What Should We Really Worry About?

Investors appear to be a bit nervous this week. Wall Street has largely looked past Friday’s better-than-expected employment report, and investors are now focused on this week’s inflation data. As a result, the S&P 500 has traded sideways to slightly lower to start the week.

Most investors are hopeful that tomorrow’s Consumer Price Index (CPI) reading will show core inflation below the expected rate of 0.6%. A lower-than-expected number would renew hopes that the Federal Reserve could wind down raising short-term interest rates soon. There’s even some hope that lower rates are possible sometime next year if inflation reaches the Fed’s 2.0% target.

Personally, I think investors should worry less about interest rates and instead be more conscious about the economy and earnings.

Consider this: The yield on the 10-year Treasury is now at 2.78%, far below its June 14 peak of 3.48%, which interestingly coincided with the market bottom. The yield curve has become noticeably inverted, with the 10-year Treasury yield now below the 3.25% yield on the two-year Treasury Bond. While the Fed still holds trillions of long-term securities and this artificially impacts the yield curve, the inversion can be interpreted to mean that the economy will likely soften, and the Fed will soon start to lower rates.

Now, let me be clear; I am not saying we will have a significant downturn and an earnings slump. There is not sufficient evidence that this will happen yet. And even though the market had a negative initial reaction to the better-than-expected employment number on Friday, the “good economic news is bad news for the market” narrative is simply not true. Valuations, especially for value stocks, are reasonable now given current earnings and interest rates. So, it is more important that earnings stay strong, even if longer-term rates go back up to their June highs.

For now, I am confident that earnings will remain good through 2023, and we are well positioned to benefit. Still, the economy is very dynamic, and we will make changes as necessary.

OMC: Advertising Giant Remaking Itself

Omnicom Group (OMC) is a holding company for many of the leading global advertising, marketing and corporate communications agencies in the world. The company operates in all major markets, and it has large and diverse client base. In fact, OMC’s 100 largest clients are primarily large international companies that accounted for approximately 54% of revenue in 2021. OMC has more than 5000 clients in over 70 countries.

OMC agencies are client focused, with firms structuring their offerings and resources around a client’s specific marketing requirements. This client-centric business model involves the collaboration of multiple agencies within Omnicom in formal and informal virtual client networks—and it allows Omnicom to execute its clients’ marketing requirements in a consistent and comprehensive manner.

Omnicom’s largest firms include creative advertising agencies BBDO and DDB Worldwide. Omnicom also owns The DAS Group of Companies, which is global group of marketing services companies that cover public relations, promotional marketing, branding, and research.

Omnicom has made several acquisitions in recent years to build its capabilities in Precision Marketing, which has now become the company’s third-largest discipline behind advertising and public relations. This group aligns the company’s global digital, data and Customer Relationship Management (CRM) capabilities to deliver a precisely targeted and meaningful customer experience at scale. These services are enabled by the company’s omni platform that combines a powerful cultural insights engine with data insights.

Advertising has changed with the Internet, and as a result, the company is no longer growing as fast as it was at the turn of the century. However, OMC still produces consistent results, with EPS expanding from $5.10 in 2017 to $6.39 in 2021. Earnings were higher each year except for pandemic-impacted 2020. Top-line results were flattish over this period, but a better cost structure and a 4.5% decline in the share count drove the EPS gains.

The company’s results in the second quarter reflect their recent portfolio shifts. Revenues were basically flat at $3.567 billion, as the company divested several underperforming agencies, which lowered sales by 6.7%. On an organic basis, which also excludes a negative currency impact of 4.7%, sales increased 11.3%. While there was strength across the board, Precision Marketing led the way higher, with revenues up 21%. A better revenue mix, lower interest expense, and stock buybacks allowed EPS to increase to $1.70 from $1.62.

EPS estimates of $6.60 this year and $6.75 next year (gains for next year will be limited by the absence of election advertising) appear to be realistic, and OMC is attractively valued at just over 10X forward estimates. While a recession remains a risk, it is least partly priced into the stock, and OMC should outperform in any reasonable economic scenario. Buy OMC under $70. My target is $80. The 4% dividend yield will add to total returns.

Position Review: All About Earnings

Cognizant Technology Solutions (CTSH) reported second-quarter EPS of $1.14, vs. $0.99 last year, which was $0.06 better than expectations. However, revenue only grew 7.0% to $4.906 billion, below expectations for $20 million, and quarterly bookings were down 3% from the second quarter of last year. As a result, the shares have not participated in the rally since releasing results.

The company has grown more careful about the work it takes in given limited human resources, and there has been a slowdown in the financial services industries. Both of which weighed on Cognizant’s orders in the latest quarter. However, orders are expected to improve in the second half of the year, and the company should realize better margins as it emphasizes profitability over growth. So, EPS guidance for the year was raised slightly, with the company now expecting full-year EPS of $4.51 to $4.57, up from previous estimates for $4.45 to $4.55.

I know Cognizant shares have been a major disappointment this year. However, the company is still doing well, and with the stock selling at only 15X this year’s EPS estimate, it would be foolish to give up on the shares. I am sticking with my $80 buy under price and $95 target for CTSH.

Fidelity National Information Services (FIS) had a good second quarter, reporting EPS of $1.73, vs. $1.61 last year, on a 7% increase in revenues. Analysts expected EPS of $1.71. There was strength across all of the company’s segments, with merchant solutions leading the way with an 11% revenue gain. Despite the strong quarterly results, the stock weakened following the earnings report as the company lowered full-year EPS guidance from $7.25 to $7.37 to $7.00 to $7.10. The lowered guidance reflects higher interest expenses, a strengthening dollar, and divestitures of underperforming businesses.

Still, the expected results for the year are a nice gain over last year’s EPS of $6.55. Considering the company’s consistent growth history, the shares seem very cheap at 14X this year’s EPS, and I expect the stock to bounce back shortly. Buy FIS below $110. My target is $130.

First Busey (BUSE) reported second-quarter EPS of $0.54, vs. $0.52 last year, which was $0.03 below expectations. The fact is the company’s FirsTech payment processing business was a little weaker than expected, and mortgage income declined as existing homes sales weakened. Still, continued loan growth and higher interest rates are setting up the company for good growth in the coming quarter, provided the economy remains healthy. EPS estimates of $2.31 this year and $2.49 next year appear to be realistic, and the stock remains cheap based on those estimates. The stock’s dividend yield of 3.8% will add to returns. Buy BUSE under $24. My target is $29.

Morgan Stanley (MS) has continued to trade firmly following the release of second-quarter earnings. I believe there is a good chance the stock can creep up to my $90 target over the next few weeks. I would not rule out the possibility of raising my target. Hold MS for now. Only buy on any market weakness that would take the stock below $78.

Although the stock price has not enjoyed a big post-earnings rally, I feel pretty good about Newell Brands (NWL) after the company reported second-quarter results. EPS of $0.57, vs. $0.56 last year, was $0.10 better than expectations, as the company continues to benefit from lower interest expense and better cost structure due to its efforts to deleverage financially and operationally. Sales were down 6.5% given the sale of its Connected Home Security Business at the end of the first quarter, for which it received $493 million. Sales were up 1.7% on an organic basis.

The good top-line result was a pleasant surprise, as some bears on the stock thought the company would be a victim of the inventory reduction happening at Target and Walmart. However, as the company pointed out on the conference call, many of its products are not discretionary items. While portions of its home furnishings business were weak, most categories performed well.

The only bad part of the report was guidance, as the company now believes EPS for the year will be $1.79 to $1.86 versus previous expectations for $1.85 to $1.93. The revised guidance reflects the ongoing strength in the dollar, as well as further divestitures and costs related to the closing of Yankee Candle stores. However, the stock remains very cheap even on the lower guidance, and I continue to believe management is on the right track for the future of the company. So, the shares will eventually move higher. Buy NWL under $24. My target is $30. The 4.6% dividend yield will add to total returns.

Old Republic (ORI) had solid second-quarter earnings, reporting operating EPS of $0.69, versus $0.73 last year, which was $0.05 better than expectations. Premiums were flat, as general insurance premiums rose 8.6%, while title insurance premiums declined 7.1% due to the slowing housing markets. Underwriting results were strong, with the loss ratio for general insurance declining to 65.3% from 68.1%, and the title insurance loss ratio declining to 2.8% from 3.0%.

Book Value in the quarter declined to $20.99 from $22.33 at the end of the first quarter due to the falling bond and stock markets. However, shares remain cheap at 1.07X book, which should improve in the current quarter with the markets improving. The stock is also cheap at 9X this year’s operating EPS of $2.50 and has an attractive dividend yield of 4.1%. ORI is a buy below $24. My target is $27.

Phibro Animal Health (PAHC) will report fiscal fourth-quarter earnings after the market close on August 24. Expectations are for EPS of $0.38, vs. $0.32 last year, on an 11.7% gain in revenues, as the company benefits from strong demand and pricing, and potentially from declining commodity prices. After trading steadily all year in a tough year for the market, the stock weakened recently before snapping back yesterday. I believe the volatility is due to concerns about how earnings may be impacted by the strong dollar. However, with the stock cheap at 14X estimates and demand fundamentals good, I believe the stock is a good buy in front of the August 24 report. Buy PAHC under $20.50. My target is $25.

Sonoco Products (SON) reported second-quarter results that were in-line with June’s positive earnings pre-announcement. The company reported EPS of $1.76, vs. $0.93 last year, on a 38% increase in revenues, as the company continues to benefit from strong demand, higher pricing and the Ball Metalpack acquisition. SON is now looking for EPS between $6.20 and $6.30 for the entire year.

The stock is obviously cheap at 10X this year’s earnings, but the question for investors is what earnings will be going forward. While the economy could pressure results next year, the company’s consistent historical returns should serve it well, and baring a significant recession, EPS should stay above $5.00 a share. At that level of profitability, the stock is still an attractive investment. Buy SON below $65. My target is $75. The 3.2% dividend yield adds to the attraction of the shares.

Target (TGT) will report earnings on August 17 before the market opens, with expectations for EPS of $0.73, vs. $3.64 last year, on a 4% increase in revenue. Margins have been squeezed by big discounts in home furnishings and other discretionary categories as the company attempts to clean out excess inventory. Actual results could vary widely from estimates. What is important is not earnings but rather how the company is positioned for the remainder of this year and next. The recent rally in the stock indicates that investors are optimistic about the company’s chances to clear out excess inventory, which given a still healthy consumer, seems to be a reasonable assumption.

I’m lowering my targets slightly to $180. The new target is based on 15X expected EPS of $12.00 a share next fiscal year, which is still below the $13.56 the company earned last year. While strong stimulus measures may have allowed the company to “over earn” last year, that does not distract from the positive changes the company made during the pandemic to drive higher store traffic and ecommerce sales. TGT also continues to trade at a significant discount to Walmart, which trades at 20X forward estimates and is also struggling with excess inventory and changing consumer demand. I believe this discount should close, and my $180 target could prove to be conservative. Buy TGT on dips below $163 in front of earnings.

Universal Health Services (UHS) reported second-quarter EPS of $2.20 a share, versus $3.76 in the prior year, on a 3.9% acquisition-aided improvement in revenues, which was in line with a negative earnings preannouncement made in late June. The lower earnings were attributed to a decline in patient volumes at acute care hospitals in the absence of Delta Variant COVID patients that boosted results last year, and rising staffing costs as shortages drove an increase in higher costs for temporary workers. Patient trends at Behavioral Health Facilities were flat in the quarter, which was an improvement over the slump in the first quarter.

The stock rallied sharply immediately after the results but gave up the gains quickly and have since traded in a tight range. However, I think the stock will eventually rally and hold the gains. UHS is only trading at 11X depressed earnings this year of $10.00 a share, and an improvement to at least $11.00 next year as staffing and patient volumes improve. As the market gains confidence that UHS results have stabilized and these estimates are realistic, the stock will move closer to my $130 target. UHS is a buy below $110.