The market remains healthy, with all major indexes in uptrends and no major signs of divergence, and thus I continue to recommend heavy investment in stocks that meet your portfolio’s goals.
This week’s recommendation is an American apparel company whose stock is cheap and thus has great capital gains potential. Plus it pays a 5.8% dividend!
As for the current portfolio, most of our stocks are performing fine; a few are hitting record highs; and one or two stocks have become worrisome, but not enough to cause me to take action.
Cabot Stock of the Week 266
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Diversification is one of my key investing tenets; it reduces the risks of concentration and increases the odds of being in winning sectors. Nevertheless, concentrations tend to form over time. Growth-oriented investments tend to group around technology themes; value-based investments tend to group around cyclicals; and dividend-centric investments are heavy in utilities and consumer staples. So, when a stock comes along that’s not in any of those groups and meets an analyst’s investing criteria and is going in the right direction, I get interested. That’s the case with today’s recommendation, which was originally recommended by Crista Huff in Cabot Undervalued Stocks Advisor. Here are Crista’s latest thoughts.
Designer Brands (DBI)
Stock markets can churn and sputter as news reports of recessions, interest rate changes and tariffs cause confusion and worry. Throw in the impact of the changing retail landscape and unusually poor weather, and it’s a wonder that investors brave the storm and continue to buy stocks! If you want to invest in a company that has avoided all of these problems, and offers an abundance of both growth and value—and yields 5.8%— look no further than Designer Brands Inc., one of North America’s largest designers, producers and retailers of footwear and accessories.
Designer Brands operates nearly 1,000 retail locations in 44 U.S. states and Canada, as well as the e-commerce site DSW.com. In March 2019, the company changed its name from DSW Inc., which represented the DSW Warehouse retailers, to reflect the acquisition of Canadian retailers The Shoe Company and Shoe Warehouse, and private label footwear producer Camuto Group. DSW was the #1 omnichannel retailer in the U.S. in 2017 and 2018, and has delivered 27 consecutive years of sales growth.
Designer Brands is delivering on a most interesting and exciting set of corporate expansion plans, reflecting many types of growth and innovation. Management is drawing upon the most successful individual aspects of DSW Warehouses, The Shoe Company and Camuto Group, and applying those profit-generating processes to each of these three divisions of the company in order to escalate revenue and gross margin growth.
For example, Camuto Group is the leader in private brand footwear in the U.S. Private brand footwear carries about 10 percentage points more of gross margin than branded footwear. Designer Brands plans to use Camuto’s expertise to provide new brands to consumers that will then boost total-store gross margins.
The Shoe Company acquisition is going extremely well, with second-quarter comparable store sales (comps) up 8.1% vs. a year ago, on top of 7.1% rising comps in the prior year. Late in the first quarter, the Canadian business relaunched its digital site and operations, leveraging DSW’s expertise and technology infrastructure. As a result, digital demand increased by 84% vs. last year.
CEO Roger Rawlins commented, “In Canada, we are learning how to operate a small-door concept.” The company can then draw upon experience with 3,000-6,000 square foot locations and duplicate the process in the U.S., which has historically operated locations with upwards of 20,000 square feet.
Designer Brands has expanded into kids’ footwear, and is now testing high-end nail services, a full complement of shoe repair services and custom-made orthotics in a few DSW stores. The company added these businesses in order to minimize reasons for customers to leave their stores. The company’s kids business delivered a 32% comp in the second quarter, and digital business grew 22%.
After a modest first-quarter earnings and revenue beat, management raised full-year EPS guidance to a range of $1.87-$1.97 vs. its previous guidance of $1.80-$1.90 per diluted share. Second-quarter EPS came in on target. CEO Roger Rawlins commented, “Each segment delivered what was needed this quarter, but our newest businesses really stood out, exceeding our expectations and moving us closer to the vision laid out at our Investor Day. In Canada, the transfer of successful practices at DSW in the U.S. to our Canadian banners fueled continued positive momentum in this business. We were particularly pleased with the growth in Canada of both the loyalty programs and e-commerce sales.”
Investors might be aware that shoe retailer Foot Locker’s (FL) second-quarter earnings release was recently met with a 19% drop in the share price. After studying the earnings release and webcast, I was greatly relieved to determine that the problem at Foot Locker was entirely attributed to company-specific situations, compounded by the bad luck of reporting earnings on a day that the S&P 500 fell 2.6% – a tremendous one-day move for the stock index. Foot Locker had a poor quarter in their apparel business (a business in which Designer Brands does not participate) and lower margins due to a shift away from private label business (Designer Brands is shifting more toward their highly-profitable private label business).
There was good news, however. Foot Locker reported strong results in women’s and kids’ shoes, sequential monthly sales growth from May through July, no resistance to higher average selling prices (ASPs), and strong performance in their Canadian stores—all themes that Designer Brands also experienced.
Threats of tariffs on Chinese imports helped Designer Brands focus on being flexible with production. CEO Roger Rawlins commented, “We feel we have many avenues to help Designer Brands mitigate the impacts of tariffs” including negotiations with manufacturing partners and vendors; large production increases that result in scale savings; and factory locations in 11 countries (expanding to 14 countries). In October 2018, 10% of Designer Brands’ products were manufactured outside of China. That number is now up to 20%, and management expects it to climb to over 40% in the next 12-18 months. Keep in mind that Designer Brands’ Canadian business is not affected by U.S. tariffs applied to Chinese imports.
DBI is an undervalued, small-cap growth stock with a huge dividend yield of 5.8%. Consensus earnings estimates project EPS growth rates of 14.5% and 14.7% in 2019 (January 2020 year end) and 2020. The current P/E is low at 9.1. Note that woes within most retail apparel businesses are not harming Designer Brands’ 2019 performance. Most famous-name apparel retailers are experiencing a drop in profit this year, while Designer Brands continues to deliver double-digit earnings growth. The company repurchased 2.7 million shares during the second quarter.
The stock came down from 33 to 14 over the past year, but since August has been on an uptrend, with short-term price resistance at 19, and a secondary near-term target of 22.5. Buy DBI for its yield as well as outsized total return potential in 2019 and beyond.
Designer Brands Inc.
810 DSW Drive
Columbus, OH 43219
614-237-7100
designerbrands.com
CURRENT RECOMMENDATIONS
Overall, our portfolio looks good, as we work back toward our fully invested position of twenty stocks. Some stocks are hitting new highs, while many are close to it, and the stocks that are weak aren’t quite weak enough to sell—though that could easily change, especially as the portfolio gets fully invested. In your own portfolio, of course, you may want to sell your weakest stock(s), especially if you’re fully invested and you can put the money in stronger stocks. Details below.
Alaska Air (ALK), originally recommended by Crista Huff for the Buy Low Opportunities Portfolio of Cabot Undervalued Stocks Advisor, has been trading tightly over the past week, having stabilized quickly after the oil price shock of the previous week. Bottom line, it looks like the growth of Alaska’s business (the carrier now expects revenue per available seat mile to rise in the 3-5% range year over year, up from a projected 2-5% range) is a more powerful factor than oil prices. And, of course, the reality of U.S. leadership in oil production means that Middle East oil shocks are not what they used to be. BUY.
Alexandria Real Estate Equities (ARE), originally recommended by Tom Hutchinson in Cabot Dividend Investor for his Safe Income Tier, hit a record high last Friday and has pulled back normally since. In his latest update, Tom wrote, “High occupancy rates for its in-demand unique laboratory properties make this stock a favorite in the current environment. It’s a highly defensive REIT that consistently grows earnings and the dividend. It should be good-to-go in any type of market.” BUY.
Apple (AAPL), originally recommended by Crista Huff for the Buy Low Opportunities Portfolio of Cabot Undervalued Stocks Advisor, remains very close to its high of two weeks ago. In today’s update, Crista wrote, “In 2020, Apple enthusiasts can expect 5G iPhones. On September 20, the Financial Post reported, “U.S. trade regulators on Friday approved 10 out of 15 requests for tariff exemptions filed by Apple amid a broader reprieve on levies on computer parts.” Wall Street expects an EPS drop of 2.2% in 2019 (September year end) followed by an increase of 9.3% in 2020. The stock emerged from a trading range on September 5 and is now rising toward its October 2018 all-time high near 230. AAPL is my favorite buy-and-hold stock for long-term capital gains.” BUY.
Bandwidth (BAND), originally recommended by Tyler Laundon for Cabot Small-Cap Confidential, has been a disappointment, and Tyler explained the reason in his update last week, writing, “Morgan Stanley came out with an extensive report on the CPaaS space and one of the punchlines was that investors should sell BAND and buy TWLO. In my research report I covered the similarities and differences between the two, namely that BAND owns its own infrastructure (much like the larger telecom carriers) whereas TWLO rents theirs. Bandwidth is much more heavily slanted toward voice, which contributes roughly 90% of revenue, versus closer to 40% for Twilio, which is heavier in messaging. Bandwidth also caters to larger clients and uses a direct sales force to target senior executives within them. Twilio focuses on developers and relies on inbound inquiries to drive sales. This is why Bandwidth has less than 2,000 customers, but generates average revenue well over $100,000 from each, while Twilio has around 150,000 customers paying closer to $9,000 a year each, on average. Bandwidth management says it only competes in roughly 20% of deals with TWLO. So, should you follow MS and sell BAND in favor of TWLO? I don’t think so. As I said in my report it’s better just to own both. They do different things and we don’t have to pick sides. If Bandwidth’s business starts to falter, that’s a different story. Even MS’s report said the analyst sees the company doing well in the short term but isn’t sure about the second half of 2020. I say let’s take it as it comes.” HOLD.
Brookfield Infrastructure Partners (BIP), originally recommended by Tom Hutchinson of Cabot Dividend Investor for his High-Yield Tier, is climbing again, heading for its two-week-old high of 49. In his latest update, Tom wrote, “The infrastructure MLP is still reasonably valued because it’s coming off a rare bad year in 2018. It’s selling below most of its 5-year valuations, a period in which the stock averaged a 15.5% average annual return. High dividend stocks with defensive businesses are in vogue right now, as is the infrastructure subsector. It also helps that new assets coming online should continue to boost earnings in the quarters ahead.” HOLD.
Carvana (CVNA), originally recommended by Mike Cintolo in Cabot Growth Investor, continues its steep correction, falling through its 50-day moving average today. In his latest update, Mike wrote, “We think it’s simply follow-on selling in a growth stock that remained near its peak. As we noted when we got in, CVNA can be extremely volatile, and yesterday proved that. It’s possible the growth stock selling we saw last week will continue, and if CVNA falls into the upper 60s, we’ll cut the loss on our position. But at this point, the stock hasn’t done anything wrong, especially considering the environment, so we’re hanging on—and if you don’t own any, we’re OK buying a half-sized position here, albeit with a tight stop in the 68 to 69 area.” BUY.
Citigroup (C), originally recommended by Crista Huff in Cabot Undervalued Stocks Advisor for her Growth & Income Portfolio, has pulled back minimally over the past week and Crista thinks it’s very close to an attractive buy area. In today’s update, she wrote, “On September 16, Reuters reported that Citigroup’s August net charge-off rate was 2.62%, vs. a 2.91% rate in July, indicating an improvement in consumers’ abilities to pay their debts. Citigroup is an undervalued, large-cap growth and income stock. Wall Street expects Citigroup’s EPS to grow 14.3% and 10.9% in 2019 and 2020. The P/E is currently 9.1. The stock is in an uptrend, with short-term price resistance at 72, and again at 77. Accumulate C, especially on pullbacks to 68.” Here you are! BUY.
Coupa Software (COUP), originally recommended by Mike Cintolo in Cabot Growth Investor, got as high as 150 today as the stock tried to rally back to its three-week old high of 156, but the sellers took control, so the stock remains in the box that has constrained it between 130 and 150 for the past two months.
In his update last week, Mike wrote, “The situation hasn’t changed much—cloud software stocks remain mostly in the doldrums (though a few have begun to find short-term support), but COUP is among the most resilient of the bunch (it’s right at its 50-day line, which is a rarity in the sector). Analysts haven’t been jumping off the bandwagon; in fact, three have offered reassuring words over the past week or so, mentioning the big potential of Coupa Pay and the overall momentum in the business. Whether all of this is enough for the stock to hold up, we can’t say—but we’re content to hold on and find out, thinking the downside risk from here (we have a mental stop in the 123 area, near our cost) is small compared to the potential upside given the best-in-class fundamentals.” HOLD.
Enterprise Products Partners (EPD), originally recommended by Tom Hutchinson of Cabot Dividend Investor for his High Yield Tier, continues to make slow progress—which is just fine for a stock yielding 6.1%. In his latest update, Tom wrote, “The energy sector finally got some. It’s the top-performing sector over the past month, up over 11%, but it’s mostly benefitting the commodity price-sensitive companies. EPD is still in the same vicinity it’s been in since March, around the 30 high point of its five-year range. This is a blue-chip energy company that is growing earnings as new projects come on line. The stock price is still 30% below the 2014 high while earnings have grown 11% per year over those five years and should accelerate going forward. Eventually the market will figure it out. Enjoy the 6% yield in the meantime.” BUY.
Grocery Outlet (GO), originally recommended in Cabot Growth Investor my Mike Cintolo, and featured here last week, looks fine, still trending higher from its low of three weeks ago. If you haven’t bought this discount grocer that operates in six states yet, you can buy now. BUY.
Huazhu Group Limited (HTHT), originally recommended in Cabot Global Stocks Explorer, is one of the portfolio’s Heritage Stocks, meaning our profit is so great and the potential so large (it’s China’s largest hotel chain) that I’ve resolved to hold the stock through normal technical sell signals. Over the past two weeks the stock has pulled back normally and now sits surrounded by and supported by its 25, 50, and 200-day moving averages. HOLD.
Luckin Coffee (LK), originally recommended by Carl Delfeld in Cabot Global Stocks Explorer, has great fundamentals—chief among them its rapid growth as it works to undercut Starbucks in the Chinese coffee market. But the stock’s action is less than impressive; in fact, the stock is now below both its 25- and 50-day moving averages. But that’s more a picture of a sideways trend than a down one. If you haven’t bought yet, you can buy here. BUY.
MakeMyTrip (MMYT), originally recommended by Carl Delfeld in Cabot Global Stocks Explorer, is also strong fundamentally, but its stock is lacking the sponsorship needed to create a real uptrend. The stock rallied for a month from its August bottom and then spent a couple of weeks consolidating that gain, but yesterday saw a failed breakout and today sellers pushed the stock lower. It’s not attractive enough to buy, but if you’re on board you can hold. HOLD.
Meritage Homes (MTH), originally recommended by Mike Cintolo in Cabot Top Ten Trader, and featured here two weeks ago, keeps hitting new highs, as investors perceive good times for this homebuilder. If you haven’t bought yet, try to buy on a pullback. Home orders through the first two months of third-quarter 2019 grew 24% from the year before to 1,549 units. BUY.
NextEra Energy (NEE), originally recommended by Tom Hutchinson of Cabot Dividend Investor for his Safe Income Tier, broke out to a new high last Friday on big volume and followed through today! In his update last week, Tom wrote, “Although this conservative utility has returned 30% already this year and averaged a 20% per-year return over the last five years, NEE could still have more room to run. It’s not only a utility but a best-in-class member of the sector that offers both stability and a higher level of growth.” HOLD.
Snap (SNAP), originally recommended by Mike Cintolo in Cabot Top Ten Trader, came very close to breaking out above its month-old high today—and prospects are good that it will do so eventually. In last week’s Cabot Growth Investor, Mike wrote, “One analyst upgraded the stock this week, citing solid user addition and ad forecast trends, while reports are that Snap is in discussions to create a dedicated news section within Snapchat. We’re close to restoring our Buy rating, and if you wanted to nibble we’re not going to argue with you. But officially we’ll stay on Hold a little longer and see if the recent pop can hold/follow-through.” HOLD.
Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, is the portfolio’s second Heritage Stock (big profits and big potential) so while it hasn’t been a market leader for years, the fact that the company is still growing at a good rate and is still far ahead of all its competitors by many measures means that long-term prospects are still very good. Today the stock of Chinese electric car competitor Nio (NIO) cratered after the company reported a big loss and layoffs—and that should have been good for TSLA. But instead TSLA stock sank today because of a lawsuit claiming that the company’s acquisition of SolarCity back in 2016 was a bailout in disguise, designed to protect the investments of the principals who had interests in both companies. Also in the automotive world, the GM strike, which is partially about reduced demand for gasoline-powered cars as electric cars (which require less labor and fewer parts) grow more important, goes on. HOLD.
THE NEXT CABOT STOCK OF THE WEEK WILL BE PUBLISHED October 1, 2019
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