Research Blog – INTERNAL USE ONLY

FW: HILIX – Q3 2020 Commentary

HILIX Commentary – Q3 2020

Thesis

Serving as a satellite holding, HILIX is a value style fund that takes advantage names that have underperformed recently and are cheaply priced. The team generates alpha by finding companies with strong fundamentals that are overlooked during times of low consensus expectations. We like that HILIX takes advantage of extremes and gains exposure to less efficient market caps by having more holdings and moderate active bets.

 

[more]

 

Overview

In the third quarter of 2020, HILIX underperformed the benchmark (MSCI EFEA Index) by 1.99% due mainly to the fund’s allocation to Energy and Financials. Heavy overweight to Energy, a sector that had poor performance during the quarter, heavily detracted from HILIX’s overall returns. Financials also underperformed and the fund’s overweight to this sector detracted from returns. Strong stock selection within Materials and Industrials contributed to returns. Additionally, selection in Developed Europe & Middle East ex UK and Japan contributed to performance, yet was offset by weak selection in Pacific Developed ex Japan.

 

Q3 2020 Summary

  • HILIX returned 2.81%, while the MSCI EAFE Index returned 4.80%
  • Top issuer contributors
    • AP Moeller-Maersk
    • Shimamura
  • Top issuer detractors
    • Not owning Siemens
    • Not owning NTT DOCOMO

 

 

 

 

Outlook

  • We continue to hold this fund and believe in our thesis due to the fund’s value and bottom-up, fundamental approach
    • YTD the fund has taken a heavy loss due to poor performance by the Value factor in International Developed markets
  • The fund continues to focus on low valued companies that are pro-cyclical
    • Energy, Financials – overweight
    • Consumer Staples, Healthcare – underweight
  • The fund managers believe with such extreme valuations on the growth side there will likely be a bounce-back in value stocks as the world emerges from the recession and a COVID vaccine becomes more attainable
    • Central banks and regulators are seeing banks as safer hands to deal with when it comes to transmission of monetary policy to privacy to cyber-crime to digital currencies – could possibility lead to high growth in Banking industry
    • Energy selloff has been a bit of an overstatement, as fossil fuels will play a large role for years to come
  • Value has been underperforming for some time, yet historically it has proven to outperform
    • HILIX remains comfortable that their holdings will be able to withstand this market turbulence

 

[Category Mutual Fund Commentary]

 

Micah Weinstein

Research Analyst

 

Direct: 617.226.0032

Fax: 617.523.8118

 

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

 

TJX Q3 Results

 
Current Price:   $62                        Price Target: $70

Position Size:    3.8%                      TTM Performance: 5%

 

Key takeaways:

·        Better than expected SSS drove revenue and EPS beat. They didn’t issue guidance for Q4. 

·         Home category continues to be the bright spot & they are adding e-commerce. They already have sites for TJ Maxx and Marshall’s, but now adding HomeGoods.com next year.

·         No guidance – but did see some weakening SSS trends in first two weeks of quarter. 

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

·         Re-instating and increasing dividend by 13%.

 

Additional Highlights:

 

·       All divisions saw sales above plan – home, beauty, and activewear businesses outperformed at Marmaxx, TJX Canada, and TJX International.

·      They were planning overall “open-only” SSS to be down -10% to -20%…street was at high end of this at -11%. They well surpassed this with overall open-only SSS down -5%.  HomeGoods was strongest at +15% and Marmaxx was weakest at -10%. Due to the temporary closing of stores from Covid, the historical definition of SSS is not applicable so they are temporarily reporting “open-only” SSS.  

·        Trends weakened slightly in the first two weeks of the quarter to down -7%. Overall open-only comp store sales were sluggish in August and improved significantly for the remainder of the quarter, with September being the strongest month, but then started to weaken in the last week of Oct. 

·        Slight margin contraction – Pre-tax margin down 70bps – very strong merchandise margin increase was more than offset by significant operating costs related to Covid and expense deleverage on the YoY sales decline.

·        Store closures with virus resurgence in Europe – 470 stores are temporarily closed due to local government mandates – the vast majority of these stores are in Europe.

·        Lighter inventory not due to availability – Inventories continue to be light due to a combination of factors, including lower planned store inventory levels, stronger than expected Q3 sales, and merchandise delivery delays due to continued bottlenecks in the supply chain, but merchandise flow to stores has improved since last quarter. 

·        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. “Overall product availability in the marketplace remains excellent and the Company continues to shift its buying towards the categories that have had the strongest demand since reopening.“

·       Adjusting inventories to align w/ current category demand trend – They are seeing softer demand for certain product categories given the number of people continuing to spend more time at home…“while we are emphasizing the high demand categories of Home, Beauty and Activewear, there is a limit to how much of our mix we would shift in the short-term to medium-term.” Ability to pivot 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. 

·       Their competition is suffering. Store closure leads to market share and real estate opportunities – better locations and lower rents. “Our relationships with vendors will grow even stronger as other retailers close stores.”

·       Long-term thesis intact – Relative to other brick-and-mortar focused retailers, TJX  continues to have a superior and very differentiated model. They acquire their inventory from an enormous (and growing) network of vendors, acting like a clearing mechanism for the retail industry…essentially opportunistically buying leftover/extra product that constantly flows from retailers, branded apparel companies etc. Growth of e-commerce has led to better inventory opportunities/ selection, not worse. They leverage their massive store footprint and centralized buying to merchandise their stores w/ current on-trend product. No one else does this at the scale they do. They have very quick inventory turns and can be nimble and re-active w/ their inventory buys and are an important partner to their sources of inventory. It’s a powerful model that continues to take share and, while they have a growing e-commerce business too, their store model has been very resistant to e-commerce encroachment. Moreover, they have a thriving Home business and a growing international store footprint and a track record of steadily positive SSS. Prior to this year, in their 43 year history they only had 1 year of negative SSS (this is unheard of!). So, with steadily positive SSS and a slowly growing store footprint, TJX steadily grows their topline w/ consistent margins that are about double that of department stores.

·         Resumed and increased dividend. Generated $4.1 billion of operating cash flow and ended the quarter with $10.6 billion of cash. Announced a cash tender offer for up to $750 million aggregate for certain bonds issued in April – looking to lower borrowing costs by reducing the outstanding amount of higher interest rate longer-dated bonds and simultaneously issuing lower interest rate 7 to 10 yr. bonds to fund the tender offer.

·         Valuation: Balance sheet remains strong. The stock has recovered from troughs and is up slightly YTD. Valuation reasonable at almost a 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]

 

Berkshire Hathaway Q3 results

On 11/7, Berkshire Hathaway reported Q3.  Operating earnings rose slightly to $6.7b from $6.3b in Q2.  As expected operating companies were hit by the economic slowdown.  Key takeaways are as follows:

  • Buffett increased share buybacks to $9b, which is more than he has ever bought, bringing the total buyback for the year to $16b.
  • Cash on books remained steady at $147B. 
  • Cash and investment portfolio represent 70% of the company’s value.
  • Sum of the parts valuation shows 20% upside

 

Current Price: $231                         Price Target: $280 (raised from $260)

Position Size: 2.7%                          TTM Performance: 5.2%

 

Segment highlights from the quarter:

  • Insurance pretax earnings were down sharply (-70%)
    • Geico reported a -27% drop in pretax earnings due to program to give consumers premium credit due to the pandemic
  • Railroads – pretax profits rose 18% rebounding from last quarter
  • Berkshire energy – pretax profits up strongly due as MidAmerican benefitted from wind energy and tax credits
  • Service and retail – Profits rebounded up 93%
  • Manufacturing – Profits rebounded up 60%

Stock portfolio highlights:

  • Increased Apple holdings.  Apple has grown to 45% of the portfolio
  • Latest filing show the follow changes:
    • Added Merck, Pfizer T-Mobile and AbbVie
    • Exits Costco
    • Continues to sell Wells Fargo

 

Valuation:  Berkshire is selling at a 20% discount to intrinsic value using sum of the parts.  Their cash of $146b represents $60 per share for B shares. 

 

Berkshire remains a core holding, is currently undervalued and is defensively positioned to take advantage of opportunities as they arise.

 

Please let me know if you have any questions.

 

Thanks,

John

 

($brk/b.us)

 

 

John R. Ingram CFA

Chief Investment Officer

Partner

 

Direct: 617.226.0021

Fax: 617.523.8118

 

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

 

Home Depot to Buy Former Unit HD Supply in $9.1 Billion Deal

Home Depot announced they are acquiring HD Supply, a leading national distributor of maintenance, repair and operations products in the multifamily and hospitality end markets. The company was previously a subsidiary of HD. This would expand their exposure to Pro customers, which is now ~45% of sales and a key area of growth for them. Sales trends among pros continue to improve and may accelerate in 2021.  

Home Depot to Buy Former Unit HD Supply in $9.1 Billion Deal (1)
2020-11-16 14:16:44.281 GMT

By Richard Clough
(Bloomberg) — Home Depot Inc. agreed to buy building
products distributor HD Supply Holdings Inc., reuniting the
home-improvement retailer with its former subsidiary more than a
decade after they split apart.
Home Depot will buy all outstanding shares for about $56
apiece, according to a statement Monday, representing a premium
of about 25% over HD Supply’s closing price on Friday. With 162
million shares outstanding, the offer is valued at almost $9.1
billion. Including net cash, the deal has an enterprise value of
about $8 billion, the companies said.
The acquisition brings back together two companies that
used to be under the same roof and will give Home Depot more
exposure to the professional contractor side of the business.
Like do-it-yourself repairs, that segment has boomed during the
pandemic as Americans want to improve the homes they’re spending
more time in.
Shares of HD Supply jumped as much as 29% before regular
trading in New York, and Home Depot increased less than 1%. HD
Supply was up 11% through Friday’s close, while Home Depot rose
27% over that span.
One of the largest industrial distributors in North
America, HD Supply provides everything from bleach, to doors and
ceramic tile to about 500,000 customers from 270 branches and 44
distribution centers, according to its annual report.
HD Supply is “a good business with solid margins,” Chuck
Grom, an analyst with Gordon Haskett, said in a note. The
company has faced underinvestment in recent years, giving the
buyer the opportunity to improve the business, he said. The tie-
up could add as much as 33 cents a share to Home Depot’s
earnings, Grom added.
The deal adds to the momentum for Home Depot, which along
with rival Lowes Cos. was deemed an essential retailer early in
the pandemic and remained open even as many stores shut down for
months. The HD Supply transaction, to be funded by cash on hand
and debt, is expected to be completed in Home Depot’s fiscal
fourth quarter, which ends Jan. 31.

Professional Sales

Professional customers currently account for about 45% of
Home Depot’s sales, and HD Supply could help it cement its
leadership position, said Drew Reading, an analyst with
Bloomberg Intelligence. “Though HD Supply has exposure to slower
growth commercial end-markets, sales trends among pros continue
to improve and may accelerate in 2021.”
Home Depot sold the construction-supply unit to a group of
buyout firms — Carlyle Group LP, Bain Capital LLC and Clayton,
Dubilier & Rice LLC — in 2007. That deal was initially valued
at $10.3 billion including debt, but in the midst of the housing
crash, it was scaled back to $8.5 billion. The chain then went
public in 2013.
Monday’s announcement comes about a week after Bloomberg
News reported that Lowe’s had recently approached HD Supply and
that the companies were in preliminary talks, citing people
familiar with the matter at the time. The report also said it
was unclear whether there were discussions with other suitors.
Lowe’s subsequently said it isn’t in talks and doesn’t plan to
pursue a transaction.

–With assistance from Gerald Porter Jr. and Matt Townsend.

To contact the reporter on this story:
Richard Clough in New York at rclough9@bloomberg.net
To contact the editors responsible for this story:
Anne Riley Moffat at ariley17@bloomberg.net
Richard Clough

To view this story in Bloomberg click here:
https://blinks.bloomberg.com/news/stories/QJW5R6DWX2PZ

$HD.US

[category earnings ]

[tag HD]

Latest on the Affordable Care Act and the Supreme Court

As most of you know, this week was the third time the Supreme Court heard a challenge to the Affordable Care Act (last times were in 2012 and 2015). Striking down the ACA today would add over 21M uninsured people, close to a 70% increase.
The Supreme Court needs to answer 2 questions before being able to dismantle the ACA:
1/decide of the lawsuit has a standing,
2/decide if the individual mandate is constitutional. The payment penalty for being uninsured was removed in 2017 – which was deemed a tax in prior hearings and thus not falling under the Supreme Court authority. The penalty now removed by Republicans, the lawsuit was started again this year by Texas & other states, while California is defending the law.
A decision will most likely not be made until June.
So far the comments that have transpired were in favor of maintaining the ACA in place.  At least 5 Supreme Court justices (including 2 conservatives) indicated they would reject the attempt to kill the ACA. Both Roberts and Kavanaugh said striking down the individual mandate did not require to struck down the law in its entirety.
  • Roberts said to the Texas Solicitor General Hawkins “I think it’s hard for you to argue that Congress intended the entire act to fall if the mandate were struck down when the same Congress that lowered the penalty to zero did not even try to repeal the rest of the act. […] I think, frankly, that they wanted the court to do that. But that’s not our job.”
  • Justice Alito said: “At the time of the first case, there was a strong reason to believe that the individual mandate was like a part in an airplane that was essential to keep the plane flying,” Alito said. “But now the part has been taken out, and the plane has not crashed. So, if we were to decide this case the way you advocate, how would we explain why the individual mandate in its present form is essential to the operation of the act?”
  • Justice Sonia Sotomayor said that the argument for striking down the whole law, without proof of substantial harm to anyone, including Texas and other conservative states, did not make much sense. “At some point, common sense seems to me would say, ‘Huh?’ “
Based on the above, I do not believe we need to make changes to our healthcare holdings. Biden could reinstate some taxes such as the 2.3% medtech tax (part of the ACA) that was ended by Trump – but I have not seen in listed in its health care plan so far.
Thanks,
Julie

Disney Q4 Results

Current Price: $138         Price Target: $165

Position size: 1.5%          TTM Performance: -4%             

 

Key Takeaways:

  • Beat on revenue and EPS.
  • Strong Disney+ performance continues – Disney+ continues to ramp better than expected w/ 73.7m subs above expectations of 65m.
  • Accelerating transition to DTC first company – key driver of LT value for the company. Investor Day in early Dec will be devoted to this transition.
  • Dividend still suspended, but plan for it to resume – This comes despite the investor letter from Third Point suggesting they permanently suspend it and channel that cash towards content. Leverage is still up, aiming to return to leverage levels consistent with single A credit rating.

 

Additional Highlights:

  • Revenue was $14.7B vs $14.2B expected. Despite revenue down 23% YoY, driven largely by an 61% YoY drop in Parks segment revenue, Disney managed to post positive op income and FCF for the quarter. Adj. op income was $393m vs expectations of about -$1B loss.
  • Financial results continued to reflect significant impacts from COVID-19 which adversely impacted segment op income by $3.1B. Parks, Experiences and Products segment was again the most severely affected with an estimated adverse impact of $2.4B in Q4.
  • Segment re-alignment – Previously announced new segment reporting starts next quarter. This will essentially put all of their content creation together in a segment called “Media and Entertainment” and separate it from distribution. Currently, Studio, streaming and cable were in separate segments. The change separates optimal distribution decisions from the type of content made. This underscores a growing focus on streaming vs studio reliance and seems to suggest more movies going directly to streaming to drive subscriber growth. 
  • Overall, a very encouraging and upbeat call with an upcoming investor day in the coming months that mgmt. seemed very positive about. They will update Disney+ profitability guidance given it’s tracking way ahead of original targets. Additionally, the long-term speculation has been for a DTC model for ESPN – so this could be a potential topic.
  • Media:
    • Media Networks revenues for the quarter increased 11% to $7.2 billion, and segment operating income increased 5% to $1.8 billion. Op income was up in Q3 due to higher results at both Broadcasting, partially offset by lower results at cable networks.
    • At Broadcasting, the increase in op income was primarily due to affiliate revenue growth and lower programming, production and marketing costs. The decrease in programming and production costs was largely driven by COVID-19 related shutdowns, the shift of college football games to fiscal 2021 and a delay in airing new season premieres. Lower results at cable networks were driven by decreases at ESPN, partially offset by increases at FX Networks and the domestic Disney channels.
    • ESPN results were lower as affiliate and advertising revenue growth were more than offset by higher programming and production costs.
  • Parks, Experiences and Products:
    • Segment revenues decreased 61% to $2.6B, and segment op income decreased $2.4B YoY to a loss of $1B.
    • “We’re very pleased with the dynamics we’re seeing at parks across the globe.” WDW was at 25% capacity…now at 35% capacity. 
    • Virus resurgence continues to drive closures – Paris re-closed recently. California still closed. Shanghai open for the full quarter. Hong Kong open for part of the quarter.
    • All resorts operating at significantly reduced capacity. Walt Disney World, Shanghai Disney Resort and Hong Kong Disneyland all achieved a net positive contribution in  Q4, which means they generated revenue that exceeded the variable costs associated with reopening.
    • Positive demand signs – Walt Disney World already booked at 77% capacity for Q1. Thanksgiving week almost booked to capacity. In other words, there are some heavy fixed costs, but it pays to have them open despite really limited capacity.
  • DTC:
    • Revenues were +42% with an operating loss of $580m- an improvement of approximately $170m compared to the prior year. This improvement was driven by higher results at Hulu and ESPN+ partially offset by costs associated with the ongoing rollout of Disney+ and a decrease at our international channels. The improvement at Hulu was due to both subscriber and advertising revenue growth, partially offset by higher programming/production costs. The improvement at ESPN+ was due to subscriber growth and increased pay-per-view income from UFC events.
    • Between Disney+, ESPN+, Hulu they now have >120m paying subs. ESPN+ subs were ahead of expectations at 10.3m vs consensus 9.1m. Hulu came in slightly below at 36.6m vs consensus 37.5m. Disney+ was 73.7m vs consensus 65m.
    • Disney+ ahead of 5 yr. target after only 1yr. – 60m subs at Disney+ was originally targeted for 2024, so they hit their 5 year target in about 8.5 months. And said they’re ahead of expectations in every geo, with big launches still ahead. India plus Indonesia are ~25% of subs. ARPU is $4.52, or $5.30 ex-India. This is basically unchanged from last quarter. They will give updated subscriber targets at their Investor Day in December. 
    • Global rollout driving sub growth – Now in more than 20 countries worldwide. They launched Disney+ in the Nordics, Belgium, Luxembourg and Portugal in September, and in Latin America this November. Rolled out Disney+ Hotstar on September 5 in Indonesia, one of the world’s most populous countries. Disney+ will launch in Brazil, Mexico, Chile, and Argentina on November 17. By year-end, Disney+ will be available in 9 of the top 10 economies in the world.
  • Studio:
    • Studio Entertainment revenues for the quarter decreased 52% to $1.6 billion and segment operating income decreased 61% to $419 million. The decrease in operating income was due to lower theatrical and home entertainment results.  Worldwide theatrical results continued to be adversely impacted by COVID-19 as theaters were closed in many key markets, both domestically and internationally, and no significant worldwide theatrical releases in the quarter.
    • Production was heavily impacted by Covid except w/ animation which was uninterrupted. They’re finally re-starting production for live action films and television.
    • Over time number of films and quality of content. New content adds subscribers. Increased pace in investment on content should be a focus at Investor Day.

 

 

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 earnings ]

[tag DIS]

 

Themes & Focus List Stocks: Artificial Intelligence and Medtronic

Going forward we thought it might be helpful to share some insights on how certain themes are present in our portfolio. This week I’m sharing an example of how the theme of Artificial Intelligence is present in our portfolio with Medtronic.
A year ago the company launched GI Genius, the first system worldwide to use Artificial Intelligence to detect colorectal polyps. It provides physicians with a powerful new solution in the fight against colorectal cancer.
The GI Genius module uses advanced artificial intelligence to highlight the presence of pre-cancerous lesions with a visual marker in real-time – serving as a second observer. Studies have shown that having a second observer can increase polyp detection rates. Medtronic also includes AI in its Diabetes solutions with Sugar.IQ (a partnership with IBM). The company’s Minimed insulin pump comes with the Guarduan 3 sensor, which uses AI to help diabetes patients beat high and low blood glucose related events.
Thanks,
Julie

tag: MDT

Themes & Focus List Stocks: Artificial Intelligence

Going forward we thought it might be helpful to share some insights on how certain themes are present in our portfolio. This week I’m sharing an example of how the theme of Artificial Intelligence is present in our portfolio…
Black Knight’s AIVA Product: AIVA (AI Virtual Assistant) is BKI’s AI technology that can help clients automate what is still a very paper intensive origination process. Mortgage originations are expensive and getting more expensive partly because they are so labor intensive. AIVA is powered by machine learning and performs manual, repetitive tasks at scale. This helps clients reduce operating costs for this time-consuming process. AIVA mimics cognitive thinking to read, comprehend and draw conclusions. “She” is able to remember patterns within data the same way humans recall what they have learned on the job. Loan applications contain hundreds of data points from various document types, including PDFs, screenshots, TIFFs of things like W2’s and paystubs.  The documents need to be verified, classified and entered into an origination system. Mortgage professionals are tasked with doing this under tight deadlines. AIVA can read, analyze and extract the data. It then creates queues of documents for a processor to scan and make corrections. In doing this, each new set of origination documents serves as training data, making AIVA “smarter” and more efficient. BKI says it reduces a 95 minute process to a 5 minute process. By performing error-prone, manual tasks, AIVA enables employees to focus on projects with greater strategic value, such as addressing exceptions and solving problems, which results in improved transaction turn times as well as reduced risk. As AIVA helps accelerate and streamline processes, lenders benefit from reduced expenses, which is key as loan origination costs hit new highs, pressuring net profits for lenders.

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

[category themes]

[tag BKI]

CSCO Q1 2021 Results

Current Price: $41                           Price Target: $58 

Position size: 2.8%                          TTM Performance: -9%

 

Key Takeaways:

·         Top line and EPS beat with better-than-expected guidance.

·         Upbeat guidance suggests macro environment showing signs of improvement. Aging network infrastructure needs to be upgraded. Growing use of new technologies and increased data demand places increased importance on this.

·         Mix shift to software and recurring revenue should continue as an increasing number of their products are to be offered this way.

·         Cost cutting to help preserve earnings power –  $1B in annual cost reductions to be implemented over next few quarters.

·         CEO Chuck Robbins said…“Cisco is off to a solid start in fiscal 2021 and we are encouraged by the signs of improvement in our business as we continue to navigate the pandemic and other macro uncertainties.”

 

Additional Highlights:  

·       Overall, business trends are weak but improving, they are lapping easy compares this coming year amidst some aggressive cost-cutting initiatives, transition to software/subscription continues, valuation is inexpensive, and they have a high dividend yield (3.5%) that’s easily covered. 

·        Q1 sales -9% YoY and EPS -10%. Q2 revenue guided to 0% to -2%. Street was expecting -3.5%.

·       New CFO announced – Scott Heron (was Autodesk CFO) , he will replace Kelly Kramer whose retirement was announced last quarter. He has a background in software and helped to lead Autodesk’s successful business model transformation from perpetual licenses to subscription software.

·       Improved demand commentary relative to last quarter…

·       By product – Soft demand w/ campus/DC switching, routing, servers, and WLAN still offsetting positive Webex, security, Cat9K, WiFi-6  trends, but order patterns are improving.

·       By end market – Positively, order patterns in public sector were solid while headwinds w/ commercial/enterprise are set to subside. Saw a pretty significant improvement in commercial orders -they were minus 23% last quarter in the midst of a “SMB meltdown,” that improved to -8% this quarter.

·       As I mentioned last quarter, Gartner expects global IT spending to decline -7% in 2020. Within this there are pockets of strength, like public cloud spending as companies shift IT budgets to areas of immediate need. For much of Cisco’s products the needs are less immediate, but the LT drivers still exist. Management talked about this dynamic on the call. “We had customers who are super-focused on getting their employees working from home productively and getting their security set up. I think everyone raced to do that and then I think they took a pause, which is what we felt in our last quarter in orders. And then I think they re-prioritized what they were going to be spending money on and I think we started seeing some of that come back and it’s sort of exactly what I expected, but we needed to see it and we’ll see if it continues. But we’re all dealing with the same macro environment.”

·        Positive commentary points to continued software/services mix shift and strength in new products –This includes strong demand for their Catalyst 9000, security, WebEx and other SaaS-based solutions. Software mix is close to 1/3 of revenue, w/ 78% of software sold as subscription. That means almost 1/4 of total sales is from software subscriptions sales (or close to $12B). Additionally, 27% of rev is services with much of that from maintenance/support which tend to be recurring. So overall recurring revenue could be 40% or more (they don’t break it out specifically). So while top line growth has been weak, the mix shift happening w/in their business should be supportive of their multiple and their margins. They intend to grow this mix over time.

·        Momentum w/ web-scale cloud providers – the positive commentary from last couple quarters continued. This is an end market where they lost share to Arista in the past, but their positioning is improving w/ new products announced last Dec. That being said, this is still early stages – mgmt. indicated it may take a year or two for this to be a meaningful top line contributor.

·        Valuation: trading at almost an 8% FCF yield on fiscal 2021, which ends in July. This is well below S&P average of <4%, for a strong balance sheet, high FCF generative business w/ a growing mix of software and recurring revenue. Despite macro headwinds, fundamentals continue to be supported by business transformation/digitization trends at a reasonable valuation while much else in tech has seen substantial multiple expansion. Additionally, their valuation is supported by a 3.5% dividend yield which they easily cover. They have ~$15B in net cash on their balance sheet, or almost 9% of their market cap.

 

 

 

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

[category earnings ]

[tag CSCO]

FW: TCPNX – Q3 2020 Commentary

TCPNX Commentary – Q3 2020

Thesis

TCPNX is a smaller fund that does not have as many assets under management compared to our other core mangers, enabling them to make more nimble and tactical decisions. By making small allocations to undervalued “riskier” asset classes (high-yield and non-dollar denominated debt), TCPNX diversifies our fixed income portfolio and generates superior returns to the benchmark (Barclays U.S. AGG). We like that the fund utilizes a bottom-up investment process through proprietary framework analysis, fundamental security review, and portfolio risk management.

 

[more]

 

 

 

 

 

 

 

 

 

Overview

In the third quarter of 2020, TCPNX outperformed the benchmark (Barclays U.S. AGG) by 54bps. The overweight to spread securities and underweight to U.S. Treasuries positively added to returns. An overweight to U.S. Agencies and Agency Multi-Family MBS, and underweight to Agency Single-Family MBS, helped contribute to performance. Underweight to CMBS and general allocation to higher quality credit and secured debt created a headwind.

 

Q3 2020 Summary

  • TCPNX returned 1.16%, while the U.S. AGG returned 0.62%
  • Quarter-end effective duration for TCPNX was 6.0 and 6.1 for the U.S. AGG
  • Three largest contributors
    • Small Business Administration Development Company Participation Certificates, airline Enhanced Equipment Trust Certificates, and High Yield bonds
  • The top detractors
    • Municipal debt and Title XI bonds

 

 

 

 

Optimistic Outlook

  • We continue to hold this fund and believe in our thesis due to the fund’s consistent and defensive approach that we expect to generate alpha through times of low volatility
  • The fund believes the decline in the recovery outlook is largely correlated with the lack of a stimulus deal
  • Tight credit spreads and high levels of economic uncertainty will create challenges for the fund to find opportunities
    • “Lower for longer” rates stated by the Fed has created opportunities in U.S. Agency debt
  • TCPNX is focusing on increasing quality names – recently exited oil and exploration companies

 

[Category Mutual Fund Commentary]

 

Micah Weinstein

Research Analyst

 

Direct: 617.226.0032

Fax: 617.523.8118

 

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

www.crestwoodadvisors.com