Author: Julie Praline

Constellation Brands (STZ) 4Q19 earnings summary

Key takeaways:

Current Price: $190 Price Target: $233

Position Size: 1.82% 1-Year Performance: +14% (since inception 12/20/2018)

STZ reported its 4Q 2019 earnings results this morning. Beer shipment remains high at +8%, and total beer sales grew +9.3%. During the call, management highlighted the strength Corona and Modelo, in addition to their product innovation capabilities, as driving continued market share gains in North America. It was highlighted that 1Q20 will reflect some inventory destocking, so a slowdown in growth rate should be expected in 1Q20. Beer EBIT margin was above last year at 40.5% vs. 37.9%. Better price/mix and lower marketing spend helped expand margins.

In addition to today’s good results, last night they announced the sale of lower-tier wines (30 brands out of the 64 lower price owned by STZ) to E&J Gallo for $1.7B, allowing STZ to focus on premium, higher growth/higher margins brands. Those brands were $1.1b in sales in FY19 (38% of wine sales). This had been talked about by management but the deal is closing sooner than what we had anticipated. Overall we are pleased with the results and look forward to future announcement around the use of cash from the wine sale.

Continue reading “Constellation Brands (STZ) 4Q19 earnings summary”

CVS update

Why is the stock down?

There has been multiple events pushing the stock down:

· Omnicare underperformance that led to an additional write-down in 4Q18

· Loss of the Centene and WellCare business as those two clients merge and will bring the PBM in-house

Outside of their control:

· Democrat’s push for Medicare-for-all would impact health insurers (and recent Aetna acquisition)

· Removal of the rebates practice in the government side of the PBM business (CVS is #3 in this space)

· Drug Pricing Transparency Act: this bill would force PBM to pass all rebates to the point of sale and no longer be kept by PBM and/or health insurers

· Push to repeal Obamacare back in the news

· Walgreens had bad earnings and cut their 2019 forecast, pushing the sector down

Why remain invested in CVS?

1/ We find CVS’s long-term strategy of vertical integration compelling:

· This can truly help CVS differentiate themselves from competitors by offering a powerful value proposition, leveraging its network and developing predictive data analysis that will help them lower costs of care

· A similar strategy was successfully implemented by UNH who saw nice margins growth after the integration of Catamaran (PBM)

2/ Retail store footprint combined with MinuteClinic and their new HealthHub concept could become a great growth engine for CVS:

· The retail stores ($19.7B in sales, >10% of total sales) have suffered from lower foot traffic following the removal of tobacco sales

· Offering customers another reason to visit the stores/pharmacy thanks to their new Health & wellness concept (to become 20% of the square footage of the store) could revive traffic

3/ Valuation: we see a disconnect between today’s stock price and the value of its businesses:

· Our sum-of-the-parts and cash flow analysis both show an attractive risk/reward profile

We are currently reviewing our position size for this stock.

[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

McCormick 1Q19 earnings results: back on track

Key Takeaways:

Current Price: $146 Price Target: $129 (under review)

Position size: 2.86% 1-Year Performance: +37%

McCormick released its 1Q19 results and reiterated their initial 2019 guidance. Organic growth is back on track (+4% organic) after the 4Q18 shortfall due to inventory issues. High volume in both Consumers and Flavor Solutions drove the sales growth this quarter. Retailers orders were supported by higher customer consumption, and increased sales to quick service restaurants helped the Flavor Solutions segment. Revenue growth is better than most food competitors, which continues to explain MKC’s premium valuation. Recent successful acquisitions (French’s mustard and RedHot sauce for example) as well as the introduction of new products are helping sustain good top line growth. Overall this quarter was pretty uneventful and continues to show why we own this stock: steady, reliable growth supported by good underlying demand for their products. Our price target is under review.

. Continue reading “McCormick 1Q19 earnings results: back on track”

CVS update

Below is an update on where we stand on CVS, and why the stock has been under pressure recently:

1. Omnicare underperformance: while we were hoping for this turnaround to take place, CVS ended up writing down a big piece of this long-term care business in 4Q18. This puts pressure on CVS to successfully integrate Aetna and execute on their synergies and strategic vision.

2. Democrat’s push for a “Medicare for All Act of 2019” bill that would replace almost all private health insurance. The measure would push all Americans (even under 65) towards a Medicare program within 2 years. Premiums, deductibles and co-pays would disappear, and guarantee a universal health care system. Medicare would dictate doctor’s fees and drug prices. No details on how much this would cost or how it would be funded… CVS’s stock however went down with the news… We think this bill is unlikely to pass.

3. The PBM model is under pressure as new legislations are being discussed:

· The Human Health Services issued a proposed rule to remove the safe harbor for drug rebates (on the government side of the business) currently permitted for Medicare and Medicaid managed care, which would directly impact PBMs. The rule would also create two new safe harbors for (1) discounts provided to the consumer at point-of-sale and (2) flat, fixed service fees paid by manufacturers to PBMs. PBMs have stated in the past that they do not keep any rebates earned under government programs, as this compensation is disclosed to CMS and reflected in plan bids in the form of lower Medicare Advantage and Medicare Part D premiums and lower Medicaid managed care plan bids.

· “The Drug Pricing Transparency Act” would force PBM in the commercial market to pass rebates to the patient directly (point-of-sale rebate). Other proposed changes are included in the bill, such as: utilizing an international pricing index in Part B, direct negotiation of drug prices by Medicare, etc… The details and impact of this bill on the supply chain economic model are still unclear at this time. CVS already offers that option, with increased acceptance in 2019 from the healthcare insurance participants. CVS only kept $300M worth of rebates (less than 3% of its 2018 EBIT).

Rebates have been a great tool used by PBMs to offer an attractive service package to their clients, and recently less of a way to make profits (profit margins are very low vs. pharmacy/managed care profits).

Valuation:

Today’s stock price for CVS reflects the above challenges. Our DCF model shows that today’s price only account for 2 segments out of 3: the retail pharmacy (stores and pharmacy business) and the Aetna segment. Even the recently negotiated 5 year PBM contract with Anthem would disappear. The PBM segment would go to zero in 2020, with the rest of CVS’s business growing at a 1% rate thereafter.

Here’s where we disagree:

· Pharmacy sales continues to grow nicely, not just due to higher drug prices (which has slowed down in 2018), but also due to higher script volume (average growth of 4% in past 7 years).

· PBM segment is unlikely to radically disappear in 2020. We could see margins contract as the government steps in, but levels are already very low (~3.5%). Also we can’t forget the power of lobbyists.

· Rebates profits are small for CVS, and we believe companies like CVS could play a role in regulating pharma prices even more. We think the main issue with drug prices does not lie solely with the PBM model but with a broader patent and FDA laws issue. By allowing Pharma to hold patents for decades, new cheaper alternatives are left out of the market place, allowing them to raise prices without competition. Recently though, Pharma companies have been trying to gain some goodwill by cutting prices or launching new generics.

· Anthem is to provide an estimated $3.8B in sales in 2019 in its first year in place, then $11B in 2020, and $62B in 2021 as the contract matures. Total PBM revenue in 2018 were $134B, so Anthem is not a negligible customer.

So in conclusion, while CVS has been under tremendous pressure, we advocate for remaining patient with this name. We continue to like its long-term thesis of vertical integration and solutions provider to clients, such as its MinuteClinic proposition and new HealthHub store format (see video below).

https://cvshealth.com/thought-leadership/cvs-health-testing-new-healthhub-store-format

$CVS.US

[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

EOG 4Q18 earnings results

Key Takeaways:

Current Price: $96.7 Price Target: $136

Position Size: 1.94% 1-year Performance: -12%

EOG reported 4Q18 EPS and EBITDA below consensus: while the US oil production beat expectations, EOG had higher unit costs and lower natural gas production. Capex was higher as well due to more efficient drilling that led to more wells being completed. Importantly, in 2H18 EOG showed improvement in its Permian performance (big driver to its growth), alleviating some concerns around this region that lingered in 1H18. The company’s premium drilling strategy started in 2015 is paying off: ROCE was 15% in 2018, way above its 10% target.

It appears that capex will be more front-end loaded in 2019, but the management team reaffirmed being committed to its capital budget (reassuring!). 2019 guidance for oil production was below consensus but that includes the international asset sales. Adjusting for the sale, the miss is only ~2%. The management team seemed confident to meet its 2019 goals thanks to good operating momentum and efficiency gains. Continue reading “EOG 4Q18 earnings results”

CVS 4Q18 earnings summary

Key Takeaways:

Current Price: $64.88 Price Target: $90

Position Size: 2.11% 1-year Performance: -1%

While CVS reported 4Q18 earnings that beat market expectations, its continued struggle within its long-term care business and lower than expected 2019 guidance is pressuring the stock today. The bright spot was the continued growth in filled prescriptions (+7.4% pharma same-store-sales), proving that the online threat is not impacting store sales. Retail/Long-Term Care (LTC) operating margin was down 130bps in the quarter on greater investments in the business and the LTC weakness. [more]

PBM claims were up +5.7%, and although purchasing economics improved, pricing pressure continued. The client retention rate remains high at 98% but excludes the Centene upcoming loss. The MinuteClinic sales grew +9.8% y/y, a good testament of the value of this service within the stores.

This was the company’s first quarter including Aetna. CVS created a new health-care-benefits segment equivalent to the former Aetna health-care segment, which includes insured and self-insured medical, pharmacy, dental and behavioral health products and services.

There are a few negative points to highlight:

· The 2015 Omnicare acquisition (long-term care business) was the biggest deal CVS did until the Aetna merger. Years later CVS hasn’t been able to fix this business, triggering some questioning regarding CVS’s ability to integrate successfully another unit. Instead of being the growth driver its was advertised to be in 2015, Omnicare is facing industry challenges such as nursing homes bankruptcy, declining occupancy rates and payment pressures. “The LTC business has continued to experience industrywide challenges that have impacted our ability to grow the business at the rate that was originally estimated when the Company acquired Omnicare, Inc. in 2015,” CVS said. Almost half of what the company paid for Omnicare has been written down so far. Right now the bull thesis on the stock lies on the ability for CVS to integrate Aetna successfully, and the Omnicare failure is definitely creating some doubts in investors’ minds. We think the management team needs to bring more clarity to their strategy going forward and gain back investors’ confidence.

· CVS sees 2019 as (yet another) year of transition:

o Aetna integration. While we should see $300-350M of expected synergies, the savings will be fully reinvested, offsetting any incremental margin expansion from the acquisition

o Retail/LTC segment will be down 10% in 2019:

§ Half of the weakness is coming from the LTC business struggles & lapping of the tax reform investment

§ Half of the weakness is coming from continued reimbursement pressure and a declining generics benefit

· The corporate tax rate drop from 35% to 21% did not all fall to the bottom line as CVS reinvested some in higher wages and benefits.

To be fair, we found their action plan for 2019 attractive (more details to come in June), such as:

· New product lines in health & beauty

· Expanding higher margins service offerings

· A new PBM “guaranteed net cost” model offers greater simplicity to healthcare partners, which CVS expects to see more widely adopted in 2020 (not much traction seen in 2019). Rebates are 100% passed on to the client

· A new cost reduction effort for the combined companies (this is in addition to the $750M synergy target)

· Applying new technologies to improve health (collaboration with Apple)

· Programs to prevent hospital readmissions: by cutting them in half for example, CVS would reduce expenses by $300M.

Overall we still think CVS has the right long-term strategy by becoming vertically integrated, however the recent acknowledgement of the failure to turn around Omnicare is putting a dent in the trust we have with CVS. We expect the next investor day in June to be very relevant in gaining back some lost confidence.

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

[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

Medtronic 3Q FY19 results summary

Key Takeaways:

Current Price: $93 Price Target: $100

Position Size: 3.14% TTM Performance: +10.8%

Medtronic released their 3Q FY19 results this morning, with organic revenue growth of 4.4%, a 50bps adjusted operating margin expansion and +9% EPS growth. Recent product launches and strength in emerging markets (+14%) helped revenue growth and was well diversified: 13% growth in China, 23% growth in South Asia, and 20% growth in the Middle East & Africa. Emerging markets now represent 16% of MDT’s sales base. MDT highlighted its differentiated strategy of using private and public partnerships and optimizing its distribution channel as making a real difference in terms of growth and increased penetration of existing products. And of course, rising demand is also a driver to EM growth.

The company raised its FY19 guidance numbers, although not to the extent that it would get anyone excited, mostly raising the lower end of its revenue from 5.0% to 5.25%. The free cash flow increase is more positive, seeing a 6% increase of its lower end, going from $4.7B-5.1B to $5.0-5.2B. Medtronic has entered a multi-year plan to expand its operating margin (less manufacturing footprint, centralization of back office functions for example), and convert a greater percentage of its net income to free cash flow. At this point, it seems that Medtronic can achieve its long-term target of top line growth (4%) and margin expansion (40-50bps). We are maintaining our price target at this point.

Continue reading “Medtronic 3Q FY19 results summary”

Pepsi 4Q18 earnings call

Key takeaways:

Current price: $115 Price target: $123

Position size: 2.30% 1-year performance: +1.5%

Pepsi reported +4.6% of organic revenue growth, helped by pricing +4% (although FX was -4%). What mattered today was the company’s 2019 guidance announcement. The company plans to return $8B to shareholders in 2019 through share repurchases and dividends. PEP expects organic top line to grow 4% (above consensus of +3.4%), and EPS of $5.50, which would be a 3% decline y/y as the company expects to reinvest for growth (more marketing spending) and incur some restructuring costs. It is pretty common to see an EPS “reset” lower as a new CEO takes the helm of a company. Thus there is no surprise there with a 3% decline in EPS this year. There is nothing completely different with newly appointed CEO Ramon Laguarta strategic vision. He has a desire to streamline Pepsi’s manufacturing and supply-chain footprint for better performance, becoming “leaner, more agile and less bureaucratic”. As costs rise, Pepsi is renewing its efforts to drive productivity gains and is targeting $1B in savings/year until 2023. Long term, Pepsi is hopeful to return to an algorithm of +4-6% organic growth, core operating margin expansion of 20-30bps and a high-single-digit core EPS growth starting in 2020. Continue reading “Pepsi 4Q18 earnings call”

Stryker trim 70bps #researchtrades

After review, we decided to trim Stryker by 70bps, and put the proceeds in cash (IVV) until our next idea makes it into the portfolio. Stryker is currently our biggest relative weight, yet at today’s valuation (+8% upside on our new $198 price target) we think this carries too much risk. The Medtech sector has seen its multiple expand in the past decade, helped by healthy fundamental drivers. While we think Stryker still has room to grow, the Medtech sector now trades at a 40% premium vs. the market.

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