Month: June 2020

Sharing some interesting stats and charts on how the U.S. economy is recovering from coronavirus… for restaurants, hotels and airlines overall negative but improving. For housing, stats point to a supply/demand picture that should support pricing (good news for our housing related names SHW, HD, BKI).

 

·         Restaurants: Opentable restaurant bookings are down 60% YoY. Opentable is also saying 25% of restaurants will close in the US.

·         Yelp says 41% of businesses listed on their site that have closed due to Covid will not re-open. Retail and restaurants are hardest hit.  

·         Hotels:

o   US Occupancy: 43.9% (-41.8% YoY).

o   US Average daily rate (ADR): US$92.20 (-31.7% YoY)

o   US Revenue per available room (RevPAR): US$40.48 (-60.3% YoY)

o   The Top 25 Markets showed lower occupancy (38.4%) than the national average. Highest are Virginia Beach (54%), Tampa/St. Petersburg, Florida (49.4%); Phoenix, Arizona (48.3%); and Detroit, Michigan (46.2%). Boston was among the lowest at 26%.

o   STR’s senior VP of lodging insights: “Demand continues to be pushed upward by drive-to spots and the destinations with outdoor offerings such as beaches.”

·         Airlines: As of 6/24, TSA reported 494,826 daily travelers going through airport security checkpoints which is down ~80% compared to 2,594,661 last year (TSA). This is up ~450% from the worst week reported since the crisis (4/12) of 90k daily passengers which was down 96% YoY.

·         Housing: Positive housing stats point to a supply/demand picture that should support pricing…

o   Mortgage applications for buying a single-family home are now up 21% compared to last year as mortgage rates drop to record lows. (Mortgage Bankers Association)

o   The median existing-home price in May was $284K, up 2.3% from May 2019, as prices increased in every region. May’s national price increase marks 99 straight months of YoY gains. (National Association of Realtors)

o   Total housing inventory at the end of May totaled 1.55 million units, up 6.2% from April, and down 18.8% YoY.

o   According to the NAR’s chief economist: ““New home construction needs to robustly ramp up in order to meet rising housing demand. Otherwise, home prices will rise too fast and hinder first-time buyers, even at a time of record-low mortgage rates.”

·         And one measure of overall activity that is kind of interesting…according to Apple, driving and walking directions are up while transit remains way down. The data is available on their site by different geographies… https://www.apple.com/covid19/mobility

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

$BKI.US

[tag BKI]

$SHW.US

[tag SHW]

$HD.US

[tag HD]

[category equity research]

 

 

Key Takeaways:

 

·         Consumer segment saw good growth this quarter on pantry loading, and demand is expected to continue

·         Food away-from-home category (20% of sales) impacted by restaurants/food services closed, and recovery will be difficult in 2020

·         Margins higher on mix and cost cutting

·         Raising our price target on better consumer trends expected for the rest of the year

 

 

Current Price: $177           Price Target: NEW $191 (prior $162)  

Position size: 3%                1-Year Performance: +17%

 

 

McCormick reported results better than expected, with sales up 9.6% ex-FX thanks to its consumer segment (+26%), offsetting weakness in its flavor solutions segment (-18.5% due to struggling restaurants/food service). This quarter includes the initial pantry loading in the Americas and EMEA, and replenishment in China. The shift to at-home consumption continued throughout the quarter, and is expected to see incremental demand throughout the year. Although the company is still not providing a 2020 guidance, it reaffirmed its long-term goals and gave some expectations around demand in its 2 segments. The management team believes the packaged food companies will return to pre-crisis levels, while food away from home – 20% of sales – will experience a harder time bouncing back. Consumers will continue to cook more from home in 2H2020 per their expectations. As noted last quarter, MKC is reducing some expenses and delaying some programs, which resulted in a 210bps increase in its operating margin, on top of the higher margin Consumer segment growing faster that its lower margin Flavor Solution business. We are raising the price target to account for better results than expected and lower discount rate in our DCF. The stock is up +56% since it bottomed in March this year.

 

 

The Thesis on MKC:

•          Industry Leader: McCormick & Company (MKC) is a leading manufacturer of spices and flavorings. MKC has been in business for 120 years and the founding family still has ownership interest

•          Growth opportunity: Spice consumption is growing 3 times faster than population growth. With the leading branded and private label position, MKC stands to be the biggest beneficiary of this global trend

•          Offense/Defense: MKC supplies spices to major food companies including PepsiCo and YUM! Brands giving it a blend of cyclical and counter-cyclical exposure

•          Balance sheet and cash flow strength offer opportunities for continued consolidation through M&A in the sector

 

$US.MKC

[tag MKC]

[category earnings]

 

 

 

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

 

 

Some updates on Apple related to their Worldwide Developer Conference (WWDC) which started yesterday and on recent antitrust news. Yesterday, at their annual Worldwide Developer Conference (WWDC) Apple confirmed the transition of Macs to in-house designed chips w/ ARM based architecture from Intel x86 chips. This was not a surprise – it had been rumored as I indicated in my email attached below. The first Macs based on Apple’s custom silicon should be shipping later this year. The transition will cut costs (~$2.5B), but more importantly, enhances their competitive advantage as they continue their efforts to own and control the primary technologies behind the products that they make. Part of what differentiates Apple is they design their own silicon for the processor chips that are the brains of their iPhones and iPads (…and now for their Macs), which gives them better control over performance and feature integration in their devices (discussed further in previous email below). They also announced a slew of additional product updates that the WSJ nicely summarizes in a video linked below if anyone is interested.

 

https://www.wsj.com/video/series/joanna-stern-personal-technology/ios-14-ipados-macos-big-sur-watchos-7-changes-coming-to-apple-devices/F05EA2C1-34A9-4BB6-BF74-1F9D3A134D98

 

On the antitrust front, Apple has had several recent developments. The risk around antitrust action is rising, but I expect the outcome to be manageable. This was not part of WWDC, though it is very relevant for the developer community (which are the key attendees of WWDC) as the issues primarily relate to fees charged in the App store. The App store relies on 3^rd party developers to write software (Apps) which is a key ingredient to Apple’s thriving ecosystem. Recent antitrust related developments include an incident relating to an email App called “Hey” that’s owned by Basecamp, and was rejected from the App store b/c it was set up to charge for its fees outside of the App store, thus circumventing Apple’s cut. This issue is ongoing and getting lots of attention from developers. Then the EU announced an investigation of Apple’s App store – this could take some time to play out. Finally, the Justice Department’s yearlong investigation into the competitive practices of digital platforms (GOOG, FB, AMZN, AAPL) is set to wrap up in July w/ the CEO’s testifying in front of Congress. Last week the Chair of the House Antitrust Committee, David Cicilline, gave a rather foreboding interview which suggests the outcome of the investigation will include a recommendation for changes to Apple’s App store.

 

As a backdrop, Apple charges a 15-30% (mostly 30%) cut of transactions made through the App store. The App store facilitates a lot of commerce – $519B to be exact – and for most of this Apple gets no cut. For example, they earn a cut on selling an App like “Goodnote” but don’t earn a fee on each Uber ride. Apple has said that 84% of Apps do not share revenue. Apple commissioned a study from the Analysis Group which they released last week which broke down the $519B:

 

·         $413 billion from physical goods and services, including $268 billion through retail apps, $57 billion through travel apps, $40 billion through ride-hailing apps, and $31 billion through food delivery apps.

·         $61 billion from digital goods and services.

·         $41 billion from in-app advertising.

 

To put this in perspective, Apple reported in 2019 that it paid ~$35B to developers. Grossing that up for Apple’s ~30% fee suggests ~$50B in sales through the App store where Apple earns a share – so Apple made ~$15B. Comparatively small relative to the $519B from Apple’s commissioned report – so, presumably, a key part of Apple’s argument will rely on the small percentage (<3%) they get of the full amount of commerce conducted through their App store. I do think the potential for antitrust action against Apple is mounting, but my view at this point is that I don’t think the outcome will be severely damaging to Apple. While it is unclear how this will play out, most importantly, Apple needs the developers and the developers need Apple. The level of fees seem to be the crux of the issue…30% is too high… the result might be some combination of lower fees and less stringent rules.

 

In terms of potential economic impact to Apple, their total Services revenue in 2019 was $46B (~18% of revenue) and is dominated by these App store fees and traffic acquisition costs (TAC) paid to them from Google (Google pays to be the default search engine). Given the above calculation, fees from the App store were close to 33% of that $46B (or less than 6% of total revenue) and TAC was another 26% (~4.5% of total revenue). The rest of Services revenue is from Apple Pay, Apple Music, Apple Care, iCloud etc. If Apple had a business model of “giving away” their hardware to make money on Services, this would be a problem. Services margins are in fact much higher, about double their hardware margins (64% vs 32%), but they do make most of their profit on their hardware.  So the App store contributes somewhere between ~10-12% of total gross profit and Products/hardware still contribute 70% (other services contribute the rest). While growth of their high margin Services business is a key part of the story, App store purchases are only one piece of that and that growth is also driven by a growing installed base and increasing relevancy of their devices driven by new applications. The installed base grows w/ greater iPhone penetration (lower priced and used phones help with this) and new types of devices like wearables. And the utility of new applications evolve w/ new technologies like 5G, AI, augmented reality, virtual reality etc. While lower fees would obviously be a hit to them, I think it would be manageable…and the counter argument is that it could spur more innovation and better Apps as the economics to the developers improve.

 

 

 

 

Sending an update on Apple regarding headlines today that they are planning to start selling Mac computers with Apple’s own main processors by next year. The chips likely would be in one laptop model, then extend beyond that. This would mean transitioning away from their current supplier Intel (Apple is ~9% of Intel’s sales). Taiwan Semiconductor (TSMC), Apple’s partner for iPhone and iPad processors, would build the new Mac chips. The potential for Apple to do this has been rumored/expected for a while. This isn’t about saving money (though it would), it’s about differentiating themselves and enhancing their competitive advantage…and is very much aligned with what Tim Cook said over a decade ago when he was COO, “we believe that we need to own and control the primary technologies behind the products that we make.” Part of what differentiates Apple is they design their own silicon for the processor chips that are the brains of their iPhones and iPads (…and now potentially for their Macs), which gives them better control over performance and feature integration in their devices. The cutting edge for them right now is their A13 bionic which TSMC (one of the few major semiconductor foundries) makes for them and is custom built on top of licensed ARM architecture (which underpins most mobile devices). Notably, this would further push ARM (owned by Softbank) architectures beyond mobile (where it dominates), to laptop/desktop (where Intel’s x86 architecture dominates) and some suggest could ultimately pose a threat to Intel’s data center business (e.g. chips in servers). For Apple, the advantage in doing this is that their silicon is unique to them and tailored for their operating system, iOS. This has proven to give them an advantage with the way they design their phones and an advantage with developers. Android and iOS basically have a duopoly in mobile operating systems…generally any smartphone that’s not an iPhone is running an Android operating system, which Alphabet gives away. That gives Apple about 15% operating system market share and Android about 85%, however that is split up across devices/brands. The fact that Alphabet’s mobile operating system is so fragmented (and that users are often not using the same/latest version) makes app development more complex, costly and time consuming. Moreover, Apple, which dominates the high-end smartphone market, has a wealthier installed base for developers to target. The app store is fueled by third-party app developers. Easier to develop apps and a target rich audience leads to a greater number of higher quality iOS apps created by these developers for iPhone owners to download, with a better user experience. This is great for Apple b/c they make a % of revenue from Apps sold through their App store. This latest potential development should build on this advantage. They would have Macs, iPhones and iPads running the same underlying technology which should make it easier for Apple to unify its apps ecosystem, including allowing iPhone and iPad apps to run on Macs. This advantage gets more and more important as computing power in phones increases, 5G delivers better connectivity and, as a result, we have the ability to use mobile phones in enhanced ways….like apps that take advantage of augmented reality and IoT related technologies. 4G enabled advances like Uber. 5G is a step function change from this. Along this same theme, last year Apple acquired Intel’s cellular modem business for ~$1B. These are the chips that connect smartphones to the internet. They had been using QCOM for these chips, then they shifted to Intel as AAPL/QCOM were embroiled in a lawsuit. That has been settled and now Apple is again using Qualcomm’s chips. But the long-term goal here is for Apple to make these chips themselves, furthering their goal of controlling the primary technologies behind their products…and moving away from suppliers like Intel and Qualcomm. All of this is aimed at cementing Apple’s technology and ecosystem advantage which is Apple’s moat and drives their massive installed base. This can be seen by the fact that despite only having about 15% of the global smartphone market, Apple earns almost all of the industry profits b/c they have a differentiated, proprietary product/ecosystem, while Android based OEMs don’t own the silicon and software.

 

 

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.US

[tag AAPL]

[category equity research]

 

Hi All – We have put together some big picture data points to help put in perspective the market recovery. This is not a call on where the market is headed, but hopefully these points can be helpful in framing discussions with clients. We’ve used revenue data for a couple reasons. First, profit numbers can be “noisier” with write-downs, mark to market accounting, pension contributions etc. and profits may go negative making % changes not meaningful especially when looking at aggregated data. Second, in thinking about whether consensus reflects a “V” shaped recovery, revenue seems to make the most sense to look at because it represents demand, whereas profits represent differences in operating leverage across companies, cost cutting decisions which vary by company, cuts to capex, etc.

 

1.       Narrow breadth is a big factor driving the market. Growth is being disproportionately driven by a small number of companies.

a.       The top 42 weighted companies in the S&P account for ~50% of the index.

b.      Based on consensus, the S&P is expected to see almost 9% weighted avg. revenue growth in 2021 vs 2019 baseline.

c.       Those top 42 weighted companies are expected to contribute ~80% of that 9% weighted avg. revenue growth in 2021 vs 2019 baseline. So they are expected to contribute 7pts of growth while the rest (or >90% of constituents) collectively contribute 2pts.

d.      Since Covid hit in the US on Feb 19, the S&P is down 7.4%. The 11 top contributors to the S&P since then make up 20% of the S&P and contributed almost 3% to performance.  

2.       Does consensus reflect a “V” shaped recovery? Not for many of the hardest hit stocks…which is a lot of companies, but a small part of the S&P.

a.       Not recovered in 2021: ~44% of constituents (~24% of the weight in the S&P) are expected to have revenue in 2021 that is still below 2019 baseline. These companies represented a 6.5% drag on S&P performance since Covid hit. The top 11 contributors offset >40% of this.

b.      Hardest hit: ~32% of S&P constituents (17% of the weight) are expected to have revenue in 2021 that is more than 5% below 2019.

c.       Multiyear recovery: ~29% of S&P constituents (15% of the weight) are expected to report revenue in 2022 that is still below 2019.

3.       Our portfolio is well positioned.

a.       Not recovered in 2021: only ~22% of our names (18% of the weight). Excludes STZ b/c of divestment.

b.      Hardest hit: ~16% of our names (11% of the weight) are expected to have 2021 revenue that is more than 5% below 2019 baseline.

c.       Multiyear recovery: ~6% of the weight and 3 names (BAC, SCHW, BKNG). For BKNG a recovery to baseline is not expected until 2023. However, using consensus numbers for a DCF valuation implies meaningful upside. That suggests the stock is discounting an even worse outcome.

d.      Proportionately, our names have seen less of a hit and are expected to recover quicker and are more profitable, higher ROIC and trading at a higher FCF yield than the S&P.

 

Conclusion: Based on consensus numbers the bounce in the market seems to be driven more by narrow breath than a broad assumption of a “V” shaped recovery. Many of the hardest hit S&P companies are expected to see an impact beyond 2021. The caveat to that is that drawing a connection between consensus expectations and market action is limited by the fact that the market is not just driven by street expectations (it’s only a piece) – this is generally true but especially so now when there is so much uncertainty related to Covid and its continued impact on the economy. Additionally, it’s not possible to delineate on an aggregate level to what extent consensus numbers indicate continued impact of the virus or a recession or both, because both circumstances tend to impact similar industries like auto, retail, travel and restaurants.  Finally, many of the names benefiting from Covid tailwinds make up a large percentage of the S&P which overwhelms the impact of the hardest hit companies.

 

Thanks,

The Research Team

 

 

 

 

 

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:   $399                     Price Target: $458 (raised from $368)

Position Size:    2.7%                     TTM Performance: +35% since inception (3/18)

 

Key Takeaways:

·         Adobe beat on EPS with adj. EPS of $2.45 vs. estimate of $2.34 (range $2.29 to $2.37). 2Q revenue was $3.13 billion, +14% YoY. This was slightly below estimate $3.16B (range $2.97B to $3.19B).

·         Not immune to Covid impact, but seeing some remote working tailwinds. Covid led to weakness in their Digital Experience segment (26% of revenue, +5% YoY), while their Digital Media segment (74% of revenue, +18% YoY) saw record Q2 results.

·         Digital Experience results were weighed down by a weak advertising market, while Digital Media benefited from the mission critical aspect of their creative and document cloud solutions in a remote work environment.

·         CEO Shantanu Narayen said…”Despite the short-term challenges, the mandate to digitally transform has taken on heightened urgency”…this “tectonic shift towards ‘all things digital’ across all customer segments globally will serve as a tailwind to our growth initiatives as we emerge from this crisis.”

 

Additional Highlights:

·         Subscription revenue at 92% of total revenue for the quarter (up from 90% in 2Q19).

·         Non-GAAP operating margin was 42.7%, +440bps vs. last year, and above consensus of ~41%.

·         Like other companies, mgmt. specifically talked about demand weakness with small and mid-sized businesses as a result of the pandemic.

·         “While it was difficult to imagine only conducting business with CMOs and CIOs virtually, a side benefit of everyone working at home is that we are able to schedule and engage with far more customers across multiple continents. In all these discussions with business leaders it is clear that investments in digital and specifically customer experience are more important than ever.”

·         Digital Media segment ($2.23B, +18% YoY; ~71% of revenue):

o   Comprised of Creative cloud (84% of segment revenue, +17% YoY) and Document Cloud (16% of segment revenue, +22% YoY).

o   Segment Annualized Recurring Revenue (“ARR”) grew to $9.2B exiting the quarter. With Creative ARR of ~$8 billion, and Document Cloud ARR of $1.2 billion.

o   Document Cloud is key in the remote work environment as the imperative to translate paper processes to digital accelerates across the globe.

o   They saw a surge in demand for digital documents, with use of web-based PDF services up nearly 40% QoQ and the number of documents shared in Acrobat increasing 50% YoY.

o   Adobe Sign (their cloud-based electronic signature solution) usage increased 175% since the start of their fiscal year. Mobile usage exploded with Acrobat Reader  – installations increased 43% YoY and Adobe Scan installations increased 66%.

·         Digital Experience segment (revenue was $826m, +5% YoY; ~29% of revenue):

o   Digital Experience subscription revenue was $707m, +8% YoY growth. Segment revenue includes: subscription revenue (which includes revenues from Advertising Cloud), Professional services revenue, and “other”, which includes perpetual, OEM and support revenue. Excluding Advertising Cloud revenue, subscription grew 18% YoY.

o   As they outlined on their last earnings call, they anticipated delays in enterprise bookings as companies prioritized employee and financial well-being. In particular, they saw an impact w/ small and medium sized businesses.

o   Advertising Cloud revs were impacted by the global decline in ad spend and the discontinuation of a low-margin product which helped clients conduct advertising transactions.

o   Key customer wins in the quarter included IBM, Walgreens, Safeway, Astellas Pharma, and Allianz.

·         Guidance: Total revenue ~$3.15B w/ Digital Media segment revenue +16 percent YoY ($344m net new ARR) and flat Digital Experience segment revenue (subscription rev +5% YoY; +14% excluding Advertising Cloud). Adj. EPS ~$2.40. Overall, despite being below the street, Q3 guidance was re-assuring – some estimates were stale and Digital Media ARR guidance of ~$340M was better than expected. Similar to most companies, they withdrew full year guidance.

·         Adobe is a rare company w/ >90% recurring revenue, double digit top line growth and ~40% FCF margins. Additionally, the headwinds from Covid (like lower global ad spending and weak SMB demand) should abate, while the accelerated secular tailwinds around digital transformation will persist.

$ADBE.US

[tag ADBE]

[category earnings]

 

 

 

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