Research Blog – INTERNAL USE ONLY

GS on Trade

Hi,

Goldman Sachs published a good article today on trade and tariffs.  Many of the article’s points parallel the points in our recent Perspective “Tariff Man”.

  • Base case -0.5 in GDP, with all threatened tariffs at -1.3% GDP
  • Concern that Huawei  ban has solidified nationalist resentment against US
  • Tariff skirmishes has turned to a trade war

The article adds a lot of detail on other implications of trade war, one of which is higher prices.  They are expecting +.2% base case and up to +1.2% in PCE increase given all threats.

GS trade 3.0

Thanks,

John

 

Update on Apple and Tariffs

Yesterday Apple’s Taiwanese manufacturing partner Hon Hai Precision (better known as Foxconn) told investors they have enough capacity outside of China to assemble iPhones for the US market. Most iPhone components are sourced outside of China but labor intensive assembly occurs within China. Apparently 25% of Foxconn’s production capacity is outside the mainland. This addresses concerns that Apple would need to either raise prices ~13-15% to offset potential tariffs or take a margin hit. Foxconn also indicated that investments are being made in India for Apple to expand production plants as a way to diversify the supply chain away from China.

$AAPL.US

[tag AAPL]

[equity research]

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

CVS Analyst Day Summary

CVS held its Analyst Day yesterday. Overall the event was a mostly positive, as the management team provided greater details on their Aetna integration and long-term strategic vision. The main points of the day are highlighted below:

· Retail/HealthHub concept:

During the presentation, CVS focused on their HealthHub initiative. After testing 3 pilot stores in Texas, CVS concluded the concept is viable and will enter 4 new markets by the end of 2019, and ultimately open 1,500 Hubs by the end of 2021. The rapid expansion of the Hubs within its retail stores will allow CVS to incorporate this offering with the benefits design for healthcare plans nationally. Areas of opportunities are chronic care management, home hemodialysis, and analytics. These initiatives should drive $850M in operating income by 2022, and $2.5B longer term.

· PBM:

This part of the business continues to see some pressure, with net new business for FY20 currently at -$8.7bn. While it is not surprising to see some downward pressure following the merger with Aetna, we hope CVS’s guidance for a return to growth longer term will materialize sooner rather than later. There are a number of overhangs in this business that will continue to weigh on sentiment including the pending rebate rule. This should be partially mitigated by continued growth in specialty pharmacy and its new guaranteed rebate net cost model.

· Healthcare Benefits:

There is an opportunity to cross-sell SilverScript’s PDP members onto Aetna Medicare platform. On the Commercial side, management sees a low-single-digit revenue growth and high-single-digit operating profit growth in the near term, as the business remains competitive.

· Guidance:

The 2020 preliminary guidance is in line with expectations:

organic growth in the Health Care Benefits and Retail/LTC segments is partially offset by continued pressure in Pharmacy Services

at least $7.00 in 2020 EPS, representing a 2%+ growth vs 2019 estimated numbers, and EPS will be helped by debt pay down of $7.5bn through the end of 2019

CVS’s 2020-22 EPS growth targets relies on three cost-savings-oriented initiatives that are expected to drive $3.5 billion in earnings improvement by 2022:

1. Enterprise Modernization of $1.5-2.0 billion;

2. Aetna integration synergies of $900 million (vs. $750M previously announced); with $300-350 million in 2019, $800 million in 2020, and $900 million in 2021 and beyond

3. Transformation initiatives of $850 million.

· The enterprise modernization initiative and integration synergies:

CVS has set initiatives to reduce costs and improve productivity, which is expected to generate run-rate savings of $1.5-2.0 billion in 2022, which is separate is from the $900 million of integration synergies.

· Capital Allocation:

Management again pointed to a priority of using cash to pay down debt.

Management expects to generate $10-12 billion of cash to enhance shareholder value in the long term. Once leverage returns to the leverage target, capital allocation will shift to dividend growth, M&A and share repurchase.

[tag CVS]

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

Mexico tariffs impacts on stocks

Last night Trump tweeted that on June 10th the US will impose a 5% tariff on all goods coming into the US from Mexico until the border crisis stops.

Tariffs are scheduled as follow until Mexico acts on the border crisis:

· tariffs will rise from 5% to 10% on July 1st

· 15% on August 1st

· 25% on October 1st where they will remain permanently “until Mexico substantially stops the illegal inflow of aliens coming through its territory

The biggest impact will be felt by STZ that produces its beer in Mexico. 73% of revenue comes from Mexican imports. On the other hand, 40% of COGS are denominated in Pesos, and a likely depreciation of the currency could actually offset some of the tariffs impact on STZ’s EPS. JP Morgan’s analyst sees a high-single-digit/low-double-digit negative impact on STZ’s EPS for the year.

STZ is trading down 5% on last night’s news.

Other names impacted are:

Union Pacific (UNP)- $2B+ of revenue to and from Mexico. Stock down 3% pre-market

Colgate: 10% sales from Mexico. No move pre-market

Pepsi: ~6% sales from Mexico. No move pre-market

[tag UNP] [tag STZ] [tag CL] [tag PEP]

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

JNJ opioids litigations impacting the stock today

It is hard to predict what will happen in the coming years for JNJ regarding the opioids lawsuits… but below are some information that hopefully will help understand the situation:

JNJ had a 10% market share in the branded opioid market, with a settlement liability estimated between $500M and $5B (per Bloomberg). This analysis is based on prior tobacco settlements and costs. Recently competitor Teva (5% market share) settled in Oklahoma for $85M (Bloomberg sees a $250M-$2.5B settlement risk nationwide for Teva). Based on JNJ financials, the settlement amount would not cause bankruptcies risks (only minor impact on EPS based on Bloomberg’s dollar settlement assumptions), but it is hard to assess reputation risks for JNJ going forward.

The company have this information on their website:

https://www.jnj.com/addressing-flawed-reporting-on-opiod-supply

"Addressing Flawed Reporting on Opioid Supply You may have seen media coverage on ongoing litigation related to opioid-based prescription pain medicines. Plaintiffs’ attorneys are distorting the facts on the way heavily regulated raw materials and Active Pharmaceutical Ingredients (APIs) were supplied by former subsidiaries of Johnson & Johnson for use in other manufacturers’ opioid-based pain medications.

We want to be clear – these allegations are false. The facts are:

1. At every step of the process, we adhered to all laws and regulations on the manufacturing, sale, and distribution of APIs and the raw materials used in their manufacture, and we produced APIs and raw materials in accordance with quotas established by the U.S. Drug Enforcement Agency (DEA).

Johnson & Johnson previously owned two subsidiaries, Noramco and Tasmanian Alkaloids, involved in the production of controlled raw materials and APIs used to manufacture prescription pain medications. This manufacturing process is strictly regulated, limited and monitored by the DEA and global authorities. They enforce regulations and set distribution quotas based on their assessment of the need for medicines containing these substances, and our businesses always complied with these rules.

Critically, as a supplier, we did not have any role in the manufacturing, sales, or marketing of the finished products of other manufacturers.

2. We no longer own these subsidiaries, and we do not promote any opioid pain medications in the U.S.

Johnson & Johnson divested Noramco and Tasmanian Alkaloids in July 2016 to focus our attention on other areas of significant unmet medical need.

While we continue to work with stakeholders to support the safe and appropriate use of prescription pain medications, we do not actively promote these medications in the U.S.

3. Although we do not promote prescription medicines containing opioids in the U.S., we believe they play an important role in appropriate pain treatment for some patients, many of whom have no viable alternatives.

Opioid pain medicines give patients and physicians valuable options to help manage the debilitating effects of serious pain. We support the tight control of these medications and their related ingredients. Opioid abuse is a serious problem, and there is consensus among the global healthcare community that we must strike the right balance between offering legitimate pain relief and preventing abuse.

Our priority is to always provide accurate information on our medicines to physicians, so they can make the best and safest choices in partnership with their patients. We acted responsibly in the marketing and promotion of our products and will continue to defend Johnson & Johnson against baseless and unsubstantiated allegations.

Although these issues remain incredibly complex and challenging, we’re committed to being part of the conversation and part of the solution."

[tag JNJ]

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

TJX 1Q20 Earnings Update

Current Price: $52 Price Target: $60

Position Size: 3.6% TTM Performance: 19%

TJX reported Q1 EPS and same store sales (SSS= sales at stores open >1yr.) that were better than expected. EPS was $0.57 vs consensus $0.55 and EPS guidance was raised. SSS were +5% vs consensus +3.6%. Full yr. SSS guidance of +2-3% was maintained. They plan to buyback 2.5-4% of their market cap this fiscal year. It has again been a very mixed quarter of results so far for retailers. KSS, JWN have stood out with weak results. TJX, along with other off-price retailers, continue to take market share.

Key takeaways:

· Traffic was again the biggest driver of SSS (SSS numbers do not include e-commerce).

· Core Marmaxx division (60% of revenue) delivered SSS growth of +6%. Remarkable performance given Marmaxx’s average age of their store base is 20 years old!

· International comp sales grew an impressive 8%. Despite the challenging retail landscape in Europe they continue to take share.

· Merchandise margin was down, but would have been positive ex-freight.

· Just launched e-commerce for Marshall’s.

· When asked on the call about the impact of tariffs they said they incorporated a minor impact in their guidance. “Historically, disruptions in the marketplace have created off price buying opportunities for us.”

· Chart below demonstrates TJX’s resistance to e-commerce and economic cycles. Despite the ramp in e-commerce share of retail over the last several years, of the companies listed below TJX is nearly half of aggregate incremental spend. The companies listed below represent ~$200B of the $275B in US apparel retail sales. Additionally, in the ’08 to ’09 period they were one of few retailers that continued to grow and post positive SSS.

Continue reading “TJX 1Q20 Earnings Update”

Medtronic 4Q19 earnings summary

Key Takeaways:

Current Price: $91 Price Target: $100

Position Size: 2.88% TTM Performance: +4%

Medtronic released their 4Q FY19 results this morning, with organic revenue growth of 3.6%, a +140bps adjusted operating margin expansion and +8.5% adjusted EPS growth. Spine sales combined with its recently acquired Mazor spinal robot grew the most in 2 years (+5.6%), a favorable sign for its upcoming general surgery robot that will be revealed in the fall. Sales were negatively impacted in the quarter by an unexpected sterilization plant closure (should be back up and running in 1Q) and lower sales in heart devices. But overall FY19 results were solid, with organic growth of 5.5%, 50bps margin improvement and a free cash flow conversion of 83%. Continue reading “Medtronic 4Q19 earnings summary”

CSCO 3Q19 Update

Current Price: $56 Target Price: Raising to $63 from $54

Position size: 5% TTM Performance: 24%

CSCO reported very strong 3Q results. Sales and EPS were better than expected and guidance was ahead of consensus. Higher tariffs are included in this better than expected guidance. Adjusted revenue was up 6% and EPS was up 18% (aided by buybacks). They delivered growth across all geographies and businesses, improving margins, double-digit EPS growth, and continued solid cash generation. “We had another strong quarter of performance across the business, demonstrating our ability to execute despite the ongoing uncertainty in both the macro and geopolitical environments.”

Thesis intact, key takeaways:

· Cisco is helping their customers change their technology infrastructure to accommodate new technologies like cloud, AI, IoT, 5G and WiFi 6.

· Their evolving portfolio of products help customers navigate this complexity by helping them simplify, automate, and secure their infrastructure. They are in the early innings of evolving network architectures, so there is a lot of runway to the growth they are seeing.

· Cisco has the only integrated multi-domain intent-based architecture with security at the foundation. It is designed to allow customers to securely connect their users and devices over any network to any application, no matter where they are.

· Tariff increase to 25% is in guidance and offset with pricing and supply chain optimization. “We see very minimal impact at this point.”

· Transition to recurring revenue model. The percentage of recurring revenue is now ~1/3 – they set a goal of 37% by 2020. They are on track to drive software revenue to 30% of total revenue by FY20. Subscription revenue was 65% of total software revenue, up 9 points YoY. This transition will drive an upward trend in CSCO’s margins over the next several years.

· Their largest segment, Infrastructure Platforms (58% of revenue), was up +5% YoY with solid growth across all businesses, switching had another good quarter with growth driven by the continued ramp of the Cat 9K. Routing grew driven by SD-WAN.

· Security was up 21% – pleased also with the integration of Duo into the security portfolio.

· Service revenue was up 3% driven by software and solutions support.

· By geography, Americas was flat, EMEA was up 9% and APJC was up 6%. Total emerging markets was up 5% with the BRICS plus Mexico down 2%.

· In terms of customer segments, enterprise was up 9%, commercial grew 5%, public sector was up 10%, and service provider continues to be weak, down 13%. This is similar to reports from competitors like Juniper which saw weakness in service provider. Service provider revenue is lumpy from quarter to quarter, it’s driven by only a few large customers whose capex is down YoY and will likely be weak until increased network build out of 5G.

Valuation:

· They have a 2.5% dividend yield which is easily covered by their FCF.

· Buyback authorization now at $18B, or over 7% of their current market cap.

· They have ~$17B in net cash. In the quarter they returned $7.5B to shareholders – $1.5B in dividends and $6B in buybacks.

· Forward FCF yield is 6.5%, well above sector average and is supported by an increasingly stable recurring revenue business model and rising FCF margins.

· The company trades on a hardware multiple, but the multiple should expand as they keep evolving to a software, recurring revenue model. Hardware trades on a lower multiple because it is lower margin, more cyclical and more capital intensive.

Thesis on Cisco:

· Industry leader in strong secular growth markets: video usage, virtualization and internet traffic.

· Cisco is the leader in enterprise switching and service provider routing and one of the few vendors that can offer end-to-end networking solutions.

· Significant net cash position and strong cash generation provide substantial resources for CSCO to develop and/or acquire new technology in high-growth markets and also return capital to shareholders.

· Cisco has taken significant steps to restructure the business which has helped reaccelerate growth and stabilize margins.

$CSCO.US

[tag CSCO]

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

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#researchtrades Increasing US Small Cap, Decreasing US Large Cap

Good Morning,

As a follow up to our earlier meeting, we will be increasing our exposure to U.S. Small Caps (IJR) and reducing exposure to U.S. large caps. Below are the trade amount (bps) across the different models. Also, attached is the presentation. Please let me know if there are any questions.

Thank You,

Pete

[Asset Allocation]

Peter Malone, CFA

Research Analyst

Direct: 617.226.0030

Fax: 617.523.8118

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

www.crestwoodadvisors.com