Saturday, January 25, 2014

Earnings Season; Top-line or Bottom-line Winning?

I read a FactSet Earnings Insight report last night and it re-affirmed to me my notion that 2014 will be predominantly a stock pickers market. The high flying tech names such as Tesla (TSLA) or Netflix (NFLX) will continue to fly as long as they continue to execute, which in all fairness, they have. However, vis-à-vis the recent economic and earnings data being released, some of the best performing stocks of 2014 will be driven by the value investor. Below is a bullet proof summary of what I found exclusively important from the report. 
  • Out of 123 companies that have reported 2013 Q4 earnings, 68% have beaten analyst EPS estimates. This compares to 73% of companies beating estimates over the past 4 years and 71% of companies beating estimates over the past 4 quarters.
    •  Thus far into earnings season, aggregate company earnings to beat Wall Street expectations have trended below average.
  • Also out of 123 companies, 67% of companies that have reported 2013 Q4 earnings have beaten analyst revenue estimates. This compares to just 59% of companies beating analyst estimates over the past 4 years and 54% beating top-line estimates over the past 4 quarters. 
    • Thus far into earnings season, average company revenues to beat analyst expectations have trended above average. 
  • The average company to beat analyst EPS expectations has surprised by 2.7%. Over the past 4 years EPS surprises have averaged 5.8%; they have averaged 3.3% over the past year.  
  • The average company to beat revenue estimates has surprised by 0.7%. This number is better than the 4 year average of 0.6% and the 1 year average of revenue surprises, which is 0.4%. 
The report accurately notes issues that may have troubled some bottom-line figures such as foreign exchange (FX) rates along with mixed performances in regions such as Europe and China. Many foreign currencies have weakened against the dollar over the past year, in turn shrinking margins for a variety of companies: especially those who rely on the general consumer. I have noticed personally in reports from companies such as Nike (NKE) and Starbucks (SBUX) that FX headwinds have been an issue. Juxtapose this phenomenon with the mixed reaction companies have received in various regions around the world, and we've bean dealt a mixed stream of bottom-line earnings which I expect to continue as companies continue to release 2013 Q4 financial results.

I have held tight to the preconception that top-line revenues will be influential to market sentiment: however as per the above data, is it possible that bottom-line disappointment is aiding the recent sell off? Frankly, who knows? I don't. All I know is that as we move through a period that will likely leave many investors puzzled, I'll be focused on the fundamentals of businesses. I'm looking for strong balance sheets, good value, and as always; a way to make money with defined risk.

Below is a chart of TTM PE values over the past 10 years.

Below are tables detailing 2013 Q4 EPS and revenue growth, segmented by sector.

Sector Earnings Growth
S&P 500 6.40%
Financials 23.50%
Telecom 16%
Industrials 14.00%
Materials 10.30%
Info. Tech. 5.90%
Consumer Disc. 3.70%
Health Care 3.30%
Consumer Staples 2.50%
Utilities -5.50%
Energy -10.90%

Sector Revenue Growth
S&P 500 0.70%
Info. Tech. 4.40%
Health Care 4.30%
Consumer Disc. 3.20%
Consumer Staples 2.50%
Materials 2.30%
Telecom 2.10%
Utilities 2.10%
Industrials 1.20%
Energy -1.40%
Financials -9.90%

Below is a table listing 12-month forward PE ratios, segmented by sector.

Sector Forward 12-Month PE Ratio
S&P 500 15.1
Consumer Disc. 17.9
Health Care 17.1
Consumer Staples 16.7
Industrials 16.4
Materials 16.1
Utilities 15.3
Info Tech. 14.9
Telecom 13.3
Energy 12.8
Financials 12.6

*All chart and table data provided by

Thursday, January 9, 2014

Choppy Start to 2014 Markets; What gives?

So far, I wouldn’t go as far as saying 2014 market returns have been bizarre, but their performance has been a bit curious to say the least. The end of 2013 saw a market that was able to fight off any bearish sentiment, ending with respective yearly returns of 26.5%, 29.6% and 38.3% in the Dow Jones Industrial Average, S&P 500 and the NASDAQ.  So what gives? Many mainstream money managers claimed January would be an up month, and that gains would continue: yet as we’ve seen that has not been the case. I’ve also listened to and read pieces by money managers who claim we’re due for a healthy correction, but now that the market is trading sideways, say their confused. So again, What gives? Furthermore, if you’ve tuned in to any of the financial networks recently, there is a good chance you’ve heard anchors and contributors speak about the famed 5 day trend; the trend that claims yearly returns tend to correlate with the first 5 trading sessions of the year. If that trend holds in 2014, we're in for quite the reversal compared to 2013. So one last time, WHAT GIVES?

My take is that this sideways performance isn’t all so bad. It’s needed. We haven’t had a meaningful pull-back or correction (5-10%) since 2011, and so eventually profits will be taken, portfolios will be rebalanced, and the markets will face some selling pressure. I’m not necessarily saying this is going to happen tomorrow, but we should at least address the drivers and factors we might encounter before a meaningful sell off: as they could be the same factors currently moving the markets sideways. In this post, I’ll list and briefly explain a bit about those drivers that may be in play currently.

As I mentioned above, the markets SOARED in 2013. So the first driver may be a derivative of that out-performance: where portfolio managers are taking profits, and rebalancing their weightings to sectors that have further growth potential in 2014. That doesn’t sound so unreasonable. Therefore when managers are managing millions or billions in assets, most (but not all) understand they need to put their clients and investors first and actually MAKE THEM SOME MONEY!

FOMC actions are the second driver. The FOMC released its minutes Wednesday which some say influenced a slight dip in the major indices. However, I didn’t find the minutes to be any different than the statement and press conference chairman Bernanke gave in December. They re-iterated; there is no predetermined timeline for future decisions regarding monetary policy; they revealed that all voting members of the committee except for one voted in favor of a reduction in bond purchases; and that a suggestion was made to consider reducing the unemployment threshold to 6% from 6.5%. The above components of the minutes are no different from what we found out in December and so I find it hard to swallow the claim that the minutes caused a fundamental, and not speculative reaction in the markets. None the less, I watched the indices dip quickly on my monitors soon as the report was released: and so regardless of what my personal opinion may be on this specific release, FOMC decisions will continue to affect the markets one way or another. I am under the impression that current uncertainty regarding continued taper decisions may be holding the markets steady.

The third significant driver will be continuously released economic data. This week we’ve seen an ADP employment change measure of 238,000: above a consensus estimate of 203,000 and up from December’s 229,000 measure. We’ve also seen initial claims measurements of 330,000, down from last month’s 345,000 number. Note that with this value, we may still need to account for seasonal unemployment effects, yet I think this measure can be trusted more, relative to December's.  Other measures such as the Michigan Consumer Sentiment Index, the unemployment rate and Non-farm Payrolls will also be closely watched; Investors are still looking to get a better holistic picture of the economy and so tomorrow’s Non-farm payroll and unemployment data will be important.

The last driver I will touch on is this upcoming earnings season. 2013 saw a string of positive earnings releases, however a significant portion of companies grew their net incomes through cost management rather than through revenue growth. This year, investors will be much more sensitive to top line revenues of companies; stocks of companies that grow their top line will outperform those who manage costs to increase their bottom line, in my opinion. As we get ready to kick off a string of earnings releases this month, market participants will be waiting to hear from a variety of management teams before they are ready to put more money to work in the markets, potentially adding pressure to current market levels as well.

As we move through this quarter, the above mentioned factors will remain intact. They may be valid  pressures holding the market in place as we speak; however future turmoil will almost certainly incorporate some, if not all of those factors as well. Below is a 5-day comparative chart of the Dow Jones Industrial Average (green), the S&P 500 (blue) and the Nasdaq 100 (turquoise).  

Tuesday, December 24, 2013

Nike - Solid Company, Promising Future; but is its stock burnt out?

Nike - Solid Company, Promising Future; but is its stock burnt out?

Written: Monday December 23/24, 2013

As an Oregon native, my preference for athletic apparel lies predominantly with Nike. I love the company, it's story, its LOCATION etc.. But I must admit that those are all hometown biases. Moving away from that bias, this post examines the public companies fiscal Q2, as per its recent earnings release and its subsequent impact on its stock. I am indeed bullish on Nike's future outlook, but I do have my reservations that I will attempt to outline. I will also share my potential trade strategy.

 Summary of Results

The company posted total revenues of $6.4B (up 8% year-over-year) with earnings of $0.59 / share, beating Wall Street consensus estimates by a penny. Converse revenues grew 11% accounting for $360M of Nike's total revenue. Gross Margin increased to 43.9%, aided in part by higher selling prices, along with improved direct-to-consumer (DTC) performance which enjoyed a 20% increase in comparable store sales. Free cash flow (FCF) for this quarter, $492M, was considerably down from this time last years FCF number of $983M. In response to an analyst question towards the end of the earnings call, the company spoke about certain emerging market FX headwinds affecting the top-line, while other investment expenses applying upward pressure on selling, general and administrative expenses (up 14% y-o-y at $2.1B). My take is that these factors along with an increase in demand creation expenses ($691M) stemming from upcoming events - The World Cup, Olympics, product launches etc. - applied downward pressure on the company's FCF. Total futures orders, which can be a telling sign for a given company's outlook, were up 13% y-o-y, on a currency neutral basis. The company is also in the midst of an $8B share repurchase program, purchasing an additional 5.5 million shares this past quarter for around $4.2M. Lastly, inventories for the company were up 11% y-o-y.

 International Footprint

Internationally, Nike had mixed performance; with certain areas enjoying increased success and others still needing improvement. Western Europe saw currency neutral revenue and futures orders growth of 15% and 23%, respectively. CEO, Mark Parker explained that the company underwent a strategy reset in this region, adding a centralized organizational structure to help: manage relationships, enhance regional consumer focus with relevant product innovations, develop deeper brand connections and create a greater retail experience. As per the mentioned revenue and futures orders measures for this region, the shift in strategy appears to be working.

Another coveted region the company seems to be paying great attention to is China, where Nike only saw modest improvements in currency neutral revenue and futures orders growth. Revenue in this region grew only 5% with futures orders barely growing at 1%. Although a strategy reset has been initiated in China as well, it clearly has not yet had the same affect as it did in Europe. The company is looking to segment and differentiate points of distribution in China, which will potentially create a more focused consumer experience. Moreover, Nike believes their merchandise strategy needs to be much better in the region as well, and they are looking to work with their whole share partners to create a "seamless operating platform."

While China is yet to reach the improvement Western Europe has realized from the company's strategy reset, performance in Emerging Markets (EM) for Nike has had multiple stories. EM currency neutral futures orders came in far higher than the greater China region at 15%, however their currency neutral revenue, grew y-o-y at a frail rate of 3%. Although revenue growth in EM was fairly weak, the company is still very confident about their future performance in various emerging markets as much of the weakness was attributable to logistical complications in Mexico. The company explained that they had endured a rocky transition from their prior Mexican logistics partner to a new third party partner in the region. Shipments from their regional distribution centers to whole sale partners were delayed which caused inventories to build up in these distribution centers, creating a shortage a of Nike product in the Mexican markets. The company emphasized it was working with their new partners to ensure fluid logistical coordination in the region, and although they expect to ship at demand by the end of next quarter, it will take a few more quarters to fully straighten things out.

Future Progress and Innovation 

The company plans to continue innovating and launching impressive products, as it has been known to do for many years. Mark Parker cites new innovations such as color dry and its new fly knit technology among many others. Color dry is an impressive dyeing process, allowing the company to replace water with recyclable carbon dioxide in its color dye process, and provide more consistent and brighter fabric colors. The fly knit technology is a material the company has began to use across many different athletic shoes, most recently in the newly designed Kobe 9 masterpiece, worn by NBA all star Kobe Bryant. To my understanding, the material serves as the only material on the upper of a given shoe, in contrast to the majority of shoes, made by any company, which incorporate multiple pieces. In addition Parker has praised new technology used in newly released World Cup Soccer Jerseys for the French and Brazilian national teams. In the earnings call he stated:

"Each kit integrates technical performance innovation with team-specific design elements. The kits feature Dri-Fit Technology, engineered mesh and laser- cut ventilation for better cooling, and our lightest NIKE Pro baselayer ever. In fact, the uniforms are 16% lighter than our 2012 Euro Champ uniforms. And they are made of recycled polyester, using the equivalent of 18 recycled water bottles in every kit."

In addition to apparel product innovation, Nike has expressed its intent to continue investing and developing its digital ecosystem. This includes the development of digital products and services such as the Nike Fuel Band as well as the further expansion of its e-commerce business, which grew 33% y-o-y.  Parker however, is convinced that this business still has significant room to grow, as it is currently less than 15% the size of Nike's DTC business in terms of revenue growth. 

Conclusion; Company and Stock Outlook

Overall, I think Nike reported another reliable quarter. The company showed growth in all major businesses and has continued to reach out to the consumer in the most effective way for them. DTC sales can be difficult for some retail business to sustain due to added fixed costs, however Nike has enjoyed wonderful success in their direct-to-consumer stores. As this quarter is traditionally the busiest for Nike's basketball category, the company's brands, NIKE and Jordan, sustained significant growth and robust sales performance. Increased connections with the worlds greatest athletes has kept the company's basketball products the most innovative and consumer attractive in the world. This strategy has also helped Nike grow or gain market share in other sport categories as well. Lastly, continued innovation and investment in its digital platform offers great potential for the company. 
 In addition, the company has recognized its shortcomings and appears diligent in their efforts to improve any struggling parts of their business, as is evident in their strategy resets and realistic projections for better logistical performance in EM. From a financial standpoint, the company remains extremely stable; continuing to create shareholder value through its overall growing business, along with its dividend increases and its current $8B share repurchase program, executed by its strong executive and management team. 

I think Nike will continue to lead the athletic apparel and footwear industry, yet that notion seems to be priced into the stock as it trades at a price-to-earnings multiple premium, relative to the market. My reservations for the stock lie predominantly with its valuation. The S&P 500 currently has a PE ratio of around 18, while Nike currently trades at a PE multiple of roughly 26; significantly higher than not only the market but the industry average as well which has a PE multiple of 23.3. The other metric that stands out to me is its Price/Cash flow (P/FCF) ratio, currently at 22.8 for the company. The S&P has a P/FCF multiple of 10.0 while the industry average is 10.3. Although Nike appears to be a bit over valued as per these metrics, I'm still bullish on the stock as I think we need to take a look at these metrics relative to other comparable companies and brands and not the entire industry. Industry averages can contain any type of niche athletic apparel company, yet Nike should only be compared with other diversified giants such as an Adidas or rising competitors such as an Under Armour. Nike's PE multiple relative to these companies is actually low, with Adidas trading at a 36.4 PE multiple and Under Armour at 62.1. 

As described earlier in this post, the headwinds that brought FCF down were related to demand creation expenses revolving around future events and other investments. It was not as if the business had worrying struggles that ate into its FCF, and so I am not too concerned with its P/FCF multiple considering over a 5 year average this multiple is usually around 20. I also think it is worth noting that the company has a brand and consumer loyalty that almost any company would be envious of. I personally know people, who ARE NOT from Oregon, that literally will sport no athletic apparel unless it has the famed swoosh on it. Take a walk through the campus as well, and you will notice a corporate culture and atmosphere that is surreal on some fronts. These traits are near impossible to instill for some businesses, so maybe; just maybe, a premium valuation on the stock is indeed warranted. 

A variety of large mutual funds and institutions also own the stock, which in my opinion, protects it from unhealthy volatility as these funds are not typically looking to trade in and out of the name on a frequent basis, that is, barring any unforeseen events that would warrant a sell off. The recent earnings release disappointed some, however if this were a name in reasonable trouble, we would have seen the stock tumble far more than the 1.5 - 2% we saw it decline. We must also consider that the stock is up near 52% on the year and so expectations tend to get a bit overstretched for companies that have significantly outperformed their counterparts. Below is a list of the top 5 mutual funds and institutions that own the stock:

Mutual Fund Ownership -
% Total Shares Held
% Total Assets
Vanguard Total Stock Mkt Idx

Institutional Ownership –
% Total Shares Held
% Total Assets
Vanguard Group, Inc.
State Street Corp
Fidelity Management and Research Company
Capital Research Global Investors
BlackRock Fund Advisors
* Above data provided by Morningstar

Trading the Name

This last part of the post will focus on my potential trading strategy for the stock. Below is a useful chart to visualize some of my rational.

The chart above is a 6-month daily chart. The white lines I have drawn in are support levels I believe are critical to the performance of the stock. As of now the stock has held that $76 area bouncing to $77.66 by the close today. I partially think some of they hyped product releases such as the Kobe 9 Masterpiece shoe or events such as the Winter Olympics are already priced into the stock, however as they surface I think we can still see an uptick in the stock. Further, I think this is a name that investors want to own over the long haul and thus, I don’t think it will see a significant drop. For now I’m looking for the $76 level to hold for at least the end of this week before I would be interested in owing the stock outright. That being said, I would much rather own the stock around the $70 range, my next support level. That would entail a 10% drop however, which I don’t expect anytime in the near future, so my ideal spot to begin nibbling would be between $72-$76. I'd also like too see the MACD convergence line cross above the signal line which could indicate a shift in momentum. This is shown on the lower portion of the above chart.

As FCF for the quarter was down considerably from last year, I think the company will be able to work out its logistical issues in EM and decrease spending for demand creation over the next 12 months. This should help bring FCF at least back to even with its 2012 Q2 number of $983M, potentially providing a nice cushion under the stock. 

I believe a sideways pattern for this stock would actually be healthy for now, but I would not want to miss out on gains if investors begin buying this dip following earnings. I trade mostly options and so I am more inclined to use derivatives to take a position in or around the name. I am considering a February 75/80 long call spread. Buying the 75’s for about $4 and selling the 80’s for $1.32, giving me a net debit of $2.68 in my account. I think the stock definitely has potential to break above $80 here soon, but I feel safer buying an in the money call, and foregoing some profit if it hikes above $80. I also feel safer selling the higher call against the purchase of the lower as I can limit my loss to a predetermined value.

Thanks for reading, and HAPPY HOLIDAYS!

*Disclosure: I currently hold no position via the options market or outright ownership in NKE. I may or may not enter into a position in the near future.

Saturday, December 21, 2013

Fed TAPERS; Bernanke and Co. Surprise Many

Fed TAPERS; Bernanke and Co. Surprise Many
Written: Evening of September 18, 2013

I titled my previous blog, Can We Taper? My response was no, and I explained in quick detail why the FOMC wouldn’t or couldn’t initiate a reduction in its asset purchases just yet. Well I was wrong. Maybe not completely but nonetheless, the Fed announced its plan to begin reducing the size of QE and this post explains my take on the market moving events that occurred earlier today.

Let me first summarize the key data Dr. Bernanke reported today in his final press conference as chairman of the FOMC. Below is a bullet point summary.
·      The Fed announced that it would begin a modest reduction in asset purchases (QE program) that would begin next month to the tune of 10 Billion Dollars. This would incorporate a decrease of $5B in Treasury purchases and $5B in Mortgage Backed Securities.
·      The committee expects:
o    The Unemployment Rate to continue decreasing to a level between 6.3 – 6.6 % by the end of 2014 and reach a long run level (past 2016) of 5.2-5.8%
o   Inflation to reach its objective target of 2% by 2016
o   GDP growth to finish 2013 between 2.2-2.3%, 2.8-3.2% in 2014, and 2.2-2.4% in the long run
·      Dr. Bernanke stated that the economy had created over 2.9 million jobs since the recession and unemployment has dropped a whole percentage from 8% to 7% during this time period.
·      Non-farm payroll measures have read on average near 200k each month since QE3 began.

I stated in my last post that I wouldn’t be completely surprised if the FOMC began tapering, however I didn’t expect it. My view was that although improvements in economic data were present, we needed to sustain those economic measures for at least a couple more months before the Fed tapered its highly accommodative monetary policy. I also wrote that the rhetoric of the statement would be what influenced the markets and that was indeed the case today as well.

Lets touch on Dr. Bernanke’s rhetoric. The chairman acknowledged that growth over the past few years has been slow. He cited the housing bubble, the subsequent financial crisis, contractionary fiscal policy and also some bad luck as examples of that. He also acknowledged that labor market conditions have been tough and stated that QE measures along with decreasing fiscal drag out of Washington should help improve these conditions. He explained that although a reduction in asset purchases will begin next month, QE is still appropriate for the economy as national production has been sluggish. He further stated that with unemployment and inflation still not reaching the fed’s target values for each respective measure, the committee will continue to purchase Treasuries and Mortgage Backed Securities to some extent.

As far as for a continued taper, he stated that, “further measured steps” that would be “deliberate and data dependent” would be taken in the future. He emphasized, “asset purchases are not on a pre-set course” and that the FOMC expected to “
Maintain the Federal Funds Target Rate, in its current near 0 range, well past the time unemployment falls below 6.5%, especially if projected inflation continues to run below 2%.”

As I listened to the chairman speak and jotted down notes of his press conference, I felt like I kept hearing reasons why the Fed SHOULD NOT taper. Yet we did, and so my first thought was maybe the committee is now starting to see the risk and feel the pressure of a massively ballooning balance sheet? I then started thinking about the motive for this decision. Did most voting members of the committee simply believe it was a healthy and appropriate time to begin tapering the asset purchases of the Fed; or rather, suddenly realize the above-mentioned risk of a highly accommodative monetary policy, and decide to taper in defense of another financial type crisis? I personally think it was a little bit of both. I am under the impression that if we could eliminate the affects of the recent government shut down, this policy decision would have been suspected by most. But the shut down threw off economic measurements, and so I personally believed the Fed would have wanted to wait longer for more data to confirm a decision. I think this occurrence forced a bad hand on the committee; who may have seen the data skew from Washington’s shutdown as far too much a risk, and needed to maintain a cutoff for balance sheet increases. Also, this may have been an opportunity to control risk using their balance sheet while also supporting markets through dovish commentary. The chairman talked about interest rates still remaining low for a considerable period and that a major reason rates would remain low was due to the substantial holdings that the Fed is currently responsible for. Equity markets would still enjoy the benefits of cheap capital markets, which would continue to help stimulate them. In my opinion the press conference was rather dovish. It seemed the committee wanted to assure investors or other market participants and citizens that accommodation in the markets will most certainly still be available. While giving this assurance, they were able to also provide a slight reduction in purchases to show hawkish market participants that the reduction process has begun. This process could have giving comfort to both camps of the taper debate, enhancing the broad based rally we saw earlier in equities.

Todays FOMC press conference was very crucial. My perception was that the Fed still maintained a dovish outlook, but had realized it needed to begin de-risking, in order to avoid any future, major economic disruptions. The job that Fed committee members take on is one of great stress and pressure, yet I will say I feel confident in those members. This policy move surprised me along with many others, but like many things, the move makes more sense in hindsight. The recent economic data displays clear improvement, and although I would have liked to see a few more releases of new data, I must tip my hat to Dr. Bernanke and co. They found a creative way to continue stimulating markets and the general economy while also slowly beginning the process of shrinking the size of their balance sheet. Most importantly… the markets were MUCH HIGHER today! We got a nice little rest over last week, and boomed today. Lets ride the uptrend through Christmas now.