Category: Equity Earnings

Good Afternoon,

Below I address the recent performance of Market Neutral and why we are comfortable holding this fund long term.

We still believe that owning market neutral is a strong investment over the long term. The main pillars of our thesis remain intact.

1.) Diversification Benefits: The fund’s return correlations to traditional asset classes should be very low, targeting a beta of zero over time.

2.) Alternative to Fixed Income: Based on its risk parameters and expected return profile, QMNIX should provide an alternative to core bonds.

3.) Opportunity for positive risk adjusted returns: The fund seeks long term Sharpe Ratio of approximately 0.7 – 1.0.

Continue reading “QMNIX – Recent Underperformance, Long Term Thesis Intact”

Below is the summary of the positive data points that came out of yesterday’s analyst day:

· Management initiated a 60% Operating Ratio in 2020 (they walked away from their prior 60% by 2019 last quarter)

· Cadence of share repurchase is more aggressive than previously announced: $20B through 2020, and funded mostly from free cash flow

· Lower capex results in higher free cash flow conversion

· Dividend increase (implied to go to 2.5% from 2%)

· Leverage is going up from 2x to 2.7x. Management was reassuring that this increase would be gradual, and that they would remain prudent if the macro environment turns negative.

All these positive news might seem aggressive knowing that UNP didn’t meet its latest volume and operating ratio guidance, but we would assume they learned from that mistake and provided an update on guidance they feel comfortable achieving.

Below is GS valuation analysis, which shows UNP as being cheaper than peers assuming UNP meets its guidance on volume, pricing, OR and buybacks:

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

PLEASE NOTE!

We moved! Please note our new location above!

Thesis intact. Key takeaways from the quarter:

Medtronic reported strong 4Q FY18 sales and earnings results this morning with +6.5% organic sales growth and +6.5% EPS growth. Top line growth was robust across all segments, with Diabetes impressive at +21% (thanks to US patient demand for its insulin pump). Operating margin expanded (+80bps) in the quarter, thanks to cost savings initiatives.

The initial FY19 organic sales growth guidance of +4-4.5% is achievable and leaves room for upside, while operating margin should expand by 50bps (better than FY18 +20bps) and EPS growth in the +8-9% range. Management thinks that its emerging market business will grow in the low double digits going forward, following a +15.5% growth in 4Q. Free cash flow conversion will improve going forward, as litigation and tax payments diminish. The tax reform will push for more overseas assets liquidation to continue.

In an interesting move, MDT hired Michael Weinstein earlier this month, a well-regarded sell-side analyst (JP Morgan), to lead its strategy. He’s bringing a deep knowledge of the medtech space, and we can expect some M&A/divestiture/capital allocation moves in the coming year. The next catalyst will be when the company introduces its long-term outlook during its investor day on June 5th.

Valuation unchanged, we are maintaining our $93 price target, reflecting the recent strength in the business.

Continue reading “Medtronic MDT reported strong 4Q FY18 results and a conservative initial FY19 guidance”

So far ~80% of the companies in the S&P 500 have reported earnings.

78% have beat on EPS. The 5-year average is 70%.

77% have beat on sales which is a record.

55% of companies have issued negative guidance which is well below the 5 yr average.

For EPS beats: consumer discretionary, tech and Energy have had the highest % surprise.

For revenue beats: REITs, Industrials and utilities have had the highest % surprise.

According to FactSet, the market is rewarding upside earnings surprises less than average and punishing downside earnings surprises more than average.

For all of 2018, analysts are projecting earnings growth of 19.5% and revenue growth of 7.2%.

Forward P/E Ratio is 16x – it was 16.4x at the beginning of the year. The 5-year average is 16.1x and the 10-Year average is 14.3x.

Continue reading “Quick Update On Earnings So Far…”

Fairfax’s reported strong Q1 2018 operating earnings of $3.96 versus $3.11 last year. Book value grew a healthy 4.9% for the quarter boosted by strong investment results. Insurance results were solid with organic premium growth of 7.1% and a combined ratio of 96%.

Current Price: $ 549 Price Target: $580

Position Size: 1.6% TTM Performance: +23.4%

Thesis Intact. Key takeaways from the quarter:

1. Insurance results
   1. 96% combined ratio with underwriting profit of $109m. All major insurance companies had combined ratios less than 100 (which means they made a profit). Favorable prior reserve development of $86m.
   2. Average annual reserve redundancy of 3.5% over past 7 years
   3. Insurance operations hold $22.7b in float ($819 per share)
   4. Incredibly well capitalized firm 23.8% debt (up from 18% due to Allied acquisition)/ capital and 8.0x interest coverage
2. Investment portfolio
   1. Holding company continues to hold a 50% cash.

2. Firm has broadened its equity holdings and reduced IBM position.

3. Firm has a large position ($114b notional value) in CPI-linked derivative, which will protect the company from a Japan-like scenario as well as potential debt solvency concerns. However, this position has recently been a drag on investment returns.
4. Looking to improve 5-year returns on investment portfolio of 2% to historical levels of 8% or better

3. Valuation:
   1. Fairfax trades at a discount to other P&C stocks at 1.2x BV.
   2. Shareholder yield of over 5.7%. Over the past 6 months Fairfax bought back $543k worth of shares. If you annualize that level, the share buyback yield is 4.0% with a dividend yield of 1.7%

The Thesis on Fairfax:

• Fairfax is a disciplined insurance underwriter with an excellent investment track record
• Unmatched book value growth – 19.5% for past 32 years
• Attractive valuation and well above average management team
• Defensively positioned balanced sheet

$FRFHF.US

John R. Ingram CFA

Managing Director

Asset Allocation and Research

Direct: 617.226.0021

Fax: 617.523.8118

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

Travelers (TRV) reported Q4 EPS of $2.46 below consensus of $2.67. The shortfall was due to storm losses – March nor’easters, California mudslides and winter storms in the UK – and weakness in business segment margins. Traveler’s underlying combined ratio was 92.4%, with strong retention rates and positive renewal premium charge. Travelers raised the dividend 7%. Travelers is a high quality, disciplined underwriter of insurance that is focused on returning capital to shareholders. Thesis intact.

Current Price: $133 Price Target: $150

Position Size: 2.3% TTM Performance: +11.9%

Thesis Intact. Key takeaways from the quarter:

1. Results were solid considering losses
   • Solid premium growth 5% and retention rates of 86%
   • Renewal premium renewal increase was 4.5% indicating some strength in pricing. JP Morgan speculated we could be seeing an inflection point in pricing.
   • Q1 ROE 11.9% which increased from 10.8 YoY. Investment results benefitted from higher interest rates and lower tax rate

2. Balance sheet strength shows quality of underwriting
   • Debt to capital ratio of 23.4%
   • High quality investment portfolio – only 2.7% below investment grade
   • Favorable reserve development for all years in all segments

3. TRV continues to aggressively return capital to shareholders – $549 in total – $351m buybacks during Q4 as part of a $5b share repurchase agreement and $198b in dividends.
   • Real yield over 10% (Buyback 8.5% + 2.3% Dividend)
   • Over the past five years, an average of 93% of annual free cash flow has been returned to shareholders for a reduction in shares of 34% – wow!

4. Travelers book value fell -3% YoY due to impact of higher interest rates on unrealized gains
   • Valuation has improved at the margin but we continue to view TRV as fairly valued (2018 P/E 12.7) relative to current ROE and BV growth – in the context of the broader market environment – and given the balance of slower pricing offset by a robust 10% real shareholder yield

The Thesis on TRV:

• We expect TRV will be able to grow book value per share in the mid-single digits over the near-medium term, and generate ROE in the 10-14% range
• Industry leader with disciplined underwriting and investment portfolio track record
• Consistent returns in the low to mid double digits
• Responsible capital allocation and proven desire to act in the best interests of shareholders

($trv.us)

John R. Ingram CFA

Managing Director

Asset Allocation and Research

Direct: 617.226.0021

Fax: 617.523.8118

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

Over the weekend, T-Mobile and Sprint officially announced a merger where T-Mobile would purchase Sprint for $26 billion in an all-equity deal. The deal still must be approved by the DOJ, and broadly analysts believe the odds of this exact deal being passed are about 50/50.

Because there is little certainty around that outcome, we will assume that the merger is going to take place. As I mentioned Friday, the major issue for CCI and other tower companies is the decommissioning of sites where Sprint and T-Mobile have shared or integrated networks.

While the headline risk centers on decommissioning of towers, there are several potential positive catalysts driven by the goal of improving 5G capabilities.

Continue reading “Sprint/T-Mobile Merger – Mixed Implications for CCI”

CCI traded down today as talks of a possible S/TMUS merger continued, with indications that a deal could be reached as early as this weekend. This is still speculation and could be held up by disputes over control of the combined company and/or push back by regulators.

I will follow up on Monday when there is more definitive information available, but below is the note that Sarah sent on April 10th after the merger talks first resurfaced (this merger has been discussed and plans collapsed on two different occasions). The worry from analysts is that, currently shared sites may be decommissioned, reducing a revenue source for CCI. There are a number of assumptions and unknowns at this point.

S/TMUS represent approximately 16% and 22% of site rental revenue respectively and have about 6% of overlapping cell sites. Based on a Goldman analysis, if they decommissioned all the overlapping sites as their contracts expired (average of 5-7 years) it looks like the net impact would be ~$8/share. This assumes an NPV on the remaining contract life and that they account for around $0.60 of AFFO. There are a lot off assumptions in that including that if a merger were even approved that they would decommission all their overlapping sites.

$CCI.US

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

PLEASE NOTE!

We moved! Please note our new location above!

Thesis Intact. Key takeaways:

Lockheed Martin released its 1Q18 earnings well above consensus expectation both on the revenue and earnings front. The management team also raised its sales (+0.7%), operating profit (+2%) and EPS (+3.9%) for the year. Yet the stock sold off as investors were expecting a lift of its 2018 cash flow guidance as the FY18 DoD budget grew, in particular the 2018 Appropriation Act offering an incremental $7B for Lockheed’s programs. The management team did not know if those incremental dollars will translate in new contracts/sales and preferred to remain conservative this early in the year. Production plans still target 90 F-35s delivered in 2018, with peak delivery year in 2025. There is an on-going dispute with the DoD over some production issue but this is not impacting revenue, and we do not think this will be a big problem to solve. Its Sikorsky business saw a nice margin expansion, most likely thanks to cost cutting and synergies flowing through post acquisition. The pension contributions are always a big part of defense companies’ expenses, and LMT is no exception. Management is guiding to the possibility of negative cash from operations in Q2 due to most of the pension contribution being made by Q3: $1.5B was made in Q1 and the full year amount will reach $5B.

Overall we keep a positive view of this holding.

Valuation: we are not changing our price target, a review of our model warrants a $374 price target.

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

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

PLEASE NOTE!

We moved! Please note our new location above!

Crown Castle International Corp. (CCI) had a strong quarter increasing yoy revenue by over 34%, exceeding the high end of guidance. AFFO per share was up 24% but fell short of broad estimates. Discussing a possible S/MTUS merger, management noted overlapping sites account for about 5% of total revenue. CCI maintains a target dividend growth rate of 7-8% annually. The company continues to work on balance sheet improvement and has reduced its leverage ratio to 5.1x. Investment has been focused on small cell and fiber where they expect long term growth trends to be in the low double digits.

Current Price: $102 TTM Return: 10.4%

Target Price: $125 Position Size: 2%

Continue reading “Crown Castle International ($CCI.US) Q1 2018: CCI exceeds high end of revenue guidance, falls short of AFFO consensus”