Research Blog – INTERNAL USE ONLY

Current Price: $1,945 Price Target: $2,400

Position Size: 2.5% TTM Performance: -1%

Booking is trading up after reporting better than expected results – a relief especially given EXPE’s report yesterday. BKNG reported in-line gross bookings and better than expected room night growth. While guidance was below consensus, they have a track record of guiding conservatively. Expedia’s earnings miss was on higher ad spend, however BKNG’s ad spend was >200bps lower as a percent of revenue YoY, which is reassuring given their better than expected room night growth. So, EXPE needed to spend more than expected on advertising to beat on room nights while BKNG spent less. They do however face the same pressures from Google that Expedia faces –this has been a theme for many quarters as they try to improve ROI on ad spend and try to get more consumers to their site directly. BKNG does have some structural advantages to EXPE including their focus on the more fragmented European lodging market which leads to higher take rates. They also have higher productivity on ad spend – this is driven in part by higher travel frequency in Europe which leads to more direct traffic and also by having fewer brands/banners than EXPE which results in less efficient ad spend.

Key Takeaways:

· Gross bookings growth was +7% constant currency. Guidance was for +3-5%.

· They booked 223 million room nights in 3Q, up 11% YoY. Guidance was for 6-8% growth constant currency.

· ADR headwind: industry occupancy is peaking and ADR’s are weakening as the lodging cycle matures. Lower ADR’s will be a cyclical headwind as revenue is a % of room revenue. This will impact them more than in past cycles as secular growth is slowing with higher penetration..

· Guidance: Management provided Q4 guidance below consensus with bookings growth decelerating to +4% YoY at the high-end of the range.

· Total ad spend declined~233bps YoY as a percentage of revenue, with direct traffic growing faster than pay channels.

· What’s driving advertising spending issues? The driver is less efficient search engine optimization (SEO). SEO refers to where their sites fall in rankings based on search results. The goal is to be at the top and get organic (free) traffic. They also advertise to get traffic. Both EXPE and BKNG spend a ton (>30% of revenue each) on advertising to drive revenue. The goal is to get more direct (go to the app or directly to the website) and/or SEO traffic to the site. The problem is that Google has reformatted how search results show up (a box appears ahead of listed results) which drives traffic to their own sites (this is a source of antitrust scrutiny) and pushes BKNG’s and EXPE’s sites lower in the search results. The consequence of this is exacerbated on small mobile screens, where an increasing amount of the traffic comes from. Yelp has been a vocal critic of Google’s behavior on this same issue.

· Alternative accommodations: “growth outpacing the overall business.

Valuation:

· Repurchased $1.4 billion of stock in Q3 – $13 billion outstanding under repurchase authorization – expect to complete this authorization in the next 2-3 years assuming stable business and market conditions.

· The stock is still undervalued – trading at ~6.5% FCF yield on 2020.

Thesis:

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

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

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

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

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

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

1.) Alternative accommodations

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

3.) Global growth of travel spend > GDP.

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

$BKNG.US

[tag BKNG]

Sarah Kanwal

Equity Analyst, Director

Direct: 617.226.0022

Fax: 617.523.8118

Crestwood Advisors

One Liberty Square, Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

Key Takeaways:

Current Price: $75 Price Target: $115

Position Size: 1.28% 1-year Performance: -34%

EOG released 3Q19 earnings that showed a miss on the revenue line by 2%, but lower costs than expected, with a drilling cost decline of 5% YTD. The premium drilling inventory level increased 17%. 1,470 premium locations were added, with the Wolfcamp M (combo oil/gas) and the 3rd Bone Spring locations. The negative material that came out of this quarterly report is that half of the premium drilling inventory is located in federal land, making it a risk if Elizabeth Warren were to be elected President (she had twitted this past year wanting to stop drilling on federal land). To somewhat offset this risk is the fact that the company has 4 years of permits in process (a permit typically takes 6-10 months to obtain). This regulatory overhang has been driving some of the EOG weakness this year.

Regarding its capital allocation, EOG is targeting a 2% dividend yield (from 1.5% currently), a sign of confidence from the management team in its future cash flows. About 2020 targets, EOG thinks it can achieve a 15% oil production rate, as long as the WTI oil price is in the mid-$50.

From an ESG standpoint, EOG provided some interesting data:

· It is the industry leader in capturing produced gas (vs. releasing it into the atmosphere)

· Remains committed in reducing greenhouse gas emissions, also a leader in this area

Continue reading “EOG 3Q19 earnings summary”

Share price: $123 Target Price: $156

Position size: 1.52% TTM return: +27%

Key Takeaways:

This morning Zoetis released its 3Q19 earnings results, with sales growth of +7% (+9% ex-FX) and EPS growth of +13%. The companion animal segment contributed nicely to performance with +23% operational sales growth thanks to its diverse portfolio of drugs and products: parasiticide, dermatology and diagnostic tools all contributed. The livestock segment declined 4% due to weakness of the US cattle market (trade uncertainty and weather), and the ongoing African Swine Fever, but poultry helped offset some of the loss. While the swine disease has been a small drag to ZTS business, the management team believes China will recover and move towards industrial production rather than returning to the mom & pop backyard swine production, which ultimately would be a good thing for ZTS. The current CEO is retiring at the end of the year, and the newly appointed CEO is Kristin Peck, who was previously VP of Operations. She was asked on the call how she saw the future strategy of the group. She highlighted the possibilities in the diagnostics/labs sector (Zoetis recently acquired Abaxis). This market has been growing over 10% y/y and there are two main players (Idexx and VCA) and Zoetis could become the third, thanks to organic and inorganic growth in the next 2 years. Near term, the launch of Simparica Trio in Europe and Canada is scheduled for 1Q20, and will be a good indicator of sales potential in the US once it is approved for sale, sometime towards the end of 1Q20. Based on those assumptions, the management team currently targets a $150M in sales in 2020. Continue reading “Zoetis 3Q19 earnings summary”

Share price: $57 Target Price: $60

Position size: 2.2% TTM return: 27%

BKI reported in-line revenue and better than expected EPS. Revenue guidance was lowered to the low end of original guidance but in-line with consensus. EPS guidance range was also lowered but the midpoint was still slightly ahead of the street. Revenues and adj. EPS were both +6%. The stock is down because of announced lawsuits between Black Knight and a client, PennyMac. PennyMac is making anti-trust claims against Black Knight and Black Knight is alleging breach of contract and misappropriation of trade secrets by PennyMac. PennyMac has been a customer of Black Knight’s mortgage software products since 2008 and claims that “due to limitations of BKI’s MSP product” they made some efforts to customize and enhance some modules of BKI’s software that they are now trying to claim as their own. Given BKI’s market share leading position, high retention rates and ability to replace the custom in-house solutions of large banks, the claims against them seem surprising and retaliatory. The lawsuit is concerning but does not suggest a change in thesis at this point.

Key Takeaways:

· Given the de-conversion of a specialty servicing client that impacted guidance last quarter and now the PennyMac situation, they are seeing some unusual headwinds into 2020 (~5% hit to top line). Long term targets continue to be 6-8% revenue growth and mid-teens EPS growth. By segment, the expectation is mid to high-single digit growth in Servicing, high-single to low-double digit growth in Origination, and low to mid-single digit growth in Data & Analytics.

· Data analytics segment (~14% of revenue) revenues were up 9% driven by growth in their property data and portfolio analytics businesses.

· Software Solutions segment (~85% of revenue) was up 5%.

o Within this segment servicing (~70% of revenue) grew 1%. This growth was impacted by the client de-conversion and early client termination mentioned on their 2Q earnings call. They continue to dominate first lien loans with leading share and are growing share in second lien loans. Market share for first mortgages has grown from 49% in 2010 to 63% as of the end of Q3.

o Originations (~16% of total revs) made up of new loans and refi’s – revenues increased 25% – lower rates help, but growth also aided by an acquisition and a termination fee.

Valuation:

· Trading at ~4.5% FCF yield on 2020 –valuation is supported by growth potential, strong ROIC with a recurring, predictable revenue model (>90% recurring revenue) and high FCF margins, which is aided by high incremental margins and capex (~9% of revenue now) which should taper as they grow.

· Leverage ratio now at 2.8x, high because of Dun & Bradstreet but decreasing.

· Capital allocation priorities include opportunistic share repurchases, debt pay down and potential acquisitions.

Thesis:

• Black Knight is an industry leader with leading market share of the mortgage servicing industry.
• Stable business with >90% recurring revenues, long-term contracts and high switching costs.
• BKI has high returns on capital and high cash flow margins.

$BKI.UA

[tag BKI}

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

PLEASE NOTE!

We moved! Please note our new location above!

Current Price: $70 Price Target: $90

Position Size: 2.41% 1-year Performance: -10%

Key Takeaways:

This morning CVS published its 3Q19 earnings results. Revenue was up 36% due to the addition of Aetna, but also thanks to positive performance in its legacy business: pharmacy same-store-sales were +4.5% and front end same-store-sales were +0.6%. On the PBM side, claims were up 9.3% y/y, but the ongoing price pressure impacted profitability. Net new business on the PBM side is improving vs. last quarter as well. The onboarding of IngenioRx (Anthem’s PBM) is progressing well. Regarding its HealthHub progress, 50 hubs will be opened by the end of this year. This store format should start having an impact on the company’s results in 2021, once it reached a more critical mass.

So far, the company has repaid $8B of net debt since the Aetna transaction closed, ahead of schedule. Its expected synergies went up from $300-350M to $400M in 2019, for a targeted $900M run rate in 2021. A reminder that in addition to the synergies with Aetna, CVS also expects $1.5-2B in run rate net savings in 2022 from its modernization efforts. It is great to see that thanks to its investments in corporate social responsibility, CVS has been listed in the Dow Jones Sustainability Index for 7 years in a row, and was just added to their World Index. The management team raised its FY19 earnings guidance once more (from $6.89-$7.0 to $6.97-$7.05) as performance has been good. We are glad to start seeing some clarity post-merger on where the combined business is heading, confirming our investment thesis. Continue reading “CVS 3Q19 earnings summary”

Current price: $66 Price target: $77

Position size: 1.67% 1 year performance: +14%

Key Takeaways:

Colgate’s 3Q19 organic sales growth of 4.5% (+1.5% pricing) was the highest in the last 3 years, although helped by easier comps (the truck drivers’ strike in Brazil last year had impacted them). Brazil and China saw a nice rebound from last year, but North America is slowing down, which is impacting gross margins, in addition to higher raw material and packaging costs. Colgate also spent more in advertising and marketing to help lift sales: competition remains tough, especially in toothpaste and manual toothbrushes. The segment that saw the best performance this quarter was Hill’s pet nutrition, up 10% y/y thanks to e-commerce and more natural ingredients. Their 2019 guidance was changed slightly, seeing sales growth between 3-4% (vs. 2-4% previously), but now expects a slight decline in gross margin (vs. slight expansion before). We remain confident the new CEO can continue to bring the company back to top line growth, and eventually margin expansion. Continue reading “Colgate 3Q19 earnings summary”

AAPL reported better revenue and EPS than estimates. Guidance for next quarter, which is seasonally their largest, was also ahead of expectations. By product, iPhone sales were down less than expected. They beat everywhere except Macs. However, for 2019 overall they generated the highest annual revenue ever for Mac.

Key Takeaways:

· Services growth accelerated to +18% and saw double-digit growth in all regions. They have several new services that aren’t making much of a contribution yet (Arcade, Apple News+, Apple TV+).

· Services segment accounted for 20% of revenue and 33% of gross profit. Positive commentary around launch of Apple Card. Apple Pay transactions more than doubled YoY to >3B transactions. Exceeding PayPal’s number of transaction and growing 4x as fast.

· Strong wearables performance (>50% growth YoY) driven by Beats, Watch and air pods. Set a Q4 records for Wearables in each and every market they track.

· iPhones declined 9% in Q4, but beat estimates (improvement from 15% decline they saw across the first three quarters). iPhone 11 is their best-selling iPhone.

· China improved – Greater China revenue at $11.1bn declined 2% Y/Y (up YoY in constant currency), improving from the 4% decline in FQ3. Management called out strong Wearables performance and double-digit Services growth as it saw more gaming approvals in the quarter.

· In general, they seem to be easing on iPhone pricing and it’s helping units. They lowered price points of the new lineup and have taken “lower exchange rates” in some markets internationally. Additionally, being promotional in the sense that customers can purchase their new iPhone with the Apple Card and pay for it over 24 months with zero interest and 3% cash back. With it they also get a year of free Apple TV+.

· Comment on tariffs: “We are paying some tariffs today as you know, some that went into effect pre-September, and some others that went into effect in September. So we are paying some that’s been comprehended. But in general, my view is very positive in terms of how things are going, and that positive view is obviously factored in our guidance as well.”

· They reiterated goal of being net cash neutral “over time.”

Valuation:

· Trading at about a 1.2% dividend yield, and ~5.5% FCF yield.

· They have about $103B in net cash on the balance sheet. That’s over 9% of their market cap.

· The stock is undervalued and substantial buyback from management’s goal of net cash neutral will support valuation.

· In addition to the >$100B in net cash they already have, they produce about $60B in FCF annually. That’s more than all the other FAANGs combined.

The Thesis for Apple:

• One of the world’s strongest consumer brands and best innovators whose product demand

has proven recession resistant.

• Halo effect -> multiplication of revenue streams: AAPL products act as revenue drivers

throughout portfolio – iPhone, iPod, MacBooks, iPad > iTunes, Apps, Software, Accessories,

• Strong Balance and cash flow generation.
• Increasing returns to shareholders via dividends and buybacks.

$AAPL.US

[tag AAPL]

Sarah Kanwal

Equity Analyst, Director

Direct: 617.226.0022

Fax: 617.523.8118

Crestwood Advisors

One Liberty Square, Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

Current Price: $50 Price Target: $61

Position Size: 2.51% 1-year Performance: +9%

Key Takeaways:

Sensata released 2319 results, with sales contracting 2.7% due to weaker end markets. During the call, the management team commented on not seeing any auto industry relief near term, with the GM strike adding salt to the injury. However, the thesis on the name is still there, with content growth allowing ST to perform better than the industry it plays in. Its balance sheet is much stronger than it was a couple of years ago thanks to aggressive deleveraging, allowing the company to act on opportunities as they come.

Segments review:

· Automotive organic sales decline of -0.4%: in China, they saw an improvement over last quarter, but sales were still down. In North America, the sector still has positive growth, but they were impacted by the General Motors strike. The European auto market is still weak.

· HVOR organic revenue growth was -6.2% y/y: construction and agriculture end markets are incrementally weaker, experiencing inventory destocking.

· Aerospace & industrial: organic growth was -6.3%, worse than last quarter. China exports were weak, HVAC was impacted by lower demand of refrigerated trucks. Aerospace remains the bright spot.

Based on current market conditions, ST lowered its growth outlook for 4Q19. They also did a good job during the call at providing more details on future growth projects, for example the role they can play in helping fleet managers reduce downtime and become more efficient though the use of truck-to-trailer link and a telematics ecosystem (a $6B market). This is a place where ST can become a key data insight partner.

Continue reading “Sensata (ST 3Q19 earnings summary”