|Kiplinger.com, Summer, 2019. This article was written with Ken Berman, founder of Gorilla Trades. It was part of a series of articles developed under an agreement with Kiplinger negotiated by me to designate Mr. Berman as a contributor and to deliver original articles for them on a regular basis.|
With a “Tariff Man” in office, investors have been buffeted by volatility and uncertainty. Where will President Donald Trump’s tariffs land next? Sure, Mexico is off the list for now – but it’s clear that Trump favors the use of tariffs for more than just trade imbalances, which means anywhere on the map (including countries we’ve reached agreements with) is fair game for future trade wars.
Which means it’s important to consider stock picks not just based on the current tariff situation, but on the possibility that Europe, Mexico and other regions could become more problematic in the future.
Finding insulation from the tariff effect is trickier than it sounds. For instance, most publicly traded casual dining restaurants operate most of their restaurants in the U.S. Thus, catering to primarily American consumers insulates them, right? Unfortunately, no. A University of California at Davis study shows 43% of fruit and vegetables – everything from strawberries and watermelons to avocados and onions – come from Mexico.
Autos? More than 1,000 Chinese companies export parts to the U.S.; some U.S. firms already are switching their suppliers. Apparel? A lot of that textile work in China is going to, um, come out in the wash. Even utilities are tricky. Sure, their customers are almost entirely domestic. But many are converting to wind and solar power, and while those natural resources are American, many of the solar panels and wind turbines are not.
Tariffs have far more impact than just the products themselves, too. The U.S. has slid from the fifth-most popular destination for Chinese tourists to 10th, thus losing some share of the estimated $315 billion they spend overseas. When considering the trade war, the warnings were about industrial companies and semiconductor firms. Few were thinking about the lodging industry.
Here, then, are five stock picks with trade war safety in mind. They come from a handful of disparate industries that provide more insulation from current and future trade salvos than most.
(1/5) Adobe Systems
- Market value: $140.6 billion
- Dividend yield: N/A
- Adobe (ADBE, $310.27) is a Wall Street darling. It’s an expensive darling, to be sure – at a price-to-earnings ratio pushing 60, it’s valued at roughly triple Standard & Poor’s 500-stock index. But with a five-year return of 325%, ADBE has delivered the goods. And with analysts projecting annual profit growth of more than 23% over the next half-decade, it’s poised to keep delivering.
Adobe provides software for creative professionals, consumers and enterprises. Its products are divided into three segments: Digital Media Solutions, Digital Marketing Solutions and Publishing. The company is best-known for its unique portfolio of software assets focused on its Creative Cloud, which allow both amateur and professionals to create and manage digital content. Most people will recognize tools such as Photoshop, InDesign and Dreamweaver. It also is well-positioned to benefit from the growing market for digital video content and advertising creation and management.
As a software company, tariffs won’t affect Adobe from an input-cost perspective. And while the company does generate about 40% of its revenues from overseas, those revenues are spread out across numerous countries. Moreover, almost 90% of Adobe’s revenues are subscription-based, meaning that even should some areas of its international base be temporarily tripped up by tense relations from a trade war, most of its sales should remain steady.
Also encouraging: Management typically beats conservative guidance for its quarterly and annual financial reports.
- Market value: $22.2 billion
- Dividend yield: N/A
Last October, we discussed health insurance stocks and how they profit by managing the federal government’s Medicare, Medicaid and other healthcare programs. This niche represents the perfect hedge against tariffs, as managing these programs is a service (requiring no imported materials), and a domestic service, at that.
The landscape has changed in that one of the health insurance stocks we recommended, Centene (CNC, $53.73), is acquiring another recommendation, WellCare Health Plans (WCG).
The merger, announced in late March, earned shareholders’ green light in June. It still must gain the approval of insurance regulators in a couple dozen states, but if it does, the deal is expected to close in the first half of 2020. Centene is paying roughly $17 billion in cash and stock, and the acquisition should yield $500 million in annual savings for the combined entity.
More importantly, the addition of WellCare to the Centene portfolio will grow the latter’s reach from 32 states to all 50. Further, WellCare is recognized as a leader in Medicare Advantage and Medicare Part D, bulking up Centene’s presence in these markets. Comparisons are hard to come by given the diversity and complexity of government healthcare programs. But the Centene-WellCare combination will create one of the largest managers of government-sponsored healthcare plans.
The play for Centene isn’t driven by M&A, per se, though the company is highly acquisitive. The opportunity rests mainly with the inexorable growth in healthcare spending. To wit, Medicare spending is projected grow 7.6% annually from 2020 through 2027, when it will reach $1.4 trillion. These figures demonstrate a large growing pie that Centene is well positioned to capitalize on.
Finally, CNC is off about 20% from its late 2018 highs and trades at just 11 times future earnings expectations. That makes now a constructive entry point if the rest of this bull case appeals to you.
(3/5) Crown Castle International
- Market value: $53.7 billion
- Dividend yield: 3.5%
5G technology has gone from being on the horizon to being in the here and now. And cell-tower companies have gotten red-hot.
The two major players in the space are American Tower (AMT) and Crown Castle International (CCI, $129.21) – a pair of telecommunications infrastructure real estate investment trusts (REITs). The names are a little misleading, however – American Tower is global, while Crown Castle’s 40,000 towers are located here in the U.S.
While domestic operations provide a barrier against trade wars, those steel-and-fiber towers provoke a question about whether Crown Castle is exposed to tariffs. In the Byzantine world of steel tariffs, it’s difficult to know whether a beneficiary today won’t be a victim tomorrow. As for the miles and miles of fiber, it’s difficult to know where it comes from. We asked CCI, but they were mum. But for what it’s worth, the company’s regular reports don’t acknowledge any exposure to tariff issues.
The answer is likely that CCI is exposed to tariffs, but just barely. The approximately $1.6 billion in capital expenditures for towers for 2018 is just under 5% of the company’s total assets and about equal to depreciation that year.
One reason to like Crown Castle is the financial strength of its customers, which consists primarily of large carriers such as AT&T (T) and Verizon (VZ), which – except for Sprint (S) – carry investment-grade debt ratings. Those ratings specifically deal with their ability to pay back bonds, but they’re also a good proxy with which we can assess their ability to pay long-term leases. Just understand the concentration risks involved in this industry, which consists of few players.
Another reason to like Crown Castle: The major carriers are testing 5G systems. The deployment of 5G services means more towers, and more importantly higher rental rates, because these networks require more power and processing at tower sites. 5G still is in the green-shoots phase, but the spread of deployment is inevitable.
Lastly, as a REIT, Crown Castle is required to distribute at least 90% of its taxable income as dividends. And like many REITs, CCI is a dividend-growth machine. The company began doling out dividends at 35 cents quarterly in 2014; that payout now stands at $1.125.
- Market value: $72.9 billion
- Dividend yield: 0.7%
- Intuit (INTU, $281.36) is another example of how technology can be sheltered from tariffs and trade issues.
Intuit provides a wide array of financial management and other business solutions for individual consumers, accounting professionals, small- and medium-sized businesses and even financial institutions. While you probably don’t know the name Intuit, you almost certainly know its products, which include TurboTax and QuickBooks. Best of all, this is predominantly a domestic business, with less than 5% of revenues coming internationally.
Intuit shares have been on a tear in 2019, racing ahead 43% to more than double the broader market. A hot fiscal second quarter (ending Jan. 31, when many people were prepping for the 2019 tax season) showed a 38% jump in QuickBooks Online subscribers, to nearly 3.9 million, with a wider operating margin. Earnings grew 19%, then another 16% in its fiscal third quarter, sending Intuit shares to a string of fresh all-time highs.
INTU is costly as a result, but this is a momentum-and-growth play. And Intuit is pouring more and more into R&D — $881 million in fiscal 2016, $998 million in ’17 and $1.2 billion in ’18 – which should help the company keep its edge. For instance, Intuit has augmented its popular TurboTax platform with TurboTax live, which lets users access a professional in real time as they prepare their taxes on using their software. This takes direct aim at tax preparer-assisted services, allowing Intuit to mine that $20 billion market.
(5/5) Store Capital
- Market value: $7.8 billion
- Dividend yield: 3.8%
Real estate investment companies can be exposed to tariffs if they are active developers and must source construction supplies. But not all REITs are builders; some buy and manage properties, reducing their vulnerability to a trade war.
- Store Capital (STOR, $34.41) is one such REIT. It focuses on single-tenant properties that house anything from auto dealers and furniture retailers to health clubs and movie theaters.
And according to the company, it doesn’t build anything.
Store Capital offers the benefit of diversification, whether you’re trying to avoid the impact of tariffs or not. Some REITs have concentration risk because they deal with a small number of tenants, or a large number of tenants but one or more tenants make up an unhealthy percentage of revenues. But Store Capital leases 2,334 properties across 447 tenants, and its top 10 customers comprise just 18% of the company’s total rents. Further, the company’s locations are spread across all 50 states, so you get geographic diversification too.
Store’s customers are decidedly middle-market, but still diversified by size with 82% that have revenues greater than $1 billion, and approximately 30% with revenues between $50 and $200 million. Retailing accounts for about 64% of rents while service and manufacturing account for the balance.
Fans of Store Capital like to point out that it offers a hedge against e-commerce. That is, car washes, auto and RV dealers, farm supply and furniture stores are “Amazon-proof.” That might be what attracted Warren Buffett, whose Berkshire Hathaway (BRK.B) owns an 8.2% stake in the company.
Store has increased funds from operations (FFO, an important measure of REIT profitability) from $55 million in 2013 to $358 million in 2018, for compound annual growth of more than 45%. Dividends have grown about 8% annually over the same time period, owing mostly to aggressive property acquisition.