Category: Equity Research

Apple Q118 Earnings Update

Apple reported record revenue and earnings, but iPhone unit sales and Q2 guidance were both below expectations.　 Revenues were better than expected at $88.3B, up 13%. EPS was $3.89, up 16% and also better than expected. iPhone units were weaker than expected at 77.3m units down -1% (and below expectations for 80m units), but iPhone revenues were up 13% driven by a record iPhone ASP of $796, up $100 from the prior year driven by iPhone X. Wearables were up 70% and were the second biggest growth driver after the iPhone. They also saw record app store sales. Heading into the iPhone launches in the fall, many analysts were predicting an iPhone “super cycle.” Sentiment has shifted dramatically given recent expectations for weaker iPhone unit sales, causing the pullback since mid-January when shares hit an all-time high of $179.

Current Price: $160　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　 Position size: 3.8%

Price Target: Under review　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　 TTM Performance: 30%

Thesis is intact, key points:

  • 1Q18 was a week shorter than 1Q17. Looking at growth metrics on a per week basis the results look a bit better.
  • Average iPhone unit sales/week were up 6% in the quarter.
  • Total sales/week were up 21%.
  • Guidance was weak, but that was widely expected. There were numerous reports heading into the quarter suggesting iPhone unit sales have been below expectations.
  • International sales accounted for 65% of the quarter’s revenue and they saw double digit growth across all geographies.
  • Sales in China gained 11% to $18B.
  • Cash is $285B, $269 of which is outside the US. Net cash is $163B. They have a provisional tax payable of $38B for planned cash repatriation.

iPhones

 

  • iPhone revenue grew 13% to $61.56B; units declined 1%.
  • On the call Tim Cook said “iPhone X surpassed our expectations and has been our top-selling iPhone every week since it shipped in November.”
  • With iPhone representing 62% of revenue, there are concerns that overall growth will slow. Unit growth is being impacted by a smartphone market that is maturing as penetration rises and the unbundling of phone and service contracts by carriers has led to a longer replacement cycle.
  • There are also concerns that replacement batteries sales for older models could further extend the replacement cycle.
  • While a lengthening replacement cycle may be a drag on unit sales, this will abate when the replacement cycle eventually stabilizes.

iPad

 

  • iPad revenue grew 6% to $5.9b.
  • Average sales/week were up 8%.
  • They released new models mid-year.
  • iPad now has 46% share of the US tablet market.

Mac

 

  • Mac sales fell 5% to $6.9B, units declined 5%.
  • Average sales/week were up 2%.
  • 60% of worldwide Mac sales are to first-time buyers or switchers.
  • Strong emerging markets performance with Mac sales up 13%.

Apple Watch

 

  • Fourth consecutive quarter at over 50% growth.
  • Total wearables were up 60%.
  • The wearables business is now approaching a Fortune 300 company.

Services

 

  • Services revenue was up 18% to $8.5 billion with record revenue on the App Store.
  • They now have 1.3 billion active devices which is fueling this growth.
  • ApplePay purchase volume tripled and is now accepted at more than half of all retail locations in the US.
  • HomePod launch should help drive Apple Music revenue.
  • Augmented Reality enabled apps (ARKit) gaining traction – they point to this as an important area going forward. “AR is going to revolutionize many of the experiences we have with mobile devices.”

By Geography:

 

  • Americas: +10%
  • Europe: +14%
  • Greater China: +11%
  • Japan: +26%
  • Rest of Asia: +17%

2Q Outlook below expectations:

 

  • Revenue between $60 billion and $62 billion (estimates were at $65B)
  • Gross margin between 38% and 38.5% (estimates were 39%)
  • Operating expenses between $7.6 billion and $7.7 billion other income/(expense) of $300 million
  • Analysts are expecting 2Q iPhone units of 59.4 million

Valuation:

 

  • Trading at over a 6% FCF yield the stock is inexpensive, especially for a company growing top line, with high FCF margins and high ROIC.
  • The current price implies little to no growth and declining FCF margins.
  • They regularly return close to 100% of FCF to shareholders.
  • Gross cash is $285B, net cash is $163B, ~$32/share. They plan to reduce net cash to zero and will update their capital allocation plans next quarter. Given that they are suggesting reducing their cash by $163B there could be a transformative acquisition on the horizon.

 

GOOGL Q417 Earnings Update

Alphabet reported strong revenue growth for Q4, but earnings were weighed down by lower mobile advertising margins and rising marketing expenses. Additionally, FCF margins were down as they invest heavily behind new areas of growth. Revenues for the quarter were $32.3B up 24%, which was far better than expected. Excluding a $10B tax expense on repatriation, they reported EPS of $9.70/share which was below expectations. Revenues were driven by strong growth in advertising.

Thesis intact, key takeaways:

The concern is that are making less money per click:

  • Paid clicks were up 43%, but cost per click was down 14% and traffic acquisition costs (TAC) were up 33%. That put TAC at 24% of revenue, up 200bps. So, basically for their primary business, pricing is down and input costs are up, which is not a trend anyone likes to see.
  • The mix shift towards lower margin mobile ads is what’s negatively impacting earnings.
  • The primary cost of advertising revenue is traffic acquisition costs (TAC) and mobile search and programmatic are their highest growth areas and they have the highest TAC.
  • The street is reacting very negatively to these metrics, but it’s not a surprise that mobile ads are the growth driver or that they are lower margin.

 

  • Management has previously indicated that they expect TAC to increase as a % of revenue and that they are more focused on profit dollar growth than margins.
  • Advertising growth is still very high, but as the mix increases, the lower economics of mobile become more visible.
  • An added concern is that Amazon is starting to compete in mobile advertising.
  • Rising content acquisition costs with YouTube and increased marketing spend to promote hardware also ate into margins.

While Alphabet is principally an advertising company, management is working hard to reduce their reliance on this business:

 

  • They are investing heavily behind their biggest bets for the future (artificial intelligence, YouTube, hardware and cloud) which is weighing on FCF margins.
  • On the call the CEO said they are “laying the foundation for the next decade as we pivot to an AI first company.”
  • They differentiate themselves with their AI competency and have spent billions trying to inject AI into all aspects of their business.
  • Their cloud business is progressing though they are still a distant 3rd in cloud market share behind MSFT and AMZN.
  • Cloud　is now a $1 billion/quarter ahead of where most analysts were estimating. AWS reported $5B in revenue for Q4.
  • Their CEO says their cloud business could eclipse their advertising business long-term.

Summary of results:

 Advertising – 84% of revenue, up 21% – mobile is ~47% of sales.

Other Revenue – 11% of revenue, up 38% – includes play store, cloud and hardware.

    • Hardware sales more than doubled in 2017 with strong holiday sales of home speakers and Pixel smartphones. This business carries a lower margin.
  • Other Bets (1% of revenue, up 49%):

 

  • This segment consistently runs at a loss, but losses were not as bad this quarter.
  • Revenues primarily generated by Nest, Fiber and Verily.
  • They paused fiber expansion in Q316, so capex from this segment was about $900m lower.
  • Nest had a strong holiday.
  • Waymo surpassed 4 million miles of real world driving and is the only company to have a fleet of driverless cars on public roads without anyone in the driver’s seat.

Strong across all regions:

 US revenues +21%

Other Americas +31%

EMEA +24%

APAC +30%

Valuation:

 FCF for the quarter was $6B and $24B for the year. This is a decline from 2017, and represents a 22% FCF margin, below their typical range of 24-25%.

  • Trading at a 3% FCF yield. This valuation relies on Alphabet continuing robust top line growth and maintaining their FCF margin.
  • $102B in cash, $140/share or 12.5% of their market cap.

Thesis on Alphabet:

 

  • Online advertising’s share of overall Ad budgets will continue to grow as:
    • People spend more time on the internet/mobile internet vs tv, radio, newspapers etc
    • Higher ROI (+ easier to measure) per marketing dollar spent online vs other ad mediums
  • They are the global leader in search.
  • Well positioned to benefit from increased smartphone penetration.
  • Flexible business model provides operating leverage with high returns (ROIC 50%) and huge free cash flow generation.

 

Microsoft Q218 Earnings Report – Cloud performance driving strong results

Microsoft reported Q218 revenues and earnings better than expected, excluding a one-time $13.8 billion charge on cash repatriation. Total revenues were up 12%, gross margin increased 12% and operating income was up 10%. Weaker US dollar benefited revenue by less than 1%. FCF was $5.3B, up 23%, of which $5.2B was returned to shareholders though dividends and buybacks. Strong cloud trends continue with commercial cloud revenue up 56%, reaching $5.3B (18% of revenue) and Azure revenue growth accelerating to +98% YoY. Commercial cloud drove about 60% of the revenue increase for the quarter. GM and operating margin outlook were increased as cloud margins improve. This is important to driving future earnings growth as cloud is lower margin and becomes a bigger piece of the pie.　 Geographically, U.S. and Western Europe performed best driven by commercial cloud sales. Overall they are seeing positive IT spending signals, a strengthening commercial PC market and growing demand for hybrid cloud.

Current Price: $94　　　　　　　　　　　　　　　　　　　　　　　　　　　　　 Price Target: Under review

Position size: 4.4%　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　 TTM Performance: 49%

Thesis intact, highlights from the quarter:

 

  • Productivity and Business Processes Segment (includes cloud-based applications like Office 365, Microsoft Dynamics and LinkedIn)
    • $9B in Q2 revenue (31% of total revenue), up 25%. LinkedIn growth accelerated.
    • LinkedIn added 4pts to top line growth and 4pts of gross margin growth.

 

  • Intelligent Cloud Segment (public, private, and hybrid cloud services, including Azure)
    • $7.8B in Q2 revenues (27% of total revenue), up 15%.
    • Gross margin increased 7bps to 55%.
    • Azure revenue growth accelerated to +98% YoY and is now at about a $6.8B annual run rate.
    • Azure margins materially improved.

 

    • More Personal Computing Segment (Windows OEM licensing, search advertising and devices like the Surface and Xbox)
      • $12.2B in Q2 revenue (42% of total revenue), up 2%; excluding phone, revenue grew 4%.
      • Stronger than anticipated commercial PC market; consumer PC market “stabilizing.”
      • Xbox was top selling gaming device over holiday.
      • Xbox moving from a hardware console platform to a subscription software platform with recurring revenues and higher incremental margins.
      • Gaming revenue grew 8% and is at a $9B run rate.
  • Commercial Cloud

 

    • This measure includes cloud revenues primarily from the first two segments – Office 365, Azure, Dynamics 365 and other cloud.
    • Annualized run rate is annualized revenue from the last month.
    • Current run rate is $21.2B, vs $20.4B in Q118 and $18.9B at FY17.

Outlook:

 

  • Expecting Q3 revenue of $25.6B.
  • Improved their full year guidance on gross margins and operating margins.
  • At current rates, Fx will add 2pts to Q3 rev.
  • Expecting a tax rate next year of 21%.
  • They didn’t specify what they would do with the repatriated cash.

Investment Thesis:

 

  • Industry Leader: Global monopoly in software that has a fast growing and underappreciated cloud business.
  • Product cycle tailwinds: Windows 10 and transition to Cloud (subscription revenues).
  • Huge improvements in operational efficiency in recent quarters providing a significant boost to margins which should continue to amplify bottom line growth.
  • Strong balance sheet ($142Bn gross cash) allows company to be opportunistic in current environment.
  • Return of Capital: High FCF generation and returning significant capital to shareholders via dividends and share repurchases.
  • Valuation is reasonable at a 4.6% FCF yield and a 1.7% dividend yield.

 

Healthcare comments related to Amazon/JP Morgan/Berkshire news

• My view is that it won’t have an impact near term to CVS, but longer term it could be disruptive. I think it will give them a bigger negotiating power over health insurance costs.
• This is not the first time large companies try to form an alliance to resolve this high healthcare cost issue: the Health Transformation Alliance, a group of 40+ large employers, covering 6 million lives, was formed to reduce costs (http://www.htahealth.com/). The group was looking to partner with CVS & Optum to reduce costs.
• Just a reminder that CVS has a higher share of the Medicare Part D scripts, representing 30% of CVS PBM scripts (according to Morgan Stanley), which is more profitable and not targeted by the AMZN/JPM/Berkshire JV. CVS’s Silverscript subsidiary is the #1 PDP insurance company by enrollment with 5.5 million lives as of January 1, 2017, accounting for 22% of total Part D lives. Continue reading “Healthcare comments related to Amazon/JP Morgan/Berkshire news”

Sanofi announces another deal (Ablynx)

Sanofi announced this morning the acquisition of Ablynx:
• Ablynx is a Belgian antibody biotech company that has multiple compounds in the works:
o Compound targeting a rare blood disorder (aTTP) that has completed phase III testing and pending European & US regulatory approval for commercialization (fit with rare disease & Bioverativ)
o compound to treat RSV infections in phase II (fits with Sanofi’s vaccine portfolio)
o early stage antibody technology platform (adding to Sanofi’s R&D efforts)
• Close of the 3.9B euros ($4.8B) all cash acquisition of Ablynx expected fairly soon, in 2Q18
• The deal will be financed by bank credit and was approved by both boards
• Deal neutral to earnings in 2018 & 2019, then low-single-digits accretive thereafter

This is not changing our view of the stock, as any incremental future sales coming from those new drugs are offset by the cost of the deals near term. As a reminder, Sanofi was outbid by Pfizer on the Medivation deal, and by JNJ on Actelion. So far 2018 is starting to be a big M&A year for Sanofi

Crown Castle (CCI) Q417 Update

Fourth quarter results were within the outlook range provided last quarter. Revenue for 2017 was $4.4B, up 35% (organic revenue growth of 5.5%). Leading this growth was small-cell revenue which was up 25% and included some revenue from the Lightower acquisition. Full year AFFO was $1.6B or $4.29/share. Guidance for 2018 total site rental revenue was increased to $4.6B (+25% yoy), but AFFO guidance was maintained. The dividend increased 8% for 2017, and is now close to a 4% yield; 7-8% growth continues to be the target going forward. They improved their balance sheet. Over the course of 2017 they reduced their leverage ratio to 5.3x (down half a turn). And with recent bond offering they lowered their average interest rate, increased their average maturity profile and increased their portion of fixed rate debt to 90%.

Current Price: $110 TTM Return: 30%
Target Price: Under Review Position Size: 2%

Thesis intact, highlights on the quarter:
Secular growth trends on track:
• Q4 total site rental revenue up 29%; Q4 AFFO up 26%
o Tower site rental revenue up 2.5%
o Fiber site rental revenue up 90% (including acquisition)
• Increased demand for wireless data is primary driver and mobile data demand expected to double every 2 years. Carriers need capacity and CCI is a low cost solution and fast to market.
• New leasing activity is accelerating. Lease-up on the small cells are about 2x the rate they experienced on towers.
• Churn remains low at 1-2%.
Capital spending by carriers may improve:
• Big 4 carriers make up 90% of site rental revenue – AT&T, Sprint, T-Mobile and Verizon. Corporate tax reform may prompt them to increase infrastructure investments.
• AT&T may begin constructing their FirstNet emergency network which will be funded in part by the government.
Benefit of new fiber assets:
• Closed three acquisitions in 2017: FiberNet, Wilcon and Lightower, expanding their high capacity metro fiber assets.
• Lightower closed in Q4, two months ahead of schedule.
• Assets have capacity to support organic growth and high incremental margins.
• Return assumptions on these fiber asset acquisitions based on current applications, i.e. new technologies like 5G, IoT, augmented and virtual reality would be upside. These technologies all would rely on CCI infrastructure assets for higher speed and lower latency requirements.
• If 5G comes to fruition, as expected, there is a stair step increase in densification required.
• Attractive shared economic model in small cell business. Lowest cost and fastest time to market for their customers. Multiple ways to monetize fiber assets improves returns and lowers cost and value proposition to customers.
Valuation:
• Strong AFFO growth will drive the valuation (up 16% in 2017). They have a 10 year AFFO CAGR of 14%.
• High incremental margins means AFFO growth should outpace site rental revenue growth.
• Low maintenance capex (~2% of revenue) supports high AFFO margins.
• $2.2B in AFFO ($5.50/share) in 2018 is a yield of 5%. This is an attractive yield given the secular growth potential.
• Price target is under review.
The Thesis on Crown Castle:
1. CCI is well positioned to capitalize on secular mobile data demand growth and small
cell/urban opportunity.
2. Strong competitive position. Leading US tower company.
3. Toll booth business – offensive (secular growth) & defensive (4% dividend & contracted cash
flows) characteristics.
4. Revenues derived from long term contracts with price escalators and good visibility.

Whirlpool 4Q17 Update

Revenues were light at $5.7 (+1% yoy, ex-currency -1.6% yoy) vs $5.84B consensus and EPS was $4.10 vs $3.99 consensus. For the year, higher prices and cost controls somewhat offset rising raw materials costs, with volumes flat overall and down in some markets. Units overall were positive and price/mix was positive in the quarter but a drag for the full year. Positives for the quarter were strong EBIT margins in N. America. The headline number they reported was a loss because it includes a one-time non-cash charge of approximately $420m due to a write-down of deferred tax assets related to tax reform. There is potential for some upside in their numbers from tariffs, currency and lower tax rate, though FCF guidance seems aggressive.

Current Price: $183 Price Target: Under Review
Position Size: 1.7% TTM Performance: -2%

They are struggling with executing and the valuation is getting high; revisiting target price. Key takeaways from the quarter:

Constant currency growth was weak in all geographies:
• N. America – sales were down 0.8% on 4.8% unit growth; margins were up 60bps.
• EMEA – sales were down 5.6% on a -6.8% unit decline; they’re operating at a slight loss in this region.
• Latin America – sales were down 4.4% on 2% unit growth; margins were up 50bps.
• Asia – sales were down 8.3% on 1.4% unit growth; they’re operating at a slight loss in this region.
Potential benefit from tariffs and currency could be a source of upside:
• Neither of these factors were included in guidance.
• Management said the impact of tariffs is hard to assess especially given actions by Samsung and LG to stockpile inventory in the US ahead of the announcement.
• With 54% of sales outside the US, currency could be a tailwind to the 2-3% industry growth they are projecting in 2018.
Free Cash Flow is running behind expectations:
• A key part of the story is FCF margins improving to 5-6%. Historically they have been 2.5-3%.
• For 2017 they were initially expecting $1B of FCF on $700-750m of capex. They reported 2017 FCF of only $700m, which was really a bit less than that as they made some adjustments.
• They are again guiding for $1B in FCF this year which would be a ~5% FCF margin.
Valuation:
• While they are projecting $15/share in EPS for 2018, it’s only about $13/share in FCF (net income regularly outpaces FCF). So, the stock is trading at a 12x forward P/E and a 7% forward FCF yield, and a 4% yield on unadjusted 2017 FCF. That’s a lot of expectation built into a stock that seems to be overpromising and under-delivering.
• If they can hit organic growth and FCF targets, the stock is undervalued, however LT top line growth has been low (<1% 10 yr. CAGR including acquisitions) and their FCF projections would require a step function improvement.
• Reviewing the price target.
The Thesis on WHR:

• Industry Leader: World’s leading manufacturer and low cost provider of major home appliances (founded 1911): 15% global market share & 35% US market share.

• Brand Value: One of the world’s most valuable brands with a portfolio that includes several $1B brands: Whirlpool, Maytag, KitchenAid, Jenn-Air.

• Growth opportunity: Significant international growth opportunity with emerging markets moving up to 1/3 of sales as emerging middle class affords a higher quality of life. WHR sales are correlated to existing home sales, which were up 1% in 2017. An improvement in household formation should accelerate new and existing home sales growth.

• Risk-adjusted return: WHR has paid a dividend every year since 1972. Dividends plus EPS growth provide attractive total return opportunity.

• Predictability/Consistency: Strong returns through the economic cycle speak to low cost leadership and brand strength.

Whirlpool Update

Whirlpool is up on news that the Trump administration is imposing a tariff on washing machines –N. America segment washers are roughly 14% of revenues. They report tomorrow after the close, so we’ll get more commentary on the impact then and on the call on Thursday.

• It’s a 20% tariff (this will decrease by 2 percentage points per year) on the first 1.2 million units and a 50% tariff on machines above that number (this will decrease by 5 percentage points per year) and will last for three years.
• Around 3.4 million units are imported annually
• The largest impact is on LG and Samsung which have roughly 33% combined share
• The impact of this will be offset by the construction of US based capacity by LG (in Tennessee) & Samsung (in S. Carolina) which is expected to start coming on line this year.
• Another mitigating factor is LG & Samsung may have shipped excess inventory in anticipation of this tariff.
• If WHR raises prices in response, assuming 80% incremental margins on a price increase, they could get $100m to $200m in incremental operating profit.

Sanofi Bioverativ Deal

Sanofi / Bioverativ overview
Bioverativ (BIVV):
• Spun off Biogen in 2017. Only pure player in the hemophilia drug market
• Had sales of $847M + $41M in royalties in 2016, guided to grow 30% in 2017
• 39% EBITDA margin in 2016 (43.4% estimated EBITDA margin for 2017)
• Pipeline of drugs targets every modality in hemophilia and other blood diseases
• The drugs are currently sold in the US, Canada, Japan and Australia

Continue reading “Sanofi Bioverativ Deal”

SLB 2017 earnings recap: positive outlook for 2018

SLB reported strong 4Q17 revenue at +15%y/y and adjusted EPS +57%, above consensus expectation.  This was driven by a better pricing environment and growth in North America activity. The management team is targeting to return to its prior cycle margins and ROIC, if not above. We are maintaining our position size and price target. Continue reading “SLB 2017 earnings recap: positive outlook for 2018”