The Weekly Summary

Billionaire CEO of JP Morgan Chase Jamie Dimon says being an American abroad is “almost an embarrassment.” The rant came on JP Morgan’s widely followed earnings call held Friday. Dimon says the media should focus more on major issues. He doesn’t like listening to the “stupid stuff” Americans have to deal with, expressing frustration over the nation’s inability to invest in infrastructure and overhaul the tax code. There would be much stronger growth if there were more intelligent decisions and less gridlock. Reporters should focus on the major issues the nation faces rather than the vagaries of the firm’s trading businesses, he said. The United States of America has to start to focus on policy which is good for all Americans, and that is infrastructure, regulation, taxation, education. He screamed, “Why you guys don’t write about it every day is completely beyond me. And, like, who cares about fixed-income trading in the last two weeks of June? I mean, seriously.” Dimon is one of the best businessmen in America and his words are known for being the hard truth. It makes sense to us that for the bull market to continue our citizens must wake up to the realities we face and take actions.

There is always a bull market here at The Bull Market Report! This week we highlight the following stocks: PayPal, Splunk, Microsoft, and Tesoro.

Highlights From The Past Week

US Bank earnings season started on Friday. Q2 earnings season for the banks kicked off on Friday morning with results from JP Morgan, Citigroup, Wells Fargo and PNC Financial. Some analysts have highlighted a more difficult setup for the group following a June rally on the back of higher bond yields and capital return announcements that beat elevated expectations. There have also been thoughts that earnings season could shift some of the focus back to the more challenging operating environment for the group. However, there really did not seem to be any meaningful discussion about downside risk to estimates. Analysts seem to be looking for the bulk of the support for Q2 to come from additional net interest margin expansion. This should offset sluggish loan growth and weaker capital markets (near double-digit declines). The latter dynamic has been widely discussed by bank executives and in the press and was a key driver of estimate reductions. Despite some pickup in concerns surrounding the Auto sector, credit is expected to remain benign. Analysts also highlighted expectations for another solid quarter of cost control. This is our first glimpse into the new earnings season.

More conjecture on ECB policy. There is further speculation on ECB policy where the ECB is likely to signal that it is gradually winding down its QE plan at its September 7th policy meeting, and President Draghi could use his appearance at the Fed Reserve's Jackson Hole conference in August to signal a policy shift. The ECB is wary of putting an end date to its QE plan. There is a need to retain flexibility in case the economic outlook sours and also the ECB wants to follow the Fed example of exiting the policy of retaining open-ended nature of program. A Reuters poll of over 75 economists showed consensus thinks the ECB is likely to shift away from ultra-easy policy in September. The Fed and ECB are two of the most powerful institutions in the world for capital markets. This is important stuff.

CBO says Trump budget would not balance. The Congressional Budget Office (CBO) said Trump’s fiscal 2018 budget would reduce the deficit by about a third over next decade. This is a smaller estimated deficit reduction than the White House forecast due to lower revenue projections. Trump’s budget would result in average GDP growth over next decade of 0.1% more than the CBO baseline. CBO also estimated that revenues under Trump’s budget would be almost $1 trillion lower than his estimates over the next decade. Trump budget's deficit reduction would stem from lower spending, including decreasing the $2 trillion base in mandatory spending, mostly from healthcare. Press reports said CBO’s findings creates new complications for Republicans who need to build a coalition of conservatives and moderates to vote for a single budget proposal. We need to start seeing some real progress out of the White House.

Britain acknowledges Brexit bill for the first time. Ahead of this week's Brexit talks between Brexit Secretary Davis and EU negotiator Barnier, a written statement was released to parliament, which acknowledged Britain has financial obligations to the EU, which will continue beyond Brexit. The Financial Times cited EU diplomats saying it goes further than UK Prime Minister May’s previous reference to Britain being willing to reach a “fair settlement” of unspecified obligations. It noted that Davis did not refer to financial issues when he released three position papers ahead of Brexit talks. The article pointed out that the British team sees the statement on financial obligations as an effort to improve the tone of talks rather than a change in substance. Meanwhile, at least 15 Conservative MPs are in talks with Labour on keeping Britain in the European Economic Area after Brexit, which would require accepting free movement of people and paying some money to the EU. The rationale for this approach is that it would give Britain time to reach a final deal with the EU and give certainty for businesses and workers. What a mess.

Dow, S&P 500 Hit Records to Close Winning Week
The S&P 500 hit a fresh record Friday and posted its best weekly performance since late May, and the Dow Industrials notched their third consecutive record close. Let’s keep this going!

 

BMR Companies & Commentary

PayPal (PYPL: $57, up 6% - new all-time high [NATH) set Friday)

The price target was raised to $70 from $54 at a research firm on the Street. PayPal is the firm's "top idea" for 2017, followed by Google (GOOG: $956, up $37, 4%). Coming opportunities with PayPal's Venmo and with partnerships caused the research firm to become even more bullish.

PayPal and Apple entered into an exciting major partnership this week that sent shares to all-time highs. PayPal and Apple have partnered to give users the ability to use PayPal as a payment method when paying for Apple’s services, which includes the App Store, Apple Music, and iTunes, to name a few. The feature will be introduced in 12 markets, including the US and the UK, and it will be integrated with several devices across Apple’s ecosystem, including the iPhone, iPod, Apple TV, and Apple Watch.

The immediate impact for PayPal is getting access to a massive revenue stream. Revenue from Apple services, which is mostly from the App Store, reached $7 billion in Q416, up 18% from last year. Although the financial terms of this deal have not been disclosed, we can estimate the potential impact. If PayPal were to charge Apple 1.25% per transaction, which is much lower than the 2.9% fee it often charges merchants, and if PayPal accounts for a third of spend on the App Store in 2017 — which will be based on consumers spending a total of $40 billion on the iOS App Store, according to Street sources — PayPal would see $165 million in revenue for 2017.

In the long run, PayPal’s partnership with Apple could give the firm an opportunity to integrate itself into additional Apple services. Over the last few years, Apple has indicated that it plans to turn its chat app, iMessage, into a robust ecosystem. The app now includes peer-to-peer payments, games, and other apps, with even more features coming in the fall with the launch of iOS 11. Although it hasn't been confirmed, it's reasonable to assume that one feature coming down the pipeline is the ability to buy products via iMessage. With PayPal already being a payment option within Apple's ecosystem, users may be more willing to use it going forward.

BMR Take: PayPal ranks among the best growth stories in all of technology and this Apple deal is just another reason as to why. Earnings are growing greater than 20% per year for as far as the eye can see and should break $3 by 2020.

 

Microsoft (MSFT: $73, up 5%, set a NATH* on Friday)
Early in the week Microsoft proposed a $10 billion effort to bring broadband internet to the rural U.S., an economic-development program aimed at a core constituency of the Trump administration. The plan, which calls for corporate and government cash, would send internet data over unused broadcast frequencies set aside for television channels. If developed, the initiative would help connect 23 million Americans in rural areas who lack high-speed internet access.
*NATH - New All-Time High

Broadband is important for all kinds of things. It’s not just streaming high-definition movies. Slow or nonexistent connections can hinder agriculture, business, education and healthcare. Broadband is arguable now a necessity of life. Microsoft’s proposal calls for a 5-year program of corporate investment and matching federal and state grants to end the gap between rural and urban access, starting with the company’s own efforts. The aim of Microsoft’s new Rural Airband Initiative is to be up and running in 12 states by next year and connect 2 million people over the next five years.

BMR Take: Doing big things like what is described above is why Microsoft is not just a tech titan, but a leader amongst the entire S&P 500. News like this continues to push the stock toward 20x consensus estimates of $4 per share of free cash flow. Do the math – that’s $80 a share.

Tesoro (TSO: $97, up 1%)

Tesoro has been a big winner and it could keep getting better. This week the company announced plans to study the possibility of turning vegetable oil into diesel fuel at its Dickinson refinery, which it purchased in 2016.

The crude oil refiner is making plans to retrofit an 8,000-barrel-per-day diesel hydrotreater to process soy and corn oil into renewable diesel alongside its Bakken crude oil processing. This $3.5 million project would use 17,000 gallons per day of vegetable oils to create a 5% renewable diesel mix to be marketed in North Dakota by the end of 2017. The North Dakota Industrial Commission granted the company a $500,000 grant to help cover the project's cost.

Compared to biodiesel that is blended into petroleum diesel at truck racks, renewable diesel is a superior quality product because, unlike biodiesel, renewable diesel is a pure hydrocarbon stream containing no oxygen. This results in a superior quality fuel that maintains vehicle performance. The company says the project is “unique and exciting.” Of course they do!

BMR Take: The stock continues to trade at a big discount to the consensus NAV* estimate of $120. In comparison, Buffet’s ownership of peer Phillips66 is valued at a premium to NAV in the market. Disconnect that the market will correct down the road? We think so. Tesoro still looks compelling to us even after the recent appreciation.
*NAV – net asset value

Upcoming Economic News

Export Price Index
Tuesday, July 18th, 8:30 AM
Period: June
Consensus: 0.05%
Prior: -0.70%

Note: The U.S. Bureau of Labor Statistics' International Price Program produces Import Price Indexes (MPI) and Export Price Indexes (XPI) containing data on changes in the prices of nonmilitary goods and services traded between the U.S. and the rest of the world.

Housing Starts
Wednesday, July 19th, 8:30 AM
Period: June
Consensus: 1,146,000
Prior: 1,092,000
Note: The number of housing units started in the United States.

Leading Economic Index
Thursday, July 20th, 10:00 AM
Period: June
Consensus: +0.30%
Prior: +0.30%

Note: The Conference Board Leading Economic Index (LEI) for the U.S. increased 0.3% in May to 127.0 (2010 = 100, following a 0.2% increase in April, and a 0.4% increase in March. Leading Indicators are economic series that tend to change direction ahead of shifts in the business cycle. There are 10 components of the U.S. Leading Composite Indicator* published by The Conference Board. The index is constructed by averaging the individual components in order to smooth out a good part of the volatility of the individual series. Historically, the cyclical turning points in the leading index have occurred before those in aggregate economic activity. Prior to 1996, the composite leading, coincident, and lagging indicators were calculated and published by the U.S. Department of Commerce.

* Average weekly hours, manufacturing
Average weekly initial claims for unemployment insurance
Manufacturers’ new orders, consumer goods and materials
ISM Index of New Orders
Manufacturers' new orders, non-defense capital goods excluding aircraft orders
Building permits, new private housing units
Stock prices, 500 common stocks
Leading Credit Index
Interest rate spread, 10-year Treasury bonds less federal funds
Average consumer expectations for business conditions

 

An Interview with Tim Cook

We read a lengthy interview of Apple CEO Tim Cook by Bloomberg Businessweek Editor Megan Murphy. We thought the following few paragraphs from it were particularly insightful:

Murphy: I was a little surprised the HomePod was pitched primarily as a music device when the competitive talk is of Amazon Echo’s Alexa and the immersive experience in the home. How will the HomePod better integrate Apple inside people’s lives?

Cook: We’re actually already in the home through the iPhone you take with you everywhere. It’s in your pocket or laying on a stand. Today, pre-HomePod, I can control my home using Siri through the iPhone. When I get up in the morning, my iPhone is my alarm clock. I say, “Good morning,” and all of a sudden, my lights come on. The temperature adjusts and a series of things occur. We’re also in the home through Apple TV. Many people use iPad as their computing device. The desktop Mac enjoys a place in the home. The thing that has arguably not gotten a great level of focus is music in the home. So we decided we would combine great sound and an intelligent speaker.

Murphy: So, it’s going to be a holistic process joining up all those touch points so people can exercise control over their lives, whether through Siri or iPad?

Cook: To put it in perspective, Siri is getting requests from 375 million devices right now. My guess is it’s the largest by far of any kind of assistant. Some of those requests are done in the home. Some of those are done on the go. That’s the platform that we build off. It’s very different from our starting point. We’re also in so many languages around the world: Siri isn’t just in English. We’re well-positioned around the world. So, again, what is the thing that’s missing in this equation? The combination of quality audio and instinct.
“I am so excited about it, I just want to yell out and scream”

Murphy: Do you think people will pay $349?

Cook: If you remember when the iPod was introduced, a lot of people said, “Why would anybody pay $399 for an MP3 player?” And when iPhone was announced, it was, “Is anybody gonna pay - whatever it was at that time - for an iPhone?” The iPad went through the same thing. We have a pretty good track record of giving people something that they may not have known that they wanted.

When I was growing up, audio was No. 1 on the list of things that you had to have. You were jammin’ out on your stereo. Audio is still really important in all age groups, not just for kids. We’re hitting on something people will be delighted with. It’s gonna blow them away. It’s gonna rock the house.

BMR Take: We were pleased to see Tim Cook’s responses for two reasons. 1) the iPhone is already the home controller of choice. We knew this, but Cook really put it in perspective. And 2) The takeover of a market is Apple’s modus operandi. Start late with a high price. Then lower prices and dominate. We have no doubt the home assistant will be any different. Amazon – watch out.

Nutanix Has a Rip-Roaring Week
The stock of Nutanix (NTNX: $22) was up 16% last week. We’ve been harping on this stock for weeks, and then along comes Goldman Sachs and says Nutanix is a “once-in-a-decade” opportunity and are looking for a $31 Target. Our Price Target is $30. Is Goldman reading The Bull Market Report? We certainly think so.

We’re already up 27% in the six weeks since we added the stock in late May. And we expect more good things from the company in the future. Nutanix is the leader in hyperconverged infrastructure, meaning it uses software to combine different storage and computing functions on one device. That space has been heating up among enterprises. More businesses are looking to adapt the technology, with 18% of chief information officers saying they expect to move to hyperconverged systems in the next two years, according to Goldman Sachs.

The company’s leadership in the space, including the combination of hardware and software it offers, makes it a “once-in-a-decade tech infrastructure story,” wrote the lead Goldman analyst on the note. They see Nutanix on a path for long-term double-digit growth, high gross margins and large operating leverage.

Additionally, in the shorter-term, Nutanix should benefit from changed accounting rules that will move its software revenues, which are currently deferred, to its profit and loss statement.

BMR Take: What more can we say? All good.

First Solar Continues its Tear
First Solar (FSLR: $43) was up another 9% this past week. We’re still down 30% or so on the stock but we are big believers in the company and management. Our timing on the addition to the Special Opportunities portfolio was bad. But we believe we will be winners in the long run. The stock is up over 55% in the last three months. Keep hanging in there.

Apple Back Up To $150.
Almost. Closed at $149, up $5 for the week. The market just can’t keep this one down. We sincerely hope you have some of this wonderful firm. You think it’s too high. Not on your life.

Annaly Just Keeps Chugging Along
And it is paying 10% a year in dividends. Annaly Capital Management (NLY: $12.33) added 2% last week. The stock has been paying double-digit dividends since inception in 1997. That’s right – 20 years. Where will the stock be in a year? Good question. We would say right about at this level, after paying another four quarterly dividends of 30 cents each. Do the math – that’s a shade under a 10% return. We love this one.

The High Yield Corner
By Michael Foster
Special to The Bull Market Report

We’re getting close to earnings season for Healthcare REITs, and the market’s expectations seem to be getting increasingly bullish. Over the last week, all of The Bull Market Report’s Healthcare REIT picks were in the green, with Omega Healthcare Investors (OHI: $33) leading the pack with a 2% gain for the week. That’s pushed the stock’s year-to-date performance much higher, with a 7% gain on top of half of the fund’s 8% dividend yield. There’s been a relatively low amount of volatility in Omega Healthcare relative to what we saw both in 2015 (where rate hike fears hit all REITs) and 2016 (when the REIT bull market suddenly corrected at the end of the year).

But what about the upcoming earnings report on July 27th? So far, analysts are expecting 86 cent FFO for the quarter, up from 83 cents from a year ago. The company has reaffirmed their 86 cent guidance as recently as early May, bringing the stock’s dividend coverage ratio to 134% if they hit the number. Gotta love it.

Before we discuss whether they will hit it or not, let’s take a quick look at Welltower (HCN: $74, up 1%), which had a similarly strong week and is also planning to release earnings soon - on July 28th before the market open. Welltower has far outperformed Omega for 2017, with a 10% price jump - although the lower dividend (5%) mostly offsets this. Like Omega Healthcare, Welltower is showing strikingly little volatility as of late, a development that makes a lot of sense given Welltower’s tremendous track record and strong dividend coverage. However, it’s surprising to see that Welltower’s dividend coverage is a shade lower than Omega’s at 128%. While that’s still good (general rule of thumb: any number over 115% is good for a REIT), it’s interesting to see how the dividend coverage ratio has slipped in the last couple of years as a result of falling funds from operations. Welltower’s earnings were down 6% from a year ago last quarter, and guidance suggests that decline is set to continue. But Welltower is also increasing dividends, which is a setup for a worrisome dynamic in which, eventually, the company will under-earn its dividend. How soon could that happen? At the current clip we’re safe for another 3-4 years, but the company clearly needs to adapt, lest it find itself suddenly in a position to halt or even cut dividends. For this reason, the company’s earnings results on the 28th and especially its forward guidance will be a key issue to watch for. We will keep a close eye on this.

Finally, Sabra Health Care REIT (SBRA: $23) had a flat week (up less than 1%) despite being one of the smallest Healthcare REITs in terms of market cap and property footprint. It’s quite unusual to see the smaller stock be less volatile than its bigger cousins, but Sabra is one of the less popular REITs out there (investors, especially retail investors, spend a lot more time focusing on Omega), and there was little news on the stock to justify much price action. On top of that, the company’s massive underperformance relative to its peers has soured a lot of investors on the company, while fundamental investors know this is a very good company with strong dividend coverage and growth potential.

So, if you have few sellers and few buyers, you end up with little price change. But how is Sabra doing as we near its earnings release at the end of July? Over the last 12 months, earnings have been weak relative to expectations, with two misses out of the last four quarters. But dividend coverage is impressive, at 132%. Some investors may be a bit concerned about the company’s relatively weak revenue growth, but it’s important to remember that Sabra is pausing on acquisitions right now and reorganizing its new property portfolio additions to maximize income. This process naturally makes revenue look bad, which again is why impatient investors have shied away. Nonetheless, the ongoing restructuring continues to be successful, as the strong dividend coverage ratio proves. Expect to see good things from Sabra in the future that will help the stock recover, but we may not see those developments for a year or more. For investors, that means sitting tight with your Sabra shares, collecting a 7% dividend while you wait for the market to catch up.

Now, with upcoming earnings for these stocks, we need to ask ourselves the likelihood of them hitting their numbers. While there are differences in each company that makes some stronger than others, the broader issue that impacts all of them is the regulatory overhang. A lot of chatter about the future of Obamacare and plans from the Republicans and President Trump to change or obliterate current regulations has left a lot of investors skittish on Healthcare for a long time. But interestingly, we’ve seen the market swiftly realize how silly these concerns are - at least as it impacts the Biopharma sector, which is up solidly for 2017 and is beating the S&P 500. But why isn’t that same relief coming to Healthcare REITs with the same speed?

Simply put, REIT investors are far more risk averse as a group, and they are much slower to recognize a change in the political landscape than growth stock investors. This puts those holding Healthcare REITs in the awkward position of needing to be patient. However, it is clear that there is little change to the regulatory environment coming, and some analysts are already noting that recent GOP proposals to change Obamacare actually look a lot like Obamacare. Whatever your political leanings and opinions on the subject, it seems pretty clear that the status quo isn’t going to change anytime soon.

Again, no matter your opinions on the growing D.C.-based controversies, there is a clear conclusion: Healthcare as it operates in America is not about to change anytime soon. Healthcare REITs have been discounted for a change that would negatively impact them. Putting these together, it’s a clear time to buy or to continue to hold Healthcare REITs both before and after the upcoming earnings season.

Good Investing,
Todd Shaver, Founder, Editor and CEO
The Bull Market Report
Since 1998