Focus On Sales Growth

2/20/2017


The S&P 500 Index is digging its way out of a so-called earnings recession, though growth remains sluggish relative to historical norms.

Recall, earnings per share for the S&P 500 Index contracted from year-earlier levels in four straight quarters, a period that stretched from the third quarter of 2015 to the second quarter of 2016. Since then, the index grew per-share profits 4% in the third quarter of 2016 and is on pace for 8% growth in the fourth quarter.

Encouragingly, analyst estimates for 2017 continue to hold up pretty well, with the consensus targeting 11% profit growth, compared to the 12.5% growth projected on Jan. 1. However, corporate profit margins are already at elevated levels and may be unsustainable amid rising wages and commodity prices. Some of those rising costs may be passed on to customers, but many companies will also need to rely on higher revenue to stoke future profit growth.

Unfortunately, sales continue to advance at an unusually slow pace. S&P 500 companies are averaging 12-month sales growth of just 4%, below their average of 7% since 1994. In just 18% of rolling 12-month periods since 1994 have companies averaged slower growth. Also, more S&P 500 companies have reported lower 12-month sales (185) than growth above 5% (178).

Our Focus List aims to identify stocks with solid growth prospects at reasonable valuations. As we show in the table below, all members of the Focus List are projected to grow sales in fiscal 2017.

The three smaller tables below show standout Focus List stocks:

• Delivering especially strong sales growth in a soft environment.

TOP REVENUE GROWERS
Company (Price; Ticker)
1-Quarter
Growth
(%)
1-Year
Growth
(%)
3-Year
Annualized
Growth
(%)
Alphabet ($837; GOOGL)
22
20
18
FedEx ($195; FDX)
20
14
7
Lam Research ($116; LRCX)
32
8
17
VMware ($91; VMW)
9
7
11
S&P 500 Index average
5
4
4

• Expanding profit margins, which should help preserve earnings growth if sales growth stalls.

TOP MARGIN EXPANDERS
-- Gross Profit Margin --
Operating Profit Margin
Company (Price; Ticker)
Number
Of Quarters
Up, Past
10 Quarters
Change,
Last Quarter
(%)
Number
Of Quarters
Up, Past
10 Quarters
Change,
Last Quarter
(%)
CDW ($59; CDW)
8
0.2
7
0.4
Lear ($144; LEA)
10
0.5
9
(0.2)
Mohawk Industries ($223; MHK)
10
1.1
10
1.3
Owens Corning ($57; OC)
7
1.6
8
0.6
S&P 500 Index average
5
(0.2)
5
0.3

• Enjoying improving prospects that might not be priced into their shares.

TOP GROWTH FORECASTS
----------------- 2017 EPS Estimates -----------------
Company (Price; Ticker)
Estimated
Growth
(%)
Estimated,
Current
Year
($)
Estimated,
30 Days
Ago
($)
30-Day
Change In
Estimate
(%)
Citizens Financial ($38; CFG)
18
2.28
2.22
2
Lam Research ($116; LRCX)
45
9.26
8.17
13
Lear ($144; LEA)
11
15.62
14.56
7
Zions Bancorp ($45; ZION)
22
2.45
2.41
2
S&P 500 Index average
7
0

Four of our favorite stocks are reviewed below.

Recent developments have strengthened the bullish case for Citizens Financial Group ($38; CFG). The Federal Reserve has hinted about accelerating the pace of interest-rate hikes this year, positioning the bank to keep expanding its net interest margin, up in each of the past four quarters. The new White House administration is also calling for lighter regulations on regional banks. Looser restrictions would likely mean lower capital requirements, allowing banks to increase loan growth and boost dividends and share repurchases.

Over the past 90 days, analyst profit estimates for Citizens have steadily risen for the March quarter, full-year 2017, and 2018. Amid the optimism, the shares have returned 25% including dividends over the past three months, pushing the trailing P/E ratio up to 20, versus the five-year average of 16. But compared to the median S&P 1500 regional bank, Citizens' stock trades at a 4% discount based on trailing earnings and a 9% discount based on year-ahead earnings. Citizens is a Focus List Buy and a Long-Term Buy.


FedEx ($195; FDX) shares have delivered a total return of 49% over the past 12 months. But the shipping giant's strong operating momentum makes its shares look attractively valued at 17 times trailing earnings, more than 20% below both their five-year average and the median S&P 1500 air-freight stock.

FedEx is one of just 10% of S&P 500 companies to deliver at least 20% sales growth in the latest quarter. Recent results have benefited from the improving global economy, proliferation of online shopping, and the $4.8 billion acquisition of TNT Express, completed in May.

The company's operating profit margins have contracted in the past few quarters, partly due to TNT Express. But management says profit margins should expand over the next three years, citing operating efficiencies in Europe. Analysts expect sales growth of 19% in both the February and May quarters. February-quarter earnings per share are projected to rise just 4% before jumping 11% in the May quarter. FedEx is a Focus List Buy and a Long-Term Buy.


An improving construction market, combined with heavy internal investment, translates to strong operating momentum for Mohawk Industries ($223; MHK), the largest player in the U.S. flooring market. December-quarter earnings per share jumped 16% to $3.26 excluding special items, exceeding the consensus by $0.04. Sales rose 9% to $2.18 billion, marking the sixth straight quarter of growth. Cash from operations surged 35%. For the year, Mohawk delivered double-digit growth for per-share profits (up 24%), revenue (up 11%), and operating cash flow (up 46%).

Although free cash flow surged 61% to $672 million last year, management has no plans to hoard excess cash on its balance sheet. Mohawk expects capital expenditures to exceed 2016 levels, which themselves rose by one-third to a record $672 million. Investments to boost capacity, broaden its product portfolio, and enter new markets should support sales, projected to climb roughly 5% in 2017 excluding acquisitions and currency fluctuations. Mohawk says operating profit margin should expand this year, marking the sixth consecutive year of greater profitability. Management sees per-share profits climbing 11% to 15% in the March quarter; the consensus had projected 14% growth at the time of the announcement. Shares rallied on the quarterly report. Mohawk is a Focus List Buy and a Long-Term Buy.


VMware ($91; VMW) CEO Patrick Gelsinger called the December quarter one of the company's most balanced three-month periods in years, based on product and geographical performance. The company completed a record number of large deals, while licensing revenue climbed 8%, its strongest growth in eight quarters. VMware's fundamentals were equally balanced in 2016, with per-share profits up 8%, sales up 7%, operating cash flow up 25%, and free cash flow up 42% to $2.23 billion.

An overhanging risk to VMware's portfolio of data-center software is that customers will gradually migrate to the public cloud, offered by the likes of Alphabet ($837; GOOGL), Amazon.com ($843; AMZN), IBM ($182; IBM) and Microsoft ($65; MSFT). With the public cloud, clients pay for a slice of a network  shared with other companies — akin to a tenant renting an office, rather than owning the building.

VMware took steps to sidestep this risk by striking a partnership with Amazon in October. Customers can move part of their operations to Amazon's public cloud while still using VMware's services. VMware has a similar arrangement with IBM.

Recent momentum should carry over into 2017. Management targets 11% higher per-share profits on revenue growth of 7%. Operating cash flow is projected to climb 11%. Shares trade at 19 times estimated 2017 profits, a 9% discount to the S&P 1500 technology sector median. VMware is a Focus List Buy and a Long-Term Buy.

FOCUS LIST
Since Added
----- To List -----
Sales
--- Change ---
Fiscal 2017
Est. Growth
---- P/E Ratio ----
------- Quadrix Scores -------
Company (Price; Ticker)
Date
Added To
Focus List
Initial
Price
($)
Price
Change
(%)
S&P
500
Change
(%)
1-Qtr.
Chg.
(%)
1-Year
Chg.
(%)
EPS
(%)
Sales
(%)
Trailing
Forward
Momen-
tum
Value
Overall
Alphabet
($837; GOOGL)
8/11/16
808
4
7
22
20
21
18
24
20
89
52
89
CBS ($65; CBS)
12/22/16
65
(1)
4
(2)
4
24
1
17
16
55
78
81
CDW ($59; CDW)
8/11/16
46
30
7
2
8
12
5
17
15
91
69
97
Centene
($71; CNC) NEW
86
78
6
15
17
15
93
95
97
Citizens Financial
($38; CFG)
12/22/16
36
7
4
NA
NA
18
6
20
17
96
78
99
FedEx ($195; FDX)
11/17/16
185
5
7
20
14
11
19
17
16
59
73
75
LabCorp Of America
($136; LH)
7/7/16
132
3
12
4
21
11
5
16
16
35
83
67
Lam Research
($116; LRCX)
8/11/16
89
31
7
32
8
46
33
17
13
94
73
99
Lear ($144; LEA)
8/1/13
69
107
38
(2)
2
12
5
10
9
84
97
100
Mohawk Industries
($223; MHK)
6/23/16
198
13
11
9
11
6
5
18
17
71
73
87
Owens Corning
($57; OC)
3/10/16
46
26
18
7
6
6
2
16
15
40
91
83
Southwest Airlines
($57; LUV)
5/19/16
42
36
15
2
4
4
5
15
15
69
88
99
VMware ($91; VMW)
2/2/17
88
3
3
9
7
11
7
18
19
70
61
92
Zions Bancorp
($45; ZION)
10/6/16
32
43
9
5
12
22
8
22
18
94
70
96
Note: Quadrix scores are percentile ranks, with 100 the best.     NEW New to list this week.     NA Not available.  

 


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