Day Hagan Smart Value Strategy Update March 2025
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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.
Strategy Update
Major equity indices evidenced mixed performance in February, with the S&P 500 down 1.3%, small-cap stocks (S&P 600) down 5.7%, and the NASDAQ down 3.97%. International equities were generally positive outside of Asia and, more specifically, Southeast Asia. Europe bounced back strongly, with Spain, Austria, Poland, and Italy advancing. Major bond indices also outperformed, with the Bloomberg U.S. Aggregate Bond index gaining 2.15%.
Currently, the market is in a state of flux, with investors trying to interpret the potential fallout from tariffs, global geopolitical upheavals, and a potential downshift in economic activity. All to say that the level of investor uncertainty in the markets is very high, and as we all know, the markets hate uncertainty.
February witnessed notable sector rotation in the equity markets, with the Consumer Staples, Real Estate, Energy, and Health Care sectors experiencing growth, while Consumer Discretionary, Information Technology, Industrials, and Communication Services faced declines. The month began amid disappointing macroeconomic indicators that dampened investor confidence, highlighted by a significant drop in the University of Michigan’s Consumer Sentiment Index. This decline pointed to rising concerns over inflation and trade policies. Additionally, January’s existing home sales fell short of expectations due to persistently high mortgage rates and affordability issues that continued to suppress housing demand.
A troubling development was a modest contraction in the services sector, described by the Purchasing Managers’ Index (PMI). This shift, not seen in over two years, raised alarms about potential economic headwinds. These indicators fueled speculation that if the Federal Reserve maintained its restrictive monetary policy for a prolonged period, it would add further pressure on equity markets.
The earnings season for Q4 2024 presented a mixed landscape. While the S&P 500 achieved an impressive 18% year-over-year growth—the strongest since Q4 2021—prominent disappointments like Nvidia’s results shook market confidence. Despite beating revenue forecasts, concerns over slowing future growth led to a significant drop in its stock price. Meanwhile, several major retailers cited cautious consumer spending and inventory challenges, resulting in weaker guidance.
Amid heightened geopolitical risks, including fresh tariffs announced by the Trump administration, investors grew increasingly uneasy over potential trade conflicts. These developments exacerbated concerns of stagflation, characterized by rising prices and slowing economic growth. Consequently, the Dow Jones Industrial Average saw its most substantial single-day drop of the year, plunging over 700 points, while the S&P 500 and Nasdaq Composite also retraced early gains.
In this climate of uncertainty, market caution has been essential. As traders monitor upcoming economic data and Federal Reserve communications, portfolio diversification and prudent risk management will remain critical in navigating the complexities of the financial landscape.
With regard to tariffs and our holdings, we note that there has been quite a bit of press around retail-oriented stocks’ exposure, particularly to tariffs on Mexico, Canada, and China. Below are brief summaries describing each company’s exposure for Lululemon (LULU), Nike (NKE), Ulta Beauty (ULTA), and Target (TGT).
Ulta Beauty is set to expand into Mexico in 2025 through a joint venture with Axo, marking its first international move beyond the United States. The Mexican beauty market, valued at approximately $9.46 billion, presents significant growth opportunities for Ulta, especially given the brand’s strong recognition among Mexican consumers. Currently, Ulta has no operational stores or revenue exposure in Mexico as the expansion is in the planning phase. In Canada, Ulta had previously announced expansion plans in 2019, which were scrapped in 2020 due to the COVID-19 pandemic, and there are no immediate initiatives to enter the market. As of March 2025, Ulta has no presence or direct exposure in China, focusing solely on U.S. operations with no plans for international ventures outside Mexico. Hence, Ulta’s current business remains primarily domestic, with its international ambitions contingent on the successful launch in Mexico.
Lululemon’s global operations show Mexico representing a modest yet growing footprint. As of early 2024, the company transitioned to company-owned operations, controlling 15 stores, which account for about 2% of its total 711 stores worldwide. Revenue from Mexico, categorized under the “Rest of World” segment, likely contributes less than 1-2% of total revenue. In Canada, its home market, Lululemon has 73 stores, representing roughly 10% of global locations and contributing an estimated 10-15% of the “Americas” segment’s revenue. Meanwhile, China emerges as a significant growth area with 127 stores, generating 13% of total revenue and positioning itself as Lululemon’s second-largest market. Overall, Lululemon remains heavily U.S.-centric, while minimizing supply chain risks through diversification, primarily sourcing production from Southeast Asia.
Nike, Inc.’s revenue from Mexico is minimal (estimated at 2-3% of total revenue), largely driven by supply chain dynamics, with 17 factories employing about 5% of its contract workforce. Canada presents a moderately higher revenue exposure (2-4% of total) through retail channels, but only has one contract factory, making its supply chain presence negligible. In contrast, China is crucial for Nike, representing 16% of total revenue and sourcing 18% of its products from 124 factories. While China’s sales have shown growth, its reliance heightens risks from economic fluctuations and trade policies. Overall, Nike’s exposure is most significant in China, with Mexico and Canada being lesser but strategically relevant markets, especially in terms of supply chain considerations and potential tariff impacts.
Starbucks maintains a modest presence in Mexico, operating approximately 770 stores, which represents 2% of its global total. In Q1 FY2025, the International segment, including Mexico, contributed $1.66 billion in revenue, with Mexico estimated to account for $100-$200 million quarterly. The country plays a minor role in Starbucks’ coffee sourcing, with less than 5% of beans sourced from Mexico, and is sensitive to potential U.S. tariffs. In Canada, Starbucks operates 1,458 stores, accounting for about 3.7% of its global count, and generating an estimated $360-$505 million quarterly. Canada is less exposed to supply chain risks but faces cost pressures from proposed U.S. tariffs. In contrast, China is Starbucks’ second-largest market, with 7,093 stores and a revenue contribution of approximately $709 million. However, competition and geopolitical risks pose challenges. Overall, Starbucks’ revenue is predominantly U.S.-centric, with significant variations in its international markets.
At this juncture, each of the four companies is on our watch list for a potential downgrade. We are currently monitoring guidance for margins, supply chains, revenues, and earnings for signs that tariffs will be more disruptive than already priced into each stock price.
We did sell two companies out of the portfolio, Home Depot and Lowe’s, and placed the funds into cash (yielding about 5%). We are actively looking to put the money back to work as opportunities avail themselves. Below are summaries from our Trade Notification sent on February 24.
Home Depot (HD):
Home Depot was sold as their last quarterly results revealed a concerning trend in consumer spending on big-ticket items. The third-quarter fiscal 2024 report, released on November 12, 2024, showed a 1.3% decline in comparable sales, highlighting ongoing consumer hesitancy toward large home improvement projects due to high interest rates and economic uncertainty. Customers are deferring purchases, waiting for improved financing conditions such as lower mortgage rates, which may not materialize soon.
Additionally, the $18.25 billion acquisition of SRS Distribution had significantly increased Home Depot’s debt, pushing total liabilities above $50 billion. To manage the elevated debt service costs, management paused share repurchases, indicating financial strain. High interest rates could further pressure profitability if sales growth doesn’t accelerate.
Economic factors compound these challenges, as U.S. mortgage rates remain near 7% and home sales have plummeted by 15% year-over-year, stifling housing turnover and renovation demand. Retail sales also dropped by 1.1% in December 2024, reflecting broader consumer caution. Moreover, despite its strong brand, Home Depot’s stock appears overvalued, trading at 25 times next year’s earnings. With 2024 guidance projecting a comparable sales decline of 3-4% and adjusted earnings per share expected to drop, this premium valuation may not be justified amid delayed economic recovery and interest rate relief.
Home Depot was first purchased in the strategy in June 2022. From then through the time of sale, the stock returned roughly +49%* to shareholders.
Based on our multifaceted framework, Home Depot’s stock price was trading above our determination of fair value.
Lowe’s (LOW):
Lowe’s latest earnings report for the third quarter of fiscal 2024 (released November 19, 2024) showed a 1.1% decline in comparable sales, driven by persistent weakness in discretionary, big-ticket DIY projects. Despite beating earnings expectations with an adjusted EPS of $2.89 versus $2.82 anticipated, the company highlighted ongoing consumer hesitancy due to high interest rates and economic uncertainty. Management noted that customers are delaying larger purchases until financing conditions improve, a trend that may persist in 2025 if rates remain elevated, potentially pressuring future sales.
Lowe’s raised its full-year 2024 outlook slightly in November, projecting sales of $83 billion to $83.5 billion and a comparable sales decline of 3% to 3.5%, better than prior estimates. However, this still reflects a year-over-year revenue drop from $86.38 billion in 2023, signaling no immediate recovery. Trading at a forward P/E of around 20.7 (based on analyst estimates ahead of its next earnings on February 25, 2025), the stock may be priced for optimism that economic conditions don’t fully support. The stock could face downward pressure if the upcoming Q4 report underperforms or guidance disappoints.
Lowes was first purchased in the strategy in June 2022. Since then through the sale date, the stock had returned nearly +43%* to shareholders.
Based on our multifaceted framework, Lowes’ stock price traded above our determination of fair value, and it was sold.
Turning to equity sectors for a moment, our largest sector allocations are Financials, Information Technology, Communication Services, and Industrials. Our target weightings versus the Russell 1000 Value Index are as follows: Information Technology 11.7% vs. 9.4% benchmark, Healthcare 1.2% vs. 14.5%, Financials 18.6% vs. 23.3%, Consumer Discretionary 9.0% vs. 6.2%, Communication Services 13.4% vs. 4.2%, Industrials 9.1% vs. 14.4%, Consumer Staples 5.9% vs. 7.7%, Energy 5.7% vs. 6.7%, Utilities 4.2% vs. 4.5%, Materials 4.2% vs. 4.3% and Real Estate 5.8% vs. 4.6%.
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 want to discuss the portfolio in more detail or learn more about our approach.
Sincerely,
Donald L. Hagan, CFA®
Regan Teague, CFA®, CFP®
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.
For more information, please contact us at:
Day Hagan Asset Management, 1000 S. Tamiami Trail, Sarasota, FL 34236
Toll-Free: (800) 594-7930 | Office Phone: (941) 330-1702
Website: https://dayhagan.com or https://dhfunds.com