Hormel Foods Earns 44 Cents per Share
Posted by Eddy Elfenbein on May 24th, 2018 at 8:53 am

This morning, Hormel Foods (HRL) posted fiscal Q2 earnings of 44 cents per share. That was up 13% over last year’s Q2.

In last week’s CWS Market Review, I said Wall Street’s estimate of 45 cents per share might be a bit too high. I was right on that. I also said I didn’t see Hormel adjusting their full-year guidance. I was right on that as well. The company reaffirmed that full-year range of $1.81 to $1.95 per share.

Here are some details from the earnings report:

COMMENTARY

“Our team delivered record earnings per share of $0.44 which was in line with our expectation and keeps us on track to maintain our full year earnings guidance,” said Jim Snee, chairman of the board, president, and chief executive officer. “We were particularly pleased with the bottom-line performance from Refrigerated Foods as our experienced team grew our value-added profits while navigating through volatile markets. Our balanced business model helped mitigate higher freight costs and a difficult commodity environment.”

“We delivered record sales led by our Refrigerated Foods and International segments. Strong top-line growth from brands such as Hormel® Natural Choice® and Hormel® Bacon 1TM and international sales of products such as Skippy® peanut butter was complemented by the strategic acquisitions of Fontanini, Columbus Craft Meats, and Ceratti,” Snee said. “Our core center store portfolio of brands such as SPAM®, Dinty Moore®, and Herdez® also showed strong growth this quarter.”

SEGMENT HIGHLIGHTS – SECOND QUARTER

Refrigerated Foods

Volume up 6%; Organic volume1 down 1%
Net sales up 14%; Organic net sales1 flat to last year
Segment profit up 18%
Volume and sales increases benefited from the inclusion of the Columbus and Fontanini acquisitions in addition to strong retail sales of Hormel® Natural Choice® products and foodservice sales of Hormel® pepperoni and Hormel® Bacon 1TM fully cooked bacon. Organic volume decreased due to lower hog harvest volumes.

Refrigerated Foods delivered segment profit growth of 18% despite a 25% decline in commodity profits, a double-digit increase in per-unit freight expenses, and higher advertising expenses. Strong results were delivered by our branded retail and foodservice businesses in addition to the inclusion of the Fontanini and Columbus acquisitions.

Grocery Products

Volume down 2%
Net sales down 1%
Segment profit down 12%
Low-single-digit sales growth in our core Grocery Products portfolio, led by Wholly Guacamole® dips, the SPAM® family of products, Herdez® salsas, Dinty Moore® stew, and Hormel® chili, was more than offset by significant sales declines across the CytoSport portfolio and our contract manufacturing business. Total Grocery Products segment profit was down due to increased promotional activity and lower volumes at CytoSport and lower earnings from our contract manufacturing business.

Jennie-O Turkey Store

Volume down 3%
Net sales down 4%
Segment profit down 34%
Sales declines were primarily due to lower whole bird pricing and volume as a result of continued oversupply of turkeys in the industry and excess meat in cold storage. Sales declines of whole birds were partially offset by increased retail sales, led by Jennie-O® lean ground turkey and Jennie-O® Oven Ready® products. Segment profit decreased as a result of lower profits from whole bird and commodity sales, double-digit increases in per-unit freight costs, and increased advertising.

International & Other

Volume up 14%; Organic volume1 up 1%
Net sales up 22%; Organic net sales1 up 8%
Segment profit up 6%
International volume and sales increases were related to strong results in China, increased export sales, and the inclusion of the Ceratti business. Earnings increased on improved profitability in China due to lower raw material costs but were partially offset by higher advertising expenses and lower branded export margins.

SELECTED FINANCIAL DETAILS

Income Statement

Selling, general and administrative expenses increased due to the impact from acquisitions and higher advertising expense.
Advertising expenses were $37 million compared to $30 million last year. Full year advertising expenses are expected to increase by approximately 20% over last year.
Operating margin was 13.1% compared to 14.4% last year.
The effective tax rate was 20.0% compared to 33.2% last year due to the passage of The Tax Cuts and Jobs Act in December 2017. The full year effective tax rate is expected to be between 17.5% and 19.5%.

Cash Flow Statement

Capital expenditures in the second quarter were $87 million compared to $39 million last year. Full year capital expenditures are expected to total $425 million. Key projects include bacon capacity increases in our Wichita, Kans., facility, a new whole bird facility in Melrose, Minn., modernization of the Austin, Minn., plant, and projects designed to increase value-added capacity.
Depreciation and amortization expense in the second quarter was $41 million compared to $32 million last year. Full year expenses are expected to be approximately $160 million.
Share repurchases to date total $45 million, representing 1.3 million shares purchased.
The Company repaid $70 million in short-term debt in the quarter.
The Company paid its 359th consecutive quarterly dividend at the annual rate of $0.75 per share, a 10% increase over the prior year.

Balance Sheet

Working capital increased to $702 million from $625 million in the first quarter, primarily related to a higher inventories from acquisitions and lower accounts payable.
Cash on hand decreased to $262 million from $386 million for the first quarter as the Company continues to pay down short-term debt related to the Columbus Craft Meats acquisition.
Total debt is $810 million. The debt is split between short-term borrowings of $185 million and long-term borrowings of $625 million.
The Company remains in a strong financial position to fund other capital needs.

OUTLOOK

“We are reaffirming our sales and earnings outlook for fiscal 2018,” Snee said. “Our balanced business model allows us to manage through volatility and deliver consistent earnings growth. We continue to execute our value-added growth strategy in Refrigerated Foods and expect our retail and foodservice branded businesses to offset higher freight costs and lower pork commodity profits. Our expectation is for strong year-over-year earnings growth for International and for Grocery Products to return to its growth trajectory. While we are starting to see early signs of a recovery in the turkey industry, we expect Jennie-O Turkey Store to continue showing earnings declines for the remainder of this year.”

“We are making excellent progress on the integrations of our recent acquisitions. These efforts, in combination with continued execution of our strategic imperatives, will ensure we remain in a position to deliver strong growth in the future.”

Fiscal 2018 Outlook

Net Sales Guidance (in billions)
$9.70 – $10.10

Earnings per Share Guidance
$1.81 – $1.95

Morning News: May 24, 2018
Posted by Eddy Elfenbein on May 24th, 2018 at 7:48 am

Canada Blocks China-Led Deal for Construction Firm

China Signals to State Giants: ‘Buy American’ Oil and Grains

Fed Minutes Signal Rate Increase in June

U.S. Launches Criminal Probe into Bitcoin Price Manipulation

FCC Chair Ajit Pai Spanked by Lawmakers for Ducking Oversight Committee’s Questions

Deutsche Bank to Cut More Than 7,000 Jobs

Dutch Payment Giant Backed by Mark Zuckerberg and Used by Uber is Going Public

Tesla Trims Up to $14,000 off Model X in China After Tariff Cuts

Uber Finds Profits in Leaving Tough Overseas Markets

Ackman Targets Lowe’s After Q1 Miss

Kroger Buys Meal-Kit Company Home Chef in Latest Online Acquisition

Paddy Power to Buys FanDuel in Bid to Dominate Sports Betting

Lawrence Hamtil: 2018: A Tale of Two Sectors and the Opportunity for Contrarians

Roger Nusbaum: Retirement: It’s Simple Math, Do The Math

Cullen Roche: Do Bonds Still Diversify When Rates Rise?

Be sure to follow me on Twitter.

Fed Minutes from Early May
Posted by Eddy Elfenbein on May 23rd, 2018 at 2:03 pm

The Fed just released the minutes from their meeting of May 1-2. Here’s the section reviewing the financial situation.

Staff Review of the Financial Situation

Early in the intermeeting period, uncertainty over trade policy and negative news about the technology sector reportedly contributed to lower prices for risky assets, but these concerns subsequently seemed to recede amid stronger-than-expected corporate earnings reports. Equity prices declined, nominal Treasury yields increased modestly, and market-based measures of inflation compensation ticked up on net. Meanwhile, financing conditions for nonfinancial businesses and households largely remained supportive of spending.

FOMC communications over the intermeeting period were generally viewed by market participants as reflecting an upbeat outlook for economic growth and as consistent with a continued gradual removal of monetary policy accommodation. The FOMC’s decision to raise the target range for the federal funds rate 25 basis points at the March meeting was widely anticipated. Market reaction to the release of the March FOMC minutes later in the intermeeting period was minimal. The probability of an increase in the target range for the federal funds rate occurring at the May FOMC meeting, as implied by quotes on federal funds futures contracts, remained close to zero; the probability of an increase at the June FOMC meeting rose to about 90 percent by the end of the intermeeting period. Expected levels of the federal funds rate at the end of 2019 and 2020 implied by OIS rates rose modestly.

The nominal Treasury yield curve continued to flatten over the intermeeting period, with yields on 2-year and 10-year Treasury securities up 17 basis points and 7 basis points, respectively. Measures of inflation compensation derived from Treasury Inflation-Protected Securities increased 4 basis points and 7 basis points at the 5- and 5-to-10-year horizons, respectively, against a backdrop of rising oil prices. Option-implied measures of volatility of longer-term interest rates continued to decline over the intermeeting period after their marked increase earlier this year.

The S&P 500 index decreased over the period on net. Equity prices declined early in the intermeeting period, reportedly in response to trade tensions between the United States and China as well as negative news about the technology sector. However, equity prices subsequently retraced some of the earlier declines as concerns about trade policy seemed to ease and corporate earnings reports for the first quarter of 2018 generally came in stronger than expected. Option-implied volatility on the S&P 500 index at the one-month horizon–the VIX–declined but remained at elevated levels relative to 2017, ending the period at approximately 15 percent. On net, spreads of yields of investment-grade corporate bonds over comparable‑maturity Treasury securities widened a bit, while spreads for speculative‑grade corporate bonds were unchanged.

Conditions in short-term funding markets remained generally stable over the intermeeting period. Spreads on term money market instruments relative to comparable-maturity OIS rates were still larger than usual in some segments of the money market. Reflecting the FOMC’s policy action in March, yields on a broad set of money market instruments moved about 25 basis points higher. Bill yields also stayed high relative to OIS rates as cumulative Treasury bill supply remained elevated. Money market dynamics over quarter-end were muted relative to previous quarter-ends.

Foreign equity markets were mixed over the intermeeting period, with investors attuned to developments related to U.S. and Chinese trade policies and to news about the U.S. technology sector. Broad Japanese and European equity indexes outperformed their U.S. counterparts, ending the period somewhat higher. Market-based measures of policy expectations and longer‑term yields were little changed in the euro area and Japan but declined modestly in the United Kingdom on weaker-than-expected economic data. Longer-term yields in Canada moved up moderately amid notably higher oil prices. In EMEs, sovereign bond spreads edged up; capital continued to flow into EME mutual funds, although at a slower pace lately.

On net, the broad nominal dollar index appreciated moderately over the intermeeting period. In the early part of the period, the index depreciated slightly, as relatively positive news about the current round of NAFTA (North American Free Trade Agreement) negotiations led to appreciation of the Mexican peso and Canadian dollar, two currencies with large weights in the index. Later in the period, there was a broad‑based appreciation of the dollar against most currencies as U.S. yields increased relative to those in AFEs and as the Mexican peso declined amid uncertainty associated with the upcoming presidential elections.

Growth in banks’ commercial and industrial (C&I) loans strengthened in March and the first half of April following relatively weak growth in January and February. Respondents to the April Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) reported that their institutions had eased standards and terms on C&I loans in the first quarter, most often citing increased competition from other lenders as the reason for doing so. Gross issuance of corporate bonds and leveraged loans was strong in March, and equity issuance was robust. The credit quality of nonfinancial corporations was stable over the intermeeting period, and the ratio of aggregate debt to assets remained near multidecade highs.

Commercial real estate (CRE) financing conditions remained accommodative over the intermeeting period. CRE loan growth at banks strengthened in March but edged down in the first half of April. Spreads on commercial mortgage-backed securities (CMBS) were little changed over the intermeeting period and remained near their post-crisis lows. CMBS issuance continued to be strong in March but slowed somewhat in April. Respondents to the April SLOOS reported easing stan­dards on nonfarm nonresidential loans and tightening standards on multifamily loans, whereas standards on construction and land development loans were little changed in the first quarter. Meanwhile, respondents indicated weaker demand for loans across these three CRE loan categories.

Financing conditions in the residential mortgage market remained accommodative for most borrowers in March and April. For borrowers with low credit scores, conditions continued to ease, but credit remained relatively tight and the volume of mortgage loans extended to this group remained low. Banks responding to the April SLOOS reported weaker loan demand across most residential real estate (RRE) loan categories, while standards were reportedly about unchanged for most RRE loan types in the first quarter.

Consumer credit growth moderated in March and the first half of April. Respondents to the April SLOOS reported that standards and terms on auto and credit card loans tightened, and that demand for these loans weakened in the first quarter. On balance, credit remained readily available to prime-rated borrowers, but tight for subprime borrowers, over the intermeeting period.

The staff provided its latest report on potential risks to financial stability; the report again characterized the financial vulnerabilities of the U.S. financial system as moderate on balance. This overall assessment incorporated the staff’s judgment that vulnerabilities associated with asset valuation pressures, while having come down a little in recent months, nonetheless continued to be elevated. The staff judged vulnerabilities from financial-sector leverage and maturity and liquidity transformation to be low, vulnerabilities from household leverage as being in the low-to-moderate range, and vulnerabilities from leverage in the nonfinancial business sector as elevated. The staff also characterized overall vulnerabilities to foreign financial stability as moderate while highlighting specific issues in some foreign economies, including–depending on the country–elevated asset valuation pressures, high private or sovereign debt burdens, and political uncertainties.

Eddy here. Stocks are bumping up a little on the news. I think they’re interpreting this to mean the Fed is willing to let inflation run hot for a bit. I think this is the right call.

Morning News: May 23, 2018
Posted by Eddy Elfenbein on May 23rd, 2018 at 7:10 am

Trade and Growth Fears Spark Dash For Safe Havens

America’s Profit Boom Leaves Europe’s Corporations Trailing

How Bad Can Things Get for Italian Markets?

BOE Cuts Sterling Adrift

Fed Survey: Americans See Brighter Economic Prospects, but Fragility Remains

A Woman Has Been Named As NYSE President. It Only Took 226 Years

Here’s What Happens If The Oil Rally Turns Into An ‘Oil Shock’

StanChart Says Focus Is on Strategy, Denting Merger Speculation

Walmart Trades Short-Term Headwinds for Decades of Opportunity

Tesla Finally Sees Some Good News (And Other Things)

Banned From Amazon: The Shoppers Who Make Too Many Returns

10 Ways the Internet of Things Will Make Our Lives Better

Nick Maggiulli: Borrow…If You Dare

Ben Carlson: The Lump Sum vs. Dollar Cost Averaging Decision

Howard Lindzon: Are There Any Good Ideas Left?

Be sure to follow me on Twitter.

The Case for Two Airline Stocks
Posted by Eddy Elfenbein on May 22nd, 2018 at 3:50 pm

There won’t be a newsletter this week, but I wanted to pass along this piece by Tony Daltorio from my syndication partners at Investor’s Alley. Click here for subscription info.

Buy These 2 Big Data Stocks Warren Buffett Wouldn’t Have Touched a Year Ago
by Tony Daltorio

Among the many most promising technologies is something called deep learning. A simple definition of deep learning is the use of artificial intelligence (AI) to carry out a form of advanced pattern recognition or advanced analytics. Deep learning has become the hottest subsector within AI thanks to technological breakthroughs in both image and language recognition that is approaching human levels of comprehension.

The potential scale of deep learning’s impact on business was laid out last month in a report from McKinsey Global Institute called Notes from the AI Frontier: Insight from Hundreds of Use Cases. The study from McKinsey found that, for some industries, deep learning has the potential to create value equivalent to as much as 9% of a company’s revenues.

One of the most promising areas for the use of deep learning, according to McKinsey, is marketing and sales for consumer-facing industries. Examples would include customer service management, creating individualized offers, acquiring customers and honing prices and promotions. Frequent interactions with customers generate the huge amount of data needed to feed the AI systems. The winners will be the companies that can sweat the largest amount of data the hardest.

Airlines Go ‘Deep’

One consumer-facing industry that is turning to big data and deep learning to improve its profitability is the airline industry. Profit margins are already narrow because of the intense competition between the airlines and now rising fuel prices are adding even more pressure.

So the industry is seeking to personalize experiences for as many travelers as possible by using the vast amount of data the airlines have on their passengers. And think about it – the airlines do have a lot of data about you – name, address, phone numbers, birth date, credit cards, favorite seating assignment, how often you visited their website, etc. In fact, some researchers say that an average transatlantic flight generates about 1,000 gigabytes of data!

Two of the airlines moving down the technology path are American Airlines Group (Nasdaq: AAL) and United Continental Holdings (NYSE: UAL).

Earlier this year, American Airlines came out with an app that allows its flight attendants to offer passengers “a gesture of goodwill”, such as air miles, when there are any sort of minor problems (such as the flight entertainment system not working). That instant customer service is a lot better than having flight attendants telling passengers (that probably have a million other things to do) to contact a customer relations representative when the flight lands. As the airline said when it rolled out the app, “Our goal is to improve the customer experience, particularly when things don’t go as planned, to make it a little bit less painful for them.”

Poor United Airlines has had a number of customer relations nightmares, such as a passenger being dragged off a plane or a dog dying. So it definitely needs to step up its customer relations game. Its flight attendants have handheld devices that give them access to customer details, such as when they last flew with the airline, whether they have a tight connection and if they have dietary requirements. And like American, United offers customers a bag-tracking service to alert them if their luggage is lost or delayed.

And United employees’ “in the moment” app will allow United personnel to compensate passengers immediately for things like flight delays or spilled drinks. Hopefully, United employees will make use of this data and technology to make passengers’ flights as easy and comfortable as possible and repair the company’s image.

Even overseas-based airlines are going ‘all in’ on big data and deep learning. Ryanair Holdings PLC (OTC: RYAAY) wants to become the “Amazon for travel” by using its customers’ data to cross-sell items, such as hotel rooms, from a one-stop-shop platform.

I expect more airlines to follow the route Ryanair is taking. Think about it – shopping an online store, while still in flight, filled with everything from ground transport options to tours to other destination-related activities. Passengers returning home could even do their grocery shopping while in-flight to have the groceries delivered when they arrive home. The possibilities are almost endless.

A study conducted by the London School of Economics and Inmarsat said that in-flight broadband – offering streaming and online shopping to passengers could create a $130 billion global market within the next 20 years.

The study estimated that the airlines’ share of that total could amount to $30 billion in 2035. That’s quite a jump from the forecast $900 million in 2018 and is just what this profit-squeezed industry needs.

Warren Buffett said famously in 2002, “If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright. He would have saved his progeny money.” And indeed the industry has been a chronic money-loser.

But even Buffett bought stakes in the four major U.S. airlines in 2017 – American and United as well as Delta Air Lines (NYSE: DAL) and Southwest Airlines (NYSE: LUV). With airlines adopting technology and using deep learning, their profitability longer-term should become more stable. That makes them an interesting investment, good enough even for Buffett.

Click here for more details.

NYSE Gets First Female President
Posted by Eddy Elfenbein on May 22nd, 2018 at 9:34 am

From Reuters:

The New York Stock Exchange has appointed Chief Operating Officer Stacey Cunningham as its first female president, an NYSE spokeswoman told Reuters on Monday.

Cunningham, who will start her new role on Friday, will replace Thomas Farley as head of NYSE, which is owned by Intercontinental Exchange Inc, the Wall Street Journal reported

Cunningham became NYSE’s chief operating officer in June 2015 and managed the company’s cash equities markets, relationship management, product management, and NYSE governance services.

Cunningham will be the NYSE’s first female head in 226 years. She started as an intern in 1994.

Morning News: May 22, 2018
Posted by Eddy Elfenbein on May 22nd, 2018 at 7:10 am

Europe’s Italian Problem Is Bigger Than Brexit

U.S., China Agree on Outline to Settle ZTE Controversy

China Makes Massive Cut to Car Tariffs After Truce With Trump

Forget About Oil at $80. The Big Rally Is in Forward Prices

Sony to Buy Out EMI Music Publishing for About $2 Billion

GE to Merge Rail Division With Wabtec in $11 Billion Deal

IHS Markit Agrees to Buy Ipreo for $1.86 Billion

Adobe Buys Magento for $1.68 Billion to Target E-Commerce

Introducing the New Fortune 500 List

Consumer Reports: We Can’t Recommend Tesla’s Model 3

The Movement to Break Up Facebook Has Begun

U.K. Unlikely to Block Proposed Sky Takeover, Minister Says

Michael Batnick: On Second Thought…

Cullen Roche: Three Things I Think I Think – So. Much. Politics.

Joshua Brown: QOTD: How Politicians Use Economics

Be sure to follow me on Twitter.

GE Will Merge Rail Division with Wabtec
Posted by Eddy Elfenbein on May 21st, 2018 at 9:51 am

General Electric (GE) used to be the shining star of American business, but it’s fallen on hard times lately. The share price is about one-third of where it was 17 years ago even though the S&P 500 has more than doubled.

Check out a chart of GE versus the S&P 500 since the beginning of last year.

Under new CEO John Flannery, the company has been working hard to right its financial ship. This means they’re selling off assets. Today, GE announced a deal we long thought was coming: they’re selling their transportation business to our own Wabtec (WAB) for $11 billion.

This is a huge deal for WAB. Bear in mind that they have a market cap of roughly $9 billion. Here’s the WSJ:

GE will receive $2.9 billion in cash at closing. GE shareholders will own 40.2% of the combined company, with GE owning about 9.9% after the deal, the companies said Monday.

Wabtec shareholders will retain 49.9% of the combined company. Wabtec’s current chairman and CEO will retain their positions after the deal, which is expected to close in early 2019.

(…)

The transportation unit is one of the smaller of GE’s seven major business lines. The division had about 8,000 employees at the start of the year, down 2,000 from a year earlier, and compares with 313,000 at GE in total.

GE’s diesel locomotives are primarily assembled in Fort Worth, Texas, and western Pennsylvania.

In the first quarter, margins and orders rose at GE’s transportation business but executives said the market for new locomotives remained slow.

GE and Wabtec said they expect the combination to eventually generate about $250 million in annual savings as well as tax benefits currently worth about $1.1 billion. GE will nominate three directors to the combined company’s board.

Wabtec, which said it will keep its headquarters in Wilmerding, Pa., had revenue of $3.9 billion last year, or about the same as GE’s transportation division. Wabtec employs about 18,000 people, or twice as many as GE’s transportation division.

Rather than a straight sale, the deal was structured in a way that would leave GE shareholders with a stake in a public company and avoid a big tax bill. It gives GE shareholders a chance to participate in the turnaround of the struggling business or cash out if they wish.

It’s early, but shares of WAB are getting a nice 4% bounce this morning. GE is up about 2.5%.

Morning News: May 21, 2018
Posted by Eddy Elfenbein on May 21st, 2018 at 7:11 am

The Greek Master Plan for Growth Revolves Around Banks

Oil Rises as U.S. Says Trade War With China is ‘On Hold’

Dollar May Drop 5% as Deficits Return to Focus, Fund Says

Could Social Security Actually Run Out of Money?

GE Nears $20 Billion Transportation Unit Sale to Wabtec

This Elon Musk Quote Is Something Every Investor Needs to Hear

New iPhone Leak Exposes Apple’s Radical Design

Why Blankfein Should Not Stay On as Goldman Chairman

Campbell’s Strategy Comes Under Scrutiny After CEO Departure

Kinder Morgan: TMP Profits Are All That Matter

Coca-Cola’s New Soda Machine Lets You Mix Your Own Flavors Via Bluetooth

Charging Electric Scooters Is a Profitable, Fun—and Occasionally Dangerous—Youth Trend

Ben Carlson: Do Long-Term Investors Need Bonds?

Jeff Miller: Will Higher Interest Rates Lead to Lower Stock Prices?

Howard Lindzon: Sheep Logic and Short Selling

Be sure to follow me on Twitter.

CWS Market Review – May 18, 2018
Posted by Eddy Elfenbein on May 18th, 2018 at 7:08 am

“Don’t gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it.” – Will Rogers

I wish I could say the stock market has been interesting lately, but it hasn’t. The market’s been pretty dull, which doesn’t bother me. For a while, the Dow looked like it was getting exciting as it had an eight-day winning streak, but that came to an end on Tuesday. The market took a mild dip on Tuesday, and things haven’t moved much since then.

The bond market has been a little more interesting. The yield on the 10-year closed Thursday at 3.11%; that’s a seven-year high. This is all part of the larger trend that’s been going on for some time. Rates are going up all across the yield curve. In fact, the yield on the three-month Treasury bill recently crossed 1.9%, and it may soon hit 2%, which it hasn’t seen in a decade. The yield on the three-month is now higher than the yield on the S&P 500. The financial crisis happened 10 years ago, and things are still getting back to normal.

In this week’s CWS Market Review, I’ll describe some of the market’s recent action. Even though it appears boring on the outside, there are some interesting stirrings just beneath the surface. I’ll explain more in a bit. I’ll also preview two of our Buy List earnings reports coming next week. Ross Stores loves to play the game of telling us that earnings for the coming quarter will be blah. But then on earnings day, they give us good news. Before we get to that, let’s look at the market’s hidden bear.

The Hidden Bear Market

Around here, we’re not much for market-timing. If I could do it well, and consistently, then I’d be all for it. The problem I’ve found is that being a market timer forces your mind to be a bear-market predictor which is a bit different. It’s pretty simple, really. If you’re looking for signs of trouble, you’ll soon start seeing them everywhere (Korea! Tariff! The Fed!), and that’s not good for your portfolio.

We just came through a good earnings season. Across the board, we’ve seen good earnings reports plus optimistic forecasts for the coming year. At the same time, the stock market peaked in late January. After the initial tumble, the bears haven’t been able to move the dial much. Don’t be fooled: they’re not done trying.

But as stock prices are down from their highs, and earnings have improved, valuations are also lower. We assume that a bear market must be a sudden and ugly drop. But what if, instead of a big plunge, the market just rolled along for several months, maybe even more than a year, and all the while earnings improved? The flat P and higher E would depress P/E Ratios, and that’s the same net effect as a bear market. Happening in this way, it almost goes unnoticed.

Related to a shift toward lower valuations, we’ve seen a pronounced rotation on Wall Street. As I mentioned in last week’s issue, energy stocks have been performing much better. They continued to get even stronger this week. This is most likely tied to an improving economy and higher long-term yields.

The tech sector, which has been creaming the market almost nonstop for five straight years, is starting to look weak. I should note we’ve seen more than one head fake from Tech in the past year. But the prospects for tech are important because they tell us how much investors are willing to shoulder risk.

When the Dow was at 15,000, loading up on FAANG stocks wasn’t too scary. Nowadays, the market is more discerning, plus the indexes are heavily dependent on large-cap names. Here’s a good example: Before it got dinged on Thursday, Cisco accounted for 6% of the entire gain for the S&P 500 this year.

Meanwhile, the defensive sectors have gotten some relief. Consumer Staples have been getting lapped by the market for more than two years. In fact, you can spot some pretty general yields among blue-chip consumer stocks. Both Smucker and Hormel yield over 2%, and Church & Dwight isn’t far behind.

Some Healthcare names have been improving as well. For example, Stryker came very close to touching a new high this week. As a technical note, I think of Healthcare as a defensive sector, but it’s not as purely defensive as Utility stocks or Consumer Staples. Still, the improvement in these sectors, combined with the weakness in Tech, leads me to think that the market is becoming more conservative and less tolerant of risk. Tesla, for example, is more than 26% off its high.

A few names on the Buy List that look particularly good at the moment include Check Point Software (CHKP), Danaher (DHR) and Cognizant Technology Solutions (CTSH). Now let’s look at two “April Cycle” Buy List stocks due to report earnings next week.

Earnings Reports Next Week from Ross Stores and Hormel Foods

We have two Buy List earnings reports next week. Both Ross Stores and Hormel Foods are due to report on May 24. Hormel reports before the market opens. Ross’s report will come after the close.

In March, Ross Stores (ROST) released a very good fiscal-Q3 earnings report, but the shares dipped due to poor guidance. Or what was perceived by others as poor guidance. Let’s run through the numbers. For Q4, the deep-discounter earned 99 cents per share. That beat its own guidance of 88 to 92 cents per share. Sales for Q4 rose 16% to $4.1 billion. The key metric to watch is same-store sales which rose 5% versus a 4% gain last year. I was particularly impressed by Ross’s operating margins.

Ross also raised its dividend by 41% from 16 to 21.5 cents per share. Ross has raised its dividend every year since 1994. The company also added $200 million to its buyback program. The authorization is now up to $1.075 billion. This is the sixth year in a row that Ross has been on our Buy List, and it’s been a big winner for us.

Now let’s turn to guidance. Barbara Rentler, the CEO, said they’re taking a “prudent approach to forecasting.” Well, they often do that. Ross projects earnings this year to range between $3.86 and $4.03 per share. Ross also said it expects same-store sales growth of 1% to 2%. Sorry, but they’re low-balling us again.

For Q1, Ross projects earnings between $1.03 and $1.07 per share. That’s up from 82 cents per share last year. Ross expects same-store sales growth of 1% to 2% for the first quarter. Again, that’s too low.

There are a few key facts to remember. For one, Ross plans to open another 100 stores this year. The company is also raising its minimum wage to $11 per hour. TJX, their main rival, has not made that pledge. Higher wages can save money in the long run since you have lower turnover and a happier workforce.

Fortunately, the shares have made back a lot of what they lost after the Q4 earnings report in March. That’s one of the benefits of our long-term approach. We don’t dump a stock just because traders get nervous.

Hormel Foods (HRL) has been one of our disappointing stocks so far this year. I don’t think the blame lies with them. Most everything in the Consumer Staples group has been treated unkindly this year. Actually, Hormel has been behaving better in recent weeks.

Three months ago, Hormel Foods reported fiscal Q1 earnings of 56 cents per share. Of that, 12 cents was due to tax reform, so on a practical level, they made 44 cents per share in terms of continuing operations. That matched Wall Street’s consensus.

Hormel raised its FY 2018 guidance to a range of $1.81 to $1.95 per share. The previous range was $1.62 to $1.72 per share. The company also raised its starting wage from $13 to $14 per hour. In November, Hormel increased its dividend from 17 cents to 18.75 cents per share. That marked its 52nd annual dividend increase.

For Q2, Wall Street’s consensus is for 45 cents per share. That may be a bit too high, but I don’t see Hormel adjusting its full-year guidance.

Buy List Updates

Cerner (CERN) has been in the news lately due to a lot of headaches involving its new digital health program from the VA. Actually, this isn’t a new story, but the new development is a report that blasted the program. The story is also getting extra attention because the project has been supported by Jared Kushner.

The project’s price tag and political sensitivity — it was designed to address nagging problems with military and veteran health care at a cost of about $20 billion over the next decade — means it is “just another ‘too big to fail’ program,” the tester said. “The end result everyone is familiar with — years and years of delays and many billions spent trying to fix the mess.”

The unclassified findings could further delay a related VA contract with Cerner Corp., the digital health-records company that began installing the military’s system in February 2017. The VA last year chose Cerner as its vendor, with the belief that sharing the same system would facilitate the exchange of health records when troops left the service. The military program, called MHS Genesis, was approved in 2015 under President Barack Obama.

In a briefing with reporters late Friday, Pentagon officials said they had made many improvements to the pilot at four bases in the Pacific Northwest since the study team ended its review in November.

To be fair, the problems don’t appear to originate with Cerner but rather with an antiquated government system. Fixing this turns out to be a bigger issue than people expected. I want to make it clear that there’s no allegation of wrongdoing on Cerner’s part. Cerner is a buy up to $61 per share.

I also want to make adjustments to two of our Buy Below prices. Before I do that, let me remind you that our Buy Below prices are not price targets. I change them pretty frequently. The Buy Below prices are merely guidance for current entry into a stock.

I often get emails asking me if stock A, which is 15% below its Buy Below, is better than stock B, which is only 5% below its Buy Below. The answer is no. As long as a stock is below its Buy Below price, I like it. We try to keep things as simple as we can around here.

This week, I’m lifting our Buy Below on Stryker (SYK) to $176 per share. I’m also raising Wabtec (WAB) to $97 per share.

That’s all for now. There will be no newsletter next week. The stock market will be closed on Monday, May 28 for Memorial Day. Next week’s market will probably be fairly tame as we head into the three-day weekend. On Wednesday, the Fed will release the minutes from its last meeting. Then on Thursday, we’ll get a look at existing-home sales. On Friday, the durable-goods report comes out. 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

Syndication Partners

I’ve teamed up with Investors Alley to feature some of their content. I think they have really good stuff. Check it out!

Dividend Investors are Happier People and How You Can Be One of Them

This week I have been giving presentations to investors attending the Las Vegas MoneyShow. One of the great parts of what I do at the show is meeting subscribers to my newsletter. My first presentation was a joint discussion of dividend investment strategies with Kelley Wright. Further below I’ll share some of rights top stock picks based in his investment strategy.

Wright is the managing editor of Investment Quality Trends. The IQT service provides buy/hold/sell recommendations on a group of about 350 blue chip stocks. To be included in the database, a company must have paid dividends for at least 25 consecutive years with histories of dividend growth. The service rates stocks based on the current yield in relation to the historic yield range. For example, if a stock’s yield is near the low end of the range it is a sell candidate. When a stock gets to the high end of the range, it would be time to buy. Total returns are generated when the share price cycle upward from a low yield to a high yield.

The IQT method is not so much about high yield stocks as a method to buy stocks when they are undervalued. The stocks in Wright’s watch list will have their highest yields when they are out of favor with the investing public. This is very much of a value strategy, and the analysis will recommend buying out of favor share of long-term high-quality companies.

Here are four stocks from Wright’s presentation that his method separates out currently as good value buys. He used the term “ridiculous values” several times.

How To Generate Safe Income From High Yield Bonds

High yield bonds, often known as junk bonds, have been very popular investments since the financial crisis of 2008. The high yield market took a nosedive around the time of the crisis, but bounced back pretty quickly, and has been stable ever since.
As interest rates have started going higher, so too have the yields on high yield bonds. For the general high yield market, yields have gone from about 5% to 6% over roughly the last year. For reference, true junk (CCC rated bonds) has a much higher yield at around 10%.

On one hand, 6% is a solid yield in this day and age. For the most part, credit risk is not something you have to worry about all that much, even with so-called junk bonds. On the other hand, a lot of highly rated stuff got crushed in 2009, when almost no one had any concerns over credit risk.

Of course, high yield investors don’t have to worry about credit risk if they use ETFs instead of the bonds themselves. It’s also much easier (and more affordable) to use a high yield bond ETF instead of buying individual high yield bonds.

The most popular high yield ETF is iShares iBoxx High Yield Corporate Bond ETF (NYSE: HYG). It’s currently got a dividend yield of 5.1% and trades over 15 million shares a day on average. The options market is also very active, with over 130,000 options trading on an average daily basis.

Speaking of options, they are a great way to generate even more income on high yield bonds or high yield ETFs. In fact, I just came across an interesting trade this week which involved writing puts on HYG.