April 2018 – Crestwood Advisors

Travelers (TRV) Q1 2018 results

Travelers (TRV) reported Q4 EPS of $2.46 below consensus of $2.67. The shortfall was due to storm losses – March nor’easters, California mudslides and winter storms in the UK – and weakness in business segment margins. Traveler’s underlying combined ratio was 92.4%, with strong retention rates and positive renewal premium charge. Travelers raised the dividend 7%. Travelers is a high quality, disciplined underwriter of insurance that is focused on returning capital to shareholders. Thesis intact.

Current Price: $133 Price Target: $150

Position Size: 2.3% TTM Performance: +11.9%

Thesis Intact. Key takeaways from the quarter:

Results were solid considering losses
- Solid premium growth 5% and retention rates of 86%
- Renewal premium renewal increase was 4.5% indicating some strength in pricing. JP Morgan speculated we could be seeing an inflection point in pricing.
- Q1 ROE 11.9% which increased from 10.8 YoY. Investment results benefitted from higher interest rates and lower tax rate

Balance sheet strength shows quality of underwriting
- Debt to capital ratio of 23.4%
- High quality investment portfolio – only 2.7% below investment grade
- Favorable reserve development for all years in all segments

TRV continues to aggressively return capital to shareholders – $549 in total – $351m buybacks during Q4 as part of a $5b share repurchase agreement and $198b in dividends.
- Real yield over 10% (Buyback 8.5% + 2.3% Dividend)
- Over the past five years, an average of 93% of annual free cash flow has been returned to shareholders for a reduction in shares of 34% – wow!

Travelers book value fell -3% YoY due to impact of higher interest rates on unrealized gains
- Valuation has improved at the margin but we continue to view TRV as fairly valued (2018 P/E 12.7) relative to current ROE and BV growth – in the context of the broader market environment – and given the balance of slower pricing offset by a robust 10% real shareholder yield

The Thesis on TRV:

We expect TRV will be able to grow book value per share in the mid-single digits over the near-medium term, and generate ROE in the 10-14% range
Industry leader with disciplined underwriting and investment portfolio track record
Consistent returns in the low to mid double digits
Responsible capital allocation and proven desire to act in the best interests of shareholders

($trv.us)

John R. Ingram CFA

Managing Director

Asset Allocation and Research

Direct: 617.226.0021

Fax: 617.523.8118

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

Sprint/T-Mobile Merger – Mixed Implications for CCI

Over the weekend, T-Mobile and Sprint officially announced a merger where T-Mobile would purchase Sprint for $26 billion in an all-equity deal. The deal still must be approved by the DOJ, and broadly analysts believe the odds of this exact deal being passed are about 50/50.

Because there is little certainty around that outcome, we will assume that the merger is going to take place. As I mentioned Friday, the major issue for CCI and other tower companies is the decommissioning of sites where Sprint and T-Mobile have shared or integrated networks.

While the headline risk centers on decommissioning of towers, there are several potential positive catalysts driven by the goal of improving 5G capabilities.

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REITs – Recent Underperformance, Still Like the Asset Class

Below I discuss the real estate sector and address the reasons for its recent underperformance. Additionally, I look at REIT performance during periods of rising rates and increased inflation.

Key Takeaways:

1.) Thesis intact – we still like REITs as a long term, strategic asset class that adds diversification to our asset allocation and has opportunity to improve risd-adjusted returns

2.) Performance During Rising Rates – the positive economic backdrop during rising rate environments acts as a tail wind for REITs as they tend to outperform over the full period of rate increases

3.) Inflation Protection – as we begin to see increased inflation, real assets should maintain pricing power

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Microsoft 3Q18 Earnings Report

Microsoft reported solid 3Q results beating on the top and bottom line and delivering strong guidance. Overall revenue grew 16% aided by the weaker dollar which added 3pts to the top line. They saw strong growth across all 3 segments with cloud continuing to be the key the driver of growth. Commercial Cloud (Office 365 commercial, Azure, Dynamics 365) revenues were $6B, up 58% (an acceleration from last quarter) and accounting for over 22% of revenue in the quarter. Despite the higher mix of lower gross margin cloud, their operating margin improved 200bps as the top line beat resulted in better leverage of opex and better than expected EPS. While cloud margins are a drag now, they will help drive better FCF margins as the business scales. Within Commercial Cloud, Azure grew 93% – estimates are for this business to be about $8B in revenue this year and for commercial cloud to be $22-23B or about 20% of total revenue. They are the number two cloud player behind AWS. The “More Personal Computing” segment which includes Windows, Xbox, Surface, and all other hardware showed meaningful improvement. That segment, which has been in decline, grew 13% to nearly $10 billion on solid results from the Surface and gaming. This segment performance is in line with their comments last quarter of a stronger than anticipated commercial PC market and that the consumer PC market was “stabilizing.” Overall they are seeing positive demand across their business and are positioned to benefit from a strong IT spending environment with digital transformation, migration to the cloud (especially hybrid where they have an edge) and companies positioning their infrastructure for IoT. Free cash flow in the quarter was over $9B and they returned $6.3 billion to shareholders pretty evenly split between dividends and share repurchases.

Valuation:

· The stock is reasonably priced trading at close to a 5% FCF yield for a company with double digit top line growth, high ROIC and a high and improving FCF margin (~30%).

· They easily cover their 1.75% dividend, which they have been consistently growing.

· Strong balance sheet with about $132B in gross cash, and about $55B in net cash.

Investment Thesis:

· Industry Leader: Global monopoly in software that has a fast growing and underappreciated cloud business.

· Product cycle tailwinds: Windows 10 and transition to Cloud (subscription revenues).

· Huge improvements in operational efficiency in recent quarters providing a significant boost to margins which should continue to amplify bottom line growth.

· Return of Capital: High FCF generation and returning significant capital to shareholders via dividends and share repurchases.

$MSFT.US

[tag MSFT]

Sarah Kanwal

Equity Analyst, Director

Direct: 617.226.0022

Fax: 617.523.8118

Crestwood Advisors

One Liberty Square, Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

PLEASE NOTE!

We moved! Please note our new location above!

CCI Down as Sprint/T-Mobile Merger Talks Ramp Up

CCI traded down today as talks of a possible S/TMUS merger continued, with indications that a deal could be reached as early as this weekend. This is still speculation and could be held up by disputes over control of the combined company and/or push back by regulators.

I will follow up on Monday when there is more definitive information available, but below is the note that Sarah sent on April 10th after the merger talks first resurfaced (this merger has been discussed and plans collapsed on two different occasions). The worry from analysts is that, currently shared sites may be decommissioned, reducing a revenue source for CCI. There are a number of assumptions and unknowns at this point.

S/TMUS represent approximately 16% and 22% of site rental revenue respectively and have about 6% of overlapping cell sites. Based on a Goldman analysis, if they decommissioned all the overlapping sites as their contracts expired (average of 5-7 years) it looks like the net impact would be ~$8/share. This assumes an NPV on the remaining contract life and that they account for around $0.60 of AFFO. There are a lot off assumptions in that including that if a merger were even approved that they would decommission all their overlapping sites.

$CCI.US

Peter Malone, CFA

Research Analyst

Direct: 617.226.0030

Fax: 617.523.8118

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

PLEASE NOTE!

We moved! Please note our new location above!

FTV 1Q18 earnings recap

Thesis intact. Key takeaways:

Fortive released its 1Q18 earnings results last night. Overall organic growth was +2.6%, and with the help of FX and acquisitions, reported sales increased 13.4%. Although core growth showed a slow start to the year, we remain confident that the company can achieve its guidance of mid-single-digit organic growth for the year. One of the reason being timing, as its Transportation Technologies business saw some orders linked to the EMV transition (gas station payment system) pushed to 2Q, causing overall flat organic growth in its Industrial Technologies segment. All six growth platforms had positive pricing, lifting operating margin, but this was partly offset by recent acquisitions. EPS grew 30% y/y. Regarding potential M&A activity, FTV commented on the possibility of adding a new platform of growth (they have 6 currently), but don’t feel the pressure to do so. The deal pipeline remains solid but sellers are currently expecting elevated prices. We remain positive on the stock.

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RMD 3Q18 earnings results

Thesis Intact. Key Takeaways:

Overall results were good, with sales up 11% ex-FX, but EPS missed slightly due to one-time restructuring charges. Resmed is guiding to growing its SG&A costs at half the rate of its revenue. The recent growth in the rest of the world was driven by recent funding policy changes in France and Japan favoring connected care solutions, where Resmed has an advantage over other competitors that would struggle with the investments required to develop a good connected care solution. The new funding rules favor their AirSense devices pushing suppliers to upgrade their fleets (this trend should persist for the medium term). On the other hand, we see its US results as a slight negative, as RMD has recently lost some market share to Philips who had a double-digit growth this past quarter vs. RMD +8%. The next quarter will determine if this is an ongoing trend to be worried about or if the company’s innovation ability is intact.

Valuation: no change at this time

The stock is supported by a ~3.2% FCF yield, and a stable dividend (current yield 1.5%). The company expects to buy-back at least enough shares to offset the dilution from share issuance
The balance sheet is strong (net debt/EBITDA at 0.17x)

Thesis on RMD:

Leading position in the underpenetrated sleep apnea space
Duopoly market
New product cycle
Returns of capital to increase: ~1% share buyback/year (back in FY18), dividend yield of 2%

$RMD.US

[tag RMD]

Julie S. Praline

Director, Equity Analyst

Direct: 617.226.0025

Fax: 617.523.8118

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

PLEASE NOTE!

We moved! Please note our new location above!

SYK 1Q18 earnings

Thesis intact. Key takeaways:

On a comparative basis, Stryker delivered solid 1Q results with 8% organic sales and 13% EPS growth. Total sales were up 8.2% on a constant currency basis, acquisitions added 1.2%, volumes and mix were a positive 8.6% while price was a negative 1.6%. Their US knee business continued to grow ahead of the market with 7.3% organic growth, gaining market share. The first quarter also saw 8,200 total knees done using the Mako robot, up from 7,150 in 4Q17, and placing a total of 28 Mako robots of which over 50% were into competitive accounts – JNJ had commented on the competitive environment pressuring their sales in that space – today’s results confirm that the market is still growing and SYK won market shares.

On the negative news front, Spine sales were weak again (flat y/y), as continued market softness in the US was impacted by double-digit price declines across the portfolio on top of last year’s high single-digit price decline (excluding innovative products such as the tritanium cage). Competitors in Spine saw negative organic growth: -7% for JNJ and -3.8% for Zimmer.

Following strong 1Q results, management raised organic revenue guidance range by 50bps from 6.0-6.5% to 6.5-7.0% growth for the year, and EPS to $7.18-7.25 (+11-12% y/y growth) from $7.07-$7.17, which includes $0.04 of dilution from recently acquired Entellus.

We continue to believe Stryker can continue to deliver above-average sales and EPS growth due to its business mix, innovative profile and M&A integration ability. We remain positive on this name, even after a strong stock move for the past 12 months.

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UNP 1Q18 earnings: remaining positive on the company’s story

Thesis Intact. Key takeaways:

UNP met consensus numbers thanks to a combination of moderate volume growth and price increases, and kept costs under control. Operating Ratio (OR) was 64.6%, but productivity gains of $35M were well below management’s expectations. The shortfall was related to the network issues the company experienced during the quarter, mostly in the Southern region.

The management team is scratching its 2019 OR target of 60% (with consensus already above that numbers ~61%, so sell-side numbers shouldn’t come down too much) and its $300-350M in productivity gains guidance. The reasons are:

· Productivity initiatives affected by problems in implementing an automated train stopping and collision avoidance system (Positive Train Control), affecting the flow of operations. PTC implementation was initially targeted to end in 2018, but now pushed towards 2020. The company has reactivated 650 locomotives (250 since February) and still has 250 still in storage. To improve its service, the company is also offering signing bonuses to attract new labor and has recalled all employees on furlough

· Price inflation less than expected (something the street had been questioning the company for a while)

It long-term OR target of 55% is remains untouched at this time. The company still benefits from high barriers to entry, supporting pricing power and margins. For 2018, management remains positive on the top line possibilities, guiding to positive full year volumes and core price gains. They are also evaluating its capital structure, and could see some debt funded buyback to be announced at its Analyst Day on May 30th. We see this quarter as a one-time blip in the company’s strong operational history. We remain positive on the name.

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Visa 2Q18 Earnings Results

Visa reported very strong 2Q18 results and raised guidance. Adjusted EPS was $1.11 (high end of street estimate was $1.06). Broad based global economic growth spurred an acceleration in payment volume growth, fueled by debit spending globally. International was particularly strong with an acceleration in cross-border volume (outbound from Europe, inbound to the US) driven by the weaker dollar. Payment volumes were up 10% and processed transactions were up +12%. EPS guidance raised from mid-20% growth to high 20’s growth. The integration of Visa Europe continues on pace with expectations. Revenue growth is now expected to be low-double-digits, up from the previous guidance of high-single-digits. Cards outstanding grew 4% (to 3.3B), with 2% growth in credit cards and 5% growth in debit cards. Debit cards continue to outpace, partly driven by Millennials who favor debit over credit. As expected, the trend of rising incentives continues as competition is intense for share of customers’ wallets and for business with issuers. Visa is continuing to develop new avenues for growth as the payments industry changes. Contactless payment penetration continues to rise globally. They are positioning themselves to grow in the evolving P2P and B2B markets. For example, in March they acquired Fraedom to help expand their B2B business. This expands their addressable market from the $45 trillion retail payment market to the $120 trillion B2B market and the $60 trillion P2P market. Visa is also in the early stages of standardizing their digital checkout. They recently announced an agreement with Amex and MasterCard to offer a common user interface for digital payments. The platform will create a single button checkout across sites and devices, eliminating the friction of online checkout across various sites.

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