Month: January 2019

Current Price: $133 Price Target: $160

Position Size: 3.8% TTM Performance: 8%

Visa continued to perform well in the first quarter with better than expected revenue and EPS. Visa continued double-digit growth in payments volume and processed transactions. Net Revenues were up 13% aided by lower client incentives and EPS was up 21%. Guidance on 2Q revenue was lowered because they are seeing some weakening macro trends in cross border which they attribute to geopolitical factors and a stronger dollar. They’re maintaining full year guidance (low double digit top line growth and mid-teens EPS growth) for now. They feel we may have more clarity on the issues impacting cross border transaction over the next few months…specifically they talked about, “economic uncertainty related to the US government shut down, Brexit, big equity market swings, and the trade dispute with China,” saying they “are starting to have an impact on consumer sentiment.” Cross border accounts for ~27% of gross revenue and is higher yield. There is no evidence in domestic volumes of broader economic weakness. US credit trends did weaken in the second half of December, but they rebounded in January. Credit trends tend to be more macro sensitive than debit.

Continue reading “Visa 1Q19 Earnings Update”

Current Price: $105 Price Target: $120

Position size: 5.5% TTM Performance: 11%

Microsoft reported a strong quarter with double-digit top and bottom line growth. Results were basically in-line with expectations – revenue was $32.5B (+13 YoY, constant currency) and EPS was $1.10 (+14% constant currency). Midpoint of top line guidance for Q3 slightly below the street. They say they continue to benefit from favorable secular trends and IT spending conditions. This was reassuring given some recent concern that IT spending is slowing. Results continue to be driven by their Commercial Cloud business which was up 48% reaching $9B. They saw flat gross margins overall and slight op margin improvement. Improving cloud margins were offset by a sales mix shift to commercial cloud and surface hardware. Free cash flow was $5.2 billion, down 2% YoY reflecting higher capex in support of their cloud business

Key Takeaways:

· Solid growth across all 3 segments:

o Productivity and business processes grew 13% (31% of revs) driven by LinkedIn revenue up 29% and Dynamics 365 up 51%. Office 365 Commercial revenue increased 33%, driven by seat growth of 27% and ARPU expansion from continued customer migration to higher-value offerings.

o Intelligent Cloud, which now includes GitHub, grew 20% (29% of revs). Azure is reported in this segment and grew 76%.

o More Personal Computing grew 7% (40% of revs).

§ Windows OEM revenue declined 5% due to weakness in consumer PCs that was negatively impacted from constrained chip supply.

§ Surface revenue grew 39%.

§ Gaming was up 8%. Gaming software and services are growing while hardware is declining.

§ They had their largest gaming revenue quarter ever with record avg. revenue per user. Xbox live now has 64 million active users.

§ They acquired another two studios this quarter, bringing the total to 13, more than doubling their first party content capacity in the past 6 months. The ambition is to build a world-class gaming platform spanning mobile, PC, and console. Like a Netflix of gaming.

· Commercial Cloud revenue (consisting of Office 365 Commercial, Azure, Dynamics Online, and LinkedIn Commercial, so pulls from the first 2 segments) was $9B, +48% YoY.

o Commercial cloud gross margin increased by 5 pts YoY to 62% driven by significant improvements in Azure gross margin.

o Within Commercial Cloud, Azure grew 76%. This suggests annual revenue for Azure close to $13B.

· Nadella again talked about their competitive advantage as a vendor enterprises can trust, whereas AMZN is often a competitor with companies it seeks as clients for their cloud business.

· Management expects a 100-200bps headwind from FX in 3Q19.

Valuation:

· FCF in the quarter was $5.2B. Returned $9.6B to shareholders ($3.5B in dividends and $6.1B in share repurchases).

· Trading at a 4.4% 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 1.8% dividend, which they have been consistently growing.

· Strong balance sheet with about $128B in gross cash, and about $60B in net cash.

· Price target 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

Key Takeaways:

Current Price: $176 Price target: $198 NEW ($188 old)

Position size: 3.70% 1-year Performance: -4%

Stryker released continued impressive results with sales up 9.4% (+8.6% organic, the best organic sales growth in a decade). The management team is very bullish on Mako’s growth, especially starting in 2020 once a big wave of training of surgeons on the robot is done in China & Japan. But growth is broad-based, and for 6 years in a row, SYK revenue growth has outperformed its competitors by 200-250bps. This quarter operating margin improved 30bps (40bps for full year) which came from continued good leverage and expenses savings. Recent acquisitions have been dilutive to their margins so they have pushed integration further this year to improve the G&A synergies faster. “Speed of integration” has been a new mantra at Stryker for the past 2 years.

Emerging markets are only 6% of sales which presents a huge opportunity for the company. During 4Q18, EM growth was broad-based:

· Russia performing well

· Latam strong after some leadership changes

· Bought out a distributor in Turley and now performing strongly

· Strong performance in China

· Tough early in India, but management changes, and 4Q strong with bright outlook

2019 Guidance:

Organic sales to grow 6.5-7.5% (with ramp up in Q3 and Q4)

30-50bps EBIT margin improvement

Adjusted EPS $8.00-8.20

Valuation: we are increasing our price target to $198 as we roll over our model to 2019. We see a premium valuation justified as growth is consistent and should continue in the near future.

SYK Thesis:

• Consistent top and bottom line growth in the mid and upper single digits respectively
• Continued operating leverage of current infrastructure
• Strong balance sheet and cash flow used in the best interest of shareholders

$SYK.US

[tag SYK]

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

Apple reported slightly better than expected Q1 results, though expectations were based on lowered guidance given by the company on Jan 2. Management cited four main factors that negatively impacted their 1Q results: iPhone launch timing vs a year ago, FX headwinds, supply constraints, weakness in emerging markets especially China. The last factor was given most of the blame. iPhone upgrades were also weaker than expected in part because the relative strength of the US dollar has made their products more expensive in many parts of the world. Revenues were down 4.5% (-3% constant currency). The decline was due to 15% lower iPhone revenue which makes up a little over 60% of sales. Though iPhone sales were down, the rest of the business grew 19%. The stock is likely up because Q2 guidance was not as bad as feared and the earnings call focused on opportunities for Apple beyond the iPhone.

Key Takeaways:

· Weakening iPhone sales and no more unit numbers – this is the first quarter where they are not reporting unit numbers. Different iPhone launch timing from a year ago impacted their results. The iPhone X launch fell into Q1 last year, instead of Q4 making the comparison tough this quarter. It is likely that average selling prices (ASPs) dropped a little this quarter because they are lapping the iPhone X launch, so the down 15% is a combination of lower units and lower ASPs. Unit sales have been a major concern given a mature smartphone market. 2018 was the 2nd year in a row of global unit declines in smartphones. The industry is expected to return to modest growth this year and next year aided by 5G compatible phones and foldable phones.

· Weakness in China –Over 100% of their worldwide YoY revenue decline was driven by their performance in Greater China. Mgmt said revenues were down $4.8B YoY, which implies revenue down 27% – despite that¸ revenues in China did grow for the calendar year. China is the largest smartphone market (30% share) and sales in 2018 were down high single digits.

· 900 million active iPhone installed base – this is a new disclosure and an important one. While units only grew 0.5% in fiscal 2018, and were in decline in 1Q19, their active base of iPhone users actually grew 9% because people are keeping their phones longer and there is a secondary market for phones. Growing their active installed base (which is now 1.4 billion devices including 500 million non-iPhone devices) is key to growing their services business.

· Non-iPhone revenue was strong – Services grew 19%, Mac revenue grew 9%, iPad sales grew 17% and the Wearables business, which includes the Apple Watch and AirPods, surged 33%.

· Gross margin disclosure – Apple is now breaking out separately gross margins of products and services. The faster growing services business has 63% gross margins vs 34% for products.

· Future beyond the iPhone – ApplePay, Apple News, Apple Music (50 million subscribers vs 87 million paid subscribers for Spotify), health tracking, AppleTV. Management also spoke of “some exciting announcements coming later this year” which I think is likely related to AppleTV.

Valuation:

· Strong balance sheet and FCF generation continue. $130B in net cash or 17% of their market cap.

· The stock is undervalued and the substantial buyback will support valuation. Management’s commitment to be net cash neutral “over time” would mean either returning to shareholders or spending on M&A their current $130B of net cash plus annual FCF production of around $60B. That’s about $300B over the next 3 years or 40% of their market cap.

· Trading at close to a 1.8% dividend yield, an 8% FCF yield and ~13.5x P/E.

The Thesis for Apple:

• One of the world’s strongest consumer brands and best innovators whose product demand

has proven recession resistant.

• Halo effect -> multiplication of revenue streams: AAPL products act as revenue drivers

throughout portfolio – iPhone, iPod, MacBooks, iPad > iTunes, Apps, Software, Accessories,

• Strong Balance and cash flow generation.
• Increasing returns to shareholders via dividends and buybacks.

$AAPL.US

[tag AAPL]

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

Key takeaways:

Current Price: $288 Price Target: $388

Position Size: 3.47% 1-year Performance: -17%

Lockheed’s 4Q18 earnings results were good enough with sales 5% above consensus, while EPS missing by a penny. What was really positive this quarter was the leading indicator for future demand known as book-to-bill ratio reaching 1.46x, and backlog hitting $130B (+19% sequentially). Margins increased 60bps in the quarter. Production improvements with the F-35 will help its margin by 50bps, as they are hitting a more mature cadence. F-35 is on track so far for 2019: deliveries should reach 131 in 2019 (+40 vs 2018) and keep growing until it reaches 160 in 2021. There were some cash collection delayed to 2019, providing a $250M boost to 2019 cash flows. On the cash flow front, the company transferred some pension liability to Prudential, thus mitigating volatility on $2.5B of pension obligations. This covers 41,000 current retirees (25% of their retired pension population). We remain positive on the company’s outlook where fundamentals are resilient and the end markets are supported in part by the US Defense budget growth.

Continue reading “LMT 4Q18 earnings summary”