Week in Review

   Stocks had a rough week. Following the politically driven decline in prices since Wednesday afternoon, each of the major large-cap indexes remains well below its respective previous-week closing levels. The Dow Industrials dropped 0.8%, the S&P 500 0.7% and the NASDAQ by 0.4%. Utilities and late bidding in energy saw these two sectors outperform, while consumer discretionary stocks ebbed. While the bulls got a boost from a rosy Consumer Confidence Survey reading (97.6) from the University of Michigan, continued negative movement on Friday underscored the recent uncertainty that has characterized trading over the past several weeks. Ongoing uncertainty in the White House has tempered investor’s initial enthusiasm on President Trumps original agenda. As these controversies mounted in recent months, traders have appeared to grow weary over the possibility that corporate tax rates, infrastructure spending and financial deregulation can be implemented before next year’s midterm election season. Terrorist attacks in Barcelona also weighed on traders’ minds.

       Earnings reporting season has come and gone, and the news has been supportive. More than 70% of the companies in the S&P 500 Index have exceeded profit expectations for the second quarter. True, there have been disappointments, and these have been dealt with harshly, especially some brick-and-mortar retail plays. On balance, however, the performance has been sufficiently positive to keep Wall Street’s bulls on board.

Here is the answer to last week’s trivia question: The ticker symbol DOOR is attributed to what NYSE listed company? Avon, Masonite International, Domino’s Pizza or ADT. Answer: Door manufacturer Masonite International Corp.

Today’s Trivia Question: Radarange, the first commercial microwave oven discovered in 1947 and sold to consumers by Amana beginning in 1967, was invented by Amana’s then parent company?  Litton Industries, General Electric, Panasonic or Raytheon.

Deere Sales Miss Expectations Despite Strong Growth

Shares of agriculture and construction machinery manufactured Deere & Co. (NYSE: DE $116.97) retreated in early trading, despite reporting strong results. Total revenue for the third quarter, including Deere’s financial-services business, rose 16% to $7.81 billion. Net equipment sales reached $6.83 billion, up 17% from last year, but shy of Street views of $6.92 billion. Deere said sales of farm and construction equipment in the U.S. and Canada grew 11% in its third quarter, while sales elsewhere in the world increased 25%. Earnings for the period was $641.8 million, or $1.97 per share, compared with $488.8 million, or $1.55 a share, a year earlier and two cents above expectations. The company still faces headwinds from U.S. farmers and crop prices, which is being partly offset by higher-growth markets internationally, especially in South America. Looking ahead, equipment sales are expected to climb 24% in the fourth quarter and rise 10% for the fiscal year and m raised full-year earnings guidance to $$2.08 billion from $2 billion.

        Elsewhere, the Moline, Illinois company agreed to acquire Germany’s Wirtgen Group for about $5.12 billion in June. Wirtgen, with strong operations in China and Brazil, could be an opportunity for Deere to increase its volume those regions. The shares are trading at an extended valuation compared to historic norms based on the improved outlook, but conservative investors may want to hold on for the longer-term.

Portfolio Change – Foot Locker

Following less-than-expected results for the past two quarters and with the outlook for the company far from bright, I am removing Foot Locker from the aggressive portfolio. With continued threats from Amazon.com and a bleak picture for the sector in general, I will concede a small loss in favor or another choice to be determined over the next few weeks.

Applied Materials Delivers Record Results; Improves Outlook

Shares of  Santa Clara, California-based Applied Materials, Inc. (NASDAQ: AMAT – $43.12) moved higher by about 4% in after-hours trading in an otherwise dismal day on Wall Street. The company, which celebrates its fiftieth anniversary later this year, increased third quarter adjusted gross margin by 2.9 points to 46.6%; grew adjusted operating margin by 5.9 points to 28.7%; and increased earnings per share on an adjusted basis by 72% to $0.86 – two cents above Street expectations. The manufacturer of equipment, services and software to the semiconductor and display industries, grew net sales by 33% to $3.74 billion year-over-year. Analysts had been anticipating revenue of $3.68 billion. The company also said it generated a record $1.37 billion in cash from operations, which represented 36% of revenue, and returned $482 million to shareholders through stock repurchases and cash dividends. “With revenue and profits at all-time highs, Applied has tremendous momentum and a very positive outlook for the future,” said CEO Gary Dickerson. “Our markets are growing with a broader set of demand drivers, and the breadth of Applied’s technology enables us to play a larger and more valuable role advancing the innovation road map in semiconductor and display.” 

       Executives also raised guidance for the fourth quarter of fiscal 2017, and now expects net sales to be in the range of $3.85 billion to $4.0 billion; the midpoint of  which would be an increase of about 19% from a year ago. Adjusted diluted earnings is expected to be in the range of $0.86 to $0.94 per share, well above the consensus of $0.82, and the midpoint of the range would be an increase of approximately 36% compared to last year’s fourth period. The growth of this cyclical company may run out of steam over the longer-term, but for now, the shares remain a solid holding for the venturesome. Also, the strong balance sheet and ample cash flow indicate future share buybacks and dividend hikes may be on the horizon.

 

Week in Review

    Stocks were down across the board this past week, as geopolitical tensions between the United States and North Korea weighed heavily on investors’ minds. However, considering all the rhetoric and threats, the markets were quite resilient and Friday saw a modest reversal to Thursday’s steep selloff. The retreat was probably well needed, as equities are at record highs with virtually no volatility. While the Dow was negative by 1%, the S&P 500 and the NASDAQ moved lower by about 1.5%. Small and mid-cap stocks were particularly hard hit giving up nearly 3%. And all sectors were in the red, led by the more volatile financial, energy and basic material stocks. Traders headed for safety and consumer staples and utilities were the least of the negative bunch. Treasuries were also sought after and safe-haven gold rose nearly $30 to a two-month high.

      The economy remains positive with a few starts and stops along the way. For example, factory orders are at an eight-month high; manufacturing is showing resilience; and exports are rising again. However, growth in non-manufacturing is slowing; the slump in auto sales is now seven months long and counting; and personal income is flattening out. This uneven pattern suggests that current-half GDP growth will vary little from the 2.6% increase in the second quarter and, thus, inflation should remain low.

       Second quarter earnings season is mostly behind us and was respectable in most regards except for brick-and-mortar retail. A few more reports from retailers are on tap for this week including aggressive choice Foot Locker, which will do well to match last year’s $0.94 per share. The July retail sales report will come out on Wednesday. We will also hear from Deere & Co. with Street estimates of $1.91 vs. $1.55. With geopolitical risks looming and valuations stretched, investments in higher-quality, dividend paying stocks appears to be the most prudent strategy.

Here is the answer to last week’s trivia question: The “40” in the WD-40 Co. brand represents the fortieth attempt to perfect the iconic lubricating formula. What does the “WD” stand for? Will-Do, Wilmer Dawson, Water Displacement or Wear Detraction. Answer: Water Displacement.

Today’s Trivia Question: The ticker symbol DOOR is attributed to what NYSE listed company? Avon Products, Masonite International, Domino’s Pizza or ADT.

Delta Air Lines Hikes Dividend

Shortly after posting yesterday’s analysis of Delta Air Lines (NYSE: DAL – $49.33), the company increased its quarterly dividend by 50% from $0.203 per share to $0.305. The new annualized rate will provide investors with a $1.22 per share payout and yield 2.5% at current quotations.

Diversification – Update

Following some recent changes to the aggressive and income portfolios, I wanted to take a look at how the diversification model is shaping up for the three lists. I believe there is an adequate level of sector diversity across the three portfolios. The conservative group is somewhat over-weighted with industrial stocks, but these positions should continue to do well in a growing global economy and each company serves a unique market. Likewise, the aggressive list has three technology names, but is well diversified within the sector to the semiconductor, electronics and healthcare information technology industries. Here is the latest view:

 

Stock to Consider: Delta Air Lines

Atlanta-based Delta Air Lines, Inc. (NYSE: DAL – $49.71) is a major international airline with ten airport hubs including New York (JFK and LaGuardia), Los Angeles, Atlanta, Detroit, Minneapolis, Seattle and Salt Lake City. Internationally, Delta provides service to every major international market as part of the Sky Team Alliance with Air France-KLM, Alitalia, Korean Air and Virgin Atlantic, among others. Delta gets about two-thirds of its revenue domestically, where trends have been more favorable than on overseas routes. Revenues by geographic region: United States – 70%; Atlantic – 15%; Pacific – 8%; and Latin America – 7%. Regional service is operated under the brand name Delta Connection. In October 2008 Delta acquired Northwest Airlines making it the largest carrier in the world in terms of scheduled passengers. The company also owns and operates an oil refinery in Pennsylvania. 

       Delta is widely viewed as the best-run major U.S. airline with disciplined capital spending, ample profit margins and an aggressive plan for returning capital to shareholders. The company also has been spending to refresh its fleet and upgrade terminals at key airports like Los Angeles International and New York’s LaGuardia. The company has a relatively old fleet of 832 aircraft, averaging about 16.6 years, against 9.8 years at American and 14.4 at United. It has replaced a quarter of its fleet in the past five years, and may replace another 25% by 2020. 

       Delta’s second-quarter earnings of $1.68 a share matched expectations, as did current-quarter guidance of 2.5% to 4.5% growth in passenger unit revenue and an 18% to 20% operating margin. Delta is calling 2017 a “transition year” as it digests fuel-price increases, aircraft purchases and a new pilot contract. Earnings this year are expected to be little changed from 2016 at about $5.43 per share. Delta’s goal is to limit nonfuel cost increases, mostly labor, to 2% annually in the next few years. Management has been strategically ahead of the industry and a good allocator of capital. Delta has also moved to improve its balance sheet and bolster an underfunded pension plan. It has an investment-grade bond rating on net debt of $8.4 billion. It aims to reduce that to $4 billion by 2020. Sooner or later, Delta’s operational and financial performance will get recognized by investors, and the company’s shares and valuation should move higher. Some analysts believe the shares could trade at 13 to 15 times earnings in a year or two as compared to 11 at current levels

        Last year Delta repurchased $2.6 billion of its stock, or 7% of its shares. Buybacks could rise in the next few years if it hits its annual free-cash-flow targets of $4.5 billion to $5.5 billion. The airline plans to return 70% of its free cash flow to shareholders and to lift the $0.81 per share dividend 50%. Thus, long-term investors willing to assume some risk in this volatile and competitive industry may want to take a closer look here. Margins should start to pick up steam next quarter, setting DAL up for solid earnings growth over the long haul. I am initiating Delta with an 8% allocation in the portfolio.

 

CVS Health Beats Estimates; Lowers Short-Term Guidance

Retail drugstore chain and pharmacy benefits manager CVS Health (NYSE: CVS – $78.02) reported adjusted earnings per share of $1.33, beating the $1.31 consensus. Revenue for the quarter rose 4.5% to $45.7 billion, also ahead of the $45.4 billion modeled by analysts. Operating profit in the Retail/Long-Term-Care Segment was in line with expectations on a 2.2% sales decrease, while operating profit in the Pharmacy Services Segment exceeded expectations with an increase of 9.5% to $32.3 billion. Pharmacy same-store sales fell 2.8%, affected by about 410 basis points by recent generic introductions. Front-of-store same-store sales fell 2.1%, caused by softer traffic and store promotions, despite the shift of the Easter holiday to the second quarter vs. in last year’s first period. During the quarter, the company opened 27 new retail locations and closed three stores and relocated 10. As of June 30, the company operated 9,700 locations, including pharmacies in Target stores, in 49 states, the District of Columbia, Puerto Rico and Brazil. As previously disclosed, the company intends to close about 70 retail stores during 2017. 

       CVS upped its full-year guidance, expecting adjusted earnings per share to be $5.83 to $5.93 versus a previous $5.77 to $5.93, and compared to Street views of $5.87. For the upcoming third quarter, however, the company is projecting adjusted earnings of $1.47 to $1.50 per share, well below consensus estimates of $1.63. Management confirmed its 2017 cash flow from operations guidance of $7.7 to $8.6 billion and free cash flow guidance of $6.0 to $6.4 billion, assuming the completion of $5.0 billion in share repurchases. 

       This equity has pulled back a bit in recent months and is negative over the past year by about 18.5%. However, appreciation potential out to 2020-2022 appears healthy, especially when viewed on a risk-adjusted basis. Strong cash flow generation should allow CVS to continue rewarding shareholders via dividends and share buybacks, too. That said, Amazon’s potential move into the pharmacy space is a concern and the company has been the subject of recent legal issues with the State of Minnesota and the Medicare program regarding pricing and billing practices, adding another degree of uncertainty for the shares. However, I am going to continue to hold on for now.

Stock to Consider: LyondellBasell

LyondellBasell Industries N.V. (NYSE: LYB – $89.10) is a global chemicals company that engages in the conversion of large volumes of liquids and gaseous hydrocarbon feedstocks into plastic resins and other chemicals. The company’s origins date back to 1953. The Lyondell Chemical Co. was spun off from Atlantic Richfield (ARCO) in 1989 and merged with Basell – originally a joint venture of Royal Dutch Shell and BASF – in 2007. Although the company is domiciled for tax purposes in The Netherlands, with offices in London, LYB has a major presence in Houston and has operations at 55 manufacturing sites in 18 countries. The company operates in five business reporting segments:

  • The refining segment (16% of 2016 sales) produces gasoline, jet fuel, heating oil, diesel fuel, lube oils, coke and sulfur from crude oil at refineries on the Gulf Coast of the U.S.
  • The two Olefins and Polyolefins businesses (59%) are the world’s largest producers of polypropylene and related compounds and a top worldwide producer of polyethylene, ethylene and propylene. Products from O&P find their way into the food packaging, container, automotive and consumer disposable industries, to name a few.
  • The Intermediates and Derivatives segment (24%) is a leading global producer and marketer of propylene oxide and its derivatives including propylene glycol, propylene glycol ethers and butanediol used in the home furnishing, insulation, electronics and automotive industries.
  • The Technology business (1%) develops and licenses polyolefin and other process technologies; provides associated engineering and other services; and develops, manufactures and sells polyolefin catalysts to manufacturers.

In 2016, 48% of revenues were from the U.S, 19% from Europe and 33% from the rest of the world.

        For the second quarter, sales were up 15%, to $8.4 billion and adjusted share net rose 15% to $2.82. Lyondell’s margins have improved markedly over the years. In 2011, LYB posted share net of $3.79 on over $51 billion in sales. In 2016, it posted share net of $9.13 on $29.2 billion in revenue. This is a significant margin enhancement and demonstrates how efficient the operating leverage has become. It should also be pointed out, however, that lower interest rates and share repurchases have helped. This year margins are apt to decline a bit due to ongoing maintenance charges and inventory write-downs.

       Over the long-run, I believe results should benefit from increasing global demand for petrochemicals and a more favorable raw material cost position in the company’s Americas unit, stemming from a projected increase in U.S. natural gas supply. LYB’s capital expenditure program and operational improvements will also help to drive earnings growth as it invests in high return projects. The company has strong cash flow and a solid balance sheet. As of March, it had nearly $17 billion in cash on its books and long-term debt of $8.4 billion is manageable. Last year the company provided investors with a respectable 63.4% return on equity, well above the industry average. Adjusted earnings for the first half of the year were $5.08 compared to $4.75 in 2016. For the full year, Street estimates are $9.89 per share on revenue of $32 billion vs. $9.13 last year on sales of $29.2 billion, affording the shares a reasonable estimated price earnings ratio of 11. The company pays a recently hiked $3.60/share annual dividend yielding investors 4% at current levels. The shares are not for the risk averse. National or global economic conditions, raw material and energy costs and a strong dollar pose possible investment threats to LYB.  But I believe longer-term the shares should do well for income investors willing to assume those risks. I am starting the position with a 9% allocation for the income portfolio.

In the interest of full disclosure, I hold in position in LyondellBasell in one of my managed accounts.