Bank of America Q3 results – Strong credit, weak interest income

On 10/13, Bank of America (BAC) reported core Q3 EPS of $.48 with positives of sharp decrease in provisions for bad loans and negatives of weak net interest income growth.  We believe BAC is managing the pandemic recession well, has a strong balance sheet, is building excess capital and has strong earnings power. 

 

Current Price: $24.2                         Price Target: $30

Position Size:   2.26%                       Trailing 12-month Performance: -17.3%

 

Q3 Highlights:

  • Strong credit quality with loan provisions falling to $1.4b from $5.1b
    • Good news!  The loan loss provisions were below street expectations and close to the normal quarterly run rate.  Considering that these provisions are forward looking, it bodes well for the state of the economy and health of the banking system.
    • US banks remain healthy.  Reserve build for the Top 5 banks in the US dropped sharply close to the normal run rate of loan provisions:

 

    • These provisions are NOT Comparable to those taken during the Great Recession. From Q4 2007 to Q4 2011, the top five banks increased provisions by $318b! More than 6x the provisions taken since the coronavirus pandemic started.
    • BAC’s outlook for credit is positive.  Consumer spending by their customers in October is about 10% above levels from last year.  Consumer deferrals balances are down from $1.7b to $0.1b in September
  • Net Interest income decreased to $10.24b from $12.34b a year ago as interest rates fell
    • Net interest margin fell to 1.72% which they believe is the bottom
    • Expect NIM to trend up as increased deposits are invested and balance sheet growth, though they noted reinvestment rates remain a headwind.
    • NIM will remain depressed until we see a sustained economic recovery.  At that point, banks will be among the industries most levered to benefit from the rebound.

 

  • Strong balance sheet
    • Nonperforming loans are lowest among peers
    • Fed’s stress test has consistently shown BAC losses to be lower than peers
    • Strong capital ratios: CET1 ratio of 11.4% which is 1.9% above required minimum
  • Attractive valuation
    • BAC is selling at a discount to book value! at 0.86x Book value and 11.8x P/E
    • BAC has strong earnings power – generates over $5b a quarter in earnings
    • BAC continues to build capital as share buybacks and dividend increases are restricted.  They have $35b in excess capital which equates to 6% of shares outstanding.

 

BAC Thesis:

 

  1. BAC has dramatically improved their Consumer Banking unit which has driven earning’s growth.  Loss metrics are best among peers.
  2. Despite current recession, BAC has strong balance sheet and earnings power
  1. Their stronger capital position should lead to increased dividends and buybacks

 

Please let me know if you have questions.

Thanks,

John

 

[category Equity Earnings]

[tag BAC]

$BAC.US

 

 

JNJ 3Q20 earnings summary

Key takeaways:

 

Current Price: $148      Price Target: $175

Position size: 2.45%     1-Year Performance: +15%

 

  • Guidance for the year raised again as its medical devices segment continues to perform ahead of expectations:
    • Medical devices results were better than expected, thanks to growth in the US and China
    • Operational sales growth of raised ~100bps to 0.5%-1.5%
    • EPS raised to $7.95-$8.05 from $7.75-$7.95

 

  • Pharma segment showed steady performance with 4.7% growth: Darzalex in oncology continued increased patient intake, Stelara and Xarelto performed better than consensus.
  • Consumer segment +3.1%, driven by US sales +12% (share growth for Tylenol, Zyrtec, Listerine and wound care)
  • Medical Devices -3.3%: negative impact came from Orthopaedics knee replacement and Sports (Covid delays), Surgery and Vision delays as well

 

Once more JNJ posted results better than forecasted, and raised its guidance for the year. While JNJ’s Medical Devices results were better than expected (beating consensus by 14%), it appears that the recent trend in September was for a flattening of the growth, which is not surprising considering the increase in COVID cases globally. They are not yet providing full 2021 guidance but guided to a strong double digits growth in Medical Devices and above market growth in Pharma. In Pharma, volume should drive growth, as pricing pressure remains (higher unemployment and potential for HC reform). Operating margins will remain at 2019 levels due to higher R&D expenses (Momenta acquisition bringing some potential blockbuster drugs in autoimmune disorders).

Some Covid vaccine news came yesterday that JNJ was pausing its vaccine trial as a person showed sign of an unexplained illness (similar to AstraZeneca a month ago). This is a normal process in any drug trial, and we think JNJ will ultimately continue its research on finding a reliable vaccine. Overall there is nothing this quarter that is changing our view on JNJ as a core holding in our healthcare portfolio.

Thesis on JNJ:

  • High quality company with consistent 20% ROE, attractive FCF yield,
  • Investments in the pipeline and moderating patent expirations create a profile for accelerated revenue and earnings growth
  • Growth opportunity: Medical Devices and Consumer offer sustainable growth and potential for expansion internationally
  • Strong balance sheet that offers opportunities for M&A.

 

 

 

[category Equity Earnings]

[tag JNJ]

$JNJ.US

 

Another #Antitrust Update…

Last night the House antitrust subcommittee issued a report which concludes their investigation that started over a year ago in June 2019…

 

·         The investigation concluded that the Big tech platform companies (Apple, Facebook, Google and Amazon) abuse their market power…more detail on this below.

·         Their investigation included the hearing this past July w/ the CEO’s of those companies.

·         The report does not directly result in actions against any of these companies. It is a series of findings that could serve as a foundation to reform antitrust laws to better address big tech business models. 

·         The current investigations by the DoJ, FTC and States Attorneys general are obviously limited to application of current law. The question is whether current law is sufficient for antitrust action against them, or whether new laws would be required.

·         The likelihood of changing the laws would increase with a change in control of the Senate.

 

Excerpt from the report…

§  “Although these four corporations differ in important ways, studying their business practices has revealed common problems. First, each platform now serves as a gatekeeper over a key channel of distribution. By controlling access to markets, these giants can pick winners and losers throughout our economy. They not only wield tremendous power, but they also abuse it by charging exorbitant fees, imposing oppressive contract terms, and extracting valuable data from the people and businesses that rely on them. Second, each platform uses its gatekeeper position to maintain its market power. By controlling the infrastructure of the digital age, they have surveilled other businesses to identify potential rivals, and have ultimately bought out, copied, or cut off their competitive threats. And, finally, these firms have abused their role as intermediaries to further entrench and expand their dominance. Whether through self-preferencing, predatory pricing, or exclusionary conduct, the dominant platforms have exploited their power in order to become even more dominant. To put it simply, companies that once were scrappy, underdog startups that challenged the status quo have become the kinds of monopolies we last saw in the era of oil barons and railroad tycoons. Although these firms have delivered clear benefits to society, the dominance of Amazon, Apple, Facebook, and Google has come at a price. These firms typically run the marketplace while also competing in it—a position that enables them to write one set of rules for others, while they play by another, or to engage in a form of their own private quasi regulation that is unaccountable to anyone but themselves.”

 

Among the recommendations in the report…

§  Reduce conflicts of interest thorough structural separations and line of business restrictions

§  Implement rules to prevent discrimination, favoritism, and self-preferencing

§  Promote innovation through interoperability and open access

§  Reduce market power through merger presumptions

§  Create an even playing field for the press

§  Prohibit abuse of Superior Bargaining Power including through anticompetitive contracts

 

 

From: Sarah Kanwal
Sent: Thursday, October 01, 2020 5:18 PM
To: Research <research@crestwoodadvisors.com>; Relationship_Managers <rm@crestwoodadvisors.com>; Portfolio_Managers <pm@crestwoodadvisors.com>
Subject: Alphabet Antitrust Update

 

Sending an update on Alphabet as the potential for a Department of Justice lawsuit is rising. As a reminder, they are being investigated by federal and state-level regulators (the DoJ and State Attorneys General) which began over the last year. It is widely expected that a lawsuit from the DoJ is imminent, which may or may not include the AG’s as part of that lawsuit (or they may take separate action). At issue is their dominance in search and their dominant position in the ad tech stack. These are separate but interconnected issues. Google’s dominance in search (~90% global share) gives them the best data (“click and query” data) which is the raw material for targeted advertising. Search also allows them to give preference to their own sites (e.g. YouTube) when placing ads. Revenue from Google’s own sites has been a key driver of growth.  In ad tech, Google is present at all significant stages of the opaque ad tech stack – they are present on both the ‘buy’ and ‘sell’ sides of the market. They serve ads to Publishers (sell side) and help advertisers place ads (buy side). The concern involves their ability to limit competition via this vertical integration.

 

There are not many historical templates for US antitrust suits – in the last 50 years, there have been three major antitrust actions against dominant U.S. companies: IBM (1969), AT&T (1974) and Microsoft (1998). One thing we know from those cases is that they take a long time – likely at least 3 years. With IBM the trial took over a decade, w/ AT&T over 7 years and w/ MSFT over 3 yrs. So while a lawsuit may be imminent, it should take time for the implications of this to play out. It’s possible this could be resolved sooner if GOOG and the DoJ can settle w/ GOOG making some concessions. Such initial lawsuits sometimes state potential suggested remedies and sometimes they do not.

 

There are a wide range of potential remedies that could be sought. Current rumors are that the DoJ lawsuit will focus more on search. One area regulator’s could target is Google’s position as the default search engine on most mobile devices (they pay Apple for this privilege which is ~5% of Apple’s rev). Regulators could also target previous acquisitions (YouTube of DoubleClick) – The Clayton Act allows regulators to unwind previously-approved mergers. Other potential outcomes include changes to search that result in less ad revenue from owned sites, sharing/licensing of click and query data (could meaningfully increase competition but could still provide a fee stream), a forced to break-up (I don’t view that as big downside risk…in fact some argue the sum trades at a discount to the value of the parts).

 

The US is not the only place GOOG is facing antitrust scrutiny. For GOOG (and AAPL, AMZN & FB) there has been an expanding global footprint of regulatory scrutiny with the EU leading the charge, but w/ no significant consequence at this point. Since 2017 the EU has fined GOOG $9B, which is not meaningful given GOOG’s valuation and cash on their balance sheet (>$100B). The EU has also gone after GOOG’s position as the default search engine on Android phones, but to no real avail at this point. https://www.wsj.com/articles/some-google-search-rivals-lose-footing-on-android-system-11601289860?mod=tech_featst_pos1

 

Partisan considerations…

Scrutiny has been bipartisan. The outcome of the presidential election is unlikely to reduce antitrust risk for GOOG. With the new Supreme Court justice the implication is not clear cut. The most meaningful change could be Democratic control of Congress which could have implications for potential new antitrust law aimed at regulating big tech (this was the focus of The House Judiciary’s Antitrust Subcommittee hearing in July w/ GOOG, AMZN, FB and AAPL CEOs).

 

In summary, I view this growing regulatory scrutiny as an evolving risk but do not expect the filing of a lawsuit to catch the market by surprise; it is expected. If there are recommended remedies in the suit, this could have an impact (as investors know which outcome to “probability weight”), but again will take some time to resolve. I expect to keep re-assessing this as we know more.

 

https://www.wsj.com/articles/google-antitrust-suit-looms-over-issues-of-search-dominance-advertising-11600948051

 

 

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

 

GOOG.US

[tag GOOG]

[category equity research]

AAPL.US

[tag AAPL]

[category equity research]

 

FW: Alphabet Antitrust Update

As a follow up to my previous email, pointing out a couple pre-emptive moves Alphabet is taking ahead of a potential lawsuit from the DoJ/State AG’s. The first pre-emptive move is that Google announced a new initiative called “Google News Showcase” which is a partnership with news publishers where GOOG will pay publishers $1B in licensing payments over the next 3 years to “to create and curate high-quality content for a different kind of online news experience.” This seems meant to mitigate one of the issues related to their search dominance – GOOG’s ability to scrape and display snippets of news from publishers w/out the publishers making a profit (no subscription or ad served on their site unless user clicks through). The EU is already addressing this issue w/ their “Copyright Directive” passed in June 2019 (it gives EU Member States until June 2021 to pass legislation that meets the directives requirements). The key provision of the Directive is that content-sharing service providers will have the obligation to identify what is copyrighted by making them liable for copyright infringement. The law is aimed at helping publishers/creators of content (e.g. journalists, musicians etc.) get a bigger piece of ad revenues that go to companies like Google and Facebook. The Google News Showcase announcement marks a big shift in attitude for Google, as their early response to the Copyright directive was more defiant.

 

https://www.wsj.com/articles/google-pledges-1-billion-in-licensing-payments-to-news-publishers-11601546401

 

The second pre-emptive move is related to GOOG’s pending acquisition of Fitbit. Earlier this summer Google said they wouldn’t use Fitbit data for advertising. They’ve increased their concessions to include “supporting other wearable manufacturers on Android and to continue to allow Fitbit users to connect to third-party services.”

 

https://www.wsj.com/articles/google-makes-concessions-in-effort-to-buy-fitbit-11601480052

 

Both of these actions highlight one of the indirect implications of this looming anti-trust action – that the threat of it is already changing management behavior and could continue to over the course of a trial as they may take proactive steps to assuage regulators and generally be more tepid in their competitive behavior…this could also include avoiding M&A that could draw further scrutiny.   

 

To summarize:

·         The potential for a Department of Justice antitrust lawsuit against Google is rising. Group of 48 State AG’s may file a suit in conjunction with this or separately.

·         The lawsuit is widely expected ahead of the election.

·         These types of lawsuits tend to take multiple years, so any formal consequence of this should take time.  We expect to keep re-assessing this as we know more.

·         This is a bipartisan effort which should not recede based on the outcome of the election.

·         In the meantime, this can weigh on the multiple, distract management, and result in more conciliatory competitive behavior.

 

 

 

From: Sarah Kanwal
Sent: Thursday, October 01, 2020 5:18 PM
To: Research <research@crestwoodadvisors.com>; Relationship_Managers <rm@crestwoodadvisors.com>; Portfolio_Managers <pm@crestwoodadvisors.com>
Subject: Alphabet Antitrust Update

 

Sending an update on Alphabet as the potential for a Department of Justice lawsuit is rising. As a reminder, they are being investigated by federal and state-level regulators (the DoJ and State Attorneys General) which began over the last year. It is widely expected that a lawsuit from the DoJ is imminent, which may or may not include the AG’s as part of that lawsuit (or they may take separate action). At issue is their dominance in search and their dominant position in the ad tech stack. These are separate but interconnected issues. Google’s dominance in search (~90% global share) gives them the best data (“click and query” data) which is the raw material for targeted advertising. Search also allows them to give preference to their own sites (e.g. YouTube) when placing ads. Revenue from Google’s own sites has been a key driver of growth.  In ad tech, Google is present at all significant stages of the opaque ad tech stack – they are present on both the ‘buy’ and ‘sell’ sides of the market. They serve ads to Publishers (sell side) and help advertisers place ads (buy side). The concern involves their ability to limit competition via this vertical integration.

 

There are not many historical templates for US antitrust suits – in the last 50 years, there have been three major antitrust actions against dominant U.S. companies: IBM (1969), AT&T (1974) and Microsoft (1998). One thing we know from those cases is that they take a long time – likely at least 3 years. With IBM the trial took over a decade, w/ AT&T over 7 years and w/ MSFT over 3 yrs. So while a lawsuit may be imminent, it should take time for the implications of this to play out. It’s possible this could be resolved sooner if GOOG and the DoJ can settle w/ GOOG making some concessions. Such initial lawsuits sometimes state potential suggested remedies and sometimes they do not.

 

There are a wide range of potential remedies that could be sought. Current rumors are that the DoJ lawsuit will focus more on search. One area regulator’s could target is Google’s position as the default search engine on most mobile devices (they pay Apple for this privilege which is ~5% of Apple’s rev). Regulators could also target previous acquisitions (YouTube of DoubleClick) – The Clayton Act allows regulators to unwind previously-approved mergers. Other potential outcomes include changes to search that result in less ad revenue from owned sites, sharing/licensing of click and query data (could meaningfully increase competition but could still provide a fee stream), a forced to break-up (I don’t view that as big downside risk…in fact some argue the sum trades at a discount to the value of the parts).

 

The US is not the only place GOOG is facing antitrust scrutiny. For GOOG (and AAPL, AMZN & FB) there has been an expanding global footprint of regulatory scrutiny with the EU leading the charge, but w/ no significant consequence at this point. Since 2017 the EU has fined GOOG $9B, which is not meaningful given GOOG’s valuation and cash on their balance sheet (>$100B). The EU has also gone after GOOG’s position as the default search engine on Android phones, but to no real avail at this point. https://www.wsj.com/articles/some-google-search-rivals-lose-footing-on-android-system-11601289860?mod=tech_featst_pos1

 

Partisan considerations…

Scrutiny has been bipartisan. The outcome of the presidential election is unlikely to reduce antitrust risk for GOOG. With the new Supreme Court justice the implication is not clear cut. The most meaningful change could be Democratic control of Congress which could have implications for potential new antitrust law aimed at regulating big tech (this was the focus of The House Judiciary’s Antitrust Subcommittee hearing in July w/ GOOG, AMZN, FB and AAPL CEOs).

 

In summary, I view this growing regulatory scrutiny as an evolving risk but do not expect the filing of a lawsuit to catch the market by surprise; it is expected. If there are recommended remedies in the suit, this could have an impact (as investors know which outcome to “probability weight”), but again will take some time to resolve. I expect to keep re-assessing this as we know more.

 

https://www.wsj.com/articles/google-antitrust-suit-looms-over-issues-of-search-dominance-advertising-11600948051

 

 

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

 

$GOOG.US

[tag GOOG]

[category equity research]

 

Constellation Brands 2Q FY21earnings summary

Key takeaways:

 

·         Sales impacted by decline in out of the house consumption, but at-home consumption remains good

·         Temporary delays in Mexican production plant due to Covid is over (for now!)

·         Hard Seltzer launch is a success, now #4 brand in that category while launching in the middle of a pandemic

·         Sale of lower priced wine and spirit brands to close at the end of Q3

 

 

Current Price: $184                Price Target: $226

Position Size: 2.52%              1-Year Performance: -11.8%

 

Constellation Brands reported a sales decline of 4% as the quarter was impacted by lower sales in its on-premise channel down -50% y/y in Q2 (consumption in restaurants, bars, etc) as well as some temporary out-of-stock at retail from its earlier in the year production disruption in Mexico.

Beer organic sales were +1%, but mostly depletion volume was positive at +4.7% (sales at retail to end consumer). This shows that at home consumption offsets the reduction in on-premise consumption. Corona Seltzer is growing nicely, helping the Corona portfolio grow double-digits. This new seltzer offering holds the #4 position in the category (6% market share), after less than a year after its launch, and in the middle of a pandemic! It is the second fastest moving Hard Seltzer on the market.

In addition, with its higher exposure to the Hispanic population (est. 15-20%) than other Seltzer brands (at ~10-15%), we should see continued growth longer term as that demographic grows faster than others.

The Covid impact on beer production in Mexico seems behind them now, with inventory levels expected to return to normal by the end of next quarter.

Regarding production capacity, they are still working with the Mexican government to find a solution to the now defunct Mexicali plant. To offset that void, they do have the Obregon brewery expansion, which once completed by the end of the fiscal year, will cover consumer demand over the medium term. This also includes a doubling of its seltzer capacity.

STZ announced taking a minority stake in Booker Vineyard’s, a “super-luxury, direct-to-consumer wine company”, reinforcing the company’s direct to consumer/e-commerce strategy. Organic sales in wines was -9%, as the lower end brands continue to underwhelm (the never ending divestment of most of those brands are scheduled for the end of next quarter).

 

And to conclude…I would trade places with him right now….

 

 

Investment Thesis:

·         Adding STZ helps position our portfolio to be more defensive at this stage of the economic cycle

·         STZ is down ~20% YTD, giving us a good entry point

·         STZ continues to have HSD top line growth and high margins that should incrementally improve going forward

·         STZ comes out of a heavy capex investment cycle to support its growth: FCF margins are set to inflect thanks to lower capex

 

[tag STZ] [category earnings]

$STZ.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

 

 

Pepsi 3Q20 earnings summary

Key takeaways:

 

·         Organic sales growth of +4.2% return to healthy levels, demonstrating the resilience of the diverse portfolio

·         Productivity gains were offset by Covid expenses (a 80bps drag) and manufacturing automation and distribution systems investments – leading to a 40bps operating margin decline

·         Financial guidance restored for 2020:

o   Organic sales growth of 4%

o   EPS of $5.50 (only 3 cents below 2019)

 

 

Current price: $140                           Price target: $153  

Position size: 2.14%                         1-year performance: +1%

 

 

Pepsi released its 3Q20 earnings this morning. Organic sales of 4% shown a return to normal levels for the company, which is encouraging, as part of its business remains impacted by the pandemic (restaurants for example). In the US, its snack business grew 6%, while Quaker Foods continues to benefit from the pandemic trend of eating at home (+6% sales growth). Europe grew an impressive +7% Asia/Pac +5%, but Latam posted a small +1% growth and Africa, Middle East and South Asia decline 2%. The rising unemployment is having an impact in those regions, although Pepsi believes it has enough of a sizing/pricing playbook to offset some weakness in the emerging markets. On the beverage side, the integration of the new energy drink Rockstar acquisition and distribution agreement with Bang is going well. The work from home trend is also benefitting SodaStream (double digits revenue growth) as consumers enjoy the convenience of making sodas at home. This trend also impact their energy drink category (Gatorade, the market leader), as people get into a routine of working out at home more and indulging in those drinks.

On the margin front, we shouldn’t expect any expansion near term as Covid expenses remain a reality.

As we near the end of the year, the management team reintroduced its 2020 guidance, which we find reassuring. Sales growth of 4% is good in today’s environment.

 

Thesis on Pepsi:

  • Global growth opportunity with about 40% of profits coming from outside the US. CSD is only 25% of sales (and Pepsi brand only 12%)
  • Strong market share in high growth emerging markets where there is low penetration and rising per capita consumption
  • Resilient snack business provides pricing power and visibility to future cash flows (more than half of sales are from snacks not beverages). CSD is only 25% of sales (and Pepsi brand only 12%)
  • Several Great brands driving global growth: Frito Lay, Quaker, Gatorade
  • Strong balance sheet and cash flows support a solid dividend yield and share buyback program

 

 

Tag: PEP

category: earnings

$PEP.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