CWS Market Review – November 10, 2017

“The path is smooth that leadeth on to danger.” – William Shakespeare, Venus and Adonis

On Thursday, the stock market looked like it was heading for its worst day since the Tuesday after Labor Day. The thing is, the market really wasn’t doing that poorly yesterday. The reality is that there have been few steep drops since September.

Fact: The S&P hasn’t had a single daily drop of more than 0.5% in the last 47 trading days. Even on Thursday, the market turned around as the day wore on. At one point, the S&P 500 was down over 1% on fears that Congress couldn’t get its act together on tax reform, but sure enough, the index rallied to close down just 0.38%.

There hasn’t been much to upset Wall Street lately. Volatility is practically dead. Last Friday, the Volatility Index dipped below 9, which isn’t just low-it’s really, really low. Nor is there a problem with earnings. With Q3 earnings season winding down, it looks like earnings for the S&P 500 rose by 8.0% last quarter compared with expectations of 5.9%.

In this week’s issue, we’ll look at this week’s earnings report from Continental Building Products. The company met Wall Street’s expectations of 29 cents per share. I’ll also preview the upcoming earnings reports from Ross Stores and JM Smucker. We also got a dividend increase from Snap-on. Plus, we have some Buy List updates. But first, let’s get to our final Buy List earnings report for this cycle.

Continental Building Products Earns 29 Cents per Share

After the close on Thursday, Continental Building Products (CBPX) reported Q3 earnings of 29 cents per share, which matched Wall Street’s estimates. Quarterly net sales rose 1.7% to $116.5 million, while adjusted EPS increased 16%.

The good news is that gross margins improved by 20 basis points. I like to see that; it’s a clue that the business is being managed well. Also, their EBITDA margin rose by 70 basis points to 27.3%. Last quarter, the company bought back more than 940,000 shares of stock. That’s 2.4% of their outstanding shares. Again, that’s nice to see.

Last quarter, Wallboard volumes rose 1.6% to 644 million square feet, and as I mentioned, net sales were up 1.7%. This is important, because you want to make sure that higher sales aren’t solely due to higher prices. It’s good that companies can raise prices, but you also want to see that they’re pushing out more goods. Of course, the ideal is a company whose product is in heavy demand and that can also raise prices. One of the most important characteristics that separates a good company from a great one is pricing power. I can’t stress this enough.

From the earnings report (note the priority of turning sales into cash flow into shareholder wealth):

“We delivered significant operating cash flow on stronger margins helped by higher net sales and improved SG&A performance,” stated Jay Bachmann, Continental’s President and Chief Executive Officer. “Higher raw material costs continued to pressure gross margins into the second half of 2017, which we have increasingly worked to offset through other cost-saving measures. The concentrated focus of our teams on continuous operational improvement and disciplined spending have supported our ability to reduce the impact of unfavorable industry cost dynamics, which allowed us to convert essentially all of our profits to operating cash flow during the quarter. Additionally, we used the cash to repurchase more than 2% of our outstanding shares in the quarter, and we are proud to announce that we have repurchased almost $100 million of our common stock since inception of the share repurchase program in November, 2015.”

The company estimates that the hurricanes pushed about 15 to 17 million square feet of wallboard into future quarters. I’m sure Continental will play a big role in helping communities rebuild.

Continental provides guidance for several metrics except for EPS. For all of 2017, the company has stated the following:

• SG&A is expected to be in the range of $37 – $39 million, down from our prior guidance of $38 – $40 million.
• Cost-of-goods-sold inflation is expected to be at 6% to 7%.
• Total capital expenditures are expected to be in the range of $22 – $27 million, down from our prior guidance of $24 – $31 million.
• Maintenance capital spending is expected to be in the range of $11 – $13 million, narrowed from our prior guidance of $12 – $14 million.
• High-return plant-network capital spending is expected to be in the range of $11 – $14 million, down from our prior guidance of $12 – $17 million.
• Depreciation and amortization is expected to be in the range of $46 – $47 million, up from our prior guidance of $43 – $45 million.
• Effective interest rate on our term loan is expected to be 4.1%, while the cash interest rate is expected to be 3.7%, up from our prior guidance of 3.6%.
• Effective tax rate is expected to be in the range of 33% – 35%.

This was a good quarter for Continental Building. This alleviates some concerns I had about the previous earnings report.

Earnings from Ross Stores and Smucker

With the earnings report from Continental Building Products behind us, that ends the September reporting cycle for our Buy List. The stocks with quarters ending in October are soon due to report. Next week, we’ll get two such earnings reports, from Ross Stores and JM Smucker. Both stocks are due to report on Thursday, November 16.

Like a lot of retailers, Ross Stores (ROST) had a tough 2017. Fortunately, things got a lot brighter for them since August, after the deep-discounter reported very good numbers for its fiscal Q2. Ross made 82 cents per share, which was well above the range of 73 to 76 cents per share they had been expecting. Even as a Ross fan, this is more than I had anticipated. The shares jumped nearly 11% after the earnings report. Ross also got a nice upgrade from JP Morgan.

For Q3, Ross sees earnings ranging between 64 and 67 cents per share. They should be able to beat that. Ross also gave Q4 guidance of 88 to 92 cents per share. If you add those two ranges together, plus the $1.64 per share Ross has already made in the first half of this year, that translates to a full-year range of $3.16 to $3.23 per share. That’s an increase over the previous full-year range of $3.07 to $3.17 per share.

Ross has also been using its cash flow to buy back tons of its own stock. I’m not wild about this practice, but at least Ross actually reduces the share count. Look for a good earnings report from Ross Stores.

I have to confess that I’m a little apprehensive about the upcoming earnings report from JM Smucker (SJM). Three months ago, the Jelly people bombed their fiscal Q1 report. Smucker earned $1.51 per share, 10 cents below Wall Street’s forecast. The share dropped nearly 10%.

The main culprit was SJM’s Folger’s coffee unit. Sales at Folger dropped by 8%, while operating profits plunged 29%. Smucker also lowered its full-year guidance range to $7.75 to $7.95 per share. That was a reduction of 10 cents at both ends.

One thing I can say about SJM is that the valuation isn’t extreme. This week, shares of SJM dipped below $100 for the first time in close to three years. Given their guidance, that means the stock is going for about 13 times this year’s earnings—assuming they don’t lower guidance any further.

Buy List Updates

This week, Snap-on (SNA) raised its quarterly dividend by 15.5%. The quarterly payout will rise from 71 to 82 cents per share. This is the eighth year in a row in which SNA has raised its dividend.

We can’t say that Snap-on is officially a Dividend Aristocrat, because they haven’t raised their dividend every year. But outside a few exceptions, Snap-on has a very good record of clicking that dividend upwards. They’ve paid out quarterly dividends since 1938, and have never decreased them. The new dividend is payable on December 8 to shareholders of record on November 17. Going by Thursday’s close, Snap-on now yields 2.05%.

Two of our Buy List stocks will soon announce earnings guidance for next year. AFLAC (AFL) said they’ll hold a conference call on December 1. Wall Street currently expects the duck stock to make $6.80 per share. Also, Express Scripts (ESRX) is going to announce 2018 financial guidance on December 14. Wall Street currently expects earnings for next year of $7.67 per share.

Before I go, I also want to adjust a few of our Buy Below prices. In August, I raised the Buy Below on HEICO (HEI) to $90 per share. In the last few weeks, the stock has established a base between $91 and $92 per share. This is a good time to bump up the Buy Below on HEICO to $95 per share.

Last week, Intercontinental Exchange (ICE) reported very good earnings. I’ve had some time to take a closer look at the stock-exchange stock, and I like what I see. This week, I’m raising ICE’s Buy Below to $71 per share

That’s all for now. There are a few key economic reports that I’ll be looking out for next week. On Wednesday, we’ll get reports on retail sales and inflation. I’ll be curious if shopping is ramping up ahead of the holiday season. I also expect to see more evidence that inflation is low. Then on Thursday, we’ll get the latest report on industrial production. On Friday, the housing starts report comes out. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy