🗞️ It's Pee In a Cup Time

WHILE YOU POUR THE JOE… ☕️ 
Report Cards Are Coming

Remember how we said that the NFP would come in weaker 📉last week? Well, we were right.

No, we don’t have a crystal ball, but to outsiders, that’s what it looks like. We simply followed the premise that both manufacturing and services PMI readings showed slower employment figures, so there was no way in hell the NFP would’ve surprised higher.

By the way, you can do this, too, each and every month by accessing our own Excel model (it’s free) to keep up with PMI data. It’s yours; all you have to do is send an email to [email protected] with the subject line “I’m ready for my model.”

Anyway, another important piece of data is coming out this Friday that will help you predict the next quarter more accurately.

It’s earnings season, and to kick it off, banks like Citigroup, J.P. Morgan Chase, and Wells Fargo will show Main Street how their businesses are doing 🔎.

In other words, you’ll get to hear directly from the masters of the universe just how well - or poorly - the universe is actually doing.

Don’t worry if you miss them; we will spend our weekend reading over investor presentations and earnings materials to bring you a dumbed-down version of it all. 

Speaking of dumbing down, let’s get on with today’s email 📧…

BALLS OF STEEL
Good For You, Pierre Ferragu

Every analyst on Wall Street has a buy rating for Nvidia Co. (NASDAQ: NVDA), but that was until New Street analyst Pierre Ferragu went all in with his career-defining call on the stock.

Analysts make a living by rating and valuing companies, and whether they are right or wrong defines how the market views their decisions and, therefore, how long they are employed.

Keep this in mind when reviewing analyst ratings, as they are often too scared to go against the grain—God forbid they get fired for it. This is why it's more impressive to see Pierre go against Nvidia by downgrading the stock from 'Buy' to 'Neutral.' 📉

But he's not wrong in this case. He quotes that the stock is overvalued today compared to how much its earnings per share 'EPS' are forecasted to grow this year.

Here’s a snippet of the semiconductor comps:

Notice how Nvidia is set to grow its EPS (EG2) by only 25.75%. In comparison, competitors like Advanced Micro Devices (NASDAQ: AMD) are forecasted for 52.2% 🔥.

Despite having twice the growth prospects, AMD only trades at a forward P/E (PE2) of 33.1x, while Nvidia's valuation went up to 37.3x.

** Quick tip 🔎: Markets typically do - and should - pay more for tomorrow's earnings if those earnings are set to grow at a more attractive rate. So, there's a crack in the foundation for Nvidia's valuation today since its growth is slowing significantly.

Even Broadcom (NASDAQ: AVGO) is set to grow its EPS near Nvidia's level. Yet, it only trades at 28.7x forward P/E, a discount of 23% to Nvidia's multiple.

The Cycle is Over for Nvidia
Most investors don't realize that the semiconductor and chips industry is as cyclical as any other, with two main ends to the life of the cycle:

1. There is a development cycle, where companies spend more as a % of revenue into research and development (R&D) to make leading technology and introduce it to customers.

2. The spending cycle is when these companies successfully lock in orders from the newly introduced products, and now they need to spend in manufacturing and delivery capabilities to fulfill these orders.

Naturally, one generates higher profit margins, while the other dries them up. So, where is Nvidia in the cycle today 👀?

The spending cycle is over, as the R&D and selling items (as a % of revenue) are down despite the business seeing gross margin expansion.

So, Nvidia now needs to go back to the drawing board and spend lots of capital to come up with the next big thing, and that my fiends, will send the stock down on a major EPS contraction in the coming quarters 📉.

Speaking of where we are in the cycle of profitability, here’s one stock currently looking to bottom its own…

WEEKSTARTER STOCK
Money Comes and… Comes?

Companies that depend heavily on commodity prices go through a profit cycle every few years. In today’s study, we are looking into West Fraser Timber (NYSE: WFG) to develop a potential investment opportunity.

For now, let’s start with the top view of housing demand in the U.S. 🏠️since it ultimately drives demand for West Fraser’s main product, lumber and timber.

U.S. building permits have seen a 7% decline in the year, with a roughly 3.5% decline over the month. The bearishness on housing prospects stems from two things:

1. High property prices, approximately 32% higher than pre-COVID for single-family

2. Expensive mortgage rates, hovering near 7% today vs 3.25% 😨only 3 years ago

So, of course it makes sense to expect West Fraser to be near - or at - the bottom of its profit cycle:

Revenue growth has been nonexistent since 2021, and it’s only worsening. Still, we are okay with that since we understand it is just the current step of the cycle. Notice the gross margin rate is also back to 2019 levels.

To keep it in perspective, we should check what lumber is doing since it is the main commodity that drives the company’s profit line:

Crashing lumber to roughly 2019 levels would explain why the company’s gross profit margin and revenue growth rates have retreated. The one good thing is that the revenue figures of $6.4 billion are still a new record.

What about the rest of the indicators driving the stock price?

When it comes to profitability, here are a few metrics that investors can lean on when gauging where a company is in is cycle:

1. Return on invested capital (ROIC). This is net income / (debt + equity)

2. Free cash flow yield. This is free cash flow / equity

3. Free cash flow as % of sales. Simple, FCF / revenue

4. Debt to total capital. This is Debt / (debt + equity)

Notice that when a company experiences rising profitability, its leverage level also goes up. This means either that interest rates are low, demand is rising quickly, and the company needs extra capital to deliver results, or both.

For West Fraser, it was both during 2020-2022. Now, leverage is significantly lower, and so is profitability. While 2023 would drive away most investors looking for a profitable business, it is the best time to start investing 🤑.

Apart from identifying the bottom of the cycle, here are a few other metrics we like about the stock today:

• Trades at only 5.4x to its five-year average FCF (we like anything below 10.0x)

• Analysts expect to see 72.7% earnings per share growth this year

• TD Securities analysts slapped a $118 a share price target on the stock, daring it to rally by as much as 57.8% 🔥from where it trades today

NOW GO AND MAKE IT HAPPEN
A Cycle Gauge, Through an Acquirer’s Lens

Today’s Book recommendation 📖is one of the books that made me understand that some stocks will show you really high ROIC but still be a fluke, just like businesses with really low ROIC aren’t necessarily ones you’d want to dump.

It also opens your eyes to a perspective not from an academic perspective but from someone who actually operates in the marketplace.

To your success,

G. 🥃