iPhone 6 Cycle Powers Apple: Now and In Future

/0 Comments/in /by

Apple (AAPL) reported another strong quarter driven by the incredible success of iPhone6 and 6 Plus.  Not that long ago, the debate surrounding the iPhone was whether Apple needed a lower end phone to sell in emerging markets.  Apparently, the missing ingredient was larger screen sizes.  AAPL sold 61.5 million iPhones in the March quarter, easily exceeding consensus estimates for 56 million.  Furthermore, growth was driven by China +71%) and emerging market in general.  Strength in iPhones led better than expected gross margins and earnings per share.

Despite the beat to consensus expectations and another big boost to the company’s share buyback program and dividend, AAPL shares lost a little ground the day after the earnings report.  We think the pause will prove temporary and have adjusted our target higher to $155, up 20% from current trading levels, based on 15x the average of 2015 and 2016 earnings estimates plus half of the company’s net cash per share.

Away from iPhone, Macs had solid growth, with units and revenue up 10%.  Newly aligned Services and Other Products saw 12% growth.  These segments include iTunes, Apple Pay, Beats, AppleTV, and soon the Apple Watch.  The on soft spot was iPad sales which saw a 23% drop in unit sales vs. a year ago.  iPad sales have now fallen five consecutive quarters.

Guidance for the June quarter matched Wall Street estimates almost exactly.  One item of interest and some controversy was management’s comment that Apple Watch gross margins would be below the corporate average during the June quarter.  Given the very high margins on high end watches generally, this came as somewhat of a surprise.  Coupled with non-specific comments about initial Apple Watch demand, we sense that investor expectations for the initial ramp of Apple Watch may have been reduced.

The massive success of the iPhone6 product cycle definitely gives Apple tough comparisons looking ahead to fiscal year 2016.  A slower ramp in Apple Watch, particularly if that is the case this coming holiday season, takes away one lever to sustain growth.  We doubt Apple management has changed its assessment of the watch at all but maybe Wall Street expectations were a bit too high.

One bullish item emerging on the conference call was when CEO Tim Cook stated that just 20% of the installed base of iPhones had upgraded to iPhone 6.  This suggests plenty of firepower to remains to drive iPhone unit volumes over the next several quarters.  It also suggests that firs time iPhone buyers and switchers from Android have been material.  With future growth hoping to emanate increasingly from services like apps, Apple Pay, an OTT TV service, or Beats streaming music, building the networked platform is important for the Apple bull case.

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.

OK Google Quarter, Next One Could Be Crucial

/0 Comments/in /by

Google (GOOG/GOOGL) shares responded favorably to its latest quarterly earnings report, rising over 3% on the first day of post-earnings trading.  The results were largely in line with Wall Street expectations, coming as a relief to many investors who feared worse due to difficult foreign exchange headwinds, slowing growth in search, and the shift in internet usage to mobile and apps from desktop.  The latest quarter does not really resolve the big questions that have kept GOOG shares from fully participating in the stocks market’s rally to new highs over the past year.  However, there was enough good news and fresh information to provide relief that should support the shares ahead of the next big event:  next quarter’s earnings and the arrival of the new Chief Financial Officer.

Adjusted for foreign currency, GOOG sustained its year over year revenue growth rate at 17%.  GOOG’s own websites grew faster at 21%.  Management has purposefully culled network sites, eliminating search volume but improving quality of the network.  This makes GOOG’s own websites performance the key to determining the health of the business.

Another important positive takeaway from the quarter was stable year over year operating margins.  A major part of the bear thesis on GOOG is that profit margins are continually falling because the company has little discipline and overspends on hopeless projects (Google Glass, self-driving cars, Google Fiber, Project Loon to name a few).  Furthermore, GOOG faces a problem in that no business it ever develops, including the very highly successful display advertising it already owns (YouTube and DoubleClick) will ever be as profitable as search.  For the second consecutive conference call, management addressed investor concerns about expense growth and in the latest quarter actually showed stable rather than declining margins.

GOOG provides the least amount of guidance of almost any company we follow but the company has opened up some over the past year.  The company seems to be showing some concern over the stagnating stock price by addressing many investor concerns.  In the most recent quarter, management discussed the massive success at YouTube for pre-roll video advertisements.  This disclosure also allowed the company to explain why cost per click, or the price GOOG receives for a click, remains under pressure and declining year-over year.  GOOG spun this to show the core search business is healthy with rising CPCs.  The added disclosure is good but it still leaves questions as to the impact on volume and pricing of searches as it relates to the shift to mobile.

In one other area of investor focus, management made limited comments when asked about the possibility of return of some of the company’s massive cash balance to shareholders through dividends or a share buyback.

What seems especially interesting to Northlake is that GOOG seems to be setting up for a critical earnings report in July, the first quarter where the new CFO will be on the conference call after she arrives in May.  Ruth Porat comes to GOOG form a very successful tenure at Morgan Stanley, where she had notable success with capital allocation and expense control.  She was also known to be very transparent about Morgan’s Stanley’s very complex business.  Ms. Porat’s expertise, including dealing with government regulators, seems to align perfectly with investor concerns and questions about GOOG.

GOOG shares remain quite reasonably valued compared to the company’s growth rate.  The latest quarter did not quell investor worries about sustaining the growth rate.  The results were good but did not contain the upside necessary to breakout the stock above recent highs.  We are willing to wait another quarter, especially with the CFO coming aboard.  It seems no coincidence that her skill set matches up so well with investor concerns about GOOG.  This provides a good setup for the type of news that will finally allow GOOG shares to catch up to the market’s rally.

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.

 

 

 

 

 

La Quinta Holdings: Bigger In Texas, But Bigger Than Just Texas

/0 Comments/in /by

La Quinta Holdings Inc. (LQ) is a new buy for Northlake clients. The company owns, operates, and franchises midscale and upper-midscale select-service hotels located in the U.S., Canada, and Mexico. LQ currently trades at an attractive valuation in comparison to its peers, and has several potential catalysts that should help drive the stock to a higher valuation. Catalysts include: (1) a growing pipeline of hotels under development, (2) upcoming initiation of capital return to shareholders, and (3) the potential tax-efficient sale of its owned hotel assets. Beyond the attractive valuation and potential catalysts, LQ’s near-term operating results should benefit from lower gasoline prices, its single-brand focus, and its largely domestic portfolio of hotels. We believe shares of LQ can reach $29.50 as these catalysts help narrow the valuation gap to its peers, representing upside of approximately 25%-30% from the current price of $23.00.

LQ currently trades at 11.3x 2015 EV/EBITDA and 9.8x 2016 EV/EBITDA, while its peers trade on average at levels closer to 14x 2015 EV/EBITDA and 12x 2016 EV/EBITDA. The discounted valuation could partly be due to concerns about declining oil prices since LQ has a large footprint in Texas. However, LQ has consistently explained that lower gasoline prices are a net positive to their business. While the company sees some softness in their oil-centric properties in Midland, Odessa, Victoria, and San Angelo, this is offset by continued strength in Dallas, San Antonio, Austin, and other Texas markets. Furthermore, 70% of LQ’s new hotel pipeline is outside of Texas. Additionally, LQ is considered a “drive-to” hotel, and the company expects to see an increase in driving travel due to lower gasoline prices.

The discounted valuation may also be due to the fact that LQ is not as diversified as some of its competitors, who each own and manage multiple brands. We see the single-brand focus at LQ as an advantage. According to Goldman Sachs, LQ franchise owners are critical of companies where multiple brands compete for similar client bases. This means LQ franchisees don’t have to compete with “sister brands” encroaching on their protected territory.

Looking more closely at the catalysts that should help narrow the valuation gap between LQ and its competitors, LQ has a robust pipeline of over 17,000 rooms compared to 41,500 rooms currently in their system. As these new rooms begin to open, LQ will increase their penetration of key hotel markets throughout the United States. According to J.P. Morgan, LQ is present in less than 70% of Smith Travel Research’s US tracts while its peers are present in 90%+.

Regarding the second catalyst, management has announced that LQ plans to begin returning capital to shareholders once the debt-to-EBITDA leverage ratio drops below 4x. We agree with analysts who project that LQ should announce capital return plans towards the end of this year in the form of dividends, share repurchases, or both.

The final catalyst is that LQ plans to sell some of its owned hotels in a tax-efficient manner. This could provide value to shareholders by highlighted the discounted valuation ascribed to the company’s remaining owned hotels, as properties are sold at a premium.

One final benefit for LQ shareholders comes from the company’s largely domestic portfolio of hotels. Most of LQ’s peers own and operate hotels around the world, while LQ is concentrated in the U.S. Investors may revalue LQ relative to its peers that have significant overseas hotel properties that will negatively impact their earnings due to foreign exchange rates.  LQ is largely protected from this issue.

LQ 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 regulatory filings can be found at www.sec.gov.  LQ is a net long position in the Entermedia Funds.  Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies.  Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s investment management company.

Mid Cap and Large Cap Growth Still Favored

/0 Comments/in /by

There are no changes to the signals from Northlake’s Market Cap and Style models for April.  The Market Cap model continues to recommend Mid Cap and the style model remains on a Large Cap Growth signal.   The growth signal has now been in place for six months and the mid cap signal for five months.  Both signals’ length is consistent with the long-term historical average during the models’ actual use and back-testing.  With no changes to the signals, Northlake clients invested in the models will continue to hold the S&P 400 Mid Cap (MDY) and the Russell 1000 Growth (IWF).

The mid cap and large cap growth signals each got slightly stronger for April.  Keep in mind that the model signals are driven by two month averages of the individual internal and external factors.  Within the Market Cap model, one internal indicator measuring market breadth flipped from small cap to large cap reflecting the down market during March.  Conversely, the external indicator looking at coincident economic indicators shifted from large cap to small cap.  This is an interesting indicator because it is forward-looking and contrarian.  The idea is that small caps perform best when the economy is weak and bottoming as the market looks ahead to the upturn that is the next phase of the economic cycle.  This indicator still sees the economy as having upside, especially after harsh winter weather, weak exports due to the strength in the dollar, and West Coast port issues led to weaker GDP growth in the first quarter.

The Style model moved further into large cap growth territory as two external indicators moved from value to growth.  The consumer vs. cyclical factor is picking up the better consumer environment driven by improved job and wage growth and lower oil prices.  This economic environment is a big boost for Northlake as our individual stock portfolio is focused on consumer discretionary industries such as media, entertainment, and leisure.  Another factor measuring net dividend yield is similarly picking up the better consumer environment as consumer stocks tend to dominate growth indices.

Performance of both models was good in March and since the current signals went into effect.  Given the efforts we made to review and revise the models, we are especially pleased to see multi-month runs of material performance for both models.

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.