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This Week's Game Plan - Patience Is The Name Of The Microsoft Game

by: Cestrian Capital Research

We lay out our investing plan for the week, with our space and tech coverage universe in mind.  Market risk abounds.

In this environment, if you're looking for a single buy-on-weakness stock, our top pick is Microsoft.

Watch the stock carefully versus the Nasdaq to time your entry well.

DISCLAIMER: This article is not directed at, nor intended to be relied upon by any UK recipients. Any information or analysis in this article is not an offer to sell or buy any securities. Nothing in it is intended to be investment advice and it should not be relied upon to make investment decisions. Cestrian Capital Research Inc or its employees or the author of this article or related persons may have a position in any investments mentioned in this article. Any opinions or probabilities expressed in this report are those of the author as of the article date of publication and are subject to change without notice.

Background - Last Week's Market

Last week was wild. The major indices swung 4-4.5% during the week, from up 1-1.5% Tuesday to down over 3% Thursday, closing the week at around a 1% drop overall.

Many individual stocks experienced a still greater swing. Within our coverage universe, Iridium (IRDM) was hardest hit, being almost 7.5% down midweek, recovering to a 3% drop on the week by Friday's close.

The Plan This Week

This is a quiet week for our individual stocks. Q2 earnings are behind us for most of our stocks, with the exception of Science Applications International Corporation (SAIC) which reports its Q2 for the financial year ending Jan-20 on 5 September. We're at Buy - Long Term Hold on SAIC and recently posted our Q2 earnings preview.

From a macro point of view, we have the Fed committee meeting minutes published Wednesday at 2pm Eastern; weekly jobless claims Thursday; and most important, Fed Chairman Jerome Powell speaking on Friday.

The Fed is embattled right now in our view. It's caught between what it thinks it should be doing from an economic orthodoxy perspective (holding rates most likely), what the Administration thinks it should be doing (dropping rates), and the market's gyrations every time Powell makes an utterance. We think the market is trying a run on the Fed, pushing it hard to see if it will commit to multiple rate drops. If the Fed acquiesces, the market will push harder for even more. If the Fed holds the line - the market is likely to drop - adding political pressure on the Fed. Tough place for Powell to be.

So this is the backdrop. And it means that risk abounds.

The Market Is Caught Between China, the Fed and the 2020 Election

In addition to the Fed matters we cover above, to the extent the Administration has influence, it will want the market to continue to rise towards the 2020 election, and it will use the tools it has at its disposal to do so. Against that, the China narrative is pushing the market down. So in our view the tussle between the Administration's electoral interests, and its handling of the China crisis, will be the primary determinants of the market direction in the next twelve months. Our best guess is a modest market rise in the runup to the 2020 election, but we think it will be a rocky, volatile ride.

What To Do With Our Stocks?

Turning now to our coverage universe. As our regular readers, followers and subscribers know, we take a long-term, 3-5 year view on our stocks. We base our analysis on company fundamentals. This helps us work out whether each company is growing revenues and earnings, and whether its balance sheet position is improving or worsening. We then take a view on the entry and exit valuation multiples - entry being - if you buy the stock today, what multiple of revenue, earnings and cashflows are you paying - and exit being - if you sell the stock 3-5 years from now, what multiple of revenues, earnings and cashflows might be possible and what does that mean for your return on investment.

Right now we're at Buy - Long Term Hold on the following stocks:

  • Aerojet Rocketdyne (AJRD)
  • Iridium (IRDM)
  • ManTech International (MANT)
  • Microsoft (MSFT)
  • Northrop Grumman (NOC)
  • Salesforce (CRM)
  • Science Applications International Corporation (SAIC)

All are a perfectly reasonable Buy at their current prices and if you're thinking of opening a position in these stocks we think that in the current market, respecting market risk and keeping position sizes modest, we stand by our Buys. Speaking for ourselves we hold positions in each of them already and so our filter is - do we want to add, hold or sell.

With that in mind, here's our plan for each of those stocks.

AJRD: The stock is slipping back after its peak at over $50/share following very strong Q2 earnings. We think there are a number of drivers to this stock - mainly the translation of the growing backlog into growing revenue. Over and above that, AJRD's "legacy space" customer base is revving up its activity - NASA is pushing hard for SLS to be ready for instance. AJRD's valuation multiples aren't so challenging (around 2x TTM revenue / 11x TTM EBITDA) and it is in a net cash position. We're adding to AJRD in small bites where we can. We prefer to add below $50. We're hesitant to commit to a large position (meaning, 10% of portfolio value) because the stock has a history of fairly brutal volatility. So we're keeping cash at the ready to buy more readily if the stock does swoon for one reason or another.

IRDM: This stock is wild. And it's wild because of the leverage. We're adding to our holdings - again, step by step, bite-size pieces only. The stock looks like it has a near-term resistance level of around $21/share, but if there's a real market correction, we could imagine this heading down into the teens. So in our view it's best to keep plenty of cash on hand to buy down there if needed. Long term we think it's a good bet. The company operates a kind of monopoly telecom service (L-band satcomms - which is to say hi-rel/low-bit-rate - data and voice comms with global coverage for demanding customers such as the US military). That monopoly will be eroded at some point but that's likely a way off yet. And until that happens it should de-lever nicely which ought to deliver value directly to equityholders. BUT we cannot say often enough - respect the leverage lest it come back to bite you. If you're going to hold this stock you have to settle in for some fairly serious volatility. We think there may be some near-term catalysts coming - refinancing which should release about $200m of restricted cash; and a potential renewal of the key US government contract.

MANT: The stock rose nicely after we went to Buy in May this year. We posted a quick blog note last week on the topic. It's sold off a little with the market - it's a fairly small cap stock ($3.3bn EV) and not well known or covered, so it's not a surprise that a market selloff hits the stock disproportionately. We want to add to our position but we don't see any near-term upward catalysts - at least until we approach Q3 earnings - and we think there may be further short-term weakness ahead if the market swoons for Fed or other reasons - so we plan to wait, although if a particularly opportune moment presents itself we may make a small addition during the week.

MSFT: We're big believers in MSFT's ability to keep outpacing the market. It might be a $1tn company but it's still undervalued in our view. If we had to pick one long-term investment to which we could add on weakness, it would be Microsoft. Its combination of growth, revenue resilience, and undervaluation make it highly appealing.

Let's take a look at how one might add to a MSFT position wisely.

Microsoft is the largest component of the S&P500. It tends not to be short-term volatile. It has something of the flywheel character about the stock - slow to spin up, slow to slow down. When the market sells off hard, and stays down for a little while, MSFT tends to fall off too, presenting periodic strong buy opportunities.

But the stock can deceive you into thinking it is sell-off resistant. It's not. Look at the chart below. It's a little tricky to follow but bear with us whilst we explain.

We've used the NASDAQ as the index comparator, not the S&P500. That's because the NASDAQ is a little more twitchy than the S&P - more volatile - and we're looking for advance indicators of when MSFT might present a dip to buy. The NASDAQ is a better leading indicator in our view.

We've shown two recent market sell-offs; Q4 2018, and Q2 2019. Look what happens. The NASDAQ goes into a decline, making repeated new lows. But MSFT keeps holding onto its recent highs. So every couple of days you could be forgiven for thinking - MSFT is selloff-proof. You might buy in then; you might rotate out of your more volatile stocks into MSFT at those recent highs, seeking protection. But a better move in the selloff periods below would have been to wait for the NASDAQ to recover by 2-3% (showing it's not a 1% bounce) and THEN buy into MSFT. You would have missed the absolute short-term bottom in MSFT but you would have bought into a nice uptrend.

History being no guide to the future, etc, we can't be certain - but we think that MSFT will continue to behave like this; meaning, market selloff, MSFT holds onto its highs but makes new short-term lows; until it finally gives up those highs and falls.

That hasn't happened yet - look at this chart of the last three months. MSFT is still holding on to highs.

So it could play out that the best plan for MSFT this week continues to be - wait.

NOC: We have a longer note coming out on NOC this week. Although the stock is elevated following Q2 numbers and raised guidance, the stock isn't overvalued and there are multiple structural factors in its favor. But we won't spoil our note here. Stay tuned this week for that. We may add a little to our position this week.

CRM: We think CRM is in the doldrums right now. The market dislikes its Tableau (DATA) acquisition as it did its Mulesoft (MULE) acquisition last year. We want to see the stock either clear its $145/share resistance level - in which case we will add on the uptrend - or come closer to its $130/share resistance level - in which case we will add on weakness. We don't plan to add more until the stock finds a direction.

SAIC: SAIC has a January 31 year end and so its Q2 earnings are due 5 September. So we have time before earnings to see how the stock plays out over the week. We would be surprised if Q2 was a bad quarter. If SAIC flatlines this week, we won't add to our position. If it continues its slide and in particular if it gets into the 70s/share, we will add small bite-size portions to our holding.

So - that's our plan for the week for our coverage universe. Want to discuss further with us? You can reach us in comments to this article, Twitter (@CestrianInc), or DM us here on Seeking Alpha.

Cestrian Capital Research, Inc - 19 August 2019.

Disclosure: I am/we are long AJRD, CRM, MANT, MSFT, NOC, SAIC, IRDM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Cestrian Capital Research, Inc is recognized as an analyst by AJRD and SAIC. We receive no compensation for this, nor do we receive any information not already in the public domain.