This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Jim Cramer's Action Alerts PLUS

Adding 2 Names to Our Bullpen

By Jim Cramer and Jack Mohr | 09/28/16 - 04:29 PM EDT
Stocks in Focus: HPE, ELLI

On a day where the markets experienced whipsaw actions following reports that OPEC members reached a deal to limit oil supply, we are initiating two names into our Bullpen: Hewlett-Packard Enterprises (HPE:Nasdaq) and Ellie Mae (ELLI:Nasdaq).

A flurry of macro issues -- oil prices today; the presidential debate lead-up and aftermath Monday and Tuesday; conversations around central bank policy every day -- we think it is critical to refresh the Bullpen by initiating innovative companies that have the ability to drive shareholder value irrespective of the macro backdrop.

We would consider adding to HPE on a pullback below $20 and ELLI on a pullback below $90. As we rotate both names into our Bullpen, we are replacing Kimberly Clark (KMB:NYSE) and Southwest Airlines (LUV:NYSE), which are more sensitive to the macro backdrop.

Hewlett-Packard Enterprises has been on our radar for the past six months. In fact, the stock was mentioned as part of our "Look Behind the Scenes" bulletin, which offered members a peek into an email exchange that revealed our ongoing interest in both HPE and Newell Brands (NWL:NYSE), the latter which we have since initiated into the portfolio. Albeit in distinct sectors, both HPE and NWL represent special, event-driven situations with outperformance driven largely by management's ability to create value through successful implementation of longer-term strategic initiatives. We like to have select exposure to stories that can unlock value independent from macro headwinds outside our control.

For context, Hewlett-Packard Enterprises was created out of Hewlett Packard's November 2015 split into two businesses: with HP Inc. retaining the old HP's personal computer and printing business and HP Enterprises focused on higher-growth areas including Enterprise (servers, storage, networking, consulting); Services; Software and Financial Services.

Since the split, HPE announced it would spin off its Software segment and subsequently merge it with Micro Focus (a pure-play, global IT services leader with deep experience managing mature software assets) for $25 billion in cash and majority (50.1%) equity interest in the newly combined company. The deal allows HPE to focus on hardware solutions. The new stand-alone HPE boasts faster growth, higher margins and stronger free cash flow generation while allowing the streamlined asset to focus on driving renewed product innovation across secure, next-generation enterprise infrastructure.

From a financial standpoint, the deal is expected to deliver HPE shareholders roughly $8.5 billion in net value, with the merger expected to produce accelerating annual synergies off a $1 billion-a-year base. Net-net, our bullish thesis is predicated on management's ability to successfully scale its customers more efficiently on a global basis, leverage existing overhead and operate profitably, with an increasingly recurring revenue stream offering enhanced visibility down the line. The new HPE will also boast a strong net cash position with tremendous balance sheet capacity, providing management with an added lever to create value via capital allocation.

We would consider initiating a position in the portfolio if shares came in below $20, and while we view $25 as a reasonable price target (based on a 7x EV/EBITDA or 13x consensus earnings), we would await a larger discount before putting our money to work in a name clouded by near-term uncertainty.

Next up, Ellie Mae is a software-as-a-service company that helps lenders streamline and even automate parts of the mortgage origination process. Ellie Mae is the only player in the business with a one-stop-shop mortgage solution that helps handle everything from figuring out if someone's worth lending to, to complying with the many federal and state regulations, to collecting mortgage payments from borrowers down the line. With its software, everything mortgage-related gets put into a single platform and no other financial technology company has anything like that.

We have dug deep into the story first, valuation second, as the company's innovative suite of solutions paves a greenfield terrain that bears argue represents uncertainty while bulls contend it reflects the seeds management has carefully sown over the past 20 years. Ellie Mae has single-handedly reshaped the future of the mortgage industry, which is plagued by structural inefficiencies, archaic architecture and a fragmented, chaotic ecosystem. (Figure 1 illustrates the complexity of the legacy mortgage process while Figure 2 illustrates Ellie Mae's full-suite solution.)

Click here for Figure 1

Click here for Figure 2

Fundamentally, Ellie Mae is an excellent example of how a brilliantly designed yet vertically focused software company can disrupt legacy solutions while creating a defensible industry titan that has snapped up 25% of U.S. market share (in other words, a quarter of mortgage loan originations flow through ELLI's software). Its competition is about converting traditional stalwarts into using their efficient, streamlined, end-to-end platform, which reduces costs.

Ellie Mae's full-suite solution is powerful, yet the greatest value ad (and competitive advantage) lies in its expertise in compliance: It has engendered the trust of regulatory bodies by creating an integrated system that facilitates compliant implementation of the torrential stream of new rules and impending legislation on the horizon. As the complexity of being compliant continues to rise, so does the cost of processing loans (which have seen a +40% or about $2,000-per-loan uptick in the last three years). Ellie Mae's optimized offering reduces costs by 50% while lifting productivity. If retention is an indicator of the company's value proposition, ELLI is next to perfect, boasting 98% retention rate.

Although risk of an economic or mortgage slowdown is certainly a factor, we would note that ELLI has managed to defy industry volatility, growing revenue ninefold and in straight-line fashion since 2009 compared to a rocky mortgage market. Its ability to take continued share, along with its largely fixed-cost model, helps the company buttress macro trends, a key consideration against the backdrop of relative uncertainty.

ELLI is also one of only three technology companies that boast over 30% sales growth and 20% operating margins, with Facebook (FB:NASDAQ) and CyberArk (CYBR:Nasdaq) being the other two. We believe this growth is sustainable and expect the breadth of future growth to be captured as the company takes share from mid- and lower-tier financial institutions that are in the early innings of adopting Ellie Mae's advanced platform. We are tempered by valuation near term, and while we value the company at $125 a share long term, we also recognize the risk of near-term valuation pressure (on any broad-based selloff in high-multiple names) and would await a pullback below $90 before pulling the trigger.

We will keep members updated as we continue to screen the market for new opportunities to deploy our cash.

Regards,

Jim Cramer, Portfolio Manager & Jack Mohr, Director of Research
Action Alerts PLUS

DISCLOSURE: At the time of publication, Action Alerts PLUS had no positions in the stocks mentioned.

Portfolio Update on 8 Key Holdings
Stocks in Focus: AAPL, C, CMCSA, COST, NXPI, PNRA, SBUX, WFC

After seesaw action Monday and Tuesday, let's take a look at Apple, Costco, Citi, Comcast, NXP, Panera, Starbucks and Wells Fargo.

09/27/16 - 05:08 PM EDT
Exiting a Financial Services Position
Stocks in Focus: PYPL

We are selling our remaining shares in PayPal as they are trading above our price target and cost basis.

09/27/16 - 10:20 AM EDT
Weekly Roundup

With the Fed decision behind it, the market focuses on earnings and oil. In the portfolio, we added to three positions and exited from one.

09/23/16 - 07:02 PM EDT

Markets

Chart of I:DJI
DOW 18,339.24 +110.94 0.61%
S&P 500 2,171.37 +11.44 0.53%
NASDAQ 5,318.5480 +12.8360 0.24%

Action Alerts PLUS Holdings

Holdings 1

Stocks we would buy right now

Symbol % Portfolio
Weighting
Industry
AA 2.98% Metals & Mining
AAPL 3.76% Consumer Durables
AGN 4.78% Drugs
BMY 1.11% Drugs
C 4.24% Banking
CSCO 4.94% Computer Hardware
DOW 3.10% Chemicals
FB 5.20% Internet
GE 2.83% Industrial
GOOGL 4.89% Internet
NWL 1.05% Consumer Durables
NXPI 3.31% Electronics
PNRA 4.64% Leisure
SBUX 3.80% Leisure
SLB 3.14% Energy
TJX 3.89% Retail
WBA 3.73% Retail
Holdings 2

Stocks we would buy on a pullback

Symbol % Portfolio
Weighting
Industry
AEP 1.31% Utilities
CMCSA 1.61% Media
COST 2.40% Retail
OXY 2.39% Energy
PEP 3.89% Food & Beverage
V 3.59% Financial Services
WFC 4.19% Banking