CWS Market Review – February 5, 2016

“There are two times in a man’s life when he shouldn’t speculate:
when he can afford to and when he can’t.” – Mark Twain

This is shaping up to be a very good earnings season for our Buy List stocks. We’ve had 12 earnings reports so far; eleven topped Wall Street’s consensus, while one merely met consensus. Guidance for 2016, however, is a mixed bag.

In this week’s CWS Market Review, I’ll cover our latest round of earnings reports. I’ll also preview our one earnings report coming next week. I’ll also talk about the wave of negative interest rates sweeping the world.

The world may be on the brink of a currency war where it’s a massive race to the bottom. This is a dangerous game with no winners. I’ll talk about what it means for our stocks. I’ll also update you on some news impacting our portfolio. But first, let’s look at the slowly emerging currency war.

Currency Wars, Begun They Have

Last week, the Bank of Japan shocked the financial world by cutting interest rates to -0.1%. In other words, savers have to pay for the trouble of lending their own money. The economy there is still a mess and the government has tried just about everything to get things moving again.

It’s a controversial policy. The Bank of Japan approved the new policy by a vote of five to four. Even retired slugger Jose Canseco criticized the idea. But the real fear of negative rates is that it could spark a currency war.

Let me explain. Governments know they can give a shot in the arm to their economies by letting their currencies fall. That helps their exports. The trick is that their currency must decline relative to their trading partners. If they respond by lowering their currencies, well…then the effect is lost. Worse still, it could trigger a cycle of competitive devaluations where everybody joins in. That’s a game nobody can win.

In Europe, for example, Mario Draghi has done just about everything to get the Eurozone moving again. He’s followed the Fed’s script—he’s lowered rates below 0%, he’s bought bonds. So what’s been the effect of all this? The euro’s actually been getting stronger. It’s not due to Draghi’s lack of effort. It’s that other countries have struck back.

Later on, I’ll cover our recent Buy List earnings reports, and you’ll notice a theme. Companies are reporting sales and earnings, and they’re also noting what sales and earnings would have been if the dollar weren’t so darn strong. (Funny, they never credit a weak dollar when it boosts their sales.) But it’s not that the dollar is strong. Rather, it’s that everybody else is doing their best to weaken their own currencies. The U.S. dollar right now is kind of like being the world’s fastest turtle.

The effect on financial markets is profound. For the last six years, Wall Street has expected the Fed to raise rates at any minute, and they’ve been wrong, wrong and wrong (see the chart below via Charlie Bilello). That is, until a few weeks ago when they were right and the Fed finally raised rates. But now, Wall Street has begun to realize that the Fed isn’t going to continue raising rates despite some bold talk from Janet and her friends at the central bank.

The futures market has given up on the idea of another rate hike this year. At best, they see another rate hike (maybe) in 2017. Some folks think the Fed’s next move may even be a cut. I don’t know about that but the issue is clear. The strong dollar has already done much of the Fed’s work for them. In fact, now that pressure is off the Fed, the dollar finally took a big hit this week. On Wednesday and Thursday, the greenback suffered its worst two-day drop in seven years.

You can really see the effect when we compare yields in the U.S. with yields in Europe. In the U.S., the two-year Treasury yields about 0.7%. But in Europe, oh dear lord! In France, their two-year yields -0.4%. In Germany, it’s -0.5%. And in Switzerland, the two-year yields -0.9%. Here’s my favorite stat: In July 2011, Ireland’s two-year was going for 23%. Today it’s -0.34%.

What does this mean for stocks? The weak dollar is good for cyclical stocks like Energy, Transports and Materials. Those areas have suffered so long and it’s far too early to say that the dollar is in a prolonged slide. Investors should continue to focus on high-quality stocks, especially ones that can prosper in any environment.

In a bit, I’ll tell you about Fiserv (FISV) which has increased its earnings by double digits for 30 straight years. Investors should also focus on rich dividends. For example, Ford Motor (F) is a strong company that currently yields 5.2%. That’s nearly three times the 10-year Treasury’s yield. Now let’s take a look at some of our earnings reports from this week.

Four Buy List Earnings Reports

On Monday, AFLAC (AFL) reported Q4 operating earnings of $1.56 per share. That was a very good report, and it beat Wall Street’s consensus by nine cents per share. The earnings report was also at the top of the company’s own range for Q4 of $1.36 to $1.56 per share. Remember that with insurance companies, it’s better to look at their operating earnings rather than net earnings.

In Q4, the weak yen cost the duck stock five cents per share. That’s bad, but it’s much less than the damage inflicted in previous quarters. For the year, AFLAC made $6.16 per share, which exactly matched what it made in 2014; the weak yen knocked 46 cents per share off their full-year earnings. In currency-neutral terms, AFLAC grew its operating EPS by 7.5% last year. That’s not bad. The original guidance was for 2% to 7%. In July, they raised it to 4% to 7%. Overall, AFLAC performed well in a difficult environment.

AFLAC is a top-notch firm, but it’s a tough business to be in when the yen is sinking and interest rates are microscopic. The company continues to gobble up large amounts of stock. For Q4, their share count was almost 5% lower than it was one year ago.

For 2016, AFLAC said it expects operating EPS to range between $6.17 and $6.41. That assumes a value for the yen of 120.99 to the dollar. AFLAC detailed the yen’s expected impact on its guidance. I’ll simplify it for you.

Basically, for every one yen the Japanese currency strengthens against the dollar, meaning the ratio goes down, three cents per share are added to AFLAC’s profits. For every one yen it weakens, meaning the ratio rises above 120.99, about 2.5 cents per share are taken away.

Please understand that I didn’t add AFLAC to our Buy List based on any outlook for the yen. That’s impossible to predict. I added AFLAC because it’s a well-run outfit, and it’s an easy prediction to say that it will continue to be well run. This week, I’m lowering my Buy Below AFLAC to $63 per share.

On Tuesday, Fiserv (FISV) reported Q4 earnings of $1.00 per share, which matched Wall Street’s estimate on the nose. Fiserv’s report was our first non-beat this earnings season. All nine previous reports, plus the two since then, beat Wall Street’s estimate.

Fiserv had already told us that Q4 earnings would range between 98 cents and $1.01 per share. When a company like Fiserv gives you a narrow range like that, you can be pretty sure it’s going to be accurate. The company was able to grow its EPS 12% over last year’s Q4.

For the entire year, Fiserv earned $3.87 per share. That’s up 15% from the $3.37 per share they made in 2014. Here’s an amazing stat: This was Fiserv’s 30th consecutive year of double-digit earnings growth. That’s truly remarkable. It’s not the most exciting stock, but Fiserv delivers the goods.

Now let’s look at guidance. For 2016, Fiserv expects internal-revenue growth of 5% to 6%, and they expect earnings to range between $4.32 and $4.44 per share. That represents a growth rate of 12% to 15%, so they should keep their double-digit streak alive. The stock has gained back much of its December slide, and it may strike a new high soon. For now, I’m keeping my Buy Below for Fiserv at $103 per share. This is simply one of the best companies out there.

On Thursday morning, Snap-on (SNA) reported Q4 earnings of $2.22 per share, which beat Wall Street’s consensus by four cents per share. That’s an increase of 12.7% over last year’s Q4. Revenue growth, however, was slight. Snap-on’s “organic sales” rose by just 3.1%. That probably reflects some of the manufacturing slowdown that hit the U.S. economy towards the end of last year.

Still, this was another solid year for Snap-on. Organic sales rose 7.1% for the year, and the company made $8.10 per share. That’s a 13.4% increase over 2014. Digging through the numbers shows that Snap-on’s Commercial and Industrial Group was the weak link; organic sales fell by 0.3% last quarter. But the Tools Group, which is Snap-on’s largest, saw organic sales rise by 8.7%.

Snap-on’s outlook for this year was vague. They expect a tax rate this year similar to what they saw in 2015. They also expect to have capital expenditures of $80 million to $90 million. I think Snap-on should be able to earn $9 per share this year, but I’ll have a better idea as the year progresses. The stock got dinged for a 5.2% loss on Thursday. I’m lowering my Buy Below on Snap-on to $158 per share.

After the closing bell on Thursday, Stericycle (SRCL) reported Q4 earnings of $1.11 per share. That beat Wall Street’s consensus by one penny per share. This was a good quarter for Stericycle. Quarterly revenues rose 31.2% to $888.3 million. Adjusting for currency, revenues were up 35.2%.

For the whole year, Stericycle earned $4.40 per share. Revenues rose 16.8% to $2.99 billion. Adjusted for currency, revenues were up 21.2%. The company has previously said it expects earnings for 2016 to range between $5.28 and $5.35 per share. I’m lowering my Buy Below on Stericycle to $125 per share.

Earnings Preview for Cognizant Technology Solutions

We only have one Buy List earnings report next week. Cognizant Technology Solutions (CTSH) is due to report Q4 earnings on Monday, February 8, before the opening bell. The IT outsourcer has been doing quite well. In fact, this company offers a good lesson in why I prefer to invest in high-quality stocks.

A year ago, Cognizant’s initial guidance for 2015 was for earnings of at least $2.91 per share. At the time, that news disappointed Wall Street, as analysts had been expecting $2.96 per share. But Cognizant stuck to its game. They consistently beat earnings and raised guidance throughout the year.

In May, Cognizant raised guidance to at least $2.93 per share. Then in August, they raised it to at least $3.00 per share. Finally, in November, Cognizant said they expect earnings of at least $3.03 per share.

So, a year ago, Wall Street thought it had been too optimistic on CTSH, when in reality, they hadn’t been optimistic enough. For Q4, Cognizant expects earnings of at least 77 cents per share. That sounds about right to me. Look for 2016 earnings guidance of around $3.45 per share.

Buy List Updates

I wanted to pass along a few updates on some of our Buy List stocks. In last week’s CWS Market Review, I mentioned the strong earnings report from CR Bard (BCR). This is a good company, and they finished up a solid year for 2015 by making $9.08 per share. I also wanted to mention their guidance for 2016. Bard said they expect 2016 earnings to range between $9.90 and $10.05 per share. That’s growth of 9% to 11%. My Buy Below was a bit too high for Bard, so this week I’m lowering it to $199 per share.

Shares of Ford Motor (F) fell again this week. The automaker said that January sales fell by 3%, but some of that was due to weather and strong sales a year ago. Ford also said it’s going to cut jobs in Europe. That region has been a difficult one for Ford. While Europe provides about one-fifth of Ford’s revenue, they had operating margins of just 1% last year. Ford said they’re going to concentrate on higher-priced models in Europe, which is a smart move. This week, shares of Ford came close to breaking below $11. On Wednesday, Ford closed at a three-year low. I still say to wait this one out. Ford remains a buy up to $13 per share.

In October, I wrote, “I think it’s possible they could do a major deal soon”—“they” being Stryker (SYK). I suppose I was on to something. This week, Stryker announced that it’s buying Sage Products for $2.775 billion.

According to Stryker, “The transaction includes an anticipated future tax benefit which is expected to exceed $500 million and to positively impact cash flows over approximately 15 years.” In other words, more money for them. Stryker raised its full-year EPS guidance by five cents at both ends. The new range is $5.55 to $5.75 per share. They said they hope the deal closes during Q2. Stryker remains a buy up to $101 per share.

Hormel Foods (HRL) will be splitting its stock 2-for-1 next Wednesday, February 10. Shareholders will then have twice as many shares as the share price is cut in half. Our Buy Below price will split along with the stock. That means that the post-split Buy Below price will be $41 per share. Earnings are due out on February 16.

Investor’s Business Daily had a good article on Ross Stores (ROST). They pointed out some key facts that many investors overlook. For example, Ross is one of the few retailers that’s relatively impervious to Amazon. I think some analysts don’t get that Ross has carved out a special niche in the deep-discount market. They’re really not in competition with many other retailers. Check out the whole article.

Wells Fargo (WFC) agreed to pay $1.2 billion to settle a government lawsuit about its FHA home-mortgage program. Wells said that will reduce its 2015 earnings by three cents to $4.12 per share. That’s not pleasant news, but the damage has been done and it’s a very small part of their business. Wells is a buy up to $52 per share.

That’s all for now. There are still more earnings reports next week. We’ll also get important economic reports on wholesale inventories (Tuesday), initial jobless claims (Thursday) and retail sales (Friday). Also, remember that Hormel Foods splits 2-for-1 on Wednesday. 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 February 5th, 2016 at 7:08 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.