CWS Market Review – May 2, 2014

“How poor are they that have not patience!” – Othello Act II, Scene 2

What a busy week for us! First-quarter earnings reports are still coming in, the Federal Reserve announced another taper, plus we had several important economic reports like Q1 GDP and ISM. On top of that, news broke that AT&T is considering buying our favorite satellite-TV stock, DirecTV. I don’t know if any deal will come about, but shares of DTV jumped more than 4% yesterday to reach a new all-time high. I’ll have more on that in a bit.

Overall, earnings season is going well. Of course, going into earnings season, a lot of companies skillfully lowered expectations just enough to exceed them. So far, 352 of the 500 companies in the S&P 500 have reported results. Of those, 75% have beaten earnings expectations, while 52% have beaten sales expectations.

Before Thursday’s minor 0.01% drop in the S&P 500, the index rallied 10 times in 12 days. In fact, during the day on Thursday, the S&P 500 reached its highest level since April 4, which was the day the index hit its all-time intra-day high. At one point, we were less than 0.5% from reaching a new all-time high. On Wednesday, the Dow Jones 30 did close at an all-time high (thanks to $100+ stocks like Merck, Exxon, 3M and our own McDonald’s).

In this week’s CWS Market Review, I’ll break down the latest goings-on for you. I’ll also preview next week’s Buy List earnings reports from DirecTV and Cognizant Technology. But first, let’s look at some recent economic news.

Q1 Was Bad, but Q2 Should Be Better

By now, the evidence is clear that the economy was lousy in Q1 thanks to the bitter winter weather. On Wednesday, the Commerce Department reported that real GDP rose by a grand total of 0.1% for the first three months of 2014. That’s pretty bad. The economy needs to grow, in real terms, around 2.5% just to absorb new folks entering the workforce. One of the positives in the report was that personal-consumption expenditures rose by 3%. Also, the big drag caused by austerity at the state and local level seems to have ended.

We won’t know until the summer how well the economy did during Q2, but I suspect we’ll see some improvements. Some evidence for my optimism came on Thursday, when we learned that the ISM Manufacturing Index rose for the third-straight month. For April, the index climbed to 54.9. Any reading above 50 means that the manufacturing sector of the economy is expanding. The ISM dropped sharply in January, and we’ve made back most of what we lost.

I’m writing this report early on Friday, ahead of the big April jobs report, which I think could be a big one (be sure to check the blog for updates). Economists expect an increase of 215,000 jobs. Earlier this week, ADP, the payroll firm, said that 220,000 private-sector jobs were created last month. I should warn you that the ADP report doesn’t have a great track record of predicting the government’s numbers. The recent initial jobless claims reports have been encouraging, although this past week’s report dropped off some. Slowly but surely, the economy and jobs market are getting better.

It’s not just me saying that, but it’s the Federal Reserve as well. Here’s the opening sentence of the Fed’s latest policy statement: “Information received since the Federal Open Market Committee met in March indicates that growth in economic activity has picked up recently, after having slowed sharply during the winter, in part because of adverse weather conditions.” (Remember how the bears laughed at the weather excuse?)

The Fed announced it will again taper its bond purchases. Starting in May, the Fed will buy $25 billion worth of Treasuries and $20 billion worth of mortgage-backed securities. Janet and her pals on the FOMC said, “The Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.” At this rate, the Fed should be completely done with its Quantitative Easing by the end of the year. Interestingly, this week’s policy statement got a unanimous vote.

On Thursday, the Commerce Department reported that consumer spending rose by 0.9% in March. That’s the biggest increase in nearly five years. Those numbers probably reflect the pent-up demand created by the frigid weather. Economists were expecting an increase of 0.6%. The evidence continues to suggest a slow- to moderate-paced recovery.

Keeping in mind the issues surrounding Q1, let’s take a look at our recent earnings reports.

Ford Misses by Seven Cents per Share

I confidently predicted that Ford Motor (F) would easily beat its earnings estimates. Boy, was I wrong. The winter hit them harder than I expected. Last Friday, Ford said that it earned 24 cents per share for Q1, which was seven cents below Wall Street’s estimates.

On the plus side, revenues came in at $35.9 billion, which was $1.7 billion more than expectations. Ford’s core business is truck sales in North America, and that was fairly sluggish, but Ford is seeing better numbers overseas. Sales in Europe were up 11%, and sales in China jumped 45%.

I was pleased to hear the automaker stick by its full-year profit forecast of $7 billion to $8 billion. On Thursday, Ford said that sales in April fell by 1%, but their truck sales were up by 7%. The company also made official what everyone expected: COO Mark Fields will take over as CEO in July when Alan Mulally departs. We should give credit to Mulally. He did a great job at Ford. I’m keeping my Buy Below on Ford at $18 per share.

Moog Is a Buy up to $69 per Share

Moog (MOG-A) was our problem child last earnings season, so I was pleased to see better news this time. Last Friday, Moog reported earnings of 82 cents per share, which matched expectations. In January, the maker of flight-control systems beat earnings by a penny per share but lowered their full-year guidance to $3.65 per share (their fiscal year ends in September). The previous range was $3.95 to $4.10 per share.

The good news is that Moog still stands by its $3.65 target for this fiscal year. The CEO said, “This was a good-news quarter, with earnings coming in ahead of plan and healthy cash flow.” I like these results. I’m raising my Buy Below on Moog to $69 per share.

Four Buy List Earnings: AFL, EBAY, ESRX and FISV

On Tuesday, we had four Buy List earnings reports. Here are summaries of each one.

With AFLAC (AFL), it’s the same story that by now we know well. The supplemental-insurance company is doing very well businesswise, but the weak yen continues to gobble up their profits. For Q1, AFLAC had operating earnings of $1.69 per share, and that’s after the unfavorable exchange rate knocked off ten cents per share (which isn’t as bad as the results from some recent quarters). Excluding currency problems, operating earnings were up 5.9% from a year ago.

What I really wanted to see was AFLAC’s guidance. For Q2, AFLAC sees earnings ranging between $1.54 and $1.68 per share. That’s pretty good. Wall Street had been expecting $1.58. The downside is that AFLAC lowered their full-year guidance. The original range was $6.31 to $6.49 per share. Now it’s $6.06 to $6.40 per share. Those estimates are based on a yen/dollar exchange rate between 100 and 105. The stock got a nice boost when the earnings report came out. I’m keeping our Buy Below at $68 per share. AFLAC is going for about 10 times this year’s estimate. Keep in mind Iago’s words from this week’s epigraph.

Shares of eBay (EBAY) got hit hard this week, even though the online marketplace beat estimates. In last week’s CWS Market Review, I said that Wall Street’s consensus of 67 cents per share was almost certainly too low, and I was right. eBay reported Q1 adjusted earnings of 70 cents per share, which topped the Street by three cents per share. Officially, eBay lost $2.3 billion last quarter, going by net earnings, but that’s because they took a massive tax charge in order to repatriate $9 billion in foreign earnings. A lot of tech companies have been warehousing mountains of cash overseas because they don’t want to generate a fat tax bill, so it was a bit of a shock that eBay went through with it. Maybe others will follow.

For Q2, eBay sees earnings of 67 to 69 cents per share, which was a tad below the Street’s consensus of 70 cents per share. Importantly, eBay reiterated their full-year guidance of $2.95 to $3.00 per share. Wall Street’s consensus was at $2.99 per share. Sales for Q1 rose 14% to $4.26 billion. These numbers are pretty much what I expected, but I think traders wanted something to get excited about. Who knows, but the stock dropped 5% on Wednesday, and I really can’t see why. I’m lowering my Buy Below on eBay to $58 to reflect the downturn, but I think the stock continues to be a very good buy.

I found the earnings report at Express Scripts (ESRX) more troubling than the one at eBay. The pharmacy-benefit manager reported Q1 earnings of 99 cents per share, which was two cents below expectations. Express Scripts also lowered their full-year guidance by six cents per share at each end. The new range is $4.82 to $4.94 per share, but that still adds up to year-over-year growth of 17% to 20%. The company said it will lay off 1,890 workers nationwide. As if that weren’t enough, the company also said that it received subpoenas related to its relationships with drug makers. Traders did not like the bad news. ESRX got dinged for a 6.2% loss on Tuesday. I’m lowering my Buy Below to $71 per share.

Fiserv (FISV) may be the big star of this earnings season. For Q1, they made 82 cents per share, which easily beat Wall Street’s estimates of 74 cents per share. Earnings were up 22% from a year ago, while quarterly revenue rose 7.1% to $1.23 billion (which also beat expectations). Fiserv reaffirmed full-year guidance of $3.28 to $3.37 per share, which represents growth of 10% to 13%. The stock jumped after the earnings news and continued to rally to a new 52-week high. I like this stock a lot. I’m raising our Buy Below on Fiserv to $64 per share.

Earnings Next Week from DirecTV and Cognizant

We have two Buy List earnings reports for next week. On Tuesday, May 6, DirecTV will report Q1 earnings. Then on Wednesday, May 7, Cognizant Technology Solutions is due to report.

Three months ago, DirecTV (DTV) smashed Wall Street’s earnings forecast by 23 cents per share. The satellite-TV firm has been doing a great business lately, especially in Latin America. I also like that DirecTV uses its share buybacks to reduce share count. Too many companies merely buy back the same amount they’ve issued to senior execs.

But the big news for DirecTV came on Thursday, when the Wall Street Journal reported that AT&T has been talking to them about a possible acquisition. This makes sense as a response to the Comcast/Time Warner Cable deal. DirecTV has a market cap of $41 billion. There aren’t many companies big enough to buy them, but AT&T is one. I can’t predict if a deal will happen, but I’ll note that it makes a lot of sense.

On Thursday, shares of DTV jumped more than 4% to close at $80.76 per share. Analysts currently expect earnings of $1.50 per share for Q1. For now, I’m keeping my Buy Below price at $84 per share.

Shares of Cognizant Technology Solutions (CTSH) have been pretty quiet lately, but I think that could change soon. Three months ago, Cognizant told us to expect Q1 earnings of 59 cents per share on revenue of $2.42 billion. Bear in mind that Cognizant earned 47 cents per share for last year’s Q1, so we’re talking about pretty strong growth.

For all of 2014, Cognizant sees earnings of at least $2.51 per share and revenues of at least $10.3 billion. To add some context, CTSH earned $2.02 per share last year and $1.72 per share in 2012. Cognizant remains a good buy up to $52 per share.

That’s all for now. More earnings reports are coming our way next week. We’ll also get reports on trade, consumer credit and productivity. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

Posted by Eddy Elfenbein on May 2nd, 2014 at 8:10 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.