“IMO 2020” IS NOT THE ONLY INDUSTRYWIDE UPROAR COMING IN JANUARY: SAY HELLO TO “CECL”
I previously gave you a heads up that new low-sulfur diesel regulations (IMO 2020) and a serious hog disease in China (African Swine Fever) are quite likely to increase inflation numbers in 2020 and beyond. Are you ready for the next sweeping industrywide change that will be hitting the credit markets?
A new accounting standard called Current Expected Credit Loss (CECL) will impact businesses that loan money, beginning in January 2020. The rule requires such businesses -- including banks, credit card companies that pair with department stores to loan money, and financing companies – to set aside reserves to cover projected loan losses right up front, at the time the loan is made. The riskier the loan, the bigger the increase in reserves that will need to be set aside. This new accounting rule will especially impact lenders’ profit margins during periods of economic recession. In addition to CECL’s less-than-rosy effect on financial company and department store balance sheets and profits, businesses and consumers will probably experience more difficulty in acquiring credit.
Here’s my suggestion on how to adjust your stock portfolio in light of CECL. As a rule of thumb, investors should own shares of banks and retailers that are projected to achieve profit growth, because those companies can probably best withstand the impact of CECL. Analysts who are late to the game will factor CECL into their earnings estimates in January, and all of Wall Street will frequently adjust earnings estimates during the first half of 2020 as banks’ and retailers’ quarterly reports give more clarity on CECL’s cost to their bottom lines. Inevitably, investors will be disappointed with some of these companies’ new numbers, and they will sell stocks, thus driving prices down. Therefore, it’s probably not wise to own shares of retailers that are frequently cited as having declining annual profits, such as Macy’s (M); nor shares of credit card companies that almost exclusively partner with retailers, including Synchrony Financial (SYF). Stick with the most profitable retail and bank stocks, monitor their earnings estimates each month during the first half of 2020, and pare back any affected stocks that have earnings growth estimates falling to the low single digits or beyond.
By the way, nowhere in my research did I see Visa (V) or MasterCard (MA) mentioned as potentially having trouble with CECL, but it still pays to be cautious.
The last CECL detail I want to mention is an eye-popping statistic about Macy’s (M). You might think of Macy’s as a department store with a credit card side business. But Macy’s is apparently more of a credit card company with a department store side business, because they glean over 60% of their EBIT profit from their customers’ credit card interest payments! Therefore, their net profit will be affected more than you might assume from CECL.
Last week, Citigroup reported a November credit card charge-off rate of 2.57%, down from 2.61% in October. I am thus far not seeing charge-off rates rise within the financial industry, indicating that the economy remains strong and consumers are not experiencing increased trouble paying their bills. I mention this because the media just spent almost two years telling the public that a recession is imminent. News flash: there cannot be a recession lurking around the corner when GDP reflects attractive economic growth, consumers continue to pay their bills on time and unemployment rates remain historically low. Therefore, either popular media pundits were incapable of deciphering the most basic of economic numbers and trends, or they were lying to you on purpose. Take your pick. If the entire point of obtaining a college degree was so that a person could sit in front of a camera and read incorrect news stories, then I question their career choice and intellectual capacity. Clearly, I was disgusted with their false “recession” mantra – and told you so repeatedly -- because it unnecessarily scared people and literally shaped decisions made by families and companies.
Please send questions and comments to Crista@CabotWealth.com.
PORTFOLIO NOTES
Be sure to review the Bulletins from December 18 and 19 in which I mentioned news, rating changes and/or price action on Baker Hughes (BKR), Broadcom (AVGO), Citigroup (C), Guess? (GES), Tyson Foods (TSN) and Voya Financial (VOYA).
TODAY’S PORTFOLIO CHANGES
(no changes)
LAST WEEK’S PORTFOLIO CHANGES
Bristol-Myers Squibb (BMY) moved from Hold to Retired.
Broadcom (AVGO) joined the Growth & Income Portfolio as a Strong Buy.
CF Industries (CF) moved from Strong Buy to Sell.
Designer Brands (DBI) moved from Strong Buy to Hold.
BEST STOCKS TO BUY TODAY
*A good choice today for investors looking for growth (G), growth & income (DIV) or trading (T).
Updates on Growth Portfolio Stocks
Quanta Services (PWR – yield 0.5%) is a leading specialty infrastructure solutions provider serving the utility, energy and communication industries. Their infrastructure projects have meaningful exposure to highly predictable, largely non-discretionary spending across multiple end-markets, including 65% of revenue coming from regulated utility customers. The company is working on a multi-year goal of increasing margins. Management is conservative when giving revenue and profit guidance to Wall Street, resulting in outperformance of quarterly consensus estimates about 80% of the time. Quanta Services was featured in the December monthly issue of Cabot Undervalued Stocks Advisor.
PWR is a mid-cap growth stock. Wall Street expects EPS to grow 15.3% and 19.8% in 2019 and 2020, while the 2020 P/E is just 10.6. This month, Quanta announced a 25% quarterly dividend increase to five cents per share. PWR traded twice its normal volume on December 20 after investment firm D.A. Davidson upgraded the stock from neutral to buy with a price target of 50. In the prior week, Citigroup named Quanta Services as one of their “top picks”. PWR rose to an annual high near 44 in November, pulled back 10%, and is now heading upwards again. Buy PWR now. Strong Buy.
Voya Financial (VOYA – yield 1.0%) is a U.S. retirement, investment and insurance company serving 14.3 million individuals and institutional customers. Voya has $568 billion in total assets under management and administration. The company is successfully increasing revenue and profits via organic growth, cost savings and share repurchases. Please refer to the Special Bulletin from December 19 in which I discussed Voya’s agreement to sell their in-force individual life insurance business. As a result of the M&A news, four investment firms raised their price targets on VOYA to a range of 65-72.
VOYA is an undervalued, mid-cap aggressive growth stock. Wall Street expects EPS to grow 20.5% per year in both 2019 and 2020. The P/E is 10.4. VOYA began a run-up to new all-time highs last week. I expect continued upside. Strong Buy.
Updates on Growth & Income Portfolio Stocks
Blackstone Group Inc. (BX – yield 3.4%*) is the world’s largest and most diversified alternative asset manager with $545.5 billion in client assets. The company deploys capital into private equity, lower-rated credit instruments, public debt and equity, real assets, secondary funds and real estate. Consensus earnings estimates point to 35.4% EPS growth in 2020, and the 2020 P/E is 18.2. Despite this year’s 92% run-up, BX continues to reach new all-time highs, and the price chart remains bullish. BX is a great quality stock with a good dividend yield, but I’m concerned that enough institutional investors will take profits in January that it could cause up to a 20% pullback in the share price. If that would bother you, use a stop-loss order. I will likely return BX to a Buy recommendation after a pullback. Hold.
*The payout varies each quarter with the total of the last four announced payouts equaling $1.92 and yielding 3.4%.
Broadcom (AVGO – yield 4.1%) is a global technology leader that designs, develops and supplies semiconductor and infrastructure software solutions that serve the world’s most successful companies. Last week, I itemized the company’s lengthy five-year history of M&A activity. Then news emerged that the company might sell their radio frequency semiconductor business for about $10 billion. My assumption is that management has identified more productive and profitable ways to deploy that capital, including pursuing an additional acquisition and debt repayment. Broadcom was featured in the December 17 update of Cabot Undervalued Stocks Advisor.
Analysts are expecting $23.11 and $25.48 EPS in 2020 and 2021, representing 8.5% and 10.3% EPS growth. The P/E is 13.8. Broadcom raised the stock’s quarterly dividend by 22.6% this month, now reflecting a quarterly payout of $3.25 per quarter and a 4.1% current yield. AVGO began a new run-up past 315 to new all-time highs this month. AVGO is a good choice for technology investors, dividend-growth investors, and large-cap growth investors. Buy AVGO now. Strong Buy.
Citigroup (C – yield 2.6%) is a global financial company that serves consumers, businesses, governments and institutions in 98 countries, and the third-largest U.S. bank by assets. Last week, Citigroup reported a November credit card charge-off rate of 2.57%, down from 2.61% in October, indicating an uptick in consumers’ abilities to pay their bills on time in this thriving economy.
The new CECL rules, which I outlined in today’s introduction, will bring modest downward revisions to consensus earnings estimates to all affected companies in the coming weeks, because many analysts did not have this huge, impactful situation previously calculated into their estimates. Also, be prepared for several months of scary news headlines from the financial media. My investment focus will remain on financial companies and retailers that are expected to deliver better profit growth than their peers. In that light, Citigroup remains my favorite large-cap bank stock.
Wall Street expects EPS to grow 15.9% and 9.2% in 2019 and 2020. The 2020 P/E is 9.3. Of note, Oppenheimer raised their price target on Citigroup stock to 119 last week, representing a 51% potential share price increase. Citigroup shares just climbed above their most recent peak of 77 dating back to January 2018. The stock hasn’t traded above 80 since 2008, so we are now witnessing a modern version of C approaching a new all-time high. Buy C now. Buy.
Guess?, Inc. (GES – yield 2.1%) is a global apparel manufacturer, selling their products through wholesale, retail, ecommerce and licensing agreements. There are 1,724 Guess stores worldwide, in approximately 100 countries. GES is a greatly undervalued, aggressive growth, small-cap stock. Consensus earnings estimates for fiscal 2021 (January 2021 year end) rose last week. Profits grew 40% last year, and are now expected to grow 39% and 23.5% this year and next year. The fiscal 2021 P/E is 13.1. GES held its gains last week after surging on bullish comments from a Cowen & Co. analyst; shares are now sitting at price resistance at 22. The high point on the share price during the last two years was 24 in April 2018. I would expect any pullback to be a brief buying opportunity. Strong Buy.
Total S.A. (TOT – yield 5.5%) is a French multinational integrated energy company that produces and markets fuels, natural gas and low-carbon electricity, operating in over 130 countries. TOT is an undervalued, large-cap growth & income stock with a large dividend yield. Wall Street expects Total’s EPS to fall 7.3% in 2019, then to increase 18.6% in 2020. The 2020 P/E is 9.8. The stock is rising along with oil prices and shares of energy industry peers. Investors who buy now will lock in the 5.5% dividend yield, and likely benefit from additional capital gains. Strong Buy.
Updates on Buy Low Opportunities Portfolio Stocks
Designer Brands Inc. (DBI – yield 6.3%) is one of North America’s largest designers, producers and retailers of footwear and accessories. The company operates DSW Warehouse, The Shoe Company and Shoe Warehouse stores with nearly 1,000 locations in 44 U.S. states and Canada; and Camuto Group. Earnings estimates for Designer Brands continue to change. At this time, consensus estimates assume no earnings growth in 2019 (January 2020 year end) and 18.4% EPS growth in 2020. The fiscal 2020 P/E is low at 8.8. DBI is an undervalued, small-cap stock. I will keep a Hold recommendation on the stock until the earnings estimates and share price stabilize. If you’re tempted to buy in order to lock in the dividend yield, do it. I still love the company and its outlook. Hold.
Mercury General Group (MCY – yield 5.2%) operates as Mercury Insurance, the leading independent agency writer of automobile and home insurance in California. Mercury also writes automobile, home and/or other lines of insurance, including business and mechanical breakdown insurance, in ten additional U.S. states.
Analysts are expecting EPS to grow 44.4% in 2019 and 22.7% in 2020. The 2020 P/E is 15.2. The stock has begun its rebound from the October price drop. (Odds are that recent selling pressure will disappear in January.) Growth investors and income-oriented investors can buy MCY now, lock in the large 5.2% current dividend yield, and expect a 9-15% capital gain as the stock retraces October trading levels of 53-56. Buy.
The Mosaic Company (MOS – yield 0.9%) is the world’s largest producer of finished phosphate and potash, supplying crop nutrients and animal feed ingredients via production facilities in the U.S., Canada, South America and the Asia-Pacific region. Profits are expected to fall to $0.56 per share in 2019 and then to rise 159% to $1.45 in 2020. The 2020 P/E is 15.0. MOS is rapidly rising toward price resistance at 23. Now that the price chart is improving, I will likely move MOS to a Buy recommendation on the first pullback. Hold.
Updates on Special Situation Stocks
Amazon.com (AMZN) – This multi-faceted online retailer is continually expanding its array of business ventures and partnerships. A recent foray into package delivery has turned Amazon Logistics into a powerful force, permanently altering and currently dominating its industry landscape. Reuters reported, “Amazon.com Inc said on Thursday it was on track to deliver 3.5 billion customer packages globally this year through its in-house delivery network. A Morgan Stanley analysis from last week estimated that Amazon logistics delivered about 20% of the company’s packages last year and nearly 46% in 2019 through August. The brokerage estimated the Amazon delivery network will move 6.5 billion packages for the company by 2022, more than UPS at 5 billion and FedEx at 3.4 billion.” Could Amazon spin off its logistics business to shareholders one day? Stay tuned.
Amazon’s slow profit growth of 2.6% 2019 is expected to be followed by 31.1% EPS growth in 2020, which will likely ignite the share price. Always remember that AMZN has a high P/E – currently 65.9 – so it’s riskier than the stocks that I normally recommend. On the bright side, the P/E ranged between 100-300 in 2014 through 2018, so a double-digit P/E actually reflects an historical bargain for the stock. AMZN continues to slowly ratchet upward from its October lows. Once AMZN passes 1850, it could sprint back to 2025. Growth stock bargain hunters should buy AMZN now. Strong Buy.
AXA Equitable Holdings (EQH* – yield 2.4%) has two principal franchises: AXA Equitable Life Insurance Co. and a majority stake in AllianceBernstein Holdings L.P. (AB), an investment management firm. The company has $701 billion in assets under management. AXA Equitable Holdings has agreed to sell U.S. Financial Life Insurance Company and MONY Life Insurance Company of the Americas, Ltd. to Heritage Life Insurance Company. The transaction is expected to close in early 2020. “This transaction simplifies our balance sheet and is aligned with our strategy to improve the return on capital of our Protection Solutions segment,” said Anders Malmstrom, Chief Financial Officer of AXA Equitable Holdings.
AXA Equitable lacks strong 2020 EPS growth expectations; however, I love the bullish price chart, very low P/E, and dividend yield. I’m probably going to keep the stock in the portfolio for the current run-up, and then move on. EQH began reaching new all-time highs in November, settled into a trading range of 23.5-25 in December, and now appears entirely capable of rising from there. EQH is a good choice for momentum investors and dividend investors. Strong Buy.
* Please note that AXA Equitable (EQH) is a different company from the French AXA S.A. (AXAHY or AXAHF). Don’t make the mistake of trading shares of AXA S.A. when aiming to trade AXA Equitable.
