Lincoln Capital Corporation

Issue #75 – March 2024

Thu, 04 Apr 2024 14:13:15 +0000

March Changes

Tax Deferred

(for mobile swipe left to right)

New Additions	Complete Sales	Partial Sales	% of Account Traded
	EMR		2.4%
	KLG		1.3%
		AMZN	2.6%
SWK			2.6%
CNQ			2.5%

Taxable

(for mobile swipe left to right)

New Additions	Complete Sales	Partial Sales	% of Account Traded
	EMR		2.3%
	KLG		1.2%
		AMZN	2.3%
SWK			2.5%
CNQ			2.2%

Summary of Month’s Action:

Last month equities gained over 3%. Energy was the standout performer, gaining over 10%. No other sector had a notable performance. Given the level of turnover in March, and our upcoming Tally, we will dedicate the balance of this commentary to trading activity. All figures are sourced from Koyfin.

We Sold WK Kellogg Co – (KLG)

We took advantage of the nearly 30% rise in KLG’s stock during March and sold our entire position. The company continues to make progress against their goal of 5% EBITDA margin improvement over the next few years (a big deal when margins are at 9%). This will require significant spending, funded using debt.

Cereal has been in perpetual decline and there is no obvious reason why that wouldn’t continue. Unionized labor and few specifics provided for further margin expansion add to the risks. If everything plays out favorably there could be more upside to KLG, however, at $19.00 or so, the risks are much more balanced. Clients recognized a 60% gain in less than 6 months.

We Reduced Shares in Amazon.com, Inc. – (AMZN)

We reduced our outsized position in Amazon as today’s price more accurately reflects fair value in our opinion. A year ago, when we added to our position around $100, it seemed as though Amazon was in for years of weak margins due to overcapacity and much slower cloud growth. One year and 80% later, it is clear that these were temporary headwinds for the business.

CEO Andy Jassy has aggressively cut costs, and North American retail margins have swung from flat to 6% as of last quarter. Amazon’s cloud business, while not really benefiting from AI to the same degree as Microsoft, has seen growth stabilize in the low teens. At today’s price, we intend to hold our remaining shares and stand ready to add if another compelling buying opportunity emerges.

We Sold Our Entire Position in Emerson Electric Co. – (EMR)

Emerson has gone through a large portfolio restructuring resulting in a company focused on automation and software—higher margin and faster growth businesses. There still may be some upside left here, but we didn’t want to overexpose the portfolio to industrials as we find Textron and Stanley Black & Decker to be more attractive investments.

We Purchased Stanley Black & Decker, Inc. – (SWK)

Stanley Black & Decker traces its roots to 1843. The company likely needs no introduction with brands such as Dewalt, Craftsman, Black + Decker, and Cub Cadet. The company primarily sells tools and outdoor equipment in addition to an industrial business focused on engineered fasteners. The company saw extremely strong sales growth during COVID, which eventually reversed, a trend that was worsened by inventory destocking at customers.

The outlook for SWK’s markets is not great, but it’s stable. Margins are currently depressed, while management has cost-cutting plans and other initiatives in place to drive them back to historical levels. Any strengthening of SWK’s end markets would hasten the margin recovery. The company is trading at a historical multiple with depressed margins, a setup that should prove profitable to investors as margins regain ground.

We Purchased Canadian Natural Resources Ltd – (CNQ)

Recent events have made us more constructive on energy, particularly oil. We have stayed away from energy mainly due to our skepticism of U.S. shale’s restraint on production growth. Shale companies pumped voraciously in the 2010’s driving down the price of crude and damaging shareholder returns. After this episode, producers began to show restraint, curtailing production and focused on maximizing cash flow. While this has obvious benefits for investors, our expectation was it would not last. This opinion was based on the price of crude being multiples of marginal cost. While our expectation hasn’t played out, something else has—consolidation. There have been large deals in U.S. shale and independent players are being bought by more patient, stable, and disciplined operators. Some deals include Exxon – Pioneer; Chevron – Hess; Occidental – CrownRock; and Diamondback – Endeavor. This likely reduces supply elasticity in the global crude market.

CNQ is an attractive way to play this constructive view. The company is expected to generate 8 to 9% of their market cap this year in free cash flow and return 100% of that back to shareholders through share repurchases and dividends. They are a dominant player in oil sands, which have attractive characteristics, including low marginal cost and low decline rates. Separately, an expansion of the Trans Mountain pipeline should be in service soon, which will tighten up the differential of Western Canadian Select and West Texas Intermediate.

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Disclosures

Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website. https://adviserinfo.sec.gov/ Past performance is not a guarantee of future results.

The investments presented are examples of the securities held, bought and/or sold in Lincoln Capital Corporation strategies during the last 12 months. These investments may not be representative of the current or future investments of those strategies. You should not assume that investments in the securities identified in this presentation were or will be profitable. We will furnish, upon your request, a list of all securities purchased, sold or held in the strategies during the 12 months preceding the date of this presentation. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of securities identified in this presentation. Lincoln Capital Corporation or one or more of its officers or employees, may have a position in the securities presented, and may purchase or sell such securities from time to time.

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Issue #74 – February 2024

Wed, 06 Mar 2024 23:40:14 +0000

February Changes

Tax Deferred

(for mobile swipe left to right)

New Additions	Complete Sales	Partial Sales	Additional Buys	% of Account Traded
			QCOM	1.6%

Taxable

(for mobile swipe left to right)

New Additions	Complete Sales	Partial Sales	Additional Buys	% of Account Traded
			QCOM	1.5%

Summary of Month’s Action:

The S&P 500 gained 5.3% in February, with particular strength seen in the Consumer Discretionary, Industrials and Materials sectors. Conversely, sector laggards were Utilities, Consumer Staples and Real Estate (according to Koyfin).

The strength of the market was notable as Fed Funds expectations ratcheted higher. Year-end 2024 Fed Funds expectations entered February at 4.0% and went as high as 4.75% during the month (per LSEG).

Trade Completed for QUALCOMM Incorporated – (QCOM)

We added to Qualcomm during the month. We started buying this position before earnings in late January and completed the trade in February. The following is what we shared last month, which still holds:

The company has changed a lot in recent years, with intellectual property licensing now representing a much smaller portion of the business. Automotive and internet of things – a category that includes wi-fi, 5G, virtual and augmented reality, and industrial applications – have grown to be increasingly important at QCOM. However, between the licensing business and Snapdragon chipsets, QCOM is still primarily a smartphone company.

QCOM fundamentals should improve in 2024, as the smartphone industry returns to underlying growth and exits a period of inventory correction. The stock should do well with this fundamental backdrop and an undemanding valuation of 14x 2024 EPS. Snapdragon has a strong position if on-device generative AI takes off (see recent Samsung S24 Ultra), while QCOM will soon ship its first iteration of a central processing unit for Windows PCs, which is a large and lucrative market.

One functional example of Qualcomm’s on-device generative AI.

Recent Troubles at UnitedHealth Group Incorporated – (UNH)

UNH had a difficult month and declined 3.5%, a slide that continued into March. On the heels of Humana’s scary outlook for elevated medical costs in 2024, UNH shares were hit hard on the revelations of a potential antitrust probe into its business. Separately, a cybersecurity breach at recently acquired Change Healthcare is sending ripples through the industry.

The antitrust inquiry seems to be relatively early with regulators looking at Optum (UNH’s provider business) and UnitedHealth (the insurer) business dealings with one another and with other ecosystem participants. The more concerning aspect of the report was scrutiny of UNH’s ability to skirt medical loss ratio rules. This is a key aspect of the bull case—the insurer is capped on how much profit they can earn per premium dollar; however, moving risk to the providers (Optum) allows for more margin.

For clarity, instead of paying a fee for each service, Optum doctor and physician groups charge insurers a fee per member per month while being on the hook to provide the necessary health services to keep that patient population healthy. The aim is that there is more preventative care and more emphasis on the most complex patients lowering the costs for keeping the entire patient group healthy. Early results have shown promise. The end result is the insurer collecting $100 in premium, paying Optum $85, and then Optum does its best to lower costs while improving quality. Importantly, Optum doesn’t just work with UnitedHealth, they also have the same arrangement with third-party insurers.

It is somewhat ironic that the Centers for Medicare and Medicaid services are pushing providers away from fee-for-service to risk-based care, while another arm of the government looks into this practice as being anti-competitive. We will be watching developments here closely and will adjust our position accordingly.

An Optum Health provider checks the breathing of a patient

Weighing a Future Purchase of Nvidia – (NVDA)

Nvidia has been the topic du jour, really since last year. Presently, the focus has intensified given its continued move higher. Lincoln Capital clients have been participating in the AI trend with our holdings of AMD. In fact, AMD has outperformed NVDA over the last six months. Nevertheless, while progress is being made to close the NVDA advantage, it is still our opinion that AMD is winning in AI only due to supply constraints at NVDA. AMD claims their chips are more performant in inferencing (i.e. prompts sent to the model versus training), but whether they play a larger role here is to be determined.

We agree with the market that AI will continue to proliferate. Its use will likely grow each year for the foreseeable future. However, semiconductors are inherently cyclical and trying to find the appropriate baseline for “graphics processing unit” (GPU) demand has been challenging. Will there be a cycle in GPUs? The probability is very high. Will it be in 2024 or 2025? We have not found concrete evidence to answer this question.

Approximately 50% of NVDA’s sales are to cloud providers, which are an inherently cyclical bunch. Goldman Sachs estimates cloud capex declined 6% in 2023 after growing 24% the year prior. Foundry capacity, cloud spending expectations, and channel inventory all add complexity to the ecosystem. We would not be surprised if there is over-ordering going on today as customers don’t want to wait until they need GPUs to get in the queue. There are already indications that lead times for H100s (NVDA’s top chip) are falling back to historical levels.

In summary, NVDA’s software advantage appears insurmountable, and there will be more demand for AI longer-term—where baseline demand is today versus a cyclical surge is the key question (it is also possible we are still below baseline). Competitive responses from AMD, Intel, and custom application specific chips at NVDA customers are all evolving. We will continue to assess these questions. While not owned today, it would not surprise us if NVDA pops into client portfolios at a later date.

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The post Issue #74 – February 2024 appeared first on Lincoln Capital Corporation.

Issue #73 – January 2024

Tue, 06 Feb 2024 14:11:37 +0000

January Changes

Tax Deferred

(for mobile swipe left to right)

New Additions	Partial Sales	Additional Buys	% of Account Traded
QCOM			0.9%
	AMD		1.5%
		SCHW	0.5%

Taxable

(for mobile swipe left to right)

New Additions	Partial Sales	Additional Buys	% of Account Traded
QCOM			0.9%
	AMD		1.5%
		SCHW	0.5%

Summary of Month’s Action:

January was a strong month for equity returns. Communication Services, Financials, and Health Care were the top performing sectors while Real Estate, Consumer Discretionary, and Materials were laggards (according to Koyfin).

The biggest contributors to performance in January were holdings of AMD and Cencora, which were up approximately 13% each, in addition to not holding Tesla, which declined 24.6% in January. Negative contributors were Schwab and UnitedHealth, which declined 8.5%, and 2.8%, respectively, in addition to not owning Nvidia, which rose sharply in January (per LSEG).

Qualcomm – (QCOM)

We started a small position in Qualcomm in January, which we subsequently added to in early February. The company has changed a lot in recent years, with intellectual property licensing now representing a much smaller portion of the business. Automotive and internet of things ─ a category that includes wi-fi, 5G, virtual and augmented reality, and industrial applications ─ have grown to be increasingly important at QCOM. However, between the licensing business and Snapdragon chipsets, QCOM is still primarily a smartphone company.

One functional example of Qualcomm’s on-device generative AI.

Advanced Micro Devices – (AMD)

AMD has done extremely well, and we believe the recent valuation is creating some high hurdles with respect to graphics processing unit (GPU) sales. With the launch of generative AI, the world has focused on Nvidia and their dominant GPU franchise. However, AMD has been expanding its GPU portfolio beyond gaming to try and compete in the data center market. The company appears to be having some success with the launch of MI300. During the Q3 2023 conference call, AMD stated they expected $400 million in MI300 sales in Q4 2023 and over $2 billion in sales in 2024. During the Q4 call in January, the company raised 2024 MI300 guidance to $3.5 billion. While impressive, Nvidia’s data center segment sales are forecasted to be $76 billion in 2024.

In general, despite attempts to close the gap, Nvidia’s CUDA software is far superior to alternatives. AMD is attempting to fight back with ROCm, an open-sourced software platform. These tools enable engineers to run AI models more efficiently on the underlying hardware. Historically, software advantages have been very difficult to displace. However, whether AMD’s ROCm is inferior or not, not all potential Nvidia customers can buy Nvidia GPUs due to insufficient supply. This sets up AMD’s business to capture sales as the next best option—potentially buying time and providing a toehold for ROCm. Time will tell. We will monitor AMD closely, and potentially trim more in the future if valuation and opportunity costs warrant.

Charles Schwab Corporation – (SCHW)

There is nothing new on the Charles Schwab thesis. Generally speaking, the deceleration of money fund flows is helping the company grow cash balances and pay down expensive short-term funding. Fundamentals will first see net interest income grow as high-cost funding gets paid down, followed by a resumption of balance sheet growth. We continue to believe that Schwab is on a path to much improved fundamentals and represents an attractive investment.

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I-Bonds’ Appeal Fades Amid Changing Rates

Tue, 23 Jan 2024 23:30:16 +0000

The Value of Holding I-Bonds Has Diminished Following a Remarkable Two-Year Run

In December 2021, Lincoln Capital wrote about Series I Savings Bonds (“I-Bonds”) being a compelling investment opportunity for several reasons. I-Bonds are government issued, inflation protected bonds that earn interest monthly (compounded semiannually). The interest rate is reset twice a year based on current inflation rates plus a fixed rate component that is constant over the life of the bond.

At the time of the writing two years ago, I-Bond interest was 7.12% (which increased to 9.62% at the following reset in May 2022), an extremely attractive alternative to bank deposit rates, money-market funds, and CD’s*. As a comparison, a five-year CD was yielding a mere 1.35% at the time, so it was hard to ignore the opportunity to earn over 7% on an investment backed by the full faith and credit of the U.S government and with zero mark-to-market risk.

Short-Term Returns Impacted by Fed Inflation Measures

The yield for I-Bonds has decreased as the Federal Reserve has aggressively combated inflation by raising the Fed Funds Rate. As of the latest update (November 2023), new I-Bonds can be purchased with a yield of 5.27%. Investors who purchased in December 2021 had their rate reset to 3.94% last fall. Currently, you can purchase a 1-year Treasury yielding 4.8% or a 3-month Treasury Bill at 5.4%.

Long-term returns on I-Bonds are unknown due to the changing inflation landscape. From 1998 through 2019, the average inflation component was 1.07% versus today’s level of 1.97% (these are 6-month inflation rates)*. The inflation component of I-Bonds is heading lower with inflation tamed by the Fed. Therefore, while long-term returns on I-Bonds are uncertain, it is apparent that their investment appeal has waned since our prior recommendation.

Penalty Considerations When Redeeming I-Bonds

I-Bonds have a minimum holding period of 1-year before redemption and, if redeemed between years 1-5, the owner forfeits the last three months of interest. For investors purchasing closer to our original I Bonds update in December 2021, the penalty is likely to be approximately 0.85%. For bonds purchased more recently, through October 2022, the penalty could increase to 1.05%. Investors who purchased during these time periods should incur the penalty and sell. For bonds purchased after October 2022, the bonds are either still within the 12-month sales restriction period, or the last 3 months of interest is too high to justify incurring.

Final Thought: Consider a Treasury Bond Ladder

This will be our last writing about I-Bonds for the foreseeable future. For investors that may be uncertain on whether to sell their I-bonds, we suggest following the process Lincoln Capital does with all investments━analyze and understand the potential rate of return, as well as the diverse types of risk, then compare them to alternative investments on a risk-adjusted basis.

For investors that hold I-Bonds, we much prefer a Treasury bond ladder to I-Bonds. Lincoln Capital’s one year treasury bond ladder was yielding 4.9% net of fees as of January 22. For clients who wish to join our Treasury bond ladder program, we offer this service at a reduced rate of 0.25% (25 basis points; $100,000 minimum).

*Treasury bond yields, including I-Bond’s and inflation data, are compiled from the website of the U.S. Department of the Treasury.

Disclosures

The views expressed represent the opinions of Lincoln Capital Corporation as of the date noted and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person. The information contained has been compiled from sources deemed reliable, yet accuracy is not guaranteed. Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website. Past performance is not a guarantee of future results.

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Issue #72 – December 2023

Fri, 05 Jan 2024 00:38:27 +0000

December Changes

Tax Deferred

(for mobile swipe left to right)

New Additions	Complete Sales	Partial Sales	Additional Buys	% of Account Traded
			TXT	1.3%

Taxable

(for mobile swipe left to right)

New Additions	Complete Sales	Partial Sales	Additional Buys	% of Account Traded
			TXT	1.4%

Summary of Month’s Action:

Equities continued to rebound in the month of December, with the S&P 500 gaining more than 4.5%. Real Estate, Industrials, and Consumer Discretionary were the sector leaders. Laggards for the month were Energy, Utilities and Consumer Staples.

As the press has widely reported, 2023 saw a large bounce from sectors that underperformed in 2022 due to improving fundamentals, an avoidance of recession and generative AI excitement. Information Technology, Communication Services (mostly Google), and Consumer Discretionary (mostly Amazon) all increased more than 40% in 2023. For the full year, Utilities, Energy and Consumer Staples underperformed. These sector groups were identical in 2022, but on the other end of the performance scale (all data compiled by LSEG).

For Lincoln Capital’s stock model, top contributors to performance in December were Advanced Micro Devices, Charles Schwab and Tyson Foods, which rose 21.7%, 12.2% and 14.8%, respectively. The major drag on performance was UnitedHealth Group, which declined 4.5% for the month. There were no company-specific news items driving share prices.

Interest Rate Cuts Anticipated for 2024

The highlight of December was the Federal Open Market Committee (FOMC) press conference. At the event, Chairman Powell blessed the growing market consensus that the next move from the central bank would be a cut to the Fed Funds rate. With FOMC participants penciling in 3 cuts to their 2024 forecasts, the market took the message and ran with it. The market priced in a Fed Funds rate that was 1.5% lower (six, 0.25% cuts) by the end of 2024. This dovish shift allowed stocks to move higher into a quiet year-end.

Textron, Inc. – (TXT)

We added to shares of Textron during December. There is widespread skepticism that strong business jet fundamentals can persist, which is keeping a lid on TXT’s share price. As of today, the company is trading at 13.1x forward EPS, much cheaper than the market despite similar earnings growth outlooks. The fundamentals of the business jet market – flight miles, used inventory availability, and pricing – are all positive, and Textron has been under-shipping orders allowing backlogs to grow and pricing to remain firm. We expect the business jet market will be stronger than the market anticipates in 2024. Key risks include the current grounding of the V-22 Osprey, the implications of the grounding on the V-280 Valor, and recent rumors of a bid for United Launch Alliance.

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Issue #71 – November 2023

Tue, 05 Dec 2023 15:59:14 +0000

November Changes

Tax Deferred

(for mobile swipe left to right)

New Additions	Complete Sales	Partial Sales	Additional Buys	% of Account Traded
	DG			0.9%
			SCHW	1.9%

Taxable

(for mobile swipe left to right)

New Additions	Complete Sales	Partial Sales	Additional Buys	% of Account Traded
	DG			1.0%
			SCHW	1.9%

Summary of Month’s Action:

November was a historically strong month for both bonds and stocks. The S&P 500 increased by more than 9%, while the Bloomberg US Aggregate produced total returns of more than 4.5% (source: Koyfin). Information Technology, Real Estate, and Consumer Discretionary gained the most, while Energy was negative in November.

For Lincoln Capital’s model, Advanced Micro Devices, Charles Schwab and Bank of America were the top performers, while Textron, Emerson Electric, and Tyson Foods were the top detractors. Tyson and Emerson both reported their latest quarterly results during November and both missed analyst expectations. While near-term setbacks, the longer-term thesis for both companies remains in-tact.

Equity performance in November benefited from multiple positive developments. First, on inflation, the Consumer Price Index report for October surprised to the downside, despite other data showing strong growth and employment. The market cheered this report as it suggests the economy is getting back to the Fed’s target and clears the path for future rate cuts.

On the Fed front, through multiple speaking engagements, officials signaled to the market that rate hikes are over. The market took this message and ran with it, not only removing further hikes from their calculus, but also bringing forward the date of the first rate cut from mid-year 2024 to March 2024. This development, plus the Treasury’s recent issuance tweak of fewer longer-dated bonds, coalesced to drive down the 10-year US Treasury rate from 4.88% on Halloween to 4.35% by November 30th (source: Koyfin).

Dollar General Corporation – (DG)

We sold the remaining position in Dollar General. Enthusiasm surrounding the ouster of the new CEO and the return of the old boss has driven shares higher. The stock now trades at 19.3x forward earnings, about even with the market.

In our opinion, at this level, the market is pricing in a bounce to earnings that we feel is still very uncertain. Price cuts and labor investments will be permanent costs rather than one-offs, which leaves the resumption of sales growth to drive margins higher. There have been no indications to date that sales have returned to growth strong enough to expand margins—we will be watching closely for this key indicator.

The Charles Schwab Corporation – (SCHW)

As mentioned in last month’s writing, we intended to build back our position in Schwab. We began the process in November, however, we were not able to do it in all accounts due to the wash sale rule. For reference, taxable accounts that sold shares at a loss in early October would not have been able to use the loss for tax purposes if we purchased the shares within 30 days.

Money fund metrics at SCHW have been turning more favorable, which likely foreshadows a turn in their short-term funding needs and, therefore, impressive net interest income growth. We are watching closely, and will look to build the position advantageously.

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Issue #70 – October 2023

Fri, 03 Nov 2023 15:00:24 +0000

October Changes

Tax Deferred

(for mobile swipe left to right)

New Additions	Complete Sales	Partial Sales	Additional Buys	% of Account Traded
KLG				1.1%
		SCHW		4.1%

Taxable

(for mobile swipe left to right)

New Additions	Complete Sales	Partial Sales	Additional Buys	% of Account Traded
KLG				1.0%
		SCHW		4.2%

Summary of Month’s Action:

Stocks posted their third consecutive month of declines in October, with the S&P 500 declining 2.1% (per CapIQ). Utilities, Information Technology, and Communication Services were the sector leaders in October, while Energy, Consumer Discretionary, and Healthcare were the laggards (Source: Koyfin).

Top contributors to Lincoln Capital’s equity model were Microsoft and United Health. Microsoft reported a strong quarter and excitement continues to build for its Copilot offerings. Copilot for Office 365 will be generally available on November 1st, though it appears to just be for larger enterprises at present. We continue to believe the uptake of these productivity tools is being underappreciated by the market and sets MSFT shares up well for the intermediate term. Portfolio laggards in October included Schwab and Emerson Electric.

For equities, we feel better today than we did at the time of our last writing. Federal Reserve Chairman Jerome Powell just had his November press conference and has essentially guided the market to expect no further rate hikes. Additionally, the Treasury has revised lower its long bond issuance expectations for the near future. These events have allowed the 10-year yield to decline and take some pressure off the economy.

We are making our way through earnings season and, so far, it appears to be an average quarter. Surprises are in line with historical norms. With this backdrop, and a better valuation than earlier in the summer, stocks appear to be okay in the near term if economic data continues to show steady progress. Geopolitics, particularly the conflict in the Middle East, is the largest near-term wildcard for the market.

The Charles Schwab Corporation – (SCHW)

We significantly reduced our position in Schwab over the month as we feared investors did not appreciate the reacceleration of cash sorting that occurred during the summer. Investors took the news in stride, however, and Schwab management pointed out a few pieces of information to alleviate investor concerns:

In September, bank sweep balances grew month over month for the first time since the Fed began hiking, and only 20% of money fund flows have been purchased via bank sweep in recent periods. With the Fed apparently on pause, we are likely close to Schwab growing deposits and beginning to pay down its high cost funding sources.

With this new information and the still positive long-term outlook for the shares, we intend to rebuild our Schwab position over the coming months.

WK Kellogg Co – (KLG)

Kellogg spun off KLG, its North America cereal business, on October 2nd. We initiated a small position in client accounts shortly thereafter. While not foolproof, spinoffs historically perform well. We believe this is due to little information on the new company, which is often a small division of a much larger enterprise, and indiscriminate selling by the new shareholders. The shareholders often sell due to not being interested in the new assets (spun off divisions are often not in attractive industries), or the proceeds received in the spinoff are very small and are therefore sold to tidy up shareholder portfolios.

We believe KLG fits this mold perfectly. Kellogg shareholders received $0.05 in KLG for every $1 held in Kellogg. KLG is also in a mature and declining category—ready-to-eat (RTE) cereal. Also helping depress the price in KLG has been the lousy market for equities in general. If the market was steady or increasing, new shareholders may be more inclined to roll the dice. However, with the weak market, risk aversion is high and Kellogg shareholders are unlikely to give KLG a chance.

As mentioned, RTE cereal is a declining market, however, KLG profits are likely on the cusp of an inflection point. The company is anticipating 9% EBITDA margins this year; however, after reinvestment in their facilities, they expect margins to expand to 13% to 14% by 2026. Achieving close to this target will show material profit growth despite a muted top line. Peers like Post and General Mills have margins above this targeted range, providing proof that KLG’s ambitious targets are indeed possible.

To unlock these margins, management intends to spend aggressively over the next few years, while paying an attractive dividend. This will push debt levels higher and free cash flow negative. This dynamic is the key reason shares trade at today’s levels – 6x EBITDA, 8.2x EPS, and a dividend yield likely north of 6% (haven’t announced it yet). However, higher debt and cash flow dynamics will be temporary.

As the market begins to appreciate the business and investment case, we expect the shares to trade at a more appropriate valuation.

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Disclosures

Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website. https://adviserinfo.sec.gov/ Past performance is not a guarantee of future results.

The post Issue #70 – October 2023 appeared first on Lincoln Capital Corporation.

Issue #69 – September 2023

Thu, 05 Oct 2023 23:58:52 +0000

September Changes

Tax Deferred

(for mobile swipe left to right)

New Additions	Complete Sales	Partial Sales	Additional Buys	% of Account Traded
	GNRC			1.3%

Taxable

(for mobile swipe left to right)

New Additions	Complete Sales	Partial Sales	Additional Buys	% of Account Traded
	GNRC			1.4%

Summary of Month’s Action:

September was a difficult month for equities and bonds, too, for that matter. The S&P 500 fell 4.8% during the month (per S&P CapIQ). From a sector perspective, energy was the only one to finish the month positive. Sector laggards included Real Estate, Information Technology, and Industrials. The key influence for the month was interest rates. The 10-year U.S. treasury closed on August 31st at 4.09% and ended the month at 4.58%, and has surged even more October-to-date (all using Koyfin data).

What has been the driver of long-term yields? The oil market appeared to be somewhat responsible yet, upon closer inspection, it didn’t seem to be a major factor. Five-year breakeven inflation rates – the market’s expectations for inflation over the next 5 years derived from the treasury inflation protected securities market (TIPs) – have not increased meaningfully and sit at 2.18% today (per the Federal Reserve Bank of St Louis).

Rather, it seems the market has removed the amount of federal funds rate cuts next year, implying a higher rate for Fed Funds as we exit 2024. This repricing has been driven by both Fed communications and also due to economic strength.

We will expand on many of these topics in our upcoming quarterly Tally and Perspective.

Generac Sold

We sold our position in Generac. As mentioned in our July commentary, we intended to sell Generac, but were looking for an opportune time to sell it. With hurricane season past its peak, we don’t think there are many upside surprises left this year and decided to liquidate the position.

As stated, demand appears to be ebbing for Generac, as the company cited lower year-over-year installations in its latest quarter despite 2022 installations being artificially depressed due to a lack of installation labor. Ultimately, Generac needs to sell more units to make money and, unlike cars or iPhones, replacement demand can offer no support if new sales slow down.

Tear Sheets

GNRC 093023

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The post Issue #69 – September 2023 appeared first on Lincoln Capital Corporation.

Issue #68 – August 2023

Thu, 31 Aug 2023 23:47:57 +0000

August Changes

Tax Deferred

(for mobile swipe left to right)

New Additions	Complete Sales	Partial Sales	Additional Buys	% of Account Traded
TSN				2.2%
		DG		1.5%

Taxable

(for mobile swipe left to right)

New Additions	Complete Sales	Partial Sales	Additional Buys	% of Account Traded
TSN				2.1%
		DG		1.5%

Summary of Month’s Action:

The S&P 500 is on track to close August down 1.5%. The top performing sectors for the month were Energy, Health Care and Consumer Discretionary. Laggards were Utilities, Consumer Staples, and Materials. Value lagged during the month of August, while quality and momentum outperformed.

Lincoln Capital portfolios were negatively impacted by the performance of Schwab and Generac. We covered Generac in detail in last month’s commentary. We continue to think Schwab offers one of the best risk/rewards in client portfolios. During the month, SCHW shares underperformed as investors got spooked by a bond sale by the firm, which suggested they needed capital. The resumption of higher long-term bond yields and strong money market flows also likely weighed on the shares. The major positive contributor for the month was Emerson Electric, though there were no material news items for EMR.

A New Addition: Tyson Foods

We added shares of Tyson Foods, Inc., (TSN) to portfolios during August. TSN, founded in 1935, produces 1 out of every 5 pounds of protein (pork, beef, chicken) that Americans consume. In addition to protein production, the company also operates a prepared foods business with brands such as Tyson, Jimmy Dean, Hillshire Farm, Ball Park, Wright, Aidells, and State Fair. The protein markets are cyclical, but due to the relatively short lives of livestock, and consumers’ ability to substitute for other proteins, the markets often quickly find balance (chicken being the fastest market to adjust).

Today, all three major markets are at cyclical troughs. This has created an opportunity to buy TSN at an attractive valuation less than book value. Since 2001, TSN has traded under book value during 6 episodes and, each time, the shares have gone on to outperform the market the following 12 to 24 months. We expect a similar dynamic to play out today, meanwhile, shareholders will collect a 3.5% dividend yield.

Exiting Dollar General

We trimmed shares of DG after another disappointing earnings call. We intend to exit the position entirely at a more favorable price in the weeks ahead. In short, this investment has not worked out as planned as we failed to appreciate the pricing adjustments and labor investments needed to stabilize the business. We will continue to monitor the stock for future purchase.

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Issue #67 – July 2023

Fri, 04 Aug 2023 16:49:06 +0000

July Changes

Tax Deferred

(for mobile swipe left to right)

New Additions	Complete Sales	Partial Sales	Additional Buys	% of Account Traded
GNRC				1.6%

Taxable

(for mobile swipe left to right)

New Additions	Complete Sales	Partial Sales	Additional Buys	% of Account Traded
GNRC				1.7%

Summary of Month’s Action:

The S&P 500 gained 3.2% during the month of July. Energy, Communication Services, and Financials were the standout performers. Healthcare, Real Estate and Consumer Staples lagged the market in July. Top gainers in Lincoln Capital portfolios, on a percentage basis, for the month of July were Schwab, Generac, and Textron, which were up 16.6%, 15.8%, and 15.0%, respectively. Negative holdings for the month were AmerisourceBergen, Microsoft, and T-Mobile, which declined 2.9%, 1.4%, and 0.8%, respectively. Generac will be discussed below.

Schwab Performance

Schwab posted their second quarter results during July and the market approved. While still losing deposits, the pace has dramatically declined as management assumed it would; in fact, peak utilization of expensive short-term funding (brokered CDs and FHLB) occurred in May and has since declined.

Also encouraging was Schwab commentary on their Advisor Services business, which serves RIAs like Lincoln Capital. Advisor Services has swung from deposit outflows to inflows and this segment has typically led the retail business. If a recession is avoided and rates play out as expected, we believe Schwab will provide attractive returns from today’s levels.

Microsoft Performance

Microsoft also reported a strong Q4 (MSFT has a June fiscal year end). Additionally, the pricing strategy of the Microsoft 365 Co-Pilots was announced. The Co-Pilots utilize generative AI and are added functionality to classic Microsoft productivity tools like Outlook, Excel, Word and PowerPoint. Microsoft will be charging an additional $30 per user per month for this product. With approximately 400 million Office users globally, Co-Pilots have the potential to be a large profit driver for Microsoft going forward. Broader release of these tools is still a few quarters out.

Generac Performance

We added a position in Generac (GNRC), which initially did well, and then did quite poorly. Generac is the leader in home standby (HSB) generators, with a market share position exceeding 75% by some estimates. Since IPO (2010), the stock has trounced the S&P 500 as more and more homeowners add HSB units. Power outages have become more prevalent due to issues with both supply and demand. Extreme weather like hurricanes or the Texas freeze in 2021 have caused supply interruptions, as have preemptive power shut offs in places like California to avoid wildfires.

Additionally, to meet regulatory standards, more power supply is being produced by renewable resources which, lacking an economic storage solution, can produce power intermittently. On the demand side, the consumption of electricity is expected to grow strongly due to electric vehicles. This all coincides to create an unreliable power supply and demand environment, and thus increases the appeal of a second source of power for homeowners.

As mentioned, demand has been strong for GNRC, especially in recent years as homeowners had extra money to spend and spent more on their homes. GNRC initially didn’t have capacity to serve this demand. Once GNRC expanded capacity, the bottleneck moved to its distributors who lacked the labor to actually install the product. Extra production capacity without the ability to install it led inventory to build up at the dealers and at GNRC. Generac under shipped demand to reduce inventory and this is the driver of the low sales in the first half of 2023. Once inventory was right-sized, Generac would be able to ship to similar rates as end market demand, and increased installation capacity at the dealers would be gravy.

Unfortunately, Generac’s Q2 report flagged waning consumer demand and, therefore, a longer timeframe to clear channel inventory. This is a troubling development for us. Overtime Generac’s sales have been volatile and determining the baseline trend is difficult. Our conviction is rattled and will likely be looking for an attractive exit point, barring new information.

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