General Mills makes a big deal, Realty Income delivers, while Energy Transfer tries to battle back to even.
By Kris Rosemann
US Secretary of Defense Jim Mattis came out in support of recommendations from the Commerce Department for targeted tariffs on steel and aluminum. While the Defense Department recognizes that imports of low-cost steel (SLX) and aluminum resulting from unfair trading practices undermine national security, it also warns that more broad action could irritate allies. President Trump has until April to decide whether or not to take action on the recommendations from the Commerce Department for tariffs up to 24% and 7.7% on foreign steel and aluminum, respectively.
Consumer food product giant General Mills (GIS) made a splash before the open February 23 when it announced its planned $8 billion cash buyout ($40 per share) of Blue Buffalo Pet Products (BUFF), though the market has not looked favorably upon the deal. The move is undoubtedly part of a search for a return to sustainable top-line growth, which has been hard to come by for many consumer staples companies (XLP) of late as competition is as intense as ever. The US pet food market is estimated at ~$30 billion and has been growing at a rate of 3%-4% annually with premiumization and subscription-like purchase patterns as potential factors in driving future growth. The BLUE brand is the leading pet food brand in the Wholesome Natural category (4x the size of the next largest brand), the pet specialty channel (2x the size of the next largest brand), and the e-commerce channel (2017 e-commerce revenue was $250 million, 75% higher than 2016).
The deal is not expected to be accretive to General Mills’ earnings until fiscal 2020, and management expects its net debt-to-EBTIDA ratio to rise to 4.2x at closing. The company expects to maintain its $0.49 per share quarterly dividend but will suspend its share buyback program as it works to hit a net debt-to-EBITDA ratio of 3.5x by the end of fiscal 2020. S&P Global Ratings (SPGI) nearly immediately downgraded General Mills’ credit rating to BBB from BBB+ as a result of the added leverage (financing will come via debt, cash on hand, and ~$1 billion in equity), and we expect a similar result on our Dividend Cushion ratio for the firm.
HP (HPQ) has rallied after a strong first quarter report in its fiscal 2018, results released after the close February 22. The company’s ‘Personal Systems’ segment delivered its fifth consecutive quarter of double-digit revenue growth on a year-over-year basis, and the global PC market grew in both units and revenue in the calendar fourth quarter of 2017 (HP’s fiscal first quarter). HP outpaced market growth in each region it serves and extended its leading market share to 23.5%, up 1.7 percentage points from a year ago.
The company’s ‘Print’ segment is also off to a strong start in fiscal 2018 as it grew revenue 12% from the year-ago period, and management is optimistic about the addressable market expansion it expects from its introduction of a lower-cost 3D printing color solution. HP is now the only 3D printing provider (PRNT) that can offer prototyping and industrial final part production on the same underlying technology platform. Overall bottom-line results were quite impressive in the quarter as non-GAAP earnings per share rose 26%, and free cash flow jumped 33% on a year-over-year basis to $1 billion.
US stocks have largely shrugged off comments regarding expectations for increased inflation in the January Fed minutes despite an initial drop following the release February 21. Nearly all of the FOMC members expect inflation to grow in 2018, and “a majority of participants noted that a stronger outlook for economic growth raised the likelihood that further gradual policy firming would be appropriate.” We continue to watch changes in benchmark interest rates.
President Trump’s Council of Economic Advisors has suggested that the gas tax Trump had endorsed as part of his plan to pay for infrastructure spending is an imperfect system. The council’s chairman noted that the gas tax, which was last raised in 1993, was implemented to fund highways when fuel economy as a whole was far lower than it is today, and inflation and fuel efficiency have since reduced the purchasing power of gas tax revenue. The group also suggested that tolls may be a more appropriate option in paying for the infrastructure investment plan. We think spending at the federal level is partly why sovereign yields have spiked.
In other government-related news, the Treasury Department is considering changing the Orderly Liquidation Authority (OLA) aspect of Dodd-Frank, which allows the FDIC to take over and restructure an insolvent bank. While OLA will still be used in extreme situations, those that oppose the regulation claim that it incentivizes risky behavior by providing a guarantee of a bailout from the government and suggest replacing the law with a new bankruptcy process, which it plans to create as Chapter 14 bankruptcy, that will result in a termination of rights for those involved in derivatives contracts with the failing bank. The financial liability of the failed entity would fall on its shareholders, management, and certain creditors rather than the federal government. OLA is one of the few aspects of Dodd-Frank that was supported by the financial sector (XLF).
Mr. Market liked what it saw in simulated Dividend Growth Newsletter idea Realty Income’s (O) fourth quarter report as its occupancy ticked slightly higher and remained robust at 98.4%, and adjusted funds from operations (AFFO) came in at $0.76 in the quarter, a $0.01 gain from the comparable period of 2016. Same-store rents moved 1% higher on a year-over-year basis, and management points to robust property acquisitions at investment spreads higher than its historical average as a key driver in its earnings growth in 2017. 2018 AFFO is expected to grow 3%-5% to a guidance range of $3.14-$3.20, and the REIT got a boost from Moody’s in the fourth quarter of 2017 as the credit rating agency raised Realty Income’s credit rating to A3 from Baa1, making it part of a select group of REITs with an ‘A’ credit rating. Shares yield ~5.3% as of this writing.
Energy Transfer Partners (ETP) moved higher following its fourth quarter 2017 report, released after the close February 21, as it shot past expectations for the period. Adjusted EBITDA jumped 30% from the year-ago period thanks to significant growth in midstream and crude oil transportation and services, while distributable cash flow, and industry-specific measure that may not be truly appropriate for distribution coverage metrics, rose to ~$1.2 billion in the period from $960 million in the fourth quarter of 2016. The MLP’s distribution coverage ratio came in at 1.3x in the quarter, but the health of the payout remains dependent on adequate access to the capital markets. Units are changing hands under $20, half of what they were prior to the “MLP collapse.” Its yield is ~11.9% as of this writing.
Simulated newsletter portfolio idea Intel (INTC) is growing its exposure to the coming implementation of 5G network connectivity via a collaboration with PC makers such as Microsoft (MSFT), Dell (DVMT), HP, and Lenovo (LNVGY). PCs with build in 5G capabilities will use Intel modems, which will also support 2G, 3G, and LTE, and are expected to hit the market by the 2019 holiday season. AT&T (T) and Verizon (VZ) are expected to begin rolling out 5G networks by the end of 2018, and Qualcomm (QCOM) is working on modems with 5G capabilities for 2019 and is collaborating with 18 phone companies.
Metals & Mining – Aluminum: AA, ACH, ATI, CENX, KALU
Metals & Mining – Steel: AKS, GGB, MT, NUE, PKX, STLD, X
Related: ETE, DDD
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Kris Rosemann 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.