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Capital 19 Catch-Up

Weekly Index Movement

S&P500-0.7%
Nasdaq-1.2%
Aussie All Ords+0.1%

Global markets hardly moved last week. Except for China. The Hang Seng China Enterprises Index has surged more than 25% this month. Mind you it is coming off the back of the title of world’s worst-performing market this year.

China got all excited because the government rolled out a sweeping package to help the embattled real estate market and a set of measures to reduce the severity of covid restrictions and try to get their economy moving again.

This is probably why iron ore prices are up 22% in November and why companies like BHP have added 18% at the same time.

The prior week was all about lower inflation. Last week has all been about the retail consumer with some conflicting reports.

Retail Sales for October came in better than expected across the board with the headline reading jumping 1.3% compared to a consensus forecast of 1.0%.  Stripping out Autos and Gas, the reported numbers exceeded consensus forecasts by an even wider margin.

Home Depot’s (HD) quarterly results beat on the top and bottom lines Tuesday as the closely watched home improvement chain reported sales growth compared to the same period last year. The company also stuck with its outlook. “We delivered another solid performance in the third quarter, driven by strength in project related categories across the business,” CEO Ted Decker said. On a more granular level, however, we can see the impact of four-decade-high inflation. The average ticket grew nearly 9% to $89.67, and sales per retail square foot grew more than 5% to $618.50. But the number of overall customer transactions for the quarter declined more than 4% to 409.8 million.

Walmart (WMT) was also a winner because it had an ace up its sleeve in being the nation’s largest grocer. Walmart also boosted its outlook for the year as the holiday shopping season churns on, and it made more progress in plowing through its excess inventory. While groceries offer smaller profit margins, Walmart’s reputation for bigger discounts has drawn in grocery shoppers during this period of high inflation, including new and higher-income customers. And, Walmart said Tuesday, its grocery market share grew in the previous quarter. The stock was up 5% on the week but trades on a PE of 46 which we find far too rich.

Target (TGT) noted in its earnings release that sales trends are softening after reporting weaker-than-expected EPS and sales.  Lowe’s (LOW) seems to be operating on a whole different landscape, though, as the company reported better-than-expected EPS and sales while raising guidance.  In an interview on CNBC, CEO Marvin Ellison noted that he has seen no signs of a consumer slowdown and no sign of trading down.  That’s two large American retailers with two entirely different viewpoints on the consumer.

All up, the results demonstrate a resilient consumer. That is something Fed Chair Powell will not be happy with.

We got an inflation follow-through last week also with another measure of inflation, the PPI, coming in lower than expected. That comes on the back of a lower CPI the week before and gave markets more reason to think we have seen peak inflation.

As we have been saying for months now, the problem central banks have is rising wages.

The RBA is concerned about this too. The ABS reported a quarterly growth of 1% to wages and the RBA minutes made it clear this is a problem.

Given the importance of avoiding a price-wage spiral, the Board will continue to pay close attention to both the evolution of the price-setting behaviour of firms and labour costs in the period ahead.”

But the labour government sees it differently. Tony Burke, employment minister said

“This Government was elected on a platform to get wages moving, and we intend to.”

There will be fun and games to be had here and is something to keep an eye on. The only thing you can guarantee from a politician is for them to try and keep their job regardless of the result. So we expect Labour to continue to push industry-wide bargaining and there to be many more strikes. The end result will be interest rates in Australia going higher than many presently expect. Don’t lock in any term deposits yet. Higher rates are around the corner.

But maybe think of selling property because the opposite will happen there.

The good news is corporate America is starting to listen.

Google’s parent Alphabet (GOOG) faced a call from a large shareholder on Tuesday to cut its soaring headcount and slash high salaries paid to non-engineers, in the latest sign of the pressure building on the biggest US tech companies to overhaul their businesses for an era of slower growth

Amazon (AMZN) plans to lay off about 10,000 employees, the largest ever headcount reduction at the e-commerce giant as it braces for slower growth and a possible recession.

Meta (META) is laying off 11,000 employees around 13% of workforce. Lyft and Stripe announced cuts to their workforces.

Elon went about it a different way at Twitter asking for unreasonable effort so his staff just walked out. He then reinstated Trump only to have Trump reject the offer to come back. We do wonder how long the blue bird can keep singing for with the non-stop bad news.

The bad news is the Tech sector only makes up 2% of the workforce. We need all industries to cut jobs to lower demand and therefore inflation. But the Tech sector has started. Hopefully others follow. The more news we have of redundancies the better the prospects for a soft-landing.

Company profits remain strong. It is only interest rates causing a re-rate of discounted cash flow models. Given CEOs have all been given ample time and warning of an economic slowdown, you would think they could reduce the cost base to cope with it and keep earnings higher next year.

This is the narrative stocks are currently running with. The S&P is trading on an earnings multiple of 18. That shows no risk of recession. Either it is very wrong or the mainstream media has scared everyone unnecessarily. We’ll let you decide which is more likely.

Sam Bankman Fried has certainly scared all the crypto investors. You heard it here first, that’s the end of crypto. At least for the next 10 years as the bubble bursts and the industry corrects itself.

Turns out he had a great plan. Take customer deposits on his exchange platform FTX, send them over the Almeda who used them to buy and sell crypto on his FTX exchange whereby FTX earned fees. Of course, this is illegal in the US. Perhaps why his company resides in the Bahamas.

As crypto assets dropped, so did the value of Almeda holdings, which was really customer deposits. It is such a mess they have appointed the same guy so worked through Enron’s collapse (John J Ray) that almost broke financial markets. He said:

Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented

Worse than Enron? Oh dear.

Here is what happens next. Complete distrust in the entire crypto industry and withdrawal of funds. At least for those that can access their funds. FTX will be locked down for years and years as they try and sort it out

There is a rumour a Canadian Pension Fund put $400m into FTX. Even if it isn’t true it will have real money funds suddenly questioning their crypto investments. No one wants to tell the press they risked $400m of retirees’ savings on a dodgy 30yr olds promises, via a Bahamas shell company.

Once the big money starts to withdraw, crypto losses all validity and it will take a long, long time to build it back. Even if it can, it probably means with regulation and suddenly the key factors that made it appealing in the first place will disappear.

Crypto might have a place or a use somewhere. I can’t quite see where. But it won’t be as a legitimate and safe store of wealth. Not until your wealth can be assured as safe anyway.

When you look back on it, all the signs of collapse were there. Every man and his doge coin were investing in crypto to get rich quick. People who have never bought a share or a property before were buying Mooncoins, and TrumpCoins, even PutinCoins. There was only one way that was going to go.

Hopefully readers of this missive will have avoided that debacle entirely. But if you do happen to have any, perhaps now is a good time to lock in your gains and try to actually get your money out.

If you want to find a serious investment, then take a look at Buffet’s portfolio.

Those eagle-eyed amongst you will notice a new addition at the bottom. Buffet added that position in the last quarter. And it makes sense why.

Semiconductors are very important and Taiwan Semiconductors (TSM) is the largest in the world. Its customers are Nvidia (NVDA), Qualcomm (QCOM) and importantly Apple (AAPL).

Oh yeah, and it trades on a PE of 10. Or it was last quarter when Buffet was buying. The news he added his first-ever semiconductor sent the price up so the PE is now 15. But that is still lower than the average stock in the S&P500 which trades at 18.

TSM also does not have much debt so won’t suffer too much if the world does slow down or rates go through the roof.

Lastly for today, the only question I suspect you are interested in. Is it time to buy yet?

I still think it is too early to switch back to growth. Stick with value and dividend shares for now. I expect this rally has another week or two left in it, but the Fed is still a long way from ending this cycle and I predict interest rates will continue to grow well into next year. Growth will find it hard in that environment.

If you are looking for more value ideas like TSM above, we have a new one this week for you. See below.

CatchUp Stock Tips

Buy DateBuy PriceCurrent PriceGain / LossStop Loss
TXN1 Aug 22177.94175.18-1.6%145.00
ASC8 Aug 228.5214.82+73.9%6.40
CDNS15 Aug 22188.83165.02-12.6%130.00
UNH22 Aug 22541.39530.00-2.1%450.00
GMS5 Sep 226.505.61-13.7%4.00
AAPL12 Sep 22159.59151.29-5.2%130.00
CRK19 Sep 2218.2217.59-3.5%12.00
OXY24 Oct70.8171.25+0.6%58.00

Buy Nine Energy Service (NINE) at no more than $8

Nine Energy Service, Inc. is a service provider for the unconventional oil and gas industry in North America and abroad. It does cementing and coiled tubing services for oil drillers

Our thinking on this one goes like this. Capex spending by the oil industry has fallen dramatically. That hurt Nine back in 2018 and 2019 and was compounded by the Pandemic in 2020. But Nine survived and was made lean during the process.

With the new upcycle in the oil price and increasing demand from Europe the US oil drillers are likely to expand capex going forward. They can do this because they are making more profits so have money to spend and have a longer-term demand structure from Europe. Biden would even be happy as it might keep a cap on oil prices.

For a company the size of Nine, increased Capex spend by the big guys is massive. We saw the first signs of this in their Q3 results

“Q3 was a very strong quarter for Nine,” said Ann Fox, President and Chief Executive Officer, Nine Energy Service, “driven mostly by price increases across our service lines, as well as increased volumes within completion tools, which enabled us to drive strong incremental margins again this quarter.”

One aspect we don’t particularly like is the amount debt they run. But they are addressing this

“De-levering the balance sheet continues to be a top priority for Nine. During Q3, we repurchased $13.0 million par value of bonds for $10.1 million of cash or 77.7% of par, leaving $307.3 million outstanding. I am extremely happy with our team’s ability to take over $90 million of debt off the balance sheet, while also maintaining strong liquidity throughout one of the most volatile environments we have faced. The Company is poised to generate free cash flow going forward and we plan to continue to reduce our financial leverage. Going forward, we believe that Nine can de-lever through a combination of growth in profitability, as well as reduction in net debt.”

When it comes to valuation, the recent margin expansion and increased demand changed the dynamics of the business. From making a loss in 2021, the company is forecast to make a profit of $2.29 in 2023, putting it on a PE of 4.5.

The stock has had a stellar run recently, we watched it go from $7 to $10 so now we don’t want to chase it but will wait for a pullback to buy into. Hopefully around the $8 mark which allows us to buy it on a PE of under 4 and we will aim to sell when that PE approaches 8 for at least a 100% gain.

Warning

Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account.

Disclaimer: Capital 19 Pty Ltd ABN 17 124 264 366 AFSL 441891 (‘Capital 19’) believes the information contained is reliable, however, no warranty is given as to its accuracy and persons relying on this information do so at their own risk. This communication is for general information only and was prepared for multiple distributions and does not take account of the specific investment objectives of individual recipients and it may not be appropriate in all circumstances. Persons relying on this information should do so considering their specific investment objectives and financial situations. Any person considering action based on this communication must seek individual advice relevant to their circumstances and investment objectives. Subject to any liability which cannot be excluded under the relevant laws. Any opinions or forecasts reflect the judgment and assumptions of Capital 19 and its representatives based on information at the date of publication and may later change without notice. Any projections contained in this presentation are estimates only and may not be realised in the future. The investment manager certifies that all the views expressed in this document accurately reflect their views about the companies and securities referred to in this document and that their remuneration is not directly or indirectly related to the views. Capital 19, its directors, representatives, employees or related parties may have an interest in any of the companies and securities in this document and may earn revenue from the sale or purchase of any financial product referred to in this document or any advice. Past performance is not a reliable indicator of future performance. Unauthorised use, copying, distribution, replication, posting, transmitting, publication, display, or reproduction in whole or in part of the information contained in this document is prohibited without obtaining prior written permission from Capital 19.