Tuesday, July 29, 2014

GDP Consensus Too High, But We're Working Hard

In a tiny sliver of the service economy in a Southern state capital, labor productivity soared when we worked a double shift one day last week.  It would have taken similar heroic efforts repeated oh-so-many times for the nation’s economic output to have meaningfully rebounded in the second quarter.  In our view, the 3.5% consensus estimate for gross domestic product growth is too sanguine. 

Nevertheless, our model expects a return to trend growth between 2.5% and 3.0%.  Our point estimate is 2.9%, which should be robust enough to reassure equity markets the expansion is healthy but not a tipping point for tighter monetary policy.

The economy contracted at a 2.9% annual rate in the first quarter, a result largely blamed on the “hibernus horribilis” of ice, snow and bitter cold in North America.

For the spring, we expect positive contributions from employment gains of more than 800,000 and a rebound from the first-quarter labor productivity decline of 3.2%.  The jobs gains also likely boosted non-residential fixed investment, which has been a consistent drag.  Confidence also probably led businesses to rebuild inventories drawn down in the harsh winter months.
However, the trade deficit widened in the first two months of the quarter, and real personal consumption expenditures declined in both April and May.  Estimates for June in these line items will be a swing factor.
Our concern is that real final sales (GDP minus inventory growth) could prove anemic, which ironically could support the liquidity-fueled equity market’s expectation of a steady near-zero interest rate policy from the Federal Reserve absent signs of inflation. 
The answer will come soon enough, as the Federal Open Market Committee will release its latest monetary policy decision in a statement Wednesday afternoon, just hours after the GDP release from the Commerce Department.  The punch bowl, we believe, will remain spiked.

Tuesday, July 8, 2014

Whole Foods Markets: Still Too Pricey

We recently embarked on a visit to losers in a bull market – the worst performing stocks in the S&P 500 in the first half of 2014.  After looking at Coach, we take a gander at Whole Foods Markets Inc. (WFM), down about 32% from January through June.  Our conclusion: Diminished expectations are baked in and the stock could overdeliver, but it’s still too rich for our taste.

The organic green grocer has more than 300 stores nationwide and in Canada and the United Kingdom and is a destination for the health food crowd willing to spend extra for the benefits of organically produced food staples, but competition from mainstream operators such as Kroger and Safeway is a natural check on growth.

On the valuation front, WFM sports forward price/earnings multiple of about 23, nearly twice that of the S&P 500, and a price/earnings-to-growth ratio of 1.93, which tells us investors believe growth will resume to levels above new guidance.  Meanwhile, the price-to-sales ratio is 1.06, vs. just 0.25 for Kroger and 0.22 for Safeway, and dividend yields at Kroger and Safeway are both above that of Whole Foods’ 1.23%.

Whole Foods’ share price plummeted in May after management reported disappointing quarterly results and slashed guidance for the remainder of the year.

Bulls will tell you that Whole Foods’ plans, which include a pipeline for 114 new stores, are solid enough to warrant a premium valuation for this solidly profitable company that has a loyal customer base.  But we wonder how many more customers there are to glean from shoppers happy enough to buy their whole wheat bread from the Wal-Mart market or visit their local independent artisanal purveyor.

In the March quarter, Whole Foods reported earnings per share of $0.38, below the consensus estimate of $0.41.  The company lowered its outlook for fiscal 2014, projecting 10.5-11% sales growth compared with 11-12% previously.  It cut its same-store sales growth forecast to 5.-5.5% from 5.5-6.2% previously.

Make no mistake, this is still a growth stock, but we think the company is priced for perfection right now.  We could be buyers at under $30, another 20% haircut from the current level of about $38 per share.  A price of $30 would put the forward PE at about 17, comparable to the S&P 500, if estimates remain the same.  That, we believe, is a better entry point for this ambitious, well-managed company.

Whole Foods Market, Inc. operates as a retailer of natural and organic foods. Its stores offer produce and floral, grocery, meat, seafood, bakery, prepared foods and catering, coffee, tea, beer, wine, cheese, nutritional supplements, vitamins, and body care products, as well as lifestyle products including books, pet products, and household products. As of May 16, 2014, the company operated 360 stores in the United States, Canada, and the United Kingdom. Whole Foods Market, Inc. was founded in 1978 and is headquartered in Austin, Texas.


Thursday, July 3, 2014

The Loser Now Will Be Later to Win -- First in a Series: Coach

(We'll be looking at laggard stocks in a bull market.  Here's our first)

We had a classy girlfriend some time ago who owned a Coach leather bag.  We wonder who’s kissing her now. Probably her grandchildren, which has been part of Coach’s recent woes, a reputation as a yesteryear luxury brand.  Be that as it may, we thought of bygone romance when looking at a list of the worst performing stocks in the S&P 500 in the first half of 2014.  While the Street is almost universally bearish, we think Coach’s turnaround strategy, overseas growth, plump dividend, profitability metrics and reasonable valuation merit a buy recommendation.

Let’s look at the bear case first. Coach, whose shares declined 38% in the first half of 2014, recently cratered after it announced it was closing 70 stores, or about 13% of its retail outlets, and would incur charges of up to $300 million over the coming quarters. CFO Jane Hamilton Nielsen told investors that as a result of the closings and a reduction in promotions revenue would decline in the low double digits

Coach was responding to plummeting same-store sales in North America, which more than offset strong gains in Chin.  In effect, Coach was admitting that its “accessible” luxury strategy was a bust.  And though not stated, the move was largely in response to the market share gains of competitors Michael Kors (KORS) and Kate Spade & Co. (KATE).  Though women’s handbags and accessories have slumped, Coach is experiencing double-digit same-store sales in Asia and a stronger men’s business. 

Some analysts have compared Coach’s about-face to the failed end-of-promotions strategy of J.C. Penney, but Coach remains a highly profitable company with the means to reposition itself, in our view.  Key to the rejuvenation of the brand will be the work of Stuart Vevers, the English designer charged with retooling the Coach look.  We’re no fashion experts, but reviews were glowing at last winter’s New York fashion week.

Key to our outlook for Coach is its reasonable valuation compared with its profitability metrics.  The shares trade at about 16.5 times next year’s earnings estimates, about even with that of the S&P 500.  But Coach boasts a 38.6% return on equity, more than double the industry average of 18.8%.

And while waiting for brand restoration to show results, investors are rewarded with a dividend yield of nearly 4%.  The dividend payout ratio of 40% is high, but with minuscule debt and positive cash flow it should be safe for now.

Our recommendation is not without risks, chief among them a collapse in consumer spending, not a negligible possibility.  And, of course, Coach could fail to recapture its cachet as America’s top luxury brand.  But we think the stock is a bargain at current levels and that a year from now it will command a price-earnings multiple equal to that of KORS.  That gives us a target price of $54, some 58% above current levels.