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. 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 Todd Shaver | Dec 23, 2019 | Free Newsletter (Sent Weekly Monday at 12pm), Weekly Newsletter 7pm Sunday
The Weekly Summary
December was chaotic last year, keeping investors glued to their screens as we watched a miserable season turn into one of the biggest rebounds in recent memory. This time around, conditions are unusually quiet as a late Thanksgiving turns into a compressed holiday season. Wall Street is already looking toward the Christmas and New Year breaks. So are we.
After all, Santa came early and often this year. The market as a whole has rebounded 28% YTD, handily recovering all ground lost in the 4Q18 rout and then continuing to push into record territory. The S&P 500 has now rallied a healthy 12% past last year's peak, with more than half of that surge coming in the last four months. Whether the motive is relief that we've skirted another year without a recession or more straightforward optimism, the mood is as good as it gets.
If anything, we're inclined to urge a little caution here. When a full 44% of investors are actively bullish and the so-called "greed index" flashing at extreme levels, this is as good a time as ever to take a little profit and rotate the returns back into stocks that haven't flown as far as the rest of your holdings or offer a comparable return for lower risk. The perfect time to buy was a year ago when everyone but us was terrified that the trade war and the Fed had triggered the end of the world. While today this is not an awful entry point, a selective approach can be your friend here . . . we would definitely not pour money into index funds right now.
After all, while the active BMR universe is up 42% so far this year, our stocks have tangible growth on their side. Earnings for the S&P 500, on the other hand, have spent the entire year in a stall, so there's no compelling mathematical reason for the index to keep moving up without straining historical multiples to the bubble point. Right now the market as a whole carries an 18X earnings multiple, well above the 15-16X that investors have normally been willing to pay.
In exchange for those inflated fundamentals, investors are getting negative growth. Those companies are actually tracking lower earnings than they did a year ago, and are likely to keep deteriorating at least into the 4Q19 reporting season. After that, we'll simply have to see if the combination of lower interest rates and a truce in the global trade war shakes a little growth free. If not, stocks will look increasingly vulnerable to any external shock to sentiment . . . the higher the multiples get, the more precipitous the fall from grace becomes.
However, there's a lot to be said for a sympathetic Federal Reserve and any relief from the trade war. The White House estimates that even Phase One in a deal with China coupled with a new NAFTA accord will boost GDP growth 0.5% in the coming year, which is enough to drive a so-so economic expansion into something approaching spectacular. It's definitely far from the recession zone that everyone was worried about a few months ago.
You need growth to decline in order to realistically talk about recession ahead. No decline means no recession. And no recession means people who retreated to the market sidelines are now having a hard time resisting the urge to get back in before they miss out completely.
Remember, while earnings haven't moved up in the past year, they haven't dropped a lot either. The trade war has delayed a lot of new corporate investment initiatives without driving executives to pull the plug on any established cost centers. We haven't seen mass layoffs. No sprawling Financial conglomerates or prominent hedge funds have imploded the last time the Treasury yield curve briefly inverted.
And that curve is healthier than a few months ago. Barring a lot of dread around the coming election, the rate environment once again reflects lower risk in the short term and higher uncertainty farther out into the future, exactly as it should. The Fed has done its work well. Investors have a reason to cheer.
So what can go wrong? While we are always quick to accentuate the positive, we also acknowledge that other investors make errors when the mood swings too far in either direction. Expectations can get stretched to unsustainable levels, setting up the next inevitable round of disappointment, second guessing and nervous selling. That's ultimately a good thing for those of us who have been watching and waiting for a chance to buy great stocks on the dip. Throughout our career (collectively well past a half century actively in the market) the long-term trend always points up and the dip is always worth buying.
There’s always a bull market here at The Bull Market Report! Gary Jefferson has the week off and with the holiday approaching, we decided to use his absence to try something new with an in-depth review of Todd's Stocks For Success. We hope that you come away from this issue with deeper understanding of why our founder likes Berkshire Hathaway so much. He would buy any of these stocks on weakness.
Finally, a scheduling note ahead of the Christmas holiday. The market will close early on Tuesday and stay shut until Thursday morning, so news will be light and our News Flashes will probably taper off a bit. We'll use the time to reflect on the year that's gone and cement our thinking on the year ahead. Ideally we'll also be able to update the site a little and perform other housekeeping as we get the portfolios in position for 2020. We'll be in touch either way, but as always, we wish you a happy holiday and the best possible experience as an investor.
Key Market Indicators
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BMR Companies and Commentary
The Big Picture: Big Rally, Narrow Bench
While the last few months have been great for the S&P 500 and our stocks as well, the gains remain restricted to a narrow field of relatively safe bets. Investors simply aren't thinking outside the box right now. They're content to park their money in a few big stocks that don't require a lot of patience or even conviction. While we'd love a little of that capital to flow immediately to a few of our smaller and more neglected recommendations, we don't mind in the slightest.
For one thing, we already recommend many of the leaders. Just seven BMR stocks account for 40% of the S&P 500's gains for the past quarter, and Apple (AAPL: $279, up 2%) alone contributed almost half of that upside. If you weren't bullish on Apple in the last few months, you missed the boat. We were right to keep the giant in our sights, and it gave us everything we hoped to see. Apple has surged a full 77% this year, recovering $700 billion in market capitalization along the way.
Microsoft, Alphabet and to some extent Facebook, Berkshire Hathaway, Johnson & Johnson and Visa also contributed a significant amount to the market's gains in the last few months . . . not to mention the year as a whole. Big stocks got big because the enterprises driving them were some of the most dynamic companies around. This year, they got even bigger. All are hitting all-time highs. How far can they go before taking a break? We'll simply have to see, but as long as earnings keep outperforming everyone else around, the stocks have all the room they need.
Then there's Amazon (AMZN: $1,787, up 1%), which is as dynamic as ever but the stock hasn't gone anywhere in the last quarter. It's also down 12% from its peak, so there's no sense of straining any kind of historical limit. When investors come back, this can once again be a $2,000 stock and a trillion-dollar company. And in that scenario, the S&P 500 gets enough of a boost to break another record. No other stock has to do any work. Amazon can do it on its own.
We see that story play out again and again. A full 3 in 5 S&P 500 constituents are actively lagging the market and the lower you go on the market food chain, the rarer true leadership gets. A staggering 85% of the stocks on Wall Street have underperformed the S&P 500 this quarter. Most are doing okay. True losses are limited. They're simply getting left out.
But the market will never tolerate an imbalance for long. Sooner or later, one or more giants will hit a wall and the money that's flowing to them now will rotate into smaller stocks. When that happens, we'll have a reason to cheer. On average, our recommendations are still down 12% from their 52-week highs, let alone lifetime peak levels. We've come a long way back in the last few months without even clearing what are still formally correction conditions from late in the summer, when Technology took a huge step back. There's money to be made here.
Look at Roku (ROKU: $137, up 3%). It's up close to 350% YTD but is 22% off its peak. That's an opportunity. Even though a handful of giant companies are doing most of Wall Street's work, plenty of smaller names keep breaking records as well. Splunk (SPLK: $151, up 5% this week), for example, is once again within sight of an all-time high, set in early December, capping a year that's literally run rings around the market as a whole. This stock has gained 44% YTD but the ride has been wild. We've seen it plunge from above $140 to below $110 twice this year, so the moral here is to hold on tight through the retreats.
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Berkshire Hathaway (BRK-B: $226, flat last week but setting an all-time high)
This stock is a must-own. If you believe in America, then Berkshire is the place to put your money where your mouth is. The stock is worth $553 billion, making it one of the top 10 largest companies in the world. Do you want to know what they do? Well, here it is, straight from Yahoo Finance. Breathe it all in:
Berkshire Hathaway Inc., through its subsidiaries engages in insurance, freight rail transportation, and utility businesses. It provides property and casualty insurance and reinsurance, as well as life, accident, and health reinsurance; and operates railroad systems in North America. The company also generates, transmits, stores, and distributes electricity from natural gas, coal, wind, solar, hydro, nuclear, and geothermal sources; operates natural gas distribution and storage facilities, interstate pipelines, and compressor and meter stations; and holds interest in coal mining assets. In addition, it offers real estate brokerage services; and leases transportation equipment and furniture. Further, the company manufactures boxed chocolates and other confectionery products; specialty chemicals, metal cutting tools, and components for aerospace and power generation applications; flooring, insulation, roofing and engineered, building and engineered components, paints and coatings, and bricks and masonry products, as well as offers homebuilding and manufactured housing finance; recreational vehicles, apparel products, jewelry, and custom picture framing products; and alkaline batteries. Additionally, it manufactures castings, forgings, fasteners/fastener systems, and aerostructures; titanium, steel, and nickel; and seamless pipes and fittings. The company distributes newspapers, televisions, and information; franchises and services quick service restaurants; distributes electronic components; and offers logistics services, grocery and foodservice distribution services, professional aviation training programs, and fractional aircraft ownership programs. In addition, it retails automobiles; furniture, bedding, and accessories; household appliances, electronics, and computers; jewelry, watches, crystal, china, stemware, flatware, gifts, and collectibles; kitchenware; and motorcycle accessories.
Here are the company’s top five holdings:
Apple
Comprising 24% of the Berkshire Hathaway portfolio, Apple represents Buffett's largest holding, with a whopping 250 million shares in the tech giant, as of November 2019. Currently worth approximately $65 billion, in 2018, Apple surpassed Wells Fargo to capture the #1 spot after Berkshire Hathaway purchased additional shares of the Steve Jobs-founded company in February of that year.
Bank of America
Warren Buffett's second-largest holding is in Bank of America, valued at $27 billion and comprising 13% of his portfolio. Buffett's interest in this company began in 2011 when he helped solidify the firm's finances, following the 2008 economic collapse. Investing in Bank of America, which is the nation's second-largest bank by assets, falls in line with Buffett's attraction to financial stocks, including Wells Fargo & Company and American Express (see below).
The Coca-Cola Company
Buffett once claimed to consume at least five cans of Coca-Cola per day, which may explain why the Coca-Cola stock is his third-largest holding. But one thing is for certain: Buffett appreciates the durability of the company’s core product, which has remained virtually unchanged over time, with the exception of the ill-fated "New Coke" formula rebranding, in the mid-1980s. This makes sense, given that Buffett started buying Coca-Cola shares in the late 1980s, following the stock market crash of 1987. Presently with 400,000,000 shares, valued at $22,000,,000,000, Coca-Cola accounts for 10% of the portfolio.
Wells Fargo
At 9% of his portfolio, Buffett currently holds shares valued at over $19 billion. Although this is Buffett's fourth-largest position, Wells Fargo previously occupied the top slot for many years. A series of scandals that began in 2016, including the creation of millions of dummy bank accounts, unauthorized modifications to mortgage plans, and the fraudulent sale of unnecessary car insurance, has hurt the bank's reputation.
American Express
This company is the third financial services company to make Buffett's top five list, occupying 8% of the portfolio. Valued at nearly $18 billion, Buffett acquired his initial stake in the credit card company in 1963, when it sorely needed capital to expand its operations. Buffett has since been a savior to the company, many times over, including during the 2008 financial crisis. With 12.5% average annual return over the past quarter-century, American Express has proven to be a valuable asset.
We’d like to say THEY COVER IT ALL. Again, if you believe in America and free enterprise, you might just want to buy one share of the A series – it’s only $340,000 per share! (A good friend of ours used to call us up at the office back in our Morgan Stanley days in the 1990s and would leave a message: “I just called to place an order for 100 shares.” That’s when the stock sold for $35,000 a share, so 100 shares was worth $3.5 million. He thought this was hilarious! Well, how about now? 100 shares is worth $34 million! HAHA.
What’s the point about all of this hilarity? Get a piece of this company. 10 shares. 100 shares. 1000 shares. Whatever you can afford. You’ll never regret it. Our Target of $230 is about to be breached. We hereby raise it to $255. Our Sell Price remains the same: We would not sell Berkshire Hathaway.
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Good Investing,
Todd Shaver, Founder and CEO
The Bull Market Report
Since 1998
