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Social Media Stocks: Short the Rallies

This article was originally published Friday April 11 on TraderPlanet.

Thursday was a bloodletting for social media stocks.  Facebook (FB), Twitter (TWTR) and LinkedIn (LNKD) were down 5.2%, 2.7% and 3.5%, respectively.  Other “new tech” stocks took a beating as well.  Pandora Media (P) was down a gut-wrenching 10.5%, Tesla Motors (TSLA) was down 5.9% and Netflix (NFLX) was down 5.2%.

SocialMediaNewTech

As I wrote two weeks ago, the momentum names of the past year have all lost momentum.  But after the rout we’ve seen, is it time to go bargain hunting?

No.  And in fact, I would use any “dead cat bounce” as an opportunity to short these names for the more aggressive traders out there.

I’ve made the obvious observation before that, even after the recent declines, social media and new technology stocks are sporting bubble valuations with no economic justification.  Twitter and Tesla have yet to earn a cent in profit yet trade for 36 and 13 times sales, respectively. Telsa’s market cap is roughly half the size of General Motors’ (GM) despite the fact that GM sells more cars in a weekend than Tesla sells in a year.  Facebook trades hands at 96 times earnings and 20 times sales; for LinkedIn the numbers are 762 and 14, respectively.  Netflix seems almost cheap by comparison at 180 and 5, respectively.

At least one could argue that Tesla and Netflix have solid business models in place and it is just a matter of growing their businesses into the rich valuations that the stock market is currently awarding.  But in the  case of the social media stocks—Facebook, Twitter and LinkedIn—their basic models are looking shaky.  As Jeff Middleswart pointed out in this week’s Behind the Numbers: Thursday Thoughts,

[FB, TWTR and LNKD] are three social networks that have already seen their growth stall for desktop computers and moved to smart phones… The race for these networks has been to overcome stalling desktop users by adding more mobile users to show advertisers an ever-larger potential customer base to tap. [Unfortunately] the problems for the networks may be about to worsen. Essentially, smart phones are tough for marketing. We have noted in that some of these companies have boosted rates per ad recently by offering better placement on screens. Our contention was there is only so much real estate on a phone screen so how can this source of growth be duplicated? …[T]he companies need to find something more to do to produce revenues beyond advertising. That is a sizable shift in focus for companies that trading at very sizeable premiums.

I love social media and I use it on a daily basis.  But as a sector its business model is questionable, and the market is pricing in massive rates of growth that I have a hard time believing will ever materialize.

Shorting an expensive stock that is showing momentum is suicide for any trader.  But now that these stocks have lost their aura of invincibility, they are fair game.

Action to take: Short a basket of social media and new technology stocks including the names mentioned in this article.  Use a fairly tight stop loss at 5%-8% and don’t be afraid of taking profits after a big down day.  I expect there to be plenty of opportunities to re-enter the short in the weeks ahead.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Groceries Are a Rotten Business

Supermarket giants Albertsons and Safeway (SWY) made news last week by agreeing to merge, creating a combined company that will fall just shy of Kroger (KR) in terms of store count.Cerberus Capital, the private equity firm that owns Albertsons, has offered to pay $40 per share for Safeway.

But naturally, whenever a large merger like this is announced, it raises questions.

I have two particular questions at the front of my mind: Will there be more industry consolidation to come? And more importantly, who are the winners and losers?

A Brutal Industry

The biggest winners in the Albertsons-Safeway merger are, of course, the Safeway shareholders. Belief that a buyout was imminent was a major factor in Safeway’s share price rising about 20% year-to-date.

Given the size of the remaining players, large consolidation is unlikely, though given the competitive dynamics of the business, it would be welcome.

 

Company

Ticker

# Stores

Revenues

ROA

ROE

Market Cap

P/E TTM

Walmart

WMT

4,005

$470 billion

8.73%

23.62%

$242 billion

15.36

Kroger

KR

2,424

$98 billion

6.31%

31.87%

$22 billion

15.02

Safeway

SWY

1,418

$36 billion

2.55%

5.61%

$8.8 billion

2.86

SuperValue

SVU

2,398

$17 billion

3.12%

N/A

$1.7 billion

N/A

Whole Foods

WFM

360

$13 billion

10.6%

15.0%

$20.2 billion

36.17

Amazon.com

AMZN

N/A

$74 billion

1.2%

3.1%

$169 billion

621.36

 

The mass-market grocery store space has been saturated for years. Kroger currently is the second-largest grocery chain in the United States after Walmart (WMT), though WMT, of course, sells much more than groceries.

Outside of premium or specialty grocers — think Whole Foods (WFM) or Trader Joe’s — growth in grocery sales is essentially limited to population growth, which has averaged less than 1% for the past decade. All jokes about Americans getting fatter aside, we’re really not eating more, and the grocery business is something of a zero-sum game for existing competitors. Again, outside of specialty or premium stores, new grocery store construction is mostly limited to new neighborhood construction.

chart 300x189 Groceries Are a Rotten Business
This is reflected in profitability, measured here by return on assets (I used return on assets over the more commonly used return on equity because it is less sensitive to differences in capital structure, i.e. debt level).

Safeway’s return on assets shot up last year due to one-off asset sales, but over the past two decades the company has struggled to generate returns much better than 5%. The same is true of Kroger.

Walmart, aided by its scale and ruthless efficiency, has been consistently more profitable, though Whole Foods has recently taken the lead.

Safeway’s merger with Albertsons should improve its competitive prospects, as the larger economies of scale and bargaining power with food manufacturers should allow the company to squeeze out slightly higher margins. But it’s worth noting that so far, over time, Kroger has had roughly similar levels of profitability as Safeway. (The spike in Safeway’s RoA was in part due to divesting Canadian stores.)

As with the rest of American retail, there are two models to higher profitability in the grocery business:

  1. Compete on cost
  2. Go upscale and compete on quality

You’re not going to beat Walmart on cost. Some smaller, niche stores — such as Aldi — can be competitive with WMT on price, though they generally lack its brand selection and variety. Kroger can’t beat Walmart on price, and it’s hard to see Albertsons-Safeway being any more effective.

Going upscale is an option, of course. Even WMT offers a limited selection of organic and premium produce, and offering a wider selection might make it less worthwhile for a neighborhood shopper to drive across town to a Whole Foods or Trader Joe’s store. But transformations like that are not particularly easy to pull off.

A more likely scenario is that Albertsons-Safeway finds itself, like Kroger, a lower-margin also-ran that is “stuck in the middle” between low cost and higher quality.

Aisle 5 Is Now Online

Then, of course, there is the elephant in the room: online grocery shopping.

Something sends a chill down the spine of a traditional retailer than hearing the name “Amazon(AMZN).” Amazon has taken a wrecking ball to every market it has entered, essentially putting Borders out of business giving Best Buy (BBY) a thorough beating.

Well, Amazon also has joined the grocery fray as well via its Amazon Food site, which sells packaged foods, and its newer Amazon Fresh, which offers fresh produce delivered to your door in a limited number of markets. AMZN encourages a subscription model whereby shoppers get certain common items — say, a two-liter bottle of Coke — delivered at a regular interval.

Not to be outdone, Walmart has jumped into online groceries as well. In addition to offering free home delivery on orders $50 and up (Amazon offers free delivery on orders $35 and up), WMT has the added bonus of offering free in-store pickup at its massive network of stores. Walmart does not deliver perishables or fresh produce — yet. But you can bet that it’s studying Amazon’s moves closely.

Albertson’s, Safeway and Kroger all also offer some limited form on online shopping or delivery, though it varies by geography.

Online groceries were an unmitigated disaster when the concept was first tried in the late 1990s. Remember HomeGrocer.com and Webvan? You probably don’t, and there is a reason for that. Neither survived the 2000-02 shakeout. It was a business model ahead of its time.

Granted, Americans are a lot more web-savvy than they were 10 years ago and have grown more accustomed to paying for delivery. And AMZN and WMT are established retail empires with massive infrastructure in place, not fledgling startups.

Still, outside of major urban areas with high population density — think New York or San Francisco — or among high-income Americans that are insensitive to price, we’re probably at least five to 10 years away from home grocery delivery being mainstream.

Why? Because groceries, again, are a low-margin business, and delivery operations are expensive to maintain — particularly in cities with sprawling suburbs like Los Angeles, Houston, or Dallas.

There Are Winners … Just Not Traditional Grocers

So, in the meantime, where are the pockets of opportunity in grocery stocks?

As a business, I consider Whole Foods to have the best prospects of the lot and best potential for growth. But WFM is only slightly more profitable than Walmart and sports a frothy P/E ratio that is more than double the industry average. I love Whole Foods as a company. But I can’t get comfortable with the exorbitant price of WFM stock.

I would argue the same for Amazon. Amazon is an amazing company, and Jeff Bezos is a CEO that I respect. But Bezos’ focus on revenue growth at the expense of all else has left the company barely profitable, and it sports the lowest return on assets in the sector. Also, AMZN stock is more than four times as expensive as WMT on a price/sales basis (2.28 vs. 0.51, respectively).

If I’m buying any grocer, it’s going to be Walmart. It has a scale that none of its competitors can match, has the highest profitability of the mass-market grocers, and offers a very reasonable valuation at 15 times trailing earnings and 13 times forward earnings. WMT has also been aggressively shrinking its share count and raising its dividend.

And before you write Walmart off as a retail dinosaur, consider that WMT has a division situated in the center of Silicon Valley — Walmart ECommerce — that is staffed with 1,500 techies whose job is to find ways to fight Amazon on its own turf.

Will Walmart catch up to Amazon in terms of sales growth any time soon? No, not realistically. But they also have a massive international logistical operation in place that Amazon is still trying to build. And frankly, no one on Wall Street expects much from WMT these days, so any surprise in performance is likely to send the shares sharply higher.

As for traditional grocery stores, I would stay out of this space. Realistically, they cannot compete with the likes of Walmart or Amazon, and they lack the scale to make home delivery work. I’m not forecasting a wave of bankruptcies any time soon, but not much in the way of profitability either.

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Booze Stocks: What to Buy, What to Sell

U.S. domestic beer sales are flatter than a day-old pint of Bud Light. There were 2.78 billion cases of beer sold in the United States last year, down from 2.9 billion cases five years ago.

But don’t tell shareholders of Boston Beer (SAM) or Constellation Brands (STZ). SAM, the brewer of Samuel Adams Boston Lager, and STZ, the importer of popular Mexican beers Corona and Modelo, have seen their share prices rise 90% and 54%, respectively, over the past year.

deo-bud-stz-sam-stock

Something doesn’t quite add up here.

True, craft beer sales have held up better that those of the large megabrewers. Boston Beer — if you still can feel good about classifying Sam Adams a “craft brew” given its success in recent years — saw core shipments rise by 25% last year. And in Constellation Brands’ latest quarterly release, beer sales were up 21%.

But investors are definitely paying up for that growth, particularly in the case of Boston Beer. SAM trades at an eye-popping 47 times trailing earnings and 32 times expected forward earnings.

Company Ticker Trailing P/E Forward P/E
Anheuser-Busch InBev BUD 11.8 17.2
Boston Beer SAM 46.5 31.8
Constellation Brands STZ 8.6 21.3
Diageo DEO 18.8 16.9
Heineken HEINY 11.0 16.3
Pernod-Ricard PDRDY 20.3 18.0

The real surprise is not that SAM and STZ have enjoyed such fantastic returns over the past year. Remember, the S&P 500 is up about 21% over the same time period, and SAM and STZ both saw their businesses do very well.

No, the surprise is how poorly the rest of the booze stocks have performed. Diageo (DEO) and Anheuser-Busch InBev (BUD) have traded sideways for the past year, and Heineken (HEINY) and Pernod-Ricard (PDRDY) actually managed to lose money.

Ironically, the factor that makes these four laggards better long-term investments is precisely what has killed them over the past 12 months: exposure to emerging markets. Heineken, for example, gets more than 60% of its sales by volume in emerging markets, and EMs account for more than half of Anheuser-Busch InBev’s sales by volume. Diageo, the leading seller of premium spirits, will get more than half its revenues from emerging markets by next year, and rival Pernon-Ricard is on pace to follow about a year later.

Meanwhile, Boston Beer and Constellation are essentially domestic companies with relatively little exposure to emerging markets (Though they are Mexican brands, Constellation only controls Modelo and Corona distribution within the United States.)

Unless you’ve been living under a rock for the past year, you’re well aware of the turbulence that has been coming out of the developing world. Argentina, South Africa, Turkey and Venezuela have all been having slow-motion currency crises, and Turkey and Venezuela have had violent political protests off and on for the past year. As a result, investors have fled emerging market stocks and punished Western companies with outsized presences in the developing world.

Is this a buying opportunity?

I would argue that it is. Emerging-market equities appear to have hit bottom in early February, and the market appears to be indicating that the worst is behind us. None of the multinational beer or spirits are wildly cheap based on their earnings multiples, but a fair amount of this is due to denominator effects—earnings are somewhat depressed due to emerging market turmoil. I would recommend accumulating shares of BUD, HEINY, DEO and PDRDY on any pullbacks.

And what about SAM and STZ? There is a lot of optimism built into the price of SAM stock, though the company continues to deliver good sales and profit growth. I consider SAM somewhat risky based on its valuation, but I also believe that the American preference for craft brews is a long-term trend that won’t be changing any time soon. I consider SAM stock attractive for aggressive portfolios.

I’m not the biggest fan of Constellation because, as a general rule, I’m not a fan of publicly traded wineries. Beer and spirits have far better branding power and, generally, fatter margins. Of course, STZ is no longer a pure wine stock; its acquisition of the Corona and Modelo brands have turned it into the third biggest beer company in America. But again, the beer market is shrinking, and I expect the euphoria surrounding STZ’s beer acquisitions to dissipate soon.

Of the six stocks considered in this article, STZ is the only one I would rate as a “sell.”

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Russian Stocks: Contrarian Buy?

Crimea’s regional parliament voted unanimously last week to secede from Ukraine and become part of Russia—virtually guaranteeing a prolonged confrontation between Russia and the West.  The current standoff is the biggest escalation between Russia and the West since at least the 1990s Balkans Wars and perhaps since the Cold War.

And yet a funny thing happened: Emerging markets across the board had a spectacular rally on Thursday. They gave  back most of those gains Friday but, as an asset class, emerging markets have been keeping pace with the S&P 500 since early February.

RSX

Has Mr. Market gone mad? Not necessarily. It would appear that the market has weighed the probabilities and decided that the chances of the Ukraine crisis truly escalating are rare.  As Vitaliy Katsenelson recently wrote in Institutional Investor, the West might show its outrage, but its options are limited to “unfriending Russia on Facebook or—worst case, if things really escalate—unfollowing Russia on Twitter.”

Though they have been mostly down for the past three years, emerging market stocks have been quietly rallying for the past month.  You can never know until after the fact whether a move like this is the start of a new bull market or merely the latest in a string of bear market rallies. But given the record outflows in emerging markets, the massive discounts seen relative to developed markets, the general sense of negativity towards the sector, and the fact that emerging market stocks have largely stopped reacting to bad news, I would say that the odds favor buying.

For the contrarians out there, I would recommend picking up shares of the Market Vectors Russia ETF (RSX).  Russia has not participated in the broad-based emerging market rally due in no small part to the fallout from the Ukraine crisis.  But when the crisis passes—and it will—I expect Russian stocks to make up lost ground quickly.

Last month,I commented on how cheap Russian stocks were but also noted that there was a catalyst missing to send the stocks higher. The climax and denouement of the Ukraine crisis should provide that catalyst.

Start with a small initial position and average in over the course of the next several weeks.  I expect returns of 30%-50% over the next 12 months.  Use an initial stop loss near $22.00.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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