Looking to Maintain the Good Times

The market has almost been in a melt-up mode over the past two weeks, as things look good on the interest rate front and there is hope for improvement in earnings.

The current softer-than-anticipated global economy has the Fed firmly on hold from engaging in any further rate increases. Plus, the Fed’s balance sheet reduction, also known as quantitative tightening, will end in September.

Meanwhile, the market is not at all nervous about the upcoming earnings season, as there is a lot of confidence that the global economy will get on track again once a trade agreement with China is signed, and earnings will be back on the rise after an expected 4% decline in the first quarter.

However, despite the great calm in the market, this is not the time to get complacent. An improved trajectory in earnings for the remainder of the year has now been largely discounted in stocks, but it is not guaranteed that this trajectory will actually happen, given the global economic uncertainty as well as weakness in the U.S. auto and housing sectors.

The next few weeks will offer good insight as to how much earnings improvement is realistic. An increase in volatility is possible until there is greater clarity about what the results for the rest of the year will be.

Our Buy List has done very well during the melt-up period, with strength especially evident in our financial names, reflecting greater optimism about the economy. However, should some of this optimism wane, I will look to make some changes in order to get more defensive.  By staying alert and picking solid names at discounted prices, such as this month’s new pick Ingredion (INGR), we should be able to add to the gains we’ve made so far in 2019.

Dishing Out All the Ingredients for a Winning Stock

Ingredion (INGR) is not a household name, but it is a pretty safe bet that its products are in your house. The company converts raw materials such as potatoes, corn, tapioca, fruits and vegetables into starches and sweeteners for a wide range of industries, including food, beverage, brewing and animal nutrition. The company operates on a global basis, with 40% of sales coming from outside the United States.

Ingredion considers 29% of its sales to be specialty ingredients, which offer more functionality and additional customer value. These ingredients are aligned with consumer health trends such as clean eating. Some of these products will also reduce costs for food companies. The company’s products are substitutes for more expensive starches, while still providing a superior texture. This product portfolio was built primarily through two acquisitions. In 2014, the company acquired Penford Corporation, which supplies a wide-range of healthy texture ingredients, for $340 million. In 2017, INGR purchased TIC Gums, which makes clean-label texturing systems, for $400 million. A smaller acquisition occurred in March of this year, when the company acquired Western Polymer. This company produces potato starches, a healthier and low-fat alternative to traditional starches.

While the company has had minimal revenue growth in recent years, it enjoyed a nice pick-up in profitability from 2013 through 2017, when earnings per share (EPS) increased from $5.05 to $7.70. The contribution of the specialty products, a decline in raw material costs and the sale of a less efficient plant in 2015 all contributed to the profitability gains. However, the company had a tough year in 2018, as EPS fell to $6.92 due to a rise in raw material costs, currency devaluations and weak demand for sweeteners in North America. The decline in profitability hit the stock hard, as it peaked in January of last year at $145, then fell to below $90 briefly during the stock market slump of last December.

While Ingredion has underperformed the broader averages this year, its shares have started to stabilize. I feel they should do well when profitability begins to improve in the second half of the year. Commodity costs and currency pressure should begin to subside, and the company will benefit from selective price increases and cost-cutting. Operating profits will continue to fall in the first quarter and the results that will be reported on May 2 are expected to show a decline in EPS from $1.94 a share to $1.66 a share. However, earnings comparisons could turn positive as early as the second quarter, and the company’s management is offering earnings guidance between $6.80 and $7.50 a share for all of 2019.

At just over 2019 13X EPS estimates, the stock is attractively valued. INGR also generates good free cash flow and its balance sheet is solid with interest charges that it has comfortably earned. This financial wherewithal should allow for more acquisitions and share buybacks.  At a time when segments of the market are getting pricey, INGR is a solid buy below $95. My target is $110. The 2.68% dividend yield will add to total returns.

Position Review

Big Lots (BIG) continues to do much better, as it has benefited from a solid fourth quarter that was also the second consecutive quarter in which comparable store sales exceeded 3%. While profitability in the current year will be held by investments in the company’s successful new store format, I do believe EPS estimates for the year of $3.65 could be conservative. This would make my $42 target easily reachable. BIG remains a buy below $34.

Chubb (CB) will report first-quarter earnings after the market closes on Tuesday, April 30. I also aim to have a conference call with Chubb’s management on the following morning. Expectations are for an EPS of $2.64 vs. $2.34 and a 4.8% rise in revenues to $6.86 billion, with firm pricing and more moderately catastrophic losses leading the way upward. Chubb’s stock has been a steady performer, and I believe the share price can reach my $145 target, or 1.2X book value, this year if large catastrophic losses during hurricane season are avoided and the market and economy both remain sound. I am raising my buy below price in CB slightly to $132.

Cognizant Technology Solutions (CTSH) has not yet set a date for first-quarter earnings but will likely report results shortly before our next issue. Expectations are for a 6.6% increase in revenues to $4.17 billion, and I would look for EPS to rise by a similar amount from last year’s $1.06, excluding currency movement. Items that deserve a close look include the company’s growth in its financial services business, which has slowed recently, as well as the comments from new CEO Brian Humphries, who took over on April 1st. CTSH remains a consistent grower and sells at a reasonable valuation of under 16X this year’s EPS. I continue to recommend the stock below $77.50. My price target is $90.

F5 Networks (FFIV) will report fiscal second-quarter earnings on April 24, after the market closes. Expectations are for an EPS of $2.54 vs. $2.31 on a 2.6% sales gain to $547 million, reflecting a strong demand for the company’s network management software. The stock has had an abrupt turnaround following initially sharp selling after the company’s acquisition of NGINX, an open-source cloud leader in application delivery, which I covered in last month’s issue. While the deal will slow EPS growth for the remainder of the year and into 2020, there is optimism that the growth will accelerate beyond that. Estimates for the next two years range widely, but I am confident the company can earn an EPS of $10.20 and $10.80, respectively, in fiscal 2019 and fiscal 2020. These estimates are supportive of my $170 target, which the stock is closing in on. Hold FFIV for now. I will keep you updated about potentially raising the target.

First Hawaiian Bank (FHB) will report first-quarter results after the market closes on April 25. Expectations are for an EPS of $0.53 vs. $0.49 on a 7.2% increase in revenues to $195 million, which is being driven by loan growth. Credit costs should remain minimal as the Hawaiian economy is staying strong. The stock’s performance has lagged behind the market since early February. However, with the shares trading at 12X EPS with a 3.9% dividend yield, I look for the stock to outperform as near-term recession concerns fade. FHB is a buy at $26. My price target is $30.

J.P. Morgan (JPM) will report first-quarter earnings this coming Friday, April 12, with expectations for a flat EPS of $2.37 and flat revenues of $28.5 billion. This is because JPM’s gains in core consumer banking will be offset by lower capital markets revenues since the company had an exceptionally strong first quarter last year when markets were very volatile. JPM shares remain attractively valued at 11X this year’s EPS estimates, with a 3.05% dividend yield, and I am looking for a rise in the quarterly dividend from $0.80 to around $0.90 later this year. JPM still remains a relatively safe way to gain exposure to the financial services sector, and I continue to recommend purchase below $100. My price target is $110.

Morgan Stanley (MS) will report first-quarter results before the market opens on April 17. Expectations are for an EPS of $1.25 vs. $1.45, as revenues are expected to decline by 7% on the sharp decline in market volatility from the first quarter of last year. MS has come a long way in recent weeks, but the stock is still cheap at 1.06X book value. Therefore, I believe that as long as markets perform reasonably, the shares should continue their recent rally. Buy MS under $46. My target is $53.

Party City (PRTY) shares rebounded last week after trading below $8 a share. In addition to the concerns about the company’s debt levels, I believe the weakness reflects sporadic retail sales in general. These factors could contribute to a weaker than expected first quarter for PRTY, which is already only at breakeven due to margin pressure from helium shortages and seasonal weakness. However, while the optics of losing approximately $0.10 a share would not be good for the company, given concern about its debt, it would not be that critical in reality. The company should be able to earn $1.60 for the remainder of the year, even with a mediocre sales performance.

The stock is trading at just over 5X EPS estimates. I believe that this valuation reflects an overly pessimistic outlook on PRTY’s earnings and the company’s ability to service its debt. While PRTY is firmly committed to trim its debt this year, I will cut our losses if I need to. For now, continue to buy the shares. My new price to buy the shares under is $9.50. My price target is now $15.

Phibro Animal Health (PAHC) will report its fiscal third-quarter results after the market closes on May 6. Expectations are for an EPS of $0.43 vs. $0.46 on a 2.7% increase in revenues to $214.6 million. Several factors will lead to the lower earnings, including spending on innovation, a weak dairy market, currency issues and a higher tax rate. However, investors seem to be getting aboard for an earlier turnaround, and the shares have performed very well since my recommendation. Since the stock traded above $44 within the past year, I believe my $36 target is very realistic once there is greater visibility for a turnaround. Buy PAHC if a market slide takes the shares below $30.50.

Valley National (VLY) will likely report first-quarter results sometime in the last week of April, with expectations for an EPS of $0.22 vs. $0.18 on a 10% gain in revenues to $264 million, as loan growth and cost savings from recent investments start to kick in. While the shares have been under pressure since early March due to concerns about a recession and lower interest rates, the stock is cheap at 10.5X EPS estimates, with a 4.5% dividend yield. I think the economy will remain firm. With operational improvements hitting the bottom line, VLY is a good choice. Buy the stock below $10.50. My target is $13.

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