Tensions between the United States and North Korea have heightened, and we may look to August 2017 as the dawn of yet another Cold War. The news has little impact on our thesis, however. Stocks generally remain overvalued, and some of them considerably. Let’s cover a few stocks in the news and reiterate our generally positive stance on defense contractors, two of our favorites recently highlighted in the Nelson Exclusive publication. Learn more about the Nelson Exclusive here.
“North Korea best not make any more threats to the United States,” Trump said, arms crossed, from his golf resort in Bedminster, New Jersey, on Tuesday. “They will be met with fire and fury like the world has never seen.” – CNN, August 8, 2017
North Korea said its leader Kim Jong Un was weighing whether to strike the US Pacific territory of Guam, just hours after Donald Trump vowed to meet Pyongyang’s threats “with fire and fury like the world has never seen”…The KPA (Korean People’s Army) strategic force is now carefully examining the operational plan for making an enveloping fire at the areas around Guam with medium-to-long-range strategic ballistic rocket Hwasong-12 in order to contain the US major military bases on Guam, including the Andersen Air Force base,” said the KPA, referring to a missile it first tested in May. US strategic bombers “threaten and blackmail [North Korea] through their frequent visits to the sky above South Korea”, the KPA added. “It is a daydream for the US to think that its mainland is an invulnerable heavenly kingdom.” – FT, August 9, 2017
By Brian Nelson, CFA
Nobody knows for certain what the future may bring, and that will never change–in life or in the stock market. Very few could have predicted the steady advance of the S&P 500 (SPY) for much of the past 8 years following the March 2009 panic bottom during the depths of the Financial Crisis, and perhaps even fewer will be able to tell you what will happen in the next 8 years. Stock investing, however, is not about predicting the future with certainty, but instead, it rests in identifying large mispricings, using a margin of safety to hedge where one might be wrong, and placing diversified capital accordingly, all to achieve goals.
Can I say for certain that today will mark the dawn of a new Cold War with North Korea? No. Is growing geopolitical uncertainty changing our overall investment thesis? No. Stocks are as overvalued today as they were last week, and some significantly so. Given Trump’s rhetoric and North Korea’s escalation, we’re monitoring share-price activity across our defense coverage universe even more closely than usual. Our favorite defense-related big-cap idea remains Boeing (BA), an idea in the Best Ideas Newsletter portfolio, but we recently highlighted two others that we also like in the Nelson Exclusive. See more about this publication here.
In other news, one of the most undervalued companies in our coverage (July 15), Michael Kors (KORS) put up a fantastic report, and shares surged more than 20% August 8. The company had been an idea in the Best Ideas Newsletter portfolio, but the small position was culled during some “Spring Cleaning…,” and we’re neither disappointed nor looking back. We maintain our view that shares still look undervalued–see its stock page here–and while we weren’t able to capitalize on the latest advance, we credit our valuation methodology for getting this in front of readers. Michael Kors set adjusted fiscal 2018 earnings per share at $3.62-$3.72 versus $3.55 consensus, and the acquisition of Jimmy Choo may prove to be fruitful in the years ahead.
Our agreement to acquire Jimmy Choo will bring together two iconic brands that are industry leaders in style and trend. Jimmy Choo has a rich history as a luxury brand with a 20-year track record of enduring customer appeal. We are committed to supporting Jimmy Choo’s strong brand equity and fashion leadership as we work with its talented management team to realize the brand’s significant growth potential. We believe that the development of a global fashion luxury group will increase long-term shareholder value as we create a more diverse product portfolio, increase our exposure to international markets and unlock additional opportunities for future growth. — Michael Kors’ first-quarter fiscal 2018 results, released August 8
Priceline’s (PCLN) shares fell during the trading session August 9 following its second-quarter results, released August 8. The performance, from our perspective, was solid, with second-quarter gross travel bookings, net of cancellations, advancing 19% year-over-year on a constant-currency basis. Gross profit and net income during the second quarter leapt 21% and 24%, respectively, versus the marks in the year-ago quarter. For the third quarter, Priceline expects bookings growth of 11%-16% and earnings-per-share of $32.40-$34.10, the latter slightly below Street consensus. We’ve grown accustomed to what appears to be “sell-on-guidance” behavior at Priceline, and we’re not worried by the market’s reaction. We are, however, monitoring Priceline’s technical pricing action very closely given that the company’s equity price has run considerably alongside the market.
Newsletter portfolio idea CVS Health (CVS) reported second-quarter results August 8, and they were generally good. Net revenues advanced 4.5% on a year-over-year basis, and the company remains a cash cow, generating cash flow from operations of $5.5 billion and free cash flow of $4.6 billion in the period. We also liked that the company raised the low end of its full-year adjusted earnings per share guidance to $5.83-$5.93 from $5.77-$5.93, confirmed full-year cash flow from operations expectations of $7.7-$8.6 billion and free cash flow expectations of $6-$6.4 billion. CVS noted that “the 2018 selling season is shaping up to be another successful one for our PBM, with solid gross and net new business achieved to date,” and we couldn’t be more pleased with the news. We continue to monitor the impact that Amazon (AMZN) may have on the space, but we’re not too concerned at the moment. Berkshire’s (BRK.A, BRK.B) second-quarter report was also uneventful, and it would take an avalanche of fundamental deterioration to part with that idea in the Best Ideas Newsletter portfolio.
Aerospace & Defense – Prime: BA, FLIR, GD, LLL, LMT, NOC, RTN
Aerospace Suppliers: AIR, AIRI, AL, ATRO, COL, HEI, HXL, ISSC, SPR, TATT, TDY, TXT
Related ETFs: ITA, XAR, PPA, DFEN