Our Cure to the Summertime Blues

August is usually a pretty slow time for the stock market, with many Wall Street traders taking advantage of the lazy days of summer to enjoy their “weekend cottages” in The Hamptons. Evidence of which was very low trading volume on the major U.S. stock exchanges during the past month, accompanied by a corresponding spike in volume of martini sales in eastern Long Island. Almost surreptitiously, the S&P 500 Index finally broke through the 2,000 level in late August while the Dow Jones Industrial Average remained above 17,000.

Although tech companies are generally regarded as comprising the bulk of “momentum stocks” that have contributed to the market’s ascent to record levels, the fact of the matter is that the tech-heavy Nasdaq Composite Index still remains almost 10% below its record level of 5,048 reached way back in March of 2000 while the other major indexes are presently at, or near, all-time record highs.

It will be interesting to see how the market performs over the remainder of this year, especially with rapidly escalating tensions in Russia and the Middle East. Throw into the mix mid-term U.S. Congressional elections only nine weeks away and you have the ingredients for a pretty volatile market.

For those reasons, we have taken a number of steps recently to lock in gains on stocks that now appear to be fully valued. The first lesson I learned as a stockbroker more than thirty years ago is “you’ll never go broke taking a profit”, and some of our holdings had appreciated to the point that we didn’t want to risk losing those gains by being too greedy.

So, over the past couple of weeks we have closed out positions in EMC (NYSE: EMC), Lenovo (OTC: LNVGY), Western Digital (NSDQ: WDC), and Seagate (NSDQ: STX). While we still like all of those companies, their share prices had appreciated to the point that we felt most of the near term gain had been realized and there was more risk than reward at current levels.

I also adjusted the Stop/Sell prices for many of our current Investments Portfolio holdings to protect against a major stock market correction. For the uninitiated, you can enter a Stop/Sell order with your broker at a price below the current market value of a stock, and if it drops down to that price it then converts to a “market order” and is executed at the next available price.

The idea is to retain most of the gains you have built up over the past year, while resisting the temptation to hold on to a stock a little longer in hopes that it might reverse course and go back up to its previous high. All too often I have witnessed investors hanging on to stocks as they slowly dropped in price, and a Stop/Sell order can prevent that from happening to you.

In addition to all of that we also made a significant enhancement to the STI analyst team last month, bringing on long time tech industry expert Rob DeFrancesco to manage the Next Wave Portfolio, to which he made two additions last month. In this issue Rob also includes an update on Next Wave holding Teradata Corp (below)., which was added to the portfolio on May 20th when the stock closed at $40.80 and is now trading above $46.

Our objective in all of these actions is to help you make more money in the stock market, which, after all, is presumably what you pay us to do. We have enjoyed a very good first eight months to this year and don’t want to give it all back in the final four months.

NASDAQ Composite Index:                                                                     

Friday, August 29 = 4,580.27                                               

Year to Date = + 10.6%                                     

Trailing 7 Days = + 1.0%                                   

Trailing 4 Weeks = + 5.1%

Portfolio Update: Teradata —Big Data Beneficiary

By Rob DeFrancesco

Even as lower-cost alternatives steadily push into its territory, Teradata (TDC) is holding its own. While there’s barely any revenue growth at the company (1% in the latest quarter), there are subtle signs of an improved outlook ahead.

Teradata is definitely benefiting from the broad demand wave for big data storage, management and analytics solutions. And expectations on Wall Street have become so tamped down that the company is now delivering upside earnings surprises. If Teradata can continue to surpass estimates, the stock has better odds of gaining upside momentum.

In the second quarter Teradata reported results that beat on both the top and bottom lines: EPS of 72 cents was above the consensus estimate of 65 cents and revenue of $676 million easily bested the consensus of $661.5 million. Product revenue of $300 million declined 1% year over year, while services revenue of $376 million rose 2%.

There was some slippage in gross margin—to 56.1% from 57.9% in the year-ago period—because of increased sales of lower-end data warehousing appliances that have slimmer margins.

Revenue in the Americas (45% of total revenue) fell 8%, but international revenue (55% of total) gained 14%. Some international deals that had been expected to close in the third quarter were clinched in Q2, driving the solid performance overseas. Western Europe and Japan remain good growers, while China has been flat of late, but is setting up for a better second half because of a build-up in the deal pipeline.

New data warehouse customer wins in the quarter were the second highest ever for a Q2, a positive metric because Teradata generally sees repeat business from new accounts within the first 12 months worth 80% of the original purchase. Given that Teradata’s deal cycles are long (that’s because the company’s deal sizes are high, averaging around $1.7 million), new accounts usually provide add-on revenue flow for three to four years after the initial signing.

One thing I like about Teradata CEO Michael Koehler is that he is very forthcoming on the earnings conference calls. He tells it like it is, whether good or bad. I remember in the fall of 2012 (when Teradata shares were trading in the low $60s), Koehler on the Q3 earnings call back then said there were indications of belt tightening at the company’s larger customers in the Americas, particularly among those that had significantly increased their spending with Teradata over the previous 30 months.

At the time, that telegraphed to me a pending downward cycle for the company. And it turned out to be the case: EPS for 2013 declined 3% and Teradata shares last year were in a general downtrend. The stock hit a 52-week low of $37.66 this past May.

On the latest earnings call, Koehler seemed generally upbeat. While he did say Q3 could present some top-line challenges (mainly because of the international deals that were pulled into Q2), the tone of the call was encouraging, as the company has been closing a solid number of data warehousing upgrade deals and also bringing on new customers for its Aster analytics solution set.

Importantly, Teradata is becoming less reliant on its 50 largest customers, which for 2014 are expected to represent 25% to 28% of total revenue, down from 33% last year and 37% in 2012. Increased business at midsize accounts helps cut down on revenue lumpiness from quarter to quarter and assists management in making better forecasts, reducing the chances of a shortfall come earnings season.

On the expense side, Teradata over the past five years increased the number of its sales territories by 50%, adding a lot of sales capacity in the process. The company is now adding selectively, meaning it can start to really benefit from increased sales force productivity without a lot of incremental expenses associated with bringing on a bunch of new reps and getting them up to speed.

For the first half of 2014, cash flow rose 26% to $481 million, with free cash flow gaining 33% to $423 million. On the balance sheet, the company has cash & investments of $934 million, with debt of $263 million. Teradata has been putting some of its cash to work buying back shares: In the first half, 4.5 million shares were repurchased at a cost of $190 million. There is $450 million remaining on the buyback authorization.

It looks like 2014 will turn out to be a transition year. Management expects revenue growth to come in at the low end of its prior guidance range of +3% to +7%, with EPS at the low end of the prior range of $2.85 to $3.00. The current consensus EPS estimate is $2.86, representing growth of 3.6% year over year.

With the pick-up in new data warehouse customer wins and continued solid demand for its solutions from its installed base of customers across a variety of verticals (including financial services, retail, manufacturing, telecom, media & entertainment and e-commerce), Teradata is positioned for a potential reacceleration in growth next year.

For 2015, the consensus revenue estimate of $2.93 billion indicates growth of 5.5% (acceleration from expected 3.1% growth based on the 2014 consensus) and the consensus EPS estimate of $3.13 represents growth of 9.4%.

Teradata remains a buy up to $45 in the STI Next Wave Portfolio.