Signs of the Season
We’ve had plenty to talk about in all of our services since our last visit here in Inner Circle, but the most important is that the market has fluctuated to new highs on word from the Federal Reserve that quantitative easing tapering would not begin until later this year. Investors have now turned their attention to what largely had been anticipated as a lackluster earnings season – but so far, the first wave of second-quarter announcements have fallen under the “good enough” category.
While about 75% of the S&P 500 companies that have reported so far have beaten consensus, this does not necessarily indicate a blowout quarter because the bar has been set unusually low. Various analyst surveys show that investors were already steeled to expect earnings growth in the anemic 1.8%-3.8% range for the market as a whole, so anything better than that may be greeted with relief and even encourage some money off the sidelines.
Despite the market remaining near record highs, confidence remains tentative, which leads me to wonder how much fuel the bulls have left before recharging.
The technology heavyweights are under significant pressure with Intel (INTC), Google (GOOG), IBM (IBM), and especially Microsoft (MSFT) delivering some degree of disappointment. In all, analysts only expected 1.97% growth from the sector, but this target will be harder to achieve with so many giants missing their marks. In fact, the harsh 12% decline in MSFT on significantly high volume tells us that investors are really ready to act on earnings results.
Netflix is another example. The stock has been volatile from the very beginning but today’s 5% dip shows us that all the positive reviews and critical acclaim of being a content provider becomes irrelevant if there’s a hard-core miss in expectations or unexpectedly weaker guidance. Meanwhile, Apple (AAPL) spiked after hours tonight on its earnings beat, but fiscal fourth-quarter sales outlook fell short of estimates. Bottom line, this is a “take no enemies” kind of earnings season.
Financial stocks fared better with JPMorgan (JPM), Morgan Stanley (MS) and Bank of America (BAC) all reporting that their profits expanded by 33% or more. And don’t forget to keep an eye on retail. With the consumer currently holding the economy together, results from retail stocks like Ralph Lauren (RL), Estee Lauder (EL) and the entire department store sector will be the real wild card that either gives the market pause or allows the bull to keep running wild.
One thing I’m watching very closely this quarter is forward guidance. With so many analysts still expecting earnings growth to rebound to double-digit levels for the remainder of 2013 and beyond, it is likely that a lot of forecasts will need to scale back.
All in all, the market remains in a precarious position, but momentum continues and we’ve prepared for upcoming choppiness by banking profits when it was smart and focusing on stocks with upside potential but less downside risk. Among the stocks we’ve talked about here in your special Inner Circle issue, there is one I want you to sell now, and I have a new recommendation for you if you want to put that money right back to work.
Sell AIG
AIG (AIG) has been on a nice run recently and is closing in on a new 52-week high thanks to market excitement that the insurance giant will announce a dividend when it reports earnings next week. While the company is expected to report solid profits, AIG will still need to convince the Federal Reserve and other regulators that it is healthy enough to return capital to shareholders instead of reserving it to prevent the need for further insurance industry bailouts.
With issues still hanging over the stock, I don’t see significant upside potential from current prices. I recommend that we use the momentum to lock in our 20% profits in less than six months. I’ll continue to watch the stock closely, and if I see another opportunity for gains, I will let you know. But for now, there’s not much room left for the stock to run. Sell AIG.
Stock of the Month: XOOM
Staggering unemployment numbers over the last few years have sent those seeking jobs wherever opportunity lies – even if it means crossing national or cultural borders to get there. Many end up leaving loved ones behind, regularly sending money back for their support. Last year alone, workers sent well over $500 billion home in the form of wire transfers and direct mobile payments – and paid an average fee of 9.05% for the privilege.
That’s the market opportunity that a newly-public, money-transfer services company called Xoom (XOOM) is targeting with advanced technology that allows it to aggressively undersell its more entrenched competitors. XOOM has only been on the market since February 15, when it went public in a low-profile IPO. I like the fact that it was a quiet IPO, and the stock did pull back after an initial run-up, so this stock has less post-IPO froth than many companies. I’m recommending it today to get in ahead of the curve and put us in great position to profit once the market catches up to its potential.
And that potential is impressive. The money-transfer services sector is truly vast and fragmented enough to give a start-up room to thrive. More than 215 million people – about 3% of the world population – are currently living and working outside their native country. That number has doubled in the last 40 years, and there’s every indication that the trend will continue as people seek opportunity in an increasingly global economy.
It’s a recession-resistant and steadily-expanding business that boasts annualized growth of around 6%, which means there’s plenty of competition. Xoom’s biggest rivals are Western Union (WU) and former Breakout winner Moneygram International (MGI), which between them raked in roughly 15% of the total revenue pot, according to their most recent quarterly results. However, their share is shrinking as new vendors roll out cheaper, more convenient phone payment systems that render their hard-built local branch networks increasingly obsolete – and no one is doing this better than XOOM.
The company has already captured 1% of the world’s fund transfer volume in its relatively short existence. That may not seem like a lot, but it’s enough to put it within striking range of Moneygram’s less-than-commanding 3%-4% share, and enough to look imposing compared to endless local and fringe international rivals. Should some consolidation take place, XOOM will either lead the way or become an especially attractive strategic takeout target.
From the consumer’s perspective, Xoom is holding all the cards needed to line up the transactions and collect the fees. Because the company runs all of its money transfers online via automated clearing house (ACH) protocols, there’s no need to support the extensive and expensive branch networks that made Western Union and Moneygram household names around the world. This dramatically reduces overhead and translates into lower fees and faster service. A $200 transfer costs a flat $4.99 if the money comes from a debit or credit card, and possibly even less as a straight bank-to-bank transfer. To get that kind of pricing from Western Union, a customer would have to wait three to five days for the cash to move. XOOM can do it in a matter of hours.
The credit card option is especially appealing for immigrant workers who may not be eager to open U.S. checking accounts. Western Union will charge $33 to go the credit card route to Brazil, for example, while XOOM will provide the same service for $6.99. Needless to say, as word of mouth about the new discount service spreads, transaction volumes, market share and revenue are unlikely to go anywhere but higher.
And it bears repeating that while individual transfers may almost look trivial by U.S. investor standards, they add up quicker than we might think. I recently traveled to a country that derives well over 40% of its GDP from expatriate workers sending money back, and even that mountain of cash represents only a minuscule percentage of the dollars that move to countries like Haiti, El Salvador and Mexico – much less India and China. If XOOM can earn its share of the fees those flows generate, it will unquestionably become a stock to watch.
Our Opportunity
Some of XOOM’s valuation may reflect investors’ hopes for a merger premium down the road, but its current share price seems based more on the company’s ability to grow its way to profitability in the relative near term. XOOM reported a fiscal first-quarter loss of $79,000 on $24 million in revenue, so unless management decides to authorize a fresh round of expensive development on the corporate platform, it may only take a tiny increase in scale to push the bottom line into the black. And after that point, XOOM has the potential to ramp up earnings a lot faster than anyone suspects.
The company’s next earnings report is scheduled for Wednesday after the close. With expectations low, I do not expect shares to move dramatically on the results and feel comfortable recommending it ahead of the report. Anything better than a fiscal second-quarter loss of $0.11 on $25.7 million in revenue, which is the very low end of guidance, should have Wall Street revising its models in a hurry.
As a newly public company without a longer-standing growth curve to support its share price, XOOM is a bit more of a speculative play than some of our other Inner Circle recommendations. However, the lock-up period for shares has passed, meaning insiders and bankers have been free to sell shares for a while. This can cause a pullback after IPOs, and I like to wait until that’s past to move in. I also like that it dipped from highs around $26.50 at the IPO to $18 and has since regained strength, so that lessens risk as well. And as the company continues to expand and operations improve, I see the taking off nicely. Buy XOOM under $28 for a target of $40 within the next 18 months.
Earnings Previews: GRA, CALM, ITUB, FWLT, HIBB
W.R. Grace and Co. (GRA) is scheduled to release second-quarter results on Thursday, July 25. Analysts are expecting $820 million in revenue and $1.05-$1.08 in earnings, which may be slightly to the lower side of guidance. Price targets have crept upward all year long and are now 17% above where they were in January. With the near-term trend soaring above longer averages, there are hints that GRA may be a little overbought even if the company emerges from bankruptcy soon and rewards shareholders with refreshed dividends and buybacks. I still expect those catalysts to ultimately drive the stock higher, so hold GRA and buy only on dips below $79.
Cal-Maine Foods (CALM) is due to report earnings before the bell on July 29. Currently trading at a 52-week high near $52 a share, it is evident that the market has baked in a lot of upside in the egg company’s recent quarter. Analysts are looking for EPS of $0.74 a share, which would represent a stunning 72% year-over-year growth if CALM hits the mark. I continue to like the stock and recommend that you hold CALM ahead of earnings.
Itau Unibanco (ITUB) welcomed a month of relative quiet following June’s firecracker protests in its native Brazil. The stock has bounced back impressively since local central bankers raised their overnight interest rate target 50 basis points on July 10 in order to get food prices under control and alleviate frustrations. While the rate move makes credit less attractive and more expensive to Brazilian consumers, ITUB is positioned to make the best of an unsteady domestic situation after management’s extensive cost cutting and redoubled efforts to diversify rate-driven revenue streams into more dependable fee-based businesses.
As a result, the turmoil of the last quarter may have no net effect on ITUB’s bottom line when it reports on July 30. I’m watching for core earnings to hang on at $0.35 a share and for relatively rapid recovery when the Brazilian economy turns its next corner. As of now, the stock remains relatively cheap with a P/E under 10 and a price well below even a significantly lowered Wall Street target of $16.57. ITUB remains a buy below $16.
Foster Wheeler (FWLT) has had a busy month, acquiring Ingen Ideas, a U.K. oil and gas engineering consultancy in early June. Management has picked its partners to build a pilot synthetic natural gas plant in China and signed a contract to help midstream energy company Enterprise Partners expand its Gulf Coast fuel storage and distribution facilities. The stock presents an interesting and relatively dynamic play on the North American energy boom – especially since Wall Street has tightened its consensus target to $26.54 over the last few weeks. Given the company’s own guidance, expectations may be a little too low. Look for any print above $885 million in revenue and $0.33 in EPS to galvanize the market when FWLT reports earnings on August 8. Buy FWLT below $24.50.
Hibbett Sports (HIBB) has been relatively quiet recently. And although it’s trading in the mid $50s, I wouldn’t be surprised if we saw a short-term reversion rally. Right now, the big question for HIBB is whether the sporting goods chain can keep expanding its national footprint ahead of rivals and whether bad weather (this time a hotter-than-normal summer) will remain a drag on earnings when it reports in mid-August. If management doesn’t blame the weather, revenue and growth may have hit a wall. Any deviation from $185 million in sales and about $0.39 cents in EPS could confuse investors, which in turn, could create an attractive buying opportunity. I recommend taking advantage of this because the stock still has catalysts in place going forward, including the debut of its new Nike Jordan sneakers later this year, and it also remains a potential acquisition target. Continue to buy HIBB up to $57.
MW’s Management Shake-Up
Men’s Wearhouse (MW) weathered the surprise ousting of its CEO, spokesman and founder George Zimmer, with a strong move to the upside and has been running ahead of the trend ever since. While Zimmer’s departure overshadowed operations for a few weeks, the company is now back on track, most recently spending $97.8 million to acquire fashion clothier Joseph Abboud and renewing its commitment to buying back $200 million of its own shares as opportunities emerge.
Although rumors of a leveraged buyout keep circulating, the stock remains attractive on weakness, and Wall Street remains convinced it will outperform the market. Earnings and dividend aren’t due until mid-September, so there is plenty of time to trade this chart on a tactical basis. MW offers a nice 2% dividend yield and a strong balance sheet with no debt, which will help them survive any potential rate increases or market volatility down the road. I expect to see substantial gains over the next 12 months from current prices. Buy MW on dips below $38.
Ask Hilary: Selling Strategy
I want to wrap up this month’s visit with a question I received from a subscriber that I thought was very fitting as we wait to see whether the market will continue to running or pull back.
Charles asks, “It is often said to let your winners run. How do you determine when they have run as much as they probably will and sell before the profit erodes away?”
This is actually two great questions in one: how do you identify a sell trigger and what discipline is required to sell shares once they hit your target.
Identifying a sell trigger can vary across my different services. For example, in GameChangers and Breakout, I include a target price with any new company that I recommend. I keep a close eye on the catalysts that will move the stock to that price, and when I believe the story has played out, we sell. This happened with SHFL Entertainment (SHFL) in GameChangers last week, which we sold after it was acquired and shares looked highly valued. We had hit our target and with little room left to run, we booked our profits.
With some of the promising discount opportunities that populate the Absolute Capital Return Buy List, setting a concrete exit target at “fair value” – the maximum price you would be willing to pay to buy in – makes a lot of sense. Beyond that point, the stock may have the fuel to keep running, but the rationale for holding it has changed. When that happens, I like to lock in my profit and then get back into the name at the next sign of weakness.
In High Octane, timing is everything. When recommending a trade, I look for specific catalysts that will move the stock (earnings reports, economic data, technical indicators or even company announcements), and I go with a call or put based on where I believe the stock will move on that catalyst. While I generally don’t include specific target prices to sell at, the goal in trading is to make quick profits. If we get the movement we were looking for, I will send a Flash Alert to sell. If we don’t, I either reassess if the story needs to play out or move on to the next opportunity.
In all cases, I recommend doing the math and setting a sell limit in advance that you feel comfortable with. This will help you stay disciplined by taking “irrational exuberance” out of the equation. If the math changes or the stock keeps moving higher, raising the limit is always an option. Otherwise, you have a built-in protection that will keep profits from slipping away.
I hope that helps to answer your question, Charles, and sheds some light on how I approach selling across our services. Remember, you can send me a question anytime by emailing service@kramersinnercircle.com. Hope to hear from you!
Sincerely,
Hilary Kramer
Editor, Inner Circle