Month: November 2019

Current Price: $44 Target Price: $63

Position size: 3.7% TTM Performance: 1%

CSCO reported good Q1 results, but guided below expectations for next quarter. Revenue growth guided to -3% to -5% vs street +2.7% and adj. EPS guided to $0.75 to $0.77 vs street $0.79. The weakness was attributed to a weakening macro environment, not company-specific issues. Last quarter they said they saw early signs of macro weakness. They said the macro environment has continued to deteriorate and was broad-based across all end markets (except public sector) and geographies. While weakening business confidence and a resultant slowdown in enterprise spending would be a headwind for them, the secular drivers that Cisco stands to benefit from are very much intact. Long-term Cisco will benefit from a product refresh cycle that is ultimately driven by increasing data traffic. With rising data traffic, technologies are changing (5G, IoT, WiFi 6) and networks are becoming more complex – Cisco’s products help companies solve for that by helping them simplify, automate, and secure their infrastructure. Capital return program should limit downside – buying back shares and now >3% dividend yield that’s easily covered (helps provide a floor, especially w/ falling rates).

Thesis intact, key takeaways:

· Deteriorating macro conditions across every region and now expanding into the Commercial (SMB’s) and Enterprise verticals. Mgmt said commercial tends to be the most resilient and they saw broad based weakening with those customers across the globe. They pointed to weakening business confidence as a result of macro uncertainty due to trade wars, Brexit, Hong Kong, uncertainty in Latin America, upcoming US elections and potential impeachment.

· In terms of macro softening management talked specifically about smaller deal sizes and approval process across industries getting longer…a leading indicator of tightening corporate budgets.

· Infrastructure Platforms (largest segment, ~58% of revs) was down -1.4% YoY. Similar to last quarter, all the businesses were up except for routing from soft Service Provider (cable and telecomm companies) demand. Switching had growth in both campus and data center with the continued ramp of the Catalyst 9000 and strength of the Nexus 9000 (both sold w/ 3-5yr software agreements). Management commented that the campus refresh cycle continues to be strong.

· Strong performance in Applications (+6% YoY) and Security (+22% YoY).

· Service revenue was up 4%, driven by software and solution support.

· Gross margins and op margins better than expected, in part benefitting from the positive impact of rising software mix.

· By end markets, Public sector order metrics remained strong (+6% YoY) while enterprise and commercial were each down 5%, and service provider was down 13%.

· By geography, Americas and EMEA were each down 3% and APJC was down 5%. Total emerging markets were down 13% with the BRICS plus Mexico down 26%. China is <3% of sales, revenue was down 31% in Q1 (was down 25% last quarter).

· Product mix continues to improve with more software/subscription. By year end, they target 50% of their revenue to be from software and services – a target which they reiterated they will hit. Subscription revenue was 71% of total software revenue, up 12pts YoY and 5 points sequentially. This transition will drive an upward trend in CSCO’s margins over the next several years.

Valuation:

· They have a >3% dividend yield which is easily covered by their FCF.

· Capital allocation strategy of returning a minimum of 50% of their FCF to shareholders annually through share repurchases and dividends. Their annual dividend is $6B.

· Forward FCF yield is ~7.5%, and is supported by an increasingly stable recurring revenue business model and rising FCF margins.

· The company trades on a hardware multiple, but the multiple should expand as they keep evolving to a software, recurring revenue model. Hardware trades on a lower multiple because it is lower margin, more cyclical and more capital intensive.

Thesis on Cisco:

· Industry leader in strong secular growth markets: video usage, virtualization and internet traffic.

· Cisco is the leader in enterprise switching and service provider routing and one of the few vendors that can offer end-to-end networking solutions.

· Significant net cash position and strong cash generation provide substantial resources for CSCO to develop and/or acquire new technology in high-growth markets and also return capital to shareholders.

· Cisco has taken significant steps to restructure the business which has helped reaccelerate growth and stabilize margins.

$CSCO.US

[tag CSCO]

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!

Share price: $137 Target price: $165

Position size: 2% 1 yr. return: 20%

Disney reported strong Q4 results. Revenue was in-line and they beat on EPS $1.07 vs street $0.95. Reiterated the guidance of DTC for Disney+, Hulu and ESPN+ that was given at the April Investor Day. They also had positive commentary around early results of Disney+ in the Netherlands and have announced new partnerships w/ Amazon Fire, Samsung and LG for streaming Disney+.

Key takeaways:

· Better than expected op income driven mostly by Parks (includes consumer products) and Studio. Studio performance driven by Lion King, Toy Story 4, and Aladdin.

· Better consumer products op income was due to growth in merchandise licensing w/ Frozen and Toy Story merchandise. Better parks op income was driven by their strategy of managing yield (i.e. dynamic pricing) to drive greater profitability. Domestic park attendance was comparable to Q4 last year, and reflects the impact of Hurricane Dorian, which adversely impacted attendance growth by about 1%. Per capita guest spending was up 5% on higher admissions, merchandise and food and beverage spending. So far this quarter, domestic resort reservations were flat YoY. Mgmt says guests are deferring visits to Disney Land and Walt Disney World until the complete opening of Galaxy’s Edge at those respective locations. While int’l parks are being negatively impacted by Hong Kong protests, it was offset by growth in Paris and Shanghai parks.

· Expectations for Disney+, which launches next week, are increasing given new partnerships, better visibility into robust slate of exclusive content, earlier than expected launch in Western Europe and positive commentary around testing in the Netherlands.

· Launch next week is in US, Canada and Netherlands, then Australia and New Zealand the following week and Western Europe in March.

· The new Star Wars series, The Mandalorian, which will be available at launch and exclusive to Disney+ is being heavily hyped after early screening of the first episode. Link to Mandalorian trailer: https://www.youtube.com/watch?v=XmI7WKrAtqs

· Disney+ distribution partners include: Apple, Amazon, Roku, Samsung, Google, Microsoft, Sony, LG.

· Media networks – cable subs down 4% YoY, driven by cord-cutting and in line w/ peers. ESPN+ now has >3.5m subs – up almost 50% QoQ. Hulu now at 28.5m subs and mgmt. announced that FX network will now be exclusive to Hulu for streaming. Additionally, FX will produce new original series exclusively for Hulu, starting with 4 new series in 2020.

Investment Thesis:

1. Disney is a global media and entertainment company that owns a massive library of intellectual property.
2. Their competitive advantage is their evergreen brands and synergistic business model. Disney can create content that builds off existing franchises and can be monetized across all their business, giving them the ability to create higher budget, quality content and an ever growing library of IP.
3. New direct-to-consumer (DTC) initiativewill strengthen synergies between businesses and lead to structurally higher margins and higher multiple on recurring revenue business.
4. Recent Fox acquisition improves their content positioning and global growth opportunities.
5. High quality company with solid balance sheet, strong FCF generation and ROIC.

$DIS.US

[tag DIS]

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

Current Price: $1,945 Price Target: $2,400

Position Size: 2.5% TTM Performance: -1%

Booking is trading up after reporting better than expected results – a relief especially given EXPE’s report yesterday. BKNG reported in-line gross bookings and better than expected room night growth. While guidance was below consensus, they have a track record of guiding conservatively. Expedia’s earnings miss was on higher ad spend, however BKNG’s ad spend was >200bps lower as a percent of revenue YoY, which is reassuring given their better than expected room night growth. So, EXPE needed to spend more than expected on advertising to beat on room nights while BKNG spent less. They do however face the same pressures from Google that Expedia faces –this has been a theme for many quarters as they try to improve ROI on ad spend and try to get more consumers to their site directly. BKNG does have some structural advantages to EXPE including their focus on the more fragmented European lodging market which leads to higher take rates. They also have higher productivity on ad spend – this is driven in part by higher travel frequency in Europe which leads to more direct traffic and also by having fewer brands/banners than EXPE which results in less efficient ad spend.

Key Takeaways:

· Gross bookings growth was +7% constant currency. Guidance was for +3-5%.

· They booked 223 million room nights in 3Q, up 11% YoY. Guidance was for 6-8% growth constant currency.

· ADR headwind: industry occupancy is peaking and ADR’s are weakening as the lodging cycle matures. Lower ADR’s will be a cyclical headwind as revenue is a % of room revenue. This will impact them more than in past cycles as secular growth is slowing with higher penetration..

· Guidance: Management provided Q4 guidance below consensus with bookings growth decelerating to +4% YoY at the high-end of the range.

· Total ad spend declined~233bps YoY as a percentage of revenue, with direct traffic growing faster than pay channels.

· What’s driving advertising spending issues? The driver is less efficient search engine optimization (SEO). SEO refers to where their sites fall in rankings based on search results. The goal is to be at the top and get organic (free) traffic. They also advertise to get traffic. Both EXPE and BKNG spend a ton (>30% of revenue each) on advertising to drive revenue. The goal is to get more direct (go to the app or directly to the website) and/or SEO traffic to the site. The problem is that Google has reformatted how search results show up (a box appears ahead of listed results) which drives traffic to their own sites (this is a source of antitrust scrutiny) and pushes BKNG’s and EXPE’s sites lower in the search results. The consequence of this is exacerbated on small mobile screens, where an increasing amount of the traffic comes from. Yelp has been a vocal critic of Google’s behavior on this same issue.

· Alternative accommodations: “growth outpacing the overall business.

Valuation:

· Repurchased $1.4 billion of stock in Q3 – $13 billion outstanding under repurchase authorization – expect to complete this authorization in the next 2-3 years assuming stable business and market conditions.

· The stock is still undervalued – trading at ~6.5% FCF yield on 2020.

Thesis:

1. Booking is a leading global online travel agent. Their global supply advantage drives a virtuous cycle: supply drives increased traffic and bookings and in turn more supply.

2. BKNG has several competitive advantages relative to Online Travel Agent (OTA) peers:

· Leading position in Europe is a structural advantage – market is highly fragmented and depends on OTAs for bookings

· They operate largely on an agency basis which allows them to continue to grow their network and do so profitably

· Strong position in China/South East Asia via Ctrip and Agoda

3. Booking’s addressable market is growing driven by:

1.) Alternative accommodations

2.) Increased penetration (growth of mobile/internet)

3.) Global growth of travel spend > GDP.

4. Their asset light “toll both” business model is characterized by high margins, low capital expenditures, and growing free cash flow. Free cash flow is expected to grow double digits over the next few years and I expect them to put this capital to good use via continued investment in their business and/or opportunistic returns of capital.

$BKNG.US

[tag BKNG]

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: $75 Price Target: $115

Position Size: 1.28% 1-year Performance: -34%

EOG released 3Q19 earnings that showed a miss on the revenue line by 2%, but lower costs than expected, with a drilling cost decline of 5% YTD. The premium drilling inventory level increased 17%. 1,470 premium locations were added, with the Wolfcamp M (combo oil/gas) and the 3rd Bone Spring locations. The negative material that came out of this quarterly report is that half of the premium drilling inventory is located in federal land, making it a risk if Elizabeth Warren were to be elected President (she had twitted this past year wanting to stop drilling on federal land). To somewhat offset this risk is the fact that the company has 4 years of permits in process (a permit typically takes 6-10 months to obtain). This regulatory overhang has been driving some of the EOG weakness this year.

Regarding its capital allocation, EOG is targeting a 2% dividend yield (from 1.5% currently), a sign of confidence from the management team in its future cash flows. About 2020 targets, EOG thinks it can achieve a 15% oil production rate, as long as the WTI oil price is in the mid-$50.

From an ESG standpoint, EOG provided some interesting data:

· It is the industry leader in capturing produced gas (vs. releasing it into the atmosphere)

· Remains committed in reducing greenhouse gas emissions, also a leader in this area

Continue reading “EOG 3Q19 earnings summary”

Share price: $123 Target Price: $156

Position size: 1.52% TTM return: +27%

Key Takeaways:

This morning Zoetis released its 3Q19 earnings results, with sales growth of +7% (+9% ex-FX) and EPS growth of +13%. The companion animal segment contributed nicely to performance with +23% operational sales growth thanks to its diverse portfolio of drugs and products: parasiticide, dermatology and diagnostic tools all contributed. The livestock segment declined 4% due to weakness of the US cattle market (trade uncertainty and weather), and the ongoing African Swine Fever, but poultry helped offset some of the loss. While the swine disease has been a small drag to ZTS business, the management team believes China will recover and move towards industrial production rather than returning to the mom & pop backyard swine production, which ultimately would be a good thing for ZTS. The current CEO is retiring at the end of the year, and the newly appointed CEO is Kristin Peck, who was previously VP of Operations. She was asked on the call how she saw the future strategy of the group. She highlighted the possibilities in the diagnostics/labs sector (Zoetis recently acquired Abaxis). This market has been growing over 10% y/y and there are two main players (Idexx and VCA) and Zoetis could become the third, thanks to organic and inorganic growth in the next 2 years. Near term, the launch of Simparica Trio in Europe and Canada is scheduled for 1Q20, and will be a good indicator of sales potential in the US once it is approved for sale, sometime towards the end of 1Q20. Based on those assumptions, the management team currently targets a $150M in sales in 2020. Continue reading “Zoetis 3Q19 earnings summary”

Share price: $57 Target Price: $60

Position size: 2.2% TTM return: 27%

BKI reported in-line revenue and better than expected EPS. Revenue guidance was lowered to the low end of original guidance but in-line with consensus. EPS guidance range was also lowered but the midpoint was still slightly ahead of the street. Revenues and adj. EPS were both +6%. The stock is down because of announced lawsuits between Black Knight and a client, PennyMac. PennyMac is making anti-trust claims against Black Knight and Black Knight is alleging breach of contract and misappropriation of trade secrets by PennyMac. PennyMac has been a customer of Black Knight’s mortgage software products since 2008 and claims that “due to limitations of BKI’s MSP product” they made some efforts to customize and enhance some modules of BKI’s software that they are now trying to claim as their own. Given BKI’s market share leading position, high retention rates and ability to replace the custom in-house solutions of large banks, the claims against them seem surprising and retaliatory. The lawsuit is concerning but does not suggest a change in thesis at this point.

Key Takeaways:

· Given the de-conversion of a specialty servicing client that impacted guidance last quarter and now the PennyMac situation, they are seeing some unusual headwinds into 2020 (~5% hit to top line). Long term targets continue to be 6-8% revenue growth and mid-teens EPS growth. By segment, the expectation is mid to high-single digit growth in Servicing, high-single to low-double digit growth in Origination, and low to mid-single digit growth in Data & Analytics.

· Data analytics segment (~14% of revenue) revenues were up 9% driven by growth in their property data and portfolio analytics businesses.

· Software Solutions segment (~85% of revenue) was up 5%.

o Within this segment servicing (~70% of revenue) grew 1%. This growth was impacted by the client de-conversion and early client termination mentioned on their 2Q earnings call. They continue to dominate first lien loans with leading share and are growing share in second lien loans. Market share for first mortgages has grown from 49% in 2010 to 63% as of the end of Q3.

o Originations (~16% of total revs) made up of new loans and refi’s – revenues increased 25% – lower rates help, but growth also aided by an acquisition and a termination fee.

Valuation:

· Trading at ~4.5% FCF yield on 2020 –valuation is supported by growth potential, strong ROIC with a recurring, predictable revenue model (>90% recurring revenue) and high FCF margins, which is aided by high incremental margins and capex (~9% of revenue now) which should taper as they grow.

· Leverage ratio now at 2.8x, high because of Dun & Bradstreet but decreasing.

· Capital allocation priorities include opportunistic share repurchases, debt pay down and potential acquisitions.

Thesis:

• Black Knight is an industry leader with leading market share of the mortgage servicing industry.
• Stable business with >90% recurring revenues, long-term contracts and high switching costs.
• BKI has high returns on capital and high cash flow margins.

$BKI.UA

[tag BKI}

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!

Current Price: $70 Price Target: $90

Position Size: 2.41% 1-year Performance: -10%

Key Takeaways:

This morning CVS published its 3Q19 earnings results. Revenue was up 36% due to the addition of Aetna, but also thanks to positive performance in its legacy business: pharmacy same-store-sales were +4.5% and front end same-store-sales were +0.6%. On the PBM side, claims were up 9.3% y/y, but the ongoing price pressure impacted profitability. Net new business on the PBM side is improving vs. last quarter as well. The onboarding of IngenioRx (Anthem’s PBM) is progressing well. Regarding its HealthHub progress, 50 hubs will be opened by the end of this year. This store format should start having an impact on the company’s results in 2021, once it reached a more critical mass.

So far, the company has repaid $8B of net debt since the Aetna transaction closed, ahead of schedule. Its expected synergies went up from $300-350M to $400M in 2019, for a targeted $900M run rate in 2021. A reminder that in addition to the synergies with Aetna, CVS also expects $1.5-2B in run rate net savings in 2022 from its modernization efforts. It is great to see that thanks to its investments in corporate social responsibility, CVS has been listed in the Dow Jones Sustainability Index for 7 years in a row, and was just added to their World Index. The management team raised its FY19 earnings guidance once more (from $6.89-$7.0 to $6.97-$7.05) as performance has been good. We are glad to start seeing some clarity post-merger on where the combined business is heading, confirming our investment thesis. Continue reading “CVS 3Q19 earnings summary”