The market has been taking investors on an unnerving and wild ride lately as rising interest rates, questions about the pace of inflation, and a narrowing equity risk premium (ERP) have thrown the market into chaos.
There’s too much here for me to give an in-depth review. But I can throw up a few charts and touch on the high-level factors driving some of this volatility.
First, interest rates. As the chart below shows, the 10-year Treasury yield has soared from 2.4% to 2.85% in 2018. That was a quick move, and as you can see the yield doesn’t need to go much higher to break out to a five-year high. More importantly, big investors see a 10-year yield around this level as one potential indicator that the market is fully valued (based on the equity risk premium no longer suggesting a favorable reward vs. risk) and, therefore, stocks are becoming much more sensitive to fluctuations in interest rates.
Given the recent surge in rates, it’s entirely possible they could fall back a bit, but given what the Fed is saying, it seems that rates are likely to go up eventually, which will lead to a number of follow-on effects. The bottom line is that tightening credit conditions represents a change (for both consumers and businesses) from what we’ve been used to for a number of years.
We’ve also had a weakening dollar that has helped power earnings growth for some time. The dollar jumped over the last two weeks, and while that’s far from a major trend, the potential for dollar strength throughout the year could mean an earnings tailwind shifts into a headwind.
Stepping back from drivers of volatility to the charts, we’ve seen that the S&P Small Cap Index has now moved back to where it was in mid-November. It’s still above its 200-day line, but not by much.
On the one hand this has been a dramatic drop.
On the other hand, we’ve known investors have been getting increasingly complacent, and that the market has gone over a year without any real corrections. Even though Trump’s tax cuts stroked enthusiasm, the market wasn’t going to go up indefinitely. Is a retracement to where we were in November that bad?
So far, I think the answer is “no”.
Clearly some things out there have changed. And while revenue and earnings growth in 2018 is still likely to be quite strong, the fact that rates are rising (and likely to go up further, even if they drop in the near-term) means we’re stepping into a new investing environment compared to the past five years.
One positive is that stock valuations are much more attractive now then they have been for a while! Forward estimates largely factor in the benefit of tax cuts, and with the market decline the forward P/E ratio for the S&P 500 is back to 16.5, and for the S&P 600 Index we’re back to 17.8.
Let’s continue to take things on a day by day and stock by stock basis. For the most part our stocks have held up quite well through this stretch. And while I suspect we’re not out of the woods just yet, I also don’t want to dump positions that might easily have become untethered from reality because we’ve hit the first bump in the road in over a year.
Today we have one rating change as U.S. Concrete (USCR) is moved to hold. We also have an earnings update for Apptio (APTI), and an acquisition for LogMeIn (LOGM) to discuss. Next week we’ll get three more earnings updates, with Instructure (INST) kicking off the action on Monday, followed by Q2 (QTWO) on Wednesday and LogMeIn on Thursday.
Updates
AppFolio (APPF) is our property management software stock. Shares dipped a couple more points this week but, thus far, appear capable of holding above their 200-day line. The stock had already pulled back a good deal from its previous high and had spent a couple months consolidating just above 40. Giving up another dollar (the stock is at 39 now) isn’t a big concession in the grand scheme of things. I think the stock looks reasonably resilient heading into its next earnings report (date not yet announced) and, provided results are good, there’s plenty of upside potential to pull investors into the name. Revenue growth should be near 30% in 2018. Perhaps more importantly, gross margins are trending up (from around 58% in 2016 to around 63% in 2017 and, most likely, around 65% in 2018) as AppFolio flexes its profit-making muscles. Keeping at buy. BUY.
Apptio (APTI) has succumbed to the market selloff over the past two sessions, despite delivering a better-than-expected Q4 earlier in the week and announcing a significant acquisition. Keeping at buy. Details on the earnings report follow the chart.
Apptio delivered revenue of $52 million (up 18%) and subscription revenue of $43 million (up 21%). Gross margins were a record high of 73% (versus 69% last year), and 12-month net retention rates are at 102%, meaning more customers are joining then leaving. This was also Apptio’s best quarter ever in terms of upsells.
Forward guidance also came in above expectations. Revenue in 2018 is expected to be in the range of $220 to $225 million, versus consensus of $216 million, while adjusted EPS should be around break even, versus consensus of $-0.05. The acquisition of Digital Fuel (more on this in a minute) is responsible for much of the increased guidance, adding roughly $7 to $8 million to expected 2018 revenue.
The new software packages appear to be selling well, including IT Financial Management (ITFM foundation) and Cloud Cost Management (CCM), which launched in Q4. In management’s own words, “Our focus on simplified offerings is giving us more customer entry points, and the upsell motion is also working. These new LAN packages accelerated our Q4 local growth and enterprise momentum. We ended the year with approximately 440 customers with contribution across the strategic enterprise and public-sector segments. Partners continue to have a meaningful impact, influencing about 40% of our deals ... Our focus on product and pricing simplification along with the partner network should help Apptio penetrate thousands of new customers over time.”
Management also talked about its acquisition of Digital Fuel, which was announced on Monday. Digital Fuel is an LA-based provider of IT business management tools that was founded in 2006. In 2011, the company was acquired by VMware, then was sold to Skyview Capital in 2016. Apptio purchased it for $42.5 million, $38.2 million of which was paid in cash. Digital Fuel will be run as a separate entity and had revenue of around $10 million in 2017. With 11 months under Apptio ownership in 2018, it should add $7 to $8 million in revenue.
Digital Fuel still maintains deep relationships with VMware, which will help Apptio give customers valuable insights into their hybrid IT infrastructure. Apptio also says Digital Fuel will help it extend integrations with financial, service management, systems management, and public and private cloud vendors. Existing Digital Fuel customers (there are about 110 of them) also provide a cross sell opportunity for current Apptio products. The company was a competitor to Apptio in certain situations where Apptio’s Cost Transparency product was being considered, so this deal removes a competitive threat.
All in all this was a good quarter and was generally met with price target increases by analysts. The stock certainly isn’t immune to the market’s volatility, and with earnings out of the way there isn’t an immediate catalyst for investors to trade around. That means it could get swept up in the chaos, but I’ll keep at buy and advise averaging in on any weakness. BUY.
Earnings: DONE
Arena Pharmaceuticals (ARNA) is our newest position and only biotech stock. Currently, Arena is focused on developing first and/or best-in-class treatments for which it owns global commercial rights. Its three most advanced investigational clinical programs are; (1) ralinepag, for pulmonary arterial hypertension (PAH), (2) etrasimod for ulcerative colitis (UC), pyoderma gangrenosum (PG) and primary biliary cholangitis (PBC), and (3) APD371, for pain associate with Crohn’s disease. We’re awaiting etrasimod UC Phase 2 Data in late-February or early-March (should be a major event), and Q4 2017 results in the second week of March (these two events could be combined). There is a slim chance management could give a material update during one of two upcoming conferences; the Leerink Global Healthcare Conference next Thursday (February 15), and the RBC Capital Markets Global Healthcare Conference on February 21. The stock is handling the market’s volatility just fine (for now), so I’m keeping at buy. BUY.
Asure Software (ASUR) still hasn’t given us an earnings release date. But for the most part, the stock has held up well since its Q3 earnings beat back in November. With a number of new acquisitions since then there’s a good chance the company will beat expectations when it does announce Q4 results. The stock dipped below its 50-day line this week and is holding just above its 200-day line (and above the level where it gapped up after the Q3 earnings release. I’ll likely downgrade if it dips below 13. BUY.
AxoGen (AXGN) also cracked its 50-day line this week, despite being initiated with an Outperform rating at William Blair. With the company likely to grow revenue above 40% this year and next, and turn profitable at some point in 2019, it’s hard to imagine investors won’t look to pick up shares on this pullback. I’m not saying it can’t go lower, but for now, I’m keeping at buy. Management will present at the Leerink Global Healthcare Conference next Wednesday. BUY.
Earnings: February 28
BioTelemetry (BEAT) is trading right around both its 50 and 200-day lines, and about the level it was when 2018 began. We don’t have an earnings release date yet. This is one report I’m very interested to get since I’m hoping to get some insight into the financial aspects of the deals with Apple and Onduo, as well as an update on the integration of LifeWatch. The stock is at 31 now, and even though a dip below its moving average lines would be disappointing, I won’t get too concerned unless it sinks below 29. BUY.
Datawatch (DWCH) has given up some of the gains it enjoyed after rumors of acquisition interest surfaced a few weeks ago. Chatter on that front has subsided since the company acquired Angoss Software, a deal that we won’t know too much more about, until after the next quarterly result is released. But we did get another incrementally positive bit of news this week—Imagine Software has incorporated Datawatch’s Panopticon product into its dashboard of real-time portfolio, risk and compliance management solutions. Partnerships like this are one more way Datawatch is trying to move the growth needle, and given Panopticon’s strong position in the financial services industry I would think this partnership will bear fruit. Datawatch reported a decent fiscal Q1 2018 on January 25, but I’ve kept at hold until we see the stock start to form a more convincing uptrend. For now, continue to hold. HOLD.
Earnings: DONE
Everbridge (EVBG) has been one of our strongest performers but after having the stock at buy for some time I moved it to hold a couple of weeks ago. Since then it’s been trending down, but thus far remains above its 50-day moving average line. This is an exciting story since growth appears to be picking up and there’s plenty of market share left to grab. But let’s continue to be a little conservative after a nice run. HOLD.
Earnings: February 21
Instructure (INST) has held in there about as well as any stock during this market turbulence. Shares hit a 52-week high on Wednesday and pulled back a little yesterday. But given the strength here it’s hard to move to hold. The one caveat is that earnings are coming out on Monday and you never know how a stock will react. As I’ve said over the past couple of weeks, the market will be particularly interested in progress selling the new Corporate LMS solution, Bridge, an update on progress to fill the Chief Revenue Officer (CRO) seat, as well as trends in non-recurring professional services revenue and revenue from early implementations. Keeping at buy. BUY.
Earnings: February 12
LogMeIn (LOGM) has been another strong performer and even though it failed to break out to a 52-week high last week, the fact that the stock is above its 50-day line is a testament to the faith of shareholders. Last week’s news of a 20% bump in the dividend certainly didn’t hurt. And now we have news that LogMeIn has jumped into the small business VOIP market with the acquisition of Jive Communications. This isn’t a small deal—the purchase price was $342 million, and Jive has over 20,000 customers around the world. It is privately-held but from the investor conference call regarding the acquisition we have quite a bit of information to work with.
The acquisition makes a lot of sense to me after reading up on it. Jive participates in a $25 billion unified communications market, and its platform is all cloud based. Roughly 90% of its customers have 1,000 employees or less. LogMeIn currently has over two million customers. A lot of businesses are ditching their landlines and going with cloud-based internet phone systems. This seems like a good market for LogMeIn to expand into given its excellence in collaboration software, and right off the bat it has a ton of cross-selling opportunities (to be addressed after integration). LogMeIn doesn’t really have a VOIP offering, and will probably “integrate” the one phone solution it does have (Grasshopper) on to the Jive platform in due course.
Jive generated around $80 million in revenue in 2017 and grew by about 20%. That’s pretty fast as compared to publicly traded competitors RingCentral (RNG), 8X8 (EGHT) and Ooma (OOMA). It sounds like LogMeIn is buying Jive after a really good platform has been built, and before Jive has invested (and benefited) from a lot of investment in sales and marketing (which LogMeIn is very good at). It also sounds like it will be about break even in the first year as part of LogMeIn, which I’m assuming is based off achieving some synergistic savings and not just growth. That said, LogMeIn management was very clear to point out that the reason to do this deal isn’t to find efficiencies—it’s to accelerate growth through a bigger and more powerful organization.
We’ll be talking more about this in the future. And next week we’ll be talking about LogMeIn’s Q4 results, which are due out on Thursday. Since the Jive acquisition hasn’t closed, management won’t be factoring it into forward guidance. HOLD HALF.
Earnings: February 15
Materialise (MTLS) is back down near 12 where it was in the beginning of the year. The trend isn’t strong here, but I think the story is compelling and the risk/reward is in our favor, if you’re not too concerned with riding out some weakness. That said, if the stock dips much below 11.50 I’ll likely change my rating as that event would signal a breach of the support level that’s held since mid-2017. An earnings date of March 6 has just been announced which might help lift the stock out of this funk. Keeping at buy. BUY.
Earnings: March 6
Q2 Holdings (QTWO) is one of the few stocks out there that’s actually gone up over the past two weeks. Granted, it sold off in December, so it wasn’t a high flyer heading into the market’s craziness. But, its nice to see some relative strength here. We’ll get Q4 earnings on Wednesday, and I’m keeping at buy heading into the event. BUY.
Earnings: February 14
U.S. Concrete (USCR) cracked its 200-day line this week and the chart looks rough enough to move to hold. We’re still sitting on a decent gain of 18% but given that the stock wasn’t exactly racing higher before this rough patch it’s wise to hold off on any new purchases. We were at this same level during a brief selloff in November so it’s not like the stock’s fallen on its face. But I’d like to see a little more steadiness before moving back to buy. We don’t have an earnings date yet. HOLD.
