CWS Market Review – May 29, 2015

Foul-cankering rust the hidden treasure frets,
But gold that’s put to use more gold begets.
– Venus and Adonis

We’re back from a nice holiday respite. I hope everyone had an enjoyable Memorial Day weekend. This has been a quiet time on Wall Street and for our Buy List. Since I sent you the last issue of CWS Market Review, our Buy List is up a whopping 0.04% while the S&P 500 has careened for a massive loss of 0.01%.

Maybe Wall Street knew I was going on vacation!

But don’t despair; there’s good news to pass along. Two of our Buy List stocks, Hormel Foods (HRL) and Ross Stores (ROST), both posted strong earnings last week. I’ll have more details in a bit. I’ll also bring you up to speed on some of the other news impacting our Buy List.

In this week’s CWS Market Review, I’ll tell you that our old friend the Strong Dollar Trade is back in town. I wrote about this a lot last year. All investors need to understand how the rising greenback impacts the stock and bond markets, and in turn, our Buy List. This is a complicated topic and I’ll break it down without using fancy econo-jargon.

Wall Street is still in a good mood. Last Thursday, the S&P 500 closed at an all-time high and one week later, we’re less than 0.5% away from record territory. Several of our Buy List stocks, like eBay (EBAY) and Snap-on (SNA), are at or near new 52-week highs. I’ve also noticed that Wall Street has mostly stopped paring back earnings estimates for Q2. That could be a good sign. Now let’s take a closer look at the return of the Strong Dollar Trade.

The Strong Dollar Trade is Back On

Late last year, I started talking a lot about the Strong Dollar Trade. This was when the U.S. dollar started soaring against other major currencies like the euro and yen. The fallout of this trade could be felt in many different arenas such as in the commodity pits as the price of oil price plunged (crude is traded in dollars) and in the stock market as energy and materials stocks floundered.

To be more precise, it wasn’t that the dollar was doing well; it was that everything else was doing worse, so the dollar, by default, looked good. In Europe, Mario Draghi finally convinced policy makers to give Quantitative Easing a shot. In Japan, after trying everything else for 25 years, the government also launched a plan to weaken the yen in hopes that it would boost the economy. In early August, one dollar would get you 102 yen. Four months later, it got you 121.

For most of this year the yen stabilized against the dollar, but recently, it’s started to fall again. In fact, the yen has lost ground against the dollar in ten of the last 11 trading sessions. The greenback just hit a 12-year high against the yen. The weak-currency tonic may be working; the Japanese stock market is in the midst of its longest rally in 27 years.

The reason why the strong dollar is back is that the market assumes that the Federal Reserve will raise interest rates at some point and those higher yields will make dollar-denominated assets more attractive. Honestly, it doesn’t look like interest rates will go up in Europe or Japan anytime soon.

The recent economic data hasn’t been great, but it’s showing that the economy is indeed moving ahead. That seems to be good enough for Janet Yellen and her friends at the Fed. Jobless claims have been below 300,000 for 12-straight weeks. Consumer confidence is up. This week we learned that pending home sales reached a nine-year high. Housing starts were up 20% in April.

The Strong Dollar Trade isn’t as pronounced as it was before. For one, the dollar hasn’t been as strong against the euro as it has been against the yen. We also see that commodities aren’t getting pounded like they did before. The price of oil is holding steady around $58 per barrel and gold is just below $1,200 per ounce. The dollar may make a run at parity with the euro, which it hasn’t seen since 2002, but it has a way to go.

I doubt we’ll see the rising dollar take a big bite out of corporate earnings like it did in the first quarter. Analysts have mostly stopped cutting back on their expectations for second-quarter earnings. The most important impact of the rising dollar will be felt in new-found respect for growth stocks. This will be seen in areas like tech. In fact, the tech sector has been outpacing the rest of the market for the last six weeks.

On our Buy List, this means that stocks like Microsoft (MSFT), Cognizant Technology (CTSH), Oracle (ORCL) and Qualcomm (QCOM) are poised to do well. As always, pay attention to my Buy Below prices. Now let’s take a closer look at two of our recent Buy List earnings reports.

Earnings from Hormel Foods and Ross Stores

We had two Buy List earnings reports last week. On Wednesday, May 20, Hormel Foods (HRL) reported fiscal Q2 earnings of 67 cents per share. That was four cents more than Wall Street had been expecting. It was also a nice increase over the 52 cents per share Hormel had made in last year’s Q2.

This was especially-welcomed news because there were concerns over the impact of the avian flu on Hormel’s business. I should say that the company has been transparent about the issue which shows you why it’s important to stick with high-quality stocks. Good companies don’t treat investors as if they’re the enemy. Quarterly revenues climbed 1.5% to $2.28 billion which was below Wall Street’s estimates of $2.39 billion.

“We achieved record second quarter earnings and sales, driving double-digit earnings growth with all five segments delivering increases,” said Jeffrey M. Ettinger, chairman of the board, president and chief executive officer.

“Although declining pork markets drove lower pricing and net sales this quarter, Refrigerated Foods increased operating profit by 52 percent with strong sales growth of foodservice and retail value-added products,” commented Ettinger. “Jennie-O Turkey Store entered the quarter with excellent momentum and drove robust sales and earnings gains, but exited the quarter with substantial supply chain challenges brought on by avian influenza. Grocery Products benefited from input cost relief and growth of our SPAM® family of products, while the export business in our International segment continued to be challenged by port issues and the strong U.S. dollar,” commented Ettinger. “Specialty Foods delivered earnings growth as the team continues to achieve synergies with the recently acquired CytoSport business.”

Hormel again acknowledged that avian flu will be an issue for them, but they’re sticking with their full-year guidance of $2.50 to $2.60 per share. That seems quite reasonable. With two quarters down, they’ve already made $1.30 per share this fiscal year.

“While we enjoyed an excellent first half, we expect Jennie-O Turkey Store to be significantly challenged going forward due to the impacts of avian influenza on our turkey supply chain,” commented Ettinger. “Refrigerated Foods and Grocery Products will continue to benefit from value-added product growth and lower pork input costs. Specialty Foods is positioned to deliver substantial earnings increases in the back half with the CytoSport business. Taking these factors into consideration, we are maintaining our 2015 non-GAAP earnings guidance at the lower end of our previously stated $2.50 to $2.60 per share range.”

The stock got a very big boost after the earnings report; HRL broke above $59 the afternoon of the earnings report. But soon after, HRL retreated back below $57. That was until this week. The stock got another boost on Wednesday when Hormel said it’s buying Applegate Farms for $775 million. Applegate is a leader in natural and organic prepared-meats. If you want 100% grass-fed beef hotdogs, then Applegate is the place to go. Hormel is wisely following eating habits as more Americans move away from those awful carbohydrates.

Hormel closed the day on Thursday at $58.20 per share. I’m keeping my Buy Below at $61. This November, I expect to see Hormel raise its dividend again. That will make 50-straight years of dividend increases. This is a good stock.

In the last issue of CWS Market Review, I told you that Ross Stores (ROST) would beat the guidance they gave—and I was right. Frankly, Ross tends to be pretty conservative with their numbers. The company projected fiscal Q1 coming in between $1.21 and $1.27 per share.

Please. I said I was expecting $1.30 and they beat that. Ross reported earnings of $1.33 per share. Quarterly sales rose 10% to $2.938 billion. Comparable store sales were up 5%. These are very good numbers.

Barbara Rentler, Chief Executive Officer, commented, “We are pleased with our better-than-expected sales and earnings in the first quarter. Our results continue to benefit from value-focused customers responding favorably to our fresh and exciting assortments of name brand bargains. Operating margin for the first quarter grew to 15.7%, up from 14.6% in the prior year, driven by a combination of higher merchandise margin, strong expense controls, and the aforementioned favorable timing of packaway-related costs.”

Ms. Rentler continued, “During the first quarter of fiscal 2015, we repurchased 1.7 million shares of common stock for an aggregate price of $176 million. As planned, we expect to buy back a total of $700 million in common stock during fiscal 2015 under the new two-year $1.4 billion authorization approved by our Board of Directors in February of this year.

The bad news is that Ross offered Q2 guidance of $1.19 to $1.24 per share with same stores sales rising by 2% to 3%. That’s pretty weak; Wall Street had been expecting $1.26 per share. But as I said, Ross tends to be conservative with their guidance.

The weak outlook clearly upset traders as shares of Ross dropped more than 4.4% last Friday. I’m not worried at all and neither should you be. Two weeks ago, I told you that Ross’s full-year guidance was too low—and the company raised it. Ross now sees full-year earnings ranging between $4.72 and $4.87 per share. The old range was $4.60 to $4.80 per share.

For some context, Ross earned $4.42 per share last year. (By the way, Ross’s guidance from last May was for $4.09 to $4.21 per share which shows you how conservative they tend to be.) All the evidence tells me that Ross is executing well. Remember that ROST will split 2-for-1 next month so don’t be alarmed when you see the lower share price. Ross Stores remains a good buy up to $107 per share.

Updates on Other Buy List Stocks

In a few weeks, I expect to see CR Bard (BCR) raise its dividend again. That’s not much of a surprise since the company has increased its payout every year since 1972. Bard currently pays out 22 cents per quarter which is rather puny. For the year, that’s less than 10% of Bard’s net. Business is going well for them and they had another good earnings report last month. CR Bard is a buy up to $184 per share.

Shares of Ford Motor (F) have been weak again—the company announced a recall this week—but I encourage you not to give up on this stock. The automaker is going for less than 10 times earnings and the dividend yield is nearly 4%. Things are clearly going well for Ford. Last month, Ford raised its estimate for operating profit margin in North America. The company is standing by its forecast of a pre-tax profit of $8.5 billion to $9.5 billion for this year. Don’t let the soggy stock scare you. Ford remains a buy up to $17 per share.

Last week, Qualcomm (QCOM) said it was launching their accelerated share repurchase program. This is part of their $15 billion buyback program they announced in March. Qualcomm aims to purchase 57.7 million shares for $5 billion. The purchase is being funded by Qualcomm’s recent $10 billion bond deal. Until the offering, Qualcomm didn’t have a dime of long-term debt.

The stock hasn’t done much in the last year, and I think the activist investors are finally having an impact on Qualcomm. The company gave us a nice dividend increase and the big share buyback. Jana Partners wants them to go further and break up the company. I don’t know if that will happen, but I agree there’s a lot of untapped value here.

Qualcomm gapped up on Wednesday of this week after the news that Broadcom (BRCM) is being bought out. Qualcomm is a buy up to $72 per share.

Barron’s recently profiled Express Scripts (ESRX). Here’s a sample:

Express Scripts will benefit from a number of trends in the health-care industry. The rising demand for so-called specialty drugs, for instance, is a one-two punch for the company. First, as a pharmacy benefit manager, it uses its clout to negotiate favorable prices from drug makers for health plans — and gets a cut of those savings. But the company also operates a large mail-order and specialty drug pharmacy. So, somewhat incongruously, it also profits from growing demand for the same high-priced therapies that are playing havoc with health insurers’ medical cost trends. These two forces should combine to push shares higher.

The article noted that ESRX trades at a lower valuation than CVS (CVS). But if you tack a multiple of 17, which is quite reasonable, onto next year’s earnings estimate that gives you a share price of $102.51. That’s a 15% climb from here. This week, I’m raising my Buy Below on Express Scripts to $92 per share.

That’s all for now. With the beginning of June, we’ll get several important turn-of-the-month economic reports next week. On Monday, the ISM report for May comes out. The April ISM was unchanged from March, and the five reports prior to that all showed declines. I want to see an improvement here. Car sales come out on Tuesday. I expect more good news from Ford Motor (F). Wednesday is the Fed’s Beige Book plus the ADP jobs report. Then on Friday is the big May jobs report. The April jobs report was a nice rebound from the weak number for March. 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

Posted by Eddy Elfenbein on May 29th, 2015 at 7:08 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.