Author: Julie Praline

FTV 1Q18 earnings recap

Thesis intact. Key takeaways:

Fortive released its 1Q18 earnings results last night. Overall organic growth was +2.6%, and with the help of FX and acquisitions, reported sales increased 13.4%. Although core growth showed a slow start to the year, we remain confident that the company can achieve its guidance of mid-single-digit organic growth for the year. One of the reason being timing, as its Transportation Technologies business saw some orders linked to the EMV transition (gas station payment system) pushed to 2Q, causing overall flat organic growth in its Industrial Technologies segment. All six growth platforms had positive pricing, lifting operating margin, but this was partly offset by recent acquisitions. EPS grew 30% y/y. Regarding potential M&A activity, FTV commented on the possibility of adding a new platform of growth (they have 6 currently), but don’t feel the pressure to do so. The deal pipeline remains solid but sellers are currently expecting elevated prices. We remain positive on the stock.

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RMD 3Q18 earnings results

Thesis Intact. Key Takeaways:

Overall results were good, with sales up 11% ex-FX, but EPS missed slightly due to one-time restructuring charges. Resmed is guiding to growing its SG&A costs at half the rate of its revenue. The recent growth in the rest of the world was driven by recent funding policy changes in France and Japan favoring connected care solutions, where Resmed has an advantage over other competitors that would struggle with the investments required to develop a good connected care solution. The new funding rules favor their AirSense devices pushing suppliers to upgrade their fleets (this trend should persist for the medium term). On the other hand, we see its US results as a slight negative, as RMD has recently lost some market share to Philips who had a double-digit growth this past quarter vs. RMD +8%. The next quarter will determine if this is an ongoing trend to be worried about or if the company’s innovation ability is intact.

Valuation: no change at this time

  1. The stock is supported by a ~3.2% FCF yield, and a stable dividend (current yield 1.5%). The company expects to buy-back at least enough shares to offset the dilution from share issuance
  2. The balance sheet is strong (net debt/EBITDA at 0.17x)

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

[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

PLEASE NOTE!

We moved! Please note our new location above!

SYK 1Q18 earnings

Thesis intact. Key takeaways:

On a comparative basis, Stryker delivered solid 1Q results with 8% organic sales and 13% EPS growth. Total sales were up 8.2% on a constant currency basis, acquisitions added 1.2%, volumes and mix were a positive 8.6% while price was a negative 1.6%. Their US knee business continued to grow ahead of the market with 7.3% organic growth, gaining market share. The first quarter also saw 8,200 total knees done using the Mako robot, up from 7,150 in 4Q17, and placing a total of 28 Mako robots of which over 50% were into competitive accounts – JNJ had commented on the competitive environment pressuring their sales in that space – today’s results confirm that the market is still growing and SYK won market shares.

On the negative news front, Spine sales were weak again (flat y/y), as continued market softness in the US was impacted by double-digit price declines across the portfolio on top of last year’s high single-digit price decline (excluding innovative products such as the tritanium cage). Competitors in Spine saw negative organic growth: -7% for JNJ and -3.8% for Zimmer.

Following strong 1Q results, management raised organic revenue guidance range by 50bps from 6.0-6.5% to 6.5-7.0% growth for the year, and EPS to $7.18-7.25 (+11-12% y/y growth) from $7.07-$7.17, which includes $0.04 of dilution from recently acquired Entellus.

We continue to believe Stryker can continue to deliver above-average sales and EPS growth due to its business mix, innovative profile and M&A integration ability. We remain positive on this name, even after a strong stock move for the past 12 months.

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UNP 1Q18 earnings: remaining positive on the company’s story

Thesis Intact. Key takeaways:

UNP met consensus numbers thanks to a combination of moderate volume growth and price increases, and kept costs under control. Operating Ratio (OR) was 64.6%, but productivity gains of $35M were well below management’s expectations. The shortfall was related to the network issues the company experienced during the quarter, mostly in the Southern region.

The management team is scratching its 2019 OR target of 60% (with consensus already above that numbers ~61%, so sell-side numbers shouldn’t come down too much) and its $300-350M in productivity gains guidance. The reasons are:

· Productivity initiatives affected by problems in implementing an automated train stopping and collision avoidance system (Positive Train Control), affecting the flow of operations. PTC implementation was initially targeted to end in 2018, but now pushed towards 2020. The company has reactivated 650 locomotives (250 since February) and still has 250 still in storage. To improve its service, the company is also offering signing bonuses to attract new labor and has recalled all employees on furlough

· Price inflation less than expected (something the street had been questioning the company for a while)

It long-term OR target of 55% is remains untouched at this time. The company still benefits from high barriers to entry, supporting pricing power and margins. For 2018, management remains positive on the top line possibilities, guiding to positive full year volumes and core price gains. They are also evaluating its capital structure, and could see some debt funded buyback to be announced at its Analyst Day on May 30th. We see this quarter as a one-time blip in the company’s strong operational history. We remain positive on the name.

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LMT 1Q18 earnings

Thesis Intact. Key takeaways:

Lockheed Martin released its 1Q18 earnings well above consensus expectation both on the revenue and earnings front. The management team also raised its sales (+0.7%), operating profit (+2%) and EPS (+3.9%) for the year. Yet the stock sold off as investors were expecting a lift of its 2018 cash flow guidance as the FY18 DoD budget grew, in particular the 2018 Appropriation Act offering an incremental $7B for Lockheed’s programs. The management team did not know if those incremental dollars will translate in new contracts/sales and preferred to remain conservative this early in the year. Production plans still target 90 F-35s delivered in 2018, with peak delivery year in 2025. There is an on-going dispute with the DoD over some production issue but this is not impacting revenue, and we do not think this will be a big problem to solve. Its Sikorsky business saw a nice margin expansion, most likely thanks to cost cutting and synergies flowing through post acquisition. The pension contributions are always a big part of defense companies’ expenses, and LMT is no exception. Management is guiding to the possibility of negative cash from operations in Q2 due to most of the pension contribution being made by Q3: $1.5B was made in Q1 and the full year amount will reach $5B.

Overall we keep a positive view of this holding.

Valuation: we are not changing our price target, a review of our model warrants a $374 price target.

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

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

PLEASE NOTE!

We moved! Please note our new location above!

Pepsi 1Q18 earnings results

Thesis intact. Key takeaways:

Pepsi reported good organic revenue growth (+2.3%) with emerging markets strength (+HSD sales growth) lifting the company’s growth this quarter. On the negative side, North America Beverages continues to face tough competition, but results improved sequentially – in the eyes of the CEO, this is a short term problem and they “know exactly how to fix it”. The gross and operating margins were weaker, with input costs inflation impacting the company (a theme we have heard from others as well). Some responsible pricing will help offset cost inflation this year. Management is guiding to a continued gross margin compression through 2018, which has typically been offset by SG&A productivity. However this year the company will increase spending to fend off competition (Coke but also smaller players). Cola is the only category Pepsi has been outspent recently, which they intend to fix to keep their market shares. The lower tax rate will instead be used to maintain earnings growth. Pepsi is maintaining its 2018 guidance.

There has been pressure for Pepsi to break its business into 2 companies: beverages and food. PEP’s CEO reiterated the importance of having both businesses together, as it is used as a bargaining tool with their customers (retailers): beverages has a high velocity in store, which is attractive to retailers (drives traffic). When warranted, beverages are sold in pair with salty snacks (salt makes you thirsty J). They also view their bottling business as a utility company that has low margins but creates lots of cash.

Pepsi remains a key holding in our consumer staples sector.

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MMM 1Q18 earnings – better than the stock reaction implies

Thesis Intact. Key Takeaways:

Yesterday MMM reported its 1Q18 results, with sales and EPS in-line, but margin missing (30bps expansion vs. 100bps expected). While EPS met consensus expectations thanks to a lower tax rate, and healthy reported sales growth of 7.7% (+2.8% organic – and all five segments in positive territory), management reduced its top end of organic sales growth guidance for 2018 to 3-4% (from 3-5%), and the top end of EPS guidance by $0.15. A guidance cut this early in the year drove the stock down on the news. In particular, its Industrials segment (1/3 of sales) fell short of expectations, with a sales deceleration to +2.2% from 5.7% last year. The auto aftermarket (auto body shops) was weak – although not new news as it was previously called out in March. But recall that IHS forecasts a return to positive global auto production for the rest of the year, which should support its auto OEM business (+3% in 1Q). Oral care saw weak demand (flat y/y), and electronics experienced a deceleration in growth.

On the positive, 3M’s pricing increase (+70bps) showed the company’s strength and sustained margins expansion, but this needs to be monitored as raw material inflation continues through 2018 and pressures margins. The management team raised its buyback target to $3-$5B from $2-$4B before. MMM remains a best-in-class industrial company, as proven by its improving ROE and consistent FCF margin (even during the last recession – see charts below).

· Valuation: we have updated our model and do not change our price target at this point.

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J&J reported 1Q18 earnings: new product launches are driving their pharma segment growth

Thesis intact. Key takeaways:

JNJ reported 1Q18 earnings results that showed the strength and breadth of its portfolio, with good performance in Pharma (Stelara and Zytiga offsetting Remicade deceleration). However, the sales beat was driven by a greater positive FX impact than expected, rather than operational outperformance. The company-wide organic sales growth was 4.3%, a modest acceleration from +4.2% in 4Q17. JNJ’s raised its 2018 operational sales growth guidance by 50bps to 4%-5% and affirmed its EPS guidance of $8.00-$8.20. The management team intends to use the extra cash from the lower tax rate for additional R&D spending. On the call it was clarified however that the pursuit of better organic growth rate will not deter from looking for more M&A targets, as it remains core to its growth strategy. In the next 5 years, the company plans to implement various supply chain actions to reduce complexity and improve cost competitiveness, resulting in $0.06-$0.08B in annual pre-tax savings. These savings will help offset some pricing pressure or internal investments.

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McCormick (MKC) 1Q 2018 earnings results were good, guidance raised on FX and tax impact

McCormick (MKC) delivered 1Q 2018 adjusted EPS of $1.00, a 32% increase y/y thanks to recent acquisitions and good product portfolio management. We are encouraged to see good progress on the margin front with continued stable top line growth. Management provided additional details on its cash use following the tax reform. Price target unchanged.

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