EMC Results Better Than Peers But Patience Has Run Out

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EMC Corporation reported first quarter 2013 revenue and EPS just barely below street estimates. Revenue of $5.39 million was just below the $5.43 billion estimate. EPS of 39 cents was a penny below estimates. Growth in revenue and EPS was 6% and 5%, respectively. Against recent reports from IBM and other companies serving very large information technology customers, these results are decent. Furthermore, the results are consistent with the guidance the company laid out in January for 8% revenue growth and 9% EPS growth in 2013. Management reaffirmed 2013 guidance in conjunction with the report.
All that said, I have decided to sell the stock for Northlake clients. EMC just never worked. Despite outperforming other enterprise focused technology companies and being the leader in must have storage technologies, investors do not seem willing to reward the company just for being better than its peers. Growth is not accelerating as I expected and headwinds to meeting management growth targets remain as large corporation and government entities face restrictions on their IT budgets. Austerity in government spending that began in 2011 with over $1 trillion in budget cuts and now another $1 trillion due to sequestration has proved costly to EMC and its peers.
As noted in my review of Apple’s latest earnings, there is a long history of great technology companies going unrewarded by investors after their high growth phase is over. Microsoft, Intel, and Cisco Systems come to mind. EMC fits in that category as well.
Previously, I believed the company’s opportunity in storage — arguably the most important byproduct of the internet revolution beyond bandwidth — could give EMC another period as a growth stock. I am no longer willing to wait despite the quality of the EMC management as evidenced by the decent performance in the most recent quarter. Sometimes you just have to admit you can find a better idea elsewhere. I was wrong on EMC and will look for that better idea to reinvest the proceeds.
No positions in EMC

Apple: Complete Reset of Expectations Could Mark The Bottom

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Apple reported its second quarter 2013 earnings at the high end of expectations and guidance. However, the real news surrounded the company’s guidance for the next quarter, commentary on future product introductions, and a large increase in the company’s capital allocation program to return cash to shareholders.
For the near-term, I see these factors in rough balance but not enough to lead to a major rally in the shares. If anything, the lack of near-term positive data points is likely to keep the shares near their recent lows. However, I do think the worst news is out and there is a good chance that positives emerge as we move into late summer and fall. As a result, I think the risk-reward tradeoff for the balance of 2013 supports holding the shares. If things go well, I think the stock can rally toward $500 later this year. Downside is now supported by the dividend increase and share buyback and reset of investor expectations. Barring a sharp market pullback, I think the share should hold in the mid $300s. That is a 2:1 ratio of upside to downside enough to keep me in the stock.
Revenues of $43.6 billion and EPS of $10.09 were at the high end of Apple’s guidance and street expectations. EPS fell 18%, the first decline in years. Gross margins of 37.5% were the culprit and came in at the low end of guidance and Street guidance. Declining gross margins reflect tough competition and a loss of product innovation leadership. This cuts confidence in Apple’s long-term positioning and keeps pressure on the shares even when the P-E ratio seems remarkably low. Unit sales of iPhones, iPads, iPods, and Macs were all inline to above expectations. Pricing was OK with iPhone average selling prices a little low as iPhone4 remains popular. This also suggests that the iPhone5 product cycle has been below expectations.
Guidance and the product roadmap is where the report fell short. Even with rampant fears of weak guidance, the company’s projection of $34.5 billion in revenue and 36.5% gross margins were well below the lowest estimates. The implication is that iPhone unit sales will be around 25 million, down vs. a year ago. EPS will be around $7.00, down 25% year over year. Making matters worse, the company indicated new products would not be coming until the fall. This suggests that the September quarter will be quite similar to the June quarter, pushing out the recovery in Apple’s growth profile to at least the December quarter. Previously, I had been willing to wait out the downside in the stock on the expectation that the June quarter would mark the bottom.
The capital allocation announcement was ahead of expectations with the company committing to $100 billion over 2013 thru 2015, composed of $40 billion in dividends and $60 billion in share buybacks. The big surprise was in the share buyback which previously was only at $10 billion. The dividend went up 15% and now sits at $12.20 for a current yield of 3% at today’s prices. Management clearly was sending a message that they think the future is bright and the stock is going back up. The company can buy back about 5% of its shares per year, a material amount and enough to boost EPS.
My overall takeaway is that this quarter marks a complete reset of expectations for Apple. The prior of Apple is over. In fact, I think one could argue that we should not even be comparing Apple of 2013 -2015 to Apple of 2005 – 2012. The company is taking an extra-long break on new product introductions; probably to market sure they get it right this time after the relatively poor reception to a complete suite of new products last December. Those products have not sold as well as expected and the company executed poorly in delivering them to market.
Apple will probably earn about $38 per share in FY 13, down from $44 in FY 12. The question now is what the earnings will be in 2014. Current consensus is around $44 and assumes new products are successful and rollout beginning this fall and thru 2014 in line with management’s comments on the conference call.
A bull case is that expectations have bottomed and investor confidence and sentiment and company growth will resume in the fourth quarter. Despite the crushing decline in the stock since last fall, I believe there is enough residual bullishness on Apple that if renewed growth becomes apparent this fall, the shares can rally sharply. This rally would be in anticipation of a new growth cycle. Ultimately, though, successful products are necessary to provide anything more than a relief rally. If new products fail to revive growth, Apple will look an awful like slow growth tech stocks such as Microsoft, Intel, and Cisco Systems. Those stocks never recovered from the collapse in their growth rates last decade.
With expectations reset to hopefully worst case levels , the share buyback and dividend increase announced, and minimal new products coming, I think Apple will be a boring stock over the next few months. Low expectations set the stage for better stock price performance as investors begin to anticipate the fall new products. Maybe the June software developer’s conference will provide some excitement with a new version of iOS hinting at a big IPhone launch in the fall. I am willing to bet that the next major move in the stock is up in anticipation of the fall product releases and resumed earnings growth in the December quarter. As a result, I am going to stick with Apple in client accounts but remember that Apple as we knew it is over and the story needs t be analyzed from scratch.
Apple is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov. Apple is a net long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, entertainment, leisure, consumer retail, communications, and related technologies. Steve is portfolio manager of Entermedia, owns a controlling stake in Entermedia’s investment management company, and has personal monies invested in the funds.

Another Solid Quarter From Google Supports Bull Case

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Google reported solid first quarter 2013 earnings with most important financial and product metrics tracking very close to expectations. With the stock off 10% from its 2013 and all-time high going into the report, the results were good enough to relieve the pressure. The shares are now up 7% off their April lows but remain about 3% below the all-time high from early March.
I continue to believe that the fourth quarter results, reported in January, marked an important turning point in investor sentiment toward the shares. Investors now see Google as benefiting from the trend toward mobile broadband (smartphones and tablets). In turn, this raises confidence that the company can sustain revenue and EPS growth near 20% a year. With that kind of growth, the shares remain inexpensive. Upside remains over $900 based on a P-E ratio of 15 times 2014 estimated earnings of $54 plus the company’s large cash balance that is contributing virtually no interest income.
Google reported revenue growth of 23% excluding the impact of foreign currency fluctuation. EPS were flat after adjusting for a lower tax rate due to dilution from the Motorola acquisition. Motorola should cease to be a problem later this year as Google finishes restructuring it and losses abate. Paid search growth decelerated slightly but remained at 20%. Cost per click (the price Google receives for a search ad) fell 4%, but the trend remains positive as last quarter was -6% and last year pricing was down double digits. As noted, each of these items was inline with Wall Steer expectations and a continuation of trends evident in the fourth quarter of 2012.
Beyond the risk to search market share and search pricing in a predominately mobile environment, the next big risk to Google is that its profit margins will come under pressure as it invests to secure its long-term growth rate. On this front, the last couple of quarters provide some confidence for bulls. Expenses are rising rapidly as the company builds out infrastructure and pays for traffic to its search engine. However, expense thus far appears manageable. Furthermore, the company is starting to gain respect as an innovator for Google glasses and self-driving cars and Google fiber (cable TV and broadband services). Thus, investors are a little less worried about expense growth on these types of projects.
Looking forward, investors will remain focused on the trade-off between the number of searches and the price received for each search. Trends here seem be stabilizing with search growth still strong, though off its highs, and search pricing down but firming up. Google is implementing new search advertising campaigns that could improve pricing on mobile searches. A positive turn in mobile search pricing over the balance of 2013 is the biggest catalyst for the shares.
Google is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov. Google is a net long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, entertainment, leisure, consumer retail, communications, and related technologies. Steve is portfolio manager of Entermedia, owns a controlling stake in Entermedia’s investment management company, and has personal monies invested in the funds.

Models Stabilize Favoring Small Cap and Value

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After several months with one or both models changing signals, the April signals showed stability. For the second consecutive month, the Market Cap model is recommending small cap and the Style model is recommending value. The small cap signal remains borderline but the value signal has moved into strong territory. This suggests that value will hold firm for a few more months, returning to the usual 4-6 month holding period for new signals, while the small cap signal could change. As a result of the updated models, Northlake clients positions dedicated to the models will be maintained in the Russell 2000 (IWM) and the Russell 1000 Value (IWD).
Last month I mentioned that volatility in the model signals reflected the sub par U.S. economic recovery off the 2008/09 crisis lows. Economic statistics released in the past month show some promise for development of a more normal economic recovery. It is too soon to conclude anything but the models may be reflecting the transition to a normal economic recovery. I am wary, however, as issues in Europe, China, and the U.S. remain volatile and hard to predict.
Last month the then new signals worked well. Small caps outperformed large caps by over 1% and both growth and value matched the market’s gains. So far this year, the Style model has produced a return in excess of the S&P 500 and the Market Cap model has matched the market’s big, early year gains.