Category: Equity Research

Some news on Canopy’s move into the US market this morning (a positive for STZ):

Bloomberg Intelligence: “Canopy’s agreement to acquire U.S. multistate cannabis operator Acreage Holdings marks a bold step toward entering the lucrative U.S. market, giving it a foothold to prepare for potential federal legalization. The deal ups the ante on other leading Canada producers, such as Aurora Cannabis, to do the same or be at a big disadvantage in seizing legal U.S. cannabis sales.”

[tag STZ]

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

The senate hearing of the PBM industry included 5 major PBM players: CVS, Express Scripts (Cigna), OptumRx (UNH), Humana and Prime Therapeutics. Continue reading “Outcome from the PBM Senate Hearing yesterday”

We are trimming UNP 50bps and allocating the proceeds to IVV based on the following reasons: Continue reading “Trimming UNP”

Why is the stock down?

There has been multiple events pushing the stock down:

· Omnicare underperformance that led to an additional write-down in 4Q18

· Loss of the Centene and WellCare business as those two clients merge and will bring the PBM in-house

Outside of their control:

· Democrat’s push for Medicare-for-all would impact health insurers (and recent Aetna acquisition)

· Removal of the rebates practice in the government side of the PBM business (CVS is #3 in this space)

· Drug Pricing Transparency Act: this bill would force PBM to pass all rebates to the point of sale and no longer be kept by PBM and/or health insurers

· Push to repeal Obamacare back in the news

· Walgreens had bad earnings and cut their 2019 forecast, pushing the sector down

Why remain invested in CVS?

1/ We find CVS’s long-term strategy of vertical integration compelling:

· This can truly help CVS differentiate themselves from competitors by offering a powerful value proposition, leveraging its network and developing predictive data analysis that will help them lower costs of care

· A similar strategy was successfully implemented by UNH who saw nice margins growth after the integration of Catamaran (PBM)

2/ Retail store footprint combined with MinuteClinic and their new HealthHub concept could become a great growth engine for CVS:

· The retail stores ($19.7B in sales, >10% of total sales) have suffered from lower foot traffic following the removal of tobacco sales

· Offering customers another reason to visit the stores/pharmacy thanks to their new Health & wellness concept (to become 20% of the square footage of the store) could revive traffic

3/ Valuation: we see a disconnect between today’s stock price and the value of its businesses:

· Our sum-of-the-parts and cash flow analysis both show an attractive risk/reward profile

We are currently reviewing our position size for this stock.

[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

· Yesterday the European Parliament passed the EU Copyright directive (see original email from Sept. below) which is primarily targeted at Google and Facebook.

· The directive includes 2 key articles – Article 11 (the ‘link tax’) and Article 13 (the ‘upload filter’). The Link Tax gives publishers the right to charge for linking to their content and the Upload Filter would put the obligation on platforms to identify what is copyrighted by making them liable for copyright infringement. Commercial deals with publishers would be required in order for Google to show hyperlinks and short snippets of news.

· Those in favor (content creators) say it protects their product, giving publishers a negotiating edge w/ Google and Facebook. Those against it say it limits the free access of the internet. Part of the concern is that the directive is vague and it’s difficult to precisely filter out what’s copyrighted and what’s not – the result may be over-blocking content in an effort to limit the risk of an infringement. The wording of the directive is apparently ambiguous enough that the impact it will have is not entirely clear and may become more clear in the future – countries may interpret the directive differently.

· User generated content on places like YouTube and Facebook would need to be filtered. Google already does this to an extent on YouTube.

· Google News would need to license all the content that shows up in search results. Google put out the screen shot below of what News search results would look like without licensing.

· Google says “we built Google to provide everyone with equal access to information”…”Article 11 means that search engines, news aggregators, apps, and platforms would have to put commercial licenses in place, and make decisions about which content to include on the basis of those licensing agreements and which to leave out.” As a result, Article 11 would mean Google is picking winners and losers based on who they establish commercial agreements with (likely the largest publishers).

· The revenue impact to Google should be limited. EMEA is about 1/3 of revenue. Ad revenue from relevant news sites in Europe is a small subset of that. Importantly, these same publishers make money by traffic landing on their sites via Google by selling ad space through Google’s AdSense product. The larger consequence may be more around limiting news results.

$GOOGL.US

[tag GOOGL]

From: Sarah Kanwal
Sent: Friday, September 14, 2018 12:33 PM
To: ”
Cc: CrestwoodAdvisors <crestwoodadvisors>
Subject: EU Copyright Directive

· The EU is on a path to create copyright laws aimed at helping publishers of content (e.g. journalists, musicians etc.) get a bigger piece of ad revenues that go to companies like Google and Facebook.

· The EU parliament voted in favor of the directive a couple days ago, but there are several more steps for this to pass.

· The new rules would give publishers the right to ask for paid licenses when a platform shares their stories (i.e. Google News) or video clips. Some are calling it a “link tax." The rules would also put the obligation on platforms to identify what is copyrighted by making them liable for copyright infringement.

· The implications aren’t entirely clear yet. For example, the rules would apply to “commercial platforms” but it’s not clear whether that applies to blogs etc., which would widen the impact.

· Other countries like Spain and Germany tried similar rules in the past and they failed. Google’s response was either to shut down Google News or just remove any news sources that wouldn’t give it free access…which meant traffic to those sites collapsed.

· The regulation might actually reinforce the dominance of the strongest players. The cost burden of this regulation would be easier for large firms like Google to absorb as it would require firms to build technology to identify and filter copyrighted content. Thus it might have the unintended consequence of strengthening Google (and other platform giants) relative to smaller firms/startups. In fact, Google already largely complies with these rules on YouTube with their “Content ID” filter.

· Opponents also say that complying with these rules would limit the free access of information that the internet is designed to offer.

· If this directive keeps progressing their will likely be more vocal industry resistance, as many who have been critical of the big tech firms don’t support it. For example, Tim Berners-Lee (inventor of the world wide web), who has spoken widely about the risks of Google’s and Facebook’s dominance, is ardently against these potential regulations.

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

Adam Fein (Drug Channels well-known author) published his predictions for a world without rebates this morning. The summary is below:

Continue reading “A world without rebates…”

Below is an update on where we stand on CVS, and why the stock has been under pressure recently:

1. Omnicare underperformance: while we were hoping for this turnaround to take place, CVS ended up writing down a big piece of this long-term care business in 4Q18. This puts pressure on CVS to successfully integrate Aetna and execute on their synergies and strategic vision.

2. Democrat’s push for a “Medicare for All Act of 2019” bill that would replace almost all private health insurance. The measure would push all Americans (even under 65) towards a Medicare program within 2 years. Premiums, deductibles and co-pays would disappear, and guarantee a universal health care system. Medicare would dictate doctor’s fees and drug prices. No details on how much this would cost or how it would be funded… CVS’s stock however went down with the news… We think this bill is unlikely to pass.

3. The PBM model is under pressure as new legislations are being discussed:

· The Human Health Services issued a proposed rule to remove the safe harbor for drug rebates (on the government side of the business) currently permitted for Medicare and Medicaid managed care, which would directly impact PBMs. The rule would also create two new safe harbors for (1) discounts provided to the consumer at point-of-sale and (2) flat, fixed service fees paid by manufacturers to PBMs. PBMs have stated in the past that they do not keep any rebates earned under government programs, as this compensation is disclosed to CMS and reflected in plan bids in the form of lower Medicare Advantage and Medicare Part D premiums and lower Medicaid managed care plan bids.

· “The Drug Pricing Transparency Act” would force PBM in the commercial market to pass rebates to the patient directly (point-of-sale rebate). Other proposed changes are included in the bill, such as: utilizing an international pricing index in Part B, direct negotiation of drug prices by Medicare, etc… The details and impact of this bill on the supply chain economic model are still unclear at this time. CVS already offers that option, with increased acceptance in 2019 from the healthcare insurance participants. CVS only kept $300M worth of rebates (less than 3% of its 2018 EBIT).

Rebates have been a great tool used by PBMs to offer an attractive service package to their clients, and recently less of a way to make profits (profit margins are very low vs. pharmacy/managed care profits).

Valuation:

Today’s stock price for CVS reflects the above challenges. Our DCF model shows that today’s price only account for 2 segments out of 3: the retail pharmacy (stores and pharmacy business) and the Aetna segment. Even the recently negotiated 5 year PBM contract with Anthem would disappear. The PBM segment would go to zero in 2020, with the rest of CVS’s business growing at a 1% rate thereafter.

Here’s where we disagree:

· Pharmacy sales continues to grow nicely, not just due to higher drug prices (which has slowed down in 2018), but also due to higher script volume (average growth of 4% in past 7 years).

· PBM segment is unlikely to radically disappear in 2020. We could see margins contract as the government steps in, but levels are already very low (~3.5%). Also we can’t forget the power of lobbyists.

· Rebates profits are small for CVS, and we believe companies like CVS could play a role in regulating pharma prices even more. We think the main issue with drug prices does not lie solely with the PBM model but with a broader patent and FDA laws issue. By allowing Pharma to hold patents for decades, new cheaper alternatives are left out of the market place, allowing them to raise prices without competition. Recently though, Pharma companies have been trying to gain some goodwill by cutting prices or launching new generics.

· Anthem is to provide an estimated $3.8B in sales in 2019 in its first year in place, then $11B in 2020, and $62B in 2021 as the contract matures. Total PBM revenue in 2018 were $134B, so Anthem is not a negligible customer.

So in conclusion, while CVS has been under tremendous pressure, we advocate for remaining patient with this name. We continue to like its long-term thesis of vertical integration and solutions provider to clients, such as its MinuteClinic proposition and new HealthHub store format (see video below).

https://cvshealth.com/thought-leadership/cvs-health-testing-new-healthhub-store-format

$CVS.US

[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

· Monthly retail & food service sales released by the Census Bureau yesterday were far worse for December than expected. Sales fell a seasonally adjusted 1.2% in December from November. Every major category tracked was down except motor vehicles and building materials. Excluding automobiles, gasoline, building materials and food services, retail sales dropped 1.7%. Since 1992, month-over-month (MoM) retail sales have averaged 0.35% and saw a low of -3.9% in Nov 2008.

· A further surprise in the report was that December online sales fell 3.9% from November. YoY online sales were up 3.7% from a year earlier.

· While some retailers have reported some softening, the numbers run counter to other indicators. For example, MasterCard SpendingPulse reported strong holiday retail sales numbers – they said sales from Nov 1 to Dec 26 were up 5.1% and that online was up 19%. Also we’ve seen strong job numbers.

· Yesterday the NRF released their holiday sales numbers of up 2.9% YoY below the 5% MasterCard reported (which was also roughly the consensus). The NRF’s chief economist said, “The combination of financial market volatility, the government shutdown and trade tensions created a trifecta of anxiety and uncertainty impacting spending.”

· While the numbers from the Census Bureau are a bit troubling, they are subject to revisions which can sometime be large and the weakness may have been temporary driven by factors like stock market volatility and the initial days of the government shutdown. For instance, Visa reported some softening in US spending in December that recovered in January.

· Retailers start reporting earnings next week. Some have already pre-released with softer than expected results including Macy’s, Kohl’s, JC Penney. However, others like Target and Costco pre-released strong numbers.

· Total retail & food service sales are ~30% of GDP, so we may see a weaker Q4 GDP number.

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

On 1/22/19, Travelers reported Q4 EPS of $2.13, slightly above consensus of $2.10. Catastrophic losses were elevated due to the devastating Camp Fire and Hurricane Michael. Excluding these losses, Traveler’s results improved year-over-year with the combined ratio falling 130bps to 91.1%. Travelers is a high quality, disciplined underwriter of insurance that is focused on returning capital to shareholders. TRV is selling at an attractive valuation of 11.4 x 2019 earnings.

Current Price: $127.16 Price Target: $145 (raised from $125)

Position Size: 2.19% TTM Performance: -5.8%

Thesis Intact. Key takeaways from the quarter:

1. Results were solid considering catastrophic losses
   • Solid premium growth 4% and retention rates of 87%
   • Investment income +15% with help from rising rates and lower taxes
   • Slight decrease in combined ratio to 91.1% due to improved results in autos and bond and specialty segments
   • 2018 ROE 10.7% up 170bps from 2017

2. TRV continues to aggressively return capital to shareholders – for 2018 TRV returned $2.1b to shareholders out of $2.4b in earnings
   • Over past 10 year shares outstanding have fallen 57%!
   • Shareholder yield of 6.2% which is a dip from +10% of prior quarters
   • Management employing capital wisely! Instead of investing in mature business with spotty pricing, they are returning excess capital to shareholders

3. Catastrophic losses have been elevated for past few years

Effective 2019, TRV significantly increased its catastrophe reinsurance, which should help smooth earnings and protect the balance sheet in the future.

4. Valuation is attractive. Currently TRV trades at a forward P/E of 11.4 which is close to the bottom of its five-year valuation range of 10 – 15.

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

Thanks,

John

($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

Last week, Wells Fargo (WFC) reported Q4 EPS of $1.21 roughly in-line with estimates. Earnings were pulled down a bit by the market’s Q4 weakness as was the case for peers. In the call, management pushed back the expected asset cap release date from mid-2019 to end of 2019. On the plus side, Wells continues to improve its culture and is aggressively buying shares, having reduced shares by 3% in the past quarter.

Current Price: $50.29 Price Target: $56

Position Size: 2.8% Trailing 12-month return: -20.7%

Highlights:

· Wells is a return of capital story with over $20b in excess capital.

o Dividend yield of 3.7% ~ 50 bips above peers

o Last quarter purchased 3% of shares spending $6.8B

o For 2018, WFC has a shareholder yield of 9.7% (3.2% dividend and 6.5% share buyback)

• Ongoing transformation of culture – Wells has made a lot of progress
  • Replaced former Chairman, John Stumpf with CEO, Tim Sloan, and added CFO Elizabeth Duke, a former Fed member, as independent chairman.
  • Named 6 new independent directors
  • Expecting the Federal Reserve to lift balance sheet asset cap restriction at end of 2019
  • On 4/20/18 Wells reported a $1b settlement with OCC and CFPD relating to forced car insurance and mortgage fees.
  • Recent moves to improve firm’s standing with employees
    • Increased base minimum hourly wage to $15.00 an increase of 11%
    • Increased 401k and profit sharing programs
    • Increased stock incentive compensation
  • Recent improvements to help customers
    • Overdraft rewind, zero-balance alerts, debit card on/off capability, and P2P payments
  • Wells still needs to settle with DOJ over residential mortgage policies dating back to the financial crises. Estimates place the settlement at $2b, but Wells has already set aside reserves of $3.2b
  • Additional lawsuits exist for overdraft fees, foreign exchange, mortgage fees, improper account closing and other smaller suits. Wells is not out of the woods, yet.
  • Plans to spend 2% of earning to philanthropy (up from 1.3%)
• Strong capital position
  • Common Equity Tier 1 Ratio of 11.7%
  • ROE 12.9% (Return on tangible equity 15.4%)
  • Returned $8.8b to shareholders through dividends and share repurchases for a shareholder yield of over 6.3%!
  • Solid credit quality – Nonperforming assets down from $8.3b in 4Q17 to $7.0b in 4Q18 as company continues to improve the balance sheet.
• Operational results
  • Noninterest revenue down -14% YoY hurt by Q4 market downturn and weak results in mortgage banking. Quarter results showed modest gains from sale of securities.
  • Noninterest expense down -21% in good cost control. Wells expect costs to fall 11% over the next 2 years.
  • Net interest income up 3% YoY loans up $6.9b
    • Deposits down 3% yielding 55 bips with low beta (33) to rising rates
    • Net interest margin stable at 2.94%
• Valuation
  • Valuation is below 5-year average at 12.1 P/E and 1.3 P/B, having bounced off a 5-year low in December of 11 P/E and 1.2 P/B
  • Yield and share buybacks provide strong support

WFC Thesis

• Best franchise in banking due to disciplined loan writing and quality mortgage underwriting
• Large deposit base that provides low cost funding
• Strong capital ratios put WFC in a good position to be opportunistic, invest for the long-term and return capital to shareholders
• Company is working hard to improve culture and repair image

($WFC.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