Good morning! Today’s word count is 1,952 words, or a 9-minute read. Let’s get to it:
Market Summary (11:30 am ET): “Investors remain cautiously optimistic that Congress will reach an agreement on narrow fiscal-stimulus measures aimed at parts of the economy,” WSJ writes.
- S&P 500: $3,438.77 (+ 0.54%)
- Nasdaq: $11,419.07 (+0.48%)
- Bitcoin: $10,913.27 (+2.29%)
- Gold: $1,893.80 (+0.16)
- U.S. 10-Year: 0.760%
Justin Oh’s Quick Read
I believe many consumer-oriented retail names are too expensive and rely too much on questions surrounding Covid-19 volumes.
Take Dollar General, for example, which is trading at a ~17 percent premium to where it traded before Covid-19 (see No. 3). Target ($TGT) is a slow growth retail giant trading at 16.5x forward EBITDA compared to 14x historically. For these two stocks, an investor has to accept a 20-30 percent lower cash flow return from these companies than before the pandemic. Their revenue growth trajectory is also unclear, as Covid-19 has spiked shopping volumes at these companies, but what happens when things go back to normal? Or will they ever go back to normal?
If you’re willing to take pandemic volume uncertainty, Albertsons ($ACI) is still my top pick by far, which trades at 4.7x forward EBITDA and an over 10 percent free cash flow yield. This is a significant discount to Kroger ($KG), which trades at 6.2x forward EBITDA and a 5.7% free cash flow yield.
Also, if you’re willing to own a capital-intensive, low-growth, and low-to-medium profit-margin store business at mid-teens EBITDA multiples, why aren’t you buying Facebook ($FB) at 13.9x forward EBITDA and 20 percent expected growth or Oracle ($ORCL) at 10.5x forward EBITDA spitting off 7 percent of its value in free cash flows?
U.S. Explores Curbs on Ant Group, Tencent Payment Systems
First TikTok and Huawei. Now, Ant Group and Tencent? The Trump administration is reportedly “exploring restrictions” on two of China’s biggest tech companies, citing national security concerns.
Why? Both Ant Group and Tencent run successful digital payment platforms. U.S. government officials are growing concerned that Chinese fintech firms will come to dominate the global payment marketplace, which could give China access to the banking and personal data of hundreds of millions.
Severe Escalation: The move only speeds up the deterioration of U.S.-China relations. Trump has levied restrictions against “Chinese success stories” TikTok, Huawei and Tencent’s WeChat since taking office.
Restricting Ant Group, a “crown jewel of the world’s second-largest economy,” is a figurative gut punch, though. Any possible restrictions could disrupt Ant Group’s potentially record-setting IPO, which is shooting for an overall valuation of $250 billion when it dual lists in Shanghai and Hong Kong, possibly by the end of the month.
- How much of an impact U.S. restrictions could make is unclear as Ant’s IPO prospectus says it produces less than 5 percent of its revenue outside of China, a fraction of which is from the U.S.
- But a handful of U.S. companies — Silver Lake, Warburg Pincus and Carlyle Group — are heavily invested in Ant, with at least $500 million at play.
What’s next is unclear. It’s unlikely any restrictions are enacted before the Nov. 3 election, and even if they were, they could be repealed in court.
I’ve been talking about the “China vs. U.S. technology cold war” for the better part of this year, where interoperability between the two platforms is limited, and they both compete on features and innovation. While China’s tech giants are healthy and expanding, U.S. tech giants have to deal with both the U.S. and European governments attacking them for being monopolistic and anti-competitive.
Owning at least some Chinese technology giants (BABA, 700:HK, or Ant Group) should keep an investor exposed to China’s future success, with their valuation discounts hopefully compensating for the additional political risk. What I would be worried about is how a technology blockade might affect companies whose investment theses rely on “China expansion.”
Dollar General to Open Stores Aimed at Wealthier Shoppers
Dollar General plans to roll out a series of brand new stores called Popshelf aimed at wealthier shoppers, WSJ reports.
Retail has struggled in the pandemic. A “record number of stores closed in the first half” of 2020, and 18 retailers filed for bankruptcy. But Dollar General’s sales have skyrocketed at a 19 percent clip.
Now, the company is refocusing its efforts to attract higher-earning shoppers. Dollar General’s core audience is “women from households earning roughly $40,000 a year.” With Popshelf, it’s trying to target households that pull in as much as $125,000 a year.
- Dollar General SVP and Chief Merchandising Officer Emily Taylor: [Even cash-strapped shoppers like the idea of] “treating themselves without the guilt associated with overspending.”
Executives began working on the idea for Popshlef roughly two years ago, which hasn’t changed course even with the pandemic.
- Over the last few years, Dollar General has added more non-consumable, higher-margin products, with sales data showing a market for more-affluent consumers exists.
The plan is to place stores in the suburbs are larget cities. Two will tentatively open in the Nashville area in the next few weeks, with a goal of 30 total by the end of 2021.
- Most items will be priced under $5, and many of the key categories Popshelf plans to sell — home decor, party supplies and beauty products — have seen increased sales during the pandemic.
Living in the Nashville area, I will go check out Popshelf for you when they open. I am skeptical about how successful this concept will be and how much it would affect your Dollar General stock ($DG). High earners aren’t necessarily shopping for items under $5, and when they do, they already have their beloved Target, Michaels, Jo-Ann’s, etc. And even if they open up 30 stores by 2021, it’s peanuts compared to the almost 17,000 Dollar General stores they have already.
I know it’s not the same category, but I’ve also seen a similar failed attempt by another Nashville corporation first-hand. Cracker Barrel ($CBRL), an “economy” restaurant, opened up a high-earning, millennial-focused biscuit chain called Holler & Dash that didn’t work in that upper category and was scrapped. I believe in $DG’s current business momentum and market share gains, but same-store sales growth will have a tough time lapping current volumes after the Covid-19 spike.
At $217 per share, $DG trades at 14.6x forward consensus EBITDA, compared to historically trading at 12.5x EBITDA. I would probably consider buying at around $185 per share, which would be in line with its historical valuation.
Where Trump and Biden Stand on Mortgage Finance
“Donald Trump and Joe Biden have divergent views on the federal government’s role in the $11 trillion mortgage market, with potential consequences for the price of home loans for millions of Americans,” WSJ writes.
Mortgage affordability is at stake. Trump and the Republicans say the government should play a more limited role in backing the mortgage markets, and that any rate increase would be minimal.
- The Biden campaign has the opposite view, arguing Trump’s approach would raise mortgage rates.
Fannie Mae and Freddie Mac: To promote affordable homeownership, the U.S. government created Fannie Mae in 1938 and Freddie Mac in 1970. These companies don’t lend money; they buy up mortgages from lenders and repackage them into securities to sell to investors.
- The arrangement gives lenders more cash to loan out, and investors like betting on low-interest, Treasury-backed securities. Homeowners benefit through 30-year mortgages with fixed-rate interest, a rarity worldwide.
- Obviously, this can go sideways too, which led to the government taking back control of these companies just over a decade ago. See: the 2008 financial crisis and “The Big Short.”
Trump’s Plan: The first step is to put Fannie Mae and Freddie Mac “on a more stable financial footing by returning them to private hands.” Of course, this would come after altering the limits on their business activities and raising the fees they charge lenders.
- And Trump doesn’t need legislation from Congress to do so.
Biden’s Plan: Keep Fannie Mae and Freddie Mac public, for now, and focus on expanding affordable housing and fixed-rate lending.
With interest rates and housing inventory so low, I believe we are seeing significantly elevated home prices. I would try to avoid purchasing a home right now, whether a personal or rental investment, unless you can really find a screaming deal or renovation opportunity.
Furthermore, I would be staying away from single-family rental REITs right now only yielding a 1-2% dividend yield. I believe single-family homes will either remain flat or crunch down once the end to the Covid-19 crisis gets homeowners to list their properties again or once mortgage delinquencies take their toll.
What’s Going On
Too Big: “In a report issued Tuesday, the Democratic-led House Antitrust Subcommittee challenged [Amazon’s] stance that its share of total U.S. retail shopping is the most relevant way to understand its size. The committee asserted repeatedly that Amazon dominates U.S. e-commerce. The company’s market share of U.S. online sales is often said to be about 39%, but the figure is as high as 74% across a range of product categories, according to the report, which also called out practices of other large tech companies.”
He Said, She Said: “The Supreme Court appeared to be divided as it heard oral arguments in the long-running legal battle between Google and Oracle in a copyright case that could alter the course of the tech industry, Reuters reported. Oracle claims that Google owes it as much as $8 billion for its use of Java code when it developed the Android operating system. Google claims that copyright law does not apply because the code it used was necessary to develop interoperable software.”
Raise Check: American cloud communications company MessageBird raised $200 million in Series C funding to give the company a $3 billion valuation, GridAI collected $18.6 million to help machine learning engineers work more efficiently and Singaporean corporate services provider Lanturn pulled in $3 million.
Step Back and Watch: “Facebook said it would suspend indefinitely all political and social-issue advertising in the U.S. after the polls close Nov. 3, in its latest move to combat potential confusion and abuse related to the election.”
Chicken Crisis: “Six current and former chicken-industry executives were indicted on price-fixing charges, expanding the U.S. government’s antitrust prosecutions in the $65 billion poultry industry.”
Spin Zone: “[IBM] announced that it plans to spin off its managed infrastructure services unit, a $19 billion business, to help it focus more squarely on newer opportunities in hybrid cloud applications and artificial intelligence.”
IPO Frenzy: “Lufax, a major Chinese online wealth management company, has filed to go public in the U.S., as the global stock market’s strength drives more startups to seek initial public offerings.”
A Deal is a Deal: “Amazon.com said its Indian partner Future Group violated a contract by entering into a $3.4 billion sale agreement with billionaire Mukesh Ambani’s Reliance Industries Ltd., a spat that could derail the country’s biggest retail deal.”
Rethinking The Plan: “Activist investor Dan Loeb is urging Walt Disney Co. to permanently suspend its dividend and redirect those funds to its streaming service, saying the entertainment giant needs to lean into a massive industry shift.”
Big Money Moves: “Morgan Stanley agreed to purchase Eaton Vance Corp. for about $7 billion in Chief Executive Officer James Gorman’s second major acquisition this year, both of which tilt the investment bank further toward the steadier business of money management.”
Long-Shot Dreams: “A low-profile investment firm is trying to entice the head of TikTok’s parent company with a long-shot alternative bid, as the popular video-sharing app remains caught in a standoff between the U.S. and China.”
Observe and Report: “Observe, a startup with deep ties to cloud database provider Snowflake, has launched with a product that diagnoses problems with cloud-based applications.”