Friday File — Buying Growth, the iPhone Supercycle, and more…

A few transactions in my Real Money Portfolio, and a new watchlist stock. Includes notes on AAPL, MPW, NVDA, QCOM, SHOP, YTRA and more.

First, let’s get the week’s changes to my Real Money Portfolio out of the way… and after that, I’ve got a few other updates on stocks that I follow for you, dear Irregulars.

We’ve got a new stock in the portfolio….

As of tomorrow, I will have a position in NVIDIA (NVDA). This is a result of a tiny options position that didn’t register as making it to the 0.10% threshold to be included in the Real Money Portfolio previously, but, thanks to NVIDIA’s surge, it went in the money recently and I allowed the contract to exercise at today’s expiration — that will create a roughly 2.5% portfolio position in NVDA shares for me at a cost of $120 per share. I’ve profited from NVDA options a few times during the company’s ridiculous run over the past two years, but this will be the first time I’ve had an equity position.

The risk here, of course, is that (like so much of the market) it “feels toppy” — but that’s been true of NVDA stock since it got close to $50 last summer. The stock is obviously expensive at 45X trailing earnings and 34X forward earnings, and it could pretty quickly fall by 50% if growth expectations change, but the earnings estimates have also been ramping up pretty dramatically — estimates for 2018, which is the fiscal year NVDA is currently in, have risen by about 50% just over the past year, and the out years are also seeing rising expectations. The real risk is if those future earnings estimates stop rising, most likely, since the stock has soared in anticipation of future “beat and raise” quarters.

Regardless of the valuation, NVDA is doing fantastically when it comes to actual operating performance. It remains compellingly positioned with leading products for the most important trends in data centers and in artificial intelligence, to say nothing of their continued strength in the high-end gaming business, which keeps surprising analysts with its growth (and potential exposure to high-end virtual reality, driverless cars, and other currently smaller businesses). I wouldn’t want to commit much more capital to this one unless there’s a meaningful pullback in the share price, and semiconductors in general can be fickle, (both because massive customers like Google or Apple sometimes try to cut out designers and develop their own chips, and because the sector is so price-competitive), but companies that develop truly necessary chips for core work in rising trends, like Intel in the 1980s or Qualcomm in the 1990s, can have scary huge potential if they are able to really hold off the competition either with their brand power or their unique technology. NVIDIA has potential to both strengthen the brand and maintain a technological lead, but neither is guaranteed — so I’ll take this growth bet on NVDA and watch it pretty closely now.

In other actual transaction news, I’ve also dickered around with my positions a little bit to increase my exposure to the iPhone supercycle that is so widely expected, but also to diversify that exposure a little bit — so I sold down a small portion of my Apple (AAPL) holdings (a little over 10%), increased my holdings in Skyworks (SWKS) by 50%, and boosted my position in Qualcomm (QCOM) by roughly 20%.

There is no real news out from any of those companies, other than the notable increase in Apple shares held by Berkshire Hathaway (BRK-B) and the large number of hedge fund luminaries who added positions in Qualcomm last quarter, presumably during the dips it has seen as their legal back-and-forth with Apple (and others, including Blackberry) continues to buffet the stock.

To sum up, Skyworks is a “growth at a reasonable price” opportunity with both iPhone and “Internet of Things” tailwinds expected, Qualcomm is just plain cheap and a high-yield dividend grower (with at least as much legal talent and experience as their adversaries, and a good record of patent and licensing agreements in China), and Apple is a reasonably valued blue chip dividend growth consumer brand company — but if Apple surges because of strong iPhone orders this Fall, my expectation is that Skyworks will surge more dramatically. We’ll see.

Medical Properties Trust (MPW) announced a large acquisition deal this morning, one that they say will be accretive to both FFO and earnings as they acquire a big portfolio of mostly acute care hospitals from Steward. If they do all debt financing they say the deal will be accretive to FFO per share by 10 cents next year — I’d guess that they’ll also end up doing a share offering, but they did offload $800 million in assets to reduce debt this year, and they’re not currently overly levered, so there is some chance that they could do an all-debt deal.

S&P cut the credit outlook for MPW because this deal exceeds the acquisitions they had forecasted for the year, but the environment for credit is still pretty friendly so I would expect them to be able to get financing for most of the deal if they want to — certainly at lower cost than the implied cost of 7% of new equity offered at this price (since that’s what they’ll have to pay in dividends unless they cut the dividend, and cutting the dividend is a “we’re entering a death spiral” move for companies like MPW so they tend to avoid it assiduously).

That said, my opinion is that it shouldn’t have a major impact on the stock — that’s portfolio growth of more than 10%, FFO growth of a maximum of 7% or so (using my rough expected FFO range of $1.25-1.30 for this year) — so I’d say it’s incrementally good news but that there will probably also be an equity offering at some point in the next six months that might well provide a lower priced entry point if you’re interested in buying shares (and, of course, this is an income investment and a REIT… so if interest rate expectations change substantially that will also impact the stock — it will likely jump higher if the 10 year note yield drops sharply, and fall if the yield rises dramatically).

As I noted after their earnings came out a couple weeks ago, I do think the valuation is eminently reasonable at $13, roughly 10X AFFO and with a 7% yield and slow dividend growth (they do raise the dividend regularly, but not sharply — my assumption is that dividend hikes should keep up with inflation)… but, naturally, it’s even more reasonable at $12. This deal is contingent on Steward acquiring IASIS and its hospital network, and Steward was already a large tenant for MPW so this increases their exposure to Steward… but it also makes Steward a significantly better and more diversified company, and they were pretty solid before (they had already had their bond rating increased in 2016, so they seem to be doing the right things).

Shopify (SHOP) did another capital raise, which in the up-is-down, black-is-white world of “story” growth stocks where investors prefer investment in growth over current earnings, might actually be a good thing because it implies that they’re going to push aggressively to grow (see Amazon for the world’s best example of this, since they’ve never posted a meaningful profit in 20+ years).

SHOP had plenty of cash already, and could even have kept growing pretty nicely without any additional capital, or even reached profitability if they wanted to, but perhaps this new influx will give them a boost. They’re raising about $500 million right now, and apparently didn’t have any trouble getting buyers (they priced it at $91 a share, slightly off their all-time highs of last week but substantially higher than the stock was two weeks ago, and the stock has come down a bit as a result — but it’s still in the high $80s)… and they also filed a shelf offering of 5X that amount, so there could certainly be more coming at some point.

And if you like to get into the weeds in thinking about this, it’s generally smart to raise capital while you’re unprofitable but growing — most investors react strongly to their per-share earnings dropping from dilution (selling new shares, but overall earnings don’t rise, so earnings per share fall), but are less attuned to potential price/sales dilution. Since they don’t have any earnings, the dilution is much less obvious.

It could obviously go poorly for Shopify as well, there’s no guarantee that they’ll continue to take market share from Magento and the other e-commerce enablers… or even that they’ll hold market share if other, much larger companies like Salesforce or others who also provide support to retailers when it comes to inventory and sales management move down the ladder and beef up their ease of use to try to appeal to smaller retailers. But they do seem to have tremendous momentum in acquiring new customers, their customers seem to love them, and if they can buy their way into real dominance for their service and their brand it may pay off handsomely in a few years (or, of course, someone like Salesforce could also try to acquire them).

They’re also a free-spending company, with new offices opening every year and an ongoing massive hiring spree… which gives room for investors to be anxious if the revenue growth ever decelerates. On the positive side, they do have their visionary founder at the helm providing leadership and holding a substantial personal equity stake. I’m not adding to my stake here, I’m hoping for some substantial dips as they hit challenging quarters along the way, but I still like the potential.

Anything of note in the watchlist? Well, I am adding a stock to that group…

Welcome Dollar General (DG) to the watchlist — this dollar store chain is cheap (but not cheap for a retailer), growing fast on the top line, and I think it has a potentially huge opportunity with other stores closing and a substantial boost to their store count this year.  

Over the past five years, DG’s profit margin has stayed flat, revenue per share has increased by 70%, and the price of the stock has gone up about 48% (52% with the dividend — they initiated a dividend a couple years ago, they’ve increased the dividend twice and the payout ratio is low, but they’re not increasing the dividend rapidly and it’s a low current yield of about 1.5%). So they’re both growing and getting cheaper, though there’s some headwind thanks to the fact that they started out being pretty expensive when everyone was betting on dollar stores as the shop lower income folks would visit when Wal-Mart got too expensive for those communities who took a long time to pull out of the recession (if, indeed, they’ve done so). Dollar General is in some ways a replacement for neighborhood stores as well, so convenience is a huge factor for the frequent replenishment/restock items they focus on — so it’s tough to really compare Dollar General to Wal-Mart other than to guess at consumer behavior…. There are roughly 16,000 Dollar General stores in the US now, to be increased by 1,000 this year, which is an incredible number — that’s also about how many McDonald’s locations there are in the US.

That doesn’t mean that Dollar General automatically “wins,” of course — and it’s no longer even the biggest chain, since Dollar Tree jumped ahead in store count after acquiring Family Dollar last year — and Dollar Tree (DLTR) is relatively appealing as well, though I prefer Dollar General because of their consistent revenue growth and profit margin stability (and the slightly cheaper valuation).

Their next earnings report is June 1, and I’m not rushing to buy shares before that.  DG beat estimates nicely in their last earnings report, for their quarter ending January 30, but has also missed estimates a couple times in the past year — and the current estimate is for $1 in earnings per share for this April quarter (and $4.45 for the year ending next January — reduced from a prior expectation of $4.60).  

That’s essentially flat with last year, so, combined with a surprise decline in same store sales late last year, those relatively low expectations helped to bring the stock down over the past few months, bringing the stock now to about 25% below where it was at the highs last Summer. Retail is still a frightening place to be in many respects, and the biggest competitive threat to Dollar General is probably the resurgent Wal-Mart (WMT), but I’m inclined to think that DG is one of the safer bets in low-end retail and has a real potential for meaningful growth with their current store expansion plans. And, of course, it is popularly believed (and probably true) that the purveyors of low-cost consumables are the retailers least likely to be upended by online shopping or the “Amazon effect.”

Incidentally, if you find low-end retail and “not as likely to be smushed by Amazon” retail at all compelling as a sector, the net lease REITs are also getting to be interesting values again — Retail Opportunity Investments Corp (ROIC), which is in my portfolio and which specializes in shopping centers anchored by grocery stores, is a relatively stable one and has come down some, but the more volatile large players Realty Income (O) and National Retail Properties (NNN), which have extraordinary records of dividend growth but also tend to rise and fall much more aggressively than ROIC, are getting appealing here as they fall… NNN is cheaper, but also has a somewhat less appealing portfolio to my mind (including 2.2% of the portfolio leased to Gander Mountain stores, since Gander Mountain filed for bankruptcy this year), and O is larger, with slightly lower cost of capital and a lot of investor love thanks to their monthly dividend increase policy, and they have big exposure to the dollar stores (about 8% of rent comes from Dollar General, Dollar Tree and Family Dollar). I don’t own NNN or O, but would consider either as decent core dividend growth REITs to look into here, with their yields getting close to 5%.

And I’ve gotten a couple questions recently about Aqua Metals (AQMS), which was teased a couple weeks ago by Cabot as a “$17 battery doubler” and seemed like an interesting idea in battery recycling. Here’s what I wrote in the Quick Take when I solved that teaser pitch:

“This one has shot up very quickly after going public in 2015 and starting production at their first recycling facility just recently, so there’s some serious optimism baked in about the first phase of their AquaRefinery rollout, but there’s also a lot to like here — they have an appealing lead-acid battery recycling technology that appears to work and to be profitable even at a small scale, they have partnerships with Johnson Controls (JCI) and Interstate Batteries that provide some validation and growth potential, and there’s a pretty clear path to growth of maybe 50% or so over the next few years without getting crazy about your expansion expectations. They report next week (May 9) and there’s not much to their financials yet, it’s still largely a “story,” so I’ll be patient on this one… but my first reaction is pretty positive.”

Well, they did indeed report on May 9, and there was some serious optimism baked in… and someone went stomping around the kitchen with a bunch of facts and numbers and the cake deflated. I didn’t consider the bear case or history of the company when taking that first look at the financials and their projected results, and clearly there’s a pretty strong bear case, as argued in a Seeking Alpha short-seller’s pitch here. I have not investigated all those claims (if it’s like most bear pitches made on Seeking Alpha, there’s probably some basis in truth but a lot of exaggeration and misleading information).

What does concern me is the lack of data about the one operating facility they do have, with their one AquaRefinery module in operation (and, they say, a few more in startup phase). One thing that stands out is the slow rollout of those modules, since the previous investor presentations had noted potential revenue of $100 million a year at the 120 tonnes/day capacity… but that capacity requires 16 operational AquaRefinery modules, and they seem to have just one operating as of last week — this is what they noted in the conference call:

“So that process is now operating. We are adding capacity to it and streamlining operations. AquaRefining itself, module 1 is operating, modules two to four are on-site and in startup mode and modules 5 to 16 are being updated to latest specifications and will be installed over the coming weeks and months.”

They seem to think they have the equipment in process to get up to that 120 tonnes/day capacity, and they still have the partnerships with Johnson Controls and Interstate Batteries to supply batteries (and buy back raw materials), so those relationships still give me some comfort, but the rollout seems to be going slowly. Which is a hallmark of these early stage R&D companies that are taken public a long time before they have a commercially viable project (like Energous (WATT), for example).

And there’s still no real notion of what the economics of the first AquaRefinery will look like, which is information I expected to start to appear in this first report — they hadn’t yet sold any lead as of the end of the first quarter, so they report only the costs, it will likely be at least next quarter before we have any idea of what the ongoing processing cost is for that first module and can start to extrapolate that across the planned 16-module or 32-module refinery. There is a lot of talk about revenue potential, but I’m still really unclear on the costs of that revenue.

So it’s too early to really get a financial picture, they’re moving pretty slowly, and it seems less interesting the more I read about it… which is sometimes the way these things go, of course. That’s why it’s always best to sit on an idea for a while, put it on the watchlist if you find it intriguing, and start to learn more about it instead of jumping right in — newsletters are always rushing to get your attention and your credit card number, and they know that the more you think the less likely you are to buy, so they help to give you the impression that you have to “rush rush rush” or you’ll miss out on the huuuuuge gains… a tendency many of us are too subject to already in this “hurry up adn do something” culture. And yes, sometimes the patient and the thoughtful folks do miss out on things (ie, when it comes to NVIDIA, I should have just bought shares in 2015 and 2016 instead of dorking around with little options positions), but, on balance, my experience is that taking your time, letting things develop a little bit, and thinking about an investment for long enough that it gets boring really helps to calm the mind.

Finally, you might have noticed that the price of the Yatra Online warrants (YTROF) in my Real Money Portfolio has almost doubled in the past couple weeks — that’s not based on any real news or change of outlook for the company, which is still a growth-phase unprofitable online travel agent in India, and the underlying stock price has not changed meaningfully. They released their first quarter as a public company recently, and it was reasonably optimistic but not surprising (Yatra went public by merging into a blank check company, which is why these 2021 warrants are available on the shares — most blank check/SPAC listings include warrants — I noted my original purchase of these warrants here). The warrants are still out of the money, but will be pretty heavily levered to any gains in YTRA shares above $13 or so before mid-December of 2021 (it’s at $9 now).

So, I’m left to guess that the warrants are sharply higher just because more people now know about them… and agree with me that five-year warrants on a strong online travel agency in India present some huge levered upside potential that’s relatively rare to find in the public markets (you can’t often buy warrants on real growth stocks with established businesses — Yatra has been around for 20 years). So with rising warrant prices in the face of an unchanged underlying stock price, nimble traders might want to take some profits here to lock in a nice short-term gain… but I’ll hold on and see what happens over the long term — with Naspers, Tencent, and MakeMyTrip all investing heavily in this sector in India, there’s both huge competitive risk and huge potential for profit either from the expected dramatic growth rate (as more people get online in India, largely through their phones, and enter the traveling middle class) and from possible consolidation in online travel brands (like we saw in the US and China over the past decade or so).

My sentiment is that my Yatra warrant position is probably best ignored for a while, at least until we see how they do over this next year, and if the additional funding they’ve received from the reverse merger enables them to really invest in growth at this opportune time.

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