Today’s news:
• Baker Hughes Company (BKR) reported fourth quarter results.
• Netflix (NFLX) joins the Special Situation & Movie Star Portfolio as a Strong Buy.
Baker Hughes Company (BKR – yield 3.2%) missed the quarter’s revenue and profit estimates. Adjusted net income was 27 cents vs. the 31 cent consensus estimate, largely due to higher tax rates and lower margins. Total revenue rose about 1% year-over-year to $6.35 billion vs. the expected $6.47 billion. Analysts were thrilled with free cash flow of $1.05 billion that beat estimates by almost 100%. “If cash is king, crown BKR in 4Q,” wrote analysts for Wolfe Research in a note.
The company’s Turbomachinery & Process Solutions (TPS) business experienced substantial order intake in 2019, and delivered a 19% profit increase vs. a year ago on productivity and cost gains. TPS revenue is forecasted to increase 20% this year, with expanding margins. Note that the TPS revenue growth projection is heavily weighted toward the second half of 2020 due to project timing. TPS growth should contribute to expected 2020 growth in free cash flow and profits.
The liquified natural gas (LNG) business has been weak on gas pricing, though positively affected by record U.S. LNG exports in October and November. The company forecasts LNG demand to grow at an annual rate of 4-5% over the next ten years.
Oilfield Services revenue was $1.04 billion, with lower-than-expected margins.
“As we look ahead to 2020, we see a macro environment that is slowly improving,” said CEO Lorenzo Simonelli. This year is expected to bring mid-single-digit revenue growth in the international oilfield service business, high-single-digit revenue growth in oilfield equipment and lower client spending in the North American drilling and completion business. The industry has been impacted by a slowdown in North American shale activity, but that’s a well-known situation that’s already been calculated into earnings expectations.
BKR is an undervalued, mid-cap aggressive growth stock. Analysts’ profit outlook for full-year 2020 remains one of strong EPS growth. Over the next two weeks, earnings estimates will continue to change as analysts rework their numbers, post-fourth quarter. The most current consensus estimate indicates 40% EPS growth in 2020, and the corresponding P/E is 19.0.
The stock traded on twice the normal volume yesterday, after the earnings report, and closed down five cents per share at 22.68.
Energy stocks are volatile. Oil prices rose substantially in December, then gave back much of those gains, as did BKR and most other stocks in the sector. Baker Hughes is expected to outperform peers on profit and free cash flow growth in 2020, partly because they run a less capital-intensive business. The stock has good price support at 22.5 and a very wide trading range. Traders, growth investors and dividend investors could benefit from buying at this low point in the trading range. Buy.
MOVIE STAR STOCKS
Let’s talk about a specific category of stocks that I like to buy after they fall from grace. These are famous stocks that don’t fall very often, but when they do, I like to snap them up because they’re almost always destined to rebound. And it just hit me: these are MOVIE STAR STOCKS. They have a glamorous aura. Investors love owning them and hearing about them in news reports.
MOVIE STAR STOCKS don’t often belong in a classic undervalued stock portfolio because they usually have high price/earnings ratios (P/E), or some other feature that doesn’t quite make the cut when doing fundamental analysis. So when I add one to our Special Situation Portfolio, I like to clearly state that there’s elevated risk in owning the stock.
One MOVIE STAR STOCK that I recently recommended on November 6 in our Special Situation Portfolio is Amazon.com (AMZN). As you can see on the price chart, the stock is rebounding nicely, as I had hoped. There have been other similarly popular stocks that I’ve recommended over the years after a disruption in their share prices, and they always returned to glory.
In the same vein, I’m adding Netflix (NFLX) to the newly renamed SPECIAL SITUATION & MOVIE STAR PORTFOLIO today. And what better stock to be christened with the MOVIE STAR STOCK name than a company that makes movies! Pure coincidence, but I’m very pleased with it.
Netflix is the world’s leading streaming entertainment service with over 167 million paid memberships in over 190 countries. Viewers can enjoy unlimited access to TV series, documentaries and feature films across a wide variety of genres and languages, all without commercial interruptions.
Netflix reported fourth quarter results this week. Adjusted fourth quarter earnings per share (EPS) of $1.30 blew away the $0.53 consensus estimate. Revenue was $5.5 billion vs. the $5.45 billion consensus estimate. The introduction to their long and informative quarterly shareholder letter, which includes financial results, reads as follows:
“We had a strong finish to 2019, with Q4 revenue growing 31% year over year, bringing full year 2019 revenue to over $20 billion, while FY19 operating income rose 62% to $2.6 billion. During the quarter, we surpassed 100 million paid memberships outside of the U.S. Streaming entertainment is a global phenomenon and we’re working hard to build on our early progress.”
The company is experiencing rapid international subscription growth and creating original foreign language content for international markets. Recent popular U.S. content includes the movie “The Irishman” and the series “The Witcher” and “The Crown”. U.S. subscriptions continue to climb, although understandably, growth is slower in the U.S. since the company has already heavily penetrated the streaming entertainment market here. Walt Disney Co. (DIS) and Apple (AAPL) have entered the streaming market as competitors to Netflix, but have not prevented Netflix from continuing to grow their U.S. subscriber base.
The company racked up 8.76 million new global subscribers in the fourth quarter, when analysts had been expecting 7.63 million. That’s incredible growth, which could easily have sent the stock soaring. We’re in luck, because the media chose to focus on the U.S. new subscriber number, which missed estimates by 240,000. The stock then dipped down to the bottom of its trading range. Perfect! I want to buy NFLX at that price!
To recap: U.S. subscriber numbers missed estimates by 240,000 while total new global subscribers exceeded estimates by 1.13 million. It’s a net win! How on earth do you turn those numbers into a negative headline? Well, I guess if you work for a U.S. media outlet, that’s your job. (Yes, I’m cynical about the media, but you already knew that.) And by the way, the company expects to add another 7 million new global subscribers in the first quarter of 2020.
In 2019, news stories focused on fears that Netflix’s rate increases and competition from Apple and Walt Disney Co. would harm Netflix’s subscriber growth. As it turns out, subscriber numbers, revenue and profits all continued to grow. Margins grew three percentage points in 2019 and are expected to do so again in 2020. Free cash flow, which has not been an attractive number on the Netflix balance sheet, improved during the quarter and is expected to continue improving.
Future earnings estimates are going to keep changing for many days hence. However, the first estimate revisions point to earnings per share rising 44% in both 2020 and 2021. The NFLX P/E is 55. That’s a big number for a value investor to embrace, for sure. But it’s not a big number if we look back on Netflix’s recent history. In September 2014, the P/E was 123. In September 2017, the P/E was 147. In October 2018, the P/E was 135. Therefore, Netflix gets to join this undervalued stock portfolio because it’s undervalued today in comparison to its trading history. That’s the exact same reason I opened the door for Amazon.com to join the portfolio in November.
The stock has been trading between about 322-340 for five weeks, amid an uptrend that began in September. There’s about 20% upside as NFLX retraces its high of about 380 from 2019, and if we’re especially lucky, NFLX could rise 29% toward its 2018 high of 420. Buy NFLX now while it’s sitting near the bottom of the current trading range. Strong Buy.