ARGUS

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April 30, 2018 ○
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Argus Outlook
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IN THIS ISSUE BY JOHN EADE, ARGUS PRESIDENT

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Despite favorable earnings from large- point for stocks, given current valuations
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ARGUS OUTLOOK 1
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cap Technology firms, stocks closed Friday relative to expected earnings growth.
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largely unchanged. First-quarter revenues Turning to earnings results, profits across

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and earnings last week continued to impress a wide variety of sectors are coming in better
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INVESTMENT on the upside, but failed to produce a similar than expected. With about half of S&P 500
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THEMES 2
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stock price reaction in the aggregate. The companies reporting March quarter results so
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Market Watch major benchmarks remain mixed so far in far, revenue growth in particular has been
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Highlights
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2018, with the Nasdaq rising 3.1%, but the impressive, up 8% from the prior year, while
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Wages Slowly Recovering

Dow and S&P 500 declining 1.7% and 0.1%, earnings are tracking for a 23% gain. Helped
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• Danaher Corp.
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1Q GDP Better Than Expected respectively. by the above-average revenue growth,

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• Johnson & Johnson Inc. Friday’s GDP report showed the U.S. continued operating margin improvement
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economy grew at a 2.3% annual rate in 1Q, and lower corporate taxes, the quarter is
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down slightly from the average of the prior shaping up as one of the strongest in years.
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PORTFOLIO
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three quarters. After a strong burst late in Still, the equity market’s muted reaction to this
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HIGHLIGHTS 3 2017, consumer spending weakened slightly performance appears to indicate it is

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Monthly Power
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in the first quarter, led by a pullback in becoming more difficult to please. Some
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and Utility Review

spending on durable goods as hurricane- skeptics saw trouble in Caterpillar’s earnings
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related replacements subsided. Capital call where the CEO noted its 1Q EPS, which
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spending strengthened, with investments into were well above trend, would be the “high
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INSIDER TRENDS 4
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equipment increasing 4.7% and investments water mark” for the year, partly attributed to
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into intellectual property rising 3.6%. Exports, rising input costs. Yet the company raised its
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benefiting from a lower U.S. dollar, advanced earnings guidance for the full year amid
WEEKLY “BEST
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at a 4.8% pace. We viewed the report as a strong end-markets, as higher commodity

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Of” COMMENTS 5
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good showing for the economy, especially prices are supporting capital investments
Facebook Inc.
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considering some capital spending, which and demand for its products. We look for a
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Raytheon Co.
was more valuable ahead of the corporate 20% rise in S&P 500 profits in 2018 (to $160),
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tax reductions, was accelerated into the and a 12% rise in 2019 (to $179), with
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fourth quarter. Overall, we expect growth to earnings in 2019-2020 growing a few points
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ARGUS RATINGS
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CHANGES 9 pick up as the year moves along, supporting faster than previously estimated as
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at least two more Fed rate hikes in 2018. accelerated depreciation and other changes
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Yields on the 10-year Treasury rose again boost capital spending and economic
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last week, briefly trading above 3% mid-week growth.

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before settling Friday at 2.96%, but up just In this week’s economic calendar,
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slightly from 2.95% the prior week. Economic Monday brings personal income and outlays
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reports remained healthy throughout the for March, as well as the pending home sales
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week. Existing home sales were up 1.1% in index for April. On Tuesday, construction
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March to an above-consensus 5.6 million, sales for March will be released, along with
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while new home sales rose 4.0% in March to motor vehicle sales for April. Wednesday
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an above-consensus 694,000. The consumer brings the ADP employment report for April,
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confidence index for April, which came in at as well as an announcement on interest rates
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128.7, remains at highs for this stage of the from the FOMC. On Thursday, factory orders
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economic expansion, with readings helped for March and the ISM non-manufacturing
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by optimism over strong employment index for April will be released. Friday brings
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For subscription information, conditions. As we’ve noted, we do not think nonfarm payrolls for April.
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please contact us at long-term yields at 3% should be a breaking

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Sales@ArgusResearch.com
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or call (212) 425-7500

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A R G U S R E S E A R C H C O M P A N Y • 6 1 B R O A D W A Y • N E W Y O R K, N.Y. 1 0 0 0 6
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 INVESTMENT THEMES

Wages Slowly Recovering

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1Q GDP Better Than Expected
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Wage growth has fluctuated greatly over the past 30 years.
In March, average hourly earnings for all employees on
private nonfarm payrolls rose by 8 cents to $26.82. Over
the year, average hourly earnings have increased by 71
cents, or 2.7%. Average hourly earnings for private-sector
production and nonsupervisory employees increased by 4
cents in March, to $22.42. The current wage growth rates
are a bit below the historical average growth rate of 3.0%,
dating to 1980. The current rate is, of course, far below the
highs of 8.0% recorded during the period of high inflation
in the early 1980s. But the current rate is also well above
the recent lows of 1.2%, recorded as the economy was just
beginning to emerge from the 2007-2009 recession in 2011.
We’ve seen this pattern in the past. In 1985, the average
growth rate slowed to 2.3%, before taking another five years
to reach the historical growth average of 3.0%. Investors
will be watching the wage growth trends closely when the
next nonfarm payrolls report is released on May 4.
AVERAGE HOURLY EARNINGS (Y/Y CHANGE)
9%
8%
7%
6%
5%
4%
3%
2%
1%
81 Jan-86 Jan-91 Jan-96
The U.S. economy advanced at a 2.3% rate in 1Q, down
slightly from the previous three quarters but still a good
showing, particularly considering inclement winter weather.
As we expected, consumer spending weakened slightly
during the quarter, led by a pullback in spending on durable
goods. Personal Consumption Expenditure growth in 1Q
was 1.1%, down from 4.0% in the prior quarter. Drilling
deeper, spending on Durable Goods declined 3.3% —
expected, as Durable Goods spending had soared on
average 9% in the previous three quarters. Spending on
Consumer Services rose a solid 2.1%. Capital Spending
strengthened, with investments into Equipment increasing
4.7% and investments into Intellectual Property increasing
3.6%. Exports, benefiting from a lower dollar, advanced at
a 4.8% pace. Elsewhere, Housing was flat, Government
Spending climbed 1.2% and Inventories rose. Offsetting
growth, Imports were higher. Pricing pressures picked up
a bit; ex food and energy, the Price index for GDP rose
2.5%, up from 1.9% in 4Q. Overall, growth is expected to
pick up as the year moves along, supporting at least two
Source: US Dept. of Labor
more Fed tightenings in 2018.
REAL GDP (% GROWTH/QTR & SMOOTHED 4 QTRS)
10
8
6
4
2
0
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Jan-01 Jan-06 Jan-11 Jan-16 -4
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Danaher Corp.
Source: Bureau of Economic Analysis, Argus
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'95 '97 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 E

(NYSE: DHR) BUY

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This leading blue-chip Industrial company seems poised

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Johnson & Johnson Inc.

to deliver mid-single-digit core sales growth, which, along (NYSE: JNJ) BUY
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with acquisitions and margin expansion, has the potential
to drive low double-digit earnings growth. Danaher typically Johnson & Johnson is a diversified healthcare company
pursues acquisitions in niche markets with little competition, that develops, manufactures and markets products in three
and drives improvement in operational efficiency and primary lines of business: Pharmaceuticals, Medical
product quality through its ‘Danaher Business System.’ We Devices and Diagnostics, and Consumer Products. We view
believe the coming years will present a favorable any pullback in the JNJ stock as an investment opportunity.
environment for acquisitions, and expect Danaher to While the company faces headwinds for mature products,
continue to streamline operations and boost margins at we believe that it also has strong growth drivers from recently
acquired companies. The company has completed the launched drugs, expanded indications for existing drugs,
transformative acquisition of Pall Corp., and has now and a solid product pipeline. Our target price is $165. The
separated into two independent companies. The new JNJ shares currently yield 2.8%. We have the shares in our
Danaher is focused on Med-Tech businesses. Since the Equity Income, Institutional and Growth model portfolios.
split, management is again making new deals and the
outlook is positive.

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 PORTFOLIO HIGHLIGHTS

Monthly Power and Utility Review

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Our rating on the Utility sector is Under-Weight. The has been largely flat. Energy efficiency programs, better
sector is underperforming in 2018, with a loss of 4.2% after appliances, conservation, and rooftop solar installations are
also underperforming in 2017, with a gain of 8.3%. Utilities some of the challenges facing utilities. Industrial load growth
outperformed the S&P 500 in 2016, with a gain of 12.2%. has also been flat to lower, again mostly due to more efficient
The sector accounts for 2.9% of the S&P 500. Over the operations, though some companies have recently seen
past five years, the weighting has ranged from 2.5% to stronger sales to industrial customers.
5.0%. We think the sector should account for about 2% of Large-scale solar investments may provide rate-base
diversified portfolios. The sector includes the electric, gas growth for utilities going forward, as regulated utilities provide
and water utility industries. solar power at about half the cost of roof-top solar, according
By our calculations (using 2018 EPS), the sector price/ to the Edison Electric Institute. Utilities also note that solar
earnings multiple is 16.2, below the market average of 16.7. projects are zero-emission, and are seeking reasonable
Earnings are expected to rise 8.1% in 2018 after rising 6.3% allowed returns on their investments. Dominion, Duke,
in 2017 and 21.5% in 2016. The sector’s debt-to-cap ratio NextEra, and Southern are increasingly looking toward rate-
is about 55%, above the market average. This represents base, utility-scale solar. About 58% of installed solar capacity
a risk, given the current state of the credit markets, is at utilities, with nonresidential (25%) and residential (17%)
particularly if corporate bond rates rise. The sector dividend making up the balance.
yield of 2.8% is above the market average of 1.8%. Many utilities are also focusing on gas investments to
Utility stocks face headwinds from slow earnings growth grow their rate base. In preparation for new emissions targets
and potential additional interest rate hikes. As the yields of under the Clean Power Act, utilities are reducing coal
relatively safer bonds rise, dividend-yielding utility stocks generation and increasing gas generation. However,
become less attractive. That said, we believe that utilities executive orders under the Trump administration may roll
with above-average dividend growth will outperform peers back environmental regulations on coal production.
with less dividend growth potential. Overall, we think the primary attraction of utility shares
The recently enacted reduction in the corporate tax rate is steady and moderately growing income. We also believe
to 21% should boost earnings and cash flow at most utilities. that most utilities in our coverage group have secure
Utilities have struggled with low load growth since the dividends and will be able to access the capital markets for
2008-2009 recession. Load growth, or the increase in external funding as balance sheets remain underleveraged.
electricity generated, typically rose at about half the rate of We see the most attractive utilities as those that are able to
GDP growth before the recession. Since then, load growth innovate while also lowering costs.

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Insider Trends
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The volume of insider transactions remains predict- buy and sell stock on a pre-planned and ongoing basis,
ably low during the current earnings season and, as such, generally without concern for the restrictions that can be
the relevance of the sentiment indicators derived from the placed on a la carte open-market transactions.
transaction data is also low. By the numbers, short-term To dig deeper, we note that 534 (or almost 67%) of the
(one-week) insider activity clearly favors selling over buy- almost 800 transaction that met the criteria for inclusion in
ing. the Vickers Weekly Insider Report this week were automatic.
Vickers’ benchmark NYSE/ASE One-Week Sell/Buy Those trades were likely pre-planned long ago as a part of
Ratio is currently 6.71, which indicates 6.71 insider sales an ongoing investment strategy that is based on a portfolio
for every one insider purchase. That’s certainly a high num- of shares often received in the form of options. Of the auto-
ber and it follows on the heels of an even higher result from matic transactions, 492 (or a whopping 92%) were pre-
last week, when the reading was 7.00. planned sales with only 42 pre-planned purchases.
Vickers’ current Total One-Week Sell/Buy Ratio (which On the flipside, with transaction volume low and open-
adds in transactions on the Nasdaq) is relatively high as market activity even lower, the few times when insiders do
well, coming in this week at 4.52 after a 4.81 reading last step up to buy and sell can stand out. This week, we note
week. open-market trades from insiders at the following compa-
On an exchange basis, selling is most pronounced at nies.
companies that trade on the New York Stock Exchange, Open-market selling was noted at Buckle Inc. (NYSE:
where the Vickers’ One-Week Sell/Buy Ratio is 8.97. That BKE), Dollar General Corp. (NYSE: DG), Eyegate Pharma-
compares to a ratio of 3.52 on the Nasdaq and 0.50 on the ceuticals Inc. (NCM: EYEG), Fedex Corp. (NYSE: FDX),
thinly traded NYSE American. PriceSmart Inc. (NGS: PSMT), Snap Inc. (NYSE: SNAP),
Still, in keeping with the theme at the top of this com- Turtle Beach Corp. (NGM: HEAR), Urban Outfitters Inc.
mentary, we note that the transaction list this week is heavily (NGS: URBN) and Wayfair Inc. (NYSE: W).
weighted toward “automatic” transactions. These allow Open-market purchases were noted at pdvWireless Inc.
corporate executives, directors and beneficial owners to (NCM: PDVW) and Tupperware Brands Corp. (NYSE: TUP).

TOTAL 8 WEEK SELL/BUY RATIO VS. DOW INDUSTRIALS

27000 0.00
26500 0.50
26000
25500 1.00
25000 1.50
24500
2.00
24000
23500 2.50
23000 3.00
22500
22000 3.50
21500 4.00
21000
4.50
20500
20000 5.00
19500 5.50
19000
18500 6.00
18000 6.50
A M J J A S O N D J F M A

Dow Jones Industrial Average (left scale) 8-Week Sell-Buy Ratio (right scale)

A Ratio between 2.00-2.50 is neutral / Under 2.00 suggests a rising market / Over 2.50 suggests weakening market

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Weekly “Best Of” Comments
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and its parent, Strategic Communications Laboratories (SCL),

FACEBOOK INC. (NGM: FB)
from Facebook on March 16. The suspension was followed by an
Rating: BUY
avalanche of press reports about the misuse of the personal data of
Recent Price: $174.16
an initially estimated 50 million Facebook users, later increased to
12-Month Target Price: $237
87 million, by an independent researcher. This researcher passed
Sector: Technology
the data to Cambridge Analytica, which, in turn, provided political
Analyst: Joe Bonner
consulting services for the Trump presidential campaign. The
FB: Strong 1Q18 amid data-privacy turmoil scandal culminated in two days of Congressional testimony for
* After a very difficult quarter on the political front, Facebook CEO Mark Zuckerberg, and followed an earlier controversy
posted strong 1Q18 results, beating the consensus EPS surrounding false content placed on Facebook during the 2016
estimate by $0.03 and consensus revenue forecast by a presidential campaign by accounts linked to the Russian
remarkable $555 million. FB shares rose more than 9% government.
on April 26. Facebook has taken a range of steps to respond to both the
Cambridge Analytica and Russian troll scandals, including a plan
* We are raising our 2018 EPS estimate to $8.58 from
$8.54 and reaffirming our 2019 forecast of $10.26. to double its security and content review staff to 20,000 by the end
of 2018. The company is under investigation by the U.S. Federal
* The Cambridge Analytica scandal has raised the risk of Trade Commission to ascertain whether the Cambridge Analytica
user backlash, though the “#delete Facebook” movement data transfer was a breach of a 2011 settlement between the agency
has thus far had little impact. and Facebook. While this particular FTC investigation may not
* The company is also facing increased regulatory scrutiny lead to any real sanctions, the issues surrounding Facebook heighten
in the U.S. and in Europe, where the EU’s new General the risk of onerous regulation. However, other than the FTC
Data Protection Regulation will take effect on May 25. investigation, there has been no real response from U.S. regulators.
ANALYSIS The European Commission is another matter. The General
INVESTMENT THESIS Data Protection Regulation (GDPR) will take effect in the EU on
We are maintaining our BUY rating on Facebook Inc. May 25. The GDPR imposes strict rules on companies’ use of
(NGM: FB) and raising our target price to $237 from $214. personal user data, including “opt in” provisions. As a result, fewer
Facebook is confronting the biggest crisis in its history over issues users may allow Facebook to harvest certain types of data, which
of data privacy and the unauthorized use by Cambridge Analytica, could impact the company’s ad-targeting capabilities. For now,
a political consulting firm, of data from 87 million Facebook users. management seems only modestly concerned about the GDPR, as
The Cambridge Analytica scandal has raised the risk of user its services will still be superior to those of other digital advertisers
backlash, though the “#delete Facebook” movement has thus far even if the new regulations diminish its ad-targeting ability.
had little impact. The company is also facing increased regulatory Facebook plans to roll out GDPR-compliant practices worldwide
scrutiny in the U.S. and in Europe, where the EU’s new General over time. The European Commission, which has not been reticent
Data Protection Regulation will take effect on May 25. about leveling multi-billion-dollar fines on U.S. tech companies,
Despite the data-privacy scandal and the threat of new may also investigate Facebook.
regulation, we believe that Facebook remains well positioned to Whether or not Facebook faces regulatory action, a true user
take advantage of the continued secular movement of audiences backlash is, we think, the most critical issue for the company.
and advertisers to mobile digital video. Facebook also continues to While user growth has migrated toward developing markets, the
post strong double-digit growth in its user base and average U.S., Facebook’s home market, is still its most lucrative. As such,
revenue per user, a remarkable feat for a company this size. a meaningful defection of U.S. users (other than to Facebook’s
In our view, Facebook’s valuation metrics do not adequately own sister applications Instagram and WhatsApp) could materially
reflect the company’s status as an industry leader. impact the company’s performance and business model. A
RECENT DEVELOPMENTS significant loss of advertisers would also be a material problem,
After a very difficult quarter on the political front, Facebook though we have not yet seen any indication that advertisers are
posted strong 1Q18 results after the close on April 25, beating the abandoning Facebook.
consensus EPS estimate by $0.03 and consensus revenue forecast Facebook’s annual developer conference, “F8,” takes place
by a remarkable $555 million. FB shares rose more than 9% on on May 1 and 2. This conference typically highlights new product
April 26. announcements and news about products under development.
First-quarter revenue rose 49% year-over-year to $11.8 Rumors are that Facebook may launch its Oculus Go, a standalone
billion. Revenue growth was unexpectedly steady after slowing in virtual reality device, at the conference. However, this year’s
the previous five quarters. Revenue benefited from a $536 million conference may also focus on new data-protection measures and
foreign exchange tailwind in 1Q18, which contributed about seven their impact on the company’s army of third-party application
percentage points to growth. A change in accounting standards to developers.
ASC 606 also contributed $130 million in incremental revenue. EARNINGS & GROWTH ANALYSIS
Advertising revenue, the company’s core earnings driver, rose We are raising our 2018 EPS estimate to $8.58 from $8.54
50% from the prior year. Total costs rose 39% and the operating and maintaining our 2019 forecast of $10.26. Our estimates imply
margin rose five percentage points to 46%. GAAP diluted EPS 21% average annual earnings growth over the next two years. Our
rose 63% to $1.69. long-term earnings growth rate forecast is 24%.
Facebook confronted the biggest crisis in its history after CEO Mark Zuckerberg’s visionary goal for Facebook has
suspending political data analytics company Cambridge Analytica morphed a bit from the original idea — to “connect everyone in the
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 WEEKLY “BEST OF” COMMENTS
world.” His goal is now to “give people the power to build
community and bring the world closer together.” Mr. Zuckerberg’s
original vision underpinned the 2014 acquisition of the WhatsApp
message service, Facebook Messenger, and the Facebook Lite and
Free Basics services (which have been rolled out in India and other
developing markets). The company now has more than 1 billion
WhatsApp daily active users, and has rolled out VoIP and video
calling using this service. Facebook Messenger had 1 billion
monthly users in 2Q16. Instagram Stories now has 250 million
daily actives. WhatsApp, Instagram and Facebook Messenger, are
what management calls its “next-generation” services. As these
services have reached critical mass, the time has come for
monetization. Instagram looks to be first up for boosting
monetization through advertising, though management is also
discussing next steps for its messaging services.
The controversies over the past year have led Facebook to
tinker with its critical user Newsfeed platform. This has added
another layer of uncertainty to the ongoing risk of decelerating ad
loads on the main Facebook site. For now, however, the value of
the company’s advertising continues to grow. The average price
per ad rose 39% in 1Q18 and the number of ad impressions rose
8%. Fourth-quarter average revenue per user (ARPU) rose 29%
year-over-year to $5.45.
Facebook’s key growth drivers are increasing membership,
member engagement, advertising loads (the number of ads it
places), and ad prices. Facebook claimed 2.2 billion monthly
active users as of the end of 1Q18, up 13.4% from 1Q17 —
including 67 million new users in 1Q alone. These figures do not
include users of Instagram, WhatsApp or Oculus. The increase
reflects strong membership growth in India, Indonesia, and Vietnam.
Under Mr. Zuckerberg, Facebook has three operating
priorities: capitalizing on the shift of computing/internet to mobile
devices, growing the number of marketers that use Facebook’s
advertising products, and making its advertising more relevant and
effective. The underlying goal is to increase member engagement
with the site. This is why Facebook’s push into video has become
almost as critical as its shift to a mobile communications platform.
Mr. Zuckerberg believes that video will be key to fueling Facebook’s
next growth stage, and is one of the company’s primary investment
areas in 2018. Management first identified member-generated
short-form video as a means of boosting engagement. It has also
begun to move into long-form professionally produced video with
the “Watch” tab. For advertisers, the company has invested heavily
in ad-technology to measure reach, engagement, and sales
conversion. An unintended consequence has been the use of
Facebook Live video to record some grisly scenes of violence.
Facebook is working to remedy this issue. While Facebook often
relies on human checkers to flag objectionable content, the company
is also applying AI technology across its product portfolio, including
News Feed, search, advertising, security, and spam filtering.
China remains the one gaping hole in Mr. Zuckerberg’s plan
to “connect the world.” Facebook, along with Twitter, has been
blocked in China since 2009 on concerns that ethnic protesters had
used the site as a platform for organizing protests. Mr. Zuckerberg
now characterizes a China reentry as a “long-term” goal, which we
take to mean about 10 years. In the meantime, Chinese domestic
social network champions WeChat, Weibo, and QQ have come to
dominate the Chinese market.
Management has often mentioned the gap between the media
time consumers spend on mobile and the small percentage of ad
budgets spent on mobile advertising. We believe that Facebook is
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well positioned to close this gap over time. The company is also
pursuing growth opportunities among small and medium-sized
businesses,
While Facebook (and its investors) are relying on Instagram,
WhatsApp, and Facebook Messenger to drive growth as the
Facebook site matures, the company’s foray into virtual and
augmented reality is seen as a more long-range opportunity.
Virtual reality is not expected to have an impact on Facebook’s
revenue in the near term. The company launched both the Samsung-
produced Oculus mobile “Gear VR” headset in late 2015 and its
own Oculus “Rift” headset in early 2016 after some delays. While
somewhat promising, these were just the initial commercial launches
of this new technology. Facebook expects to launch the Oculus Go,
its latest development in VR technology, in 2018. The Oculus Go
is expected to be an untethered, standalone VR headset, i.e.,
mobile. The company also recognizes that it must invest in the
buildout of the virtual reality ecosystem, particularly games, in
order for VR to become a more popular mass market device.
Oculus has also begun to line up content programming partners,
including Netflix, 20th Century Fox, and Lionsgate, for streaming
movies and TV; and Microsoft for video games such as “Minecraft.”
Over the next ten years, Facebook plans to focus on three
broad technological areas. The first of these is virtual reality/
augmented reality (VR/AR), as exemplified by the Oculus VR.
Second, the company will focus on internet connectivity — with
the goal of connecting more than 4 billion potential Facebook users
who currently have no access to mobile broadband, who are too
poor to afford a handset, or who are simply unaware that Facebook
exists. Facebook’s introduction of its Free Basics service in
developing countries; its development of more efficient antennae
for mobile broadband; and its experiments with drones, solar
powered planes, satellites, and laser beams are part of the
connectivity initiative. The company’s third focus area is artificial
intelligence, which has already begun to underpin new applications.
Mr. Zuckerberg’s vision is certainly grand, even if every idea
or product does not perform as expected. Of course, the company’s
goals are not simply altruistic; their purpose is to keep the Facebook
user base and user engagement growing.
FINANCIAL STRENGTH & DIVIDEND
We rate Facebook’s financial strength as High, the highest
rating on our five-point scale.
The company had cash, equivalents and marketable securities
of $44 billion at the end of 1Q18, and no debt. It generated $5
billion in free cash flow in 1Q18 and $18.75 billion in the trailing
12-month period, up 49% from the prior year.
Facebook does not intend to pay a dividend in the near term.
The company repurchased $2 billion of its stock in 2017 and $1.7
billion in 1Q18, and remains committed to further repurchases to
offset expected dilution from stock options. The board has
authorized a new $9 billion buyback program. The share count was
essentially flat year-over-year in 1Q18.
MANAGEMENT & RISKS
Facebook is almost entirely dependent on advertising revenue,
which has grown to more than 98% of total revenue. The secular
trend of advertisers devoting more and more of their advertising
dollars to internet-based advertising has generally softened the
impact of cyclical swings in the online advertising market; however,
this trend may not continue indefinitely.
The Cambridge Analytica scandal has highlighted the risks
inherent in Facebook as the repository of a vast amount of personal
information on its users, which it uses to make its targeted advertising
 WEEKLY “BEST OF” COMMENTS
more valuable to marketers. If large numbers of users refuse to
allow Facebook to use their personal data, the company’s advertising
could become less valuable. As noted above, Facebook is also
vulnerable to regulatory backlash related to the perceived misuse
of members’ private information. Facebook may also be subject to
attacks from individuals or organizations attempting to steal member
information.
Mobile is a critical growth engine for Facebook and the
company derives over 90% of its advertising revenue from mobile
applications. Management has also warned that it is willing to
sacrifice short-term margin expansion for long-term membership
growth and increased member engagement.
Competition in the internet space is intense and Facebook is
up against a number of larger companies with greater resources,
including Google, Microsoft, and Apple. As Facebook expands
internationally, it must manage its entry into new markets, where
it may have limited understanding of the local culture. It also faces
pressure from “national champion” competitors, especially in
China, from which it is currently banned. Government regulation
and the possible censorship of site content could also become much
more burdensome in the coming years, both in the U.S. and in
international markets. The Snowden revelations involving the use
of American internet company data by the NSA could make
Facebook’s penetration of foreign markets much more difficult,
and result in restrictions or outright bans by foreign governments.
Facebook has expanded its role from simple interpersonal
communications, i.e., timeline posts, to become a broad-based
news media outlet. However, this expansion has been fraught with
allegations of bias. It has also raised concerns about the company’s
role in disseminating fake news, in which bad actors game
Facebook’s news algorithms to plant false news stories or
propaganda. Management is now in an “arms race” with individuals
trying to use its service to distribute fake news. The Russian
government’s usage of the company’s advertising systems has
brought this issue into a harsher light.
Like any start-up, Facebook must successfully manage its
explosive growth trajectory. It must also ensure 24/7 system
reliability in the face of increasingly toxic computer network
attacks from sources who would like nothing more than the
headlines from a successful attack on a high-profile target like
Facebook.
Goodwill and intangible assets are a significant 24% of total
assets. Though Facebook does not have a history of write-downs,
such assets are always subject to reappraisal. Moreover, since they
are such a significant part of the company’s assets, any write-down
could be a serious negative for FB shares.
More than most internet start-ups, Facebook is identified
with its founder, chairman and CEO Mark Zuckerberg, and his
possible loss would undoubtedly be a major blow to the company.
COMPANY DESCRIPTION
Facebook operates the world’s largest social networking
website. The site enables users to communicate with friends and
family by posting to the site; commenting on others’ posts; sharing
photographs, website links, and videos; messaging and playing
games. Facebook also partners with application developers to add
functionality to the site, and allows users to pay for virtual goods
and services through its Payments function. In recent years, the
company has acquired photo-sharing and social networking site
Instagram, messaging service WhatsApp, and virtual reality developer
Oculus VR. Facebook derives about 55% of its revenue from outside
the U.S. and Canada. Facebook went public on May 18, 2012.
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VALUATION
Facebook shares have risen 20% in the last year, compared
to a 12% increase for the S&P 500 and a 25% increase for the S&P
Information Technology Index. Facebook’s trailing EV/EBITDA
multiple of 18 is near the peer median. The forward enterprise
value/EBITDA multiple of 12.5 is 26% below the peer average,
compared to an average premium of 3% over the past two years.
We are maintaining our BUY rating on Facebook to a target price
of $237.
On April 26, BUY-rated FB closed at $174.16, up $14.47.
(Joseph Bonner, CFA, 4/26/18)
RAYTHEON CO. (NYSE: RTN)
Rating: BUY
Recent Price: $204.50
12-Month Target Price: $235
Sector: Industrial
Analyst: John Eade
RTN: Boosting target by $10 to $235
* RTN shares have outperformed the market over the past
quarter.
* Raytheon recently posted 1Q results that were up from
the prior year and above consensus expectations.
* Management has raised its outlook based on solid sales
growth and a lower tax rate.
* Our target price of $235 implies premium valuations –
which we believe that Raytheon merits given its well-
positioned portfolio of businesses and its growth outlook.
ANALYSIS
INVESTMENT THESIS
Our rating on Raytheon Co. (NYSE: RTN) is BUY. We
expect management’s focus on its international and cybersecurity
businesses to generate stronger growth over the next three to five
years. RTN’s business mix appears favorable compared to that of
most defense industry peers, and given rising geopolitical threats,
we like its emphasis on advanced missile defense, electronic
warfare, counter-insurgency and counter-terrorism systems. The
company is also generating strong cash flow and aggressively
returning cash to shareholders through increased dividends and
share buybacks. Our target price of $235, raised from $225,
implies premium valuations – which we believe that Raytheon
merits given its well-positioned portfolio of businesses and its
growth outlook. The shares are a suitable core holding for a
diversified portfolio.
RECENT DEVELOPMENTS
RTN shares have outperformed the market over the past
quarter with a decline of 1% while the S&P 500 has dropped 9%.
Over the past year, the shares have also outperformed, rising 33%
compared to the market’s advance of 11.5%. The shares have
outperformed the industrial sector IYJ ETF over the past 1-, 5- and
10-year periods. The beta on RTN is 0.64.
On April 26, Raytheon posted quarterly results that once
again topped expectations. Net sales rose 4.5% to $6.3 billion. The
total business segment operating margin increased 10 basis points
to 11.9%. EPS from continuing operations rose 27% to $2.20,
ahead of the consensus forecast of $2.11. Total bookings came to
$6.3 billion, up 11% from the prior year.
Along with the results, management raised guidance for
2018 EPS. The company projects 2018 sales growth of 4%, based
 WEEKLY “BEST OF” COMMENTS
on the strong bookings trend, and EPS of $9.70-49.90, up from
prior guidance of $9.55-$9.75.
The company also raised the dividend by 8.8%.
EARNINGS & GROWTH ANALYSIS
RTN has five primary business segments: Integrated Defense
Systems (23% of 1Q sales); Intelligence, Information and Services
(25%); Missile Systems (27%); Space and Airborne Systems
(23%); and Forcepoint (2%). First-quarter results and trends by
segment are summarized below.
In Integrated Defense Systems (IDS), which provides air-
and-missile defense systems and naval combat and ship electronic
systems, net sales rose 7% year-over-year, reflecting higher sales
on an international Patriot missile program that started in 1Q18.
The segment operating margin widened to 18.3% from 15.2%, due
to a favorable change in the sales mix. For 2018, we look for sales
to increase at a mid-single-digit pace, and margins near 16%-17%.
In Intelligence, Information, and Services (IIS), which
provides services to intelligence customers, revenue and operating
income rose 5%. The operating margin was steady at 7.4%. During
the quarter, IIS booked almost $600 million of new business,
including deals in support of Warfighter Field Operations Customer
Support program, as well as a number of classified accounts. We
expect low-single-digit sales growth from this segment this year
with stable margins around 7.7%.
In Missile Systems, which develops missile and combat
systems, net sales increased 5% year-over-year. Operating income
declined, as the operating margin narrowed 80 basis points to
11.5%. The segment has benefited from strong sales of AIM-9X
Sidewinder short-range air-to-air missiles; Paveway laser-guided
bombs; and Tube-launched, Optically-Tracked, Wireless-Guided
(TOW) missiles. In 2018, we expect sales to grow at a mid-single-
digit rate, while margins increase slightly above last year’s 13.2%.
In Space and Airborne Systems (SAS), which serves the
satellite and space markets, net sales increased 1%, and margins
increased 10 basis points to 12.3%. In 2018, management expects
sales to grow at a high-single-digit rate, while margins decrease
slightly from last year.
Finally, in Forcepoint, net sales declined 2% from the prior
year. Operating income totaled a loss of $8 million, down sharply
due to investments in sales and marketing.
The total company backlog at the end of FY17 was $38.1
billion, unchanged from last quarter.
Turning to our estimates, based on the solid bookings trend
as well as expectations for lower taxes, we are raising our 2018 to
$9.86 from $9.70. We look for another year of double-digit growth
in 2019 and are boosting our preliminary EPS forecast from $11.15
to $11.33. Our five-year earnings growth rate forecast is 10%.
FINANCIAL STRENGTH & DIVIDEND
Our financial strength rating for Raytheon is Medium-High,
the second-highest rank on our five-point scale. The company
receives above-average scores on our main financial strength
criteria of debt levels, fixed-cost coverage, cash flow generation
and profitability.
Raytheon has a stock buyback program. At the end of 1Q, the
share count was down 2% year-over-year.
Raytheon pays a quarterly dividend. In March 2018, the
board increased the dividend by 8.8% to $3.47 annually, for a yield
of about 1.5%. The dividend appears secure and we expect it to
grow. We look for payouts of $3.40 in 2018 and $3.76 in 2019.
MANAGEMENT & RISKS
Thomas Kennedy is the Chairman and CEO of Raytheon.
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Mr. Kennedy has been with Raytheon for more than 30 years, and
previously served as COO. Anthony O’Brien became the company’s
CFO in March 2015. Mr. O’Brien joined Raytheon in 1986 and
most recently served as CFO of the Integrated Defense Systems
business.
Raytheon management sees a potential increase in demand
for its products as foreign governments respond to increased global
threats. In addition, Raytheon continues to see opportunities in the
cyber protection market, driven by evolving threat levels. In 2Q15,
it signed an agreement with Vista Equity Partners to form Raytheon/
Websense, a jointly owned cyber security company that is now
called Forcepoint. Going forward, Raytheon also plans to invest in
emerging areas such as next-generation radar, high-energy lasers,
and hypersonics.
Investors in RTN shares face risks. As a key supplier to the
U.S. military, Raytheon is likely to be impacted by defense
spending pressures over the next decade, especially in its short-
cycle businesses. Most of the company’s sales come from U.S.
government contracts, and new or renegotiated contracts may be
on the chopping block in the coming years.
That said, Raytheon has a diverse product base, which
effectively reduces its dependence on any single platform; in fact,
no single program provides more than 5% of total sales. It also has
one of the largest international sales programs in the defense peer
group (approximately 32% of sales in 2017), which adds stability
to revenues.
And in any event, with a Republican in the White House and
the House and Senate both controlled by the GOP, the outlook for
defense spending has brightened. Congress recently enacted the
Consolidated Appropriation Act of 2018, which raised Department
of Defense-based budget funding to $600 billion — up 14% from
2017 and the largest year-over-year increase in base budget funding
in 15 years. Coupled with funding for overseas contingency
operations, the total DoD appropriation rose to $665 billion.
COMPANY DESCRIPTION
Raytheon’s operations encompass a wide range of
government- and defense-related activities. The company is based
in Waltham, Massachusetts and has about 63,000 employees. RTN
shares are a component of the S&P 500.
VALUATION
We think that RTN shares are attractively valued at current
prices near $210. The shares are trading near the top of their 52-
week range of $154-$229. On a technical basis, they have been in
a bullish trend of higher highs and higher lows dating back to
September 2011. The shares have fallen about 8% from all-time
highs along with the market in recent weeks.
To value the stock on a fundamental basis, we use peer and
historical multiple comparisons, as well as a dividend discount
model. RTN shares are trading at 21-times projected 2018 earnings,
at the high end of the historical range of 12-21. On a price/sales
basis, the shares are also trading close to the top of the five-year
range. The dividend yield of 1.5% is below the midpoint of the
five-year range. RTN’s multiples are in line with or slightly above
industry averages. But we think that RTN merits a premium
valuation, as we expect management’s focus on international and
cybersecurity businesses to pay off over time. Our dividend
discount model renders fair value for RTN above $250. Blending
our valuation approaches, we arrive at a new 12-month target price
of $235.
On April 27 at midday, BUY-rated RTN traded at $204.50,
down $6.57. (John Eade, 4/27/18)
Argus Ratings Changes
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ARGUS RESEARCH RATING DISTRIBUTION MASTER LIST CHANGES

Rating Date
900 Stock From To Change
870
800 Adtran Inc ADTN BUY HOLD 4/19/18
700 Walmart Inc WMT HOLD BUY 4/19/18
Procter & Gamble Co PG BUY HOLD 4/20/18
600 Blackhawk Network Holdings Inc HAWK BUY HOLD 4/25/18
575
500
RECENT BUY UPGRADES
400
300 Stock Raised to BUY
Symbol On this date
200
183 Walmart Inc WMT 4/19/18
100
0
BUY HOLD SELL

ARGUS RATING SYSTEM

Argus uses three ratings for stocks: BUY, HOLD and SELL.
Stocks are rated relative to a benchmark, the S&P 500.

A BUY-rated stock is expected to outperform the S&P 500 on a

risk-adjusted basis over a 12-month period. To make this
determination, Argus Analysts set target prices, use beta as the
measure of risk, and compare risk-adjusted stock returns to the
S&P 500 forecasts set by the Argus Market Strategist.

A HOLD-rated stock is expected to perform in line with the

S&P 500.

A SELL-rated stock is expected to underperform the S&P 500.

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