3Q24 Earnings Updates: Part Two – NXST, SONY, HD, and WMT

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Nexstar Media Group (NXST): NXST reported good 3Q24 earnings despite a shortfall in political advertising revenue.  Political ended up flat with the 2020 Presidential cycle after expectations had been raised over the summer for growth.  NXST offset the shortfall with improving results at the CW Network and good expense control.  The shares initially rallied to an 18-month high after management outlined a confident outlook for 2025 and indicated the new administration and Congress was likely to deregulate the local TV broadcasting industry.  As the industry leader with a strong balance sheet, lots of free cash flow, and a successful history of station acquisitions, NXST is poised to complete accretive M&A.  If the deals are not so large that they push leverage above 4X, we are comfortable with this path.  The shortfall in political advertising was overlooked when NXST reported.  This hit home the next day when another large TV station owner, Gray Television, missed political advertising estimates.  In fact, all the major station owners missed except for E.W. Scripps, which reported a big positive surprise.  The overall industry shortfall triggered fears that local TV political advertising could enter a period of secular decline as market share shifts to digital and streaming TV advertising platforms.  Despite NXST’s success (the stock has tripled since we first bought it for clients 7 years ago), the collapse of newspapers, radio, and linear TV networks has long had investors on edge.  NXST shares declined 12% on the day following its earnings report.  It actually held better than most of the other TV station owners!  This seems clearly an overreaction to us, and we are pleased to see the stock rebound from that decline.  Nonetheless, the bear case on the industry has new strength that is balanced by the developing but not certain regulatory relief coming from the new administration and Congress.  We expect the shares to remain in a trading range for the next few months until we see whether deregulation happens.  If it does, NXST shares have significant upside.  Regardless, the shares remain supported by excellent management, the turnaround at the CW Network, and the potential for NewsNation to further develop into a material asset as a growing cable news network.

Sony Corporation (SONY): SONY reported slightly better than expected operating profits on slightly lower than expected earnings for its 2Q24.  SONY is on a March fiscal year but still considers the year ending March 31, 2025 to be its 2024 fiscal year.  The shares responded well since the upside came from the right segments.  Video Games led the way, a segment that has witnessed slower growth over the past year.  Improved 3rd party software sales and a stabilization in PS5 units generated the upside.  Imaging Sensors also had upside vs expectations.  This is another business that has faced challenges in the past year.  Most of the business is related to semiconductors used in high-end cellphone cameras.  Growth picked up ahead of the expected timeline and should continue as AI mobile phones trigger a replacement cycle.  The upside in operating profits for the corporation came despite a small shortfall in revenues.  This is indicative of SONY’s strong management that closely scrutinizes operating expenses.  All three of these positive drivers are expected to be sustained in 2025.  SONY also should see continued growth in its music business (#2 in the world) and corporate growth will be higher after the company spins off its financial services arm next fall.  With growth expected to pick up, we believe our patience with SONY stock will finally pay off in 2025.

Home Depot (HD): HD saw some green shoots when reporting its 3Q24 results.  Sales have been under pressure over the past year from the combination of high mortgage rates and a pull forward of demand in 2021 and 2022 related to the pandemic.  3Q24 reported sales and guidance for 4Q24 still show slightly negative comparable sales growth.  However, the declines are moderating and a return to growth could occur in 2025 if mortgage rates fall further.  HD shares were volatile after the earnings report and conference call.  Initially, they traded higher since not only sales, but earnings were better than expected.  Investors sold the shares as management explained some of the upside was do better than expected weather that elongated the home improvement season in northern climates.  Management also noted that hurricane rebuilding boosted sales in October.  Also impacting the share action was a jump in market-determined interest rates.  HD shares have always been sensitive to interest rates and the current environment is complicated by uncertainty over the impact of policy in the new Trump Administration.  As analysts dug deeper into management’s comments several green shoots appeared.  First, even after backing out the good wealth and hurricane rebuild impacts, sales showed sequential improvement.  Second, the initial impact of the controversial acquisition of SRS Distribution is quite positive.  SRS customers have dramatically accelerated purchases at Home Depot stores and the SRS trade credit program for professional contractors is being successfully extended to contractors already doing business with Home Depot.  The bottom line is management is doing everything they can with what they can control.  The core business shows initial signs of improvement.  SRS is off to a good start and if successful can materially increase the company’s total addressable market.  DIY projects are likely to improve ahead of contractors since the latter require financing and thus lower interest rates.  High-quality stocks like HD are worth waiting for and that is exactly our plan for HD.  The shares have already recovered to near their all-time highs achieved at the end of 2021.  When green shoots ignite the next leg of growth, we see substantial upside for the shares.

Walmart (WMT): WMT reported another beat-and-raise quarter, continuing a string of results that Wall Street loves.  The shares responded positively, rising to new all-time highs.  WMT is now up 68% this year, better than Apple, Alphabet, and Meta Platforms.  WMT’s results were good across the board.  We particularly liked the fact that revenue and comparable store sales exceeded expectations driven by both higher traffic and higher transaction value.  WMT also continues to benefit from its efforts in ecommerce, advertising, and fulfillment.  These are much higher growth businesses, currently growing at 20% plus vs the core stores growing revenue in the low to mid-single digits.  Advertising and fulfillment are also much more profitable businesses.  Ecommerce is still losing money, but the losses are falling fast, and profits are not far away and should ramp quickly given the fast-growing revenue.  When you add WMT’s world-class supply chain to its technology-driven growth businesses, it almost makes sense to compare the company to the Magnificent 7.  One other takeaway for WMT occurred the next day when Target reported earnings.  Target’s results were weak, and its forecast was much weaker than expected.  Target same stores sales grew less than 1% compared to 5% for WMT.  Looking to the critical holiday quarter, Target forecast negative comparable store sales verses an expected gain of 3-4% for WMT.  In ecommerce, WMT grew over 20% last quarter and projected more of the same of the same.  Looking ahead, WMT forecasts continued growth in excess of 20%, while Target will struggle to get to double-digit growth.  Our investment thesis for WMT has been that it is gaining market share and improving profitability at the same time.  The comparison with Magnificent 7 and contrast with Target suggest that our thesis is intact.  WMT shares are no longer discounted but there is reason to expect continued gains as long as fundamentals are strengthening.

NXST, SONY, HD, and WMT are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is the sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.

3Q23 Earnings Updates: Part Two – AAPL, NXST, DIS, SONY, HD, and WMT

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Apple (AAPL): AAPL 4Q23 earnings and 1Q24 guidance were mixed.  The shares are down 1% in a very strong market following the report.  4Q23 results were in line on revenue and ahead on EPS with iPhone sales holding up and Services coming in ahead.  Other hardware including Macs, iPads, and Wearables were weak.  Good cost control and the mix shift toward Services revenue led to record-high profit margins and better-than-expected EPS.  Guidance for the all-important quarter called for flat iPhones, continued similar growth in Services, and ongoing weakness in the other hardware businesses.  AAPL has now gone four straight quarters with small year-over-year declines in revenue.  Cost controls, increased services mix, and consistent stock buybacks have allowed EPS to grow.  However, with concerns about the economy amid many headwinds and uncertainty on the company’s large business in China (geopolitics, a new competitor, weak recovery), investors want to see top line drive growth to reward AAPL shares.  The outlook is hardly dire but given the stock’s mid 20s P-E more balanced growth drivers are needed.  Given the company’s history and elevated R&D spending, it is likely that revenue growth will resume and lead to the balanced growth investors desire.  In the meantime, the shares are likely to lag strong upward stock market trends.  Short of a major negative change in the company’s outlook, the downside is protected as AAPL is almost a staple for consumers in the Apple ecosystem.  Northlake plans to sit tight with AAPL other than trades that have to do with unique client circumstances.  A strong holiday season that leads to 1Q24 results ahead of guidance is the next major catalyst for renewed upward momentum for the stock.

Nexstar Media Group (NXST): NXST shares are currently in a tough spot as the proverbial “best house in a bad neighborhood.”  NXST has been one of the few big winners in media with the shares up about 10X since we started buying it for Northlake clients in 2017.  Over this same time, almost all media stocks have lost value. NXST has done well thanks to timely accretive acquisitions, operational excellence, superior financial management, and shareholder friendly capital allocation. We raised a couple of issues after 2Q23 regarding the possibility of a guidance cut and a shift of the company’s strategy.  3Q23 results saw these issues at the forefront again.  Free cash flow guidance was cut after the company settled with DirecTV after a multi-month blackout.  Lower guidance also likely reflects more investment and a longer path to profitability for the company’s new national broadcast strategy.  Management struck a positive tone on both issues on its conference call noting that the return on the lost revenue from the blackout would have a high return based on the new multiyear deal that went into effect immediately and the investments in new sports content for the CW Network would have a much larger payoff than originally planned for a small delay in achieving profitability.  We trust management based on their long record of successfully navigating the secular headwinds that are buffeting the media industry.  However, those winds are likely too strong for NXST shares to sustain an uptrend in the near term.  2024 does offer relief when political ad spending will lead to a surge of profits and free cash flow.  Given NXST’s strong, low-debt balance sheet, this should control the downside in the shares. For NXST to become another multiyear winner will require several things.  First, uncertainty about the economy that is slowing advertising sales must recede.  Second, the recent settlement between Charter Communications and Disney must slow the rate of cable TV cord cutting and firm up affiliate fees paid to NXST’s local TV stations.  Finally, the company must make clear progress toward profitability goals at the CW without further large-scale acquisitions.  NXST shares are inexpensive at just 6 times EBITDA.  Any positive momentum on investment fundamentals could easily bring the shares back to recent highs around $200 next year.  This upside against a strong balance sheet that protects downside warrants showing patience.  The secular challenges are steep, and our confidence is lower than usual, but management has earned our trust, so we will sit tight on our long positions for now.

Disney (DIS): DIS shares have had a rough stretch since peaking at $200 in March 2021.  A lot has gone wrong.  Much was beyond management control – Wall Street bearishness on streaming, a decline in traditional cable TV and broadcast networks, higher interest rates, uncertain economic outlook.  Management also made errors – poor quality control on accelerated output in movies and television, political fights in Florida, corporate restructuring that negatively impacted content control and profitability.  A year ago, DIS brought Bob Iger back to the CEO role to reset corporate strategy, rebuild investor confidence, and improve profit growth.  Iger enjoyed a brief honeymoon only for the stock downtrend to continue as secular challenges grew and the company was unable to articulate or show evidence of a successful corporate and financial strategy.  We have been wrong to hold through such a devastating stock price decline, but it appears that the company’s 4Q23 ending in September represents a pivot point to better performance.  Earnings came in ahead of expectations with beats at the segment level across the board.  Parks, Sports, and streaming all came through.  DIS earnings are notably lumpy even in the good old days but this is the first quarter in a while that progress was broad.  More importantly, Iger articulated a clear strategy moving forward focused on making streaming profitable, rolling out ESPN as a streaming service, investing in Parks for growth, and getting back to producing the highest quality films.  Confidence in the pivot from fixing and restructuring to growth was supported by a big boost to 2024 free cash flow guidance and reinstatement of a dividend.  The shares responded well.  However, progress is not guaranteed and is likely to be volatile on a quarterly basis.  Nonetheless, we like the shift in tone, the clear articulation of strategy, and improved free cash flow.  Trading at less than 20 times still depressed 2024 EPS estimates, DIS shares offer a lot of upside if upcoming news and earnings support the four pillars of the new strategy.  Downside seems better protected by the much higher than expected free cash flow.  Most clients own DIS.  Those who don’t might in the weeks ahead.

Sony (SONY): We were surprised by the sharp, negative initial reaction (-7%) to SONY’s 2Q23 earnings report.  The initial trading after the report took place in the U.S. market.  Our view that the shares overreacted proved accurate when the stock rebounded nicely in Japanese trading with the gains holding when U.S. markets opened again.  SONY shares are still down a little following the report.  A small decline is justified after the company missed earnings estimates and talked about risks to their imaging semiconductor business in 2024.  Most of the 2Q23 miss was due to mark-to-market accounting at its finance subsidiary, a business that is not core to our bullish investment thesis, and a business that will be spun out in the next year or two.  The most important businesses are video games, TV and film production, music, and imaging semiconductors.  Other than semis, these business segments were at least in line with expectations with forward guidance maintained.  The payoff in SONY shares looks more likely in 2024 than 2023 as growth is expected to accelerate next year in the growth businesses.  We plan to wait as the shares look undervalued relative to peer companies in music, video games, and entertainment even after assigning a conglomerate discount.  SONY management is leader in Japan where more shareholder friendly actions are being supported by the government.  Given the company’s growth fundamentals, it is only a matter of time before the shares move back above $100.

Home Depot (HD): HD reported results slightly ahead of low expectations as the company grapples with higher interest rates, low housing turnover, stressed consumers, and the aftermath of heavy spending on homes during the pandemic.  The company is doing a great job managing what is under their control – expenses, profit margins, growing the Pro business.  Looking ahead, management narrowed guidance ranges for the year which came as a major relief against investor sentiment thinking there was a downside risk to sales and earnings.  Visibility is low into 2024 but recent monthly trends have been linear with no apparent incremental slowing in the business (same stores sales have been running down 3-4%).  HD shares rebounded strongly following the report, moving up from yearly lows below $280 to almost $310, which is just about unchanged for the year.  At Northlake, we will stick with quality stocks even if cyclical trends are a headwind if the long-term growth opportunity remains, and management is executing at a consistently superior level.  HD fits the profile perfectly.  Via aggressive expansion of the Pro business and secular changes due to work-from-home, we think HD’s long-term growth opportunity is as good as ever.  The last few quarters’ earnings have held up against negative same store sales, revealing how well HD is managing the business.  The current 2024 consensus EPS implies growth of about 4% and flattish same store sales that return to positive in the second half of the year.  In a higher-for-longer interest rate scenario, there is downside risk to the growth outlook.  We are willing to wait given our high regard for HD’s growth profile and management, the possibility that the Fed is cutting interest rates late next year, and our continued view that the economy will avoid a severe downturn.  A return to all-time highs around $400 offers attractive upside against what appears to be limited downside based on how the company has handled the weak home improvement environment in 2023.

Walmart (WMT): For the first time since we purchased WMT in June 2022, the company reported a quarter and offered guidance that creates turbulence for our near-term outlook.  Long-term, the latest news further cements our thesis that WMT is gaining market share and improving profit growth.  3Q23 earnings were a little ahead of expectations in terms of revenue and EPS but only inline on operating income.  Looking to the fourth quarter, management offered an outlook for a similar result.  The lack of upside to operating income is important because the financial side of the investment thesis for WMT is based on management’s promise that operating profit margins would steadily expand, leading to operating income growing at twice the rate of sales.  Management did not back down from this promise but indicated that progress might not be linear every quarter.  For 2H 2023, management noted a slowdown in sales in late October, one-time legal costs, timing of remodels, the Cat 5 hurricane that hit Mexico City, and a few other items that are liming margin expansion.  Most concerning to analysts was the choppiness in sales.  There is pressure on consumers, especially lower income consumers that are the core of WMT sales.  The question being asked is whether a slower pace of same store sales gains due to weaker consumer spending and a lower rate of inflation can continue to produce operating leverage.  We believe that it can and point to WMT showing mid-single-digit traffic growth vs. declining traffic at most retailers.  This is evidence of market share gains that are driven by improved execution, especially in ecommerce and fulfillment efforts.  WMT is expanding its addressable market by appealing to a broader base of consumers, including higher-income households, and increasing revenue from higher-margin activities like advertising and third-party fulfillment.  The expanded revenue opportunity is coupled with more efficient management of its supply chain at warehouses and in the back of the stores.  The shares could struggle to regain their footing until sales trends are clear and/or margin expansion is shown on lower top line growth.  Based on the history of success over the last few years, Northlake is giving WMT the benefit of the doubt.  We will continue to hold the shares.

AAPL, NXST, DIS, SONY, HD, and WMT 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.

2Q23 Earnings Updates: Part Two – ATVI, AAPL, NXST, SONY, DIS, HD, and WMT

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Activision Blizzard (ATVI): ATVI reported strong 2Q23 results well ahead of analyst consensus.  A good launch for the latest Diablo game, ongoing strength in King mobile games, and steady results for Call of Duty and World of Warcraft led to the positive quarter.  Analyst estimates moved up for 2023 but less for 2024.  The more important news from ATVI concerned a dramatically increased likelihood that Microsoft will complete its takeover the of the company at $95 per share in cash before November.  Microsoft won its court case vs the US government which was attempting to block the merger on antitrust grounds.  The only remaining regulatory approval needed is from the UK, which rejected the deal earlier this year.  However, Microsoft offered new concessions and is negotiating with the UK regulatory authorities who have noted an immanent completion date for their renewed merger review.  Analysts now expect the deal to close with 95% certainty and ATVI shares have moved up to $92 reflecting the high likelihood of closing.  Interestingly, with another strong quarter of earnings, we now see fair value for ATVI shares be $85-$90 in a deal break scenario.  Microsoft is a getting a good deal but we are extremely happy to sell Northlake’s ATVI shares at $95.  Initial purchases for clients go back to 2014 when we paid just over $20 per share.  ATVI encountered several periods of extreme downside volatility where we held strong.  ATVI validates our patient approach to quality companies offering long-term earnings and cash flow growth.

Apple (AAPL): AAPL reported slight upside to EPS on a very small shortfall in revenue.  The stock has reacted poorly due to the revenue shortfall and guidance for the September quarter that implies another period of negative revenue growth.  EPS grew in the June quarter due to tight cost controls and higher gross margins, driven by a mix shift in revenue towards Services. EPS is forecasted to grow again in the September quarter. In fact, Services revenues showed the best growth in a couple of years as trends accelerated with the continued growth of AAPL’s installed base of iPhones, iPads, Macs, Watches, and AirPods.  Apple Pay, Apple Music, and the App Store led the way for Services growth.  AAPL’s net income this quarter was slightly less than the September quarter of 2021.  EPS are higher thanks to share repurchases, but trailing 12 months EPS are unchanged since the end of 2021.  Despite the lack of net income growth, the stock has performed well thanks to growth in high-margin Services revenues and a large and steady share buyback program. Accelerated hardware sales – especially iPhones – is needed for the stock to move meaningfully higher.  This may prove difficult given iPhone market share in the U.S. is nearly saturated.  Fortunately, emerging markets like China and India continue to offer market share opportunities for Apple in markets with less smartphone penetration.  Analysts project renewed EPS growth in 2024 built upon continued growth in Services and a recovery in iPhone growth.  The new Vision Pro mixed-reality headset is a wild card with low expectations given the extremely expensive price point for the first-generation device.  We have been through these periods before with Apple and remained patient due to the company’s superior cost management and capital allocation.  Those things remain in place so we shall continue to be patient.  AAPL positions in client accounts are heavily overweighted, so if you see a small sale of part of your shares, it is just portfolio management to keep risk and rewarded balanced and diversification maintained.

Nexstar (NXST): NXST reported 2Q23 earnings that were slightly ahead of consensus estimates and company guidance for revenue, EBITDA, and free cash flow. Nonetheless, the shares sold off on the day of the report and again the next day, dropping about 10%. The problem is that NXST management did not affirm its previously issued guidance for 2023/2024. NXST guides on two-year averages due to the massive impact of political advertising in even years. Queried extensively about this on the quarterly conference call, management noted that with a more than month-long blackout with DirecTV due a carriage fee dispute, it was inappropriate to comment or update guidance. Blackouts are a regular occurrence for NXST and other TV broadcasters. Often, they occur in the summer when there is not a lot of original TV shows or a heavy sports calendar. The blackouts are usually resolved by the start of the NFL and college football seasons in early September. NXST noted that it is in active negotiations with DirecTV and expressed confidence that a deal would be reached. As streaming becomes a more prevalent way to watch TV, including local channels and sports, there is always a risk that a major TV provider like DirecTV will choose to drop local channels. Local channels are consistently the most watched, and surveys show they are highly valued by viewers for their local news. Thus, we think it highly unlikely that DirecTV risks a blackout that lasts much longer. Ultimately, NXST will get paid and any guidance update should prove minor. That said, the story at NXST is changing as the company is maxed out on local TV ownership and is shifting to developing properties with national reach like the CW Network and NewsNation. NewsNation is going well but has taken longer than initially planned. The CW strategy has evolved and management is willing to spend on content which creates risk in the current environment for traditional TV. There is also risk that management acquires additional national TV assets. NXST could be a buyer of ABC and the ABC large market TV stations owned by Disney which are apparently for sale. NXST is a volatile stock and is up about 10X from our initial purchases. We have held through other periods of controversy because we believe management is among the best we have ever encountered. The secular challenges to the TV business raise the stake but for now we are willing to trust management and expect a settlement with DirecTV, better advertising trends over the next year, and the surge in political advertising in 2024 that drives free cash flow and shareholder friendly capital allocation. Based on current estimates, we think the shares can trade back to $200.

Sony (SONY):SONY reported slightly better than expected earnings while maintaining guidance. There were some gives and takes in the report and guidance that has created downward volatility but Northlake is not concerned that there is a change in the bullish long-term investment thesis. Three items seem to be bothering investors: a weaker quarter of PS5 sales, a downgrade in the outlook for image sensors due to weak smartphone sales in the US and China (called out by Apple), and the Hollywood strikes. None of these issues should prove lasting, so we are surprised the stock has declined 5% since the earnings report. Management addressed each issue. PS5 full-year sales guidance is maintained with a new promotional push planned for the rest of the year that was always in the budget. Image sensors should rebound as inventory is well controlled and the new set of phones set to be introduced should improve demand. The strikes are a problem and cannot be forecast but at least in the short term they pull forward free cash flow. It is also important to note is that management repeatedly mentioned “conservative” when discussing their updated outlook. Further, despite some near-term headwinds, guidance for the current year was maintained. We remain positive on SONY being aggressive in its strategic planning and capital allocation. The shares trade at a sharp discount to peers in video games, music, entertainment, and semiconductors. More aggressive management, including the support of the Japanese government to drive shareholder value throughout Japan’s largely conglomerate corporations, should close the valuation gap over time. The upcoming separation of SONY’s financial services business is a good example.

Disney (DIS):DIS has had a rough go in the last 12 months but things might be looking better. Operating income returned to growth in 3Q23 and management forecasted renewed growth ahead including in the current quarter. Cost cutting, lower content spending, and greatly reduced losses on streaming should drive growth in operating income, free cash flow, and earnings per share. Management showed confidence by indicating a dividend would be reinstated soon and share buybacks are likely in a year or two. Returning CEO Bob Iger is establishing a clearer vision for Disney. Streaming is shifting to a profit focus with price increases and ad-supported tiers. Iger is willing to sell the non-sports linear businesses including ABC, TV stations, and cable networks. ESPN will stay part of Disney but the company is looking for outside investors to support the transition to streaming. Parks will continue to get fresh investment including two new cruise ships. The film and TV studios have produced a series of underperforming content, but Iger’s shift in focus from distribution to content creators in the corporate structure and culture should resolve this issue given the company’s premier franchises and track record. According to J.P. Morgan, DIS should produce $15B in operating cash flow this year. By 2026, there should be a $5B favorable swing in streaming from a $2B loss to a $3B profit at which point streaming margins will only be half of what Netflix produces. The traditional linear TV businesses are in steady decline and will see profits fall by up to $2B or 30% over the next three years. Parks remains a growth business and should have $2B higher profits at a mid-to upper single digit growth rate. Put it all together compared to depressed 2023 levels, profits should grow by 50% in the next three years with EPS growing faster, from near $4.00 to almost $7.00. Struggles over the last few years have DIS in the penalty box, so despite the favorable outlook, DIS is a show-me story. We think the just-reported quarter marks the bottom and the turn upward will be evident in the next few quarters. DIS shares offer substantial upside to over $100.

Home Depot (HD): HD reported better-than-expected 2Q23 earnings with some positive signs that the digestion period from heavy customer spending during COVID is nearing an end.  Same store sales, total revenues, profit margins, and earnings per share all exceed analyst estimates.  As we have often noted, HD management is quite conservative when it comes to guidance, so consensus estimates were cautiously positioned.  July was the strongest month of the quarter with same store sales near unchanged.  However, management guided for a low single-digit decline for 3Q.  Traffic has improved, which is important, as the benefit of inflation is shifting to disinflation.  Investors generally prefer traffic-driven growth.  Working against a resumption of growth off the higher post-COVID base is that consumers and contractor pros are doing smaller projects.  The news on profit margins was good, with HD no longer suffering supply chain inefficiencies and operating expenses under strict control of management.  In fact, management outlined meaningful cuts in operating expenses for 2024.  Analyst earnings estimates for 2023 held steady with a slight uptick in 2024.  HD shares have recovered nicely since reaching 2023 lows in the spring.  The shares trade at 20X next year’s earnings, a slight discount to their historical average.  With COVID impacts receding and earnings estimate revisions moving from negative to positive, HD shares should continue to recover.  Our long-term thesis for consistent growth built around a secular shift to spending on the home is intact.

Walmart (WMT): WMT reported better than expected 2Q24 (fiscal year ends in January) with revenue, same store sales, and profit margins all materially ahead of consensus estimates.  WMT is executing very well on both its core store level business and its ecommerce and advertising business.  Two highlights in the quarter were 24% growth in ecommerce revenue and expanding operating margins.  WMT is gaining market share at the store level and in ecommerce through sharp pricing in a pressured consumer environment, an uptick in higher income households shopping in store and online, and an ongoing mix shift toward grocery, healthcare, and wellness products where WMT offers superior selection.  Despite the good quarter, WMT shares have traded down in a weak market since the report.  The only negative in the quarter was 3Q24 guidance for slower sales growth and a step back in margin expansion.  Sales growth may slow on tough comparisons from high gasoline prices a year ago (Sam’s is a major seller of gasoline).  When management announced that they would grow operating income faster than sales (i.e., margin expansion), they noted it would not be linear every quarter.  Northlake remains bullish on WMT with FY25 (essentially 2024) EPS estimates rising to almost $7.  The year ahead P-E of 22X remains attractive given market share increases and margin expansion.

ATVI, AAPL, NXST, SONY, DIS, HD, and WMT 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.

Bard Does Northlake 1Q23 Earnings Updates: Part Two – DIS, NXST, VICI, HD, and WMT

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So far, we have found using Bard GAI to help analyze earnings report to be insightful and fun.  Insightful to discover more about the capabilities and shortfalls of GAI and fun to try something different.  Several more companies have reported since our last update, and we decided to stick with the same format for Part Two of the 1Q23 Earnings recap.

Disney (DIS)

Query: Analyze the most recent quarterly results from DIS from a fundamental perspective.

Bard Answer: The Walt Disney Company (DIS) reported its fiscal second quarter 2023 results on May 10, 2023. The company missed analyst expectations on earnings per share (EPS) by 1 cent, but beat on revenue by $16.24 million. DIS’s revenue was $21.82 billion, up 23% year-over-year. This growth was driven by strong performance in the company’s Media and Entertainment Distribution segment, which includes Disney+, Hulu, ESPN+, and other streaming services. This segment’s revenue grew 33% year-over-year to $4.8 billion. DIS’s operating income was $3.8 billion, up 22% year-over-year. This growth was driven by the same factors that drove revenue growth. DIS’s EPS was $0.93, down 1 cent year-over-year. This decline was due to a number of factors, including increased costs related to the launch of Disney+ and other streaming services, as well as higher interest expense. Despite the decline in EPS, DIS’s results were generally positive. The company’s revenue and operating income grew significantly year-over-year, driven by strong performance in its streaming business. DIS also continued to generate strong cash flow, with free cash flow of $1.6 billion in the quarter. Looking forward, DIS is well-positioned for continued growth. The company has a strong portfolio of brands and content, and it is investing heavily in its streaming business. DIS is also benefiting from the reopening of its theme parks, which were closed for a significant portion of 2020 and 2021. Overall, DIS’s most recent quarterly results were positive. The company’s revenue and operating income grew significantly year-over-year, and it continued to generate strong cash flow. DIS is well-positioned for continued growth in the future. Here are some key takeaways from DIS’s most recent quarterly results:

  • Revenue grew 23% year-over-year to $21.82 billion.
  • Operating income grew 22% year-over-year to $3.8 billion.
  • EPS was $0.93, down 1 cent year-over-year.
  • Free cash flow was $1.6 billion.
  • The company is well-positioned for continued growth in the future.

Northlake Comments:  As often appears to be the case, Bard gets the general sense of the earnings and the tone of the press release correct but makes factual errors and seems unable to provide context.  Interestingly, Bard notes the correct revenue figure but then misses the year-over-year growth which was 13% not 23%.  EPS is correct as is the one penny miss of expectations.  However, operating income fell 14% from a year ago.  Free cash flow is quoted at $1.6 billion when it was actually -$150 million.  Growth in streaming revenue is also misquoted.  It seems odd that parts of Bard analysis quotes facts lifted directly from the earnings report but miss completely on other facts in the report.  This seems to be a recurring problem but one that should get better with time as AI capabilities advance.  These errors lead Bard to the incorrect conclusion that DIS’s Latest earnings were positive.  Certainly, the market does not agree as the shares dropped 10% in response to the report.  Much of the stock price decline is related to the conference call that followed the earnings report.  We asked Bard to analyze the conference call and despite the fact the transcript is publicly available we did not get a worthy answer.  On the call, CEO Iger made news when he disclosed plans for Hulu’s streaming service to be folded into Disney+.  This is a reversal from Iger’s comments three months ago that general entertainment was not necessarily a good business.  Adding Hulu to Disney+ also means the DIS will have to buy out Comcast’s 33% stake in the service, adding $9 billion plus to Disney’s debt load.  We do not view Disney as heavily indebted after this but presently investors are avoiding more heavily indebted companies.  The call also amplified the press release noting weakness in linear TV (EPSN, ABC, and other cable channels).  These businesses underperformed low expectations creating additional concern that streaming profits will never replace linear thus limiting long-term growth potential of the corporation.  On the positive side, unmentioned by Bard, is the continued fantastic performance by the company’s theme parks and renewed momentum in film as more blockbuster releases hit theaters.  Northlake still like DIS.  We feel the decline since the earnings report is overdone and ignored notable profit improvement in streaming.  The path over the next year is less clear with the Hulu news and ongoing pressure in linear, so a decline in the stock is warranted.  We believe the company’s unique asset base and strong management will ultimately win investor admiration and believe this quarter may act as the proverbial “kitchen sink” with expectations having now bottomed out with easy comparisons ahead.  More patience than we expected may be required but growth in FY24 can drive the shares back to $120, providing over 30% from current trading levels.

Nexstar Media Group (NXST)

Query:  Please analyze the latest earnings report and conference call from Nexstar Media Group.

Bard Answer: Nexstar Media Group (NXST) reported earnings of $2.97 per share on revenue of $1.26 billion for the first quarter of 2023. This beat analyst expectations of $2.56 per share on revenue of $1.24 billion.

The company’s results were driven by strong advertising revenue growth, which increased 12% year-over-year. Nexstar’s digital advertising revenue was particularly strong, growing 20% year-over-year.

The company also benefited from its acquisition of The Hill, a political news website, in the third quarter of 2021. The Hill contributed $10 million in revenue in the first quarter.

Nexstar’s management team is optimistic about the company’s future prospects. They believe that the strong advertising market will continue, and they are investing in new content and technology to drive growth.

The company’s conference call with analysts was positive. Management discussed the strong advertising market, the growth of its digital business, and its plans for investing in new content and technology.

Overall, Nexstar’s earnings report and conference call were positive. The company is well-positioned for continued growth in the years to come.

Here are some key takeaways from the earnings report and conference call:

  • Nexstar’s earnings beat analyst expectations.
  • The company’s advertising revenue grew 12% year-over-year.
  • Nexstar’s digital advertising revenue grew 20% year-over-year.
  • The company’s acquisition of The Hill contributed $10 million in revenue in the first quarter.
  • Nexstar’s management team is optimistic about the company’s future prospects.
  • The company is investing in new content and technology to drive growth.

Northlake Comments:  In what we now see is a common occurrence, Bard gets some facts incorrect.  NXST did report $2.97 in EPS and $1.25 billion in revenue, both which slightly exceeded consensus expectations.  However, advertising revenue fell 3% rather than rise 12% and digital advertising only rose 17% rather than 20%.  Bard failed to address distribution revenues which are the fees NXST is paid by cable, satellite and streaming services for the rights to carry the feed of the local TV stations the company owns.  These fees are growing nicely currently despite a high level of cord cutting thanks to the timing of NXST’s renewals, the fact that local stations are underpriced relative to their importance to viewers due to local news, and NXST’s massive nationwide scale which gives the company leverage in negotiations with distributors.  Despite a positive outlook for distribution revenues in 2023 and 2024, investors are concerned that cord cutting and a shift to streaming services that lack local stations are secular headwinds to growth.  Advertising remains cyclical so uncertainty about the economic outlook is also weighing on investor sentiment.  NXST is well-positioned with its nationwide reach, low level of debt, high free cash flow, and the content investments Bard picked up.  However, in the near-term the stock is under pressure due to questions about the economy and cord cutting.  The outlook for 2024 is much better when these questions should be answered, and political revenues will surge.  Northlake anticipated the headwinds for NXST and made partial sales of the shares in the second half of 2022. Our current bias is to further reduce or completely sell NXST as the shares rebound when the focus shifts to 2024.  In the meantime, we will be patient since NXST has one of the best management teams of any company we closely follow in terms of operational and financial excellent and shareholder friendly capital allocation (dividend and buybacks).

VICI Properties (VICI)

Query: Please discuss recent trends in AFFO per share at VICI Properties.

Bard Answer:  VICI Properties’ AFFO per share has been trending upwards in recent quarters. In the fourth quarter of 2022, AFFO per share was $0.51, up 2% from the third quarter of 2022 and up 6.1% from the fourth quarter of 2021. For the full year 2022, AFFO per share was $1.93, up 6.1% from 2021.

There are a few factors that have contributed to the recent increase in AFFO per share. First, VICI Properties has been able to increase its occupancy rates. In the fourth quarter of 2022, occupancy was 98.2%, up from 97.7% in the third quarter of 2022 and 96.7% in the fourth quarter of 2021. Second, VICI Properties has been able to increase its average rent per square foot. In the fourth quarter of 2022, average rent was $43.22 per square foot, up from $42.52 per square foot in the third quarter of 2022 and $40.72 per square foot in the fourth quarter of 2021. Third, VICI Properties has been able to reduce its expenses. In the fourth quarter of 2022, expenses were $681.1 million, down from $691.8 million in the third quarter of 2022 and $727.6 million in the fourth quarter of 2021.

The recent increase in AFFO per share is a positive sign for VICI Properties. It indicates that the company is well-positioned to continue growing its earnings in the future.

Here are some additional details about VICI Properties’ recent financial performance:

  • Total revenues increased 72.3% year-over-year to $2.6 billion in 2022.
  • Net income attributable to common stockholders increased 10.2% year-over-year to $1.1 billion in 2022.
  • AFFO increased 61.7% year-over-year to $1.7 billion in 2022.

VICI Properties’ strong financial performance is due to a number of factors, including:

  • The continued recovery of the Las Vegas Strip, which is VICI Properties’ primary asset.
  • The company’s focus on acquiring high-quality assets in attractive markets.
  • VICI Properties’ strong balance sheet, which provides the company with financial flexibility to pursue growth opportunities.

Overall, VICI Properties is a well-managed company with a strong financial performance. The company is well-positioned to continue growing its earnings in the future.

Northlake Comments:  We had a hard time getting any relevant reply when asking about VICI earnings, so we decided to try asking about AFFO (available funds from operations), the relevant measure by which REITs are analyzed. In reply we got one of the best answers yet from Bard even though it did not cover the just reported first quarter 2023 results.  Those results supported the bullish tone and outlook provided by Bard.  AFFO per share grew to 53 cents, up 19% vs. 1Q22.  Large property acquisitions played a big part in the growth with revenues more than doubling.  Core growth remained firm in the low to mid-single-digits thanks to rent increases hedged to inflation and tight cost controls.  VICI continues to expand its asset ownership, venturing into Canada for the first time, and starting relationships with two Native American tribes that operate casinos.  VICI has plenty more U.S-based casinos to acquire and continues to add experiential, non-casino, entertainment assets.  AFFO in 2023 should grow to over $2 per share, enough to support a stock price in the upper $30s, for 25% total return including the company’s generous dividend.

Home Depot (HD)

Query: Please review Home Depot’s earnings reported yesterday including the updated guidance.

Bard Answer:  Home Depot reported earnings of $3.82 per share on revenue of $37.26 billion for the first quarter of fiscal 2023, which ended April 30, 2023. This was below analyst expectations of $3.80 per share on revenue of $38.28 billion.

Comparable sales decreased 4.5%, and comparable sales in the U.S. decreased 4.6%. The company attributed the decline in sales to a number of factors, including:

  • Rising interest rates, which could make it more expensive for consumers to borrow money and finance home improvement projects.
  • Inflation, which is eroding consumer purchasing power.
  • The ongoing war in Ukraine, which is causing economic uncertainty and could lead to a slowdown in global growth.

In addition to reporting earnings, Home Depot also updated its guidance for fiscal 2023. The company now expects sales and comparable sales to decline between 2% and 5% compared to fiscal 2022. Home Depot also expects its operating margin rate to be between 14.3% and 14.0% in fiscal 2023, slightly lower than the 14.5% previously expected.

The decline in Home Depot’s earnings and guidance is a sign that the home improvement market is starting to cool off. However, the company is still a leader in the industry and is well positioned to benefit from continued demand for home improvement products and services.

Northlake Comments: Only revenue came in below expectations.  EPS was a couple pennies ahead of consensus.  The big disappointment was comp stores sales growth in the first quarter and the lowered comp guidance for the balance of the year.  Comps are below what we were expecting but an encouraging offset was profit margin in the quarter and the forecast.  Despite slower sales, margins are holding up better than expected.  We attribute this to our long-held view that HD management is excellent.  Bard also attributes to comp issues to generic items including inflation, interest rates, and the war in Ukraine.  These items have definitely colored sales trends but investors are more interested in the impact of weather, lumber prices, and home improvement spending as a percent of household budgets.  This last item is key to the outlook for HD shares.  Management is assuming that home improvement spending share will recede to pre-pandemic levels over the balance of 2023 after surging during the pandemic.  Bearish investors believe that the pull forward will take several years to digest and that market share must fall below pre-pandemic levels.  The outcome of this debate is critical to earnings growth since management has shown that it can manage profit margins in the current weak spending environment.  Northlake continues to believe that the pandemic has provided a secular boost to home improvement spending thanks to work from home trends and more focus on home activities.  Higher, though below peak, home prices also support home improvement spending.  We also believe many homeowners are locked into their current residence with mortgage rates of 3% vs. current rates of 6% if they were to move.  Thus, the secular story for home improvement remains solid and HD is proven to be a superior company.  The debate over home improvement demand is unlikely to be resolved in the next few quarters, so HD shares are likely to stay in a trading range. Northlake is a long-term investor and we are willing to wait.  As an aside, HD shares initially dropped 5% when the results were reported.  The loss on the day ended up less than 2% and the day following the report the stock popped 4% and trades above pre-earnings levels.  This is a good example of how expectations often govern immediate stock reactions.  HD’s weak comp sales and forecast were widely anticipated by investors with the shares down 9% this year heading into the report.

Walmart (WMT)

Query:  Please review Walmart’s earnings reported yesterday and updated guidance for both the current quarter and the current fiscal year.

Bard:  Walmart reported earnings yesterday that beat analysts’ expectations. The company reported adjusted earnings of $1.47 per share on revenue of $152.3 billion. Analysts had been expecting earnings of $1.32 per share on revenue of $148.9 billion.

Walmart’s U.S. same-store sales climbed 7.4%, ahead of analysts’ estimates of 5.5%. The company’s international sales were also strong, up 26%.

Walmart raised its financial forecasts for fiscal 2024. The company now expects adjusted earnings of between $6.10 to $6.20 per share, while analysts had been expecting $6.14. Revenue for the year is now expected to increase about 3.5%.

Walmart’s guidance for the current quarter was below consensus. The company expects second-quarter earnings of between $1.63 and $1.68 per share. Analysts had been expecting earnings of $1.71.

Walmart’s earnings beat and raised guidance is a positive sign for the retail sector. The company is well-positioned to benefit from strong consumer spending and rising inflation.

Here is a more detailed breakdown of Walmart’s earnings:

  • U.S. same-store sales: 7.4%
  • International sales: 26%
  • Adjusted earnings per share: $1.47
  • Revenue: $152.3 billion

Here is Walmart’s updated guidance for fiscal 2024:

  • Adjusted earnings per share: $6.10 to $6.20
  • Revenue: 3.5% increase

Here is Walmart’s guidance for the current quarter:

  • Earnings per share: $1.63 to $1.68

Northlake Comments:  This the best Bard answer so far.  The information is accurate, and the answer is a direct response to our query.  The only point we would quibble with is that WMT’s earnings are a positive sign for the retail sector.  WMT’s sales strength came from the grocery side of the business, while general merchandise sales remained weak.  In addition, WMT digital sales grew 27% as the company is gaining share with its revived and refocused ecommerce efforts.  Success within ecommerce is allowing WMT to develop a rapidly growing advertising business.  Many retailers primarily offer general merchandise, where demand is weak as inflation and post-pandemic demand trends is hurting spending.  Ecommerce is a struggle for many retailers as large platforms dominate market share and smaller platforms or websites do not have scale to ramp up digital advertising.  This mistaken analysis from Bard highlights Northlake’s bull case for WMT.  The company remains a good defensive play as household balance sheets are pressured by inflation making WMT’s pricing attractive, including some trade down from higher income households.  WMT has completely revamped its ecommerce efforts with success in membership, volume, and advertising, leading to market share gains across all income cohorts.  Successful operational execution also extends to profitability.  WMT has lowered the comparable sales point that triggers operating leverage (profit margin expansion) and is forecasting significant growth in profits above the rate of sales growth.  To Northlake, this is a sign that management has successfully positioned the company and now has an offensive aspect to its historical defensive investment thesis.  Given the challenging macro environment, the combination of offense and defensive is especially valuable.  We see further upside in the shares that still trade at a reasonable 21 times next year’s highly predictable earnings estimate.

DIS, NXST, VICI, HD, and WMT 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.

4Q22 Earnings Updates:  Part Three – WMT, HD, VICI and NXST

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Walmart (WMT): When we purchased WMT as a new long-term investment last June, our thesis was built on the idea that the stock offered both offensive and defensive characteristics.  The defensive characteristics were important with the economy and market in an uncertain period amid high inflation and the Fed’s aggressive monetary policy tightening to slow price increases.  WMT is playing offense by investing in technology to build out a broader revenue stream including full ecommerce capabilities,  buy online pick up at store, advertising, and improved operation execution at the core retail business.  WMT’s 4Q22 earnings report reinforced both sides of our thesis even as the company issued cautious EPS guidance for 2023.  Sales remain strong, showing no signs of slowing consumer economy.  Nonetheless, EPS guidance implies slower sales growth.  EPS guidance is also penalized by non-operating items like inventory timing expenses, losses on investments, and higher interest expense.  Importantly, the excess inventory that hit earnings and the stock price early in 2022 are behind the company.  Throughout the quarterly conference call, management spoke confidently about the future indicating market share gains continued across all income cohorts.  WMT needs its offensive initiatives, particularly in ecommerce and in-store groceries, to hold higher income customers when the economic outlook improves.  We are confident this will be case thanks to a recent history strong management execution and smart strategies.  The defensive strategies of everyday low pricing for the company’s core low- and middle-income cohorts remain effective while inflation is elevated and the risk of an economic slowdown is high.  WMT shares have performed well since our purchase, up 15% against a gain of just 2% for the S&P 500.  We think more positive absolute and relative performance remains ahead for WMT shares driven by better-than-expected results against the conservative reset guidance and continued success gaining profitable market share across the store and online.

Home Depot (HD): HD reported solid results to close 2022 and issued lower than expected guidance for 2023.  Most of the guidance shortfall relates to a discretionary management decision to raise pay across the workforce by $1 billion annually.  We support the initiative as it is another sign of management’s prowess in positioning the company to sustain leadership and continue to gains market share in the home improvement industry.  Much like Walmart, management took a cautious view of consumer demand and guided to flat comparable store sales for 2023.  Unlike Walmart, Home Depot is seeing a slowdown in its top line as it appears the first wave of higher demand related to the pandemic has run its course.  Mostly, this reflects consumer spending preferences shifting back toward services (travel, live events, eating out, etc.) where spending remains well below pre-pandemic levels.  The pandemic led to a boost in spending on homes thanks to work from home, lower housing turnover, and rising home prices.  Northlake believes the emphasis on home improvement spending related to the pandemic is secular.  However, it appears a period of digestion lies ahead in 2023 as a lot of demand has already been fulfilled, while consumers shift toward services spending that takes place outside the home.  Consumer spending on services remains a few percent below its share of total consumer spending before the pandemic.  Management is assuming that services share reverts to historical levels in 2023 in a no-growth economy.  This presents a several-hundred basis point headwind to sales growth.  Should the consumer spending grow or decline vs management’s expectation for little change, HD guidance could prove optimistic or pessimistic.  All of this makes 2023 a tricky year to forecast HD shares.  Northlake maintains a longer-term view and believes the combination of a secular rise in home improvement spending, continued market share gains for HD among consumer spending, and increasingly effective and large initiatives to service Pro accounts will provide strong growth post any digestion period.  We are willing to wait given the high-quality growth and financial strength offered by HD.  Looking ahead to 2024, we think the shares can recover to the mid-$300s.

VICI Properties (VICI): VICI wrapped up a transformational 2022 with another boring earnings report.  The company provided strong guidance for nearly double-digit earnings growth in 2023 boosted by recent acquisitions, inflation escalators in rent, and organic growth investment in properties owned for many years.  Furthermore, guidance is diluted by a recent sale of shares to fund future acquisitions.  In 2022, VICI acquired their largest casino REIT competitor, added major properties on the Las Vegas Strip, acquired their first non-U.S. casinos in Canada, and continued expanding outside of gaming in other experiential assets in theme parks and golf.  VICI remains one of our favorite stocks due to highly predictable growth thanks to quality tenants paying rent on time.  As we have noted in the past, during the pandemic, when Vegas and regional casinos were closed, VICI received every dollar of rent it was owed.  This gives us great comfort should a consumer recession develop in 2023 or 2024.  VICI has been a great investment for Northlake and we expect continued outperformance.  Since the company came public five years ago the total return has been double the S&P 500 and NASDAQ at what we believe is a lower risk level.  Earnings have grown at a CAGR of almost 8% and dividends have average about 5%, leading to CAGR of 13%.    Guidance for 2023 offers more of the same, well ahead of S&P 500 earnings growth estimates of plus or minus 1-2% with a dividend yield under 3%. VICI’s superb management team deserves credit for identifying opportunities, closing transactions, and making smart financing decisions.  Opportunities remain for similar growth in the next five years as there remain many casino properties still be REIT-financed, expansion in non-casino areas is underway, and international markets are large and untapped.  Inflation protection is supported by rent escalators providing further predictability in the company’s consistent business and financial model.  VICI shares still trade a discount to other REITs proving lesser growth outlooks.  Multiple expansion and organic growth offer upside to the low $40s with a current dividend yield of 4.6% adding to the return profile.  Finally, we especially like VICI’s potential return and predictability against an uncertain economic and stock market environment.  Above average growth with below average risk is tough to beat.

Nexstar Media Group (NXST): NXST reported slightly disappointing 4Q22 earnings and 2023/24 guidance.  It is worth noting that the disappointment is against weak sentiment for local TV related to cord cutting.  Additionally, NXST is always held to well-earned and well-deserved high expectations.  Finally, the company’s acquisition of the CW network likely created a confusing set of consensus expectations.  All that said, NXST shares could be entering a more challenging period after being up 16% during 2020’s bear market.  For 2023, the biggest concerns are related to the economic outlook, relationships with virtual distributors like YouTube TV and Sling TV, and continued cord cutting.  The outlook for 2024 improves as another year of political advertising kicks in and losses related repositioning the CW begin to recede.  On a longer-term basis, there is little doubt that NXST massive free cash flow and management’s excellent stewardship of capital allocation will continue.  However, we are beginning to wonder if organic growth opportunities are big enough to offset the secular pressures from a changing TV landscape.  Secular concerns drove our decision to reduce client positions in NXST during 2022 at prices quite close to today’s post-earnings sell off.  For now, we are holding NXST shares as hitting current expectations in 2024 could push the shares to new all-time highs at $220 or higher.  For 2023, we suspect the stock is stuck in a range of about $160 to $200.  We are taking a serious look at taking the win and selling NXST much as we did earlier this year with Comcast. That is a change after years of defending NXST against secular and cyclical concerns and watching the stock triple vs our initial purchases in 2017 against a gain of just 60% for the S&P 500.

WMT, HD, VICI and NXST 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.

January’s Market Rally Consistent with Northlake’s Favored Strategies

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The stock market is off to a great start in 2023 in line with Northlake’s Market Outlook anticipating more volatility, avoidance of a severe recession, and positive returns in 2023.  We are encouraged that our models, favored themes, and individual stocks are off to a good start.

Our Market Cap model favors mid cap again this month after shifting from large cap to mid cap (MDY) to start the year.  The Style model remains neutral between growth (IWF) and value (IWD).  The shift to mid cap looks good so far as small and mid cap outperformed large cap in January.  The expansion in market breadth to companies of all sizes is also evident in strong returns for both growth and value so far this year.  In our thematic strategies that do not use our models, we have maintained a modest bias toward value and small/mid cap and we continue to believe that is the best approach.  Our outlook for a mild recession at worst accompanied by an end to Fed tightening in the spring supports continued good performance from these themes.  We also maintain exposure to international equities across many client strategies.  Intentional performed relatively well last year with performance accelerating in the fourth quarter and continuing in January.  A weaker dollar is now joined by China’s COVID reopening as bullish underpinnings for international equity performance.

Northlake’s individual stock portfolio is off to a good start this year, with earnings reports still due from most of our holdings.  Disney (DIS) and Meta Platforms (META) are each up 24% this year as they rebound from awful performance in 2022.  Neither has reported 4Q22 earnings.  Nexstar (NXST), Sony (SONY), and Comcast (CMCSA) are up between 15% and 18%.  Only CMCSA reported earnings and we sold the shares shortly thereafter.  Part One of our 4Q22 earnings review blog post discussed the sale of Comcast.  Alphabet (GOOG/GOOGL), Apple (AAPL), and T Mobile USA (TMUS) are up 8-10% in 2023.  TMUS reported good 4Q22 results and initiated solid 2023 guidance.  AAPL and GOOGL report this week.  IBM (IBM), Home Depot (HD), and Walmart (WMT) have lagged with IBM selling off after a mixed 4Q22 report.  More comments on IBM can also be found in our Part One 4Q22 blog post.  Home Depot and Walmart report later in February.

MDY, IWF, IWD, DIS, META, NXST, SONY, GOOG/GOOGL, AAPL, TMUS, IBM, HD and WMT 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.

3Q22 Earnings Updates: Part Two – SONY, NXST, DIS, ATVI, WMT, HD, and META Follow-Up

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Sony (SONY): SONY had improved results after a couple quarters of modest downward revisions.  2Q22 earnings came in ahead of consensus, and the company raised its guidance for FY22 which ends on 3/31/23.  Importantly, SONY’s games segment showed signs of stability as the post-pandemic shift in behavior that has reduced engagement appears to have runs its course.  The new Call of Duty game and the company’s first-party God of War both launch new versions in November and should provide a boost to the software side of the business.  Hardware also looks better with the supply chain issues that have held back production of the PS5 in the rear-view mirror.  As the games segment stabilizes, music and pictures are performing ahead of expectations.  Music is seeing strong growth in streaming, and recent acquisitions are ahead of budget.  Pictures benefits from SONY’s position as an “arms dealer” while demand from streamers and theaters for new TV shows and films is booming. Image Sensors, another important segment which supplies sensors for smartphones and autos, is also benefiting from an improved supply chain as well as strong sales of high-end smartphones.  A portion of the upside in the quarter and guidance is due to the weak yen and strong dollar.  Most U.S. companies are being pressured by dollar strength.  SONY instead benefits from current currency trends, with much of its operations and costs based in Japan and a lot of revenue earned in dollars.  Northlake usually does not ascribe much impact to foreign currency since it effects companies equally, but it is nice diversification to be on SONY’s side now.  Overall, SONY is stabilizing and well set up for long-term growth. We see the quarter and updated guidance as a positive catalyst to close what we see as a hugely discounted sum of the parts valuation.  The stock remains at a multiple well below the average multiples of peers in video games, music, filmed entertainment, and sensors.  SONY remains one of our favorite ideas for the conservative nature coming from its Japanese management style and the above-average long-term growth opportunities in its portfolio of businesses.

Nexstar Media Group (NXST): Northlake took partial profits in NXST for the second time this year ahead of the 3Q22 earnings report.  NXST reported another strong quarter, completely bucking the trend of other local TV broadcasters this quarter.  Despite the good news from NXST, the shares have pulled back significantly from our sale price.  Broadcasters face headwinds from rising interest rates and fear of a recession.  Advertising is still about 30% of NXST’s sales with another 50% coming from retransmission fees paid by cable, satellite, and streaming distributors.  Advertising is showing signs of weakening across all traditional and digital media even as consumer demand remains firm.  Retrans headwinds have picked up as cord cutting has accelerated in the last six months.  NXST is well positioned against these trends given its scale, best-in-class management, and healthy balance sheet.  The company slightly exceeded aggressive guidance for political ad revenue while all other publicly-traded local TV broadcasters fell short.  This is a testament to the company’s scale and management acumen.  Given almost full national reach, it did not matter to NXST if races in certain states saw less spending since the spending shifted to other states.  NXST also faces little pressure on its balance sheet due to moderate debt levels compared to other heavily indebted companies.  Local TV produces a lot of free cash flow.  NXST hit its free cash flow guidance, while peers fell way short.  The penalty for peers has been declines of 30% or more in share prices whereas NXST trades near its pre-earnings level despite being well below Northlake’s latest sale.  The next six months are going to be tricky for NXST as political ads go away, macroeconomic concerns remain, and cord cutting remains elevated.  The company also faces financial and operational challenges on its acquisition of the CW Network, although the core business is more than 10 times larger.  Our two sales to take profits (up nearly 3 times our initial purchase) have right-sized client positions so we plan to ride out any further volatility given the companies superb track record and free cash flow that can be used to support the stock price.  Our prior targets above $200 are probably unrealistic until market and economic headwinds begin to subside, but using what we hope are conservative estimates, we still think the stock offers good value, especially on a long-term basis.

Disney (DIS): DIS reported disappointing earnings to close out its 2022 fiscal year.  Losses in streaming were larger than expected, and Theme Parks surprisingly fell short of estimates as costs rose ahead of expectations.  A limited slate of films did not allow the film studio to help, and traditional television businesses like ESPN and ABC continue to feel pressure from cord cutting.  Advertising trends showed weakness as advertisers cut back ahead of concern about a recession.  The poor earnings report was compounded by weak guidance calling for larger than expected losses in streaming in FY23 and continued pressure on theme park margins.  Management did reaffirm that FY22 represented the peak of streaming losses and continues to forecast a turn toward streaming profitability at some point in FY23.  The shares tumbled to lows from the start of the pandemic.  Northlake still believes DIS is well positioned long-term with its collection of premier assets across media and entertainment.  This quarter could very well turn out to be the one that fully resets expectations.  At this point, merely hitting lowered FY23 expectations should allow the shares to rebound 20-30%.  Northlake maintains a more optimistic view on the economy, expecting no worse than a mild recession.  We also believe that inflation has peaked which will ease pressure on monetary policy.  Our overall thesis is that the race between currently healthy economic growth and inflation and tightening monetary policy will be won by economic growth.  DIS is a premier play on this thesis given its strong collection of industry leading assets and now washed-out expectations.

Activision Blizzard (ATVI): While we await regulatory rulings on Microsoft’s attempted acquisition of ATVI, we are pleased with the progress the company is making on its own.  ATVI stumbled badly with far-reaching human resources scandals that crashed the stock price and led to Microsoft’s pending acquisition.  Employee issues were likely partially responsible for last year’s weak Call of Duty release and other underperforming franchise titles.  We remain hopeful that the acquisition will go though in mid-2023 providing a windfall return to shareholders.  However, if the deal is blocked, we are encouraged by the progress ATVI has made since the deal was announced.  Operating with less public pressure, the company has improved its employee relations and gotten back on track with the quality of its game releases.  In particular, the new Call of Duty game, the company’s most important franchise, has received a rousing reception in its first days on sale, breaking records for dollar and unit sales.  Other games within the Call of Duty franchise also are performing better.  Franchises for Overwatch, Diablo Immortal, and World of Warcraft also are enjoying renewed momentum with their latest releases.  ATVI’s mobile gaming segment, built around Candy Crush, is still growing even as mobile gaming has encountered pullbacks almost everywhere else as consumers are no longer stuck at home with nothing else to do.  This renewed strength across ATVI’s portfolio has led to rising earnings estimates for 2023 even as Electronic Arts and Take Two Interactive, the other large U.S. video game companies, have seen their outlooks fall.  ATVI now trades at about 19 times 2023 estimated earnings, a level that provides good support should the Microsoft deal be blocked.  We expect the stock to take a short-term hit if the deal falls through.  The risk-reward looks good given upside of 30% should it be approved and downside of around 10% if not.  Thus, we continue to hold and expect to know more by June 2023.

Walmart (WMT): In May, WMT fell sharply after noting it had excess general merchandise inventory due to a shift in consumer buying patterns towards staples and groceries, and supply chain issues that led to poorly timed deliveries.  In July, the company noted that earnings would be impacted more than previously expected by these issues.  When the company reported in August, there were signs of improvement with inventories coming down significantly and sales coming in stronger than expected.  In the company’s latest earnings report, the news was even better.  Inventories are now about back to normal and the sales improvement from July and August has sustained.  Earnings came in better than expected and management raised its guidance for the year.  We recap this history because it supports Northlake’s view that WMT is well managed and strategically well positioned.  Although not directly comparable, WMT’s recovery since May contrasts with Target’s continuing struggles.  We believe the company’s differing paths are evidence of our WMT investment thesis. The company executes well at the store level and is gaining share in groceries and among high-income customers.  Efforts in ecommerce with Walmart+ are gaining traction.  Digital sales were up 16% in the quarter and comprise over 10% of sales.  WMT’s website is hosting increasing amounts of third-party sellers, much like Amazon.  Pickup and delivery efforts are going well.  The company also has a growing advertising business taking advantage of its first-party shopper data.  WMT is playing offense with these strategic efforts while also benefitting from its historical value perception. WMT increasingly looks like a win in any economic environment, especially if it can retain high-income customers with good store execution and expanding ecommerce strategies.  Continued success offers the possibility for expansion of the stock’s P-E multiple that would support a price into the $160s in the year ahead.

Home Depot (HD): Despite a tough housing market and a high level of skepticism among investors, HD reported another better-than-expected quarter.  Trends have remained the same with the Pro business leading growth as the DIY business sees a slight pullback in traffic.  Management sees no signs of a major slowdown but is planning cautiously.  When we reviewed 2Q22, we noted that we see secular growth in home spending built on some permanent level of post-pandemic work-from-home raising the importance of home improvement spending in household budgets.  Management noted another factor supporting spending against a weaker economy.  40% of all homes are owned outright, with no mortgage.  Of the remaining 60%, 90% have fixed rate mortgages with 73% at an interest rate below 4%.  This data supports consumer spending even as inflation remains elevated.  Most households largest monthly expense is fixed.  Home prices are softening but remain 40% above 2019 levels.  A small decline still leaves most households with a low interest rate mortgage and more valuable asset that is worth investing in.  Management is doing very well with everything that it can control, but the stock faces a wall of worry concerning the economic outlook.  Northlake believes HD shares reflect too much caution at just 17 times below consensus 2023 earnings.  Our view on the company’s secular positioning and excellent management supports a higher multiple and we are willing to wait and absorb upside and downside volatility as the economic developments dictate.

Meta Platforms (META): Part One of the 3Q22 Earnings Update included a look at META, formerly known as Facebook. We concluded that the news was bad, we had less confidence in management, but we wanted to let the dust settle before considering selling the shares.  The main problem was with the company’s plans to accelerate operating expenses and capital spending against a weakening digital ad environment and the uncertain profitability timeline for the metaverse.  This week, news broke that META is laying off 11% of its workforce and dialing down its capital spending plans.  The company revised guidance for operating expenses and capital spending lower.  These savings will fall directly to the bottom line in a material amount relative to current EPS estimates.  Importantly, they appear incremental to the slower hiring pace management outlined on the earnings call.  We see this as an important step to restoring investor (and our own) confidence in management.  META has a history of bringing expenses down about 10% from initial guidance.  This step is less than a 2% reduction, so substantial room remains to cut costs. Of course, recent decelerating revenue trends still have to fully stabilize and return to growth to rebuild the stock’s valuation.  On this front, management used the guidance update to maintain the newly issued revenue outlook for 4Q22.  Overall, Northlake has a little more trust in management and will give the stock more time than we had previously thought.

SONY, NXST, DIS, ATVI, WMT, HD, and META 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.

2Q22 Earnings Updates: Part Two – ATVI, NXST, DIS, WMT, and HD

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Activision Blizzard (ATVI): ATVI and Microsoft (MSFT) continue to await a regulatory ruling on the proposed acquisition of ATVI for $95 per share.  The companies expect to close the deal in 2023, and Northlake continues to expect approval despite the large discount to the deal price at which ATVI trades.  Recently, the discount has narrowed with the shares trading at $80-$81 up from a range of $77-$78 from April through mid-July.  We think a couple of things are at work.  First, the companies have completed all regulatory filings and there hasn’t been much resistance from the government.  This may not mean anything, but controversial deals often hit a roadblock late in the filing process.  Second, government regulation of tech companies has been focused on privacy and self-dealing, neither of which are a factor in this acquisition.  It also helps that MSFT has not been a target of new regulation and congressional reviews focused on Apple, Amazon, Google, and Facebook.  Third, ATVI has been making progress on corporate governance and employee relations.  Fourth, ATVI is beginning to show improved earnings after a very tough stretch triggered by game release delays and weak performance of new games that were likely triggered by the distraction from the company’s governance and employee relations issues.  This factor was confirmed in ATVI’s 2Q earnings report that revealed better results and laid out a timeline for a series of new releases that renew earnings power in 2023 and 2024.  This is especially important as it raises the downside support level should the deal be blocked by regulators.  With a high likelihood of deal approval and improved earnings support, we like ATVI with 17% upside to the $95 acquisition price.  This upside is especially attractive in a tricky period for the stock market and economy.

Nexstar Media Group (NXST): NXST reported another healthy quarter as the company continues to outperform virtually all other legacy media companies.  The stock is up 29% this year against a 10%-20% decline for the major averages and worse declines for many other media stocks.  We still see another 10%-20% upside based on the company’s prodigious free cash flow generation and management’s shareholder friendly use of this cash.  NXST beat street expectations for EBITDA and all-important free cash flow in 2Q22.  Management guides on a two-year cycle to account for political advertising in even years, so with the current guidance time frame of 2022/2023, guidance was maintained since it is only the first quarter of the period.  NXST has three main revenue lines:  core advertising, political advertising, and retransmission fees paid by cable, satellite, and streaming services.  Political looks set for a record again this year as the battle for House and Senate control and governorships remains closely fought and intense.  We expect another record in 2024, a presidential election year when control of the House and Senate will again be up for grabs.  Retransmission fees should continue to grow even after NXST pays ABC, CBS, FOX, and NBC for programming rights.  This revenue line has long-term risk from cord cutting and mix shift from linear to streaming viewing.  We expect continued growth at least through 2025, but should cracks appear the multiple of cash flow on NXST shares will compress even if financial returns keep growing.  Core advertising was once 80% of local TV station revenue.  The rise of retransmission (now about 50% of revenue) and political (about 25% of revenue over the two-year cycle) leaves core ads at just 35% of revenue, greatly insulating NXST and local TV from a recession.  The less cyclical revenue streams support valuation for NXST shares.  We see 7X-7.5X EBITDA as appropriate, slightly below pre-pandemic levels.  This equates to a target of $215-$240 on what we expect are modestly conservative estimates. At $240, NXST shares would be 4X Northlake’s original purchase for clients five years ago, a remarkable performance for a traditional media company.

Disney (DIS): DIS reported better than expected 3Q22 earnings driven mostly by outstanding performance at the company’s theme parks.  Consumer Products, Content Licensing, and Linear TV also helped on operating income.  Streaming losses were worse than forecast but offset by better-than-expected subscriber growth.  Theme parks look solid – even in the event of a recession – and linear is declining, but not terribly so.  Avatar and Black Panther lie ahead to boost film studio profits and drive streaming subs.  These non-streaming businesses produce a good level of base profits and underpins a big chunk of the current price.  We suggested last quarter that everything besides streaming is worth $100 per share.  The tricky part is valuing streaming, and 3Q22 offered a lot of interesting new information.  Management revised long-term subscriber targets downward, but most of the decline was in India where monthly subscriptions are just $1.  For the first time, subscriber guidance breaks out Hotstar, which covers India and other low-value SE Asia and Africa markets.  The new sub guidance in developed markets is only a bit less than before and better than investors feared.  Management also outlined price increases for the streaming services in the U.S. with the intent to eventually roll them out to Europe and developed Asia.  The price increases on Disney+, Hulu, and ESPN+ are substantial amid concerns about consumer spending and inflation.  As offsets, the company formally outlined the plans for a lower-cost advertising-supported version of Disney+ and offered new bundles with and without ads that provide dramatic savings vs. buying the services individually.  The idea appears to be to force people into bundles, which helps sub counts at Hulu and ESPN+ and lowers churn, thus offsetting the risk that the big price increases boost churn as they appear to do whenever Netflix raises prices.  Management reiterated that streaming losses would peak this year, but losses in 2022 and 2023 are higher than previously expected.  The company is sticking by its goal to show streaming profits in 2024, although this is unlikely on a full-year basis until 2025.  One helpful new data point is that content spending will plateau near the current $30 billion annual level.  This mirrors plans by Netflix and Warner Brothers Discovery and reinforces the idea that streaming can be a profitable business within a few years.  After the material subscriber and profit reset at Netflix and drop in Netflix shares from $700 to $200, this is welcome news.  An improved outlook on streaming and ongoing great performance at theme parks justifies the 5% rally in DIS shares following the earnings report.  It allows a modestly higher target price for DIS of $145, up from $130 after last quarter’s weak earnings report.  Should the 2024/25 profit outlook firm up, multiple expansion can push DIS shares far beyond our current target.

Walmart (WMT): WMT reported 2Q22 earnings on August 16th after preannouncing a significant disappointment last month and lowering its EPS forecast for the year by about 10%.  As we noted in our prior writeup recapping the preannouncement, WMT shares needed a signal that consumer spending in its stores had firmed up in order for the stock to work again.  2Q22 results came in better than lowered expectations on sales and earnings, and management noted a pickup in late July and early August.  This is the news we were hoping for even if it arrived ahead of schedule.  WMT shares have fully recovered the losses following the preannouncement.  Management also noted that inventory clearance in general merchandise, the primary cause of the guidance cut, is on or ahead of schedule.  A final significant item from the earnings call is that the company is seeing higher income shoppers trade down to shop at WMT instead of other more expensive stores, which is offsetting weakness from heavily inflation-impacted lower income consumers in the company’s base.  Interestingly, this trade-down sustained in the initial stages of the decline in gas prices.  WMT shares are not out of the woods given the tricky macro environment but we continue to like the combination of offense and defense from the more aggressive management of the base business, market share gains in weak economic environments, and early success for Walmart+.

Home Depot (HD): Despite higher mortgage rates and a major slowing of the housing market, HD reported better-than-expected revenues and earnings in 2Q22.  Comparable store sales grew 5%, in line with Wall Street expectations, with transactions down and ticket size up.  Gross margins held steady – an important factor given investors often worry about this datapoint.  HD indicated that supply chain pressures are easing, and it has been able to raise prices to offset higher costs.  Management maintained 2022 guidance, which Northlake finds prudent given uncertainty in the macroeconomic outlook.  Northlake’s investment thesis for HD is built on consistent execution by a best-in-class management team.  One particularly helpful aspect of the corporate strategy is the focus on the pro customer/contractor.  As COVID impacts have eased, homeowners are allowing contractors in their home to fulfill a backlog of projects.  This has more than offset any softening in the do-it-yourself market that boomed during COVID stay-at-home restrictions.  The combination of higher ticket and lower transactions likely reflects the company’s focus on the pro customer.  Northlake has been patient with HD even as worries about the housing market have dominated headlines and driven the stock lower.  We believe there is a secular shift to spending on homes as individual priorities have changed post COVID.  This factor may be less than we first expected as spending has shifted back to the decade-long emphasis on services (travel, entertainment, dining, etc.).  However, a small incremental gain along with the exposure to pro spending should allow HD to continue to thrive even if discretionary purchases are pressured by inflation.  It is also important to remember that HD is not very sensitive to new home construction.  Rather, it is remodeling that drives the business.  Slower housing turnover of existing homes is a risk we are monitoring.  We also are watching the high growth in inventories even as management explained that it was purposeful to keep shelves stocked.  Other retailers including Target and Walmart have been forced to cut guidance to clear elevated inventories.  We believe the company’s product selection is less exposed to inventory obsolescence. HD shares are valued at less than 20 times earnings, a level we do not think adequately reflects the company’s growth prospects, financial strength, and management quality.  A return to a low 20s P-E multiple can push the shares into the upper $300s as the Wall Street calendar turns toward 2023 and beyond.

ATVI, NXST, DIS, WMT, and HD 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. 

1Q22 Earnings Update: Part Three – VICI, NXST, SONY, DIS, HD

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VICI Properties (VICI):  VICI reported its typically boring quarter with results in line to slightly better than street expectations.  Boring is exactly what we like about VICI.  As a landlord to the nation’s two leading gaming companies, Caesars and MGM, VICI’s business model is highly predictable.  The company collects rents with built-in escalators.  Beyond the annual rent increases, VICI also grows by buying other casino properties.  Essentially, VICI acts as a financing partner for casino companies.

While 1Q22 offered little news in the reported results, it was a critical quarter for VICI.  The company closed on its acquisition of The Venetian, one the most significant properties on the Las Vegas Strip.  VICI also completed its merger with MGM Properties, combining the two largest Gaming REITs.  With the big deals closed, VICI issued updated guidance for the combined company that was in line with our estimates and slightly ahead of street estimates.  VICI pays out most of its earnings in dividends but there is several hundred million left over that the company uses for additional acquisitions that are smaller in scope than Venetian and MGM transactions.

We think a period of calm will be good for VICI shares as the power of the enlarged company can shine.  VICI is now one of the three largest REITs by market capitalization, something we believe will be a source of incremental demand from real estate focused investors.  The shares currently have a dividend yield of 5% and we expect dividend growth to be in the mid-single digits annually.  We expect the multiple to expand as investors gain appreciation for VICI’s business model and the acumen of its superb management team.  After never missing a rent payment during peak COVID, when many of its tenants shut their casinos, we have little concern about credit risk even if the economy slips into recession.  The primary risk in the shares is rising intermediate to long-term interest rates that weaken the relative value of VICI’s dividend yield. The combination of dividend yield, moderate earnings growth, and multiple expansion offers VICI shareholders upside of 15-20% in the next twelve months and a long-term return profile of 8-10% annually.

Nexstar Media Group (NXST):  Over the nearly ten years that we have been investing in NXST, we have grown accustomed to good earnings reports that meet or beat expectations and steady increases in estimates of free cash flow (NXST and other local TV station owners are valued primarily on free cash flow rather than EPS or EBITDA).  In our long history with NXST, 1Q22 was one of the best quarters.  Revenues, EBITDA, and free cash flow each comfortably exceeded our own and Wall Street estimates.  Perhaps more importantly, management indicated no slowdown in advertising or the net retransmission fees it receives from cable, satellite and vMVPDs (YouTube TV, Sling, Hulu Live TV) despite the war in Ukraine, rising inflation and interest rates, and investor fears of an imminent recession.  Other local TV broadcasters offered similar comments.

We attribute the company’s outlook and performance to its best-in-class management team that executes flawlessly on sales, expense control, free cash flow conversion, and mergers and acquisitions.  On its 1Q22 conference call, management noted multiple times that its three-year outlook is strong and has high visibility.  Political advertising looks set for one of its biggest years ever this year with control of the House and Senate at stake.  The Presidential election in 2024 will surely be hard fought and the House and Senate will likely still be close to evenly divided.  Retransmission fees should take a step up as a new round of negotiations is underway with local TV channels still underpriced relative to their viewership share.

NXST will generate free cash flow of about $1.4 billion per year in 2022 and 2023, which equates to over 20% of the current stock price.  Capital allocation includes steady increases in the dividend, significant share buybacks, and tuck-in acquisitions of digital properties that enhance the national reach of the company’s TV station group.

NXST shares reached $190 before the market correction.  We think the stock can get back there and reach $210 assuming 2022 and 2023 results meet expectations.  The primary near-term risk is a recession that impacts the company’s advertising.  However, core advertising (non-political ads) is only around 30% of revenues now vs. 80% during the 2007-2009 Great Financial Crisis.  Despite what many investors think, local TV broadcasters are not particularly economically sensitive.  Long-term risk emanates from changing TV viewing habits that could reduce time spent with the company’s local news broadcasts.

Sony (SONY):  SONY reported results in line with investor expectations for 4Q21 (which ended on 3/31/22).  Looking at the full fiscal year, operating income came in about 20% above initial guidance.  SONY typically guides conservatively.  This gives us great comfort that the newly issued guidance for a small decline in operating income in FY22 will prove conservative.  This especially appears the case in the company’s Gaming segment where management is guiding to a 34% revenue gain but unchanged operating income.  Guidance in Music calls for continued growth fueled by streaming and label acquisitions.  Image Sensors used in mobile phone cameras should grow as well although COVID lockdowns in China could prove a challenge for the supply chain.  Pictures will have a down year comping against the massive success of the latest Spiderman movie, which is one of the all-time box office leaders.  These four businesses provide the bulk of SONY’s earnings and are key to why we think the stock is significantly undervalued.  SONY shares have performed poorly this year, pressured by fears about the impact of Microsoft’s proposed acquisition of Activision Blizzard.  SONY and Microsoft are big rivals in gaming consoles (PlayStation vs. Xbox).  The stock has also been under pressure due to significant weakness in the yen vs. the dollar and multiple compression that has hurt all growth stocks.

We are encouraged by the recent improvement in SONY shares relative to the market.  SONY shares are unchanged since April 27, while the S&P 500 is down 6% and the NASDAQ is down 7%.  We think this is just the start of improved performance for SONY.  The stock trades at less than 8X EBITDA while peers in the video game, music, semiconductor, and film and TV production industries trade at significantly higher multiples.  SONY’s results are never linear due to the company’s complexity and conservative financial reporting practices.  However, we expect the company to materially beat its 2022 forecasts and its recently issued three-year forecasts.  This should allow multiple expansion to 10X, which gives us a target of $120, up more than 40% from current trading levels.

Disney (DIS):  DIS shares have been the worst performer in the Dow Jones Industrial Average so far this year, driven lower primarily by the collapse in Netflix shares.  Netflix’s weak subscriber growth and lowered profit margin forecast have undercut confidence in DIS’s own transition to streaming despite better-than-expected growth in subscribers at Disney+.

DIS had solid results in 2Q22 but cautious comments on the company’s conference call for the balance of FY22 have pushed the shares lower again.  Higher expenses in streaming reinforce the worries triggered by Netflix’s margin guidance.  Investors are asking if streaming will ever produce material profits.  Netflix also has raised worries that DIS subscriber growth will fall short of management’s expectations of 230-260 million at Disney+ in 2024 (currently near 140mm).  On the 2Q conference call, management noted that the incremental growth in subs in 2H22 vs 1H22 would be less than previously forecast.  Investors interpreted this news negatively, but we would point out that 1H22 sub growth came in well ahead of expectations and there is no change to the number of new subs expected in 2H22.  We remain confident that streaming subs are on track given many new countries are being launched later this year and a surge in fresh content is coming now that COVID is no longer impacting production schedules.

While we wait for clarity on long-term streaming trends, Disney’s theme parks are booming.  Domestic theme parks are already operating well ahead of 2019 pre-COVID levels and international visitation has barely restarted.  If we value DIS at 12X EBITDA reflecting a premium for theme parks and the film studio and a discount for traditional media, we get a value of $100 per share.  This approach embeds a multibillion-dollar loss on streaming.  At our 12X multiple, this equates to $30 billion of market cap or about $20 per share.  Netflix may face growth concerns, but it is profitable today and valued at $90 billion.  Each $10 billion in value ascribed to DIS streaming is worth about $4 a share.  We feel extremely comfortable valuing DIS streaming at 80% of Netflix which would equate to a target of $130 for DIS.  We feel this target is conservative but realistic until investors regain confidence in long-term streaming economics.  While $130 is well below targets of over $200 we held previously, it is enough to keep us long DIS shares ahead of what we hope will be better news on streaming later this year.

Home Depot (HD):  HD reported excellent 1Q22 results and, in an unusual move, raised its full year guidance.  The news was good in almost every area with profit margins a highlight for us after so many recent quarters where margins seemed to trip up the investment thesis.  Good margin performance contrasted with the big earnings misses and guidance reductions at Walmart and Target due to the impact of inflation and supply chain problems.  The conference call overall was quite bullish, much more so than in we usually hear from HD’s conservative management team.

Unfortunately, HD shares gave up all their initial gains and fell sharply along with the rest of the retail stocks after the plunges in Walmart and Target stocks.  If there was one issue that worried HD investors, it was related to composition of the 3% comparable store sales gain.  The gain was made up of 11% price increase and an 8% decline in traffic.  Given current Wall Street worries about a recession driven by a pullback in consumer spending, the traffic decline is worrisome.  However, HD reminded investors that (1) it gets a significant portion of its sales from contractors or Pros, and (2) Pro demand reflects the spending by consumers.  Management also offered an interesting take on housing economy as it relates to the sharp jump in mortgage rates this year.  To summarize, there are about 130 million housing units in the US of which 100 million are either single family homes or non-rental properties.  Turnover of these homes in a typical year is 4-5 million units.  Of the reaming units, about 85% have fixed rate mortgages.  These statistics suggest that the impact of higher mortgage rates is less than generally perceived.  Furthermore, management noted if homeowners feel unable to move because of higher mortgage rates on their new purchase, they may decide to invest more in their current home.  It crossed our mind that a shorthand way of saying this is that the industry is referred to as home improvement not new home construction.  Northlake would also believe HD is getting a boost from a secular shift of consumer budgets to the home driven by the COVID experience.  We continue to find HD shares attractive with a current target of $340 based on 15 times EBITDA or 20 times projected earnings.  This target is below our earlier targets since the market multiple has contracted sharply but provides plenty of upside for a blue-chip company in a tough market environment.

VICI, NXST, SONY, DIS, and HD 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. 

Nexstar Good Again From “The Bottom Up”

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Nexstar Media Group (NXST) has been of the best stocks in Northlake’s portfolio, up over 3 times from initial purchases in 2017.  The company’s latest earnings report for 4Q21 showed exactly why.  The company exceeded consensus earnings estimates for revenue, EBITDA, and free cash flow.  Management also rolled forward free cash flow guidance to a 2022/2023 average from the prior 2021/2022 figures.  The new guidance also exceeded consensus, a welcome sign for a management team known for providing positive but conservative outlooks that are almost always exceeded.

Stock Reaction:  On another tough day for the market, NXST shares are trading up almost 1% (S&P 500, -1.3%).  Nexstar shares are down only 3% from their all-time high that was set just one week ago even as the S&P 500 is -10% and the NASDAQ is -15% so far in 2022.

Earnings Analysis:  We have always been impressed by NXST’s management team, which we often have held out as one of the best of any company in any industry that we closely follow.  Management excellence extends to strategy, operations, and finances.  On the 4Q21 call, CEO Perry Sook said something we don’t remember hearing before when he noted, “Nexstar is managed from the bottom up.”  He was specifically referring to the focus on free cash flow above all else, but this quote also applies to careful and effective management of each individual TV station the company owns.  Our prior favorite comment about Mr. Sook was that he could probably answer a question in detail about sales trends at any of the company’s 199 TV stations.

Beyond the better-than-expected results and good guidance, the highlight of NXST’s results was core advertising revenue.  Despite auto ads still being down significantly, core advertising was up 4% vs last year and up vs pre-pandemic 2019.  8 of the top 10 categories were up and several were up well above 10%.  Sports betting has become a top 3 category and continues to grow as more states legalize.  Given the secular concern that local TV is dying and the cyclical worries about slowing economic growth and consumers cutting back as stimulus fades, these revenue results are unequivocally good news.  Management spoke confidently about the advertising outlook and noted so far trends in 2022 are as strong or stronger than the end of 2021.

Target Price:  Based on management’s new guidance, we see the shares with upside to $195, up from our prior $180.  We continue to use a conservative multiple of just 7X EBITDA despite NXST’s improved balance sheet, shareholder-friendly capital allocation including buybacks, January’s 29% dividend increase, and strong and highly visible multiyear outlook (ad recovery and mid-term political this year, renegotiation of affiliate fees and more ad recovery in 2023, and the Presidential election in 2024).  In other words, we see our target as potentially conservative.

NXST 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.