Author: Julie Praline

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

 

 

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

 

 

Key Takeaways:

 

·         Consumer segment: trend of eating more at home is now becoming a habit globally driving growth for this segment to +15%

o   CEO quote: “Even before COVID-19 the consumers were cooking more at home. They were using more spices, and seasonings and sauces to prepare fresher healthier meals, they were moving to trusted and inherited brands. […]. The pandemic accelerated these trends and other trends like e-commerce that already underpin our strategies and that we were already capitalizing on”

·         Quick service restaurants are recovering strongly (but are lower margins), while other foodservice is slower to rebound which is a higher margin business (-1.1% decline in its Flavor solutions segment, especially in the Americas as Asia/Pacific had a +7% growth)

·         Packaged food is returning to pre-Covid levels

·         High demand in the US put pressure on supply chain, while EMEA and APZ had already built extra capacity

·         Margins pressure from Covid related costs, and scaling up production/on-boarding people

·         Guidance reinstated: organic sales 5% to 6%, flat margins, EPS growth of 6% to 8%

·         Stock split 2 for 1 on 11/30/2020 (last one was 18 years ago) in order to provide greater liquidity

 

 

 

Current Price: $190                 Price Target: NEW $202 (prior $191)  

Position size: 3.15%                1-Year Performance: +24%

 

 

McCormick had another impressive sales growth of 8.6% this quarter, but this was shadowed a bit by the margin pressure, which should continue near term with Covid-related costs and additional capacity needed to meet higher demand.

In the Americas Consumer segment (its biggest in sales), the data points are encouraging, and supportive of MKC’s premium valuation, as its portfolio grew 28%, gaining share in 7 out of 11 categories, while household penetration and repeat buyers increased 8% and 7% respectively. Regarding the supply chain pressure in the US, the company is rapidly scaling up, and should meet demand by the end of the year.

Because the company continues to invest behind its brands, restocking shelves and restarting SKUs that were put on hold, the company believes it can produce positive growth in 2021 even with tough comps later in the year. While it is a bit early to talk about 2021 yet, the management team thought necessary to clarify some questions on the future growth of the company. Another positive this quarter was the early deleverage target of below 3X reached a quarter earlier than targeted, which can certainly open the door for acquisitions in the near term. We are updating our price target to reflect better 2020 sales numbers and increased scale providing a lift to margins longer term.

 

 

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

 

 

Key Takeaways:

 

·         Quarterly organic sales decline 17%y/y on a comparable basis, better than expectations, showing a faster recovery than modeled earlier in the Covid crisis

·         Renewed focus on top line growth:

o   early signs of market share gains due to new product launches, focus on innovation

o   Pace of tuck-in M&A expected to accelerate (3 recently)

o   Cultural changes within the sales team as well: market share gains are now part of their metrics in FY22

 

Current Price: $104                             Price Target: $121   

Position Size: 2.72%                           TTM Performance: -1%

 

Medtronic released its quarterly earnings with a beat vs. expectations. Last quarter, sales expectations were for a worsening of the situation (lower than -25%) but the company achieved a (17%) – still a big decline but showing a faster recovery of the business (in Cardiac/vascular and Restorative Therapies).  With 52% of sales coming from the US – down in the low 20% vs the rest of the developed countries in the mid-single digits to mid-teens decline – Medtronic is affected by the high rate of COVID still impacting the US. The situation continues to evolve of course: Europe is back to seeing climbing cases and imposing some restrictions again. We still don’t have any guidance for the FY2021 year, but with so many moving pieces, this is not surprising.

 

During the video call (a first!), CEO Geoff Martha – on the job since the end of April – sounded particularly positive regarding the company’s renewed focus on top line growth, thanks to their broad innovation pipeline and recent share gains. There seems to be interest in accelerating the number of smaller acquisitions (most recent 3 added to $1B spent), as their balance sheet allows them to.

 

·         In the Cardiac/Vascular segment, sales were helped by the new Micra technology(transcatheter pacing system) and Cobalt and Crome platform (defibrillators), helping the company gain market share, and regaining share in TAVR.

·         The Minimally Invasive Technology segment was helped by the sales of ventilators (sales doubled y/y). Ventilators production increased to 1,000/week to meet demand. Emerging markets are currently driving the demand.

·         In Restorative Therapies, MDT is gaining share in Spine products, and the pending acquisition of Medicrea should push gains even more, expanding the offering with AI technology to personalized spine implants.

·         The diabetes segment (the smallest in revenues) has been a drag on MDT results for a while now. This quarter it was impacted by a delay in the new pumps in the US and continued competitive pressure. But there seems to be some light at the end of the tunnel: the Blackstone partnership and the Companion acquisition are positive news for this franchise. Companion Medical is the manufacturer of the InPen product, the only FDA approved “smart” insulin pen integrated with a diabetes management app. The Blackstone partnership provides funds to accelerate 4 R&D projects.

 

While margin expansion is possible, this will be kept to a minimum in the near term, as the management team puts efforts into R&D spending to drive future top line growth. Since the beginning of the year, 130 new products have been approved worldwide. Those new products have helped MDT gain 100bps of market share in the US in its heart business.

 

Overall we thought the tone of the call was positive and we hope to see some continued market share gains in the coming quarter, thanks to a renewed focus by the leaders on driving top line growth.

 

 

MDT Thesis:

·         Stands to benefit from secular trends (1) increased utilization from Obamacare (2) developed populations age

·         Strong balance sheet and cash flows. Increased access to non-cash should allow MDT to meaningfully increase their dividend

·         6% normalized Real Cash yield provides solid total return profile over next 2-3 years

·         Ownership interest aligned. Management incentivized to maximize shareholder returns – 14% 10yr average ROIC

Category: Equity Earnings

 

Tag: MDT

 

$MDT.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:

 

·         COVID-19 had less an impact on the US Companion segment than expected

·         Sales up 4% organic (FX impact -4%):

o   Companion animal +13% organic growth (US +19%, International +2%)

o   Livestock -5% organic (US -18%, International +4%)

·         Operating profit margin up 160bps

·         Q3 launch of disruptive technology diagnostic platform (Vetscan Imagyst)

·         Guidance raised due to Companion segment recovery

 

Share price: $161                     Target Price: $177 NEW (from $156)

Position size: 2.27%                TTM return: +30%

 

Zoetis released their 2Q20 results yesterday, with organic sales +4% organic (-4% FX impact), and a 4% increase in adjusted net income. Innovation was the driver of growth this quarter.

On the Companion Animal segment, their new drug Simparica Trio performed well in its full quarter of sales ($43M, vs. $15M in Q1 – with $100-125M targeted for the year), which was a pretty tough quarter for launching a new drug (limited rep sales, less vet visits). The drug also cannibalized less than expected the older Simparica drug, a positive surprise. Overall this segment recovered faster than expected from the Covid shutdowns.  

 

US Livestock product sales came down as meatpackers faced Covid related supply chain and manufacturing disruptions, and the food-service industry struggled with lockdowns. The company is expecting that this segment will remain under pressure throughout the rest of the year. The international livestock performed better as the diversity of the animal base mitigated some of the pressure.

 

The company is launching a new diagnostic system for in-clinic use called Vetscan Imagyst. This tool will use a combination of image recognition technology, algorithms and AI to deliver rapid detection of harmful parasites in pets. ZTS will charge a fee per read for each sample. This new toll will be launch towards the end of Q3 2020.

 

The resiliency of their pet business and ability to push innovation in the market were shown this quarter, and in our eyes justifies the premium valuation of the stock. We are raising our price target following a good quarter.

 

Guidance for 2020:

Revenue up 3%-6%

EPS $3.52-$3.68 from May guidance of $3.17-$3.42

 

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

 

 

Key Takeaways:

 

·         Good quarter with revenue up 10%, gross margin expansion of 60bps, operating profits up 24%

·         Strong ventilator sales (~10% of company sales) offsetting some sleep slowdown (~90% of sales) due to COVID

·         Gradual U-shaped recovery expected

·         Stock is weak today as next couple quarters see lower demand in ventilators that were supporting growth, and masks/devices take time to recover – stock had been a strong performer YTD, consolidation not surprising (we trimmed on valuation/position size at the end of June)

 

Current price: $179                     Price target: %179 (new from $168)  

Position size: 3.58%                    1-year performance: +56%

 

The company has manufactured 100,000 ventilators in 4Q, a rate we don’t expect to continue going forward. Resmed has partnered with Novartis, AstraZeneca, Orion and Boehringer on various inhalers. They now cover 90% of all inhalers in the US!

Software-as-a-service sales grew 7% this quarter, and is expected to keep growth in the mid-single-digits in the coming quarters as customers (mostly nursing facilities) struggle with COVID. The company accelerated the launch of its cloud-based remote monitoring software for ventilators across Europe, to allow doctor to remotely monitor patient’s conditions. The remote monitoring built into the devices pushed better compliance of usage by patients, and ability for clinicians to adjust the treatment. The greater push towards “value-based” reimbursement is also a trigger to get real feedback on treatment effectiveness.

Gross margin expanded 60bps thanks to product mix changes, partially offset by higher air freight costs. SG&A expenses went down 4% as the company saved on travel costs due to COVID-19.

 

The stock is down today as the tailwind from ventilator sales will fade in the coming quarters, combined with continued in-patient sleep labs below pre-COVID levels (~30% decrease in capacity). The management team reported a double-digit decline in new sleep patient diagnosis rate (COVID delaying doctor’s visits). Germany bounced back quicker (85% pre-COVID capacity), US at 70% while China behind at 50%. They are talking about a U-shaped recovery for their business. While in the US new patient starts is improving, the recovery is lagging expectations, on a stock that has performed very well YTD compared to peers. Their US resupply program with a recurring revenue stream is helping sales levels, providing some resiliency to revenue: around 80% of US mask growth comes from existing patients (not the case outside the US). In Western Europe and Asia, strict lock-downs, a smaller installed based, and payer constraints limits the resupply program (and thus masks growth this past quarter).

 

Outside the US, sales of ventilators lifted devices sales (+35%) thanks to contracts with national governments

Our long-term view on the stock is still valid, with the global sleep apnea market only ~20-30% penetrated, and market volume growth rate ~10% per year – an attractive market where Resmed and Philips play in duopoly. We are updating out estimate as we believe a recovery in FY21 will happen, and we roll forward our model.

 

FY21 guidance:

No gross margin expansion due to mix shift reversal and freight costs

SG&A to increase by low single digits

R&D growth in HSD to LDD

Tax rate 17-19%

 

 

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:

 

·         “The environment surrounding COVID-19 is accelerating our transformation, giving us new opportunities to demonstrate the power of our integrated offerings and the ability to deliver care to consumers in the community, in the home and in the palm of their hand which has never been more important.” Said CEO Larry Merlo

·         Results lifted by the Health Benefits segment (increased sales and profits) and PBM

·         Retail segment weaker on lower volume and additional operating expenses

·         EPS and cash flow guidance for the year increased

 

 

Current Price: $64                            Price Target: $90

Position Size: 2.10%                        1-year Performance: +19%

 

CVS printed mixed results this morning with outperformance coming from their Health Benefits segment (+6.1% revenue growth y/y as it grew its medical members), which saw increased profitability (+141% y/y) driven by lower utilization rate (COVID impact of delaying elective surgeries, care visits). The company saw a shift in customer mix: less commercial as corporations furloughed employees/shrank workforce, and more people on Medicaid.

The PBM segment also delivered better results with higher volume in scripts. It retention rate for the 2021 selling season remains high at 98%. But the retail segment suffered from pantry destocking and additional operational expenses. The July trend in Retail looks to decelerate from June (+4.6% from +7.1%), similar to pharmacy trends (+1.9% in July vs. +12.4% in June).

During the call, the management team emphasized a greater focus on the flu vaccine season this year, as symptoms are close to the COVID symptoms, and the role their pharmacies can play in distributing those vaccines. Getting vaccinated against the flu could limit the public confusion as the flu season starts this fall. The COVID-19 is most likely accelerating the development of its integrated model of care vision (including telehealth and monitoring at home). The company currently has more than 1,800 drive-thru testing sites, and has launched a B-to-B testing program for corporations and colleges (40 signed up so far, with over 1,000 prospects). Interestingly, 40% of tested people through their site was not a CVS customer previously, which CVS intend to convert as they connect digitally. Overall we would say that CVS is on track with its 2022 target of integrating Aetna and normalizing EPS.

 

As a results of this quarter’s performance, the company is raising its FY20 EPS guidance:

·         EPS up to $7.14-$7.27 from $7.04-$7.17

·         Cash flow $11B-$11.5B from $10.5B-$11B

 

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

Category: earnings

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

 

 

Key Takeaways:

·         Organic sales +5.5%

o   EM sales +2%

o   Developed markets: +8%

o   Hill’s pet nutrition +11.5% (are pets eating more now that their owners are with them all day?)

o   E-commerce sales +50% overall; US +200%, Hills +50%

·         Gross margin increased 120bps, operating margin up 30bps (increase in SG&A expenses was a negative)

·         2020 guidance not reinstated, most likely due to LatAm region uncertainty

·         Priority given to debt pay down over share repo in 2H20 – but good news! share repurchase activity to return in 2H

 

Current price: $76.9                Price target: $82 (from $77)  

Position size: 1.72%                1 year performance: +8% 

 

Once again Colgate delivered good organic growth, still benefitting from the pandemic impact on consumers staying at home in Europe and North America (less so in emerging markets as their lower growth rate shows). We should expect some of that pantry loading to go away in 2H (assuming no major second wave hitting Europe/North America), and sales level stabilize in the lower single digits range. FX continues to be a drag (-6%) and is forecasted to remain a negative this year. Profitability has seen the benefit of both volume (+2%) and price increases (+3.5%).

Colgate has a higher share of sales in oral care (58%) in the emerging markets (vs total company sales), and offers products in every price tier. So while Latin America struggles to recover from the COVID-19 crisis, likely impacting GDP growth, we can expect the consumers to trade down in price, which has been beneficial to Colgate in the past. During the last recession in Brazil, Colgate was able to gain market share in a pretty resilient category. The same happened in Russia (recession in 2015) and in Mexico (+170bps market share gain).

A testament of Colgate wide portfolio and resilient brands is its track record of positive organic growth, which has been positive every quarter but one since 2005.

 

 

Colgate has good cash management, with cash flows covering capex, dividend and share buyback needs. We updated our model and raise our price target to $82.

 

 

The Thesis on Colgate

• High exposure to fast growing emerging markets (36% of Operating Profit from Latin America; 50%+ from EM)
• Defensive Product set (soap and toothpaste). Product line less vulnerable to trade downs due to low private label exposure in the categories
• Strong balance sheet (net debt/ebitda 1.4x) and highest ROIC in the sector
• 2.64% dividend yield

 

$CL.US [tag CL] [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

 

 

Key Takeaways:

 

·         Sales down -24% but exit rate -10%, margins deleverage due to mix and sales decline

·         No guidance still due to uncertainties

·         Mako robots still in demand despite the crisis; SYK offering financial option to help hospital afford the robot (less upfront capex for hospitals, use of lease agreements)

·         Financial liquidity remains good with $3B of undrawn credit facilities

·         Wright Medical acquisition pending (borrowed $2.3B at low rates), should close in late 3Q/early 4Q – no other major transaction in the foreseeable future

 

 

Current Price: $190                          Price target: $232

Position size: 2.40%                        1-year Performance: -9%          

  

 

Stryker released their 2Q20 results with organic sales down 24% y/y. This decline in sales is related to COVID-19 as close to half of Stryker’s sales are levered to elective surgeries. Within the quarter, trends improved from -36% in April to -10% in June (and even better trend seen in July). Geographically China, Australia, and Germany recovered the quickest, reaching ~85-90% of pre-COVID-19 levels. On the other side, the UK, India, and LatAm are seeing a slower recovery, reaching less than 50%.  The management team commented on the high profitability of the hip/knee/extremities reconstructive surgeries, and the need for the hospitals to get those done, thus accelerating the pace of the recovery for those categories. The rapid expansion of inpatient & ICU capacity globally has pushed up the demand for their beds/stretcher, defibrillators and PPE equipment. While Mako has seen increased competition recently and hospital budgets squeezed, SYK has noted an even faster rate of new accounts deals. We see this as a proof of the quality of its robots and the good job of the sales team during the crisis. On the profitability front, gross margins were down quite a bit y/y (860bps) due to the sales mix and reduced top line (deleverage). The manufacturing capacity stood at 60% in 2Q, and should go to 85% in 3Q, still pressuring margins down. This should reverse towards 2021 as sales bounce back.

Overall the quarter was as expected (aside from Mako sales strength). We think this is a company that should come out of the crisis stronger, between the diversity of its products and resilience of its sales team, it should continue to perform well long-term.

 

 

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:

 

·         Sales down 12%, better than expected thanks to resilient utility end-markets (50% of revenue)

·         Issued a $1B green bond at 1.95% and 2.25% rate, in efforts to improve sustainability and financing strategy

·         Full year guidance not reinstated as uncertainties remain

 

 

Current Price: $74                      Price Target: $81

Position Size: 2.46%                 Performance: +12% (since inception on 04/07/20)

 

Xylem reported total organic growth declining 12% in the quarter (better than the 20-20% decline initially predicted, in line with preannounced earnings a couple weeks ago) as the utility sector proved more resilient. As seen towards the end of Q1, China recovered, now in positive territory (+6% growth). Margins were impacted by the lower volume, which was partially offset by productivity improvements. Free cash flow grew as working capital improved y/y and capex was lower.

 

Organic growth by end-markets:

·         Utilities: -9%

·         Industrial: -16%

·         Commercial: -10%

·         Residential: -15%

 

Organic growth by regions:

·         US: -15%

·         Emerging markets: -15%

·         Western Europe: -4%

 

Some interesting tidbits from the quarter:

Wastewater utilities trends:

·         Increased emergency clogs from disposable wipes and more household waste (as people stay at home more)

·         Potential medium-term impact on utilities capex budget  from reduced revenue but more partnerships opportunities

Clean water utilities trends:

·         Large projects postpones but expect growth to recover as social distancing requirements ease

·         No cancellation of awards or projects in the bidding process but some delay in decisions

Industrial sector trends:

·         Limited access to visitors, causing slower orders

·         Modest recovery as activity resumes

 

Fundamentals accelerated by this crisis:

·         Need for essential water services & safety

·         Interest in digital adoption

·         Shift in the way Xylem works internally and with customers

This in turn has pushed XYL’s investments in remote monitoring, connectivity & interoperability and focus in high growth markets.

 

Looking forward, with a backlog up 10%, we have a good indication for 2021 and beyond. Regarding 3Q forecasts, revenue are expected between -8% and -12%, and a sequential margin improvement from 2Q but still lowered y/y.

 

 

 

Xylem’s investment thesis is:

 

         Xylem has strong sustainable secular growth drivers in a fragmented industry:

         Access to clean water is a necessity

         Population growth & urbanization

         Aging infrastructure

 

         More defensive sales base thanks to:

         50% of sales to utility sector

         sticky client base due to high switching costs

         high level of replacement parts demand

         Long-term contracts with ½ of the revenue base recurring

 

         Margin expansion overtime from productivity efforts

 

         M&A strategy has increased their scope in the water cycle

 

         Valuation is attractive today

 

XYL.US

Category: earnings

Tag: XYL

 

 

 

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