by Scott Martin | Nov 17, 2024 | Weekly Newsletter 7pm Sunday
Market Summary
The Bull Market Report
From an earnings standpoint, the quarterly confessions are practically over, with only Retail and a few stragglers (not to mention mighty Nvidia, Wednesday) still scheduled to report. The season has been solid. The S&P 500 managed to raise the bottom line 5% from last year, which is actually a full percentage point better than either we or Wall Street dared to dream a few months ago.
The election is over too, with the results widely being interpreted as business friendly. Taxes will almost certainly go down instead of up. Regulations will weaken. This is an opportunity for strong corporate leaders to achieve their goals and for shareholders to come along on the ride to glory. Even so, the narrow majority in Congress suggests another few years of partisan gridlock and limited policy progress. Once again, when Washington is absorbed in internal debate, Wall Street gets a free hand to innovate and excel.
And another Fed meeting has come and gone. Jay Powell and his colleagues gave us another rate cut and remain open to more down the road. Unfortunately, the persistence of inflation leaves them without much room to put their talk into practice. While interest rates may still be high enough to gradually starve price pressure, they might be approaching a point that's too low to keep inflation under control, much less give the Fed what it needs to declare victory once and for all. Add all that up and this is the cloud on the market horizon as we look toward the end of the year.
For now, performance has been bullish across the board. Investors have finally stopped fretting about whether their gains are "real" or just a figment. Instead, the mood has swung back to envy when we're all nominal winners but some do better than others. We felt the sharp side of that story this month with our recommendations giving back a little room in the aggregate, taking our YTD performance back below the major benchmarks.
In our view, this is a feature of our diversification posture and not a problem in the long term. Yes, our strong defense holds us back in the good times: High Yield and the REITs have struggled and Healthcare has turned more than a little icy amid concerns over policy in the new administration, but when the mood turns again, these sectors will demonstrate their usefulness as strong shields against the weather. And in the meantime, at least they keep paying dividends from quarter to quarter, justifying our continued attention with a little regular cash every three months.
But the real stars remain our core Stocks For Success, up 29% YTD, beating the S&P 500 and the Nasdaq by several percentage points. And then there's Long Term Growth and High Technology, which are doing even better. Special Opportunities, often a weak point in recent years, are matching the broad market right now. This is great stuff. The "full" half of the glass is more than half full. The "empty" portfolios will fill us up later. We're excited. We hope you are too. Either way, our conviction carries a high price in terms of diligence, forcing us to cut a few recommendations now and then when they don't work out. We'll do that this week.
There's always a bull market here at The Bull Market Report. As we wait for mighty Nvidia to weigh in with the last Mega Tech numbers of the season, The Big Picture provides a refresher course on what "guidance" really is and why it moves the market more than what each company reports about the trailing quarter. We might not trust management to have a 100% accurate crystal ball, but their views on the future are a whole lot more interesting than their take on the past. Speaking of the future, The Bull Market High Yield Investor is where we tell you some sobering things about the Fed's anticipated glide path in the wake of recent inflation reports. Now is the time to pivot away from bonds into more interesting yield investments like the ones we recommend. And as always, we want to keep a few stocks and funds on your radar.
Key Market Indicators
The Big Picture: Why "Guidance" Moves Stocks
Obsessing over the earnings outlook has become a staple in the financial world, a regular ritual accompanying every quarterly earnings report. But this seemingly modern practice of companies predicting their future performance is actually an age-old tradition dressed up in new clothes. So, is it truly a crystal ball for investors, or just smoke and mirrors? Let's break down what earnings guidance is, why it matters, and why some companies are starting to buck the trend.
Simply put, earnings guidance is a company's public prediction of its upcoming financial performance. Think of it as management's best guess of what the current quarter or the coming year will look like. Investors and analysts cling to these pronouncements, using them to adjust their expectations and decide whether to buy, sell, or hold a company's stock. But there's a catch: these figures are far from foolproof. They can be missed, manipulated, or simply misunderstood.
Before the days of the Internet and instant information, earnings guidance existed in a murkier form — the "whisper number." This was an era when select analysts received privileged insights from companies, giving their clients a potential edge. The SEC put a stop to this selective whispering with Regulation Fair Disclosure (Reg FD) in 2000. Now, companies must broadcast their predictions to the entire world simultaneously, ensuring a level playing field for all investors.
Regardless of how the information circulates, the outlook plays a vital role in the investment process. After all, who knows a company better than its own management team? They have the inside scoop on everything from sales trends to upcoming product launches. Guidance, in theory, bridges the information gap between companies and investors, contributing to a more efficient market where stock prices accurately reflect a company's true value.
However, the cynics among us argue that guidance is just a tool for manipulation. In booming bull markets, companies might inflate their forecasts to attract eager investors looking for high-growth stocks. Conversely, during bear markets, they might lowball expectations, making it easier to "beat the number" come earnings season. Managing to the quarter is a terrible way to run a company in the interest of long-term shareholders, which is why a growing number of companies have decided to ditch earnings guidance altogether. Warren Buffett's Berkshire Hathaway is a prime example.
But does eliminating guidance actually solve the problem? Critics argue it merely raises the odds of the quarterly numbers coming as a complete shock, potentially increasing volatility around the report and conference call. Without guidance as an anchor, analysts' estimates become more dispersed, leading to wider variances from actual results. Imagine a stock swinging wildly because a company missed earnings estimates by a few pennies! This increased volatility could make the market a more turbulent place.
Analysts rely heavily on earnings guidance as a starting point for their own financial models. They dissect management's assumptions, scrutinize industry trends, and conduct their own independent research to arrive at their own earnings forecasts. Without guidance, their task becomes more challenging, potentially leading to less accurate predictions.
What investors do is use guidance to make informed investment decisions. We're just as wary of blindly following management's predictions as we are when it comes to using "consensus" as our benchmark. Savvy investors dig deeper, considering factors such as the company's track record, industry conditions and overall economic climate. That's how we do it at The Bull Market Report. And while we've focused a lot on the trailing numbers, we'd love to get back to reporting our sense of what each company's next quarterly report will look like, provided of course that management has been clear on its own internal expectations in the past.
After all, that stuff is a matter of public record, even if it revolves around pronouncements in the future. And that's where we all spend the rest of our lives, right? Leave the past to the past. Focus on the outlook.
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BMR Companies and Commentary
Energy Transfer Partners (ET: $17.29, flat last week. Yield: 7.4%)
ENERGY PORTFOLIO
BMR FEATURED STOCK
Energy Transfer Partners, a leading player in the midstream energy segment, released its third-quarter results two weeks ago, reporting $20.8 billion in revenue, flat compared to $20.7 billion a year ago. It posted a profit of $1.1 billion, or $0.32 per share, more than doubling from $470 million, or $0.15. You have to like that!
Volumes across the company's extensive list of assets continue to hit new records, with crude oil transportation and export volumes growing 25% and 49% YoY, respectively. The company achieved a 6% increase in midstream gathered volumes and a 26% increase in midstream produced volumes. Furthermore, natural gas liquids transportation and fractionation volumes grew by 4% and 12%, respectively.
Energy Transfer is a prominent player in the energy industry, operating a vast network of pipelines and energy infrastructure. The company plays a crucial role in transporting and storing natural gas, natural gas liquids, and crude oil.
Key Business Segments:
- Natural Gas Pipelines: Energy Transfer owns and operates a substantial network of natural gas pipelines, facilitating natural gas transportation from production basins to major consumption markets.
- Crude Oil Pipelines: The company's extensive crude oil pipeline system enables the efficient movement of crude oil from production sites to refineries and export terminals.
- Natural Gas Liquids Pipelines: Energy Transfer transports NGLs, such as propane, butane, and ethane, to various markets, including petrochemical plants and export terminals.
- Storage and Terminals: The company owns and operates a network of storage terminals for crude oil, NGLs, and refined products, providing flexibility and efficiency in the energy supply chain.
The company boasts an extensive network that spans approximately 125,000 miles across the United States, with roughly 90,000 miles dedicated to natural gas pipelines and the remaining 35,000 miles for crude oil pipelines. This network allows the company to connect major production basins to key consumption markets, ensuring a reliable and efficient supply of energy resources.
There were several strategic highlights during the quarter, starting with the completion of the $3.25 billion WTG Midstream Holdings acquisition, which brought an additional 6,000 miles of gas-gathering pipelines into the company’s fold. It inked a new partnership with Sunoco, combining their respective assets in the Permian Basin, with Energy Transfer as the operator.
The company has plenty of catalysts and long-term tailwinds in its favor, the most prominent of which is the rising demand for natural gas and new power plants being set to fuel the increasing energy demands of data centers. Many data centers could soon have their own captive gas-fired power plants, supplied directly via pipelines built and owned by the company, creating a massive runway for growth.
Similarly, the incoming Trump administration is another catalyst that will help ease up on regulations holding the sector back and allow it to proceed with long-awaited LNG export projects. The stock is up 25% YTD while still offering a delectable yield of 7.4%, which is expected to grow. The company produced $10.2 billion in cash flow.
We expect big things from the company in the future. Management has big plans for the future and continues to be very acquisitive. ET is the largest natural gas pipeline company in the United States, with 84,000 miles of pipe and a market cap of $60 billion. The 2nd largest is DCP Midstream, a private company with 55,000 miles. Kinder Morgan (KMI) has 51,000 miles, also a $60 billion company, but only pays a 4.2% dividend.
Our Target is $18, and our Sell Price of $12 is hereby changed to We Would Not Sell Energy Transfer. We are raising our Target today to $20.
Blackstone (BX: $181, up 2%)
STOCKS FOR SUCCESS PORTFOLIO
Alternative asset manager Blackstone released its third-quarter results recently, reporting $2.4 billion in revenue, up 5% YoY, compared to $2.3 billion a year ago. It posted a profit of $1.3 billion, or $1.01 per share, against $1.2 billion, or $0.94, beating estimates at the top and bottom lines, owing to growing assets under management and robust investment activity following the much-needed Fed rate cut.
Like most other PE firms, high interest rates had been a drag on Blackstone’s performance for several quarters. Still, the weight has been lifted, albeit marginally following the September rate cuts, with more expected to follow suit. As a result, the firm’s private equity and infrastructure funds had their best performance in three years, growing 6% and 5%, followed by credit and real estate at 3% and 1%.
Blackstone is seeing broad-based acceleration across its business units, spurred by an increasingly robust macro climate. It deployed $34 billion for new acquisitions during the quarter, up from $12 billion a year ago, with $16 billion earmarked for just one major deal, Australia-based data center company AirTrunk. The firm also acquired enterprise work management platform SmartSheets in an $8.5 billion deal.
It realized proceeds of $23 billion during the quarter, up from $15 billion a year ago, as IPOs and M&A markets have started to come back following over three years of dormancy. Investments in its funds, too, are picking up pace, with $40 billion in inflows, bringing total assets under management (AUM) to a mind-boggling $1.1 trillion, of which $820 billion is fee-earning AUM, with $430 billion perpetual AUM. (Perpetual capital strategies are real estate core-plus, infrastructure, insurance solutions, and private credit.)
The stock is up 41% YTD, hitting an all-time high of $183 this week and taking Blackstone’s market capitalization to $220 billion. The company is known for rewarding investors generously, and this quarter was no exception, with $1.2 billion in stock buybacks and dividends during the third quarter and $5 billion YTD. The total dry-powder, or liquid capital, hit $170 billion, with $2.5 billion in cash, $12.8 billion in debt, and $4.2 billion in cash flow on its balance sheet.
Our stock blew through our Target of $150 a month ago, so we are raising it today to $220. After all, they are the largest asset manager in the world, clocking in at $1.1 trillion. Do you think they will be satisfied to stop here at this level? Neither do we.
We would never sell this great company.
Zscaler (ZS: $201, up 3%)
HIGH TECHNOLOGY PORTFOLIO
Cloud security giant Zscaler released its fiscal fourth quarter (which ended July 31) results a few months ago, which means Wall Street has already digested every detail and moved on to anticipating the next quarterly report in early December. Nonetheless, we think it's important to review what we know about the previous period: $590 million in revenue, up 30% YoY compared to $460 million a year ago, and a profit of $140 million ($0.88 per share) against $100 million ($0.64) a year ago.
Everything we've laid out so far beat consensus estimates, but the stock took a steep pullback following the results, owing to a weak forecast for 2025. This was an overreaction, as the company still guided 20% YoY sales growth, and the stock has recovered in the weeks since. After a decade of consistently posting a CAGR of 50%, this was, in some ways, long-coming, with the company falling victim to the high expectations that it had set. We believe this was a remarkable quarter for the company in more ways than one.
Calculated billings are up 27% YoY to $910 million, with deferred revenue following suit at $1.9 billion, up 32% YoY. Currently, 570 customers use the platform with annual contract values (ACVs) greater than $1 million and 3,100 with ACVs of $100,000 or more. It maintains a healthy dollar-based retention rate of 115%, meaning that for every dollar of revenue generated from a customer, the company generates $1.15 in revenue from that customer in the following period. This is a significant number.
Zscaler’s FedRAMP-approved Zero-Trust architecture is now the gold standard for government and industry. The federal vertical continues to make gains, having already landed 13 of the 15 cabinet-level agencies and other lower-ranked federal bodies. The company notes that its Federal landed base represents a 20x upsell opportunity, making it a key driver of growth over the next couple of years.
Having hit the milestone of $2.5 billion in annual recurring revenue during the fourth quarter, the company has set its sights on $3.0 billion in 2025 and is on its way to hit $5 billion over the next few years. Zscaler doesn’t have buybacks or dividends, but this could be coming soon, given its rising cash flows at $200 million and strong balance sheet, with $2.0 billion in cash and $1.2 billion in debt.
Our Target is $240, and our SP is $170. This is one volatile stock. It hit $260 in February and proceeded to drop to $155 by May, rising to $208 by July, dipping to $153 by September, and now over $200. Let’s go back and look at revenues: $1.1 billion in fiscal 2022, $1.6 billion in 2023, and a shade under $2.2 billion in 2024. To review, Zscaler is a leading cloud security company that provides a comprehensive suite of security solutions to protect businesses from cyber threats. The company's core business is to secure access to applications and data, regardless of where users, devices, or applications are located. The broader global cloud security market is projected to reach approximately $200 billion by 2029, growing at a compound annual growth rate of over 22% from $73 billion in 2024.
First Trust Nasdaq Semiconductor ETF (FTXL: $86, down 8%)
REMOVING FROM COVERAGE
The First Trust Nasdaq Semiconductor ETF is a renowned name in the semiconductor space, providing investors with a balanced exposure to this burgeoning industry. Despite having exposure to high-fliers such as Nvidia, Axcelis, and Broadcom, among others, the fund’s performance over the past year has been rather uninspiring, with a YTD return of just 9.2%, trailing both the Nasdaq and the S&P 500.
The fund has also lagged behind other semiconductor ETFs, such as VanEck Semiconductor ETF (SMH; $240), which has posted a YTD gain of 42%, which we also have in the High Technology Portfolio. This, however, has everything to do with differing philosophies on diversification, with First Trust allocating assets to 31 stocks. At the same time, VanEck includes just 26 while being remarkably top-heavy, with its top 5 holdings constituting 50% of total assets.
First Trust’s underperformance can be attributed to its significant stake in Intel, at 9.5% of total assets, while the stock has declined nearly 50% YTD. We believe management has missed the boat and are extremely disappointed. We would move our money to VanEck Semiconductor ETF.
We added the stock at $103 in July; our timing couldn’t have been worse when it comes to diversifying our core semiconductor holdings. This one proves that diversification has a downside when the managers overweight the wrong stocks. We live, we learn. And we're happy to be overweight NVIDIA (NVDA) across the board.
iShares US Oil & Gas & Production ETF (IEO: $98, up 1%)
ENERGY PORTFOLIO
The outlook for global energy prices appears bleak, with factors like increased US domestic production and slowing Chinese demand contributing to a potential supply glut. A strengthening US dollar could further exacerbate this trend. However, pure-play US oil and gas exploration and production companies are set to get better from here.
The iShares Oil and Gas ETF offers exposure to the US domestic upstream energy sector without investing in large-cap giants like ExxonMobil or Chevron. This ETF provides an opportunity to participate in the growth potential of smaller, more dynamic companies in the industry. While it allocates 22% of its assets to the midstream segment, it steers clear of vertically integrated firms, eliminating redundancies.
Leaving aside the rest of the world’s problems, US energy markets look remarkably robust, with multiple rate cuts over the next few years helping spur consumption and a favorable new administration in Washington for the industry. Given the growing energy demand from data centers and the role of natural gas as a transition fuel for renewable energy, we further see strong mid-term tailwinds.
There are several other mid-to-long-term catalysts for both crude oil and natural gas, and barring certain geopolitical events that could result in spikes, the G7 plan to phase out all coal-fired power plants by 2035, will increase demand for natural gas, again as a base-load energy source. Also, the US Strategic Reserve supports prices at current levels, which will incentivize the industry.
The fund is up 4% YTD and a remarkable 360% since its all-time low during the pandemic in 2020 while still trading at an attractive valuation and offering a 2.9% annualized yield. With an extensive track record of 18 years and coming from Blackrock’s illustrious lineage, the fund is perfect for investors seeking exposure to the energy sector, especially considering its low expense ratio of just 0.40%.
Our initial recommendation in 2022 has earned 22% so far from a base of $80. The Target is $120, and the SP is $95. We’re tight to the Sell Price now, and due to uncertainty in the world today, we will hold to this and book our profit if it moves to that level.
Occidental Petroleum (OXY: $50, down 1%)
ENERGY PORTFOLIO
Warren Buffett's favorite hydrocarbon giant released its third-quarter results last week, reporting $7.2 billion in revenue, down 3% YoY, compared to $7.4 billion. It posted a profit of $980 million, or $1.00 per share, against $1.1 billion, or $1.18, the prior year, with a cautionary outlook for the coming year, owing to tough macro conditions and depressed energy prices.
The better-than-expected results, despite lower commodity prices during the quarter, were largely the result of its robust production performance, at 1.4 million barrels of oil equivalent per day. In addition, the integration of CrownRock has started to pay off, with substantial operational and efficiency gains already, with more to be realized over the coming years.
As always, the oil and gas segment led the way with $5.7 billion in sales, up 2% YoY, despite a 6% YoY decline in realized crude prices at $75.30 per barrel. Natural gas liquids came in at $20.47 per barrel, down 4% YoY. Natural gas realized prices were down 26% from the prior year, offset by a 16% increase in production.
Other segments, namely OxyChem, generated $1.2 billion in sales, down 8% YoY. The midstream and marketing business brought in $440 million, a decline of 20% from the prior year. Occidental plans to generate an additional $1 billion in annual cash flow from these two non-oil segments and its innovative new carbon capture and storage segment.
The company has done a remarkable job at reducing debt, with 90% of the $4.7 billion reduction target already achieved. It still has a substantial $28 billion in debt on its books, which will continue hammering downwards. Management is clearly driven to excel, closing the quarter with $1.8 billion in cash and an impressive $11.3 billion in cash flow. However, Occidental has been hammered (to re-use a good word) since April when it was trading at $69. Once a "value" stock, this is now a super-value stock. Our Target is $90, which appeared reachable when the stock was at $70 but is quite a distance higher now, as you know. We will lower it today to $70 with a SP of $50. We can’t see exiting the stock at this level; we would accumulate more here at $50. That's what Warren is doing.
Moderna (MRNA: $37%)
REMOVING FROM COVERAGE
Biotech startup Moderna released its third-quarter results last week, reporting $1.9 billion in revenue, up 2% YoY, compared to $1.8 billion a year ago. It posted a profit of $13 million, or $0.03 per share, against a loss of $3.6 billion, or $9.53. The stock pulled back due to several issues brewing in the background.
The company produced better-than-expected COVID-19 vaccine sales at $1.8 billion, and the launch of the new RSV shot, which generated $10 million in US sales and has since received approval from Qatar, Norway, the European Union, and Iceland. Another key factor behind the return to profitability was the decision to cut the R&D budget by $1.1 billion two months ago.
Yet, the stock remains under pressure, which began ever since the cut in R&D spending was announced. This signaled a lack of confidence in its ability to generate strong revenues and the efficacy of its pipeline, which saw five programs being cut as a result. This is particularly concerning for a company whose valuation is heavily reliant on its research and development efforts.
The new RSV vaccine faces tough competition from GSK’s Arexvy and Pfizer’s Abrysvo, both established candidates from deep-pocketed players, leaving Moderna at a significant disadvantage. To make matters worse, the possible appointment of Robert F. Kennedy Jr, an outspoken critic of childhood vaccinations, to head the Department of Health and Human Services does not bode well for the company and other firms in the space, like Eli Lilly.
The stock is down 36% over the past month and 67% YTD, and while we believe in the robust underlying mRNA technology and the impressive product pipeline, we’re tired of waiting and believe that the time frame for the promised revenues and profits has been moved out as well. It is time to call it quits. Moderna is not a sinking ship; far from it. Still, while it works towards a long, drawn-out course correction, our money can do better elsewhere at significantly more attractive valuations.
We added the stock at $193 in 2023; needless to say, we did not heed our Sell Prices. Live and learn.
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The Bull Market High Yield Investor
When you live on hope that the Fed will be your friend and lower interest rates whenever it gets an excuse, it feels like a betrayal when the inflation reports take that excuse back off the table. That's exactly what happened in the last few weeks. Jay Powell and company gave us another rate rollback to feed the post-election euphoria, but then, days later, hints of stubborn price pressure in the economy shook a lot of traders' confidence in an extended stream of additional cuts ahead. At this point, we might consider ourselves lucky if the Fed relaxes one more time in December and then takes at least a brief break early next year to make sure they haven't once again let the inflationary demon out of the bottle.
What this means is that overnight lending rates are already about halfway to the lowest point we'll see in the next 12 months. There's still some room for the Fed to move, but the odds are good that in a few weeks we'll get our first taste of what will become the next "new normal" in the rate environment for the foreseeable future. This is more or less how life will work: not quite as much pressure or pain as when the tightening cycle was at its peak, but not a lot more reason ahead to relax. And as the overnight end of the rate curve stabilizes for the first time in years, all the uncertainty in the bond market starts feeding into the other end where long-term yields go.
If the mood around the economy remains decent, money will flow into stocks instead of bonds, pushing yields higher as the curve steepens to reflect a healthy continued economic expansion. And if the mood goes sour, we'll see long-term yields drop. We'll also see the Fed revisit its easing posture in order to shield Main Street from a serious recession. That's not great for bond investors either because they'll have to settle for even lower coupon rates than the 4-4.5% they're getting now.
Either way, we always recommend investments that are not quite so rock-solid reliable as Treasury debt but have the proven potential to pay a lot more. Otherwise, you're practically asking inflation to take your money away. Here are a few:
Ares Capital (ARCC: $22, flat. Yield=8.9%)
HIGH YIELD PORTFOLIO
Ares Capital is a leading business development company that offers financing to private equity and real estate developers. The company released its third quarter results recently, reporting $780 million in revenue, up 18% YoY, compared to $660 million a year ago, with a profit of $360 million, or $0.58 per share against, against $290 million, or $0.59, beating estimates at the top, but missing at the bottom. During the quarter, Ares issued and sold 14.7 million shares of common stock under its equity distribution agreements, with net proceeds totaling approximately $300 million.
Ares made commitments of $3.9 billion, up 140% YoY, compared to $1.6 billion last year, along with $2.6 billion worth of exits, up 100% YoY, across 74 different transactions during the quarter. Investments at fair value now stand at $26 billion, up from $22 billion last year, aided by rate cuts and improving macro conditions in recent months.
The portfolio is more diversified than ever, with allocations across 535 different companies, 53% in first-lien senior secured notes, and 70% of all loans are floating-rate investments. Non-accrual loans, or loan accounts that have failed to receive any payment for 30 days or more, stood at 0.60%, down from 0.70% the prior quarter, which was already relatively low and well within generally accepted risk frameworks to begin with.
Two months ago, the cut in interest rates spurred a flurry of activity in capital and debt markets, with Ares benefiting from a flood of new originations and investment gains. Â Of course, the drop in rates was on the short end of the curve, and longer rates have increased. Despite the various moves in rates, Ares' balanced portfolio and strategic approach, including fixed and floating-rate investments, help mitigate these risks.
The stock is up 7% YTD while offering a well-covered annualized yield of 8.9%, and this comes at a time when most other BDCs struggle to cover payouts. With a perfectly balanced portfolio and an investment-grade credit rating, it is well-positioned to weather the dynamic economic landscape. Ares ended the quarter trading at a 9% premium to book value.
This is a very steady stock over the years, but note that it is trading a whisker from the all-time high of $22.35 set in 2021. We've successfully reached our $22 price target for the stock, which we initially purchased at $17 in 2021. But this stock is going higher. We are raising our Target to $24, which would be nice to see in 2025, an event we find quite promising. The Sell Price of $19 is raised today to $20. What a great company.
And if you are worried about the volatility in the markets lately, this one is non-correlated to the overall stock market. It has a beta of 0.42, whereas a beta of 1.0 would move exactly with the market. We like low-beta stocks for our high dividend-producing stocks. We want it nice and slow, paying that big 8.9% dividend, not worried about what the overall market is doing as measured by the S&P 500.
Realty Income (O: $57, down 2%. Yield=5.6%)
REIT PORTFOLIO
Realty Income, one of the largest investors in free-standing, single-tenant commercial properties, released its third-quarter results last week, reporting $1.3 billion in revenue, up 26% YoY, compared to $1.0 billion a year ago. It posted a profit, or FFO, of $860 million, or $0.99 per share, against $740 million, or $1.04, beating consensus estimates at the top but missing on the bottom line.
The company saw strong occupancy rates of 98.7%, alongside a 105% rent recapture rate across 170 renewed leases, which refers to a 5% bump in rents across the renewed leases. This was an eventful quarter, with $740 million in fresh deployments, with a weighted average yield of 7.4%, and $250 million in proceeds from the disposition of 92 properties.
Same-store rentals came in flat at $1 billion, and the bump in earnings was primarily the result of its $9.3 billion acquisition of Spirit Realty. We expect more efficiencies to be unlocked, alongside certain synergistic gains to be realized over the next few years. The all-stock merger brought an additional 2,000 properties into its fold, perfectly positioning it for tailwinds ahead. Founded in 1969, the company invests in diversified commercial real estate and has a portfolio of 15,500 properties in all 50 U.S. states, the U.K., and six other European countries.
Speaking of tailwinds, the recent rate cuts were perfect, helping spur consumption and bolstering brick-and-mortar retail, which makes up a large part of the company’s tenants. We expect more rate cuts over the next couple of months, which will help REITs in more ways than one, including making their yields more attractive relative to treasuries, CDs, and other fixed-income funds and investments.
Realty Income is now diversifying beyond freestanding retail to include consumer-centric medical, industrial, data center development, and gaming centers. The total addressable market across these sectors is $5.4 trillion in the US alone, leaving plenty of room for growth.
The company ended the quarter with $410 million in cash, $27 billion in debt, and $3.4 billion in cash flow. Our Target of $70 looked like it would be tested in the middle of October, as it ran from $53 in July to $65, but the stock has faltered a bit, giving us all an excellent opportunity to buy stock 12% off its yearly high. The stock has been higher, hitting $82 in 2020 before the pandemic hit (it was cut in half a month later) and then rising steadily to $75 in 2022. We have confidence in the business plan, in management, and in the fact that they are acquisitive. We believe the company will reach 20,000 properties sometime in 2026 or 2027.
Talk about a low beta. It comes in at 0.05, down from 0.60 in June. This is not a misprint. We would expect the stock to move higher if the overall stock market decides to take a break and move lower.
FS KKR Capital (FSK: $21, up 1%. Yield=13.2%)
HIGH YIELD PORTFOLIO
FS KKR Capital, another BDC run in partnership with FS Investments and PE giant Kohlberg Kravis Roberts, released its third-quarter results last week, reporting $440 million in revenue, down 5% YoY compared to $470 million a year ago. Profit per share was steady at $0.77, while beating consensus estimates on the top and bottom lines. The slight dip on the bottom line doesn't concern us so much as the ability to cover its $0.70 dividend and have a little left over. Based on these numbers, there's little need for concern.
The company has been on a fiery streak when it comes to originations, at $1.1 billion, up from $500 million a year ago. Exits and repayments, however, were higher at $1.3 billion, nearly doubling from $680 million. As such, the fair value of investments declined 5% YoY, to $13.9 billion, down from $14.7 billion a year ago, which has helped reduce its non-accruals from 2.5% to 1.7%, a significant improvement.
FS KKR has done a remarkable job at improving credit quality and bolstering the balance sheet over the past couple of years. This includes $4.7 billion in liquidity, up from $4.2 billion in the prior quarter, and a reduction in debt YoY at $8.1 billion, compared to $8.2 billion a year ago. All of this bodes well for the company as we enter into a strong business environment that is set to extend well into 2025. There is less likelihood of a recession over the next couple of years and fewer chances of their portfolio companies defaulting on their borrowings. Moreover, with nearly 70% of assets in secure first and second-lien loans, the company will be first in line to recover its assets if things go awry. This and its extensive diversification make it a rather safe bet despite the high yield it offers.
The stock is up nearly 5% YTD and is positioned very lucratively relative to other BDC players, trading at an 11% discount to book value while offering an impressive yet well-covered annualized yield of 12.1%. This, alongside the company’s improving fundamentals, makes it perfect for income-seeking investors. It ended the quarter with $370 million in cash, $8.1 billion in debt, and $1.1 billion in cash flow.
We added the stock at $20 in September and placed a Target of just $21. It has reached that level, and we are raising it to $22. Our Sell Price remains the same at $18. This stock has a beta identical to Ares at 0.42. The stock has been about this price for the last three years. Very calm and steady, slowly paying out 13.2% a year.
Nuveen AMT-Free Municipal Credit Income Fund (NVG: $12.86, flat. Yield=6.2% tax free, or the equivalent of 8.2% taxable even if you're "only" in a 25% earned income bracket)
HIGH YIELD PORTFOLIO
Given its secure, tax-free yields, this fund has long been the vehicle of choice for conservative, income-seeking investors. The closed-end fund has been on a hot streak recently, owing to the cut in interest rates and an aggressive hike in distributions. The possibility of more rate cuts by the Fed, alongside favorable conditions for munis, makes it a compelling investment for income seekers.
Despite the rate cuts, Treasury yields have risen owing to the Presidential election and the uncertainties surrounding the same. Due to this, munis were unable to shine all that much in recent weeks, but things will start turning now. Aside from this, several other tailwinds favor munis, such as if the Tax Cuts and Jobs Act were allowed to sunset in 2025, making tax-exempts more attractive.
Another reason behind suppressed yields is the surge in new issues during this year's second and third quarters. This mainly constituted issues that were backlogged due to execution issues, alongside those that were moved up to get ahead of the Presidential elections. Either way, these are all done now, and the time is indeed ripe for munis to start shining once again.
Following a crash in munis and the broader bond market in 2022, there are plenty of reasons for bonds and funds to rally back to their previous highs. Nuveen’s funds are known to perform significantly better relative to peers and the market, given their use of leverage to amplify returns. This strategy works exceptionally well during a low-interest rate environment when the cost of said leverage is lower.
The fund still trades at a 6% discount to book value, a figure that has narrowed considerably from 14% last year. With sturdy municipal balance sheets, low supply, and dropping yields elsewhere, munis are perfect for income-seeking investors who don’t want to risk much, and the Nuveen fund is the ideal vehicle to gain exposure to the same, given its extensive track record.
Good Investing,
Todd Shaver, Founder and CEO
The Bull Market Report
Since 1998
by Scott Martin | Jun 2, 2024 | Weekly Newsletter 7pm Sunday
Market Summary
The Bull Market Report
The last two weeks were a tale of one stock. We spent a few days waiting for NVIDIA (NVDA) to release its quarterly results, leaving Wall Street almost literally breathless in the meantime. Then we watched money crowd into NVIDIA after the SEC filing, swelling the stock to lofty levels ($2.7 trillion, more than the entire German market). And finally, investors tired of scrutinizing this AI giant found a distraction in the form of a potentially threatening uptick in bond yields. We're happy we have NVIDIA in our High Technology portfolio. It's already soared close to 140% in the last six months for us.
But we'll never be satisfied with exposure to just one stock, no matter how strong it is in the moment. If that were the case, we'd have cut everything but Apple (AAPL) or Berkshire Hathaway (BRK-B) long ago, and had to live with the day-to-day consequences of that decision. In our world, a balanced portfolio of themes will win in the end. When Technology is triumphant, we have plenty of those stocks scattered around our universe. When Silicon Valley hits a wall, our Financials or Energy or Real Estate holdings tend to benefit as the pendulum of sentiment swings in their favor. And throughout the cycle, our High Yield recommendations keep paying dividends.
How has that paid out for us in the last two weeks? NVIDIA obviously did extremely well on its own, but its success sucked all the air out of the Technology portfolio and cut big holes into our results in the Stocks For Success and Long-Term Growth portfolios as well. Only mighty Apple managed to rise above the tide on the Stocks For Success side. First Solar (FSLR) was an absolute triumph and helped buoy Long-Term Growth. See below.
What's more interesting is the way the Early Stage recommendations were split between a 12% gain in the past two weeks for C3.ai (AI) and a 12% loss from Recursion Pharmaceuticals (RXRX), leaving the portfolio neutral for the period. A lot of our portfolios sat out the NVIDIA cycle close to neutral. This was a non-event as far as they were concerned. Now that Wall Street's attention has moved on, we expect them to recover their momentum and get back to work.
For now, this was a "rebuilding" period for our stocks. The Dow Industrials lost more ground but the Nasdaq, overweight NVIDIA as it is, held up better than the BMR universe in the aggregate. That's okay. Ordinarily our "equal weight" system for accounting for our performance plays out in our favor. This time, the single standout name was so strong (and nearly everything else was so tentative) that only portfolios that were heavily concentrated in NVIDIA managed to do well. One way or another, earnings season is over. It was a good one. We can afford to let the AI giant hog the spotlight. After all, we own it too.
In our view, bond yields are a sideshow. They sting, but the real story is what the Fed said two weeks ago. It's going to take serious pain in the Treasury market to feed back into our stocks. And get serious: that kind of pain in the Treasury market is not going to entice smart investors to pull their money out of stocks and flood into the "safety" of bonds paying less than 5% a year. That kind of pain is not enticing. It's scary. And it feeds on itself. Stocks like ours may even look defensive in that scenario. But in our view, the scenario is unlikely. The bond market corrects itself. When yields are attractive to the people who want bonds, you'll know. Otherwise, we focus on stocks.
There's always a bull market here at The Bull Market Report. With earnings season on the books, The Big Picture tackles the question of whether stocks have gotten ahead of their growth rates, while The Bull Market High Yield Investor sets the scene for the next Fed meeting And as always, we can't resist updating you on our latest thoughts on our favorite recommendations.
Key Market Indicators
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The Big Picture: Record Earnings, Record Stocks
Despite the persistent drag from the Fed on the short end of the yield curve and a weakening bond market on the long end, the economy remains resilient and the largest corporations in the world are making more money than ever. With 98% of S&P 500 companies reporting results, the index is on track for a healthy 6% growth in earnings per share. This surpasses analysts’ earlier forecasts of 3.2% growth, marking the biggest year-over-year increase since mid-2022 and quite the upside surprise. So far, nothing in the recent past has provided even a speed bump, and guidance suggests that things get even stronger in the current quarter and beyond.
When earnings hit records, stocks deserve to hit records too. That part is inevitable. The only question is how far investors' comfort zone will stretch to accommodate stronger fundamentals when valuations across the market are already on the high side of recent memory. After doing the math, we aren't especially worried that stocks have gotten ahead of their growth trend.
Think about it. Yes, the S&P 500 is currently priced at 20.3X forward earnings, which is significantly elevated when you consider that across the past decade the market only commanded a 17.8X multiple. However, it's barely a notch above where it's averaged out over the last five extreme bear-and-bull-and-bear-and-bull years. And because growth shows every sign of accelerating in the coming year, we wouldn't be shocked next summer to see the market as a whole at least 15% above where it is now. That's better than what stocks have historically delivered over the long haul. It's a boom.
And even in this 15% scenario, there's a strong argument that stocks will be strategically attractive at that point. The Fed will find an excuse to guide the short end of the yield curve down. That's a good thing for the market, giving valuations an excuse to reinflate as the "risk-free" return rate on cash drops. Long-term yields should drop far enough with it to take a lot of pressure off the economy and Wall Street alike.
Meanwhile, earnings expansion is on track to speed up from 11% for this year to 14% in 2025.
Those extra 3 percentage points bend the P/E calculations just enough to eliminate just about any rational fear that stocks are overvalued now. Remember, smart investors pay extra for faster growth because every additional percentage point on that side shortens the amount of time you need to wait in uncertainty and doubt to see your companies grow into what would otherwise look like high valuations. We wouldn't be shocked to recheck the numbers in 12 months and see the S&P 500 in the aggregate bringing in as much as $50 more per "share" (spread across all 500 stocks of course) than it's making now, and then at the end of 2025, adding another $35-$40 to that pool of cash takes the S&P 500 multiple down BELOW long-term historical averages if the market doesn't move appreciably in either direction in the meantime.
All you need to take advantage of that discounted future is buy stocks today and hold on until next summer. There will undoubtedly be volatility. Maybe it will take the market down, in which case the discount will be even more substantial a year from now. And maybe it will take the market up, in which case the route to positive returns pays off earlier. All in all, analysts collectively think the market can rally another 13% or so in the next 12 months. At that point, if all the projections line up with reality, the market looks LESS overheated on an earnings basis, even though investors would have reason to cheer with a better-than-average annual gain on the books.
We like the odds of executives continuing to outperform. They've already successfully weathered an earnings recession, a slowing global economy and just about everything inflation and interest rates can throw at them. Give them a little relief and the numbers will go through the roof. All we need to provide is that year of fortitude. It feels like a pretty good bet.
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BMR Companies and Commentary
C3.ai (AI: $30, up 23% last week)
Early Stage Portfolio
Enterprise AI company C3.ai released its fourth-quarter results last week, reporting $87 million in revenue, up 20% YoY, compared to $72 million a year ago. The company posted a loss of $14 million, or $0.11 per share, against $15 million, or $0.13, with a beat on estimates on the top and bottom lines, coupled with robust guidance for the new year bringing much-needed glad tidings for investors.
For the full year, the company posted $310 million in revenue, up 16% YoY, compared to $270 million a year ago, with a loss of $56 million, or $0.47, against $46 million, or $0.42. With demand for enterprise AI solutions continuing to intensify across industries, the company exceeded the top end of its guidance for the full year as well. It marked its fifth consecutive quarter of accelerating revenue growth.
During the quarter, the company signed 47 new agreements, including 32 new pilots, with marquee clients such as ExxonMobil, General Mills, BASF Petronas, and the US Navy, among others. This has resulted in subscription revenues rising 41% YoY, constituting 92% of its total revenue, giving the company much-needed stability and certainty regarding its cash flow position going forward.
C3’s focus on expanding its partner network has paid off well, with 91 of the 115 agreements closed last year from companies such as AWS, Google Cloud, and Microsoft Azure. The qualified opportunity pipeline with the partner network grew a huge 63% YoY. The company received a blockbuster response for its GenAI offerings, with 50,000 inquiries coming from 3,000 businesses during the fourth quarter; alone.
Some thoughts:
C3.ai's future holds promise, but it's definitely on the speculative side of the AI industry. Here's a breakdown of their potential and competition where it fits into the landscape of the AI revolution:
Strengths:
- Focus on Enterprise Applications: Unlike some AI companies targeting broad consumer markets, C3.ai focuses on developing enterprise-grade AI solutions for specific industries like manufacturing, energy, and healthcare. This targeted approach allows them to cater to specific needs and potentially achieve faster adoption.
- C3 AI Suite: Their core product, the C3 AI Suite, offers a comprehensive platform for developing, deploying, and managing AI applications. This can be attractive to businesses looking for an all-in-one solution.
- Partnerships: C3.ai has established partnerships with major technology players like Microsoft and Google. This gives them a leg up in terms of access to resources and market reach.
Challenges and Competition:
- Emerging Market: The enterprise AI market is still evolving, and it's not guaranteed that its approach will be the most successful in the long run. They face competition from established tech giants like Microsoft, Amazon (AWS), and IBM, all with significant resources and cloud computing expertise.
Profitability: C3.ai is not yet profitable, and it's unclear how quickly they can achieve profitability in this competitive landscape
The best choice for you depends on your risk tolerance and specific investment goals. The company offers a potentially high reward but also carries a higher risk due to the competitive landscape and its unproven track record of profitability.
The stock has had a fairly volatile year so far, but the recent rally following its fourth-quarter results has put it firmly in the green. As of now, the company is focused on growth, giving profitability a pass, but a pole position in the potentially $1 trillion enterprise AI market will ultimately will make it worthwhile. The company has sound financials, with $750 million in cash, and no debt. Our Target for this very speculative high-flyer is $50 with the Sell Price at $24. We added the stock at $22 in 2023, so we are up 34%. But is it worth the anguish or the volatility? Only YOU can decide that!
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The Trade Desk (TTD: $93, down 2%)
High Technology Portfolio
Pioneering ad tech company The Trade Desk released its first quarter results recently, reporting $490 million in revenue, up 28% YoY, compared to $380 million a year ago. It produced a profit of $130 million, or $0.26 per share, compared to $110 million, or $0.23, with a beat on consensus estimates on the top and bottom lines, coupled with an upbeat forecast for the second quarter. We are impressed by the profitability level – 27% after tax. That’s up there with some of the greatest companies in the market, like Apple, Google and Facebook.
During the quarter, the company was aided by continued penetration of connected TVs, with industry giants such as Disney, NBC Universal, and Roku making deeper pivots into this segment. This comes as the company’s UID2*, its alternative to the aging browser cookies, as it becomes more and more ubiquitous across the open internet, resulting in robust value for advertisers, and undeniably strong moats for Trade Desk. Unified ID 2.0 (UID2) is a non-proprietary, open standard accessible to constituents across the advertising ecosystem. It enables advertisers, agencies, ad technology companies, and ad publishers selling advertising to interoperate together in advertising workflows. The company struck a string of new collaborations and partnerships with its UID2 during the quarter, starting with Times Internet, a leading media conglomerate in India, followed by satellite TV giant, Dish Media, along with TF1 and M6, two of the largest broadcasters in France. As a result, the platform now has access to ad inventory in over 11,000 destinations across connected TV, display, mobile, and audio.
The Trade Desk isn't just another ad network; it provides a self-service, cloud-based platform for ad buyers. This platform allows businesses and agencies to plan, manage, and optimize their advertising campaigns across various channels and devices. Here's what makes them special:
- Independent and Open Platform: Unlike some ad networks that prioritize their own inventory, The Trade Desk offers an independent platform with access to a vast marketplace of ad inventory. This gives ad buyers more control and flexibility in reaching their target audience.
- Data-Driven Targeting: The Trade Desk leverages data and analytics to help ad buyers target specific audiences with greater precision. This can lead to more effective and efficient advertising campaigns.
- Programmatic Bidding: They automate the ad buying process, allowing advertisers to bid on ad impressions in real-time based on pre-defined criteria. This can help them secure better ad placements at more competitive prices.
Why They Are Leaders:
- Focus on Innovation: The Trade Desk is constantly innovating and developing new features to stay ahead of the curve in the fast-evolving advertising landscape.
- Transparency & Control: They prioritize transparency and control for advertisers. This builds trust and encourages long-term partnerships.
- Global Reach: The Trade Desk operates in a global marketplace, giving advertisers access to a vast audience.
The Trade Desk has strong secular tailwinds in its favor within the digital advertising market, which stood at $600 billion in 2023, expected to rise to over $870 billion by 2027. Global streaming giants are doubling down on advertising: Netflix with its 40 million ad-tier subscribers and Disney+ have already announced partnerships with the company to monetize their massive ad inventory.
The stock had a phenomenal year in 2023, up 60%, which has been extended this year with a YTD rally of 31%. While the valuation is anything but cheap, at 22 times sales and 120 times earnings, the massive addressable market and an impressive compound annual growth rate of 32% largely make up for it. The company ended the quarter with $1.4 billion in cash, just $240 million in debt, and $600 million in cash flow. Our Target is $100 and our Sell Price is $64. We’re raising both to $120 and $84 respectively. The stock hit $97 two weeks ago, not quite a new all-time high, as that was set in 2021 at $114. But we can see that number being broken later this year if the market holds steady and moves higher. If not, that is why we have such a tight stop. No matter how good a company is, if the overall market tanks hard, it will bring these high flyers down with it. Revenues are great – moving from $840 million in 2020 to $1.2 billion, to $1.6 billion to $1.95 billion in 2023. What worries us the most, is its low level of profitability. Watch this one closely.
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Workday (WDAY: $211, up 4%)
TERMINATING COVERAGE
Workday, a leading financial and human capital management solutions provider, released its first quarter results last week, reporting $2.0 billion in revenue, up 18% YoY, compared to $1.7 billion a year ago. It posted a profit of $103 million, or $0.38 per share, against -$10 million, or $0. The company beat on consensus estimates but lowered full-year guidance a bit. See below.
As always, subscription revenues led the way at $1.8 billion, up 19% YoY, with the rest coming from professional services at $180 million, up 12% YoY. The company’s 12-month subscription backlog now stands at $6.6 billion, up 18% YoY, followed by total subscription backlog at $21 billion, an increase of 24% YoY. The gross revenue retention rate came in at 95%, representing a churn of just 5% over the year.
During the quarter, the company onboarded several marquee new companies. This includes Asda, Electrolux, TopGolf, and LVHM, among others. In the public sector, the company acquired the Defense Intelligence Agency (DIA) as a customer for its Workday Government Cloud. It now counts 60% of the global Fortune 500 as customers and was named a leader in cloud Human Capital Management for 1,000+ employees by Gartner.
The company continues to double down on AI and now has 50 AI and 25 generative AI use cases in its roadmap. Workday completed the acquisition of HiredScore, an AI-powered talent acquisition and internal mobility solution. With 65 million users and 800 billion transactions on its platform each year, the company has a wealth of data to train its AI and leapfrog competitors.
Following a robust performance last year, the stock has had a rough start to 2024, and is down 21% YTD, mostly owing to its high valuation. We believe that this is unjustifiable, and overblown, considering the massive addressable market of $140 billion, and an impressive 5-year CAGR of 20%. Workday ended the quarter with $7.2 billion in cash, $3.3 billion in debt, and $2.2 billion in cash flow. Our Target is $325 and our Sell Price is $250.
We, that is, you and we have a decision to make. Do we let the company go here? Or do we buckle down and add more? We added the stock at $139 in 2018, so we are up over 50%. You, however, may have a higher entry price. Not that that makes any difference. It just feels better if you can sell and take a profit, even though the stock was at $311 in February. Revenues have been growing for the past four years, from $4.3 billion in 2020, to $5.1 billion, to $6.2 billion, to $7.3 billion in 2023. At the current rate it looks like $8.0 billion is probable for 2024. Growth appears to be slowing and we wonder: Is this 10% growth rate worth such a high valuation? The market just might have something here.
Here’s what occurred: When Workday reported quarterly earnings a week ago, it lowered its forecast for fiscal 2025 subscription revenue to between $7.7 billion to $7.725 billion from a prior call for $7.725 billion to $7.775 billion. That prompted a flurry of price-target cuts from Wall Street. This is a tiny lowering. It is such a small reduction, that you have to re-read the sentence to understand the difference. The stock was smashed. This is what the market is doing to great companies. We’re not happy about it, but it is reality. For this reason, and the slowdown in growth discussed in the previous paragraph, we are going to exit the stock. Tough decision, but the market is just destroying growth companies with slower growth in the forecast.
If you wish to stay in the stock, the knockdown of the stock by $52 a share (19%) since earnings a week ago, certainly creates a better valuation now. It’s down $100 (32%) since February. With cash of $7.2 billion and debt of $3.3 billion, the balance sheet is strong.
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First Solar (FSLR: $272, up 2%)
Long-Term Growth Portfolio
First Solar released its first quarter results recently, reporting $800 million in revenue, up 45% YoY, compared to $550 million a year ago. It posted a profit of $240 million, or $2.20 per share, against $42 million, or $0.40, with a beat on consensus estimates on the top and bottom lines, all driven by macro regulatory tailwinds, ever since the passing of the IRA Act in 2022.
The company has a sales backlog of 78.3 GW, up from 71.6 GW a year ago, with net YTD bookings at 2.7 GW, down from 12.1 GW. Its average selling price stands at 31.3 cents per watt, down from 31.8 cents a year ago. The company expects its bookings backlog to extend through 2030, as there is seemingly no stopping demand for rooftop solar and large-scale solar energy generation projects.
While much of the solar energy industry reels from the structural overcapacity in China, First Solar has circumvented this threat, with its focus on differentiation and its business model. The company’s cadmium telluride semiconductor technology is vastly better than the commoditized crystalline silicon modules coming from China, which are known to harbor various reliability and quality issues.
Beyond the regulatory tailwinds, the company stands to benefit from the rise of generative AI as tech giants look to transition towards green energy to operate their massive new data centers, with First Solar being the preferred choice. A typical query on ChatGPT consumes 50 times more energy than a Google Search, so the giants of AI must make this shift to solar if they want to save money and don’t want to come under criticism.
It is already up 58% YTD and is showing no signs of slowing with plenty of tailwinds in its favor, and a pole position in the market. First Solar ended the quarter with a robust balance sheet, with $2 billion in cash reserves, just $680 million in debt, and $900 million in cash flow.
Many leading analysts from UBS, Piper Sandler, and JP Morgan Chase have increased their Price Targets for the stock. UBS raised its target to $320, from $270, the highest on the Street. Our Target was destroyed in the last two weeks as the stock rallied from $187 on May 14th to its present level of $272. We’re up 40% in less than a year. At $215 it is time to raise. We love this company so we are going to best UBS and place a $325 Target on the stock. Our Sell Price of $140 is hereby raised to $240.
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iShares US Oil & Gas Exploration & Production ETFÂ (IEO: $103, up 2%)
Energy Portfolio
A pure-play energy fund with concentrated exposure to oil and gas companies that are exclusively involved in exploration and production, this fund closely tracks global energy companies and is thus subject to the industry’s swings and volatility. So far this year, the fund is off to a flying start and is up 9% YTD, mainly owing to the recovery in natural gas prices following a prolonged slump over the past year.
Given a short to medium-term horizon, the oil and gas industry is always eventful, with plenty of geopolitics and macroeconomic factors coming into play. For example, right now there is the Red Sea crisis, a prolonged conflict in the Middle East, and Ukraine intensifying its attacks on Russian oil refineries, among a host of other things to factor in, that could lead to swings in global energy prices.
On the macro front, the demand from China is still weak, but a recovery is in the cards, which could push oil prices beyond the $85 mark. Apart from that, a rate cut by the Fed sometime later this year, and a recovery in demand from Europe this winter for space heating and other residential and commercial uses can all lead to a much-needed rally in natural gas prices, which remain at multi-year lows.
When taking a long-term view, there is a lot to be optimistic about oil and gas stocks. This might seem counterintuitive considering the growing environmental movements the world over, alongside new alternative energy sources, but we believe that natural gas and hydrogen will play an outsized role in this transition. This too will take anywhere from two to three decades to become a reality, and in the meantime, oil and gas giants will be reaping profits.
The Exchange Traded Fund allows investors to ride this trend with its highly concentrated portfolio, with 45% of its assets held in ConocoPhillips, EOG Resources, Marathon Petroleum, and Phillips 66. These are all companies with massive inventories and low production costs, helping generate outsized returns during bullish streaks in energy prices, while still outperforming when prices slump.
Our Target is $120 and our Sell Price is $95. This fund is a great way to own an assortment of energy companies in one transaction. We added the fund at $80 two years ago.
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Recursion Pharmaceuticals (RXRX: $8.28, down 10%)
Early Stage Portfolio
Recursion Pharmaceuticals, a leading AI and machine learning company in the biotech space, released its first quarter results a month ago, reporting $13.8 million in revenue, up 14% YoY, compared to $12.1 million a year ago. It posted a loss of $91 million, or $0.39 per share, as against a loss of $65 million, or $0.34 the prior year, but posted a beat on consensus estimates on the top and bottom lines.
Rising losses were largely the result of increasing R&D expenses, at $68 million, up from $47 million a year ago. This was followed by a similar rise in administrative expenses at $31 million, up from $23 million, as the company has been on a hiring spree. Revenues during the quarter were entirely from its partnership with Swiss life sciences company, Roche, which the company expects to scale further.
Recursion has plenty of value catalysts coming up over the next few quarters, which can be quite profitable for the company in a significant way. This includes five drugs in phase 2 clinical trials, each with over 100,000 potential patients worldwide, and no competitor. If the company can successfully commercialize just one of these five drugs, it can add significant value from current levels.
Its AI-enabled drug discovery platform continues to gain momentum, with potential new partnerships and the exercising of existing partnership options capable of driving top-line growth. The company’s 20 petabytes of data collected from real patients, when used with its internal AI software is a game changer for the industry, prompting Roche and Bayer to start working with Recursion.
The company’s AI play has been formidable enough to warrant a $50 million investment from Nvidia, and it has grand plans in this regard, including a next-generation supercomputer. The stock is down 16% YTD, and it stands to offer enormous value if catalysts start to align going forward from present levels. It has a robust balance sheet, with $300 million in cash, and just $50 million in debt. Our Target is $28 and our Sell Price is $8, which is getting tight. We added the stock at $10 just six months ago and it ran up to $17 in February but has since settled down. This is a speculative stock for sure. Enjoy the ride, but be careful.
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ARK Innovation ETF (ARKK: $42, down 4%)
TERMINATING COVERAGE
Cathie Wood's flagship Innovation ETF has had a rough start to the year and is down 16% YTD. This comes as the broader equity markets, including disruptive tech stocks, have posted a rally this year. The pullback can be attributed to its high exposure to Tesla, which has been a key detractor for the fund in recent quarters.
The fund’s overreliance on Tesla is clearly wearing it down, and alongside this, other key weak investments include Roku (down 88% from peak), Unity Software (down 90%), Pacific Biosciences (down 96$), and Teladoc, which is down 50% this year and over 95% from its peak in 2021. Ark attributes the weakness in Tesla to auto sales still being lower than pre-COVID levels, but we think the various controversies surrounding Tesla’s founder, Elon Musk, and his controversial $45 billion compensation package could have contributed just as much, not to mention his purchase of Twitter, spending half his time with SpaceX, and many other strange personal quirks that this genius brings to the table. In our opinion, the fund’s underperformance in recent quarters is largely due to it being underweight on market leaders and mega-cap stocks, which have led the rally in 2023 and this year so far.
Investors should start treating the Ark Innovation ETF like a venture capital or private equity fund, which often comes with a lock-in period lasting a few years, up to a decade. That’s how long it takes for disruptive innovations to pay off, and at current levels the stock offers robust value, making it perfect for value-seeking investors with a long enough time horizon.
We are asking ourselves some tough questions lately. Cathie Wood has clearly lost her magic. We added the stock in 2021 at $117, after it had hit an all-time high of $158. We thought it was overvalued and waited patiently for it to come down. Come down it did, but it has continued to erode for the past three years, going nowhere for the past two years, languishing in the low 40s. Why do we continue to hang on to this stock? That’s a good question. We have again been patient with this fund, but for far too long. We don’t have the time to wait any longer. There are much better places for our funds, than the many pie-in-the-sky investments she has made these past few years.
We are exiting the fund and moving on. We’d rather own more Nvidia, more Super Micro Computers, or Eli Lilly and Novo Nordisk.
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The Bull Market High Yield Investor
The clock is now ticking on the next Fed policy meeting on June 12. Nobody expects a rate cut or a rate hike at this point. We're more interested in seeing whether consumer inflation numbers due out that morning have any impact on Jay Powell's prepared marks: a soft or "cool" print could once again prompt a lot of talk about relaxing overnight lending rates when the moment is right, while anything hotter than expected could have the opposite effect. Whatever we see this month, it's unlikely to change the primary narrative around the Fed, which is that we'll probably be in a place where Powell and company can start relaxing in September and cut more aggressively after that.
We've been saying it for months and we were right. Short-term interest rates have peaked. People parked in money markets are unlikely to earn more on those accounts than they're making right now. And as the short end of the yield curve recedes, upward pressure on the long end will evaporate along with it. There simply won't be a reason for capital to keep flowing out of Treasury bonds into those money market accounts. And as the bond market stabilizes, long-term yields have less reason to keep climbing to the point where they spook us here in the stock market.
Add it all up and if you're looking for a relatively smooth income stream without the strain of life in the stock market, you need to lock in Treasury yields where they are. That means settling for 4-5% a year, which translates into 2-3% above where the Fed wants to guide inflation in the long term. Maybe a 2-3% real return is enough for you. We have a feeling most investors will want their money to work a little harder, which is why we're banging the drum on stocks and funds like these.
Arbor Realty (ABR: $13.68, up 2%. Yield=12.6%)
REIT Portfolio
Leading Mortgage REIT Arbor Realty released its first quarter results recently, reporting $104 million in revenue, down 5% YoY, compared to $109 million a year ago. It posted a profit or FFO of $58 million, or $0.31 per share, down from $84 million, or $0.46. This was a mixed quarter for the company, with a beat on the top line, but a miss at the bottom, largely owing to a big drop in loan originations across the board due to the tougher mortgage business, due to 7% 30-year loans.
Agency loan originations during the quarter stood at $850 million, down from $1.1 billion a year ago, which Arbor had warned against a couple of months back. The company believes that the first two quarters of this year will include peak stress, as interest rates remain higher, with a possibility of a rate cut in late 2024. Borrowers are deferring taking loans in anticipation of lower rates.
Arbor’s structured portfolio, however, continues to do well, albeit with a small YoY decline, with $256 million in originations, down from $266 million the prior year, with a total of 59 loans being originated, the same as last year. Similarly, the company’s servicing portfolio hit new highs during the quarter, at $31 billion, up 8% YoY, compared to $29 billion a year ago, with a net servicing revenue of $31 million.
The company has done remarkably well throughout the pandemic, and the volatile interest rates environment that followed. This was largely owing to its diversified business model with multiple countercyclical income streams. For instance, if interest rates continue to remain high, originations will take a hit, but the mortgage servicing rights portfolio will increase in value due to low refinancing rates. Who is going to refinance a 3-4% loan at today’s 7% level?
This has helped it maintain its distributable earnings in excess of dividends, and a payout ratio of at least 90% throughout, all the while maintaining its book value, currently at $13.02. Over the past few months, Arbor has held outsized reserves to hedge against delinquencies and has continued to shore up liquidity, resulting in a robust balance sheet, with $910 million in cash, $12 billion in debt, and $550 million in cash flow.
Realty Income Corporation (O: $53, up 2%. Yield=5.9%)
REIT Portfolio
Realty Income, "the Monthly Dividend Company," is one of the largest investors in commercial real estate across the globe and recently reported $1.2 billion in revenue, up 40% YoY, compared to $940 million a year ago. It posted a profit or FFO of $790 million, or $0.94 per share, against $680 million, or $1.03, with a beat on top-line estimates, but a miss at the bottom, making it a mixed performance.
The company is structured as a real estate investment trust, and its monthly dividends are supported by the cash flow from over 13,250 real estate properties owned under long-term lease agreements with commercial clients. During the quarter, the company invested $600 million across a wide range of properties, with a weighted average yield of 7.8%. A significant chunk of these investments, or $320 million was allocated towards assets in the UK and Europe, with an average yield of 8.2%. The company invested $38 million in a US-based data center joint venture, marking its first investment in the space.
Another big milestone during the quarter was the completion of the $9.2 billion acquisition of Spirit Realty Capital, with the new combined firm valued at $63 billion, and Spirit shareholders set to own 13% of it. The CEO of Arbor stated that the transaction is immediately accretive. This gives Realty Income significantly more size, scale, and diversification across asset, geographical, and demographic lines, along with the potential for realizing various cost and operational synergies.
This was an eventful quarter for the company in terms of capital activity, starting with a secondary offering to raise $550 million an at average price of $56.93 per share. Followed by $450 million in 4.750% senior unsecured notes due on February 2029, and $800 million worth of 5.125% senior unsecured notes due on February 2034, resulting in $4 billion in liquidity, to fund $2 billion in investments during the year.
The stock is down by nearly 10% so far this year, but there are a few key catalysts that could turn things around, most importantly a rate cut by the Fed, later this year. What makes this REIT truly impressive is its diversification across classes, assets, and geographies, leaving it well off in all market conditions. It ended the quarter with $680 million in cash, $26 billion in debt, and $3 billion in cash flow.
Invesco Municipal Trust (VKQ: $7.93, up 2%. Yield=5.1% tax free, or the equivalent of 7.8% taxable)
High Yield Portfolio
The Invesco Municipal Trust is a closed-end fund that invests in tax-free municipal bonds, with the aim of generating steady current income for investors, with limited volatility and downside risks given a long-term horizon. It is a perfect product for retirees and other conservative investors seeking consistent tax-free income, but don’t want to stomach any excessive market risks.
The fund posted a stellar rally starting in October when the Fed officially ended its hawkish stance, but as the anticipation of further rate cuts soured, it has been increasingly rangebound over this year. It is, however, making the most of the higher nominal yields in recent months.
Following two consecutive years of net outflows, $140 billion in 2022, and $8 billion in 2023, muni bonds are set for a turnaround this year. Bonds posted negative performance in April, mostly owing to the better-than-expected employment and inflation data, prompting a hawkish reaction from the Fed. New issuances, however, swelled to $45 billion, 29% over the 5-year average, and were oversubscribed 3.8 times. After several months of limited supply, this quarter presented an opportunity for funds to add yield to their portfolios at an attractive risk-reward proposition.
Despite its phenomenal 22% rally since mid-year 2023, the fund offers an attractive discount of 12% to book value, while providing tax-free yields of 5.15%. This makes for a very impressive proposition, not just for conservative, income-seeking investors, but for speculators seeking value as well. With its extensive 30-year track record and a low expense ratio of just 1.3%, this fund is for those who want no risk from equities.
Good Investing,
Todd Shaver, Founder and CEO
The Bull Market Report
Since 1998
by Scott Martin | Jan 24, 2024 | Instant News Flash
Streaming giant Netflix (indicated at $538, up 9% overnight) Â had a spectacular fourth quarter, hitting $8.8 billion in revenues, up 12% YoY, compared to $7.8 billion a year ago. The company posted a profit of $940 million, or $2.11 per share, up from just $60 million, or $0.12 a year ago, with a beat on consensus estimates on the top and bottom lines, coupled with healthy core metrics lifting the stock as high as $50, following the results, in the post and pre-market trading.
The company’s full-year figures were just as impressive, with $33.7 billion in revenues, up 7% YoY, compared to $31.6 billion, with a profit of $5.4 billion, or $12.03 per share, against $4.5 billion, or $9.95 during the same period a year ago. In the midst of all this, Netflix’s guidance for the upcoming first quarter of 2024 stole the spotlight, with $9.2 billion in revenues, up 13% YoY, and profits expected to more than double.
Netflix unveiled a slew of changes to its platform in 2023, starting with the crackdown on password sharing, followed by lower-tiered pricing, and ad-supported accounts. These initiatives have exceeded all expectations, with 13 million new subscriber additions during the fourth quarter alone, bringing its total headcount to a record 260 million, well ahead of estimates.
These changes were complemented by a strong slate of new releases during the quarter, such as the final season of its long-running royal drama, The Crown, among many others. This is amidst the sea of other content that keeps viewers around the world hooked, leading many observers and analysts to conclude once and for all that Netflix has won the online streaming game.
Despite rising competition from all over the world, Netflix is the only company in this space that has consistently posted growth, while remaining profitable. This year it plans to invest $17 billion in fresh content, and just signed a $5 billion deal to livestream the World Wrestling Entertainment’s RAW, along with other exclusive programming and content on the platform by 2025.
The stock has rallied over 35% during the past year, and 48% if you include today’s big jump, and shows no signs of slowing down as the company goes on the offensive to unlock more value across its platform. We love the fact that the company is buying back its stock. During the fourth quarter alone, Netflix repurchased $2.4 billion worth, made possible by its strong and growing balance sheet position with $7.1 billion in cash, $15 billion in debt, and a massive $7.3 billion in free cash flow. Our Target has been a big $590 because we believe so much in this company. We would not sell Netflix. Would you like to know why? Take a peek at this chart and YOU decide:
| Year |
Number of Subscribers (Millions) |
| 2014 |
57 |
| 2015 |
69 |
| 2016 |
82 |
| 2017 |
94 |
| 2018 |
137 |
| 2019 |
158 |
| 2020 |
195 |
| 2021 |
209 |
| 2022 |
221 |
| 2023 (Q3) |
247 |
by Scott Martin | Aug 25, 2023 | Weekly Newsletter 7pm Sunday
Market Summary
It's been a bumpy couple of weeks, but baby bull markets tend to sputter a little sometime between the 60- and 120-day mark. With that in mind, this test of investors' courage seems almost foreordained in terms of where it fits in the larger Wall Street cycle. Yes, things were going extremely well. Yes, stocks were racing back to the levels they comfortably commanded before the pandemic inflated and then deflated a bubble. And yes, that rebound is largely justified. We just need to test that justification in order to shake off our residual trauma from the bubble collapse; and the last few years in general.
This is how stocks normally behave. If the bull market has hit a wall this early, it will be the shortest significant rally in modern history. Bull markets generally run for 5-6 years and even in the depths of the Great Depression, the recovery was both more robust and more sustained. Granted, we live in unusually unsettled times, but sooner or later every statistical aberration reverts to the long-term trend. For the S&P 500 and large stocks in general, that means moving up 8-11% a year across the long term. And for Treasury yields, that means about 1% above inflation.
Keep that last part in the back of your head when people try to tell you that 4% bond yields are poison for the stock market. Across generations, inflation has averaged a little over 3% a year. Adding a full percentage point to that "normal" historical level gives you a number above 4%, which means this is where long-term yields should be. If anything, with the latest read on consumer prices coming in at 3.2%, both inflation and interest rates are exactly where they should be under normal circumstances.
Of course, accepting this argument means letting go of a lot of assumptions and expectations that have accumulated over the last 10-15 years. Extremely low interest rates were a historical aberration left over from the 2008 crisis. They needed to come back up, for a lot of reasons. Whether the trigger that gets them back on track is the Fed or a sudden Treasury credit downgrade is secondary. And stocks have historically rallied in the face of exactly this kind of interest rate environment. This is a market fact. Unless you think something fundamental has broken within the American psyche that will prevent us from rising above all current obstacles like we did in the wake of the 2008 crash, or the dotcom crash, or 911, or World War II, or the Great Depression itself for that matter, the numbers are on our side.
In the meantime, the numbers are not great, but they aren't terrible either. The S&P 500 is up 16% YTD, which is accelerated performance when you look at the statistics. Granted, a lot of investors still have wounds left to heal before they really start feeling good about their experience in the last few years, but things are still moving fast in the right direction. The Nasdaq is up a blistering 30% in barely 7 months. Our stocks, balanced between a strong defense and plenty of aggressive growth recommendations, are right in the middle. We've scored a 22% bounce so far this year. In just another 7 percentage points, we'll be back where we were at the end of 2021 ... right before the zero-rate bubble started to rupture.
The big market benchmarks are in a similar state. Even counting the recent pullback, Wall Street as a whole hasn't exactly fallen off a cliff. Stocks are within sight of record territory. And as you know, these relatively rarefied levels near all-time peaks tend to be a little precarious. Investors and traders challenge every move. The bulls need to fight for every inch. Sometimes we need a little time to build up our strength and go over each wall of worry in turn. But it happens. On average, the bulls run for 5-6 years before a real obstacle gets in the way and forces a major downswing. Across each multi-year run, the market as a whole tends to quadruple in value.
In other words, things look a long way from unsustainable or overheated. This is a pause, not a halt. Corporate earnings support this. This has been a mediocre earnings season but the mood has been more hopeful than depressed and a lot of investors have even showed signs of impatience. People can't wait to see the numbers on the current quarter and then guidance for the end of the year. There's a strong sense that by then, the Fed will be finished raising short-term interest rates, which means the pressure on the economy will not get much worse. And when things can't get much worse, they generally get better from there.
Inflation is no longer accelerating. The Fed is getting traction. Earnings across the S&P 500 are not great, but they aren't plunging either. At worst, the tone reads "stagnation," a stall instead of a swoon. That's not a hard landing. Unless the real cliff is coming, this is the soft landing we needed. The recession so mild that it barely even registers after years of disruption, upheaval and, most recently, an economy too strong for anyone's comfort. When investors run from signs of the job market running too hot, it's really a sign that we could all use a break. The economy needs to cool off. That's what the Fed is doing. The alternative is watching prices keep soaring indefinitely, which creates a vicious cycle in which the dollar ends up much lower. Nobody wants that. This is preferable. This is what normal feels like.
There's always a bull market here at The Bull Market Report. As earnings season winds down, the drama has shifted back to the bond market, which shifts The High Yield Investor into the spotlight as we work to explain how rising yields pushed our stocks back down 3% in the last two weeks. As a result, The Big Picture once again revolves around benchmarking the current stock market environment against history, and finds the results highly encouraging. And if you're still paying attention to earnings, we've got plenty of updates for you as always.
Key Market Indicators
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The Big Picture: From Baby Bull To Tempestuous Tot
If you’ve already written this bull market off for dead, we have to admit, you’ve given up on the stock market and we can’t help you. For this bull market to have been born in June and dead by August, the economic environment would need to be worse than it was in 1932, in the deepest depths of the Great Recession. That’s when the shortest bull market in modern memory happened. Back then, investors only got two months after rallying 20% from its peak before the bear recouped control of Wall Street. Those were truly bad times.
But even then, investors who bought the brief rally didn’t have a lot to complain about. That two-month rally sent the S&P 500 up a dizzying 91%. The brief but savage retreat that followed took about 30% off that peak, leaving the market roughly 55% off its low. Maybe you think the world is in worse shape now than it was 80 years ago and the market just no longer has what it takes to recover. In that scenario, you’ve effectively given up on stocks, the economy and the American people.
Because in every other crisis over the past eight decades, the bulls got years to run. Other than the 1932 shudder, the shortest modern bull market lasted 1.8 years, before the grim lead into World War II cut the rally short. Only the 2020-2021 pandemic bubble was anywhere near that truncated. It took real determination for the bulls to start running this time around. The mood bottomed out in October and it took eight months for the S&P 500 to recover 20% from that low point. During that period, it became clear that even the Fed’s aggressive rate hikes wouldn’t be severe enough to crash the economy immediately.
And in the absence of that crash, guess what? We survived. Corporations didn’t implode like people feared. A recession like the one we saw in 2008 didn’t happen this time around. We're thinking the recession is already well underway for corporations. Earnings are down from last year. But in the new third quarter, we’re looking for a slight uptick. Even if that doesn’t happen, the comparisons practically guarantee better times ahead for the end of the year. In that scenario, we’ve already lived through the worst of it. Things get better from here. In a few months, members of the S&P 500 will be getting bigger again in the aggregate. The economy will be growing.
That’s good for investors. It’s hard for stocks to go down for long when the economy is feeding more profit across big companies year after year, which is why bull markets are hard to kill once they get going. Admittedly, it isn’t a smooth ride. The first few months of any baby bull are the most intense. But then there’s generally a lull and a pause for the market to test its convictions. Things slow down. People get nervous and start second guessing themselves. But in history, the bull has never backed down this fast. History can bend, but it rarely breaks. If the bear takes over again, we'll be shocked.
Remember, bond yields move in the opposite direction from bond prices. If bonds are falling and rates rising, that means money is pouring out of that particular side of the global financial markets. Within the dollar sphere, money flowing out of bonds means money flows into cash or stocks. Cash is bad news as long as inflation remains high. You might be able to get 4% in money markets, but you’re probably going to lose it all from inflation. Only stocks can make enough right now to keep ahead of inflation. Some may go down instead but the right stocks have a fighting chance. When that’s the best bet you get, you take it. We have the right stocks.
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BMR Companies and Commentary
Moderna (MRNA: $101, down 6% last week)
Healthcare Portfolio
Get ready for a good long read on this extraordinary company. This is not a 1- or 2-minute read. It will be 5-10 minutes. So, hang on. Here we go.
Leading biotechnology company and mRNA pioneer, Moderna, released its second quarter results a week ago. The company posted $340 million in revenues, down by a colossal 94% YoY, compared to $4.7 billion a year ago. It further posted a loss of $1.4 billion, or $3.62 per share, against a profit of $2.2 billion, or $5.24. This was largely the result of the seasonal nature of its COVID-19 vaccine sales.
While this was expected as the world moves on from the pandemic, the company, however, expects $6 to $8 billion in revenues from its COVID shot this year, with the US alone expected to buy anywhere between 50 to 100 million doses for the fall. Its updated COVID vaccine, targeting the omicron subvariant XBB.1.5. Is still awaiting FDA approval, but will be ready for a rollout over the coming months.
The company is confident of seeing robust demand for the shot, not just in the US, but also in Europe, Japan, and other leading markets. With COVID-19 becoming ubiquitous, Moderna expects this great business to continue. Far from resting on its laurels, however, it has gone all out to ensure its pandemic windfall is used towards developing more sustainable products.
This includes a robust pipeline of vaccines targeting cancer, heart disease, and a slew of other conditions, and are all set to hit the market by 2030. This pipeline includes its experimental vaccine for respiratory syncytial virus, aimed at adults aged 60 and above, followed by its personalized cancer vaccine in partnership with Merck, which passed its first major clinical trial early last month, with flying colors.
The stock is down by 44% YTD and over 78% from its all-time high in 2021, and as such, is quite de-risked. It currently trades under 4 times sales and 35 times earnings, which might seem rich, but is perfectly justified for a growth stock such as this. It has since repurchased stock worth $1.5 billion and ended the quarter with $8.5 billion in cash, $1.2 billion in debt, and negative $230 million in cash flow. Our Target is $250 and our Sell Price is $150. SO, let’s discuss. These numbers are there for you to decide what to do. And each and every one of you has a different scenario of buying the stock. Some of you bought the stock in January 2023 when we added the stock at $193. Some of you bought the stock beforehand in February 2020 at $26. As the stock has come down from the all-time high of $464 in September of 2021, and more recently from the $218 level in January of this year, you have decisions to make on a day-to-day basis. And all of these decisions are personal, based on a myriad of things that are going on in your life. We could list them here, but you know what we mean here. It comes down to a decision that YOU have to make: Do I sell? Do I stay with it? Do I add more? Tough questions. We highly recommend GTC Stop Orders. Good-‘Til-Canceled orders are orders to sell a stock at a certain price. If it hits the number, the order executes and you are out of the stock. If you bought in January, you could have put a stop order in place to sell at say, $181. Or $171 or whatever price you picked. They used to call this order a Stop Loss order because that’s what it does. Now it is just called a Stop order.
We’re not real happy that the market has drubbed this company the way it has. But we believe in the firm long term, and since we are a long-term investment newsletter, we believe in the companies that we follow and if the stock moves lower, in many cases we like it even more than it was at the higher price. That is the case with Moderna. We would buy the stock here as they have a strong, diverse set of new products coming to market this year, in 2024 and 2025, and beyond.
The future looks bright for Moderna. The company has a strong pipeline of new products, including vaccines for influenza, respiratory syncytial virus (RSV), cytomegalovirus (CMV)*, and HIV. Moderna is also developing a personalized cancer vaccine that could revolutionize the treatment of cancer. The potential dollar size of these markets is enormous. The global market for influenza vaccines is estimated to be worth $8.5 billion, the RSV market is worth $2.5 billion, the CMV market is worth $1.5 billion, and the HIV market is worth $30 billion. Moderna could capture a significant share of these markets with its innovative products.
*CMVÂ is related to the viruses that cause chickenpox, herpes simplex, and mononucleosis. CMV may cycle through periods when it lies dormant and then reactivates.
In addition to its new products, Moderna is also expanding its manufacturing capacity. This will allow the company to meet the growing demand for its vaccines and other products. Moderna is well-positioned to be a major player in the pharmaceutical industry for years to come.
Here are some specific examples of new products that Moderna has in the pipeline. The company is committed to using its mRNA technology to develop innovative new treatments for a wide range of diseases:
A bivalent influenza vaccine that protects against both influenza A and influenza B.
An RSV vaccine that is more effective than existing RSV vaccines.
A CMV vaccine that could prevent congenital CMV infection, which can lead to serious health problems in newborns.
A personalized cancer vaccine that is designed to target the specific mutations in a patient's cancer cells.
The company is worth $39 billion now. At its peak, it was worth $189 billion. Can it go there again in the future? We believe so.
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Axcelis Technologies (ACLS: $167, down 5%)
High Technology Portfolio
This company is one of the largest suppliers of capital equipment for the semiconductor industry, leading some industry observers to call it one of the most important companies in the world. During its second quarter, despite a glut in the Chip industry, the company has continued its strong streak, with $270 million in revenues, up 24% YoY, compared to $220 million a year ago. The company posted a profit of $62 million, or $1.86 per share, against $48 million, or $1.43, in addition to a beat on consensus estimates at the top and bottom lines. Its dominant position within this space, amid an industry that in many places has been turned upside down, has resulted in substantial tailwinds for Axcelis, something that is unlikely to subside even in the case of a glut in the market.
Axcelis Technologies ended the quarter with an order backlog of over $1.2 billion, including fresh orders of $200 million. This is largely the result of persistent demand for its Purion family of products, particularly from the silicon carbide power markets. These are semiconductors used in cars, particularly electric vehicles, which are growing fast around the world.
The company’s customers span markets of advanced logic chips, memory chips, and storage chips, all of which are set to witness robust demand, as a result of the unprecedented growth in AI, machine learning, and cloud computing. It is further the only ion implant company capable of providing full-recipe coverage for all power device applications, allowing for high-volume, low-cost manufacturing.
As a result, the company has increased its revenue forecast for the full year by $70 million, giving the stock that is already up by 115% YTD, more reason to rally. Axcelis has a strong balance sheet position with $450 million in cash, just $80 million in debt, and $250 million in cash flow. This puts many lucrative value-creation opportunities, such as dividends and stock repurchases on the horizon going forward. Our Target is $150 and our Sell Price is $125. We are raising the Target today to $195, and the Sell Price to $148.
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Roku (ROKU: $79, down 8%)
Early Stage Portfolio
Streaming giant Roku caught another break with its second quarter results a week ago. The company posted $850 million in revenues, up 11% YoY, compared to $760 million a year ago, with a loss of $110 million, or $0.76 per share, down from $112 million, or $0.82, in addition to a beat on consensus estimates on the top and bottom lines.
The company posted strong growth across key operational metrics, with total active accounts at 74 million, up 16% YoY, and reaching a level of 25 billion hours streamed on the platform during the quarter, up by 4 billion hours from last year. The Roku channel now accounts for 1.1% of total TV viewership, establishing it as a leading player in the global streaming space, with plenty of room to grow.
The platform’s average revenue per user slid 7% YoY, to $40.67, but this is mostly owing to a global advertising slowdown, which has since started to turn around, as recessionary fears abate. Roku is perfectly poised to reap rewards from this trend, given its dominance in the connected TV space with a market share of 50% in North America, and billions of dollars of unmonetized ad inventory.
Roku continues to face substantial challenges as a result of supply chain constraints and inflationary pressures, particularly when it comes to its hardware business. Its decision to not pass these additional costs onto customers is what led to the string of losses in recent quarters. This same strategy will pay off in the long run, as it faces stiff competition from the likes of Alphabet TV, Amazon, and Apple TV.
The stock is down by over 85% since its all-time high in 2021 but has posted a 95% rally YTD, amid substantial challenges and headwinds. It currently trades at under 3.5 times sales, which is very reasonable for a growth stock with a landed base and massive competitive moats. Roku ended the quarter with $1.8 billion in cash, just $650 million in debt, and $15 million in cash flow. Our Target is $110 and our Sell Price is $62.
With all of this said, we are not very happy about the fact that the company can’t make a profit. Yes, they have a ton of cash to tide them over the next year or two. But gee whiz, after all these years, WHY CAN’T THEY MAKE A PROFIT? We’ve always said to ourselves: When you are not happy about something, you have to take some action. We’re pretty darn tired of waiting for this one, so yes, their future looks bright, but the stock had better move higher, and if it doesn’t, we are going to move on. The way we like to do this is to set a Stop. We would suggest that you put a Sell Stop in place at $74. If it goes there, we are out. If it goes higher, we will move the stop up accordingly over time.
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PayPal (PYPL: $62, down 2%)
Financial Portfolio
PayPal released its second quarter results two weeks ago, reporting $7.3 billion in revenues, up 7% YoY, compared to $6.8 billion a year ago. The company posted a profit of $1.3 billion, or $1.16 per share, against $1.1 billion and $0.93. Despite posting in line with estimates, the stock witnessed a pullback following the results, owing to a slew of factors and operating metrics.
During the quarter, the company processed over $370 billion in payments, across 6.1 billion transactions, up 11% and 10% YoY, respectively. It processed 55 transactions per active account, an increase of 12% YoY, with total active accounts growing to 435 million, up marginally from 428 million during the same period a year ago. It is truly an astounding number of accounts.
PayPal is an online payment platform that facilitates payments between individuals and businesses. It is one of the most popular online payment platforms in the world. PayPal is successful because it is easy to use, secure, and trusted by businesses and consumers alike.
PayPal has a new deal with private-equity giant Kohlberg, Kravis & Roberts. According to this deal, the PE firm will be acquiring PayPal’s ‘Buy Now, Pay Later’ loans originated within the UK and other European countries, to the tune of $44 billion, with $1.8 billion in net proceeds to PayPal set to be realized over the next few months alone. This provides the fintech giant with much-needed liquidity and stability, as it forays deeper into the lucrative consumer credit markets. In addition to this, the company has seen enormous traction with its recent rollout of PayPal Complete Payments, onboarding big ticket channel partners, the likes of Adobe, WooCommerce, Shopify, Stack Payments, and LightSpeed among others.
As PayPal grows by leaps and bounds, it hasn’t lost sight of its promise to continue delivering exceptional value to shareholders, with $1.5 billion being returned via buybacks during the second quarter alone. It plans to scale past $5 billion in buybacks in 2023, giving strong support to the stock, while hardly denting its robust balance sheet, with $11 billion in cash, just $12 billion in debt, and $5.8 billion in cash flow. And the firm is quite profitable, as noted above in the first paragraph. The Target is $125 and we would not sell PayPal.
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The Trade Desk (TTD: $75, down 12%)
Early Stage Portfolio
One of the largest demand-side advertising platforms, The Trade Desk released its second quarter results last week, reporting $460 million in revenues, up 23% YoY, compared to $380 million a year ago. The company posted a profit of $140 million, or $0.28 per share, against $100 million, or $0.20, driven by its relentless streak of onboarding new brands, inventory, and partnerships throughout the past year.
Despite a beat on consensus estimates at the top and bottom lines, the market reaction following the results put a damper on the stock’s 100% YTD rally. The results themselves had nothing to warrant an adverse reaction, and in our opinion, this was everything to do with the company’s unjustifiably high valuations of 22 times sales and 290 times earnings, many times higher than the industry average.
The Trade Desk is a technology company that helps businesses buy and sell digital advertising. They are successful because they offer a platform that is easy to use, transparent, and effective. The company has a strong focus on data and analytics, which allows them to help businesses target their ads more effectively. While demand for advertising has hit a rough patch over the past few quarters, the company’s precision and transparency-driven platform has remained resilient nonetheless. Its business development initiatives have made its solutions indispensable for large brands, resulting in a 95% customer retention rate for the ninth consecutive year.
In a niche filled with walled gardens from the likes of Meta and Alphabet, The Trade Desk has succeeded by making this business more accessible to everyone. It has continually gained market share at the expense of its two major competitors, and while the threat of Alphabet’s renewed efforts in this space is substantial, TTD’s expansive moats, industry partnerships, and integrations will not be easy to breach.
The stock was upgraded by many firms on the Street, including Wells Fargo, raising their target to $100 from $82. Piper Sandler has a nice round $100 price target, with Morgan Stanley at $105. During the quarter the company repurchased stock worth over $40 million, with a further $360 million in pending authorizations. This should provide it with much-needed support during volatile times like the present. The Trade Desk ended the quarter with $1.4 billion in cash, a mere $250 million in debt, and $630 million in cash flow. Note: We wrote about The Trade Desk in The Bull Market Report of July 17th. Check it out on the website.
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HF Sinclair (DINO: $59, up 8%)
Energy Portfolio
Independent petroleum refiner HF Sinclair released its second quarter results two weeks ago, reporting $7.8 billion in revenues, down 30% YoY, compared to $11.2 billion a year ago. The company posted a profit of $500 million, or $2.60 per share, down from $1.3 billion, or $5.59, but the beat on consensus estimates at the top and bottom lines sent the stock on a strong rally from $51, and the $46 level in July. We added the stock at $61 in December, so the weakness this year has been put behind it.
During the quarter, the company was hurt by the drop in volumes due to the drop in energy prices and the economic slowdown globally, along with a slowdown in refining margins. The gross margin per barrel stood at $22, down 40% YoY, compared to $36 a year ago. This was coupled with lower production of 554,000 barrels of oil per day, down from 627,000 barrels during the second quarter of last year. This is in sharp contrast to the previous quarter, when the company looked upbeat as a result of increasing utilization rates, falling oil refining capacities, and a widening crack spread, owing to the normalization of global energy markets. (Crack Spread is the margin or pricing difference between a barrel of crude oil and the finished petroleum products.)
HF Sinclair is an energy company that produces and sells a variety of fuels, including gasoline, diesel, jet fuel, renewable diesel, specialty lubricant products, specialty chemicals, and specialty and modified asphalt. They have a long history in the energy industry, having been founded in 1916. They have a strong financial position and are committed to innovation. The company used its windfall gains over the past year exceptionally well, paring down debt to $3.6 billion, while offering a well-covered annualized dividend yield of 3%, ending the quarter with $1.6 billion in cash, and $2.5 billion in cash flow during the quarter. Our Target is at $72 and our Sell Price is at $51. This is a solid $11 billion company with a strong management team.
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Sunrun (RUN: $16.64, down 5%)
TERMINATING COVERAGE
Photovoltaic cells and energy storage solutions provider Sunrun is riding the post-IRA high life, as evidenced by its second quarter results two weeks ago. The company posted a profit of $55 million, or $0.25 per share, against a loss of $12 million, $0.06. This was still a fairly mixed quarter, with earnings blowing past estimates by a wide margin, with top-line figures coming in below expectations.
Market reactions aside, this was a spectacular quarter for the company, with 103 megawatt hours of fresh installations, up 35%. Total solar energy capacity installations reached 300 megawatts, exceeding the high-end of its guidance at the end of the quarter. Net subscriber value hit $12,320, up by $320 from the prior quarter. Much of this was made possible by the tax credits availed to consumers since the passing of the $700 billion Inflation Reduction Act last year. With tax credits now covering 30% of the installation costs, solar companies such as Sunrun are on a fiery streak.
The company unveiled a slew of new products and initiatives during the quarter, starting with the Sunrun Shift, a home solar subscription that aims at maximizing value under California’s new solar policy. It further signed a partnership with PG&E to develop a distributed power plant that turns home solar storage systems into resources during periods of peak demand, helping prevent blackouts.
Sunrun is an undisputed leader in an industry that is set to hit $400 billion by 2030, and following a 30% YTD pullback, and an 83% decline since its all-time high in 2021, it is trading at a mere 1.5 times sales. The company ended the quarter with $670 million in cash, and over $10 billion in debt which is concerning, but has the assets and is now generating sufficient cash flow to back this up.
With all of this said, we’re not happy with the performance of the firm. After thinking this through long and hard, we believe their marketing philosophy is skewed. The firm offers solar leases, solar loans, and purchase agreements where customers agree to buy the electricity generated by their solar panels for a fixed price over a set period. They don't have to pay upfront for the solar panels, and they don't have to worry about maintenance or repairs. This all sounds great at first glance, but the financing costs for the firm are exorbitant at $10 billion, which is WAY out of line. We added the stock at $29 and we reluctantly exit the stock here. We will be replacing this with a much better solar option in the coming weeks.
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Twilio (TWLO: $62, up 1%)
Long-Term Growth Portfolio
Twilio is the leading provider of cloud-based programmable communications solutions. It released its second quarter results last week, reporting $1.0 billion in revenues, up 10% YoY, compared to $940 million a year ago. It posted a profit of $120 million, or $0.54 per share, against a loss of $7 million, or $0.11, coupled with a beat on estimates for the next quarter sending the stock up from the $58 level following the results.
The company hit a rough patch over the past year, owing to persistent macro pressures, which in turn resulted in longer sales cycles, lower deal sizes, and a substantially lower dollar-based net expansion rate* at 103%, compared to 123% a year ago. The slowdown in the social, streaming, and crypto verticals has made things worse, yet Twilio has successfully managed to hold its ground as things start to turn around.
* Dollar-based net expansion rate (DBNER) is a measure of how much revenue you earned from existing customers due to add-ons, upselling, and cross-selling.
Twilio currently has 304,000 active customers on its platform, against 275,000 a year ago, which is largely in line with estimates. The company’s communications revenues led the way at $910 million, up 10% YoY, followed by data and applications at $125 million, up 12%.
Over the past few years, the company has made significant progress in offering a differentiated customer value proposition. It has done this via acquisitions, partnerships, and integrations, which have since resulted in wide, impenetrable moats. The tailwinds as a result of this are only just beginning to be realized and have since prompted a flurry of analyst rate hikes, with the high end of its target at $110.
The stock is up by 23% YTD, but is still off by 86% from its all-time high in 2021 at $457, while trading at a mere 2.8 times sales, making it a fairly priced growth stock. The company completed $500 million in stock repurchases during the quarter, from its $1 billion in authorizations at the beginning of this year. It ended the quarter with a strong balance sheet with $3.7 billion in cash, $1.2 billion in debt, and a stable cash flow position. Will the stock ever reach its all-time high again? We believe so, but certainly not for a few years. In the meantime, we see steady, profitable growth ahead and look forward to breaching our Target of $135. Our Sell Price is $65, with the stock under that price now, as you know, so if you are anxious, set a sell stop at your pain point, say $55 or so. We don’t believe this can happen, but a lot depends on the world economies and all of the potential negatives in the world. We are optimists, as the American economy and markets have grown through thick and thin, through war and viruses, and bull markets and bears, for 200 years. We’ll come through again, of that there is no doubt.
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The Bull Market High Yield Investor
It happened like clockwork. Something nudges long-term interest rates above 4% and a perfectly good rally in the stock market evaporates. This week, the trigger was a shock cut to the Treasury’s credit rating, a significant shift in the bond market but not necessarily anything the rest of Wall Street needs to worry about. Most of the big players blew off the downgrade. Warren Buffett, Jamie Dimon, Janet Yellen, everyone. The rating agency that pulled the trigger, Fitch, is relatively minor, with maybe 15% of the global heft in this space. Neither of the true giants spoke up.
And the timing of this downgrade is strange to say the least. It feels like a PR stunt, a desperate reach for relevance. But for now, that 15% of the world that pays attention now needs to adjust its bond portfolios to mirror this move, which means selling Treasury debt to make room for whatever this agency decides is still worth its top rating. Demand for Treasury bonds goes down a bit. And the laws of economics say that when demand for a thing suddenly drops, the price drops with it. When bond prices drop, yields go up. Suddenly yields on the 10-year are above 4%.
This is a historical pain point for the market. Round numbers scare people. The thought is that if you can lock in 4% a year on bonds for the foreseeable future, enough investors will pull their money out of stocks to buy those bonds. But wait a minute. Money flowing out of stocks into bonds means demand for bonds picks up again. Prices in this scenario firm up. And guess what, yields go down. The situation just resolved itself.
That’s how this works. It’s how it worked in 2011 and it’s how it’s going to work now. Yields have had trouble getting above 4% in this cycle. It’s going to take a massive shift in the landscape to get them permanently above that level now. If you’re worried about yields, buy bonds when they hit 4%. And if you’re unwilling to buy bonds at 4%, stick with the stocks that can deliver better under the right circumstances. Beyond that, 4% is just a number.
After all, there are two things here to keep in mind. First and foremost, when long bond yields are stuck at roughly 4% and the Fed has pushed short-term rates well above 5%, the system is showing dramatic signs of stress. That’s the inverted yield curve that tends to foreshadow a recession. The Fed controls the short end. The market decides the long end. When the market keeps buying so many Treasury bonds that long yields stay below short yields, the market is already so fixated on an economic downturn ahead that the prophecy becomes self fulfilling.
But if long-term Treasury yields were to rise back above the short end of the curve, that recession signal goes away. Keep that in mind when people talk about how lethal 4% really is. The only way this curve can heal is if those long yields climb well above 4% or if the Fed wakes up and decides there’s been a terrible mistake. You know the first scenario is the only plausible one. And that’s the second factor to watch. We remember back to 1994, when Treasury yields started at 5.92% and crossed 8% by November. They didn’t get back below 5.5% until 1998. That’s at least four years the world survived yields much higher than 4%, a period in which the S&P 500 doubled. It was the dotcom boom, one of the greatest rallies in history. And it happened in the face of those rates.
What’s lethal about 4% yields? Fear itself. We’ll get through this. Stocks will recover and get back to work. If yields stay above 4%, it’s going to be a lot harder to argue that there’s a recession looming. And if they fall below 4%, where does all that fear go? For now, if you're happy earning 4% a year, bonds are attractive. If you want more, you need to reach for a few of our higher-yield recommendations like the two profiled here.
Apollo Commercial Real Estate Finance (ARI: $10.74, flat. Yield=13.0%)
High Yield Portfolio
New York-based Apollo Commercial Real Estate Finance primarily invests in real estate-backed debt instruments, including senior mortgages and mezzanine loans. The company released its second quarter results recently, reporting $63 million in revenues, up 10% YoY, compared to $57 million a year ago, with a loss of $16 million, or $0.11 per share, against a profit of $50 million, or $0.35. The numbers were weighed down by net realized losses on investments of $82 million, or $0.61 per share, from a subordinate loan backed by an ultra-luxury residential property. This was a significant event, one that saw a $60 million increase to its special current expected credit loss allowance, bringing it to a total of $141 million. This includes an already realized loss of nearly $80 million on the same Manhattan-based ultra-luxurious residential property and is a reflection of the state of New York’s property market, which continues to struggle with a very tough post-COVID recovery.
The company continues to benefit from higher interest rates because 99% of its portfolio is held in floating debt. This led to another consistent quarter of strong distributable earnings of $0.51, well above the quarterly dividend of $0.35. There has been some talk of a dividend cut, but with the level of coverage, we are not concerned. We believe the likelihood of interest rates remaining high for the foreseeable future is quite high.
Leaving this aside, Apollo’s loan portfolio remains as sturdy as ever, with a total portfolio value of $8.3 billion, a weighted average yield of 8.6%, with nearly 94% of them being first mortgages, making this a good place to be in a high-interest rate environment. The trust further funded two first mortgage loans worth $170 million, and received repayments worth $600 million.
The stock is down by 1% YTD, trading at an enticing 27% discount to book value. Apollo ended the quarter with $370 million in cash, $7.0 billion in debt, and $330 million in cash flow.
BlackRock Income Trust (BKT: $11.82, down 2%. Yield=8.9%)
High Yield Portfolio
The BlackRock Income Trust, one of the leading investors in agency mortgage-backed securities and US Government securities offers plenty of value for conservative investors looking for capital preservation, alongside regular income. With its exposure to quality AAA-rated securities, its risk quotient is only a notch below treasuries and munis, while offering higher yields and avenues for capital appreciation.
Ever since the Fed began its hawkish stance, the fund has witnessed a steady pullback and is currently down 6% this year so far. As a result, it offers an enticing 9% dividend yield, all the while trading at a 5% discount to book. With inflation slowing down, and the Fed’s rate hikes finally coming to an end, this fund represents a stellar economic opportunity during the months ahead.
The thing about this fund is that while it may be affected by macroeconomic headwinds and market volatilities in the short term, for investors with a long enough time horizon, the risk of loss is very low. This is made possible thanks to its exposure to mortgage-backed securities, all insured by Fannie Mae, Freddie Mac, and Ginnie Mae, which while not explicitly guaranteed by the US government, we know for a fact that the latter will step in to keep these entities solvent.
The biggest drawback when it comes to investing in the BlackRock Income Trust is the lack of any significant hedges against interest rate risks. During a high-interest rate environment like the present, a portfolio of mortgage servicing rights offers much-needed cushioning against volatility, but they don’t own any, as Rithm Capital and others do. We feel that the company, at current levels, has limited downside risk as the current interest rate levels are very beneficial for the fund.
Good Investing,
Todd Shaver, Founder and CEO
The Bull Market Report
Since 1998
by Scott Martin | Dec 13, 2019 | 7am News Flash
From a good Fed outlook to rumblings about a breakthrough on trade, istocks that struggled over the past year are breaking new records.
The trade deal is reportedly all ready but the final paperwork. If so, Phase One is happening before the end of the year and tariffs on Chinese exports set to kick in on Sunday will be scrapped. In return, China will start buying U.S. agricultural products again. We're looking at $40 billion flowing to our farmers from the pork-starved people of Asia.
This is good timing for the Chinese, who have recently been reeling in the face of nearly 20% food inflation. And the news is good for U.S. consumers who were staring at steeper prices on about $500 billion in products. Some of those proposed tariffs will roll back today. The others are now on the table for renegotiation.
Every BMR stock now has a constructive catalyst on its side. In particular, the high-growth stories that soared to high valuations early this year now have their growth scenario restored. If the trade war was the factor clouding these stocks' prospects, a trade truce should logically clear those clouds, right? And since uncertainty itself was what was really holding many of these companies back, now that we know the shape of a deal, everyone can finally start moving forward again.
This means that corporate plans put in place a year ago can get executed. Budgets can be made and money allocated to strategic initiatives. Big software packages can be bought, installed and used. And the companies that support these initiatives can sign the contracts they had in the bag a year ago. That money has no reason not to come in now. All the revenue they saw coming will arrive.
Take a fresh look at Aggressive and Technology stocks that have fallen from big heights "because of growth fears." The reason to question their growth trends has evaporated. And we know where the stocks can go when there's no fear in the way. These companies soared in the first place because the businesses are moving so fast.
One example: Alteryx ($95, down 12% this week). It fell recently for no reason anyone can point to beyond "growth fears." Management couldn't figure it out. Analysts were clueless. But if the biggest drag on growth just evaporated, the people trying to talk this company down don't even have talk on their side any more.
