Author: Sarah Kanwal

Hilton’s CEO yesterday afternoon said they plan to close most of their hotels in major US cities and that global occupancy rates could fall to 10% to 15%. All the hotel operators are trading down dramatically today including HLT down 17%, MAR down 21%, CHH down 14%, and Hyatt down 14%. Executives from major hotel and casino companies met with President Trump yesterday as the hospitality industry is seeking $150B in emergency funding with most of that to cover lost wages for employees.

As of now, hoteliers say they are expecting a quick rebound. A new survey from the Lodging Industry Investment Council (the hotel industry’s preeminent think tank) released yesterday highlights that many expect a quick bounce back later in the year after the impact from the coronavirus pandemic settles. The LIIC survey shows 27% expect a full recovery in six months, while 48% anticipate “full normalization within six months to a year” and 75% expecting that within a year. 43% of LIIC anticipates issues with the Federal Government and/or State Governments potentially commandeering hotels for use in housing virus inflicted patients or other related purposes.

Sarah

Recommending we add ADBE to 2.5% and trim CSCO by 100bps. The proceeds from CSCO, along with the proceeds from Fairfax, will help fund the ADBE position. The rest will come from IVV.

Investment thesis on ADBE:

• Market leader with technology, switching cost and network effect driven moat.
• Benefiting from secular growth driven by digital transformation, device proliferation, rising content creation and evolving content mediums including voice, augmented reality and virtual reality.
• Recurring revenue (~90%) and diverse industry end markets provide resilience in a downturn.
• Capital light model with high FCF margins and ROIC. Secular growth plus modest operating leverage combined with share buybacks leads to strong long term value creation.

Reasons for trimming CSCO:

·         No change in log-term thesis. The rationale for trimming is that due to the changing environment, catalysts look to be longer term in nature than originally anticipated.

·         Long-term, Cisco stands to benefit from a product refresh cycle and evolving network demands that ultimately are driven by increasing data traffic. With rising data traffic, technologies are changing (cloud, 5G, IoT, WiFi 6, AI) and networks are becoming more complex – Cisco’s products help companies solve for that by helping them simplify, automate, and secure their infrastructure.

·         The difficult thing for Cisco right now is that these technologies are still early stages and still a looming benefit.  Before the outbreak of the coronavirus, they were facing some headwinds in IT spending which I think in the medium term may increase. It’s a chain reaction of technology changes/upgrades that leads to spending on CSCO’s products, which I think companies can put off for a period of time, but not indefinitely.

·         When we added to CSCO last fall, CSCO was unique in terms of its discount to intrinsic value…the opportunity set is changing.

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

$CSCO.US

[tag CSCO]

[category equity research]

$ADBE.US

[tag ADBE]

[category equity research]

Disney to Close Disneyland Park & Disney California Adventure

By Linly Lin

(Bloomberg)

Disneyland Park and Disney California Adventure will be closed from March 14 through the end of the month, after Disney reviewed the guidelines of the Governor of California’s executive order.

The Hotels of Disneyland Resort will remain open until Monday, March 16

Downtown Disney will remain open

There have been no reported cases of COVID-19 at Disneyland Resort

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

$DIS.US

[category equity research]

[tag DIS]

·         Yesterday Booking announced that it is withdrawing its previously announced 1Q 2020 financial guidance as a result of the worsening impact of the COVID-19 outbreak on travel demand. This is not a surprise given that their primary market is Europe and Italy has gone into lockdown since Booking gave guidance (of Q1 revenue down -9% to -5%).

·         From their press release:  “the situation has worsened and the negative impact on travel demand has increased since we provided guidance, in particular more broadly across Europe and in North America”…”while the full impact and duration of the COVID-19 outbreak is unknown at this time, we have been through travel disruptions in the past and expect that this disruption will ultimately be temporary.”

·         The sell-side has started lowering numbers. The most aggressive I have seen is from Cowen…

·         Scenario analysis: The current valuation I believe is discounting a very severe impact from the coronavirus. In the first box I put together a breakeven DCF to try to contextualize this. The point of the breakeven DCF is to try to figure out what numbers imply the stock is fairly valued. Below that is consensus…some sell-side analysts have updated numbers, others have not. But it gives a sense of what investors had been expecting in the out years. Assuming consumer behavior is not permanently changed and/or a prolonged recession, the implied numbers are quite low (their 5 yr. avg. FCF margin is 33%). The 2020 number is a little below Cowen’s assumption, and my numbers don’t imply the recovery that Cowen does (or that management suggests). Cowen assumes the hotel market gets back to 2019 baseline by 2022. The breakeven analysis assumes they still aren’t there by 2024 (BKNG did $15B in rev last year and $4.5B in FCF). Additionally, they have a strong balance sheet, and not a lot of op leverage (their biggest cost is ad spend which they can toggle down) so margins should hold up.

·         Given the bearishness of the breakeven DCF, from the perspective of upside/downside risk, the valuation is compelling. Booking is now at ~$62B market cap. If the environment returns to normal and they can do close to $6B in FCF in 2022 or 2023 and the stock returns to a 5-6% FCF yield, then it’s feasible to think the stock could be up 60-80% over that time period.

Here are some points that Cowen made about how their estimates could be better or worse than expected – I think these points are broadly applicable beyond BKNG…  

Why things may be worse than projected:

·         If containment/mitigation efforts are not successful, it is possible COVID-19 could create problematic outbreaks for multiple years.

·         The outbreak and knock-on effects of social distancing, including the shock to travel, oil, and numerous other industries, could lead to significant layoffs and a potentially severe and prolonged global recession.

·         It could take years to alleviate concerns over disease and the potential for extremely unpleasant and inconvenient travel-related quarantines.

Why things may be better than expected:

·         COVID-19, at least as of now (this could easily change), appears to have been well contained in China and Korea. Outbreaks in Europe and the US may follow a similar pattern.

·         Historically, travel has bounced back quickly from disasters and other disease scares.

·         The number of people actually affected by COVID-19, at present, remains only a tiny fraction of other common viruses like seasonal influenza, in terms of both confirmed infections and deaths.

·         The underlying economy, prior to the appearance of COVID-19, appeared to be very healthy.

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

$BKNG.US

[category equity research]

[tag BKNG]

Good morning – We are buying Accenture (ACN) in Focus Equity to 2.5%, using proceeds from IVV. Accenture is a leading global consulting, technology and outsourcing services firm with over 500K employees.

Investment Thesis:

• Market leader uniquely positioned to benefit from secular growth driven by evolving technologies including cloud, analytics, security, blockchain, IoT and artificial intelligence.
• Their differentiated strategy positions them well to continue gaining share. Having a consulting arm with deep industry expertise, combined with technology expertise, is a structural advantage as it enables them to provide end-to-end strategic technology solutions for their clients across industries.
• Their competitive advantage is their brand, their scale, and their breadth of expertise. They build on this advantage by continuously innovating and investing for future relevance. Disciplined M&A and investment in training and R&D helps them attract and retain top talent and reinforces their market leadership.
• Diversified industry and geographic end market exposure provides a level of defensiveness.
• High ROIC, strong FCF generation and disciplined capital allocation – enduring model for shareholder value creation, with share buybacks, a growing dividend and M&A supported by strong free cash flow generation and a solid balance sheet.

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

[category equity research]

[tag ACN]

Just sharing some thoughts on Hilton and exposure to Coronavirus impact and, in general, the impact of a weakening environment…

·         RevPAR in previous downturns:

o   The last two major downturns in RevPar we have seen were with the Financial Crisis and after 9/11. In 2001, US RevPAR was down 7%, then down 2.7% in 2002. In 2009, US RevPar was down 16.5% then was up 5% in 2010.

o   Not a perfect comparison to now b/c of the severity of the recession w/ the Financial Crisis. And 9/11 may have had a longer term impact given general fears around traveling that persisted. Geographically, they are most exposed to the Americas (78% of rooms).

o   Absent a recession, one would expect a quick-ish recovery after fears of the virus have abated.

·         Pipeline Growth protects in a downturn:

o   In a sensitivity analysis to a market downturn, mgmt. said they would expect flat to slightly positive growth in EBITDA and positive growth in FCF in an environment where RevPAR were to decline 5% to 6%.

o   The reason they could still grow in a downturn is their massive pipeline of new rooms which equate to 40% of their existing room base and more than 50% of that pipeline is already under construction.

o   They project room growth of ~6% per year, so several years of room growth is already under construction. Lower rates means financing for developers just got cheaper. If things get worse, independents are more likely to run for cover with a brand which makes conversions a bit countercyclical. This could aid room growth.

·         Asset Light w/ high mix of Franchise fees is a buffer…

o   In the event of a more severe and prolonged downturn, profits should fall more in line with top line given the asset light model. This is different than previous downturns, where they owned more of their hotels. That means higher fixed costs and higher operating leverage, in which case profits would fall much faster than sales.

o   75% of HLT’s rooms are under franchise agreements, 23% under management agreements versus 2% still owned by the company.

o   This higher mix of franchise rooms than Managed rooms is helpful in a downturn because the fee stream in franchising is not tied to profitability. So it is the less volatile of the two and a differentiator between them and Marriott.  Franchise rooms are straight royalty, while hotels w/ Management agreements have Incentive Fees built in that are tied to profits, and, as a result, disproportionately impacted due to the high fixed cost structure of the business.

·         Low mix of Luxury: Luxury tends to be the worst performing segment in a downturn and HLT has very low luxury exposure at 3% of rooms vs 19% for Hyatt and 9% for Marriott. See chart below.

·         Valuation: This is not a projection, just a sensitivity analysis. But this assumes -10% top line and flat in 2021. Given pipeline growth, RevPAR would have to be way worse than 10% for this to happen. Given the upside in such a scenario, you could argue the valuation is pricing in something worse than this.

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

$HLT.US

[category equity research]

[tag HLT]

Sharing some thoughts on Disney given the stocks reaction to the coronavirus. The biggest impact to Disney would be to their Parks business and their Theatrical Distribution business assuming more parks close or park attendance just drops, along with attendance at theaters. I’m also including some commentary on their surprise CEO change, which I think has had a lesser impact on the stock.

Parks & Experiences:

·         This business was expected to be a little under 30% of op income. About 90% of that is their US Parks and related resorts. Essentially Walt Disney World, Walt Disney Land, Epcot and the resorts that surround them. The segment also includes 4 Cruise ships, but this is a very small part of their business.

Theatrical Distribution:

·         Theatrical distribution portion is ~42% of Studio segment or about 7% of total op income.

·         Their Box office is spread geographically. So, to the extent that Coronavirus is popping up in certain areas, while subsiding in others this should mitigate the total impact.

·         Additionally, they have the option to delay film releases. For instance, they have done this with Mulan in China.

·         Disney+ is the exclusive landing spot for content. To the extent that this pushes subscribers to Disney+ because they missed a movie in the theaters, I would argue the lifetime value of a sub is likely worth much more than their take rate per visit at the box office. Obviously only a fraction of lost theater visits will convert as new subs. But the larger point is that they do have an offset. And an incremental subscriber is all margin for them. If they last 1 yr. it’s ~$70. They have 40-50% take rate at the box office.

Valuation:

·         For perspective, below is a sum-of-the-parts analysis by Goldman. This analysis suggests, Disney’s Parks and Theatrical Distribution are worth roughly 39% of their business (assuming the value of Theatrical Distribution is in proportion to their revenue contribution to Studio).

·         You could argue that the recent drop in price (~21%) suggests that more than HALF of the value of these businesses permanently disappeared. With no offsetting benefit to any other part of their business (i.e. DTC).

·         To the extent that consumer behavior returns to normal after the coronavirus subsides…however long that takes…the out year numbers that are in expectations should be intact. As the valuation multiple on those numbers returns, so should the stock price.

CEO change:

·         Iger is staying on until the end of his contract, through the end of 2021. He is being succeeded as CEO, effective immediately, by Bob Chapek.

·         Iger will continue to be focused on a key part of the business – content – and continue to be central to Disney’s effort to shift their content model to DTC. In fact, he will be more focused on this than he would have been were he to stay in the CEO role. The skeptical take on this would be – does this mean there’s an issue with content? Maybe with the Fox integration? Given excellent subscriber numbers and the potential benefit/upside of Iger spending all his time on content, I don’t think there is a reason to be overly negative about this change.

·         Impression of the new Bob by investors seem to be quite positive.

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

$DIS.US

[category equity research]

[tag DIS]

Visa is the latest to reduce guidance on Coronavirus impact…

(Bloomberg) — Visa sees 2Q net revenue growth to be about 2.5% to 3.5% percentage points lower than the outlook shared on Jan. 30.

·         “Cross-border growth rates have deteriorated week by week since the coronavirus outbreak in China, and trends through February 28, 2020 do not yet fully reflect the impact of the coronavirus spreading outside of Asia. As such, we anticipate that this deteriorating trend has not bottomed out yet”

·         The most significant impact has been on travel to and from Asia

·         Cross-border eCommerce unrelated to travel has thus far not been significantly impacted, except in some Asian markets

·         In markets where Visa processes the majority of its transactions, domestic spending growth, both credit and debit, remains largely stable, with the exception of some impact in Hong Kong and Singapore

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

$V.US

[category equity research]

[tag V]