CWS Market Review
August 25, 2017
“The main purpose of the stock market is to make fools of as many men as possible.”
– Bernard Baruch
Mad truth, Bernie. The market does fool-making exceedingly well. Consider the last few months as Wall Street has easily brushed aside concerns about North Korea, President Trump, a weak dollar, the Fed, Tax Reform, you name it, Wall Street’s been as calm as a clam.
Let’s look at some facts. The Dow Jones Industrial Average has now gone 85 days in a row without a 1% daily gain. That’s the longest such streak in over a decade. Bear in mind that historically, a 1% up day is about as common as you can get. The S&P 500 still hasn’t had a 3% drawdown since the election. That means, going by each day’s close, the index hasn’t registered a 3% total decline in more than nine months.
Despite the market’s tranquility, there’s still a lot of news. This week, we had three Buy List earnings report. HEICO raised its full-year guidance, while Hormel and Smucker cut theirs. I’ll have all the details. I’ll also bring up to speed on some recent Buy List news. But first, let’s review this past earnings season.
The Weak Dollar Is Boosting Profits
We don’t have every last number in yet, but we’re very close, and it appears that the S&P 500 had operating earnings of $30.73 for Q2 (that’s the index-adjusted figure). That’s an all-time record. It also represents an increase of 19.6% over last year’s Q2.
This is very good news because there had been growing concerns that the corporate sector was in danger of a slowdown. Instead, this was the fourth quarter in a row of growing earnings. Before that, the S&P 500 went through a nasty earnings recession that lasted seven quarters. What’s important to understand is that earnings are being helped by expanding profit margins. That’s a good sign. For Q2, operating margins topped 10% for the first time since 2014.
The second quarter was also notable because earnings estimates weren’t severely slashed before earnings season. You’ll see that a lot. Estimates will plunge low enough for the results to barely claim an “earnings beat.” Lower the bar far enough so you can step over it. It’s true that earnings estimates almost always start out too high, but the results for Q2 were only 4.7% below the estimate from the beginning of the year. That’s pretty good. Right now, the estimates for Q3 are only 2.7% below where they were at the start of the year. The slashing-estimates game seems to have passed.
So far, 71% of S&P 500 companies have beaten expectations for Q2. Less than 7% of tech stocks missed on earnings. That’s impressive, but the biggest reason for the earnings resurgence is the energy sector. The energy sector went from earning $42.94 per share in 2014 to losing $13.71 in 2015. (Again, these are index-adjusted figures, but in this case, it’s to the S&P 500 Energy Index.) That threw the entire earnings picture for the S&P 500 out of whack. Now energy profits are back, and the overall picture looks much better.
We’re still not quite two-thirds of the way through 2017, but it looks like the S&P 500 is on pace to make about $125 to $130 per share this year. The S&P 500 is going for about 19 times this year’s earnings, and probably about 17 times 2018’s earnings. That’s elevated, but nothing crazy.
What’s happening is that we’ve gone from a period where the strong dollar was distorting corporate earnings. Now the weak dollar is helping the bottom line. It comes down to this: Europe’s economy is trailing by about three years. All of what Mr. Draghi is doing, and has been doing, comes largely from Mr. Bernanke’s playbook.
A few years ago, we were growing, and the Europeans were stuck in a rut. As a result, the dollar rallied, and rates in Europe went negative. Now Europe is much better, so the euro is up and the dollar is down. In fact, Draghi is talking about how he wants to exit all that yucky QE and ZIRP stuff. I don’t blame him. If there’s any big news from Jackson Hole this weekend, it’ll probably be from Mario instead of Janet.
The key takeaway is that the investing environment continues to be favorable for investors. But remember that the weak U.S. dollar is being a big help for us. Now let’s look at our recent earnings reports.
This Week’s Buy List Earnings Reports
We had three Buy List earnings reports this week. Get ready for an earnings lull, because these will be the last ones for a while. RPM International will probably be the next to report sometime in early October. After that, Signature Bank will most likely kick off the Q3 earnings season sometime around October 21.
After the closing bell on Wednesday, HEICO (HEI) reported fiscal Q3 earnings of 53 cents per share. That was in line with Wall Street’s consensus. Because HEICO is a niche player, I like to keep a close eye on their operating margin. It was 19.4% last quarter, which is quite good. Quarterly net sales rose 10% to $391.5 million. In the third quarter of last year, the company earned 49 cents per share.
Laurans A. Mendelson, HEICO’s Chairman and CEO, commented on the Company’s third quarter and year-to-date results, stating, “HEICO’s operating segments have continued to execute at a high level of profitable performance, and I am very pleased with the record financial results. These outstanding results reflect record net sales and operating income for the first nine months of fiscal 2017 within both the Flight Support Group and Electronic Technologies Group, achieved through increased demand for the majority of our products. Additionally, our subsidiaries continue to deliver strong cash flows in support of our overall corporate strategy of high cash-flow generation.
Now for the good news: HEICO also raised its guidance for full-year earnings. They previously expected full-year net income growth of 12% to 14%. They now expect net income growth of 14% to 16%.
Unfortunately, the company doesn’t provide per-share guidance, so we need to bust out some math. Last year, HEICO made $1.86 per share. Shares count is up 1.8% this year, so factoring that in, the new guidance implies $2.08 to $2.12 per share. Since HEICO has already made $1.53 per share through the first three quarters; that implies Q4 earnings of 55 to 59 cents per share.
Wall Street had been expecting 55 cents for Q4 and $2.09 for the entire year. It seems like it was only last week that HEICO was downgraded by Deutsche Bank. Because it was. The shares jumped 2.8% in Thursday’s trading. I like this company a lot. HEICO remains a buy up to $90 per share.
On Thursday morning, Hormel Foods (HRL) said they made 34 cents per share for their fiscal Q3 (ending July 31). That was three cents below Wall Street’s estimate. Sales fell 4.4% to $2.2 billion. For comparison, Hormel made 36 cents per share in last year’s Q3.
So what caused the earnings miss? The major problem is that there’s been a surge in demand for bacon. Normally, that’s a good thing, but Hormel hasn’t been able to catch up with the cost change. Their CEO said that since April, porl-belly prices have doubled. Hormel said they probably will not be able to raise prices until October. As a result, the company’s profit margins got squeezed hard last quarter.
That’s not all. Hormel also had a poor quarter from their Muscle Milk unit, which they’ve spent heavily on. Plus, their turkey unit continues to see poor sales. The silver lining is that Hormel’s grocery-store biz, with brands like Skippy Peanut butter, is doing well.
This was a frustrating quarter for Hormel, but these are solvable issues. With an earnings miss, it’s important to dissect the problems. Are they transitory, or do they go to the heart of the company’s business model? With Hormel’s quarter, it’s more about the environment.
Hormel has also been busy on the M&A front. Last week, the company announced the acquisition of Fontanini Italian Meats and Sausages. This week, they spent $104 million to buy Cidade do Sol, a Brazilian meat company.
Now for guidance. Hormel is lowering its full-year guidance range to $1.54 to $1.58 per share, from the previous range of $1.65 to $1.71 per share. For the first three quarters, Hormel made $1.17 per share, so their guidance means a Q4 range of 37 to 41 cents per share. Wall Street had been expecting 46 cents per share.
This is tough news. The shares dropped 5.4% on Thursday and touched a new 52-week low. In 2015, Hormel could do no wrong. Now they seemingly can do no right. I want to see some improvement here before I feel confident about Hormel.
Also on Thursday morning, JM Smucker (SJM) said they made $1.51 per share for their fiscal Q1. That was ten cents below estimates. Quarterly revenue fell 3.7% to $1.749 billion.
The main culprit was SJM’s Folger’s coffee unit. Sales at Folger dropped by 8%, while operating profits plunged 29%. The company raised coffee prices earlier this year, but then lowered them in July. Smucker’s biggest business, which is pet food, had a sluggish quarter. Sales rose by just 0.5%.
“While our first quarter results fell slightly short of our projections, primarily driven by lower than anticipated volume for Folgers® roast and ground coffee, we have taken actions to improve our competitive positioning for Folgers®. As a result, volume trends are improving. In addition, we remain pleased with the performance of the remainder of our coffee portfolio and look forward to the launch of new coffee products later this fiscal year,” said Mark Smucker, Chief Executive Officer. “We are also pleased with the progress on our cost-management programs, as we continue to deliver on our synergy and cost-savings targets. Across all our businesses, we are executing on our strategic plan that provides a clear path to sustainable, long-term growth by delivering on current consumer and retail trends.”
Smucker also lowered its full-year forecast. The initial guidance was for $7.85 to $8.05 per share. Now Smucker sees FY 2018 earnings of $7.75 to $7.95 per share. Bear in mind that’s a decrease of about 1% at either end.
Shares of SJM dropped 9.5% on Thursday. This was a very disappointing quarter for Smucker, but the selloff gives them a decent valuation, especially if the new guidance is accurate. I feel better about SJM’s earnings than I do about Hormel’s. This week, I’m lowering my Buy Below on Smucker to $118 per share.
Buy List Updates
I have a few quick updates for some of our Buy List stocks.
On Wednesday, Stryker (SYK) said that it’s doing a voluntary recall of “specific lots of Oral Care products sold through the company`s Sage Products business unit.” The problem seems to have come from a third-party provider. Fortunately, Stryker said that it’s not aware of any serious adverse effects.
Earlier Stryker gave full-year guidance of $6.45 to $6.55 per share. Now the company expects to come in at the low end of that range. For Q3, Stryker expects to be at the low end of the previously announced range of $1.50 to $1.55 per share.
This is disappointing news, but hardly enough to shake my confidence in Stryker.
I also wanted to follow up on Ross Stores (ROST). The deep discounter had a very good earnings report last week, but I wasn’t able to see the market’s reaction until after I sent you the newsletter. On Friday, shares of ROST jumped 10.7%. Yesterday, the shares broke above $60 for the first time in two months. Our patience is being rewarded. Ross is a buy up to $61 per share.
Three weeks ago, Cinemark (CNK) reported earnings of 44 cents per share. The market initially reacted favorably, but then it changed its mind. CNK has been trending lower ever since. At one point, shares of CNK fell eight times in nine days. Frankly, I should have lowered our Buy Below earlier, but I’ll do it this week. Cinemark is now a buy up to $36 per share.
That’s all for now. Next week is the final week of trading before the Labor Day holiday. On Wednesday, the government will revise the Q2 GDP figure. The initial report showed growth of 2.6%. On Friday, the Labor Department will release the August labor report just ahead of the Labor Day weekend. I’ll try not to belabor the point. The last report showed unemployment at 4.3%, which tied a 16-year low. 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!
– Eddy
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