Month: July 2018

Microsoft 4Q18 Earnings Report

Current Price: $106 Price Target: $120 (new target price; increased from $105)

Position size: 5% TTM Performance: 42%

Microsoft reported solid Q4 results beating on the top and bottom line and delivering above consensus guidance. Revenue growth accelerated slightly from 16% last quarter to +17%, with double digit revenue growth across all segments. Revenue was $30B for the quarter and for the year crossed $100B for the first time. Top line results were aided by the weaker dollar which added 2pts. Windows and the PC cycle still matter, but Cloud is the key driver of growth. They saw strong demand in both, driven by a robust IT spending environment. Though Microsoft has trailed AWS, Cloud adoption is moving into a phase where Microsoft should have an advantage. The results this quarter substantiate that. The key is hybrid cloud and multi-cloud. Early cloud adopters tended to be smaller companies and digital native companies – companies that didn’t have enormous legacy data centers with tons of money invested in equipment or with critical data that they wanted to keep in-house. As larger companies with legacy IT infrastructure increasingly shift to the cloud, they will take a hybrid approach, which just means they still keep some stuff on-premise. It is a bridge between the old and new. Microsoft has an advantage with Azure stack because it is a highly differentiated product and the leading technology for hybrid. They are also well positioned because they have entrenched enterprise relationships. The trend to multi-cloud refers to companies wanting to use multiple vendors so there is no vendor lock-in or loss of bargaining power. So, adopting AWS doesn’t mean you wouldn’t also use Azure. Microsoft is and will continue to be a beneficiary of this trend.

Commercial Cloud (Office 365 commercial, Azure, Dynamics 365) revenues were $6.9B, up 53% and accounting for 23% of revenue in the quarter (up slightly from 22% last quarter). For the full year, Commercial Cloud was $23.2 a little ahead of expectations and full year cloud run rate is now close to $28B. Importantly, cloud margins continue to improve (+600bps YoY) which will help drive better FCF margins as the business scales. Within Commercial Cloud, Azure grew 89%. The “More Personal Computing” segment which includes Windows, Xbox, Surface, and all other hardware continues to improve. That segment accelerated to 17% growth on solid results from Windows Commercial (+23%), Surface (+25%) and gaming (+39%). This segment performance is consistent with their previous comments of an improving commercial PC market and a “stabilizing” consumer PC market. Free cash flow in the quarter was over $7.4B down 15% YoY reflecting higher capex in support of their cloud business. Capex was $4B in the quarter vs $2.3B in 4Q17. They returned $5.3 billion to shareholders with $3.2B in dividends and $2.1B in share repurchases.

Valuation:

· They produced $32B in FCF for the year putting them at close to a 4% FCF yield – reasonable for a company with double digit top line growth, high ROIC and a high and improving FCF margins.

· They easily cover their 1.6% dividend, which they have been consistently growing.

· Strong balance sheet with about $134B in gross cash, and about $57.5B in net cash.

· Increasing price target to $120 based on ~30% FCF margins and mid-to-high single digit top line growth.

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!

UNP 2Q18 earnings recap: underlying business trend is good, one-time items hit its operating ratio

Key Takeaways:

UNP reported revenue growth of 8%, but an operating ratio of 63% above consensus of 62% (lower is better). Fuel prices had a negative impact on margin of -100 bps (fuel costs +48% y/y), as the company passes on the increased fuel expenses to clients with a lag. The services related costs increase offset the productivity gains this quarter. UNP noted some one-time challenges that impacted performance: a tunnel collapse being out of service from May 29 to June 20 (this added 4-5 days for some freight as trains had to be re-routed), and train-crew shortages (which is improving). While those costs should persist in 3Q, overall 2H should show some productivity gains. Another negative point highlighted during the call was the decline in Permian volumes Frac Sand, as local sand mines come online. Freight revenue experienced positive performance: +4% volume (accelerating from 2% in 1Q18), +2% core pricing, +3.5% fuel surcharge, and a -1% mix impact. Free cash flow was better than expected, but helped by lower capex than estimates. The management team is more positive in its business environment outlook, and lifted its volume growth guidance for 2018 to low-to-mid single digit growth (from low single digit).

Volume growth will be supported by:

o future plastic shipments (chemical plants coming on stream)

o truck drivers shortages pushing conversion to rail in intermodal

o e-commerce supporting shipment of parcels.

So far UNP is being lifted by positive trends lifting volumes and prices, but a couple of one-time items impacted its productivity, masking any improvement in its operating ratio. We will monitor the fuel cost increase to make sure it is being passed on to customers in the coming quarters. We are not lifting our price target at this time, as we need to see its operating ratio improve at this stage of the economic cycle.

Continue reading “UNP 2Q18 earnings recap: underlying business trend is good, one-time items hit its operating ratio”

Crown Castle International ($CCI.US) Q2 2018: Outpaced guidance and expectations

Crown Castle International Corp. (CCI) had another strong quarter, outpacing guidance and expectations for top and bottom line as well as FFO per share. CCI introduced slightly higher guidance for Q3 2018 and the remainder of the year. During the quarter, CCI paid out a dividend of $1.05 per share, a year over year increase of 11%. This is above the company’s goal of 7-8% dividend growth annually. Growth in the towers industry continues to be driven by consumer demand for data which leads to investment by mobile carriers. CCI’s investment in small cells and fiber are performing better than expected and should accelerate in the second half of the year.

Current Price: $111 TTM Return: 13.05%

Target Price: $125 Position Size: 2%

Continue reading “Crown Castle International ($CCI.US) Q2 2018: Outpaced guidance and expectations”

CVS – 2 causes for today’s weakness

CVS is seeing some pressure today as the FTC chairman said Aetna and CVS shouldn’t get a free pass because this is a vertical integration. Just a reminder that UnitedHealth is already a vertical integration at play, and has never been highlighted as being anti-competitive.

There are also comments coming from a proposed regulation entitled “removal of safe harbor protection for rebates to plans or PBMs involving prescription pharmaceuticals and creation of new safe harbor protection” (wow that was long to type!). Details are not currently available. This is yet another push from the Trump administration to reform the healthcare system. Drugmakers are seeing pressure too and trying to avoid damages to their business models: Pfizer and Novartis recently announced holding off raising prices for the rest of 2018, in response to Trump’s attacks.

As a reminder, a key function of the PBM is to leverage scale and competition to reduce drug costs for clients. PBM keep up to 10% of the “saving”, although CVS mentioned being closer to 5%. Per Goldman Sachs, the rebates business represents a mid-single digit % of its EBITDA. Below is Goldman’s calculation:

[tag CVS}

$CVS.US

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!

Wells Fargo (WFC) Q2 2018 Results

Wells Fargo (WFC) reported core Q2 EPS of $1.11 versus street expectations of $1.12. Results were a bit messy and included several one-timers. Wells continues to make progress on improving relations with employees and customers as they look to put the various scandals behind them. Wells is becoming a return of capital story with over $25b in excess capital. Wells plans to increase dividends and double their already sizable share repurchase program – increasing shareholder yield to over 11%.

Current Price: $56.7 Price Target: $60 (increased from $56 15x 2018 earnings)

Position Size: 3.6% Trailing 12-month: 6.1%

Highlights:

  • Update on settlements, lawsuits and balance sheet restrictions
    • Expects the Federal Reserve to lift balance sheet restriction during first half of 2019
    • Accrued charges in Q2 2018 to refund customers for pricing of foreign exchange transactions and fee calculations for wealth management area
    • On 4/20/18 Wells reported a $1b settlement with OCC and CFPD relating to forced car insurance and mortgage fees.
    • Wells still needs to settle with DOJ over residential mortgage policies dating back to the financial crises. Estimates place the settlement at $2b, but Wells has already set aside reserves of $3.2b
    • Additional lawsuits exist for overdraft fees, foreign exchange, mortgage fees, improper account closing and other smaller suits. Wells is not out of the woods, yet.
    • Replaced former Chairman, John Stumpf with CEO, Tim Sloan, and CFO Elizabeth Duke, a former Fed member, as independent chairman.
    • Named 6 new independent directors
    • Plans to spend 2% of earning to philanthropy (up from 1.3%)
    • Recent moves to improve standing of employees
      • Increased base minimum hourly wage to $15.00 an increase of 11%
      • Increased 401k and profit sharing programs
      • Increased stock incentive compensation
    • Recent improvements to help customers
      • Overdraft rewind, zero-balance alerts, debit card on/off capability, and P2P payments
  • Wells is a return of capital story
    • Common Equity Tier 1 Ratio of 12.0% with a target of 10% – $25b in excess capital
    • ROE 10.6% (Return on tangible equity 12.6%)
    • Returned $4.0b to shareholders through dividends and share repurchases.
    • Increased dividend 10% from $.39 to $.43.
    • Increased share repurchases from $4b to over $8b which is shareholder yield of over 11%.
  • Excellent banking business
    • Strong balance sheet – Net charge offs and Nonperforming loans near historic lows.
    • Balance sheet restrictions has allowed trimming of lower quality loans – autos loans and pick-a-pay mortgage loans
    • Return on tangible equity 12.6%
    • Generates $5b per quarter in earnings
    • $1.27 trillion deposits with average cost of 40 bps
  • Noninterest revenue down -8% yoy – area affected most by changes to companies practices
    • Weak Mortgage banking with drop in margins for origination
    • Consumer fees (deposit service, card fees and other) were down in effort to please customers
    • Noninterest expenses were up 3% YoY mainly on higher salaries and benefits
    • Efficiency ratio improved to 64.9
  • Net interest income improved 1% yoy
    • Average total loans down 1% yoy
    • Consumer loans down $6.6b with largest reduction in auto loans
    • Rate paid on deposits has risen from 0.17% 1Q17 to .40% 2Q18
  • Valuation is fair on depressed earnings WFC now trades at 14.5x P/E. WFC is targeting $4.0b in cost savings over the next two years – an aggressive target.

WFC Thesis:

  • Best franchise in banking due to disciplined loan writing and quality mortgage underwriting
  • Large deposit base that provides low cost funding
  • Strong capital ratios put WFC in a good position to be opportunistic, invest for the long-term and return capital to shareholders
  • Fair valuation and potential for earnings rebound in 2018

($WFC.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

JNJ 2Q18 earnings results strong thanks to growth in Pharma

Key Takeaways:

JNJ reported 2Q18 earnings results that beat consensus thanks to very strong Pharma sales (+17.6% organic). Medical Devices grew 1.9% organic, still experiencing weakness in diabetes and Ortho. Their consumer segment is still showing weak growth, but the re-launch of the baby care business in the US should help lift sales in the coming quarters. JNJ has now experienced its 5th consecutive quarter of sales growth acceleration, as new drugs gains are over time offsetting older drugs facing generics competition (although 2H18 should see increased generics pressure). Guidance for operational sales growth in 2018 is up slightly, now 4.5-5.5% from 4-5%, and EPS guidance was lifted by 2 cents. Reported numbers will see more impact from currency however. As Pespi’s CEO did last week, JNJ’s CEO mentioned their recently released ESG report “Health for Humanity” during his presentation.

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Pepsi 2Q18 earnings: some relief from good growth but margins going forward still need monitoring

Key Takeaways:

Pepsi released Q2 earnings that were better than expected (granted on recently lowered sell-side expectations). Organic growth was +2.6% (consensus +2.2%). North America beverages remains soft, but saw sequential improvements following additional advertising efforts + new products (Bubly and Gatorade Zero), and should see continued positive momentum in 2H18. Frito Lay’s good performance in price and volume helped lift the overall company’s gross margin (positive mix impact). The emerging markets had strong growth +6% even with the Brazil truck driver strike limiting distribution of goods. As I had mentioned leading up to this earnings season, the company (as well as other consumer staples) is experiencing higher commodity and freight costs. Since a good portion of this quarter’s growth came from one-time items (Thailand beverage refranchising for example), the quality of growth going forward needs to be monitored. The company reiterated its FY18:

ü organic revenue growth of at least +2.3%

ü EPS +9% y/y.

Continue reading “Pepsi 2Q18 earnings: some relief from good growth but margins going forward still need monitoring”

McCormick 2Q18 recap

Key Takeaways:

Last week McCormick released its 2Q18 earnings, with a sales and gross margin beat (+340bps y/y à leading to a 330bps operating margin expansion) and EPS +24% y/y. Revenue ex-FX grew 16% (+13% from the addition of Frank’s and French’s brands), driven by +2.5% volume/mix and 0.5% price. China had the strongest Consumer segment growth with +5.7% volume growth. In its Flavor segment, Americas was the leading geography with +5.3% volume growth. The addition of new brands helped expand the company’s overall margins. MKC reduced its cash conversion cycle by 9 days, a sign of good cash flow management skills, supporting faster debt pay down.

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