Inflation May Slow, but Interest Rates Are the Real Key

Inflation continues to be a huge concern for Wall Street, and so far this week, the latest reports are driving the market. Case in point: All of the major indices rallied today following the release of the Consumer Price Index (CPI) report.

Although the CPI came in hot today with an 8.5% annual increase in March, stocks regained some of yesterday’s losses. Investors are more hopeful that inflation is peaking, as core CPI, which excludes food and energy, only increased 0.3% in March. That was lower than economists’ expectations for a 0.5% increase.

Still, with high inflation comes elevated interest rates. In fact, the yield on the 10-year Treasury note rose to 2.77% on Monday before settling around 2.7% today. Bond yields increased sharply on Monday due to reports that China’s Factory Prices rose at a record rate. In comparison, the 10-year Treasury had a yield of 1.7% on March 1, at which point the Fed ceased its QE program.

It will be interesting to see how rates react if the Federal Reserve begins to reduce the size of its balance sheet in May, as we expect. Unless we see some signs that interest rates are stabilizing, stocks may have trouble sustaining any meaningful rallies.

Although I am lukewarm regarding the current market, I still like the stocks on our Buy List. Their valuations should be able to withstand a future increase in rates. In addition, I look for their earnings to be good in a critical earnings season where many companies will likely report slower growth. Overall, I am confident that our stocks will produce solid returns for the remainder of the year.

TGT: Right on Target

Target Corp. (TGT) is a well-known retail giant that operates 1,931 stores throughout the U.S. These stores come in two sizes: those over 170,000 square feet have food offerings equivalent to that of a supermarket, while those under 50,000 square feet offer more limited food choices.

Through the majority of its stores, the company sells a wide variety of merchandise at affordable prices, with beauty and household items accounting for 27% of sales; food and beverage, home furnishings and apparel each accounting for 19%; and hardlines accounting for the remaining 16%. Approximately 19% of the company’s sales are digital, with most of these sales still picked up in stores.

TGT has benefited from several factors in recent years, and these factors should help drive future growth for the company. These factors include the growing popularity of the company’s private-label items, which account for 31% of sales; a period of heavy investing in stores from 2018 through 2021 to create a better shopping experience; the use of their stores as hubs to allow for efficient pick-up of digital orders.

The pandemic has also benefitted Target. Digital sales have grown by $13 billion over the past two years to account for 19% of total sales today. That’s nearly triple 2019 levels. The company also believes that customers who picked up their merchandise at Target during the height of COVID returned to the stores once health concerns eased. This helped drive a 12.3% increase in store traffic last year, on top of a 3.7% gain that occurred in 2020 despite the pandemic.

Thanks to the aforementioned factors, Target’s results have improved dramatically over the past two years. EPS increased from $6.39 in the January 2020 fiscal year to $13.56 in the January 2022 fiscal year. Comparable store sales gained 19.3% and 12.7% in the January 2021 and January 2022 fiscal years, respectively, driving an increase in total sales from $77.1 billion to $104.6 billion from January 2020 to January 2022 fiscal years.

The current fiscal year is expected to get off to a slower start, as the company has a very difficult margin comparison from last year, and like all retailers, it is facing higher shipping costs. However, management believes that margins will improve as the year progresses, and with sales expected to grow from the low- to mid-single digits, the company can still earn $14.50 a share this year.

Long-term, while the recent growth and margins expansion is not sustainable, Target believes it can grow sales and operating income in the mid-single digits and grow EPS in the high single digits with the benefit of share buybacks and debt reduction. While the top-line forecast may be aggressive in my opinion, Target has won over many new customers in recent years, and this should translate into sustained growth. So, I do not think the EPS target will be too far off the mark.

The stock has been struggling, but it surged on Friday after an analyst said sales in February and March remained steady, which helped reduce concerns that inflation was hurting consumers’ buying power.  With the stock selling for only 15X this year’s EPS estimate, more upside is possible. TGT not only sells at a steep discount to the market PE of close to 20X this year’s earnings estimates, but it also sells at a discount to Walmart’s (WMT) 22.3X this year’s EPS estimates, even though WMT is not growing as fast as TGT.

Buy TGT under $225. My target price of $260 is lower than last year’s high of $269.

Position Review: Earnings Coming

Cognizant Technology Solutions (CTSH) will report first-quarter earnings in the first week of May. Expectations are for EPS of $1.04 vs. $0.97 last year on a 9.6% increase in revenues. The company should report another strong quarter as its digital business keeps growing. Given recent results, I believe chances are good that CTSH will once again beat estimates. So, I believe the recent market-related weakness in the shares will be short-lived. CTSH is a buy below $80. My target is $95.

Fidelity National Information Services (FIS) will report first-quarter earnings on May 3. Expectations are for EPS of $1.45 vs. $1.30 last year on a 6.6% increase in revenues. FIS has continued to benefit from processing the increasing number of credit cards and online transactions. The stock has been acting well recently as I believe the fears of increasing competition may be fading. FIS remains extremely cheap considering its long history of solid growth at just over 14X this year’s EPS estimate. I am optimistic that earnings will serve as a further catalyst for the shares. Buy FIS under $110. My target is $130.

First Busey Corp. (BUSE) will report first-quarter earnings in the last week of April. Expectations are for EPS of $0.52 vs. $0.69 last year with the decline reflecting the absence of credit loss reversals.  I do expect earnings before credit considerations to rise, with the company benefitting from loan growth and good results from insurance brokerage and investment management divisions.

BUSE has been under pressure like all banks on concerns that Fed tightening will result in weaker economic growth and a potential recession. While the Fed’s impact on the economy deserves watching, there isn’t anything that has me concerned that the fiscal year 2022 EPS estimates of $2.12 will not be met. In fact, that number could be conservative. The stock is very cheap at 12X this estimate, and the shares are made more attractive by a 3.8% dividend yield. Given less favorable market conditions, I am lowering my buy under and target price for BUSE to $28 and $31, respectively.

Molson Coors Beverage Company (TAP) will report first-quarter earnings before the market opens on May 3. Expectations are for EPS of $0.19 vs. $0.01 last year on a 13.5% increase in revenues. Results will improve from a weak COVID-influenced quarter last year but will still be weakened by higher costs for bottles and aluminum cans. Results should improve as we move towards a more seasonally strong period of the year in the second and third quarters. TAP’s stock has done well this year, as the market is gaining confidence in the company’s recovery story, with market shares of Miller Lite and Coors Lite stabilizing. The stock remains cheap at 13X this year’s EPS estimates, and I believe it can continue to outperform the market. TAP is a buy below $50. My target is $57.

Newell Brands (NWL) will report first-quarter earnings in early May, with expectations for EPS of $0.27 vs. $0.30 last year and revenues flat on a difficult comparison. Although the year likely started slow for NWL, moderating costs and price increases will drive improvement for the remainder of the year, and I still look for the company to earn $1.90 per share for the year, up from $1.81 last year. At under 12X this year’s EPS, the risk-versus-reward characteristics of the shares are very favorable.  NWL is a buy below $24. My target is $30. The 4.1% dividend yield will add to total returns.

Phibro Animal Health (PAHC) will report fiscal third-quarter earnings after the market closes on Wednesday, May 4. Expectations are for EPS of $0.35 vs. $0.34 last year on a 5% increase in revenues. Demand for the company’s animal health products should be strong, driven by growth in emerging markets and the company’s entrance into pet health. Higher costs, though, will cut into profitability. Given recent signs of renewed top-line growth, the stock is very attractively valued at 15X this year’s EPS estimate. PAHC is a buy below $20.50. My target is $25.

I recently discussed Sonoco Products’ (SON) positive first-quarter earnings pre-announcement here. The stock has continued to trade firmly since the news, despite the volatile market. I believe the company can earn over $5.00 a share this year, and I see further upside for the stock. Buy SON under $65. My target is $75.

The GAP (GPS) remains under pressure on concerns that a comeback in the company’s earnings could prove elusive. Things looked great at GPS just a year ago, but perceptions can change fast in clothing retailers. Still, I do not think things are nearly as grim as the market suggests. Even if EPS estimates of $1.87 this year are too high, I think GPS earnings can stabilize at $1.40 a share, which should allow the stock to do well from its current price. As a sell-side analyst recently pointed out, the stock is now cheap enough that the previously nixed idea of separating high-performing Old Navy from the rest of the company could start making sense, with the company selling for just 66% of Old Navy’s annual sales. The share price currently reflects an overly gloomy scenario, which I do not see happening. GPS remains a buy, although I am lowering my buy under price to $15 and my target to $18.