Alphabet: Solid 3Q18 Results

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Alphabet (GOOG/GOOGL) outperformed 3Q18 earnings estimates despite slightly missing on revenues for the first time since 1Q16. The sales shortfall was largely driven by foreign exchange losses in Brazil and Argentina due to the stronger US dollar. Revenues still grew 21%, or 22% after adjusting for the currency impact.

Operating expenses were up 26%, pacing ahead of sales growth. Traffic Acquisition Cost (TAC) growth finally appears to be slowing down, which will help improve overall profitability for GOOG. In fact, EBITDA margins for the trailing twelve months are expected to rise from 32% to 37% over the coming quarters as the company anniversaries investments in TAC partnerships. Net income margin is expected to hover around 20% for the foreseeable future.

Segment results were encouraging, with particular strength from mobile search, YouTube, cloud, and desktop search. Alphabet continues to make disciplined investments for ongoing growth in areas such as cloud computing, machine learning, artificial intelligence, Waymo’s self-driving car fleet rollout, and Verily’s healthcare research.

GOOG shares have traded lower since reporting earnings in a tricky market environment for growth stocks, but Northlake continues to like the outlook for the stock. The rare combination of Alphabet’s consistent high sales and earnings growth, market share dominance, scale, ongoing innovation with untapped opportunities, and relatively attractive valuation is hard to come by. Offering consistent 15-20% growth, GOOG currently trades at roughly 14.5x 2018 EV/EBITDA and 12x 2019 EV/EBITDA. Rolling those multiples forward implies upside to roughly $1,300 in 2019 and $1,500 in 2020.

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.

Sherwin Williams Reduces Top End of Guidance

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For the third quarter in a row, Sherwin Williams (SHW) adjusted 2018 EPS guidance. In 1Q18, SHW dropped the estimate from $19.05 to $18.65 due to new investments in an expanded partnership with Lowe’s. Then in 2Q18, SHW turned around and increased EPS to $19.20 after a strong start to the year. Now in 3Q18, SHW reduced 2018 EPS guidance to a midpoint of $19.13, with an expected range of $19.05 to $19.20 instead of the previous high end at $19.35.

The stock reacted poorly to the most recent change amid a difficult stock market environment with concerns ranging from slowing housing growth to runaway raw material inflation and new tariff increases. The moving guidance target can be explained by the confluence of integrating the transformative acquisition of Valspar, aggressively investing in attractive new partnerships such as Lowe’s, and the quickly changing inflationary environment tied to the price of oil and trade war rhetoric.

While slower housing construction and home sales have become points of macroeconomic interest, remodeling and repainting of homes makes up 80% of the industry demand which bodes well for continued low single digit growth over the long term. The contractor business was once again a strong point for SHW this quarter.

Inflation is running ahead of SHW’s price increases for now, but the company has demonstrated the consistent ability to pass inflation-based price increase through to partners with minimal push back. SHW has more price increases scheduled in 4Q18 and 1Q19, and will continue to take price to keep up with inflation.

The integration of Valspar has gone fairly smoothly and is now largely complete. Moving forward, SHW expects to find several opportunities to grow both brands and find incremental synergies. The investments in the Lowe’s partnership appeared to deliver good results quickly in 2Q18 and similar results should become apparent in 2019 as SHW recoups the upfront investment in the expansion.

Looking past all the noise, Northlake continues to believe SHW is on track to deliver 2020 EPS of $25, which could push the stock above $500 at current price-to-earnings multiples of 22x this year and 19x next year’s EPS estimates.

SHW 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.  SHW 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.

Activision Blizzard: Conservative 3Q18 Guidance Concerns Investors

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Activision Blizzard (ATVI) reported 3Q18 revenues matching estimates with EPS ahead of expectations. However, implied 4Q18 guidance was weaker than expected, sending the shares sharply lower. While the guidance was likely conservative given the highly competitive holiday season this year, 3Q18 results were not good enough to support the stock in a punishing environment for growth stocks.

ATVI called out a negative impact from the under-performance of the recently launched expansion for Destiny 2. This is a concern, however, Call of Duty: Black Ops 4 should sell well enough to help overcome that weakness. King Digital also released a new title in the popular Candy Crush series that is expected to do well.

ATVI has accomplished a lot in 2018 with blockbuster game launches and major expansions along with the successful growth of the Overwatch League. The company has been firing on all cylinders for the past several years, owns a strong library of old and new franchises, and has exciting opportunities to grow via e-sports and mobile advertising.

While the stock might be taking a breather, the long-term prospects of ATVI appear strong. For now, Northlake is focused on 4Q results and upcoming FY19 guidance. If the recent game launches deliver as expected, the stock could see a quick rebound. Even assuming lower multiples across the video game industry and other growth sectors, Northlake continues to see upside of $64 to $80 reflecting 20x to 25x 2019 EPS of $3.20. At the current depressed price-to-earnings multiple of 14.5x, Northlake believes the market is now underestimating a compelling growth story.

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. Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.