Valuentum Exclusive Analysis for the Discerning Investor

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Image shown: Dollar General's stock has performed very well since being added to the Best Ideas Newsletter portfolio.

We were very happy to see newsletter portfolio idea Altria surge back above $70 per share in recent days. Dollar General continues its strength as the economy churns out more of its demographic, and we continue to believe the dollar store arena may be one of the few spaces of retail that is truly insulated from the Amazon effect. Verint Systems, on the other hand, has faced selling pressure, which we think is flat-out unwarranted.

By Kris Rosemann and Brian Nelson, CFA

In case you missed the latest video from President of Investment Research Brian Nelson here, we’ve been following very closely developments in North Korea and the Bitcoin markets, but we’ve also been working hard to get the “right” information and things to be mindful of to readers when it comes to fees and ETFs. All fees matter, and we encourage the financial industry to start reporting fund performance after adviser fees, to provide the individual investor better information. Also, we’ve long been concerned about the implications of investors thinking they are buying “value” instruments, but somehow end up with an ETF of potentially “overvalued” stocks in the case of when intrinsic-value approaches, namely discounted cash-flow analysis, are not pursued in the instrument's methodology.

There are a few things we want to make you aware of on December 7, 2017. Obviously, we humbly pay our respects to those that lost their lives at Pearl Harbor, as we will never forget. In part, that’s why we wanted to make sure you’re aware of the path to war the US and North Korea appear to be taking, as we outlined in the video here. The markets, however, appear to be sleeping, and while this has us concerned given the lack of price discovery that such volatility implies, we’re also not shying away from highlighting the strongest of companies. One such company is Altria (MO), an idea in both the Best Ideas Newsletter portfolio and Dividend Growth Newsletter portfolio. We’ve been very pleased to see its shares skyrocket back over $70 per share in recent days. We’ve tactically “taken some off the table” recently, but we still very much like the pricing power of its business model even in the face of declining cigarette volumes.

Best Ideas Newsletter portfolio idea Dollar General (DG) is well on its way to its 28th consecutive year of same-store sales growth. In its fiscal 2017 third quarter, report released December 7, the company reported same-store sales growth of 4.3%, driven by an uptick in both customer traffic and average transaction amount. Strength in consumables, seasonal, and apparel categories helped drive net sales to $5.9 billion in the quarter, an increase of 11% from the year-ago period. Through the first three quarters of its fiscal year, Dollar General reported same-store sales growth of 2.6% and overall sales growth of 8.5%.

Dollar General’s bottom line fared well in its fiscal third quarter, too, though it did face an earnings headwind of approximately $0.05 per share due to hurricane-related issues. Diluted earnings per share grew to $0.93 in the fiscal third quarter from $0.84 in the comparable period of fiscal 2016, but investors should note the role that a reduction in shares outstanding played in this growth. Net income grew to $253 million in the quarter from $235 million a year earlier, but margins faced pressure as a result of hurricane-related expenses and an increase in retail labor expenses.

Dollar General's free cash flow faced pressure as a result of an increase in capital expenditures, but we like this investment spending (net cash from operations expanded slightly). For one, the company continues to open new stores as well as remodel existing stores at a tremendous pace. Dollar General plans to open ~1,285 new stores in fiscal 2017 in addition to 760 remodels or relocations, and fiscal 2018 is expected to bring the opening of ~900 new stores, remodeling of ~1,000, and relocation of ~100.

The discount retailer’s strong fiscal third quarter performance led management to increase its full year top-line guidance and tighten its earnings per share guidance. It now expects net sales growth of ~7% and same-store sales growth of 2.5% on a year-over year basis, compared to previous guidance of 5%-7% for net sales growth and slightly positive to up 2% for same-store sales growth. Earnings per share guidance has been adjusted to a range of $4.37-$4.47 from $4.35-$4.50. 

We do not expect to make any changes as it relates to Dollar General in the Best Ideas Newsletter portfolio. The company continues to impress us with its resiliency in the face of a difficult broader retail environment, and shares look to have room to move higher on the basis of the upper bound of our fair value range, which currently sits at $107 per share. Regardless, Dollar General has been a big winner for the Best Ideas Newsletter portfolio thus far in 2017 as it was added just under $69 per share in April, all while offering investors a ~1.15% yield.

On the other hand, Verint Systems (VRNT) is facing selling pressure that we think is completely unwarranted. The company beat expectations on both the top and bottom line in its third-quarter report, released December 6, and it offered preliminary guidance for the fiscal year ending January 2019. It expects total revenue to advance to $1.215 billion with a range of +/- 2%, while it expects $3 per share in non-GAAP diluted earnings at the midpoint, implying that shares are trading at ~13 times forward earnings in a market where the average S&P 500 company is trading at over 18 times. Plus, Verint is growing like a weed and has tapped into the burgeoning cybersecurity market. We think the market is mostly concerned about the presentation of GAAP versus non-GAAP, but cash flow trends say it all.

Through the first nine months of the fiscal year, Verint Systems has pulled in $96.2 million in net cash from operating activities while it has spent $26.4 million in property and equipment, implying healthy free cash flow (it has also grown year-over-year). The company does have a net debt position, but it also has substantial liquidity, with ~$313 million in cash and cash equivalents. Long-term debt of ~$766 million isn’t overbearing either given cash-flow generation and growth prospects. Verint still looks cheap to us on both a forward earnings multiple basis and on a discounted cash-flow basis, and the company is tied into the growing cybersecurity market, an open-ended opportunity. Here’s what Verint had to say in the third-quarter press release:

In Cyber Intelligence, we are a market leader in security and intelligence data mining software and we are pleased with our double-digit year-over-year revenue growth for the third consecutive quarter this year. Our results reflect the demand for solutions that can address terrorism, crime, cyber-attacks, and other threats that remain pervasive around the world. We believe our broad portfolio, domain expertise and on-going innovation will contribute to sustained long-term growth.

We think “the shorts” are beating up a stock that frankly doesn’t deserve it. In any case, we like what we’re seeing across both newsletter portfolios, Dollar General continues to act well, and it was good to see Altria spring back to life. Most of the fee-based market is going to tell you to ignore everything and keep your money with them, but that’s why we’re independent. We have the unique privilege to tell you about the real risks, not only with respect to the geopolitical environment but also with respect to overall valuations and what we think is simply irrational behavior by many stock market participants. Please keep paying attention to preserving your hard-earned savings. Don't let complacency cost you big!

That’s all for now.