Style Shifts to Neutral

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Northlake’s Style model shifted from favoring growth to a neutral reading for December.  As a result, one half of client positions in the Russell 1000 Growth (IWF) were sold and the proceeds were reinvested into the Russell 1000 Value (IWD).  The Market Cap model is still recommending mid cap for December.  Therefore, client positions in the S&P 400 Mid Cap (MDY) will be held for at least another month.

The shift in the Style model represents the first change in 13 months.  Since the growth signal was initiated on 11/1/14, the model has performed exceptionally well.  IWF gained 7.6% against a loss of -1.87% for the Russell 1000 Value (IWD), the Style model’s primary alternative to IWF.  The S&P 500 gained 3.1% while the growth signal was in place.  This is exactly how the models are supposed to work — invest in the best performing themes relative to direct alternatives and beat the benchmark market index.  Given that 11/1/14 was the first month using the updated models, this result is encouraging.

We mentioned last month that the Style model was moving toward value and away from growth.  In addition to updating the factors and weightings that drive each model, the 2014 update also created a “neutral” recommendation for the Style model.  Previously, it was only growth or value.  Our analysis of growth vs. value over long period of times indicated that neutral was a value-added recommendation for the Style model.  The shift that took place this month is mostly reflective of larger changes in the underlying indicators that favored value last month.  The final model reading and recommendation represent a two month average in order to reduce volatility in the signals as we are shooting for longer term performance.  Presently, six Style indicators favor value and eight favor growth with both internal and external factors having a roughly even split.

The Market Cap model remains pretty firmly in mid cap territory with a slight bias toward small cap.  There are sixteen indicators that comprise the Market Cap model.  Presently, eight favor large cap and eight favor small cap.  In addition, the internal and external indicators are also split at four each for small and large cap.  As reminder, the individual indicators in the Market Cap model recommend only small or large cap and a split decision cumulatively defaults to a mid cap recommendation.  The Market Cap model has performed fairly well this year, gaining about 1% more than the S&P 500.  The model has been on a mid cap signal all year except for June and July when large cap was favored.

MDY, IWD, and IWF are 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. 

After Rough Stretch CBS Stabilizing

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CBS reported a mixed quarter against low expectations.  The highlight of the quarter is the company is returning to growth on the operating income line with a big accelerating ahead on 2016 on the back of political advertising.  CBS shares have perfomed poorly this year as earnings estimates moved steadily lower.  At one point, Northlake felt that CBS could earn $4.65 in2016.  That now looks more like $4.00.  Weak TV ratings, a lesser number of shows sold into syndication, and advertising declines impacting all TV companies have led to reduced expectations.  It appears the worse is over as several of these trends are stabilizing or reversing and for the first time in recent memory CBS reported earnings and Wall Street analysts did not reduce their estimates.

We have stuck with CBS because the company is very shareholder friendly with buybacks and dividends and because the company is relatively well protected from fears about cord cutting and cord shaving.  CBS remains the most popular network in America and is included in all the skinny bundles of less TV channels being offered by cable and satellite companies or OTT providers.  This means that CBS has mostly locked in a ramp in revenue and profit contribution as retransmission fees escalate over the next four years.

We are also pleased to see CBS as a leader among traditional TV companies in testing ideas for the new digital age of TV.  The company offers CBS All Access and Showtime as OTT services and has launched on online only news service.  As a leading producer of TV shows, CBS is also well positioned to benefit from demand for new TV shows that is coming from OTT providers like Netflix and Hulu.

CBS shares look cheap at 12X stable 2016 earnings estimates.  We think a couple quarters of stability are enough to allow the multiple to expand and drive the shares higher.  We have been overly patient with CBS in the past year but 2016 sets up well so it is worth hanging on for at least a little longer with the support of the best management team in the business.

CBS 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.  CBS is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

Disney Reassures with Good Quarter and Commentary

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Disney (DIS) reported better than expected 4Q15 earnings, a great relief to investors following the controversial 3Q 15 report in August that send DIS and other media stocks into a spiral of declines ranging from 20-30% in just a few weeks.  The issue in August was a lowering of guidance due to foreign currency hedges expiring and a reduction in the subscriber base at ESPN.  IT was the ESPN news that caused trouble for DIS and media stocks as it ignited fears that cord cutting and cord shaving had reached a tipping point.  Given the reliance of TV networks and cable and satellite providers have on subscription fees and advertising via ratings, accelerating subscriber losses would quickly damage the profitable and heretofore steadily growing TV business.

Northlake felt that investors overreacted to the ESPN news because we did not see a massive acceleration in cord cutting/shaving that was implied by the plunge in stock prices.  Furthermore, we believed that confusion surrounding Nielsen data probably led Disney to include a couple of years of sub losses into one guidance update.  With Disney making no further changes to their ESPN guidance and stating that they have seen no pickup in sub losses recently, investors are feeling a lot better about this important asset for DIS that represents around 20% of the company’s financial profile.  Also comforting investors has been the latest set of earnings reports from satellite, cable, and telco companies that show no acceleration in sub losses.

With less concern about the imminent demise of ESPN’s economics, investors are free to focus on many other positives at DIS.  The new Star Wars movie hits theaters in December and all indications are it will be a smash hit  Early consumer product sales and interest in the video game produced by Electronic Arts are positive signs.  DIS can also look forward to the opening of ts resort in Shanghai next spring.  The resort will produce a loss in in its first year but offers big long-term promise on its own and to help build interest in Disney properties in China.

Other positives emerging from the latest report include better than expected programming expense guidance for 2016 for ESPN, improved advertising growth at ESPN and ABC, and a continued aggressive pace of share buybacks to utilize the company’s excellent balance sheet.

DIS shares have recovered all but 3% of August’s 20% plunge.  Northlake sees the potential for DIS shares to rise another 10-15% over the next six months.  The big upside may be in the rear view mirror after the shares doubled in less than three years form our initial purchase but we think this quality company is worth an investment for at least a little while longer.

DIS 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.  DIS is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

All Quiet On Liberty Front For Now

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It was a quiet quarter for the Liberty Media family of companies owned in Northlake client portfolios.  We could get some fresh news on these event driven stocks later this week when Liberty hosts its annual analyst meeting in New York.  We will be attending this year.

Liberty Media (LMCA) remains tied to its 60% stake in Sirius Satellite Radio (SIRI).  SIRI shares have performed and are trading near 52 week highs after another good quarter of subscriber and financial growth.  At some point, SIRI and LMCA will merge or spilt, an event we feel will be bullish for LMCA shares.  While we wait, SIRI continues to be on a good growth path with better competitive position than the market appreciates.

Liberty Broadband (LBRDA) is a lead investor in Charter Communications.  Charter is trying to get regulatory approval to merge with Time Warner Cable.  We believe the odds are good despite rejection of Comcast’s attempt to merge with Time Warner Cable.  A merger would be very bullish for LBRDA, so we are patiently waiting on the FCC.  We think a close in the spring of 2016 is a good target.

Liberty Global (LBTYK) is an operating company and the largest cable company in Europe.  The company’s third quarter report showed signs of the acceleration we are expecting in subscriber, revenue, and cash flow growth.  Management guidance for further acceleration in the fourth quarter gives us confidence that much higher share prices lay ahead for LBTYK.

Liberty Global LiLAC (LILAK) was recently spun out of LBTYK.  LILAK has cable assets in Puerto Rico and Chile.  The spin was designed to separate Europe from Latin America and create vehicle for LILAK to consolidate the fragmented cable and telecommunications industry in Latin America.  LILAK announced it is in merger discussion with Cable and Wireless earlier this month.  We should know the outcome of these discussions by Thanksgiving.  A merger is highly accretive for LILAK and would be a big bullish catalyst for the shares.

LMCA/LMCK, LBRDA/LBRDK, LBTYK, and LILAK  are 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 LMCA/LMCK, LBRDA/LBRDK, LBTYK, and LILAK are net long positions in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies

Activision: The New KING of Mobile

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Activision Blizzard (ATVI) announced strong quarterly results that beat street estimates on sales and earnings per share while raising full year guidance. The updated full year guidance is slightly below street consensus estimates, but seems understandably conservative ahead of ATVI’s launch of the next iteration of their most important franchise, Call of Duty: Black Ops III, which could make or break their full year results.

The bigger story at ATVI is the announced acquisition of King Digital Entertainment (KING), a leader in mobile gaming and creator of popular franchises such as Candy Crush. From a financial perspective, the deal appears to be good for ATVI. The company estimates that the acquisition will be highly accretive, adding approximately 30% to next year’s earnings per share, implying a jump from previous estimates of $1.57 to $2.04. KING currently trades at a large discount to established gaming companies like ATVI due to a comparative lack of diversity in game offerings and potentially declining interest in currently popular franchises.

The KING acquisition appears to be a great use of overseas cash that is currently earning nothing. Instead of waiting for clarity from the Federal Government on the possibility of repatriating overseas cash at a discounted tax rate, or choosing to pay full taxes to bring the cash back to the U.S., ATVI chose to buy a hopefully steady stream of free cash flow. The deal also strategically diversifies ATVI by bolstering their mobile game offerings and creating a new avenue for growth. Additionally, there may be revenue synergies from cross-promotion of the combined company’s franchises, which could help lower marketing expenses and drive incremental sales.

Overall, the KING acquisition appears to be good for ATVI as long as income from Candy Crush and other KING franchises does not decline faster than currently expected. The KING deal in combination with ATVI’s exciting pipeline of upcoming product launches and strong execution leave us feeling positive on the company’s outlook. ATVI has already been one of Northlake’s biggest winners this year rising 80% from the low $20’s to the mid-$30’s. While we plan to take a deeper look at the risks related to the KING acquisition, we currently believe that shares of ATVI could trade at 20x 2016 EPS of $2.04, pushing the stock into the low-$40’s.

ATVI 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.  ATVI is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

Underlying Shifts Large But Mid Cap and Growth Survive Another Month

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There are no changes to the recommendations from Northlake’s Market Cap and Style models for November.  Mid Cap and Large Cap growth remain the favored themes.  As a result, client assets invested in the models will continue to be held in the S&P 400 Mid Cap (MDY) and the Russell 1000 Growth (IWF) for at least another month.

While there is no change in the recommendation from either model, there was significant underlying movement in both models.  The Market Cap model moved in favor of small caps and the Style model moved in the direction of value.

Three indicators in the Market Cap model moved from large cap to small cap to November.  Each indicator is in the internal group and is related to stock market breadth: Stocks Above 200 Day Moving Average, Stocks Above 50 Day Moving Average, and Net New Highs.  These indicators switched in favor of small cap as a result of large and broad-based rally in the market in October.  Strong, positive market breadth is usually a leading indicator that more volatile small cap stocks will outperform and lead the market higher.

Prior to the November readings, the Market Cap model was close to moving from a mid cap signal to a large cap signal.  With the three indicators just described moving toward small cap, the overall model is now back firmly in mid cap mode.

The Style model shifted in favor of value for November and another month of similar of readings would shift the overall model to a neutral reading from favoring growth.  This is a significant change as the growth recommendation has been in place since November 2014.  Three indicators shifted from growth to value for November.  As in the Market Cap model, indicators related to stock market technicals flipped.  In the case of the Style model, the change came from leadership for beaten down industries within value during October’s big rally.  Energy, commodity, industrial and emerging market stocks led higher as investor concerns about instability and downward trends in currency and commodity markets eased.  Wall Street is less concerned about a global recession than a few months ago.

During October, the Market Cap model lagged the market’s gains.  For all of 2015, the Market model is performing in line with S&P 500.  The Style model matched the market in October as growth and value each fully participated in the rally.  Year-to-date, the Style model is performing very well, producing a price only return of almost 6% against a gain of just 1% for the S&P 500 and a low single digit percentage loss for the value indices that have been avoided.

MDY and IWF are 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. 

 

 

Boring Apple Quarter Good Enough For Now

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Northlake clients have owned Apple (AAPL) since early 2005, a period now covering over 40 quarterly earnings reports and conference calls.  The most recent report and quarter ahead guidance issued earlier this week was the closest match to Wall Street estimates so far.  Granted when Tim Cook took over as CEO, the company changed its methodology to more accurately provide guidance and stop the game of guiding conservatively and producing upside “surprises.”  What makes this quarter interesting is that typically AAPL needs to “beat and raise” when it reports to cause an immediate upward move in the stock.  This quarter a merely inline report and guidance has allowed the stock to move up 5% in two days.

The reaction to this quarter shows just how poor the sentiment has gotten toward AAPL over the past few months as the company faces the formidable challenge of growing revenue and earnings against the monster success of the iPhone 6 cycle.  iPhone 6 introduced larger screen phones, kicking off an upgrade cycle among current iPhone users and new users switching from Android phones.  iPhone 6 set very difficult comparisons for AAPL and many investors fear it represented that last major growth phase for the company.  Recent product introductions like Apple Pay, Apple TV, and Apple Watch have proven moderately successful but not nearly large enough to drive growth for the company.  Macs chug along but in a mobile world traditional PC and laptop forms are mature products.  iPads and tablets in general have fallen off much more rapidly than expected not yet shown signs of stabilization.

Thus, iPhones remain the key driver of AAPL growth and stock price.  Recent datapoints from suppliers to AAPL suggested that iPhone 6s was producing disappointing unit sales and the company could see its first ever year over year decline in iPhone unit volumes this quarter against the huge holiday season last year.  However, AAPL’s guidance implied higher unit volumes, albeit only low single digit growth.  Against the cautious sentiment dominating AAPL since the stock peaked at $135 earlier, that was good enough for a relief rally.

Northlake sees the current outlook for AAPL as fairly balanced.  We share some of the growth concerns.  In particular, we have a hard time seeing the company grow net income beyond the upper single digits over the next year or two.  This is mostly just a law of large numbers challenge.  We do not share the bearish view of declining iPhone volumes in FY16.  Only about 30% of the installed base of iPhone users has upgraded to the iPhone 6 series and growth in emerging markets, China especially, appears to be sustainable.

A modest growth outlook is well reflected in AAPL shares which trade at just 12X 2016 earnings estimates ignoring about $25 per share in net cash on the balance sheet.  We see valuation providing good downside support and still negative sentiment giving way over the next three months as expectations for iPhone unit volumes firm.  While we are less enthusiastic about big upside in the stock in the near future, we see a move to the 2015 highs as likely.  That is enough for us to continue to hold the shares for Northlake clients and be patient for non-iPhone growth drivers to kick in.

AAPL 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.  AAPL is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

Holding Hilton, Selling La Quinta Amid Lodging Challenges

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Hilton Worldwide (HLT) and La Quinta Holdings (LQ) reported 3Q earnings in line with current expectations.  HLT expectations had come in slightly as concerns about the health of the lodging industry grew over the summer and early fall.  HLT’s results were fairly good against the lowered expectations and the company’s growth profile appears to be at the higher end of lodging industry peers.  HLT guidance for 4Q15 matched street expectations but seem likely to be near the low end of the range provided given commentary on the conference call about weak transient business in October.

LQ reported in line with the significantly reduced guidance the company provided when it announced disappointing 2Q15 results in July.  LQ maintained the lowered full year 2015 guidance from July.  This indicates stabilization in operating fundamentals, albeit at a materially lower level than previously expected.  On the 3Q15 conference call, the interim CEO indicated that the company is likely to undertake actions to improve perception of the brand.  These could include hotel renovations advertising, increased customer service and digital investments.  Against what appears to be still weak demand for LQ properties, these investments seem likely to pressure 2016 earnings estimates.  Management is showing confidence in the business by accelerating share repurchases and is exploring alternatives to realize value from the asset base of owned hotels.  One group of 24 hotels is being sold already.  However, on the call, management appeared cautious about opportunities for a larger scale financial restructuring.  Short of an outright sale of the company, Northlake no longer sees financial engineering as providing as much support to the stock as previously thought.  Given this view and the likelihood that 2016 is a transitional year of investment in the brand under a new, as yet unidentified CEO, we have decided to sell LQ for Northlake clients.

It makes sense to hang onto HLT even against challenges faced by the hotel industry including rising room supply, the growing impact of Airbnb, and reduced international travel to gateway U.S. cities.  HLT has very strong management, a shareholder friendly approach to capital allocation and potential financial engineering, and most importantly, a great set of brands that is well positioning to navigate near-term challenges to the lodging industry.  3Q15 results and 4Q15 guidance show HLT’s top of the industry performance that merits patience given long-term value potential.

HLT 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. 

Despite Worries, Comcast Remains on Solid Ground

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Comcast (CMCSK) reported results right in line with Wall Street expectations for 3Q15.  Revenues grew 11% and Operating Cash Flow gained 8.4%.  CMCSK is really two entities, the core Comcast Cable business now operated under the Xfinity brand, and the entertainment businesses operated at NBC Universal.  NBCU consists of the NBC TV Network, cable TV networks, Universal theme parks, and the Universal Film and TV studio.  Both sides of CMCSK’s business performed well in 3Q but it was outstanding success in films and theme parks that led growth.

Investors are most interested in Xfinity, however, which makes sense given it represents 2/3rds of revenue and 75% of operating cash flow.  Thankfully, once again, despite lots of concerns about the cable business (net neutrality, cord cutting, cord shaving).  Revenue and EBITDA each grew 6.4% and while the company lost 48,000 subscribers, this was the best subscriber performance in a third quarter in 9 years!  Xfinity added 320,000 high speed internet customers and saw revenues from broadband grow by over 10%.  There is no denying that how consumers TV is changing and there is some risk to the TV side of the cable business but at Comcast, and the cable industry in general,  the changes are impacting fundamentals very slowly. Furthermore, Xfinity should not really be called a cable company anymore but rather a broadband company.

NBCU was led by a 64% gain in revenue at the film studio that translated to a gain of 150% in operating cash flow.  Minions, Fast and Furious, and Jurassic World led the way in a record breaking year for the studio.  Theme Parks saw 14% growth in revenue and operating cash flow, driven by the Harry Potter attractions in Orlando and Fast and Furious ride in Hollywood.  The TV networks, also facing challenges from declining sub growth and lower ratings due to Netflix and cord cutting, reported modest growth.  Once again, the story is likely one where sentiment toward the TV networks is a lot worse than the reality of the impact on the business in the near-term.

CMCSK shares are up about 8% this year despite the concerns about the changing TV business.  Since August, when ESPN lowered its growth forecast and media stocks fell a quick 20%, Comcast is down just 5%.  Northlake thinks this shows the strength of Comcast’s business and expects continued solid quarterly results to eventually get CMCSK shares moving higher again.  Trading at less than 8 times operating cash flow while producing high free cash flow that is being reinvested in the business and returned to shareholders through dividends and share repurchases, CMCSK continue to look attractive.  We maintain our target for CMCSK to trade in the $70s over the next 6 to 12 months.

 

CMCSK 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.  CMCSK is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

 

Strong Results from Alphabet: G is for Growth, Google

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Alphabet (formerly known as Google and still trading as GOOG/GOOGL) reported good results in 3Q15.  This marks the second consecutive quarter that the company has beaten Wall Street expectations after a string of slightly disappointing results.  The shares responded, rising from $500-550 for much of the first half of the year to over $700 today.

Results the last two quarters have dented the bear case that Google is facing rapidly decelerating growth in revenues and profits as the world shifts to using apps within mobile internet.  This reduces the value of search and should hurt the volume of searches and pricing for searches.  The last six months have instead seen acceleration in the number of searches with pricing per search falling but not at an accelerating rate.

Stabilizing or improving fundamentals are not the sole reason for the surge in GOOG shares.   The company has brought in in a new CFO and promoted a new CEO.  The founders of the company have taken a step back and restructured the corporation.  Alphabet is the holding company with basically two divisions:  Google as we know it for search and YouTube and all the other things Google invests in outside the core such Google Glass, self-driving cars, weather balloon delivered internet, etc.  The management and operational restructuring has dramatically improved the corporate culture from an investor perspective.  Disclosure and transparency has improved, capital and operational expenses are more tightly managed, and the company initiated a share buyback.

Put all this together, and Google investors are enjoying the favorable combination of rising earnings estimates and higher valuation of those earnings.  Northlake thinks more is yet to come with upcoming catalysts including the seasonally strong holiday season, greater detail on the “other bets” outside core Google, and possibly some improvement in mobile search pricing.    Core Google can probably earn close to $40 in 2016.  Even if you ascribe zero or negative value to the other bets, conservative in Northlake’s view especially if you also consider the company holds over $100 per share in cash, a target of $800+ seems plausible, or 20x core earnings.  There are very few really large companies in the world with organic growth in the range of 20%.  Google is one of them and deserving of a premium valuation.

GOOG/GOOGL 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.  GOOG/GOOGL is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.