Research Blog – INTERNAL USE ONLY

Good morning,

 

Hydrogen has been talked a lot in the past couple of years. I wanted to provide a high level understanding of what it is, and its application for the vehicle market. Attached is also BMO’s primer on the subject (very dense report…) and BTIG’s initiation on PLUG.

 

Hydrogen can be produced in various ways, see the chart below:

 

 

 

Comparison of fuel cell electric vehicles (FCEV or hydrogen),  and battery electric vehicles (BEV).

 

Currently there are millions of plug-in electric cars (mostly battery EV)  globally vs. thousands of hydrogen cars, dominating the automotive market. Until industrial production and supply of hydrogen improves, looks like this will remain the case for cars. But for the larger vehicle and aviation markets and even in industrial and domestic heating, hydrogen could be a good alternative to meet net zero carbon emissions target. One technology is not exclusive of the other, they could both play a role in decarbonization efforts.

 

Who makes hydrogen fuel cell vehicles? Toyota, Honda, Hyundai. Some automakers have stopped funding hydrogen research favoring BEV, while some maintained a portion of R&D spending towards it.

 

Hydrogen cars:

Positive of hydrogen:

• Quick to refill tank (like fossil fuel)
• Longer driving range than BEV – could be better suited for trucks with heavy loads
• Light to transport
• Great for warehouses that can refill on site quickly
• Hybrid hydrogen vehicles seems a good alternative

 

Negative of hydrogen:

• High risks of explosion, especially during transportation/processing – not so much during use in a car (fuel tanks are Kevlar-lined to protect from detonation.
• Processing of hydrogen is not very energy efficient, running at 25-30% efficiency vs. 70-80% for BEV due to processing & transporting it
• 95% of hydrogen comes from fossil fuel, although the technology for green hydrogen is progressing
• Infrastructure is small compared to charging stations for BEV
• Cost of hydrogen for refueling is higher than fossil fuel, although some auto manufacturers offer to pay for it (in California)

 

Battery EV:

Positive of electric battery:

• More energy efficient than hydrogen fuel cell cars
• Technology more suitable for mass rollout (more cost efficient to produce), resulting in accelerated production rate

 

Negative of electric EV:

• Time to recharge battery
• Doesn’t work well for heavy vehicles
• Battery degradation

 

 

 

 

 

 

Potential positive catalysts:

• Infrastructure bill: in the US, the trillion dollar infrastructure bill that earmarks billions for EV charging infrastructure, hydrogen production/hubs and many other programs has been held up in the House of Representatives. $15B for electrification and related services, including $7.5B for EV charging stations (500K vs 100K available today) and $9.5B for hydrogen projects including $8B for regional supply, $1B for electrolyzers and $500M for companies that innovate with hydrogen (the US DOE intends to reduce the cost of green hydrogen production to $2/kg by 2026).

 

• The proposed Build Back Better Act (budget reconciliation bill) has many provisions for electrification of mobility as well as a clean hydrogen production tax credit). Another key provision being discussed is a new clean hydrogen production tax credit that would offer $3/kg to hydrogen with 95% fewer lifecycle GHG emissions than hydrogen made through the currently dominant method, steam reforming.

 

• COP26 (ongoing this week and next): Stated goals of COP26 include securing global net-zero by mid-century and keep global warming within 1.5 degrees. Recommendations could come for phasing-out coal, reducing deforestation and accelerating EV/renewable energy.

 

 

 

PLUG stock comments:

Plug Power is a leading supplier of hydrogen fuel cell technology. It currently has a first-mover advantage in scaling its technology and deploying a network of hydrogen production/fueling system. It has a partnership with SK Group and Renault, Brookfield Energy, Apex to name a few. It main focus is currently large warehouses with a high number of forklifts to justify the cost of installation before accounting for CO2 emissions reductions, putting Amazon and Walmart as big customers – driving 70% of revenues (a risk in our eyes, which needs to be mitigated over time by signing on new clients).

The company also focuses on heavy duty trucks, medium duty (for example delivery vans), small robotics and aerospace UAVs. Their focus is not individual cars. Higher oil and natural gas prices are an opportunity for PLUG, with cost of ownership of diesel trucks higher than FCEV and BEV.

Valuation currently looks rich as it is not profitable (could be in 2023-24), and assumes supportive government policies. The stock is very volatile.

 

 

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

 

Share Price: $141            Target Price: $160 (increased from $150)

Position Size: 2%              1 Yr. Return: +64%

 

 

Key takeaways:

• Very positive quarter and strong progress on recovery as RevPAR continues to recover faster than expected leading to better than expected Q3 results. Q2 system-wide RevPAR continued to improve vs. 2019 baseline, w/ RevPAR for the quarter down -19% vs 2019.
• Seeing very robust demand trends – trends continued to improve into the current quarter, leisure demand is exceptionally strong and business travel is recovering.

• Solid unit growth, ahead of guidance (+6.6% YoY) – this provides key support to LT growth story, as industry leading RevPAR premiums continue to drive a high quality pipeline.
• China is not a problem – China is an important part of their pipeline and growth there is intact. Commentary around China was very optimistic.

 

 

Highlights:

• Demand is recovering…despite (now easing) headwinds from international travel restrictions
• Leisure is leading the recovery w/ record performance; leisure rates are already exceeding 2019 levels
• Bookings for all future periods are just 8% below 2019
• Roughly 40% of system-wide hotels have exceeded 2019 RevPAR levels in October month-to-date.
• Business transient is improving, Group will be last to recover.
• Business transient room nights were roughly 75% of prior peak levels and group RevPAR was approximately 60% of 2019 levels, both improving meaningfully from 2Q.
• Outlook for business travel is very strong. Currently business is being heavily driven by SMB demand, which is more rate sensitive. About 80% of their corporate demand is from SMBs – they’re getting close to 2019 levels while large corporates are down 40% from 2019.
• Group demand takes longer to recover given planning lead times for large social events and business conferences. Future group booking are occurring at higher rates than 2019. They are seeing huge amounts of pent-up demand and think 2022 will be a “barn burner” year for their group business. “Rates are up because we’re being super disciplined recognizing that there is a limited amount of meeting space is going to be a gargantuan amount of demand and we can be a bit patient.”
• Margins going up…in an inflationary environment, they have pricing power and a significant portion of their revenues are royalties tied to top line. Franchising is almost 2/3 of EBITDA and tied to top line, managing is another 25% of EBITDA where the fee stream is a mix of base management fees (% of room revenue) and incentive management fees (% of hotel profitability). So, in an inflationary environment, pricing power = margin expansion. This margin tailwind is in addition to cost efficiencies gained through Covid, including lowering labor intensity.
• Inflation and pricing power…
• “the laws of economics are alive and well. Why is leisure so strong in rate? why are we able to price above historically high levels? because they’re crazy amounts of demand. Like our weekend demand is off the charts, we’re running 85% to 90% system-wide in the US on the weekends. And we’re pricing over ’19 levels, obviously because we have a lot of demand.”
• “typically it’s a grind to build back occupancy and rate lags significantly, ….rate is leading the charge.”
• “we’re in an inflationary environment and guess what? We can re-price our product every second of every day we’re a very good hedge in that way to inflation and we’re being very thoughtful about how we’re pricing our product.”
• “we’re going to have more inflationary environment broadly. Thank you, Federal Reserve and the US Congress for fiscal and monetary stimulus, …we could debate transitory or otherwise. But those things are translating into broadly, a more highly inflationary environment and that applies to us too, and that obviously is helping from a pricing power point of view.”
• Pipeline – Stable unit growth underpins the story
• Development activity continues to gain momentum across the globe as the recovery progresses.
• China development activity is particularly strong – China net unit growth rising due to new franchising  initiatives and rapidly growing demand for mid-scale hotels in China. The say the addressable market there is enormous (easily 20K hotels or more). This will be a LT source of growth for them.
• Unit growth in Q3 was 6.6% YoY and the pipeline increased to >400K rooms. That represents 40% room growth from their current installed base of rooms and more than half are under construction (helps underpin several yrs. of predictable growth).
• 62% of their pipeline is located outside the US (mid-tier focus tied to growing global middle class)
• Continued strength in their market leading RevPAR index. RevPAR index is their RevPAR premium/discount relative to peers adjusted for chain scale. I.e. Hampton Inn (35 year old brand) has a RevPAR index of 120. They are the market leaders – this is helpful because it’s what leads to pipeline growth (hotel operators want to associate w/ the brand that yields the best rates and occupancy) and is helpful in a macro downturn because it’s even more crucial for a developer to be associated with a market leading brand to get financing. The thought is that they would likely take more pipeline share if lending standards tighten and that’s exactly what we’ve seen during Covid. The other countercyclical aspect of their pipeline growth is conversions (an existing hotel changes their banner to Hilton). They continue to see a record number of conversion signings which were 1/3 of total signings in the quarter.
• ESG – named the number three World’s Best Workplace by Fortune

• Shareholder returns should improve w/ recovery – likely will resume 1H22. In 2019 they returned more than 8% of their market cap to shareholders in the form of buybacks and dividends. They intend to return to their historical capital return model.

 

New hotel to keep in mind if you’re headed to Japan….. Roku Kyoto…https://lxrhotels3.hilton.com/lxr/roku-kyoto/

 

$HLT.US

[category earnings]

[tag HLT]

 

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:   $328                     Price Target: $375 (from $340)

Position Size:    8.3%                     TTM Performance: 62%

 

Key takeaways:

• Broad beat with 22% YoY revenue growth and +27% op. income growth.
• Azure continues to be key growth driver – continuing to take share in the public cloud with revenue growth of +51% YoY (+45% constant currency), similar to last quarter.

• PC Market better than expected despite supply chain headwinds –  Windows OEM numbers blew away their guidance and guidance for December quarter was also way above what investors were expecting. “The future of how we work, connect, and play, one thing is clear: the PC will be more critical than ever. There has been a structural shift in PC demand emerging from this pandemic.”

• CEO, Satya Nadella said…“Digital technology is a deflationary force in an inflationary economy. Businesses – small and large – can improve productivity and the affordability of their products and services by building tech intensity.”

 

Additional Highlights:

 

• More quotes…
• On labor market: “We are experiencing a great reshuffle across the global labor market as people are rethinking not only where and how they work, but why, and as more people change jobs than ever before.” Hires on LinkedIn were +160% YoY.
• “Cybersecurity is the number one threat facing businesses today.”
• “will need to watch the advertising market through the quarter because obviously their willingness to spend is entirely connected to their supply as well.”
• On inflation: “in an inflationary environment, the first place any business should go to is, how to really ensure that they’re able to get productivity gains and, even dealing with constraints for example, if you have supply chain constraints one of the things you want to do is run your factories at the efficient frontier. That means things like digital twins, simulation are the ones where you are going to make sure that every production run has the least amount of wastage. So I think any which way you look, whether it’s in the knowledge worker, first-line worker, whether it’s actually digital twins and simulation, all of those things are going to be the best way for any company to deal with inflationary pressures, so that they can in fact have the best productivity and thereby the best ability to be able to meet aggregate demand out there. So that’s why we are very, very excited about sort of making sure our software products are available to our business customers all around to be able to manage through this inflationary environment.”
• Commercial cloud, which aggregates Azure, Office 365, the commercial portion of LinkedIn and Dynamics accelerated by 500bps sequentially to +36% YoY cc growth reaching >$80bn run rate (Azure is high $30B’s run rate, so approaching half). They continue to see significant growth in the number of $10 million plus Azure and Microsoft 365 contracts. Cloud gross margins increased 400bps (excluding the impact of an accounting change).
• While Microsoft benefited from accelerated digital transformation from the pandemic, they are well positioned to capitalize on a number of long-term secular trends that will continue to drive mid-to-high teens earnings growth. Secular drivers include public cloud and SaaS adoption, continued digital transformation, AI/ML, BI/analytics, and DevOps. As organizations become increasingly digital, MSFT’s products are evolving from being primarily productivity tools to being more strategic tools. This suggests an improving value proposition to customers, which is key to the durability of their LT growth and profitability.
• Productivity and Business Processes ($15B, +22% YoY):
• LinkedIn – revenue increased 42% (up 39% in constant currency) driven by Marketing Solutions growth of 61%. LinkedIn now has nearly 800 million members. And now has 15K enterprise customer for LinkedIn Learning and seeing high demand for upskilling/reskilling employees.
• Office 365 Commercial (rev +23%)- driven by installed base expansion as well as higher ARPU.
• Dynamics 365 (rev +48%) – Power Platform (low-code, no-code tools, robotic process automation, virtual agents and business intelligence) now has nearly 20 million monthly active users up 76% YoY.
• Intelligent Cloud ($17B, +31% YoY):
• Server products and cloud services revenue increased 35% with Azure revenue growth of 50% (48% cc). Exceeded their expectations across consumption and per user Azure businesses as well as their on-premises server products business.
• An increasing mix of large, long-term Azure contracts can drive quarterly volatility in the growth rates. Leader in hybrid cloud and have more datacenter regions than any other provider – and continuing to add data center regions, including new regions in China, Indonesia, Malaysia, as well as the US.
• More Personal Computing ($13.3B +12% YoY):
• Windows OEM revenue increased 10%
• Surface was weak (down 17%) as constraints in the supply chain continue
• Gaming revenue increased 11% (7% in constant currency). Xbox hardware revenue grew a 166%, driven by demand for new consoles and better than expected supply. Xbox and content and services revenue increased 2% against a high prior year comparable.
• Search advertising revenue increased +40% YoY as companies pick up spending on digital advertising
• Valuation:
• Recurring revenue is ~60% of total, underpins most of their valuation and is resilient and poised for additional growth. Particularly Azure, Office 365 and Dynamics 365. Stock is trading at <3% forward FCF yield; a premium to the S&P, but supported by their high moat and solid secular growth drivers.

 

 

 

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

 

Advising to not buy in new accounts or add money to the position. Will use LMT over time to fund new ideas.

 

Generally, the slowdown was expected, with the stock’s performance reflecting this (flattish prior to this quarter’s earnings release). What was surprising was the magnitude of the decrease in sales growth projected for 2021-2023, with new programs coming online later in the decade, vs. what we were expecting (a faster timeline of execution). Lockheed has been a solid, consistent performer in the last 10 years. This guidance revision is unexpected, and looks to us like a red flag to the investment thesis.

 

Current Price: $332        Price Target: $396 (NEW) 

Position Size: 2.27%      1-year Performance: -5%

 

A new price target of $396 is reflecting the lower top line growth and flat margins. While valuation and dividends are somewhat attractive, we think it could take years for this growth to materialize and reflect a below-peers growth story near-term.

 

Overview of 3Q2021 results:

Results were mixed, with sales below consensus but margins better. The -3% sales decline was mostly due to Missile and Space segments (-6.4% y/y  from tactical and strike missiles, sensors and sustainment programs) and Space segment down 5% (due to the AWE program – the UK nuclear program).

Overall margins held well +130bps overall.

 

Guidance downgrade:

For 2021

• Sales guidance reduced by 1.5% due to Aeronautics sector but margins maintained. Mostly due to supply chain delays.
• Cash flow guidance reduced by 6.7%

For 2022

2022 seems like the reset year for growth going forward. There is about a $1B headwind to 2022 revenue from various parts of the portfolio, driving the 1.5% sales decline:

• Top line reduced due to supply chain delays, and the continuing effects of the ongoing COVID pandemic and extended delivery timelines across our supply chain – worsen towards the end of Q3 2021.

• Moderating growth rates in the U.S. defense budget: LMT guided to lower growth than what the DoD budget is set to grow at, and lower than peers – peers could possibly guide to high?
• Shifts in customer priorities driven by recent events, such as:
• the withdrawal of U.S. forces from Afghanistan ($200M or 0.3% of total 2021 sales)
• the renationalization of the AWE program in the UK (1.2% of total revenue for 2021)
• Program maturity:
• F-35: while the entire program $ remains the same, the delivery timing is pushed to out years, impacting the next couple of years’ sales. What this means is that instead of delivering 170 F-35, the company now targets 156 F-35 for a longer time period (through 2035). In addition, the F-35 sustainment growth was reduced slightly from high single digits announced in September to 6%. 2022 impact from F-35: $400M or 0.6% of 2021 revenue
• Black Hawk: $350M impact from program reaching maturity
• Previously mentioned classified program is still early on and won’t offset decline in other programs quite yet.

Cash flow guidance reduction of 6.7%, and unclear thereafter. Aerojet purchase remains on the table but pushed out to 1Q22 rather than 4Q21.

 

For 2023-2026:

Slight increase in 2023 with steady growth after – depending on new programs production start. Operating cash flow guidance is not clear, depending on growth program cash needs.

Drivers to growth:

• Performance on current programs
• Sikorsky CH-53K has funding support – should add incremental $300M in 2022
• Space funding support OPIR and GPS
• Ability to win new programs
• Future defense budget
• Global political landscape

Growth areas:

• Hypersonic portfolio – working on 6  programs currently with multiple ones entering production in 2023 and 2026
• Classified activity: production could start in 2023 and 2026
• CH-53K heavy-lift helicopter, F-35 sustainment, PAC-3 increased production, modernization of Fleet Ballistic Missile

 

Capital allocation update:

LMT is looking to do a $6B of share repurchase in 2022-2023 (already announced prior to this earnings report). An additional $5B was accepted in Q3, shifting the focus to share repo near term.  Capex will go up in 2022 to support the Space segment. Any remaining cash will go towards dividends (+8% just authorized – increasing the yield to 3.4%).

 

 

Because LMT has made multiple advance payment in its pension plan, it is not expected to make a required pension cash contribution before 2026 with minimal contributions thereafter.

There is a potential change comping for R&D tax amortization, removing the allowance to write off R&D from a tax perspective. Instead of being able to expense it all in the year it was expensed, it will be amortized over 5 years. This means that in 2022, only 20% of 2022 R&D expenses can be used as a tax shield. For LMT, this represents a $2.2B impact on 2022 FCF.

 

 

 

 

LMT Thesis:

·         Lockheed Martin is a primary beneficiary from the replacement cycle for aging military aircraft and ships

·         Excellent management team focused on returning capital to shareholders

·         Strong cash flow and financial position

    

[category earnings] [tag LMT] $LMT.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:

 

Current price: $263                     Price target: $322  

Position size: 2.95%                    1-year performance: +50%

 

• Revenue growth of +20% y/y thanks in part to the Philips recall that had a positive impact on Resmed sales, adding $80-90M. The launch of AirSense 11 is also boosting sales, while the prior model AirSense 10 has not seen a price decrease as usually would be the case, most likely due to worsening supply chain issue. Q2 and Q3 sales growth will be impacted by supply chain issues, but the  company did not lower its full year sales guidance, suggesting a return to normal towards next summer.
• Devices sales lifted by competitor Philips recall:
• US devices sales were +40%
• Rest of world devices sales +24%
• Masks segment saw a sales slowdown due to lower new patient intake, but still reaching +9%
• US masks sales +4.5%, supported by their resupply program of current patients – the lower level of new patients will have an impact on future growth though
• Ex-US market +18%
• Software-as-a-service business: mid-single digits growth to increase high-single-digits throughout the year.
• Covid-driven demand for ventilator is now $4M from $40M last year.
• Gross margin impacted by higher freight costs. bps y/y  The launch of premium priced AirSense 11 (+15-25% per Goldman Sachs) should help gross margins in the coming quarters.

 

 

On the M&S front, RMD is under levered and has access to $1.5B in liquidity for bolt-on deals. This quarter, RMD completed the acquisition of Ectosense (a global producer of cloud-connected home sleep tests).

We think the stock is down today due to higher freight costs (profitability impact) and potential slowdown in sales in the coming quarters due to supply chain issues (by now, hopefully this is no longer a new theme to anyone!!).

 

 

Thesis on RMD:

• Leading position in the underpenetrated sleep apnea space
• Duopoly market
• New product cycle
• Returns of capital to increase: ~1% share buyback/year (back in FY18), dividend yield of 2%

 

$RMD.US

[category earnings] [category equity research] [tag RMD]

 

 

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:

Current Price: $266                          Price target: $293

Position size: 2.41%                        1-year Performance: +31%          

 

Stryker released its 3Q 2021 earnings last evening. Sales were up +4.5% organically y/y (+8.4% from 2019).

• The US knee/hip/spine business showed some slowdown during the quarter, as those procedures are more deferrable than others more urgent.
• The Delta variant was most impactful in Florida and Texas, with a peak seen in early September.
• Staffing shortage worsen between July and September
• Medical and surgical equipment remains good with orders up.
• Ongoing demand for Mako (Robotic surgery) continues, despite competitive landscape. Half of new sales were in new hospitals.
• New catalyst: the company is developing a shoulder surgery robot for shoulder implants as well – no launch date yet.
• Gross margins expanded 55bps vs. 2019 but operating margins were flat.

 

Although the management team had increased its guidance for 2021 due to good recovery in Q2, it is now lowering its target by ~2% (now 7-9% from 9-10%)) to account for Delta variant impact and staffing shortages likely to persist through year-end. EPS guidance is lowered as well to $9.08-9.15 (versus $9.25-9.40 prior).

 

Valuation is not overvalued, but not cheap either where I would want to add to the position. Long-term thesis is intact.

 

 

   SYK Thesis:

• Consistent top and bottom line growth in the mid and upper single digits respectively
• Continued operating leverage of current infrastructure
• Strong balance sheet and cash flow used in the best interest of shareholders

 

$SYK.US

[category earnings] [tag SYK]

 

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

 

Current price: $318         Price target: $330

Position size: 4%              TTM Performance: 38%

 

 

Key Takeaways:

• Results being weighed on by supply chain constraints that are resulting in raw materials shortages. Mgmt. had already cut guidance in the beginning of September.
• Price increases are lagging higher raw materials costs which is weighing on margins now, but will improve. Committed to fully passing through higher raw materials which they now expect to be in the low-20’s percent increase for the year vs expectations for mid-teens previously.
• Underlying demand trends continue to be strong and mgmt. feels shortages are starting to improve. Strong housing market and improving industrial end markets bode well for demand.
• DIY demand is normalizing after pandemic driven surge. Increased demand from Pros, commercial and industrial are offsetting.

• Quotes from the call…
• “the demand environment remains robust across our pro architectural and industrial end markets. Many external indicators and, more importantly, our customers remained highly positive. Demand is not the issue“
• “raw material inflation remained persistently high and raw material availability failed to improve.”
• “We are aggressively combating raw material inflation with significant pricing actions across each of our businesses. We implemented multiple price increases in the quarter. We will continue to do so as necessary. We continue to work closely with our suppliers on solutions to improve availability sooner rather than later. At the same time, we’re exploring every avenue to better control our own destiny going forward, including our recent announcement to acquire Specialty Polymers.”
• “we are confident we will see significant margin expansion as availability and inflation headwinds eventually subside.”

 

 

Additional Highlights:

• Revenue and margin headwinds will subside…
• Supply chain disruptions are temporary headwind to growth – sales increased 0.5% as raw material availability negatively impacted sales by an estimated high-single-digit percentage.
• Gross Margins will improve – similar to past cycles, price increases come at a lag to higher raw material costs which are 80-85% of COGS for paint. The result is a near term hit to gross margins, but they will maintain pricing and see gross margins expand as some of the temporary drivers to higher commodity costs recede. A 630bps hit to GM was partially offset by 90bps lower SG&A.
• They’re taking action (all of which is aided by their scale & pricing power) – price increases, vertical acquisition (specialty polymers) that will aid supply, and they continue to invest in growth initiatives – they have significant production capacity available today and are bringing 50 million gallons of incremental architectural production capacity online over the next two quarters.
• “We’re leveraging all of our assets, including our store platform, our fleet, our distribution centers and more, to let us come up with unique and creative customer solutions that others simply can’t”…” We are unique in the fact that we have our own fleet of vehicles, we have 860 tractors and 2,100 trailers that we use to expedite these raw materials into our plants and in many cases right now from our plans to customer projects, so it’s the entire supply chain… working to expedite and cut out as many days as possible.”
• America’s Group ($3B), -0.4%:
• Significant raw material availability headwinds; same store sales decreased 2.8%
• Pro architectural demand remains robust; expect delayed projects to be completed with improved product availability.
• DIY sales down double-digits, driven by difficult prior year comparisons and consumers returning to the workplace
• Consumer Brands Group ($647m), -23%:
• Lower DIY demand was a big drag (but is their smallest segment) resulting in lower sales volumes to their retail customers – this was partially offset by selling price increases. Also saw drag from raw material availability and a divestiture.
• The Performance Coatings Group ($1.5B), +17%:
• Sales increased 17.4% with growth in all divisions and regions
• Packaging and General Industrial had highest YoY  increases and positive in every region; Coil strength continues globally. Auto Refinish solid as miles driven nearing pre-pandemic levels. Industrial Wood impacted by customer shutdowns in Southeast Asia due to COVID.
• Acquiring Specialty Polymers, should close by year-end – they’re a US based leading manufacturer of water-based polymers used in architectural and industrial coatings. This adds to their existing internal resin manufacturing capability.
• FY Guidance: expect high-single-digits percentage sales increase
• TAG: up high-single-digits percentage
• CBG: down mid-teens percentage – includes negative 4% related to Wattyl divestiture
• PCG: up low-twenties percentage
• Raw materials: up low-twenties percentage
• Continue to expect margin expansion over the long-term and maintain their gross margin target in the 45% to 48% range…from <42% now.
• Balance sheet remains strong – leverage ratio is ~2.6x. Debt is 92% fixed rate.
• Strong history of returning capital to shareholders continues – In 2020, they increased their dividend 19%, marking the 42nd consecutive year they increased their dividend.
• Valuation – trading at ~3.1% forward FCF yield.

 

 

 

 

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

 

$SHW.US

[category earnings]

[tag SHW]

 

Current Price: $149                                                    Price Target: $166

Position Size: 6.7% (our smallest active position)TTM Performance: +29%

 

Key Takeaways:

 

• Issues with supply, not demand: quarterly results and guidance are being negatively impacted by supply chain constraints, but they continue to see record demand. The revenue miss for the quarter was entirely supply driven (semi shortages and Covid related manufacturing disruptions in southeast Asia).
• China continues to be strong – +83% YoY growth, significantly growing the installed base.
• Guidance – Supply constraints will be a bigger impact in Q1 (December quarter) than in Q4, but still expect to set a new revenue record for the December quarter. Supply constraints will be biggest w/ iPad – expect YoY revenue growth for each product category, except for iPad. Expect Services growth to decelerate. Expect gross margin to be between 41.5 and 42.5% (from <40% in 2020).

 

Additional highlights:

 

• Seeing record demand – Q4 revenue was $83.4B, +29%, putting FY revenue at $366B, +33%, with record performance across the board. Every product category and every geographic segment set a new annual revenue record and was up at least 20% over fiscal 2020.….despite larger-than-expected supply constraints.
• Margins expanding – gross margins are up significantly YoY (but down sequentially) aided by higher margin Services. Services gross margin hit an all-time high of 70.5%, up 70bps sequentially, mainly due to a different mix.
• Supply constraints:
• Impacted Q4 by $6B which was much bigger than their revenue miss.
• Q1 (December quarter) will see an even bigger impact.
• Key issues were semi shortages and Covid related manufacturing disruptions. The semi shortages will continue, but the factory closures are improving. Chip shortages impacting iPhone, iPad and Mac.
• Shortages are in legacy nodes (these are less sophisticated chips and less in their control b/c they have proprietary leading edge chips, but not their own legacy chips). “In terms of the chip shortage, the chip shortage is happening on legacy nodes, primarily we buy leading edge nodes, and we’re not having issues on leading edge nodes. But on legacy nodes, we compete with many different companies for supply and it’s difficult to forecast when those things will balance, because you’d have to know kind of how the economy is going to be in 2022 and the accuracy of everyone else demand projections. And so I don’t feel comfortable in making a prediction.”
• Segments:
• iPhone – $39B in Q4 revenue, up +47% YoY. The iPhone 13 family was introduced and is in very high demand. Installed base is >1 billion devices.
• Mac – this quarter was all time record and the last five quarters for Mac have been its best four quarters ever. Revenues were up +2% YoY despite supply constraints.
• iPad – up 21% in spite of significant supply constraints. On the 9^th generation iPad, powered by the M1 chip.
• Wearables – grew 12% YoY. Nearly 75% of Apple Watch buyers were new to the product. This quarter, they introduced Apple Watch 7.
• Strong Services growth driven by growing installed base –
• Revenue +26% YoY; set a new all-time revenue record ($18.3B in Q4; $68B for FY21).
• All-time record for cloud services, music, video, advertising, AppleCare and payment services
• Now at 745m subs, added 45m from Q3; and up 160m from last yr. and 5x the number of subs they had less than  5yrs. ago.
• Apple Card won a J.D. Power award for customer satisfaction in its very first year of eligibility
• Introduced Apple Podcast subscriptions last quarter
• 5G upgrade cycle – only in the early innings of 5G. If you look at their 5G penetration around the world, there is only a couple of countries that are in the double digits yet.
• Why we still like…
• Big moat underpinned by growing installed base which drives their virtuous cycle.. More users of their devices lures developers to create better apps which lures more users. This is key to their LT growth. Apple continues to significantly expand their installed base. And they have multiple new products being launched and more in the pipeline (e.g. AR glasses, Apple car) that could be key drivers of LT growth….and, importantly, a growing services business tied to all these products. Part of what differentiates Apple is they design their own silicon for the processor chips that are the brains of their iPhones and iPads and now their Macs, which gives them better control over performance and feature integration in their devices. This has proven to give them an advantage with the way they design their products and an advantage with developers. So, now they have Macs, iPhones and iPads running the same underlying technology which should make it easier for Apple to unify its apps ecosystem, including allowing iPhone and iPad apps to run on Macs. This advantage and the relevance of their ecosystem gets more and more important as computing power in phones increases, 5G delivers better connectivity and, as a result, we have the ability to use their devices in enhanced ways (w/ increased revenue opportunities) ….like apps that take advantage of augmented reality and IoT related technologies.
• Apple is still not expensive…
• Trading at >4% FCF yield on 2022 (in line w/ S&P) and a 0.6% dividend yield w/ another almost 3% of their market cap ($66B) in net cash on their balance sheet.
• For reference, pre-pandemic in Jan 2020, Apple was trading at ~4.7% FCF yield and 1% dividend yield with ~7% of their market cap in net cash.
• Their market cap has been tracking their massive increase in FCF estimates.
• Huge amount of cash on their balance sheet w/ years of buybacks to support valuation
• Capital returns may need to expand further to hit their net-cash-neutral target in a few years. 
• With current net cash of ~$66B and expectations of nearly $450B of FCF over the next 4 years, shareholder returns could be ~$500B or  >20% of their current market cap.
• They’ve returned >$530B since 2012. So, from 2012 to 2026, they may return >$1T.

 

 

 

 

 

 

$AAPL.US

[category earnings]

[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

 

Key Takeaways:

 

Current Price: $74.3                       Price Target: $88   

Position Size: 1.90%                       1-year performance: +20%

 

Fortive (FTV) reported 3Q earnings last night. Overall the recovery is taking hold, and FTV is showing its strength with pricing gains this quarter.

• Organic growth of +9% (+12% total growth)

o   All three segments had positive sales growth:

Ø  Advanced Healthcare Solution +5% organic (24% of revenue): elective procedures in the US were below pre-covid levels and impacted the sales of consumables products. However capital equipment continues to grow

Ø  Precision Technologies +7.7% organic (36% of revenue)

Ø  Intelligent Operating Solutions +13% organic (41% of revenue)

• Software-as-a-service grew 13%: FTV is building scale and differentiation with its software offerings: it has almost $750M of annualized revenue growing +double-digits
• with high recurring revenue / operating margins
• Adjusted operating margin 22.8%, +325bps, above guidance, thanks to multiple drivers: software-as-a-service strength, better pricing (+2.2%) and cost control benefits
• There is good momentum going into 4Q and 2022 thanks to order growth of 20%, amid the supply-chain challenges
• Some of the demand is being pushed-out to 2022 on delays, but remains strong and should supply returns to normal little by little, growth in 2022 would be better than the mid-single-digit target

 

2021 guidance updated:

·       narrowed 2021 guidance for adjusted EPS to $2.70-$2.75 (vs $2.65-$2.75 prior), up 29-32% y/y

·       Organic sales growth now seen at 10.5-11% (vs 10.5-12% prior)

·       Adjusted operating margins at 23-23.5% (vs 22.5-23.5% prior)

 

 

FTV Thesis:

• Market leader:
• Leadership position in most of the markets they serve
• Experienced leadership team
• Above industry margins with strong cash flows
• Quality:
• FCF yield ~5%
• Organic growth target of 3-3.5% (4-5% in last 2 quarters after being under the target in prior quarters)
• M&A strategy to enhance top line growth
• Margins expansion from new products introduction, continued application of the Fortive Business Systems and M&A integration
• Shareholder friendly:
• Management team focused on shareholder wealth creation through top line sustainability and margin expansion

$

FTV.US

Category: earnings

Tag: FTV

 

 

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

 

Current Price: $2,923     Price Target: $3,450 (raised from $3,100)

Position Size: 4.8%         TTM Performance:+93%

 

Key Takeaways:

• Broad beat – gross revenues were $65.1B up 41%
• Continued meaningful op leverage despite resumption of spending on headcount – OM expanded sequentially for the 5th quarter in a row. Now at 39% on net rev, well ahead of high 20’s pre-pandemic.
• Digital ad spending continues to surge – saw broad-based strength in advertiser spend, particularly w/ retailers
• Cloud strength continues – was +45% w/ losses narrowing
• Capex spending resuming – continuing to pick up the pace of investment in office facilities and data centers… “We continue to increase the pace of investment in fit-outs and ground-up construction of office facilities to accommodate our ongoing headcount growth globally. We will continue to pursue real estate acquisition opportunities where it makes sense.”

 

Similar to last earnings call, there was a big focus on Retail/e-commerce…

• “as the world begins to reopen, shoppers are returning to stores. Brick and mortar isn’t dead – instead, omnichannel is in full force. Searches for ‘open now near me’ are up four times globally vs. last year.”
• Omnichannel and next-gen user experiences are core to their shopping strategy, including:
• Easier ways for businesses to show the local services they offer across Search and Maps.
• Local inventory ads that highlights which products are in-stock and when to pick them up.
• Free shipping and easy return annotations across Search and Shopping.
• AR capabilities that bring in-store moments online and let users try before they buy.
• Instantly shoppable images with Google Lens.
• New visual, browsable experience on Search.
• ” There’s a lot more to come…including tapping into commerce on YouTube“. They are still in the early innings w/ e-commerce potential w/ YouTube. Possibilities include: shoppable livestream events w/ large retailers or letting viewers buy directly from their favorite creators’ videos.

Heavy focus on AI capabilities on the call which is relevant across segments

Google is faring better than others from Apple’s app tracking changes…

• Earlier this year, w/ the latest iOS release, Apple changed their app tracking policies, referred to as ATT (app tracking transparency)…now users need to opt in rather than opt out. This small change has made a very big difference in the digital ad space.
• Google indicated only a “modest impact” to YouTube while Facebook and Snap have both indicated this as a significant headwind for their business.

 

“Search & Other” revenue: $38B, up 44%

• Seeing broad-based strength in advertiser spend across industries, but some unevenness still across geographies depending on local regulations and vaccines.
• Retail was gain by far the largest contributor to the YoY growth of their Ads business.
• Media & entertainment, Finance and Travel were also strong contributors.

YouTube ad sales: $7.2B, up +43% YoY

• Over 120 million people watch YouTube on TVs every month; that’s up from ~100 million last year
• Strong value proposition to advertisers & positioned to capture the shift in advertising away from linear TV
• “YouTube’s reach is becoming increasingly incremental to TV”
• YouTube helps advertisers reach audiences they can’t reach anywhere else (especially younger audiences) and helping brands do it more efficiently
• Nielsen found that US advertisers who shifted just 20% of spend from TV to YouTube generated a 25% increase to the total campaign reach within their target audience while lowering the cost per reach point by almost 20%.

 

Network ad revenues: $8B, up 40%. This is revenue from ads placed on sites other than their own, like an ad placed on the NYT site.

 

Google cloud = Google Cloud Platform (“GCP”) + Google Workspace (i.e. collaboration tools):

• Revenue grew 45% YoY to $5B w/ an operating loss of $644m
• GCP’s revenue growth was again above Cloud overall, reflecting significant growth in both infrastructure and platform services.

Other Bets

• Revenues were $182 million, the operating loss was $1.3 billion
• Waymo – Next year will open a dedicated trucking hub in the Dallas-Fort Worth area, helping support commercial freight routes across the Southwest
• Announced last week the first commercial expansion of Wing’s on-demand air delivery service to Walgreens customers in select locations
• https://www.nbcdfw.com/news/business/walgreens-googles-wing-bring-store-to-door-drone-deliveries-to-dfw/2777244/

ESG:

• They aim to operate on 24-7 carbon free energy by 2030
• 2/3 of the electricity consumed by Google data centers in 2020 was matched with local, carbon-free sources on an hourly basis
• New Carbon Footprint tool gives customers carbon emissions insights associated with their Google Cloud Platform usage

 

Valuation – They generated $59B in FCF in the last 12 mos. and ended the quarter with $114B in net cash, ~6% of their market cap. The stock is still reasonably valued, trading at a >4% FCF yield on 2022 and they‘ve been stepping up their pace of buybacks.

 

 

 

 

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