Author: Sarah Kanwal

Current price: $160          Target price: $190

Position size: 2.5%           TTM Performance: 13%

Key takeaways:

• CCI guided to a slower than expected ramp in 2021 tower leasing activity and services, but outlook for small cell bookings in 2021 remains stable. Long-term secular growth dynamics unchanged.
• Despite this, given lower int. expense and capex, they’re on track to generate AFFO/ share growth this year that is consistent with their 7% to 8% target and expect growth to accelerate to 10% in 2021.
• Announced an 11% increase in dividend – ahead of LT 7-8% dividend growth target.
• Higher dividend, emphasis on lower fiber capital intensity and new board members likely a response to Elliot mgmt.

Additional highlights:

• CCI reduced their outlook for 2020 tower leasing activity to $150mn ($170mn – $180mn prior) and reduced their outlook for services revenue in 2020 (by -$50mn). The full rebound in activity on towers is continuing to occur a bit slower and later than mgmt. previously expected, with a portion of the activity they expected to occur in late 2020 shifting into early 2021.
• For 2021, guidance may be conservative given potential for lower Sprint consolidation churn and it doesn’t include a material contribution from Dish in 2021. Outlook for small cell bookings in 2021 remains stable, with mix shift towards colocation nodes.
• They should see improvement in 2022 from C-band spectrum deployment and from a step-up in investment from Dish.
• Beyond that, tower leasing activity will increasingly be driven by spectrum deployment for 5G – particularly w/ small cells.
• iPhone 12 as a catalyst – quote from CEO on call “Last week, we saw an important milestone and the march towards greater network densification, when Apple announced that all iPhone 12 models sold in the US support millimeter-wave spectrum bands…This announcement reminds me a lot of 2007. At the time the wireless carriers in the US had accumulated a vast supply of 3G capable spectrum, but there were no use cases identified requiring that much capacity. At the time phones were used for talking and in limited cases texting. Ringtones were the exciting feature you could download to personalize your device. Then Apple launched the original iPhone and the world changed.” The introduction of the iPhone kicked-off an era of wireless innovation that spurred unprecedented investments in wireless networks. 
• The situation is similar now. The new iPhone was launched for spectrum bands that are not yet deployed at scale. The use cases for 5G are few, but as the iPhone 12 proliferates, the installed base grows the incentive for new applications to be created and for the relevant spectrum to be deployed. And the relevant spectrum requires densification (millimeter wave spectrum provides significantly more capacity, but over a fraction of the geographic coverage area) – and densification is a driver of additional leasing on their tower assets and small cells.
• Carriers have ~20X the spectrum capacity they did in 2007, w/ a significant portion yet to be deployed and w/ upcoming (C-band) auctions. C-band is mid-band spectrum and mmWave is high-band, the former can be deployed via towers and small cell but the latter is lower propagation and should primarily be deployed using small cells  – both will drive lease up activity for CCI. This should drive improving returns as they expect decreasing capital intensity for growth within their small cell and fiber business.
• Strong balance sheet. No meaningful debt maturities until 2022. Trading at >4% 2021 AFFO yield.

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

$CCI.US

[category earnings]

[tag CCI]

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

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]

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.

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]

Key Takeaways:

1.       They missed estimates and issued weak guidance. Revenue however was at the midpoint of their guided range and took a 2pt hit from lower travel re-imbursement headwinds. Full year EPS ahead of guided range.

2.       While headwinds in some end markets persist, digital transformation imperative is long-term secular growth driver to their business.

3.       Strong bookings and they continue to take significant market share, signifying solid business fundamentals. They grew 4x the market in the last 2 quarters.

4.       CEO Julie Sweet said…”Post Covid leadership requires that every business become a cloud first business quickly moving from today’s approximately 20% in the cloud to 80%. This is a once-in the digital era massive re-platforming of Global business.”

Current Price: $216     Price Target: $267

Position size: 4%          Performance since inception (3/11): +31%

Additional highlights:

·         While headwinds in some end markets persist, digital transformation imperative is long-term secular growth driver to their business. Before Covid there was already exponential technology change taking place with every business becoming a digital business. Mgmt. thought it would take a decade, now they think it is more like five years. “We are rapidly moving to a complete re-platforming of global business… it is hugely significant.” Accenture has been positioning themselves to be a leader in digital capabilities since 2014, which is why they are the leader, continue taking share and are well positioned in the future, despite “this incredibly difficult challenging macro environment.” Accenture’s unique positioning of trusted partner w/ leading edge technology expertise combined with deep industry expertise is key to this.

·         Industry end market performance – headwinds in some industries persist:

o   Similar to last quarter, ~50% of revenues came from 7 industries that were less impacted from the pandemic that, in aggregate, grew high-single-digits with continued double-digit growth in software platforms, Life Sciences & Public Service.

o   >20% of revenue from clients in highly impacted industries which continue to be pressured – this includes travel, retail, energy, aerospace & defense and industrials. Last quarter they called out banking/capital markets as a weak area, but this quarter they did not. While performance varies by group collectively declined mid-teens. This is an acceleration from last quarter when this group declined high-single-digits.

o   This underscores the benefit of diversified industry end markets.

·         Delivered full year revenues within guided range and EPS above guided range. For the full fiscal year adjusted earnings per share were $7.46, $0.03 above their adjusted guided range for the year.

·         Consulting revenues were $5.7B, down 8% in local currency, which includes a 3pt headwind from lower travel reimbursement.

·         Outsourcing revenues were $5.2B, up 7% in local currency.

·         Continued mix shift to “the new” – now 70% of revenue. Digital, cloud and security grew low single digits.

·         Geographic breakdown: strongest markets were Japan (double digit growth) and Brazil (high single digit growth). Europe was down 5% (Italy strong, UK weak), North America was flat.

·         Large client tailwind – Ended FY20 with 216 Diamond clients (represents their largest client relationships) – an increase of 15 clients from 2019. Diamond clients account for more the 50% of revs.

·         In Q4, they had 17 clients w/ new bookings of over $100m. For example, Accenture and Microsoft entered into a five-year strategic agreement with Halliburton to advance their digital capabilities, complete its move to cloud-based digital platforms and migrate all of its physical data centers to Azure.

·         Strong bookings of $14 billion, up 9% YoY with a book-to-bill of 1.3. Consulting book-to-bill of 1.1 and outsourcing book-to-bill of 1.5. Bookings dominated by high demand for digital cloud and security-related services, which they estimate represented ~70% of new bookings in the quarter.

·         Capital allocation: continuing all elements of their capital allocation program – they continues to return cash to shareholders through cash dividends and share repurchases. In fiscal 2020, they returned $5B to shareholders, including $2B in dividends and $3B in share repurchases.

·         They are now 45% women; on track for their 2025 goal of a 50-50 gender balance

·         Guidance:

o   For FY 21, they expect revenue to be in the range of 2% to 5% growth. This includes a 1pt hit from lower travel.

o   Expect diluted EPS in the range of $7.80 to $8.10 or +5% to +9%

o   FY21 FCF to be in the range of $5.7B to $6.2B

o   “We view fiscal year 21 as turning a page. We are no longer navigating a crisis we are facing a new reality and we plan on returning to pre-covid growth rates by the second half of this fiscal year.”

·         Valuation:

o   The stock is undervalued trading at a ~4.5% forward yield. They have an easily covered 1.6% dividend and no net debt.

o   Multiple underpinned by ACN being a best-in-class company with stable growth that’s buffered by geographic and end market diversity and long-standing client relationships (95 of their top 100 clients have been with them for >10 years).

o   They have $8.4B in cash on their balance sheet. The only debt they have on their balance sheet are capitalized leases, which were added last fiscal year due to an accounting change. Substantially all of their lease obligations are for office real estate.

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

$ACN.US

[tag ACN]

[category equity research]

Current Price:   $480                     Price Target: $520 (raised from $494)

Position Size:    3%                      TTM Performance: +63% since inception (3/18)

Key Takeaways:

·         Adobe beat highest estimates on revenue and EPS and guided in-line for Q4. Full year 2020 total revenue and EPS guidance are ahead of pre-pandemic targets.

·         Digital Media segment continues to be stronger than Digital Experience segment. Current environment is causing tailwinds for Digital Media as it benefits from the mission critical aspect of their creative and document cloud solutions in a remote work environment. While Digital Experience is seeing headwinds from a weak advertising market.

·         CEO Shantanu Narayen said…”Content creation and consumption are exploding in a world where connecting visually has become even more essential…our strategy of unleashing creativity for all, accelerating document productivity and powering digital businesses is more relevant than ever and driving our strong performance across every geography and audience.”

Additional Highlights:

·         ADBE reported 3Q total revenue growth of 14%. EPS was $2.57 vs. consensus $2.41. This compares to guidance of $3.15B and $2.40, respectively. Operating margin was 44%, up ~280bps vs. last year and above consensus of ~42%.

·         Some sequential improvement, but overall till seeing some headwinds w/ SMB’s.

·         “Students are adapting to learning remotely instead of in a classroom. Entire industries from media and entertainment to pharma, retail, automotive and financial services, have had to pivot overnight to digital operations to engage with customers and ensure business continuity. Electronic workflows and signatures are the only way to efficiently complete business transactions. The world has changed in a way that none of us could have foreseen. This reality has created new tailwinds for Adobe.”

·         Digital Media segment ($2.23B, +19% YoY; ~71% of revenue):

o   Comprised of Creative cloud (84% of segment revenue, +19% YoY) and Document Cloud (16% of segment revenue, +22% YoY).

o   Segment Annualized Recurring Revenue (“ARR”) grew to $9.6B exiting the quarter. With Creative ARR of ~$8.3 billion, and Document Cloud ARR of $1.3 billion.

o   Creative Cloud is benefiting from “exploding” content creation and consumption across phones, tables and desktops. “Web content, mobile application creation, imaging, video, animation, screen design, AR and 3D are all surging in this new era of digital storytelling and business transformation.”

o   Saw improvement in retention driven by increased engagement and product usage among individuals, teams and enterprises.

o   Document Cloud is key in the remote work environment as the imperative to translate paper processes to digital accelerates across the globe. Acrobat Mobile installs up 33% year-to-date; significant momentum with Adobe Sign. Key customer wins include Citi, PwC, Pepsi, HSBC, Merkle and J-Power.

·         Digital Experience segment (revenue was $838m, +2% YoY; ~29% of revenue):

o   Digital Experience subscription revenue was +7% or +14% YoY excluding ad cloud. Segment revenue includes: subscription revenue, professional services revenue, and “other”, which includes perpetual, OEM and support revenue.

o   Advertising Cloud revs were impacted by the global decline in ad spend and the discontinuation of a low-margin product which helped clients conduct advertising transactions.

o   Key customer wins include Eli Lilly, Truist, Nike, Lowe’s, Shell, Lloyds and the US Department of Commerce;

o   Started a partnership with IBM and Red Hat to enable Experience Cloud deployment in hybrid cloud environments that further strengthens real-time data security for enterprises in regulated industries

o   Recognition as a leader in six Gartner Magic Quadrant and Forrester Wave reports. In the Gartner Magic Quadrant for CRM Lead Management, Adobe was the leader, achieving the best scores across Ability to Execute and Completeness of Vision.

·         Guidance: Total revenue ~$3.35B w/ Digital Media segment revenue +18 percent YoY ($540m net new ARR) and flat Digital Experience segment revenue (subscription rev +1% YoY; +12% excluding Advertising Cloud). Adj. EPS ~$2.64. Overall, in line with the street and ahead of pre-pandemic full year targets.

·         Adobe is a rare company w/ >90% recurring revenue, double digit top line growth and ~40% FCF margins. Additionally, the headwinds from Covid (like lower global ad spending and weak SMB demand) should abate, while the accelerated secular tailwinds around digital transformation will persist.

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

$ADBE.US

[tag ADBE]

[category earnings]

Current Price:    $54                        Price Target: $70

Position Size:    3.5%                      TTM Performance: 3.5%

Key takeaways:

·         Revenue beat and EPS missed. Lower EPS was driven by a tax adjustment. They didn’t issue guidance for Q2, but top and bottom lines well exceeded internal plans.

·         Better than expected SSS aided by strong Home category sales – SSS for open-only stores were -3% w/ HomeGoods/HomeSense SSS at +20% and Marmaxx at -6%

·         Weakening trends at re-opened stores – they guided SSS trends for Q3 well below Q2, but low inventory levels (which should improve) are a big factor.

·         Seeing extremely plentiful inventory buying opportunities bodes well for the future.

·         Despite the Covid related headwinds they face right now, management’s tone on the call was extremely positive about long term outlook and positioning.

·         CEO Ernie Herrman said…”the way all of the retailers had to shut down, has resulted in tremendous pack-away opportunities which our merchants have really recently started taking advantage of…we have the utmost of confidence that as we go through this… given all the store closures we just think we are going to begin to take major market share.”

Additional Highlights:

·         Sales declined -31.8% YoY vs consensus of -33%, with “open-only” SSS of -3%.

·         2Q loss includes a significant negative impact from tax expense. The tax expense was primarily driven by a tax loss carry back benefit that was booked in Q1 and was reversed in 2Q due to their better than expected results.

·         For Q3, they are planning overall open-only SSS to be down -10% to -20%. This is in-line with the sales trends they’ve seen since the middle of July and through August month-to-date. This reflects lighter inventory, weaker foot traffic at Marmaxx and an anticipated slower back-to-school selling season. Initial re-opening trends benefited from pent-up demand and, to some degree, from stimulus, but trends weakened in large part to lower inventory.

·         Lighter inventory negatively impacting SSS trends…this is a short-term issue

o   Lower inventory is Covid related and not related to lack of inventory availability. Inventory issue exacerbated by stronger than expected sales in 2Q as it created a need to replenish store inventories faster than anticipated.

o   Seeing extremely plentiful inventory buying opportunities which should benefit them in future quarters. Seeing new vendors across all categories reach out to do business w/ them.

o   Covid is causing logistical bottlenecks in inventory flowing to stores due to supply chain and logistics challenges with some third-party affiliates.

o   Vendors and transportation providers ramping their businesses back up caused some logistical delays with merchandise arriving to distribution centers. 

o   As retailers stopped ordering and Covid shut down manufacturing, the flow of goods was disrupted which had prevented them from chasing hot categories the way they normally would. This should be a short-term issue w/ inventory in “hot” categories continuing to improve as manufacturing resumes.

o   They also lowered store inventory to promote social distancing with wider aisle spacing and fewer racks.

o   The inventory they do have is turning quickly which is a positive sign.

·         Traffic at Marmaxx is weak – This is also weighing on SSS trends. Covid is causing lower foot traffic as some customers are still not comfortable coming to stores. However the customers that are coming are buying and basket sizes are up. States where there have been a second wave are negatively impacting traffic trends. As traffic slowly normalizes and inventory improves, they are well positioned.

·         Adjusting inventories to align w/ current category demand trends…

o   Home is extremely strong. Shifting more inventory to home.

o   Apparel trends shifting as people are not buying business clothes. They are working to adjust their inventory to these category trends.

o   They are pivoting to “hot categories” – this has always been one of TJXs advantages. Centralized merchandising combined with high turns and constantly flowing goods to stores allows them to be nimble with inventory and respond to current trends. This has been a key part of their ability to drive LT positive SSS trends for decades. Covid has disrupted this, as discussed above, but this should be a short-term issue.

·         Merchandise margins were strong as markdowns were significantly lower than anticipated due to the greater than expected demand.

·         Nearly all stores worldwide open for business by the end of June as expected. Stores were only open a little more than two-thirds of the second quarter.

·         As competitors close stores confident they can capitalize on real estate opportunities and continue to take share.

·         No guidance other than SSS.

·         Dividend still halted, but committed to resuming.

·         Valuation: Balance sheet remains strong. The stock has recovered from troughs and is now down ~10% YTD. Valuation reasonable at >4% FCF yield on 2019.

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

$TJX.US

[tag TJX]

[category earnings]