Research Blog – INTERNAL USE ONLY

On 10/13, Bank of America (BAC) reported core Q3 EPS of $.48 with positives of sharp decrease in provisions for bad loans and negatives of weak net interest income growth.  We believe BAC is managing the pandemic recession well, has a strong balance sheet, is building excess capital and has strong earnings power. 

 

Current Price: $24.2                         Price Target: $30

Position Size:   2.26%                       Trailing 12-month Performance: -17.3%

 

Q3 Highlights:

• Strong credit quality with loan provisions falling to $1.4b from $5.1b
• Good news!  The loan loss provisions were below street expectations and close to the normal quarterly run rate.  Considering that these provisions are forward looking, it bodes well for the state of the economy and health of the banking system.
• US banks remain healthy.  Reserve build for the Top 5 banks in the US dropped sharply close to the normal run rate of loan provisions:

 

• These provisions are NOT Comparable to those taken during the Great Recession. From Q4 2007 to Q4 2011, the top five banks increased provisions by $318b! More than 6x the provisions taken since the coronavirus pandemic started.
• BAC’s outlook for credit is positive.  Consumer spending by their customers in October is about 10% above levels from last year.  Consumer deferrals balances are down from $1.7b to $0.1b in September
• Net Interest income decreased to $10.24b from $12.34b a year ago as interest rates fell
• Net interest margin fell to 1.72% which they believe is the bottom
• Expect NIM to trend up as increased deposits are invested and balance sheet growth, though they noted reinvestment rates remain a headwind.
• NIM will remain depressed until we see a sustained economic recovery.  At that point, banks will be among the industries most levered to benefit from the rebound.

 

• Strong balance sheet
• Nonperforming loans are lowest among peers
• Fed’s stress test has consistently shown BAC losses to be lower than peers
• Strong capital ratios: CET1 ratio of 11.4% which is 1.9% above required minimum
• Attractive valuation
• BAC is selling at a discount to book value! at 0.86x Book value and 11.8x P/E
• BAC has strong earnings power – generates over $5b a quarter in earnings
• BAC continues to build capital as share buybacks and dividend increases are restricted.  They have $35b in excess capital which equates to 6% of shares outstanding.

 

BAC Thesis:

 

0. BAC has dramatically improved their Consumer Banking unit which has driven earning’s growth.  Loss metrics are best among peers.
1. Despite current recession, BAC has strong balance sheet and earnings power

0. Their stronger capital position should lead to increased dividends and buybacks

 

Please let me know if you have questions.

Thanks,

John

 

[category Equity Earnings]

[tag BAC]

$BAC.US

 

 

Key takeaways:

 

Current Price: $148      Price Target: $175

Position size: 2.45%     1-Year Performance: +15%

 

• Guidance for the year raised again as its medical devices segment continues to perform ahead of expectations:
• Medical devices results were better than expected, thanks to growth in the US and China
• Operational sales growth of raised ~100bps to 0.5%-1.5%
• EPS raised to $7.95-$8.05 from $7.75-$7.95

 

• Pharma segment showed steady performance with 4.7% growth: Darzalex in oncology continued increased patient intake, Stelara and Xarelto performed better than consensus.
• Consumer segment +3.1%, driven by US sales +12% (share growth for Tylenol, Zyrtec, Listerine and wound care)
• Medical Devices -3.3%: negative impact came from Orthopaedics knee replacement and Sports (Covid delays), Surgery and Vision delays as well

 

Once more JNJ posted results better than forecasted, and raised its guidance for the year. While JNJ’s Medical Devices results were better than expected (beating consensus by 14%), it appears that the recent trend in September was for a flattening of the growth, which is not surprising considering the increase in COVID cases globally. They are not yet providing full 2021 guidance but guided to a strong double digits growth in Medical Devices and above market growth in Pharma. In Pharma, volume should drive growth, as pricing pressure remains (higher unemployment and potential for HC reform). Operating margins will remain at 2019 levels due to higher R&D expenses (Momenta acquisition bringing some potential blockbuster drugs in autoimmune disorders).

Some Covid vaccine news came yesterday that JNJ was pausing its vaccine trial as a person showed sign of an unexplained illness (similar to AstraZeneca a month ago). This is a normal process in any drug trial, and we think JNJ will ultimately continue its research on finding a reliable vaccine. Overall there is nothing this quarter that is changing our view on JNJ as a core holding in our healthcare portfolio.

Thesis on JNJ:

• High quality company with consistent 20% ROE, attractive FCF yield,
• Investments in the pipeline and moderating patent expirations create a profile for accelerated revenue and earnings growth
• Growth opportunity: Medical Devices and Consumer offer sustainable growth and potential for expansion internationally
• Strong balance sheet that offers opportunities for M&A.

 

 

 

[category Equity Earnings]

[tag JNJ]

$JNJ.US

 

Last night the House antitrust subcommittee issued a report which concludes their investigation that started over a year ago in June 2019…

 

·         The investigation concluded that the Big tech platform companies (Apple, Facebook, Google and Amazon) abuse their market power…more detail on this below.

·         Their investigation included the hearing this past July w/ the CEO’s of those companies.

·         The report does not directly result in actions against any of these companies. It is a series of findings that could serve as a foundation to reform antitrust laws to better address big tech business models. 

·         The current investigations by the DoJ, FTC and States Attorneys general are obviously limited to application of current law. The question is whether current law is sufficient for antitrust action against them, or whether new laws would be required.

·         The likelihood of changing the laws would increase with a change in control of the Senate.

 

Excerpt from the report…

§  “Although these four corporations differ in important ways, studying their business practices has revealed common problems. First, each platform now serves as a gatekeeper over a key channel of distribution. By controlling access to markets, these giants can pick winners and losers throughout our economy. They not only wield tremendous power, but they also abuse it by charging exorbitant fees, imposing oppressive contract terms, and extracting valuable data from the people and businesses that rely on them. Second, each platform uses its gatekeeper position to maintain its market power. By controlling the infrastructure of the digital age, they have surveilled other businesses to identify potential rivals, and have ultimately bought out, copied, or cut off their competitive threats. And, finally, these firms have abused their role as intermediaries to further entrench and expand their dominance. Whether through self-preferencing, predatory pricing, or exclusionary conduct, the dominant platforms have exploited their power in order to become even more dominant. To put it simply, companies that once were scrappy, underdog startups that challenged the status quo have become the kinds of monopolies we last saw in the era of oil barons and railroad tycoons. Although these firms have delivered clear benefits to society, the dominance of Amazon, Apple, Facebook, and Google has come at a price. These firms typically run the marketplace while also competing in it—a position that enables them to write one set of rules for others, while they play by another, or to engage in a form of their own private quasi regulation that is unaccountable to anyone but themselves.”

 

Among the recommendations in the report…

§  Reduce conflicts of interest thorough structural separations and line of business restrictions

§  Implement rules to prevent discrimination, favoritism, and self-preferencing

§  Promote innovation through interoperability and open access

§  Reduce market power through merger presumptions

§  Create an even playing field for the press

§  Prohibit abuse of Superior Bargaining Power including through anticompetitive contracts

 

 

 

Sending an update on Alphabet as the potential for a Department of Justice lawsuit is rising. As a reminder, they are being investigated by federal and state-level regulators (the DoJ and State Attorneys General) which began over the last year. It is widely expected that a lawsuit from the DoJ is imminent, which may or may not include the AG’s as part of that lawsuit (or they may take separate action). At issue is their dominance in search and their dominant position in the ad tech stack. These are separate but interconnected issues. Google’s dominance in search (~90% global share) gives them the best data (“click and query” data) which is the raw material for targeted advertising. Search also allows them to give preference to their own sites (e.g. YouTube) when placing ads. Revenue from Google’s own sites has been a key driver of growth.  In ad tech, Google is present at all significant stages of the opaque ad tech stack – they are present on both the ‘buy’ and ‘sell’ sides of the market. They serve ads to Publishers (sell side) and help advertisers place ads (buy side). The concern involves their ability to limit competition via this vertical integration.

 

There are not many historical templates for US antitrust suits – in the last 50 years, there have been three major antitrust actions against dominant U.S. companies: IBM (1969), AT&T (1974) and Microsoft (1998). One thing we know from those cases is that they take a long time – likely at least 3 years. With IBM the trial took over a decade, w/ AT&T over 7 years and w/ MSFT over 3 yrs. So while a lawsuit may be imminent, it should take time for the implications of this to play out. It’s possible this could be resolved sooner if GOOG and the DoJ can settle w/ GOOG making some concessions. Such initial lawsuits sometimes state potential suggested remedies and sometimes they do not.

 

There are a wide range of potential remedies that could be sought. Current rumors are that the DoJ lawsuit will focus more on search. One area regulator’s could target is Google’s position as the default search engine on most mobile devices (they pay Apple for this privilege which is ~5% of Apple’s rev). Regulators could also target previous acquisitions (YouTube of DoubleClick) – The Clayton Act allows regulators to unwind previously-approved mergers. Other potential outcomes include changes to search that result in less ad revenue from owned sites, sharing/licensing of click and query data (could meaningfully increase competition but could still provide a fee stream), a forced to break-up (I don’t view that as big downside risk…in fact some argue the sum trades at a discount to the value of the parts).

 

The US is not the only place GOOG is facing antitrust scrutiny. For GOOG (and AAPL, AMZN & FB) there has been an expanding global footprint of regulatory scrutiny with the EU leading the charge, but w/ no significant consequence at this point. Since 2017 the EU has fined GOOG $9B, which is not meaningful given GOOG’s valuation and cash on their balance sheet (>$100B). The EU has also gone after GOOG’s position as the default search engine on Android phones, but to no real avail at this point. https://www.wsj.com/articles/some-google-search-rivals-lose-footing-on-android-system-11601289860?mod=tech_featst_pos1

 

Partisan considerations…

Scrutiny has been bipartisan. The outcome of the presidential election is unlikely to reduce antitrust risk for GOOG. With the new Supreme Court justice the implication is not clear cut. The most meaningful change could be Democratic control of Congress which could have implications for potential new antitrust law aimed at regulating big tech (this was the focus of The House Judiciary’s Antitrust Subcommittee hearing in July w/ GOOG, AMZN, FB and AAPL CEOs).

 

In summary, I view this growing regulatory scrutiny as an evolving risk but do not expect the filing of a lawsuit to catch the market by surprise; it is expected. If there are recommended remedies in the suit, this could have an impact (as investors know which outcome to “probability weight”), but again will take some time to resolve. I expect to keep re-assessing this as we know more.

 

https://www.wsj.com/articles/google-antitrust-suit-looms-over-issues-of-search-dominance-advertising-11600948051

 

 

Sarah Kanwal

Equity Analyst, Director

 

Direct: 617.226.0022

Fax: 617.523.8118

 

Crestwood Advisors

One Liberty Square, Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

 

GOOG.US

[tag GOOG]

[category equity research]

AAPL.US

[tag AAPL]

[category equity research]

 

As a follow up to my previous email, pointing out a couple pre-emptive moves Alphabet is taking ahead of a potential lawsuit from the DoJ/State AG’s. The first pre-emptive move is that Google announced a new initiative called “Google News Showcase” which is a partnership with news publishers where GOOG will pay publishers $1B in licensing payments over the next 3 years to “to create and curate high-quality content for a different kind of online news experience.” This seems meant to mitigate one of the issues related to their search dominance – GOOG’s ability to scrape and display snippets of news from publishers w/out the publishers making a profit (no subscription or ad served on their site unless user clicks through). The EU is already addressing this issue w/ their “Copyright Directive” passed in June 2019 (it gives EU Member States until June 2021 to pass legislation that meets the directives requirements). The key provision of the Directive is that content-sharing service providers will have the obligation to identify what is copyrighted by making them liable for copyright infringement. The law is aimed at helping publishers/creators of content (e.g. journalists, musicians etc.) get a bigger piece of ad revenues that go to companies like Google and Facebook. The Google News Showcase announcement marks a big shift in attitude for Google, as their early response to the Copyright directive was more defiant.

 

https://www.wsj.com/articles/google-pledges-1-billion-in-licensing-payments-to-news-publishers-11601546401

 

The second pre-emptive move is related to GOOG’s pending acquisition of Fitbit. Earlier this summer Google said they wouldn’t use Fitbit data for advertising. They’ve increased their concessions to include “supporting other wearable manufacturers on Android and to continue to allow Fitbit users to connect to third-party services.”

 

https://www.wsj.com/articles/google-makes-concessions-in-effort-to-buy-fitbit-11601480052

 

Both of these actions highlight one of the indirect implications of this looming anti-trust action – that the threat of it is already changing management behavior and could continue to over the course of a trial as they may take proactive steps to assuage regulators and generally be more tepid in their competitive behavior…this could also include avoiding M&A that could draw further scrutiny.   

 

To summarize:

·         The potential for a Department of Justice antitrust lawsuit against Google is rising. Group of 48 State AG’s may file a suit in conjunction with this or separately.

·         The lawsuit is widely expected ahead of the election.

·         These types of lawsuits tend to take multiple years, so any formal consequence of this should take time.  We expect to keep re-assessing this as we know more.

·         This is a bipartisan effort which should not recede based on the outcome of the election.

·         In the meantime, this can weigh on the multiple, distract management, and result in more conciliatory competitive behavior.

 

 

 

 

Sending an update on Alphabet as the potential for a Department of Justice lawsuit is rising. As a reminder, they are being investigated by federal and state-level regulators (the DoJ and State Attorneys General) which began over the last year. It is widely expected that a lawsuit from the DoJ is imminent, which may or may not include the AG’s as part of that lawsuit (or they may take separate action). At issue is their dominance in search and their dominant position in the ad tech stack. These are separate but interconnected issues. Google’s dominance in search (~90% global share) gives them the best data (“click and query” data) which is the raw material for targeted advertising. Search also allows them to give preference to their own sites (e.g. YouTube) when placing ads. Revenue from Google’s own sites has been a key driver of growth.  In ad tech, Google is present at all significant stages of the opaque ad tech stack – they are present on both the ‘buy’ and ‘sell’ sides of the market. They serve ads to Publishers (sell side) and help advertisers place ads (buy side). The concern involves their ability to limit competition via this vertical integration.

 

There are not many historical templates for US antitrust suits – in the last 50 years, there have been three major antitrust actions against dominant U.S. companies: IBM (1969), AT&T (1974) and Microsoft (1998). One thing we know from those cases is that they take a long time – likely at least 3 years. With IBM the trial took over a decade, w/ AT&T over 7 years and w/ MSFT over 3 yrs. So while a lawsuit may be imminent, it should take time for the implications of this to play out. It’s possible this could be resolved sooner if GOOG and the DoJ can settle w/ GOOG making some concessions. Such initial lawsuits sometimes state potential suggested remedies and sometimes they do not.

 

There are a wide range of potential remedies that could be sought. Current rumors are that the DoJ lawsuit will focus more on search. One area regulator’s could target is Google’s position as the default search engine on most mobile devices (they pay Apple for this privilege which is ~5% of Apple’s rev). Regulators could also target previous acquisitions (YouTube of DoubleClick) – The Clayton Act allows regulators to unwind previously-approved mergers. Other potential outcomes include changes to search that result in less ad revenue from owned sites, sharing/licensing of click and query data (could meaningfully increase competition but could still provide a fee stream), a forced to break-up (I don’t view that as big downside risk…in fact some argue the sum trades at a discount to the value of the parts).

 

The US is not the only place GOOG is facing antitrust scrutiny. For GOOG (and AAPL, AMZN & FB) there has been an expanding global footprint of regulatory scrutiny with the EU leading the charge, but w/ no significant consequence at this point. Since 2017 the EU has fined GOOG $9B, which is not meaningful given GOOG’s valuation and cash on their balance sheet (>$100B). The EU has also gone after GOOG’s position as the default search engine on Android phones, but to no real avail at this point. https://www.wsj.com/articles/some-google-search-rivals-lose-footing-on-android-system-11601289860?mod=tech_featst_pos1

 

Partisan considerations…

Scrutiny has been bipartisan. The outcome of the presidential election is unlikely to reduce antitrust risk for GOOG. With the new Supreme Court justice the implication is not clear cut. The most meaningful change could be Democratic control of Congress which could have implications for potential new antitrust law aimed at regulating big tech (this was the focus of The House Judiciary’s Antitrust Subcommittee hearing in July w/ GOOG, AMZN, FB and AAPL CEOs).

 

In summary, I view this growing regulatory scrutiny as an evolving risk but do not expect the filing of a lawsuit to catch the market by surprise; it is expected. If there are recommended remedies in the suit, this could have an impact (as investors know which outcome to “probability weight”), but again will take some time to resolve. I expect to keep re-assessing this as we know more.

 

https://www.wsj.com/articles/google-antitrust-suit-looms-over-issues-of-search-dominance-advertising-11600948051

 

 

Sarah Kanwal

Equity Analyst, Director

 

Direct: 617.226.0022

Fax: 617.523.8118

 

Crestwood Advisors

One Liberty Square, Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

 

$GOOG.US

[tag GOOG]

[category equity research]

 

Key takeaways:

 

·         Sales impacted by decline in out of the house consumption, but at-home consumption remains good

·         Temporary delays in Mexican production plant due to Covid is over (for now!)

·         Hard Seltzer launch is a success, now #4 brand in that category while launching in the middle of a pandemic

·         Sale of lower priced wine and spirit brands to close at the end of Q3

 

 

Current Price: $184                Price Target: $226

Position Size: 2.52%              1-Year Performance: -11.8%

 

Constellation Brands reported a sales decline of 4% as the quarter was impacted by lower sales in its on-premise channel down -50% y/y in Q2 (consumption in restaurants, bars, etc) as well as some temporary out-of-stock at retail from its earlier in the year production disruption in Mexico.

Beer organic sales were +1%, but mostly depletion volume was positive at +4.7% (sales at retail to end consumer). This shows that at home consumption offsets the reduction in on-premise consumption. Corona Seltzer is growing nicely, helping the Corona portfolio grow double-digits. This new seltzer offering holds the #4 position in the category (6% market share), after less than a year after its launch, and in the middle of a pandemic! It is the second fastest moving Hard Seltzer on the market.

In addition, with its higher exposure to the Hispanic population (est. 15-20%) than other Seltzer brands (at ~10-15%), we should see continued growth longer term as that demographic grows faster than others.

The Covid impact on beer production in Mexico seems behind them now, with inventory levels expected to return to normal by the end of next quarter.

Regarding production capacity, they are still working with the Mexican government to find a solution to the now defunct Mexicali plant. To offset that void, they do have the Obregon brewery expansion, which once completed by the end of the fiscal year, will cover consumer demand over the medium term. This also includes a doubling of its seltzer capacity.

STZ announced taking a minority stake in Booker Vineyard’s, a “super-luxury, direct-to-consumer wine company”, reinforcing the company’s direct to consumer/e-commerce strategy. Organic sales in wines was -9%, as the lower end brands continue to underwhelm (the never ending divestment of most of those brands are scheduled for the end of next quarter).

 

And to conclude…I would trade places with him right now….

 

 

Investment Thesis:

·         Adding STZ helps position our portfolio to be more defensive at this stage of the economic cycle

·         STZ is down ~20% YTD, giving us a good entry point

·         STZ continues to have HSD top line growth and high margins that should incrementally improve going forward

·         STZ comes out of a heavy capex investment cycle to support its growth: FCF margins are set to inflect thanks to lower capex

 

[tag STZ] [category earnings]

$STZ.US

 

 

 

Julie S. Praline

Director, Equity Analyst

 

Direct: 617.226.0025

Fax: 617.523.8118

 

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

 

www.crestwoodadvisors.com

 

 

Key takeaways:

 

·         Organic sales growth of +4.2% return to healthy levels, demonstrating the resilience of the diverse portfolio

·         Productivity gains were offset by Covid expenses (a 80bps drag) and manufacturing automation and distribution systems investments – leading to a 40bps operating margin decline

·         Financial guidance restored for 2020:

o   Organic sales growth of 4%

o   EPS of $5.50 (only 3 cents below 2019)

 

 

Current price: $140                           Price target: $153  

Position size: 2.14%                         1-year performance: +1%

 

 

Pepsi released its 3Q20 earnings this morning. Organic sales of 4% shown a return to normal levels for the company, which is encouraging, as part of its business remains impacted by the pandemic (restaurants for example). In the US, its snack business grew 6%, while Quaker Foods continues to benefit from the pandemic trend of eating at home (+6% sales growth). Europe grew an impressive +7% Asia/Pac +5%, but Latam posted a small +1% growth and Africa, Middle East and South Asia decline 2%. The rising unemployment is having an impact in those regions, although Pepsi believes it has enough of a sizing/pricing playbook to offset some weakness in the emerging markets. On the beverage side, the integration of the new energy drink Rockstar acquisition and distribution agreement with Bang is going well. The work from home trend is also benefitting SodaStream (double digits revenue growth) as consumers enjoy the convenience of making sodas at home. This trend also impact their energy drink category (Gatorade, the market leader), as people get into a routine of working out at home more and indulging in those drinks.

On the margin front, we shouldn’t expect any expansion near term as Covid expenses remain a reality.

As we near the end of the year, the management team reintroduced its 2020 guidance, which we find reassuring. Sales growth of 4% is good in today’s environment.

 

Thesis on Pepsi:

• Global growth opportunity with about 40% of profits coming from outside the US. CSD is only 25% of sales (and Pepsi brand only 12%)
• Strong market share in high growth emerging markets where there is low penetration and rising per capita consumption
• Resilient snack business provides pricing power and visibility to future cash flows (more than half of sales are from snacks not beverages). CSD is only 25% of sales (and Pepsi brand only 12%)
• Several Great brands driving global growth: Frito Lay, Quaker, Gatorade
• Strong balance sheet and cash flows support a solid dividend yield and share buyback program

 

 

Tag: PEP

category: earnings

$PEP.US

 

 

 

Julie S. Praline

Director, Equity Analyst

 

Direct: 617.226.0025

Fax: 617.523.8118

 

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

 

www.crestwoodadvisors.com

 

 

Key Takeaways:

 

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

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

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

·         Packaged food is returning to pre-Covid levels

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

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

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

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

 

 

 

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

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

 

 

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

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

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

 

 

The Thesis on MKC:

•          Industry Leader: McCormick & Company (MKC) is a leading manufacturer of spices and flavorings. MKC has been in business for 120 years and the founding family still has ownership interest

•          Growth opportunity: Spice consumption is growing 3 times faster than population growth. With the leading branded and private label position, MKC stands to be the biggest beneficiary of this global trend

•          Offense/Defense: MKC supplies spices to major food companies including PepsiCo and YUM! Brands giving it a blend of cyclical and counter-cyclical exposure

•          Balance sheet and cash flow strength offer opportunities for continued consolidation through M&A in the sector

 

$US.MKC

[tag MKC]

[category earnings]

 

 

Julie S. Praline

Director, Equity Analyst

 

Direct: 617.226.0025

Fax: 617.523.8118

 

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

 

www.crestwoodadvisors.com

 

 

Key Takeaways:

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

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

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

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

 

Current Price: $216     Price Target: $267

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

 

Additional highlights:

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

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

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

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

o   This underscores the benefit of diversified industry end markets.

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

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

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

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

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

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

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

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

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

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

·         Guidance:

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

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

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

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

·         Valuation:

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

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

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

 

 

 

Sarah Kanwal

Equity Analyst, Director

 

Direct: 617.226.0022

Fax: 617.523.8118

 

Crestwood Advisors

One Liberty Square, Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

 

$ACN.US

[tag ACN]

[category equity research]

 

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

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

 

Key Takeaways:

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

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

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

 

Additional Highlights:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

 

Sarah Kanwal

Equity Analyst, Director

 

Direct: 617.226.0022

Fax: 617.523.8118

 

Crestwood Advisors

One Liberty Square, Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

 

$ADBE.US

[tag ADBE]

[category earnings]

 

 

Key Takeaways:

 

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

·         Renewed focus on top line growth:

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

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

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

 

Current Price: $104                             Price Target: $121   

Position Size: 2.72%                           TTM Performance: -1%

 

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

 

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

 

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

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

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

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

 

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

 

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

 

 

MDT Thesis:

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

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

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

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

Category: Equity Earnings

 

Tag: MDT

 

$MDT.US

 

 

Julie S. Praline

Director, Equity Analyst

 

Direct: 617.226.0025

Fax: 617.523.8118

 

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

 

www.crestwoodadvisors.com