Apple’s Positive Guidance Provides Bridge to 5G Driven Growth

/0 Comments/in /by

Apple (AAPL) reported in line 3Q19 results and released guidance for 3Q19 that is ahead of expectations.  It is worth noting that revenues grew just 1% vs the year ago quarter and operating income fell -8.5%.  Guidance calls for similar growth rates next quarter.  The stock is trading up about 4% to its highest level in 2019 and since the downturn off last fall’s all-time highs.  The narrative around AAPL has changed mightily given the stock can act well even ex-growth in the overall business.  Investors now accept that the iPhone is no longer a growth business but services and wearables related the massive installed base of iPhones, iPads, and Macs can sustain superior returns for shareholders.  This is primarily due the huge free cash flow the company generates and a disciplined capital allocation strategy that returns the cash to shareholders via dividends and buybacks.  Northlake believes the stock can continue to work under this investment thesis until iPhone picks up again with a replacement cycle when 5G becomes the global wireless industry standard.  5G phones should begin to sell in material amounts in late 2020.

The stock is trading up primarily due to the very positive tone of the conference call and surprisingly robust guidance.  Guidance implies above historical sequential growth from 3Q to 4Q.  In the press release, Tim is quoted saying “major launches on all of our platforms, new services, and several new products” are coming in the September quarter.  Last year the 2Q19 press release noted only that “we are excited about the products and services in our pipeline.”  This incremental confidence is boosting the stock today as it gives confidence in the near-term which provides a bridge to the 5G upgrade cycle.

The tone of the conference call was good as management noted several items that may have understated growth in the quarter.  Foreign exchange took a larger than expected 3% off revenue growth.  China improved, although still down year over year.  IPhone inventories came down.  iPhone sales improved in June especially at Apple’s stores on online at Apple.com.  Services grew below expectations but adjusted for foreign currency and a one-time benefit a year ago sustained the upper teens growth rate of recent quarters.  Management spent considerable time reviewing growth opportunities in services and wearables.  These businesses represented 32% of revenues in the quarter with wearables (Watch and Airpods) especially strong, up 48%.

The recovery in AAPL shares off about $150 at the start of 2019 leaves less upside in the near-term.  However, looking ahead to 2020 continued growth in services and wearables and the prospects for renewed iPhone growth should allow the shares to regain their all-time high around $240 over the next six to twelve months.  Given AAPL’s financial strength and consistency, that is enough for Northlake to continue to hold AAPL.

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. 

 

Revenue Growth Rebounds at Google

/0 Comments/in /by

Alphabet (GOOG/GOOGL) reported strong 2Q19 results, with constant-currency revenue growth of 22% coming on the heels of a disappointing 1Q19 report. The reacceleration of revenue growth back above the crucial 20% bogey will help put to rest concerns that a secular slowdown at GOOGL has begun. Along with strong sales, GOOGL also reported better-than-expected profit margins leading to a nice upside surprise on earnings. Shares of GOOGL traded up almost 12% on the good news, bringing the previous all-time high reached the day before the 1Q19 earnings disappointment back within reach. The typically tight-lipped management team also provided more detail than usual, particularly around the fast-growing cloud business.

In 1Q19, revenue growth unexpectedly decelerated below 20% . The stock was hit hard, as investors have long focused on the surprising ability of the company to consistently maintain greater than 20% revenue growth despite the massive scale and high market share of the primary digital advertising business. GOOGL noted on the 1Q19 call that the timing of product changes were the cause of the slowdown and declined to provide further detail. On the 2Q19 earnings call, management did not elaborate much more about the previous slowdown, but did note that new products always go through extensive and time-consuming testing before being rolled out to customers. Management sounds as confident as ever that there are plentiful opportunities allowing the company to sustain elevated growth. Although Wall Street panic hit the stock hard after 1Q19, it appears investors are again willing to give GOOGL the benefit of the doubt that product innovation in Search and fast-growing businesses like Cloud and YouTube can sustain historical growth rates.

Looking toward the back half of 2019 and ahead to 2020, Northlake expects GOOGL move toward $1,350-$1,400 based upon reasonable valuations o25x 2020E EPS or 12x 2020E EBITDA. Further upside support should be unlocked over the medium-to-long term as the various “other bets” begin to contribute meaningful profits. Waymo is a good example of this potential, as the Alphabet-owned company’s self-driving cars are already conducting live tests with paying customers. Northlake views  other bets as providing good upside optionality, while still paying a fair price for the strong growth of the core Google businesses.

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.

MGM Fundamentals Resume Positive Trend

/0 Comments/in /by

MGM Resorts (MGM) reported its best quarter since 2017 when releasing 2Q19 results.  For the first time since the 10/1/17 shooting at Mandalay Bay, earnings estimates are likely to move up.  Equally important, the conference call went very well.  Management was focused, detailed, and confident in its outlook.  In fact, the final analyst question concluded by noting, “answers are perfectly clear not just to my question but to all of them today.”  Beginning with the tragic shooting, MGM management has seemed off balance.  Since the shooting, five of the six quarters prior to 2Q19 saw activity level on the Las Vegas Strip slow.  Even with the hit from the shooting, this caught management and most investors by surprise given strong travel and leisure trend generally.  Besides the shooting, the China trade war has played a role as Las Vegas receives heavy visitation and baccarat play from Chinese gamblers.  Those volumes appear to have dropped by half.  MGM probably compounded the issues by reacting poorly to the Strip slowdown in terms of immediate operating strategy and guidance.

Northlake stuck with MGM even as the shares gave up about 1/3rd of the gains it had achieved into early 2018.  We did so because we felt the sum of the parts valuation was deeply undervaluing the shares and our belief that management was good given our experience with the company prior to 2018 when the company executed beautifully on a profit improvement plan.  2Q19 results and management’s 2019 and 2020 outlook appear to be a turning point for the better.  Strip results improved and management laid out a credible outlook for sustaining the trend in 2H19 and 2020 based on a strong entertainment event calendar in Las Vegas.  As a reminder, MGM owns about 40% of the hotel room on the Strip.  Another crucial factor is that the company’s latest strategic initiative, the MGM 2020 Plan, has kicked into gear.  This plan is similar to the well-executed cost cutting plan completed in 2016 and 2017.  MGM 2020 is more balanced between cost savings and revenue initiatives and includes a strategic reorientation to cut layers of management and focus on a more entrepreneurial approach at the property level.  This is similar to the strategy used by Eldorado Resorts, a company we have had success with in the Entermedia hedge fund at Northlake’s sister company.  In concert with the 2Q19 results, management raised guidance for 2019 savings, providing important support to 2019 and 2020 earnings estimates.  Finally, MGM is coming through a period of heavy investment.  Over the past five years the company has developed major new properties in Washington, D.C., Springfield, MA, Macau, and Las Vegas.  These developments surely took a lot of management time in the aftermath of the Mandalay Bay shooting and the Strip slowdown.  Each of these developments are now ramping, albeit with inconsistent results, and the benefits to free cash flow as capital spending sharply moderates is significant.

Putting all of this together with what looks like a possible improvement in the outlook for the Strip in general leaves MGM shares poised to continue to move higher as investor confidence improves.  Looking ahead, there is a possible catalyst in the fall when the company announces the conclusion of the review of its real estate committee to monetize owned real estate on the Strip (MGM Grand, Bellagio, Aria).  Analyst estimates also could rise sharply with another quarter of good results as current consensus for 2020 EBITDAR is well below managements MGM 2020 goal of $3.6-$3.9 billion.  We see the shares having upside to $37 based on current consensus and $40 should 202o estimates move into management’s guidance range.

MGM 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.  MGM 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.

 

The Formula is Working at Comcast

/0 Comments/in /by

You would not know it from the constant headlines about cord cutting but things are going quite well at Comcast.  This is because the margins are not very good on cable video subscribers which are declining, while the margins are very good and getting better on broadband internet subscribers which are growing.  Also growing with an above average margin is the business customer segment.  Thus, as long as the growth businesses stay firm, Comcast can keep growing and keep generating free cash flow from its cable business.  As management said on the call today, “the formula is working.”  We think it continues to work over at least the balance of 2019, so Northlake clients will continue to hold Comcast with a target in the upper $40s.

In 2Q19, Comcast said its cable business grew revenues 3.9% and EBITDA grew 7.4%.  This is despite losing 224,000 video subscribers and seeing video subscribers fall by -2% since a year ago.  Both broadband internet and business services grew revenue by 9-10% driving the attractive financial performance.  Also helping is the mix shift away from video which saw the company boost margins and free cash flow.  Management raised margin guidance and lowered capital spending forecasts for 2019 for the second consecutive quarter.

Comcast has diversified from cable via its purchases over the years of NBC Universal and Sky.  NBCU is cable and broadcast networks, a film and TV studio, and theme parks.  Sky is Europe’s largest TV distributor concentrated in the UK, Germany, and Italy.  Except for theme parks, these businesses face challenges due to cord cutting.  We are concerned about the long-term outlook but for now, there are no urgent problems.  Sky is performing better than expected so far and the company has been able to mitigate cord cutting and sharply falling TV ratings with cost cutting.  Nonetheless, the upside we see for Comcast shares is limited by the secular changes in the TV business, driven by internet-delivered TV.  Think Netflix, Hulu, Roku, and Amazon Prime Video.  We are probably closer to selling Comcast in favor of another investment opportunity than any other individual stock in Northlake’s portfolio.  For now though, the formula is working and we are sitting tight.

CMCSA 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.  CMCSA 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.

 

Facebook Sustains Growth Amid Controversies

/0 Comments/in /by

Facebook (FB) reported largely inline results in 2Q19 reinforcing that the company has weathered the storm surrounding the privacy issues that have plagued the stock since mid-2018.  Revenue growth has decelerated and expenses are higher as management has signaled.  However, in both cases the actual results have been better than expected from an investor perspective.  Revenues on a currency neutral basis grew 32% in 2Q19, ahead of consensus estimates of 28%.  Prior to the emergence of the Cambridge Analytica scandal, FB was growing the top line at 40-50%.  In summer of 2018, management forecast sharp deceleration in growth occurring on a sequential basis (each quarter growth slower than the last).  This has occurred but at a more moderate pace than expected.  Similarly, management guided to accelerated expense growth to deal with the privacy issues. Expenses have grown, generally by mid-to-upper 30% each quarter on a year-over-year basis.  But management had guided to expense growth of as much as 55% per year.  Put this together and FB earnings have held up much better than expected with better than feared revenue and operating expense growth.  At one point, we thought 2020 earnings for FB could be near $8.00.  They now look comfortably over $9.00 and possibly as high as $10.00.

On the 2Q19 conference call, management indicated that the sequential deceleration in revenue growth would continue into 2020.  This is a negative but given that the last several quarters have comfortably exceeded revenue growth guidance, management is probably being conservative.  Most analysts raised 2020 revenue in their models after the report and now show low-to-mid 20% growth.  Most also assume that expense growth decelerates further to match the level of revenue growth resulting in stable operating margins after two years of decline.  Should this occur, earnings in 2020 should reach $10+ and the stock could trade back to new highs in the mid-$200 range.

Northlake believes the odds of this are good.  However, the stock is probably due for a little pause as investors grapple with the new comments on revenue deceleration continuing into 2020 and the new Justice Department antitrust investigation.  Settlement with FTC, even with a $5 billion fine and new privacy requirements, is a modest positive as it frees FB to pursue innovation again, including its cryptocurrency play Libra.  Northlake plans to sit tight with FB as we believe the bull case of stabilizing margins and sustained revenue growth at least in the upper 20% range is most likely.

FB 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. 

Sticking with Mid Cap and Growth as Economic and Technical Evidence Align

/0 Comments/in /by

For the fifth consecutive month, there is no change to the recommendations from Northlake’s Market Cap and Style models for July.  This is toward the top end of the range for recommendation stability across both models.  The Market Cap model continues to recommend Mid Cap and the Style model still favors Growth.  With no changes for July, client positions following the models will continue to be invested for at least one more month in the S&P 400 Mid Cap (MDY) and either the Russell 1000 Growth (IWSF) or S&P 500 Growth (SPYG).

There was some interesting movement in the indicators that drive the Market Cap model.  Overall, the model continues to be a weak mid cap signal that is much more likely to shift to large cap than small cap on its next move.  What is interesting is that there is a split developing between the models internal and external indicators.  The internal indicators, which measures stock market trends and technicals, remain solidly in favor of large caps.   This makes sense given large caps easily outperforming small caps over the past twelve months and so far in 2019.  The external indicators that cover economic fundamentals took a big step toward small cap, moving from almost unanimous support for large caps to a 50/50 split between large cap and small cap.  The shift is a direct reflection of current macroeconomic trends — weakening economic data and a dovish Federal Reserve.  Small caps tend to outperform when economic data is weak as investors look ahead to the next move that is most likely to be improvement in the economic data.  Thus, an indicator that measures the ratio of coincident to lagging economic data has moved to a mode that favors small caps.  Another indicator that measures the shape of the yield curve has shifted toward small caps as the yield curve has begun to steepen slightly reflecting the likelihood that the Federal Reserve cuts the Federal funds rate over the next several months.  The movement in these two indicators makes sense.  The Fed is doing everything it can to accelerate economic growth after a steady deterioration in the data.  This is a good setup for small caps to outperform large caps.  The Mid Cap signal reflects the mixed data in the model but would work well should small caps regain the upper hand.

The Style model remains on a strong growth signal with little change since last month.  Both the internal and external indicators strongly favor growth, a reflection of weakening economic data and continued market leadership for large cap growth stocks.  Growth companies need less help from the economy to hit their earnings growth targets and expectations, so investors continue to favor investing in growth sectors supporting the trend and technical evidence that favors growth.

MDY, IWF and SPYG 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