Stock Market Outlook for 2021
publication date: Feb 8, 2021
author/source: Valuentum Analysts
By Valuentum Analysts
February 8, 2021
2020 was one for the history books.
We covered our thoughts and reflections on the past year in our “2020 Won’t Soon Be Forgotten” article (link here), and now we are looking towards the future. Global health authorities should be able to bring an end to the ongoing coronavirus (‘COVID-19’) pandemic sooner than many had expected as several vaccines have already been improved for emergency use and several others appear increasingly likely to get approved. Global vaccine distribution activities are currently underway, and this should allow the world to slowly return to pre-pandemic activities. Before then, immense stimulus measures launched primarily in developed nations should support global economic activities until the public health crisis is put to an end, establishing a positive outlook for the upcoming year.
With that said, 2021 may be no less stressful an environment than 2020, with systemic risk rearing its ugly head. In the early days of 2021, “bull raids,” or aggressive and orchestrated “short squeezes” on stocks, have translated into excessive volatility and irrational market behavior driven in part by Reddit WallStreetBets (WSB) users and Robinhood traders and exacerbated by price-agnostic trading from traditional quant algorithms. The posterchild of the times has been GameStop (GME), the shares of which went from a 52-week low of $2.57 in March 2020 to a 52-week high of $159.18 in January, and are now trading at ~$50-$70 per share at the time of this writing--still far above what may be considered to be a fair value estimate of the equity.
There have been more instances of crazy market behavior so far in 2021, too. Other heavily shorted stocks including Express (EXPR), Macerich (MAC), Bed Bath & Beyond (BBBY), and AMC Entertainment (AMC) have become tools of trading madness. As with the “fad” of investing in bankrupt companies in 2020 when the Robinhood crowd whipsawed prices of Hertz (HTZ), Whiting Petroleum (WLL), GNC (GNC) and Chesapeake Energy (CHKAQ) among others, in early 2021, the trading sharks circled heavily-shorted names to drive aggressive short-squeezes, often in conjunction with the application of deep out of the money call options. Several overextended hedge funds felt the pain.
Though we reiterate our fair value estimate of the S&P 500 is $3,530-$3,920 based on common-sense normalized expectations, we also believe that systematic risk is increasing as price-agnostic trading continues to proliferate across the market. Fewer and fewer investors are paying attention to intrinsic value estimates, and this could have severe implications on the health of the global financial system. With that said, let’s walk through key fundamental themes touching on the spaces of technology, e-commerce and retail, fintech and payment processing, energy and oil/gas, green energy, biotech and healthcare, 5G wireless, old industrial, video streaming, traditional banking, and cryptocurrencies.
We hope you enjoy. Here’s to a great 2021!
Stocks in the information technology sector performed incredibly well in 2020, all things considered, and we expect that will continue in 2021. Though one could argue that the COVID-19 pandemic pulled forward demand for certain tech offerings, meaning growth will be harder for certain firms to come by going forward, we see recent trends as a sign that the digital transition is accelerating.
For instance, digital advertising was already steadily becoming a larger part of total advertising spending given the highly targeted and flexible nature of these campaigns. GroupM, a division of WPP (WPP), forecasted that 2020 could be the first year digital advertising represents over half of all advertising spending in the US (when excluding political ad spending). Looking ahead, we expect digital advertising will continue to grow in both relative (as a percent of total ad spending) and nominal terms, with GroupM forecasting US digital advertising to continue to take market share in 2021.
The outlook for the global digital advertising market is quite promising due to the rise of the “global middle class” (higher incomes supports greater revenue per user) and rising Internet penetration rates in emerging economies (creating new growth opportunities). We continue to be huge fans of Alphabet (GOOG) (GOOGL) and Facebook (FB) given their dominant positions in the digital ad industry.
Both companies have pristine balance sheets, stellar cash flow profiles, high-margin businesses, promising growth outlooks and are trading well below their intrinsic value estimates (as of this writing) which is why we include both Alphabet Class C shares and shares of Facebook in the Best Ideas Newsletter portfolio. To read more about Alphabet, click here. As it relates to anti-trust concerns facing Facebook, we are not concerned as a breakup of the firm could counterintuitively see its share price converge toward our estimate of its intrinsic value at a faster pace than as a standalone company (we covered this in detail here).
Another realm that has experienced strong growth of late, and will likely continue to do so, is cloud computing. Microsoft (MSFT) has witnessed sales at its cloud-focused Azure business segment surge higher in the recent past, supported by its big data analytics offerings (more on MSFT here). Though Amazon (AMZN) has long been a leader in the cloud-computing space in terms of market share, Microsoft is starting to catch up. Even Alphabet is starting to see its Google Cloud unit start to gain some traction while Oracle’s (ORCL) cloud-oriented businesses have performed well of late, which helped lead to management issuing favorable near-term guidance during Oracle’s latest earnings call (more on ORCL here). We include shares of ORCL in our Dividend Growth Newsletter portfolio.
Third-party market research service Research and Markets forecasts the global cloud-computing market in terms of revenues will post compound annual growth rates in the high teens through 2025 (versus 2020 levels). With a greater number of employees now working from home, enterprise IT needs have fundamentally changed as there is a now much greater need for flexible productivity offerings that can be securely accessed.
Microsoft’s telecommunications-focused Teams service is integrated with its other products and services, such as Dynamics 365 (focuses on enterprise resource planning and customer relationship management applications), highlighting the company’s ability to cross-sell and upsell its various offerings to enterprises large and small (made possible by Microsoft’s focus on cloud-oriented services). We include Microsoft in both the Best Ideas Newsletter and Dividend Growth Newsletter portfolios.
Cybersecurity needs are on the rise. The recent SolarWinds (SWI) hack, which US intelligence agencies view as being conducted by Russian entities with ties to the Russian government, further highlights the need for top-tier cybersecurity offerings. Crowdstrike (CRWD), Okta (OKTA), and Zscaler (ZS) are three top-tier cybersecurity-oriented firms that provide their offerings via Software-as-a-Service (‘SaaS’) delivery methods. The Russian hacking group attempted to break into Crowdstrike’s operations via the SolarWinds hack but was ultimately unsuccessful. All three of these companies were investor favorites in 2020, and we expect that interest in companies operating in the cybersecurity space will remain elevated throughout 2021, especially for SaaS firms.
In our view, demand for dynamic cybersecurity services will continue to grow at a brisk clip going forward. The need to secure sensitive information and the potential cost of that sensitive information getting stolen underpins our optimistic outlook towards the space. Sony (SNE) was hacked by a North Korea entity in 2014 that saw sensitive information about Sony’s employees released to the public along with several movies that had yet to be released.
The potential damage hacks can have on a company is immense, especially if that company’s core business model is built around storing sensitive information regarding its customer and/or user base. Equifax’s (EFX) public image took a big hit when it was hacked (the hack was announced back in 2017), and the firm was forced into a multimillion dollar settlement.
Third-party research service Grand View Research forecasts the global cybersecurity market will increase by a 10% compound annual growth rate from 2020 to 2027. Companies are likely willing to pay up for top tier cybersecurity offerings, in our view, which further supports the outlook for the industry given the favorable impact pricing power can have on operating margins.
E-Commerce & Retail
Pivoting to e-commerce, the recent surge in households turning to e-commerce firms like Amazon to meet their routine needs such as groceries, toilet paper, and other consumer staples products via home delivery options has legs. Third-party market researcher eMarketer predicts that US e-commerce sales grew by over 32% annually in 2020, climbing to north of $790 billion from about $600 billion in 2019. By 2024, eMarketer views US e-commerce sales hitting $1.2 trillion. An increasing number of purchases across all types of product categories (from groceries to clothes to appliances and more) will be made online all over the world going forward, in our view.
Traditional retailers that invested heavily in home-delivery, curbside pickup, and in-store pickup fulfillment options and their digital operations more broadly (having an e-commerce platform that is easy to use) were well prepared when the COVID-19 pandemic hit. Dick’s Sporting Goods (DKS) and Home Depot (HD) are two prime examples of companies that were able to lean on their past investments in omni-channel sales capabilities and meaningful digital investments to ride out the storm while generating impressive same-store sales growth (more on DKS here and HD here).
Dick’s Sporting Goods has placed a big emphasis on improving its mobile app over the years (the source of over half of its e-commerce sales in the third quarter of fiscal 2020), such as integrating the app with its popular customer loyalty program. This strategy has proven to be a boon for the company. Home Depot continues to benefit from strong do-it-yourself (‘DIY’) demand as households pursue home improvement projects while stuck indoors due to COVID-19. These customers are increasingly turning to Home Depot’s e-commerce platform to place orders online and pick up in-store. Additionally, Home Depot is well-positioned to meet strong demand from the domestic housing market as it has a top notch professional-facing business. We include both firms in our Dividend Growth Newsletter portfolio.
Dollar General (DG) has made significant improvements to its digital operations in recent years, though the firm still relies on its physical presence to meet demand. Given that Dollar General focuses on small cities and towns in the US with populations of 20,000 or less, we view its business model as being well-insulated from e-commerce competition due to the logistical hurdles that companies face when attempting to meet demand in these remote regions via home delivery fulfillment options. We include Dollar General in the Best Ideas Newsletter portfolio and continue to be impressed with the stellar same-store sales growth the retailer has put up of late (more on Dollar General here).
Fintech and Payment Processing
One of the dynamic effects the rise of e-commerce has had on the global economy involves creating greater demand for online-oriented payment processing services. PayPal (PYPL) is one of our favorite companies in this space as its growth outlook is stellar, supported by its high-quality cash flow profile and pristine balance sheet. The firm also owns Venmo, the popular peer-to-peer money transfer mobile-oriented app, and we are excited about the numerous ways PayPal could monetize this business. After separating from eBay (EBAY) in 2015, PayPal has steadily grown its total payment volume (‘TPV’). Its TPV was up 36% year-over-year on a constant currency basis in the third quarter of 2020.
The ultimate end game of the fintech and payment processing space is to create a “walled garden” where companies can provide multiple services at once with limited competition in certain instances. For instance, if a customer buys something online and that product is located overseas in a country with a different currency, PayPal can make money both by processing the payment and by providing foreign currency transaction solutions, along with any other required service (without necessarily being compelled to provide other options to the customer for each individual service).
We are also big fans of Visa (V). As households get ready to resume pre-pandemic activities such as business trips and vacationing in the wake of global health authorities eventually putting an end to the public health crisis, Visa’s lucrative travel-oriented businesses should stage a strong recovery. In the meantime, its online-facing businesses continue to do well, and the firm does not have any credit risk exposure as it does not lend money. PayPal has a relatively small lending operation. We include both PayPal and Visa in the Best Ideas Newsletter portfolio and are big fans of both companies. Check out this article here to read about an intriguing partnership between the two firms, along with commentary on their financial positions.
Apple (AAPL), a holding in both the Best Ideas Newsletter and Dividend Growth Newsletter portfolios, sought to grow its fintech business when it partnered with Goldman Sachs (GS) to launch the Apple Card (which we covered here). The company also has its Apple Pay service, and the Apple Card is a logical extension of its efforts in this space. By leveraging its large hardware user base, Apple aims to grow its services-oriented revenues over time, and its foray into fintech is part of that strategy. We are keeping a close eye on Apple’s growing services business given the high-margin nature of these revenue streams and the long growth runway the iPhone giant has on this front if successful.
Facebook aims to grow its payment processing business with an eye towards its WhatsApp messenger service. In 2020, Facebook partnered up with Jio Platforms (acquiring a ~10% equity stake in the firm for about $5.7 billion), an Indian telecommunications and digital platform company (we covered the deal here). The goal appears to be built around creating a sizable e-commerce and payment processing business in India by connecting WhatsApp users with small and large stores across the country. While these are still early days, we are incredibly excited at the potential WhatsApp offers Facebook in terms of building up e-commerce and payment processing business, leveraging WhatsApp large active user base to do so.
Reportedly, Jamie Dimon, CEO of JPMorgan Chase (JPM), noted that key fintech players such as PayPal, Square (SQ), Stripe, and Ant Financial along with the fintech divisions of major tech giants needed to be monitored given their potential ability to completely disrupt the financial services sector. For instance, Square, which is run by Jack Dorsey who also runs Twitter (TWTR) (Mr. Dorsey is CEO of both firms and co-founded/founded both firms), plans to launch its own bank this year. Known as Square Financial Services, the bank will operate as an independently run subsidiary of Square and “its primary purpose will be to offer small business loans for Square Capital’s commercial lending business, and to offer deposit products.”
The Federal Deposit Insurance Corporation (‘FDIC’) conditionally approved Square Financial Services’ deposit insurance application (as it concerns the firm’s industrial loan bank charter) back in March 2020, and Square has already received charter approval from the Utah Department of Financial Institutions. We are intrigued by this news given the implications it has for the broader fintech space.
We’re closely monitoring how the fintech and payment processing landscape will continue to evolve in 2021. The resumption of travel activities will be a major boon for credit card networks Visa and MasterCard (MA), and more broadly, the secular transition away from cash (which picked up steam in 2020) continues to support the long-term outlook of both companies. The growing prevalence of e-commerce will continue to provide PayPal with a massive tailwind (same goes for Visa and MasterCard), as will slowly unlocking the full revenue generation potential of PayPal’s Venmo service. We’re keeping a very close eye on this situation as Venmo recently launched its own branded credit card which is issued by Synchrony Financial (SYF) and backed by Visa’s payment network.
We added Financial Select Sector SPDR (XLF) to the Best Ideas Newsletter portfolio on January 12 (link here). The improving outlook for the banking space is a product of expectations that the global economy will recover, which in turn should limit credit write-offs while putting upward pressure on interest rates (off a low base) which supports the outlook for net interest margins (‘NIMs’).
Energy, Oil & Gas
The ongoing recovery in raw energy resources pricing (crude oil, liquified natural gas, natural gas, natural gas liquids) has gone a long way to improve the outlook for upstream firms, companies involved in the extraction of oil & gas from the ground, albeit off an incredibly low base. Expectations that energy demand will recover meaningfully in the coming quarters due to a combination of the COVID-19 vaccine distribution efforts currently underway and actions taken by the OPEC+ oil cartel to limit global oil supplies (for an extended period) have been key to supporting the market--we covered these dynamics in detail in this article here).
In our view, the outlook for the upstream oil & gas industry has shifted from dire to manageable with WTI and Brent pushing back into the $50s per barrel range. Higher raw energy resources pricing needs to be combined with disciplined capital investment strategies for the heavily indebted upstream oil & gas industry to truly take advantage of the upturn. Significant headwinds remain however, and for the recovery to have legs, recent increases in raw energy resources pricing needs to be sustained.
The outlook for integrated energy companies has also improved significantly of late. Integrated energy firms generally have large upstream divisions alongside substantial midstream (pipelines, storage facilities, processing plants), downstream (refineries and petrochemical plants) and retail (gas stations and related convenience stores) operations. Integrated energy companies often generate an outsized portion of their operating cash flows from their upstream operations, so any improvement on this front can go a long way to improve their company-wide financial performance.
As it concerns the midstream and downstream industries, the resumption of pre-pandemic activities should lead to a recovery in gasoline and diesel demand in the near term, with demand for jet fuel (made from kerosene) potentially recovering in the medium term given the headwinds facing commercial airliners will likely linger. This in turn should benefit both refineries and the pipelines that transport refined petroleum products to end buyers, along with the related energy infrastructure such as storage facilities and marine terminals. Rising oil & gas production levels support midstream assets that cater to the upstream industry such as gathering & processing (‘G&P’) operations along with long haul pipelines.
Petrochemical plant operators should benefit from a recovering global economy given that the industry produces the building blocks of modern society (such as plastics, adhesives, detergents, and more), as should the midstream assets that support petrochemical operations. That includes cryogenic processing plants that separate “dry” natural gas (methane) from “wet” natural gas (mixed Y-grade natural gas liquids), and fractionators that separate the various natural gas liquids (e.g., propane, butane, ethane) from the Y-grade natural gas liquids into standalone products.
Rising input prices for the downstream space (i.e., higher raw energy resources pricing) will likely be offset by higher utilization rates, which generally provides an uplift to operating margins given the high fixed costs the industry faces. This will be made possible by expected demand growth creating a need for greater production volumes.
Effectively, the potential for the COVID-19 pandemic to end sooner than expected supports the entire oil & gas industry. We also added Energy Select Sector SPDR (XLE) to the Best Ideas Newsletter portfolio January 12 to gain broad exposure to the space and the potential for a sustained recovery. Our favorite midstream firms are Enterprise Products Partners LP (EPD) and Magellan Midstream Partners LP (MMP), two top tier companies that are included in the High Yield Dividend Newsletter portfolio.
The dichotomy between equities in the green energy space and equities in the oil & gas energy space couldn’t be more apparent. A prolonged period of low raw energy resources pricing (the downturn began back in late-2014) and sharp improvements in the economics of green energy operations led investors to shift capital away from equities in the fossil fuel space towards equities with exposure to renewable energy. Several provisions geared toward supporting the green energy space were included in the recently passed omnibus spending and emergency fiscal relief package in the US, something we covered in detail in this article here.
Electric vehicles (‘EVs’) are clearly an investor favorite with shares of Tesla (TSLA), Li Auto (LI), Lordstown Motors (RIDE), Nio (NIO), BYD Group (BYDDF), Xpeng (XPEV) and Workhorse Group (WKHS) all moving sharply higher over the past year. Looking ahead, the long-term outlook for EVs remains bright as does the outlook for companies with exposure to the space (though many companies in this space are currently trading at arguably generous valuations). In terms of units, the EV market remains relatively small as things stand today, though that should change over time as we covered in this article here. By some estimates, the EV market in terms of unit sales should rise by more than ten-fold from 2020 to 2030, at least according to privately-held Deloitte.
There are several things we’re keeping a close eye on in 2021 including 1) how effective the EV industry is at scaling up manufacturing activities, 2) how the EV sales growth trajectory is evolving in key growth markets (China, Western Europe, and the US), 3) what kind of EV investments traditional automakers are making, and 4) what level of interest there is in EV pickup offerings. Tesla has the Cybertruck, General Motors (GM) has its all-electric Hummer pickup truck, and privately-held Rivian has its all-electric R1T pickup truck offering, though note that it will be at least a few years until these offerings are readily available (meaning short delivery times instead of long waits). General Motors has recently rotated towards EVs, as have other traditional automakers with Ford (F) partnering up with Volkswagen (VWAPY) to assist in their collective EV and autonomous vehicle efforts.
Pivoting now to electric utilities, firms that prioritized green energy investments were clearly investor favorites in 2020, and we expect that to continue into 2021. NextEra Energy (NEE) owns two Florida-focused electric utilities and a large economic stake in NextEra Energy Partners (NEP), which is focused on renewable energy generation assets. During the past five years, the share price of NEE (adjusted for stock splits) and the unit price of NEP have both more than tripled as of this writing. The NextEra Energy family continues to invest large sums toward growing its green energy operations by building new solar plants, wind farms and battery storage facilities which underpins the electric utility family’s promising growth outlook. We include Utilities Select Sector SPDR Fund (XLU) in the High Yield Dividend Newsletter portfolio to gain broad exposure to the space.
NextEra Energy is not alone in its green energy push. American Electric Power (AEP) aggressively touts its plan to fundamentally change its power generation mix. From 2020 to 2030, the utility aims to reduce coal power to 24% from 43% of its company-wide power generation capacity while electric generated by ‘Hydro, Wind, Solar and Pumped’ are forecasted to rise from 18% to 39% of its company-wide power generation capacity during this period. Nuclear power is expected to remain at a high-single digit percentage of its power generation mix during this period as nuclear power can continue meeting demand when the wind isn’t blowing, and the sun isn’t shining.
Even Berkshire Hathaway (BRK.A) (BRK.B), a holding in the Best Ideas Newsletter portfolio, is directing its majority-owned Berkshire Hathaway Energy unit to invest heavily in green energy with an eye towards wind farms in Iowa and Alberta, Canada (something we covered in this article here). Berkshire Hathaway in the recent past has hyped the sharp improvements in the economics of its wind farms over the years as a way to save its customers money while creating growth opportunities for its energy operations. An enormous part of that improvement in power generation economics is due to innovation at firms like General Electric (GE) and Siemens (SIEGY) which manufacture the turbines used in wind farms.
First Solar (FSLR), a US-based manufacturer of solar modules, is excited about the kinds of economic improvements its copper replacement project could yield. Copper prices have been incredibly strong of late, and reducing solar module costs while improving cell efficiency could go a long way to improve the industry’s outlook. The National Renewable Energy Laboratory (‘NREL’) and First Solar aim to reduce the amount of copper used in cadmium telluride solar cells by “placing… elements from the fifth column of the periodic table… such as antimony or arsenic, onto tellurium crystal sites at extremely high speeds by low-cost methods required for mass production.” Though copper is still an essential part of the industry as an electrical conductor, it appears the industry is beginning to challenge old habits.
Biotech and Healthcare
One of our favorite biotech ideas is Vertex Pharmaceuticals (VRTX). Vertex’s commercialized therapeutics portfolio is heavily weighted towards treating cystic fibrosis (‘CF’) across various age groups including: TRIKAFTA/KAFTRIO (age 12 and older), SYMDEKO/SYMKEVI (age six and older), ORKAMBI (age two and older), and KALYDECO (age four months and older). Back in October 2019, Vertex’s TRIKAFTA offering was approved by the US Food and Drug Administration (‘FDA’).
CF is a profoundly serious disease. Recent pharmaceutical breakthroughs have significantly advanced the ability for healthcare providers to treat and manage patients with CF, with Vertex leading the way on this front. The approval in the US and Europe covered slightly different applications of Vertex’s TRIKAFTA/KAFTRIO treatments. In August 2020, the European Commission (‘EC’) approved KAFTRIO (the European-branded name of the TRIKAFTA therapeutic) to treat certain forms of CF in patients ages 12 years and older in combination with KALYDECO.
Back in October 2015, Vertex and CRISPR Therapeutics AG (CRSP) announced a strategic partnership that aimed to use “CRISPR’s gene editing technology, known as CRISPR-Cas9, to discover and develop potential new treatments aimed at the underlying genetic causes of human disease.” CRISPR focuses on gene therapies. The partnership is currently working on treating transfusion-dependent beta thalassemia (‘TDT’), CF and SCD. We are intrigued by the potential therapeutic breakthroughs that the Vertex-CRISPR partnership could uncover.
Johnson & Johnson’s (JNJ) recent performance has been better than expected. Within the company’s earnings presentation covering the final quarter of fiscal 2020, Johnson & Johnson noted it generated ~$20.0 billion in free cash flow last fiscal year and exited fiscal 2020 with a ~$10.0 billion net debt position. Given its ability to generate meaningful free cash flow in almost any environment, a product of its impressive business model, we view Johnson & Johnson as well-positioned to manage its net debt load and dividend obligations going forward.
Johnson & Johnson is working on its own COVID-19 vaccine, and interim clinical trial data has been promising. The company’s management team noted that it was getting ready to share data from its Phase 3 clinical trial soon, which could add yet another arrow to the quiver of global health authorities assuming the clinical trial provides promising efficacy and safety results. Though we do not expect Johnson & Johnson to generate needle-moving revenue from the potential COVID-19 vaccine should the vaccine candidate receive emergency authorization, if the company proves to be successful on this front, that would go a long way to improving its corporate image worldwide.
Vertex and Johnson & Johnson weren’t the only ones showcasing exciting fundamentals during 2020, as several biotech and pharmaceutical companies also revealed the resilience of their business models in the year when faced with severe exogenous headwinds created by the coronavirus (‘COVID-19’) pandemic. For broad-based diversified exposure tied to secular growth tailwinds across the largest drug development companies in the world (and their robust pipelines of drugs and therapies), we include the Health Care Select Sector SPDR ETF (XLV) in both the Best Ideas Newsletter and Dividend Growth Newsletter portfolios.
Next-generation 5G wireless technology has been highlighted as a game-changer for much more than just smartphones, a sentiment we generally agree with. Apple, another one of our favorite companies, launched its first-ever 5G iPhone when releasing its iPhone 12 line-up (link here) back in October. Channel checks indicate that demand for the iPhone 12 has held up well in China and elsewhere, and the company reportedly plans to boost production. We expect that the iPhone 12 will post strong sales performance in the US as well, aided by both the technological improvements of 5G technology and consumers saving money on discretionary activities (travel, eating out) during the pandemic (meaning they have more money to spend on new items like a premium smartphone).
The adoption rate of 5G wireless technology companies is uncertain, though the COVID-19 pandemic created turbulence that is unprecedented. We expect that 5G adoption will pick up steam in 2021. AT&T (T), Verizon (VZ), and T-Mobile (TMUS) are all aggressively advertising their 5G wireless services, and many of those ads focus on the new 5G-capable iPhone 12 lineup. We include AT&T in the High Yield Dividend Newsletter portfolio due to its impressive free cash flow generating abilities, potential upside from its nascent HBO Max video streaming service, and the expected uplift from 5G wireless adoption (more on AT&T here).
Going forward, the number of 5G-capable smartphones on the market will likely continue to grow. Samsung (SSNLF) offers various 5G-capable smartphone offerings and competes with Apple by selling both low- and high-end offerings. There is room for multiple winners in this space, and we continue to be impressed with Apple’s ability to monetize the success of its hardware sales to create new growth opportunities.
Cisco Systems (CSCO) provides some of the software that supports 5G operations including its Cisco ONE architecture offering, which is “a cloud-first, software-defined architecture that spans enterprise and service provider deployments seamlessly--this includes open roaming between cellular and Wi-Fi, including the new Wi-Fi 6.” We include shares of CSCO in our Best Ideas Newsletter and Dividend Growth Newsletter portfolios (read more about CSCO here).
We’re big fans of Cisco’s pristine balance sheet and stellar cash flow profile. Its near-term outlook indicates the company is putting the worst of the COVID-19 pandemic behind it (the pandemic weighted negatively on Cisco’s total product sales performance due to soft demand in certain enterprise and commercial markets). The company’s software business has continued to move in the right direction of late, supported by its cybersecurity and telecommunications offerings, along with its exposure to the rollout of 5G wireless infrastructure and related activities.
Qualcomm (QCOM) is a leader in 5G modem and radio frequency (‘RF”) technology and is a leading supplier of the related semiconductor components to smartphone manufacturers. It also has a very lucrative licensing business. The company’s recent truce with Apple and Huawei supports its outlook, and Qualcomm stands to be a big winner from the adoption of 5G technology (more on Qualcomm’s stellar outlook here). We are big fans of Qualcomm and include the firm in the Dividend Growth Newsletter portfolio.
The ongoing coronavirus (‘COVID-19’) has weighed negatively on the industrial sector for most of 2020, before the space started to recover during the latter part of the year. Industrial conglomerate General Electric’s fourth-quarter earnings for 2020 showed the beaten-down firm is on the rebound. What really impressed us was that GE Industrial’s free cash flow came in at $4.4 billion in the final quarter of last year which pushed the segment’s full year free cash flow up to a positive $0.6 billion in 2020. GE may be starting its comeback.
Caterpillar (CAT) and Honeywell (HON) have been communicating to investors that 2021 will likely be a year of recovery. Caterpillar expects its financial performance to improve as it is seeing signs of improving end-user demand and the need for dealers to restock their inventories (after dealer inventories declined in the final quarter of 2020). Honeywell expects its financial performance will rebound in 2021 with management guiding for both organic sales growth and margin expansion this year. Cost structure improvements, particularly those embarked on during the COVID-19 pandemic, will also be key. Honeywell is included in the Dividend Growth Newsletter portfolio.
One old industrial firm that may continue to have fits and starts as it struggles to right the ship is Boeing (BA). Problems at its 737 MAX offering, delays in aircraft deliveries due to the COVID-19 pandemic (resulting in a large inventory buildup), and sharp reductions in its monthly aircraft production rates (reduced economies of scale) have weighed very heavily on its operational and financial performance. At the end of 2020, Boeing’s net debt load stood at $38.0 billion (inclusive of short-term debt) and that is on top of hefty long-term pension and retiree health care obligations. The company is far from out of the woods.
Other old industrial names are faring better. 3M (MMM), for example, has a meaningful personal protective equipment (‘PPE’) business and has raced to keep up with elevated demand due to the COVID-19 pandemic. Looking ahead, 3M aims to grow its total sales by 5%-8% annually in 2021, with annual organic currency-neutral growth forecasted at 3%-6%. The firm expects its EPS will come in between $9.20-$9.75 this year, a meaningful increase from its adjusted non-GAAP EPS of $8.74 in 2020 (3M posted $9.25 in diluted EPS on a GAAP basis in 2020).
We are optimistic that video streaming services will maintain their recent gains in terms of paying subscriber growth throughout 2021. Disney (DIS), a holding in the Best Ideas Newsletter portfolio, is one of our favorite ways to play the space as its Hulu, Disney+, and ESPN+ video streaming services have posted tremendous paid subscriber growth of late (more on DIS here). For refence, Disney owns 67% of Hulu and 80% of ESPN, and uses its controlling stake in those businesses to generate synergies by bundling those services with its Disney+ service.
Even more importantly, Disney’s forecasted paid subscriber growth through fiscal 2024 is stunning. By fiscal 2024, Disney aims to have 300-350 million in total paid subscribers across its core video streaming services. Launching new video streaming services (such as its pending Star and Star+ services that are geared towards international markets) while expanding its existing services into new markets will support Disney’s paid subscriber growth trajectory going forward.
Disney intends to prioritize investments in original content in the coming years to keep the momentum going in the right direction. For that reason, Disney expects its video streaming services will incur meaningful operating losses (on a standalone basis) in the next couple of fiscal years before becoming sizable profit generators. We see these investments as a good use of capital. A resumption of pre-pandemic activities does not mean that households will shed their preference for video streaming services, and we expect many subscribers will stay around for the original content.
As an aside, note that Disney’s financial performance should improve considerably in the coming quarters as global health authorities work to bring an end to the COVID-19 pandemic. When Disney can resume operations at its theme parks and resorts at or near pre-pandemic capacity levels, its financials should experience a material tailwind given that these assets have historically been its major profit generators. Furthermore, sporting events will be able to resume in earnest (though many already have) and the threat of sporting events getting cancelled will diminish significantly.
Netflix (NFLX) should also continue to do well as it is now finally in a position to go from burning through vast amounts of cash on an annual basis to generating positive free cash flows (more on NFLX here). Sharp growth in its net paid subscriber base (up about 17% from the end of 2019 to the end of the third quarter of 2020) combined with the delay of some production activities which reduced content development costs enabled Netflix to generate about $2.6 billion in positive net operating cash flow and $2.2 billion in free cash flow during the first three quarters of 2020. Back during the first three quarters of 2019, Netflix posted -$1.4 billion (negative $1.4 billion) in net operating cash flow, resulting in a large negative free cash flow figure.
While competition in this industry continues to grow, seen through the recent launch of AT&T’s HBO Max service and the recent launch of Comcast’s (CMCSA) NBCUniversal segment’s Peacock service, we see room for multiple winners in this space. Bundling live TV packages with existing video streaming content further eliminates the need for households to retain a cable package, and Hulu offers these types of services. Apple has its Apple TV+ service, Amazon has Amazon Prime, and even Roku (ROKU) is getting ready to push into the space after reportedly acquiring the failed startup Quibi’s streaming content. The industry’s growth outlook is bright, and once scale is achieved; the video streaming business can be quite lucrative.
Though we’re generally cautious on banking business models due to the arbitrary nature of cash-flow generation within the banking system and the difficulty in valuing such entities on the basis of a free-cash-flow-to-the firm framework, the traditional banking system held up quite well during 2020, all things considered.
We like Morgan Stanley (MS)--and its return on tangible equity of 17.7% during the fourth quarter of 2020 speaks to solid economic-value creation. Goldman Sachs (GS) annualized return on total equity (ROTE) was an impressive 22.5% during its fourth quarter, helping drive the full-year measure to 11.1% for 2020, and the Federal Reserve and Treasury continues to backstop much of the system.
Bank of America (BAC) had been an idea in the Best Ideas Newsletter portfolio in the past, but we removed the company June 11, 2020. We continue to view the banking system more as utility-like serving as an extension of the federal government (e.g. Paycheck Protection Program loans), and as such, we generally don’t think they’ll be able to muster above-average returns in the longer-run. That said, we still include diversified exposure to the financial sector in the Best Ideas Newsletter portfolio via the Financial Select Sector SPDR (XLF), but only for diversification purposes.
Citigroup (C) remains among our least favorite banking entities. Wells Fargo (WFC) used to be a well-run bank, but consumer perception has certainly changed with its “fake account scandal” that cost it $3 billion to settle criminal and civil charges. JP Morgan's return metrics were solid like Morgan Stanley’s and Goldman’s, with return on equity (ROE) coming in at 19% and return on total common equity (ROTCE) coming in at 24% in the quarter. The banking system remains on stable ground, nonetheless.
With the Federal Reserve and Treasury continuing to flood the market system with excess liquidity and stimulus, money is flowing into assets that perhaps it shouldn’t. Cryptocurrencies of all kinds from Bitcoin (GBTC) to Ethereum to Dogecoin have been skyrocketing. These instruments are more like trading vehicles than assets with intrinsic worth as they depend entirely on the confidence that at some point in the future, they will become viable currencies. In short, their prices are being propelled by the “greater fool theory,” meaning someone else must be willing to buy at a higher price to take existing holders out.
In light of the proliferation of price-agnostic trading for the past many decades that has catapulted the conversation of “value versus growth” to headlines, offering a foundation for many quant funds that specialize in these areas to thrive, it would not be surprising for similar dynamics to take hold in the cryptocurrency markets, whereupon “castles in the air” provide enough support for such instruments to become more commonplace within the global financial system than they otherwise should.
Celebrities are backing crypto and even Tesla has added Bitcoin to its balance sheet. With so much money sloshing around, even the value of baseball cards has started to surge. When combined with the irrational trading of bankrupt stocks and what looks to be coordinated short squeezes, the markets have become a playground, or better yet, a casino for many. We continue to believe that those that focus on intrinsic values will come out ahead in the long run, and a market system that prioritizes intrinsic value analysis will ultimately be the healthiest.
2020 was one from the history books and a year that will live on in infamy. That said, we are excited for the future as global health authorities are steadily putting an end to the public health crisis created by COVID-19, aided by the quick discovery of safe and viable vaccines.
Tech, fintech, and payment processing firms were all big winners in 2020, and we expect that to continue being the case in 2021. Digital advertising, cloud-computing, and e-commerce activities are set to continue dominating their respective fields. Cybersecurity demand is moving higher and the constant threats posed by both governments (usually nations that are hostile to Western interests) and non-state actors highlights how crucial these services are.
Retailers with omni-channel selling capabilities are well-positioned to ride the global economic recovery upwards. Green energy firms will continue to grow at a brisk pace in 2021, though the oil & gas industry appears ready for a comeback. The adoption of 5G wireless technologies and smartphones will create immense growth opportunities for smartphone makers, semiconductor players and telecommunications giants. Video streaming services have become ubiquitous over the past decade with room to continue growing as households “cut the cord” and instead opt for several video streaming packages.
We’re not too big of fans of old industrial names given their capital-intensive nature relative to capital-light technology or fintech, but there are select names that have appeal. Cryptocurrencies have taken the market by storm as we turn the calendar into 2021, but the traditional banking system remains healthy enough to withstand another shock should it be on the horizon. Our fair value estimate of the S&P 500 remains $3,530-$3,920, but we may still be on a roller coaster ride for the year.
Here’s to a great 2021!
Tickerized for the IWV.
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Callum Turcan and Brian Nelson do not own shares or units 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.
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