Sector Rotation

  • 26 Jul
    KSU is breaking out – how far can it go?

    KSU is breaking out – how far can it go?

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    Throughout the year, transportation stocks have mostly lagged the rest of the market. There are multiple reasons that just about anybody could point to – increasing fuel costs, broad-based market uncertainty and volatility related to questions about the economy’s health and rising interest rates, and certainly questions about ongoing trade tensions – but the truth is that investing in this segment this year has translated to some tough sledding. Interestingly enough, however it looks like this is a sector that is starting to move into favor. The Dow Transportation Average is up almost 2% since last Friday, and almost 5% after rebounding off of support from its 200-day moving average line earlier last week. That momentum has given a nice push to a lot of well-known, large transportation names like Union Pacific (UNP) and CSX (CSX). If this momentum holds, those stocks could keep pushing to new all-time highs, but my bet is on the smallest Class 1 railroad in the United States. I think Kansas City Southern (KSU) is a stock you should be paying attention to.

    Trade tensions between the U.S. and its allies are a concern, and the truth is that KSU is exposed to a significant amount of trade war risk, since the railroad focuses on the north/south freight corridor that connects the central  and southern areas of the United States with northern Mexico. NAFTA-related concerns have mostly taken a back seat in the national narrative about trade, as tariffs against China and the European Union have dominated headlines; but the fact is that the same kinds of questions exist for the U.S. with Canada and with Mexico. In KSU’s most recent quarterly report, however, management reported a 19% increase year-over-year in cross-border volumes. 

    Management seems to believe that trend will continue, as their CEO stated on the earnings call that he expects volume growth to continue through 2019. Yesterday President Trump announced an agreement with the European Union to halt further tariffs on each other, and to work on reducing existing tariffs – including those on steel and aluminum – and increase trade on U.S. goods like soybeans and liquified natural gas. That news didn’t include Mexico, or relate directly to questions about NAFTA, of course, but the idea that the U.S. is going back to the negotiating table with the E.U., rather than continuing to escalate trade tensions, seems to be giving the market at large some hope it will do the same for its other trading partners. That is a dynamic that I think will continue to provide some uncertainty and volatility to stocks like KSU for the time being, but more positive trade developments could also add an extra boost of bullish enthusiasm to the stock’s price activity.

    Fundamental and Value Profile

    Kansas City Southern (KCS) is a holding company. The Company has domestic and international rail operations in North America that are focused on the north/south freight corridor connecting commercial and industrial markets in the central United States with industrial cities in Mexico. The Company’s subsidiaries include The Kansas City Southern Railway Company (KCSR) and Kansas City Southern de Mexico, S.A. de C.V. (KCSM). KCSR serves a 10-state region in the midwest and southeast regions of the United States and has the north/south rail route between Kansas City, Missouri and various ports along the Gulf of Mexico in Alabama, Louisiana, Mississippi and Texas. KCSM operates a corridor of the Mexican railroad system. KCSM’s rail lines provide rail access to the United States and Mexico border crossing at Nuevo Laredo, Tamaulipas. KCSM also provides rail access to the Port of Lazaro Cardenas on the Pacific Ocean. KSU’s current market cap is $11.9 billion.

    • Earnings and Sales Growth: Over the last twelve months, earnings  grew almost 16% while revenue growth great about 4%. Growing earnings faster than sales is difficult to do, and generally isn’t sustainable in the long-term; but it is also a positive mark of management’s ability to maximize business operations. The company also operates with healthy operating margins, since Net Income for the past year was 36% of revenues and almost 22% for the last quarter. 
    • Free Cash Flow: KSU’s free cash flow is healthy, at almost $455 million. This is a number that has increased steadily since late 2015, when it was below 0.
    • Debt to Equity: KSU has a debt/equity ratio of .54. Their balance sheet indicates their operating profits are more than sufficient to service their debt.
    • Dividend: KSU pays an annual dividend of $1.44 per share, which translates to a yield of about 1.24% at the stock’s current price.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for KSU is $48.85 and translates to a Price/Book ratio of 2.37 at the stock’s current price. Their historical average Price/Book ratio is 2.98, which to provides a strong basis for continued long-term upside for this stock, since a break above its 52-week high makes it difficult to forecast new resistance levels. A move to par with its historical average would put the stock above $144 per share. That would mark a new all-time high, but given the company’s overall strength and the momentum the sector appears to be drawing right now, it also looks like a reachable long-term target price.

    Technical Profile

    Here’s a look at the stock’s latest technical chart.


    • Current Price Action/Trends and Pivots: It’s pretty easy to see what the broader momentum and interest in the transportation sector has done for KSU over the last several days; the stock bounced off of range support last week, and used that bullish momentum to break above range resistance around $113 this morning. Swing and momentum traders like to see this kind of break, since it can act as a very good signal for a short-term trade.
    • Near-term Keys: If your prefer is to work with a short-term trade, this could be a very good signal to buy the stock or to work with call options. The stock’s all-time high was reached in late 2013 at around $124 per share, and so that price level could provide a good target point to exit a swing or momentum trade. If you’re willing to take a longer-term view, however, buying the stock gives you the opportunity to draw its dividend and hopefully take advantage of a value-based opportunity that offers nearly 25% upside potential. Risks to either kind of a trade – short or long-term – are related primarily to lingering trade questions. It isn’t a given that yesterday’s positive news with the E.U. will carry over to Mexico or NAFTA concerns, and that means that you have to be willing to accept some price volatility if you decide to take a position in this stock. Also, if the stock starts to lose bullish momentum and drop back down, watch the $104 price level. A drop below that price would mark an important break below range support and could force the stock into an extended downward trend.

  • 10 Jul
    PFG could be a winner if Financial stocks come back into favor

    PFG could be a winner if Financial stocks come back into favor

    Since the beginning of the year, the Financial sector has lagged the rest of the market; as measured by the SPDR Financial Select Sector Fund (XLF), as of this writing it is down about 10% from its late January highs, and while the broad market appears to be recovering some bullish momentum this week, financial stocks remain mostly lower, constrained by the downward trend they’ve been following for the last six months. While interest rates have been rising for the last year or so, those gradual increases have kept rates near historically low levels, a fact that puts pressure on a variety of asset management offerings from savings accounts to certificates of deposit, bonds, and interest-bearing insurance products like annuities. I believe that fact has played a role in the sector’s underperformance. Insurance companies have also suffered not only from narrow margins resulting from low interest rates, but also from tepid revenues; that is a trend that could change, but is mostly expected to do so gradually.

    The best opportunities in the Financial sector for investors, I think come from companies that can offer a balanced mix of products between asset management (including investment, savings and retirement) services and insurance services. Principal Financial Group (PFG) is a good example of one of those kinds of companies. The other fact is that a lot of stocks, like PFG in the Insurance industry have really been beaten down over the last six months, far more than the -10% I referred to at the beginning of this post. PFG, for example is down about 38% from its late January high, and that is a level that I think is starting to offer a pretty nice value proposition. Let’s take a more detailed look.

    Fundamental and Value Profile

    Principal Financial Group, Inc. is an investment management company. The Company offers a range of financial products and services, including retirement, asset management and insurance. Its segments include Retirement and Income Solutions; Principal Global Investors, Principal International; U.S. Insurance Solutions, and Corporate. The Company offers a portfolio of products and services for retirement savings and retirement income. The Company’s Principal Global Investors segment manages assets for investors around the world. The Company offers pension accumulation products and services, mutual funds, asset management, income annuities and life insurance accumulation products. The Company’s U.S. Insurance Solutions segment provides group and individual insurance solutions. It focuses on small and medium-sized businesses, providing a range of retirement and employee benefit solutions, and individual insurance solutions to meet the needs of the business owners and their employees. PFG has a current market cap of $15.7 billion.

    • Earnings and Sales Growth: Over the last twelve months, earnings increased about 10%, while sales decreased almost 6%. Growing earnings faster than sales is difficult to do, and generally isn’t sustainable in the long-term; however it is also a good indication of a management’s ability to maximize their business operations. The company’s Net Income versus Revenue was almost 14% in the last quarter, which indicates their margins are pretty healthy.
    • Free Cash Flow: PFG’s Free Cash Flow is strong, at about $4.2 billion. This number has improved from a little under $3.5 billion a year ago.
    • Debt to Equity: PFG has a debt/equity ratio of .26, which is conservative. The company has more than $4.9 billion in cash and liquid assets, which means they they have plenty of liquidity, against only about $3.2 billion in total long-term debt. Cash and liquid assets have improved over the past year from about $3.3 billion.
    • Dividend: PFG pays an annual dividend of $2.08 per share, which at its current price translates to a dividend yield of about 3.8%.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for PFG is $42.79 per share. At the stock’s current price, that translates to a Price/Book Ratio of 1.27. The average for the Insurance industry is 1.2, while the historical average for PFG is 1.54. That might not sound like much of a discount, but it actually indicates the stock is a little more than 17% below the $66 level that a rally to par with its historical average would provide. That’s pretty attractive and offers a nice opportunity from a value-oriented perspective if the Financial sector comes back into favor as I’ve seen some analysts suggest should happen soon. If the stock’s downward trend continues, that proposition is only likely to improve.

    Technical Profile

    Here’s a look at the stock’s latest technical chart.

    • Current Price Action/Trends and Pivots: The red diagonal line on the chart highlights the stock’s downward trend since January, and also provides the range needed to calculate the Fibonacci retracement lines shown on the right side of the chart. The stock’s gradual, but consistent stair-step pattern since February is a good indication of the downward trend’s strength. It’s also pretty easy to the stock’s recent bullish strength as it has rebounded from a trend low at around $52 per share to its current price level. The downward trend will remain in place until and only if the stock can break the $61 level marked by the 38.2% retracement line. A push above that point would likely mark and important reversal point. If the stock breaks below its current support around $52, its next most likely support level would be around $49; continued bearish momentum beyond that point could push the stock as low as $45.
    • Near-term Keys: If the stock’s current bullish momentum holds, and the stock can break above immediate resistance around $56, the stock should have little trouble rallying near to $61 per share; that could be a decent opportunity for a bullish short-term trade by buying the stock outright or using call options. A drop below $52 could act as a good signal for a bearish trade using put options or by shorting the stock.

  • 06 Jun
    PH is a very interesting value play

    PH is a very interesting value play

    Finding good investment opportunities can be a pretty hard thing to do, no matter how much knowledge or experience you have in the market. Part of the problem, I think comes from the nature of the (social) media-driven, instant-information society we live in today. If you pay attention to media news outlets for market information, you’ll usually find that a lot of what gets talked about doesn’t change a whole lot from one day to the next. Politics, monetary policy and interest rates are three primary themes from which the talking heads never really seem to move very far afield.

    One of the methods that I have learned is useful as a tool to stay abreast of current market events and to identify pockets of opportunity is called sector analysis. That might sound pretty complicated, but it really just means taking time to pay attention to the different industries that make up our economy. As business flows back and forth from one economic segment to another, you can begin to see specific industries rise into and fall out of favor in the stock market. That ebb and flow creates opportunities within the broader scope of overall market movement to pick industries, and therefore stocks that might be trading at discounted levels but that have a reasonable basis to be trading higher.

    The last day or so has given me an opportunity to go through my sector analysis, and I wasn’t really all that surprised to see a few sectors, like Consumer Staples, Real Estate, Financials and Industrials lagging the market. It’s true that since the broad market hit a new all-time high in late January, most sectors are down, or only marginally higher for the year. However, these three sectors have stood out from the crowd. The reasons for that are interesting, and can provide some good insight about where the greatest risks, and best opportunities in these areas are.

    The Real Estate and Financial sectors are both being weighed down by the prospect of higher interest rates. While the Fed has generally maintained the posture and attitude towards rates that it has been telegraphing to the market for some time now, there is still speculation that the economy could start heating up more than expected and force the Fed to accelerate the timing and size of rate increases moving forward. I also believe that Real Estate, which has generally seen big gains in property values over the last year nationwide, is starting to reflect some investor uncertainty. At what point does the strength in the economy translate to an overbuilt housing market that will force property values to drop? At what point does the surge in property values reach a tipping point, where average Americans looking to buy a home simply can’t afford it? To what extent will higher interest rates translate to higher mortgage costs that frustrate and stymie home buyers? I think Real Estate right now is acting as an early indicator of much broader economic uncertainty and concerns that have yet to be fully realized or refuted.

    Consumer Staples companies include well-known and long-established names like General Mills (GIS), Kraft-Heinz (KHC), and Campbell Soup (CPB). This is a sector that a lot of analysts, myself included, like to think of as a defensive segment of the market; it generally performs well when the market is showing signs of strength, and is usually less sensitive in nature than other sectors, whose cyclic nature leaves them vulnerable to broader economic weakness. If there are signs of economic uncertainty starting to show, defensive stocks like those in this industry should hold up pretty well. That hasn’t been the case for the last few months, as most of names you and I think of immediately when we think about things grocery shopping have been under pressure by shifting consumer trends away from processed and packaged foods to generally healthier, more organic alternatives. This is a trend that I’m not sure is done playing itself out, despite the fact that many of the companies in this sector have terrific balance sheets and overall fundamental strength.

    Industrials have been showing some very attractive earnings growth, fueled in part by the Tax Reform Act from December of last year, but for the last couple of months have been under pressure by the looming threat of a trade war that is starting to shows signs of increased costs on a lot of basic materials besides the steel and aluminum imports that recently imposed tariffs on Mexico, Canada and the European Union targeted. Trade tensions with these countries and with China are still playing themselves out, and so making a play in this space could be risky. I think it’s useful to remember that tariffs on imports, while deemed by market analysts and political wags as bad, misguided policy, have also been applauded by a lot of American companies as necessary steps to assure a level playing field on a global scale. I think the opportunities in this sector lie in targeting industries that tariffs are designed to protect, and among those are companies that work in aerospace and defense. PH is a great example of that, with a very solid fundamental profile, and a depressed market price that offers a nice opportunity if you’re willing to take a long-term view.

    Fundamental and Value Profile

    Parker-Hannifin Corporation (PH) is a manufacturer of motion and control technologies and systems, providing precision engineered solutions for a range of mobile, industrial and aerospace markets. The Company operates through segments: Diversified Industrial and Aerospace Systems. The Diversified Industrial Segment is an aggregation of several business units, which manufacture motion-control and fluid power system components for builders and users of various types of manufacturing, packaging, processing, transportation, agricultural, construction, and military vehicles and equipment. The Diversified Industrial Segment consists of Automation Group, Engineered Materials Group, Filtration Group, Fluid Connectors Group, Hydraulics Group and Instrumentation Group. The Aerospace Systems Segment produces hydraulic, fuel, pneumatic and electro-mechanical systems and components, which are utilized on domestic commercial, military and general aviation aircrafts. PH has a current market cap of $23 billion.

    • Earnings and Sales Growth: Over the last twelve months, earnings increased by more than 30, while sales grew a little over 20%. It’s hard for a company to grow earnings faster than sales, and generally not sustainable over time. Initially, however it is a good sign that management is doing a good job of maximizing their business operations.
    • Free Cash Flow: Free Cash Flow has shown strong improvement dating back to the fourth quarter of 2015, when the company reversed a two-year trend of negative Free Cash Flow growth. As of their last earnings report, PH’s Free Cash Flow was more than $1.2 billion.
    • Debt to Equity: the company’s debt to equity ratio is .82, a number that is generally manageable. Their debt has also declined by a little more than 10% over the past year.
    • Dividend: PH pays an annual dividend of $3.04 per share, which translates to an annual yield of 1.76% at the stock’s current price.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods uses the stock’s Book Value, which for PH is $44.20 per share. At the stock’s current price, that translates to a Price/Book Ratio of 3.9. I usually like to see this ratio closer to 1, or even better, below that level, but higher ratios in certain industries aren’t uncommon. The Machinery industry’s average is 5.13, putting PH quite a bit below its counterparts. The stock’s historical Price/Book Ratio is 3.2, which is below its current level and could be a sign the stock is fairly valued right now. The stock would have to move about 24% higher to reach par with its industry average, however, which translates to a long-term target price above $210 per share.

    Technical Profile

    Here’s a look at the stock’s latest technical chart.

    • Current Price Action: Over the last week or so, the stock has been dropping from a pivot high at around $184 per share (which I’ve marked B on the chart). The stock does appear to be showing some signs of stabilization over the last few days between $170 and its current price, which I’ve marked with a C on the chart.
    • Trends: I’ve highlighted the stock’s intermediate-term downward trend, which dates back to its high near $213 in mid-January with the red diagonal line. The stock’s recent decline has been following that line, meaning that the trend is acting as resistance for the stock’s price right now. The dotted green line on the chart traces the intermediate trend’s low point at about $161 along with the stock’s recent stabilization around $170 per share. If the stock’s current support holds, the difference between the short-term upward trend line and the intermediate-term downward trend line will continue to decrease. You think of that like the tightening compression of a coiled spring; the longer that lasts, the more likely there will be a significant move, or release of tension out of that range. If it breaks higher, the stock should see little near-term resistance until it reaches about $184 per share. In the longer-term, and given the stock’s underlying fundamental strength, I think there is a good basis to suggest the stock could revisit the highs it approached at the beginning of the year.
    • Near-term Keys: Watch the stock’s movement carefully over the next few days. A break above $175 would likely mark a reversal the downward trend and could mark a good bullish trade, either by buying the stock or working with call options. On the other hand, a break below $170 could offer an attractive bearish trade, either by shorting the stock or using put options.