Shares of our two recent recommendations, Rolls-Royce Holdings PLC (OTC: RYCEY) and GlaxoSmithKline (NYSE: GSK), are both higher than our entry levels.
In the case of Rolls-Royce, earnings came out on Valentine’s Day and the shares fell about 3%. For us, that fall came after a nice 10% run-up in the week following our initial recommendation. A look deeper into the numbers does not give me any reason to worry. (I am detailing Rolls-Royce further in the next issue of Beyond the Dollar, which will be emailed to you soon.)
The quarter saw a massive loss of more than $5 billion. A good chunk of that came in the form of write-downs, revaluations and provisions for the fines levied against the company for bribery and a hit as a result of the collapse of the British pound due to Brexit.
For example, any dollar-denominated debt would have to be marked up as a result of the pound falling almost 25% against the dollar since June. Like I mentioned above, you’ll get a full write-up of the company in the next issue of Beyond the Dollar.
Rolls-Royce has to adapt to new accounting rules as well, which will affect number comparisons moving forward. These changes involved revenue recognition. In the past, the company could record revenues at the time a sale was made. New rules require it to recognize revenue upon delivery. So there will be a lag between the order and the recognition.
Looking a little deeper into the numbers, we see a few things that stand out. The company’s three largest divisions were very profitable, though down from the previous year. Targets for cash flow and operating profits for 2016 were met after being adjusted lower midyear. The weaker pound will represent a tailwind of about $400 million in sales and $50 million in profits if the pound remains at the current level. 2016 was a bad year for Rolls-Royce. It was a year of massive upheaval and transition. 2017 should show how well the changes have taken root. So far, the metrics are turning around, and that bodes well for Rolls-Royce going forward.
We bought in close to the lows, and I believe the company is in the right places to benefit from global growth in commercial aviation and defense spending. Continue to hold the shares, and buy the second 50% below $9. Take your time and try to get the best price. After the recent surge, I would expect a pullback to the mid-$8s.
Additionally, GlaxoSmithKline, or GSK, reported better-than-expected numbers, and the shares moved above $40 as a result. The upcoming year will be quite interesting given the anti-healthcare company sentiment that is floating around. Despite this, companies in the sector are actually doing quite well as the bark so far has been worse than the bite.
All the recent studies I have seen show that the pollution levels in developing countries are leading to increased cases of respiratory-related diseases. That is good news for GSK as it has a stable of products to address these issues. Some are coming off patent, but they will still have a lion’s share of the generic and OTC market. Add to this a deep pipeline, a fat, sustainable dividend and a valuation lower than that of its peers, and I think GSK represents a very good opportunity in this sector. The cheaper pound is also a tailwind for GSK, much like it is for Rolls-Royce.
The U.S. dollar continues to be range-bound, and while it is trying to break higher, it’s being hit regularly by comments coming out of the White House. The president and his money men are pushing for a weaker greenback, and that bodes well for our lower dollar strategy. It’s in the middle innings and the dollar’s days of strength are numbered, which is good for us. It gives us even more time to load up on investments that are cheap both in historical terms and in relative terms.
Sell Stop Update
As shares of Glencore (OTC: GLCNF) have soared more than 100%, it is prudent to move up our sell stop to protect profits. Change the sell stop on Glencore to a 25% trailing stop. This means you should sell Glencore if and when it drops 25% from its highest traded level since you purchased your shares.
Cheers,
Karim Rahemtulla
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