By moving the S&P 500 within a couple of percentage points of its all-time high just six days after it appeared ready to break down, investors seem to be making two bets.
The first bet is that the Fed will begin to lower interest rates soon, perhaps as early as next week’s meeting. The second bet is that even though the economy is slowing, we will not have a recession, and earnings will continue to grow.
I do not believe the first assumptions invoke much controversy. Recent statements from Fed officials indicate that they are ready to act, and these remarks came before Friday’s weak employment report. I think it is very possible the Fed could lower rates at next week’s meeting, as I do not think Chairman Jerome Powell really wants a lot of market speculation about a potential rate cut; he would prefer to get it out of the way.
What is less certain is how many rate cuts we eventually will have. Here I think the market may get ahead of itself. While one cut is just about a sure thing, I think Chair Powell will want to be patient before cutting any further.
The second assumption is not as much of a sure thing. Despite the overall rally, some groups are trading like a recession is imminent. While the S&P 500 now is practically unchanged over the past three weeks, nearly one-third of retail stocks have corrected at least 10% over the same periods, as concerns about consumer spending and, to a lesser extent, tariffs are taking a toll on the group. To show further market skepticism about the economy, stable demand sectors such as utilities and consumer staples have led the way higher.
However, while the economy is perhaps in a soft spot, I think we will avoid a recession, especially with rate cuts and a potential end to tariffs increasing business confidence. Therefore, I expect the S&P 500 to surpass the May highs and trade above 3,000 by year end. Additionally, I look for our recommended stocks, which have been held back in large part due to macro concerns, to shine during the remainder of the year. I cannot think of a time in the five-year history of Value Authority that our stocks looked so cheap compared to the market, with most of our stocks trading at less than 12X next year’s earnings per share (EPS) estimates for roughly a 25% discount to the S&P 500. I will make adjustments, if necessary, but I am very optimistic about the Recommended List at the present time.
Universal Health — It Will Help Keep Your Investments Well
Our newest Value Authority stock, Universal Health Services (UHS), was founded in 1979 by Alan B. Miller, the company’s current CEO and chairman. The company since grown since then to be a giant with $10.7 billion in revenues and more than 87,000 employees. The company operates acute care hospitals and behavioral health facilities. UHS owns 26 acute health care facilities, nine free-standing emergency centers, six outpatient centers and one surgical hospital in the United States.
In the behavioral health side of the business, UHS operates 188 in-patient and 19 out-patient behavioral health facilities in the United States; 133 in-patient and two outpatient behavioral health facilities in the United Kingdom; and three in-patient behavioral health facilities in Puerto Rico. In 2018, acute care centers and related businesses accounted for 53% of its revenues, and behavioral health facilities accounted for the remaining 47%.
In an age where hospital admissions are flat to slightly lower, and the length of hospital stays is on the decline, the company has had success by focusing on Mr. Miller’s strategy of providing patients quality service and focusing on operational excellence, while making strategic acquisition in areas where the population is growing. The last five years have been busy for acquisitions, with UHS spending a total $2.7 billion from 2014 through 2018. Universal Health entered the U.K. market in 2014 by purchasing Cygnet Health Care, a behavioral health provider for $335 million. The company followed this up by acquiring Alpha Hospitals, an operator of U.K. mental health facilities for $148 million. The company’s most significant acquisition in the United States was its purchase of Foundations Recovery Network based in Brentwood, Tennessee, for $350 million. Foundation Recovery operated four behavioral health facilities with 322 beds and eight outpatient centers.
The acquisitions have helped the company realize steady growth, with revenues increasing from $8 billion in 2014 to $10.7 billion last year. Also aiding growth was an improved occupancy rate of 62% in 2018, compared to 57% in 2014, in acute care hospitals. Occupancy rates at behavioral health centers remained steady at 75%. There was little change in operation margins, and earnings per share (EPS) increased from $5.78 in 2014 to $9.53 in 2018, aided by a 7% decline in outstanding shares due to buybacks and a lower tax rate in 2018 from U.S. tax legislation.
In the first quarter of 2019, revenues increased 4.3% to $2.8 billion, as patient days rose 4.4% in acute care services and 0.9% in behavioral health. However, margins narrowed as surgeries, a big profit driver, started the year on a soft note. EPS was flat at $2.45, about $0.17 less than expectations. The company did note though that surgery volumes were improving, and the weak quarter did not have as much of an impact on the stock.
What has been putting pressure on the stock since March, when the shares traded above $140, is the concerns about reimbursement and usage levels, as the U.S. may seek to lower healthcare costs, especially if there is political change in Washington after the election next year. This issue has hurt a lot of healthcare stocks, but I think the selling is overdone. I also feel UHS’s position in behavioral health protects it from potential price cuts to expensive procedures that acute care hospitals may face. Trading at just 12.3X 2019 EPS estimates of $10.00, there is a good margin of safety in the stock, and UHS should do very well, especially if we are entering a lower growth, low interest rate environment. UHS is a buy below $125. My target is $140.
Position Review
The activist investors at Bed, Bath and Beyond (BBBY) got what they wanted, as long-time CEO Steven Tamares stepped down. BBBY also named four additional independent directors, which satisfied all of the activist investors wishes, and they dropped their lawsuit against the company. However, the poor environment for retail stocks, along with uncertainty about what the company’s plans are until a permanent CEO is named, has hit the shares since my April 30 recommendation.
While the future strategy is uncertain, the new CEO should have some options. The stock is trading at a miniscule .17X Enterprise Values to Revenues. By comparison, Walmart trades at .73X Enterprise Value to Revenues. What this means is that management should have plenty of room to reduce less profitable sales through closing stores or selling or closing some of the company’s non-Bed, Bath and Beyond chains, such buybuyBaby or Harmon’s, and still have enough revenues left to achieve earnings that would justify a considerably higher stock price.
I am hopeful we will hear from the company prior to earnings on July 10, which I will preview in next month’s issue of Value Authority. A rebound will not be easy to achieve, but correct moves made now will lead to a considerably higher stock price over time. Buy BBBY under $16. My target is $20.
Big Lots (BIG) rallied sharply yesterday to get back the gains it achieved following a solid first-quarter earnings report. Click here to read my analysis of the latest earnings report. Concerns about consumer demand and the impact of tariffs briefly sent the stock lower than where it stood prior to the report. Although the price action of Big Lots is extremely frustrating, the company’s underlying results continue to improve, and look good for the future, with BIG now having 17 million loyalty members, and stores of the future seeking comparable store sales growth in the high single-digit percentages. I look for the stock to make a big move higher on any favorable tariff news or signs that economic growth is re-accelerating. With the stock trading at just 7X EPS estimates, buy BIG under $32. My target is $40.
Cognizant Technology Solutions (CTSH) shares have begun to stabilize, as investors took shelter in larger, financially stable companies in May. The stock still represents good value in the shares at 16X this year’s EPS. I have confidence that new CEO Brian Humphries will be able to revitalize growth, given his strong track record of building Vodafone’s service business. I continue to recommend CTSH below $62. My target is $75.
Softness in earnings of many cloud computing-related companies has hit the shares of F5 Networks (FFIV), whose primary business is software that is used to help enterprises launch applications across multi-cloud environments. However, given the high amount of service and other recurring revenue in the company’s business model, I do not believe there will be a drastic reduction in estimates, if any, and the stock is attractively valued at 13.5X fiscal September 2019 EPS estimates. FFIV is a buy under $155. My target is $170.
Shares of First Hawaiian Inc. (FHB) have struggled with the softening economy and the inverting of the yield curve. However, I see no near-term danger to estimates, and I do not think we are in immediate danger of recession. Also, I see the yield curve widening at some point, since a Fed cut of short-term rates is widely expected and could breathe new life into the economy. If so, longer-term rates would rise. I see no near-term risk of a meaningful cut in estimates, and the stock looks cheap at 12.5X 2019 EPS estimates with a 4.2% dividend yield. Buy FHB below $26. My target is $30.
Ingredion (INGR) shares have come under significant pressure, as a steep increase in corn prices forced farmers to delay planting due to wet weather, threatening to further reduce earnings estimates for 2019. However, with the stock selling for less than 12x this year’s EPS estimates, and corn prices starting to fall last week, I believe there is significant upside in the stock. Corn prices inevitably will fall at some point, and the company continues to make progress in building its value-added portfolio. INGR is a buy below $90. My target is $105.
Morgan Stanley (MS) has underperformed since the market top on May 1. If we stay out of a recession, I look for underperformance to change. The shares are attractively valued at 1.14X tangible book value, which should grow 8% to 10% per year. In addition, the recent market volatility could give a nice lift to second-quarter earnings, giving the stock a potential near-term catalyst. MS is a buy below $46. My target is $53.
Party City (PRTY) was unable to extend its gains following a good first-quarter earnings report, since the company still needs to improve it can reduce inventory and debt. Party City will not do that until the critical Halloween season is past. However, the company’s results have been very stable, and it has taken steps to solve its helium shortage. I believe the company will achieve its objectives this year. With the stock selling for less than 5X this year’s EPS estimates, the upside is considerable, even if the company falls a little short of the current $1.67 EPS consensus estimate. PRTY is a buy below $8. My target is $12.
I feel that shares of Valley National (VLY) have hung in fairly well, despite the sharp decline in long term interest rates which will hurt margins at banks at some point and is leading to weakened recent performance for the group. As long as credit costs remain low, I believe loan growth and savings through the company’s cost reduction program will offset the interest margin weakness, and I expect the yield to be steepen later this year. Trading at 11X 2019 EPS with a 4.4% dividend yield, VLY is a buy below $10.50. My target is $12.50.