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SEC Approves Financial Weapon of Mass Destruction and More Earnings Reports

publication date: May 3, 2017
author/source: Brian Nelson, CFA

Let’s talk about quadruple-leveraged ETFs, Apple’s and Altria’s earnings reports, Coach’s fundamental improvement, Gilead’s fall from grace, IBM’s ongoing deterioration and more.

By Brian Nelson, CFA

Well, it is what it is as they say. In our ETF research and analysis, we consistently warn readers about the long-term price erosion dynamics of ultra-leveraged ETFs (of the double and triple variety), vehicles that we have emphasized are for “day traders,” not long-term investors. Believe it or not, however -- we received news May 3 that the SEC approved a request to now list quadruple-leveraged ETFs, what we describe to be “financial weapons of mass destruction.” Yikes.

You read that correctly--quadruple-leveraged exchange traded funds, ones that mimic the movement of the index they track times four. Said differently, one of the ETFs, the ForceShares Daily 4X Market Futures Long Fund (UP) is crafted to deliver 4 times the performance of the S&P 500 (SPY) in a single trading day, while the ForceShares Daily 4X US Market Futures Short Fund (DOWN) seeks to deliver 4 times the inverted performance of the S&P 500 index in a single trading day. Do investors really need more leverage? Do investors really need more ETFs?

Though the long-term impact of the proliferation of these exotic trading vehicles on the market remains to be seen, it stands to reason that intra-day movements of the S&P 500 may become increasingly more pronounced as traders use these ultra-leveraged instruments (now four times over) as hedging vehicles during individual sessions. Certainly there may be reasonable uses for these instruments among the most sophisticated traders, but we doubt their creation marks a step forward toward promoting market integrity--nor do we think such ultra-leveraged ETFs make sense for most individual investors or financial advisors to consider them. They should come with warning labels. We must move on to other topics, however.

Two of our very favorite ideas reported calendar first-quarter results recently. Though all investors weren’t completely thrilled with Apple’s (AAPL) fiscal second-quarter results, released April 2, we were pleased with the near-5% revenue advance in the quarter, a nice 10.5% increase in the dividend, to $0.63 per quarter, and a boost in its buyback authorization to $210 billion (yes, that’s correct -- $210 billion, more than the market capitalizations of most companies in the S&P 500, just to buy back its own stock!). If you think the iPhone is “dead,” ponder this--there are still people like me that have an iPhone 5 and are looking to upgrade to the next version. Needless to say, we continue to be super excited about Apple’s future, and we trust income investors are very pleased with the pace of the latest dividend hike (10%+). Apple is included in both the Best Ideas Newsletter portfolio and Dividend Growth Newsletter portfolio.

Another heavy-hitter that we include in both newsletter portfolios is Altria (MO), the cigarette and wine maker, but also part owner in ABInBev/SABMiller (BUD), one of its most valuable assets. In its first-quarter report, released May 2, Altria’s adjusted diluted earnings per share nudged higher a bit, and the company reaffirmed its guidance for 2017. Management noted that it is off to a “solid start” in 2017, and we view the company’s target for adjusted EPS growth this year in the 7.5%-9.5% range as achievable. Even if it comes up a bit light in this area, however, we’re not too worried. Altria has a fantastic business model, and its dividend is further backed by the financial flexibility provided by its stake in ABInBev/SABMiller. Here is a quick excerpt from Altria’s press release:

In March 2017, Altria’s Board of Directors (Board) declared a regular quarterly dividend of $0.61 per share. Altria’s current annualized dividend rate is $2.44 per share. As of April 28, 2017, Altria’s annualized dividend yield was 3.4%. Altria paid nearly $1.2 billion in dividends in the first quarter and expects to continue to return a large amount of cash to shareholders in the form of dividends by maintaining a dividend payout ratio target of approximately 80% of its adjusted diluted EPS. Future dividend payments remain subject to the discretion of the Board.

We continue to include shares of Coach (COH) in the Dividend Growth Newsletter portfolio, but we continue to view them as a source of cash, too, meaning that we won’t care too much about parting with the company in the coming months. Rumors have been flying that Coach is interested in buying Kate Spade (KATE) or more recently Jimmie Choo, and we don’t like the idea of Coach being on the buying-end of M&A (we like its cash on its balance sheet more than any acquisition spree it may engage in). That said, Coach put up decent calendar first-quarter results (its fiscal third quarter) May 2 that showed Coach brand North America comparable-store sales advancing 3% and its bottom line improving nicely. Shares are now north of $42, a modest gain from their average cost of ~$37.

How about Gilead (GILD)? I seem to have lost some readers when we warned about the potential for Gilead to underperform significantly when we removed shares from the Best Ideas Newsletter portfolio at $83.37 in early January 2016, swapping it out for Johnson & Johnson (JNJ) at $104.180. Gilead is now languishing in the mid-$60s, while J&J is trading well north of $120 per share. Perhaps Gilead should never have been added to the Best Ideas Newsletter portfolio in the first place, but we’ve made up for it with J&J and a variety of other calls. If anything, capitalizing on our market instincts with Gilead could have been a good thing, and while we continue to prefer J&J, we could add Gilead back as shares do still look incredibly cheap.

For those that are involved with Hanesbrands (HBI), we still like the company, but we’re still disappointed with its share-price performance out of the gates. The “story” with Hanesbrands is a cash-flow one, and we like that the company continues to work to drive annual cash flow from operations higher. For a dividend idea, a company that is focused on the following business strategy, “Sell More, Spend Less, Generate Cash,” seems to line up well with what we’re looking for. By the end of 2019, Hanesbrands’ strategy is expected to drive $300 million of incremental annual net cash from operations, which will in part help support the dividend payout. We didn’t like that organic sales dropped 4% in the first quarter, but management expects this to normalize during the second half of the year. In any case, we’ll be watching organic performance closely, but we don’t think there is any cause for alarm at this point. Remember, in the newsletter portfolios, we view things from a portfolio standpoint -- see “Alpha-Creating Hasbro-Hanesbrands (February 2017).”

I wanted to put a few more items on your radar. A Wall Street Journal article indicated that IAC/InterActiveCorp (IAC) is planning to buy Angie’s List (ANGI), so our updated fair value estimate reflects a potential take-out price. Beleaguered IBM (IBM) received a ratings downgrade from Moody’s today. We think IBM’s troubles started many years ago when it set its operating earnings per share goals to $20, instead of setting a return-on-investment (ROI) goal. You can read about that saga here.

In other news, Sprint’s (S) shares have seen better days, and we continue to believe that a takeout is the best possible scenario for shareholders. Telecom rivalries have become as cutthroat as they get. Dish Network (DISH) is rumored to be a likely suitor, though our team has little interest in gambling on takeout speculation. It’s just not what we do, nor is it something any long-term investor should consider. And finally – did you see the Dividend Cushion ratio come up big again? Frontier Communication’s (FTR) Dividend Cushion ratio of -1.6 preceded its 60%+ dividend cut May 2! This metric is incredible – get to know it. View the list of other high dividend-yielding stocks we think are at risk here.

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