The market continued with another solid day on Thursday on the back of better than expected jobless claims, which continued to bolster employment data for the week. Jobless claims came in at 340K versus 355K expectations. Leading into Friday's non-farm payrolls, the market enjoyed the good news, moving slightly higher. The Japanese and English central banks also left key borrowing rates unchanged, which helped the dollar descend on the day. It was a quiet day of news, overall. The market is preparing for the big day Friday with non-farm payrolls and the unemployment rate. The market continues to ignore issues from Italy, cuts from government through sequestration, and high levels of unemployment. Friday, though, if we get a bad jobs report, it could spell the end of this joyous ride for a bit of time. Be careful!
Stocks To Trade:
The first stock we are looking at today is Abbott Labs. ABT continues to be one of our favorite long-term plays in the stock market. The company combines decent growth with good value and a great dividend, which is a trio of success for stocks. In 2013, ABT is expected to see a large revenue decline due to breaking off of AbbVie (ABBV), the pharmaceutical research and development arm of Abbott Labs. Yet, in 2014, the company will once again see 6% growth in sales. We believe that ABT breaking off ABBV is good for the company, and that at the current price ABT has nice upside. First, let's take a look at what the split means.
ABBV splitting off from ABT means that the company does lose some of its growth strength from new pharmaceuticals as ABT focuses on nutritional supplements, medical devices, and generic drugs. In actuality, though, we believe that ABT is actually the more interesting growth play because ABT focuses on developing markets for growth (40% of sales come from emerging markets). Those emerging markets are good markets for generic drugs as the rising population levels and rising levels of economies mean more buyers. Further, the company expects to improve operating margins on nutrition from 13% to 20%. We believe that rising margins and the company's connection to the growth of basic medicine/nutrition in emerging markets is attractive. Further, a lot of the risk of pharmaceutical development has been taken out of ABT.
On top of this, ABT is a great value with a solid yield. The company's shares are currently trading at a 15 future P/E, which is a level that we look at for value, price/sales is just 1.4, which is another sign of good value. The dividend yield is 1.6%, which is not as strong as before the split, but it is still solid because we see a lot of potential for growth of equity value. One interesting aspect of ABT is that many expect that margins will decline as the company loses its large margin pharmaceuticals. Yet, at the same time, the company anticipates growth in margins in devices, nutrition, and diagnostics. And despite 6% growth expected in sales, the company expects to see over 11% growth in earnings in 2014. We believe that the company has massive potential in emerging market growth and with decreased value (due to many still wondering if the split will work) presents a great opportunity for entry.
Trade: ABT, Long
Entry: Break of $35
Another stock we like right now is Wells Fargo. WFC got some great news in after hours that it had passed the first-round of the stress test from the Federal Reserve, which will likely mean that the company can now return more to investors. The company passed the Fed's stress test as it had Tier 1 common equity ratio of 7% or 8.3% in the Fed's stress test. The difference is that the Fed determined it at 7% while WFC determined it to be 8.3%. A common ratio is equity capital compared with risk-backed assets. The minimum level that the Fed required was 5%. WFC outperformed competitors Bank of America (BAC) and JPMorgan (JPM), who came in under 7%. We believe that WFC's very healthy levels could mean a share buyback, increased dividend, or some combination of both is on the way. Next Thursday, the Fed will confirm/deny whether or not requests to raise dividends or return capital to investors is acceptable.
Last year, WFC raised its dividend over 80% when it passed, and while we cannot confirm that the company will do this, we believe its passing the stress test opens up the possibility and removes risk. Even without an increase, WFC already offers a 2.8% yield along with great value. Future P/E sits below 10, which shows great value. WFC is expected to see flat revenue growth over the next two years, but it is expected to continue to see income rising. Without revenue growth, however, we believe that WFC's overall potential is limited.
One area that does interest us, though, that we believe is not currently being priced into the stock is WFC's potential to enter into mortgage servicing rights, which is the buying and selling of collection rights for mortgages. As can be seen by the stress test, WFC has solid capital right now. If interest rates rise, it hurts capital as mortgage service rights go up. Yet, with this recent stress test, it shows WFC in good capital position. WFC has not moved into MSR like other banks because it continues to be one of the "safest" financial institutions in the USA. If the company does step into it, we believe it will create a solid new revenue stream.
There are a lot of positive catalysts for WFC going right now, and we believe the company looks solid after breaking strong resistance at $36. Our best approach is to do a bull put spread on the company that will benefit from solid movement in the stock but allow us to take on shares at lower levels on any sharp declines. We like the Apr20 34/32 bull put spread, offering 7%.
Trade: WFC, Apr20, 34/32 Bull Put Spread
Max Gain: 7%
Finally, we like the looks of Pandora Media. The company reported some very enticing earnings in after hours on Thursday, and we like its potential moving forward. While we question the company's long-term economic moat, we believe that the company has lots of growth potential, good value along with that, and is a strong buyout candidate. In the report, Pandora noted some great developments for the company. The company reported that listener hours were up 42% year/year, revenue was at $125M versus $121M expectations, and beat EPS at -0.04 versus -0.05 expectations. What may have been the most exciting development is that P reported that the company forecasted that it might see a slight profit in 2013. Additionally, the company reported potential revenue at $120-$125M versus $119M expectations. With that news in the back window and shares expected to gap up on Friday, could it continue higher?
We believe the two keys are mobile growth, value, and potential for a buyout. Mobile revenue grew over 110% year/year, which is a great sign that the company is being used on mobile phones. Further, the mobile revenue accounted for 2/3 of total revenue for the quarter. As technology continues to move more and more towards mobile over desktops/laptops, we believe its mobile potential is crucial. Growth looks great for the company, but is there value? Shares are currently trading at decent levels. Price/sales is just north of 5, which is not extremely high for a stock that is expected to see around 55% increase in sales year/year.
Overall, we believe that P is an appealing business, and it's a great potential buyout candidate. One issue that will develop for P is that the company is going to see rising competition from Apple (AAPL) and Google (GOOG). Both companies have showed interest in getting into internet radio. We believe that much like Netflix (NFLX) the company will benefit from being the first and most popular name. Another solid for P that is different than NFLX is that content costs are low.
Pandora is a great buyout candidate because the company is still young and cheap and would offer companies looking for internet radio exposure great access to the market. A company like AAPL or GOOG could take that service, apply their business model to it, and develop it into many other products. Apple phones with Pandora built in or Google able to push its advertisement business into the Pandora business would be very profitable for GOOG. We see it as a great buyout candidate for them or even Dell (DELL) and HP (HPQ) to give them an edge.
We believe that P has a lot of potential to take off on this news and moving forward. We like buying shares on a break of $14.
Trade: P, Long
Entry: Break of $14
Friday, the market will be transfixed on the nonfarm payrolls report. Unemployment data is key to the market. As high as the market is right now, we need a strong report to see more upside. A miss on expectations Friday could bring about the start of some correcting. There are several issues that the market seems to be ignoring...the sequester, issues in Italy, and recent issues rising in China's property market. Expectations are that nonfarm payrolls will come in at 160K along with unemployment rate at 7.9%. Additionally, the Chinese Trade Balance will be key to the market as well. We expect even with a beat in NFP that it could be a sell the news event as a beat is somewhat priced in due to solid ADP Employment Change and the drop in initial jobless claims.
Chart courtesy of finviz.com.