Thirteen Cabot Benjamin Graham Value Investor companies reported quarterly financial results or other noteworthy news. Included in my summaries are three new sell recommendations: BJ’s Restaurants (BJRI), W.W. Grainger (GWW) and iShares Minimum Volatility USA ETF (USMV).
I also include questions from subscribers along with my answers. Prices appearing after each stock symbol are the closing prices on Thursday, October 20, 2016. Reports are for the quarter ended September 30, 2016 unless otherwise stated. Sales and earnings increases and decreases are based on year-ago comparisons.
My schedule for the next five weeks will be:
* Thursday, October 27, Cabot Wealth Advisory
* Friday, October 28, Weekly Update
* Tuesday, November 1, Wall Street’s Best Daily
* Thursday, November 3, Cabot Value Model issue 268V
* Friday, November 4, Weekly Update
* Thursday, November 10, Cabot Enterprising Model issue 268E
* Friday, November 11, Weekly Update
* Friday, November 18, Weekly Update
Company Reports
Alliance Data Systems (ADS 204.77) reported exceptional results and initiated the first dividend in its history. Sales surged 19% and EPS jumped 20% after increasing 17% and 11% in the prior quarter. The company’s board of directors declared an initial quarterly dividend of $0.52, which provides a 1.0% yield. Management raised its fourth-quarter estimates for sales and earnings, and forecast 10% growth for sales and earnings in 2017. Buy at 212.25 or below.
Alphabet (GOOG 796.97), parent of Google, reached an agreement with CBS for its planned Web TV service. The new service will probably start in early 2017. Also, Google’s new Pixel smartphone goes on sale this week at prices starting at $649. Orders for the phone are well ahead of expectations due to extraordinary features and because disappointed buyers of Samsung’s Note 7 are expected to abandon Samsung and buy Pixels. Pixel uses the Android operating system, the same system used in Samsung phones. GOOG will report third-quarter financial results on October 27. Buy at 759.96 or below.
BJ’s Restaurants (BJRI 34.45) shares fell after the company reported disappointing results. Sales climbed 2% but EPS plunged 38% after increasing 8% and 19% in the previous quarter. Same-store sales declined a hefty 3.4% compared to the prior quarter’s decrease of 0.2%. The restaurant industry is hampered by a glut of restaurants and lower demand from consumers who are eating out less often.
BJ’s opened five new restaurants in the third quarter but will open fewer restaurants than originally planned for 2017. Recent restaurant bankruptcies, including seven chains, will begin to reduce the current oversupply of restaurants in the U.S. To further combat industry weakness, BJ’s is introducing new menu items to draw more customers. However, the supply/demand imbalance in the restaurant industry could continue during the next 12 months or longer, so I am changing my opinion to Sell from Hold. Sell.
Celanese (CE 70.90) shares surged even though sales and earnings results were mixed. Sales declined 6% and EPS advanced 12% after sales declined 9% and EPS gained 1% in the prior quarter. Management anticipates good results for the current quarter. Celanese raised its prices on several products, which is a good sign that demand is strengthening. Hold.
Eaton Vance (EV 37.29) hiked its quarterly dividend to $0.28 from $0.265. The resulting dividend yield is 3.0%. Eaton will report results on November 24. Hold.
Grainger, W.W. (GWW 205.46) reported lackluster results. Sales advanced 1% and EPS declined 1% after sales rose 2% and EPS dropped 15% in the previous quarter. Sales in the U.S. dipped 1% while sales in Canada declined a hefty 16%, hurt by a 22% decline in fire-ravaged Alberta. Sales in Grainger’s other areas of operation, including Asia, Europe and Latin America, soared 36% from year-ago levels. Management lowered its sales and earnings forecast slightly for the current quarter. Grainger is suffering from weak economic growth in the U.S. and around the world, which will continue in 2017. Therefore, I recommend selling your GWW shares now. Sell.
iShares Minimum Volatility USA ETF (USMV 44.35) underperformed the stock market indexes during the third quarter. While the S&P 500 Index advanced 3.3%, USMV declined 1.7% during the three months ended September 30. USMV’s impressive 10% advance in the first half of 2016 has given way to weakness, which could extend into 2017. The problem is clear: fearful investors have gobbled up low volatility stocks and sent their shares to extraordinary heights. The current P/E for USMV stocks is 24.0 compared to an average of about 15.0 for the past 10 years. Low volatility stocks are one of the most overpriced sectors in the stock market. Sell.
IntercontinentalExchange (ICE 265.03) will split its shares 5 for 1. Stockholders of record October 27 will receive four additional shares for each ICE share held on the record date. The new shares will be payable on November 3 and will begin trading on a split-adjusted basis on November 4. Buy at 277.34 or below before the split or 53.87 or below after the split.
Penske Automotive (PAG 43.55) increased its quarterly dividend by a penny to $0.29. This continues the company’s record of increasing the dividend every quarter since the dividend was initiated in 2011. The current yield is now 2.7%. Penske’s stock price declined 6.5% yesterday, but the weakness seems normal after a big run-up in the third quarter when its price soared from 30 to 50. Hold.
Schlumberger (SLB 82.99) reported weak results, as expected. Sales fell 17% and EPS plummeted 68% after declining 20% and 74% in the previous quarter compared to a year ago. Sales and earnings were about even with second-quarter results, so second- and third-quarter results indicate that the worst is over.
Schlumberger Chairman and CEO Paal Kibsgaard provided an upbeat assessment of the oil markets, “In the global oil market, the supply and demand of crude is now more or less balanced as evidenced by flattening petroleum inventory levels and the start of consistent draws toward the end of the quarter, particularly in North America. At the same time, oil demand for 2017 was again revised upward in October and if combined with OPEC’s announced intention to cut production, this suggests further inventory draws in the coming quarters that should lead to upward movement in prices.” Hold.
Taiwan Semiconductor ADR (TSM 31.06) reported excellent sales and earnings results on the back of Apple’s successful introduction of the iPhone 7. Sales rose 23% and EPS jumped 26% compared to declines of 13% and 21% in the year-ago quarter. The company is the sole foundry that manufactures chips for Apple’s iPhone 7. The company is also rebounding from a massive earthquake in Taiwan earlier this year, and at the same time, is catching up to strong demand from Apple. In addition, Apple and Taiwan Semiconductor will likely benefit from the recent failure of Samsung’s Note 7 launch. Hold.
Team Health (TMH 40.90) shares surged during the past week. Team Health has not publicly announced whether it has received any buyout offers recently, but Blackstone Group is rumored to be ready to make an offer. The offer could be around $4 billion ($54 per share). TMH received a $71 per share offer from AmSurg a year ago, but the company’s board turned the offer down. The appointment of several new board members will likely lead to better decision-making by the board.
Team Health has made quite a few small acquisitions during the past couple of years which have boosted sales, but earnings growth has been lagging. Demand for the company’s healthcare professional staffing services has been robust, but management can’t seem to capitalize on the many opportunities in front of them. For example, return on equity (a measure of profitability) has dropped from 40% to 24% during the past three years.
Third- and fourth-quarter EPS should be about $0.70, although the company could beat estimates if cost savings from recent purchases finally begin to materialize. Third-quarter results are due out on November 3. Hopefully, though, Blackstone will step up with an offer in the $54 per share range, which Team Health’s board will accept. I will probably issue a sell advisory when and if the stock rises over $50. I advise holding your shares, awaiting further news. Hold.
Travelers Companies (TRV 109.52) shares sagged even though the company reported better than expected revenue and earnings. Revenue rose 3% and EPS dropped 18% after revenue increased 1% and EPS fell 13% in the prior quarter. Net investment income declined 5% due to lower returns in Travelers’ fixed income portfolio caused by lower reinvestment rates. Interest rates will likely rise during the next 12 months, which will boost interest income from the company’s $65 billion bond portfolio. Hold.
UnitedHealth Group (UNH 145.07) beat my sales and EPS estimates and raised earnings guidance for the fourth quarter. Sales climbed 12% and EPS surged 23% after increasing 28% and 10% in the prior quarter. OptumHealth, a subsidiary of UNH, led revenue growth. OptumHealth’s revenue advanced 23% due to growth in its health care delivery businesses and expansion of its behavioral services into new Medicaid markets. UnitedHealth’s strong performance should continue into 2017, aided by the company’s planned exit from the unprofitable portion of its Affordable Care Act exchange business. Buy at 142.01 or below.
Questions and Answers
Q. What is your current opinion on Cognizant Tech? (from subscriber J.S.)
A. Cognizant Technology (CTSH 50.08) shares dropped on September 30 on news that the company is conducting an internal investigation into whether some payments in India violated the U.S. Foreign Corrupt Practices Act. Cognizant’s investigation is in its beginning stages, so the severity and impact on earnings and financial position are unknown at this time.
The company reported that its board of directors’ audit committee and outside lawyers are focusing on a “small number of company-owned facilities.” Cognizant also announced that it has appointed a new president, Rajeev Mehta, the former chief executive officer of the company’s IT services division. He replaces Gordon Coburn who resigned just prior to when the investigation report was made public.
During the past two weeks, the stock has regained half of its loss, and I expect a full recovery to 55 within the next two to four weeks. The investigation appears to be much less serious than initial reactions indicate.
Cognizant’s expansion overseas and advancement into the telecomm, media and entertainment sectors offer outstanding opportunities for future growth. The company is already the outsourcing leader in the financial services and healthcare industries. I expect sales and EPS to increase more than 12% during the next 12 months ending September 30, 2017.
I recommend buying CTSH while the share price remains low. CTSH is reasonably valued at 15.2 times current earnings per share. I expect CTSH to increase 65% to my Min Sell Price of 83.25 within two years. Buy at 54.93 or below.
Q. What is your current recommendation for FIG Fortress? (from subscriber T.L.)
A. Fortress Investment (FIG 5.22) had a poor year in 2015 because its investment managers underperformed in the alternative investment sphere. Investment results have improved in 2016, but clients continue to withdraw investment dollars--although the drawdown was less than 1% in the second quarter. I am optimistic that revenue and earnings will start growing in the current quarter and lead to much better results in 2017.
I switched my opinion on Fortress from Buy to Hold this month to make room for Stifel Financial in my model. Stifel is less speculative than Fortress.
Fortress is still way undervalued. At 5.1 times latest 12-month EPS and with the dividend yield of 7.1%, which is safe, Fortress shares should catch fire sometime soon, and get back to a more reasonable price above 7 or 8. The company is due to report third-quarter earnings on October 31, which will probably be around $0.22 per share compared to year-ago EPS of $0.15. Revenue should also improve from $264 million to $300 million. A bad miss would likely cause me to abandon the stock unless management has a really good explanation. Hold.
Q. You referred to “the Internet of Things”. What is that? (from subscriber F.S.)
A. You probably have seen the ad on TV depicting a young couple on a beach, and the wife asks her husband if he remembered to lock the doors when they left home. He says yes dear, as he is locking the doors from his smartphone--from the beach! The phone communicated through the internet to the doors, which are equipped with a small device called a sensor. The sensor is programmed to respond to signals from the phone to control the door locks.
Electronic devices include any devices that can connect to the internet such as computers, tablets, smartphones or devices using artificial intelligence including Amazon’s Alexa. These devices can control almost anything containing sensors. Sensors can be placed on cars, home appliances, home lighting, the locks in your home, etc.
For example, your smartphone could have an application that would let you control the lighting in your home if your lights have an electronic sensor. With the internet in your phone you can turn your lights on and off from any location where you can get an internet connection. If you are driving down your street in your car and want to turn on the lights in your home and open the garage door, you can do it with your smartphone from any distance away--as long as you have an internet connection on your smartphone and your lights and locks have sensors. You could even turn out your lights and lock the doors from your hotel room hundreds of miles away to make sure you didn’t forget them before you left your home!
I referred to artificial intelligence above. With an interactive device such as Alexa, you can place Alexa in the middle of your living room, turn it on, and ask questions for the device to answer (much like Siri in iPhones), or tell Alexa to turn on lights, the stove, the TV or whatever has an electronic sensor on it. You can even tell Alexa to play your favorite songs and tell Alexa to turn the volume up, or down.
In summary, the internet of things is the interaction between electronic devices and items to be controlled communicating through the internet. Index of Latest Summaries – Recommendations featured in recent issues.