Lowe’s Misses, Nordstrom Buckles, Target and Best Buy Shine
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Need short idea considerations in this tumultuous market? Consider the Exclusive publication here. We release a new short idea consideration each month, in addition to an income and capital-appreciation idea.
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East Coast friends: Brian will be available for a book signing at Headline Books booth 957 at the American Library Association Conference at the Walter E. Washington Convention Center in Washington DC June 22 (more details to follow). Value Trap has been named a Next-Generation Indie Award Winner!
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By Brian Nelson, CFA
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When asked about whether Valuentum is all about stock timing, I sometimes cringe. Roughly 90% of our work goes into figuring out what may be the best fair value estimate for a company’s shares, and this involves one of the most extensive processes to do so, the enterprise free cash flow model, also known as the DCF (discounted cash flow) model. The predictive information in fair value estimates is second to none, in my opinion. Here is a read (pdf).
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Here’s how I think about our service. Timing elements aside, we think we offer one of the best valuation services around. We’re not simply highlighting stocks on price-observed, readily-available, ambiguous P/E or EV/EBITDA ratios, of which everyone and their mother has access to on the Internet this day and age. We’re not highlighting stocks simply on the basis of the size of their dividend yields. Anybody can do this. I really mean anybody, and there are ETFs that can do this for you. Order the High Yield Dividend Newsletter here. All of this price-observed information is readily available and free. That’s not where the value of financial information rests.
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Building an enterprise free cash flow model and arriving at a fair value estimate on the other hand is a considerably more robust and intensive exercise. Enterprise valuation takes into consideration all elements of a company from how we expect revenue to progress, to the operating leverage of the company, to the financial risks of the entity, to how capital allocation decisions impact dividend health. We try to make investing as easy as it can be and no harder, but we think enterprise valuation is the baseline. We don’t think advisors and investors are practicing due diligence without a service that offers this framework for valuing companies and the underlying within ETFs and other financial instruments.
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That said, enterprise valuation fits well into the concept of timing. Stocks that are undervalued on the basis of an intrinsic value estimate may be more likely to be purchased by market participants, and those stocks already exhibiting strong share-price momentum may be less likely to be value traps (both we and the market agree shares are undervalued in this case, increasing the likelihood the stock is truly undervalued and shares will move higher, in our view). Importantly, we’re only interested in the timing element on significantly undervalued stocks with strong competitive advantages and solid economic returns. These are the types of stocks a tried-and-true value investor may own anyway.
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The way to think about this is rather simple. Our process is yet an added margin of safety even beyond the fair value range, or what might be traditionally viewed as a margin of safety (“buying stocks at a discount to intrinsic value”). Even if we’re wrong on timing, we still have a stock that has a lot of things going for it, and an idea that may be the best of what other value-focused providers may have to offer. We’re not just looking for a good company–you know good companies don’t always make good stocks. We’re looking for stocks that are deeply undervalued on an enterprise valuation basis, have strong economic castles, that are exhibiting top-line growth, and are appreciating in price, among other criteria.
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Yesterday, I was thinking about the traditional quantitative value factor and all it’s glory in academic literature. More recently, however, the traditional quant value factor has been underperforming its counterpart (growth) during the past couple decades or so, and while many continue to have arbitrary (and meaningless) value versus growth conversations, my view is that the traditional quant factor has always been spurious. It is based on arbitrary book value, an ambiguous book-to-market ratio, and uses realized data, when we know that stock prices and returns are based on expectations, realized or not. Timing the traditional quant value factor is an afterthought, as it may very well be be entirely spurious. Read more in
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And this is where those other firms want to confuse you. They want you to think that all value is the same, that observing a company’s P/E ratio is the same as building a discounted cash flow model and asking the primary question: What is a company’s worth? It’s not. Observing a P/E ratio or EV/EBITDA multiple on the market is like watching the ticker tape. Is it any wonder why 90% of active management has been underperforming during the past 15-year period? Most may not even be measuring value! My hypothesis is that many may just be trading on price-observed multiples and applying the failed quantitative processes of yesteryear. Some want more disruption. I’m trying to fix this industry. 90% underperformance is simply unacceptable!
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With that said, I wanted to answer a question from a long-time member. Here’s the question: “I have a legacy position in 3M (MMM) with a cost basis of $45..and knew it had overrun in valuation over the years. What is your estimate of the basic business? Is it another GE (GE) story or is the business stronger? What do you think about a dividend cut possibility?” I think this is where the systematic application of our methodology across our service stands out and adds considerable value to a membership. The answer to this question and questions like it are already on our website. Unlike other blogs like Seeking Alpha, for example, you don’t need an article to get our opinion. Our opinion is embedded in the interpretation of our key metrics that we derive.
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Let’s visit 3M’s stock page. The company is trading at about $170 each, and our fair value estimate is $175, so we’d view shares as about fairly valued, and we’d really only grow interested in them if they approached the low end of the fair value range (~$130), and we’d only consider adding them to the newsletter portfolios if they were near that low end of the range and advancing in price (not falling) — it would then be an undervalued stock that is going up in price (a Valuentum stock). Incidentally, as 3M’s shares rocketed to ~$260 in early 2018, our fair value estimate stayed well under $200, helping to warn readers that shares were getting pricey. Enterprise valuation matters!
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Now what about the dividend? The company’s Dividend Report (pdf)indicates that 3M has a lengthy dividend growth track record, meaning management has a willingness to keep raising the dividend through thick and thin. 3M also has a solid Dividend Cushion ratio of 1.4, meaning that at the moment, we think 3M will generate enough free cash flow to cover expected cash dividends paid over the next five years in the context of its net balance sheet. All things considered, we think 3M is priced about right, and we’re not worried to much about its dividend at this time. The systematic methodology is a huge benefit of the Valuentum platform, and it’s so easy to use.
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Simply put, there is a tremendous amount of information included in the 16-page reports and dividend reports, and a couple data points (as in the 3M example) can tell you as much as a 1000-word article, even one of beautiful prose. That’s why it’s so important for you to learn our methodology, so you can maximize the value of our service (and save time!). But not only do we have reports for a plethora of companies, but we also provide newsletter portfolios, too, and 3M is not a “holding” of any newsletter portfolio. This offers even more information about how we think about shares. The company is not a top consideration. With all of this said this morning, let’s dig into some earnings reports!
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Ideas mentioned by ticker symbol: AAP, BBY, CTRP, HRL, JWN, LOW, TGT, VFC.
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Advance Auto Parts (AAP): Advance Auto Parts reported first-quarter results May 22 that came in better than expected. Net sales advanced 2.7% thanks to a similar increase in comparable store sales, while adjusted operating income leapt nearly 9%. The highlight of the quarter was cash-flow performance, with operating cash flow increasing more than 30%, and free cash flow following through with a near-20% advance. Management pointed to its “disciplined approach to cash management” as the reason for the strong free cash flow growth, and Advance Auto Parts’ strategic transformation is bearing fruit, even in the face of inflationary headwinds. Full-year 2019 guidance is calling for comparable store sales to increase 1%-2.5% and free cash flow to be a minimum of $650 million. We expect a modest bump in our fair value estimate. View Advance Auto Parts’
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Best Buy (BBY): Best Buy has come roaring back despite being written off as dead during the depths of the Financial Crisis as Amazon came to eat its lunch. Not only is Best Buy a survivor but the company is now thriving thanks in part to extremely helpful in-store personnel. As technology makes our lives easier, it is not necessarily getting easier to understand, and that’s why we think Best Buy has navigated the market in the face of Amazon quite well. The company’s first quarter fiscal 2020 results, released May 23, were solid, with comparable store sales growth of 1.1% lapping a very strong 7.7% comp in last year’s quarter. Management is calling for comp growth of 0.5%-2.5% during fiscal 2020 and non-GAAP diluted earnings per share in the range of $5.45-$5.65, which considers its “best estimate of the impact associated with the recent increase in tariffs on goods imported from China.” Our $76 per share fair value estimate remains unchanged. View Best Buy’s stock page >>
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Ctrip (CTRP): Ctrip posted strong first-quarter results May 22. The Chinese provider of online travel and related services showed resilience in the face of US-China trade tremors, with revenue advancing by 21% and income from operations surging 50% in the period versus that of the prior-year quarter. International business accounted for ~35% of revenue in the period. The outlook of the travel industry in China could not be more robust given Ctrip’s performance, and Ctrip has considerable competitive advantages in its one-stop travel platform. The company is targeting net revenue growth of 16%-21% during the second quarter of the year–another solid report from China. We include Booking Holdings (BKNG), formerly Priceline, in the Best Ideas Newsletter portfolio, so this indirectly is good news. View Ctrip’s stock page >>
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Hormel (HRL): Hormel reported decent fiscal second-quarter results May 23, but the company lowered its earnings guidance for fiscal 2019. Although the company reported record net sales during the fiscal second quarter, management pointed to the impact African swine fever in China had on global hog and pork markets and the corresponding higher costs it caused. The company said it is taking pricing actions to help resolve what may turn into a one-time transient event, but nonetheless, its fiscal 2019 outlook for earnings was subdued. Management is now looking for earnings for the year in the range of $1.71-$1.85 per share (was $1.77-$1.91). We’re not reading too much into the revision, and we don’t expect to make a material change to our $35 per-share fair value estimate as a result. Hormel has a very healthy Dividend Cushion ratio and a fantastic multi-decade track record of consecutive annual dividend increases. View Hormel’s stock page >>
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Nordstrom (JWN): We had talked about the troubles anchor store retailers in malls are encountering, and Nordstrom was no exception. Following disappointments from J.C. Penney and Kohl’s, perhaps Nordstrom’s first-quarter report, released May 21, which showed misses on both the top- and bottom-line, shouldn’t have been that surprising. The market still drove shares down more than 9% during the trading session May 22, however. The commentary was flat out “scary:” While (Nordstrom) expected softer trends from the fourth quarter to continue into the first quarter, (it) experienced a further deceleration.” Again, this was consistent with our channel checks when we were flat-out surprised at how empty some of the malls were these days. For fiscal 2019, the company cut its revenue outlook to -2%-0% (was +1%-2%) and its earnings per share outlook to $3.25-$3.65 (was $3.65-$3.90). We view Nordstrom as “uninvestable,” much like the rest of department store retail. We plan to adjust our fair value estimate lower on the news. View Nordstrom’s stock page >>
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Lowe’s (LOW): Home improvement retailer Lowe’s didn’t quite live up to expectations during its first-quarter report, released May 22, missing both on the top and bottom lines. Many were focused on the company’s gross margin, which slipped 165 basis points from last year, but underlying trends weren’t that bad. Sales advanced 2.2% in the period, while comps increased 3.5%. Management noted the good performance on the top line, but it also had a lot to say about its expanding cost profile and the ineffectiveness of its legacy pricing tools, the latter of some concern. The company had been forecasting adjusted earnings per share in the range of $6.00-$6.10 for fiscal 2019 (ends January 2020), but now management thinks the range of $5.45-$5.65 is more likely. Shares are now priced about right after the sell-off, in our opinion. View Lowe’s stock page >>
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Target (TGT): Target put up a glowing first-quarter report May 22 that showed a beat on the top and bottom line. Comparable store sales advanced 4.8% thanks mostly to increased traffic, while comparable digital channel sales expanded 42%, lapping a 28% increase in last quarter. The company leveraged this strong comp growth into a 9% increase in operating income during the period. The market liked the news as it may have suggested that tariffs on product imports from China won’t damage demand or profitability (much like the read through of Best Buy’s outlook), but management is still targeting a low- to mid-single-digit increase in comparable sales and adjusted earnings per share in the range of $5.75-$6.05 for the year. It wasn’t increased. Our fair value estimate of Target remains $79. View Target’s stock page >>
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V.F. Corp (VFC): V.F. Corp reported fiscal fourth-quarter results May 22 that showed a beat on both