The stock market is not insanely overpriced, but it is certainly not cheap either. We’re watching the technicals and moves in the 10-year Treasury closely for signs of where the market may go next. We discuss Walmart’s recent disappointment and add another to the list of companies that the Dividend Cushion ratio effectively highlighted the heightened income risk profile of, prior to the dividend cut. Chipotle is on the move!
By Kris Rosemann and Brian Nelson, CFA
According to the February 16, 2018 release of Factset’s Earnings Insight, the forward 12-month P/E ratio for the S&P 500 is still north of 17 times, above both the 5-year average of 16 and the 10-year average of 14.3. The “right” multiple for this is debatable, given the benefits of corporate tax reform and the headwinds from higher discount rates (risk-free rates) as a result, but forward valuations aren’t “insane,” assuming earnings projections prove accurate, something far from guaranteed. Bottom-up earnings-per-share analysis by Factset indicates that calendar year 2019 earnings could be $173.94 on the S&P 500 (SPY), meaning stocks at the moment are trading at 16 times calendar year earnings per share estimates for 2019, which include all the benefits coming from the new tax code. Again, not insane, but certainly not cheap either, especially in the face of rising rates and debt loads.
On February 20, the US Treasury sold $179 billion in short-dated debt at the highest yields since 2008 (three- and six-month bonds hit such levels). We continue to keep a close eye on Treasury bond yields (TLT, TBT) and are generally most interested in what longer-term bond yields do, especially the 10-year variety (which is a benchmark rate for most debt and used within most equity valuation frameworks as a normalized duration). One-month bonds were sold to yield 1.38%, 3-month bonds at 1.64%, 6-month bonds at 1.82%, and 2-year bonds at 2.25%. The shortest term bond saw a bit of demand pressure in the auctions, but the three- and six-month notes did not seem to be impacted by the recent suspension of the US debt ceiling. This is just the beginning of US debt auctions as the Treasury expects to issue $441 billion in net marketable debt in the first quarter of 2018, and many will be watching longer-term bond auctions with much higher intensity.
In world news, the Brexit (EWU) divorce bill may not be a done deal, at least in the eyes of Brits. Brexit Secretary David Davis made the UK’s position clear in that it does not consider the £39 billion bill to be finalized, which is sure to upset EU officials. A trade deal between the two parties is necessary for any form of payment to be made by the UK government, according to Davis, and he has said that the two issues are “bound up into one.” Meanwhile, the Eurozone continues its recent momentum as one of the best-performing major economies, even as concerns over inflation and a stronger currency crop up. IHS Markit’s most recent Purchasing Managers’ Index (PMI) reading, a preliminary number for the month of February, dropped slightly from January but still marked one of the most expansionary readings in more than 11 years. The preliminary US PMI reading for the month of February came in above expectations February 21 and hit a 27 month high of 55.9.
Rising rates may be having an impact on the US housing market (XHB), too, as limited inventory coupled with rising rates are weighing on housing affordability, though we warn against putting too much stock in any short-term measures. US mortgage applications continued their recent fall in the week ended February 16 as 30-year mortgage interest rates hit their highest point in four years at ~4.64%, but it is important to note that mortgage applications were still ~3% higher than a year ago and interest rates remain well below their historical averages. Existing home sales in the US fell 3.2% in the month of January on a sequential basis (4.8% decline year-over-year), but the month also marked the 71st consecutive month of price gains, highlighting the limited supply in the market–total housing inventory was down 9.5% from the end of January 2017–and the potential for homebuilders to continue taking advantage of pent-up demand from the past decade.
US-based self-storage leader Public Storage (PSA) moved higher following its fourth quarter 2017 report, released after the close February 20, as same-store rental income advanced 2.2% from the year-ago period. Core FFO (funds from operations) per share grew 3.8% in the quarter on a year-over-year basis to $2.75, and revenue per available square foot (REVPAF) advanced to $16.11 in the full-year 2017 from $15.63 in 2016. Funds available for distribution in 2017 came in at nearly $1.7 billion (up 2%+ from 2016), while its distribution payout ratio, which utilized FAD, rose to 83.4% in 2017 from 77.6% in 2017.
Shares of Walmart (WMT) have faced substantial selling pressure following its fiscal fourth quarter report, results released before the open February 20, despite US comp sales growth of 2.6% on a year-over-year basis, which easily beat estimates for 2% growth. Total revenue expansion of 4.1% from the year-ago period, but operating income fell by less than 1% when excluding the impact of discrete charges. Though management expects fiscal 2019 US comparable sales to grow 2%, it issued full-year earnings per share guidance of $4.75-$5, which came in well below consensus estimates of $5.13. Investors were also likely disappointed to see e-commerce growth slow to 23% in the quarter compared to some recent periods in which Walmart turned in 40%+ growth in e-commerce.
Home Depot (HD) continued its impressive run of late as it reported a 7.5% year-over-year rise in comparable sales during the fourth quarter of fiscal 2017, results released before the open February 20. Higher SG&A spending in the quarter weighed on the firm’s operating margin, which fell to 9.0% from 9.3% a year earlier, but management is targeting an operating margin of 14.4%-15.0% in fiscal 2020 on $115-$120 billion in sales (was $100.9 billion in fiscal 2017). In fiscal 2018, sales growth is expected to be 6.5% with comparable sales targeted at 5.0%, and full-year earnings per share guidance has been set at $9.31.
Simulated Dividend Growth Newsletter portfolio idea Cracker Barrel (CBRL) was hit by investors following its fiscal second quarter report, released before the open February 20, despite setting its full-year adjusted earnings per diluted share guidance ($9.30-$9.50) well above consensus ($9.13). Comparable store sales grew 1.1% in the quarter on a year-over-year basis, outperforming the casual dining industry, but traffic fell 0.9%. However, its operating-income margin fell by one percentage point from the year-ago period to 9.7%, as a result of increases in operating expenses related to certain initiatives and commodity inflation. The strong bottom-line guidance is largely a result of changes in its anticipated tax rate for the year as operating margin is expected to remain suppressed in the year (guided to a range of 9.5%-10.0%).
Elsewhere in the restaurant space, Dine Brands Global (DIN) rocketed higher following its fourth quarter report, released before the open February 20. Domestic system-side comparable same-restaurant sales grew 1.3% from the year-ago period, but the significant move in shares was likely tied to a change in its capital management strategy. The company also slashed its quarterly dividend by ~35% to $0.63 as it works to revamp its capital allocation framework, a move that should come as no surprise to members as its Dividend Cushion ratio sat at -1.8 (negative 1.8) at last check. Free cash flow in 2017 came in at ~$52 million, well short of covering annual cash dividend obligations of ~$70 million, and its long-term debt load remains elevated at nearly $1.3 billion (excluding long-term capital lease obligations of ~$62 million) as of the end of 2017.
In M&A news, Albertsons has agreed to purchase what remains of Rite Aid (RAD) after the purchase agreement between Rite Aid and Walgreens Boots Alliance (WBA) for an undisclosed sum of cash and stock. The deal is expected to enable Albertsons to go public after being privately-held for more than a decade, and Rite Aid shareholders will own ~28-29% of the to-be-combined entity, depending on the ultimate combination of cash and stock exchanged in the deal. Most Albertsons pharmacies will be rebranded at Rite Aid while Rite Aid stores will continue to operate as standalones, and the deal underscores a movement from retailers to fight off encroaching online threats by expanding both their physical footprints as well as capabilities aimed at increasing store traffic, an area in which pharmacies are attractive due to the frequency of prescription drug purchases, pick-ups, and refills.
Taco Bell, a division of Yum Brands (YUM), registered 5% sales growth in 2017, helping it jump past Burger King (QSR) as the fourth largest US restaurant brand by total sales, according to Technomic, behind McDonald’s (MCD), Starbucks (SBUX), and Subway. Embattled fast-casual Mexican grill Chipotle (CMG) is likely feeling good about its recent hire of former Taco Bell CEO Brian Niccol to the same position; Niccol has been credited with re-branding and breakfast initiatives at Taco Bell, both of which have been key drivers. We liked the hire by Chipotle a lot, and its shares have rocketed higher since.
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Kris Rosemann and Brian Nelson do 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.