Penn...After Hours
The musings of an investment professional and a happy warrior, culled from our weekly economic and investment research. These stories are for informational purposes only, and should never be construed as specific investment advice. Always consult with your investment professional before making a decision. See more disclaimers at the bottom of each page.
Sign up to get the top business & investment headlines of the week delivered right to your inbox!...
Create wealth by reading beyond the headlines...
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?
Headlines for the Week of 24 Mar 2019—30 Mar 2019
Economics: Goods & Services
Final read on fourth-quarter GDP comes in as expected, so we now know the rate of growth for the US economy in 2018. The final expected read on growth in the US for the fourth quarter of 2018 was 2.2%, and that is precisely the number we got. The puzzle is now complete for the year, with quarterly growth of: 2.2%, 4.2%, 3.4%, and 2.2%, respectively. Add those figures up and divide by four and we have the US GDP rate of growth for the year: 3% on the nose. Now, the real question becomes whether or not we can pull out another 3% growth year in 2019. Reductions in consumer spending on goods (rather than services), as well as reduced government spending at both the state and national levels helped stifle the Q4 figure, but are either of those factors really a bad thing? The first predictions for Q1 are coming in, with an average expected growth rate of 1.5%—lower than any of the 2018 figures. The hopes are that the first quarter of the year will represent the trough, with the final three quarters of the year coming in higher. If a massive trade deal gets done and the global economy stabilizes, that is a probability. Here's our ideal scenario for the economy and the markets this year: growth picks back up, but not so much that the Fed feels the need to change course yet again and raise rates one more time. If that scenario plays out, it should provide the rich soil for a nice, double-digit growth rate for the markets in 2019.
Global Strategy: Latin America
More evidence that Russia remains an enemy to the US, and a force for instability: 100 Russian troops arrive in Venezuela. The human suffering taking place in Venezuela is difficult to watch, and equally difficult to fathom. After a year which saw a one million percent inflation rate in the country, the hapless Maduro hangs on to power, despite worldwide condemnation. Two countries continue to stand by the dictator, however: China and Russia. Putin, with his delusions of power, believes he can prevent an overthrow of the communist regime, as evidenced by the arrival of 100 Russian troops in Caracas. According to the Russian foreign ministry, a team has been dispatched to "discuss military cooperation at the request of the government in Caracas." For his part, President Trump has demanded that all Russian troops exit the country, and restated his position that "all options" remain on the table to make that happen. With Putin involved, Venezuelan opposition leader Juan Guaidó needs to reinforce his security team. If the recognized leader of the country suddenly falls ill, doctors should immediately check his system for the radioactive substance polonium-210. This is a battle which Putin and Maduro cannot win—the level of human suffering is too great for the regime to survive much longer. To Putin, however, he sees his involvement as tit-for-tat for America's involvement in places like Ukraine and Syria. Additionally, losing an anti-American ally on the continent will be a very hard pill to swallow.
Health Care Providers & Services
Two health care providers for government-sponsored programs to merge. Health care plan sponsor Centene (CNC $50-$52-$138) announced it will acquire competitor WellCare Health Plans Inc (WCG $188-$255-$325) in a $15.3 billion deal. The companies are major players in the government-sponsored managed care world, with both providing services to Medicare and Medicaid recipients. The goal is to turn two regional players into one with a national footprint, with 22 million combined members and expected revenues nearing $100 billion in 2019. As for being a sound investment, is now really the time to take a chance on a major Obamacare (corporate) recipient? After all, a federal judge just ruled that Obama's marquee legislation violated the US Constitution by forcing individuals to buy health insurance. While the Roberts-led US Supreme Court didn't come to the same conclusion several years ago, the law is certainly still up in the air. Back to the deal—the acquirer (Centene) dropped about 10% on news of the merger, while the company to be acquired (WellCare Health Plans) spiked double digits. This merger is expected to close in early 2020, but we wouldn't touch either firm now—or the new entity next year, as there are too many moving parts that won't be settled for some time. We currently do not own any health care providers within any of the Penn platforms.
Restaurants
Penn member McDonald's buys Israeli startup to improve online marketing, in-store ordering experience. In its biggest acquisition in a few decades, Penn Global Leaders Club member McDonald's (MCD $153-$187-$191) announced it will buy Israeli startup Dynamic Yield, LTD—a digital efficiency company—for $300 million. The company's digital technology will first be used to enhance the ordering displays at the fast food chain's drive-thru windows. Factors such as what the customer is ordering and what the weather is like outside will be able to immediately impact what is on the screen. For example, if the weather is hot, the technology will tell the system to begin advertising ice cream cones; if a customer orders one type of meal, complimentary food ideas will appear on the screen almost instantaneously. For McDonald's, it's all about creating a personalized experience while improving efficiencies—two components very few companies can make compatible. The chain is reporting great success with its mobile order and pay systems, as well as its digital menu boards, all of which increase efficiency. We can think of a few other fast food chains that could take a page out of McDonald's playbook. McDonald's simply remains the industry benchmark for others to emulate. Burger King (owned by Restaurant Brands Int'l, QSR) can run all of the goofy little ads of the king chasing Ronald McDonald, but that is where they will remain—chasing the leader.
Textiles, Apparel, & Luxury Goods
Beaten-down Tiffany & Co is suddenly on a roll. On Christmas Eve of 2018, high-end jewelry store Tiffany & Co (TIF $73-$103-$142) was sitting down 22.65% year-to-date. Not the kind of performance one would expect for the luxury retailer in the midst of its busiest season. What a difference the turn of a year makes. Suddenly, on the back of upbeat growth expectations as voiced by CEO Alessandro Bogliolo, Tiffany is up 28.2% thus far in 2019. As for Q4, sales dropped 1% from the previous year, to $1.32 billion, while net earnings rose from $62 million in Q4 of 2017 to $204.5 million last quarter. Tiffany's biggest challenge going forward will continue to be the slowdown in global growth, especially in China. The CEO, in fact, cited Chinese and European shoppers spending less on jewelry as a reason for the Q4 sales miss. While the stock is still well below its 52-week high, we wouldn't bite until the global economic environment firms up. While the higher-end retailer tends to be more insulated from economic slowdowns, 75% of Tiffany shops are in department stores, which continue to face headwinds from online competition. We wouldn't be in a hurry to pick up shares at this price. We did, however, pick up Signet Jewelers (SIG: Zales, Kay, Jared) in the Intrepid Trading Platform when it hit a 52-week low.
Final read on fourth-quarter GDP comes in as expected, so we now know the rate of growth for the US economy in 2018. The final expected read on growth in the US for the fourth quarter of 2018 was 2.2%, and that is precisely the number we got. The puzzle is now complete for the year, with quarterly growth of: 2.2%, 4.2%, 3.4%, and 2.2%, respectively. Add those figures up and divide by four and we have the US GDP rate of growth for the year: 3% on the nose. Now, the real question becomes whether or not we can pull out another 3% growth year in 2019. Reductions in consumer spending on goods (rather than services), as well as reduced government spending at both the state and national levels helped stifle the Q4 figure, but are either of those factors really a bad thing? The first predictions for Q1 are coming in, with an average expected growth rate of 1.5%—lower than any of the 2018 figures. The hopes are that the first quarter of the year will represent the trough, with the final three quarters of the year coming in higher. If a massive trade deal gets done and the global economy stabilizes, that is a probability. Here's our ideal scenario for the economy and the markets this year: growth picks back up, but not so much that the Fed feels the need to change course yet again and raise rates one more time. If that scenario plays out, it should provide the rich soil for a nice, double-digit growth rate for the markets in 2019.
Global Strategy: Latin America
More evidence that Russia remains an enemy to the US, and a force for instability: 100 Russian troops arrive in Venezuela. The human suffering taking place in Venezuela is difficult to watch, and equally difficult to fathom. After a year which saw a one million percent inflation rate in the country, the hapless Maduro hangs on to power, despite worldwide condemnation. Two countries continue to stand by the dictator, however: China and Russia. Putin, with his delusions of power, believes he can prevent an overthrow of the communist regime, as evidenced by the arrival of 100 Russian troops in Caracas. According to the Russian foreign ministry, a team has been dispatched to "discuss military cooperation at the request of the government in Caracas." For his part, President Trump has demanded that all Russian troops exit the country, and restated his position that "all options" remain on the table to make that happen. With Putin involved, Venezuelan opposition leader Juan Guaidó needs to reinforce his security team. If the recognized leader of the country suddenly falls ill, doctors should immediately check his system for the radioactive substance polonium-210. This is a battle which Putin and Maduro cannot win—the level of human suffering is too great for the regime to survive much longer. To Putin, however, he sees his involvement as tit-for-tat for America's involvement in places like Ukraine and Syria. Additionally, losing an anti-American ally on the continent will be a very hard pill to swallow.
Health Care Providers & Services
Two health care providers for government-sponsored programs to merge. Health care plan sponsor Centene (CNC $50-$52-$138) announced it will acquire competitor WellCare Health Plans Inc (WCG $188-$255-$325) in a $15.3 billion deal. The companies are major players in the government-sponsored managed care world, with both providing services to Medicare and Medicaid recipients. The goal is to turn two regional players into one with a national footprint, with 22 million combined members and expected revenues nearing $100 billion in 2019. As for being a sound investment, is now really the time to take a chance on a major Obamacare (corporate) recipient? After all, a federal judge just ruled that Obama's marquee legislation violated the US Constitution by forcing individuals to buy health insurance. While the Roberts-led US Supreme Court didn't come to the same conclusion several years ago, the law is certainly still up in the air. Back to the deal—the acquirer (Centene) dropped about 10% on news of the merger, while the company to be acquired (WellCare Health Plans) spiked double digits. This merger is expected to close in early 2020, but we wouldn't touch either firm now—or the new entity next year, as there are too many moving parts that won't be settled for some time. We currently do not own any health care providers within any of the Penn platforms.
Restaurants
Penn member McDonald's buys Israeli startup to improve online marketing, in-store ordering experience. In its biggest acquisition in a few decades, Penn Global Leaders Club member McDonald's (MCD $153-$187-$191) announced it will buy Israeli startup Dynamic Yield, LTD—a digital efficiency company—for $300 million. The company's digital technology will first be used to enhance the ordering displays at the fast food chain's drive-thru windows. Factors such as what the customer is ordering and what the weather is like outside will be able to immediately impact what is on the screen. For example, if the weather is hot, the technology will tell the system to begin advertising ice cream cones; if a customer orders one type of meal, complimentary food ideas will appear on the screen almost instantaneously. For McDonald's, it's all about creating a personalized experience while improving efficiencies—two components very few companies can make compatible. The chain is reporting great success with its mobile order and pay systems, as well as its digital menu boards, all of which increase efficiency. We can think of a few other fast food chains that could take a page out of McDonald's playbook. McDonald's simply remains the industry benchmark for others to emulate. Burger King (owned by Restaurant Brands Int'l, QSR) can run all of the goofy little ads of the king chasing Ronald McDonald, but that is where they will remain—chasing the leader.
Textiles, Apparel, & Luxury Goods
Beaten-down Tiffany & Co is suddenly on a roll. On Christmas Eve of 2018, high-end jewelry store Tiffany & Co (TIF $73-$103-$142) was sitting down 22.65% year-to-date. Not the kind of performance one would expect for the luxury retailer in the midst of its busiest season. What a difference the turn of a year makes. Suddenly, on the back of upbeat growth expectations as voiced by CEO Alessandro Bogliolo, Tiffany is up 28.2% thus far in 2019. As for Q4, sales dropped 1% from the previous year, to $1.32 billion, while net earnings rose from $62 million in Q4 of 2017 to $204.5 million last quarter. Tiffany's biggest challenge going forward will continue to be the slowdown in global growth, especially in China. The CEO, in fact, cited Chinese and European shoppers spending less on jewelry as a reason for the Q4 sales miss. While the stock is still well below its 52-week high, we wouldn't bite until the global economic environment firms up. While the higher-end retailer tends to be more insulated from economic slowdowns, 75% of Tiffany shops are in department stores, which continue to face headwinds from online competition. We wouldn't be in a hurry to pick up shares at this price. We did, however, pick up Signet Jewelers (SIG: Zales, Kay, Jared) in the Intrepid Trading Platform when it hit a 52-week low.
Headlines for the Week of 17 Mar 2019—23 Mar 2019
Biotechnology
Biogen falls 27% after it abandons Alzheimer's drug. The saddest part of this story is not the drop in the share price of a company, but the setback for Alzheimer's sufferers. US biotech firm Biogen (BIIB $249-$235-$389) closed Wednesday's trading session at $321 per share; it opened Thursday around $235 per share—nearly a $100 drop. This loss of one-quarter of the company's market cap is tied to the announcement that the firm will halt trials of its Alzheimer's treatment Aducanumab (AD ju CAN uh mab) after an independent group's analysis showing that the trials were unlikely to yield tangible results. There was enormous promise built up around this product, with a Goldman Sachs analyst projecting sales of $12 billion once it was on the market. BIIB CEO Michel Vounatsos, in a written statement, said that this (ending of the trials) confirms "the complexity of treating Alzheimer's disease and the need to further advance knowledge in (the field of) neuroscience." The surprise announcement led to a slew of Biogen downgrades. This was a terrible setback, but we believe the Street overreacted to the news. BIIB had a P/E ratio of 15, which dropped to 10.5 after the massive drop in the share price. On the low side, we value Biogen at $350 per share—a 50% upside for investors.
Global Strategy: Latin America
Brazil, with its new pro-American president, will open up space launch base to the United States. A good portion of Latin America has been a hotbed of socialism and anti-American rhetoric going back to Fidel Castro's rise to power in 1959. Over the past decade, however, that has been rapidly changing. Mainly due to the economic destruction that comes along with socialism, countries have been throwing out their leftist leaders in favor of market reformers. One of the greatest examples is the hugely-important nation of Brazil. While Lula da Silva and "Aunt Bea" Rousseff weren't as openly hostile to the US as Chavez, Maduro, and Ortega, they still shoveled the anti-American rhetoric. Not so with new President Jair Bolsonaro. . Not only does the president, who visited with US President Trump this week, embrace relations with the United States, he freely quotes Ronald Reagan and boasts of wishing to emulate the US. How refreshing to see the winds of change blow out tired, old socialists in the Americas (well, with the exception of Mexico, which is going in the other direction). One benefit of our great new relationship with Brazil is already manifesting: the country will open up its Alcantara Space Launch Base to US agencies and companies. While the agreement will need the approval of Brazil's congress, that hurdle should be cleared thanks to the backing of President Bolsonaro. The fact that Brazil lies directly across the equator gives the US an enormous advantage for the launch of spacecraft. Strategically, China and Russia will not be happy with this new capability, let along the budding new friendship between the two countries. The US needs to be careful not to overplay its hand with our new friends in Latin America, as our enemies are constantly trying to foment anti-American sentiment in the region. An economically-vibrant South America will spell doom for leftists and great news—both economically and geopolitically—for the US. Look for strong new investments coming from the emerging markets of the region over the next several years.
Textiles, Apparel, & Luxury Goods
Levi Strauss to investors: give us your money and keep your opinions to yourself. This Thursday, denim-maker Levi Strauss will go public—again. There are a lot of things we don't like about this IPO, and many of those things can be distilled down to this component: the company will "offer" dual shares, with the dupe investors gaining control of 1% of the firm (yet paying for the lion's share of market cap), while the anointed family owners will control the other 99%. In other words, Levi's IPO sales pitch is: give us your money and keep your mouth shut. So, when the outspoken "social action" firm puts out there next politically-infused commercial, save your grumblings. At least you can always sell your stock. Just be sure and do so before the company goes private again. Sadly, political activism by publicly-traded companies is on the rise. Some management teams (almost always spearheaded by the founder/CEO) are finding it easier to wade into the political arena through their ads and their company-backed commentary. It's no longer enough for the individuals to speak out (as individuals), they want to put the weight of their company behind their opinions. And opinions are all they are. Just because a founder is worth $X billion doesn't mean they are any more intelligent, compassionate, or thoughtful than anyone else. But don't try to tell them that. The best course of action is to simply shun the shares of companies which have made the (erroneous) strategic decision to go down this path.
Food & Staples Retailing
South Korea's StarKist settles with Kroger, other food chains over price-fixing scandal. Pittsburgh-based, South Korean subsidiary StarKist has reached an agreement with Kroger (KR), Wal-Mart (WMT), Target (TGT), and other grocery store chains after admitting that it conspired with multiple seafood packagers to jack-up the price of canned tuna. California-based Bumblebee Foods LLC had previously plead guilty to the US Department of Justice charges. The most interesting point of this story: who knew StarKist tuna was a subsidiary of South Korea's Dongwon Industries? (It's Charlie® the Tuna, for Pete's sake.) Want to know the two best brands of tuna to buy, based on sustainability, traceability, and other factors? Wild Planet and American Tuna tied for the top spot. Both brands can be purchased from Amazon. The more informed American consumers get about what they are putting in their bodies, the harder it is for companies with questionable products or practices to hide. While we are not saying StarKist or Bumble Bee are unsafe by any means, we are saying that, when it comes to your health, nobody will look out for your best interests better than you. If you question a product, do a little digging.
Hotels, Resorts, & Cruise Lines
Investors like Marriott's aggressive growth plan. Hotel chain Marriott (MAR $101-$125-$142) saw its shares jump after CEO Arne Sorenson announced an aggressive new growth strategy: the $42 billion firm will open 1,700 hotels around the world, return over $10 billion to shareholders via increased dividends and buybacks, and generate a profit of $8.50 per share—all within the next 36 months. Marriott currently operates 1.3 million rooms across 30 different brands, including Marriott, Sheraton, Ritz-Carlton, and St. Regis. We've been down on Marriott's corporate culture ever since the firm's cowardly firing of 49-year-old Roy Jones after pressure from Mainland China. At that time, MAR shares were trading at $136. We continue to favor Hilton (HLT).
Specialty Retail
Dick's to remove more guns from its stores, shares plummet 11%. Dick's Sporting Goods' (DKS $30-$35-$41) CEO Ed Stack's war on guns continues, even as the store's sales slump. Most recently, the $3.4 billion chain reported a 3.1% drop in same-store sales and offered gloomy guidance going forward. Management now expects comparable sales to be in the "flat to up 2% range" for the entire year. After Tuesday's double-digit drop, Dick's has now lost 45% of its value over the course of two years. When management steps into the political arena, they turn off half of their customer base. Actually, in the case of Stack and his war on guns, it is fair to say that over half of the store's demographics were against this move. Getting into politics is well and good—until you drag your shareholders into the political arena with you.
Textiles, Apparel, & Luxury Goods
Dear Levi Strauss, when you go public (again), please stick to blue jeans, not politics. Levi Strauss, the company founded in 1853 to provide a sturdier set of britches to California gold miners, is about to go public—again. The San Francisco-based apparel maker announced its intentions on Monday, and expects to raise around $600 million in the IPO. That amount would value the company at roughly $6 billion—in the sweet spot of the mid-cap range. LEVI (the expected ticker) plans to offer 36.7 million shares priced somewhere between $14 and $16 per share, but should investors bite? Global demand for denim products is strong, and Levi is certainly an iconic brand, but consider how other specialty apparel retailers appealing to the same demographic group—like Gap (GAP), Abercrombie (ANF), American Eagle (AEO), and Urban Outfitters (URBN)—have been struggling. That being said, Levi plans to increase its offerings to attract a younger demographic group, offering such services as a tailor shop, and customer-centric designs which can be placed on blue jeans and T-shirts. In management's own words, Levi wants to become, "a full-fledged global lifestyle leader for both men and women." Certainly, Levi has something other small retailers don't: a massive network of wholesalers who also sell their goods. Additionally, the firm is increasing its offerings on Amazon, and undertaking a new marketing and advertising campaign for direct sales. Here's our biggest concern, however: the company is going to feel the urge to push politics in their ads (remember United Colors of Benetton and their embarrassingly-political ads?). If that happens, Levi will telegraph who they don't want buying their clothing, whittling down their customer base in a very competitive environment. It shouldn't take long for investors to figure out which path management has chosen for the brand. As mentioned, this is not Levi's first IPO. It went public in 1971, but pulled out of the market in 1985 to avoid the "short-term pressures of Wall Street." We could see a short-term pop in share value, but expect it won't be long before LEVI begins to languish, yet again. They do make a great pair of blue jeans, however.
Aerospace & Defense
Boeing falls double-digits after a second deadly crash of its new 737 MAX 8. Last October, a brand new Lion Air-owned Boeing (BA $292-$377-$446) 787 MAX 8 aircraft crashed after taking off from Jakarta, Indonesia, killing all 189 passengers on board. This past Sunday, a three-month-old Ethiopian Airlines-owned Boeing 787 MAX 8 crashed minutes after taking off from Addis Ababa, Ethiopia, killing all 157 on board. The two disasters prompted China and Indonesia to ground the aircraft. While the investigation of the latest crash is just getting underway, and it is dangerous to speculate (the two black boxes have just been recovered), a new software system is garnering a lot of attention from investigators.
Boeing made some adjustments to its new 737 MAX to increase efficiency; namely, moving the aircraft's more fuel-efficient engines slightly forward and higher up. This adjustment caused—albeit slightly—how the jet responds under certain circumstances: there is a tendency of the nose to pitch slightly more upward than usual. To counteract this tendency, Boeing installed the new Maneuvering Characteristics Augmentation System (MCAS) on the aircraft. The MCAS, in simplest terms, pushes the nose back down. This is done without any pilot interaction. Here's the major problem: air carrier unions are arguing that Boeing has not given clear instructions to pilots on what to do to override this new system, the actions of which can catch them off guard.
As mentioned, it is too early to definitively say that the MCAS—and the pilots' response—is at the core of the latest crash, but that didn't stop the Chinese from grounding their fleet. Why is China so important to this story? By far, the country operates the most (96) 787 MAX 8s, and will be the recipient of the plurality of future orders for the aircraft. Boeing has notched orders for over 5,000 of the jet thus far. The FAA will certainly expedite the investigation of the latest crash, comparing the data from the black boxes to what was discovered during the Jakarta investigation. Boeing needs to act decisively to put the airlines and, more importantly, air travelers' minds at ease. In the US, Southwest Airlines (LUV) and American Airlines (AAL) currently fly the jet.
It might seem tempting to pick up shares of Boeing after their worst daily decline in a decade, but it is too early to know the ramifications of these two disasters, or if they are even related. If passengers are asking how safe it is to fly on an aircraft (and they are), that can be a public relations disaster for the aircraft's maker. Of course, those concerns pale in comparison to how this tragic loss of life has affected the families of the passengers aboard the two doomed flights.
Biogen falls 27% after it abandons Alzheimer's drug. The saddest part of this story is not the drop in the share price of a company, but the setback for Alzheimer's sufferers. US biotech firm Biogen (BIIB $249-$235-$389) closed Wednesday's trading session at $321 per share; it opened Thursday around $235 per share—nearly a $100 drop. This loss of one-quarter of the company's market cap is tied to the announcement that the firm will halt trials of its Alzheimer's treatment Aducanumab (AD ju CAN uh mab) after an independent group's analysis showing that the trials were unlikely to yield tangible results. There was enormous promise built up around this product, with a Goldman Sachs analyst projecting sales of $12 billion once it was on the market. BIIB CEO Michel Vounatsos, in a written statement, said that this (ending of the trials) confirms "the complexity of treating Alzheimer's disease and the need to further advance knowledge in (the field of) neuroscience." The surprise announcement led to a slew of Biogen downgrades. This was a terrible setback, but we believe the Street overreacted to the news. BIIB had a P/E ratio of 15, which dropped to 10.5 after the massive drop in the share price. On the low side, we value Biogen at $350 per share—a 50% upside for investors.
Global Strategy: Latin America
Brazil, with its new pro-American president, will open up space launch base to the United States. A good portion of Latin America has been a hotbed of socialism and anti-American rhetoric going back to Fidel Castro's rise to power in 1959. Over the past decade, however, that has been rapidly changing. Mainly due to the economic destruction that comes along with socialism, countries have been throwing out their leftist leaders in favor of market reformers. One of the greatest examples is the hugely-important nation of Brazil. While Lula da Silva and "Aunt Bea" Rousseff weren't as openly hostile to the US as Chavez, Maduro, and Ortega, they still shoveled the anti-American rhetoric. Not so with new President Jair Bolsonaro. . Not only does the president, who visited with US President Trump this week, embrace relations with the United States, he freely quotes Ronald Reagan and boasts of wishing to emulate the US. How refreshing to see the winds of change blow out tired, old socialists in the Americas (well, with the exception of Mexico, which is going in the other direction). One benefit of our great new relationship with Brazil is already manifesting: the country will open up its Alcantara Space Launch Base to US agencies and companies. While the agreement will need the approval of Brazil's congress, that hurdle should be cleared thanks to the backing of President Bolsonaro. The fact that Brazil lies directly across the equator gives the US an enormous advantage for the launch of spacecraft. Strategically, China and Russia will not be happy with this new capability, let along the budding new friendship between the two countries. The US needs to be careful not to overplay its hand with our new friends in Latin America, as our enemies are constantly trying to foment anti-American sentiment in the region. An economically-vibrant South America will spell doom for leftists and great news—both economically and geopolitically—for the US. Look for strong new investments coming from the emerging markets of the region over the next several years.
Textiles, Apparel, & Luxury Goods
Levi Strauss to investors: give us your money and keep your opinions to yourself. This Thursday, denim-maker Levi Strauss will go public—again. There are a lot of things we don't like about this IPO, and many of those things can be distilled down to this component: the company will "offer" dual shares, with the dupe investors gaining control of 1% of the firm (yet paying for the lion's share of market cap), while the anointed family owners will control the other 99%. In other words, Levi's IPO sales pitch is: give us your money and keep your mouth shut. So, when the outspoken "social action" firm puts out there next politically-infused commercial, save your grumblings. At least you can always sell your stock. Just be sure and do so before the company goes private again. Sadly, political activism by publicly-traded companies is on the rise. Some management teams (almost always spearheaded by the founder/CEO) are finding it easier to wade into the political arena through their ads and their company-backed commentary. It's no longer enough for the individuals to speak out (as individuals), they want to put the weight of their company behind their opinions. And opinions are all they are. Just because a founder is worth $X billion doesn't mean they are any more intelligent, compassionate, or thoughtful than anyone else. But don't try to tell them that. The best course of action is to simply shun the shares of companies which have made the (erroneous) strategic decision to go down this path.
Food & Staples Retailing
South Korea's StarKist settles with Kroger, other food chains over price-fixing scandal. Pittsburgh-based, South Korean subsidiary StarKist has reached an agreement with Kroger (KR), Wal-Mart (WMT), Target (TGT), and other grocery store chains after admitting that it conspired with multiple seafood packagers to jack-up the price of canned tuna. California-based Bumblebee Foods LLC had previously plead guilty to the US Department of Justice charges. The most interesting point of this story: who knew StarKist tuna was a subsidiary of South Korea's Dongwon Industries? (It's Charlie® the Tuna, for Pete's sake.) Want to know the two best brands of tuna to buy, based on sustainability, traceability, and other factors? Wild Planet and American Tuna tied for the top spot. Both brands can be purchased from Amazon. The more informed American consumers get about what they are putting in their bodies, the harder it is for companies with questionable products or practices to hide. While we are not saying StarKist or Bumble Bee are unsafe by any means, we are saying that, when it comes to your health, nobody will look out for your best interests better than you. If you question a product, do a little digging.
Hotels, Resorts, & Cruise Lines
Investors like Marriott's aggressive growth plan. Hotel chain Marriott (MAR $101-$125-$142) saw its shares jump after CEO Arne Sorenson announced an aggressive new growth strategy: the $42 billion firm will open 1,700 hotels around the world, return over $10 billion to shareholders via increased dividends and buybacks, and generate a profit of $8.50 per share—all within the next 36 months. Marriott currently operates 1.3 million rooms across 30 different brands, including Marriott, Sheraton, Ritz-Carlton, and St. Regis. We've been down on Marriott's corporate culture ever since the firm's cowardly firing of 49-year-old Roy Jones after pressure from Mainland China. At that time, MAR shares were trading at $136. We continue to favor Hilton (HLT).
Specialty Retail
Dick's to remove more guns from its stores, shares plummet 11%. Dick's Sporting Goods' (DKS $30-$35-$41) CEO Ed Stack's war on guns continues, even as the store's sales slump. Most recently, the $3.4 billion chain reported a 3.1% drop in same-store sales and offered gloomy guidance going forward. Management now expects comparable sales to be in the "flat to up 2% range" for the entire year. After Tuesday's double-digit drop, Dick's has now lost 45% of its value over the course of two years. When management steps into the political arena, they turn off half of their customer base. Actually, in the case of Stack and his war on guns, it is fair to say that over half of the store's demographics were against this move. Getting into politics is well and good—until you drag your shareholders into the political arena with you.
Textiles, Apparel, & Luxury Goods
Dear Levi Strauss, when you go public (again), please stick to blue jeans, not politics. Levi Strauss, the company founded in 1853 to provide a sturdier set of britches to California gold miners, is about to go public—again. The San Francisco-based apparel maker announced its intentions on Monday, and expects to raise around $600 million in the IPO. That amount would value the company at roughly $6 billion—in the sweet spot of the mid-cap range. LEVI (the expected ticker) plans to offer 36.7 million shares priced somewhere between $14 and $16 per share, but should investors bite? Global demand for denim products is strong, and Levi is certainly an iconic brand, but consider how other specialty apparel retailers appealing to the same demographic group—like Gap (GAP), Abercrombie (ANF), American Eagle (AEO), and Urban Outfitters (URBN)—have been struggling. That being said, Levi plans to increase its offerings to attract a younger demographic group, offering such services as a tailor shop, and customer-centric designs which can be placed on blue jeans and T-shirts. In management's own words, Levi wants to become, "a full-fledged global lifestyle leader for both men and women." Certainly, Levi has something other small retailers don't: a massive network of wholesalers who also sell their goods. Additionally, the firm is increasing its offerings on Amazon, and undertaking a new marketing and advertising campaign for direct sales. Here's our biggest concern, however: the company is going to feel the urge to push politics in their ads (remember United Colors of Benetton and their embarrassingly-political ads?). If that happens, Levi will telegraph who they don't want buying their clothing, whittling down their customer base in a very competitive environment. It shouldn't take long for investors to figure out which path management has chosen for the brand. As mentioned, this is not Levi's first IPO. It went public in 1971, but pulled out of the market in 1985 to avoid the "short-term pressures of Wall Street." We could see a short-term pop in share value, but expect it won't be long before LEVI begins to languish, yet again. They do make a great pair of blue jeans, however.
Aerospace & Defense
Boeing falls double-digits after a second deadly crash of its new 737 MAX 8. Last October, a brand new Lion Air-owned Boeing (BA $292-$377-$446) 787 MAX 8 aircraft crashed after taking off from Jakarta, Indonesia, killing all 189 passengers on board. This past Sunday, a three-month-old Ethiopian Airlines-owned Boeing 787 MAX 8 crashed minutes after taking off from Addis Ababa, Ethiopia, killing all 157 on board. The two disasters prompted China and Indonesia to ground the aircraft. While the investigation of the latest crash is just getting underway, and it is dangerous to speculate (the two black boxes have just been recovered), a new software system is garnering a lot of attention from investigators.
Boeing made some adjustments to its new 737 MAX to increase efficiency; namely, moving the aircraft's more fuel-efficient engines slightly forward and higher up. This adjustment caused—albeit slightly—how the jet responds under certain circumstances: there is a tendency of the nose to pitch slightly more upward than usual. To counteract this tendency, Boeing installed the new Maneuvering Characteristics Augmentation System (MCAS) on the aircraft. The MCAS, in simplest terms, pushes the nose back down. This is done without any pilot interaction. Here's the major problem: air carrier unions are arguing that Boeing has not given clear instructions to pilots on what to do to override this new system, the actions of which can catch them off guard.
As mentioned, it is too early to definitively say that the MCAS—and the pilots' response—is at the core of the latest crash, but that didn't stop the Chinese from grounding their fleet. Why is China so important to this story? By far, the country operates the most (96) 787 MAX 8s, and will be the recipient of the plurality of future orders for the aircraft. Boeing has notched orders for over 5,000 of the jet thus far. The FAA will certainly expedite the investigation of the latest crash, comparing the data from the black boxes to what was discovered during the Jakarta investigation. Boeing needs to act decisively to put the airlines and, more importantly, air travelers' minds at ease. In the US, Southwest Airlines (LUV) and American Airlines (AAL) currently fly the jet.
It might seem tempting to pick up shares of Boeing after their worst daily decline in a decade, but it is too early to know the ramifications of these two disasters, or if they are even related. If passengers are asking how safe it is to fly on an aircraft (and they are), that can be a public relations disaster for the aircraft's maker. Of course, those concerns pale in comparison to how this tragic loss of life has affected the families of the passengers aboard the two doomed flights.
Headlines for the Week of 03 Mar 2019—09 Mar 2019
Work & Pay
The February jobs number almost had to be a fluke. We've seen some misses before on the jobs front, but none like this. Against expectations for 180,000 new jobs in the month of February, the US added only 20,000. That is a remarkable, almost unbelievable miss, especially after January's revised 311,000 number. The unemployment rate ticked down to 3.8%, and average hourly earnings increased at a 3.4% annualized clip—the best in a decade. The country's severe February weather probably played a role, as evidenced by the report's construction figures, which showed 31,000 fewer jobs in that industry. Futures reacted first with shock, as the Dow dropped about 200 on the news, but then with suspicion, regaining ground before the open. Yes, there is certainly an international slowdown in economic activity, but it would be hard to buy that US hires are being so strongly affected by European and Asian woes. More than likely, the Feb jobs number will end up being a very strange "one-off." The Dow, having been down between 100 and 200 points nearly all of Friday's trading session, actually rallied to close down just 23 points. The S&P 500 was off 6, and the NASDAQ was down 13. Not a pretty week, with every major average finishing in the red every single session. In the end, all three major indexes lost over 2% on the week. If there was a bright side to the five sessions, it was the fact that we didn't see any of the wild swings that became the norm in Q4.
Beverages
LaCroix maker National Beverage Corp misses, but the real story was the CEO's bizarre rantings. You may not be familiar with the name National Beverage Corp (FIZZ $66-$54-$127), but you probably pass the company's colorful LaCroix brand sparkling water cans every time you go to the grocery store. FIZZ just reported earnings, and it wasn't pretty. Sales dropped 3% from the same quarter last year, to $221 million, and net income plummeted 40%, from $41 million to $24.8 million. As bad as those numbers were, they are not solely responsible for the stock dropping 22% on Friday, punching through its old 52-week low. CEO Nick Caporella (and his sideshow act) was the real culprit. In the earnings release, the CEO said that "Negligence nor mismanagement nor woeful acts of God were not the reasons (sic)—much of this was the result of injustice!" That piqued our curiosity. But it gets better. He went on to compare managing a brand like LaCroix to caring for someone who becomes handicapped. Huh? What an idiotic, tone deaf comment. Caporella was apparently pointing to a class-action lawsuit claiming false advertising in the LaCroix ingredients list. In his defense, some of the articles written of this suit have been far from responsible, and bordering on the ludicrous. Claims that "LaCroix uses a chemical found in cockroach insecticide" may be true; as true as making the same claim about water. The chemical in question is linalool, a naturally-occurring substance found in extracts from the likes of tangerines, lemons, and cinnamon. (And yes, it may be added to "cockroach insecticide). Interesting hit job. Unfortunately, the billionaire CEO of National Beverage is making some headlines of his own: the 82-year-old is being sued by two male pilots of his business jet for "inappropriate touching." Forget the claims of non-natural ingredients—those lawsuits will ultimately be thrown out. The real concern is Caporella's unprofessional commentary in the earnings report. FIZZ had a market cap of $5.7 billion last September, but that number now sits at $2.5 billion due to the cratering of the share price. Its 15 P/E ratio may make the shares look attractive, but we don't think the fallout is over. Plus, what industry is currently more saturated than the flavored sparkling water business?
Specialty Retail
Barnes & Noble misses (again); shares drop double-digits at open (again). Precisely 13 years ago, in March of 2006, bookseller Barnes & Noble (BKS $4-$5-$8) was a $2 billion small-cap stock. On Thursday, after the company reported another quarter of flat revenues, shares dropped double digits and the market cap dropped to a paltry $372 million. The $1.2 billion in revenue recorded for fiscal Q3 matched the previous year's $1.2 billion, and the company reported net earnings of $67 million—quite a bit better than the $64 million loss it took in the previous year's quarter. Something must change, however. Just six years ago, BKS was ringing up over $7 billion in sales; that number has been cut in half, and we don't see the catalyst for change. The best outcome would be a white knight riding in and taking the company private. If that happens, it just might survive. BKS is selling at $5 per share. It would be a total roll of the dice, but if a buyer does appear (or even the rumor of a buyer appearing), odds are pretty good that the shares would spike big-time. If we had a group of investors willing to pony-up $500 million or so, we would buy the company and take it private. A pipe dream, of course, but for someone with strategic vision, and a love of books and technology, this company could absolutely be turned around. Incredibly, this type of leadership will probably not surface.
Textiles, Apparel, & Luxury Goods
Should L Brands follow Gap's lead and spinoff Bath & Body Works from Victoria's Secret? Two years ago, we blasted Victoria's Secret's decision to shutdown its swimwear line. Now, parent company L Brands (LB $24-$28-$46) has done an about face and is reintroducing the line. Yet another warning sign that Les Wexner's management team—to include himself—is floundering. Wexner founded L Brands, then known as Limited Brands, back in 1963, and has remained at the helm ever since. While he did recently replace the head of Victoria's Secret, we don't see a clear strategy for the $7.5 billion retailer going forward. Activist investor Barington Capital has an idea: spinoff the company's strong Bath & Body Works chain into its own publicly-trade company, ala Gap and its Old Navy brand. Barington only owns around 1% of the firm (Drexler owns 17%), so we doubt management will take their advice. But is it a good idea? As with the Gap/Old Navy decision, we don't see a split doing much to uncover hidden value within any of the company's individual entities, which also include PINK, LaSenza, and C.O. Bigelow (it shuttered its Henri Bendel stores last year). Victoria's Secret still has great potential, it just needs some new vision to take back the market share it has lost recently to the likes of online player ThirdLove and Amazon's Iris & Lilly. A spinoff won't generate that creative magic. We have traded L Brands long before it changed its moniker from Limited and its ticker from LTD. It looks so tempting at $28 per share, with its 7.5% dividend yield and its 12 P/E ratio. But we just can't pull the trigger. The story would be different if there were any signs that Wexner was prepared to step down, making room for a dynamic new management team.
Multiline Retail
Penn holding Target shoots up on strong earnings report. Back near the end of December, as the retailers were getting obliterated, we saw—and bought—a grossly undervalued major multiline retailer: Target Corp (TGT $60-$78-$90). Picking the shares up at $62.39 within the Intrepid Trading Platform, we put an initial target price of $78 per share on the company. After handily beating expectations for both revenue and earnings, shares spiked Tuesday morning to within pennies of the target price we set just over two months ago. Same-store sales at Target rose 5.3% Y/Y, and digital sales surged 25%. The retailer's numbers fly in the face of the dour Commerce Department report on retail sales for Q4. We believed at the time that the mainstream press was giving that report too much oxygen, and the actual retail earnings reports are supporting that claim. As for Target, which is now up 25% from our purchase price, we will raise our target price—and our stop. We love conflicting or skewed government reports; they offer a great opportunity to swoop in and buy industry players (whatever that industry might be) at unfairly-discounted prices. When a storyline is developing in the press, it is time to dig deeper and pick through the carnage for undervalued gems.
Automotive
Tesla's move to online sales makes a great deal of sense for the company. Every time I walk in a new automobile showroom (which isn't that often, as we buy our vehicles from Carmax KMX—an incredible experience), I always look around and wonder what the monthly overhead is on the place. From heating and cooling the behemoth, to the confiscatory rate the owners/landlords are charging each month for all that indoor and outdoor space. That came to mind when I read of Elon Musk's plan to start selling all Tesla (TSLA $245-$285-$387) models online. Additionally, he also announced the company would sell its Model 3's at a starting base price of $35,000—a price that necessitates the need to do away with the showrooms. I went to the Tesla online showroom to check it out, and the process seems incredibly straightforward and simple. Within minutes you can order your car and have it shipped to you within a few weeks. Buyers will be given one week or 1,000 miles to return the car and receive a full refund. Of course (this is Tesla, after all), many will disagree with our opinion, but we find the strategy to be brilliant. Imagine the overhead the company will save, and let's face it, the shopping experience is moving online more rapidly than anyone could have predicted. The pundits will probably claim this is another nail in the coffin of Tesla; we believe just the opposite. Tesla remains a decade ahead of any of the "we sell electric cars, too!" automakers. Tesla is currently selling at $288 per share. While the risk is certainly there, we see this as an outstanding point for investors to jump in at the higher end of their risk/reward spectrum. One more note of interest: Musk will hold an event for the new Model Y unveiling a week from Thursday (on the 14th of March). This may be another catalyst for the stock price to move higher.
The February jobs number almost had to be a fluke. We've seen some misses before on the jobs front, but none like this. Against expectations for 180,000 new jobs in the month of February, the US added only 20,000. That is a remarkable, almost unbelievable miss, especially after January's revised 311,000 number. The unemployment rate ticked down to 3.8%, and average hourly earnings increased at a 3.4% annualized clip—the best in a decade. The country's severe February weather probably played a role, as evidenced by the report's construction figures, which showed 31,000 fewer jobs in that industry. Futures reacted first with shock, as the Dow dropped about 200 on the news, but then with suspicion, regaining ground before the open. Yes, there is certainly an international slowdown in economic activity, but it would be hard to buy that US hires are being so strongly affected by European and Asian woes. More than likely, the Feb jobs number will end up being a very strange "one-off." The Dow, having been down between 100 and 200 points nearly all of Friday's trading session, actually rallied to close down just 23 points. The S&P 500 was off 6, and the NASDAQ was down 13. Not a pretty week, with every major average finishing in the red every single session. In the end, all three major indexes lost over 2% on the week. If there was a bright side to the five sessions, it was the fact that we didn't see any of the wild swings that became the norm in Q4.
Beverages
LaCroix maker National Beverage Corp misses, but the real story was the CEO's bizarre rantings. You may not be familiar with the name National Beverage Corp (FIZZ $66-$54-$127), but you probably pass the company's colorful LaCroix brand sparkling water cans every time you go to the grocery store. FIZZ just reported earnings, and it wasn't pretty. Sales dropped 3% from the same quarter last year, to $221 million, and net income plummeted 40%, from $41 million to $24.8 million. As bad as those numbers were, they are not solely responsible for the stock dropping 22% on Friday, punching through its old 52-week low. CEO Nick Caporella (and his sideshow act) was the real culprit. In the earnings release, the CEO said that "Negligence nor mismanagement nor woeful acts of God were not the reasons (sic)—much of this was the result of injustice!" That piqued our curiosity. But it gets better. He went on to compare managing a brand like LaCroix to caring for someone who becomes handicapped. Huh? What an idiotic, tone deaf comment. Caporella was apparently pointing to a class-action lawsuit claiming false advertising in the LaCroix ingredients list. In his defense, some of the articles written of this suit have been far from responsible, and bordering on the ludicrous. Claims that "LaCroix uses a chemical found in cockroach insecticide" may be true; as true as making the same claim about water. The chemical in question is linalool, a naturally-occurring substance found in extracts from the likes of tangerines, lemons, and cinnamon. (And yes, it may be added to "cockroach insecticide). Interesting hit job. Unfortunately, the billionaire CEO of National Beverage is making some headlines of his own: the 82-year-old is being sued by two male pilots of his business jet for "inappropriate touching." Forget the claims of non-natural ingredients—those lawsuits will ultimately be thrown out. The real concern is Caporella's unprofessional commentary in the earnings report. FIZZ had a market cap of $5.7 billion last September, but that number now sits at $2.5 billion due to the cratering of the share price. Its 15 P/E ratio may make the shares look attractive, but we don't think the fallout is over. Plus, what industry is currently more saturated than the flavored sparkling water business?
Specialty Retail
Barnes & Noble misses (again); shares drop double-digits at open (again). Precisely 13 years ago, in March of 2006, bookseller Barnes & Noble (BKS $4-$5-$8) was a $2 billion small-cap stock. On Thursday, after the company reported another quarter of flat revenues, shares dropped double digits and the market cap dropped to a paltry $372 million. The $1.2 billion in revenue recorded for fiscal Q3 matched the previous year's $1.2 billion, and the company reported net earnings of $67 million—quite a bit better than the $64 million loss it took in the previous year's quarter. Something must change, however. Just six years ago, BKS was ringing up over $7 billion in sales; that number has been cut in half, and we don't see the catalyst for change. The best outcome would be a white knight riding in and taking the company private. If that happens, it just might survive. BKS is selling at $5 per share. It would be a total roll of the dice, but if a buyer does appear (or even the rumor of a buyer appearing), odds are pretty good that the shares would spike big-time. If we had a group of investors willing to pony-up $500 million or so, we would buy the company and take it private. A pipe dream, of course, but for someone with strategic vision, and a love of books and technology, this company could absolutely be turned around. Incredibly, this type of leadership will probably not surface.
Textiles, Apparel, & Luxury Goods
Should L Brands follow Gap's lead and spinoff Bath & Body Works from Victoria's Secret? Two years ago, we blasted Victoria's Secret's decision to shutdown its swimwear line. Now, parent company L Brands (LB $24-$28-$46) has done an about face and is reintroducing the line. Yet another warning sign that Les Wexner's management team—to include himself—is floundering. Wexner founded L Brands, then known as Limited Brands, back in 1963, and has remained at the helm ever since. While he did recently replace the head of Victoria's Secret, we don't see a clear strategy for the $7.5 billion retailer going forward. Activist investor Barington Capital has an idea: spinoff the company's strong Bath & Body Works chain into its own publicly-trade company, ala Gap and its Old Navy brand. Barington only owns around 1% of the firm (Drexler owns 17%), so we doubt management will take their advice. But is it a good idea? As with the Gap/Old Navy decision, we don't see a split doing much to uncover hidden value within any of the company's individual entities, which also include PINK, LaSenza, and C.O. Bigelow (it shuttered its Henri Bendel stores last year). Victoria's Secret still has great potential, it just needs some new vision to take back the market share it has lost recently to the likes of online player ThirdLove and Amazon's Iris & Lilly. A spinoff won't generate that creative magic. We have traded L Brands long before it changed its moniker from Limited and its ticker from LTD. It looks so tempting at $28 per share, with its 7.5% dividend yield and its 12 P/E ratio. But we just can't pull the trigger. The story would be different if there were any signs that Wexner was prepared to step down, making room for a dynamic new management team.
Multiline Retail
Penn holding Target shoots up on strong earnings report. Back near the end of December, as the retailers were getting obliterated, we saw—and bought—a grossly undervalued major multiline retailer: Target Corp (TGT $60-$78-$90). Picking the shares up at $62.39 within the Intrepid Trading Platform, we put an initial target price of $78 per share on the company. After handily beating expectations for both revenue and earnings, shares spiked Tuesday morning to within pennies of the target price we set just over two months ago. Same-store sales at Target rose 5.3% Y/Y, and digital sales surged 25%. The retailer's numbers fly in the face of the dour Commerce Department report on retail sales for Q4. We believed at the time that the mainstream press was giving that report too much oxygen, and the actual retail earnings reports are supporting that claim. As for Target, which is now up 25% from our purchase price, we will raise our target price—and our stop. We love conflicting or skewed government reports; they offer a great opportunity to swoop in and buy industry players (whatever that industry might be) at unfairly-discounted prices. When a storyline is developing in the press, it is time to dig deeper and pick through the carnage for undervalued gems.
Automotive
Tesla's move to online sales makes a great deal of sense for the company. Every time I walk in a new automobile showroom (which isn't that often, as we buy our vehicles from Carmax KMX—an incredible experience), I always look around and wonder what the monthly overhead is on the place. From heating and cooling the behemoth, to the confiscatory rate the owners/landlords are charging each month for all that indoor and outdoor space. That came to mind when I read of Elon Musk's plan to start selling all Tesla (TSLA $245-$285-$387) models online. Additionally, he also announced the company would sell its Model 3's at a starting base price of $35,000—a price that necessitates the need to do away with the showrooms. I went to the Tesla online showroom to check it out, and the process seems incredibly straightforward and simple. Within minutes you can order your car and have it shipped to you within a few weeks. Buyers will be given one week or 1,000 miles to return the car and receive a full refund. Of course (this is Tesla, after all), many will disagree with our opinion, but we find the strategy to be brilliant. Imagine the overhead the company will save, and let's face it, the shopping experience is moving online more rapidly than anyone could have predicted. The pundits will probably claim this is another nail in the coffin of Tesla; we believe just the opposite. Tesla remains a decade ahead of any of the "we sell electric cars, too!" automakers. Tesla is currently selling at $288 per share. While the risk is certainly there, we see this as an outstanding point for investors to jump in at the higher end of their risk/reward spectrum. One more note of interest: Musk will hold an event for the new Model Y unveiling a week from Thursday (on the 14th of March). This may be another catalyst for the stock price to move higher.
Headlines for the Week of 24 Feb 2019—02 Mar 2019
Market Pulse
Strong Friday session was enough to pull the major indexes up for the week (minus a flat Dow). After three down sessions, Monday through Wednesday, it looked like the S&P's winning streak would come to an end. Good economic numbers, a quiet Fed, and rosy expectations for a trade deal helped push the S&P and the NASDAQ positive for the week, however. While the Dow ended down, it wasn't by much: the index fell by just six points on the week, to 26,026. Oil fell 2.3%, to $55.75 per barrel, and gold dropped 2.8%, to $1,294 per ounce. It was nice to have a relatively calm, quiet week in the markets. Remember our comparison to 1987/88 going into the year? The graphs of the two periods are looking eerily similar. We'll take it.
Consumer Electronics
Fitbit is profitable again, but shares drop 14% after management's downbeat guidance. The last time—before the most recent quarter—that smartwatch device maker Fitbit (FIT $4-$6-$8) turned a quarterly profit was the third quarter of 2016. While the $1.5 billion small-cap did manage to earn $15 million on its $571 million in sales during the fourth quarter of 2018, management quickly threw cold water on that modest success by projecting a loss of $0.22 per share on revenues of $250 million to $268 million for Q1 of 2019. Trying to get investors excited for the future, CEO James Park pointed to a new subscription software service for its devices coming in the second half of the year. Yawn. FIT had a $50 share price just three and a half years ago. We're not saying the company is in a death spiral, but if management is pointing to a subscription software plan for its future success, there could be serious trouble ahead.
Specialty Retail
Gap to split into two publicly-traded companies, spinning off Old Navy. When we hear talk of the "retail wreck," iconic mall retailer Gap (GPS $24-$31-$35) almost always enters the conversation. The San Francisco-based clothier could be a case study in the decline of specialty retail. At the turn of the century, in February of 2000, Gap was a $45 billion enterprise. Today, its market cap sits just north of $10 billion. Nonetheless, investors pushed shares up 21% pre-market Friday after the company announced some financial engineering (a pejorative in our investment lexicon): it would be splitting into two publicly-traded companies, with Old Navy becoming a standalone enterprise. It amazes us that investors would reward this act, which does nothing to improve the overall health of the company, by pumping up shares this much. This reminds us of the investor who wouldn't touch a company at $100 per share, but when it had a 4-1 split, he couldn't get enough at $25 per share. As for the Gap decision, it is an implicit admission that the company's namesake brand, along with its Banana Republic, Athleta, and Intermix names, have been struggling—and will probably continue to struggle. We don't find that to be a good rationale for jettisoning their strongest brand, the chronic-discounter Old Navy. Analysts are still bullish on Gap; even more so, in fact, after this announcement. We just don't buy it, and we don't see any magical retail elixir that will allow either of the two new parts to excel going forward. They are ho-hum retailers in a hyper-competitive space.
Space Sciences & Exploration
Forget the monkey or the dog (sick communist Soviets), SpaceX will place a spacesuit-wearing dummy on its first Crew Dragon launch. This Saturday marks a huge milestone on the road to American astronauts returning to space via American ships (we still find it disgusting that this lapse in capabilities was ever allowed to happen—actually, orchestrated). SpaceX plans to make its first Crew Dragon test at 0248 local time, as the Falcon 9 rocket carrying the capsule is set to launch from Cape Canaveral Air Force Station, lighting up the pre-dawn sky. Ultimately, the Crew Dragon will shuttle astronauts to and from low Earth orbit (LEO). While no humans (or animals) will be on this first test mission, the capsule will have someone at the controls: a spacesuit-wearing anthropomorphic test dummy, or ATD. The sensor-laden dummy will measure the flight responses on the human body and various metrics of the environment. While NASA didn't request the ATD for the flight, how much cooler will it be for the crew of the International Space Station to open the hatch and find a traveler in the commander's seat? Based on his fight with the SEC, we now hope that Elon Musk keeps SpaceX private. And we are sad about that new opinion, as we were really looking forward to picking up some SPCX (just guessing) stock after the IPO.
Technology Hardware, Storage, & Peripherals
We never bought into the HP turnaround story; now the evidence is backing up our opinion. A lot of analysts have been bullish on "old tech" name HP Inc (HPQ $19-$20-$27), half of the old Hewlett-Packard that was split in two by lackluster former CEO Meg Whitman (let's split one mediocre company into two parts and see what happens). The HPQ side dealt with the hardware one thinks of with HP (printers, ink supplies, personal computers), while HPE—HP Enterprises—handles the IT services side of the business. HPQ just released their quarterly earnings report, and the numbers backed up our misgivings. Shares fell 17% after the company gave poor guidance for the printer supply business throughout 2019, specifically calling out weaker-than-expected demand in Europe, Africa, and the Middle East. Both revenues and earnings missed expectations. Ink, copiers, and ubiquitous personal computers. Why would someone want to take the helm at the company, and who still believes they have a grand turnaround strategy in the works? We often say that a great leader can create a turnaround story within virtually any industry. HPQ may challenge that notion. Stay away.
Corporate Culture
Are your customers advocates, ambivalent, or covertly unhappy? I recall watching a cocky, arrogant little Oscar Munoz, CEO of United Continental (UAL $65-$90-$98), being interviewed on a major business network right after an incident in which a man was dragged off an overbooked United flight. The story, rightfully, made national headlines. Instead of simply apologizing for his airline's terrible handling of the situation, a defiant Munoz essentially blamed the passenger. Within hours his tune had changed—no doubt after someone at the company made him aware of the blowback—but the CEO's true colors were on display in that first interview.
Fast forward. I have been a reader of the Wall Street Journal for decades. I was once an advocate for the paper. Over the past four years, however, I have gone from advocate to someone who would jump ship as a subscriber at the drop of a hat. Unfortunately, the company's product isn't fungible—there just aren't many good alternatives out there, and they know it. Perhaps that is the reason they have spiked their prices by 16%, 14%, 12%, and 5.4% over the past four years, respectively. Maybe their input costs went up? Not likely—as a digital-only customer they would not save one cent if I left (one of the incredible benefits to a company operating in a digital world). So, I will politely complain to the company (as I have for the past two years), I will get a cold fish response, and I will fume on.
But is that really how to run a business? We cannot change someone else's organization, but we can shape our own. Always be considering how products and services can be improved, and never forget who is keeping the lights on. You may offer clients a unique value proposition, but that doesn't mean you shouldn't constantly be evaluating the customer experience. Look at Lord Jeffrey's words of wisdom (quote of the day) from the 18th century. Nothing has changed in the 270 years since he penned them; they remain excellent words to live by, and to embed within your own corporate culture.
Before the likes of Amazon, companies (from bookstores to clothing retailers) had much greater pricing power. While there may be only a few "top-notch" business publications out there right now, the news industry will undoubtedly continue to be disrupted by technological advances. For arrogant management teams who treat customers like cattle, that is bad news. For the new breed of disruptors who treat their customers like gold, that is incredibly exciting.
Metals & Mining
Newmont Mining wants to buy rival Goldcorp for $10 billion. There's just one problem: Barrick wants to take out Newmont first. The deal would create the world's largest gold producer. And $19 billion Newmont Mining (NEM $29-$35-$42) was even willing to pay a nice premium for a competitor half its size, offering Goldcorp (GG $8-$11-$15) shareholders a $10 billion all-stock deal. It made a lot of sense: Goldcorp has a great growth story—operating large mines in Canada, Mexico, and South America—and it seemed amenable to a takeover. Then Barrick Gold (GOLD $10-$13-$14) felt the need to get in on the action, making a hostile bid for Newmont with an offer below fair value. It was a bizarre twist in an industry deserving of its own Netflix drama series. Barrick, for its part, actually had a smaller market cap than its prey until late last year when it bought South African gold miner Rangold for $6.5 billion. So much for digesting that kill before going on the hunt again. While Newmont has rejected the hostile bid, it's too early to know what will happen. Both miners have big operations virtually right next to each other in Nevada, so the synergies could be huge. In the end, Goldcorp shareholders might be the losers as the dance between the two bigger miners plays itself out. One reason we are following this story so closely, beyond the sheer intrigue, is our bullish call on gold this year. After five years of flat gold prices, a spike should equal a nice jump in revenues—and net income—at the top firms.
e-Commerce
Stamps.com loses half of its market value in one session. It always seemed like an odd business model to us: in a world going away from physical mail, sell (ultra-low-margin) postage stamps online. Nonetheless, Stamps.com (STMP $82-$99-$286) made it work—at least until last week. After ending its exclusive partnership with the USPS, the company’s shares went from $200 to $100 in one session. Of course, the smarmy lawyers immediately came out of their hovels to begin soliciting investors for a massive class action lawsuit. A great lesson for traders interested in only the technicals of a stock—not the fundamentals of a company. Unless you were an insider, you wouldn't have known that the company would sever its ties with the source of its primary product, but that didn't mean you couldn't evaluate the efficacy of the company's offerings. What was the unique value proposition of the products (ease)? How wide was the company's moat (pretty wide as long as the deal was in place)? What could go wrong (a lot)?
Global Debt
Nearly one-quarter of all government-issued notes around the world now have a negative yield. For the minority of economists arguing for more Fed rate hikes, the chief argument has been that the central bank needs to re-stock its ammo pile to be prepared for the next economic downturn. The higher the rates, the more the government can lower those rates to spur economic activity. Compared to the rest of the world, however, it appears that the US Treasury has the largest stockpile of ammo. It is a difficult concept to fathom, but right now nearly one-quarter of all government-issued notes around the world offer a negative yield to investors. $8 trillion worth of bonds around the world will pay investors precisely zilch in interest. That is wrong in so many ways, but here's the most pressing concern: economic activity around the world is slowing, but the central banks will watch their respective economies fall while they sit with their hands tied behind their backs. Japan and developed Europe—especially Germany—are the most at risk, in our opinion. On the sliding yield curve, you would have to go out eight years to find a German bond yielding anything above 0.0%. On a bright note, Japan's 10-year bond now offers investors a positive yield: 0.01%. Incredible. A lot of blame for the economic slowdown has been placed on Trump's trade battle with China, but global government wonks need to look in the mirror to find the real culprit—it has simply been too easy of an "out" to put new charges on the government credit card. Odds are great that we will see a US/China trade deal reached soon. However, this will not be a panacea for the global debt crisis. Responsible government behavior is the only solution, but—from Brussels to Tokyo to DC—when is the last time we saw that manifest in a real and lasting manner?
Industrial Conglomerates
If General Electric sells all of its units, it will be able to pay down (some of) its debt. It is so sad what has happened to one of America's great companies. Through rotten "leadership," beginning with Jeffrey Immelt, General Electric (GE $7-$12-$16) has become a comical shell of its former self. Here's the latest: the $88 billion company, once the largest company in the world, has agreed to sell its biotech unit to Danaher (DHR $95-$121-$121) for $21 billion to pay down some of its debt. Once a universe apart in market cap, the two companies are now approximately the same size. It should be noted that GE's current CEO, Larry Culp, was once the CEO of Danaher, which makes this deal all the more interesting. For fun, let's compare the two companies' financials. GE has a market cap, as mentioned, of $88 billion. It has total current liabilities of $110 billion and long-term liabilities of $148 billion. As for Danaher, the company has a market cap of $85 billion, current liabilities of $5 billion, and long-term liabilities of $15 billion. But it gets even better. GE's overhead includes the salaries of 313,000 workers around the world. Costly enough, but that is nothing compared to its underfunded pension plan. GE has over 600,000 past and current workers covered by a defined-benefit pension plan (as opposed to the modern-day defined contribution plan, such as the common 401(k)). While workers have been promised roughly $100 billion in payments by the company, it only has $70 billion set aside for those payments (i.e. it is underfunded to the tune of $30 billion). While the $21 billion it gets from the sale of its biotech unit will help, it will also lose the $3 billion per year in revenue currently generated by that unit. GE was up 15% on the news of this deal. Larry Culp claims to have a strategic plan for GE's turnaround, but it has yet to crystalize in any way we can see. Investors applauded the plan to pay down a bit of the company's massive debt load, but there are so many systemic issues with this company that we still consider it a sucker's bet.
Strong Friday session was enough to pull the major indexes up for the week (minus a flat Dow). After three down sessions, Monday through Wednesday, it looked like the S&P's winning streak would come to an end. Good economic numbers, a quiet Fed, and rosy expectations for a trade deal helped push the S&P and the NASDAQ positive for the week, however. While the Dow ended down, it wasn't by much: the index fell by just six points on the week, to 26,026. Oil fell 2.3%, to $55.75 per barrel, and gold dropped 2.8%, to $1,294 per ounce. It was nice to have a relatively calm, quiet week in the markets. Remember our comparison to 1987/88 going into the year? The graphs of the two periods are looking eerily similar. We'll take it.
Consumer Electronics
Fitbit is profitable again, but shares drop 14% after management's downbeat guidance. The last time—before the most recent quarter—that smartwatch device maker Fitbit (FIT $4-$6-$8) turned a quarterly profit was the third quarter of 2016. While the $1.5 billion small-cap did manage to earn $15 million on its $571 million in sales during the fourth quarter of 2018, management quickly threw cold water on that modest success by projecting a loss of $0.22 per share on revenues of $250 million to $268 million for Q1 of 2019. Trying to get investors excited for the future, CEO James Park pointed to a new subscription software service for its devices coming in the second half of the year. Yawn. FIT had a $50 share price just three and a half years ago. We're not saying the company is in a death spiral, but if management is pointing to a subscription software plan for its future success, there could be serious trouble ahead.
Specialty Retail
Gap to split into two publicly-traded companies, spinning off Old Navy. When we hear talk of the "retail wreck," iconic mall retailer Gap (GPS $24-$31-$35) almost always enters the conversation. The San Francisco-based clothier could be a case study in the decline of specialty retail. At the turn of the century, in February of 2000, Gap was a $45 billion enterprise. Today, its market cap sits just north of $10 billion. Nonetheless, investors pushed shares up 21% pre-market Friday after the company announced some financial engineering (a pejorative in our investment lexicon): it would be splitting into two publicly-traded companies, with Old Navy becoming a standalone enterprise. It amazes us that investors would reward this act, which does nothing to improve the overall health of the company, by pumping up shares this much. This reminds us of the investor who wouldn't touch a company at $100 per share, but when it had a 4-1 split, he couldn't get enough at $25 per share. As for the Gap decision, it is an implicit admission that the company's namesake brand, along with its Banana Republic, Athleta, and Intermix names, have been struggling—and will probably continue to struggle. We don't find that to be a good rationale for jettisoning their strongest brand, the chronic-discounter Old Navy. Analysts are still bullish on Gap; even more so, in fact, after this announcement. We just don't buy it, and we don't see any magical retail elixir that will allow either of the two new parts to excel going forward. They are ho-hum retailers in a hyper-competitive space.
Space Sciences & Exploration
Forget the monkey or the dog (sick communist Soviets), SpaceX will place a spacesuit-wearing dummy on its first Crew Dragon launch. This Saturday marks a huge milestone on the road to American astronauts returning to space via American ships (we still find it disgusting that this lapse in capabilities was ever allowed to happen—actually, orchestrated). SpaceX plans to make its first Crew Dragon test at 0248 local time, as the Falcon 9 rocket carrying the capsule is set to launch from Cape Canaveral Air Force Station, lighting up the pre-dawn sky. Ultimately, the Crew Dragon will shuttle astronauts to and from low Earth orbit (LEO). While no humans (or animals) will be on this first test mission, the capsule will have someone at the controls: a spacesuit-wearing anthropomorphic test dummy, or ATD. The sensor-laden dummy will measure the flight responses on the human body and various metrics of the environment. While NASA didn't request the ATD for the flight, how much cooler will it be for the crew of the International Space Station to open the hatch and find a traveler in the commander's seat? Based on his fight with the SEC, we now hope that Elon Musk keeps SpaceX private. And we are sad about that new opinion, as we were really looking forward to picking up some SPCX (just guessing) stock after the IPO.
Technology Hardware, Storage, & Peripherals
We never bought into the HP turnaround story; now the evidence is backing up our opinion. A lot of analysts have been bullish on "old tech" name HP Inc (HPQ $19-$20-$27), half of the old Hewlett-Packard that was split in two by lackluster former CEO Meg Whitman (let's split one mediocre company into two parts and see what happens). The HPQ side dealt with the hardware one thinks of with HP (printers, ink supplies, personal computers), while HPE—HP Enterprises—handles the IT services side of the business. HPQ just released their quarterly earnings report, and the numbers backed up our misgivings. Shares fell 17% after the company gave poor guidance for the printer supply business throughout 2019, specifically calling out weaker-than-expected demand in Europe, Africa, and the Middle East. Both revenues and earnings missed expectations. Ink, copiers, and ubiquitous personal computers. Why would someone want to take the helm at the company, and who still believes they have a grand turnaround strategy in the works? We often say that a great leader can create a turnaround story within virtually any industry. HPQ may challenge that notion. Stay away.
Corporate Culture
Are your customers advocates, ambivalent, or covertly unhappy? I recall watching a cocky, arrogant little Oscar Munoz, CEO of United Continental (UAL $65-$90-$98), being interviewed on a major business network right after an incident in which a man was dragged off an overbooked United flight. The story, rightfully, made national headlines. Instead of simply apologizing for his airline's terrible handling of the situation, a defiant Munoz essentially blamed the passenger. Within hours his tune had changed—no doubt after someone at the company made him aware of the blowback—but the CEO's true colors were on display in that first interview.
Fast forward. I have been a reader of the Wall Street Journal for decades. I was once an advocate for the paper. Over the past four years, however, I have gone from advocate to someone who would jump ship as a subscriber at the drop of a hat. Unfortunately, the company's product isn't fungible—there just aren't many good alternatives out there, and they know it. Perhaps that is the reason they have spiked their prices by 16%, 14%, 12%, and 5.4% over the past four years, respectively. Maybe their input costs went up? Not likely—as a digital-only customer they would not save one cent if I left (one of the incredible benefits to a company operating in a digital world). So, I will politely complain to the company (as I have for the past two years), I will get a cold fish response, and I will fume on.
But is that really how to run a business? We cannot change someone else's organization, but we can shape our own. Always be considering how products and services can be improved, and never forget who is keeping the lights on. You may offer clients a unique value proposition, but that doesn't mean you shouldn't constantly be evaluating the customer experience. Look at Lord Jeffrey's words of wisdom (quote of the day) from the 18th century. Nothing has changed in the 270 years since he penned them; they remain excellent words to live by, and to embed within your own corporate culture.
Before the likes of Amazon, companies (from bookstores to clothing retailers) had much greater pricing power. While there may be only a few "top-notch" business publications out there right now, the news industry will undoubtedly continue to be disrupted by technological advances. For arrogant management teams who treat customers like cattle, that is bad news. For the new breed of disruptors who treat their customers like gold, that is incredibly exciting.
Metals & Mining
Newmont Mining wants to buy rival Goldcorp for $10 billion. There's just one problem: Barrick wants to take out Newmont first. The deal would create the world's largest gold producer. And $19 billion Newmont Mining (NEM $29-$35-$42) was even willing to pay a nice premium for a competitor half its size, offering Goldcorp (GG $8-$11-$15) shareholders a $10 billion all-stock deal. It made a lot of sense: Goldcorp has a great growth story—operating large mines in Canada, Mexico, and South America—and it seemed amenable to a takeover. Then Barrick Gold (GOLD $10-$13-$14) felt the need to get in on the action, making a hostile bid for Newmont with an offer below fair value. It was a bizarre twist in an industry deserving of its own Netflix drama series. Barrick, for its part, actually had a smaller market cap than its prey until late last year when it bought South African gold miner Rangold for $6.5 billion. So much for digesting that kill before going on the hunt again. While Newmont has rejected the hostile bid, it's too early to know what will happen. Both miners have big operations virtually right next to each other in Nevada, so the synergies could be huge. In the end, Goldcorp shareholders might be the losers as the dance between the two bigger miners plays itself out. One reason we are following this story so closely, beyond the sheer intrigue, is our bullish call on gold this year. After five years of flat gold prices, a spike should equal a nice jump in revenues—and net income—at the top firms.
e-Commerce
Stamps.com loses half of its market value in one session. It always seemed like an odd business model to us: in a world going away from physical mail, sell (ultra-low-margin) postage stamps online. Nonetheless, Stamps.com (STMP $82-$99-$286) made it work—at least until last week. After ending its exclusive partnership with the USPS, the company’s shares went from $200 to $100 in one session. Of course, the smarmy lawyers immediately came out of their hovels to begin soliciting investors for a massive class action lawsuit. A great lesson for traders interested in only the technicals of a stock—not the fundamentals of a company. Unless you were an insider, you wouldn't have known that the company would sever its ties with the source of its primary product, but that didn't mean you couldn't evaluate the efficacy of the company's offerings. What was the unique value proposition of the products (ease)? How wide was the company's moat (pretty wide as long as the deal was in place)? What could go wrong (a lot)?
Global Debt
Nearly one-quarter of all government-issued notes around the world now have a negative yield. For the minority of economists arguing for more Fed rate hikes, the chief argument has been that the central bank needs to re-stock its ammo pile to be prepared for the next economic downturn. The higher the rates, the more the government can lower those rates to spur economic activity. Compared to the rest of the world, however, it appears that the US Treasury has the largest stockpile of ammo. It is a difficult concept to fathom, but right now nearly one-quarter of all government-issued notes around the world offer a negative yield to investors. $8 trillion worth of bonds around the world will pay investors precisely zilch in interest. That is wrong in so many ways, but here's the most pressing concern: economic activity around the world is slowing, but the central banks will watch their respective economies fall while they sit with their hands tied behind their backs. Japan and developed Europe—especially Germany—are the most at risk, in our opinion. On the sliding yield curve, you would have to go out eight years to find a German bond yielding anything above 0.0%. On a bright note, Japan's 10-year bond now offers investors a positive yield: 0.01%. Incredible. A lot of blame for the economic slowdown has been placed on Trump's trade battle with China, but global government wonks need to look in the mirror to find the real culprit—it has simply been too easy of an "out" to put new charges on the government credit card. Odds are great that we will see a US/China trade deal reached soon. However, this will not be a panacea for the global debt crisis. Responsible government behavior is the only solution, but—from Brussels to Tokyo to DC—when is the last time we saw that manifest in a real and lasting manner?
Industrial Conglomerates
If General Electric sells all of its units, it will be able to pay down (some of) its debt. It is so sad what has happened to one of America's great companies. Through rotten "leadership," beginning with Jeffrey Immelt, General Electric (GE $7-$12-$16) has become a comical shell of its former self. Here's the latest: the $88 billion company, once the largest company in the world, has agreed to sell its biotech unit to Danaher (DHR $95-$121-$121) for $21 billion to pay down some of its debt. Once a universe apart in market cap, the two companies are now approximately the same size. It should be noted that GE's current CEO, Larry Culp, was once the CEO of Danaher, which makes this deal all the more interesting. For fun, let's compare the two companies' financials. GE has a market cap, as mentioned, of $88 billion. It has total current liabilities of $110 billion and long-term liabilities of $148 billion. As for Danaher, the company has a market cap of $85 billion, current liabilities of $5 billion, and long-term liabilities of $15 billion. But it gets even better. GE's overhead includes the salaries of 313,000 workers around the world. Costly enough, but that is nothing compared to its underfunded pension plan. GE has over 600,000 past and current workers covered by a defined-benefit pension plan (as opposed to the modern-day defined contribution plan, such as the common 401(k)). While workers have been promised roughly $100 billion in payments by the company, it only has $70 billion set aside for those payments (i.e. it is underfunded to the tune of $30 billion). While the $21 billion it gets from the sale of its biotech unit will help, it will also lose the $3 billion per year in revenue currently generated by that unit. GE was up 15% on the news of this deal. Larry Culp claims to have a strategic plan for GE's turnaround, but it has yet to crystalize in any way we can see. Investors applauded the plan to pay down a bit of the company's massive debt load, but there are so many systemic issues with this company that we still consider it a sucker's bet.
Headlines for the Week of 17 Feb 2019—23 Feb 2019
Food Products
Kraft Heinz loses one-quarter of its value, and Buffett's Berkshire pays the price. The deal felt smarmy to us from the beginning. A storied American company, Kraft Heinz (KHC $35-$35-$70), being purchased by a Brazilian company thanks to the help of Berkshire Hathaway's (BRK.B) Warren Buffett. The price? $72.50 per share. At the time, Buffett said "This is my kind of deal." Now, after falling 25% in one morning, KHC sits at $35 per share, and Berkshire earnings are getting cut in half due to the meltdown of the company's largest holding. The loss of one-quarter of its (KHC's) market cap was the result of a slew of bad news being thrown at investors in the earnings release: The company would take a $15.4 billion write-down on its two biggest names, Kraft and Oscar Meyer; the KHC dividend would be slashed by 36%; both revenue and earnings came in well below expectations; oh, and the SEC is investigating the firm for its accounting policies and internal controls. A number of industry analysts cut their ratings on the company after the shockingly-bad report. Pardon us while we shed some crocodile tears for this formerly-great American company, now controlled by Buffett, Berkshire, and Brazil's 3G. It has used questionable tactics to go after rivals, it has allowed 3G to employ their typical "slash and burn" cost-cutting tactics (with employees paying the price), and it is in an industry which consumers are now shunning. Let's see what the "oracle of Omaha" has to say about this mess at the annual Berkshire sycophant-fest this May.
Global Strategy: Europe
The UK jobs market remains strong, despite growing business angst over Brexit uncertainty. In this week's upcoming issue of The Penn Wealth Report, we take a look at the five possible outcomes to the UK's exit from the European Union. Spoiler alert: it is going to be a rough-and-tumble spring and summer for the country. Despite the growing concern over the potential of a "hard" Brexit, the British jobs market is rocking. Unemployment is at its lowest level since 1975 (4%), and workers' pay grew at its highest rate in nearly a decade (3.5% annualized). Those figures fly in the face of a recent mainstream British news poll claiming that "one in three UK businesses are considering moving out of the country if there is a hard Brexit." While that poll had to be biased to the point of absurdity, it does make this week's labor numbers all the more impressive. The European Union continues to foment fear among the British people as payback for the country choosing to leave the Union. One fact cannot escape the attention of the politicians in Brussels: the UK has the second-largest economy in Europe—behind Germany's and atop France's. In the fourth spot is Italy, which is Europe's second biggest headache. Despite all of the ticking time bombs, the Union refuses to renegotiate its Brexit terms with London. This will be fun to watch—from afar.
Kraft Heinz loses one-quarter of its value, and Buffett's Berkshire pays the price. The deal felt smarmy to us from the beginning. A storied American company, Kraft Heinz (KHC $35-$35-$70), being purchased by a Brazilian company thanks to the help of Berkshire Hathaway's (BRK.B) Warren Buffett. The price? $72.50 per share. At the time, Buffett said "This is my kind of deal." Now, after falling 25% in one morning, KHC sits at $35 per share, and Berkshire earnings are getting cut in half due to the meltdown of the company's largest holding. The loss of one-quarter of its (KHC's) market cap was the result of a slew of bad news being thrown at investors in the earnings release: The company would take a $15.4 billion write-down on its two biggest names, Kraft and Oscar Meyer; the KHC dividend would be slashed by 36%; both revenue and earnings came in well below expectations; oh, and the SEC is investigating the firm for its accounting policies and internal controls. A number of industry analysts cut their ratings on the company after the shockingly-bad report. Pardon us while we shed some crocodile tears for this formerly-great American company, now controlled by Buffett, Berkshire, and Brazil's 3G. It has used questionable tactics to go after rivals, it has allowed 3G to employ their typical "slash and burn" cost-cutting tactics (with employees paying the price), and it is in an industry which consumers are now shunning. Let's see what the "oracle of Omaha" has to say about this mess at the annual Berkshire sycophant-fest this May.
Global Strategy: Europe
The UK jobs market remains strong, despite growing business angst over Brexit uncertainty. In this week's upcoming issue of The Penn Wealth Report, we take a look at the five possible outcomes to the UK's exit from the European Union. Spoiler alert: it is going to be a rough-and-tumble spring and summer for the country. Despite the growing concern over the potential of a "hard" Brexit, the British jobs market is rocking. Unemployment is at its lowest level since 1975 (4%), and workers' pay grew at its highest rate in nearly a decade (3.5% annualized). Those figures fly in the face of a recent mainstream British news poll claiming that "one in three UK businesses are considering moving out of the country if there is a hard Brexit." While that poll had to be biased to the point of absurdity, it does make this week's labor numbers all the more impressive. The European Union continues to foment fear among the British people as payback for the country choosing to leave the Union. One fact cannot escape the attention of the politicians in Brussels: the UK has the second-largest economy in Europe—behind Germany's and atop France's. In the fourth spot is Italy, which is Europe's second biggest headache. Despite all of the ticking time bombs, the Union refuses to renegotiate its Brexit terms with London. This will be fun to watch—from afar.
Headlines for the Week of 10 Feb 2019—16 Feb 2019
Global Strategy: Europe
Germany, with its hapless leader and within its chaotic Union, barely dodges a technical recession. Developed Europe is in a world of hurt, and it is hard to see what magical catalyst is going to shake them out of their economic funk. While forging full-steam-ahead with onerous new regulations on businesses (their latest is the just-passed Article 13 "meme ban"), their biggest Asian importer is hurting. Germany is a great example: China has been that country's largest importer for the past two years, taking over the mantle from the US. But China's rate of growth is clearly declining. Within Europe, Germany has always been able to count on deep-pocketed buyers in the UK. Now, however, with the ugly and contentious Brexit overhang, that trade relationship has soured measurably. How bad is it for Germany right now? After an economic contraction of 0.2% for the third quarter, the Q4 figures just came out: Germany's economy grew 0.0%. Two consecutive quarters of contraction defines a technical recession. With a three-year look-back, the situation isn't much better. There has been only one brief period in which real GDP growth in the country climbed above 1%. Yet another reason why Merkel is serving out her final term as chancellor. One of Europe's major trade challenges has revolved around the auto tariff battle with the US. While this situation hurts US automakers, it is being felt much more acutely by the German automakers. As much as the leaders in Berlin and Brussels despise dealing with Trump, it behooves them to swallow their pride and strike a deal sooner rather than later.
Aerospace & Defense
Following years of hype, a dearth of new orders is forcing Airbus to abandon its giant A380. It was the largest aircraft ever built (at least for ferrying passengers), and a huge hit with aviation enthusiasts and industry journalists. Then again, similar comments could have been made about Howard Hughes's Spruce Goose back in 1947. Much like that wooden behemoth, Airbus's (EADSY $22-$31-$32) A380 never lived up to the hype. Which is why it came as no surprise to us when the European conglomerate announced it would be ending the program by 2021. Back in 2000, when it started the program, Airbus expected at least 1,500 orders for the 555-passenger A380 "747-killer" over the coming decades, but only about 200 are currently flying. While Airbus said it considers that production level a success, it also means that it will need to continue servicing this skeleton fleet for at least the next fifteen years—a costly proposal. In the end, it wasn't the fact that so few airports could handle the 1.3 million pound giant that doomed the project, it was the advances made by Boeing (BA) with composite carbon fiber parts, and the stunning efficiency of new engines produced by GE, Pratt & Whitney, and Rolls-Royce. With fuel costs playing such a major role in an airline's profitability (or lack thereof), the increased range and fuel efficiency of smaller jets simply made the A380 obsolete. The final straw came when Emirates, one of the earliest supporters of the A380, announced it would only accept 14 more aircraft instead of the 53 it had on firm order. Despite Boeing's lower P/E ratio, its shares have far outperformed Airbus's over the past three years—the former is up 282% over that timeframe versus 118% for the latter. Airbus is an EU-sponsored public/private enterprise, filled with the bloat one would expect from a European company beholden to legislators in Brussels. There is no doubt which aircraft maker we expect to outperform going forward, which is why we hold Boeing in the Penn Global Leaders Club.
E-Commerce
After officially abandoning their HQ2 plans we must ask, what made Amazon believe they would be welcome in NYC? In our last report, we outlined the reasons why NYC was a questionable choice for Amazon's (AMZN $1,307-$1,625-$2,051) enormous HQ2 project, so no need to rehash. However, it is now official: the world's third-largest company (Microsoft and Apple just leapfrogged in front of them) has announced the deal is off. We said that this was the best course of action Amazon could take at this point, and for anyone doubting it, just consider what Amazon "supporter" and NYC Mayor Bill DeBlasio tweeted after they pulled out: "You have to be tough to make it in New York City...Amazon threw away the opportunity they were given...." Wow, with supporters like that, who needs opponents? Yes, mayor, it is tough to live in NYC, just ask the groundhog you killed while touting him a few years back. What a great analogy: you held Amazon lovingly in your arms, and then you threw them to the ground. Arrogance and socialism—what a combination. To his credit, Governor Cuomo placed the blame where it belonged—on the state senate and the individual politicians who manifested a political football out of the deal to further their own careers. The New York Times' Andrew Ross Sorkin, a lifetime New Yorker and a reasonable voice from the left, was near apoplectic. He called out the mayor for his sophomoric tweet, and said the city will pay the price for this dangerous message they sent to the business community. Opponents, however, were too busy spiking that imaginary football to hear his warning. While Amazon won't pay any long-term price for this botched deal, it does make us question management's strategic thinking. They turned a brilliant marketing opportunity into an embarrassing mea culpa. The real winners? Virginia and Tennessee, the states which welcomed the Amazon investment with open arms. Of course, Virginia currently has a mess of its own it is trying to deal with. And an interesting side-note: signed contracts on the purchase of condos and other, similar pieces of property within Long Island City spiked 180% after Amazon announced it was coming to town. Imagine how those buyers feel now.
Happiness Index
What in the world happened to the glowing reports on holiday retail sales, and which releases do we choose to believe? Just a few months ago we wrote about the strong holiday retail sales figures, as noted in a release by Mastercard SpendingPulse. On Thursday morning, Dow futures went from up nearly double-digits to down nearly double-digits after a Commerce Department report flew in the face of those rosy numbers. What gives? How can two data points be so different for the same time period? The Commerce Department's Advance Monthly Retail Trade Report shows a drop of just over 1% in consumer spending for the last month of the year, against expectations for a gain. Drilling down into the report, it gets even more depressing: outside of vehicles and building materials, every retail category dropped, with department store sales falling 3.3% year over year (YOY)—the weakest retail sales figure in nearly a decade. We could chalk it up to the rise of the online retailer, but if we dig even deeper into the Commerce Department's figures we find a 3.9% decline in sales for mail-order and e-commerce vendors. After Wall Street digested this sour breakfast, the only thing keeping the indexes from falling further was the premise that Jay Powell just lost more oxygen for his rate hike argument. We have a different takeaway, however. The press gave this report way too much airtime. Back in December (it seems so long ago), consumers were dealing with two months of a plummeting stock market, talk of a slowing global economy, and the specter of a government shutdown (you can bet that somewhere around 800,000 government workers cut back on Christmas spending leading into the actual event). Furthermore, we reject the argument that adding more to our $1 trillion outstanding credit card balance by spending with abandon is somehow good for the economy. Yes, we are chronically drilled with the cliché that the US consumer accounts for two-thirds of GDP, but padding an economy with more consumer debt is an unsustainable condition. Maybe, just maybe, the American consumer became a bit more responsible this past Christmas season. The press made too much of this report, and we probably did as well. After decades of following government releases on the state of the economy, we have been amazed at just how often they (the releases) have been quickly refuted with new data. We expect that willl be the case this time as well.
Media & Entertainment
Gaming stocks got slashed the first week of February, but one has risen from the dead. Quick, answer this question: Of the three major online gaming companies—Activision Blizzard, Electronic Arts, and Take-Two Interactive—which one owns the big dog in the space, Fortnite? Alright, it was a trick question—none of them do. As we outlined in December, the world's most popular video game was actually created by North Carolina-based Epic Games, a private entity (though China's Tencent Holdings owns a 48% stake). Fortnite's success has apparently come at the expense of the three major publicly-traded gaming companies, as Q4 earnings reports from Electronic Arts (EA) and Take-Two Interactive (TTWO) came in weak, sending chills through investors' spines and driving the entire group down. Activision Blizzard (ATVI), in fact, has plunged 51% since October, while rival Take-Two has lost one-third of its value since then. But one company in the space, Electronic Arts, has separated from the pack and is staging a comeback. The reason? The surprise success of its Apex Legends game, which just topped the 25-million-users mark. Could this game, which is in the battle royale genre, supplant Fortnite as the world's most popular online gaming experience? It's hard to say, considering the fickle gaming community, but it has already surpassed Fortnite's early attraction rate. From a review of the financials, EA also appears to be the healthiest player, with a solid operating margin, a manageable debt load, and a P/E ratio less than half that of Activision Blizzard. Gaming stocks are nearly always speculative plays, and most have widely divergent ratings issued by industry analysts. Take Activision Blizzard as an example: some analysts have a $60 target price on the shares, which would represent a 50% upside from the current $40/share price. However, the rumor mill is abuzz about the company's plans to layoff hundreds of employees on weak sales. For investors wanting to make a play in the industry, consider GAMR ($37-$42-$55), the Video Gaming Tech ETF, which holds 78 gaming and related companies.
E-Commerce
The real reason for the NYC opposition to Amazon: it is a non-union shop. Of all the pro-business cities which were vying for the coveted prize of landing Amazon's (AMZN $1,266-$1,596-$2,051) second headquarters, it struck us as quite odd that the company selected one of the most pro-union, anti-business, high-tax cities in the country: New York City (well, technically the Long Island City neighborhood of Queens). Forget the incentives, why would any business willingly go into this battleground environment unless they had to? Even some financial institutions have fled the "financial capital of the world" for greener (literally) pastures. We just felt it was a bad choice. Now, it appears that Amazon executives may be coming to the same conclusion. The company hasn't purchased any real estate in Queens yet, which may be their saving grace as the move is facing mounting opposition by local lawmakers, labor unions, and "civic action groups." What makes all of this so ironic is that the ultra-far-left mayor of New York, Bill de Blasio, as well as the far left governor of New York, Andrew Cuomo, both celebrated the decision. After all, Amazon would create roughly 25,000 new jobs—with an average salary of $150,000 per worker—in the region. Governor Cuomo voiced his anger at the opposition by stating, "You know what the incentive package was? We get $27 billion in revenue, they get $3 billion back. I would do that all day long." NYC Council Member Jimmy van Bramer pointed out the elephant in the room during a semi-heated exchange with CNBC's David Faber Monday morning. After calling the deal a "pyramid scheme" (huh?), he mentioned three times in five minutes that Amazon is a non-union shop and that the company would fight any efforts by employees in New York to organize. And there you have it. Whether the company is Walmart (WMT) or Amazon, that is simply an unacceptable stance. It reminds us of that great scene in Independence Day when the president asks the alien, "what do you want us to do?" The alien's reply? "Die." The wisest course of action for Amazon to take at this point would be to pull out of the deal, placing the onus on the NYC legislative opponents. Then, select a welcoming, business-friendly town for the new HQ2. For such a seemingly well-managed company, this was simply a strategic blunder—they should have seen it coming.
Telecommunication Services
Why is Sprint suing AT&T over what you see at the top of your smartphone? Just how big is the 5G revolution? From a speed standpoint, imagine everything you do via the internet, whether on your mobile device or laptop, transpiring at least ten times faster—and that is a conservative estimate. But 5G is so much more. It will allow the "Internet of Things," or IoT, to become a reality. Virtually everything you use, from the car you drive to your home appliances, will become "connected." It is not a stretch to say it will change the way we live. Here's the thing, though: 5G isn't available yet. The technology requires that a much higher frequency—millimeter wave bandwidth, or mmWave—be used, and the infrastructure buildout effort will be enormous. But, that hasn't stopped AT&T (T $27-$30-$38) from running a massive campaign built around their "5GE" technology, which is nothing more than a dressed-up version of their 4G LTE system. In other words, it is not, in any way, 5G technology (the "E" stands for evolution, by the way). In addition to the ad campaigns, the company has been persuading hardware companies like Apple (AAPL) to put the "5GE" label on the top of their smartphones, where users typically see something like "LTE" when they are out of wi-fi range. This is clearly a questionable tactic, to say the least, and it has the other carriers fuming. Sprint (S), in fact, has filed a lawsuit in federal court against AT&T which states, in part, that "the significance of AT&T's deception cannot be overstated." Despite holding the telecom giant in our Strategic Income Portfolio, we completely agree with the complaint. It is clearly—in our minds—deception. T will be one of the first companies to roll out 5G technology, but that doesn't give them the right to fool consumers. Investors, as well as consumers, should be incredibly excited about the rollout of 5G technology. The investment opportunities created by the IoT will be bountiful. Here's something many Apple critics probably haven't considered: everyone who wants blazing-fast speed (and isn't that all of us?) using the new technology will need a brand new smartphone equipped to handle the mmWave bandwidth, which will lead to massive demand for new iPhones. And that is something Tim Cook is certainly well aware of.
Household & Personal Products
Is e.l.f Beauty on the Fed's radar screen after North Korean eyelash incident? The sky was the limit back in October of 2016 when e.l.f. Beauty (ELF $8-$9-$22) became only the third beauty products company in a decade to go public. A lot has changed since the company's halcyon first quarter; in fact, ELF's share price is now down 70% since the end of 2016. There was a lot of excitement around the company at the time of its IPO, and we fielded questions from clients interested in taking an early position in the stock. Our recommendation? Stick with tried and true names like Ulta Beauty (ULTA) and Estee Lauder (EL). That turned out to be good advice, but what was the reason for ELF's most-recent market tumble? False eyelashes and North Korea. The Oakland-based firm just agreed to pay $1 million in fines after the US Office of Foreign Assets Control—a division of Treasury—accused them of importing 156 shipments of the false eyelash kits from China, but with materials emanating from North Korea. The cosmetics firm said an internal audit did uncover the source of the materials after the fact, a statement the OFAC confirmed, but this probably makes the $450 million company susceptible to closer scrutiny going forward. ELF had a market cap of $1.4 billion a few months after going public. How have the beauty companies performed since e.l.f. went public? The clear winner is The Estee Lauder Companies, up 75% while the competitors have been languishing. EL also has the biggest gross profit margin of the group, at 77%.
Germany, with its hapless leader and within its chaotic Union, barely dodges a technical recession. Developed Europe is in a world of hurt, and it is hard to see what magical catalyst is going to shake them out of their economic funk. While forging full-steam-ahead with onerous new regulations on businesses (their latest is the just-passed Article 13 "meme ban"), their biggest Asian importer is hurting. Germany is a great example: China has been that country's largest importer for the past two years, taking over the mantle from the US. But China's rate of growth is clearly declining. Within Europe, Germany has always been able to count on deep-pocketed buyers in the UK. Now, however, with the ugly and contentious Brexit overhang, that trade relationship has soured measurably. How bad is it for Germany right now? After an economic contraction of 0.2% for the third quarter, the Q4 figures just came out: Germany's economy grew 0.0%. Two consecutive quarters of contraction defines a technical recession. With a three-year look-back, the situation isn't much better. There has been only one brief period in which real GDP growth in the country climbed above 1%. Yet another reason why Merkel is serving out her final term as chancellor. One of Europe's major trade challenges has revolved around the auto tariff battle with the US. While this situation hurts US automakers, it is being felt much more acutely by the German automakers. As much as the leaders in Berlin and Brussels despise dealing with Trump, it behooves them to swallow their pride and strike a deal sooner rather than later.
Aerospace & Defense
Following years of hype, a dearth of new orders is forcing Airbus to abandon its giant A380. It was the largest aircraft ever built (at least for ferrying passengers), and a huge hit with aviation enthusiasts and industry journalists. Then again, similar comments could have been made about Howard Hughes's Spruce Goose back in 1947. Much like that wooden behemoth, Airbus's (EADSY $22-$31-$32) A380 never lived up to the hype. Which is why it came as no surprise to us when the European conglomerate announced it would be ending the program by 2021. Back in 2000, when it started the program, Airbus expected at least 1,500 orders for the 555-passenger A380 "747-killer" over the coming decades, but only about 200 are currently flying. While Airbus said it considers that production level a success, it also means that it will need to continue servicing this skeleton fleet for at least the next fifteen years—a costly proposal. In the end, it wasn't the fact that so few airports could handle the 1.3 million pound giant that doomed the project, it was the advances made by Boeing (BA) with composite carbon fiber parts, and the stunning efficiency of new engines produced by GE, Pratt & Whitney, and Rolls-Royce. With fuel costs playing such a major role in an airline's profitability (or lack thereof), the increased range and fuel efficiency of smaller jets simply made the A380 obsolete. The final straw came when Emirates, one of the earliest supporters of the A380, announced it would only accept 14 more aircraft instead of the 53 it had on firm order. Despite Boeing's lower P/E ratio, its shares have far outperformed Airbus's over the past three years—the former is up 282% over that timeframe versus 118% for the latter. Airbus is an EU-sponsored public/private enterprise, filled with the bloat one would expect from a European company beholden to legislators in Brussels. There is no doubt which aircraft maker we expect to outperform going forward, which is why we hold Boeing in the Penn Global Leaders Club.
E-Commerce
After officially abandoning their HQ2 plans we must ask, what made Amazon believe they would be welcome in NYC? In our last report, we outlined the reasons why NYC was a questionable choice for Amazon's (AMZN $1,307-$1,625-$2,051) enormous HQ2 project, so no need to rehash. However, it is now official: the world's third-largest company (Microsoft and Apple just leapfrogged in front of them) has announced the deal is off. We said that this was the best course of action Amazon could take at this point, and for anyone doubting it, just consider what Amazon "supporter" and NYC Mayor Bill DeBlasio tweeted after they pulled out: "You have to be tough to make it in New York City...Amazon threw away the opportunity they were given...." Wow, with supporters like that, who needs opponents? Yes, mayor, it is tough to live in NYC, just ask the groundhog you killed while touting him a few years back. What a great analogy: you held Amazon lovingly in your arms, and then you threw them to the ground. Arrogance and socialism—what a combination. To his credit, Governor Cuomo placed the blame where it belonged—on the state senate and the individual politicians who manifested a political football out of the deal to further their own careers. The New York Times' Andrew Ross Sorkin, a lifetime New Yorker and a reasonable voice from the left, was near apoplectic. He called out the mayor for his sophomoric tweet, and said the city will pay the price for this dangerous message they sent to the business community. Opponents, however, were too busy spiking that imaginary football to hear his warning. While Amazon won't pay any long-term price for this botched deal, it does make us question management's strategic thinking. They turned a brilliant marketing opportunity into an embarrassing mea culpa. The real winners? Virginia and Tennessee, the states which welcomed the Amazon investment with open arms. Of course, Virginia currently has a mess of its own it is trying to deal with. And an interesting side-note: signed contracts on the purchase of condos and other, similar pieces of property within Long Island City spiked 180% after Amazon announced it was coming to town. Imagine how those buyers feel now.
Happiness Index
What in the world happened to the glowing reports on holiday retail sales, and which releases do we choose to believe? Just a few months ago we wrote about the strong holiday retail sales figures, as noted in a release by Mastercard SpendingPulse. On Thursday morning, Dow futures went from up nearly double-digits to down nearly double-digits after a Commerce Department report flew in the face of those rosy numbers. What gives? How can two data points be so different for the same time period? The Commerce Department's Advance Monthly Retail Trade Report shows a drop of just over 1% in consumer spending for the last month of the year, against expectations for a gain. Drilling down into the report, it gets even more depressing: outside of vehicles and building materials, every retail category dropped, with department store sales falling 3.3% year over year (YOY)—the weakest retail sales figure in nearly a decade. We could chalk it up to the rise of the online retailer, but if we dig even deeper into the Commerce Department's figures we find a 3.9% decline in sales for mail-order and e-commerce vendors. After Wall Street digested this sour breakfast, the only thing keeping the indexes from falling further was the premise that Jay Powell just lost more oxygen for his rate hike argument. We have a different takeaway, however. The press gave this report way too much airtime. Back in December (it seems so long ago), consumers were dealing with two months of a plummeting stock market, talk of a slowing global economy, and the specter of a government shutdown (you can bet that somewhere around 800,000 government workers cut back on Christmas spending leading into the actual event). Furthermore, we reject the argument that adding more to our $1 trillion outstanding credit card balance by spending with abandon is somehow good for the economy. Yes, we are chronically drilled with the cliché that the US consumer accounts for two-thirds of GDP, but padding an economy with more consumer debt is an unsustainable condition. Maybe, just maybe, the American consumer became a bit more responsible this past Christmas season. The press made too much of this report, and we probably did as well. After decades of following government releases on the state of the economy, we have been amazed at just how often they (the releases) have been quickly refuted with new data. We expect that willl be the case this time as well.
Media & Entertainment
Gaming stocks got slashed the first week of February, but one has risen from the dead. Quick, answer this question: Of the three major online gaming companies—Activision Blizzard, Electronic Arts, and Take-Two Interactive—which one owns the big dog in the space, Fortnite? Alright, it was a trick question—none of them do. As we outlined in December, the world's most popular video game was actually created by North Carolina-based Epic Games, a private entity (though China's Tencent Holdings owns a 48% stake). Fortnite's success has apparently come at the expense of the three major publicly-traded gaming companies, as Q4 earnings reports from Electronic Arts (EA) and Take-Two Interactive (TTWO) came in weak, sending chills through investors' spines and driving the entire group down. Activision Blizzard (ATVI), in fact, has plunged 51% since October, while rival Take-Two has lost one-third of its value since then. But one company in the space, Electronic Arts, has separated from the pack and is staging a comeback. The reason? The surprise success of its Apex Legends game, which just topped the 25-million-users mark. Could this game, which is in the battle royale genre, supplant Fortnite as the world's most popular online gaming experience? It's hard to say, considering the fickle gaming community, but it has already surpassed Fortnite's early attraction rate. From a review of the financials, EA also appears to be the healthiest player, with a solid operating margin, a manageable debt load, and a P/E ratio less than half that of Activision Blizzard. Gaming stocks are nearly always speculative plays, and most have widely divergent ratings issued by industry analysts. Take Activision Blizzard as an example: some analysts have a $60 target price on the shares, which would represent a 50% upside from the current $40/share price. However, the rumor mill is abuzz about the company's plans to layoff hundreds of employees on weak sales. For investors wanting to make a play in the industry, consider GAMR ($37-$42-$55), the Video Gaming Tech ETF, which holds 78 gaming and related companies.
E-Commerce
The real reason for the NYC opposition to Amazon: it is a non-union shop. Of all the pro-business cities which were vying for the coveted prize of landing Amazon's (AMZN $1,266-$1,596-$2,051) second headquarters, it struck us as quite odd that the company selected one of the most pro-union, anti-business, high-tax cities in the country: New York City (well, technically the Long Island City neighborhood of Queens). Forget the incentives, why would any business willingly go into this battleground environment unless they had to? Even some financial institutions have fled the "financial capital of the world" for greener (literally) pastures. We just felt it was a bad choice. Now, it appears that Amazon executives may be coming to the same conclusion. The company hasn't purchased any real estate in Queens yet, which may be their saving grace as the move is facing mounting opposition by local lawmakers, labor unions, and "civic action groups." What makes all of this so ironic is that the ultra-far-left mayor of New York, Bill de Blasio, as well as the far left governor of New York, Andrew Cuomo, both celebrated the decision. After all, Amazon would create roughly 25,000 new jobs—with an average salary of $150,000 per worker—in the region. Governor Cuomo voiced his anger at the opposition by stating, "You know what the incentive package was? We get $27 billion in revenue, they get $3 billion back. I would do that all day long." NYC Council Member Jimmy van Bramer pointed out the elephant in the room during a semi-heated exchange with CNBC's David Faber Monday morning. After calling the deal a "pyramid scheme" (huh?), he mentioned three times in five minutes that Amazon is a non-union shop and that the company would fight any efforts by employees in New York to organize. And there you have it. Whether the company is Walmart (WMT) or Amazon, that is simply an unacceptable stance. It reminds us of that great scene in Independence Day when the president asks the alien, "what do you want us to do?" The alien's reply? "Die." The wisest course of action for Amazon to take at this point would be to pull out of the deal, placing the onus on the NYC legislative opponents. Then, select a welcoming, business-friendly town for the new HQ2. For such a seemingly well-managed company, this was simply a strategic blunder—they should have seen it coming.
Telecommunication Services
Why is Sprint suing AT&T over what you see at the top of your smartphone? Just how big is the 5G revolution? From a speed standpoint, imagine everything you do via the internet, whether on your mobile device or laptop, transpiring at least ten times faster—and that is a conservative estimate. But 5G is so much more. It will allow the "Internet of Things," or IoT, to become a reality. Virtually everything you use, from the car you drive to your home appliances, will become "connected." It is not a stretch to say it will change the way we live. Here's the thing, though: 5G isn't available yet. The technology requires that a much higher frequency—millimeter wave bandwidth, or mmWave—be used, and the infrastructure buildout effort will be enormous. But, that hasn't stopped AT&T (T $27-$30-$38) from running a massive campaign built around their "5GE" technology, which is nothing more than a dressed-up version of their 4G LTE system. In other words, it is not, in any way, 5G technology (the "E" stands for evolution, by the way). In addition to the ad campaigns, the company has been persuading hardware companies like Apple (AAPL) to put the "5GE" label on the top of their smartphones, where users typically see something like "LTE" when they are out of wi-fi range. This is clearly a questionable tactic, to say the least, and it has the other carriers fuming. Sprint (S), in fact, has filed a lawsuit in federal court against AT&T which states, in part, that "the significance of AT&T's deception cannot be overstated." Despite holding the telecom giant in our Strategic Income Portfolio, we completely agree with the complaint. It is clearly—in our minds—deception. T will be one of the first companies to roll out 5G technology, but that doesn't give them the right to fool consumers. Investors, as well as consumers, should be incredibly excited about the rollout of 5G technology. The investment opportunities created by the IoT will be bountiful. Here's something many Apple critics probably haven't considered: everyone who wants blazing-fast speed (and isn't that all of us?) using the new technology will need a brand new smartphone equipped to handle the mmWave bandwidth, which will lead to massive demand for new iPhones. And that is something Tim Cook is certainly well aware of.
Household & Personal Products
Is e.l.f Beauty on the Fed's radar screen after North Korean eyelash incident? The sky was the limit back in October of 2016 when e.l.f. Beauty (ELF $8-$9-$22) became only the third beauty products company in a decade to go public. A lot has changed since the company's halcyon first quarter; in fact, ELF's share price is now down 70% since the end of 2016. There was a lot of excitement around the company at the time of its IPO, and we fielded questions from clients interested in taking an early position in the stock. Our recommendation? Stick with tried and true names like Ulta Beauty (ULTA) and Estee Lauder (EL). That turned out to be good advice, but what was the reason for ELF's most-recent market tumble? False eyelashes and North Korea. The Oakland-based firm just agreed to pay $1 million in fines after the US Office of Foreign Assets Control—a division of Treasury—accused them of importing 156 shipments of the false eyelash kits from China, but with materials emanating from North Korea. The cosmetics firm said an internal audit did uncover the source of the materials after the fact, a statement the OFAC confirmed, but this probably makes the $450 million company susceptible to closer scrutiny going forward. ELF had a market cap of $1.4 billion a few months after going public. How have the beauty companies performed since e.l.f. went public? The clear winner is The Estee Lauder Companies, up 75% while the competitors have been languishing. EL also has the biggest gross profit margin of the group, at 77%.
Headlines for the Week of 03 Feb 2019—09 Feb 2019
Restaurants
Chipotle's (latest) secret to success: mobile ordering and a lack of new outbreaks. Chipotle Mexican Grill (CMG $248-$597-$606), the high-growth phenom which exists in a slow-growth industry, seemed unstoppable a few years back. Then the E. coli outbreaks hit, sending shares tumbling from a high of $750 in October of 2015 to a low of $274 two years later. Slowly, however, the company has been staging a comeback. The latest catalyst, which helped CMG notch a double-digit percentage gain on Thursday, was a glowing Q4 earnings report. Sales rose 10.4% Y/Y, to $1.225B, with $1.72 per share filtering down as profit. The earnings report provided the data points, but what led to the increase in sales? Two standouts: customers are embracing the chain's new mobile ordering platform (who wouldn't want to bypass those long lines?), and a lack of issues (or headlines) with respect to food safety. On the former point, the company is pushing full steam ahead, installing new pickup counters and even experimenting with drive-through pick-up windows at some locations. Admittedly, we never stopped eating at Chipotle, even in the midst of the negative headlines. However, the winding lines—often reaching the entrance—have been a turn off. The new mobile ordering system should manifest as more revenue beats in coming quarters. The biggest concern now? The 90 P/E ratio on the share price (compared to a 23 multiple for McDonald's, or a 30 for Starbucks).
Commercial Banks
BB&T to buy SunTrust, creating the sixth-largest bank in the US. BB&T Corp (BBT $41-$51-$56) is a $40 billion regional bank and a regular member of the Penn Strategic Income Portfolio. SunTrust Banks (STI $46-$65-$75) is a bit smaller ($30 billion) regional bank with operations in the same geographical area as BB&T—the Southeastern United States. In a move that makes a lot of sense, the two companies have announced plans to merge into one entity, creating the sixth-largest bank in the US. The primary driver of this deal has been the move by so many Americans to online banking. The days of walking into a bricks-and-mortar bank to transact business are rapidly going by the wayside. The synergy created by this merger should give the new entity—to be named before the deal closes—a much larger digital presence while helping the bottom line due to increased efficiencies. The all-stock deal will give BBT investors 57% of the new company, with STI shareholders controlling the remaining 43%. Regional banks have historically been a great place to dig for hidden gems—high dividend payers with clean balance sheets, under the radar of most investors. Technology (FinTech, online banking, etc.) may be changing that, however. The hurdle to get into the banking business, while still tall, is not near as difficult to clear as it once was. With online banking transforming the industry, regional players must adapt or face obscurity.
Multiline Retail
JC Penney to stop selling appliances; furniture will only be available online. It was just three years ago that JC Penney (JCP $1-$1-$5) CEO Marvin Ellison spearheaded "Project Silver," which brought back appliances to the store after a 33-year absence in the space. Now, with Ellison gone, new CEO Jill Soltau has made one of her first major strategic decisions: the store will stop selling appliances, and will only sell furniture online and in a very few, select stores. This actually makes a lot of sense, despite the argument that Sears' (SHLD) demise will have shoppers looking elsewhere in the mall for their household appliances. The segment has a very thin profit margin, and the company—whose shares are now trading at $1.33—does not have the luxury of using valuable space for low-margin items. The same goes for furniture, though they are not abandoning that business altogether. It is rather interesting to see how the background of each of JC Penney's last three CEOs impacted the decisions they made at the retailer. The bumbling Ron Johnson, who spearheaded the Apple store format when he was with the Cupertino tech giant, tried to bring the concept to JCP locations with segmented little "stores within a store." That alienated Penney's customer base quickly. Ellison, who had come from Home Depot (and who is now the Lowe's CEO) brought in appliances—akin to what is available at the home improvement stores. Jill Soltau's background is in retail fashion and fabrics, having just come from Jo-Ann Stores. She wasted no time in dumping the appliances to create more room for fashion. Hopefully, the third time (CEO) is the charm. We saw the demise of Radio Shack and Sears coming well before their respective management teams knew what hit them—they were too close to the problem to see it rationally. We don't feel that way about JCP. Its demise is certainly not set in stone, but it needs to act quickly and decisively. Once again, it will all distill down to leadership—either it will be there or it won't. And the livelihood of around 100,000 employees will be dependent upon the answer to that question.
Specialty Retail
Why did Tupperware lose one-third of its value over the course of a few days? It is an iconic American brand, the center of attention in millions of households since the 1950s during what became known as "Tupperware parties." The company even patented the seal process which caused the distinguishing "burp" of the lid. Tupperware Brands (TUP $26-$28-$53) hit a decent, mid-cap valuation of $5 billion in 2014, and shares of the company were up nearly 21% year-to-date through January 29th. And then the 30th hit. Within a few trading sessions, one-third of the company's value had been lopped off by investors deeply troubled by the latest earnings report. Revenue fell 14% Y/Y, to $505.9 million, and net income came in at a frail $17.3 million (for a 3.42% profit margin). And the specialty retailer's ridiculously-high 10% dividend yield? It was reduced by a reasonable 60%—to a yield of 3.85%. Around the globe, the decline in sales is troubling: 7% off in North America, 12% in Europe, and 16% in Asia (which includes a 45% drop in the Indian market). While the Orlando-based company said it plans on spending $100 million over the next three years on innovation and marketing, it is in such an easily-replicated business that it is hard to see how it can continue to provide a unique value proposition to customers. Then again, the same could have been said about Starbucks and the coffee shop business a generation ago. Whether TUP can pull off a stunning turnaround in a market with no moat will be dependent upon the skill emanating from the C-suite. Tupperware has such a thin margin and seemingly nebulous strategy going forward that we wouldn't touch the company's shares right now, even after hitting their lowest level in a decade. We consider it an extremely speculative play.
Interactive Media & Services
Despite a massive beat, Alphabet shares tumbled after earnings report. The figures are staggering. For the fourth quarter, Google parent Alphabet (GOOGL $978-$1,129-$1,291) reported revenue of $39.3 billion—a 22% spike from the same quarter in the previous year. But what about earnings? They came in at $12.77 per share, versus expectations for $10.86 per share. Investors rewarded these glowing numbers by chipping 3% off of the share price after hours. What bothered the fickle investment community? The operating margin contracted a bit (21% versus 29.6% in Q4 of 2017) because of the company's enormous research and development budget. In Q4, Google had $7.1 billion in capital expenditures (CapEx), with $6 billion of that going to R&D. Compare that to the $4.3 billion it spent a year earlier, and we have some spooked investors. Isn't that supposed to be a good thing? A company actually staying on the cutting edge instead of performing some type of financial engineering wizardry to make the numbers look a certain way? Google's very capable CFO, Ruth Porat, did say that CapEx spending should be more in line with previous years' spending for the remainder of 2019, but it costs a lot of money to invest in the type of industries the company sees at the core of its strategic future, like artificial intelligence and autonomous vehicles. In the meantime, advertisers overwhelmingly find Google the most effective way to attract new business, providing the company with a steady revenue stream to fund future ventures. Love 'em or hate 'em, Google remains the dominant player in digital advertising, not to mention its wide array (hence the name change to Alphabet) of other money-making units. It would be fair to consider them the sector's version of General Electric in the 1950s and '60s. With a rock solid management team, the company is undervalued at its current price.
Space Sciences & Exploration
SpaceX successfully tests an operational version of its new Raptor engine, moving the needle closer to Starship's first launch. Imagine 31 Raptor engines, each providing 200 metric tons of power, grouped together to launch into space one of the biggest rockets ever built. That vision came a step closer to reality this past Sunday, as Elon Musk's SpaceX successfully test fired one of the operational, methane-burning Raptor engines at the firm's Rocket Development and Test Facility in McGregor, Texas. Ultimately, Starship (formerly known as BFR) will launch humans into space on a journey to Mars, with three vacuum-optimized Raptors propelling the upper stage toward its destination. The first major milestone, however, should come this year as Starship proves it can deliver payloads into low Earth orbit (LEO). An interim step will come when the craft carries Japanese billionaire Yusaku Maezawa and a half-dozen others on a six-day trip around the moon and back. Space travel has been one of the most well-protected domains on Earth, as very few nations and very few companies (Boeing, Lockheed Martin) have the capital and experience to undertake such ventures. SpaceX has shifted that paradigm, opening the door for other private companies to join the race, and literally ushering in a new era of space travel. Investment opportunities within this industry will be abundant.
Chipotle's (latest) secret to success: mobile ordering and a lack of new outbreaks. Chipotle Mexican Grill (CMG $248-$597-$606), the high-growth phenom which exists in a slow-growth industry, seemed unstoppable a few years back. Then the E. coli outbreaks hit, sending shares tumbling from a high of $750 in October of 2015 to a low of $274 two years later. Slowly, however, the company has been staging a comeback. The latest catalyst, which helped CMG notch a double-digit percentage gain on Thursday, was a glowing Q4 earnings report. Sales rose 10.4% Y/Y, to $1.225B, with $1.72 per share filtering down as profit. The earnings report provided the data points, but what led to the increase in sales? Two standouts: customers are embracing the chain's new mobile ordering platform (who wouldn't want to bypass those long lines?), and a lack of issues (or headlines) with respect to food safety. On the former point, the company is pushing full steam ahead, installing new pickup counters and even experimenting with drive-through pick-up windows at some locations. Admittedly, we never stopped eating at Chipotle, even in the midst of the negative headlines. However, the winding lines—often reaching the entrance—have been a turn off. The new mobile ordering system should manifest as more revenue beats in coming quarters. The biggest concern now? The 90 P/E ratio on the share price (compared to a 23 multiple for McDonald's, or a 30 for Starbucks).
Commercial Banks
BB&T to buy SunTrust, creating the sixth-largest bank in the US. BB&T Corp (BBT $41-$51-$56) is a $40 billion regional bank and a regular member of the Penn Strategic Income Portfolio. SunTrust Banks (STI $46-$65-$75) is a bit smaller ($30 billion) regional bank with operations in the same geographical area as BB&T—the Southeastern United States. In a move that makes a lot of sense, the two companies have announced plans to merge into one entity, creating the sixth-largest bank in the US. The primary driver of this deal has been the move by so many Americans to online banking. The days of walking into a bricks-and-mortar bank to transact business are rapidly going by the wayside. The synergy created by this merger should give the new entity—to be named before the deal closes—a much larger digital presence while helping the bottom line due to increased efficiencies. The all-stock deal will give BBT investors 57% of the new company, with STI shareholders controlling the remaining 43%. Regional banks have historically been a great place to dig for hidden gems—high dividend payers with clean balance sheets, under the radar of most investors. Technology (FinTech, online banking, etc.) may be changing that, however. The hurdle to get into the banking business, while still tall, is not near as difficult to clear as it once was. With online banking transforming the industry, regional players must adapt or face obscurity.
Multiline Retail
JC Penney to stop selling appliances; furniture will only be available online. It was just three years ago that JC Penney (JCP $1-$1-$5) CEO Marvin Ellison spearheaded "Project Silver," which brought back appliances to the store after a 33-year absence in the space. Now, with Ellison gone, new CEO Jill Soltau has made one of her first major strategic decisions: the store will stop selling appliances, and will only sell furniture online and in a very few, select stores. This actually makes a lot of sense, despite the argument that Sears' (SHLD) demise will have shoppers looking elsewhere in the mall for their household appliances. The segment has a very thin profit margin, and the company—whose shares are now trading at $1.33—does not have the luxury of using valuable space for low-margin items. The same goes for furniture, though they are not abandoning that business altogether. It is rather interesting to see how the background of each of JC Penney's last three CEOs impacted the decisions they made at the retailer. The bumbling Ron Johnson, who spearheaded the Apple store format when he was with the Cupertino tech giant, tried to bring the concept to JCP locations with segmented little "stores within a store." That alienated Penney's customer base quickly. Ellison, who had come from Home Depot (and who is now the Lowe's CEO) brought in appliances—akin to what is available at the home improvement stores. Jill Soltau's background is in retail fashion and fabrics, having just come from Jo-Ann Stores. She wasted no time in dumping the appliances to create more room for fashion. Hopefully, the third time (CEO) is the charm. We saw the demise of Radio Shack and Sears coming well before their respective management teams knew what hit them—they were too close to the problem to see it rationally. We don't feel that way about JCP. Its demise is certainly not set in stone, but it needs to act quickly and decisively. Once again, it will all distill down to leadership—either it will be there or it won't. And the livelihood of around 100,000 employees will be dependent upon the answer to that question.
Specialty Retail
Why did Tupperware lose one-third of its value over the course of a few days? It is an iconic American brand, the center of attention in millions of households since the 1950s during what became known as "Tupperware parties." The company even patented the seal process which caused the distinguishing "burp" of the lid. Tupperware Brands (TUP $26-$28-$53) hit a decent, mid-cap valuation of $5 billion in 2014, and shares of the company were up nearly 21% year-to-date through January 29th. And then the 30th hit. Within a few trading sessions, one-third of the company's value had been lopped off by investors deeply troubled by the latest earnings report. Revenue fell 14% Y/Y, to $505.9 million, and net income came in at a frail $17.3 million (for a 3.42% profit margin). And the specialty retailer's ridiculously-high 10% dividend yield? It was reduced by a reasonable 60%—to a yield of 3.85%. Around the globe, the decline in sales is troubling: 7% off in North America, 12% in Europe, and 16% in Asia (which includes a 45% drop in the Indian market). While the Orlando-based company said it plans on spending $100 million over the next three years on innovation and marketing, it is in such an easily-replicated business that it is hard to see how it can continue to provide a unique value proposition to customers. Then again, the same could have been said about Starbucks and the coffee shop business a generation ago. Whether TUP can pull off a stunning turnaround in a market with no moat will be dependent upon the skill emanating from the C-suite. Tupperware has such a thin margin and seemingly nebulous strategy going forward that we wouldn't touch the company's shares right now, even after hitting their lowest level in a decade. We consider it an extremely speculative play.
Interactive Media & Services
Despite a massive beat, Alphabet shares tumbled after earnings report. The figures are staggering. For the fourth quarter, Google parent Alphabet (GOOGL $978-$1,129-$1,291) reported revenue of $39.3 billion—a 22% spike from the same quarter in the previous year. But what about earnings? They came in at $12.77 per share, versus expectations for $10.86 per share. Investors rewarded these glowing numbers by chipping 3% off of the share price after hours. What bothered the fickle investment community? The operating margin contracted a bit (21% versus 29.6% in Q4 of 2017) because of the company's enormous research and development budget. In Q4, Google had $7.1 billion in capital expenditures (CapEx), with $6 billion of that going to R&D. Compare that to the $4.3 billion it spent a year earlier, and we have some spooked investors. Isn't that supposed to be a good thing? A company actually staying on the cutting edge instead of performing some type of financial engineering wizardry to make the numbers look a certain way? Google's very capable CFO, Ruth Porat, did say that CapEx spending should be more in line with previous years' spending for the remainder of 2019, but it costs a lot of money to invest in the type of industries the company sees at the core of its strategic future, like artificial intelligence and autonomous vehicles. In the meantime, advertisers overwhelmingly find Google the most effective way to attract new business, providing the company with a steady revenue stream to fund future ventures. Love 'em or hate 'em, Google remains the dominant player in digital advertising, not to mention its wide array (hence the name change to Alphabet) of other money-making units. It would be fair to consider them the sector's version of General Electric in the 1950s and '60s. With a rock solid management team, the company is undervalued at its current price.
Space Sciences & Exploration
SpaceX successfully tests an operational version of its new Raptor engine, moving the needle closer to Starship's first launch. Imagine 31 Raptor engines, each providing 200 metric tons of power, grouped together to launch into space one of the biggest rockets ever built. That vision came a step closer to reality this past Sunday, as Elon Musk's SpaceX successfully test fired one of the operational, methane-burning Raptor engines at the firm's Rocket Development and Test Facility in McGregor, Texas. Ultimately, Starship (formerly known as BFR) will launch humans into space on a journey to Mars, with three vacuum-optimized Raptors propelling the upper stage toward its destination. The first major milestone, however, should come this year as Starship proves it can deliver payloads into low Earth orbit (LEO). An interim step will come when the craft carries Japanese billionaire Yusaku Maezawa and a half-dozen others on a six-day trip around the moon and back. Space travel has been one of the most well-protected domains on Earth, as very few nations and very few companies (Boeing, Lockheed Martin) have the capital and experience to undertake such ventures. SpaceX has shifted that paradigm, opening the door for other private companies to join the race, and literally ushering in a new era of space travel. Investment opportunities within this industry will be abundant.
Headlines for the Week of 27 Jan 2019—02 Feb 2019
Work & Pay
Hiring surge! Job growth in the US nearly double the expectations for January. It truly is amazing this occurred. In the midst of the longest government shutdown in US history (and hopefully the last), the United States added an enormous 304,000 new jobs to the economy. One very interesting note on the $4 trillion balance sheet, that the Fed had been reducing at a clip of $500 billion per month: it now appears as if it may get down to $3.5 trillion and the QT (quantitative tightening) will actually stop. That is an enormous shift in policy from the central bank. As for rate hikes, we stick by our one (max) for the year; probably coming in June or even later.
Monetary Policy
Unlike Powell's disastrous Q4 remarks, Wall Street cheered his new attitude. Every news conference, every Q&A session, every guest appearance Fed Chief Jerome Powell performed at in the fourth quarter was a disaster. He was, in good measure, the reason we had such an ugly quarter. Somebody or something got to him, as he gave the performance of a lifetime on Wednesday. We didn't need Nielsen for the feedback, we had the markets: by the end of the day the Dow was up 435, the S&P was up 41, and the NASDAQ spiked 155. Powell used the terms "patient" or "patience" at least eight times that we counted. It was brilliant. Instead of the reduction of the $4 trillion Fed balance sheet being on "auto pilot" (Powell-speak in 2018), it was "we will wait and see." We couldn't have written a better performance. One very interesting note on the $4 trillion balance sheet, that the Fed had been reducing at a clip of $500 billion per month: it now appears as if it may get down to $3.5 trillion and the QT (quantitative tightening) will actually stop. That is an enormous shift in policy from the central bank. As for rate hikes, we stick by our one (max) for the year; probably coming in June or even later.
Consumer Electronics
Don't tell the neighborhood kid, but iRobot wants to cut your lawn. Not since Beaver Cleaver wheeled away his reel mower for the last time has there been such an exciting transformation to the age-old American tradition of mowing the family lawn. What seems like a tolerable—if not enjoyable—task in May quickly turns into downright drudgery by Independence Day. Now, from the company that brought you the Roomba® robotic vacuum, comes the Terra™ robotic lawn mower. Consumer electronics company iRobot (IRBT $56-$89-$119) is already rolling out the cute little device in Germany, and plans on introducing it to the American market this year. While the price will be hefty (at least for early adopters), iRobot has pinpointed this corner of the market as a potential $5 billion annual opportunity, and it has already been in contact with the FCC with respect to its wireless beacon system used by the Terra. For anyone who loves technology (or grew up watching The Jetsons with rapt attention—like we did), this is simply an exciting company. And, unlike so many other $2.5 billion s(m)id caps, it is actually turning a profit! In fact, the company's P/E ratio is a rather slender 38. We should have trusted our instinct when it was selling at $60 per share last summer. Nonetheless, with its $2.5 billion market cap and its current and planned product lineup, it still looks cheap.
Aerospace & Defense
Boeing knocks it out of the park in Q4, shares spike in response. It would have been hard to script a better fourth quarter earnings report for Penn member Boeing (BA $292-$391-$394), which explains the aerospace giant's 7% spike in share price—bringing shares very close to a new 52-week high. For the first time in its history, Boeing recorded $100 million in annual sales, and the company delivered a record 806 aircraft for the full year. But it gets better: management confidently projected adding 100 aircraft to that figure over the course of 2019, and now expects to earn around $20 per share when the dust settles on the year. That is simply enormous. CEO Dennis Muilenburg cited the company's strategic initiative, "One Boeing," as the catalyst for the exemplary quarter. That initiative was designed to streamline the company's disparate units in an effort to create a more cohesive organization. Boeing is the company China dreams of emulating and replicating, but those dreams won't manifest for generations, if ever. Airbus (EADSY) sees itself on par with Boeing (arrogant Europeans), but that state-sponsored enterprise remains plagued with problems and is weighted down by a bloated and byzantine management structure. Boeing remains our "go-to" aerospace investment, but other American firms like Raytheon (RTN), Lockheed-Martin (LMT), Northrop Grumman (NOC), and General Dynamics (GD), also make the grade. Of course, an investor could simply buy a basket of these great aerospace firms by picking up ITA, the iShares US Aerospace & Defense ETF (which is one of the holdings within the Penn Dynamic Growth Strategy).
Technology, Hardware, & Peripherals
Apple jumps 6% after a "not disastrous" quarter. After a good six months of near-constant bashing by analysts, the bar wasn't set very high for Apple (AAPL $142-$162-$233) heading into its Q4 earnings report. Nonetheless, the Street was bracing for the worst. Fears were allayed when the numbers and guidance came out, however, and the stock jumped 6% by the start of Wednesday's session. This was the first quarter manifesting the "no more unit sales numbers" announcement that rattled investors late last year, which meant the company's pay-for-services business was clearly in focus—and those numbers were strong. On $84.3 billion in sales over the quarter (down 4.5% Y/Y), Apple earned $4.18 in earnings per share. While revenue from iPhone sales fell 15% Y/Y, sales in the lucrative and growing services category (think Apple Music, iCloud storage, etc.) rose 19%. Of the $84.3 billion of total revenue, in fact, services broke above the $10 billion mark for the first time ever. Services are great; they provide a reliable stream of constant revenue with higher gross profit margins than the products side (63% versus 34% for products), but the services revenue will not continue to grow without the products which are at the core of Apple's ecosystem. For the first time, we are truly beginning to question the leadership (as opposed to management) abilities of Tim Cook. If he doesn't have some revolutionary—or at least highly evolutionary—products up his sleeve, the company could begin to stagnate. It is safe to say that he is not a Steve Jobs, an Elon Musk, or a Jack Welch, but he had better pull a rabbit out of his hat at one of the upcoming Apple events.
Global Strategy: Europe
May needs to bring a skilled negotiator with a spine of steel to renewed Brexit talks. Within the next couple of day, British PM Theresa May and new Brexit Secretary Stephen Barclay will head to Brussels in an attempt to renegotiate the deal for the UK's exit from the EU bloc. It is not an enviable task for the most skilled negotiator, let alone this less-than-dynamic duo. At the heart of the matter is the Irish backstop, an unacceptable provision that would almost guarantee Northern Ireland will stay in the EU's orbit despite being an "exiting" member along with England. This return visit was forced on May after the House of Commons (rightfully) handed her a historic defeat on the original plan—due primarily to this provision. Here's the problem: the EU feels as though it has nothing to lose. Add that stacked deck to their notoriously arrogant attitude and May's lack of negotiating skills, and we are presented with a trifecta of bad omens leading into the talks. It is hard to see how this turns out positively for Great Britain. In the next issue of The Penn Wealth Report, we take a deeper dive into the Irish backstop nightmare, which can trace its roots back to the Irish War of Independence, fought precisely a century ago.
Electronics Equipment & Components
Penn member Corning spikes on a fantastic earnings report. Not all Apple (AAPL) suppliers are on the skids. Granted, high-tech glassmaker Corning (GLW $26-$34-$37) does a lot more than make screens for iPhones, which probably helps explain the blowout quarter it just notched. After downbeat reports from the likes of Nvidia (NVDA), Corning's report was a breath of fresh air. Sales came in at $3.04 billion, up 15% Y/Y, and $292 million of that amount (9.6%) flowed down as net income. A lot better than the same quarter last year, in which Corning took a $1.412 billion net loss. What led to the great numbers? The company took advantage of telecom companies ramping up their 5G effort, which led to a 26% increase in Corning's optical communications division. The biggest drag on the report was its specialty materials unit, which makes Gorilla Glass for...yep...iPhone covers. Corning was up over 11% on the earnings release. It's not enough for us to look at the technicals of a company which seems to have a steadily rising chart. We must also delve into what makes that company tick: the unique value proposition, the goods, the services, who its major customers are, and the like. Consider some of the high-flying chipmakers who relied on Apple (or Huawei, for that matter) for the lion's share of their sales. Two years ago, their technicals may have looked fantastic. Now, many are sitting down 80-90% from their highs. Fundamentals matter! Know what you are investing in and why.
Industrials: Machinery
Caterpillar drags the market down to start the week off with a whimper. Before Nvidia's disconcerting comments about China, we had Caterpillar's (CAT $112-$125-$169) less-than-comforting earnings report. Echoing what the chipmaker said, Cat posted a decline in sales to the Asian region thanks to—you guessed it—cooling Chinese demand. As for the numbers: Cat did ring up sales of $14.34 billion over the course of the quarter, up 11% Y/Y, but earnings per share came in at $2.55 versus the $2.99 expected. As seems to be a recent theme, the company also tamped down expectations for the full year, offering guidance which would equate to four more quarters like the one just reported on. Cat dropped over 9% on the day, and now sits just about $12 above its 52-week low. If the global economy is, indeed, slowing down, big machinery companies like Cat will be some of the hardest hit. We still like the industrials sector, but we are avoiding this sub-industry.
Semiconductors/Equipment
Nvidia's plunge points to chronic economic problems in China. The world was living under the fantasy assumption—foisted upon us by the media—that China's economic growth had no end. Investors are now beginning to understand just what a fallacy that argument was, and they are not taking it well. The latest evidence comes from chipmaker Nvidia (NVDA $124-$134-$293), which plunged 17% on Monday morning after warning investors to expect a huge revenue miss—from $2.7 billion guidance to $2.2 billion likely—over the course of this past quarter. Management cited deteriorating economic conditions in China, and a weakening global economy. CEO Jensen Huang called the quarter "extraordinary, unusually turbulent, and disappointing." Nvidia is a leading designer of graphics chips that enhance the experience on computing platforms (think high-end gaming systems). We believe the fair value of NVDA is somewhere below the current price of the stock, despite the enormous pullback to near a 52-week low. We still prefer the companies which make the equipment for the chipmakers, as they reduce concentration risk.
Hiring surge! Job growth in the US nearly double the expectations for January. It truly is amazing this occurred. In the midst of the longest government shutdown in US history (and hopefully the last), the United States added an enormous 304,000 new jobs to the economy. One very interesting note on the $4 trillion balance sheet, that the Fed had been reducing at a clip of $500 billion per month: it now appears as if it may get down to $3.5 trillion and the QT (quantitative tightening) will actually stop. That is an enormous shift in policy from the central bank. As for rate hikes, we stick by our one (max) for the year; probably coming in June or even later.
Monetary Policy
Unlike Powell's disastrous Q4 remarks, Wall Street cheered his new attitude. Every news conference, every Q&A session, every guest appearance Fed Chief Jerome Powell performed at in the fourth quarter was a disaster. He was, in good measure, the reason we had such an ugly quarter. Somebody or something got to him, as he gave the performance of a lifetime on Wednesday. We didn't need Nielsen for the feedback, we had the markets: by the end of the day the Dow was up 435, the S&P was up 41, and the NASDAQ spiked 155. Powell used the terms "patient" or "patience" at least eight times that we counted. It was brilliant. Instead of the reduction of the $4 trillion Fed balance sheet being on "auto pilot" (Powell-speak in 2018), it was "we will wait and see." We couldn't have written a better performance. One very interesting note on the $4 trillion balance sheet, that the Fed had been reducing at a clip of $500 billion per month: it now appears as if it may get down to $3.5 trillion and the QT (quantitative tightening) will actually stop. That is an enormous shift in policy from the central bank. As for rate hikes, we stick by our one (max) for the year; probably coming in June or even later.
Consumer Electronics
Don't tell the neighborhood kid, but iRobot wants to cut your lawn. Not since Beaver Cleaver wheeled away his reel mower for the last time has there been such an exciting transformation to the age-old American tradition of mowing the family lawn. What seems like a tolerable—if not enjoyable—task in May quickly turns into downright drudgery by Independence Day. Now, from the company that brought you the Roomba® robotic vacuum, comes the Terra™ robotic lawn mower. Consumer electronics company iRobot (IRBT $56-$89-$119) is already rolling out the cute little device in Germany, and plans on introducing it to the American market this year. While the price will be hefty (at least for early adopters), iRobot has pinpointed this corner of the market as a potential $5 billion annual opportunity, and it has already been in contact with the FCC with respect to its wireless beacon system used by the Terra. For anyone who loves technology (or grew up watching The Jetsons with rapt attention—like we did), this is simply an exciting company. And, unlike so many other $2.5 billion s(m)id caps, it is actually turning a profit! In fact, the company's P/E ratio is a rather slender 38. We should have trusted our instinct when it was selling at $60 per share last summer. Nonetheless, with its $2.5 billion market cap and its current and planned product lineup, it still looks cheap.
Aerospace & Defense
Boeing knocks it out of the park in Q4, shares spike in response. It would have been hard to script a better fourth quarter earnings report for Penn member Boeing (BA $292-$391-$394), which explains the aerospace giant's 7% spike in share price—bringing shares very close to a new 52-week high. For the first time in its history, Boeing recorded $100 million in annual sales, and the company delivered a record 806 aircraft for the full year. But it gets better: management confidently projected adding 100 aircraft to that figure over the course of 2019, and now expects to earn around $20 per share when the dust settles on the year. That is simply enormous. CEO Dennis Muilenburg cited the company's strategic initiative, "One Boeing," as the catalyst for the exemplary quarter. That initiative was designed to streamline the company's disparate units in an effort to create a more cohesive organization. Boeing is the company China dreams of emulating and replicating, but those dreams won't manifest for generations, if ever. Airbus (EADSY) sees itself on par with Boeing (arrogant Europeans), but that state-sponsored enterprise remains plagued with problems and is weighted down by a bloated and byzantine management structure. Boeing remains our "go-to" aerospace investment, but other American firms like Raytheon (RTN), Lockheed-Martin (LMT), Northrop Grumman (NOC), and General Dynamics (GD), also make the grade. Of course, an investor could simply buy a basket of these great aerospace firms by picking up ITA, the iShares US Aerospace & Defense ETF (which is one of the holdings within the Penn Dynamic Growth Strategy).
Technology, Hardware, & Peripherals
Apple jumps 6% after a "not disastrous" quarter. After a good six months of near-constant bashing by analysts, the bar wasn't set very high for Apple (AAPL $142-$162-$233) heading into its Q4 earnings report. Nonetheless, the Street was bracing for the worst. Fears were allayed when the numbers and guidance came out, however, and the stock jumped 6% by the start of Wednesday's session. This was the first quarter manifesting the "no more unit sales numbers" announcement that rattled investors late last year, which meant the company's pay-for-services business was clearly in focus—and those numbers were strong. On $84.3 billion in sales over the quarter (down 4.5% Y/Y), Apple earned $4.18 in earnings per share. While revenue from iPhone sales fell 15% Y/Y, sales in the lucrative and growing services category (think Apple Music, iCloud storage, etc.) rose 19%. Of the $84.3 billion of total revenue, in fact, services broke above the $10 billion mark for the first time ever. Services are great; they provide a reliable stream of constant revenue with higher gross profit margins than the products side (63% versus 34% for products), but the services revenue will not continue to grow without the products which are at the core of Apple's ecosystem. For the first time, we are truly beginning to question the leadership (as opposed to management) abilities of Tim Cook. If he doesn't have some revolutionary—or at least highly evolutionary—products up his sleeve, the company could begin to stagnate. It is safe to say that he is not a Steve Jobs, an Elon Musk, or a Jack Welch, but he had better pull a rabbit out of his hat at one of the upcoming Apple events.
Global Strategy: Europe
May needs to bring a skilled negotiator with a spine of steel to renewed Brexit talks. Within the next couple of day, British PM Theresa May and new Brexit Secretary Stephen Barclay will head to Brussels in an attempt to renegotiate the deal for the UK's exit from the EU bloc. It is not an enviable task for the most skilled negotiator, let alone this less-than-dynamic duo. At the heart of the matter is the Irish backstop, an unacceptable provision that would almost guarantee Northern Ireland will stay in the EU's orbit despite being an "exiting" member along with England. This return visit was forced on May after the House of Commons (rightfully) handed her a historic defeat on the original plan—due primarily to this provision. Here's the problem: the EU feels as though it has nothing to lose. Add that stacked deck to their notoriously arrogant attitude and May's lack of negotiating skills, and we are presented with a trifecta of bad omens leading into the talks. It is hard to see how this turns out positively for Great Britain. In the next issue of The Penn Wealth Report, we take a deeper dive into the Irish backstop nightmare, which can trace its roots back to the Irish War of Independence, fought precisely a century ago.
Electronics Equipment & Components
Penn member Corning spikes on a fantastic earnings report. Not all Apple (AAPL) suppliers are on the skids. Granted, high-tech glassmaker Corning (GLW $26-$34-$37) does a lot more than make screens for iPhones, which probably helps explain the blowout quarter it just notched. After downbeat reports from the likes of Nvidia (NVDA), Corning's report was a breath of fresh air. Sales came in at $3.04 billion, up 15% Y/Y, and $292 million of that amount (9.6%) flowed down as net income. A lot better than the same quarter last year, in which Corning took a $1.412 billion net loss. What led to the great numbers? The company took advantage of telecom companies ramping up their 5G effort, which led to a 26% increase in Corning's optical communications division. The biggest drag on the report was its specialty materials unit, which makes Gorilla Glass for...yep...iPhone covers. Corning was up over 11% on the earnings release. It's not enough for us to look at the technicals of a company which seems to have a steadily rising chart. We must also delve into what makes that company tick: the unique value proposition, the goods, the services, who its major customers are, and the like. Consider some of the high-flying chipmakers who relied on Apple (or Huawei, for that matter) for the lion's share of their sales. Two years ago, their technicals may have looked fantastic. Now, many are sitting down 80-90% from their highs. Fundamentals matter! Know what you are investing in and why.
Industrials: Machinery
Caterpillar drags the market down to start the week off with a whimper. Before Nvidia's disconcerting comments about China, we had Caterpillar's (CAT $112-$125-$169) less-than-comforting earnings report. Echoing what the chipmaker said, Cat posted a decline in sales to the Asian region thanks to—you guessed it—cooling Chinese demand. As for the numbers: Cat did ring up sales of $14.34 billion over the course of the quarter, up 11% Y/Y, but earnings per share came in at $2.55 versus the $2.99 expected. As seems to be a recent theme, the company also tamped down expectations for the full year, offering guidance which would equate to four more quarters like the one just reported on. Cat dropped over 9% on the day, and now sits just about $12 above its 52-week low. If the global economy is, indeed, slowing down, big machinery companies like Cat will be some of the hardest hit. We still like the industrials sector, but we are avoiding this sub-industry.
Semiconductors/Equipment
Nvidia's plunge points to chronic economic problems in China. The world was living under the fantasy assumption—foisted upon us by the media—that China's economic growth had no end. Investors are now beginning to understand just what a fallacy that argument was, and they are not taking it well. The latest evidence comes from chipmaker Nvidia (NVDA $124-$134-$293), which plunged 17% on Monday morning after warning investors to expect a huge revenue miss—from $2.7 billion guidance to $2.2 billion likely—over the course of this past quarter. Management cited deteriorating economic conditions in China, and a weakening global economy. CEO Jensen Huang called the quarter "extraordinary, unusually turbulent, and disappointing." Nvidia is a leading designer of graphics chips that enhance the experience on computing platforms (think high-end gaming systems). We believe the fair value of NVDA is somewhere below the current price of the stock, despite the enormous pullback to near a 52-week low. We still prefer the companies which make the equipment for the chipmakers, as they reduce concentration risk.
Headlines for the Week of 20 Jan 2019—26 Jan 2019
Hotels, Resorts, & Cruise Lines
In what should be a momentous occasion, a lot of steam has been taken out of Boeing's delivery of the first KC-46 Tanker to the US Air Force. Going into December of last year, $7.5 billion resorts and casinos conglomerate Vail Resorts Inc (MTN $180-$187-$303) had exemplary performance—up 31% on the year, in fact. Then, like an experienced skier flying down a black slope, it plummeted. By the end of 2018, the company's shares were actually down 1%, and the slide has carried forward into January. So, what happened to the owner of such pristine ski areas as Vail, Breckenridge, Keystone, Beaver Creek, and Park City? At first glance, the season-to-date numbers look pretty good: lift ticket revenue up 12%, ski school revenue up 10%, dining revenue up 15%, and number of skiers up 17%. It all boils down to the rate of growth investors built into the company's price, however. The 26 P/E ratio certainly doesn't seem out of line for a company in the resorts and casinos business, but management's revised guidance for earnings "slightly below the low end" of expectations caught investors off guard. Other than that, the excuses for the large, two-month drop seem pretty flimsy. Despite being a "seasonal" player, Vail has built an annuitized revenue stream with its Epic Pass membership program, which allows for unlimited, unrestricted skiing at the company's resorts (and a fat "off-season" income stream for Vail). Another concern of investors has been the emergence of Alterra Mountain Company and its Ikon Pass. We believe that threat is highly exaggerated, and find MTN undervalued as it sits near its 52-week low. We don't think a $300 share price would be out of line for this well-run company.
Hotels, Resorts, & Cruise Lines
Why has Vail Resorts lost a third of its value in under two months? Going into December of last year, $7.5 billion resorts and casinos conglomerate Vail Resorts Inc (MTN $180-$187-$303) had exemplary performance—up 31% on the year, in fact. Then, like an experienced skier flying down a black slope, it plummeted. By the end of 2018, the company's shares were actually down 1%, and the slide has carried forward into January. So, what happened to the owner of such pristine ski areas as Vail, Breckenridge, Keystone, Beaver Creek, and Park City? At first glance, the season-to-date numbers look pretty good: lift ticket revenue up 12%, ski school revenue up 10%, dining revenue up 15%, and number of skiers up 17%. It all boils down to the rate of growth investors built into the company's price, however. The 26 P/E ratio certainly doesn't seem out of line for a company in the resorts and casinos business, but management's revised guidance for earnings "slightly below the low end" of expectations caught investors off guard. Other than that, the excuses for the large, two-month drop seem pretty flimsy. Despite being a "seasonal" player, Vail has built an annuitized revenue stream with its Epic Pass membership program, which allows for unlimited, unrestricted skiing at the company's resorts (and a fat "off-season" income stream for Vail). Another concern of investors has been the emergence of Alterra Mountain Company and its Ikon Pass. We believe that threat is highly exaggerated, and find MTN undervalued as it sits near its 52-week low. We don't think a $300 share price would be out of line for this well-run company.
Textiles, Apparel, & Luxury Goods
For investors bummed that they missed the Canada Goose train, a potential window has opened. Almost two years ago, we reported on the IPO of trendy Canadian outerwear-maker Canada Goose ($28-$46-$72). The stock began trading around $16 per share in March of 2017. By mid-November of last year, the company's shares were topping out above $70. Pretty remarkable, considering what happened to the overall market in Q4. For anyone kicking themselves for not getting in before the meteoric rise, there is a bit of respite: GOOS fell over 7% on Thursday after a Wells Fargo analyst downgraded the stock by one notch, to market perform. Wells cited valuation (the company has a 65 P/E—not outrageous for a company like this), and the fact that the company is "not as popular on Google Trends" as it once was. The firm lowered its target price for the stock from $80 to $68, which would still represent nearly a 50% jump from here. We love the company's products, but they are definitely for the luxury goods buyer, with jackets going for $1,000 on average or higher. In the space, we prefer a Lululemon (LULU) or an Ulta Beauty (ULTA)—more enticing stories and better multiples.
Global Strategy: Latin America
The US officially recognizes opposition leader as interim president of Venezuela. How long have we been saying that the starving Venezuelan people will eventually rise up and remove, one way or another, communist thug Nicolás Maduro from power? It truly is amazing that it has been allowed to go on this long. When a thug dictator remains in power while his people starve, it is almost always due to the military tamping down any opposition. Right now, in Venezuela, high-ranking military officers earn about $50 to $85 per month in pay; common ground-pounders earn around $8 per month. The individuals who are allowing Maduro to remain in power are watching their own families starve. The US just ratcheted up pressure against the murderous regime, officially recognizing 35-year-old Juan Guaidò, the opposition leader, as the country's interim president. Many other countries are following the US lead. In response, Maduro has broken off relations with the US (stupid move, as we buy half of the country's dwindling oil supply) and has ordered all American diplomats out of the country within 72 hours. Our dear friends, the Russians and Chinese, are still backing Maduro. As for Guaidò, he has courageously taken an oath of office in front of tens of thousands of cheering onlookers. If he survives, and when the military finally turns on Maduro, this brave patriot will usher in a new age for the Venezuelan people, and the region will become vastly more stable. The end of the cartoonish Chavez clone is near. Every civilized nation in the world recognizes his reelection to a second, six-year term as a sham. Inflation is so high that the bolivar is as worthless as Deutsche marks were in 1923 (one dollar would buy around one trillion notes). The end of Maduro is at hand, but it is interesting to note who, in addition to Putin and Xi, supports Maduro's murderous regime: Mexico's new leftist leader Obrador, Turkish President Erdogan, Cuba's president, and Bolivia's far-left Evo Morales. One would hope that the United States will remember this list long after Maduro falls.
Corporate Governance
Palantir CEO excoriates Silicon Valley for its growing "un-American" attitude towards US government work. It truly is amazing how rapidly a society can change; and not, sadly, always for the better. Palantir is a privately-held data mining company started by Peter Thiel and currently led by CEO Alex Karp. In a brilliant monologue delivered to CNBC's Andrew Ross Sorkin at the World Economic Forum in Davos, Karp unloaded both barrels on Silicon Valley for their refusal to work with government agencies such as the Department of Defense. To his credit, Amazon's Jeffrey Bezos echoed similar sentiments a few months ago. If there was one specific catalyst for the blowback, it was Google's decision to stop working with the DoD on a project after an employee petition was circulated at the company which urged Alphabet's CEO, Sundar Pichai, to shun the agency. Meanwhile, as Karp so eloquently put it, many Silicon Valley companies have no problem selling products which are "adversarial to America." Outstanding and refreshing to hear a few C-suite executives push back against this dangerous new anti-American attitude oozing its way through the Valley, instead of just cowardly hanging their hats on the popular, faux, ginned-up civil movements of the day. There will be a point on the fulcrum at which this madness will backfire. The "for-profit" companies that pay the salaries of these smarmy individuals will eventually say "enough!" Either that, or they will have their lunch eaten by competitors around the world who still understand their reason for being.
Metals & Mining
Arconic melts down after announcing it is no longer up for sale. Admittedly, we lost interest in Alcoa (AA) after it spun its downstream aluminum products division off into a new publicly-traded company, Arconic (ARNC $16-$17-$31). Then we really lost interest when the former CEO of the combined entity, Klaus Kleinfeld, got canned from his role leading Arconic. Apparently, we are not the only ones who are now indifferent to the once-great aluminum-products maker. Arconic dropped 20% after management announced that the company was no longer looking for a suitor, with CEO John Plant indicating a dearth of interest by potential buyers. Somewhat ironically, the company's major challenge stems from the rising cost of aluminum—the raw product it was once able to provide itself. Down 43% over the past year, shares of ARNC are now trading right about where they were after the split from Alcoa back in November of 2016. The company probably should have taken Apollo's $11 billion offer, which would have made Arconic a private entity. While a global trade deal (and a subsequent end to tariffs) would help the firm's revenue, a global slowdown will present another major problem for the New York-based firm. For investors, this is a complete speculative play—if another buyer comes along, the shares could have a 30% upside.
Global Strategy: East & Southeast Asia
China's slowing growth and a great lesson in how the media creates a false narrative. As recently as a few years ago, we were inundated with stories in the US media (and, of course, within the state-controlled Chinese media) of how China would soon overtake the United States as the world's number one economic superpower. Funny how those stories have disappeared. Here's the dirty little secret: If you take a look at real GDP growth within the Chinese economy, there have been many years since 1990 in which the number did, indeed, grow at a double-digit clip; however, the media pulled a fast one by extrapolating that double-digit growth into forward years, and then calculating the point on the graph at which the Chinese line broke through the US line to the upside. Story after story was written based on this faulty premise. Of course an emerging market—by definition—can move faster than a developed economy the size of America's. However, as the numbers get larger, it is simply impossible to maintain that growth rate. And so, here we are. Shockingly (not), China just recorded its slowest year of growth since 1990. Furthermore, 2018's 6.6% rate is expected to continue dropping in subsequent years. Now, if the press could turn their attention to graphs which should concern Americans, like the decimation of the "Social Security trust fund" (there really isn't one) or the burgeoning level of US government debt, they would actually be providing a service to be proud of. China's problems are deeper than the numerical inability to maintain a double-digit growth rate. Between internal demographic problems and up-and-coming emerging market challengers like India, their fastest growth years are in the rear-view mirror.
Personal Finance: Company Plans
How much should you be investing in your company's retirement plan? For most Americans, a company-sponsored retirement plan represents their largest nest egg for retirement, but that does not mean these plans are as healthy as they should be. In a previous issue of The Penn Wealth Report, we took a brief look at these vehicles: their history, how much should be added each pay period, and how they should be allocated. To read a copy of the article, click here.
In what should be a momentous occasion, a lot of steam has been taken out of Boeing's delivery of the first KC-46 Tanker to the US Air Force. Going into December of last year, $7.5 billion resorts and casinos conglomerate Vail Resorts Inc (MTN $180-$187-$303) had exemplary performance—up 31% on the year, in fact. Then, like an experienced skier flying down a black slope, it plummeted. By the end of 2018, the company's shares were actually down 1%, and the slide has carried forward into January. So, what happened to the owner of such pristine ski areas as Vail, Breckenridge, Keystone, Beaver Creek, and Park City? At first glance, the season-to-date numbers look pretty good: lift ticket revenue up 12%, ski school revenue up 10%, dining revenue up 15%, and number of skiers up 17%. It all boils down to the rate of growth investors built into the company's price, however. The 26 P/E ratio certainly doesn't seem out of line for a company in the resorts and casinos business, but management's revised guidance for earnings "slightly below the low end" of expectations caught investors off guard. Other than that, the excuses for the large, two-month drop seem pretty flimsy. Despite being a "seasonal" player, Vail has built an annuitized revenue stream with its Epic Pass membership program, which allows for unlimited, unrestricted skiing at the company's resorts (and a fat "off-season" income stream for Vail). Another concern of investors has been the emergence of Alterra Mountain Company and its Ikon Pass. We believe that threat is highly exaggerated, and find MTN undervalued as it sits near its 52-week low. We don't think a $300 share price would be out of line for this well-run company.
Hotels, Resorts, & Cruise Lines
Why has Vail Resorts lost a third of its value in under two months? Going into December of last year, $7.5 billion resorts and casinos conglomerate Vail Resorts Inc (MTN $180-$187-$303) had exemplary performance—up 31% on the year, in fact. Then, like an experienced skier flying down a black slope, it plummeted. By the end of 2018, the company's shares were actually down 1%, and the slide has carried forward into January. So, what happened to the owner of such pristine ski areas as Vail, Breckenridge, Keystone, Beaver Creek, and Park City? At first glance, the season-to-date numbers look pretty good: lift ticket revenue up 12%, ski school revenue up 10%, dining revenue up 15%, and number of skiers up 17%. It all boils down to the rate of growth investors built into the company's price, however. The 26 P/E ratio certainly doesn't seem out of line for a company in the resorts and casinos business, but management's revised guidance for earnings "slightly below the low end" of expectations caught investors off guard. Other than that, the excuses for the large, two-month drop seem pretty flimsy. Despite being a "seasonal" player, Vail has built an annuitized revenue stream with its Epic Pass membership program, which allows for unlimited, unrestricted skiing at the company's resorts (and a fat "off-season" income stream for Vail). Another concern of investors has been the emergence of Alterra Mountain Company and its Ikon Pass. We believe that threat is highly exaggerated, and find MTN undervalued as it sits near its 52-week low. We don't think a $300 share price would be out of line for this well-run company.
Textiles, Apparel, & Luxury Goods
For investors bummed that they missed the Canada Goose train, a potential window has opened. Almost two years ago, we reported on the IPO of trendy Canadian outerwear-maker Canada Goose ($28-$46-$72). The stock began trading around $16 per share in March of 2017. By mid-November of last year, the company's shares were topping out above $70. Pretty remarkable, considering what happened to the overall market in Q4. For anyone kicking themselves for not getting in before the meteoric rise, there is a bit of respite: GOOS fell over 7% on Thursday after a Wells Fargo analyst downgraded the stock by one notch, to market perform. Wells cited valuation (the company has a 65 P/E—not outrageous for a company like this), and the fact that the company is "not as popular on Google Trends" as it once was. The firm lowered its target price for the stock from $80 to $68, which would still represent nearly a 50% jump from here. We love the company's products, but they are definitely for the luxury goods buyer, with jackets going for $1,000 on average or higher. In the space, we prefer a Lululemon (LULU) or an Ulta Beauty (ULTA)—more enticing stories and better multiples.
Global Strategy: Latin America
The US officially recognizes opposition leader as interim president of Venezuela. How long have we been saying that the starving Venezuelan people will eventually rise up and remove, one way or another, communist thug Nicolás Maduro from power? It truly is amazing that it has been allowed to go on this long. When a thug dictator remains in power while his people starve, it is almost always due to the military tamping down any opposition. Right now, in Venezuela, high-ranking military officers earn about $50 to $85 per month in pay; common ground-pounders earn around $8 per month. The individuals who are allowing Maduro to remain in power are watching their own families starve. The US just ratcheted up pressure against the murderous regime, officially recognizing 35-year-old Juan Guaidò, the opposition leader, as the country's interim president. Many other countries are following the US lead. In response, Maduro has broken off relations with the US (stupid move, as we buy half of the country's dwindling oil supply) and has ordered all American diplomats out of the country within 72 hours. Our dear friends, the Russians and Chinese, are still backing Maduro. As for Guaidò, he has courageously taken an oath of office in front of tens of thousands of cheering onlookers. If he survives, and when the military finally turns on Maduro, this brave patriot will usher in a new age for the Venezuelan people, and the region will become vastly more stable. The end of the cartoonish Chavez clone is near. Every civilized nation in the world recognizes his reelection to a second, six-year term as a sham. Inflation is so high that the bolivar is as worthless as Deutsche marks were in 1923 (one dollar would buy around one trillion notes). The end of Maduro is at hand, but it is interesting to note who, in addition to Putin and Xi, supports Maduro's murderous regime: Mexico's new leftist leader Obrador, Turkish President Erdogan, Cuba's president, and Bolivia's far-left Evo Morales. One would hope that the United States will remember this list long after Maduro falls.
Corporate Governance
Palantir CEO excoriates Silicon Valley for its growing "un-American" attitude towards US government work. It truly is amazing how rapidly a society can change; and not, sadly, always for the better. Palantir is a privately-held data mining company started by Peter Thiel and currently led by CEO Alex Karp. In a brilliant monologue delivered to CNBC's Andrew Ross Sorkin at the World Economic Forum in Davos, Karp unloaded both barrels on Silicon Valley for their refusal to work with government agencies such as the Department of Defense. To his credit, Amazon's Jeffrey Bezos echoed similar sentiments a few months ago. If there was one specific catalyst for the blowback, it was Google's decision to stop working with the DoD on a project after an employee petition was circulated at the company which urged Alphabet's CEO, Sundar Pichai, to shun the agency. Meanwhile, as Karp so eloquently put it, many Silicon Valley companies have no problem selling products which are "adversarial to America." Outstanding and refreshing to hear a few C-suite executives push back against this dangerous new anti-American attitude oozing its way through the Valley, instead of just cowardly hanging their hats on the popular, faux, ginned-up civil movements of the day. There will be a point on the fulcrum at which this madness will backfire. The "for-profit" companies that pay the salaries of these smarmy individuals will eventually say "enough!" Either that, or they will have their lunch eaten by competitors around the world who still understand their reason for being.
Metals & Mining
Arconic melts down after announcing it is no longer up for sale. Admittedly, we lost interest in Alcoa (AA) after it spun its downstream aluminum products division off into a new publicly-traded company, Arconic (ARNC $16-$17-$31). Then we really lost interest when the former CEO of the combined entity, Klaus Kleinfeld, got canned from his role leading Arconic. Apparently, we are not the only ones who are now indifferent to the once-great aluminum-products maker. Arconic dropped 20% after management announced that the company was no longer looking for a suitor, with CEO John Plant indicating a dearth of interest by potential buyers. Somewhat ironically, the company's major challenge stems from the rising cost of aluminum—the raw product it was once able to provide itself. Down 43% over the past year, shares of ARNC are now trading right about where they were after the split from Alcoa back in November of 2016. The company probably should have taken Apollo's $11 billion offer, which would have made Arconic a private entity. While a global trade deal (and a subsequent end to tariffs) would help the firm's revenue, a global slowdown will present another major problem for the New York-based firm. For investors, this is a complete speculative play—if another buyer comes along, the shares could have a 30% upside.
Global Strategy: East & Southeast Asia
China's slowing growth and a great lesson in how the media creates a false narrative. As recently as a few years ago, we were inundated with stories in the US media (and, of course, within the state-controlled Chinese media) of how China would soon overtake the United States as the world's number one economic superpower. Funny how those stories have disappeared. Here's the dirty little secret: If you take a look at real GDP growth within the Chinese economy, there have been many years since 1990 in which the number did, indeed, grow at a double-digit clip; however, the media pulled a fast one by extrapolating that double-digit growth into forward years, and then calculating the point on the graph at which the Chinese line broke through the US line to the upside. Story after story was written based on this faulty premise. Of course an emerging market—by definition—can move faster than a developed economy the size of America's. However, as the numbers get larger, it is simply impossible to maintain that growth rate. And so, here we are. Shockingly (not), China just recorded its slowest year of growth since 1990. Furthermore, 2018's 6.6% rate is expected to continue dropping in subsequent years. Now, if the press could turn their attention to graphs which should concern Americans, like the decimation of the "Social Security trust fund" (there really isn't one) or the burgeoning level of US government debt, they would actually be providing a service to be proud of. China's problems are deeper than the numerical inability to maintain a double-digit growth rate. Between internal demographic problems and up-and-coming emerging market challengers like India, their fastest growth years are in the rear-view mirror.
Personal Finance: Company Plans
How much should you be investing in your company's retirement plan? For most Americans, a company-sponsored retirement plan represents their largest nest egg for retirement, but that does not mean these plans are as healthy as they should be. In a previous issue of The Penn Wealth Report, we took a brief look at these vehicles: their history, how much should be added each pay period, and how they should be allocated. To read a copy of the article, click here.
Headlines for the Week of 13 Jan 2019—19 Jan 2019
Aerospace & Defense
The US will begin working on an advanced Space Sensor Layer to counter new threats from Russia and China. Over the course of the past year, both Russia and China have been boasting about a new generation of hypersonic missiles in their respective arsenals. If you listen to Putin (and the press does with bated breath), the US has no real defense for these advanced new weapons. These new non-ballistic, hypersonic vehicles travel several times the speed of sound at the edge of the atmosphere, and can move in unpredictable directions—all of which pose a problem for our current missile defense system. Now, the first US missile defense review in nine years (President George Bush commissioned the last one) has presented a solution: build an advanced Space Sensor Layer—a constellation of satellites in low- and medium-earth orbit to fill the "gaps" in our current identification and tracking system. The enemy missiles are designed to ride atop an existing, fully trackable ICBM, but they would then "break off" from those missiles and glide just atop the earth's atmosphere to evade detection. They could be used in a tactical manner to, for example, attack a carrier, or they could be tipped with a nuclear warhead for strategic combat. The new SSL would be able to identify these "rogue" objects after separation. The Department of Defense plans to fight the battle on dual fronts: they have awarded contracts for design proposals on the SSL array, and they have simultaneously commissioned design studies for hypersonic weapons to intercept and destroy any incoming threat. The United States Missile Defense Agency will spearhead and manage the program, which could be heavily funded from the 2020 defense budget. We can anticipate which companies will be at the forefront of this technology by reviewing the study contracts already awarded. Winners included Raytheon (RTN), Lockheed Martin (LMT), Northrop Grumman (NOC), and General Atomics (not yet publicly-traded). Contracts to design the weapon systems went to several of the same companies, as well as L3 Technologies (LLL) and BAE Systems PLC (BAESY). The best way for an investor to hedge their bets would be to own ITA, the iShares US Aerospace & Defense ETF. This ETF is currently a member of the Penn Dynamic Growth Strategy.
Textiles, Apparel, & Luxury Goods
Jewelry powerhouse Signet plummets on weak holiday numbers, lowered guidance. Last March, we purchased Signet Jewelers (SIG $28-$26-$71) within the Penn Intrepid Trading Platform for $40 per share. Three months later, in June, we closed out the position at $51.04 for a 28% short-term gain. Today, after the parent company of Kay, Zales, and Jared announced weaker same-store sales over the holiday season and reduced its guidance for 2019, investors hammered the stock down by 25%—with shares punching through a 52-week low. When all of the numbers are in (the company reports on 14 Mar), expect a 1.5% decline in same-store sales during the 2018 holiday shopping season from the previous year. Considering the 5.1% increase in consumer spending this past Christmas, those numbers spell potential trouble ahead. Before Signet purchased the company, we use Zales (former symbol ZLC) as one of our favorite trading stocks. When they got gobbled up, we turned to Signet with great success. Right now, we see the fair value of SIG in the low $40s range, which would imply a 60% upside from where it currently sits.
Interactive Media & Services
Is Snap in a death spiral after more executives flee the company? Two years ago, social media networking company Snap (SNAP $5-$6-$21), parent company of Snapchat, had a market cap of $31 billion and a share price of $27. Today, the company's size sits at $7 billion (a 77% drop) and its shares are going for $5.71. Its latest double-digit drop came this week after CFO Tim Stone announced he was bolting the firm—after eight months on the job. The fact that Stone will lose 80% of the SNAP stock he was given as part of his new-hire package speaks volumes about where he thinks the company is headed. Over the course of 2018, SNAP has seen the departure of two CFOs, its Chief Strategy Officer, its VP of Content, and its VP of Global Business Solutions. Fourth quarter earnings will be released on the 5th of Feb. Herein lies the beauty of the investment world: while analysts are slashing price targets on SNAP, Morningstar reiterated its $14 fair value figure for the shares, stating that the company may have some surprises in store regarding Q4's performance. The only concrete numbers we have to base an opinion on are the TTM figures through Q3, during which the company had revenue of $1 billion and net income of negative $1.4 billion. Investing in SNAP shares would be a highly speculative undertaking.
Global Strategy: Europe
A roller coaster few days for British Prime Minister Theresa May. After a stunning defeat of her Brexit deal in Parliament late last year, one must question the thought process behind British Prime Minister Theresa May's decision to bring the same plan up for an almost-certain second defeat. That is exactly what happened on Tuesday, as the lower House of Commons shot the deal down in a 432-202 rout--the largest Parliamentary defeat for any sitting government in the history of the UK. Of course, Labour Party leader Jeremy Corbyn, a disaster-in-waiting as he eyes May's job for himself, is sitting back loving every minute of May's misery, despite the fact that his country will pay the price for a hard Brexit. The same goes for the arrogant EU heads, who want to exact revenge for the "petulant" British citizens who voted to leave such a socialist utopia. After May's defeat on Tuesday, she did get a bit of good news on Wednesday: she survived a no-confidence vote brought about by Labour. But it was a squeaker. Lawmakers voted 325 to 306 in favor of rejecting the no-confidence motion, with the Northern Ireland delegation voting in May's favor. What's next? May announced she will be meeting with all sides to hammer out a better Brexit deal. Unfortunately, the EU must approve any new deal. Also unfortunately, opposition leader Corbyn has remained a no-show at the talks. There are a lot of possible outcomes to the Brexit mess, the best one being an extension to the 29 March deadline and a renegotiated settlement. Sadly, other possible outcomes include Corbyn ending up the PM in a general election, a hard Brexit (with a hard border between Northern Ireland and the rest of the country), and an attempt to re-vote on Brexit in the hopes voters have changed their minds. Ugly choices, all.
Metals & Mining
Another huge gold mining merger brings more consolidation to the industry. Near the end of last year, we reported that Barrick Gold (now symbol GOLD) would acquire Randgold Resources in a $6 billion deal. Now comes news of an even bigger merger within the industry: gold producer Newmont Mining (NEM $29-$31-$42) announced plans to acquire Goldcorp (GG) in a $10 billion deal. This latest action will create the world's largest gold producer by output. Five years of stagnation in the price of the metal plus higher extraction costs have forced these companies to act. How bad has it been? Take a look at the one-year chart comparing gold prices to the performance of Barrick and Newmont: gold has remained essentially flat, while both companies' shares have been reduced by one-fifth. We like the deal. Another great lesson for investors: Just because gold prices rise doesn't mean your gold mining stocks will follow suit. Think about the location of some of the world's biggest mines and then consider the instability within the countries where they are located. Also, the operational challenges within the industry are enormous. While we don't currently own any gold mining companies in our portfolios, we did just buy Gold—the commodity—within the Penn Dynamic Growth Strategy as a satellite position.
Media & Entertainment
Netflix raises prices yet again. It is too bad analysts don't give Tesla (TSLA) the kind of leeway they give Netflix (NFLX $216-$353-$423), even though the latter has a huge multiple of 127. The latest "pass" was given after Netflix announced they would be, yet again, raising the price customers must pay for the streaming service. The 13-18% price increase will affect all three layers of plans: Basic (one device, no HD) will go from $7.99 to $8.99; Standard (two devices, plurality of customers) will go from $10.99 to $12.99; Premium (four devices, 4K viewing option) will go from $13.99 to $15.99. The last price hike came just over a year ago. Sycophantic analysts argue that the company must keep hiking prices to pay the enormous production costs generated from their "original" shows. Meanwhile, an ever-increasing number of streaming service entrants (Disney will be the newest) should begin chipping away at Netflix's market share. Investors apparently sided with analysts, driving the stock up 7% on the day. Despite its 127 PE ratio, NFLX has been a "darling" stock over the past several years. It is also one subject to wild swings in price. We still consider it a speculative stock, and would love to have the guts to short the name.
Commercial Banks
JP Morgan shares fall on revenue, profit miss. For fourteen straight months, $335 billion banking giant JP Morgan (JPM $91-$99-$119) beat Wall Street estimates. That string has ended, as the company missed on both revenue and income estimates for 2018Q4, driving the stock down about 2%, to $99 per share. But just because the bank didn't hit the Street's estimates doesn't mean they aren't still growing. Revenue for the quarter came in at $26.8 billion, which represents a 15% quarterly YoY jump, and net income came in at $7.07 billion, a whopping 67% spike from the same quarter in 2017. Breaking down the numbers: consumer, community, and commercial banking beat estimates, while the investment and wealth management side (think trading) missed. The drop on the trading side may seem odd, considering the whirlwind of trade activity in the ugly fourth quarter, but it actually stems from a big drop in fixed income trading as investors weigh the Fed's next move. JP Morgan is one of the most well-run banks in the world, thanks in good measure to CEO Jamie Dimon's skilled leadership. Below $100 per share, this bank provides a good entry point.
Electric Utilities
PG&E announces plans to file for bankruptcy in wake of California wildfires, CEO resigns, shares plummet. Three months ago, California’s largest utility, PG&E Corp (PCG $9-$9-$49), had a market cap of $35 billion and a healthy dividend yield of over 4%. A regulated utility with a fat dividend—why on earth wouldn’t a conservative investor pick up some shares for the income stream alone? If investors needed to feel better about a purchase, they only had to look at some of the glowing industry analyst reports on the company. Then the California wildfires hit, with evidence pointing to sparks emanating from faulty Pacific Gas & Electric-managed power lines sitting at ground zero. The company’s market cap shot down to $12 billion, and shares were slashed in half, from near $50 to $25. Fast forward to Monday the 14th of January, and we have the surprise announcement that the company would file for Chapter 11 bankruptcy protection. After that announcement, PG&E’s market cap fell to under $5 billion, and shares were down 50%, to under $10 per share. The company also announced that CEO Geisha Williams was stepping down, effective immediately. We discuss the case of PG&E further in the next issue of The Penn Wealth Report, but it points to the need for investors to understand the stocks they are adding to their portfolio—or rely on a financial professional to that end. PG&E has been down this path before—they went through a bankruptcy back in 2001. Furthermore, a large percentage of the California legislature had been gunning for the company even before this latest round of disastrous wildfires.
The US will begin working on an advanced Space Sensor Layer to counter new threats from Russia and China. Over the course of the past year, both Russia and China have been boasting about a new generation of hypersonic missiles in their respective arsenals. If you listen to Putin (and the press does with bated breath), the US has no real defense for these advanced new weapons. These new non-ballistic, hypersonic vehicles travel several times the speed of sound at the edge of the atmosphere, and can move in unpredictable directions—all of which pose a problem for our current missile defense system. Now, the first US missile defense review in nine years (President George Bush commissioned the last one) has presented a solution: build an advanced Space Sensor Layer—a constellation of satellites in low- and medium-earth orbit to fill the "gaps" in our current identification and tracking system. The enemy missiles are designed to ride atop an existing, fully trackable ICBM, but they would then "break off" from those missiles and glide just atop the earth's atmosphere to evade detection. They could be used in a tactical manner to, for example, attack a carrier, or they could be tipped with a nuclear warhead for strategic combat. The new SSL would be able to identify these "rogue" objects after separation. The Department of Defense plans to fight the battle on dual fronts: they have awarded contracts for design proposals on the SSL array, and they have simultaneously commissioned design studies for hypersonic weapons to intercept and destroy any incoming threat. The United States Missile Defense Agency will spearhead and manage the program, which could be heavily funded from the 2020 defense budget. We can anticipate which companies will be at the forefront of this technology by reviewing the study contracts already awarded. Winners included Raytheon (RTN), Lockheed Martin (LMT), Northrop Grumman (NOC), and General Atomics (not yet publicly-traded). Contracts to design the weapon systems went to several of the same companies, as well as L3 Technologies (LLL) and BAE Systems PLC (BAESY). The best way for an investor to hedge their bets would be to own ITA, the iShares US Aerospace & Defense ETF. This ETF is currently a member of the Penn Dynamic Growth Strategy.
Textiles, Apparel, & Luxury Goods
Jewelry powerhouse Signet plummets on weak holiday numbers, lowered guidance. Last March, we purchased Signet Jewelers (SIG $28-$26-$71) within the Penn Intrepid Trading Platform for $40 per share. Three months later, in June, we closed out the position at $51.04 for a 28% short-term gain. Today, after the parent company of Kay, Zales, and Jared announced weaker same-store sales over the holiday season and reduced its guidance for 2019, investors hammered the stock down by 25%—with shares punching through a 52-week low. When all of the numbers are in (the company reports on 14 Mar), expect a 1.5% decline in same-store sales during the 2018 holiday shopping season from the previous year. Considering the 5.1% increase in consumer spending this past Christmas, those numbers spell potential trouble ahead. Before Signet purchased the company, we use Zales (former symbol ZLC) as one of our favorite trading stocks. When they got gobbled up, we turned to Signet with great success. Right now, we see the fair value of SIG in the low $40s range, which would imply a 60% upside from where it currently sits.
Interactive Media & Services
Is Snap in a death spiral after more executives flee the company? Two years ago, social media networking company Snap (SNAP $5-$6-$21), parent company of Snapchat, had a market cap of $31 billion and a share price of $27. Today, the company's size sits at $7 billion (a 77% drop) and its shares are going for $5.71. Its latest double-digit drop came this week after CFO Tim Stone announced he was bolting the firm—after eight months on the job. The fact that Stone will lose 80% of the SNAP stock he was given as part of his new-hire package speaks volumes about where he thinks the company is headed. Over the course of 2018, SNAP has seen the departure of two CFOs, its Chief Strategy Officer, its VP of Content, and its VP of Global Business Solutions. Fourth quarter earnings will be released on the 5th of Feb. Herein lies the beauty of the investment world: while analysts are slashing price targets on SNAP, Morningstar reiterated its $14 fair value figure for the shares, stating that the company may have some surprises in store regarding Q4's performance. The only concrete numbers we have to base an opinion on are the TTM figures through Q3, during which the company had revenue of $1 billion and net income of negative $1.4 billion. Investing in SNAP shares would be a highly speculative undertaking.
Global Strategy: Europe
A roller coaster few days for British Prime Minister Theresa May. After a stunning defeat of her Brexit deal in Parliament late last year, one must question the thought process behind British Prime Minister Theresa May's decision to bring the same plan up for an almost-certain second defeat. That is exactly what happened on Tuesday, as the lower House of Commons shot the deal down in a 432-202 rout--the largest Parliamentary defeat for any sitting government in the history of the UK. Of course, Labour Party leader Jeremy Corbyn, a disaster-in-waiting as he eyes May's job for himself, is sitting back loving every minute of May's misery, despite the fact that his country will pay the price for a hard Brexit. The same goes for the arrogant EU heads, who want to exact revenge for the "petulant" British citizens who voted to leave such a socialist utopia. After May's defeat on Tuesday, she did get a bit of good news on Wednesday: she survived a no-confidence vote brought about by Labour. But it was a squeaker. Lawmakers voted 325 to 306 in favor of rejecting the no-confidence motion, with the Northern Ireland delegation voting in May's favor. What's next? May announced she will be meeting with all sides to hammer out a better Brexit deal. Unfortunately, the EU must approve any new deal. Also unfortunately, opposition leader Corbyn has remained a no-show at the talks. There are a lot of possible outcomes to the Brexit mess, the best one being an extension to the 29 March deadline and a renegotiated settlement. Sadly, other possible outcomes include Corbyn ending up the PM in a general election, a hard Brexit (with a hard border between Northern Ireland and the rest of the country), and an attempt to re-vote on Brexit in the hopes voters have changed their minds. Ugly choices, all.
Metals & Mining
Another huge gold mining merger brings more consolidation to the industry. Near the end of last year, we reported that Barrick Gold (now symbol GOLD) would acquire Randgold Resources in a $6 billion deal. Now comes news of an even bigger merger within the industry: gold producer Newmont Mining (NEM $29-$31-$42) announced plans to acquire Goldcorp (GG) in a $10 billion deal. This latest action will create the world's largest gold producer by output. Five years of stagnation in the price of the metal plus higher extraction costs have forced these companies to act. How bad has it been? Take a look at the one-year chart comparing gold prices to the performance of Barrick and Newmont: gold has remained essentially flat, while both companies' shares have been reduced by one-fifth. We like the deal. Another great lesson for investors: Just because gold prices rise doesn't mean your gold mining stocks will follow suit. Think about the location of some of the world's biggest mines and then consider the instability within the countries where they are located. Also, the operational challenges within the industry are enormous. While we don't currently own any gold mining companies in our portfolios, we did just buy Gold—the commodity—within the Penn Dynamic Growth Strategy as a satellite position.
Media & Entertainment
Netflix raises prices yet again. It is too bad analysts don't give Tesla (TSLA) the kind of leeway they give Netflix (NFLX $216-$353-$423), even though the latter has a huge multiple of 127. The latest "pass" was given after Netflix announced they would be, yet again, raising the price customers must pay for the streaming service. The 13-18% price increase will affect all three layers of plans: Basic (one device, no HD) will go from $7.99 to $8.99; Standard (two devices, plurality of customers) will go from $10.99 to $12.99; Premium (four devices, 4K viewing option) will go from $13.99 to $15.99. The last price hike came just over a year ago. Sycophantic analysts argue that the company must keep hiking prices to pay the enormous production costs generated from their "original" shows. Meanwhile, an ever-increasing number of streaming service entrants (Disney will be the newest) should begin chipping away at Netflix's market share. Investors apparently sided with analysts, driving the stock up 7% on the day. Despite its 127 PE ratio, NFLX has been a "darling" stock over the past several years. It is also one subject to wild swings in price. We still consider it a speculative stock, and would love to have the guts to short the name.
Commercial Banks
JP Morgan shares fall on revenue, profit miss. For fourteen straight months, $335 billion banking giant JP Morgan (JPM $91-$99-$119) beat Wall Street estimates. That string has ended, as the company missed on both revenue and income estimates for 2018Q4, driving the stock down about 2%, to $99 per share. But just because the bank didn't hit the Street's estimates doesn't mean they aren't still growing. Revenue for the quarter came in at $26.8 billion, which represents a 15% quarterly YoY jump, and net income came in at $7.07 billion, a whopping 67% spike from the same quarter in 2017. Breaking down the numbers: consumer, community, and commercial banking beat estimates, while the investment and wealth management side (think trading) missed. The drop on the trading side may seem odd, considering the whirlwind of trade activity in the ugly fourth quarter, but it actually stems from a big drop in fixed income trading as investors weigh the Fed's next move. JP Morgan is one of the most well-run banks in the world, thanks in good measure to CEO Jamie Dimon's skilled leadership. Below $100 per share, this bank provides a good entry point.
Electric Utilities
PG&E announces plans to file for bankruptcy in wake of California wildfires, CEO resigns, shares plummet. Three months ago, California’s largest utility, PG&E Corp (PCG $9-$9-$49), had a market cap of $35 billion and a healthy dividend yield of over 4%. A regulated utility with a fat dividend—why on earth wouldn’t a conservative investor pick up some shares for the income stream alone? If investors needed to feel better about a purchase, they only had to look at some of the glowing industry analyst reports on the company. Then the California wildfires hit, with evidence pointing to sparks emanating from faulty Pacific Gas & Electric-managed power lines sitting at ground zero. The company’s market cap shot down to $12 billion, and shares were slashed in half, from near $50 to $25. Fast forward to Monday the 14th of January, and we have the surprise announcement that the company would file for Chapter 11 bankruptcy protection. After that announcement, PG&E’s market cap fell to under $5 billion, and shares were down 50%, to under $10 per share. The company also announced that CEO Geisha Williams was stepping down, effective immediately. We discuss the case of PG&E further in the next issue of The Penn Wealth Report, but it points to the need for investors to understand the stocks they are adding to their portfolio—or rely on a financial professional to that end. PG&E has been down this path before—they went through a bankruptcy back in 2001. Furthermore, a large percentage of the California legislature had been gunning for the company even before this latest round of disastrous wildfires.
Headlines for the Week of 06 Jan 2019—12 Jan 2019
Penn Trading Desk
Our oil call was spot on. On 18 Dec 2018, oil was down around $45 per barrel. While we loved the $1.77 price at the pumps, we knew it wouldn't last. Oil was near the bottom line of our channel, and we didn't believe those who saw $40 as the next stop. On that day, we purchased OIL, the iPath S&P GSCI Crude Oil ETN within the Dynamic Growth Strategy with an initial target price of $59 per share. While it is not there yet, the graph shows what the exchange traded note has done since purchase. Oil futures can be one of the most lucrative trades to play, as the price moves up and as it moves down. In this Sunday's Penn Wealth Report, we look at the role of inverse funds within a portfolio. We have successfully used DUG (the inverse to OIL), for example, since its inception back in 2007.
e-Commerce
How Jeff Bezos lost $65 billion overnight. At the end of 2018, Amazon (AMZN $1,237-$1,653-$2,051) founder and CEO Jeff Bezos retained his title as the world's richest person, and it wasn't even close. Bezos finished the year out with a cool $130 billion or so under his belt, in one form or another. The world's second richest person, Bill Gates, came in at a paltry $90 billion (though it should be noted that most of these ultra-wealthy individuals give away enormous amounts of their wealth each year to charitable organizations). Bezos may just move down about six notches on the list this year, however, as one action will separate him from half of his wealth: he and his wife MacKenzie have announced their divorce. Under Washington state law, assets gained over the course of a marriage are split down the middle, with each side getting half. Actually, the divorce appears quite amicable, and the two will continue their joint work on the the Day One Fund, their charitable organization. The two have been married for 25 years; he is 55, she is 48. Amazon dropped a bit on the news, but this is a company we fully expect to (as amazing as it sounds) double in size over the next several years. It will be interesting to watch the proceedings, however, to see how Bezos's control of 16% of outstanding AMZN shares are affected. This is going to be one complex split from a financial standpoint.
Road & Rail
Penn member Union Pacific spikes on new COO announcement. Within the Industrials sector, Union Pacific (UNP $121-$150-$166) is our one railroad position in the Penn Global Leaders Club. There are a number of reasons we like the rail, including CEO Lance Fritz's exemplary leadership. While it is rare for an addition other than a CEO to matter to investors, the announcement of Jim Vena as the company's new chief operating officer was the catalyst for a nearly 10% spike in UNP shares on Tuesday. Vena has forty years of experience with Canadian National Railway (CNI); for rail watchers, that means one thing: he served under the infamous Hunter Harrison. While the draconian leader Harrison is now deceased, UNP investors are hoping that his "precision scheduled railroading" mindset lives on in Vena. (Harrison would watch his tracks in "real time," and was known for calling an engineer personally if a shipment was behind schedule.) UNP's version of this efficiency standard is called Unified Plan 2020, a strategy designed to "increase operating efficiency and reduce network complexity." Between Fritz and Vena, there is little doubt that we own the right railroad moving forward. The rails are very sensitive to the state of the economy, both domestically and globally. Right now, two issues are front and center: a potential global economic slowdown and the odds of the US-Mexico-Canada Trade Agreement passing a hostile House of Representatives. We believe there will be an ugly fight on purely political grounds, but the deal will be ratified. On the global front, we believe the slowdown will be relatively mild. We remain neutral to bullish on the rails.
Automotive
In good company: Tesla's second-largest shareholder knows a thing or two about business. We have been—and remain—a long-term bull on electric vehicle maker Tesla (TSLA $245-$336-$387). We argue that, were it not for the dynamic catalyst in the form of Elon Musk, other car companies would still be in the fossil fuel stone age. It took real leadership for Musk to create this new company, and we find it rather cowardly for the likes of Ford and GM to come along and claim that "we were here first!" Of course, most of the blowhard talking heads of the industry continue to write off the firm as a failure, due in good measure to some sick combination of hubris, jealousy, and lack of vision. Leaders put their money where their mouth is, however, and we just found out that Tesla's second-largest shareholder happens to be a legendary name in tech. According to a regulatory filing with the SEC, Oracle (ORCL) founder and sixth-richest person in the world, Larry Ellison, owns around three million shares of firm through his revocable trust. At the company's current share price, those shares are worth in excess of $1 billion. Pretty good company for founder Musk, who owns 20% of Tesla's outstanding shares. If we want to talk about risk, let's talk about Ford and GM losing market share around the globe. How risky are those investments, despite their fat dividend yields? We are rooting for both, and both are making inroads into autonomous vehicle technology, but they have each made a number of missteps recently. At least Musk is passionate about what he is doing—reminiscent of the first generation Busch, or the first generation Ford.
Multiline Retail
It is official: Sears is done. But it didn't need to be this way. In this coming Sunday's Penn Wealth Report, we will offer a brief epitaph for Sears, Roebuck and Company (SHLD $0.12-$0.22-$4), which became no more on Tuesday the 8th of January after a bankruptcy judge agreed to management's request for liquidation. Ironically, the store could be considered the Amazon of the early 20th century, riding in to save the masses in rural America from local merchants and their often questionable pricing tactics. The Sears catalog opened a world of goods to all people, with clearly-stated pricing. But the wrong management team put the chain, which bought KMart back in 2004, on a clear path towards irrelevance. Now, 50,000 employees—down from 300,000 six years ago—will lose their positions. We will discuss the demise of the firm in the next issue of The Penn Wealth Report.
Our oil call was spot on. On 18 Dec 2018, oil was down around $45 per barrel. While we loved the $1.77 price at the pumps, we knew it wouldn't last. Oil was near the bottom line of our channel, and we didn't believe those who saw $40 as the next stop. On that day, we purchased OIL, the iPath S&P GSCI Crude Oil ETN within the Dynamic Growth Strategy with an initial target price of $59 per share. While it is not there yet, the graph shows what the exchange traded note has done since purchase. Oil futures can be one of the most lucrative trades to play, as the price moves up and as it moves down. In this Sunday's Penn Wealth Report, we look at the role of inverse funds within a portfolio. We have successfully used DUG (the inverse to OIL), for example, since its inception back in 2007.
e-Commerce
How Jeff Bezos lost $65 billion overnight. At the end of 2018, Amazon (AMZN $1,237-$1,653-$2,051) founder and CEO Jeff Bezos retained his title as the world's richest person, and it wasn't even close. Bezos finished the year out with a cool $130 billion or so under his belt, in one form or another. The world's second richest person, Bill Gates, came in at a paltry $90 billion (though it should be noted that most of these ultra-wealthy individuals give away enormous amounts of their wealth each year to charitable organizations). Bezos may just move down about six notches on the list this year, however, as one action will separate him from half of his wealth: he and his wife MacKenzie have announced their divorce. Under Washington state law, assets gained over the course of a marriage are split down the middle, with each side getting half. Actually, the divorce appears quite amicable, and the two will continue their joint work on the the Day One Fund, their charitable organization. The two have been married for 25 years; he is 55, she is 48. Amazon dropped a bit on the news, but this is a company we fully expect to (as amazing as it sounds) double in size over the next several years. It will be interesting to watch the proceedings, however, to see how Bezos's control of 16% of outstanding AMZN shares are affected. This is going to be one complex split from a financial standpoint.
Road & Rail
Penn member Union Pacific spikes on new COO announcement. Within the Industrials sector, Union Pacific (UNP $121-$150-$166) is our one railroad position in the Penn Global Leaders Club. There are a number of reasons we like the rail, including CEO Lance Fritz's exemplary leadership. While it is rare for an addition other than a CEO to matter to investors, the announcement of Jim Vena as the company's new chief operating officer was the catalyst for a nearly 10% spike in UNP shares on Tuesday. Vena has forty years of experience with Canadian National Railway (CNI); for rail watchers, that means one thing: he served under the infamous Hunter Harrison. While the draconian leader Harrison is now deceased, UNP investors are hoping that his "precision scheduled railroading" mindset lives on in Vena. (Harrison would watch his tracks in "real time," and was known for calling an engineer personally if a shipment was behind schedule.) UNP's version of this efficiency standard is called Unified Plan 2020, a strategy designed to "increase operating efficiency and reduce network complexity." Between Fritz and Vena, there is little doubt that we own the right railroad moving forward. The rails are very sensitive to the state of the economy, both domestically and globally. Right now, two issues are front and center: a potential global economic slowdown and the odds of the US-Mexico-Canada Trade Agreement passing a hostile House of Representatives. We believe there will be an ugly fight on purely political grounds, but the deal will be ratified. On the global front, we believe the slowdown will be relatively mild. We remain neutral to bullish on the rails.
Automotive
In good company: Tesla's second-largest shareholder knows a thing or two about business. We have been—and remain—a long-term bull on electric vehicle maker Tesla (TSLA $245-$336-$387). We argue that, were it not for the dynamic catalyst in the form of Elon Musk, other car companies would still be in the fossil fuel stone age. It took real leadership for Musk to create this new company, and we find it rather cowardly for the likes of Ford and GM to come along and claim that "we were here first!" Of course, most of the blowhard talking heads of the industry continue to write off the firm as a failure, due in good measure to some sick combination of hubris, jealousy, and lack of vision. Leaders put their money where their mouth is, however, and we just found out that Tesla's second-largest shareholder happens to be a legendary name in tech. According to a regulatory filing with the SEC, Oracle (ORCL) founder and sixth-richest person in the world, Larry Ellison, owns around three million shares of firm through his revocable trust. At the company's current share price, those shares are worth in excess of $1 billion. Pretty good company for founder Musk, who owns 20% of Tesla's outstanding shares. If we want to talk about risk, let's talk about Ford and GM losing market share around the globe. How risky are those investments, despite their fat dividend yields? We are rooting for both, and both are making inroads into autonomous vehicle technology, but they have each made a number of missteps recently. At least Musk is passionate about what he is doing—reminiscent of the first generation Busch, or the first generation Ford.
Multiline Retail
It is official: Sears is done. But it didn't need to be this way. In this coming Sunday's Penn Wealth Report, we will offer a brief epitaph for Sears, Roebuck and Company (SHLD $0.12-$0.22-$4), which became no more on Tuesday the 8th of January after a bankruptcy judge agreed to management's request for liquidation. Ironically, the store could be considered the Amazon of the early 20th century, riding in to save the masses in rural America from local merchants and their often questionable pricing tactics. The Sears catalog opened a world of goods to all people, with clearly-stated pricing. But the wrong management team put the chain, which bought KMart back in 2004, on a clear path towards irrelevance. Now, 50,000 employees—down from 300,000 six years ago—will lose their positions. We will discuss the demise of the firm in the next issue of The Penn Wealth Report.
Headlines for the Week of 30 Dec 2018—05 Jan 2019
Economics: Work & Pay
The US had stellar jobs growth in December, but how will the Fed read that? Expectations were for 176,000 new jobs created in the month of December. The economists got it wrong by some 77%. The US added a whopping 312,000 new jobs in the last month of 2018, and 419,000 new workers entered the workforce. That latter fact helped drive unemployment back up to 3.9% (from 3.7%), but any way you parse the numbers, the report was great. Of that 312,000 figure, 301,000 new private sector jobs were created. Of course, any time we get a strong jobs report we must now be concerned that the Fed will use this as rationale for yet another rate hike, but futures stayed steady (the Dow was up around 300) after the number came out. Inflation is not on the horizon, and the global economy is slowing; those are the data points the Fed should be looking at, not a rosy jobs number. If Powell and company continue to blather on about two more rate hikes in 2019, any market gains won't hold. If they simply shut up about predicting new rate hikes, the market will cheer. Back to the jobs report: the December figure capped off the creation of a whopping 2.6 million new jobs in 2018—an impressive feat. Don't expect another 312k number soon. If we could maintain an average of 150,000 to 200,000 new jobs created each month in 2019, it will be a good year. If the Fed presses pause on any further rate hikes, the markets will have a year of double-digit gains. Could once, just once, the eggheads at the Fed celebrate a good jobs report and keep their respective mouths shut about more rate hikes?
Trading Desk
Added a non-correlated asset to the Dynamic Growth Strategy. It is always good to hold a portion of non-correlated assets within your portfolio, especially when the markets are in the midst of violent swings and tumultuous downturns. The challenge has been finding investments that have not moved down alongside equities. Bonds haven't been the answer—they have moved down in value as rates went up. Commodities? A popular trading basket of commodities (DBC) dropped 20% in the fourth quarter. That being said, we did identify a non-correlated asset that appears poised for strong growth in 2019, irrespective of how the markets perform. We added it to the Dynamic Growth Strategy, and Clients/Members can see it by logging into the Trading Desk. Of course, the investment was automatically added to the appropriate Penn Wealth Management client accounts. We will discuss the rationale behind the purchase of this investment in the next issue of The Penn Wealth Report.
Trading Desk
The ship has sailed on the inverse Treasury trade. It was an idea that has run its course, but it made perfect sense at the time. We picked up TBT, the ProShares UltraShort 20+ Year Treasury ETF, as the Fed set sail on its great rate hike expedition. As rates rise, values of bonds fall; the longer the bond, the greater the fall. And TBT, which goes up twice as fast as long bond values fall, was following the script. Then Q4 hit. All of a sudden, as the market fell with a vengeance, the idea that the Fed would slam on the brakes became a popular theme—TBT fell in lockstep with the markets. Seeing no catalyst for near-term growth, we yanked TBT from the Dynamic Growth Strategy. Forget the two to three rate hikes Fed watchers were predicting last year for 2019; we believe there will be either zero or one. And, we will probably go through a loosening cycle (the Fed lowering rates) before they go up again. In other words, now might just be a good time to start loading up on bonds, as their values will hold up a lot better in a flat rate environment.
Pharmaceuticals
Bristol-Myers Squibb to buy biotech Celgene in $74 billion deal. Going into the trading day, biotech firm Celgene (CELG $59-$88-$110) was valued at $46.5 billion. All of that changed with Bristol-Myers Squibb's (BMY $47-$48-$70) $74 billion plan to buy the firm. Under the terms of the deal, BMY will pay CELG owners $50 in cash for each share of the company they own, along with a 31% stake in BMY after the deal closes. We hate to lose another great publicly-traded biotech firm, but the deal makes great sense for Bristol. The merged entity will have nine blockbuster drugs, with each bringing in over $1 billion in sales annually. Considering BMY's annual revenue has been in the $20 billion range, that is huge. This acquisition is part of an overall strategy at the company to beef up its oncology business—last year it bought cancer drug developer Juno Therapeutics in a $9 billion deal. Bristol-Myers Squibb is in the Penn Global Leaders Club as a "pharmaceuticals" holding. This deal is a great example of why we are constantly looking for up-and-coming biotech companies to buy within the Penn New Frontier Fund (we currently hold four biotechs in the portfolio).
Market Pulse
What the first trading day portends for the rest of the year. Yes, it would be quite a stretch to extrapolate one trading day into anything meaningful for the year, but here we go. Watching the futures on Trading Day 1 of 2019 felt like standing on the tracks watching the oncoming train in the distance. Dow futures were down somewhere around 400 points most of the morning, and that is where the index opened. Somehow, however, the market was able to change course late in the session, with the S&P 500, the Dow Jones Industrial Average, and the NASDAQ all posting gains. How is the day's trading a microcosm of the year? Expect to see many harrowing sessions but, in the end, the markets will finish the year in the green. How far in the green? We expect the S&P 500 to close the year between 2,800 and 2,900, which would equate to a 12-15% gain for 2019.
Trading Desk
Cybersecurity addition to the Penn Dynamic Growth Strategy. The NASDAQ is in the doldrums; meanwhile, cyber threats are on the rise thanks to state-sponsored hackers in China, Russia, and North Korea. With both of those factors in mind, we added a cybersecurity position to the Penn Dynamic Growth Strategy, marking the first trade of 2019. May it be a fruitful one. Clients and Members can see the trade by logging into the Trading Desk.
Automotive
Tesla misses Q4 production expectations, stock takes a hit. It seems like an impressive number. Electric-vehicle maker Tesla (TSLA $245-$300-$387) built and sold 1,000 cars per day in the fourth quarter of 2018—90,700 in all. Unfortunately for the company, Wall Street was expecting a 92,000 figure, and that 1.2% miss drove Tesla shares down 10% in early trading. Another concern for not just Tesla, but all EV makers, is the federal tax credit cut that went in place on 01 Jan. The $7,500 credit was halved to $3,750. To counter that loss, Tesla announced it was reducing the price of all models by $2,000. Tesla isn't at risk of insolvency, and the EV market's growth trajectory is only going to get steeper as the march to replace the combustible engine picks up steam. Based on these two factors, is $300 the right price to jump into TSLA? It's hard to say, primarily because emotions are so heavily involved in TSLA trading.
The US had stellar jobs growth in December, but how will the Fed read that? Expectations were for 176,000 new jobs created in the month of December. The economists got it wrong by some 77%. The US added a whopping 312,000 new jobs in the last month of 2018, and 419,000 new workers entered the workforce. That latter fact helped drive unemployment back up to 3.9% (from 3.7%), but any way you parse the numbers, the report was great. Of that 312,000 figure, 301,000 new private sector jobs were created. Of course, any time we get a strong jobs report we must now be concerned that the Fed will use this as rationale for yet another rate hike, but futures stayed steady (the Dow was up around 300) after the number came out. Inflation is not on the horizon, and the global economy is slowing; those are the data points the Fed should be looking at, not a rosy jobs number. If Powell and company continue to blather on about two more rate hikes in 2019, any market gains won't hold. If they simply shut up about predicting new rate hikes, the market will cheer. Back to the jobs report: the December figure capped off the creation of a whopping 2.6 million new jobs in 2018—an impressive feat. Don't expect another 312k number soon. If we could maintain an average of 150,000 to 200,000 new jobs created each month in 2019, it will be a good year. If the Fed presses pause on any further rate hikes, the markets will have a year of double-digit gains. Could once, just once, the eggheads at the Fed celebrate a good jobs report and keep their respective mouths shut about more rate hikes?
Trading Desk
Added a non-correlated asset to the Dynamic Growth Strategy. It is always good to hold a portion of non-correlated assets within your portfolio, especially when the markets are in the midst of violent swings and tumultuous downturns. The challenge has been finding investments that have not moved down alongside equities. Bonds haven't been the answer—they have moved down in value as rates went up. Commodities? A popular trading basket of commodities (DBC) dropped 20% in the fourth quarter. That being said, we did identify a non-correlated asset that appears poised for strong growth in 2019, irrespective of how the markets perform. We added it to the Dynamic Growth Strategy, and Clients/Members can see it by logging into the Trading Desk. Of course, the investment was automatically added to the appropriate Penn Wealth Management client accounts. We will discuss the rationale behind the purchase of this investment in the next issue of The Penn Wealth Report.
Trading Desk
The ship has sailed on the inverse Treasury trade. It was an idea that has run its course, but it made perfect sense at the time. We picked up TBT, the ProShares UltraShort 20+ Year Treasury ETF, as the Fed set sail on its great rate hike expedition. As rates rise, values of bonds fall; the longer the bond, the greater the fall. And TBT, which goes up twice as fast as long bond values fall, was following the script. Then Q4 hit. All of a sudden, as the market fell with a vengeance, the idea that the Fed would slam on the brakes became a popular theme—TBT fell in lockstep with the markets. Seeing no catalyst for near-term growth, we yanked TBT from the Dynamic Growth Strategy. Forget the two to three rate hikes Fed watchers were predicting last year for 2019; we believe there will be either zero or one. And, we will probably go through a loosening cycle (the Fed lowering rates) before they go up again. In other words, now might just be a good time to start loading up on bonds, as their values will hold up a lot better in a flat rate environment.
Pharmaceuticals
Bristol-Myers Squibb to buy biotech Celgene in $74 billion deal. Going into the trading day, biotech firm Celgene (CELG $59-$88-$110) was valued at $46.5 billion. All of that changed with Bristol-Myers Squibb's (BMY $47-$48-$70) $74 billion plan to buy the firm. Under the terms of the deal, BMY will pay CELG owners $50 in cash for each share of the company they own, along with a 31% stake in BMY after the deal closes. We hate to lose another great publicly-traded biotech firm, but the deal makes great sense for Bristol. The merged entity will have nine blockbuster drugs, with each bringing in over $1 billion in sales annually. Considering BMY's annual revenue has been in the $20 billion range, that is huge. This acquisition is part of an overall strategy at the company to beef up its oncology business—last year it bought cancer drug developer Juno Therapeutics in a $9 billion deal. Bristol-Myers Squibb is in the Penn Global Leaders Club as a "pharmaceuticals" holding. This deal is a great example of why we are constantly looking for up-and-coming biotech companies to buy within the Penn New Frontier Fund (we currently hold four biotechs in the portfolio).
Market Pulse
What the first trading day portends for the rest of the year. Yes, it would be quite a stretch to extrapolate one trading day into anything meaningful for the year, but here we go. Watching the futures on Trading Day 1 of 2019 felt like standing on the tracks watching the oncoming train in the distance. Dow futures were down somewhere around 400 points most of the morning, and that is where the index opened. Somehow, however, the market was able to change course late in the session, with the S&P 500, the Dow Jones Industrial Average, and the NASDAQ all posting gains. How is the day's trading a microcosm of the year? Expect to see many harrowing sessions but, in the end, the markets will finish the year in the green. How far in the green? We expect the S&P 500 to close the year between 2,800 and 2,900, which would equate to a 12-15% gain for 2019.
Trading Desk
Cybersecurity addition to the Penn Dynamic Growth Strategy. The NASDAQ is in the doldrums; meanwhile, cyber threats are on the rise thanks to state-sponsored hackers in China, Russia, and North Korea. With both of those factors in mind, we added a cybersecurity position to the Penn Dynamic Growth Strategy, marking the first trade of 2019. May it be a fruitful one. Clients and Members can see the trade by logging into the Trading Desk.
Automotive
Tesla misses Q4 production expectations, stock takes a hit. It seems like an impressive number. Electric-vehicle maker Tesla (TSLA $245-$300-$387) built and sold 1,000 cars per day in the fourth quarter of 2018—90,700 in all. Unfortunately for the company, Wall Street was expecting a 92,000 figure, and that 1.2% miss drove Tesla shares down 10% in early trading. Another concern for not just Tesla, but all EV makers, is the federal tax credit cut that went in place on 01 Jan. The $7,500 credit was halved to $3,750. To counter that loss, Tesla announced it was reducing the price of all models by $2,000. Tesla isn't at risk of insolvency, and the EV market's growth trajectory is only going to get steeper as the march to replace the combustible engine picks up steam. Based on these two factors, is $300 the right price to jump into TSLA? It's hard to say, primarily because emotions are so heavily involved in TSLA trading.
Headlines for the Week of 23 Dec—29 Dec 2018
East/Southeast Asia
Hack gives Li'l Kim information on nearly 1,000 defectors in South Korea. When dealing with a mentally unstable, mercurial dictator who happens to be the leader of a socialist state, there really is only one strategic plan: containment and constant pressure at all levels. There can never be a lasting deal with a madman. We don't doubt that, for a brief tract of time, Kim Jong-un liked Donald Trump, and was willing to make a deal with the West, but that time is over. He will need to feign overtures to end the economic containment of his country, but he will never give up his war-fighting capabilities or end his electronic warfare against the civilized world. With respect to the latter, the South Korean Unification Ministry announced that a malware hack has allowed the release of the names, birth dates, and addresses of 997 North Koreans who had previously defected to the South. The Ministry, whose raison d'être is to support a "one Korea" solution, apologized for the lapse and has notified the defectors. That should comfort them (considering the fact that Kim's half-brother was killed in Kuala Lumpur). Investors need to understand this point: there will be times at which it appears all is relatively calm on the Korean peninsula, but that is a mirage. South Korea has a vibrant economy which happens to be the 11th largest in the world, but North Korean spies permeate the fabric of society in the South. The theft of intellectual property by the North on the South rivals only the IP theft of American technology by the Chinese. Fortunately (or unfortunately for the poor souls who live in the North), Li'l Kim doesn't have the economic infrastructure to do much with that technology—except undermine the South Korean economy as much as possible.
Media & Entertainment
Fortnite parent pocketed $3 billion in 2018. It isn't a publicly-traded company (yet), but if it were, Epic Games would have a value of $15 billion or so. That is due, in great measure, to its Fortnite release, which happens to be the world's most popular video game. Despite being "free" to players, once sucked into the game the 125 million or so gamers it currently boasts can buy digital items for their characters, such as outfits and dance moves. But how much can these nickel and dime purchases really yield for the company? According to insider reports, Epic grossed a $3 billion profit in 2018. Not revenues; gross profit. Epic, which Chinese conglomerate Tencent Holdings purchased a 48% stake in six years ago, just made another big move: it launched the Epic Game Store. Online gaming is now a $100 billion industry, and there are no signs of player fatigue—at least for the industry overall. Individual games, of course, can lose a fickle audience overnight. Looking for a way to ride the latest video game wave? The top publicly-traded companies in the space are Activision Blizzard (ATVI), Take-Two Interactive (TTWO), and Electronic Arts (EA). The latter happens to be on sale: its stock is down roughly 50% from July highs.
South Asia
Foxconn's India plans are another warning shot to China. The seductive concept of an emerging market with 1.4 billion potential new customers lured American companies to China. Now, more and more of these companies are realizing that conducting business in a communist country is fraught with dangers and pitfalls. While the government will never admit it, that country's written plan ("Made in China 2025") for world economic domination is now backfiring, as it provided a rallying cry to its biggest trading partners in the West. With the advent of the trade skirmishes, companies began scrambling to look for alternative locations to manufacture products without raising their labor costs greatly. The latest move comes from Taiwanese electronics parts-maker Foxconn, which just announced plans to begin producing high-end Apple (AAPL) iPhone parts in India. Foxconn is an enormous company. As the world's leading contract electronics manufacturer, the company employs nearly one million workers and generates an annual revenue of $160 billion (with lofty increases every year). India is a democratic republic, with no plans to take over the world (economically or otherwise), and with an equally-impressive 1.3 billion citizens. Expect more companies to follow Foxconn into this much "safer" manufacturing environment. Whether or not a trade deal gets done, China has a lot of trouble on its horizon. When investing in emerging markets in 2019, be sure and check the fund's exposure to China—you may be shocked at just how heavily the fund manager has overweighted the Chinese position.
Happiness Index
Christmas shopping rose a healthy 5.1%, but another metric is even more impressive. $850 billion. That is the amount Americans spent during the 2018 holiday shopping season. That figure represents a 5.1% increase over last year—and the strongest number in six years, according to Mastercard SpendingPulse. But there is an even more impressive number in the report: online sales rose nearly 20% from last year. This means that retailers who have embraced this new online reality should continue to excel, while those who have put forth a halfhearted effort into building their online presence will continue to struggle. Besides the obvious winners such as Amazon (AMZN), who had done the best with this strategic shift? Walmart (WMT) and Target (TGT) have both put a massive effort into their respective online shopping experience. The worst? Sears (SHLD), Kmart (SHLD), and Marshalls (TJX). With the beaten-down market, there are a lot of great opportunities in retail, but beware of the shops who have not "figured it out" yet; the future of the retailing experience, that is. We expect big winners to include: Amazon, Walmart, Target, Best Buy (BBY), and Macy's (M)—though that last example could end up going either way. Of course, all of that online ordering requires a shipper to deliver it to your door. Here, we like FedEx (FDX), hands down. It happens to be on sale right now as well!
Hack gives Li'l Kim information on nearly 1,000 defectors in South Korea. When dealing with a mentally unstable, mercurial dictator who happens to be the leader of a socialist state, there really is only one strategic plan: containment and constant pressure at all levels. There can never be a lasting deal with a madman. We don't doubt that, for a brief tract of time, Kim Jong-un liked Donald Trump, and was willing to make a deal with the West, but that time is over. He will need to feign overtures to end the economic containment of his country, but he will never give up his war-fighting capabilities or end his electronic warfare against the civilized world. With respect to the latter, the South Korean Unification Ministry announced that a malware hack has allowed the release of the names, birth dates, and addresses of 997 North Koreans who had previously defected to the South. The Ministry, whose raison d'être is to support a "one Korea" solution, apologized for the lapse and has notified the defectors. That should comfort them (considering the fact that Kim's half-brother was killed in Kuala Lumpur). Investors need to understand this point: there will be times at which it appears all is relatively calm on the Korean peninsula, but that is a mirage. South Korea has a vibrant economy which happens to be the 11th largest in the world, but North Korean spies permeate the fabric of society in the South. The theft of intellectual property by the North on the South rivals only the IP theft of American technology by the Chinese. Fortunately (or unfortunately for the poor souls who live in the North), Li'l Kim doesn't have the economic infrastructure to do much with that technology—except undermine the South Korean economy as much as possible.
Media & Entertainment
Fortnite parent pocketed $3 billion in 2018. It isn't a publicly-traded company (yet), but if it were, Epic Games would have a value of $15 billion or so. That is due, in great measure, to its Fortnite release, which happens to be the world's most popular video game. Despite being "free" to players, once sucked into the game the 125 million or so gamers it currently boasts can buy digital items for their characters, such as outfits and dance moves. But how much can these nickel and dime purchases really yield for the company? According to insider reports, Epic grossed a $3 billion profit in 2018. Not revenues; gross profit. Epic, which Chinese conglomerate Tencent Holdings purchased a 48% stake in six years ago, just made another big move: it launched the Epic Game Store. Online gaming is now a $100 billion industry, and there are no signs of player fatigue—at least for the industry overall. Individual games, of course, can lose a fickle audience overnight. Looking for a way to ride the latest video game wave? The top publicly-traded companies in the space are Activision Blizzard (ATVI), Take-Two Interactive (TTWO), and Electronic Arts (EA). The latter happens to be on sale: its stock is down roughly 50% from July highs.
South Asia
Foxconn's India plans are another warning shot to China. The seductive concept of an emerging market with 1.4 billion potential new customers lured American companies to China. Now, more and more of these companies are realizing that conducting business in a communist country is fraught with dangers and pitfalls. While the government will never admit it, that country's written plan ("Made in China 2025") for world economic domination is now backfiring, as it provided a rallying cry to its biggest trading partners in the West. With the advent of the trade skirmishes, companies began scrambling to look for alternative locations to manufacture products without raising their labor costs greatly. The latest move comes from Taiwanese electronics parts-maker Foxconn, which just announced plans to begin producing high-end Apple (AAPL) iPhone parts in India. Foxconn is an enormous company. As the world's leading contract electronics manufacturer, the company employs nearly one million workers and generates an annual revenue of $160 billion (with lofty increases every year). India is a democratic republic, with no plans to take over the world (economically or otherwise), and with an equally-impressive 1.3 billion citizens. Expect more companies to follow Foxconn into this much "safer" manufacturing environment. Whether or not a trade deal gets done, China has a lot of trouble on its horizon. When investing in emerging markets in 2019, be sure and check the fund's exposure to China—you may be shocked at just how heavily the fund manager has overweighted the Chinese position.
Happiness Index
Christmas shopping rose a healthy 5.1%, but another metric is even more impressive. $850 billion. That is the amount Americans spent during the 2018 holiday shopping season. That figure represents a 5.1% increase over last year—and the strongest number in six years, according to Mastercard SpendingPulse. But there is an even more impressive number in the report: online sales rose nearly 20% from last year. This means that retailers who have embraced this new online reality should continue to excel, while those who have put forth a halfhearted effort into building their online presence will continue to struggle. Besides the obvious winners such as Amazon (AMZN), who had done the best with this strategic shift? Walmart (WMT) and Target (TGT) have both put a massive effort into their respective online shopping experience. The worst? Sears (SHLD), Kmart (SHLD), and Marshalls (TJX). With the beaten-down market, there are a lot of great opportunities in retail, but beware of the shops who have not "figured it out" yet; the future of the retailing experience, that is. We expect big winners to include: Amazon, Walmart, Target, Best Buy (BBY), and Macy's (M)—though that last example could end up going either way. Of course, all of that online ordering requires a shipper to deliver it to your door. Here, we like FedEx (FDX), hands down. It happens to be on sale right now as well!
Headlines for the Week of 16 Dec—22 Dec 2018
Market Pulse
A week to forget. So much for the Santa Claus Rally. Actually, the phenomenon typically happens in the last week of December, but that would be some heavy lifting to ask of just 3.5 trading days before the new year. Instead of the rally, we just got the worst week for the markets since the 2008 financial crisis, with US equities losing $2 trillion of value. December, typically one of the stronger months of the year, is heading for its worst showing since 1931. After the Santa Claus Rally comes the January Effect, which occurs as investors pick up stocks which they might have sold in December for tax-loss harvesting, and as big organizations rebalance their portfolios. The good news continues to be a relatively strong US economy, with no sign of recession on the horizon for 2019. This "feels" more like the October/November timeframe of 1987 (yes, I was invested, and yes, I had a Business Week subscription, which came to my USAF base). In October of 1987, the S&P 500 was down something like 23%, and the slide continued into November (down another 9% or so). Time will tell. In the meantime, we continue to make sure our asset allocation looks good, and check that our stops are on the appropriate positions. The median investment house forecast for 2019 (as of the start of this past week) is 3,200 on the S&P 500 by year's-end. That would represent a 33% gain between now and then. The last thing investors felt like doing by the end of November, 1987 was having money in the market. Look at the percentage increase between November, 1987 and June, 1988.
Multiline Retail
Trade Action: This major multiline retailer is simply too undervalued to pass up. Members can see the purchase we just added to the Intrepid Trading Platform by signing in. Trading Desk.
Global Strategy: E/SE Asia
In long overdue move, the US just ratcheted up the fight on Chinese-sponsored economic espionage. One of the (few) bright spots we have anticipated for the markets in the coming year revolves around a US/China trade deal getting done. They will never admit it, but China desperately needs a deal, as their economy is suffering greatly. At first glance, Thursday's actions by the FBI seemed to throw a wrench into the works. The agency brought forth criminal charges against two Chinese citizens for their role in a state-sponsored espionage campaign against US government agencies and American companies. The two were part of a group labeled APT10 by US intelligence officials, with the acronym standing for "advanced persistent threats." This has been an ongoing effort to steal sensitive and highly technical data from such industries as aerospace, banking and finance, healthcare, automotive, and mining. Most importantly, these charges came after a coordinated effort between the US, Canada, Japan, and the UK. While there is an Interpol issue out for the arrest of these two individuals, there is virtually no chance they will travel outside of the safety of China and risk arrest. It should be noted that the Chinese have audaciously stepped up their intellectual property theft efforts since they signed a pact with then-President Obama back in 2015 promising to end such behavior. One thing is certain, no matter what deal they sign to ease their economic pain, they will cheat (on any deal) to the greatest possible degree. Some deal will probably be hammered out, and most or all of the tariffs will be lifted, but it won't take long for China to get caught hacking, once again, into US systems. The best bet, besides the legal efforts, will be for the US to continue development of its quantum computing program. Potential winners in this new "arms" race will be IBM, Google, Microsoft, and Intel.
Monetary Policy
Powell's second mistake at the FOMC news conference. In addition to the harshly-negative reaction the markets had to Powell's "more hikes to come" comments following the ninth rate hike in three years, there was something else he alluded to that angered and spooked investors. Of the Fed's four major tools for shaping monetary policy, two are at the forefront right now: moving the federal funds rate (which it did on Wednesday), and controlling the size of its balance sheet through open market operations. As if the specter of two more rate hikes in 2019 wasn't bad enough, Powell made it clear that the systematic unwinding of the $4 trillion balance sheet (already reduced from $4.5 trillion) would continue like clockwork. The Fed is currently allowing roughly $50 billion per month to run off the balance sheet by letting government debt instruments simply mature, and not issuing new debt to replace it. On its face, that sounds like good fiscal policy, as it reduces the overall level of government debt. But investors see a lot of troubling factors on the horizon, and they expected Powell to tip his hat to this and hint that the unwinding, or quantitative tightening (QT, as opposed to QE) might be put on pause or, at least, slowed. They were sadly disappointed. Forget what Powell says, signs that the Fed "gets it" will come in the form a reduced runoff of the balance sheet. I use the Federal Reserve Board website to look at the data. I have placed a link to this site at the top of the Monetary Policy page at PennEconomics. Take a look!
Pharmaceuticals
Pfizer and Glaxo to create world's largest seller of over-the-counter drugs. Earlier this year, we discussed soon-to-be-former CEO Ian Read's plan to split Pfizer (PFE $33-$42-$46) into three distinct parts—one being the Consumer Healthcare Unit which makes and markets over-the-counter medications. Ever since that idea was hatched, Pfizer has had something else in mind: selling that unit altogether to focus on the more lucrative prescription drug market. British drugmaker GlaxoSmithKline plc (GSK $35-$37-$42) relies on its OTC business for about 25% of revenues (versus 7% at Pfizer), but Read came to them with an offer they couldn't refuse—merging both companies' respective units into one, creating the largest non-prescription drug seller in the world. Product lines would include familiar names like: Advil, Tums, Centrum, Chapstick, Sensodyne, Boost, and Abreva. The new company will, more than likely, be listed on the London Stock Exchange, with GSK owning roughly two-thirds of the entity and Pfizer owning the other one-third. We have competing thoughts on this deal. Pfizer, which is currently in the Penn Global Leaders Club, will lose a consistent money-maker to focus on its riskier (by nature) prescription drug business. The same goes for Glaxo. We will further outline the positives and negatives of the move in the next issue of The Penn Wealth Report.
Monetary Policy
Another rate hike: fed funds rate now at 2.5%, long-run funds rate lowered to 2.8%. It was one of the most heated periods of debate leading up to any FOMC meeting in recent memory. And the camps were about evenly split between "the Fed must raise rates," and "the Fed will lose credibility if it raises rates again." Going into the 1pm CST decision, the Dow was up nearly 300 points; within seconds after the announcement, it was flat. What bothered the markets so much wasn't the highly-anticipated ninth rate hike since October of 2015, it was the fact that the language wasn't quite dovish enough. If Fed Chair Powell hadn't said that more rate hikes will probably be needed in 2019, markets probably would have maintained their gains on the day. Instead, he hinted at two more hikes in 2019, and potentially even one for 2020. The "long-run funds rate," which had been at 3%, was lowered to 2.8%. That would indicate one to two more hikes next year—not what investors wanted to hear. Despite the loss of most of the day's gains after the Fed announcement, markets can digest this one (mainly because stocks have been so deflated this quarter already). However, if the Fed obstinately raises rates in 2019, expect an immediate tantrum in the markets. One more X-factor to be concerned with next year.
Corporate Governance
If economic conditions are deteriorating, why did American companies just buy back $1.1 trillion worth of their own stock? The latest was aerospace giant Boeing (BA $293-$327-$394), whose board of directors just approved a whopping $20 billion share buyback and a hefty hike in the dividend. The CFO cited strong aircraft demand for the actions. Before that it was Johnson & Johnson (JNJ $119-$130-$149), which announced a $5 billion buyback after shares got pounded on new (unsubstantiated) claims of asbestos in the company's talc. All told, it has been a record year for buybacks at American firms. To date in 2018, over $1 trillion has been committed, and over $800 billion already spent. There is one universal theme to these massive buybacks: the respective CFOs of the companies see their shares as being grossly undervalued. And who would be in a better position to gauge a company's health than their CFO? The global economy is indeed probably slowing a bit, but that doesn't warrant the big selloff we have seen this quarter. Forget what CEOs and CFOs say in quarterly conference calls for the consumption of the analysts and investors; instead, watch what they actually do for clues on how a stock might perform going forward. Buybacks are one of the metrics we use to gauge a company's probable stock performance, at least in the short run.
E-Commerce
Blue Apron just became a penny stock. When I was a relative "kid" in the 1980s, I had a subscription to a weekly newspaper called The Penny Stock News. It listed all of the publicly-traded stocks with share prices below $10. One issue I recall highlighted a company called The Puerto Rican Cement Company, which had just risen some 5,000% in price, moving from something like a dime up to five bucks or so per share. Home meal kit provider Blue Apron (APRN $1-$1-$5) should be so lucky (to be trading at $5). They would, however, now qualify to be an entry in The Penny Stock News, as their share price fell to $0.87 on Tuesday. It was a slow-moving train wreck from the start. With so much competition, what were the owners thinking? They could have stayed private and eked out a nice living for themselves, outside of the spotlight of the investing public. There was just too much competition in the space, with no real unique value proposition (UVP) for any one of these companies. We said back in September of 2017 that the company's only hope was to find a deep-pocketed buyer, such as Walmart (WMT) or another grocery chain. Well, Walmart has started their own meal kit business, Albertson's has purchased Blue Apron competitor Plated, and Kroger (KR) acquired Home Chef, so it is not looking good for the new penny stock. It's easy for founders to be blinded by the perceived value of a company they started, but there is no excuse for investors not to consider a company's unique value (or selling) proposition. If the products or services can't justifiably stand out from the competition in any meaningful way, what would be the catalyst for purchasing shares? A question that investors who got in on the IPO of Blue Apron are probably asking themselves right now.
Energy Commodities
Oil breaks into the $40s, hitting new 2018 low. Oversupply and concerns about a global economic slowdown helped drive down crude oil futures down to their lowest level since August of 2017, falling 25% in the last three months alone. That's great news for drivers, not so much for US drillers. However, oil would have to drop to the mid-$40s range for most drillers in this country to see their profits evaporate. It was just a few weeks ago that the OPEC/Russian alliance agreed to cut production by 1.2 million barrels per day (BPD), but considering the fact that the US is now producing a record 12 million BPD, and that Russia will probably cheat (low oil is killing their economy), downward pressure remains intact. Additionally, Mexico's President "Amlo," who took office on 01 Dec, announced plans to raise that country's oil and gas output by 50% within the next six years. US light crude closed Tuesday's session at $45.91 per barrel. Despite the oversupply and global growth concerns, the mid-$40s is, we believe, the bottom channel for US light crude. For action we took in this area, members can visit the Trading Desk.
Media & Entertainment
Disney hits $7 billion in global box office ticket sales for the second time in the industry's history. There have been only two times in which a movie studio has broken through the $7 billion mark in annual global ticket sales, and the same company is responsible for both. Walt Disney (DIS $98-$113-$120) just surpassed that mark with a strong box office showing by "Ralph Breaks the Internet," the animated sequel to their 2012 hit "Wreck-It Ralph." Disney is nearing its old Hollywood record of $7.6 billion in ticket sales which it racked up in 2016, but can it surpass that figure? Considering the fact that "Mary Poppins Returns" will hit theaters on the 19th of December, it is almost a given. What were the top two Disney blockbusters thus far in 2018? Marvel's "Avengers: Infinity War" and Marvel's "Black Panther" topped the global and domestic box offices, respectively. It appears the $4.24 billion Disney payed for Marvel back in 2009 was a pretty smart deal. Disney is one of the 40 holdings in the Penn Global Leaders Club. Although Disney is now in the new Communications Services sector (moving over from Consumer Discretionary in September), it is certainly still a "discretionary goods" company—meaning nobody really needs Disney's products to survive. While companies which sell discretionary goods and services are typically the first to get hit as an economy slows down on its way to a cyclical recession, Disney is moving forward at a fast clip with its strategic plan to create an annuitized stream of income through its planned subscription services. This should help the company weather any downturns quite nicely. With its 13 PE ratio and 40 Relative Strength Index rating, we still consider the company undervalued.
A week to forget. So much for the Santa Claus Rally. Actually, the phenomenon typically happens in the last week of December, but that would be some heavy lifting to ask of just 3.5 trading days before the new year. Instead of the rally, we just got the worst week for the markets since the 2008 financial crisis, with US equities losing $2 trillion of value. December, typically one of the stronger months of the year, is heading for its worst showing since 1931. After the Santa Claus Rally comes the January Effect, which occurs as investors pick up stocks which they might have sold in December for tax-loss harvesting, and as big organizations rebalance their portfolios. The good news continues to be a relatively strong US economy, with no sign of recession on the horizon for 2019. This "feels" more like the October/November timeframe of 1987 (yes, I was invested, and yes, I had a Business Week subscription, which came to my USAF base). In October of 1987, the S&P 500 was down something like 23%, and the slide continued into November (down another 9% or so). Time will tell. In the meantime, we continue to make sure our asset allocation looks good, and check that our stops are on the appropriate positions. The median investment house forecast for 2019 (as of the start of this past week) is 3,200 on the S&P 500 by year's-end. That would represent a 33% gain between now and then. The last thing investors felt like doing by the end of November, 1987 was having money in the market. Look at the percentage increase between November, 1987 and June, 1988.
Multiline Retail
Trade Action: This major multiline retailer is simply too undervalued to pass up. Members can see the purchase we just added to the Intrepid Trading Platform by signing in. Trading Desk.
Global Strategy: E/SE Asia
In long overdue move, the US just ratcheted up the fight on Chinese-sponsored economic espionage. One of the (few) bright spots we have anticipated for the markets in the coming year revolves around a US/China trade deal getting done. They will never admit it, but China desperately needs a deal, as their economy is suffering greatly. At first glance, Thursday's actions by the FBI seemed to throw a wrench into the works. The agency brought forth criminal charges against two Chinese citizens for their role in a state-sponsored espionage campaign against US government agencies and American companies. The two were part of a group labeled APT10 by US intelligence officials, with the acronym standing for "advanced persistent threats." This has been an ongoing effort to steal sensitive and highly technical data from such industries as aerospace, banking and finance, healthcare, automotive, and mining. Most importantly, these charges came after a coordinated effort between the US, Canada, Japan, and the UK. While there is an Interpol issue out for the arrest of these two individuals, there is virtually no chance they will travel outside of the safety of China and risk arrest. It should be noted that the Chinese have audaciously stepped up their intellectual property theft efforts since they signed a pact with then-President Obama back in 2015 promising to end such behavior. One thing is certain, no matter what deal they sign to ease their economic pain, they will cheat (on any deal) to the greatest possible degree. Some deal will probably be hammered out, and most or all of the tariffs will be lifted, but it won't take long for China to get caught hacking, once again, into US systems. The best bet, besides the legal efforts, will be for the US to continue development of its quantum computing program. Potential winners in this new "arms" race will be IBM, Google, Microsoft, and Intel.
Monetary Policy
Powell's second mistake at the FOMC news conference. In addition to the harshly-negative reaction the markets had to Powell's "more hikes to come" comments following the ninth rate hike in three years, there was something else he alluded to that angered and spooked investors. Of the Fed's four major tools for shaping monetary policy, two are at the forefront right now: moving the federal funds rate (which it did on Wednesday), and controlling the size of its balance sheet through open market operations. As if the specter of two more rate hikes in 2019 wasn't bad enough, Powell made it clear that the systematic unwinding of the $4 trillion balance sheet (already reduced from $4.5 trillion) would continue like clockwork. The Fed is currently allowing roughly $50 billion per month to run off the balance sheet by letting government debt instruments simply mature, and not issuing new debt to replace it. On its face, that sounds like good fiscal policy, as it reduces the overall level of government debt. But investors see a lot of troubling factors on the horizon, and they expected Powell to tip his hat to this and hint that the unwinding, or quantitative tightening (QT, as opposed to QE) might be put on pause or, at least, slowed. They were sadly disappointed. Forget what Powell says, signs that the Fed "gets it" will come in the form a reduced runoff of the balance sheet. I use the Federal Reserve Board website to look at the data. I have placed a link to this site at the top of the Monetary Policy page at PennEconomics. Take a look!
Pharmaceuticals
Pfizer and Glaxo to create world's largest seller of over-the-counter drugs. Earlier this year, we discussed soon-to-be-former CEO Ian Read's plan to split Pfizer (PFE $33-$42-$46) into three distinct parts—one being the Consumer Healthcare Unit which makes and markets over-the-counter medications. Ever since that idea was hatched, Pfizer has had something else in mind: selling that unit altogether to focus on the more lucrative prescription drug market. British drugmaker GlaxoSmithKline plc (GSK $35-$37-$42) relies on its OTC business for about 25% of revenues (versus 7% at Pfizer), but Read came to them with an offer they couldn't refuse—merging both companies' respective units into one, creating the largest non-prescription drug seller in the world. Product lines would include familiar names like: Advil, Tums, Centrum, Chapstick, Sensodyne, Boost, and Abreva. The new company will, more than likely, be listed on the London Stock Exchange, with GSK owning roughly two-thirds of the entity and Pfizer owning the other one-third. We have competing thoughts on this deal. Pfizer, which is currently in the Penn Global Leaders Club, will lose a consistent money-maker to focus on its riskier (by nature) prescription drug business. The same goes for Glaxo. We will further outline the positives and negatives of the move in the next issue of The Penn Wealth Report.
Monetary Policy
Another rate hike: fed funds rate now at 2.5%, long-run funds rate lowered to 2.8%. It was one of the most heated periods of debate leading up to any FOMC meeting in recent memory. And the camps were about evenly split between "the Fed must raise rates," and "the Fed will lose credibility if it raises rates again." Going into the 1pm CST decision, the Dow was up nearly 300 points; within seconds after the announcement, it was flat. What bothered the markets so much wasn't the highly-anticipated ninth rate hike since October of 2015, it was the fact that the language wasn't quite dovish enough. If Fed Chair Powell hadn't said that more rate hikes will probably be needed in 2019, markets probably would have maintained their gains on the day. Instead, he hinted at two more hikes in 2019, and potentially even one for 2020. The "long-run funds rate," which had been at 3%, was lowered to 2.8%. That would indicate one to two more hikes next year—not what investors wanted to hear. Despite the loss of most of the day's gains after the Fed announcement, markets can digest this one (mainly because stocks have been so deflated this quarter already). However, if the Fed obstinately raises rates in 2019, expect an immediate tantrum in the markets. One more X-factor to be concerned with next year.
Corporate Governance
If economic conditions are deteriorating, why did American companies just buy back $1.1 trillion worth of their own stock? The latest was aerospace giant Boeing (BA $293-$327-$394), whose board of directors just approved a whopping $20 billion share buyback and a hefty hike in the dividend. The CFO cited strong aircraft demand for the actions. Before that it was Johnson & Johnson (JNJ $119-$130-$149), which announced a $5 billion buyback after shares got pounded on new (unsubstantiated) claims of asbestos in the company's talc. All told, it has been a record year for buybacks at American firms. To date in 2018, over $1 trillion has been committed, and over $800 billion already spent. There is one universal theme to these massive buybacks: the respective CFOs of the companies see their shares as being grossly undervalued. And who would be in a better position to gauge a company's health than their CFO? The global economy is indeed probably slowing a bit, but that doesn't warrant the big selloff we have seen this quarter. Forget what CEOs and CFOs say in quarterly conference calls for the consumption of the analysts and investors; instead, watch what they actually do for clues on how a stock might perform going forward. Buybacks are one of the metrics we use to gauge a company's probable stock performance, at least in the short run.
E-Commerce
Blue Apron just became a penny stock. When I was a relative "kid" in the 1980s, I had a subscription to a weekly newspaper called The Penny Stock News. It listed all of the publicly-traded stocks with share prices below $10. One issue I recall highlighted a company called The Puerto Rican Cement Company, which had just risen some 5,000% in price, moving from something like a dime up to five bucks or so per share. Home meal kit provider Blue Apron (APRN $1-$1-$5) should be so lucky (to be trading at $5). They would, however, now qualify to be an entry in The Penny Stock News, as their share price fell to $0.87 on Tuesday. It was a slow-moving train wreck from the start. With so much competition, what were the owners thinking? They could have stayed private and eked out a nice living for themselves, outside of the spotlight of the investing public. There was just too much competition in the space, with no real unique value proposition (UVP) for any one of these companies. We said back in September of 2017 that the company's only hope was to find a deep-pocketed buyer, such as Walmart (WMT) or another grocery chain. Well, Walmart has started their own meal kit business, Albertson's has purchased Blue Apron competitor Plated, and Kroger (KR) acquired Home Chef, so it is not looking good for the new penny stock. It's easy for founders to be blinded by the perceived value of a company they started, but there is no excuse for investors not to consider a company's unique value (or selling) proposition. If the products or services can't justifiably stand out from the competition in any meaningful way, what would be the catalyst for purchasing shares? A question that investors who got in on the IPO of Blue Apron are probably asking themselves right now.
Energy Commodities
Oil breaks into the $40s, hitting new 2018 low. Oversupply and concerns about a global economic slowdown helped drive down crude oil futures down to their lowest level since August of 2017, falling 25% in the last three months alone. That's great news for drivers, not so much for US drillers. However, oil would have to drop to the mid-$40s range for most drillers in this country to see their profits evaporate. It was just a few weeks ago that the OPEC/Russian alliance agreed to cut production by 1.2 million barrels per day (BPD), but considering the fact that the US is now producing a record 12 million BPD, and that Russia will probably cheat (low oil is killing their economy), downward pressure remains intact. Additionally, Mexico's President "Amlo," who took office on 01 Dec, announced plans to raise that country's oil and gas output by 50% within the next six years. US light crude closed Tuesday's session at $45.91 per barrel. Despite the oversupply and global growth concerns, the mid-$40s is, we believe, the bottom channel for US light crude. For action we took in this area, members can visit the Trading Desk.
Media & Entertainment
Disney hits $7 billion in global box office ticket sales for the second time in the industry's history. There have been only two times in which a movie studio has broken through the $7 billion mark in annual global ticket sales, and the same company is responsible for both. Walt Disney (DIS $98-$113-$120) just surpassed that mark with a strong box office showing by "Ralph Breaks the Internet," the animated sequel to their 2012 hit "Wreck-It Ralph." Disney is nearing its old Hollywood record of $7.6 billion in ticket sales which it racked up in 2016, but can it surpass that figure? Considering the fact that "Mary Poppins Returns" will hit theaters on the 19th of December, it is almost a given. What were the top two Disney blockbusters thus far in 2018? Marvel's "Avengers: Infinity War" and Marvel's "Black Panther" topped the global and domestic box offices, respectively. It appears the $4.24 billion Disney payed for Marvel back in 2009 was a pretty smart deal. Disney is one of the 40 holdings in the Penn Global Leaders Club. Although Disney is now in the new Communications Services sector (moving over from Consumer Discretionary in September), it is certainly still a "discretionary goods" company—meaning nobody really needs Disney's products to survive. While companies which sell discretionary goods and services are typically the first to get hit as an economy slows down on its way to a cyclical recession, Disney is moving forward at a fast clip with its strategic plan to create an annuitized stream of income through its planned subscription services. This should help the company weather any downturns quite nicely. With its 13 PE ratio and 40 Relative Strength Index rating, we still consider the company undervalued.
Headlines for the Week of 02 Dec—08 Dec 2018
Market Pulse
Investors got it dead wrong on Friday: a trade deal gets done and the markets rally. Certainly, the rise of electronic trading and "quant" funds had a lot to do with the recent selloff—when certain benchmarks hit a certain point computer programs initiate a sell. But the fundamental reason for the wild swings in this week's trading revolved around the arrest of the Huawei executive in Canada and the presumption that this quashes a trade deal between the US and China. Investors got it dead wrong: a trade deal happens and the markets surge. There will be a lot of disconcerting issues in 2019, to be sure; the trade deal with China, however, will come off the table as an issue relatively early. Many major US firms believe this as well, as evidenced by the massive stock buyback programs currently underway. Facebook's (FB $127-$139-$219) board of directors, for example, just raised that company's stock buyback plan by a whopping $9 billion. Again, there will be lot of issues to be concerned with in 2019, but major trade issues will be resolved relatively soon. Additionally, the other major disruptive issue for the markets, interest rate hikes, will cease to be a drag on the markets as the Fed continues to water down its hawkish tone. Look for a December hike and two more in 2019—very manageable for the economy in general and the housing market specifically.
Beverages & Tobacco Products
Altria is making the moves needed to survive in an anti-cigarette world. Yes, there are still plenty of smokers around the world. In fact, over 50% of Chinese men continue to smoke cigarettes (only 2.4% of Chinese women smoke) despite the health risks. Nonetheless, tobacco giant Altria (MO $53-$56-$74) sees the writing on the wall: increased government regulation and a continual stream of public opinion hit jobs done on the 2,000-year-old product will continue to erode sales. Despite owning the Marlboro brand, which holds a 40% market share globally, the $105 billion company has decided it is time to expand their horizons, making two recent moves which make a lot of sense. Last month is was reported that Altria will buy up to a 40% stake in e-cigarette company Juul Labs, by far the fastest growing e-cig on the market. Juul, in fact, now has roughly a 75% market share among all vaping devices, and the company produces some 20 million device pods per month. The second, and most recent move by Altria has enormous growth potential. While cigarettes (even vaping devices) are being demonized, the growth trajectory of cannabis sales around the world is sky high. To that end, big MO just took a $1.8 billion stake in Canadian marijuana grower Cronos (CRON $3-$13-$15). To put that investment in perspective, at the beginning of November Cronos had a market cap of $1.2 billion. The investment gives Altria 45% ownership of the firm along with warrants which could increase that stake to 55%. Read what we think of Altria's plans, and whether or not it is a good investment right now, in the next issue of The Penn Wealth Report.
Internet Retail
Amazon Go: cashierless store coming to an airport near you. You may recall us discussing Amazon Go earlier in the year—Amazon’s (AMZN $1,151-$1,699-$2,051) cashierless store experience in which you walk in, pick up what you want, and simply walk out. It seems as though the $831 billion retailer has found the perfect venue for launching these futuristic stores: your local airport. Reuters has reported of several meeting requests between Amazon executives and officials at a number of large US airports to discuss the idea. The locations seem ideal: hundreds of millions of time-constrained passengers fly in and out of major US airports each year. The ability to scan a smartphone at a turnstile entrance, pick up what you want, and then simply walk out and head to your gate would be wildly popular. Additionally, the relatively higher-level of security in non-gate areas of airports should help dissuade theft while Amazon continues to test and perfect the technology behind the concept. Read more about Amazon's strategic plans in the next issue of The Penn Wealth Report.
Global Strategy: Trade
Arrest of senior Huawei executive sends chills through markets as trade deal seen in jeopardy. Huawei (pron. "WAH weigh") Technologies is the pride and joy of China and a symbol of the country's burgeoning tech sector. The company is the world's leading supplier of network gear, and the second largest smartphone maker. It is also one of the world's chief perpetrators of intellectual property theft—with the government's tacit approval. Under that backdrop, let's consider what happened last Saturday. Unbeknownst to investors and perhaps even the respective presidents of the US and China, as trade relations were thawing over a dinner in Argentina, Huawei's CFO—and the daughter of the company's founder—was being arrested in Vancouver on charges of sanctions violations with Iran. Meng Wanzhou now faces possible extradition to the US on the charges. The Dow dropped nearly 800 points on news of the arrest before a massive rebound. Some believe Tuesday's big selloff was the result of insider information of the arrest. It seems almost unfathomable that neither of the two world leaders knew of the arrest before the Saturday dinner. This leads us to believe there is more to the story than is being reported, or is known. The Eurasia Group, a political risk consulting firm, believes this may well derail trade talks. We don't buy it. We look for some "unexpected" news to unfold in the coming days on the arrest.
Energy Commodities
Another crack in the bloc: Qatar to leave OPEC. In the big scheme of things, Qatar is somewhat of a blip on the radar screen within OPEC. In fact, you have to go through ten countries—from a production standpoint—until you get to the peninsular Arab nation. That being said, the country's decision to leave OPEC after 57 years (it joined the year after the organization was founded) is another sign of trouble for the once-dominant oil producing cabal. Why is Qatar leaving? In the first place, it has had a long-running spat with Saudi Arabia, OPEC's titular head, with the Saudis accusing Qatar of being a state sponsor of terrorism. Secondly, the country wants to curry favor with the US, and sees this as a way to stick it to Saudi Arabia and cozy up to the US at the same time. Qatar has some leverage: the country's breakeven point on oil—the point in the fulcrum at which it can still maintain a balanced budget—is $47 per barrel versus $88 for Saudi Arabia. Additionally, the tiny country is the world's largest exporter of liquified natural gas (LNG), so its reliance on oil is not as high. The move by Qatar, from the US standpoint, is a good one. Not only does it hurt OPEC, it keeps the US/Qatar alliance strong, and weakens the ties between Iran and Qatar. This move should help to keep oil prices near the lower band of their recent channel.
Capital Markets
Penn member Blackstone made a brilliant deal with Crocs investment. We talk a lot about corporate management—how a great CEO can allow a company to excel while a lousy CEO can drown a previously-strong company. In the asset management arena, few do it better than Stephen Schwarzman, the longtime CEO of Blackstone Group, LP (BX $30-$35-$41). A case in point is the company's $200 million investment four years ago in a struggling footwear company called Crocs (CROX). Back in early 2014, the maker of those ubiquitous, multi-colored rubber shoes needed some cash. Blackstone stepped in, making a $200 million investment in exchange for a 13% stake in the company, two board seats, and preferred stock which could be converted to common after three years at a price of $14.50/share. At the time, CROX was selling at $13 per share. Now, with Crocs selling at $29 per share, the company will buy back about half of those preferreds from Blackstone for $183.7 million—nearly equal to the asset manager's entire investment. Crocs CEO Andrew Rees praised the work of the Blackstone-positioned board members, saying that their strategic guidance had helped put them in the financial position to execute the buyback. Private equity deals take place every day, typically outside of the purview of the common investor. Owning shares of a company like Blackstone can give investors of every size a chance to see the inner-workings (or at least as much is required by the SEC) of a private equity firm. We own Blackstone Group in the Penn Strategic Income Portfolio. The company, by the way, has a 7% dividend yield.
Global Strategy: Europe
The powder keg issue of the Yellow Vest protests in France: gas tax hikes. Clashes between police and the so-called Yellow Vest protesters in France turned violent over the weekend, with little sign that either side is willing to back down. While the bigger issue is one of government overreach versus individual freedoms, this most recent movement stems from one specific action: the Macron government's decision to raise gas taxes (by the equivalent of about $0.30 per gallon) as part of a wider environmental push to reduce the use of fossil fuels. Average, ordinary French citizens see this carbon tax as a sign of just how out of touch the elitists in government really are, and they see Macron as one of the elites. It is a classic battle between the masses in flyover country, and the ruling class. And it is not limited to France—spillover protests are taking place in Belgium and other nations in Europe. Odds are great that the carbon tax will remain in place, further reducing Macron's already anemic approval numbers. As a small segment of the protesters deface and otherwise harm monuments and other symbols of national pride, public opinion will turn slightly against them—which the French press will happily help to foment. However, the simmering will continue. If the unemployment rate remains stubbornly high—it has been sitting near 9.5%—strikes and general protests will continue, and French/European GDP will continue to be flat. Another reason we are underweighting developed Europe in our international mix.
Investors got it dead wrong on Friday: a trade deal gets done and the markets rally. Certainly, the rise of electronic trading and "quant" funds had a lot to do with the recent selloff—when certain benchmarks hit a certain point computer programs initiate a sell. But the fundamental reason for the wild swings in this week's trading revolved around the arrest of the Huawei executive in Canada and the presumption that this quashes a trade deal between the US and China. Investors got it dead wrong: a trade deal happens and the markets surge. There will be a lot of disconcerting issues in 2019, to be sure; the trade deal with China, however, will come off the table as an issue relatively early. Many major US firms believe this as well, as evidenced by the massive stock buyback programs currently underway. Facebook's (FB $127-$139-$219) board of directors, for example, just raised that company's stock buyback plan by a whopping $9 billion. Again, there will be lot of issues to be concerned with in 2019, but major trade issues will be resolved relatively soon. Additionally, the other major disruptive issue for the markets, interest rate hikes, will cease to be a drag on the markets as the Fed continues to water down its hawkish tone. Look for a December hike and two more in 2019—very manageable for the economy in general and the housing market specifically.
Beverages & Tobacco Products
Altria is making the moves needed to survive in an anti-cigarette world. Yes, there are still plenty of smokers around the world. In fact, over 50% of Chinese men continue to smoke cigarettes (only 2.4% of Chinese women smoke) despite the health risks. Nonetheless, tobacco giant Altria (MO $53-$56-$74) sees the writing on the wall: increased government regulation and a continual stream of public opinion hit jobs done on the 2,000-year-old product will continue to erode sales. Despite owning the Marlboro brand, which holds a 40% market share globally, the $105 billion company has decided it is time to expand their horizons, making two recent moves which make a lot of sense. Last month is was reported that Altria will buy up to a 40% stake in e-cigarette company Juul Labs, by far the fastest growing e-cig on the market. Juul, in fact, now has roughly a 75% market share among all vaping devices, and the company produces some 20 million device pods per month. The second, and most recent move by Altria has enormous growth potential. While cigarettes (even vaping devices) are being demonized, the growth trajectory of cannabis sales around the world is sky high. To that end, big MO just took a $1.8 billion stake in Canadian marijuana grower Cronos (CRON $3-$13-$15). To put that investment in perspective, at the beginning of November Cronos had a market cap of $1.2 billion. The investment gives Altria 45% ownership of the firm along with warrants which could increase that stake to 55%. Read what we think of Altria's plans, and whether or not it is a good investment right now, in the next issue of The Penn Wealth Report.
Internet Retail
Amazon Go: cashierless store coming to an airport near you. You may recall us discussing Amazon Go earlier in the year—Amazon’s (AMZN $1,151-$1,699-$2,051) cashierless store experience in which you walk in, pick up what you want, and simply walk out. It seems as though the $831 billion retailer has found the perfect venue for launching these futuristic stores: your local airport. Reuters has reported of several meeting requests between Amazon executives and officials at a number of large US airports to discuss the idea. The locations seem ideal: hundreds of millions of time-constrained passengers fly in and out of major US airports each year. The ability to scan a smartphone at a turnstile entrance, pick up what you want, and then simply walk out and head to your gate would be wildly popular. Additionally, the relatively higher-level of security in non-gate areas of airports should help dissuade theft while Amazon continues to test and perfect the technology behind the concept. Read more about Amazon's strategic plans in the next issue of The Penn Wealth Report.
Global Strategy: Trade
Arrest of senior Huawei executive sends chills through markets as trade deal seen in jeopardy. Huawei (pron. "WAH weigh") Technologies is the pride and joy of China and a symbol of the country's burgeoning tech sector. The company is the world's leading supplier of network gear, and the second largest smartphone maker. It is also one of the world's chief perpetrators of intellectual property theft—with the government's tacit approval. Under that backdrop, let's consider what happened last Saturday. Unbeknownst to investors and perhaps even the respective presidents of the US and China, as trade relations were thawing over a dinner in Argentina, Huawei's CFO—and the daughter of the company's founder—was being arrested in Vancouver on charges of sanctions violations with Iran. Meng Wanzhou now faces possible extradition to the US on the charges. The Dow dropped nearly 800 points on news of the arrest before a massive rebound. Some believe Tuesday's big selloff was the result of insider information of the arrest. It seems almost unfathomable that neither of the two world leaders knew of the arrest before the Saturday dinner. This leads us to believe there is more to the story than is being reported, or is known. The Eurasia Group, a political risk consulting firm, believes this may well derail trade talks. We don't buy it. We look for some "unexpected" news to unfold in the coming days on the arrest.
Energy Commodities
Another crack in the bloc: Qatar to leave OPEC. In the big scheme of things, Qatar is somewhat of a blip on the radar screen within OPEC. In fact, you have to go through ten countries—from a production standpoint—until you get to the peninsular Arab nation. That being said, the country's decision to leave OPEC after 57 years (it joined the year after the organization was founded) is another sign of trouble for the once-dominant oil producing cabal. Why is Qatar leaving? In the first place, it has had a long-running spat with Saudi Arabia, OPEC's titular head, with the Saudis accusing Qatar of being a state sponsor of terrorism. Secondly, the country wants to curry favor with the US, and sees this as a way to stick it to Saudi Arabia and cozy up to the US at the same time. Qatar has some leverage: the country's breakeven point on oil—the point in the fulcrum at which it can still maintain a balanced budget—is $47 per barrel versus $88 for Saudi Arabia. Additionally, the tiny country is the world's largest exporter of liquified natural gas (LNG), so its reliance on oil is not as high. The move by Qatar, from the US standpoint, is a good one. Not only does it hurt OPEC, it keeps the US/Qatar alliance strong, and weakens the ties between Iran and Qatar. This move should help to keep oil prices near the lower band of their recent channel.
Capital Markets
Penn member Blackstone made a brilliant deal with Crocs investment. We talk a lot about corporate management—how a great CEO can allow a company to excel while a lousy CEO can drown a previously-strong company. In the asset management arena, few do it better than Stephen Schwarzman, the longtime CEO of Blackstone Group, LP (BX $30-$35-$41). A case in point is the company's $200 million investment four years ago in a struggling footwear company called Crocs (CROX). Back in early 2014, the maker of those ubiquitous, multi-colored rubber shoes needed some cash. Blackstone stepped in, making a $200 million investment in exchange for a 13% stake in the company, two board seats, and preferred stock which could be converted to common after three years at a price of $14.50/share. At the time, CROX was selling at $13 per share. Now, with Crocs selling at $29 per share, the company will buy back about half of those preferreds from Blackstone for $183.7 million—nearly equal to the asset manager's entire investment. Crocs CEO Andrew Rees praised the work of the Blackstone-positioned board members, saying that their strategic guidance had helped put them in the financial position to execute the buyback. Private equity deals take place every day, typically outside of the purview of the common investor. Owning shares of a company like Blackstone can give investors of every size a chance to see the inner-workings (or at least as much is required by the SEC) of a private equity firm. We own Blackstone Group in the Penn Strategic Income Portfolio. The company, by the way, has a 7% dividend yield.
Global Strategy: Europe
The powder keg issue of the Yellow Vest protests in France: gas tax hikes. Clashes between police and the so-called Yellow Vest protesters in France turned violent over the weekend, with little sign that either side is willing to back down. While the bigger issue is one of government overreach versus individual freedoms, this most recent movement stems from one specific action: the Macron government's decision to raise gas taxes (by the equivalent of about $0.30 per gallon) as part of a wider environmental push to reduce the use of fossil fuels. Average, ordinary French citizens see this carbon tax as a sign of just how out of touch the elitists in government really are, and they see Macron as one of the elites. It is a classic battle between the masses in flyover country, and the ruling class. And it is not limited to France—spillover protests are taking place in Belgium and other nations in Europe. Odds are great that the carbon tax will remain in place, further reducing Macron's already anemic approval numbers. As a small segment of the protesters deface and otherwise harm monuments and other symbols of national pride, public opinion will turn slightly against them—which the French press will happily help to foment. However, the simmering will continue. If the unemployment rate remains stubbornly high—it has been sitting near 9.5%—strikes and general protests will continue, and French/European GDP will continue to be flat. Another reason we are underweighting developed Europe in our international mix.
Headlines for the Week of 25 Nov—01 Dec 2018
Hotels, Resorts, and Cruise Lines
Another reason to dislike Marriott: up to 500M guests got their personal data hacked. Ever since the Blackstone Group (BX) took Hilton (HLT) public back in 2013, it has been our go-to hotel investment. Not only do we like the chain, we despise their biggest publicly-traded nemesis, Marriott (MAR $107-$115-$149). You may recall that we raked the company over the coals back in March due to their disgraceful treatment of employee Roy Jones; now, we have another reason to stay away from the company as an investment. Marriott reported that up to 500 million guests over the past four years had their personal data compromised. Data included passport numbers, home address and phone numbers, and payment card information. The breach stems from a hack at Starwood Hotels, which Marriott bought in 2016, and apparently began a full four years ago—which doesn't say much for the company's cybersecurity program. With 500 million potential victims, this is now the second-largest hack in history (behind Yahoo's damaging data breach). We see the global economy slowing down as we move into 2019, and don't expect much growth from this industry in the near future. That being said, Hilton and Royal Caribbean (RCL) are our two top picks in the industry.
Commercial Banks
More evidence that the German economy is floundering? Look no further than their prized bank. Back in January, we wrote a brief article on the $1.8 billion charge that Germany's leading private bank, Deutsche Bank (DB $9-$10-$20), would be taking thanks to tax reform in the US. At the time, DB was selling for $20 per share and had a market cap of $40 billion—down from its $60 billion market cap back in 2011. Apparently, a few "enterprising" bank officers tried to claw back some of those losses by helping some shady customers set up off-shore bank accounts to launder money. On Thursday morning, nearly 200 German police officers, prosecutors, and tax inspectors raided Deutsche Bank's offices in Frankfurt and other locations searching for evidence. Over 900 bank clients may have accounts at the DB subsidiary in the Virgin Islands at the center of the investigation. Shares of DB were trading down just over 3% on news of the raids. Is DB a bargain at $9.50 per share? We don't believe so. The bank had aspirations of competing against their American counterparts for big institutional deals, but this dark cloud hanging over the institution has repelled potential clients. Furthermore, the European Central Bank is not taking the proactive steps necessary (unlike the US Fed) to create a positive environment for the big European banks. Stick to North American financial institutions for now, i.e. US and Canadian commercial banks.
Market Pulse
Fed Chairman pushes Dow up over 600 points with dovish speech. It didn't take much, just one little nuanced line that "we are nearing neutral" with respect to interest rates. But that line, delivered to the Economic Club of New York by Fed Chair Jay Powell, was enough to push the Dow higher by 618 points, the S&P 500 by 62 points, and the NASDAQ by a whopping 209 points by Wednesday's close. It really was a refreshing speech by Powell, who has been especially hawkish in his views on rate hikes. Just this past summer he insinuated that we are "well below normal" with respect to rates. So, what does this mean for a December hike? Probably nothing—it is all but baked in. But it does mean that the Fed will probably limit 2019 to a few hikes and be done. We believe that this is a goldilocks scenario (overused term, we know) for rates. They will get high enough for clients to grab some decent yielding bonds, but remain low enough that the housing market won't get crushed. This actually makes us a bit more sanguine and upbeat about 2019.
Specialty Retailer
In the midst of a bull session, Chico's has its worst day ever. Specialty women's retailer Chico's Fashion (CHS $4-$5-$11) closed the trading day on Tuesday at $7.32 per share. By the time the market opened on Wednesday, CHS had fallen to $5.01/share and one-third of its market cap was gone. (This is a great lesson for anyone using stop-losses, by the way.) What caused the massive drop? An earnings report that didn't live up to expectations and a downgrade of the company's full-year outlook. Third-quarter revenues fell 6% YOY, from $532M in Q3 of 2017 to $500M this past quarter. Earnings were equally as disappointing, falling from $0.13 per share to $0.05 per share, a 62% drop. Our take? Don't get sucked in by the 7 PE ratio or the 7% dividend yield. We don't see what could possibly turn this tiny ($665M) boat around, especially in the shark-infested waters of the retail world.
Housing
Don't fear all of the negative headlines about homebuilders, buyers will adapt to higher mortgage rates. For virtually all of 2018, the overwhelming majority of housing headlines have been somewhere between blah and dire. We recently reported, in fact, that our benchmark homebuilder ETF, the iShares US Home Construction fund (ITB), is now down 29% YTD. Today's news was more of the same: new single-family home sales fell 8.9% in October, and 12% from the same period a year ago. The regular tick-up in the median new home price actually ticked down for the month, falling 3.1% to $309,700. One last data point: the average 30-year mortgage rate has risen from 3.95% at the start of January to 4.81% right now. We believe this backdrop is too gloomy, however, and we don't buy the hype that a huge housing correction is coming. We will see, more than likely, three to four more rate hikes before we plateau. Four more hikes would probably cap the 30-year average mortgage rate at somewhere around 6%—a "reasonable" level. Certainly not high enough for another mass migration to rental units like we saw following the 2008-2009 housing crisis. While we don't currently own any homebuilders in any of the Penn portfolios, valuations are making several of them mighty tempting. Lennar (LEN), Pulte (PHM), and D.R. Horton (DHI), for example, all have PE ratios in the high single digits—about half of where they were sitting at the start of the year. The Index ETF, symbol ITB, has fallen from $45 at the start of the year to a current price of $31.26.
E-Commerce
When you think online advertising, two names come to mind; but the new #3 may surprise you. Alphabet's (GOOGL $984-$1,049-$1,291) chief subsidiary, Google, is obviously the undisputed leader in online advertising. In fact, one out of every three dollars spent around the globe on digital advertising goes into the pockets of Google. Put another way, about 95% of Alphabet's $130 billion in revenues TTM was generated from ad dollars. In second place would be Facebook (FB), with virtually all of its $52 billion in TTM revenue coming from online ads. So, who is in third place? Twitter (TWTR) was our immediate guess. Alas, that was incorrect. Online retailer Amazon (AMZN), of all companies, just took the bronze medal for online ad revenue, surpassing Verizon (VZ) and Microsoft (MSFT). Granted, the company's $4.6 billion ad take is peanuts when compared to the first- and second-place players, but their dominant e-commerce business makes perfect sense for companies looking to highlight their products and services. Expect the company to rapidly increase its ad market share over the coming years. How far we have come from the Mad Men age of the 1960s. While traditional ad agencies still exist (WPP is the largest, at $16 billion), over half of all money spent on ads now go into the online venue. The importance of this when evaluating Alphabet, Facebook, and Amazon as investments should not be underestimated. As for Twitter, the company is at risk of losing the advertisers it already has unless it dramatically changes its strategy.
Tech Hardware, Storage, & Peripherals
Who just caught up to Apple in size? When Apple (AAPL $150-$173-$233) became the first trillion-dollar company in history, it had a couple of tech giants in its rear view mirror; namely, Alphabet (GOOGL) and Amazon (AMZN). What few would have predicted is yet another company, stodgy old Microsoft (MSFT), being the one to catch the Cupertino-based iPhone maker. But that's just what happened: both Microsoft and Apple now have a market cap of $821 billion. Of course, Apple did the heavy lifting, falling nearly 25% within the past two months. We believe both companies are excellent buys at their respective share prices. And both continue to develop world-class services businesses which assure a steady stream of monthly income from users. We pay both each month, and it would be difficult to turn off either stream. In other words, they have created a "sticky" customer base.
Alternatives: Commodities
Goldman is predicting commodities will launch in 2019. Goldman Sachs doesn't exactly have a perfect record with respect to its past commodities predictions, but we do find this one interesting. The $72 billion financial services firm said the upcoming G-20 meeting in Argentina could be the catalyst needed for the beginning of a big uptick—perhaps 17% over the coming months—in commodities overall. Specifically, analysts at the firm claim the markets have not baked any potential thawing of US-China relations into the equation; an event which would certainly help commodity prices. Which commodities will rise the most if Goldman is right? The firm cites soybean as a specific beneficiary of improved relations between the world's two largest economies, as the US exports such a large amount of the product to China. They see oil, which has fallen on worries about trade and a global slowdown, also rising over the coming months. Finally, Goldman predicts that a global economic slowdown would help gold prices—which have fallen nearly double-digits YTD—in 2019. Our go-to commodities basket is DBC ($15-$15-$19), the Invesco DB Commodity Tracking ETF. The fund, which was up nearly 12% at the beginning of October, is now down 7.22% YTD.
Fixed Income Desk
Treasuries turn lower on slump in homebuilder confidence levels. First it was concern over rates going too high too quickly on the back of consistent Fed hikes. Now, thanks to the downturn in homebuilder sentiment, we are seeing real yields actually drift lower. The benchmark 10-year Treasury, for example, topped out at a 3.263% yield in the first week of October, but now carries just a 3.069% rate. The 2-year T note isn't far behind, at 2.796%. In other words, why would investors take on the added duration of the 10-year for such a small comparative advantage over the 2-year? Rate "normalization" suddenly looks a lot lower than it did when the Fed began raising its FFR precisely three years ago. As for homebuilder confidence, the NAHB's confidence index fell by 8 points in November, to a level of 60 (any level above 50 is considered expansionary, while levels below 50 reflect a contraction). One of our current fixed income picks is a 5.5-year JP Morgan step-up CD yielding between 3.1% at the start to 5.5% at the finish. The CD, cusip 48128FS29, has a survivor's option.
Consumer Discretionary: Automotive
General Motors to shutter five North American plants, slash salaried workforce.
(Update: President Trump has threatened to cut off all subsidies for GM's growing electric car business due to the blue collar cuts.)
General Motors (GM $31-$38-$46) calls it "unallocating," but to the 6,000 factory workers who will lose their jobs, the word is "closing." The $54 billion US automaker announced that it will shutter five North American auto-producing plants—four in the US and one in Canada—by the end of 2019. The plan, which also calls for a 15% cut in the salaried workforce, is part of a global overhaul by the company to account for slowing auto sales, growing SUV and truck sales, and rapidly-increasing autonomous vehicle technology. While the restructuring will cost nearly $4 billion, GM says the moves will improve free cash flow by $6 billion before the end of 2020. Angry union workers at the Canadian plant noted that GM was not slashing any positions at its Mexican facilities. General Motors spiked over 7% on news of the global restructuring, but then gave most of that back after backlash from the White House.
Global Strategy: Russia
Ukraine set to declare martial law as tensions with Russia heat up. Ukraine has been in an undeclared state of war with Russia ever since the 2014 Russian invasion of Crimea. As tense as the situation has been over the past four years, the heat just got turned up. Over the weekend, Russia opened fire on and subsequently detained three Ukrainian vessels—two armored artillery ships and one tugboat—as the small convoy passed through the Kerch Strait. Since the invasion, Russia has claimed the waters around the strait; a claim which Kiev (rightfully so) has never recognized. With the sailors in custody, Ukrainian President Petro Poroshenko—a US ally—has asked parliament to declare martial law in the country, giving the military extended power for at least sixty days. Odds are, Putin will bow to pressure and release the sailors soon, but the simmering pot between the Black Sea and the Sea of Azov is getting closer to the boiling point. The VanEck Vectors Russia ETF (RSX $20.10) is off around 2% on the day and down 5.26% YTD.
Another reason to dislike Marriott: up to 500M guests got their personal data hacked. Ever since the Blackstone Group (BX) took Hilton (HLT) public back in 2013, it has been our go-to hotel investment. Not only do we like the chain, we despise their biggest publicly-traded nemesis, Marriott (MAR $107-$115-$149). You may recall that we raked the company over the coals back in March due to their disgraceful treatment of employee Roy Jones; now, we have another reason to stay away from the company as an investment. Marriott reported that up to 500 million guests over the past four years had their personal data compromised. Data included passport numbers, home address and phone numbers, and payment card information. The breach stems from a hack at Starwood Hotels, which Marriott bought in 2016, and apparently began a full four years ago—which doesn't say much for the company's cybersecurity program. With 500 million potential victims, this is now the second-largest hack in history (behind Yahoo's damaging data breach). We see the global economy slowing down as we move into 2019, and don't expect much growth from this industry in the near future. That being said, Hilton and Royal Caribbean (RCL) are our two top picks in the industry.
Commercial Banks
More evidence that the German economy is floundering? Look no further than their prized bank. Back in January, we wrote a brief article on the $1.8 billion charge that Germany's leading private bank, Deutsche Bank (DB $9-$10-$20), would be taking thanks to tax reform in the US. At the time, DB was selling for $20 per share and had a market cap of $40 billion—down from its $60 billion market cap back in 2011. Apparently, a few "enterprising" bank officers tried to claw back some of those losses by helping some shady customers set up off-shore bank accounts to launder money. On Thursday morning, nearly 200 German police officers, prosecutors, and tax inspectors raided Deutsche Bank's offices in Frankfurt and other locations searching for evidence. Over 900 bank clients may have accounts at the DB subsidiary in the Virgin Islands at the center of the investigation. Shares of DB were trading down just over 3% on news of the raids. Is DB a bargain at $9.50 per share? We don't believe so. The bank had aspirations of competing against their American counterparts for big institutional deals, but this dark cloud hanging over the institution has repelled potential clients. Furthermore, the European Central Bank is not taking the proactive steps necessary (unlike the US Fed) to create a positive environment for the big European banks. Stick to North American financial institutions for now, i.e. US and Canadian commercial banks.
Market Pulse
Fed Chairman pushes Dow up over 600 points with dovish speech. It didn't take much, just one little nuanced line that "we are nearing neutral" with respect to interest rates. But that line, delivered to the Economic Club of New York by Fed Chair Jay Powell, was enough to push the Dow higher by 618 points, the S&P 500 by 62 points, and the NASDAQ by a whopping 209 points by Wednesday's close. It really was a refreshing speech by Powell, who has been especially hawkish in his views on rate hikes. Just this past summer he insinuated that we are "well below normal" with respect to rates. So, what does this mean for a December hike? Probably nothing—it is all but baked in. But it does mean that the Fed will probably limit 2019 to a few hikes and be done. We believe that this is a goldilocks scenario (overused term, we know) for rates. They will get high enough for clients to grab some decent yielding bonds, but remain low enough that the housing market won't get crushed. This actually makes us a bit more sanguine and upbeat about 2019.
Specialty Retailer
In the midst of a bull session, Chico's has its worst day ever. Specialty women's retailer Chico's Fashion (CHS $4-$5-$11) closed the trading day on Tuesday at $7.32 per share. By the time the market opened on Wednesday, CHS had fallen to $5.01/share and one-third of its market cap was gone. (This is a great lesson for anyone using stop-losses, by the way.) What caused the massive drop? An earnings report that didn't live up to expectations and a downgrade of the company's full-year outlook. Third-quarter revenues fell 6% YOY, from $532M in Q3 of 2017 to $500M this past quarter. Earnings were equally as disappointing, falling from $0.13 per share to $0.05 per share, a 62% drop. Our take? Don't get sucked in by the 7 PE ratio or the 7% dividend yield. We don't see what could possibly turn this tiny ($665M) boat around, especially in the shark-infested waters of the retail world.
Housing
Don't fear all of the negative headlines about homebuilders, buyers will adapt to higher mortgage rates. For virtually all of 2018, the overwhelming majority of housing headlines have been somewhere between blah and dire. We recently reported, in fact, that our benchmark homebuilder ETF, the iShares US Home Construction fund (ITB), is now down 29% YTD. Today's news was more of the same: new single-family home sales fell 8.9% in October, and 12% from the same period a year ago. The regular tick-up in the median new home price actually ticked down for the month, falling 3.1% to $309,700. One last data point: the average 30-year mortgage rate has risen from 3.95% at the start of January to 4.81% right now. We believe this backdrop is too gloomy, however, and we don't buy the hype that a huge housing correction is coming. We will see, more than likely, three to four more rate hikes before we plateau. Four more hikes would probably cap the 30-year average mortgage rate at somewhere around 6%—a "reasonable" level. Certainly not high enough for another mass migration to rental units like we saw following the 2008-2009 housing crisis. While we don't currently own any homebuilders in any of the Penn portfolios, valuations are making several of them mighty tempting. Lennar (LEN), Pulte (PHM), and D.R. Horton (DHI), for example, all have PE ratios in the high single digits—about half of where they were sitting at the start of the year. The Index ETF, symbol ITB, has fallen from $45 at the start of the year to a current price of $31.26.
E-Commerce
When you think online advertising, two names come to mind; but the new #3 may surprise you. Alphabet's (GOOGL $984-$1,049-$1,291) chief subsidiary, Google, is obviously the undisputed leader in online advertising. In fact, one out of every three dollars spent around the globe on digital advertising goes into the pockets of Google. Put another way, about 95% of Alphabet's $130 billion in revenues TTM was generated from ad dollars. In second place would be Facebook (FB), with virtually all of its $52 billion in TTM revenue coming from online ads. So, who is in third place? Twitter (TWTR) was our immediate guess. Alas, that was incorrect. Online retailer Amazon (AMZN), of all companies, just took the bronze medal for online ad revenue, surpassing Verizon (VZ) and Microsoft (MSFT). Granted, the company's $4.6 billion ad take is peanuts when compared to the first- and second-place players, but their dominant e-commerce business makes perfect sense for companies looking to highlight their products and services. Expect the company to rapidly increase its ad market share over the coming years. How far we have come from the Mad Men age of the 1960s. While traditional ad agencies still exist (WPP is the largest, at $16 billion), over half of all money spent on ads now go into the online venue. The importance of this when evaluating Alphabet, Facebook, and Amazon as investments should not be underestimated. As for Twitter, the company is at risk of losing the advertisers it already has unless it dramatically changes its strategy.
Tech Hardware, Storage, & Peripherals
Who just caught up to Apple in size? When Apple (AAPL $150-$173-$233) became the first trillion-dollar company in history, it had a couple of tech giants in its rear view mirror; namely, Alphabet (GOOGL) and Amazon (AMZN). What few would have predicted is yet another company, stodgy old Microsoft (MSFT), being the one to catch the Cupertino-based iPhone maker. But that's just what happened: both Microsoft and Apple now have a market cap of $821 billion. Of course, Apple did the heavy lifting, falling nearly 25% within the past two months. We believe both companies are excellent buys at their respective share prices. And both continue to develop world-class services businesses which assure a steady stream of monthly income from users. We pay both each month, and it would be difficult to turn off either stream. In other words, they have created a "sticky" customer base.
Alternatives: Commodities
Goldman is predicting commodities will launch in 2019. Goldman Sachs doesn't exactly have a perfect record with respect to its past commodities predictions, but we do find this one interesting. The $72 billion financial services firm said the upcoming G-20 meeting in Argentina could be the catalyst needed for the beginning of a big uptick—perhaps 17% over the coming months—in commodities overall. Specifically, analysts at the firm claim the markets have not baked any potential thawing of US-China relations into the equation; an event which would certainly help commodity prices. Which commodities will rise the most if Goldman is right? The firm cites soybean as a specific beneficiary of improved relations between the world's two largest economies, as the US exports such a large amount of the product to China. They see oil, which has fallen on worries about trade and a global slowdown, also rising over the coming months. Finally, Goldman predicts that a global economic slowdown would help gold prices—which have fallen nearly double-digits YTD—in 2019. Our go-to commodities basket is DBC ($15-$15-$19), the Invesco DB Commodity Tracking ETF. The fund, which was up nearly 12% at the beginning of October, is now down 7.22% YTD.
Fixed Income Desk
Treasuries turn lower on slump in homebuilder confidence levels. First it was concern over rates going too high too quickly on the back of consistent Fed hikes. Now, thanks to the downturn in homebuilder sentiment, we are seeing real yields actually drift lower. The benchmark 10-year Treasury, for example, topped out at a 3.263% yield in the first week of October, but now carries just a 3.069% rate. The 2-year T note isn't far behind, at 2.796%. In other words, why would investors take on the added duration of the 10-year for such a small comparative advantage over the 2-year? Rate "normalization" suddenly looks a lot lower than it did when the Fed began raising its FFR precisely three years ago. As for homebuilder confidence, the NAHB's confidence index fell by 8 points in November, to a level of 60 (any level above 50 is considered expansionary, while levels below 50 reflect a contraction). One of our current fixed income picks is a 5.5-year JP Morgan step-up CD yielding between 3.1% at the start to 5.5% at the finish. The CD, cusip 48128FS29, has a survivor's option.
Consumer Discretionary: Automotive
General Motors to shutter five North American plants, slash salaried workforce.
(Update: President Trump has threatened to cut off all subsidies for GM's growing electric car business due to the blue collar cuts.)
General Motors (GM $31-$38-$46) calls it "unallocating," but to the 6,000 factory workers who will lose their jobs, the word is "closing." The $54 billion US automaker announced that it will shutter five North American auto-producing plants—four in the US and one in Canada—by the end of 2019. The plan, which also calls for a 15% cut in the salaried workforce, is part of a global overhaul by the company to account for slowing auto sales, growing SUV and truck sales, and rapidly-increasing autonomous vehicle technology. While the restructuring will cost nearly $4 billion, GM says the moves will improve free cash flow by $6 billion before the end of 2020. Angry union workers at the Canadian plant noted that GM was not slashing any positions at its Mexican facilities. General Motors spiked over 7% on news of the global restructuring, but then gave most of that back after backlash from the White House.
Global Strategy: Russia
Ukraine set to declare martial law as tensions with Russia heat up. Ukraine has been in an undeclared state of war with Russia ever since the 2014 Russian invasion of Crimea. As tense as the situation has been over the past four years, the heat just got turned up. Over the weekend, Russia opened fire on and subsequently detained three Ukrainian vessels—two armored artillery ships and one tugboat—as the small convoy passed through the Kerch Strait. Since the invasion, Russia has claimed the waters around the strait; a claim which Kiev (rightfully so) has never recognized. With the sailors in custody, Ukrainian President Petro Poroshenko—a US ally—has asked parliament to declare martial law in the country, giving the military extended power for at least sixty days. Odds are, Putin will bow to pressure and release the sailors soon, but the simmering pot between the Black Sea and the Sea of Azov is getting closer to the boiling point. The VanEck Vectors Russia ETF (RSX $20.10) is off around 2% on the day and down 5.26% YTD.
Headlines for the Week of 04 Nov— 10 Nov 2018
The news you need, without the mainstream bias you don't...
Energy: Commodities
Oil futures just broke into the $50s in longest daily losing streak since 1984. Approximately one month ago, on the 3rd of October, crude was going for $76.24 per barrel, and consumers were paying out the nose at the pumps. Now, just four days after the much-hyped new Iranian sanctions went into full effect, oil broke into the $50s, closing Friday at $59.87 per barrel. Once again, the oil experts were wrong. And oil in the $50s is great: it provides some relief at the pump but still offers some nice profits to US drillers. Speaking of which, the US just hit another historic level of production: 11.6 million barrels per day. OPEC and their quasi-partner Russia are now threatening more cuts to increase the price of crude; let them, the American energy renaissance is alive and well (despite the Obama-appointed federal judge in Montana who just placed the Keystone Pipeline on hold once again).
Space Sciences & Travel
SpaceX to build and fly a "mini-BFR" to launch atop Falcon 9 as soon as next year. Anyone following the renaissance that is the American manned space program is probably familiar with SpaceX's planned BFR, or Big Falcon Rocket (although the F is often replaced with a more colorful term by the founder). This is the ship designed to take men and women to Mars and beyond. Actually, consider the BFR to be the equivalent of the Saturn V which launched Americans into orbit on their way to the moon. The BFS (Ship) would be the equivalent of the manned capsule which contained the lunar lander. Now, the company has created a stepping stone, a "mini-BFS," that it plans to build and subsequently test atop a Falcon 9 rocket as soon as June of 2019. Founder Elon Musk tweeted hints of the spaceship, saying it would be used to test the new technologies and recovery strategy of the system. SpaceX has now successfully launched seventeen Falcon 9 missions thus far in 2018.
Health Care: Pharmaceuticals
Eli Lilly's animal health spinoff, Elanco, reports solid first numbers. Animals are now considered part of the family in millions of households across the country, so it makes perfect sense that health care issues would affect them as they do their human family members. In a burgeoning segment of the industry, companies are racing to research, produce, and sell therapies which will extend the length of and enhance the quality of life for our furry friends. That frenzy was a major catalyst for Eli Lilly's (LLY) decision to spin off its Elanco Animal Health (ELAN $30-$34-$38) unit as its own publicly-traded entity. That company, which is now $12 billion in size (LLY has a market cap of $114B), just released its first quarterly earnings report since its IPO, and the numbers looked strong—beating expectations on both revenues and gross income. Elanco, which had been part of the Eli Lilly family since 1954, also makes animal food products, vaccines, and antibiotics for the livestock industry.
Global Strategy: Middle East
US sanctions against Iran are already hurting the radical regime. For all the talk of a global backlash for pulling out of the horrendously-bad Iran nuclear deal, and the Iranian's comical "vow" to not be affected by US actions, new sanctions are already pounding the rogue regime. A full one-third of Iran's oil exports—one million barrels per day—have been halted. With an overwhelmingly oil-based economy, Iran may talk tough, but it is sweating. Foreign direct investment, the other source of life blood for the Iranian economy, has almost completely dried up (Russia is trying to help, but its investment capabilities amount to drops in the bucket). On Monday the 5th of November, full Iranian sanctions took effect, with the US carving out around eight temporary exemptions for countries which rely heavily on Iranian crude, giving them time to find replacements. In the meantime, oil prices have not gone up due to the sanctions, as many experts had predicted they would. In fact, crude prices fell a full 12% in the month of October alone. All of this spells bad news for a tyrannical regime already feeling the heat from its people.
Oil futures just broke into the $50s in longest daily losing streak since 1984. Approximately one month ago, on the 3rd of October, crude was going for $76.24 per barrel, and consumers were paying out the nose at the pumps. Now, just four days after the much-hyped new Iranian sanctions went into full effect, oil broke into the $50s, closing Friday at $59.87 per barrel. Once again, the oil experts were wrong. And oil in the $50s is great: it provides some relief at the pump but still offers some nice profits to US drillers. Speaking of which, the US just hit another historic level of production: 11.6 million barrels per day. OPEC and their quasi-partner Russia are now threatening more cuts to increase the price of crude; let them, the American energy renaissance is alive and well (despite the Obama-appointed federal judge in Montana who just placed the Keystone Pipeline on hold once again).
Space Sciences & Travel
SpaceX to build and fly a "mini-BFR" to launch atop Falcon 9 as soon as next year. Anyone following the renaissance that is the American manned space program is probably familiar with SpaceX's planned BFR, or Big Falcon Rocket (although the F is often replaced with a more colorful term by the founder). This is the ship designed to take men and women to Mars and beyond. Actually, consider the BFR to be the equivalent of the Saturn V which launched Americans into orbit on their way to the moon. The BFS (Ship) would be the equivalent of the manned capsule which contained the lunar lander. Now, the company has created a stepping stone, a "mini-BFS," that it plans to build and subsequently test atop a Falcon 9 rocket as soon as June of 2019. Founder Elon Musk tweeted hints of the spaceship, saying it would be used to test the new technologies and recovery strategy of the system. SpaceX has now successfully launched seventeen Falcon 9 missions thus far in 2018.
Health Care: Pharmaceuticals
Eli Lilly's animal health spinoff, Elanco, reports solid first numbers. Animals are now considered part of the family in millions of households across the country, so it makes perfect sense that health care issues would affect them as they do their human family members. In a burgeoning segment of the industry, companies are racing to research, produce, and sell therapies which will extend the length of and enhance the quality of life for our furry friends. That frenzy was a major catalyst for Eli Lilly's (LLY) decision to spin off its Elanco Animal Health (ELAN $30-$34-$38) unit as its own publicly-traded entity. That company, which is now $12 billion in size (LLY has a market cap of $114B), just released its first quarterly earnings report since its IPO, and the numbers looked strong—beating expectations on both revenues and gross income. Elanco, which had been part of the Eli Lilly family since 1954, also makes animal food products, vaccines, and antibiotics for the livestock industry.
Global Strategy: Middle East
US sanctions against Iran are already hurting the radical regime. For all the talk of a global backlash for pulling out of the horrendously-bad Iran nuclear deal, and the Iranian's comical "vow" to not be affected by US actions, new sanctions are already pounding the rogue regime. A full one-third of Iran's oil exports—one million barrels per day—have been halted. With an overwhelmingly oil-based economy, Iran may talk tough, but it is sweating. Foreign direct investment, the other source of life blood for the Iranian economy, has almost completely dried up (Russia is trying to help, but its investment capabilities amount to drops in the bucket). On Monday the 5th of November, full Iranian sanctions took effect, with the US carving out around eight temporary exemptions for countries which rely heavily on Iranian crude, giving them time to find replacements. In the meantime, oil prices have not gone up due to the sanctions, as many experts had predicted they would. In fact, crude prices fell a full 12% in the month of October alone. All of this spells bad news for a tyrannical regime already feeling the heat from its people.
Headlines for the Week of 28 Oct — 03 Nov 2018
SAM rocks, BUD tumbles...
Consumer Staples: Beverages
A US beer company spikes, while a foreign beer company plummets. The chart is simply remarkable. American brewer Sam Adams (SAM, Boston Beer Co) is up 63% YTD, while Brazilian/Belgian brewer Anheuser-Busch (BUD) is down 34% YTD. Why? It couldn’t just be that Fenway Park has dumped BUD for SAM. Maybe it’s the fact that A-B saw a 10% drop in revenues this past quarter, while Boston Beer saw a 24% spike in sales. Speaking anecdotally, our consumption of SAM also spiked after BUD was forced into foreign hands by the bungling mismanagement (our opinion) of Buschies III and IV.
Global Strategy: Europe
Twilight (finally) descends on Merkel's political career. Talk about someone overstaying their welcome. Angela Merkel has been chancellor of Germany for eighteen long years, and this past weekend's regional elections show just how weary German voters have become of her leadership style and policies. A few weeks ago, Merkel's alliance parties were hit in Bavaria with their worst election losses since 1950. This past weekend, regional elections moved to the wealthy state of Hesse—home to the German financial industry—and the outcome was similar. Merkel's ruling Christian Democratic Union (CDU) and alliance Social Democrats party (SPD) garnered less that 47% of the vote in aggregate. It was such a deep loss for Merkel that she abruptly announced she would step down as chairman of the party this December. While she also announced she would not seek a fifth term in 2021, her party may seek another option: removing her as chancellor before the next national election.
A US beer company spikes, while a foreign beer company plummets. The chart is simply remarkable. American brewer Sam Adams (SAM, Boston Beer Co) is up 63% YTD, while Brazilian/Belgian brewer Anheuser-Busch (BUD) is down 34% YTD. Why? It couldn’t just be that Fenway Park has dumped BUD for SAM. Maybe it’s the fact that A-B saw a 10% drop in revenues this past quarter, while Boston Beer saw a 24% spike in sales. Speaking anecdotally, our consumption of SAM also spiked after BUD was forced into foreign hands by the bungling mismanagement (our opinion) of Buschies III and IV.
Global Strategy: Europe
Twilight (finally) descends on Merkel's political career. Talk about someone overstaying their welcome. Angela Merkel has been chancellor of Germany for eighteen long years, and this past weekend's regional elections show just how weary German voters have become of her leadership style and policies. A few weeks ago, Merkel's alliance parties were hit in Bavaria with their worst election losses since 1950. This past weekend, regional elections moved to the wealthy state of Hesse—home to the German financial industry—and the outcome was similar. Merkel's ruling Christian Democratic Union (CDU) and alliance Social Democrats party (SPD) garnered less that 47% of the vote in aggregate. It was such a deep loss for Merkel that she abruptly announced she would step down as chairman of the party this December. While she also announced she would not seek a fifth term in 2021, her party may seek another option: removing her as chancellor before the next national election.
Headlines for the Week of 21 Oct — 27 Oct 2018
The headlines you need, minus the mainstream slant...
Media & Entertainment
Can an Apple TV subscription service really compete with Netflix? We are about to find out. Yes, Apple (AAPL $150-$223-$233) has a piece of hardware called Apple TV. But don’t confuse that with the new Apple TV subscription service the company is getting ready to launch. Let there be no doubt: the incredible success that Netflix (NFLX) has had in finding people willing to shell out $10.99 per month (there are currently 120 million of us) is the catalyst for this move. But can Apple really deliver? We will find out beginning in early, 2019. That is when, according to tech site The Information, the company will have a high-profile launch of the service in over 100 countries. In the next issue of The Penn Wealth Report, we identify Apple's ace in the hole that will all but assure this program's success.
Aerospace & Defense
Boeing singlehandedly pushed the Dow from negative to positive in pre-market trading. It is a great example of just how fickle the Dow can be. Futures were trading down around 100 points pre-open on Wednesday, and then the Boeing (BA $255-$350-394) earnings report hit the wires. The company beat on revenues ($25B, up from $24B), beat on earnings ($3.58/sh, up from $2.62/sh), and raised its full-year guidance on the back of strong commercial aircraft orders. And, just like that, futures went from down triple digits to up triple digits. (Boeing is a member of the 40-company Penn Global Leaders Club). If earnings continue to roll in strong, investors should be willing to shake off fears over rates, slowing Chinese growth, and geopolitical issues. We continue to expect a strong Q4 when the dust settles.
Interactive Media & Services
Is Facebook about to pick up a major cybersecurity firm? The rumor mill is abuzz with stories of Facebook's (FB $149-$155-$219) interest in buying a major cybersecurity firm to take on the herculean task of strengthening its users' data security. With all of the company's recent problems and negative headlines, it is easy to forget that its market cap still hovers around half-a-trillion dollars. Only five publicly-traded entities in the world are larger than Facebook. So, which cybersecurity firm might they go after? Odds are good the target company is owned within both of our two favorite cyber ETFs, HACK ($36.75) and CIBR ($25.60). Within the field, we like Fortinet (FTNT), FireEye (FEYE), Palo Alto Networks (PANW), and Proofpoint (PFPT). Of those, FireEye would be the easiest pill for investors to swallow, as the company has a relatively small $3.5 billion market cap. For the record, we own CIBR as a satellite position in the Penn Dynamic Growth Strategy, so we are prepared for one to have a nice pop.
Can an Apple TV subscription service really compete with Netflix? We are about to find out. Yes, Apple (AAPL $150-$223-$233) has a piece of hardware called Apple TV. But don’t confuse that with the new Apple TV subscription service the company is getting ready to launch. Let there be no doubt: the incredible success that Netflix (NFLX) has had in finding people willing to shell out $10.99 per month (there are currently 120 million of us) is the catalyst for this move. But can Apple really deliver? We will find out beginning in early, 2019. That is when, according to tech site The Information, the company will have a high-profile launch of the service in over 100 countries. In the next issue of The Penn Wealth Report, we identify Apple's ace in the hole that will all but assure this program's success.
Aerospace & Defense
Boeing singlehandedly pushed the Dow from negative to positive in pre-market trading. It is a great example of just how fickle the Dow can be. Futures were trading down around 100 points pre-open on Wednesday, and then the Boeing (BA $255-$350-394) earnings report hit the wires. The company beat on revenues ($25B, up from $24B), beat on earnings ($3.58/sh, up from $2.62/sh), and raised its full-year guidance on the back of strong commercial aircraft orders. And, just like that, futures went from down triple digits to up triple digits. (Boeing is a member of the 40-company Penn Global Leaders Club). If earnings continue to roll in strong, investors should be willing to shake off fears over rates, slowing Chinese growth, and geopolitical issues. We continue to expect a strong Q4 when the dust settles.
Interactive Media & Services
Is Facebook about to pick up a major cybersecurity firm? The rumor mill is abuzz with stories of Facebook's (FB $149-$155-$219) interest in buying a major cybersecurity firm to take on the herculean task of strengthening its users' data security. With all of the company's recent problems and negative headlines, it is easy to forget that its market cap still hovers around half-a-trillion dollars. Only five publicly-traded entities in the world are larger than Facebook. So, which cybersecurity firm might they go after? Odds are good the target company is owned within both of our two favorite cyber ETFs, HACK ($36.75) and CIBR ($25.60). Within the field, we like Fortinet (FTNT), FireEye (FEYE), Palo Alto Networks (PANW), and Proofpoint (PFPT). Of those, FireEye would be the easiest pill for investors to swallow, as the company has a relatively small $3.5 billion market cap. For the record, we own CIBR as a satellite position in the Penn Dynamic Growth Strategy, so we are prepared for one to have a nice pop.
Headlines for the Week of 14 Oct — 20 Oct 2018
The headlines you need, without the mainstream slant...
Under the Radar
Espy Manufacturing & Electronics Corp. Espey (ESP $21-$29-$33), a $70 million micro-cap in the Electronic Components industry, does the grunt work for the US military. The company develops, designs, and produces specialized military and industrial electronics, transformers, shipboard systems, metal fabrication, testing equipment, and a host of other mission-critical items. With just 150 employees, the company had revenue of $32 million last year and generates positive net income yearly. Read more about this company in The Penn Wealth Report, Vol 6 Issue 04.
Global Strategy: East/Southeast Asia
Chinese stock market plummets 3% in one trading day. The Chinese government, via its state-controlled media, always plays offense with respect to the nation's economic stability and growth, but it's hard to spin Thursday's huge market loss as a positive. Fears and concerns over the trade war, national debt levels, and massive government infrastructure spending all conspired to spook investors out of Chinese stocks, sending the benchmark Shanghai Composite down just shy of 3% on the day. The Shanghai has lost one-quarter of its value since the start of the year, while the US benchmark S&P 500 is up 5% year-to-date.
Economics: Housing
Higher prices and higher rates combine to pound down new mortgage applications. One week does not make a trend, but the 7.1% drop in weekly mortgage applications certainly reflects buyer angst over higher prices and higher rates. Between summer and autumn of 2016, 30-year mortgage rates troughed at about 3.41%; last week, that rate hit 4.95%. To be sure, that one-year high doesn't come close to the long-term average of 8.10%, but it does give buyers one more excuse to pause on that purchase. The bright news for homebuilders and the economy? It doesn't look like rates have much further to go—considering our relatively tame inflation numbers—before they stabilize and the Fed puts the brakes on rate hikes.
Economics: Goods & Services
US manufacturing capacity rises for 16th straight month. The American industrial resurgence marches on. Manufacturing capacity, which is the capability of a plant to produce output for a specified period of time, rose in the United States for the sixteenth-straight month, adding fuel to America's economic engine and providing some support for recent stock market valuations. The Federal Reserve, which compiles the report, also noted that US factory output rose in September, pushing overall production up 0.3% for the month. US oil and gas production, which has steadily increased over the past eighteen months, was an important component of the glowing report, as were the corporate tax cuts, which spurred industrial companies to spend more on increasing their overall plant capacity.
Economics: Work & Pay
Job openings in the United States just hit an all-time high, and it wasn't even close. The US Department of Labor just released a remarkable statistic: there were 7.14 million new job openings in the month of August. Not only hasn't that figure ever surpassed seven million before, it only surpassed the six million number for the first time in history in April of 2017. The JOLTS (Job Openings and Labor Turnover Survey) figure also showed a record number of new hires in August: 5.78 million. The jobless rate in the US fell to 3.7% in September—the lowest rate in nearly half a century.
Pharmaceuticals
The Trump Administration has a novel message for drug companies: show the price in your ads. President Trump has railed against high drug prices since he was candidate Trump. (Oddly enough, the political organization AARP has never given him credit for this, but that's an easy one to figure out.) Now, his Health & Human Services Secretary, Alex Azar, is pushing an interesting new rule for big pharma: show the list price of the drugs you are advertising. The pharma industry has given a counter-offer: they want to direct viewers to a website where the list price of the drug will be shown. Considering the $5.8 billion spent on drug commercials in 2017, the big broadcasters may be the ones getting hit hardest if this rule is put in place. As for Secretary Azar, he understands the industry intimately, as he was a top executive at Eli Lilly (LLY) before taking the helm at HHS.
Global Strategy: East/Southeast Asia
Think China's debt load is too high? You don't know the half of it. There have been many alarming stories published over the past few years with respect to China’s unsustainable debt load, which threatens to quash the country’s steep growth trajectory. According to a report issued by S&P Global Ratings, conditions may be even more dire than known. As could be expected, the Communist Central Government in Beijing controls how much Chinese provinces and other local governments within the country can spend. To skirt these restrictions, however, these entities have been turning to local government financing vehicles, or LGFVs. These are off-balance sheet debt loads hidden from the world’s rating agencies, but they are very real, nonetheless. In the next issue of The Penn Wealth Report, we delve into China's real debt load, which could be double what the communist government is reporting.
Aerospace & Defense
Harris, L3 to have "merger of equals," creating sixth-largest aerospace behemoth. While we haven’t traded L3 Technologies (LLL $180-$219-$219) much in the past, Harris Corp (HRS $134-$172-$171) has been one of our favorite “under-the-radar” (no pun intended) defense contractors for decades. It took us by surprise when we heard the two companies had agreed to a “merger of equals,” but the potential synergies created by a combination are palpable. Harris is a $20 billion communications equipment company which makes products for space and intelligence systems, air traffic management, energy and maritime companies, and ground network operations. LLL is a $17 billion industrials company that makes high-tech products, systems, and subsystems for the defense electronics business. The two companies would fit together like two adjacent pieces on a puzzle, with very few little overlap. While shareholders at both firms need to approve the all-stock deal, it is as good as done. In the next issue of the Penn Wealth Report we discuss the merger in further detail.
Multiline Retail
Sears (finally) pulls the trigger on bankruptcy, Lampert will change his title. Until it lost the honor to Walmart (WMT) in 1990, Sears (SHLD $0.34-$0.41-$6.83) was America's largest retailer. In April of 2007, the company had a share price of $133 and a market cap of $23 billion. Then Eddie Lampert and his eponymous ESL Investments began steering the company, along with the Kmart brand they picked up along the way, down the river of its slow, painful demise. Today, SHLD shares are selling for 40 cents, and the combined company is worth a paltry $44 million. As suppliers are no longer willing to take any of Lampert's refinancing deals, the company has been forced to file for bankruptcy. While Lampert will step down as CEO, he will remain chairman of the firm. Five years ago, the company had around 2,000 stores nationwide. Today, that number has fallen to 700, with another 142 to be shuttered by year's end. Lampert says the Chapter 11 bankruptcy proceedings will give the company time to speed up its "strategic transformation" and "return to profitability." It's hard to say whether he really believes that, but one thing is certain—the creditors do not.
Espy Manufacturing & Electronics Corp. Espey (ESP $21-$29-$33), a $70 million micro-cap in the Electronic Components industry, does the grunt work for the US military. The company develops, designs, and produces specialized military and industrial electronics, transformers, shipboard systems, metal fabrication, testing equipment, and a host of other mission-critical items. With just 150 employees, the company had revenue of $32 million last year and generates positive net income yearly. Read more about this company in The Penn Wealth Report, Vol 6 Issue 04.
Global Strategy: East/Southeast Asia
Chinese stock market plummets 3% in one trading day. The Chinese government, via its state-controlled media, always plays offense with respect to the nation's economic stability and growth, but it's hard to spin Thursday's huge market loss as a positive. Fears and concerns over the trade war, national debt levels, and massive government infrastructure spending all conspired to spook investors out of Chinese stocks, sending the benchmark Shanghai Composite down just shy of 3% on the day. The Shanghai has lost one-quarter of its value since the start of the year, while the US benchmark S&P 500 is up 5% year-to-date.
Economics: Housing
Higher prices and higher rates combine to pound down new mortgage applications. One week does not make a trend, but the 7.1% drop in weekly mortgage applications certainly reflects buyer angst over higher prices and higher rates. Between summer and autumn of 2016, 30-year mortgage rates troughed at about 3.41%; last week, that rate hit 4.95%. To be sure, that one-year high doesn't come close to the long-term average of 8.10%, but it does give buyers one more excuse to pause on that purchase. The bright news for homebuilders and the economy? It doesn't look like rates have much further to go—considering our relatively tame inflation numbers—before they stabilize and the Fed puts the brakes on rate hikes.
Economics: Goods & Services
US manufacturing capacity rises for 16th straight month. The American industrial resurgence marches on. Manufacturing capacity, which is the capability of a plant to produce output for a specified period of time, rose in the United States for the sixteenth-straight month, adding fuel to America's economic engine and providing some support for recent stock market valuations. The Federal Reserve, which compiles the report, also noted that US factory output rose in September, pushing overall production up 0.3% for the month. US oil and gas production, which has steadily increased over the past eighteen months, was an important component of the glowing report, as were the corporate tax cuts, which spurred industrial companies to spend more on increasing their overall plant capacity.
Economics: Work & Pay
Job openings in the United States just hit an all-time high, and it wasn't even close. The US Department of Labor just released a remarkable statistic: there were 7.14 million new job openings in the month of August. Not only hasn't that figure ever surpassed seven million before, it only surpassed the six million number for the first time in history in April of 2017. The JOLTS (Job Openings and Labor Turnover Survey) figure also showed a record number of new hires in August: 5.78 million. The jobless rate in the US fell to 3.7% in September—the lowest rate in nearly half a century.
Pharmaceuticals
The Trump Administration has a novel message for drug companies: show the price in your ads. President Trump has railed against high drug prices since he was candidate Trump. (Oddly enough, the political organization AARP has never given him credit for this, but that's an easy one to figure out.) Now, his Health & Human Services Secretary, Alex Azar, is pushing an interesting new rule for big pharma: show the list price of the drugs you are advertising. The pharma industry has given a counter-offer: they want to direct viewers to a website where the list price of the drug will be shown. Considering the $5.8 billion spent on drug commercials in 2017, the big broadcasters may be the ones getting hit hardest if this rule is put in place. As for Secretary Azar, he understands the industry intimately, as he was a top executive at Eli Lilly (LLY) before taking the helm at HHS.
Global Strategy: East/Southeast Asia
Think China's debt load is too high? You don't know the half of it. There have been many alarming stories published over the past few years with respect to China’s unsustainable debt load, which threatens to quash the country’s steep growth trajectory. According to a report issued by S&P Global Ratings, conditions may be even more dire than known. As could be expected, the Communist Central Government in Beijing controls how much Chinese provinces and other local governments within the country can spend. To skirt these restrictions, however, these entities have been turning to local government financing vehicles, or LGFVs. These are off-balance sheet debt loads hidden from the world’s rating agencies, but they are very real, nonetheless. In the next issue of The Penn Wealth Report, we delve into China's real debt load, which could be double what the communist government is reporting.
Aerospace & Defense
Harris, L3 to have "merger of equals," creating sixth-largest aerospace behemoth. While we haven’t traded L3 Technologies (LLL $180-$219-$219) much in the past, Harris Corp (HRS $134-$172-$171) has been one of our favorite “under-the-radar” (no pun intended) defense contractors for decades. It took us by surprise when we heard the two companies had agreed to a “merger of equals,” but the potential synergies created by a combination are palpable. Harris is a $20 billion communications equipment company which makes products for space and intelligence systems, air traffic management, energy and maritime companies, and ground network operations. LLL is a $17 billion industrials company that makes high-tech products, systems, and subsystems for the defense electronics business. The two companies would fit together like two adjacent pieces on a puzzle, with very few little overlap. While shareholders at both firms need to approve the all-stock deal, it is as good as done. In the next issue of the Penn Wealth Report we discuss the merger in further detail.
Multiline Retail
Sears (finally) pulls the trigger on bankruptcy, Lampert will change his title. Until it lost the honor to Walmart (WMT) in 1990, Sears (SHLD $0.34-$0.41-$6.83) was America's largest retailer. In April of 2007, the company had a share price of $133 and a market cap of $23 billion. Then Eddie Lampert and his eponymous ESL Investments began steering the company, along with the Kmart brand they picked up along the way, down the river of its slow, painful demise. Today, SHLD shares are selling for 40 cents, and the combined company is worth a paltry $44 million. As suppliers are no longer willing to take any of Lampert's refinancing deals, the company has been forced to file for bankruptcy. While Lampert will step down as CEO, he will remain chairman of the firm. Five years ago, the company had around 2,000 stores nationwide. Today, that number has fallen to 700, with another 142 to be shuttered by year's end. Lampert says the Chapter 11 bankruptcy proceedings will give the company time to speed up its "strategic transformation" and "return to profitability." It's hard to say whether he really believes that, but one thing is certain—the creditors do not.
Headlines for the Week of 07 Oct — 13 Oct 2018
The headlines you need, without the mainstream slant...
Market Pulse
Don't fear Wednesday's 3% selloff. It is never fun to see screaming-red headlines on the news sensationalizing a massive market selloff. Of course, the Dow is always mentioned first because of the law of large numbers: Wednesday's 832-point plummet sounds more dramatic than the S&P's 95-point drop (though the S&P drop actually did more damage). When the trading day ended, the Dow and S&P 500 were each down just over 3%, and the Nasdaq was down just over 4%. The reason for the big selloff? Fear that rising interest rates will harm the corporate earnings outlook, as input costs will rise. This reminds us of the "Taper Tantrum," that period when it became obvious to Wall Street that the Fed would soon begin raising interest rates for the first time in over a decade. We thought the same thing back then as we do now: of all the reasons for a massive market selloff, we will take rate hike fears. Not a slowing economy; not rising inflation; not high unemployment; not a banking crisis; not an attack on our soil; just rising rates—rates which are still below normal. As for perspective, look no further than the graph. Wednesday's drop took the Nasdaq back to July levels, and both the Dow and S&P back to August levels—all well ahead of where we were in February. Fundamentally, we still look strong, and the US is faring much better economically than virtually any other major area around the globe. If it makes you feel any better, look no further than the MSCI China All Shares Index, which is now down 21% year-to-date.
Automotive
Honda will invest nearly $3 billion in GM's autonomous vehicles. Honda and General Motors (GM $32-$33-$47) are teaming up to build autonomous vehicles, with the former seeding GM with $750 million and the promise of another $2 billion. GM Cruise, LLC will develop autonomous vehicles from conception to design to production, with plans to sell the vehicles around the world and share the revenues (Honda will have a 5.7% stake in the new firm). This is a huge win for GM, and a great plan overall. Honda had been in talks to work with Alphabet's (GOOG) autonomous division, Waymo, so this is quite the coup for GM. It is also another hit to Ford (F), which dropped on the news. We had high hopes for Ford after, ironically, its former smart car boss—Jim Hackett—took over as CEO. It has been a relatively steady decline for Ford shares since Hackett took the helm in May of 2017. If he is not careful, he will go the way of GE's 13-month CEO Flannery and be shown the exit door. The other shoe for Ford will drop when the company's is forced to slash its now 6.7% dividend yield.
Restaurants
The hedge fund manager we cannot stand just made a trade we do not like. Pershing Square's Bill Ackman. One of those arrogant guys it is just so easy to dislike. It has been a case of schadenfreude with respect to his recent lousy decisions: buying JCP under Ron Johnson; buying Valeant under Rubenesque blowhard CEO J. Michael Pearson; dogging out well-run company ADP, demanding the CEO's ouster; you get the picture. Now, the former darling of the hedge fund world just made another call we believe he will regret (but never admit to regretting): he bought a 1.1% stake ($775 million if you buy his stated share price) in Starbucks (SBUX $47-$57-$62). Ackman argues that the younger generation is ditching soda for coffee, and China remains a huge under-tapped market for the drink. Both may be true, but Starbucks does not operate in an industry vacuum any longer. Anyway, we find ourselves once again rooting for him to fail.
Basic Materials: Chemicals
PPG plummets double-digits as sales disappoint, raw materials costs rise. We made a lot of money on Pittsburgh Paint & Glass, otherwise known as PPG (PPG $100-$99-$122), over the past several years. So much so, in fact, that we sold the company with a nice profit last year, our sell decision being based solely on valuations. Timing was good. PPG plummeted 10% after the company announced that Q3 earnings would decline from the previous year's third quarter earnings. In addition to "disappointing" sales, the specialty chemicals maker (think pigment for autos and dozens of other similar products) is also getting pounded by the rising costs of the raw materials it uses in product development. Weakening foreign currency exchange rates (as compared to the USD) and softer demand from a slowing Chinese market also played a factor in the sales decline. Shares fell below their 52-week low on the announcement.
Global Strategy: Latin America
Brazil's market rocks as Conservative, pro-business candidate one step closer to presidency. Since 1985, Brazil has been under the control of several leftist presidents. Needless to say, corruption was rampant during that timeframe and the Brazilian economy went south. Former President Lula da Silva (2003-2011) is now in prison, and his protégé, Dilma "Aunt Bea" Rousseff was kicked out of office in 2016. It appears as if Brazilians have seen enough losing. Former Army Captain Jair Bolsonaro is on the precipice of pulling off an unlikely victory for the presidential suite. The pro-business Conservative pulled in 46% of the national vote amongst a crowded field of competitors—17 percentage points higher than the next-closest candidate. The world's fourth-largest democracy is dusting off the cobwebs of Latin American socialism and, once again, prepared to embrace capitalism. A devout Christian, Bolsonaro ran on ideas like strengthening public safety, loosening the gun laws to allow citizens the right to better protect themselves, ridding the government of corruption, and reducing government control of businesses operating in the country. The final step on the road to victory? Bolsonaro must beat (he will) Workers' Party candidate Fernando Haddad in the 28 Oct runoff. Suddenly, democracy and free enterprise are blossoming once again in Latin America—well, except for Mexico, which just elected a leftist president. Let's compare the Mexican economy over the next four years to that of Brazil's. Our money is on the latter.
Don't fear Wednesday's 3% selloff. It is never fun to see screaming-red headlines on the news sensationalizing a massive market selloff. Of course, the Dow is always mentioned first because of the law of large numbers: Wednesday's 832-point plummet sounds more dramatic than the S&P's 95-point drop (though the S&P drop actually did more damage). When the trading day ended, the Dow and S&P 500 were each down just over 3%, and the Nasdaq was down just over 4%. The reason for the big selloff? Fear that rising interest rates will harm the corporate earnings outlook, as input costs will rise. This reminds us of the "Taper Tantrum," that period when it became obvious to Wall Street that the Fed would soon begin raising interest rates for the first time in over a decade. We thought the same thing back then as we do now: of all the reasons for a massive market selloff, we will take rate hike fears. Not a slowing economy; not rising inflation; not high unemployment; not a banking crisis; not an attack on our soil; just rising rates—rates which are still below normal. As for perspective, look no further than the graph. Wednesday's drop took the Nasdaq back to July levels, and both the Dow and S&P back to August levels—all well ahead of where we were in February. Fundamentally, we still look strong, and the US is faring much better economically than virtually any other major area around the globe. If it makes you feel any better, look no further than the MSCI China All Shares Index, which is now down 21% year-to-date.
Automotive
Honda will invest nearly $3 billion in GM's autonomous vehicles. Honda and General Motors (GM $32-$33-$47) are teaming up to build autonomous vehicles, with the former seeding GM with $750 million and the promise of another $2 billion. GM Cruise, LLC will develop autonomous vehicles from conception to design to production, with plans to sell the vehicles around the world and share the revenues (Honda will have a 5.7% stake in the new firm). This is a huge win for GM, and a great plan overall. Honda had been in talks to work with Alphabet's (GOOG) autonomous division, Waymo, so this is quite the coup for GM. It is also another hit to Ford (F), which dropped on the news. We had high hopes for Ford after, ironically, its former smart car boss—Jim Hackett—took over as CEO. It has been a relatively steady decline for Ford shares since Hackett took the helm in May of 2017. If he is not careful, he will go the way of GE's 13-month CEO Flannery and be shown the exit door. The other shoe for Ford will drop when the company's is forced to slash its now 6.7% dividend yield.
Restaurants
The hedge fund manager we cannot stand just made a trade we do not like. Pershing Square's Bill Ackman. One of those arrogant guys it is just so easy to dislike. It has been a case of schadenfreude with respect to his recent lousy decisions: buying JCP under Ron Johnson; buying Valeant under Rubenesque blowhard CEO J. Michael Pearson; dogging out well-run company ADP, demanding the CEO's ouster; you get the picture. Now, the former darling of the hedge fund world just made another call we believe he will regret (but never admit to regretting): he bought a 1.1% stake ($775 million if you buy his stated share price) in Starbucks (SBUX $47-$57-$62). Ackman argues that the younger generation is ditching soda for coffee, and China remains a huge under-tapped market for the drink. Both may be true, but Starbucks does not operate in an industry vacuum any longer. Anyway, we find ourselves once again rooting for him to fail.
Basic Materials: Chemicals
PPG plummets double-digits as sales disappoint, raw materials costs rise. We made a lot of money on Pittsburgh Paint & Glass, otherwise known as PPG (PPG $100-$99-$122), over the past several years. So much so, in fact, that we sold the company with a nice profit last year, our sell decision being based solely on valuations. Timing was good. PPG plummeted 10% after the company announced that Q3 earnings would decline from the previous year's third quarter earnings. In addition to "disappointing" sales, the specialty chemicals maker (think pigment for autos and dozens of other similar products) is also getting pounded by the rising costs of the raw materials it uses in product development. Weakening foreign currency exchange rates (as compared to the USD) and softer demand from a slowing Chinese market also played a factor in the sales decline. Shares fell below their 52-week low on the announcement.
Global Strategy: Latin America
Brazil's market rocks as Conservative, pro-business candidate one step closer to presidency. Since 1985, Brazil has been under the control of several leftist presidents. Needless to say, corruption was rampant during that timeframe and the Brazilian economy went south. Former President Lula da Silva (2003-2011) is now in prison, and his protégé, Dilma "Aunt Bea" Rousseff was kicked out of office in 2016. It appears as if Brazilians have seen enough losing. Former Army Captain Jair Bolsonaro is on the precipice of pulling off an unlikely victory for the presidential suite. The pro-business Conservative pulled in 46% of the national vote amongst a crowded field of competitors—17 percentage points higher than the next-closest candidate. The world's fourth-largest democracy is dusting off the cobwebs of Latin American socialism and, once again, prepared to embrace capitalism. A devout Christian, Bolsonaro ran on ideas like strengthening public safety, loosening the gun laws to allow citizens the right to better protect themselves, ridding the government of corruption, and reducing government control of businesses operating in the country. The final step on the road to victory? Bolsonaro must beat (he will) Workers' Party candidate Fernando Haddad in the 28 Oct runoff. Suddenly, democracy and free enterprise are blossoming once again in Latin America—well, except for Mexico, which just elected a leftist president. Let's compare the Mexican economy over the next four years to that of Brazil's. Our money is on the latter.
Headlines for the Week of 31 Sep — 06 Oct 2018
Boeing has a serious winning streak going; the company just won a $9 billion contract to build the next-gen trainer...
Courtesy: Boeing
Cybersecurity
US, UK, Dutch authorities bust massive Russian hacking effort. In a joint effort to counter cybersecurity threats, officials from the United States, Brittain, and the Netherlands have busted Russian GRU (the country's military intelligence unit) officers in a massive, years-long hacking campaign. In one effort of the campaign, these agents tried to hack into the computers of the Organization for the Prohibition of Chemical Weapons. This followed the Kremlin's use of deadly nerve agents on targets in Britain. In another, agents attempted to gain entry into the servers of international antidoping organizations and the email accounts of officials at the agencies. Recall that Russia was banned from the 2018 Winter Olympics due to the use of illegal substances by athletes. Most disconcerting, US intelligence officials caught the Russians trying to hack into the servers of nuclear reactor design company Westinghouse Electric Corp. This involved setting up fake corporate domains, sending phishing emails to employees at the firm, and attempting the outright theft of employee credentials. On Thursday, the US Department of Justice indicted seven Russian intel officers for their role in the hacks.
Cybersecurity
Bloomberg investigation shows Chinese hacking of computer networks at highest levels. Despite denials by the likes of Apple (AAPL), and Super Micro (SMCI), Bloomberg has released an exclusive report providing evidence that the Chinese, via their People's Liberation Army, have "seeded" tiny microchip spy devices in thousands of server motherboards; computer equipment that was sold to at least 30 American companies, including Apple. The devices were implanted during the manufacturing process at Chinese facilities, and (according to the Bloomberg report) at Super Micro Computer (SMCI), a San Jose-based server manufacturer which employs primarily Asian workers. These devices, which Amazon (AMZN) first uncovered and reported on to US authorities, allow the attacker to create a "doorway" into any network on which the servers reside. Consider this: these are "viruses" which are impossible to remove, because they are part of the machine's hardware, not software. The networks in question run the most sensitive systems from a national security standpoint, operated by agencies such as the CIA, NASA, and the Department of Defense. This story should send shivers through the US intelligence community, and it should be the impetus needed to begin the search for other sources of manufacturers, outside of the reach of the Chinese military. This story also portends a long, ugly road ahead for US-Chinese trade negotiations. This is precisely the type of illegal intellectual property theft the Administration has railed against. Super Micro fell by 33% shortly after the Bloomberg article was released.
Economics: Work & Pay
Blowing past expectations, private sector adds 230,000 new jobs. And the incredibly strong economy just keeps rolling along. The American private sector added an aggregate 230,000 new jobs in the month of September—24% more than the 185,000 economists had predicted. Buttressing the importance of the tax cut for everyday Americans (and small business owners), most of those new hires came from small- and mid-sized businesses in the services sector. According to ADP, a small-sized company is one which employs between 1 and 49 workers, while a mid-sized firm employs between 50 and 499 workers. It looks as though the ultra-low unemployment rate is not done falling.
Pharmaceuticals
(Holding Update: Penn Global Leaders Club) Pfizer's dynamic CEO to step down from that role in 2019. We are placing pharmaceutical giant Pfizer (PFE $33-$45-$45) on watch after a CEO we have highly touted, Ian Read, announced that he would be stepping down from that role at the company in early, 2019. Chief Operating Officer Albert Bourla will take over the position. Pfizer skillfully navigated some turbulent waters during Read's eight year tenure, and he helped the company build an impressive pipeline of drugs. Bourla also has an impressive resume during his 25 years at the company, but it still makes us a bit nervous. One upside: Read will take on the role of executive chairman of the board after he steps down from his CEO position.
Specialty Retail: e-Commerce
(Without a government mandate,) Amazon raises minimum wage to $15/hour. It is amazing how many people—and the dolts they elect to represent them—don't understand basic economics. That thought came to mind as we read the Amazon (AMZN $950-$2,007-$2,051) press release announcing the company's plans to raise the minimum employee wage to $15 per hour. Why do it? Because the company now has a quarterly free cash flow of $4.2 billion and earnings per share of $6.32. And, they want to attract and retain the best workers in an ultra-tight (thanks to America's booming economy) labor force. This new minimum wage will also apply to the 100,000-strong temp workforce the company will bring in for the Christmas holiday season. Don't believe what Crazy Uncle Bernie says, this occurred because of the company's profitability, not government pressure. If Crazy Uncle Bernie wants to take credit, let him.
Global Trade
Another trade deal done, and this one was huge. The lousy, 24-year-old NAFTA deal is dead. Long live the US-Mexico-Canada Agreement, or USMCA. While the limited trade agreement reached with the EU a few months back was good, and the US-Korea Free Trade Agreement (KORUS) was better, the new North American deal is huge. It ends the bickering between the three nations with respect to trade, helps America's manufacturing base, and puts the entire continent on better footing with respect to world trade. It also helped the US garner two new allies on the united front against China's unfair trade practices. The stock market agreed, with the Dow jumping a few hundred points after the deal was inked. While legislators in all three nations must still approve the USMCA deal, there is little chance that any will shirk their duties, as that would mean an enormous setback in free trade. While the Democrats might well win the House this November, and they would love to deal a blow to President Trump, we don't believe their constituents would let them pull off something so audacious as killing this trade deal. Their radical fringe would love it, but there are still too many blue collar voters and unions aligned with the party to let that happen, except in the most unhinged districts. Next stops on the trade train: a deal with Japan and a more extensive deal with the unruly and petulant EU, led by the likes of Trump-hater Angela Merkel.
Industrial Conglomerates
GE fires Flannery after thirteen months on the job. After it became apparent that General Electric's (GE $11-$12-$25) new boss was a lot like its old boss (who presided over a disastrous period for the once-great company), the board decided enough was enough. After just thirteen months in the role, GE's board of directors fired CEO John Flannery. Not only wasn't the company moving in a positive direction, it appeared as if Flannery was continuing to dig even deeper into the hole in which Jeffrey Immelt placed the company. Great units were being sold off, and a general sense of disarray permeated the company. The final straw came with the 2018 full-year guidance: the company would miss both revenue and profit targets. Additionally, GE announced it would take a $23 billion write-down for its power unit. There is some good news: the board tapped former Danaher CEO—and current GE board member—Larry Culp as the new chairman and CEO. Culp had an impressive record heading up the $76 billion healthcare firm. Is it too late for a turnaround act at General Electric? Perhaps. But, if anyone can pull it off, it is probably Culp. GE was up double-digits on news of Flannery's firing.
Multiline Retail
JC Penney falls double-digits (again) after CFO leaves firm. Granted, when your company's stock is selling for a few dollars a share, it doesn't take much to move the needle by double—or even triple—digits. Nonetheless, it was another bad headline JC Penney (JCP $2-$2-$5) did not need. The catalyst for the latest 10% drop in the stock was news that the company's chief financial officer, Jeff Davis, was leaving after fourteen months on the job. When someone who can see the financials in all their glory decides to bolt, it is probably not a good sign that a recovery is around the corner. The company is now down 50.5% year-to-date and has a market cap of $493 million. Just over a decade ago, JC Penney was a $20 billion company. This was not inevitable. Instead of installing a strong, forward-looking management team, the company made disastrously-bad decisions which led them to this point.
Automotive
Musk settles with SEC, causing shares of Tesla to spike. The SEC and Elon Musk have settled out of court, and the markets celebrated. Despite the organization's draconian demands in the lawsuit stemming from Musk's boneheaded tweet about taking Tesla (TSLA $245-$305-$387) private, there was every possibility that they would have ultimately won—they are, after all, the government. Musk, who had rejected the initial plea deal offered by the SEC, was convinced by his lawyers to request another plea. The SEC reluctantly agreed, but made the terms stiffer: Musk would have to pay a $20 million fine, the company would have to pay a $20 million fine, and Tesla's founder would be barred from the chairman's seat for three years. Additionally, the company would have to create two new independent board seats, and Musk would have to have any social media comments reviewed before posting. It sounds like a rough pill to swallow, but considering the SEC's lawsuit sought to have Musk banned for life from a management role at Tesla, it had to be taken. This should allow Musk, who was allowed to retain his position as CEO, to return his focus to Model 3 "logistics hell." Tesla spiked over 16% on news of the settlement.
Aerospace & Defense
Boeing notches another huge win over Lockheed—awarded the new US Air Force trainer contract. Earlier in the week, we reported that Penn Global Leaders Club member Boeing (BA $253-$367-$374) won a $2.4 billion contract to build the replacement for the aging Huey chopper fleet. Now, the company can boast a much bigger prize: it beat out Lockheed Martin (LMT) in a bid to build a new trainer for the United States Air Force. The contract, worth up to $9.2 billion, will allow Boeing's T-X program to move forward, building at least 351 jets, 46 simulators, and associated ground equipment. The T-X (yet to be numbered and named) will replace the venerable T-38 Talon fleet which has been used to train military pilots for two generations. Boeing, which is risk-sharing this project with Sweden's Saab Group (SAABF), will build the aircraft at their St. Louis, MO facilities.
Media & Entertainment
Fox to sell remaining Sky position to Comcast for $15 billion. Four days after a fat bidding war gave majority ownership of Sky PLC (BSYBF $12-$22-$23)—the UK's only satellite television provider and the country's largest pay-TV provider—to Comcast (CMCSA), Fox (FOX) threw in the towel and announced it would sell its remaining stake to Comcast for just over $15 billion. This is really a win-win for both Comcast and Disney (DIS), which would have gained control of Sky after its deal to buy a wide swath of Fox assets closed. While Comcast paid a huge premium for Sky, Disney can use the proceeds from Fox's 39% stake in Sky to help pay down some of the $71 billion it paid for the Fox assets. Additionally, had Disney ended up with Sky, the company would have probably been forced by regulators to divest itself of other units as part of the deal. For the record, we purchased Disney in the Penn Global Leaders Club last year for $96.92.
Monetary Policy
Fed sees bright economic future, raises rates once again. The Federal Reserve is bullish on the growth within the US economy, and they do not want that growth to lead to runaway inflation (even though there are really no signs of this happening). With that as the backdrop, the FOMC raised the Fed Funds Rate 25 basis points on Wednesday, to 2.25%. But they didn't stop there. After raising their economic outlook for the country, members also projected one more hike this year and three in calendar year 2019. In the long run, however, they see a stable Fed Funds Rate at 3%, meaning a few potential rate cuts after 2020. While we don't necessarily believe they will deliver on the four-more-hikes prediction, what would this do to the 30-year mortgage rate? Although certainly still below generational highs, the average mortgage would probably cost buyers 6% to 6.25%. With existing-home sales already slowing, that could certainly impact homebuilders. However, we still see that in the manageable range—not high enough to hurt the economy. From an investment standpoint, we should continue to see improved yields, which will provide welcome relief to those seeking more income but less risk.
Energy Commodities
Crude hits four-year high, but not everyone is hurting. Most people cringe when they see the price of oil go up. Not only does that equate to spending more money at the pump, it also helps many of our enemies, or at least "questionable friends" around the world, such as Russia and OPEC member-states. Since America's energy renaissance, however, at least we can take a little comfort in the fact that the American energy sector, and its mostly blue collar workforce, also reap the benefits of higher oil prices. Take a look at the chart: crude just hit $71.76 per barrel, a four-year high; but US oil production followed suit, hitting a remarkable 11 million bpd. With new Iranian sanctions taking effect soon, Venezuela offline due to political strife, and OPEC/Russian desire for $80/barrel, we wouldn't be shorting oil right now. The one bright spot, we believe, is the fact that China's rate of economic growth continues to slow.
Global Strategy: East & Southeast Asia
US, South Korea finalize trade deal. The United States and South Korea held an official signing ceremony at the United Nations this week to celebrate a new trade deal, or at least a major revamp of the KORUS deal on the books between the two allies. Korea exports just over $10 billion more in goods and services each year to the United States than the US does to South Korea. This new trade deal is an attempt to rectify that situation. Under its terms, South Korea will now allow each American automaker to export 50,000 vehicles annually into the country which meet US—not South Korean—safety standards. A 25% tariff on Korean trucks coming to the US not only remains in place, it has been extended to 2041. With respect to steel, the Asian country agreed to slash its exports to the US by nearly one-third; in return, the country's steel exports no longer face the 25% tariff imposed on imports by the Administration. South Korea is currently the third-largest exporter of steel to the US. This was a nice win for both countries: the US will get a "more-level" playing field, while Moon Jae-in garnered more support in his efforts to mend ties with North Korea. After discussing the recent meeting between the two Korean leaders, President Trump announced that a follow-up meeting with Kim Jong-un will take place soon.
Aerospace & Defense
Boeing beats out Lockheed, Sierra Nevada to win Huey replacement contract. The Pentagon has awarded a $2.4 billion contract to Penn Global Leaders Club member Boeing (BA $251-$368-$374) to build a replacement for the aging UH-1N Iroquois choppers, affectionately known as "Hueys." Boeing, which teamed up with Italy's Leonardo SpA for the bid, will build the 84 military choppers at its facilities near Philadelphia, PA. The "MH-139" aircraft will be used to help protect America's ICBM sites around the country, as well as other critical tasks around the world. Boeing beat out privately-held Sierra Nevada and the famed Sikorsky unit of Lockheed Martin to win the Air Force deal.
Restaurants
Sonic to be acquired by private restaurant conglomerate Inspire Brands for $2.3 billion. Back in early summer, iconic American fast-food chain Sonic (SONC $23-$44-$45) had a market cap of just $879 million. After a nice fall rally, the company grew to about $1.25 billion in size. Double that amount and you have what Arby's and Buffalo Wild Wings parent Inspire Brands plans to spend to take the company private. Shares of SONC shot up 20% after the announcement. Recall that Inspire paid the same amount—$2.3 billion—to buy Buffalo Wild Wings last year after, in our opinion, years of mismanagement at that chain. Inspire seems to be building a fast-food and casual dining empire. Sadly, they are building that empire by taking out publicly-traded companies.
Textiles, Apparel, & Luxury Goods
Michael Kors set to buy Versace, but what kind of headaches might come with the deal? When Gianni Versace was gunned down in Miami Beach twenty-one years ago, his eponymous company was thrown into turmoil. His sister, Donatella, became creative director at the firm after the fashion designer died, but the family-controlled business hasn't been the same since. Now, in an effort to gain a foothold in higher-end European fashion, Michael Kors (KORS $46-$67-$76) has announced plans to buy the firm for around $2 billion. On its face, the deal makes sense for the growing Kors (the company bought high-end shoemaker Jimmy Choo last year for $1.2 billion), but several serious questions remain. Versace is closely-held by members of the family, many of whom may come along with the deal. Additionally, the company generated only around $920 million in revenue last year, with a paltry $20 million or so flowing down as net profit. Other fashion companies like Tiffany & Co (reportedly) balked at the price tag. What did investors think of the news? Kors fell 8% after the announcement.
Metals & Mining
Barrick Gold to buy Randgold, creating an $18 billion mining behemoth. The world's largest gold miner, Toronto-based Barrick Gold Corp (ABX $10-$11-$17), will acquire Randgold Resources Limited (GOLD $60-$68-$104), primarily a Sub-Saharan Africa miner, in a deal which will value the combined company at $18 billion. Under the terms of the deal, Randgold shareholders will receive just over six shares of Barrick for each share of GOLD they own. Barrick shareholders will then control two-thirds of the combined company, with CEO John Thornton becoming the executive chairman of the new entity. Considering that both of these companies have lost one-third of their market value over the past year, this was a good move. The synergies should allow the new entity to operate more efficiently; a critically important factor considering the recent drop in the price of gold. The market agreed—both companies rose about 7% on the news.
Media & Entertainment
SiriusXM to buy Pandora for $3.5 billion. In what would ultimately equate to bad news for listeners who enjoy free music, aggressive-marketing satellite radio service SiriusXM (SIRI $5-$7-$8) has announced its intent to buy rival Pandora Media (P $4-$9-$10) in an all-stock deal valued at $3.5 billion. Before news of the planned acquisition, Sirius had a surprisingly-high market cap of $30 billion (it fell 5% in pre-market) and Pandora had a market cap of $2.6 billion (it popped 8% on the news). If the deal goes through as expected, the new entity would be the largest audio entertainment company in the world. SiriusXM has over 35 million paid subscribers and Pandora has over 70 million active monthly listeners. Pandora, which has free listening option for members, has been bleeding money annually since it went public, while Sirius, which only has a subscription model, has recorded a positive net cash flow since 2010. Speaking from experience, the Sirius platform is simply unrivaled, but the sales tactics used as a subscription period nears its end are relentless and aggressive. In other words, the company uses a vastly different strategy than does Apple (AAPL) with its music streaming service. We love the SiriusXM service, but we wouldn't touch the stock.
US, UK, Dutch authorities bust massive Russian hacking effort. In a joint effort to counter cybersecurity threats, officials from the United States, Brittain, and the Netherlands have busted Russian GRU (the country's military intelligence unit) officers in a massive, years-long hacking campaign. In one effort of the campaign, these agents tried to hack into the computers of the Organization for the Prohibition of Chemical Weapons. This followed the Kremlin's use of deadly nerve agents on targets in Britain. In another, agents attempted to gain entry into the servers of international antidoping organizations and the email accounts of officials at the agencies. Recall that Russia was banned from the 2018 Winter Olympics due to the use of illegal substances by athletes. Most disconcerting, US intelligence officials caught the Russians trying to hack into the servers of nuclear reactor design company Westinghouse Electric Corp. This involved setting up fake corporate domains, sending phishing emails to employees at the firm, and attempting the outright theft of employee credentials. On Thursday, the US Department of Justice indicted seven Russian intel officers for their role in the hacks.
Cybersecurity
Bloomberg investigation shows Chinese hacking of computer networks at highest levels. Despite denials by the likes of Apple (AAPL), and Super Micro (SMCI), Bloomberg has released an exclusive report providing evidence that the Chinese, via their People's Liberation Army, have "seeded" tiny microchip spy devices in thousands of server motherboards; computer equipment that was sold to at least 30 American companies, including Apple. The devices were implanted during the manufacturing process at Chinese facilities, and (according to the Bloomberg report) at Super Micro Computer (SMCI), a San Jose-based server manufacturer which employs primarily Asian workers. These devices, which Amazon (AMZN) first uncovered and reported on to US authorities, allow the attacker to create a "doorway" into any network on which the servers reside. Consider this: these are "viruses" which are impossible to remove, because they are part of the machine's hardware, not software. The networks in question run the most sensitive systems from a national security standpoint, operated by agencies such as the CIA, NASA, and the Department of Defense. This story should send shivers through the US intelligence community, and it should be the impetus needed to begin the search for other sources of manufacturers, outside of the reach of the Chinese military. This story also portends a long, ugly road ahead for US-Chinese trade negotiations. This is precisely the type of illegal intellectual property theft the Administration has railed against. Super Micro fell by 33% shortly after the Bloomberg article was released.
Economics: Work & Pay
Blowing past expectations, private sector adds 230,000 new jobs. And the incredibly strong economy just keeps rolling along. The American private sector added an aggregate 230,000 new jobs in the month of September—24% more than the 185,000 economists had predicted. Buttressing the importance of the tax cut for everyday Americans (and small business owners), most of those new hires came from small- and mid-sized businesses in the services sector. According to ADP, a small-sized company is one which employs between 1 and 49 workers, while a mid-sized firm employs between 50 and 499 workers. It looks as though the ultra-low unemployment rate is not done falling.
Pharmaceuticals
(Holding Update: Penn Global Leaders Club) Pfizer's dynamic CEO to step down from that role in 2019. We are placing pharmaceutical giant Pfizer (PFE $33-$45-$45) on watch after a CEO we have highly touted, Ian Read, announced that he would be stepping down from that role at the company in early, 2019. Chief Operating Officer Albert Bourla will take over the position. Pfizer skillfully navigated some turbulent waters during Read's eight year tenure, and he helped the company build an impressive pipeline of drugs. Bourla also has an impressive resume during his 25 years at the company, but it still makes us a bit nervous. One upside: Read will take on the role of executive chairman of the board after he steps down from his CEO position.
Specialty Retail: e-Commerce
(Without a government mandate,) Amazon raises minimum wage to $15/hour. It is amazing how many people—and the dolts they elect to represent them—don't understand basic economics. That thought came to mind as we read the Amazon (AMZN $950-$2,007-$2,051) press release announcing the company's plans to raise the minimum employee wage to $15 per hour. Why do it? Because the company now has a quarterly free cash flow of $4.2 billion and earnings per share of $6.32. And, they want to attract and retain the best workers in an ultra-tight (thanks to America's booming economy) labor force. This new minimum wage will also apply to the 100,000-strong temp workforce the company will bring in for the Christmas holiday season. Don't believe what Crazy Uncle Bernie says, this occurred because of the company's profitability, not government pressure. If Crazy Uncle Bernie wants to take credit, let him.
Global Trade
Another trade deal done, and this one was huge. The lousy, 24-year-old NAFTA deal is dead. Long live the US-Mexico-Canada Agreement, or USMCA. While the limited trade agreement reached with the EU a few months back was good, and the US-Korea Free Trade Agreement (KORUS) was better, the new North American deal is huge. It ends the bickering between the three nations with respect to trade, helps America's manufacturing base, and puts the entire continent on better footing with respect to world trade. It also helped the US garner two new allies on the united front against China's unfair trade practices. The stock market agreed, with the Dow jumping a few hundred points after the deal was inked. While legislators in all three nations must still approve the USMCA deal, there is little chance that any will shirk their duties, as that would mean an enormous setback in free trade. While the Democrats might well win the House this November, and they would love to deal a blow to President Trump, we don't believe their constituents would let them pull off something so audacious as killing this trade deal. Their radical fringe would love it, but there are still too many blue collar voters and unions aligned with the party to let that happen, except in the most unhinged districts. Next stops on the trade train: a deal with Japan and a more extensive deal with the unruly and petulant EU, led by the likes of Trump-hater Angela Merkel.
Industrial Conglomerates
GE fires Flannery after thirteen months on the job. After it became apparent that General Electric's (GE $11-$12-$25) new boss was a lot like its old boss (who presided over a disastrous period for the once-great company), the board decided enough was enough. After just thirteen months in the role, GE's board of directors fired CEO John Flannery. Not only wasn't the company moving in a positive direction, it appeared as if Flannery was continuing to dig even deeper into the hole in which Jeffrey Immelt placed the company. Great units were being sold off, and a general sense of disarray permeated the company. The final straw came with the 2018 full-year guidance: the company would miss both revenue and profit targets. Additionally, GE announced it would take a $23 billion write-down for its power unit. There is some good news: the board tapped former Danaher CEO—and current GE board member—Larry Culp as the new chairman and CEO. Culp had an impressive record heading up the $76 billion healthcare firm. Is it too late for a turnaround act at General Electric? Perhaps. But, if anyone can pull it off, it is probably Culp. GE was up double-digits on news of Flannery's firing.
Multiline Retail
JC Penney falls double-digits (again) after CFO leaves firm. Granted, when your company's stock is selling for a few dollars a share, it doesn't take much to move the needle by double—or even triple—digits. Nonetheless, it was another bad headline JC Penney (JCP $2-$2-$5) did not need. The catalyst for the latest 10% drop in the stock was news that the company's chief financial officer, Jeff Davis, was leaving after fourteen months on the job. When someone who can see the financials in all their glory decides to bolt, it is probably not a good sign that a recovery is around the corner. The company is now down 50.5% year-to-date and has a market cap of $493 million. Just over a decade ago, JC Penney was a $20 billion company. This was not inevitable. Instead of installing a strong, forward-looking management team, the company made disastrously-bad decisions which led them to this point.
Automotive
Musk settles with SEC, causing shares of Tesla to spike. The SEC and Elon Musk have settled out of court, and the markets celebrated. Despite the organization's draconian demands in the lawsuit stemming from Musk's boneheaded tweet about taking Tesla (TSLA $245-$305-$387) private, there was every possibility that they would have ultimately won—they are, after all, the government. Musk, who had rejected the initial plea deal offered by the SEC, was convinced by his lawyers to request another plea. The SEC reluctantly agreed, but made the terms stiffer: Musk would have to pay a $20 million fine, the company would have to pay a $20 million fine, and Tesla's founder would be barred from the chairman's seat for three years. Additionally, the company would have to create two new independent board seats, and Musk would have to have any social media comments reviewed before posting. It sounds like a rough pill to swallow, but considering the SEC's lawsuit sought to have Musk banned for life from a management role at Tesla, it had to be taken. This should allow Musk, who was allowed to retain his position as CEO, to return his focus to Model 3 "logistics hell." Tesla spiked over 16% on news of the settlement.
Aerospace & Defense
Boeing notches another huge win over Lockheed—awarded the new US Air Force trainer contract. Earlier in the week, we reported that Penn Global Leaders Club member Boeing (BA $253-$367-$374) won a $2.4 billion contract to build the replacement for the aging Huey chopper fleet. Now, the company can boast a much bigger prize: it beat out Lockheed Martin (LMT) in a bid to build a new trainer for the United States Air Force. The contract, worth up to $9.2 billion, will allow Boeing's T-X program to move forward, building at least 351 jets, 46 simulators, and associated ground equipment. The T-X (yet to be numbered and named) will replace the venerable T-38 Talon fleet which has been used to train military pilots for two generations. Boeing, which is risk-sharing this project with Sweden's Saab Group (SAABF), will build the aircraft at their St. Louis, MO facilities.
Media & Entertainment
Fox to sell remaining Sky position to Comcast for $15 billion. Four days after a fat bidding war gave majority ownership of Sky PLC (BSYBF $12-$22-$23)—the UK's only satellite television provider and the country's largest pay-TV provider—to Comcast (CMCSA), Fox (FOX) threw in the towel and announced it would sell its remaining stake to Comcast for just over $15 billion. This is really a win-win for both Comcast and Disney (DIS), which would have gained control of Sky after its deal to buy a wide swath of Fox assets closed. While Comcast paid a huge premium for Sky, Disney can use the proceeds from Fox's 39% stake in Sky to help pay down some of the $71 billion it paid for the Fox assets. Additionally, had Disney ended up with Sky, the company would have probably been forced by regulators to divest itself of other units as part of the deal. For the record, we purchased Disney in the Penn Global Leaders Club last year for $96.92.
Monetary Policy
Fed sees bright economic future, raises rates once again. The Federal Reserve is bullish on the growth within the US economy, and they do not want that growth to lead to runaway inflation (even though there are really no signs of this happening). With that as the backdrop, the FOMC raised the Fed Funds Rate 25 basis points on Wednesday, to 2.25%. But they didn't stop there. After raising their economic outlook for the country, members also projected one more hike this year and three in calendar year 2019. In the long run, however, they see a stable Fed Funds Rate at 3%, meaning a few potential rate cuts after 2020. While we don't necessarily believe they will deliver on the four-more-hikes prediction, what would this do to the 30-year mortgage rate? Although certainly still below generational highs, the average mortgage would probably cost buyers 6% to 6.25%. With existing-home sales already slowing, that could certainly impact homebuilders. However, we still see that in the manageable range—not high enough to hurt the economy. From an investment standpoint, we should continue to see improved yields, which will provide welcome relief to those seeking more income but less risk.
Energy Commodities
Crude hits four-year high, but not everyone is hurting. Most people cringe when they see the price of oil go up. Not only does that equate to spending more money at the pump, it also helps many of our enemies, or at least "questionable friends" around the world, such as Russia and OPEC member-states. Since America's energy renaissance, however, at least we can take a little comfort in the fact that the American energy sector, and its mostly blue collar workforce, also reap the benefits of higher oil prices. Take a look at the chart: crude just hit $71.76 per barrel, a four-year high; but US oil production followed suit, hitting a remarkable 11 million bpd. With new Iranian sanctions taking effect soon, Venezuela offline due to political strife, and OPEC/Russian desire for $80/barrel, we wouldn't be shorting oil right now. The one bright spot, we believe, is the fact that China's rate of economic growth continues to slow.
Global Strategy: East & Southeast Asia
US, South Korea finalize trade deal. The United States and South Korea held an official signing ceremony at the United Nations this week to celebrate a new trade deal, or at least a major revamp of the KORUS deal on the books between the two allies. Korea exports just over $10 billion more in goods and services each year to the United States than the US does to South Korea. This new trade deal is an attempt to rectify that situation. Under its terms, South Korea will now allow each American automaker to export 50,000 vehicles annually into the country which meet US—not South Korean—safety standards. A 25% tariff on Korean trucks coming to the US not only remains in place, it has been extended to 2041. With respect to steel, the Asian country agreed to slash its exports to the US by nearly one-third; in return, the country's steel exports no longer face the 25% tariff imposed on imports by the Administration. South Korea is currently the third-largest exporter of steel to the US. This was a nice win for both countries: the US will get a "more-level" playing field, while Moon Jae-in garnered more support in his efforts to mend ties with North Korea. After discussing the recent meeting between the two Korean leaders, President Trump announced that a follow-up meeting with Kim Jong-un will take place soon.
Aerospace & Defense
Boeing beats out Lockheed, Sierra Nevada to win Huey replacement contract. The Pentagon has awarded a $2.4 billion contract to Penn Global Leaders Club member Boeing (BA $251-$368-$374) to build a replacement for the aging UH-1N Iroquois choppers, affectionately known as "Hueys." Boeing, which teamed up with Italy's Leonardo SpA for the bid, will build the 84 military choppers at its facilities near Philadelphia, PA. The "MH-139" aircraft will be used to help protect America's ICBM sites around the country, as well as other critical tasks around the world. Boeing beat out privately-held Sierra Nevada and the famed Sikorsky unit of Lockheed Martin to win the Air Force deal.
Restaurants
Sonic to be acquired by private restaurant conglomerate Inspire Brands for $2.3 billion. Back in early summer, iconic American fast-food chain Sonic (SONC $23-$44-$45) had a market cap of just $879 million. After a nice fall rally, the company grew to about $1.25 billion in size. Double that amount and you have what Arby's and Buffalo Wild Wings parent Inspire Brands plans to spend to take the company private. Shares of SONC shot up 20% after the announcement. Recall that Inspire paid the same amount—$2.3 billion—to buy Buffalo Wild Wings last year after, in our opinion, years of mismanagement at that chain. Inspire seems to be building a fast-food and casual dining empire. Sadly, they are building that empire by taking out publicly-traded companies.
Textiles, Apparel, & Luxury Goods
Michael Kors set to buy Versace, but what kind of headaches might come with the deal? When Gianni Versace was gunned down in Miami Beach twenty-one years ago, his eponymous company was thrown into turmoil. His sister, Donatella, became creative director at the firm after the fashion designer died, but the family-controlled business hasn't been the same since. Now, in an effort to gain a foothold in higher-end European fashion, Michael Kors (KORS $46-$67-$76) has announced plans to buy the firm for around $2 billion. On its face, the deal makes sense for the growing Kors (the company bought high-end shoemaker Jimmy Choo last year for $1.2 billion), but several serious questions remain. Versace is closely-held by members of the family, many of whom may come along with the deal. Additionally, the company generated only around $920 million in revenue last year, with a paltry $20 million or so flowing down as net profit. Other fashion companies like Tiffany & Co (reportedly) balked at the price tag. What did investors think of the news? Kors fell 8% after the announcement.
Metals & Mining
Barrick Gold to buy Randgold, creating an $18 billion mining behemoth. The world's largest gold miner, Toronto-based Barrick Gold Corp (ABX $10-$11-$17), will acquire Randgold Resources Limited (GOLD $60-$68-$104), primarily a Sub-Saharan Africa miner, in a deal which will value the combined company at $18 billion. Under the terms of the deal, Randgold shareholders will receive just over six shares of Barrick for each share of GOLD they own. Barrick shareholders will then control two-thirds of the combined company, with CEO John Thornton becoming the executive chairman of the new entity. Considering that both of these companies have lost one-third of their market value over the past year, this was a good move. The synergies should allow the new entity to operate more efficiently; a critically important factor considering the recent drop in the price of gold. The market agreed—both companies rose about 7% on the news.
Media & Entertainment
SiriusXM to buy Pandora for $3.5 billion. In what would ultimately equate to bad news for listeners who enjoy free music, aggressive-marketing satellite radio service SiriusXM (SIRI $5-$7-$8) has announced its intent to buy rival Pandora Media (P $4-$9-$10) in an all-stock deal valued at $3.5 billion. Before news of the planned acquisition, Sirius had a surprisingly-high market cap of $30 billion (it fell 5% in pre-market) and Pandora had a market cap of $2.6 billion (it popped 8% on the news). If the deal goes through as expected, the new entity would be the largest audio entertainment company in the world. SiriusXM has over 35 million paid subscribers and Pandora has over 70 million active monthly listeners. Pandora, which has free listening option for members, has been bleeding money annually since it went public, while Sirius, which only has a subscription model, has recorded a positive net cash flow since 2010. Speaking from experience, the Sirius platform is simply unrivaled, but the sales tactics used as a subscription period nears its end are relentless and aggressive. In other words, the company uses a vastly different strategy than does Apple (AAPL) with its music streaming service. We love the SiriusXM service, but we wouldn't touch the stock.
Headlines for the Week of 16 Sep — 22 Sep 2018
Airstream's parent company makes bold move into European, Chinese markets with acquisition...
Photo courtesy: Penn Wealth/YCharts
Market Pulse
After another solid week, the major indexes rock into Autumn. Now that the St Leger Day horse race is done, we suppose it is "safe" to get back in the markets ("sell in May, go away..."). Actually, any investor out of the markets this summer missed a great run in equities, and it appears to still be going strong. The Dow and S&P indexes hit new all-time highs this week as investors seemed to grow weary (and leery) of the "great trade war" fears fomented by the media. We have actually noticed some cracks in the firewall, with a couple of journalists finally pointing out that China simply doesn't have near as much ammo as the United States does in the skirmish. Refreshing to see them take a break from the false narratives. And remember how we were told that investors would throw a tantrum when the 10-year Treasury yield hit 3%? It did just that this past Tuesday—as the Dow was busy climbing 185 points. All-in-all, a good week. Next on the horizon: an almost certain rate hike next week (yawn), and the mid-term elections (potential trouble for markets).
Housing
Mortgage rates hit their highest level in seven years, forcing would-be buyers into action. One year ago, the average 30-year mortgage rate in the US was 3.78%. As of right now, that figure sits at 4.87%—the highest it has been since the spring of 2011. Something else has been going up this year: the cost of buying a home. In the first quarter of 2018, the US existing home median sales price was $240,800. That figure has spiked 10% since January, and now sits at $264,800. With the promise of more Fed rate hikes coming between now and the end of 2019, the Mortgage Bankers Association reported a 1.6% rise in mortgage applications within the past week. Here's the simple fact, however: this rate hike cycle has a definite cap on it, and it is in the 4% or less range for the fed funds rate—a far cry from the 7% or higher rates we have seen in the past. This should set up a Goldilocks scenario for the housing market, homebuilders, and new homeowners over the next several years.
Aerospace & Defense
Airbus's nightmarish A320 delays are more good news for Penn member Boeing. Airbus SE (EADSY $22-$31-$32), the EU government-supported European aircraft maker, is having a turbulent year. The latest blow comes in the form of costly delays to its A320neo (new engine option) aircraft line, which the company touts as the world's most advanced and fuel efficient single-aisle aircraft (think of it as a competitor to Boeing's widely-successful 737). The company announced that it needs another year to get A320 production back on track after a series of design snags and supplier problems. In another blow to the company, Airbus's head of sales, Eric Schulz, abruptly left that post after just nine months with the firm. Schulz had been the President of Civil Aerospace at Rolls-Royce plc prior to the gig. All of this is good news for American aerospace giant (and Penn Global Leaders Club member) Boeing (BA $251-$371-$374), whose shares have been climbing back near their 52-week high.
Food Products
Agriculture is getting pounded from Hurricane Florence. In addition to its devastating effect on the lives of millions in the region, expect the fallout from Hurricane Florence to include higher poultry prices at the supermarket. It's hard to fathom, but somewhere around 3.4 million chickens and turkeys have been destroyed by the storm, along with nearly 6,000 hogs. Nearly half of all tobacco grown in the US comes from North Carolina, and those crops were devastated, along with fields of sweet potatoes, corn, and cotton. Overall, the best estimate at the aggregate damage caused by the hurricane now sits above the $20 billion mark, with the overwhelming majority of that damage taking place in the Carolinas. Agriculture, insurance, and restaurant firms operating in the region have been most impacted by the hurricane, while mobile generator manufacturing firm Generac Holdings (GNRC $43-$59-$61) is up about 6.5% in the past month.
Automotive
Airstream parent makes its biggest purchase ever with German acquisition. Airstream. That iconic, uniquely-shaped monstrosity which conjures up images of an American family on vacation—circa 1955. It would have been easy for Airstream's parent company, Thor Industries (THO $88-$102-$161), to spiral into a slow demise like so many other generations-old consumer discretionary companies. Instead, through astute strategic planning and slick marketing, the $5 billion mid-cap is flush with cash, and it is about to spend some of that cash to grow internationally. Thor has announced it will acquire German RV-maker Erwin Hymer Group in a $2.2 billion cash and stock deal. Hymer boasts a couple of dozen brands of RVs, campers, caravans, and accessories. The purchase is part of Thor's plan to move into new markets, especially those in Europe and China. THO has a tiny p/e ratio of 12, and booked sales of $8.4 billion worth of equipment over the trailing twelve months—nearly all of which came from the US and Canada.
Consumer Finance
Merchants notch a victory over credit card swipe fees. For years, merchants have been held hostage to the arbitrary fees they get hit with every time a customer swipes a Visa (V) or Mastercard (MC) piece of plastic through a machine at their respective establishments. Now, as a result of a thirteen-year-old class action lawsuit, the card issuers will pay a tiny bit of those fees back. The two big credit card issuers and a number of banks have agreed to pay $6.2 billion to settle the fight. Visa will pay the lion's share of the agreement—$4.1 billion—with the remaining companies ponying up the rest. Don't feel too bad for the credit card issuers, however, as they have had a strong run over the past year and their shares seem to be shrugging off the news of this settlement.
Global Strategy: Europe
In typical elitist fashion, London's mayor calls for new Brexit vote. Full disclosure: London's mayor, Sadiq Khan, is a full-throated leftist, angry at the UK's Brexit outcome from the day the surprise results were announced. Against that backdrop (lest anyone think he is simply a nonpartisan Londoner), the mayor, who tried to ban President Donald Trump from entering London, has called for a second Brexit referendum. In his "anguished" speech, the mayor decried the prime minister's handling of the negotiations and said that a new referendum was the only way to clear the air. i.e. he didn't get the results he wanted, and is now throwing a temper tantrum. The second referendum has been dubbed the "people's vote" by supporters like the hapless Khan, whose politics are in the same vein as New York's socialist mayor DeBlasio. If this new vote is the "people's vote," who, exactly, voted in the first referendum?
Interactive Media & Services
Twitter falls after analyst downgrades, calls accounting into question. “Smoke and mirrors” was the term Michael Nathanson at MoffettNathanson used to describe some aspects of Twitter’s (TWTR $17-$29-$48) financial accounting for the first half of the year. Nathanson noted that investors will soon take into account the growing demand for the vast amount of cash needed to run the business—cash the company doesn’t have on hand. In the end, the analyst reduced his rating on the stock to a “sell,” and reduced the price target from $23 to $21 per share—a 28% drop from the current price. (Note: this story falls into the new GICS category "Interactive Media & Services," formerly "Internet Software & Services." The industry can be found under the new "Communication Services" sector.)
Specialty & Generic Drugs
Teva pops 8% on FDA approval of migraine drug. Israeli drugmaker Teva Pharmaceutical Industries (TEVA $11-$25-$26) seems to be on a comeback tear. After bottoming out at $10.85 per share last November, the $25 billion company has clawed back to within a dollar of its 52-week high. The latest surge came after news that the FDA had approved the company's injection for the preventative treatment of migraines. Ajovy will cost around $600 per monthly injection and be available in pharmacies sometime in early October. Teva still has a long way to go to regain its multi-year high of $71 per share, which it hit back in the summer of 2015.
After another solid week, the major indexes rock into Autumn. Now that the St Leger Day horse race is done, we suppose it is "safe" to get back in the markets ("sell in May, go away..."). Actually, any investor out of the markets this summer missed a great run in equities, and it appears to still be going strong. The Dow and S&P indexes hit new all-time highs this week as investors seemed to grow weary (and leery) of the "great trade war" fears fomented by the media. We have actually noticed some cracks in the firewall, with a couple of journalists finally pointing out that China simply doesn't have near as much ammo as the United States does in the skirmish. Refreshing to see them take a break from the false narratives. And remember how we were told that investors would throw a tantrum when the 10-year Treasury yield hit 3%? It did just that this past Tuesday—as the Dow was busy climbing 185 points. All-in-all, a good week. Next on the horizon: an almost certain rate hike next week (yawn), and the mid-term elections (potential trouble for markets).
Housing
Mortgage rates hit their highest level in seven years, forcing would-be buyers into action. One year ago, the average 30-year mortgage rate in the US was 3.78%. As of right now, that figure sits at 4.87%—the highest it has been since the spring of 2011. Something else has been going up this year: the cost of buying a home. In the first quarter of 2018, the US existing home median sales price was $240,800. That figure has spiked 10% since January, and now sits at $264,800. With the promise of more Fed rate hikes coming between now and the end of 2019, the Mortgage Bankers Association reported a 1.6% rise in mortgage applications within the past week. Here's the simple fact, however: this rate hike cycle has a definite cap on it, and it is in the 4% or less range for the fed funds rate—a far cry from the 7% or higher rates we have seen in the past. This should set up a Goldilocks scenario for the housing market, homebuilders, and new homeowners over the next several years.
Aerospace & Defense
Airbus's nightmarish A320 delays are more good news for Penn member Boeing. Airbus SE (EADSY $22-$31-$32), the EU government-supported European aircraft maker, is having a turbulent year. The latest blow comes in the form of costly delays to its A320neo (new engine option) aircraft line, which the company touts as the world's most advanced and fuel efficient single-aisle aircraft (think of it as a competitor to Boeing's widely-successful 737). The company announced that it needs another year to get A320 production back on track after a series of design snags and supplier problems. In another blow to the company, Airbus's head of sales, Eric Schulz, abruptly left that post after just nine months with the firm. Schulz had been the President of Civil Aerospace at Rolls-Royce plc prior to the gig. All of this is good news for American aerospace giant (and Penn Global Leaders Club member) Boeing (BA $251-$371-$374), whose shares have been climbing back near their 52-week high.
Food Products
Agriculture is getting pounded from Hurricane Florence. In addition to its devastating effect on the lives of millions in the region, expect the fallout from Hurricane Florence to include higher poultry prices at the supermarket. It's hard to fathom, but somewhere around 3.4 million chickens and turkeys have been destroyed by the storm, along with nearly 6,000 hogs. Nearly half of all tobacco grown in the US comes from North Carolina, and those crops were devastated, along with fields of sweet potatoes, corn, and cotton. Overall, the best estimate at the aggregate damage caused by the hurricane now sits above the $20 billion mark, with the overwhelming majority of that damage taking place in the Carolinas. Agriculture, insurance, and restaurant firms operating in the region have been most impacted by the hurricane, while mobile generator manufacturing firm Generac Holdings (GNRC $43-$59-$61) is up about 6.5% in the past month.
Automotive
Airstream parent makes its biggest purchase ever with German acquisition. Airstream. That iconic, uniquely-shaped monstrosity which conjures up images of an American family on vacation—circa 1955. It would have been easy for Airstream's parent company, Thor Industries (THO $88-$102-$161), to spiral into a slow demise like so many other generations-old consumer discretionary companies. Instead, through astute strategic planning and slick marketing, the $5 billion mid-cap is flush with cash, and it is about to spend some of that cash to grow internationally. Thor has announced it will acquire German RV-maker Erwin Hymer Group in a $2.2 billion cash and stock deal. Hymer boasts a couple of dozen brands of RVs, campers, caravans, and accessories. The purchase is part of Thor's plan to move into new markets, especially those in Europe and China. THO has a tiny p/e ratio of 12, and booked sales of $8.4 billion worth of equipment over the trailing twelve months—nearly all of which came from the US and Canada.
Consumer Finance
Merchants notch a victory over credit card swipe fees. For years, merchants have been held hostage to the arbitrary fees they get hit with every time a customer swipes a Visa (V) or Mastercard (MC) piece of plastic through a machine at their respective establishments. Now, as a result of a thirteen-year-old class action lawsuit, the card issuers will pay a tiny bit of those fees back. The two big credit card issuers and a number of banks have agreed to pay $6.2 billion to settle the fight. Visa will pay the lion's share of the agreement—$4.1 billion—with the remaining companies ponying up the rest. Don't feel too bad for the credit card issuers, however, as they have had a strong run over the past year and their shares seem to be shrugging off the news of this settlement.
Global Strategy: Europe
In typical elitist fashion, London's mayor calls for new Brexit vote. Full disclosure: London's mayor, Sadiq Khan, is a full-throated leftist, angry at the UK's Brexit outcome from the day the surprise results were announced. Against that backdrop (lest anyone think he is simply a nonpartisan Londoner), the mayor, who tried to ban President Donald Trump from entering London, has called for a second Brexit referendum. In his "anguished" speech, the mayor decried the prime minister's handling of the negotiations and said that a new referendum was the only way to clear the air. i.e. he didn't get the results he wanted, and is now throwing a temper tantrum. The second referendum has been dubbed the "people's vote" by supporters like the hapless Khan, whose politics are in the same vein as New York's socialist mayor DeBlasio. If this new vote is the "people's vote," who, exactly, voted in the first referendum?
Interactive Media & Services
Twitter falls after analyst downgrades, calls accounting into question. “Smoke and mirrors” was the term Michael Nathanson at MoffettNathanson used to describe some aspects of Twitter’s (TWTR $17-$29-$48) financial accounting for the first half of the year. Nathanson noted that investors will soon take into account the growing demand for the vast amount of cash needed to run the business—cash the company doesn’t have on hand. In the end, the analyst reduced his rating on the stock to a “sell,” and reduced the price target from $23 to $21 per share—a 28% drop from the current price. (Note: this story falls into the new GICS category "Interactive Media & Services," formerly "Internet Software & Services." The industry can be found under the new "Communication Services" sector.)
Specialty & Generic Drugs
Teva pops 8% on FDA approval of migraine drug. Israeli drugmaker Teva Pharmaceutical Industries (TEVA $11-$25-$26) seems to be on a comeback tear. After bottoming out at $10.85 per share last November, the $25 billion company has clawed back to within a dollar of its 52-week high. The latest surge came after news that the FDA had approved the company's injection for the preventative treatment of migraines. Ajovy will cost around $600 per monthly injection and be available in pharmacies sometime in early October. Teva still has a long way to go to regain its multi-year high of $71 per share, which it hit back in the summer of 2015.
Headlines for the Week of 09 Sep — 15 Sep 2018
Major shakeup in Sweden...
Multiline Retail
Target's Christmas hiring plan portends good things for economy. Retail is often a strong harbinger for the overall economy. After all, if consumers are in dire financial straits or don't feel good about their economic prospects, they don't buy as much; and vice versa. This is why we should pay attention to what major retailers are doing, as they are an indicator of sentiment. To that end, multiline retailer Target (TGT $54-$88-$90) just announced their 2018 plans for the upcoming Christmas and holiday season. The company will hire 120,000 seasonal workers this year, which is 20% more than last year (which was more than the previous year). Workers hired for the holiday rush will start out making $12 per hour, and will receive the standard employee discount on purchases. Target's hiring plans are anecdotal, but we see a robust economic environment going into the 2018 Christmas season, with both consumer confidence and business confidence levels near all-time highs.
Consumer Electronics
Sonos had to have a perfectly stellar quarter; it didn't. Any time we are reviewing a specific company, one of the paramount questions we ask is, "what is this organization's unique value proposition?" To survive and thrive in a competitive business environment, a company must offer a solution that consumers strongly desire, and a solution that is difficult to replicate by others. That is why we were skeptical when wireless speaker company Sonos (SONO $16-$18-$24) went public last month at $15 per share. The company makes cool wireless speakers for in-home use, but what's to stop larger companies (think Apple, for example) from making similar products? Under that backdrop, all eyes were on Sonos Inc's first quarterly report as a publicly-traded entity. Wall Street expectations were met—the company brought in $208 million in revenue—but sales were down 7% from the same timeframe last year. Further down the income statement, the company accumulated $27 million in net losses—nearly double the $15 million lost in Q3 of 2017. Shares plunged 16% in after-hours trading on the earnings report. Keep in mind that investors drove SONO shares up to $23.60 within days of the IPO.
Specialty Retail
KeyBanc analyst upgrades Restoration Hardware after big sell-off. Earlier this month, shares of luxury home goods retailer Restoration Hardware (RH $68-$126-$164) plummeted from $162 to $122 after the company lowered its 2018 revenue guidance. KeyBanc Capital Markets analyst Bradley Thomas believes investors overreacted to the (actually pretty decent) report, and upgraded the company from Sector Weight to Overweight, with a price target of $166 per share—a 32% gain from here. Without doubt, the upper-end American consumer is spending robustly, and this should help a company like RH. What worries us, however, is the rich 90 multiple on the shares—and that is after the drop. We would steer clear.
Road & Rail
Trucker US Xpress Enterprises launches "Full Ride" scholarship program for employees, dependents. US Xpress Enterprises (USX $13-$16-$17) has only been a publicly-traded company for about three months, but the trucking firm has launched a new employee benefits program which is earning it high marks on Wall Street and praise from its workforce. Touted as the "first of its kind within the trucking industry," the company's "Full Ride" program will provide scholarships covering 100% of tuition at Ashford University for not only employees, but also their dependents. Under the program, any combination of two family members at any given time can get an online bachelor's or master's degree at the fully accredited Ashford at no cost. When one family member graduates, another can enter the program. The typical annual cost for students at Ashford is the same as the in-state tuition for most universities—around $17,000. With the robust state of the US economy and a 3.9% unemployment rate, the trucking industry is facing a serious shortage of drivers. US Xpress, the fifth largest asset-based carrier in the US by revenue, hopes to attract quality drivers with this new program. The company, which operates a fleet of 6,800 tractors and 16,000 trailers, was founded in 1985 and is based out of Chattanooga, Tennessee. Information on the program and becoming a driver for USX can be found at the company's website.
Global Strategy: Europe
Stunning surge by right-wing party in Sweden shakes up establishment. Virtually every country in Europe has lashed out, in one way or another, against the EU's forced immigration policy—telling member-states how many immigrants they must accept. Over the weekend, Sweden added their name to the list as voter anger manifested itself at the polls, pushing the typically left-leaning nation further to the right. Up until now, the major ruling force has been an alliance between the leftist Social Democrat Party and the further-left Green Party. The leader of the Social Democrats, Stefan Löfven, also happens to be the current prime minister of Sweden. During the campaign season, the right wing Sweden Democrats ran an efficient campaign based primarily on two planks: immigration and crime. This resonated with voters, and the party was rewarded by gaining nearly 20% of the national vote. Now, two allegiances must vie for power: one from the left (led by the Social Democrats), and one from the right (known as the Alliance). Both groups scored about 40% of the votes in the election. Calls for Prime Minister Löfven to step down are intensifying in the wake of the election, and the formation of a brand new government are all but certain.
Target's Christmas hiring plan portends good things for economy. Retail is often a strong harbinger for the overall economy. After all, if consumers are in dire financial straits or don't feel good about their economic prospects, they don't buy as much; and vice versa. This is why we should pay attention to what major retailers are doing, as they are an indicator of sentiment. To that end, multiline retailer Target (TGT $54-$88-$90) just announced their 2018 plans for the upcoming Christmas and holiday season. The company will hire 120,000 seasonal workers this year, which is 20% more than last year (which was more than the previous year). Workers hired for the holiday rush will start out making $12 per hour, and will receive the standard employee discount on purchases. Target's hiring plans are anecdotal, but we see a robust economic environment going into the 2018 Christmas season, with both consumer confidence and business confidence levels near all-time highs.
Consumer Electronics
Sonos had to have a perfectly stellar quarter; it didn't. Any time we are reviewing a specific company, one of the paramount questions we ask is, "what is this organization's unique value proposition?" To survive and thrive in a competitive business environment, a company must offer a solution that consumers strongly desire, and a solution that is difficult to replicate by others. That is why we were skeptical when wireless speaker company Sonos (SONO $16-$18-$24) went public last month at $15 per share. The company makes cool wireless speakers for in-home use, but what's to stop larger companies (think Apple, for example) from making similar products? Under that backdrop, all eyes were on Sonos Inc's first quarterly report as a publicly-traded entity. Wall Street expectations were met—the company brought in $208 million in revenue—but sales were down 7% from the same timeframe last year. Further down the income statement, the company accumulated $27 million in net losses—nearly double the $15 million lost in Q3 of 2017. Shares plunged 16% in after-hours trading on the earnings report. Keep in mind that investors drove SONO shares up to $23.60 within days of the IPO.
Specialty Retail
KeyBanc analyst upgrades Restoration Hardware after big sell-off. Earlier this month, shares of luxury home goods retailer Restoration Hardware (RH $68-$126-$164) plummeted from $162 to $122 after the company lowered its 2018 revenue guidance. KeyBanc Capital Markets analyst Bradley Thomas believes investors overreacted to the (actually pretty decent) report, and upgraded the company from Sector Weight to Overweight, with a price target of $166 per share—a 32% gain from here. Without doubt, the upper-end American consumer is spending robustly, and this should help a company like RH. What worries us, however, is the rich 90 multiple on the shares—and that is after the drop. We would steer clear.
Road & Rail
Trucker US Xpress Enterprises launches "Full Ride" scholarship program for employees, dependents. US Xpress Enterprises (USX $13-$16-$17) has only been a publicly-traded company for about three months, but the trucking firm has launched a new employee benefits program which is earning it high marks on Wall Street and praise from its workforce. Touted as the "first of its kind within the trucking industry," the company's "Full Ride" program will provide scholarships covering 100% of tuition at Ashford University for not only employees, but also their dependents. Under the program, any combination of two family members at any given time can get an online bachelor's or master's degree at the fully accredited Ashford at no cost. When one family member graduates, another can enter the program. The typical annual cost for students at Ashford is the same as the in-state tuition for most universities—around $17,000. With the robust state of the US economy and a 3.9% unemployment rate, the trucking industry is facing a serious shortage of drivers. US Xpress, the fifth largest asset-based carrier in the US by revenue, hopes to attract quality drivers with this new program. The company, which operates a fleet of 6,800 tractors and 16,000 trailers, was founded in 1985 and is based out of Chattanooga, Tennessee. Information on the program and becoming a driver for USX can be found at the company's website.
Global Strategy: Europe
Stunning surge by right-wing party in Sweden shakes up establishment. Virtually every country in Europe has lashed out, in one way or another, against the EU's forced immigration policy—telling member-states how many immigrants they must accept. Over the weekend, Sweden added their name to the list as voter anger manifested itself at the polls, pushing the typically left-leaning nation further to the right. Up until now, the major ruling force has been an alliance between the leftist Social Democrat Party and the further-left Green Party. The leader of the Social Democrats, Stefan Löfven, also happens to be the current prime minister of Sweden. During the campaign season, the right wing Sweden Democrats ran an efficient campaign based primarily on two planks: immigration and crime. This resonated with voters, and the party was rewarded by gaining nearly 20% of the national vote. Now, two allegiances must vie for power: one from the left (led by the Social Democrats), and one from the right (known as the Alliance). Both groups scored about 40% of the votes in the election. Calls for Prime Minister Löfven to step down are intensifying in the wake of the election, and the formation of a brand new government are all but certain.
Headlines for the Week of 02 Sep — 08 Sep 2018
South Africa falls into recession...
Specialty Retail
GameStop jumps on rumors it will go public, investors should take the opportunity to cut their losses. Let's be frank: video game retailer GameStop (GME $12-$16-$21) had about as much business going public as Radio Shack had being public in its waning days. It is a digital world, especially in the video game industry, and GameStop's tiny moat shows its vulnerabilities. For anyone who still owns the stock, rumors that the company was looking to go private provided the best opportunity to trim losses—GME popped about 13% on the news. For anyone thinking that the company is a bargain at $15.75 per share, consider this: the stock has a p/e ratio of 407.
Global Strategy: Africa
South Africa enters recession, currency falls against dollar. The South African rand has fallen 16% versus the US dollar in the past six months, a precursor to the economic report issued this week showing the most industrialized economy on the continent has fallen into a recession. South Africa is the latest emerging market to hit turbulent waters this year, highlighting the risks investors face when buying into this asset class. The benchmark iShares MSCI Emerging Markets ETF (EEM $41-$42-$52) is now down 20% since it peaked back in January, and we see no reason to buy on the dip. As for South Africa, the 2nd quarter economic contraction of 0.7% is bad news for President Cyril Ramaphosa, who entered office in February armed with promises of economic reforms for this nation of 58 million.
Textiles, Apparel, & Luxury Goods
Nike steps in it by signing Colin Kaepernick. What a stupid move. It amazes us how many management teams have made the tactical decision lately to insert their publicly-traded companies into the political arena, knowing (if they are smart enough to realize it) that they will turn off a large percentage of their customer base in the process. Athletic apparel maker Nike (NKE $50-$80-84) is the latest, with their decision to hire washed-up former NFL quarterback Colin Kaepernick. The delusional Kaepernick, who still believes he was not given a new contract due to his political beliefs and not his horrendous play, will be featured in Nike's 30th anniversary "Just Do It" campaign. This is humorous for so many reasons. Perhaps, for example, if the QB had focused more on his professional athletic career and less on his hatred for the National Anthem and what it stands for, he might still be a viable spokesman for an athletic shoe company. As it stands, Nike has given a has-been another platform from which to spew his disdain for this country. We will remember that the next time we are shopping for athletic apparel. NKE was down 3% at the open.
GameStop jumps on rumors it will go public, investors should take the opportunity to cut their losses. Let's be frank: video game retailer GameStop (GME $12-$16-$21) had about as much business going public as Radio Shack had being public in its waning days. It is a digital world, especially in the video game industry, and GameStop's tiny moat shows its vulnerabilities. For anyone who still owns the stock, rumors that the company was looking to go private provided the best opportunity to trim losses—GME popped about 13% on the news. For anyone thinking that the company is a bargain at $15.75 per share, consider this: the stock has a p/e ratio of 407.
Global Strategy: Africa
South Africa enters recession, currency falls against dollar. The South African rand has fallen 16% versus the US dollar in the past six months, a precursor to the economic report issued this week showing the most industrialized economy on the continent has fallen into a recession. South Africa is the latest emerging market to hit turbulent waters this year, highlighting the risks investors face when buying into this asset class. The benchmark iShares MSCI Emerging Markets ETF (EEM $41-$42-$52) is now down 20% since it peaked back in January, and we see no reason to buy on the dip. As for South Africa, the 2nd quarter economic contraction of 0.7% is bad news for President Cyril Ramaphosa, who entered office in February armed with promises of economic reforms for this nation of 58 million.
Textiles, Apparel, & Luxury Goods
Nike steps in it by signing Colin Kaepernick. What a stupid move. It amazes us how many management teams have made the tactical decision lately to insert their publicly-traded companies into the political arena, knowing (if they are smart enough to realize it) that they will turn off a large percentage of their customer base in the process. Athletic apparel maker Nike (NKE $50-$80-84) is the latest, with their decision to hire washed-up former NFL quarterback Colin Kaepernick. The delusional Kaepernick, who still believes he was not given a new contract due to his political beliefs and not his horrendous play, will be featured in Nike's 30th anniversary "Just Do It" campaign. This is humorous for so many reasons. Perhaps, for example, if the QB had focused more on his professional athletic career and less on his hatred for the National Anthem and what it stands for, he might still be a viable spokesman for an athletic shoe company. As it stands, Nike has given a has-been another platform from which to spew his disdain for this country. We will remember that the next time we are shopping for athletic apparel. NKE was down 3% at the open.
Headlines for the Week of 26 Aug — 01 Sep 2018
Coca-Cola just made a major move into a high-growth arena...
Photo courtesy: Costa Coffee
Automotive
Ford scraps plans to import Chinese-made auto, while GM will seek an exemption. Due to the 25% tariff which would have been imposed on each vehicle, Ford Motor Company (F $9-$9-$13) has announced that it will cancel plans to import the Chinese-made Focus Active crossover to the US. Ford's chief US rival, General Motors (GM $35-$36-$47), is taking a different approach with respect to its Chinese-made Buick Envision—it will seek an exemption from the government on the tariffs. Both Ford and GM shares have been under intense pressure this year; the only saving grace is their 6.2% and 4.2% respective dividend yields.
Beverages
Coca-Cola just bought one of the world's largest coffee chains. A few weeks ago it was BodyArmor. This week it is British coffee chain Costa. Coca-Cola (KO $41-$45-$49) is suddenly making some serious strategic moves, and we like it. As for Costa, Coke will pay $5.1 billion to buy the firm from Whitbread, Plc, giving it immediate ownership of nearly 4,000 locations across 31 countries.
Don’t look for Coke to compete with Starbucks’ (SBUX) 28,000 stores however; this deal was more about getting the company’s toe in the door of a red-hot industry. While physical storefronts do build brand awareness, Coke plans to use its global leverage to get Costa products in stores, restaurants, and office buildings around the world. The company’s fizzy drink business has seen slowing growth over the past several years, so it will use this new addition to become adept at competing in a high-growth arena.
To that end, Coke plans on keeping the entire Costa team in place, and it will glean what it can about the industry from the inside. When Coke CEO James Robert Quincey learned that Whitbread wanted to divest itself of the holding, he moved quickly—paying a $1 billion premium in the process—to snag the brand before another coffee chain was able to make an offer. Quincey, who is British, was very familiar with the Costa name—about half of the chain’s shops are located in England.
Ultimately, expect to see Costa beans and drink products in grocery and convenience stores everywhere, as Coke’s massive marketing team and logistical advantage help push the brand. Also, expect the company to continue opening physical locations in China, Costa’s quickest-growing market. KO was down about 1% on news of the acquisition, while Whitbread Plc (WTBDY) was trading up around 14%.
Global Strategy: Middle East
Unemployment, inflation, and broken promises are killing Rouhani, not American aggression. America has been the go-to bogeyman for thug regimes in trouble around the world for generations, but there are signs, at least in Iran, that this story is getting old. Hassan Rouhani was reelected as president of Iran a year ago, convincing some 24 million voters that he would release political prisoners, give more rights to women, and get the economy back in shape. Fast forward a year. Iran now has a 12.5% unemployment rate, inflation is off the charts, and he has broken every one of his pledges for social change in the country. Conditions are so bad in the country that Rouhani was called before parliament this past Tuesday and given a rare verbal lashing. As further evidence that the new American actions are having an impact, legislators lambasted him for not dealing better with the US-led sanctions. The value of the Iranian rial has been cut in half since the new sanctions were announced: in January it took 40,000 rials to buy a US dollar; the exchange rate is now 100,000 rials to the dollar. Adding injury to insult, the Iranian parliament threw out Rouhani's economy minister, labor minister, and central bank governor to help change the economic landscape in the totalitarian country. It won't work. Only real reform and abandoning the Islamic state's nuclear ambitions can right the ship, and both of those courses are unacceptable to the hardliners running the show.
Food Products
After management ran Campbell Soup into the ground, a sale is the best option. We have dogged Campbell Soup's (CPB $33-$40-$51) management—especially CEO Denise Morrison—for years. After 149 years as an entity, all it takes is one bad management team making lousy strategic decisions to end a storied company. Campbell Soup is still alive, but, after getting rid of Morrison, it is time to put itself up for sale. Instead, the company is selling off its international and fresh food lines only, such as Bolthouse Farms, in an effort to raise cash and pay down its massive debt. Campbell has a current market cap of just $12 billion, yet it spent over $6 billion to buy snacks firm Snyder's-Lance in a deal which closed earlier this year. In an interesting twist, activist Dan Loeb of Third Point is teaming up with a relative of founder John P. Dorrance, the "father of condensed soup," in an effort to force a sale. Other family members of the founder, however, are fighting that course of action. While several of them sit on the board (and are the largest shareholders), Loeb will push for ousting the entire board of directors as they come up for reelection later this year. There is no good way out for Campbell other than a full sale; the Dorrance family members should take the money and run.
Happiness Index
Consumer confidence jumps to its highest level since 2000. October of 2000, nearly eighteen years ago. That is the last time the American consumer was as confident as they are right now. The surprise reading, from a report conducted by Nielsen for The Conference Board, hit a remarkable 133.4 in August, up from a very high 127.9 reading in July. To put this in perspective, the Consumer Confidence Index hit a low of 38 in October of 2008 in the midst of the financial crisis. The American consumer is the engine for growth, not only in America but around the world. A full 70% of economic activity in the country, in fact, comes from consumer spending. The Consumer Confidence reading is also important to the Fed, as they use this number as a metric to help them shape monetary policy. Suffice to say that we can expect a rate hike at their September meeting.
Global Strategy: Trade
US/Mexico trade pact is a big deal; Canada will feel the heat to join the party. So much for the joint effort against Donald Trump: Mexico just proved that bilateral agreements can be reached. Markets were up, and up big, after President Trump and Mexican President Enrique Pena Nieto held a joint news conference—with the latter on speakerphone—from the Oval Office to announce that the US and Mexico had reached a trade agreement. While the Mexican president still referred to the deal as being part of NAFTA, President Trump called for renaming the pact, due to its negative connotation. Canada is trying to put on a brave face, but this bilateral agreement puts the onus on the Trudeau government to join the party. The Mexican peso was stronger after the deal was announced (as could be expected), but so was the Canadian dollar—implying that Canada will now be more willing to strike a deal.
Global Strategy: Trade
Hogs, corn, and a railroad jump following news of US/Mexico trade deal. While the general markets were rallying on news of a US/Mexico trade deal, certain segments did better than others. Kansas City Southern (KSU $99-$118-$119), the "NAFTA" railroad, spiked 4% on the news, while hog and corn prices rose because Mexico is one of the largest importers of American corn and pork. As for Kansas City Southern, the railroad operates a commercial corridor of the Mexican rail system with direct passage between Texas and Mexico City. By far, KSU is the major railroad most affected by North American trade, as it operates primarily on a north/south rail network.
Global Strategy: Europe
Italy to veto EU budget over failure of bloc to follow-through on immigration reform. Recall that Italy is now being governed by leaders swept into power by Italian citizens angry with the lack of a cogent immigration policy on the continent. Fast forward to today: Italian leaders have vowed to veto the EU budget currently on the table because other European nations (Germany is the big antagonist) have refused to follow-through on an immigration deal hammered out in June. The issue came to a head with the the case of 177 immigrants sitting in a boat off the coast of Italy. Italian Interior Minister Matteo Salvini, a member of the Northern League (Lega Nord) party, wanted commitments by other European nations to take responsibility for the majority of immigrants before he would let the vessel dock. The Diciotti was finally allowed to dock in a Sicilian port after ten days at sea. The Lega Nord party wants more power for individual regions within Italy (think "states rights" in the US) and less for the central government, and certainly less for the European Union. In a sham, Salvini now faces a probe by his political enemies (who favor the EU) for "kidnapping and illegally detaining" the immigrants. This issue is red-hot in Italy, and the arrogant response coming from Brussels is only fueling the fire of discontent among the populace.
Ford scraps plans to import Chinese-made auto, while GM will seek an exemption. Due to the 25% tariff which would have been imposed on each vehicle, Ford Motor Company (F $9-$9-$13) has announced that it will cancel plans to import the Chinese-made Focus Active crossover to the US. Ford's chief US rival, General Motors (GM $35-$36-$47), is taking a different approach with respect to its Chinese-made Buick Envision—it will seek an exemption from the government on the tariffs. Both Ford and GM shares have been under intense pressure this year; the only saving grace is their 6.2% and 4.2% respective dividend yields.
Beverages
Coca-Cola just bought one of the world's largest coffee chains. A few weeks ago it was BodyArmor. This week it is British coffee chain Costa. Coca-Cola (KO $41-$45-$49) is suddenly making some serious strategic moves, and we like it. As for Costa, Coke will pay $5.1 billion to buy the firm from Whitbread, Plc, giving it immediate ownership of nearly 4,000 locations across 31 countries.
Don’t look for Coke to compete with Starbucks’ (SBUX) 28,000 stores however; this deal was more about getting the company’s toe in the door of a red-hot industry. While physical storefronts do build brand awareness, Coke plans to use its global leverage to get Costa products in stores, restaurants, and office buildings around the world. The company’s fizzy drink business has seen slowing growth over the past several years, so it will use this new addition to become adept at competing in a high-growth arena.
To that end, Coke plans on keeping the entire Costa team in place, and it will glean what it can about the industry from the inside. When Coke CEO James Robert Quincey learned that Whitbread wanted to divest itself of the holding, he moved quickly—paying a $1 billion premium in the process—to snag the brand before another coffee chain was able to make an offer. Quincey, who is British, was very familiar with the Costa name—about half of the chain’s shops are located in England.
Ultimately, expect to see Costa beans and drink products in grocery and convenience stores everywhere, as Coke’s massive marketing team and logistical advantage help push the brand. Also, expect the company to continue opening physical locations in China, Costa’s quickest-growing market. KO was down about 1% on news of the acquisition, while Whitbread Plc (WTBDY) was trading up around 14%.
Global Strategy: Middle East
Unemployment, inflation, and broken promises are killing Rouhani, not American aggression. America has been the go-to bogeyman for thug regimes in trouble around the world for generations, but there are signs, at least in Iran, that this story is getting old. Hassan Rouhani was reelected as president of Iran a year ago, convincing some 24 million voters that he would release political prisoners, give more rights to women, and get the economy back in shape. Fast forward a year. Iran now has a 12.5% unemployment rate, inflation is off the charts, and he has broken every one of his pledges for social change in the country. Conditions are so bad in the country that Rouhani was called before parliament this past Tuesday and given a rare verbal lashing. As further evidence that the new American actions are having an impact, legislators lambasted him for not dealing better with the US-led sanctions. The value of the Iranian rial has been cut in half since the new sanctions were announced: in January it took 40,000 rials to buy a US dollar; the exchange rate is now 100,000 rials to the dollar. Adding injury to insult, the Iranian parliament threw out Rouhani's economy minister, labor minister, and central bank governor to help change the economic landscape in the totalitarian country. It won't work. Only real reform and abandoning the Islamic state's nuclear ambitions can right the ship, and both of those courses are unacceptable to the hardliners running the show.
Food Products
After management ran Campbell Soup into the ground, a sale is the best option. We have dogged Campbell Soup's (CPB $33-$40-$51) management—especially CEO Denise Morrison—for years. After 149 years as an entity, all it takes is one bad management team making lousy strategic decisions to end a storied company. Campbell Soup is still alive, but, after getting rid of Morrison, it is time to put itself up for sale. Instead, the company is selling off its international and fresh food lines only, such as Bolthouse Farms, in an effort to raise cash and pay down its massive debt. Campbell has a current market cap of just $12 billion, yet it spent over $6 billion to buy snacks firm Snyder's-Lance in a deal which closed earlier this year. In an interesting twist, activist Dan Loeb of Third Point is teaming up with a relative of founder John P. Dorrance, the "father of condensed soup," in an effort to force a sale. Other family members of the founder, however, are fighting that course of action. While several of them sit on the board (and are the largest shareholders), Loeb will push for ousting the entire board of directors as they come up for reelection later this year. There is no good way out for Campbell other than a full sale; the Dorrance family members should take the money and run.
Happiness Index
Consumer confidence jumps to its highest level since 2000. October of 2000, nearly eighteen years ago. That is the last time the American consumer was as confident as they are right now. The surprise reading, from a report conducted by Nielsen for The Conference Board, hit a remarkable 133.4 in August, up from a very high 127.9 reading in July. To put this in perspective, the Consumer Confidence Index hit a low of 38 in October of 2008 in the midst of the financial crisis. The American consumer is the engine for growth, not only in America but around the world. A full 70% of economic activity in the country, in fact, comes from consumer spending. The Consumer Confidence reading is also important to the Fed, as they use this number as a metric to help them shape monetary policy. Suffice to say that we can expect a rate hike at their September meeting.
Global Strategy: Trade
US/Mexico trade pact is a big deal; Canada will feel the heat to join the party. So much for the joint effort against Donald Trump: Mexico just proved that bilateral agreements can be reached. Markets were up, and up big, after President Trump and Mexican President Enrique Pena Nieto held a joint news conference—with the latter on speakerphone—from the Oval Office to announce that the US and Mexico had reached a trade agreement. While the Mexican president still referred to the deal as being part of NAFTA, President Trump called for renaming the pact, due to its negative connotation. Canada is trying to put on a brave face, but this bilateral agreement puts the onus on the Trudeau government to join the party. The Mexican peso was stronger after the deal was announced (as could be expected), but so was the Canadian dollar—implying that Canada will now be more willing to strike a deal.
Global Strategy: Trade
Hogs, corn, and a railroad jump following news of US/Mexico trade deal. While the general markets were rallying on news of a US/Mexico trade deal, certain segments did better than others. Kansas City Southern (KSU $99-$118-$119), the "NAFTA" railroad, spiked 4% on the news, while hog and corn prices rose because Mexico is one of the largest importers of American corn and pork. As for Kansas City Southern, the railroad operates a commercial corridor of the Mexican rail system with direct passage between Texas and Mexico City. By far, KSU is the major railroad most affected by North American trade, as it operates primarily on a north/south rail network.
Global Strategy: Europe
Italy to veto EU budget over failure of bloc to follow-through on immigration reform. Recall that Italy is now being governed by leaders swept into power by Italian citizens angry with the lack of a cogent immigration policy on the continent. Fast forward to today: Italian leaders have vowed to veto the EU budget currently on the table because other European nations (Germany is the big antagonist) have refused to follow-through on an immigration deal hammered out in June. The issue came to a head with the the case of 177 immigrants sitting in a boat off the coast of Italy. Italian Interior Minister Matteo Salvini, a member of the Northern League (Lega Nord) party, wanted commitments by other European nations to take responsibility for the majority of immigrants before he would let the vessel dock. The Diciotti was finally allowed to dock in a Sicilian port after ten days at sea. The Lega Nord party wants more power for individual regions within Italy (think "states rights" in the US) and less for the central government, and certainly less for the European Union. In a sham, Salvini now faces a probe by his political enemies (who favor the EU) for "kidnapping and illegally detaining" the immigrants. This issue is red-hot in Italy, and the arrogant response coming from Brussels is only fueling the fire of discontent among the populace.
Headlines for the Week of 19 Aug — 25 Aug 2018
Without a single citizen visiting the voting booth, Australians woke up to a new leader...
Skyline of downtown Sydney (Photo licensed)
Oil & Gas Refining, Storage, & Transportation
Pipeline company Enbridge raises offer to $3.3 billion to buy its own unit. Energy infrastructure giant Enbridge Inc. (ENB $29-$36-$42) just raised its bid to buy Spectra Energy, the company's own master limited partnership (MLP), to $3.3 billion, or 1.111 shares of ENB for each Spectra share. In an odd twist, new US tax law allows for MLPs to change their structural form, thus permitting Enbridge to make this offer for its own unit. The company wishes to streamline its pipeline operations, and absorbing Spectra would go a long way toward that goal. Whether or not the deal is done (it probably will be), the combined entity is the largest energy storage and pipeline company in North America, with ENB offering a 7.46% dividend to investors. Enbridge is based out of Calgary, Alberta.
Restaurants
Is Papa John's grooming itself for a sale? After the recent brouhaha featuring the company's founder, pizza delivery joint Papa John's (PZZA $38-$45-$79) fell into disfavor with investors. The company announced that it has hired Bank of America and Lazard to help the firm "stabilize" after the incident, but is this really a signal that the $1.4 billion small cap wants to put itself on the auction block? Under CEO John Schnatter, who founded the company back in 1984, there was absolutely no interest in selling out. However, now that management has essentially stripped him of all power, there seems to be little from stopping such a move—the company certainly doesn't hold the same sentimental value for anyone else on the board. Schnatter owns just under 30% of outstanding PZZA shares, and the company recently passed a "poison pill" plan to keep him from taking that stake to 51%. If we believe a sale is imminent, are shares a good deal at $44.70? Maybe. PZZA had a market cap of over $3 billion just two years ago. We don't see the risk/reward being worth it, but it will be fun to see what transpires.
Automotive
Under the Radar: We see AutoNation as a potential undervalued gem. Americans buy roughly 40 million used cars and 20 million new vehicles each year. AutoNation (AN $42-$46-$62) is the largest automotive dealer in the US, with more than 250 dealerships in 16 states. The company brings in over $5 billion year in and year out, and has been profitable as far back as the eye can see. Why, then, with its single-digit p/e ratio, is the company sitting near its 52-week low? Analyst house SunTrust took notice of the company today, initiating coverage on the stock with a "hold" rating and a price target of $48 per share, but the average analyst price target for AN is $53 per share. We believe Michael Jackson, the company's long-tenured CEO, is one of the brightest minds in the industry, and has been called as much by the Automotive Hall of Fame. The company's biggest risk lies in the fact that over 60% of sales come from only three states: California, Texas, and Florida, but we could easily make the case for the share price heading back to the mid 50s—a 20% premium from where they are trading now. AN is a $4 billion mid-cap value play.
Global Strategy: Australasia
No citizens voted, but Australians just woke up to a new leader. Australia has had five different leaders over the course of the past 11 years. Overnight, it got its sixth. The ruling Liberal Party, which is actually a center-right conservative party, ousted Prime Minister Malcolm Turnbull and put 50-year-old Scott Morrison in his place. Australia's political structure is different than America's: citizens vote for a ruling party which, in turn, selects a party member to lead the country. Party members were becoming increasingly uncomfortable with Turnbull's left-leaning views, and his decision to enforce Paris Climate Accord rules within the country was the straw that broke the camel's back. It was appearing more and more likely that the ruling Liberal Party would lose ground to the left-leaning Labor Party in next year's election. 76 seats are needed for a majority in the Australian House of Representatives. As of now, the Liberal Party holds precisely 76 seats.
The country's new prime minister had been manager of Tourism Australia, an organization created by Prime Minister John Howard during his 11-year tenure, and is considered a hard-liner—at least compared to Turnbull. He supports greater religious freedom within the country, was against the Paris Climate Accord, and took a tough stance against asylum-seekers as the country's immigration minister. Most recently, Morrison was Australia's treasurer, well respected for his business acumen and fiscal problem-solving abilities. In 2017, he successfully pushed through tax cut legislation for Australia's small- and mid-sized businesses, but lost in his bid to get tax cuts for the country's largest companies. Morrison must now prove that he can keep the infighting to a minimum within the Liberal Party, and lead a successful bid against Labor in 2019.
Chemicals
Can pot help Scotts Miracle-Gro get its groove back? This past January we reported that Scotts Miracle-Gro (SMG $73-$74-$110) had purchased a hydroponic joint, Hawthorne Gardening Company, in an effort to get its toe in the door of the burgeoning cannabis market. After that pickup failed to help the company's bottom line, SMG shares plunged about 20% and are currently down 30% year-to-date. Now, the company appears ready to double-down on the bet. Hawthorne has teamed up with Flowr Corp, a Canadian pot grower, to build a 50,000-square-foot cannabis research facility in British Colombia. The lab will be used to study all aspects of marijuana growth in an effort to create the right mix of products for the rapidly-expanding industry. It's an interesting proposition: if Scotts is successful in becoming a leader in the growth of cannabis, you can bet it won't be sitting on its 52-week low (which it hit last week) for long. SMG has a market cap of $4 billion (mid-cap core) and a p/e ratio of 23.
Energy Commodities
Has the Saudi Aramco IPO really been cancelled? Although the press is making it sound like a new story, we reported on a probable delay in the massive Saudi Aramco IPO this past March. The real issue is the price tag: Saudi Arabia wants to raise $100 million in the IPO of its national oil company, but is only willing to sell 5% of the company to the public. That would value the oil giant at a ridiculous $2 trillion. Keep in mind that Apple just became the first trillion dollar company in the world. While Reuters has been reporting that the Saudis called the IPO off due to challenges raising the capital, energy minister Khalid-al-Falih said the public offering was still a go—just at a time when market conditions are more favorable. That probably means no earlier than late 2019. Keep in mind, however, that the Saudis need the price of oil to remain high to make this work; preferably higher than the current $71 per barrel for Brent Crude. With technology increasing America's ability to pull oil from the ground, a reduced regulatory stance in the US, and the rise of alternative energy, we believe $70 per barrel should be the high of the range. Anything above that probably has more to do with market manipulation than the forces of supply and demand.
Real Estate Management & Development
Amherst looks to raise $1 billion for investment in single-family rental homes. Amherst Capital Management, a real estate LLC specializing in single-family equity, commercial real estate lending, and mortgaged-backed securities, looks to raise a whopping $1 billion from investors to buy single-family rental homes. The company already owns and manages 20,000 properties through its Main Street Renewal subsidiary. Private equity funds such as the Blackstone Group (BX, a Penn Strategic Income Portfolio holding), have been pouring money into the single-family rental (SFR) space since the housing crisis of 2008/2009. According to Amherst, the total institutional investment in SFR homes hit $33 billion at the end of 2016. The duration of an investment within the new Amherst fund will be at least ten years.
Life Sciences Tools & Services
Exact Sciences jumps by 30% on Cologuard deal with Pfizer. Shares of diagnostics and research firm Exact Sciences Corp (EXAS $37-$65-$72), maker of the Cologuard cancer screening test (and that cute little talking box from the commercials), surged 30% following the announcement that the company was teaming up with Pfizer (PFE) to promote DNA screening. Under the terms of the three-year deal, Pfizer will co-promote the Cologuard test beginning in the fourth quarter. In return, Exact Sciences will share a portion of the gross profits from the sale of the kits and pay some of the marketing expenses incurred. There are few things that a man over 50 wants to do less than get a colonoscopy, which is why this sort of DNA testing will continue to become increasingly popular. Shares of EXAS have been all over the place during the last few months, hitting a high of $71.60 in June, followed by a bottoming-out at $47.85 in early August, and then the current run-up to $65 today.
Multiline Retail
Target joins other major retailers with its own lights-out quarter. One year ago, conventional retail wisdom had Amazon (AMZN) cleaning the clock of every major bricks-and-mortar store in America. That narrative has certainly changed. Multiline retailer Target (TGT $54-$83-$84) joined the weeklong earnings celebration with its own blowout report on the second quarter. Both traffic and same-store sales at the 1,800 or so Targets around the country grew by 6.5% on aggregate from the same quarter last year—the best metrics in over a decade—and online sales grew 41% over last year. That is right in line with the digital growth we reported from Walmart (WMT) last week. Revenues rose from $16.43 billion in Q2 of 2017 to $17.55 billion last quarter, and earnings rose from $1.22 to $1.47 per share over the same period. CEO Brian Cornell attributed the strong quarter to the company's turnaround plan, and the "strongest consumer environment" he has seen in his career. Target shares were trading up about 6% on the earnings report.
Construction & Engineering
Penn member Johnson Controls up 4% after Argus upgrade. Admittedly, $37 billion construction and engineering firm Johnson Controls (JCI $33-$40-$43) hasn't done much since we added it to the Penn Global Leaders Club last year. It now appears, however, that the company may be ready to dust off the cobwebs and begin a new stretch of outperformance. Shares rallied about 4% after analyst house Argus Research raised the firm to a "buy," with a $45 per share price target. We see a fair value for the shares closer to the $50 range. Johnson operates in two distinct industry segments: the building technologies unit builds, installs, and services HVAC systems and provides fire and security solutions; the power unit makes vehicle batteries which are sold to both automakers as an OEM (Original Equipment Manufacturer) and aftermarket retailers. We wrote about Johnson Controls in the Penn Wealth Report, Vol 6, Issue 01.
Homes & Durables
Toll Brothers jumps 11% as luxury US home market remains red-hot. Toll Brothers (TOL $33-$39-$53), the largest luxury homebuilder in the US, spiked 11% after the company reported a surge in new orders and a 27% increase in revenues for the third quarter. Sales during the three-month period rose to $1.91 billion for the Pennsylvania-based builder, while net income rose 30%, to $193 million. Despite the recent negative headlines surrounding rising interest rates and tepid buyers, TOL recorded an 18% increase in signed contracts. The company is now on track to build between 8,100 and 8,400 units this year, with the average sales price sitting at $851,900. TOL is nearing a $6 billion market cap and the company has a current p/e of 10.
Global Strategy: Latin America
Maduro devalues already-worthless currency as Venezuelans flee country. Inflation in the socialist state of Venezuela is currently chugging along at an annualized rate of 1 million percent. That is no joke and no typo. Talk about putting the Weimar Republic to shame. Now, inept, bumbling socialist leader Nicolas Maduro is taking it to the next level by devaluing the national currency, the bolivar, by 95%. Put another way, before Maduro’s devaluation, it took 285,000 bolivars to buy one US dollar. Post devaluation, it will take six million bolivar to buy that same dollar. Of course, this is insane; which is why 2.3 million Venezuelans—in a nation of just 31 million—have fled the country since Maduro took over from his deceased mentor, Hugo Chavez. To assuage his citizens, der comandante is raising the minimum wage from the equivalent of $1 per month to $30 per month. Venezuelan society is literally collapsing before our very eyes. Why, then, has Maduro not been removed? We will discuss that very topic in this coming Sunday's Penn Wealth Report.
Beverages
PepsiCo to buy SodaStream for $3.2 billion. And the battle of the cola wars continues. Last week we reported that Coca-Cola (KO) was purchasing sports drink phenom BodyArmor—a blow to PepsiCo (PEP $96-$115-$123) and its Gatorade brand. Now, the latter is making a big move into the DIY at-home soda market with its purchase of Israeli beverage firm SodaStream (SODA $57-$143-$143). If you own one of the wonderful SodaStream machines, you have probably noted in the past that Coke syrups are everywhere, but not Pepsi. After Pepsi's $3.2 billion takeover of the company, expect that to change dramatically. Just one month ago, SODA was trading at $84 per share and had a $2 billion market cap. It now trades at $142.80—a new 52-week high—and has a market cap equal to Pepsi's offer price. Did the company overpay? We don't believe so. This is a growing niche space in the industry, and SodaStream is the hands-down leader. The company, while under Pepsi ownership, will continue to operate as a separate entity.
Pipeline company Enbridge raises offer to $3.3 billion to buy its own unit. Energy infrastructure giant Enbridge Inc. (ENB $29-$36-$42) just raised its bid to buy Spectra Energy, the company's own master limited partnership (MLP), to $3.3 billion, or 1.111 shares of ENB for each Spectra share. In an odd twist, new US tax law allows for MLPs to change their structural form, thus permitting Enbridge to make this offer for its own unit. The company wishes to streamline its pipeline operations, and absorbing Spectra would go a long way toward that goal. Whether or not the deal is done (it probably will be), the combined entity is the largest energy storage and pipeline company in North America, with ENB offering a 7.46% dividend to investors. Enbridge is based out of Calgary, Alberta.
Restaurants
Is Papa John's grooming itself for a sale? After the recent brouhaha featuring the company's founder, pizza delivery joint Papa John's (PZZA $38-$45-$79) fell into disfavor with investors. The company announced that it has hired Bank of America and Lazard to help the firm "stabilize" after the incident, but is this really a signal that the $1.4 billion small cap wants to put itself on the auction block? Under CEO John Schnatter, who founded the company back in 1984, there was absolutely no interest in selling out. However, now that management has essentially stripped him of all power, there seems to be little from stopping such a move—the company certainly doesn't hold the same sentimental value for anyone else on the board. Schnatter owns just under 30% of outstanding PZZA shares, and the company recently passed a "poison pill" plan to keep him from taking that stake to 51%. If we believe a sale is imminent, are shares a good deal at $44.70? Maybe. PZZA had a market cap of over $3 billion just two years ago. We don't see the risk/reward being worth it, but it will be fun to see what transpires.
Automotive
Under the Radar: We see AutoNation as a potential undervalued gem. Americans buy roughly 40 million used cars and 20 million new vehicles each year. AutoNation (AN $42-$46-$62) is the largest automotive dealer in the US, with more than 250 dealerships in 16 states. The company brings in over $5 billion year in and year out, and has been profitable as far back as the eye can see. Why, then, with its single-digit p/e ratio, is the company sitting near its 52-week low? Analyst house SunTrust took notice of the company today, initiating coverage on the stock with a "hold" rating and a price target of $48 per share, but the average analyst price target for AN is $53 per share. We believe Michael Jackson, the company's long-tenured CEO, is one of the brightest minds in the industry, and has been called as much by the Automotive Hall of Fame. The company's biggest risk lies in the fact that over 60% of sales come from only three states: California, Texas, and Florida, but we could easily make the case for the share price heading back to the mid 50s—a 20% premium from where they are trading now. AN is a $4 billion mid-cap value play.
Global Strategy: Australasia
No citizens voted, but Australians just woke up to a new leader. Australia has had five different leaders over the course of the past 11 years. Overnight, it got its sixth. The ruling Liberal Party, which is actually a center-right conservative party, ousted Prime Minister Malcolm Turnbull and put 50-year-old Scott Morrison in his place. Australia's political structure is different than America's: citizens vote for a ruling party which, in turn, selects a party member to lead the country. Party members were becoming increasingly uncomfortable with Turnbull's left-leaning views, and his decision to enforce Paris Climate Accord rules within the country was the straw that broke the camel's back. It was appearing more and more likely that the ruling Liberal Party would lose ground to the left-leaning Labor Party in next year's election. 76 seats are needed for a majority in the Australian House of Representatives. As of now, the Liberal Party holds precisely 76 seats.
The country's new prime minister had been manager of Tourism Australia, an organization created by Prime Minister John Howard during his 11-year tenure, and is considered a hard-liner—at least compared to Turnbull. He supports greater religious freedom within the country, was against the Paris Climate Accord, and took a tough stance against asylum-seekers as the country's immigration minister. Most recently, Morrison was Australia's treasurer, well respected for his business acumen and fiscal problem-solving abilities. In 2017, he successfully pushed through tax cut legislation for Australia's small- and mid-sized businesses, but lost in his bid to get tax cuts for the country's largest companies. Morrison must now prove that he can keep the infighting to a minimum within the Liberal Party, and lead a successful bid against Labor in 2019.
Chemicals
Can pot help Scotts Miracle-Gro get its groove back? This past January we reported that Scotts Miracle-Gro (SMG $73-$74-$110) had purchased a hydroponic joint, Hawthorne Gardening Company, in an effort to get its toe in the door of the burgeoning cannabis market. After that pickup failed to help the company's bottom line, SMG shares plunged about 20% and are currently down 30% year-to-date. Now, the company appears ready to double-down on the bet. Hawthorne has teamed up with Flowr Corp, a Canadian pot grower, to build a 50,000-square-foot cannabis research facility in British Colombia. The lab will be used to study all aspects of marijuana growth in an effort to create the right mix of products for the rapidly-expanding industry. It's an interesting proposition: if Scotts is successful in becoming a leader in the growth of cannabis, you can bet it won't be sitting on its 52-week low (which it hit last week) for long. SMG has a market cap of $4 billion (mid-cap core) and a p/e ratio of 23.
Energy Commodities
Has the Saudi Aramco IPO really been cancelled? Although the press is making it sound like a new story, we reported on a probable delay in the massive Saudi Aramco IPO this past March. The real issue is the price tag: Saudi Arabia wants to raise $100 million in the IPO of its national oil company, but is only willing to sell 5% of the company to the public. That would value the oil giant at a ridiculous $2 trillion. Keep in mind that Apple just became the first trillion dollar company in the world. While Reuters has been reporting that the Saudis called the IPO off due to challenges raising the capital, energy minister Khalid-al-Falih said the public offering was still a go—just at a time when market conditions are more favorable. That probably means no earlier than late 2019. Keep in mind, however, that the Saudis need the price of oil to remain high to make this work; preferably higher than the current $71 per barrel for Brent Crude. With technology increasing America's ability to pull oil from the ground, a reduced regulatory stance in the US, and the rise of alternative energy, we believe $70 per barrel should be the high of the range. Anything above that probably has more to do with market manipulation than the forces of supply and demand.
Real Estate Management & Development
Amherst looks to raise $1 billion for investment in single-family rental homes. Amherst Capital Management, a real estate LLC specializing in single-family equity, commercial real estate lending, and mortgaged-backed securities, looks to raise a whopping $1 billion from investors to buy single-family rental homes. The company already owns and manages 20,000 properties through its Main Street Renewal subsidiary. Private equity funds such as the Blackstone Group (BX, a Penn Strategic Income Portfolio holding), have been pouring money into the single-family rental (SFR) space since the housing crisis of 2008/2009. According to Amherst, the total institutional investment in SFR homes hit $33 billion at the end of 2016. The duration of an investment within the new Amherst fund will be at least ten years.
Life Sciences Tools & Services
Exact Sciences jumps by 30% on Cologuard deal with Pfizer. Shares of diagnostics and research firm Exact Sciences Corp (EXAS $37-$65-$72), maker of the Cologuard cancer screening test (and that cute little talking box from the commercials), surged 30% following the announcement that the company was teaming up with Pfizer (PFE) to promote DNA screening. Under the terms of the three-year deal, Pfizer will co-promote the Cologuard test beginning in the fourth quarter. In return, Exact Sciences will share a portion of the gross profits from the sale of the kits and pay some of the marketing expenses incurred. There are few things that a man over 50 wants to do less than get a colonoscopy, which is why this sort of DNA testing will continue to become increasingly popular. Shares of EXAS have been all over the place during the last few months, hitting a high of $71.60 in June, followed by a bottoming-out at $47.85 in early August, and then the current run-up to $65 today.
Multiline Retail
Target joins other major retailers with its own lights-out quarter. One year ago, conventional retail wisdom had Amazon (AMZN) cleaning the clock of every major bricks-and-mortar store in America. That narrative has certainly changed. Multiline retailer Target (TGT $54-$83-$84) joined the weeklong earnings celebration with its own blowout report on the second quarter. Both traffic and same-store sales at the 1,800 or so Targets around the country grew by 6.5% on aggregate from the same quarter last year—the best metrics in over a decade—and online sales grew 41% over last year. That is right in line with the digital growth we reported from Walmart (WMT) last week. Revenues rose from $16.43 billion in Q2 of 2017 to $17.55 billion last quarter, and earnings rose from $1.22 to $1.47 per share over the same period. CEO Brian Cornell attributed the strong quarter to the company's turnaround plan, and the "strongest consumer environment" he has seen in his career. Target shares were trading up about 6% on the earnings report.
Construction & Engineering
Penn member Johnson Controls up 4% after Argus upgrade. Admittedly, $37 billion construction and engineering firm Johnson Controls (JCI $33-$40-$43) hasn't done much since we added it to the Penn Global Leaders Club last year. It now appears, however, that the company may be ready to dust off the cobwebs and begin a new stretch of outperformance. Shares rallied about 4% after analyst house Argus Research raised the firm to a "buy," with a $45 per share price target. We see a fair value for the shares closer to the $50 range. Johnson operates in two distinct industry segments: the building technologies unit builds, installs, and services HVAC systems and provides fire and security solutions; the power unit makes vehicle batteries which are sold to both automakers as an OEM (Original Equipment Manufacturer) and aftermarket retailers. We wrote about Johnson Controls in the Penn Wealth Report, Vol 6, Issue 01.
Homes & Durables
Toll Brothers jumps 11% as luxury US home market remains red-hot. Toll Brothers (TOL $33-$39-$53), the largest luxury homebuilder in the US, spiked 11% after the company reported a surge in new orders and a 27% increase in revenues for the third quarter. Sales during the three-month period rose to $1.91 billion for the Pennsylvania-based builder, while net income rose 30%, to $193 million. Despite the recent negative headlines surrounding rising interest rates and tepid buyers, TOL recorded an 18% increase in signed contracts. The company is now on track to build between 8,100 and 8,400 units this year, with the average sales price sitting at $851,900. TOL is nearing a $6 billion market cap and the company has a current p/e of 10.
Global Strategy: Latin America
Maduro devalues already-worthless currency as Venezuelans flee country. Inflation in the socialist state of Venezuela is currently chugging along at an annualized rate of 1 million percent. That is no joke and no typo. Talk about putting the Weimar Republic to shame. Now, inept, bumbling socialist leader Nicolas Maduro is taking it to the next level by devaluing the national currency, the bolivar, by 95%. Put another way, before Maduro’s devaluation, it took 285,000 bolivars to buy one US dollar. Post devaluation, it will take six million bolivar to buy that same dollar. Of course, this is insane; which is why 2.3 million Venezuelans—in a nation of just 31 million—have fled the country since Maduro took over from his deceased mentor, Hugo Chavez. To assuage his citizens, der comandante is raising the minimum wage from the equivalent of $1 per month to $30 per month. Venezuelan society is literally collapsing before our very eyes. Why, then, has Maduro not been removed? We will discuss that very topic in this coming Sunday's Penn Wealth Report.
Beverages
PepsiCo to buy SodaStream for $3.2 billion. And the battle of the cola wars continues. Last week we reported that Coca-Cola (KO) was purchasing sports drink phenom BodyArmor—a blow to PepsiCo (PEP $96-$115-$123) and its Gatorade brand. Now, the latter is making a big move into the DIY at-home soda market with its purchase of Israeli beverage firm SodaStream (SODA $57-$143-$143). If you own one of the wonderful SodaStream machines, you have probably noted in the past that Coke syrups are everywhere, but not Pepsi. After Pepsi's $3.2 billion takeover of the company, expect that to change dramatically. Just one month ago, SODA was trading at $84 per share and had a $2 billion market cap. It now trades at $142.80—a new 52-week high—and has a market cap equal to Pepsi's offer price. Did the company overpay? We don't believe so. This is a growing niche space in the industry, and SodaStream is the hands-down leader. The company, while under Pepsi ownership, will continue to operate as a separate entity.
Headlines for the Week of 12 Aug — 18 Aug 2018
You wouldn't know it by listening to the press, but comrade Putin has some serious troubles on the home front...
Licensed Copyright: <a href='https://www.123rf.com/profile_animagistr'>animagistr / 123RF Stock Photo</a>
Market Pulse
Thursday's market rally was all about Walmart and China. It has been a rough few weeks for the markets. At best, the indexes have been moving sideways since the last nice three-day rally near the end of July. Thanks to a blowout Walmart earnings report, however, and news that the communist Chinese were heading back to the negotiating table, the indexes got the infusion they have been searching for. The Dow Jones Industrial Average was the big winner on the day, jumping 396 points, or 1.58%. The broader S&P 500 was up 22 points, or 0.79%, while tech stocks continue to struggle as of late—the Nasdaq finished up 32 points, or 0.42%. We remain bullish on the second half of the year, and will use any pullbacks as an opportunity to pick up some of our favorite names at a discount.
Global Strategy: Russia
You wouldn't know it by listening to the press, but Putin's approval numbers are falling sharply. Can we at least agree that the mainstream media is myopic (and that is being very generous) in their treatment of certain politicians at home versus certain dictatorial leaders overseas? Take Vladimir Putin. We have read story after story of how popular the Russian leader is within his home country, but is that really true? Yes, for a people who could once brag about Soviet military might, the national pride goes up every time he makes a move like his illegal annexation of Crimea—and so do his poll numbers, but that pride does not put meat on the family table or rubles (which are cheapened almost weekly) in the pockets of workers. In a recent issue of the Penn Wealth Report, we reported on Russia's daunting economic issues and that country's massive over-reliance on oil revenues, along with a growing level of discomfort among his citizens. According to the Levada Analytical Center, Putin's trust rating in the country has dropped from 60% in January to just 48% in June. And the numbers are a lot worse for his lapdogs, like Foreign Minister Sergei Lavrov. Domestic economic troubles are forcing tough moves at home, like raising the retirement age to 65 for men and 60 for women. That may not seem draconian in the Western world, but to someone living in a communist nanny state, it is appalling. Despite Putin's troubles, it is inconceivable that he would be removed from power. However, the domestic turmoil does mean that he will become even more dangerous on the world stage as he tries to deflect any personal criticism and distract his hungry masses.
Food & Staples Retailing
Retail, the Good: Walmart blows away quarterly expectations, jumps 10%. Early in Thursday trading, the Dow was up over 300 points; about one-third of that was due to one company--Penn Global Leaders Club member Walmart (WMT $78-$100-$110). The $294 billion retailer (which started the day out as a $265 billion retailer) released its Q2 earnings report Thursday morning, and the numbers were remarkable from top to bottom. Revenues came in at $128 billion versus $122 billion in the same quarter of 2017, while earnings per share grew from $0.96 to $1.29 over the same period. Same-store sales in the US grew 4.5%, or about double what was expected, and online sales at the company grew a whopping 40%. With skilled digital mastermind Marc Lore (former CEO of jet.com, which WMT purchased a few years ago) at the e-commerce helm, brands are now rushing to get their goods into the Walmart online platform. As soon as the report was announced, WMT shares spiked by over 10%. CEO Doug McMillon has been the driving force behind the Walmart renaissance, and we expect the company to see continued growth moving forward.
Multiline Retail
Retail, the Bad: Dillard's reports a loss of $2.9 million in the second quarter. The headlines coming from two Arkansas-based retailers elicited very different responses from Wall Street. While Walmart (WMT) was blowing away the quarter, Little Rock-based multiline retailer Dillard
Thursday's market rally was all about Walmart and China. It has been a rough few weeks for the markets. At best, the indexes have been moving sideways since the last nice three-day rally near the end of July. Thanks to a blowout Walmart earnings report, however, and news that the communist Chinese were heading back to the negotiating table, the indexes got the infusion they have been searching for. The Dow Jones Industrial Average was the big winner on the day, jumping 396 points, or 1.58%. The broader S&P 500 was up 22 points, or 0.79%, while tech stocks continue to struggle as of late—the Nasdaq finished up 32 points, or 0.42%. We remain bullish on the second half of the year, and will use any pullbacks as an opportunity to pick up some of our favorite names at a discount.
Global Strategy: Russia
You wouldn't know it by listening to the press, but Putin's approval numbers are falling sharply. Can we at least agree that the mainstream media is myopic (and that is being very generous) in their treatment of certain politicians at home versus certain dictatorial leaders overseas? Take Vladimir Putin. We have read story after story of how popular the Russian leader is within his home country, but is that really true? Yes, for a people who could once brag about Soviet military might, the national pride goes up every time he makes a move like his illegal annexation of Crimea—and so do his poll numbers, but that pride does not put meat on the family table or rubles (which are cheapened almost weekly) in the pockets of workers. In a recent issue of the Penn Wealth Report, we reported on Russia's daunting economic issues and that country's massive over-reliance on oil revenues, along with a growing level of discomfort among his citizens. According to the Levada Analytical Center, Putin's trust rating in the country has dropped from 60% in January to just 48% in June. And the numbers are a lot worse for his lapdogs, like Foreign Minister Sergei Lavrov. Domestic economic troubles are forcing tough moves at home, like raising the retirement age to 65 for men and 60 for women. That may not seem draconian in the Western world, but to someone living in a communist nanny state, it is appalling. Despite Putin's troubles, it is inconceivable that he would be removed from power. However, the domestic turmoil does mean that he will become even more dangerous on the world stage as he tries to deflect any personal criticism and distract his hungry masses.
Food & Staples Retailing
Retail, the Good: Walmart blows away quarterly expectations, jumps 10%. Early in Thursday trading, the Dow was up over 300 points; about one-third of that was due to one company--Penn Global Leaders Club member Walmart (WMT $78-$100-$110). The $294 billion retailer (which started the day out as a $265 billion retailer) released its Q2 earnings report Thursday morning, and the numbers were remarkable from top to bottom. Revenues came in at $128 billion versus $122 billion in the same quarter of 2017, while earnings per share grew from $0.96 to $1.29 over the same period. Same-store sales in the US grew 4.5%, or about double what was expected, and online sales at the company grew a whopping 40%. With skilled digital mastermind Marc Lore (former CEO of jet.com, which WMT purchased a few years ago) at the e-commerce helm, brands are now rushing to get their goods into the Walmart online platform. As soon as the report was announced, WMT shares spiked by over 10%. CEO Doug McMillon has been the driving force behind the Walmart renaissance, and we expect the company to see continued growth moving forward.
Multiline Retail
Retail, the Bad: Dillard's reports a loss of $2.9 million in the second quarter. The headlines coming from two Arkansas-based retailers elicited very different responses from Wall Street. While Walmart (WMT) was blowing away the quarter, Little Rock-based multiline retailer Dillard