Author: Sarah Kanwal

Current Price:    $203                      Price Target: $224

Position Size:    7.6%                      TTM Performance: 52%

 

Key takeaways:

·         MSFT beat on revenue and EPS. Total revenue growth was +13% on a constant currency basis.

·         Couple negatives in the quarter. Azure revenue was slightly below expectations…+47% growth vs +49% expected.

Currency was a drag – constant currency, Azure was up 50%. Also guidance was a little below expectations w/ SMB spending a key weak area. But long-term drivers and positioning still very strong.

·         Cloud strength continues to be a key theme – commercial cloud surpassed $50 billion in annual revenue, +36% YoY.

·         Satya Nadella said, “The last five months have made it clear that tech intensity is the key to business resilience. Organizations that build their own digital capability will recover faster and emerge from this crisis stronger”…” over the next decade technology spending as a percentage of GDP is projected to double and we are well-positioned to participate in that growth by innovating and defining the key technologies that empower every person and every organization on the planet to build more of their own tech intensity.”

 

Additional Highlights:

·         “We are seeing businesses accelerate the digitization of every part of their operations from manufacturing to sales and customer service to reimagine how they meet customer needs from curbside pickup and contactless shopping in retail to telemedicine in healthcare. That’s why we are building the full modern technology stack powered by cloud and AI and underpinned by security and compliance to help every organization digitally transform.”

·         Strength in cloud but some offset w/ slowdown in transactional licensing especially in SMB and LinkedIn ad spending. This is consistent w/ trends they called out in the last few weeks of the last quarter.

·         As previously announced, they closed their ~80 retail stores. $450m charge related to this.

·         Productivity and Business Processes ($11.8B) +8% YoY cc:

o   Cloud usage and demand increased as customers continued to work and learn from home. Transactional license purchasing continued to slow, particularly in small and medium businesses, and LinkedIn was negatively impacted by the weak job market and reductions in advertising spend.

o   Strength especially w/ Office 365 Commercial (up 22%), Dynamics 365 (up 40%).

o   LinkedIn slowed from up 22% last Q to up 11%. Less hiring is weighing on this. Office 365 now has 258 million paid seats.

o   Dynamics 365 is helping organizations in every industry digitize their end-to-end business operations from sales and customer service to supply chain management. BNY Mellon chose Dynamics 365 this quarter to help investment managers build stronger relations with their customers. FedEx uses Dynamics 365 to drive more precise logistics and inventory management. In retail, “Dynamics 365 Connected Store” now offers in-store traffic analytics and curbside pickup prioritizing safety as stores reopen

o   Teams product is really shining for them right now. Accelerating Teams innovation, adding new capabilities. Deeper integration between Teams and Power Platform brings faster application creation and deployment.  Expanding Teams beyond the workplace making it easy to add personnel Teams account on mobile.

o   Teams is not just about having lots and lots of video meetings. Teams is about actually getting work done where meetings and video is one part. The utility of it will only increase w/ mixed office and WFH environment in the future.

o   LinkedIn continues to see record engagement despite revenue headwinds due to lower hiring needs. Now at 706m professionals. Content shared was nearly — up nearly 50%. Professionals watched nearly 4x the amount of LinkedIn Learning content in June than they did a year ago.

·         Intelligent Cloud ($13B) +19% YoY cc:

o   Cloud usage and demand increased as customers continued to work and learn from home.

o   Server products and cloud services revenue increased 21% with Azure revenue growth of 50% driven by continued strong growth in their consumption-based business.

o   With Azure they have more data center regions than any other cloud provider. This quarter, they announced new regions in Italy, New Zealand and Poland…last quarter they added Mexico and Spain.

o   In FY ’20 closed a record number of multimillion-dollar commercial cloud agreements with material growth in the number of $10 million-plus Azure contracts.

o   Enterprise Services revenue increased 2% constant currency.

·         More Personal Computing ($12.9B) +16% YoY cc:

o   Windows OEM, Surface, and Gaming benefited from increased demand to support “work, play, and learn-from-home” scenarios, while Search was negatively impacted by reductions in advertising spend. Seeing headwinds from SMB spending.

o   Strength in Xbox and Surface. Xbox content and services revenue increased 65% (up 68% in constant currency. Surface revenue increased 28% (up 30%in constant currency)

o   “A breakthrough quarter for Gaming”…they saw record engagement and monetization led by strength on and off console as “people everywhere turn to gaming to connect, socialize and play with others.” Xbox Game Pass is seeing record subscriber growth.

o   Windows OEM revenue increased 7%.

o   Search ad rev ex-TAC down 17%

o   Windows Commercial products and cloud services revenue increased 11%

·         Commercial Cloud ($14.3B, +32% YoY ($50B full year, +36% YoY))

o   “Commercial cloud” aggregates the cloud businesses w/in the first two segments: Office 365, Azure, the commercial portion of LinkedIn, Dynamics 365.

o   Gross margin percentage increased 1 point YoY on improvement in Azure gross margins.

o   COVID-19 has accelerated the urgent need for every business to create no-code, low-code apps. This is small for them, but important in terms of strategic positioning and future growth. The Power Platform enables non-technical employees to analyze data and create apps/workflows without coding knowledge. For example, companies like Schlumberger and T-Mobile are using Power Platform to address challenges created by COVID-19. Power BI is the clear leader in business intelligence in the cloud and is growing significantly faster than competition, 96% of the Fortune 500 now use Power BI to find insights in their data.

Valuation:

·         FCF was $14 billion, up 16%. They returned $9B to shareholders w/ $5B in share repurchases and $4B in dividends an increase of 16% vs Q419.

·         Recurring revenue is ~60% of total, underpins most of their valuation and is resilient and poised for additional growth. Particularly Azure, Office 365 and Dynamics 365.

·         Stock is getting more expensive, trading at <3% FCF yield on next year.

 

 

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

 

 

$MSFT.US

[category earnings ]

[tag MSFT]

 

Sharing some interesting stats and charts on how the U.S. economy is recovering from coronavirus… for restaurants, hotels and airlines overall negative but improving. For housing, stats point to a supply/demand picture that should support pricing (good news for our housing related names SHW, HD, BKI).

 

·         Restaurants: Opentable restaurant bookings are down 60% YoY. Opentable is also saying 25% of restaurants will close in the US.

·         Yelp says 41% of businesses listed on their site that have closed due to Covid will not re-open. Retail and restaurants are hardest hit.  

·         Hotels:

o   US Occupancy: 43.9% (-41.8% YoY).

o   US Average daily rate (ADR): US$92.20 (-31.7% YoY)

o   US Revenue per available room (RevPAR): US$40.48 (-60.3% YoY)

o   The Top 25 Markets showed lower occupancy (38.4%) than the national average. Highest are Virginia Beach (54%), Tampa/St. Petersburg, Florida (49.4%); Phoenix, Arizona (48.3%); and Detroit, Michigan (46.2%). Boston was among the lowest at 26%.

o   STR’s senior VP of lodging insights: “Demand continues to be pushed upward by drive-to spots and the destinations with outdoor offerings such as beaches.”

·         Airlines: As of 6/24, TSA reported 494,826 daily travelers going through airport security checkpoints which is down ~80% compared to 2,594,661 last year (TSA). This is up ~450% from the worst week reported since the crisis (4/12) of 90k daily passengers which was down 96% YoY.

·         Housing: Positive housing stats point to a supply/demand picture that should support pricing…

o   Mortgage applications for buying a single-family home are now up 21% compared to last year as mortgage rates drop to record lows. (Mortgage Bankers Association)

o   The median existing-home price in May was $284K, up 2.3% from May 2019, as prices increased in every region. May’s national price increase marks 99 straight months of YoY gains. (National Association of Realtors)

o   Total housing inventory at the end of May totaled 1.55 million units, up 6.2% from April, and down 18.8% YoY.

o   According to the NAR’s chief economist: ““New home construction needs to robustly ramp up in order to meet rising housing demand. Otherwise, home prices will rise too fast and hinder first-time buyers, even at a time of record-low mortgage rates.”

·         And one measure of overall activity that is kind of interesting…according to Apple, driving and walking directions are up while transit remains way down. The data is available on their site by different geographies… https://www.apple.com/covid19/mobility

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

$BKI.US

[tag BKI]

$SHW.US

[tag SHW]

$HD.US

[tag HD]

[category equity research]

 

 

Some updates on Apple related to their Worldwide Developer Conference (WWDC) which started yesterday and on recent antitrust news. Yesterday, at their annual Worldwide Developer Conference (WWDC) Apple confirmed the transition of Macs to in-house designed chips w/ ARM based architecture from Intel x86 chips. This was not a surprise – it had been rumored as I indicated in my email attached below. The first Macs based on Apple’s custom silicon should be shipping later this year. The transition will cut costs (~$2.5B), but more importantly, enhances their competitive advantage as they continue their efforts to own and control the primary technologies behind the products that they make. Part of what differentiates Apple is they design their own silicon for the processor chips that are the brains of their iPhones and iPads (…and now for their Macs), which gives them better control over performance and feature integration in their devices (discussed further in previous email below). They also announced a slew of additional product updates that the WSJ nicely summarizes in a video linked below if anyone is interested.

 

https://www.wsj.com/video/series/joanna-stern-personal-technology/ios-14-ipados-macos-big-sur-watchos-7-changes-coming-to-apple-devices/F05EA2C1-34A9-4BB6-BF74-1F9D3A134D98

 

On the antitrust front, Apple has had several recent developments. The risk around antitrust action is rising, but I expect the outcome to be manageable. This was not part of WWDC, though it is very relevant for the developer community (which are the key attendees of WWDC) as the issues primarily relate to fees charged in the App store. The App store relies on 3^rd party developers to write software (Apps) which is a key ingredient to Apple’s thriving ecosystem. Recent antitrust related developments include an incident relating to an email App called “Hey” that’s owned by Basecamp, and was rejected from the App store b/c it was set up to charge for its fees outside of the App store, thus circumventing Apple’s cut. This issue is ongoing and getting lots of attention from developers. Then the EU announced an investigation of Apple’s App store – this could take some time to play out. Finally, the Justice Department’s yearlong investigation into the competitive practices of digital platforms (GOOG, FB, AMZN, AAPL) is set to wrap up in July w/ the CEO’s testifying in front of Congress. Last week the Chair of the House Antitrust Committee, David Cicilline, gave a rather foreboding interview which suggests the outcome of the investigation will include a recommendation for changes to Apple’s App store.

 

As a backdrop, Apple charges a 15-30% (mostly 30%) cut of transactions made through the App store. The App store facilitates a lot of commerce – $519B to be exact – and for most of this Apple gets no cut. For example, they earn a cut on selling an App like “Goodnote” but don’t earn a fee on each Uber ride. Apple has said that 84% of Apps do not share revenue. Apple commissioned a study from the Analysis Group which they released last week which broke down the $519B:

 

·         $413 billion from physical goods and services, including $268 billion through retail apps, $57 billion through travel apps, $40 billion through ride-hailing apps, and $31 billion through food delivery apps.

·         $61 billion from digital goods and services.

·         $41 billion from in-app advertising.

 

To put this in perspective, Apple reported in 2019 that it paid ~$35B to developers. Grossing that up for Apple’s ~30% fee suggests ~$50B in sales through the App store where Apple earns a share – so Apple made ~$15B. Comparatively small relative to the $519B from Apple’s commissioned report – so, presumably, a key part of Apple’s argument will rely on the small percentage (<3%) they get of the full amount of commerce conducted through their App store. I do think the potential for antitrust action against Apple is mounting, but my view at this point is that I don’t think the outcome will be severely damaging to Apple. While it is unclear how this will play out, most importantly, Apple needs the developers and the developers need Apple. The level of fees seem to be the crux of the issue…30% is too high… the result might be some combination of lower fees and less stringent rules.

 

In terms of potential economic impact to Apple, their total Services revenue in 2019 was $46B (~18% of revenue) and is dominated by these App store fees and traffic acquisition costs (TAC) paid to them from Google (Google pays to be the default search engine). Given the above calculation, fees from the App store were close to 33% of that $46B (or less than 6% of total revenue) and TAC was another 26% (~4.5% of total revenue). The rest of Services revenue is from Apple Pay, Apple Music, Apple Care, iCloud etc. If Apple had a business model of “giving away” their hardware to make money on Services, this would be a problem. Services margins are in fact much higher, about double their hardware margins (64% vs 32%), but they do make most of their profit on their hardware.  So the App store contributes somewhere between ~10-12% of total gross profit and Products/hardware still contribute 70% (other services contribute the rest). While growth of their high margin Services business is a key part of the story, App store purchases are only one piece of that and that growth is also driven by a growing installed base and increasing relevancy of their devices driven by new applications. The installed base grows w/ greater iPhone penetration (lower priced and used phones help with this) and new types of devices like wearables. And the utility of new applications evolve w/ new technologies like 5G, AI, augmented reality, virtual reality etc. While lower fees would obviously be a hit to them, I think it would be manageable…and the counter argument is that it could spur more innovation and better Apps as the economics to the developers improve.

 

 

 

 

Sending an update on Apple regarding headlines today that they are planning to start selling Mac computers with Apple’s own main processors by next year. The chips likely would be in one laptop model, then extend beyond that. This would mean transitioning away from their current supplier Intel (Apple is ~9% of Intel’s sales). Taiwan Semiconductor (TSMC), Apple’s partner for iPhone and iPad processors, would build the new Mac chips. The potential for Apple to do this has been rumored/expected for a while. This isn’t about saving money (though it would), it’s about differentiating themselves and enhancing their competitive advantage…and is very much aligned with what Tim Cook said over a decade ago when he was COO, “we believe that we need to own and control the primary technologies behind the products that we make.” Part of what differentiates Apple is they design their own silicon for the processor chips that are the brains of their iPhones and iPads (…and now potentially for their Macs), which gives them better control over performance and feature integration in their devices. The cutting edge for them right now is their A13 bionic which TSMC (one of the few major semiconductor foundries) makes for them and is custom built on top of licensed ARM architecture (which underpins most mobile devices). Notably, this would further push ARM (owned by Softbank) architectures beyond mobile (where it dominates), to laptop/desktop (where Intel’s x86 architecture dominates) and some suggest could ultimately pose a threat to Intel’s data center business (e.g. chips in servers). For Apple, the advantage in doing this is that their silicon is unique to them and tailored for their operating system, iOS. This has proven to give them an advantage with the way they design their phones and an advantage with developers. Android and iOS basically have a duopoly in mobile operating systems…generally any smartphone that’s not an iPhone is running an Android operating system, which Alphabet gives away. That gives Apple about 15% operating system market share and Android about 85%, however that is split up across devices/brands. The fact that Alphabet’s mobile operating system is so fragmented (and that users are often not using the same/latest version) makes app development more complex, costly and time consuming. Moreover, Apple, which dominates the high-end smartphone market, has a wealthier installed base for developers to target. The app store is fueled by third-party app developers. Easier to develop apps and a target rich audience leads to a greater number of higher quality iOS apps created by these developers for iPhone owners to download, with a better user experience. This is great for Apple b/c they make a % of revenue from Apps sold through their App store. This latest potential development should build on this advantage. They would have Macs, iPhones and iPads running the same underlying technology which should make it easier for Apple to unify its apps ecosystem, including allowing iPhone and iPad apps to run on Macs. This advantage gets more and more important as computing power in phones increases, 5G delivers better connectivity and, as a result, we have the ability to use mobile phones in enhanced ways….like apps that take advantage of augmented reality and IoT related technologies. 4G enabled advances like Uber. 5G is a step function change from this. Along this same theme, last year Apple acquired Intel’s cellular modem business for ~$1B. These are the chips that connect smartphones to the internet. They had been using QCOM for these chips, then they shifted to Intel as AAPL/QCOM were embroiled in a lawsuit. That has been settled and now Apple is again using Qualcomm’s chips. But the long-term goal here is for Apple to make these chips themselves, furthering their goal of controlling the primary technologies behind their products…and moving away from suppliers like Intel and Qualcomm. All of this is aimed at cementing Apple’s technology and ecosystem advantage which is Apple’s moat and drives their massive installed base. This can be seen by the fact that despite only having about 15% of the global smartphone market, Apple earns almost all of the industry profits b/c they have a differentiated, proprietary product/ecosystem, while Android based OEMs don’t own the silicon and software.

 

 

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

 

 

$AAPL.US

[tag AAPL]

[category equity research]

 

Hi All – We have put together some big picture data points to help put in perspective the market recovery. This is not a call on where the market is headed, but hopefully these points can be helpful in framing discussions with clients. We’ve used revenue data for a couple reasons. First, profit numbers can be “noisier” with write-downs, mark to market accounting, pension contributions etc. and profits may go negative making % changes not meaningful especially when looking at aggregated data. Second, in thinking about whether consensus reflects a “V” shaped recovery, revenue seems to make the most sense to look at because it represents demand, whereas profits represent differences in operating leverage across companies, cost cutting decisions which vary by company, cuts to capex, etc.

 

1.       Narrow breadth is a big factor driving the market. Growth is being disproportionately driven by a small number of companies.

a.       The top 42 weighted companies in the S&P account for ~50% of the index.

b.      Based on consensus, the S&P is expected to see almost 9% weighted avg. revenue growth in 2021 vs 2019 baseline.

c.       Those top 42 weighted companies are expected to contribute ~80% of that 9% weighted avg. revenue growth in 2021 vs 2019 baseline. So they are expected to contribute 7pts of growth while the rest (or >90% of constituents) collectively contribute 2pts.

d.      Since Covid hit in the US on Feb 19, the S&P is down 7.4%. The 11 top contributors to the S&P since then make up 20% of the S&P and contributed almost 3% to performance.  

2.       Does consensus reflect a “V” shaped recovery? Not for many of the hardest hit stocks…which is a lot of companies, but a small part of the S&P.

a.       Not recovered in 2021: ~44% of constituents (~24% of the weight in the S&P) are expected to have revenue in 2021 that is still below 2019 baseline. These companies represented a 6.5% drag on S&P performance since Covid hit. The top 11 contributors offset >40% of this.

b.      Hardest hit: ~32% of S&P constituents (17% of the weight) are expected to have revenue in 2021 that is more than 5% below 2019.

c.       Multiyear recovery: ~29% of S&P constituents (15% of the weight) are expected to report revenue in 2022 that is still below 2019.

3.       Our portfolio is well positioned.

a.       Not recovered in 2021: only ~22% of our names (18% of the weight). Excludes STZ b/c of divestment.

b.      Hardest hit: ~16% of our names (11% of the weight) are expected to have 2021 revenue that is more than 5% below 2019 baseline.

c.       Multiyear recovery: ~6% of the weight and 3 names (BAC, SCHW, BKNG). For BKNG a recovery to baseline is not expected until 2023. However, using consensus numbers for a DCF valuation implies meaningful upside. That suggests the stock is discounting an even worse outcome.

d.      Proportionately, our names have seen less of a hit and are expected to recover quicker and are more profitable, higher ROIC and trading at a higher FCF yield than the S&P.

 

Conclusion: Based on consensus numbers the bounce in the market seems to be driven more by narrow breath than a broad assumption of a “V” shaped recovery. Many of the hardest hit S&P companies are expected to see an impact beyond 2021. The caveat to that is that drawing a connection between consensus expectations and market action is limited by the fact that the market is not just driven by street expectations (it’s only a piece) – this is generally true but especially so now when there is so much uncertainty related to Covid and its continued impact on the economy. Additionally, it’s not possible to delineate on an aggregate level to what extent consensus numbers indicate continued impact of the virus or a recession or both, because both circumstances tend to impact similar industries like auto, retail, travel and restaurants.  Finally, many of the names benefiting from Covid tailwinds make up a large percentage of the S&P which overwhelms the impact of the hardest hit companies.

 

Thanks,

The Research Team

 

 

 

 

 

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

 

 

Current Price:   $399                     Price Target: $458 (raised from $368)

Position Size:    2.7%                     TTM Performance: +35% since inception (3/18)

 

Key Takeaways:

·         Adobe beat on EPS with adj. EPS of $2.45 vs. estimate of $2.34 (range $2.29 to $2.37). 2Q revenue was $3.13 billion, +14% YoY. This was slightly below estimate $3.16B (range $2.97B to $3.19B).

·         Not immune to Covid impact, but seeing some remote working tailwinds. Covid led to weakness in their Digital Experience segment (26% of revenue, +5% YoY), while their Digital Media segment (74% of revenue, +18% YoY) saw record Q2 results.

·         Digital Experience results were weighed down by a weak advertising market, while Digital Media benefited from the mission critical aspect of their creative and document cloud solutions in a remote work environment.

·         CEO Shantanu Narayen said…”Despite the short-term challenges, the mandate to digitally transform has taken on heightened urgency”…this “tectonic shift towards ‘all things digital’ across all customer segments globally will serve as a tailwind to our growth initiatives as we emerge from this crisis.”

 

Additional Highlights:

·         Subscription revenue at 92% of total revenue for the quarter (up from 90% in 2Q19).

·         Non-GAAP operating margin was 42.7%, +440bps vs. last year, and above consensus of ~41%.

·         Like other companies, mgmt. specifically talked about demand weakness with small and mid-sized businesses as a result of the pandemic.

·         “While it was difficult to imagine only conducting business with CMOs and CIOs virtually, a side benefit of everyone working at home is that we are able to schedule and engage with far more customers across multiple continents. In all these discussions with business leaders it is clear that investments in digital and specifically customer experience are more important than ever.”

·         Digital Media segment ($2.23B, +18% YoY; ~71% of revenue):

o   Comprised of Creative cloud (84% of segment revenue, +17% YoY) and Document Cloud (16% of segment revenue, +22% YoY).

o   Segment Annualized Recurring Revenue (“ARR”) grew to $9.2B exiting the quarter. With Creative ARR of ~$8 billion, and Document Cloud ARR of $1.2 billion.

o   Document Cloud is key in the remote work environment as the imperative to translate paper processes to digital accelerates across the globe.

o   They saw a surge in demand for digital documents, with use of web-based PDF services up nearly 40% QoQ and the number of documents shared in Acrobat increasing 50% YoY.

o   Adobe Sign (their cloud-based electronic signature solution) usage increased 175% since the start of their fiscal year. Mobile usage exploded with Acrobat Reader  – installations increased 43% YoY and Adobe Scan installations increased 66%.

·         Digital Experience segment (revenue was $826m, +5% YoY; ~29% of revenue):

o   Digital Experience subscription revenue was $707m, +8% YoY growth. Segment revenue includes: subscription revenue (which includes revenues from Advertising Cloud), Professional services revenue, and “other”, which includes perpetual, OEM and support revenue. Excluding Advertising Cloud revenue, subscription grew 18% YoY.

o   As they outlined on their last earnings call, they anticipated delays in enterprise bookings as companies prioritized employee and financial well-being. In particular, they saw an impact w/ small and medium sized businesses.

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 in the quarter included IBM, Walgreens, Safeway, Astellas Pharma, and Allianz.

·         Guidance: Total revenue ~$3.15B w/ Digital Media segment revenue +16 percent YoY ($344m net new ARR) and flat Digital Experience segment revenue (subscription rev +5% YoY; +14% excluding Advertising Cloud). Adj. EPS ~$2.40. Overall, despite being below the street, Q3 guidance was re-assuring – some estimates were stale and Digital Media ARR guidance of ~$340M was better than expected. Similar to most companies, they withdrew full year guidance.

·         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.

$ADBE.US

[tag ADBE]

[category earnings]

 

 

 

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

 

 

Sharing some quotes from earnings calls from some non-Focus Equity names. Thought these quotes would be interesting to share as they tie into some of the recent Q1 themes we’ve discussed…

 

 

Shopify (SHOP), cloud based platform that helps merchants create online storefronts

Theme: Rising e-commerce competition

COO, Harley Finkelstein said, “It has become increasingly important for merchants of all sizes to sell online and to have better options for getting their goods to buyers…we’re helping, getting more large merchants online in our core geographies faster… and I have to tell you on a personal level, these are brands that I’ve been after for years to join Shopify and join Shopify Plus that told me that eventually they will do it. They are now doing it. And so, in many ways, what the situation is doing is it’s accelerating the catalyst for people to move from wholesale businesses to direct consumer businesses and move from businesses that traditionally were only brick and mortar to being more in a brick and click sort of model. So pleased to see that and we think that will continue.

 

Regency Centers (REG), Retail REIT

Theme: Rising e-commerce competition

CEO, Lisa Palmer said, “the part of retail real estate that we operate in, I think it’s best positioned. Whatever that post-pandemic world looks like, I like the fact that we are close to neighborhoods and that we have grocery-anchored shopping centers and the quality of our real estate. It’s something that was true pre-COVID, and it’s certainly going to be, I think, even more true post-COVID as retailers continue to focus on having physical presence, which I think they still need. And if anything — and perhaps this is highlighted, some of the difficulties in the cost of delivering picking up. And that physical presence really is going to be critical as part of their overall strategy. And being close to the customer and having the best locations is going to be of critical importance to them.”

 

Zillow (ZG), E-commerce real estate platform

Theme: Strength in housing/home improvement

CEO, Rich Barton said, “According to MIT about half the U.S. workforce is now working from home. And they’re not just working from home, they’re teaching their kids, feeding each meal, conducting their social lives all from home. But they are dreaming about an extra room for an office, a bigger yard or less dense neighborhood or for many of you may be a new second home, there is evidence that the experience has uncorked new aspirations and hopes of what home can be and needs to be…. Amid the jolting stories of lives, jobs and business lost, we are grateful to be able to share not just strong Q1 results, but evidence of the housing markets resilience and an encouraging readiness, perhaps pent up restlessness among people who are shopping on Zillow… We have seen all our metrics bounce off the bottom. Some metrics at the top of the funnel like visits have more than fully recovered and are up double-digit percentages year-over-year, indicating to us even higher demand to move or at least fantasize about moving than before.”

 

 

 

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

 

 

$SHOP.US

[tag SHOP]

$REG.US

[tag REG]

$ZG.US

[tag ZG]

[category equity research]

 

Current Price:    $54                        Price Target: $70

Position Size:    3.5%                      TTM Performance: 3.5%

 

Key takeaways:

·         Revenue missed at $4.41B, -52% YoY. However, consensus number not that meaningful as the range of estimates was incredibly wide w/ some seemingly not updated.

·         Prior to the pandemic, SSS trends were strong.

·         They have begun re-opening stores (1600 so far) and say most stores could be re-opened by the end of June.

·         Strong re-openings. Stores that have opened have seen increased volumes YoY.

·         Seeing plentiful off-price buying opportunities

·         Committed to resuming dividend payments

·         No guidance

 

Additional Highlights:

 

·         Pre-virus trends: February SSS were +5% driven by higher traffic. All 4 major divisions had a February comp increase of 5% or better. Strong comp trend continued into the first week of March

·         Virus response: They closed stores in all nine countries and their online shopping sites as well as their distribution centers, and offices around the world. On April 11 they temporarily furloughed the majority of their hourly store and distribution center associates in the US and Canada and took comparable actions with parts of their workforce in Europe and Australia. They started out w/ a strong balance sheet, but took additional steps to maintain their liquidity and flexibility – they halted their dividend, drew down $1B of their credit facility and raised $4B in debt at the end of March. They don’t expect to issue a dividend in Q2 either, but remain committed to their dividend long-term.

·         Rent: they paid most of their rent through April. However, they have worked with many of their landlords and negotiated deferral of some of their April rent and a meaningful portion of their 2Q rent payments, until later dates.

·         Re-openings: they have reopened >1600 stores worldwide (of their >4500 stores). Stores in mainland Europe including Germany, Poland, Austria, and the Netherlands are open and stores in Australia are open. In the US, they’ve fully or partially reopened in 25 states.

o   “for the 1,100 plus stores that have been open for at least a week, sales overall have been above last year across all states and countries where we are open.”

o   “In our early results, we are seeing very strong demand at HomeGoods and in our home categories across all of our banners.”

o   “in this environment, we believe more consumers may discover our e-commerce sites, which could also drive additional visits to our stores as historically the vast majority of returns from our online sites have gone to our stores.”

·         Inventory: The marketplace is loaded with inventory which is an opportunity for them. They are taking markdowns on seasonal stuff, to clear through some of their own inventory. But they stand to benefit as they can be opportunistic in the current environment for goods that they can flow into stores now and goods that they can packaway. The inventory situation broadly is unprecedented. In fact it’s causing vendors to pack-away some inventory for next year as some inventory in the channel never even made it to stores. This is a new dynamic given how severe the situation is and bodes watching going forward.

·         Valuation: 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]

 

Key Takeaways:

·         HD reported strong Q1 results, beating on revenue but missing on EPS due to elevated costs related to COVID-19.

·         Strong SSS for the quarter (+6.4%), with “significant acceleration” to double-digit SSS at the end of April into May. This included self-imposed limits on foot traffic, adjusted store hours and halted non-essential install services (“several points of SSS impact in the quarter”).

·         Omni-channel strategy shines. E-Commerce sales were 15% of sales in the quarter, up+80% YoY, with >60% of online sales picked up in store. Their e-commerce sales accelerate to triple-digit growth by the end of April.

 

Additional Highlights:

·         Elevated opex (benefits/wages) used to support employees during the pandemic. HD made a series of adjustments to support associates including improving benefits, eliminating co-pays, increasing overtime wages and expanded paid time off for all hourly associates. This eroded margins in the quarter, but they should see improvement – excluding the increased benefits margins would have increased by 120 bps on strong expense control.  

·         Macro commentary: strong housing market heading into this. In normal, non-housing led recession, they would expect flat SSS.

·         Investments in omni-channel & distribution infrastructure were key in enabling them to grow in this environment

o   Online: As shelter-in-place orders were rolled out across the country in mid to late March, they saw their digital businesses accelerate from ~30% growth in early March to triple-digit growth by the end of April. Investments in their omni-channel strategy enabled them to support these record e-commerce orders and quickly shift to contactless curbside pickup.

o   SSS benefited from different fulfillment capabilities like buy online, pickup in store, and enhanced delivery capabilities, like flatbed truck, box truck and car and van service. Their BOPUS and deliver from store fulfillment options saw a triple-digit growth in the first quarter.

·         SSS Details:

o   For Q1 SSS were +6.4% vs street 4.3%. US SSS were +7.5%.

o   Positive comps of 9.3% in February, 7.1% in March and 4.2% in April. Comps in the US were positive 7.5% for the quarter, with positive comps of 9.7% in February, 7.5% in March and 6.4% in April. Those SSS include a 3 week period, just after shelter-in-place orders – the last week of March and the first two weeks of April – where they saw negative comps in most departments.

o   Prior to the outbreak, saw strong sales across the store with all departments showing mid-single to double-digit comps.

o   Ticket increased 11% and transactions decreased 4%, reflecting the lower traffic. Saw strong performance in big ticket categories like appliances and riding lawnmowers. This was offset by pressure in categories like special order kitchens, countertops and flooring, where they intentionally limited installation services in customers’ homes.

o   Not surprisingly, and related to the above point, DIY sales grew faster than Pro sales.

o   For the full quarter, they reported positive comps in 11 of their 14 merchandising departments.

o   Comps in kitchen and bath, flooring and millwork, departments with a heavy reliance on in-home installation were negative during the quarter.

·         No guidance. “Month-to-month and even week-to-week, we saw extreme ups and downs across different categories and geographies. As a result, we are cautious to extrapolate trends from the first quarter into a forecast for the remaining of the year, particularly given the tremendous amount of uncertainty we face with regards to the duration and continued impacts of the virus.”

·         ESG: I think a quote from the CEO on the call really captures one of HD’s advantages: their culture. Associates tend to be long-tenured and experienced which is an advantage in servicing Pro customers. They also often give data points about how many Executives started as store associates. This all hits at the relevance of “S” in ESG. He said, “This reminds me of the words of our Founder, Bernie Marcus, that have never resonated more deeply than they do today. If you take care of our associates, they take care of the customers and everything else takes care of itself.”

·         Capital allocation: suspended share repurchase, dividend maintained.

·         Valuation: Strong balance sheet, defensive qualities and trading 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

 

 

$HD.US

[tag HD]

[category earnings]

 

 

Key Takeaways:

·         Solid results and guidance: sales and EPS beat street expectations w/ results at the low end of guidance (which was issued pre-pandemic). Guidance for the next quarter is above the street – reassuring given most companies are not even issuing guidance.

·         The company is seeing tailwinds from certain aspects of the WFH environment, offsetting some diminishing order rates as Enterprise IT managers delay some investments.

·         Current environment highlighting the LT story: With the world going online practically overnight, the demand on networks has never been greater. Aging infrastructure needs to be upgraded. Growing use of new technologies and increased data demand places increased importance on this.

·         CEO Chuck Robbins said…”I have had a lot of customers who are not at the center of this crisis who realized during this pandemic that they have a fair amount of technical debt, and they have a lot of aged equipment. And so we don’t know what the time frame is, but many of them have said this is a wake-up call, and this is going to actually give us air cover to talk to our senior leadership team about upgrading and building out a more robust, modernized infrastructure.”

 

Additional Highlights:  

·         COVID Impact – Positives seem to be offsetting the negatives. Their business was performing ahead of its expectations through March, but began to see a slowdown in April w/ lockdowns. Despite this, the impact to Product orders was no worse than last quarter. So, coronavirus didn’t increase overall headwinds for them. This is b/c they are seeing some offsetting effects. Strength in Collaboration (especially Webex), Security, and the Service Provider business (CMTS and Routing) are offsetting softer Campus Networking sales (particularly in hard hit industries like hospitality, retail and transportation). They are mitigating the impact of some of these harder hit industries by extending credit. They announced $2.5B in financing, their “Business Resiliency Program” to support business continuity to help customers invest for recovery and defer most of the payments until early 2021. Also, they did have some supply chain disruption in the business – particularly the Infrastructure Platforms segment, but they didn’t quantify the impact on results.

·         Revenue by geography/customer segment – The Americas was flat, EMEA was down 4%, and APJC was down 22%. Total emerging markets were down 21%, with the BRICS plus Mexico down 29%. Public sector was up 1%, while enterprise was down 4%. Commercial was down 11%, and service provider was down 3%. “Commercial” is SMBs. So, SMB, Asia and Emerging Markets were weakest.

·         Tailwinds – remote work impact on security & collaboration demand, free WebEx 90 trials converting, improvement in Service Provider spending w/ increased network demands, growing strength w/ webscale customers, new 8K line of products moving from testing phase to implementation (not even benefiting webscale revenues yet), strength in software/service related revenues will continue to drive recurring revenue mix and margins.

·         Long-term picture: The initial phase of this has been companies focusing on business continuity as people rapidly moved to WFH. That transition had the effect of exposing weaknesses in technology infrastructure. So, the focus is starting to shift from immediate virus response to preparedness for the “new normal.” This includes a variety of technologies around digital transformation and infrastructure to support them. And things like big  data/machine-learning, and IoT will increase the demands on networks and thus increased investment by enterprises globally.

o   “We’re working very closely with higher education because you see in the news the discussion around whether students will be on campus in the fall. As one of the heads of one of the biggest systems in the United States told me, they used anything and everything they could to get students online back in March. And now they need to go step back and actually build the real, robust, long-term architecture that they need, and we’re working with them to do that.”

o   “I think telehealth is here finally. And I think that’s going to change forever. And I think that those — that industry will continue to work and build out a more robust architecture to support telehealth as opposed to what we put together as quickly as we could with them over the last few months.”

·         Valuation: trading at >7% FCF yield on 2020, and we’re partway through their fiscal 2020 fourth quarter. This is well below S&P average for a strong balance sheet, high FCF generative business w/ multiple data points supportive of improving top line growth and growing mix of recurring revenue. Moreover, their valuation is supported by a 3.3% dividend yield which they easily cover.

 

 

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

 

 

Key Takeaways:

·         Revenue was better than expected and EPS was worse, however throughout the quarter they saw a phased impact of COVID 19 in their results as it hit different geographies that I think made consensus numbers not that meaningful. In Q1, partial impact of the coronavirus led to significant decrease in bookings. Gross travel bookings decreased 50% and room nights decreased 43%, w/ ADRs down mid-teens. Given their Europe focus, they felt the impact sooner than the US. Newly booked room nights, which exclude the impact of cancellations were down over 60% YoY in March and down over 85% in April.

·         In response to the current environment they’ve halted stock buybacks, reduced costs including cutting marketing (their largest expense), had layoffs/furloughs and bolstered their liquidity position.

·         No guidance. They expect a significantly larger impact in Q2 relative to Q1.

·         CEO Glen Fogel said… “we are seeing some stability in our newly booked room night growth trends. We hope that this is the beginning of the road back to recovery, but it’s certainly too early to say with certainty”…” we believe that domestic travel will rebound sooner than international travel as we expect travelers to look to their home country or region first for safe travel options.”

Highlights:

·         Total revenues were down 19% and adj. EPS was $3.77, down 66%.

·         Revenue was less negatively impacted than room nights and gross bookings due to the fact that many cancellations were received in Q1 with the check-ins expected to occur in later quarters.

·         Preliminary April results: newly booked room nights in April were down over 85% YoY. Reported room nights were negative in April (and March) as cancellations outpaced new bookings. For April, they saw a meaningfully higher domestic mix in their business. Historically, domestic accommodation bookings represent about ~45% of their total business and if Western Europe is considered as one market, the historic mix increases to about 55%. In April, their domestic share increased to ~70% and for Western Europe the domestic mix increased >75%. They also saw a shift to alternative accommodations associated with longer-term bookings. Towards the end of April, they saw some very early indications that domestic travel was starting to return in certain markets where shelter-in-place rules were relaxed, including Greater China, South Korea, Vietnam and Germany. In the US, newly booked room nights declined less than the global average in April and they saw an improvement in domestic travel during – and those trends cannot be tied to a relaxation in shelter-in-place rules as those have only happened in a few states and in recent days. They say it is too early to think we’re witnessing anything like a broad rebound in travel especially as they’ve seen some countries like Singapore, where travel demand was less impacted than other places initially, relapse. They are now seeing significant travel demand decreases associated with new outbreaks.

·         Management says their assumption are that it will be likely be years, not quarters, before we witness a full recovery of global travel demand and that they expect travel to fully recover later than many other industries.

·         They do benefit from having a highly variable cost structure which they can toggle in periods like this.

·         Balance sheet: Q1 ending cash and investment balance was ~$9B. They did spend $1.3B on buybacks early in the quarter, but then halted buybacks once they recognized the growing impact of the pandemic. Subsequent to the end of the quarter they had a debt offering. Including that and a refund of a sizable Dutch tax prepayment, their cash is now at >$14B.

·         Valuation: The stock has recovered from trough valuation in March, but still inexpensive relative to 2019 FCF, trading at close to an 8% FCF yield on 2019.  

Thesis:

1. Booking is a leading global online travel agent. Their global supply advantage drives a virtuous cycle: supply drives increased traffic and bookings and in turn more supply.

2. BKNG has several competitive advantages relative to Online Travel Agent (OTA) peers:

·         Leading position in Europe is a structural advantage – market is highly fragmented and depends on OTAs for bookings

·         They operate largely on an agency basis which allows them to continue to grow their network and do so profitably

·         Strong position in China/South East Asia via Ctrip and Agoda

3. Booking’s addressable market is growing driven by:

1.) Alternative accommodations

2.) Increased penetration (growth of mobile/internet)

3.) Global growth of travel spend > GDP.

4. Their asset light “toll both” business model is characterized by high margins, low capital expenditures, and growing free cash flow. Free cash flow is expected to grow double digits over the next few years and I expect them to put this capital to good use via continued investment in their business and/or opportunistic returns of capital.

 

$BKNG.US

[tag BKNG]

[category earnings]

 

 

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