February 19, 2016
“Buy not on optimism, but on arithmetic.” – Benjamin Graham
Last Thursday, the S&P 500 tested the “Tchaikovsky” low of 1,812, and this time, it broke through to a new one. The market loves to do these tests and retests. Once the new low was set, then the big cannons appeared again and blasted the market upward.
For three straight sessions, the S&P 500 gained more than 1.6%. We couldn’t make it four straight, which hasn’t happened in over 30 years, but the bulls had done well for themselves. From last Thursday’s low to Wednesday’s high, the index gave 6.66%. Indeed, the devil is in the details.
I’m happy to report that Q4 earnings season is now over for our Buy List stocks. We didn’t have a single earnings miss all season. Three of our stocks reported Q4 earnings this week, and one more, Hormel Foods, was the first to report Q1 earnings.
Hormel had another very good report. The Spam stock jumped more than 7% on Tuesday to reach a new 52-week high. Not only was Hormel our top-performing stock last year with a 50% gain, but it’s our top-performing this year as well, with an 8.5% YTD gain. Let your winners run!
In this week’s CWS Market Review, I’ll go over all our earnings reports, plus we have another Q1 report coming our way next week. But first I want to discuss the broader outlook for corporate earnings, which hasn’t been very good.
Another Weak Earnings Season for Wall Street
For the most part, this was another sluggish earnings season for Wall Street. We don’t have the final numbers yet, but about two-thirds of companies are beating estimates. That’s about the long-term average. That’s right, on Planet Wall Street you’re expected to beat expectations. Your stock can get dinged hard if it merely meets expectations, which is often completely unexpected. For Q4, about half the companies have topped the Street’s revenue estimates.
So far, Q4 earnings for the S&P 500 are tracking at $26.19. That’s the index-adjusted figure. (I’m using the figures from S&P, so other sources you may see could be different.) Earnings are down about 2% from Q4 of 2014. This will be the fifth quarter in a row of declining earnings for the S&P 500. Operating margins are also down.
For 2015, the S&P 500 looks to earn $103.58. That’s down from $113.01 in 2014. Bear in mind that for much of 2014, Wall Street expected the S&P 500 to earn more than $135 for 2015. The experts weren’t even close, and that’s why I’m often leery of establishment opinion, especially when it has an inherent bias.
With that caveat, I’ll mention that Wall Street now expects the S&P 500 to earn $120 this year, and $138 for 2017. To be honest, that seems a lot more reasonable, and it means the index is going for about 16 times this year’s earnings and 14 times next year’s. If those guesses are correct (a very big if!), then the broader market is fairly valued.
Around here, we like to focus on high-quality stocks, and our stocks have been doing much better than the overall market. Of our 16 Buy List stocks that reported earnings over the past month, 13 beat Wall Street’s estimate, and three matched estimates. None of our stocks missed earnings. Guidance, however, was not always favorable.
Unlike the last market squall, I don’t believe this one will pass so quickly. While the recent uptick for the market is good to see, I want you to expect more volatility. Here’s a fascinating stat from Callie Bost. The VIX, that’s the volatility index, hasn’t closed below 19 once all year. Last year, it was below that level 80% of the time. Ryan Detrick notes that the S&P 500 has closed up or down more than 1% on 63.3% of the trading days this year: “only 1931, 1932 and 1933 were higher.”
Will the market rally from here? I can’t say for sure, but to reflect on Benjamin Graham from this week’s epigraph, the math favors stocks. The earnings yield for the S&P 500—that’s earnings dividend by price—is running about 6.3%. The 10-year bond is yielding less than 1.8%. The numbers are on our side but the challenge for investors is to ride out the volatility. With that said, let’s look at our earnings for this week.
Hormel Foods Does It Again
The Spam stock has been a big winner for us, and it’s continuing to lead the market. Hormel gave us 50% profits last year, plus a stock split this year, and now another solid earnings report. On Tuesday morning, Hormel Foods (HRL) reported fiscal Q1 earnings of 43 cents per share. That’s for November, December and January. Hormel’s earnings were six cents better than estimates. One weak spot is that revenues fell 4.3% to $2.29 billion, which was a bit below consensus.
But the best news is that Hormel raised its full-year 2016 forecast. The original range was $1.43 to $1.48 per share. Now it’s $1.50 to $1.56 per share. That seems to incorporate the six-cent earnings beat. Please remember that Hormel is a lot more than Spam. Their turkey biz has been weak lately, but they expect that to recover.
“We are pleased to report a double-digit earnings increase for the quarter, with four of our five segments posting earnings growth,” said Jeffrey M. Ettinger, chairman of the board and chief executive officer. “This marks our eleventh consecutive quarter of achieving record earnings results.”
“Our commitment to investing in the sustained growth of the business is evident in our results. Our business performance continues to be influenced by our company-wide spirit of innovation, increased brand support, prudent capital investment, and portfolio-expanding acquisitions,” commented Ettinger. “While sales were muted this quarter by turkey supply constraints and lower pricing due to declining pork markets, we enjoyed strong performance from many great products across our portfolio, such as HORMEL GATHERINGS® party trays, APPLEGATE® natural breakfast sausage, HORMEL® FIRE BRAISEDTM meats, MUSCLE MILK®PRO SERIES protein beverages, and WHOLLY GUACAMOLE® refrigerated dips.”
“We expect favorable input costs to continue for Refrigerated Foods, Grocery Products, and Specialty Foods, while we look for pork operating margins to moderate as the year progresses,” commented Snee. “Our turkey production is on pace to return to normalized levels by the end of the second quarter, positioning Jennie-O Turkey Store for strong growth in the back half of fiscal 2016 with our on-trend portfolio of JENNIE-O® turkey products. We expect International to achieve improved results with increased sales of our SKIPPY® peanut butter and SPAM® family of products.”
At one point on Tuesday, Hormel’s stock was up more than 10%. Bloomberg noted that this is Hormel’s largest intra-day move in over 10 years. I’m very happy with this earnings report. I’m raising my Buy Below on Hormel to $45 per share.
Earnings from Cerner and Express Scripts
We got two more earnings reports after the closing bell on Tuesday. Cerner (CERN) reported Q4 earnings of 61 cents per share, which beat Wall Street’s expectation by four cents per share. Quarterly revenue rose 27% to $1.175 billion.
For the year, the healthcare IT firm earned $2.11 per share, which was a nice increase from $1.65 per share in 2014. While that’s impressive growth, there are some signs of trouble. Bookings rose 16% last quarter, below Cerner’s forecast, and backlog is up by just 2% from Q3.
For Q1, Cerner expects revenue between $1.15 billion and $1.2 billion, and EPS between 52 and 54 cents. Wall Street had been expecting 54 cents per share. For the year, Cerner sees revenue ranging between $4.9 billion and $5.1 billion. They see full-year EPS between $2.30 and $2.40. The Street had been expecting $2.36 per share.
That’s basically what I had been expecting from Cerner, but the stock got crushed in Tuesday’s after-hours market. At one point, CERN was down as much as 17%. Fortunately, cooler heads prevailed on Wednesday. As it turned out, Cerner lost just 5% during Wednesday’s session. This is a good reminder to view after-hours trading with a bit of skepticism.
Cerner is doing just fine, but I’m going to lower my Buy Below to $58 per share to reflect the sell-off.
Also on Tuesday, Express Scripts (ESRX) reported Q4 earnings of $1.56 per share, which matched Wall Street’s consensus. Earnings for the pharmacy-benefits management company weren’t much of a surprise, since they already told us to expect earnings to range between $1.54 and $1.58 per share.
“Our business model of alignment, developed 30 years ago, has never been more relevant than it is today,” said George Paz, Chairman and CEO. “Our job is to continue to take advantage of the opportunities and uniquely help clients withstand the constant challenges in the healthcare marketplace by taking bold actions to effectively balance pharmacy cost and care. Our focused alignment continues to control client costs, improve patient care and drive long-term value to our shareholders.”
Express raised, ever so slightly, its guidance for 2016. Initially, they expected earnings of $6.08 to $6.28 per share. Now they expect $6.10 to $6.28 per share. True, that’s not the most earth-shattering revision, but it’s better than nothing. The new guidance implies earnings growth of 10% to 14%. It also means the stock is going for about 11 times this year’s earnings. That’s not bad. For Q1, Express expects earnings of $1.18 to $1.22 per share. Wall Street had been expecting $1.28 per share.
This week, I’m lowering my Buy Below on Express Scripts to $76 per share.
Wabtec is a Buy up to $76 per Share
On Thursday, we got our final Buy List earnings report for Q4. Wabtec (WAB) reported earnings of $1.05 per share, which matched Wall Street’s consensus. Quarterly revenue increased 1.5% to $833 million, which was a bit below consensus. For the year, Wabtec made $4.10 per share.
Raymond T. Betler, Wabtec’s president and chief executive officer, said: “We finished 2015 with a strong performance and are positioned for record results again in 2016, even as we face challenges in some of our key markets. We have responded to these challenges by accelerating our cost- and efficiency-improvement programs. At the same time, we continue to invest in our growth strategies and remain optimistic about our long-term prospects, thanks to continued investment in freight rail and passenger-transit projects around the world. As always, we expect to benefit from our diversified business model, balanced growth strategies and rigorous application of the Wabtec Performance System.”
Wabtec also offered guidance for 2016. They see earnings ranging between $4.30 and $4.50 per share. Wall Street had been expecting $4.36 per share. Wabtec added, “The company expects 2016 quarterly results to improve sequentially during the year as it realizes the benefits of ongoing cost-reduction initiatives and as projects already in backlog begin to ramp up.”
I was pleased with the results and the stock gapped up at Thursday’s open. At one point, WAB was up more than 10%. Gradually, however, the sellers returned, and WAB closed lower by a little less than 1%. I’m lowering my Buy Below on Wabtec to $76 per share. This is a good stock.
HEICO Reports on February 25
HEICO (HEI), one of our new stocks this year, is due to report fiscal Q1 earnings after the market closes on Thursday, February 25. HEICO is a bit different from our other stocks in that few Wall Street analysts follow the stock. You would think a stock that’s up 90-fold since 1994 would be a little more popular, but that’s not always the case.
The company makes parts for the aerospace industry. HEICO isn’t well-known, but it is well run. HEICO made 41 cents per share for last year’s Q1. I’m expecting about 46 cents per share this time. I always tell investors not to overlook the boring stocks.
Now begins the quiet period for our earnings reports. We only have two Buy List stocks with quarters that end in February, Ross Stores (ROST) and Bed Bath & Beyond (BBBY). Ross is due to report on March 1, and BBBY won’t report until April 6.
That’s all for now. Only one Buy List earnings report next week! But there will be some important economic reports. In particular, I’m looking forward to Friday’s update to the Q4 GDP report. The initial report said the economy grew by a scant 0.7% during the final three months of 2015. We’ll also get the January durable-goods report on Thursday. 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!