Research Reports Archives - Aptus Capital Advisors

Before we highlight one of the Aptus Compounder’s holdings (15-stock, high-conviction strategy – shoot me an email if you have any questions on this unpackaged SMA strategy), let’s touch base on two things today:

Given the recent volatility, if you have any specific holding or portfolio level questions, please don’t hesitate to reach out to us. We are here to help. As many of you know, a few of our strategies are our best expression of owning volatility as an asset class, the S&P 500 had sold off ~6.5% (NASDAQ closer to -10% / Small Caps were -16%) given the headline risk around tariffs. We love how we are positioned.

Historically, the market experiences three 5%+ pullbacks per year on average. These corrections are healthy and should not be alarming. The data below shows that these pullbacks are common rather than extraordinary. Since 1928, the largest intra-year drawdown averages -16.0%, yet year-end returns typically remain positive. The message here is clear: it pays to stay patient, not reactive.

Lastly, in my opinion, this feels like a normal pull back, as the areas of the market that have been hit the hardest are the places that many would consider to have had irrational exuberance in their returns since the election, i.e., high-beta stocks, highly-valued stocks, and the most risk-on areas of the market have led the pull back. When these areas of the market are leading the pullback, it tends to be a healthy and short-lived correction.

I’ve slowed down on my individual stock writing for the “Aptus Musings”, but given the recent pullback in the market and the moving pieces under the hood of the S&P 500, I thought I’d bring it back. For reference, dispersion across names in the S&P 500 is in the 98th percentile over the last five years. This means that there is a lot of dispersion amongst names and low correlation, i.e., names are doing wild and crazy things as we are going through a period of time where CY 2024 earnings are being reported and a potential / threat for a substantial amount of change in Washington, D.C. policy.

In today’s musing, we’ll be highlighting Aptus’ most recent addition to the portfolio – NVIDIA Corp. (NVDA).

Compounder Factsheet
Compounder Philosophy

NVIDIA Corporation

Tech’s negative trend is probably one of the most important equity market developments to start 2025. It doesn’t mean good charts can’t be found within the sector, but the likelihood of consistently picking winners goes down without the sector at your back. But this type of weakness does breed opportunity, and we continue to believe that there is opportunity to own NVDA.

As of 3/4/2025, NVDA is -13% from its recent ATH, but the weakness in the stock feels more like a hedge fund de-grossing story for the entire semiconductor / AI space than a fundamental growth worry. And when you get pullbacks that are caused by this type of liquidity event, it’s tough to recognize when the selling will stop, so I cannot call a bottom. However, we believe that NVDA is hitting a point of valuation support.

Let’s talk valuation because I feel like that is the go-to scapegoat as a reason not to own the stock. The stock currently trades at 25x forward earnings:

NVDA now trades BELOW parity relative to the PHLX Semiconductor Sector Index (SOX) – something the market has seen only once or twice in the past decade;

NVDA only trades at a slight S&P premium, the lowest they have been since 2016.

And this is the cheapest valuation the stock has seen, and it’s at the beginning of a new product cycle, which baffles me. The stock tends to do well during new product cycles, such as the Hopper. Though I do recognize that the Blackwell introduction has not gone as smoothly as Jensen would have liked, a few of our research partners have stated that Blackwell witnessed $11B of shipments in January, suggesting that the floodgates have been opened.

We don’t just like the valuation of NVDA, we love it. And we love the growth opportunity because the U.S. is already starting to price in a slowdown of growth – and this is before the tariffs debacle. Then, global growth is also undoubtedly slowing. We believe that this leaves the AI trade as an idiosyncratic area of growth. The scarcity growth premium might find its way back to NVDA.

So, what is there for investors to worry about?

Increased Regulation: Given the current trade tensions, there could be more restrictions and bans on China shipments. I would note that NVDA’s China sales, while reaching record levels (~$17B in FY25), are at the lowest % of revenue (13%) in the last 10 years.

AI Diffusion Occurs in May: These are basically new rules that place additional controls on where advanced AI components can be shipped. Said another way, it will force customers in many countries to obtain new licenses in order to purchase sizable amounts of NVDA hardware. We believe NVDA’s H20 shipments to China should be unaffected by the new controls as they only seem to apply to components already impacted by prior controls (the H20 is low enough performance to be exempt from restrictions).

The AI Trade is Long in the Tooth: Personally, I think that this is a bit premature. Why? Sentiment has clearly pivoted for now on the AI group. However, spending intentions seemingly continue to rise, plus a new product cycle is just kicking off. For example, there continues to be outsized investments in capex and R&D have supported the exceptional performance of US stocks during the past decade. In 2025, the Magnificent 7 companies will boost their capex by 31% YoY to $331B. If you simply rewind history back to October, just four months ago, these companies were “only” expected to spend $263B on capex (+13%).

Given how noisy 2025 has been so far, I think being quiet isn’t such a bad thing. Even though there was tremendous angst going into NVDA’s recent earnings results the other week, I would characterize the print as relatively quiet. It appears that the company is through the worst of the ramp issues, with all Blackwell configurations now in full production across the board. Gross margins at 71% might be a minor nitpick, but I won’t argue that getting product out the door should be the primary consideration at the moment, given that demand seemingly remains off the charts and the company still sees them coming back into the mid-70s range by year-end.

Overall, the secular story around that demand seems as robust as ever as the market moves from pre-training to a post-training world, with management remaining bullish that compute requirements are only growing stronger from here.

Overall Thesis

We see NVDA as a major beneficiary of the 4th tectonic shift in computing, in which parallel

processing captures share in the computing market. We believe that the market underappreciates NVDA’s businesses and its transformation from a traditional PC graphics chip vendor into a supplier of high-end gaming, enterprise graphics, cloud, accelerated computing, and automotive markets. From our perspective, the company has executed consistently and has a solid balance sheet with what we believe to be a demonstrated commitment to capital returns. We understand the unwelcoming landscape regarding China and the U.S. restrictions but believe that they are manageable over time.

And don’t mention valuation to us – it trades at 25.2x forward earnings, a level lower than most of the Magnificent Seven. At this valuation level, it’s the stock’s weakest level in a year and close to 10-year lows. In fact, the stock now trades below parity relative to the SOX (something we have seen only once or twice in the past decade) and at only a slight S&P premium, the lowest they have been since 2016.

Disclosures

This commentary offers generalized research, not personalized investment advice. It is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this commentary should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment & tax professional before implementing any investment strategy. Investing involves risk. Principal loss is possible.

The content and/or when a page is marked “Advisor Use Only” or “For Institutional Use”, the content is only intended for financial advisors, consultants, or existing and prospective institutional investors of Aptus. These materials have not been written or approved for a retail audience or use in mind and should not be distributed to retail investors. Any distribution to retail investors by a registered investment adviser may violate the new Marketing Rule under the Investment Advisers Act. If you choose to utilize or cite material, we recommend the citation be presented in context, with similar footnotes in the material and appropriate sourcing to Aptus and/or any other author or source references. This is notwithstanding any considerations or customizations with regards to your operations, based on your own compliance process, and compliance review with the marketing rule effective November 4, 2022. ACA-2503-11.

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Aptus Musing: Stock Highlight – Chemed Corporation (CHE)

David Wagner — Tue, 05 Dec 2023 15:12:34 +0000

In today’s report, we’ll be covering Chemed Corporation (“CHE”) – in our opinion, one of the last, great remaining publicly traded conglomerate companies. Conglomerates were in vogue for the majority of the 20th century. They came about because most of the mergers in the 1960s and 1970s were conglomerates (buyer and seller operating unrelated businesses) since horizontal (same industry) and vertical mergers were closely scrutinized and often rejected by FTC regulators. Contrary to the hype, all those conglomerates petered out sooner or later for the simple reason that there was no economic justification for their existence. If an investor wishes to diversify and have stakes in, say, airlines, oil and gas, and insurance, they can simply buy shares in companies operating in these industries. Investors don’t need conglomerate companies to do the diversification for them.

And now, CHE is continually asked by shareholders if they should break apart into two publicly-traded companies and the CEO, Kevin McNamara, always has a resounding and emphatic… “No”. So, what are the two (2) businesses that Chemed runs?

The Che Guevara Business – Surprisingly, CHE and Che have a few things in common, though they remain far different. The latter was an expert in guerilla warfare and is notorious for his involvement in killings throughout Cuba, Venezuela, and Africa. The former is also known in the death space – though, unlike Che, they help assist in the most peaceful of manners. Over 50% of Chemed’s revenue comes from being the #1 hospice player in the United States, with the company VITAS.

The Cousin Eddie Business – Happy Christmas time. Cousin Eddie is most infamous for draining his RV’s waste into a sewer in the suburbs of Chicago in the movie, National Lampoon’s Christmas Vacation. However, he chose to use a different subset of verbiage while performing the act in a short bathroom robe that would barely yield the coverage of a Kentucky Derby jockey. Instead of performing this act, Cousin Eddie should have called Chemed’s other Business, Roto-Rooter, which happens to be the largest plumbing company in America.

Let’s dive in.

Chemed Corporation (CHE)

What Does the Company Do?

Chemed (CHE) is a conglomerate that operates in two distinct businesses:

VITAS Healthcare (55% of Revenues): Largest provider of Hospice Services for patients with severe, life-limiting illnesses with approximately 7% of the U.S. market share. Operates a comprehensive range of hospice services through 45 operating programs in 15 states and the District of Columbia.

Roto-Rooter (45% of Revenues): The largest provider of plumbing and drain cleaning services in North America with services to ~90% of the U.S. and 40% of the Canadian population. This is a fragmented market where Roto-Rooter maintains an estimated 15% of drain cleaning market share and only 2%-3% of same-day service plumbing market.

Why Have I Been So Impressed With the Company and Its Management Team?

The below chart states everything that you need to know. Growing your dividend at double-digit rates and buying back over $2B (on an $8B mkt. cap stock) since 2007 shows the strength of this business, as this would not be possible if they were not able to grow revenue, expand margins and increase the bottom line.

What Has Impressed Aptus Lately?

It’s no secret that keeping and retaining labor has been a very difficult task for companies and CHE has been no different. In fact, it has substantially de-railed some of VITAS’ growth aspirations. But this past quarter was a pretty large clearing event and this is why the stock was +10% after the report.

This past quarter we were most impressed with the results of the company labor retention program, which we believe will set them up relative to peers for quite some time – having the right, consistent labor is in fact a competitive advantage in this space. The program was just another highlight of continued management execution during periods of adversity. Management had previously assumed a slight uptick in turnover and a slowdown in hiring at the end of the program, which fortunately did not materialize. The strong labor market for CHE has prompted management to increase its current year average daily census (“ADC”) growth guidance for the second consecutive quarter to 9.3-9.5% (from 6.5–7.5%).

VITAS is finally back to growth mode.

Walk Through the Yield + Growth Framework:

Chemed has multiple levers to successfully grow. Many believe that CHE likely has a GDP-like growth, given that the Roto-Rooter business and the Hospice business reimbursement is controlled by the government. This is not exactly true, particularly on the Roto-Rooter business (“RR”). The company has continued to grow organically, even via new lines of business, such as water restoration (which began in 2016). Inorganically, RR continues to snatch up non-controlled franchises. VITAS is unlikely to grow inorganically, as the compliance and integrations tend to be complicated, especially with a lot of government scrutiny – in a heavy reimbursement-based business, it’s sometimes best to not have the spotlight on you.

Nonetheless, the company has substantial room to grow with a lot of pricing power.

Sales Growth Rate + Roto-Rooter Inorganic Growth + Margin Expansion + Share Repurchases = Growth Rates: 6.50% + 1.00% + 0.50% + 2.00% = 10.00%

Should the Company Break Into Two Companies?

Surprisingly, when speaking with the management team, I don’t take a contentious stance here because I actually agree with keeping the companies together. Both sides of the business ying and yang with each other, as the RR business tends to be a bit more cyclical, given the exposure to restaurants, while VITAS is more of a staple. From a valuation perspective, I don’t think the move would benefit them, but if you want to have that conversation, we can take that offline.

From a portfolio standpoint, specifically in the Aptus Compounders 15-stock, non-diversified portfolio, I prefer to own a conglomerate. Since we’re limited in the number of holdings that the portfolio can have, I like increasing diversification with a business that performs work in the Health Care and Industrial sectors.

Why are We so Convicted in CHE?

We believe that CHE is a very strong operator with tailwinds on both sides of its business. On the Roto-Rooter segment, given its above-peer margins, its asset-light model, the reduced exposure to economic cycles (due to its growing exposure to water restoration), and limited online competition, we believe that this line of business deserves an above-average premium relative to peers. Meanwhile, given the size of the VITAS platform (scarcity value), the positive outlook for the hospice industry, and the positive near and medium-term outlook for Medicare reimbursement rates, we believe that VITAS also deserves an above-average premium relative to peers.

CHE has demonstrated to be a very strong operator, with minimal leverage at the corporate level, a growing dividend, and accretive share repurchases. With this, we believe that the company is very undervalued relative to peers and should be an all-weather holding in a portfolio given its downside protection along with its outperformance in normalized market scenarios.

Disclosures

Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that securities sold have not been repurchased. The securities discussed may not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. It should not be assumed that any of the securities transactions, holdings or sectors discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. Information was obtained from third party sources which we believe to be reliable but are not guaranteed as to their accuracy or completeness. Forward looking statements cannot be guaranteed.

Advisory services are offered through Aptus Capital Advisors, LLC, a Registered Investment Adviser registered with the Securities and Exchange Commission. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (251) 517-7198. Aptus Capital Advisors, LLC is headquartered in Fairhope, Alabama. ACA-2312-8.

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Aptus Musings: Stock Highlight – UnitedHealth Group, Inc (UNH)

David Wagner — Tue, 25 Jul 2023 18:19:04 +0000

On recent travels, I’ve been doing some thinking on the overall valuation of the domestic market – alongside reading a few differentiated thoughts on the matter. I don’t want to go as far as saying that investors need to be discounting a revolutionary change in the economy from artificial intelligence (“A.I.”) that renders the old rules useless. AI could indeed be a long-term positive for the economy that will usher in a step-function boom in productivity. But let’s think through this a bit more simplistically.

What if there has been a foundational change in what the absolute level in which the market will be priced at moving into the future? To me, it can sometimes feel like the market is always over-valued. Back in the 2000s, many investors thought that 13x earnings was wildly overpriced – we’re 50% higher than that now. Even as recently as 2015, some stock pickers wouldn’t even touch a stock greater than 18x forward earnings. Look at us now!

Over the last few decades, there has been an increased usage of diversification, which could make investors understand that they need to accept higher valuations, given ease of access to information and relative times savings. The best analogy that I have heard regarding this is: Imagine that you’re an investor in the 1930s/1940s and you wanted diversification. You’d have to buy mutual funds that has exuberant fee loads of like 7% – 9% (plus annual mgmt. fees). And, if you didn’t want to realize those fees, investors could do the work themselves. But that requires time and would be an even more difficult task to execute on, given the lack of access to information. Not to mention the time necessary to manage those holdings after time of purchase.

Then, imagine the unknown in the market after the Great Depression – the worst economic crisis in our history – without easy access to information, it would have been very difficult to make a well-informed decision on if one should stay invested. Today, it feels like investors have just kept buying … “just because”. Investing today is far simpler and cheaper that it was nearly a century ago…and that’s just the new cost of investing that has demanded a higher multiple relative to before.

Now, I’m not going to say that this market isn’t expensive, as I think that it’s saying more that investors may need to tread lightly at this level. What I am trying to say is that valuation is just another arrow in one’s quiver – it shouldn’t be the sole rationale as to why one should not currently invest. Remember, using valuation as a short-term timing tool is a fool’s errand. As the market changes, investors must also change, or they could quickly become a sacrificial lamb.

Now, let’s talk UNH – luckily, we believe that their valuation is very palatable.

UNH Case Study

UnitedHealth Group, Inc. (UNH):
What Do They Do?: UnitedHealth Group, the largest private health insurer in the U.S., provides a diverse and comprehensive array of health and well-being services to people through all stages of life. The company provides medical benefits to over 50 million members through employer-sponsored, self-directed, and government-backed insurance plans in the U.S. and internationally. UnitedHealth has two operating units: UnitedHealthcare (77% of Revenue) and Optum (23% of Revenue).

Overall Thesis: We remain convicted on UNH due to an attractive valuation, potential for hardening pricing in 2024, and attractive LT growth in value-based care. As I wrote about in our Aptus Compounders Halftime Report – 1H ’23, time is one of our best assets. Going back a year, we liked the UNH story, but were not too enthusiastic about its valuation. But, when you own for longer periods of time, you have to deal with the ebbs and flow of valuation as you let your capital compound for you. Yet, today, we don’t just like the valuation of UNH, we love it. About 12 months ago, the stock traded at a 30% premium to the market, now it trades at a 10% discount. With the stock down ~3% YTD and valuation down to 0.9x of SPX, we believe most of the associated uncertainty regarding medical costs are priced in. We believe UNH is a best-in-class managed care organization (“MCO”) and value-based care (“VBC”) company, and current valuation offers a unique opportunity to buy a piece of a business with a large runway of growth in front of it at very attractive valuation.

Yield + Growth Frameworks:
Dividend Yield: 1.48%
Growth Rate: 12.00%
Y + G = 13.48%

I’m deriving our growth rate from the following information:

1. Optum: We see gov’t MCO and OptumCare as strong growth pillars for UNH and are interested in what will emerge over the next 5-10 years as their 3rd pillar of their business model. Given their HC system technology, UNH’s management expects 13-16% LT EPS growth targets for Optum.

2. United HealthCare: Health care spending has grown consistently for many years and comprises approximately 18% of U.S. GDP. This trend is likely to continue as baby boomers continue to age. With this, I’d expect this segment to grow at a healthy rate.

The Valuation: UNH relative valuation at 0.9x is very attractive relative to historic levels. We believe that investors could see the stock trading at 1.1x – 1.2x for UNH, and view 1.2x as a normal high-end of historic relative valuations. During ’22, we saw valuations getting as high as 1.4x, which we felt were stretched. The current 0.9x is very attractive to us, near “Medicare for All” lows of 0.85x. We believe long term UNH will trade at 1.1 to 1.2x the market, presenting further upside.

The Wildcard: UNH typically derives ~1/3rd of its growth from M&A, of which, they have a great track record – we’ll see what happens with Amedysis (AMED), which is coincidentally one of the largest competitors to Chemed Corp.’s (CHE) subsidiary, Vitas – which is held in the Aptus Compounders portfolio.

UNH did a great job growing Optum, which diversified its business from UnitedHealth, but we believe that management will start looking for a third leg to the stool with another large, transformational acquisition. We’d assume that they are looking for a high growth business to complement its VBC and government MCO businesses. We believe UNH is developing growth engines in health system enablement and consumerism. We believe the health system enablement strategy should present an explosive opportunity leveraging AI and care automation to revolutionize the costs of care delivery.

In its current form, OptumInsights is focused on incremental health system enablement, in areas like revenue cycle management and efficiencies. UNH is positioned to assist health systems in the transition to VBC by enabling the taking and managing of clinical risk, leveraging its OptumHealth and UHC capabilities. The biggest long-term opportunity though is the leverage of digital and AI to expand the supply of care delivery to reduce costs and expand volume for health systems. While many will target this opportunity, UNH is well positioned given its capabilities and existing role with health systems.

Technical Thoughts: UNH – Since the end of 2021, UNH has essentially gone nowhere. It was up in 2022 while most things were down and has severely underperformed the broader indices and its sector YTD. But, through all that, it’s also found a nice base in the $450-$500 range, and recently exhibited a “double bottom” support move off of $450 with higher volume pushing it above $500. While not exactly saying “full steam ahead”, it’s arguable that it’s found a low and should compound higher over the medium- to long-term from here. Targets are pretty obvious @ $550 and a breakout there would see it easily clearing $600 and beyond after making this 1.5 year base / consolidation move around $450. Could be a multi-year upside move once it gets started.

Disclosures

This is not a recommendation to buy or sell a particular security. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that securities sold have not been repurchased. The securities discussed may not represent an account’s entire portfolio and, in the aggregate, may represent only a small percentage of an account’s portfolio holdings. It should not be assumed that any of the securities transactions, holdings or sectors discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. A complete list of holdings is available upon request.

Advisory services are offered through Aptus Capital Advisors, LLC, a Registered Investment Adviser registered with the Securities and Exchange Commission. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies, and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (251) 517-7198. Aptus Capital Advisors, LLC is headquartered in Fairhope, Alabama. ACA-2307-27.

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Aptus Musings: Stock Highlight – Copart, Inc (CPRT)

David Wagner — Thu, 04 May 2023 12:34:49 +0000

With the Kentucky Derby scheduled for this weekend, I’ve been thinking about the multiple similarities between horse racing and stock picking. The market for common stocks is like the pari-mutuel betting system at the racetrack. Patrons go to the track to make bets on horses and the odds change based on those bets – much like the stock market. If someone believes that a particular horse is likely to do better than the odds suggest, one will bet on the horse. But if all bettors predict a horse to win, the odds will reflect that decision, and the return on investment will be poor. This analogy holds true for the stock market.

This month, I’ll be talking about Copart, Inc (CPRT).

See the updated CPRT Bull/Bear Case here.

Since I did a musing on CPRT 18 months ago, I’m going to throw some odd ball facts in about the company.

Copart, Inc. (CPRT)

What Do They Do?

Copart, Inc. is a leading provider of online auctions and vehicle remarketing services. Through their patented platform, their site auctions off used cars that are salvage titled, damaged, or rebuilt. I believe CPRT presents a great investment opportunity because:

Unique business model provides great profitability with an economic moat

CPRT shows strong revenue growth and a bright future outlook

Their management team shows a track record of financial discipline

CPRT has a very unique business model with two approaches for listing vehicles. They may directly purchase cars damaged by accidents or natural disasters and then sell the vehicle through the platform. Alternatively, they provide auction services for insurance companies, financial institutions, or individuals to sell vehicles on their behalf. On the purchasing side, most buyers are licensed vehicle dismantlers, rebuilders, repair licensees, or used car dealers.

We believe this revenue growth will continue into the foreseeable future and possibly accelerate because of the 1) increasing technological complexity of new cars, 2) increasing labor costs, and 3) auto part shortages are causing insurance companies to designate cars as totaled with greater frequency.

Real Life Thoughts:

I’ve been in contact with the company’s Co-CEOs (Willis J. Johnson, the company’s founder has been out of the reigns for about 7 years now – awesome story if you have time to read up on him), as I’ve been trying to drive the company to start paying a dividend. The company is sitting on a record amount of cash, close to $1.7B, that can be deployed through shareholder yield that would increase the universe of potential investors – I’ll keep everyone apprised to see if our hard-fought commentary will ultimately push them to start implementing one.

Outside of that update, I love that CPRT’s management team invests with their shareholders – almost 10% of the shares outstanding are owned by the executive board (Given their age, I bet they’d love some yield from a CPRT dividend!). This means that each major decision made has a lot of ramifications to their own net wealth. But the craziest fact is that one of the Co-CEOs has an annual salary of $1. That means all of his compensation is based off of share price performance. Talk about an alignment of interests!

We’ve been really impressed with CPRT, which operated in a duopolistic market. The only other competitor is IAA, Inc. CPRT has continued to take market share from IAA. In fact, they won the contract with GEICO, which was previously 100% serviced by IAA. Why? Simply put, IAA had historical weak execution after few major events, i.e., hurricanes. Secondly, given CPRT’s international expansion, they have a far more reaching global network than IAA – hence, they had more potential buyers to bid up a car’s salvage value, i.e., a higher yield. CPRT has continued to expand internationally – something IAA is not doing.

CPRT in a Recession:

Surprisingly, auto salvage is actually a recession-resistant business model. Let’s look at it from both sides of the business:

The first of these drivers, the number of cars Copart salvages each year, varies over time according to a simple formula: total miles driven x accidents per mile driven x vehicles per accident x salvage rate x Copart’s market share. In a recession, total miles driven decreases, but not by much. Even in the 2008-2009 recession, total miles driven only fell by 3%. Neither accidents per mile driven nor vehicles per accident is much affected by recessions. The salvage rate, all other things equal, actually increases in a recession because repair costs as a percentage of pre-accident values go up as used car prices go down. Copart’s market share also tends to increase during recessions as some weaker players go out of business or sell to Copart. The net result is that the number of cars salvaged tends to rise even in most recessions.

The second of Copart’s revenue drivers, revenue per car, is more negatively impacted by recessionary environments. Revenue per car is tied to the auction value of the vehicle, the number of services consumed, the pricing of these services, and international exchange rates. Auction value generally decreases during recessions because consumers typically defer big-ticket purchases, pressuring new and used car prices. In the 2008-2009 recession, used car prices decreased by roughly 15%.

Amazingly, Copart was able to completely offset this price decline through some combination of increased services per car and increased price per service, leading to marginal growth in revenue.

Yield + Growth Framework:

0.00% + 10.75% = 10.75%

Revenue Growth + Margin Expansion + M&A + Share Repurchases = Proprietary Growth Rate

8.25% + 2.0% + 0.5% = 10.75%

Overall Thesis:

Given their technology, CPRT has a first mover advantage, especially compared to their mom-and-pop competitors. This advantage gives the company a significant advantage to be the preferred auctioneer, as it increases yield per vehicle. Copart has seen consistently high growth in both net income and margins, while steadily utilizing free cash flow to finance projects and acquisitions. They have placed a strong focus on growing through acquisitions, creating economies of scale, and providing their customers with the best technology in the industry. Copart has been making a strong effort to diversify away from the U.S. segment by utilizing their tried-and-true processes to push for growth both globally, as well by increasing their breadth of service. We feel confident in the management’s ability to carefully steward shareholders’ capital and accretively invest and continue to compound capital at attractive yields over the long run. Not to mention, insiders own 10% of the shares outstanding, so we are investing alongside the owners. In a nutshell, CPRT is an easy way to play the ever-growing problem of texting and driving!

Disclosures

Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. Forward looking statements cannot be guaranteed. It should not be assumed that any of the securities transactions, holdings or sectors discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. A complete list of holdings is available upon request.

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Aptus Musings: Stock Highlight – NVIDIA Corporation

David Wagner — Mon, 05 Sep 2022 15:56:02 +0000

With this Aptus Musing focusing on the stock of the month, I thought I’d review the stock that has the least amount of U.S. exposure in our Compounders Portfolio – NVIDIA Corporation (NVDA). See the compliance approved Case Study here.

But, before we start our dive on NVDA, let’s revisit the Aptus Compounders overall strategy exposure to China – hint, it’s de minimis. NVDA is the outlier in the portfolio with the company deriving around 25% of its revenues from China, but the rest of the portfolio’s positions are 10% or lower. Holistically, the portfolio has half the exposure to China relative to the S&P 500. Given the macroeconomic worries in China, growth and potential flaws in the real estate market, we’d love to keep this underweight.

NVIDIA Corporation (NVDA)

What Does NVDA Do?

NVDA is a software and fabless company which designs graphics processing units (GPUs), application programming interface (APIs) for data science and high-performance computing as well as system on a chip units (SoCs) for the mobile computing and automotive market. NVIDIA is a global leader in artificial intelligence hardware and software.

At its core, NVIDIA looks to use its rich history of GPU technology in order to penetrate some of the fastest growing and largest end-markets in the semiconductor industry. Several of these markets have TAMs in the $10s of billions range, and NVIDIA has been able to drive double-digit 3-year revenue CAGRs in most of these markets. The company can drive accelerated innovation by leveraging its GPU architecture and its software across all of its end-markets. By doing this, NVIDIA is able to introduce “industry-first” technologies. Over the next several quarters and years, we expect the company to continue to drive innovation in the gaming, professional visualization, data center, and automotive markets. Finally, we expect the company to continue investing in its technology in order to maintain its market leading position across its verticals.

Tackling the Elephant in the Room – U.S. Tensions with China:

Many of you know that this stock is down 28% since the market’s high on June 16^th, 2022, underperforming the S&P 500 by close to 20%. The big question is … why?

What’s Going On?

Last week NVIDIA put out an 8-K highlighting new export license requirements for their A100 and H100 shipments into China, quantifying $400M potential impact in Q3 2022,

and highlighting further risks such as potential delays to H100 development. It appears now that NVIDIA received some further approvals after releasing this 8-K and put out another 8-K last Thursday. Upon the initial announcement, NVIDIA would have been prohibited from shipping product to themselves or their partners in China for the purpose of finalizing development of the forthcoming H100 system – hence yesterday’s release signaled potential for delay. The new permissions now remove this risk and give NVIDIA the ability to ship product for this purpose. The new authorization gives NVIDIA permission to perform exports to support US customers. The China revenue (~$400M/Q at least as of Q3 2022) remains at risk. But we’ve seen most analysts deduct this from their models – showing it could be a permanent demand destruction. We believe NVIDIA’s datacenter opportunity is very large, and not dependent on China (relevant revenues are LDD% of datacenter sales, not trivial but not devastating either). However, the risk of potential restrictions on advanced hardware sales to China, while already on the radar screen, is now going to be an even bigger and more visible controversy. The natural questions will be who could be next, what potential escalations we might see (from either side) going forward, and what China might do in response long term.

What Does This Mean? The geopolitical tensions between the U.S. and China are not going away anytime soon. NVDA generates 25.4% of their revenue from China. We will probably continue to see this exposure get discounted in the company’s valuation, much like we have seen this entire year.

D + G Framework:

0.12% + 12.57% = 12.69%
Yield: 0.12%

NVDA hasn’t increased its dividend the last few years from $0.16/year. The company pays a paltry dividend, but we know that the company continues to invest in growth, hence why its dividend payout ratio is less than 10%.

Growth: 12.57%
Organic Growth + Inorganic Growth + Margin + Share Repurchases = Growth Rate 12.57% + 0.00% + 0.00% + 0.00% = 12.57%

Our estimates are slightly below most analyst’s expectations as we 1) tend to be more conservative than most, and 2) believe that continued inventories will remain elevated in the near future.

Valuation Analysis:

NVDA is not an easy company to analyze. With its fingers in so many forward-looking technology pots, it’s hard keeping up with developments that represent new potential upsides for the company. However, when you distill it down to its essentials, we view NVIDIA as an enabler of industries and a facilitator of the technologies they use. And, because of its approach to new technologies, we believe it has evolved into a company with a near-perpetual upside. Whether it’s gaming, data centers, autonomous systems, data science, or any one of the numerous industries it engages with, NVIDIA provides the superlatives that its clients need to maintain their own edge – fastest, smallest, most powerful, and so on and so forth. Some investors net out cash when computing the P/E multiples – given the capital on the balance sheet here, you can do that – making NVDA look a bit cheaper.

NVDA has not been immune to the re-rating that the market has gone through this year. Given their market penetration and addressable TAM, we place heavy emphasis on consistent and profitable growth into the future.

Bull Case:

A Diversified Juggernaut with a Competitive Edge– Given that NVDA has its fingers in so many forward-looking technology pots, we believe it is hard keeping up with developments that represent new potential upsides for the company. However, when you distill it down to its essentials, NVIDIA can be seen as an enabler of industries and a facilitator of the technologies they use. Whether it is gaming, data centers, autonomous systems, data science, or any one of the numerous industries it engages with, we believe NVIDIA provides the superlatives that its clients need to maintain their own edge – fastest, smallest, and most powerful.

Continued Strong Product Demand – NVDA continues to post double-digit revenue growth, and yet, they still cannot get enough product to satisfy all of the demand.

Innovation Strength – The ongoing push in enterprise software suites is an opportunity into tens of millions of servers and which should be incremental to valuation when revenue contribution takes off, in our view. Management expects supply constraints to last through most of next year, notably in gaming, which bodes well once inventory eventually rebuilds begin. RTX is still in an early cycle ramp with an estimated adoption rate of only 20%.

Bear Case:

Highly Competitive Industry– Unlike many of our holdings, NVDA does not compete in a monopolistic or oligopolistic market environment. NVDA operates in highly competitive markets with strong competitors – RMD, INTC, plus numerous others. Luckily, we believe NVIDIA has a leading or strong market share in multiple industry verticals which seems to have come from what we consider an aggressive R&D expenditure and product release cadence.

Continued U.S. / China Restrictions– Continued tensions between the United States and China could lead to increased regulation, potentially hurting the company’s valuation.

Semiconductors is a Cyclical Industry– Historically, the industry has experienced drastic fluctuations leading to overcapacity in the market. These downturns can be prolonged and can drastically impact revenue, profitability, cash flows, and stock performance.

Investment Thesis:

We see NVDA as a major beneficiary of the 4th tectonic shift in computing, in which parallel processing captures share in the computing market. We believe that the market underappreciates NVDA’s businesses and its transformation from a traditional PC graphics chip vendor: into a supplier into high-end gaming, enterprise graphics, cloud, accelerate computing and automotive markets. From our perspective, the company has executed consistently, and has a solid balance sheet with what we believe to be a demonstrated commitment to capital returns.

We understand the unwelcoming landscape regarding China and the U.S. restrictions but believe that they are manageable over time.

Disclosures

The S&P 500® Index is the Standard & Poor’s Composite Index and is widely regarded as a single gauge of large cap U.S. equities. It is market cap weighted and includes 500 leading companies, capturing approximately 80% coverage of available market capitalization.

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Aptus Musings: Stock Highlight – Dollar General

David Wagner — Wed, 29 Jun 2022 15:06:24 +0000

It’s been quite some time since we highlighted a single stock in our Aptus Compounders sleeve. To be quite honest, it makes complete sense given the level of market uncertainty here. We know that volatility creates opportunities – especially in the equity world, as not all stocks are created equally. Let’s focus on a stock that has performed quite well through this period. In fact, as of 6/27/2022, the stock is up 6.6% YTD, outperforming the S&P 500 by 24.1%. Surprising to many, this is not an energy stock – in fact, it’s quite different than an energy stock – it’s the discount retailer, Dollar General (ticker: DG).

See the compliance approved Bull/Bear Case Study here.

Let’s dive in:

What Does Dollar General Do?: Dollar General is the largest dollar store chain in the United States by revenue and second largest by store count. The company generated roughly $37.4bn in revenue in 2021 and operates more than 18,000 stores in 44 states offering an assortment of everyday items, including highly consumable merchandise, seasonal, home products and basic apparel.

Source: Company Annual Report, Data as of 5/27/2022.

What is our Overall Thesis?: DG remains an attractive “all-weather” investment opportunity. In our view, DG has the capabilities and real estate growth strategy (multiyear) to gain market share by targeting quick “fill-in” trips for cash-strapped consumers, in a wide variety of economic environments. While there are investor questions on the low-end consumer’s spending power, employment still remains strong and DG’s value (low price points, small packing sizes, etc.) to that customer is even more important in today’s inflationary environment. Furthermore, rising fuel prices (currently ~$4.60/gallon) could lead to consumers to shop more closely to their home (75% of the U.S. population is within five miles of a DG store). Finally, while cost/supply chain inflation remains a concern for the value retail space, we believe DG’s private fleet is a competitive advantage (~20% savings vs. third-party fleets).

Why Do We Have Conviction? We believe the combination of DG’s NCI and pOpshelf initiatives alongside the ongoing consumer trade-down related to the current inflationary environment provide the company with ample opportunities to drive growth moving forward. DG currently trades at ~19x P/E and ~15x EV/EBITDA on a FY’22 basis, relatively in line with historical averages.

Yield + Growth Framework

0.88% + 10.75% = 11.63%

Yield: The current indicated yield of 0.88%. The more impressive aspect is that DG has been able to grow its dividend by 10% on average a year since the div. initiation, while keeping the dividend payout ratio ~20%, allowing plenty of room for investment regarding growth.

Growth Rate: SS Comp + Inorganic Growth + Margin Expansion from Strategic Initiatives + Share Repurchases = Growth Rate: 4.25%% + 2.50% + 0.50% + 3.50% = 10.75%

Other Thoughts on SS Comp Growth: DG is confident that their core customer remains in relatively good shape, buoyed by a strong job market. That said, DG has observed notable changes in shopping behavior, including, 1) softer discretionary sales and trade down into private label assortments, 2) shorter trip distances with more customers shopping closer to home, and 3) smaller basket sizes.

Other Thoughts on Margin: Margins on consumables are better than they were three years ago. Margins in consumables have benefited from DG Fresh, while Health & Beauty margins are more similar to non-consumables and DG has been deliberately growing that part of the business. DG is probably one of the few companies growing their margin during this period.

Other Thoughts on EPS: EPS growth should accelerate meaningfully in 2H 2022 as sales comps get easier and DG laps short-term gross margin headwinds from freight and LIFO (“Last-in-First-Out”).

Valuation Analysis

We think DG’s strategic initiatives should help mitigate margin pressures and provide support to margin, and ultimately, valuation. The strategic initiatives include including:

1) DG Fresh

2) Expanded health offerings

3) NCI rollout

4) Cooler door expansion

5) Digital enhancements

7) DG’s private fleet expansion

8) Real estate projects, among others.

While strategic initiatives won’t expand the current multiple in our opinion, it should help insulate it as the market has started to punish those companies that are witnessing margin compression. As mentioned above, DG may be one of the few companies where we may see margin expansion in the current environment.

Bull Case

Accelerated Store Remodels/Relocations & Incremental Store Openings:

The most important driver of Dollar General’s performance has been the success of its real estate projects. A traditional store remodel delivers a 4% to 5% comp lift and the DG Traditional Plus or DG Plus remodels deliver a 10% to 15% comp lift. Importantly, management plans to accelerate new store openings to 1,100 stores and remodels/relocations to 1,580 stores, with ~70% of store remodels in the DG Traditional Plus or DG Plus format (higher comp lift). As a result, a greater percentage of the store base will be in an updated format. The greater percentage of remodels mixed with an acceleration of new store openings and instore initiatives should continue to drive solid sale sales growth in the future.

International Expansion is a Nascent but Potentially Lucrative Opportunity:

We believe DG’s expansion into Mexico provides ample growth opportunities. While the company has previously acknowledged it will take time to achieve scale in the region, we believe this initiative could provide meaningful benefits to the company over time.

Incremental Value Adds:

DG noted that its NCI and pOpshelf initiatives continue to present attractive growth opportunities.

To this end, NCI is available in >13,000 stores and the company indicated that NCI stores continue to generate an incremental 2.5% total comp sales lift on average in the first year after implementation as well as drive a meaningful improvement in GM.
DG also noted its pOpshelf opportunity is significant, with the company highlighting strong customer reception, healthy average basket sizes, and robust unit economics. With 90%of products below $5, we view pOpshelf as well-positioned in the current environment.
Increased Share Repurchases and Cash Dividends:

Over the last five years, Dollar General has returned almost $6B in capital via dividends and share buybacks to shareholders. This equates to 14% of current market cap – a staggering figure. This policy should help the stock outperform during market volatility, as it has in recent periods.

Bear Case

Too Many Stores:

Admittedly, with the changing retail environment, there is a big worry about the potential of Dollar General having too many stores. Dollar General is one of the few companies increasing its store footprint during the new Amazon age.

Very Competitive Environment:

Dollar General competes against many retailers, i.e., grocery, big box, drug stores, etc. Competition is very high and at the end of the day, the consumer decides where to shop. Therefore, if management is unable to successfully drive store traffic, Dollar General’s top line growth would diminish.

Macroeconomic Slowdown:

A negative change to macroeconomic factors could reduce customer’s spending and thereby negatively impact Dollar General’s profitability. To note, many of Dollar General’s customers have limited amount of income to spend on discretionary products; therefore, any impact to their disposable income could drive decreased sales and earnings for Dollar General.

Disclosures

All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment & tax professional before implementing any investment strategy. Investing involves risk. Principal loss is possible.

The company identified above is an example of a holding and is subject to change without notice. The company has been selected to help illustrate the investment process described herein. A complete list of holdings is available upon request. This information should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the holdings listed have been or will be profitable, or that investment recommendations or decisions we make in the future will be profitable.

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Aptus Musings: Stock Highlight – Home Depot, Inc. (HD)

David Wagner — Thu, 10 Feb 2022 23:22:18 +0000

Who-Dey Fans-

I am writing this with a smile on my face. The Cincinnati Bengals are going to the Superbowl – something I never thought I’d say – I’ve re-watched the game thrice. I keep my “Joey Burrow Prayer Candle” next to my laptop, as I don’t want to let it out of my sight – Joey Burrow has never been injured during a game while it has been lit. This isn’t superstitious – just a little ‘stitious.

Two years ago, the Bengals won only two games. Last year, they won 4. The Cincinnati Bengals have started to build, from the ground up, quite a franchise around young players – Joe Mixon, Ja’Marr Chase, Joey Burrow.

So, on our stock highlight of the month, I chose a company that focuses on building from the ground up. A company that sports a large orange sign – Home Depot, Inc. (HD).

Please note – at the bottom of this email, I’ll provide some commentary on a few idiosyncratic stock earnings reports – y’all can probably guess the culprits.

Home Depot, Inc. (HD)

What Do They Do?

Many homeowners know the Home Depot brand, as they can attest to their continued shopping at national hardware store for home remodeling, but what they may not be aware of is that only about half of the company is dedicated to serving “Do It Yourself” homeowners. The other half of the business is acting as a key supplier to small contractors – which the company calls “Pros” – who depend on Home Depot as a mission critical business partner.

Why is the Business Structure Appealing?

This Pro segment accounts for just 4% of their customer base, but about 45% of revenue. Basic math implies that this means the average contractor customer spends about 20x the amount that the average homeowner customer spends. In an industry where you want to drive high levels of sales per store, the contractor customer profile is super attractive. It is why Home Depot spends so much focus on serving contractors (Pros), and it has led to a great success as HD generates about 30% more revenue per store than its main competitor, Lowe’s – which has far fewer professional contractor customers. Given this statistic, its no surprise that Lowe’s has tried to enter this market – we don’t see this as a significant risk in the NT.

We largely believe that Lowe’s (LOW) is behind the eight-ball regarding their rollout because HD has heavily invested in this program, especially online. For instance, their Pro Online interface allows for the exporting of order history to Quickbooks, the accounting software used by most small contractors, making it easy to manage delivery options to a large number of active job sites. This technology creates sticky and loyal business customers.

Bull Case:

Strong US Consumer & An Aging Housing Supply: Record low unemployment, improving wage growth, and 50% of US homes are older than 40 years of age all bode well for HD. The low interest rate environment and a strong housing sector stimulates home buying/selling activity which directly benefits sales. Looser credit gives consumers more ability to do bigger scale projects. This has resulted in a continual Increase in sales per square foot and increased customer productivity.
Pressing the PRO Advantage – While already ~45% of sales, HD’s Pro business represents one of the most significant growth opportunities over the next several years. Specifically, the addition of enhanced delivery capabilities, improved data analytics, a personalized B2B website, and enhanced capabilities around services such as tool rental represent key levers that should help HD tap into new Pro customers and expand its wallet share with existing Pros in the years ahead. We also believe the acquisition of HD Supply will allow HD to accelerate market share in the highly fragmented MRO space.
Post-Pandemic Beneficiaries – As Americans emerge from the pandemic, they will be reevaluating their housing needs. Remote work options may cause more homeowners to consider moving, with home improvement projects being common in preparation for sale as well as when a new family first moves into a house. Many people who do not move will still plan to work from home with some regularity, driving demand to create office space in their house with associated remodeling expenditures.
Vertical Integration on the Supply-Chain = Control Your Own Destiny – HD is in the midst of a multi-year journey to transform/redesign its “downstream” supply chain, with the goal of creating the fastest, most efficient delivery offering. In short, HD is significantly expanding its direct fulfillment center network and is adding cross-dock facilities to facilitate same/next-day delivery in the top 40 markets. While stores will still play a large role in secondary markets, HD is consolidating delivery into fewer locations to drive efficiencies.

Bear Case:

Housing Market Deterioration – Renewed deterioration in the housing market could negatively impact demand for HD’s products/services, particularly those driven by housing turnover activity. In addition, home price depreciation could cause weakness in bigger-ticket home improvement projects/renovations.
Economic Conditions – A contraction in consumer spending resulting from macroeconomic factors such as higher interest rates, rising fuel and energy costs, prolonged weakness in the housing market, and increased unemployment levels could negatively impact sales.
Irrational Pricing – Industry players could become more aggressive with price in an attempt to drive traffic and market share gains. Any price war would adversely impact both sales and profit margins.
Increased Restrictions in Credit Availability – Increased restrictions in credit availability could negatively impact sales, as big-ticket home improvement projects are often financed.

Q3 2021 Earnings – Nailed it !

Home Depot reports Q4 2021 earnings on February 22^nd. So, let’s take a quick look at their Q3 earnings. HD had better-than-expected Q3 results, which reinforced our positive view on the name. Specifically, Home Depot is flexing its considerable scale and operating capabilities to navigate unprecedented supply chain friction, secure inventory and capitalize on still healthy sector demand trends. When combined with a portfolio approach to handling product cost inflation and renewed emphasis on expense management, HD’s P&L agility was fully on display during the quarter. This is why we love the stock – their dynamic nature to adapt in a difficult supply chain environment, i.e., great management leadership with a strong business structure in place.

Is Amazon a Threat?

Despite the rise of Amazon, Home Depot has generated outstanding results for shareholders during the rise of eCommerce, even as Home Depot’s end market in housing suffered the worst collapse in a century. Of course, when competing with Amazon, having a strong eCommerce or Omnichannel strategy is just table stakes. But due to the nature of home improvement spending, where parts are often needed the same day and in many cases are heavy, bulky objects, the fact that well over 50% of Home Depot’s online orders are picked up in store, despite offering 2-day delivery to 90% of US households, speaks to the unique nature of this category and why we do not view Amazon as a meaningful threat.

Growth:

Who doesn’t like growth? Because HD has scalability. The best way to think about companies like Home Depot that generate high returns on invested capital (“ROIC”) is that these businesses can grow without needing to invest as much in their business to generate any given level of growth compared to companies with lower returns on capital – it’s the beauty of owning companies with inelastic pricing and a competitive moat. For HD, their success in growing the business without needing to invest that much capital is well illustrated by their fundamental growth over the last decade – the number of stores they operate has only increased by 2%, even while revenue has more than doubled. Economies of scale at its finest.

Technicals:

HD dropped to its 2021 May highs and the 200-SMA at the same time during this year’s pullback, pointing to a great long-term entry with a long-term trend. The company reports earnings on 2/22 and the next steps for HD is to maintain the 200-day moving average lows and look to take out the 50-SMA, which is turning negative from above near $400. Support should be near the 400-SMA and the lows from June last year near $300 on any drop further.

Source: Bloomberg, Data as of 2/2/2022

Overall Thesis:

While Home Depot has executed extremely well over the last decade, it did so in the context of a weak overall economy, the worst housing crash in a century, an existing base of homes that had more new homes (needing less home improvement work) than the historical average, and low or even negative equity restricting homeowners’ ability to finance home improvement projects. But we believe the housing end market is in the midst of a Great Reshuffling, especially given the current “post-COVID” world.

We believe HD remains a strong story in the retail sector given company-specific sales and margin initiatives, the duopoly/AMZN resistant nature of the industry, and significant financial and operating leverage that amplifies EPS growth in better sales environments. With internal momentum building, we expect HD to benefit from its refocused branding and value proposition, which has driven favorable traffic and ticket trends at the retailer. In addition, internal initiatives enable HD to gain share vs. its competitors. These efforts should yield accelerating incremental margins, good cash flow, and EBITDA growth that will necessitate more leverage (thus buybacks and dividends). HD has a proven track record of a deep focus on the culture with a strong customer/employee experience while also historically proving strong shareholder returns. In our opinion HD makes a relatively boring business innovative and fun by engaging the customer whether it be in the store or its growing online business.

Updated Yield + Growth Framework

Yield + Growth = Total Return

1.77% + 9.75% = 11.52%

Sales Growth + Margin Growth + Inorganic Growth + Repurchases = Growth Rates

7.75% + 0.50% + 0.00% + 1.50% = 9.75%

Idiosyncratic Earnings Reports:

Meta (FB) – It was a perfect storm to hit Facebook Meta as they guided poorly regarding their FY Q1 2022 earnings – but, at its core, I guess it’s better to invest in growth than to stay stagnant?
1. Earnings: While Q4 revenues were in-line, pressure on Q1 growth was more pronounced than anticipated, as Meta deliberately shifts towards lower-monetizing video content compounding impacts from tougher comps, FX translation and Apple’s privacy changes. Obviously ad spending was the black eye of the guidance. Looking further ahead, we see Q2 trends somewhat similar to Q1 before 2H growth benefits from easier comps, more tools to combat privacy headwinds, and presumably improving video monetization. With Q1 guidance out of the way, we continue to see a brighter path for shares once investors focus on re-accelerating double-digit growth in 2H.
2. Valuation: We believe after hours valuation is attractive at ~13x 2022E Core EPS vs. mid-teens LT EPS growth.
PayPal Holdings (PYPL) – Long Road to Redemption Here In My Opinion, as PYPL’s Strategy Pivots Away from User Growth
1. Earnings: The call shed more light on the startlingly low Net New Active Account guide for FY22, as management has pivoted towards driving more engagement from high-value customers, & pulled the target of 750M active users by FY25. We view the market’s reaction to this report as justified. At Aptus, we think that PYPL needs a new direction, thinking that to drive growth they need more physical POS processing, something which may require M&A – which is not likely under the current management team.
2. Valuation: We believe that valuation remains the biggest worry here, outside that the market may be too optimistic on LT growth now. Given our POS comments and the company needing a new direction, PYPL shares could trade at a discount to Visa (V) and Mastercard (MA).

Disclosures

The company identified above is an example of a holding and is subject to change without notice. The company has been selected to help illustrate the adviser’s investment process. A complete list of holdings is available upon request. This information should not be considered a recommendation to purchase or sell any particular security. The securities identified and described do not represent all of the securities purchased, sold, or recommended for client accounts. It should not be assumed that any of the holdings listed have been or will be profitable, or that investment recommendations or decisions we make in the future will be profitable. Recommendations made in the last 12 months are available upon request.

Advisory services offered through Aptus Capital Advisors, LLC, a Registered Investment Adviser registered with the Securities and Exchange Commission. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (251) 517-7198. Aptus Capital Advisors, LLC is headquartered in Fairhope, Alabama. ACA-2202-13.

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Aptus Musings: Stock Highlight – Roper Technologies, Inc. (ROP)

David Wagner — Thu, 09 Dec 2021 23:17:41 +0000

Many of you know that we run various “stock sleeves” that we use as S&P 500 tracking replacements – Aptus Compounder (15 high-conviction stocks) and Aptus Core (~50 Stocks) that is composed of both the Aptus Value (25 stocks) and Aptus Growth (25 stocks) portfolios. The intended use of these sleeves is to give single stock exposure to portfolios that does its best to have minimal tracking error to its model replacement, i.e., the S&P 500. With all of these stocks, we provide occasional updates, bull/bear cases, and research reports for clients/advisors to use at their leisure.

So, moving forward, we’d like to highlight one of the Aptus Compounder stocks a month (We did FIS last month). We monitor every stock daily, so we figured that it would be easy for us to transition our notes into a palatable report for everyone.

Compliance Disclosure: Past performance is not indicative of future results. All references to “we/us/our” refer to the views and observations of JD, John Luke, Beckham, and myself.

Roper Technologies, Inc (ROP)

What Do They Do?

Roper operates in niche markets that are generally neglected by technology and insulated from broad competitive threats. At Aptus, we ascribe the value of Roper less to the collection of end markets served and more to the company’s methodology of perpetual capital deployment into asset-light businesses that continually enhance the firm’s cash return on investment (CRI), enable FCF to compound rapidly, and ultimately feed a virtuous cycle of acquired and organic growth.

Roper’s collection of software is mostly in boring verticals (think insurance, power plants, automation, supply chains, and the like). There are some “fun” businesses like 3D animation software in there but mostly it’s stuff in the same “essential but unexciting”.

Bull Case:

Best-in-Class M&A Model – Roper gets a lot of credit for its time-tested M&A model, and we believe that credit is much deserved. Roper has common attributes with private equity firms in that it applies a financial/strategic methodology and consistently acquires companies. Unlike private equity firms, Roper tends to be an acquirer of choice because it: allows current owners to take meaningful cash out, plus Roper runs a decentralized business model, allowing previous owners/founders to maintain its corporate identity and continue to participate in the upside as the business performs.
Compounding Free Cash Flow is the Magic Elixir – It is hard to call free cash flow a secret, magic, or critical to a business strategy without sounding like Captain Obvious, but we will anyway. Aptus believes the way management thinks about cash flow generation is fairly rare in the public domain. The playbook is straightforward: generate as much cash as possible with minimal assets and roll that cash into acquisitions that fuel further cash generation and feed the virtuous cycle. Seems simple, but we believe the execution has been stellar, and it is exemplified in the company’s financials.
Investing in Niche Markets Creates a Barrier-of-Entry – A common tenet of the Roper story is its focus on vertical markets or market niches. This focus creates a meaningful barrier to entry, limits the scale and strength of competitive dynamics, and facilitates a positive pricing dynamic in markets with rational competitors.

Bear Case:

Acquisition Model Risks – Roper’s future growth will largely be linked to management’s ability to acquire and successfully integrate new businesses. Roper’s intense acquisition strategy presents risks related to target availability, integration, financing, and target selection. Financing these acquisitions will be dependent on Roper’s ability to generate FCF in the future.
End-Market Volatility – A portion of Roper’s annual revenue is rooted in industrial (~17%) and energy (~12% oil and gas) markets, which are typically cyclical and reliant on the well-being of local and global economies.
Price is What you Pay, Value is What you Get – ROP trades at a premium valuation on almost all traditional metrics, most notably P/E and EV/EBITDA. However, when considering the company’s cash conversion, superior margins, and light asset exposure, we believe the premium can be easily justified. The main hurdle for maintaining the premium valuation will be continued M&A execution and balance sheet management – two things management has been doing very well for more than 18 years. Furthermore, given their goal of selling off the lower margin businesses, we could see overall company margins increase – potentially re-rating the company’s valuation higher.

Like it? Nah, We Love ROP:

Roper Technologies is a diversified industrial technology company that provides software and engineered solutions to a diverse and attractive set of end markets including medical, industrial, energy, transportation, food, and other end markets. Its model is predicated on competing in niche markets with an asset-light model to generate gaudy amounts of FCF, which compound over time to feed Roper’s acquisition engine. Our constructive view of ROP is based on shares being catalyzed by accelerating organic growth and effective capital deployment (M&A), which will create strong FCF generation allowing the company to reinvest in high returning projects. We have full faith in the management team to continue executing this strategy at a very high-level.

Recent News

Last month, Roper announced it will divest its third largest business, TransCore, the leading smart city solutions company, to ST Engineering. The $2.68 billion transaction is expected to close by the end of Q1 ‘22 and represents the largest divestiture in the firm’s history. While we are huge fans of TransCore, we like the transaction from virtually every angle – and it is right in line with our de-lever, deal flow, and divestitures thesis post its recent acquisition of Vertafore.

As a company, Roper is targeting a 50% EBITDA margin from its operations, yet TransCore was pulling in just 24%. Secondly, TransCore had shown minimal organic growth in recent years, whereas some of Roper’s businesses have had decent growth prospects on their own. So, Roper is selling a business that is only half as profitable as its other businesses for a multiple of 20x EBITDA. Currently, Roper is trading around 19x forward EV/EBITDA. The market thinks the business overall, with its focus on software and 50% EBITDA margins is worth around this multiple. Yet, it just sold one of its lower margin, no-growth divisions at 20x EBITDA. Makes you wonder what sort of price Roper could get if it tried to monetize some of its flashier assets. So, even though its current multiple may feel expensive on an absolute basis, maybe it’s undervalued à receiving the conglomerate discount.

Growth:

Since its 1992 IPO, Roper has grown revenue, EBITDA, and EPS in excess of 20% annually. A mix of internal growth and margin accretive acquisitions has driven revenue and FCF growth. ROP still operates in select cyclical industries, yet the diversification strategy has been a major focus of management (Medical, business applicationsoftware) to ensure solid internal growth, margins and FCF growth through economic cycles and reduce capital intensity. Over the next few years, Wall Street analysts are expecting growth to sustainably be double-digits.

Technicals:

ROP consolidated well over the last 18 months. Late in 2020 and early 2021, it tested supportive fundamental levels ($370 area) as well as LT trend lines (200 and 400 sma’s). $450 was resistance until it broke out decidedly in July ’21. During the Sep-Oct broader market swoon, it fell to its 200 sma for support and also found buyers @ the $450 level again. Support from here should be expected near the $450 level and 200 sma as LT investors buy on LT trends.

Source: Factset, Data as of 12/9/2021

Updated Yield + Growth Framework

Yield + Growth = Total Return

0.53% + 10.50% = 11.03%

Sales Growth + Margin Growth + Inorganic Growth + Repurchases = Growth Rates

9.00% + 1.50% + 0.50% – 0.50% = 10.50%

Disclosures

The post Aptus Musings: Stock Highlight – Roper Technologies, Inc. (ROP) appeared first on Aptus Capital Advisors.