CWS Market Review
March 3, 2017
“Become more humble as the market goes your way.” – Bernard Baruch
John Maynard Keynes famously spoke of how “animal spirits” can override rational human behavior. Given Wall Street’s extreme placidity of late, I think those animals are currently possums, sloths and snails.
Finally, we saw some action this week. On Tuesday, the Dow snapped its 12-day winning streak, the longest in three decades. Then on Wednesday, the S&P 500 had its first daily move of over 1% in nearly three months. Surprisingly, the move was to the upside. For the first time ever, the index topped 2,400.
So what’s the cause for the burst of optimism? For one, Wall Street reacted positively to President Trump’s Tuesday address. Plus, there’s been more positive economic news. Consumer confidence is now at a 15-year high. In fact, Wall Street is beginning to think that another Fed rate hike will come in less than two weeks.
In this week’s CWS Market Review, I’ll tell you what it all means. I’ll also highlight our two Buy List earnings reports from this week. Both Ross Stores and HEICO beat estimates, plus Ross gave us an 18.5% dividend hike. I’ll also update some of our Buy Below prices. But first, let’s look at why things suddenly look so rosy on Wall Street.
Get Ready for an Ides of March Rate Hike
In December, the Federal Reserve said that they expect to raise interest rates three times this year. At the time, I said that forecast was wildly optimistic. Suddenly, it doesn’t look so wild. In just a few days, Wall Street’s view on a rate increase has shifted dramatically.
What changed? Several things came together all at once. The inflation report for January was well above expectations. Existing home sales rose to a 10-year high. The minutes from the Fed’s last meeting indicated that some members are ready to hike. This week, we learned that consumer confidence rose to a 15-year high and initial jobless claims fell to a 44-year low.
Perhaps the most influential event was when Bill Dudley, the top dog at the New York Fed, said, “I think the case for monetary policy tightening has become a lot more compelling.” After that, the rate-hike odds for March doubled.
The Fed meets again on March 14-15. Two weeks ago, before Janet Yellen testified before Congress, the future market pegged the odds of a March rate hike at 16%. Now it’s at 79.7%. It doesn’t stop there. The odds of another hike in June are roughly 50-50.
The change of mind is impacting the financial markets in several ways. Obviously, stocks are rallying. An improving economy means consumers have more money to spend, and that means greater profits for companies. The S&P 500 is already up 6.4% this year.
The bond market is also adjusting. The “short-end” of the yield curve is the highest it’s been in years. This week, the yields on the three- and six-month Treasuries, plus the one- and two-year notes, all hit their highest levels in seven or eight years.
On Thursday, for example, the yield on the six-month Treasury closed at 0.84%. Obviously, that’s not very high, but it’s double the yield of six months ago. Let’s remember that just 17 months ago, the two-year was going for 0.08%. The one-year Treasury is close to breaking above 1% for the first time since November 2008. After many, many false starts, it appears that yields are truly going higher.
What’s interesting is that the long end of the yield curve (over 10 years) hasn’t moved much recently. After the election, those maturities saw their yields gap up, but since the start of the new year, they’ve been fairly stable. This may suggest that the Fed won’t have to do a lot of hiking to get the job done.
When we see long-term yields go up, that generally aligns with good times for cyclical stocks. When short yields rise, that’s usually good for banks and financials. For example, on our Buy List, Signature Bank (SBNY), recently came within inches of hitting a new all-time high.
In last week’s issue, I mentioned the earnings report from Continental Building Products (CBPX). I think of the company as a classic cyclical stock. What’s interesting is that traders didn’t know what to do after the earnings report. At one point last Friday, the shares were down more than 4%. Then the market changed its mind, and CBPX rallied. From Friday’s low to Thursday’s close, the stock gained more than 12%. You never know what will happen in the short term. CBPX is now one of our seven Buy List stocks that are up double digits in 2017.
The last few weeks have been very busy with earnings reports. Now that earnings season is behind us, we’re in for a long stretch with almost no earnings. Over the next six weeks, only RPM Inc. (RPM) is scheduled to release its earnings. Now let’s turn to our two Buy List earnings reports from this week.
Ross Stores Beats and Raises Dividend
After the closing bell, Ross Stores (ROST) reported fiscal Q4 earnings (ending January 28) of 77 cents per share. That’s a good number. The deep discounter had told us to expect Q4 earnings between 72 and 75 cents per share. Wall Street pegged Q4 at 75 cents per share.
Quarterly sales rose 8% to $3.5 billion, and comparable-store sales were up 4%. The latter is the key metric to watch for any retailer, and 4% growth is quite good. For all of 2016, Ross made $2.83 per share. That’s up 13% over last year. Full-year sales rose 8% to $12.9 billion. Comp-store sales were up 4%.
Barbara Rentler, Chief Executive Officer, commented, “We are very pleased with our better-than-expected sales and earnings results for the fourth quarter and fiscal year, especially given our strong multi-year comparisons and the highly competitive and promotional holiday season. Our results continued to benefit from our ability to offer customers great values on a wide assortment of gifts and fashions for the family and the home.”
Ms. Rentler continued, “Fourth-quarter operating margin grew 90 basis points to 13.6%, up from 12.7% in the prior year. This improvement was mainly driven by our above-plan sales along with a favorable comparison of packaway-related costs versus last year’s fourth quarter. For the 2016 fiscal year, operating margin increased 40 basis points to a new record of 14.0%.”
Those are some solid numbers. Ross also approved a new, two-year $1.75 billion share-buyback program. At ROST’s current price, that’s about 6% of their outstanding shares.
Ross also bumped up its quarterly dividend from 13.5 to 16 cents per share. That’s an increase of 18.5%. Over the last seven years, Ross has raised its dividend by 300%. The new dividend is payable on March 31 to stockholders of record as of March 10.
Now for guidance. Bear in mind that Ross tends to be very conservative with their forecasts. Ross projects full-year 2017 earnings between $3.02 and $3.15 per share. That’s up 7% to 11% over 2016. However, the current fiscal year is 53 weeks long. The company estimates that the extra week adds eight cents per share. Ross sees same-store growth this year of 1% to 2%.
For Q1, Ross forecasts earnings of 76 to 79 cents per share and comp-store sales growth of 1% to 2%. This strikes me as very conservative.
Why so low? The CEO said, “There continues to be uncertainty in the political, macro-economic, and retail climates, and we also face our own challenging sales and earnings comparisons. Thus, while we hope to do better, we believe it is prudent to remain somewhat cautious in planning our business for the 2017 fiscal year.”
Ross was one of the few stocks to lose ground on Wednesday. I’m not at all concerned. Ross Stores remains a buy up to $70 per share.
HEICO Beats and Raises Guidance
Also on Tuesday, HEICO (HEI) reported fiscal Q1 earnings of 59 cents per share. That’s five cents higher than expectations. Net sales grew 12% to $343.4 million. The company makes replacement parts for the aircraft industry.
Laurans A. Mendelson, HEICO’s Chairman and CEO, commented on the Company’s first-quarter results, stating, “We are pleased to report exceptional first quarter year-over-year increases in net sales and operating income within both our Flight Support Group and Electronic Technologies Group. These results principally reflect strong organic growth of 8% within both of our operating segments as well as the excellent performance of our well-managed and profitable fiscal 2016 acquisitions.
Cash flow provided by operating activities was strong, increasing 24% to $56.0 million in the first quarter of fiscal 2017, representing 137% of net income, as compared to $45.2 million in the first quarter of fiscal 2016.
Our total-debt-to-shareholders’-equity ratio was 38.3% as of January 31, 2017. Our net-debt-to-shareholders’-equity ratio was 34.1% as of January 31, 2017, with net debt (total debt less cash and cash equivalents) of $371.4 million principally incurred to fund acquisitions in fiscal 2016 and 2015. We have no significant debt maturities until fiscal 2019 and plan to utilize our financial flexibility to aggressively pursue high-quality acquisition opportunities to accelerate growth and maximize shareholder returns.
The best news is that HEICO is raising its outlook for this year. Unfortunately, they don’t provide EPS guidance. Previously, HEICO expected sales growth of 5% to 7%, and net income growth of 7% to 10%. Now they see sales growth of 6% to 8%, and net income growth of 9% to 11%. Assuming share count doesn’t change, the EPS range works out to $2.53 to $2.57.
HEICO also said they’re considering a stock split. This week, I’m raising my Buy Below on HEICO to $89 per share.
I also want to update a few of our Buy Below prices. This week, I’m raising Fiserv’s (FISV) Buy Below to $122 per share. The shares recently had a run of rising 14 times in 16 days. I’m also raising Cerner (CERN) to $57 per share. CERN was one of our worst stocks like year, but one of our best this year. Interesting how that works. I’m lifting Danaher’s (DHR) Buy Below to $90. Last week, DHR raised its dividend by 12%. Finally, I’m raising Stryker (SYK) to $136. Since mid-November, SYK has rallied more than 22%.
Before I go, here are a few links to pass along. Morningstar looked at Ingredion (INGR). Barron’s highlighted Axalta Coating Systems (AXTA). Cinemark (CNK) was featured in Forbes.
That’s all for now. The big news next week will be the jobs report on Friday, March 10. This will be the last major event before the Fed meeting. If the report is strong (over 175,000 nonfarm jobs), then that almost certainly guarantees another rate hike. It will also increase the odds for a second hike in June. 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!