No change to newsletter portfolios.
By Brian Nelson, CFA
Against a backdrop of US-China trade tensions, a Fed that continues to balance the need to hike rates with caution against purposefully and meaningfully inverting the yield curve, US GDP growth humming along at 2%-3%, and news from Tesla (TSLA) CEO Elon Musk, who says something big is in store for tonight. Incidentally, he changed his Twitter name to Elon Tusk. Was it to match our typo yesterday? Elon – if you’re listening, give us a shout out! We love Tesla’s future expected free cash flow!
Just some housekeeping items before we get started. For our High Yield Dividend Newsletter members and our Exclusive members, we do not house the archived newsletters on our website, as these newsletters are separate than the regular premium or financial advisor level memberships. The archives to the High Yield Dividend Newsletter, a product that I do not think could have done better during this kind of yield environment, can be accessed here, as of December 2018. The Exclusive has its own website here. Order the High Yield Dividend Newsletter here.
There were a swath of companies that had disappointing reports after the bell February 27 and this morning, but almost all outside the newsletter portfolios. Remember – we use our own research to build the newsletter portfolios to help members distill the vast amount of information on our website. Think of us as a small “buyside shop” that is a financial publisher offering our thoughts in full transparency. You know what we think about each name, but you also know which ideas our favorites are as they are included in the newsletter portfolios.
Let’s get started on an earnings roundup. Keurig Dr. Pepper (KDP) reported decent fourth-quarter results, but its guidance came up a little short. We’re not reading too much into it, but we do think investors should be paying very close attention to the balance sheets of many of the beverage makers. For example, Coca-Cola (KO), while an absolute powerhouse, has a net debt position in the mid-$20 billion range and expectations for comparable EPS from continuing operations in 2019 of ~$2.08, meaning shares are trading at about 22x forward earnings, with a huge net debt position on lower-than-expected growth prospects and flat year-over-year earnings.
I’m not saying Coca-Cola is a bad company (on the contrary, it is legendary), but from a valuation standpoint, things are starting to make less and less sense with shares trading in the mid-$40s, even after their steep decline. Our fair value estimate for Coca-Cola stands at less than $40, and that’s optimistic. Keurig Dr. Pepper’s balance sheet is also loaded with net debt (it has billions of dollars in net debt in the mid-teens range), with adjusted diluted earnings per share expected in the range of $1.20-$1.22 for 2019, implying shares are trading at 22 times forward adjusted earnings, too.
Be careful. These are great companies, as everyone and their mother knows, but you’re paying up for them. It’s very unusual for slow-growing entities to be trading at more than 20 times forward earnings with a substantial amount of net debt on the books. If you look at other fast-growing considerations in our newsletter portfolio, for example. Facebook (FB) is trading at a similar multiple as Coca-Cola and Keurig Dr. Pepper, but Facebook has a net cash position of $40+ billion, and its free cash flow is phenomenal, all the while consensus pegs expectations for earnings to expand nearly 20% in 2020, which we think may be conservative.
These are the types of instincts that I want you to develop. As I outline in Value Trap: Theory of Universal Valuation, there are three main sources of cash-based intrinsic value: net cash on the books, future expected enterprise free cash flows and hidden assets/liabilities. You should be seeking out these financial items in every company you own, and you should be evaluating them in the context of sustainability, in particular their competitive advantages. How wide is the company’s economic moat and how luxurious is their economic castle (the magnitude to their economic profit spread), for example?
Let’s get into a couple companies that we think are just too-difficult to own. Crocs (CROX) had a decent fourth-quarter report, but its shares are facing some pressure. Fiscal 2019 guidance wasn’t too bad though, implying revenue growth in the range of 5%-7%. We view Crocs as more of a faddish-type company, not conducive to long-term investing. L Brands (LB) dropped after its guidance for 2019 came in lower than others were expecting, and its wide range of $2.20-$2.60 suggests management doesn’t have too good of a handle on developing trends, particularly with respect to the positioning of its Victoria’s Secret brand. We think consumer trends are against L Brands.
As is customarily the case, Bookings Holding (BKNG), which reported fourth-quarter results February 27, put up a solid showing, but issued guidance lower than what the Street had been expecting. Bookings’ has been doing this for about as long as the company has been a part of the Best Ideas Newsletter portfolio. We’re not worried and are huge fans of the company’s free cash flow generation, which came in at ~$4.9 billion in 2018 (nice year-over-year expansion, too). Management also expects non-GAAP net income per diluted share, on a constant currency-basis, to advance at a low double-digit pace. The Street is overreacting yet again, in our view.
That’s it for now. We’ll have Part III of Warren Buffett’s Letter to Berkshire Shareholders to you later today.
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Brian Nelson does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.