CWS Market Review – August 5, 2016

“The cleverly expressed opposite of any generally accepted
idea is worth a fortune to somebody.” – F. Scott Fitzgerald

The boring stock market is back. Which isn’t such a bad thing, considering all the dramatic news we’ve had this summer. Except for the two days immediately following Brexit, the S&P 500 hasn’t had a 1% daily drop in four months (see the chart below). It took a few days, but Wall Street has reverted to its pre-Brexit slumber.

Personally, I prefer boring markets. Like the tortoise, slow and steady wins the race. In this week’s CWS Market Review, I’ll bring you up to speed on some recent economic reports. The U.S. economy is soggy, but it’s mildly positive. Sure, there’s lots of room for improvement, especially with wages, but we’re not near a recession. Don’t let the fear-mongers get to you.

I’ll also update you on our two Buy List earnings reports from this week. Both Cerner and Fiserv beat the Street by a penny per share. Shares of Cerner jumped 7% on Wednesday. The stock is up more than 32% from its March low. But the big story this week was Biogen. The biotech stock jumped nearly 10% on news that it may be a takeover target. I’ll have full details in a bit, plus I’ll give you my promised analysis of Stericycle. But first, let’s run down some recent economic news.

The U.S. Economy Plods Along

Last Friday, the government said that real GDP grew by 1.2% during Q2. Frankly, that’s pretty weak, and it was less than half of what Wall Street had been expecting. Since the recession ended seven years ago, the economy has grown by just over 2% per year. This is one of the weakest recoveries on record.

One positive note in the GDP report was that consumer spending increased by 4.2% during Q2. The soft spots were sluggish business investment, less government spending and lower inventories.

Despite the sluggish numbers, we’re still a long way from the risk of a recession. In fact, JPMorgan lowered their odds of a recession in the next year to 30%. One of my favorite indicators, the spread between the two- and ten-year Treasuries, stands at 0.87%. The danger zone isn’t until the spread falls below 0.15%.

On Tuesday, the BEA said that personal income rose by 0.2% in June and personal spending rose by 0.4%. Those figures were included in the GDP, and it shows us how healthy consumer spending has been. That may not last. Part of consumers’ strength has been the improving jobs picture. The unemployment rate was 4.9% in June. However, wage growth has been weak. We need to see improvement here.

In last week’s policy statement, the Federal Reserve said, “near-term risks to the economic outlook have diminished.” That’s Fedspeak for, “we’re not following Europe off a cliff.” While that’s encouraging, I don’t believe the Fed thinks the economy is ready, just yet, for another rate hike. The futures market doesn’t see another rate hike coming for another ten months.

Now about earnings. The second-quarter earnings season is quickly coming to a close. Less than one-fourth of the S&P 500 has yet to report. So far, 78% of reports have beaten earnings estimates, while 57% have beaten their sales estimates. Earnings for the S&P 500 are now projected to fall by 3.2% for Q2. That’s not good, but one month ago, the decline was expected to be 5.4%. I think there’s a good chance we’ll see an earnings increase for Q3.

Let me caution you not to be overly concerned with the plodding economy. Much of the weakness in the past year was caused by the strong dollar. As the greenback has stabilized, we can expect some of those effects will fade. Investors should continue to focus on high-quality stocks like you’ll find on our Buy List. From our stocks, Ford Motor (F) and Snap-on (SNA) look particularly attractive at the moment. Now let’s look at our big winner from this week.

Biogen Soars on Takeover Rumors

We got a big surprise on Tuesday afternoon when shares of Biogen (BIIB) rocketed higher after The Wall Street Journal reported that two companies were interested in buying the biotech firm. The news hit the markets at exactly 2:42 p.m. Shares of Biogen immediately jumped from around $300 to nearly $330. In fact, trading in the stock was briefly halted. When trading closed on Tuesday, Biogen had gained 9.37% on the day.

Specifically, the WSJ said that Merck (MRK) and Allergan (AGN) are interested in buying Biogen. The stock has struggled since its peak at $480 in March 2015. That’s one of the reasons why I added it to this year’s Buy List. One analyst at RBC Capital said Biogen could fetch between $375 and $475 per share. I think that’s probably too high, but there’s definitely pressure on big-time healthcare companies to find merger partners. Allergan wanted to hook up with Pfizer earlier this year, but the government blocked a possible inversion.

Whether there is a deal or not, the interest in Biogen shows the hunger big pharmaceutical companies have for new sources of growth.

After years in which their pipelines were depleted, new-drug approvals are up. But the companies have become so large that adding a new blockbuster drug in many cases isn’t enough to increase growth substantially—especially given the pricing pressures that they face. Merck had a market value of $162 billion; Allergan’s was $101 billion.

Biogen had sales of $10.8 billion last year, up 11%. The company, based in Cambridge, Mass., dominates the lucrative market for multiple-sclerosis drugs, now worth nearly $20 billion a year. Its Tecfidera treatment for the condition had one of the best new-drug launches after its 2013 approval, and Biogen stock has roughly doubled since the beginning of that year, even after a sharp recent drop.

Two weeks ago, Biogen became the star of our earnings season. The biotech company reported Q2 earnings of $5.21 per share, which beat estimates by 54 cents per share. Traders loved that news, and the stock jumped 7.6% that day. Biogen also announced a $5 billion share buyback. The company said it sees EPS ranging between $19.70 and $20 this year.

On Wednesday and Thursday, Biogen’s stock pulled back as Merck, Allergan and Biogen all said there’s no deal on the table. Of course, that’s what they’re supposed to say. Still, the WSJ was confident enough to run with the story, so somebody somewhere knows something. It’s clear to me that Merck is the more likely suitor.

Here’s my view: Despite any official denials, Biogen is in play. There’s a weird dynamic in the merger game where one company may do a deal, not because they like it, but because they didn’t want a competitor to do it. A lot of companies would like to have Biogen in their tent. Even if a deal doesn’t come soon—and there’s no guarantee one will—this is a good time for Biogen shareholders. Let the bidders play! This week, I’m lifting my Buy Below on Biogen to $330 per share.

Fiserv and Cerner Beat Estimates

We had two more Buy List earnings reports on Tuesday, plus Cognizant Technology Solutions (CTSH) reports later today. Fiserv (FISV), the financial-services firm, reported Q2 earnings of $1.08 per share, which beat estimates by one penny. That’s an increase of 14% over last year’s Q2. So far, Fiserv has earned $2.14 per share for the first two quarters of this year. Revenues came in at $1.36 billion, which was below estimates.

Overall, this was a solid quarter from Fiserv:

“Our second -quarter results were highlighted by strong growth in the Payments segment, leading to double-digit gains in adjusted EPS,” said Jeffery Yabuki, President and Chief Executive Officer of Fiserv. “Strong sales results in the quarter should add to our momentum in the second half of the year.”

Fiserv was confident enough to raise its full-year range. The old range was $4.32 to $4.44 per share. The new range is $4.38 to $4.45 per share. To add context, Fiserv earned $3.87 per share last year, which means this will be Fiserv’s 30th-straight year of double-digit earnings growth. The shares pulled back on Wednesday, but it was nothing too dramatic. Fiserv is a consistent winner. I’m keeping Fiserv’s Buy Below at $110 per share.

Cerner (CERN) reported Q2 earnings of 58 cents per share, which was also a penny better than expectations. The company had previously given us guidance of 56 to 59 cents per share. Quarterly revenues rose 8% to $1.22 billion, which narrowly beat estimates.

“Cerner’s strong second-quarter results reflect good execution and competitiveness in the U.S. and abroad,” said Zane Burke, Cerner President. “We continued to gain share in what remains an active Electronic Health Record replacement market, while also having strong sales of revenue cycle and population health solutions that help our clients navigate the rapidly evolving reimbursement landscape.”

For Q3, Cerner sees earnings ranging between 59 and 61 cents per share. The Street had been expecting 61 cents per share. The company reiterated its full-year guidance of $2.30 to $2.40 per share, but it lowered its full-year revenue guidance to $4.9 billion to $5.0 billion. The previous range was $4.9 billion to $5.1 billion.

This was a solid report from Cerner, and Wall Street was impressed. Shares of CERN jumped 7% on Wednesday. I like this stock a lot. I’m lifting my Buy Below on Cerner to $71 per share.

Update on Stericycle

Last week, I promised you a detailed update on Stericycle (SRCL). The medical-waste stock got pounded for a 14.8% loss last Friday. At one point it was down more than 22% on the day. All told, SRCL fell to a four-year low.

Here’s what happened: The Q2 earnings report was fine. The company earned $1.18 per share, which matched Wall Street’s estimate, but the company also announced an accounting issue. That normally scares the bejeezus out of traders.

Stericycle said they improperly recognized loss reserves for two litigation issues. As a result, the company overstated its profit for last year’s Q1 by $46.5 million. But they also understated their profits by $27.4 million in last year’s Q2, and by $17.2 million in Q3. There was no difference in the company’s overall profit. Still, it’s embarrassing and doesn’t reassure investors.

I don’t believe the accounting issue is the tip of some kind of fraud. But I am concerned that Stericycle’s management has grown overly reliant on smaller mergers and “rollups” in an attempt to mask slowing organic sales. As a result, the earnings quality has gradually deteriorated. That’s a bad sign. I think it’s interesting that their earnings were inline with expectations, but sales were much less than expected.

On the earnings call, Stericycle said that this year’s earnings will range between $4.68 and $4.75 per share. That’s well below what I had been expecting. I have to be straight with you—I’m disturbed by Stericycle’s recent behavior. I suspected that management had been positioning the company for a sale, and they got sloppy (or greedy). Now I’m not sure that will happen. I’m going to lower my Buy Below on Stericycle to $95 per share.

Before I go, I want to give you an update on Ross Stores (ROST). Three months ago, Ross stunned Wall Street by reporting earnings that matched expectations. Clearly, no one had been expecting that. Think I’m joking? The stock dropped 5.5% after the expected earnings report.

At the time, I told investors not to worry, and that Ross was doing well. Sure enough, once the dust settled, Ross began to rally again, and it continues to be a big winner for us. The stock recently broke though $62 per share and touched an all-time high.

On August 18, the deep discounter will report fiscal Q2 earnings. This week, I’m raising my Buy Below on Ross to $63 per share.

That’s all for now. The July jobs report is due out later today. The June report showed an impressive gain of 287,000 jobs. We’ll have more economic reports next week. On Tuesday, the Q2 productivity report comes out. The job-openings report is due out on Wednesday. Then on Friday, the retail-sales report comes out. 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 August 5th, 2016 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.