Day Hagan Smart Value Strategy Update December 3, 2024
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Summary
The DH Smart Value Portfolio continues to invest in companies producing excess returns through positive economic profitability, supported by solid balance sheets (quality), significant cash generation (profitability), and trading with considerable margins of safety (valuation). We believe these factors will continue to provide rational opportunities for the foreseeable future. Using our consistent and differentiated investment approach, the DH Smart Value Portfolio is focused on outperformance, seeking higher total returns with lower volatility.
Strategy Update
Equity markets around the world spiked higher in November, with the S&P 500 and Nasdaq increasing 5.9% and 6.2%, respectively. Global equities (MSCI ACWI index) increased by 4.9%, while fixed income (U.S. Treasuries) improved by approximately 1.03%. Small caps (using the Russell 2000 as a proxy) increased by 11.0% as economic data generally met or exceeded expectations. The month was solid as equities rebounded from the lull in October, with investors recalibrating their outlook following the U.S. elections.
The U.S. dollar index fell below 106 last week, marking its first decline in nine weeks. This pullback followed the nomination of Scott Bessent as U.S. Treasury Secretary, which eased market concerns about potential policy shifts under the incoming Trump administration. The decline accelerated after U.S. PCE inflation data met expectations, indicating little change in the Federal Reserve’s approach to interest rate cuts. Markets are now pricing in a 66.5% probability of a 25-basis point rate cut in December, up from 55.9% the previous week. Despite this week’s drop, the dollar index is still on track for a 2% rise in November. Trump’s election victory spurred expectations of fiscal expansion and inflationary policies propping up growth. In manufacturing, the S&P Global Flash U.S. Manufacturing PMI rose to 48.8 in November 2024 from 48.5 in October, indicating ongoing deterioration in the goods-producing sector but at a moderated pace. Conversely, the S&P Global US Services PMI surged to 57 from 55, surpassing expectations and reflecting significant growth in the services sector. November’s equity gains reflect optimism that a second Trump administration will implement a more business-friendly strategy, potentially adopting a more moderate trade tariff stance. Our models’ indicators show that manufacturing strength and valuations are negative, but technical indicators, including momentum, mean reversion, and breadth, are bullish, with ETF inflows, sentiment, and business conditions also supportive.
Several of our portfolio holdings released quarterly earnings reports during November. The net results were positive overall. However, they weren’t perfect, with Target being a disappointment and our energy holdings evidencing the ongoing decline in energy prices. The following are key points from each company’s earnings call that was reported in November.
Zoom (ZM): Beat earnings and revenue expectations. At Zoomtopia, Zoom unveiled its AI Companion 2.0, garnering positive reactions for features such as meeting summaries, queries, and smart composition tools. The company is also broadening its AI capabilities by introducing customizable solutions and industry-specific applications, particularly targeting healthcare and education sectors for monetization. Recently, Zoom showcased its enterprise strengths by securing a substantial 20,000-seat contact center agreement with the Spanish Revenue Service. In Q3, Zoom reported a 4% year-over-year increase in revenue, with enterprise revenue rising 6%, and highlighted strong customer metrics, including 3,995 clients generating over $100,000 in annual revenue—a 7.1% increase from the previous year. The company’s GAAP net income for Q3 reached $207.1 million, translating to $0.66 per share. To bolster financial performance, Zoom raised its full-year revenue and profitability guidance while also authorizing a $1.2 billion share repurchase program, adding to the $2 billion total available for buybacks. With a resilient enterprise customer base and a robust net dollar expansion rate of 98%, Zoom is well-positioned for continued growth and success in the marketplace.
Deere (DE): Beat earnings and revenue expectations. In 2024, Deere showcased remarkable resilience despite facing significant industry challenges, achieving margins above 18% along with record investments in its operations. The company effectively managed its resources amid declining demand, successfully reducing field inventory and controlling costs. However, Deere anticipates a continued contraction in agricultural markets globally, particularly in the U.S. and Canada, with projections of around a 30% decline in large ag equipment sales in 2025. Deere implemented targeted dealer programs and financing offers to address high levels of used equipment. The company aims to achieve higher margins in 2025 at lower sales levels, thanks to structural improvements and ongoing investments in innovation. With a solid manufacturing footprint in the U.S. and a skilled workforce, Deere is prepared to navigate potential policy shifts. Financially, net income fell to $1.245 billion in Q4 2024 from $2.369 billion the previous year, with full-year income at $7.1 billion compared to $10.166 billion in 2023. Despite these challenges, Deere remains committed to investing in future growth and enhancing customer productivity while facing various risk factors that could impact its operations.
Target (TGT): Missed earnings and revenue expectations. Target declined sharply following its earnings announcement. While we still have a profit, we were disappointed that investors seemingly overreacted to the news. In Q3, Target experienced a traffic increase of 2.4% with over 10 million additional transactions; however, this growth was tempered by a decline in average ticket size, largely due to weaknesses in discretionary spending. The performance varied across categories, with beauty, food & beverage, and essentials showing strength, while apparel, home, and hardlines continued to struggle. The company faced operational hurdles, including adverse weather events and supply chain disruptions, which led to increased costs. As a result, earnings fell short of expectations. Looking ahead to Q4, Target is adopting a cautious stance, anticipating flat comparable sales and earnings per share (EPS) in the range of $1.85 to $2.45. Despite these short-term challenges, Target remains optimistic about its long-term strategy, emphasizing its unique merchandising and fulfillment capabilities. In Q3, comparable sales rose 0.3%, supported by robust digital performance, which saw a 10.8% increase. Gross margin was slightly down but has shown improvement year-to-date. Lastly, the trailing 12-month return on invested capital (ROIC) improved to 15.9%, reflecting better operating income against higher average invested capital.Top of Form
Lowes (LOW): Beat earnings and revenue expectations. Lowe’s reported Q3 2024 sales of $20.2 billion, experiencing a slight 1.1% decline in comparable sales, which was better than anticipated. The company faced challenges due to a tough macroeconomic climate marked by high inflation and interest rates, yet there remains optimism about long-term demand for home improvement. Lowe’s has actively supported disaster relief efforts related to Hurricanes Helene and Milton, pledging $12 million in assistance. The firm saw continued growth in pro and online sales, alongside strength in outdoor and seasonal product categories, highlighting its MyLowe’s loyalty program. CFO Brandon Sink detailed the financial results, which included challenges from the hurricanes and an updated full-year outlook. Earnings per share (EPS) were reported at $2.99, with adjusted EPS at $2.89. For the full year, total sales are projected to be between $83.0 billion and $83.5 billion, with an adjusted diluted EPS of $11.80 to $11.90. Lowe’s also repurchased 2.9 million shares for $758 million and distributed $654 million in dividends while recognizing a $54 million pre-tax gain from the 2022 sale of its Canadian retail business, enhancing EPS by $0.10.
Amdocs (DOX): Beat earnings and revenue expectations. Amdocs had a strong performance in Fiscal Year 2024, achieving record revenue and improved profitability, with cloud services now comprising 25% of total revenue. Looking ahead to Fiscal Year 2025, the company anticipates revenue growth between 1-4.5% on a pro forma, constant currency basis, along with another year of double-digit growth in cloud services. Amdocs aims to enhance its non-GAAP operating margins to 21.1-21.7%, up from 18.4%, by focusing on operational excellence and eliminating low-margin, non-core activities. Additionally, the company expects a non-GAAP diluted EPS growth of 6.5-10.5%, maintaining its commitment to delivering double-digit total shareholder returns. Amdocs is strategically concentrating on high-margin areas such as cloud, monetization platforms, and generative AI, leveraging its advancements in generative AI and strengthening partnerships with customers like Etisalat and T-Mobile to maintain its leadership position in the market.
Home Depot (HD): Beat earnings and revenue expectations. In Q3 2024, the company reported sales of $40.2 billion, marking a 6.6% increase from the previous year, despite a 1.3% decline in comparable sales, with U.S. store comps down 1.2%. Hurricanes Helene and Milton impacted the quarter; however, excluding these effects, performance surpassed expectations, particularly in seasonal goods and outdoor projects as weather conditions stabilized. The company adjusted its fiscal 2024 guidance, now projecting a 4% sales growth, a 2.5% decline in comparable sales, and about a 1% decrease in adjusted EPS. Strategic efforts are focused on enhancing the interconnected customer experience, increasing pro wallet share, and integrating the recent SRS acquisition, which added $2.9 billion in revenue. Investments are also being directed toward improving the pro-customer experience with new management roles and better inventory practices. While some categories showed positive comps, larger discretionary projects face pressure due to rising interest rates. The CEO acknowledged macroeconomic uncertainty but emphasized that overall performance exceeded expectations, buoyed by increased engagement in seasonal and hurricane-related sales.
National Fuel Gas (NFG): Missed earnings and revenue expectations. In the fourth quarter of 2024, National Fuel reported adjusted operating results of $0.77 per share, bolstered by significant gains from their hedge book and favorable outcomes from regulated sectors despite the pressure of low natural gas prices. Along with Seneca and NFG Midstream, the company is directing its efforts toward the Eastern Development Area, which offers the best returns and plans to enhance capacity through the Tioga Pathway project, set to transport 190 MMcf/d of Seneca’s production. However, due to rising project costs, National Fuel has opted against pursuing an extension for the Northern Access project’s FERC certificate. Additionally, a three-year settlement in its New York rate case is expected to generate an $86 million annual revenue increase, phased in gradually. Advocating for an "all-of-the-above" energy policy, the company highlights concerns over New York’s electrification agenda leading to increased consumer electricity costs. Looking forward, National Fuel revised its fiscal 2025 adjusted EPS guidance to between $5.50 and $6.00, relying on a disciplined hedging strategy while continuing to prioritize shareholder returns through dividends and buybacks.
CVS Health (CVS): Missed earnings expectations and beat revenue expectations, yet the stock was up 6.4% over the past month following the news. David Joyner has recently taken over as the CEO of CVS Health, focusing on enhancing the company’s overall performance. The healthcare benefits segment is currently facing challenges due to high utilization levels, impacting Medicare Advantage and individual exchange businesses. In response, CVS Health is implementing changes to benefit design, pricing, and leadership to improve this segment’s performance. Conversely, the pharmacy and consumer wellness segment is thriving, experiencing strong script growth and gaining market share. Overall, CVS Health reported a 6.3% increase in total revenues, reaching $95.4 billion in Q3 2024. However, operating income plummeted by 77.5%, largely due to a $1.1 billion charge for premium deficiency reserves in the healthcare benefits segment, resulting in an adjusted operating loss of $924 million. Despite these challenges, the health services segment, including Caremark and healthcare delivery assets, has shown resilience with a modest revenue decrease but an increased adjusted operating income. CVS has also finalized a restructuring plan involving $1.2 billion in charges related to store impairments and workforce optimization. While the company isn’t providing formal guidance for 2024, it has offered insights into potential scenarios and its outlook for 2025.
Owens Corning (OC): Beat earnings and revenue expectations. Owens Corning reported a remarkable quarter, showcasing exceptional commercial and operational performance despite facing tough market conditions. The company achieved an adjusted EBIT margin of 19% and an adjusted EBITDA margin of 25%, maintaining its streak of 17 consecutive quarters with mid-teens or better EBIT margins and over 20% EBITDA margins. In a strategic move, Owens Corning announced the sale of its building products business in China and Korea, allowing a stronger focus on its positions in North America and Europe. A new fiberglass insulation production line will be established in Kansas City to address robust market demand. While the company anticipates that challenging market conditions and typical seasonal trends may influence Q4 2024 results, it remains dedicated to executing its strategic initiatives, which aim for over 20% adjusted EBITDA margins and substantial free cash flow generation, through disciplined capital allocation and continuous integration efforts.
Qualcomm (QCOM): Beat earnings and revenue expectations. Qualcomm is undergoing a significant transformation, evolving from a wireless communications company into a connected computing leader tailored for the AI era, emphasizing on-device AI capabilities strongly. The company has recently introduced advanced mobile, PC, and automotive platforms such as the Snapdragon 8 Elite and the Snapdragon X Plus 8-core, boasting notable performance improvements and AI enhancements. In addition, Qualcomm is expanding its reach into emerging markets, including XR, industrial IoT, and edge networking through innovative AI-driven solutions. Financially, Qualcomm has reported robust results for the fourth quarter and fiscal year 2024, achieving revenues of $39 billion and a GAAP EPS of $8.97, marking a significant year-over-year increase. CEO Cristiano Amon highlighted a remarkable 30% growth in EPS during the fourth quarter. The Board of Directors has authorized a $15 billion stock repurchase program to reinforce its financial strategy, supplementing an existing $1 billion from a prior initiative. Qualcomm has provided a positive outlook for Q1 2025, focused on continued growth across its IoT, automotive, and flagship Android handset segments. The company’s use of non-GAAP financial measures enables better evaluation of its core operations and competitive positioning.
OGE Energy (OGE): Missed earnings and revenue expectations. OGE Energy swiftly addressed the recent storms in Oklahoma and Arkansas, successfully restoring power to 86% of affected customers within 24 hours. Their financial performance for Q3 2024 was robust, with consolidated earnings reaching $1.09 per share, fueled by strong demand growth across all customer segments. They anticipate closing the year at the high end of their original earnings guidance. The company reported impressive weather-normalized load growth of 8.4% for Q3 and expects to achieve its 4-6% load growth target for the year. OGE is also expanding its reach into tribal enterprises, healthcare, and data centers within its service area. They are considering filing a new Integrated Resource Plan and upgrading existing generation capacities to address the higher-than-expected load growth. Additionally, they are focused on ensuring that large new loads, such as data centers, positively impact their current customer base through effective cost allocation while maintaining a strong financial position with a targeted 17% FFO-to-debt ratio for future growth financing.
Franklin Resources (BEN): Matched earnings and missed revenue expectations. Over the past five years, Franklin Templeton has significantly expanded and diversified its operations, with acquisitions now accounting for 55% of its adjusted operating revenue. The company has notably increased its institutional assets under management (AUM) from 25% to 45%, achieving a balanced approach between institutional and wealth management. With a strong focus on growth areas such as alternative assets, ETFs, and customized investment solutions, Franklin Templeton aims to triple its ETF AUM and quintuple Canvas assets over the next five years. The firm recognizes a substantial opportunity in private wealth management and plans to double the size of Fiduciary Trust International during the same period. Despite facing challenges at its Western Asset subsidiary, which has experienced significant net outflows amid an ongoing investigation, Franklin Templeton reported $16 billion in long-term net inflows for fiscal 2024, reflecting a 25% increase from the previous year. However, recent performance reveals a preliminary net loss of $84.7 million for the September 30, 2024 quarter, with a fiscal year net income of $464.8 million, down from $882.8 million the prior year. The firm also returned $946 million to shareholders through dividends and share repurchases, showcasing its commitment to delivering value.
Chevron (CVX): Missed earnings and beat revenue expectations. In the third quarter of 2024, Chevron reported impressive financial and operational performance, achieving record cash returns to shareholders. The company made significant strides on major projects, notably TCO and Gorgon, with TCO reaching its highest daily production in 31 years. Additionally, Chevron announced asset sales amounting to approximately $8 billion in before-tax proceeds across Canada, Alaska, and Congo. The Permian assets demonstrated robust performance, and the company plans to prioritize free cash flow management over mere growth. To enhance efficiency, Chevron outlined a $2-$3 billion structural cost reduction initiative focused on optimizing its portfolio and improving work processes by 2026. The organization maintained a strong balance sheet while recommitting to shareholder returns through dividends and share buybacks. Technological advancements are paving the way for new developments in the Gulf of Mexico, while disciplined capital spending strategies will be further detailed in the future. The firm reported earnings of $4.5 billion, with cash flow from operations at $9.7 billion. Chevron also announced a $6.5 billion asset sale in Canada and received clearance for its merger with Hess Corporation, signaling a proactive approach to enhancing its operational efficiencies.
Overall, each of these companies presents unique opportunities for investors, marked by positive financial metrics, strategic positions in their markets, and attractive margins of safety.
The Smart Value portfolio strategy utilizes measures of economic profitability, balance sheet sustainability, cash flow generation, valuation, economic trends, monetary liquidity, and market sentiment to make objective, rational decisions about how much capital to put at risk and where to put that capital.
Please let us know if you would like to discuss the portfolio in more detail or learn more about our approach.
Sincerely,
Donald L. Hagan, CFA®
Regan Teague, CFA®, CFP®
Rob Herman, MBA
Jeffery Palmer, CIPM
Steve Zimmerman, MBA
Steven Goode, CFA®
Disclosure: The aforementioned positions may change at any time.
Disclosure: *Note that individuals’ percentage gains relative to those mentioned in this report may differ slightly due to portfolio size and other factors. Returns are based on a representative account. The data and analysis contained herein are provided "as is" and without warranty of any kind, either express or implied. Day Hagan Asset Management, any of its affiliates or employees, or any third-party data provider shall not have any liability for any loss sustained by anyone who has relied on the information contained in any Day Hagan Asset Management literature or marketing materials. All opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before investing. Day Hagan Asset Management accounts that Day Hagan Asset Management or its affiliated companies manage, or their respective shareholders, directors, officers, and/or employees, may have long or short positions in the securities discussed herein and may purchase or sell such securities without notice. Day Hagan Asset Management uses and has historically used various methods to evaluate investments which, at times, produce contradictory recommendations with respect to the same securities. The performance of Day Hagan Asset Management’s past recommendations and model results is not a guarantee of future results. The securities mentioned in this document may not be eligible for sale in some states or countries nor be suitable for all types of investors; their value and income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates, or other factors.
There is no guarantee that any investment strategy will achieve its objectives, generate dividends, or avoid losses.
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