Month: February 2020

 

Key Takeaways:

 

·         4Q19 results were better than expected as content growth story continues (Sensata’s strategy is to grow the amount of sensors used in a car over time – by making more sensors that answer a manufacturer’s need to comply to changing regulations for example)

·         Coronavirus impact on 2020 results was clearly quantified by the management team, which lifted some concerns on the name

·         2020 guidance showed the power of the company’s strategy, even when end-markets show some weakness

·         Sensata is still attractively priced, with a FCF yield of 5.3%

 

[more]

 

Current Price: $50              Price Target: $61

Position Size: 2.10%          1-year Performance: +2.4%

 

Sensata released 4Q19 results, with organic sales contracting -0.8%, better than guidance and expectations, thanks to strength in its Industrials segment. Free cash flow was better than guided and in line with the prior year, reflecting a better conversion rate from net income. This past quarter, operating income was impacted by sales deleverage, some productivity headwinds and design & development investments. During the year, ST reduced its share count by ~5%, a wise capital allocation decision by the management team in times of high M&A prices and a stock price still attractively priced.

 

Segments review:

·         Automotive organic sales decline of -1%: Sensata outgrew this sector by 490bps, thanks to strong content growth in China (double digit growth), but negative impact of the GM strike in North America and softness of European exports to China

·         HVOR organic revenue growth was -2% y/y: Sensata outgrew this sector by 1190bps, thanks to content growth in China as OEM prepare for the implementation of the China VI regulations

·         Aerospace & industrial: organic growth was +1%: thanks to the double digits aerospace growth

 

The management team provided guidance for 2020 of -1% to +2%, reflecting the impact of the coronavirus on factory closures and supply chain disruptions ($40M sales impact and $20M operating profit hit that will not be recovered later in the year). Without this one-time (hopefully) event that is the virus outbreak, sales and profits would have shown a return to stable demand, which is what consensus was expecting. 1Q20 will be the weakest with -8% to -6% organic growth (Coronavirus impact). The management team assumes global auto market production to decline 5% y/y, China auto down 6% y/y, and the global HVOR market down 9% y/y.

 

The Thesis on Sensata

• Sensata has a clear revenue growth strategy (content growth + bolt-on M&A)
• ST is diversifying its end markets exposure away from the cyclical auto sector over time through acquisitions, also expanding its addressable market size
• ST is a consolidator in a fragmented industry and still has room to acquire businesses
• Margins should expand as the integration of the prior two deals is under way, regardless of top line growth, and efficiencies in manufacturing are continuously pursued as they are gaining scale
• ST is deleveraging its balance sheet post acquisitions, leaving room for future M&A or a return to share buybacks, and improving EPS growth

 

 

Tag: ST

category: earnings

$ST.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

 

 

Key Takeaways:

 

·         On track with its Aetna integration to become an integrated health-care solutions provider

·         Integration synergies ahead of initial guidance for 2019 and 2020

·         2020 guidance is underwhelming but most likely conservative

 

Current Price: $73                            Price Target: $90

Position Size: 2.35%                        1-year Performance: +10%

 

This morning CVS published its 4Q19 earnings results, beating consensus estimates as every segments provided positive results. CVS is going through a multi-year integration process of its acquisition of Aetna. While CVS’s CEO said the integration was successful during the call, the prior Aetna CEO made some noise earlier this month by saying he was being pushed out of the board and that the integration was “far from over”. So far integration synergies are ahead of the initial plan, so we’ll take that as a sign that things are progressing in the right direction. It will most likely take another year before we see greater leverage on the top and bottom line of the integration and offering of better solutions to clients. CVS will be

 

Segment details:

·         Pharmacy services: revenues up 6.2% thanks to higher claims volume although generics dispensing rate increased (lower prices)

·         Retail/Long-term care: revenues +2.5% due to higher prescription volume but reimbursement and generic pressure

·         Retail pharmacy: same-store-sales +3.2% with front store sales up 0.7% and pharmacy sales +4.1% (driven by continued adoption of patient care programs)

·         Health care benefits: year-end membership was in line with expectations

 

Initial 2020 guidance:

·         Sales up 2-3.5%

·         EPS of $7.04-$7.17 (consensus $7.15), a 3-5% growth y/y, but we would not be surprised to see this number go up as the year progresses

·         Integration synergies expected to be $800-$900M

·         Enterprise modernization expected to drive a benefit of $450-$550M

·         600-650 HealthHub locations by the end of the year

·         CFO of $10.5-$11B

·         Leverage ratio to be in the low 3x in 2022

 

 

Thesis on CVS

• Market leader: largest pharmacy benefit manager (PBM) in the US. This gives CVS scale advantage and negotiating power with pharma companies to obtain better drug pricing discounts. Also the largest US pharmacy retailer, giving it more touch points with consumers/patients. Finally, market share leader in long-term care pharmacy sector thanks to its Omnicare acquisition.
• Stable and predictable top line and margin profile. CVS benefits from an ageing population in increasing needs of prescription drugs.
• shareholder friendly, offering a 7% shareholder yield (5% share repurchase + 2.6% dividend yield)

 

$CVS.US

Category: earnings

tag: CVS

 

 

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

 

 

Key takeaways:

1.       Current RevPAR trends are slowing, but still expected to be slightly positive in 2020.

2.       Their asset light model and solid net unit growth means they are less sensitive to macro driven RevPAR trends. Despite weakening RevPAR, Hilton continues to grow EBITDA and FCF/share aided by 6-7% unit growth, and a robust pipeline that represents 40% future room growth.

3.       Coronavirus is not in guidance, but likely not more than -1% impact to overall FY RevPAR and 50bps impact to unit growth. This could be ~-1% to -2% impact to FY20 EBITDA (China is only 2.7% of their EBITDA). They have shut down 150 hotels (33k rooms) in China which they are estimating could be closed for 3-6 months and an additional 3-6 months of recovery period.

 

Share Price: $114               Target Price: Raising to $137 from $105

Position Size: 3%              1 Yr. Return: 55%

 

Hilton beat on revenue and EPS – Q4 RevPAR was slightly below expectations, offset by higher licensing fees. On ~1% FY19 RevPAR growth, they grew EBITDA 10% and EPS 14%, demonstrating the strength of their asset light business model and strong unit growth. While RevPAR is weakening, Hilton’s robust development story means they are a lot less dependent on macro driven RevPAR. Their business model is structurally different than it was last cycle because they own fewer of their hotels and instead receive high margin management and franchise fees. About 7% of their EBITDA is generated from owned hotels vs over 40% in the last recession – this asset light model means less operating leverage and a less volatile earnings stream if RevPAR continues to weaken. Moreover, unit growth will aid EBITDA growth regardless of RevPAR trends. (RevPAR = revenue per available room. It’s their total room revenue divided by their total number of rooms). Their development pipeline is delivering 6-7% unit growth and has some countercyclical aspects. In 2019 they returned more than 8% of their market cap to shareholders in the form of buybacks and dividends. The stock is undervalued, trading at ~4.5% FCF yield on 2020.

 

Highlights:

·         Currency neutral system-wide RevPAR was -1% for Q4 and +0.8% for the full year. They maintained 2020 RevPAR guidance of 0% to +1% and expect 2020 net unit growth of 6-7%.

·         Q4 by geography – Q4 US RevPAR fell 80 bps, on softer business travel. Europe was +1.4%, Overall AsiaPac was -3.8% and w/in that China was -7.8% (includes impact from Hong Kong), Middle East & Africa was -4.3% (political tensions in Lebanon and supply growth in the UAE continued to pressure rate). Full year stats in chart below.

·         Softer business travel negatively impacted results in the US. Corporate demand (transient and group) drives 70%+ of HLT’s business system-wide.

·         Solid pipeline continues to drive capital efficient growth – Current pipeline represents close to 40% unit growth or 387k rooms. That is several years’ worth of growth w/ over 50% of that pipeline under construction, the majority of which are outside the US. More than 90% of their deals do not require any capital from them.

·         In a sensitivity analysis to a market downturn, mgmt. said they would expect flat to slightly positive growth in adjusted EBITDA and positive growth in free cash flow in an environment where RevPAR were to decline 5% to 6%. This is b/c unit growth will aid EBITDA growth regardless of RevPAR trends.

·         Continued strength in their market leading RevPAR index = counter-cyclicality – RevPAR index is their RevPAR premium/discount relative to peers adjusted for chain scale. They are the market leaders – this is helpful because it’s what leads to pipeline growth (hotel operators want to associate w/ the brand that yields the best rates and occupancy) and is helpful in a macro downturn because it’s even more crucial for a developer to be associated with a market leading brand to get financing. i.e. they would likely take more pipeline share if lending standards tighten. The other countercyclical aspect of their pipeline growth is conversions (an existing hotel changes their banner to Hilton). I.e. Hampton Inn (35 year old brand) has a RevPAR index of 120.

·         Loyalty members hit 104m and account for >64% of system-wide occupancy. Loyalty members continues to grow and % penetration continues to improve – both of which bode well for LT RevPAR trends as they typically see a doubling of wallet share once a customer signs up for the loyalty, and share improves w/ status level.  They get 75-80% share of hotel wallet from Diamond Honors customers.

·         In 2019 they returned more than 8% of their market cap to shareholders in the form of buybacks and dividends.

·         The stock is undervalued, trading at ~4.5% FCF yield on 2020.

 

 

 

 

Investment Thesis:

 

∙       Hotel operator and franchiser with geographic and chain scale diversity of 17 brands, 6,100 hotels and 970k rooms across 119 countries (Hilton, DoubleTree, Hampton Inn & Hilton Garden Inn ≈ 80% of portfolio).

∙       Network effect moat of leading hotel brand and global scale lead to room revenue premiums and lower distribution costs.

∙       Shift from hotel ownership to franchising results in resilient, asset-light, fee-based model.

∙       Record pipeline generating substantial returns on minimal capital will lead to increasing ROIC and a higher multiple.

∙       Unit growth and fee based model reduce cyclicality – Lower operating leverage vs ownership reduces earnings volatility and unit growth offsets potential room rate weakness.

∙       Generating significant cash which is returned to shareholders through dividends and buybacks.

 

 

 

 

$HLT.US

[category earnings]

[tag HLT]

 

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

 

 

 

AAPL reported a very strong quarter beating across segments except a minor miss on services. They raised guidance for next quarter well above the street. iPhones sales were a big positive surprise at up 7.6% YoY vs expected down ~1%. Encouragingly Greater China returned to growth, which helped with the iPhone beat. The coronavirus will have an impact on supply given Apple’s manufacturing footprint in China and will also have an impact on sales within China given some store closures. All of this is factored into their above consensus guidance.  

 

Key Takeaways:

·         Revenue was up 9% YoY.

·         iPhone 11 continues to be their best-selling iPhone.

·         Mac and iPad sales were down 3% and 11% YoY, respectively. The comparison was tough due to new launches a year ago.

·         Big beat on Wearables, Home & Accessories category – set all-time records for both Apple Watch and AirPods.. The strong wearables results were in spite of supply constraints for both the Apple Watch Series 3 and Airpods Pro.

·         Active installed base of devices has now surpassed 1.5 billion.

·         Services growth decelerated very slightly to ~17% – saw double-digit growth in all regions. The miss here will probably be a focus in the news given that the LT story on Apple rides on this category. However, they are still in the early stages of ramping their opportunity with services. Including several new services that aren’t making much of a contribution yet (Arcade, Apple News+, Apple TV+). A key advantage Apple has is its uniform operating system across devices. The smartphone market is dominated by two operating systems, Apple’s iOS and Android. Apple has mid-teens % of the global market and Android has almost all the rest. However, Android’s operating system is fragmented across multiple manufacturers which can make app development for Android more difficult than for iOS. Apple’s iOS ties in a growing ecosystem of devices including wearables and they have a wealthier installed base that is more likely to pay for Apps. I think this could become more important with 5G because taking advantage of 5G across devices requires app development. 5G’s faster speeds and lower latency will enable new Apps that let people do more with their wireless devices. For instance, Apps that take advantage of artificial intelligence, augmented reality and IoT (Internet of Things). 4G enabled things like Uber and a slew of food delivery apps and Netflix and Facebook on your phone.

·         On a run rate basis with the results of the December quarter they’ve already reached their goal of doubling their fiscal year ’16 Services revenue during 2020.

·         Tim Cook suggested the potential for them to do targeted video advertising in a way that would not infringe on privacy though he wouldn’t “speculate” as to whether they would actually take advantage of that opportunity. This probably depends on the success of Apple TV+ as a subscription service. It does suggest that if they don’t get a lot of subscribers they have an alternate video strategy.

·         China – iPhone sales were up double-digits. Services and wearables were also up double-digits, Cook says iPhone 11 is doing particularly well there. Trade-in and finance programs were also well received

·         Impact from Coronavirus – Apple does have some suppliers in the Wuhan area. There are alternatives and Apple is looking for increases from them. Factories are starting back up after the Lunar Holiday on Feb. 10 which is later than expected. All of that is factored into guidance and management pointed to that as the reason for a wider than usual top line guidance range. One of their retail stores has been closed, and some partners have closed stores or reduced operating hours. Sales within the Wuhan area are small, but retail traffic across China has been reduced. Again, Apple has accounted for this in its outlook.

·         Apple Pay, revenue and transactions more than doubled year-over-year with a run-rate exceeding 15 billion transactions a year.

·         They reiterated goal of being net cash neutral “over time.”

 

Valuation:

·         Trading at about a 1% dividend yield, and ~4.7% FCF yield.

·         They have about $99B in net cash on the balance sheet. That’s about 7% of their market cap.

·         The stock is still reasonably valued and continued buyback from management’s goal of net cash neutral will support valuation.

·         In addition to the $99B in net cash they already have, they produce >$65B in FCF annually (that’s more than all the other FAANGs combined). This suggests they could buyback over 20% of their current market cap over the next 3 years.  

 

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

[category earnings]

[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

 

 

 

Current Price: $567        Price Target: $660

Position Size: 3.4%         TTM Performance: +45%

 

SHW missed on revenue and earnings. Miss was driven by softness in certain industrial end markets and choppiness in their international businesses. This was offset by strength in the America’s group (their chain of paint stores) and growth with their largest North American retail partners. They again had strong paint stores SSS performance of ~5%. In terms of 2020 outlook, management said they expect a similar environment with North American architectural demand remaining solid and industrial demand remaining variable by geography and end market. Last quarter they called out the same weakness.

 

Key Takeaways:

·         For full year 2020, they expect sales to increase 2% to 4%. By segment, they expect the Americas Group to be at or above the high end of that range. They expect Consumer Brands to be flat or slightly up and Performance Coatings to be up low-single-digits.

·         Guided to adj. 2020 EPS of $22.70 to $23.50 (+9.4% at the midpoint). This is below consensus of $24.33.

·         Management expects flat raw material costs for 2020, with 1H being down slightly.

·         They gave multiple data points on the strength they are seeing in US commercial and residential end markets including contractor and builder sentiment and strengthening in single and multifamily permits.

·         “We enter 2020 well positioned and focused on what we can control.”

·         For FY19 margins increased in all 3 segments. Gross margin expanded as pricing initiatives offset the raw material inflation they have experienced since 2017.

·         The Americas Group:  55% of sales, +5% in Q4

o   SSS of +5%. Prices increases will be a tailwind to 2020 SSS.

o   Opened 62 net new stores for the year.

o   Professional painting contractor customers continue to report strong demand.

·         Consumer Brands Group: 16% of sales, +1% in Q4

o   Q4 growth due to selling price increases and higher volume sales to some of the group’s retail customers.

o   Full year segment sales decreased due to lower than expected sales in Asia and Australia and the impact of the Guardsman divestiture.

o   Supply chain efficiencies, pricing initiatives, moderating raw material costs aided margins

·         Performance Coatings Group: 29% of sales, -5% in Q4

o   Softer sales outside of North America and unfavorable currency translation, partially offset by selling price increases.

o   Sales for the year were variable by geography and end market. Growth in North America and Latin America was more than offset by softness in Europe and Asia. Mid-single-digit growth in packaging and coil lines was offset by softness in other product lines, most notably industrial wood.

Valuation:

• Expected free cash flow of ~$2.2B in 2020, trading at >4% FCF yield.
• Given growth prospects, steady FCF margins and high ROIC the stock is undervalued. They deserve a premium multiple based on large exposure to the N. American paint contractor market and lack of exposure to the cyclical sensitive auto OEM end market.

·         Share buybacks should increase in 2020 as their leverage ratio is now below target of 3x.

 

Thesis:

• SHW is the largest supplier of architectural coatings in the US. Sherwin-Williams has the leading market share among professional painters, who value brand, quality, and store proximity far more than their consumer (do-it-yourself) counterparts.
• Their acquisition of Valspar creates a more diversified product portfolio, greater geographic reach, and is expected to be accretive to margins and EPS. The combined company is a premier global paint and coatings provider.
• SHW is a high-quality materials company leveraged to the U.S. housing market. Current macro and business factors are supportive of demand:
  • High/growing U.S. home equity values. Home equity supportive of renovations.
  • Improving household formation rates off trough levels (aging millennials).
  • Baby boomers increasingly preferring to hire professionals vs. DIY.
  • Solid job gains and low mortgage rates support homeownership.
  • Residential repainting makes up two thirds of paint volume. Homeowners view repainting as a low-cost, high-return way of increasing the value of their home, especially before putting it on the market.

 

$SHW.US

[category earnings]

[tag SHW]

 

 

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

 

 

 

Amazon reported Q4 revenue above consensus forecasts, with the company exceeding the high-end of its revenue guidance for the first time since 1Q18. AWS revenue grew +34%. The big positive surprises in the quarter were an acceleration in N. American revenues (chart below) and better than feared AWS sales (estimates had been coming down). The AWS result (+34%), while a deceleration, was a relief given concerns of an even bigger deceleration from share losses to Azure. Operating income came in above consensus though margins contracted ~80bps YoY.

 

Guidance: Management guided to Q1 revenue of $69B – $73B vs. consensus of $71.6B. Guidance implies growth of +16% to +22% YoY. They guided Q1 operating income of $3B – $4.2B vs. consensus of $4.1B, but this guidance includes an ~$800m lower depreciation expense due to an increase in the estimated useful life of servers.

 

N. A. Retail sales up, but profitability down: Online (+15% in Q4) and 3^rd party seller services (+31% in Q4) both accelerated from Q418. Since third party fees grew faster than online sales, either their share of gross merchandise volume (GMV) grew or their take rate did. The sustainability of their nearly 27% take rate, which is a key retail profit driver for them, continues to be a risk. This accelerated growth was driven by expensive one-day delivery (which was expanded to lower priced items) that pushed e-commerce sales up, but also drove shipping costs up (to $12.9B) +43% and, as a result, operating margins lower in North America. This is reflected in N. American segment revenues accelerating to 22% from 18% and operating margins that deteriorated 150bps in Q4 and ~100bps for the full year. So, despite the robust top line growth, N. American profit dollars were down YoY – in Q4 from $2.3B to $1.9B and for the year from $7.3B in 2018 to $7B in 2019. Given that advertising and Prime fees are included in their N. American operating profit, these high margin businesses are clearly driving all of that 4.1% margin and making up for higher losses in retail. This suggests that the unit economics in North American retail continue to be challenged as one day shipping just increased their variable costs. International is still not profitable and operating income for Q4 was essentially flat (~$600m loss) on sales up 14%.

 

 

 

 

AWS not as bad as feared, but losing share to Azure and margins down: AWS is their primary source of profitability but decelerating and losing share to Azure which grew 64% this quarter, well ahead of AWS’s 34%. AWS margins declined >300bps YoY in Q4 and ~200bps YoY for FY19. By contrast, MSFT just reported Azure margins up 500bps. Alphabet’s cloud investments also pose a growing competitive threat to AWS. Mounting pressure on the AWS business seems to be one of the biggest fears of investors.

 

 

Trends with their FCF margins continue – valuation is still very expensive:  Adj. FCF margins were 4.3% (similar to 2018) resulting in ~$12B in FCF after capital leases. This is ~1.2% TTM FCF yield. The stock continues to be very expensive. Importantly, this $12B in FCF benefits from the $6.8B they pay in non-cash compensation through SBC and the $1.4B in excess tax benefits they get from SBC on top of that. Many analysts seem to use a sum of the parts valuation that places a multiple on GMV to value their online business. The problem with this is that it may be overstating the value of a retail business that continues to be subscale (i.e. losing money) w/ now likely over $340B in gross sales (GMV) and whose unit economics appear to be going in the wrong direction.

 

 

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

 

$AMZN.US

[category earnings]

[tag AMZN]

 

 

Current Price: $174                          Price Target: Increasing to $195 from $170

Position size: 6.7%                          TTM Performance: 58%

 

Microsoft reported solid Q2 results, beating street high estimates on both revenue and EPS. The beat was broad based with better than expected growth in all segments. Double-digit top and bottom line growth, driven by the strength of commercial cloud. Q1 revenue was $37B (+15% YoY), gross margin dollars were up 25%, op income was up 39% and EPS was $1.51(+41%). Commercial Cloud business was up 41% constant currency and saw continued margin improvement, helping to drive op income up 39%. Counted w/in that is Azure, which was up 64% constant currency. They are taking share from Amazon’s cloud offering, AWS. This should continue as they are better positioned as more large enterprises, that are longtime customers, move to the cloud. Given their enterprise customer base, recent partnerships with SAP, VMware and Oracle, and superior Azure hybrid architecture, the company is uniquely positioned to capitalize on the growing demand for cloud services.

 

Key Takeaways:

 

·         FY 2020 revenue guidance reiterated at up double-digits and op margins guidance increased to +200bps from “increase slightly.”

·         Company Q2 gross margin was 67%, up 5 points YoY, driven by favorable sales mix and improvement across all three segments.

·         Solid growth across all 3 segments:

o   Productivity & Business Processes, up 19% YoY, $11.8B – driven by strong performance in Office commercial and LinkedIn

o   Intelligent Cloud, up 28% YoY, $11.9B – driven by continued strong growth in Azure, +64%. Suggests annualized Azure revenue of ~$17B.

o   More Personal Computing, up 3% YoY, $13.2B.

§  Ahead of expectations as better-than-expected performance across Windows businesses more than offset lower than expected search (+7%) and Surface revenue (+8%).

§  Weakness in gaming with lower console sales as we approach the next Xbox launch – revenues declined 20% constant currency.  The lower console sales benefited gross margins.

·         Q1 Commercial Cloud (consisting of O365 Commercial, Azure, Dynamics Online, and LinkedIn Commercial – this includes some revenue from the first two segments above) was $12.5B, up 41% constant currency in the quarter. Commercial cloud gross margin percentage increased 500bps, driven by material improvement in Azure gross margin.

·         Within Commercial Cloud, Azure growth accelerated to +64% constant currency, from +63% last quarter.

·         Recently  announced exclusive partnership with SAP makes Azure the preferred destination for every SAP customer. Large customers mentioned on call include Accenture, Coca Cola, Rio Tinto and Walgreens.

·         Ambitious new sustainability commitment: Microsoft will be carbon-negative by 2030. And by 2050, they say they will remove all the carbon they have emitted since the company was founded in 1975. And their $1 billion Climate Innovation Fund will accelerate the development of carbon reduction and removal technologies.

·         Returned $8.5 billion to shareholders through share repurchases and dividends.

 

Valuation:

·         Trading at a 3-4% FCF yield –still reasonable for a company with double digit top line growth, high ROIC and a high and improving FCF margins.

·         They easily cover their 1.2% dividend, which they have been consistently growing.

·         Strong balance sheet with about $134B in gross cash, and about $47B 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

[category earnings]

[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

 

 

Current Price: $1,434                      Price Target: under review

Position Size: 4.9%                          TTM Performance: +25%

 

Alphabet missed estimates but improved disclosures. The stock is down today, but about even with where it opened yesterday. For the first time they broke out YouTube revenue separate from search revenue and also disclosed Cloud revenue. Despite the miss, 2019 revenue grew +20% (that’s $25B in incremental revenue for the year). Weaker hardware sales contributed to the 4Q miss, but they saw ongoing strength in YouTube and Google Cloud.

 

Key takeaways:

·         Top growth drivers were mobile search, YouTube and cloud.

·         Ad Revenue:

o   Google properties (includes search and YouTube) grew ~17% in FY19, which continues to grow faster than Network member sites at +7% – these are ads placed on sites that Google does not own.  

o   Search revenue was +15% (a deceleration from +22% in 2018) and YouTube was +36%.

o   YouTube ad revenue was revealed to be a $15B business – there seemed to be a wide range of estimates on how big this was, but this is in the range. Interestingly, their YouTube ad revenue is bigger than CBS, NBC, Fox and ABC ad revenue combined. See chart below.

o   They do not report YouTube’s profitability.

·         Google Cloud was +53% and is at a $10B run rate. GCP’s growth rate accelerated from 2018 to 2019. Commentary around this business, including backlog, was very strong. They are investing heavily behind this.

·         Google Other Revenues (includes Google Play, Hardware and YouTube’s non-advertising revenue)

o   In Q4, other revenues were up 10% YoY, primarily driven by growth in YouTube and Play, offset by declines in hardware. Lapping product launched contributed to lower growth.

o   YouTube now has over 20 million music and premium paid subscribers and over 2 million YouTube TV paid subscribers, ending 2019 at a $3 billion annual run rate in YouTube subscriptions and other non-advertising revenues. They also have a YouTube shopping initiative where people can now buy products in YouTube’s home feed and search results.

·         Other Bets: Losses grew. Management brought up the intention to get outside investors in these businesses. Verily is an example of a company in the portfolio that has outside investors like Silver Lake. They said they would consider opportunities for some of their Other Bets to take similar steps over time.

·         Key expense lines:

o   Higher cost of revenues driven by costs associated with data centers and servers, and content acquisition costs, primarily for YouTube.

o   Headcount was key driver in opex increases. They added 20k employees in 2019, an increase of over 20%! Majority of new hires were engineers and product managers. The most sizable headcount increases were again in Google Cloud for both technical and sales roles.

·         Share buybacks increased 59% QoQ.

 

Valuation:

·         Reasonably valued, trading at ~3.5-4% FCF yield on 2020.

·         $105B in net cash, ~11% of their market cap.

 

 

$G OOGL.US

[category earnings]

[tag GOOGL]

 

Sarah Kanwal

Equity Analyst, Director

 

Direct: 617.226.0022

Fax: 617.523.8118

 

Crestwood Advisors

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Boston, MA 02109

www.crestwoodadvisors.com

 

 

 

Key takeaways are:  

 

1. Better than expected Disney+ subscriber numbers of 26.5m subs (consensus ~20m) for Q1 and 28.6m subs as of Monday.

2. Headwinds: Coronavirus impact is manageable and temporary which negatively impacted guidance by $280m. Seeing some impact from cord-cutting which is expected and offset by DTC over time.

3. Despite this, long-term fundamentals remain strong, as Disney’s subscriber numbers demonstrate the quality of their content puts them in a solid position to win viewers that shift from cable TV bundles to streaming

 

Share price: $140              Target price: $165

Position size: 1.8%           1 yr. return: 28%

 

Disney beat expectations for revenue and earnings and reported impressive subscriber numbers on Disney+ of 26.5m subs (consensus ~20m) for Q1 and 28.6m subs as of Monday. These subscribers are mostly domestic, with big international launches coming later this year. They have already almost hit the 30m US subs that mgmt. was targeting in year 5. They are ramping this business far faster than Netflix, which took several years to hit that mark and has ~62m US subs after over a decade. Better subs and solid ARPU mean the economics of DTC are tracking ahead of expectations.

A key headwind for Disney right now is the coronavirus which negatively impacted guidance by $280m due to the closure of their Shanghai and Hong Kong parks. The full impact is not clear yet as the length of closures is uncertain, but their Int’l parks business is much smaller and lower margin than their US parks. Theater closures could also impact Studio results. The Chinese box office varies a lot by movie (most recently, 8.5% for Frozen 2). Aside from the temporary impact of the coronavirus, they saw a negative impact to ad revenue in their Media segment from more cord cutting. This highlights the fact that Disney is juggling viewers shifting from cable bundles to Disney+, Hulu and ESPN+, which can be a tailwind to one segment and a headwind to another. Despite this, long-term fundamentals remain strong, as Disney’s subscriber numbers demonstrate the quality of their content puts them in a solid position to win viewers that shift from cable TV bundles to streaming and also their ability to profit from their intellectual property in multiple ways across segments. Over time, their DTC initiative should strengthen synergies between their businesses, lead to higher margins and a higher multiple on recurring revenue.  

 

Highlights:

·         EPS of $1.53 vs $1.46 consensus, driven largely by Studio and Broadcasting.

·         Total revenue was slightly better than expected, with beats in all segments (especially Broadcasting and Studio) offset by higher than expected eliminations from licensing to DTC.

·         Direct-to Consumer (DTC) & International:

o   All DTC platforms, including ESPN and Hulu are tracking ahead of expectations. 7.6m ESPN+ subscribers (guidance of 8-10m in 2024). 30.7m Hulu paid subs (guidance of 40-60m in 2024). Of those, 3m pay for Hulu’s cable-like service, Hulu Live. Hulu is seeing strong ad revenue with their ad supported subscription level. Hulu will begin expanding internationally in 2021.

o   Disney+:

§  Original guidance was for FY 2024 subs of 60-90m globally, w/ 20-30m in the US and 40-60m international. They didn’t raise guidance, but they are basically already at the high end of this in the US after less than 3 months.

§  Q1 op income losses associated with launch of Disney+ were lower than expected. Breakeven originally guided to 2024. Given better subs and solid average revenue per user, the economics of this business is tracking better than expected.

§  Key investor concerns overcome: investors questioned how big contribution of Verizon offer for free 1 year of Disney+ with unlimited plans would be and also questioned whether churn would spike following the end of The Mandalorian season one which ended on 12/27. The contribution from Verizon free offer was lower than expected (5-6m subs). Subs have continued to increase since the end of Dec. with broad-based viewership across genres, which helps validate the appeal of their content beyond key new exclusives. So far, churn and conversions from free trials to pay have been better than expected.  

§  NFLX comparison: Disney went from 10m subs on day 1 (in November), to almost 29m now. NFLX reported 10m subs at the end of 2008. It took them until Q1 2013 to get to 29m. For sure, not an entirely fair comparison as streaming was a newer concept then and broadband speeds were slower, but still a benchmark. NFLX now has 169m subscribers (US is ~62m of that).

§  DTC geographic expansion will be a tailwind to sub growth: multiple geographies launching later this year including several European markets and India in March.

·         Parks:

o   Domestic park revenue +10% driven by pricing, higher guest spending and 2% attendance growth. Int’l parks results hurt by lower attendance in Hong Kong due to political events.

o   They guided to a coronavirus 2Q op income headwind of $280m, which assumes their Shanghai and Hong Kong parks are closed for two months. The closures came at a lucrative peak travel time with Lunar New Year.

o   Disneyland and Disney World make up the majority of revenue for this segment and at a much higher margin than their international parks.

o   If the Coronavirus spreads and were to cause a closure of their US parks this would be a far bigger impact. Domestic Parks and Experiences (which includes cruise ships) is ~$4B or ~25% of their total operating income.

·         Media:

o   They had a good quarter with better broadcasting results, but an acceleration in cord-cutting could squeeze TV ad and affiliate revenue (though likely a benefit to DTC segment). ESPN saw ad revenue decline 4.5% this quarter, which was partially offset by higher pricing. Ad revenue was ~15% of total revenue in 2019 with 2/3 of this from the Media segment and the rest from DTC. Their growing DTC segment is an offset to this segment and ESPN+ could eventually be a home for more sports content over time.

·         Studio:

o   Frozen 2 was a big contributor this quarter. They are lapping a strong movie slate from last year. This business is hit driven and thus results can be lumpy.

o   China could potentially weigh on results but impact should be small. Their next major film release is Mulan on March 27. This was expected to do well in China.  

o   China’s movie regulator typically allows only 34 foreign films to be shown in theaters each year. Attaining a slot can significantly boost a movie’s global box office. For example, China made up ~22% of Avenger Endgame’s total box office – which is larger than what’s typical and was the biggest Hollywood film ever in China. In general, super hero movies tend to do well in the Chinese market, more so than animated movies. Most recently, about 8.5% of Frozen 2’s box office was from China.  

·         Consumer Products:

o   Strong sales of Frozen and Star Wars merchandise

o   Baby Yoda from the Mandalorian has apparently “taken the world by storm.”

 

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) initiative will 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

[category earnings]

[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

 

 

 

A U.S. District judge ruling today cleared the way for a T-Mobile/Sprint merger. Tower operators (CCI, SBAC, AMT) would see a headwind to leasing activity as the combined company eliminates redundant towers but this would happen over time as contracts expire –  mitigating this are concessions to the merger that could boost near-term leasing activity. Dish (which would acquire Sprint’s prepaid wireless business) and the New T-Mobile have each committed to extensive 5G build-outs as part of the DoJ’s merger-related agreements.  

 

 

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

 

$CCI.US

[category equity research]

[tag CCI]