Huawei regarding a patent dispute. CEO Steve Mollenkopf said that the San Diego-based firm would pocket a cool $1.8 billion in Q4 as a result of the agreement. Upgrades came rolling in after the deal was announced, as it clears the way for Qualcomm to maintain its leadership position as the 5G rollout begins picking back up steam following Covid-related delays. The 15% jump in the share price was also helped along by JP Morgan's new price target of $120, and Cowen's $130 (from $115) target. Mollenkopf remains, in our opinion, one of the most adroit CEOs in the industry. His ability to get deals done despite obstacles that would derail lesser CEOs is a major reason the company remains a dominant player and the leading handset chipmaker. We have no plans to sell QCOM at either of those price targets.
Media & Entertainment
03. A&E Network loses half its viewers after dropping Live PD
The year started off on a strong note for cable TV network A&E Entertainment, a Walt Disney (DIS $117) unit. Viewership for Q1 was up 4% from the prior year, a metric built almost solely on the success of hit reality show "Live PD." Then came the renewed racial strife and a decision by A&E to cancel not only that show, but several ancillary programs such as "The First 48" and "Court Cam." From a ratings standpoint, that decision was disastrous: prime-time viewership dropped 49%. And the pain will carry over to the company's financials, as the shows brought in roughly $300 million in advertising dollars in 2019, and had already generated nearly $100 million in ad spends in Q1. The "Live PD Nation" fan base is up in arms over the cancellation and is demanding the network revive the series', but it is highly probable that Disney won't do the admirable thing and stand up to the heat that move would bring. We closed out our Disney position in the Penn Global Leaders Club in mid-July at $119.43.
IT Software & Services
02. We love Microsoft's planned deal to buy TikTok's US business
Odds were very good that the Trump administration was about to ban the use of TikTok in the United States on grounds that the Chinese-based company was a conduit for the transfer of personal data on Americans into the hands of the communist regime. Then Microsoft (MSFT $131-$217-$218) CEO Satya Nadella, a refreshingly non-partisan figure, decided his firm might just want to make a bid for the US part of the massively popular social media platform. After talking with the president over the weekend, it appears that Nadella may get his wish, potentially purchasing the platform's operations in the US, Canada, Australia, and New Zealand from parent company ByteDance Ltd. Microsoft, one of the 40 holdings in the Penn Global Leaders Club, already had a lot going for it, but this acquisition would make the firm a real player in the lucrative advertising world of social media. With one purchase, albeit a big one, Microsoft would bring nearly 100 million users into its ecosystem, greatly expanding its footprint among 18-34 year olds. While the government-controlled Chinese press labelled the potential purchase a "smash and grab" by the US, we believe the deal will get done, assuming Nadella can convince both the administration and The Committee on Foreign Investment in the United States (CFIUS) that it will put the proper security measures in place for users. Investors applauded the potential move, driving the price of Microsoft shares up over 5% on Monday. ByteDance CEO Zhang Yiming has been labelled a traitor and a coward on Chinese social media. the reason? He dared to praise the freedom of speech in the United States, "unlike in China, where opinions are one-sided." Yiming's Weibo account (Weibo is an enormous Chinese social media site) was suspended after the pro-US comments were made. Update: Apple (AAPL) is now rumored to also be interested in purchasing the assets.
Under the Radar Investment
01. Under the Radar: Air Lease Corp, the ultimate contrarian play?
Who in their right mind would buy a company that makes its money from buying and subsequently leasing jet aircraft to airlines around the world? After all, the industry is going through the biggest shock to its system in 100 years of service. That being said, shares of Air Lease Corp (AL $27) are sitting down 46% from where they traded in February, and that seems like a serious overreaction based on the company's fat profit margin and rock solid business going into the pandemic. The Los Angeles-based $3 billion company, which now carries a paltry P/E ratio of 5, earned nearly $600 million on $2 billion in revenues in 2019, and has maintained a positive net income for the past decade. The company's strong profitability metrics (see graph) will no doubt take a hit when the earnings release comes out in two days, but we would still place the fair value of AL shares at $40—a 48% upside from here.
Answer
Travel between two cities on opposite sides of Tampa Bay, St. Petersburg and Tampa, Florida, took about two hours by steamship or anywhere between four and twelve hours by rail, depending on stops. The St. Petersburg-Tampa Airboat Line, created by Florida sales rep Percival Elliott Fansler, began operation on 01 Jan 1914, cutting the trip down to about twenty minutes. The airline made two flights per day, six days a week, with a ticket costing $5 per person. Tickets were sold out for sixteen weeks in advance.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
The first commercial airline service...
We mention in an article below that the airline industry is currently suffering through the biggest shock to its system in 100 years, even more so than during the 9/11 shutdowns. The industry is actually over 100 years old; when did commercial airline travel begin and what was the first official route?
Penn Trading Desk:
(30 Jul 20) Six Flags stops out
Six Flags (SIX) made a run at it after we purchased, but it could not hold its gains. The stock hit its stop loss at $17.47 and closed out of the Intrepid for a 9.15% loss in one month.
(24 Jul 20) Raise stop on Bed Bath & Beyond after quick run-up
On 09 July we added Bed Bath & Beyond (BBBY $10) to the Intrepid Trading Platform at $7.75, with a $10 price target. Shares of the specialty retailer have risen 40% since purchase, and we are raising the stop to $9.50 to protect gains.
(23 Jul 20) Open Residential REIT in Strategic Income Portfolio
We have opened a $5 billion residential REIT with a 5.4% dividend yield and a very unique story within the Penn Strategic Income Portfolio. We purchased it for several reasons: It has been unfairly beaten down due to specific concerns over the pandemic, it is highly undervalued, it holds the top spot in its niche market, and it has a great dividend yield at a time of horrendous bond rates. Members, visit the Trading Desk for more details.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Food & Staples Retailing
10. Analysts are giddy over newly-IPO'd Albertsons; are they right to be?
This isn't the first rodeo for the firm, as Albertsons Companies (ACI $16) was publicly traded up until 2006, when the debt-laden grocer was forced to sell assets and become acquired by SuperValu and hedge fund Cerberus. So why did the second-largest North American grocer (behind Kroger—KR) decide to become a publicly-traded entity yet again? Actually, Cerberus has been looking to offload the company for some time, even planning an IPO back in 2015. Back then, however, a soft retail environment forced management to hold off on the plans. Today, as grocery chains are benefiting from increased business due to the lockdown and restaurant closures, management decided to forge ahead with the offering. It was less than spectacular. Despite looking for an initial share price between $18 and $20, the market priced the shares at $16—and they proceeded to fall 3.44% on the day, closing at $15.45. So why are a dozen or so major analysts suddenly initiating coverage with a "Buy" rating, especially with privately-held German rival Aldi about to go on a US building spree? The comments range from "positive macro-trends as more Americans work from home," to "expanded curbside pickup." Yawn. Here's what we see: A debt-to-equity ratio (leverage of debt holders over equity holders) of 3.825, compared to Kroger's 1.440 and Walmart's 0.777, and a non-distinct business strategy with no moat. The price targets range from $18 to $21 per share, but we wouldn't touch the shares, even below their IPO price.
Food & Staples Retailing
09. Walmart to close on Thanksgiving this year, give staff another bonus
We recall the days when about the only store open on Thanksgiving and Christmas was Walgreen (WBA). Heck, we even remember the Blue laws, which kept nearly all stores closed on Sundays! How times have changed. One thing is changing back to the old ways, at least for one season: $375 billion mega-retailer Walmart (WMT $132) has announced it will remain closed for Thanksgiving this year. The move makes sense. Not only will social distancing make holiday shopping more challenging, the pandemic will also force management teams to change the way they market and execute sales for the busiest season of the year. Walmart, a member of the Penn Global Leaders Club, is simply taking the lead, and we can expect many more retailers to follow. In addition to the closure, the company also announced a new round of bonuses for employees to thank them for their efforts during the pandemic. The company will spend $428 million for the latest round of bonuses, bringing the total 2020 aggregate bonus spend up to $1.1 billion. Something tells us that this year's online shopping activity on Thanksgiving Day will make up for the missed in-store experience.
Pharmaceuticals
08. US government places massive vaccine order with Pfizer
Earlier in the week we reported that shares of Penn member Pfizer (PFE $38) were spiking due to the British government's order for 30 million doses of its yet-to-be-approved Covid-19 vaccine. The US government just upped the ante, ordering 100 million doses from the company for a price of $1.95 billion. In addition to that order, it also acquired the right to buy 500 million additional doses. These governments would not be placing billion dollar orders for a therapy unless they felt very confident in the drug's ultimate success in trials. In the case of Pfizer's drug, divide the amount paid by the number of doses and we come up with a per-dose cost of $19.50, though the Department of Health and Human Services has announced that Americans will not be charged to get the vaccine once it is approved. It is absolutely feasible that these vaccines could hit doctors' offices by December. When that happens, watch the economy launch once again.
Global Health Threats
07. China busted trying to steal Covid-19 vaccine data from Moderna
China, the communist-controlled nation which unleashed a pandemic on the world, is now trying to steal the potential vaccine for the virus from the men and women working tirelessly to develop the therapy. The United States Department of Justice announced last week the indictment of two government-backed Chinese hackers who had targeted Massachusetts-based biotech firm Moderna (MRNA $12-$75-$95) in an attempt to access classified data surrounding a Covid-19 vaccine in late-state trials. Cybersecurity experts working with the firm uncovered the criminal activities and alerted the FBI, who were able to ultimately finger the perps. The DoJ also mentioned breaches at two other biotech firms, one in California and another in Maryland, stemming from China. Last week the United States ordered the Chinese consulate in Houston closed due to a number of national security threats emanating from members of the consulate—such as providing fake passports and credentials to Chinese nationals attempting to gain employment at medical research facilities. China has denied all charges, labeling them "baseless accusations." Moderna's most promising vaccine, with the help of a $483 million government contract, has entered a Phase 3 trial with 30,000 participants.
Automotive
06. Tesla will build gigafactory, new production facility in Austin, Texas
If the location of the new site wasn't telegraphed, it was sure hinted at. Electric vehicle maker Tesla (TSLA $1,415) announced that it would build a new gigafactory and second production facility on 2,000 acres just outside of Austin in what will be one of the biggest economic development programs in the city's history. The $1.1 billion facility will be used to build the Tesla Cybertruck, its Semi, and both the Models 3 and Y for the eastern part of the United States. A few months ago, as California officials were trying to keep Tesla's Fremont location closed due to the pandemic, Musk angrily tweeted out that he may move everything to Texas. While that fight has dissipated, there is clearly a love affair between Musk, whose net worth is now valued at $70 billion, and the state of Texas. Ultimately, the new plant, which will be built along the Colorado River, will employ 5,000 workers with wages starting at $35,000 per year. As for keeping the area pristine, Musk said the factory will be an "ecological paradise," with a boardwalk and a hiking/biking trail.
Behavioral Finance
05. The insane trading of Eastman Kodak shares should raise concern
Quick, what comes to mind when you hear the word Kodak (KODK $2-$18-$33)? Maybe an old camera you or your parents used to take on vacations in the 1970s? Or maybe that workhorse inkjet printer sitting in your home office? Perhaps even a classic Paul Simon song from 1973? Chances are, the name doesn't make you think of active pharmaceutical ingredients (APIs) for use in drugs. Nonetheless, that last category has been the catalyst for frenetic movement in the company's share price over the past two weeks. It began when the iconic camera maker landed a $765 million government loan under the new Defense Production Act—authorized by President Trump back in May—to help fix America's medical supply chain problem; specifically, our reliance upon communist China for about 85% of our drug ingredients. While the shift from photos and printers to drug production may seem like a radical departure for the 132-year-old company, the firm has a long history of working with chemicals and advanced materials. But the real story is the stock's crazy price movement. This company went from having a $95 million market cap in June to a $1.5 billion market cap at the end of July. Now wait a minute. Even if the government loan (which can be paid back over 25 years) were an outright gift, that would still just bring the market cap up to $860 million. Here's the magic formula that made KODK an overnight darling among Robinhood users: it was selling for under $10 per share, and there was a nice story to tell with the DPA loan. Bammo! Price goes from $2 to $33 to $18 all in the matter of ten trading days. Now the reality: This deal will help energize a company that was floundering badly, but it is not a magical panacea that will suddenly make it investment-worthy.
Semiconductors
04. Qualcomm spikes 15% after reaching settlement with Huawei
Shares of Penn New Frontier Fund member Qualcomm (QCOM $45-$107-$96) punched through their 52-week high of $96.17 after the company announced it had reached a settlement with Chinese telecom giant Huawei regarding a patent dispute. CEO Steve Mollenkopf said that the San Diego-based firm would pocket a cool $1.8 billion in Q4 as a result of the agreement. Upgrades came rolling in after the deal was announced, as it clears the way for Qualcomm to maintain its leadership position as the 5G rollout begins picking back up steam following Covid-related delays. The 15% jump in the share price was also helped along by JP Morgan's new price target of $120, and Cowen's $130 (from $115) target. Mollenkopf remains, in our opinion, one of the most adroit CEOs in the industry. His ability to get deals done despite obstacles that would derail lesser CEOs is a major reason the company remains a dominant player and the leading handset chipmaker. We have no plans to sell QCOM at either of those price targets.
Media & Entertainment
03. A&E Network loses half its viewers after dropping Live PD
The year started off on a strong note for cable TV network A&E Entertainment, a Walt Disney (DIS $117) unit. Viewership for Q1 was up 4% from the prior year, a metric built almost solely on the success of hit reality show "Live PD." Then came the renewed racial strife and a decision by A&E to cancel not only that show, but several ancillary programs such as "The First 48" and "Court Cam." From a ratings standpoint, that decision was disastrous: prime-time viewership dropped 49%. And the pain will carry over to the company's financials, as the shows brought in roughly $300 million in advertising dollars in 2019, and had already generated nearly $100 million in ad spends in Q1. The "Live PD Nation" fan base is up in arms over the cancellation and is demanding the network revive the series', but it is highly probable that Disney won't do the admirable thing and stand up to the heat that move would bring. We closed out our Disney position in the Penn Global Leaders Club in mid-July at $119.43.
IT Software & Services
02. We love Microsoft's planned deal to buy TikTok's US business
Odds were very good that the Trump administration was about to ban the use of TikTok in the United States on grounds that the Chinese-based company was a conduit for the transfer of personal data on Americans into the hands of the communist regime. Then Microsoft (MSFT $131-$217-$218) CEO Satya Nadella, a refreshingly non-partisan figure, decided his firm might just want to make a bid for the US part of the massively popular social media platform. After talking with the president over the weekend, it appears that Nadella may get his wish, potentially purchasing the platform's operations in the US, Canada, Australia, and New Zealand from parent company ByteDance Ltd. Microsoft, one of the 40 holdings in the Penn Global Leaders Club, already had a lot going for it, but this acquisition would make the firm a real player in the lucrative advertising world of social media. With one purchase, albeit a big one, Microsoft would bring nearly 100 million users into its ecosystem, greatly expanding its footprint among 18-34 year olds. While the government-controlled Chinese press labelled the potential purchase a "smash and grab" by the US, we believe the deal will get done, assuming Nadella can convince both the administration and The Committee on Foreign Investment in the United States (CFIUS) that it will put the proper security measures in place for users. Investors applauded the potential move, driving the price of Microsoft shares up over 5% on Monday. ByteDance CEO Zhang Yiming has been labelled a traitor and a coward on Chinese social media. the reason? He dared to praise the freedom of speech in the United States, "unlike in China, where opinions are one-sided." Yiming's Weibo account (Weibo is an enormous Chinese social media site) was suspended after the pro-US comments were made. Update: Apple (AAPL) is now rumored to also be interested in purchasing the assets.
Under the Radar Investment
01. Under the Radar: Air Lease Corp, the ultimate contrarian play?
Who in their right mind would buy a company that makes its money from buying and subsequently leasing jet aircraft to airlines around the world? After all, the industry is going through the biggest shock to its system in 100 years of service. That being said, shares of Air Lease Corp (AL $27) are sitting down 46% from where they traded in February, and that seems like a serious overreaction based on the company's fat profit margin and rock solid business going into the pandemic. The Los Angeles-based $3 billion company, which now carries a paltry P/E ratio of 5, earned nearly $600 million on $2 billion in revenues in 2019, and has maintained a positive net income for the past decade. The company's strong profitability metrics (see graph) will no doubt take a hit when the earnings release comes out in two days, but we would still place the fair value of AL shares at $40—a 48% upside from here.
Answer
Travel between two cities on opposite sides of Tampa Bay, St. Petersburg and Tampa, Florida, took about two hours by steamship or anywhere between four and twelve hours by rail, depending on stops. The St. Petersburg-Tampa Airboat Line, created by Florida sales rep Percival Elliott Fansler, began operation on 01 Jan 1914, cutting the trip down to about twenty minutes. The airline made two flights per day, six days a week, with a ticket costing $5 per person. Tickets were sold out for sixteen weeks in advance.
Headlines for the Week of 12 Jul 2020—18 Jul 2020
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
Expectations for a historic achievement, but preparation for the worst...
What little-known draft was prepared for President Richard Nixon on 18 Jul 1969?
Penn Trading Desk:
(17 Jul 20) Take profits on Disney
Our enthusiasm for The Walt Disney Company (DIS $118.75) has waned: we see serious challenges ahead and there is a new, untested CEO at the helm; taking our long-term profits and removing from the Penn Global Leaders Club.
(16 Jul 20) Open Sector Position in Dynamic Growth
We have been underweighting several sectors for some time—for good cause. We expect one of these out-of-favor groups, however, to have a serious mean reversion over the coming twelve months, and have added its sector SPDR to the Dynamic Growth Strategy as a satellite position.
(13 Jul 20) Carnival downgraded at Suntrust
Citing chronic challenges from the pandemic that won't subside for some time, analysts at Suntrust downgraded cruise line Carnival Corp (CCL $8-$15-$52) to a sell, giving the shares a $10 price target—33% lower than their current depressed price.
(13 Jul 20) Take profits on Clorox
Our Clorox (CLX $229) went above our target price, fell back and stopped out for a 14.5% s/t gain in the Intrepid Trading Platform.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Aerospace & Defense
10. American Airlines to Boeing: Help us secure financing or else...
It wasn't exactly a tacit threat—it was more like a promise. American Airlines (AAL $8-$12-$35), which has been scrambling to find financing for the seventeen Boeing (BA $89-$178-$391) 737-MAX jets it had previously ordered, told the aircraft maker that it needs to help the company finance the jets or the order would be cancelled. There is a lot of irony in this request, as it was American's desire for more fuel-efficient aircraft that led to the development of the MAX in the first place. Of course, Boeing could have simply developed a completely new, more efficient craft; instead, disastrously as it would turn out, the Chicago-based firm decided to simply enhance its 55-year-old design that was the 737. Boeing, which lost $636 million last year on $77 billion in revenues, cannot afford to say no—despite its own ailing finances. (The company has $32 billion in long-term assets and $58 billion in long-term liabilities.) Then again, what's another seventeen on top of the 400 MAX orders which have already been cancelled this year. Some may look at Boeing's share price, which is now off 60% from where it was trading in March of 2019, and see a battered gem; we look at the company's insipid management team and see a company that is, at best, fairly valued.
Global Strategy: Europe
09. Much to the Chagrin of Putin, Poland's Duda wins reelection
The tough, outspoken, pro-democracy, law-and-order leader of Poland, Andrzej Duda, won a stunning election over the weekend to secure another five years in charge of the Eastern European country. Duda's victory will assure Poland, a staunch US ally, will remain a thorn in the side of not only Russia, but also EU leaders in Brussels who have been unable to coral the feisty leader. Duda, who won over ten million votes in a country of 38 million citizens, is a staunch advocate of pro-growth policies designed to transform Poland into a major business hub in the region. FTSE Russell, a leading global provider of asset benchmarks, recently upgraded Poland from emerging market to developed market status. We believe the country will continue to rise in economic stature and ultimately achieve its aim of becoming a global economic powerhouse. Poland's strategic location, which has been the cause of incredible pain and suffering among the Polish people over the past century (invasions by Germany and Russia), will be one of its biggest assets going forward. One of the easiest ways to invest in the Polish economy is through the iShares MSCI Poland ETF (EPOL $12-$17-$24), which appears undervalued.
Economics: Demographics & Lifestyle
08. Americans' revolving credit debt drops below $1 trillion once again
In a perverse way to use the metric, economists often gauge the health of the US economy by how much Americans are spending—whether they have the discretionary income or not. Since consumption by Americans accounts for 70% of the US economy, they argue, increased spending means a healthier GDP. Our argument has always been this: Why don't we create a stronger and healthier economy by spending within our means and selling more of our goods and services to people living outside of the country? Alas, that is apparently archaic and low-brow thinking. There is one positive development with respect to household debt in the US, however: aggregate revolving debt outstanding has once again dropped below the $1 trillion mark. Revolving debt is mostly made up of credit card balances (bottom line in graph), but also includes personal lines of credit and home equity lines of credit. In May, this figure fell to $996 billion, but the drop is mostly a reflection of the pandemic and its accompanying "lockdown," which forced Americans to stay at home. While online sales ticked up, they were not enough to overcome the massive drop in discretionary spending which typically takes place at restaurants, malls, sporting events, and the like. The two largest components of total outstanding consumer credit debt in the US are student loans ($1.5 trillion) and auto loans ($1.35 trillion), but we're sure that credit card debt will re-join the trillion dollar club soon as the economy reopens. That is bad news for American households, but good news for the banks and financial services companies who issue the unsecured lines of credit.
Global Strategy: East/Southeast Asia
07. Yet another Western democracy bans Huawei in its 5G buildout
Drawing the ire of the US administration, the British government—under the leadership of conservative Boris Johnson—refused to buckle to requests that it ban China's Huawei Technologies from assisting in the country's massive 5G buildout plan. Then came the pandemic, wreaking havoc on the world due to Chinese stonewalling and silence. In the aftermath of the avoidable global disaster, the British government has done an about-face, joining the United States, Australia, New Zealand, Japan, and Taiwan—representing one-third of the world's GDP—in banning the company and its technology. While a number of European countries, along with the Canadian government of Justin Trudeau, remain on the fence, the US argument that Huawei is a Chinese Trojan Horse continues to gain traction.
And could anyone with a rational mind actually believe that this Chinese entity would not be used to steal trade secrets from and spy on the Western world? Who remembers the enormous Equifax breach in which 150 million Americans had their personal data—to include social security and driver's license numbers—stolen? (A reason, by the way, that every American should have some form of ID theft protection—this information will eventually be used to harm the US.) Three high-ranking members of the Chinese military were identified as the ringleaders. China has an insatiable appetite for stolen intellectual property and has proven it will do whatever it takes to dominate on the world scene. The sooner that other Western democracies—like Germany and France—realize this, the better prepared they will be to fight this increasingly-dangerous global menace.
Commercial Banks
06. The misery keeps growing at Wells Fargo
Considering what the bank did to clients, it is hard to have any sympathy for Wells Fargo (WFC $22-$24-$55); we'll reserve that emotion for investors who own the stock. The latest round of horrendous news on the $100 billion financial services firm came in the form of its Q2 earnings report. The company reported its first quarterly loss since 2008 as it set aside nearly ten billion dollars for credit losses—about 72% more than analysts were expecting and over one-third of the $28 billion written off by all banks in the quarter. That is money the bank expects to need for loans that went bad ("provisions for bad loans"). The company's 8.6% dividend—so high because the shares are so low—could obviously not be sustained by a company which is bleeding cash. Therefore, the bank announced it would be slashing that dividend by 80%—from $0.51 to $0.10 per share. The one saving grace for banks in an era of ultra-low interest rates has been their trading activity, which has been doing exceptionally well. Which bank doesn't have an institutional trading desk? Yep, Wells Fargo. Shares of WFC fell about 7% after the earnings report was released. Looking for a bank that 1. is still undervalued and 2. has a trading desk? Consider Citigroup (C $51), whose shares are off roughly 40% from their January highs.
Interactive Media & Services
05. Twitter suffers massive cyber-attack
It was the worst security breach in the polarizing social media company's history, causing its shares to plunge. Midweek, some of Twitter's (TWTR $20-$34-$46) most notable users, to include names like Obama, Gates, Buffett, and Bezos, began posting odd requests for money to be sent to bitcoin accounts. "I am giving back to the community," read Joe Biden's tweet, "All Bitcoin sent to the address below will be sent back doubled!" It worked, in fact, as hundreds of thousands of dollars may have been collected from the scam within minutes of the tweets being posted. It appears likely that the hack took place with the help of insiders—Twitter employees who were able to access internal account management tools. At a time when Twitter is under pressure from government officials for its political forays, and activist investors for the underwhelming monetization of its platform, this serious incident was the last thing the company needed. Last year, CEO Jack Dorsey's own personal account was hacked, with bizarre tweets emanating from the founder's handle. Twitter, which began trading in November of 2013, will report earnings this coming Thursday.
Economics: Supply, Demand, & Prices
04. Retail sales come roaring back in June as more shops opened
Against expectations for a 5.2% gain, US retail sales came in at a scorching 7.5% increase in June, showing pent up consumer demand needs an outlet—with or without mask requirements. According to the Commerce Department numbers, total retail sales in June clocked in at $524 billion, which was up from $487 billion in May and virtually inline with pre-pandemic levels. Breaking it down by category, clothing made the strongest comeback, with a 105% increase in sales from the previous month; consumer electronics purchases rose 37% from May, while furniture sales were up 32.5%. Despite the mandated wearing of masks in cities around the country, restaurants and bars are showing signs of life—receipts rose 20% from May to June. A 15% increase in gas sales for the month supported the thesis that Americans are ready to get out of the house and resume some semblance of normalcy. Consider this: these impressive numbers occurred in the absence of a Covid-19 therapy or vaccine; imagine the coming spike in economic activity when we these last two pieces of the puzzle are in place.
Pharmaceuticals
03. Penn Member Pfizer jumps on vaccine news, UK contract for doses
We added drug giant Pfizer (PFE $28-$37-$43) back into the Penn Global Leaders Club on 09 March, during the session we referred to as "bloodbath day" in our purchase notes (the Dow dropped 2,014 points, or 7.79% on that day). The $206 billion pharma company was trading up Monday morning as it entered into an agreement, along with partner BioNTech (BNTX $94), to provide 30 million doses of its Covid-19 vaccine candidate to the United Kingdom subject to its clinical success and regulatory approval. Under the joint firms' BNT162 program, at least four mRNA (messenger RNA) vaccines—each representing a unique target antigen/mRNA combination—are being tested, with the expectation that at least one will produce neutralizing antibodies in the immune system equal to or greater than those produced naturally in patients who have recovered from the virus. Two of the versions were granted "fast-track" designations last week based on positive early results. Relatively low dose studies have been so encouraging that the British government decided to enter into the agreement. Pfizer is shooting for regulatory approval as early as October, and the joint venture is expecting to produce 100 million doses by the end of the year, and over one billion doses by the end of next year. Pfizer has a P/E ratio of 12, and a dividend yield of 4.2%.
Integrated Oil & Gas
02. Chevron to buy Noble Energy for $5 billion
Somewhat incredibly, we now own only one energy position in the Penn Global Leaders Club: Chevron Corp (CVX $52-$85-$127). On Monday, the $160 billion integrated oil and gas giant announced that it would buy oil and gas exploration and production company Noble Energy (NBL $3-$10-$27) for $5 billion in an all-stock transaction. Based on the nightmare scenario which has been playing out for US E&P companies since the pandemic, why on earth would Chevron agree to this deal? Actually, there are a couple of good reasons. By owning Noble, Chevron will vastly expand its footprint in the Permian Basin, and they are getting the company at about half its summer, 2019 value. Here's the part we find most enticing, however: Noble has critical natural gas projects in the eastern Med, and these holdings supply enormous amounts of natural gas to Israel, Jordan, and Egypt. Above and beyond the current supply levels, the natural gas demand in these Mideastern countries will only grow as coal-powered plants are shunned. We knew there would be bankruptcies and M&A activity in this industry due to the precipitous drop in oil and gas prices since the pandemic; this deal is a brilliant example of the latter. Chevron was, in our opinion, the most well-managed integrated oil company in the business, with mega-talented Mike Wirth at the helm. This deal supports our opinion. We think back to the foiled Anadarko deal—foiled by Warren Buffett, who helped Occidental Petroleum (OXY) outbid Chevron—and we have to laugh. Chevron should send a THANK YOU card to Buffett. Occidental paid $38 billion for Anadarko thanks to Buffett; OXY now has a market cap of $15 billion. Is there a point at which the "oracle" moniker goes away?
Under the Radar Investment
01. Under the Radar: PC Connections Inc
Here's a concept: A publicly-traded, $1 billion small-cap technology retailer that is actually turning a profit—and has each year for at least the past decade. The company, PC Connection Inc (CNXN $30-$41-$56), is a national provider of a range of IT solutions, providing computer systems, software and peripheral equipment, networking communications, and other related products (425,000 in all) to enterprise, business, and public sector customers. Not only has the company remained profitable, it has actually increased its earnings per share (EPS) each year for the past decade. CNXN may be a good way to play the economic rebound, and it starts from very solid footing. Not many small-cap retailers can say that.
Answer
Most people are familiar with William Safire as an acclaimed former New York Times syndicated columnist, but he also happened to be a speechwriter for President Richard Nixon in the 1960s. On 18 Jul 1969, two days before Neil Armstrong and Buzz Aldrin set foot on another world, Safire drafted an address labeled: "IN EVENT OF MOON DISASTER." The address, which the president was to read if the Apollo 11 mission went horribly wrong, began, "Fate has ordained that the men who went to the moon to explore in peace will stay on the moon to rest in peace." Needless to say, the address was never delivered, and one of the greatest achievements in human history took place two days after it was written.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
Expectations for a historic achievement, but preparation for the worst...
What little-known draft was prepared for President Richard Nixon on 18 Jul 1969?
Penn Trading Desk:
(17 Jul 20) Take profits on Disney
Our enthusiasm for The Walt Disney Company (DIS $118.75) has waned: we see serious challenges ahead and there is a new, untested CEO at the helm; taking our long-term profits and removing from the Penn Global Leaders Club.
(16 Jul 20) Open Sector Position in Dynamic Growth
We have been underweighting several sectors for some time—for good cause. We expect one of these out-of-favor groups, however, to have a serious mean reversion over the coming twelve months, and have added its sector SPDR to the Dynamic Growth Strategy as a satellite position.
(13 Jul 20) Carnival downgraded at Suntrust
Citing chronic challenges from the pandemic that won't subside for some time, analysts at Suntrust downgraded cruise line Carnival Corp (CCL $8-$15-$52) to a sell, giving the shares a $10 price target—33% lower than their current depressed price.
(13 Jul 20) Take profits on Clorox
Our Clorox (CLX $229) went above our target price, fell back and stopped out for a 14.5% s/t gain in the Intrepid Trading Platform.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Aerospace & Defense
10. American Airlines to Boeing: Help us secure financing or else...
It wasn't exactly a tacit threat—it was more like a promise. American Airlines (AAL $8-$12-$35), which has been scrambling to find financing for the seventeen Boeing (BA $89-$178-$391) 737-MAX jets it had previously ordered, told the aircraft maker that it needs to help the company finance the jets or the order would be cancelled. There is a lot of irony in this request, as it was American's desire for more fuel-efficient aircraft that led to the development of the MAX in the first place. Of course, Boeing could have simply developed a completely new, more efficient craft; instead, disastrously as it would turn out, the Chicago-based firm decided to simply enhance its 55-year-old design that was the 737. Boeing, which lost $636 million last year on $77 billion in revenues, cannot afford to say no—despite its own ailing finances. (The company has $32 billion in long-term assets and $58 billion in long-term liabilities.) Then again, what's another seventeen on top of the 400 MAX orders which have already been cancelled this year. Some may look at Boeing's share price, which is now off 60% from where it was trading in March of 2019, and see a battered gem; we look at the company's insipid management team and see a company that is, at best, fairly valued.
Global Strategy: Europe
09. Much to the Chagrin of Putin, Poland's Duda wins reelection
The tough, outspoken, pro-democracy, law-and-order leader of Poland, Andrzej Duda, won a stunning election over the weekend to secure another five years in charge of the Eastern European country. Duda's victory will assure Poland, a staunch US ally, will remain a thorn in the side of not only Russia, but also EU leaders in Brussels who have been unable to coral the feisty leader. Duda, who won over ten million votes in a country of 38 million citizens, is a staunch advocate of pro-growth policies designed to transform Poland into a major business hub in the region. FTSE Russell, a leading global provider of asset benchmarks, recently upgraded Poland from emerging market to developed market status. We believe the country will continue to rise in economic stature and ultimately achieve its aim of becoming a global economic powerhouse. Poland's strategic location, which has been the cause of incredible pain and suffering among the Polish people over the past century (invasions by Germany and Russia), will be one of its biggest assets going forward. One of the easiest ways to invest in the Polish economy is through the iShares MSCI Poland ETF (EPOL $12-$17-$24), which appears undervalued.
Economics: Demographics & Lifestyle
08. Americans' revolving credit debt drops below $1 trillion once again
In a perverse way to use the metric, economists often gauge the health of the US economy by how much Americans are spending—whether they have the discretionary income or not. Since consumption by Americans accounts for 70% of the US economy, they argue, increased spending means a healthier GDP. Our argument has always been this: Why don't we create a stronger and healthier economy by spending within our means and selling more of our goods and services to people living outside of the country? Alas, that is apparently archaic and low-brow thinking. There is one positive development with respect to household debt in the US, however: aggregate revolving debt outstanding has once again dropped below the $1 trillion mark. Revolving debt is mostly made up of credit card balances (bottom line in graph), but also includes personal lines of credit and home equity lines of credit. In May, this figure fell to $996 billion, but the drop is mostly a reflection of the pandemic and its accompanying "lockdown," which forced Americans to stay at home. While online sales ticked up, they were not enough to overcome the massive drop in discretionary spending which typically takes place at restaurants, malls, sporting events, and the like. The two largest components of total outstanding consumer credit debt in the US are student loans ($1.5 trillion) and auto loans ($1.35 trillion), but we're sure that credit card debt will re-join the trillion dollar club soon as the economy reopens. That is bad news for American households, but good news for the banks and financial services companies who issue the unsecured lines of credit.
Global Strategy: East/Southeast Asia
07. Yet another Western democracy bans Huawei in its 5G buildout
Drawing the ire of the US administration, the British government—under the leadership of conservative Boris Johnson—refused to buckle to requests that it ban China's Huawei Technologies from assisting in the country's massive 5G buildout plan. Then came the pandemic, wreaking havoc on the world due to Chinese stonewalling and silence. In the aftermath of the avoidable global disaster, the British government has done an about-face, joining the United States, Australia, New Zealand, Japan, and Taiwan—representing one-third of the world's GDP—in banning the company and its technology. While a number of European countries, along with the Canadian government of Justin Trudeau, remain on the fence, the US argument that Huawei is a Chinese Trojan Horse continues to gain traction.
And could anyone with a rational mind actually believe that this Chinese entity would not be used to steal trade secrets from and spy on the Western world? Who remembers the enormous Equifax breach in which 150 million Americans had their personal data—to include social security and driver's license numbers—stolen? (A reason, by the way, that every American should have some form of ID theft protection—this information will eventually be used to harm the US.) Three high-ranking members of the Chinese military were identified as the ringleaders. China has an insatiable appetite for stolen intellectual property and has proven it will do whatever it takes to dominate on the world scene. The sooner that other Western democracies—like Germany and France—realize this, the better prepared they will be to fight this increasingly-dangerous global menace.
Commercial Banks
06. The misery keeps growing at Wells Fargo
Considering what the bank did to clients, it is hard to have any sympathy for Wells Fargo (WFC $22-$24-$55); we'll reserve that emotion for investors who own the stock. The latest round of horrendous news on the $100 billion financial services firm came in the form of its Q2 earnings report. The company reported its first quarterly loss since 2008 as it set aside nearly ten billion dollars for credit losses—about 72% more than analysts were expecting and over one-third of the $28 billion written off by all banks in the quarter. That is money the bank expects to need for loans that went bad ("provisions for bad loans"). The company's 8.6% dividend—so high because the shares are so low—could obviously not be sustained by a company which is bleeding cash. Therefore, the bank announced it would be slashing that dividend by 80%—from $0.51 to $0.10 per share. The one saving grace for banks in an era of ultra-low interest rates has been their trading activity, which has been doing exceptionally well. Which bank doesn't have an institutional trading desk? Yep, Wells Fargo. Shares of WFC fell about 7% after the earnings report was released. Looking for a bank that 1. is still undervalued and 2. has a trading desk? Consider Citigroup (C $51), whose shares are off roughly 40% from their January highs.
Interactive Media & Services
05. Twitter suffers massive cyber-attack
It was the worst security breach in the polarizing social media company's history, causing its shares to plunge. Midweek, some of Twitter's (TWTR $20-$34-$46) most notable users, to include names like Obama, Gates, Buffett, and Bezos, began posting odd requests for money to be sent to bitcoin accounts. "I am giving back to the community," read Joe Biden's tweet, "All Bitcoin sent to the address below will be sent back doubled!" It worked, in fact, as hundreds of thousands of dollars may have been collected from the scam within minutes of the tweets being posted. It appears likely that the hack took place with the help of insiders—Twitter employees who were able to access internal account management tools. At a time when Twitter is under pressure from government officials for its political forays, and activist investors for the underwhelming monetization of its platform, this serious incident was the last thing the company needed. Last year, CEO Jack Dorsey's own personal account was hacked, with bizarre tweets emanating from the founder's handle. Twitter, which began trading in November of 2013, will report earnings this coming Thursday.
Economics: Supply, Demand, & Prices
04. Retail sales come roaring back in June as more shops opened
Against expectations for a 5.2% gain, US retail sales came in at a scorching 7.5% increase in June, showing pent up consumer demand needs an outlet—with or without mask requirements. According to the Commerce Department numbers, total retail sales in June clocked in at $524 billion, which was up from $487 billion in May and virtually inline with pre-pandemic levels. Breaking it down by category, clothing made the strongest comeback, with a 105% increase in sales from the previous month; consumer electronics purchases rose 37% from May, while furniture sales were up 32.5%. Despite the mandated wearing of masks in cities around the country, restaurants and bars are showing signs of life—receipts rose 20% from May to June. A 15% increase in gas sales for the month supported the thesis that Americans are ready to get out of the house and resume some semblance of normalcy. Consider this: these impressive numbers occurred in the absence of a Covid-19 therapy or vaccine; imagine the coming spike in economic activity when we these last two pieces of the puzzle are in place.
Pharmaceuticals
03. Penn Member Pfizer jumps on vaccine news, UK contract for doses
We added drug giant Pfizer (PFE $28-$37-$43) back into the Penn Global Leaders Club on 09 March, during the session we referred to as "bloodbath day" in our purchase notes (the Dow dropped 2,014 points, or 7.79% on that day). The $206 billion pharma company was trading up Monday morning as it entered into an agreement, along with partner BioNTech (BNTX $94), to provide 30 million doses of its Covid-19 vaccine candidate to the United Kingdom subject to its clinical success and regulatory approval. Under the joint firms' BNT162 program, at least four mRNA (messenger RNA) vaccines—each representing a unique target antigen/mRNA combination—are being tested, with the expectation that at least one will produce neutralizing antibodies in the immune system equal to or greater than those produced naturally in patients who have recovered from the virus. Two of the versions were granted "fast-track" designations last week based on positive early results. Relatively low dose studies have been so encouraging that the British government decided to enter into the agreement. Pfizer is shooting for regulatory approval as early as October, and the joint venture is expecting to produce 100 million doses by the end of the year, and over one billion doses by the end of next year. Pfizer has a P/E ratio of 12, and a dividend yield of 4.2%.
Integrated Oil & Gas
02. Chevron to buy Noble Energy for $5 billion
Somewhat incredibly, we now own only one energy position in the Penn Global Leaders Club: Chevron Corp (CVX $52-$85-$127). On Monday, the $160 billion integrated oil and gas giant announced that it would buy oil and gas exploration and production company Noble Energy (NBL $3-$10-$27) for $5 billion in an all-stock transaction. Based on the nightmare scenario which has been playing out for US E&P companies since the pandemic, why on earth would Chevron agree to this deal? Actually, there are a couple of good reasons. By owning Noble, Chevron will vastly expand its footprint in the Permian Basin, and they are getting the company at about half its summer, 2019 value. Here's the part we find most enticing, however: Noble has critical natural gas projects in the eastern Med, and these holdings supply enormous amounts of natural gas to Israel, Jordan, and Egypt. Above and beyond the current supply levels, the natural gas demand in these Mideastern countries will only grow as coal-powered plants are shunned. We knew there would be bankruptcies and M&A activity in this industry due to the precipitous drop in oil and gas prices since the pandemic; this deal is a brilliant example of the latter. Chevron was, in our opinion, the most well-managed integrated oil company in the business, with mega-talented Mike Wirth at the helm. This deal supports our opinion. We think back to the foiled Anadarko deal—foiled by Warren Buffett, who helped Occidental Petroleum (OXY) outbid Chevron—and we have to laugh. Chevron should send a THANK YOU card to Buffett. Occidental paid $38 billion for Anadarko thanks to Buffett; OXY now has a market cap of $15 billion. Is there a point at which the "oracle" moniker goes away?
Under the Radar Investment
01. Under the Radar: PC Connections Inc
Here's a concept: A publicly-traded, $1 billion small-cap technology retailer that is actually turning a profit—and has each year for at least the past decade. The company, PC Connection Inc (CNXN $30-$41-$56), is a national provider of a range of IT solutions, providing computer systems, software and peripheral equipment, networking communications, and other related products (425,000 in all) to enterprise, business, and public sector customers. Not only has the company remained profitable, it has actually increased its earnings per share (EPS) each year for the past decade. CNXN may be a good way to play the economic rebound, and it starts from very solid footing. Not many small-cap retailers can say that.
Answer
Most people are familiar with William Safire as an acclaimed former New York Times syndicated columnist, but he also happened to be a speechwriter for President Richard Nixon in the 1960s. On 18 Jul 1969, two days before Neil Armstrong and Buzz Aldrin set foot on another world, Safire drafted an address labeled: "IN EVENT OF MOON DISASTER." The address, which the president was to read if the Apollo 11 mission went horribly wrong, began, "Fate has ordained that the men who went to the moon to explore in peace will stay on the moon to rest in peace." Needless to say, the address was never delivered, and one of the greatest achievements in human history took place two days after it was written.
Headlines for the Week of 05 Jul 2020—11 Jul 2020
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
A sign of a housing market with momentum?..
There are a number of ways to try and gauge the overall health of the housing market, and what may be coming next, from sentiment surveys to new contracts underwritten to actual homes sold. One early indicator we like to look at, however, is the performance of wood and timber funds. Specifically, WOOD and CUT. Using 01 Jan as our pre-virus starting point, what percentage did these funds fall before bottoming out on 23 March, and do you think they have rebounded yet?
Penn Trading Desk:
(10 Jul 20) Open resort in Global Leaders
Every now and again we run across a grossly under-priced stock that is in the doldrums mainly due to sentiment—one of our favorite words when hunting for contrarian plays. We added an "entertaining" resort to the Penn Global Leaders Club that is priced at precisely half its fair value (in our opinion).
(09 Jul 20) Phillips 66 stopped out for gain
Our Phillips 66 position stopped out in the Global Leaders Club for a 30% s/t gain. We still like the position going forward, but believe there may be some short-term pain and a pullback. May add again if it goes below $50/share.
(08 Jul 20) Adding a drug retail position to the Global Leaders Club
We added a well-known drug retailer to the Penn Global Leaders Club based on its strategy, price (undervalued by 40%), steady business model (beta 0.55), and yield.
(07 Jul 20) Take s/t gain on Inphi
Inphi Corp (IPHI) rose above our target price and stopped out at $122.04 for a 10.24% gain in 2 weeks inside the Intrepid.
(07 Jul 20) New pharma position in Intrepid
Following news that the US gov't has signed a $450M contract to buy up to 1.3M doses of the company's Covid "cocktail" we opened new pharma position in Intrepid.
(06 Jul 20) STAA stops out in Intrepid
Our Staar surgical (STAA) hit its stop and closed at $59 for a 38% one-month gain in the Intrepid Trading Platform.
(02 Jul 20) New REIT position in Strategic Income Portfolio
Opened a residential REIT (think upscale apartment complexes) in the Strategic Income Portfolio. Well under our fair value mark, with a strong balance sheet and near-4% dividend yield.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Demographics & Lifestyle
10. The unthinkable: San Fran landlords are being forced to lower rents*
In the next issue of the Penn Wealth Report we track the remarkable events transpiring in San Francisco (well, at least one of the remarkable events): landlords are losing tenants at a record clip, and must lower monthly leases to keep occupancy rates from falling further. The median rent for a one-bedroom apartment in the city has fallen 12% year-over-year as many high-tech workers lose their jobs, and many others are suddenly free to work from home—which means they can flee the confiscatory expenses that come with living in the city and move to the suburbs. We believe the pandemic has ushered in an epoch transformation for the REIT sector, with clear winners and losers. We discuss this in further detail in the Report.
IT Services
09. Our highly-touted data analytics firm, Palantir, files to go public
We have had privately-held data analytics firm Palantir, co-founded by Peter Thiel, on our radar for at least two years. Now, it appears we are getting closer to being able to purchase shares in the firm, as it filed confidential draft registration paperwork with the SEC this week. Founded in 2004 by Thiel, current CEO Alex Karp, and two others, Palantir's analytics are credited with helping US troops locate—and ultimately kill—Osama bin Laden. With a who's who list of government and corporate clients and a treasure trove of advanced data mining tools, the company should exceed revenues of $1 billion this year. In addition to its estimated market cap of $20 billion, the Palo Alto firm is in the midst of raising almost $1 billion in new capital. While the confidential SEC filing does not guarantee a 2020 IPO for Palantir, one thing is sure: we will be owners on the first day it begins trading.
Food & Staples Retailing
08. Walmart rises 7.77% on the day it announces Prime-like service
Shares of seasoned Penn Global Leaders Club member Walmart (WMT $102-$128-$133) spiked nearly 8% after the $363 billion retailer announced it would be rolling out a new Amazon (AMZN) Prime-like service to be called Walmart+. According to tech news site Recode, the subscription-based service will launch in July and cost $98 per year. For that fee, members will enjoy same-day home grocery delivery, gas discounts, special "member-only" deals, and a number of other perks. After Amazon made it big, many retail analysts were ready to write the epitaph for the Arkansas-based retailer. It didn't take long for a skilled management team, however, to figure the out e-commerce business—or hire the best and brightest minds for the job—and prove the naysayers wrong. We have little doubt that Walmart+ will be a rousing success. And we will have a straightforward yardstick for measuring that success: Amazon currently boasts roughly 150 million Prime members.
Drug Retail
07. Walgreens' latest move to win health care biz: add primary care docs
In the constant battle among drug retailers to gain more ground in the health care arena, Walgreens Boots Alliance (WBA $37-$43-$65) is about to seriously up the ante. As rival CVS Health (CVS $63) continues to aggressively fight for market share, the company has announced plans to add health care sites, complete with MDs, to roughly 700 of its stores over the coming few years. To do this, Walgreens is teaming up with primary-care provider VillageMD, which will staff the new sites and pay Walgreens to use the space. In return, the drug retailer will invest around $1 billion in VillageMD through equity and convertible debt positions. After the full investment has been made, Walgreens will own about one-third of the business. The company's strategic vision is simple: become a destination for health and wellness, and provide as many services and products as possible to meet the medical needs of its customers. We've had our doubts about the C-suite at Walgreens in the past, but we believe this was a dynamic move to make, and that they will be able to pull it off. Additionally, shares have fallen substantially since we last excoriated the CEO.. Selling for around $42 per share, WBA carries a dividend yield of 4% and a paltry P/E ratio of 10.
Aerospace & Defense
06. SpaceX and Boeing: two companies on very different paths
Talk about two space programs going in vastly different directions. Last month, SpaceX made a stunning manned launch from US soil of its Crew Dragon capsule aboard its Falcon 9 rocket, ultimately delivering the two astronauts safely to the International Space Station (ISS). Meanwhile, NASA continues to find new flaws in Boeing's (BA $180) competing Starliner craft after a failed test flight last December. While the unmanned craft was able to achieve orbit and ultimately land safely, it failed to achieve the correct orbit to hook up with the ISS—its primary objective. Now, the Starliner program is on indefinite hold after NASA Administrator Jim Bridenstine revealed that the test flight "had a lot of anomalies." In fact, at least eleven "top-priority corrective actions" will need to be taken by Boeing, but the space agency expects to find more. At least one of the issues identified could have caused "catastrophic spacecraft failure," according to the preliminary report. The bitter irony of the software problems plaguing the Starliner, which is now three years behind schedule, is that the program provided Boeing a great opportunity to juxtapose its space efforts against its 737-MAX software nightmare. Now, it is pretty hard to differentiate between the two business segments.
Textiles, Apparel, & Luxury Goods
05. It is hard to find any rationale for investing in Levi Strauss & Co
Precisely one year ago, on 10 Jul 2019, we wrote that "Even writing about this company (Levi Strauss) bores the hell out of us." At the time, shares were sitting at $21, or roughly where they traded on IPO day. Today, LEVI shares are at $12.90, and we still see no reason to invest—despite the 50% discount. The company just reported quarterly results, and they were not good. Sales were off 62%, coming in at $498 million, and the company reported a net loss of $364 million. As could be expected, the earnings commentary revolved around the pandemic, but it is difficult to see what drives this company higher when the smoke clears. In a bid to save $100 million per year, the "woke" Levi announced that it would be firing 700 workers, or 15% of its workforce. What is a fair value for LEVI shares? Probably right around where they sit right now. Look for a deep value play elsewhere.
Economics: Work & Pay
04. Initial jobless claims number comes in better than expected
On the heels of two surprisingly-strong jobs reports, the US economy got another bit of hopeful news this week as initial jobless claims came in cooler than expected. The 1.314 million figure was better than the expected 1.39 million economists had predicted for new claims, and that number is 99,000 fewer than the previous week. Continuing jobless claims fell by 698,000, to 18.06 million. To be sure, these numbers still represent a staggering amount of Americans who are out of work, but at least they are moving in the right direction. Over the past two months, 7.5 million jobs have been created—both months blowing estimates out of the water—and the unemployment rate has dropped from 14.7% to 11.1%. The CARES Act, which adds an additional $600 per week to the unemployment benefits, is set to expire on the 31st of July. It will be interesting to track the continuing claims number from the first week of August through the remainder of the year. Our best guess is that these numbers will continue to improve as the economy and the schools ramp back up, masks and all.
Specialty Retail
03. Bed Bath & Beyond shares fall 25% as sales are cut in half
In the company's fiscal first quarter of last year, retailer Bed Bath & Beyond (BBBY $8) reported sales of $2.57 billion but still managed to lose $371 million. And that's the good news. The company's most recent fiscal Q1 ended in May, and sales came in about half of what they were a year earlier, at $1.3 billion. Somewhat impressively, the company was able to cut their loss to $302 million for the quarter. Unfortunately, that represents the sixth-straight earning report showing a net loss. It looks like the company is not through trimming costs, either, as management announced it would be closing around 200 of its 1,500 stores (about 15%) over the next two years. New CEO (Nov 2019) Mark Tritton, formerly an executive vice president at both Nordstrom (JWN) and Target (TGT), said the company should save around $300 million annually due to the closures. That would almost equal this past quarter's losses. Shares of BBBY, off 25% on the day and 75% over three years, sure look tempting at $7.75—the price as we write this. We would put a fair value of $10 on the shares, or about 30% higher than where they are. The stock has certainly proven that it can move that distance in a very short period of time. What we like: The CEO has proven experience with top retailers (he was also at Nike for a spell), and the company's e-commerce business has been getting stronger (up 80% Y/Y last quarter). What we don't like: The company sold about half of its real estate to pay down debt—before the pandemic. They got $250 million in the deal, which is less than they lost last quarter. Tough call, but we believe the shares will climb back into double-digits relatively soon.
Market Pulse
02. Markets cobble together another positive week
Volatility certainly reared its ugly head again this week—there were two trading days in which the Dow went up around 400 points, and two trading days in which it fell around 400 points—but in the end, not a bad week at all. The tech stocks led the charge, with the Nasdaq jumping a full 4%, followed by the S&P with its gain of 1.76%. The Dow was, once again, the laggard, gaining just shy of 1%. When I see the Dow underperforming the S&P, I typically just chalk it up to Boeing. Here is what is becoming more and more evident: the pandemic is going to continue to wreak havoc (we know this because of the dire cut-and-paste headlines the mainstream media throws in our faces daily), but the economy is not going to shut down again. Furthermore, schools are going to reopen this fall—at least most of them. Will students end up being sent home? There is a good chance that distance learning will supplant the classroom environment at some point in the fall semester, for sure. But, despite the doom and gloom headlines (which are by design, it should be noted), Americans are becoming adept at donning their masks and forging ahead. And that is a good thing. Yes, we are all awaiting a super-effective vaccine and therapy for the virus, but in the meantime, we cautiously but persistently keep moving forward. Cheers, and here's to celebrating another positive week!
Under the Radar Investment
01. Under the Radar: Aerojet Rocketdyne Holdings
We featured Aerojet Rocketdyne (AJRD $34-$36-%57) in our Under the Radar section precisely three years ago, on 10 Jul 2017. At the time, it was selling for $21.57—a price we called undervalued. Today, this $3 billion mid-cap rocket maker is selling for $35.84—a price we call undervalued. This company is a premier provider of rockets, weapons systems, space applications, and a host of other mission-critical components for NASA, the DoD, and governments/private aerospace companies around the world. We would value the shares at $50—back where they were before the pandemic.
Answer
WOOD, the iShares Global Timber & Forestry ETF, dropped 40.48% between the first of the year and the 23rd of March; CUT, the Invesco MSCI Global Timber ETF was down 39% over the same time frame. Between 23 March and today, WOOD has rebounded 41.5% and CUT has risen 38.54%. A very good sign indeed.
Stories with an asterisk* in the headline will be discussed in further detail in the upcoming issue of The Penn Wealth Report...
Question
A sign of a housing market with momentum?..
There are a number of ways to try and gauge the overall health of the housing market, and what may be coming next, from sentiment surveys to new contracts underwritten to actual homes sold. One early indicator we like to look at, however, is the performance of wood and timber funds. Specifically, WOOD and CUT. Using 01 Jan as our pre-virus starting point, what percentage did these funds fall before bottoming out on 23 March, and do you think they have rebounded yet?
Penn Trading Desk:
(10 Jul 20) Open resort in Global Leaders
Every now and again we run across a grossly under-priced stock that is in the doldrums mainly due to sentiment—one of our favorite words when hunting for contrarian plays. We added an "entertaining" resort to the Penn Global Leaders Club that is priced at precisely half its fair value (in our opinion).
(09 Jul 20) Phillips 66 stopped out for gain
Our Phillips 66 position stopped out in the Global Leaders Club for a 30% s/t gain. We still like the position going forward, but believe there may be some short-term pain and a pullback. May add again if it goes below $50/share.
(08 Jul 20) Adding a drug retail position to the Global Leaders Club
We added a well-known drug retailer to the Penn Global Leaders Club based on its strategy, price (undervalued by 40%), steady business model (beta 0.55), and yield.
(07 Jul 20) Take s/t gain on Inphi
Inphi Corp (IPHI) rose above our target price and stopped out at $122.04 for a 10.24% gain in 2 weeks inside the Intrepid.
(07 Jul 20) New pharma position in Intrepid
Following news that the US gov't has signed a $450M contract to buy up to 1.3M doses of the company's Covid "cocktail" we opened new pharma position in Intrepid.
(06 Jul 20) STAA stops out in Intrepid
Our Staar surgical (STAA) hit its stop and closed at $59 for a 38% one-month gain in the Intrepid Trading Platform.
(02 Jul 20) New REIT position in Strategic Income Portfolio
Opened a residential REIT (think upscale apartment complexes) in the Strategic Income Portfolio. Well under our fair value mark, with a strong balance sheet and near-4% dividend yield.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Demographics & Lifestyle
10. The unthinkable: San Fran landlords are being forced to lower rents*
In the next issue of the Penn Wealth Report we track the remarkable events transpiring in San Francisco (well, at least one of the remarkable events): landlords are losing tenants at a record clip, and must lower monthly leases to keep occupancy rates from falling further. The median rent for a one-bedroom apartment in the city has fallen 12% year-over-year as many high-tech workers lose their jobs, and many others are suddenly free to work from home—which means they can flee the confiscatory expenses that come with living in the city and move to the suburbs. We believe the pandemic has ushered in an epoch transformation for the REIT sector, with clear winners and losers. We discuss this in further detail in the Report.
IT Services
09. Our highly-touted data analytics firm, Palantir, files to go public
We have had privately-held data analytics firm Palantir, co-founded by Peter Thiel, on our radar for at least two years. Now, it appears we are getting closer to being able to purchase shares in the firm, as it filed confidential draft registration paperwork with the SEC this week. Founded in 2004 by Thiel, current CEO Alex Karp, and two others, Palantir's analytics are credited with helping US troops locate—and ultimately kill—Osama bin Laden. With a who's who list of government and corporate clients and a treasure trove of advanced data mining tools, the company should exceed revenues of $1 billion this year. In addition to its estimated market cap of $20 billion, the Palo Alto firm is in the midst of raising almost $1 billion in new capital. While the confidential SEC filing does not guarantee a 2020 IPO for Palantir, one thing is sure: we will be owners on the first day it begins trading.
Food & Staples Retailing
08. Walmart rises 7.77% on the day it announces Prime-like service
Shares of seasoned Penn Global Leaders Club member Walmart (WMT $102-$128-$133) spiked nearly 8% after the $363 billion retailer announced it would be rolling out a new Amazon (AMZN) Prime-like service to be called Walmart+. According to tech news site Recode, the subscription-based service will launch in July and cost $98 per year. For that fee, members will enjoy same-day home grocery delivery, gas discounts, special "member-only" deals, and a number of other perks. After Amazon made it big, many retail analysts were ready to write the epitaph for the Arkansas-based retailer. It didn't take long for a skilled management team, however, to figure the out e-commerce business—or hire the best and brightest minds for the job—and prove the naysayers wrong. We have little doubt that Walmart+ will be a rousing success. And we will have a straightforward yardstick for measuring that success: Amazon currently boasts roughly 150 million Prime members.
Drug Retail
07. Walgreens' latest move to win health care biz: add primary care docs
In the constant battle among drug retailers to gain more ground in the health care arena, Walgreens Boots Alliance (WBA $37-$43-$65) is about to seriously up the ante. As rival CVS Health (CVS $63) continues to aggressively fight for market share, the company has announced plans to add health care sites, complete with MDs, to roughly 700 of its stores over the coming few years. To do this, Walgreens is teaming up with primary-care provider VillageMD, which will staff the new sites and pay Walgreens to use the space. In return, the drug retailer will invest around $1 billion in VillageMD through equity and convertible debt positions. After the full investment has been made, Walgreens will own about one-third of the business. The company's strategic vision is simple: become a destination for health and wellness, and provide as many services and products as possible to meet the medical needs of its customers. We've had our doubts about the C-suite at Walgreens in the past, but we believe this was a dynamic move to make, and that they will be able to pull it off. Additionally, shares have fallen substantially since we last excoriated the CEO.. Selling for around $42 per share, WBA carries a dividend yield of 4% and a paltry P/E ratio of 10.
Aerospace & Defense
06. SpaceX and Boeing: two companies on very different paths
Talk about two space programs going in vastly different directions. Last month, SpaceX made a stunning manned launch from US soil of its Crew Dragon capsule aboard its Falcon 9 rocket, ultimately delivering the two astronauts safely to the International Space Station (ISS). Meanwhile, NASA continues to find new flaws in Boeing's (BA $180) competing Starliner craft after a failed test flight last December. While the unmanned craft was able to achieve orbit and ultimately land safely, it failed to achieve the correct orbit to hook up with the ISS—its primary objective. Now, the Starliner program is on indefinite hold after NASA Administrator Jim Bridenstine revealed that the test flight "had a lot of anomalies." In fact, at least eleven "top-priority corrective actions" will need to be taken by Boeing, but the space agency expects to find more. At least one of the issues identified could have caused "catastrophic spacecraft failure," according to the preliminary report. The bitter irony of the software problems plaguing the Starliner, which is now three years behind schedule, is that the program provided Boeing a great opportunity to juxtapose its space efforts against its 737-MAX software nightmare. Now, it is pretty hard to differentiate between the two business segments.
Textiles, Apparel, & Luxury Goods
05. It is hard to find any rationale for investing in Levi Strauss & Co
Precisely one year ago, on 10 Jul 2019, we wrote that "Even writing about this company (Levi Strauss) bores the hell out of us." At the time, shares were sitting at $21, or roughly where they traded on IPO day. Today, LEVI shares are at $12.90, and we still see no reason to invest—despite the 50% discount. The company just reported quarterly results, and they were not good. Sales were off 62%, coming in at $498 million, and the company reported a net loss of $364 million. As could be expected, the earnings commentary revolved around the pandemic, but it is difficult to see what drives this company higher when the smoke clears. In a bid to save $100 million per year, the "woke" Levi announced that it would be firing 700 workers, or 15% of its workforce. What is a fair value for LEVI shares? Probably right around where they sit right now. Look for a deep value play elsewhere.
Economics: Work & Pay
04. Initial jobless claims number comes in better than expected
On the heels of two surprisingly-strong jobs reports, the US economy got another bit of hopeful news this week as initial jobless claims came in cooler than expected. The 1.314 million figure was better than the expected 1.39 million economists had predicted for new claims, and that number is 99,000 fewer than the previous week. Continuing jobless claims fell by 698,000, to 18.06 million. To be sure, these numbers still represent a staggering amount of Americans who are out of work, but at least they are moving in the right direction. Over the past two months, 7.5 million jobs have been created—both months blowing estimates out of the water—and the unemployment rate has dropped from 14.7% to 11.1%. The CARES Act, which adds an additional $600 per week to the unemployment benefits, is set to expire on the 31st of July. It will be interesting to track the continuing claims number from the first week of August through the remainder of the year. Our best guess is that these numbers will continue to improve as the economy and the schools ramp back up, masks and all.
Specialty Retail
03. Bed Bath & Beyond shares fall 25% as sales are cut in half
In the company's fiscal first quarter of last year, retailer Bed Bath & Beyond (BBBY $8) reported sales of $2.57 billion but still managed to lose $371 million. And that's the good news. The company's most recent fiscal Q1 ended in May, and sales came in about half of what they were a year earlier, at $1.3 billion. Somewhat impressively, the company was able to cut their loss to $302 million for the quarter. Unfortunately, that represents the sixth-straight earning report showing a net loss. It looks like the company is not through trimming costs, either, as management announced it would be closing around 200 of its 1,500 stores (about 15%) over the next two years. New CEO (Nov 2019) Mark Tritton, formerly an executive vice president at both Nordstrom (JWN) and Target (TGT), said the company should save around $300 million annually due to the closures. That would almost equal this past quarter's losses. Shares of BBBY, off 25% on the day and 75% over three years, sure look tempting at $7.75—the price as we write this. We would put a fair value of $10 on the shares, or about 30% higher than where they are. The stock has certainly proven that it can move that distance in a very short period of time. What we like: The CEO has proven experience with top retailers (he was also at Nike for a spell), and the company's e-commerce business has been getting stronger (up 80% Y/Y last quarter). What we don't like: The company sold about half of its real estate to pay down debt—before the pandemic. They got $250 million in the deal, which is less than they lost last quarter. Tough call, but we believe the shares will climb back into double-digits relatively soon.
Market Pulse
02. Markets cobble together another positive week
Volatility certainly reared its ugly head again this week—there were two trading days in which the Dow went up around 400 points, and two trading days in which it fell around 400 points—but in the end, not a bad week at all. The tech stocks led the charge, with the Nasdaq jumping a full 4%, followed by the S&P with its gain of 1.76%. The Dow was, once again, the laggard, gaining just shy of 1%. When I see the Dow underperforming the S&P, I typically just chalk it up to Boeing. Here is what is becoming more and more evident: the pandemic is going to continue to wreak havoc (we know this because of the dire cut-and-paste headlines the mainstream media throws in our faces daily), but the economy is not going to shut down again. Furthermore, schools are going to reopen this fall—at least most of them. Will students end up being sent home? There is a good chance that distance learning will supplant the classroom environment at some point in the fall semester, for sure. But, despite the doom and gloom headlines (which are by design, it should be noted), Americans are becoming adept at donning their masks and forging ahead. And that is a good thing. Yes, we are all awaiting a super-effective vaccine and therapy for the virus, but in the meantime, we cautiously but persistently keep moving forward. Cheers, and here's to celebrating another positive week!
Under the Radar Investment
01. Under the Radar: Aerojet Rocketdyne Holdings
We featured Aerojet Rocketdyne (AJRD $34-$36-%57) in our Under the Radar section precisely three years ago, on 10 Jul 2017. At the time, it was selling for $21.57—a price we called undervalued. Today, this $3 billion mid-cap rocket maker is selling for $35.84—a price we call undervalued. This company is a premier provider of rockets, weapons systems, space applications, and a host of other mission-critical components for NASA, the DoD, and governments/private aerospace companies around the world. We would value the shares at $50—back where they were before the pandemic.
Answer
WOOD, the iShares Global Timber & Forestry ETF, dropped 40.48% between the first of the year and the 23rd of March; CUT, the Invesco MSCI Global Timber ETF was down 39% over the same time frame. Between 23 March and today, WOOD has rebounded 41.5% and CUT has risen 38.54%. A very good sign indeed.
Question
Looking forward to the next mask-free roller coaster ride...
Despite owning more theme parks and waterparks combined than any other amusement park company in the world, Six Flags ranks seventh on the attendance list in that category. Which park operators rank in the top three from an attendance standpoint?
Penn Trading Desk:
(30 Jun 20) DA Davidson: Initiate Buy rating on Clorox
Calling it a play on changing disinfectant habits, analyst house DA Davidson initiated a Buy rating on Penn Intrepid Trading Platform member Clorox (CLX $219), placing a $256 per share target on the price. The company expects Clorox to see 17% sales growth in Q4. Our shares are up 10% since we added to the Intrepid precisely one month ago.
(30 Jun 20) Raise stop on Staar Surgical
Our Staar Surgical Co (STAA $60) position in the Intrepid Trading Platform continues its march higher, and is now up 41% from our purchase price earlier this month. Raise stop to $59 to protect s/t gains.
(29 Jun 20) Open a global stock exchange in the PGLC
We have been underweighted in Financials (for good reason). However, we just added a global stock exchange to the mix—a capital markets firm greatly unaffected by ultra-low rates and concerns about the state of consumer finance.
(26 Jun 20) Open resort hotel REIT in Intrepid
Opening a (s)mid-cap resort REIT at a 50% discount to its fair value; Style: Deep Value.
(26 Jun 20) Open Semiconductor manufacturer in Intrepid
Opening a $5.4B mid-cap semiconductor play to the Intrepid; Style: Momentum.
(25 Jun 20) Open leisure company in Intrepid
Adding a contrarian play from the leisure industry to the Intrepid; sitting at a 50% discount from its fair value.
(24 Jun 20) Teradyne stops out
Teradyne (TER $83) fell to our $83 stop loss and sold in the New Frontier Fund; took our 38% one-month gain.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Sovereign Debt & Global Fixed Income
10. Canada loses its triple-A rating on a key sovereign debt metric
Believe it or not, considering the country's $26 trillion (and growing) debt load, the United States still carries a triple-A debt rating by the major credit rating agencies. I recall the hubbub back in 2013 when Fitch put our credit rating on "negative watch," citing budget battles and debt level concerns. This week, Fitch did more than warn Canada about its own fiscal problems—it actually stripped the country of its AAA "long-term foreign currency issuer default rating," lowering it to AA+. The ratings agency cited big annual deficits and higher-than-expected post-Covid public debt levels. As a sign of the country's challenges, new manufacturing orders within Canada have fallen to the lowest levels since the 2008/09 financial meltdown. While lower ratings generally make it more expensive for a nation to finance its activities, one has to wonder if it will matter much with the ultra-low rates prevalent around the world; rates which probably won't go up for years.
Leisure Equipment, Products, & Facilities
09. Six Flags Entertainment: the ultimate contrarian play?
Six Flags Entertainment Corp (SIX $9-$19-$60) is a $1.6 billion small-cap theme park operator with 25 locations in North America and Mexico. With annual attendance of nearly 50 million visitors, the company generates roughly $1.5 billion in sales annually. The Texas-based firm made news this week when it hired the highly-qualified former Guess CFO, Sandeep Reddy, to fill the top finance role. Shares of SIX topped out near $60 last August, but are currently 67% off that high. Based on the company's financials, the current price seems to bake in zero growth going forward, an assumption we don't buy into.
Textiles, Apparel, & Luxury Goods
08. Nike plunges on horrendous quarter...that every analyst got wrong
100% of analysts covering the stock. That is how many got it dead-wrong with respect to Nike's (NKE $94) Q4—which ended in May. Against an aggregate prediction for an estimated gain of $0.07 per share, the outspoken, highly-political shoe company actually lost $0.51 per share. The range of analyst estimates went from a loss of $0.38 to a gain of $0.46 per share, with all overshooting the mark. The company got slammed with a whopping 38% decline in sales for the quarter, most notably from its North American business, which was cut almost in half. Shocked investors responded by dragging the stock down nearly 8% on the day. With its 38 P/E ratio and propensity to get mixed up in politics, we would stick with names like Adidas (ADDYY) or even beaten-down Under Armour (UA) before touching Nike. That being said, the company's new CEO, former PayPal chief John Donahoe, is bound to do a much better job at the helm than buffoonish Mark Parker. Sadly, Parker is now the executive chairman at the firm.
Restaurants
07. Out of luck and out of time: Luckin drops bid to be delisted
It was a black eye for the normally-adroit Nasdaq. Less than one year ago, the coffee company labeled "the Starbuck's of China" began publicly trading on the exchange; to much fanfare, we might add. By January of 2020, shares of Luckin Coffee (LK $1) had risen from $20 to $50, and the company's market cap peaked at $13 billion. Then came the news that executives had been cooking the books to levels which would make Enron executives envious, and the charade was over. This past week, with shares sitting just north of $1, the company abandoned its appeal to remain listed on the exchange. This news sent the stock down another 50% and dropped Luckin's market cap to $350 million. We remember the glowing reports espoused on the financial news networks about this "Starbuck's killer," and the calls we received from interested investors. For all of the brainpower at the Nasdaq (we won't accuse the financial networks of having that problem), how was this train wreck not averted, even before it left the station? Like the country in which they operate, Chinese entities have all the transparency of pea soup, and an equivalent level of trustworthiness. American regulatory bodies are not allowed to dive into the books, so we accept the numbers in good faith. Perhaps, between Luckin, the pandemic, and a number of other recent examples, that will soon change.
Oil/Gas Exploration & Production
06. Loaded with debt, fracking pioneer Chesapeake heads for Chapter 11
Founded in 1989 by Aubrey McClendon, Cheseapeake Energy (CHK $8-$12-$430) was a pioneer in the fracking movement—the process which helped the United States become the largest energy producer in the world. Now, with its market cap sitting at $115 million and its debt load sitting north of $8 billion, the company has announced that it will file for Chapter 11 bankruptcy protection. This action follows a missed $10 million debt service payment the company was scheduled to make on 16 Jun. Chesapeake will continue to operate while in Chapter 11, and management believes it can wipe out roughly $7 billion of debt during the process and emerge with $2.5 billion in new debt financing from existing lenders. Franklin Resources and Fidelity are two of the firm's largest creditors. As for McClendon, the founder was killed in a 2016 single-vehicle crash the day after being indicted on charges of conspiring to rig bids for oil and natural gas leases. If we had to pick one player within the industry it would probably be $4.4 billion Parsley Energy (PE $4-$11-$21), but we can think of about 185 industries (out of 197) we would rather look at right now.
Global Strategy: Latin America
05. Latest attack in Mexico exemplifies seismic challenges country faces
For all of the challenges the US currently faces, it could be worse. Mexico, despite its potential, remains weighted down by government corruption and cronyism, decaying infrastructure, and rampant crime—among other massive challenges. The latest example of rampant crime comes to us from Mexico City, where a well-orchestrated attack on the city's police chief has left the city—and country—shaken. Armed with assault rifles, grenades, and a Barrett sniper rifle, members of the Jalisco cartel launched the daylight attack last Friday, wounding the police chief and killing two of his bodyguards and a woman on her way to work. Small businesses in Mexico City face extortion ("pay us or pay the consequences"), civilians and tourists face the constant risk of being caught in the crossfire, and opposing crime groups often turn city streets into war zones. When the perpetrators are caught, police officials and federal judges are often targeted for taking action. A few weeks before this most recent attack, a federal judge overseeing organized crime cases was gunned down at his home in front of his wife and two children. Ironically, Mexican President "AMLO" has taken a softer approach toward dealing with cartel violence. His efforts at placating the groups seems to be falling on deaf ears. Until the country can gain some semblance of control over the violence and stem government corruption, Mexico remains a foreign market for investors to avoid.
Leisure Equipment, Products, & Facilities
04. Lululemon will buy at-home fitness company Mirror for $500M
It seems like a better fit for a company such as Peloton (PTON), but athleisure firm Lululemon (LULU $129-$294-$325) has announced that it will make its first-ever acquisition: it will buy home-fitness startup Mirror for $500 million. By now, most have probably seen ads for the firm's product and services—the ultra-cool, futuristic-looking stand up "mirror" ($1,495), and the embedded workouts which require a monthly subscription fee ($39) to stream to the device. The deal makes more sense when we consider that LULU was one of the first to provide seed money to the company, investing $1 million when the private firm was less than one year old. Additionally, for a company whose sole source of revenue is derived from its retail clothing business and selling ancillary workout equipment such as yoga mats, the acquisition could provide a real boost to future growth. Following the deal, Mirror will operate as a standalone company within the $38 billion parent firm. Sitting just shy of $300, we believe shares of LULU are fully valued.
South Asia
03. India is banning China's top apps, and that will have a big impact
Some in the media love to point out that China is a nation with 1.3 billion citizens. All well and good, but population doesn't equate to economic might. In fact, it would be fairly easy to argue that it hurts—all the more mouths to feed. Additionally, we will continue to argue that technology will be the great driver of economic growth going forward, so it is paramount that the world's largest economy, the United States, maintains its technological advantage. Speaking of technology and population, it should be pointed out that China's regional nemesis, India, also has 1.3 billion citizens, and that country's government just slapped a big setback on China's tech push: it has banned 59 of the communist nation's largest apps over cybersecurity concerns. Among the apps are TikTok, which currently has more users in India than anywhere else outside of China. The apps on the banned list are now blocked from download in India, and already-downloaded apps will stop working by early next week. Make no mistake about it, this action will a powerful and deleterious effect on these prize Chinese entities. India is where China was about 15 years ago—an emerging market just waiting to flourish. There is one big difference between the two: India doesn't have world domination as a stated goal ("China 2025").
Market Pulse
02. The markets—a leading indicator—come roaring back in Q2
The stock market historically leads the economy. If that holds true this time around, the economy should be in for a roaring-good second half of the year. After the fastest market decline in US history during Q1, the Nasdaq just put in its best quarterly showing since 2001, the S&P 500 since 1998, and the Dow since 1987. While the latter two indexes are still negative for the year, all three have surged back since the dark days of March—despite a resurgence in Covid cases, which the markets have largely brushed off. Between the pandemic, racial strife, and a major upcoming election, there are plenty of unknowns remaining for the latter six months of 2020, but the stock market is showing good faith that we are back on track for solid growth, and that the Fed will continue to provide lubrication along the way.
Under the Radar Investment
01. Under the Radar: Canadian Solar Inc
Canadian Solar (CSIQ $19) is a $1.1 billion integrated provider of solar power products, services, and system solutions. The firm designs, develops, and manufactures solar wafers, cells, modules, and other products integral to the industry. With an ultra-low P/E ratio of 3.8, short- and long-term assets which easily cover debt loads, and a positive annual cash flow (the firm made $172 million on $3.2 billion in sales last year), Canadian Solar is one of the better-run companies in a challenging—but highly promising—industry. Founded in 2001, the Ontario-based small-cap derives most of its revenue from Asia, but is active in over 160 countries around the world. We believe shares of CSIQ are trading at a 32% discount to their fair value of $25.
Answer
The top spot for amusement park attendance is a no-brainer: Walt Disney parks, in aggregate, pulled in roughly 170 million visitors last year; followed by the UK's Merlin Entertainments (think Legoland, Madame Tussauds Wax Museum, and Sea Life Centers), with 75 million; and Universal Parks & Resorts, with 60 million. The next three are Chinese conglomerates, with Six Flags coming in seventh.
Looking forward to the next mask-free roller coaster ride...
Despite owning more theme parks and waterparks combined than any other amusement park company in the world, Six Flags ranks seventh on the attendance list in that category. Which park operators rank in the top three from an attendance standpoint?
Penn Trading Desk:
(30 Jun 20) DA Davidson: Initiate Buy rating on Clorox
Calling it a play on changing disinfectant habits, analyst house DA Davidson initiated a Buy rating on Penn Intrepid Trading Platform member Clorox (CLX $219), placing a $256 per share target on the price. The company expects Clorox to see 17% sales growth in Q4. Our shares are up 10% since we added to the Intrepid precisely one month ago.
(30 Jun 20) Raise stop on Staar Surgical
Our Staar Surgical Co (STAA $60) position in the Intrepid Trading Platform continues its march higher, and is now up 41% from our purchase price earlier this month. Raise stop to $59 to protect s/t gains.
(29 Jun 20) Open a global stock exchange in the PGLC
We have been underweighted in Financials (for good reason). However, we just added a global stock exchange to the mix—a capital markets firm greatly unaffected by ultra-low rates and concerns about the state of consumer finance.
(26 Jun 20) Open resort hotel REIT in Intrepid
Opening a (s)mid-cap resort REIT at a 50% discount to its fair value; Style: Deep Value.
(26 Jun 20) Open Semiconductor manufacturer in Intrepid
Opening a $5.4B mid-cap semiconductor play to the Intrepid; Style: Momentum.
(25 Jun 20) Open leisure company in Intrepid
Adding a contrarian play from the leisure industry to the Intrepid; sitting at a 50% discount from its fair value.
(24 Jun 20) Teradyne stops out
Teradyne (TER $83) fell to our $83 stop loss and sold in the New Frontier Fund; took our 38% one-month gain.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Sovereign Debt & Global Fixed Income
10. Canada loses its triple-A rating on a key sovereign debt metric
Believe it or not, considering the country's $26 trillion (and growing) debt load, the United States still carries a triple-A debt rating by the major credit rating agencies. I recall the hubbub back in 2013 when Fitch put our credit rating on "negative watch," citing budget battles and debt level concerns. This week, Fitch did more than warn Canada about its own fiscal problems—it actually stripped the country of its AAA "long-term foreign currency issuer default rating," lowering it to AA+. The ratings agency cited big annual deficits and higher-than-expected post-Covid public debt levels. As a sign of the country's challenges, new manufacturing orders within Canada have fallen to the lowest levels since the 2008/09 financial meltdown. While lower ratings generally make it more expensive for a nation to finance its activities, one has to wonder if it will matter much with the ultra-low rates prevalent around the world; rates which probably won't go up for years.
Leisure Equipment, Products, & Facilities
09. Six Flags Entertainment: the ultimate contrarian play?
Six Flags Entertainment Corp (SIX $9-$19-$60) is a $1.6 billion small-cap theme park operator with 25 locations in North America and Mexico. With annual attendance of nearly 50 million visitors, the company generates roughly $1.5 billion in sales annually. The Texas-based firm made news this week when it hired the highly-qualified former Guess CFO, Sandeep Reddy, to fill the top finance role. Shares of SIX topped out near $60 last August, but are currently 67% off that high. Based on the company's financials, the current price seems to bake in zero growth going forward, an assumption we don't buy into.
Textiles, Apparel, & Luxury Goods
08. Nike plunges on horrendous quarter...that every analyst got wrong
100% of analysts covering the stock. That is how many got it dead-wrong with respect to Nike's (NKE $94) Q4—which ended in May. Against an aggregate prediction for an estimated gain of $0.07 per share, the outspoken, highly-political shoe company actually lost $0.51 per share. The range of analyst estimates went from a loss of $0.38 to a gain of $0.46 per share, with all overshooting the mark. The company got slammed with a whopping 38% decline in sales for the quarter, most notably from its North American business, which was cut almost in half. Shocked investors responded by dragging the stock down nearly 8% on the day. With its 38 P/E ratio and propensity to get mixed up in politics, we would stick with names like Adidas (ADDYY) or even beaten-down Under Armour (UA) before touching Nike. That being said, the company's new CEO, former PayPal chief John Donahoe, is bound to do a much better job at the helm than buffoonish Mark Parker. Sadly, Parker is now the executive chairman at the firm.
Restaurants
07. Out of luck and out of time: Luckin drops bid to be delisted
It was a black eye for the normally-adroit Nasdaq. Less than one year ago, the coffee company labeled "the Starbuck's of China" began publicly trading on the exchange; to much fanfare, we might add. By January of 2020, shares of Luckin Coffee (LK $1) had risen from $20 to $50, and the company's market cap peaked at $13 billion. Then came the news that executives had been cooking the books to levels which would make Enron executives envious, and the charade was over. This past week, with shares sitting just north of $1, the company abandoned its appeal to remain listed on the exchange. This news sent the stock down another 50% and dropped Luckin's market cap to $350 million. We remember the glowing reports espoused on the financial news networks about this "Starbuck's killer," and the calls we received from interested investors. For all of the brainpower at the Nasdaq (we won't accuse the financial networks of having that problem), how was this train wreck not averted, even before it left the station? Like the country in which they operate, Chinese entities have all the transparency of pea soup, and an equivalent level of trustworthiness. American regulatory bodies are not allowed to dive into the books, so we accept the numbers in good faith. Perhaps, between Luckin, the pandemic, and a number of other recent examples, that will soon change.
Oil/Gas Exploration & Production
06. Loaded with debt, fracking pioneer Chesapeake heads for Chapter 11
Founded in 1989 by Aubrey McClendon, Cheseapeake Energy (CHK $8-$12-$430) was a pioneer in the fracking movement—the process which helped the United States become the largest energy producer in the world. Now, with its market cap sitting at $115 million and its debt load sitting north of $8 billion, the company has announced that it will file for Chapter 11 bankruptcy protection. This action follows a missed $10 million debt service payment the company was scheduled to make on 16 Jun. Chesapeake will continue to operate while in Chapter 11, and management believes it can wipe out roughly $7 billion of debt during the process and emerge with $2.5 billion in new debt financing from existing lenders. Franklin Resources and Fidelity are two of the firm's largest creditors. As for McClendon, the founder was killed in a 2016 single-vehicle crash the day after being indicted on charges of conspiring to rig bids for oil and natural gas leases. If we had to pick one player within the industry it would probably be $4.4 billion Parsley Energy (PE $4-$11-$21), but we can think of about 185 industries (out of 197) we would rather look at right now.
Global Strategy: Latin America
05. Latest attack in Mexico exemplifies seismic challenges country faces
For all of the challenges the US currently faces, it could be worse. Mexico, despite its potential, remains weighted down by government corruption and cronyism, decaying infrastructure, and rampant crime—among other massive challenges. The latest example of rampant crime comes to us from Mexico City, where a well-orchestrated attack on the city's police chief has left the city—and country—shaken. Armed with assault rifles, grenades, and a Barrett sniper rifle, members of the Jalisco cartel launched the daylight attack last Friday, wounding the police chief and killing two of his bodyguards and a woman on her way to work. Small businesses in Mexico City face extortion ("pay us or pay the consequences"), civilians and tourists face the constant risk of being caught in the crossfire, and opposing crime groups often turn city streets into war zones. When the perpetrators are caught, police officials and federal judges are often targeted for taking action. A few weeks before this most recent attack, a federal judge overseeing organized crime cases was gunned down at his home in front of his wife and two children. Ironically, Mexican President "AMLO" has taken a softer approach toward dealing with cartel violence. His efforts at placating the groups seems to be falling on deaf ears. Until the country can gain some semblance of control over the violence and stem government corruption, Mexico remains a foreign market for investors to avoid.
Leisure Equipment, Products, & Facilities
04. Lululemon will buy at-home fitness company Mirror for $500M
It seems like a better fit for a company such as Peloton (PTON), but athleisure firm Lululemon (LULU $129-$294-$325) has announced that it will make its first-ever acquisition: it will buy home-fitness startup Mirror for $500 million. By now, most have probably seen ads for the firm's product and services—the ultra-cool, futuristic-looking stand up "mirror" ($1,495), and the embedded workouts which require a monthly subscription fee ($39) to stream to the device. The deal makes more sense when we consider that LULU was one of the first to provide seed money to the company, investing $1 million when the private firm was less than one year old. Additionally, for a company whose sole source of revenue is derived from its retail clothing business and selling ancillary workout equipment such as yoga mats, the acquisition could provide a real boost to future growth. Following the deal, Mirror will operate as a standalone company within the $38 billion parent firm. Sitting just shy of $300, we believe shares of LULU are fully valued.
South Asia
03. India is banning China's top apps, and that will have a big impact
Some in the media love to point out that China is a nation with 1.3 billion citizens. All well and good, but population doesn't equate to economic might. In fact, it would be fairly easy to argue that it hurts—all the more mouths to feed. Additionally, we will continue to argue that technology will be the great driver of economic growth going forward, so it is paramount that the world's largest economy, the United States, maintains its technological advantage. Speaking of technology and population, it should be pointed out that China's regional nemesis, India, also has 1.3 billion citizens, and that country's government just slapped a big setback on China's tech push: it has banned 59 of the communist nation's largest apps over cybersecurity concerns. Among the apps are TikTok, which currently has more users in India than anywhere else outside of China. The apps on the banned list are now blocked from download in India, and already-downloaded apps will stop working by early next week. Make no mistake about it, this action will a powerful and deleterious effect on these prize Chinese entities. India is where China was about 15 years ago—an emerging market just waiting to flourish. There is one big difference between the two: India doesn't have world domination as a stated goal ("China 2025").
Market Pulse
02. The markets—a leading indicator—come roaring back in Q2
The stock market historically leads the economy. If that holds true this time around, the economy should be in for a roaring-good second half of the year. After the fastest market decline in US history during Q1, the Nasdaq just put in its best quarterly showing since 2001, the S&P 500 since 1998, and the Dow since 1987. While the latter two indexes are still negative for the year, all three have surged back since the dark days of March—despite a resurgence in Covid cases, which the markets have largely brushed off. Between the pandemic, racial strife, and a major upcoming election, there are plenty of unknowns remaining for the latter six months of 2020, but the stock market is showing good faith that we are back on track for solid growth, and that the Fed will continue to provide lubrication along the way.
Under the Radar Investment
01. Under the Radar: Canadian Solar Inc
Canadian Solar (CSIQ $19) is a $1.1 billion integrated provider of solar power products, services, and system solutions. The firm designs, develops, and manufactures solar wafers, cells, modules, and other products integral to the industry. With an ultra-low P/E ratio of 3.8, short- and long-term assets which easily cover debt loads, and a positive annual cash flow (the firm made $172 million on $3.2 billion in sales last year), Canadian Solar is one of the better-run companies in a challenging—but highly promising—industry. Founded in 2001, the Ontario-based small-cap derives most of its revenue from Asia, but is active in over 160 countries around the world. We believe shares of CSIQ are trading at a 32% discount to their fair value of $25.
Answer
The top spot for amusement park attendance is a no-brainer: Walt Disney parks, in aggregate, pulled in roughly 170 million visitors last year; followed by the UK's Merlin Entertainments (think Legoland, Madame Tussauds Wax Museum, and Sea Life Centers), with 75 million; and Universal Parks & Resorts, with 60 million. The next three are Chinese conglomerates, with Six Flags coming in seventh.
Question
America's bright future in space...
America is on the brink of a new renaissance in space travel. After a disgraceful period in which we willingly relinquished the ability to launch astronauts from US soil, we can now expect an increasing number of annual human flights to launch from 2020 on. Who is credited with building and launching the world's first liquid-fueled rocket?
Penn Trading Desk:
(23 Jun 20) Raise stop on Teradyne
Teradyne (TER $85) is up 38% since we added it to the New Frontier Fund two months ago, and has blown by our $80/share price target. While the NFF is not designed to be a trading strategy, the shares have moved so quickly that we want to protect our gains. Raise stop to $83/share.
(22 Jun 20) Raise stop on STAA
Staar Surgical (STAA $56) is now up 30% since we purchased three weeks ago; raise stop to $53 to protect gains.
(23 Jun 20) UBS: Cut AmEx to Sell
American Express (AXP $67-$99-$138) was trading down a few percentage points after analysts at UBS downgraded the $82 billion credit card issuer from Neutral to Sell. The company cited its belief that travel and entertainment spending by affluent customers won't bounce back to pre-virus levels anytime soon. We believe AXP has a fair value somewhere in the $110 range.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Housing
10. Mortgage demand hits 11-year high as low rates entice buyers
Remember all of the concern about the impact of lockdown on the housing market? At the height of the media's feeding frenzy, we picked up the largest homebuilder (by revenue) in the country: Lennar Corp (LEN $65) at $42.99/share. It didn't seem logical that Americans were suddenly going to shun home ownership due to the health crisis, especially with record-low interest rates. Sure enough, the new mortgage applications count is in, and it is nearly as stunning as the jobs report of a few weeks ago and the retail sales report issued last week. As reported by the Mortgage Bankers Association, mortgage demand rose 21% from a year ago, representing an 11-year high, as the average contract interest rate on a 30-year loan fell to 3.18%. One disappointment was housing starts (up 4.3% vs 22.3% expected), but this was due to the builders' inability to ramp back up in time to meet demand. Unsure of where the virus was headed, the purchase of land on which to build essentially came to a screeching halt between mid-February and the end of April. Additionally, the flow of building materials was also constricted during that time. Builders are now playing a game of catch-up to meet rising demand. The housing market has come roaring back to life.
Global Strategy: European Union/China
09. The EU moves to limit China's takeover of European companies
We were outraged when the US government allowed a Chinese conglomerate to buy Smithfield Foods, the largest US producer of pork, back in 2013. This deal came as images of dead pigs floating in the toxic waters of China's Yangtze River were still fresh in our mind. We don't believe that deal would have been allowed today, but it is now a fait accompli. Fortunately, Europe finally seems to be waking up to China's business practices and appears poised to do something substantive to curb that country's influence in the region. Several countries, France and Germany included, are putting together legislation which would forbid the acquisition of European firms by Chinese interests which are found to have received government subsidies. In other words, if China is bankrolling a company, that company would not be allowed to buy a European firm. If the legislation ever sees the light of day, and these rules were enforced, that should eliminate nearly all M&A activity by Chinese companies; after all, name one that is not subsidized by the state. We have zero faith in the Europeans to actually apply these rules, but at least they are now showing some rare signs of lucidity with respect to China's motives.
Space Sciences & Exploration
08. Virgin Galactic lands a deal with NASA for astronaut training program
Considering Richard Branson's Virgin Galactic (SPCE $7-$17-$42) spacecraft, SpaceShipTwo, doesn't even leave the upper atmosphere (it goes roughly 100km, or 62m up), we were surprised to see the company awarded a contract from NASA. Nonetheless, under the latest Space Act Agreement, the US space agency will pay Virgin to develop a private orbital astronaut readiness program. The idea is to train non-NASA astronauts for eventual trips to the International Space Station, though they will have to hitch a ride to the ISS on an actual space launch vehicle. Investors liked the news, driving SPCE shares up 15% on Monday. In addition to its new astronaut training program, Virgin Galactic is ramping up its space tourism business, which will take passengers to the edge of space, and is also developing plans for a hypersonic point-to-point travel business. We are impressed by the way NASA is fostering America's new civilian space program, but we wouldn't rush to buy SPCE shares, as the company is a long way from profitability.
Industrials: Professional Services
07. Hertz tried to issue up to $500 million in new stock...from bankruptcy
There is audacity in the C-suites, then there is what Hertz Global (HTZ $0-$2-$21) tried to pull. As we previously reported, the car rental company filed for Chapter 11 bankruptcy last month. Then, to the shock of the Securities and Exchange Commission, it announced plans to issue up to $500 million in new shares to the public. The fact that these executives tried to pull such a stunt is amazing in itself; even more amazing—they probably would have found plenty of buyers who wanted to buy a "cheap" stock (HTZ currently sits at precisely $1.73/share). It didn't take long for Jay Clayton's SEC to inform the company that an immediate review of the upcoming issuance would take place, which caused Hertz executives to say, "um, never mind." Carl Icahn had already thrown in the towel on his Hertz investment at a steep loss, and odds would have been stellar that investors in these new shares would have lost everything. We are at an odd time in the investment world. We are coming out (hopefully) of a global pandemic, so many investors are rightfully timid. Meanwhile, there are still some really good bargains out there. Then you have a new group of investors that look for "cheap" stocks, earnings be damned! Like I say, an odd time indeed.
Telecommunications Services
06. The US Air Force has big plans for the SpaceX Starlink constellation
Readers are well familiar with SpaceX's plans to build a constellation of satellites in low Earth orbit (LEO) designed to ultimately provide low-cost, high-speed internet access to every part of the world—no matter how remote. To date, the company has placed 540 Starlink satellites in orbit, but that pales in comparison to the 12,000 the FCC has already approved. And even that number seems paltry to the 40,000 units SpaceX said it might eventually deploy. While we have reported on the civilian benefits of this massive network, it will also become a critical component of the nation's defense system. Last December, the United States Air Force held an Advanced Battle Management System exercise in which an AC-130 gunship connected with Starlink, proving its effectiveness for providing pinpoint accuracy. The next exercise, which was due to take place in April but was postponed due to the pandemic, will connect a number of military assets—from various branches—to the system, and will include live-fire drills against a UAV and a cruise missile. While SpaceX is a privately-held enterprise valued at roughly $36 billion, Elon Musk's company may end up bringing the SpaceX Starlink business public in an IPO, according to CEO Gwynne Shotwell. Sign us up.
Business & Professional Services
05. Wirecard CEO resigns after company "loses" $2 billion; shares dive
The FinTech arena is red-hot, specifically with respect to its payment processing segment. Companies like PayPal, Square, and Stripe are well-known players, but one German company that can't be left out of the conversation is Wirecard AG (WRCDF $33). The payment processor had a market cap of $28 billion under two years ago, along with a bright and shiny future in the industry. All of that changed this week after the company "lost" $2 billion worth of payments. Actually, it may be that the money, which was supposedly being held in two banks in the Philippines, never existed at all, but was part of a growing coverup to hide losses at the firm. After the banks publicly stated that they knew nothing about these deposits, shares of Wirecard fell over 70%, from $113 to $33, and the company's longtime CEO resigned. Last October, after a whistle-blower raised questions about falsified invoices, the company appointed KPMG as an outside auditor. Within six months, the auditing firm announced it was having challenges putting together paper trails for payments. Today, Wirecard sits at $4 billion in size, and is scrambling to salvage $2 billion worth of credit lines which may be cancelled. Too bad they can't tap into the $2 billion they supposedly held in the Philippines. Our favorite player in the space, by the way, remains PayPal (PYPL $169), which also owns the popular Venmo payment app.
Materials
04. In positive sign for global economy, materials are surging back
Of the eleven broad areas in the market, the most forgotten tends to be the materials sector. Granted, just 3.33% of all S&P 500 companies operate within the 15 industries of the sector, but that doesn't mean it shouldn't be represented in your portfolio. The pandemic decimated the performance of most materials firms as demand dried up, and they weren't doing all that well before the incident hit. Suddenly, however, the group is surging back—and that may spell good news for the global economy. Since mid-March, the Materials Select Sector SPDR (XLB $56) has risen 48% (it hit a 52-week low of $37.69 on 16 Mar). Oil and copper are the two most obvious drivers of the rally, and those two areas tend to move in direct correlation to economic activity—as opposed to gold miners, for instance. So, what are some of the top component companies in the materials sector? Air Products & Chemicals (APD, chemicals), Sherwin-Williams (SHW, specialty chemicals), Vulcan Materials (VMC, building materials), and FMC Corp (FMC, agricultural inputs) are all top holdings. In addition to XLB, investors may want to consider the Fidelity MSCI Materials ETF (FMAT $30), or the VanEck Vectors Rare Earth/Strategic Metals ETF (REMX $35).
Biotechnology
03. Gilead will begin human trials on inhaled version of remdesivir
Drug giant Gilead (GILD $60-$75-$86) made news a few months ago with its Covid-19 treatment remdesivir, a therapy which was showing promise in patients inflicted with the malady. Now, the biotech says it is ready to begin human trials of an inhaled version of the therapy, first in healthy adults, and soon (hopefully August) in healthier, non-hospitalized patients with the virus. Remdesivir is currently given intravenously, as a pill form of the drug would cause a chemical imbalance within the body. A successful inhaled version would mean patients could take the drug earlier in its progression, and from the comfort of their own homes. Remdesivir helps block the virus from taking over healthy cells and replicating itself in the body. We took our profits on GILD after the shares ran up to our $77 price target after news of the therapy first broke. The news with respect to both Covid therapies and vaccines continues to move at breakneck speed, which is another reason we remain bullish on the economy for the second half of the year.
Multiline Retail
02. Should Amazon buy Macy's?! Barron's thinks so, and so do we
What a fun synergy to imagine! Remember when Amazon (AMZN $2,757) was looking at buying Whole Foods (former symbol WFDS)? The critics came out of the woodwork telling us how the deal would ruin the natural grocer's reputation. We knew that was bunk, and it was. The acquisition now looks brilliant. So, with that in mind, try this fit: Barron's has written a piece urging the trillion-dollar online retailer to buy Penn member Macy's (M $7), a $2 billion multiline retailer we bought at $5.55 several weeks ago. We think the idea is a home run, and not just because it would help us hit our $10 price target quicker. Amazon should absolutely own a bricks-and-mortar multiline retailer, and Macy's has the same level of quality in that industry that Whole Foods has in food retailing. The future of retail will not be dominated by online shopping; the ideal will be a hybrid online/physical model. Not to knock Macy's digital presence, but let's just say it is not the benchmark. Amazon could have a "shop-in-shop" member experience for Macy's like it does for Whole Foods, or even Zappos, which the company purchased about a decade ago. All of this is speculation, of course, as neither Amazon nor Macy's has floated the idea, but we are adamantly in the Barron's camp. Hopefully some board members of both companies will run across the article and become intrigued.
Under the Radar Investment
01. Under the Radar investment: Performance Food Group
To say that most people have never heard of Performance Food Group (PFGC $29) is probably an understatement. In fact, as the third-largest food-service distributor in the country, it is fair to say that many people have not even heard of the company's two bigger rivals: Sysco (SYY) and US Foods (USFD). There are many reasons we like Performance, from its size to its financial situation to its current undervalued state. As opposed to Sysco, with its $30 billion market cap, Performance is a $3.8 billion mid-cap with strong growth potential. The company, which has turned a profit every year for the past decade, was pummeled for obvious reasons during the pandemic—it delivers food to restaurants. We believe its fall from $54 per share in mid-February to its current price fails to take into consideration the strong relationship it has built with its clients, and the nascent comeback in the food industry in the US. We would value the shares north of $40.
Answer
American engineer, professor, physicist, and inventor Robert H. Goddard successfully launched his liquid-fueled rocket from a field in Auburn, Massachusetts on 16 Mar 1926, ushering in a new era of spaceflight. In June of 1944, Germany's V-2 rocket became the first to enter space—just twenty-five years and one month before America landed humans on the moon. Not only is America the only country to ever land humans on another world, we will be the first to go back, with NASA's Artemis program on schedule for a 2024 lunar landing.
America's bright future in space...
America is on the brink of a new renaissance in space travel. After a disgraceful period in which we willingly relinquished the ability to launch astronauts from US soil, we can now expect an increasing number of annual human flights to launch from 2020 on. Who is credited with building and launching the world's first liquid-fueled rocket?
Penn Trading Desk:
(23 Jun 20) Raise stop on Teradyne
Teradyne (TER $85) is up 38% since we added it to the New Frontier Fund two months ago, and has blown by our $80/share price target. While the NFF is not designed to be a trading strategy, the shares have moved so quickly that we want to protect our gains. Raise stop to $83/share.
(22 Jun 20) Raise stop on STAA
Staar Surgical (STAA $56) is now up 30% since we purchased three weeks ago; raise stop to $53 to protect gains.
(23 Jun 20) UBS: Cut AmEx to Sell
American Express (AXP $67-$99-$138) was trading down a few percentage points after analysts at UBS downgraded the $82 billion credit card issuer from Neutral to Sell. The company cited its belief that travel and entertainment spending by affluent customers won't bounce back to pre-virus levels anytime soon. We believe AXP has a fair value somewhere in the $110 range.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Housing
10. Mortgage demand hits 11-year high as low rates entice buyers
Remember all of the concern about the impact of lockdown on the housing market? At the height of the media's feeding frenzy, we picked up the largest homebuilder (by revenue) in the country: Lennar Corp (LEN $65) at $42.99/share. It didn't seem logical that Americans were suddenly going to shun home ownership due to the health crisis, especially with record-low interest rates. Sure enough, the new mortgage applications count is in, and it is nearly as stunning as the jobs report of a few weeks ago and the retail sales report issued last week. As reported by the Mortgage Bankers Association, mortgage demand rose 21% from a year ago, representing an 11-year high, as the average contract interest rate on a 30-year loan fell to 3.18%. One disappointment was housing starts (up 4.3% vs 22.3% expected), but this was due to the builders' inability to ramp back up in time to meet demand. Unsure of where the virus was headed, the purchase of land on which to build essentially came to a screeching halt between mid-February and the end of April. Additionally, the flow of building materials was also constricted during that time. Builders are now playing a game of catch-up to meet rising demand. The housing market has come roaring back to life.
Global Strategy: European Union/China
09. The EU moves to limit China's takeover of European companies
We were outraged when the US government allowed a Chinese conglomerate to buy Smithfield Foods, the largest US producer of pork, back in 2013. This deal came as images of dead pigs floating in the toxic waters of China's Yangtze River were still fresh in our mind. We don't believe that deal would have been allowed today, but it is now a fait accompli. Fortunately, Europe finally seems to be waking up to China's business practices and appears poised to do something substantive to curb that country's influence in the region. Several countries, France and Germany included, are putting together legislation which would forbid the acquisition of European firms by Chinese interests which are found to have received government subsidies. In other words, if China is bankrolling a company, that company would not be allowed to buy a European firm. If the legislation ever sees the light of day, and these rules were enforced, that should eliminate nearly all M&A activity by Chinese companies; after all, name one that is not subsidized by the state. We have zero faith in the Europeans to actually apply these rules, but at least they are now showing some rare signs of lucidity with respect to China's motives.
Space Sciences & Exploration
08. Virgin Galactic lands a deal with NASA for astronaut training program
Considering Richard Branson's Virgin Galactic (SPCE $7-$17-$42) spacecraft, SpaceShipTwo, doesn't even leave the upper atmosphere (it goes roughly 100km, or 62m up), we were surprised to see the company awarded a contract from NASA. Nonetheless, under the latest Space Act Agreement, the US space agency will pay Virgin to develop a private orbital astronaut readiness program. The idea is to train non-NASA astronauts for eventual trips to the International Space Station, though they will have to hitch a ride to the ISS on an actual space launch vehicle. Investors liked the news, driving SPCE shares up 15% on Monday. In addition to its new astronaut training program, Virgin Galactic is ramping up its space tourism business, which will take passengers to the edge of space, and is also developing plans for a hypersonic point-to-point travel business. We are impressed by the way NASA is fostering America's new civilian space program, but we wouldn't rush to buy SPCE shares, as the company is a long way from profitability.
Industrials: Professional Services
07. Hertz tried to issue up to $500 million in new stock...from bankruptcy
There is audacity in the C-suites, then there is what Hertz Global (HTZ $0-$2-$21) tried to pull. As we previously reported, the car rental company filed for Chapter 11 bankruptcy last month. Then, to the shock of the Securities and Exchange Commission, it announced plans to issue up to $500 million in new shares to the public. The fact that these executives tried to pull such a stunt is amazing in itself; even more amazing—they probably would have found plenty of buyers who wanted to buy a "cheap" stock (HTZ currently sits at precisely $1.73/share). It didn't take long for Jay Clayton's SEC to inform the company that an immediate review of the upcoming issuance would take place, which caused Hertz executives to say, "um, never mind." Carl Icahn had already thrown in the towel on his Hertz investment at a steep loss, and odds would have been stellar that investors in these new shares would have lost everything. We are at an odd time in the investment world. We are coming out (hopefully) of a global pandemic, so many investors are rightfully timid. Meanwhile, there are still some really good bargains out there. Then you have a new group of investors that look for "cheap" stocks, earnings be damned! Like I say, an odd time indeed.
Telecommunications Services
06. The US Air Force has big plans for the SpaceX Starlink constellation
Readers are well familiar with SpaceX's plans to build a constellation of satellites in low Earth orbit (LEO) designed to ultimately provide low-cost, high-speed internet access to every part of the world—no matter how remote. To date, the company has placed 540 Starlink satellites in orbit, but that pales in comparison to the 12,000 the FCC has already approved. And even that number seems paltry to the 40,000 units SpaceX said it might eventually deploy. While we have reported on the civilian benefits of this massive network, it will also become a critical component of the nation's defense system. Last December, the United States Air Force held an Advanced Battle Management System exercise in which an AC-130 gunship connected with Starlink, proving its effectiveness for providing pinpoint accuracy. The next exercise, which was due to take place in April but was postponed due to the pandemic, will connect a number of military assets—from various branches—to the system, and will include live-fire drills against a UAV and a cruise missile. While SpaceX is a privately-held enterprise valued at roughly $36 billion, Elon Musk's company may end up bringing the SpaceX Starlink business public in an IPO, according to CEO Gwynne Shotwell. Sign us up.
Business & Professional Services
05. Wirecard CEO resigns after company "loses" $2 billion; shares dive
The FinTech arena is red-hot, specifically with respect to its payment processing segment. Companies like PayPal, Square, and Stripe are well-known players, but one German company that can't be left out of the conversation is Wirecard AG (WRCDF $33). The payment processor had a market cap of $28 billion under two years ago, along with a bright and shiny future in the industry. All of that changed this week after the company "lost" $2 billion worth of payments. Actually, it may be that the money, which was supposedly being held in two banks in the Philippines, never existed at all, but was part of a growing coverup to hide losses at the firm. After the banks publicly stated that they knew nothing about these deposits, shares of Wirecard fell over 70%, from $113 to $33, and the company's longtime CEO resigned. Last October, after a whistle-blower raised questions about falsified invoices, the company appointed KPMG as an outside auditor. Within six months, the auditing firm announced it was having challenges putting together paper trails for payments. Today, Wirecard sits at $4 billion in size, and is scrambling to salvage $2 billion worth of credit lines which may be cancelled. Too bad they can't tap into the $2 billion they supposedly held in the Philippines. Our favorite player in the space, by the way, remains PayPal (PYPL $169), which also owns the popular Venmo payment app.
Materials
04. In positive sign for global economy, materials are surging back
Of the eleven broad areas in the market, the most forgotten tends to be the materials sector. Granted, just 3.33% of all S&P 500 companies operate within the 15 industries of the sector, but that doesn't mean it shouldn't be represented in your portfolio. The pandemic decimated the performance of most materials firms as demand dried up, and they weren't doing all that well before the incident hit. Suddenly, however, the group is surging back—and that may spell good news for the global economy. Since mid-March, the Materials Select Sector SPDR (XLB $56) has risen 48% (it hit a 52-week low of $37.69 on 16 Mar). Oil and copper are the two most obvious drivers of the rally, and those two areas tend to move in direct correlation to economic activity—as opposed to gold miners, for instance. So, what are some of the top component companies in the materials sector? Air Products & Chemicals (APD, chemicals), Sherwin-Williams (SHW, specialty chemicals), Vulcan Materials (VMC, building materials), and FMC Corp (FMC, agricultural inputs) are all top holdings. In addition to XLB, investors may want to consider the Fidelity MSCI Materials ETF (FMAT $30), or the VanEck Vectors Rare Earth/Strategic Metals ETF (REMX $35).
Biotechnology
03. Gilead will begin human trials on inhaled version of remdesivir
Drug giant Gilead (GILD $60-$75-$86) made news a few months ago with its Covid-19 treatment remdesivir, a therapy which was showing promise in patients inflicted with the malady. Now, the biotech says it is ready to begin human trials of an inhaled version of the therapy, first in healthy adults, and soon (hopefully August) in healthier, non-hospitalized patients with the virus. Remdesivir is currently given intravenously, as a pill form of the drug would cause a chemical imbalance within the body. A successful inhaled version would mean patients could take the drug earlier in its progression, and from the comfort of their own homes. Remdesivir helps block the virus from taking over healthy cells and replicating itself in the body. We took our profits on GILD after the shares ran up to our $77 price target after news of the therapy first broke. The news with respect to both Covid therapies and vaccines continues to move at breakneck speed, which is another reason we remain bullish on the economy for the second half of the year.
Multiline Retail
02. Should Amazon buy Macy's?! Barron's thinks so, and so do we
What a fun synergy to imagine! Remember when Amazon (AMZN $2,757) was looking at buying Whole Foods (former symbol WFDS)? The critics came out of the woodwork telling us how the deal would ruin the natural grocer's reputation. We knew that was bunk, and it was. The acquisition now looks brilliant. So, with that in mind, try this fit: Barron's has written a piece urging the trillion-dollar online retailer to buy Penn member Macy's (M $7), a $2 billion multiline retailer we bought at $5.55 several weeks ago. We think the idea is a home run, and not just because it would help us hit our $10 price target quicker. Amazon should absolutely own a bricks-and-mortar multiline retailer, and Macy's has the same level of quality in that industry that Whole Foods has in food retailing. The future of retail will not be dominated by online shopping; the ideal will be a hybrid online/physical model. Not to knock Macy's digital presence, but let's just say it is not the benchmark. Amazon could have a "shop-in-shop" member experience for Macy's like it does for Whole Foods, or even Zappos, which the company purchased about a decade ago. All of this is speculation, of course, as neither Amazon nor Macy's has floated the idea, but we are adamantly in the Barron's camp. Hopefully some board members of both companies will run across the article and become intrigued.
Under the Radar Investment
01. Under the Radar investment: Performance Food Group
To say that most people have never heard of Performance Food Group (PFGC $29) is probably an understatement. In fact, as the third-largest food-service distributor in the country, it is fair to say that many people have not even heard of the company's two bigger rivals: Sysco (SYY) and US Foods (USFD). There are many reasons we like Performance, from its size to its financial situation to its current undervalued state. As opposed to Sysco, with its $30 billion market cap, Performance is a $3.8 billion mid-cap with strong growth potential. The company, which has turned a profit every year for the past decade, was pummeled for obvious reasons during the pandemic—it delivers food to restaurants. We believe its fall from $54 per share in mid-February to its current price fails to take into consideration the strong relationship it has built with its clients, and the nascent comeback in the food industry in the US. We would value the shares north of $40.
Answer
American engineer, professor, physicist, and inventor Robert H. Goddard successfully launched his liquid-fueled rocket from a field in Auburn, Massachusetts on 16 Mar 1926, ushering in a new era of spaceflight. In June of 1944, Germany's V-2 rocket became the first to enter space—just twenty-five years and one month before America landed humans on the moon. Not only is America the only country to ever land humans on another world, we will be the first to go back, with NASA's Artemis program on schedule for a 2024 lunar landing.
Question
A true shopping destination...
What was the first shopping center in the world designed to accommodate shoppers arriving by automobile, and what city was it architecturally designed after?
Penn Trading Desk:
(12 Jun 20) Sell Chipotle in Global Leaders Club
On 12 Mar, as the markets were bottoming, we added Chipotle Mexican Grill (CMG) to the Global Leaders Club at $590.85. We intended to hold for a longer period, but shares ran up 66% in three months and our $1,000 stop hit at $983.41. Took profits. Members, see the Trading Desk
(12 Jun 20) Add to Pharma/Biotech Powerhouse in Global Leaders Club
While we already owned this pharmaceutical company in the Penn Global Leaders Club, its masterful handling of the Celgene biotech acquisition (plus its 3% dividend yield) made us pick up more shares in the Penn Global Leaders Club. Members, see the Trading Desk
(10 Jun 20) Open retail REIT in Penn Contrarian Investor
We added a retail REIT right on the border between small- and mid-cap. A contrarian play to be sure. Target price is 47% higher than purchase. Members, see the Trading Desk
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Airlines
10. Buffett's sale of his airline stocks helped the industry find a bottom
Back in 2016, investor Warren Buffett decided to bet big on the US airline industry, with his Berkshire Hathaway (BRK.B) spending over $7 billion to accumulate shares. Around mid to late April, as the airlines were suffering through a virtually complete shutdown, Buffett threw in the towel, liquidating all of his holdings in the industry at a loss. Berkshire held an enormous position in the four American carriers—to the tune of approximately 10% of the outstanding shares of each. Right when these airlines were most vulnerable, Buffett bailed. It didn't take long, however, for astute investors to gobble up the shares the billionaire sold, betting on a recovery. They bet right. Since 01 May, American (AAL) is up 84%, United (UAL) is up 69%, Delta (DAL) is up 51%, and Southwest (LUV) is up 35%. Buffett's opportunity cost due to his panic selling? Just shy of $3 billion.
Global Strategy: East/Southeast Asia
09. North Korea cuts ties with South in effort to break US/Korean alliance
We knew it was too good to believe that the pot-bellied dictator of North Korea, Kim Jong-un, had actually assumed room temperature. Not only is he still alive, he is back to his old mercurial self. North Korea announced that it was shutting down a joint liaison office it just opened with the South back in 2018, and has turned off the "hotline" established between the two nations designed to avoid catastrophic incidents from arising. Kim claims these steps were simply in response to anti-government leaflets coming across the border from the south via balloons, but his tactics are clear: force President Moon Jae-in to sever ties with the US. His strategic goal is also crystal clear: one unified Korea, with him at the helm. The juxtaposition of the economic might of South Korea and the abject blight of North Korea is staggering to look at. Sadly, in a similar way that China believed it could simply absorb the golden goose that was Hong Kong, Kim believes that this capitalism-built wealth will be his for the taking. In reality, of course, South Koreans would end up living more like their impoverished neighbors to the north than the other way around. For his part, despite the fact that he is rather dovish, Moon is not about to sever his strong ties with the West. It doesn't help Pyongyang's cause when Kim's minions refuse to answer calls made from Seoul on the military hotline—an incident which occurred this past Tuesday.
Financials: Insurance
08. Online insurance provider Lemonade files to go public
Move over fintech, now there is insurtech, which promises to "disrupt the insurance industry through innovation and online efficiencies." Only time will tell just how disruptive a force it will become, but we will soon have a new metric to measure its success. Lemonade, the insurtech firm backed by SoftBank, has filed to go public. Reviewing the startup's 08 June filing with the SEC, it plans to raise $100 million in an IPO and trade on the New York Stock Exchange under the symbol LMND, with Goldman Sachs and Morgan Stanley underwriting the deal. According at the company's website, Lemonade offers home and renters insurance "built for the 21st century." The company uses artificial intelligence and machine learning to increase efficiencies, thereby creating savings (at least in theory) for its customers. While the company, which has been around since 2016, is not profitable (it lost $36.5 million on $26.2 million in revenues last quarter), that doesn't mean shares won't take off when they begin trading within the next few months. Investors are hungry for IPOs, as there was a dearth of new offerings during the heart of the pandemic. Should you invest? While we could see the stock spiking out of the gate, our advice would be to remain patient—odds are good it will be trading below its IPO price within months after the launch. As for Masayoshi Son's SoftBank, the VC firm desperately needs a win following the massive losses it took in WeWork, Sprint, and Uber—putting a serious dent in Son's 300-year master plan.
Retail REITs
07. Simon Property Group terminates merger deal with Taubman Centers
Although February is just four months behind us, it seems like an eternity ago. Retail REIT Taubman Centers (TCO $26-$34-$53) is no doubt thinking the same thing. Shares of the $2 billion real estate investment trust fell 25% Wednesday morning after much larger rival Simon Property Group (SPG $42-$80-$169) exercised its right to walk away from a $3.6 billion deal to acquire the firm. Simon, the biggest US mall owner, gave the ostensible excuse that Taubman did not take the proper steps to protect its properties from the pandemic, but that is a hard one to swallow. After all, were any of Simon's malls open in March or April? Simon is also suing its $4 billion tenant Gap (GAP $5-$11-$20) for failing to pay rent during the pandemic—while the mall was closed! There are plenty of unseemly characters in the landlord business; Simon is one we wouldn't want to do business with—or, quite frankly, invest in. In fact, with its 10 P/E ratio, 6% dividend yield, and positive free cash flow, TCO looks like a much better deal to us. SPG was trading down 8% on the news it had walked away from the deal.
Monetary Policy
06. Fed's projections show zero interest rates and explosive debt
Great news if you are going to buy a new home or auto; terrible news if you are living off of the income generated from your investment portfolio. During last week's Federal Open Market Committee meeting and Powell's subsequent news conference, the central bank made it clear that near-zero interest rates will be the norm through 2022. Additionally, the Fed will keep buying bonds, to the tune of $80 billion a month in Treasuries and $40 billion in mortgage-backed securities. Telling us what we already assumed, the Fed projects a 6.5% contraction in the US economy this year. If there was one bright spot in the meeting/commentary it was this: the bank's economic models predict a 5% GDP growth rate in 2021 followed by a 3.5% gain in 2022. Chairman Powell sees a strong bounce-back in economic growth in the second half of this year, assuming no major recurrence of the pandemic this fall. As for the Fed's balance sheet, which it had whittled down to $4 trillion or so, it has now mushroomed back to over $7.2 trillion—and it is growing by roughly $120 billion each month. Putting that in historical perspective, in 2009 the Fed's balance sheet added up to a grand total of $475 billion.
Economic Outlook
05. No lemming here: Morgan Stanley says expect a v-shaped recovery
The business media sounded like an echo chamber: nearly all voices were telling us not to expect a v-shaped economic recovery. Even during the depths of March's market plunge, we did expect a quicker recovery than most were predicting, based on promising therapy and vaccine news, and the American Spirit which still resides in most of us (despite what the press chooses to report on). At least one major investment house also had a rosy outlook: Morgan Stanley's top economist, Chetan Ahya, sees a distinct v-shaped recession based on the temporary (as opposed to systemic) challenges that yanked away our nice growth trajectory. Another aspect of Morgan Stanley's thesis we agree with is the idea that not all industries will see a sharp comeback in the second half of the year; specifically, office REITs are going to have to adjust to a new world where fewer come back to the office setting. For an industry that banked on ultra-low occupancy rates and clockwork-like rate increases, this should be interesting to watch—from the sidelines. We are moving into other areas of the REIT market. At this point, we would even take retail REITs over their corporate office space cousins. As for the overall recover, Morgan Stanley sees us back to pre-virus productivity levels by the fourth quarter of this year and the first quarter of 2021.
Economics: Supply & Demand
04. Shoppers are back! May retail sales figure reflects biggest surge ever
Futures were already heavily in the green early Tuesday morning on news that the Trump administration was going to float a $1 trillion infrastructure bill to spur the economy, then the retail sales numbers for May hit the wires. Expectations called a month-over-month gain of around 8%; instead, sales rocketed 17.7%—the highest monthly spike on record. Delving into the report, sales of motor vehicles led the charge, with that group jumping 44.1%. Restaurants also staged a remarkable comeback, with receipts jumping by 29.1%. Interestingly, even though the home improvement retailers remained open during the height of the pandemic, that segment also notched an impressive 16% gain in May. Within minutes of the report's release, futures doubled their gains on all three major indexes.
Telecom Services
03. T-Mobile double-whammy: outages and SoftBank liquidations
Former Penn Intrepid Trading Platform member (we sold it on 11 May) T-Mobile (TMUS $103) got some fantastic news in February when a federal judge ruled that the company's merger with Sprint could proceed. Since then, however, the news has been less-than-stellar. Most recently, a string of nationwide outages has plagued the company and frustrated customers. The FCC just announced a formal investigation into the disruptions, calling them "unacceptable." Now comes news that SoftBank plans to divest itself of up to two-thirds of its stake in the merged company. That amount would total about $20 billion, or a little over 15% of the company's market cap. The announced sale says more about SoftBank's need to raise cash than it does about the new T-Mobile, but the move will certainly put downward pressure on the shares. Although we could have held out for a larger gain (our shares stopped out at $96), we believe the sideline is the place to be with respect to the carrier right now. The company's strategy for moving into the 5G environment is still a big question mark.
Global Strategy: South Asia
02. India proves the media's tired narrative on China is false
Here is the tired and worn media narrative: China was well on its way towards eclipsing the US as the world's largest economy—something the other countries of the world were fine with—when the US came along with its destructive trade war. Sorry, media, that false narrative continues to crumble. Even before the pandemic, a majority of nations around the world had a bitter, firsthand taste of China's unfair trade tactics and bullying behavior. Countries from Vietnam to India have had a longstanding animosity toward and distrust of Beijing. The latest example comes to us from the border region between India and China. A seven-week military standoff between the two countries along the disputed Himalayan border turned deadly, as India confirmed that at least 20 of its troops have been killed. China is blaming New Delhi—specifically the government of Narendra Modi—for the escalation, but China has been increasingly exerting its control over regions from the South Sea to Taiwan to Hong Kong. In fact, the catalyst for this most recent deadly incident was probably the deployment of Chinese troops to an area between western Tibet and Kashmir; an incendiary move which caught India off guard. China despises the fact that India has been aligning itself more with the United States recently, and this may have been part of a larger strategy of intimidation against the Modi government. With both countries holding a population of roughly 1.3 billion people, it is in the best interest of the United States to support the economic expansion of India—the world's largest democracy. Expect increasingly alarming stories of China's regional ambitions over the coming months and years. Unlike with India, China's economic growth does pose a direct threat both to the region and the globe.
Under the Radar Investment
01. Under the Radar Investment: Advanced Energy Industries Inc
Advanced Energy Industries Inc (AEIS $67) is a $2.5 billion (s)mid-cap industrials company in the electrical equipment and parts industry—one of those small but mighty powerhouses which few have heard of, but that pulls in steady revenues and operates in the black year after year. The company exists in the realm between raw power production and the useful application of that power. With customers in a large number of industries across several sectors, its products include power control modules (control and measure temps during manufacturing), thin-film power conversion systems (control and modify raw power into a customizable power source), and plasma power generators for use in flat panel displays, glass coatings, and semiconductor/solar panel manufacturing. A majority of the Denver-based firm's revenues are generated in the United States, with the rest primarily from Europe and Asia. AEIS, which was founded in 1981, trades on the NASDAQ and is a member component of 453 mutual funds (as of Mar, 2020).
Answer
We gave the answer away in our headline image: The Country Club Plaza in Kansas City, which JC Nichols began accumulating the land for in 1907, opened to the public in 1923. The venue, which includes 804,000 square feet of retail space and 468,000 square feet of office space, was designed architecturally after the city of Seville, Spain. Taubman Centers (TCO) and Macerich Co (MAC) have joint ownership of the shopping district.
A true shopping destination...
What was the first shopping center in the world designed to accommodate shoppers arriving by automobile, and what city was it architecturally designed after?
Penn Trading Desk:
(12 Jun 20) Sell Chipotle in Global Leaders Club
On 12 Mar, as the markets were bottoming, we added Chipotle Mexican Grill (CMG) to the Global Leaders Club at $590.85. We intended to hold for a longer period, but shares ran up 66% in three months and our $1,000 stop hit at $983.41. Took profits. Members, see the Trading Desk
(12 Jun 20) Add to Pharma/Biotech Powerhouse in Global Leaders Club
While we already owned this pharmaceutical company in the Penn Global Leaders Club, its masterful handling of the Celgene biotech acquisition (plus its 3% dividend yield) made us pick up more shares in the Penn Global Leaders Club. Members, see the Trading Desk
(10 Jun 20) Open retail REIT in Penn Contrarian Investor
We added a retail REIT right on the border between small- and mid-cap. A contrarian play to be sure. Target price is 47% higher than purchase. Members, see the Trading Desk
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Airlines
10. Buffett's sale of his airline stocks helped the industry find a bottom
Back in 2016, investor Warren Buffett decided to bet big on the US airline industry, with his Berkshire Hathaway (BRK.B) spending over $7 billion to accumulate shares. Around mid to late April, as the airlines were suffering through a virtually complete shutdown, Buffett threw in the towel, liquidating all of his holdings in the industry at a loss. Berkshire held an enormous position in the four American carriers—to the tune of approximately 10% of the outstanding shares of each. Right when these airlines were most vulnerable, Buffett bailed. It didn't take long, however, for astute investors to gobble up the shares the billionaire sold, betting on a recovery. They bet right. Since 01 May, American (AAL) is up 84%, United (UAL) is up 69%, Delta (DAL) is up 51%, and Southwest (LUV) is up 35%. Buffett's opportunity cost due to his panic selling? Just shy of $3 billion.
Global Strategy: East/Southeast Asia
09. North Korea cuts ties with South in effort to break US/Korean alliance
We knew it was too good to believe that the pot-bellied dictator of North Korea, Kim Jong-un, had actually assumed room temperature. Not only is he still alive, he is back to his old mercurial self. North Korea announced that it was shutting down a joint liaison office it just opened with the South back in 2018, and has turned off the "hotline" established between the two nations designed to avoid catastrophic incidents from arising. Kim claims these steps were simply in response to anti-government leaflets coming across the border from the south via balloons, but his tactics are clear: force President Moon Jae-in to sever ties with the US. His strategic goal is also crystal clear: one unified Korea, with him at the helm. The juxtaposition of the economic might of South Korea and the abject blight of North Korea is staggering to look at. Sadly, in a similar way that China believed it could simply absorb the golden goose that was Hong Kong, Kim believes that this capitalism-built wealth will be his for the taking. In reality, of course, South Koreans would end up living more like their impoverished neighbors to the north than the other way around. For his part, despite the fact that he is rather dovish, Moon is not about to sever his strong ties with the West. It doesn't help Pyongyang's cause when Kim's minions refuse to answer calls made from Seoul on the military hotline—an incident which occurred this past Tuesday.
Financials: Insurance
08. Online insurance provider Lemonade files to go public
Move over fintech, now there is insurtech, which promises to "disrupt the insurance industry through innovation and online efficiencies." Only time will tell just how disruptive a force it will become, but we will soon have a new metric to measure its success. Lemonade, the insurtech firm backed by SoftBank, has filed to go public. Reviewing the startup's 08 June filing with the SEC, it plans to raise $100 million in an IPO and trade on the New York Stock Exchange under the symbol LMND, with Goldman Sachs and Morgan Stanley underwriting the deal. According at the company's website, Lemonade offers home and renters insurance "built for the 21st century." The company uses artificial intelligence and machine learning to increase efficiencies, thereby creating savings (at least in theory) for its customers. While the company, which has been around since 2016, is not profitable (it lost $36.5 million on $26.2 million in revenues last quarter), that doesn't mean shares won't take off when they begin trading within the next few months. Investors are hungry for IPOs, as there was a dearth of new offerings during the heart of the pandemic. Should you invest? While we could see the stock spiking out of the gate, our advice would be to remain patient—odds are good it will be trading below its IPO price within months after the launch. As for Masayoshi Son's SoftBank, the VC firm desperately needs a win following the massive losses it took in WeWork, Sprint, and Uber—putting a serious dent in Son's 300-year master plan.
Retail REITs
07. Simon Property Group terminates merger deal with Taubman Centers
Although February is just four months behind us, it seems like an eternity ago. Retail REIT Taubman Centers (TCO $26-$34-$53) is no doubt thinking the same thing. Shares of the $2 billion real estate investment trust fell 25% Wednesday morning after much larger rival Simon Property Group (SPG $42-$80-$169) exercised its right to walk away from a $3.6 billion deal to acquire the firm. Simon, the biggest US mall owner, gave the ostensible excuse that Taubman did not take the proper steps to protect its properties from the pandemic, but that is a hard one to swallow. After all, were any of Simon's malls open in March or April? Simon is also suing its $4 billion tenant Gap (GAP $5-$11-$20) for failing to pay rent during the pandemic—while the mall was closed! There are plenty of unseemly characters in the landlord business; Simon is one we wouldn't want to do business with—or, quite frankly, invest in. In fact, with its 10 P/E ratio, 6% dividend yield, and positive free cash flow, TCO looks like a much better deal to us. SPG was trading down 8% on the news it had walked away from the deal.
Monetary Policy
06. Fed's projections show zero interest rates and explosive debt
Great news if you are going to buy a new home or auto; terrible news if you are living off of the income generated from your investment portfolio. During last week's Federal Open Market Committee meeting and Powell's subsequent news conference, the central bank made it clear that near-zero interest rates will be the norm through 2022. Additionally, the Fed will keep buying bonds, to the tune of $80 billion a month in Treasuries and $40 billion in mortgage-backed securities. Telling us what we already assumed, the Fed projects a 6.5% contraction in the US economy this year. If there was one bright spot in the meeting/commentary it was this: the bank's economic models predict a 5% GDP growth rate in 2021 followed by a 3.5% gain in 2022. Chairman Powell sees a strong bounce-back in economic growth in the second half of this year, assuming no major recurrence of the pandemic this fall. As for the Fed's balance sheet, which it had whittled down to $4 trillion or so, it has now mushroomed back to over $7.2 trillion—and it is growing by roughly $120 billion each month. Putting that in historical perspective, in 2009 the Fed's balance sheet added up to a grand total of $475 billion.
Economic Outlook
05. No lemming here: Morgan Stanley says expect a v-shaped recovery
The business media sounded like an echo chamber: nearly all voices were telling us not to expect a v-shaped economic recovery. Even during the depths of March's market plunge, we did expect a quicker recovery than most were predicting, based on promising therapy and vaccine news, and the American Spirit which still resides in most of us (despite what the press chooses to report on). At least one major investment house also had a rosy outlook: Morgan Stanley's top economist, Chetan Ahya, sees a distinct v-shaped recession based on the temporary (as opposed to systemic) challenges that yanked away our nice growth trajectory. Another aspect of Morgan Stanley's thesis we agree with is the idea that not all industries will see a sharp comeback in the second half of the year; specifically, office REITs are going to have to adjust to a new world where fewer come back to the office setting. For an industry that banked on ultra-low occupancy rates and clockwork-like rate increases, this should be interesting to watch—from the sidelines. We are moving into other areas of the REIT market. At this point, we would even take retail REITs over their corporate office space cousins. As for the overall recover, Morgan Stanley sees us back to pre-virus productivity levels by the fourth quarter of this year and the first quarter of 2021.
Economics: Supply & Demand
04. Shoppers are back! May retail sales figure reflects biggest surge ever
Futures were already heavily in the green early Tuesday morning on news that the Trump administration was going to float a $1 trillion infrastructure bill to spur the economy, then the retail sales numbers for May hit the wires. Expectations called a month-over-month gain of around 8%; instead, sales rocketed 17.7%—the highest monthly spike on record. Delving into the report, sales of motor vehicles led the charge, with that group jumping 44.1%. Restaurants also staged a remarkable comeback, with receipts jumping by 29.1%. Interestingly, even though the home improvement retailers remained open during the height of the pandemic, that segment also notched an impressive 16% gain in May. Within minutes of the report's release, futures doubled their gains on all three major indexes.
Telecom Services
03. T-Mobile double-whammy: outages and SoftBank liquidations
Former Penn Intrepid Trading Platform member (we sold it on 11 May) T-Mobile (TMUS $103) got some fantastic news in February when a federal judge ruled that the company's merger with Sprint could proceed. Since then, however, the news has been less-than-stellar. Most recently, a string of nationwide outages has plagued the company and frustrated customers. The FCC just announced a formal investigation into the disruptions, calling them "unacceptable." Now comes news that SoftBank plans to divest itself of up to two-thirds of its stake in the merged company. That amount would total about $20 billion, or a little over 15% of the company's market cap. The announced sale says more about SoftBank's need to raise cash than it does about the new T-Mobile, but the move will certainly put downward pressure on the shares. Although we could have held out for a larger gain (our shares stopped out at $96), we believe the sideline is the place to be with respect to the carrier right now. The company's strategy for moving into the 5G environment is still a big question mark.
Global Strategy: South Asia
02. India proves the media's tired narrative on China is false
Here is the tired and worn media narrative: China was well on its way towards eclipsing the US as the world's largest economy—something the other countries of the world were fine with—when the US came along with its destructive trade war. Sorry, media, that false narrative continues to crumble. Even before the pandemic, a majority of nations around the world had a bitter, firsthand taste of China's unfair trade tactics and bullying behavior. Countries from Vietnam to India have had a longstanding animosity toward and distrust of Beijing. The latest example comes to us from the border region between India and China. A seven-week military standoff between the two countries along the disputed Himalayan border turned deadly, as India confirmed that at least 20 of its troops have been killed. China is blaming New Delhi—specifically the government of Narendra Modi—for the escalation, but China has been increasingly exerting its control over regions from the South Sea to Taiwan to Hong Kong. In fact, the catalyst for this most recent deadly incident was probably the deployment of Chinese troops to an area between western Tibet and Kashmir; an incendiary move which caught India off guard. China despises the fact that India has been aligning itself more with the United States recently, and this may have been part of a larger strategy of intimidation against the Modi government. With both countries holding a population of roughly 1.3 billion people, it is in the best interest of the United States to support the economic expansion of India—the world's largest democracy. Expect increasingly alarming stories of China's regional ambitions over the coming months and years. Unlike with India, China's economic growth does pose a direct threat both to the region and the globe.
Under the Radar Investment
01. Under the Radar Investment: Advanced Energy Industries Inc
Advanced Energy Industries Inc (AEIS $67) is a $2.5 billion (s)mid-cap industrials company in the electrical equipment and parts industry—one of those small but mighty powerhouses which few have heard of, but that pulls in steady revenues and operates in the black year after year. The company exists in the realm between raw power production and the useful application of that power. With customers in a large number of industries across several sectors, its products include power control modules (control and measure temps during manufacturing), thin-film power conversion systems (control and modify raw power into a customizable power source), and plasma power generators for use in flat panel displays, glass coatings, and semiconductor/solar panel manufacturing. A majority of the Denver-based firm's revenues are generated in the United States, with the rest primarily from Europe and Asia. AEIS, which was founded in 1981, trades on the NASDAQ and is a member component of 453 mutual funds (as of Mar, 2020).
Answer
We gave the answer away in our headline image: The Country Club Plaza in Kansas City, which JC Nichols began accumulating the land for in 1907, opened to the public in 1923. The venue, which includes 804,000 square feet of retail space and 468,000 square feet of office space, was designed architecturally after the city of Seville, Spain. Taubman Centers (TCO) and Macerich Co (MAC) have joint ownership of the shopping district.
Headlines for the Week of 31 May 2020—06 Jun 2020
Question
Marketing Magic...
While orange groves were abundant in Southern California in the early 20th century, the California Fruit Grower's Exchange, which officially changed its name to Sunkist in 1952, had a real challenge getting Americans to embrace their other, less prolific citrus fruit, the lemon. What historic event did the Exchange's marketing director, Don Francisco, use to catapult the sour yellow fruit to fame?
Penn Trading Desk:
(03 Jun 20) Penn: Open medical instruments company Intrepid
We opened a new small-cap ($1.9B) medical instruments and supplies company in the Intrepid Trading Platform. Members can view the Trading Desk for details.
(01 Jun 20) Penn: Close VEEV in Intrepid
Veeva systems (VEEV $214) surpassed our price target; sell in Intrepid Trading Platform @ $214.06 for 14.14% short-term gain.
(28 May 20) Penn: Open airline in the new Penn Contrarian Investors fund
We didn't think that we would be ready to jump back into an airline this soon after the disastrous event which grounded 90% of flights, but one major airline was priced at too steep a value to pass up.
(28 May 20) Penn: Open aerospace and defense juggernaut in Global Leaders
Since removing Boeing from the GLC after the first 737 MAX crash we have held an open spot for an aerospace giant. We have added an exemplary US firm to the Club of 40. Members, see the Trading Desk for details.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Economics: Work & Pay
10. A simply incredible May jobs report—to the upside—shocks analysts
All morning long, well before the monthly jobs report came out, the press was preparing us for the worst. We were told to expect to see 7.5 million jobs lost in the country, sending the US unemployment rate up to 19.5%. Oddly, market futures seemed to be shrugging off the impending doom—all three major averages were in the green pre-market. As the numbers hit, I happened to be watching two different business channels—CNBC and Bloomberg. The looks on the faces of the two respective economics reporters were priceless. Instead of losing 7.5 million jobs, the US economy actually added 2.51 million jobs. Steve Liesman on CNBC looked at the figures twice to assure there wasn't a negative sign in front of the number. Instead of hitting a 20% unemployment rate, that figure dropped from 14.7% to 13.3%. Still horrendous, to be sure, but very, very few people predicted this v-shaped jobs rebound, especially after we lost 21 million jobs in April. Virtually all of the metrics in the report looked good. A large percentage of the jobs gain were in the services sector—the area most beaten down by the virus—and manufacturing jobs also made a big comeback. In other words, the workers seeing the strongest gains were those in the lower- to middle-income brackets. How did the markets react to these spectacular numbers? As we write this the Dow is up over 900 points (3.43%) and the NASDAQ is up 224 (2.33%). Now we must wonder...what else that the press has been selling us will prove to be dead wrong?
Specialty Retail
09. Penn member Tractor Supply gives strong second-quarter outlook
Shares of home improvement retailer Tractor Supply Co (TSCO $64-$115-$114) punched through their 52-week-high on Wednesday following management's rosy forecast for Q2. The $13 billion farm-focused retailer, which is up 122% since we added it to the Penn Global Leaders Club, expects to earn between $2.45 and $2.65 per share over the course of the quarter—well above the $1.78 analysts were forecasting. Additionally, the company now expects sales of $3 billion in the three-month period, versus the $2.53 billion analyst estimate. Those are remarkable numbers for a retailer operating in the midst of a pandemic, but management took the bull by the horns early on, preparing their stores for a new "low-contact" environment, adding curbside pickup, and hiring 5,000 new workers for the 1,900 locations and eight distribution centers. The company also greatly enhanced their eCommerce business; something one might not expect from a farm supply company. In early April, we said that we expected to see shares climb from their current $88 price to above $100 in 2020. That prediction took all of one month to come true. It is amazing what strong management can accomplish, even in the most staid of industries. Shares of TSCO are up over 24% year-to-date.
Global Strategy: Europe
08. The EU's bailout plan will create enormous friction among members
We have been convinced for years that fissures in the bedrock that is the European Union will continue to widen, causing mass economic dysfunction on the continent. The greatest example of this—to date—was Brexit. Now, thanks to the Chinese-borne pandemic, Brussels is about to undertake a $2 trillion COVID response plan that is guaranteed to deepen the rift between the nation-states in the union. Ironically, the plan is designed to interweave the separate economies together in an unprecedented manner. The proposal calls for $824 billion worth of immediate aid and a budget of $1.21 trillion spent over the next seven years to reverse the damage caused by the virus. Using the vehicle of commonly issued debt, the plan will transfer massive amounts of wealth to the poorer EU nations in the south, namely Greece, Italy, and Spain. Northern countries from Austria to Sweden are crying foul, arguing that their own fiscal responsibility is being punished to support their less responsible neighbors to the south. Pressure will be intense for all 27 members to approve the plan, and expect Germany and France to browbeat the other nations into submission ("You need the money, and we have it—agree to our terms or else"). Proving the bloc's America-envy (they set up the EU to emulate this country's system), the German finance minister compared the plan to Alexander Hamilton's 1790 move to assume states' debt from the American Revolution in exchange for an abdication of some powers. The comparison is, in fact, uncanny in certain ways. In both examples, the northern and southern states (13 in the US at the time, 27 currently in the EU) had/have very different ideas on matters of great importance. This will be fun to watch play out from the other side of the globe.
Pharmaceuticals
07. AstraZeneca shares jump thanks to its exciting new lung cancer drug
As UK-based drugmaker AstraZeneca (AZN $36-$54-$57) prepared to unblind the latest study of its lung cancer drug Tagrisso, expectations were high. The process of unblinding, or disclosing to participants and the study group who received the actual therapy and who received the placebo, was already two years ahead of schedule based on the seemingly overwhelming effectiveness of the drug. As the results were evaluated, one thing became clear: the expectations were set too low. Two years after surgery, 89% of lung cancer patients who received the Tagrisso were cancer-free, versus 53% of those given a placebo. Researchers at the firm calculate that the drug cuts the risk of disease recurrence or death of patients with forms of early-stage non-small cell lung cancer by 83%. AstraZeneca reported sales of $3.2 billion for the drug—which was approved by the FDA five years ago—last year, but that figure is now expected to rise substantially based on these remarkable results. AZN generated income of $1.3 billion last year on $24.4 billion in revenue. Is AZN a bargain for investors? With its P/E ratio of 94, it seems expensive—even with the great Tagrisso news.
Global Strategy: East/Southeast Asia
06. China faces new reality of falling orders from overseas customers
We have talked ad nauseam about China's growth fallacy, supported by the dolts in the media—the idea that the communist nation's growth trajectory would maintain its double-digit annual clip. We knew it was a matter of time before those sky-high GDP rates came falling back to earth. What we didn't foresee was a pandemic emanating from the country adding downward momentum to the trip. Despite that country's boast that it was coming back online with government-run efficiency (OK, that we do buy), there is a major cog in the machinery: a dearth of new international orders. While the new-export-orders subindex of China's "official" (meaning padded) PMI report showed improvement from 33.5 in April to 35.3 in May, that is still a horrendously-bad number. Keep in mind that any number above 50 reflects economic expansion, while sub-50 represents contraction. Here's the question only time will answer: how much of the contraction is simply due to other countries still trying to shake off the economic effects of the pandemic, and how much is due to countries attempting to source their goods from elsewhere. Granted, it would be rather difficult to undertake the latter effort on the fly, but we get the idea that a better management of country risk will force importers to begin looking outside of mainland China for more and more of their goods.
Market Risk Management
05. Don't look now, but the volatility index is suddenly down to 27
The volatility index, or VIX, measures the implied expected volatility of the US stock market; hence its nickname, the "fear gauge." The higher the figure, on a scale of 0 to 100, the higher the level of concern. Considering the fear gauge rose all the way to 66.96 at the height of the financial meltdown, it would have been hard to imagine that number being eclipsed. Then came the pandemic. In the middle of March, as the markets were in free fall, the VIX climbed all the way to 82.69. At the time, we mentioned that any semblance of normalcy couldn't be expected until the VIX fell back to within a reasonable distance from its long-term average of 18.59. Don't say it too loudly, but our little fear monitor has suddenly dropped to 27.51. Still elevated, but certainly a more comforting level. While the so-called economic experts continue to throw cold water on the idea of a v-shaped recovery, the fear gauge looks to be giving us the flip side of that argument.
Personal Finance
04. It took a national lockdown, but the US savings rate hit a new record
If we have one mantra, one financial maxim above all others, it is this: The first ten cents of every dollar you earn goes into your savings/investment "vault," and that money is not to be touched until you have enough to fund your desired lifestyle with a 5% per year withdrawal. Unfortunately, Americans have one of the lowest savings rates in the developed world. Until this past April, that is. According to the Bureau of Economic Analysis (BEA), the personal savings rate—the percentage of disposable income Americans save each month—hit a whopping 33% in the month of April. As you look at the chart and see the 8.85% average, keep in mind that the figure does not mean Americans save an average of 8.85% of their gross or net income—merely their disposable income. Yes, the US consumer accounts for two-thirds of the domestic economy (and much of the Chinese economy), but imagine what household wealth would look like if everyone did actually put 10% of even their net income to work in an investment plan. Perhaps then we could begin to tackle our $1 trillion worth of lingering credit card debt and $1.5 trillion worth of student loan debt. It is not the duty of the American consumer to support retailers, domestic or foreign; it is their duty to assure the fiscal solvency of their household.
Telecom Services
03. Zoom is now worth more than the four major US airlines...combined
Before we discuss what a strong quarter Zoom Video (ZM $208) just reported, it is important to point out that the video conferencing platform has a rather rich multiple: its P/E ratio now sits at 2,162. Nonetheless, thanks to an exponential increase in cloud-based company meetings, Q1 was a barn-burner. Against expected revenues of $203 million, the company reported $328 million in sales—a 169% increase over the same quarter last year. Earnings expectations of $0.09 per share were dwarfed by the $0.20 reported, and expected Q2 revenues of nearly $500 million are over twice what the Street expects. Is this crazy-high multiple deserved? That all depends on how many of the platform's millions of users can be convinced to convert from the free service to the paid subscription model. To put Zoom's new market cap of $59 billion in perspective, the top four US airlines—Delta, United, American, and Southwest—have a combined size of $46 billion.
Space Sciences & Exploration
02. America ushers in an exciting new era of spaceflight
As a lifelong space buff, I have always equated/compared human spaceflight to the discovery, exploration, and ultimate colonization of the New World. That effort moved at a snail's pace until private enterprise got involved. This past week, in a truly historic moment for mankind's future in space, humans took off for the first time ever on a private launch vehicle—with some help from NASA, of course. Equally important, America regained the power it willingly abdicated a decade ago to launch astronauts from American soil. Bob Behnken and Doug Hurley, former members of the US Air Force and United States Marine Corps, respectively, blasted off in their Crew Dragon capsule nestled atop a SpaceX Falcon 9 rocket in a spectacular launch. Even more thrilling to watch than a Space Shuttle mission, the launch more closely resembled a Saturn V launch from the Apollo glory days. As for the astronauts, they docked with the International Space Station about 19 hours after launch. The Crew Dragon is an enormous asset to have docked at the ISS, as it gives the astronauts on board a "life raft," so to speak, should they need to exit the orbiting research platform. As for when Behnken and Hurley will return to earth, that depends on when the next commercial crew launch will be ready for takeoff. Even that is an incredible statement. Imagine having the Apollo 11 astronauts remain on the moon until Apollo 12 was ready to go! We have truly ushered in a new era of human spaceflight. Thank you, Elon Musk.
Under the Radar Investment
01. Under the Radar Investment: Grocery Outlet Holding Corp
CrowdStrike Holdings (CRWD $93) is a $20 billion leading global cybersecurity vendor specializing in endpoint (think laptops, smartphones, tablets, workstations) protection, threat intelligence and hunting, and attack remediation. Founded in 2011, the company sells packaged tiers of cybersecurity protection and offers individual security modules via its online marketplace. The company's new Falcon platform could be a game-changer: it is designed to stop breaches and improve performance while operating within the cloud using a radical new AI-based security architecture. CrowdStrike's growth trajectory has soared in the work-at-home environment, and we don't believe its new corporate customers will be leaving the platform as employees re-enter the office. CRWD is the number one holding in our First Trust NASDAQ Cybersecurity ETF (CIBR) positioned in the Dynamic Growth Strategy.
Answer
As commercial lemon farming finally began to take hold in 1918, there were plenty of citrus-producing trees but little consumer demand. Don Francisco, who had recently left his role as fruit examiner to become Sunkist's advertising manager, saw a golden opportunity in the Spanish Flu epidemic sweeping the world. As the flu began pounding US cities in the fall of 2018, Francisco began sending ads—disguised as public service announcements—out to newspapers across the nation extolling the health benefits of the lemon. Careful not to label it an actual medicine, the ads urged Americans to "drink one or two glasses of hot lemonade each day" to ward off sickness. Lemon sales rose 80% in one month, and government agencies got involved to help stem price gouging. Through slick marketing (and a gullible and scared public), the lemon found a new place of honor in homes across America.
Marketing Magic...
While orange groves were abundant in Southern California in the early 20th century, the California Fruit Grower's Exchange, which officially changed its name to Sunkist in 1952, had a real challenge getting Americans to embrace their other, less prolific citrus fruit, the lemon. What historic event did the Exchange's marketing director, Don Francisco, use to catapult the sour yellow fruit to fame?
Penn Trading Desk:
(03 Jun 20) Penn: Open medical instruments company Intrepid
We opened a new small-cap ($1.9B) medical instruments and supplies company in the Intrepid Trading Platform. Members can view the Trading Desk for details.
(01 Jun 20) Penn: Close VEEV in Intrepid
Veeva systems (VEEV $214) surpassed our price target; sell in Intrepid Trading Platform @ $214.06 for 14.14% short-term gain.
(28 May 20) Penn: Open airline in the new Penn Contrarian Investors fund
We didn't think that we would be ready to jump back into an airline this soon after the disastrous event which grounded 90% of flights, but one major airline was priced at too steep a value to pass up.
(28 May 20) Penn: Open aerospace and defense juggernaut in Global Leaders
Since removing Boeing from the GLC after the first 737 MAX crash we have held an open spot for an aerospace giant. We have added an exemplary US firm to the Club of 40. Members, see the Trading Desk for details.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Economics: Work & Pay
10. A simply incredible May jobs report—to the upside—shocks analysts
All morning long, well before the monthly jobs report came out, the press was preparing us for the worst. We were told to expect to see 7.5 million jobs lost in the country, sending the US unemployment rate up to 19.5%. Oddly, market futures seemed to be shrugging off the impending doom—all three major averages were in the green pre-market. As the numbers hit, I happened to be watching two different business channels—CNBC and Bloomberg. The looks on the faces of the two respective economics reporters were priceless. Instead of losing 7.5 million jobs, the US economy actually added 2.51 million jobs. Steve Liesman on CNBC looked at the figures twice to assure there wasn't a negative sign in front of the number. Instead of hitting a 20% unemployment rate, that figure dropped from 14.7% to 13.3%. Still horrendous, to be sure, but very, very few people predicted this v-shaped jobs rebound, especially after we lost 21 million jobs in April. Virtually all of the metrics in the report looked good. A large percentage of the jobs gain were in the services sector—the area most beaten down by the virus—and manufacturing jobs also made a big comeback. In other words, the workers seeing the strongest gains were those in the lower- to middle-income brackets. How did the markets react to these spectacular numbers? As we write this the Dow is up over 900 points (3.43%) and the NASDAQ is up 224 (2.33%). Now we must wonder...what else that the press has been selling us will prove to be dead wrong?
Specialty Retail
09. Penn member Tractor Supply gives strong second-quarter outlook
Shares of home improvement retailer Tractor Supply Co (TSCO $64-$115-$114) punched through their 52-week-high on Wednesday following management's rosy forecast for Q2. The $13 billion farm-focused retailer, which is up 122% since we added it to the Penn Global Leaders Club, expects to earn between $2.45 and $2.65 per share over the course of the quarter—well above the $1.78 analysts were forecasting. Additionally, the company now expects sales of $3 billion in the three-month period, versus the $2.53 billion analyst estimate. Those are remarkable numbers for a retailer operating in the midst of a pandemic, but management took the bull by the horns early on, preparing their stores for a new "low-contact" environment, adding curbside pickup, and hiring 5,000 new workers for the 1,900 locations and eight distribution centers. The company also greatly enhanced their eCommerce business; something one might not expect from a farm supply company. In early April, we said that we expected to see shares climb from their current $88 price to above $100 in 2020. That prediction took all of one month to come true. It is amazing what strong management can accomplish, even in the most staid of industries. Shares of TSCO are up over 24% year-to-date.
Global Strategy: Europe
08. The EU's bailout plan will create enormous friction among members
We have been convinced for years that fissures in the bedrock that is the European Union will continue to widen, causing mass economic dysfunction on the continent. The greatest example of this—to date—was Brexit. Now, thanks to the Chinese-borne pandemic, Brussels is about to undertake a $2 trillion COVID response plan that is guaranteed to deepen the rift between the nation-states in the union. Ironically, the plan is designed to interweave the separate economies together in an unprecedented manner. The proposal calls for $824 billion worth of immediate aid and a budget of $1.21 trillion spent over the next seven years to reverse the damage caused by the virus. Using the vehicle of commonly issued debt, the plan will transfer massive amounts of wealth to the poorer EU nations in the south, namely Greece, Italy, and Spain. Northern countries from Austria to Sweden are crying foul, arguing that their own fiscal responsibility is being punished to support their less responsible neighbors to the south. Pressure will be intense for all 27 members to approve the plan, and expect Germany and France to browbeat the other nations into submission ("You need the money, and we have it—agree to our terms or else"). Proving the bloc's America-envy (they set up the EU to emulate this country's system), the German finance minister compared the plan to Alexander Hamilton's 1790 move to assume states' debt from the American Revolution in exchange for an abdication of some powers. The comparison is, in fact, uncanny in certain ways. In both examples, the northern and southern states (13 in the US at the time, 27 currently in the EU) had/have very different ideas on matters of great importance. This will be fun to watch play out from the other side of the globe.
Pharmaceuticals
07. AstraZeneca shares jump thanks to its exciting new lung cancer drug
As UK-based drugmaker AstraZeneca (AZN $36-$54-$57) prepared to unblind the latest study of its lung cancer drug Tagrisso, expectations were high. The process of unblinding, or disclosing to participants and the study group who received the actual therapy and who received the placebo, was already two years ahead of schedule based on the seemingly overwhelming effectiveness of the drug. As the results were evaluated, one thing became clear: the expectations were set too low. Two years after surgery, 89% of lung cancer patients who received the Tagrisso were cancer-free, versus 53% of those given a placebo. Researchers at the firm calculate that the drug cuts the risk of disease recurrence or death of patients with forms of early-stage non-small cell lung cancer by 83%. AstraZeneca reported sales of $3.2 billion for the drug—which was approved by the FDA five years ago—last year, but that figure is now expected to rise substantially based on these remarkable results. AZN generated income of $1.3 billion last year on $24.4 billion in revenue. Is AZN a bargain for investors? With its P/E ratio of 94, it seems expensive—even with the great Tagrisso news.
Global Strategy: East/Southeast Asia
06. China faces new reality of falling orders from overseas customers
We have talked ad nauseam about China's growth fallacy, supported by the dolts in the media—the idea that the communist nation's growth trajectory would maintain its double-digit annual clip. We knew it was a matter of time before those sky-high GDP rates came falling back to earth. What we didn't foresee was a pandemic emanating from the country adding downward momentum to the trip. Despite that country's boast that it was coming back online with government-run efficiency (OK, that we do buy), there is a major cog in the machinery: a dearth of new international orders. While the new-export-orders subindex of China's "official" (meaning padded) PMI report showed improvement from 33.5 in April to 35.3 in May, that is still a horrendously-bad number. Keep in mind that any number above 50 reflects economic expansion, while sub-50 represents contraction. Here's the question only time will answer: how much of the contraction is simply due to other countries still trying to shake off the economic effects of the pandemic, and how much is due to countries attempting to source their goods from elsewhere. Granted, it would be rather difficult to undertake the latter effort on the fly, but we get the idea that a better management of country risk will force importers to begin looking outside of mainland China for more and more of their goods.
Market Risk Management
05. Don't look now, but the volatility index is suddenly down to 27
The volatility index, or VIX, measures the implied expected volatility of the US stock market; hence its nickname, the "fear gauge." The higher the figure, on a scale of 0 to 100, the higher the level of concern. Considering the fear gauge rose all the way to 66.96 at the height of the financial meltdown, it would have been hard to imagine that number being eclipsed. Then came the pandemic. In the middle of March, as the markets were in free fall, the VIX climbed all the way to 82.69. At the time, we mentioned that any semblance of normalcy couldn't be expected until the VIX fell back to within a reasonable distance from its long-term average of 18.59. Don't say it too loudly, but our little fear monitor has suddenly dropped to 27.51. Still elevated, but certainly a more comforting level. While the so-called economic experts continue to throw cold water on the idea of a v-shaped recovery, the fear gauge looks to be giving us the flip side of that argument.
Personal Finance
04. It took a national lockdown, but the US savings rate hit a new record
If we have one mantra, one financial maxim above all others, it is this: The first ten cents of every dollar you earn goes into your savings/investment "vault," and that money is not to be touched until you have enough to fund your desired lifestyle with a 5% per year withdrawal. Unfortunately, Americans have one of the lowest savings rates in the developed world. Until this past April, that is. According to the Bureau of Economic Analysis (BEA), the personal savings rate—the percentage of disposable income Americans save each month—hit a whopping 33% in the month of April. As you look at the chart and see the 8.85% average, keep in mind that the figure does not mean Americans save an average of 8.85% of their gross or net income—merely their disposable income. Yes, the US consumer accounts for two-thirds of the domestic economy (and much of the Chinese economy), but imagine what household wealth would look like if everyone did actually put 10% of even their net income to work in an investment plan. Perhaps then we could begin to tackle our $1 trillion worth of lingering credit card debt and $1.5 trillion worth of student loan debt. It is not the duty of the American consumer to support retailers, domestic or foreign; it is their duty to assure the fiscal solvency of their household.
Telecom Services
03. Zoom is now worth more than the four major US airlines...combined
Before we discuss what a strong quarter Zoom Video (ZM $208) just reported, it is important to point out that the video conferencing platform has a rather rich multiple: its P/E ratio now sits at 2,162. Nonetheless, thanks to an exponential increase in cloud-based company meetings, Q1 was a barn-burner. Against expected revenues of $203 million, the company reported $328 million in sales—a 169% increase over the same quarter last year. Earnings expectations of $0.09 per share were dwarfed by the $0.20 reported, and expected Q2 revenues of nearly $500 million are over twice what the Street expects. Is this crazy-high multiple deserved? That all depends on how many of the platform's millions of users can be convinced to convert from the free service to the paid subscription model. To put Zoom's new market cap of $59 billion in perspective, the top four US airlines—Delta, United, American, and Southwest—have a combined size of $46 billion.
Space Sciences & Exploration
02. America ushers in an exciting new era of spaceflight
As a lifelong space buff, I have always equated/compared human spaceflight to the discovery, exploration, and ultimate colonization of the New World. That effort moved at a snail's pace until private enterprise got involved. This past week, in a truly historic moment for mankind's future in space, humans took off for the first time ever on a private launch vehicle—with some help from NASA, of course. Equally important, America regained the power it willingly abdicated a decade ago to launch astronauts from American soil. Bob Behnken and Doug Hurley, former members of the US Air Force and United States Marine Corps, respectively, blasted off in their Crew Dragon capsule nestled atop a SpaceX Falcon 9 rocket in a spectacular launch. Even more thrilling to watch than a Space Shuttle mission, the launch more closely resembled a Saturn V launch from the Apollo glory days. As for the astronauts, they docked with the International Space Station about 19 hours after launch. The Crew Dragon is an enormous asset to have docked at the ISS, as it gives the astronauts on board a "life raft," so to speak, should they need to exit the orbiting research platform. As for when Behnken and Hurley will return to earth, that depends on when the next commercial crew launch will be ready for takeoff. Even that is an incredible statement. Imagine having the Apollo 11 astronauts remain on the moon until Apollo 12 was ready to go! We have truly ushered in a new era of human spaceflight. Thank you, Elon Musk.
Under the Radar Investment
01. Under the Radar Investment: Grocery Outlet Holding Corp
CrowdStrike Holdings (CRWD $93) is a $20 billion leading global cybersecurity vendor specializing in endpoint (think laptops, smartphones, tablets, workstations) protection, threat intelligence and hunting, and attack remediation. Founded in 2011, the company sells packaged tiers of cybersecurity protection and offers individual security modules via its online marketplace. The company's new Falcon platform could be a game-changer: it is designed to stop breaches and improve performance while operating within the cloud using a radical new AI-based security architecture. CrowdStrike's growth trajectory has soared in the work-at-home environment, and we don't believe its new corporate customers will be leaving the platform as employees re-enter the office. CRWD is the number one holding in our First Trust NASDAQ Cybersecurity ETF (CIBR) positioned in the Dynamic Growth Strategy.
Answer
As commercial lemon farming finally began to take hold in 1918, there were plenty of citrus-producing trees but little consumer demand. Don Francisco, who had recently left his role as fruit examiner to become Sunkist's advertising manager, saw a golden opportunity in the Spanish Flu epidemic sweeping the world. As the flu began pounding US cities in the fall of 2018, Francisco began sending ads—disguised as public service announcements—out to newspapers across the nation extolling the health benefits of the lemon. Careful not to label it an actual medicine, the ads urged Americans to "drink one or two glasses of hot lemonade each day" to ward off sickness. Lemon sales rose 80% in one month, and government agencies got involved to help stem price gouging. Through slick marketing (and a gullible and scared public), the lemon found a new place of honor in homes across America.
Headlines for the Week of 17 May 2020—23 May 2020
Question
Back to the Future...
This week, the US Treasury Department issued 20-year T bonds for the first time since 1986. What were the rates when the last batch was issued in December of '86, and what rate did this week's auction (quite feverishly) support?
Penn Trading Desk:
All trade notifications are immediately sent out via Twitter from @PennWealth. If using the platform, remember to Follow us!
(21 May 20) Penn: Close Ciena Corp in Intrepid
After Ciena Corp (CIEN $52), which was our Under the Radar stock in the last "...After Hours," rose above our target price of $52, we raised our stop; about an hour later it hit and we closed our position with an 11.52% short-term gain.
(18 May 20) Penn: Close Charles River Labs in Intrepid
After Charles River Labs (CRL $175) hit our target price after seven sessions, we raised our stop; it hit at $174.92 for an 11.66% gain.
(14 May 20) Penn: Open semiconductor manufacturer to Global Leaders
We added a US-based semiconductor firm back into the Global Leaders Club because of the way management is now embracing the future of technology. Members see the Penn Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Media & Entertainment
10. Our prediction on an AMC takeover may be coming to fruition
A few weeks back, we speculated that beleaguered Kansas-based AMC Entertainment (AMC $2-$5-$14) was an excellent takeover candidate. Unfortunately, that didn't give us enough fodder to invest in the theater chain, which had dropped in size from a $4 billion company precisely three years ago to a $225 million shell of its former self by mid-April of this year. Lo and behold, along comes none other than Jeff Bezos's $1.2 trillion juggernaut, Amazon (AMZN $2,409), showing interest in acquiring the firm, which caused AMC's share price to jump $1.22. Since that dollar figure doesn't sound impressive, let's put that in percentage gain terms: AMC shares spiked 30% in one session on the rumor. While China's Dalian Wanda Group, which bought AMC several years ago, has been unable to bring any synergy to the table, we believe Amazon (parent, of course, of Amazon Prime Video) could breathe new life into the chain and its 11,041 screens. Just as the strongest malls are not dying—just reinventing themselves, theaters which embrace new concepts can help create a new generation of moviegoers. So, is it time to invest? Tempting. But what if Amazon ends up not biting, or AMC shareholders decide not to sell with the company's market cap so low, or the Department of Justice nixes any deal? While we are not ready to bite, it will be interesting to watch what happens to AMC's $5 share price—a value cheaper than the cost of admission to one feature film at the chain.
Automotive
09. Elon Musk's most excellent lawsuit against a local California fiefdom
He may have been born a citizen of South Africa, but Elon Musk could teach more than a few people in this country what it means to be an American. The feud between the Tesla (TSLA $177-$831-$969) CEO and Alameda County began when the head of the country health department, a small-time nobody with delusions of grandeur, ordered the company's Fremont factory to remain closed until it—the health department—had reviewed the reopening plan and decreed it acceptable. This led to Musk's first tweet on the matter:
"Frankly, this is the final straw. Tesla will move its HQ and future programs to Texas/Nevada immediately. If we even retain Fremont manufacturing activity at all, it will be dependent on how Tesla is treated in the future. Tesla is the last carmaker left in CA."
Obviously stewing, and anxious to get his plant reopened, Musk followed up with this one:
"Tesla is filing a lawsuit against Alameda County immediately. The unelected & ignorant 'Interim Health Officer' of Alameda is acting contrary to the Governor, the President, our Constitutional freedoms & just plain common sense."
Finally, Musk sent his ultimatum:
"Tesla is restarting production today against Alameda County rules. I will be on the line with everyone else. If anyone is arrested, I ask that it be only me."
The latest? Musk reopened his plant, standing side-by-side with his workers. No arrests reported, though we doubt Alameda will go quietly with its tail between its legs. As for the threat, we heard numerous "experts" weigh in on the near-impossibility of moving a plant the "size of ten Costcos" (as one put it) to another state. They do not understand how Musk thinks.
First, it should be noted that Musk has now sold all of his houses in California. Second is the issue of his financial incentives. There are twelve tranches or productivity metric points which, if hit, would put $55 billion in Musk's pocket. I recall journalists laughing at these targets as recently as a year ago; now, they seem fully achievable. Based on California's confiscatory marginal tax rate of 13.3%—the highest in the US, sorry New York—Musk could save somewhere in the ballpark of $7 billion in taxes if he moves to Texas or Nevada! Neither of those states levy personal income taxes. The Texas constitution, in fact, forbids it. Right now, the 48-year-old Musk has a personal fortune of nearly $40 billion. We have heard arrogant California officials laugh off any impact that one individual would have by moving out of the state, lock, stock, and barrel. Let's see how hard they are laughing after they push him too far.
Semiconductors & Related Equipment
08. Taiwan Semiconductor to build Arizona chip plant
Finally, after decades of complacency, a full strategic review of our unacceptable dependence on communist China for critical goods and materials is taking place. The products in question range from rare earth materials for high-tech equipment to active pharmaceutical ingredients (APIs) for drugs taken by Americans on a daily basis. Square in the middle of this issue sits semiconductor manufacturing. President Trump has made it clear that he wants the most advanced chips in the world to be made, once again, in the United States. Penn Global Leaders Club member Intel (INTC $59) has already green-lighted its own commitment to the project. Now, a second global leader in chip production has made a bold move to further this cause: Taiwan Semiconductor (TSM $52) has announced plans to build a $12 billion manufacturing facility in Arizona. Building the plant, which will employ 1,600, is sure to enrage Beijing, which claims Taiwan as part of its territory. Yet another skirmish in a trade war which is far from over—but one which must be fought.
Pharmaceuticals
07. Sanofi walks back "US-first" comments after French backlash
French pharma giant Sanofi (SNY $38-$48-$52) is all over the COVID-19 virus. The company is working on a vaccine with Glaxo (GSK), a potential treatment (Kevzara), and a home diagnostic kit for the malady. While there are no guarantees the vaccine will ultimately be effective, the company is already retrofitting its manufacturing facilities to pump out hundreds of millions of doses in preparation for success. The French people may be applauding the work of their homegrown company, but the CEO's comments about who would get the vaccine first caused outrage in the country. Making note that the US bankrolled the lion's share of vaccine research done by Sanofi, CEO Paul Hudson said that the US would be the first country to receive the vaccine. Now, after a meeting with French President Emmanuel Macron, the company is backtracking on those comments. A spokesman for the firm issued an amended statement saying that, "there will be no particular advance for any country...." The French drugmaker is using an existing therapy designed for influenza, adding a Glaxo ingredient, and applying it to the new virus which causes the COVID-19 disease in the body. The candidate vaccine is slated for clinical trials later this year. Sanofi is a $118 billion drug manufacturer with over $40 billion in annual sales, strong cash flow, and a 3.71% dividend yield.
Homes & Durables
06. Our Lennar position jumps 12% in one day on homebuilder optimism
On the morning of Friday the 13th of May, we had just experienced a 2,353-point drop in the Dow. This followed a 1,465-point drop on Wednesday the 11th. Two trading days, nearly three thousand points wiped out. One of our favorite homebuilders, Lennar Corp (LEN $57), dropped to $42.99 on the 13th, and we quickly picked up shares for the Penn Global Leaders Club. We figured that Lennar, the largest homebuilder in the US, would be one of the first to benefit as activity picked up and the markets came back. Shares of the Miami-based company shot up 12% on Monday as homebuilder sentiment rose from a level of 30 to 37, which was higher than expected. Granted, on a 100-point scale, a 37 may not seem impressive, but we believe that reflects just how much more room we have to grow. With mortgage rates at all-time lows and much of the spring buying season decimated by lockdown orders, we see strong growth ahead for Lennar—well above the 32% gains recorded since we picked up the shares.
Fixed Income
05. Back to the 80s: Treasury is bringing back the 20-year bond this week
Back in January, we wrote that the Treasury Department would be issuing 20-year T bonds for the first time since 1986 to help fund the growing deficit. At the time, we anticipated the yield to investors would be somewhere between the 1.84% yield on the 10-year and the 2.29% yield on the 30-year. The big week has arrived: $20 billion worth of the the new debt went up for auction on Wednesday the 20th. The only factor that has changed since January is the yield. In exchange for your principal, you will earn around 1.15% each year for the next twenty years. Thanks to the pandemic, the federal deficit is projected to hit $3.4 trillion this fiscal year. The US government, like governments around the world, literally cannot afford to have interest rates rise. That should lead to an interesting situation when inflation begins to get out of control once again—which it inevitably will—and the Fed is forced to raise rates to control it. What an ugly corner we have been painted into.
Food & Staples Retailing
04. Three Global Leaders Club members were stalwarts during lockdown
Considering there are only 40 positions in the Penn Global Leaders Club and 197 industries from which we have to choose, it may seem somewhat unusual that we hold three names in the strategy from the same industry: Discount Stores. As it turns out, all three, Dollar General (DG $180), Walmart (WMT $126), and Target (TGT $122), were relative rock stars during the pandemic-induced market meltdown. While the Dow is still down 14% year-to-date, Target is only down 5%, Walmart is up 6%, and Dollar General is up nearly 16%. While we are still waiting for DG to report Q1 earnings (on the 28th of May), both Walmart and Target have already reported scorchingly-hot numbers for the first three months of the year. Here are a few metrics we pulled out of Walmart's earnings report: same-store sales rose 10%; customers spent 16.5% more per visit; digital sales rose 74%; traffic at the Sam's Club unit rose by 12%; operating cash flow doubled—to $7 billion. Of course, this begs the question, can these discount retailers keep up their momentum as things return to normal? Considering the battered state of the US (and global) consumer, we still have a strong conviction toward all three names.
Global Strategy: Australasia
03. An emotionally-fragile China slaps an 80% tariff on Australian barley
What did the Communist Party of China do when social media began noting the likeness of General Secretary Xi Jinping to Winnie the Pooh? Ban the lovable cartoon character in the country, of course, and go after any Chinese citizens posting the comparison. Sadly, nothing should surprise us with respect to a communist regime, to include the fawning adoration of the American press. A recent Bloomberg headline read: "Trump to pull out of W.H.O., leaving Xi to lead worldwide pandemic effort." Huh? Do they mean lead the re-spreading of the pandemic effort, which began in a disgusting Wuhan wet market? Remember when China banned flights from Wuhan to other Chinese cities but kept international flights leaving Wuhan up and running? That story escaped the attention of a (disturbingly) large percentage of the American press.
Knowing what we do about communist regimes, therefore, it comes as no surprise that China has slapped an 80% tariff for a five-year period on all barley coming from their main supplier, Australia, after officials in that country began calling for an international investigation into the pandemic. If COVID-19 began at a US Army lab in America, as posited by a mouthpiece of the government (other than Bloomberg), then why not welcome a fair investigation? Of course, we all know the answer to that. As America slowly weans itself off of cheap Chinese goods, we must consider how much our great ally Australia is dependent upon China for its own economic well-being. Hint: It makes America's dependence look almost nonexistent. We delve deeper into this story in the next issue of The Penn Wealth Report. As for the tariffs on barley, China has promised more pain to come unless Australia "gets its mind right." The dollar amounts in the chart, by the way, represent monthly export values, not annual.
Global Strategy: East & Southeast Asia
02. Luckin Coffee is the poster child for Chinese firms on US exchanges
We received several calls about the IPO precisely one year ago. A Chinese coffee house that was going to decimate Starbuck's (SBUX $78) in the country of 1.4 billion people was about to go public. Our recommendation about Luckin Coffee (LK $2-$3-$51)? Don't touch it. We peruse financial reports on US companies with a critical eye, always wondering what level of obfuscation might be baked in to bury the real story. With companies based in mainland China, we just assume we are being hoodwinked. Luckin came out of the gate to great fanfare, rising to around $20 per share before dropping to $15 a few days later. Investors seemed to sense a bargain at $15, and pumped the shares up to $51.38 by January of 2020. Then the wheels came off the wagon. It was revealed that senior management at the $12 billion firm had been cooking the books all along. Shares plummeted. Then came the threat of delisting by Nasdaq, Inc., which ultimately led to trading being suspended. When trading resumed, shareholders headed for the exits, driving shares down from $25 to $2.58, as Nasdaq confirmed the delisting plans. Ultimately, any buyer who did not get out will see the value of their investment go to zero. Investors shouldn't feel too bad about their purchase, however, as they are in good company: Goldman Sachs (GS) admitted that an entity controlled by Luckin Chairman Charles Zhengyao had defaulted on a $518 million margin loan. Between their WeWork and Luckin Coffee investments, it has been a rough year for Goldman. As for investors, let this be a valuable lesson with respect to buying shares in Chinese companies, even if they are listed on US exchanges.
Under the Radar Investment
01. Under the Radar Investment: Grocery Outlet Holding Corp
Grocery Outlet Holding Corp (GO $28-$37-$48) is a fascinating story in a usually boring industry: grocery stores. This $3.4 billion US-based mid-cap offers quality, name-brand products generally priced 40% to 70% below what their competitors charge. The stores are run by independent operators, and are designed to create a neighborhood feel through personalized service and localized offerings. The outlet, which was founded by Jim Read (who began selling highly-discounted military surplus the year after World War II ended), now has over 300 locations, primarily on the West Coast and in the Pacific Northwest. A fascinating story, good free cash flow, and strong growth potential makes this mid-cap worthy of a look. By the way, GO is able to discount its food and home goods items so steeply due to deals the company has forged with the manufacturers; for example, they might buy a bulk supply of excess inventory, or goods with damaged packaging (but no damage to the actual product).
Answer
When the 20-year Treasury bond was last discontinued, in December of 1986, the issues carried a 7.28% yield-to-maturity. When new 20-year T bonds rolled out this week, they came with a rate of around 1.16%.
Back to the Future...
This week, the US Treasury Department issued 20-year T bonds for the first time since 1986. What were the rates when the last batch was issued in December of '86, and what rate did this week's auction (quite feverishly) support?
Penn Trading Desk:
All trade notifications are immediately sent out via Twitter from @PennWealth. If using the platform, remember to Follow us!
(21 May 20) Penn: Close Ciena Corp in Intrepid
After Ciena Corp (CIEN $52), which was our Under the Radar stock in the last "...After Hours," rose above our target price of $52, we raised our stop; about an hour later it hit and we closed our position with an 11.52% short-term gain.
(18 May 20) Penn: Close Charles River Labs in Intrepid
After Charles River Labs (CRL $175) hit our target price after seven sessions, we raised our stop; it hit at $174.92 for an 11.66% gain.
(14 May 20) Penn: Open semiconductor manufacturer to Global Leaders
We added a US-based semiconductor firm back into the Global Leaders Club because of the way management is now embracing the future of technology. Members see the Penn Trading Desk.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Media & Entertainment
10. Our prediction on an AMC takeover may be coming to fruition
A few weeks back, we speculated that beleaguered Kansas-based AMC Entertainment (AMC $2-$5-$14) was an excellent takeover candidate. Unfortunately, that didn't give us enough fodder to invest in the theater chain, which had dropped in size from a $4 billion company precisely three years ago to a $225 million shell of its former self by mid-April of this year. Lo and behold, along comes none other than Jeff Bezos's $1.2 trillion juggernaut, Amazon (AMZN $2,409), showing interest in acquiring the firm, which caused AMC's share price to jump $1.22. Since that dollar figure doesn't sound impressive, let's put that in percentage gain terms: AMC shares spiked 30% in one session on the rumor. While China's Dalian Wanda Group, which bought AMC several years ago, has been unable to bring any synergy to the table, we believe Amazon (parent, of course, of Amazon Prime Video) could breathe new life into the chain and its 11,041 screens. Just as the strongest malls are not dying—just reinventing themselves, theaters which embrace new concepts can help create a new generation of moviegoers. So, is it time to invest? Tempting. But what if Amazon ends up not biting, or AMC shareholders decide not to sell with the company's market cap so low, or the Department of Justice nixes any deal? While we are not ready to bite, it will be interesting to watch what happens to AMC's $5 share price—a value cheaper than the cost of admission to one feature film at the chain.
Automotive
09. Elon Musk's most excellent lawsuit against a local California fiefdom
He may have been born a citizen of South Africa, but Elon Musk could teach more than a few people in this country what it means to be an American. The feud between the Tesla (TSLA $177-$831-$969) CEO and Alameda County began when the head of the country health department, a small-time nobody with delusions of grandeur, ordered the company's Fremont factory to remain closed until it—the health department—had reviewed the reopening plan and decreed it acceptable. This led to Musk's first tweet on the matter:
"Frankly, this is the final straw. Tesla will move its HQ and future programs to Texas/Nevada immediately. If we even retain Fremont manufacturing activity at all, it will be dependent on how Tesla is treated in the future. Tesla is the last carmaker left in CA."
Obviously stewing, and anxious to get his plant reopened, Musk followed up with this one:
"Tesla is filing a lawsuit against Alameda County immediately. The unelected & ignorant 'Interim Health Officer' of Alameda is acting contrary to the Governor, the President, our Constitutional freedoms & just plain common sense."
Finally, Musk sent his ultimatum:
"Tesla is restarting production today against Alameda County rules. I will be on the line with everyone else. If anyone is arrested, I ask that it be only me."
The latest? Musk reopened his plant, standing side-by-side with his workers. No arrests reported, though we doubt Alameda will go quietly with its tail between its legs. As for the threat, we heard numerous "experts" weigh in on the near-impossibility of moving a plant the "size of ten Costcos" (as one put it) to another state. They do not understand how Musk thinks.
First, it should be noted that Musk has now sold all of his houses in California. Second is the issue of his financial incentives. There are twelve tranches or productivity metric points which, if hit, would put $55 billion in Musk's pocket. I recall journalists laughing at these targets as recently as a year ago; now, they seem fully achievable. Based on California's confiscatory marginal tax rate of 13.3%—the highest in the US, sorry New York—Musk could save somewhere in the ballpark of $7 billion in taxes if he moves to Texas or Nevada! Neither of those states levy personal income taxes. The Texas constitution, in fact, forbids it. Right now, the 48-year-old Musk has a personal fortune of nearly $40 billion. We have heard arrogant California officials laugh off any impact that one individual would have by moving out of the state, lock, stock, and barrel. Let's see how hard they are laughing after they push him too far.
Semiconductors & Related Equipment
08. Taiwan Semiconductor to build Arizona chip plant
Finally, after decades of complacency, a full strategic review of our unacceptable dependence on communist China for critical goods and materials is taking place. The products in question range from rare earth materials for high-tech equipment to active pharmaceutical ingredients (APIs) for drugs taken by Americans on a daily basis. Square in the middle of this issue sits semiconductor manufacturing. President Trump has made it clear that he wants the most advanced chips in the world to be made, once again, in the United States. Penn Global Leaders Club member Intel (INTC $59) has already green-lighted its own commitment to the project. Now, a second global leader in chip production has made a bold move to further this cause: Taiwan Semiconductor (TSM $52) has announced plans to build a $12 billion manufacturing facility in Arizona. Building the plant, which will employ 1,600, is sure to enrage Beijing, which claims Taiwan as part of its territory. Yet another skirmish in a trade war which is far from over—but one which must be fought.
Pharmaceuticals
07. Sanofi walks back "US-first" comments after French backlash
French pharma giant Sanofi (SNY $38-$48-$52) is all over the COVID-19 virus. The company is working on a vaccine with Glaxo (GSK), a potential treatment (Kevzara), and a home diagnostic kit for the malady. While there are no guarantees the vaccine will ultimately be effective, the company is already retrofitting its manufacturing facilities to pump out hundreds of millions of doses in preparation for success. The French people may be applauding the work of their homegrown company, but the CEO's comments about who would get the vaccine first caused outrage in the country. Making note that the US bankrolled the lion's share of vaccine research done by Sanofi, CEO Paul Hudson said that the US would be the first country to receive the vaccine. Now, after a meeting with French President Emmanuel Macron, the company is backtracking on those comments. A spokesman for the firm issued an amended statement saying that, "there will be no particular advance for any country...." The French drugmaker is using an existing therapy designed for influenza, adding a Glaxo ingredient, and applying it to the new virus which causes the COVID-19 disease in the body. The candidate vaccine is slated for clinical trials later this year. Sanofi is a $118 billion drug manufacturer with over $40 billion in annual sales, strong cash flow, and a 3.71% dividend yield.
Homes & Durables
06. Our Lennar position jumps 12% in one day on homebuilder optimism
On the morning of Friday the 13th of May, we had just experienced a 2,353-point drop in the Dow. This followed a 1,465-point drop on Wednesday the 11th. Two trading days, nearly three thousand points wiped out. One of our favorite homebuilders, Lennar Corp (LEN $57), dropped to $42.99 on the 13th, and we quickly picked up shares for the Penn Global Leaders Club. We figured that Lennar, the largest homebuilder in the US, would be one of the first to benefit as activity picked up and the markets came back. Shares of the Miami-based company shot up 12% on Monday as homebuilder sentiment rose from a level of 30 to 37, which was higher than expected. Granted, on a 100-point scale, a 37 may not seem impressive, but we believe that reflects just how much more room we have to grow. With mortgage rates at all-time lows and much of the spring buying season decimated by lockdown orders, we see strong growth ahead for Lennar—well above the 32% gains recorded since we picked up the shares.
Fixed Income
05. Back to the 80s: Treasury is bringing back the 20-year bond this week
Back in January, we wrote that the Treasury Department would be issuing 20-year T bonds for the first time since 1986 to help fund the growing deficit. At the time, we anticipated the yield to investors would be somewhere between the 1.84% yield on the 10-year and the 2.29% yield on the 30-year. The big week has arrived: $20 billion worth of the the new debt went up for auction on Wednesday the 20th. The only factor that has changed since January is the yield. In exchange for your principal, you will earn around 1.15% each year for the next twenty years. Thanks to the pandemic, the federal deficit is projected to hit $3.4 trillion this fiscal year. The US government, like governments around the world, literally cannot afford to have interest rates rise. That should lead to an interesting situation when inflation begins to get out of control once again—which it inevitably will—and the Fed is forced to raise rates to control it. What an ugly corner we have been painted into.
Food & Staples Retailing
04. Three Global Leaders Club members were stalwarts during lockdown
Considering there are only 40 positions in the Penn Global Leaders Club and 197 industries from which we have to choose, it may seem somewhat unusual that we hold three names in the strategy from the same industry: Discount Stores. As it turns out, all three, Dollar General (DG $180), Walmart (WMT $126), and Target (TGT $122), were relative rock stars during the pandemic-induced market meltdown. While the Dow is still down 14% year-to-date, Target is only down 5%, Walmart is up 6%, and Dollar General is up nearly 16%. While we are still waiting for DG to report Q1 earnings (on the 28th of May), both Walmart and Target have already reported scorchingly-hot numbers for the first three months of the year. Here are a few metrics we pulled out of Walmart's earnings report: same-store sales rose 10%; customers spent 16.5% more per visit; digital sales rose 74%; traffic at the Sam's Club unit rose by 12%; operating cash flow doubled—to $7 billion. Of course, this begs the question, can these discount retailers keep up their momentum as things return to normal? Considering the battered state of the US (and global) consumer, we still have a strong conviction toward all three names.
Global Strategy: Australasia
03. An emotionally-fragile China slaps an 80% tariff on Australian barley
What did the Communist Party of China do when social media began noting the likeness of General Secretary Xi Jinping to Winnie the Pooh? Ban the lovable cartoon character in the country, of course, and go after any Chinese citizens posting the comparison. Sadly, nothing should surprise us with respect to a communist regime, to include the fawning adoration of the American press. A recent Bloomberg headline read: "Trump to pull out of W.H.O., leaving Xi to lead worldwide pandemic effort." Huh? Do they mean lead the re-spreading of the pandemic effort, which began in a disgusting Wuhan wet market? Remember when China banned flights from Wuhan to other Chinese cities but kept international flights leaving Wuhan up and running? That story escaped the attention of a (disturbingly) large percentage of the American press.
Knowing what we do about communist regimes, therefore, it comes as no surprise that China has slapped an 80% tariff for a five-year period on all barley coming from their main supplier, Australia, after officials in that country began calling for an international investigation into the pandemic. If COVID-19 began at a US Army lab in America, as posited by a mouthpiece of the government (other than Bloomberg), then why not welcome a fair investigation? Of course, we all know the answer to that. As America slowly weans itself off of cheap Chinese goods, we must consider how much our great ally Australia is dependent upon China for its own economic well-being. Hint: It makes America's dependence look almost nonexistent. We delve deeper into this story in the next issue of The Penn Wealth Report. As for the tariffs on barley, China has promised more pain to come unless Australia "gets its mind right." The dollar amounts in the chart, by the way, represent monthly export values, not annual.
Global Strategy: East & Southeast Asia
02. Luckin Coffee is the poster child for Chinese firms on US exchanges
We received several calls about the IPO precisely one year ago. A Chinese coffee house that was going to decimate Starbuck's (SBUX $78) in the country of 1.4 billion people was about to go public. Our recommendation about Luckin Coffee (LK $2-$3-$51)? Don't touch it. We peruse financial reports on US companies with a critical eye, always wondering what level of obfuscation might be baked in to bury the real story. With companies based in mainland China, we just assume we are being hoodwinked. Luckin came out of the gate to great fanfare, rising to around $20 per share before dropping to $15 a few days later. Investors seemed to sense a bargain at $15, and pumped the shares up to $51.38 by January of 2020. Then the wheels came off the wagon. It was revealed that senior management at the $12 billion firm had been cooking the books all along. Shares plummeted. Then came the threat of delisting by Nasdaq, Inc., which ultimately led to trading being suspended. When trading resumed, shareholders headed for the exits, driving shares down from $25 to $2.58, as Nasdaq confirmed the delisting plans. Ultimately, any buyer who did not get out will see the value of their investment go to zero. Investors shouldn't feel too bad about their purchase, however, as they are in good company: Goldman Sachs (GS) admitted that an entity controlled by Luckin Chairman Charles Zhengyao had defaulted on a $518 million margin loan. Between their WeWork and Luckin Coffee investments, it has been a rough year for Goldman. As for investors, let this be a valuable lesson with respect to buying shares in Chinese companies, even if they are listed on US exchanges.
Under the Radar Investment
01. Under the Radar Investment: Grocery Outlet Holding Corp
Grocery Outlet Holding Corp (GO $28-$37-$48) is a fascinating story in a usually boring industry: grocery stores. This $3.4 billion US-based mid-cap offers quality, name-brand products generally priced 40% to 70% below what their competitors charge. The stores are run by independent operators, and are designed to create a neighborhood feel through personalized service and localized offerings. The outlet, which was founded by Jim Read (who began selling highly-discounted military surplus the year after World War II ended), now has over 300 locations, primarily on the West Coast and in the Pacific Northwest. A fascinating story, good free cash flow, and strong growth potential makes this mid-cap worthy of a look. By the way, GO is able to discount its food and home goods items so steeply due to deals the company has forged with the manufacturers; for example, they might buy a bulk supply of excess inventory, or goods with damaged packaging (but no damage to the actual product).
Answer
When the 20-year Treasury bond was last discontinued, in December of 1986, the issues carried a 7.28% yield-to-maturity. When new 20-year T bonds rolled out this week, they came with a rate of around 1.16%.
Headlines for the Week of 03 May 2020—09 May 2020
Question
Bad, but not the worst...
The current unemployment rate in the US—14.7%—is horrific, but it is not the highest level the country has experienced. What was the highest unemployment rate experienced in the US and when did it occur?
Penn Trading Desk:
All trade notifications are immediately sent out via Twitter from @PennWealth. If using the platform, remember to Follow us!
(08 May 20) Penn: Raise stop on TMUS
T-Mobile has hit our price target since we purchased last month; raise stop on TMUS to $95.50 to protect gains. Ultimately, we may move TMUS out of the Intrepid and into a longer-term strategy such as the Penn Global Leaders Club.
(07 May 20) Penn: Open agricultural inputs player in Intrepid
We opened a very old and familiar agricultural inputs company in the Intrepid based on a rather non-traditional and very new customer base; any ideas? "Expand your mind, dude" and you can probably guess what it is. Members see the Penn Trading Desk, or email us for the answer.
(07 May 20) Penn: Close BIO
Bio-Rad Laboratories (BIO $450) hit target then became volatile; close BIO @ $450 to protect gains.
(07 May 20) Penn: Raise stop/close NVDA
NVIDIA Corp (NVDA $305) hit our target price, stopped out and exited; close NVDA @ $304.90.
(05 May 20) Penn: Raise stop loss on TEAM
Our Atlassian Corp (TEAM $172) has hit our target price in the Intrepid; raise stop loss on TEAM to $171 to protect double-digit gains.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Food Products
10. Tyson Foods plummets after reporting lousy numbers for the quarter, warning of food chain disruption
At first blush, if you had to pick one industry holding up well in the pandemic you might say farm products. After all, the hoarding of goods quickly moved from toilet paper and Clorox (CLX) wipes to meat and dairy products. More specifically, you might zero in on US-based poultry providers like Tyson Foods (TSN $43-$55-$94). That is why we did a double take when the $20 billion Arkansas-based chicken, beef, and pork producer announced it had badly missed its Q2 earnings target and warned of more pain to come. So what happened? Part of the reason the company earned just $0.77 per share instead of the $1.20 expected (a 36% miss) has to do with outbreaks of the coronavirus at a number of its plants, forcing their closure. Couple that with the virtually complete loss of foodservice business for the better part of two months—so far—and the numbers begin to make sense. As if those two factors weren't enough to contend with, Chairman of the Board John Tyson warned that the entire food supply chain seems to be breaking. We don't actually agree with Tyson's contention, as the meat supplied by the company is generally sourced locally, and certainly domestically. Nonetheless, his words did cause a number of grocery chains such as Kroger to begin limiting meat purchases within their stores. So, after falling 8% in one day and 40% ytd, is TSN a bargain for investors? Actually, it probably is. While we don't like the excuse-filled earnings report, the shares have a fair value in the range of $75 to $85, conservatively.
Pharmaceuticals
09. Pfizer begins human testing for coronavirus vaccine in US
On the 9th of March, as the Dow was in the midst of falling 2,014 points in one session, we were busy picking up unfairly beaten-down stocks for the Penn Global Leaders Club. American pharmaceutical powerhouse Pfizer (PFE $28-$38-$45) was a member of that group. While we didn't hit the exact bottom (shares dropped to $28.49 on the market bottom day of 23 Mar), the holding has steadily gained ground ever since, and we see plenty of growth ahead. To that end, Pfizer announced that it would begin human trials in the US on its potential coronavirus vaccine, BNT162. In a joint program with German drugmaker BioNTech, Pfizer has advanced this vaccine from pre-clinical studies to human trials in a matter of four months—a seemingly impossible feat. If the trials are successful, Pfizer said it hopes to produce millions of doses of the vaccine by year-end, and hundreds of millions of doses in 2021, according to Dr. Mikael Dolsten, the firm's chief scientific officer. Pfizer has a p/e ratio of 13 and a dividend yield of nearly 4%.
Hotels, Resorts, & Cruise Lines
08. Norwegian Cruise Line concerned about ability to remain in business
Last summer, in a scathing article on Carnival Cruise Lines (CCL) and its inept (our opinion) CEO, Arnold Donald, we made the comment that "while we don't own a cruise line, if we did it would probably be Norwegian...." At the time, Norwegian Cruise Line Holdings (NCLH $7-$13-$60) was trading for $52 per share and had a conservative multiple of 12. Fast forward eleven months and Norwegian's multiple has dropped to 3, its price has dropped to $13, its market cap has dropped from $12B to under $3B, and management is expressing real concern that the firm can stay in business. In a Tuesday securities filing, the Miami-based company admitted that their is "substantial doubt" about its ability to carry forward as a "going concern." Norwegian also said that it does not have enough cash to meet its short-term obligations. NCLH holds $730M in current assets and has $3.58B in current liabilities. We are changing our pick to Royal Caribbean Cruises LTD (RCL $19-$40-$135), though we wouldn't touch any company in the industry right now.
Specialty REITs
07. Short on REITs but worried about tenants? Consider this specialty
Real estate investment trusts (REITs) can offer a dynamic range of investment options, but investors can get burned if they don't do their homework. For example, retail REITs who own B- and C-level malls were getting hammered leading into the pandemic; now they are getting crushed. Office space REITs must contend with tenants not paying their monthly leases or going out of business during the lockdown. There is one niche specialty in the REIT world, however, that many investors fail to consider: cell tower owners. Take $67 billion REIT Crown Castle International (CCI $114-$158-$169), for example. The company owns and leases roughly 40,000 cell towers in the United States: cell towers which will be rife with 5G antennas over the coming few years. Did we mention that the company also owns over 80,000 route miles of fiber-optic cables? The kind of high-speed lines which allow hundreds of millions of Americans to attend classes online and take part in Zoom (ZM) videoconferencing calls. With its p/e ratio of 80, CCI may seem expensive, but its 11.33% YTD performance has put the major indices to shame, and we expect the company's rock-solid growth to continue into the future. Looking for a cell tower REIT with a lower multiple? Consider American Tower Corp (AMT $240) with its 57 multiple. These real estate entities will play a major role in America's 5G build-out.
Global Strategy: Latin America
06. Mexico's economy shrinking as pandemic takes toll
Mexico's gross domestic product (GDP) fell 1.6% both from the previous quarter and the same quarter in 2019, showing the effect the pandemic is having on this emerging market economy. Unfortunately, this comes on the heels of the country's first full-year contraction in a decade. Comparing Mexico's numbers to its northern neighbor, US GDP shrank 4.8% annualized in Q1, while Mexico is now on pace for a 6.1% full-year contraction. The country's manufacturing-heavy economy saw a number of supply-chain disruptions caused by the virus, to include a suspension of operations at a number of auto assembly plants. Production in March of autos and light trucks fell 25% from the same period a year ago, and production in April will almost certainly be zero as new vehicle sales have dropped 90% from a year ago. If the Q1 annualized projection holds, it will be Mexico's worst economic contraction since 1995. Last month, Moody's downgraded the country's credit rating to Baa1—just one notch above junk.
Business & Professional Services
05. San Francisco getting hammered as job losses hit Silicon Valley
(07 May 2020) Last week ride-sharing service provider Lyft (LYFT $14-$33-$68) furloughed 17% of its workforce, or roughly 1,000 positions; this week, competitor Uber (UBER $14-$30-$47) announced that it would lay off 14% of its workers, or 3,700 full-time employees. Keep in mind that these are actual corporate positions—not the companies' contract drivers. Soon-to-be-IPO Airbnb just announced 1,900 layoffs, or 25% of its workforce. The company's CEO called it "the most harrowing crisis of our lifetime." What do these three nascent firms have in common? They are all glittering examples of San Francisco-based Silicon Valley startups. While it may seem as though many high-tech firms would be somewhat immune from a lockdown due to the online nature of their business models, we need to consider the customer base of these companies and how they are being effected. It doesn't matter much if the products and services of a Salesforce (CRM) are completely digital, if their customers are bleeding cash, the cuts they are forced to make will hit third-party vendors like Salesforce. Then there is the high cost of living in the Bay area. It was tough enough for these workers to make ends meet before a pandemic came along; now, for many, it will become impossible. There will be some wonderfully-undervalued technology names to select from over the coming months, but investors need to dive deeper than the balance sheet and consider the financial state of the group actually responsible for the revenues—the customers. Those wacky p/e ratios (CRM's is 1,091) may no longer be justifiable.
Cybersecurity
04. Penn New Frontier Fund member Fortinet jumps 21% in one session
For the past few years, we have been extremely bullish on the cybersecurity space. The chronic threat of cyber attacks from the likes of China, Russia, North Korea, and Iran, all working to inflict maximum pain on the US, is only going to grow moving forward. In the Penn Dynamic Growth Strategy, our ETF portfolio, we own CIBR, the First Trust NASDAQ Cybersecurity ETF; and in the Penn New Frontier Fund we own Fortinet (FTNT $69-$137-$122), a California-based cybersecurity vendor that sells detection and protection products to businesses of all sizes and a large number of government entities around the world. The company reported Q1 numbers this week that soundly beat expectations, and investors celebrated the news. Not only did the firm increase revenues by 22% y/y, net income rose by 76% from the same quarter last year—beating expectations by 120%. After the earnings release, FTNT shares proceeded to climb 21% in one session, finishing the week up 31% and easily punching through a 52-week high. Fortinet also happens to be one of the top ten holdings in CIBR.
Economics: Work & Pay
03. A record number of Americans file for unemployment, stocks spike
One thing we have learned in this business, after being hit in the face with hundreds of examples, is that good economic news often brings a market drop, while dour news often leads to a market rally. This bizarre relationship surfaced yet again on Friday, when a record-bad jobs report led to a 455-point Dow rally. The report was unfathomably bad: 20.5 million Americans filed for unemployment, and the unemployment rate went from a 50-year low to rates not seen since the Great Depression. So, with nearly one in five Americans out of work, and with many of those still working seeing their hours or pay reduced, why the big rally on the day and the week? Americans are generally beginning to see some light at the end of the tunnel. With lockdowns coming to an end soon, barring a major spike in new infections, there is a real sense that things will begin returning to some semblance of normalcy. A growing number of economists believe that April will end up being the worst month for job losses, and that it will be a slow but sure climb back from here. A full 88% of those laid off in April, in fact, believe they will be returning to their same jobs over the coming months. That optimism led to another strong week in the markets: the Dow was up 2.56%, the S&P 500 rose 3.5%, and the NASDAQ spiked an impressive 6%.
Market Risk Management
02. The P/E ratio has become temporarily useless; try this metric instead
It is typically the first number we look at—even before the share price—when evaluating a stock. Of all the key stats, few paint a better picture of a company's general value than the price-to-earnings (P/E) ratio. Granted, we may buy a growth stock with a P/E of 78 like Chipotle Mexican Grill (CMG $926), and ignore one with a P/E of 7 like General Motors (GM $24), but when comparing companies within and industry this metric can help us identify undervalued gems.
That being said, this valuation tool is on a roller coaster ride that is rendering it relatively useless, at least for now. First came the sudden drop in the "P" thanks to the 35% market correction (with many styles, such as small caps, dropping even more). In essence, we were looking at a number that reflected current prices but stale earnings ("E"), driving the P/E lower on nearly all stocks. Now that pandemic-tainted earnings are finally rolling in, the figure is going to be driven artificially higher, unless one believes that a certain company's earnings will never recover. At the start of the year, analysts were predicting a 6% rate of growth in earnings for companies in the S&P 500; they have now revised that number to -12% for Q1, and -24% for Q2. Until "real" numbers begin to return, hopefully in fall of this year, we can pretty much ignore the P/E ratio.
Considering the damage done by the virus, the metric we are most focused on right now is a company's current ratio, which divides current assets by current liabilities. The higher that number the better, as it gives us an idea as to which companies are going to be able to weather this storm, and which are fighting to remain in business. For example, if a company has $4.4 billion in current assets and $2 billion in current liabilities (Advanced Micro Devices AMD $53), its current ratio is a very solid 2.2. If, however, a company has $7.9 billion in current assets and $16.09 billion in current liabilities (United Airlines UAL $25), its current ratio is 0.49. Serious trouble brewing. What's a good current ratio to look for? While the number varies from industry to industry, a general rule of thumb is to look for companies with a current ratio of 1.2 or higher.
Under the Radar Investment
01. Under the Radar Investment: Ciena Corp
Ciena Corp (CIEN $31-$48-$50) is a communications equipment maker which provides network hardware, software, and services that support the management of video, data, and voice traffic on communications networks around the world. We expect the company to play a key role as companies upgrade their existing communication networks to the 5G infrastructure. As the US government has placed Chinese firm Huawei on its banned companies list, look for Ciena to continue gaining market share, both in this country and in Europe. Not only does does the company have a strong growth trajectory, it has strong financial health: with current assets of $2.27B and current liabilities of $733M, its current ratio is 3.09.
Answer
The highest rate of US unemployment was 24.9%, which took place in 1933 during the heart of the Great Depression. The record low occurred twenty years later, in 1953 during the Eisenhower administration, when unemployment fell to 2.5%.
Bad, but not the worst...
The current unemployment rate in the US—14.7%—is horrific, but it is not the highest level the country has experienced. What was the highest unemployment rate experienced in the US and when did it occur?
Penn Trading Desk:
All trade notifications are immediately sent out via Twitter from @PennWealth. If using the platform, remember to Follow us!
(08 May 20) Penn: Raise stop on TMUS
T-Mobile has hit our price target since we purchased last month; raise stop on TMUS to $95.50 to protect gains. Ultimately, we may move TMUS out of the Intrepid and into a longer-term strategy such as the Penn Global Leaders Club.
(07 May 20) Penn: Open agricultural inputs player in Intrepid
We opened a very old and familiar agricultural inputs company in the Intrepid based on a rather non-traditional and very new customer base; any ideas? "Expand your mind, dude" and you can probably guess what it is. Members see the Penn Trading Desk, or email us for the answer.
(07 May 20) Penn: Close BIO
Bio-Rad Laboratories (BIO $450) hit target then became volatile; close BIO @ $450 to protect gains.
(07 May 20) Penn: Raise stop/close NVDA
NVIDIA Corp (NVDA $305) hit our target price, stopped out and exited; close NVDA @ $304.90.
(05 May 20) Penn: Raise stop loss on TEAM
Our Atlassian Corp (TEAM $172) has hit our target price in the Intrepid; raise stop loss on TEAM to $171 to protect double-digit gains.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Food Products
10. Tyson Foods plummets after reporting lousy numbers for the quarter, warning of food chain disruption
At first blush, if you had to pick one industry holding up well in the pandemic you might say farm products. After all, the hoarding of goods quickly moved from toilet paper and Clorox (CLX) wipes to meat and dairy products. More specifically, you might zero in on US-based poultry providers like Tyson Foods (TSN $43-$55-$94). That is why we did a double take when the $20 billion Arkansas-based chicken, beef, and pork producer announced it had badly missed its Q2 earnings target and warned of more pain to come. So what happened? Part of the reason the company earned just $0.77 per share instead of the $1.20 expected (a 36% miss) has to do with outbreaks of the coronavirus at a number of its plants, forcing their closure. Couple that with the virtually complete loss of foodservice business for the better part of two months—so far—and the numbers begin to make sense. As if those two factors weren't enough to contend with, Chairman of the Board John Tyson warned that the entire food supply chain seems to be breaking. We don't actually agree with Tyson's contention, as the meat supplied by the company is generally sourced locally, and certainly domestically. Nonetheless, his words did cause a number of grocery chains such as Kroger to begin limiting meat purchases within their stores. So, after falling 8% in one day and 40% ytd, is TSN a bargain for investors? Actually, it probably is. While we don't like the excuse-filled earnings report, the shares have a fair value in the range of $75 to $85, conservatively.
Pharmaceuticals
09. Pfizer begins human testing for coronavirus vaccine in US
On the 9th of March, as the Dow was in the midst of falling 2,014 points in one session, we were busy picking up unfairly beaten-down stocks for the Penn Global Leaders Club. American pharmaceutical powerhouse Pfizer (PFE $28-$38-$45) was a member of that group. While we didn't hit the exact bottom (shares dropped to $28.49 on the market bottom day of 23 Mar), the holding has steadily gained ground ever since, and we see plenty of growth ahead. To that end, Pfizer announced that it would begin human trials in the US on its potential coronavirus vaccine, BNT162. In a joint program with German drugmaker BioNTech, Pfizer has advanced this vaccine from pre-clinical studies to human trials in a matter of four months—a seemingly impossible feat. If the trials are successful, Pfizer said it hopes to produce millions of doses of the vaccine by year-end, and hundreds of millions of doses in 2021, according to Dr. Mikael Dolsten, the firm's chief scientific officer. Pfizer has a p/e ratio of 13 and a dividend yield of nearly 4%.
Hotels, Resorts, & Cruise Lines
08. Norwegian Cruise Line concerned about ability to remain in business
Last summer, in a scathing article on Carnival Cruise Lines (CCL) and its inept (our opinion) CEO, Arnold Donald, we made the comment that "while we don't own a cruise line, if we did it would probably be Norwegian...." At the time, Norwegian Cruise Line Holdings (NCLH $7-$13-$60) was trading for $52 per share and had a conservative multiple of 12. Fast forward eleven months and Norwegian's multiple has dropped to 3, its price has dropped to $13, its market cap has dropped from $12B to under $3B, and management is expressing real concern that the firm can stay in business. In a Tuesday securities filing, the Miami-based company admitted that their is "substantial doubt" about its ability to carry forward as a "going concern." Norwegian also said that it does not have enough cash to meet its short-term obligations. NCLH holds $730M in current assets and has $3.58B in current liabilities. We are changing our pick to Royal Caribbean Cruises LTD (RCL $19-$40-$135), though we wouldn't touch any company in the industry right now.
Specialty REITs
07. Short on REITs but worried about tenants? Consider this specialty
Real estate investment trusts (REITs) can offer a dynamic range of investment options, but investors can get burned if they don't do their homework. For example, retail REITs who own B- and C-level malls were getting hammered leading into the pandemic; now they are getting crushed. Office space REITs must contend with tenants not paying their monthly leases or going out of business during the lockdown. There is one niche specialty in the REIT world, however, that many investors fail to consider: cell tower owners. Take $67 billion REIT Crown Castle International (CCI $114-$158-$169), for example. The company owns and leases roughly 40,000 cell towers in the United States: cell towers which will be rife with 5G antennas over the coming few years. Did we mention that the company also owns over 80,000 route miles of fiber-optic cables? The kind of high-speed lines which allow hundreds of millions of Americans to attend classes online and take part in Zoom (ZM) videoconferencing calls. With its p/e ratio of 80, CCI may seem expensive, but its 11.33% YTD performance has put the major indices to shame, and we expect the company's rock-solid growth to continue into the future. Looking for a cell tower REIT with a lower multiple? Consider American Tower Corp (AMT $240) with its 57 multiple. These real estate entities will play a major role in America's 5G build-out.
Global Strategy: Latin America
06. Mexico's economy shrinking as pandemic takes toll
Mexico's gross domestic product (GDP) fell 1.6% both from the previous quarter and the same quarter in 2019, showing the effect the pandemic is having on this emerging market economy. Unfortunately, this comes on the heels of the country's first full-year contraction in a decade. Comparing Mexico's numbers to its northern neighbor, US GDP shrank 4.8% annualized in Q1, while Mexico is now on pace for a 6.1% full-year contraction. The country's manufacturing-heavy economy saw a number of supply-chain disruptions caused by the virus, to include a suspension of operations at a number of auto assembly plants. Production in March of autos and light trucks fell 25% from the same period a year ago, and production in April will almost certainly be zero as new vehicle sales have dropped 90% from a year ago. If the Q1 annualized projection holds, it will be Mexico's worst economic contraction since 1995. Last month, Moody's downgraded the country's credit rating to Baa1—just one notch above junk.
Business & Professional Services
05. San Francisco getting hammered as job losses hit Silicon Valley
(07 May 2020) Last week ride-sharing service provider Lyft (LYFT $14-$33-$68) furloughed 17% of its workforce, or roughly 1,000 positions; this week, competitor Uber (UBER $14-$30-$47) announced that it would lay off 14% of its workers, or 3,700 full-time employees. Keep in mind that these are actual corporate positions—not the companies' contract drivers. Soon-to-be-IPO Airbnb just announced 1,900 layoffs, or 25% of its workforce. The company's CEO called it "the most harrowing crisis of our lifetime." What do these three nascent firms have in common? They are all glittering examples of San Francisco-based Silicon Valley startups. While it may seem as though many high-tech firms would be somewhat immune from a lockdown due to the online nature of their business models, we need to consider the customer base of these companies and how they are being effected. It doesn't matter much if the products and services of a Salesforce (CRM) are completely digital, if their customers are bleeding cash, the cuts they are forced to make will hit third-party vendors like Salesforce. Then there is the high cost of living in the Bay area. It was tough enough for these workers to make ends meet before a pandemic came along; now, for many, it will become impossible. There will be some wonderfully-undervalued technology names to select from over the coming months, but investors need to dive deeper than the balance sheet and consider the financial state of the group actually responsible for the revenues—the customers. Those wacky p/e ratios (CRM's is 1,091) may no longer be justifiable.
Cybersecurity
04. Penn New Frontier Fund member Fortinet jumps 21% in one session
For the past few years, we have been extremely bullish on the cybersecurity space. The chronic threat of cyber attacks from the likes of China, Russia, North Korea, and Iran, all working to inflict maximum pain on the US, is only going to grow moving forward. In the Penn Dynamic Growth Strategy, our ETF portfolio, we own CIBR, the First Trust NASDAQ Cybersecurity ETF; and in the Penn New Frontier Fund we own Fortinet (FTNT $69-$137-$122), a California-based cybersecurity vendor that sells detection and protection products to businesses of all sizes and a large number of government entities around the world. The company reported Q1 numbers this week that soundly beat expectations, and investors celebrated the news. Not only did the firm increase revenues by 22% y/y, net income rose by 76% from the same quarter last year—beating expectations by 120%. After the earnings release, FTNT shares proceeded to climb 21% in one session, finishing the week up 31% and easily punching through a 52-week high. Fortinet also happens to be one of the top ten holdings in CIBR.
Economics: Work & Pay
03. A record number of Americans file for unemployment, stocks spike
One thing we have learned in this business, after being hit in the face with hundreds of examples, is that good economic news often brings a market drop, while dour news often leads to a market rally. This bizarre relationship surfaced yet again on Friday, when a record-bad jobs report led to a 455-point Dow rally. The report was unfathomably bad: 20.5 million Americans filed for unemployment, and the unemployment rate went from a 50-year low to rates not seen since the Great Depression. So, with nearly one in five Americans out of work, and with many of those still working seeing their hours or pay reduced, why the big rally on the day and the week? Americans are generally beginning to see some light at the end of the tunnel. With lockdowns coming to an end soon, barring a major spike in new infections, there is a real sense that things will begin returning to some semblance of normalcy. A growing number of economists believe that April will end up being the worst month for job losses, and that it will be a slow but sure climb back from here. A full 88% of those laid off in April, in fact, believe they will be returning to their same jobs over the coming months. That optimism led to another strong week in the markets: the Dow was up 2.56%, the S&P 500 rose 3.5%, and the NASDAQ spiked an impressive 6%.
Market Risk Management
02. The P/E ratio has become temporarily useless; try this metric instead
It is typically the first number we look at—even before the share price—when evaluating a stock. Of all the key stats, few paint a better picture of a company's general value than the price-to-earnings (P/E) ratio. Granted, we may buy a growth stock with a P/E of 78 like Chipotle Mexican Grill (CMG $926), and ignore one with a P/E of 7 like General Motors (GM $24), but when comparing companies within and industry this metric can help us identify undervalued gems.
That being said, this valuation tool is on a roller coaster ride that is rendering it relatively useless, at least for now. First came the sudden drop in the "P" thanks to the 35% market correction (with many styles, such as small caps, dropping even more). In essence, we were looking at a number that reflected current prices but stale earnings ("E"), driving the P/E lower on nearly all stocks. Now that pandemic-tainted earnings are finally rolling in, the figure is going to be driven artificially higher, unless one believes that a certain company's earnings will never recover. At the start of the year, analysts were predicting a 6% rate of growth in earnings for companies in the S&P 500; they have now revised that number to -12% for Q1, and -24% for Q2. Until "real" numbers begin to return, hopefully in fall of this year, we can pretty much ignore the P/E ratio.
Considering the damage done by the virus, the metric we are most focused on right now is a company's current ratio, which divides current assets by current liabilities. The higher that number the better, as it gives us an idea as to which companies are going to be able to weather this storm, and which are fighting to remain in business. For example, if a company has $4.4 billion in current assets and $2 billion in current liabilities (Advanced Micro Devices AMD $53), its current ratio is a very solid 2.2. If, however, a company has $7.9 billion in current assets and $16.09 billion in current liabilities (United Airlines UAL $25), its current ratio is 0.49. Serious trouble brewing. What's a good current ratio to look for? While the number varies from industry to industry, a general rule of thumb is to look for companies with a current ratio of 1.2 or higher.
Under the Radar Investment
01. Under the Radar Investment: Ciena Corp
Ciena Corp (CIEN $31-$48-$50) is a communications equipment maker which provides network hardware, software, and services that support the management of video, data, and voice traffic on communications networks around the world. We expect the company to play a key role as companies upgrade their existing communication networks to the 5G infrastructure. As the US government has placed Chinese firm Huawei on its banned companies list, look for Ciena to continue gaining market share, both in this country and in Europe. Not only does does the company have a strong growth trajectory, it has strong financial health: with current assets of $2.27B and current liabilities of $733M, its current ratio is 3.09.
Answer
The highest rate of US unemployment was 24.9%, which took place in 1933 during the heart of the Great Depression. The record low occurred twenty years later, in 1953 during the Eisenhower administration, when unemployment fell to 2.5%.
Headlines for the Week of 26 Apr 2020—02 May 2020
Question (From information in The Penn Wealth Report, Vol 8/Issue 02)
Deeply diminished Libyan output...
Right now, thanks to internal strife and the growing power of General Haftar's Libyan National Army (Haftar is an opponent of Islamic extremism), the OPEC nation is currently producing just 400,000 barrels of oil per day. In its heyday, the Gulf nation was pumping out 2.4 million barrels per day. What year did it hit that peak, and what related event was going on in the United States at the time?
Penn Trading Desk:
(29 Apr 20) Penn: Open Life Sciences technology provider
We added a new technology systems provider for the health care arena to the Intrepid Trading Platform. Members, visit the Trading Desk for details. Remember that all trade notifications are sent out via Twitter from @PennWealth. If using the platform, remember to Follow us!
(28 Apr 20) Penn: Raise stop on ZYXI
Zynex ZYXI $16.50 rose above our target price in the Intrepid. Raise stop to $16 on ZYXI shares. UPDATE: ZYXI hit stop @ $15.90 for 9.6% gain in three trading days.
(28 Apr 20) Penn: Raise stop on EBS
Emergent BioSolutions EBS $81 rose above our target price in the Intrepid. Raise stop to $80 on EBS shares. UPDATE: EBS sold @ $80 for 10% gain in 2 trading days.
(27 Apr 20) Penn: Raise stop on PSX
Our Phillips 66 (PSX $40-$64-$120) addition to the Penn Global Leaders Club is now up 40% in just five weeks since purchase. Even though the Global Leaders Club generally has less-stringent stops, that is a fast run-up. We need to protect the position. Raise stop from $40 to $60 on PSX shares.
(27 Apr 20) Penn: BYND stopped out
After a downgrade (unwarranted) by UBS analyst, our Beyond Meat fell and hit the $99.50 stop we had in place and liquidated from the New Frontier Fund for an 86% short-term gain. We still believe in the company, and plan to pick it up again in the future as price warrants. Sell BYND @ $99.50.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Automotive
10. GM had one thing going for it: its dividend yield; now that is gone
Granted, General Motors' (GM $14-$22-$42) investors have watched their holding get cut precisely in half since last August, but at least they could point to the $0.38 quarterly dividend consistently paid out on the shares. Not bad, considering that $1.52 per year equated to a 7% yield based on the current share price. Now, however, in an effort to shore up its battered balance sheet, the company has announced it will no longer issue a dividend payment. To say the balance sheet is battered is an understatement. GM has current liabilities totaling $85 billion (113% of short-term assets) and long-term liabilities of $97 billion (63% of long-term assets). Keep in mind that the company's market cap is now under $31 billion. In the last week of March, credit rating agency Moody's placed GM on watch for a possible ratings cut to junk level, which would make debt restructuring more difficult and certainly more costly, despite the ultra-low current rate environment. Shares fell about 2% on news of the dividend cut.
Energy Equipment & Services
09. Diamond Offshore declares bankruptcy, shares plunge 61%
Diamond Offshore (DO $0-$0-$11) used to be a great trading stock—yet another way to play the oil markets. I began trading it in 1998 when it was roughly $20 per share. Near the end of 2007, shares peaked around $150 apiece and the contract driller hit $20 billion in size. In this surreal era of negative oil prices, however, no energy company is safe. For oil drillers, the question has shifted from "how much equipment do we need to lease?" to "how can we shutdown wells most cost effectively?" That is a nightmare scenario for the owners of oil and gas drilling equipment. Which brings us back to Diamond. Futures were dropping 61% pre-market—to below $1—on DO shares as the company announced it would declare bankruptcy and cease all interest payments on outstanding debt. Trading was subsequently halted. Sadly, this will not be the last American oil and gas company to take this route. This past December, which seems so long ago, Barron's interviewed market master Peter Lynch, whose Fidelity Magellan Fund averaged an incredible 29% per year for the thirteen years he was at the helm. Asked about the opportunities he saw on the horizon, the beaten down energy sector seemed the most interesting. What a difference a season makes.
Aerospace & Defense
08. We've been so focused on Boeing's woes that we forgot about Airbus
For decades we have watched with rapt attention the raging battle between the two global aerospace giants: America's Boeing (BA $89-$130-$391) and Europe's government-subsidized Airbus (EADSY $13-$14-$38). Ever since the second Boeing crash, however, and the focus on that company's inept management team, we sort of forgot about the European trust fund baby. We just assumed things were humming along as they picked up all of the lost Boeing contracts. Not so fast. In the first place, we are happy—and somewhat surprised—to announce that Boeing is still the larger company, despite its fall from grace and its share price drop from $440 in March of 2019 to $89 precisely one year later: BA weighs in at $73B; EADSY comes in at $43B. In the second place, Airbus CEO Guillaume Faury just sent an ominous letter to staff that made it abundantly clear the company is in dire straits. In the letter, Faury told 135,000 workers that the company's very existence is at stake, and to prepare for deep job cuts. In our last ...After Hours we noted the massive government-paid furloughs taking place across Europe, but the letter warned of "more far-reaching measures" to come. "The survival of Airbus is in question if we don't act now," said Faury. Something tells us that everyone who is not furloughed will be on board with the draconian plans. Our guess, based on the figures which have been made public, is that Airbus has lost roughly 50% of its orders due to the pandemic.
Life Sciences Tools & Services
07. Quest Diagnostics rolls out consumer-based Covid antibody test
In a move aimed squarely at the massive consumer market (as opposed to the health care sector), lab services company Quest Diagnostics (DGX $73-$115-$125) is rolling out a Covid-19 antibody test which will detect whether or not an individual has been exposed to the virus, and if they have built up antibodies in response. The program, called Quest Direct, will involve the consumer ordering the kit directly from the company then being directed to one of 2,200 patient-service centers nationwide to have blood drawn. Within a day or two, they will then be able to go to the company's patient portal, MyQuest, to check results and speak with a physician if they desire. Earlier in the week, rival LabCorp (LH $98-$177-$196) announced a similar program involving a nasal swab test kit being sent directly to consumers' homes. Both companies are trading with a fairly conservative multiple of roughly 20, and both saw their respective share prices hammered in the initial stages of the downturn.
Media & Entertainment
06. AMC, in fight for its life, battles Universal over streaming spat
Leawood, Kansas-based AMC Entertainment (AMC $2-$4-$15), with its 1,004 theaters and 11,041 screens, has a message for Universal Pictures: your movies are no longer welcome at our establishment. What led to the all-out war against the motion picture division of Comcast (CMCSA)? The studio's decision to simultaneously release movies in the theaters and to streaming services alike. This so-called breaking of the "theatrical window" came to a head when Universal, armed with its new Trolls World Tour movie and no screens to show it on thanks to the pandemic, decided to break custom and release the movie directly to the streaming services. The icing on the cake was when studio executives made it clear that this would be the practice going forward. Enraged, AMC CEO Adam Aron called the move categorically unacceptable, and announced the ban of all Universal movies until the new policy is changed. AMC, meanwhile, is a shell of its former self. The company, now controlled by China's Dalian Wanda Group, has seen its share price drop from $35 three years ago to under $5 today. With its $450M market cap, we still believe the company is a good takeover candidate.
Technology Hardware, Storage, & Peripherals
05. Our Phillips 66 shares are up 60% in one month because...
In the heat of the downturn, right after the second shoe (the oil war between Saudi and Russia) dropped, midstream refiner and downstream marketer Phillips 66 (PSX $40-$72-$120) was plummeting to $45 for share—off 61% in a number of months. To us, that didn't make sense. While refining would certainly suffer to some degree due to low (or negative) oil prices, they still need to operate, meaning a constant stream of revenue. And the company's 6,000+ stations around the country would continue to make money. Finally, the company was now unencumbered by its former parent entity, integrated oil giant ConocoPhillips (COP). We immediately added PSX to the longer-term Penn Global Leaders Club (Position #37/40) on 16 Mar 2020 at $45.49 per share. We liked the company so much we wrote a full-page spread on its prospects in a recent Penn Wealth Report. On Thursday, shares hit $73, for a 60% gain in just over a month. And we have no intention of selling anytime soon (though we did raise our stop to $60 due to the rapid move in the share price). Phillips 66 has since been upgraded by a number of firms due to its strong financial position and rosy outlook.
Integrated Oil & Gas
04. Speaking of big oil, Shell cuts dividend for first time since WWII
As alluded to above, big integrated oil companies continue to get pounded by demand destruction. To illustrate: Shares of Royal Dutch Shell (RDSA $21-$34-$66) have fallen so far that the company now has a dividend yield of 10%—up from 5% when shares were $66 apiece. Obviously, this is unsustainable, forcing the company to do something it hasn't done since World War II: cut its dividend. Retroactive to the first quarter, RDSA shares will have a payout of $0.16, or 66% less than the previous rate. Shell will also cut its capital expenditures for the year from $25 billion to $20 billion, and end all share buybacks. Each of these moves is needed, but that didn't stop investors from pushing RDSA shares down 11% on the news. Interestingly, competitor BP (BP $24) announced it will not cut its dividend rate, which currently yields 9.7%. This despite the fact that the multiple on BP shares (22) is over double that of Royal Dutch (9). In synopsis, we wouldn't be buying any new positions in big oil right now, and we wouldn't be keen on selling existing positions at this level. Our favorite big oil name remains US-based Chevron Corp (CVX $93).
Consumer Finance
03. Hey, at least they turned a profit: Freddie Mac's income down 88%
US government-sponsored enterprise (GSE) Federal Home Loan Mortgage Corp, affectionately (not) known as Freddie Mac (FMCC $1-$2-$4), actually turned a profit in the first quarter. That's the good news. The bad news is that it fell from $1.4 billion in Q1 of 2019 to $173 million for the same period this year—an 88% drop. Obviously, the virus was the culprit, which forced FMCC to book $1.1B worth of credit-related expenses. Single-family home loans, the company's bread and butter, took an enormous hit due to the lockdown, which means we can expect an ugly second quarter as well. Freddie has been under government control since the slew of bad loans emanating from the 2008 financial crisis began to manifest, but it was moving ever-closer to privatization going into the year. Sadly, that movement has been stopped dead in its tracks. Then again, the same taxpayer bailout that led to the government taking control in 2008 would probably have circled back around thanks to the pandemic, so the organization might as well remain a government albatross for the foreseeable future. Europe would be proud.
Economic Outlook
02. No surprise: Here come the horrendous economic reports
How can we possibly be having a strong month in the markets when disastrous economic reports keep flowing in? The answer: the nightmare was already baked into the cake. First, US GDP: the economy contracted by 4.8% in Q1. I read headlines like "worse than feared" when the report came out, but that's disingenuous. Actually, nobody knew what the numbers would look like thanks to this new beast which we have not faced before. We saw economist predictions ranging from 0% growth to a 15% contraction. That would explain why the Dow actually rose 532 points on Wednesday. Then we have the 3.8 million new jobless claims figure to contend with. Once again, we knew it would be brutal—consider all the closed businesses! There have now been 30 million submitted claims—nearly one in ten Americans—for unemployment insurance since mid-March. A full 12.4% of US workers covered by unemployment benefits are now receiving them. Staggering. On the European side, similar reports began flowing in. The EU's GDP contracted by 3.8% in the first quarter, and France—with its 5.8% contraction—officially entered recession. Europe's largest economy, Germany, is bracing for its worst recession since the end of World War II. The biggest catalyst for April's market gains was hope. We are beginning to finally see positive signs on the testing, treatment, and vaccine fronts. We fully expect that momentum to pick up as we enter late spring and early summer. If that is the case, we could continue our march back to Dow 29,000.
Under the Radar Investment
01. Under the Radar Investment: Veeva Systems Inc.
"The Industry Cloud for Life Sciences." That is the slogan on the home page of Veeva Systems' (VEEV $118-$183-$196), and it is more than just hype. The company is a best-in-breed supplier of vertical software solutions for the life sciences industry. From small emerging biotechs, to behemoth pharmaceutical manufacturers, Veeva uses its expansive cloud-based platform to improve the efficiencies of its customers, and to assure they remain in compliance with regulatory requirements—a herculean task for the industry.
Veeva already controls 40% of the addressable market, despite its relative youth (it went public about six years ago), and it is extremely well positioned to increase that market share in a highly-fragmented space. VEEV would be suitable for the Intrepid (short-term trading) or the New Frontier Fund (longer-term investment in new technologies).
Answer
Libya hit its oil-producing stride back in 1973, when production ramped up to 2.4 million barrels per day. Not by coincidence, this was also the year that the United States found itself in the midst of the OPEC-imposed oil embargo.
Deeply diminished Libyan output...
Right now, thanks to internal strife and the growing power of General Haftar's Libyan National Army (Haftar is an opponent of Islamic extremism), the OPEC nation is currently producing just 400,000 barrels of oil per day. In its heyday, the Gulf nation was pumping out 2.4 million barrels per day. What year did it hit that peak, and what related event was going on in the United States at the time?
Penn Trading Desk:
(29 Apr 20) Penn: Open Life Sciences technology provider
We added a new technology systems provider for the health care arena to the Intrepid Trading Platform. Members, visit the Trading Desk for details. Remember that all trade notifications are sent out via Twitter from @PennWealth. If using the platform, remember to Follow us!
(28 Apr 20) Penn: Raise stop on ZYXI
Zynex ZYXI $16.50 rose above our target price in the Intrepid. Raise stop to $16 on ZYXI shares. UPDATE: ZYXI hit stop @ $15.90 for 9.6% gain in three trading days.
(28 Apr 20) Penn: Raise stop on EBS
Emergent BioSolutions EBS $81 rose above our target price in the Intrepid. Raise stop to $80 on EBS shares. UPDATE: EBS sold @ $80 for 10% gain in 2 trading days.
(27 Apr 20) Penn: Raise stop on PSX
Our Phillips 66 (PSX $40-$64-$120) addition to the Penn Global Leaders Club is now up 40% in just five weeks since purchase. Even though the Global Leaders Club generally has less-stringent stops, that is a fast run-up. We need to protect the position. Raise stop from $40 to $60 on PSX shares.
(27 Apr 20) Penn: BYND stopped out
After a downgrade (unwarranted) by UBS analyst, our Beyond Meat fell and hit the $99.50 stop we had in place and liquidated from the New Frontier Fund for an 86% short-term gain. We still believe in the company, and plan to pick it up again in the future as price warrants. Sell BYND @ $99.50.
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Automotive
10. GM had one thing going for it: its dividend yield; now that is gone
Granted, General Motors' (GM $14-$22-$42) investors have watched their holding get cut precisely in half since last August, but at least they could point to the $0.38 quarterly dividend consistently paid out on the shares. Not bad, considering that $1.52 per year equated to a 7% yield based on the current share price. Now, however, in an effort to shore up its battered balance sheet, the company has announced it will no longer issue a dividend payment. To say the balance sheet is battered is an understatement. GM has current liabilities totaling $85 billion (113% of short-term assets) and long-term liabilities of $97 billion (63% of long-term assets). Keep in mind that the company's market cap is now under $31 billion. In the last week of March, credit rating agency Moody's placed GM on watch for a possible ratings cut to junk level, which would make debt restructuring more difficult and certainly more costly, despite the ultra-low current rate environment. Shares fell about 2% on news of the dividend cut.
Energy Equipment & Services
09. Diamond Offshore declares bankruptcy, shares plunge 61%
Diamond Offshore (DO $0-$0-$11) used to be a great trading stock—yet another way to play the oil markets. I began trading it in 1998 when it was roughly $20 per share. Near the end of 2007, shares peaked around $150 apiece and the contract driller hit $20 billion in size. In this surreal era of negative oil prices, however, no energy company is safe. For oil drillers, the question has shifted from "how much equipment do we need to lease?" to "how can we shutdown wells most cost effectively?" That is a nightmare scenario for the owners of oil and gas drilling equipment. Which brings us back to Diamond. Futures were dropping 61% pre-market—to below $1—on DO shares as the company announced it would declare bankruptcy and cease all interest payments on outstanding debt. Trading was subsequently halted. Sadly, this will not be the last American oil and gas company to take this route. This past December, which seems so long ago, Barron's interviewed market master Peter Lynch, whose Fidelity Magellan Fund averaged an incredible 29% per year for the thirteen years he was at the helm. Asked about the opportunities he saw on the horizon, the beaten down energy sector seemed the most interesting. What a difference a season makes.
Aerospace & Defense
08. We've been so focused on Boeing's woes that we forgot about Airbus
For decades we have watched with rapt attention the raging battle between the two global aerospace giants: America's Boeing (BA $89-$130-$391) and Europe's government-subsidized Airbus (EADSY $13-$14-$38). Ever since the second Boeing crash, however, and the focus on that company's inept management team, we sort of forgot about the European trust fund baby. We just assumed things were humming along as they picked up all of the lost Boeing contracts. Not so fast. In the first place, we are happy—and somewhat surprised—to announce that Boeing is still the larger company, despite its fall from grace and its share price drop from $440 in March of 2019 to $89 precisely one year later: BA weighs in at $73B; EADSY comes in at $43B. In the second place, Airbus CEO Guillaume Faury just sent an ominous letter to staff that made it abundantly clear the company is in dire straits. In the letter, Faury told 135,000 workers that the company's very existence is at stake, and to prepare for deep job cuts. In our last ...After Hours we noted the massive government-paid furloughs taking place across Europe, but the letter warned of "more far-reaching measures" to come. "The survival of Airbus is in question if we don't act now," said Faury. Something tells us that everyone who is not furloughed will be on board with the draconian plans. Our guess, based on the figures which have been made public, is that Airbus has lost roughly 50% of its orders due to the pandemic.
Life Sciences Tools & Services
07. Quest Diagnostics rolls out consumer-based Covid antibody test
In a move aimed squarely at the massive consumer market (as opposed to the health care sector), lab services company Quest Diagnostics (DGX $73-$115-$125) is rolling out a Covid-19 antibody test which will detect whether or not an individual has been exposed to the virus, and if they have built up antibodies in response. The program, called Quest Direct, will involve the consumer ordering the kit directly from the company then being directed to one of 2,200 patient-service centers nationwide to have blood drawn. Within a day or two, they will then be able to go to the company's patient portal, MyQuest, to check results and speak with a physician if they desire. Earlier in the week, rival LabCorp (LH $98-$177-$196) announced a similar program involving a nasal swab test kit being sent directly to consumers' homes. Both companies are trading with a fairly conservative multiple of roughly 20, and both saw their respective share prices hammered in the initial stages of the downturn.
Media & Entertainment
06. AMC, in fight for its life, battles Universal over streaming spat
Leawood, Kansas-based AMC Entertainment (AMC $2-$4-$15), with its 1,004 theaters and 11,041 screens, has a message for Universal Pictures: your movies are no longer welcome at our establishment. What led to the all-out war against the motion picture division of Comcast (CMCSA)? The studio's decision to simultaneously release movies in the theaters and to streaming services alike. This so-called breaking of the "theatrical window" came to a head when Universal, armed with its new Trolls World Tour movie and no screens to show it on thanks to the pandemic, decided to break custom and release the movie directly to the streaming services. The icing on the cake was when studio executives made it clear that this would be the practice going forward. Enraged, AMC CEO Adam Aron called the move categorically unacceptable, and announced the ban of all Universal movies until the new policy is changed. AMC, meanwhile, is a shell of its former self. The company, now controlled by China's Dalian Wanda Group, has seen its share price drop from $35 three years ago to under $5 today. With its $450M market cap, we still believe the company is a good takeover candidate.
Technology Hardware, Storage, & Peripherals
05. Our Phillips 66 shares are up 60% in one month because...
In the heat of the downturn, right after the second shoe (the oil war between Saudi and Russia) dropped, midstream refiner and downstream marketer Phillips 66 (PSX $40-$72-$120) was plummeting to $45 for share—off 61% in a number of months. To us, that didn't make sense. While refining would certainly suffer to some degree due to low (or negative) oil prices, they still need to operate, meaning a constant stream of revenue. And the company's 6,000+ stations around the country would continue to make money. Finally, the company was now unencumbered by its former parent entity, integrated oil giant ConocoPhillips (COP). We immediately added PSX to the longer-term Penn Global Leaders Club (Position #37/40) on 16 Mar 2020 at $45.49 per share. We liked the company so much we wrote a full-page spread on its prospects in a recent Penn Wealth Report. On Thursday, shares hit $73, for a 60% gain in just over a month. And we have no intention of selling anytime soon (though we did raise our stop to $60 due to the rapid move in the share price). Phillips 66 has since been upgraded by a number of firms due to its strong financial position and rosy outlook.
Integrated Oil & Gas
04. Speaking of big oil, Shell cuts dividend for first time since WWII
As alluded to above, big integrated oil companies continue to get pounded by demand destruction. To illustrate: Shares of Royal Dutch Shell (RDSA $21-$34-$66) have fallen so far that the company now has a dividend yield of 10%—up from 5% when shares were $66 apiece. Obviously, this is unsustainable, forcing the company to do something it hasn't done since World War II: cut its dividend. Retroactive to the first quarter, RDSA shares will have a payout of $0.16, or 66% less than the previous rate. Shell will also cut its capital expenditures for the year from $25 billion to $20 billion, and end all share buybacks. Each of these moves is needed, but that didn't stop investors from pushing RDSA shares down 11% on the news. Interestingly, competitor BP (BP $24) announced it will not cut its dividend rate, which currently yields 9.7%. This despite the fact that the multiple on BP shares (22) is over double that of Royal Dutch (9). In synopsis, we wouldn't be buying any new positions in big oil right now, and we wouldn't be keen on selling existing positions at this level. Our favorite big oil name remains US-based Chevron Corp (CVX $93).
Consumer Finance
03. Hey, at least they turned a profit: Freddie Mac's income down 88%
US government-sponsored enterprise (GSE) Federal Home Loan Mortgage Corp, affectionately (not) known as Freddie Mac (FMCC $1-$2-$4), actually turned a profit in the first quarter. That's the good news. The bad news is that it fell from $1.4 billion in Q1 of 2019 to $173 million for the same period this year—an 88% drop. Obviously, the virus was the culprit, which forced FMCC to book $1.1B worth of credit-related expenses. Single-family home loans, the company's bread and butter, took an enormous hit due to the lockdown, which means we can expect an ugly second quarter as well. Freddie has been under government control since the slew of bad loans emanating from the 2008 financial crisis began to manifest, but it was moving ever-closer to privatization going into the year. Sadly, that movement has been stopped dead in its tracks. Then again, the same taxpayer bailout that led to the government taking control in 2008 would probably have circled back around thanks to the pandemic, so the organization might as well remain a government albatross for the foreseeable future. Europe would be proud.
Economic Outlook
02. No surprise: Here come the horrendous economic reports
How can we possibly be having a strong month in the markets when disastrous economic reports keep flowing in? The answer: the nightmare was already baked into the cake. First, US GDP: the economy contracted by 4.8% in Q1. I read headlines like "worse than feared" when the report came out, but that's disingenuous. Actually, nobody knew what the numbers would look like thanks to this new beast which we have not faced before. We saw economist predictions ranging from 0% growth to a 15% contraction. That would explain why the Dow actually rose 532 points on Wednesday. Then we have the 3.8 million new jobless claims figure to contend with. Once again, we knew it would be brutal—consider all the closed businesses! There have now been 30 million submitted claims—nearly one in ten Americans—for unemployment insurance since mid-March. A full 12.4% of US workers covered by unemployment benefits are now receiving them. Staggering. On the European side, similar reports began flowing in. The EU's GDP contracted by 3.8% in the first quarter, and France—with its 5.8% contraction—officially entered recession. Europe's largest economy, Germany, is bracing for its worst recession since the end of World War II. The biggest catalyst for April's market gains was hope. We are beginning to finally see positive signs on the testing, treatment, and vaccine fronts. We fully expect that momentum to pick up as we enter late spring and early summer. If that is the case, we could continue our march back to Dow 29,000.
Under the Radar Investment
01. Under the Radar Investment: Veeva Systems Inc.
"The Industry Cloud for Life Sciences." That is the slogan on the home page of Veeva Systems' (VEEV $118-$183-$196), and it is more than just hype. The company is a best-in-breed supplier of vertical software solutions for the life sciences industry. From small emerging biotechs, to behemoth pharmaceutical manufacturers, Veeva uses its expansive cloud-based platform to improve the efficiencies of its customers, and to assure they remain in compliance with regulatory requirements—a herculean task for the industry.
Veeva already controls 40% of the addressable market, despite its relative youth (it went public about six years ago), and it is extremely well positioned to increase that market share in a highly-fragmented space. VEEV would be suitable for the Intrepid (short-term trading) or the New Frontier Fund (longer-term investment in new technologies).
Answer
Libya hit its oil-producing stride back in 1973, when production ramped up to 2.4 million barrels per day. Not by coincidence, this was also the year that the United States found itself in the midst of the OPEC-imposed oil embargo.
Headlines for the Week of 19 Apr 2020—25 Apr 2020
Question (From information in The Penn Wealth Report, Vol 8/Issue 02)
Creative corporate leadership...
Admittedly, we love CarMax (KMX). The entire process of finding, buying, and financing a used vehicle can be completed within a matter of hours. The concept of CarMax came from a rather odd place. What company developed the idea under the code name "Project X"?
Penn Trading Desk:
(24 Apr 20) Penn: Place stop on BYND
We added Beyond Meat (BYND $108) to the Penn New Frontier Fund within five minutes of the company's first-ever trade. It is up 102% since then, just under a one-year period. We believe in the long-term viability of this industry-leading firm, but want to protect gains here. If it sells, we can always buy back in the future. Place $99.50 stop on shares.
(24 Apr 20) Penn: Add specialty drugmaker to Intrepid
Added a mid-cap specialty drugmaker focusing on biodefense (w/big government contracts) in the Intrepid. With $3.8B market cap, huge potential w double-digit EPS and net income growth.
(23 Apr 20) Penn: Add medical device small-cap
Added a small-cap medical device maker to Intrepid. Members see the Trading Desk.
(23 Apr 20) Penn: PFE stopped-out, taking profits
Pfizer hit our target price w double-digit gains in Intrepid, raised stop to $37, executed for 10% s/t gain.
(22 Apr 20) Penn: Close DPZ, taking profits
Closed our Domino's Pizza DPZ position in the Intrepid for a 7.72% gain in one week.
(22 Apr 20) Credit Suisse: Raise price target on CMG
After the company reported strong sales for the quarter, Credit Suisse raised its price target on shares of Penn Global Leaders Club member Chipotle (CMG $415-$860-$940) from $900 to $940. See story below.
Current Intrepid Trading Platform buy-in value/unit: $12,360 (S&P 500 @ 2,837)
Performance since inception: S&P 500: -1.32%; Intrepid: -0.46%
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Energy Commodities
10. Negative oil prices are about as silly as negative interest rates
We thought we had seen it all when governments around the world began issuing sovereign debt with negative interest rates, implying that anyone who wanted to buy a government bill, note, or bond would have to pay for the right to do so. We just wrapped our head around that insane concept and along comes negative oil prices. No, the gas stations aren't going to begin paying you to fill up your SUV, but the fact that May futures contracts for West Texas crude fell to -$37.63 per barrel does highlight what crazy times we are living through. While the May contracts attracted all of the headlines (of course), the real price of oil is not negative. June contracts are trading around $16/bbl, and subsequent months go up from there, with December sitting around $30/bbl.
As global economies begin coming back online, the price of crude will rise again; in the meantime, however, energy companies are finding it extremely expensive to park all of the oil they have coming out of the ground. Their only option is even less palatable: pay an enormous price for shuttering the fields, many of which may never come back online. The Saudis and the Russians are trying to force the American firms into the second choice so they can regain their "rightful" roles as the world's top two producers, and then jack prices back up. To prevent this, the US government is going to have to provide financial support to the industry. The fact that the two OPEC+ nations undertook this price war in the midst of the pandemic is loathsome—and it now appears to have been coordinated. Devious plans often bring unintended consequences, however. Saudi Arabia and Russia might not want to celebrate just yet.
IT Services
09. IBM beats Q1 expectations, but its warning drove the market lower
Former Penn Global Leaders Club member IBM (IBM $91-$116-$159), which we shed when Ginni Rometty announced that she would be leaving the CEO role, didn't have all that bad of a first quarter: revenues of $17.57 billion were off 3.36% y/y and EPS came in at $1.84 per share, a bit higher than last year's Q1 rate of $1.79. The problem came when management began discussing guidance, or the lack thereof. The company pulled its full-year guidance, and then gave a rather dour outlook on the current mindset of customers. Not only was there a sharp decline in software sales in late March, the feedback they did glean from customers (many weren't responding) pointed to a "cash-conservation" mentality. In turn, this feedback will lead to the company putting many of its big cloud build-out projects on hold. This is an ugly cycle we are witnessing in industry after industry, with the pain being felt by everyone along the vertical chain, but one we had hoped would somewhat bypass the software industry, which operates in the digital world. Apparently, that is not the case. We need to get the economy back up and running before we can gauge just how rapidly companies are willing to exit the bunker and begin spending on growth once again.
Restaurants
08. Penn member Chipotle jumps double-digits on earnings, upgrades
We didn't quite get the bottom, but we came close. We picked up shares of fast-casual restaurant Chipotle Mexican Grill (CMG $415-$894-$940) on the 12th of March—in the heat of the market crash—at $590.85 per share. They fell further, then began their stunning comeback. Shares rose to $894 following the company's first-quarter earnings release. Talk about a restaurant that bucked the trend by embracing digital sales. Sales rose 8% in Q1, to $1.4B, and digital sales rose 81% for the quarter. Customers took advantage of the CMG app to order from home and either have the meals delivered or ready for pick-up on location. Chipotle began embracing the digital platform concept last year, and it has paid off in spades. We agree with many of the analysts who commented that CMG is simply the best growth story in the restaurant space. Shares are up over 50% in the one month since re-adding the chain to the Global Leaders Club.
Global Strategy: Europe
07. Think America has it rough? Check out Europe's economy
We have been writing recently about Europe's great shift in attitude toward China. The country many globalists on the continent saw as the natural replacement for America—the trading partner many of them loathe—has suddenly lost its luster. And that is putting it mildly. Thanks to the pandemic, Europe finds itself in the throes of its worst economic collapse in history. Consider this metric: the composite Purchasing Managers Index (PMI), which measures activity in the private sector, just fell to 13.5—the lowest reading ever. Any measure above 50 indicates expansion, while any figure below 50 indicates contraction. Putting that in perspective, at the low point of the global financial crisis Europe's PMI dropped to 36.2. One human aspect of this great collapse is the fact that at least twenty million Europeans are now on paid leave, with their respective governments picking up the tab. While the EU finance ministers have just approved a €500 billion ($540B) stimulus plan (€100B of which will go to subsidize wages), the fight over how it will be funded is going to be brutal. Many EU members believe the issuance of "corona bonds" is warranted, but Germany stands in opposition to the idea. The internecine battles are going to be epic, but the overriding message is this: Europe's anger at China over the cause of this great meltdown will dramatically shift the concept of trade between the two blocs.
Textiles, Apparel, & Luxury Goods
06. Just when things were looking (slightly) better for L Brands...
The company that Les Wexner started back in 1963 and brought to the public market in 1969, Limited Brands (now L Brands, LB $10), had a good run. After hitting the skids during the financial crisis of 2008/09, the veteran CEO maneuvered the company back to a $30 billion market cap as recently as 2015. Then the long, downhill slide began. The parent of Victoria's Secret, PINK, and Bath & Body Works saw its shares drop from $100 in November of 2015 to $10 this week, bringing its market cap down to $2.8 billion. We had mixed emotions when we heard that the company would be selling a 55% stake in its Victoria's Secret line to private equity firm Sycamore Partners, but at least it would bring in $525 million to the firm's bottom line. Not so fast. Sycamore is now claiming that the company breached covenants in the agreement by laying off workers due to the coronavirus, and it wants out of the deal. Does anyone believe that argument? This was legal speak for "we made a bad decision and want out of the deal." L Brands will vigorously fight the attempted termination, and we believe they should win. But if they do, why would you want to hold shares of a company partly owned by someone who desperately tried to get out of the marriage? Steer clear.
Technology Hardware, Storage, & Peripherals
05. Apple will begin making its own chips, and that is bad news for Intel*
Penn Global Leaders Club member Apple (AAPL $170-$283-$328) will begin selling Mac computers next year equipped with the company's own chips, and that appears to be just the beginning. Project Kalamata calls for the development of a number of different chips for use in everything from the iPhone to the iPad to the Mac lineup of computers. This could present a real threat to the company's current main supplier of semiconductors: Intel (INTC $43-$59-$69). There are multiple reasons for Apple to develop its own chips, but one major catalyst has been the reliance on Intel's technological advancements for the firm's own success. Apple has implicitly blamed a slowdown in Intel chip advances on a slower Mac upgrade cycle. By bringing chip development in-house, the trillion-dollar company would have more control over its own destiny—not to mention the critical supply chain logistics. As for Apple's stock price, the usual suspects are once again lowering their price targets, this time due to the pandemic. And once again, they will be proven wrong. Between INTC @ $59 and a 12 p/e ratio and Apple @ $283 and a 22 p/e ratio, we would choose the latter in an instant.
Interactive Media & Services
04. Facebook takes on Zoom by introducing new videoconferencing tool
It's called Messenger Rooms, and it will enable up to 50 people to meet via videoconference without a time limit, and without cost. Facebook's (FB $137-$190-$224) newest tool for users didn't move the needle much with respect to the company's share price, but the announcement was enough to drop Zoom's (ZM $61-$159-$182) share price by about 15%. Then again, that's a drop in the bucket considering Zoom's price move since the office and the school moved into the homes of most Americans. Facebook said that Messenger Rooms can be joined via phone or computer, and does not require a software download. While "rooms" can be created within the FB or Messenger apps, no Facebook account will be required to use the service. In an apparent dig at Zoom's recent privacy issues, the company said it does not view or listen to any calls, and that the room creator will have complete control over who sees the room and whether or not it will be locked or unlocked to new guests. This is a hyper-competitive space, and we are more concerned about Facebook's loss in ad revenue thanks to the pandemic than we are excited about the new service. As for Zoom, its 1,650 p/e ratio (Facebook's is 30) is a pretty good reason to move with caution. At their current share prices, both companies come with a high risk premium.
Automotive
03. Will fallout from the pandemic boost auto sales in the US?
There has clearly been a move away from individual car ownership in favor of public transportation and ride-sharing services in the US over the past several years. When I was growing up, getting a car was the first (well, maybe second) thing on the minds of most sixteen-year-old kids; but the zeitgeist began to change when millennials started shunning vehicle ownership in favor of rides-as-a-service. Now, thanks to a pandemic which will ultimately create a new generation of germophobes, the automakers may be back in the driver's seat. That being said, we are also looking at a major hit to the pocketbooks of an enormous number of Americans due to the virus. While the automakers are already offering special financing to lube seized-up vehicle sales, investors might be better off looking at the publicly traded used car chains like CarMax (KMX $71) and e-commerce platforms like Carvana (CVNA $92). Among those two choices, CarMax has a much better valuation (they actually turn a profit). Also, look for the automakers to tighten loan standards to reduce future defaults—a factor which could hinder new car sales.
Market Pulse
02. A worrisome start to the week gave way to relatively mild losses
By the close of business on Tuesday, the Dow had given up over 1,200 points and 5% of its value. Ditto the S&P 500 and NASDAQ, percentage-wise. Talk of the dreaded "w" recovery (meaning another leg down to the 23 March bottoms) permeated the business headlines. Without time to get overly worried, however, the markets rallied to end the week only mildly in the red. When the dust settled, the S&P was down roughly 1%, the Dow 2%, and the NASDAQ was flat. Oil was the big story of the week, with May futures going heavily negative on Tuesday and spot prices hitting $9 per barrel. By Friday afternoon, spot prices had climbed back to $17 per barrel, down just 5% for the week. It feels as though emotions are beginning to subside a bit, and we can point to a volatility level of 36 (VIX) to support this thesis. While a number south of 20 would be ideal, 36 is a far cry from the record 83 level recorded on the VIX in the middle of March. It may not feel like it, but the markets are in a confirmed uptrend; the question remains: can it be sustained. The state of Georgia, which began reopening for business, should provide some answers to that question over the coming days.
Under the Radar Investment
01. Stock of the Day: Emergent BioSolutions Inc
Emergent BioSolutions (EBS $72) is a truly fascinating mid-cap ($3.8B) specialty drug manufacturer. The company has two divisions: biodefense and biosciences. The biodefense unit focuses on an extremely timely area: countermeasures that address public health threats. Needless to say, the US government provides a good measure of the funding for this area, and we only see the division growing. Emergent's biosciences unit is primarily focused on hematology and oncology, with a secondary focus on transplants, infectious diseases, and autoimmunity. This mid-cap has growing sales, growing income, and one heck of a strong investment thesis based on current events.
One more little nugget of info: Emergent will manufacture a Covid-19 vaccine in the US which is currently being developed by Johnson & Johnson "at risk," meaning J&J plans to have large doses of the drug on hand even before regulatory approval. The company also has contracts in place to produce vaccines from Novavax (NVAX) and Vaxart (VXRT).
Answer
In addition to the code name "Project X," Circuit City executives, under the leadership of then-CEO Richard Sharp, also called the project "Honest Rick's Used Cars." The company had been evaluating opportunities outside of selling consumer electronics. Sadly, Circuit City no longer exists, but "Honest Rick's" became a thriving, $12 billion business known as CarMax.
Creative corporate leadership...
Admittedly, we love CarMax (KMX). The entire process of finding, buying, and financing a used vehicle can be completed within a matter of hours. The concept of CarMax came from a rather odd place. What company developed the idea under the code name "Project X"?
Penn Trading Desk:
(24 Apr 20) Penn: Place stop on BYND
We added Beyond Meat (BYND $108) to the Penn New Frontier Fund within five minutes of the company's first-ever trade. It is up 102% since then, just under a one-year period. We believe in the long-term viability of this industry-leading firm, but want to protect gains here. If it sells, we can always buy back in the future. Place $99.50 stop on shares.
(24 Apr 20) Penn: Add specialty drugmaker to Intrepid
Added a mid-cap specialty drugmaker focusing on biodefense (w/big government contracts) in the Intrepid. With $3.8B market cap, huge potential w double-digit EPS and net income growth.
(23 Apr 20) Penn: Add medical device small-cap
Added a small-cap medical device maker to Intrepid. Members see the Trading Desk.
(23 Apr 20) Penn: PFE stopped-out, taking profits
Pfizer hit our target price w double-digit gains in Intrepid, raised stop to $37, executed for 10% s/t gain.
(22 Apr 20) Penn: Close DPZ, taking profits
Closed our Domino's Pizza DPZ position in the Intrepid for a 7.72% gain in one week.
(22 Apr 20) Credit Suisse: Raise price target on CMG
After the company reported strong sales for the quarter, Credit Suisse raised its price target on shares of Penn Global Leaders Club member Chipotle (CMG $415-$860-$940) from $900 to $940. See story below.
Current Intrepid Trading Platform buy-in value/unit: $12,360 (S&P 500 @ 2,837)
Performance since inception: S&P 500: -1.32%; Intrepid: -0.46%
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Energy Commodities
10. Negative oil prices are about as silly as negative interest rates
We thought we had seen it all when governments around the world began issuing sovereign debt with negative interest rates, implying that anyone who wanted to buy a government bill, note, or bond would have to pay for the right to do so. We just wrapped our head around that insane concept and along comes negative oil prices. No, the gas stations aren't going to begin paying you to fill up your SUV, but the fact that May futures contracts for West Texas crude fell to -$37.63 per barrel does highlight what crazy times we are living through. While the May contracts attracted all of the headlines (of course), the real price of oil is not negative. June contracts are trading around $16/bbl, and subsequent months go up from there, with December sitting around $30/bbl.
As global economies begin coming back online, the price of crude will rise again; in the meantime, however, energy companies are finding it extremely expensive to park all of the oil they have coming out of the ground. Their only option is even less palatable: pay an enormous price for shuttering the fields, many of which may never come back online. The Saudis and the Russians are trying to force the American firms into the second choice so they can regain their "rightful" roles as the world's top two producers, and then jack prices back up. To prevent this, the US government is going to have to provide financial support to the industry. The fact that the two OPEC+ nations undertook this price war in the midst of the pandemic is loathsome—and it now appears to have been coordinated. Devious plans often bring unintended consequences, however. Saudi Arabia and Russia might not want to celebrate just yet.
IT Services
09. IBM beats Q1 expectations, but its warning drove the market lower
Former Penn Global Leaders Club member IBM (IBM $91-$116-$159), which we shed when Ginni Rometty announced that she would be leaving the CEO role, didn't have all that bad of a first quarter: revenues of $17.57 billion were off 3.36% y/y and EPS came in at $1.84 per share, a bit higher than last year's Q1 rate of $1.79. The problem came when management began discussing guidance, or the lack thereof. The company pulled its full-year guidance, and then gave a rather dour outlook on the current mindset of customers. Not only was there a sharp decline in software sales in late March, the feedback they did glean from customers (many weren't responding) pointed to a "cash-conservation" mentality. In turn, this feedback will lead to the company putting many of its big cloud build-out projects on hold. This is an ugly cycle we are witnessing in industry after industry, with the pain being felt by everyone along the vertical chain, but one we had hoped would somewhat bypass the software industry, which operates in the digital world. Apparently, that is not the case. We need to get the economy back up and running before we can gauge just how rapidly companies are willing to exit the bunker and begin spending on growth once again.
Restaurants
08. Penn member Chipotle jumps double-digits on earnings, upgrades
We didn't quite get the bottom, but we came close. We picked up shares of fast-casual restaurant Chipotle Mexican Grill (CMG $415-$894-$940) on the 12th of March—in the heat of the market crash—at $590.85 per share. They fell further, then began their stunning comeback. Shares rose to $894 following the company's first-quarter earnings release. Talk about a restaurant that bucked the trend by embracing digital sales. Sales rose 8% in Q1, to $1.4B, and digital sales rose 81% for the quarter. Customers took advantage of the CMG app to order from home and either have the meals delivered or ready for pick-up on location. Chipotle began embracing the digital platform concept last year, and it has paid off in spades. We agree with many of the analysts who commented that CMG is simply the best growth story in the restaurant space. Shares are up over 50% in the one month since re-adding the chain to the Global Leaders Club.
Global Strategy: Europe
07. Think America has it rough? Check out Europe's economy
We have been writing recently about Europe's great shift in attitude toward China. The country many globalists on the continent saw as the natural replacement for America—the trading partner many of them loathe—has suddenly lost its luster. And that is putting it mildly. Thanks to the pandemic, Europe finds itself in the throes of its worst economic collapse in history. Consider this metric: the composite Purchasing Managers Index (PMI), which measures activity in the private sector, just fell to 13.5—the lowest reading ever. Any measure above 50 indicates expansion, while any figure below 50 indicates contraction. Putting that in perspective, at the low point of the global financial crisis Europe's PMI dropped to 36.2. One human aspect of this great collapse is the fact that at least twenty million Europeans are now on paid leave, with their respective governments picking up the tab. While the EU finance ministers have just approved a €500 billion ($540B) stimulus plan (€100B of which will go to subsidize wages), the fight over how it will be funded is going to be brutal. Many EU members believe the issuance of "corona bonds" is warranted, but Germany stands in opposition to the idea. The internecine battles are going to be epic, but the overriding message is this: Europe's anger at China over the cause of this great meltdown will dramatically shift the concept of trade between the two blocs.
Textiles, Apparel, & Luxury Goods
06. Just when things were looking (slightly) better for L Brands...
The company that Les Wexner started back in 1963 and brought to the public market in 1969, Limited Brands (now L Brands, LB $10), had a good run. After hitting the skids during the financial crisis of 2008/09, the veteran CEO maneuvered the company back to a $30 billion market cap as recently as 2015. Then the long, downhill slide began. The parent of Victoria's Secret, PINK, and Bath & Body Works saw its shares drop from $100 in November of 2015 to $10 this week, bringing its market cap down to $2.8 billion. We had mixed emotions when we heard that the company would be selling a 55% stake in its Victoria's Secret line to private equity firm Sycamore Partners, but at least it would bring in $525 million to the firm's bottom line. Not so fast. Sycamore is now claiming that the company breached covenants in the agreement by laying off workers due to the coronavirus, and it wants out of the deal. Does anyone believe that argument? This was legal speak for "we made a bad decision and want out of the deal." L Brands will vigorously fight the attempted termination, and we believe they should win. But if they do, why would you want to hold shares of a company partly owned by someone who desperately tried to get out of the marriage? Steer clear.
Technology Hardware, Storage, & Peripherals
05. Apple will begin making its own chips, and that is bad news for Intel*
Penn Global Leaders Club member Apple (AAPL $170-$283-$328) will begin selling Mac computers next year equipped with the company's own chips, and that appears to be just the beginning. Project Kalamata calls for the development of a number of different chips for use in everything from the iPhone to the iPad to the Mac lineup of computers. This could present a real threat to the company's current main supplier of semiconductors: Intel (INTC $43-$59-$69). There are multiple reasons for Apple to develop its own chips, but one major catalyst has been the reliance on Intel's technological advancements for the firm's own success. Apple has implicitly blamed a slowdown in Intel chip advances on a slower Mac upgrade cycle. By bringing chip development in-house, the trillion-dollar company would have more control over its own destiny—not to mention the critical supply chain logistics. As for Apple's stock price, the usual suspects are once again lowering their price targets, this time due to the pandemic. And once again, they will be proven wrong. Between INTC @ $59 and a 12 p/e ratio and Apple @ $283 and a 22 p/e ratio, we would choose the latter in an instant.
Interactive Media & Services
04. Facebook takes on Zoom by introducing new videoconferencing tool
It's called Messenger Rooms, and it will enable up to 50 people to meet via videoconference without a time limit, and without cost. Facebook's (FB $137-$190-$224) newest tool for users didn't move the needle much with respect to the company's share price, but the announcement was enough to drop Zoom's (ZM $61-$159-$182) share price by about 15%. Then again, that's a drop in the bucket considering Zoom's price move since the office and the school moved into the homes of most Americans. Facebook said that Messenger Rooms can be joined via phone or computer, and does not require a software download. While "rooms" can be created within the FB or Messenger apps, no Facebook account will be required to use the service. In an apparent dig at Zoom's recent privacy issues, the company said it does not view or listen to any calls, and that the room creator will have complete control over who sees the room and whether or not it will be locked or unlocked to new guests. This is a hyper-competitive space, and we are more concerned about Facebook's loss in ad revenue thanks to the pandemic than we are excited about the new service. As for Zoom, its 1,650 p/e ratio (Facebook's is 30) is a pretty good reason to move with caution. At their current share prices, both companies come with a high risk premium.
Automotive
03. Will fallout from the pandemic boost auto sales in the US?
There has clearly been a move away from individual car ownership in favor of public transportation and ride-sharing services in the US over the past several years. When I was growing up, getting a car was the first (well, maybe second) thing on the minds of most sixteen-year-old kids; but the zeitgeist began to change when millennials started shunning vehicle ownership in favor of rides-as-a-service. Now, thanks to a pandemic which will ultimately create a new generation of germophobes, the automakers may be back in the driver's seat. That being said, we are also looking at a major hit to the pocketbooks of an enormous number of Americans due to the virus. While the automakers are already offering special financing to lube seized-up vehicle sales, investors might be better off looking at the publicly traded used car chains like CarMax (KMX $71) and e-commerce platforms like Carvana (CVNA $92). Among those two choices, CarMax has a much better valuation (they actually turn a profit). Also, look for the automakers to tighten loan standards to reduce future defaults—a factor which could hinder new car sales.
Market Pulse
02. A worrisome start to the week gave way to relatively mild losses
By the close of business on Tuesday, the Dow had given up over 1,200 points and 5% of its value. Ditto the S&P 500 and NASDAQ, percentage-wise. Talk of the dreaded "w" recovery (meaning another leg down to the 23 March bottoms) permeated the business headlines. Without time to get overly worried, however, the markets rallied to end the week only mildly in the red. When the dust settled, the S&P was down roughly 1%, the Dow 2%, and the NASDAQ was flat. Oil was the big story of the week, with May futures going heavily negative on Tuesday and spot prices hitting $9 per barrel. By Friday afternoon, spot prices had climbed back to $17 per barrel, down just 5% for the week. It feels as though emotions are beginning to subside a bit, and we can point to a volatility level of 36 (VIX) to support this thesis. While a number south of 20 would be ideal, 36 is a far cry from the record 83 level recorded on the VIX in the middle of March. It may not feel like it, but the markets are in a confirmed uptrend; the question remains: can it be sustained. The state of Georgia, which began reopening for business, should provide some answers to that question over the coming days.
Under the Radar Investment
01. Stock of the Day: Emergent BioSolutions Inc
Emergent BioSolutions (EBS $72) is a truly fascinating mid-cap ($3.8B) specialty drug manufacturer. The company has two divisions: biodefense and biosciences. The biodefense unit focuses on an extremely timely area: countermeasures that address public health threats. Needless to say, the US government provides a good measure of the funding for this area, and we only see the division growing. Emergent's biosciences unit is primarily focused on hematology and oncology, with a secondary focus on transplants, infectious diseases, and autoimmunity. This mid-cap has growing sales, growing income, and one heck of a strong investment thesis based on current events.
One more little nugget of info: Emergent will manufacture a Covid-19 vaccine in the US which is currently being developed by Johnson & Johnson "at risk," meaning J&J plans to have large doses of the drug on hand even before regulatory approval. The company also has contracts in place to produce vaccines from Novavax (NVAX) and Vaxart (VXRT).
Answer
In addition to the code name "Project X," Circuit City executives, under the leadership of then-CEO Richard Sharp, also called the project "Honest Rick's Used Cars." The company had been evaluating opportunities outside of selling consumer electronics. Sadly, Circuit City no longer exists, but "Honest Rick's" became a thriving, $12 billion business known as CarMax.
Headlines for the Week of 12 Apr 2020—18 Apr 2020
Question (From information in The Penn Wealth Report, Vol 8/Issue 02)
Four pandemics so far...this century...
Keeping in mind that we are only twenty years in, it is sobering to think that we have already witnessed four official pandemics this century. That fact should serve as the catalyst for the world to take action to prevent the next one, at least after we have control of Covid-19. Sadly, the usual suspects will go silent. The first pandemic of the century was the 2003 outbreak known as SARS. Where did this terrible malady, with its 10% mortality rate, originate?
Penn Trading Desk:
(17 Apr 20) Penn: Close DXCM
Closed our Dexcom position in the Intrepid for an 11% gain in four trading sessions.
(16 Apr 20) Penn: Close AMD
Closed our AMD position in the Intrepid for a 10.3% gain in three trading sessions.
Current Intrepid Trading Platform buy-in value: $12,417 (S&P 500 @ 2,875)
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Economics: Work & Pay
10. IMF: Global GDP will shrink 3% this year, grow 5.8% next year
After several years of growth in the mid-3% range, the International Monetary Fund predicts the recession brought on by the pandemic—"the worst since the Great Depression"—will cause global growth to contract by 3% this year. In January, before the world knew of what was going on in Wuhan, the IMF's forecast called for a 3.3% global expansion. There is some good news buried in the latest report, however: the DC-based international organization anticipates a 5.8% rate of growth in 2021 as economies come roaring back to life.
Economics: Work & Pay
09. The UK's pro-China trade policy is changing directions at a rapid clip*
The US has been at odds with the UK recently with respect to the latter's move to court Chinese trade in a post-Brexit world. The most recent dust-up came over Britain's decision to allow Chinese telecom giant Huawei to play a major role in the country's 5G rollout. Now, thanks to British anger over the Chinese coverup of the Covid-19 virus, UK lawmakers from all major parties are demanding that the trade relationship be reviewed. This comes on the heels of a number of African countries filing official complaints with the Chinese government over the way black migrants have been treated in the country since the outbreak. A McDonald's in the industrial city of Guangzhou had a sign on the door barring blacks from entering the restaurant in the wake of the virus.
Economics: Work & Pay
08. J&J actually gives guidance, raises dividend, projects virus vaccine
Last year, most of the talk surrounding health care giant Johnson & Johnson (JNJ $109-$146-$155) involved the firm's ongoing litigation. Now, after bouncing back incredibly well from the virus pounding the shares took (they are now flat YTD), the company has shifted the narrative to more positive talking points. First topic: guidance. While many companies have yanked their guidance for the year due to the pandemic, J&J said the firm expects to see earnings in the range of $7.50 to $7.90 per share. While lowered from previous expectations, those figures are higher than what the Street expected. Second topic: dividend. It is almost becoming heresy for a company to talk about dividends as trillions of taxpayer dollars begin to head out of the Treasury's door to buttress the financial situation of individual Americans and US corporations. Not only did J&J bring the topic up, they announced a 6% increase in the quarterly dividend rate. Third topic: virus vaccine. The company said it plans on being "first to human" with its coronavirus vaccine trials, set to begin as soon as this September. If they go as planned, the company believes it can produce between 600 million and 900 million doses by then end of Q1, 2021. Then, according to the company's CFO, that number can ramp up to one billion doses annually. Shares rose 5% as the earnings conference call was taking place.
Economics: Work & Pay
07. Amazon threatens to stop French deliveries after silly court order
As with many companies in this day-and-age of political correctness run amok, we have a love-hate relationship with Amazon (AMZN $1,626-$2,283-$2,292). Leave it up to the French to put us clearly on the side of the company. This week, a French court gave the $1.1 trillion company twenty-four hours to begin selling only essential goods to citizens. To the average thinking person, the logistics of this seems unfathomable. To a bunch of arrogant French judges sitting on their thrones, this is simply a decree which must be followed. This outrageously stupid ruling gives us an idea as to why Britain voted to leave the European Union, which is essentially led by a group of French and German autocrats. As for Amazon, the company is threatening to halt all activity at its French warehouses until the ruling is overturned. In the meantime, activity will cease between the 16th and 20th (at least) of April so that Amazon can assess its health and safety measures at the locations.
Economics: Work & Pay
06. Viral opportunity: mobile payment use will ramp up dramatically
Let's face it: people don't want to touch anything while out in public any longer. All of the daily tactile actions we would once take without thinking twice about, we now consciously consider. Investors should constantly be asking themselves, "How might the situation before us affect our portfolio, and what needs to be done, if anything?" Take the rise in the use of smartphones to make payments. What was once a novelty at places like Starbucks (SBUX) is rapidly becoming the primary way we transact business. We take our goods to the register, hold our phones or smart watches by a scanner, and voilà, payment made—with zero touch outside of our own devices. Remember how the checkbooks at the grocery store counter suddenly gave way to a debit card swipe? The same migration from physical debit cards to payment apps in our phone is now taking place, and the pandemic is accelerating the movement. Investors could consider companies such as PayPal (PYPL $108, owns Venmo), Square (SQ $58, point-of-sale software), Amazon (AMZN $2,420, Amazon Pay), and Apple (AAPL $287, Apple Pay) as potential ways to take advantage of this movement. Better yet, why not hedge your bets with IPAY ($38.63), the ETFMG Prime Mobile Payments ETF. This fund invests in 38 companies engaged in the development and deployment of software, hardware, architecture, and infrastructure for the payment processing and services industry.
Economics: Work & Pay
05. Penn member Gilead surges after hours following virus drug trials
Penn Global Leaders Club member Gilead Sciences (GILD $61-$84-$86) surged more than 15% after hours on news that the company's Covid-19 antiviral drug remdesivir appears to be showing promise in the University of Chicago's phase 3 drug trials. According to healthcare publication STAT News, most of the patients on the drug had "rapid recoveries in fever and respiratory symptoms" and were discharged in under a week. The university recruited 125 patients with the virus for the late-stage trials, 113 of whom were severely sick with the condition. This drug may well be a game changer. It's nice that one of our pharma holdings developed the drug; but it is enormous that a potential blockbuster was developed this quickly.
Economics: Work & Pay
04. Chinese misinformation can't hide fact that their economy is reeling
Our first response was anger. China, the country responsible for a global recession and tens of trillions of dollars lost in a matter of months, was boasting that their economy was nearly fully recovered from the pandemic. After that initial emotional response, however, we began looking at the facts; facts which China would never admit to. GDP: China's economy shrank 6.8% (at least) in Q1—the country's first contraction in decades, and the worst performance since it began reporting GDP data back in 1992. Retail sales: dropped 16% in March. Exports: fell 6.6% in March, while imports only fell 0.9%—expect the export numbers to look a lot worse in Q2 due to the economic pain China foisted upon the world. The WTO reported that 2020 could reflect the worst collapse in international trade since the Great Depression, and no country would be hurt more than China by that condition. Loss of global prestige: China has taken no responsibility for the virus which originated in Wuhan, even floating a trial balloon that it emanated from a DoD lab in the US. The worldwide outrage at China over the virus will manifest itself in a number of ways, including a review of trade dependence on the nation. China claims that it is back up and running, with even Wuhan factories humming along at full speed. Deep inside the bowels of the Communist Party of China, however, there is angst and finger-pointing going on, with even General Secretary Xi Jinping feeling the heat.
Economics: Work & Pay
03. Don't forget small-caps on your market comeback strategy list
As we enter a recession, small-cap stocks—companies valued between roughly $300 million and $2 billion—tend to get hit the hardest. And that makes sense, as these firms generally operate on thinner margins and have less room for error, or to maneuver in tough economic times. It is hard to imagine a worse scenario for small-caps than a complete shutdown of the economy. After all, many of these small gems don't operate in the arena of "essential goods," meaning mass layoffs and an uncertain future. However, it is important to note that, while small-caps may lead us into a recession, they also generally lead us out. The graph is a case-in-point: the Russell 2000 was down a whopping 41% in the one month period between mid-February and mid-March. Since that time, the index has rallied an impressive 22%. Considering ETFs that track the Russell 2000 carry both the winners and losers, the best bet is to create a list of specific names to own as we emerge from the downturn; companies that should thrive (e.g. not retail) in the post-virus environment. A few names to get you started: cloud-based security and compliance solutions provider Qualys Inc (QLYS $106); telecom provider Acacia Communications (ACIA $68), and medical products firm Tactile Systems Tech (TCMD $50).
Economics: Work & Pay
02. A wobbly start, but a solid finish to the week
After last week's strong finish in the markets, Monday came in looking like a dud. Was the prior week yet another head fake on the way back towards testing the lows? Tuesday made us feel better, then Wednesday came and kicked us again, as the S&P dropped 63 points (2.2%). No wonder investors are on edge. Despite the now-commonplace heavy volatility of the week, we actually cobbled together a decent five sessions. The NASDAQ led the charge, up 6.09%, while the Dow—thanks to laggard Boeing (BA)—brought up the rear with a 2.21% gain. Incredibly, following an OPEC+ agreement to cut 10% of the world's oil production, crude finished the week down yet another 23%, closing at $18.14 per barrel.
Economics: Work & Pay
01. Stock of the Day: BioMarin Pharmaceutical Inc.
BioMarin Pharmaceutical (BMRN $63-$87-$97) is a US-based biotech which focuses on rare-disease therapies. We first wrote about this $15 billion dynamic company three years ago, and find it at a very attractive price point yet again. It arguably holds monopolies in a number of rare-disease niche markets, and has formed alliances with larger biotech firms to develop, manufacture, and market a number of potentially life-saving drugs. The company’s approved drugs have been granted orphan-drug status, meaning they have seven years of market exclusivity in the US, and ten years in the European Union. The company’s operating revenue has increased every year for the past decade, with sales of $1.7 billion in 2019 (steadily up from $370 million a decade ago). We still consider BMRN to be on the short list of takeover candidates in the industry. The company's shares recently broke out of a cup with handle pattern and appear to have room to run.
(Disclaimer: BioMarin is a member of the Penn New Frontier Fund.)
Answer
SARS, or severe acute respiratory syndrome, originated in a marketplace in China's Guangdong Province; an area filled with caged animals of all types—wild and domesticated—awaiting purchase and slaughter. Does any of this sound remotely familiar?
Media & Entertainment
For Disney, the pandemic has done the unthinkable: closed its theme parks for months, thus proving the brilliance of Disney+. When an industry analyst would appear on one of the business networks, I would always give him or her automatic deference. After all, they are being paid big bucks to know their respective corner of the market inside and out, right? My automatic respect for these so-called gurus disappeared years ago, and some of their comments on The Walt Disney Company (DIS $79-$106-$154) just prior to the Disney+ streaming service rollout are a great example as to why. A theme among industry analysts was that the $200 billion entertainment giant would lose focus if it went big into the streaming business, taking the eye off the ball of their main source of revenues: the theme parks. Granted, nobody could have predicted that a global disaster would come along and force the closure of every Disney theme park around the world, but the company is looking rather brilliant right now thanks to that very diversification plan. Not only is Disney+ an instant success, it is also shattering even the company's own projections. Management had hoped to have 40 million subscribers by the end of 2020, and between 60M and 90M by the end of 2024. The division just recorded its 50 millionth paid subscriber. Suddenly, analysts are predicting 70M subs by summer, and 80M by early next year. Disney+, which just launched in the middle of November of 2019, now has one-third as many subscribers as Netflix (NFLX), and it just began operating in India—a country filled with movie-crazed citizens. And remember, when the parks do re-open, the shiny new Star Wars: Galaxy's Edge will be waiting to transport visitors to a faraway land: a welcome respite after living through a global pandemic and forced quarantine. We are still a bit bothered by Bob Iger's surprise departure as CEO, and the way it was announced, but we believe the company is a steal with its shares sitting in the low $100s. (Disclaimer: DIS holds position #12 in the Penn Global Leaders Club.
Commercial Banks
JP Morgan raises borrowing standards for home buyers and the middle class will be the group paying the price. There is no doubt that Congress' politically-motivated antics, combined with the political hacks at Fannie Mae and Freddie Mac at the time (who got rich in the process—remember Franklin Delano Raines?), directly led to the financial meltdown of 2008-2009. Of course, the big banks were willing accomplices, as Congress gave them cover to make loans they knew would probably never be repaid—they just repackaged them in giant hot potatoes and made sure they weren't the ones who got burnt. At first blush, and keeping the financial meltdown in mind, JP Morgan's (JPM $77-$103-$141) latest tightening of home loan standards—raise the credit score required and demand a 20% down payment to help assure the loans don't go south—might seem like a good idea. The bank argues they are simply using proper risk management techniques forced upon them by the economic fallout of the pandemic. But dig a little deeper, and something smells rotten. Let's turn the standard five economic quintiles into three to illustrate our point: the wealthy, the middle class, and low income households. The so-called "wealthy" will have no problem with the 20% down payment. Low income households can take advantage of the company's Chase DreaMaker Mortgage Program, which slashes the credit score requirement and just requires a 3% down payment (which can be borrowed!). That leaves the wide swath known collectively as the middle class. Assuming you pass the credit score requirement (JPM changed it to 18 points above the average American's score of 682), a $425,000 home would cost you $85,000 for the down payment alone—regardless of your ability to pay back the loan based on income levels. We imagine many will cheer this decision, but we don't: something tells us it won't reduce the number of loans going bad (DreaMaker will make sure of that), but it will reduce the number of middle class Americans who can buy a home, at least through JP Morgan. As if the home builders aren't going to be hit hard enough from the pandemic. Banks can be an effective tool for Americans wishing to get ahead in life—from providing home loans to funding a new or existing business. But a word of caution: Never consider the banks an ally. Their revenues are generated from customers paying interest on loans (probably confiscatory if the loans are on revolving credit) and service/account fees. On assets held, the banks make their money off the difference between what they pay savers and what they charge borrowers. None of this is necessarily bad, but the financial goal in life should be to have enough money to serve as your own bank! Chase's comical name for their credit card aside, that is the real meaning of "freedom."
Four pandemics so far...this century...
Keeping in mind that we are only twenty years in, it is sobering to think that we have already witnessed four official pandemics this century. That fact should serve as the catalyst for the world to take action to prevent the next one, at least after we have control of Covid-19. Sadly, the usual suspects will go silent. The first pandemic of the century was the 2003 outbreak known as SARS. Where did this terrible malady, with its 10% mortality rate, originate?
Penn Trading Desk:
(17 Apr 20) Penn: Close DXCM
Closed our Dexcom position in the Intrepid for an 11% gain in four trading sessions.
(16 Apr 20) Penn: Close AMD
Closed our AMD position in the Intrepid for a 10.3% gain in three trading sessions.
Current Intrepid Trading Platform buy-in value: $12,417 (S&P 500 @ 2,875)
Members can see all trades made in the five Penn strategies by signing into the Penn Trading Desk.
Economics: Work & Pay
10. IMF: Global GDP will shrink 3% this year, grow 5.8% next year
After several years of growth in the mid-3% range, the International Monetary Fund predicts the recession brought on by the pandemic—"the worst since the Great Depression"—will cause global growth to contract by 3% this year. In January, before the world knew of what was going on in Wuhan, the IMF's forecast called for a 3.3% global expansion. There is some good news buried in the latest report, however: the DC-based international organization anticipates a 5.8% rate of growth in 2021 as economies come roaring back to life.
Economics: Work & Pay
09. The UK's pro-China trade policy is changing directions at a rapid clip*
The US has been at odds with the UK recently with respect to the latter's move to court Chinese trade in a post-Brexit world. The most recent dust-up came over Britain's decision to allow Chinese telecom giant Huawei to play a major role in the country's 5G rollout. Now, thanks to British anger over the Chinese coverup of the Covid-19 virus, UK lawmakers from all major parties are demanding that the trade relationship be reviewed. This comes on the heels of a number of African countries filing official complaints with the Chinese government over the way black migrants have been treated in the country since the outbreak. A McDonald's in the industrial city of Guangzhou had a sign on the door barring blacks from entering the restaurant in the wake of the virus.
Economics: Work & Pay
08. J&J actually gives guidance, raises dividend, projects virus vaccine
Last year, most of the talk surrounding health care giant Johnson & Johnson (JNJ $109-$146-$155) involved the firm's ongoing litigation. Now, after bouncing back incredibly well from the virus pounding the shares took (they are now flat YTD), the company has shifted the narrative to more positive talking points. First topic: guidance. While many companies have yanked their guidance for the year due to the pandemic, J&J said the firm expects to see earnings in the range of $7.50 to $7.90 per share. While lowered from previous expectations, those figures are higher than what the Street expected. Second topic: dividend. It is almost becoming heresy for a company to talk about dividends as trillions of taxpayer dollars begin to head out of the Treasury's door to buttress the financial situation of individual Americans and US corporations. Not only did J&J bring the topic up, they announced a 6% increase in the quarterly dividend rate. Third topic: virus vaccine. The company said it plans on being "first to human" with its coronavirus vaccine trials, set to begin as soon as this September. If they go as planned, the company believes it can produce between 600 million and 900 million doses by then end of Q1, 2021. Then, according to the company's CFO, that number can ramp up to one billion doses annually. Shares rose 5% as the earnings conference call was taking place.
Economics: Work & Pay
07. Amazon threatens to stop French deliveries after silly court order
As with many companies in this day-and-age of political correctness run amok, we have a love-hate relationship with Amazon (AMZN $1,626-$2,283-$2,292). Leave it up to the French to put us clearly on the side of the company. This week, a French court gave the $1.1 trillion company twenty-four hours to begin selling only essential goods to citizens. To the average thinking person, the logistics of this seems unfathomable. To a bunch of arrogant French judges sitting on their thrones, this is simply a decree which must be followed. This outrageously stupid ruling gives us an idea as to why Britain voted to leave the European Union, which is essentially led by a group of French and German autocrats. As for Amazon, the company is threatening to halt all activity at its French warehouses until the ruling is overturned. In the meantime, activity will cease between the 16th and 20th (at least) of April so that Amazon can assess its health and safety measures at the locations.
Economics: Work & Pay
06. Viral opportunity: mobile payment use will ramp up dramatically
Let's face it: people don't want to touch anything while out in public any longer. All of the daily tactile actions we would once take without thinking twice about, we now consciously consider. Investors should constantly be asking themselves, "How might the situation before us affect our portfolio, and what needs to be done, if anything?" Take the rise in the use of smartphones to make payments. What was once a novelty at places like Starbucks (SBUX) is rapidly becoming the primary way we transact business. We take our goods to the register, hold our phones or smart watches by a scanner, and voilà, payment made—with zero touch outside of our own devices. Remember how the checkbooks at the grocery store counter suddenly gave way to a debit card swipe? The same migration from physical debit cards to payment apps in our phone is now taking place, and the pandemic is accelerating the movement. Investors could consider companies such as PayPal (PYPL $108, owns Venmo), Square (SQ $58, point-of-sale software), Amazon (AMZN $2,420, Amazon Pay), and Apple (AAPL $287, Apple Pay) as potential ways to take advantage of this movement. Better yet, why not hedge your bets with IPAY ($38.63), the ETFMG Prime Mobile Payments ETF. This fund invests in 38 companies engaged in the development and deployment of software, hardware, architecture, and infrastructure for the payment processing and services industry.
Economics: Work & Pay
05. Penn member Gilead surges after hours following virus drug trials
Penn Global Leaders Club member Gilead Sciences (GILD $61-$84-$86) surged more than 15% after hours on news that the company's Covid-19 antiviral drug remdesivir appears to be showing promise in the University of Chicago's phase 3 drug trials. According to healthcare publication STAT News, most of the patients on the drug had "rapid recoveries in fever and respiratory symptoms" and were discharged in under a week. The university recruited 125 patients with the virus for the late-stage trials, 113 of whom were severely sick with the condition. This drug may well be a game changer. It's nice that one of our pharma holdings developed the drug; but it is enormous that a potential blockbuster was developed this quickly.
Economics: Work & Pay
04. Chinese misinformation can't hide fact that their economy is reeling
Our first response was anger. China, the country responsible for a global recession and tens of trillions of dollars lost in a matter of months, was boasting that their economy was nearly fully recovered from the pandemic. After that initial emotional response, however, we began looking at the facts; facts which China would never admit to. GDP: China's economy shrank 6.8% (at least) in Q1—the country's first contraction in decades, and the worst performance since it began reporting GDP data back in 1992. Retail sales: dropped 16% in March. Exports: fell 6.6% in March, while imports only fell 0.9%—expect the export numbers to look a lot worse in Q2 due to the economic pain China foisted upon the world. The WTO reported that 2020 could reflect the worst collapse in international trade since the Great Depression, and no country would be hurt more than China by that condition. Loss of global prestige: China has taken no responsibility for the virus which originated in Wuhan, even floating a trial balloon that it emanated from a DoD lab in the US. The worldwide outrage at China over the virus will manifest itself in a number of ways, including a review of trade dependence on the nation. China claims that it is back up and running, with even Wuhan factories humming along at full speed. Deep inside the bowels of the Communist Party of China, however, there is angst and finger-pointing going on, with even General Secretary Xi Jinping feeling the heat.
Economics: Work & Pay
03. Don't forget small-caps on your market comeback strategy list
As we enter a recession, small-cap stocks—companies valued between roughly $300 million and $2 billion—tend to get hit the hardest. And that makes sense, as these firms generally operate on thinner margins and have less room for error, or to maneuver in tough economic times. It is hard to imagine a worse scenario for small-caps than a complete shutdown of the economy. After all, many of these small gems don't operate in the arena of "essential goods," meaning mass layoffs and an uncertain future. However, it is important to note that, while small-caps may lead us into a recession, they also generally lead us out. The graph is a case-in-point: the Russell 2000 was down a whopping 41% in the one month period between mid-February and mid-March. Since that time, the index has rallied an impressive 22%. Considering ETFs that track the Russell 2000 carry both the winners and losers, the best bet is to create a list of specific names to own as we emerge from the downturn; companies that should thrive (e.g. not retail) in the post-virus environment. A few names to get you started: cloud-based security and compliance solutions provider Qualys Inc (QLYS $106); telecom provider Acacia Communications (ACIA $68), and medical products firm Tactile Systems Tech (TCMD $50).
Economics: Work & Pay
02. A wobbly start, but a solid finish to the week
After last week's strong finish in the markets, Monday came in looking like a dud. Was the prior week yet another head fake on the way back towards testing the lows? Tuesday made us feel better, then Wednesday came and kicked us again, as the S&P dropped 63 points (2.2%). No wonder investors are on edge. Despite the now-commonplace heavy volatility of the week, we actually cobbled together a decent five sessions. The NASDAQ led the charge, up 6.09%, while the Dow—thanks to laggard Boeing (BA)—brought up the rear with a 2.21% gain. Incredibly, following an OPEC+ agreement to cut 10% of the world's oil production, crude finished the week down yet another 23%, closing at $18.14 per barrel.
Economics: Work & Pay
01. Stock of the Day: BioMarin Pharmaceutical Inc.
BioMarin Pharmaceutical (BMRN $63-$87-$97) is a US-based biotech which focuses on rare-disease therapies. We first wrote about this $15 billion dynamic company three years ago, and find it at a very attractive price point yet again. It arguably holds monopolies in a number of rare-disease niche markets, and has formed alliances with larger biotech firms to develop, manufacture, and market a number of potentially life-saving drugs. The company’s approved drugs have been granted orphan-drug status, meaning they have seven years of market exclusivity in the US, and ten years in the European Union. The company’s operating revenue has increased every year for the past decade, with sales of $1.7 billion in 2019 (steadily up from $370 million a decade ago). We still consider BMRN to be on the short list of takeover candidates in the industry. The company's shares recently broke out of a cup with handle pattern and appear to have room to run.
(Disclaimer: BioMarin is a member of the Penn New Frontier Fund.)
Answer
SARS, or severe acute respiratory syndrome, originated in a marketplace in China's Guangdong Province; an area filled with caged animals of all types—wild and domesticated—awaiting purchase and slaughter. Does any of this sound remotely familiar?
Media & Entertainment
For Disney, the pandemic has done the unthinkable: closed its theme parks for months, thus proving the brilliance of Disney+. When an industry analyst would appear on one of the business networks, I would always give him or her automatic deference. After all, they are being paid big bucks to know their respective corner of the market inside and out, right? My automatic respect for these so-called gurus disappeared years ago, and some of their comments on The Walt Disney Company (DIS $79-$106-$154) just prior to the Disney+ streaming service rollout are a great example as to why. A theme among industry analysts was that the $200 billion entertainment giant would lose focus if it went big into the streaming business, taking the eye off the ball of their main source of revenues: the theme parks. Granted, nobody could have predicted that a global disaster would come along and force the closure of every Disney theme park around the world, but the company is looking rather brilliant right now thanks to that very diversification plan. Not only is Disney+ an instant success, it is also shattering even the company's own projections. Management had hoped to have 40 million subscribers by the end of 2020, and between 60M and 90M by the end of 2024. The division just recorded its 50 millionth paid subscriber. Suddenly, analysts are predicting 70M subs by summer, and 80M by early next year. Disney+, which just launched in the middle of November of 2019, now has one-third as many subscribers as Netflix (NFLX), and it just began operating in India—a country filled with movie-crazed citizens. And remember, when the parks do re-open, the shiny new Star Wars: Galaxy's Edge will be waiting to transport visitors to a faraway land: a welcome respite after living through a global pandemic and forced quarantine. We are still a bit bothered by Bob Iger's surprise departure as CEO, and the way it was announced, but we believe the company is a steal with its shares sitting in the low $100s. (Disclaimer: DIS holds position #12 in the Penn Global Leaders Club.
Commercial Banks
JP Morgan raises borrowing standards for home buyers and the middle class will be the group paying the price. There is no doubt that Congress' politically-motivated antics, combined with the political hacks at Fannie Mae and Freddie Mac at the time (who got rich in the process—remember Franklin Delano Raines?), directly led to the financial meltdown of 2008-2009. Of course, the big banks were willing accomplices, as Congress gave them cover to make loans they knew would probably never be repaid—they just repackaged them in giant hot potatoes and made sure they weren't the ones who got burnt. At first blush, and keeping the financial meltdown in mind, JP Morgan's (JPM $77-$103-$141) latest tightening of home loan standards—raise the credit score required and demand a 20% down payment to help assure the loans don't go south—might seem like a good idea. The bank argues they are simply using proper risk management techniques forced upon them by the economic fallout of the pandemic. But dig a little deeper, and something smells rotten. Let's turn the standard five economic quintiles into three to illustrate our point: the wealthy, the middle class, and low income households. The so-called "wealthy" will have no problem with the 20% down payment. Low income households can take advantage of the company's Chase DreaMaker Mortgage Program, which slashes the credit score requirement and just requires a 3% down payment (which can be borrowed!). That leaves the wide swath known collectively as the middle class. Assuming you pass the credit score requirement (JPM changed it to 18 points above the average American's score of 682), a $425,000 home would cost you $85,000 for the down payment alone—regardless of your ability to pay back the loan based on income levels. We imagine many will cheer this decision, but we don't: something tells us it won't reduce the number of loans going bad (DreaMaker will make sure of that), but it will reduce the number of middle class Americans who can buy a home, at least through JP Morgan. As if the home builders aren't going to be hit hard enough from the pandemic. Banks can be an effective tool for Americans wishing to get ahead in life—from providing home loans to funding a new or existing business. But a word of caution: Never consider the banks an ally. Their revenues are generated from customers paying interest on loans (probably confiscatory if the loans are on revolving credit) and service/account fees. On assets held, the banks make their money off the difference between what they pay savers and what they charge borrowers. None of this is necessarily bad, but the financial goal in life should be to have enough money to serve as your own bank! Chase's comical name for their credit card aside, that is the real meaning of "freedom."
Headlines for the Week of 05 Apr 2020—11 Apr 2020
Energy Commodities
Saudi Arabia and Russia agree to cut oil production, but we believe this is predicated on the US joining in. The world produces roughly 100 million barrels per day of oil. Of that amount, America is now the leading producer, at 13M bpd. Saudi Arabia comes in second, at 12M bpd, and Russia is third, at 11M bpd. After President Trump spoke directly with Crown Prince MBS of Saudi and President Putin of Russia, he announced that the two energy-reliant nations had agreed to a much-needed 10M bpd cut, or roughly 10% of current production. While the two have implicitly backed what the president is saying, we believe there is a little more to the story. As the leading producer in the world, it seems as though MBS and Putin expect the US to play a major role in those cuts. While we don't know exactly how Trump's meeting with oil executives in the White House (the day after his OPEC+ calls) went, we are seeing some signs of movement among the big US producers. Exxon Mobil (XOM $30-$42-$83) announced a 30% reduction in capital expenditures, which would almost certainly mean cuts in production—the largest CapEx cuts will be in the Permian Basin. US shale producer Continental Resources (CLR $7-$11-$52), another White House meeting participant, just announced that it would slash April and May production by 30%, suspending its dividend along the way. In fact, Continental CEO and famed energy maven Harold Hamm went as far as telling an industry publication that US producers had all but promised a 30% production cut. He said President Trump went out of his way to tell executives that no coordination would be needed (no doubt to tamp down the appearance of collusion), but that he expected they would do the right thing for their companies, and the industry as a whole. Will that be enough to assuage the Saudis and the Russians? Actually, it probably will be. No country is exactly in the catbird seat with respect to this issue, and none of the major producing nations want oil to remain in the $20s—or lower. That should be enough for the 10M bpd cut to actually happen. Interestingly, crude prices were falling mid-week (to $24 or so) despite the talk of curtailing production. That seems to be due to an OPEC+ video meeting being delayed until later in the week. Despite the drop, oil is still up around 20% in the past week.
Specialty Retail
Penn member Tractor Supply to hire 5,000 new workers, extend bonus pay to front-line workers. Tractor Supply Co (TSCO $64-$88-$114) is simply one of those stalwart companies we have never had to worry about. When we first added the retail farm and ranch supply store to the Global Leaders Club back in August of 2017 at $52.11, it had recently dropped from around $80 per share and we knew it was highly undervalued. Now, in the midst of a horrendous wave of retail layoffs, Tractor Supply is bucking the trend: the company announced that it was looking to hire 5,000 new team members for its 1,900 stores and eight distribution centers around the US. It will also be adding greeters at each store to drive awareness of social distancing among customers, monitor occupancy, and help clean key pieces of highly-touched items such as carts and registers. New members will also help with curbside delivery for customers who order online and wish to pick up. In addition to the new hires, the firm has announced it would extend its $2 per hour bonus for front-line workers until the 9th of May. Finally, the $10 billion Tennessee-based firm will waive the co-pay requirement for employees wishing to use the telemedicine service from the company's health plan. Although shares of Tractor Supply certainly fell along with virtually every other company during the Covid downturn, they have rebounded nicely, and we expect them to climb back above $100 in the near future. Like, this year.
Saudi Arabia and Russia agree to cut oil production, but we believe this is predicated on the US joining in. The world produces roughly 100 million barrels per day of oil. Of that amount, America is now the leading producer, at 13M bpd. Saudi Arabia comes in second, at 12M bpd, and Russia is third, at 11M bpd. After President Trump spoke directly with Crown Prince MBS of Saudi and President Putin of Russia, he announced that the two energy-reliant nations had agreed to a much-needed 10M bpd cut, or roughly 10% of current production. While the two have implicitly backed what the president is saying, we believe there is a little more to the story. As the leading producer in the world, it seems as though MBS and Putin expect the US to play a major role in those cuts. While we don't know exactly how Trump's meeting with oil executives in the White House (the day after his OPEC+ calls) went, we are seeing some signs of movement among the big US producers. Exxon Mobil (XOM $30-$42-$83) announced a 30% reduction in capital expenditures, which would almost certainly mean cuts in production—the largest CapEx cuts will be in the Permian Basin. US shale producer Continental Resources (CLR $7-$11-$52), another White House meeting participant, just announced that it would slash April and May production by 30%, suspending its dividend along the way. In fact, Continental CEO and famed energy maven Harold Hamm went as far as telling an industry publication that US producers had all but promised a 30% production cut. He said President Trump went out of his way to tell executives that no coordination would be needed (no doubt to tamp down the appearance of collusion), but that he expected they would do the right thing for their companies, and the industry as a whole. Will that be enough to assuage the Saudis and the Russians? Actually, it probably will be. No country is exactly in the catbird seat with respect to this issue, and none of the major producing nations want oil to remain in the $20s—or lower. That should be enough for the 10M bpd cut to actually happen. Interestingly, crude prices were falling mid-week (to $24 or so) despite the talk of curtailing production. That seems to be due to an OPEC+ video meeting being delayed until later in the week. Despite the drop, oil is still up around 20% in the past week.
Specialty Retail
Penn member Tractor Supply to hire 5,000 new workers, extend bonus pay to front-line workers. Tractor Supply Co (TSCO $64-$88-$114) is simply one of those stalwart companies we have never had to worry about. When we first added the retail farm and ranch supply store to the Global Leaders Club back in August of 2017 at $52.11, it had recently dropped from around $80 per share and we knew it was highly undervalued. Now, in the midst of a horrendous wave of retail layoffs, Tractor Supply is bucking the trend: the company announced that it was looking to hire 5,000 new team members for its 1,900 stores and eight distribution centers around the US. It will also be adding greeters at each store to drive awareness of social distancing among customers, monitor occupancy, and help clean key pieces of highly-touched items such as carts and registers. New members will also help with curbside delivery for customers who order online and wish to pick up. In addition to the new hires, the firm has announced it would extend its $2 per hour bonus for front-line workers until the 9th of May. Finally, the $10 billion Tennessee-based firm will waive the co-pay requirement for employees wishing to use the telemedicine service from the company's health plan. Although shares of Tractor Supply certainly fell along with virtually every other company during the Covid downturn, they have rebounded nicely, and we expect them to climb back above $100 in the near future. Like, this year.
Headlines for the Week of 29 Mar 2020—04 Apr 2020
Market Pulse
Goodbye and good riddance to Q1, it is time to focus on our comeback plan. Goodbye, good riddance, adios, sayonara, and whatever the Chinese word is for "see you later" (since this is all China's fault) to the first quarter of 2020. If someone had been in a deep sleep and woke to see only the fallout, they might have figured a rogue North Korean nuke found its way to the California coast, or that Iran had successfully engaged in biological warfare with the United States. The second guess wouldn't have been far off, as what really happened amounts to a biological weapon being released on the world by the controlled confines of communist China. What's done is done, so now we must calculate how to proceed.
You wouldn't know it by watching or reading the news, but there are some positive signs on the economic and investment front. From an investment standpoint, the recent market downturn—at least thus far—looks almost identical to the two-month-long downturn which occurred in the fall of '87. And that means we should be able to pull off a rapid recovery in the markets like we witnessed in 1988. This was not a crisis caused by a systemic problem, although governments around the world are spending tens of trillions of dollars to staunch the economic impact. While that massive government spending will come back to haunt us in the future (despite the fact that it is absolutely needed to help individuals pay their bills in the here and now), that is an issue for down the road.
To be sure, some businesses will never come back. Many retailers who were teetering on the edge of solvency and a number of small companies in the food services and entertainment industry will have a difficult time surviving the shutdown, and that is tremendously sad. However, the fact that most firms were able to maintain their operations with a temporarily home-based workforce means that they should be able to ramp things back up to full speed shortly after the immediate crisis ends. That is something which would not have been possible even a generation ago, so here's to the technology that made it possible. Most of the high tech companies saw their shares wantonly sold during the downturn, and they now sit at multi-year low valuations. A stock market priced for perfection in January suddenly looks more reasonably-valued. And that means opportunity for investors.
New bull markets always begin when the news is still bad. Checkmark on that point. Countries which were hit the earliest by the virus are beginning to ramp their operations back up with relative speed; another good sign. Despite three rough days in the markets last week we are beginning to see volatility taper off a bit, and lower volume during Friday's selloff—caused by the shocking jobs report we all knew was coming—was another good sign. Whether are in the midst of a w- or a u-shaped recovery, now is the time to prepare a list of the companies which will spring back the quickest.
While we continue to sit on large amounts of cash, we are beginning to slowly take positions in these companies—the most recent being the new Raytheon Technologies (RTX). That being said we enter no new position, company or ETF, without a tight stop-loss order in place. If the markets turn south yet again, we may well stop-out with a small loss on these positions, but the goal is to take advantage of a post-virus rally. We are sticking with holdings that have a wide moat (protection from competitors) and unique/needed goods and services. Microsoft (MSFT) is another good example. Again, the key is to bring portfolios back as efficiently as possible, but with the proper protection in place. We still maintain that a 50% jump in the markets between the bottom (which hopefully took place on Monday the 23rd of March) and December 31st is highly possible. Incredibly, that would just bring us back to early February levels.
Aerospace & Defense
The new United Technologies/Raytheon entity begins trading with a new ticker. Two of our favorite industrial/aerospace and defense companies have merged into one, and the new entity began trading Friday under a fresh ticker. Raytheon (formerly RTN) and United Technologies (formerly UTX) finalized their "merger of equals" this week, creating Raytheon Technologies (RTX), selling for around $50 per share. With the new firm quickly shedding its non-defense Otis Elevator and Carrier units, Raytheon Technologies will be laser focused on what it does best: serving the military and civilian aerospace market. Not only will this firm be a dominant defense player, it also owns Pratt & Whitney, chief supplier of aircraft engines. With aggregate sales of around $75 billion per year, the size and scope of Raytheon will allow for some remarkable accomplishments. Complete systems, from propulsion to instruments to hydraulic controls, can now be bundled together and packaged for customers. The synergies should begin paying off immediately. With Boeing (BA) in the gutter, RTX is the one dominant industry player to own. Despite the global costs of dealing with the virus from China, defense spending will not go down. Additionally, RTX will be the main recipient of dollars flowing in from the nascent civilian space race. Oh, and just to sweeten the deal, RTX offers a healthy—and completely safe—dividend yield of 5.8%.
Crude oil spiked double digits after President Trump's conversation with Putin and MBS; expectations are for a 10B/bpd cut...
Restaurants
Muddy Waters' prescient January call on China's Luckin Coffee. Back in January, shares of China's Luckin Coffee (LK $5-$5-$51) cratered after Muddy Waters Research disclosed a short position in the firm, citing highly-questionable financials coming from management. That 50% drop pales in comparison to what happened with LK shares following an investigation confirming those fears this week: the stock fell 80% on news that the firm's COO completely fabricated sales figures. Several other executives were named as co-conspirators.
It was just last year that we were being told Luckin posed an existential threat to Starbucks (SBUX), at least in Asia. A major US business publication wrote, just one year ago, that "(Starbucks') large presence in China is under threat by a new, agile, and fierce competitor." The Xinhua News Agency couldn't have written it any better, and they are an extension of the Communist Party of China. Now, however, the chickens have come home to roost. The news publication that wrote the slanted article will never take responsibility for their irresponsibility ("How could we have known they were cooking the books," we imagine them arguing), but the facts have been laid bare. Luckin's $12 billion market cap has been reduced to $1.5 billion, and nobody has heard from COO Jian Liu.
Muddy Waters, which based their short sale on an 89-page anonymous report sent to them in January, has been vindicated. What's next? Will we find out that the latest coronavirus did actually start at a Wuhan wet market and wasn't created in a US Department of Defense lab? It's a crazy world.
This story highlights the dangers that come with investing in any China-based, publicly-traded company—even if that company is listed on a US exchange. Understand what you are investing in, and if something smells fishy, dig deeper.
(02 Apr 2020) Initial jobless claims hit 6.64 million versus 3.1 million estimated
Personal Finance
The CARES Act suspends required minimum distributions (RMDs) for 2020. While investors who have already taken their required minimum distributions for 2020 appear to be out of luck, the government has offered some reprieve for others: 2020 RMDs have been permanently suspended. With the historic market losses of the first quarter, this is being done to allow those people who were required to take distributions the ability to keep all of their funds working in qualified accounts as the markets stage a comeback. In addition to this relief, 2020 is also the first year of the new required beginning date (RBD) of age 72. The silly half-year rule is no longer in effect ("70 1/2 years old in prior year of distribution..."), which means investors no longer need to calculate when their half-birthday was: if you were 72 in the prior year, an RMD is required. Not counting 2020, that is. Not only has roughly $10 trillion worth of investment value been shaved off of portfolios since mid-February, many companies will be whittling down their dividends to preserve much-needed cash for the economic recovery period. Those are the first two punches income-oriented investors are now facing; the third is the ultra-low interest rates being offered in the bond market, with a Fed funds rate of 0%. We can't see the third condition changing anytime soon.
Beverages & Tobacco
British American Tobacco says it can have a Covid-19 vaccine ready by June. Who knew that the maker of Lucky Strike cigarettes, British American Tobacco (BTI $27-$35-$46), even had a US biotech division? Apparently the $81 billion tobacco giant does, and the company claims its Kentucky BioProcessing (KBP) unit has already cloned a portion of Covid-19's genetic sequence and inserted the antigen into thousands of tobacco plants. The tobacco plant has the ability to grow antigens faster than conventional methods. If testing goes as planned, British American said it can produce between one and three million doses per week of the vaccine by June. For all the destruction in the economy and the stock market throughout this crisis, the way individuals (minus the toilet paper hoarders) and companies from all industries have responded is heartwarming. Here's to British American's success in this endeavor. And one further note: despite its industry, BTI has a rock-solid balance sheet, strong earnings, an 11 P/E ratio, and a 7.5% dividend yield.
(01 Apr 2020) T-Mobile completes merger with Sprint; the "S" ticker is available again...anyone?
(01 Apr 2020) Macy's removed from the S&P 500
East & Southeast Asia
China's divorce rate skyrockets as quarantine is lifted. Last year, there were approximately four million divorce cases filed in China. While the data are only compiled and published once per year in the country, huge lines have been forming outside of divorce lawyers' offices around formerly-quarantined regions of the country, indicating the four million mark will be eclipsed in 2020. Approximately 75% of the cases being filed are initiated by women. In quintessential communist style, judges in the country have final say over whether or not permission will be granted for a divorce application to move forward, but if a couple initiates a second filing (assuming the first was thrown out), the judge normally grants the request. Ironically, in a nation of 1.4 billion citizens, the Chinese government is encouraging couples to not only stay together, but to have more children. The country's birthrate in 2019 was its lowest since the founding of the People's Republic of China in 1949, while the percentage of non-working elderly continues to grow. Also in 2019, the average household income in China was around $4,500 per year.
Multiline Retail
Macy's to furlough most of its 130,000 workers. Back in February, about a week before the great downturn began, we wrote of Macy's (M $5-$5-$26) latest turnaround plan. Actually, we made fun of Macy's latest turnaround plan. We excoriated management for coming up with yet another grand strategic plan with a super-secret code name that would do exactly zilch for the company's real problem: a staff that didn't seem to want to be at work, and disheveled, disorganized departments. When we wrote our commentary, shares of M were sitting at $17, and we recommended steering clear. Now, with the shares at $5, it seems as though the staffing problem will be addressed: the company is about to furlough most of its 130,000 workers. Some might look at the chart and see an incredibly-undervalued diamond in the rough; we just see a company that lost its way—long before a nightmare virus came along. The retailers which are holding up the "best" during the COVID shutdown are the ones that embraced an online presence years ago. Macy's did not, and they are now paying a brutal price. As for the workers, they will receive no pay from the company once furloughed, but will continue to receive health benefits coverage at least through the end of May.
Hotels, Resorts, & Cruise Lines
Eldorado Resorts' shareholders should be out with pitchforks searching for Carl Icahn. We are ambivalent with respect to hedge fund manager/corporate raider Carl Icahn. that being said, we despise him more often that we love him. In fact, his most endearing quality is his disdain for the smarmy Bill Ackman of Pershing Square. It is doubtful their two egos could fit in one room. That is enough of a backdrop for the following story. Last June we wrote of a forced marriage between two debt-laden companies, with Icahn holding the shotgun. Eldorado Resorts (ERI $6-$12-$71), which at the time had a market cap of $4 billion and long-term debt of $3 billion, wanted to acquire the larger Caesars Entertainment (CZR $3-$6-$15), which at the time had a market cap of $7 billion and long-term debt of $9 billion. Why on earth would anyone on the Caesars board ever go for such a harebrained scheme? It seems they agreed only at the "strong urging" of fellow board member Icahn, who would make out like a bandit in the deal. We called it financial engineering of the worst kind. Fast forward nine months. Eldorado is now a $923 million company, and Caesars has a market cap of $4.4 billion. Citing the pandemic, regulators have just informed the two parties that the deal's review would be put on indefinite hold. When they ultimately shoot it down (and they will), Eldorado will be forced to pay an $837 million breakup fee—or roughly what their company is now worth. This story stinks from start to finish. ERI shareholders should be disgusted, and CZR shareholders should run Icahn out of town on a rail and clear the board of anyone who supported this nefarious financial engineering. Disgusting. We've just talked ourselves out of having ambivelence for Icahn; he is, in our humble opinion, a (add your preferred expletive here).
Goodbye and good riddance to Q1, it is time to focus on our comeback plan. Goodbye, good riddance, adios, sayonara, and whatever the Chinese word is for "see you later" (since this is all China's fault) to the first quarter of 2020. If someone had been in a deep sleep and woke to see only the fallout, they might have figured a rogue North Korean nuke found its way to the California coast, or that Iran had successfully engaged in biological warfare with the United States. The second guess wouldn't have been far off, as what really happened amounts to a biological weapon being released on the world by the controlled confines of communist China. What's done is done, so now we must calculate how to proceed.
You wouldn't know it by watching or reading the news, but there are some positive signs on the economic and investment front. From an investment standpoint, the recent market downturn—at least thus far—looks almost identical to the two-month-long downturn which occurred in the fall of '87. And that means we should be able to pull off a rapid recovery in the markets like we witnessed in 1988. This was not a crisis caused by a systemic problem, although governments around the world are spending tens of trillions of dollars to staunch the economic impact. While that massive government spending will come back to haunt us in the future (despite the fact that it is absolutely needed to help individuals pay their bills in the here and now), that is an issue for down the road.
To be sure, some businesses will never come back. Many retailers who were teetering on the edge of solvency and a number of small companies in the food services and entertainment industry will have a difficult time surviving the shutdown, and that is tremendously sad. However, the fact that most firms were able to maintain their operations with a temporarily home-based workforce means that they should be able to ramp things back up to full speed shortly after the immediate crisis ends. That is something which would not have been possible even a generation ago, so here's to the technology that made it possible. Most of the high tech companies saw their shares wantonly sold during the downturn, and they now sit at multi-year low valuations. A stock market priced for perfection in January suddenly looks more reasonably-valued. And that means opportunity for investors.
New bull markets always begin when the news is still bad. Checkmark on that point. Countries which were hit the earliest by the virus are beginning to ramp their operations back up with relative speed; another good sign. Despite three rough days in the markets last week we are beginning to see volatility taper off a bit, and lower volume during Friday's selloff—caused by the shocking jobs report we all knew was coming—was another good sign. Whether are in the midst of a w- or a u-shaped recovery, now is the time to prepare a list of the companies which will spring back the quickest.
While we continue to sit on large amounts of cash, we are beginning to slowly take positions in these companies—the most recent being the new Raytheon Technologies (RTX). That being said we enter no new position, company or ETF, without a tight stop-loss order in place. If the markets turn south yet again, we may well stop-out with a small loss on these positions, but the goal is to take advantage of a post-virus rally. We are sticking with holdings that have a wide moat (protection from competitors) and unique/needed goods and services. Microsoft (MSFT) is another good example. Again, the key is to bring portfolios back as efficiently as possible, but with the proper protection in place. We still maintain that a 50% jump in the markets between the bottom (which hopefully took place on Monday the 23rd of March) and December 31st is highly possible. Incredibly, that would just bring us back to early February levels.
Aerospace & Defense
The new United Technologies/Raytheon entity begins trading with a new ticker. Two of our favorite industrial/aerospace and defense companies have merged into one, and the new entity began trading Friday under a fresh ticker. Raytheon (formerly RTN) and United Technologies (formerly UTX) finalized their "merger of equals" this week, creating Raytheon Technologies (RTX), selling for around $50 per share. With the new firm quickly shedding its non-defense Otis Elevator and Carrier units, Raytheon Technologies will be laser focused on what it does best: serving the military and civilian aerospace market. Not only will this firm be a dominant defense player, it also owns Pratt & Whitney, chief supplier of aircraft engines. With aggregate sales of around $75 billion per year, the size and scope of Raytheon will allow for some remarkable accomplishments. Complete systems, from propulsion to instruments to hydraulic controls, can now be bundled together and packaged for customers. The synergies should begin paying off immediately. With Boeing (BA) in the gutter, RTX is the one dominant industry player to own. Despite the global costs of dealing with the virus from China, defense spending will not go down. Additionally, RTX will be the main recipient of dollars flowing in from the nascent civilian space race. Oh, and just to sweeten the deal, RTX offers a healthy—and completely safe—dividend yield of 5.8%.
Crude oil spiked double digits after President Trump's conversation with Putin and MBS; expectations are for a 10B/bpd cut...
Restaurants
Muddy Waters' prescient January call on China's Luckin Coffee. Back in January, shares of China's Luckin Coffee (LK $5-$5-$51) cratered after Muddy Waters Research disclosed a short position in the firm, citing highly-questionable financials coming from management. That 50% drop pales in comparison to what happened with LK shares following an investigation confirming those fears this week: the stock fell 80% on news that the firm's COO completely fabricated sales figures. Several other executives were named as co-conspirators.
It was just last year that we were being told Luckin posed an existential threat to Starbucks (SBUX), at least in Asia. A major US business publication wrote, just one year ago, that "(Starbucks') large presence in China is under threat by a new, agile, and fierce competitor." The Xinhua News Agency couldn't have written it any better, and they are an extension of the Communist Party of China. Now, however, the chickens have come home to roost. The news publication that wrote the slanted article will never take responsibility for their irresponsibility ("How could we have known they were cooking the books," we imagine them arguing), but the facts have been laid bare. Luckin's $12 billion market cap has been reduced to $1.5 billion, and nobody has heard from COO Jian Liu.
Muddy Waters, which based their short sale on an 89-page anonymous report sent to them in January, has been vindicated. What's next? Will we find out that the latest coronavirus did actually start at a Wuhan wet market and wasn't created in a US Department of Defense lab? It's a crazy world.
This story highlights the dangers that come with investing in any China-based, publicly-traded company—even if that company is listed on a US exchange. Understand what you are investing in, and if something smells fishy, dig deeper.
(02 Apr 2020) Initial jobless claims hit 6.64 million versus 3.1 million estimated
Personal Finance
The CARES Act suspends required minimum distributions (RMDs) for 2020. While investors who have already taken their required minimum distributions for 2020 appear to be out of luck, the government has offered some reprieve for others: 2020 RMDs have been permanently suspended. With the historic market losses of the first quarter, this is being done to allow those people who were required to take distributions the ability to keep all of their funds working in qualified accounts as the markets stage a comeback. In addition to this relief, 2020 is also the first year of the new required beginning date (RBD) of age 72. The silly half-year rule is no longer in effect ("70 1/2 years old in prior year of distribution..."), which means investors no longer need to calculate when their half-birthday was: if you were 72 in the prior year, an RMD is required. Not counting 2020, that is. Not only has roughly $10 trillion worth of investment value been shaved off of portfolios since mid-February, many companies will be whittling down their dividends to preserve much-needed cash for the economic recovery period. Those are the first two punches income-oriented investors are now facing; the third is the ultra-low interest rates being offered in the bond market, with a Fed funds rate of 0%. We can't see the third condition changing anytime soon.
Beverages & Tobacco
British American Tobacco says it can have a Covid-19 vaccine ready by June. Who knew that the maker of Lucky Strike cigarettes, British American Tobacco (BTI $27-$35-$46), even had a US biotech division? Apparently the $81 billion tobacco giant does, and the company claims its Kentucky BioProcessing (KBP) unit has already cloned a portion of Covid-19's genetic sequence and inserted the antigen into thousands of tobacco plants. The tobacco plant has the ability to grow antigens faster than conventional methods. If testing goes as planned, British American said it can produce between one and three million doses per week of the vaccine by June. For all the destruction in the economy and the stock market throughout this crisis, the way individuals (minus the toilet paper hoarders) and companies from all industries have responded is heartwarming. Here's to British American's success in this endeavor. And one further note: despite its industry, BTI has a rock-solid balance sheet, strong earnings, an 11 P/E ratio, and a 7.5% dividend yield.
(01 Apr 2020) T-Mobile completes merger with Sprint; the "S" ticker is available again...anyone?
(01 Apr 2020) Macy's removed from the S&P 500
East & Southeast Asia
China's divorce rate skyrockets as quarantine is lifted. Last year, there were approximately four million divorce cases filed in China. While the data are only compiled and published once per year in the country, huge lines have been forming outside of divorce lawyers' offices around formerly-quarantined regions of the country, indicating the four million mark will be eclipsed in 2020. Approximately 75% of the cases being filed are initiated by women. In quintessential communist style, judges in the country have final say over whether or not permission will be granted for a divorce application to move forward, but if a couple initiates a second filing (assuming the first was thrown out), the judge normally grants the request. Ironically, in a nation of 1.4 billion citizens, the Chinese government is encouraging couples to not only stay together, but to have more children. The country's birthrate in 2019 was its lowest since the founding of the People's Republic of China in 1949, while the percentage of non-working elderly continues to grow. Also in 2019, the average household income in China was around $4,500 per year.
Multiline Retail
Macy's to furlough most of its 130,000 workers. Back in February, about a week before the great downturn began, we wrote of Macy's (M $5-$5-$26) latest turnaround plan. Actually, we made fun of Macy's latest turnaround plan. We excoriated management for coming up with yet another grand strategic plan with a super-secret code name that would do exactly zilch for the company's real problem: a staff that didn't seem to want to be at work, and disheveled, disorganized departments. When we wrote our commentary, shares of M were sitting at $17, and we recommended steering clear. Now, with the shares at $5, it seems as though the staffing problem will be addressed: the company is about to furlough most of its 130,000 workers. Some might look at the chart and see an incredibly-undervalued diamond in the rough; we just see a company that lost its way—long before a nightmare virus came along. The retailers which are holding up the "best" during the COVID shutdown are the ones that embraced an online presence years ago. Macy's did not, and they are now paying a brutal price. As for the workers, they will receive no pay from the company once furloughed, but will continue to receive health benefits coverage at least through the end of May.
Hotels, Resorts, & Cruise Lines
Eldorado Resorts' shareholders should be out with pitchforks searching for Carl Icahn. We are ambivalent with respect to hedge fund manager/corporate raider Carl Icahn. that being said, we despise him more often that we love him. In fact, his most endearing quality is his disdain for the smarmy Bill Ackman of Pershing Square. It is doubtful their two egos could fit in one room. That is enough of a backdrop for the following story. Last June we wrote of a forced marriage between two debt-laden companies, with Icahn holding the shotgun. Eldorado Resorts (ERI $6-$12-$71), which at the time had a market cap of $4 billion and long-term debt of $3 billion, wanted to acquire the larger Caesars Entertainment (CZR $3-$6-$15), which at the time had a market cap of $7 billion and long-term debt of $9 billion. Why on earth would anyone on the Caesars board ever go for such a harebrained scheme? It seems they agreed only at the "strong urging" of fellow board member Icahn, who would make out like a bandit in the deal. We called it financial engineering of the worst kind. Fast forward nine months. Eldorado is now a $923 million company, and Caesars has a market cap of $4.4 billion. Citing the pandemic, regulators have just informed the two parties that the deal's review would be put on indefinite hold. When they ultimately shoot it down (and they will), Eldorado will be forced to pay an $837 million breakup fee—or roughly what their company is now worth. This story stinks from start to finish. ERI shareholders should be disgusted, and CZR shareholders should run Icahn out of town on a rail and clear the board of anyone who supported this nefarious financial engineering. Disgusting. We've just talked ourselves out of having ambivelence for Icahn; he is, in our humble opinion, a (add your preferred expletive here).
Headlines for the Week of 22 Mar 2020—28 Mar 2020
Market Pulse, Point 1
The pandemic was the earthquake; the earnings reports and economic data will be the aftershocks. We all know what happened to stock markets around the world due to the pandemic, so we won't get back into the ugly numbers. Instead, let's talk about what comes next with respect to the heinous business and economic numbers that will roll in over the next quarter. We can expect a GDP contraction for the first half of 2020, the first negative period in this country since 2014. We should also brace for scary jobless claims being flashed across the news screens, and we can expect fear-mongering headlines like, "WORST SINCE GREAT DEPRESSION." Then the quarterly earnings reports will be released for the affected period, and they will be ghastly. Here's the good news, however: With the press throwing around terms like "Great Depression" and "permanent changes to the economy" (two of the plethora I made note of due to their outrageous nature) it is fair to say the worst-case scenario has already been baked into the cake. Let's face it, the "here's what comes next" headlines from journalists did a lot more harm to the markets than the actual impact from the virus and two weeks of shutdowns, simply by generating so much abject fear. So, when Americans begin rolling back into their offices, and companies begin ramping back up more quickly than anyone expected, the enormous sigh of relief should lead to some stunning days in the market. On that note...
Market Pulse, Point 2
Demand destruction or a coiled spring: Is a 50% spike in the markets possible by year-end? Between mid-February and mid-March, the major indexes fell by one-third. The Dow Jones Industrial Average went from just below 30,000 to just below 20,000. Mathematically, that means roughly a 50% jump in the index will be required just to get us back to where we were in the second week of February. Ditto the S&P 500 and NASDAQ, but let's stick with the Dow for our illustration, as investors seem to pay most attention to those levels. Here's the great unknown: How long will it take the markets to regain all lost ground? A recent report issued by one of the most reliable investment houses caught my attention late last week. The shocking synopsis of the report was that the major indexes will spike 50% between now and the end of the year. Right now, that seems completely unfathomable, but is it possible? We can all agree that the catalyst for this downturn was the pandemic, just like we can all agree that the 54% drop in the Dow between 2007 and 2009 was caused by the banking crisis and subsequent financial meltdown. But the two are very different beasts. One was a systemic problem for the economy, while the other is simply a short-term shock. Don't believe the headlines that this pandemic will radically change the global economic landscape. Will certain companies end up shuttering their doors for good? Absolutely. But we can expect the fiscally strong firms to come back stronger than ever. James Bullard is the president of the Federal Reserve Bank of St. Louis; his business acumen is impressive—and typically spot on. Bullard sees some jaw-dropping numbers coming in the wake of the crisis, like a 30% unemployment rate and a 50% drop in GDP for the second quarter. However, he then sees a massive ramping back up of the economy beginning in Q3 and hitting its stride in the fourth quarter of 2020 and the first quarter of 2021. If things play out the way Bullard predicts, a 50% jump in the markets by year-end is absolutely possible. That being said, forget passive funds, the money will be made in actively selecting the right companies and ETFs. On that note...
Market Pulse, Point 3
Which companies and industries to buy in a post-pandemic environment, and which to avoid like the plague. While the market's rapid descent seemed to indiscriminately drag everything down (including bonds), there will be clear winners and losers as we climb out of the crisis. This will certainly not be a time to go back into passively-managed index funds, like the S&P 500 or QQQ, the NASDAQ-100 fund. Why not? Because these vehicles will be chock full of both the winners and losers in the post-crisis world. Here's an example of what we mean: Microsoft (MSFT), Apple (AAPL), and Amazon (AMZN) are the three largest holdings in QQQ. These three exemplary firms will come roaring back to life this year, and that will be reflected in their respective share prices. Included in the QQQ, however, are a lot of high-tech companies with B- and C-rated financial strength, and companies in the discretionary sector which will have a difficult time regaining their pre-crisis footing. Twitter (TWTR), for example, was already having a difficult time hitting their net income goals a few months ago; what will happen to earnings as companies inevitably continue to pull back on advertising as they use their much-needed cash on more urgent expenditures—like paying their employees? We have created a number of screens to filter out the winners as we emerge from the crisis. Some of the metrics include:
Financial Strength (A to A++ financials); low relative debt load;
Industry (energy, financials, and consumer discretionary will face added pressure, while health care, utilities, and many companies in the tech sector should spring back strongly);
Products & Services (Look for products and services people needed throughout the crisis, or will immediately need once we begin going back to the offices);
Management (Sadly, there are a number of mediocre management teams out there, even among the biggest companies; a great example of this is Occidental Petroleum's C-suite, which dramatically overpaid for Anadarko Petroleum late last year, while Chevron's team had the sense to walk away. It will take highly-skilled CEOs and CFOs to shift course as needed and rebuild the hammered balance sheets);
EPS (Were quarterly and annual earnings growing going into the crisis, and how do we expect them to bounce back after two ugly quarters?);
Ownership (Have insiders been accumulating or shedding shares, and what percentage of the shares are owned by big institutions?)
In short, this will not be another 1997-1999—where just about every company was rewarded, despite their fundamentals, financials, and management teams. For both stocks and ETFs, a highly-refined selection process will be needed. If we emerge relatively quickly from this crisis, and the right mix of investments are in the portfolio, the growth between now and the end of the year could be impressive. Don't think the market can move that rapidly? Just consider the past five weeks. (Or, on the positive side, the year following the October, 1987 meltdown.)
E-Commerce
Amazon raises overtime pay to warehouse workers, increases minimum wage. It was around 06 March when shares of online retail giant Amazon (AMZN $1,626-$1,830-$2,186) detached from the overall market and began to stabilize. The reason is obvious: Amazon has been one of the top players in helping to keep America running during the downturn, which has meant unprecedented use of the company's services over the past few weeks. With that in mind, Amazon has announced that hourly workers at its US warehouses will receive double-pay for all overtime hours incurred between 15 March and 09 May. Additionally, the $931 billion firm said it would hike its minimum wage from $15 to $17 per hour and hire 100,000 new warehouse and delivery workers to handle the flood of new orders coming in. Since 06 March, shares of AMZN are down roughly 2% while its index, the Nasdaq, has dropped 20%. Despite its 81 P/E ratio, $1,830 will end up being a great entry point for AMZN shares. The challenge right now is finding any willing buyers.
The pandemic was the earthquake; the earnings reports and economic data will be the aftershocks. We all know what happened to stock markets around the world due to the pandemic, so we won't get back into the ugly numbers. Instead, let's talk about what comes next with respect to the heinous business and economic numbers that will roll in over the next quarter. We can expect a GDP contraction for the first half of 2020, the first negative period in this country since 2014. We should also brace for scary jobless claims being flashed across the news screens, and we can expect fear-mongering headlines like, "WORST SINCE GREAT DEPRESSION." Then the quarterly earnings reports will be released for the affected period, and they will be ghastly. Here's the good news, however: With the press throwing around terms like "Great Depression" and "permanent changes to the economy" (two of the plethora I made note of due to their outrageous nature) it is fair to say the worst-case scenario has already been baked into the cake. Let's face it, the "here's what comes next" headlines from journalists did a lot more harm to the markets than the actual impact from the virus and two weeks of shutdowns, simply by generating so much abject fear. So, when Americans begin rolling back into their offices, and companies begin ramping back up more quickly than anyone expected, the enormous sigh of relief should lead to some stunning days in the market. On that note...
Market Pulse, Point 2
Demand destruction or a coiled spring: Is a 50% spike in the markets possible by year-end? Between mid-February and mid-March, the major indexes fell by one-third. The Dow Jones Industrial Average went from just below 30,000 to just below 20,000. Mathematically, that means roughly a 50% jump in the index will be required just to get us back to where we were in the second week of February. Ditto the S&P 500 and NASDAQ, but let's stick with the Dow for our illustration, as investors seem to pay most attention to those levels. Here's the great unknown: How long will it take the markets to regain all lost ground? A recent report issued by one of the most reliable investment houses caught my attention late last week. The shocking synopsis of the report was that the major indexes will spike 50% between now and the end of the year. Right now, that seems completely unfathomable, but is it possible? We can all agree that the catalyst for this downturn was the pandemic, just like we can all agree that the 54% drop in the Dow between 2007 and 2009 was caused by the banking crisis and subsequent financial meltdown. But the two are very different beasts. One was a systemic problem for the economy, while the other is simply a short-term shock. Don't believe the headlines that this pandemic will radically change the global economic landscape. Will certain companies end up shuttering their doors for good? Absolutely. But we can expect the fiscally strong firms to come back stronger than ever. James Bullard is the president of the Federal Reserve Bank of St. Louis; his business acumen is impressive—and typically spot on. Bullard sees some jaw-dropping numbers coming in the wake of the crisis, like a 30% unemployment rate and a 50% drop in GDP for the second quarter. However, he then sees a massive ramping back up of the economy beginning in Q3 and hitting its stride in the fourth quarter of 2020 and the first quarter of 2021. If things play out the way Bullard predicts, a 50% jump in the markets by year-end is absolutely possible. That being said, forget passive funds, the money will be made in actively selecting the right companies and ETFs. On that note...
Market Pulse, Point 3
Which companies and industries to buy in a post-pandemic environment, and which to avoid like the plague. While the market's rapid descent seemed to indiscriminately drag everything down (including bonds), there will be clear winners and losers as we climb out of the crisis. This will certainly not be a time to go back into passively-managed index funds, like the S&P 500 or QQQ, the NASDAQ-100 fund. Why not? Because these vehicles will be chock full of both the winners and losers in the post-crisis world. Here's an example of what we mean: Microsoft (MSFT), Apple (AAPL), and Amazon (AMZN) are the three largest holdings in QQQ. These three exemplary firms will come roaring back to life this year, and that will be reflected in their respective share prices. Included in the QQQ, however, are a lot of high-tech companies with B- and C-rated financial strength, and companies in the discretionary sector which will have a difficult time regaining their pre-crisis footing. Twitter (TWTR), for example, was already having a difficult time hitting their net income goals a few months ago; what will happen to earnings as companies inevitably continue to pull back on advertising as they use their much-needed cash on more urgent expenditures—like paying their employees? We have created a number of screens to filter out the winners as we emerge from the crisis. Some of the metrics include:
Financial Strength (A to A++ financials); low relative debt load;
Industry (energy, financials, and consumer discretionary will face added pressure, while health care, utilities, and many companies in the tech sector should spring back strongly);
Products & Services (Look for products and services people needed throughout the crisis, or will immediately need once we begin going back to the offices);
Management (Sadly, there are a number of mediocre management teams out there, even among the biggest companies; a great example of this is Occidental Petroleum's C-suite, which dramatically overpaid for Anadarko Petroleum late last year, while Chevron's team had the sense to walk away. It will take highly-skilled CEOs and CFOs to shift course as needed and rebuild the hammered balance sheets);
EPS (Were quarterly and annual earnings growing going into the crisis, and how do we expect them to bounce back after two ugly quarters?);
Ownership (Have insiders been accumulating or shedding shares, and what percentage of the shares are owned by big institutions?)
In short, this will not be another 1997-1999—where just about every company was rewarded, despite their fundamentals, financials, and management teams. For both stocks and ETFs, a highly-refined selection process will be needed. If we emerge relatively quickly from this crisis, and the right mix of investments are in the portfolio, the growth between now and the end of the year could be impressive. Don't think the market can move that rapidly? Just consider the past five weeks. (Or, on the positive side, the year following the October, 1987 meltdown.)
E-Commerce
Amazon raises overtime pay to warehouse workers, increases minimum wage. It was around 06 March when shares of online retail giant Amazon (AMZN $1,626-$1,830-$2,186) detached from the overall market and began to stabilize. The reason is obvious: Amazon has been one of the top players in helping to keep America running during the downturn, which has meant unprecedented use of the company's services over the past few weeks. With that in mind, Amazon has announced that hourly workers at its US warehouses will receive double-pay for all overtime hours incurred between 15 March and 09 May. Additionally, the $931 billion firm said it would hike its minimum wage from $15 to $17 per hour and hire 100,000 new warehouse and delivery workers to handle the flood of new orders coming in. Since 06 March, shares of AMZN are down roughly 2% while its index, the Nasdaq, has dropped 20%. Despite its 81 P/E ratio, $1,830 will end up being a great entry point for AMZN shares. The challenge right now is finding any willing buyers.
Headlines for the Week of 15 Mar 2020—21 Mar 2020
Personal Finance: Retirement Plans
Under pressure: let's take a look at how those "risk managed" target date funds have performed during the downturn. I don't recall precisely when they came on the scene, maybe 2000 to 2002 or so, but I do recall that Vanguard led the charge. Jack Bogle, the recently-deceased founder of the fund company, went so far as to call for the government to limit employees' options to these creatures. What are these panacea investments? Target date funds. The Sesame Street school of fund selection: you simply look for the fund whose number corresponds with the year you plan to retire, and voilà! What could be simpler? At first I was intrigued; however, as soon as their track records began rolling in I was underwhelmed. They didn't seem to provide much support in a downturn (despite the fact that they are supposed to adjust between equities, bonds, and cash based on how long one has to retirement), and they certainly didn't perform as well as the markets in upturns. Perhaps the latter could be expected, based on the allocation to fixed income and cash, but what an incredible opportunity to see how the major target date funds have performed under duress. Take a look at the chart. In fairness, the Vanguard Target Retirement 2025 fund did perform the best of the bunch—it only lost 20.69% over the course of a month. Following behind is the Fidelity Freedom® 2025 fund, then the T. Rowe Price Retirement 2025 fund. So, if you were five years to retirement and placed your entire portfolio in one of these "glide-path" funds, you lost between one-fifth and one-quarter of your overall value. Granted, that is better than the 33.63% you would have lost in a Dow index fund, but that isn't all too comforting. I have yet to see a target-date fund which has lived up to its hype. Anyone within several years of retirement should have a decent percentage of their company plan assets sitting directly in the money market or "stable" option of the plan.
Automotive
Ford to suspend all dividend payments, halt North American production. It seemed as though the situation couldn't get any worse for the traditional American automakers, namely Ford (F $4-$5-$11) and General Motors (GM $14-$19-$42); then the pandemic hit. Ford, which generated a paltry $47 million in profits on $156 billion in revenues over the trailing twelve months, seems to be in a particularly precarious situation. For investors who have witnessed the value of their Ford shares drop by 50% year-to-date, at least they could point to a fat dividend yield. With the share price falling, however, the yield on the dividend rose to an unsustainable 13.13% as of Friday. Which is why it came as little shock when the company's uninspiring CEO, Jim Hackett, announced a suspension of all dividend payments to conserve cash. Additionally, Ford will halt all production in the US, Mexico, and Canada through at least the 30th of March. For its part, the UAW has requested that all US automakers shut down operations for at least two weeks to help assure the safety of its workers. Don't let the $5 share price fool you, Ford is an expensive stock to own. Since the company is still turning a profit, it actually has a P/E ratio, but that metric has been vacillating somewhere between 225 and 465 throughout the past three months. Like we said, expensive.
Media Malpractice
CNBC's trumpeting of a Bill Ackmam interview is a disgraceful example of media malpractice. "HELL IS COMING." That was statement CNBC viewers saw throughout the day, plastered on the chyron at the bottom of the screen. The smarmy, hyperbolic, fear-mongering quote was uttered by the typically-wrong hedge fund manager Bill Ackman in a CNBC interview done early Wednesday morning. An interview which, with CNBC's trumpeting, helped drive the market down over 1,300 points on the day. When Bill Ackman comes on CNBC (he is a frequent guest), I do one of two things: mute the sound, or listen to him talk and keep notes—then record the date his comments were proven wrong. He has been a walking disaster as a hedge fund manager. He has lost billions on egregiously wrong bets. Yet, there is CNBC having another interview with the exalted genius. Other than Ackman's HELL IS COMING quote, the main takeaway from his blathering (it should be noted that he often bets against US companies by shorting them) was that the United States should completely shut its economy down for 30 days, calling it an extended spring break. What lofty thinking. Brilliant. If only you were president, Ackman. I don't say this lightly: CNBC is culpable for a good percentage of Wednesday's market losses. Their irresponsibility amounted to yelling "FIRE!" in a crowded theater. They will hide behind their phony press credentials, of course, but they should be forced to run the following chyron announcement for one full day: "WE DID IT FOR RATINGS." Having vented my rant, it should be pointed out that my go-to business network is still CNBC. The majority of journalists on the network do an excellent job of non-biased reporting. Every now and again, however, something like this happens—and they must be called out for it.
Personal Finance
The IRS will delay taxes due—not return deadline—by 90 days. As part of the government’s overall COVID-19 response, Americans will see their tax deadline extended out 90 days from the traditional 15 April due date. During the deferral, no interest or penalties will accrue on any amount owed. This delay will be available to individuals who will owe under $1 million in taxes and corporations which will owe $10 million or less. The IRS pointed out, however, that Americans still need to send in their returns by 15 April, just not the taxes due. The point of this move is to provide much-needed liquidity to households over this three-month period. Treasury Secretary Steven Mnuchin told lawmakers the delay could help provide up to $300 billion in temporary liquidity. To that end, the treasury secretary highly recommended that Americans who believe they will be getting a refund file as soon as possible to gain access to those funds. The IRS announced that it would continue to process returns in a timely manner during the crisis. Unless the actual deadline date for filing is extended, however, tax preparers see confusion clouding the issue. The “decoupling” of the filing date and the due date will undoubtedly cause confusion. Our guess is that, ultimately, the filing date will be extended out as well. In the meantime, it would be wise to proceed as normal to file—and pay—by the traditional due date.
Market Risk Management
Performance of the various asset classes during the downturn: not much to like. The entire point of asset allocation is to allow investors the right amount of balance under all market conditions. Some asset classes generally run in tandem, while others are non-correlated to the markets, while still others are typically inversely-correlated: they go up when stocks go down (see fixed income story below). This has held true in virtually every market correction—until this one. Using the accompanying chart, let's take a look at the "best," the middling, and the worst performing classes during the downturn.
Gold and fixed income tend to spike during market and economic uncertainty; while these two asset classes have held up the best during our nearly one month long travail, they are down 8% and 9%, respectively.
Hanging out around the major indexes (the S&P 500 is now down just about 30% in what is its worst month since October of 1987) are: commodities, utilities, real estate, and international equities. Utilities may be the most disturbing—or enlightening—of the bunch, as this group consists mostly of regulated gas and electric companies with low valuations. After all, utilities are the least discretionary of all budgetary expenses. Utilities have lost, in aggregate, one-quarter of their value in under a month.
Perhaps understandably, following the oil war which has erupted between Saudi Arabia and Russia, the oil commodities are off 45% since the downturn. About a month ago, I heard a young CEO (actually, the CEO of Virgin Gallactic) push the notion that everyone should have a percentage of their investment dollars in bitcoin as a hedge. Of all asset classes during the downturn, digital currency—as represented by bitcoin in our graph—is the number one worst performer.
It is understandable that emotions tend to take over when selling begins to snowball, further exacerbating the selloff. Over the past few weeks, in fact, a number of our stop-loss orders have hit, with the money flowing to cash. But when blue-chip utilities and other companies flush with cash (like Apple, Microsoft, Walmart, and Target) are thrown in the mix, it generally increases the odds of a "v-shaped" recovery. Of course, all of this is dependent upon the unknown factor of how the US ultimately deals with the crisis at hand, but we suspect the graph will end up looking a lot like the 1987 downturn. If that is the case, now is a decent time to slowly begin looking at some of the lowest-risk US companies with the strongest of financial ratings. Without a doubt, their share prices are also dancing at or near 52-week lows.
An extended discussion of this topic and the following (fixed income) will appear in the next issue of The Penn Wealth Report.
Fixed Income Desk
A disturbing look into the world of fixed income during the downturn. A lot of wretched things occur to investments during market downturns, but there has always been one stabilizing truth: As equities are plummeting, bonds serve as the beacon in the storm—the one asset class that is most often inversely correlated to stocks. Bond values go up while equity values drop, right? With the global fiscal irresponsibility that has been the norm since the financial meltdown of 2008/09, we can officially throw that paradigm out the window. After three bruising weeks in the market, we took this "golden opportunity" to review eleven popular fixed income holdings. We didn't cherry-pick: they run the gamut of choices, from government bonds to corporates to high yield to emerging markets, and what we found is disturbing—especially considering the Fed lowered rates 50 basis points in the middle of this time-frame, which should have buoyed bond prices. Take a look at the accompanying chart. Two fixed income categories actually underperformed the S&P 500: high yield bonds and convertible securities. Only one category was in the green: US Treasuries, as represented by the iShares US Treasury Bond ETF (GOVT). The second-highest performer in our group was the Invesco Total Return Bond ETF (GTO), which holds a nice mix of government bonds, corporates, and securitized notes (think packaged baskets of mortgages and other debt obligations), which lost only 3.71% over the last three weeks. The third-best performer, with a return of -4.26%, was the iShares TIPS Bond ETF (TIP), which we have used as a hedge against inflation. If there is one message to be gleaned from this exercise, it is that old paradigms have been turned on their head thanks to a stew of fiscally irresponsible ingredients. If it is of any comfort at all, at least our money market funds have yet to break the buck. An extended discussion of this topic will appear in the next issue of The Penn Wealth Report.
Aerospace & Defense
Boeing's value has been cut in half in thirty days. Between the October, 2018 737 MAX crash in Indonesia and the March, 2019 737 MAX crash in Ethiopia, we jettisoned aircraft maker Boeing (BA $155-$170-$399) from the Penn Global Leaders Club. That turned out to be a fortuitous move, as shares of the beleaguered company have done nothing but go down ever since. In fact, while the S&P 500 has been busy losing one-quarter of its value over a few week time-frame, Boeing has doubled that—down 50%. The company which had a $250 billion market cap one year ago is now worth $98 billion. Over the course of the past two weeks, we have been looking for outstanding American companies to buy as their share prices lay battered and bruised in the carnage; despite the fact that Boeing is now trading where it did three full years ago, we don't consider it a bargain. Considering the uninspired management team at the company refuses to even drop the tainted MAX name, who can blame us? Boeing needs massive structural changes, but the people who would need to implement such changes happen to be part of the problem. That is not good.
Consumer Defensives
Pepsi will buy Rockstar Energy for $3.85 billion. Both Pepsi (PEP $115-$134-$147) and Coca-Cola (KO $45-$54-$60), two companies which could have easily declined into obscurity had they continued to rely on the sale of sugary sodas for growth, have done a masterful job at moving into more lucrative markets, such as bottled water, tea, and energy drinks. Pepsi's latest move highlights the enormous growth potential of that last group: the company announced it would buy Rockstar Energy for $3.85 billion. While Pepsi has had a distribution agreement with Rockstar since 2009, the agreement limited what the $186 billion company could do with respect to the distribution of competitor brands, to include its own Mountain Dew Kickstart, GameFuel, and AMP lines. The energy drink business has been one in which both Coke and Pepsi have been struggling to gain traction against entrenched private players, such as Monster and Red Bull, so this deal will mark a huge win for Pepsi's relatively new CEO, Ramon Laguarta, who took over for Indra Nooyi in late 2018. Pepsi's last big acquisition was that of Israeli-based SodaStream in 2018 for $3.2 billion. Both Pepsi and Coca-Cola have held up better than the S&P 500 index—of which they are both members—during the recent downturn. Both have low betas (risk measure) roughly equal to half that of the S&P 500, and both carry a reasonable P/E ratio of 25. Ironically, both also carry nearly identical dividend yields of just below 3%. Both are probably pretty safe bets right now (we don't own either in the Penn strategies), but we would give the slight edge to Coca-Cola at $52 from a valuation standpoint.
Under pressure: let's take a look at how those "risk managed" target date funds have performed during the downturn. I don't recall precisely when they came on the scene, maybe 2000 to 2002 or so, but I do recall that Vanguard led the charge. Jack Bogle, the recently-deceased founder of the fund company, went so far as to call for the government to limit employees' options to these creatures. What are these panacea investments? Target date funds. The Sesame Street school of fund selection: you simply look for the fund whose number corresponds with the year you plan to retire, and voilà! What could be simpler? At first I was intrigued; however, as soon as their track records began rolling in I was underwhelmed. They didn't seem to provide much support in a downturn (despite the fact that they are supposed to adjust between equities, bonds, and cash based on how long one has to retirement), and they certainly didn't perform as well as the markets in upturns. Perhaps the latter could be expected, based on the allocation to fixed income and cash, but what an incredible opportunity to see how the major target date funds have performed under duress. Take a look at the chart. In fairness, the Vanguard Target Retirement 2025 fund did perform the best of the bunch—it only lost 20.69% over the course of a month. Following behind is the Fidelity Freedom® 2025 fund, then the T. Rowe Price Retirement 2025 fund. So, if you were five years to retirement and placed your entire portfolio in one of these "glide-path" funds, you lost between one-fifth and one-quarter of your overall value. Granted, that is better than the 33.63% you would have lost in a Dow index fund, but that isn't all too comforting. I have yet to see a target-date fund which has lived up to its hype. Anyone within several years of retirement should have a decent percentage of their company plan assets sitting directly in the money market or "stable" option of the plan.
Automotive
Ford to suspend all dividend payments, halt North American production. It seemed as though the situation couldn't get any worse for the traditional American automakers, namely Ford (F $4-$5-$11) and General Motors (GM $14-$19-$42); then the pandemic hit. Ford, which generated a paltry $47 million in profits on $156 billion in revenues over the trailing twelve months, seems to be in a particularly precarious situation. For investors who have witnessed the value of their Ford shares drop by 50% year-to-date, at least they could point to a fat dividend yield. With the share price falling, however, the yield on the dividend rose to an unsustainable 13.13% as of Friday. Which is why it came as little shock when the company's uninspiring CEO, Jim Hackett, announced a suspension of all dividend payments to conserve cash. Additionally, Ford will halt all production in the US, Mexico, and Canada through at least the 30th of March. For its part, the UAW has requested that all US automakers shut down operations for at least two weeks to help assure the safety of its workers. Don't let the $5 share price fool you, Ford is an expensive stock to own. Since the company is still turning a profit, it actually has a P/E ratio, but that metric has been vacillating somewhere between 225 and 465 throughout the past three months. Like we said, expensive.
Media Malpractice
CNBC's trumpeting of a Bill Ackmam interview is a disgraceful example of media malpractice. "HELL IS COMING." That was statement CNBC viewers saw throughout the day, plastered on the chyron at the bottom of the screen. The smarmy, hyperbolic, fear-mongering quote was uttered by the typically-wrong hedge fund manager Bill Ackman in a CNBC interview done early Wednesday morning. An interview which, with CNBC's trumpeting, helped drive the market down over 1,300 points on the day. When Bill Ackman comes on CNBC (he is a frequent guest), I do one of two things: mute the sound, or listen to him talk and keep notes—then record the date his comments were proven wrong. He has been a walking disaster as a hedge fund manager. He has lost billions on egregiously wrong bets. Yet, there is CNBC having another interview with the exalted genius. Other than Ackman's HELL IS COMING quote, the main takeaway from his blathering (it should be noted that he often bets against US companies by shorting them) was that the United States should completely shut its economy down for 30 days, calling it an extended spring break. What lofty thinking. Brilliant. If only you were president, Ackman. I don't say this lightly: CNBC is culpable for a good percentage of Wednesday's market losses. Their irresponsibility amounted to yelling "FIRE!" in a crowded theater. They will hide behind their phony press credentials, of course, but they should be forced to run the following chyron announcement for one full day: "WE DID IT FOR RATINGS." Having vented my rant, it should be pointed out that my go-to business network is still CNBC. The majority of journalists on the network do an excellent job of non-biased reporting. Every now and again, however, something like this happens—and they must be called out for it.
Personal Finance
The IRS will delay taxes due—not return deadline—by 90 days. As part of the government’s overall COVID-19 response, Americans will see their tax deadline extended out 90 days from the traditional 15 April due date. During the deferral, no interest or penalties will accrue on any amount owed. This delay will be available to individuals who will owe under $1 million in taxes and corporations which will owe $10 million or less. The IRS pointed out, however, that Americans still need to send in their returns by 15 April, just not the taxes due. The point of this move is to provide much-needed liquidity to households over this three-month period. Treasury Secretary Steven Mnuchin told lawmakers the delay could help provide up to $300 billion in temporary liquidity. To that end, the treasury secretary highly recommended that Americans who believe they will be getting a refund file as soon as possible to gain access to those funds. The IRS announced that it would continue to process returns in a timely manner during the crisis. Unless the actual deadline date for filing is extended, however, tax preparers see confusion clouding the issue. The “decoupling” of the filing date and the due date will undoubtedly cause confusion. Our guess is that, ultimately, the filing date will be extended out as well. In the meantime, it would be wise to proceed as normal to file—and pay—by the traditional due date.
Market Risk Management
Performance of the various asset classes during the downturn: not much to like. The entire point of asset allocation is to allow investors the right amount of balance under all market conditions. Some asset classes generally run in tandem, while others are non-correlated to the markets, while still others are typically inversely-correlated: they go up when stocks go down (see fixed income story below). This has held true in virtually every market correction—until this one. Using the accompanying chart, let's take a look at the "best," the middling, and the worst performing classes during the downturn.
Gold and fixed income tend to spike during market and economic uncertainty; while these two asset classes have held up the best during our nearly one month long travail, they are down 8% and 9%, respectively.
Hanging out around the major indexes (the S&P 500 is now down just about 30% in what is its worst month since October of 1987) are: commodities, utilities, real estate, and international equities. Utilities may be the most disturbing—or enlightening—of the bunch, as this group consists mostly of regulated gas and electric companies with low valuations. After all, utilities are the least discretionary of all budgetary expenses. Utilities have lost, in aggregate, one-quarter of their value in under a month.
Perhaps understandably, following the oil war which has erupted between Saudi Arabia and Russia, the oil commodities are off 45% since the downturn. About a month ago, I heard a young CEO (actually, the CEO of Virgin Gallactic) push the notion that everyone should have a percentage of their investment dollars in bitcoin as a hedge. Of all asset classes during the downturn, digital currency—as represented by bitcoin in our graph—is the number one worst performer.
It is understandable that emotions tend to take over when selling begins to snowball, further exacerbating the selloff. Over the past few weeks, in fact, a number of our stop-loss orders have hit, with the money flowing to cash. But when blue-chip utilities and other companies flush with cash (like Apple, Microsoft, Walmart, and Target) are thrown in the mix, it generally increases the odds of a "v-shaped" recovery. Of course, all of this is dependent upon the unknown factor of how the US ultimately deals with the crisis at hand, but we suspect the graph will end up looking a lot like the 1987 downturn. If that is the case, now is a decent time to slowly begin looking at some of the lowest-risk US companies with the strongest of financial ratings. Without a doubt, their share prices are also dancing at or near 52-week lows.
An extended discussion of this topic and the following (fixed income) will appear in the next issue of The Penn Wealth Report.
Fixed Income Desk
A disturbing look into the world of fixed income during the downturn. A lot of wretched things occur to investments during market downturns, but there has always been one stabilizing truth: As equities are plummeting, bonds serve as the beacon in the storm—the one asset class that is most often inversely correlated to stocks. Bond values go up while equity values drop, right? With the global fiscal irresponsibility that has been the norm since the financial meltdown of 2008/09, we can officially throw that paradigm out the window. After three bruising weeks in the market, we took this "golden opportunity" to review eleven popular fixed income holdings. We didn't cherry-pick: they run the gamut of choices, from government bonds to corporates to high yield to emerging markets, and what we found is disturbing—especially considering the Fed lowered rates 50 basis points in the middle of this time-frame, which should have buoyed bond prices. Take a look at the accompanying chart. Two fixed income categories actually underperformed the S&P 500: high yield bonds and convertible securities. Only one category was in the green: US Treasuries, as represented by the iShares US Treasury Bond ETF (GOVT). The second-highest performer in our group was the Invesco Total Return Bond ETF (GTO), which holds a nice mix of government bonds, corporates, and securitized notes (think packaged baskets of mortgages and other debt obligations), which lost only 3.71% over the last three weeks. The third-best performer, with a return of -4.26%, was the iShares TIPS Bond ETF (TIP), which we have used as a hedge against inflation. If there is one message to be gleaned from this exercise, it is that old paradigms have been turned on their head thanks to a stew of fiscally irresponsible ingredients. If it is of any comfort at all, at least our money market funds have yet to break the buck. An extended discussion of this topic will appear in the next issue of The Penn Wealth Report.
Aerospace & Defense
Boeing's value has been cut in half in thirty days. Between the October, 2018 737 MAX crash in Indonesia and the March, 2019 737 MAX crash in Ethiopia, we jettisoned aircraft maker Boeing (BA $155-$170-$399) from the Penn Global Leaders Club. That turned out to be a fortuitous move, as shares of the beleaguered company have done nothing but go down ever since. In fact, while the S&P 500 has been busy losing one-quarter of its value over a few week time-frame, Boeing has doubled that—down 50%. The company which had a $250 billion market cap one year ago is now worth $98 billion. Over the course of the past two weeks, we have been looking for outstanding American companies to buy as their share prices lay battered and bruised in the carnage; despite the fact that Boeing is now trading where it did three full years ago, we don't consider it a bargain. Considering the uninspired management team at the company refuses to even drop the tainted MAX name, who can blame us? Boeing needs massive structural changes, but the people who would need to implement such changes happen to be part of the problem. That is not good.
Consumer Defensives
Pepsi will buy Rockstar Energy for $3.85 billion. Both Pepsi (PEP $115-$134-$147) and Coca-Cola (KO $45-$54-$60), two companies which could have easily declined into obscurity had they continued to rely on the sale of sugary sodas for growth, have done a masterful job at moving into more lucrative markets, such as bottled water, tea, and energy drinks. Pepsi's latest move highlights the enormous growth potential of that last group: the company announced it would buy Rockstar Energy for $3.85 billion. While Pepsi has had a distribution agreement with Rockstar since 2009, the agreement limited what the $186 billion company could do with respect to the distribution of competitor brands, to include its own Mountain Dew Kickstart, GameFuel, and AMP lines. The energy drink business has been one in which both Coke and Pepsi have been struggling to gain traction against entrenched private players, such as Monster and Red Bull, so this deal will mark a huge win for Pepsi's relatively new CEO, Ramon Laguarta, who took over for Indra Nooyi in late 2018. Pepsi's last big acquisition was that of Israeli-based SodaStream in 2018 for $3.2 billion. Both Pepsi and Coca-Cola have held up better than the S&P 500 index—of which they are both members—during the recent downturn. Both have low betas (risk measure) roughly equal to half that of the S&P 500, and both carry a reasonable P/E ratio of 25. Ironically, both also carry nearly identical dividend yields of just below 3%. Both are probably pretty safe bets right now (we don't own either in the Penn strategies), but we would give the slight edge to Coca-Cola at $52 from a valuation standpoint.
Headlines for the Week of 01 Mar 2020—07 Mar 2020
Pharmaceuticals
Gilead's acquisition of Forty Seven should give its cancer-fighting efforts a nice boost. We added $95 billion drugmaker Gilead Sciences (GILD $61-$75-$79) to the Penn Global Leaders Club last April at $61.71 per share, right near its 52-week low at the time, because we liked management's commitment to becoming a leader in the oncology space. That investment has paid off nicely thus far, and the company continues to ramp up its effort. To that end, Gilead just announced that it would acquire immuno-oncology firm Forty Seven Inc (FTSV $6-$94-$95) for $4.9 billion, which will bring highly promising cancer treatment magrolimab into its clinical mid/late stage pipeline. Magrolimab, a monoclonal antibody in clinical development for the treatment of several different cancer types, has been granted Fast Track status by the FDA. Gilead has been one of the few stocks bucking the recent downturn thanks to its efforts in creating a COVID-19 vaccine. In 2019, Gilead earned $5.4 billion on the back of $22.5 billion in revenues. With its healthy pile of cash, an 18 P/E ratio, a 3.36% dividend yield, and a commitment to becoming the world's leading cancer-fighting company, there is a lot to like about GILD shares.
Thermo Fisher Scientific (TMO) to buy Qiagen N.V. (QGEN, medical sample processing) for $10.1 billion
Personal Finance
Robinhood users miss out on largest one-day point gain ever in Dow after system-wide failure. Robinhood, a trading platform we have called "Stock Candy Crush Saga," just suffered a major malfunction, and users want more than answers. On a day when the Dow rose 1,294 points, the largest one-day point gain in history, the platform suffered a system-wide outage which prevented any buy or sell orders from being placed. As could be imagined, users took to Twitter and other social media outlets to voice their outrage. More than venting anger, many are calling for a class-action lawsuit to recoup what they lost due to their inability to trade. That would be a hard case to win, as the system wouldn't even let users access their accounts, meaning no evidence exists of any trades that would have taken place. Something tells us there are more than a few lawyers out there ready to take the case, however. Obviously, Robinhood didn't exist back in 1999, but it sure would have fit in with the zeitgeist of the late '90s. And that is not a compliment.
2020.03.02 Dow notches a record point gain; markets jump over 5% on Monday.
Personal Finance
A record number of 401(k) participants shuffled their investments around last week after the carnage, and that is troubling. Our mantra has been and continues to be: know your Risk Tolerance Number and invest accordingly in the proper Penn tactical asset allocation—all of which are updated quarterly. New research from Alight Solutions presents us with some troubling news on the asset allocation front. The group, which tracks the activity of millions of 401(k) participants, noted a record number of intra-account transfers last Friday, with the overwhelming amount consisting of money going from equity buckets and into fixed income funds and cash. Let's further define a record number: sixteen times the average number of trades took place last week. In other words, after the carnage had already occurred, employees locked in their losses by moving massive amounts of money out of where the growth would occur in a comeback. This makes two things evident: most people weren't allocated correctly in the first place, and/or they let their emotions drive their investment decisions. We have been witnessing some disturbing reminders of what went on leading into the great tech bubble burst of 2000 to 2002. 401(k) plans being grossly out of whack is certainly one specter of 1999; emotional trading another. Perhaps last week was a wake-up call for employees with a company retirement plan.
Gilead's acquisition of Forty Seven should give its cancer-fighting efforts a nice boost. We added $95 billion drugmaker Gilead Sciences (GILD $61-$75-$79) to the Penn Global Leaders Club last April at $61.71 per share, right near its 52-week low at the time, because we liked management's commitment to becoming a leader in the oncology space. That investment has paid off nicely thus far, and the company continues to ramp up its effort. To that end, Gilead just announced that it would acquire immuno-oncology firm Forty Seven Inc (FTSV $6-$94-$95) for $4.9 billion, which will bring highly promising cancer treatment magrolimab into its clinical mid/late stage pipeline. Magrolimab, a monoclonal antibody in clinical development for the treatment of several different cancer types, has been granted Fast Track status by the FDA. Gilead has been one of the few stocks bucking the recent downturn thanks to its efforts in creating a COVID-19 vaccine. In 2019, Gilead earned $5.4 billion on the back of $22.5 billion in revenues. With its healthy pile of cash, an 18 P/E ratio, a 3.36% dividend yield, and a commitment to becoming the world's leading cancer-fighting company, there is a lot to like about GILD shares.
Thermo Fisher Scientific (TMO) to buy Qiagen N.V. (QGEN, medical sample processing) for $10.1 billion
Personal Finance
Robinhood users miss out on largest one-day point gain ever in Dow after system-wide failure. Robinhood, a trading platform we have called "Stock Candy Crush Saga," just suffered a major malfunction, and users want more than answers. On a day when the Dow rose 1,294 points, the largest one-day point gain in history, the platform suffered a system-wide outage which prevented any buy or sell orders from being placed. As could be imagined, users took to Twitter and other social media outlets to voice their outrage. More than venting anger, many are calling for a class-action lawsuit to recoup what they lost due to their inability to trade. That would be a hard case to win, as the system wouldn't even let users access their accounts, meaning no evidence exists of any trades that would have taken place. Something tells us there are more than a few lawyers out there ready to take the case, however. Obviously, Robinhood didn't exist back in 1999, but it sure would have fit in with the zeitgeist of the late '90s. And that is not a compliment.
2020.03.02 Dow notches a record point gain; markets jump over 5% on Monday.
Personal Finance
A record number of 401(k) participants shuffled their investments around last week after the carnage, and that is troubling. Our mantra has been and continues to be: know your Risk Tolerance Number and invest accordingly in the proper Penn tactical asset allocation—all of which are updated quarterly. New research from Alight Solutions presents us with some troubling news on the asset allocation front. The group, which tracks the activity of millions of 401(k) participants, noted a record number of intra-account transfers last Friday, with the overwhelming amount consisting of money going from equity buckets and into fixed income funds and cash. Let's further define a record number: sixteen times the average number of trades took place last week. In other words, after the carnage had already occurred, employees locked in their losses by moving massive amounts of money out of where the growth would occur in a comeback. This makes two things evident: most people weren't allocated correctly in the first place, and/or they let their emotions drive their investment decisions. We have been witnessing some disturbing reminders of what went on leading into the great tech bubble burst of 2000 to 2002. 401(k) plans being grossly out of whack is certainly one specter of 1999; emotional trading another. Perhaps last week was a wake-up call for employees with a company retirement plan.
Headlines for the Week of 23 Feb 2020—29 Feb 2020
Monetary Policy
Fed makes rare "between-meeting" move, and all it did was drive the markets down and sink the 10-year to record lows. The last time the Federal Reserve made an interest rate cut between FOMC meetings was during the heat of the financial crisis. Today, the Fed shocked the markets by making the equivalent of not one, but two cuts. The 50-basis-point drop moved the Federal funds rate to a channel between 1% and 1.25%. At first, markets seemed to like the action, with the Dow moving from several hundred points down to several hundred points up. That didn't last long. Within a few hours, the Dow was down 800 points and all three major indexes were off around 3%, giving up most of Monday's gains. Not only did the Fed's action not assuage investors' fears, it also drove the 10-year Treasury down to below a 1% yield for the first time in its history. As we write this, it sits at 0.942%. What the markets are looking for now is not more easing, but better news on the coronavirus front. The chronic, minute-by-minute and hour-by-hour hyperbolic coverage is bouncing around in the psyche of investors; until those headlines subside, expect wild trading days with the volatility index, as recorded by the VIX, remaining highly elevated.
Application & Systems Software
Intuit to buy Credit Karma for $7.1 billion. Many Americans may not recognize the name Intuit (INTU $236-$280-$307), but odds are pretty good they have used one of the company's online financial services, such as TurboTax, QuickBooks, or budgeting platform Mint. In its most recent move to shore up its fintech services, the company just announced that it will buy personal finance portal Credit Karma for $7.1 billion in cash and stock. News of the deal was music to the ears of Credit Karma's 700 employees, who will receive around $300 million worth of INTU restricted stock, to be paid out over four years. That company provides free credit scores to consumers, in addition to credit monitoring and tax preparation and filing services. The deal will close in the second half of the year. Intuit's P/E ratio of 45 may seem a bit rich, but it is in line with other firms in the software applications industry. For example, Adobe (ADBE), perhaps our favorite firm in the industry, has a P/E ratio of 59. Additionally, Intuit's financials look great: solidly growing revenues, an operating margin of 27%, and a relatively low debt load. Shares are down 9% on the market pullback, but will the coronavirus stop anyone from filing their taxes or balancing their books?
Aerospace & Defense
Boeing board changes better late than never, except for those who lost their lives. We have been excoriating Boeing (BA $303-$306-$446) for the past year, primarily because a boardroom attitude of arrogance drove a glittering jewel of the American economy off the road and into a ditch. Our disappointment turned to disgust when we took a deeper look into who was sitting on the Boeing board of directors. Take the notion of a professional corporate board, one replete with industry experience and complementary insight, and turn that concept on its head; you then get a feel for the Boeing board. The one word that came to mind was “cronyism.” Surprisingly, it now appears that some movement is underway to change that condition. The company has nominated two outsiders with extensive safety and engineering experience to join the board. Akhil Johri has been the CFO at United Technologies (UTX), and Steve Mollenkopf—one of our favorite CEOs—is at the helm of chipmaker Qualcomm (QCOM, a Penn New Frontier Fund member). While those are two welcome additions, there are still members which need to go. After the moves were announced, Chairman Larry Kellner, a former CEO of Continental Airlines (cronyism), said, “We just feel like this is the right balance...” Considering proxy advisory firm Glass Lewis recommended shareholders vote against retaining Kellner on the board last year, his sentiments ring a bit hollow. These two excellent nominees represent a step in the right direction, but it still feels as though the company doesn't fully comprehend the scope of what is going on. Keeping the MAX name is evidence of that. If you would have told us, at virtually any other time in the past 23 years, that Boeing shares were sitting at their 52-week low, we would have immediately jumped in. Right now, though that condition exists, the shares are not even on our radar.
2020.02.25 SmileDirectClub (SDC) falls 20% after hours following revenue miss and lowered guidance...
2020.02.25 Stocks tumble for second day; major indexes now off in excess of 6% over two trading days (we called for a 10-15% correction in the first quarter of the year in our 2020 Outlook & Strategy report)...
2020.02.24 Zoom Technologies spikes 21% as market plummets as more business meetings held via technology as opposed to travel (and by the end of the trading session, it had given back 23%, ending the session down 1.79%...
2020.02.24 Dow briefly drops over 1,000 points as coronavirus spreads...
Media & Entertainment
A shocking change in the Disney C-suite: Iger is leaving the CEO role. We were relieved to hear Walt Disney (DIS $107-$123-$153) CEO Bob Iger state, late last year, that he wouldn't be retiring until 2021. We are up massively in our Disney position within the Penn Global Leaders Club, and Iger can take responsibility for the lion's share of the stock's move. That is why we were shocked to hear that Iger is actually stepping out of the CEO role, effective immediately. Technically, he is not leaving the company until 2021, but if he knew he would be stepping aside, he should have made that clear. There are reports that Iger recently told a journalist that he "didn't want to run the company anymore." Well and good, but give us some advance notice. We were not alone in our surprise—senior executives at the media and entertainment giant were apparently caught off guard as well. With Iger moving into the executive chairman role, we can envision one of two not-very-positive scenarios: either he will overshadow the new CEO—at least within the C-suite—and their relationship will become strained, or he will simply be a figurehead. Neither alternative seems very palatable. The new CEO, Bob Chapek, will report to both Iger and the board of directors. Uh oh. Hello, scenario one? As the recent head of parks and resorts, Chapek undoubtedly knows that side of the business, but what about the company's enormous strategic move into the streaming business? Chapek beat out, in fact, Disney's head of that up-and-coming service, Kevin Mayer. Disney employees throughout the company didn't get a memo about the change until after Iger and Chapek gave a joint conference call to analysts and an interview on a major business network. We have to wonder how that went over within the walls of the company. All of this is very uncharacteristic for the Disney we revered under the control of the skilled Iger. We will have to wait and see how the story unfolds going forward. While we have no plans to sell our Disney shares from the Global Leaders Club, we have put the company on our watch list for possible action. Management matters, and we just don't yet know enough about Chapek, or what internal struggles might ensue over the coming year or two.
Fed makes rare "between-meeting" move, and all it did was drive the markets down and sink the 10-year to record lows. The last time the Federal Reserve made an interest rate cut between FOMC meetings was during the heat of the financial crisis. Today, the Fed shocked the markets by making the equivalent of not one, but two cuts. The 50-basis-point drop moved the Federal funds rate to a channel between 1% and 1.25%. At first, markets seemed to like the action, with the Dow moving from several hundred points down to several hundred points up. That didn't last long. Within a few hours, the Dow was down 800 points and all three major indexes were off around 3%, giving up most of Monday's gains. Not only did the Fed's action not assuage investors' fears, it also drove the 10-year Treasury down to below a 1% yield for the first time in its history. As we write this, it sits at 0.942%. What the markets are looking for now is not more easing, but better news on the coronavirus front. The chronic, minute-by-minute and hour-by-hour hyperbolic coverage is bouncing around in the psyche of investors; until those headlines subside, expect wild trading days with the volatility index, as recorded by the VIX, remaining highly elevated.
Application & Systems Software
Intuit to buy Credit Karma for $7.1 billion. Many Americans may not recognize the name Intuit (INTU $236-$280-$307), but odds are pretty good they have used one of the company's online financial services, such as TurboTax, QuickBooks, or budgeting platform Mint. In its most recent move to shore up its fintech services, the company just announced that it will buy personal finance portal Credit Karma for $7.1 billion in cash and stock. News of the deal was music to the ears of Credit Karma's 700 employees, who will receive around $300 million worth of INTU restricted stock, to be paid out over four years. That company provides free credit scores to consumers, in addition to credit monitoring and tax preparation and filing services. The deal will close in the second half of the year. Intuit's P/E ratio of 45 may seem a bit rich, but it is in line with other firms in the software applications industry. For example, Adobe (ADBE), perhaps our favorite firm in the industry, has a P/E ratio of 59. Additionally, Intuit's financials look great: solidly growing revenues, an operating margin of 27%, and a relatively low debt load. Shares are down 9% on the market pullback, but will the coronavirus stop anyone from filing their taxes or balancing their books?
Aerospace & Defense
Boeing board changes better late than never, except for those who lost their lives. We have been excoriating Boeing (BA $303-$306-$446) for the past year, primarily because a boardroom attitude of arrogance drove a glittering jewel of the American economy off the road and into a ditch. Our disappointment turned to disgust when we took a deeper look into who was sitting on the Boeing board of directors. Take the notion of a professional corporate board, one replete with industry experience and complementary insight, and turn that concept on its head; you then get a feel for the Boeing board. The one word that came to mind was “cronyism.” Surprisingly, it now appears that some movement is underway to change that condition. The company has nominated two outsiders with extensive safety and engineering experience to join the board. Akhil Johri has been the CFO at United Technologies (UTX), and Steve Mollenkopf—one of our favorite CEOs—is at the helm of chipmaker Qualcomm (QCOM, a Penn New Frontier Fund member). While those are two welcome additions, there are still members which need to go. After the moves were announced, Chairman Larry Kellner, a former CEO of Continental Airlines (cronyism), said, “We just feel like this is the right balance...” Considering proxy advisory firm Glass Lewis recommended shareholders vote against retaining Kellner on the board last year, his sentiments ring a bit hollow. These two excellent nominees represent a step in the right direction, but it still feels as though the company doesn't fully comprehend the scope of what is going on. Keeping the MAX name is evidence of that. If you would have told us, at virtually any other time in the past 23 years, that Boeing shares were sitting at their 52-week low, we would have immediately jumped in. Right now, though that condition exists, the shares are not even on our radar.
2020.02.25 SmileDirectClub (SDC) falls 20% after hours following revenue miss and lowered guidance...
2020.02.25 Stocks tumble for second day; major indexes now off in excess of 6% over two trading days (we called for a 10-15% correction in the first quarter of the year in our 2020 Outlook & Strategy report)...
2020.02.24 Zoom Technologies spikes 21% as market plummets as more business meetings held via technology as opposed to travel (and by the end of the trading session, it had given back 23%, ending the session down 1.79%...
2020.02.24 Dow briefly drops over 1,000 points as coronavirus spreads...
Media & Entertainment
A shocking change in the Disney C-suite: Iger is leaving the CEO role. We were relieved to hear Walt Disney (DIS $107-$123-$153) CEO Bob Iger state, late last year, that he wouldn't be retiring until 2021. We are up massively in our Disney position within the Penn Global Leaders Club, and Iger can take responsibility for the lion's share of the stock's move. That is why we were shocked to hear that Iger is actually stepping out of the CEO role, effective immediately. Technically, he is not leaving the company until 2021, but if he knew he would be stepping aside, he should have made that clear. There are reports that Iger recently told a journalist that he "didn't want to run the company anymore." Well and good, but give us some advance notice. We were not alone in our surprise—senior executives at the media and entertainment giant were apparently caught off guard as well. With Iger moving into the executive chairman role, we can envision one of two not-very-positive scenarios: either he will overshadow the new CEO—at least within the C-suite—and their relationship will become strained, or he will simply be a figurehead. Neither alternative seems very palatable. The new CEO, Bob Chapek, will report to both Iger and the board of directors. Uh oh. Hello, scenario one? As the recent head of parks and resorts, Chapek undoubtedly knows that side of the business, but what about the company's enormous strategic move into the streaming business? Chapek beat out, in fact, Disney's head of that up-and-coming service, Kevin Mayer. Disney employees throughout the company didn't get a memo about the change until after Iger and Chapek gave a joint conference call to analysts and an interview on a major business network. We have to wonder how that went over within the walls of the company. All of this is very uncharacteristic for the Disney we revered under the control of the skilled Iger. We will have to wait and see how the story unfolds going forward. While we have no plans to sell our Disney shares from the Global Leaders Club, we have put the company on our watch list for possible action. Management matters, and we just don't yet know enough about Chapek, or what internal struggles might ensue over the coming year or two.
Headlines for the Week of 16 Feb 2020—22 Feb 2020
Market Pulse
A subtle specter of the late 1990s is beginning to manifest. Back in 1999, when I was a broker at a tiny Edward Jones office, I began to notice an interesting trend. An increasing number of prospective clients began calling or dropping by the office with an intense interest in the stock market. At first, I patted myself on the back, confident that all of my hard work was finally paying off. Nearly all of the questions, however, seemed to revolve around pie-in-the-sky companies which had never turned a profit. Companies like Infospace, Pets.com, Global Crossing, and AT&T spinoff Lucent—with no earnings but a $250 billion market cap! Within three years, the index all of these companies called home—the NASDAQ—had lost 78% of its value. No, it is not 1999, but there is a sudden movement afoot that reminds us a lot of that pre-bubble-burst year. Through apps being offered by companies like Betterment, Robinhood, and Stash, traders (we can't call them investors) are able to buy fractional shares. Want to buy into Amazon (AMZN), but only have $10 to spend? No problem! Just buy 1/200th of a share! Heck, don't have $10 to spend? You can "invest" on Robinhood with just $1. Want to venture some guesses as to the most-bought stocks on Robinhood? If you are thinking of blue chips like Union Pacific, McDonald's, and General Mills, forget it. Some of the most hotly-traded stocks include: Cronos (marijuana), GoPro (barely turns a profit but hey, selling for under $4), Aurora Cannabis, and Fitbit (last profit, 2015). In other words, they are playing the equity version of Candy Crush Saga on their iPhones. I remember how confident those prospects were back in 1999. If only they knew what was waiting for them around the corner. Again, this is not 1999, and we feel relatively confident with where the economy and the markets are sitting right now. However, fundamentals still matter. Ask 99 out of 100 Robinhood traders what the PE ratio is for the Aurora Cannabis stock they just bought, and they wouldn't have a clue. (Trick question: a company has to have earnings to register a PE ratio).
Sovereign Debt & Global Fixed Income
The 30-year Treasury just hit the lowest yield in its history. How bad is it for fixed income investors? Consider this: the longer you go out on the maturity ladder, the more interest rate risk you are taking on, meaning you will be rewarded for that risk. Right now, the US government will pay you a whopping 1.9% to take on the interest rate risk of buying a 30-year Treasury. In fact, the long bond hit a historic low yield intraday of 1.88% on Friday. Madness. For those living on the income from their bonds, what choice do they have but to take on more risk and move a larger percentage of their portfolios into dividend-paying stocks? While that condition is helping to prop up fat dividend payers, it also means that many older Americans with a low risk tolerance are probably taking on more risk than they should within their portfolios—and that condition is unlikely to change anytime soon. Of course, if interest rates do move up, the government will be forced to pay even more to service the country's $23 trillion debt load. Incredibly, yields in the US are some of the highest in the developed world. As we say, utter madness. This global debt party absolutely will bust one of these days, and it will probably put the tech bubble of 2000-2002 and the banking crisis of 2007-2009 to shame. Sovereign irresponsibility is at an all-time high.
2020.02.21 Dropbox DBX aims for profitability by the end of 2020; stock up 23% post-earnings
2020.02.20 L Brands LB confirms Victoria's Secret will go public, Sycamore Partners buying for $1.1B
2020.02.20 Penn member Viacom/CBS VIACA plunges 14% after first post-merger earnings report: missed on top and bottom; PE of 4?!
2020.02.20...DPZ Domino's Pizza strong beat, shares up 25% on day; earnings, revenue beat; CEO calls aggregators "circling firing squad"
2020.02.20...Gold is negatively correlated to the US dollar; don't let their recent correlation fool you
Capital Markets
Morgan Stanley to buy E*Trade in all-stock deal valued at $13 billion. Just three months after the major announcement that discount brokerage firm Charles Schwab (SCHW) would buy TD Ameritrade (AMTD) for $26 billion, Morgan Stanley (MS $39-$52-$58) decided it had better get in the game—the $83 billion financial services giant will buy online brokerage firm E*Trade (ETFC $35-$53-$57) for $13 billion in an all-stock deal. With the acquisition, MS will pick up around five million retail customers, over $350 million in new assets, and—most importantly—get in the lucrative and growing online banking marketplace. The company had rolled out an online tool for smaller customers last year, which will be cobbled together with the E*Trade system. Clearly, CEO James Gorman aims to take on Schwab and Fidelity by making this move, but will it work? As could be expected, shares of E*Trade spiked nearly 28% immediately after the announcement, but they proceeded to fall about ten percent from the peak as investors began to digest the news. As for the acquirer, shares of MS were off about 6% in the two days following the release. Many larger shareholders were clearly underwhelmed by the move, especially with E*Trade retaining its name. Time will tell, but with the advent of fintech, it did feel as though Morgan Stanley needed to make a bold move. This leaves Goldman Sachs (GS) on the big banking side, and Interactive Brokers (IBKR) as the last major online discount brokerage not going through some type of recent or planned merger. Interestingly, it appears that management teams at both of these companies considered their own play for E*Trade, with both deciding against a move. We love Interactive's fiery founder and CEO, Hungarian-born Thomas Peterffy, and would like to see that company remain independent—and profitable.
Interactive Media & Services
Groupon, dropping 42% in one day alone, becomes a shell of its former self. Companies have personalities, just like people. Some we love, some we loathe, and some are just...meh. For us, Groupon (GRPN $2-$2-$4) has remained in the second category pretty much ever since it went public. The company (meaning top executives) took some actions early on that made us question everything about the firm. Needless to say, we have never owned the discount "middleman." And that has been a good thing. Once a $5 billion company selling for $26 per share, GRPN now has a market cap of $1 billion and is going for $1.78. The final red flag for investors seemed to come when management telegraphed it would be looking to do a reverse split—almost always a sign of desperation. That is pure financial engineering and window dressing, designed to make a potential disaster-in-the-making look like a more attractive option for investment dollars. (Plus, are you really going to attract more investors with a $4 stock as opposed to a $2 stock?) Yet another red flag was raised this week when Groupon announced it would be exiting the physical goods space altogether, focusing on "local experiences." Stating that the physical goods space was saturated, it saw a $1 trillion market for these experiences. That enormous number may hold true, but who knows what microscopic fraction of the $1 trillion will involve someone using Groupon? And, even if they do, the company receives just a tiny percentage of that amount. As for what really matters, the numbers: Groupon's revenues fell 23% YoY in the most recent quarter. Yikes. There is a lot more I would like to say about this company, but better judgment says to leave it at this: avoid the stock like the plague.
eCommerce
Fiverr International pops over 7% on FY2020 forecast, smaller losses than expected. Fiverr International LTD (FVRR $17-$30-$44) is to the digital services world what Amazon (AMZN) is to the physical products world. The company is a digital marketplace, acting as the conduit between professionals selling their services and customers who are looking for those services. Shares of FVRR, which just began trading last summer, jumped over 7% after the company reported guidance in excess of what the Street was looking for, and after announcing quarterly losses which were smaller than expected. Fiverr said it expects revenues of around $140 million in FY2020—versus the average analyst forecast of $135 million—and reported losses of $0.23 per share versus an $0.84 per share loss in the same quarter last year. Quarterly revenues rose from $20 million a year ago to $30 million this past quarter. We have used Fiverr and thoroughly enjoyed the experience. An excellent array of services at good prices and with plenty of competition to choose from within the platform. Since going public, quarterly YoY revenue growth has been: 42%, 41%, and 42%, chronologically. Not bad. Definitely a higher-risk proposition, but worth a look for the higher-beta portion of a portfolio.
Food Products
Buffet's Kraft-Heinz dealmaking blunder continues to go south. Sour grapes? Absolutely. We used to love trading Kraft (formerly KRFT) before Warren Buffet's financial engineering forced the company into the arms of Brazil's 3G, which owned the floundering Heinz (now KHC $25-$27-$49). Just like we used to love owning Burlington Northern Santa Fe (formerly BNI) before Buffet gobbled the company up because he "liked playing with toy railroads as a kid." So forgive us for having a little schadenfreude with respect to the current state of Kraft-Heinz since the forced marriage. Shares of the food products company are now down 72% in the past three years, despite (or aided by) the draconian cost-cutting and employee-slashing tactics that 3G is so well known for. Now comes word that the company's debt has lost its coveted investment-grade status, meaning it is now in junk bond territory—which can lead to a host of new financial troubles for the firm. The company is trying to buy its way out of dire straits through even more acquisitions, but it was forced to end its bid for both Unilever and Pinnacle Foods as of late. With higher input costs and ineffective leadership, steer clear. Sadly, the company owns some iconic lines, like Oscar Meyer and Kraft cheese (obviously). These lines were doing just fine until the Buffet-sponsored takeover. Sad.
Space Sciences & Exploration
Virgin Galactic's meteoric rise says more about investors' thirst for exciting options than it does about Branson's company. It is exciting, it is cutting edge, it is science fiction come to life, and it is...ridiculously overpriced. Sir Richard Branson's space tourism company, Virgin Galactic (SPCE $7-$30-$29) didn't shoot out of the gate; it kind of limped out of the gate. After going public last year, its stock price floated around $10 per share before abruptly falling to $7.25 last November—just three months ago. All of that changed around 05 Dec, when the company began its crazy ride from $7.25 to $29.70 this week. So, what changed? Actually, really not much at all. Yet another piece of evidence that efficient market theory is bunk, the only real catalyst for the rise was Morgan Stanley initiating coverage on the firm with a Buy rating and a $22/share price target. The analyst compared the company's risk/reward profile to a biotech firm, but that is pretty flimsy. After all, a biotech can hit it big with a blockbuster and be in the black virtually overnight. Virgin Galactic only has so much capacity in its six-person Unity spacecraft. Even at $250k per flight, it would need a fleet of spacecraft launching daily to justify the stock price. More than a statement about the firm, investors are merely showing their desire for stocks in this exciting industry. We are waiting for Elon Musk's SpaceX to go public, but don't see that happening anytime soon. Space travel is going to be a multi-trillion dollar industry in due time. In the meantime, we suggest investors look for small- and mid-cap support companies which supply the high-flying names with parts and components.
A subtle specter of the late 1990s is beginning to manifest. Back in 1999, when I was a broker at a tiny Edward Jones office, I began to notice an interesting trend. An increasing number of prospective clients began calling or dropping by the office with an intense interest in the stock market. At first, I patted myself on the back, confident that all of my hard work was finally paying off. Nearly all of the questions, however, seemed to revolve around pie-in-the-sky companies which had never turned a profit. Companies like Infospace, Pets.com, Global Crossing, and AT&T spinoff Lucent—with no earnings but a $250 billion market cap! Within three years, the index all of these companies called home—the NASDAQ—had lost 78% of its value. No, it is not 1999, but there is a sudden movement afoot that reminds us a lot of that pre-bubble-burst year. Through apps being offered by companies like Betterment, Robinhood, and Stash, traders (we can't call them investors) are able to buy fractional shares. Want to buy into Amazon (AMZN), but only have $10 to spend? No problem! Just buy 1/200th of a share! Heck, don't have $10 to spend? You can "invest" on Robinhood with just $1. Want to venture some guesses as to the most-bought stocks on Robinhood? If you are thinking of blue chips like Union Pacific, McDonald's, and General Mills, forget it. Some of the most hotly-traded stocks include: Cronos (marijuana), GoPro (barely turns a profit but hey, selling for under $4), Aurora Cannabis, and Fitbit (last profit, 2015). In other words, they are playing the equity version of Candy Crush Saga on their iPhones. I remember how confident those prospects were back in 1999. If only they knew what was waiting for them around the corner. Again, this is not 1999, and we feel relatively confident with where the economy and the markets are sitting right now. However, fundamentals still matter. Ask 99 out of 100 Robinhood traders what the PE ratio is for the Aurora Cannabis stock they just bought, and they wouldn't have a clue. (Trick question: a company has to have earnings to register a PE ratio).
Sovereign Debt & Global Fixed Income
The 30-year Treasury just hit the lowest yield in its history. How bad is it for fixed income investors? Consider this: the longer you go out on the maturity ladder, the more interest rate risk you are taking on, meaning you will be rewarded for that risk. Right now, the US government will pay you a whopping 1.9% to take on the interest rate risk of buying a 30-year Treasury. In fact, the long bond hit a historic low yield intraday of 1.88% on Friday. Madness. For those living on the income from their bonds, what choice do they have but to take on more risk and move a larger percentage of their portfolios into dividend-paying stocks? While that condition is helping to prop up fat dividend payers, it also means that many older Americans with a low risk tolerance are probably taking on more risk than they should within their portfolios—and that condition is unlikely to change anytime soon. Of course, if interest rates do move up, the government will be forced to pay even more to service the country's $23 trillion debt load. Incredibly, yields in the US are some of the highest in the developed world. As we say, utter madness. This global debt party absolutely will bust one of these days, and it will probably put the tech bubble of 2000-2002 and the banking crisis of 2007-2009 to shame. Sovereign irresponsibility is at an all-time high.
2020.02.21 Dropbox DBX aims for profitability by the end of 2020; stock up 23% post-earnings
2020.02.20 L Brands LB confirms Victoria's Secret will go public, Sycamore Partners buying for $1.1B
2020.02.20 Penn member Viacom/CBS VIACA plunges 14% after first post-merger earnings report: missed on top and bottom; PE of 4?!
2020.02.20...DPZ Domino's Pizza strong beat, shares up 25% on day; earnings, revenue beat; CEO calls aggregators "circling firing squad"
2020.02.20...Gold is negatively correlated to the US dollar; don't let their recent correlation fool you
Capital Markets
Morgan Stanley to buy E*Trade in all-stock deal valued at $13 billion. Just three months after the major announcement that discount brokerage firm Charles Schwab (SCHW) would buy TD Ameritrade (AMTD) for $26 billion, Morgan Stanley (MS $39-$52-$58) decided it had better get in the game—the $83 billion financial services giant will buy online brokerage firm E*Trade (ETFC $35-$53-$57) for $13 billion in an all-stock deal. With the acquisition, MS will pick up around five million retail customers, over $350 million in new assets, and—most importantly—get in the lucrative and growing online banking marketplace. The company had rolled out an online tool for smaller customers last year, which will be cobbled together with the E*Trade system. Clearly, CEO James Gorman aims to take on Schwab and Fidelity by making this move, but will it work? As could be expected, shares of E*Trade spiked nearly 28% immediately after the announcement, but they proceeded to fall about ten percent from the peak as investors began to digest the news. As for the acquirer, shares of MS were off about 6% in the two days following the release. Many larger shareholders were clearly underwhelmed by the move, especially with E*Trade retaining its name. Time will tell, but with the advent of fintech, it did feel as though Morgan Stanley needed to make a bold move. This leaves Goldman Sachs (GS) on the big banking side, and Interactive Brokers (IBKR) as the last major online discount brokerage not going through some type of recent or planned merger. Interestingly, it appears that management teams at both of these companies considered their own play for E*Trade, with both deciding against a move. We love Interactive's fiery founder and CEO, Hungarian-born Thomas Peterffy, and would like to see that company remain independent—and profitable.
Interactive Media & Services
Groupon, dropping 42% in one day alone, becomes a shell of its former self. Companies have personalities, just like people. Some we love, some we loathe, and some are just...meh. For us, Groupon (GRPN $2-$2-$4) has remained in the second category pretty much ever since it went public. The company (meaning top executives) took some actions early on that made us question everything about the firm. Needless to say, we have never owned the discount "middleman." And that has been a good thing. Once a $5 billion company selling for $26 per share, GRPN now has a market cap of $1 billion and is going for $1.78. The final red flag for investors seemed to come when management telegraphed it would be looking to do a reverse split—almost always a sign of desperation. That is pure financial engineering and window dressing, designed to make a potential disaster-in-the-making look like a more attractive option for investment dollars. (Plus, are you really going to attract more investors with a $4 stock as opposed to a $2 stock?) Yet another red flag was raised this week when Groupon announced it would be exiting the physical goods space altogether, focusing on "local experiences." Stating that the physical goods space was saturated, it saw a $1 trillion market for these experiences. That enormous number may hold true, but who knows what microscopic fraction of the $1 trillion will involve someone using Groupon? And, even if they do, the company receives just a tiny percentage of that amount. As for what really matters, the numbers: Groupon's revenues fell 23% YoY in the most recent quarter. Yikes. There is a lot more I would like to say about this company, but better judgment says to leave it at this: avoid the stock like the plague.
eCommerce
Fiverr International pops over 7% on FY2020 forecast, smaller losses than expected. Fiverr International LTD (FVRR $17-$30-$44) is to the digital services world what Amazon (AMZN) is to the physical products world. The company is a digital marketplace, acting as the conduit between professionals selling their services and customers who are looking for those services. Shares of FVRR, which just began trading last summer, jumped over 7% after the company reported guidance in excess of what the Street was looking for, and after announcing quarterly losses which were smaller than expected. Fiverr said it expects revenues of around $140 million in FY2020—versus the average analyst forecast of $135 million—and reported losses of $0.23 per share versus an $0.84 per share loss in the same quarter last year. Quarterly revenues rose from $20 million a year ago to $30 million this past quarter. We have used Fiverr and thoroughly enjoyed the experience. An excellent array of services at good prices and with plenty of competition to choose from within the platform. Since going public, quarterly YoY revenue growth has been: 42%, 41%, and 42%, chronologically. Not bad. Definitely a higher-risk proposition, but worth a look for the higher-beta portion of a portfolio.
Food Products
Buffet's Kraft-Heinz dealmaking blunder continues to go south. Sour grapes? Absolutely. We used to love trading Kraft (formerly KRFT) before Warren Buffet's financial engineering forced the company into the arms of Brazil's 3G, which owned the floundering Heinz (now KHC $25-$27-$49). Just like we used to love owning Burlington Northern Santa Fe (formerly BNI) before Buffet gobbled the company up because he "liked playing with toy railroads as a kid." So forgive us for having a little schadenfreude with respect to the current state of Kraft-Heinz since the forced marriage. Shares of the food products company are now down 72% in the past three years, despite (or aided by) the draconian cost-cutting and employee-slashing tactics that 3G is so well known for. Now comes word that the company's debt has lost its coveted investment-grade status, meaning it is now in junk bond territory—which can lead to a host of new financial troubles for the firm. The company is trying to buy its way out of dire straits through even more acquisitions, but it was forced to end its bid for both Unilever and Pinnacle Foods as of late. With higher input costs and ineffective leadership, steer clear. Sadly, the company owns some iconic lines, like Oscar Meyer and Kraft cheese (obviously). These lines were doing just fine until the Buffet-sponsored takeover. Sad.
Space Sciences & Exploration
Virgin Galactic's meteoric rise says more about investors' thirst for exciting options than it does about Branson's company. It is exciting, it is cutting edge, it is science fiction come to life, and it is...ridiculously overpriced. Sir Richard Branson's space tourism company, Virgin Galactic (SPCE $7-$30-$29) didn't shoot out of the gate; it kind of limped out of the gate. After going public last year, its stock price floated around $10 per share before abruptly falling to $7.25 last November—just three months ago. All of that changed around 05 Dec, when the company began its crazy ride from $7.25 to $29.70 this week. So, what changed? Actually, really not much at all. Yet another piece of evidence that efficient market theory is bunk, the only real catalyst for the rise was Morgan Stanley initiating coverage on the firm with a Buy rating and a $22/share price target. The analyst compared the company's risk/reward profile to a biotech firm, but that is pretty flimsy. After all, a biotech can hit it big with a blockbuster and be in the black virtually overnight. Virgin Galactic only has so much capacity in its six-person Unity spacecraft. Even at $250k per flight, it would need a fleet of spacecraft launching daily to justify the stock price. More than a statement about the firm, investors are merely showing their desire for stocks in this exciting industry. We are waiting for Elon Musk's SpaceX to go public, but don't see that happening anytime soon. Space travel is going to be a multi-trillion dollar industry in due time. In the meantime, we suggest investors look for small- and mid-cap support companies which supply the high-flying names with parts and components.
Headlines for the Week of 09 Feb 2020—15 Feb 2020
Real Estate Services
Redfin, a company you've probably never heard of, just beat expectations and spiked over 18%. Quick, answer this question: What does Redfin do? Sort of sounds like Red Hat, which IBM just bought, so your first guess might be, "technology of some type." Partially right. Redfin (RDFN $15-$30-$26) is a tech-based real estate brokerage company. It is—to real estate—what fintech is to the financial services industry. For around a 1% listing fee, the company will deploy a host of technology and social media solutions, combined with a Redfin agent on the ground, to sell your home—or find you one to buy—while saving you "thousands of dollars" (according to the company). Investors have been buying into the hype, with shares of the $2.8 billion Zillow (ZG) competitor jumping 18% after posting a smaller loss than expected. With this week's bump, shares of Redfin have now gained 65% over the past year. The company, which has yet to turn a profit, brought in $233 million in revenues in Q4, losing $0.08 per share in the process. The Street was expecting a per share loss of 12 cents. This is a highly competitive industry, and $10 billion Zillow has a lot more firepower to deploy. Furthermore, traditional real estate companies are getting more savvy at deploying technology, either organic or third-party. We would steer clear of this current small-cap darling.
Retail REITs
Our favorite retail REIT, Simon Property Group, to buy Taubman Centers in a $3.6 billion deal. While everyone is predicting the end of the physical store, and certainly the big mall, the second-largest REIT in the country—and largest retail REIT—is aggressively pushing forward with its ambitious strategic plans. To that end, Simon Property Group (SPG $130-$141-$186) just announced it would be purchasing smaller competitor Taubman Centers (TCO $53) in a $3.6 billion deal. Here's what investors need to understand about retail REITs: it's all about quality and location. While as many as one-third of all big malls across America may close over the next ten years, the victims will overwhelmingly be Class B and Class C properties. The top-tier malls, the Class A variety, are the ones owned by Simon Property Group and Taubman. Let's take a look at the numbers. In Q4, Simon reported an average of $693 per square foot in sales. That number is impressive, but it pales in comparison to Taubman's $972 in sales per square foot in the same quarter. The combination will be powerful. Readers may recall that we highlighted Simon at $140 per share in our last report. In addition to its acquisition strategy and a massive plan (already underway) to create "experiences" at its malls, Simon is not afraid to pick up actual retailers: management announced last week that it would buy Forever 21 out of bankruptcy for a paltry $81 million. Who better than a first-rate landlord to turnaround a struggling retailer? When the Taubman deal is done, Simon will have a healthy capitalization rate of around 6.2%. We will be doing some renovating of our own within the REIT portion of our strategies. Look for Simon to replace another REIT which has had a strong run for us, but whose peak seems to be forming. Additionally, Simon's 6% dividend yield is about twice that of the one we look to jettison soon. Members will be kept up to date in the Trading Desk, while Penn Wealth Management* clients will have the trades automatically made within their accounts.
Telecom Services
The federal judge handling the Sprint/T-Mobile merger lawsuit has ruled in favor of the companies, pushing Sprint shares up 73% at Tuesday's open. Despite all of the naysayers predicting this merger would be shot down, here is what we said in December of 2019:
What is the federal judge telegraphing about the T-Mobile/Sprint lawsuit? (09 Dec 2019) The lawsuit was a colossal joke from the start. A group of thirteen (down from sixteen) state attorneys general, led by New York and California (which tells us everything we need to know), is suing to stop the Sprint (S $5-$5-$8)/T-Mobile (TMUS $60-$76-$85) merger on grounds that it will limit competition in the 5G arena, harming consumers. News flash for the political hack AGs: Sprint probably won't make it without the merger, so what will that do to the competitive landscape? For its part, the Department of Justice has already given the green light to the merger, which further points to the politics at the heart of the lawsuit. In the latest move, US District Judge Victor Marrero told both sides in the suit to skip their opening arguments and get on with calling their witnesses. This indicates to us that he has very little patience in the matter, which we believe bodes well for the telecom companies. It should be noted that, as part of the DoJ approval process, Sprint would have to divest itself of some assets to Dish Network (DISH) so that company would be able to build its own 5G network. We believe the judge recognizes this suit as the frivolous waste of taxpayer money that it is, and will ultimately rule for the merger. We can't wait to see the bloviating AGs rush to the microphones to screech about the injustice thrust upon the public by the judicial system. Maybe Al Sharpton will even show up with his bullhorn.
Energy Commodities
Everyone is bashing oil, and crude just fell below $50 per barrel. What a great time to buy oil. Crude oil fell below $50 per barrel on Monday, and we love it. Not only is gas sitting around $2 per gallon at our nearby Walmart, one of the two ETFs we use to go long crude, USO, is sitting near $10 per share. While we don't expect it to hit its old high of $117 (the ETF, that is), oil will not stay below $50 for the rest of this year—sadly. Yes, everyone is predicting the end of fossil fuels, right after they utter the politically-correct acronym ESG (seemingly every five minutes), but we have a long way to go before crude meets its demise. And yes, China is stinging economically from the coronavirus and domestic troubles, but there are plenty of forces that will assure crude doesn't go much lower. Seems like a good time to pick up some USO, enjoy the $2/gallon gas each fill-up, sit back, and wait. Odds are good you will be rewarded. Furthermore, if you have been listening to all of the ESG lemmings—many of whom are just uttering what they think others want to hear—you are probably underweight energy anyway. Let's play a game. You buy $10,000 worth of the First Trust Global Wind Energy ETF (FAN $15.23), an ESG darling, and I'll lay odds on $10,000 worth of USO at $10.43, and we'll check the balances in one year. I made myself a note for 11 Feb 2021 to report back. And for the record, I love Tesla, their gigafactories, and alternative energy, from solar to hydrogen. I am simply saying the pundits have gotten a little bit ahead of themselves.
IT: Cybersecurity
The US government charges four Chinese military members for the massive 2017 Equifax data breach. Back in the fall of 2017, we reported on the security breach at Equifax (EFX $106-$154-$157) that left around 150 million Americans' private data exposed. At the time, we didn't know who was directly behind the cyberattack, but we didn't have nice things to say about Equifax. As the hack was taking place, the company was busy lobbying congress to reduce its liability when consumers get hit in a security breach. We now have the missing piece of the puzzle, as Attorney General William Barr announced the indictment of four military officers (we assume officers, rank unknown) stationed in the People's Liberation Army 54th Research Institute. We figured it would ultimately come back to North Korea, China, or Iran, and we must assume that all three countries will continue trying to disrupt American commerce to the greatest possible degree. What was stolen in the 2017 hack? How about social security numbers, driver's license numbers, birthdays, and addresses. Essentially, everything needed to ruin someone's financial life. The CEO of Equifax, Richard Smith, was ultimately fired, but does anyone feel safer? Obviously, China will never extradite the Chinese officers—who were working under the direction of the Communist Party of China—to the US, nor will they probably even admit to the hack, but at least the truth is out. We completely supported the administration's tough negotiations with China over their unfair trade practices, and the phase 1 deal is a good first step. However, China will remain an adversary of the US until the communists are no longer in charge. That will be awhile. In the meantime, excellent job by the Justice Department in identifying the state-sponsored criminals. Everyone should be using a strong identity theft protection program—but we would advise against the one Equifax offers, for obvious reasons.
Global Strategy: Trade
Making good on part of the phase one of trade deal, China halves tariffs on $75 billion worth of US products. Upholding its end of the bargain, China has announced that it will cut in half the tariffs imposed on $75 billion worth of US goods coming into the country—yet another de-escalation of the tensions caused by the trade war, and more welcome news for US manufacturers and investors. Over 1,700 goods are on the affected list, to include agricultural products, oil, and autos. While skeptics still question whether or nor the Chinese will live up to their promise to buy an additional $200 billion worth of US goods over the next two years, this reduction in tariffs is certainly a good sign. While the coronavirus is having a real impact on the Chinese economy, keep in mind that nearly half of that country's pigs have either died from African swine fever or been killed to staunch the outbreak. That sad tragedy means the country must import massive amounts of pork, much of which coming from the US. China has its hands full right now, fighting the coronavirus and political turmoil in Hong Kong and Taiwan. While the virus is a human tragedy, these internal challenges will keep them focused on limiting internal damage, meaning less time to saber-rattle against the US. We fully expect the $200 billion worth of US goods to be purchased, which will certainly help US GDP. Additionally, the USMCA will take effect 90 days after Canada ratifies the treaty, which will provide another shot in the arm to the US economy.
Redfin, a company you've probably never heard of, just beat expectations and spiked over 18%. Quick, answer this question: What does Redfin do? Sort of sounds like Red Hat, which IBM just bought, so your first guess might be, "technology of some type." Partially right. Redfin (RDFN $15-$30-$26) is a tech-based real estate brokerage company. It is—to real estate—what fintech is to the financial services industry. For around a 1% listing fee, the company will deploy a host of technology and social media solutions, combined with a Redfin agent on the ground, to sell your home—or find you one to buy—while saving you "thousands of dollars" (according to the company). Investors have been buying into the hype, with shares of the $2.8 billion Zillow (ZG) competitor jumping 18% after posting a smaller loss than expected. With this week's bump, shares of Redfin have now gained 65% over the past year. The company, which has yet to turn a profit, brought in $233 million in revenues in Q4, losing $0.08 per share in the process. The Street was expecting a per share loss of 12 cents. This is a highly competitive industry, and $10 billion Zillow has a lot more firepower to deploy. Furthermore, traditional real estate companies are getting more savvy at deploying technology, either organic or third-party. We would steer clear of this current small-cap darling.
Retail REITs
Our favorite retail REIT, Simon Property Group, to buy Taubman Centers in a $3.6 billion deal. While everyone is predicting the end of the physical store, and certainly the big mall, the second-largest REIT in the country—and largest retail REIT—is aggressively pushing forward with its ambitious strategic plans. To that end, Simon Property Group (SPG $130-$141-$186) just announced it would be purchasing smaller competitor Taubman Centers (TCO $53) in a $3.6 billion deal. Here's what investors need to understand about retail REITs: it's all about quality and location. While as many as one-third of all big malls across America may close over the next ten years, the victims will overwhelmingly be Class B and Class C properties. The top-tier malls, the Class A variety, are the ones owned by Simon Property Group and Taubman. Let's take a look at the numbers. In Q4, Simon reported an average of $693 per square foot in sales. That number is impressive, but it pales in comparison to Taubman's $972 in sales per square foot in the same quarter. The combination will be powerful. Readers may recall that we highlighted Simon at $140 per share in our last report. In addition to its acquisition strategy and a massive plan (already underway) to create "experiences" at its malls, Simon is not afraid to pick up actual retailers: management announced last week that it would buy Forever 21 out of bankruptcy for a paltry $81 million. Who better than a first-rate landlord to turnaround a struggling retailer? When the Taubman deal is done, Simon will have a healthy capitalization rate of around 6.2%. We will be doing some renovating of our own within the REIT portion of our strategies. Look for Simon to replace another REIT which has had a strong run for us, but whose peak seems to be forming. Additionally, Simon's 6% dividend yield is about twice that of the one we look to jettison soon. Members will be kept up to date in the Trading Desk, while Penn Wealth Management* clients will have the trades automatically made within their accounts.
Telecom Services
The federal judge handling the Sprint/T-Mobile merger lawsuit has ruled in favor of the companies, pushing Sprint shares up 73% at Tuesday's open. Despite all of the naysayers predicting this merger would be shot down, here is what we said in December of 2019:
What is the federal judge telegraphing about the T-Mobile/Sprint lawsuit? (09 Dec 2019) The lawsuit was a colossal joke from the start. A group of thirteen (down from sixteen) state attorneys general, led by New York and California (which tells us everything we need to know), is suing to stop the Sprint (S $5-$5-$8)/T-Mobile (TMUS $60-$76-$85) merger on grounds that it will limit competition in the 5G arena, harming consumers. News flash for the political hack AGs: Sprint probably won't make it without the merger, so what will that do to the competitive landscape? For its part, the Department of Justice has already given the green light to the merger, which further points to the politics at the heart of the lawsuit. In the latest move, US District Judge Victor Marrero told both sides in the suit to skip their opening arguments and get on with calling their witnesses. This indicates to us that he has very little patience in the matter, which we believe bodes well for the telecom companies. It should be noted that, as part of the DoJ approval process, Sprint would have to divest itself of some assets to Dish Network (DISH) so that company would be able to build its own 5G network. We believe the judge recognizes this suit as the frivolous waste of taxpayer money that it is, and will ultimately rule for the merger. We can't wait to see the bloviating AGs rush to the microphones to screech about the injustice thrust upon the public by the judicial system. Maybe Al Sharpton will even show up with his bullhorn.
Energy Commodities
Everyone is bashing oil, and crude just fell below $50 per barrel. What a great time to buy oil. Crude oil fell below $50 per barrel on Monday, and we love it. Not only is gas sitting around $2 per gallon at our nearby Walmart, one of the two ETFs we use to go long crude, USO, is sitting near $10 per share. While we don't expect it to hit its old high of $117 (the ETF, that is), oil will not stay below $50 for the rest of this year—sadly. Yes, everyone is predicting the end of fossil fuels, right after they utter the politically-correct acronym ESG (seemingly every five minutes), but we have a long way to go before crude meets its demise. And yes, China is stinging economically from the coronavirus and domestic troubles, but there are plenty of forces that will assure crude doesn't go much lower. Seems like a good time to pick up some USO, enjoy the $2/gallon gas each fill-up, sit back, and wait. Odds are good you will be rewarded. Furthermore, if you have been listening to all of the ESG lemmings—many of whom are just uttering what they think others want to hear—you are probably underweight energy anyway. Let's play a game. You buy $10,000 worth of the First Trust Global Wind Energy ETF (FAN $15.23), an ESG darling, and I'll lay odds on $10,000 worth of USO at $10.43, and we'll check the balances in one year. I made myself a note for 11 Feb 2021 to report back. And for the record, I love Tesla, their gigafactories, and alternative energy, from solar to hydrogen. I am simply saying the pundits have gotten a little bit ahead of themselves.
IT: Cybersecurity
The US government charges four Chinese military members for the massive 2017 Equifax data breach. Back in the fall of 2017, we reported on the security breach at Equifax (EFX $106-$154-$157) that left around 150 million Americans' private data exposed. At the time, we didn't know who was directly behind the cyberattack, but we didn't have nice things to say about Equifax. As the hack was taking place, the company was busy lobbying congress to reduce its liability when consumers get hit in a security breach. We now have the missing piece of the puzzle, as Attorney General William Barr announced the indictment of four military officers (we assume officers, rank unknown) stationed in the People's Liberation Army 54th Research Institute. We figured it would ultimately come back to North Korea, China, or Iran, and we must assume that all three countries will continue trying to disrupt American commerce to the greatest possible degree. What was stolen in the 2017 hack? How about social security numbers, driver's license numbers, birthdays, and addresses. Essentially, everything needed to ruin someone's financial life. The CEO of Equifax, Richard Smith, was ultimately fired, but does anyone feel safer? Obviously, China will never extradite the Chinese officers—who were working under the direction of the Communist Party of China—to the US, nor will they probably even admit to the hack, but at least the truth is out. We completely supported the administration's tough negotiations with China over their unfair trade practices, and the phase 1 deal is a good first step. However, China will remain an adversary of the US until the communists are no longer in charge. That will be awhile. In the meantime, excellent job by the Justice Department in identifying the state-sponsored criminals. Everyone should be using a strong identity theft protection program—but we would advise against the one Equifax offers, for obvious reasons.
Global Strategy: Trade
Making good on part of the phase one of trade deal, China halves tariffs on $75 billion worth of US products. Upholding its end of the bargain, China has announced that it will cut in half the tariffs imposed on $75 billion worth of US goods coming into the country—yet another de-escalation of the tensions caused by the trade war, and more welcome news for US manufacturers and investors. Over 1,700 goods are on the affected list, to include agricultural products, oil, and autos. While skeptics still question whether or nor the Chinese will live up to their promise to buy an additional $200 billion worth of US goods over the next two years, this reduction in tariffs is certainly a good sign. While the coronavirus is having a real impact on the Chinese economy, keep in mind that nearly half of that country's pigs have either died from African swine fever or been killed to staunch the outbreak. That sad tragedy means the country must import massive amounts of pork, much of which coming from the US. China has its hands full right now, fighting the coronavirus and political turmoil in Hong Kong and Taiwan. While the virus is a human tragedy, these internal challenges will keep them focused on limiting internal damage, meaning less time to saber-rattle against the US. We fully expect the $200 billion worth of US goods to be purchased, which will certainly help US GDP. Additionally, the USMCA will take effect 90 days after Canada ratifies the treaty, which will provide another shot in the arm to the US economy.
Headlines for the Week of 02 Feb 2020—08 Feb 2020
Economics: Work & Pay
Another month, another excellent jobs report. Employers in the US added a whopping 225,000 new jobs in January, far exceeding what was predicted, and 183,000 formerly-discouraged workers moved back in. That was the upshot of a simply excellent jobs report, which was released by the Labor Department on Friday. While the unemployment rate did tick up one notch, from 3.5% to 3.6%, that was a direct result of so many Americans piling back into the workforce. The three-month rolling average rose to 212,000 new jobs created per month. The most impressive new-hires figure came from the health care and education sectors, which added 72,000 new workers. Construction and the leisure/hospitality sectors also came in hot, adding 44,000 and 36,000 new jobs, respectively. Wages also grew more than expected, hitting a 3.1% year-over-year pace. Despite the strong jobs report, the Fed is unlikely to raise rates anytime soon. Inflation remains below their 2% target rate, and that seems to be their central focus right now. Some have been predicting a rate cut, but it would be hard to justify that move.
Multiline Retail
Macy's has a turnaround plan. It looks a lot like their last turnaround plan. We are rooting for Macy's (M $14-$17-$26) to succeed, but we fear they just don't get it. For all of management's big talk, why is the level of service so bad when we go into one of their stores? With the C-suite focusing on code-named strategic turnaround plans, they apparently don't have time to tackle the details, like sending secret shoppers into the stores to gauge what the customer—their only source of revenue—is experiencing. The latest grand strategy is code-named Polaris, which consists of a three-year plan to focus on the healthy parts of the business, address the unhealthy parts, and explore new revenue streams. The first two planks are business school gobbledygook; the third makes sense. In CEO Jeff Gennette's press release on Operation Polaris, which seems eerily similar to 2017's North Star strategy, one particular line caught our attention: "...we have shown we can grow the top-line; however, we have significant work to do to improve the bottom-line." Has he seen a graph of the company's revenues? Hardly proof they know how to grow the top line. Furthermore, "improve the bottom-line" is management-speak for close locations and cut jobs. And, in fact, Macy's plans to shutter 125 locations and can 2,000 employees. We're sure Jeff Gennette is a fine manager, but managers manage declines; leaders lead true turnarounds. Unfortunately, we don't see any real leadership at the firm. Perhaps the best bit of news Macy's received from their Q4 earnings release was the fact that same-store sales only fell 0.7% year-over-year. Hardly something to celebrate, but it did push the company's shares up 5%. We would love to invest in Macy's again—after all, it still has a tiny multiple of 5.45 and an enormous dividend yield of 8.91%, but we just don't believe management has a full grasp on reality.
Household & Personal Products
Casper soars out of the gate, then floats back down to earth on first trading day. It is pretty remarkable what has happened to the tired old mattress industry over the past five years or so, but to say it has been reinvigorated by a number of new entrants would be an understatement. From Purple to Leesa to Sleep Number to Casper, Americans suddenly have a lot of homework to do before plopping down big bucks on a new mattress. The last company mentioned, Casper (CSPR $14), just made its debut as a publicly-traded company this week, but scorched IPO investors seemed to tread lightly after the likes of SmileDirectClub (SDC), Lyft (LYFT), and the mission-aborted WeWork debacle. Initially priced in the $17-$18 range, the underwriters ended up offering 8.35 million shares of the mattress and bedding supplies company at $12. Out of the gate, that appeared to be a smart strategy, as shares were up 30% within a matter of minutes. As the day wore on, however, doubts seemed to creep back in and the stock finished its first trading day at $13.60. While it faces stiff competition, Casper was one of the first "new breed" mattress companies to come along, launching in 2014. Additionally, Target (TGT) has invested $80 million in the firm. Counter that, however, with reports that the giant retailer was prepared to plop down $1 billion to buy the firm outright back in 2017. They dodged a bullet on that one, as Casper's current valuation isn't close to that figure. In addition to its main direct-to-consumer online presence, Casper products are also available from retailers such as Target (obviously), Costco, and Amazon. The best news for the firm, probably, is the fact that they didn't come close to getting the IPO price they wanted. That would have made the downward trajectory look a lot worse. Maybe something good actually came out of the Class of 2019's worst unicorns. Of all the new mattress firms, Casper is probably the strongest. That being said, there is virtually no barrier to entry, so expect the competitive landscape to only become more bloody. We wouldn't touch the shares.
Consumer Electronics
Penn holding iRobot jumps nearly 20% after earnings beat. Last quarter we added consumer robotics company iRobot (IRBT $42-$58-$133) to the Penn New Frontier Fund at $48.80 per share. Not only does the US-based maker of such devices as the Roomba Robot Vacuum and Braava Robot Mop have strong and growing sales, it also has a number of exciting new robotic products coming online soon or in the works. We had several fundamental reasons for buying the firm, but one of the top was the brilliant CEO running the company, Colin Angle. The polar opposite of a slick marketing guy, Angle is the MIT-trained technologist behind these little devices; well, him and his team of engineers. With a low multiple and very low debt load, we felt investors were missing this company's unique story. Many woke up to that story after the Q4 earnings report was released. Revenue was up 11% Y/Y, to $427 million, and earnings came in at $0.70 per share—both metrics beating estimates. The earnings figure was nearly double what the Street was projecting. Shares ended the day up nearly 20%, to $58. We will be highlighting iRobot in the upcoming Robotics issue of The Penn Wealth Report.
Technology Hardware & Equipment
Apple sold nearly 50% more watches last year than the entire Swiss watch industry. According to industry research firm Strategy Analytics, Apple (AAPL $168-$321-$328) shipped 31 million units of its Apple Watch in 2019. That is a staggering number, especially when compared to the fact that the entire Swiss watch industry, which includes the likes of Rolex, Swatch, Breitling, TAG Heuer, and Cartier, sold only 21 million units. That means one American company sold roughly 50% more watches than the country historically known for making timepieces. Considering that the Apple Watch was just launched five years ago, this should serve as a reminder—especially for investors—of just how quickly an industry can be disrupted by new technologies, products, and services. While the Swiss watchmakers are trying to catch up by introducing their own "smart" watches, that effort has been floundering. What they fail to understand is that the buyers of connected devices are buying into the ecosystem story, and nobody can come close to Apple's iOS ecosystem. We used to trade Swatch (SWGAY) on a regular basis. In the five years since the Apple Watch launch, that company has lost 40% of its market cap. There is no such thing as autopilot when it comes to investing; diligence is, and must always remain, the key theme when it comes to making money and protecting portfolios.
e-Commerce
Why would the parent company of the New York Stock Exchange want to buy Internet retailer eBay? Intercontinental Exchange (ICE $72-$96-$102), owner of the New York Stock Exchange, has made a seemingly bizarre offer: it wants to buy global online marketplace eBay (EBAY $34-$37-$42) in a deal that would ultimately be valued well above the company's $30 billion market cap. While there is no indication that eBay has yet to engage with the exchange, news of the offer sent its shares up by over 8%. If you are scratching your head over this one, you are not alone: ICE closed the day down over 7% on the news. Technically, both companies are "exchanges" in the broad sense, and it would even be fair to call both auction houses—pitting buyer versus seller and keeping a cut of the spread. but it is hard to imagine how eBay fits in the exchange's strategic plan. Management at the Atlanta-based firm didn't have a lot to say, other than to confirm the offer and that the company has a "track record of creating shareholder value, both through organic growth and acquisitions...." As for creating shareholder value, it is certainly fair to say that eBay is ripe for a new strategy, after losing immense ground to the likes of Amazon (AMZN). Until the spring of 2007, in fact, eBay was the larger online retailer of the two. We hope the deal goes through—what do eBay shareholders have to lose? If a deal happens, it will be interesting to see how ICE's application of new technologies work in revamping one of the first online marketplaces. It may become a template for other companies—especially in the fintech arena—to emulate.
Beverages & Tobacco
After taking a $4.1 billion write-down on disastrous Juul investment, is there any value to be found in Altria shares? It was supposed to be yet another tactical move to diversify away from its much-maligned tobacco business: pay $12.8 billion for a 35% stake in e-cigarette phenom Juul. Instead, this move has been nothing short of a nightmare for the leading US cigarette and smokeless tobacco company, Altria (MO $39-$47-$58). After taking yet another write-down on its Juul investment ($4.1 billion), its 35% stake is now worth just about $4 billion. With both their cigarette and e-cig businesses under relentless attack by the government and anti-smoking forces, why would an investor want to buy in right now? Actually, there are a number of factors that make MO look attractive at current prices. First is the company's fat 7% dividend yield, which looks to be safe. Secondly, it still appears the company might reunite with its former Philip Morris International (PM) unit which became a separate company back in 2008. Under withering assault, it just makes sense for these allied forces to combine. A third reason to look at MO shares has to do with their successful diversification attempts. The firm now owns a 10.2% stake in Anheuser-Busch InBev (BUD), and has been increasing its stake in cannabis companies. Finally, there is a lot of promise around a new "heat-don't-burn" cigarette technology known as IQOS. This system heats the tobacco to 650°F without any actual combustion taking place. With shares down following news of the Juul charge, yield-hungry investors might want to take a nibble at $47 per share. While we don't own either MO or PM in any of the Penn Strategies, we would place a fair value on Altria shares at $55.
IT Services
CEO Ginni Rometty was one of the reasons we owned IBM, so what does her departure mean for shares of Big Blue? We have often pointed to Virginia "Ginni" Rometty as one of the best CEOs in the country. While shares of pioneering tech company IBM (IBM $127-$144-$153) have struggled under her tenure, she is the one responsible for taking the helm and steering the 109-year-old firm in a different direction—away from its legacy hardware business and into the lucrative world of cloud computing. That is why we immediately got concerned for our Penn Global Leaders Club holding when it was announced that she would be leaving the firm in April. Our concerns were assuaged when we saw who would be taking over: Arvind Krishna is the wonkish Senior Vice President for Cloud and Cognitive Software at the firm, and the principal architect behind IBM's acquisition of Red Hat, a leading cloud and open-source software player. While "wonkish" is not typically an adjective we want to hear associated with a chief executive, that moniker has also been applied to Satya Nadella, the adroit leader responsible for Microsoft's (MSFT) big turnaround. The two men appear to be eerily similar. Both are deep tech gurus with strong engineering backgrounds (Krishna has a PhD in electrical and computer engineering), and both ran the cloud computing business at their respective companies before being elevated to the top spot. The icing on the cake? Red Hat's highly-skilled CEO, Jim Whitehurst, will be Krishna's second-in-command, serving as IBM's new president. Krishna brings a brilliant tech mind to the table, while Whitehurst, who attended the London School of Business and carries an MBA from Harvard, brings the strong management background. Both are scheduled to take on their new roles on the 6th of April. In addition to IBM's quite low (for a tech company) multiple of 14, the attractive 4.5% dividend is a nice bonus for yield-starved investors. It is too early to tell whether or not Krishna will be another Nadella, but we like the odds.
Another month, another excellent jobs report. Employers in the US added a whopping 225,000 new jobs in January, far exceeding what was predicted, and 183,000 formerly-discouraged workers moved back in. That was the upshot of a simply excellent jobs report, which was released by the Labor Department on Friday. While the unemployment rate did tick up one notch, from 3.5% to 3.6%, that was a direct result of so many Americans piling back into the workforce. The three-month rolling average rose to 212,000 new jobs created per month. The most impressive new-hires figure came from the health care and education sectors, which added 72,000 new workers. Construction and the leisure/hospitality sectors also came in hot, adding 44,000 and 36,000 new jobs, respectively. Wages also grew more than expected, hitting a 3.1% year-over-year pace. Despite the strong jobs report, the Fed is unlikely to raise rates anytime soon. Inflation remains below their 2% target rate, and that seems to be their central focus right now. Some have been predicting a rate cut, but it would be hard to justify that move.
Multiline Retail
Macy's has a turnaround plan. It looks a lot like their last turnaround plan. We are rooting for Macy's (M $14-$17-$26) to succeed, but we fear they just don't get it. For all of management's big talk, why is the level of service so bad when we go into one of their stores? With the C-suite focusing on code-named strategic turnaround plans, they apparently don't have time to tackle the details, like sending secret shoppers into the stores to gauge what the customer—their only source of revenue—is experiencing. The latest grand strategy is code-named Polaris, which consists of a three-year plan to focus on the healthy parts of the business, address the unhealthy parts, and explore new revenue streams. The first two planks are business school gobbledygook; the third makes sense. In CEO Jeff Gennette's press release on Operation Polaris, which seems eerily similar to 2017's North Star strategy, one particular line caught our attention: "...we have shown we can grow the top-line; however, we have significant work to do to improve the bottom-line." Has he seen a graph of the company's revenues? Hardly proof they know how to grow the top line. Furthermore, "improve the bottom-line" is management-speak for close locations and cut jobs. And, in fact, Macy's plans to shutter 125 locations and can 2,000 employees. We're sure Jeff Gennette is a fine manager, but managers manage declines; leaders lead true turnarounds. Unfortunately, we don't see any real leadership at the firm. Perhaps the best bit of news Macy's received from their Q4 earnings release was the fact that same-store sales only fell 0.7% year-over-year. Hardly something to celebrate, but it did push the company's shares up 5%. We would love to invest in Macy's again—after all, it still has a tiny multiple of 5.45 and an enormous dividend yield of 8.91%, but we just don't believe management has a full grasp on reality.
Household & Personal Products
Casper soars out of the gate, then floats back down to earth on first trading day. It is pretty remarkable what has happened to the tired old mattress industry over the past five years or so, but to say it has been reinvigorated by a number of new entrants would be an understatement. From Purple to Leesa to Sleep Number to Casper, Americans suddenly have a lot of homework to do before plopping down big bucks on a new mattress. The last company mentioned, Casper (CSPR $14), just made its debut as a publicly-traded company this week, but scorched IPO investors seemed to tread lightly after the likes of SmileDirectClub (SDC), Lyft (LYFT), and the mission-aborted WeWork debacle. Initially priced in the $17-$18 range, the underwriters ended up offering 8.35 million shares of the mattress and bedding supplies company at $12. Out of the gate, that appeared to be a smart strategy, as shares were up 30% within a matter of minutes. As the day wore on, however, doubts seemed to creep back in and the stock finished its first trading day at $13.60. While it faces stiff competition, Casper was one of the first "new breed" mattress companies to come along, launching in 2014. Additionally, Target (TGT) has invested $80 million in the firm. Counter that, however, with reports that the giant retailer was prepared to plop down $1 billion to buy the firm outright back in 2017. They dodged a bullet on that one, as Casper's current valuation isn't close to that figure. In addition to its main direct-to-consumer online presence, Casper products are also available from retailers such as Target (obviously), Costco, and Amazon. The best news for the firm, probably, is the fact that they didn't come close to getting the IPO price they wanted. That would have made the downward trajectory look a lot worse. Maybe something good actually came out of the Class of 2019's worst unicorns. Of all the new mattress firms, Casper is probably the strongest. That being said, there is virtually no barrier to entry, so expect the competitive landscape to only become more bloody. We wouldn't touch the shares.
Consumer Electronics
Penn holding iRobot jumps nearly 20% after earnings beat. Last quarter we added consumer robotics company iRobot (IRBT $42-$58-$133) to the Penn New Frontier Fund at $48.80 per share. Not only does the US-based maker of such devices as the Roomba Robot Vacuum and Braava Robot Mop have strong and growing sales, it also has a number of exciting new robotic products coming online soon or in the works. We had several fundamental reasons for buying the firm, but one of the top was the brilliant CEO running the company, Colin Angle. The polar opposite of a slick marketing guy, Angle is the MIT-trained technologist behind these little devices; well, him and his team of engineers. With a low multiple and very low debt load, we felt investors were missing this company's unique story. Many woke up to that story after the Q4 earnings report was released. Revenue was up 11% Y/Y, to $427 million, and earnings came in at $0.70 per share—both metrics beating estimates. The earnings figure was nearly double what the Street was projecting. Shares ended the day up nearly 20%, to $58. We will be highlighting iRobot in the upcoming Robotics issue of The Penn Wealth Report.
Technology Hardware & Equipment
Apple sold nearly 50% more watches last year than the entire Swiss watch industry. According to industry research firm Strategy Analytics, Apple (AAPL $168-$321-$328) shipped 31 million units of its Apple Watch in 2019. That is a staggering number, especially when compared to the fact that the entire Swiss watch industry, which includes the likes of Rolex, Swatch, Breitling, TAG Heuer, and Cartier, sold only 21 million units. That means one American company sold roughly 50% more watches than the country historically known for making timepieces. Considering that the Apple Watch was just launched five years ago, this should serve as a reminder—especially for investors—of just how quickly an industry can be disrupted by new technologies, products, and services. While the Swiss watchmakers are trying to catch up by introducing their own "smart" watches, that effort has been floundering. What they fail to understand is that the buyers of connected devices are buying into the ecosystem story, and nobody can come close to Apple's iOS ecosystem. We used to trade Swatch (SWGAY) on a regular basis. In the five years since the Apple Watch launch, that company has lost 40% of its market cap. There is no such thing as autopilot when it comes to investing; diligence is, and must always remain, the key theme when it comes to making money and protecting portfolios.
e-Commerce
Why would the parent company of the New York Stock Exchange want to buy Internet retailer eBay? Intercontinental Exchange (ICE $72-$96-$102), owner of the New York Stock Exchange, has made a seemingly bizarre offer: it wants to buy global online marketplace eBay (EBAY $34-$37-$42) in a deal that would ultimately be valued well above the company's $30 billion market cap. While there is no indication that eBay has yet to engage with the exchange, news of the offer sent its shares up by over 8%. If you are scratching your head over this one, you are not alone: ICE closed the day down over 7% on the news. Technically, both companies are "exchanges" in the broad sense, and it would even be fair to call both auction houses—pitting buyer versus seller and keeping a cut of the spread. but it is hard to imagine how eBay fits in the exchange's strategic plan. Management at the Atlanta-based firm didn't have a lot to say, other than to confirm the offer and that the company has a "track record of creating shareholder value, both through organic growth and acquisitions...." As for creating shareholder value, it is certainly fair to say that eBay is ripe for a new strategy, after losing immense ground to the likes of Amazon (AMZN). Until the spring of 2007, in fact, eBay was the larger online retailer of the two. We hope the deal goes through—what do eBay shareholders have to lose? If a deal happens, it will be interesting to see how ICE's application of new technologies work in revamping one of the first online marketplaces. It may become a template for other companies—especially in the fintech arena—to emulate.
Beverages & Tobacco
After taking a $4.1 billion write-down on disastrous Juul investment, is there any value to be found in Altria shares? It was supposed to be yet another tactical move to diversify away from its much-maligned tobacco business: pay $12.8 billion for a 35% stake in e-cigarette phenom Juul. Instead, this move has been nothing short of a nightmare for the leading US cigarette and smokeless tobacco company, Altria (MO $39-$47-$58). After taking yet another write-down on its Juul investment ($4.1 billion), its 35% stake is now worth just about $4 billion. With both their cigarette and e-cig businesses under relentless attack by the government and anti-smoking forces, why would an investor want to buy in right now? Actually, there are a number of factors that make MO look attractive at current prices. First is the company's fat 7% dividend yield, which looks to be safe. Secondly, it still appears the company might reunite with its former Philip Morris International (PM) unit which became a separate company back in 2008. Under withering assault, it just makes sense for these allied forces to combine. A third reason to look at MO shares has to do with their successful diversification attempts. The firm now owns a 10.2% stake in Anheuser-Busch InBev (BUD), and has been increasing its stake in cannabis companies. Finally, there is a lot of promise around a new "heat-don't-burn" cigarette technology known as IQOS. This system heats the tobacco to 650°F without any actual combustion taking place. With shares down following news of the Juul charge, yield-hungry investors might want to take a nibble at $47 per share. While we don't own either MO or PM in any of the Penn Strategies, we would place a fair value on Altria shares at $55.
IT Services
CEO Ginni Rometty was one of the reasons we owned IBM, so what does her departure mean for shares of Big Blue? We have often pointed to Virginia "Ginni" Rometty as one of the best CEOs in the country. While shares of pioneering tech company IBM (IBM $127-$144-$153) have struggled under her tenure, she is the one responsible for taking the helm and steering the 109-year-old firm in a different direction—away from its legacy hardware business and into the lucrative world of cloud computing. That is why we immediately got concerned for our Penn Global Leaders Club holding when it was announced that she would be leaving the firm in April. Our concerns were assuaged when we saw who would be taking over: Arvind Krishna is the wonkish Senior Vice President for Cloud and Cognitive Software at the firm, and the principal architect behind IBM's acquisition of Red Hat, a leading cloud and open-source software player. While "wonkish" is not typically an adjective we want to hear associated with a chief executive, that moniker has also been applied to Satya Nadella, the adroit leader responsible for Microsoft's (MSFT) big turnaround. The two men appear to be eerily similar. Both are deep tech gurus with strong engineering backgrounds (Krishna has a PhD in electrical and computer engineering), and both ran the cloud computing business at their respective companies before being elevated to the top spot. The icing on the cake? Red Hat's highly-skilled CEO, Jim Whitehurst, will be Krishna's second-in-command, serving as IBM's new president. Krishna brings a brilliant tech mind to the table, while Whitehurst, who attended the London School of Business and carries an MBA from Harvard, brings the strong management background. Both are scheduled to take on their new roles on the 6th of April. In addition to IBM's quite low (for a tech company) multiple of 14, the attractive 4.5% dividend is a nice bonus for yield-starved investors. It is too early to tell whether or not Krishna will be another Nadella, but we like the odds.
Headlines for the Week of 26 Jan 2020—01 Feb 2020
Road & Rail
Navistar International jumps 55% as VW looks to make a big move into the US commercial vehicle market. Shares of commercial bus and truck maker Navistar International (NAV $21-$37-$40) opened Friday's session trading up by 55% after the Illinois-based company received an unsolicited buyout offer from Traton, Volkswagen's (VWAGY) recent trucking spinoff. Navistar's board said it is in the process of reviewing the offer, and that there is certainly no guarantee a deal can be reached. It is clear that VW wants to move into the lucrative US commercial truck market, and this would give them a strong platform to do so. Traton sold nearly a quarter-of-a-million units around the world last year, while Navistar, under its International® brand name, sold approximately 70,000 buses, trucks, and defense-related vehicles in the US. It should also be noted that Traton already owns 17% of NAV and holds two seats on the company's 17-member board. Another great example of a decent company with little enthusiasm circling around it by investors or analysts suddenly getting a huge price pop due to a takeover bid. Investing in a company solely based on takeover hopes is a fool's errand, but it can certainly be an important part of any equation when evaluating the fundamentals of a company.
Application & Systems Software
Another quarter, another set of blowout numbers from Microsoft. When Satya Nadella took the helm from the "animated" (we are being kind) Steve Ballmer at Microsoft (MSFT $102-$168-$168) in 2014, shares of the pioneer software company were trading for around $36, and the company had a market cap of $300 billion. That is approximately when we added the company to the Penn Global Leaders Club. We were decidedly not fans of Ballmer, but we loved the strategic vision Nadella was laying out for the firm. Since he took over, Microsoft has risen 360% versus an 88% rise in the S&P 500. With its $1.3 trillion market cap, the company comes in just behind Apple (AAPL) as the world's largest publicly-traded company. Based on the firm's just-released earnings report, expect that trajectory to continue. Microsoft generated revenues of $36.9 billion versus expectations for $35.7 billion; earnings per share came in at $1.51, well ahead of the $1.32 the Street was expecting. Most impressive was the company's Azure cloud segment—the segment Amazon (AMZN) is suing the government over, which posted a remarkable 62% jump in year-over-year sales. Perhaps even more amazing, the company's seemingly archaic Windows division notched a 26% spike in Y/Y sales thanks to strong demand for Windows 10. Finally, the Office 365 software subscription service (we are one of 120 million monthly active users) continues to bring in an enormous monthly income stream to the company. We are as bullish on Microsoft now as we were when Nadella took over. After Bill Gates left as the company's first CEO, Microsoft could have easily rested on its laurels (as we would argue it did under the goofy Ballmer) and made a slow descent into irrelevance. Instead, true leadership took over in 2014 and re-imagined what the company could be and do for an ever-increasing number of customers. Leadership made the difference.
Textiles, Apparel, & Luxury Goods
Victoria's Secret's parent company pops 12% after Les Wexner finally shows signs of letting go. He is the longest-serving CEO of any company in the S&P 500. At 82, Leslie Wexner founded what was once called Limited Brands (LTD) back in 1962, and has been at the helm ever since the company went public in 1969. We have followed the company, now called L Brands (LB $16-$23-$29), for a long time, and have traded the parent company of Victoria's Secret and Bath & Body Works with good success through the years. A year ago, however, when shares were sitting at a seemingly-undervalued $28, we wrote that until Wexner is prepared to move on from the company's day-to-day operations, we wouldn't consider buying back in. Now, after a 12% pop, LB is sitting at $23 per share. The catalyst? Wexner is reportedly in talks to sell the $6 billion retail chain. For the record, the company had a market cap of $27 billion precisely four years ago, and a share price of $96. Wexner's age is irrelevant; what is relevant are some of the poor decisions he has made in recent years. For example, instead of embracing the omni-channel marketing approach and creating a vibrant online presence, he stood firmly behind his mall-based approach, telling The Wall Street Journal that he had "5,000 years of history on my side." Um, Les, the ancient Sumerians didn't have high-speed Internet and Amazon accounts. Another terrible decision was ditching swimsuits. Three years after that decision was made, they were brought back. It is no-doubt very difficult to walk away from a company you founded two generations ago, but Wexner is finally making a really good decision. To be frank, we would have been long LB had we known that the founder was close to "looking for strategic options." Now that the word is out, it might still be a worthy buy, albeit a higher-risk proposition, and we could easily see the shares climbing to $30.
Global Strategy: Trade
An obstinate US Congress wasn't the last hurdle for USMCA—the Canadian Parliament holds that distinction. For all the concern we had about Mexico's new president, AMLO, taking office before any of the three participating countries had ratified the new North American trade agreement known as USMCA, his country's legislature was actually the first to get the job done. They did so in December, with AMLO's full support. That turned our concerns to DC, where the opposition to President Trump—at least among the majority in the House—is palpable. Somewhat remarkably, with their eyes laser-focused on impeachment, Congress actually ratified the treaty a few weeks ago. Somehow, Canada just seemed like an afterthought. However, while we still fully expect ratification by the Canadian Parliament, it won't be smooth sailing. While Prime Minister Justin Trudeau's Liberal Party of Canada holds a plurality of seats in the lower chamber, it will need to cobble together support from other parties. That shouldn't be a problem, as the Conservative Party of Canada has said it supports the deal. That leaves the upper chamber, which is controlled by the ISG, or Independent Senators Group. Many left-of-center MPs oppose virtually any free trade deal, while the Bloc Quebecois—who hold 32 of the 100 seats in the senate—oppose the deal on grounds it will hurt Quebec's dairy farmers. Ultimately, the deal will get ratified north of the border, but the question becomes one of timing. Opponents can drag the process out, calling witness after witness in an effort to stall passage. As the agreement won't take effect until 90 days after the last country ratifies it, we may be looking at late-year before its impact is felt. Every country is claiming they got the best deal in the USMCA, but it will provide a very real stimulus to the US economy. From forcing Mexico to raise its wages for autoworkers, to US dairy exports to Canada jumping by over 40%, the agreement is full of specific action items that will directly affect our GDP in a positive way.
Beverages & Tobacco
Our Canopy Growth marijuana holding spikes double-digits following upgrade, praise for product lineup. We added medical and recreational marijuana company Canopy Growth Corp (CGC $14-$24-$53) to the Intrepid a few weeks ago not because we are bullish on the industry (we're really not), but because the company appears best positioned to take advantage of the medical marijuana niche going forward. Additionally, our favorite booze company, Constellation Brands (STZ), took a big position in the firm last year. Shares of Canopy popped 11% on Tuesday following glowing comments from BMO's Tamy Chen, who raised her rating on the stock to Outperform and posited a pretty strong growth story for the firm going forward. She also likes Canopy's new mix of value-added products which should resonate well with Canadian customers. She raised her price target on Canopy shares to C$40, or roughly $30.50. The shares have risen 20% since our purchase, and are about halfway to our target price of $30.
Commercial Banks
Despite yet another new CEO, Wells Fargo's troubles are far from over. On Janet Yellen's last day in office, the Federal Reserve slapped Wells Fargo (WFC $43-$47-$55) with an unusually tough penalty for the bank's misdeeds: not only did it fine the bank, it also limited its future growth by capping the bank's total allowable assets. This came on the heels of disgraced CEO John Stumpf being fired by the board, then forfeiting $41 million in stock awards, and finally having $28 million in salary clawed back. Stumpf's replacement, Tim Sloan, held the position for just over two years before being forced out in March of 2019. After a period in which the general council of the bank took the helm, it was announced that Charlie Scharf would be the new permanent CEO. The honeymoon didn't last long. Regulators just handed down $59 million worth of fines against ex-Wells Fargo executives, with Stumpf agreeing to pay $17.5 million and accept a lifetime ban from the banking industry. The executive in charge of the retail banking division at the heart of the fake accounts scandal was fined $25 million and told the amount could climb higher. The Office of the Comptroller of the Currency outlined these penalties in a huge document which detailed the "illegal activity and catastrophic...damage" done by the bank. In his first conference call since taking over at the bank, Scharf indicated that the regulators are probably not done yet. Not exactly what investors wanted to hear. We are beginning to see an ugly recent trend. There has always been arrogance in the C-suites of major corporations, but both Boeing and Wells Fargo should be a wake-up call to investors: no matter how big and supposedly stable the company, don't assume there aren't landmines buried throughout the seemingly staid corporate landscape. Always be prepared to make a move as unexpected events unfold.
Aerospace & Defense
Canadian transport manufacturer Bombardier, with its shares sitting below $1, looks to team up with French rival Alstom on rail business. Just a few short years ago, Canadian aircraft and transport manufacturer Bombardier (BDRBF $1-$1-$2) had a market cap of $10 billion, a potentially lucrative market for its new A220/C-Series narrow-body commercial jets, and a strong rail division. Unfortunately, it has been all downhill for the Montreal-based firm since. The first misstep was teaming up with Europe's Airbus (EADSY), which essentially usurped the A220, taking a 50.01% stake in the line and rebranding the aircraft as the Airbus A220. Then, due to a mountain of debt stemming from its development of the A220, Bombardier was forced to sell its regional jet series (known as the CRJ) to Mitsubishi for $550 million. Now, with short-term liabilities greater than its current assets, and long-term liabilities greater than its long-term assets, the firm is looking to team up with yet another rival—France's Alstom SA (AOMFF)—on its rail business. We expect Alstom to take control of the rail unit the way Airbus did with the C-Series program. With increased competition in the rail industry coming from China, Bombardier had first tried to team up with Germany's Siemens AG (SMAWF), but that company ultimately rebuffed the firm to pursue its own deal with Alstom (a deal which the EU ultimately shot down). And the bad news continues: not only is the rail deal facing antitrust scrutiny, Bombardier just shook investors by warning of disappointing Q4 sales and saying it may exit the Airbus joint venture altogether—taking a huge writedown in the process. While the rail division accounts for over half of the company's revenues, that unit faced a humiliation several weeks ago when New York City was forced to pull 300 Bombardier subway cars from service due to malfunctioning door mechanisms. When it rains it pours. We have traded Bombardier in the past with good success, but we wouldn't touch the company right now, even with its $0.91 share price (on the B shares, the A shares are trading at $1.02). We can't imagine the Canadian government letting the company fail, but that is a weak rationale for buying in right now.
Navistar International jumps 55% as VW looks to make a big move into the US commercial vehicle market. Shares of commercial bus and truck maker Navistar International (NAV $21-$37-$40) opened Friday's session trading up by 55% after the Illinois-based company received an unsolicited buyout offer from Traton, Volkswagen's (VWAGY) recent trucking spinoff. Navistar's board said it is in the process of reviewing the offer, and that there is certainly no guarantee a deal can be reached. It is clear that VW wants to move into the lucrative US commercial truck market, and this would give them a strong platform to do so. Traton sold nearly a quarter-of-a-million units around the world last year, while Navistar, under its International® brand name, sold approximately 70,000 buses, trucks, and defense-related vehicles in the US. It should also be noted that Traton already owns 17% of NAV and holds two seats on the company's 17-member board. Another great example of a decent company with little enthusiasm circling around it by investors or analysts suddenly getting a huge price pop due to a takeover bid. Investing in a company solely based on takeover hopes is a fool's errand, but it can certainly be an important part of any equation when evaluating the fundamentals of a company.
Application & Systems Software
Another quarter, another set of blowout numbers from Microsoft. When Satya Nadella took the helm from the "animated" (we are being kind) Steve Ballmer at Microsoft (MSFT $102-$168-$168) in 2014, shares of the pioneer software company were trading for around $36, and the company had a market cap of $300 billion. That is approximately when we added the company to the Penn Global Leaders Club. We were decidedly not fans of Ballmer, but we loved the strategic vision Nadella was laying out for the firm. Since he took over, Microsoft has risen 360% versus an 88% rise in the S&P 500. With its $1.3 trillion market cap, the company comes in just behind Apple (AAPL) as the world's largest publicly-traded company. Based on the firm's just-released earnings report, expect that trajectory to continue. Microsoft generated revenues of $36.9 billion versus expectations for $35.7 billion; earnings per share came in at $1.51, well ahead of the $1.32 the Street was expecting. Most impressive was the company's Azure cloud segment—the segment Amazon (AMZN) is suing the government over, which posted a remarkable 62% jump in year-over-year sales. Perhaps even more amazing, the company's seemingly archaic Windows division notched a 26% spike in Y/Y sales thanks to strong demand for Windows 10. Finally, the Office 365 software subscription service (we are one of 120 million monthly active users) continues to bring in an enormous monthly income stream to the company. We are as bullish on Microsoft now as we were when Nadella took over. After Bill Gates left as the company's first CEO, Microsoft could have easily rested on its laurels (as we would argue it did under the goofy Ballmer) and made a slow descent into irrelevance. Instead, true leadership took over in 2014 and re-imagined what the company could be and do for an ever-increasing number of customers. Leadership made the difference.
Textiles, Apparel, & Luxury Goods
Victoria's Secret's parent company pops 12% after Les Wexner finally shows signs of letting go. He is the longest-serving CEO of any company in the S&P 500. At 82, Leslie Wexner founded what was once called Limited Brands (LTD) back in 1962, and has been at the helm ever since the company went public in 1969. We have followed the company, now called L Brands (LB $16-$23-$29), for a long time, and have traded the parent company of Victoria's Secret and Bath & Body Works with good success through the years. A year ago, however, when shares were sitting at a seemingly-undervalued $28, we wrote that until Wexner is prepared to move on from the company's day-to-day operations, we wouldn't consider buying back in. Now, after a 12% pop, LB is sitting at $23 per share. The catalyst? Wexner is reportedly in talks to sell the $6 billion retail chain. For the record, the company had a market cap of $27 billion precisely four years ago, and a share price of $96. Wexner's age is irrelevant; what is relevant are some of the poor decisions he has made in recent years. For example, instead of embracing the omni-channel marketing approach and creating a vibrant online presence, he stood firmly behind his mall-based approach, telling The Wall Street Journal that he had "5,000 years of history on my side." Um, Les, the ancient Sumerians didn't have high-speed Internet and Amazon accounts. Another terrible decision was ditching swimsuits. Three years after that decision was made, they were brought back. It is no-doubt very difficult to walk away from a company you founded two generations ago, but Wexner is finally making a really good decision. To be frank, we would have been long LB had we known that the founder was close to "looking for strategic options." Now that the word is out, it might still be a worthy buy, albeit a higher-risk proposition, and we could easily see the shares climbing to $30.
Global Strategy: Trade
An obstinate US Congress wasn't the last hurdle for USMCA—the Canadian Parliament holds that distinction. For all the concern we had about Mexico's new president, AMLO, taking office before any of the three participating countries had ratified the new North American trade agreement known as USMCA, his country's legislature was actually the first to get the job done. They did so in December, with AMLO's full support. That turned our concerns to DC, where the opposition to President Trump—at least among the majority in the House—is palpable. Somewhat remarkably, with their eyes laser-focused on impeachment, Congress actually ratified the treaty a few weeks ago. Somehow, Canada just seemed like an afterthought. However, while we still fully expect ratification by the Canadian Parliament, it won't be smooth sailing. While Prime Minister Justin Trudeau's Liberal Party of Canada holds a plurality of seats in the lower chamber, it will need to cobble together support from other parties. That shouldn't be a problem, as the Conservative Party of Canada has said it supports the deal. That leaves the upper chamber, which is controlled by the ISG, or Independent Senators Group. Many left-of-center MPs oppose virtually any free trade deal, while the Bloc Quebecois—who hold 32 of the 100 seats in the senate—oppose the deal on grounds it will hurt Quebec's dairy farmers. Ultimately, the deal will get ratified north of the border, but the question becomes one of timing. Opponents can drag the process out, calling witness after witness in an effort to stall passage. As the agreement won't take effect until 90 days after the last country ratifies it, we may be looking at late-year before its impact is felt. Every country is claiming they got the best deal in the USMCA, but it will provide a very real stimulus to the US economy. From forcing Mexico to raise its wages for autoworkers, to US dairy exports to Canada jumping by over 40%, the agreement is full of specific action items that will directly affect our GDP in a positive way.
Beverages & Tobacco
Our Canopy Growth marijuana holding spikes double-digits following upgrade, praise for product lineup. We added medical and recreational marijuana company Canopy Growth Corp (CGC $14-$24-$53) to the Intrepid a few weeks ago not because we are bullish on the industry (we're really not), but because the company appears best positioned to take advantage of the medical marijuana niche going forward. Additionally, our favorite booze company, Constellation Brands (STZ), took a big position in the firm last year. Shares of Canopy popped 11% on Tuesday following glowing comments from BMO's Tamy Chen, who raised her rating on the stock to Outperform and posited a pretty strong growth story for the firm going forward. She also likes Canopy's new mix of value-added products which should resonate well with Canadian customers. She raised her price target on Canopy shares to C$40, or roughly $30.50. The shares have risen 20% since our purchase, and are about halfway to our target price of $30.
Commercial Banks
Despite yet another new CEO, Wells Fargo's troubles are far from over. On Janet Yellen's last day in office, the Federal Reserve slapped Wells Fargo (WFC $43-$47-$55) with an unusually tough penalty for the bank's misdeeds: not only did it fine the bank, it also limited its future growth by capping the bank's total allowable assets. This came on the heels of disgraced CEO John Stumpf being fired by the board, then forfeiting $41 million in stock awards, and finally having $28 million in salary clawed back. Stumpf's replacement, Tim Sloan, held the position for just over two years before being forced out in March of 2019. After a period in which the general council of the bank took the helm, it was announced that Charlie Scharf would be the new permanent CEO. The honeymoon didn't last long. Regulators just handed down $59 million worth of fines against ex-Wells Fargo executives, with Stumpf agreeing to pay $17.5 million and accept a lifetime ban from the banking industry. The executive in charge of the retail banking division at the heart of the fake accounts scandal was fined $25 million and told the amount could climb higher. The Office of the Comptroller of the Currency outlined these penalties in a huge document which detailed the "illegal activity and catastrophic...damage" done by the bank. In his first conference call since taking over at the bank, Scharf indicated that the regulators are probably not done yet. Not exactly what investors wanted to hear. We are beginning to see an ugly recent trend. There has always been arrogance in the C-suites of major corporations, but both Boeing and Wells Fargo should be a wake-up call to investors: no matter how big and supposedly stable the company, don't assume there aren't landmines buried throughout the seemingly staid corporate landscape. Always be prepared to make a move as unexpected events unfold.
Aerospace & Defense
Canadian transport manufacturer Bombardier, with its shares sitting below $1, looks to team up with French rival Alstom on rail business. Just a few short years ago, Canadian aircraft and transport manufacturer Bombardier (BDRBF $1-$1-$2) had a market cap of $10 billion, a potentially lucrative market for its new A220/C-Series narrow-body commercial jets, and a strong rail division. Unfortunately, it has been all downhill for the Montreal-based firm since. The first misstep was teaming up with Europe's Airbus (EADSY), which essentially usurped the A220, taking a 50.01% stake in the line and rebranding the aircraft as the Airbus A220. Then, due to a mountain of debt stemming from its development of the A220, Bombardier was forced to sell its regional jet series (known as the CRJ) to Mitsubishi for $550 million. Now, with short-term liabilities greater than its current assets, and long-term liabilities greater than its long-term assets, the firm is looking to team up with yet another rival—France's Alstom SA (AOMFF)—on its rail business. We expect Alstom to take control of the rail unit the way Airbus did with the C-Series program. With increased competition in the rail industry coming from China, Bombardier had first tried to team up with Germany's Siemens AG (SMAWF), but that company ultimately rebuffed the firm to pursue its own deal with Alstom (a deal which the EU ultimately shot down). And the bad news continues: not only is the rail deal facing antitrust scrutiny, Bombardier just shook investors by warning of disappointing Q4 sales and saying it may exit the Airbus joint venture altogether—taking a huge writedown in the process. While the rail division accounts for over half of the company's revenues, that unit faced a humiliation several weeks ago when New York City was forced to pull 300 Bombardier subway cars from service due to malfunctioning door mechanisms. When it rains it pours. We have traded Bombardier in the past with good success, but we wouldn't touch the company right now, even with its $0.91 share price (on the B shares, the A shares are trading at $1.02). We can't imagine the Canadian government letting the company fail, but that is a weak rationale for buying in right now.
Headlines for the Week of 19 Jan 2020—25 Jan 2020
Fraud, Waste, & Abuse of Power
In a typical nanny state move, New York City bans cashless stores. Bad news, nanny state: technology is coming, whether you like it or not. In the most recent case of "tech is evil," New York City has joined with the San Francisco city council (shocker) in banning stores from going cashless. You may recall that Amazon Go is a new store concept launched by the trillion-dollar company in which busy commuters can pop in, grab what they need, and go. The company's "just walk out" technology works with the Amazon Go app, which is read when one enters the store. As you walk around and put items in your basket, sensing technology knows what items you selected, charges your Amazon account as you leave, and immediately sends you a digital receipt so you can verify your purchases. It should be noted that you can also use a debit or credit card for the purchases. The NYC council says this discriminates against its citizens who only carry cash (and apparently who need to shop in this tiny store as opposed to the 20 bodegas within a five-block radius). Never mind the fact that literally anyone can turn cash into a pre-paid debit card at a local store—no bank account needed. Also, never mind the fact that a store which does not allow cash cannot be robbed...for cash. But, the root of our problem with this petulent little law made by petulent little people is the way it infringes on the personal freedoms of those who would like to use such stores. It is akin to Chicago banning Walmart from operating stores within the city limits—stores which would save consumers money. As usual, these dolts are really hurting those they purport to be looking out for. The New York City council won't stop progress. They will win a few temporary battles, like this one, but in the end the courts will either overturn their draconian rulings or enough money will flee the city that they will be forced to capitulate. In the meantime, they are always fun to watch and report on.
Space Sciences & Exploration
After SpaceX nailed a critical test flight, its Crew Dragon capsule is ready to fly astronauts. It was the mother of all un-piloted tests: send the Crew Dragon space capsule up atop a Falcon 9 rocket, create a simulated disaster 85 seconds into the flight while the vehicle is traveling at mach 2.2, and abort the mission. In the process, the Crew Dragon was to ignite its eight Super Draco thrusters, separate from its trunk section, use smaller thrusters to reorient the craft's heat shield for re-entry, then deploy two drogue—followed by four main—parachutes for a soft landing in the ocean. The atmospheric pressure, meanwhile, would destroy the Falcon 9 in a fiery burst. And all of that, miraculously to the untrained eye, is precisely what happened. We remember watching the very first Space Shuttle launch in April of 1981 with Young and Crippen onboard. Although Crew Dragon was "manned" only by two anthropomorphic test dummies, it brought back memories of that incredible spring day. The battle between SpaceX and Boeing (BA), which just completed a failed mission of its Starliner capsule, is suddenly looking like no contest. It could be as soon as this March, just two short months away, that the SpaceX Crew Dragon carries two astronauts from American soil to the International Space Station, marking America's triumphant return to manned spaceflight. Disgracefully, the country willingly ended that capability back in 2012. As for Boeing, we expect it to iron out the multitude of issues with the Starliner, but we are yearning for the days of an independent McDonnell Douglas, before the company was acquired by Boeing. We are in the nascent stages of an unprecedented private enterprise/government partnership designed to take back America's leadership role in space exploration; a role abdicated in 2012. As exciting as the missions will be, investors need to be paying close attention to the publicly-traded players, especially those lesser-known companies in the support role. Think names like Astrotech (ASTC), Moog Inc (MOG.B), Ducommun (DCO), and Aerojet Rocketdyne Holdings (AJRD).
Global Strategy: Trade
Trump's threat to tax French wine and cheese forces Macron to back down on digital tax. Last year, France unilaterally imposed a 3% "digital tax" on revenue from tech companies with over $832 million (€750M) in global sales. That move was clearly aimed squarely at US tech giants like Google, Amazon, Facebook, and Apple. French President Macron was hoping the rest of the European Union would follow suit, but the confiscatory plan required a unanimous vote, and our friends in the smaller European countries voted against the plan. Then came President Donald Trump's retaliatory strike: the US would tax roughly $2.4 billion worth of French goods coming into the country; goods sitting at the heart of French pride, like cheese and wine. Suddenly, Macron has decided to "pause" the digital tax as long as the US puts its own tax on hold. A clear win for the US. Macron, along with a number of other world leaders, may still be playing the odds that President Trump will not be re-elected, at which time he (Macron) can re-implement the digital tax. That is a dangerous gambit, as Trump has a long memory when it comes to perceived or real personal affronts.
Sovereign Debt & Global Fixed Income
For the first time since 1986, the US Treasury will issue 20-year bonds. Yet again, the government is facing a trillion dollar deficit—as in our collective US Representatives are going to spend $1 trillion more in a year than the government will take from taxpayers. Sadly, the answer is never to actually balance the budget. To pay for that cool trillion, the Treasury is about to do something it hasn't done since the mid-1980s—issue 20-year Treasury bonds to fund the deficit. There is some good news that comes with this decision: the Treasury Department squelched the idea it was floating of issuing 50-year bonds or even 100-year "century" bonds. They no doubt got the idea for the latter from countries in developed Europe who are already issuing these 100-year paperweights. The new bonds will start trading in May, with more details to be released on 05 Feb. As for the offered rate, we can obviously expect something between the current 10-year Treasury yield of 1.84%, and the current 30-year yield of 2.29%. If you're keeping tally, the Treasury issued $2.7 trillion worth of new debt in 2019, a figure that goes directly to the waistline of the $23 trillion national debt. We recently added TLT, the iShares 20+ Year Treasury Bond ETF, to the Strategic Income Portfolio. We feel relatively safe in stating that the Fed cannot afford to raise rates any time soon.
Commercial Banks
As earnings soar at the big US banks, results from UBS highlight the economic challenges of developed Europe. We have to be careful not to play the mainstream media game of shaping the facts to fit our narrative, but recent reports coming from the big European banks certainly fit well with our rather dour economic outlook for developed Europe. Shares of the $46 billion Swiss bank UBS Group AG (UBS $10-$13-$14) were trading off around 4% at Tuesday's open following news that it had missed nearly all of its key 2019 targets. Net profit from the investment banking unit fell Y/Y from $1.67B to $1.06B, while net interest income fell from $5.05B in 2018 to $4.5B last year. This led to a series of management downgrades for the year ahead—on profit, assets under management, and dividend growth. The bank is trying to staunch the bleeding after losing nearly $5 billion in assets in Q4 alone. What's worse (for Europe) is the fact that UBS's downgrades come on the heels of both Credit Suisse (CS) and Deutsche Bank (DB) lowering their own expectations for the year ahead. The European banks' woes are juxtaposed by record profits rolling in for their major US counterparts. As we wrote in our 2020 Outlook issue of The Penn Wealth Report, we are underweighting developed Europe but see the emerging markets as one of the year's major success stories.
In a typical nanny state move, New York City bans cashless stores. Bad news, nanny state: technology is coming, whether you like it or not. In the most recent case of "tech is evil," New York City has joined with the San Francisco city council (shocker) in banning stores from going cashless. You may recall that Amazon Go is a new store concept launched by the trillion-dollar company in which busy commuters can pop in, grab what they need, and go. The company's "just walk out" technology works with the Amazon Go app, which is read when one enters the store. As you walk around and put items in your basket, sensing technology knows what items you selected, charges your Amazon account as you leave, and immediately sends you a digital receipt so you can verify your purchases. It should be noted that you can also use a debit or credit card for the purchases. The NYC council says this discriminates against its citizens who only carry cash (and apparently who need to shop in this tiny store as opposed to the 20 bodegas within a five-block radius). Never mind the fact that literally anyone can turn cash into a pre-paid debit card at a local store—no bank account needed. Also, never mind the fact that a store which does not allow cash cannot be robbed...for cash. But, the root of our problem with this petulent little law made by petulent little people is the way it infringes on the personal freedoms of those who would like to use such stores. It is akin to Chicago banning Walmart from operating stores within the city limits—stores which would save consumers money. As usual, these dolts are really hurting those they purport to be looking out for. The New York City council won't stop progress. They will win a few temporary battles, like this one, but in the end the courts will either overturn their draconian rulings or enough money will flee the city that they will be forced to capitulate. In the meantime, they are always fun to watch and report on.
Space Sciences & Exploration
After SpaceX nailed a critical test flight, its Crew Dragon capsule is ready to fly astronauts. It was the mother of all un-piloted tests: send the Crew Dragon space capsule up atop a Falcon 9 rocket, create a simulated disaster 85 seconds into the flight while the vehicle is traveling at mach 2.2, and abort the mission. In the process, the Crew Dragon was to ignite its eight Super Draco thrusters, separate from its trunk section, use smaller thrusters to reorient the craft's heat shield for re-entry, then deploy two drogue—followed by four main—parachutes for a soft landing in the ocean. The atmospheric pressure, meanwhile, would destroy the Falcon 9 in a fiery burst. And all of that, miraculously to the untrained eye, is precisely what happened. We remember watching the very first Space Shuttle launch in April of 1981 with Young and Crippen onboard. Although Crew Dragon was "manned" only by two anthropomorphic test dummies, it brought back memories of that incredible spring day. The battle between SpaceX and Boeing (BA), which just completed a failed mission of its Starliner capsule, is suddenly looking like no contest. It could be as soon as this March, just two short months away, that the SpaceX Crew Dragon carries two astronauts from American soil to the International Space Station, marking America's triumphant return to manned spaceflight. Disgracefully, the country willingly ended that capability back in 2012. As for Boeing, we expect it to iron out the multitude of issues with the Starliner, but we are yearning for the days of an independent McDonnell Douglas, before the company was acquired by Boeing. We are in the nascent stages of an unprecedented private enterprise/government partnership designed to take back America's leadership role in space exploration; a role abdicated in 2012. As exciting as the missions will be, investors need to be paying close attention to the publicly-traded players, especially those lesser-known companies in the support role. Think names like Astrotech (ASTC), Moog Inc (MOG.B), Ducommun (DCO), and Aerojet Rocketdyne Holdings (AJRD).
Global Strategy: Trade
Trump's threat to tax French wine and cheese forces Macron to back down on digital tax. Last year, France unilaterally imposed a 3% "digital tax" on revenue from tech companies with over $832 million (€750M) in global sales. That move was clearly aimed squarely at US tech giants like Google, Amazon, Facebook, and Apple. French President Macron was hoping the rest of the European Union would follow suit, but the confiscatory plan required a unanimous vote, and our friends in the smaller European countries voted against the plan. Then came President Donald Trump's retaliatory strike: the US would tax roughly $2.4 billion worth of French goods coming into the country; goods sitting at the heart of French pride, like cheese and wine. Suddenly, Macron has decided to "pause" the digital tax as long as the US puts its own tax on hold. A clear win for the US. Macron, along with a number of other world leaders, may still be playing the odds that President Trump will not be re-elected, at which time he (Macron) can re-implement the digital tax. That is a dangerous gambit, as Trump has a long memory when it comes to perceived or real personal affronts.
Sovereign Debt & Global Fixed Income
For the first time since 1986, the US Treasury will issue 20-year bonds. Yet again, the government is facing a trillion dollar deficit—as in our collective US Representatives are going to spend $1 trillion more in a year than the government will take from taxpayers. Sadly, the answer is never to actually balance the budget. To pay for that cool trillion, the Treasury is about to do something it hasn't done since the mid-1980s—issue 20-year Treasury bonds to fund the deficit. There is some good news that comes with this decision: the Treasury Department squelched the idea it was floating of issuing 50-year bonds or even 100-year "century" bonds. They no doubt got the idea for the latter from countries in developed Europe who are already issuing these 100-year paperweights. The new bonds will start trading in May, with more details to be released on 05 Feb. As for the offered rate, we can obviously expect something between the current 10-year Treasury yield of 1.84%, and the current 30-year yield of 2.29%. If you're keeping tally, the Treasury issued $2.7 trillion worth of new debt in 2019, a figure that goes directly to the waistline of the $23 trillion national debt. We recently added TLT, the iShares 20+ Year Treasury Bond ETF, to the Strategic Income Portfolio. We feel relatively safe in stating that the Fed cannot afford to raise rates any time soon.
Commercial Banks
As earnings soar at the big US banks, results from UBS highlight the economic challenges of developed Europe. We have to be careful not to play the mainstream media game of shaping the facts to fit our narrative, but recent reports coming from the big European banks certainly fit well with our rather dour economic outlook for developed Europe. Shares of the $46 billion Swiss bank UBS Group AG (UBS $10-$13-$14) were trading off around 4% at Tuesday's open following news that it had missed nearly all of its key 2019 targets. Net profit from the investment banking unit fell Y/Y from $1.67B to $1.06B, while net interest income fell from $5.05B in 2018 to $4.5B last year. This led to a series of management downgrades for the year ahead—on profit, assets under management, and dividend growth. The bank is trying to staunch the bleeding after losing nearly $5 billion in assets in Q4 alone. What's worse (for Europe) is the fact that UBS's downgrades come on the heels of both Credit Suisse (CS) and Deutsche Bank (DB) lowering their own expectations for the year ahead. The European banks' woes are juxtaposed by record profits rolling in for their major US counterparts. As we wrote in our 2020 Outlook issue of The Penn Wealth Report, we are underweighting developed Europe but see the emerging markets as one of the year's major success stories.
Headlines for the Week of 12 Jan 2020—18 Jan 2020
E-Commerce
Grubhub says it's not for sale, but investors are betting on an acquisition. Just three months ago, in October of 2019, we reported on food delivery service Grubhub's (GRUB $32-$56-$88) 43% share price decline in just one session. That massive drop was due to a pretty lousy Q3 earnings report. Now, three months later, GRUB shares have climbed back out of that hole, regaining all lost ground. It isn't that the financials are looking better, it is simply the fact that investors are betting big on a larger player swooping in to acquire the $5 billion company. With competition in the food delivery space increasing almost monthly, and with well-known rivals such as Uber Eats, DoorDash, and Postmates, the arguable pioneer in the industry needs to do something. DoorDash, in fact, just supplanted GRUB as the number one delivery service, with a market share of 32%. What company might acquire Grubhub? The most fascinating name we've heard circulated is Amazon (AMZN), which abandoned its own Amazon Restaurants delivery service last year. The company which is now delivering 3.5 billion of its own packages per year apparently wants back in on the food delivery game. It took some real fortitude to buy GRUB shares at or near their low of $32.11 back in late October, but those who did buy in have been rewarded with a 75% run since. Hoping that a buyer comes along soon, however, is a dangerous game to play. If one doesn't manifest, expect the shares to plummet back down.
Aerospace & Defense
Boeing's most disturbing internal messages to date shed more light on a corporate culture in deep trouble. We almost hate to bring up one of the recently-released internal messages from Boeing (BA $320-$331-$446) employees written a year before the fatal Lion Air crash in Indonesia. In a company the size of Boeing, there are always going to be some boneheaded digital conversations just waiting to be uncovered but, nonetheless, this particularly chilling message seems to point to a dangerous level of wanton arrogance at a company which claims to have a corporate culture based on safety and design excellence. Indonesia's Lion Air wanted to put its pilots through simulator (sim) training on the 737 MAX before flying the aircraft, and expressed this desire to Boeing in 2017. In response to the request, one Boeing employee wrote: "Now friggin Lion Air might need a sim to fly the MAX, and maybe because of their own stupidity. I'm scrambling trying to figure out how to unscrew this now! idiots." He apparently succeeded, as Boeing talked Lion Air out of the costly (to Boeing) simulator training. A little over a year after this internal message was written, a Lion Air 737 MAX crashed, killing all 189 people on board. The Indonesian National Transportation Safety Committee cited Boeing's failure to inform pilots of the new MCAS flight control system at the heart of the crash. To be sure, both deadly crashes involved pilot error with respect to emergency procedures, but the slew of internal memos now coming to light certainly implicates Boeing in the pilots' shortcomings. One day, Boeing will return to greatness, but that won't happen under the current CEO and board of directors.
Medical Devices, Equipment, & Supplies
SmileDirectClub soars for second time in a week on news it will sell aligners directly to dentists. Last week we mentioned what a tough time it has been for orthodontics equipment distributor SmileDirectClub (SDC $8-$12-$21) since going public last year. We also said how much we liked the company's deal with Walmart (WMT) to sell a new line of oral care products to the retailer; a deal which made the company's share price pop 21%. On Tuesday, shares of SDC were trading up 16% following another major announcement from management: the company will begin selling its aligners directly to dentists. Another smart move by the company, but what is most interesting about this story is the relationship between SmileDirectClub and Align Technologies (ALGN $170-$291-$298), which had been the key supplier of clear aligners to SDC, and an owner of 17% of the company's outstanding shares. As part of that deal, SmileDirect would only sell its aligners directly to consumers—a move which had alienated dentists. The company said it was no longer beholden to that 2016 contract (ALGN no longer owns the 17% stake), and that it would make its own aligners at the firm's manufacturing facility in Antioch, Tennessee. While SDC shares were spiking, ALGN shares were off around 2% on the news. Will dentists be willing to embrace a former competitor and sell the SmileDirectClub aligners? Considering the aligners will now come with an in-office option, meaning all work can be done under the supervision of the family dentist, our guess is yes. Align appears to be the one left out in the cold.
Food Products
Don't look now, but Beyond Meat is up 54% year-to-date, and we are only eight trading days in. As we have bloviated about any number of times, we bought plant-based "meat" company Beyond Meat (BYND $26-$116-$240) within minutes of it going public back on May 2nd. It came out of the gate trading around $52 per share, and proceeded to climb all the way up to $240/share by mid-summer. We bought Beyond as an investment, not a trade, within the Penn New Frontier Fund, so we did get a little slack when we stood by the firm as the shares came falling back to earth, dropping into the mid-$70s range. Now, all of a sudden, shares of BYND have climbed 54% within eight trading days on the back of very little groundbreaking news. One catalyst came when privately-held competitor Impossible Foods announced it didn't have the product to satisfy a potential McDonald's (MCD) deal, but that was a big nothing-burger: the world's largest fast-food chain was already experimenting with the PLT (plant, lettuce, and tomato) in Canada, a proprietary blend using Beyond Meat's product. We continue to believe that an enormous deal with MCD is in the works. CEO Ethan Brown is a visionary, and a uniquely-dynamic leader. While we aren't ready to compare him to a Jobs or a Musk, we have no doubt that Beyond will continue to be the benchmark alt-meat producer for other to follow. We also believe this industry will climb to a size few currently envision. Would we still buy in at $116 per share? No doubt.
Pharmaceuticals
The next big wave in knock-off drugs might not be generics, exactly. They're known as "me too" drugs—compounds that copy the biological function of existing drugs, but which have a different enough molecular structure (which differentiates them from generics) to avoid patent infringement. Of most importance to patients: these drugs may cost as little as 20% of the therapy they are emulating; considering some of these treatments cost hundreds of thousands a year, that is a big deal. One new startup in particular, EQRx Inc, backed by private equity funding from the likes of Andreesen Horowitz and Google Ventures (now "GV"), plans to bring nearly a dozen of these "me too" drugs to the market relatively soon. While the typical drug costs around $2 billion to develop, EQRx believes they can cut those costs to under $400 million apiece, mainly by utilizing new technologies to increase efficiencies in the lab. While companies such as EQRx will face backlash on a myriad of fronts, from well-established competitors to the FDA to insurers and PBMs, their model may just usher in a new, simpler pricing structure and lower overall costs for patients. While EQRx is not publicly traded, an interesting generic drug play right now might be Israeli-based Teva Pharmaceuticals Industries (TEVA $6-$9-$20), the largest generic drug manufacturer in the world, which is trading more than 50% off of its 52-week high.
Robotics & Industrial Machinery
Walmart is about to launch a new robotic workforce at its stores. Remember when you would go to the store to pick up a few items, find the shortest checkout lane, then proceed to get stuck behind someone reaching down to leisurely pull out their checkbook? It may seem archaic, but that scenario was commonplace not all that long ago. Now, with debit cards, smartphones, and self-checkout lanes, that problem has been alleviated, but stores are still struggling with the critical task of keeping items in stock. Walmart (WMT $93-$116-$125), the world's largest brick-and-mortar retailer, has a tactical plan to change that: deploy an army of six-foot-tall shelf-scanning robotic workers to diligently roam each aisle, sending alerts to employees' hand-held devices when an item is out of stock. Within relatively short order, Walmart will have over 1,000 of the robots, designed by privately-held Bossa Nova Robotics, roaming through its stores. While Walmart hasn't released the metrics, the company's senior vice president of store innovations said the enhancements will greatly reduce the odds of an item not being available to shoppers. While Bossa Nova is supplying the current crop of robot workers, Simbe Robotics has a competing device. Both of these tech companies are US-based. While Bossa Nova and Simbe are privately-held, NCR Corp (NCR $25-$35-$36), which has supplied Walmart with self-checkouts for years and cash registers for decades, will service the robotic workforce.
Global Strategy: East/Southeast Asia
Communist China dealt another political blow as Taiwan elections turn out a lot like the Hong Kong elections. Under two months ago, the Hong Kong electorate overwhelmingly voted for pro-democracy candidates to fill seats in the island's legislature, sending shock waves through the Communist Party of China (CPC). This past weekend, voters in Taiwan sent a similar message to Beijing. A staunch defender of Taiwan's freedom from the CPC, President Tsai Ing-wen won re-election in a historic landslide, badly setting back China's aims to gain more control over the island. 8.2 million voters, almost precisely one-third of the island's total population, voted for Ms. Tsai, the largest vote ever recorded in Taiwan. China had embarked on a stealthy campaign to unseat Tsai, using tactics such as military drills in the waters around the island, and stronger control of travel between the mainland and Taiwan. It appears these tactics backfired badly, with increased sympathy from the Taiwanese people to the plight of pro-democracy demonstrators in Hong Kong. It also didn't help that Beijing reiterated its claim that Taiwan is part of its territory. China has pushed for its so-called "one country, two systems" framework to be adopted by Taiwan, but the citizens are getting a first-hand look at the illusion of that promise through what is going on in Hong Kong. In a speech following her landslide win, Tsai commented on the special relationship Taiwan has with the United States—comments that probably enraged many in the CPC. The Communist Chinese Party had already internalized what its own highly-political press corps was spewing, backed up by the dupes in the American press corps: that China's rise to the leading economic power in the world was already set in stone. Reports of that rise, as the old joke goes, have been highly exaggerated.
Consumer Cyclical: Leisure
Six Flags plummets nearly 18% over concerns about the completion of its planned China theme parks. Shares of Six Flags Entertainment Corp (SIX $41-$36-$64) plunged below their 52-week lows following the company's ominous warnings about its planned theme parks in China—problems so dire that they may lead to the cancellation of the build altogether. It seems as though Six Flags' Chinese development partner, Riverside Investment Group, has defaulted on its required payments to the company, and unless additional funding can be secured all construction will halt. Getting all the bad news out at once, the Texas-based amusement park operator also warned of a fourth quarter revenue drop, perhaps $8 million to $10 million less than it made in the same quarter a year earlier. For investors buying into SIX for its dividend yield—now 9.14% after the most recent share price drop—be forewarned, it is doubtful that the company can keep that rate intact. Between 2010 and 2018, shares of SIX rose nearly 650%; since 2018, they have plunged from $73 per share to $36 per share. Relying solely on its 25 theme parks for revenue, we don't see a catalyst for future growth. Even though they may appear cheap, we wouldn't touch the shares—especially since China was supposed to be their next growth engine.
Grubhub says it's not for sale, but investors are betting on an acquisition. Just three months ago, in October of 2019, we reported on food delivery service Grubhub's (GRUB $32-$56-$88) 43% share price decline in just one session. That massive drop was due to a pretty lousy Q3 earnings report. Now, three months later, GRUB shares have climbed back out of that hole, regaining all lost ground. It isn't that the financials are looking better, it is simply the fact that investors are betting big on a larger player swooping in to acquire the $5 billion company. With competition in the food delivery space increasing almost monthly, and with well-known rivals such as Uber Eats, DoorDash, and Postmates, the arguable pioneer in the industry needs to do something. DoorDash, in fact, just supplanted GRUB as the number one delivery service, with a market share of 32%. What company might acquire Grubhub? The most fascinating name we've heard circulated is Amazon (AMZN), which abandoned its own Amazon Restaurants delivery service last year. The company which is now delivering 3.5 billion of its own packages per year apparently wants back in on the food delivery game. It took some real fortitude to buy GRUB shares at or near their low of $32.11 back in late October, but those who did buy in have been rewarded with a 75% run since. Hoping that a buyer comes along soon, however, is a dangerous game to play. If one doesn't manifest, expect the shares to plummet back down.
Aerospace & Defense
Boeing's most disturbing internal messages to date shed more light on a corporate culture in deep trouble. We almost hate to bring up one of the recently-released internal messages from Boeing (BA $320-$331-$446) employees written a year before the fatal Lion Air crash in Indonesia. In a company the size of Boeing, there are always going to be some boneheaded digital conversations just waiting to be uncovered but, nonetheless, this particularly chilling message seems to point to a dangerous level of wanton arrogance at a company which claims to have a corporate culture based on safety and design excellence. Indonesia's Lion Air wanted to put its pilots through simulator (sim) training on the 737 MAX before flying the aircraft, and expressed this desire to Boeing in 2017. In response to the request, one Boeing employee wrote: "Now friggin Lion Air might need a sim to fly the MAX, and maybe because of their own stupidity. I'm scrambling trying to figure out how to unscrew this now! idiots." He apparently succeeded, as Boeing talked Lion Air out of the costly (to Boeing) simulator training. A little over a year after this internal message was written, a Lion Air 737 MAX crashed, killing all 189 people on board. The Indonesian National Transportation Safety Committee cited Boeing's failure to inform pilots of the new MCAS flight control system at the heart of the crash. To be sure, both deadly crashes involved pilot error with respect to emergency procedures, but the slew of internal memos now coming to light certainly implicates Boeing in the pilots' shortcomings. One day, Boeing will return to greatness, but that won't happen under the current CEO and board of directors.
Medical Devices, Equipment, & Supplies
SmileDirectClub soars for second time in a week on news it will sell aligners directly to dentists. Last week we mentioned what a tough time it has been for orthodontics equipment distributor SmileDirectClub (SDC $8-$12-$21) since going public last year. We also said how much we liked the company's deal with Walmart (WMT) to sell a new line of oral care products to the retailer; a deal which made the company's share price pop 21%. On Tuesday, shares of SDC were trading up 16% following another major announcement from management: the company will begin selling its aligners directly to dentists. Another smart move by the company, but what is most interesting about this story is the relationship between SmileDirectClub and Align Technologies (ALGN $170-$291-$298), which had been the key supplier of clear aligners to SDC, and an owner of 17% of the company's outstanding shares. As part of that deal, SmileDirect would only sell its aligners directly to consumers—a move which had alienated dentists. The company said it was no longer beholden to that 2016 contract (ALGN no longer owns the 17% stake), and that it would make its own aligners at the firm's manufacturing facility in Antioch, Tennessee. While SDC shares were spiking, ALGN shares were off around 2% on the news. Will dentists be willing to embrace a former competitor and sell the SmileDirectClub aligners? Considering the aligners will now come with an in-office option, meaning all work can be done under the supervision of the family dentist, our guess is yes. Align appears to be the one left out in the cold.
Food Products
Don't look now, but Beyond Meat is up 54% year-to-date, and we are only eight trading days in. As we have bloviated about any number of times, we bought plant-based "meat" company Beyond Meat (BYND $26-$116-$240) within minutes of it going public back on May 2nd. It came out of the gate trading around $52 per share, and proceeded to climb all the way up to $240/share by mid-summer. We bought Beyond as an investment, not a trade, within the Penn New Frontier Fund, so we did get a little slack when we stood by the firm as the shares came falling back to earth, dropping into the mid-$70s range. Now, all of a sudden, shares of BYND have climbed 54% within eight trading days on the back of very little groundbreaking news. One catalyst came when privately-held competitor Impossible Foods announced it didn't have the product to satisfy a potential McDonald's (MCD) deal, but that was a big nothing-burger: the world's largest fast-food chain was already experimenting with the PLT (plant, lettuce, and tomato) in Canada, a proprietary blend using Beyond Meat's product. We continue to believe that an enormous deal with MCD is in the works. CEO Ethan Brown is a visionary, and a uniquely-dynamic leader. While we aren't ready to compare him to a Jobs or a Musk, we have no doubt that Beyond will continue to be the benchmark alt-meat producer for other to follow. We also believe this industry will climb to a size few currently envision. Would we still buy in at $116 per share? No doubt.
Pharmaceuticals
The next big wave in knock-off drugs might not be generics, exactly. They're known as "me too" drugs—compounds that copy the biological function of existing drugs, but which have a different enough molecular structure (which differentiates them from generics) to avoid patent infringement. Of most importance to patients: these drugs may cost as little as 20% of the therapy they are emulating; considering some of these treatments cost hundreds of thousands a year, that is a big deal. One new startup in particular, EQRx Inc, backed by private equity funding from the likes of Andreesen Horowitz and Google Ventures (now "GV"), plans to bring nearly a dozen of these "me too" drugs to the market relatively soon. While the typical drug costs around $2 billion to develop, EQRx believes they can cut those costs to under $400 million apiece, mainly by utilizing new technologies to increase efficiencies in the lab. While companies such as EQRx will face backlash on a myriad of fronts, from well-established competitors to the FDA to insurers and PBMs, their model may just usher in a new, simpler pricing structure and lower overall costs for patients. While EQRx is not publicly traded, an interesting generic drug play right now might be Israeli-based Teva Pharmaceuticals Industries (TEVA $6-$9-$20), the largest generic drug manufacturer in the world, which is trading more than 50% off of its 52-week high.
Robotics & Industrial Machinery
Walmart is about to launch a new robotic workforce at its stores. Remember when you would go to the store to pick up a few items, find the shortest checkout lane, then proceed to get stuck behind someone reaching down to leisurely pull out their checkbook? It may seem archaic, but that scenario was commonplace not all that long ago. Now, with debit cards, smartphones, and self-checkout lanes, that problem has been alleviated, but stores are still struggling with the critical task of keeping items in stock. Walmart (WMT $93-$116-$125), the world's largest brick-and-mortar retailer, has a tactical plan to change that: deploy an army of six-foot-tall shelf-scanning robotic workers to diligently roam each aisle, sending alerts to employees' hand-held devices when an item is out of stock. Within relatively short order, Walmart will have over 1,000 of the robots, designed by privately-held Bossa Nova Robotics, roaming through its stores. While Walmart hasn't released the metrics, the company's senior vice president of store innovations said the enhancements will greatly reduce the odds of an item not being available to shoppers. While Bossa Nova is supplying the current crop of robot workers, Simbe Robotics has a competing device. Both of these tech companies are US-based. While Bossa Nova and Simbe are privately-held, NCR Corp (NCR $25-$35-$36), which has supplied Walmart with self-checkouts for years and cash registers for decades, will service the robotic workforce.
Global Strategy: East/Southeast Asia
Communist China dealt another political blow as Taiwan elections turn out a lot like the Hong Kong elections. Under two months ago, the Hong Kong electorate overwhelmingly voted for pro-democracy candidates to fill seats in the island's legislature, sending shock waves through the Communist Party of China (CPC). This past weekend, voters in Taiwan sent a similar message to Beijing. A staunch defender of Taiwan's freedom from the CPC, President Tsai Ing-wen won re-election in a historic landslide, badly setting back China's aims to gain more control over the island. 8.2 million voters, almost precisely one-third of the island's total population, voted for Ms. Tsai, the largest vote ever recorded in Taiwan. China had embarked on a stealthy campaign to unseat Tsai, using tactics such as military drills in the waters around the island, and stronger control of travel between the mainland and Taiwan. It appears these tactics backfired badly, with increased sympathy from the Taiwanese people to the plight of pro-democracy demonstrators in Hong Kong. It also didn't help that Beijing reiterated its claim that Taiwan is part of its territory. China has pushed for its so-called "one country, two systems" framework to be adopted by Taiwan, but the citizens are getting a first-hand look at the illusion of that promise through what is going on in Hong Kong. In a speech following her landslide win, Tsai commented on the special relationship Taiwan has with the United States—comments that probably enraged many in the CPC. The Communist Chinese Party had already internalized what its own highly-political press corps was spewing, backed up by the dupes in the American press corps: that China's rise to the leading economic power in the world was already set in stone. Reports of that rise, as the old joke goes, have been highly exaggerated.
Consumer Cyclical: Leisure
Six Flags plummets nearly 18% over concerns about the completion of its planned China theme parks. Shares of Six Flags Entertainment Corp (SIX $41-$36-$64) plunged below their 52-week lows following the company's ominous warnings about its planned theme parks in China—problems so dire that they may lead to the cancellation of the build altogether. It seems as though Six Flags' Chinese development partner, Riverside Investment Group, has defaulted on its required payments to the company, and unless additional funding can be secured all construction will halt. Getting all the bad news out at once, the Texas-based amusement park operator also warned of a fourth quarter revenue drop, perhaps $8 million to $10 million less than it made in the same quarter a year earlier. For investors buying into SIX for its dividend yield—now 9.14% after the most recent share price drop—be forewarned, it is doubtful that the company can keep that rate intact. Between 2010 and 2018, shares of SIX rose nearly 650%; since 2018, they have plunged from $73 per share to $36 per share. Relying solely on its 25 theme parks for revenue, we don't see a catalyst for future growth. Even though they may appear cheap, we wouldn't touch the shares—especially since China was supposed to be their next growth engine.
Headlines for the Week of 05 Jan 2020—11 Jan 2020
Market Risk Management
Don't let the market's odd reaction to an Iranian attack allow you to become complacent. We've seen a lot of counter-intuitive behavior in the markets over twenty-two years of managing assets, but that doesn't mean they can't still surprise. For example, we expect a temporary pullback in stocks—especially high-growth names—at some point in the first quarter. We also expect, as our headline image might suggest, that the catalyst will come from the Middle East. So, after watching Dow futures fall over 400 points as Iran was lobbing missiles at bases in Iraq which house US troops, we figured the catalyst was set in motion. The tragic icing on the cake of our anticipated scenario was a deadly 737 crash over Iran. Oil and gold would spike the next day (today), while the markets would plummet. Instead, the Dow ended the session up 160 points, and both oil and gold prices fell. Granted, the president's remarks helped, as did some tweets coming from Iran, but an about face in such a short amount of time was impressive. We've seen this movie before. Just when it seems as though the Teflon market is impervious to bad news, it tends to pull out a bat and wallop investors. We continue to remain positive on the markets for 2020 (actually, we have become more bullish since fall), but we will have frightening pullbacks. In our Outlook 2020 report we comment that "a 10% pullback at some point in Q1 seems reasonable." Of course, just when the hyperbolic headlines begin to foment mass selling, markets make a u-turn and regain old highs. And that is part of the beauty of the stock market. Although my background is in finance, in hindsight I would have loved to get a secondary degree in psychology. From the arrogance of EMH (efficient market hypothesis) to the fear that peaks as the market troughs, an investor can be very successful by being a contrarian and not following the crowd. With the amount of data we now have available at our fingertips, and all of the "experts" telling us what it means, that has never been a more relevant statement.
Aerospace & Defense
Yet another deadly crash for Boeing—more evidence that the board needs to be broomed. When a CEO needs to go, a company's board of directors can step in and make that happen. But what happens when the board itself needs to be broomed? An activist hedge fund manager can make that happen, but when the company has a $200 billion market cap like Boeing (BA $320-$333-$446), it would take some impressively deep pockets to supplant even one board member. Institutions—think mutual funds—own 69% of Boeing's outstanding shares, so it may be time for them to band together and demand change, but more than likely they will just sell more shares. The catalyst for my most recent dive into exactly who sits on the board of directors (each of whom making about $350k per year for their "expertise") was yet another 737 crash, killing all on board. This happened shortly after the aircraft took off from Iran, headed for Kiev. While this 737 wasn't the MAX version which was involved in the last two crashes, that may be even worse for the company. Passengers already don't want to fly the MAX, but now they may be thinking about their safety on any 737. The aircraft was only three years off the assembly line. Not good. After reviewing the board, which is stuffed with seemingly political appointees, I took a look at the company's recent news releases on their investor site. The first headline that caught my eye was this: "Boeing Starliner Completes First Orbital Test with Successful Landing." Um, OK. But I watched the launch and followed the failed mission. Inside the report, two sentences out of eight paragraphs mentioned the "anomoly" which caused the mission to fail. The remaining sentences sang the praises of the "historic" flight. I can understand putting a positive spin on corporate news, but please. Arrogance and tone-deafness seem to permeate this organization's leadership. What makes us the most angry about Boeing's nightmare condition (actually, the word "nightmare" should be reserved for the latest victims' families) is the fact that this company is one of the crown jewels of American economic might. We never expected this to happen. Now that it has, however, it is time for someone to take charge and clean up the mess. And that means making massive changes to management and the "independent" board.
Biotechnology
Cancer death rates in the US drop most on record on back of advances in treatment and early detection. According to new data compiled by the American Cancer Society, the death rate from the disease dropped 2.2% in the one year period between 2016 and 2017 (the most recent data available), representing the largest one-year drop on record. The most impressive declines came in the areas of lung cancer and melanoma, helped by successful new therapies from firms such as Roche (RHHVF $326) and Bristol-Myers Squibb (BMY $64). Strong progress was also noted in the areas of prostate, breast, and colorectal cancers, primarily driven by new diagnostic tools from the likes of Exact Sciences (EXAS $100), maker of the Cologuard® colon cancer screening kit, and Illumina (ILMN $330), which is developing a broad cancer profiling test. Most impressively, the total death rate linked to cancer has fallen by nearly one-third over the past generation. Changes in lifestyle behavior, such as a reduction in smoking rates, were also cited in the study. We are entering the golden age of cancer treatment and, dare we say, cancer cures thanks to the "fifth pillar" of cancer care—gene therapy and immunotherapy. In this weekend's Penn Wealth Report, we will name our favorite biotech company engaged in this exciting new frontier, but here's our favorite basket of biotech holdings: the SPDR® S&P Biotech ETF, symbol XBI.
Space Sciences & Exploration
The United States Space Force officially completes its first launch with the SpaceX Falcon 9. A historic day. The United States Space Force (USSF) just kicked off its existence by managing the first launch of 2020, a SpaceX Falcon 9 rocket carrying the third batch of sixty Starlink satellites into orbit. The USSF operation went flawlessly, with the first stage of the Falcon 9 rocket, which was making its fourth flight, touching down perfectly on its drone ship landing platform named "Of Course I Still Love You." With 162 Starlink satellites currently in orbit, SpaceX is now in charge of the world's largest commercial satellite constellation. The company plans to begin operating the network, which will ultimately provide high-speed, low-latency internet access across the globe—no matter how remote the location, later this year. Launches are inherently risky, but SpaceX is making the event seem commonplace—an enormous milestone for spaceflight, and one which has never existed before. The company's most important test to date will come later this year when SpaceX astronauts make the maiden (manned) voyage aboard the Crew Dragon space capsule.
Medical Devices
SmileDirectClub soars after announcing suite of oral care products for Walmart. It has been a rough slog for SmileDirectClub (SDC $8-$10-$21) since the orthodontics equipment maker went public back in September of 2019. After coming out of the gate at $23, shares quickly dropped to $16.67 by the end of IPO day. From there, it was a relatively straight shot down to $7.56 per share, a mark hit on 12 Dec as the rest of the market was in rally mode. Now, however, the company's shares received a much needed boost—jumping 21% in one day—after announcing a new line of oral care products which will be available exclusively at Walmart (WMT). While the company won't offer its primary product, the teeth aligners, the line will include an electric toothbrush, a premium teeth whitening system (complete with LED light), toothpastes, and an ultrasonic UV cleaner. Analyst firm Craig-Hallum initiated coverage of SDC with a Buy rating and a $20 price target on the shares. We were about as down as one could be on shares of SDC, considering the copious field of competitors in the space. That being said, we love this strategic move to diversify their business by landing Walmart as a customer. We don't have the conviction to pull the trigger and buy shares just yet, despite the $10 price tag, but Craig-Hallum might have made a brilliant call. Time will tell.
Precious Metals
Our gold investment continues to pay off, and we are not even thinking about taking profits. On 03 Jan 2019, almost precisely one year ago, we told readers that we were buying gold in the Penn Dynamic Growth Strategy via the SPDR® Gold Shares ETF (GLD $120-$148-$148). One year later and the precious metal, known for its ability to attract buyers during volatile environments, looks as good to us now as it did back then. Despite the fact that gold just hit its highest level since 2013 ($1,590.90 intraday), there are a number of reasons it still has room to run. First and foremost, geopolitical tensions are near the boiling point, and we see that continuing throughout the year. Secondly, fiscal irresponsibility continues to run rampant around the globe. Our own $23 trillion national debt, which grows by $1 trillion per year, is probably the envy of leaders in the EU, who just can't seem to spend enough. Right now, we are nearing in on ten cents out of every dollar the government collects going to servicing the national debt—the "interest" portion. And that is with incredibly-low interest rates. If inflation took off again and interest rates doubled around the world (not a far stretch, considering the $12 trillion worth of negative rate bonds out there), that would mean roughly one-fifth of what the government takes in would go to simply service the debt. Unsustainable. No, really: UNSUSTAINABLE. If the government is taking $2 trillion from us each year in taxes and other revenue, but spending $3 trillion each year via the budget, what happens when the economy contracts again? All more fodder in the bullish case for gold. It may seem like I am going off on a tangent here but I'm not: if three-quarters of the states affirmed two constitutional amendments—term limits and a balanced budget amendment—we could finally begin tackling the problem of our monstrous national debt (and gold might not be such an attractive investment). Here's the problem: two-thirds of both the House and the Senate must propose such amendments before they head out to the states. But, who is even talking about either of these amendments?
Specialty Retail
Bed Bath & Beyond is selling nearly half of its real estate holdings; is that a good thing or a tactical mistake? Financial engineers call it unlocking capital. We call it giving up control. Following in what has become a common practice for retailers, especially ones under siege by activists with dollar signs in their eyes, home furnishings retailer Bed Bath & Beyond (BBBY $7-$16-$20) is selling over $250 million worth of its $587 million in real estate assets. The company will sell the 2.1 million square feet of property to Oak Street Real Estate Capital LLC, and then continue to occupy the buildings under long-term lease agreements. Why would a struggling retailer give up control of its best assets? The same reason a family in deep credit card debt would take out a second mortgage on their real estate—the home—to pay down that debt. Now, instead of being at the mercy of creditors, the company will be at the mercy of a landlord which has the right to raise their rent. And that, let's face it, is all but guaranteed. Target (TGT), our favorite retailer, rebuffed activist (and all-around punk in our opinion) Bill Ackman's Pershing Square when it insisted the chain begin selling properties. Barneys New York took the Bed Bath & Beyond route, selling its real estate and leasing the properties back. That company was forced into bankruptcy after their landlord nearly doubled the rent on its Madison Avenue store. Under new management, Bed Bath & Beyond is trying to pry itself away from its coupon-offering culture. There is one major problem with that: the last ten times we went into a BBBY store it was as a direct result of receiving one of those coupons. This reminds us of what the hapless Ron Johnson tried to do at JC Penney (JCP $1), and we know how that turned out.
Maritime
Global shipping industry is getting its groove back, spurred by economics, trade, and geopolitics. Not long ago, we discussed "The State of Global Shipping" in an issue of The Penn Wealth Report (see From the Archives section below). We compared the industry, which had been decimated by the trade war and global economic slowdown, to Bank of America (BAC), which was selling for $2.53 during the height of the financial crisis. In other words, look for this industry to come roaring back. Specifically, we mentioned picking up Nordic American Tankers (NAT) at $2.10 per share. On Friday, NAT hit $5.05 per share, and tanker stocks are soaring as trade tensions ease and geopolitical tensions in the Middle East heat up. Management at NAT just issued a press release outlining how much revenue is now being generated from their vessels' spot voyages. In short, it is a lot higher than it was a year ago. And we see this comeback story continuing in 2020. We believe global growth has troughed and should pick back up over the coming quarters. This should certainly help the bottom line of quality shipping companies. The industry can be challenging to navigate, however; we recommend members re-visit the Penn Wealth Report story, which briefly discusses fundamentals, chief players, and industry trends.
Don't let the market's odd reaction to an Iranian attack allow you to become complacent. We've seen a lot of counter-intuitive behavior in the markets over twenty-two years of managing assets, but that doesn't mean they can't still surprise. For example, we expect a temporary pullback in stocks—especially high-growth names—at some point in the first quarter. We also expect, as our headline image might suggest, that the catalyst will come from the Middle East. So, after watching Dow futures fall over 400 points as Iran was lobbing missiles at bases in Iraq which house US troops, we figured the catalyst was set in motion. The tragic icing on the cake of our anticipated scenario was a deadly 737 crash over Iran. Oil and gold would spike the next day (today), while the markets would plummet. Instead, the Dow ended the session up 160 points, and both oil and gold prices fell. Granted, the president's remarks helped, as did some tweets coming from Iran, but an about face in such a short amount of time was impressive. We've seen this movie before. Just when it seems as though the Teflon market is impervious to bad news, it tends to pull out a bat and wallop investors. We continue to remain positive on the markets for 2020 (actually, we have become more bullish since fall), but we will have frightening pullbacks. In our Outlook 2020 report we comment that "a 10% pullback at some point in Q1 seems reasonable." Of course, just when the hyperbolic headlines begin to foment mass selling, markets make a u-turn and regain old highs. And that is part of the beauty of the stock market. Although my background is in finance, in hindsight I would have loved to get a secondary degree in psychology. From the arrogance of EMH (efficient market hypothesis) to the fear that peaks as the market troughs, an investor can be very successful by being a contrarian and not following the crowd. With the amount of data we now have available at our fingertips, and all of the "experts" telling us what it means, that has never been a more relevant statement.
Aerospace & Defense
Yet another deadly crash for Boeing—more evidence that the board needs to be broomed. When a CEO needs to go, a company's board of directors can step in and make that happen. But what happens when the board itself needs to be broomed? An activist hedge fund manager can make that happen, but when the company has a $200 billion market cap like Boeing (BA $320-$333-$446), it would take some impressively deep pockets to supplant even one board member. Institutions—think mutual funds—own 69% of Boeing's outstanding shares, so it may be time for them to band together and demand change, but more than likely they will just sell more shares. The catalyst for my most recent dive into exactly who sits on the board of directors (each of whom making about $350k per year for their "expertise") was yet another 737 crash, killing all on board. This happened shortly after the aircraft took off from Iran, headed for Kiev. While this 737 wasn't the MAX version which was involved in the last two crashes, that may be even worse for the company. Passengers already don't want to fly the MAX, but now they may be thinking about their safety on any 737. The aircraft was only three years off the assembly line. Not good. After reviewing the board, which is stuffed with seemingly political appointees, I took a look at the company's recent news releases on their investor site. The first headline that caught my eye was this: "Boeing Starliner Completes First Orbital Test with Successful Landing." Um, OK. But I watched the launch and followed the failed mission. Inside the report, two sentences out of eight paragraphs mentioned the "anomoly" which caused the mission to fail. The remaining sentences sang the praises of the "historic" flight. I can understand putting a positive spin on corporate news, but please. Arrogance and tone-deafness seem to permeate this organization's leadership. What makes us the most angry about Boeing's nightmare condition (actually, the word "nightmare" should be reserved for the latest victims' families) is the fact that this company is one of the crown jewels of American economic might. We never expected this to happen. Now that it has, however, it is time for someone to take charge and clean up the mess. And that means making massive changes to management and the "independent" board.
Biotechnology
Cancer death rates in the US drop most on record on back of advances in treatment and early detection. According to new data compiled by the American Cancer Society, the death rate from the disease dropped 2.2% in the one year period between 2016 and 2017 (the most recent data available), representing the largest one-year drop on record. The most impressive declines came in the areas of lung cancer and melanoma, helped by successful new therapies from firms such as Roche (RHHVF $326) and Bristol-Myers Squibb (BMY $64). Strong progress was also noted in the areas of prostate, breast, and colorectal cancers, primarily driven by new diagnostic tools from the likes of Exact Sciences (EXAS $100), maker of the Cologuard® colon cancer screening kit, and Illumina (ILMN $330), which is developing a broad cancer profiling test. Most impressively, the total death rate linked to cancer has fallen by nearly one-third over the past generation. Changes in lifestyle behavior, such as a reduction in smoking rates, were also cited in the study. We are entering the golden age of cancer treatment and, dare we say, cancer cures thanks to the "fifth pillar" of cancer care—gene therapy and immunotherapy. In this weekend's Penn Wealth Report, we will name our favorite biotech company engaged in this exciting new frontier, but here's our favorite basket of biotech holdings: the SPDR® S&P Biotech ETF, symbol XBI.
Space Sciences & Exploration
The United States Space Force officially completes its first launch with the SpaceX Falcon 9. A historic day. The United States Space Force (USSF) just kicked off its existence by managing the first launch of 2020, a SpaceX Falcon 9 rocket carrying the third batch of sixty Starlink satellites into orbit. The USSF operation went flawlessly, with the first stage of the Falcon 9 rocket, which was making its fourth flight, touching down perfectly on its drone ship landing platform named "Of Course I Still Love You." With 162 Starlink satellites currently in orbit, SpaceX is now in charge of the world's largest commercial satellite constellation. The company plans to begin operating the network, which will ultimately provide high-speed, low-latency internet access across the globe—no matter how remote the location, later this year. Launches are inherently risky, but SpaceX is making the event seem commonplace—an enormous milestone for spaceflight, and one which has never existed before. The company's most important test to date will come later this year when SpaceX astronauts make the maiden (manned) voyage aboard the Crew Dragon space capsule.
Medical Devices
SmileDirectClub soars after announcing suite of oral care products for Walmart. It has been a rough slog for SmileDirectClub (SDC $8-$10-$21) since the orthodontics equipment maker went public back in September of 2019. After coming out of the gate at $23, shares quickly dropped to $16.67 by the end of IPO day. From there, it was a relatively straight shot down to $7.56 per share, a mark hit on 12 Dec as the rest of the market was in rally mode. Now, however, the company's shares received a much needed boost—jumping 21% in one day—after announcing a new line of oral care products which will be available exclusively at Walmart (WMT). While the company won't offer its primary product, the teeth aligners, the line will include an electric toothbrush, a premium teeth whitening system (complete with LED light), toothpastes, and an ultrasonic UV cleaner. Analyst firm Craig-Hallum initiated coverage of SDC with a Buy rating and a $20 price target on the shares. We were about as down as one could be on shares of SDC, considering the copious field of competitors in the space. That being said, we love this strategic move to diversify their business by landing Walmart as a customer. We don't have the conviction to pull the trigger and buy shares just yet, despite the $10 price tag, but Craig-Hallum might have made a brilliant call. Time will tell.
Precious Metals
Our gold investment continues to pay off, and we are not even thinking about taking profits. On 03 Jan 2019, almost precisely one year ago, we told readers that we were buying gold in the Penn Dynamic Growth Strategy via the SPDR® Gold Shares ETF (GLD $120-$148-$148). One year later and the precious metal, known for its ability to attract buyers during volatile environments, looks as good to us now as it did back then. Despite the fact that gold just hit its highest level since 2013 ($1,590.90 intraday), there are a number of reasons it still has room to run. First and foremost, geopolitical tensions are near the boiling point, and we see that continuing throughout the year. Secondly, fiscal irresponsibility continues to run rampant around the globe. Our own $23 trillion national debt, which grows by $1 trillion per year, is probably the envy of leaders in the EU, who just can't seem to spend enough. Right now, we are nearing in on ten cents out of every dollar the government collects going to servicing the national debt—the "interest" portion. And that is with incredibly-low interest rates. If inflation took off again and interest rates doubled around the world (not a far stretch, considering the $12 trillion worth of negative rate bonds out there), that would mean roughly one-fifth of what the government takes in would go to simply service the debt. Unsustainable. No, really: UNSUSTAINABLE. If the government is taking $2 trillion from us each year in taxes and other revenue, but spending $3 trillion each year via the budget, what happens when the economy contracts again? All more fodder in the bullish case for gold. It may seem like I am going off on a tangent here but I'm not: if three-quarters of the states affirmed two constitutional amendments—term limits and a balanced budget amendment—we could finally begin tackling the problem of our monstrous national debt (and gold might not be such an attractive investment). Here's the problem: two-thirds of both the House and the Senate must propose such amendments before they head out to the states. But, who is even talking about either of these amendments?
Specialty Retail
Bed Bath & Beyond is selling nearly half of its real estate holdings; is that a good thing or a tactical mistake? Financial engineers call it unlocking capital. We call it giving up control. Following in what has become a common practice for retailers, especially ones under siege by activists with dollar signs in their eyes, home furnishings retailer Bed Bath & Beyond (BBBY $7-$16-$20) is selling over $250 million worth of its $587 million in real estate assets. The company will sell the 2.1 million square feet of property to Oak Street Real Estate Capital LLC, and then continue to occupy the buildings under long-term lease agreements. Why would a struggling retailer give up control of its best assets? The same reason a family in deep credit card debt would take out a second mortgage on their real estate—the home—to pay down that debt. Now, instead of being at the mercy of creditors, the company will be at the mercy of a landlord which has the right to raise their rent. And that, let's face it, is all but guaranteed. Target (TGT), our favorite retailer, rebuffed activist (and all-around punk in our opinion) Bill Ackman's Pershing Square when it insisted the chain begin selling properties. Barneys New York took the Bed Bath & Beyond route, selling its real estate and leasing the properties back. That company was forced into bankruptcy after their landlord nearly doubled the rent on its Madison Avenue store. Under new management, Bed Bath & Beyond is trying to pry itself away from its coupon-offering culture. There is one major problem with that: the last ten times we went into a BBBY store it was as a direct result of receiving one of those coupons. This reminds us of what the hapless Ron Johnson tried to do at JC Penney (JCP $1), and we know how that turned out.
Maritime
Global shipping industry is getting its groove back, spurred by economics, trade, and geopolitics. Not long ago, we discussed "The State of Global Shipping" in an issue of The Penn Wealth Report (see From the Archives section below). We compared the industry, which had been decimated by the trade war and global economic slowdown, to Bank of America (BAC), which was selling for $2.53 during the height of the financial crisis. In other words, look for this industry to come roaring back. Specifically, we mentioned picking up Nordic American Tankers (NAT) at $2.10 per share. On Friday, NAT hit $5.05 per share, and tanker stocks are soaring as trade tensions ease and geopolitical tensions in the Middle East heat up. Management at NAT just issued a press release outlining how much revenue is now being generated from their vessels' spot voyages. In short, it is a lot higher than it was a year ago. And we see this comeback story continuing in 2020. We believe global growth has troughed and should pick back up over the coming quarters. This should certainly help the bottom line of quality shipping companies. The industry can be challenging to navigate, however; we recommend members re-visit the Penn Wealth Report story, which briefly discusses fundamentals, chief players, and industry trends.
Headlines for the Week of 29 Dec 2019—04 Jan 2020
Market Watch
The last trading day of the December is all green, which is fitting for the year we just had. The Dow gained 76 points for the day and 22% for the year; the S&P gained 9 points for the day and 29% for the year; the tech-heavy NASDAQ gained 27 points for the day and a whopping 35% for the year. What a fitting last day to a pretty remarkable year. We had our scares in May and August, and our fill of trade war drama, but it would be hard to write a much better script for investors than what actually happened in 2019. Even bond holdings, buoyed by the Fed lowering rates, gained value over the course of the year. Now, we can briefly celebrate, but then we must get on with 2020—a much different beast. Although we feel better about the year ahead than we have at any other point in the past six months, the P/E ratio of the S&P 500 is sitting at a rather fat 24, and plenty of landmines are still out there. In other words, it wouldn't take much of a catalyst to start a first-quarter pullback (which we expect, by the way). But let's take some time and bask in the glow of a quite successful 2019. Our 2020 Outlook report will be released soon, but here are a few ticklers: Bonds won't have a good year, so fixed income investors will look for yield in Blue Chip stocks. Emerging markets will make a big rebound—but be selective, as some areas will flounder. Gold will shine, and oil will surprise. And then there's biotech.... Stay tuned.
Automotive
Ghosn's Great Escape: we feel a Netflix movie coming. While we have never been big fans of former Nissan/Renault chief Carlos Ghosn due, in part, to his extreme arrogance—even for a French CEO (actually, he is a Brazilian-born French businessman of Lebanese ancestry), we found ourselves actually rooting for him in this case. For over a year, Ghosn has been imprisoned in Japan on charges of corruption and misappropriation of funds while head of the Japanese/European conglomerate (Ghosn was CEO of Alliance, the partnership between Renault, Nissan, and Mitsubishi). For some reason still not fully understood, he was often kept in a small cell with little access to his loved ones or even his lawyer. It looked a little bit more like Midnight Express (great movie, Turkish prison) than it did justice in a democracy. Ghosn, who was finally released from prison and on house arrest while awaiting his trial, which was due to take place sometime in 2020, finally made his great escape. With wild rumors circulating of just how he pulled off the stunt (one involved him being hidden in a crate filled with musical instruments), one thing is certain: Ghosn escaped Japan and is now in his childhood home of Lebanon, hailed as some type of fugitive hero. Not only is he somewhat of a folk hero in Lebanon, which once issued a stamp with his likeness on the face, the country has no extradition arrangement with Japan, so odds are about zero that he will ever up back in Tokyo. As for the charges, Japan argues he misappropriated the funds to fuel his extravagant lifestyle, but others believe Nissan executives set him up as payback for Renault's growing power over the Japanese automaker. Either or both seem plausible to us. Nonetheless, he will now face trial in absentia. It truly is a story ready-made for TV. As Ghosn is not shy of the camera, it will be interesting to hear what he has to say over the coming weeks.
Judicial Watch
Uber and Postmates take the gloves off, sue California over slanted gig law. It is known as Assembly Bill 5, or simply AB5, and its goal is clear: force companies which operate within the "gig economy" to label workers as employees rather than independent contractors, whether those workers wish to be considered employees (they don't) or not. And it is clearly aimed at companies such as Uber (UBER $29), Lyft (LYFT $43), DoorDash, Postmates, and other innovative firms. AB5 would require companies to offer workers all the benefits traditional employees receive, such as paid time off, sick leave, unemployment, and other benefits. Now, Uber and Postmates are fighting back against the law, which is set to go into effect in California on New Year's Day. The firms are suing both the state and Attorney General Xavier Becerra, calling the legislation unconstitutional as it targets only certain workers and companies. Despite the hyperbolic bull being thrown around by the state, the new law is unconstitutional, and it will ultimately be struck down by the judicial system. The question for firms like Uber and Postmates is this: what happens between January 1st and the inevitable final ruling? This bill, soon to become law, is a glaring example of why companies are flooding out of California for greener pastures. Much like with China, however, too many companies cannot simply cease doing business in the region, no matter how warped the government becomes.
Global Strategy: Latin America
Bolivia ratchets up the pressure on Mexico and Spain after those countries show support for former president (and dictator) Morales. Back on 11 Nov, we reported on Evo Morales' fall from grace in Bolivia following his latest fraudulent election win. After members of the South American nation's military walked off their respective posts, including those stationed around the presidential palace, the dictator was forced to flee, seeking refuge in Mexico while his minions fled to the Mexican embassy in La Paz, Bolivia. Now, after uncovering further evidence that both Mexico and Spain have been aiding and abetting members of the Morales regime, Bolivia's acting president, Jeanine Anez, has given the Mexican ambassador and two high-ranking Spanish diplomats 72 hours to leave the country. Bolivia is demanding that Mexico hand over the officials in the embassy who have outstanding arrest warrants. As for Spain's role, a number of Spanish embassy officials—accompanied by security officers—attempted to sneak into the Mexican residence in La Paz in a probable attempt to move the asylum seekers. Spain has officially denied the charges, saying the diplomats just wished to visit. While Morales has now left Mexico City for the open arms of Argentina (and the newly-elected socialist Fernandez/Kirchner regime), this case buttresses our argument that Mexico is reverting back to its own leftist, anti-capitalist roots. While emerging markets will have a strong year ahead, Mexico won't be part of that movement.
Aerospace & Defense
Despite a new CEO, steer clear of Boeing. About two weeks before he was canned as CEO, the now out-of-work Boeing (BA $309-$331-$446) chief Dennis Muilenburg was given high praise by the company's chairman, David Calhoun. "Dennis has done everything right," Calhoun fervently proclaimed. "We stick by him completely." Granted, that kind of talk by a board member is often a kiss of death akin to a team being featured on the cover of Sports Illustrated, but watching Calhoun speak those words we got the sense that he was being fully sincere. And, if he was being sincere, Boeing investors have much to worry about: Calhoun will be taking over as the new permanent CEO of the Chicago-based aerospace giant in January. Earlier in the month we said that Boeing needs dynamic new leadership to pull itself out of its nosedive; instead, we got a failed Starliner mission and a warmed-over board member taking the helm. And the more digging we did, the more troubling the outlook. For example, why is Caroline Kennedy one of the thirteen board members? Why are there so many board members? Why do so few have aerospace experience? Why is the median pay of the board—$346,000 per year—so high? Which leads us to the most important—and most disconcerting—question: who will hold the board accountable? For the vast majority of the past 22 years, we have held Boeing within our clients' portfolios. Presciently, we got out of the stock between the first and second 747 MAX crashes. Boeing is an integral part of the American economy, and it is almost criminal that the management team—at least in our opinion—is so woefully unprepared to lead the company back to its former greatness.
The last trading day of the December is all green, which is fitting for the year we just had. The Dow gained 76 points for the day and 22% for the year; the S&P gained 9 points for the day and 29% for the year; the tech-heavy NASDAQ gained 27 points for the day and a whopping 35% for the year. What a fitting last day to a pretty remarkable year. We had our scares in May and August, and our fill of trade war drama, but it would be hard to write a much better script for investors than what actually happened in 2019. Even bond holdings, buoyed by the Fed lowering rates, gained value over the course of the year. Now, we can briefly celebrate, but then we must get on with 2020—a much different beast. Although we feel better about the year ahead than we have at any other point in the past six months, the P/E ratio of the S&P 500 is sitting at a rather fat 24, and plenty of landmines are still out there. In other words, it wouldn't take much of a catalyst to start a first-quarter pullback (which we expect, by the way). But let's take some time and bask in the glow of a quite successful 2019. Our 2020 Outlook report will be released soon, but here are a few ticklers: Bonds won't have a good year, so fixed income investors will look for yield in Blue Chip stocks. Emerging markets will make a big rebound—but be selective, as some areas will flounder. Gold will shine, and oil will surprise. And then there's biotech.... Stay tuned.
Automotive
Ghosn's Great Escape: we feel a Netflix movie coming. While we have never been big fans of former Nissan/Renault chief Carlos Ghosn due, in part, to his extreme arrogance—even for a French CEO (actually, he is a Brazilian-born French businessman of Lebanese ancestry), we found ourselves actually rooting for him in this case. For over a year, Ghosn has been imprisoned in Japan on charges of corruption and misappropriation of funds while head of the Japanese/European conglomerate (Ghosn was CEO of Alliance, the partnership between Renault, Nissan, and Mitsubishi). For some reason still not fully understood, he was often kept in a small cell with little access to his loved ones or even his lawyer. It looked a little bit more like Midnight Express (great movie, Turkish prison) than it did justice in a democracy. Ghosn, who was finally released from prison and on house arrest while awaiting his trial, which was due to take place sometime in 2020, finally made his great escape. With wild rumors circulating of just how he pulled off the stunt (one involved him being hidden in a crate filled with musical instruments), one thing is certain: Ghosn escaped Japan and is now in his childhood home of Lebanon, hailed as some type of fugitive hero. Not only is he somewhat of a folk hero in Lebanon, which once issued a stamp with his likeness on the face, the country has no extradition arrangement with Japan, so odds are about zero that he will ever up back in Tokyo. As for the charges, Japan argues he misappropriated the funds to fuel his extravagant lifestyle, but others believe Nissan executives set him up as payback for Renault's growing power over the Japanese automaker. Either or both seem plausible to us. Nonetheless, he will now face trial in absentia. It truly is a story ready-made for TV. As Ghosn is not shy of the camera, it will be interesting to hear what he has to say over the coming weeks.
Judicial Watch
Uber and Postmates take the gloves off, sue California over slanted gig law. It is known as Assembly Bill 5, or simply AB5, and its goal is clear: force companies which operate within the "gig economy" to label workers as employees rather than independent contractors, whether those workers wish to be considered employees (they don't) or not. And it is clearly aimed at companies such as Uber (UBER $29), Lyft (LYFT $43), DoorDash, Postmates, and other innovative firms. AB5 would require companies to offer workers all the benefits traditional employees receive, such as paid time off, sick leave, unemployment, and other benefits. Now, Uber and Postmates are fighting back against the law, which is set to go into effect in California on New Year's Day. The firms are suing both the state and Attorney General Xavier Becerra, calling the legislation unconstitutional as it targets only certain workers and companies. Despite the hyperbolic bull being thrown around by the state, the new law is unconstitutional, and it will ultimately be struck down by the judicial system. The question for firms like Uber and Postmates is this: what happens between January 1st and the inevitable final ruling? This bill, soon to become law, is a glaring example of why companies are flooding out of California for greener pastures. Much like with China, however, too many companies cannot simply cease doing business in the region, no matter how warped the government becomes.
Global Strategy: Latin America
Bolivia ratchets up the pressure on Mexico and Spain after those countries show support for former president (and dictator) Morales. Back on 11 Nov, we reported on Evo Morales' fall from grace in Bolivia following his latest fraudulent election win. After members of the South American nation's military walked off their respective posts, including those stationed around the presidential palace, the dictator was forced to flee, seeking refuge in Mexico while his minions fled to the Mexican embassy in La Paz, Bolivia. Now, after uncovering further evidence that both Mexico and Spain have been aiding and abetting members of the Morales regime, Bolivia's acting president, Jeanine Anez, has given the Mexican ambassador and two high-ranking Spanish diplomats 72 hours to leave the country. Bolivia is demanding that Mexico hand over the officials in the embassy who have outstanding arrest warrants. As for Spain's role, a number of Spanish embassy officials—accompanied by security officers—attempted to sneak into the Mexican residence in La Paz in a probable attempt to move the asylum seekers. Spain has officially denied the charges, saying the diplomats just wished to visit. While Morales has now left Mexico City for the open arms of Argentina (and the newly-elected socialist Fernandez/Kirchner regime), this case buttresses our argument that Mexico is reverting back to its own leftist, anti-capitalist roots. While emerging markets will have a strong year ahead, Mexico won't be part of that movement.
Aerospace & Defense
Despite a new CEO, steer clear of Boeing. About two weeks before he was canned as CEO, the now out-of-work Boeing (BA $309-$331-$446) chief Dennis Muilenburg was given high praise by the company's chairman, David Calhoun. "Dennis has done everything right," Calhoun fervently proclaimed. "We stick by him completely." Granted, that kind of talk by a board member is often a kiss of death akin to a team being featured on the cover of Sports Illustrated, but watching Calhoun speak those words we got the sense that he was being fully sincere. And, if he was being sincere, Boeing investors have much to worry about: Calhoun will be taking over as the new permanent CEO of the Chicago-based aerospace giant in January. Earlier in the month we said that Boeing needs dynamic new leadership to pull itself out of its nosedive; instead, we got a failed Starliner mission and a warmed-over board member taking the helm. And the more digging we did, the more troubling the outlook. For example, why is Caroline Kennedy one of the thirteen board members? Why are there so many board members? Why do so few have aerospace experience? Why is the median pay of the board—$346,000 per year—so high? Which leads us to the most important—and most disconcerting—question: who will hold the board accountable? For the vast majority of the past 22 years, we have held Boeing within our clients' portfolios. Presciently, we got out of the stock between the first and second 747 MAX crashes. Boeing is an integral part of the American economy, and it is almost criminal that the management team—at least in our opinion—is so woefully unprepared to lead the company back to its former greatness.
Headlines for the Week of 22 Dec 2019—28 Dec 2019
Specialty Retail
The Michaels Companies Inc gains 30% in one day as a Walmart exec takes the helm. Granted, shares of crafts specialty chain Michaels (MIK $5-$8-$16) were off around 56% YTD going into the day, but investors sure liked what they heard with respect to a management overhaul at the Irving, Texas-based firm. Ashley Buchanan will bring her twelve years of executive experience at Walmart (WMT) with her when she takes over at the struggling yet iconic brand on the 6th of January. Michaels has appeared—at least in our opinion—to be stuck in the pre-digital age, with plenty of ongoing in-store sales offered to customers, but a less-than-stellar online presence. The board hopes to turn that image around via Buchanan, who was the chief merchandising officer and chief operating officer for Walmart's domestic eCommerce business. For all its challenges (and the disastrous 2019 stock performance), Michaels' income statement seems to be on solid footing, with revenues increasing almost every year for the past decade (FY 2019 was flat), and net income remaining in the black. That being said, the company's market cap has dropped from $6.5 billion in 2016 to just $1.1 billion as Buchanan prepares to come aboard. Nonetheless, with a relatively fervent and dedicated customer base, we wouldn't write this company off just yet. It also helps that one of the company's chief competitors, A.C. Moore, announced that it would be closing all of its stores. We are rooting for Buchanan, and would love to write about her success in a year, but we sure couldn't justify buying the company—even at $8 per share.
Economics: Work & Pay
American workers are making more money, and the bottom 25% of earners are seeing the biggest spike. According to the Federal Reserve Bank of Atlanta, pay for the lowest 25% of American workers rose 4.5% over the past year—the biggest spike in over a decade. On the other side of the spectrum, the top 25% of wage earners also saw a nice jump, with a 2.9% increase year-over-year (Y/Y). This report from the Fed supports the Labor Department statistics we reported on a few weeks ago: average hourly wages for nonsupervisory and production workers (excluding government workers) rose 3.7% Y/Y. What does that equate to in dollars and cents? The average nonsupervisory worker earned just under $24 per hour in November. There are a number of reasons for the pay raises, chief among them being the lowest unemployment level in fifty years. Companies are being forced to pony up higher pay to attract or retain qualified workers, even with more formerly-discouraged workers (as tracked in the U-6 unemployment rate) re-entering the job market. All of this good news looks to carry into the new year, as the job market remains extremely tight at all levels and in all corners—with the possible exception of government workers—and the economy remains strong. For all of the talk of robots and AI stealing jobs from workers across virtually every industry, we have statistical full employment in the US right now. That being said, now is not the time for workers to get complacent. By performing a little market research, individuals can uncover developing trends within their respective line of work and take steps to remain as proficient as possible, or even seek out more promising industries.
Technology Hardware & Equipment
Another small step into vertical integration for Apple as it appears ready to buy Japanese smartphone screen maker. With its past troubles with suppliers, Apple (AAPL 142-$290-$290) has been taking steps recently to better control its supply chain. It now appears the $1.3 trillion iPhone maker is prepared to buy one of the factories that makes smartphone screens for its devices. Japan Display Inc, which has been faced with mounting financial troubles, is reportedly in talks with both Apple and Foxconn's Sharp Corp to sell the plant for as much as $820 million. The company still owes Apple over $800 million for funding the plant's construction in western Japan four years ago. More intriguing, it doesn't appear as though Apple and Sharp are engaged in a bidding war; rather, the two are discussing various ways to share the facility. Japan Display is in such deep financial trouble that it will accept 90 billion yen ($822 billion) in funding from a Japanese asset management firm in return for control of the company. One of Tim Cook's biggest headaches has revolved around the company's attempt to have some semblence of control over the network of suppliers which make components for Apple devices. Nonetheless, he has moved with extreme caution with respect to vertical integration. If this deal gets done, it will only happen after a complete and thorough due diligence process. We also like the fact that the plant is located in Japan and not China, removing more variables from the equation.
Automotive
Once again, Elon Musk gets the last laugh as short sellers take it on the chin. Most automotive industry analysts love to hate Tesla (TSLA $177-$419-$420) and its founder, Elon Musk. Perhaps it is envy, or perhaps their limited imaginations refuse to accept that a successful car company can be created out of thin air in the modern era. Whatever the reason, we have to chuckle every time Musk proves them wrong, as he just did yet again. It was a little over sixteen months ago that Musk made his infamous tweet, "Am considering taking Tesla private at $420. Funding secured." What percentage of the tweet was serious and what percentage was simply a failed attempt at some marijuana humor we may never know, but one thing is certain: the SEC didn't find it funny. The commission fined Tesla $20 million and its CEO $20 million for the pithy comment. Many who wanted Musk barred from running his company—a preposterous notion—were disappointed. Months of personal bashing ensued, and the brouhaha helped drive Tesla stock all the way down to $179 per share by the following summer. We recall analysts predicting the company's demise with unconstrained glee. Then something happened. Suddenly the carmaker began surprising to the upside on sales and deliveries (and even a profitable quarter), and the stock began its incredible 135% upward march over the course of six months. Short sellers got crushed. The funniest part of the run was that Tesla shares hit that magical $420 per share mark. Of course, that was too juicy for Musk to pass up. Within minutes he tweeted, "Whoa the stock is so high lol." Classic. Tesla is the benchmark electric vehicle maker, despite what the old, stodgy, "me too" carmakers are projecting for their own electric fleets. We expect that to continue, and we expect many profitable quarters in Tesla's future. Now, if Musk would only bring SpaceX public.
Telecommunication Services
Could Apple's secret plan to beam data via satellites impact the telecom giants? Right now, there is a battle royale going on in the federal courts over whether or not Sprint (S) and T-Mobile's (TMUS) planned merger would create an oligopoly of telecom companies in the US, with AT&T (T), Verizon (VZ), and the newly-formed S/TMUS entity in control of virtually every American's cellphone plan when 5G hits. We don't buy the argument, and believe the judge will side with the government and allow the deal to go through, but if Apple (AAPL) has its way, it may become a moot point within a few years. According to sources cited by Bloomberg, the $1.26 trillion Cupertino-based company is working on a secret plan that would allow a network of communications satellites and next-gen (5G) wireless technology to beam data directly to users' devices, potentially negating the need for wireless carriers altogether. With SpaceX deploying thousands of small satellites for what will be its Starlink constellation, and Amazon (AMZN) planning to deploy over 3,000 satellites as part of its own constellation, the idea doesn't seem that far-fetched. Certainly, massively expensive projects like the Iridium satellite boondoggle highlight the risks associated with this type of undertaking, but we believe it is a matter of when, not if. Compare these constellations to the groups of Europeans who attempted to create settlements in the New World in the 16th and 17th centuries: while the early attempts ended in tragedy, the inevitable success of the strategy was all but assured. That doesn't mean you should begin dumping your AT&T and Verizon stock just yet, however—it will take a decade (in our estimation) for these lofty plans to come to fruition. Nonetheless, it pays to be thinking a number of steps ahead when investing in the technology arena. Look for the companies which make the hardware for the satellites and their accompanying 5G terrestrial components; companies like Qualcomm (QCOM), Raytheon (RTN), and Astronics (ATRO). And move cautiously around high-flying cell tower companies like American Tower (AMT), which often carry tech-like multiples. It wouldn't take much to spook investors into taking their profits and exiting these names. Ultimately, Tim Cook may abandon this plan as too expensive, but we could see him teaming up with Elon Musk's Starlink constellation. Imagine the incredible synergies that could be created with a joint Apple and SpaceX project. (We own Apple in the Penn Global Leaders Club, and Qualcomm in the Penn New Frontier Fund.)
Aerospace & Defense
After a nightmarish year, Boeing desperately needed a win; instead it got a failed Starliner test mission. It was only fitting that CEO Dennis Muilenburg was at the launch site to watch the mission unfold. The man ultimately responsible for Boeing's (BA $292-$330-$446) success or failure witnessed a spectacular launch of the Starliner, the company's answer to SpaceX's Crew Dragon capsule designed to carry US astronauts into space. But, symbolic of Boeing's 2019, it went downhill from there. The unmanned craft, which was supposed to rendezvous and dock with the International Space Station (ISS), quickly went off course, dooming the mission. The company pointed out that the software problem which caused the malfunction could have been corrected had astronauts been onboard during the test mission, but that misses the bigger point: For a company with two recent deadly aircraft crashes in its rear view mirror, both due to a software glitch, this latest failure accentuates the negatives surrounding the firm. While Boeing's competition on the aircraft side of the business, Europe's Airbus (EADSY), gained ground after the air disasters, we expect that Elon Musk's privately-held SpaceX, whose Crew Dragon successfully docked with the ISS back in March, will garner even more favor from NASA after this failed test flight. Both companies are scheduled to have manned flights in 2020, but that has become an extremely tall task for Boeing after this latest incident. More fodder in the case to jettison Muilenburg and overhaul Boeing's board of directors. We have argued that one of the worst CEOs in the airline business is United's Oscar Munoz, who is (thankfully) stepping down from his role soon. According to the Wall Street Journal, Muilenburg turned to Munoz for advice after the two air disasters. How fitting. He needs to go now, and the company needs to find a leader like former BA CEO Jim McNerney to right the ship before more damage is done.
Update: Shortly after the previous story was written, the Boeing board of directors fired CEO Dennis Muilenburg. Chairman David Calhoun will take over as the new permanent CEO of the company in early January.
The Michaels Companies Inc gains 30% in one day as a Walmart exec takes the helm. Granted, shares of crafts specialty chain Michaels (MIK $5-$8-$16) were off around 56% YTD going into the day, but investors sure liked what they heard with respect to a management overhaul at the Irving, Texas-based firm. Ashley Buchanan will bring her twelve years of executive experience at Walmart (WMT) with her when she takes over at the struggling yet iconic brand on the 6th of January. Michaels has appeared—at least in our opinion—to be stuck in the pre-digital age, with plenty of ongoing in-store sales offered to customers, but a less-than-stellar online presence. The board hopes to turn that image around via Buchanan, who was the chief merchandising officer and chief operating officer for Walmart's domestic eCommerce business. For all its challenges (and the disastrous 2019 stock performance), Michaels' income statement seems to be on solid footing, with revenues increasing almost every year for the past decade (FY 2019 was flat), and net income remaining in the black. That being said, the company's market cap has dropped from $6.5 billion in 2016 to just $1.1 billion as Buchanan prepares to come aboard. Nonetheless, with a relatively fervent and dedicated customer base, we wouldn't write this company off just yet. It also helps that one of the company's chief competitors, A.C. Moore, announced that it would be closing all of its stores. We are rooting for Buchanan, and would love to write about her success in a year, but we sure couldn't justify buying the company—even at $8 per share.
Economics: Work & Pay
American workers are making more money, and the bottom 25% of earners are seeing the biggest spike. According to the Federal Reserve Bank of Atlanta, pay for the lowest 25% of American workers rose 4.5% over the past year—the biggest spike in over a decade. On the other side of the spectrum, the top 25% of wage earners also saw a nice jump, with a 2.9% increase year-over-year (Y/Y). This report from the Fed supports the Labor Department statistics we reported on a few weeks ago: average hourly wages for nonsupervisory and production workers (excluding government workers) rose 3.7% Y/Y. What does that equate to in dollars and cents? The average nonsupervisory worker earned just under $24 per hour in November. There are a number of reasons for the pay raises, chief among them being the lowest unemployment level in fifty years. Companies are being forced to pony up higher pay to attract or retain qualified workers, even with more formerly-discouraged workers (as tracked in the U-6 unemployment rate) re-entering the job market. All of this good news looks to carry into the new year, as the job market remains extremely tight at all levels and in all corners—with the possible exception of government workers—and the economy remains strong. For all of the talk of robots and AI stealing jobs from workers across virtually every industry, we have statistical full employment in the US right now. That being said, now is not the time for workers to get complacent. By performing a little market research, individuals can uncover developing trends within their respective line of work and take steps to remain as proficient as possible, or even seek out more promising industries.
Technology Hardware & Equipment
Another small step into vertical integration for Apple as it appears ready to buy Japanese smartphone screen maker. With its past troubles with suppliers, Apple (AAPL 142-$290-$290) has been taking steps recently to better control its supply chain. It now appears the $1.3 trillion iPhone maker is prepared to buy one of the factories that makes smartphone screens for its devices. Japan Display Inc, which has been faced with mounting financial troubles, is reportedly in talks with both Apple and Foxconn's Sharp Corp to sell the plant for as much as $820 million. The company still owes Apple over $800 million for funding the plant's construction in western Japan four years ago. More intriguing, it doesn't appear as though Apple and Sharp are engaged in a bidding war; rather, the two are discussing various ways to share the facility. Japan Display is in such deep financial trouble that it will accept 90 billion yen ($822 billion) in funding from a Japanese asset management firm in return for control of the company. One of Tim Cook's biggest headaches has revolved around the company's attempt to have some semblence of control over the network of suppliers which make components for Apple devices. Nonetheless, he has moved with extreme caution with respect to vertical integration. If this deal gets done, it will only happen after a complete and thorough due diligence process. We also like the fact that the plant is located in Japan and not China, removing more variables from the equation.
Automotive
Once again, Elon Musk gets the last laugh as short sellers take it on the chin. Most automotive industry analysts love to hate Tesla (TSLA $177-$419-$420) and its founder, Elon Musk. Perhaps it is envy, or perhaps their limited imaginations refuse to accept that a successful car company can be created out of thin air in the modern era. Whatever the reason, we have to chuckle every time Musk proves them wrong, as he just did yet again. It was a little over sixteen months ago that Musk made his infamous tweet, "Am considering taking Tesla private at $420. Funding secured." What percentage of the tweet was serious and what percentage was simply a failed attempt at some marijuana humor we may never know, but one thing is certain: the SEC didn't find it funny. The commission fined Tesla $20 million and its CEO $20 million for the pithy comment. Many who wanted Musk barred from running his company—a preposterous notion—were disappointed. Months of personal bashing ensued, and the brouhaha helped drive Tesla stock all the way down to $179 per share by the following summer. We recall analysts predicting the company's demise with unconstrained glee. Then something happened. Suddenly the carmaker began surprising to the upside on sales and deliveries (and even a profitable quarter), and the stock began its incredible 135% upward march over the course of six months. Short sellers got crushed. The funniest part of the run was that Tesla shares hit that magical $420 per share mark. Of course, that was too juicy for Musk to pass up. Within minutes he tweeted, "Whoa the stock is so high lol." Classic. Tesla is the benchmark electric vehicle maker, despite what the old, stodgy, "me too" carmakers are projecting for their own electric fleets. We expect that to continue, and we expect many profitable quarters in Tesla's future. Now, if Musk would only bring SpaceX public.
Telecommunication Services
Could Apple's secret plan to beam data via satellites impact the telecom giants? Right now, there is a battle royale going on in the federal courts over whether or not Sprint (S) and T-Mobile's (TMUS) planned merger would create an oligopoly of telecom companies in the US, with AT&T (T), Verizon (VZ), and the newly-formed S/TMUS entity in control of virtually every American's cellphone plan when 5G hits. We don't buy the argument, and believe the judge will side with the government and allow the deal to go through, but if Apple (AAPL) has its way, it may become a moot point within a few years. According to sources cited by Bloomberg, the $1.26 trillion Cupertino-based company is working on a secret plan that would allow a network of communications satellites and next-gen (5G) wireless technology to beam data directly to users' devices, potentially negating the need for wireless carriers altogether. With SpaceX deploying thousands of small satellites for what will be its Starlink constellation, and Amazon (AMZN) planning to deploy over 3,000 satellites as part of its own constellation, the idea doesn't seem that far-fetched. Certainly, massively expensive projects like the Iridium satellite boondoggle highlight the risks associated with this type of undertaking, but we believe it is a matter of when, not if. Compare these constellations to the groups of Europeans who attempted to create settlements in the New World in the 16th and 17th centuries: while the early attempts ended in tragedy, the inevitable success of the strategy was all but assured. That doesn't mean you should begin dumping your AT&T and Verizon stock just yet, however—it will take a decade (in our estimation) for these lofty plans to come to fruition. Nonetheless, it pays to be thinking a number of steps ahead when investing in the technology arena. Look for the companies which make the hardware for the satellites and their accompanying 5G terrestrial components; companies like Qualcomm (QCOM), Raytheon (RTN), and Astronics (ATRO). And move cautiously around high-flying cell tower companies like American Tower (AMT), which often carry tech-like multiples. It wouldn't take much to spook investors into taking their profits and exiting these names. Ultimately, Tim Cook may abandon this plan as too expensive, but we could see him teaming up with Elon Musk's Starlink constellation. Imagine the incredible synergies that could be created with a joint Apple and SpaceX project. (We own Apple in the Penn Global Leaders Club, and Qualcomm in the Penn New Frontier Fund.)
Aerospace & Defense
After a nightmarish year, Boeing desperately needed a win; instead it got a failed Starliner test mission. It was only fitting that CEO Dennis Muilenburg was at the launch site to watch the mission unfold. The man ultimately responsible for Boeing's (BA $292-$330-$446) success or failure witnessed a spectacular launch of the Starliner, the company's answer to SpaceX's Crew Dragon capsule designed to carry US astronauts into space. But, symbolic of Boeing's 2019, it went downhill from there. The unmanned craft, which was supposed to rendezvous and dock with the International Space Station (ISS), quickly went off course, dooming the mission. The company pointed out that the software problem which caused the malfunction could have been corrected had astronauts been onboard during the test mission, but that misses the bigger point: For a company with two recent deadly aircraft crashes in its rear view mirror, both due to a software glitch, this latest failure accentuates the negatives surrounding the firm. While Boeing's competition on the aircraft side of the business, Europe's Airbus (EADSY), gained ground after the air disasters, we expect that Elon Musk's privately-held SpaceX, whose Crew Dragon successfully docked with the ISS back in March, will garner even more favor from NASA after this failed test flight. Both companies are scheduled to have manned flights in 2020, but that has become an extremely tall task for Boeing after this latest incident. More fodder in the case to jettison Muilenburg and overhaul Boeing's board of directors. We have argued that one of the worst CEOs in the airline business is United's Oscar Munoz, who is (thankfully) stepping down from his role soon. According to the Wall Street Journal, Muilenburg turned to Munoz for advice after the two air disasters. How fitting. He needs to go now, and the company needs to find a leader like former BA CEO Jim McNerney to right the ship before more damage is done.
Update: Shortly after the previous story was written, the Boeing board of directors fired CEO Dennis Muilenburg. Chairman David Calhoun will take over as the new permanent CEO of the company in early January.
Headlines for the Week of 15 Dec 2019—21 Dec 2019
Demographics & Lifestyle
Move over millennials, Gen Z is rushing in, and they love to shop at the malls. When I was a kid growing up in the 80s, some of my favorite times were spent at the local mall. I worked there, shopped there, hung out with friends there. Over the past five years or so, however, many have tried to write the epitaph of the giant, enclosed, climate-controlled oasis. After all, they argued, millennials love shopping online (so do I, by the way), and foot traffic is perennially decreasing at the local brick-and-mortar stores. While online shopping will continue to gain ground, we never bought the thesis that it would mean the demise of the physical store. And now, new research seems to be supporting our argument. Backed by data from eMarketer, a professional market research company, real estate services firm CBRE has compiled some interesting statistics on Gen Z—kids, teens, and young adults roughly between the ages of seven and twenty. The group directly spends around $143 billion per year on discretionary goods, and influences another $450 billion or so in spending by others. And an overwhelming 76% of the members of this group say they prefer to do their shopping in nearby physical stores. Even though they often order clothing or other goods online, they want to pick up those goods at the local store ("click and collect")—meaning they are visiting the websites of brick-and-mortar companies like Nordstrom (JWN), Macy's (M), Victoria's Secret (LB), and Sephora (LVMUY), instead of Amazon (AMZN). In short, while they embrace technology, they want the social experience provided by a visit to the mall. And that fact is resonating with the likes of Simon Property Group (SPG) and Macerich (MAC), two higher-end (Class A) mall REITs which have been adding more experience-based components to their properties. In other words, Gen Z appears to be taking us back to the 80s, but with some cool new features added. We recently highlighted Macerich (MAC) as an interesting REIT play, but we also like Kimco (KIM), Simon (SPG), and Pennsylvania Real Estate (PEI) in the retail REIT space.
Homes & Durables
US housing starts for November far exceed expectations, new permits hit 12-year high. On Monday, the NAHB survey was released showing homebuilder confidence at a 20-year high. On Tuesday, we received more good news on the housing front: November housing starts rose 3.2% (against expectations for a 2% jump) to an annualized rate of 1.365 million new homes. Furthermore, permits for future home construction surged to a 12-year high. Perhaps most impressive in the Commerce Department report for the month of November was the whopping 13.6% spike in year-on-year starts, showing positive momentum for this critical economic indicator as we move into 2020. There is one complaint being voiced by builders: they are having trouble finding enough workers to build the new homes. With rates remaining low throughout 2020 (more than likely) and unemployment at 50-year lows, the coming year should be another strong one for the homebuilders.
Transportation Infrastructure
In what smells a lot like payback, Amazon forbids third-party sellers from using FedEx. For years, $877 billion online retailer Amazon (AMZN $1,307-$1,769-$2,036) relied on shipping giant FedEx (FDX $138-$164-$199) to deliver packages to the growing multitude of Amazon Prime members. Then, this past summer, as tensions hit a fevered pitch over pricing and Amazon's well-telegraphed internal delivery plans, the company Fred Smith founded in 1971 abruptly announced it would not be renewing either the ground- or air-shipping contracts with the Seattle-based retailer. Instead, FedEx would position itself as the main e-commerce shipper for companies like Walmart (WMT) and Target (TGT); in other words, Amazon's direct competition. Now, in what appears to be a rather petulent tit-for-tat move, Amazon is forbidding its third-party sellers—which account for over half of the goods sold through Amazon.com—from shipping their goods via Fedex (though they can still use the company's more expensive "Express" service). Needless to say, many of these retailers are furious. For its part, Amazon is ostensibly ordering the action due to Fedex's performance metrics. The evidence seems to belie that argument, as Fedex, UPS, and Amazon's own delivery service all rate between a 90% and 94% on-time delivery percentage, according to shipping data analysis from ShipMatrix. It smells like pure payback to us. FedEx had revenue of $70 billion TTM. The Amazon contracts amounted to roughly $900 million of annual revenue. Some in the financial press have foisted the narrative that FedEx is reliant on Amazon, which is absurd. We see FDX as one of the big contrarian plays of 2020 (which we will write about in our upcoming 2020 Market Outlook edition of The Penn Wealth Report).
Economics: Housing
Homebuilder sentiment hits highest level since 1999. US homebuilder confidence is measured by the NAHB/Wells Fargo Housing Market Index on a scale between one and 100. Any reading below 50 represents a negative outlook, 51 or higher reflects a positive outlook. The NAHB Index jumped five points in December, to a highly-impressive reading of 76. Even more impressive, that is the highest reading since the summer of 1999. That figure also represents a 20-point rise since December of 2018. There are a number of reasons for the rosy outlook among homebuilders. The economy is strong, interest rates are low, more US workers have jobs now than at any other time in the last fifty years, and there is a relatively low supply of existing homes on the market. Based on the internals of the index, the good vibe should carry into next year: the "sales expectations in the next six months" reading jumped to 79 on the 100-point scale. Our favorite way to play this industry continues to be ITB ($45.18), the iShares US Home Construction ETF, which includes the likes of PulteGroup (PHM), D.R. Horton (DHI), Lennar (LEN), and Sherwin-Williams (SHW). As for individual housing names, Lennar @ $58 per share still looks nicely undervalued.
Aerospace & Defense
Boeing: at the intersection of massive arrogance and unfettered industry consolidation. At the start of the trading week, US aerospace giant Boeing (BA $292-$329-$446) was off yet another 4% following a Wall Street Journal report that the company is actually weighing suspending—or even halting— 737 MAX production. While that may be a stunning notion, it seems more reasonable considering how many orders Boeing has now lost to its European rival, Airbus (EADSY). We once held Boeing in the highest regard, considering the company a symbol of American corporate strength. Sadly, arrogance in the boardroom and runaway industry consolidation have changed our views on the firm. In early 2018, we wrote about Boeing's complaint to the US International Trade Commission over Delta's (DAL) purchase of Canadian Bombardier aircraft. In a fascinating turn of events, Delta was so incensed over Boeing's complaint that they made a large purchase of Airbus aircraft instead of the Boeing jets they were going to buy—jets known as the 737 MAX. So, because Boeing was more interested in taking legal action to stop an American air carrier from buying elsewhere than they apparently were in fielding concerns about the safety of their own jets, Delta ended up being completely free of the soon-to-be-grounded 737 MAX. Talk about poetic justice.
Boeing's board of directors said it stands fully behind CEO Dennis Muilenburg. That tells us that not only does the company have a CEO who should be broomed, it also has a board which needs to be overhauled. All the way back in 1997, we wrote of the clash of arrogant personalities on full display when Boeing acquired McDonnell Douglas, leaving one massively-big US aerospace and defense behemoth in the aftermath. Today, fortunately, companies such as privately-held SpaceX are threatening even Boeing's dominance of the US manned space program, with NASA awarding the former with billions worth of launch and supply contracts. Perhaps a little renewed competition in the industry will help retrain Boeing's focus on creating exemplary systems and away from filing legal complaints.
The icing on the cake in the complaint against Delta's purchase of Bombardier jets: the US ITC threw it out, finding the argument without merit. Until Muilenburg is gone and BA shows signs of changing its ways, we wouldn't touch the stock, even near its 52-week-lows. And that is sad. We expect this sort of arrogance from government-sponsored entities in Europe; we cannot stand for it in a meritocracy.
Global Strategy: Europe
Strikes continue to paralyze much of France as labor battles Macron over pension reform. It began nearly two weeks ago, on 05 December, and it now threatens to bleed over into the heart of the Christmas travel period. Government transit workers and teachers across France have walked away from their posts and joined the picket lines to protest the French president's proposed pension reforms, which include raising the full-pension retirement age from 62 to 64. Despite the fact that France has one of the most lucrative retirement plans in all of Europe (and that is saying a lot considering some of the progressive Nordic countries), there are scant signs that labor is willing to back down, forcing millions of French workers to bike or scooter their way through snarled and blockaded streets to get to their jobs. Air traffic controllers have also walked off the job, which could mean a nightmare scenario for those planning air travel over the holiday season. Protesters have also blocked oil refineries in an attempt to keep motorists from fueling up.Here are some of the proposed changes to the country's pension plan: there will be one plan instead of the confusing 42 plans currently in place; the legal retirement age of 64 will go into effect in 2027 but not affect those born before 1975; those with "hardship" jobs, which include police, firefighters, night workers and nurses, will still be able to receive full retirement at age 62. France currently spends 14% of its GDP on the pension retirement system—more than virtually any other EU nation—and that percentage is growing at an unsustainable rate. The government has signaled a willingness to negotiate on the proposed changes, but the unions have shown little interest in halting the nationwide strikes, arguing that a "red line" has been crossed. In the end, we expect little in the way of actual reform, kicking a larger can down the road for another generation to handle.
Move over millennials, Gen Z is rushing in, and they love to shop at the malls. When I was a kid growing up in the 80s, some of my favorite times were spent at the local mall. I worked there, shopped there, hung out with friends there. Over the past five years or so, however, many have tried to write the epitaph of the giant, enclosed, climate-controlled oasis. After all, they argued, millennials love shopping online (so do I, by the way), and foot traffic is perennially decreasing at the local brick-and-mortar stores. While online shopping will continue to gain ground, we never bought the thesis that it would mean the demise of the physical store. And now, new research seems to be supporting our argument. Backed by data from eMarketer, a professional market research company, real estate services firm CBRE has compiled some interesting statistics on Gen Z—kids, teens, and young adults roughly between the ages of seven and twenty. The group directly spends around $143 billion per year on discretionary goods, and influences another $450 billion or so in spending by others. And an overwhelming 76% of the members of this group say they prefer to do their shopping in nearby physical stores. Even though they often order clothing or other goods online, they want to pick up those goods at the local store ("click and collect")—meaning they are visiting the websites of brick-and-mortar companies like Nordstrom (JWN), Macy's (M), Victoria's Secret (LB), and Sephora (LVMUY), instead of Amazon (AMZN). In short, while they embrace technology, they want the social experience provided by a visit to the mall. And that fact is resonating with the likes of Simon Property Group (SPG) and Macerich (MAC), two higher-end (Class A) mall REITs which have been adding more experience-based components to their properties. In other words, Gen Z appears to be taking us back to the 80s, but with some cool new features added. We recently highlighted Macerich (MAC) as an interesting REIT play, but we also like Kimco (KIM), Simon (SPG), and Pennsylvania Real Estate (PEI) in the retail REIT space.
Homes & Durables
US housing starts for November far exceed expectations, new permits hit 12-year high. On Monday, the NAHB survey was released showing homebuilder confidence at a 20-year high. On Tuesday, we received more good news on the housing front: November housing starts rose 3.2% (against expectations for a 2% jump) to an annualized rate of 1.365 million new homes. Furthermore, permits for future home construction surged to a 12-year high. Perhaps most impressive in the Commerce Department report for the month of November was the whopping 13.6% spike in year-on-year starts, showing positive momentum for this critical economic indicator as we move into 2020. There is one complaint being voiced by builders: they are having trouble finding enough workers to build the new homes. With rates remaining low throughout 2020 (more than likely) and unemployment at 50-year lows, the coming year should be another strong one for the homebuilders.
Transportation Infrastructure
In what smells a lot like payback, Amazon forbids third-party sellers from using FedEx. For years, $877 billion online retailer Amazon (AMZN $1,307-$1,769-$2,036) relied on shipping giant FedEx (FDX $138-$164-$199) to deliver packages to the growing multitude of Amazon Prime members. Then, this past summer, as tensions hit a fevered pitch over pricing and Amazon's well-telegraphed internal delivery plans, the company Fred Smith founded in 1971 abruptly announced it would not be renewing either the ground- or air-shipping contracts with the Seattle-based retailer. Instead, FedEx would position itself as the main e-commerce shipper for companies like Walmart (WMT) and Target (TGT); in other words, Amazon's direct competition. Now, in what appears to be a rather petulent tit-for-tat move, Amazon is forbidding its third-party sellers—which account for over half of the goods sold through Amazon.com—from shipping their goods via Fedex (though they can still use the company's more expensive "Express" service). Needless to say, many of these retailers are furious. For its part, Amazon is ostensibly ordering the action due to Fedex's performance metrics. The evidence seems to belie that argument, as Fedex, UPS, and Amazon's own delivery service all rate between a 90% and 94% on-time delivery percentage, according to shipping data analysis from ShipMatrix. It smells like pure payback to us. FedEx had revenue of $70 billion TTM. The Amazon contracts amounted to roughly $900 million of annual revenue. Some in the financial press have foisted the narrative that FedEx is reliant on Amazon, which is absurd. We see FDX as one of the big contrarian plays of 2020 (which we will write about in our upcoming 2020 Market Outlook edition of The Penn Wealth Report).
Economics: Housing
Homebuilder sentiment hits highest level since 1999. US homebuilder confidence is measured by the NAHB/Wells Fargo Housing Market Index on a scale between one and 100. Any reading below 50 represents a negative outlook, 51 or higher reflects a positive outlook. The NAHB Index jumped five points in December, to a highly-impressive reading of 76. Even more impressive, that is the highest reading since the summer of 1999. That figure also represents a 20-point rise since December of 2018. There are a number of reasons for the rosy outlook among homebuilders. The economy is strong, interest rates are low, more US workers have jobs now than at any other time in the last fifty years, and there is a relatively low supply of existing homes on the market. Based on the internals of the index, the good vibe should carry into next year: the "sales expectations in the next six months" reading jumped to 79 on the 100-point scale. Our favorite way to play this industry continues to be ITB ($45.18), the iShares US Home Construction ETF, which includes the likes of PulteGroup (PHM), D.R. Horton (DHI), Lennar (LEN), and Sherwin-Williams (SHW). As for individual housing names, Lennar @ $58 per share still looks nicely undervalued.
Aerospace & Defense
Boeing: at the intersection of massive arrogance and unfettered industry consolidation. At the start of the trading week, US aerospace giant Boeing (BA $292-$329-$446) was off yet another 4% following a Wall Street Journal report that the company is actually weighing suspending—or even halting— 737 MAX production. While that may be a stunning notion, it seems more reasonable considering how many orders Boeing has now lost to its European rival, Airbus (EADSY). We once held Boeing in the highest regard, considering the company a symbol of American corporate strength. Sadly, arrogance in the boardroom and runaway industry consolidation have changed our views on the firm. In early 2018, we wrote about Boeing's complaint to the US International Trade Commission over Delta's (DAL) purchase of Canadian Bombardier aircraft. In a fascinating turn of events, Delta was so incensed over Boeing's complaint that they made a large purchase of Airbus aircraft instead of the Boeing jets they were going to buy—jets known as the 737 MAX. So, because Boeing was more interested in taking legal action to stop an American air carrier from buying elsewhere than they apparently were in fielding concerns about the safety of their own jets, Delta ended up being completely free of the soon-to-be-grounded 737 MAX. Talk about poetic justice.
Boeing's board of directors said it stands fully behind CEO Dennis Muilenburg. That tells us that not only does the company have a CEO who should be broomed, it also has a board which needs to be overhauled. All the way back in 1997, we wrote of the clash of arrogant personalities on full display when Boeing acquired McDonnell Douglas, leaving one massively-big US aerospace and defense behemoth in the aftermath. Today, fortunately, companies such as privately-held SpaceX are threatening even Boeing's dominance of the US manned space program, with NASA awarding the former with billions worth of launch and supply contracts. Perhaps a little renewed competition in the industry will help retrain Boeing's focus on creating exemplary systems and away from filing legal complaints.
The icing on the cake in the complaint against Delta's purchase of Bombardier jets: the US ITC threw it out, finding the argument without merit. Until Muilenburg is gone and BA shows signs of changing its ways, we wouldn't touch the stock, even near its 52-week-lows. And that is sad. We expect this sort of arrogance from government-sponsored entities in Europe; we cannot stand for it in a meritocracy.
Global Strategy: Europe
Strikes continue to paralyze much of France as labor battles Macron over pension reform. It began nearly two weeks ago, on 05 December, and it now threatens to bleed over into the heart of the Christmas travel period. Government transit workers and teachers across France have walked away from their posts and joined the picket lines to protest the French president's proposed pension reforms, which include raising the full-pension retirement age from 62 to 64. Despite the fact that France has one of the most lucrative retirement plans in all of Europe (and that is saying a lot considering some of the progressive Nordic countries), there are scant signs that labor is willing to back down, forcing millions of French workers to bike or scooter their way through snarled and blockaded streets to get to their jobs. Air traffic controllers have also walked off the job, which could mean a nightmare scenario for those planning air travel over the holiday season. Protesters have also blocked oil refineries in an attempt to keep motorists from fueling up.Here are some of the proposed changes to the country's pension plan: there will be one plan instead of the confusing 42 plans currently in place; the legal retirement age of 64 will go into effect in 2027 but not affect those born before 1975; those with "hardship" jobs, which include police, firefighters, night workers and nurses, will still be able to receive full retirement at age 62. France currently spends 14% of its GDP on the pension retirement system—more than virtually any other EU nation—and that percentage is growing at an unsustainable rate. The government has signaled a willingness to negotiate on the proposed changes, but the unions have shown little interest in halting the nationwide strikes, arguing that a "red line" has been crossed. In the end, we expect little in the way of actual reform, kicking a larger can down the road for another generation to handle.
Headlines for the Week of 08 Dec 2019—14 Dec 2019
Global Strategy: Europe
In biggest win since Margaret Thatcher's 1987 victory, Boris Johnson now has the votes to complete Brexit process. For months, we have been predicting a Tory victory in the UK large enough to give Prime Minister Boris Johnson the votes needed to carry out the will of the people and blow out of the EU. That is precisely what happened, but even we were surprised by the level of voter anger focused on the Labour Party, which had all but promised another national referendum on Brexit (hoping for a different outcome). In the end, the British people said "enough!" This vote all but assures England will leave the EU on 31 Jan 2020. The national vote was such a thumping for Labour that leader Jeremy Corbyn, who had hoped to be elected prime minister, said he will step down as party leader. Markets loved the news, with the FTSE 100 jumping 1% in early trading, and the pound sterling spiking 2% against the US dollar. After 31 Jan, the UK will have the freedom to ignore much of the byzantine EU regulatory process, negotiate its own trade deals with other countries, and set its own immigration rules. President Donald Trump congratulated the prime minister on his stunning victory, and hinted that a big trade deal between the two allies would come to fruition early in the new year. For the EU leaders in Brussels, this is a nightmare scenario.
Airlines
With its new stake in Wheels Up, Penn member Delta Airlines moves more heavily into rapidly-growing space. The private jet charter business has been blossoming over the past few years, and Penn Global Leader Club member Delta Airlines (DAL $45-$57-$63), already an active participant in the space with its Delta Private Jets unit, is doubling down by becoming the single largest shareholder in Wheels Up. The company, in fact, will streamline its business by combining Delta Private Jets with the membership-based, pay-as-you-go charter company. Meanwhile, Delta has been selling off its non-core businesses to focus exclusively on its key profit drivers. CEO Ed Bastian, arguably the best airline chief in the industry, considers this deal more than a minority stake, he considers it a merger. According to the company's press release, "The transaction will pair Wheels Up's membership programs, innovative digital platform, and world-class lifestyle experiences with Delta's...service and scale." When the dust settles, the unit will operate 190 private aircraft and boast over 8,000 paying members and customers. Wheels Up said it would also like to expand into Europe, a region where Delta owns 49% of Virgin Atlantic Airways. Bravo to Delta on the move. Unlike the inept United (UAL) CEO Oscar Munoz, who (thankfully) announced he would be stepping down in early 2020, Bastian has done a masterful job at leading Delta through turbulent times. Interestingly, Delta was the one major carrier which had no Boeing (BA) 737-MAXs in its fleet.
Media & Entertainment
Users have already downloaded Disney+ on their mobile devices an incredible 22 million times. We knew it was going to be an enormous success, but The Walt Disney Company's (DIS $100-$148-$153) new Disney+ streaming service has already surpassed the rosiest of expectations. Apptopia, a mobile app research firm, reported that the Disney+ app has already been downloaded 22 million times on mobile devices, making it—easily—the most popular app in both the Apple and Google app stores. Keep in mind that Apptopia does not monitor downloads on smart TVs, devices by the likes of Roku and Apple, or desktop browsers. Disney announced that it had 22 million such signups on day one, crashing the system. While Verizon (VZ) is giving its customers a one-year free membership to the streaming service, and those who download the app have seven days of free viewing, Apptopia noted that Disney has already made $20 million in revenue from its app—which does not even include the cut given to app stores. The icing on the cake? Google's annual search trend report, which came out this week, listed "Disney+" as the top trending search of 2019. (Disney holds position #12/40 within the Penn Global Leaders Club.) Netflix (NFLX) has been the company we love to hate for the past several years. We expect the company's 95 P/E ratio isn't going to cut it going forward, based on the impressive new entrants.
Specialty Retail
Living up (or is it down?) to our expectations, GameStop plummets to around $5 per share. When shares of video game company GameStop (GME $3-$5-$17) were trading at $21 per share, we urged investors to get out and don't look back. When GME shares dropped to $16, we said that the company "has about as much business being publicly-traded as Radio Shack did in its waning days." For GME investors who didn't listen, more bad news hit this week. Shares were trading down 17%, to $5.41, in early trading on Wednesday after the company issued bleak guidance amid plunging sales. Q3 saw a revenue decline of 26%, while net losses came in at $83.4 million. GameStop, which sells new and second-hand video game hardware and both physical and digital video game software in the US, Canada, Europe, and Australia, also warned in its Q3 report that a lack of new consoles until the fourth-quarter of 2020 means dwindling hardware sales before that period. One analyst house, Benchmark Research, lowered its price target on GME shares from $6.51 to $3 after the earnings conference call. So, at $5, are the shares a deep value play? After all, Morningstar lists a fair value on the company's shares at $14.44. No, we would have to side with the Benchmark analyst.
Energy Commodities
Saudi Aramco just made history as the world's largest-ever IPO. Five years ago, Alibaba became the largest company to ever go public—raising around $25 billion. Saudi Aramco, which just made its debut on the Saudi stock exchange, surpassed that level with just 1.5% of the company's shares being listed. Based on the price of those shares, which spiked up to the daily allowable limit of 10% on the Saudi exchange, the entire company has a market cap of $1.88 trillion. By comparison, Apple—the largest publicly-traded company in the world until Aramco—has a market cap of $1.2 trillion. Saudi Arabia's Gulf allies certainly helped the cause, with Kuwait and the United Arab Emirates investing $1 billion and $1.5 billion, respectively, in the shares. That being said, just about 10% of the IPO offers came from outside of the Kingdom, with the remaining 90% of funds generated from Saudi investment houses, companies, and wealthy local families. As we have previously outlined, a vast majority of the amount raised in the successful IPO will be used to help fund Saudi Vision 2030, Crown Prince Salman's massive effort to diversify the Kingdom's economy away from—somewhat ironically—oil. In the last issue of The Penn Wealth Report we made the case for investing in Saudi Arabia as we enter the new year. Despite the geopolitical risks and the muted price of oil, we see abundant investment opportunities in the region—at least among the nations embracing capitalism.
Travel/Hotels, Resorts, & Cruise Lines
After decades in San Francisco, Oracle is moving its massive annual convention to Vegas for two very specific reasons. Back in 1996, $182 billion enterprise software giant Oracle (ORCL $42-$56-$61) began hosting an annual conference for business leaders and decision makers to show off the firm's latest technologies. For nearly that long, Oracle has held the convention, known as OpenWorld, in San Francisco. Now, that is about to change. The company confirmed that it has inked a deal with Caesars Forum, a massive new 550,000 square-foot convention center in Las Vegas, to host the event for at least the next three years. Oracle said that two glaring complaints rose to the top of attendee feedback: the city's hotel rates were too high, and the street conditions were poor. Citing a 2018 NPR report, San Francisco's city streets are "strewn with trash, needles, and human feces." The San Francisco Travel Association, a private nonprofit which promotes tourism in the Bay area, said the move will cost the city approximately $64 million per year in lost revenue. The event attracts more than 60,000 Oracle customers and partners each year. Without commenting on San Francisco, it is fair to say that Las Vegas has done a tremendous job in attracting new corporate customers to the city over the past decade.
Telecom Services
What is the federal judge telegraphing about the T-Mobile/Sprint lawsuit? The lawsuit was a colossal joke from the start. A group of thirteen (down from sixteen) state attorneys general, led by New York and California (which tells us everyting we need to know), is suing to stop the Sprint (S $5-$5-$8)/T-Mobile (TMUS $60-$76-$85) merger on grounds that it will limit competition in the 5G arena, harming consumers. News flash for the political hack AGs: Sprint probably won't make it without the merger, so what will that do to the competitive landscape? For its part, the Department of Justice has already given the green light to the merger, which further points to the politics at the heart of the lawsuit. In the latest move, US District Judge Victor Marrero told both sides in the suit to skip their opening arguments and get on with calling their witnesses. This indicates to us that he has very little patience in the matter, which we believe bodes well for the telecom companies. It should be noted that, as part of the DoJ approval process, Sprint would have to divest itself of some assets to Dish Network (DISH) so that company would be able to build its own 5G network. We believe the judge recognizes this suit as the frivolous waste of taxpayer money that it is, and will ultimately rule for the merger. We can't wait to see the bloviating AGs rush to the microphones to screach about the injustice thrust upon the public by the judicial system. Maybe Al Sharpton will even show up with his bullhorn.
Biotechnology
Two little-known biotech firms skyrocket after offers from big pharma. The battle to develop the next generation of cancer-fighting therapies is entering a new phase, and that is a good thing in the herculean effort to eradicate the disease. French drugmaker Sanofi (SNY 40-$46-$47), attempting to regain lost ground, has agreed to buy cancer biotech firm Synthorx (THOR $11-$67-$27) for $2.5 billion, sending the latter's shares up 169%. Synthorx's lead product candidate is THOR-707, a therapy designed to kill tumor cells. Not to be outdone, $226 billion US pharma giant Merck (MRK $71-$89-$89) announced its intent to buy small-cap biotech ArQule (ARQL $2-$20-$12) for $2.7 billion, sending shares of the Massachusetts-based firm up 103%. Merck said the deal will expand its oncology pipeline into targeted therapies used to fight blood cancers. ArQule's stated objective is to discover, develop, and commercialize novel small molecule drugs in areas of high unmet needs. These deals pale in comparison to Bristol-Myers Squibb's (BMY) purchase of Penn Global Leaders Club member Celgene (formerly CELG) last month for $74 billion. While Celgene is no longer a publicly-traded company, we do own its acquirer, BMY, within the Penn portfolios. Within the health sciences space we also own Amgen (AMGN), Biogen (BIIB), Gilead (GILD), and AbbVie (ABBV). Look for plenty of more deals to come as the major pharma giants battle it out for the title of lead cancer-fighting drugmaker. Sneak preview: Health Care is one of the sectors we are overweighting for 2020.
Updtate: Sanofi announced it would end research in cardiovascular diseases and
In biggest win since Margaret Thatcher's 1987 victory, Boris Johnson now has the votes to complete Brexit process. For months, we have been predicting a Tory victory in the UK large enough to give Prime Minister Boris Johnson the votes needed to carry out the will of the people and blow out of the EU. That is precisely what happened, but even we were surprised by the level of voter anger focused on the Labour Party, which had all but promised another national referendum on Brexit (hoping for a different outcome). In the end, the British people said "enough!" This vote all but assures England will leave the EU on 31 Jan 2020. The national vote was such a thumping for Labour that leader Jeremy Corbyn, who had hoped to be elected prime minister, said he will step down as party leader. Markets loved the news, with the FTSE 100 jumping 1% in early trading, and the pound sterling spiking 2% against the US dollar. After 31 Jan, the UK will have the freedom to ignore much of the byzantine EU regulatory process, negotiate its own trade deals with other countries, and set its own immigration rules. President Donald Trump congratulated the prime minister on his stunning victory, and hinted that a big trade deal between the two allies would come to fruition early in the new year. For the EU leaders in Brussels, this is a nightmare scenario.
Airlines
With its new stake in Wheels Up, Penn member Delta Airlines moves more heavily into rapidly-growing space. The private jet charter business has been blossoming over the past few years, and Penn Global Leader Club member Delta Airlines (DAL $45-$57-$63), already an active participant in the space with its Delta Private Jets unit, is doubling down by becoming the single largest shareholder in Wheels Up. The company, in fact, will streamline its business by combining Delta Private Jets with the membership-based, pay-as-you-go charter company. Meanwhile, Delta has been selling off its non-core businesses to focus exclusively on its key profit drivers. CEO Ed Bastian, arguably the best airline chief in the industry, considers this deal more than a minority stake, he considers it a merger. According to the company's press release, "The transaction will pair Wheels Up's membership programs, innovative digital platform, and world-class lifestyle experiences with Delta's...service and scale." When the dust settles, the unit will operate 190 private aircraft and boast over 8,000 paying members and customers. Wheels Up said it would also like to expand into Europe, a region where Delta owns 49% of Virgin Atlantic Airways. Bravo to Delta on the move. Unlike the inept United (UAL) CEO Oscar Munoz, who (thankfully) announced he would be stepping down in early 2020, Bastian has done a masterful job at leading Delta through turbulent times. Interestingly, Delta was the one major carrier which had no Boeing (BA) 737-MAXs in its fleet.
Media & Entertainment
Users have already downloaded Disney+ on their mobile devices an incredible 22 million times. We knew it was going to be an enormous success, but The Walt Disney Company's (DIS $100-$148-$153) new Disney+ streaming service has already surpassed the rosiest of expectations. Apptopia, a mobile app research firm, reported that the Disney+ app has already been downloaded 22 million times on mobile devices, making it—easily—the most popular app in both the Apple and Google app stores. Keep in mind that Apptopia does not monitor downloads on smart TVs, devices by the likes of Roku and Apple, or desktop browsers. Disney announced that it had 22 million such signups on day one, crashing the system. While Verizon (VZ) is giving its customers a one-year free membership to the streaming service, and those who download the app have seven days of free viewing, Apptopia noted that Disney has already made $20 million in revenue from its app—which does not even include the cut given to app stores. The icing on the cake? Google's annual search trend report, which came out this week, listed "Disney+" as the top trending search of 2019. (Disney holds position #12/40 within the Penn Global Leaders Club.) Netflix (NFLX) has been the company we love to hate for the past several years. We expect the company's 95 P/E ratio isn't going to cut it going forward, based on the impressive new entrants.
Specialty Retail
Living up (or is it down?) to our expectations, GameStop plummets to around $5 per share. When shares of video game company GameStop (GME $3-$5-$17) were trading at $21 per share, we urged investors to get out and don't look back. When GME shares dropped to $16, we said that the company "has about as much business being publicly-traded as Radio Shack did in its waning days." For GME investors who didn't listen, more bad news hit this week. Shares were trading down 17%, to $5.41, in early trading on Wednesday after the company issued bleak guidance amid plunging sales. Q3 saw a revenue decline of 26%, while net losses came in at $83.4 million. GameStop, which sells new and second-hand video game hardware and both physical and digital video game software in the US, Canada, Europe, and Australia, also warned in its Q3 report that a lack of new consoles until the fourth-quarter of 2020 means dwindling hardware sales before that period. One analyst house, Benchmark Research, lowered its price target on GME shares from $6.51 to $3 after the earnings conference call. So, at $5, are the shares a deep value play? After all, Morningstar lists a fair value on the company's shares at $14.44. No, we would have to side with the Benchmark analyst.
Energy Commodities
Saudi Aramco just made history as the world's largest-ever IPO. Five years ago, Alibaba became the largest company to ever go public—raising around $25 billion. Saudi Aramco, which just made its debut on the Saudi stock exchange, surpassed that level with just 1.5% of the company's shares being listed. Based on the price of those shares, which spiked up to the daily allowable limit of 10% on the Saudi exchange, the entire company has a market cap of $1.88 trillion. By comparison, Apple—the largest publicly-traded company in the world until Aramco—has a market cap of $1.2 trillion. Saudi Arabia's Gulf allies certainly helped the cause, with Kuwait and the United Arab Emirates investing $1 billion and $1.5 billion, respectively, in the shares. That being said, just about 10% of the IPO offers came from outside of the Kingdom, with the remaining 90% of funds generated from Saudi investment houses, companies, and wealthy local families. As we have previously outlined, a vast majority of the amount raised in the successful IPO will be used to help fund Saudi Vision 2030, Crown Prince Salman's massive effort to diversify the Kingdom's economy away from—somewhat ironically—oil. In the last issue of The Penn Wealth Report we made the case for investing in Saudi Arabia as we enter the new year. Despite the geopolitical risks and the muted price of oil, we see abundant investment opportunities in the region—at least among the nations embracing capitalism.
Travel/Hotels, Resorts, & Cruise Lines
After decades in San Francisco, Oracle is moving its massive annual convention to Vegas for two very specific reasons. Back in 1996, $182 billion enterprise software giant Oracle (ORCL $42-$56-$61) began hosting an annual conference for business leaders and decision makers to show off the firm's latest technologies. For nearly that long, Oracle has held the convention, known as OpenWorld, in San Francisco. Now, that is about to change. The company confirmed that it has inked a deal with Caesars Forum, a massive new 550,000 square-foot convention center in Las Vegas, to host the event for at least the next three years. Oracle said that two glaring complaints rose to the top of attendee feedback: the city's hotel rates were too high, and the street conditions were poor. Citing a 2018 NPR report, San Francisco's city streets are "strewn with trash, needles, and human feces." The San Francisco Travel Association, a private nonprofit which promotes tourism in the Bay area, said the move will cost the city approximately $64 million per year in lost revenue. The event attracts more than 60,000 Oracle customers and partners each year. Without commenting on San Francisco, it is fair to say that Las Vegas has done a tremendous job in attracting new corporate customers to the city over the past decade.
Telecom Services
What is the federal judge telegraphing about the T-Mobile/Sprint lawsuit? The lawsuit was a colossal joke from the start. A group of thirteen (down from sixteen) state attorneys general, led by New York and California (which tells us everyting we need to know), is suing to stop the Sprint (S $5-$5-$8)/T-Mobile (TMUS $60-$76-$85) merger on grounds that it will limit competition in the 5G arena, harming consumers. News flash for the political hack AGs: Sprint probably won't make it without the merger, so what will that do to the competitive landscape? For its part, the Department of Justice has already given the green light to the merger, which further points to the politics at the heart of the lawsuit. In the latest move, US District Judge Victor Marrero told both sides in the suit to skip their opening arguments and get on with calling their witnesses. This indicates to us that he has very little patience in the matter, which we believe bodes well for the telecom companies. It should be noted that, as part of the DoJ approval process, Sprint would have to divest itself of some assets to Dish Network (DISH) so that company would be able to build its own 5G network. We believe the judge recognizes this suit as the frivolous waste of taxpayer money that it is, and will ultimately rule for the merger. We can't wait to see the bloviating AGs rush to the microphones to screach about the injustice thrust upon the public by the judicial system. Maybe Al Sharpton will even show up with his bullhorn.
Biotechnology
Two little-known biotech firms skyrocket after offers from big pharma. The battle to develop the next generation of cancer-fighting therapies is entering a new phase, and that is a good thing in the herculean effort to eradicate the disease. French drugmaker Sanofi (SNY 40-$46-$47), attempting to regain lost ground, has agreed to buy cancer biotech firm Synthorx (THOR $11-$67-$27) for $2.5 billion, sending the latter's shares up 169%. Synthorx's lead product candidate is THOR-707, a therapy designed to kill tumor cells. Not to be outdone, $226 billion US pharma giant Merck (MRK $71-$89-$89) announced its intent to buy small-cap biotech ArQule (ARQL $2-$20-$12) for $2.7 billion, sending shares of the Massachusetts-based firm up 103%. Merck said the deal will expand its oncology pipeline into targeted therapies used to fight blood cancers. ArQule's stated objective is to discover, develop, and commercialize novel small molecule drugs in areas of high unmet needs. These deals pale in comparison to Bristol-Myers Squibb's (BMY) purchase of Penn Global Leaders Club member Celgene (formerly CELG) last month for $74 billion. While Celgene is no longer a publicly-traded company, we do own its acquirer, BMY, within the Penn portfolios. Within the health sciences space we also own Amgen (AMGN), Biogen (BIIB), Gilead (GILD), and AbbVie (ABBV). Look for plenty of more deals to come as the major pharma giants battle it out for the title of lead cancer-fighting drugmaker. Sneak preview: Health Care is one of the sectors we are overweighting for 2020.
Updtate: Sanofi announced it would end research in cardiovascular diseases and
Headlines for the Week of 01 Dec 2019—07 Dec 2019
Leisure Equipment & Products
It takes a warped, angry mind—or an industry enemy—to feign outrage over the new Peloton ad. It is one of my favorite commercials this holiday season. A television ad for Peloton (PTON $20-$34-$37) depicts a nice-looking young couple and the Peloton workout bike the man gave the woman as a Christmas gift one year earlier. In thirty seconds, the spot travels along on the woman's one year physical fitness journey, showing how the bike has enhanced her overall well being. With all of the truly infantile ads out there, we found this one refreshing. Not so fast. Social media is abuzz with outrage (nothing new there) and feigned insult over the ad. Some call it sexist (the guy trying to get the woman in shape), while others are just mean-spirited ("wow, she went from 116 to 112 in a year"), while still others simply parody the spot. Our first thought was that one of the old-guard stationary bike companies frothed up this brouhaha because they are being soundly thumped by this dynamic upstart. That may be the case, but it still takes a lot of true boneheads to elevate the anger to viral status. Hopefully, Peloton will continue to run the spot and ignore the haters. We first read about this so-called backlash from an email issued by Ad Age, a slanted marketing and media "publication" that markets itself as being "Important to Important People." Um, OK.
Global Strategy: Europe
Merkel comes one step closer to the end of the line as German chancellor. It is remarkable that German Chancellor Angela Merkel has been able to hang onto power this long. Vacillating positions are one thing, and nothing new for a politician, but remaining in power as your country's economy teeters on recession, now that's a feat. Just ask Bush 41, who was riding high after Desert Storm only to lose the 1992 election as the US economy hit a speed bump. Merkel is a member of the Christian Democratic Union of Germany, or CDU. She has remained in power thanks to a grand coalition between the CDU, the Christian Social Union (CSU), and the Social Democratic Party of Germany, or SDP. Over the weekend she was dealt a serious blow as the SPD soundly defeated her vice chancellor, Olaf Scholz, as its leader. Instead, party voters installed two anti-alliance lawmakers, Norbert Walter-Borjans and Saskia Esken, in the leadership role. While Merkel has announced she won't run again, it is hard to imagine she can accomplish much between now and the end of 2021 when her current term is up. Germany is in a tenuous position, not only economically but also geopolitically as the EU grapples with the Brexit issue. Germany has long been the titular head of the EU, which means more turmoil for that body in 2020. We reiterate our underweight position on developed Europe as a whole, but expect the UK to see nice growth on the heels of that country's 12 Dec election—providing the results are what we expect them to be.
Energy Exploration & Production
Apache suffers biggest one-day loss in over a decade as questions arise over South American well. It has been a rough enough year for energy explorers without any unexpected surprises. Unfortunately for Apache (APA $19-$18-$38), one of the world's largest independent exploration and production companies, an apparent surprise with respect to a major South American well helped pound its shares down near a 20-year low. The well in question, the Maka Central-1 located just offshore of Suriname in South America, is apparently not yielding much in the way of hydrocarbons, at least based on cryptic company messages. Already having drilled to a depth of 20,000 feet, Apache just announced that it would be making "equipment modifications to the rig," giving it the ability to go even deeper—to a new depth of 6,200 meters, or around 23,000 feet. Despite Exxon Mobil's (XOM) great success in a nearby well, industry analysts read this as a sign that Apache's well has come up dry. The company added that it will only provide an update once it has conclusive results to relay. While the energy sector is the worst year-to-date performer, essentially flat for 2019, Apache is off nearly 30% over the same time-frame. We have traded Apache shares for twenty-two years. At $18.38, it is undervalued.
Aerospace & Defense
General Dynamics just landed the largest shipbuilding contract in the history of the US Navy. General Dynamics (GD $144-$178-$194), the $52 billion American aerospace and defense juggernaut, just won a huge prize: a $22.2 billion contract from the United States Navy—the largest it has ever awarded—to build at least nine more nuclear-powered Virginia-class submarines for the fleet. The Navy also threw in an option to buy a 10th sub, which would bring the contract value to $24 billion. As if that wasn't enough of a golden goose for the Virginia-based firm, they are also designing the next-gen nuclear sub, the Columbia-class, which is being developed to replace the Trident II-armed Ohio-class ballistic missile submarines. Construction on the Columbia-class subs will begin in 2021. General Dynamics isn't the only beneficiary of the US Navy contract—Huntington Ingalls Industries (HII $174-$250-$261) is the company's top subcontractor on the deal. Not only does General Dynamics build weapons systems for the US military via their Electric Boat subsidiary, they also own the Gulfstream line of executive jets—a line which holds a commanding position in the high-end business jet arena. The largest threat to the company would be an anti-defense-spending wave coming to Washington. We don't see that happening anytime soon. The shares are still undervalued, and the same could be said of Huntington Ingalls, which owns the renowned Newport News Shipbuilding unit.
Corporate Bonds
Companies are taking on debt at a record clip thanks to ultra-low rates; that should raise red flags for bond and stock investors alike. Nearly $2.5 trillion worth of new red ink. The only balance sheet in which that number would not seem outrageous is one which compared it to the US national debt of $23 trillion. What does $2.5 trillion represent? That is nearly the amount of new debt companies around the world have issued thus far in 2019. In part, this makes sense. Why not take advantage of ultra-low (ridiculously-low in Europe) interest rates to gather more assets to fund the enterprise? While rates may be low, this is still a new debt load for the respective company; one which, if the company is run like a government, may never go away. Bond investors have been the beneficiary of this debt-issuing spree, not because they are buying the new debt, but because the value of their existing bond portfolios have risen as new issues have been sold at lower rates. Now, with the Fed indicating the rate-loosening cycle has come to a probable end, bond investors should not expect to see their fixed income values rising much more. From an equity standpoint, this new debt on the books heightens the concern that companies are over-levering, for which they may pay a deep price during the next market downturn. The only positive? The world cannot afford to raise rates any time soon, so at least most bond portfolios shouldn't get pounded within the near future. For a visual of how corporate debt has been on the rise, take a look at the graph below. US debt outstanding among companies in non-financial sectors is now over $15 trillion.
It takes a warped, angry mind—or an industry enemy—to feign outrage over the new Peloton ad. It is one of my favorite commercials this holiday season. A television ad for Peloton (PTON $20-$34-$37) depicts a nice-looking young couple and the Peloton workout bike the man gave the woman as a Christmas gift one year earlier. In thirty seconds, the spot travels along on the woman's one year physical fitness journey, showing how the bike has enhanced her overall well being. With all of the truly infantile ads out there, we found this one refreshing. Not so fast. Social media is abuzz with outrage (nothing new there) and feigned insult over the ad. Some call it sexist (the guy trying to get the woman in shape), while others are just mean-spirited ("wow, she went from 116 to 112 in a year"), while still others simply parody the spot. Our first thought was that one of the old-guard stationary bike companies frothed up this brouhaha because they are being soundly thumped by this dynamic upstart. That may be the case, but it still takes a lot of true boneheads to elevate the anger to viral status. Hopefully, Peloton will continue to run the spot and ignore the haters. We first read about this so-called backlash from an email issued by Ad Age, a slanted marketing and media "publication" that markets itself as being "Important to Important People." Um, OK.
Global Strategy: Europe
Merkel comes one step closer to the end of the line as German chancellor. It is remarkable that German Chancellor Angela Merkel has been able to hang onto power this long. Vacillating positions are one thing, and nothing new for a politician, but remaining in power as your country's economy teeters on recession, now that's a feat. Just ask Bush 41, who was riding high after Desert Storm only to lose the 1992 election as the US economy hit a speed bump. Merkel is a member of the Christian Democratic Union of Germany, or CDU. She has remained in power thanks to a grand coalition between the CDU, the Christian Social Union (CSU), and the Social Democratic Party of Germany, or SDP. Over the weekend she was dealt a serious blow as the SPD soundly defeated her vice chancellor, Olaf Scholz, as its leader. Instead, party voters installed two anti-alliance lawmakers, Norbert Walter-Borjans and Saskia Esken, in the leadership role. While Merkel has announced she won't run again, it is hard to imagine she can accomplish much between now and the end of 2021 when her current term is up. Germany is in a tenuous position, not only economically but also geopolitically as the EU grapples with the Brexit issue. Germany has long been the titular head of the EU, which means more turmoil for that body in 2020. We reiterate our underweight position on developed Europe as a whole, but expect the UK to see nice growth on the heels of that country's 12 Dec election—providing the results are what we expect them to be.
Energy Exploration & Production
Apache suffers biggest one-day loss in over a decade as questions arise over South American well. It has been a rough enough year for energy explorers without any unexpected surprises. Unfortunately for Apache (APA $19-$18-$38), one of the world's largest independent exploration and production companies, an apparent surprise with respect to a major South American well helped pound its shares down near a 20-year low. The well in question, the Maka Central-1 located just offshore of Suriname in South America, is apparently not yielding much in the way of hydrocarbons, at least based on cryptic company messages. Already having drilled to a depth of 20,000 feet, Apache just announced that it would be making "equipment modifications to the rig," giving it the ability to go even deeper—to a new depth of 6,200 meters, or around 23,000 feet. Despite Exxon Mobil's (XOM) great success in a nearby well, industry analysts read this as a sign that Apache's well has come up dry. The company added that it will only provide an update once it has conclusive results to relay. While the energy sector is the worst year-to-date performer, essentially flat for 2019, Apache is off nearly 30% over the same time-frame. We have traded Apache shares for twenty-two years. At $18.38, it is undervalued.
Aerospace & Defense
General Dynamics just landed the largest shipbuilding contract in the history of the US Navy. General Dynamics (GD $144-$178-$194), the $52 billion American aerospace and defense juggernaut, just won a huge prize: a $22.2 billion contract from the United States Navy—the largest it has ever awarded—to build at least nine more nuclear-powered Virginia-class submarines for the fleet. The Navy also threw in an option to buy a 10th sub, which would bring the contract value to $24 billion. As if that wasn't enough of a golden goose for the Virginia-based firm, they are also designing the next-gen nuclear sub, the Columbia-class, which is being developed to replace the Trident II-armed Ohio-class ballistic missile submarines. Construction on the Columbia-class subs will begin in 2021. General Dynamics isn't the only beneficiary of the US Navy contract—Huntington Ingalls Industries (HII $174-$250-$261) is the company's top subcontractor on the deal. Not only does General Dynamics build weapons systems for the US military via their Electric Boat subsidiary, they also own the Gulfstream line of executive jets—a line which holds a commanding position in the high-end business jet arena. The largest threat to the company would be an anti-defense-spending wave coming to Washington. We don't see that happening anytime soon. The shares are still undervalued, and the same could be said of Huntington Ingalls, which owns the renowned Newport News Shipbuilding unit.
Corporate Bonds
Companies are taking on debt at a record clip thanks to ultra-low rates; that should raise red flags for bond and stock investors alike. Nearly $2.5 trillion worth of new red ink. The only balance sheet in which that number would not seem outrageous is one which compared it to the US national debt of $23 trillion. What does $2.5 trillion represent? That is nearly the amount of new debt companies around the world have issued thus far in 2019. In part, this makes sense. Why not take advantage of ultra-low (ridiculously-low in Europe) interest rates to gather more assets to fund the enterprise? While rates may be low, this is still a new debt load for the respective company; one which, if the company is run like a government, may never go away. Bond investors have been the beneficiary of this debt-issuing spree, not because they are buying the new debt, but because the value of their existing bond portfolios have risen as new issues have been sold at lower rates. Now, with the Fed indicating the rate-loosening cycle has come to a probable end, bond investors should not expect to see their fixed income values rising much more. From an equity standpoint, this new debt on the books heightens the concern that companies are over-levering, for which they may pay a deep price during the next market downturn. The only positive? The world cannot afford to raise rates any time soon, so at least most bond portfolios shouldn't get pounded within the near future. For a visual of how corporate debt has been on the rise, take a look at the graph below. US debt outstanding among companies in non-financial sectors is now over $15 trillion.
Headlines for the Week of 24 Nov 2019—30 Nov 2019
Multiline Retail
Dollar Tree drops 16% after lousy earnings report, lowered guidance by finger-pointing management. Dollar Tree (DLTR $81-$95-$120), owner of 7,000 discount stores under its own brand name and 8,200 under the Family Dollar name, just reported Q3 earnings, and the Street didn't like what it heard. The company, which is about one-half the size of Penn Global Leaders Club member Dollar General (DG), had revenues of $5.75 billion, which was up 3.8% from the same quarter last year, but earnings dropped 8.5% year-on-year, to $1.08 per share. What bothered investors the most, however, was the company's projection for earnings per share between $1.70 and $1.80 in the lucrative fourth quarter, well below expectations. Management placed much of the blame for the lowered expectations on the Section 301 tariffs set to hit on December 15th; tariffs which will target many of Dollar Tree's staple items. It is looking more and more likely that the 15 Dec tariffs will be put on hold, but we still wouldn't buy this company on the dip in the hopes of such a delay. Dollar General, we believe, is a much more efficient enterprise.
Global Strategy: East/Southeast Asia
The communist party just got walloped in Hong Kong, creating another massive problem for Xi but a nice byproduct for the US. By any measure, it was a landslide. The young, energetic, pro-democracy activists in Hong Kong completely pounded virtually all of the Chinese Communist Party's candidates in the elections which just took place across Hong Kong. If the elections were meant to be a barometer, the measured pressure was off the charts. With a record voter turnout of 71%—double the number from four years ago, pro-democracy candidates won 90% of the 452 district council seats. What the people of Hong Kong are demanding is clear: China must stick to its 1997 promise of "one country, two systems." A promise we never believed they would keep. The elections may have had a positive, unintended consequence for the US. In a phone call with US trade reps, Chinese officials finally put the issue of intellectual property on the table. In other words, with increased pressure from their southern border, they may finally be willing to complete the first leg of a trade deal. The US markets liked that news. While the election results in Hong Kong were fantastic, the Communist Party of China will never capitulate. The best we can hope for is a stalemate akin to a weakened version of China vs Taiwan. If that condition is unacceptable to Beijing, they will take actions which will drive even more capital away from their former golden goose.
Pharmaceuticals
Novartis will buy The Medicines Company for nearly $10 billion, sending the latter's shares up nearly 25%. One year ago, The Medicines Company (MDCO $16-$84-$84) was a $1.6 billion small-cap pharma outfit selling for $16.69 per share. Now that $205 billion drug giant Novartis (NVS $73-$91-$95) has taken an interest in the New Jersey firm, it is worth nearly $8 billion and is trading at $84 per share. In fact, MDCO shares spiked nearly 25% on Monday morning after Novartis announced its intent to buy the firm for $9.7 billion in an all-cash deal. It's a risky bet for the Switzerland-based drugmaker, as MDCO has essentially become a one-drug wonder—its cholesterol-lowering treatment Inclisiran will be submitted to the FDA for (hopeful) approval before the year is up. This deal came to fruition not because of a skilled management team at The Medicines Company; it came about because activist biotech investor Dr. Alex Denner, founding partner and chief investment officer of Sarissa Capital Management, got involved. Denner saw a bloated firm with ineffective management chasing unprofitable avenues. After taking considerable control of the company, he "persuaded" MDCO to reduce its board from 12 to 7 directors and begin selling off unprofitable units. In the end, it was left with Inclisiran—and a fat offer from Novartis. Activists can be very detrimental to a company and its shareholders (we won't mention any names, but they should be obvious to our regular readers), or they can be extremely beneficial. Alex Denner is directly responsible for MDCO shareholders becoming about 400% wealthier in their position over the course of one year. Now that's impressive, irrespective of what happens to Inclisiran at the FDA.
Textiles, Apparel, & Luxury Goods
Done deal: LVMH will buy American luxury jeweler Tiffany in all-cash deal. France's LVMH (Louis Vuitton Moet Hennessy) will acquire American jeweler Tiffany (TIF $73-$133-$130) for $16.2 million in cash, or $135 per share. LVMH, under the control of French billionaire Bernard Arnault, controls over 75 brands and is one of Europe's largest companies, worth an estimated $225 billion. The Tiffany deal is part of a larger strategy by the company to move more heavily into China, a marketplace in which the American company has been effectively able to infiltrate. Sadly, despite its success in China, Tiffany has been floundering under various leadership regimes for years, while LVMH has focused on providing exceptional customer service to its high-end shoppers. Tiffany will continue to operate with its name intact while under the LVMH umbrella, it just won't be an American interest—or publicly-traded company. Tiffany's life in the doldrums was of its own making. Instead of providing excellent customer service to its high-end clients, it floundered without a sound strategic plan. The final straw was bringing in Alessandro Bogliolo—someone who had absolutely no vested interest in keeping the company independent—to run the company back in 2017. With a better choice, this acquisition could have been averted, and Tiffany could have been returned to its glory days.
Transportation Infrastructure
Uber shares drop about 4% after the ride-hailing service loses its London license. In a move stinking of politics, and cronyism, London's transport regulator has ruled that Uber (UBER $26-$28-$47) is "not fit and proper" to remain in operation in the city. The organization, clearly on the side of London's black cabs (their version of the local taxi services), made the claim that Uber placed passenger safety and security at risk, yet it gave scant evidence that there was any higher risk for a Londoner to ride in an Uber versus a black cab. Of course, the highly-partisan mayor of London and enemy of free enterprise, Sadiq Khan, celebrated the decision, clamoring that Uber had "directly put passengers' safety at risk." The Independent Workers of Great Britain (IWGB) labor union has called the move a "hammer blow" to Uber's drivers and is demanding to meet with the mayor. For its part, Uber, which has 45,000 licensed drivers in the city, said it will appeal the decision. It has a 21-day window to do so, during which it may continue to operate. This is nothing short of a hit-job by a government organization against a legally-operated private entity. For business owners, this should serve as a reminder to have a strong documentation and risk management system in place, and to constantly be evaluating the landscape for potential threats.
Food Products
Bumble Bee files for bankruptcy, sending it into the arms of a Taiwan-based fishery. This past March we reported on a price-fixing scandal that rocked the canned tuna world. The most surprising fact brought to life in the story: who knew StarKist was not an American firm? Now, that scandal has claimed its first victim, as California-based Bumble Bee Foods will file for bankruptcy after getting hit with a $25 million fine by the US Department of Justice (it still owes the DoJ $17 million). Although based out of California, Bumble Bee was purchased in 2010 by a London-based private equity firm for $980 million. Now that the company is under bankruptcy protection, it has received an offer by Taiwan-based FCF Fishery to buy the firm for $275 million in cash and the assumption of $638 million worth of debt. We have also reported on the woes of "middle aisle" food products companies, as shoppers seek healthier alternatives. Sales of canned tuna, in fact, have dropped by nearly 50% over the past generation. Want to enjoy your tuna without worrying about mercury levels? Check out Safe Catch, Wild Planet, and American Tuna—all offering wild-caught, mercury-tested seafood, and all available at natural grocers or through Amazon.
Dollar Tree drops 16% after lousy earnings report, lowered guidance by finger-pointing management. Dollar Tree (DLTR $81-$95-$120), owner of 7,000 discount stores under its own brand name and 8,200 under the Family Dollar name, just reported Q3 earnings, and the Street didn't like what it heard. The company, which is about one-half the size of Penn Global Leaders Club member Dollar General (DG), had revenues of $5.75 billion, which was up 3.8% from the same quarter last year, but earnings dropped 8.5% year-on-year, to $1.08 per share. What bothered investors the most, however, was the company's projection for earnings per share between $1.70 and $1.80 in the lucrative fourth quarter, well below expectations. Management placed much of the blame for the lowered expectations on the Section 301 tariffs set to hit on December 15th; tariffs which will target many of Dollar Tree's staple items. It is looking more and more likely that the 15 Dec tariffs will be put on hold, but we still wouldn't buy this company on the dip in the hopes of such a delay. Dollar General, we believe, is a much more efficient enterprise.
Global Strategy: East/Southeast Asia
The communist party just got walloped in Hong Kong, creating another massive problem for Xi but a nice byproduct for the US. By any measure, it was a landslide. The young, energetic, pro-democracy activists in Hong Kong completely pounded virtually all of the Chinese Communist Party's candidates in the elections which just took place across Hong Kong. If the elections were meant to be a barometer, the measured pressure was off the charts. With a record voter turnout of 71%—double the number from four years ago, pro-democracy candidates won 90% of the 452 district council seats. What the people of Hong Kong are demanding is clear: China must stick to its 1997 promise of "one country, two systems." A promise we never believed they would keep. The elections may have had a positive, unintended consequence for the US. In a phone call with US trade reps, Chinese officials finally put the issue of intellectual property on the table. In other words, with increased pressure from their southern border, they may finally be willing to complete the first leg of a trade deal. The US markets liked that news. While the election results in Hong Kong were fantastic, the Communist Party of China will never capitulate. The best we can hope for is a stalemate akin to a weakened version of China vs Taiwan. If that condition is unacceptable to Beijing, they will take actions which will drive even more capital away from their former golden goose.
Pharmaceuticals
Novartis will buy The Medicines Company for nearly $10 billion, sending the latter's shares up nearly 25%. One year ago, The Medicines Company (MDCO $16-$84-$84) was a $1.6 billion small-cap pharma outfit selling for $16.69 per share. Now that $205 billion drug giant Novartis (NVS $73-$91-$95) has taken an interest in the New Jersey firm, it is worth nearly $8 billion and is trading at $84 per share. In fact, MDCO shares spiked nearly 25% on Monday morning after Novartis announced its intent to buy the firm for $9.7 billion in an all-cash deal. It's a risky bet for the Switzerland-based drugmaker, as MDCO has essentially become a one-drug wonder—its cholesterol-lowering treatment Inclisiran will be submitted to the FDA for (hopeful) approval before the year is up. This deal came to fruition not because of a skilled management team at The Medicines Company; it came about because activist biotech investor Dr. Alex Denner, founding partner and chief investment officer of Sarissa Capital Management, got involved. Denner saw a bloated firm with ineffective management chasing unprofitable avenues. After taking considerable control of the company, he "persuaded" MDCO to reduce its board from 12 to 7 directors and begin selling off unprofitable units. In the end, it was left with Inclisiran—and a fat offer from Novartis. Activists can be very detrimental to a company and its shareholders (we won't mention any names, but they should be obvious to our regular readers), or they can be extremely beneficial. Alex Denner is directly responsible for MDCO shareholders becoming about 400% wealthier in their position over the course of one year. Now that's impressive, irrespective of what happens to Inclisiran at the FDA.
Textiles, Apparel, & Luxury Goods
Done deal: LVMH will buy American luxury jeweler Tiffany in all-cash deal. France's LVMH (Louis Vuitton Moet Hennessy) will acquire American jeweler Tiffany (TIF $73-$133-$130) for $16.2 million in cash, or $135 per share. LVMH, under the control of French billionaire Bernard Arnault, controls over 75 brands and is one of Europe's largest companies, worth an estimated $225 billion. The Tiffany deal is part of a larger strategy by the company to move more heavily into China, a marketplace in which the American company has been effectively able to infiltrate. Sadly, despite its success in China, Tiffany has been floundering under various leadership regimes for years, while LVMH has focused on providing exceptional customer service to its high-end shoppers. Tiffany will continue to operate with its name intact while under the LVMH umbrella, it just won't be an American interest—or publicly-traded company. Tiffany's life in the doldrums was of its own making. Instead of providing excellent customer service to its high-end clients, it floundered without a sound strategic plan. The final straw was bringing in Alessandro Bogliolo—someone who had absolutely no vested interest in keeping the company independent—to run the company back in 2017. With a better choice, this acquisition could have been averted, and Tiffany could have been returned to its glory days.
Transportation Infrastructure
Uber shares drop about 4% after the ride-hailing service loses its London license. In a move stinking of politics, and cronyism, London's transport regulator has ruled that Uber (UBER $26-$28-$47) is "not fit and proper" to remain in operation in the city. The organization, clearly on the side of London's black cabs (their version of the local taxi services), made the claim that Uber placed passenger safety and security at risk, yet it gave scant evidence that there was any higher risk for a Londoner to ride in an Uber versus a black cab. Of course, the highly-partisan mayor of London and enemy of free enterprise, Sadiq Khan, celebrated the decision, clamoring that Uber had "directly put passengers' safety at risk." The Independent Workers of Great Britain (IWGB) labor union has called the move a "hammer blow" to Uber's drivers and is demanding to meet with the mayor. For its part, Uber, which has 45,000 licensed drivers in the city, said it will appeal the decision. It has a 21-day window to do so, during which it may continue to operate. This is nothing short of a hit-job by a government organization against a legally-operated private entity. For business owners, this should serve as a reminder to have a strong documentation and risk management system in place, and to constantly be evaluating the landscape for potential threats.
Food Products
Bumble Bee files for bankruptcy, sending it into the arms of a Taiwan-based fishery. This past March we reported on a price-fixing scandal that rocked the canned tuna world. The most surprising fact brought to life in the story: who knew StarKist was not an American firm? Now, that scandal has claimed its first victim, as California-based Bumble Bee Foods will file for bankruptcy after getting hit with a $25 million fine by the US Department of Justice (it still owes the DoJ $17 million). Although based out of California, Bumble Bee was purchased in 2010 by a London-based private equity firm for $980 million. Now that the company is under bankruptcy protection, it has received an offer by Taiwan-based FCF Fishery to buy the firm for $275 million in cash and the assumption of $638 million worth of debt. We have also reported on the woes of "middle aisle" food products companies, as shoppers seek healthier alternatives. Sales of canned tuna, in fact, have dropped by nearly 50% over the past generation. Want to enjoy your tuna without worrying about mercury levels? Check out Safe Catch, Wild Planet, and American Tuna—all offering wild-caught, mercury-tested seafood, and all available at natural grocers or through Amazon.
Headlines for the Week of 17 Nov 2019—23 Nov 2019
Business & Professional Services
What is Honey Science and why is PayPal willing to pay $4 billion to get its hands on it? With its 267 million active users—22 million of which are merchant accounts, digital and mobile payments processor PayPal (PYPL $77-$102-$121) is the big dog with respect to secure, online transactions. Honey Science is a digital company which offers a free web browser extension to online shoppers which automatically seeks and applies coupons to whatever items a consumer happens to be looking for on the internet. For example, searching for some Levi's 502 slim fit jeans? Just search a site and add the product to the site's respective shopping cart, go to checkout, and Honey will apply all of the possible discounts, often dramatically lowering the price you pay. We tried it—it is pretty cool. So cool, in fact, that $120 billion PayPal is willing to pay $4 billion to acquire the company. For PayPal, this is part of a trend: buy new tools to keep users happy and figure out how to monetize these tools within the company's ecosystem. You have probably heard the term "fintech" used recently. Understand this term, because there is a lot of money to be made with the synergies generated between technology and financial services. Working in the industry, we see it on a daily basis, and the momentum is growing. Brilliant move and smart overall strategy by PayPal, a company which we agree is undervalued. p.s. Don't tell millennials but the company also owns their darling online payment service, Venmo.
Automotive
Elon Musk reveals Tesla's new "out of this world" pickup, the Cybertruck. One never knows what to expect from the fertile mind of Elon Musk, but boring is never an option. The Tesla (TSLA $177-$355-$379) CEO just revealed the company's new pickup, the Cybertruck, and it is nothing short of unreal. With production set to begin in 2021, the company's sixth vehicle will have a starting price of $40,000 with plans to compete in the lucrative Ford F-150 and Chevy Silverado market. Looking beyond the truck's futuristic design, it will offer a range of between 250 and 500 miles per charge, depending on the model, come equipped with Tesla's Autopilot feature, and have a towing capacity of between 7,500 and 14,000 pounds—again, depending on the model. By comparison, the best-selling Ford F-150 offers a towing capacity of between 5,000 and 8,000 pounds. For use at the jobsite, the Cybertruck comes complete with 120-volt and 240-volt power outlets and an onboard air compressor. For off-duty fun, consumers will be able to buy Tesla's new electric all-terrain vehicle, designed to roll up into the back of the Cybertruck. For all his detractors, Elon Musk has been an extreme disruptor within the automotive industry, forcing other automakers to innovate beyond what they would have if Tesla did not exist. They have no problem poking fun at Musk, meanwhile they are constantly scrambling to make "us too!" moves. Incredibly, he is causing the same disruption to the nascent commercial spaceflight industry with his privately-held SpaceX. It is easy to compare Musk to a Henry Ford or a Steve Jobs, but that might not be giving him the credit he is due. In June of this year, TSLA shares were selling at $176.99 and the lemming analysts came after Musk with both barrels. Since 03 Jun, shares are up precisely 100% (as of Friday morning). Short sellers who listened to the analysts' advice on this stock have been decimated.
Capital Markets
Charles Schwab announces plans to buy TD Ameritrade for $26 billion. Three years ago, $15 billion (at the time) brokerage firm TD Ameritrade (AMTD $33-$51-$58) gobbled up St. Louis-based Scottrade for $4 billion. Now, just a few short weeks after Charles Schwab (SCHW $35-$50-$50) jolted the industry by reducing commissions to zero—forcing everyone to follow, it appears that TD will be gobbled up by that firm. Going into the day, Schwab had a market cap of roughly $60 billion, with TD about one-third that size. This deal, which sent shares of TD up 25% at the open and Schwab shares up over 12%, makes a lot of sense. The zero commission proposition certainly hurt TD Ameritrade more than it did Schwab, and consolidation seems to be the norm in an industry being disrupted by new web-based entrants. Once combined, the new entity will hold about $5 trillion in assets, giving it tremendous leverage. This begs the question: what will now happen to $10 billion E*Trade (ETFC) and and $20 billion Interactive Brokers Group (IBKR)? Interestingly, the one loser in the industry on the morning of this news was E*Trade, which was down over 6% at the open. This is because most analysts expected that firm to be the target company for the next acquisition. It might make sense for Interactive to buy E*Trade, assuming the former doesn't wish to be a takeover target itself. Want to play the entire industry? There's an ETF for that: the iShares US Broker-Dealers & Securities Exchanges ETF (IAI $52-$68-$68).
Technology Hardware & Equipment
Apple breaks ground on its stunning new Austin campus. It will cost $1 billion to build, cover 133 acres, and be home to 5,000 employees—with the capacity to house another 10,000. It is the stunning new Austin campus of Apple, Inc (AAPL $142-$265-$268), set to be completed in 2022. The company broke ground on the new facility this week, with CEO Tim Cook and President Donald Trump in attendance. For all the promises made by US companies to bring manufacturing back to the US, Apple is clearly delivering, and this new facility is $1 billion worth of proof. While the company plans to build its new high-end Mac Pro, starting price $6,000, at the facility, workers are already constructing the machines at a nearby Austin location, with deliveries to customers expected to begin next month. In addition to its new Austin behemoth, Apple said it is also expanding facilities in Boulder, Culver City, New York, Pittsburgh, San Diego, and Seattle. We think back to all of the shade being thrown Apple's way this past summer and chuckle. If there is one stock in the world to own right now, it is AAPL.
Global Strategy: East & Southeast Asia
Senate passes Hong Kong support bill, enraging the communist Chinese government. Just as it appeared likely that at least part of a trade deal with China was going to get done, new events continue to foil the effort. The latest: the United States Senate unanimously passed the Hong Kong Human Rights and Democracy Act, a bill designed to show support for Hong Kong's protestation of China's infiltration into the Special Administrative Region. The House already passed a similar bill, but the two chambers must cobble together a piece of compromise legislation before it can be sent to the White House for presidential approval. Whether that hurdle can be jumped is debatable, especially with the House myopically focused on impeachment, but even the specter of a final bill has enraged Beijing. While both sides have publicly claimed that the two issues, trade and Hong Kong, are separate, this is such a hot-button topic for China that the two are almost certainly intertwined. Yet another roadblock in the way. That being said, the Senate did the right thing by passing the bill in a bipartisan manner. At least the two political parties can agree on something. China can do all of the saber-rattling it likes, the country is truly being hurt by this trade war. They will never give up on controlling Hong Kong, however, and that issue will not go away—trade deal or not.
Leisure Equipment & Products
After falling over 25% in a month, is it time to pick up toymaker Hasbro? Ever since Mattel (MAT $9-$12-$17) lost its sixty-year lock on Disney (DIS) products to rival toymaker Hasbro (HAS $77-$95-$127), we have been arguing that an investment in the latter made a lot more sense. In addition to fumbling away this critically-important relationship, Mattel has also gone through something like three CEOs in as many years. Not a situation that portends good things to come. That being said, Hasbro took a 25% dive in October after Q3 failed to deliver. So, heading into its sweet spot of the year, is it time to pick up some shares? We don't think so. Somewhere around 70% of Hasbro's toys emanate from China, and those are the precise products due to get pounded by the planned December wave of tariffs. We also don't like the high multiple (46 P/E) on the shares, and are having a hard time figuring out how that could be justified. This isn't exactly a high-growth industry, after all. An investor could pick up some shares of Mattel, maker of Barbie, Hot Wheels, and Fisher-Price, and pray for a buyout offer from Hasbro (three times its size), but that seems like a risky prospect. In short, it is best to steer clear of this industry until one of the players figures out how to dominate in an era of high-tech video games. If investors really want to gamble in this space, we offer up Jakks Pacific (JAKK), the $30 million toymaker selling for $0.85 per share (down from $20 in 2011).
Economic Outlook
Home Depot and Kohl's gave investors reason to worry; Lowe's and Target eased their mind. We weren't so surprised by the lousy Kohl's (KSS) earnings report, as we have no faith in the company's ability to execute. The unimpressive Home Depot (HD) report, however, gave us cause for concern, as it is one of the most well-run companies in the industry, and often a bellwether for the US economy. A short twenty-four hours later, and two new reports are easing our concerns. Home Depot's doppelganger, Lowe's (LOW $85-$113-$118), reported a beat in Q3, with comparable-store sales rising 3% and adjusted earnings per share coming in at $1.35—a 36% increase from last year. Guidance was also strong: the company expects to bring in $72.74 billion in revenue for the year, up about 2% from last year. The other retailer helping to ease Wall Street concerns was Penn Global Leaders Club member Target (TGT $60-$121-$115). Shares of the $62 billion multiline retailer were up nearly 10%—blowing through their 52-week high—after that company trounced analysts' expectations. Same-store sales were up an impressive 4.5% from the same period last year, and full-year adjusted EPS are expected to be within the range of $6.25 to $6.45. In other words, the ugly retail reports rolling in seem to be company-centric and not a sign of a weakening economy. Be prepared, however: there are six fewer shopping days than normal this year between Thanksgiving and Christmas, which may skew results and make for some troubling headlines. We are now turning our attention to the 15 Dec tariffs set to take affect unless some semblance of a Phase I trade deal comes together. Unfortunately, the atmosphere between the two sides seems to be getting toxic yet again.
Multiline Retail
The retailer we love to hate, Kohl's, loses one-fifth of its value in one day. Multiline retailers were getting hammered on Tuesday as a major player reduced its guidance for the remainder of the year. Shares of Kohl's (KSS $43-$47-$76) were trading down by roughly 20% after the company reported that its same-store sales were flat (0.4%), total revenue was flat (-0.1%), and net income was off by 24%, to $123 million. The final straw was the reduced full-year guidance ahead of the busiest shopping period of the year. Unfortunately, the dour Kohl's report dragged down Nordstrom (JWN) and Macy's (M) as well, with each falling about 5%. Both of those retailers will report before the bell on Thursday. We wouldn't touch KSS, despite the 20% sale on shares. We thought the company's plan to accept Amazon returns was bizarre, half-baked, and reeked of desperation. We do, however, find both JWN and M intriguing. Two deep value stocks that actually still turn a profit, despite their troubles.
Market Pulse
Morgan Stanley bearish on US markets in 2020, sees more opportunity internationally. To be sure, we see an unusually-high amount of volatility in the markets next year, with an endless stream of election-centric hyperbolic headlines coming from the press, a China which believes it can out-wait Trump, and anti-Brexiteers screaming like stuck pigs as the UK finally exits the Union. That being said, we are not ready to join the Morgan Stanley camp, which believes the S&P will end 2020 at 3,000 (a 4% drop), the dollar will weaken, oil will fall (with Brent going from $63 to $60 per barrel), and US corporate debt will underperform global bonds. Where does MS see growth? Strategists at the firm see opportunity in emerging markets (especially Brazil), Japan, gold, the euro, and the British pound. Before putting too much stock in the predictions, the bank called for a flat equities market in 2019. Our biggest concern revolves around the fallout from a no-holds-barred election fight. The press will be given plenty of fodder, and they will use it to foment chaos. Rates will remain low, which will be a good thing for the US markets, but investors should be ready to implement some market downturn strategies to protect their 2019 gains.
Automotive
Ford launches its new electric vehicle lineup with the Mustang Mach-E SUV. The reservation site is now live: consumers can visit the Ford (F $7-$9-$11) website to order their new, all-electric Mustang Mach-E SUV. Starting price: $44,000. The company is late to the party, with Tesla (TSLA) controlling 80% of the EV market and a handful of other players splitting the other 20%, but with Tesla's new electric pickup truck and its Model Y SUV hitting the road soon, at least the $35 billion automaker is now in the game. It was an interesting gamble to launch its $11 billion EV program with an iconic name attached to an SUV, but Ford needs to be bold if it hopes to compete in this space. The company says it will offer 40 all-electric and hybrid vehicles by 2022—an aggressive timeline we highly question. As for the Mustang Mach-E, customers should be able to take delivery by Q4 of next year. How will Ford turn a profit on an all-electric SUV for $44,000 ($60k for the GT)? The vehicles will be built in Mexico, saving thousands per unit on labor costs. We haven't had a lot of faith in Ford CEO Jim Hackett's ability to see the future of the industry, but if the company can make its EV lineup a viable player in the industry, it could spell the beginnings of a turnaround. Let's see how well they execute before investing, however.
Household & Personal Products
Global beauty brand Coty buys 51% of Kylie Cosmetics for $600 million. Back on 19 August, when shares of $9 billion cosmetics firm Coty (COTY $6-$12-$14) were trading at $9.19, we said they were worth a serious look. Even though the shares have rallied 33% in the 90 days since, we still believe they have room to run. Those shares got a little bump on Monday as the company announced it would buy a 51% stake in Kylie Jenner's beauty line, Kylie Cosmetics, for $600 million. The deal represents part of a larger strategy by the company to garner a greater market share among a younger clientele. The cosmetics firm will take over responsibility for the product lineup, while the 22-year-old billionaire Jenner will remain the face of the company. Coty is majority owned by JAB Holdings Corp, owner of Keurig, Panera, Krispy Kreme, and a number of other companies we used to have the luxury of trading (before being gobbled up and taken private). Coty is following a recent trend set by other industry players such as The Estee Lauder Companies (EL) and Revlon (REV), which have been on a buying spree as of late. Estee Lauder, for example, just bought the two-thirds of South Korea's "Have & Be Company" which it didn't already own, establishing its first foothold in the lucrative Asian market. While more of a retailer than a maker of products, we believe the most undervalued player in the space is Ulta Beauty (ULTA $224-$244-$369), which is trading relatively near its 52-week low.
Global Strategy: Middle East
Violent protests take place across Iran as ruling mullahs end gas subsidies. Talk about rich irony. OPEC member-state Iran holds around 10% of the world's proven oil reserves and 15% of its gas. It is the world's fourth-largest oil producer. Against that backdrop, the ruling mullahs in the country just began rationing gasoline and ended gas subsidies to the citizenry, pushing prices up by over 50%. Understandably, Iranians have taken to the streets in cities across the country to protest these draconian measures, with many of the demonstrations turning violent. In an effort to keep the world in the dark with respect to the domestic violence, network tracking agency NetBlocks reports that the government has all but completely shutdown internet services in the country. US sanctions against the Iranian regime, the country's lack of refining capacity, and the general mismanagement of the economy are all contributing factors with respect to the energy shortage and the subsequent protests. Despite the efforts of the government to deflect blame to the United States, the protestors are overwhelmingly focused on their own leaders, demanding an end to the onerous rationing and price spikes. Ultimately, this will not end with a positive outcome for the mullahs or President Hassan Rouhani. And this is not Hong Kong; eventually, these protestors will win.
Global Strategy: Middle East
Sorry, Saudi Arabia, Aramco is not worth $1.7 trillion. As of Monday's open, there were two companies in the world worth over $1 trillion: Apple (AAPL, $1.18T) and Microsoft (MSFT, $1.14T). If Saudi Arabia has its way, it will offer an entity up for IPO that will immediately blow those two great American companies out of the water, at least from a valuation standpoint. We can poke a lot of holes in their narrative, however. The company in question is Saudi Aramco, officially known as the Saudi Arabian Oil Company. Granted, the state-owned entity had supposed revenues last year of $356 billion, which would make it the sixth-largest company in the world—public or private—from a revenue standpoint, but a lot of their math seems "fuzzy," not to mention how reliant that revenue stream is on the price of oil, which has been coming down over the past year. Furthermore, the company only plans to IPO a 1.5% stake in the firm, offering roughly 3 billion shares at around $8 per share, which would yield $24 billion in much-needed funding for the Kingdom. The company's public debut appears set for next month, and we fully expect it to be successful. It may even beat the record $25 billion raised by Alibaba (BABA) during its 2014 debut. Somewhat ironically, Saudi Arabia will use the proceeds from the offering to diversify its economy away from oil revenues. There are too many unknowns swirling around the energy industry right now as the world grapples with an increasing supply of oil, lower demand, and an ever-increasing demand for alternatives. We wouldn't touch the 0.5% of Saudi Aramco (out of the 1.5%) that will actually be available to individual investors.
What is Honey Science and why is PayPal willing to pay $4 billion to get its hands on it? With its 267 million active users—22 million of which are merchant accounts, digital and mobile payments processor PayPal (PYPL $77-$102-$121) is the big dog with respect to secure, online transactions. Honey Science is a digital company which offers a free web browser extension to online shoppers which automatically seeks and applies coupons to whatever items a consumer happens to be looking for on the internet. For example, searching for some Levi's 502 slim fit jeans? Just search a site and add the product to the site's respective shopping cart, go to checkout, and Honey will apply all of the possible discounts, often dramatically lowering the price you pay. We tried it—it is pretty cool. So cool, in fact, that $120 billion PayPal is willing to pay $4 billion to acquire the company. For PayPal, this is part of a trend: buy new tools to keep users happy and figure out how to monetize these tools within the company's ecosystem. You have probably heard the term "fintech" used recently. Understand this term, because there is a lot of money to be made with the synergies generated between technology and financial services. Working in the industry, we see it on a daily basis, and the momentum is growing. Brilliant move and smart overall strategy by PayPal, a company which we agree is undervalued. p.s. Don't tell millennials but the company also owns their darling online payment service, Venmo.
Automotive
Elon Musk reveals Tesla's new "out of this world" pickup, the Cybertruck. One never knows what to expect from the fertile mind of Elon Musk, but boring is never an option. The Tesla (TSLA $177-$355-$379) CEO just revealed the company's new pickup, the Cybertruck, and it is nothing short of unreal. With production set to begin in 2021, the company's sixth vehicle will have a starting price of $40,000 with plans to compete in the lucrative Ford F-150 and Chevy Silverado market. Looking beyond the truck's futuristic design, it will offer a range of between 250 and 500 miles per charge, depending on the model, come equipped with Tesla's Autopilot feature, and have a towing capacity of between 7,500 and 14,000 pounds—again, depending on the model. By comparison, the best-selling Ford F-150 offers a towing capacity of between 5,000 and 8,000 pounds. For use at the jobsite, the Cybertruck comes complete with 120-volt and 240-volt power outlets and an onboard air compressor. For off-duty fun, consumers will be able to buy Tesla's new electric all-terrain vehicle, designed to roll up into the back of the Cybertruck. For all his detractors, Elon Musk has been an extreme disruptor within the automotive industry, forcing other automakers to innovate beyond what they would have if Tesla did not exist. They have no problem poking fun at Musk, meanwhile they are constantly scrambling to make "us too!" moves. Incredibly, he is causing the same disruption to the nascent commercial spaceflight industry with his privately-held SpaceX. It is easy to compare Musk to a Henry Ford or a Steve Jobs, but that might not be giving him the credit he is due. In June of this year, TSLA shares were selling at $176.99 and the lemming analysts came after Musk with both barrels. Since 03 Jun, shares are up precisely 100% (as of Friday morning). Short sellers who listened to the analysts' advice on this stock have been decimated.
Capital Markets
Charles Schwab announces plans to buy TD Ameritrade for $26 billion. Three years ago, $15 billion (at the time) brokerage firm TD Ameritrade (AMTD $33-$51-$58) gobbled up St. Louis-based Scottrade for $4 billion. Now, just a few short weeks after Charles Schwab (SCHW $35-$50-$50) jolted the industry by reducing commissions to zero—forcing everyone to follow, it appears that TD will be gobbled up by that firm. Going into the day, Schwab had a market cap of roughly $60 billion, with TD about one-third that size. This deal, which sent shares of TD up 25% at the open and Schwab shares up over 12%, makes a lot of sense. The zero commission proposition certainly hurt TD Ameritrade more than it did Schwab, and consolidation seems to be the norm in an industry being disrupted by new web-based entrants. Once combined, the new entity will hold about $5 trillion in assets, giving it tremendous leverage. This begs the question: what will now happen to $10 billion E*Trade (ETFC) and and $20 billion Interactive Brokers Group (IBKR)? Interestingly, the one loser in the industry on the morning of this news was E*Trade, which was down over 6% at the open. This is because most analysts expected that firm to be the target company for the next acquisition. It might make sense for Interactive to buy E*Trade, assuming the former doesn't wish to be a takeover target itself. Want to play the entire industry? There's an ETF for that: the iShares US Broker-Dealers & Securities Exchanges ETF (IAI $52-$68-$68).
Technology Hardware & Equipment
Apple breaks ground on its stunning new Austin campus. It will cost $1 billion to build, cover 133 acres, and be home to 5,000 employees—with the capacity to house another 10,000. It is the stunning new Austin campus of Apple, Inc (AAPL $142-$265-$268), set to be completed in 2022. The company broke ground on the new facility this week, with CEO Tim Cook and President Donald Trump in attendance. For all the promises made by US companies to bring manufacturing back to the US, Apple is clearly delivering, and this new facility is $1 billion worth of proof. While the company plans to build its new high-end Mac Pro, starting price $6,000, at the facility, workers are already constructing the machines at a nearby Austin location, with deliveries to customers expected to begin next month. In addition to its new Austin behemoth, Apple said it is also expanding facilities in Boulder, Culver City, New York, Pittsburgh, San Diego, and Seattle. We think back to all of the shade being thrown Apple's way this past summer and chuckle. If there is one stock in the world to own right now, it is AAPL.
Global Strategy: East & Southeast Asia
Senate passes Hong Kong support bill, enraging the communist Chinese government. Just as it appeared likely that at least part of a trade deal with China was going to get done, new events continue to foil the effort. The latest: the United States Senate unanimously passed the Hong Kong Human Rights and Democracy Act, a bill designed to show support for Hong Kong's protestation of China's infiltration into the Special Administrative Region. The House already passed a similar bill, but the two chambers must cobble together a piece of compromise legislation before it can be sent to the White House for presidential approval. Whether that hurdle can be jumped is debatable, especially with the House myopically focused on impeachment, but even the specter of a final bill has enraged Beijing. While both sides have publicly claimed that the two issues, trade and Hong Kong, are separate, this is such a hot-button topic for China that the two are almost certainly intertwined. Yet another roadblock in the way. That being said, the Senate did the right thing by passing the bill in a bipartisan manner. At least the two political parties can agree on something. China can do all of the saber-rattling it likes, the country is truly being hurt by this trade war. They will never give up on controlling Hong Kong, however, and that issue will not go away—trade deal or not.
Leisure Equipment & Products
After falling over 25% in a month, is it time to pick up toymaker Hasbro? Ever since Mattel (MAT $9-$12-$17) lost its sixty-year lock on Disney (DIS) products to rival toymaker Hasbro (HAS $77-$95-$127), we have been arguing that an investment in the latter made a lot more sense. In addition to fumbling away this critically-important relationship, Mattel has also gone through something like three CEOs in as many years. Not a situation that portends good things to come. That being said, Hasbro took a 25% dive in October after Q3 failed to deliver. So, heading into its sweet spot of the year, is it time to pick up some shares? We don't think so. Somewhere around 70% of Hasbro's toys emanate from China, and those are the precise products due to get pounded by the planned December wave of tariffs. We also don't like the high multiple (46 P/E) on the shares, and are having a hard time figuring out how that could be justified. This isn't exactly a high-growth industry, after all. An investor could pick up some shares of Mattel, maker of Barbie, Hot Wheels, and Fisher-Price, and pray for a buyout offer from Hasbro (three times its size), but that seems like a risky prospect. In short, it is best to steer clear of this industry until one of the players figures out how to dominate in an era of high-tech video games. If investors really want to gamble in this space, we offer up Jakks Pacific (JAKK), the $30 million toymaker selling for $0.85 per share (down from $20 in 2011).
Economic Outlook
Home Depot and Kohl's gave investors reason to worry; Lowe's and Target eased their mind. We weren't so surprised by the lousy Kohl's (KSS) earnings report, as we have no faith in the company's ability to execute. The unimpressive Home Depot (HD) report, however, gave us cause for concern, as it is one of the most well-run companies in the industry, and often a bellwether for the US economy. A short twenty-four hours later, and two new reports are easing our concerns. Home Depot's doppelganger, Lowe's (LOW $85-$113-$118), reported a beat in Q3, with comparable-store sales rising 3% and adjusted earnings per share coming in at $1.35—a 36% increase from last year. Guidance was also strong: the company expects to bring in $72.74 billion in revenue for the year, up about 2% from last year. The other retailer helping to ease Wall Street concerns was Penn Global Leaders Club member Target (TGT $60-$121-$115). Shares of the $62 billion multiline retailer were up nearly 10%—blowing through their 52-week high—after that company trounced analysts' expectations. Same-store sales were up an impressive 4.5% from the same period last year, and full-year adjusted EPS are expected to be within the range of $6.25 to $6.45. In other words, the ugly retail reports rolling in seem to be company-centric and not a sign of a weakening economy. Be prepared, however: there are six fewer shopping days than normal this year between Thanksgiving and Christmas, which may skew results and make for some troubling headlines. We are now turning our attention to the 15 Dec tariffs set to take affect unless some semblance of a Phase I trade deal comes together. Unfortunately, the atmosphere between the two sides seems to be getting toxic yet again.
Multiline Retail
The retailer we love to hate, Kohl's, loses one-fifth of its value in one day. Multiline retailers were getting hammered on Tuesday as a major player reduced its guidance for the remainder of the year. Shares of Kohl's (KSS $43-$47-$76) were trading down by roughly 20% after the company reported that its same-store sales were flat (0.4%), total revenue was flat (-0.1%), and net income was off by 24%, to $123 million. The final straw was the reduced full-year guidance ahead of the busiest shopping period of the year. Unfortunately, the dour Kohl's report dragged down Nordstrom (JWN) and Macy's (M) as well, with each falling about 5%. Both of those retailers will report before the bell on Thursday. We wouldn't touch KSS, despite the 20% sale on shares. We thought the company's plan to accept Amazon returns was bizarre, half-baked, and reeked of desperation. We do, however, find both JWN and M intriguing. Two deep value stocks that actually still turn a profit, despite their troubles.
Market Pulse
Morgan Stanley bearish on US markets in 2020, sees more opportunity internationally. To be sure, we see an unusually-high amount of volatility in the markets next year, with an endless stream of election-centric hyperbolic headlines coming from the press, a China which believes it can out-wait Trump, and anti-Brexiteers screaming like stuck pigs as the UK finally exits the Union. That being said, we are not ready to join the Morgan Stanley camp, which believes the S&P will end 2020 at 3,000 (a 4% drop), the dollar will weaken, oil will fall (with Brent going from $63 to $60 per barrel), and US corporate debt will underperform global bonds. Where does MS see growth? Strategists at the firm see opportunity in emerging markets (especially Brazil), Japan, gold, the euro, and the British pound. Before putting too much stock in the predictions, the bank called for a flat equities market in 2019. Our biggest concern revolves around the fallout from a no-holds-barred election fight. The press will be given plenty of fodder, and they will use it to foment chaos. Rates will remain low, which will be a good thing for the US markets, but investors should be ready to implement some market downturn strategies to protect their 2019 gains.
Automotive
Ford launches its new electric vehicle lineup with the Mustang Mach-E SUV. The reservation site is now live: consumers can visit the Ford (F $7-$9-$11) website to order their new, all-electric Mustang Mach-E SUV. Starting price: $44,000. The company is late to the party, with Tesla (TSLA) controlling 80% of the EV market and a handful of other players splitting the other 20%, but with Tesla's new electric pickup truck and its Model Y SUV hitting the road soon, at least the $35 billion automaker is now in the game. It was an interesting gamble to launch its $11 billion EV program with an iconic name attached to an SUV, but Ford needs to be bold if it hopes to compete in this space. The company says it will offer 40 all-electric and hybrid vehicles by 2022—an aggressive timeline we highly question. As for the Mustang Mach-E, customers should be able to take delivery by Q4 of next year. How will Ford turn a profit on an all-electric SUV for $44,000 ($60k for the GT)? The vehicles will be built in Mexico, saving thousands per unit on labor costs. We haven't had a lot of faith in Ford CEO Jim Hackett's ability to see the future of the industry, but if the company can make its EV lineup a viable player in the industry, it could spell the beginnings of a turnaround. Let's see how well they execute before investing, however.
Household & Personal Products
Global beauty brand Coty buys 51% of Kylie Cosmetics for $600 million. Back on 19 August, when shares of $9 billion cosmetics firm Coty (COTY $6-$12-$14) were trading at $9.19, we said they were worth a serious look. Even though the shares have rallied 33% in the 90 days since, we still believe they have room to run. Those shares got a little bump on Monday as the company announced it would buy a 51% stake in Kylie Jenner's beauty line, Kylie Cosmetics, for $600 million. The deal represents part of a larger strategy by the company to garner a greater market share among a younger clientele. The cosmetics firm will take over responsibility for the product lineup, while the 22-year-old billionaire Jenner will remain the face of the company. Coty is majority owned by JAB Holdings Corp, owner of Keurig, Panera, Krispy Kreme, and a number of other companies we used to have the luxury of trading (before being gobbled up and taken private). Coty is following a recent trend set by other industry players such as The Estee Lauder Companies (EL) and Revlon (REV), which have been on a buying spree as of late. Estee Lauder, for example, just bought the two-thirds of South Korea's "Have & Be Company" which it didn't already own, establishing its first foothold in the lucrative Asian market. While more of a retailer than a maker of products, we believe the most undervalued player in the space is Ulta Beauty (ULTA $224-$244-$369), which is trading relatively near its 52-week low.
Global Strategy: Middle East
Violent protests take place across Iran as ruling mullahs end gas subsidies. Talk about rich irony. OPEC member-state Iran holds around 10% of the world's proven oil reserves and 15% of its gas. It is the world's fourth-largest oil producer. Against that backdrop, the ruling mullahs in the country just began rationing gasoline and ended gas subsidies to the citizenry, pushing prices up by over 50%. Understandably, Iranians have taken to the streets in cities across the country to protest these draconian measures, with many of the demonstrations turning violent. In an effort to keep the world in the dark with respect to the domestic violence, network tracking agency NetBlocks reports that the government has all but completely shutdown internet services in the country. US sanctions against the Iranian regime, the country's lack of refining capacity, and the general mismanagement of the economy are all contributing factors with respect to the energy shortage and the subsequent protests. Despite the efforts of the government to deflect blame to the United States, the protestors are overwhelmingly focused on their own leaders, demanding an end to the onerous rationing and price spikes. Ultimately, this will not end with a positive outcome for the mullahs or President Hassan Rouhani. And this is not Hong Kong; eventually, these protestors will win.
Global Strategy: Middle East
Sorry, Saudi Arabia, Aramco is not worth $1.7 trillion. As of Monday's open, there were two companies in the world worth over $1 trillion: Apple (AAPL, $1.18T) and Microsoft (MSFT, $1.14T). If Saudi Arabia has its way, it will offer an entity up for IPO that will immediately blow those two great American companies out of the water, at least from a valuation standpoint. We can poke a lot of holes in their narrative, however. The company in question is Saudi Aramco, officially known as the Saudi Arabian Oil Company. Granted, the state-owned entity had supposed revenues last year of $356 billion, which would make it the sixth-largest company in the world—public or private—from a revenue standpoint, but a lot of their math seems "fuzzy," not to mention how reliant that revenue stream is on the price of oil, which has been coming down over the past year. Furthermore, the company only plans to IPO a 1.5% stake in the firm, offering roughly 3 billion shares at around $8 per share, which would yield $24 billion in much-needed funding for the Kingdom. The company's public debut appears set for next month, and we fully expect it to be successful. It may even beat the record $25 billion raised by Alibaba (BABA) during its 2014 debut. Somewhat ironically, Saudi Arabia will use the proceeds from the offering to diversify its economy away from oil revenues. There are too many unknowns swirling around the energy industry right now as the world grapples with an increasing supply of oil, lower demand, and an ever-increasing demand for alternatives. We wouldn't touch the 0.5% of Saudi Aramco (out of the 1.5%) that will actually be available to individual investors.
Headlines for the Week of 10 Nov 2019—16 Nov 2019
Market Pulse
The Dow Jones Industrial Average just hit a new milestone, closing above 28,000 for the first time. Granted, we still have around six full weeks of trading days left in 2019, but what a difference this fourth quarter is shaping up to be as opposed to the last quarter of 2018. The Dow Jones Industrial Average just smashed through a new milestone, rising above 28,000 for the first time. This after a four-week win streak for that benchmark, a six-week win streak for the S&P 500, and a seven-week win streak for the Nasdaq. All three major indexes, in fact, closed at record highs on Friday. The best performer in the Dow since summer? Shares of Apple (AAPL $142-$266-$266), which were being impugned by analysts back in July, are now up 30% since, hitting an all-time high at Friday's close. Even beaten down, trade-sensitive industrials joined the party, with Caterpillar (CAT), General Electric (GE), and even beleaguered Boeing (BA) all rising on the week. Call us bullish, but we see a Phase I trade deal getting signed, and a 12 Dec election in the UK turning out well for the pro-Brexit cause. Add the stronger-than expected quarter of earnings in the mix, as well as some positive economic signs finally emanating from Europe, and this market can go higher. The biggest threat? The 2020 nastiness and scorched-earth policy which will swirl around the approaching US election cycle.
Financials: Capital Markets
Now that the discount brokerages have pushed the nuke button on fees, how in the world do will make money? When I became a professionally-licensed stockbroker in 1997, things hadn't changed all that much for the financial services industry in generations. In fact, I still recall filling out trade orders on little forms, pushing hard enough so that all layers were legible, and giving the forms to the one person in the building who could submit the order for execution. A $10,000 purchase of General Motors stock might cost a client 4%, or $400. The advent of the discount brokerage changed all that, but now even that model is being disrupted. Interactive Brokers (IBKR) got the ball rolling with free trades on their IBKR Lite platform. Charles Schwab (SCHW) then announced that all trades by customers would come with no fee. Fidelity, TD Ameritrade (AMTD), and E-Trade (ETFC) quickly followed suit. But, with no commissions coming in any longer from the massive trade activity at these firms, how on earth will they keep the revenues from drying up? The answer, to a great degree, lies in net interest margin. Say, for example, that a client had $100,000 held in a cash reserves account at their brokerage firm. While the firm will pay a small interest rate to the client, they will make a much larger percentage by loaning that money out. The difference between what they pay the customer and what they receive on the assets is the net interest margin. These companies also make money on proprietary products (Fidelity, for example, has a lineup of ETFs and open-ended mutual funds) and cross-selling other financial services. This means one thing: the name of the game will be sheer numbers of clients to make the accounting work; those who accumulate new clients will do well, while those who stagnate will face increase pressure to be acquired. So far, Schwab is winning the battle—the firm announced it opened 142,000 new brokerage accounts in the month of October, a 31% increase from September. Our only question is this: if it is strictly a numbers game, what level of service are all of these new clients going to receive? I made my first trade when I was still a teenager, purchasing shares of Lockheed Martin from a stockbroker. I still remember how big of a commission was charged for my chump-change investment. It is an exciting time to invest, but zero fees and ease of trading also means a higher level of risk management will be needed. If it is extremely cheap and easy to buy stocks (a good thing), it is also extremely easy to lose money in a downturn. And not paying $4.95 per trade won't seem like that big of a deal when 30% of a portfolio has been eroded away by market loss.
Food & Staples Retailing
Walmart opens at an all-time high after another blowout quarter. America's largest retailer, Walmart (WMT $86-$121-$125), punched through an all-time-high stock price at Thursday's open after reporting a 41% jump in online sales over the same quarter a year ago—quite a remarkable feat. That impressive number was helped by strong growth in online grocery orders, a service which the company has been actively pushing throughout the year. Ahead of the Christmas shopping season, CEO Doug McMillon also raised the firm's annual earnings outlook for the second time this year. With this latest earnings report, Walmart has notched its 21st straight quarter of domestic growth. The Arkansas-based retailer earned $3.29 billion on the back of $128 billion in sales. Under intense pressure from Amazon (AMZN), it would have been so easy for Walmart to stagnate and begin a steady decline. Instead, under the leadership of CEO Doug McMillon, the $345 billion retailer has embraced the role of technology in the industry to become an even stronger force. The critical importance of leadership on display once again. Walmart holds position #38 (of 40) in the Penn Global Leaders Club.
Media & Entertainment
Penn member Disney jumps 8% after record-breaking first day for new streaming service. A lot of pundits had doubts about Walt Disney's (DIS $100-$148-$150) ability to become a viable combatant in the streaming wars, taking on the likes of well-established Netflix (NFLX). We didn't. Now, the facts are in: despite an overwhelmed system, the company announced that ten million new subscribers signed up for Disney+ on day one. Let's put that into context: Netflix, the undisputed leader in streaming, which has been around for two decades (how time flies), has about 60 million US subscribers. So, on day one, Disney+ is about one-sixth the size of Netflix, at least domestically. And let's not forget that Netflix is a one-trick pony, while Disney had $70 billion in revenue last year from its theme parks, media network (like its ABC unit), studio units (Lucasfilm, Pixar, Marvel), and character licenses. Disney CEO Bob Iger expects the new streaming service to have between 60 million and 90 million subs by the end of its fiscal 2024. Considering this week's launch was only in the US, Canada, and the Netherlands, that shouldn't be a problem. Netflix shares fell 2.95% on the day. With the host of new entrants, owners of Netflix shares should consider taking their profits off the table. Meanwhile, we see green pastures ahead for Disney, which holds position #12 (of 40) within the Penn Global Leaders Club.
Food Products
America's largest milk producer, Dean Foods, files for Chapter 11 bankruptcy. Going into 2017, Dean Foods (DF $1-$1-$6) was a $2 billion borderline small-/mid-cap value company that also happened to be the largest producer of milk products in the US. Now, in another sign of the struggles dairy farmers have been facing due to declining domestic milk consumption, Dean Foods, sitting at $0.80 per share and with a $73.5 million market cap, has filed for Chapter 11 bankruptcy protection. The company, which was founded in the 1920s by Samuel E. Dean, owner of an evaporated milk processing facility in Illinois, operates over 60 manufacturing facilities in 30 states with distribution to all 50 states. In addition to the downward shift in demand, many grocery chains have built their own milk plants, reducing their reliance on Dean. The Kansas City-based Dairy Farmers of America, a conglomerate of around 14,000 dairy producers, has expressed deep interest in acquiring the company out of bankruptcy, and has "financially prepared for this situation," according to Monica Massey, the organization's executive vice president. While Americans now consume about 40% less milk than they did 40 years ago, overall dairy consumption has grown by about 20% over that time-frame thanks to strong growth in yogurt and cheese sales. For their part, Dean's board of directors has hired advisers and launched a strategic review to consider pending offers. Despite residing in the consumer defensives sector, food products companies like Dean, Cal-Maine (CALM, largest egg producer), Kraft Heinz (KHC), and JM Smucker (SJM) are no longer the low-risk propositions they once were for investors. Like the phone companies of the 1970s, this industry is rapidly morphing into a new animal—with odd new alliances and new tech-based products such as plant-based meats and drinks. Opportunities will arise, but investors need to look closely at a respective company's management team and evaluate whether or not they grasp—and embrace—what is coming.
Beverages & Tobacco
Another one bites the dust: Budweiser takes out the Craft Brew Alliance. More often than not, that case of craft beer you picked up at the liquor store last weekend wasn't actually boiled, fermented, and bottled by an independent brewer. Though many of the big dogs, like Anhueser-Busch InBev (BUD), Molson Coors (TAP, also owns Miller), and Constellation Brands (STZ), like to poke fun at the craft beer industry, they have been tripping over themselves to gobble up the truly independent brewers. The latest instance: InBev-owned Anhueser-Busch announced it would acquire the 70% or so of Craft Brew Alliance (BREW $7-$16-$17) it didn't already own, driving the $150 million (before Tuesday) bottler up by 122% at Tuesday's open. BREW is a conglomerate of independents such as The Kona Brewing Company out of Hawaii and the Redhook Brewlab out of Portland. Here's the interesting back story: BREW had fallen from around $20 per share to $8 per share because Bud had balked at buying the company out for a previously-negotiated $22 per share. It will now buy the remaining shares for $16.50, which values the company around $320 million. In a bit of irony, readers may recall that the Belgian/Brazilian conglomerate InBev was able to swoop in and buy Anhueser-Busch on the cheap back in 2008 because of gross mismanagement and a weak US dollar (members can read our original story here). We have to wonder what the respective brewers in the Alliance think about this sale. Oh well, at least we still have the fiercely-independent, mid-cap brewer Boston Beer Company (SAM), which has outperformed Bud by 80% over the past eighteen months.
Global Strategy: Europe
In an enormous win for Boris Johnson, Brexiteer leader Nigel Farage will go after Labour, not Tories this election cycle. We talk until we are blue in the face about the false narratives created on a daily basis by the mainstream media. Try this headline on for size, which sat atop a story on a major business network's website: "Farage backs down in Brexit fight." Probably not enough for Farage to bring a lawsuit against this New York—based financial news outlet, but it is certainly a wormy little false narrative foisted by a biased reporter. British voters will go to the polls on Thursday, the 12th of December. As soon as the election was announced, we predicted a fed up electorate will give Johnson enough pro-Brexit seats to finally blow out of the European Union as demanded by voters over three years ago. The highly-intelligent Farage, whose raison d'être is Brexit, has now publicly stated that he will target the opposing Labour Party—whose goal is a second referendum overturning the first—in the upcoming election rather than nit-pick a fight with Johnson. Understandably, this is not what the media wanted to hear; hence the smarmy headline by the petulant reporter. Add Farage's support (he is wildly popular with the pro-Brexit crowd in England) to Johnson's determination, and we double-down on our prediction for the election outcome. A true exit from the EU is getting closer by the day.
Real Estate Management & Development
Is WeWork really going to hire a loudmouth nut-job to take over for a loudmouth nut-job? Just when you think things can't get any crazier for the dysfunctional entity known as WeWork, the board swoops in and surprises once again. Adam Neumann may have co-founded the company, but his oddball, mercurial behavior and greedy lifestyle doomed the company's IPO. In crazy-debt, the board was forced to take another bailout offer by made by Masayoshi Son's SoftBank, giving Son virtual control over the company. He moves in his buddy, Marcelo Claure, to lead the turnaround effort. Son had previously hired Claure to turnaround Sprint (the jury is still out on his success there, pending the T-Mobile merger). One or both of the men, Son and/or Claure, then decide it would be a good idea to hire the loudmouth, flamboyant CEO of T-Mobile, John Legere, whom they have been working with intimately on the Sprint/T-Mobile merger, to take over as CEO at WeWork. So, the biggest wildcard with respect to the telecom merger—Legere and his slick salesman personality—will probably now take over for Neumann at WeWork. Wow. Masayoshi Son is still living off his fame—and wealth—from being an early investor in Alibaba (BABA). But the incredibly arrogant Son, who has a 300 year business plan for SoftBank, has made some critically dumb mistakes over the past few years. This is yet another one. Imagine Son, Neumann, and Legere in a room at the same time, throw in some booze, and imagine the fanciful stories that would be told.
Global Strategy: Latin America
Bolivia's leftist president resigns after pressure from armed forces. It is hard to imagine a fraudulent election in Latin America actually being exposed—with real consequences being applied—but that is exactly what has just happened in Bolivia. President Evo Morales, fast friends with the likes of Putin, Castro, and Maduro, has been forced to step down from his office after 13 years, pressured by the Bolivian army after a fraudulent national election has spurred rioting in the streets. On Sunday, Morales took to Twitter to announce that he would not leave the country, despite an outstanding arrest warrant against him. What is different from this case and Venezuela's illegitimate president Maduro remaining in power? One big factor is the move by members of the Bolivian army to abandon their posts, including those guarding the presidential palace. The Venezuelan army has not found the mettle to take such a bold step, at least not yet. Russia is labeling the incident a coup, with Cuba, Venezuela, and Mexico joining that chorus. The first three usual suspects shouldn't surprise anyone; the Mexican response, however, should give pause to anyone who refused to believe that President Amlo was nothing but a full-throated leftist cut from the same cloth as Morales, Castro, and the room-temperature Chavez. It is refreshing to see this level of boldness both by the citizens of a Latin American country and its armed forces. Perhaps their courage will serve as inspiration for the people of Venezuela, many of whom are choosing to flee their home country instead of fighting to put recognized President Juan Guaido in his rightful seat.
Technology Hardware & Equipment
Xerox wants to buy HP—a company three times its size. Talk about audacity. Xerox (XRX $19-$39-$39), the company that brings to mind a copy machine from the 1970s, wants to buy the company formerly known as Hewlett Packard (HPQ $16-$20-$25), a name synonymous with a 1970s personal computer. Several thoughts immediately come to mind, but let's start with the obvious: Xerox has a market cap of $8 billion, while its target has a market cap of roughly $30 billion. If our math is correct, that would mean taking on debt equal to over three times the size of the company. Some analysts have speculated that this is Xerox's way to get HP's attention and initiate a reverse-takeover. Whatever the rationale, could two flailing printer and copier businesses really come to each other's rescue? Doubtful. Xerox may feel the need to take bold action after it ended its partnership with Fujifilm, meaning it no longer has an Asian distribution conduit. HP, which couldn't make a quality PC to save its life (based on our own experiences), is banking on the future of 3-D printing. Gee, no competition there. What about revenues? In 2010, Xerox had sales of $21 billion; last year it had sales of $9.5 billion. For its part, HP Inc had sales of $125 billion in 2010, versus sales of $58 billion last year. We are trying to find one word to describe a marriage between Xerox and HP Inc, but cannot find a specific antonym to the word "synergy." Anyone holding either XRX or HPQ in their portfolios should take the recent run-up in price as an excuse to exit the position(s).
The Dow Jones Industrial Average just hit a new milestone, closing above 28,000 for the first time. Granted, we still have around six full weeks of trading days left in 2019, but what a difference this fourth quarter is shaping up to be as opposed to the last quarter of 2018. The Dow Jones Industrial Average just smashed through a new milestone, rising above 28,000 for the first time. This after a four-week win streak for that benchmark, a six-week win streak for the S&P 500, and a seven-week win streak for the Nasdaq. All three major indexes, in fact, closed at record highs on Friday. The best performer in the Dow since summer? Shares of Apple (AAPL $142-$266-$266), which were being impugned by analysts back in July, are now up 30% since, hitting an all-time high at Friday's close. Even beaten down, trade-sensitive industrials joined the party, with Caterpillar (CAT), General Electric (GE), and even beleaguered Boeing (BA) all rising on the week. Call us bullish, but we see a Phase I trade deal getting signed, and a 12 Dec election in the UK turning out well for the pro-Brexit cause. Add the stronger-than expected quarter of earnings in the mix, as well as some positive economic signs finally emanating from Europe, and this market can go higher. The biggest threat? The 2020 nastiness and scorched-earth policy which will swirl around the approaching US election cycle.
Financials: Capital Markets
Now that the discount brokerages have pushed the nuke button on fees, how in the world do will make money? When I became a professionally-licensed stockbroker in 1997, things hadn't changed all that much for the financial services industry in generations. In fact, I still recall filling out trade orders on little forms, pushing hard enough so that all layers were legible, and giving the forms to the one person in the building who could submit the order for execution. A $10,000 purchase of General Motors stock might cost a client 4%, or $400. The advent of the discount brokerage changed all that, but now even that model is being disrupted. Interactive Brokers (IBKR) got the ball rolling with free trades on their IBKR Lite platform. Charles Schwab (SCHW) then announced that all trades by customers would come with no fee. Fidelity, TD Ameritrade (AMTD), and E-Trade (ETFC) quickly followed suit. But, with no commissions coming in any longer from the massive trade activity at these firms, how on earth will they keep the revenues from drying up? The answer, to a great degree, lies in net interest margin. Say, for example, that a client had $100,000 held in a cash reserves account at their brokerage firm. While the firm will pay a small interest rate to the client, they will make a much larger percentage by loaning that money out. The difference between what they pay the customer and what they receive on the assets is the net interest margin. These companies also make money on proprietary products (Fidelity, for example, has a lineup of ETFs and open-ended mutual funds) and cross-selling other financial services. This means one thing: the name of the game will be sheer numbers of clients to make the accounting work; those who accumulate new clients will do well, while those who stagnate will face increase pressure to be acquired. So far, Schwab is winning the battle—the firm announced it opened 142,000 new brokerage accounts in the month of October, a 31% increase from September. Our only question is this: if it is strictly a numbers game, what level of service are all of these new clients going to receive? I made my first trade when I was still a teenager, purchasing shares of Lockheed Martin from a stockbroker. I still remember how big of a commission was charged for my chump-change investment. It is an exciting time to invest, but zero fees and ease of trading also means a higher level of risk management will be needed. If it is extremely cheap and easy to buy stocks (a good thing), it is also extremely easy to lose money in a downturn. And not paying $4.95 per trade won't seem like that big of a deal when 30% of a portfolio has been eroded away by market loss.
Food & Staples Retailing
Walmart opens at an all-time high after another blowout quarter. America's largest retailer, Walmart (WMT $86-$121-$125), punched through an all-time-high stock price at Thursday's open after reporting a 41% jump in online sales over the same quarter a year ago—quite a remarkable feat. That impressive number was helped by strong growth in online grocery orders, a service which the company has been actively pushing throughout the year. Ahead of the Christmas shopping season, CEO Doug McMillon also raised the firm's annual earnings outlook for the second time this year. With this latest earnings report, Walmart has notched its 21st straight quarter of domestic growth. The Arkansas-based retailer earned $3.29 billion on the back of $128 billion in sales. Under intense pressure from Amazon (AMZN), it would have been so easy for Walmart to stagnate and begin a steady decline. Instead, under the leadership of CEO Doug McMillon, the $345 billion retailer has embraced the role of technology in the industry to become an even stronger force. The critical importance of leadership on display once again. Walmart holds position #38 (of 40) in the Penn Global Leaders Club.
Media & Entertainment
Penn member Disney jumps 8% after record-breaking first day for new streaming service. A lot of pundits had doubts about Walt Disney's (DIS $100-$148-$150) ability to become a viable combatant in the streaming wars, taking on the likes of well-established Netflix (NFLX). We didn't. Now, the facts are in: despite an overwhelmed system, the company announced that ten million new subscribers signed up for Disney+ on day one. Let's put that into context: Netflix, the undisputed leader in streaming, which has been around for two decades (how time flies), has about 60 million US subscribers. So, on day one, Disney+ is about one-sixth the size of Netflix, at least domestically. And let's not forget that Netflix is a one-trick pony, while Disney had $70 billion in revenue last year from its theme parks, media network (like its ABC unit), studio units (Lucasfilm, Pixar, Marvel), and character licenses. Disney CEO Bob Iger expects the new streaming service to have between 60 million and 90 million subs by the end of its fiscal 2024. Considering this week's launch was only in the US, Canada, and the Netherlands, that shouldn't be a problem. Netflix shares fell 2.95% on the day. With the host of new entrants, owners of Netflix shares should consider taking their profits off the table. Meanwhile, we see green pastures ahead for Disney, which holds position #12 (of 40) within the Penn Global Leaders Club.
Food Products
America's largest milk producer, Dean Foods, files for Chapter 11 bankruptcy. Going into 2017, Dean Foods (DF $1-$1-$6) was a $2 billion borderline small-/mid-cap value company that also happened to be the largest producer of milk products in the US. Now, in another sign of the struggles dairy farmers have been facing due to declining domestic milk consumption, Dean Foods, sitting at $0.80 per share and with a $73.5 million market cap, has filed for Chapter 11 bankruptcy protection. The company, which was founded in the 1920s by Samuel E. Dean, owner of an evaporated milk processing facility in Illinois, operates over 60 manufacturing facilities in 30 states with distribution to all 50 states. In addition to the downward shift in demand, many grocery chains have built their own milk plants, reducing their reliance on Dean. The Kansas City-based Dairy Farmers of America, a conglomerate of around 14,000 dairy producers, has expressed deep interest in acquiring the company out of bankruptcy, and has "financially prepared for this situation," according to Monica Massey, the organization's executive vice president. While Americans now consume about 40% less milk than they did 40 years ago, overall dairy consumption has grown by about 20% over that time-frame thanks to strong growth in yogurt and cheese sales. For their part, Dean's board of directors has hired advisers and launched a strategic review to consider pending offers. Despite residing in the consumer defensives sector, food products companies like Dean, Cal-Maine (CALM, largest egg producer), Kraft Heinz (KHC), and JM Smucker (SJM) are no longer the low-risk propositions they once were for investors. Like the phone companies of the 1970s, this industry is rapidly morphing into a new animal—with odd new alliances and new tech-based products such as plant-based meats and drinks. Opportunities will arise, but investors need to look closely at a respective company's management team and evaluate whether or not they grasp—and embrace—what is coming.
Beverages & Tobacco
Another one bites the dust: Budweiser takes out the Craft Brew Alliance. More often than not, that case of craft beer you picked up at the liquor store last weekend wasn't actually boiled, fermented, and bottled by an independent brewer. Though many of the big dogs, like Anhueser-Busch InBev (BUD), Molson Coors (TAP, also owns Miller), and Constellation Brands (STZ), like to poke fun at the craft beer industry, they have been tripping over themselves to gobble up the truly independent brewers. The latest instance: InBev-owned Anhueser-Busch announced it would acquire the 70% or so of Craft Brew Alliance (BREW $7-$16-$17) it didn't already own, driving the $150 million (before Tuesday) bottler up by 122% at Tuesday's open. BREW is a conglomerate of independents such as The Kona Brewing Company out of Hawaii and the Redhook Brewlab out of Portland. Here's the interesting back story: BREW had fallen from around $20 per share to $8 per share because Bud had balked at buying the company out for a previously-negotiated $22 per share. It will now buy the remaining shares for $16.50, which values the company around $320 million. In a bit of irony, readers may recall that the Belgian/Brazilian conglomerate InBev was able to swoop in and buy Anhueser-Busch on the cheap back in 2008 because of gross mismanagement and a weak US dollar (members can read our original story here). We have to wonder what the respective brewers in the Alliance think about this sale. Oh well, at least we still have the fiercely-independent, mid-cap brewer Boston Beer Company (SAM), which has outperformed Bud by 80% over the past eighteen months.
Global Strategy: Europe
In an enormous win for Boris Johnson, Brexiteer leader Nigel Farage will go after Labour, not Tories this election cycle. We talk until we are blue in the face about the false narratives created on a daily basis by the mainstream media. Try this headline on for size, which sat atop a story on a major business network's website: "Farage backs down in Brexit fight." Probably not enough for Farage to bring a lawsuit against this New York—based financial news outlet, but it is certainly a wormy little false narrative foisted by a biased reporter. British voters will go to the polls on Thursday, the 12th of December. As soon as the election was announced, we predicted a fed up electorate will give Johnson enough pro-Brexit seats to finally blow out of the European Union as demanded by voters over three years ago. The highly-intelligent Farage, whose raison d'être is Brexit, has now publicly stated that he will target the opposing Labour Party—whose goal is a second referendum overturning the first—in the upcoming election rather than nit-pick a fight with Johnson. Understandably, this is not what the media wanted to hear; hence the smarmy headline by the petulant reporter. Add Farage's support (he is wildly popular with the pro-Brexit crowd in England) to Johnson's determination, and we double-down on our prediction for the election outcome. A true exit from the EU is getting closer by the day.
Real Estate Management & Development
Is WeWork really going to hire a loudmouth nut-job to take over for a loudmouth nut-job? Just when you think things can't get any crazier for the dysfunctional entity known as WeWork, the board swoops in and surprises once again. Adam Neumann may have co-founded the company, but his oddball, mercurial behavior and greedy lifestyle doomed the company's IPO. In crazy-debt, the board was forced to take another bailout offer by made by Masayoshi Son's SoftBank, giving Son virtual control over the company. He moves in his buddy, Marcelo Claure, to lead the turnaround effort. Son had previously hired Claure to turnaround Sprint (the jury is still out on his success there, pending the T-Mobile merger). One or both of the men, Son and/or Claure, then decide it would be a good idea to hire the loudmouth, flamboyant CEO of T-Mobile, John Legere, whom they have been working with intimately on the Sprint/T-Mobile merger, to take over as CEO at WeWork. So, the biggest wildcard with respect to the telecom merger—Legere and his slick salesman personality—will probably now take over for Neumann at WeWork. Wow. Masayoshi Son is still living off his fame—and wealth—from being an early investor in Alibaba (BABA). But the incredibly arrogant Son, who has a 300 year business plan for SoftBank, has made some critically dumb mistakes over the past few years. This is yet another one. Imagine Son, Neumann, and Legere in a room at the same time, throw in some booze, and imagine the fanciful stories that would be told.
Global Strategy: Latin America
Bolivia's leftist president resigns after pressure from armed forces. It is hard to imagine a fraudulent election in Latin America actually being exposed—with real consequences being applied—but that is exactly what has just happened in Bolivia. President Evo Morales, fast friends with the likes of Putin, Castro, and Maduro, has been forced to step down from his office after 13 years, pressured by the Bolivian army after a fraudulent national election has spurred rioting in the streets. On Sunday, Morales took to Twitter to announce that he would not leave the country, despite an outstanding arrest warrant against him. What is different from this case and Venezuela's illegitimate president Maduro remaining in power? One big factor is the move by members of the Bolivian army to abandon their posts, including those guarding the presidential palace. The Venezuelan army has not found the mettle to take such a bold step, at least not yet. Russia is labeling the incident a coup, with Cuba, Venezuela, and Mexico joining that chorus. The first three usual suspects shouldn't surprise anyone; the Mexican response, however, should give pause to anyone who refused to believe that President Amlo was nothing but a full-throated leftist cut from the same cloth as Morales, Castro, and the room-temperature Chavez. It is refreshing to see this level of boldness both by the citizens of a Latin American country and its armed forces. Perhaps their courage will serve as inspiration for the people of Venezuela, many of whom are choosing to flee their home country instead of fighting to put recognized President Juan Guaido in his rightful seat.
Technology Hardware & Equipment
Xerox wants to buy HP—a company three times its size. Talk about audacity. Xerox (XRX $19-$39-$39), the company that brings to mind a copy machine from the 1970s, wants to buy the company formerly known as Hewlett Packard (HPQ $16-$20-$25), a name synonymous with a 1970s personal computer. Several thoughts immediately come to mind, but let's start with the obvious: Xerox has a market cap of $8 billion, while its target has a market cap of roughly $30 billion. If our math is correct, that would mean taking on debt equal to over three times the size of the company. Some analysts have speculated that this is Xerox's way to get HP's attention and initiate a reverse-takeover. Whatever the rationale, could two flailing printer and copier businesses really come to each other's rescue? Doubtful. Xerox may feel the need to take bold action after it ended its partnership with Fujifilm, meaning it no longer has an Asian distribution conduit. HP, which couldn't make a quality PC to save its life (based on our own experiences), is banking on the future of 3-D printing. Gee, no competition there. What about revenues? In 2010, Xerox had sales of $21 billion; last year it had sales of $9.5 billion. For its part, HP Inc had sales of $125 billion in 2010, versus sales of $58 billion last year. We are trying to find one word to describe a marriage between Xerox and HP Inc, but cannot find a specific antonym to the word "synergy." Anyone holding either XRX or HPQ in their portfolios should take the recent run-up in price as an excuse to exit the position(s).
Headlines for the Week of 03 Nov 2019—09 Nov 2019
Media & Entertainment
Disney jumps another 6% after yet another great earnings report. Shares of Penn member Walt Disney (DIS $100-$141-$147) were trading up over 6% following an earnings beat for the company's fiscal fourth quarter. Revenues came in at $19.1 billion and the company had adjusted earnings per share of $1.07—both better than what analysts had projected. Studio Entertainment revenues, which now include the acquired 21st Century Fox assets, were up an impressive 52% from the same quarter last year, helped by such blockbusters as The Lion King, Aladdin, and Toy Story 4. That growth pales in comparison, however, to quarterly YoY revenue generated by the streaming segment (which now includes Hulu), which rose from $825 million to $3.4 billion. And these impressive numbers serve as a beautiful backdrop to the launch of Disney+, the company's streaming service which will ramp up in the US next Tuesday. As if Disney+ will need any help to garner subscribers at its $6.99 per month rate, the company announced a new deal with Amazon (AMZN) to carry the service on its Fire TV devices. Disney holds Position #12 in the Penn Global Leaders Club. Shares bottomed out on Christmas Eve last year, at $100.35, and have climbed 41% since.
Semiconductors & Equipment
Penn New Frontier member Qualcomm surges after earnings report. Back on 24 June, when shares of semiconductor company Qualcomm (QCOM $49-$90-$90) were sitting at $72.72, we added it to the Penn New Frontier Fund. In an accompanying article in The Penn Wealth Report on 5G technology, we noted it as one of the "must-buys" in the arena, and the only major US player which builds 5G modems and antennas. After posting solid earnings for its most recent quarter, QCOM shares are trading at $90, and a slew of analyst houses have rushed in to raise their price targets. After reporting a beat on top-line revenues and bottom-line net income, CEO Steve Mollenkkopf—one of our favorite CEOs in the industry—said that "Our technology and inventions leave us extremely well positioned as 5G accelerates in 2020." We agree with that as much now as we did when we recommended the stock back in June. There are so many players claiming to be winners (on the come) of the 5G race, that it can be hard to separate the truth from the hype, which is one reason we wrote our article on the 5G revolution. Qualcomm is the real deal.
Drug Retail
Can Walgreens really pull off the biggest leveraged buyout in history? Doubtful. It's a tough time to be a retail pharmacy. With pressure coming from online competitors, insurance companies, and government blowhards, one can understand why a drug retailer would want to go private. However, when you are Walgreens Boots Alliance (WBA $49-$60-$86), with a market cap of $53 billion and another $17 billion in debt, that would amount to herculean task of epic proportions. Nonetheless, the drugstore chain has hired a legal team and has met with private equity firms to discuss just that—going private in a leveraged buyout. Investors have sobered up to the reality of just how much debt such a deal would create, with the 7% jump WBA shares made following the news now all but gone. The previous record-high for an LBO came in 2007, when private equity firms raised $44 billion to buy Texas energy interest TXU. This deal would be about 60% larger.
Somewhat ironically, the news that management is looking to go private has increased our doubts about the firm going forward, as it brings into question the company's strategic plans. While CVS (CVS) picked up health insurer Aetna and benefits manager Caremark, greatly expanding their breadth of offerings and the firm's vertical integration, WBA has been slow to the party. Yes, they picked up a 26% stake in drug distributor Amerisource Bergen (ABC) and have been in joint ventures with Humana, but three-quarters of the firm's revenues come from the billion or so prescriptions it fills annually, and those margins are under increasing pressure. It also doesn't help that Amazon (AMZN) bought online pharmacy PillPack last year. As we said, it's a tough time to be a retail pharmacy.
We wouldn't touch shares of WBA right now. Leadership involves formulating a strong and cogent strategic plan based on foresight and vision, not running for the exit sign when the going gets tough. Unfortunately, CEO Stefano Pessina is making it clear he would prefer the latter.
Transportation Infrastructure
Shares of Uber hit a fresh all-time low as insiders become eligible to sell shares. In fairness, "all-time low" equates to the short, six-month period since the company went public, but shares of Uber (UBER $28-$27-$47) did, indeed, punch through their former low of $27.97 by about a buck as 1.5 billion of the 1.7 billion outstanding shares are now eligible to trade. For many early investors, that meant running for the door and dumping the shares. In fact, Wednesday was the second-most-active day for UBER shares (IPO day one was the most active), with over 90 million of them trading hands at an average price of under $27. But is this rational? These early investors were certainly thrilled to get their shares before the rest of us, so shouldn't they love the shares even more now that they are down over 45% from their high? Granted, one of our favorite metrics to look at when evaluating a company for purchase, year-on-year growth of quarterly earnings per share, doesn't even exist for UBER—that would require actual earnings per share. But this is not WeWork or Pets.com. This company will still be viable in a decade and, dare we say, profitable by then. This implies a fair value does exist for the shares right now at some dollar amount. We predict early investors will look back on today and kick themselves all over again. As primarily value investors, it is tempting to buy today as all the rats are fleeing the ship, but we can't. If we had to put a fair value on Uber, we would say around $40 per share—a whopping 50% jump from where they are now. Our conviction on that number just isn't strong enough to make the move.
Food & Staples Retailing
Penn member Kroger jumps 12% after its 2019 Investor Day leaves analysts impressed. We only hold around 40 companies at any one time in the Penn Global Leaders Club. Out of our five strategies, this is the one we rarely use tools such as stop-loss orders to protect positions, as these companies are, as the name implies, industry leaders. Perhaps the one holding we have had trepidation about lately in this strategy has been America's leading grocer, Kroger (KR $21-$28-$32). Back in August of 2018, we wrote glowingly of CEO Rodney McMullen's vision, and the company's well-executed journey into Asian markets through its Alibaba (BABA) partnership. It should be noted that shares of Kroger were selling for $30 at the time. Yesterday, after a sanguine Investor Day helped drive the shares up nearly 12%, they sit near $28 per share. As for the event, management announced a $1 billion stock buyback program, raised its 2020 EPS guidance to $2.30-$2.40, and detailed a new branding campaign, complete with a new logo, slogan, and cute little "Kroji" characters to "keep Kroger fun." The store's Restock Kroger plan is also paying off, and the company has a number of enormous fulfillment centers in the works to remain competitive in the online food ordering space. All that being said, management needs to execute near-perfectly in this hyper-competitive, low margin industry. Unlike Walmart (WMT) and Amazon (AMZN), it doesn't have other lines to fall back on. Hence, our trepidation. We are rooting for Kroger to succeed against Amazon and Walmart—two companies we also happen to hold in the PGLC. However, after this recent run-up in share price, we will probably do something unusual within the strategy and place a stop on the shares to protect our gains. (Update: See Trading Desk notes above)
Media Malpractice
CNBC's The Profit is a great example of how a false narrative can be foisted upon an unsuspecting public. When the CNBC reality TV show The Profit first appeared on the network, I loved it. Here was a wildly successful billionaire businessman (I assumed) helping struggling small business owners pull their enterprises out of certain death spirals. Raw emotions on display by people in financial trouble—that just had great TV ratings written all over it. I was so enthralled by host Marcus Lemonis that I decided to do a little research in hopes of gleaning some nuggets of entrepreneurial wisdom. In the process, I quickly found out that Lemonis's own company was publicly traded—Camping World Holdings (CWH). A $4 billion mid-cap just a few years ago, Camping World has now lost 78% of its value, making the company worth around $880 million. Lemonis controls Camping World through his super-voting shares of CWH; shares the rest of us couldn't touch (not that we would want to). Fitting for the man who has been sued by a number of the small business owners he purports to help. One ironic note on Camping World: his wife, whom he married last year, bought 99,094 shares of CWH in March of this year at $13.27 per share. In eight months, they have lost 25% of their value. But hey, as long as viewers are watching his show, isn't that all that matters? CNBC is currently running ads for the new season of The Profit. Let them serve as a reminder of how many false narratives are crammed down our throats on a daily basis, through the media, slick marketers, and other nefarious so-called professionals. If we aren't able to do our own research, we need to have a group of professionals we trust to give us the straight story—not entertaining pap that will end up costing us dearly.
Textiles, Apparel, & Luxury Goods
Is Under Armour a screaming buy after the shares plummet on news of accounting investigation? It is amazing how rapidly conditions can change in the investment world, both at a macro- and micro-level. Take athletic apparel maker Under Armour (UA $15-$16-$25). Almost immediately out of the gate, the company was touted as the biggest up-and-coming challenger to industry leader Nike (NKE). By July of 2019, shares had already climbed 50% year-to-date and the firm carried a P/E ratio of 1,200. Since that date, the shares have fallen 36%—nearly 20% of that loss coming on Monday after the firm announced it was at the center of a DoJ and SEC investigation for potential accounting fraud. So, with a more reasonable (yet still high) P/E of 82, is it time to pick up some shares on the cheap? Probably not. What concerns us more than the investigations are the downward-trending earnings per share figures. UA saw quarterly YoY double-digit growth back as far as the eyes could see—at least until recently. While still positive, the last four quarters saw EPS growth of: 1.4%, 1.6%, 1.5%, and 2.4%. That slow growth is hardly deserving of the rich multiples. And, sadly, the accounting investigation and the slower growth rates are related. It seems as though the company (allegedly) may have used some creative accounting to pump the numbers up as they fell into the single digits. Seriously, what are financial executives thinking when they (allegedly) pull such a stunt? While all of this is going on, skilled CEO Kevin Plank announced he would be stepping down from that role effective 01 Jan 2020, though he will take on the role of executive chairman. We still believe in Under Armour, and the double-digit growth will eventually return. In the interim, there are too many questions swirling around the firm to pick up shares, even near their 52-week low.
Restaurants
McDonald's just fired one of the best CEOs in the C-suite, not just the industry; we are putting the company on watch list. To be blunt, we didn't think of touching shares of McDonald's (MCD $169-$191-$222) while Don Thompson was at the helm. He reminded us of a John Sculley at Apple (AAPL) or (yikes) a Ron Johnson at JC Penney (JCP), all of whom were in over their heads. Then Brit Steve Easterbrook came in and completely turned the ship around with his passionate, dynamic, creative, bold leadership. We immediately added the company to the Penn Global Leaders Club (we had followed MCD closely for two decades and knew the moment to strike was at hand). The stock has nearly doubled since Easterbrook took over. Now, over the course of a weekend, Easterbrook is out. A divorced man canned by the board for having a consensual relationship with an employee. It wasn't that he didn't tell the board (though he apparently didn't). It wasn't like anyone was accusing him of promoting this female employee based on their relationship. It was simply that the company had a zero-tolerance policy with respect to senior management seeing anyone at the firm. It is so easy for the usual suspects in the press to come out and condemn Easterbrook, paragons of virtue that they are. We think firing Easterbrook was a cowardly act, however. We also don't believe the narrative that Chris Kempczinski, the president of McDonald's USA and the new CEO, can seamlessly take over where Easterbrook left off. It's about leadership, not continuity, and the board immediately placing this incident under the moniker of sexual harassment makes us question theirs. Shares of MCD were off about 2% on news of the firing. We didn't necessarily want to place a restaurant in the Penn Global Leaders Club, considering how competitive the industry is and how low the margins tend to be. It was because of Easterbrook and his strategic plans that we made the move. Shares fell below $190 on Monday and we are placing the company on watch for potential removal from the strategy.
Economics: Work & Pay
Was last week's jobs report really a "game-changer"? I recall a presidential election years back in which the echo chamber that is the America press became enamored with the word "gravitas" and used it until it was lying dead on the floor, void of any meaning. Members of the media have a tendency to hear a word or phrase uttered by one of their fellow "professionals" and borrow it for their own use. I thought back to the "gravitas" case last week when I either read or heard at least three different outlets refer to Friday's October jobs report as a game-changer. After reviewing the internals of the report, however, the description seems fitting. Nonfarm payrolls rose by 128,000, well above the 85,000 predicted by economists, and all the more impressive because the GM strike took over 40,000 jobs away from that figure. Additionally, 20,000 temp US Census workers fell off, as did 3,000 other government jobs. The icing on the cake was the upward revision to both the August and September jobs numbers. While the jobless rate ticked up one notch to 3.6%, even that was good news: more Americans were lured back into the workforce, thus reducing the U6 "discouraged worker" rate. In other words, more people are flowing in to fuel the US economy, and that means more money for consumers to spend this Christmas. Following the release of past strong reports, markets fell on fears that the Fed would use the respective report as an excuse to stop lowering rates. But, with rates already so low, investors didn't even register that fear; instead, they celebrated by driving the Dow nearly 400 points higher. The October jobs report was yet another bullish sign for the US economy and another sign that we will probably avoid a near-term recession. A lot can happen in two months, but so far the markets are in a much happier place than they were during this period last year. Now, we look to Phase 1 of the trade deal and a new election in England as the next potential catalysts. As for elections in the UK, we fully expect pro-Brexit forces to gain more seats.
Disney jumps another 6% after yet another great earnings report. Shares of Penn member Walt Disney (DIS $100-$141-$147) were trading up over 6% following an earnings beat for the company's fiscal fourth quarter. Revenues came in at $19.1 billion and the company had adjusted earnings per share of $1.07—both better than what analysts had projected. Studio Entertainment revenues, which now include the acquired 21st Century Fox assets, were up an impressive 52% from the same quarter last year, helped by such blockbusters as The Lion King, Aladdin, and Toy Story 4. That growth pales in comparison, however, to quarterly YoY revenue generated by the streaming segment (which now includes Hulu), which rose from $825 million to $3.4 billion. And these impressive numbers serve as a beautiful backdrop to the launch of Disney+, the company's streaming service which will ramp up in the US next Tuesday. As if Disney+ will need any help to garner subscribers at its $6.99 per month rate, the company announced a new deal with Amazon (AMZN) to carry the service on its Fire TV devices. Disney holds Position #12 in the Penn Global Leaders Club. Shares bottomed out on Christmas Eve last year, at $100.35, and have climbed 41% since.
Semiconductors & Equipment
Penn New Frontier member Qualcomm surges after earnings report. Back on 24 June, when shares of semiconductor company Qualcomm (QCOM $49-$90-$90) were sitting at $72.72, we added it to the Penn New Frontier Fund. In an accompanying article in The Penn Wealth Report on 5G technology, we noted it as one of the "must-buys" in the arena, and the only major US player which builds 5G modems and antennas. After posting solid earnings for its most recent quarter, QCOM shares are trading at $90, and a slew of analyst houses have rushed in to raise their price targets. After reporting a beat on top-line revenues and bottom-line net income, CEO Steve Mollenkkopf—one of our favorite CEOs in the industry—said that "Our technology and inventions leave us extremely well positioned as 5G accelerates in 2020." We agree with that as much now as we did when we recommended the stock back in June. There are so many players claiming to be winners (on the come) of the 5G race, that it can be hard to separate the truth from the hype, which is one reason we wrote our article on the 5G revolution. Qualcomm is the real deal.
Drug Retail
Can Walgreens really pull off the biggest leveraged buyout in history? Doubtful. It's a tough time to be a retail pharmacy. With pressure coming from online competitors, insurance companies, and government blowhards, one can understand why a drug retailer would want to go private. However, when you are Walgreens Boots Alliance (WBA $49-$60-$86), with a market cap of $53 billion and another $17 billion in debt, that would amount to herculean task of epic proportions. Nonetheless, the drugstore chain has hired a legal team and has met with private equity firms to discuss just that—going private in a leveraged buyout. Investors have sobered up to the reality of just how much debt such a deal would create, with the 7% jump WBA shares made following the news now all but gone. The previous record-high for an LBO came in 2007, when private equity firms raised $44 billion to buy Texas energy interest TXU. This deal would be about 60% larger.
Somewhat ironically, the news that management is looking to go private has increased our doubts about the firm going forward, as it brings into question the company's strategic plans. While CVS (CVS) picked up health insurer Aetna and benefits manager Caremark, greatly expanding their breadth of offerings and the firm's vertical integration, WBA has been slow to the party. Yes, they picked up a 26% stake in drug distributor Amerisource Bergen (ABC) and have been in joint ventures with Humana, but three-quarters of the firm's revenues come from the billion or so prescriptions it fills annually, and those margins are under increasing pressure. It also doesn't help that Amazon (AMZN) bought online pharmacy PillPack last year. As we said, it's a tough time to be a retail pharmacy.
We wouldn't touch shares of WBA right now. Leadership involves formulating a strong and cogent strategic plan based on foresight and vision, not running for the exit sign when the going gets tough. Unfortunately, CEO Stefano Pessina is making it clear he would prefer the latter.
Transportation Infrastructure
Shares of Uber hit a fresh all-time low as insiders become eligible to sell shares. In fairness, "all-time low" equates to the short, six-month period since the company went public, but shares of Uber (UBER $28-$27-$47) did, indeed, punch through their former low of $27.97 by about a buck as 1.5 billion of the 1.7 billion outstanding shares are now eligible to trade. For many early investors, that meant running for the door and dumping the shares. In fact, Wednesday was the second-most-active day for UBER shares (IPO day one was the most active), with over 90 million of them trading hands at an average price of under $27. But is this rational? These early investors were certainly thrilled to get their shares before the rest of us, so shouldn't they love the shares even more now that they are down over 45% from their high? Granted, one of our favorite metrics to look at when evaluating a company for purchase, year-on-year growth of quarterly earnings per share, doesn't even exist for UBER—that would require actual earnings per share. But this is not WeWork or Pets.com. This company will still be viable in a decade and, dare we say, profitable by then. This implies a fair value does exist for the shares right now at some dollar amount. We predict early investors will look back on today and kick themselves all over again. As primarily value investors, it is tempting to buy today as all the rats are fleeing the ship, but we can't. If we had to put a fair value on Uber, we would say around $40 per share—a whopping 50% jump from where they are now. Our conviction on that number just isn't strong enough to make the move.
Food & Staples Retailing
Penn member Kroger jumps 12% after its 2019 Investor Day leaves analysts impressed. We only hold around 40 companies at any one time in the Penn Global Leaders Club. Out of our five strategies, this is the one we rarely use tools such as stop-loss orders to protect positions, as these companies are, as the name implies, industry leaders. Perhaps the one holding we have had trepidation about lately in this strategy has been America's leading grocer, Kroger (KR $21-$28-$32). Back in August of 2018, we wrote glowingly of CEO Rodney McMullen's vision, and the company's well-executed journey into Asian markets through its Alibaba (BABA) partnership. It should be noted that shares of Kroger were selling for $30 at the time. Yesterday, after a sanguine Investor Day helped drive the shares up nearly 12%, they sit near $28 per share. As for the event, management announced a $1 billion stock buyback program, raised its 2020 EPS guidance to $2.30-$2.40, and detailed a new branding campaign, complete with a new logo, slogan, and cute little "Kroji" characters to "keep Kroger fun." The store's Restock Kroger plan is also paying off, and the company has a number of enormous fulfillment centers in the works to remain competitive in the online food ordering space. All that being said, management needs to execute near-perfectly in this hyper-competitive, low margin industry. Unlike Walmart (WMT) and Amazon (AMZN), it doesn't have other lines to fall back on. Hence, our trepidation. We are rooting for Kroger to succeed against Amazon and Walmart—two companies we also happen to hold in the PGLC. However, after this recent run-up in share price, we will probably do something unusual within the strategy and place a stop on the shares to protect our gains. (Update: See Trading Desk notes above)
Media Malpractice
CNBC's The Profit is a great example of how a false narrative can be foisted upon an unsuspecting public. When the CNBC reality TV show The Profit first appeared on the network, I loved it. Here was a wildly successful billionaire businessman (I assumed) helping struggling small business owners pull their enterprises out of certain death spirals. Raw emotions on display by people in financial trouble—that just had great TV ratings written all over it. I was so enthralled by host Marcus Lemonis that I decided to do a little research in hopes of gleaning some nuggets of entrepreneurial wisdom. In the process, I quickly found out that Lemonis's own company was publicly traded—Camping World Holdings (CWH). A $4 billion mid-cap just a few years ago, Camping World has now lost 78% of its value, making the company worth around $880 million. Lemonis controls Camping World through his super-voting shares of CWH; shares the rest of us couldn't touch (not that we would want to). Fitting for the man who has been sued by a number of the small business owners he purports to help. One ironic note on Camping World: his wife, whom he married last year, bought 99,094 shares of CWH in March of this year at $13.27 per share. In eight months, they have lost 25% of their value. But hey, as long as viewers are watching his show, isn't that all that matters? CNBC is currently running ads for the new season of The Profit. Let them serve as a reminder of how many false narratives are crammed down our throats on a daily basis, through the media, slick marketers, and other nefarious so-called professionals. If we aren't able to do our own research, we need to have a group of professionals we trust to give us the straight story—not entertaining pap that will end up costing us dearly.
Textiles, Apparel, & Luxury Goods
Is Under Armour a screaming buy after the shares plummet on news of accounting investigation? It is amazing how rapidly conditions can change in the investment world, both at a macro- and micro-level. Take athletic apparel maker Under Armour (UA $15-$16-$25). Almost immediately out of the gate, the company was touted as the biggest up-and-coming challenger to industry leader Nike (NKE). By July of 2019, shares had already climbed 50% year-to-date and the firm carried a P/E ratio of 1,200. Since that date, the shares have fallen 36%—nearly 20% of that loss coming on Monday after the firm announced it was at the center of a DoJ and SEC investigation for potential accounting fraud. So, with a more reasonable (yet still high) P/E of 82, is it time to pick up some shares on the cheap? Probably not. What concerns us more than the investigations are the downward-trending earnings per share figures. UA saw quarterly YoY double-digit growth back as far as the eyes could see—at least until recently. While still positive, the last four quarters saw EPS growth of: 1.4%, 1.6%, 1.5%, and 2.4%. That slow growth is hardly deserving of the rich multiples. And, sadly, the accounting investigation and the slower growth rates are related. It seems as though the company (allegedly) may have used some creative accounting to pump the numbers up as they fell into the single digits. Seriously, what are financial executives thinking when they (allegedly) pull such a stunt? While all of this is going on, skilled CEO Kevin Plank announced he would be stepping down from that role effective 01 Jan 2020, though he will take on the role of executive chairman. We still believe in Under Armour, and the double-digit growth will eventually return. In the interim, there are too many questions swirling around the firm to pick up shares, even near their 52-week low.
Restaurants
McDonald's just fired one of the best CEOs in the C-suite, not just the industry; we are putting the company on watch list. To be blunt, we didn't think of touching shares of McDonald's (MCD $169-$191-$222) while Don Thompson was at the helm. He reminded us of a John Sculley at Apple (AAPL) or (yikes) a Ron Johnson at JC Penney (JCP), all of whom were in over their heads. Then Brit Steve Easterbrook came in and completely turned the ship around with his passionate, dynamic, creative, bold leadership. We immediately added the company to the Penn Global Leaders Club (we had followed MCD closely for two decades and knew the moment to strike was at hand). The stock has nearly doubled since Easterbrook took over. Now, over the course of a weekend, Easterbrook is out. A divorced man canned by the board for having a consensual relationship with an employee. It wasn't that he didn't tell the board (though he apparently didn't). It wasn't like anyone was accusing him of promoting this female employee based on their relationship. It was simply that the company had a zero-tolerance policy with respect to senior management seeing anyone at the firm. It is so easy for the usual suspects in the press to come out and condemn Easterbrook, paragons of virtue that they are. We think firing Easterbrook was a cowardly act, however. We also don't believe the narrative that Chris Kempczinski, the president of McDonald's USA and the new CEO, can seamlessly take over where Easterbrook left off. It's about leadership, not continuity, and the board immediately placing this incident under the moniker of sexual harassment makes us question theirs. Shares of MCD were off about 2% on news of the firing. We didn't necessarily want to place a restaurant in the Penn Global Leaders Club, considering how competitive the industry is and how low the margins tend to be. It was because of Easterbrook and his strategic plans that we made the move. Shares fell below $190 on Monday and we are placing the company on watch for potential removal from the strategy.
Economics: Work & Pay
Was last week's jobs report really a "game-changer"? I recall a presidential election years back in which the echo chamber that is the America press became enamored with the word "gravitas" and used it until it was lying dead on the floor, void of any meaning. Members of the media have a tendency to hear a word or phrase uttered by one of their fellow "professionals" and borrow it for their own use. I thought back to the "gravitas" case last week when I either read or heard at least three different outlets refer to Friday's October jobs report as a game-changer. After reviewing the internals of the report, however, the description seems fitting. Nonfarm payrolls rose by 128,000, well above the 85,000 predicted by economists, and all the more impressive because the GM strike took over 40,000 jobs away from that figure. Additionally, 20,000 temp US Census workers fell off, as did 3,000 other government jobs. The icing on the cake was the upward revision to both the August and September jobs numbers. While the jobless rate ticked up one notch to 3.6%, even that was good news: more Americans were lured back into the workforce, thus reducing the U6 "discouraged worker" rate. In other words, more people are flowing in to fuel the US economy, and that means more money for consumers to spend this Christmas. Following the release of past strong reports, markets fell on fears that the Fed would use the respective report as an excuse to stop lowering rates. But, with rates already so low, investors didn't even register that fear; instead, they celebrated by driving the Dow nearly 400 points higher. The October jobs report was yet another bullish sign for the US economy and another sign that we will probably avoid a near-term recession. A lot can happen in two months, but so far the markets are in a much happier place than they were during this period last year. Now, we look to Phase 1 of the trade deal and a new election in England as the next potential catalysts. As for elections in the UK, we fully expect pro-Brexit forces to gain more seats.
Headlines for the Week of 27 Oct 2019—02 Nov 2019
Economics: Goods & Services
A coming recession looks less and less likely as Q3 GDP rolls in at a decent clip. Against expectations for a 1.6% growth rate, the US economy actually grew 1.9% in the third quarter, mainly on the back of strong consumer spending. While business investment continues to pull back, a fifty-year-low unemployment rate has most Americans feeling good about their situation, as evidenced by their spending habits in the quarter. October payrolls also came in hot, hitting 125,000 and beating expectations by 25%. The final piece of the puzzle was government spending, which rose at a 2% annualized rate in the quarter. Not exactly scorching economic growth in Q3, but certainly no signs of a contraction in sight. Add a third rate cut to the mix, and the US economy should continue to chug along. Here's our prediction for the fourth quarter with respect to the trade war: The president and his economic team fully understand that the 15 December tariffs, if put in place, will have a negative impact on consumer spending (a slew of consumer goods will be hit with a 25% fee). Therefore, it will behoove the administration to make some sort of deal which will allow them to pull those tariffs off the table, at least temporarily. While we still believe the Xi regime thinks it can outlast the Trump Administration, they have to see a dearth of candidates who would be willing to make a sweetheart deal and return to the "good old days" of unfettered trade. Therefore, they should also be willing to move the needle forward with respect to a Phase 2 deal. This means we also expect to see a Phase 1 deal signed within 45 days. All of this reiterating our belief that a US recession over the next twelve months is unlikely.
eCommerce
Food delivery service GrubHub just plummeted 43% in one trading day. Talk about a great business idea...that is incredibly easy to replicate. Online takeout food platform GrubHub (GRUB $33-$33-$98) arguably brought food delivery to the masses, allowing consumers to order from thousands of restaurants instead of just one. With over 50,000 restaurant partners and 20 million active users, the company makes money from both ends: it charges the establishments a commission on each order, and it charges users a delivery fee. Brilliant idea. So brilliant, in fact, that other players began flooding into the space. Uber Eats, DoorDash, Postmates, and Delivery.com are just a few of the competitors GRUB must now contend with. And all of this competition finally caught the eye of investors, with the help of a bizarre letter by CEO Matt Maloney which accompanied the Q3 earnings report. In the letter, Maloney decried the fact that "...online diners are becoming more promiscuous." Huh? Odd choice of words, but he apparently meant that there is no brand loyalty—users will go to whichever platform they feel like at the time. This commentary by management, combined with a squishy quarter, drove the stock down 43% by the close of trading. But forget the drop from $57 to $31, the shares were actually sitting at $146.11 just over one year ago. The company's quarterly YoY revenue growth is impressive, and it actually turns a profit year over year, but investors have suddenly become very skeptical that the trend can continue. A slew of downgrades came flooding in after the earnings report and the accompanying letter to shareholders. Were an investor to simply focus on a number of GRUB's financial metrics, a buy-in at $31 might seem like a tempting offer. We agree with the bears in this case, however, and are betting on the continued "promiscuity" of consumers. We wouldn't touch the company.
Application & Systems Software
Microsoft hits a record high after beating front-runner Amazon for huge Pentagon contract. Amazon's (AMZN) on-demand cloud computing platform, Amazon Web Services (AWS), has grown so big that it is now roughly three times larger—based on computing capacity—than the next ten largest competitors combined. For big companies looking to streamline their IT infrastructure, AWS has been somewhat of a no-brainer. Microsoft (MSFT $94-$143-$146) also has a cloud computing service, known as Azure, but it pales in comparison to AWS in both size and scope. That is why it came as such a shock, both to the Street and to Amazon, that Azure was the winner of the Pentagon's JEDI Cloud contract designed to modernize the Department of Defense's technology infrastructure, and worth up to $10 billion over ten years. Granted, for a company that generates $10 billion a month in revenue, that is barely a drop in the bucket. However, we believe this contract will be an enormous catalyst for Azure, with many more companies and organizations giving the platform another look. As mentioned, the news came as a shock to Amazon, which has promised to file a complaint over the award. Don't hold your breath, Bezos. While Azure and AWS were the two finalists, IBM (IBM) and Oracle (ORCL) had also submitted bids for the contract. Like Amazon, Oracle has vowed to appeal its elimination. As an aside, Google (GOOGL) dropped out of the race due to a "conflict with corporate values." (An ugly can of worms we won't get into here—worms being the keyword.) Both Amazon and Microsoft are among the 40 companies in the Penn Global Leaders Club. While Amazon's take-on-the-world style has garnered much attention, we continue to be impressed with Satya Nadella's quiet, stoic leadership. No showmanship, just results.
Multiline Retail
Nordstrom just celebrated the opening of its flagship store in New York City, but will it help the bottom line? Somewhat incredibly, high-end fashion retailer Nordstrom (JWN $25-$37-$68) didn't already have a full-line location at the epicenter of its most lucrative market: New York City. That changed last week as the Seattle-based company opened its massive, 300,000 square foot retail shopping space for women—the largest project investment in its history—just south of Central Park and across from the firm's men's store. The store comes complete with seven stories of curated clothing, seven dining options, and 110 beauty services—including Botox injections, hair salons, and a spa. At a cost of $500 million, it was a risky bet for a company that has been under intense pressure this year. JWN shares are still down 20% for 2019, but that is a nice comeback from the 46% they were down YTD through the 20th of August. Unlike other chains, however, Nordstrom is pushing full steam ahead, only shuttering a few underperforming stores over the past few years. Interestingly, one successful aspect of management's strategy has been to entice customers to order online (30% of their sales come from the internet) and then drop by a physical location to try on and pick up the clothing. By far, a plurality of the company's online orders emanate from NYC, which is another reason this flagship store made sense. Plus, now that the location is open, the massive capital expenditures for the project will begin to ebb. Unfortunately, they are now subject to the city's confiscatory annual property tax rate. We applaud Nordstrom for not adopting the bunker mentality of a number of its peers. The company has been able to grow top-line sales and maintain a positive net income every year—though it did brush the top of the x-axis back in 2017 for the latter metric. While it is looking less and less likely that the Nordstrom family will attempt to take the company private (one reason we gave for buying the shares earlier this year), we still believe the shares could climb to $60 in the not-too-distant future.
Telecom Services
Penn member AT&T jumps 5% not so much on earnings, but on making nice with the hedge fund thorn in its side. More often than not, we take a company's side over an activist hedge fund fomenting chaos in the name of change at a firm. Bill Ackman of Pershing Square could be the poster boy for causing such destruction. However, in the case of Penn Strategic Income Portfolio member AT&T (T $27-$39-$39), the board of directors and CEO Randall Stephenson needed to have some fireworks lit beneath their feet. The $67 billion acquisition of DirecTV has been a bust, as subscribers continue to flee the beast, and the $109 billion purchase of Time Warner has been somewhat of a boondoggle. Hence, the caustic letter to the board from activist investor Paul Singer's Elliott Management. The hedge fund demanded change, accountability, and an end to a wanton buying spree by the $280 billion telecom giant. The firm finally capitulated, writing a new three-year strategic plan and agreeing to put a freeze on any new acquisitions in the time-frame. Despite a lackluster earnings report (sales dropped 2% from Q3 of 2018 and earnings came in below expectations), investors cheered the Elliott-induced strategic plan. Shares jumped 5%—to $38.86, a new 52-week high—on the news. Under Elliott's watchful eye, we continue to believe in our AT&T position, which is up nicely since our purchase. Additionally, we bought it in the strategy designed for income, and T's 5.5% yield isn't in any danger. At $39, we wouldn't be buying more shares, but we have no plans to sell our position anytime soon.
Textiles, Apparel, & Luxury Goods
High-end jeweler Tiffany rockets after Louis Vuitton makes an unsolicited bid to buy the company for $14.5 billion. Tiffany (TIF $73-$130-$118) is a 180-year-old iconic American jeweler, and one of our favorite trading stocks (along with Signet, SIG) in the luxury goods industry. Going into the week, the company had a market cap of roughly $10 billion. LVMH Moet Hennessy Louis Vuitton SE (LVMUY) is a $214 billion French luxury goods maker and the parent company of Louis Vuitton and Givenchy. LVMH wants to expand its footprint in the world's most lucrative consumer market—the US—and has made an unsolicited bid to buy the jewelry store for $14.5 billion. When news of the offer came to light on Monday morning, shares of Tiffany blew past their 52-week high of $117.92, opening the day around $130 per share. The all-cash bid values TIF at about $120 per share, but that offer will be rebuffed by management as undervalued. It is important to note that Tiffany is now being run by Alessandro Bogliolo, who was at Italian luxury brand Bulgari for sixteen years. The board brought him in two years ago to revamp the brand after private equity firm Jana Partners pushed for change. In other words, he has no real vested, long-term interest in the company he now runs. A deal will get done, but not at the current offer price. Jana Partners and Bogliolo are interested in the bottom line, not preserving a company with a rich American heritage. We expect the deal to be forged when the offer hits the $150-$160 per share mark, or around one-third higher than the current offer. Tiffany will still be around, it just won't be an American company any longer. It will become the Budweiser of the luxury goods industry—American-sounding name, foreign ownership.
Health Care Providers & Services
A rather interesting IPO: Progyny, a fertility and family building solutions provider, jumps 22% on its first day of trading. Progyny (PGNY $13-$16-$16) is a New York-based health benefits provider which serves large, self-insured employers in the US. Sounds pretty plain vanilla. Except that Progyny's entire business model revolves around helping couples have babies. Their slogan says it all: "Progyny envisions a world where anyone who wants to have a child can do so." The employees of companies that use Progyny have access to high-level, targeted treatment for infertility. Launched in 2008 as a fertility education platform (CEO David Schlanger is the former head of online health platform WebMD), the company began offering health benefits packages to employers in 2018. For the trailing twelve months (TTM), Progyny recorded a net income of $1.4M on revenues of $160M. Perhaps due to the shaky IPO year thus far, the underwriters priced ten million PGNY shares at $13 for the offering—under the expected range of $14-$16. By Friday's close, however, the shares were trading at $15.94, a 22.6% spike from the offering price. JP Morgan, Goldman Sachs, and Bank of America led the underwriting on the Nasdaq. According to Allied Market Research, the global fertility services market is projected to rise from its current $17 billion to $31 billion by 2024. And, with the tight job market thanks to a 50-year-low unemployment rate, more and more big companies are offering specialized benefits to lure in and retain workers. Progyny also boasts a much higher success rate than the national average. That being said, we wouldn't jump in just yet to buy the $1.3 billion small-cap. Let's see if it can sustain its growth trajectory and continue to operate in the black in rougher economic times.
A coming recession looks less and less likely as Q3 GDP rolls in at a decent clip. Against expectations for a 1.6% growth rate, the US economy actually grew 1.9% in the third quarter, mainly on the back of strong consumer spending. While business investment continues to pull back, a fifty-year-low unemployment rate has most Americans feeling good about their situation, as evidenced by their spending habits in the quarter. October payrolls also came in hot, hitting 125,000 and beating expectations by 25%. The final piece of the puzzle was government spending, which rose at a 2% annualized rate in the quarter. Not exactly scorching economic growth in Q3, but certainly no signs of a contraction in sight. Add a third rate cut to the mix, and the US economy should continue to chug along. Here's our prediction for the fourth quarter with respect to the trade war: The president and his economic team fully understand that the 15 December tariffs, if put in place, will have a negative impact on consumer spending (a slew of consumer goods will be hit with a 25% fee). Therefore, it will behoove the administration to make some sort of deal which will allow them to pull those tariffs off the table, at least temporarily. While we still believe the Xi regime thinks it can outlast the Trump Administration, they have to see a dearth of candidates who would be willing to make a sweetheart deal and return to the "good old days" of unfettered trade. Therefore, they should also be willing to move the needle forward with respect to a Phase 2 deal. This means we also expect to see a Phase 1 deal signed within 45 days. All of this reiterating our belief that a US recession over the next twelve months is unlikely.
eCommerce
Food delivery service GrubHub just plummeted 43% in one trading day. Talk about a great business idea...that is incredibly easy to replicate. Online takeout food platform GrubHub (GRUB $33-$33-$98) arguably brought food delivery to the masses, allowing consumers to order from thousands of restaurants instead of just one. With over 50,000 restaurant partners and 20 million active users, the company makes money from both ends: it charges the establishments a commission on each order, and it charges users a delivery fee. Brilliant idea. So brilliant, in fact, that other players began flooding into the space. Uber Eats, DoorDash, Postmates, and Delivery.com are just a few of the competitors GRUB must now contend with. And all of this competition finally caught the eye of investors, with the help of a bizarre letter by CEO Matt Maloney which accompanied the Q3 earnings report. In the letter, Maloney decried the fact that "...online diners are becoming more promiscuous." Huh? Odd choice of words, but he apparently meant that there is no brand loyalty—users will go to whichever platform they feel like at the time. This commentary by management, combined with a squishy quarter, drove the stock down 43% by the close of trading. But forget the drop from $57 to $31, the shares were actually sitting at $146.11 just over one year ago. The company's quarterly YoY revenue growth is impressive, and it actually turns a profit year over year, but investors have suddenly become very skeptical that the trend can continue. A slew of downgrades came flooding in after the earnings report and the accompanying letter to shareholders. Were an investor to simply focus on a number of GRUB's financial metrics, a buy-in at $31 might seem like a tempting offer. We agree with the bears in this case, however, and are betting on the continued "promiscuity" of consumers. We wouldn't touch the company.
Application & Systems Software
Microsoft hits a record high after beating front-runner Amazon for huge Pentagon contract. Amazon's (AMZN) on-demand cloud computing platform, Amazon Web Services (AWS), has grown so big that it is now roughly three times larger—based on computing capacity—than the next ten largest competitors combined. For big companies looking to streamline their IT infrastructure, AWS has been somewhat of a no-brainer. Microsoft (MSFT $94-$143-$146) also has a cloud computing service, known as Azure, but it pales in comparison to AWS in both size and scope. That is why it came as such a shock, both to the Street and to Amazon, that Azure was the winner of the Pentagon's JEDI Cloud contract designed to modernize the Department of Defense's technology infrastructure, and worth up to $10 billion over ten years. Granted, for a company that generates $10 billion a month in revenue, that is barely a drop in the bucket. However, we believe this contract will be an enormous catalyst for Azure, with many more companies and organizations giving the platform another look. As mentioned, the news came as a shock to Amazon, which has promised to file a complaint over the award. Don't hold your breath, Bezos. While Azure and AWS were the two finalists, IBM (IBM) and Oracle (ORCL) had also submitted bids for the contract. Like Amazon, Oracle has vowed to appeal its elimination. As an aside, Google (GOOGL) dropped out of the race due to a "conflict with corporate values." (An ugly can of worms we won't get into here—worms being the keyword.) Both Amazon and Microsoft are among the 40 companies in the Penn Global Leaders Club. While Amazon's take-on-the-world style has garnered much attention, we continue to be impressed with Satya Nadella's quiet, stoic leadership. No showmanship, just results.
Multiline Retail
Nordstrom just celebrated the opening of its flagship store in New York City, but will it help the bottom line? Somewhat incredibly, high-end fashion retailer Nordstrom (JWN $25-$37-$68) didn't already have a full-line location at the epicenter of its most lucrative market: New York City. That changed last week as the Seattle-based company opened its massive, 300,000 square foot retail shopping space for women—the largest project investment in its history—just south of Central Park and across from the firm's men's store. The store comes complete with seven stories of curated clothing, seven dining options, and 110 beauty services—including Botox injections, hair salons, and a spa. At a cost of $500 million, it was a risky bet for a company that has been under intense pressure this year. JWN shares are still down 20% for 2019, but that is a nice comeback from the 46% they were down YTD through the 20th of August. Unlike other chains, however, Nordstrom is pushing full steam ahead, only shuttering a few underperforming stores over the past few years. Interestingly, one successful aspect of management's strategy has been to entice customers to order online (30% of their sales come from the internet) and then drop by a physical location to try on and pick up the clothing. By far, a plurality of the company's online orders emanate from NYC, which is another reason this flagship store made sense. Plus, now that the location is open, the massive capital expenditures for the project will begin to ebb. Unfortunately, they are now subject to the city's confiscatory annual property tax rate. We applaud Nordstrom for not adopting the bunker mentality of a number of its peers. The company has been able to grow top-line sales and maintain a positive net income every year—though it did brush the top of the x-axis back in 2017 for the latter metric. While it is looking less and less likely that the Nordstrom family will attempt to take the company private (one reason we gave for buying the shares earlier this year), we still believe the shares could climb to $60 in the not-too-distant future.
Telecom Services
Penn member AT&T jumps 5% not so much on earnings, but on making nice with the hedge fund thorn in its side. More often than not, we take a company's side over an activist hedge fund fomenting chaos in the name of change at a firm. Bill Ackman of Pershing Square could be the poster boy for causing such destruction. However, in the case of Penn Strategic Income Portfolio member AT&T (T $27-$39-$39), the board of directors and CEO Randall Stephenson needed to have some fireworks lit beneath their feet. The $67 billion acquisition of DirecTV has been a bust, as subscribers continue to flee the beast, and the $109 billion purchase of Time Warner has been somewhat of a boondoggle. Hence, the caustic letter to the board from activist investor Paul Singer's Elliott Management. The hedge fund demanded change, accountability, and an end to a wanton buying spree by the $280 billion telecom giant. The firm finally capitulated, writing a new three-year strategic plan and agreeing to put a freeze on any new acquisitions in the time-frame. Despite a lackluster earnings report (sales dropped 2% from Q3 of 2018 and earnings came in below expectations), investors cheered the Elliott-induced strategic plan. Shares jumped 5%—to $38.86, a new 52-week high—on the news. Under Elliott's watchful eye, we continue to believe in our AT&T position, which is up nicely since our purchase. Additionally, we bought it in the strategy designed for income, and T's 5.5% yield isn't in any danger. At $39, we wouldn't be buying more shares, but we have no plans to sell our position anytime soon.
Textiles, Apparel, & Luxury Goods
High-end jeweler Tiffany rockets after Louis Vuitton makes an unsolicited bid to buy the company for $14.5 billion. Tiffany (TIF $73-$130-$118) is a 180-year-old iconic American jeweler, and one of our favorite trading stocks (along with Signet, SIG) in the luxury goods industry. Going into the week, the company had a market cap of roughly $10 billion. LVMH Moet Hennessy Louis Vuitton SE (LVMUY) is a $214 billion French luxury goods maker and the parent company of Louis Vuitton and Givenchy. LVMH wants to expand its footprint in the world's most lucrative consumer market—the US—and has made an unsolicited bid to buy the jewelry store for $14.5 billion. When news of the offer came to light on Monday morning, shares of Tiffany blew past their 52-week high of $117.92, opening the day around $130 per share. The all-cash bid values TIF at about $120 per share, but that offer will be rebuffed by management as undervalued. It is important to note that Tiffany is now being run by Alessandro Bogliolo, who was at Italian luxury brand Bulgari for sixteen years. The board brought him in two years ago to revamp the brand after private equity firm Jana Partners pushed for change. In other words, he has no real vested, long-term interest in the company he now runs. A deal will get done, but not at the current offer price. Jana Partners and Bogliolo are interested in the bottom line, not preserving a company with a rich American heritage. We expect the deal to be forged when the offer hits the $150-$160 per share mark, or around one-third higher than the current offer. Tiffany will still be around, it just won't be an American company any longer. It will become the Budweiser of the luxury goods industry—American-sounding name, foreign ownership.
Health Care Providers & Services
A rather interesting IPO: Progyny, a fertility and family building solutions provider, jumps 22% on its first day of trading. Progyny (PGNY $13-$16-$16) is a New York-based health benefits provider which serves large, self-insured employers in the US. Sounds pretty plain vanilla. Except that Progyny's entire business model revolves around helping couples have babies. Their slogan says it all: "Progyny envisions a world where anyone who wants to have a child can do so." The employees of companies that use Progyny have access to high-level, targeted treatment for infertility. Launched in 2008 as a fertility education platform (CEO David Schlanger is the former head of online health platform WebMD), the company began offering health benefits packages to employers in 2018. For the trailing twelve months (TTM), Progyny recorded a net income of $1.4M on revenues of $160M. Perhaps due to the shaky IPO year thus far, the underwriters priced ten million PGNY shares at $13 for the offering—under the expected range of $14-$16. By Friday's close, however, the shares were trading at $15.94, a 22.6% spike from the offering price. JP Morgan, Goldman Sachs, and Bank of America led the underwriting on the Nasdaq. According to Allied Market Research, the global fertility services market is projected to rise from its current $17 billion to $31 billion by 2024. And, with the tight job market thanks to a 50-year-low unemployment rate, more and more big companies are offering specialized benefits to lure in and retain workers. Progyny also boasts a much higher success rate than the national average. That being said, we wouldn't jump in just yet to buy the $1.3 billion small-cap. Let's see if it can sustain its growth trajectory and continue to operate in the black in rougher economic times.
Headlines for the Week of 20 Oct 2019—26 Oct 2019
Interactive Media & Services
Twitter's one, massive, overarching, disastrous problem: it still doesn't know how to effectively monetize its platform. As a money-making machine, social media platform Twitter's (TWTR $26-$31-$46) business model seemed like a no-brainer. Tell advertisers from companies of all sizes that their highly-visual ads could be seen by a total addressable market of over 100 million potential buyers, and then simply let the ad dollars begin flooding in, as has been the case with Facebook (FB) and Google (GOOGL). That is the one problem Twitter has chronically struggled with: it simply hasn't been able to master the ability to market its product to advertisers. And, considering 90% of its revenues come from ad dollars (the other 10% comes from licensing the user data it collects), that's a pretty severe problem. Like, a "fix it or die" problem. Ironically, analysts have been so focused on the monetizable daily active usage (MDAU) rate that they didn't stop to consider what would happen if the company couldn't actually "monetize" that group. The one bright spot of the just-released earnings report—the report that drove shares of TWTR down 20% in a matter of hours—was the growth of MDAU: it reached 145 million, which is 17% (or 21 million) higher than last year. But a software bug which affected the company's Mobile Application Promotion (MAP) product stifled sales, and management warned that the fallout will continue into Q4. That was enough to slash the share price by one-fifth in one session. There is so much potential for this company. It could certainly be listed alongside Facebook and Google as an online ad behemoth if management could finally figure out the right strategy to attract more ad dollars. Unfortunately, this latest incident shows they continue to fumble forward.
Automotive
Stop the presses: Tesla turned a profit! We have never hidden our admiration and respect for Elon Musk, and we continue to root for all of the companies which have been formed directly out of his visionary mind. Likewise, we have never hidden our disrespect for the established old-school car companies that have taken potshots at Tesla (TSLA $177-$300-$379) as they sat back and rested on their laurels (until Musk forced them to begin to innovate once again—spineless wonders). We will throw many do-nothing analysts in the mix as well, who have all but guaranteed that we will never see Tesla turn a profit. Sorry to disappoint, but against Street expectations for a $0.46 per share loss, Tesla just reported a $1.86 per share profit. The company's blockbuster earnings report shocked just about everyone, and investors responded by pushing TSLA shares up 18% in pre-market action, topping $300 for the first time since the end of February. Since the third of June, shares have now quietly risen 68%, though they were down heavily through the first five months of the year. The company's $1.86 per share profit came on the back of $6.3 billion in Q3 sales, roughly in line with the same quarter last year. Production of the company's Model 3 sedan hit just shy of 80,000 in Q3, versus 53,200 in the same quarter of last year—a 50% spike. The icing on the cake: With Thursday's spike in its share price, Tesla overtook GM (GM) in market cap. Tesla is worth $54 billion; GM, $52 billion; and Ford, $35 billion. While the Model 3 is currently the company's biggest profit driver, it is gearing up for production of its next big blockbuster, the Model Y crossover utility vehicle (CUV). Tesla is finishing the buildout of its Gigafactory number 3 in Shanghai, in addition to a new production facility in that city. When all facilities are online by the middle of next year, the company is projecting a global production rate of 500,000 vehicles annually. Orders continue to outpace production. We believe short sellers are making a grave error by betting against this firm.
Consumer Electronics
With iRobot shares down 65% in six months, is the consumer electronics firm a screaming buy? As a kid, my favorite Saturday morning cartoon was The Jetsons. I fully expected that, by the time I turned my current age, we would have little robotic devices autonomously scurrying around the house, performing mundane tasks like sweeping up crumbs and bringing us our coffee. While Rosie the maid hasn't come to fruition yet, iRobot (IRBT $51-$48-$133) is sort of like the Spacely Sprockets of our era. The company makes the Roomba® robot vacuum, the Braava® robot mop, and—coming soon to a yard near you—the Terra™ robot mower. If that's not cool enough, it is also getting into the entertainment and education arena with its new Root® coding robot for students and educators. How about the financials? Well, the company has a tiny P/E ratio of 15, has turned a profit every year for the past decade, and just notched its thirteenth-straight quarter of year-over-year growth. So, how are investors rewarding this stellar company? Shares of IRBT have fallen 65% in precisely the past six months. Where is the disconnect? That's an excellent question, considering this week's earnings release shows yet another beat on top line revenues and bottom line earnings. Investors got hung up on the lowered guidance. Management said it had to roll back recent price increases due to tariffs placed on the company's products, and also scaled back expectations for the Christmas shopping season. While the firm is based out of Bedford, Mass., it builds most of its devices in China, and they have been a direct target of the 25% tariffs which went into effect this past May. Perhaps it is skittishness due to the economic environment, but we have seen investors turn too bearish—in our opinion— on too many strong companies recently. iRobot's founder and CEO, Colin Angle (image courtesy of iRobot), is a brilliant industry pioneer, with degrees in computer science and electrical engineering from MIT. He was also recently named CEO of the Year by the Mass Technology Leadership Council, one of Fortune Small Business Magazine's Best Bosses, and Ernst and Young's New England Entrepreneur of the Year. We wouldn't be surprised to see the stock at $100 per share in the not-too-distant future.
Application & Systems Software
Analysts turn cautious on business software firm ServiceNow after CEO bolts for Nike; we disagree. ServiceNow (NOW $148-$212-$303) is a $40 billion enterprise software company which provides customized workflow digitization to companies. In other words, it will take a look at what a company does, and it will streamline and automate all aspects of workflow, from customer interaction to back office functions. To quote incoming CEO Bill McDermott, the company provides a "fully integrated platform to drive productivity." Speaking of the incoming CEO, the C-suite shuffle is the reason some analysts have turned negative on the firm. Athletic apparel company Nike (NIKE) hired away NOW CEO John Donahoe to take over for the invertebrate Mark Parker ("Yank the Betsy Ross shoes"), who will—sadly—remain at the firm as the executive chairman. (Parker: "I will lean-in to help Donahoe...." Gag.) Donohoe doesn't need Parker's help—before successfully leading ServiceNow, he was chairman of PayPal. As for the company he is leaving, we can't imagine a better leader than SAP's (SAP) Bill McDermott. Under his leadership, in fact, SAP grew from a $39 billion firm to a $160 billion applications software juggernaut. He is, in our opinion, one of the best CEOs in the industry. Ironically, NOW sits almost precisely at the size of SAP when McDermott took over that firm. We strongly disagree with the downgrades. ServiceNow offers benchmark enterprise solutions to the world's largest organizations. Its customer retention rate is a crazy-high 98%. We would place a fair value on NOW shares at $300, or about 42% higher than where they sit following the downgrades.
Real Estate Management & Development
In a truly disgusting business saga, the erratic founder who ran WeWork into the ground may get $1.7 billion to go away. If there is one positive aspect to the WeWork saga, it is the fact that millions of unsuspecting investors didn't lose their shirts by buying shares of the We Company IPO that went up in smoke. Which points to one of our main problems with technical analysis purists. Granted, there weren't any charts to look at yet, but only a thorough fundamental analysis of an entity would uncover the fatally-flawed humans running some of these companies. Which brings us to Adam Neumann. The guy who demanded super-voting-rights (each of his shares would be worth ten voting shares for us common rubes) on WeWork once it went public, the guy who demanded that his wife be given overarching control if anything happened to him, the guy who (ab)used a $500 million line of credit by buying mansions, is now set to walk away with up to $1.7 billion in severance. All of this as loyal WeWork employees are fired en masse. (Did we mention that the company couldn't afford the severance payments for the employees being firing?)
It appears that the WeWork board will take SoftBank's offer to take control of the company for another $5 billion or so (they are already on the hook for $11 billion, after all). As part of the agreement, SoftBank will pay around $970 million to buyout Neumann's shares, $185 million consulting fees to Neumann (WHAT?!), and they will payoff the $500 million line of credit he already spent! How does one respond to this? What do the fired workers think of this? This guy is the poster boy for arrogance and greed. The fact that SoftBank is stepping in to save their $11 billion investment makes us root against the firm all the more. Disgraceful.
SoftBank will have the guy they sent to Kansas City to fix Sprint (S) now fly to New York to run WeWork. First of all, if Sprint doesn't get its merger with T-Mobile (TMUS) approved, it "ain't" fixed. Second of all, good luck. Oh, and the company that is set to run out of money next month (at least until the new $5B comes in) is also on the hook for nearly $50 billion in lease payments over the coming years. Again, good luck.
Biotechnology
Penn New Frontier holding Biogen jumps 37% following announcement that it would seek approval for Alzheimer's drug. When we purchased $50 billion biotech star Biogen (BIIB $216-$293-$344) on 21 March, it had just fallen 27% on news that the company was abandoning its Alzheimer's treatment aducanumab (AD ju CAN uh mab). The news led to a slew of downgrades, but we had followed the company intimately and strongly believed the Street was overreacting. We immediately added it to the Penn New Frontier Fund. Lo and behold, what treatment is Biogen is planning to submit to the FDA for approval? Yep, aducanumab. While we certainly could not have foreseen this reversal of fortune, we'll take the 37% gain notched by BIIB within hours of the announcement. The therapy, which the company plans to submit for marketing application in early 2020, is an antibody that attacks the amyloid protein which builds up in the brain of people with the disease. When we purchased the stock, we mentioned that a Goldman Sachs analyst had been projecting sales of $12 billion if the therapy made it to market. For the 5.5 million Americans suffering from this terrible disease, we pray it does. We believe the March setback of aducanumab was somewhat of a wake-up call for Biogen to increase its stable of pipeline drugs, both through mergers and organic development of new therapies. That appears to be underway, and we see the fair value of BIIB shares at $350, conservatively.
Specialty Retail: eCommerce
Online pet pharmacy PetMed Express rockets up 38% in intraday trading, so we sold our position. As of early Monday afternoon, shares of PetMed Express (PETS $15-$27-$33) were trading up 37.71% after the $540 million small-cap value company reported fiscal second-quarter earnings. That is what makes the earnings season so thrilling—there are always some major surprises from unexpected places. It wasn't that the quarter was lights-out for the Delray Beach, Florida company, with its 199 employees; it was simply that the numbers weren't anywhere near as bad as expected. Sales actually declined 2% for the quarter (YoY), to $69.9 million, but that beat estimates for $69.7 million. Net income fell from $0.52 per share in Q2 of 2018 to $0.33 this year, but that beat street estimates for $0.26 per share. "Not as bad as feared" earnings reports make us nervous, so we took the 38% spike as an opportunity to unload the shares and grab our short-term profit. Soon after we purchased PETM in the Penn Intrepid Trading Platform, the shares took a big hit; based on our fair value estimate, however, we held off on putting a stop-loss on the stock. In this case it paid off, but that is not always the way it works out. Unless an investor has the ability to diligently watch "trading stocks" (as opposed to long-term investments), there should be some protection on these holdings.
Industrials: Airlines
Stifel analyst makes some pretty explosive comments about Southwest Airlines and its reliance on the 737. Diversification is a good risk management tool, whether putting together an investment portfolio or managing a fleet of aircraft. Southwest Airlines (LUV 44-$53-$59) operates an all-Boeing 737 fleet and, while only a portion were 737 MAX aircraft, that fact caught the attention of Stifel Nicolaus analyst Joseph Denardi. Not only did Stifel downgrade shares of LUV, reducing the price target from $75 to $60, Denardi said that the MAX grounding may be placing Southwest near "the tipping point." Using CEO's Gary Kelly's own comments that it would take years to diversify its fleet, the analyst pushed the notion that the airline might need to gobble up a smaller competitor to make that happen immediately. One possible acquisition Denardi mentioned as a good fit was Jet Blue (JBLU $15-$18-$20), which rose about 5% after the analyst's comments. Southwest is a $30 billion airline; Jet Blue is a $5 billion mid-cap. Thanks to Boeing, it is an even rougher time to be in the airliner business. Our one holding remains Delta Airlines (DAL), which is up 10% year-to-date and 7.5% since the second MAX crash. One reason? The company diversified away from Boeing and owns a large complementary fleet of Airbus (EADSY) aircraft. In January of 2018 we wrote of Boeing's formal complaint against Delta for buying Bombardier aircraft from Canada—a suit it (Boeing) quickly lost. The sweet irony was that Bombardier, fearing Boeing would win, forged a joint manufacturing alliance with Airbus. Boeing is a great American company with some really rotten leadership. We believe that arrogance began to permeate the C-suite, driving bad decisions (sort of like August Busch III at Budweiser before it ceased to be an American-owned firm). It is time for Dennis Muilenburg—and maybe a good portion of the board—to go.
Media & Entertainment
South Park is closing in on half-a-billion dollar streaming deal. $500 million seems to be the going rate for the purchase of hit TV reruns by streaming services. Friends, The Office, Seinfeld, and now South Park are all very close to that range of what the highest bidders in the frenetic streaming wars are willing to pay to win exclusive airing rights. As for the long-running South Park, which first aired in 1997, Disney-owned Hulu paid $192 million to Viacom (VIA) and the show's creators, Trey Parker and Matt Stone, just four years ago in what now appears to be a bargain-basement price for the episodes. Now that Hulu's deal is close to its expiration date, up to six media outlets are set to put bids in for the show, which recently aired its 300th episode. Half of the final amount will go to Comedy Central parent Viacom, with the other half going to Parker and Stone. The one major new entrant which probably won't be putting in a bid? Apple (AAPL) is expected to pass, as South Park has been banned in China after poking fun at the communist regime (pretty much proving the point of the episode). Apple doesn't want to anger the dictatorial regime of one of its largest iPhone markets. If anyone in the media and entertainment industry deserves this kind of jack it is Trey Parker and Matt Stone. The two have thumbed their noses at political correctness and the Hollywood elite from the start. Bravo.
Twitter's one, massive, overarching, disastrous problem: it still doesn't know how to effectively monetize its platform. As a money-making machine, social media platform Twitter's (TWTR $26-$31-$46) business model seemed like a no-brainer. Tell advertisers from companies of all sizes that their highly-visual ads could be seen by a total addressable market of over 100 million potential buyers, and then simply let the ad dollars begin flooding in, as has been the case with Facebook (FB) and Google (GOOGL). That is the one problem Twitter has chronically struggled with: it simply hasn't been able to master the ability to market its product to advertisers. And, considering 90% of its revenues come from ad dollars (the other 10% comes from licensing the user data it collects), that's a pretty severe problem. Like, a "fix it or die" problem. Ironically, analysts have been so focused on the monetizable daily active usage (MDAU) rate that they didn't stop to consider what would happen if the company couldn't actually "monetize" that group. The one bright spot of the just-released earnings report—the report that drove shares of TWTR down 20% in a matter of hours—was the growth of MDAU: it reached 145 million, which is 17% (or 21 million) higher than last year. But a software bug which affected the company's Mobile Application Promotion (MAP) product stifled sales, and management warned that the fallout will continue into Q4. That was enough to slash the share price by one-fifth in one session. There is so much potential for this company. It could certainly be listed alongside Facebook and Google as an online ad behemoth if management could finally figure out the right strategy to attract more ad dollars. Unfortunately, this latest incident shows they continue to fumble forward.
Automotive
Stop the presses: Tesla turned a profit! We have never hidden our admiration and respect for Elon Musk, and we continue to root for all of the companies which have been formed directly out of his visionary mind. Likewise, we have never hidden our disrespect for the established old-school car companies that have taken potshots at Tesla (TSLA $177-$300-$379) as they sat back and rested on their laurels (until Musk forced them to begin to innovate once again—spineless wonders). We will throw many do-nothing analysts in the mix as well, who have all but guaranteed that we will never see Tesla turn a profit. Sorry to disappoint, but against Street expectations for a $0.46 per share loss, Tesla just reported a $1.86 per share profit. The company's blockbuster earnings report shocked just about everyone, and investors responded by pushing TSLA shares up 18% in pre-market action, topping $300 for the first time since the end of February. Since the third of June, shares have now quietly risen 68%, though they were down heavily through the first five months of the year. The company's $1.86 per share profit came on the back of $6.3 billion in Q3 sales, roughly in line with the same quarter last year. Production of the company's Model 3 sedan hit just shy of 80,000 in Q3, versus 53,200 in the same quarter of last year—a 50% spike. The icing on the cake: With Thursday's spike in its share price, Tesla overtook GM (GM) in market cap. Tesla is worth $54 billion; GM, $52 billion; and Ford, $35 billion. While the Model 3 is currently the company's biggest profit driver, it is gearing up for production of its next big blockbuster, the Model Y crossover utility vehicle (CUV). Tesla is finishing the buildout of its Gigafactory number 3 in Shanghai, in addition to a new production facility in that city. When all facilities are online by the middle of next year, the company is projecting a global production rate of 500,000 vehicles annually. Orders continue to outpace production. We believe short sellers are making a grave error by betting against this firm.
Consumer Electronics
With iRobot shares down 65% in six months, is the consumer electronics firm a screaming buy? As a kid, my favorite Saturday morning cartoon was The Jetsons. I fully expected that, by the time I turned my current age, we would have little robotic devices autonomously scurrying around the house, performing mundane tasks like sweeping up crumbs and bringing us our coffee. While Rosie the maid hasn't come to fruition yet, iRobot (IRBT $51-$48-$133) is sort of like the Spacely Sprockets of our era. The company makes the Roomba® robot vacuum, the Braava® robot mop, and—coming soon to a yard near you—the Terra™ robot mower. If that's not cool enough, it is also getting into the entertainment and education arena with its new Root® coding robot for students and educators. How about the financials? Well, the company has a tiny P/E ratio of 15, has turned a profit every year for the past decade, and just notched its thirteenth-straight quarter of year-over-year growth. So, how are investors rewarding this stellar company? Shares of IRBT have fallen 65% in precisely the past six months. Where is the disconnect? That's an excellent question, considering this week's earnings release shows yet another beat on top line revenues and bottom line earnings. Investors got hung up on the lowered guidance. Management said it had to roll back recent price increases due to tariffs placed on the company's products, and also scaled back expectations for the Christmas shopping season. While the firm is based out of Bedford, Mass., it builds most of its devices in China, and they have been a direct target of the 25% tariffs which went into effect this past May. Perhaps it is skittishness due to the economic environment, but we have seen investors turn too bearish—in our opinion— on too many strong companies recently. iRobot's founder and CEO, Colin Angle (image courtesy of iRobot), is a brilliant industry pioneer, with degrees in computer science and electrical engineering from MIT. He was also recently named CEO of the Year by the Mass Technology Leadership Council, one of Fortune Small Business Magazine's Best Bosses, and Ernst and Young's New England Entrepreneur of the Year. We wouldn't be surprised to see the stock at $100 per share in the not-too-distant future.
Application & Systems Software
Analysts turn cautious on business software firm ServiceNow after CEO bolts for Nike; we disagree. ServiceNow (NOW $148-$212-$303) is a $40 billion enterprise software company which provides customized workflow digitization to companies. In other words, it will take a look at what a company does, and it will streamline and automate all aspects of workflow, from customer interaction to back office functions. To quote incoming CEO Bill McDermott, the company provides a "fully integrated platform to drive productivity." Speaking of the incoming CEO, the C-suite shuffle is the reason some analysts have turned negative on the firm. Athletic apparel company Nike (NIKE) hired away NOW CEO John Donahoe to take over for the invertebrate Mark Parker ("Yank the Betsy Ross shoes"), who will—sadly—remain at the firm as the executive chairman. (Parker: "I will lean-in to help Donahoe...." Gag.) Donohoe doesn't need Parker's help—before successfully leading ServiceNow, he was chairman of PayPal. As for the company he is leaving, we can't imagine a better leader than SAP's (SAP) Bill McDermott. Under his leadership, in fact, SAP grew from a $39 billion firm to a $160 billion applications software juggernaut. He is, in our opinion, one of the best CEOs in the industry. Ironically, NOW sits almost precisely at the size of SAP when McDermott took over that firm. We strongly disagree with the downgrades. ServiceNow offers benchmark enterprise solutions to the world's largest organizations. Its customer retention rate is a crazy-high 98%. We would place a fair value on NOW shares at $300, or about 42% higher than where they sit following the downgrades.
Real Estate Management & Development
In a truly disgusting business saga, the erratic founder who ran WeWork into the ground may get $1.7 billion to go away. If there is one positive aspect to the WeWork saga, it is the fact that millions of unsuspecting investors didn't lose their shirts by buying shares of the We Company IPO that went up in smoke. Which points to one of our main problems with technical analysis purists. Granted, there weren't any charts to look at yet, but only a thorough fundamental analysis of an entity would uncover the fatally-flawed humans running some of these companies. Which brings us to Adam Neumann. The guy who demanded super-voting-rights (each of his shares would be worth ten voting shares for us common rubes) on WeWork once it went public, the guy who demanded that his wife be given overarching control if anything happened to him, the guy who (ab)used a $500 million line of credit by buying mansions, is now set to walk away with up to $1.7 billion in severance. All of this as loyal WeWork employees are fired en masse. (Did we mention that the company couldn't afford the severance payments for the employees being firing?)
It appears that the WeWork board will take SoftBank's offer to take control of the company for another $5 billion or so (they are already on the hook for $11 billion, after all). As part of the agreement, SoftBank will pay around $970 million to buyout Neumann's shares, $185 million consulting fees to Neumann (WHAT?!), and they will payoff the $500 million line of credit he already spent! How does one respond to this? What do the fired workers think of this? This guy is the poster boy for arrogance and greed. The fact that SoftBank is stepping in to save their $11 billion investment makes us root against the firm all the more. Disgraceful.
SoftBank will have the guy they sent to Kansas City to fix Sprint (S) now fly to New York to run WeWork. First of all, if Sprint doesn't get its merger with T-Mobile (TMUS) approved, it "ain't" fixed. Second of all, good luck. Oh, and the company that is set to run out of money next month (at least until the new $5B comes in) is also on the hook for nearly $50 billion in lease payments over the coming years. Again, good luck.
Biotechnology
Penn New Frontier holding Biogen jumps 37% following announcement that it would seek approval for Alzheimer's drug. When we purchased $50 billion biotech star Biogen (BIIB $216-$293-$344) on 21 March, it had just fallen 27% on news that the company was abandoning its Alzheimer's treatment aducanumab (AD ju CAN uh mab). The news led to a slew of downgrades, but we had followed the company intimately and strongly believed the Street was overreacting. We immediately added it to the Penn New Frontier Fund. Lo and behold, what treatment is Biogen is planning to submit to the FDA for approval? Yep, aducanumab. While we certainly could not have foreseen this reversal of fortune, we'll take the 37% gain notched by BIIB within hours of the announcement. The therapy, which the company plans to submit for marketing application in early 2020, is an antibody that attacks the amyloid protein which builds up in the brain of people with the disease. When we purchased the stock, we mentioned that a Goldman Sachs analyst had been projecting sales of $12 billion if the therapy made it to market. For the 5.5 million Americans suffering from this terrible disease, we pray it does. We believe the March setback of aducanumab was somewhat of a wake-up call for Biogen to increase its stable of pipeline drugs, both through mergers and organic development of new therapies. That appears to be underway, and we see the fair value of BIIB shares at $350, conservatively.
Specialty Retail: eCommerce
Online pet pharmacy PetMed Express rockets up 38% in intraday trading, so we sold our position. As of early Monday afternoon, shares of PetMed Express (PETS $15-$27-$33) were trading up 37.71% after the $540 million small-cap value company reported fiscal second-quarter earnings. That is what makes the earnings season so thrilling—there are always some major surprises from unexpected places. It wasn't that the quarter was lights-out for the Delray Beach, Florida company, with its 199 employees; it was simply that the numbers weren't anywhere near as bad as expected. Sales actually declined 2% for the quarter (YoY), to $69.9 million, but that beat estimates for $69.7 million. Net income fell from $0.52 per share in Q2 of 2018 to $0.33 this year, but that beat street estimates for $0.26 per share. "Not as bad as feared" earnings reports make us nervous, so we took the 38% spike as an opportunity to unload the shares and grab our short-term profit. Soon after we purchased PETM in the Penn Intrepid Trading Platform, the shares took a big hit; based on our fair value estimate, however, we held off on putting a stop-loss on the stock. In this case it paid off, but that is not always the way it works out. Unless an investor has the ability to diligently watch "trading stocks" (as opposed to long-term investments), there should be some protection on these holdings.
Industrials: Airlines
Stifel analyst makes some pretty explosive comments about Southwest Airlines and its reliance on the 737. Diversification is a good risk management tool, whether putting together an investment portfolio or managing a fleet of aircraft. Southwest Airlines (LUV 44-$53-$59) operates an all-Boeing 737 fleet and, while only a portion were 737 MAX aircraft, that fact caught the attention of Stifel Nicolaus analyst Joseph Denardi. Not only did Stifel downgrade shares of LUV, reducing the price target from $75 to $60, Denardi said that the MAX grounding may be placing Southwest near "the tipping point." Using CEO's Gary Kelly's own comments that it would take years to diversify its fleet, the analyst pushed the notion that the airline might need to gobble up a smaller competitor to make that happen immediately. One possible acquisition Denardi mentioned as a good fit was Jet Blue (JBLU $15-$18-$20), which rose about 5% after the analyst's comments. Southwest is a $30 billion airline; Jet Blue is a $5 billion mid-cap. Thanks to Boeing, it is an even rougher time to be in the airliner business. Our one holding remains Delta Airlines (DAL), which is up 10% year-to-date and 7.5% since the second MAX crash. One reason? The company diversified away from Boeing and owns a large complementary fleet of Airbus (EADSY) aircraft. In January of 2018 we wrote of Boeing's formal complaint against Delta for buying Bombardier aircraft from Canada—a suit it (Boeing) quickly lost. The sweet irony was that Bombardier, fearing Boeing would win, forged a joint manufacturing alliance with Airbus. Boeing is a great American company with some really rotten leadership. We believe that arrogance began to permeate the C-suite, driving bad decisions (sort of like August Busch III at Budweiser before it ceased to be an American-owned firm). It is time for Dennis Muilenburg—and maybe a good portion of the board—to go.
Media & Entertainment
South Park is closing in on half-a-billion dollar streaming deal. $500 million seems to be the going rate for the purchase of hit TV reruns by streaming services. Friends, The Office, Seinfeld, and now South Park are all very close to that range of what the highest bidders in the frenetic streaming wars are willing to pay to win exclusive airing rights. As for the long-running South Park, which first aired in 1997, Disney-owned Hulu paid $192 million to Viacom (VIA) and the show's creators, Trey Parker and Matt Stone, just four years ago in what now appears to be a bargain-basement price for the episodes. Now that Hulu's deal is close to its expiration date, up to six media outlets are set to put bids in for the show, which recently aired its 300th episode. Half of the final amount will go to Comedy Central parent Viacom, with the other half going to Parker and Stone. The one major new entrant which probably won't be putting in a bid? Apple (AAPL) is expected to pass, as South Park has been banned in China after poking fun at the communist regime (pretty much proving the point of the episode). Apple doesn't want to anger the dictatorial regime of one of its largest iPhone markets. If anyone in the media and entertainment industry deserves this kind of jack it is Trey Parker and Matt Stone. The two have thumbed their noses at political correctness and the Hollywood elite from the start. Bravo.
Headlines for the Week of 13 Oct 2019—19 Oct 2019
Aerospace & Defense
The last thing Boeing needed: "smoking gun" instant messages from 737 MAX pilot come to light. The New York Times is reporting that the chief technical pilot of the 737 MAX sent instant messages to another Boeing (BA $292-$351-446) pilot back in November of 2016 complaining of the MCAS system at the heart of two deadly crashes. According to the NYT report, pilot Mark Forkner texted pilot Pat Gustavsson, "Granted, I suck at flying, but even this was egregious." Self-deprecating humor aside, the real question is whether or not Forkner relayed any of his concerns over the MCAS to Boeing. For its part, the FAA is furious that Boeing knew about these texts for months, but just turned them into the Department of Transportation late this week. The FAA is in the process of re-certifying the 737 MAX for a return to service following the MCAS modifications. This may be a case of the pilot being on the hook, as he told FAA regulators that any mention of the MCAS system doesn't even need to be included in the aircraft's manual, as the system is so benign. Earlier in the week we said that now is not the time to jump back into Boeing. The shares were at $373. After today's revelations, shares are down over 6%, at $345.70.
Trading Companies & Distributors
United Rentals takes off on earnings report, upgrade. We purchased the stalwart industrial equipment leasing company United Rentals (URI $94-$128-$143) as position #1 in the Intrepid Trading Portfolio back in July at $121.19 after it got hammered on Q2's earnings report. At the Trading Desk, we commented: "There was no good reason for shares of the $10 billion industrials company to drop 8% after a decent earnings report (revenue jumped 21%), but it did." Sure enough, the company handily beat on Q3 earnings, both on revenues and net income, and the shares popped over 5%. It didn't hurt that Goldman Sachs upgraded the $10 billion Stamford-based firm, raising their target price from $128 (where shares spiked to on Thursday) to $165 per share. We remain bullish on the company, as any downturn in economic sentiment would only drive companies away from purchasing and towards this reliable leasing partner. The quarterly (year over year) growth on this company is remarkable, which is one reason it filtered through our screeners in the first place. Quarterly YoY earnings have increased every single quarter since 2016.
Restaurants
Following in the footsteps of Disney and Starbucks, Chipotle Mexican Grill will offer free college to employees. With so many generational trends heading in the wrong direction, we are happy to point to one recent trend that will have an incredibly positive impact on millions of US workers. Following similar announcements by Walt Disney (DIS) and Starbucks (SBUX), Chipotle Mexican Grill (CMG $383-$829-$858) will begin offering free college tuition to all of its employees. Workers will be able to choose from 75 different business and technology degree options at a number of different universities, with Chipotle picking up 100% of the tuition costs up-front. The restaurant's Cultivate Education program will also allow workers to be paid back up to $5,250 per year by pursuing degrees at other institutions of their own choosing. In addition to the three companies mentioned, Walmart (WMT) is offering free SAT and ACT prep courses to its employees still in high school, and college tuition for a business or supply-chain management degree for $1 per day out of the employee's paycheck. Perhaps some of these programs have come about due to the 3.5% unemployment rate and the battle for workers, but we see this trend continuing as other companies follow suit. The importance of educating the American workforce in an age of automation, digitization, and robotics cannot be overemphasized. We believe that younger job seekers will consider a company's education benefits package as much as the previous generation considered 401(k) matching programs, and as much as past generations of workers considered the near-extinct defined benefit (pension) plans.
Global Strategy: Europe
It's official: the British Parliament is more dysfunctional than the US Congress (and that was a big hurdle). Simply a joke. Britons everywhere should be outraged, and it probably is time to call for a new general election. After three years and millions of hours of bloviating by politicians, Prime Minister Boris Johnson and European Commission President Jean-Claude Juncker performed a miracle: they came to an actual agreement on the terms of Brexit. An actual agreement, not the one shoved down the throat of an ineffectual Theresa May. And that is pretty remarkable considering the EU's objection to renegotiating that sweet (for the bloc) deal.
So, facing the 31 Oct Brexit deadline, it came down to a simple up or down vote by a special Saturday session of parliament—the first such weekend gathering since the 1982 Falklands War. The smart action would have been to approve the deal, despite the minority Labour's objections (they want back in power, which means their aim is to foment chaos). Granted, Boris Johnson's Conservative Party (the Tories) needed help from a coalition of other parties to get enough ayes to win the vote, but the deal would have actually codified the will of the people from a three-year-old national referendum. The only other option, we thought, was a failure.
Nope, the buffoonish, malleable, linguine-spined body of politicians couldn't even decide between a simple yes or no. Instead, they gave the most cowardly possible answer: they demanded Johnson go back and ask for more time from Brussels. Yet another delay. The prime minister did, however, stick a thumb in the eye of the milquetoasts: he refused to sign his name on the delay request, instead sending an accompanying letter asking the EU to turn down the very request parliament forced him to send. Funny.
A 31 Oct Brexit is still not dead. Prime Minister Johnson is actively arm-twisting and is expected to ask that the deal be put up for another up-or-down vote this week. Furthermore, all 27 other members (excluding the UK) of the EU must approve another delay, and Hungary has been vacillating. If parliament refuses to vote aye on the deal, and the EU refuses to grant an extension, hello "hard" Brexit.
All of the so-called experts are predicting a dire economic result for England if it blows out of the EU without a deal. That is baloney. The world is being fed yet another false narrative by the press and the politicians. One way or another, Johnson still believes the exit will take place this month.
Global Strategy: Europe
If the UK Parliament cannot pass the new Brexit agreement, they will supplant the US Congress as the world's most ineffective legislative body. Maybe a bit of hyperbole, but not much. After three years and millions of hours of bloviating by politicians, Prime Minister Boris Johnson and European Commission President Jean-Claude Juncker performed a miracle: they came to an actual agreement on the terms of Brexit. The deal may not have been perfect (what negotiated deal is?), but it dealt effectively with the gargantuan sticking point: there will be no "hard" border between the Republic of Ireland and Northern Ireland. For that reason alone, parliament should sit down this Saturday, swallow their pride, put their country first, and vote "AYE". Will it actually pass when parliament sits for their first Saturday session since the 1982 Falklands War? It looks like a toss of the coin, and that is being hopeful. For anyone holding out hope that the minority Labour Party will see members crossing the line to vote yes, remember that this party would do anything to regain power, and a failed Brexit—they believe—will give them their best shot at that. As for Johnson's own Tories and his rag-tag coalition, if he gets their votes, the deal will pass. Certainly, they will have heartburn with issues like a operational border between Northern Ireland and the rest of the UK, but without that wording, the hard Irish border would have remained in play. There will be time to figure out ways to smooth over the rough edges later—the majority coalition needs to get this deal done now. If they don't, the UK will continue to descend down a dark path, and the irresolution will only further damage their economic situation. As we alluded to, Labour has the goal of chaos to worm their way back to power, so expect no support from their MPs on Saturday. If the majority coaltion cannot get the votes, a lot of the "no" voters will be tossed out in the next general election in a wave of anger. We put the odds for a Saturday victory at 45%.
Economics: Housing
More six-figure income families are choosing to rent their homes instead of buying. The residential real estate investment trust (REIT) corner of the housing market has been on an interesting journey over the past decade. The subprime mortgage implosion which led to the financial crisis drove many homeowners into the arms of landlords, and understandably so. The rental market, both for multi-unit and single-family dwellings, swelled to new heights. As interest rates plummeted and balance sheets improved, home ownership took off once again.
But now, an interesting trend is developing. A record number of families with six-figure incomes are choosing to rent their home over taking advantage of ultra-low mortgage rates (the 30-year fixed mortgage is sitting around 3.65%). In fact, according to a Wall Street Journal review of US Census Bureau data, about one out of five households with $100k+ incomes are now renting; that is nearly double what the rate was going into the Great Recession.
A major catalyst has been the rapid growth in home values. The Case-Shiller Home Price Index, which measures changes in the price of single-family residences (going back to January of 1987), has been on a steady upward trajectory for the past eight years, meaning families can get "more home for their buck" by renting instead of buying. The lack of savings for a 20% down payment has been another catalyst for the shift.
And residential REITs like American Homes 4 Rent (AMH $19-$26-$26) are taking the hint, building new homes strictly for renters, complete with urban-like parks and shopping areas within walking distance. This begs the question: if this demographic shift is occurring with rates so low, what happens when they eventually trough and begin to head higher?
In addition to American Homes 4 Rent, we also have AvalonBay Communities (AVB), Equity Residential (EQR), UDR Inc (UDR), and Essex Property Trust (ESS) on our radar within this real estate sub-sector. In fact, we have owned Essex Property Trust within the Penn Global Leaders Club for the past two years.
Recreational Vehicles
Harley halts production of its electric vehicle due to quality check issues. We recall Harley-Davidson's (HOG $30-$35-$44) renaissance in the late '90s, as wait lists for a new bike from the century-old motorcycle manufacturer could be as long as a year. While the great tech wreck of 2000-2002 certainly did some damage, the company roared back, hitting $70 per share in December of 2006. Unfortunately, the firm was unable to weather the financial meltdown like it did the bursting tech bubble, and HOG shares didn't stop dropping until they hit $10.10 in February of 2009. Once again, the company climbed back, hitting $74 per share by spring of 2014. The past five years saw the lean times return, with shares being halved as the bikes fell out of favor with a younger generation of consumers.
Harley has a plan to change all that, however, with its secret weapon: LiveWire, the electric bike designed to attract a new generation of riders. At $30,000, it is a bit pricey (starting prices for the motorcycles range from $19k to $28k), but it is easier to ride, with no clutch and no gears—riders will simply use a "twist-and-go" throttle. The bikes were supposed to begin delivery in August, but it appears that we will have to wait and see if this strategy to pull Harley out of the doldrums will actually work. The company is delaying delivery due to "issues discovered during quality checks," with some indication that the problem revolves around the charging process. Only time will tell just how serious of a setback this is, but Harley needs to nail the landing. With steadily declining sales since 2014, there is little room for error.
With its 4.25% dividend yield and with shares sitting near their 52-week low, it may sound tempting to pick up some HOG right now. We see shares fairly valued at $35, however, and even owning them at this price would make us nervous. A lot is riding on this strategic gamble towards electric bikes, and it is just too early to gauge whether or not it will pay off.
Aerospace & Defense
Boeing board clips CEO Muilenburg's wings, and rightfully so. It may be easy to armchair quarterback following unexpected events, but it wasn't like the world's largest aerospace firm, Boeing (BA $292-$373-$446), didn't have a previous wake-up call in the form of a 737 MAX 8 crash in Indonesia which killed 189. In our opinion, it was arrogance that led the manufacturer to write this crash off as pilot error, instead of demanding better answers. Could the Ethiopian Airlines 737 MAX 8 crash that occurred five months later have been prevented? Almost certainly, if the MCAS system was identified as the problem in the first crash. Up to the point of the second crash, we had been one of Boeing's biggest supporters. Although we didn't own the $210 billion company at the time, it had been a regular member of the Penn Global Leaders Club. The more we delved into the follow-up of both tragedies, however, the more disappointed we became. Now, the board of directors is stepping up to the plate (albeit late) and stripping CEO Dennis Muilenburg of his role as chairman of the board. This will allow him, in the words of the board, to focus on the day-to-day operations of the firm, with the new chairman serving in an oversight role. That new chairman will be former GE aerospace executive David Calhoun—a solid pick. As for Muilenburg, he said he fully supports the decision, and then used one of the most tired phrases in business, stating his team is "laser-focused" on returning the 737 MAX safely to service. Like GE, Boeing has had some incredibly talented CEOs in the past. Key word being "past." By no means is the company at risk of being dethroned as the global aerospace leader, but it has lost so much trust among airlines around the world that we are certainly not ready to jump back in yet.
Real Estate Management & Development
Is SoftBank about to take control of WeWork after its nightmarish investment in the startup? It hasn't been a good year for SoftBank, Masayoshi Son's investment holding company. In fact, the recent quarter or two can be summed up in two words: Uber and WeWork. Thanks to major investments in those two once-golden startups, the company appears poised to potentially writedown as much as $5 billion. The WeWork investment is particularly painful, as SoftBank has already plowed $11 billion into the boondoggle, giving it one-third ownership of the office space leasing company. Now that We has pulled its IPO and relegated mercurial founder Adam Neumann to a support role (a far cry from the former dictate giving his wife near-absolute power if anything were to happen to him), it is in desperate need of cash to avoid insolvency. SoftBank may come to the rescue yet again, but this time the gift is a Gordian knot: Son's Vision Fund will offer a sorely-needed finance package in return for control of the firm.
But SoftBank is not the only one on the hook for its WeWork losses; Jamie Dimon's JP Morgan (JPM) has not only provided billions in loans to the firm, the bank's personal wealth management side had also extended around $100 million in personal loans to Neumann, which he tapped to buy mansions and other symbols of the exorbitantly wealthy. A consortium of banks, including JPM, provided the founder with upwards of a $500 million line of credit. We have always held Dimon in the highest regard, and this level of financial sophistry by the bank surprises us. To counter a potential SoftBank offer, JPM is reportedly trying to cobble together a multibillion-dollar rescue package designed to better protect its own investments in the firm. In the meantime, few landlords or real estate developers are interested in doing any further deals with WeWork, making a comeback all the more tenuous. There is a point at which an investment firm, be it a bank or a private equity fund, must bite the bullet and cut its losses. Perhaps if SoftBank took the entire operation over, it could turn the company around, but we wouldn't bet on it.
Electric Utilities
Investors need to be very leery of buying into a "safe and regulated" utility company operating out of California. Precisely two years ago, PG&E (PCG $5-$8-$49) was a $35 billion large-cap value utility selling at $70 per share and offering investors a 3% dividend. Now, the company is worth $4 billion, has a share price of $8, and offers no dividend yield. Such is the world for an electric utility company operating in the dangerous environment—both literal and political—of California.
After a series of devastating wildfires hit California, due to a deadly combination of heavy winds, dry land, and sparking power lines, the state passed a series of laws holding companies liable for property damage if any evidence can point back to the assets of the respective utility. As a direct result of those laws, power providers like PG&E came up with a seemingly-draconian plan to tactically cut off power to certain regions when dangerously high winds are present. Most recently, this program was used as the mechanism to cut off power to some 700,000 customers across 34 counties as winds up to 60 MPH hit the Bay area. In addition to causing understandable anger among customers, the economic impact of the rolling outages is nearing $3 billion. Imagine a grocery store, for example, losing the power needed to keep its perishable food items cold or frozen, and then extrapolate that out to tens of thousands of businesses in the 34 counties.
Governor Gavin Newsom, the prototypical leader for modern-day California, has excoriated PG&E for implementing the rolling blackout program. The irony in his feigned outrage is laughable. One of the very politicians who helped put the utilities on the liability hook for the wildfires now lambasts them for taking preventative action. What a shame. Such a beautiful state soiled by a combination of feel-good policies (like not being able to clear-cut dead trees in heavily-wooded regions), arrogant politicians, and corporate mistakes. It has to be a tough time to be a small business owner in California.
I once inherited a client with a roughly $1 million portfolio, nearly all of it in telecommunications stocks. From her handwritten ledger, I could see that the portfolio was once worth $3 million. When I asked her about it, she explained that her husband was a longtime AT&T employee, and they had been conditioned to keep all of their investment assets in "safe and regulated phone companies." Paradigms are made to be shattered. Investments once considered safe can turn lethal almost overnight. It is of critical importance to keep up with the changing landscape and be prepared to move quickly.
Global Strategy: Trade
One hidden catalyst for the trade deal: African swine fever. On Friday, a major deal on trade between the US and China was announced in the Oval Office, with both sides celebrating the breakthrough. While both sides my tout the prowess of their respective negotiating teams, many variables—some hidden from the headlines—helped lead to the deal.
One of the major concessions by the Chinese was an agreement to purchase between $40 billion and $50 billion worth of American agricultural products—far more than was purchased even before the tensions ratcheted up. Of that amount, a major portion will include pork imports from US farmers. Why would China, which is by far the leading producer of pork in the world (that country also accounts for over half of the world's pork consumption), need to increase its imports from the US? Namely, an epidemic of African swine flu sweeping across Asia. It is now estimated that over one quarter of the world's pork supply could be lost to the epidemic, which is devastating Chinese farms. How interesting that China will now remove the stiff tariffs placed on US pork coming into the country.
On another Asian front, evidence is mounting that North Korea, which has claimed to be virtually "African swine flu-free," is also reeling from the disease. The Food and Agriculture Organization of the UN now project that 47.8% of North Koreans are suffering from malnutrition. The fact that North Korea has not officially acknowledged the epidemic is only compounding their dire economic predicament. Pork accounts for 80% of that country's protein consumption.
While the US does have one of the world's most skilled trade negotiators in Robert Lighthizer, the economic and geopolitical pressures mounting on China cannot be underestimated in the trade war. From Hong Kong to North Korea to African swine fever, the Chinese plans to hold out until the next US election—no doubt fueled by the whisperings of some US politicians—may be unraveling. And that is a good thing for America.
The last thing Boeing needed: "smoking gun" instant messages from 737 MAX pilot come to light. The New York Times is reporting that the chief technical pilot of the 737 MAX sent instant messages to another Boeing (BA $292-$351-446) pilot back in November of 2016 complaining of the MCAS system at the heart of two deadly crashes. According to the NYT report, pilot Mark Forkner texted pilot Pat Gustavsson, "Granted, I suck at flying, but even this was egregious." Self-deprecating humor aside, the real question is whether or not Forkner relayed any of his concerns over the MCAS to Boeing. For its part, the FAA is furious that Boeing knew about these texts for months, but just turned them into the Department of Transportation late this week. The FAA is in the process of re-certifying the 737 MAX for a return to service following the MCAS modifications. This may be a case of the pilot being on the hook, as he told FAA regulators that any mention of the MCAS system doesn't even need to be included in the aircraft's manual, as the system is so benign. Earlier in the week we said that now is not the time to jump back into Boeing. The shares were at $373. After today's revelations, shares are down over 6%, at $345.70.
Trading Companies & Distributors
United Rentals takes off on earnings report, upgrade. We purchased the stalwart industrial equipment leasing company United Rentals (URI $94-$128-$143) as position #1 in the Intrepid Trading Portfolio back in July at $121.19 after it got hammered on Q2's earnings report. At the Trading Desk, we commented: "There was no good reason for shares of the $10 billion industrials company to drop 8% after a decent earnings report (revenue jumped 21%), but it did." Sure enough, the company handily beat on Q3 earnings, both on revenues and net income, and the shares popped over 5%. It didn't hurt that Goldman Sachs upgraded the $10 billion Stamford-based firm, raising their target price from $128 (where shares spiked to on Thursday) to $165 per share. We remain bullish on the company, as any downturn in economic sentiment would only drive companies away from purchasing and towards this reliable leasing partner. The quarterly (year over year) growth on this company is remarkable, which is one reason it filtered through our screeners in the first place. Quarterly YoY earnings have increased every single quarter since 2016.
Restaurants
Following in the footsteps of Disney and Starbucks, Chipotle Mexican Grill will offer free college to employees. With so many generational trends heading in the wrong direction, we are happy to point to one recent trend that will have an incredibly positive impact on millions of US workers. Following similar announcements by Walt Disney (DIS) and Starbucks (SBUX), Chipotle Mexican Grill (CMG $383-$829-$858) will begin offering free college tuition to all of its employees. Workers will be able to choose from 75 different business and technology degree options at a number of different universities, with Chipotle picking up 100% of the tuition costs up-front. The restaurant's Cultivate Education program will also allow workers to be paid back up to $5,250 per year by pursuing degrees at other institutions of their own choosing. In addition to the three companies mentioned, Walmart (WMT) is offering free SAT and ACT prep courses to its employees still in high school, and college tuition for a business or supply-chain management degree for $1 per day out of the employee's paycheck. Perhaps some of these programs have come about due to the 3.5% unemployment rate and the battle for workers, but we see this trend continuing as other companies follow suit. The importance of educating the American workforce in an age of automation, digitization, and robotics cannot be overemphasized. We believe that younger job seekers will consider a company's education benefits package as much as the previous generation considered 401(k) matching programs, and as much as past generations of workers considered the near-extinct defined benefit (pension) plans.
Global Strategy: Europe
It's official: the British Parliament is more dysfunctional than the US Congress (and that was a big hurdle). Simply a joke. Britons everywhere should be outraged, and it probably is time to call for a new general election. After three years and millions of hours of bloviating by politicians, Prime Minister Boris Johnson and European Commission President Jean-Claude Juncker performed a miracle: they came to an actual agreement on the terms of Brexit. An actual agreement, not the one shoved down the throat of an ineffectual Theresa May. And that is pretty remarkable considering the EU's objection to renegotiating that sweet (for the bloc) deal.
So, facing the 31 Oct Brexit deadline, it came down to a simple up or down vote by a special Saturday session of parliament—the first such weekend gathering since the 1982 Falklands War. The smart action would have been to approve the deal, despite the minority Labour's objections (they want back in power, which means their aim is to foment chaos). Granted, Boris Johnson's Conservative Party (the Tories) needed help from a coalition of other parties to get enough ayes to win the vote, but the deal would have actually codified the will of the people from a three-year-old national referendum. The only other option, we thought, was a failure.
Nope, the buffoonish, malleable, linguine-spined body of politicians couldn't even decide between a simple yes or no. Instead, they gave the most cowardly possible answer: they demanded Johnson go back and ask for more time from Brussels. Yet another delay. The prime minister did, however, stick a thumb in the eye of the milquetoasts: he refused to sign his name on the delay request, instead sending an accompanying letter asking the EU to turn down the very request parliament forced him to send. Funny.
A 31 Oct Brexit is still not dead. Prime Minister Johnson is actively arm-twisting and is expected to ask that the deal be put up for another up-or-down vote this week. Furthermore, all 27 other members (excluding the UK) of the EU must approve another delay, and Hungary has been vacillating. If parliament refuses to vote aye on the deal, and the EU refuses to grant an extension, hello "hard" Brexit.
All of the so-called experts are predicting a dire economic result for England if it blows out of the EU without a deal. That is baloney. The world is being fed yet another false narrative by the press and the politicians. One way or another, Johnson still believes the exit will take place this month.
Global Strategy: Europe
If the UK Parliament cannot pass the new Brexit agreement, they will supplant the US Congress as the world's most ineffective legislative body. Maybe a bit of hyperbole, but not much. After three years and millions of hours of bloviating by politicians, Prime Minister Boris Johnson and European Commission President Jean-Claude Juncker performed a miracle: they came to an actual agreement on the terms of Brexit. The deal may not have been perfect (what negotiated deal is?), but it dealt effectively with the gargantuan sticking point: there will be no "hard" border between the Republic of Ireland and Northern Ireland. For that reason alone, parliament should sit down this Saturday, swallow their pride, put their country first, and vote "AYE". Will it actually pass when parliament sits for their first Saturday session since the 1982 Falklands War? It looks like a toss of the coin, and that is being hopeful. For anyone holding out hope that the minority Labour Party will see members crossing the line to vote yes, remember that this party would do anything to regain power, and a failed Brexit—they believe—will give them their best shot at that. As for Johnson's own Tories and his rag-tag coalition, if he gets their votes, the deal will pass. Certainly, they will have heartburn with issues like a operational border between Northern Ireland and the rest of the UK, but without that wording, the hard Irish border would have remained in play. There will be time to figure out ways to smooth over the rough edges later—the majority coalition needs to get this deal done now. If they don't, the UK will continue to descend down a dark path, and the irresolution will only further damage their economic situation. As we alluded to, Labour has the goal of chaos to worm their way back to power, so expect no support from their MPs on Saturday. If the majority coaltion cannot get the votes, a lot of the "no" voters will be tossed out in the next general election in a wave of anger. We put the odds for a Saturday victory at 45%.
Economics: Housing
More six-figure income families are choosing to rent their homes instead of buying. The residential real estate investment trust (REIT) corner of the housing market has been on an interesting journey over the past decade. The subprime mortgage implosion which led to the financial crisis drove many homeowners into the arms of landlords, and understandably so. The rental market, both for multi-unit and single-family dwellings, swelled to new heights. As interest rates plummeted and balance sheets improved, home ownership took off once again.
But now, an interesting trend is developing. A record number of families with six-figure incomes are choosing to rent their home over taking advantage of ultra-low mortgage rates (the 30-year fixed mortgage is sitting around 3.65%). In fact, according to a Wall Street Journal review of US Census Bureau data, about one out of five households with $100k+ incomes are now renting; that is nearly double what the rate was going into the Great Recession.
A major catalyst has been the rapid growth in home values. The Case-Shiller Home Price Index, which measures changes in the price of single-family residences (going back to January of 1987), has been on a steady upward trajectory for the past eight years, meaning families can get "more home for their buck" by renting instead of buying. The lack of savings for a 20% down payment has been another catalyst for the shift.
And residential REITs like American Homes 4 Rent (AMH $19-$26-$26) are taking the hint, building new homes strictly for renters, complete with urban-like parks and shopping areas within walking distance. This begs the question: if this demographic shift is occurring with rates so low, what happens when they eventually trough and begin to head higher?
In addition to American Homes 4 Rent, we also have AvalonBay Communities (AVB), Equity Residential (EQR), UDR Inc (UDR), and Essex Property Trust (ESS) on our radar within this real estate sub-sector. In fact, we have owned Essex Property Trust within the Penn Global Leaders Club for the past two years.
Recreational Vehicles
Harley halts production of its electric vehicle due to quality check issues. We recall Harley-Davidson's (HOG $30-$35-$44) renaissance in the late '90s, as wait lists for a new bike from the century-old motorcycle manufacturer could be as long as a year. While the great tech wreck of 2000-2002 certainly did some damage, the company roared back, hitting $70 per share in December of 2006. Unfortunately, the firm was unable to weather the financial meltdown like it did the bursting tech bubble, and HOG shares didn't stop dropping until they hit $10.10 in February of 2009. Once again, the company climbed back, hitting $74 per share by spring of 2014. The past five years saw the lean times return, with shares being halved as the bikes fell out of favor with a younger generation of consumers.
Harley has a plan to change all that, however, with its secret weapon: LiveWire, the electric bike designed to attract a new generation of riders. At $30,000, it is a bit pricey (starting prices for the motorcycles range from $19k to $28k), but it is easier to ride, with no clutch and no gears—riders will simply use a "twist-and-go" throttle. The bikes were supposed to begin delivery in August, but it appears that we will have to wait and see if this strategy to pull Harley out of the doldrums will actually work. The company is delaying delivery due to "issues discovered during quality checks," with some indication that the problem revolves around the charging process. Only time will tell just how serious of a setback this is, but Harley needs to nail the landing. With steadily declining sales since 2014, there is little room for error.
With its 4.25% dividend yield and with shares sitting near their 52-week low, it may sound tempting to pick up some HOG right now. We see shares fairly valued at $35, however, and even owning them at this price would make us nervous. A lot is riding on this strategic gamble towards electric bikes, and it is just too early to gauge whether or not it will pay off.
Aerospace & Defense
Boeing board clips CEO Muilenburg's wings, and rightfully so. It may be easy to armchair quarterback following unexpected events, but it wasn't like the world's largest aerospace firm, Boeing (BA $292-$373-$446), didn't have a previous wake-up call in the form of a 737 MAX 8 crash in Indonesia which killed 189. In our opinion, it was arrogance that led the manufacturer to write this crash off as pilot error, instead of demanding better answers. Could the Ethiopian Airlines 737 MAX 8 crash that occurred five months later have been prevented? Almost certainly, if the MCAS system was identified as the problem in the first crash. Up to the point of the second crash, we had been one of Boeing's biggest supporters. Although we didn't own the $210 billion company at the time, it had been a regular member of the Penn Global Leaders Club. The more we delved into the follow-up of both tragedies, however, the more disappointed we became. Now, the board of directors is stepping up to the plate (albeit late) and stripping CEO Dennis Muilenburg of his role as chairman of the board. This will allow him, in the words of the board, to focus on the day-to-day operations of the firm, with the new chairman serving in an oversight role. That new chairman will be former GE aerospace executive David Calhoun—a solid pick. As for Muilenburg, he said he fully supports the decision, and then used one of the most tired phrases in business, stating his team is "laser-focused" on returning the 737 MAX safely to service. Like GE, Boeing has had some incredibly talented CEOs in the past. Key word being "past." By no means is the company at risk of being dethroned as the global aerospace leader, but it has lost so much trust among airlines around the world that we are certainly not ready to jump back in yet.
Real Estate Management & Development
Is SoftBank about to take control of WeWork after its nightmarish investment in the startup? It hasn't been a good year for SoftBank, Masayoshi Son's investment holding company. In fact, the recent quarter or two can be summed up in two words: Uber and WeWork. Thanks to major investments in those two once-golden startups, the company appears poised to potentially writedown as much as $5 billion. The WeWork investment is particularly painful, as SoftBank has already plowed $11 billion into the boondoggle, giving it one-third ownership of the office space leasing company. Now that We has pulled its IPO and relegated mercurial founder Adam Neumann to a support role (a far cry from the former dictate giving his wife near-absolute power if anything were to happen to him), it is in desperate need of cash to avoid insolvency. SoftBank may come to the rescue yet again, but this time the gift is a Gordian knot: Son's Vision Fund will offer a sorely-needed finance package in return for control of the firm.
But SoftBank is not the only one on the hook for its WeWork losses; Jamie Dimon's JP Morgan (JPM) has not only provided billions in loans to the firm, the bank's personal wealth management side had also extended around $100 million in personal loans to Neumann, which he tapped to buy mansions and other symbols of the exorbitantly wealthy. A consortium of banks, including JPM, provided the founder with upwards of a $500 million line of credit. We have always held Dimon in the highest regard, and this level of financial sophistry by the bank surprises us. To counter a potential SoftBank offer, JPM is reportedly trying to cobble together a multibillion-dollar rescue package designed to better protect its own investments in the firm. In the meantime, few landlords or real estate developers are interested in doing any further deals with WeWork, making a comeback all the more tenuous. There is a point at which an investment firm, be it a bank or a private equity fund, must bite the bullet and cut its losses. Perhaps if SoftBank took the entire operation over, it could turn the company around, but we wouldn't bet on it.
Electric Utilities
Investors need to be very leery of buying into a "safe and regulated" utility company operating out of California. Precisely two years ago, PG&E (PCG $5-$8-$49) was a $35 billion large-cap value utility selling at $70 per share and offering investors a 3% dividend. Now, the company is worth $4 billion, has a share price of $8, and offers no dividend yield. Such is the world for an electric utility company operating in the dangerous environment—both literal and political—of California.
After a series of devastating wildfires hit California, due to a deadly combination of heavy winds, dry land, and sparking power lines, the state passed a series of laws holding companies liable for property damage if any evidence can point back to the assets of the respective utility. As a direct result of those laws, power providers like PG&E came up with a seemingly-draconian plan to tactically cut off power to certain regions when dangerously high winds are present. Most recently, this program was used as the mechanism to cut off power to some 700,000 customers across 34 counties as winds up to 60 MPH hit the Bay area. In addition to causing understandable anger among customers, the economic impact of the rolling outages is nearing $3 billion. Imagine a grocery store, for example, losing the power needed to keep its perishable food items cold or frozen, and then extrapolate that out to tens of thousands of businesses in the 34 counties.
Governor Gavin Newsom, the prototypical leader for modern-day California, has excoriated PG&E for implementing the rolling blackout program. The irony in his feigned outrage is laughable. One of the very politicians who helped put the utilities on the liability hook for the wildfires now lambasts them for taking preventative action. What a shame. Such a beautiful state soiled by a combination of feel-good policies (like not being able to clear-cut dead trees in heavily-wooded regions), arrogant politicians, and corporate mistakes. It has to be a tough time to be a small business owner in California.
I once inherited a client with a roughly $1 million portfolio, nearly all of it in telecommunications stocks. From her handwritten ledger, I could see that the portfolio was once worth $3 million. When I asked her about it, she explained that her husband was a longtime AT&T employee, and they had been conditioned to keep all of their investment assets in "safe and regulated phone companies." Paradigms are made to be shattered. Investments once considered safe can turn lethal almost overnight. It is of critical importance to keep up with the changing landscape and be prepared to move quickly.
Global Strategy: Trade
One hidden catalyst for the trade deal: African swine fever. On Friday, a major deal on trade between the US and China was announced in the Oval Office, with both sides celebrating the breakthrough. While both sides my tout the prowess of their respective negotiating teams, many variables—some hidden from the headlines—helped lead to the deal.
One of the major concessions by the Chinese was an agreement to purchase between $40 billion and $50 billion worth of American agricultural products—far more than was purchased even before the tensions ratcheted up. Of that amount, a major portion will include pork imports from US farmers. Why would China, which is by far the leading producer of pork in the world (that country also accounts for over half of the world's pork consumption), need to increase its imports from the US? Namely, an epidemic of African swine flu sweeping across Asia. It is now estimated that over one quarter of the world's pork supply could be lost to the epidemic, which is devastating Chinese farms. How interesting that China will now remove the stiff tariffs placed on US pork coming into the country.
On another Asian front, evidence is mounting that North Korea, which has claimed to be virtually "African swine flu-free," is also reeling from the disease. The Food and Agriculture Organization of the UN now project that 47.8% of North Koreans are suffering from malnutrition. The fact that North Korea has not officially acknowledged the epidemic is only compounding their dire economic predicament. Pork accounts for 80% of that country's protein consumption.
While the US does have one of the world's most skilled trade negotiators in Robert Lighthizer, the economic and geopolitical pressures mounting on China cannot be underestimated in the trade war. From Hong Kong to North Korea to African swine fever, the Chinese plans to hold out until the next US election—no doubt fueled by the whisperings of some US politicians—may be unraveling. And that is a good thing for America.
Headlines for the Week of 06 Oct 2019—12 Oct 2019
Global Strategy: Trade
President Trump: "We are very close to ending the trade war." After a terrible start to the trading week, it sure looked like we were heading for our fourth straight down week in the markets. A highly-successful two days of trade negotiations turned that narrative on its head, however, and the Dow rocketed up nearly 600 points over the course of two days on the news. It is a fascinating turn of events, considering comments from the Chinese side that the negotiating team sent to DC planned to leave after only one day, downplaying any chance for substantive progress. Instead, the week ended with President Trump, Vice Premiere Liu He, and both teams sitting in the Oval Office celebrating a substantial "Phase 1" deal. While chief trade negotiator Robert Lighthizer said the Huawei issue was put on hold, this deal includes intellectual property agreements, foreign exchange (FX) and financial services agreements, and a plan for the Chinese to buy between $40 billion and $50 billion worth of American agriculture products. Considering the $8 billion they are currently purchasing, or even the $16 billion they were purchasing before the trade wars began, that is enormous. The deal is expected to take about four to five weeks to hammer out on paper, but it will be ready to be signed by President Trump and President Xi Jinping in a ceremony at the Asia-Pacific Economic Cooperation Leaders' summit in Chile in mid-November. Despite breaking Trump's major trade deal up into two or three parts, the president made a very hopeful comment before Friday's Oval Office meeting: "Very close to ending trade war." The next major benchmark for progress will be whether or not the tariffs scheduled to go into place on 15 December will be removed. Those tariffs would hit a litany of consumer goods. Going into an election year, we can't imagine the president wanting to see pain inflicted on the American consumer just ten days before Christmas. Call us optimists, but we are now relatively confident that the trade war is entering its final leg. We are also relatively confident that the same could be said for Brexit. There is still time to be proven wrong on both counts, however.
Global Strategy: Europe
British pound has its biggest one-day rally since March on renewed hope of a Brexit deal. While the huge catalyst for the market's late-week rally was the successful trade talks in DC, investors also liked what they heard from Europe. The British pound jumped on Thursday after Prime Minister Boris Johnson and Irish leader Leo Varadkar announced that they "see a pathway to a deal" on Brexit. Considering the fact that border issues between Northern Ireland, which is part of Britain, and the Republic of Ireland, which will remain in the EU, have been the main issue with Brexit, this could be enormously-good news. Since Britain will leave the EU Customs Union, that bloc has been demanding a "hard" border separating one side of Ireland from the other; an idea unacceptable to nearly everyone. If that sticking point could be resolved, an orderly Brexit might just take place by the 31 October deadline. JP Morgan analysts were even rosier, saying, "This changes everything—we now expect a deal." D-Day is 17 October, when Johnson and his team will meet with EU leaders to try and negotiate a deal just two weeks before the deadline. One way or another, that should be a market-moving event. We still believe the UK will blow out of the EU this month, despite Parliament's claim that they can stop that action. The Labour Party, which desperately wants to regain power through a general election, would love to stop any deal in Brussels from taking place. Despite their wishes, party leader Jeremy Corbyn has little chance of winning in a new national election.
Media & Entertainment
How in the world does streaming device maker Roku have a sustainable growth model? Mention the name Roku (ROKU $26-$118-$177), and most people would immediately think of those little devices that plug into the side or back of a TV to allow for streaming. Considering those handy little devices just cost about $40, why in the world are shares of the company up 286% (yep, you read that right) year-to-date? Furthermore, just last month we reported on Pivotal Research's sell rating on the firm with an accompanying price target of $60—half of where it trades as of this writing. Then comes Macquarie's Outperform rating (see Trade Alerts & Analyst Rating Changes above) and $130 target price. Head spinning. These widely disparate viewpoints made us do a deeper dive into Roku's revenue stream, and growth drivers for the future.
There are two operating segments within Roku: Player and Platform. The Player segment consists of revenue generated from the sale of those little "sticks" mentioned above, as well as other media players and accessories. This segment is also responsible for working with TV manufacturers to allow the Roku Operating System (OS) to be preinstalled within the sets. This is a win/win, as the manufacturers do not need to create their own OS to make the TVs "smart." The Player segment accounts for roughly half of all revenues, but the real goal is to get as many people using the platform as possible, fueling the second segment.
The Platform segment is the side of the equation we have been missing in our cursory review of the firm. There are currently 27 million active Roku users, and Macquarie believes that figure will be 72 million worldwide by 2022. On that side, the company makes money in three different ways. Transaction video on demand (TVOD) involves channels on which the service takes a fee of 20% from the rental cost, with the rest going to the provider. Subscription video on demand (SVOD) involves Roku's cut when new subscribers sign up for a channel—like Hulu or HBO NOW—through its OS. Finally, and perhaps the most lucrative for the company down the road, is Advertising video on Demand (AVOD). Have you noticed how many "free" content comes with the baggage of ads you must endure? Companies are obviously paying for those ads, and that revenue goes directly to Roku. All of a sudden, Roku's business model makes a lot more sense. We still don't like the fact that the company has yet to turn a profit, but if it can keep gaining users at the rate Macquarie predicts, we should begin to see its losses abate. Keep in mind, however, that the stock is highly unpredictable: it has dropped from $176 to $118 in the matter of one month.
Specialty Retail
Bed Bath & Beyond spikes 21% on announcement of the company's new CEO. Granted, it doesn't take much to spike 21% when your shares are trading in the single digits, but investors clearly loved the choice of Target's (TGT) former executive VP and chief marketing officer to take the helm at struggling specialty retailer Bed Bath & Beyond (BBBY $7-$12-$20). When the post-close announcement was made that Mark Tritton would become the company's new president and CEO next month, shares of BBBY went from $9.95 to $12.05 in a matter of minutes. Indeed, Tritton led a number of successful initiatives at Target, which holds position #12 in the Penn Global Leaders Club, but does that automatically equate to success at Bed Bath & Beyond? We have long memories, like that of Apple (AAPL) wunderkind Ron Johnson coming to JC Penney (JCP) with great fanfare, only to run that company into the ground. (Sorry, Ron, a JCP store is not an Apple Genius Bar.) Or how about an arrogant John Sculley coming to Apple's rescue, firing Steve Jobs in the process. There is a lot of structural work to do at the former large-cap (now small-cap) retailer, which carried an $80 share price just four years ago. Tritton may be taking the yoke of a Cessna in a nosedive, just above sea level. There is no doubt, however, that new blood was needed at the top. We have traded BBBY a number of times in the past, but we don't see a clear path back to profitability for the firm. Which is exactly why activist investors forced out 16-year CEO Steven Temares earlier in the year. We wouldn't touch the company until we get a sense that Tritton has a dynamic strategy in the works.
Judicial Watch
Washington State wants to stop Montana from exporting coal via its shores; is that legal? This will be a great judicial battle to watch. The United States produced about 755 million short tons of coal last year. Of that amount, Montana produced 45 million tons, placing it at the number seven spot of coal-producing states. As coal has become a dirty word in this country, states have turned to big consumers in Asia to buy their supply and, subsequently, fund their coal infrastructure and workforce. To get the coal from the supplier to the buyer, landlocked states must, obviously, transport the coal to coastal states via primarily rail, and then via cargo ships to their destination. Now, Washington State has a message to Montana: we don't want your coal, and we won't even allow you to ship it from our ports. Our immediate thought was that this is simply illegal, as it clearly goes against the Commerce Clause in the United States Constitution, which gives the federal government the right to regulate commerce through the various states. Hence the lawsuit.
Lighthouse Resources, the company trying to build a coal export terminal on the Columbia River—on a site that already allows coal exports, we might add—has been told by Washington State that it will not be given permission to do so. Citing the Commerce Clause, Lighthouse sued Governor Jay Inslee and two state regulators for the seemingly-illegal action. Not surprisingly, a partisan state appeals court upheld the decision, as would (we have no doubt) the comical 9th Circuit Court of Appeals in San Francisco—the most overturned court in the land. Montana is not the first state to have issues with Washington State. Two coal companies in Wyoming went bankrupt after similar antics were pulled in 2017 due to the inability to freely move their supply to the buyers. Eight states, in fact, have filed an amicus brief on the grounds of economic discrimination by coastal states over those which are landlocked.
This is a fascinating and historical case to watch; one which has the flavor of the 1830s rather than the 21st century. We can almost imagine Andrew Jackson sending troops to the shores of the Columbia River to assure safe passage of the cargo to the North Pacific. In the end, we see the Supreme Court of the United States ruling, by a 5-4 or 6-3 decision, in favor of Lighthouse Resources and the landlocked states. In the meantime, how many more coal companies will go belly up? Washington State is hoping that number is large.
Global Trade
China's response to the NBA, South Park tweets exemplifies the great challenge in making deals with a communist state. Houston Rockets General Manager Daryl Morey had the audacity to tweet his support for democracy around the globe, to include within the special administrative region (SAR) of Hong Kong. The Communist Chinese backlash was swift; nearly as swift was the NBA's groveling apologies for his tweet. The Chinese Consulate-General in Houston tells this private American citizen to "correct the error." Morey deletes the tweet and apologizes, but now his position with the team is being challenged. Chinese companies have cut ties to the Houston Rockets, yanking any team products from their sites, and the government-controlled media outlets have yanked all NBA preseason games from the airwaves.
The creators of the long-running comedy South Park offered a tongue-in-cheek apology to the Communist Chinese for producing the episode "Band in China," which was quickly eradicated on the mainland. After Trey Parker and Matt Stone tweeted, "...we welcome the Chinese censors into our homes and into our hearts..," Beijing deleted all evidence that the show ever existed: clips, episodes, social media commentary, all scrubbed by the central government. Just how sensitive is this bunch? In 2017, Chinese authorities began banning images of Winnie the Pooh on social media after comparisons between the bear and Xi Jinping began popping up. Disney's "Christopher Robin" movie, featuring the cuddly bear, was also banned in the country.
These are just a few of a litany of examples of US entities getting censored and bullied by the Chinese, making one thing abundantly clear: trade deal or not, China is not going to transform from an iron-fisted communist country to a freedom-loving democracy, at least while Xi is alive. Look no further than Hong Kong for proof of that. Under British rule (and free enterprise), the region became the golden goose of Asia. Here again, China wants to loot, just not the freedoms which allowed the loot to be created. There are no easy answers, but caving to China to get a quick trade deal done is not a solution in any sane world.
The Communist Chinese are used to rolling the United States and other Western democracies in trade deals. Even if the details seem acceptable, the devil is in the accountability. And, by the time they are caught breaking the terms of the agreement, either through theft of intellectual property or unfair trade practices, the damage is done, the deal is sealed. That is not happening this time, and the Chinese don't like it. Ideally, the US should have a coalition of allied trading partners to take the Chinese on with a united front. Unfortunately, that ship has probably sailed.
Space Sciences & Exploration
With Virgin Galactic's IPO on the near horizon, Boeing takes a stake in the venture. Sir Richard Branson's space travel startup, Virgin Galactic, is scheduled to become a publicly-traded entity at some point in the fourth quarter, and Boeing (BA $292-$377-$446) wants in on the action. The world's largest aerospace company (double the size of Airbus) will use its venture arm, HorizonX, to buy a $20 million stake in the firm in exchange for an equal amount of shares after it opens for trading. Marketed as the first space tourism company, Galactic will offer rides to the edge of space in its six-passenger Unity spacecraft. The craft will liftoff from and land at Spaceport America, the company's FAA-licensed space operations center not far from Las Cruces, New Mexico. Over 600 customers have already signed up for the $250,000 flight. Branson's goal is to greatly reduce the cost of the trip as the journey becomes commonplace. Virgin Galactic currently has an enterprise value of around $1.5 billion. Investors will have an abundance of opportunities to invest in the commercial push into human spaceflight. While company's like SpaceX (privately held) and Virgin Galactic will take the headlines, there will be a plethora of small- and mid-cap support companies providing the hardware and services for these ventures. The key is to discover those firms before their names become well known.
Technology Hardware & Equipment
We are happy to admit being wrong about iPhone 11 demand. We own electronics device maker and services juggernaut Apple (AAPL $142-$228-$228) as position #18 (of 40) within the Penn Global Leaders Club. We have been, and remain, bullish on the $1 trillion firm's outlook. That being said, we didn't expect much from the company's launch of the iPhone 11, arguing that most users would hold off until a 5G-compatible device is released (probably) in the fall of 2020. What we didn't see happening was the company telling its massive supply chain to be prepared for an increase in production of the iPhone 11 by as much as 10%. We also didn't see the phone's new camera as being a catalyst for sales, but it is apparently that good. The phone's battery life, which has been a chronic source of past complaints, has also been greatly extended in the new model, and the $699 pricetag comes in $50 below the iPhone XR—the tenth-anniversary model that was met with a muted consumer response. Investors have welcomed news of the increased demand, driving Apple shares to a new high, and putting the firm back in the trillion-dollar club. We have expressed our concerns about Tim Cook relying too much on services revenue at the expense of hardware innovations. The iPhone 11 is sort of proving us wrong on that count as well. Now, let's see how well Apple can master the exciting world of 5G.
Automotive
If the UAW strike hasn't hurt GM, the US auto industry, and the unions already, it is just a matter of time. Talk about a bad time for a walkout. US automaker General Motors (GM $31-$34-$42) has been battling international competitors eating into the company's market share, sagging new auto sales, a global economic slowdown, a trade war, and a costly effort to develop electric and autonomous vehicles. As if Mary Barra's plate wasn't full enough, her management team is now dealing with a four-week-old, UAW-instigated strike by over 46,000 of its unionized workers. Shares of GM are already down over 10% since the strike began, and a senior union chief told reporters that the negotiations have taken a turn for the worst. Perhaps that is just chest-pounding, but the UAW is trying to send a message to Ford (F) and Fiat Chrysler (FCAU)—the next two targets for contract talks—that it won't be rolled over, despite the souring economic landscape. Consulting firm Anderson Economic Group estimates that GM's daily losses from the strike could rise from $10 million per day at the start, to as much as $90 million per day if it goes on much longer. Interestingly, the threat of tariffs being placed on foreign-made autos seems to have emboldened the union in its talks. GM will eventually make it through these negotiations relatively unscathed, but the automation of labor and the reality of global competition are two genies which will never be put back in the bottle. The UAW had better make the most of this walkout; the next one will see them in a weaker position.
Industrial Conglomerates
GE will freeze pensions for 20,000 salaried employees as it struggles to fix its broken retirement system. While companies have been migrating away from the defined benefit plan (think pensions) in favor of the defined contribution plan (think 401k) for decades, struggling industrial conglomerate General Electric (GE $7-$9-$14) still has a major legacy problem with the former. (See our story, Investing in Your Company Plan.) Over 600,000 workers, both current and retired, are covered by the company's pension plan, and GE is on the hook for about $100 billion in payments. Here's the problem: the company only has around $70 billion in assets set aside for the plan, meaning it is $30 billion underfunded. In an effort to reduce this gap, which brings with it increased government scrutiny, GE has announced it will freeze the pensions for 20,000 salaried workers. It will also offer lump-sum buyouts for retired employees who have yet to begin collecting on their pensions. The company hopes to narrow its $30 billion shortfall by about $6 billion with the new plan. GE closed its pension to new employees in 2012. The numbers just don't add up for GE, once the world's largest firm. It now has a market cap of just $75 billion, 25% less than its pension IOUs.
Media & Entertainment
Streaming wars update: Disney will ban Netflix ads from all channels except ESPN. With The Walt Disney Co (DIS $100-$130-$147) gearing up for the launch of its Disney+ streaming service next month, reports are swirling that the media giant will no longer allow Netflix (NFLX) ads to be aired on any of its TV networks except ESPN. That means you won't be seeing any ads for the top streaming service on ABC or Freform, two Disney-owned entities. In an effort to get ahead of the slew of new streaming services coming online soon, Netflix spent nearly $2 billion on advertising over the trailing twelve months. In a separate but related move, Disney CEO Bob Iger resigned from Apple's (AAPL) board of directors last month on the very day that Apple TV+ was announced. Disney+ will cost consumers $6.99 per month, while Apple low-balled the field with a $5 per month subscription fee for its new service, which is set to debut the 1st of November. Here's what we see happening: All three of these companies will own fat slices of the subscriber pie, while Comcast's (CMCSA) "Peacock" and AT&T's (T) HBO Max will struggle to gain traction. Considering AT&T's DirecTV problems, that company can ill-afford another major flop. While we own both Disney and Apple, we have steered clear of Netflix since the competition began flooding into the space. This past July, NFLX shares were selling for $386; they now sit at $273. While we own AT&T in the Strategic Income Portfolio (and it has performed well since added), we are placing it on the watch list due to its growing list of potential problems, to include a pending management shakeup.
President Trump: "We are very close to ending the trade war." After a terrible start to the trading week, it sure looked like we were heading for our fourth straight down week in the markets. A highly-successful two days of trade negotiations turned that narrative on its head, however, and the Dow rocketed up nearly 600 points over the course of two days on the news. It is a fascinating turn of events, considering comments from the Chinese side that the negotiating team sent to DC planned to leave after only one day, downplaying any chance for substantive progress. Instead, the week ended with President Trump, Vice Premiere Liu He, and both teams sitting in the Oval Office celebrating a substantial "Phase 1" deal. While chief trade negotiator Robert Lighthizer said the Huawei issue was put on hold, this deal includes intellectual property agreements, foreign exchange (FX) and financial services agreements, and a plan for the Chinese to buy between $40 billion and $50 billion worth of American agriculture products. Considering the $8 billion they are currently purchasing, or even the $16 billion they were purchasing before the trade wars began, that is enormous. The deal is expected to take about four to five weeks to hammer out on paper, but it will be ready to be signed by President Trump and President Xi Jinping in a ceremony at the Asia-Pacific Economic Cooperation Leaders' summit in Chile in mid-November. Despite breaking Trump's major trade deal up into two or three parts, the president made a very hopeful comment before Friday's Oval Office meeting: "Very close to ending trade war." The next major benchmark for progress will be whether or not the tariffs scheduled to go into place on 15 December will be removed. Those tariffs would hit a litany of consumer goods. Going into an election year, we can't imagine the president wanting to see pain inflicted on the American consumer just ten days before Christmas. Call us optimists, but we are now relatively confident that the trade war is entering its final leg. We are also relatively confident that the same could be said for Brexit. There is still time to be proven wrong on both counts, however.
Global Strategy: Europe
British pound has its biggest one-day rally since March on renewed hope of a Brexit deal. While the huge catalyst for the market's late-week rally was the successful trade talks in DC, investors also liked what they heard from Europe. The British pound jumped on Thursday after Prime Minister Boris Johnson and Irish leader Leo Varadkar announced that they "see a pathway to a deal" on Brexit. Considering the fact that border issues between Northern Ireland, which is part of Britain, and the Republic of Ireland, which will remain in the EU, have been the main issue with Brexit, this could be enormously-good news. Since Britain will leave the EU Customs Union, that bloc has been demanding a "hard" border separating one side of Ireland from the other; an idea unacceptable to nearly everyone. If that sticking point could be resolved, an orderly Brexit might just take place by the 31 October deadline. JP Morgan analysts were even rosier, saying, "This changes everything—we now expect a deal." D-Day is 17 October, when Johnson and his team will meet with EU leaders to try and negotiate a deal just two weeks before the deadline. One way or another, that should be a market-moving event. We still believe the UK will blow out of the EU this month, despite Parliament's claim that they can stop that action. The Labour Party, which desperately wants to regain power through a general election, would love to stop any deal in Brussels from taking place. Despite their wishes, party leader Jeremy Corbyn has little chance of winning in a new national election.
Media & Entertainment
How in the world does streaming device maker Roku have a sustainable growth model? Mention the name Roku (ROKU $26-$118-$177), and most people would immediately think of those little devices that plug into the side or back of a TV to allow for streaming. Considering those handy little devices just cost about $40, why in the world are shares of the company up 286% (yep, you read that right) year-to-date? Furthermore, just last month we reported on Pivotal Research's sell rating on the firm with an accompanying price target of $60—half of where it trades as of this writing. Then comes Macquarie's Outperform rating (see Trade Alerts & Analyst Rating Changes above) and $130 target price. Head spinning. These widely disparate viewpoints made us do a deeper dive into Roku's revenue stream, and growth drivers for the future.
There are two operating segments within Roku: Player and Platform. The Player segment consists of revenue generated from the sale of those little "sticks" mentioned above, as well as other media players and accessories. This segment is also responsible for working with TV manufacturers to allow the Roku Operating System (OS) to be preinstalled within the sets. This is a win/win, as the manufacturers do not need to create their own OS to make the TVs "smart." The Player segment accounts for roughly half of all revenues, but the real goal is to get as many people using the platform as possible, fueling the second segment.
The Platform segment is the side of the equation we have been missing in our cursory review of the firm. There are currently 27 million active Roku users, and Macquarie believes that figure will be 72 million worldwide by 2022. On that side, the company makes money in three different ways. Transaction video on demand (TVOD) involves channels on which the service takes a fee of 20% from the rental cost, with the rest going to the provider. Subscription video on demand (SVOD) involves Roku's cut when new subscribers sign up for a channel—like Hulu or HBO NOW—through its OS. Finally, and perhaps the most lucrative for the company down the road, is Advertising video on Demand (AVOD). Have you noticed how many "free" content comes with the baggage of ads you must endure? Companies are obviously paying for those ads, and that revenue goes directly to Roku. All of a sudden, Roku's business model makes a lot more sense. We still don't like the fact that the company has yet to turn a profit, but if it can keep gaining users at the rate Macquarie predicts, we should begin to see its losses abate. Keep in mind, however, that the stock is highly unpredictable: it has dropped from $176 to $118 in the matter of one month.
Specialty Retail
Bed Bath & Beyond spikes 21% on announcement of the company's new CEO. Granted, it doesn't take much to spike 21% when your shares are trading in the single digits, but investors clearly loved the choice of Target's (TGT) former executive VP and chief marketing officer to take the helm at struggling specialty retailer Bed Bath & Beyond (BBBY $7-$12-$20). When the post-close announcement was made that Mark Tritton would become the company's new president and CEO next month, shares of BBBY went from $9.95 to $12.05 in a matter of minutes. Indeed, Tritton led a number of successful initiatives at Target, which holds position #12 in the Penn Global Leaders Club, but does that automatically equate to success at Bed Bath & Beyond? We have long memories, like that of Apple (AAPL) wunderkind Ron Johnson coming to JC Penney (JCP) with great fanfare, only to run that company into the ground. (Sorry, Ron, a JCP store is not an Apple Genius Bar.) Or how about an arrogant John Sculley coming to Apple's rescue, firing Steve Jobs in the process. There is a lot of structural work to do at the former large-cap (now small-cap) retailer, which carried an $80 share price just four years ago. Tritton may be taking the yoke of a Cessna in a nosedive, just above sea level. There is no doubt, however, that new blood was needed at the top. We have traded BBBY a number of times in the past, but we don't see a clear path back to profitability for the firm. Which is exactly why activist investors forced out 16-year CEO Steven Temares earlier in the year. We wouldn't touch the company until we get a sense that Tritton has a dynamic strategy in the works.
Judicial Watch
Washington State wants to stop Montana from exporting coal via its shores; is that legal? This will be a great judicial battle to watch. The United States produced about 755 million short tons of coal last year. Of that amount, Montana produced 45 million tons, placing it at the number seven spot of coal-producing states. As coal has become a dirty word in this country, states have turned to big consumers in Asia to buy their supply and, subsequently, fund their coal infrastructure and workforce. To get the coal from the supplier to the buyer, landlocked states must, obviously, transport the coal to coastal states via primarily rail, and then via cargo ships to their destination. Now, Washington State has a message to Montana: we don't want your coal, and we won't even allow you to ship it from our ports. Our immediate thought was that this is simply illegal, as it clearly goes against the Commerce Clause in the United States Constitution, which gives the federal government the right to regulate commerce through the various states. Hence the lawsuit.
Lighthouse Resources, the company trying to build a coal export terminal on the Columbia River—on a site that already allows coal exports, we might add—has been told by Washington State that it will not be given permission to do so. Citing the Commerce Clause, Lighthouse sued Governor Jay Inslee and two state regulators for the seemingly-illegal action. Not surprisingly, a partisan state appeals court upheld the decision, as would (we have no doubt) the comical 9th Circuit Court of Appeals in San Francisco—the most overturned court in the land. Montana is not the first state to have issues with Washington State. Two coal companies in Wyoming went bankrupt after similar antics were pulled in 2017 due to the inability to freely move their supply to the buyers. Eight states, in fact, have filed an amicus brief on the grounds of economic discrimination by coastal states over those which are landlocked.
This is a fascinating and historical case to watch; one which has the flavor of the 1830s rather than the 21st century. We can almost imagine Andrew Jackson sending troops to the shores of the Columbia River to assure safe passage of the cargo to the North Pacific. In the end, we see the Supreme Court of the United States ruling, by a 5-4 or 6-3 decision, in favor of Lighthouse Resources and the landlocked states. In the meantime, how many more coal companies will go belly up? Washington State is hoping that number is large.
Global Trade
China's response to the NBA, South Park tweets exemplifies the great challenge in making deals with a communist state. Houston Rockets General Manager Daryl Morey had the audacity to tweet his support for democracy around the globe, to include within the special administrative region (SAR) of Hong Kong. The Communist Chinese backlash was swift; nearly as swift was the NBA's groveling apologies for his tweet. The Chinese Consulate-General in Houston tells this private American citizen to "correct the error." Morey deletes the tweet and apologizes, but now his position with the team is being challenged. Chinese companies have cut ties to the Houston Rockets, yanking any team products from their sites, and the government-controlled media outlets have yanked all NBA preseason games from the airwaves.
The creators of the long-running comedy South Park offered a tongue-in-cheek apology to the Communist Chinese for producing the episode "Band in China," which was quickly eradicated on the mainland. After Trey Parker and Matt Stone tweeted, "...we welcome the Chinese censors into our homes and into our hearts..," Beijing deleted all evidence that the show ever existed: clips, episodes, social media commentary, all scrubbed by the central government. Just how sensitive is this bunch? In 2017, Chinese authorities began banning images of Winnie the Pooh on social media after comparisons between the bear and Xi Jinping began popping up. Disney's "Christopher Robin" movie, featuring the cuddly bear, was also banned in the country.
These are just a few of a litany of examples of US entities getting censored and bullied by the Chinese, making one thing abundantly clear: trade deal or not, China is not going to transform from an iron-fisted communist country to a freedom-loving democracy, at least while Xi is alive. Look no further than Hong Kong for proof of that. Under British rule (and free enterprise), the region became the golden goose of Asia. Here again, China wants to loot, just not the freedoms which allowed the loot to be created. There are no easy answers, but caving to China to get a quick trade deal done is not a solution in any sane world.
The Communist Chinese are used to rolling the United States and other Western democracies in trade deals. Even if the details seem acceptable, the devil is in the accountability. And, by the time they are caught breaking the terms of the agreement, either through theft of intellectual property or unfair trade practices, the damage is done, the deal is sealed. That is not happening this time, and the Chinese don't like it. Ideally, the US should have a coalition of allied trading partners to take the Chinese on with a united front. Unfortunately, that ship has probably sailed.
Space Sciences & Exploration
With Virgin Galactic's IPO on the near horizon, Boeing takes a stake in the venture. Sir Richard Branson's space travel startup, Virgin Galactic, is scheduled to become a publicly-traded entity at some point in the fourth quarter, and Boeing (BA $292-$377-$446) wants in on the action. The world's largest aerospace company (double the size of Airbus) will use its venture arm, HorizonX, to buy a $20 million stake in the firm in exchange for an equal amount of shares after it opens for trading. Marketed as the first space tourism company, Galactic will offer rides to the edge of space in its six-passenger Unity spacecraft. The craft will liftoff from and land at Spaceport America, the company's FAA-licensed space operations center not far from Las Cruces, New Mexico. Over 600 customers have already signed up for the $250,000 flight. Branson's goal is to greatly reduce the cost of the trip as the journey becomes commonplace. Virgin Galactic currently has an enterprise value of around $1.5 billion. Investors will have an abundance of opportunities to invest in the commercial push into human spaceflight. While company's like SpaceX (privately held) and Virgin Galactic will take the headlines, there will be a plethora of small- and mid-cap support companies providing the hardware and services for these ventures. The key is to discover those firms before their names become well known.
Technology Hardware & Equipment
We are happy to admit being wrong about iPhone 11 demand. We own electronics device maker and services juggernaut Apple (AAPL $142-$228-$228) as position #18 (of 40) within the Penn Global Leaders Club. We have been, and remain, bullish on the $1 trillion firm's outlook. That being said, we didn't expect much from the company's launch of the iPhone 11, arguing that most users would hold off until a 5G-compatible device is released (probably) in the fall of 2020. What we didn't see happening was the company telling its massive supply chain to be prepared for an increase in production of the iPhone 11 by as much as 10%. We also didn't see the phone's new camera as being a catalyst for sales, but it is apparently that good. The phone's battery life, which has been a chronic source of past complaints, has also been greatly extended in the new model, and the $699 pricetag comes in $50 below the iPhone XR—the tenth-anniversary model that was met with a muted consumer response. Investors have welcomed news of the increased demand, driving Apple shares to a new high, and putting the firm back in the trillion-dollar club. We have expressed our concerns about Tim Cook relying too much on services revenue at the expense of hardware innovations. The iPhone 11 is sort of proving us wrong on that count as well. Now, let's see how well Apple can master the exciting world of 5G.
Automotive
If the UAW strike hasn't hurt GM, the US auto industry, and the unions already, it is just a matter of time. Talk about a bad time for a walkout. US automaker General Motors (GM $31-$34-$42) has been battling international competitors eating into the company's market share, sagging new auto sales, a global economic slowdown, a trade war, and a costly effort to develop electric and autonomous vehicles. As if Mary Barra's plate wasn't full enough, her management team is now dealing with a four-week-old, UAW-instigated strike by over 46,000 of its unionized workers. Shares of GM are already down over 10% since the strike began, and a senior union chief told reporters that the negotiations have taken a turn for the worst. Perhaps that is just chest-pounding, but the UAW is trying to send a message to Ford (F) and Fiat Chrysler (FCAU)—the next two targets for contract talks—that it won't be rolled over, despite the souring economic landscape. Consulting firm Anderson Economic Group estimates that GM's daily losses from the strike could rise from $10 million per day at the start, to as much as $90 million per day if it goes on much longer. Interestingly, the threat of tariffs being placed on foreign-made autos seems to have emboldened the union in its talks. GM will eventually make it through these negotiations relatively unscathed, but the automation of labor and the reality of global competition are two genies which will never be put back in the bottle. The UAW had better make the most of this walkout; the next one will see them in a weaker position.
Industrial Conglomerates
GE will freeze pensions for 20,000 salaried employees as it struggles to fix its broken retirement system. While companies have been migrating away from the defined benefit plan (think pensions) in favor of the defined contribution plan (think 401k) for decades, struggling industrial conglomerate General Electric (GE $7-$9-$14) still has a major legacy problem with the former. (See our story, Investing in Your Company Plan.) Over 600,000 workers, both current and retired, are covered by the company's pension plan, and GE is on the hook for about $100 billion in payments. Here's the problem: the company only has around $70 billion in assets set aside for the plan, meaning it is $30 billion underfunded. In an effort to reduce this gap, which brings with it increased government scrutiny, GE has announced it will freeze the pensions for 20,000 salaried workers. It will also offer lump-sum buyouts for retired employees who have yet to begin collecting on their pensions. The company hopes to narrow its $30 billion shortfall by about $6 billion with the new plan. GE closed its pension to new employees in 2012. The numbers just don't add up for GE, once the world's largest firm. It now has a market cap of just $75 billion, 25% less than its pension IOUs.
Media & Entertainment
Streaming wars update: Disney will ban Netflix ads from all channels except ESPN. With The Walt Disney Co (DIS $100-$130-$147) gearing up for the launch of its Disney+ streaming service next month, reports are swirling that the media giant will no longer allow Netflix (NFLX) ads to be aired on any of its TV networks except ESPN. That means you won't be seeing any ads for the top streaming service on ABC or Freform, two Disney-owned entities. In an effort to get ahead of the slew of new streaming services coming online soon, Netflix spent nearly $2 billion on advertising over the trailing twelve months. In a separate but related move, Disney CEO Bob Iger resigned from Apple's (AAPL) board of directors last month on the very day that Apple TV+ was announced. Disney+ will cost consumers $6.99 per month, while Apple low-balled the field with a $5 per month subscription fee for its new service, which is set to debut the 1st of November. Here's what we see happening: All three of these companies will own fat slices of the subscriber pie, while Comcast's (CMCSA) "Peacock" and AT&T's (T) HBO Max will struggle to gain traction. Considering AT&T's DirecTV problems, that company can ill-afford another major flop. While we own both Disney and Apple, we have steered clear of Netflix since the competition began flooding into the space. This past July, NFLX shares were selling for $386; they now sit at $273. While we own AT&T in the Strategic Income Portfolio (and it has performed well since added), we are placing it on the watch list due to its growing list of potential problems, to include a pending management shakeup.
Headlines for the Week of 29 Sep 2019—05 Oct 2019
Economics: Work & Pay
Markets celebrate a solid jobs report for September in the wake of pretty lousy ISM data. It is always fun to watch the immediate market reaction to economic reports as they roll in. This morning, all eyes were on the September jobs growth number and the new unemployment rate. Following the foreboding ISM figures released Wednesday and Thursday, one could hear a huge sigh of relief from the markets as the jobs numbers came in just about perfect. There were 136,000 new jobs created in September, with 85% of those positions coming from the private sector. The unemployment rate dropped to 3.5%, which is the lowest rate since 1969. It is hard to imagine a more perfectly-balanced set of results, which is why the markets moved from negative to up a couple of hundred points in short order. The numbers for August were also revised up, from 130,000 to 168,000 new jobs created. Why was this report so good? It struck the perfect balance between economic growth and not so much economic growth that the Fed wouldn't cut rates again this month. In fact, average hourly wages remained unchanged, which would only help the argument for another cut. Both black and Hispanic unemployment rates dropped to their lowest rates ever recorded. We are not out of the woods yet, but the September jobs report was a welcome respite. If we can make it through the next four weeks we move into the best six-month period for the markets, at least historically.
Global Trade
After the World Trade Organization hands the US a win, more tariffs scheduled to be slapped on European goods. The WTO confirmed what the world has known for decades: the European Union has been illegally funneling government subsidies to Boeing (BA) competitor Airbus (EADSY $22-$31-$37). While the world may have already known it, the ruling physically authorizes the US to slap $7.5 billion in sanctions on the EU. As one could imagine in this climate, it didn't take long for the US to announce a 10% penalty on on Airbus-made aircraft and a 25% penalty on other products, such as French cheeses and Irish whiskies. For their part, Boeing wanted a 100% tariff slapped on aircraft coming from Europe, which would have been fully authorized by the WTO ruling. While the new tariffs are scheduled for implementation on the 18th of October, it should be noted that US and EU trade representatives are scheduled to meet four days ahead of this deadline, so there is a chance—albeit a slim one—that the two sides can work an agreement. Interestingly, the WTO will rule on an EU complaint regarding the US government's (alleged) special treatment of Boeing within the next several months, which could provide them with a tool to hit back at US tariffs. A deal should be hammered out with the EU immediately; but, then again, we are still waiting for the USMCA to be brought to the floor of the US House of Representatives for a vote, and that deal was signed by the leaders of the respective countries a year ago.
Real Estate Management & Development
Airbnb will probably go the direct listing route, and we think that makes great sense for the company. In the last Penn...After Hours report, we asked the question, "what percentage of IPOs going public in 2019 are profitable?" The answer was not pretty. It won't be going public this year, but we can sure point to a company coming to the market in 2020 that is quite profitable: Airbnb. The online property rental marketplace has truly infused life into a tired industry, and it has plenty of room to grow. More importantly, from an investment standpoint anyway, the company has been profitable since 2017. That fact certainly sets it apart from the WeWorks of the world. Now we hear that the company is leaning toward doing something WeWork would never be able to pull off—taking the direct listing route to the public markets over the traditional dog-and-pony IPO roadshow. We love that idea. When we defined the direct listing on our Financial Terms & Concepts page, we made this comment: "Our favorite aspect of a DPO (direct public offering) lies in the fact that a small, select group of 'elite' clients of the big brokerage houses can't get their hands on the shares before the rest of the investing public." For companies built on smoke and mirrors, the DPO equates to a cross being shown to Dracula. These companies need the roadshow so Goldman Sachs sales reps can create the illusion of a tasty yolk inside of that cracked egg. You know, like "WeWork is a technology company...which fosters human connection through collaboration and holistically supports members both personally and professionally." Gag. Just don't try to bring meat to the joint if you are an employee, that is verboten. But we digress. Certainly, there are still a lot of unknowns lurking in the books of a private company, but we don't expect any nasty surprises in the case of Airbnb. And the direct listing rumors make us even more comfortable with that view. Our one IPO to buy in 2019 has been Beyond Meat (BYND), which was certainly a winner. Palantir is the next one we expect to buy on day one. After that, Airbnb.
Automotive
Ford, General Motors slide on Q3 earnings data. For General Motors (GM $31-$35-$42), which is in the midst of dealing with a UAW-fomented strike, the news wasn't good. Against expectations for a 7.8% jump in sales from Q3 of 2018, the automaker had an increase of just 6.3%. That miss was enough to drive shares of the company down 4% within minutes. But GM's earnings report looks glowing next to that of rival Ford's (F $7-$9-$11), as that company saw sales fall 4.9% from the same quarter last year. Perhaps because shares of Ford had already been beaten down, at least compared to GM, that company's stock also fell 4%. The day before these two automakers reported, The Wall Street Journal ran an extensive article on how the US middle class is being priced out of their vehicles, with just 18% of car buyers able to pay cash for the purchase. The other 82% are forced to resort to financing, and the seven-year auto loan is becoming commonplace. Adding to the downward pressure on the typical family's budget, the average monthly cost of financing a vehicle is around $550. Considering how low interest rates currently sit, that spells big trouble going forward. Furthermore, the average duration for existing auto loans is 69 months, meaning most won't even be paid off by the time the owner is searching for a new one. Most auto loans are packaged, bundled, and offloaded to investors. Does that sound familiar? Granted, the $1.3 trillion in outstanding auto loan debt is nothing compared to the housing loan crisis that caused the 2008 financial meltdown, but it is something to pay close attention to—especially if we go into a recession. Auto loan delinquencies also turned the corner and began rising in the third quarter of 2014. Is anyone paying attention to the warning signs? We don't own any automakers within any of the five Penn strategies, but we do own a couple of used car retailers. A record 41 million used vehicles will probably be sold in 2019, and we expect this trend to continue as more and more Americans are priced out of the new car market.
Economics: Goods & Services
Markets tank on US manufacturing data. The markets have been looking for an excuse for a brief pullback, and a key economic report on Wednesday gave them the one they needed. The Institute for Supply Management's Manufacturing PMI takes the pulse of the country's manufacturing activity, with any number above 50 representing growth, and any number below 50 representing a contraction. September's report came in with a 47.80 reading, down from a 49.10 reading in August, and a 51.20 in July. As the graph indicates, we peaked in August of last year, with a robust 61.30 figure, but the chart has been on a downward slope since. Economists point to the historical record which shows an average ISM manufacturing reading of 44 leading into a recession, and an average of 43 once in a recession. So, the question becomes this: will this ISM measurement fall another five points or so? There's another factor which offers some hope, however. While the US was once overwhelmingly reliant on the manufacturing base, we have become a predominantly services-based economy. In fact, the GDP of the US is now roughly 80/20, with the 80% being services. The ISM Non-Manufacturing PMI had a healthy 56.40 reading in August, which was up a full five points from the previous month. The other issue revolves around the trade dispute. If a deal can be cobbled together anytime soon, expect our manufacturing activity to pick back up. Despite the contraction represented in the ISM report, we do not believe the US is headed for a recession within the next twelve months. With an election thirteen months away, however, you can bet that volatility will be our ever-present companion.
Retail REITs
Simon Property Group's plan to battle online competition? Start an online site. Simon Property Group (SPG $145-$150-$191), the largest retail REIT and the second-largest REIT in the country, has joined forces with online shopping site Rue La La to create a new experience for shoppers built around its premium outlet malls. ShopPremiumOutlets.com is an effort to team up with mall tenants to sell their goods online, typically at the same deep discount found in their brick-and-mortar stores. Simon has already convinced such brands as Under Armour (UA), Nautica, Saks, and Aeropostale to join the venture, and the site already offers around 300,000 products. Simon will contribute $280 million to the project and plans an ongoing marketing strategy to raise awareness of the site. For what it's worth, the company said it does not believe the new online experience will reduce foot traffic at its outlet malls. This is simply a smart move, and one which needed to be done to remain relevant. Simon, which owns mostly Class A malls, has a P/E ratio of 20 and a dividend yield of 5.5%. At $150, the shares look discounted.
Management & Development
The WeWork story continues to unravel, and New York City is on the hook. Anyone who has read our writings on WeWork (We Co.) knows that we have been dubious of the firm from the start. Actually, that is being kind: the more we delved into founder Adam Neumann, the more we thought "flim-flam man." Why didn't Masayoshi Son of SoftBank see through his thin veneer before plowing $10 billion into the real estate leasing startup? Is Neumann really that charismatic when he is putting the pinch on someone?
Reminiscent of when WorldCom got their bid to buy Sprint (S) shot down by the US Department of Justice, We Company's day of reckoning may have been hastened by one big event—the botched IPO attempt in this case. And this failure may end up doing some harm to New York City in the process. As for the IPO, the company formally withdrew its prospectus on Monday. The problem—at least for We—is that it sorely needed the funds it would have received from the IPO to help staunch its massive losses.
Let's use the company's 88 University Place building as a case study. The firm bought the New York office property with fashion designer Elie Tahari in 2015 for $70 million. It subsequently took out a $78 million loan against the property. In an effort to raise capital, We is trying to sell the building for $110 million. Assuming it gets that amount, it would still be $38 million in the hole on the deal.
Supplanting JP Morgan, We is now New York City's largest tenant, with seven million square feet of office space. Considering the company lost $1.9 billion in 2018 and is on pace to beat that mark this year, what happens to the city's commercial real estate market if WeWork simply ceases to be? Certainly, the tenants subleasing that space would still be there, but this palpable fear of something bad happening explains why very few New York City landlords are willing to lease to WeWork right now. The company's rapid growth may suddenly turn into a rapid contraction.
Until relatively recently, WeWork seemed to be the IPO investors couldn't wait to get a piece of. This story highlights the importance of understanding not only what a company does before making an investment, but also looking into the finances as much as possible, and certainly doing some background checks on upper management. Either of those actions would have gone a long way in dissuading would-be investors.
Judicial Watch
Federal judge in New York throws out states' lawsuit over SALT deductions. One of the more interesting components of the Tax Cuts and Jobs Act of 2017 was the $10,000 limit on state and local income tax deductions. In other words, wealthy individuals, primarily residing in states like New York and New Jersey, could only "write off" their first $10,000 of taxes paid each year to their state and local governments. Think of it this way: by having confiscatory state tax rates in place (hello, New York), citizens were forced to pay exorbitant amounts of money for the privilege of living in their respective state. The state governments told them, in essence, "hey, at least you can deduct everything you paid us on your federal tax returns!" The 2017 massive tax overhaul changed all of that, limiting the amount that could be claimed to $10,000 each year. High tax states went ballistic, suing the IRS and Treasury Secretary Steven Mnuchin. This week, that lawsuit ended with a thud. A federal judge in New York, of all places, threw out the case, claiming that the states failed to show that the limitation was unconstitutional (a truly lame argument by the states). Perhaps more citizens of these states will begin fighting outrageously-high state and local tax rates, or simply move to states with lower tax rates. The latter has already begun to manifest. God bless the American experiment, which had the audacity to take control away from a central government and place it in the hands of the individual states, which must then reckon their actions with their own residents. When studying the tactics of politicians, always view their comments and actions through this prism: Are they doing what they are doing to empower the central government, or to place more power at the lowest possible level—the level closest to the people?
Markets celebrate a solid jobs report for September in the wake of pretty lousy ISM data. It is always fun to watch the immediate market reaction to economic reports as they roll in. This morning, all eyes were on the September jobs growth number and the new unemployment rate. Following the foreboding ISM figures released Wednesday and Thursday, one could hear a huge sigh of relief from the markets as the jobs numbers came in just about perfect. There were 136,000 new jobs created in September, with 85% of those positions coming from the private sector. The unemployment rate dropped to 3.5%, which is the lowest rate since 1969. It is hard to imagine a more perfectly-balanced set of results, which is why the markets moved from negative to up a couple of hundred points in short order. The numbers for August were also revised up, from 130,000 to 168,000 new jobs created. Why was this report so good? It struck the perfect balance between economic growth and not so much economic growth that the Fed wouldn't cut rates again this month. In fact, average hourly wages remained unchanged, which would only help the argument for another cut. Both black and Hispanic unemployment rates dropped to their lowest rates ever recorded. We are not out of the woods yet, but the September jobs report was a welcome respite. If we can make it through the next four weeks we move into the best six-month period for the markets, at least historically.
Global Trade
After the World Trade Organization hands the US a win, more tariffs scheduled to be slapped on European goods. The WTO confirmed what the world has known for decades: the European Union has been illegally funneling government subsidies to Boeing (BA) competitor Airbus (EADSY $22-$31-$37). While the world may have already known it, the ruling physically authorizes the US to slap $7.5 billion in sanctions on the EU. As one could imagine in this climate, it didn't take long for the US to announce a 10% penalty on on Airbus-made aircraft and a 25% penalty on other products, such as French cheeses and Irish whiskies. For their part, Boeing wanted a 100% tariff slapped on aircraft coming from Europe, which would have been fully authorized by the WTO ruling. While the new tariffs are scheduled for implementation on the 18th of October, it should be noted that US and EU trade representatives are scheduled to meet four days ahead of this deadline, so there is a chance—albeit a slim one—that the two sides can work an agreement. Interestingly, the WTO will rule on an EU complaint regarding the US government's (alleged) special treatment of Boeing within the next several months, which could provide them with a tool to hit back at US tariffs. A deal should be hammered out with the EU immediately; but, then again, we are still waiting for the USMCA to be brought to the floor of the US House of Representatives for a vote, and that deal was signed by the leaders of the respective countries a year ago.
Real Estate Management & Development
Airbnb will probably go the direct listing route, and we think that makes great sense for the company. In the last Penn...After Hours report, we asked the question, "what percentage of IPOs going public in 2019 are profitable?" The answer was not pretty. It won't be going public this year, but we can sure point to a company coming to the market in 2020 that is quite profitable: Airbnb. The online property rental marketplace has truly infused life into a tired industry, and it has plenty of room to grow. More importantly, from an investment standpoint anyway, the company has been profitable since 2017. That fact certainly sets it apart from the WeWorks of the world. Now we hear that the company is leaning toward doing something WeWork would never be able to pull off—taking the direct listing route to the public markets over the traditional dog-and-pony IPO roadshow. We love that idea. When we defined the direct listing on our Financial Terms & Concepts page, we made this comment: "Our favorite aspect of a DPO (direct public offering) lies in the fact that a small, select group of 'elite' clients of the big brokerage houses can't get their hands on the shares before the rest of the investing public." For companies built on smoke and mirrors, the DPO equates to a cross being shown to Dracula. These companies need the roadshow so Goldman Sachs sales reps can create the illusion of a tasty yolk inside of that cracked egg. You know, like "WeWork is a technology company...which fosters human connection through collaboration and holistically supports members both personally and professionally." Gag. Just don't try to bring meat to the joint if you are an employee, that is verboten. But we digress. Certainly, there are still a lot of unknowns lurking in the books of a private company, but we don't expect any nasty surprises in the case of Airbnb. And the direct listing rumors make us even more comfortable with that view. Our one IPO to buy in 2019 has been Beyond Meat (BYND), which was certainly a winner. Palantir is the next one we expect to buy on day one. After that, Airbnb.
Automotive
Ford, General Motors slide on Q3 earnings data. For General Motors (GM $31-$35-$42), which is in the midst of dealing with a UAW-fomented strike, the news wasn't good. Against expectations for a 7.8% jump in sales from Q3 of 2018, the automaker had an increase of just 6.3%. That miss was enough to drive shares of the company down 4% within minutes. But GM's earnings report looks glowing next to that of rival Ford's (F $7-$9-$11), as that company saw sales fall 4.9% from the same quarter last year. Perhaps because shares of Ford had already been beaten down, at least compared to GM, that company's stock also fell 4%. The day before these two automakers reported, The Wall Street Journal ran an extensive article on how the US middle class is being priced out of their vehicles, with just 18% of car buyers able to pay cash for the purchase. The other 82% are forced to resort to financing, and the seven-year auto loan is becoming commonplace. Adding to the downward pressure on the typical family's budget, the average monthly cost of financing a vehicle is around $550. Considering how low interest rates currently sit, that spells big trouble going forward. Furthermore, the average duration for existing auto loans is 69 months, meaning most won't even be paid off by the time the owner is searching for a new one. Most auto loans are packaged, bundled, and offloaded to investors. Does that sound familiar? Granted, the $1.3 trillion in outstanding auto loan debt is nothing compared to the housing loan crisis that caused the 2008 financial meltdown, but it is something to pay close attention to—especially if we go into a recession. Auto loan delinquencies also turned the corner and began rising in the third quarter of 2014. Is anyone paying attention to the warning signs? We don't own any automakers within any of the five Penn strategies, but we do own a couple of used car retailers. A record 41 million used vehicles will probably be sold in 2019, and we expect this trend to continue as more and more Americans are priced out of the new car market.
Economics: Goods & Services
Markets tank on US manufacturing data. The markets have been looking for an excuse for a brief pullback, and a key economic report on Wednesday gave them the one they needed. The Institute for Supply Management's Manufacturing PMI takes the pulse of the country's manufacturing activity, with any number above 50 representing growth, and any number below 50 representing a contraction. September's report came in with a 47.80 reading, down from a 49.10 reading in August, and a 51.20 in July. As the graph indicates, we peaked in August of last year, with a robust 61.30 figure, but the chart has been on a downward slope since. Economists point to the historical record which shows an average ISM manufacturing reading of 44 leading into a recession, and an average of 43 once in a recession. So, the question becomes this: will this ISM measurement fall another five points or so? There's another factor which offers some hope, however. While the US was once overwhelmingly reliant on the manufacturing base, we have become a predominantly services-based economy. In fact, the GDP of the US is now roughly 80/20, with the 80% being services. The ISM Non-Manufacturing PMI had a healthy 56.40 reading in August, which was up a full five points from the previous month. The other issue revolves around the trade dispute. If a deal can be cobbled together anytime soon, expect our manufacturing activity to pick back up. Despite the contraction represented in the ISM report, we do not believe the US is headed for a recession within the next twelve months. With an election thirteen months away, however, you can bet that volatility will be our ever-present companion.
Retail REITs
Simon Property Group's plan to battle online competition? Start an online site. Simon Property Group (SPG $145-$150-$191), the largest retail REIT and the second-largest REIT in the country, has joined forces with online shopping site Rue La La to create a new experience for shoppers built around its premium outlet malls. ShopPremiumOutlets.com is an effort to team up with mall tenants to sell their goods online, typically at the same deep discount found in their brick-and-mortar stores. Simon has already convinced such brands as Under Armour (UA), Nautica, Saks, and Aeropostale to join the venture, and the site already offers around 300,000 products. Simon will contribute $280 million to the project and plans an ongoing marketing strategy to raise awareness of the site. For what it's worth, the company said it does not believe the new online experience will reduce foot traffic at its outlet malls. This is simply a smart move, and one which needed to be done to remain relevant. Simon, which owns mostly Class A malls, has a P/E ratio of 20 and a dividend yield of 5.5%. At $150, the shares look discounted.
Management & Development
The WeWork story continues to unravel, and New York City is on the hook. Anyone who has read our writings on WeWork (We Co.) knows that we have been dubious of the firm from the start. Actually, that is being kind: the more we delved into founder Adam Neumann, the more we thought "flim-flam man." Why didn't Masayoshi Son of SoftBank see through his thin veneer before plowing $10 billion into the real estate leasing startup? Is Neumann really that charismatic when he is putting the pinch on someone?
Reminiscent of when WorldCom got their bid to buy Sprint (S) shot down by the US Department of Justice, We Company's day of reckoning may have been hastened by one big event—the botched IPO attempt in this case. And this failure may end up doing some harm to New York City in the process. As for the IPO, the company formally withdrew its prospectus on Monday. The problem—at least for We—is that it sorely needed the funds it would have received from the IPO to help staunch its massive losses.
Let's use the company's 88 University Place building as a case study. The firm bought the New York office property with fashion designer Elie Tahari in 2015 for $70 million. It subsequently took out a $78 million loan against the property. In an effort to raise capital, We is trying to sell the building for $110 million. Assuming it gets that amount, it would still be $38 million in the hole on the deal.
Supplanting JP Morgan, We is now New York City's largest tenant, with seven million square feet of office space. Considering the company lost $1.9 billion in 2018 and is on pace to beat that mark this year, what happens to the city's commercial real estate market if WeWork simply ceases to be? Certainly, the tenants subleasing that space would still be there, but this palpable fear of something bad happening explains why very few New York City landlords are willing to lease to WeWork right now. The company's rapid growth may suddenly turn into a rapid contraction.
Until relatively recently, WeWork seemed to be the IPO investors couldn't wait to get a piece of. This story highlights the importance of understanding not only what a company does before making an investment, but also looking into the finances as much as possible, and certainly doing some background checks on upper management. Either of those actions would have gone a long way in dissuading would-be investors.
Judicial Watch
Federal judge in New York throws out states' lawsuit over SALT deductions. One of the more interesting components of the Tax Cuts and Jobs Act of 2017 was the $10,000 limit on state and local income tax deductions. In other words, wealthy individuals, primarily residing in states like New York and New Jersey, could only "write off" their first $10,000 of taxes paid each year to their state and local governments. Think of it this way: by having confiscatory state tax rates in place (hello, New York), citizens were forced to pay exorbitant amounts of money for the privilege of living in their respective state. The state governments told them, in essence, "hey, at least you can deduct everything you paid us on your federal tax returns!" The 2017 massive tax overhaul changed all of that, limiting the amount that could be claimed to $10,000 each year. High tax states went ballistic, suing the IRS and Treasury Secretary Steven Mnuchin. This week, that lawsuit ended with a thud. A federal judge in New York, of all places, threw out the case, claiming that the states failed to show that the limitation was unconstitutional (a truly lame argument by the states). Perhaps more citizens of these states will begin fighting outrageously-high state and local tax rates, or simply move to states with lower tax rates. The latter has already begun to manifest. God bless the American experiment, which had the audacity to take control away from a central government and place it in the hands of the individual states, which must then reckon their actions with their own residents. When studying the tactics of politicians, always view their comments and actions through this prism: Are they doing what they are doing to empower the central government, or to place more power at the lowest possible level—the level closest to the people?
Headlines for the Week of 22 Sep 2019—28 Sep 2019
Global Exchanges & Indexes
Endeavor yanks its IPO just a day before going public after watching Peloton struggle and others flop. The ugly opening-day response of investors to companies fresh out of the IPO gate has claimed its first victim: just a day before it was slated to go public, global entertainment (think Hollywood talent agency owner) company Endeavor Group Holdings pulled its listing from the New York Stock Exchange. Goldman Sachs (GS) was the lead underwriter of the firm started by—among others—Rahm Emanuel's brother, Ari, which was to begin trading Friday under the symbol "EDR." As recently as last week, the company hoped to price in the range of $30-$32 per share, but that range abruptly fell to $26-$29 this week. The company was hoping to raise more than $600 million in net proceeds from the offering, but after that was shaved down closer to $350 million, the deal was shelved. While they can certainly give it another go down the road, this is not a good sign for the likes of The We Company (WeWork), which just ditched its CEO in an effort to salvage its own listing. It used to be a given that a company was expected to be turning a profit before it was brought to the public market. How much has that tenet been turned on its head? It is estimated that 80% of all companies brought public over the past twelve months have been firms which had yet to turn a profit.
Leisure Equipment & Products
Peloton shares are a bargain—at some price point. In the wild and frenetic arena of 2019 IPOs, there have been some companies we had to own on the first day of trading, some we wouldn't touch at any price, and a few we just weren't sure of. Connected fitness equipment company Peloton Interactive (PTON $25-$26-$28) fell under that last category, the one with a question mark.
We believe that, despite the perennial net losses, the company will be a success, taking out long-established fitness equipment makers along the way, but that belief didn't warrant a purchase on IPO day. In fact, PTON shares ended their first day down just over 11%, closing at $25.76. That puts the company's valuation around $7 billion, which still seems about 25-30% high to us. Supporting that argument, the company was valued at just over $4 billion last year in the private market.
Why do we believe the company will be a success? More than just a maker of treadmills and stationary bikes, Peloton has created a fitness platform that people want to be a part of, and they join the club by purchasing the high-priced equipment (current revenue) and becoming monthly, paying members (recurring income stream). Peloton currently has 1.4 million members, all of whom have access to thousands of hours of live and on-demand classes that can be taken anywhere and at anytime. For those not ready to shell out the $2,000 for the bike or $4,000 for the treadmill (0%, monthly-pay financing available), the digital membership comes with an app allowing users to workout with their own equipment.
There will be plenty of perma-bears out there, naysaying analysts who will recommend shorting the stock with each new financial metric released, but we see enormous growth potential for the company, both domestically and around the world. Controlling virtually all aspects of the process from manufacturing to sales to video production of the classes, Peloton has an enviable vertical integration that others won't easily replicate. New production facilities are currently being built in the UK and Germany, and new studios are coming to New York and London this year. While a lot of fitness companies will come and go, Peloton is the real deal. The only thing we are unsure of is when they will generate positive earnings per share.
If we had to pick a price at which PTON shares would look attractive, it would probably be just under $20, or $6 below the company's opening-day close.
Food Products
Our early prediction on Beyond Meat may be coming to fruition. Within five minutes of its IPO debut, we owned shares of plant-based meat products company Beyond Meat (BYND $45-$154-$240) for our clients, and we added it to the Penn New Frontier Fund. One of our earliest predictions for the company was that, before 2019 was in the books, they would land a huge contract with the world's strongest fast-food chain, McDonald's (MCD). While not a full-blown rollout, the $161 billion restaurant has announced that it will, indeed, begin testing the PLT (plant, lettuce, and tomato) at 28 of its locations throughout Ontario. The PLT is a Beyond Meat burger specially crafted for McDonald's. While BYND shares spiked $16 on the news, analysts still question whether or not the company will ultimately win a big US contract from Steve Easterbrook's company. We don't. They will. Of course there are competitors to Beyond Meat, and certainly more will enter the fray. However, we believe the company's head-start, organizational structure (including supply chain management), and exemplary management will make it the benchmark for this exciting and growing industry for years to come.
Global Strategy: Europe
At the risk of sounding like a broken record, Europe's economy is in the tank. It seems as though we are discussing the dour state of the European economy on a weekly basis, but that is only because the stream of bad news from the region continues unabated. Take Germany's PMI (purchasing managers' index) survey, which just rolled in for September. As the name implies, this economic indicator gauges the level of activity of purchasing managers at businesses that make up any given sector. Any number above 50 reflects growth, while any reading below 50 signals contraction. Germany's PMI for the manufacturing sector dropped from an anemic 43.5 in August to a disconcerting 41.4 in September, its lowest level in over a decade. In a written statement, the Bundesbank (Germany's central bank) acknowledged that the country is probably already in a recession. Throughout the eurozone, the composite PMI fell nearly two points, to 50.4—on the razor's edge of contraction. For all intents and purposes, Germany currently has no leader. Angela Merkel, once the de facto head of the EU, is in lame duck status, with no dynamic figures emerging. The country's only answer appears to be dropping interest rates even further below zero. This is simply not a sound strategy, and we are not sure what miraculous event will put the economy back on the right trajectory. Furthermore, even if such an event does manifest, how steep of a trajectory will be needed to soak up all of the liquidity created by the Bundesbank and the Bundestag? Steer clear.
Media & Entertainment
Roku falls nearly 20% in one day after scathing analyst call. It would take more than one hand to count the number of times we questioned not owning streaming device-maker Roku (ROKU $26-$108-$177) in any of our strategies following double-digit pops in its share price. Last Friday was not one of those days. Shares of Roku fell nearly 20% after Pivotal Research initiated coverage on the $12 billion company with a Sell rating and a $60/share target price—a 45% downside from where it now trades. The analyst makes the argument that, with all the new entrants, similar streaming devices or capabilities will be offered free to customers. Comcast (CMCSA), for example, will give Peacock (its new streaming service) subscribers a free device, while Facebook (FB) announced a new Portal box which will allow direct streaming from TV sets. While there are still plenty of Roku bulls who point to the company's overseas growth potential, we still see a company which has never turned an annual profit. The gravy train for investors may be coming to an end. There is no arguing the fact that early Roku investors have made a lot of money by owning the stock, but without any positive earnings metrics, an investor needs to be able to make the case for a company's unique value proposition moving forward. Otherwise, the investment breaks down into a simple gamble, and we would rather be sipping a drink at the craps table.
Endeavor yanks its IPO just a day before going public after watching Peloton struggle and others flop. The ugly opening-day response of investors to companies fresh out of the IPO gate has claimed its first victim: just a day before it was slated to go public, global entertainment (think Hollywood talent agency owner) company Endeavor Group Holdings pulled its listing from the New York Stock Exchange. Goldman Sachs (GS) was the lead underwriter of the firm started by—among others—Rahm Emanuel's brother, Ari, which was to begin trading Friday under the symbol "EDR." As recently as last week, the company hoped to price in the range of $30-$32 per share, but that range abruptly fell to $26-$29 this week. The company was hoping to raise more than $600 million in net proceeds from the offering, but after that was shaved down closer to $350 million, the deal was shelved. While they can certainly give it another go down the road, this is not a good sign for the likes of The We Company (WeWork), which just ditched its CEO in an effort to salvage its own listing. It used to be a given that a company was expected to be turning a profit before it was brought to the public market. How much has that tenet been turned on its head? It is estimated that 80% of all companies brought public over the past twelve months have been firms which had yet to turn a profit.
Leisure Equipment & Products
Peloton shares are a bargain—at some price point. In the wild and frenetic arena of 2019 IPOs, there have been some companies we had to own on the first day of trading, some we wouldn't touch at any price, and a few we just weren't sure of. Connected fitness equipment company Peloton Interactive (PTON $25-$26-$28) fell under that last category, the one with a question mark.
We believe that, despite the perennial net losses, the company will be a success, taking out long-established fitness equipment makers along the way, but that belief didn't warrant a purchase on IPO day. In fact, PTON shares ended their first day down just over 11%, closing at $25.76. That puts the company's valuation around $7 billion, which still seems about 25-30% high to us. Supporting that argument, the company was valued at just over $4 billion last year in the private market.
Why do we believe the company will be a success? More than just a maker of treadmills and stationary bikes, Peloton has created a fitness platform that people want to be a part of, and they join the club by purchasing the high-priced equipment (current revenue) and becoming monthly, paying members (recurring income stream). Peloton currently has 1.4 million members, all of whom have access to thousands of hours of live and on-demand classes that can be taken anywhere and at anytime. For those not ready to shell out the $2,000 for the bike or $4,000 for the treadmill (0%, monthly-pay financing available), the digital membership comes with an app allowing users to workout with their own equipment.
There will be plenty of perma-bears out there, naysaying analysts who will recommend shorting the stock with each new financial metric released, but we see enormous growth potential for the company, both domestically and around the world. Controlling virtually all aspects of the process from manufacturing to sales to video production of the classes, Peloton has an enviable vertical integration that others won't easily replicate. New production facilities are currently being built in the UK and Germany, and new studios are coming to New York and London this year. While a lot of fitness companies will come and go, Peloton is the real deal. The only thing we are unsure of is when they will generate positive earnings per share.
If we had to pick a price at which PTON shares would look attractive, it would probably be just under $20, or $6 below the company's opening-day close.
Food Products
Our early prediction on Beyond Meat may be coming to fruition. Within five minutes of its IPO debut, we owned shares of plant-based meat products company Beyond Meat (BYND $45-$154-$240) for our clients, and we added it to the Penn New Frontier Fund. One of our earliest predictions for the company was that, before 2019 was in the books, they would land a huge contract with the world's strongest fast-food chain, McDonald's (MCD). While not a full-blown rollout, the $161 billion restaurant has announced that it will, indeed, begin testing the PLT (plant, lettuce, and tomato) at 28 of its locations throughout Ontario. The PLT is a Beyond Meat burger specially crafted for McDonald's. While BYND shares spiked $16 on the news, analysts still question whether or not the company will ultimately win a big US contract from Steve Easterbrook's company. We don't. They will. Of course there are competitors to Beyond Meat, and certainly more will enter the fray. However, we believe the company's head-start, organizational structure (including supply chain management), and exemplary management will make it the benchmark for this exciting and growing industry for years to come.
Global Strategy: Europe
At the risk of sounding like a broken record, Europe's economy is in the tank. It seems as though we are discussing the dour state of the European economy on a weekly basis, but that is only because the stream of bad news from the region continues unabated. Take Germany's PMI (purchasing managers' index) survey, which just rolled in for September. As the name implies, this economic indicator gauges the level of activity of purchasing managers at businesses that make up any given sector. Any number above 50 reflects growth, while any reading below 50 signals contraction. Germany's PMI for the manufacturing sector dropped from an anemic 43.5 in August to a disconcerting 41.4 in September, its lowest level in over a decade. In a written statement, the Bundesbank (Germany's central bank) acknowledged that the country is probably already in a recession. Throughout the eurozone, the composite PMI fell nearly two points, to 50.4—on the razor's edge of contraction. For all intents and purposes, Germany currently has no leader. Angela Merkel, once the de facto head of the EU, is in lame duck status, with no dynamic figures emerging. The country's only answer appears to be dropping interest rates even further below zero. This is simply not a sound strategy, and we are not sure what miraculous event will put the economy back on the right trajectory. Furthermore, even if such an event does manifest, how steep of a trajectory will be needed to soak up all of the liquidity created by the Bundesbank and the Bundestag? Steer clear.
Media & Entertainment
Roku falls nearly 20% in one day after scathing analyst call. It would take more than one hand to count the number of times we questioned not owning streaming device-maker Roku (ROKU $26-$108-$177) in any of our strategies following double-digit pops in its share price. Last Friday was not one of those days. Shares of Roku fell nearly 20% after Pivotal Research initiated coverage on the $12 billion company with a Sell rating and a $60/share target price—a 45% downside from where it now trades. The analyst makes the argument that, with all the new entrants, similar streaming devices or capabilities will be offered free to customers. Comcast (CMCSA), for example, will give Peacock (its new streaming service) subscribers a free device, while Facebook (FB) announced a new Portal box which will allow direct streaming from TV sets. While there are still plenty of Roku bulls who point to the company's overseas growth potential, we still see a company which has never turned an annual profit. The gravy train for investors may be coming to an end. There is no arguing the fact that early Roku investors have made a lot of money by owning the stock, but without any positive earnings metrics, an investor needs to be able to make the case for a company's unique value proposition moving forward. Otherwise, the investment breaks down into a simple gamble, and we would rather be sipping a drink at the craps table.
Headlines for the Week of 08 Sep 2019—14 Sep 2019
Monetary Policy
The Fed made its second rate cut, and the markets were unsure how to react. It was almost a given going into this week's FOMC meeting: Powell and company would cut rates 25 basis points, to a lower limit target rate of 1.75%. And that is precisely what happened. The somewhat odd initial reaction by the stock market was a selloff. Why? A rate cut is what investors (and the president) were clamoring for, so why throw a fit? Taking it a step further, Powell did a nice job during his post-rate-cut news conference, essentially stating that he still expects economic growth domestically, but that the global economy is certainly slowing. Nothing we didn't already know. To be sure, if Donald Trump were the Fed Chair, we would already have negative rates, following Germany and much of the world down dangerously-uncharted waters, but we believe Powell did the right thing. Perhaps it was the larger number of dissenters (including non-voting members) this time around: five fed members wanted no rate cut, five supported the cut, and seven of the twelve believe there should be one more cut later this year. We believe the seven will get their way—gear up for a 1.5% rate and expect no more. The market's reactionary response is getting a bit silly. What is the point of cutting interest rates other than spurring economic activity? If companies cannot afford to finance new projects with rates where they are now, they probably shouldn't be borrowing at all. We still believe Europe's experiment with negative interest rates and new quantitative easing will end badly. And that is what investors are currently missing.
Media & Entertainment
The streaming wars are heating up and getting (a lot) costlier as services pay big for hit TV shows. Two months ago we discussed how overvalued we thought Netflix ($231-$295-$387) was, especially after taking into account the slew of new entrants all vying to both create new hit shows and buy proven ones for their respective libraries. At the time, Netflix was selling for $380 per share—nearly $100 more than where the shares currently trade. We are beginning to get a taste for how the new platforms will cause upheaval in the industry as the feeding frenzy for proven shows heats up.
HBO Max, AT&T's (T $27-$37-$39) new service which will launch next spring, reportedly just paid around $500 million for the five-year rights to The Big Bang Theory, which is currently running on WarnerMedia's (now part of T) TBS network. That new service also yanked Friends away from Netflix for $425 million. Not to be outdone, Netflix acquired the global streaming rights to the classic sitcom Seinfeld for around $500 million. Rights to The Office, which has been running on Netflix, were purchased for $500 million by Comcast's (CMCSA $33-$47-$47) new NBCUniversal streaming service, which will be called "Peacock." The Walt Disney Company (DIS $100-$136-$147) pulled its entire library of Disney and Marvel shows and films from Netflix, as they will have exclusivity on the new Disney+ platform. Disney's streaming service will also be the only place to watch shows and movies from the Star Wars franchise. Whew. A lot of moving parts, and an incredible amount of cash being thrown around. This gives us a sense for how the moat around streaming pioneer Netflix has begun to shrink. And we didn't even touch on Apple TV+, Apple's (AAPL $142-$221-$233) new service coming this fall.
Is your head spinning after trying to keep track of where all these hit shows will land? That's part of the problem. Consumers of entertainment are only going to plop down so much per month for the various services, and you can bet there will be some losers. But let's focus on who will win the battle of the living room (or wherever you watch shows on your devices). From the above list, we see Disney and Apple coming away as the clear winners. Not so much because their services will outperform the competition, but because their platforms are just one part of growing array of other products and services they offer to the global marketplace.
Energy Commodities
Oil-based ETF in Dynamic Growth Strategy spikes double digits following attack on Saudi oilfields. First, let's get the obvious out of the way: Iran is responsible for the weekend missile and drone attacks on Saudi Arabian oil installations. Less obvious but equally certain: Saudi Arabia will not let these attacks go unpunished, and odds are the retaliatory measures will take place before the press gets wind of the plans. Crown Prince Mohammad bin Salman is, for all intents and purposes, in charge of that country, and he is a hawk, especially with respect to Iran (another reason our relationship with the prince is so important from a strategic standpoint). As for fallout from the attacks, which took about 5.7 million barrels per day (out of 7M bpd total) out of production, oil immediately jumped around 14%. On 18 Dec 2018, we purchased OIL—the iPath S&P GSCI Crude Oil ETN—within the Penn Dynamic Growth Strategy when crude was sitting at $47 per barrel. That investment spiked around 14% as soon as the trading session opened following the attacks. The tensions in the Middle East, from attacks on oil assets to the pirating of tankers in the Gulf, will ratchet up before they subside, and that means we are in no hurry to take our profits on OIL. Iran is feeling cocky, and it badly miscalculated with this latest attack. While members of the Trump administration are directly pointing fingers at the country, the president is slightly more reticent on the issue, which means other factors may be in play. If Iran reads this as hesitation, the mullahs are likely to dig the hole they are in a little bit deeper. In other words, count on them to do the wrong thing. Another note of interest: While America has become essentially oil-independent as the new world leader in production, China still relies heavily on Saudi Oil. This will be yet another reason for that country to iron out a trade deal with the US.
Global Strategy: Europe
How wonderfully ironic if Hungary provided England with the weapon to blow out of the EU. We love the Eastern European democracies. Poland, Romania, Hungary, Estonia, Slovakia, the Czech Republic; countries which went through a figurative hell while under the thumb of either Nazi Germany or the Soviet Union, or both. These countries are the 21st century version of the United States in its early days. They embrace freedom and reject—understandably—oppressive government control. They are the world's new pioneers. They are also among America's strongest global allies. One more very important factor: they all happen to be members of the European Union, the very organization that Great Britain is attempting to detach itself from. While the British Parliament is doing its best to keep Prime Minister Boris Johnson from fulfilling the voters' wishes, he may have an ace up his sleeve involving one of these countries and the "hard Brexit" deadline of 31 October. It seems that any single member state can veto an extension, effectively forcing the UK out on the last day of next month. The powers that be in Brussels are worried that Johnson is plotting with Hungary for that country to torpedo the extension. Hungarian Prime Minister Viktor Orban has already clashed with Brussels over a number of issues (ditto every other Eastern European nation), and this could provide him a golden opportunity to stick it to the leadership apparatchik. Officially, the country is simply saying it will make up its mind when the time comes. Of course, the EU could threaten to withhold a chunk of the annual funding which flows to Hungary, but that threat may not be enough to intimidate Orban. Yet another exciting twist in one of the best dramas of the early 21st century. Ever since Prime Minister Johnson expressed his plans to delay parliament's return this fall, he has lost battle after battle mounted by angry MPs. He remains determined, however, to force the fruition of the 2016 vote to leave. We still lay the odds of a hard Brexit at 50%—much higher than the oddsmakers right now.
Consumer Discretionary: Restaurants
After falling 30% since May, is Dave & Buster's a scorching buy opportunity? Investors seem to love overreacting to any news on Dave & Buster's (PLAY $37-$42-$67), either pushing shares of the entertainment and dining establishment up rapidly, or helping shares gap down—typically after a less-than-spectacular earnings report. The latter was the case this past week as PLAY shares fell 15% in a matter of minutes following the release of Q2's financial results. What seemed to spook investors most in the report was the 2% decline in walk-in sales from last year. Revenues, however, increased 8%—to $345M—and earnings were up 7%—to $0.90 per share. Besides the drop in traffic, another downward driver for the shares was management's lowering of full-year guidance due to the planned costs and disruptions associated with a major store re-vamp. The company plans a major push into e-sports, sports betting, and increased virtual reality experiences for guests, all of which are sound moves in our opinion. With its P/E ratio of 13, Dave & Buster's is "cheaper" than the S&P with its 21 multiple, and the restaurant industry's 29 multiple. Near its 52-week low, shares of PLAY are certainly worth a look. We place a fair value of $50 on shares of PLAY. CEO Brian Jenkins has over two decades of experience in the food, beverage, and entertainment industry (he was previously the senior vice president of finance at Six Flags), and seems to be executing fairly well on the company's sound strategic plan.
Government Fraud, Waste, & Abuse of Power
California: the state that time forgot. California is truly a spectacular state from a geographical perspective. Sadly, from a government control standpoint, Sacramento might as well be Caracas. And the leftists who control San Francisco have more in common with Nicolás Maduro than they do with the American system of free enterprise. Actually, that latter comparison might not be fair, as even Maduro probably wouldn't have banned toys from being included in Happy Meal bags. The latest comical act that comes to us from California revolves around the state legislators' refusal to acknowledge the gig economy. To the cabal in Sacramento, American workers are expected to take a job at a blue collar factory out of high school, work there 35 years, and retire with a gold watch and a company-supplied pension. And the ingrates had better like it. This newfangled concept of a dynamic young workforce freelancing it and taking part-time gigs simply doesn't register in their ancient and dusty brains. The latest salvo launched by this crotchety bunch of highbrows is aimed squarely at home-grown companies like Uber (UBER) and Lyft (LYFT). Both chambers of the state legislature are poised to (easily) approve a mandate which will magically reclassify all entrepreneurial drivers as employees of their respective company. Labor unions are ecstatic, and Governor Gavin Newsom (former mayor of San Francisco, by the way) said he will be "proud" to sign the bill into law. Never mind that a vast majority of enterprising drivers don't want to be employees of the companies they drive for. Too bad. The nanny state knows what is best. The spirits of Che Guevara and Hugo Chavez would be proud. Here's the good news: while California may have a sympathetic Ninth Circuit Court of Appeals in its own backyard, Uber and Lyft will ultimately win, with the California law being ruled unconstitutional. In the meantime, the giant migration of lifelong residents leaving California for greener pastures will continue. Maybe Sacramento can pass a law restricting movement without authorization. If that doesn't work, they can always build a wall keeping their citizens in.
Consumer Discretionary: Restaurants
While McDonald's forges ahead with innovative new ideas, Wendy's will go back to a 35-year-old playbook and try breakfast again. Despite operating in an industry with razor-thin margins, there are actually a number of fast-service and fast-casual restaurants we like from an investment standpoint. McDonald's (MCD $157-$210-$222), which we have held for some time in the Penn Global Leaders Club, is clearly our favorite, but we have also written glowingly about the likes of Dunkin' Brands (DNKN), Chipotle (CMG), Jack in the Box (JACK), and even Dave & Buster's (PLAY) on occasion. One name we have steered clear of, however, has been Wendy's (WEN $15-$20-$23). This week, the Ohio-based company announced it would take a hit to full-year adjusted earnings because it plans to spend $20 million—and hire 20,000 new employees—to launch a breakfast menu. If we knew that McDonald's all-day breakfast would be such a hit (and it has been), why doesn't this excite us? Perhaps it is because this is something like the fourth time they have tried it over the years. This time around, it just feels like an "us too!" move by management. And talk about competitive: Wendy's will now be competing against McDonald's, Burger King, Chick-fil-A, and even Taco Bell, which began serving breakfast four years ago. CEO Todd Penegor proclaimed that Wendy's breakfast menu will "set us apart from the competition." Um, OK. Pardon our skepticism. Apparently we weren't the only ones questioning this move—the company dropped 10% immediately after the announcement.
Real Estate Management & Development
WeWork's largest private investor asks the company to shelve its IPO. When SoftBank, Masayoshi Son's Japanese holding company best known for its majority ownership of Sprint (S), invested $2 billion in WeWork this past January, the workspace company had a valuation of nearly $50 billion. Around that time we wrote of how insanely overvalued the company was, especially considering the startup's goofball founder, Adam Neumann. Since January, as more light has been shed on the convoluted inner workings of this operation, an increasing number of analysts have begun to question virtually every aspect of The We Co., as it is formally known. Now, the wheels appear to be coming off the cart, as SoftBank has urged the firm to shelve its IPO altogether. The more enlightened would-be investors became, the faster WeWork's valuation dropped. As SoftBank was making its request, M&A experts were valuing the company between $15 billion and $20 billion, and even that level was facing resistance. There is still a strong desire at WeWork to go public, which makes sense considering the firm needs an estimated $10 billion infusion of funding to become cash-flow positive. A part of us really wants to see this company go public soon, as it would be a textbook case in poor corporate governance. On the other hand, would-be investors now get to keep their hard-earned money.
The Fed made its second rate cut, and the markets were unsure how to react. It was almost a given going into this week's FOMC meeting: Powell and company would cut rates 25 basis points, to a lower limit target rate of 1.75%. And that is precisely what happened. The somewhat odd initial reaction by the stock market was a selloff. Why? A rate cut is what investors (and the president) were clamoring for, so why throw a fit? Taking it a step further, Powell did a nice job during his post-rate-cut news conference, essentially stating that he still expects economic growth domestically, but that the global economy is certainly slowing. Nothing we didn't already know. To be sure, if Donald Trump were the Fed Chair, we would already have negative rates, following Germany and much of the world down dangerously-uncharted waters, but we believe Powell did the right thing. Perhaps it was the larger number of dissenters (including non-voting members) this time around: five fed members wanted no rate cut, five supported the cut, and seven of the twelve believe there should be one more cut later this year. We believe the seven will get their way—gear up for a 1.5% rate and expect no more. The market's reactionary response is getting a bit silly. What is the point of cutting interest rates other than spurring economic activity? If companies cannot afford to finance new projects with rates where they are now, they probably shouldn't be borrowing at all. We still believe Europe's experiment with negative interest rates and new quantitative easing will end badly. And that is what investors are currently missing.
Media & Entertainment
The streaming wars are heating up and getting (a lot) costlier as services pay big for hit TV shows. Two months ago we discussed how overvalued we thought Netflix ($231-$295-$387) was, especially after taking into account the slew of new entrants all vying to both create new hit shows and buy proven ones for their respective libraries. At the time, Netflix was selling for $380 per share—nearly $100 more than where the shares currently trade. We are beginning to get a taste for how the new platforms will cause upheaval in the industry as the feeding frenzy for proven shows heats up.
HBO Max, AT&T's (T $27-$37-$39) new service which will launch next spring, reportedly just paid around $500 million for the five-year rights to The Big Bang Theory, which is currently running on WarnerMedia's (now part of T) TBS network. That new service also yanked Friends away from Netflix for $425 million. Not to be outdone, Netflix acquired the global streaming rights to the classic sitcom Seinfeld for around $500 million. Rights to The Office, which has been running on Netflix, were purchased for $500 million by Comcast's (CMCSA $33-$47-$47) new NBCUniversal streaming service, which will be called "Peacock." The Walt Disney Company (DIS $100-$136-$147) pulled its entire library of Disney and Marvel shows and films from Netflix, as they will have exclusivity on the new Disney+ platform. Disney's streaming service will also be the only place to watch shows and movies from the Star Wars franchise. Whew. A lot of moving parts, and an incredible amount of cash being thrown around. This gives us a sense for how the moat around streaming pioneer Netflix has begun to shrink. And we didn't even touch on Apple TV+, Apple's (AAPL $142-$221-$233) new service coming this fall.
Is your head spinning after trying to keep track of where all these hit shows will land? That's part of the problem. Consumers of entertainment are only going to plop down so much per month for the various services, and you can bet there will be some losers. But let's focus on who will win the battle of the living room (or wherever you watch shows on your devices). From the above list, we see Disney and Apple coming away as the clear winners. Not so much because their services will outperform the competition, but because their platforms are just one part of growing array of other products and services they offer to the global marketplace.
Energy Commodities
Oil-based ETF in Dynamic Growth Strategy spikes double digits following attack on Saudi oilfields. First, let's get the obvious out of the way: Iran is responsible for the weekend missile and drone attacks on Saudi Arabian oil installations. Less obvious but equally certain: Saudi Arabia will not let these attacks go unpunished, and odds are the retaliatory measures will take place before the press gets wind of the plans. Crown Prince Mohammad bin Salman is, for all intents and purposes, in charge of that country, and he is a hawk, especially with respect to Iran (another reason our relationship with the prince is so important from a strategic standpoint). As for fallout from the attacks, which took about 5.7 million barrels per day (out of 7M bpd total) out of production, oil immediately jumped around 14%. On 18 Dec 2018, we purchased OIL—the iPath S&P GSCI Crude Oil ETN—within the Penn Dynamic Growth Strategy when crude was sitting at $47 per barrel. That investment spiked around 14% as soon as the trading session opened following the attacks. The tensions in the Middle East, from attacks on oil assets to the pirating of tankers in the Gulf, will ratchet up before they subside, and that means we are in no hurry to take our profits on OIL. Iran is feeling cocky, and it badly miscalculated with this latest attack. While members of the Trump administration are directly pointing fingers at the country, the president is slightly more reticent on the issue, which means other factors may be in play. If Iran reads this as hesitation, the mullahs are likely to dig the hole they are in a little bit deeper. In other words, count on them to do the wrong thing. Another note of interest: While America has become essentially oil-independent as the new world leader in production, China still relies heavily on Saudi Oil. This will be yet another reason for that country to iron out a trade deal with the US.
Global Strategy: Europe
How wonderfully ironic if Hungary provided England with the weapon to blow out of the EU. We love the Eastern European democracies. Poland, Romania, Hungary, Estonia, Slovakia, the Czech Republic; countries which went through a figurative hell while under the thumb of either Nazi Germany or the Soviet Union, or both. These countries are the 21st century version of the United States in its early days. They embrace freedom and reject—understandably—oppressive government control. They are the world's new pioneers. They are also among America's strongest global allies. One more very important factor: they all happen to be members of the European Union, the very organization that Great Britain is attempting to detach itself from. While the British Parliament is doing its best to keep Prime Minister Boris Johnson from fulfilling the voters' wishes, he may have an ace up his sleeve involving one of these countries and the "hard Brexit" deadline of 31 October. It seems that any single member state can veto an extension, effectively forcing the UK out on the last day of next month. The powers that be in Brussels are worried that Johnson is plotting with Hungary for that country to torpedo the extension. Hungarian Prime Minister Viktor Orban has already clashed with Brussels over a number of issues (ditto every other Eastern European nation), and this could provide him a golden opportunity to stick it to the leadership apparatchik. Officially, the country is simply saying it will make up its mind when the time comes. Of course, the EU could threaten to withhold a chunk of the annual funding which flows to Hungary, but that threat may not be enough to intimidate Orban. Yet another exciting twist in one of the best dramas of the early 21st century. Ever since Prime Minister Johnson expressed his plans to delay parliament's return this fall, he has lost battle after battle mounted by angry MPs. He remains determined, however, to force the fruition of the 2016 vote to leave. We still lay the odds of a hard Brexit at 50%—much higher than the oddsmakers right now.
Consumer Discretionary: Restaurants
After falling 30% since May, is Dave & Buster's a scorching buy opportunity? Investors seem to love overreacting to any news on Dave & Buster's (PLAY $37-$42-$67), either pushing shares of the entertainment and dining establishment up rapidly, or helping shares gap down—typically after a less-than-spectacular earnings report. The latter was the case this past week as PLAY shares fell 15% in a matter of minutes following the release of Q2's financial results. What seemed to spook investors most in the report was the 2% decline in walk-in sales from last year. Revenues, however, increased 8%—to $345M—and earnings were up 7%—to $0.90 per share. Besides the drop in traffic, another downward driver for the shares was management's lowering of full-year guidance due to the planned costs and disruptions associated with a major store re-vamp. The company plans a major push into e-sports, sports betting, and increased virtual reality experiences for guests, all of which are sound moves in our opinion. With its P/E ratio of 13, Dave & Buster's is "cheaper" than the S&P with its 21 multiple, and the restaurant industry's 29 multiple. Near its 52-week low, shares of PLAY are certainly worth a look. We place a fair value of $50 on shares of PLAY. CEO Brian Jenkins has over two decades of experience in the food, beverage, and entertainment industry (he was previously the senior vice president of finance at Six Flags), and seems to be executing fairly well on the company's sound strategic plan.
Government Fraud, Waste, & Abuse of Power
California: the state that time forgot. California is truly a spectacular state from a geographical perspective. Sadly, from a government control standpoint, Sacramento might as well be Caracas. And the leftists who control San Francisco have more in common with Nicolás Maduro than they do with the American system of free enterprise. Actually, that latter comparison might not be fair, as even Maduro probably wouldn't have banned toys from being included in Happy Meal bags. The latest comical act that comes to us from California revolves around the state legislators' refusal to acknowledge the gig economy. To the cabal in Sacramento, American workers are expected to take a job at a blue collar factory out of high school, work there 35 years, and retire with a gold watch and a company-supplied pension. And the ingrates had better like it. This newfangled concept of a dynamic young workforce freelancing it and taking part-time gigs simply doesn't register in their ancient and dusty brains. The latest salvo launched by this crotchety bunch of highbrows is aimed squarely at home-grown companies like Uber (UBER) and Lyft (LYFT). Both chambers of the state legislature are poised to (easily) approve a mandate which will magically reclassify all entrepreneurial drivers as employees of their respective company. Labor unions are ecstatic, and Governor Gavin Newsom (former mayor of San Francisco, by the way) said he will be "proud" to sign the bill into law. Never mind that a vast majority of enterprising drivers don't want to be employees of the companies they drive for. Too bad. The nanny state knows what is best. The spirits of Che Guevara and Hugo Chavez would be proud. Here's the good news: while California may have a sympathetic Ninth Circuit Court of Appeals in its own backyard, Uber and Lyft will ultimately win, with the California law being ruled unconstitutional. In the meantime, the giant migration of lifelong residents leaving California for greener pastures will continue. Maybe Sacramento can pass a law restricting movement without authorization. If that doesn't work, they can always build a wall keeping their citizens in.
Consumer Discretionary: Restaurants
While McDonald's forges ahead with innovative new ideas, Wendy's will go back to a 35-year-old playbook and try breakfast again. Despite operating in an industry with razor-thin margins, there are actually a number of fast-service and fast-casual restaurants we like from an investment standpoint. McDonald's (MCD $157-$210-$222), which we have held for some time in the Penn Global Leaders Club, is clearly our favorite, but we have also written glowingly about the likes of Dunkin' Brands (DNKN), Chipotle (CMG), Jack in the Box (JACK), and even Dave & Buster's (PLAY) on occasion. One name we have steered clear of, however, has been Wendy's (WEN $15-$20-$23). This week, the Ohio-based company announced it would take a hit to full-year adjusted earnings because it plans to spend $20 million—and hire 20,000 new employees—to launch a breakfast menu. If we knew that McDonald's all-day breakfast would be such a hit (and it has been), why doesn't this excite us? Perhaps it is because this is something like the fourth time they have tried it over the years. This time around, it just feels like an "us too!" move by management. And talk about competitive: Wendy's will now be competing against McDonald's, Burger King, Chick-fil-A, and even Taco Bell, which began serving breakfast four years ago. CEO Todd Penegor proclaimed that Wendy's breakfast menu will "set us apart from the competition." Um, OK. Pardon our skepticism. Apparently we weren't the only ones questioning this move—the company dropped 10% immediately after the announcement.
Real Estate Management & Development
WeWork's largest private investor asks the company to shelve its IPO. When SoftBank, Masayoshi Son's Japanese holding company best known for its majority ownership of Sprint (S), invested $2 billion in WeWork this past January, the workspace company had a valuation of nearly $50 billion. Around that time we wrote of how insanely overvalued the company was, especially considering the startup's goofball founder, Adam Neumann. Since January, as more light has been shed on the convoluted inner workings of this operation, an increasing number of analysts have begun to question virtually every aspect of The We Co., as it is formally known. Now, the wheels appear to be coming off the cart, as SoftBank has urged the firm to shelve its IPO altogether. The more enlightened would-be investors became, the faster WeWork's valuation dropped. As SoftBank was making its request, M&A experts were valuing the company between $15 billion and $20 billion, and even that level was facing resistance. There is still a strong desire at WeWork to go public, which makes sense considering the firm needs an estimated $10 billion infusion of funding to become cash-flow positive. A part of us really wants to see this company go public soon, as it would be a textbook case in poor corporate governance. On the other hand, would-be investors now get to keep their hard-earned money.
Headlines for the Week of 01 Sep 2019—07 Sep 2019
Judicial Watch
Department of Justice begins antitrust probe into four automakers and a deal they struck with California. The next time you are in a Lowes or Home Depot, pick up virtually any container on the shelf and you are likely to see a warning from the state of California that the item in your hand probably causes cancer. Just how bad has it gotten in the formerly Golden State? Lawmakers are now demanding that the Proposition 65 cancer warning is staring you in the face with every cup of Starbucks coffee you order. (They claim that a carcinogen is created by the bean roasting process.) Against that backdrop comes the Department of Justice's fight with four automakers which capitulated to California's draconian emissions standards rules. Ford, Honda, BMW, and Volkswagen joined together to sign an agreement promising to follow California's rules—instead of the US government's rules—regarding tailpipe emissions. The point of the inquiry is to find out whether this cabal's agreement was tantamount to making a sweetheart deal with the state to curry favor as new models come due for approval. In other words, will these four get preferential treatment over the automakers (like GM) which did not sign the agreement. The point the DoJ is trying to make: federal law trumps state and local law, not the other way around. Every year since 2014, net migration to California (from other states) has dropped. Every year since 2016, California has had a net negative flow of residents, with most fleeing to Arizona, Nevada, or Texas. Sadly, the Proposition 65 warnings will follow them wherever they go.
Interactive Media & Services
Alphabet unit YouTube ordered to pay $170 million for collecting data on children. The Federal Trade Commission has ordered YouTube's parent company, Alphabet (GOOGL $978-$1,210-$1,297), to pay the US $136 million and the state of New York $34 million on charges that the video streaming service violated the Children's Online Privacy Protection Act of 1998. The government alleges that YouTube used tracking technology on channels geared toward kids without receiving consent from parents. The FTC also ordered the service to develop a system to notify channel owners of their responsibilities, and to disable the personalized ads being delivered on those channels. Recall that Alphabet was also in the news recently after billionaire tech entrepreneur Peter Thiel accused the company of embracing China with open arms while shunning the US Department of Defense and other American agencies. Google's former motto, which had also been part of its corporate code of conduct, was "Don't be evil." What a joke.
Application & Systems Software
Shares of software company Slack fall 15% on earnings before regaining footing late in the day. The charts haven't been pretty for cloud-based software-as-a-services company Slack (WORK $28-$30-$42) since going public this past spring. In fact, looking at a chart of the share price reminds us of one of those slides we used to speed down—riding atop a burlap bag—as kids. And let's face it, should a company that provides a chat app for the workplace environment ever have been given a $20 billion market cap by investors? Yes, the collaborative "channels" built into the app provide a pretty cool experience for team members, but isn't that exactly how the Microsoft (MSFT) Teams app works? This week was a big one for Slack, as the company issued its first quarterly earnings report since going public. Revenue came in a bit stronger than expected, at $145 million, and net losses were only $0.14 per share versus last year's $0.25 per share loss (as a private company). Upon first look, investors quickly sold off WORK after hours, driving the stock down 15%, but the shares actually clawed back most of those losses during the ensuing session. For Q3, management set revenue guidance in the $154M to $156M range, and projected a loss of $0.09 per share. Better, but certainly not great. We just don't see the catalyst that would make WORK a good investment. We don't see any barriers to entry or a unique value proposition. Steer clear.
Pharmaceuticals
Mallinckrodt may be the latest "victim" in the opioid crisis as shares fall 40% after-hours on possible bankruptcy news. We put the word "victim" in quotation marks because, of course, the real victims in the opioid crisis are the individuals who became addicted and their family members who had to suffer along with them. Mallinckrodt PLC (MNK $2-$2-$34) is a specialty and generic drugmaker, spun off from Covidien (which was subsequently purchased by Medtronic) back in 2013. As recently as June of 2015, the company had a market cap of $15 billion and a share price of $125. Now, the company is a shell of its former self, with a market cap of $172 million and a share price of $2. The company lost about 40% of its remaining market cap after Bloomberg reported that the company is exploring its options; read that as bankruptcy. What happened? Mallinckrodt is in the pain management business, and the number one tool in its pain management toolkit has been prescription opioids like Hydrocodone and Oxycodone. Incredibly, the St. Louis-based and Ireland-headquartered company was responsible for nearly 40% of the opioids prescribed between 2006 and 2012, based on DEA database records. With the army of lawyers standing at the gates to get their fair share from the opioid lawsuits, we don't see any way for MNK to come out of this. Hence, the "considering all options" comment from management. Johnson & Johnson recently lost its opioid case in the state of Oklahoma and was ordered to pay $572 million. You can bet that this ruling was the tip of the iceberg. Other companies in the hot seat (besides MNK) are Purdue Pharma, Endo Int'l (ENDP), Teva Pharmaceuticals (TEVA), and Allergan (AGN).
Global Strategy: Trade
US trade gap may have narrowed in July, but it is still too big. I recall someone whom I respected, someone in the public eye, proclaim about fifteen years ago that the national debt is not a bad or good thing, it simply "is." This was someone considered to be fiscally conservative. I think of that comment every time I hear an expert proclaim that it is perfectly normal and healthy for the US to run a massive trade deficit each month. I put equal stock in both of those comments. They are simply wrong. The US trade deficit for July slipped a bit from the previous month, which really isn't saying much since that number still clocked in at $54 billion. The US, as the most advanced technological powerhouse in the world, has roughly 330 million citizens. That leaves another 7.3 billion people in the world. Take out the lowest three quintiles on the global income scale, and that still leaves at least 1.5 billion people capable of buying goods and services emanating from the US—nearly five times the US population, including all economic quintiles in this country. Certainly, the American consumer is the engine of economic growth for countries around the world (we do a lot of consuming), but that is no excuse to accept a $600+ billion trade deficit each year. Furthermore, $379 billion of 2018's $621 billion deficit came from our lopsided trade with one country: China. Yes, we need to get a trade deal done or the global economy will continue to suffer; and no, we don't like tweets "ordering" US companies to find alternatives to China (a decree that an iron-fisted communist nation would issue), but the president is right about one thing: we have simply accepted our raw deal with China for too long. Back to July's numbers: the biggest decrease in imports came from capital goods such as computers and telecom equipment—the very items currently on the tariffs list. China may be looking for a face-saving way out, but between the capital fleeing Hong Kong and the foreign companies leaving the mainland with a giant sucking sound (thanks for that great line, Ross Perot), they are going to have a really hard time waiting until 2021 to get a deal done. And that is based on their (dangerous) assumption that there will not be a Trump second term.
Automotive
UAW members vote to give union right to call strike if demands aren't met during negotiations. As if dealing with a trade war, new competitors around the globe, and the industry shift to electric vehicles weren't enough, the major US automakers are about to engage in negotiations with their biggest adversary: the United Auto Workers. In a sign of the struggle ahead, UAW member just voted—with a 96% majority—to give the union the right to call a strike if it doesn't get what it wants out of the talks. And expect these talks to be contentious. The UAW will start with GM (GM $31-$37-$42), which recently announced it will close four US plants—a guaranteed flashpoint. Adding an interesting wrinkle to the talks, UAW President Gary Jones had his home raided by federal agents last week as part of a union corruption probe. Charges have already been filed against other union officials as part of the investigation. The current, four-year contract between the automakers and the UAW is set to expire on 15 Sep, but short-term contract extensions are normal as the two sides negotiate. There are currently around 400,000 UAW members, down from 1.5 million in the 1970s. Foreign automakers with plants in the US, along with electric vehicle maker Tesla, have been able to successfully fend off attempts by the UAW to organize workers at their facilities. We wouldn't touch GM, Ford, or Fiat Chrysler as these negotiations get underway. We believe they will be the ugliest in at least twelve years (the UAW last called for a strike against GM in 2007), and we believe neither side will walk away the winner. In other words, there will be a lose/lose result when all is said and done, and tensions between management and workers will be tighter after the talks conclude than they are today. And that is saying a lot.
Household & Personal Products
Ulta Beauty suffers nightmare day in the market, shares plunge 30%. For the better part of a decade, investors have priced beauty retailer Ulta (ULTA $224-$237-$369) more like an upscale luxury brand than a personal products company. All of that changed following the company's Q2 earnings report, which spurred a one-day, 30% selloff in the shares. The numbers themselves weren't exactly disastrous: revenues rose 12% year-over-year, to $1.67 billion, while earnings rose 8.8% from the same period last year. The trouble came in the form of a statement released by CEO Mary Dillon which accompanied the earnings report. Dillon cited industry-wide headwinds as the major reason management had to downgrade full-year growth expectations. As for the valuation of ULTA shares, they have quickly dropped to a P/E ratio of 20, well below the specialty retail industry average of 38.27. We discuss Ulta in further detail in the next issue of The Penn Wealth Report. Members can get a look at our fair value for the company by logging in at the Trading Desk.
Department of Justice begins antitrust probe into four automakers and a deal they struck with California. The next time you are in a Lowes or Home Depot, pick up virtually any container on the shelf and you are likely to see a warning from the state of California that the item in your hand probably causes cancer. Just how bad has it gotten in the formerly Golden State? Lawmakers are now demanding that the Proposition 65 cancer warning is staring you in the face with every cup of Starbucks coffee you order. (They claim that a carcinogen is created by the bean roasting process.) Against that backdrop comes the Department of Justice's fight with four automakers which capitulated to California's draconian emissions standards rules. Ford, Honda, BMW, and Volkswagen joined together to sign an agreement promising to follow California's rules—instead of the US government's rules—regarding tailpipe emissions. The point of the inquiry is to find out whether this cabal's agreement was tantamount to making a sweetheart deal with the state to curry favor as new models come due for approval. In other words, will these four get preferential treatment over the automakers (like GM) which did not sign the agreement. The point the DoJ is trying to make: federal law trumps state and local law, not the other way around. Every year since 2014, net migration to California (from other states) has dropped. Every year since 2016, California has had a net negative flow of residents, with most fleeing to Arizona, Nevada, or Texas. Sadly, the Proposition 65 warnings will follow them wherever they go.
Interactive Media & Services
Alphabet unit YouTube ordered to pay $170 million for collecting data on children. The Federal Trade Commission has ordered YouTube's parent company, Alphabet (GOOGL $978-$1,210-$1,297), to pay the US $136 million and the state of New York $34 million on charges that the video streaming service violated the Children's Online Privacy Protection Act of 1998. The government alleges that YouTube used tracking technology on channels geared toward kids without receiving consent from parents. The FTC also ordered the service to develop a system to notify channel owners of their responsibilities, and to disable the personalized ads being delivered on those channels. Recall that Alphabet was also in the news recently after billionaire tech entrepreneur Peter Thiel accused the company of embracing China with open arms while shunning the US Department of Defense and other American agencies. Google's former motto, which had also been part of its corporate code of conduct, was "Don't be evil." What a joke.
Application & Systems Software
Shares of software company Slack fall 15% on earnings before regaining footing late in the day. The charts haven't been pretty for cloud-based software-as-a-services company Slack (WORK $28-$30-$42) since going public this past spring. In fact, looking at a chart of the share price reminds us of one of those slides we used to speed down—riding atop a burlap bag—as kids. And let's face it, should a company that provides a chat app for the workplace environment ever have been given a $20 billion market cap by investors? Yes, the collaborative "channels" built into the app provide a pretty cool experience for team members, but isn't that exactly how the Microsoft (MSFT) Teams app works? This week was a big one for Slack, as the company issued its first quarterly earnings report since going public. Revenue came in a bit stronger than expected, at $145 million, and net losses were only $0.14 per share versus last year's $0.25 per share loss (as a private company). Upon first look, investors quickly sold off WORK after hours, driving the stock down 15%, but the shares actually clawed back most of those losses during the ensuing session. For Q3, management set revenue guidance in the $154M to $156M range, and projected a loss of $0.09 per share. Better, but certainly not great. We just don't see the catalyst that would make WORK a good investment. We don't see any barriers to entry or a unique value proposition. Steer clear.
Pharmaceuticals
Mallinckrodt may be the latest "victim" in the opioid crisis as shares fall 40% after-hours on possible bankruptcy news. We put the word "victim" in quotation marks because, of course, the real victims in the opioid crisis are the individuals who became addicted and their family members who had to suffer along with them. Mallinckrodt PLC (MNK $2-$2-$34) is a specialty and generic drugmaker, spun off from Covidien (which was subsequently purchased by Medtronic) back in 2013. As recently as June of 2015, the company had a market cap of $15 billion and a share price of $125. Now, the company is a shell of its former self, with a market cap of $172 million and a share price of $2. The company lost about 40% of its remaining market cap after Bloomberg reported that the company is exploring its options; read that as bankruptcy. What happened? Mallinckrodt is in the pain management business, and the number one tool in its pain management toolkit has been prescription opioids like Hydrocodone and Oxycodone. Incredibly, the St. Louis-based and Ireland-headquartered company was responsible for nearly 40% of the opioids prescribed between 2006 and 2012, based on DEA database records. With the army of lawyers standing at the gates to get their fair share from the opioid lawsuits, we don't see any way for MNK to come out of this. Hence, the "considering all options" comment from management. Johnson & Johnson recently lost its opioid case in the state of Oklahoma and was ordered to pay $572 million. You can bet that this ruling was the tip of the iceberg. Other companies in the hot seat (besides MNK) are Purdue Pharma, Endo Int'l (ENDP), Teva Pharmaceuticals (TEVA), and Allergan (AGN).
Global Strategy: Trade
US trade gap may have narrowed in July, but it is still too big. I recall someone whom I respected, someone in the public eye, proclaim about fifteen years ago that the national debt is not a bad or good thing, it simply "is." This was someone considered to be fiscally conservative. I think of that comment every time I hear an expert proclaim that it is perfectly normal and healthy for the US to run a massive trade deficit each month. I put equal stock in both of those comments. They are simply wrong. The US trade deficit for July slipped a bit from the previous month, which really isn't saying much since that number still clocked in at $54 billion. The US, as the most advanced technological powerhouse in the world, has roughly 330 million citizens. That leaves another 7.3 billion people in the world. Take out the lowest three quintiles on the global income scale, and that still leaves at least 1.5 billion people capable of buying goods and services emanating from the US—nearly five times the US population, including all economic quintiles in this country. Certainly, the American consumer is the engine of economic growth for countries around the world (we do a lot of consuming), but that is no excuse to accept a $600+ billion trade deficit each year. Furthermore, $379 billion of 2018's $621 billion deficit came from our lopsided trade with one country: China. Yes, we need to get a trade deal done or the global economy will continue to suffer; and no, we don't like tweets "ordering" US companies to find alternatives to China (a decree that an iron-fisted communist nation would issue), but the president is right about one thing: we have simply accepted our raw deal with China for too long. Back to July's numbers: the biggest decrease in imports came from capital goods such as computers and telecom equipment—the very items currently on the tariffs list. China may be looking for a face-saving way out, but between the capital fleeing Hong Kong and the foreign companies leaving the mainland with a giant sucking sound (thanks for that great line, Ross Perot), they are going to have a really hard time waiting until 2021 to get a deal done. And that is based on their (dangerous) assumption that there will not be a Trump second term.
Automotive
UAW members vote to give union right to call strike if demands aren't met during negotiations. As if dealing with a trade war, new competitors around the globe, and the industry shift to electric vehicles weren't enough, the major US automakers are about to engage in negotiations with their biggest adversary: the United Auto Workers. In a sign of the struggle ahead, UAW member just voted—with a 96% majority—to give the union the right to call a strike if it doesn't get what it wants out of the talks. And expect these talks to be contentious. The UAW will start with GM (GM $31-$37-$42), which recently announced it will close four US plants—a guaranteed flashpoint. Adding an interesting wrinkle to the talks, UAW President Gary Jones had his home raided by federal agents last week as part of a union corruption probe. Charges have already been filed against other union officials as part of the investigation. The current, four-year contract between the automakers and the UAW is set to expire on 15 Sep, but short-term contract extensions are normal as the two sides negotiate. There are currently around 400,000 UAW members, down from 1.5 million in the 1970s. Foreign automakers with plants in the US, along with electric vehicle maker Tesla, have been able to successfully fend off attempts by the UAW to organize workers at their facilities. We wouldn't touch GM, Ford, or Fiat Chrysler as these negotiations get underway. We believe they will be the ugliest in at least twelve years (the UAW last called for a strike against GM in 2007), and we believe neither side will walk away the winner. In other words, there will be a lose/lose result when all is said and done, and tensions between management and workers will be tighter after the talks conclude than they are today. And that is saying a lot.
Household & Personal Products
Ulta Beauty suffers nightmare day in the market, shares plunge 30%. For the better part of a decade, investors have priced beauty retailer Ulta (ULTA $224-$237-$369) more like an upscale luxury brand than a personal products company. All of that changed following the company's Q2 earnings report, which spurred a one-day, 30% selloff in the shares. The numbers themselves weren't exactly disastrous: revenues rose 12% year-over-year, to $1.67 billion, while earnings rose 8.8% from the same period last year. The trouble came in the form of a statement released by CEO Mary Dillon which accompanied the earnings report. Dillon cited industry-wide headwinds as the major reason management had to downgrade full-year growth expectations. As for the valuation of ULTA shares, they have quickly dropped to a P/E ratio of 20, well below the specialty retail industry average of 38.27. We discuss Ulta in further detail in the next issue of The Penn Wealth Report. Members can get a look at our fair value for the company by logging in at the Trading Desk.
Headlines for the Week of 25 Aug 2019—31 Aug 2019
Beverages & Tobacco
Eleven years after they split, Philip Morris and Altria are set to reunite. Back in 2008, we recall mulling over the pending jettison of Philip Morris (PM $65-$75-$93) from Altria (MO $42-$46-$66), with the former focused on the international tobacco market and the latter remaining focused on US smokers. At the time, an enormous number of Asians were daily smokers, while the habit was coming under fierce fire in this country. We recall wondering how Altria would possibly hold up without the overseas market. Ironically, over the past ten years Altria has risen 153% in value while Philip Morris is up just 62%. Now, it appears the two are set to re-merge in a deal that would create a company with a $200 billion market cap. While both firms face ever-mounting anti-smoking headwinds, Altria has been strategically diversifying away some of that risk, taking a 10% stake in ABInBev (BUD), a 35% stake in JUUL Labs (e-cigs), and a 45% stake in pot grower Cronos Group (CRON). Furthermore, both are set to take the lead in the next technology innovation for the industry (after e-cigs), IQOS—a "heat don't burn" system that heats tobacco up to a temperature of 650°F, without the combustion, fire, ash, or smoke. While both companies ended up falling the day that the deal was announced, it makes more sense that these two large players band back together than continue going it alone. Is there any value in the shares of either company right now? Well, both have beaten-down share prices, both have a low P/E ratio of around 15, both have a dividend yield north of 5%, and the merger should create some nice cost-saving synergies. We see about a 20% to 25% upside to either at their current respective prices. Then again, it's always risky investing in an industry so clearly in the cross-hairs of both regulators and public opinion.
FOREX
Pound sterling's most recent drop against the dollar exemplifies the emotionality of markets. Prime Minster Boris Johnson confirmed his plans to delay parliament's return from summer recess this fall, and the pound quickly fell to $1.22 against the US greenback—its weakest level since the mid-1980s. This amounted to currency traders saying "uh oh, this guy is serious about leaving the EU." Really? What gave it away. Boris Johnson has been clear that England is leaving the EU by 31 October, deal or no deal. There has been no waffling, no Theresa May shuffle, no hedging of bets. His fair warning that he intends to ask the queen to delay the end of summer recess for lawmakers makes perfect sense if you have been listening to this man. Perhaps we should give traders the benefit of the doubt and just assume they believe more ugliness will result in this full-on Brexit move, but hasn't the exit already been baked into the pound's weakness? We believe so. So, prepare for two months of ugly headlines of the dire straits (a great Deptford, UK band, by the way) England will find itself in come 01 Nov, and prepare to take action. If you believe the hype has been frothed up by the media and a certain group of British politicians (like we do), then two possible moves to take advantage of the false narratives would a purchase of EWU shares—the iShares MSCI UK ETF, currently at $29.91, and FXB—the Invesco CurrencyShares® British Pound Sterling ETF, currently at $119.14.
Food Products
After falling 8% in one session, JM Smucker finds itself right back where it was two years ago. The mantra with respect to investing in the consumer staples space, specifically food products, has been that the inner aisles of the grocery store (think canned goods) are dead while the outside aisles (think organic fruits and vegetables and the like) are driving sales as a new generation of shopper takes the helm. For good or bad, JM Smucker's (SJM $91-$104-$128) stock price seems to buttress that argument. Precisely two years ago, we wrote a story outlining SJM's double-digit, one-day drop on the heels of a lousy earnings report and lowered guidance for 2018. Change the year to 2020, and we can basically leave the rest of the story intact. Management blamed falling coffee and peanut butter prices, in addition to increased competition in the pet-food segment, for the revenue and net income miss for the quarter, and it lowered its full year revenue guidance down to "between -1% and zero." Smucker owns such iconic brands as Folgers, Jif, Smucker's, Crisco, Milk-Bone, and Meow Mix. The Ohio-based company, which has been in business since 1897, now has a market cap of $12 billion. With its 3.3% dividend yield and lower stock price, is SJM a worthy investment? After all, consumer staples tend to be a good defensive play going into an economic downturn. We don't think so. It is sitting right at its fair value, and its 28 P/E ratio is pretty rich for that category. Our one Penn holding in the space continues to be General Mills (GIS), thanks to its exemplary management team, led by 52-year-old CEO Jeff Harmening.
Pharmaceuticals
A judge hands down a $572 million ruling against Johnson & Johnson, and the stock soars 5% after hours. That headline may cause a case of cognitive disconnect, but considering what the state of Oklahoma was seeking, the judgment could certainly be considered a win for Johnson & Johnson (JNJ $121-$131-$149). The case revolves around America's opioid epidemic, with Oklahoma arguing that J&J both enticed and misled physicians in an effort to sell more "magic pills," as the state put it. The state claimed that J&J told docs that the risk of addiction by patients was around 2.5%, when in reality it was much higher. The judge bought the argument, but balked on Oklahoma's request for $17 billion in punitive damage, questioning the legitimacy of the data used to come up with that figure. Most Wall Street analysts had been baking in a $1 billion to $2 billion award, thus the after-hours pop in the share price. Johnson & Johnson will appeal the ruling. We don't currently hold JNJ in any of the Penn strategies, but we still hold shares for clients due to the enormous unrealized capital gain. While we would not recommend buying at this level, we wouldn't rush out and sell shares (especially in a taxable account) either.
Multiline Retail
Penn member Target to build "shop-in-shop" areas for Disney at a number of its locations. Two of our favorite companies—both Penn strategy members—have joined forces, and we love it. Multiline retailer Target (TGT $60-$105-$107) has announced plans to build specialty "shop-in-shop" locations for Walt Disney (DIS $100-$134-$147) products in at least 75 of its stores beginning this fall. Target will feature over 400 Disney products, many of which had been exclusive to Disney retail outlets, to its customers both via these dedicated store sections, and a special web page on its site. These products, which will include Pixar, Marvel, and Spider-Man items, will be available for same-day pickup and delivery as well as two-day shipping. Shares of both companies have hit all-time highs within the past several months. In two challenging industries, how fitting that two of the biggest innovators should come together in a joint effort to spur sales. Yet another example of why we own both within the Penn strategies. Creative leadership.
Textiles, Apparel, & Luxury Goods
Slashed in half in just one year, is PVH now a screaming buy? What do Calvin Klein, Tommy Hilfiger, IZOD, Van Heusen, ARROW, Speedo, and Geoffrey Beene all have in common? They are all portfolio lines owned by $5 billion fashion company PVH (PVH $67-$69-$157). Despite having a tiny P/E ratio of 8, steadily rising revenue and net income, and extremely solid management in the form of CEO Manny Chirico, the trade war and the global slowdown have combined to hammer PVH's stock price down by 55% in one year, and 25% year-to-date. At $69.01, the shares are selling at a deep discount to fair value. Granted, two lines—Calvin Klein and Tommy Hilfiger—account for over 80% of the firm's revenue, and over half of all revenue emanates from outside the US, but we believe investors have unfairly punished this global fashion powerhouse. Very conservative estimates put the fair value of PVH at $100 per share. While we are currently underweighting the consumer discretionary sector, this company looks mighty attractive. Retail has certainly been under pressure on all fronts, especially the big brick-and-mortar players like Macy's, JC Penney, and Dillard's. While PVH sells its wares to these companies, there is no shortage of its products for sale on Amazon.com, making it less sensitive to transformational changes in the retail industry.
Eleven years after they split, Philip Morris and Altria are set to reunite. Back in 2008, we recall mulling over the pending jettison of Philip Morris (PM $65-$75-$93) from Altria (MO $42-$46-$66), with the former focused on the international tobacco market and the latter remaining focused on US smokers. At the time, an enormous number of Asians were daily smokers, while the habit was coming under fierce fire in this country. We recall wondering how Altria would possibly hold up without the overseas market. Ironically, over the past ten years Altria has risen 153% in value while Philip Morris is up just 62%. Now, it appears the two are set to re-merge in a deal that would create a company with a $200 billion market cap. While both firms face ever-mounting anti-smoking headwinds, Altria has been strategically diversifying away some of that risk, taking a 10% stake in ABInBev (BUD), a 35% stake in JUUL Labs (e-cigs), and a 45% stake in pot grower Cronos Group (CRON). Furthermore, both are set to take the lead in the next technology innovation for the industry (after e-cigs), IQOS—a "heat don't burn" system that heats tobacco up to a temperature of 650°F, without the combustion, fire, ash, or smoke. While both companies ended up falling the day that the deal was announced, it makes more sense that these two large players band back together than continue going it alone. Is there any value in the shares of either company right now? Well, both have beaten-down share prices, both have a low P/E ratio of around 15, both have a dividend yield north of 5%, and the merger should create some nice cost-saving synergies. We see about a 20% to 25% upside to either at their current respective prices. Then again, it's always risky investing in an industry so clearly in the cross-hairs of both regulators and public opinion.
FOREX
Pound sterling's most recent drop against the dollar exemplifies the emotionality of markets. Prime Minster Boris Johnson confirmed his plans to delay parliament's return from summer recess this fall, and the pound quickly fell to $1.22 against the US greenback—its weakest level since the mid-1980s. This amounted to currency traders saying "uh oh, this guy is serious about leaving the EU." Really? What gave it away. Boris Johnson has been clear that England is leaving the EU by 31 October, deal or no deal. There has been no waffling, no Theresa May shuffle, no hedging of bets. His fair warning that he intends to ask the queen to delay the end of summer recess for lawmakers makes perfect sense if you have been listening to this man. Perhaps we should give traders the benefit of the doubt and just assume they believe more ugliness will result in this full-on Brexit move, but hasn't the exit already been baked into the pound's weakness? We believe so. So, prepare for two months of ugly headlines of the dire straits (a great Deptford, UK band, by the way) England will find itself in come 01 Nov, and prepare to take action. If you believe the hype has been frothed up by the media and a certain group of British politicians (like we do), then two possible moves to take advantage of the false narratives would a purchase of EWU shares—the iShares MSCI UK ETF, currently at $29.91, and FXB—the Invesco CurrencyShares® British Pound Sterling ETF, currently at $119.14.
Food Products
After falling 8% in one session, JM Smucker finds itself right back where it was two years ago. The mantra with respect to investing in the consumer staples space, specifically food products, has been that the inner aisles of the grocery store (think canned goods) are dead while the outside aisles (think organic fruits and vegetables and the like) are driving sales as a new generation of shopper takes the helm. For good or bad, JM Smucker's (SJM $91-$104-$128) stock price seems to buttress that argument. Precisely two years ago, we wrote a story outlining SJM's double-digit, one-day drop on the heels of a lousy earnings report and lowered guidance for 2018. Change the year to 2020, and we can basically leave the rest of the story intact. Management blamed falling coffee and peanut butter prices, in addition to increased competition in the pet-food segment, for the revenue and net income miss for the quarter, and it lowered its full year revenue guidance down to "between -1% and zero." Smucker owns such iconic brands as Folgers, Jif, Smucker's, Crisco, Milk-Bone, and Meow Mix. The Ohio-based company, which has been in business since 1897, now has a market cap of $12 billion. With its 3.3% dividend yield and lower stock price, is SJM a worthy investment? After all, consumer staples tend to be a good defensive play going into an economic downturn. We don't think so. It is sitting right at its fair value, and its 28 P/E ratio is pretty rich for that category. Our one Penn holding in the space continues to be General Mills (GIS), thanks to its exemplary management team, led by 52-year-old CEO Jeff Harmening.
Pharmaceuticals
A judge hands down a $572 million ruling against Johnson & Johnson, and the stock soars 5% after hours. That headline may cause a case of cognitive disconnect, but considering what the state of Oklahoma was seeking, the judgment could certainly be considered a win for Johnson & Johnson (JNJ $121-$131-$149). The case revolves around America's opioid epidemic, with Oklahoma arguing that J&J both enticed and misled physicians in an effort to sell more "magic pills," as the state put it. The state claimed that J&J told docs that the risk of addiction by patients was around 2.5%, when in reality it was much higher. The judge bought the argument, but balked on Oklahoma's request for $17 billion in punitive damage, questioning the legitimacy of the data used to come up with that figure. Most Wall Street analysts had been baking in a $1 billion to $2 billion award, thus the after-hours pop in the share price. Johnson & Johnson will appeal the ruling. We don't currently hold JNJ in any of the Penn strategies, but we still hold shares for clients due to the enormous unrealized capital gain. While we would not recommend buying at this level, we wouldn't rush out and sell shares (especially in a taxable account) either.
Multiline Retail
Penn member Target to build "shop-in-shop" areas for Disney at a number of its locations. Two of our favorite companies—both Penn strategy members—have joined forces, and we love it. Multiline retailer Target (TGT $60-$105-$107) has announced plans to build specialty "shop-in-shop" locations for Walt Disney (DIS $100-$134-$147) products in at least 75 of its stores beginning this fall. Target will feature over 400 Disney products, many of which had been exclusive to Disney retail outlets, to its customers both via these dedicated store sections, and a special web page on its site. These products, which will include Pixar, Marvel, and Spider-Man items, will be available for same-day pickup and delivery as well as two-day shipping. Shares of both companies have hit all-time highs within the past several months. In two challenging industries, how fitting that two of the biggest innovators should come together in a joint effort to spur sales. Yet another example of why we own both within the Penn strategies. Creative leadership.
Textiles, Apparel, & Luxury Goods
Slashed in half in just one year, is PVH now a screaming buy? What do Calvin Klein, Tommy Hilfiger, IZOD, Van Heusen, ARROW, Speedo, and Geoffrey Beene all have in common? They are all portfolio lines owned by $5 billion fashion company PVH (PVH $67-$69-$157). Despite having a tiny P/E ratio of 8, steadily rising revenue and net income, and extremely solid management in the form of CEO Manny Chirico, the trade war and the global slowdown have combined to hammer PVH's stock price down by 55% in one year, and 25% year-to-date. At $69.01, the shares are selling at a deep discount to fair value. Granted, two lines—Calvin Klein and Tommy Hilfiger—account for over 80% of the firm's revenue, and over half of all revenue emanates from outside the US, but we believe investors have unfairly punished this global fashion powerhouse. Very conservative estimates put the fair value of PVH at $100 per share. While we are currently underweighting the consumer discretionary sector, this company looks mighty attractive. Retail has certainly been under pressure on all fronts, especially the big brick-and-mortar players like Macy's, JC Penney, and Dillard's. While PVH sells its wares to these companies, there is no shortage of its products for sale on Amazon.com, making it less sensitive to transformational changes in the retail industry.
Headlines for the Week of 11 Aug 2019—17 Aug 2019
Monetary Policy
At Jackson Hole, Powell's comments help the Dow dig out of its 100-point deficit, at least until the tweets started. Fed Chair Jerome Powell was certainly walking the tightrope at Friday's Kansas City Fed-sponsored symposium in Jackson Hole, Wyoming. If he made it seem as though the US economy is bucking the global trend and may not need more rate cuts for stimulus, the reaction would have been brutal. If he made it sound like the US economy is teetering on the edge of a recession, thus necessitating more rate cuts, the reaction would have been brutal. Actually, he did a pretty good job of remaining balanced, which helped the Dow claw back from a 100-point morning deficit and move into the green. Citing the examples of 1995 and 1998, he reaffirmed the Fed's commitment to providing additional stimulus if the global slowdown begins hurting the US. Those two examples are telling, in that each of those years the Fed cut rates three times and then stopped. That is precisely what we expect to happen this time around: barring any unforeseen negative economic event, we expect two more 25-basis-point cuts. Unfortunately, the markets barely had time to digest these comments and push the markets back up before President Trump's latest tweet storm. In one elongated tweet he "ordered" US companies to find alternatives to working with/in China. Somewhat of a hollow threat, as the president doesn't have the power to order companies to do any such thing (though he can make it tougher via executive actions), but the tweets quickly drove the market 700 points in the opposite direction—with the Dow going from up 100 to down over 600 points by the end of Friday's session. Yes, the new US policy of playing hardball with China is having a devastating effect on that country's economy. But it is appearing more and more likely that China will dig in its heels, despite the pain, and wait for the next election cycle in the US to come and go.
Multiline Retail
Holy smokes, Nordstrom just jumped over 16% in one day. Sure, to be fair, it is a lot easier to jump double digits when you are sitting at $25 per share, but we'll take what we can get from beleaguered retailer Nordstrom (JWN $25-$31-$67) at this point. So, what was the catalyst for Thursday's big gain? An earnings report that announced a 5% drop in revenue from last year. Seems a bit weird, but analysts were projecting a deeper revenue decline and a smaller earnings per share (EPS) number. The upscale retailer made $0.90 in EPS against expectations for $0.75. Making the one-day spike even more bizarre, management cut its expectations for the year. Our guess is that a lot of retail investors are still hoping for a Nordstrom family-backed buyout, with the company being taken private. That's what we were thinking when we added shares of JWN to the Intrepid. At least we erased some of our losses on Thursday. Trying to time a buyout is tricky business at best, and a fool's errand at worst. We still see the company going private in the near future, with the announcement leading to a big spike in the share price.
Global Strategy: Latin America
The US may not be going into a recession, but Mexico is on the verge. In late November of last year, leftist "AMLO" was sworn in as Mexico's 58th president. He ran on a platform of economic growth and a clampdown on corruption. While Mexicans celebrated his victory, we were dubious of his promises—to put it mildly. Well, corruption is still rampant in the country, and the Mexican economy is about to slip into recession. After notching a first-quarter decline of 0.2%, the country's Q2 GDP came in at 0.1%, narrowly missing the recession mark. This Friday, however, that rate is expected to be revised slightly downward. If that revision moves the needle more than ten basis points to the left, recession has hit our neighbor to the south. And why wouldn't it? How does a country boost social spending, roll back the privatization of industries, pretend to rein in rampant corruption, and still continue to grow with a global economy in the doldrums? It doesn't. Nonetheless, we expect the citizenry will give the beloved AMLO the benefit of the doubt for years to come. We reduced our exposure to Mexico (which primarily resided in emerging markets ETFs) after AMLO's election, and we don't see that exposure increasing anytime soon.
Multiline Retail
Penn member Target spikes nearly 20% in one session. It was the 21st of December, 2018. Investors had unfairly hammered down multiline retailer Target (TGT $60-$102-$90), along with most every other retail stock, so we swooped in and bought shares of the firm for the Intrepid Trading Platform at $62.39. Fast forward precisely eight months, and we are witnessing a 20%, one-day rally in the stock. The holding is now up over 65% from where we bought it in the last few weeks of last year. The reason for Wednesday's huge spike in share price revolves around the company's second quarter results and forward guidance. Revenue came in at $18.4 billion (a 4.8% jump) while same-store sales rose 3%. Against expectations for $1.62 in earnings per share, the actual figure was $1.82/share. Management also raised guidance for the full year, expecting earnings of $5.90 to $6.20 per share. This has been such a well-run company since the hapless Gregg Steinhafel left, that we may ultimately end up moving it to the longer-term Penn Global Leaders Club.
Real Estate Management & Development
WeWork: a ticking time bomb waiting to be offloaded on unsuspecting investors. It didn't take long for us to begin questioning the business antics of WeWork, an office space leasing firm readying itself to go public. WeWork's parent entity, the We Company, filed its S-1—the requisite pre-IPO registration statement—with the SEC last week, and the report only exacerbated our concerns. The company's business model seems solid enough: in an era of new startups and a transitory, mobile workforce, offer shared workspaces at locations around the world for a reasonable monthly fee. The facade of that apparently-sound model begins to crack as soon as we meet the company's founder, Adam Neumann. Bizarre is the best word we can think of to describe this man. Carnival side show act might be the best term. Sticking to the S-1, however, the most glaring aspect is probably the company's reported $900 million in losses through the first six months of 2019, following $1.9 billion worth of losses in 2018. A senior equity analyst at MKM Partners estimates the firm will have about "six months in execution runway ahead before facing a cash crunch." While we see that expenses quadrupled between 2016 and 2018, the company provided no occupancy rate detail in the report. In the past we have railed against the dual-class share structure, a "gimmicky" system that keeps power in the hands of a few anointed individuals. WeWork won't have a dual-class share structure. It will, instead, have three classes of stock. This company comes to the market looking like the world's largest Rube Goldberg machine. Sadly, that fact won't stop millions of investors from getting suckered in by the headlines and investing their hard-earned money in the least-favorable class of shares. When this company begins trading, just stay away. After the shares' initial spike and eventual fall back to earth, just stay away.
Household & Personal Products
Estee Lauder shares soar on—wait for it—strong sales in Asia. Apparently management at The Estee Lauder Companies (EL $121-$202-$195) didn't get the memo: blame slowing revenues and thin profits on weak Asian sales due to the trade dispute. Not only did the cosmetics powerhouse grow its revenues by 9% over last year, to $3.59 billion in the fiscal fourth quarter, they did so on the back of an 18% spike in Asia-Pacific net sales. These numbers, coupled with management's rosy projection for 9-10% net sales growth in fiscal Q1 of 2020, helped drive shares of the company up over 12% on the day, punching through their old 52-week high of $195. In addition to its name brand products, EL's portfolio includes such brands as Clinique, Origins, Bobbi Brown, and Aveda. With the global slowdown, we have been told to stick to North American-centric businesses; considering Estee Lauder's North American sales account for just over one-third of the company's revenues, that advice was turned on its head. CEO Fabrizio Freda continues to shine, one decade after he took the helm at the $73 billion firm. A well-run company in the toiletries and cosmetics industry can serve as a nice defensive play in a downturn, as consumers tend to stick with their favorite beauty brands no matter the state of the economy.
Media & Entertainment
Following Disney's new Star Wars-themed area, Universal is building its own new theme park in Orlando. The Walt Disney Company (DIS $100-$137-$147) recently made a major splash at its US theme parks with the opening of Star Wars: Galaxy's Edge, a futuristic area based on the company's Star Wars franchise. Not to be outdone, Comcast's (CMCSA $32-$44-$45) Universal Studios just announced that it will build an entirely new theme park on a 750-acre plot of land the company owns near its existing Universal Orlando Resort™. Epic Universe will represent the largest-ever investment in Universal's park properties, with plans to include attractions, hotels, dining, and (of course) plenty of shopping. The ultimate goal, besides besting Disney World (which will never happen), is to create a week-long destination for travelers, rather than just a two- or three-day jaunt to the parks. Epic Universe will represent the company's fourth theme park area in Orlando. While Disney World remains the undisputed champion, Universal has been picking up steam in recent years, especially after its last big upgrade—The Wizarding World of Harry Potter™. From an investment standpoint, Disney continues to be one of our brightest stars in the Penn Global Leaders Club, while we continue to shy away from owning Comcast for various reasons. The company is awash in debt, we don't see much value in its recent Sky acquisition, and management seems to be struggling to cogently define its strategic vision.
Global Trade
Amazon fires back against France's new "digital tax," hits sellers with the full cost. Last month we wrote about France's plan to place a 3% "digital tax" on big US companies, like Facebook (FB), Amazon (AMZN) and Alphabet (GOOGL), who do business in the country. We also said it will be a fascinating battle to watch unfold. To that end, Amazon has just made the first counterattack, passing along the entire 3% tax to the French businesses who use the company's platform to sell their goods. Thousands of French business owners began receiving emails recently announcing the fee increase, directly linking the new tax to the higher fees. Assuming the companies continue to do business in the Amazon marketplace, they must either eat the new charges or pass them along to consumers in the form of higher prices—precisely what opponents of the tax predicted would happen. The next chapter of the saga? The targeted US firms will testify on Capitol Hill as lawmakers mull retributions, and the US Trade Representative's Office has opened a probe into the tax, which could lead to new tariffs on French goods entering the country. Does anyone really believe the big tech companies will be the ones hurt by this wanton action? As evidenced by Amazon's actions, it will be the small business owners and consumers absorbing the pain.
Industrial Conglomerates
Madoff whistleblower calls GE's accounting practices the biggest case of fraud he has ever witnessed. General Electric (GE $7-$8-$14) was once our most respected company, with shares sitting in nearly every client's portfolio. A symbol of great American ingenuity and innovation, it topped the list of the world's largest companies back in 2000, with a market cap of nearly $500 billion. How quickly things can change—due to management—in the fast-paced world of business. Today, the company is a shell of its former self, with a market cap of just $70 billion following its largest decline since the financial crisis. The reason for the 11%, one-day drop was a bombshell report issued by the man who blew the lid off the Bernie Madoff Ponzi scheme, Harry Markopolos. The certified fraud analyst calls the company's accounting practices "a bigger fraud than Enron and WorldCom combined," and even set up a website (gefraud.com) to detail the company's purportedly nefarious acts. Markopolos said his team spent seven months analyzing the company's accounting practices, finding $38 billion worth of fraud hidden by bogus financial statements. The company vociferously denied the allegations, with CEO Larry Culp buying over a quarter-of-a-million shares after they fell below the $8 mark. Only time will tell whether or not the analyst's accusations are correct, but the company has been on a downward slide ever since Jack Welch handed over the top spot to Jeffrey Immelt back in 2001. Remarkably, Immelt leapfrogged over Robert Nardelli and James McNerney, two highly-successful business leaders, to be awarded the CEO position from GE's board of directors. Larry Culp succeeded Immelt in October of last year. Whether or not these serious accusations are true, we wouldn't touch GE shares in any of our five strategies. The company continues to flop and flounder in search of a cogent strategic plan that involves more than shedding units to raise cash and lower its debt load.
Economic Outlook
An inverted yield curve drives Dow down 400 points at open. On Wednesday morning, the yield on a 2-year Treasury hit 1.634%. In and of itself, that shouldn't have been a big deal. The problem came when, at the precise same time, the yield on a 10-year Treasury hit 1.623%, lower than the two-year. Thus comes the infamous yield curve inversion—when longer-term Treasuries offer less than their shorter-term counterparts. The two- and the ten-year Treasuries are considered benchmarks, and when these two benchmark rates invert, a recession normally hits about 22 months later. Yes, this is anecdotal, but it was enough to spook investors into a big, early morning selloff. While the last five inversions have preceded recessions, that doesn't necessarily spell doom-and-gloom for the markets, however. On average, one year after an inversion the S&P 500 is up 12% from the date of the event. So why does a yield curve ever invert in the first place? It has to do with supply and demand. If bond buyers believe economic trouble is on the horizon, they see continued monetary easing to accommodate weaker economic activity, meaning lower yields for a long period of time. This makes them shy away from longer bonds and load up on shorter-term notes. We see a lot of lingering challenges for the economic environment going forward, both at home and abroad. While the GDP has remained relatively strong at home, and unemployment remains low, there is a point at which the global slowdown hits home. Our Tactical Asset Allocation models for Summer, 2019 reflect those concerns. Clients and members can login to see the models, which are adjusted as needed updated quarterly.
Economics: Housing
The Fed's first rate cut in eleven years causes big spike in mortgage loan activity. On the last day of July, the Fed did something it hasn't done since December of 2008: lower the Fed funds rate. The lower band of the target now sits at 2%, which would be somewhat remarkable were it not for the $14 trillion worth of bonds and notes around the world which carry negative yields. The Fed's most recent action saw one intended consequence come to fruition: there was a flurry of mortgage loan activity last week. According to new data from the Mortgage Bankers Association, volume in mortgage applications spiked just over 20% last week, or a whopping 81% from the same time last year. The vast majority of this volume came from current homeowners looking to lock in lower rates—and lower monthly payments—on their existing homes, as evidenced by the meager 2% rise in mortgage applications for new purchasers. The average rate on a 30-year fixed mortgage fell to 3.93%, its lowest level since November of 2016. The one disconcerting figure in the data is the lack of any real activity by new buyers. Despite the low mortgage rates and historically-low level of unemployment, rising home prices are making affordability a real issue. An under-supply of new homes, especially at the lower end of the spectrum, appears to be the major culprit. Although we are currently shying away from the homebuilders, D.R. Horton (DHI), which constructs homes ranging in price from $100,000 to over $1,000,000, is our current favorite player in the industry.
Global Strategy: Latin America
Argentina's stock market melts down following President Macri's primary loss. Four years ago, in the winter of 2015, we wrote of Mauricio Macri's unlikely presidential win in Argentina. In a leftist country which blames America for the military coup d'etat
of 1976 and the ensuing Dirty War, it was remarkable that a center-right, pro-business candidate could ascend to the office. Now, Macri's unlikely journey has come to an end. Anger among voters over austerity measures put in place following an International Monetary Fund (IMF) bailout in 2018, and the country's rampant inflation, led to a drubbing in the primaries for the president. A strong showing by the populist Peronists—those sharing the leftist ideology of former President Juan Domingo Perón and his second wife, Eva Perón—pushed Alberto Fernández easily over the finish line. Most disconcerting may be the fact that his running mate will be the nation's former president, Cristina Kirchner, an anti-American nationalist. In addition to the country's stock market plummeting, the Argentine peso has weakened about 25% since the primary results. Instead of celebrating, the citizens should be pondering the country's economic path under a Fernández/Kirchner regime—it won't be pretty. Argentina has South America's second-largest economy, behind Brazil. Instead of buying a basket of Latin American stocks (such as the iShares Latin America 40, symbol ILF), consider country-specific ETFs from areas making economic progress, such as the iShares MSCI Brazil Capped ETF (symbol EWZ).
Global Strategy: East/Southeast Asia
Is Hong Kong suddenly becoming the biggest threat to the markets? It has to be one of the most predictable, slow-moving train wrecks in history. When the UK handed over control of the glittering economic jewel that is Hong Kong to the communist country of China, its future became set in stone. A gigantic clash of cultures was inevitable. Now, with pro-democracy demonstrators shutting down the Hong Kong airport, one of the busiest in the world, they are almost daring China's communist leaders to respond with force. Not only are these freedom fighters impeding the flow of cash from this vibrant economic region, they are also giving China's image a black eye, and the latter will not be tolerated by a country which controls its false narratives with an iron fist. No matter how this most recent protest at the airport ends, the battles are only going to intensify. And when that happens, expect some ugly volatility in the markets. Official minions of the Chinese government are already using the word "terrorism" to describe some of the protesters' actions. This language is choreographed, designed to lend some warped sense of credibility to the Chinese military's potential moves in the region. While investors have been focused on the tattered state of US/China trade talks, this powder keg could steal the headline on any given day. This geopolitical issue should be factored into every investor's risk management matrix.
At Jackson Hole, Powell's comments help the Dow dig out of its 100-point deficit, at least until the tweets started. Fed Chair Jerome Powell was certainly walking the tightrope at Friday's Kansas City Fed-sponsored symposium in Jackson Hole, Wyoming. If he made it seem as though the US economy is bucking the global trend and may not need more rate cuts for stimulus, the reaction would have been brutal. If he made it sound like the US economy is teetering on the edge of a recession, thus necessitating more rate cuts, the reaction would have been brutal. Actually, he did a pretty good job of remaining balanced, which helped the Dow claw back from a 100-point morning deficit and move into the green. Citing the examples of 1995 and 1998, he reaffirmed the Fed's commitment to providing additional stimulus if the global slowdown begins hurting the US. Those two examples are telling, in that each of those years the Fed cut rates three times and then stopped. That is precisely what we expect to happen this time around: barring any unforeseen negative economic event, we expect two more 25-basis-point cuts. Unfortunately, the markets barely had time to digest these comments and push the markets back up before President Trump's latest tweet storm. In one elongated tweet he "ordered" US companies to find alternatives to working with/in China. Somewhat of a hollow threat, as the president doesn't have the power to order companies to do any such thing (though he can make it tougher via executive actions), but the tweets quickly drove the market 700 points in the opposite direction—with the Dow going from up 100 to down over 600 points by the end of Friday's session. Yes, the new US policy of playing hardball with China is having a devastating effect on that country's economy. But it is appearing more and more likely that China will dig in its heels, despite the pain, and wait for the next election cycle in the US to come and go.
Multiline Retail
Holy smokes, Nordstrom just jumped over 16% in one day. Sure, to be fair, it is a lot easier to jump double digits when you are sitting at $25 per share, but we'll take what we can get from beleaguered retailer Nordstrom (JWN $25-$31-$67) at this point. So, what was the catalyst for Thursday's big gain? An earnings report that announced a 5% drop in revenue from last year. Seems a bit weird, but analysts were projecting a deeper revenue decline and a smaller earnings per share (EPS) number. The upscale retailer made $0.90 in EPS against expectations for $0.75. Making the one-day spike even more bizarre, management cut its expectations for the year. Our guess is that a lot of retail investors are still hoping for a Nordstrom family-backed buyout, with the company being taken private. That's what we were thinking when we added shares of JWN to the Intrepid. At least we erased some of our losses on Thursday. Trying to time a buyout is tricky business at best, and a fool's errand at worst. We still see the company going private in the near future, with the announcement leading to a big spike in the share price.
Global Strategy: Latin America
The US may not be going into a recession, but Mexico is on the verge. In late November of last year, leftist "AMLO" was sworn in as Mexico's 58th president. He ran on a platform of economic growth and a clampdown on corruption. While Mexicans celebrated his victory, we were dubious of his promises—to put it mildly. Well, corruption is still rampant in the country, and the Mexican economy is about to slip into recession. After notching a first-quarter decline of 0.2%, the country's Q2 GDP came in at 0.1%, narrowly missing the recession mark. This Friday, however, that rate is expected to be revised slightly downward. If that revision moves the needle more than ten basis points to the left, recession has hit our neighbor to the south. And why wouldn't it? How does a country boost social spending, roll back the privatization of industries, pretend to rein in rampant corruption, and still continue to grow with a global economy in the doldrums? It doesn't. Nonetheless, we expect the citizenry will give the beloved AMLO the benefit of the doubt for years to come. We reduced our exposure to Mexico (which primarily resided in emerging markets ETFs) after AMLO's election, and we don't see that exposure increasing anytime soon.
Multiline Retail
Penn member Target spikes nearly 20% in one session. It was the 21st of December, 2018. Investors had unfairly hammered down multiline retailer Target (TGT $60-$102-$90), along with most every other retail stock, so we swooped in and bought shares of the firm for the Intrepid Trading Platform at $62.39. Fast forward precisely eight months, and we are witnessing a 20%, one-day rally in the stock. The holding is now up over 65% from where we bought it in the last few weeks of last year. The reason for Wednesday's huge spike in share price revolves around the company's second quarter results and forward guidance. Revenue came in at $18.4 billion (a 4.8% jump) while same-store sales rose 3%. Against expectations for $1.62 in earnings per share, the actual figure was $1.82/share. Management also raised guidance for the full year, expecting earnings of $5.90 to $6.20 per share. This has been such a well-run company since the hapless Gregg Steinhafel left, that we may ultimately end up moving it to the longer-term Penn Global Leaders Club.
Real Estate Management & Development
WeWork: a ticking time bomb waiting to be offloaded on unsuspecting investors. It didn't take long for us to begin questioning the business antics of WeWork, an office space leasing firm readying itself to go public. WeWork's parent entity, the We Company, filed its S-1—the requisite pre-IPO registration statement—with the SEC last week, and the report only exacerbated our concerns. The company's business model seems solid enough: in an era of new startups and a transitory, mobile workforce, offer shared workspaces at locations around the world for a reasonable monthly fee. The facade of that apparently-sound model begins to crack as soon as we meet the company's founder, Adam Neumann. Bizarre is the best word we can think of to describe this man. Carnival side show act might be the best term. Sticking to the S-1, however, the most glaring aspect is probably the company's reported $900 million in losses through the first six months of 2019, following $1.9 billion worth of losses in 2018. A senior equity analyst at MKM Partners estimates the firm will have about "six months in execution runway ahead before facing a cash crunch." While we see that expenses quadrupled between 2016 and 2018, the company provided no occupancy rate detail in the report. In the past we have railed against the dual-class share structure, a "gimmicky" system that keeps power in the hands of a few anointed individuals. WeWork won't have a dual-class share structure. It will, instead, have three classes of stock. This company comes to the market looking like the world's largest Rube Goldberg machine. Sadly, that fact won't stop millions of investors from getting suckered in by the headlines and investing their hard-earned money in the least-favorable class of shares. When this company begins trading, just stay away. After the shares' initial spike and eventual fall back to earth, just stay away.
Household & Personal Products
Estee Lauder shares soar on—wait for it—strong sales in Asia. Apparently management at The Estee Lauder Companies (EL $121-$202-$195) didn't get the memo: blame slowing revenues and thin profits on weak Asian sales due to the trade dispute. Not only did the cosmetics powerhouse grow its revenues by 9% over last year, to $3.59 billion in the fiscal fourth quarter, they did so on the back of an 18% spike in Asia-Pacific net sales. These numbers, coupled with management's rosy projection for 9-10% net sales growth in fiscal Q1 of 2020, helped drive shares of the company up over 12% on the day, punching through their old 52-week high of $195. In addition to its name brand products, EL's portfolio includes such brands as Clinique, Origins, Bobbi Brown, and Aveda. With the global slowdown, we have been told to stick to North American-centric businesses; considering Estee Lauder's North American sales account for just over one-third of the company's revenues, that advice was turned on its head. CEO Fabrizio Freda continues to shine, one decade after he took the helm at the $73 billion firm. A well-run company in the toiletries and cosmetics industry can serve as a nice defensive play in a downturn, as consumers tend to stick with their favorite beauty brands no matter the state of the economy.
Media & Entertainment
Following Disney's new Star Wars-themed area, Universal is building its own new theme park in Orlando. The Walt Disney Company (DIS $100-$137-$147) recently made a major splash at its US theme parks with the opening of Star Wars: Galaxy's Edge, a futuristic area based on the company's Star Wars franchise. Not to be outdone, Comcast's (CMCSA $32-$44-$45) Universal Studios just announced that it will build an entirely new theme park on a 750-acre plot of land the company owns near its existing Universal Orlando Resort™. Epic Universe will represent the largest-ever investment in Universal's park properties, with plans to include attractions, hotels, dining, and (of course) plenty of shopping. The ultimate goal, besides besting Disney World (which will never happen), is to create a week-long destination for travelers, rather than just a two- or three-day jaunt to the parks. Epic Universe will represent the company's fourth theme park area in Orlando. While Disney World remains the undisputed champion, Universal has been picking up steam in recent years, especially after its last big upgrade—The Wizarding World of Harry Potter™. From an investment standpoint, Disney continues to be one of our brightest stars in the Penn Global Leaders Club, while we continue to shy away from owning Comcast for various reasons. The company is awash in debt, we don't see much value in its recent Sky acquisition, and management seems to be struggling to cogently define its strategic vision.
Global Trade
Amazon fires back against France's new "digital tax," hits sellers with the full cost. Last month we wrote about France's plan to place a 3% "digital tax" on big US companies, like Facebook (FB), Amazon (AMZN) and Alphabet (GOOGL), who do business in the country. We also said it will be a fascinating battle to watch unfold. To that end, Amazon has just made the first counterattack, passing along the entire 3% tax to the French businesses who use the company's platform to sell their goods. Thousands of French business owners began receiving emails recently announcing the fee increase, directly linking the new tax to the higher fees. Assuming the companies continue to do business in the Amazon marketplace, they must either eat the new charges or pass them along to consumers in the form of higher prices—precisely what opponents of the tax predicted would happen. The next chapter of the saga? The targeted US firms will testify on Capitol Hill as lawmakers mull retributions, and the US Trade Representative's Office has opened a probe into the tax, which could lead to new tariffs on French goods entering the country. Does anyone really believe the big tech companies will be the ones hurt by this wanton action? As evidenced by Amazon's actions, it will be the small business owners and consumers absorbing the pain.
Industrial Conglomerates
Madoff whistleblower calls GE's accounting practices the biggest case of fraud he has ever witnessed. General Electric (GE $7-$8-$14) was once our most respected company, with shares sitting in nearly every client's portfolio. A symbol of great American ingenuity and innovation, it topped the list of the world's largest companies back in 2000, with a market cap of nearly $500 billion. How quickly things can change—due to management—in the fast-paced world of business. Today, the company is a shell of its former self, with a market cap of just $70 billion following its largest decline since the financial crisis. The reason for the 11%, one-day drop was a bombshell report issued by the man who blew the lid off the Bernie Madoff Ponzi scheme, Harry Markopolos. The certified fraud analyst calls the company's accounting practices "a bigger fraud than Enron and WorldCom combined," and even set up a website (gefraud.com) to detail the company's purportedly nefarious acts. Markopolos said his team spent seven months analyzing the company's accounting practices, finding $38 billion worth of fraud hidden by bogus financial statements. The company vociferously denied the allegations, with CEO Larry Culp buying over a quarter-of-a-million shares after they fell below the $8 mark. Only time will tell whether or not the analyst's accusations are correct, but the company has been on a downward slide ever since Jack Welch handed over the top spot to Jeffrey Immelt back in 2001. Remarkably, Immelt leapfrogged over Robert Nardelli and James McNerney, two highly-successful business leaders, to be awarded the CEO position from GE's board of directors. Larry Culp succeeded Immelt in October of last year. Whether or not these serious accusations are true, we wouldn't touch GE shares in any of our five strategies. The company continues to flop and flounder in search of a cogent strategic plan that involves more than shedding units to raise cash and lower its debt load.
Economic Outlook
An inverted yield curve drives Dow down 400 points at open. On Wednesday morning, the yield on a 2-year Treasury hit 1.634%. In and of itself, that shouldn't have been a big deal. The problem came when, at the precise same time, the yield on a 10-year Treasury hit 1.623%, lower than the two-year. Thus comes the infamous yield curve inversion—when longer-term Treasuries offer less than their shorter-term counterparts. The two- and the ten-year Treasuries are considered benchmarks, and when these two benchmark rates invert, a recession normally hits about 22 months later. Yes, this is anecdotal, but it was enough to spook investors into a big, early morning selloff. While the last five inversions have preceded recessions, that doesn't necessarily spell doom-and-gloom for the markets, however. On average, one year after an inversion the S&P 500 is up 12% from the date of the event. So why does a yield curve ever invert in the first place? It has to do with supply and demand. If bond buyers believe economic trouble is on the horizon, they see continued monetary easing to accommodate weaker economic activity, meaning lower yields for a long period of time. This makes them shy away from longer bonds and load up on shorter-term notes. We see a lot of lingering challenges for the economic environment going forward, both at home and abroad. While the GDP has remained relatively strong at home, and unemployment remains low, there is a point at which the global slowdown hits home. Our Tactical Asset Allocation models for Summer, 2019 reflect those concerns. Clients and members can login to see the models, which are adjusted as needed updated quarterly.
Economics: Housing
The Fed's first rate cut in eleven years causes big spike in mortgage loan activity. On the last day of July, the Fed did something it hasn't done since December of 2008: lower the Fed funds rate. The lower band of the target now sits at 2%, which would be somewhat remarkable were it not for the $14 trillion worth of bonds and notes around the world which carry negative yields. The Fed's most recent action saw one intended consequence come to fruition: there was a flurry of mortgage loan activity last week. According to new data from the Mortgage Bankers Association, volume in mortgage applications spiked just over 20% last week, or a whopping 81% from the same time last year. The vast majority of this volume came from current homeowners looking to lock in lower rates—and lower monthly payments—on their existing homes, as evidenced by the meager 2% rise in mortgage applications for new purchasers. The average rate on a 30-year fixed mortgage fell to 3.93%, its lowest level since November of 2016. The one disconcerting figure in the data is the lack of any real activity by new buyers. Despite the low mortgage rates and historically-low level of unemployment, rising home prices are making affordability a real issue. An under-supply of new homes, especially at the lower end of the spectrum, appears to be the major culprit. Although we are currently shying away from the homebuilders, D.R. Horton (DHI), which constructs homes ranging in price from $100,000 to over $1,000,000, is our current favorite player in the industry.
Global Strategy: Latin America
Argentina's stock market melts down following President Macri's primary loss. Four years ago, in the winter of 2015, we wrote of Mauricio Macri's unlikely presidential win in Argentina. In a leftist country which blames America for the military coup d'etat
of 1976 and the ensuing Dirty War, it was remarkable that a center-right, pro-business candidate could ascend to the office. Now, Macri's unlikely journey has come to an end. Anger among voters over austerity measures put in place following an International Monetary Fund (IMF) bailout in 2018, and the country's rampant inflation, led to a drubbing in the primaries for the president. A strong showing by the populist Peronists—those sharing the leftist ideology of former President Juan Domingo Perón and his second wife, Eva Perón—pushed Alberto Fernández easily over the finish line. Most disconcerting may be the fact that his running mate will be the nation's former president, Cristina Kirchner, an anti-American nationalist. In addition to the country's stock market plummeting, the Argentine peso has weakened about 25% since the primary results. Instead of celebrating, the citizens should be pondering the country's economic path under a Fernández/Kirchner regime—it won't be pretty. Argentina has South America's second-largest economy, behind Brazil. Instead of buying a basket of Latin American stocks (such as the iShares Latin America 40, symbol ILF), consider country-specific ETFs from areas making economic progress, such as the iShares MSCI Brazil Capped ETF (symbol EWZ).
Global Strategy: East/Southeast Asia
Is Hong Kong suddenly becoming the biggest threat to the markets? It has to be one of the most predictable, slow-moving train wrecks in history. When the UK handed over control of the glittering economic jewel that is Hong Kong to the communist country of China, its future became set in stone. A gigantic clash of cultures was inevitable. Now, with pro-democracy demonstrators shutting down the Hong Kong airport, one of the busiest in the world, they are almost daring China's communist leaders to respond with force. Not only are these freedom fighters impeding the flow of cash from this vibrant economic region, they are also giving China's image a black eye, and the latter will not be tolerated by a country which controls its false narratives with an iron fist. No matter how this most recent protest at the airport ends, the battles are only going to intensify. And when that happens, expect some ugly volatility in the markets. Official minions of the Chinese government are already using the word "terrorism" to describe some of the protesters' actions. This language is choreographed, designed to lend some warped sense of credibility to the Chinese military's potential moves in the region. While investors have been focused on the tattered state of US/China trade talks, this powder keg could steal the headline on any given day. This geopolitical issue should be factored into every investor's risk management matrix.
Headlines for the Week of 04 Aug 2019—10 Aug 2019
Food Products
Kraft will delay second-quarter earnings filing, stock plummets yet again. 63%. That is how far shares of Kraft-Heinz (KHC $27-$27-$62) have fallen since Warren Buffet helped 3G force the two companies together back in 2015. There are a couple of reasons for Thursday's 14% drop in early trading. First, the company disclosed that it would take a $1.22 billion write-down due to the reduced value of both its operations in several emerging markets and a number of product lines, such as Miracle Whip, Velveeta, and Maxwell House. The second shoe to drop was the announcement that the company would have to delay its quarterly filing with the SEC. This comes on the heels of an SEC investigation into KHC's accounting practices and internal controls (which Warren Buffett categorized as a "dispute with its auditor"). As for the $1.22 billion reduction in the book value of assets, it pales in comparison to the $15 billion write-down the company took on its Kraft and Oscar Mayer brands earlier this year. Sitting at their all-time low, are shares of KHC attractive at $27 per share? We could look at the company's P/E ratio, but there isn't one (you need the "E" part of the equation to be a positive number). We could consider management, but that wouldn't lend comfort. Then there there is the industry outlook for a company whose main products reside on the "inner shelves" of the grocery store. Ouch. Not sure what the growth catalyst is, but we can think of a number of reasons for the stock to go lower.
Global Strategy: Europe
Germany's economy is in the tank, and sorry, it is not because of the US/China trade war. First the cold, hard, facts: German industrial production just suffered its worst annual decline in a decade, down 5.2% from the previous, unimpressive year. Every single maturity of German government bonds being issued now comes with a negative yield. German automakers are slashing their estimates, and unemployment is on the rise. Now the narrative being foisted by the media: it is all America's fault. If we hadn't started this "unwinnable" trade war, the world's third-largest economy would be humming along. Please. Doesn't it make more sense that China and Germany would be cozying up, vis-à-vis trade, to battle the big bully Trump? No, this is about Merkel's weak leadership, a country going down an insane Keynesian path, and a futile attempt to stimulate an economy using below-zero rates. With France and Germany as the titular heads of the European Union, is it any wonder Brits voted to vamoose? Back in February, we reported that Germany barely skirted a recession thanks to a 0.2% GDP in the third quarter of 2018. Now, however, the Bundesbank is predicting the nation's economy contracted again in the second quarter, fueling fears of a recession. To us, that seems like a foregone conclusion. Germany is an incredible country, filled with hard-working individuals and a rich past—minus the pure evil that enveloped the land in the early-to-mid 20th century. The beast that is the EU, however, has tainted their thinking and warped their ability to maintain sound fiscal policy. The country that was once paranoid about inflation (following the nightmare of the 1930s) is now issuing 30-year bonds with a negative yield! And that is sheer madness.
Currency Trading/FOREX
As if everyone didn't already know it: China has been officially labeled a currency manipulator. Under the framework of the Trade and Competitiveness Act of 1988, it is the duty of the US Department of Treasury to analyze the exchange rate policies of countries around the world to assure manipulation—to gain an unfair trade advantage—of a national currency is not taking place. To that end, and following the recent weakening of the Chinese yuan by the People's Bank of China (PBOC), Treasury has officially labeled the Chinese a currency manipulator. The weaker a country's currency, the cheaper their goods become for others around the world, making purchases more enticing. Right now, one US dollar will buy 7.02 Chinese yuan—the most since March of 2008, just before the huge market selloff due to the financial crisis. While countries are supposed to let their currency float freely, swayed by the market forces of supply and demand, the communist Chinese have openly stated they are willing to use the yuan's level as a weapon in their arsenal. Talk about admitting guilt. The next step for the United States is to bring the case before two bodies: the International Monetary Fund (IMF), and the World Trade Organization (WTO). While the IMF has little power other than confirming the manipulation claim, the WTO can authorize countries to place punitive tariffs in response to violations. But does that really matter? After all, President Trump has already announced a 10% tariff on the remaining $300 billion worth of goods coming from China as of the 1st of September. Here's an interesting take on China's yuan manipulation, highlighting the tenuous position they are in: If the new tariffs actually see the light of day, it will mean $30 billion in funds flowing to the Treasury Department. The big argument has been that this will be tantamount to a tax on US corporations and the American consumer—to the degree that each will pay for the added costs. However, the weaker China's yuan becomes, the less it will cost to import those goods, thus offsetting a good portion of that 10%.
Specialty Retail
The layoffs at Lowe's have a lot to do with management and little to do with the US economy. We have all known people who just can't seem to get things right. They make mistake after mistake, never growing from the lessons of the past. Companies are a lot like people—they have personalities, and they have their own unique style—be it good or bad. Take Lowe's (LOW $85-$96-$118), for instance. As opposed to archrival Home Depot (HD), the company has done little right over the past decade. Poor service, long checkout lines, and a lack of self-checkouts (do they think their customers are prone to stealing?) have been chronic foibles of the company. This past week, Lowe's announced it would be laying off thousands of maintenance and assembly workers (those people you see putting products together in the store) to save money. According to the company, this will allow employees more time to spend serving the customers. That sounds great—in theory. However, as the recipient of dagger-laden stares when asking employees for help finding an item, paint us skeptical. The store has a personality problem: customers don't like theirs. And layoffs are only going to exacerbate that problem. Mistake after mistake. The company needed a serious renovation, so who did it tap as a new CEO? The man who furthered JC Penney's decline (after Ron Johnson mucked it up), Marvin Ellison.
Kraft will delay second-quarter earnings filing, stock plummets yet again. 63%. That is how far shares of Kraft-Heinz (KHC $27-$27-$62) have fallen since Warren Buffet helped 3G force the two companies together back in 2015. There are a couple of reasons for Thursday's 14% drop in early trading. First, the company disclosed that it would take a $1.22 billion write-down due to the reduced value of both its operations in several emerging markets and a number of product lines, such as Miracle Whip, Velveeta, and Maxwell House. The second shoe to drop was the announcement that the company would have to delay its quarterly filing with the SEC. This comes on the heels of an SEC investigation into KHC's accounting practices and internal controls (which Warren Buffett categorized as a "dispute with its auditor"). As for the $1.22 billion reduction in the book value of assets, it pales in comparison to the $15 billion write-down the company took on its Kraft and Oscar Mayer brands earlier this year. Sitting at their all-time low, are shares of KHC attractive at $27 per share? We could look at the company's P/E ratio, but there isn't one (you need the "E" part of the equation to be a positive number). We could consider management, but that wouldn't lend comfort. Then there there is the industry outlook for a company whose main products reside on the "inner shelves" of the grocery store. Ouch. Not sure what the growth catalyst is, but we can think of a number of reasons for the stock to go lower.
Global Strategy: Europe
Germany's economy is in the tank, and sorry, it is not because of the US/China trade war. First the cold, hard, facts: German industrial production just suffered its worst annual decline in a decade, down 5.2% from the previous, unimpressive year. Every single maturity of German government bonds being issued now comes with a negative yield. German automakers are slashing their estimates, and unemployment is on the rise. Now the narrative being foisted by the media: it is all America's fault. If we hadn't started this "unwinnable" trade war, the world's third-largest economy would be humming along. Please. Doesn't it make more sense that China and Germany would be cozying up, vis-à-vis trade, to battle the big bully Trump? No, this is about Merkel's weak leadership, a country going down an insane Keynesian path, and a futile attempt to stimulate an economy using below-zero rates. With France and Germany as the titular heads of the European Union, is it any wonder Brits voted to vamoose? Back in February, we reported that Germany barely skirted a recession thanks to a 0.2% GDP in the third quarter of 2018. Now, however, the Bundesbank is predicting the nation's economy contracted again in the second quarter, fueling fears of a recession. To us, that seems like a foregone conclusion. Germany is an incredible country, filled with hard-working individuals and a rich past—minus the pure evil that enveloped the land in the early-to-mid 20th century. The beast that is the EU, however, has tainted their thinking and warped their ability to maintain sound fiscal policy. The country that was once paranoid about inflation (following the nightmare of the 1930s) is now issuing 30-year bonds with a negative yield! And that is sheer madness.
Currency Trading/FOREX
As if everyone didn't already know it: China has been officially labeled a currency manipulator. Under the framework of the Trade and Competitiveness Act of 1988, it is the duty of the US Department of Treasury to analyze the exchange rate policies of countries around the world to assure manipulation—to gain an unfair trade advantage—of a national currency is not taking place. To that end, and following the recent weakening of the Chinese yuan by the People's Bank of China (PBOC), Treasury has officially labeled the Chinese a currency manipulator. The weaker a country's currency, the cheaper their goods become for others around the world, making purchases more enticing. Right now, one US dollar will buy 7.02 Chinese yuan—the most since March of 2008, just before the huge market selloff due to the financial crisis. While countries are supposed to let their currency float freely, swayed by the market forces of supply and demand, the communist Chinese have openly stated they are willing to use the yuan's level as a weapon in their arsenal. Talk about admitting guilt. The next step for the United States is to bring the case before two bodies: the International Monetary Fund (IMF), and the World Trade Organization (WTO). While the IMF has little power other than confirming the manipulation claim, the WTO can authorize countries to place punitive tariffs in response to violations. But does that really matter? After all, President Trump has already announced a 10% tariff on the remaining $300 billion worth of goods coming from China as of the 1st of September. Here's an interesting take on China's yuan manipulation, highlighting the tenuous position they are in: If the new tariffs actually see the light of day, it will mean $30 billion in funds flowing to the Treasury Department. The big argument has been that this will be tantamount to a tax on US corporations and the American consumer—to the degree that each will pay for the added costs. However, the weaker China's yuan becomes, the less it will cost to import those goods, thus offsetting a good portion of that 10%.
Specialty Retail
The layoffs at Lowe's have a lot to do with management and little to do with the US economy. We have all known people who just can't seem to get things right. They make mistake after mistake, never growing from the lessons of the past. Companies are a lot like people—they have personalities, and they have their own unique style—be it good or bad. Take Lowe's (LOW $85-$96-$118), for instance. As opposed to archrival Home Depot (HD), the company has done little right over the past decade. Poor service, long checkout lines, and a lack of self-checkouts (do they think their customers are prone to stealing?) have been chronic foibles of the company. This past week, Lowe's announced it would be laying off thousands of maintenance and assembly workers (those people you see putting products together in the store) to save money. According to the company, this will allow employees more time to spend serving the customers. That sounds great—in theory. However, as the recipient of dagger-laden stares when asking employees for help finding an item, paint us skeptical. The store has a personality problem: customers don't like theirs. And layoffs are only going to exacerbate that problem. Mistake after mistake. The company needed a serious renovation, so who did it tap as a new CEO? The man who furthered JC Penney's decline (after Ron Johnson mucked it up), Marvin Ellison.
Headlines for the Week of 28 Jul 2019—03 Aug 2019
Monetary Policy
Are you kidding? Did the market just have a mini-meltdown because rates may not go even lower? Virtually every Fed watcher expected what the central bank gave us on Wednesday: a 25-basis-point cut in the target Fed funds rate. The lower channel of the target range now sits right at 2%. As is so often the case, the market's trajectory shifted as Fed Chair Powell gave his post-meeting news conference. Despite the fact that Powell never said there wouldn't be another rate cut, investors read the commentary as a "one and done," sending the Dow down 400 points before clawing some of that back. Bizarro World. If only these market-movers got this upset over a $22 trillion national debt that is growing (in a strong economy and with ultra-low rates) by a trillion dollars per year. Now that is something to have a meltdown over. There are so many crazy aspects to this story to consider, so let's go in a different direction with this question to ponder: Rates around the world are sitting near zero, but do you think the typical American family's revolving credit card interest rate has come down from its confiscatory 19.99%? Yet another missed aspect of the rate story to be truly outraged over.
Global Strategy: Trade
Tax our tech and we'll tax your wine. If you think our politicians hate big tech, try going to Europe. Call it envy, but various EU government entities have had it out for the likes of Facebook (F), Amazon (AMZN), Apple (AAPL), and Alphabet (GOOGL) for some time. If these American giants aren't in the midst of being slapped with new fines or made-up taxes, they are busy defending themselves against new charges coming from every direction of the continent. The latest example comes to us from our old friends, the French. Not only will that country begin levying a 3% "digital services" tax on big US tech companies (nearly all French companies are exempted based on the way the reg was written), they will make it retroactive to the start of 2019—showing that country's reckless abandon with respect to international business law. But this time, the US is fighting back. The Trump Administration is threatening France where it hurts: it is considering a tax on all French wine entering the country. How big a deal is that? The United States is the largest importer of French wine, accounting for nearly one-quarter of all bottles exported. The French, for their part, say the digital tax should be universally applied to big tech by all countries, but that they are happy to "go it alone" for now. That is a dangerous game, and one which will almost assuredly be met with a more onerous response. This will be a fascinating battle to watch unfold. Most French politicians have an arrogant disdain for Trump, but he holds a much bigger stick than do they. For its part, the US Trade Representative's Office (USTR) will hold a hearing on 19 Aug to delve into the tax and discuss countermeasures to offer the president.
Currency Trading/FOREX
The British pound looks tempting as anti-Brexit fear-mongers drive its value down. Listening to the pundits, you would think that England is set to sink into the North Atlantic if the country blows out of the hapless EU this fall without a deal in place. That is precisely the kind of drivel we heard surrounding the actual Brexit vote back in 2016—if England leaves the sanctity of the Union, it was doomed. Of course, we now know that the dire predictions never came to pass (like the mass exodus of companies to mainland Europe), but that hasn't stopped the doomsayers from spewing their vacuous warnings all over again. All of this talk has had a detrimental effect on the jittery British pound, which has fallen against the US dollar to levels it really hasn't seen (with the exception of the period immediately following the Brexit vote) since the mid-'80s. One British pound will now fetch approximately 1.21 US dollars. Granted, that is still about 20% from the relative parity the pound reached with the dollar some 35 years ago, but expect it to weaken further as a no-deal Brexit becomes more likely. We heard one FOREX trader predict a trading range for the pound/US dollar of 1.10 to 1.40—the former if a "no-deal" exit takes place, and the latter if a deal gets done. FXB is the symbol for the Invesco CurrencyShares® British Pound Sterling Trust. This exchange-traded instrument has dropped nearly 30% over the past five years, and is entering an interesting trading range—which will probably get more favorable as we get closer to the current 31 October Brexit deadline.
Telecom Services
The latest in the Sprint/T-Mobile saga: a major hurdle cleared, a loss of the Sprint name, and lingering state lawsuits. Settle in—there are plenty of twists and turns remaining in the biggest story in telecom services: the proposed merger between T-Mobile (TMUS $59-$82-$85) and Sprint (S $5-$8-$8). To recap: AT&T (T) and Verizon (VZ) are the big dogs in the industry, with T-Mobile and Sprint coming in a distant third and fourth, respectively. The latter two wish to merge to better compete, but several state AGs are claiming this would lead to price gouging. (A ludicrous claim, as it is more likely that Sprint would be on the slow path towards insolvency without the merger, which would leave the same two major players and one less small fry.) Now that the Department of Justice has finally given its blessing to the merger, assuming the two players sell assets to Dish Network (DISH) to help it become a new 5G wireless player, the story should be over, right? Not so fast. Attorneys general from fourteen states—including California and New York—have filed suit to stop the merger, claiming low-income families will be hurt. Ultimately, we expect the lawsuit to be thrown out, but that won't happen until late this year at the earliest. When the $26 billion deal finally does go through (and it will), expect to say goodbye to the Sprint name. The new company will be called T-Mobile, and that firm's odd-duck CEO, John Legere, will run the show. While that may be a scary prospect, under the agreement made with the DoJ and the FCC, both the new T-Mobile and the new entrant Dish will be required to rollout 5G service to virtually every corner of the US, no matter how rural the area. And that is a very good thing. We own AT&T in the Strategic Income Portfolio, and that is the only carrier that looks attractive right now. Sprint's market cap has moved above the $26 billion deal price-tag, and Dish is going to have to spend a ton of money to make good on its promises to the FCC.
Textiles, Apparel, & Luxury Goods
Are Under Armour shares a bargain after suffering a double-digit decline on weak earnings? Shares of athletic apparel maker Under Armour (UA $15-$22-$25) plunged about 20% following the company's Q2 earnings release and revised full-year guidance. Sales weren't bad—up about 1.5%, to $1.19 billion, over last year's second quarter—but the Baltimore-based firm suffered a net loss of $17.3 million in the quarter. While that is a lot better than last year's Q2 loss of $95 million, analysts are beginning to question whether or not the $10 billion company can keep pace in North America with the likes of much larger rivals Nike (NKE) and Adidas (ADDYY). While maintaining the global forecast for the year, management now sees a decline in North American sales for FY2019; Under Armour sold just $816 million worth of goods in the region during the quarter. After watching product sales slide in third-party stores such as Dick's Sporting Goods (DKS) and Foot Locker (FL), the company is making a strategic push into direct-to-consumer sales, both via its online presence and through its roughly 300 North American stores. Management has also undertaken a major restructuring effort to reduce spending and create a more efficient supply chain. For investors, it's a waiting game to see whether or not CEO Kevin Plank has a little more magic up his sleeve. We want to see Under Armour take some market share from Nike, but prospects of that happening appear to be a coin toss at best right now. Furthermore, we have railed against dual-class shares that give the anointed few an inordinate amount of voting control—UA has three share classes, with Plank's class B shares controlling the game.
Technology Hardware & Equipment
If you own an iPhone, you may not want to upgrade until next year. A few months ago, we posited a theory that Apple (AAPL $142-$210-$233) shares would take a strong upward tick in 2020 thanks to one amazing new technology: 5G. We mentioned that, unbeknownst to many, the current smartphones on the market—outside of a Samsung (SSNGY) model or two—do not support the technology, and that everyone will be clamoring for 5G once they get a glimpse of it. Apple apparently feels the same way, at least according to one major Apple analyst. Based on a story in MacRumors, all iPhone models which Apple will introduce in 2020 will be 5G-capable, thus signaling the beginning of the end for 4G's run—at least that is the speculation of TF Securities analyst Ming-Chi Kuo. We agree with his analysis. Apple knows it cannot allow foreign competitors like Samsung to get a leg-up on this critical new technology, which is one reason the company recently agreed to to buy Intel's modem division (think 5G technology) for $1 billion. We will play this theory out a step further: expect soft iPhone sales this fall as more and more Apple users (like us) decide to wait until the 5G-capable phones hit the market. This will scare some analysts, and may lead to a great buying opportunity in Apple shares in September or October. We already own the company in the Penn Global Leaders Club, but this fall may end up being a great time for newcomers to jump in. We remain concerned about Tim Cook's lack of apparent commitment (in our opinion) to new hardware, despite the 5G iPhone rollout coming next year. The company needs a new Jony Ive or, dare we say, Steve Jobs-like figure to enter the scene to develop the next generation of incredible Apple hardware.
Are you kidding? Did the market just have a mini-meltdown because rates may not go even lower? Virtually every Fed watcher expected what the central bank gave us on Wednesday: a 25-basis-point cut in the target Fed funds rate. The lower channel of the target range now sits right at 2%. As is so often the case, the market's trajectory shifted as Fed Chair Powell gave his post-meeting news conference. Despite the fact that Powell never said there wouldn't be another rate cut, investors read the commentary as a "one and done," sending the Dow down 400 points before clawing some of that back. Bizarro World. If only these market-movers got this upset over a $22 trillion national debt that is growing (in a strong economy and with ultra-low rates) by a trillion dollars per year. Now that is something to have a meltdown over. There are so many crazy aspects to this story to consider, so let's go in a different direction with this question to ponder: Rates around the world are sitting near zero, but do you think the typical American family's revolving credit card interest rate has come down from its confiscatory 19.99%? Yet another missed aspect of the rate story to be truly outraged over.
Global Strategy: Trade
Tax our tech and we'll tax your wine. If you think our politicians hate big tech, try going to Europe. Call it envy, but various EU government entities have had it out for the likes of Facebook (F), Amazon (AMZN), Apple (AAPL), and Alphabet (GOOGL) for some time. If these American giants aren't in the midst of being slapped with new fines or made-up taxes, they are busy defending themselves against new charges coming from every direction of the continent. The latest example comes to us from our old friends, the French. Not only will that country begin levying a 3% "digital services" tax on big US tech companies (nearly all French companies are exempted based on the way the reg was written), they will make it retroactive to the start of 2019—showing that country's reckless abandon with respect to international business law. But this time, the US is fighting back. The Trump Administration is threatening France where it hurts: it is considering a tax on all French wine entering the country. How big a deal is that? The United States is the largest importer of French wine, accounting for nearly one-quarter of all bottles exported. The French, for their part, say the digital tax should be universally applied to big tech by all countries, but that they are happy to "go it alone" for now. That is a dangerous game, and one which will almost assuredly be met with a more onerous response. This will be a fascinating battle to watch unfold. Most French politicians have an arrogant disdain for Trump, but he holds a much bigger stick than do they. For its part, the US Trade Representative's Office (USTR) will hold a hearing on 19 Aug to delve into the tax and discuss countermeasures to offer the president.
Currency Trading/FOREX
The British pound looks tempting as anti-Brexit fear-mongers drive its value down. Listening to the pundits, you would think that England is set to sink into the North Atlantic if the country blows out of the hapless EU this fall without a deal in place. That is precisely the kind of drivel we heard surrounding the actual Brexit vote back in 2016—if England leaves the sanctity of the Union, it was doomed. Of course, we now know that the dire predictions never came to pass (like the mass exodus of companies to mainland Europe), but that hasn't stopped the doomsayers from spewing their vacuous warnings all over again. All of this talk has had a detrimental effect on the jittery British pound, which has fallen against the US dollar to levels it really hasn't seen (with the exception of the period immediately following the Brexit vote) since the mid-'80s. One British pound will now fetch approximately 1.21 US dollars. Granted, that is still about 20% from the relative parity the pound reached with the dollar some 35 years ago, but expect it to weaken further as a no-deal Brexit becomes more likely. We heard one FOREX trader predict a trading range for the pound/US dollar of 1.10 to 1.40—the former if a "no-deal" exit takes place, and the latter if a deal gets done. FXB is the symbol for the Invesco CurrencyShares® British Pound Sterling Trust. This exchange-traded instrument has dropped nearly 30% over the past five years, and is entering an interesting trading range—which will probably get more favorable as we get closer to the current 31 October Brexit deadline.
Telecom Services
The latest in the Sprint/T-Mobile saga: a major hurdle cleared, a loss of the Sprint name, and lingering state lawsuits. Settle in—there are plenty of twists and turns remaining in the biggest story in telecom services: the proposed merger between T-Mobile (TMUS $59-$82-$85) and Sprint (S $5-$8-$8). To recap: AT&T (T) and Verizon (VZ) are the big dogs in the industry, with T-Mobile and Sprint coming in a distant third and fourth, respectively. The latter two wish to merge to better compete, but several state AGs are claiming this would lead to price gouging. (A ludicrous claim, as it is more likely that Sprint would be on the slow path towards insolvency without the merger, which would leave the same two major players and one less small fry.) Now that the Department of Justice has finally given its blessing to the merger, assuming the two players sell assets to Dish Network (DISH) to help it become a new 5G wireless player, the story should be over, right? Not so fast. Attorneys general from fourteen states—including California and New York—have filed suit to stop the merger, claiming low-income families will be hurt. Ultimately, we expect the lawsuit to be thrown out, but that won't happen until late this year at the earliest. When the $26 billion deal finally does go through (and it will), expect to say goodbye to the Sprint name. The new company will be called T-Mobile, and that firm's odd-duck CEO, John Legere, will run the show. While that may be a scary prospect, under the agreement made with the DoJ and the FCC, both the new T-Mobile and the new entrant Dish will be required to rollout 5G service to virtually every corner of the US, no matter how rural the area. And that is a very good thing. We own AT&T in the Strategic Income Portfolio, and that is the only carrier that looks attractive right now. Sprint's market cap has moved above the $26 billion deal price-tag, and Dish is going to have to spend a ton of money to make good on its promises to the FCC.
Textiles, Apparel, & Luxury Goods
Are Under Armour shares a bargain after suffering a double-digit decline on weak earnings? Shares of athletic apparel maker Under Armour (UA $15-$22-$25) plunged about 20% following the company's Q2 earnings release and revised full-year guidance. Sales weren't bad—up about 1.5%, to $1.19 billion, over last year's second quarter—but the Baltimore-based firm suffered a net loss of $17.3 million in the quarter. While that is a lot better than last year's Q2 loss of $95 million, analysts are beginning to question whether or not the $10 billion company can keep pace in North America with the likes of much larger rivals Nike (NKE) and Adidas (ADDYY). While maintaining the global forecast for the year, management now sees a decline in North American sales for FY2019; Under Armour sold just $816 million worth of goods in the region during the quarter. After watching product sales slide in third-party stores such as Dick's Sporting Goods (DKS) and Foot Locker (FL), the company is making a strategic push into direct-to-consumer sales, both via its online presence and through its roughly 300 North American stores. Management has also undertaken a major restructuring effort to reduce spending and create a more efficient supply chain. For investors, it's a waiting game to see whether or not CEO Kevin Plank has a little more magic up his sleeve. We want to see Under Armour take some market share from Nike, but prospects of that happening appear to be a coin toss at best right now. Furthermore, we have railed against dual-class shares that give the anointed few an inordinate amount of voting control—UA has three share classes, with Plank's class B shares controlling the game.
Technology Hardware & Equipment
If you own an iPhone, you may not want to upgrade until next year. A few months ago, we posited a theory that Apple (AAPL $142-$210-$233) shares would take a strong upward tick in 2020 thanks to one amazing new technology: 5G. We mentioned that, unbeknownst to many, the current smartphones on the market—outside of a Samsung (SSNGY) model or two—do not support the technology, and that everyone will be clamoring for 5G once they get a glimpse of it. Apple apparently feels the same way, at least according to one major Apple analyst. Based on a story in MacRumors, all iPhone models which Apple will introduce in 2020 will be 5G-capable, thus signaling the beginning of the end for 4G's run—at least that is the speculation of TF Securities analyst Ming-Chi Kuo. We agree with his analysis. Apple knows it cannot allow foreign competitors like Samsung to get a leg-up on this critical new technology, which is one reason the company recently agreed to to buy Intel's modem division (think 5G technology) for $1 billion. We will play this theory out a step further: expect soft iPhone sales this fall as more and more Apple users (like us) decide to wait until the 5G-capable phones hit the market. This will scare some analysts, and may lead to a great buying opportunity in Apple shares in September or October. We already own the company in the Penn Global Leaders Club, but this fall may end up being a great time for newcomers to jump in. We remain concerned about Tim Cook's lack of apparent commitment (in our opinion) to new hardware, despite the 5G iPhone rollout coming next year. The company needs a new Jony Ive or, dare we say, Steve Jobs-like figure to enter the scene to develop the next generation of incredible Apple hardware.
Headlines for the Week of 21 Jul 2019—27 Jul 2019
Medical Devices
It has been a super-rough year for the maker of Invisalign. The business model seems brilliant: instead of parents paying out thousands upon thousands of dollars to the orthodontist, or adults being forced to wear braces to work, create a nearly-invisible teeth-aligning system for a fraction of the price. And, in fact, Align Technology (ALGN $178-$200-$399), maker of the Invisalign system, saw its share price go from $50 five years ago to $400 by the fall of 2018. That was a nice ride up for investors, but anyone discovering the stock a year ago would be hurting—shares have been cut nearly in half since last July, falling a full 27% on Thursday. The somewhat bizzarre aspect to the massive drop in share price is the company's Q2 beat on both the top and bottom lines, earning $147 million (+39% y/y) on $601 million in sales (+22.5% y/y). The breakdown occurred, however, as analysts began poring over the post-earnings press release. Laying the blame on weakness in China and slower growth in North America, CEO Joe Hogan greatly muted expectations for the third quarter. The first excuse is simply that: an excuse. The second complaint has us befuddled: Hogan said that there appears to be "a little more reticence on consumers to spend." We haven't seen a pullback in spending by the US consumer anywhere else. Could it be that new entrants are finally eating into Invisalign's market share? This stock was priced for perfection, and with a number of patents expiring, expect a flood of competition to put downward pressure on the shares. Don't touch it.
Interactive Media & Services
"Everyone" hates Facebook, but is anyone concerned about government overreach? It feels as though we are in the 5% minority on this issue, but we are bothered by the wanton use of force against private-sector companies by the anointed ones in the public sector. The Federal Trade Commission just hit Facebook (FB $123-$204-$219) with a $5 billion fine (er, "settlement") stemming from privacy violations it claims the company committed back in 2012, plus stripped CEO Mark Zuckerberg and the FB board of some rather ordinary leadership powers. The fine is no big deal for the $600 billion firm, but the intrusion into the board room by a bunch of politicians is a big deal. Even more disconcerting is the angry reaction by Democrats sitting on the FTC, who wanted Zuckerberg held personally liable. Is that where we are at right now in this country? How about we start throwing CEOs in prison every time there is a data breach? Why stop there, let's give them ninety days of jail time for an earnings miss. After all, Dodd-Frank put corporate leaders on the hot seat for virtually everything that happens at a company. It may sound facetious, but the scariest component of this story is the percentage of Americans who would be happy placing someone in the pokey because they disagree with their political point of view. We are not talking about real criminals, like Kozlowski of Tyco, Ebbers of Worldcom, or Ken Lay of Enron; we are talking about people simply disliked for the way they think. That sounds a lot more like North Korea than a Western republic. A little more analytical thought and a lot less gulping down of the false narratives presented as fact by a lazy and tainted press corps would go a long way in leading us back down the road toward national sanity. While it was down on news of the settlement, Facebook regained all lost ground after reporting unexpectedly-high revenues of $17 billion for the quarter, and profit roughly equal to the FTC fine (settlement).
Telecom Services
AT&T surges as wireless business grows, overshadowing the cord-cutter problem. First the bad news: Penn member AT&T's (T $27-$33-$34) DirecTV problems continue to mount, as a record number of customers drop the service. In fact, a full 778,000 DirecTV and U-Verse customers cut the cord over the course of the quarter. Now the good news: against expectations for 27,000 new phone subscribers, T actually netted 72,000 new sign-ups. The latter metric, combined with excitement over the launch of HBO (a T company) Max this coming spring, helped push T shares up over 3% at Wednesday's open. While the company is still riddled with debt following its massive purchase of Time Warner, management remains committed to reducing that debt load to $150 billion (down from $180 billion) by the end of the year. T is up around 10% since we added it back to the Strategic Income Portfolio this past February. We moved it into the SIP due to its 6% dividend yield and solid outlook.
Food Products
It's not McDonald's, but Beyond Meat just landed at Dunkin'. Several months ago we predicted that Beyond Meat (BYND $45-$203-$208), the high-flying, plant-based meat company we bought at IPO, would land McDonald's (MCD) as a client by the end of the year. While that has not happened yet, Dunkin' Brands (DNKN) did just become the first national chain to offer a sandwich made with the company's Beyond Sausage product. While the breakfast sandwich will initially be rolled out at Dunkin' stores in NYC, we can expect them at nationwide locations soon. Massive Canadian coffee chain Tim Hortons, owned by Restaurant Brands International (QSR), has already rolled out a similar breakfast sandwich, in addition to offering its customers The Beyond Burger. Shares of BYND have surged recently in anticipation of the company's first quarterly earnings report since going public. Beyond will report its Q2 earnings this coming Monday, with analysts expecting to see $52.7 million in revenue for the quarter.
Global Strategy: Europe
You heard it here first: with Prime Minister Boris Johnson, Britain will finally blow out of the EU. The machinations of government grind so slowly that we often misread the strong undercurrents of a political movement. The press dutifully report the movement as simply a bunch of crackpots blowing off some steam...at least until the subterranean activity manifests in a shocking (at least to those who believed the reporting) manner. That is precisely what is happening in the United Kingdom right now. Erudite journalists writing for pompous publications like The Economist laugh off the likes of a Boris Johnson, the outspoken Brexiteer and former mayor of London, right up to the point at which the target of their ridicule becomes the leader of the country. And that is exactly what will happen this week, as the man who assured Britons that Brexit will happen this year, with or without a deal in place, becomes Prime Minister Boris Johnson. The hatred for this man is palpable, and loud. But that doesn't matter now. He will assume the throne, execute the will of the people, and lead Britain out of the bumbling, inept EU. And England will not only survive, it will thrive. And that will make Boris Johnson all the more hated by the arrogant cabal which has impugned him incessantly for the past three years. The iShares MSCI United Kingdom ETF, symbol EWU, is down 23% over the past five years. If we are correct in our predictions, now might be a good time to pick up some shares to fill any international gaps in a portfolio. It certainly looks better than an investment in a basket of French or German companies right now.
Technology Hardware & Equipment
A new twist in the Apple/Qualcomm 5G saga: Apple is buying Intel's modem division for $1 billion. This past April we reported on Intel's (INTC $42-$51-$60) surprise announcement that it was abandoning its 5G platform, leaving rival Qualcomm (QCOM) in the driver's seat. This was almost certainly a catalyst for Apple's dropping of its suit against Qualcomm. This was also, in fact, one of the reasons we added Qualcomm to the Penn New Frontier Fund. Now, in another stunning development, Apple has announced that it will buy Intel's 5G modem division for around $1 billion. For Apple, which is sitting on well over $100 billion in cash, this was a smart move. With the purchase, it will acquire the patents and the talent needed to bring this critical component to 5G in-house. They will almost certainly still rely on Qualcomm for the needed wireless chip hardware, but this acquisition makes them much less vulnerable to supply chain disruptions, or the type of "extortionary fees" that were at the heart of Apple's case against the device maker. As could be expected, Apple and Intel rose on the news, while Qualcomm shares fell about 3%. We still like our QCOM position, and feel better about our AAPL position in the Global Leaders Club.
Food Products
Cal-Maine shares drop big after quarterly miss, but stage quick comeback. Based on its rather innocuous industry, it may seem odd that Cal-Maine Foods (CALM $37-$39-$52) has been one of our favorite trading stocks over the years. In fact, America's largest egg producer was once in our Strategic Income Portfolio thanks to its 6% dividend yield and steady revenue stream. The 6% dividend may gone, but the "predictable volatility" of CALM shares remains intact. After reporting a wider-than-expected loss for its fiscal fourth quarter due to an oversupply of eggs on the market (the company actually lost $20 million—as compared to the $72 million in made in the same quarter a year earlier), shares fell about 5%. By the end of the trading day, however, it had clawed back nearly all of those losses. This is a scenario that seems to play out each time the company drops on earnings. Cal-Maine, which owns such brands as Egg-Land's Best and Land O' Lakes, is a great way to play price movements in this ag commodity. Further, we believe that egg prices are sitting in a trough and could easily move higher from here.
Automotive
The 8th-generation Corvette, or C8, should provide a nice boost for shares of General Motors. I recall when the 4th-generation Corvette came out in 1984; I stared at the futuristic-looking machine in amazement. That old feeling came back last week when General Motors (GM $31-$40-$42) introduced their Corvette C8, the latest iteration of the beast Chevrolet first introduced at the 1953 GM Motorama car show. I also recalled several recent stories detailing how both GM and Ford (F) were, essentially, exiting the car business to focus on SUVs and light trucks. The rollout of this new beauty, whose base price will start out at a very reasonable $60k, seems to fly in the face of that narrative. While it is true that a full 80% of GM's volume now comes from light trucks like the Chevy Silverado, we expect the new Vette to reinvigorate car sales both in North America and around the world. In the meantime, investors can take their nearly 4% dividend yield to the bank. We will review GM's investment outlook in the next issue of The Penn Wealth Report.
It has been a super-rough year for the maker of Invisalign. The business model seems brilliant: instead of parents paying out thousands upon thousands of dollars to the orthodontist, or adults being forced to wear braces to work, create a nearly-invisible teeth-aligning system for a fraction of the price. And, in fact, Align Technology (ALGN $178-$200-$399), maker of the Invisalign system, saw its share price go from $50 five years ago to $400 by the fall of 2018. That was a nice ride up for investors, but anyone discovering the stock a year ago would be hurting—shares have been cut nearly in half since last July, falling a full 27% on Thursday. The somewhat bizzarre aspect to the massive drop in share price is the company's Q2 beat on both the top and bottom lines, earning $147 million (+39% y/y) on $601 million in sales (+22.5% y/y). The breakdown occurred, however, as analysts began poring over the post-earnings press release. Laying the blame on weakness in China and slower growth in North America, CEO Joe Hogan greatly muted expectations for the third quarter. The first excuse is simply that: an excuse. The second complaint has us befuddled: Hogan said that there appears to be "a little more reticence on consumers to spend." We haven't seen a pullback in spending by the US consumer anywhere else. Could it be that new entrants are finally eating into Invisalign's market share? This stock was priced for perfection, and with a number of patents expiring, expect a flood of competition to put downward pressure on the shares. Don't touch it.
Interactive Media & Services
"Everyone" hates Facebook, but is anyone concerned about government overreach? It feels as though we are in the 5% minority on this issue, but we are bothered by the wanton use of force against private-sector companies by the anointed ones in the public sector. The Federal Trade Commission just hit Facebook (FB $123-$204-$219) with a $5 billion fine (er, "settlement") stemming from privacy violations it claims the company committed back in 2012, plus stripped CEO Mark Zuckerberg and the FB board of some rather ordinary leadership powers. The fine is no big deal for the $600 billion firm, but the intrusion into the board room by a bunch of politicians is a big deal. Even more disconcerting is the angry reaction by Democrats sitting on the FTC, who wanted Zuckerberg held personally liable. Is that where we are at right now in this country? How about we start throwing CEOs in prison every time there is a data breach? Why stop there, let's give them ninety days of jail time for an earnings miss. After all, Dodd-Frank put corporate leaders on the hot seat for virtually everything that happens at a company. It may sound facetious, but the scariest component of this story is the percentage of Americans who would be happy placing someone in the pokey because they disagree with their political point of view. We are not talking about real criminals, like Kozlowski of Tyco, Ebbers of Worldcom, or Ken Lay of Enron; we are talking about people simply disliked for the way they think. That sounds a lot more like North Korea than a Western republic. A little more analytical thought and a lot less gulping down of the false narratives presented as fact by a lazy and tainted press corps would go a long way in leading us back down the road toward national sanity. While it was down on news of the settlement, Facebook regained all lost ground after reporting unexpectedly-high revenues of $17 billion for the quarter, and profit roughly equal to the FTC fine (settlement).
Telecom Services
AT&T surges as wireless business grows, overshadowing the cord-cutter problem. First the bad news: Penn member AT&T's (T $27-$33-$34) DirecTV problems continue to mount, as a record number of customers drop the service. In fact, a full 778,000 DirecTV and U-Verse customers cut the cord over the course of the quarter. Now the good news: against expectations for 27,000 new phone subscribers, T actually netted 72,000 new sign-ups. The latter metric, combined with excitement over the launch of HBO (a T company) Max this coming spring, helped push T shares up over 3% at Wednesday's open. While the company is still riddled with debt following its massive purchase of Time Warner, management remains committed to reducing that debt load to $150 billion (down from $180 billion) by the end of the year. T is up around 10% since we added it back to the Strategic Income Portfolio this past February. We moved it into the SIP due to its 6% dividend yield and solid outlook.
Food Products
It's not McDonald's, but Beyond Meat just landed at Dunkin'. Several months ago we predicted that Beyond Meat (BYND $45-$203-$208), the high-flying, plant-based meat company we bought at IPO, would land McDonald's (MCD) as a client by the end of the year. While that has not happened yet, Dunkin' Brands (DNKN) did just become the first national chain to offer a sandwich made with the company's Beyond Sausage product. While the breakfast sandwich will initially be rolled out at Dunkin' stores in NYC, we can expect them at nationwide locations soon. Massive Canadian coffee chain Tim Hortons, owned by Restaurant Brands International (QSR), has already rolled out a similar breakfast sandwich, in addition to offering its customers The Beyond Burger. Shares of BYND have surged recently in anticipation of the company's first quarterly earnings report since going public. Beyond will report its Q2 earnings this coming Monday, with analysts expecting to see $52.7 million in revenue for the quarter.
Global Strategy: Europe
You heard it here first: with Prime Minister Boris Johnson, Britain will finally blow out of the EU. The machinations of government grind so slowly that we often misread the strong undercurrents of a political movement. The press dutifully report the movement as simply a bunch of crackpots blowing off some steam...at least until the subterranean activity manifests in a shocking (at least to those who believed the reporting) manner. That is precisely what is happening in the United Kingdom right now. Erudite journalists writing for pompous publications like The Economist laugh off the likes of a Boris Johnson, the outspoken Brexiteer and former mayor of London, right up to the point at which the target of their ridicule becomes the leader of the country. And that is exactly what will happen this week, as the man who assured Britons that Brexit will happen this year, with or without a deal in place, becomes Prime Minister Boris Johnson. The hatred for this man is palpable, and loud. But that doesn't matter now. He will assume the throne, execute the will of the people, and lead Britain out of the bumbling, inept EU. And England will not only survive, it will thrive. And that will make Boris Johnson all the more hated by the arrogant cabal which has impugned him incessantly for the past three years. The iShares MSCI United Kingdom ETF, symbol EWU, is down 23% over the past five years. If we are correct in our predictions, now might be a good time to pick up some shares to fill any international gaps in a portfolio. It certainly looks better than an investment in a basket of French or German companies right now.
Technology Hardware & Equipment
A new twist in the Apple/Qualcomm 5G saga: Apple is buying Intel's modem division for $1 billion. This past April we reported on Intel's (INTC $42-$51-$60) surprise announcement that it was abandoning its 5G platform, leaving rival Qualcomm (QCOM) in the driver's seat. This was almost certainly a catalyst for Apple's dropping of its suit against Qualcomm. This was also, in fact, one of the reasons we added Qualcomm to the Penn New Frontier Fund. Now, in another stunning development, Apple has announced that it will buy Intel's 5G modem division for around $1 billion. For Apple, which is sitting on well over $100 billion in cash, this was a smart move. With the purchase, it will acquire the patents and the talent needed to bring this critical component to 5G in-house. They will almost certainly still rely on Qualcomm for the needed wireless chip hardware, but this acquisition makes them much less vulnerable to supply chain disruptions, or the type of "extortionary fees" that were at the heart of Apple's case against the device maker. As could be expected, Apple and Intel rose on the news, while Qualcomm shares fell about 3%. We still like our QCOM position, and feel better about our AAPL position in the Global Leaders Club.
Food Products
Cal-Maine shares drop big after quarterly miss, but stage quick comeback. Based on its rather innocuous industry, it may seem odd that Cal-Maine Foods (CALM $37-$39-$52) has been one of our favorite trading stocks over the years. In fact, America's largest egg producer was once in our Strategic Income Portfolio thanks to its 6% dividend yield and steady revenue stream. The 6% dividend may gone, but the "predictable volatility" of CALM shares remains intact. After reporting a wider-than-expected loss for its fiscal fourth quarter due to an oversupply of eggs on the market (the company actually lost $20 million—as compared to the $72 million in made in the same quarter a year earlier), shares fell about 5%. By the end of the trading day, however, it had clawed back nearly all of those losses. This is a scenario that seems to play out each time the company drops on earnings. Cal-Maine, which owns such brands as Egg-Land's Best and Land O' Lakes, is a great way to play price movements in this ag commodity. Further, we believe that egg prices are sitting in a trough and could easily move higher from here.
Automotive
The 8th-generation Corvette, or C8, should provide a nice boost for shares of General Motors. I recall when the 4th-generation Corvette came out in 1984; I stared at the futuristic-looking machine in amazement. That old feeling came back last week when General Motors (GM $31-$40-$42) introduced their Corvette C8, the latest iteration of the beast Chevrolet first introduced at the 1953 GM Motorama car show. I also recalled several recent stories detailing how both GM and Ford (F) were, essentially, exiting the car business to focus on SUVs and light trucks. The rollout of this new beauty, whose base price will start out at a very reasonable $60k, seems to fly in the face of that narrative. While it is true that a full 80% of GM's volume now comes from light trucks like the Chevy Silverado, we expect the new Vette to reinvigorate car sales both in North America and around the world. In the meantime, investors can take their nearly 4% dividend yield to the bank. We will review GM's investment outlook in the next issue of The Penn Wealth Report.
Headlines for the Week of 07 Jul 2019—13 Jul 2019
Road & Rail
CSX may be "puzzled" by the environment, but our rail posted a strong quarter. Admittedly, we got a little worried about our Union Pacific (UNP $128-$172-$180) position after CSX (CSX) announced a pretty rotten quarter. In fact, UNP shares fell (about half as much as CSX's) in sympathy with that report. The Omaha-based railroad beat expectations, however, and all of the recent losses suffered by UNP shares were wiped clean immediately following the earnings release. Against analyst expectations for a drop in revenues to $5.58 billion, the company generated sales of $5.6 billion in the quarter; earnings per share were expected to come in at $2.12, but instead rose to $2.22. While total carloads decreased 4%, identical to CSX's decrease, increased efficiencies at the carrier offset those declines. As usual, one of our favorite American CEOs, Lance Fritz, delivered for investors. Fritz did mention the uncertainty which will be in place until the USMCA is passed, a viable trade agreement is made with China, and Japan/Europe trade issues are tackled. Fair points.
Media & Entertainment
Netflix earnings flop: the first drop in US subscribers in a decade cause shares to plunge. Not a full day after trucker JB Hunt (JBHT) gave us a rosy outlook for the second half of the year, along comes rail giant CSX (CSX $58-$71-$81) to splash cold water on that halcyon image. Shares of the $60 billion railroad were falling by double digits on Wednesday after earnings disappointed and management's comments stirred up some serious concerns. While the $3.1 billion in revenues generated during Q2 were in line with the same quarter last year, shipments fell by 4% from last year. Most disconcerting, however, was management's lowering of full-year guidance, and negative comments made about the economic environment. CEO James Foote used adjectives such as "puzzling" when discussing seasonal patterns for the industry. CSX has pulled about 300 locomotives (out of an inventory of 3,900) out of service over the past year. In sympathy, shares of our Union Pacific (UNP) holding were trading lower by about 5%.
Industrials: Road & Rail
If JB Hunt's results allayed fears of a recession, CSX's exacerbated them. Not a full day after trucker JB Hunt (JBHT) gave us a rosy outlook for the second half of the year, along comes rail giant CSX (CSX $58-$71-$81) to splash cold water on that halcyon image. Shares of the $60 billion railroad were falling by double digits on Wednesday after earnings disappointed and management's comments stirred up some serious concerns. While the $3.1 billion in revenues generated during Q2 were in line with the same quarter last year, shipments fell by 4% from last year. Most disconcerting, however, was management's lowering of full-year guidance, and negative comments made about the economic environment. CEO James Foote used adjectives such as "puzzling" when discussing seasonal patterns for the industry. CSX has pulled about 300 locomotives (out of an inventory of 3,900) out of service over the past year. In sympathy, shares of our Union Pacific (UNP) holding were trading lower by about 5%.
Financials: Commercial Banks
Bank of America's Q2 results show strong growth, solid consumer activity. Despite low interest rates, which are bound to head lower this year, Bank of America (BAC $23-$29-$32) reported strong revenues and profit for the quarter. Revenues rose from $22.55 billion last year to $23.08 billion in the most recent quarter, while the bank's net profit rose from $6.78 billion to $7.35 billion—a fat 32% profit margin. In the earnings conference call, CEO Brian Moynihan cited solid consumer activity across the board, and noted a 5% uptick in spending by bank customers over the same quarter last year. Now that these metrics are in, it will be interesting to see how the major and regional banks absorb a rate cut or two. We currently hold four financials (out of 40 positions) within the Penn Global Leaders Club: a global bank, a capital markets firm, and two credit services firms. We continue to underweight financials: 8% versus the 16% S&P 500 benchmark.
Industrials: Road & Rail
JB Hunt's decent quarter allays—somewhat—fear of a coming recession. When a recession is looming, one typical early indicator is weakness in the transports, especially within the rail and trucking industries. Well, one of the top surface transportation companies in North America just reported earnings, and investors breathed a sigh of relief. JB Hunt (JBHT $84-$97-$130), with its extensive operations through the three USMCA countries, reported revenues of $2.26 billion (a 5.7% increase Y/Y), and a net profit of $1.37/share (versus $1.35 expected). What led to the 5% spike in the shares, however, was the relatively rosy outlook management gave for the remainder of the year. While the intermodal cargo business was soft in the first six months of 2019, analysts left the conference call confident that the second half would see improvement. It seems as though the economy may be softening just enough to give investors what they want—a rate cut or two by the Fed. In the midst of the ongoing trade war saga, and without certainty that Congress will pass the USMCA in short order (which is a disgrace), we have been underweighting the transports. Union Pacific (UNP) is our only current holding in the industry.
Food & Staples Retailing
Blue Apron jumps 30% after the company announces it will begin featuring Beyond Meat in its kits. The two IPOs could hardly have been more different. Blue Apron (APRN $6-$10-$58), which went public two summers ago (hard to believe it has been that long), came out of the gate around $150 per share and proceeded to slide all the way to $6. Beyond Meat (BYND $45-$172-$202), on the other hand, opened around $50 per share and has been on a tear, regaining the $170 mark on Tuesday. After the meal kit delivery company announced it entered into a partnership with Beyond Meat, however, its shares suddenly spiked 70%. While they didn't hold all those gains, it was still up 30% at the close of business. Blue Apron announced it would begin selling kits with Beyond Meat products in them by the end of summer, to include the "caramelized onion and cheddar burger." As for BYND, the shares were up 3%, to $171.60, on the day. We continue to stand by two claims: most people underestimate the potential of the plant-based meat industry going forward, and Beyond will be the industry benchmark for others to follow. We bought the company near $50 per share as a long-term investment, not a trade.
Global Strategy: East & Southeast Asia
Despite massive government stimulus, China's GDP hits weakest level in 27 years. When you are a communist state, you can do whatever you like with little pushback from the media (which you control) or the citizenry (which you also control). With this carte blanche, China has built a mountain of debt in a vain attempt to stimulate its economy. How much debt? Try $5.2 trillion, or nearly one-half the country's GDP. Despite these efforts, however, China just recorded its slowest level of growth since 1992. Granted, the 6.2% annualized rate recorded in Q2 seems enviable, but growth rates for an emerging economy always appear exacerbated when compared to a developed economy. Imagine tossing a lighter baseball in the air (emerging economy) versus a dense bowling ball (developed economy), and this begins to make sense. While our graph only goes back to the first quarter of 2011, we have to travel back to Q1 of 1992—the earliest data on record—to find an equivalent rate of growth. Clearly, the trade war with the US has been the catalyst for the most recent drop, but China has been propping up its economy on an unsustainable river of new debt; the trade war merely ripped up the pristine veneer covering the rotted wood. Furthermore, despite the inevitable end to the trade war, the damage has been done—companies from around the world continue to diversify their Asian operations to countries with more business-friendly forms of government. Emerging market economies in East and Southeast Asia, outside of China, continue to look extremely promising moving forward. When purchasing an emerging markets ETF, be sure and check its exposure to China. For example, two of the largest emerging markets ETFs, VWO and EEM, each have one-third of their holdings emanating from China.
Beverages & Tobacco
Anheuser-Busch InBev yanks its Asian IPO due to lack of interest. Leuven, Belgium-based AB InBev (BUD $65-$89-$107) hoped to raise up to $10 billion on the deal. The plan was to sell a minority stake in the company's Asia-Pacific business through an IPO on the Hong Kong stock exchange. There was just one problem: a lack of interest. While the official excuse from the company for yanking the deal was "prevailing market conditions," the truth is they simply couldn't convince enough high-rolling investors that the reward would be worth the risk. China, where BUD offers dozens of different brews, has certainly been the company's fastest-growing market, but the company has been losing market share in the communist country to other European competitors like Heineken and Carlsberg. BUD will now look for other ways to reduce its hefty balance sheet, to include potentially cutting its dividends, which currently yield 2.3%. Shares are now trading approximately where they were back in October of 2012. We shed no tears for this formerly-great American company, which lost its way thanks to the arrogant offspring of a brilliant brewer.
Application & Systems Software
Two weeks ago we sold Symantec on acquisition rumors, this week that deal fell apart. Talk about great timing. Two weeks ago, when Broadcom (AVGO) announced it would be purchasing software applications company Symantec (SYMC $17-$21-$26), the latter rocketed over 20% to a new one-year high. So we sold the position (at $25.34) in the Intrepid Trading Platform. Now, however, it appears the two sides could not come to terms with respect to price, and Symantec promptly fell by nearly the same amount. You've heard the old investment adage, "buy the rumor, sell the news," but sometimes it is smart to take profits on the rumor and eliminate the odds of the deal never coming to fruition. We remain ultra-bullish on the cybersecurity industry, but we are not ready to pick up SYMC again just yet. Too many other great companies in the space.
National Security
Peter Thiel accuses Google of working with the Chinese military. One of our favorite billionaire entrepreneurs, Peter Thiel, has leveled some lofty charges against internet giant Google (GOOGL $978-$1,143-$1,297). The PayPal co-founder is openly calling on the FBI and the CIA to investigate the $800 billion firm for possible infiltration by the Chinese military. He calls out the company for its "seemingly treasonous" decision to cheerfully perform work for the Chinese military while vocally shunning jobs for the US Department of Defense. What can we say, this is absolute fact. Thiel just raises the question of whether or not this is due to anti-American bias in management, or infiltration by the Chinese Communist Party. One year ago, Google ended its contract with the Department of Defense after thousands of employees signed a petition threatening to resign. More cowardice in the C-suite. We have no doubt that many in upper management at Alphabet, and a ton of millennial workers at Alphabet, have more sympathy for communist China than they have respect for America, based on a lazy, arrogant lack of historical understanding. That is simply the zeitgeist in this country right now. The inevitable course of events bound to unfold, however, will change that attitude within upcoming generations.
CSX may be "puzzled" by the environment, but our rail posted a strong quarter. Admittedly, we got a little worried about our Union Pacific (UNP $128-$172-$180) position after CSX (CSX) announced a pretty rotten quarter. In fact, UNP shares fell (about half as much as CSX's) in sympathy with that report. The Omaha-based railroad beat expectations, however, and all of the recent losses suffered by UNP shares were wiped clean immediately following the earnings release. Against analyst expectations for a drop in revenues to $5.58 billion, the company generated sales of $5.6 billion in the quarter; earnings per share were expected to come in at $2.12, but instead rose to $2.22. While total carloads decreased 4%, identical to CSX's decrease, increased efficiencies at the carrier offset those declines. As usual, one of our favorite American CEOs, Lance Fritz, delivered for investors. Fritz did mention the uncertainty which will be in place until the USMCA is passed, a viable trade agreement is made with China, and Japan/Europe trade issues are tackled. Fair points.
Media & Entertainment
Netflix earnings flop: the first drop in US subscribers in a decade cause shares to plunge. Not a full day after trucker JB Hunt (JBHT) gave us a rosy outlook for the second half of the year, along comes rail giant CSX (CSX $58-$71-$81) to splash cold water on that halcyon image. Shares of the $60 billion railroad were falling by double digits on Wednesday after earnings disappointed and management's comments stirred up some serious concerns. While the $3.1 billion in revenues generated during Q2 were in line with the same quarter last year, shipments fell by 4% from last year. Most disconcerting, however, was management's lowering of full-year guidance, and negative comments made about the economic environment. CEO James Foote used adjectives such as "puzzling" when discussing seasonal patterns for the industry. CSX has pulled about 300 locomotives (out of an inventory of 3,900) out of service over the past year. In sympathy, shares of our Union Pacific (UNP) holding were trading lower by about 5%.
Industrials: Road & Rail
If JB Hunt's results allayed fears of a recession, CSX's exacerbated them. Not a full day after trucker JB Hunt (JBHT) gave us a rosy outlook for the second half of the year, along comes rail giant CSX (CSX $58-$71-$81) to splash cold water on that halcyon image. Shares of the $60 billion railroad were falling by double digits on Wednesday after earnings disappointed and management's comments stirred up some serious concerns. While the $3.1 billion in revenues generated during Q2 were in line with the same quarter last year, shipments fell by 4% from last year. Most disconcerting, however, was management's lowering of full-year guidance, and negative comments made about the economic environment. CEO James Foote used adjectives such as "puzzling" when discussing seasonal patterns for the industry. CSX has pulled about 300 locomotives (out of an inventory of 3,900) out of service over the past year. In sympathy, shares of our Union Pacific (UNP) holding were trading lower by about 5%.
Financials: Commercial Banks
Bank of America's Q2 results show strong growth, solid consumer activity. Despite low interest rates, which are bound to head lower this year, Bank of America (BAC $23-$29-$32) reported strong revenues and profit for the quarter. Revenues rose from $22.55 billion last year to $23.08 billion in the most recent quarter, while the bank's net profit rose from $6.78 billion to $7.35 billion—a fat 32% profit margin. In the earnings conference call, CEO Brian Moynihan cited solid consumer activity across the board, and noted a 5% uptick in spending by bank customers over the same quarter last year. Now that these metrics are in, it will be interesting to see how the major and regional banks absorb a rate cut or two. We currently hold four financials (out of 40 positions) within the Penn Global Leaders Club: a global bank, a capital markets firm, and two credit services firms. We continue to underweight financials: 8% versus the 16% S&P 500 benchmark.
Industrials: Road & Rail
JB Hunt's decent quarter allays—somewhat—fear of a coming recession. When a recession is looming, one typical early indicator is weakness in the transports, especially within the rail and trucking industries. Well, one of the top surface transportation companies in North America just reported earnings, and investors breathed a sigh of relief. JB Hunt (JBHT $84-$97-$130), with its extensive operations through the three USMCA countries, reported revenues of $2.26 billion (a 5.7% increase Y/Y), and a net profit of $1.37/share (versus $1.35 expected). What led to the 5% spike in the shares, however, was the relatively rosy outlook management gave for the remainder of the year. While the intermodal cargo business was soft in the first six months of 2019, analysts left the conference call confident that the second half would see improvement. It seems as though the economy may be softening just enough to give investors what they want—a rate cut or two by the Fed. In the midst of the ongoing trade war saga, and without certainty that Congress will pass the USMCA in short order (which is a disgrace), we have been underweighting the transports. Union Pacific (UNP) is our only current holding in the industry.
Food & Staples Retailing
Blue Apron jumps 30% after the company announces it will begin featuring Beyond Meat in its kits. The two IPOs could hardly have been more different. Blue Apron (APRN $6-$10-$58), which went public two summers ago (hard to believe it has been that long), came out of the gate around $150 per share and proceeded to slide all the way to $6. Beyond Meat (BYND $45-$172-$202), on the other hand, opened around $50 per share and has been on a tear, regaining the $170 mark on Tuesday. After the meal kit delivery company announced it entered into a partnership with Beyond Meat, however, its shares suddenly spiked 70%. While they didn't hold all those gains, it was still up 30% at the close of business. Blue Apron announced it would begin selling kits with Beyond Meat products in them by the end of summer, to include the "caramelized onion and cheddar burger." As for BYND, the shares were up 3%, to $171.60, on the day. We continue to stand by two claims: most people underestimate the potential of the plant-based meat industry going forward, and Beyond will be the industry benchmark for others to follow. We bought the company near $50 per share as a long-term investment, not a trade.
Global Strategy: East & Southeast Asia
Despite massive government stimulus, China's GDP hits weakest level in 27 years. When you are a communist state, you can do whatever you like with little pushback from the media (which you control) or the citizenry (which you also control). With this carte blanche, China has built a mountain of debt in a vain attempt to stimulate its economy. How much debt? Try $5.2 trillion, or nearly one-half the country's GDP. Despite these efforts, however, China just recorded its slowest level of growth since 1992. Granted, the 6.2% annualized rate recorded in Q2 seems enviable, but growth rates for an emerging economy always appear exacerbated when compared to a developed economy. Imagine tossing a lighter baseball in the air (emerging economy) versus a dense bowling ball (developed economy), and this begins to make sense. While our graph only goes back to the first quarter of 2011, we have to travel back to Q1 of 1992—the earliest data on record—to find an equivalent rate of growth. Clearly, the trade war with the US has been the catalyst for the most recent drop, but China has been propping up its economy on an unsustainable river of new debt; the trade war merely ripped up the pristine veneer covering the rotted wood. Furthermore, despite the inevitable end to the trade war, the damage has been done—companies from around the world continue to diversify their Asian operations to countries with more business-friendly forms of government. Emerging market economies in East and Southeast Asia, outside of China, continue to look extremely promising moving forward. When purchasing an emerging markets ETF, be sure and check its exposure to China. For example, two of the largest emerging markets ETFs, VWO and EEM, each have one-third of their holdings emanating from China.
Beverages & Tobacco
Anheuser-Busch InBev yanks its Asian IPO due to lack of interest. Leuven, Belgium-based AB InBev (BUD $65-$89-$107) hoped to raise up to $10 billion on the deal. The plan was to sell a minority stake in the company's Asia-Pacific business through an IPO on the Hong Kong stock exchange. There was just one problem: a lack of interest. While the official excuse from the company for yanking the deal was "prevailing market conditions," the truth is they simply couldn't convince enough high-rolling investors that the reward would be worth the risk. China, where BUD offers dozens of different brews, has certainly been the company's fastest-growing market, but the company has been losing market share in the communist country to other European competitors like Heineken and Carlsberg. BUD will now look for other ways to reduce its hefty balance sheet, to include potentially cutting its dividends, which currently yield 2.3%. Shares are now trading approximately where they were back in October of 2012. We shed no tears for this formerly-great American company, which lost its way thanks to the arrogant offspring of a brilliant brewer.
Application & Systems Software
Two weeks ago we sold Symantec on acquisition rumors, this week that deal fell apart. Talk about great timing. Two weeks ago, when Broadcom (AVGO) announced it would be purchasing software applications company Symantec (SYMC $17-$21-$26), the latter rocketed over 20% to a new one-year high. So we sold the position (at $25.34) in the Intrepid Trading Platform. Now, however, it appears the two sides could not come to terms with respect to price, and Symantec promptly fell by nearly the same amount. You've heard the old investment adage, "buy the rumor, sell the news," but sometimes it is smart to take profits on the rumor and eliminate the odds of the deal never coming to fruition. We remain ultra-bullish on the cybersecurity industry, but we are not ready to pick up SYMC again just yet. Too many other great companies in the space.
National Security
Peter Thiel accuses Google of working with the Chinese military. One of our favorite billionaire entrepreneurs, Peter Thiel, has leveled some lofty charges against internet giant Google (GOOGL $978-$1,143-$1,297). The PayPal co-founder is openly calling on the FBI and the CIA to investigate the $800 billion firm for possible infiltration by the Chinese military. He calls out the company for its "seemingly treasonous" decision to cheerfully perform work for the Chinese military while vocally shunning jobs for the US Department of Defense. What can we say, this is absolute fact. Thiel just raises the question of whether or not this is due to anti-American bias in management, or infiltration by the Chinese Communist Party. One year ago, Google ended its contract with the Department of Defense after thousands of employees signed a petition threatening to resign. More cowardice in the C-suite. We have no doubt that many in upper management at Alphabet, and a ton of millennial workers at Alphabet, have more sympathy for communist China than they have respect for America, based on a lazy, arrogant lack of historical understanding. That is simply the zeitgeist in this country right now. The inevitable course of events bound to unfold, however, will change that attitude within upcoming generations.
Headlines for the Week of 07 Jul 2019—13 Jul 2019
Energy Commodities: Oil
Thanks to troubles in two Gulfs on opposite sides of the globe, oil is suddenly above $60 again. Earlier this week, three Iranian vessels tried to carry out what the mullahs had promised: stop the flow of oil through the Strait of Hormuz. Thanks to the Royal Navy's frigate HMS Montrose, however, the three ships stood down as the BP oil tanker pushed through. The Royal Navy was assisted with intelligence data collected from a US Navy P-3 Orion in the skies above the Strait. That incident, coupled with the specter of Tropical Storm Barry rolling through the Gulf of Mexico, heading for Louisiana's refineries, led to WTI crude spiking back above the $60 mark for the first time in six weeks. Roughly 50% of drilling activities in the Gulf of Mexico have ceased, and refineries are being temporarily shut down in preparation of Barry hitting landfall. While the storm in the Gulf of Mexico will come and go, there is no end in sight for the geopolitical storm in the other Gulf. So, despite talk of a global slowdown, we see oil prices on some pretty solid footing. We bought the ETF OIL when WTI crude was at $45. We do not see any reason to take our double-digit, short-term gains on the investment.
Global Strategy: Europe
Center-right New Democracy party takes over in Greece after Tsipras fails to deliver. Talk about a tough job. Imagine trying to steer Greece out of its massive fiscal hole immediately after the defeated, left-leaning Syriza party threw a bunch of economic goodies at the citizenry in a vain attempt to retain power. That task, and dealing with a European Union to which the country owes roughly $250 billion after a decade of bailouts, is what awaits the newly-elected Prime Minister, Kyriakos Mitsotakis. Mitsotakis won a plurality of the vote in this month's election by running on a pro-business, lower-tax, reduced-bureaucracy platform which promised 4% economic growth. The country desparately needs that level of growth, considering its debt-to-GDP ratio is around 175%. The new prime minister's New Democracy party also now controls the 300-seat Parliament in Athens. We will discuss the Greek elections and the investment outlook for Greece in the next Penn Wealth Report.
Textiles, Apparel, & Luxury Goods
Levi Strauss reports; stock drops; who cares? This past March, we wrote a scathing commentary on Levi Strauss (LEVI $19-$21-$25) just before the company's most-recent IPO. Shares ultimately began trading at $22.22; right now, after today's 10% drop, they sit at $21.32. Still overpriced. Ironically, the 10% hammering came on the heels of a decent earnings report. The jeans maker had $1.31 billion in sales for the quarter, up 5% y/y, with international markets generating 58% of that revenue. The bottom line, however, is probably what spooked investors: the company only made $28.2 million on that $1.31 billion, down from $75 million in the same quarter last year. In the earnings release, CEO Chip Bergh said "(insert boilerplate rosy CEO-speak here)." Even writing about this company bores the hell out of us. They will flop and flounder until, once again, they are taken private. Buy right before that announcement is made, and there may be some short-term profit in the trade. If you are an investor who gets excited about LEVI, you will love Abercrombie & Fitch (ANF). They are cut from the same cloth.
Media & Entertainment
With a triple-digit multiple and bleeding shows to new platforms, how long until Netflix crashes? For years, Netflix (NFLX $231-$380-$420) was the only show in town. At least the only streaming show in town. Remember the red and white envelopes we would get in our mailboxes, containing the night's viewing entertainment? Then, as technology improved and the industry embraced (sort of) the Netflix model, the company had an app on virtually every smart TV sold. Despite our strong dislike for CEO Reed Hastings, with his smug attitude and strongly-biased views, it is hard to argue with the performance of NFLX shares. Now, however, the $166 billion company, with its ultra-rich multiple of 135, is beginning to face some tangible competition. First it was Disney (DIS), which pulled its entire library of shows and movies from the Netflix platform in anticipation of its own Disney+ streaming service. Then came the news that Comcast's (CMCSA) NBCUniversal will pull The Office when the contract with Netflix expires, as that media company launches its own service. Now, WarnerMedia (owned by AT&T) will pull Friends off of Netflix, as it will be a staple show on HBO Max when it launches. Sure, 41 million viewers have already tuned into the third season of Stranger Things, but the company will shell out $15 billion this year to keep its exclusive content rolling in. That's a lot, considering the company's 2018 net income of $1 billion. The company's cash burn is real, and it will only get worse as mega-competitors like Disney and Time Warner flood into the space. At $380 per share, we wouldn't touch the company. Back when NFLX was sitting at $353, we noted that we would love to have the guts to short the stock. While that bet would not have paid off, we would be more comfortable making that play right now.
Space Sciences & Exploration
Virgin Galactic, with paying passengers in tow, appears set to go public this year. It will certainly be the world's first publicly-traded space tourism company. Sir Richard Branson announced plans to IPO Virgin Galactic this year, and he assured potential investors that the company would be profitable within two years. In fact, six hundred individuals have already ponied up an aggregate of $80 million for tickets on the spacecraft, which separates from a specially-designed aircraft at 50,000 feet, rockets to a distance of 62 miles from earth (380,000 feet, or the very edge of "space"), then returns for a runway landing. While the entire trip, from booster aircraft takeoff to spaceship landing, would last just under three hours, the six passengers on each flight would be weightless for only around five minutes. Earlier this year, two Virgin Galactic pilots earned their civilian astronaut wings, taking the spacecraft Unity to an altitude of 60 miles. Chief Astronaut Instructor Beth Moses rode as a passenger on the flight. While the company currently sets the price of a ticket at $250,000, Branson said he expects those prices to fall substantially as the journey becomes more commonplace, and other entrants begin offering flights (think SpaceX and Blue Origin). We are truly witnessing the nascent stages of a massive movement into space travel. While an investment in Virgin Galactic, which has an enterprise value of around $1.5 billion, would be an extremely risky proposition, the opportunity for investors in this industry will be prolific.
Global Strategy: Middle East
Turkey is proceeding with Russian S-400 deployment, will face substantive consequences. Despite being a longtime member of NATO (which has always been a tenuous proposition for a country with split loyalties), Turkey has decided not to heed Washington's warnings, and will deploy a Russian antiaircraft system designed to shoot American aircraft from the sky. Turkey was not only slated to receive the most advanced fighter in the world, the F-35 Lightning II, Turkish companies also built a number of components for the Lockheed Martin (LMC $240-$370-$370) aircraft. After satellite confirmation that the country is proceeding with construction of the S-400 deployment sites, the US State Department has announced that all F-35 sales to Turkey have been terminated, and Turkish participation in the building of F-35 parts will be "unwinded." Putin is no doubt thrilled with the decision, but Turkey will pay the price. In addition to the US sanctions, we expect there will be a retribution from NATO coming as well. It is hard to fathom why Erdogan would make such a silly gamble, considering Russia's diminished role in the world. Perhaps he received a call from John Kerry assuring him everything would be smoothed over after the 2021 inauguration. We don't say that tongue-in-cheek, based on previous John Kerry missives which have been intercepted/uncovered.
Commercial Banks
Investors aren't biting on Deutsche Bank's restructuring effort. Deutsche Bank (DB $7-$7-$13), Germany's top private bank, announced a major restructuring effort on Monday (something like its third in five years), and investors were underwhelmed. So much so, in fact, that they drove shares of the iconic German lender down over 6%, to $7.54. As part of the restructuring, 18,000 DB workers will lose their situations by 2021. We will discuss this story in further detail in the upcoming Penn Wealth Report, or you can visit the Penn Wealth channel at Apple News.
Thanks to troubles in two Gulfs on opposite sides of the globe, oil is suddenly above $60 again. Earlier this week, three Iranian vessels tried to carry out what the mullahs had promised: stop the flow of oil through the Strait of Hormuz. Thanks to the Royal Navy's frigate HMS Montrose, however, the three ships stood down as the BP oil tanker pushed through. The Royal Navy was assisted with intelligence data collected from a US Navy P-3 Orion in the skies above the Strait. That incident, coupled with the specter of Tropical Storm Barry rolling through the Gulf of Mexico, heading for Louisiana's refineries, led to WTI crude spiking back above the $60 mark for the first time in six weeks. Roughly 50% of drilling activities in the Gulf of Mexico have ceased, and refineries are being temporarily shut down in preparation of Barry hitting landfall. While the storm in the Gulf of Mexico will come and go, there is no end in sight for the geopolitical storm in the other Gulf. So, despite talk of a global slowdown, we see oil prices on some pretty solid footing. We bought the ETF OIL when WTI crude was at $45. We do not see any reason to take our double-digit, short-term gains on the investment.
Global Strategy: Europe
Center-right New Democracy party takes over in Greece after Tsipras fails to deliver. Talk about a tough job. Imagine trying to steer Greece out of its massive fiscal hole immediately after the defeated, left-leaning Syriza party threw a bunch of economic goodies at the citizenry in a vain attempt to retain power. That task, and dealing with a European Union to which the country owes roughly $250 billion after a decade of bailouts, is what awaits the newly-elected Prime Minister, Kyriakos Mitsotakis. Mitsotakis won a plurality of the vote in this month's election by running on a pro-business, lower-tax, reduced-bureaucracy platform which promised 4% economic growth. The country desparately needs that level of growth, considering its debt-to-GDP ratio is around 175%. The new prime minister's New Democracy party also now controls the 300-seat Parliament in Athens. We will discuss the Greek elections and the investment outlook for Greece in the next Penn Wealth Report.
Textiles, Apparel, & Luxury Goods
Levi Strauss reports; stock drops; who cares? This past March, we wrote a scathing commentary on Levi Strauss (LEVI $19-$21-$25) just before the company's most-recent IPO. Shares ultimately began trading at $22.22; right now, after today's 10% drop, they sit at $21.32. Still overpriced. Ironically, the 10% hammering came on the heels of a decent earnings report. The jeans maker had $1.31 billion in sales for the quarter, up 5% y/y, with international markets generating 58% of that revenue. The bottom line, however, is probably what spooked investors: the company only made $28.2 million on that $1.31 billion, down from $75 million in the same quarter last year. In the earnings release, CEO Chip Bergh said "(insert boilerplate rosy CEO-speak here)." Even writing about this company bores the hell out of us. They will flop and flounder until, once again, they are taken private. Buy right before that announcement is made, and there may be some short-term profit in the trade. If you are an investor who gets excited about LEVI, you will love Abercrombie & Fitch (ANF). They are cut from the same cloth.
Media & Entertainment
With a triple-digit multiple and bleeding shows to new platforms, how long until Netflix crashes? For years, Netflix (NFLX $231-$380-$420) was the only show in town. At least the only streaming show in town. Remember the red and white envelopes we would get in our mailboxes, containing the night's viewing entertainment? Then, as technology improved and the industry embraced (sort of) the Netflix model, the company had an app on virtually every smart TV sold. Despite our strong dislike for CEO Reed Hastings, with his smug attitude and strongly-biased views, it is hard to argue with the performance of NFLX shares. Now, however, the $166 billion company, with its ultra-rich multiple of 135, is beginning to face some tangible competition. First it was Disney (DIS), which pulled its entire library of shows and movies from the Netflix platform in anticipation of its own Disney+ streaming service. Then came the news that Comcast's (CMCSA) NBCUniversal will pull The Office when the contract with Netflix expires, as that media company launches its own service. Now, WarnerMedia (owned by AT&T) will pull Friends off of Netflix, as it will be a staple show on HBO Max when it launches. Sure, 41 million viewers have already tuned into the third season of Stranger Things, but the company will shell out $15 billion this year to keep its exclusive content rolling in. That's a lot, considering the company's 2018 net income of $1 billion. The company's cash burn is real, and it will only get worse as mega-competitors like Disney and Time Warner flood into the space. At $380 per share, we wouldn't touch the company. Back when NFLX was sitting at $353, we noted that we would love to have the guts to short the stock. While that bet would not have paid off, we would be more comfortable making that play right now.
Space Sciences & Exploration
Virgin Galactic, with paying passengers in tow, appears set to go public this year. It will certainly be the world's first publicly-traded space tourism company. Sir Richard Branson announced plans to IPO Virgin Galactic this year, and he assured potential investors that the company would be profitable within two years. In fact, six hundred individuals have already ponied up an aggregate of $80 million for tickets on the spacecraft, which separates from a specially-designed aircraft at 50,000 feet, rockets to a distance of 62 miles from earth (380,000 feet, or the very edge of "space"), then returns for a runway landing. While the entire trip, from booster aircraft takeoff to spaceship landing, would last just under three hours, the six passengers on each flight would be weightless for only around five minutes. Earlier this year, two Virgin Galactic pilots earned their civilian astronaut wings, taking the spacecraft Unity to an altitude of 60 miles. Chief Astronaut Instructor Beth Moses rode as a passenger on the flight. While the company currently sets the price of a ticket at $250,000, Branson said he expects those prices to fall substantially as the journey becomes more commonplace, and other entrants begin offering flights (think SpaceX and Blue Origin). We are truly witnessing the nascent stages of a massive movement into space travel. While an investment in Virgin Galactic, which has an enterprise value of around $1.5 billion, would be an extremely risky proposition, the opportunity for investors in this industry will be prolific.
Global Strategy: Middle East
Turkey is proceeding with Russian S-400 deployment, will face substantive consequences. Despite being a longtime member of NATO (which has always been a tenuous proposition for a country with split loyalties), Turkey has decided not to heed Washington's warnings, and will deploy a Russian antiaircraft system designed to shoot American aircraft from the sky. Turkey was not only slated to receive the most advanced fighter in the world, the F-35 Lightning II, Turkish companies also built a number of components for the Lockheed Martin (LMC $240-$370-$370) aircraft. After satellite confirmation that the country is proceeding with construction of the S-400 deployment sites, the US State Department has announced that all F-35 sales to Turkey have been terminated, and Turkish participation in the building of F-35 parts will be "unwinded." Putin is no doubt thrilled with the decision, but Turkey will pay the price. In addition to the US sanctions, we expect there will be a retribution from NATO coming as well. It is hard to fathom why Erdogan would make such a silly gamble, considering Russia's diminished role in the world. Perhaps he received a call from John Kerry assuring him everything would be smoothed over after the 2021 inauguration. We don't say that tongue-in-cheek, based on previous John Kerry missives which have been intercepted/uncovered.
Commercial Banks
Investors aren't biting on Deutsche Bank's restructuring effort. Deutsche Bank (DB $7-$7-$13), Germany's top private bank, announced a major restructuring effort on Monday (something like its third in five years), and investors were underwhelmed. So much so, in fact, that they drove shares of the iconic German lender down over 6%, to $7.54. As part of the restructuring, 18,000 DB workers will lose their situations by 2021. We will discuss this story in further detail in the upcoming Penn Wealth Report, or you can visit the Penn Wealth channel at Apple News.
Headlines for the Week of 30 Jun 2019—06 Jul 2019
Work & Pay
A stronger-than-expected jobs report...so Dow futures drop nearly triple digits. It appears as though we have entered that crazy alternate universe again, where bad news is good and good news drives the markets lower. Friday morning brought us the June payrolls number, and it was good: nonfarm payrolls rose 224,000, or 36% better than the 165,000 figure expected. That number sent shivers down the spines of Fed watchers, who are geared up for a potential 50-basis-point rate cut at this month's FOMC meeting. (For the record, the most we ever expected in July was a cut of 25 basis points.) The rosy report has many fearing the Fed will use it as an excuse to keep rates where they are—at historically low levels, for the record. Breaking down the numbers in the report, professional services and the health care sector led the charge, adding 51,000 and 35,000 jobs, respectively. The unemployment rate did tick up one notch, to 3.7%, but that was due to a jump in the labor force participation rate. Suddenly, the US economy isn't living up to the narrative that it is slowing. We still don't see the case for lowering rates—which now sit at 2.25% (target Fed funds rate lower limit).
Automotive
Tesla hits record production and delivery numbers, stock soars. Critics in the press, many of whom seem to have a personal animus towards Elon Musk, jumped all over Tesla's (TSLA $177-$238-$387) big deliveries miss two quarters ago, helping to drive shares down to a one-year low of $177. That was not the case this last quarter, however, as the company announced it had produced 87,000 vehicles and delivered another 95,200—both figures blowing by analyst expectations. Furthermore, anticipation is high for Q3 as the company also announced it will be entering the quarter with a large backlog of orders. Shares spiked about 6% after the earnings report was released. The press painted a narrative of empty showrooms and a general loss of enthusiasm for Tesla vehicles. That was simply not the case, giving us another great example of how we can take advantage of misreporting and faulty analysis.
Energy Commodities
OPEC+ agrees to extend supply cuts in bid to keep oil prices high, but America is the spoiler. OPEC, or OPEC+ as it is sometimes now referred to as Russia builds stronger ties to the group, has agreed to keep its 1.2 million barrel-per-day supply cut in place for at least the next nine months—until March of 2020—as it grapples with attempts to keep the price elevated. Here's the problem with their plan: neither Saudi Arabia nor Russia are the leading producer of crude in the world any longer; that prize now goes to the United States. Thanks to the shale renaissance and a loosening of the restrictive standards put in place under the previous administration, the US is now on pace to produce between 12 and 13 million barrels per day in 2019. That is a nightmare scenario for OPEC, but even more so for their quasi-member Russia, which relies on income generated from the sale of oil to build their military and support their flailing economy. A full 70% of Russia's exports are oil- and gas-based, and over 50% of the country's federal budget revenues come from the energy sector. We continue to believe the sweet spot for crude, which is now at $56.22, is between $45 and $60 per barrel. This is high enough for US producers to turn a profit, but low enough to hurt Russia's economy and keep a clamp on Putin's military aspirations. We added the ETF OIL to the Dynamic Growth Strategy when crude dropped to around $45/barrel.
Technology Hardware & Equipment
Dear Apple, without killer new hardware, we have little need for your services. In a November, 2018 issue of The Penn Wealth Report, after Apple (AAPL $142-$201-$233) shares had dropped 25% in price—to $177, we gave a full-throated defense of the company. While our thesis has played out and the shares have moved back above the $200 mark, the announcement that Jony Ive is leaving the firm gives us pause. Even more troubling than the departure of Steve Jobs' kindred spirit (Tim Cook could certainly not claim that moniker), we now learn that Ive essentially checked out years ago. Based on stories from The Wall Street Journal and tech industry publications, Ive has apparently been upset with Apple's focus—under Cook—on services, at the expense of new hardware. We have certainly sensed that shift; most recently with the failed attempt to create an effective device charging pad and the company's mediocre attempt to enter the home automation space with the Apple HomePod (yawn). Not long before Steve Jobs died, he proclaimed that he had cracked the TV code. Something tells us that what he envisioned was certainly not the underwhelming Apple TV of today. If Jony Ive did mentally check out from Apple years ago, that would explain the company's recent lack of exciting new products. What concerns us the most, however, is the fact that Tim Cook doesn't seem to get it: without killer new products, we will soon have little need for your services. A Steve Jobs, or a Jony Ive at his prime, certainly doesn't come around every day, but Apple had better begin searching for that old magic. If not, they might as well bring back the hapless John Sculley—who is only remembered for the fact that he fired Steve Jobs.
A stronger-than-expected jobs report...so Dow futures drop nearly triple digits. It appears as though we have entered that crazy alternate universe again, where bad news is good and good news drives the markets lower. Friday morning brought us the June payrolls number, and it was good: nonfarm payrolls rose 224,000, or 36% better than the 165,000 figure expected. That number sent shivers down the spines of Fed watchers, who are geared up for a potential 50-basis-point rate cut at this month's FOMC meeting. (For the record, the most we ever expected in July was a cut of 25 basis points.) The rosy report has many fearing the Fed will use it as an excuse to keep rates where they are—at historically low levels, for the record. Breaking down the numbers in the report, professional services and the health care sector led the charge, adding 51,000 and 35,000 jobs, respectively. The unemployment rate did tick up one notch, to 3.7%, but that was due to a jump in the labor force participation rate. Suddenly, the US economy isn't living up to the narrative that it is slowing. We still don't see the case for lowering rates—which now sit at 2.25% (target Fed funds rate lower limit).
Automotive
Tesla hits record production and delivery numbers, stock soars. Critics in the press, many of whom seem to have a personal animus towards Elon Musk, jumped all over Tesla's (TSLA $177-$238-$387) big deliveries miss two quarters ago, helping to drive shares down to a one-year low of $177. That was not the case this last quarter, however, as the company announced it had produced 87,000 vehicles and delivered another 95,200—both figures blowing by analyst expectations. Furthermore, anticipation is high for Q3 as the company also announced it will be entering the quarter with a large backlog of orders. Shares spiked about 6% after the earnings report was released. The press painted a narrative of empty showrooms and a general loss of enthusiasm for Tesla vehicles. That was simply not the case, giving us another great example of how we can take advantage of misreporting and faulty analysis.
Energy Commodities
OPEC+ agrees to extend supply cuts in bid to keep oil prices high, but America is the spoiler. OPEC, or OPEC+ as it is sometimes now referred to as Russia builds stronger ties to the group, has agreed to keep its 1.2 million barrel-per-day supply cut in place for at least the next nine months—until March of 2020—as it grapples with attempts to keep the price elevated. Here's the problem with their plan: neither Saudi Arabia nor Russia are the leading producer of crude in the world any longer; that prize now goes to the United States. Thanks to the shale renaissance and a loosening of the restrictive standards put in place under the previous administration, the US is now on pace to produce between 12 and 13 million barrels per day in 2019. That is a nightmare scenario for OPEC, but even more so for their quasi-member Russia, which relies on income generated from the sale of oil to build their military and support their flailing economy. A full 70% of Russia's exports are oil- and gas-based, and over 50% of the country's federal budget revenues come from the energy sector. We continue to believe the sweet spot for crude, which is now at $56.22, is between $45 and $60 per barrel. This is high enough for US producers to turn a profit, but low enough to hurt Russia's economy and keep a clamp on Putin's military aspirations. We added the ETF OIL to the Dynamic Growth Strategy when crude dropped to around $45/barrel.
Technology Hardware & Equipment
Dear Apple, without killer new hardware, we have little need for your services. In a November, 2018 issue of The Penn Wealth Report, after Apple (AAPL $142-$201-$233) shares had dropped 25% in price—to $177, we gave a full-throated defense of the company. While our thesis has played out and the shares have moved back above the $200 mark, the announcement that Jony Ive is leaving the firm gives us pause. Even more troubling than the departure of Steve Jobs' kindred spirit (Tim Cook could certainly not claim that moniker), we now learn that Ive essentially checked out years ago. Based on stories from The Wall Street Journal and tech industry publications, Ive has apparently been upset with Apple's focus—under Cook—on services, at the expense of new hardware. We have certainly sensed that shift; most recently with the failed attempt to create an effective device charging pad and the company's mediocre attempt to enter the home automation space with the Apple HomePod (yawn). Not long before Steve Jobs died, he proclaimed that he had cracked the TV code. Something tells us that what he envisioned was certainly not the underwhelming Apple TV of today. If Jony Ive did mentally check out from Apple years ago, that would explain the company's recent lack of exciting new products. What concerns us the most, however, is the fact that Tim Cook doesn't seem to get it: without killer new products, we will soon have little need for your services. A Steve Jobs, or a Jony Ive at his prime, certainly doesn't come around every day, but Apple had better begin searching for that old magic. If not, they might as well bring back the hapless John Sculley—who is only remembered for the fact that he fired Steve Jobs.
Headlines for the Week of 23 Jun 2019—29 Jun 2019
Metals & Mining
Early in the year we bought gold; that precious metal just hit a six-year high. Despite all of the silly commercials on TV promising wild returns in gold, the precious metal traded precisely flat during the five year period between the beginning of 2014 and the end of 2018. Based on what we saw developing in 2019, both economically and geopolitically, we took a stake in gold, via the SPDR® Gold Shares ETF (GLD $111-$133-$136), on the first trading day of the year. What we saw developing has, in great measure, come to fruition, leading to gold prices hitting a six-year high this week. Gold futures currently sit at $1,420 per ounce, or roughly the highest level since May of 2013. The specter of the Fed lowering rates due to a softening economy, concerns over the trade war, and tensions with Iran have all helped to elevate gold prices, as investors look to shelter some of their money in an asset class considered to be a safer haven. We anticipate holding this investment as a satellite position within the Penn Dynamic Growth Strategy for the remainder of the year, at least.
Global Strategy: Trade
If reports prove correct, Xi will make demands at the G20 which Trump cannot accept, and the markets may react violently. There is little doubt that the United States and China were within feet of a trade deal several months ago. There is also little doubt that the Chinese Communist Party pulled the rug out from under that deal. Now, the Wall Street Journal has reported that Xi Jinping will make a set of demands before talks can resume, to include: a lifting of the US ban on the sale of technology to Huawei (probably not acceptable), the end of all punitive tariffs (doubtful that will happen), and an end to the demand that China buy more goods from the US (isn't that what this entire issue is about?). All in all, if these reports are even close to accurate, they will not be acceptable to the US side. And, if the markets don't like what they see over the weekend, it could spell some ugly trading days early next week. As of now, the US has imposed a 25% tariff rate on roughly $200 billion worth of Chinese goods entering the country. The president is also poised to impose a tariff—first 10% then potentially rising to 25%—on another $300 billion worth of goods. Those are staggering numbers, made possible by the fact that last year we imported $540 billion worth of goods from China but only exported $120 billion worth of goods to China. That imbalance, coupled with the systematic process by which China steals US intellectual property, is at the heart of the issue, and these two challenges often appear to be insurmountable. We hold out little hope that anything constructive gets done this weekend. In fact, both sides seem to be digging in. That said, China simply does not have the economic firepower to win a sustained conflict with the United States.
Pharmaceuticals
Pharmaceutical company AbbVie to buy Allergan for $63 billion. It was three years ago that Pfizer (PFE) walked away from its $150 billion deal to buy Botox-maker Allergan (AGN $114-$163-$197) after the acquisition was effectively killed by an administration trying to shine a light on tax inversions. Now, almost three years to the month later, Allergan is poised to be acquired by drugmaker AbbVie (ABBV $74-$66-$100) in a $63 billion deal. The offer, which equates to $188.24 per share, represents a 45% premium to Allergan's prior-day close. Why is AbbVie, with its $100 billion market cap, willing to pay so much? The company wants to take a dominant position in the aesthetics (i.e. beauty) market, and last year Allergan projected the value of its aesthetics division would double—to $8 billion—by 2024. In addition to Botox, Allergan owns the CoolSculpting fat-freezing systems, Jevederm (dermal filler), and a number of other beauty treatments. As for the competition, last year Allergan acquired Bonti Inc., which makes a shorter-acting variation of Botox. Making a move was smart for AbbVie, which is in the process of losing its patent on the world's best selling drug—Humira—in Europe right now, and in the US within the next four years. AbbVie investors were a little rattled by the price tag, pushing shares down 16% and through their 52-week low, but Allergan shareholders (obviously) cheered, with AGN shares trading up 26%. Keep in mind that Pfizer was willing to pay $150 million for Allergan just three years ago. We love the deal, and applaud CEO Rick Gonzalez's courage. Furthermore, we love the fact that Allergan's skilled CEO, Brent Saunders, will hold an AbbVie board seat.
Capital Markets
Buffett denies tension with 3G Capital, which is unfortunate for his legacy. Precisely four years ago, Warren Buffett teamed up with Brazilian private equity firm 3G Capital to take control of American icon Kraft and force it into a nebulous food products blob with Heinz, another company it gobbled up. The combined entity, The Kraft Heinz Co (KHC $27-$30-$65), has now lost 60% of its value since the draconian 3G rebranded it for investor consumption. This has led to stories of a growing tension between Buffett and his friends at 3G, though he strongly denies these reports. Time will tell—let's see if these "good friends" do another deal together anytime soon. It is hard to fathom that Berkshire didn't know the modus operandi of 3G: slash and burn costs at the expense of the human equation. That process may look good on a spreadsheet, but the unintended consequences of moving in like a bull in a china shop often doom the strategy.
Hotels, Resorts, & Cruise Lines
Eldorado Resorts will merge with Caesars, but investing in the new entity is a roll of the dice. Let's consider the individual entities: Caesars Entertainment (CZR $6-$10-$12), which emerged from bankruptcy just two years ago, has a market cap of $7 billion and long-term debt of $9 billion; Eldorado Resorts (ERI $32-$51-$55), which owns gaming facilities in five states, has a market cap of $4 billion and long-term debt of $3 billion. Exactly what magic will manifest out of thin air with the combination of these two companies? Nonetheless, at the "urging" of Caesars board member Carl Icahn, the two companies have agreed to merge in a deal valued at $8.6 billion. Eldorado offered $12.75 per share to a company whose stock price has floundered around $10 for the past four years (and carries a P/E ratio of 90). Shockingly (sarcasm), Icahn just fattened his wallet at the expense of Eldorado shareholders. When the deal is done, ERI will fold into the Caesars name, and that stock (CZR) will continue to trade. This merger will create an entity large enough to compete with the likes of MGM Resorts (MGM), Wynn Resorts (WYNN), and Las Vegas Sands (LVS), but we wouldn't touch it. The merger was not about creating synergies to grow the company; it was a feat of financial engineering performed by one of the masters of that trade: Carl Icahn.
Early in the year we bought gold; that precious metal just hit a six-year high. Despite all of the silly commercials on TV promising wild returns in gold, the precious metal traded precisely flat during the five year period between the beginning of 2014 and the end of 2018. Based on what we saw developing in 2019, both economically and geopolitically, we took a stake in gold, via the SPDR® Gold Shares ETF (GLD $111-$133-$136), on the first trading day of the year. What we saw developing has, in great measure, come to fruition, leading to gold prices hitting a six-year high this week. Gold futures currently sit at $1,420 per ounce, or roughly the highest level since May of 2013. The specter of the Fed lowering rates due to a softening economy, concerns over the trade war, and tensions with Iran have all helped to elevate gold prices, as investors look to shelter some of their money in an asset class considered to be a safer haven. We anticipate holding this investment as a satellite position within the Penn Dynamic Growth Strategy for the remainder of the year, at least.
Global Strategy: Trade
If reports prove correct, Xi will make demands at the G20 which Trump cannot accept, and the markets may react violently. There is little doubt that the United States and China were within feet of a trade deal several months ago. There is also little doubt that the Chinese Communist Party pulled the rug out from under that deal. Now, the Wall Street Journal has reported that Xi Jinping will make a set of demands before talks can resume, to include: a lifting of the US ban on the sale of technology to Huawei (probably not acceptable), the end of all punitive tariffs (doubtful that will happen), and an end to the demand that China buy more goods from the US (isn't that what this entire issue is about?). All in all, if these reports are even close to accurate, they will not be acceptable to the US side. And, if the markets don't like what they see over the weekend, it could spell some ugly trading days early next week. As of now, the US has imposed a 25% tariff rate on roughly $200 billion worth of Chinese goods entering the country. The president is also poised to impose a tariff—first 10% then potentially rising to 25%—on another $300 billion worth of goods. Those are staggering numbers, made possible by the fact that last year we imported $540 billion worth of goods from China but only exported $120 billion worth of goods to China. That imbalance, coupled with the systematic process by which China steals US intellectual property, is at the heart of the issue, and these two challenges often appear to be insurmountable. We hold out little hope that anything constructive gets done this weekend. In fact, both sides seem to be digging in. That said, China simply does not have the economic firepower to win a sustained conflict with the United States.
Pharmaceuticals
Pharmaceutical company AbbVie to buy Allergan for $63 billion. It was three years ago that Pfizer (PFE) walked away from its $150 billion deal to buy Botox-maker Allergan (AGN $114-$163-$197) after the acquisition was effectively killed by an administration trying to shine a light on tax inversions. Now, almost three years to the month later, Allergan is poised to be acquired by drugmaker AbbVie (ABBV $74-$66-$100) in a $63 billion deal. The offer, which equates to $188.24 per share, represents a 45% premium to Allergan's prior-day close. Why is AbbVie, with its $100 billion market cap, willing to pay so much? The company wants to take a dominant position in the aesthetics (i.e. beauty) market, and last year Allergan projected the value of its aesthetics division would double—to $8 billion—by 2024. In addition to Botox, Allergan owns the CoolSculpting fat-freezing systems, Jevederm (dermal filler), and a number of other beauty treatments. As for the competition, last year Allergan acquired Bonti Inc., which makes a shorter-acting variation of Botox. Making a move was smart for AbbVie, which is in the process of losing its patent on the world's best selling drug—Humira—in Europe right now, and in the US within the next four years. AbbVie investors were a little rattled by the price tag, pushing shares down 16% and through their 52-week low, but Allergan shareholders (obviously) cheered, with AGN shares trading up 26%. Keep in mind that Pfizer was willing to pay $150 million for Allergan just three years ago. We love the deal, and applaud CEO Rick Gonzalez's courage. Furthermore, we love the fact that Allergan's skilled CEO, Brent Saunders, will hold an AbbVie board seat.
Capital Markets
Buffett denies tension with 3G Capital, which is unfortunate for his legacy. Precisely four years ago, Warren Buffett teamed up with Brazilian private equity firm 3G Capital to take control of American icon Kraft and force it into a nebulous food products blob with Heinz, another company it gobbled up. The combined entity, The Kraft Heinz Co (KHC $27-$30-$65), has now lost 60% of its value since the draconian 3G rebranded it for investor consumption. This has led to stories of a growing tension between Buffett and his friends at 3G, though he strongly denies these reports. Time will tell—let's see if these "good friends" do another deal together anytime soon. It is hard to fathom that Berkshire didn't know the modus operandi of 3G: slash and burn costs at the expense of the human equation. That process may look good on a spreadsheet, but the unintended consequences of moving in like a bull in a china shop often doom the strategy.
Hotels, Resorts, & Cruise Lines
Eldorado Resorts will merge with Caesars, but investing in the new entity is a roll of the dice. Let's consider the individual entities: Caesars Entertainment (CZR $6-$10-$12), which emerged from bankruptcy just two years ago, has a market cap of $7 billion and long-term debt of $9 billion; Eldorado Resorts (ERI $32-$51-$55), which owns gaming facilities in five states, has a market cap of $4 billion and long-term debt of $3 billion. Exactly what magic will manifest out of thin air with the combination of these two companies? Nonetheless, at the "urging" of Caesars board member Carl Icahn, the two companies have agreed to merge in a deal valued at $8.6 billion. Eldorado offered $12.75 per share to a company whose stock price has floundered around $10 for the past four years (and carries a P/E ratio of 90). Shockingly (sarcasm), Icahn just fattened his wallet at the expense of Eldorado shareholders. When the deal is done, ERI will fold into the Caesars name, and that stock (CZR) will continue to trade. This merger will create an entity large enough to compete with the likes of MGM Resorts (MGM), Wynn Resorts (WYNN), and Las Vegas Sands (LVS), but we wouldn't touch it. The merger was not about creating synergies to grow the company; it was a feat of financial engineering performed by one of the masters of that trade: Carl Icahn.
Headlines for the Week of 16 Jun 2019—22 Jun 2019
Hotels, Resorts, & Cruise Lines
A weaker outlook is just the latest problem for Carnival Cruise Lines. Admittedly, we have never been a fan of Carnival Cruise Lines (Carnival Corp, CCL $46-$48-$68) from an investment standpoint. We believe that the higher-end lines, such as Royal Caribbean (RCL) or Norwegian Cruise Line (NCLH), are not only better-managed, but also better able to navigate turbulent economic waters. And, in fact, 2019 has proven our thesis to be strong: while we haven't exactly faced an economic downturn this year, Carnival's stock is negative YTD, while both Norwegian and Royal Caribbean are up around 27%. The latest bit of bad news for the $35 billion budget (our term) cruise line came in the form of lowered guidance for the remainder of the year. Management blamed, among other things, the US government's ban on docking in Cuba. That seems like a pretty flimsy excuse. Following the report and the earnings call, CCL fell nearly 10% and received a downgrade from Nomura, with the analyst lowering his price target from $60 to $52 per share. While we don't currently own a cruise line in any of the Penn portfolios, if we had to pick one to buy right now it would be Norwegian, with its 12 P/E ratio and strong management team.
Monetary Policy
The Fed held steady with their benchmark rate: the markets cheered and the president jeered. The Fed Funds Target Rate is currently in a band between 2.25% and 2.5%. By all historical standards, that is ultra-low. Furthermore, the unemployment rate in the US sits at 3.6%—full employment by the Fed's own definition. Why, then, would the central bank even consider lowering rates? The argument, made by the president and others, is that inflation continues to be frustratingly low—well below the Fed's 2% target. Also, there are signs of slowing productivity in the country, as measured by GDP. As for inflation, we have posited our rationale for the low rate many times in the past. It has to do with technological advancements keeping a clamp on prices. And we have time to wait and see how the GDP numbers look going forward. In other words, why lower rates? Markets rallied after Wednesday's decision not because the Fed stood pat, but because they left the door wide open for rate cuts as soon as the July meeting. What we find most interesting in this story is the leaked report that President Trump either wants to fire Fed Chief Powell (he cannot) or demote him (he probably cannot). Did Powell screw up with the December rate hike last year? Perhaps. But he has actually done a very good job at balancing economic needs with stock market wants. And that is no easy act. If the president tries to demote Jerome Powell, the markets will not rally (as Jim Cramer predicted). It would amount to the creation of a crisis out of thin air. From a logistical standpoint, it would be fascinating to watch. Hopefully, the conflict will be relegated to our imagination and the columns of pot-stirring journalists.
Cybersecurity
CrowdStrike Holdings: The IPO we haven't talked about happens to be in a red-hot industry. When it comes to corporate and consumer protection, it is hard to imagine a growth industry hotter than cybersecurity. While all eyes were focused on exciting IPOs like Beyond Meat (BYND), Zoom (ZM), Fiverr (FVRR), and Chewy (CHWY), one with enormous potential may have been lost in the weeds: CrowdStrike Holdings (CRWD $56-$78-$79). This cybersecurity Software-as-a-Service (SaaS) company, founded in 2011, suddenly finds itself with a $15 billion market cap just one week after its initial listing. CrowdStrike offers a subscription service (Falcon) which protects IT platforms such as laptops, servers, virtual machines, and devices, in addition to personalized services such as incident response and data protection compliance. The company has already gained wide recognition and praise for the instrumental role it played in uncovering state-sanctioned hackers in China, North Korea, and Russia. Within 48 hours of the well-publicized Sony hack in 2014, for example, CrowdStrike had identified the nefarious player (North Korea) and outlined how the attack was carried out, step-by-step. Here's our major challenge with the company's stock (well, besides the lack of net income): it has a dual share class, which means that anointed investors will get ten votes per share while the rest of us will have just one. An inherently flawed—but perfectly legal—system. Thanks to investors' current fervor for IPOs, CRWD rocketed out of the starting gate. We wouldn't pick it up at its current price, and find better value in well-established cybersecurity names like FireEye (FEYE), Proofpoint (PFPT), or even the Prime Cyber Security ETF (HACK), which holds a basket of approximately 50 firms from the industry.
Specialty Retail
Best Buy is about to jump into the fitness industry. Let's face it, between millennials and baby boomers, wearable electronics and personal fitness are two of the hottest trends going. Best Buy (BBY $48-$69-$84), a company we added to the Intrepid last month at $63.63 per share, already owns a nice market share of the first trend, and now it is moving boldly into the latter. The company will create dedicated space for workout equipment in over 100 of its locations by the end of 2019. The goal is to embrace health/tech synergies made possible with the advent of connected devices. The space will showcase equipment ranging from smart spin bikes (think NordicTrack, and maybe Peloton in the near future) to intelligent treadmills which allow riders/runners to travel through various trails around the world. Another smart move and another thumb in the eye of everyone who wrote off this "old-fashioned box store." We never wrote them off. Yes, technology and online retail go together, but Americans want to see and touch and experience big tech purchases before they buy. Furthermore, we have always been a fan of the Geek Squad move, as well as the newer In-Home Advisor program.
Interactive Media & Services
We hate bitcoin, but we love Facebook's new move into digital currency. It is simply a brilliant new strategic move by Facebook (FB $123-$191-$219), the #22 company (out of 40) in the Penn Global Leaders Club. The $547 billion social media firm just created a new subsidiary—Calibra—which will be responsible for creating the digital wallet to house Facebook's new digital currency, the Libra coin. Unlike its tarnished cousin, bitcoin, the Libra will be a stable currency, as its value will be tied to real-world "hard" currencies. The goal (besides Facebook making a ton of money off the proposition), according to Calibra chief David Marcus, is to "provide billions of people around the world with access to a more inclusive, more open financial ecosystem." In other words, the 67 million underbanked (those who manage their finances primarily through cash transactions) Americans out there are about to have an exciting new way to conduct business and buy goods and services. As for privacy, the Calibra division won't share any personal data with the social media side of Facebook (yes, we hear you cynics out there), which means no ad targeting and the like for Libra users. For doubters, consider this: companies already partnering with the Libra include Visa, Mastercard, PayPal, Uber, Lyft, and eBay. Facebook expects the digital wallet to be up and running by next year, and it will be accessible via a standalone app, Facebook Messenger, and WhatsApp. This will be an enormously prosperous enterprise and Facebook will reap the benefits. Period.
Pharmaceuticals
Pfizer enhances its cancer drug lineup with acquisition of Array BioPharma. Three years ago, Boulder, Colorado-based Array BioPharma Inc (ARRY $13-$46-$47) was a $500 million small-cap biotech trading for roughly $3 per share. On Monday, following Pfizer's (PFE) announcement to buy the firm for $48 per share in cash, Array was suddenly worth $11 billion. What spurred Pfizer, which holds position #1 in the Penn Global Leaders Club, to pay a premium to pick up Array? It is all about the firm's cancer drug research and its innovative approach to developing targeted cancer therapies. In addition to selling a number of drugs that target skin cancers, Array also currently has a therapy for colorectal cancer in Phase 3 trials. Colorectal cancer is the second leading cause of cancer deaths in the US, with an estimated 140,000 new cases projected for 2019. Pfizer already has proven expertise in fighting breast and prostate cancers, so this move will add diversity to its lineup. Despite the hefty premium paid, we love Pfizer's move to acquire Array. The $240 billion pharma giant has a strategic goal of becoming the most viable cancer-fighting drug company in the world, and the growth in its product pipeline buttresses that goal.
Specialty Retail
Famed auction house Sothebys to be acquired, taken private. We never really saw a good reason to own renowned art dealer and auction house Sothebys (BID $32-$56-$60). After all, revenues haven't grown much per year over the past decade, profits have been flat, and the price of the company's stock has fallen 15% over the past five years. That last statistic changed dramatically on Monday when Bidfair USA, a private venture firm owned by art collector Patrick Drahi, announced it would buy the Sothebys for $3.7 billion, or $57 per share. At the open, BID quickly rallied nearly 60%, close to that bid price. The acquisition will end the company's three decade run as a publicly-traded entity. Another fascinating lesson for investors. There really weren't any foreseeable catalysts for price appreciation in BID—except the possibility of a takeover (which few saw coming). Trading a stock and then hoping for a takeover can be a risky premise, but it can pay off handsomely with the right call. Understanding an industry intimately helps the odds (of picking a winner) tremendously. Biotechnology, for example, is an industry rife with takeover possibilities.
A weaker outlook is just the latest problem for Carnival Cruise Lines. Admittedly, we have never been a fan of Carnival Cruise Lines (Carnival Corp, CCL $46-$48-$68) from an investment standpoint. We believe that the higher-end lines, such as Royal Caribbean (RCL) or Norwegian Cruise Line (NCLH), are not only better-managed, but also better able to navigate turbulent economic waters. And, in fact, 2019 has proven our thesis to be strong: while we haven't exactly faced an economic downturn this year, Carnival's stock is negative YTD, while both Norwegian and Royal Caribbean are up around 27%. The latest bit of bad news for the $35 billion budget (our term) cruise line came in the form of lowered guidance for the remainder of the year. Management blamed, among other things, the US government's ban on docking in Cuba. That seems like a pretty flimsy excuse. Following the report and the earnings call, CCL fell nearly 10% and received a downgrade from Nomura, with the analyst lowering his price target from $60 to $52 per share. While we don't currently own a cruise line in any of the Penn portfolios, if we had to pick one to buy right now it would be Norwegian, with its 12 P/E ratio and strong management team.
Monetary Policy
The Fed held steady with their benchmark rate: the markets cheered and the president jeered. The Fed Funds Target Rate is currently in a band between 2.25% and 2.5%. By all historical standards, that is ultra-low. Furthermore, the unemployment rate in the US sits at 3.6%—full employment by the Fed's own definition. Why, then, would the central bank even consider lowering rates? The argument, made by the president and others, is that inflation continues to be frustratingly low—well below the Fed's 2% target. Also, there are signs of slowing productivity in the country, as measured by GDP. As for inflation, we have posited our rationale for the low rate many times in the past. It has to do with technological advancements keeping a clamp on prices. And we have time to wait and see how the GDP numbers look going forward. In other words, why lower rates? Markets rallied after Wednesday's decision not because the Fed stood pat, but because they left the door wide open for rate cuts as soon as the July meeting. What we find most interesting in this story is the leaked report that President Trump either wants to fire Fed Chief Powell (he cannot) or demote him (he probably cannot). Did Powell screw up with the December rate hike last year? Perhaps. But he has actually done a very good job at balancing economic needs with stock market wants. And that is no easy act. If the president tries to demote Jerome Powell, the markets will not rally (as Jim Cramer predicted). It would amount to the creation of a crisis out of thin air. From a logistical standpoint, it would be fascinating to watch. Hopefully, the conflict will be relegated to our imagination and the columns of pot-stirring journalists.
Cybersecurity
CrowdStrike Holdings: The IPO we haven't talked about happens to be in a red-hot industry. When it comes to corporate and consumer protection, it is hard to imagine a growth industry hotter than cybersecurity. While all eyes were focused on exciting IPOs like Beyond Meat (BYND), Zoom (ZM), Fiverr (FVRR), and Chewy (CHWY), one with enormous potential may have been lost in the weeds: CrowdStrike Holdings (CRWD $56-$78-$79). This cybersecurity Software-as-a-Service (SaaS) company, founded in 2011, suddenly finds itself with a $15 billion market cap just one week after its initial listing. CrowdStrike offers a subscription service (Falcon) which protects IT platforms such as laptops, servers, virtual machines, and devices, in addition to personalized services such as incident response and data protection compliance. The company has already gained wide recognition and praise for the instrumental role it played in uncovering state-sanctioned hackers in China, North Korea, and Russia. Within 48 hours of the well-publicized Sony hack in 2014, for example, CrowdStrike had identified the nefarious player (North Korea) and outlined how the attack was carried out, step-by-step. Here's our major challenge with the company's stock (well, besides the lack of net income): it has a dual share class, which means that anointed investors will get ten votes per share while the rest of us will have just one. An inherently flawed—but perfectly legal—system. Thanks to investors' current fervor for IPOs, CRWD rocketed out of the starting gate. We wouldn't pick it up at its current price, and find better value in well-established cybersecurity names like FireEye (FEYE), Proofpoint (PFPT), or even the Prime Cyber Security ETF (HACK), which holds a basket of approximately 50 firms from the industry.
Specialty Retail
Best Buy is about to jump into the fitness industry. Let's face it, between millennials and baby boomers, wearable electronics and personal fitness are two of the hottest trends going. Best Buy (BBY $48-$69-$84), a company we added to the Intrepid last month at $63.63 per share, already owns a nice market share of the first trend, and now it is moving boldly into the latter. The company will create dedicated space for workout equipment in over 100 of its locations by the end of 2019. The goal is to embrace health/tech synergies made possible with the advent of connected devices. The space will showcase equipment ranging from smart spin bikes (think NordicTrack, and maybe Peloton in the near future) to intelligent treadmills which allow riders/runners to travel through various trails around the world. Another smart move and another thumb in the eye of everyone who wrote off this "old-fashioned box store." We never wrote them off. Yes, technology and online retail go together, but Americans want to see and touch and experience big tech purchases before they buy. Furthermore, we have always been a fan of the Geek Squad move, as well as the newer In-Home Advisor program.
Interactive Media & Services
We hate bitcoin, but we love Facebook's new move into digital currency. It is simply a brilliant new strategic move by Facebook (FB $123-$191-$219), the #22 company (out of 40) in the Penn Global Leaders Club. The $547 billion social media firm just created a new subsidiary—Calibra—which will be responsible for creating the digital wallet to house Facebook's new digital currency, the Libra coin. Unlike its tarnished cousin, bitcoin, the Libra will be a stable currency, as its value will be tied to real-world "hard" currencies. The goal (besides Facebook making a ton of money off the proposition), according to Calibra chief David Marcus, is to "provide billions of people around the world with access to a more inclusive, more open financial ecosystem." In other words, the 67 million underbanked (those who manage their finances primarily through cash transactions) Americans out there are about to have an exciting new way to conduct business and buy goods and services. As for privacy, the Calibra division won't share any personal data with the social media side of Facebook (yes, we hear you cynics out there), which means no ad targeting and the like for Libra users. For doubters, consider this: companies already partnering with the Libra include Visa, Mastercard, PayPal, Uber, Lyft, and eBay. Facebook expects the digital wallet to be up and running by next year, and it will be accessible via a standalone app, Facebook Messenger, and WhatsApp. This will be an enormously prosperous enterprise and Facebook will reap the benefits. Period.
Pharmaceuticals
Pfizer enhances its cancer drug lineup with acquisition of Array BioPharma. Three years ago, Boulder, Colorado-based Array BioPharma Inc (ARRY $13-$46-$47) was a $500 million small-cap biotech trading for roughly $3 per share. On Monday, following Pfizer's (PFE) announcement to buy the firm for $48 per share in cash, Array was suddenly worth $11 billion. What spurred Pfizer, which holds position #1 in the Penn Global Leaders Club, to pay a premium to pick up Array? It is all about the firm's cancer drug research and its innovative approach to developing targeted cancer therapies. In addition to selling a number of drugs that target skin cancers, Array also currently has a therapy for colorectal cancer in Phase 3 trials. Colorectal cancer is the second leading cause of cancer deaths in the US, with an estimated 140,000 new cases projected for 2019. Pfizer already has proven expertise in fighting breast and prostate cancers, so this move will add diversity to its lineup. Despite the hefty premium paid, we love Pfizer's move to acquire Array. The $240 billion pharma giant has a strategic goal of becoming the most viable cancer-fighting drug company in the world, and the growth in its product pipeline buttresses that goal.
Specialty Retail
Famed auction house Sothebys to be acquired, taken private. We never really saw a good reason to own renowned art dealer and auction house Sothebys (BID $32-$56-$60). After all, revenues haven't grown much per year over the past decade, profits have been flat, and the price of the company's stock has fallen 15% over the past five years. That last statistic changed dramatically on Monday when Bidfair USA, a private venture firm owned by art collector Patrick Drahi, announced it would buy the Sothebys for $3.7 billion, or $57 per share. At the open, BID quickly rallied nearly 60%, close to that bid price. The acquisition will end the company's three decade run as a publicly-traded entity. Another fascinating lesson for investors. There really weren't any foreseeable catalysts for price appreciation in BID—except the possibility of a takeover (which few saw coming). Trading a stock and then hoping for a takeover can be a risky premise, but it can pay off handsomely with the right call. Understanding an industry intimately helps the odds (of picking a winner) tremendously. Biotechnology, for example, is an industry rife with takeover possibilities.
Headlines for the Week of 09 Jun 2019—15 Jun 2019
e-Commerce
The big winner in the Chewy IPO: Petsmart; the big loser: investors. By the time an average, ordinary investor (i.e. not a fat-cat NY client of a Morgan Stanley or JP Morgan) could buy shares of the latest bloated IPO, Chewy Inc. (CHWY), it was going for $48 per share. That gives the online pet products company a valuation of $14 billion. Consider this: our favorite pet food company, Blue Buffalo, was acquired by General Mills (GIS) last year for $8 billion. Petsmart itself, which was the sole owner of Chewy before it went public, was sold to a private equity firm in 2014 for just $8.7 billion. Don't get us wrong, Chewy has a great, customer-centric model, and its prices are in line with e-Commerce giant Amazon (AMZN), but it is massively overvalued. We were in the business of managing clients' money when Pets.com went public in February of 2000, and we remember the frenzy surrounding that IPO. We also remember the Blue Apron (APRN) IPO. What is the competitive advantage for Chewy? How high are the barriers to entry for competitors in the space? When we ask ourselves these questions, we don't like the answer. And the nail in the coffin is this: CHWY has a dual-class structure (a financially-engineered creature we revile) which gives Petsmart (and its private equity investors) majority control over the company. After the IPO, we went in and registered our dogs on chewy.com, and we may even buy some dog food from the site. Even if we end up loving the company and its exemplary customer service, that doesn't mean we can't loathe the company from an investment standpoint. We wouldn't touch CHWY above $9 per share, which is where it should have been priced. Even then, we probably still wouldn't touch it. And we are not afraid of sky-high valuations, as evidenced by our initial investment in Beyond Meat (BYND) at $53.60, or our probable pick up of IPO Fiverr (FVRR $36) soon.
Global Strategy: Europe
In a major win for Brexiteers, MPs reject plan to halt a "no-deal" exit from the EU. It appears that many in England simply refuse to accept the vote of the people. Three years—almost to the day—after Brits voted to leave the EU, a massive attempt to undo that referendum remains underway. The poor sport crowd suffered another loss this week as MPs in the House of Commons voted 309-298 against a motion which would have prevented a no-deal Brexit. Specifically, were the motion successful it would have blocked the next prime minister from leaving the EU this October without a deal. It was arguably aimed directly at Boris Johnson, the probable next PM, and an ardent advocate of leaving the bloc with or without a deal in place. Opponents argued that voting for the motion would have all but guaranteed a Labour Party win in the next election, putting the far-left Jeremy Corbyn in power. After some disconcerting months in which the odds of another referendum coming before the voters rose substantially, the new odds favor England leaving the EU by this fall—with or without a deal in place. Opponents have used fear-mongering to create the illusion of an economic earthquake if England leaves without a deal in place, similar to the specter they envisioned if the referendum passed in the first place. England will be just fine, economically and otherwise, following the breakup. In fact, breaking free from the chains of Brussels should foster economic growth in the country, especially after a bilateral trade deal with the US is put in place.
Energy Commodities
Oil jumps after latest attack on tankers in the Middle East. In December of last year, when crude was sitting close to $45 per share, we added the iPath S&P GSCI Crude Oil ETN (OIL $45-$54-$79), an oil tracking note, as a satellite position within the Dynamic Growth Strategy. With a nearly straight trajectory up, the note (and oil) quickly hit $65. We chose to keep that position open, as we see crude in a clear channel, and we are in no hurry to take profits. Case in point: just as oil had dropped near a multi-month low and the lemmings were predicting further drops due to demand destruction, another series of tanker attacks took place in the Strait of Hormuz. One of the two ships hit was carrying methanol from Saudi Arabia to Singapore, while the other was bound for Japan with its cargo of naptha—a petrochemical feedstock. As for the culprit, there is no doubt. While we like Becky Quick of CNBC, she is the quintessential journalist—she inferred that Iran couldn't be responsible, as they helped rescue the survivors. Wow. Back to oil prices: they are in a channel, and we see a number of possible events driving prices higher. We purchased OIL in December, and plan on holding the ETN for at least one year. We have used this tool, and its bearish cousin DUG, for over a decade to trade the usually-predictable swing in crude prices.
Multiline Retail
A JC Penney board member just bought 1 million shares of the company, for $1 million. As our members know, earlier in the week we purchased shares of downtrodden retailer JC Penney (JCP $1-$1-$3) for $1.02 per share within the Intrepid Trading Platform. This was a pure trade, not an investment, as we expect a catalyst to push the price higher (like a private equity firm riding in to take the company private). It seems as though we are in pretty good company, as JCP board of directors member Javier Teruel, a former executive vice president of Colgate-Palmolive (CL), picked up just shy of one million shares of the 117-year-old company for around $1 million. This is Teruel's first new purchase of shares in two years. Just a reminder on what we consider a "trade" versus an "investment": the latter is based on a fundamental analysis of a company, while the former represents something that caught our attention in the technicals of a stock. We don't need to particularly like a company or an industry to make a trade—we simply want, and expect, a double-digit pop in price.
East & Southeast Asia
Hong Kong protests grow as pro-Beijing leader Carrie Lam pursues extradition legislation. It has always been our contention that Hong Kong, which transformed itself into a major economic hub while under British control, should have ultimately become a sovereign nation. The gigantic clash of cultures which began when China took control of the region in 1997 was inevitable, and it is far from over. Twenty years after Hong Kong became a Special Administrative Region of the People's Republic of China, Beijing puppet Carrie Lam was installed as Hong Kong's chief executive. There was no vote among the seven million residents of Hong Kong; a simply majority of an election committee handed her the job. Now, true to form, Lam is pushing legislation which would allow for the extradition of residents to mainland China, further eroding the "one country, two systems" facade which is currently in place. Large crowds of protesters blocked roads leading to the Legislative Council, which is set to take up the extradition proposal, which in turn led to police in riot gear lobbing tear gas and firing rubber bullets at the protesters. In the end, the legislation will be put in place, as China ultimately controls this region, despite their false promises of autonomy. The citizens of Hong Kong, however, will not go quietly into the night. Will Hong Kong ultimately become the thorn in the side of China that is Taiwan? Probably not to that extent—Taiwan is, after all, a sovereign state, despite China's argument to the contrary. Nonetheless, the Hong Kong issue will continue to haunt China into the foreseeable future.
Economics: Housing
Mortgage applications spike 27% as rates continue to drop. According to data from the Mortgage Banker's Association, mortgage applications spiked by a whopping 26.8% last week on the heels of the lowest interest rates in two years. With the 30-year fixed rate dropping below 4%, a relatively equal number of home purchasers and those wishing to refinance led to the surge. Muted inflation and some softening in the economy, along with trade war fears, have led to a plunging 10-year Treasury rate and speculation that at least one rate cut by the Fed is in the cards for 2019. The recent market rally was caused, in part, by a strong belief that the Fed will cut rates this year. We don't believe that is a certainty.
Application & Systems Software
Salesforce drops 5% after announcing it will buy big data firm Tableau for $15 billion. $120 billion Software as a Service (SaaS) company Salesforce.com (CRM $114-$153-$168) dropped about 5% in share price following the announcement that it would buy big data firm Tableau Software (DATA $92-$167-$137) for $15.3 billion in an all-stock deal. While CRM was down on the news, DATA flew past its 52-week high, gaining about 35%. So, what will Tableau do for Salesforce? The company is a data visualization firm, meaning it manipulates massive amounts of raw data, turning that data into useful information. For example, imagine eye-pleasing charts and dashboards accessible to anyone at an organization, regardless of their technical savvy. While we have never been a fan of CRM's CEO, Marc Benioff, this appears to be a solid pickup. Remember the likes of MS-DOS, COBOL, and FORTRAN? (OK, we are seriously dating ourselves here.) It used to take a background in the computer languages to do much with the brick sitting on the desk in front of you. While big tech companies like Microsoft and Apple changed that, there now exists an army of smaller application software firms moving us into the next generation. While DATA will no longer be a publicly-traded entity, look for other small- and mid-cap names in the software applications industry. Elastic NV (ESTC), Domo (DOMO), and Blackbaud (BLKB) are three examples of similar companies which could be acquired by a larger industry player. There are always hidden gems hiding out in this little corner of the market.
Commercial Banks
Deutsche Bank falls to a new all-time low as Fitch downgrades the German bank yet again. Deutsche Bank (DB $7-$7-$13) is to Germany what JP Morgan (JPM) and Bank of America (BAC) combined are to the United States. As the largest private financial institution in the country, DB is a symbol of German productivity...and pride. That pride took another hit this past week as ratings agency Fitch downgraded the bank's creditworthiness to BBB—just two notches above "junk" status. Fitch cited low profitability and a murky strategic plan as two reasons for the downgrade. The bank's woes serve as a microcosm for the EU's largest economy—Germany barely missed slipping back into recession earlier this year, and rates remain so low that the 10-year German bund still carries a negative interest rate. Making matters worse, the German banking system is a convoluted machine consisting of gears which seem to grind, constantly in conflict with one another. Furthermore, the bank must not only deal with regulation by the central bank (Bundesbank) and the Financial Regulatory Authority of Germany, it is also under the auspices of the EU's European Central Bank. It is no wonder that profitability continues to elude DB while the major American banks have seen their profit grow considerably since the 2007 global banking crisis. Not only have we been underweighting developed Europe, we consider the European banking system to be at the epicenter of the region's troubles. We would not hold any European financial institution right now.
Aerospace & Defense
United Technologies and Raytheon to merge, creating aerospace and defense behemoth. Growing up in the Cold War '70s, we remember the names of at least a dozen mega-sized aerospace and defense giants. Over the past generation, as the Cold War subsided and the cost of building new systems became prohibitive for all but a handful of players, merger mania permeated the industry, as exemplified by the 1997 deal which combined McDonnell Douglas and rival Boeing (BA). Now, a deal similar in size and scope is on the horizon: Penn Global Leaders Club member Raytheon (RTN $144-$199-$215) and former member United Technologies (UTX) have agreed to merge. The combined entity, to be called Raytheon Technologies Corp., would hold a market cap of around $120 billion, making it the second-largest aerospace and defense firm in the world—behind only Boeing. UTX shareholders would own 57% of the company, with CEO Gregory Hayes retaining that role, while Raytheon shareholders will own the other 43%, with RTN CEO Tom Kennedy becoming the new chairman. In other words, Hayes will have operational control of the company. Despite having coexisted within the same industry, the two companies have very little overlap in specific lines, making the deal all but assured. Post-merger, about 50% of revenue will come from civilian sales and 50% from the sale of military systems, which we view as a great mix. On the news, Raytheon was up around 7%, and UTX was up about half that amount. Since we don't currently own Boeing (it really mishandled the 737-MAX situation from the start), Raytheon Technologies Corp. will be the "must own" aerospace and defense name. It will be interesting to see how the two corporate cultures assimilate (the McDonnell Douglas and Boeing process saw an ugly and brutal clash of cultures), but we foresee owning this company for the long haul.
The big winner in the Chewy IPO: Petsmart; the big loser: investors. By the time an average, ordinary investor (i.e. not a fat-cat NY client of a Morgan Stanley or JP Morgan) could buy shares of the latest bloated IPO, Chewy Inc. (CHWY), it was going for $48 per share. That gives the online pet products company a valuation of $14 billion. Consider this: our favorite pet food company, Blue Buffalo, was acquired by General Mills (GIS) last year for $8 billion. Petsmart itself, which was the sole owner of Chewy before it went public, was sold to a private equity firm in 2014 for just $8.7 billion. Don't get us wrong, Chewy has a great, customer-centric model, and its prices are in line with e-Commerce giant Amazon (AMZN), but it is massively overvalued. We were in the business of managing clients' money when Pets.com went public in February of 2000, and we remember the frenzy surrounding that IPO. We also remember the Blue Apron (APRN) IPO. What is the competitive advantage for Chewy? How high are the barriers to entry for competitors in the space? When we ask ourselves these questions, we don't like the answer. And the nail in the coffin is this: CHWY has a dual-class structure (a financially-engineered creature we revile) which gives Petsmart (and its private equity investors) majority control over the company. After the IPO, we went in and registered our dogs on chewy.com, and we may even buy some dog food from the site. Even if we end up loving the company and its exemplary customer service, that doesn't mean we can't loathe the company from an investment standpoint. We wouldn't touch CHWY above $9 per share, which is where it should have been priced. Even then, we probably still wouldn't touch it. And we are not afraid of sky-high valuations, as evidenced by our initial investment in Beyond Meat (BYND) at $53.60, or our probable pick up of IPO Fiverr (FVRR $36) soon.
Global Strategy: Europe
In a major win for Brexiteers, MPs reject plan to halt a "no-deal" exit from the EU. It appears that many in England simply refuse to accept the vote of the people. Three years—almost to the day—after Brits voted to leave the EU, a massive attempt to undo that referendum remains underway. The poor sport crowd suffered another loss this week as MPs in the House of Commons voted 309-298 against a motion which would have prevented a no-deal Brexit. Specifically, were the motion successful it would have blocked the next prime minister from leaving the EU this October without a deal. It was arguably aimed directly at Boris Johnson, the probable next PM, and an ardent advocate of leaving the bloc with or without a deal in place. Opponents argued that voting for the motion would have all but guaranteed a Labour Party win in the next election, putting the far-left Jeremy Corbyn in power. After some disconcerting months in which the odds of another referendum coming before the voters rose substantially, the new odds favor England leaving the EU by this fall—with or without a deal in place. Opponents have used fear-mongering to create the illusion of an economic earthquake if England leaves without a deal in place, similar to the specter they envisioned if the referendum passed in the first place. England will be just fine, economically and otherwise, following the breakup. In fact, breaking free from the chains of Brussels should foster economic growth in the country, especially after a bilateral trade deal with the US is put in place.
Energy Commodities
Oil jumps after latest attack on tankers in the Middle East. In December of last year, when crude was sitting close to $45 per share, we added the iPath S&P GSCI Crude Oil ETN (OIL $45-$54-$79), an oil tracking note, as a satellite position within the Dynamic Growth Strategy. With a nearly straight trajectory up, the note (and oil) quickly hit $65. We chose to keep that position open, as we see crude in a clear channel, and we are in no hurry to take profits. Case in point: just as oil had dropped near a multi-month low and the lemmings were predicting further drops due to demand destruction, another series of tanker attacks took place in the Strait of Hormuz. One of the two ships hit was carrying methanol from Saudi Arabia to Singapore, while the other was bound for Japan with its cargo of naptha—a petrochemical feedstock. As for the culprit, there is no doubt. While we like Becky Quick of CNBC, she is the quintessential journalist—she inferred that Iran couldn't be responsible, as they helped rescue the survivors. Wow. Back to oil prices: they are in a channel, and we see a number of possible events driving prices higher. We purchased OIL in December, and plan on holding the ETN for at least one year. We have used this tool, and its bearish cousin DUG, for over a decade to trade the usually-predictable swing in crude prices.
Multiline Retail
A JC Penney board member just bought 1 million shares of the company, for $1 million. As our members know, earlier in the week we purchased shares of downtrodden retailer JC Penney (JCP $1-$1-$3) for $1.02 per share within the Intrepid Trading Platform. This was a pure trade, not an investment, as we expect a catalyst to push the price higher (like a private equity firm riding in to take the company private). It seems as though we are in pretty good company, as JCP board of directors member Javier Teruel, a former executive vice president of Colgate-Palmolive (CL), picked up just shy of one million shares of the 117-year-old company for around $1 million. This is Teruel's first new purchase of shares in two years. Just a reminder on what we consider a "trade" versus an "investment": the latter is based on a fundamental analysis of a company, while the former represents something that caught our attention in the technicals of a stock. We don't need to particularly like a company or an industry to make a trade—we simply want, and expect, a double-digit pop in price.
East & Southeast Asia
Hong Kong protests grow as pro-Beijing leader Carrie Lam pursues extradition legislation. It has always been our contention that Hong Kong, which transformed itself into a major economic hub while under British control, should have ultimately become a sovereign nation. The gigantic clash of cultures which began when China took control of the region in 1997 was inevitable, and it is far from over. Twenty years after Hong Kong became a Special Administrative Region of the People's Republic of China, Beijing puppet Carrie Lam was installed as Hong Kong's chief executive. There was no vote among the seven million residents of Hong Kong; a simply majority of an election committee handed her the job. Now, true to form, Lam is pushing legislation which would allow for the extradition of residents to mainland China, further eroding the "one country, two systems" facade which is currently in place. Large crowds of protesters blocked roads leading to the Legislative Council, which is set to take up the extradition proposal, which in turn led to police in riot gear lobbing tear gas and firing rubber bullets at the protesters. In the end, the legislation will be put in place, as China ultimately controls this region, despite their false promises of autonomy. The citizens of Hong Kong, however, will not go quietly into the night. Will Hong Kong ultimately become the thorn in the side of China that is Taiwan? Probably not to that extent—Taiwan is, after all, a sovereign state, despite China's argument to the contrary. Nonetheless, the Hong Kong issue will continue to haunt China into the foreseeable future.
Economics: Housing
Mortgage applications spike 27% as rates continue to drop. According to data from the Mortgage Banker's Association, mortgage applications spiked by a whopping 26.8% last week on the heels of the lowest interest rates in two years. With the 30-year fixed rate dropping below 4%, a relatively equal number of home purchasers and those wishing to refinance led to the surge. Muted inflation and some softening in the economy, along with trade war fears, have led to a plunging 10-year Treasury rate and speculation that at least one rate cut by the Fed is in the cards for 2019. The recent market rally was caused, in part, by a strong belief that the Fed will cut rates this year. We don't believe that is a certainty.
Application & Systems Software
Salesforce drops 5% after announcing it will buy big data firm Tableau for $15 billion. $120 billion Software as a Service (SaaS) company Salesforce.com (CRM $114-$153-$168) dropped about 5% in share price following the announcement that it would buy big data firm Tableau Software (DATA $92-$167-$137) for $15.3 billion in an all-stock deal. While CRM was down on the news, DATA flew past its 52-week high, gaining about 35%. So, what will Tableau do for Salesforce? The company is a data visualization firm, meaning it manipulates massive amounts of raw data, turning that data into useful information. For example, imagine eye-pleasing charts and dashboards accessible to anyone at an organization, regardless of their technical savvy. While we have never been a fan of CRM's CEO, Marc Benioff, this appears to be a solid pickup. Remember the likes of MS-DOS, COBOL, and FORTRAN? (OK, we are seriously dating ourselves here.) It used to take a background in the computer languages to do much with the brick sitting on the desk in front of you. While big tech companies like Microsoft and Apple changed that, there now exists an army of smaller application software firms moving us into the next generation. While DATA will no longer be a publicly-traded entity, look for other small- and mid-cap names in the software applications industry. Elastic NV (ESTC), Domo (DOMO), and Blackbaud (BLKB) are three examples of similar companies which could be acquired by a larger industry player. There are always hidden gems hiding out in this little corner of the market.
Commercial Banks
Deutsche Bank falls to a new all-time low as Fitch downgrades the German bank yet again. Deutsche Bank (DB $7-$7-$13) is to Germany what JP Morgan (JPM) and Bank of America (BAC) combined are to the United States. As the largest private financial institution in the country, DB is a symbol of German productivity...and pride. That pride took another hit this past week as ratings agency Fitch downgraded the bank's creditworthiness to BBB—just two notches above "junk" status. Fitch cited low profitability and a murky strategic plan as two reasons for the downgrade. The bank's woes serve as a microcosm for the EU's largest economy—Germany barely missed slipping back into recession earlier this year, and rates remain so low that the 10-year German bund still carries a negative interest rate. Making matters worse, the German banking system is a convoluted machine consisting of gears which seem to grind, constantly in conflict with one another. Furthermore, the bank must not only deal with regulation by the central bank (Bundesbank) and the Financial Regulatory Authority of Germany, it is also under the auspices of the EU's European Central Bank. It is no wonder that profitability continues to elude DB while the major American banks have seen their profit grow considerably since the 2007 global banking crisis. Not only have we been underweighting developed Europe, we consider the European banking system to be at the epicenter of the region's troubles. We would not hold any European financial institution right now.
Aerospace & Defense
United Technologies and Raytheon to merge, creating aerospace and defense behemoth. Growing up in the Cold War '70s, we remember the names of at least a dozen mega-sized aerospace and defense giants. Over the past generation, as the Cold War subsided and the cost of building new systems became prohibitive for all but a handful of players, merger mania permeated the industry, as exemplified by the 1997 deal which combined McDonnell Douglas and rival Boeing (BA). Now, a deal similar in size and scope is on the horizon: Penn Global Leaders Club member Raytheon (RTN $144-$199-$215) and former member United Technologies (UTX) have agreed to merge. The combined entity, to be called Raytheon Technologies Corp., would hold a market cap of around $120 billion, making it the second-largest aerospace and defense firm in the world—behind only Boeing. UTX shareholders would own 57% of the company, with CEO Gregory Hayes retaining that role, while Raytheon shareholders will own the other 43%, with RTN CEO Tom Kennedy becoming the new chairman. In other words, Hayes will have operational control of the company. Despite having coexisted within the same industry, the two companies have very little overlap in specific lines, making the deal all but assured. Post-merger, about 50% of revenue will come from civilian sales and 50% from the sale of military systems, which we view as a great mix. On the news, Raytheon was up around 7%, and UTX was up about half that amount. Since we don't currently own Boeing (it really mishandled the 737-MAX situation from the start), Raytheon Technologies Corp. will be the "must own" aerospace and defense name. It will be interesting to see how the two corporate cultures assimilate (the McDonnell Douglas and Boeing process saw an ugly and brutal clash of cultures), but we foresee owning this company for the long haul.
Headlines for the Week of 02 Jun 2019—08 Jun 2019
Monetary Policy
Markets soar on growing odds of a rate cut by the end of the year. It's enough to give an investor whiplash. All we have heard from the Fed for four years is the need for steady, measured rate hikes. Even after nine quarter-point jumps, rates are still sitting very low in their historical range—the lower band of the channel for the Fed's target sits at 2.25%. Nonetheless, investors took Fed Chief Jerome Powell's dovish remarks made on Tuesday and ran with them. He didn't exactly mention a rate cut, but he did indicate that the Fed was closely monitoring the landscape for any potential deterioration in conditions. That statement, coupled with stubornly-low inflation, has placed the odds of one to two rate cuts by the end of the year somewhere around 90%. Those odds seem pretty high, and we will believe it when we see it, but the markets sure liked the speculation: the Dow jumped 512 points on the day, and the Nasdaq regained positive territory on the week. Rate cuts or no rate cuts, one thing is certain: low interest rates are going to be sticking around for some time to come. This means investors need to re-visit all of the higher-yielding tools (like REITs and utilities) income-seekers tend to flock to when there is a dearth of solid bonds to choose from.
Food Products
Rumor has it that Beyond Meat will land a major fast-food deal before the year is up; a look at its board may offer some clues. The only regret we have with respect to our purchase, within five minutes of the opening trade, of Beyond Meat (BYND $45-$107-$105) is that we didn't buy twice as much. We believe the company will be a benchmark for the burgeoning plant-based meat alternative industry. In fact, we are more bullish on the space than even the most ardent supporters. Beyond, which is now up over 100% since our purchase one month ago, is rumored to be close to landing a major deal to have its burgers featured at a major fast-food restaurant. We know it won't be Burger King (owned by Restaurant Brands International), which already offers an Impossible™ Whopper, so McDonald's (MCD) would be the next-most-obvious choice. To add fuel to that speculation, consider who sits on Beyond's board: none other than former McDonald's CEO Don Thompson. The chain's current (brilliant) CEO, Brit Steve Easterbrook, has proven he is not afraid to make bold moves, and a growing percentage of fast-food customers are clamoring for a vegan option. Logistically, adding a Beyond Quarter Pounder, for example, would be a challenge, as new kitchen hardware and procedures would be required. Nonetheless, we are predicting this announcement is made before the year is up. Beyond Meat, despite being a food products company, is actually a member of the Penn New Frontier Fund—a great reminder for investors that innovation can be found in even the most staid, old-school industries.
Energy: Exploration & Production
Carl Icahn is spot-on in his attack on Occidental for grossly overextending itself to buy Anadarko. We have been clear in our opinion of the effort to buy Permian player Anadarko Petroleum (APC $40-$70-$77): Chevron's $33 billion bid should have won the day, and it would have made for a win-win situation. Instead, with the backing of Warren Buffett's confiscatory offer to Occidental (OXY $50-$50-$80), which was great for him but will be disastrous for everyone else, that company was emboldened to up its bid for Anadarko to $38 billion. Keep in mind that Anadarko was worth $22 billion before the bidding war began. Now, Occidental shareholder Carl Icahn has taken action against the overpriced offer—he has filed a complaint in Delaware questioning CEO Vicki Hollub's decision-making as related to proper corporate governance. Icahn believes that Occidental itself should be put up for sale, but the massive amount of debt it will incur to purchase Anadarko (Buffett's "gift" gives him 100,000 preferred shares with an 8% annual dividend) amounts to a poison pill which will keep potential buyers at bay. Odds are slim that Icahn can stop Occidental's ill-fated acquisition, which is why shares of the company remain at their 52-week low. Penn member Chevron (CVX) is the real winner in this battle. Had its offer been accepted, APC would have been a great fit for the $220 billion energy conglomerate. Instead, it will get a cool $1 billion in free cash for Anadarko backing out of the deal.
Markets soar on growing odds of a rate cut by the end of the year. It's enough to give an investor whiplash. All we have heard from the Fed for four years is the need for steady, measured rate hikes. Even after nine quarter-point jumps, rates are still sitting very low in their historical range—the lower band of the channel for the Fed's target sits at 2.25%. Nonetheless, investors took Fed Chief Jerome Powell's dovish remarks made on Tuesday and ran with them. He didn't exactly mention a rate cut, but he did indicate that the Fed was closely monitoring the landscape for any potential deterioration in conditions. That statement, coupled with stubornly-low inflation, has placed the odds of one to two rate cuts by the end of the year somewhere around 90%. Those odds seem pretty high, and we will believe it when we see it, but the markets sure liked the speculation: the Dow jumped 512 points on the day, and the Nasdaq regained positive territory on the week. Rate cuts or no rate cuts, one thing is certain: low interest rates are going to be sticking around for some time to come. This means investors need to re-visit all of the higher-yielding tools (like REITs and utilities) income-seekers tend to flock to when there is a dearth of solid bonds to choose from.
Food Products
Rumor has it that Beyond Meat will land a major fast-food deal before the year is up; a look at its board may offer some clues. The only regret we have with respect to our purchase, within five minutes of the opening trade, of Beyond Meat (BYND $45-$107-$105) is that we didn't buy twice as much. We believe the company will be a benchmark for the burgeoning plant-based meat alternative industry. In fact, we are more bullish on the space than even the most ardent supporters. Beyond, which is now up over 100% since our purchase one month ago, is rumored to be close to landing a major deal to have its burgers featured at a major fast-food restaurant. We know it won't be Burger King (owned by Restaurant Brands International), which already offers an Impossible™ Whopper, so McDonald's (MCD) would be the next-most-obvious choice. To add fuel to that speculation, consider who sits on Beyond's board: none other than former McDonald's CEO Don Thompson. The chain's current (brilliant) CEO, Brit Steve Easterbrook, has proven he is not afraid to make bold moves, and a growing percentage of fast-food customers are clamoring for a vegan option. Logistically, adding a Beyond Quarter Pounder, for example, would be a challenge, as new kitchen hardware and procedures would be required. Nonetheless, we are predicting this announcement is made before the year is up. Beyond Meat, despite being a food products company, is actually a member of the Penn New Frontier Fund—a great reminder for investors that innovation can be found in even the most staid, old-school industries.
Energy: Exploration & Production
Carl Icahn is spot-on in his attack on Occidental for grossly overextending itself to buy Anadarko. We have been clear in our opinion of the effort to buy Permian player Anadarko Petroleum (APC $40-$70-$77): Chevron's $33 billion bid should have won the day, and it would have made for a win-win situation. Instead, with the backing of Warren Buffett's confiscatory offer to Occidental (OXY $50-$50-$80), which was great for him but will be disastrous for everyone else, that company was emboldened to up its bid for Anadarko to $38 billion. Keep in mind that Anadarko was worth $22 billion before the bidding war began. Now, Occidental shareholder Carl Icahn has taken action against the overpriced offer—he has filed a complaint in Delaware questioning CEO Vicki Hollub's decision-making as related to proper corporate governance. Icahn believes that Occidental itself should be put up for sale, but the massive amount of debt it will incur to purchase Anadarko (Buffett's "gift" gives him 100,000 preferred shares with an 8% annual dividend) amounts to a poison pill which will keep potential buyers at bay. Odds are slim that Icahn can stop Occidental's ill-fated acquisition, which is why shares of the company remain at their 52-week low. Penn member Chevron (CVX) is the real winner in this battle. Had its offer been accepted, APC would have been a great fit for the $220 billion energy conglomerate. Instead, it will get a cool $1 billion in free cash for Anadarko backing out of the deal.
Headlines for the Week of 26 May 2019—01 Jun 2019
Global Strategy: Trade
It will be a long, hot summer if new tariffs on goods from Mexico are actually put in place. We have, overall, been a big supporter of bilateral trade negotiations. NAFTA was outdated, China has built its economy on the theft of American technology, and inept US negotiators from previous administrations had us locked into mediocre to downright bad trade deals. We are befuddled by this latest move, however. With all the heat on China, and with the USMCA simply waiting for ratification from the three North American countries, why on earth would we slap a 5% tariff on all goods coming from Mexico? The illegal immigration problem is real, and it must be dealt with, but using tariffs as a weapon after negotiating a trade deal makes it look like the US cannot be trusted to hold up its end of the bargain. There were dozens of other arrows in the quiver to get Mexico to help us in this effort; just about any of them would have been better than this. Unless this gets walked back quickly, it could be a long, hot summer for the markets. There really is no good place to hide from this latest threat, other than cash. The ten-year Treasury yield fell to 2.135%, its lowest rate since September of 2017, and every sector fell on the news. Commodities were down as well. Our instinct is that these tariffs will never see the light of day, and the markets will react positively. We just could have avoided Friday's bloodbath (good riddance, May) had the threat never been made.
Global Strategy: Trade
As predicted, China issues a veiled threat to cut off supply of vital rare earth minerals. Last week, we re-ran a story from the summer of 2018 outlining how China has used its abundant supply of mined rare earth materials as a weapon against other nations in the past. Specifically, the communist country cut off the supply of critical materials to Japan in 2010 as part of a territorial dispute. These substances are used in a range of high-tech products, from electric car batteries to wind turbines to smartphones, and they most definitely have a national security component. Now, the country is issuing thinly-veiled threats that it may pull a similar tactic against the West as part of the ongoing trade dispute. It's not that there is a worldwide shortage of these materials outside of China; it is that China has allowed its mining companies free rein to pillage the land in an effort to extract the materials, while other nations have implemented environmental policies which prohibit unfettered mining. It really is that simple. Unfortunately, the West has held a myopic view of the issue despite the warning signs along the way, such as the 2010 action against Japan. We can no longer afford to maintain the illusion of safety—it is time to act. Here's what investors need to unearth: there will be companies which continue to keep their heads buried in the sand and rely on China to an untenable degree (for the sake of short-term profit), and there will be companies which adroitly diversify both their markets and their operations to the point that one non-domestic country cannot threaten their overall success. If you hear a company screaming like a stuck pig that tariffs are threatening their very existence, it is time to do a deeper dive into the strategic vision of that company.
Automotive
The merger would create the third-largest automaker in the world, but do you really want to own it? For France's Renault (RNSDF $58-$58-$100), which had been trading at its one-year low, and Italy's Fiat Chrysler (FCAU $13-$14-$23), which was sitting just a buck off of its low, it was a joint venture forged out of necessity. The two European car companies announced a "merger of equals" this week, with each side owning 50% of the newly-formed company. Combined, the carmakers sold 8.7 million vehicles last year and generated $9 billion in net profit, but margins are fast-disappearing in an industry beset with challenges. While touting the deal as a way to save nearly $6 billion in annual costs, it will be interesting to see how that is done, considering France's demand that no jobs be cut at the firm following the merger. Both boards, Italy, France, and the automakers' union must all OK the deal, but it will almost assuredly be completed. The fun part will be watching a Northern European carmaker merge with a Southern European one, considering the dichotomy in thinking between the two regions. While stocks of both companies popped on the news, we wouldn't touch the new entity when it is formed. Instead, grab some popcorn and enjoy the show.
It will be a long, hot summer if new tariffs on goods from Mexico are actually put in place. We have, overall, been a big supporter of bilateral trade negotiations. NAFTA was outdated, China has built its economy on the theft of American technology, and inept US negotiators from previous administrations had us locked into mediocre to downright bad trade deals. We are befuddled by this latest move, however. With all the heat on China, and with the USMCA simply waiting for ratification from the three North American countries, why on earth would we slap a 5% tariff on all goods coming from Mexico? The illegal immigration problem is real, and it must be dealt with, but using tariffs as a weapon after negotiating a trade deal makes it look like the US cannot be trusted to hold up its end of the bargain. There were dozens of other arrows in the quiver to get Mexico to help us in this effort; just about any of them would have been better than this. Unless this gets walked back quickly, it could be a long, hot summer for the markets. There really is no good place to hide from this latest threat, other than cash. The ten-year Treasury yield fell to 2.135%, its lowest rate since September of 2017, and every sector fell on the news. Commodities were down as well. Our instinct is that these tariffs will never see the light of day, and the markets will react positively. We just could have avoided Friday's bloodbath (good riddance, May) had the threat never been made.
Global Strategy: Trade
As predicted, China issues a veiled threat to cut off supply of vital rare earth minerals. Last week, we re-ran a story from the summer of 2018 outlining how China has used its abundant supply of mined rare earth materials as a weapon against other nations in the past. Specifically, the communist country cut off the supply of critical materials to Japan in 2010 as part of a territorial dispute. These substances are used in a range of high-tech products, from electric car batteries to wind turbines to smartphones, and they most definitely have a national security component. Now, the country is issuing thinly-veiled threats that it may pull a similar tactic against the West as part of the ongoing trade dispute. It's not that there is a worldwide shortage of these materials outside of China; it is that China has allowed its mining companies free rein to pillage the land in an effort to extract the materials, while other nations have implemented environmental policies which prohibit unfettered mining. It really is that simple. Unfortunately, the West has held a myopic view of the issue despite the warning signs along the way, such as the 2010 action against Japan. We can no longer afford to maintain the illusion of safety—it is time to act. Here's what investors need to unearth: there will be companies which continue to keep their heads buried in the sand and rely on China to an untenable degree (for the sake of short-term profit), and there will be companies which adroitly diversify both their markets and their operations to the point that one non-domestic country cannot threaten their overall success. If you hear a company screaming like a stuck pig that tariffs are threatening their very existence, it is time to do a deeper dive into the strategic vision of that company.
Automotive
The merger would create the third-largest automaker in the world, but do you really want to own it? For France's Renault (RNSDF $58-$58-$100), which had been trading at its one-year low, and Italy's Fiat Chrysler (FCAU $13-$14-$23), which was sitting just a buck off of its low, it was a joint venture forged out of necessity. The two European car companies announced a "merger of equals" this week, with each side owning 50% of the newly-formed company. Combined, the carmakers sold 8.7 million vehicles last year and generated $9 billion in net profit, but margins are fast-disappearing in an industry beset with challenges. While touting the deal as a way to save nearly $6 billion in annual costs, it will be interesting to see how that is done, considering France's demand that no jobs be cut at the firm following the merger. Both boards, Italy, France, and the automakers' union must all OK the deal, but it will almost assuredly be completed. The fun part will be watching a Northern European carmaker merge with a Southern European one, considering the dichotomy in thinking between the two regions. While stocks of both companies popped on the news, we wouldn't touch the new entity when it is formed. Instead, grab some popcorn and enjoy the show.
Headlines for the Week of 19 May 2019—25 May 2019
Specialty Retail
Best Buy announces blowout quarter—and the company's shares drop 7%. It really could not have been much better of an earnings report. With all of the renewed talk of a brick-and-mortar retail train wreck, Hubert Joly's Best Buy (BBY $48-$65-$84) delivered on all fronts in the first quarter. Revenues came in at $9.14 billion (a slight increase from last year), net income rose to $265 million (a 27% Y/Y increase), and online sales spiked 14.5%, to $1.3 billion. Investors rewarded the stellar quarter by dragging the stock down 7% in under a day. It probably didn't help that CEO Joly speculated on the impact of lingering tariffs in his final conference call and kept the full-year forecast muted, but we can think of a lot of great American companies that would be affected to a much larger degree than Best Buy. Furthermore, the company is known for keeping expectations low and then overperforming. Still, the comments spooked many into punting their shares. BBY has been one of our favorite trading stocks for two decades, and the last time we sold shares (Feb of this year) they were going for $70. We took a 24%, ten-week gain. Efficient-market hypothesis? Please. Did we take any action in our trading account—the Penn Intrepid—this time around? Members can keep up-to-date on all of our trades by logging into the Trading Desk.
Multiline Retail
We bought Target on its darkest day, and it has continued to perform as expected. Having followed—and traded—multiline retailer Target (TGT $60-$78-$90) for decades, we liked what we saw on the 21st of December. Shares had been dropping like a rock since early November, and they plunged to around $62 per share four days before Christmas on dour analyst comments and an overall sour mood in the markets. (Who can forget the Christmas eve bloodbath?) While others were busy dumping it, we took the opportunity to pick up the battered retailer within the Penn Intrepid Trading Platform, with a target price of $78 per share. After Wednesday's stellar earnings report, our target price has been hit, but we are holding steady with the expectation for further gains. For the quarter, Target saw same-store sales growth of 4.8%, and digital sales growth of 42%. While Walmart (WMT) is busy battling Amazon (AMZN) for the mantle of low-cost and fast-delivery leader, we see Target continuing to solidify its niche clientele. We weren't touching the stock with tone-deaf CEO Gregg Steinhafel ("hack, what hack?") haplessly running the company, but Brian Cornell has the right strategy, and his team is delivering. We are raising our target price to $85 per share. Once again, further evidence that leadership—not the industry—makes or breaks the company. Target wisely dumped its sad sack CEO, but too many other companies settle for mediocrity in the C-suite. More often than not, the root of the problem can be found by delving into the cozy relationship between CEO and board.
Semiconductors & Equipment
Qualcomm shares plunge double-digits after federal court rules the company violated antitrust laws. It was just a month ago that semiconductor-maker Qualcomm (QCOM $49-$69-$90) and one of its biggest customers, Apple (AAPL), buried the hatchet and dropped their competing lawsuits. That drove shares of the company, which primarily makes chips for smartphones, up by nearly 25% in a matter of weeks. Now, it is giving much of those gains back as a federal judge has ruled that Qualcomm is using its market dominance to squeeze customers, ordering the firm to renegotiate licensing agreements without using the threat of halting supplies as a tactic. Shares plunged 11% after US District Court Judge Lucy Koh sided with the Federal Trade Commission in the dispute, which Qualcomm vows to fight. While the company sells needed hardware for smartphones, most of its revenue is derived from lucrative licensing deals (the root of the Apple lawsuit) surrounding the use of its technology. Despite Qualcomm's dominance in this space and in the coming 5G arena (Intel recently announced it would abandon its own program), we are not touching the company until we see these legal issues subsiding—both at home and abroad. That being said, the company's fair value probably sits in the $85 to $95 per share range.
Global Strategy: Middle East
US gives Turkey two weeks to cancel its deal to buy a Russian anti-aircraft system. The United States has sent a rightful ultimatum to Turkey: renounce the deal to buy the S-400 surface-to-air missile system from Russia, or lose the F-35 fighter contract and face further punitive actions. The fact that a NATO member would have the audacity to buy a system designed to shoot down NATO aircraft is almost unfathomable, and certainly grounds for the organization to review that country's membership. Finally, the United States is standing up (like NATO should have been from the beginning) to the Erdogan regime and clearly telling it that this will not stand. In addition to demanding the $2.5 billion deal with Russia be cancelled, the US also said it expects Turkey to buy Raytheon's (RTN $144-$183-$215) Patriot surface-to-air missile system—a system which seamlessly integrates within NATO's ecosystem—or face further actions from Washington. Turkey has until the end of the first week of June to make its decision. We are torn, as it is becoming more and more evident that Erdogan is no friend to the West, and F-35 technology—the most advanced in the world—may well end up in Russian hands if the aircraft are delivered to Ankara. Despite what decision Turkey makes on the missile system, the mere fact that it was preparing to deploy a system hostile to NATO should make it clear that the country, at least under Erdogan, cannot be trusted going forward.
Global Strategy: Europe
JP Morgan predicts Boris Johnson will be prime minister by fall. In what would be a stunning turn of events, US banking giant JP Morgan (JPM) is predicting that former foreign minister and London mayor Boris Johnson will take over as the UK's next prime minister, and that it will happen by September. Johnson is a staunch supporter of Brexit, the plan to leave the EU which was supported by a majority of voters nearly three years ago. Despite the long, three-year runway the country had to make it happen, both Prime Minister Theresa May and the UK Parliament have managed to fritter that time away without executing the plan. Johnson got so frustrated by the lack of a cogent plan that he quit his post as foreign minister last year. As the drama is unfolding in England, the EU is preparing for its own European Parliament elections, with another stunner in the works in that contest. Nigel Farage's Brexit Party is suddenly the frontrunner to gain the most votes within the UK. That would send shock waves across Europe and into the Brussels headquarters of the pompous EU leaders who have attempted to foil Brexit at every turn. Finally, as for Theresa May, she is trying yet again to revive her own Brexit deal; a deal which has already been rejected three times by Parliament. In a bizarre twist, she is promising the legislature the chance to vote for another Brexit referendum if they go along (this time) with her agreement. Not likely. We still believe there will be no repeat referendum in the UK for Brexit. The voters have spoken, and to toss the first referendum aside would invite mass chaos in the country. We also predict a Prime Minister Johnson, followed by his call for a general election and, ultimately, a real exit from Brussels, with or without an Irish Backstop in place.
Multiline Retail
As JC Penney's losses widen, the company's stock is close to breaking a buck—again. In February we reported on new JC Penney (JCP $1-$1-$3) CEO Jill Soltau's decision to dump furniture and electronics at the company's 850+ stores, with the former Jo-Ann Stores CEO re-focusing on fashion. It is still early in her reign, to be sure, but the latest earnings report didn't offer much in the way of hope. On revenues of $2.44 billion—a 6% drop from the same quarter last year—the retailer managed to bleed $154 million in losses. That was nearly double the $78 million it lost in the first quarter of 2018. Ironically, most of the losses stemmed from the lack of furniture and appliance sales. Comparable sales, which (sadly) include online orders, fell 5.5% Y/Y. Shares were off 8%—to $1.05—on the heels of the report. At $1 per share, many speculators may be tempted to jump in and buy some JCP. After all, a simple rise to $2 per share would double an investor's stake. That would truly be a speculative gamble, however, as this company could go either way over the next twelve months.
Technology Hardware & Equipment
Google suspends its business with Huawei, dealing the Chinese company an enormous blow. Trade tensions, specifically as related to intellectual property theft, ratcheted up last Wednesday when the Trump Administration, on grounds of national security, greatly restricted Chinese telecom hardware maker Huawei's access to US markets. Considering the company's very limited business in the US, that action may not have appeared to carry much loft, but the gravity of the move was evident on Monday, when Google (GOOGL) announced that it was cutting ties with the firm, ending the licensing agreement for the use of its Android mobile operating system. And that is enormous. This means that any future phones Huawei sells in Europe, for example, won't have the Google services on them which drive most smartphone sales. These devices will become, in essence, simple products that cannot do much more than make and receive calls. Put another way, imagine an Apple user purchasing a new generation iPhone which was void of all apps, or the ability to add them. Huawei will only be able to use a public version of the operating system via the Android Open Source Project. Considering the company had plans to overtake Apple in sales this year, this is a devastating blow. China is certain to retaliate, and Apple may be the next target. In another twist, Chinese state media . Most geopolitical analysts continue to underestimate India's potential to become a world economic superpower. Massive reform—underpinned by a general acceptance of free market ideals—is still required for this to happen, but the country continues its slow march forward. A Modi loss would have represented a major setback to this effort.
Global Strategy: South Asia
Modi's reelection in India is good news not just for Indian markets, but also for overall geopolitical stability. We have often made the case that little will keep the Communist Chinese government in check more than a strong and growing India—a parliamentary democracy and staunch ally to the United States. Which is why the Communist Party of China (CPC) can't be happy about the outcome of India's national elections. Prime Minister Narendra Modi, a fiscal and military hawk, appears headed for another five-year term as the country's leader, and the benchmark S&P BSE SENSEX index, the "Dow 30" for India, is having its best day since 2013—up nearly 4%. While Modi's ruling Bharatiya Janata Party (BJP) may lose its outright majority in parliament, its relatively strong coalition will almost certainly remain in charge. This should mean a continued march towards the privatization of the nation's industrial base, which will encourage further foreign direct investment in the economy. Modi and his party were swept into power in 2014 on promises to modernize the country and make it a competitive place to do business. India's economy, now growing at a rate above 6.5% per year, surpassed Russia's in size back in 2014 and, at $2.6 trillion, is poised to surpass that of the France's this year, which would make it the sixth-largest in the world. Most geopolitical analysts continue to underestimate India's potential to become a world economic superpower. Massive reform—underpinned by a general acceptance of free market ideals—is still required for this to happen, but the country continues its slow march forward. A Modi loss would have represented a major setback to this effort.
Best Buy announces blowout quarter—and the company's shares drop 7%. It really could not have been much better of an earnings report. With all of the renewed talk of a brick-and-mortar retail train wreck, Hubert Joly's Best Buy (BBY $48-$65-$84) delivered on all fronts in the first quarter. Revenues came in at $9.14 billion (a slight increase from last year), net income rose to $265 million (a 27% Y/Y increase), and online sales spiked 14.5%, to $1.3 billion. Investors rewarded the stellar quarter by dragging the stock down 7% in under a day. It probably didn't help that CEO Joly speculated on the impact of lingering tariffs in his final conference call and kept the full-year forecast muted, but we can think of a lot of great American companies that would be affected to a much larger degree than Best Buy. Furthermore, the company is known for keeping expectations low and then overperforming. Still, the comments spooked many into punting their shares. BBY has been one of our favorite trading stocks for two decades, and the last time we sold shares (Feb of this year) they were going for $70. We took a 24%, ten-week gain. Efficient-market hypothesis? Please. Did we take any action in our trading account—the Penn Intrepid—this time around? Members can keep up-to-date on all of our trades by logging into the Trading Desk.
Multiline Retail
We bought Target on its darkest day, and it has continued to perform as expected. Having followed—and traded—multiline retailer Target (TGT $60-$78-$90) for decades, we liked what we saw on the 21st of December. Shares had been dropping like a rock since early November, and they plunged to around $62 per share four days before Christmas on dour analyst comments and an overall sour mood in the markets. (Who can forget the Christmas eve bloodbath?) While others were busy dumping it, we took the opportunity to pick up the battered retailer within the Penn Intrepid Trading Platform, with a target price of $78 per share. After Wednesday's stellar earnings report, our target price has been hit, but we are holding steady with the expectation for further gains. For the quarter, Target saw same-store sales growth of 4.8%, and digital sales growth of 42%. While Walmart (WMT) is busy battling Amazon (AMZN) for the mantle of low-cost and fast-delivery leader, we see Target continuing to solidify its niche clientele. We weren't touching the stock with tone-deaf CEO Gregg Steinhafel ("hack, what hack?") haplessly running the company, but Brian Cornell has the right strategy, and his team is delivering. We are raising our target price to $85 per share. Once again, further evidence that leadership—not the industry—makes or breaks the company. Target wisely dumped its sad sack CEO, but too many other companies settle for mediocrity in the C-suite. More often than not, the root of the problem can be found by delving into the cozy relationship between CEO and board.
Semiconductors & Equipment
Qualcomm shares plunge double-digits after federal court rules the company violated antitrust laws. It was just a month ago that semiconductor-maker Qualcomm (QCOM $49-$69-$90) and one of its biggest customers, Apple (AAPL), buried the hatchet and dropped their competing lawsuits. That drove shares of the company, which primarily makes chips for smartphones, up by nearly 25% in a matter of weeks. Now, it is giving much of those gains back as a federal judge has ruled that Qualcomm is using its market dominance to squeeze customers, ordering the firm to renegotiate licensing agreements without using the threat of halting supplies as a tactic. Shares plunged 11% after US District Court Judge Lucy Koh sided with the Federal Trade Commission in the dispute, which Qualcomm vows to fight. While the company sells needed hardware for smartphones, most of its revenue is derived from lucrative licensing deals (the root of the Apple lawsuit) surrounding the use of its technology. Despite Qualcomm's dominance in this space and in the coming 5G arena (Intel recently announced it would abandon its own program), we are not touching the company until we see these legal issues subsiding—both at home and abroad. That being said, the company's fair value probably sits in the $85 to $95 per share range.
Global Strategy: Middle East
US gives Turkey two weeks to cancel its deal to buy a Russian anti-aircraft system. The United States has sent a rightful ultimatum to Turkey: renounce the deal to buy the S-400 surface-to-air missile system from Russia, or lose the F-35 fighter contract and face further punitive actions. The fact that a NATO member would have the audacity to buy a system designed to shoot down NATO aircraft is almost unfathomable, and certainly grounds for the organization to review that country's membership. Finally, the United States is standing up (like NATO should have been from the beginning) to the Erdogan regime and clearly telling it that this will not stand. In addition to demanding the $2.5 billion deal with Russia be cancelled, the US also said it expects Turkey to buy Raytheon's (RTN $144-$183-$215) Patriot surface-to-air missile system—a system which seamlessly integrates within NATO's ecosystem—or face further actions from Washington. Turkey has until the end of the first week of June to make its decision. We are torn, as it is becoming more and more evident that Erdogan is no friend to the West, and F-35 technology—the most advanced in the world—may well end up in Russian hands if the aircraft are delivered to Ankara. Despite what decision Turkey makes on the missile system, the mere fact that it was preparing to deploy a system hostile to NATO should make it clear that the country, at least under Erdogan, cannot be trusted going forward.
Global Strategy: Europe
JP Morgan predicts Boris Johnson will be prime minister by fall. In what would be a stunning turn of events, US banking giant JP Morgan (JPM) is predicting that former foreign minister and London mayor Boris Johnson will take over as the UK's next prime minister, and that it will happen by September. Johnson is a staunch supporter of Brexit, the plan to leave the EU which was supported by a majority of voters nearly three years ago. Despite the long, three-year runway the country had to make it happen, both Prime Minister Theresa May and the UK Parliament have managed to fritter that time away without executing the plan. Johnson got so frustrated by the lack of a cogent plan that he quit his post as foreign minister last year. As the drama is unfolding in England, the EU is preparing for its own European Parliament elections, with another stunner in the works in that contest. Nigel Farage's Brexit Party is suddenly the frontrunner to gain the most votes within the UK. That would send shock waves across Europe and into the Brussels headquarters of the pompous EU leaders who have attempted to foil Brexit at every turn. Finally, as for Theresa May, she is trying yet again to revive her own Brexit deal; a deal which has already been rejected three times by Parliament. In a bizarre twist, she is promising the legislature the chance to vote for another Brexit referendum if they go along (this time) with her agreement. Not likely. We still believe there will be no repeat referendum in the UK for Brexit. The voters have spoken, and to toss the first referendum aside would invite mass chaos in the country. We also predict a Prime Minister Johnson, followed by his call for a general election and, ultimately, a real exit from Brussels, with or without an Irish Backstop in place.
Multiline Retail
As JC Penney's losses widen, the company's stock is close to breaking a buck—again. In February we reported on new JC Penney (JCP $1-$1-$3) CEO Jill Soltau's decision to dump furniture and electronics at the company's 850+ stores, with the former Jo-Ann Stores CEO re-focusing on fashion. It is still early in her reign, to be sure, but the latest earnings report didn't offer much in the way of hope. On revenues of $2.44 billion—a 6% drop from the same quarter last year—the retailer managed to bleed $154 million in losses. That was nearly double the $78 million it lost in the first quarter of 2018. Ironically, most of the losses stemmed from the lack of furniture and appliance sales. Comparable sales, which (sadly) include online orders, fell 5.5% Y/Y. Shares were off 8%—to $1.05—on the heels of the report. At $1 per share, many speculators may be tempted to jump in and buy some JCP. After all, a simple rise to $2 per share would double an investor's stake. That would truly be a speculative gamble, however, as this company could go either way over the next twelve months.
Technology Hardware & Equipment
Google suspends its business with Huawei, dealing the Chinese company an enormous blow. Trade tensions, specifically as related to intellectual property theft, ratcheted up last Wednesday when the Trump Administration, on grounds of national security, greatly restricted Chinese telecom hardware maker Huawei's access to US markets. Considering the company's very limited business in the US, that action may not have appeared to carry much loft, but the gravity of the move was evident on Monday, when Google (GOOGL) announced that it was cutting ties with the firm, ending the licensing agreement for the use of its Android mobile operating system. And that is enormous. This means that any future phones Huawei sells in Europe, for example, won't have the Google services on them which drive most smartphone sales. These devices will become, in essence, simple products that cannot do much more than make and receive calls. Put another way, imagine an Apple user purchasing a new generation iPhone which was void of all apps, or the ability to add them. Huawei will only be able to use a public version of the operating system via the Android Open Source Project. Considering the company had plans to overtake Apple in sales this year, this is a devastating blow. China is certain to retaliate, and Apple may be the next target. In another twist, Chinese state media . Most geopolitical analysts continue to underestimate India's potential to become a world economic superpower. Massive reform—underpinned by a general acceptance of free market ideals—is still required for this to happen, but the country continues its slow march forward. A Modi loss would have represented a major setback to this effort.
Global Strategy: South Asia
Modi's reelection in India is good news not just for Indian markets, but also for overall geopolitical stability. We have often made the case that little will keep the Communist Chinese government in check more than a strong and growing India—a parliamentary democracy and staunch ally to the United States. Which is why the Communist Party of China (CPC) can't be happy about the outcome of India's national elections. Prime Minister Narendra Modi, a fiscal and military hawk, appears headed for another five-year term as the country's leader, and the benchmark S&P BSE SENSEX index, the "Dow 30" for India, is having its best day since 2013—up nearly 4%. While Modi's ruling Bharatiya Janata Party (BJP) may lose its outright majority in parliament, its relatively strong coalition will almost certainly remain in charge. This should mean a continued march towards the privatization of the nation's industrial base, which will encourage further foreign direct investment in the economy. Modi and his party were swept into power in 2014 on promises to modernize the country and make it a competitive place to do business. India's economy, now growing at a rate above 6.5% per year, surpassed Russia's in size back in 2014 and, at $2.6 trillion, is poised to surpass that of the France's this year, which would make it the sixth-largest in the world. Most geopolitical analysts continue to underestimate India's potential to become a world economic superpower. Massive reform—underpinned by a general acceptance of free market ideals—is still required for this to happen, but the country continues its slow march forward. A Modi loss would have represented a major setback to this effort.
Headlines for the Week of 12 May 2019—18 May 2019
Global Strategy: Middle East
As if we didn't know: Saudis point finger at Iran for recent attacks on oil assets. Last Sunday it was an attack on four oil tankers just off the coast of the UAE. On Tuesday, drones attacked a Saudi oil pipeline, with an Iran-backed Houthi rebel group claiming responsibility. As Iran lashes out in the region in response to President Trump's enforcement of sanctions against the terrorist regime, and as the USS Abraham Lincoln carrier strike group enters the Gulf, countries will need to choose sides in the coming battles; and they are coming. Other than Russia, North Korea, . Many analysts predicted Walmart's demise in the age of Amazon, but the company has been making the right moves to remain the dominant retailer in the country. The 2014 pickup of e-Commerce company Jet.com was brilliant, in that it brought the company's founder, Marc Lore, into the fold. Lore is considered one of the masters of the online retail world.
Food & Staples Retailing
Penn member Walmart rises on solid earnings report. Penn Global Leaders Club member Walmart (WMT $82-$103-$106) brought in a staggering $124 billion in the first quarter of 2019, and the company reported a 3.4% growth rate in Y/Y same-store sales. Even more impressive was the company's 37% growth rate in its e-Commerce business—a business looking more and more like it can compete with the Goliath Amazon (AMZN). As for profitability, net income came in at $3.84 billion, which was 80% higher than the same period last year. Even the store's Sam's Club chain saw a 1.5% jump in sales over last year. The one downside was Walmart's 4.9% drop in international sales, due primarily to the global economic environment. Walmart has been investing heavily in its supply chain, arguably the best in the world, and its e-Commerce business. Shortly after Amazon announced its one-day delivery promise to Prime members, the Bentonville-based company said it would be implementing a similar program, no membership strings attached. Investors liked what they saw in the report, sending shares up over 3%. Many analysts predicted Walmart's demise in the age of Amazon, but the company has been making the right moves to remain the dominant retailer in the country. The 2014 pickup of e-Commerce company Jet.com was brilliant, in that it brought the company's founder, Marc Lore, into the fold. Lore is considered one of the masters of the online retail world.
Global Strategy: East/Southeast Asia
A trio of bad economic reports coming from China. Remember when all we were hearing about China from the journalist community was the country's double-digit economic growth rate, extending out as far as the eyes could see? As we pointed out years ago, of course an emerging market can grow at a double-digit clip—at least until it gets to a certain size. Unfortunately for China's ruling Communist party, they bought into that narrative completely. Despite the bravado coming from China, a slew of recent economic reports confirm the slowdown in that country's rate of growth. Retail sales are down 1.5% year-over-year, vehicle production dropped 16%, and the country's exports fell more than expected due the the tariffs and weakening global demand. Despite these economic facts, the Chinese Commerce Ministry and the mouthpiece Chinese news outlets are throwing down an imaginary gauntlet, promising "all necessary countermeasures" will be deployed to make the United States pay dearly for the latest round of tariffs. These are hollow threats, as the firepower simply doesn't exist. As for the threat to begin shedding itself of the $1.12 trillion in US Treasuries it owns, that entire amount is just a fraction (sadly) of the $22 trillion the US has in outstanding debt. That move would weaken the US dollar, which would make US goods cheaper for other countries to purchase, thus increasing our exports. China's economic slowdown will add impetus for that country to come back to the bargaining table and re-offer some of the promises it had already committed to in previous talks.
Media & Entertainment
Disney gains, for all intents and purposes, complete control of Hulu. Last month we wrote about streaming service Hulu's repurchase of AT&T's (T) 9.5% stake in the firm, leaving Disney (DIS $99-$133-$142) with 67% ownership, and Comcast (CMCSA) with the remaining 33%. Now, as Disney prepares to launch its own streaming service, Disney+, it has struck a deal with Comcast giving it virtually complete control of Hulu, and its 25 million subscribers. Under the terms of the deal, Comcast will sell its stake to Disney by 2024 for at least $27.5 billion, but it is handing over complete operational control of the company effective immediately. This means that Disney will control customer management, the database, and the technology behind Hulu. It can even bundle the service with Disney+ if it prefers. This is a great deal for the company, especially considering that NBC, a division of Comcast, currently rakes in $500 million per year from Hulu for its library of films and TV shows. Disney is a member of the Penn Global Leaders Club and remains our favorite—by far—player in the Media & Entertainment industry.
Transportation Infrastructure
At some price point, Uber is a bargain; the rub, of course, is figuring out where that point sits. Let's face it, compared to Lyft's (LYFT $50-$47-$89) disastrous IPO, ride-sharing giant Uber's (UBER $36-$36-$45) offering went off relatively smoothly. That being said, shares fell double-digits on Monday, to $36.26. The $80 billion company is now worth $60 billion. Yes, on $11 billion in 2018 revenues—a 45% increase—the company did report a net loss of $1.8 billion, but that is a 15% decrease from what it lost in 2017. All we are hearing from the analysts is the lack of an apparent path to profitability. We don't buy that mantra, however. The company, under the capable leadership of Dara Khosrowshahi, has a lot going for it. With nearly 100 million users spread over 63 countries, no other ride-sharing service comes close to matching the revenue level or customer base of this ten-year-old juggernaut. Not just a one-trick pony, Uber Eats in addition to newer lines of business such as Uber Freight (and an eventual autonomous driver unit) should allow the company to keep its commanding market share of a $400 billion industry. We believe Uber is worth at least $50 per share, which would give it back its short-lived $80 billion market cap. However, we want to watch the trading action a bit longer before adding it to any Penn portfolio.
Global Strategy: Trade
If China plans to wait out the Trump Administration, it is playing a dangerous game. It is hard to say who might be affecting Xi's decision-making process, but a new strategy is beginning to crystallize: the Chinese president believes he can simply wait out President Trump's tenure and deal with the next US administration. He sees himself, after all, as president for life, and exalted ruler over the information seen by the Chinese people. He also, no doubt, reads Chinese translations of New York Times headlines. Xi needs to be careful, however, and think back to early 2017, when his American sources were assuring him that Trump would be impeached within six months. Now that the trade deal—which was all but a fait accompli just a week ago—has imploded, and the new wave of tariffs are set to take effect, the ball is in China's court. Actually, instead of a ball, picture the ACME bomb that always seemed to end up in Wile E. Coyote's hands. The United States imported a whopping $540 billion from China in 2018, but China allowed only $120 billion worth of US goods and services into the mainland last year—22% as much. Three pertinent facts: 1. The United States remains, by far, the largest purchaser of goods and services in the world; 2. China cannot play a game of tit-for-tat with respect to tariffs, it is simply a mathematical impossibility; 3. Companies are migrating away from China and to places like Vietnam and India for the manufacture of their goods. Xi may get a warm, fuzzy feeling when he reads the NYT headlines, but The Grapes of Wrath, which portrayed a devastating picture of the American economy during the Great Depression, was one of Hitler's favorite movies—it gave him a false sense of security. Nobody knows who will be sworn in on 20 Jan 2021, but we do know that a lot of damage can be done to the Chinese economy between now and then sans a trade deal. The markets are in pullback mode due to the apparent breakdown in trade talks. We consider this an opportunity to buy on the dip. Consider overweighting small- and mid-caps which are US-centric, and take a look at exchange traded funds focused on the countries which stand to gain by China's bravado, such as Vietnam (no friend to China) and India.
As if we didn't know: Saudis point finger at Iran for recent attacks on oil assets. Last Sunday it was an attack on four oil tankers just off the coast of the UAE. On Tuesday, drones attacked a Saudi oil pipeline, with an Iran-backed Houthi rebel group claiming responsibility. As Iran lashes out in the region in response to President Trump's enforcement of sanctions against the terrorist regime, and as the USS Abraham Lincoln carrier strike group enters the Gulf, countries will need to choose sides in the coming battles; and they are coming. Other than Russia, North Korea, . Many analysts predicted Walmart's demise in the age of Amazon, but the company has been making the right moves to remain the dominant retailer in the country. The 2014 pickup of e-Commerce company Jet.com was brilliant, in that it brought the company's founder, Marc Lore, into the fold. Lore is considered one of the masters of the online retail world.
Food & Staples Retailing
Penn member Walmart rises on solid earnings report. Penn Global Leaders Club member Walmart (WMT $82-$103-$106) brought in a staggering $124 billion in the first quarter of 2019, and the company reported a 3.4% growth rate in Y/Y same-store sales. Even more impressive was the company's 37% growth rate in its e-Commerce business—a business looking more and more like it can compete with the Goliath Amazon (AMZN). As for profitability, net income came in at $3.84 billion, which was 80% higher than the same period last year. Even the store's Sam's Club chain saw a 1.5% jump in sales over last year. The one downside was Walmart's 4.9% drop in international sales, due primarily to the global economic environment. Walmart has been investing heavily in its supply chain, arguably the best in the world, and its e-Commerce business. Shortly after Amazon announced its one-day delivery promise to Prime members, the Bentonville-based company said it would be implementing a similar program, no membership strings attached. Investors liked what they saw in the report, sending shares up over 3%. Many analysts predicted Walmart's demise in the age of Amazon, but the company has been making the right moves to remain the dominant retailer in the country. The 2014 pickup of e-Commerce company Jet.com was brilliant, in that it brought the company's founder, Marc Lore, into the fold. Lore is considered one of the masters of the online retail world.
Global Strategy: East/Southeast Asia
A trio of bad economic reports coming from China. Remember when all we were hearing about China from the journalist community was the country's double-digit economic growth rate, extending out as far as the eyes could see? As we pointed out years ago, of course an emerging market can grow at a double-digit clip—at least until it gets to a certain size. Unfortunately for China's ruling Communist party, they bought into that narrative completely. Despite the bravado coming from China, a slew of recent economic reports confirm the slowdown in that country's rate of growth. Retail sales are down 1.5% year-over-year, vehicle production dropped 16%, and the country's exports fell more than expected due the the tariffs and weakening global demand. Despite these economic facts, the Chinese Commerce Ministry and the mouthpiece Chinese news outlets are throwing down an imaginary gauntlet, promising "all necessary countermeasures" will be deployed to make the United States pay dearly for the latest round of tariffs. These are hollow threats, as the firepower simply doesn't exist. As for the threat to begin shedding itself of the $1.12 trillion in US Treasuries it owns, that entire amount is just a fraction (sadly) of the $22 trillion the US has in outstanding debt. That move would weaken the US dollar, which would make US goods cheaper for other countries to purchase, thus increasing our exports. China's economic slowdown will add impetus for that country to come back to the bargaining table and re-offer some of the promises it had already committed to in previous talks.
Media & Entertainment
Disney gains, for all intents and purposes, complete control of Hulu. Last month we wrote about streaming service Hulu's repurchase of AT&T's (T) 9.5% stake in the firm, leaving Disney (DIS $99-$133-$142) with 67% ownership, and Comcast (CMCSA) with the remaining 33%. Now, as Disney prepares to launch its own streaming service, Disney+, it has struck a deal with Comcast giving it virtually complete control of Hulu, and its 25 million subscribers. Under the terms of the deal, Comcast will sell its stake to Disney by 2024 for at least $27.5 billion, but it is handing over complete operational control of the company effective immediately. This means that Disney will control customer management, the database, and the technology behind Hulu. It can even bundle the service with Disney+ if it prefers. This is a great deal for the company, especially considering that NBC, a division of Comcast, currently rakes in $500 million per year from Hulu for its library of films and TV shows. Disney is a member of the Penn Global Leaders Club and remains our favorite—by far—player in the Media & Entertainment industry.
Transportation Infrastructure
At some price point, Uber is a bargain; the rub, of course, is figuring out where that point sits. Let's face it, compared to Lyft's (LYFT $50-$47-$89) disastrous IPO, ride-sharing giant Uber's (UBER $36-$36-$45) offering went off relatively smoothly. That being said, shares fell double-digits on Monday, to $36.26. The $80 billion company is now worth $60 billion. Yes, on $11 billion in 2018 revenues—a 45% increase—the company did report a net loss of $1.8 billion, but that is a 15% decrease from what it lost in 2017. All we are hearing from the analysts is the lack of an apparent path to profitability. We don't buy that mantra, however. The company, under the capable leadership of Dara Khosrowshahi, has a lot going for it. With nearly 100 million users spread over 63 countries, no other ride-sharing service comes close to matching the revenue level or customer base of this ten-year-old juggernaut. Not just a one-trick pony, Uber Eats in addition to newer lines of business such as Uber Freight (and an eventual autonomous driver unit) should allow the company to keep its commanding market share of a $400 billion industry. We believe Uber is worth at least $50 per share, which would give it back its short-lived $80 billion market cap. However, we want to watch the trading action a bit longer before adding it to any Penn portfolio.
Global Strategy: Trade
If China plans to wait out the Trump Administration, it is playing a dangerous game. It is hard to say who might be affecting Xi's decision-making process, but a new strategy is beginning to crystallize: the Chinese president believes he can simply wait out President Trump's tenure and deal with the next US administration. He sees himself, after all, as president for life, and exalted ruler over the information seen by the Chinese people. He also, no doubt, reads Chinese translations of New York Times headlines. Xi needs to be careful, however, and think back to early 2017, when his American sources were assuring him that Trump would be impeached within six months. Now that the trade deal—which was all but a fait accompli just a week ago—has imploded, and the new wave of tariffs are set to take effect, the ball is in China's court. Actually, instead of a ball, picture the ACME bomb that always seemed to end up in Wile E. Coyote's hands. The United States imported a whopping $540 billion from China in 2018, but China allowed only $120 billion worth of US goods and services into the mainland last year—22% as much. Three pertinent facts: 1. The United States remains, by far, the largest purchaser of goods and services in the world; 2. China cannot play a game of tit-for-tat with respect to tariffs, it is simply a mathematical impossibility; 3. Companies are migrating away from China and to places like Vietnam and India for the manufacture of their goods. Xi may get a warm, fuzzy feeling when he reads the NYT headlines, but The Grapes of Wrath, which portrayed a devastating picture of the American economy during the Great Depression, was one of Hitler's favorite movies—it gave him a false sense of security. Nobody knows who will be sworn in on 20 Jan 2021, but we do know that a lot of damage can be done to the Chinese economy between now and then sans a trade deal. The markets are in pullback mode due to the apparent breakdown in trade talks. We consider this an opportunity to buy on the dip. Consider overweighting small- and mid-caps which are US-centric, and take a look at exchange traded funds focused on the countries which stand to gain by China's bravado, such as Vietnam (no friend to China) and India.
Headlines for the Week of 05 May 2019—11 May 2019
Global Strategy: Middle East
USS Abraham Lincoln Carrier Strike Group and bomber task force headed to Persian Gulf on new Iranian threats. The United States has been tipped off by Israeli intelligence that Tehran is planning on "aggressive action" in response to new sanctions placed on the rogue regime—more evidence of the severe impact these sanctions are having on Iran. The carrier strike group (CSG) consists of: Carrier Air Wing 7 (primarily F-18 Super Hornets), the Ticonderoga-class guided-missile cruiser USS Leyte Gulf, Destroyer Squadron 2, and several Arleigh Burke-class guided-missile cruisers. Additionally, US Air Force F-35 fighters and B-52 bombers have also been deployed to the region in direct response to this threat. For their part, Israeli intelligence sensors are zeroing in on the activity of Iranian ships carrying short-range ballistic missiles which have sailed into the Persian Gulf in recent weeks. Much like China from an economic standpoint, Iran is beginning to realize that their old tricks, formerly used so successfully against previous administrations, are no longer working. Perhaps Iran, like China, believe they can hold out until another administration is in the White House. That is a dangerous and misguided strategy. As for the current situation in the Middle East, Israel has been under increasing attack within the past two weeks. It is almost inevitable that the Iranian Revolutionary Guard, which the US has now deemed a terrorist organization, will brazenly attempt something in late spring/early summer. That would be a dangerous and misguided tactic.
Currency Trading: FOREX
Bitcoin theft highlights the severe challenges of dealing in "non-physical" currencies. The value of one bitcoin peaked just before Christmas, 2017, just shy of $20,000. One year later, the same unit of digital currency was worth $3,200—an 85% drop. Beyond a shadow of a doubt, the greatest threat to this new currency is the ability of hackers to break into the exchanges and commit large-scale theft. The latest case-in-point came this Tuesday when Binance, one of the largest cryptocurrency exchanges, discovered that 7,000 bitcoins had been stolen from one wallet. While the company has promised to make good on the missing money, this is a condition which must be rectified before any large-scale adoption of cryptocurrencies will take place. To date, nearly $2 billion worth of cryptocurrencies have been reported stolen, and that doesn't count the massive number of hidden thefts not reported. Bitcoins currently trade at $5,839 per unit. For traders not afraid of risk, the Grayscale Bitcoin Trust (GBTC $7.81) is the easiest way to play the currency. But beware: GBTC was trading at $38.05 in December of 2017.
Global Strategy: Trade
Markets have grossly overreacted to talk of new tariffs. The wild swings in the market—mainly to the downside—on Monday and Tuesday can be traced back, almost exclusively, to presidential tweets about new tariffs against Chinese goods being implemented by the end of the week. This understandably spooked investors, who have all but set a new US/China trade deal in stone. What few were reporting on Monday was that the tweets emanated from some critical components of the potential deal being walked back by top Chinese officials. These guarantees, many already in writing, swirled around the sensitive topic of Chinese theft of US intellectual property, or IP. While journalists jumped on rumors that the trade delegation might not even come to the US this Thursday as planned, within a day those rumors were quelled. Not only is the delegation still coming, it will be headed up by Liu Hu, the one person outside of Xi who can authorize a deal be struck. The $20 trillion US economy just notched another 3.2% annualized growth rate in the first quarter; the $12 trillion Chinese economy desperately needs access to the world's most lucrative market. The Chinese may have had cold feet about some of the promises they made, and were almost certainly rattled by US demands for ongoing verification, but they will do what they must to get the deal done. The state of the Chinese economy rides on it. Any market pullbacks in 2019 should be used by investors as an opportunity to scour industries for undervalued gems. When the dust settles on the year, it will look a lot more like 2017 than 2018.
Energy: Exploration & Production
Thanks to Buffett, the (far) less qualified company will now acquire Anadarko. When the deal was announced back in April, we called it a brilliant move. Penn member Chevron (CVX), a $225 billion oil and gas conglomerate, would pick up E&P company (and big Permian player) Anadarko Petroleum (APC) in a deal valued at $33 billion. A shale player only slightly bigger than Anadarko, Occidental Petroleum (OXY), had previously made a bid for the company, but the added debt load would have seriously strained the company. With Anadarko's management backing the Chevron bid, and with almost certain backing by shareholders, in saunters Warren Buffett with a $10 billion cash infusion to Occidental, contingent on that company buying Anadarko. For his "gift," Buffett would receive 100,000 shares of cumulative perpetual preferred stock, with a liquidation value of $100,000 each (so, he could get his $10B back) and an 8% annual dividend. This sounds like a great deal...for Buffett. Everyone else, not so much. Let's see how successful Occidental is at servicing that added debt to the Oracle of Omaha. For its part, Anadarko must pay Chevron a $1 billion breakup fee for walking away from that deal. This deal makes us about as happy as when Buffett helped draconian Brazilian firm 3G get their hands on Kraft, to begin the ruination of an iconic American brand. Or when he took our favorite railroad, Burlington Northern Santa Fe (BNSF), away from the public markets because he "always liked playing with railroads." Maybe it is time for Buffett to focus on his philanthropic projects and let Wall Street do its thing. As for this most recent deal, we are sure the Saudis are happy about it.
Basic Materials: Chemicals
If Glenview Capital's Larry Robbins is right, dump your 3M and Chemours now. Larry Robbins, the founder and CEO of Glenview Capital Management, is one of those rare individuals you unmute your TV for when you see his face. You can bet he has something interesting to say about the investment world, and his delivery is masterful. During Monday's Sohn Conference, he didn't mince words about two stocks he is shorting: 3M (MMM $177-$183-$220) and The Chemours Company (pron "KHUH moors", CC $25-$32-$53), and he clearly spelled out the reason why: the companies' intimate relationship with PFAS ("P-fas"), per- and polyfluoroalkyl substances, also known as PFCs. He calls these substances, which were invented by 3M in the 1930s, "forever chemicals" due to their incredibly long shelf life. Unfortunately, evidence is mounting that these chemicals, which are used in everything from Teflon® pans to Scotchgard® fabric protectors, are highly toxic to the environment—and they virtually never break down. While both 3M and DuPont, which recently spun off its Chemours unit, have already shelled out hundreds of millions of dollars to settle PFAS claims, Robbins believes this is just the tip of the iceberg. We agree: expect a mountain of litigation coming down the pike from class action lawsuits and state and local government suits. Back in 2016, following the spinoff, Citron Research called Chemours a "bankruptcy waiting to happen"—further claiming that DuPont jettisoned the company knowing full well what was coming. That assertion seems to be logical and quite believable. Steer clear of these companies.
Global Strategy: Middle East
What does an autocratic state ruler do when an election goes against them? Void the results, of course. The fact that Turkey is a member of NATO and was given the right to purchase the most advanced fighter in the world—the F-35—should send chills down the spine of the free world. The latest example of abuse of power by the country's iron-fisted ruler, Recep Erdogan, came this week as the president's crony national election board threw out the results of Istanbul's mayoral race—a race that the opposition party won. Ekrem Imamoglu, who was sworn in three weeks ago as mayor, called Erdogan a "sore loser" for demanding new elections. Despite the outrage over the nullification, want to lay odds on who will be the victor in the new round of elections? Although Russia has had a tumultuous relationship with Turkey, Vlad Putin is a master at playing geopolitical chess. He understands (unlike former US presidents) just how critical a linchpin the country is to regional stability, given its location between the Western and Eastern worlds. The most illustrative example of this can be found in the country's purchase of American F-35s, and a Russian anti-aircraft system designed to shoot down...F-35s.
Food Products
The Kraft Heinz train wreck continues: company to restate earnings due to misconduct. At the risk of being redundant, we hated the Kraft/Heinz merger from the start. Warren Buffett's deal to take Kraft (then symbol KFT) off the market and put it under the control of draconian cost-cutter 3G, a Brazilian company, smelled rotten from the start. Our predictions for the outcome of the deal have played out time and time again since the July, 2015 merger, with the latest iteration coming Monday: Kraft Heinz (KHC $32-$32-65) will restate its financial statements for a two year period due to employee misconduct. It wasn't that the company found the misconduct due to proactive measures; the internal audit took place after the SEC launched an investigation of its own. The nefarious deeds centered around the way in which earnings were calculated during the period in question. When Buffett spawned the merger, the new entity was trading at $72.50 per share. The share price now sits at $32.35—a 55% slide over the course of four years. Yes, it is a challenging environment for the food products industry, but companies like Kraft Heinz and Campbell's Soup (CPB) have compounded the problem by having a dearth of effective leadership. Steer clear of both.
USS Abraham Lincoln Carrier Strike Group and bomber task force headed to Persian Gulf on new Iranian threats. The United States has been tipped off by Israeli intelligence that Tehran is planning on "aggressive action" in response to new sanctions placed on the rogue regime—more evidence of the severe impact these sanctions are having on Iran. The carrier strike group (CSG) consists of: Carrier Air Wing 7 (primarily F-18 Super Hornets), the Ticonderoga-class guided-missile cruiser USS Leyte Gulf, Destroyer Squadron 2, and several Arleigh Burke-class guided-missile cruisers. Additionally, US Air Force F-35 fighters and B-52 bombers have also been deployed to the region in direct response to this threat. For their part, Israeli intelligence sensors are zeroing in on the activity of Iranian ships carrying short-range ballistic missiles which have sailed into the Persian Gulf in recent weeks. Much like China from an economic standpoint, Iran is beginning to realize that their old tricks, formerly used so successfully against previous administrations, are no longer working. Perhaps Iran, like China, believe they can hold out until another administration is in the White House. That is a dangerous and misguided strategy. As for the current situation in the Middle East, Israel has been under increasing attack within the past two weeks. It is almost inevitable that the Iranian Revolutionary Guard, which the US has now deemed a terrorist organization, will brazenly attempt something in late spring/early summer. That would be a dangerous and misguided tactic.
Currency Trading: FOREX
Bitcoin theft highlights the severe challenges of dealing in "non-physical" currencies. The value of one bitcoin peaked just before Christmas, 2017, just shy of $20,000. One year later, the same unit of digital currency was worth $3,200—an 85% drop. Beyond a shadow of a doubt, the greatest threat to this new currency is the ability of hackers to break into the exchanges and commit large-scale theft. The latest case-in-point came this Tuesday when Binance, one of the largest cryptocurrency exchanges, discovered that 7,000 bitcoins had been stolen from one wallet. While the company has promised to make good on the missing money, this is a condition which must be rectified before any large-scale adoption of cryptocurrencies will take place. To date, nearly $2 billion worth of cryptocurrencies have been reported stolen, and that doesn't count the massive number of hidden thefts not reported. Bitcoins currently trade at $5,839 per unit. For traders not afraid of risk, the Grayscale Bitcoin Trust (GBTC $7.81) is the easiest way to play the currency. But beware: GBTC was trading at $38.05 in December of 2017.
Global Strategy: Trade
Markets have grossly overreacted to talk of new tariffs. The wild swings in the market—mainly to the downside—on Monday and Tuesday can be traced back, almost exclusively, to presidential tweets about new tariffs against Chinese goods being implemented by the end of the week. This understandably spooked investors, who have all but set a new US/China trade deal in stone. What few were reporting on Monday was that the tweets emanated from some critical components of the potential deal being walked back by top Chinese officials. These guarantees, many already in writing, swirled around the sensitive topic of Chinese theft of US intellectual property, or IP. While journalists jumped on rumors that the trade delegation might not even come to the US this Thursday as planned, within a day those rumors were quelled. Not only is the delegation still coming, it will be headed up by Liu Hu, the one person outside of Xi who can authorize a deal be struck. The $20 trillion US economy just notched another 3.2% annualized growth rate in the first quarter; the $12 trillion Chinese economy desperately needs access to the world's most lucrative market. The Chinese may have had cold feet about some of the promises they made, and were almost certainly rattled by US demands for ongoing verification, but they will do what they must to get the deal done. The state of the Chinese economy rides on it. Any market pullbacks in 2019 should be used by investors as an opportunity to scour industries for undervalued gems. When the dust settles on the year, it will look a lot more like 2017 than 2018.
Energy: Exploration & Production
Thanks to Buffett, the (far) less qualified company will now acquire Anadarko. When the deal was announced back in April, we called it a brilliant move. Penn member Chevron (CVX), a $225 billion oil and gas conglomerate, would pick up E&P company (and big Permian player) Anadarko Petroleum (APC) in a deal valued at $33 billion. A shale player only slightly bigger than Anadarko, Occidental Petroleum (OXY), had previously made a bid for the company, but the added debt load would have seriously strained the company. With Anadarko's management backing the Chevron bid, and with almost certain backing by shareholders, in saunters Warren Buffett with a $10 billion cash infusion to Occidental, contingent on that company buying Anadarko. For his "gift," Buffett would receive 100,000 shares of cumulative perpetual preferred stock, with a liquidation value of $100,000 each (so, he could get his $10B back) and an 8% annual dividend. This sounds like a great deal...for Buffett. Everyone else, not so much. Let's see how successful Occidental is at servicing that added debt to the Oracle of Omaha. For its part, Anadarko must pay Chevron a $1 billion breakup fee for walking away from that deal. This deal makes us about as happy as when Buffett helped draconian Brazilian firm 3G get their hands on Kraft, to begin the ruination of an iconic American brand. Or when he took our favorite railroad, Burlington Northern Santa Fe (BNSF), away from the public markets because he "always liked playing with railroads." Maybe it is time for Buffett to focus on his philanthropic projects and let Wall Street do its thing. As for this most recent deal, we are sure the Saudis are happy about it.
Basic Materials: Chemicals
If Glenview Capital's Larry Robbins is right, dump your 3M and Chemours now. Larry Robbins, the founder and CEO of Glenview Capital Management, is one of those rare individuals you unmute your TV for when you see his face. You can bet he has something interesting to say about the investment world, and his delivery is masterful. During Monday's Sohn Conference, he didn't mince words about two stocks he is shorting: 3M (MMM $177-$183-$220) and The Chemours Company (pron "KHUH moors", CC $25-$32-$53), and he clearly spelled out the reason why: the companies' intimate relationship with PFAS ("P-fas"), per- and polyfluoroalkyl substances, also known as PFCs. He calls these substances, which were invented by 3M in the 1930s, "forever chemicals" due to their incredibly long shelf life. Unfortunately, evidence is mounting that these chemicals, which are used in everything from Teflon® pans to Scotchgard® fabric protectors, are highly toxic to the environment—and they virtually never break down. While both 3M and DuPont, which recently spun off its Chemours unit, have already shelled out hundreds of millions of dollars to settle PFAS claims, Robbins believes this is just the tip of the iceberg. We agree: expect a mountain of litigation coming down the pike from class action lawsuits and state and local government suits. Back in 2016, following the spinoff, Citron Research called Chemours a "bankruptcy waiting to happen"—further claiming that DuPont jettisoned the company knowing full well what was coming. That assertion seems to be logical and quite believable. Steer clear of these companies.
Global Strategy: Middle East
What does an autocratic state ruler do when an election goes against them? Void the results, of course. The fact that Turkey is a member of NATO and was given the right to purchase the most advanced fighter in the world—the F-35—should send chills down the spine of the free world. The latest example of abuse of power by the country's iron-fisted ruler, Recep Erdogan, came this week as the president's crony national election board threw out the results of Istanbul's mayoral race—a race that the opposition party won. Ekrem Imamoglu, who was sworn in three weeks ago as mayor, called Erdogan a "sore loser" for demanding new elections. Despite the outrage over the nullification, want to lay odds on who will be the victor in the new round of elections? Although Russia has had a tumultuous relationship with Turkey, Vlad Putin is a master at playing geopolitical chess. He understands (unlike former US presidents) just how critical a linchpin the country is to regional stability, given its location between the Western and Eastern worlds. The most illustrative example of this can be found in the country's purchase of American F-35s, and a Russian anti-aircraft system designed to shoot down...F-35s.
Food Products
The Kraft Heinz train wreck continues: company to restate earnings due to misconduct. At the risk of being redundant, we hated the Kraft/Heinz merger from the start. Warren Buffett's deal to take Kraft (then symbol KFT) off the market and put it under the control of draconian cost-cutter 3G, a Brazilian company, smelled rotten from the start. Our predictions for the outcome of the deal have played out time and time again since the July, 2015 merger, with the latest iteration coming Monday: Kraft Heinz (KHC $32-$32-65) will restate its financial statements for a two year period due to employee misconduct. It wasn't that the company found the misconduct due to proactive measures; the internal audit took place after the SEC launched an investigation of its own. The nefarious deeds centered around the way in which earnings were calculated during the period in question. When Buffett spawned the merger, the new entity was trading at $72.50 per share. The share price now sits at $32.35—a 55% slide over the course of four years. Yes, it is a challenging environment for the food products industry, but companies like Kraft Heinz and Campbell's Soup (CPB) have compounded the problem by having a dearth of effective leadership. Steer clear of both.
Headlines for the Week of 28 Apr 2019—04 May 2019
Technology Hardware, Storage, & Peripherals
Another blowout jobs report; lowest unemployment rate since the year we first landed on the moon. Fifty years ago. Neil Armstrong and Buzz Aldrin had just stepped foot on the lunar surface, and the US unemployment rate fell to 3.6%. It suddenly feels like 1969 all over again, minus the hippies at Woodstock. Against expectations for a healthy 190,000 new jobs, the US economy actually added 263,000 new nonfarm payrolls to the books. The unemployment rate in the world's largest economy (by far) dropped to 3.6%, and average hourly wages for the private sector grew by 3.2% year-over-year. Productivity is the cherry atop the sundae: the output of goods and services produced by each worker for each hour on the job increased at a seasonally-adjusted rate of 3.6%. Productivity tends to show the strongest gains early in a recovery (and, indeed, this number was the best since 2010), so the fact that this rate was strong this far into the recovery bodes well for the economy going forward. Overall, just an excellent report, and a far cry from what economists had been predicting for the first half of 2019. Anything can happen to upset the apple cart, from domestic political trouble to global terrorism issues, but the US economy currently resides on a very sold foundation. The Fed will be kept quiet, we believe, thanks to the 1.6% rate of inflation. This is below the target 2% and, if the trend continues, would make it very hard for the Fed to justify another rate hike.
Technology Hardware, Storage, & Peripherals
Apple surges after a big earnings beat. What a crazy ride. Going into the year, Penn Global Leaders Club member Apple (AAPL $142-$212-$233) had been quite unfairly—in our opinion—beaten down. The first company to ever reach the coveted $1 trillion market cap was suddenly worth a mere $672 billion during the first week of January. While we didn't hit the exact bottom, we did add to our position when shares were sitting at $164.35—the company itself bought back billions of dollars in shares at $167. Suddenly, Apple has gained 45% since that January low, and is now just about $1.50 per share from regaining the $1 trillion mark. The latest catalyst, which pushed the stock 5% higher (to $212/share) was the Q2 earnings report. In addition to beating both on top-line revenues and bottom-line profit, CEO Tim Cook said that the company would spend another $75 billion on share repurchases. It can afford it: though down 8%, its cash bucket now sits at $225.4 billion. Even more astounding, the company is still sitting on a pile of cash $113 billion higher than net cash neutral (per Tim Cook, this can be defined as "having an equal amount of cash and debt...that balances to zero"). After announcing its $58 billion in revenues for Q2, the company guided higher for the third quarter, which thrilled investors. While everyone is now focusing on the faster-growing services business, we still believe that the company's hardware lines have some pleasant surprises coming down the pike. If nothing else, remember this: the 5G evolution will force everyone to buy a next generation smartphone. Few understand just how seismic that shift will be.
Global Strategy: Latin America
It appears the dam is about to burst in Venezuela: Guaido says he has military backing. Claiming he now has support from high-ranking military members, US-backed Venezuelan opposition leader Juan Guaido has called for a mass popular uprising throughout the streets of his country. Maduro and his Russian-backed minions, however, see things differently. Maduro's information minister claims that a small band of military traitors are in the midst of being quashed by the government. As he spoke, Guaido was flanked both by members of the military and by Leopoldo López, Venezuela's most prominent political prisoner who was apparently freed by members sympathetic to the movement. This needs to happen now. One would hope that all members of the Venezuelan military, who have universally witnessed their family members going hungry, would immediately choose the right side and end Maduro's reign. If this fizzles out, Guaido could well become a martyr. Stay tuned.
Wall Street: Market Pulse
We have a long memory: Why news of a Chewy IPO sent chills down our spine. Call it anecdotal, but we read a news story that immediately transported us back to the "dot-com" halcyon days of 1999...and the subsequent implosion. Chewy, the online pet store owned by PetSmart (which, in turn, is owned by private equity firm Argos Holdings), has filed paperwork for an Initial Public Offering. We vividly remember the slow-moving train wreck that was Pets.com (remember the sock puppet?), the company that symbolized the "we don't need no stinking earnings!" days of the late-'90s. We didn't feel this way when Blue Buffalo (formerly BUFF, purchased by General Mills last year) went public in 2015. We didn't even feel this way when Lyft (LYFT) went public earlier this month. But this Chewy deal has an ominous ring to it. The company has never turned a profit, nor does it have any apparent plans to ("We have a history of losses and expect to generate operating losses as we continue to expand our business"—from Chewy's filing documents). Yes, the economy is strong; and no, market valuations are not crazy-high. But when unprofitable, internet-based companies begin flooding the market, all we can say is be very careful. To borrow a term from a former Fed chair, this IPO feels irrational. Please, don't touch CHWY when it goes public. Furthermore, if by some chance it spikes 40% on its debut trading day, consider tightening the stops on your equity holdings—a storm may be a brewin'.
Media & Entertainment
Everyone knew this was coming: Disney's "Avengers: Endgame" shatters the box office records. When we heard that movie theaters would be open around-the-clock last weekend for the box office release of the latest installment of Disney's (DIS $98-$140-$140) Marvel Studios film, "Avengers: Endgame," we had a suspicion that it would break all kinds of opening weekend records, and did it ever. The movie raked in $1.22 billion around the world—$356 million of it in the US—and was responsible for nine out of ten tickets sold in North America this weekend. Critics gave rave reviews to the three-hour-long movie, which became the first flick to break the $1 billion debut mark, and odds are it will topple "Avatar" as the largest grossing film in history. Between news of the company's new streaming service and this movie, Penn Global Leaders Club member Disney is having its best month in 32 years. And for the icing on the cake: viewers will have one place to go to watch "Endgame" after it leave the big screen—their Disney+ subscription service. One more reason for Abigail Disney to take her complaints about Bob Iger's pay and go fly a kite. We view Disney as more than just a "great company to invest in." We see the company as a case study in greatness for anyone wishing to build and grow their business. While a study of Bob Iger's management style would have to be part of that curriculum, one should really go back to the beginning and study Walt Disney's life to fully understand what makes this iconic American company tick.
Hotels, Resorts, & Cruise Lines
In bid to battle Airbnb, Marriott is expanding its home-rental business. The company began with a small pilot program in Europe—leasing 340 properties in major cities. But the test has proven so successful for Marriott (MAR $101-$136-$142), the world's largest hotelier, that the Bethesda-based company will begin rolling out its new home-rental business in North America this year. Soon, guests will be able to make reservations for any of 2,000 properties in approximately 100 cities directly through the Marriott website. The stays will range in price from $200 to over $10,000 per night, depending on the property, and Marriott will allow Bonvoy members to redeem and earn loyalty points for their stays, just as they would at any of the company's 1.3 million hotel rooms. As for Airbnb, which is expected to go public this year, the company has been attempting to encroach further into the hotel business. The most recent move is a deal with a New York developer to create a 200-room hotel in Manhattan. Our favorite hotel from an investment standpoint continues to be Hilton (HLT), but the company has not made any indication that it wants to follow Marriott's path into the home-rental business. We believe it is inevitable, however, that the lines between hotel rooms and other property rentals will become blurred as new competition enters the space.
Another blowout jobs report; lowest unemployment rate since the year we first landed on the moon. Fifty years ago. Neil Armstrong and Buzz Aldrin had just stepped foot on the lunar surface, and the US unemployment rate fell to 3.6%. It suddenly feels like 1969 all over again, minus the hippies at Woodstock. Against expectations for a healthy 190,000 new jobs, the US economy actually added 263,000 new nonfarm payrolls to the books. The unemployment rate in the world's largest economy (by far) dropped to 3.6%, and average hourly wages for the private sector grew by 3.2% year-over-year. Productivity is the cherry atop the sundae: the output of goods and services produced by each worker for each hour on the job increased at a seasonally-adjusted rate of 3.6%. Productivity tends to show the strongest gains early in a recovery (and, indeed, this number was the best since 2010), so the fact that this rate was strong this far into the recovery bodes well for the economy going forward. Overall, just an excellent report, and a far cry from what economists had been predicting for the first half of 2019. Anything can happen to upset the apple cart, from domestic political trouble to global terrorism issues, but the US economy currently resides on a very sold foundation. The Fed will be kept quiet, we believe, thanks to the 1.6% rate of inflation. This is below the target 2% and, if the trend continues, would make it very hard for the Fed to justify another rate hike.
Technology Hardware, Storage, & Peripherals
Apple surges after a big earnings beat. What a crazy ride. Going into the year, Penn Global Leaders Club member Apple (AAPL $142-$212-$233) had been quite unfairly—in our opinion—beaten down. The first company to ever reach the coveted $1 trillion market cap was suddenly worth a mere $672 billion during the first week of January. While we didn't hit the exact bottom, we did add to our position when shares were sitting at $164.35—the company itself bought back billions of dollars in shares at $167. Suddenly, Apple has gained 45% since that January low, and is now just about $1.50 per share from regaining the $1 trillion mark. The latest catalyst, which pushed the stock 5% higher (to $212/share) was the Q2 earnings report. In addition to beating both on top-line revenues and bottom-line profit, CEO Tim Cook said that the company would spend another $75 billion on share repurchases. It can afford it: though down 8%, its cash bucket now sits at $225.4 billion. Even more astounding, the company is still sitting on a pile of cash $113 billion higher than net cash neutral (per Tim Cook, this can be defined as "having an equal amount of cash and debt...that balances to zero"). After announcing its $58 billion in revenues for Q2, the company guided higher for the third quarter, which thrilled investors. While everyone is now focusing on the faster-growing services business, we still believe that the company's hardware lines have some pleasant surprises coming down the pike. If nothing else, remember this: the 5G evolution will force everyone to buy a next generation smartphone. Few understand just how seismic that shift will be.
Global Strategy: Latin America
It appears the dam is about to burst in Venezuela: Guaido says he has military backing. Claiming he now has support from high-ranking military members, US-backed Venezuelan opposition leader Juan Guaido has called for a mass popular uprising throughout the streets of his country. Maduro and his Russian-backed minions, however, see things differently. Maduro's information minister claims that a small band of military traitors are in the midst of being quashed by the government. As he spoke, Guaido was flanked both by members of the military and by Leopoldo López, Venezuela's most prominent political prisoner who was apparently freed by members sympathetic to the movement. This needs to happen now. One would hope that all members of the Venezuelan military, who have universally witnessed their family members going hungry, would immediately choose the right side and end Maduro's reign. If this fizzles out, Guaido could well become a martyr. Stay tuned.
Wall Street: Market Pulse
We have a long memory: Why news of a Chewy IPO sent chills down our spine. Call it anecdotal, but we read a news story that immediately transported us back to the "dot-com" halcyon days of 1999...and the subsequent implosion. Chewy, the online pet store owned by PetSmart (which, in turn, is owned by private equity firm Argos Holdings), has filed paperwork for an Initial Public Offering. We vividly remember the slow-moving train wreck that was Pets.com (remember the sock puppet?), the company that symbolized the "we don't need no stinking earnings!" days of the late-'90s. We didn't feel this way when Blue Buffalo (formerly BUFF, purchased by General Mills last year) went public in 2015. We didn't even feel this way when Lyft (LYFT) went public earlier this month. But this Chewy deal has an ominous ring to it. The company has never turned a profit, nor does it have any apparent plans to ("We have a history of losses and expect to generate operating losses as we continue to expand our business"—from Chewy's filing documents). Yes, the economy is strong; and no, market valuations are not crazy-high. But when unprofitable, internet-based companies begin flooding the market, all we can say is be very careful. To borrow a term from a former Fed chair, this IPO feels irrational. Please, don't touch CHWY when it goes public. Furthermore, if by some chance it spikes 40% on its debut trading day, consider tightening the stops on your equity holdings—a storm may be a brewin'.
Media & Entertainment
Everyone knew this was coming: Disney's "Avengers: Endgame" shatters the box office records. When we heard that movie theaters would be open around-the-clock last weekend for the box office release of the latest installment of Disney's (DIS $98-$140-$140) Marvel Studios film, "Avengers: Endgame," we had a suspicion that it would break all kinds of opening weekend records, and did it ever. The movie raked in $1.22 billion around the world—$356 million of it in the US—and was responsible for nine out of ten tickets sold in North America this weekend. Critics gave rave reviews to the three-hour-long movie, which became the first flick to break the $1 billion debut mark, and odds are it will topple "Avatar" as the largest grossing film in history. Between news of the company's new streaming service and this movie, Penn Global Leaders Club member Disney is having its best month in 32 years. And for the icing on the cake: viewers will have one place to go to watch "Endgame" after it leave the big screen—their Disney+ subscription service. One more reason for Abigail Disney to take her complaints about Bob Iger's pay and go fly a kite. We view Disney as more than just a "great company to invest in." We see the company as a case study in greatness for anyone wishing to build and grow their business. While a study of Bob Iger's management style would have to be part of that curriculum, one should really go back to the beginning and study Walt Disney's life to fully understand what makes this iconic American company tick.
Hotels, Resorts, & Cruise Lines
In bid to battle Airbnb, Marriott is expanding its home-rental business. The company began with a small pilot program in Europe—leasing 340 properties in major cities. But the test has proven so successful for Marriott (MAR $101-$136-$142), the world's largest hotelier, that the Bethesda-based company will begin rolling out its new home-rental business in North America this year. Soon, guests will be able to make reservations for any of 2,000 properties in approximately 100 cities directly through the Marriott website. The stays will range in price from $200 to over $10,000 per night, depending on the property, and Marriott will allow Bonvoy members to redeem and earn loyalty points for their stays, just as they would at any of the company's 1.3 million hotel rooms. As for Airbnb, which is expected to go public this year, the company has been attempting to encroach further into the hotel business. The most recent move is a deal with a New York developer to create a 200-room hotel in Manhattan. Our favorite hotel from an investment standpoint continues to be Hilton (HLT), but the company has not made any indication that it wants to follow Marriott's path into the home-rental business. We believe it is inevitable, however, that the lines between hotel rooms and other property rentals will become blurred as new competition enters the space.
Headlines for the Week of 21 Apr 2019—27 Apr 2019
Global Strategy: Europe
Poetic justice: In effort to increase production, Russia sends tainted oil to Germany. Poland is a true friend to America, and of democracy, so one aspect of this story is sad; another aspect is just downright funny. The United States has been demanding that Germany cancel a planned gas pipeline, the Nord Stream 2, which would send Russian gas to the country. Russia is well-known for using the flow of oil and gas to Europe as a bargaining chip—or club—to exert pressure on pro-US countries such as Poland and Ukraine, so the US and most other European countries have opposed the project, but Germany has not backed down. Now, in an unrelated incident, Germany, Poland, and Slovakia have suspended all imports of Russian oil via a major pipeline. The reason? In an effort to boost oil output, a Russian producer contaminated the oil with high levels of organic chloride. This chemical was supposed to have been removed prior to shipment, as it is corrosive to refining equipment. It wasn't. The incident typifies Russia's arrogance towards the Europeans, despite desperately needing their euros from the sale of gas and oil. As for the Nord Stream 2, an interesting twist is developing. The hapless Jean-Claude Juncker will be replaced as European Commission president this May. The leading candidate for the job is Bavarian Manfred Weber. One of Weber's first planned actions as president? Halt the Nord Stream 2. Stay tuned, things are getting interesting. For all the talk of a dysfunctional D.C., Americans don't realize the extent of discord in Europe. And it goes a lot deeper than Brexit (though that movement typifies the major problems). Fortunately, we have full confidence in the former Eastern bloc countries, who have wholeheartedly embraced capitalism, to continue their ascendancy on the continent.
Forex
For a snapshot of America versus Europe, economically speaking, simply look to the latter's two-year currency slide. For all of the blather coming from Brussels about rosy economic growth returning soon to the eurozone, it is important to stick to the facts. Here's one to try on: the euro just hit a fresh two-year low against the US dollar. That means that the US economy is getting stronger, while the EU economy continues to languish. Specifically, one euro will now buy just $1.12, and it seems to be heading closer to parity. Considering the fact that weak auto sales in Germany can be traced directly to fewer exports to China, the EU commissioners probably blame Trump's trade war for the problem. Additionally, they explicitly point to Brexit (damn Brexiteers) as a reason for the continent's economic woes. Perhaps one day they will look in the mirror as they search for solutions. Then again, probably not. We continue to underweight developed Europe. The first step to fixing a problem is to correctly identify its causes, and the clownish Jean-Claude Juncker and his troupe of buffoons aren't willing to do that—it is too easy to point fingers elsewhere.
e-Commerce
Amazon is bringing free one-day shipping to its Prime customers. A slew of analysts raised their price targets on $945 billion Amazon (AMZN $1,307-$1,920-$2,051) after the company reported stellar first-quarter numbers. While top-line revenues grew 17%, to an enormous $60 billion for the quarter, what really impressed analysts was the company's margin expansion. Let these numbers sink in: In the first quarter of 2018, Amazon had a net profit of $1.6 billion, or $3.27 per share; in the first quarter of 2019, the company had a profit of $3.6 billion, or $7.09 per share. That is a 125% gain in pure profits, which is simply a staggering statistic. What is the company going to do with all that cash? For one thing, they spent $800 million in Q1 preparing for the move from free two-day shipping for Prime members to free one-day shipping. For years, the company has claimed its goal is same-day shipping for those willing to shell out the annual Prime fee, and they are certainly headed in that direction. This should send shudders through the bones of brick-and-mortar retailers—even those who have been putting together their own omnichannel programs. Amazon appears to be simply unstoppable, and the company has forced efficiencies in competitors which never would have happened otherwise. We see the e-commerce giant only getting stronger.
Goods & Services
First-quarter's blockbuster GDP number blows negative expectations out of the water. Economists had been preparing us for the ugly numbers to come. On 28 March, we wrote about the final Q4 GDP growth rate of 2.2%, and average economist predictions for a 1.5% first quarter. While that average worked its way up to a 2.5% growth rate, even that wasn't close: the US economy grew at a scorching 3.2% pace in the first three months of the year. Virtually no one predicted such a healthy economy to start the year. Not only is the first quarter notoriously weak (compared to the others), we also had the lingering hangover of a government shutdown to deal with. What led to the unexpected growth? Exports of US goods actually rose 3.7%, state and local government spending ticked up, and companies spent more to build up their inventories. Private investment in intellectual property, which includes R&D, software investment, and new proprietary processes, grew 8.6%. That last statistic torpedoes the argument that companies simply spent their tax cut "windfall" on buying back shares instead of putting it to work in the company. As for the building up of inventories, perhaps companies are placing a bet that a massive trade deal with China is around the corner. Putting together a 3.2% first quarter GDP bodes well for the remainder of the year. For all the talk of a global economic slowdown, we don't see any reason why the US economy can't piece together another 3% year.
Interactive Media & Services
Facebook jumps nearly double-digits as the social media giant posts scorching revenue gains. As investors were piling on social media behemoth Facebook (FB $123-$200-$219), and as congressional airheads were haranguing company executives on the Hill, we were busy picking up shares of the company near a 52-week low for the Penn Global Leaders Club. Our timing could hardly have been better. After posting a 26% jump in revenue for the quarter, to $15.08 billion, shares jumped nearly 10%, to $200. As for all of the blowhard talk in D.C. actually manifesting into action against the company, management announced it was setting aside $3 billion for a probable ruling against them. That may seem like a lot (and, indeed, it would be one of the biggest fines in corporate history), but keep in mind that FB is sitting on a stockpile of around $42 billion in cash. New ad dollars are going to the digital world—that is simply a fact. And other than Alphabet (GOOGL), no other digital company is raking in those ad dollars like Facebook. We expect $250 per share to be the next stop.
Industrial Conglomerates
3M's lousy earnings report single-handedly drove the Dow down triple-digits at open. Of the 20% or so of companies reporting their Q1 earnings thus far, 80% have exceeded analyst expectations. Then came 3M's (MMM $177-$201-$220) dud. The diversified industrials company missed on nearly every metric and in every business line. Revenues dropped 4.8%, to $7.9 billion, and earnings fell 10.8%, to $2.23 per share. Management pointed to "slowing conditions in key end markets" (read China and Europe) as the culprit for the lousy quarter, and announced job cuts and restructuring to address the problem. The $112 billion, St. Paul-based firm said it would eliminate 2,000 positions worldwide and realign its structure into four distinct business units. Shares of 3M were headed for their worst day since Black Monday, 1987, following the results. We love American industrials; just not the big conglomerates like GE and 3M. For growth, scan the universe of wonderful mid-cap industrials between $2 billion and $10 billion in size.
Market Pulse
What earnings recession? Q1 numbers are coming in hot. Remember all of the dire talk about lousy earnings reports in the first quarter of 2019 dousing hopes for a good year in the markets, and even—perhaps—portending a nearing recession? That talk is looking cheap as the first wave of earnings reports are coming in hot. Let's take a look at a few of the companies reporting, along with the percentage by which they beat the estimates: Lockheed Martin (34%), PulteGroup (25%), United Technologies (12%), Whirlpool (9%), Nucor (9%), Coca-Cola (4%). Additionally, forward guidance given by the companies has been generally positive. 20% of the companies in the S&P 500 have reported thus far, with an average EPS beat of 6.1%. Earnings concerns were a major weight on the markets going into 2019. There are certainly a slew of other concerns—especially geopolitical, but the domestic economic situation is shaping up as a nice backdrop for a positive year in the US markets.
Food Products
In one of the most interesting IPOs of the year, meat substitute company Beyond Meat will go public this month. 2019 is shaping up as one of the most exciting years in a decade from the perspective of the IPO market. Furthermore, instead of just a slew of dot-com names, this market has breadth. Case in point: next week a plant-based meat substitute company called Beyond Meat will list on the Nasdaq. In its filing with the SEC, the El Segundo-based company said it plans to price shares between $19 and $21, which would give it an initial value of just over $1 billion. And this company, which will trade under the symbol BYND, is for real. Not only are its products nationwide in stores such as Whole Foods, Safeway, and Natural Grocers, their "meat" can also be found in select burgers at chains including Carl's Jr. and T.G.I. Friday's. Last year the company reported earnings of $88 million and a net loss of $30 million. It will use the proceeds from the offering to increase its R&D, expand manufacturing facilities, and market its meat-alternative products. This company is a leader in a nascent but burgeoning industry. While speculative in nature, it will be worth a look right after the IPO.
Interactive Media & Services
Has Twitter finally figured out how to monetize its business? The latest earnings report is a good sign. Shares of social media company Twitter (TWTR $26-$40-$48) were up around 17% in early Tuesday trading on the back of a strong Q1 earnings report. The company, which is now worth around $28 billion, generated revenues of $787 million versus 2018Q1 revenues of $665 million, and earnings per share of $0.37 versus a paltry $0.08 in the same quarter last year. Keep in mind that 2018 is the first year in which Twitter actually reported positive net cash flow. So, what changed? It appears that the company is finally focusing on bringing ad dollars in rather than simply building their user base. For evidence of that (besides the strong quarterly numbers), Twitter said it will stop reporting on the number of monthly active users (MAUs) and replace it with a new metric: monetizable daily active users (mDAUs). In short, this figure represents how many users are actually paying to advertise on the platform. Ad revenue did, in fact, jump 18.3% year-over-year, to $787 million. In the middle of 2018, TWTR had a P/E ratio of 4,500. Almost incredibly, that number is now a very reasonable 22. That is right in line with Penn Member Facebook's (FB) 24 P/E ratio. If the company continues to clean up abusive tweets and focus on ad dollars, its stock has a lot of room to run.
Wall Street
Pinterest and Zoom IPOs show strong investor appetite for new opportunities. Answer this question: what was the one major difference between last week's Pinterest (PINS) and Zoom (ZM) IPOs versus the previous week's Lyft (LYFT) IPO? Answer: Pinterest and Zoom actually turn a profit. Perhaps that is why investors flocked to the two most recent additions to the exchanges as quickly as they continue to flee Lyft. As for social media company (a moniker it hates) Pinterest, shares closed up 28% on its first trading day. Meanwhile, video conferencing company Zoom saw its shares rise 72%. Somewhat ironically (or forebodingly), Zoom's pop was the biggest since the 2013 debut of Twitter—a company which has been under nearly-constant pressure since going public. Investors need to keep some of their powder dry, as many more companies will debut on the various exchanges over the coming months, to include the highly-anticipated Uber offering. Between the two most recent IPOs, we prefer Pinterest. Yes, Zoom is turning a profit, but there are simply so many other companies in that industry—like Adobe and Microsoft—competing for the same client base. We believe it will be hard for the company to continue differentiating its products and services.
Technology Hardware, Storage, & Peripherals
CNBC test drives the Samsung Galaxy Fold...and it breaks after two days. Sure, a foldable smartphone sounds pretty cool on its face. You can use it like a regular phone, then fold it open to use more like a tablet, viewing your photos—for example—on a double-sized screen. Samsung must think highly of their new device—they want you to shell out nearly $2,000 for it. There's only one problem with the phone, however: it appears to be prone to breaking, like nearly instantly. Tech writers at CNBC got their hands on one of the devices, and it stopped working correctly after two days. Specifically, the hinges that allow the device to swing open can act up, causing bulges, distortions, and outright failures on the screen. About the only comment Samsung has had thus far is to say that users are not supposed to remove the protective screen. CNBC didn't. The phone is due to launch on the 26th of April, and the company is currently taking pre-orders. It may want to rethink that launch date. This reminds us a lot of the exploding Galaxy 7s of just over two years ago. Is beating Apple to the market really worth the damage to a company's reputation when a faulty product is released? Not that we are dogging Samsung in general—our Samsung television seems to be the one piece of electronics in the house that hasn't met with an early demise thanks to poor craftsmanship (like our GE washer, LG fridge, Sony TV, Chinese-made sump pump with an American name, and HVAC motor made who knows where).
Semiconductors & Equipment
Qualcomm soaring after settling battle with Apple and Intel's departure from 5G. It has been a very good week for chip maker Qualcomm (QCOM $49-$81-$77). First came the announcement that it had settled its long-running legal battle with Apple (AAPL) over patent infringements and royalty payments, with the two coming to an agreement even as the costly court battle raged on. Not only will Apple pay Qualcomm an undisclosed amount in the settlement (it had been withholding a whopping $8 billion due in royalties), the two also forged a new six-year licensing agreement. This was in Apple's best interest, as it needs QCOM's chips as it enters the transformational world of 5G. Then came the announcement, just hours later, that Qualcom's chief rival, Intel (INTC), was leaving the 5G chip business altogether. Our guess is that Tim Cook thought he could count on Intel's nascent 5G business to fill the void, but that the company simply wasn't making the necessary progress in the field. This leaves one company standing as the dominant player in the space. Rightfully so, investors rewarded QCOM stock with a 23% spike on Tuesday and a 13% jump at Wednesday's open. Despite constant pushback from smartphone makers with respect to the royalty payments demanded by Qualcomm for their chip technology, the company is the undisputed worldwide leader in this technology. Our biggest challenge with the stock continues to be its high valuation (QCOM has a 50 P/E ratio as compared to INTC's 14, for example). Investing in semiconductor companies can be a harrowing experience; for evidence of that, just look back to the industry's fourth-quarter drubbing. To take advantage of the industry as a whole—instead of taking a chance on any one player—investors can consider ETFs like the iShares PHLX Semiconductor fund (SOXX) or the VanEck Vectors Semiconductor fund (SMH). QCOM is a top-tier holding within each.
Media & Entertainment
Hulu buys back AT&T stake, strengthening Disney's position. There are a lot of moving parts in the real-life Game of Thrones that is the media and entertainment streaming business. The latest move? Hulu has purchased back AT&T's 9.5% stake it held in the streaming video company for $1.4 billion. Post sale, Hulu will be controlled by just two players: Disney (DIS), with its 67% stake (it gained about 34% when it bought the Fox assets); and Comcast (CMCSA), with the remaining 33%. With Disney's plans to compete head-to-head with Netflix (NFLX) via its Disney+ streaming service, why is it interested in controlling the money-losing Hulu instead of just focusing on its own new subs (subscribers)? It appears that the company is positioning Disney+ as the more "family-oriented" portion of the business, while Hulu attracts more mature content that Disney would prefer not to lend its name to. Additionally, despite its current losses, Disney wants to greatly expand Hulu's global footprint and bring the company to profitability within a few years, with a goal of doubling subs from 25 million to 50 million within four years. (For comparison, Netflix currently has around 130 million subscribers around the world.) And that's where Comcast comes in: its recent purchase of Rupert Murdoch's Sky assets will give Hulu a potentially-enormous footprint in Europe, allowing it to battle Netflix's overseas growth. Like we say, Game of Thrones. How can investors take advantage of this fast-paced industry? In the first place, own Disney (with its 18 P/E) over Netflix (132 P/E). Secondly, own the device makers: Amazon (AMZN) owns the Fire TV Stick and Fire TV Cube, and Roku (ROKU) provides the other set of streaming players and built-in software (on select sets).
Specialty Retail
After crafting an amazing turnaround, Hubert Joly is handing over the reins at Best Buy. Back in 2012, it would have been easy to imagine specialty electronics retailer Best Buy (BBY $48-$73-$84) going the way of Circuit City, Radio Shack, or Toys "R" Us. At the time, BBY shares were going for around $12, and the company didn't seem to have a viable turnaround plan in place. Then, the company turned to outsider Hubert Joly to develop and execute a sound strategic plan of action. Now, after just over six years on the job, shares are trading at $73, the company has turned a profit every year since 2014, and the P/E ratio is a respectable 18. Happy with the company's progress, Joly announced that he will be handing the reins over to CFO Corie Barry, who, at 44, will become one of the youngest chief executives in the S&P 500. Ms. Barry, who also sits on the board of Domino's Pizza (DPZ), has been with Best Buy since 1999, serving in a variety of high-level roles. Joly will remain with the company, serving as executive chairman. Had BBY fallen on the news, we might have taken the opportunity to pick up shares—once again—in this well-run company. As it was, investors showed confidence in this major move and the shares remained steady. We expect Best Buy to continue to wage a successful campaign against online competitors such as Amazon (AMZN) and retain (or even grow) its market share in the space.
Poetic justice: In effort to increase production, Russia sends tainted oil to Germany. Poland is a true friend to America, and of democracy, so one aspect of this story is sad; another aspect is just downright funny. The United States has been demanding that Germany cancel a planned gas pipeline, the Nord Stream 2, which would send Russian gas to the country. Russia is well-known for using the flow of oil and gas to Europe as a bargaining chip—or club—to exert pressure on pro-US countries such as Poland and Ukraine, so the US and most other European countries have opposed the project, but Germany has not backed down. Now, in an unrelated incident, Germany, Poland, and Slovakia have suspended all imports of Russian oil via a major pipeline. The reason? In an effort to boost oil output, a Russian producer contaminated the oil with high levels of organic chloride. This chemical was supposed to have been removed prior to shipment, as it is corrosive to refining equipment. It wasn't. The incident typifies Russia's arrogance towards the Europeans, despite desperately needing their euros from the sale of gas and oil. As for the Nord Stream 2, an interesting twist is developing. The hapless Jean-Claude Juncker will be replaced as European Commission president this May. The leading candidate for the job is Bavarian Manfred Weber. One of Weber's first planned actions as president? Halt the Nord Stream 2. Stay tuned, things are getting interesting. For all the talk of a dysfunctional D.C., Americans don't realize the extent of discord in Europe. And it goes a lot deeper than Brexit (though that movement typifies the major problems). Fortunately, we have full confidence in the former Eastern bloc countries, who have wholeheartedly embraced capitalism, to continue their ascendancy on the continent.
Forex
For a snapshot of America versus Europe, economically speaking, simply look to the latter's two-year currency slide. For all of the blather coming from Brussels about rosy economic growth returning soon to the eurozone, it is important to stick to the facts. Here's one to try on: the euro just hit a fresh two-year low against the US dollar. That means that the US economy is getting stronger, while the EU economy continues to languish. Specifically, one euro will now buy just $1.12, and it seems to be heading closer to parity. Considering the fact that weak auto sales in Germany can be traced directly to fewer exports to China, the EU commissioners probably blame Trump's trade war for the problem. Additionally, they explicitly point to Brexit (damn Brexiteers) as a reason for the continent's economic woes. Perhaps one day they will look in the mirror as they search for solutions. Then again, probably not. We continue to underweight developed Europe. The first step to fixing a problem is to correctly identify its causes, and the clownish Jean-Claude Juncker and his troupe of buffoons aren't willing to do that—it is too easy to point fingers elsewhere.
e-Commerce
Amazon is bringing free one-day shipping to its Prime customers. A slew of analysts raised their price targets on $945 billion Amazon (AMZN $1,307-$1,920-$2,051) after the company reported stellar first-quarter numbers. While top-line revenues grew 17%, to an enormous $60 billion for the quarter, what really impressed analysts was the company's margin expansion. Let these numbers sink in: In the first quarter of 2018, Amazon had a net profit of $1.6 billion, or $3.27 per share; in the first quarter of 2019, the company had a profit of $3.6 billion, or $7.09 per share. That is a 125% gain in pure profits, which is simply a staggering statistic. What is the company going to do with all that cash? For one thing, they spent $800 million in Q1 preparing for the move from free two-day shipping for Prime members to free one-day shipping. For years, the company has claimed its goal is same-day shipping for those willing to shell out the annual Prime fee, and they are certainly headed in that direction. This should send shudders through the bones of brick-and-mortar retailers—even those who have been putting together their own omnichannel programs. Amazon appears to be simply unstoppable, and the company has forced efficiencies in competitors which never would have happened otherwise. We see the e-commerce giant only getting stronger.
Goods & Services
First-quarter's blockbuster GDP number blows negative expectations out of the water. Economists had been preparing us for the ugly numbers to come. On 28 March, we wrote about the final Q4 GDP growth rate of 2.2%, and average economist predictions for a 1.5% first quarter. While that average worked its way up to a 2.5% growth rate, even that wasn't close: the US economy grew at a scorching 3.2% pace in the first three months of the year. Virtually no one predicted such a healthy economy to start the year. Not only is the first quarter notoriously weak (compared to the others), we also had the lingering hangover of a government shutdown to deal with. What led to the unexpected growth? Exports of US goods actually rose 3.7%, state and local government spending ticked up, and companies spent more to build up their inventories. Private investment in intellectual property, which includes R&D, software investment, and new proprietary processes, grew 8.6%. That last statistic torpedoes the argument that companies simply spent their tax cut "windfall" on buying back shares instead of putting it to work in the company. As for the building up of inventories, perhaps companies are placing a bet that a massive trade deal with China is around the corner. Putting together a 3.2% first quarter GDP bodes well for the remainder of the year. For all the talk of a global economic slowdown, we don't see any reason why the US economy can't piece together another 3% year.
Interactive Media & Services
Facebook jumps nearly double-digits as the social media giant posts scorching revenue gains. As investors were piling on social media behemoth Facebook (FB $123-$200-$219), and as congressional airheads were haranguing company executives on the Hill, we were busy picking up shares of the company near a 52-week low for the Penn Global Leaders Club. Our timing could hardly have been better. After posting a 26% jump in revenue for the quarter, to $15.08 billion, shares jumped nearly 10%, to $200. As for all of the blowhard talk in D.C. actually manifesting into action against the company, management announced it was setting aside $3 billion for a probable ruling against them. That may seem like a lot (and, indeed, it would be one of the biggest fines in corporate history), but keep in mind that FB is sitting on a stockpile of around $42 billion in cash. New ad dollars are going to the digital world—that is simply a fact. And other than Alphabet (GOOGL), no other digital company is raking in those ad dollars like Facebook. We expect $250 per share to be the next stop.
Industrial Conglomerates
3M's lousy earnings report single-handedly drove the Dow down triple-digits at open. Of the 20% or so of companies reporting their Q1 earnings thus far, 80% have exceeded analyst expectations. Then came 3M's (MMM $177-$201-$220) dud. The diversified industrials company missed on nearly every metric and in every business line. Revenues dropped 4.8%, to $7.9 billion, and earnings fell 10.8%, to $2.23 per share. Management pointed to "slowing conditions in key end markets" (read China and Europe) as the culprit for the lousy quarter, and announced job cuts and restructuring to address the problem. The $112 billion, St. Paul-based firm said it would eliminate 2,000 positions worldwide and realign its structure into four distinct business units. Shares of 3M were headed for their worst day since Black Monday, 1987, following the results. We love American industrials; just not the big conglomerates like GE and 3M. For growth, scan the universe of wonderful mid-cap industrials between $2 billion and $10 billion in size.
Market Pulse
What earnings recession? Q1 numbers are coming in hot. Remember all of the dire talk about lousy earnings reports in the first quarter of 2019 dousing hopes for a good year in the markets, and even—perhaps—portending a nearing recession? That talk is looking cheap as the first wave of earnings reports are coming in hot. Let's take a look at a few of the companies reporting, along with the percentage by which they beat the estimates: Lockheed Martin (34%), PulteGroup (25%), United Technologies (12%), Whirlpool (9%), Nucor (9%), Coca-Cola (4%). Additionally, forward guidance given by the companies has been generally positive. 20% of the companies in the S&P 500 have reported thus far, with an average EPS beat of 6.1%. Earnings concerns were a major weight on the markets going into 2019. There are certainly a slew of other concerns—especially geopolitical, but the domestic economic situation is shaping up as a nice backdrop for a positive year in the US markets.
Food Products
In one of the most interesting IPOs of the year, meat substitute company Beyond Meat will go public this month. 2019 is shaping up as one of the most exciting years in a decade from the perspective of the IPO market. Furthermore, instead of just a slew of dot-com names, this market has breadth. Case in point: next week a plant-based meat substitute company called Beyond Meat will list on the Nasdaq. In its filing with the SEC, the El Segundo-based company said it plans to price shares between $19 and $21, which would give it an initial value of just over $1 billion. And this company, which will trade under the symbol BYND, is for real. Not only are its products nationwide in stores such as Whole Foods, Safeway, and Natural Grocers, their "meat" can also be found in select burgers at chains including Carl's Jr. and T.G.I. Friday's. Last year the company reported earnings of $88 million and a net loss of $30 million. It will use the proceeds from the offering to increase its R&D, expand manufacturing facilities, and market its meat-alternative products. This company is a leader in a nascent but burgeoning industry. While speculative in nature, it will be worth a look right after the IPO.
Interactive Media & Services
Has Twitter finally figured out how to monetize its business? The latest earnings report is a good sign. Shares of social media company Twitter (TWTR $26-$40-$48) were up around 17% in early Tuesday trading on the back of a strong Q1 earnings report. The company, which is now worth around $28 billion, generated revenues of $787 million versus 2018Q1 revenues of $665 million, and earnings per share of $0.37 versus a paltry $0.08 in the same quarter last year. Keep in mind that 2018 is the first year in which Twitter actually reported positive net cash flow. So, what changed? It appears that the company is finally focusing on bringing ad dollars in rather than simply building their user base. For evidence of that (besides the strong quarterly numbers), Twitter said it will stop reporting on the number of monthly active users (MAUs) and replace it with a new metric: monetizable daily active users (mDAUs). In short, this figure represents how many users are actually paying to advertise on the platform. Ad revenue did, in fact, jump 18.3% year-over-year, to $787 million. In the middle of 2018, TWTR had a P/E ratio of 4,500. Almost incredibly, that number is now a very reasonable 22. That is right in line with Penn Member Facebook's (FB) 24 P/E ratio. If the company continues to clean up abusive tweets and focus on ad dollars, its stock has a lot of room to run.
Wall Street
Pinterest and Zoom IPOs show strong investor appetite for new opportunities. Answer this question: what was the one major difference between last week's Pinterest (PINS) and Zoom (ZM) IPOs versus the previous week's Lyft (LYFT) IPO? Answer: Pinterest and Zoom actually turn a profit. Perhaps that is why investors flocked to the two most recent additions to the exchanges as quickly as they continue to flee Lyft. As for social media company (a moniker it hates) Pinterest, shares closed up 28% on its first trading day. Meanwhile, video conferencing company Zoom saw its shares rise 72%. Somewhat ironically (or forebodingly), Zoom's pop was the biggest since the 2013 debut of Twitter—a company which has been under nearly-constant pressure since going public. Investors need to keep some of their powder dry, as many more companies will debut on the various exchanges over the coming months, to include the highly-anticipated Uber offering. Between the two most recent IPOs, we prefer Pinterest. Yes, Zoom is turning a profit, but there are simply so many other companies in that industry—like Adobe and Microsoft—competing for the same client base. We believe it will be hard for the company to continue differentiating its products and services.
Technology Hardware, Storage, & Peripherals
CNBC test drives the Samsung Galaxy Fold...and it breaks after two days. Sure, a foldable smartphone sounds pretty cool on its face. You can use it like a regular phone, then fold it open to use more like a tablet, viewing your photos—for example—on a double-sized screen. Samsung must think highly of their new device—they want you to shell out nearly $2,000 for it. There's only one problem with the phone, however: it appears to be prone to breaking, like nearly instantly. Tech writers at CNBC got their hands on one of the devices, and it stopped working correctly after two days. Specifically, the hinges that allow the device to swing open can act up, causing bulges, distortions, and outright failures on the screen. About the only comment Samsung has had thus far is to say that users are not supposed to remove the protective screen. CNBC didn't. The phone is due to launch on the 26th of April, and the company is currently taking pre-orders. It may want to rethink that launch date. This reminds us a lot of the exploding Galaxy 7s of just over two years ago. Is beating Apple to the market really worth the damage to a company's reputation when a faulty product is released? Not that we are dogging Samsung in general—our Samsung television seems to be the one piece of electronics in the house that hasn't met with an early demise thanks to poor craftsmanship (like our GE washer, LG fridge, Sony TV, Chinese-made sump pump with an American name, and HVAC motor made who knows where).
Semiconductors & Equipment
Qualcomm soaring after settling battle with Apple and Intel's departure from 5G. It has been a very good week for chip maker Qualcomm (QCOM $49-$81-$77). First came the announcement that it had settled its long-running legal battle with Apple (AAPL) over patent infringements and royalty payments, with the two coming to an agreement even as the costly court battle raged on. Not only will Apple pay Qualcomm an undisclosed amount in the settlement (it had been withholding a whopping $8 billion due in royalties), the two also forged a new six-year licensing agreement. This was in Apple's best interest, as it needs QCOM's chips as it enters the transformational world of 5G. Then came the announcement, just hours later, that Qualcom's chief rival, Intel (INTC), was leaving the 5G chip business altogether. Our guess is that Tim Cook thought he could count on Intel's nascent 5G business to fill the void, but that the company simply wasn't making the necessary progress in the field. This leaves one company standing as the dominant player in the space. Rightfully so, investors rewarded QCOM stock with a 23% spike on Tuesday and a 13% jump at Wednesday's open. Despite constant pushback from smartphone makers with respect to the royalty payments demanded by Qualcomm for their chip technology, the company is the undisputed worldwide leader in this technology. Our biggest challenge with the stock continues to be its high valuation (QCOM has a 50 P/E ratio as compared to INTC's 14, for example). Investing in semiconductor companies can be a harrowing experience; for evidence of that, just look back to the industry's fourth-quarter drubbing. To take advantage of the industry as a whole—instead of taking a chance on any one player—investors can consider ETFs like the iShares PHLX Semiconductor fund (SOXX) or the VanEck Vectors Semiconductor fund (SMH). QCOM is a top-tier holding within each.
Media & Entertainment
Hulu buys back AT&T stake, strengthening Disney's position. There are a lot of moving parts in the real-life Game of Thrones that is the media and entertainment streaming business. The latest move? Hulu has purchased back AT&T's 9.5% stake it held in the streaming video company for $1.4 billion. Post sale, Hulu will be controlled by just two players: Disney (DIS), with its 67% stake (it gained about 34% when it bought the Fox assets); and Comcast (CMCSA), with the remaining 33%. With Disney's plans to compete head-to-head with Netflix (NFLX) via its Disney+ streaming service, why is it interested in controlling the money-losing Hulu instead of just focusing on its own new subs (subscribers)? It appears that the company is positioning Disney+ as the more "family-oriented" portion of the business, while Hulu attracts more mature content that Disney would prefer not to lend its name to. Additionally, despite its current losses, Disney wants to greatly expand Hulu's global footprint and bring the company to profitability within a few years, with a goal of doubling subs from 25 million to 50 million within four years. (For comparison, Netflix currently has around 130 million subscribers around the world.) And that's where Comcast comes in: its recent purchase of Rupert Murdoch's Sky assets will give Hulu a potentially-enormous footprint in Europe, allowing it to battle Netflix's overseas growth. Like we say, Game of Thrones. How can investors take advantage of this fast-paced industry? In the first place, own Disney (with its 18 P/E) over Netflix (132 P/E). Secondly, own the device makers: Amazon (AMZN) owns the Fire TV Stick and Fire TV Cube, and Roku (ROKU) provides the other set of streaming players and built-in software (on select sets).
Specialty Retail
After crafting an amazing turnaround, Hubert Joly is handing over the reins at Best Buy. Back in 2012, it would have been easy to imagine specialty electronics retailer Best Buy (BBY $48-$73-$84) going the way of Circuit City, Radio Shack, or Toys "R" Us. At the time, BBY shares were going for around $12, and the company didn't seem to have a viable turnaround plan in place. Then, the company turned to outsider Hubert Joly to develop and execute a sound strategic plan of action. Now, after just over six years on the job, shares are trading at $73, the company has turned a profit every year since 2014, and the P/E ratio is a respectable 18. Happy with the company's progress, Joly announced that he will be handing the reins over to CFO Corie Barry, who, at 44, will become one of the youngest chief executives in the S&P 500. Ms. Barry, who also sits on the board of Domino's Pizza (DPZ), has been with Best Buy since 1999, serving in a variety of high-level roles. Joly will remain with the company, serving as executive chairman. Had BBY fallen on the news, we might have taken the opportunity to pick up shares—once again—in this well-run company. As it was, investors showed confidence in this major move and the shares remained steady. We expect Best Buy to continue to wage a successful campaign against online competitors such as Amazon (AMZN) and retain (or even grow) its market share in the space.
Headlines for the Week of 07 Apr 2019—13 Apr 2019
Energy Exploration & Production
In a brilliant strategic move, Chevron will acquire exploration and production company Anadarko for $33 billion. Traders will soon have one less E&P company to buy and sell, but Friday's announcement that Penn Global Leaders Club member Chevron Corp (CVX $100-$120-$131) will buy Anadarko Petroleum (APC $40-$62-$77) for $33 billion was a brilliant move that investors applauded, sending APC shares up 33% from Thursday's close. Anadarko is one of the renaissance US shale players that Saudi Arabia—using the club that is OPEC—promised to knee-cap. Once these pesky US competitors were knocked out of business via low oil prices, the Kingdom reasoned, OPEC could once again control pricing. Now, with the majors moving into the space, that is not going to happen. One interesting twist to this deal: Occidental Petroleum (OXY) announced that it had previously made a stronger bid for Anadarko, and that they will now "explore their options." Good luck: APC shareholders should feel much more comfortable with CVX as the new owner. Saudi Arabia had to hate hearing this news, and probably fear more acquisitions of this type will follow. Other players which could be gobbled up include: Apache (APA), Devon Energy (DVN), Concho Resources (CXO), Diamondback Energy (FANG), and even OXY itself.
Media & Entertainment
Penn Member Disney jumps 12% at open following details on company's new streaming service. The Walt Disney Co (DIS $98-$130-$120) offered up some much-anticipated details on its new Disney+ streaming service, and investors loved what they heard—DIS punched through its 52-week-high by $10 per share, or nearly 12%. The new service will cost consumers $6.99 per month or $70 per year, and will include 30 seasons of "Simpsons" episodes, Pixar movies, Marvel films, Disney's own vault of movies, 5,000 episodes of Disney Channel shows, and over 100 Disney Channel original movies. There is also talk of a bundled package of Disney+, HULU (Disney owns 60%), and ESPN+ for subscribers. It is hard to imagine an American family with young kids at home not subscribing to this service. The company, in fact, is projecting 60-90 million new subscribers over the next five years. The new service will launch 12 November. Netflix (NFLX), with its 132 P/E ratio (DIS has a P/E ratio of 19), was down nearly 4% at Friday's open. We own DIS in the Penn Global Leaders Club, and continue to be impressed with CEO Bob Iger's leadership. Now, if someone could tell Roy Disney's daughter, Abigail, to shut up about Iger's pay, that would be awesome. Roy's kids have been a thorn in the side of the company for decades, which makes sense to anyone who has read the incredible story of Walt Disney's life. For anyone interested, my favorite book on Walt's life is, "Walt Disney: The Triumph of the American Imagination," by Neil Gabler. I would highly recommend it.
Global Strategy: Europe
Voters in the UK should be outraged as Brexit becomes a farce. Three years. That is the length of the runway between Brits voting to leave the European Union and the actual takeoff. Three years, and they couldn't get it done. As with the indolent kid pleading for more time from the teacher to get his homework done, we all know what happens when the teacher grants the stay: the kid breathes a sigh of relief and still doesn't get it done by the extended deadline. So, the EU is giving the UK an extension to 31 October for an exit plan. How magnanimous, and how fitting the date. Unlike the kind teacher in our story, the EU knows it has simply provided more rope for England to hang itself (i.e. end up remaining in the Union). This is truly an outrage, and Brits should rise up and demand their majority voice at the ballot box be heard. What, exactly, is Parliament going to magically work out between now and Halloween? The majority party cannot come together to save their members' respective lives, and they have demonstrated an inability to work with an ineffectual prime minster. Meanwhile, the smarmy elitists in Brussels sit back and laugh at the dolts. Brexit would have happened by now had the Republic of Ireland voted the same way as England in the referendum, but they didn't. They remain a thorn in the side of England, siding with their "friends" in the EU, stoked by a deep-seated hatred for the way England has treated them over the centuries. Now, after this latest farce, the most probable outcome is no exit from the EU by England; they will remain stuck in the nightmare that is the Customs Union. We know how the opportunist Labour Party will react, but the real question is how the Brexiteers will respond to this travesty. That could get interesting.
Transportation Infrastructure
After Uber shoots for a valuation of up to $100 billion, investors flee Lyft. We always knew that Uber was the big ride-hailing service out there, despite all of the drama at the firm over the past year or so. No doubt, Lyft (LYFT $66-$60-$89) thought they would take some of the air out of the sails of Uber by beating them to the public market. Boy, did that ever backfire. After a rough start (shares topped out at $88.60 on IPO day before tumbling), Lyft's shares seemed to be stabilizing, at least until Wednesday. After Uber announced that it was shooting for an IPO price between $48 and $55, giving it a valuation of as much as $100 billion, Lyft shares plunged another 11%, dropping below their all-time (OK, it's only been a week) low. Why the drop? Uber lead underwriters Morgan Stanley and Goldman Sachs were floating a valuation of $120 billion or so as recently as late last year. Ironically, it was Lyft's poor performance in their own debut that led to the more conservative figures from Uber, that led to another drop for Lyft. If you want to gamble on this industry, which is only going to get bigger as more and more urban-dwelling Americans ditch their cars, we would recommend picking up some Tesla shares at their current price of $277, and wait for that company to build out its planned autonomous ride-hailing service. At least you know they also build vehicles for a living.
Airlines
Penn Member Delta Air Lines beats expectations for both revenue and profit in Q1. Delta Air Lines (DAL $45-$57-$61) continues to be our favorite airline, which is one of the reasons we own it in the Penn Global Leaders Club. True to form, the carrier just released Q1 earnings that beat Street expectations on both the top and bottom lines. Against forecasts for $10.42 billion in revenue, the company brought in $10.47 billion—a 5.1% jump from the same quarter last year; earnings came in at $730 million—up from $557 million in Q1 of 2018. A beaming Ed Bastian, the company's CEO, announced that this has been the strongest first quarter (typically the weakest for airlines) in the history of Delta. A fortuitous note: the company was not flying any 737 MAX aircraft at the time of the grounding. Delta has already surpassed our first price target of $55; we have raised our target price to $65 per share.
Restaurants
Financial engineering at its worst: Chuck E. Cheese has no business going public again. There are so many financial engineering gimmicks out there designed to separate investors from their money that it's not even remotely funny. The question "how stupid do they think we are?" does not have to be rhetorical; just look at the price of a stock between the time the gimmick is foisted upon the investment community and when it is back in the dumpster to answer that question. So, Chuck E. Cheese's parent company, CEC Entertainment, purchased five years ago by Apollo Management Group (APO), plans to go public yet again. Why? What has changed? Despite what Apollo might tell you, here's our belief: this is a quick way to raise a lot of capital for the primary stakeholders. To help it sneak in the back door of the publicly-traded marketplace, CEC Entertainment will combine with Leo Holdings Corp (LHC), a $258 million micro-cap, which will then change its name to Chuck E. Cheese Brands Inc. Slick. Our advice? Run the other way. In our opinion, which we have every right to espouse, this move will enhance the bank accounts of a few "financial engineers" and their teams of lawyers, but the poor shareholders will be left holding the bag. Let's check back in a year and see if we are right or wrong.
Beverages & Tobacco Products
Constellation Brands' strategy: ditch the cheap wine, load up on the beer and the pot. Last August we argued that, despite our support of booze maker Constellation Brands' (STZ $150-$193-$237) minority purchase of pot joint Canopy Growth (CGC), the stock was still a bit overvalued. At the time, STZ was sitting at $202/share. Now, Constellation is making an even bolder move: the company just sold 30-some brands of its lower-end wines (like Clos du Bois and Mark West) to E. & J. Gallo Winery for $1.7 billion to focus in on its beer and pot business lines—going after a younger demographic group. Investors seemed to like the news, sending the price up double-digits after the latest earnings report came out. Constellation owns such beers as Corona, Modelo, and Pacifico. While it continues to be our favorite booze joint, we would wait until STZ was between its one-year low and $175/share before picking back up. Shares are still down 15% over the past year.
E-Commerce
The best possible outcome for Amazon: Bezos's amicable divorce. Considering the fact that Jeff Bezos's now-ex-wife MacKenzie is entitled to half of the two's combined assets, an ugly divorce could have spelled trouble for Amazon (AMZN $1,307-$1,819-$2,051). That is because the company's founder is also the largest owner of its stock, controlling 16% of the outstanding shares, along with their voting rights. On Thursday, however, MacKenzie tweeted that the divorce process has been finalized, and that she has agreed to give the ex her entire interest in rocket company Blue Origin and The Washington Post, and 75% of their joint AMZN shares, or 12%. While she will still own the remaining 4%, she has also given Bezos voting control over those shares. That really is the best possible outcome, and a far cry from the infamous Steve Wynn (WYNN) divorce. The 4% of shares MacKenzie kept, by the way, are worth $35.6 billion, making her somewhere around the third richest woman in the world; following Francoise Bettencourt Meyers (L'Oreal) and Alice Walton (you can guess), and ahead of Jacqueline Mars (you can guess). As for Bezos, he will remain the wealthiest person in the world, worth a figure somewhere north of $100 billion when the dust settles. Amazon is position #40 in the forty stocks of the Penn Global Leaders Club.
Global Strategy: Europe
Germany's economy continues to get pounded due to global slowdown, trade issues with China. German industrial orders plunged 8.4% year/year—their biggest drop in a decade—on the heels of a general global slowdown, and continued trade tensions with China. Europe's largest economy reported that demand for new factory orders from customers outside the eurozone fell a disconcerting 7.9% in February; this news caused the euro to fall about 15 basis points against the dollar (to $1.12), and the 10-year German bund to fall back into negative yield territory. We continue to underweight developed Europe within our international allocation, as we don't see any quick fixes to their problems—regardless of any purported trade deal with China.
Global Organizations & Accords
Turkey was always an odd selection when it came to membership in NATO. During the heat of the Cold War, each respective side had its global alliance: the communist nations had the Warsaw Pact, and Western democracies had the North Atlantic Treaty Organization, or NATO. Following the collapse of the Soviet Union and the understandable demise of the Warsaw Pact, NATO took some interesting twists and turns, but perhaps the oddest story revolves around a country which became a member back in 1952: Turkey. That country has always been torn between the East (it is mostly surrounded by Islamic or former communist nations), and the West. Once again, cracks are turning into fissures between NATO and its most volatile member. The latest eruption surrounds an insultingly-brazen decision by Turkey's president, Reycap...developing. The entire free world is acutely aware of China's long-running abuses of trade policy; it took the United States to finally stand up and say enough is enough. But don't wait for Juncker to give the US credit for any easing of China's trade practices.
Transportation Infrastructure
Lyft hit correction territory—on its first full trading day. Just a few short years ago, Uber's founder and then-CEO Travis Kalanick wanted to take out the company's much-smaller competitor in the ride-hailing space, Lyft (LYFT $78-$69-$89). That company's founders, despite their firm's small relative size, said no thanks. Kalanick didn't stop there. If he couldn't buy the company, he could at least get their drivers to defect. Uber would have operatives order Lyft rides so they could attempt to cajole the drivers into changing teams.
Then, almost out of nowhere, the high-flying Uber hit some serious bumps on the road to the Exchange. After a slew of lawsuits and bad press surrounding everything from the theft of trade secrets to charges of sexism, the man who started the company found himself out of a job. Talk of an IPO was put on hold as Dara Khosrowshahi, the former CEO of Expedia, was brought in to clean up the mess.
Three years ago, few would have believed that Lyft had any chance at all at beating Uber to the IPO market. Nonetheless, there they were, ringing the opening bell at the Nasdaq last Friday. Initially setting a price between $62 and $68 per share for the IPO, they raised that price to $72 due to heavy demand. Virtually within minutes of opening, investors were paying $88.60 per share for the seven-year-old company—valuing the firm somewhere in the $25 billion range. Sure, relative chump change compared to Uber's $120 billion ballpark, but still, quite impressive.
Then Monday hit. It was as if investors suddenly sobered up to the realization that Lyft lost nearly $1 billion last year, up from the nearly $700 million they lost the prior year. In a flash, Lyft found itself in correction territory, with shares closing down over 20% from their $88.60 high.
What does this portend for Uber's IPO later in the year? In our opinion, probably not much. In fact, we believe that a number of large investors have been keeping their powder dry for the big dog in the space.
Lyft's IPO presents a great lesson for investors. We remember managing client assets back during the turn of the century, when investors would call in to see if they could get in on the latest and greatest dot-com IPO, like InfoSpace or pets.com. It may be twenty years later (the frenzy seemed to peak in 1999), but the memories are still fresh in our minds. Our advice? Be patient. From Uber to Pinterest to around one hundred other unicorn IPOs heading our way, there will be plenty of time to get in on some great bargain-basement prices—many coming well after that first day of trading.
Global Trade
In a refreshing twist, EU's Juncker points his vitriol at China, not the US. We have virtually no respect for the clowns running the European Union from Brussels, but every now and again one of them does something which shows a modicum of intelligence. European Commissioner Jean-Claude Juncker, who typically opens his mouth before his brain engages, actually decided to bash China's restrictive trade policies, aiming his vitriol in the right direction for once. After a March meeting with Chinese President Xi Jinping, Juncker excoriated China for its unfair trade practices, stating that the situation—of Europe being open to Chinese business but not vice versa—has to change before real progress can be made. He also condemned China's iron-fisted reaction to any criticism of that country's human rights violations. The entire free world is acutely aware of China's long-running abuses of trade policy; it took the United States to finally stand up and say enough is enough. But don't wait for Juncker to give the US credit for any easing of China's trade practices.
Capital Markets
A broker would have to be nuts to join Morgan Stanley (in our humble opinion). It is known as the Protocol for Broker Recruiting, and it effectively allows brokers to leave one firm for another, taking basic information on their clients with them so that they can let investors know where they have gone. In 2017, Morgan Stanley (MS $37-$43-$56) sent shockwaves through the brokerage industry when it abruptly pulled out of the Protocol, sending a shot across the bow to brokers who were thinking of changing firms. The harsh legal filings against brokers leaving Morgan Stanley since the company exited the agreement, however, have been met with skepticism by judges. Most recently, MS attempted to get a temporary restraining order (TRO) issued against a two-person team who bolted for another firm. The duo managed nearly $300 million in client assets. Texas state district judge Bridgett Whitmore, however, wasn't buying the company's argument, and shot down the request. MS has since filed another claim with FINRA, the national regulatory body, to stop the team from contacting clients. Based on our experience, here's the real question to ask: would a broker or team of brokers have been able to build up the same book of client business had they been at a competing firm, or was it Morgan Stanley's unique corporate culture that allowed these brokers to build their book? To us, the answer is obvious: it was the brokers, NOT Morgan Stanley, that built the book of business. Morgan Stanley, in our opinion, should be ashamed of its draconian behavior. Then again, as a broker myself I might be a bit biased. I only hope that other brokerage firms fervently attack Morgan Stanley when that company entices brokers to join with them. Which would beg the question, why the hell would a broker willingly enter that kind of environment?
In a brilliant strategic move, Chevron will acquire exploration and production company Anadarko for $33 billion. Traders will soon have one less E&P company to buy and sell, but Friday's announcement that Penn Global Leaders Club member Chevron Corp (CVX $100-$120-$131) will buy Anadarko Petroleum (APC $40-$62-$77) for $33 billion was a brilliant move that investors applauded, sending APC shares up 33% from Thursday's close. Anadarko is one of the renaissance US shale players that Saudi Arabia—using the club that is OPEC—promised to knee-cap. Once these pesky US competitors were knocked out of business via low oil prices, the Kingdom reasoned, OPEC could once again control pricing. Now, with the majors moving into the space, that is not going to happen. One interesting twist to this deal: Occidental Petroleum (OXY) announced that it had previously made a stronger bid for Anadarko, and that they will now "explore their options." Good luck: APC shareholders should feel much more comfortable with CVX as the new owner. Saudi Arabia had to hate hearing this news, and probably fear more acquisitions of this type will follow. Other players which could be gobbled up include: Apache (APA), Devon Energy (DVN), Concho Resources (CXO), Diamondback Energy (FANG), and even OXY itself.
Media & Entertainment
Penn Member Disney jumps 12% at open following details on company's new streaming service. The Walt Disney Co (DIS $98-$130-$120) offered up some much-anticipated details on its new Disney+ streaming service, and investors loved what they heard—DIS punched through its 52-week-high by $10 per share, or nearly 12%. The new service will cost consumers $6.99 per month or $70 per year, and will include 30 seasons of "Simpsons" episodes, Pixar movies, Marvel films, Disney's own vault of movies, 5,000 episodes of Disney Channel shows, and over 100 Disney Channel original movies. There is also talk of a bundled package of Disney+, HULU (Disney owns 60%), and ESPN+ for subscribers. It is hard to imagine an American family with young kids at home not subscribing to this service. The company, in fact, is projecting 60-90 million new subscribers over the next five years. The new service will launch 12 November. Netflix (NFLX), with its 132 P/E ratio (DIS has a P/E ratio of 19), was down nearly 4% at Friday's open. We own DIS in the Penn Global Leaders Club, and continue to be impressed with CEO Bob Iger's leadership. Now, if someone could tell Roy Disney's daughter, Abigail, to shut up about Iger's pay, that would be awesome. Roy's kids have been a thorn in the side of the company for decades, which makes sense to anyone who has read the incredible story of Walt Disney's life. For anyone interested, my favorite book on Walt's life is, "Walt Disney: The Triumph of the American Imagination," by Neil Gabler. I would highly recommend it.
Global Strategy: Europe
Voters in the UK should be outraged as Brexit becomes a farce. Three years. That is the length of the runway between Brits voting to leave the European Union and the actual takeoff. Three years, and they couldn't get it done. As with the indolent kid pleading for more time from the teacher to get his homework done, we all know what happens when the teacher grants the stay: the kid breathes a sigh of relief and still doesn't get it done by the extended deadline. So, the EU is giving the UK an extension to 31 October for an exit plan. How magnanimous, and how fitting the date. Unlike the kind teacher in our story, the EU knows it has simply provided more rope for England to hang itself (i.e. end up remaining in the Union). This is truly an outrage, and Brits should rise up and demand their majority voice at the ballot box be heard. What, exactly, is Parliament going to magically work out between now and Halloween? The majority party cannot come together to save their members' respective lives, and they have demonstrated an inability to work with an ineffectual prime minster. Meanwhile, the smarmy elitists in Brussels sit back and laugh at the dolts. Brexit would have happened by now had the Republic of Ireland voted the same way as England in the referendum, but they didn't. They remain a thorn in the side of England, siding with their "friends" in the EU, stoked by a deep-seated hatred for the way England has treated them over the centuries. Now, after this latest farce, the most probable outcome is no exit from the EU by England; they will remain stuck in the nightmare that is the Customs Union. We know how the opportunist Labour Party will react, but the real question is how the Brexiteers will respond to this travesty. That could get interesting.
Transportation Infrastructure
After Uber shoots for a valuation of up to $100 billion, investors flee Lyft. We always knew that Uber was the big ride-hailing service out there, despite all of the drama at the firm over the past year or so. No doubt, Lyft (LYFT $66-$60-$89) thought they would take some of the air out of the sails of Uber by beating them to the public market. Boy, did that ever backfire. After a rough start (shares topped out at $88.60 on IPO day before tumbling), Lyft's shares seemed to be stabilizing, at least until Wednesday. After Uber announced that it was shooting for an IPO price between $48 and $55, giving it a valuation of as much as $100 billion, Lyft shares plunged another 11%, dropping below their all-time (OK, it's only been a week) low. Why the drop? Uber lead underwriters Morgan Stanley and Goldman Sachs were floating a valuation of $120 billion or so as recently as late last year. Ironically, it was Lyft's poor performance in their own debut that led to the more conservative figures from Uber, that led to another drop for Lyft. If you want to gamble on this industry, which is only going to get bigger as more and more urban-dwelling Americans ditch their cars, we would recommend picking up some Tesla shares at their current price of $277, and wait for that company to build out its planned autonomous ride-hailing service. At least you know they also build vehicles for a living.
Airlines
Penn Member Delta Air Lines beats expectations for both revenue and profit in Q1. Delta Air Lines (DAL $45-$57-$61) continues to be our favorite airline, which is one of the reasons we own it in the Penn Global Leaders Club. True to form, the carrier just released Q1 earnings that beat Street expectations on both the top and bottom lines. Against forecasts for $10.42 billion in revenue, the company brought in $10.47 billion—a 5.1% jump from the same quarter last year; earnings came in at $730 million—up from $557 million in Q1 of 2018. A beaming Ed Bastian, the company's CEO, announced that this has been the strongest first quarter (typically the weakest for airlines) in the history of Delta. A fortuitous note: the company was not flying any 737 MAX aircraft at the time of the grounding. Delta has already surpassed our first price target of $55; we have raised our target price to $65 per share.
Restaurants
Financial engineering at its worst: Chuck E. Cheese has no business going public again. There are so many financial engineering gimmicks out there designed to separate investors from their money that it's not even remotely funny. The question "how stupid do they think we are?" does not have to be rhetorical; just look at the price of a stock between the time the gimmick is foisted upon the investment community and when it is back in the dumpster to answer that question. So, Chuck E. Cheese's parent company, CEC Entertainment, purchased five years ago by Apollo Management Group (APO), plans to go public yet again. Why? What has changed? Despite what Apollo might tell you, here's our belief: this is a quick way to raise a lot of capital for the primary stakeholders. To help it sneak in the back door of the publicly-traded marketplace, CEC Entertainment will combine with Leo Holdings Corp (LHC), a $258 million micro-cap, which will then change its name to Chuck E. Cheese Brands Inc. Slick. Our advice? Run the other way. In our opinion, which we have every right to espouse, this move will enhance the bank accounts of a few "financial engineers" and their teams of lawyers, but the poor shareholders will be left holding the bag. Let's check back in a year and see if we are right or wrong.
Beverages & Tobacco Products
Constellation Brands' strategy: ditch the cheap wine, load up on the beer and the pot. Last August we argued that, despite our support of booze maker Constellation Brands' (STZ $150-$193-$237) minority purchase of pot joint Canopy Growth (CGC), the stock was still a bit overvalued. At the time, STZ was sitting at $202/share. Now, Constellation is making an even bolder move: the company just sold 30-some brands of its lower-end wines (like Clos du Bois and Mark West) to E. & J. Gallo Winery for $1.7 billion to focus in on its beer and pot business lines—going after a younger demographic group. Investors seemed to like the news, sending the price up double-digits after the latest earnings report came out. Constellation owns such beers as Corona, Modelo, and Pacifico. While it continues to be our favorite booze joint, we would wait until STZ was between its one-year low and $175/share before picking back up. Shares are still down 15% over the past year.
E-Commerce
The best possible outcome for Amazon: Bezos's amicable divorce. Considering the fact that Jeff Bezos's now-ex-wife MacKenzie is entitled to half of the two's combined assets, an ugly divorce could have spelled trouble for Amazon (AMZN $1,307-$1,819-$2,051). That is because the company's founder is also the largest owner of its stock, controlling 16% of the outstanding shares, along with their voting rights. On Thursday, however, MacKenzie tweeted that the divorce process has been finalized, and that she has agreed to give the ex her entire interest in rocket company Blue Origin and The Washington Post, and 75% of their joint AMZN shares, or 12%. While she will still own the remaining 4%, she has also given Bezos voting control over those shares. That really is the best possible outcome, and a far cry from the infamous Steve Wynn (WYNN) divorce. The 4% of shares MacKenzie kept, by the way, are worth $35.6 billion, making her somewhere around the third richest woman in the world; following Francoise Bettencourt Meyers (L'Oreal) and Alice Walton (you can guess), and ahead of Jacqueline Mars (you can guess). As for Bezos, he will remain the wealthiest person in the world, worth a figure somewhere north of $100 billion when the dust settles. Amazon is position #40 in the forty stocks of the Penn Global Leaders Club.
Global Strategy: Europe
Germany's economy continues to get pounded due to global slowdown, trade issues with China. German industrial orders plunged 8.4% year/year—their biggest drop in a decade—on the heels of a general global slowdown, and continued trade tensions with China. Europe's largest economy reported that demand for new factory orders from customers outside the eurozone fell a disconcerting 7.9% in February; this news caused the euro to fall about 15 basis points against the dollar (to $1.12), and the 10-year German bund to fall back into negative yield territory. We continue to underweight developed Europe within our international allocation, as we don't see any quick fixes to their problems—regardless of any purported trade deal with China.
Global Organizations & Accords
Turkey was always an odd selection when it came to membership in NATO. During the heat of the Cold War, each respective side had its global alliance: the communist nations had the Warsaw Pact, and Western democracies had the North Atlantic Treaty Organization, or NATO. Following the collapse of the Soviet Union and the understandable demise of the Warsaw Pact, NATO took some interesting twists and turns, but perhaps the oddest story revolves around a country which became a member back in 1952: Turkey. That country has always been torn between the East (it is mostly surrounded by Islamic or former communist nations), and the West. Once again, cracks are turning into fissures between NATO and its most volatile member. The latest eruption surrounds an insultingly-brazen decision by Turkey's president, Reycap...developing. The entire free world is acutely aware of China's long-running abuses of trade policy; it took the United States to finally stand up and say enough is enough. But don't wait for Juncker to give the US credit for any easing of China's trade practices.
Transportation Infrastructure
Lyft hit correction territory—on its first full trading day. Just a few short years ago, Uber's founder and then-CEO Travis Kalanick wanted to take out the company's much-smaller competitor in the ride-hailing space, Lyft (LYFT $78-$69-$89). That company's founders, despite their firm's small relative size, said no thanks. Kalanick didn't stop there. If he couldn't buy the company, he could at least get their drivers to defect. Uber would have operatives order Lyft rides so they could attempt to cajole the drivers into changing teams.
Then, almost out of nowhere, the high-flying Uber hit some serious bumps on the road to the Exchange. After a slew of lawsuits and bad press surrounding everything from the theft of trade secrets to charges of sexism, the man who started the company found himself out of a job. Talk of an IPO was put on hold as Dara Khosrowshahi, the former CEO of Expedia, was brought in to clean up the mess.
Three years ago, few would have believed that Lyft had any chance at all at beating Uber to the IPO market. Nonetheless, there they were, ringing the opening bell at the Nasdaq last Friday. Initially setting a price between $62 and $68 per share for the IPO, they raised that price to $72 due to heavy demand. Virtually within minutes of opening, investors were paying $88.60 per share for the seven-year-old company—valuing the firm somewhere in the $25 billion range. Sure, relative chump change compared to Uber's $120 billion ballpark, but still, quite impressive.
Then Monday hit. It was as if investors suddenly sobered up to the realization that Lyft lost nearly $1 billion last year, up from the nearly $700 million they lost the prior year. In a flash, Lyft found itself in correction territory, with shares closing down over 20% from their $88.60 high.
What does this portend for Uber's IPO later in the year? In our opinion, probably not much. In fact, we believe that a number of large investors have been keeping their powder dry for the big dog in the space.
Lyft's IPO presents a great lesson for investors. We remember managing client assets back during the turn of the century, when investors would call in to see if they could get in on the latest and greatest dot-com IPO, like InfoSpace or pets.com. It may be twenty years later (the frenzy seemed to peak in 1999), but the memories are still fresh in our minds. Our advice? Be patient. From Uber to Pinterest to around one hundred other unicorn IPOs heading our way, there will be plenty of time to get in on some great bargain-basement prices—many coming well after that first day of trading.
Global Trade
In a refreshing twist, EU's Juncker points his vitriol at China, not the US. We have virtually no respect for the clowns running the European Union from Brussels, but every now and again one of them does something which shows a modicum of intelligence. European Commissioner Jean-Claude Juncker, who typically opens his mouth before his brain engages, actually decided to bash China's restrictive trade policies, aiming his vitriol in the right direction for once. After a March meeting with Chinese President Xi Jinping, Juncker excoriated China for its unfair trade practices, stating that the situation—of Europe being open to Chinese business but not vice versa—has to change before real progress can be made. He also condemned China's iron-fisted reaction to any criticism of that country's human rights violations. The entire free world is acutely aware of China's long-running abuses of trade policy; it took the United States to finally stand up and say enough is enough. But don't wait for Juncker to give the US credit for any easing of China's trade practices.
Capital Markets
A broker would have to be nuts to join Morgan Stanley (in our humble opinion). It is known as the Protocol for Broker Recruiting, and it effectively allows brokers to leave one firm for another, taking basic information on their clients with them so that they can let investors know where they have gone. In 2017, Morgan Stanley (MS $37-$43-$56) sent shockwaves through the brokerage industry when it abruptly pulled out of the Protocol, sending a shot across the bow to brokers who were thinking of changing firms. The harsh legal filings against brokers leaving Morgan Stanley since the company exited the agreement, however, have been met with skepticism by judges. Most recently, MS attempted to get a temporary restraining order (TRO) issued against a two-person team who bolted for another firm. The duo managed nearly $300 million in client assets. Texas state district judge Bridgett Whitmore, however, wasn't buying the company's argument, and shot down the request. MS has since filed another claim with FINRA, the national regulatory body, to stop the team from contacting clients. Based on our experience, here's the real question to ask: would a broker or team of brokers have been able to build up the same book of client business had they been at a competing firm, or was it Morgan Stanley's unique corporate culture that allowed these brokers to build their book? To us, the answer is obvious: it was the brokers, NOT Morgan Stanley, that built the book of business. Morgan Stanley, in our opinion, should be ashamed of its draconian behavior. Then again, as a broker myself I might be a bit biased. I only hope that other brokerage firms fervently attack Morgan Stanley when that company entices brokers to join with them. Which would beg the question, why the hell would a broker willingly enter that kind of environment?