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By Brian Nelson, CFA
There’s never a dull moment in the Tesla (TSLA) story. Just when we thought things were getting back to “normal,” Tesla’s CEO Elon Musk has been hit with a contempt charge for a tweet that allegedly violated his prior deal with the SEC. We don’t think the tweet was a big deal, by itself, and it may have included content from a prior conference call, but given Musk’s prior behavior, including being outspoken about not having any respect for the SEC, he doesn’t have much wiggle room with the authorities. From our perspective, Musk is in now in some serious hot water.
We’ve always viewed Tesla as “uninvestable,” not necessarily because of the executive suite, but mostly because automaking is one tough business when entrenched competitors have been dominating the space for decades. We’re on the sidelines with respect to Tesla, and we’re not being aggressive in anticipating significant downside given the company’s expected positive free cash flow generation. Our favorite automaker remains General Motors (GM), which recently surpassed $40 per share in trading. Our fair value estimate of GM is $50+ per share.
The department stores continue to be under a significant amount of pain as consumer buying behavior continues to shift toward the likes of Amazon (AMZN) and as the decades of excessive couponing and under-innovation come back to haunt the group. Macy’s (M) fourth-quarter results, released February 26, showed some life with respect to comparable store sales, but this may only be a positive blip in an overall secular decline. Macy’s continues to trade near 52-week lows.
Dillard’s (DDS) also reported positive comp sales, but again, the department-store backdrop is very difficult. Sears has already succumbed to the pressures of operating in the fast-paced digital 21st century with a Chapter 11 filing, and while we’ve been saying this for some time, J.C. Penney (JCP) may be the next to fold. From the failed Ron Johnson experiment years ago to the underinvestment in its stores, the struggling retailer is on its last legs. Though not all of big-box retail is suffering–Best Buy (BBY) is holding up extremely well, for example, even thriving in some areas–we have little long-term interest in the space.
As we mentioned in our email to members February 26, Summit Midstream (SMLP) became the latest in a long line of midstream MLPs to cut its distribution (was $0.575, now $0.2875). We continue to reiterate the hazards of the MLP arena when it comes to capital-market dependence, and we continue to believe investors should focus on future expected traditional free cash flow in the context of balance-sheet health when evaluating dividend strength. Check out this awesome graphic on the differences between distributable cash flow and free cash flow in this article here. S&P Global is spot on with this piece.
From highlighting the risks of the Kraft-Heinz (KHC) and Owens & Minor (OMI) dividend cuts, Valuetnum’s Dividend Cushion ratio, a forward-looking cash-based measure of dividend health, is performing as expected (maybe even better than expected). This metric, alone, is worth the price of a membership, in my humble opinion. Remember–a Dividend Cushion ratio significantly above 1 indicates a dividend or distribution that is much less risky than one with a ratio below 0, as was the case with respect to Kraft-Heinz and Owens & Minor, which cut their payouts. Here is more on the Dividend Cushion ratio >>
Cracker Barrel’s (CBRL) fiscal second-quarter results, released February 26, weren’t bad, as we previously stated. Though comparable store retail sales were weaker in the period, the company’s comparable restaurant sales advanced 3.8%, not a bad showing at all in the ultra-competitive restaurant arena. Traffic is the big metric to continue to watch at Cracker Barrel, and this nudged up in the period. Cracker Barrel’s store-within-a-restaurant concept and its unique menu offerings are key advantages, in our view. The company’s Dividend Cushion ratio is 1.4, but it’s largely because of its special dividends that this restaurant owner makes its way into the Dividend Growth Newsletter portfolio.
Looking ahead to all of fiscal 2019, Cracker Barrel raised its revenue guidance to $3.05 billion, up from $3.04 billion, still reflecting 8 new store openings but an increase in comparable store restaurant sales growth (now 1%-2%, was flat to 1%). Food and commodity cost inflation will continue to provide stiff headwinds to operating-margin expansion, and management kept its target of a 9%-9.3% operating margin unchanged after the report. There may be some upside to that range, but through the first six months of fiscal 2019, the company is hovering at just below the bottom end on a GAAP basis.
As it relates to broader economic considerations, we maintain our view that the Fed will likely pause for some time, or if they do raise, it will be very, very modest. Our biggest concern, and one that we highlighted a few weeks ago, is the behavioral implications of the inversion of the 1/10-year yield curve, and how an inversion, itself, may actually cause the behavior that would lead to recession (i.e. people save more, sell stocks). We don’t the Fed will purposely and meaningfully invert the yield curve. We talked about this in an email to members a few weeks ago here.
The housing market, in any case, has been a mixed bag. On one hand, Toll Brothers’ (TOL) performance, first-quarter results released February 26, came in better than expected, but economic data is telling of a more ominous backdrop. Housing starts, for example, fell to a two-year low in December, and even if this was just a blip, Home Depot’s (HD) miss before the bell February 26, didn’t really provide a lot of confidence. We think higher interest rates are having some impact, if only at the margin, and Lowes (LOW) may be making some competitive advances against its chief publicly-traded rival.
Regardless, comparable store sales at Home Depot and Lowes are expected to be up at a nice clip during fiscal 2019 (+5% and +3%, respectively). Home Depot also increased its dividend a whopping 30%+, to $1.36 on a quarterly basis. We think the company has room to do so, given its Dividend Cushion ratio, but we caution investors not to get swept up by the pace of dividend expansion too much. As we outline in Value Trap: Theory of Universal Valuation, an underlying estimate of intrinsic value will act as the anchor to the stock price (and the dividend payment is a reduction to intrinsic value as cash is removed from the balance sheet). We value shares of Home Depot at $193 at the very high end of our range, so some caution may be in order.
We’d be remiss not to mention the bounce in General Electric (GE) since the December 2018 lows. Though we, too, thought GE was worth in the low-teens when it was trading in single-digit territory, its chart remains a mess, and selling off prized businesses, as in what it recently did in selling its biopharma business to Danaher (DHR) isn’t a path to long-term success for the company. If it wasn’t already, the heyday of GE may be over, and what’s left of the company may further be carved up to eager acquirers. Unfortunately, bad luck following the Financial Crisis in doubling-down on energy and ditching financials and an over-aggressive stock buyback program may be most to blame. GE is too speculative for us.
That’s it for this morning. We’ll pick up in digesting Warren Buffett’s 2018 Letter to Berkshire shareholders in Part III tomorrow. If you have any questions, we’re always here. Thank you for your membership.
Also tickerized for: DHI, JOE, KBH, LEN, MDC, MTH, NVR, PHM, XHB
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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.