Author: Julie Praline

Key Takeaways:

 Share price: $213                    Target Price: $227 NEW ($213 prior) 

Position size: 2.30%                TTM return: +21%

 

Zoetis once again beat expectations and generated sales and earnings growth of 10% in the quarter. The International segment came in higher at +14% while the US were +7%. Livestock declined 2% due to generic competition and a tough y/y comparison, but was in positive territory internationally (favorable export conditions for meat producers). Companion Animal continued its solid trajectory with +19% sales growth led by Simparica Trio uptake and key dermatology products reaching $300M in sales, a historical high. Pain medication (Librela/Solensia) is above expectations in its first full quarter launch in Europe. The company continues to innovate to differentiate itself from generics & competitors. For example, it launched a chewable version of Apoquel (to treat dog allergy/itching). Looking forward to 2022, we expect pet health to continue its growth trajectory, as pet ownership has seen such a boost during Covid and increased pet owners awareness of their companion’s health in general, thanks to WFH. The mix was favorable to margins, with gross margins going back to historical high.

Valuation remains at a premium but is justified by innovation, market share gains (growing above industry levels) and consistent execution.

Guidance raised for 2021 again:

• Revenue growth of +14-14.5% from +12.5% to 13.5% previously to reflect good 3Q
• Adjusted net income range increased to $2.2B-$2.25B with operational growth of 16.5-18% from 13% to 15% previously

Zoetis investment thesis:

·         Attractive industry profile: mid-single-digit growth rate, little generic threat, cash payers, pet sub-sector is very fragmented

·         ZTS is a leading diversified animal pharma company that continues to innovate to fulfill unmet animal needs

·         ZTS is growing above the industry rate and has proven resilient throughout economic cycle

·         Experienced management team has proven successful in increasing revenue and margins since the IPO in 2013

·         Good capital allocation strategy: M&A and capex spending have lifted sales and improved profitability

 

$ZTS.US

[category earnings] [tag ZTS]

 

 

 

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

 

Good morning,

 

Hydrogen has been talked a lot in the past couple of years. I wanted to provide a high level understanding of what it is, and its application for the vehicle market. Attached is also BMO’s primer on the subject (very dense report…) and BTIG’s initiation on PLUG.

 

Hydrogen can be produced in various ways, see the chart below:

 

 

 

Comparison of fuel cell electric vehicles (FCEV or hydrogen),  and battery electric vehicles (BEV).

 

Currently there are millions of plug-in electric cars (mostly battery EV)  globally vs. thousands of hydrogen cars, dominating the automotive market. Until industrial production and supply of hydrogen improves, looks like this will remain the case for cars. But for the larger vehicle and aviation markets and even in industrial and domestic heating, hydrogen could be a good alternative to meet net zero carbon emissions target. One technology is not exclusive of the other, they could both play a role in decarbonization efforts.

 

Who makes hydrogen fuel cell vehicles? Toyota, Honda, Hyundai. Some automakers have stopped funding hydrogen research favoring BEV, while some maintained a portion of R&D spending towards it.

 

Hydrogen cars:

Positive of hydrogen:

• Quick to refill tank (like fossil fuel)
• Longer driving range than BEV – could be better suited for trucks with heavy loads
• Light to transport
• Great for warehouses that can refill on site quickly
• Hybrid hydrogen vehicles seems a good alternative

 

Negative of hydrogen:

• High risks of explosion, especially during transportation/processing – not so much during use in a car (fuel tanks are Kevlar-lined to protect from detonation.
• Processing of hydrogen is not very energy efficient, running at 25-30% efficiency vs. 70-80% for BEV due to processing & transporting it
• 95% of hydrogen comes from fossil fuel, although the technology for green hydrogen is progressing
• Infrastructure is small compared to charging stations for BEV
• Cost of hydrogen for refueling is higher than fossil fuel, although some auto manufacturers offer to pay for it (in California)

 

Battery EV:

Positive of electric battery:

• More energy efficient than hydrogen fuel cell cars
• Technology more suitable for mass rollout (more cost efficient to produce), resulting in accelerated production rate

 

Negative of electric EV:

• Time to recharge battery
• Doesn’t work well for heavy vehicles
• Battery degradation

 

 

 

 

 

 

Potential positive catalysts:

• Infrastructure bill: in the US, the trillion dollar infrastructure bill that earmarks billions for EV charging infrastructure, hydrogen production/hubs and many other programs has been held up in the House of Representatives. $15B for electrification and related services, including $7.5B for EV charging stations (500K vs 100K available today) and $9.5B for hydrogen projects including $8B for regional supply, $1B for electrolyzers and $500M for companies that innovate with hydrogen (the US DOE intends to reduce the cost of green hydrogen production to $2/kg by 2026).

 

• The proposed Build Back Better Act (budget reconciliation bill) has many provisions for electrification of mobility as well as a clean hydrogen production tax credit). Another key provision being discussed is a new clean hydrogen production tax credit that would offer $3/kg to hydrogen with 95% fewer lifecycle GHG emissions than hydrogen made through the currently dominant method, steam reforming.

 

• COP26 (ongoing this week and next): Stated goals of COP26 include securing global net-zero by mid-century and keep global warming within 1.5 degrees. Recommendations could come for phasing-out coal, reducing deforestation and accelerating EV/renewable energy.

 

 

 

PLUG stock comments:

Plug Power is a leading supplier of hydrogen fuel cell technology. It currently has a first-mover advantage in scaling its technology and deploying a network of hydrogen production/fueling system. It has a partnership with SK Group and Renault, Brookfield Energy, Apex to name a few. It main focus is currently large warehouses with a high number of forklifts to justify the cost of installation before accounting for CO2 emissions reductions, putting Amazon and Walmart as big customers – driving 70% of revenues (a risk in our eyes, which needs to be mitigated over time by signing on new clients).

The company also focuses on heavy duty trucks, medium duty (for example delivery vans), small robotics and aerospace UAVs. Their focus is not individual cars. Higher oil and natural gas prices are an opportunity for PLUG, with cost of ownership of diesel trucks higher than FCEV and BEV.

Valuation currently looks rich as it is not profitable (could be in 2023-24), and assumes supportive government policies. The stock is very volatile.

 

 

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

 

Advising to not buy in new accounts or add money to the position. Will use LMT over time to fund new ideas.

 

Generally, the slowdown was expected, with the stock’s performance reflecting this (flattish prior to this quarter’s earnings release). What was surprising was the magnitude of the decrease in sales growth projected for 2021-2023, with new programs coming online later in the decade, vs. what we were expecting (a faster timeline of execution). Lockheed has been a solid, consistent performer in the last 10 years. This guidance revision is unexpected, and looks to us like a red flag to the investment thesis.

 

Current Price: $332        Price Target: $396 (NEW) 

Position Size: 2.27%      1-year Performance: -5%

 

A new price target of $396 is reflecting the lower top line growth and flat margins. While valuation and dividends are somewhat attractive, we think it could take years for this growth to materialize and reflect a below-peers growth story near-term.

 

Overview of 3Q2021 results:

Results were mixed, with sales below consensus but margins better. The -3% sales decline was mostly due to Missile and Space segments (-6.4% y/y  from tactical and strike missiles, sensors and sustainment programs) and Space segment down 5% (due to the AWE program – the UK nuclear program).

Overall margins held well +130bps overall.

 

Guidance downgrade:

For 2021

• Sales guidance reduced by 1.5% due to Aeronautics sector but margins maintained. Mostly due to supply chain delays.
• Cash flow guidance reduced by 6.7%

For 2022

2022 seems like the reset year for growth going forward. There is about a $1B headwind to 2022 revenue from various parts of the portfolio, driving the 1.5% sales decline:

• Top line reduced due to supply chain delays, and the continuing effects of the ongoing COVID pandemic and extended delivery timelines across our supply chain – worsen towards the end of Q3 2021.

• Moderating growth rates in the U.S. defense budget: LMT guided to lower growth than what the DoD budget is set to grow at, and lower than peers – peers could possibly guide to high?
• Shifts in customer priorities driven by recent events, such as:
• the withdrawal of U.S. forces from Afghanistan ($200M or 0.3% of total 2021 sales)
• the renationalization of the AWE program in the UK (1.2% of total revenue for 2021)
• Program maturity:
• F-35: while the entire program $ remains the same, the delivery timing is pushed to out years, impacting the next couple of years’ sales. What this means is that instead of delivering 170 F-35, the company now targets 156 F-35 for a longer time period (through 2035). In addition, the F-35 sustainment growth was reduced slightly from high single digits announced in September to 6%. 2022 impact from F-35: $400M or 0.6% of 2021 revenue
• Black Hawk: $350M impact from program reaching maturity
• Previously mentioned classified program is still early on and won’t offset decline in other programs quite yet.

Cash flow guidance reduction of 6.7%, and unclear thereafter. Aerojet purchase remains on the table but pushed out to 1Q22 rather than 4Q21.

 

For 2023-2026:

Slight increase in 2023 with steady growth after – depending on new programs production start. Operating cash flow guidance is not clear, depending on growth program cash needs.

Drivers to growth:

• Performance on current programs
• Sikorsky CH-53K has funding support – should add incremental $300M in 2022
• Space funding support OPIR and GPS
• Ability to win new programs
• Future defense budget
• Global political landscape

Growth areas:

• Hypersonic portfolio – working on 6  programs currently with multiple ones entering production in 2023 and 2026
• Classified activity: production could start in 2023 and 2026
• CH-53K heavy-lift helicopter, F-35 sustainment, PAC-3 increased production, modernization of Fleet Ballistic Missile

 

Capital allocation update:

LMT is looking to do a $6B of share repurchase in 2022-2023 (already announced prior to this earnings report). An additional $5B was accepted in Q3, shifting the focus to share repo near term.  Capex will go up in 2022 to support the Space segment. Any remaining cash will go towards dividends (+8% just authorized – increasing the yield to 3.4%).

 

 

Because LMT has made multiple advance payment in its pension plan, it is not expected to make a required pension cash contribution before 2026 with minimal contributions thereafter.

There is a potential change comping for R&D tax amortization, removing the allowance to write off R&D from a tax perspective. Instead of being able to expense it all in the year it was expensed, it will be amortized over 5 years. This means that in 2022, only 20% of 2022 R&D expenses can be used as a tax shield. For LMT, this represents a $2.2B impact on 2022 FCF.

 

 

 

 

LMT Thesis:

·         Lockheed Martin is a primary beneficiary from the replacement cycle for aging military aircraft and ships

·         Excellent management team focused on returning capital to shareholders

·         Strong cash flow and financial position

    

[category earnings] [tag LMT] $LMT.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:

 

Current price: $263                     Price target: $322  

Position size: 2.95%                    1-year performance: +50%

 

• Revenue growth of +20% y/y thanks in part to the Philips recall that had a positive impact on Resmed sales, adding $80-90M. The launch of AirSense 11 is also boosting sales, while the prior model AirSense 10 has not seen a price decrease as usually would be the case, most likely due to worsening supply chain issue. Q2 and Q3 sales growth will be impacted by supply chain issues, but the  company did not lower its full year sales guidance, suggesting a return to normal towards next summer.
• Devices sales lifted by competitor Philips recall:
• US devices sales were +40%
• Rest of world devices sales +24%
• Masks segment saw a sales slowdown due to lower new patient intake, but still reaching +9%
• US masks sales +4.5%, supported by their resupply program of current patients – the lower level of new patients will have an impact on future growth though
• Ex-US market +18%
• Software-as-a-service business: mid-single digits growth to increase high-single-digits throughout the year.
• Covid-driven demand for ventilator is now $4M from $40M last year.
• Gross margin impacted by higher freight costs. bps y/y  The launch of premium priced AirSense 11 (+15-25% per Goldman Sachs) should help gross margins in the coming quarters.

 

 

On the M&S front, RMD is under levered and has access to $1.5B in liquidity for bolt-on deals. This quarter, RMD completed the acquisition of Ectosense (a global producer of cloud-connected home sleep tests).

We think the stock is down today due to higher freight costs (profitability impact) and potential slowdown in sales in the coming quarters due to supply chain issues (by now, hopefully this is no longer a new theme to anyone!!).

 

 

Thesis on RMD:

• Leading position in the underpenetrated sleep apnea space
• Duopoly market
• New product cycle
• Returns of capital to increase: ~1% share buyback/year (back in FY18), dividend yield of 2%

 

$RMD.US

[category earnings] [category equity research] [tag RMD]

 

 

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:

Current Price: $266                          Price target: $293

Position size: 2.41%                        1-year Performance: +31%          

 

Stryker released its 3Q 2021 earnings last evening. Sales were up +4.5% organically y/y (+8.4% from 2019).

• The US knee/hip/spine business showed some slowdown during the quarter, as those procedures are more deferrable than others more urgent.
• The Delta variant was most impactful in Florida and Texas, with a peak seen in early September.
• Staffing shortage worsen between July and September
• Medical and surgical equipment remains good with orders up.
• Ongoing demand for Mako (Robotic surgery) continues, despite competitive landscape. Half of new sales were in new hospitals.
• New catalyst: the company is developing a shoulder surgery robot for shoulder implants as well – no launch date yet.
• Gross margins expanded 55bps vs. 2019 but operating margins were flat.

 

Although the management team had increased its guidance for 2021 due to good recovery in Q2, it is now lowering its target by ~2% (now 7-9% from 9-10%)) to account for Delta variant impact and staffing shortages likely to persist through year-end. EPS guidance is lowered as well to $9.08-9.15 (versus $9.25-9.40 prior).

 

Valuation is not overvalued, but not cheap either where I would want to add to the position. Long-term thesis is intact.

 

 

   SYK Thesis:

• Consistent top and bottom line growth in the mid and upper single digits respectively
• Continued operating leverage of current infrastructure
• Strong balance sheet and cash flow used in the best interest of shareholders

 

$SYK.US

[category earnings] [tag SYK]

 

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:

 

Current Price: $74.3                       Price Target: $88   

Position Size: 1.90%                       1-year performance: +20%

 

Fortive (FTV) reported 3Q earnings last night. Overall the recovery is taking hold, and FTV is showing its strength with pricing gains this quarter.

• Organic growth of +9% (+12% total growth)

o   All three segments had positive sales growth:

Ø  Advanced Healthcare Solution +5% organic (24% of revenue): elective procedures in the US were below pre-covid levels and impacted the sales of consumables products. However capital equipment continues to grow

Ø  Precision Technologies +7.7% organic (36% of revenue)

Ø  Intelligent Operating Solutions +13% organic (41% of revenue)

• Software-as-a-service grew 13%: FTV is building scale and differentiation with its software offerings: it has almost $750M of annualized revenue growing +double-digits
• with high recurring revenue / operating margins
• Adjusted operating margin 22.8%, +325bps, above guidance, thanks to multiple drivers: software-as-a-service strength, better pricing (+2.2%) and cost control benefits
• There is good momentum going into 4Q and 2022 thanks to order growth of 20%, amid the supply-chain challenges
• Some of the demand is being pushed-out to 2022 on delays, but remains strong and should supply returns to normal little by little, growth in 2022 would be better than the mid-single-digit target

 

2021 guidance updated:

·       narrowed 2021 guidance for adjusted EPS to $2.70-$2.75 (vs $2.65-$2.75 prior), up 29-32% y/y

·       Organic sales growth now seen at 10.5-11% (vs 10.5-12% prior)

·       Adjusted operating margins at 23-23.5% (vs 22.5-23.5% prior)

 

 

FTV Thesis:

• Market leader:
• Leadership position in most of the markets they serve
• Experienced leadership team
• Above industry margins with strong cash flows
• Quality:
• FCF yield ~5%
• Organic growth target of 3-3.5% (4-5% in last 2 quarters after being under the target in prior quarters)
• M&A strategy to enhance top line growth
• Margins expansion from new products introduction, continued application of the Fortive Business Systems and M&A integration
• Shareholder friendly:
• Management team focused on shareholder wealth creation through top line sustainability and margin expansion

$

FTV.US

Category: earnings

Tag: FTV

 

 

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