The Rally Is Back On!

The market appeared on the ropes last week, with stocks falling sharply last Thursday on concerns about the global economy.

S&P 500 earnings estimates for 2019 are already down to $169.76 from last year’s peak of close to $180, with a directional bias for estimates to fall closer to the $161.50 final number expected for 2018. Therefore, any further economic softening and subsequent lowering of earnings estimates would not be welcome news for stocks.

However, the bears could not follow up on the weakness. With a budget agreement close to done and hopes for a trade agreement rising, the market soared today. The news from the Fed also continues to be quite bullish, with San Francisco Fed Chief Mary Daly saying on Friday that the central bank could use its balance sheet as a regular part of its toolkit, leaving open the potential for quantitative easing even when we are not in a recession.

The Fed may now be willing to give the market and the economy enough support for this bullish scenario to work for a while. While earnings growth will be tepid in 2019, it still will be positive, and we will be set up for additional strength in the second half as earnings growth will be expected to re-accelerate in 2020.

However, we are not at that place quite yet. The market may stay in a relatively tight range until we have better visibility in 2020 results, with the potential of a 3% to 5% setback on any bad macro news.

I think our current Recommended List is positioned to do well in most market outcomes. However, I do realize the current economic and market situations are very dynamic, and I will adjust and become either more or less aggressive as needed.

F5 Running Networks Smoothly

F5 Networks (FFIV) develops and sells software and hardware which allows networks to run more efficiently and safely. The company’s solutions allow applications to move faster and safer through the multi-cloud platforms in use at most enterprises today. The company’s core technology, Traffic Management Operating System (TMOS), was developed in 2004 and enables the company’s products to inspect and modify the content of Internet Protocol (IP) traffic flows at network speeds to deliver a range of application services. Security and firewall features of TMOS were improved though a series of acquisitions in 2013 and 2014.

Today, most of the company’s product sales come from its BIG-IP application delivery controllers, through which an enterprise can handle application traffic and secure infrastructure, and its VIPRON bladé servers, which are programmable and scalable to help manage current and future applications. Services are a critical part of the company’s business model, accounting for 55.5% of sales in the September 2018 fiscal year, while realizing margins that are even greater than products. Services include maintenance contracts, consulting and training. Importantly, the company reports high levels of customer satisfaction, 9.6 out of 10, with its customer support team.

F5 has achieved consistent growth in recent years, with revenues rising from $1.73 billion to $2.16 billion from the September 2014 to the September 2018 fiscal year. Most of this growth came from increased sales of services as the company’s installed base of customers needing the services grew. Having more services in the revenue base allowed margins to improve, and earnings per share (EPS) grew from $5.43 to $9.87 over the same time period. EPS comparisons also benefited from share buybacks, which reduced average shares outstanding 18.6%.

FFIV had a solid first quarter of the 2019 fiscal year, with revenues up 4% to $543.8 million, led by higher software and services sales. EPS grew 19.4% to $2.70 a share, with margins continuing to benefit from the changing sales mix and EPS aided by share buybacks. Given current momentum, I believe current estimates for $10.75 a share in the September 2018 fiscal year are realistic.

In conclusion, FFIV is a solid niche company with a strong services business with high amounts of customer satisfaction which should bring consistency to future results. The company also has a very strong balance sheet, with cash and investment of $883 million, over $14 a share, versus long term liabilities of $435 million. In addition, most of these liabilities are not true financial obligations, but unearned revenue related to services. These factors combined with a favorable valuation of 15.1X September 2019 EPS estimates could make the stock a potential takeover target. Buy FFIV under $162. My target is $180.

Review of other positions

Big Lots (BIG) has not yet set a day for fourth-quarter earnings, but they will be released sometime before our next issue. Expectations are for EPS of $2.30 vs. $2.57 on a 2.8% decline in sales to $1.6 billion. When announcing third-quarter results, BIG said that that the fourth quarter got off to a slow start in November, but results then improved the first week of December. Rising wage and freight costs will also weigh on the bottom line. The key for the stock will be guidance for 2019, with current expectations for flattish results with EPS of $3.70 comparable to current year’s results. I do believe this result is realistic, with the company’s new model stores doing well and margin comparisons easy in the first half of the year. At current depressed levels, the stock should do well if earnings stabilize as I anticipate. BIG is a buy below $32. My target is $42.

The Children’s Place (PLCE) will report fourth-quarter results in mid-March, and I will have an earnings preview in our next issue. The stock is having trouble sustaining any rallies, as valuation ratios through the retail sector remain depressed. There remains concerns about inventory being liquidated at low prices in children’s clothing as Gymboree closes stores. However, I still feel that PLCE is a quality company that will get through the short-term issues in good shape and continue to grow. Continue to buy PLCE below my new buy under price of $95. My new target is $115.

Chubb (CB) reported core operating EPS of $2.02 vs. $3.17, which was $0.05 better than expectations. Results were lower than last year due to the high catastrophic losses from wildfires in California, along with higher losses in U.S. commercial lines. The stock was weak following the report, as net written premium growth of 4.2% was short of expectations of 5%. However, pricing was firm, and management was confident about the 2019 outlook. Given a more normal level of catastrophic losses, the company should earn over $11 a share in 2019. I believe Chubb should do well in most market environments at current environments. Buy CB below $130. My target is $145.

Cognizant Technology Solutions (CTSH) posted a good earnings report and the stock has reacted very well. Revenues of $4.13 billion were up 7.9%, or 8.8% in constant currency, while EPS of $1.13 vs. $1.03 was $0.06 above expectations. Slightly better-than-expected sales along with strong projection execution drove the earnings beat. The company gave guidance for EPS of at least $4.40 in 2019, and I believe current estimates of $4.45, up from $4.02 in 2018 are very realistic. Growth will be driven by increased digital revenues, which were up in the mid 20% range in the most recent quarter.

The company also announced a CEO transition. Brian Humphries is taking over for company founder Francisco D’Souza. Mr. Humphries comes to Cognizant from British telecom giant Vodafone, where he was successful in growing that company’s services revenues.

Trading at 16X this year’s EPS, CTSH provides great value considering its stable growth outlook. Buy the CTSH under $77.50. My target is $90.

Emcor Group (EME) will report earnings on Thursday, Feb. 21, with expectations for EPS of $1.35 vs. $1.13 last year, on revenue growth of 2%. The company will likely to report good growth in both its mechanical and electrical construction and its building services segments. Given recent operating momentum, I would not be surprised if the estimates prove to be conservative. However, the market seems not concerned about current results, but the macroeconomic outlook, which is holding the stock back. However, I believe confidence will grow in current EPS estimates for 2019 of $5.20 as the year goes on, which should drive a good stock performance. So while I will keep an eye on the economy, for now I continue to recommend the shares. Continue to buy EME below my new buy under price of $67. My new target is $78.

First Hawaiian (FHB) had a solid earnings report. The EPS of $0.58 versus $0.50 was $0.06 better than expectations. The upside was driven largely by cost controls, although 3.8% loan growth and an expanding net interest margin of 3.23% versus 3.11% set the company up for a strong 2019. Results exclude $0.14 a share of losses on sales of securities the company took in the quarter as it repositioned its investment portfolio. However, higher interest income from the new portfolio should allow the company to recover these losses in only two years. More good news came from BNP Paribas selling its remaining interest in the company of a secondary offering. These secondary offerings will now stop, eliminating a supply of the stock that helped hold down its price. At 12X this year’s EPS estimates with a 3.9% dividend yield following a 8.3% dividend hike, the stock has excellent value, and provided the economy can remain firm and keep credit costs low, FHB should have a good 2019. Buy FHB below $26. My target is $30.

J.M. Smucker (SJM) will report fiscal fourth-quarter earnings on Tuesday, Feb. 26, before the market opens. Expectations are for EPS of $2.02 versus $2.50 on a 4% gain in revenues to 4.3%, with the revenue gains coming from the Ainsworth Pet Nutrition acquisitions, offset by the sale of the company’s baked goods divestiture, which will also hurt EPS by $0.07. Higher marketing and freight costs will also continue to pressure earnings. Recent disappointing results from other foods companies and analyst downgrades in the industry continue to hurt SJM shares. While the industry challenges are greater than I anticipated, I would like to give the company a couple more quarters to prove itself. Its balance sheet is among the best in the industry and it is attractively valued at 13X forward EPS, with easy earnings comparisons coming up. In addition, should economic fears rise again, there should be renewed interest in investing in food stocks. Buy SJM under $108. My target is $120.

J.P. Morgan (JPM) came under pressure last week on concerns over the international economy, which took away a lot of the gains in the stock after fourth-quarter earnings, which we reviewed in the last issue. However, I believe JPM remains the bank that will handle an industry decline better than any other. With the Fed now on pause, short-term funding increases are less of a concern. Valuation remains friendly at just over 10X 2019 EPS, with a solid 3.1% dividend yield which will grow over time. Buy JPM under $100. My target is $110.

Morgan Stanley (MS) shares have been under pressure since reporting fourth quarter EPS of $0.73 vs, $0.84, which was $0.16 below expectations. However, the disappointment was driven largely by the tough year-end market conditions and some non-recurring investment losses, but the core of Morgan Stanley businesses remains strong. Trading at 1.1X tangible book value of $37 a share, and just 8X EPS estimates of $5.00, there is good value in the shares. As long as the economy and market remain reasonable, the stock should do well this year. Buy MS under $46. My target is $53.

Party City (PRTY) will likely report fourth quarter earnings early next month, with expectations for EPS of $1.09 vs. $0.81, driven largely by a massive share buyback late last year and a lower tax rate. Revenues are expected to increase 3.6% to $818 million, largely due to the company acquiring previously franchised stores. With results for the critical Halloween season already announced, I would not expect a lot of variance in results relative to expectations. The stock has been under some pressure the past few weeks, as have most retailers that do not primarily sell everyday consumable items such as Walmart (WMT) and Target (TGT). Selling for 7X trailing EPS, investors still seem to anticipate some kind of big drop in earnings in PRTY, despite little evidence of such an event. As I have said in the past, management would be much better off allocating capital exclusively to debt reduction until these fears subside. However, we are now close to support levels for PRTY. I recommend buying PRTY under $10.50. My target is $16.

Valley National Bancorp (VLY) reported Q4 EPS of $0.21 vs. $0.16 in the prior year and $0.21 in the third quarter, which was $0.01 to $0.02 below expectations. The disappointment due to higher-than-anticipated expenses, an increase in loans losses related to the company’s taxi medallion portfolio and an unexpected decline in the net interest margin to 3.10% from 3.13% in the third quarter and 3.12% in the year ago period. After initially sending the stock lower, investors then reversed course and the stock gained. This reflected the close to 4% sequential loan growth the company achieved in the fourth quarter, hope that recent investments to cut costs will start positively impacting the bottom line and still low credit costs despite the taxi medallion losses. While current EPS estimates for 2019 of $0.97 seem a little ambitious given the current quarterly run rate of $0.21, I think just coming reasonably close to that estimate, along with a decent economy, should allow VLY shares to have a good 2019. Buy VLY below $10.50. My target is $13. The 4.19% yield will add to total returns.