3Q24 Earnings Updates: Part One – IBM, TMUS, GOOG/GOOGL, META, AAPL, VICI

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IBM (IBM): IBM shares sold off following a mixed report for 3Q24.  The selloff is mostly related to elevated expectations after the stock had doubled since October 2022, with over half of the gain coming since the start of 2024.  Our original purchase of IBM just over five years ago was based on an investment thesis that the company was poised to return to growth.  A new CEO focused on software after the Red Hat acquisition, using strict expense management, combined with a very depressed valuation, provided a good setup.  The dividend yield was around 5% which was paying us to wait for investors to see the new growth profile.  Our thesis was working out across the board and was then boosted by IBM’s exposure to AI.  IBM was an early player in AI with Watson.  The company is positioned well for the current AI boom through its consulting, software, and infrastructure businesses.  Management has noted steady increases in AI bookings, now at over $3B, from virtually nothing a year ago.  The bull case was evident in management’s discussion of the 3Q24 results, the outlook for 4Q24, and preliminary commentary on 2025.  The stock sold off because consulting and infrastructure segments fell slightly short of estimates.  A 3Q24 acceleration in software is more important for the long-term story, but when a stock is up 2X in two years and more than 60% in 2024, there is no room for error.  This is especially the case for IBM, a fallen angel in the tech world where there remains skepticism about the growth turnaround.  The consulting shortfall relates to cautious spending on traditional technology at large enterprises while AI bookings gradually materialize as revenue.  The balance should shift by the second half of 2025.  Infrastructure represents IBM’s mainframe business.  The company announces a new mainframe every few years and the next generation is soon to arrive.  The weakness in 3Q24 is related to clients waiting for the new systems to ship.  Software is the most important growth driver and picked up to mid-teens.  We expect AI bookings to translate to revenue later next year.  This could create a stall in the stock’s upward progress but the return to growth story looks even stronger today.  The dividend still provides an above average 3% yield and the P-E of 19X 2025 estimates is reasonable compared to the market given the AI and software exposure.  Much of our thesis has played out but we think there is one more leg up in the stock through 2025.

T Mobile USA (TMUS): Sometimes a Wall Street analyst gets straight to the point even better than we do.  Summarizing the third quarter, Cowen and Company stated: “TMUS posted solid 3Q24 results, with a beat on most financials including EBITDA, revenue, and FCF, a postpaid phone adds beat on good churn, an ARPU beat, and slightly raised 2024 guidance.”  These results are what we have gotten used to for TMUS since purchasing the stock for clients over two years ago.  The shares are up 5% to a new all-time high in response to the good results.  The shares are also just shy of a double on our initial TMUS purchases.  In our last few quarterly updates on TMUS, we noted that while the company was still gaining market share and far outgrowing AT&T and Verizon, the upside relative to consensus had begun to wane.  The big positive response to 3Q24 is partially due to the return of TMUS to across-the-board beat-and-raise results.  TMUS shares trade at a substantial premium to AT&T and Verizon and cable companies Comcast and Charter.  The premium is well earned thanks to consistently higher growth, a better balance sheet, higher free cash flow, and more share buybacks.  All of this is built on the company having the best wireless network and the most capacity.  Wireless and broadband services are fully penetrated in the US.  TMUS has a couple more years of share gains in wireless in rural and big city suburban markets and large and small businesses.  Fixed wireless and fiber to the home also are share gainers for the foreseeable future.  Eventually, TMUS growth will slow toward the industry averages and the company will face strategic decisions about how to proceed.  Wireless and broadband markets are converging rapidly and TMUS may need to make larger investments in mergers and networks.  However, that is a problem we will worry about in a year or two.  In the meantime, we think the shares can grind higher on continued industry-leading results despite their premium valuation.  Sometimes you pay for growth.  Sometimes you pay for quality.  At TMUS, we pay for both.

Alphabet (GOOG/GOOGL): GOOG/GOOGL reported strong 3Q24 against cautious expectations and concern about regulatory developments.  The company beat expectations on almost every financial metric at the corporate and segment level.  The most significant upside was at Google Cloud which grew revenues 5% with significantly expanding profit margins.  Cloud is now solidly profitable and turning into a material driver of revenue and profit growth for the entire company.  Google Cloud is gaining market share from Microsoft Azure and Amazon AWS but remains a distant third player.  Alphabet’s leading AI technology positions the company well to continue gaining share in a fast-growing market.  The beat at Search was modest but given concerns about market share losses to AI chatbots and retail media, the results came as a relief to investors and analysts.  Management did a credible job on the conference call to note the company’s strong position in all aspects of AI technology.  Management also laid out an interesting argument that the addition of AI output to search queries is increasing engagement and use cases for search.  They seemed to be saying that the search business might be more competitive, but AI will make it grow more rapidly, insulating the company from modest market share loss.  YouTube results were barely ahead of expectations and the business is growing less quickly than digital advertising peers like Meta Platforms.  However, sustaining low to mid-double-digit growth at YouTube with as much potential to accelerate as decelerate is a win for the stock in the near-term.  The shares responded positively to the report, holding gains of 4-5% for most of the post-earnings trading day.  The shares would probably be much higher if the company did not face major changes to its business after losing the trial over monopoly tactics with the DOJ.  In a few weeks, the government will formally present the judge with its favored remedies.  The shares trade at a discount to the S&P 500 and a larger discount to peers like Meta, Apple, Microsoft and Amazon. Alphabet will probably be fine in the long run even with the most drastic remedies but the upside in the shares is likely delayed until their clarity on the remedies and the timing of their being put in place given a lengthy appeals process.  Northlake maintains a bullish long-term outlook for GOOG/GOOGL shares after balancing the superior growth, strong management, leading technology, and financial strength against the legal and regulatory depressed valuation of the shares.

Meta Platforms (META): META reported good 3Q24 results and issued positive guidance for 4Q24 against high expectations.  The company also gave indications that heavy investment in AI would continue in 2025.  META has asserted leadership in AI and appears to have the most current, direct benefit from AI investments on any of the Magnificent 7 besides Nvidia.  META is already using AI to drive increased engagement, more effective advertising, and better conversion of ads for advertisers.  Improved advertising services also opens a greater pool of companies that can use META’s Facebook, Instagram, WhatsApp, and other platforms.  A key strength of META relative to peers is that its revenue comes from a huge tail of smaller companies.  Improving the creative and conversion of advertising at lower cost is important to driving more ad demand at higher margins for META.  The share traded down following the earnings but are holding up better than other internet and AI related stocks that have reported good results so far this quarter.  The primary concern for META and other AI beneficiaries is the massive investment required to power AI.  META implied another huge increase in capital expenditures is coming in 2025, above even the highest estimates on the street.  This capex pressures free cash flow and net income.  Thus far, META has been able to offset these impacts by sustaining double-digit revenue growth and limiting expenses through its AI investments.  We think this continues but there is little margin for error.  The shares trade at the top end of the historical valuation range but this seems deserved given the company’s leadership in AI and better path to monetization of AI investments than peers.  EPS above $30 annually could come into focus over the next twelve months.  If so, the shares offer upside to north of $700 by sustaining the current P-E ratio. We cannot control short-term investor reaction to AI trends, but management has earned the credibility to invest heavily.  It is an investment that we feel will pay off in the long term.

Apple (AAPL): AAPL shares traded slightly lower following the company’s 4Q24 earnings report and guidance update for the December quarter.  3Q24 results exceeded expectations following a series of lowered estimates from analysts and investors.  Concern had mounted that initial sales of the iPhone 16 family was off to a slow start, particularly in relation to expectations that this could be a super cycle driven by Apple Intelligence, the company’s “on phone” addition of AI features.  Most of the concern came from tracking lead times from order to delivery for the new phones.  It turns out that Apple started production of the new phones earlier than usual to avoid shortages.  Shortages drive lead times higher.  Apple CEO Tim Cook often reminds the street not to over interpret unique datapoints since investors do not have the entire picture.  Ultimately, the company exceeded the lowered estimates for the quarter.  However, management offered slightly weaker than expected guidance for the important holiday-driven December quarter that implies very modest growth for iPhones.  Investors now have another reason to reconsider the super cycle and AAPL’s earnings growth outlook.  Northlake believes that the slow rollout of Apple Intelligence, on a feature and geographic basis, will lead to a strong cycle but one that is spread out over the next 18-24 months.  Given questions swirling around use cases for AI, this leaves open the possibility that AAPL shares will remain in a trading range as they have been since August.  Due to its massive size, AAPL is unlikely to sustain organic growth in revenue much above the mid-single digits on a long-term basis.  Shareholder returns can be significantly better since the company has been steadily driving profit margins upward and the business generates enormous free cash flow that is used to buy back shares and pay and raise dividends.  AAPL has reduced its outstanding shares by nearly 40% in the past 10 years, dramatically supporting growth in earnings per share.  We expect this pattern to continue even with modest organic revenue growth.  AAPL shares are expensive, trading at over 30 times earnings, well above historical levels on an absolute and relative basis.  We believe AAPL is worth premium given the company’s consistency, financial strength, and the possibility that there is still “one more thing” left to accelerate growth.

VICI Properties (VICI): VICI reported another typical quarter offering mid-to-high single-digit growth in revenues and earnings.  Combined with the 5% plus dividend, VICI shares offer consistent double-digit annual returns and dividend growth.  As a reminder, VICI is a REIT offering various forms of financing to casinos and other leisure properties   The company typically owns land and buildings and is paid rent by the tenants that operate the businesses on the properties.  Rent has an annual inflation adjustment that can drive earnings and dividend growth.  VICI enhances its growth profile by financing new properties for its current and new tenants.  Given the highly predictable nature of the business model, quarterly earnings do not create much volatility in the shares.  In the conference call following the recently released 3Q24, the primary discussion was the slow pace of new financing deals over the past few months.  Management noted, the pipeline is full of large and small deals but volatility and uncertainty in the macroeconomic and political outlook, and especially interest rates has slowed the closing of transactions.  Ultimately, the pace of transactions will pick up.  In the meantime, inflation escalators and the dividend provide a good, low-risk return profile for investors.  In the long run, we expect VICI to produce compound annual returns in the 10-15% range.  This return profile makes VICI shares an excellent anchor for client equity portfolios.

IBM, TMUS, GOOG/GOOGL, META, AAPL, and VICI 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.

4Q23 Earnings Updates: Part One – IBM, TMUS, and GOOG/GOOGL

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International Business Machines (IBM): IBM reported a good quarter with nice upside on the all-important free cash flow.  Guidance was also good with free cash flow again surprising positively.  The stock responded very well to the earnings report, mostly because management noted another big acceleration in orders related to artificial intelligence.  As a reminder, IBM has been investing in AI for many years, long before the ChatGPT Generative AI breakthrough last year.  Watson has been winning on Jeopardy and beating chess grandmasters for decades.  Now the company has rapidly moved to reorient Watson to address AI models and governance and use the company’s strong presence in technology consulting to assist other organizations with their own AI needs.  We have to admit we got a little lucky with IBM becoming an AI stock.  Our investment thesis was built on a return to growth after a new CEO prioritized the company’s acquisition of Red Hat that created growth opportunities in hybrid cloud.  Hybrid cloud happens when an organization uses combination of public cloud services like Amazon’s AWS with their own servers or internal cloud.  IBM was perfectly positioned for hybrid cloud thanks to its strong market share in privacy dominated sectors including health care, financial services, and government.  Hybrid cloud continues to be a driver of growth for IBM.  AI adds a second high-growth area and adds a lot of excitement for investors.  Even after the runup in the stock this year, we still find the shares undervalued at 18x 2024 earnings estimates and 15x free cash flow.  Both these measures are discounts to the market when IBM is growing faster than the average company with a clearer line of sight to future growth.  Management credibility has also gone way up as a result of the successful restructuring of the company to growth vectors and consistent execution as evidenced by beating free cash flow guidance against a skeptical analyst community.

T-Mobile USA (TMUS): TMUS continues to at least hit all of its financial and operational guidance.  4Q23 saw subscribers, revenue, EBITDA, and free cash flow all grow again at multiples of its peer wireless and cable competitors.  We still like the shares, but the investment thesis is transitioning.  Previously, we expected regular beat-and-raise quarters because of the company’s innovative marketing as a value wireless service, and better-than-expected synergies from the acquisition of Sprint. We also anticipated a big increase in share buybacks and the establishment of a dividend.  TMUS showed far superior growth to the wireless and broadband industries over the last couple of quarters, but subscriber and financial growth was in line with elevated expectations.  We expect more of the same with TMUS steadily gaining market share leading to double-digit growth in EBITDA and greater than 20% gains in free cash flow.  With cable and wireless peers growing low single digits, TMUS remains an attractive investment on a relative basis.  Absolute performance should be helped by continued aggressive share buybacks.  We expect another big buyback announcement later this year.  The main risk is aggressive competition that leads to discounting.  Right now, however, wireless promotions are at nadir as each of AT&T, Verizon, Comcast, and Charter Communication have reason to harvest profits.  TMUS faces no internal pressures and can happily grow in a stable competitive environment.  We don’t expect TMUS shares to rocket higher, but the ability to grind out steady gains and provide defense should the stock market enter a correction make the stock an attractive investment for the year ahead.

Alphabet (GOOG/GOOGL): GOOG met targets for most financial measures in the fourth quarter, but the compositions of revenues caused a shortfall against elevated expectations.  Revenue actually beat expectations, but the upside came from subscriptions like YouTube TV and Music when investors were looking for a positive surprise in digital advertising at Search and YouTube.  Both divisions reported another quarter of accelerating growth, but investors wanted more after analyst checks indicated upside was possible.  Continued good expense control allowed operating income and EPS to slightly exceed consensus estimates.  Free cash flow fell short but only due to a large tax payment management had alluded to on the third quarter earnings call.  The bull-bear debate for GOOG revolves around the impact of AI on Search.  Bears believe that AI chat products like ChatGPT or Google’s own Bard will take a material share of search queries and hurt monetization of Google Search which is the company’s dominant product.  Furthermore, the cost to compete in a new AI era could be higher, pressuring Google’s margins and return on capital.  Two aspects of the 4Q23 report stoked bearish sentiment.  First, the fact that Search revenue did not positively surprise despite checks could be an indication that Search market share is shifting to AI chatbots.  Second, management announced a large increase in capital spending to support the company’s AI efforts, a sign that return on investment might indeed be lower in the future.  These two points plus the huge runup in GOOG in 2023 (up nearly 60%) dominated trading and overwhelmed an otherwise good earnings report, leading Alphabet shares to fall 7% following the report.  In the near-term, it may be hard for the company to disprove the risks as the AI transition is early.  Earnings also face tougher comparisons later in 2024, and many observers think Alphabet is going to lose the antitrust case filed by the DOJ.  Thus, the short-term setup for the shares has headwinds.  Northlake invests on a multiyear time horizon.  We think bearish investors are underestimating Alphabet’s leadership in AI, which has been integral to the company’s product, services, and operating execution for many years already.  We believe Alphabet will ultimately be an AI winner, setting the stage for a return of the shares to a premium valuation.

IBM, TMUS, and GOOG/GOOGL 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.

3Q23 Earnings Updates: Part One – GOOG/GOOGL, TMUS, META, IBM, and VICI

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Alphabet (GOOG/GOOGL): GOOGL reported mixed results for 3Q23.  The two dominant businesses, Search and YouTube, had better-than-expected revenue growth as advertising accelerated ahead of high expectations.  On the downside, Cloud revenue grew more slowly than expected, up 22%, with management alluding to cloud spending optimization that has previously tripped up Microsoft Azure and Amazon AWS, the two leading cloud players. Upside in Search and YouTube revenue more than offset the shortfall at Cloud, but higher than expected growth in operating expenses led to a small miss vs. consensus operating income.  GOOGL shares are down 9% following the earnings report.  Despite the sharp negative reaction, Northlake does not see the quarter as having structural implications to a positive long-term investment thesis.  However, the shares may struggle to regain momentum in the near-term.  GOOGL shares have long been highly sensitive to trends in operating expenses and operating profit margins.  With concerns industrywide about elevated operating expenses and capital spending necessary to activate AI upside, the timing of a margin and operating income miss is poor.  Investors had been anticipating upside to 2024 EPS at GOOGL.  Despite higher revenue estimates at Search and YouTube after the strong 3Q23, the combo of lower Cloud revenue forecasts and slightly lower profit margins has taken upside to 2024 estimates off the table for now.  We think upside is still possible but the shares will be in “prove it” mode for the time being.  Importantly, management remains committed to operating margin expansion (revenue grows faster than expenses), headcount growth is moderate, and a reimagining of the company’s cost structure for efficiency remains in place.  GOOGL profit margins have expanded greatly since 2019 when investor concerns about expense growth were also high.  The management team has credibility on profit margins and should be able to balance the added investment related to AI thanks to better-than-expected growth in Search and YouTube, which together generate 70% of company revenues.  The shares remain reasonably valued at 11X 2024 slightly lower 2024 EBITDA estimates and trade at a small discount to their historical multiple with sustained growth ahead in key businesses and the potential of AI to open large, new revenue opportunities.

T Mobile USA (TMUS): TMUS reported solid 3Q23 results and modestly raised guidance for subscribers, EBITDA, and free cash flow.  The shares are holding up well on a tough day for the market after rallying sharply over the past week following good earnings reports from peers AT&T and Verizon.  Importantly, despite intense competition in wireless – including cable companies – and seemingly full penetration of the population, industry growth remains positive and the promotional environment is tough but stable.  The Sprint acquisition is now fully integrated with cost synergies achieved ahead of projections.  The network now reaches 300 million people, a goal that has been achieved a year ahead of schedule.  Excess capacity acquired thru Sprint has allowed TMUS to build a large wireless broadband business that competes effectively with cable broadband.  Wireless broadband appears to be an enduring business despite initial skepticism it was a temporary, low-capability, low-priced solution similar to DSL.  Wireless broadband is also bringing many new customers to TMUS that can be upsold wireless phone plans.  TMUS is now every bit a peer of AT&T and Verizon in terms of subscribers and churn.  The TMUS network is fully 5G and the best in the industry.  One area where TMUS lags its peers is in operating profit margin.  TMUS margin has steadily improved to 50% but remains below the 55% level at AT&T and Verizon.  As the company closes the gap, revenue growth in the low to mid-single-digits will translate into high single-digit growth in EBITDA.  Free cash flow will rise faster as capital spending on integrating and building out the networks peaks this year.  In contrast, AT&T and Verizon are barley growing each of these financial measures.  Following the completion of cost synergies, a surge in subscribers and market share, TMUS fundamentals reflect industry leading growth in subscribers, financials, and capital return (dividends and share buybacks).  The next few years should see TMUS maintain leadership.  We expect an upward trend in the shares to resume and still see potential above $180 as the company continues its superior execution.

META Platforms (META): META reported good 3Q23 results.  However, following the mixed report from Alphabet, investors were in no mood for any controversy.  Guidance and the commentary surrounding it provided the controversy and the shares pulled back sharply.  We think this is mostly manufactured controversy in a bearish tape and remain very positive on the outlook for META shares over the next year.  As noted, 3Q23 was clean beat on revenue and profits.  Furthermore, guidance for 2024 operating expenses and capital spending was a positive surprise.  Both will return to growth but well below the bearish fears heading into the report and a clear sign that management’s 2023 Year of Efficiency is becoming part of the corporate DNA.  This is extremely bullish on a long-term basis.  The controversy surrounded a wider range for 4Q23 revenue growth and the potential implications for 2024.  The wider range came about due to a drop in the lower end of the growth rate.  Management noted there was some volatility at the outset of the war between Israel and Hamas although the choppiness has since stabilized.  Management also called out the recent large contribution to advertising growth from Chinese ecommerce retailers, Shein and Temu.  Most of this strength is outside the U.S., especially LatAm, but investors are worried it creates a tough comp in 2024 amid the deteriorating relationship between U.S. and China.  Concern about the top line in a confusing macro environment has taken away the upside to 2024 that many investors previously expected. EPS estimates are pretty stable at $17-18 for 2024 but there had been hope $20 could be achieved.  Northlake still thinks $20 is possible next year and even at $17 the shares are inexpensive at a P-E of 17X.  Most importantly, the new culture at META focusing on efficiency protects EPS if the macro environment proves a headwind and warrants a higher P-E on a long-term basis.

International Business Machines (IBM): IBM reported better-than-expected 3Q23 results.  Revenue, EPS, and free cash flow each were better than consensus expectations.  Free cash flow is especially important as it is an important metric that investors are focused on for IBM, as it reveals the quality of the company’s renewed earnings growth.  The shares responded very positively in a lousy market.  We have three takeaways from IBM’s latest results.  First, management is building credibility by adding another positive quarter.  Second, the company is a real player in AI as it builds on its early entrance in AI via the well-known Watson.  Management noted IBM has booked hundreds of millions of dollars in AI revenue.  Third, despite a shortfall in revenue growth for the Red Hat software business that has been largely responsible for the company’s turnaround, investors still bid up the shares aggressively.  IBM shares are getting more notice with multiple new buy recommendations from analysts who previously did not follow the stock.  IBM has made good acquisitions, including Red Hat, and divested its slow-growth businesses.  Red Hat remains a growth driver with a good explanation for the slower growth in 3Q.  Watson looks like it can drive a second new growth angle in AI.  The shares remain inexpensive at 14X 2024 earnings and 4.7% dividend yield.  We have waited awhile for the turnaround at IBM to be rewarded by investors.  The high dividend and a one-time spinoff we monetized has provided return while we have been patient.  If the company keeps stacking good quarters driven by growth in software and AI, it is only a matter of time until a bigger reward is achieved as the P-E multiple expands to reflect the company’s renewed growth.

VICI Properties (VICI): VICI had another quarter of good execution in the extremely predictable business of owning casino real estate and receiving inflation-adjusted rent payments from leading casino operators like Caesars Entertainment and MGM Properties.  Revenue and Adjusted Funds from Operations (AFFO) both came in slightly higher than expectations.  AFFO is the metric REITs focus on in lieu of EPS.  It represents cash that must be mostly paid out as dividends.  VICI has been built through large acquisitions of casino properties like Caesars Palace, Bellagio, and many regional casinos in states all over the country.  Recently, the company has been entering new real estate markets in what it refers to as “experiential real estate.”  In the third quarter, the company announced several transactions in this area including acquiring a chain of bowling alleys (yes, bowling remains popular and is attracting capital from large businesses) and wellness centers as it expands its relationship with Canyon ranch.  VICI also continues to acquire more casino properties but most recent transactions have been small.  One criticism of VICI’s prospects could be that fewer large transactions are available that can drive the outsized growth the company has enjoyed in the last ten years.  This might be fair but ignores management’s effectiveness at combining many small deals equivalent to a larger deal and the fact there is less risk in smaller deals.  VICI shares have been under pressure as REITs trade mostly on dividend yield and the sharp rise in interest rates makes REITs less attractive.  We are happy to wait for the next leg up in VICI that will be driven by stable or lower interest rates and continued superior execution driving growth in AFFO and dividends.  We see the shares returning to at least the mid-$30s over the next couple of years, providing a low-risk, double digit annual return.

GOOGL, TMUS, META, IBM, and VICI 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 One – IBM, GOOG/GOOGL, META, VICI, TMUS

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IBM (IBM): IBM reported an inline quarter with the normal give and take that any large, diversified corporation will experience.  All guidance was reiterated with a slight boost to the growth rate for software revenue.  Software was a little better than expected driven by double-digit growth at Red Hat for hybrid cloud and transaction processing that builds off the latest mainframe cycle (every two to three years).  Consulting growth was slower but performed well after several peers had indicated weakness in the prior few months.  This is important as an indicator that IBM could be gaining market share, key to our thesis that the stock’s P-E multiple can expand.  Growth was held back by the aging of the latest mainframe which is reported in the company’s Infrastructure segment.  Software and Consulting are the growth drivers and represent over 70% of company revenue.  Mainframes are still important in highly regulated industries like finance and health care where IBM remains a key IT supplier.  IBM has a chance to be a player in AI as the company was an early player with Watson and in June launched a series of AI initiatives built on the well-known Watson brand.  Unsurprisingly, analysts asked a lot of questions about AI on the conference call and management was well prepared.  The tone was optimistic with favorable comparisons for revenue build to the company’s success in hybrid cloud since the Red Hat acquisition.  Management also noted a lot of initial interest from customers with over 150 already engaging.  Overall, the quarter is supportive of our thesis that IBM has returned to growth and deserves a higher P-E multiple.  A little fairy dust from a legitimate entry into AI consulting and software could provide significant additional upside.  We still like the shares after this year’s consolidation of last year’s double digit total return in a bear market.  Upside to $150-$160 plus the 5% dividend yield provides mid-teens return potential into yearend with progress on AI adding meaningful incremental potential.

Alphabet (GOOG/GOOGL): Alphabet reported a better-than-expected quarter with most key business lines and financial metrics outperforming expectations.  Growth in Search and YouTube improved for the first time in several quarters.  Cloud growth held steady, a better performance than the continued slight deceleration from Microsoft Azure (Amazon doesn’t report for another week).  The improvement in revenue growth was reflected in operating income as expense growth was below revenue growth, reversing a concerning trend over the past year.  Alphabet has tightened expenses but not as publicly aggressively as Meta Platforms and other big tech companies.  Employees were down and the company noted continued efforts to optimize real estate.  Free cash flow was solid and management allayed concerns about a big near-term acceleration in capital spending to support AI initiatives.  Not surprisingly, AI dominated the call, both in management’s prepared remarks and analyst questions.  Management was upbeat throughout, noting the company has vast experience with AI already, has first party data to train models, and has many large businesses where AI can offer incremental monetization.  A big concern of investors is that Google Search will hit an air pocket as search moves to Generative AI.  Management feels confident that there are many opportunities to monetize through ads in answers to generative queries.  This is more likely to be a 2024 issue, if at all.  In the meantime, digital advertising trends have turned the corner upward and should accelerate in the second half of the year with tight expense control continuing.  This sets up the potential for more upside surprises amid less worry about AI impacts in the next six to nine months.  GOOGL shares till look reasonably priced at under 20 times new, higher 2024 earnings estimates.  Free cash flow remains strong and funds the heavy AI investment cycle and continuing large share buybacks.  We think the stock can work to $150-$160 and much higher if AI proves additive to financial results in the next 12 to 18 months.

Meta Platforms (META): It is hard to believe where META sits today vs a year ago.  The company just reported a beat and raise quarter that now has 2023 consensus estimates at double the level of last fall.  A year ago, META faced a slowing digital ad market, excessive expense growth, severe margin expansion, and a loss of confidence in company management and strategy.  Today, META is operating with strict financial discipline, while executing strategies to compete against TikTok, implement AI, and build new platforms, and better monetize large services like Messenger and WhatsApp.  Wall Street has renewed confidence in management and is even willing to look past another spike in losses from the company’s metaverse investments.  META shares are back to near where they were in 2021 before things began to fall apart.  It is difficult to see the stock triple off the fall 2022 low and still be bullish.  However, back in 2021, the thought was META could earn about $16 per share in 2024.  Today, consensus estimates are moving up to $18, with $20 easy to justify.  At $320, the stock trades at less than 18 times forward earnings.  This is hardly a stretch given accelerating growth in the core business, new growth opportunities, and importantly, a firm commitment to continue operating with strict financial discipline.  Management will use some its renewed credibility to increase investment in 2024 for growth opportunities and the metaverse.  Should the digital ad market soften again that creates risk for the stock.  A year ago, I was ready to throw in the towel.  The transformation at META has been remarkable and I will gladly admit to having been lucky to bite my tongue and keep my fingers off the SELL button.  A path to $400 or 20 times the stretch EPS target of $20 is plausible and provides a further 25% upside to new all-time highs.

VICI Properties (VICI): VICI reported another consistent growth quarter.  The core business is extremely predictable as the company collects rents on casino properties it owns and leases to a variety of casino gaming companies.  VICI never encountered a missed rent payment during the pandemic when many of the casinos it owns were closed. Now, its casino lessees are in strong financial condition with inflation escalators in the contract.  The bottom line is the core business is sound and growing in the low to mid-single digits.  The excitement at VICI surrounds future property acquisitions in gaming and what management calls experiential real estate.  In gaming the company recently closed several acquisitions or regional gaming properties in the U.S. and its first ever international acquisition in Canada.  These delas provide diversification based on geography and bring in new lessees.  Bigger news was expansions of the VICI’s relationship with Canyon Ranch, a leading owner of wellness resorts serving high income individuals.  VICI is financing an expansion of Canyon Ranch’s business into more resorts and urban clubs.  VICI’s investment includes preferred equity, mortgage loans, and secured loans.  We deeply trust VICI’s excellent management team and like the rationale for the Canyon Ranch deal and the diversification strategy more generally.  VICI shares are trading lower after the 2Q23 report but that has to do with a spike higher in interest rates that is pressuring all REITs.  We continue to expect VICI to produce double digit annual returns driven by core growth, new property acquisitions, and a healthy 5% dividend yield.

T-Mobile USA (TMUS): TMUS produced another good quarter, leading the wireless and broadband industries in new subscriber additions.  Continued subscriber growth is driving TMUS financial results which slightly exceeded estimates except for unimportant equipment sales (mobile phones).  The company sports the best growth rate in revenue, EBITDA, and free cash flow among its telco and cable peers and does so with the best balance sheet in the industry.  This combination of growth and financial strength sets up an attractive share buyback over the next few years when the company has committed to repurchasing 1/3rd of its shares outstanding.  As long as moderate growth continues, this should drive the shares materially higher.  TMUS has been a good investment for Northlake clients but the shares have stalled over concerns about competition in the fully penetrated wireless phone and broadband industries.  We think TMUS can continue to gain share and drive growth due its best quality and highest capacity 5G network, the low market shares the company still has in rural and enterprise markets, and the long successful innovative Uncarrier promotional strategy.  The shares also face a technical hurdle related to the Spring acquisition where Softbank is entitled to a large share bonus if TMUS cross $150 for a prolonged period.  The first phase of TMUS share buyback should be complete late this summer setting up the fall for a new buyback announcement that we expect will address the Softbank bonus shares.  We believe the shares can reach $200 in the next few years, where they will trade at a modest, well deserved premium to slower growing, more heavily indebted peers.

IBM, GOOG/GOOGL, META, VICI, and TMUS 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 One – IBM, GOOG, ATVI, META, TMUS, and SONY

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Given the excitement surrounding Generative Artificial Intelligence (GAI) since Microsoft and OpenAI released ChatGPT to the public in November, we thought it would be educational, interesting, and fun to let GAI write our regular quarterly earnings updates.  ChatGPT only has data through 2021, so we are using Google’s GAI app, Bard. Kind of fun to have Shakespeare comment on our favorite stocks!

For each company, we first show the query we gave to Bard.  Next, we show Bard’s answer.  We then follow with comments of our own about the Bard answer where we also expand a bit on the analysis.  We varied the queries slightly from company to company to help test Bard.

IBM Corporation (IBM)

Query: Please analyze IBM’s first quarter 2023 and the implications for IBM stock.

Bard Answer: IBM’s first quarter 2023 earnings results were mixed. On the one hand, the company reported revenue of $14.3 billion, up 0.4% from the same quarter a year ago. This was driven by growth in its software and consulting businesses. On the other hand, IBM’s net income of $927 million was down 26% from the same quarter a year ago. This was due to a number of factors, including restructuring charges and the sale of its healthcare data and analytics business.

Overall, IBM’s first quarter results were in line with expectations. The company is still in the midst of a transformation, as it shifts its focus to cloud computing and artificial intelligence. These are long-term growth areas, but they are also more competitive than IBM’s traditional businesses. As a result, IBM’s earnings growth is likely to be more muted in the near term.

In the long term, IBM is well-positioned to benefit from the growth of cloud computing and artificial intelligence. The company has a strong track record of innovation and a deep pool of talent. However, IBM will need to continue to invest in these areas and execute its transformation plan in order to achieve its long-term goals.

As for IBM stock, it has been on a downward trend in recent years. The stock is currently trading at around $130 per share, which is down from its peak of over $200 per share in 2013. The decline in IBM’s stock price is due to a number of factors, including the company’s slow revenue growth, its declining market share, and its high debt load.

Despite the challenges facing IBM, the company still has a number of strengths. It has a strong brand name, a loyal customer base, and a deep pool of talent. If IBM can successfully execute its transformation plan, it could be a good investment for the long term.

Northlake Comments:  Overall, this is a pretty good answer.  The key data points are accurate, although we would argue with IBM having a high debt load.  IBM doesn’t generate free cash flow like Alphabet, Apple, Microsoft, and Meta Platforms, but the balance sheet is strong compared to most.  IBM also is on target to generate nearly $10 per share in free cash flow this year after the transformation eliminated its most capital intensive, slowest growth businesses.  We would classify IBM’s results as better than expected, especially following a series of datapoints indicating IT spending had slowed sharply in the first quarter.  In fact, against broader IT spending trends, IBM appears to be gaining market share.  The company’s cloud and AI efforts are growing nicely but not as fast as industry leaders, Amazon, Microsoft, and Google.  Northlake doesn’t mind the slower growth as IBM is a value stock not a growth stock.  The P-E ratio is well below the average stock in the S&P 500 despite similar low to mid-single earnings growth.  IBM shareholders also receive a healthy 5%+ dividend yield while we wait for the story to play out.  IBM needs to grind out more quarters of steady, moderate growth to build investor confidence.  A similar transformation occurred at Cisco and Oracle in the last five years and both stocks saw their P-E multiples expand.  A similar path for IBM would put the shares over $150, plus the dividend for an above average total return.

Alphabet (GOOG/GOOGL)

Query: Please analyze the conference hosted by Alphabet discussing its first quarter 2023 earnings held on April 25, 2023.

Bard Answer: On April 25, 2023, Alphabet held its quarterly earnings call to discuss its first quarter 2023 financial results. The company reported earnings of $1.17 per share on revenue of $69.79 billion. Earnings beat analyst expectations of $1.07 per share, while revenue was in line with expectations.

The company’s advertising business, which accounts for the majority of its revenue, grew 3% year-over-year. However, this was the slowest pace of growth in over a decade. The company attributed the slowdown to a number of factors, including the ongoing war in Ukraine, rising inflation, and supply chain disruptions.

Despite the slowdown in advertising revenue, Alphabet’s overall results were strong. The company’s cloud computing business, Google Cloud, continued to grow rapidly, with revenue up 28% year-over-year. And its other bets, which include businesses like Waymo and Verily, also showed signs of progress.

Overall, Alphabet’s earnings report was a mixed bag. The company’s advertising business is facing headwinds, but its cloud computing business is growing rapidly and its other bets are showing signs of progress. Investors will be watching closely to see how these trends play out in the coming quarters.

Here are some additional thoughts on Alphabet’s earnings report:

  • The company’s advertising revenue growth is slowing. This is a concern for investors, as advertising revenue accounts for the majority of Alphabet’s revenue.
  • The company’s cloud computing business is growing rapidly. This is a positive sign for the company, as cloud computing is a high-growth market.
  • The company is investing heavily in new businesses, such as Waymo and Verily. These businesses have the potential to be major drivers of growth in the coming years.
  • The company is facing regulatory scrutiny. Alphabet is facing increased scrutiny from regulators around the world. This could lead to fines or other penalties, which could hurt the company’s bottom line.

Overall, Alphabet’s earnings report was a mixed bag. The company is facing some challenges in the current environment, but it is still a dominant player in the technology industry. Investors should carefully consider these challenges before investing in Alphabet’s stock.

During the conference call, Alphabet CEO Sundar Pichai discussed the company’s progress in a number of areas, including:

  • The growth of Google Cloud, which is now the third-largest cloud computing platform in the world.
  • The progress of Waymo, Alphabet’s self-driving car company, which is now testing its cars in more than 20 cities around the world.
  • The launch of Verily, Alphabet’s life sciences company, which is focused on developing new technologies to improve human health.

Pichai also discussed the company’s commitment to responsible innovation, and said that Alphabet is working to develop technologies that are beneficial to society.

Overall, the conference call was positive for Alphabet. The company is facing some challenges, but it is still a dominant player in the technology industry and is investing heavily in new growth areas.

Northlake Comments: Despite a little repetition, we’d rate this answer highly, although Waymo and Verily got virtually no mention in the press release or conference call, so we are not sure where that came from.  These Other Bets, as Alphabet calls them, do have value for GOOG/GOOGL shareholders.  While the answer is thorough on revenue and growth drivers, it ignores two important items that have been driving investor sentiment for GOOG/GOOGL shares.  First, there is the threat posed by ChatGPT as Microsoft has the early lead in GAI and the breadth of products to challenge Google’s virtual monopoly in Search, the gravy train and growth driver for Alphabet profits.  Second, investors have been looking for greater detail and larger efforts in cost control at Alphabet.

We think Alphabet is playing a catch up in GAI but is not far behind and has substantial resources of its own and history of using AI to build the advertising products that are used in Search and YouTube.  Additionally, the integration of ChatGPT into Microsoft’s Bing search engine has not made a dent so far in Google Search.  Bard may have ignored Alphabet’s cost controls but management did not.  Investors would love big layoffs and a “year of efficiency” like at Meta, but that is not Alphabet’s style even though the company has been taking steps to reduce costs and be more disciplined with its investments.  Cost savings are more likely to show up in financial results in 2024 which could lead to a big growth year if the economy is doing better and top line growth picks up.  GOOG/GOOGL shares are in a “prove it” mode against AI challenges and macro impacts.  We think the worries are overdone and will wait it out with the shares trading at a 15% discount to their historical valuation and just above a market multiple.

Activision Blizzard (ATVI)

Query: Please analyze the first quarter 2023 earnings reported issued this week by ATVI in lieu of the merger news from the UK.

Bard Answer: Here is my analysis of the first quarter 2023 earnings reported issued this week by ATVI in lieu of the merger news from the UK:

  • Activision Blizzard reported strong first-quarter earnings results. The company beat analyst expectations on both revenue and earnings per share.
  • The company’s results were driven by strong performance from its Call of Duty and World of Warcraft franchises. Call of Duty: Vanguard was the best-selling game of the quarter, and World of Warcraft: Dragonflight is expected to be a major release in the second half of the year.
  • Activision Blizzard also benefited from strong growth in its digital channels. The company’s digital revenue grew by 28% year-over-year, driven by increased sales of digital games and in-game content.
  • Despite the strong earnings results, Activision Blizzard’s stock price fell in the wake of the merger news from the UK. Investors are concerned that the deal could be blocked by regulators, which would be a major setback for the company.

Overall, Activision Blizzard’s first-quarter earnings results were strong. However, the company’s outlook is uncertain in the wake of the merger news from the UK. Investors should be cautious about investing in ATVI stock until the deal is finalized.

Here are some additional thoughts on the merger news and its impact on ATVI stock:

  • The CMA’s decision is a major setback for Microsoft. The company had hoped to close the deal by the end of 2023, but it is now unclear when or if the deal will be approved.
  • The deal is facing significant regulatory scrutiny. In addition to the CMA, the DOJ is also reviewing the deal. It is possible that the deal will be blocked by one or more regulators.
  • If the deal is blocked, it would be a major setback for Microsoft. The company would lose out on the opportunity to acquire one of the largest video game companies in the world.
  • It is also possible that the deal will be approved, but with conditions. For example, Microsoft may be required to sell off some of Activision Blizzard’s assets.
  • The outlook for ATVI stock is uncertain in the wake of the merger news. Investors should be cautious about investing in ATVI stock until the deal is finalized.

Northlake Comments:  Another pretty solid answer.  Ignored is the steadily growing Mobile division (Candy Crush), which again reported double-digit growth way ahead of mobile gaming industry trends.  Also left unmentioned is the upcoming releases of Diablo IV, the next Call of Duty game, Call of Duty’s mobile version, and the online game Call of Duty Warzone.  ATVI did not hold a conference call, which perhaps limited Bard’s ability to answer our query and include a complete response.  We have liked the set up at ATVI given the possibility of Microsoft closing its deal to buy ATVI for $95 later this year.  The rejection by the UK came as a surprise since they had already passed on blocking the deal related to console gaming which is well over 95% of the non-mobile gaming market today.  Instead, rejection came due to fear that Microsoft could dominate cloud gaming and block competitors given it would control some of the best games and an industry leader in cloud software and services.  As we have previously explained, ATVI is performing well in core operations and the shares are reasonably valued at 17X 2023 earnings estimates, in line with closest peer Electronic Arts.   We think management has issued conservative guidance for 2023 and growth will continue in 2024.  A successful buyout seems unlikely at this point, but we think the shares have the potential to exceed the $95 buyout price during 2024 as strength in Call of Duty, Candy Crush, Diablo, Overwatch, and World of Warcraft drive growth in earnings.

Meta Platforms (META)

Query:  Please analyze Meta Platforms earnings report released last week.

Bard Answer: Meta Platforms (META) released its first-quarter 2023 earnings report on April 26, 2023. The company reported revenue of $28.65 billion, which was an increase of 3% year-over-year, and an increase of 6% year-over-year on a constant currency basis. Earnings per share of $2.20 beat analysts’ expectations of $2.03.

Here are some of the key takeaways from Meta’s earnings report:

  • Revenue growth slowed in the first quarter, as the company faced headwinds from a number of factors, including increased competition from TikTok and other short-form video platforms, Apple’s privacy changes, and a slowdown in global economic growth.
  • Meta’s daily active users (DAUs) declined for the first time in its history, falling to 1.96 billion in the first quarter.
  • Meta’s advertising revenue grew 20% year-over-year in the first quarter, but this was below the company’s guidance of 23% growth.
  • Meta’s Reality Labs segment, which includes its virtual reality and augmented reality businesses, continued to lose money. The segment lost $2.96 billion in the first quarter, wider than the $2.10 billion loss it reported in the same period a year ago.

Despite the challenges Meta faces, CEO Mark Zuckerberg remains confident in the company’s long-term growth prospects. He highlighted Meta’s investments in the metaverse, which he believes will be the next major computing platform. Zuckerberg also said that Meta is “making progress” on its efforts to improve its ad targeting capabilities in the wake of Apple’s privacy changes.

Overall, Meta’s first-quarter earnings report was mixed. The company’s revenue growth slowed, but earnings per share beat expectations. Zuckerberg is confident in the company’s long-term growth prospects, and he highlighted Meta’s investments in the metaverse. However, it remains to be seen whether Meta will be able to overcome the challenges it faces in the near term.

Here are some of the factors that could affect Meta’s stock price in the future:

  • The success of the metaverse. The metaverse is a new computing platform that Meta is betting on as the next major growth driver. If the metaverse is successful, it could lead to significant revenue growth for Meta. However, it is still too early to tell whether the metaverse will be a success.
  • The impact of Apple’s privacy changes. Apple’s privacy changes have made it more difficult for Meta to target ads. This could lead to slower revenue growth for Meta in the near term.
  • The global economic environment. A slowdown in global economic growth could hurt Meta’s advertising business.

Overall, Meta’s stock price is likely to be volatile in the near term. The company faces a number of challenges, but it also has some long-term growth opportunities. Investors should carefully consider these factors before investing in Meta’s stock.

Northlake Comments:  While the opening sentences get the headline numbers on the quarter correct, this is the weakest effort from Bard among all the companies covered in Part One.  It appears that the analysis on daily average users, ad growth, and metaverse losses looks back to the first quarter of last year.  Note how the opening says revenue grew 3% and then the analysis says advertising grew 20%.  Virtually all of META’s revenues are advertising.

We see several important takeaways from META’s 1Q23.  First, despite rising expectations into the report, results still beat estimates.  Second, management remains focused on cost control and continues to downsize the employee base (and related expenses like occupancy, travel, etc.) and correct for its errors of over hiring in 2021 and 2022.  Second, analysts are dramatically raising earnings estimates for 2023 and 2024.  2024 EPS estimates now range from $15-17 per share.  It was only a year ago when we discussed the fact that earnings estimates would be half of what was expected in late 2021 and early 2022.  Management has since cut its 2023 operating expense and capital spending outlooks by at least $10 billion each.  To put this in perspective, 2023 revenue estimates average $126 billion.  All the opex and capex cuts flow at virtually a 100% margin to the bottom line for EPS and free cash flow.  Third, despite the massive spending cuts and the disruption they must be causing, META is growing again.  Partially, comparisons have eased but management appears to have done a good job of reworking advertising software and services to deal with Apple’s privacy changes.   META is growing faster than Google for the first time in a long while and has stabilized vs Tik Tok where growth has sharply slowed amid scrutiny and competition. Finally, management discussed AI and noted that while Generative AI is not yet a product, the company is a leader in monetizing AI from backend investments that improve advertising creation, targeting, and placement.  In fact, META may be a leader in AI technology and monetization despite not participating in the GAI sphere.  Overall, we see further recovery in META shares as confidence grows in the 2024 and beyond outlook.  Even after more than doubling off the low, the stock trades at just 15 times 2024 consensus estimates, below the market multiple.  META faces challenges on the competitive and regulatory fronts, but we believe it deserves a premium valuation.

T Mobile USA (TMUS)

Query: Why did T Mobile stock fall yesterday after the company reported earnings?

Bard Answer: T-Mobile US Inc. (NASDAQ:TMUS) reported earnings of 57 cents per share on an adjusted basis for the first quarter of 2023, which beat analysts’ expectations of 44 cents per share. However, revenue of $20.12 billion missed analysts’ expectations of $20.13 billion. The company added 589,000 postpaid phone subscribers in the quarter, which was below analysts’ expectations of 600,000.

There are a few reasons why T-Mobile’s stock fell yesterday after the company reported earnings. First, the company’s revenue missed analysts’ expectations. Second, the company’s subscriber growth was below analysts’ expectations. Third, the company’s guidance for the second quarter was below analysts’ expectations.

Overall, T-Mobile’s earnings report was mixed. The company’s earnings per share beat expectations, but its revenue and subscriber growth missed expectations. The company’s guidance for the second quarter was also below expectations. These factors likely contributed to the decline in T-Mobile’s stock price yesterday.

In addition to the factors mentioned above, it is also worth noting that the broader stock market was down yesterday. The S&P 500 index fell 1.5%, and the Nasdaq Composite index fell 2.3%. This decline in the broader stock market may have also contributed to the decline in T-Mobile’s stock price.

Northlake Comments:  This is one of the better answers Bard provided so far.  Our major complaint is that it lacks context.  In fact, lack of context is probably one of our biggest criticisms of Bard.

While it is true that TMUS 1Q23 results fell just short of estimates on most metrics, the misses were very small and Bard failed to note that the most important metric, free cash flow, exceeded estimates.  Furthermore, despite a “missed quarter” management raised guidance on almost every important measure including those that missed.  The quarter represents a transition for TMUS shares.  The stock has performed exceptionally well as a beat and raise story driven by big beats in subscriber growth that investors viewed as setting up future earnings and free cash growth.  With the Sprint merger integration largely complete and TMUS now a full peer to AT&T and Verizon, the investment thesis is shifting to leveraged free cash flow.  Unlike most leveraged free cash flow stories (Northlake’s favorite stock thesis), TMUS has modest debt with net debt to EBITDA at just 2.5 times.  Free cash flow is exploding as synergies are fully realized and top line growth continues, leaving the shares trading at a free cash flow yield of 15-20% starting in 2024.  The Board is going to continue to authorize massive share buybacks that will drive per share growth and should push the stock higher.  TMUS free cash flow yield is 2-3X AT&T and Verizon leaving plenty of upside for the shares, especially after it breaks through the $150 resistance posed by a share issuance due to Softbank related to the Spring merger.

Sony Corporation (SONY)

Query: Please analyze Sony’s latest quarterly earnings report and guidance.

Bard Answer: Sony Corporation (SONY) released its earnings report for the first quarter of fiscal year 2023 (ended March 31, 2023) on April 28, 2023. The company reported revenue of ¥3,412.9 billion ($24,197.6 million), which was an increase of 13% year-over-year. Earnings per share of ¥263.89 ($1.87) were down from ¥276.65 ($1.95) in the same period a year ago.

Here are some of the key takeaways from Sony’s earnings report:

  • Revenue growth was driven by strong performance in the Game & Network Services segment, which includes the PlayStation business. The segment’s revenue grew 17% year-over-year to ¥752.8 billion.
  • Operating profit declined 10% year-over-year to ¥250.7 billion. This was due to a number of factors, including increased costs in the Game & Network Services segment, as well as higher costs in the Imaging & Sensing Solutions segment.
  • Sony’s guidance for the second quarter of fiscal year 2023 was below analysts’ expectations. The company expects revenue to be in the range of ¥2.2 trillion to ¥2.4 trillion, and operating profit to be in the range of ¥250 billion to ¥280 billion.

Overall, Sony’s earnings report was mixed. The company’s revenue growth was strong, but its operating profit declined. Sony’s guidance for the second quarter was also below analysts’ expectations.

Here are some of the factors that could affect Sony’s stock price in the future:

  • The performance of the PlayStation business. The PlayStation business is Sony’s largest segment, and it is a key driver of the company’s revenue and earnings. The performance of the PlayStation business will be closely watched by investors.
  • The global economic environment. A slowdown in global economic growth could hurt Sony’s business, as it could lead to lower demand for the company’s products and services.
  • The competitive landscape. Sony faces competition from a number of other companies in the gaming, imaging, and sensing markets. The company will need to continue to innovate and invest in order to maintain its competitive edge.

Overall, Sony’s stock price is likely to be volatile in the near term. The company faces a number of challenges, but it also has some long-term growth opportunities. Investors should carefully consider these factors before investing in Sony’s stock.

Northlake Comments: The numbers are on target but given the breadth of Sony’s operations more detail away from the video games businesses would have been good.  Sony also has industry leading positions in music, image sensors (semiconductors for camera phones and self-driving cars), and filmed entertainment.  Bard also is correct in noting second quarter guidance was light but the “miss” was minor and the forecast contained several one-time issues that balanced out to a negative.  Furthermore, Sony management consistently guides conservatively and usually beats the guidance.  It is also worth noting that Sony shares were exceptionally strong heading into the report thanks to the UK rejection of Microsoft’s acquisition of Activison Blizzard.  Investors have been concerned that Microsoft could hamper Sony’s video game growth as cloud-based gaming grows.  The big recent gains in Sony shares may have created a setup for a larger than warranted decline in repose to slightly disappointing earnings and guidance.

Overall, 4Q22 (Sony uses a March fiscal year and discusses earnings based on when the bulk of the year takes place) and guidance for 1Q23 and 2023 did not impact our thesis and we remain bullish.  Sony is a leader in its main business lines and the valuation of the shares remains at a large discount to the sum of the parts.  Some discount is warranted given the diversified business model and the complexity it invites.  This is offset by excellent operational and strategic management, consistently strong financial strength, and the benefits of the conservative Japanese business culture in a period of high macroeconomic uncertainty.

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.

4Q22 Earnings Updates: Part One – IBM, TMUS, and CMCSA Sale

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IBM (IBM): IBM reported mixed 4Q22 results that were not good enough to support the stock in the near-term or bad enough to derail Northlake’s bullish long-term thesis.  Revenue came in above expectations, which for us is the key component in the bull case.  IBM has not shown consistent growth for a long time.  The company is growing under the new CEO thanks to the timely acquisition of Red Hat opening up a growth opportunity in cloud services.  Management also completed the divestiture of its lowest-growth businesses last year.  New guidance calls for mid-single-digit revenue growth and the last several quarters have been right on target, including the just announced 4Q22.  If IBM consistently grows at a mid-single-digit rate, the P-E multiple for the stock can expand from its current discounted level of 14X 2023 estimates.  The stock performed well in 2022, rising 5% against declines of 18% to 33% for major stock market averages as investors began to believe in the company’s return to growth.  IBM shares also pay a dividend yielding roughly 5%, so the total return in 2022 was nearly 10%.  One thing about success on Wall Street is that it raises the expectations bar.  In 4Q22, IBM fell short of expectations for free cash flow, lacked profit margin upside despite the incremental revenue growth, and guided 2023 revenue and cash flow to the low end of previously announced ranges.  These factors led to the stock declining about 8% since the report.  Pressure is on IBM to achieve the new guidance amid a softer macroeconomic environment that could limit enterprise spending on technology.  Northlake takes solace in strong revenue growth in recent quarters and expects 2023 results to support our bullish outlook. Our price target is now $155 based on 2024 estimates that assume two years of mid-single-digit earnings growth.  Including the dividend, this would provide a double-digit annual return in the shares.

T-Mobile USA (TMUS): TMUS preannounced subscriber metrics that were better than expected leaving quarterly financial results and an update to 2023 guidance for the 4Q22 earnings report.  As usual, the company reported good quarterly results.  Guidance was positive but could have been a little better.  TMUS has a long history of initiating conservative but positive annual guidance and then beating and raising guidance as the year goes on.  2023 guidance was introduced in 2021 when the company’s acquisition of Sprint closed.  Amazingly, despite stiff competition, slowing mobile phone subscriber growth, and a slowing economy, TMUS updated guidance for 2023 is unchanged.  When the 4Q22 report was released, the all-important free cash flow guidance looked a little light, but management explained some one-time items and guidance assumptions that reassured investors.  One issue that came up on the call was the fact that Softbank, a major backer of Sprint and TMUS over the years, receives additional TMUS shares if the stock crosses $150.  This fact is well known and it seems as though it has kept the stock from breaking through $150 despite all the good news over the past year.  TMUS indicated they talk regularly with Softbank and that while no transaction is currently close, it is possible that something will be done.  Softbank appears unwilling to sell at $150 which is supportive of our bullish view on the shares.  We are making no changes to our valuation model on TMUS after the latest earnings report.  We see upside to at least $170 based on EBITDA, free cash flow, and the company’s massive stock buyback.  The primary risk is an industry slowdown in new mobile phone subscribers that creates even more intense competition.  TMUS is best positioned to weather this potential headwind with the biggest and most advanced 5G network and lowest cost mobile phone plans.

Comcast (CMCSA): Nine years after Northlake’s initial purchase of CMCSA, we sold all the shares held for clients after the company reported 4Q22 results.  The earnings report was in line with expectations and not the direct cause of the decision to sell.  We have noted in previous blogs that we were growing impatient with Comcast as growth slowed in its broadband internet and TV networks business. The company faces stiff competition in broadband from fiber overbuilds and new fixed wireless services.  The cable industry has fought off competition before but the difference now is that broadband is fully penetrated in the United States with all homes that can afford it having a connection.  The TV networks business is much smaller but faces severe secular challenges from competing streaming services.  Comcast’s streaming service, Peacock, is struggling to compete against Netflix, Disney, and others.  We don’t hate Comcast stock.  Rather we just see better opportunities developing elsewhere and view the 40% pop in the shares in since the October lows as bringing the stock to almost fully valued and creating a selling opportunity.  Furthermore, we continue to focus on diversification efforts in Northlake’s individual stock holdings.  IBM, VICI Properties, Walmart, Home Depot, and T Mobile have all been added to the portfolio over the last couple of years.  Each has produced nice gains and, importantly, provided diversification from the media stock focus in place when Northlake was established in 2004.  We have a lot of knowledge in media stocks that can help produce winners such as Comcast, but we also realize secular changes in the media landscape have severely hurt long-term growth prospects, even for the best media companies.

IBM and TMUS 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 One – IBM, GOOG, META, CMCSA, TMUS, AAPL, VICI

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IBM (IBM): IBM reported good results in a tough macro environment, further increasing our confidence in the transformation underway at the company.  Revenue and EPS exceeded expectations with strength across all segments of the company.  Management raised 2022 revenue guidance and maintained free cash flow guidance.  The only real negative in the quarter and outlook is currency translation due to U.S. dollar strength.  While this leads to lower EPS estimates, investors largely overlook the impact since it equally affects all companies.  On the quarterly call, analysts asked about the long-term outlook previously provided calling for mid-single-digit revenue growth and $34 billion in free cash flow in the 2022 thru 2024 period.  Management reiterated confidence while noting increasing foreign exchange impact and a few signs that weaker demand may emerge in Europe.  Demand in the rest of the world is firm.  IBM serves very large corporations where IT upgrades to cloud computing so far remain intact given they have a quick and meaningful financial payoff.  Northlake’s thesis on IBM is that the company is going to grow again thanks to the acquisition of Red Hat driving a corporate transformation focused on hybrid cloud computing.  The new CEO engineered the acquisition before he was promoted.  The company spun off most of its slowest growth potential businesses a year ago to continue the strategic shift.  IBM shares have done well this year, down just 5% and a flat total return after the healthy dividend.  The shares trade at about 13X forward earnings estimates and we think multiple expansion will occur if the company continues to meet expectations.  Investors still are not buying the IBM turnaround despite multiple quarters of good results.  Our morning notes from a dozen brokerage firms only contained one note recapping IBM’s results.  A year from now we expect the story to be better appreciated, resulting in multiple expansion.  A P-E of 15X on 2024 estimates would put the shares at $160, up 25% on top of the 4% gain post the earnings report.  The stock carries a safe 5% dividend yield enhancing the total return potential and providing near-term support.

Alphabet (GOOG/GOOGL): GOOG reported a disappointing third quarter.  We expected a continued slowdown in revenue growth, but the weakness accelerated even excluding the material impact of the strong U.S. dollar.  Search held up better with a bigger deceleration at YouTube.  Most disappointing to us was the sharp contraction in operating margins.  With the benefit of hindsight, it is clear that GOOG over-earned in 2021 due to the pandemic accelerating the top line and depressing certain operating expenses like travel and marketing.  One of our core reasons for holding GOOG shares has been the added discipline that CFO Ruth Porat brought to the firm when she was hired years ago.  While it may be beyond her control given the circumstances of the pandemic and unusual macro environment, 3Q22 was a step backwards.  GOOG now employs 186,000, up from 150,000 a year ago, and up 12,000 since June 30th.  GOOG is smart to continue invest in the many opportunities it has across search, media, mobile, and entertainment; sustaining industry leading AI and machine learning is critical to the company’s long-term growth and competitive position.  Nonetheless, Wall Street is going to penalize the shares until better cost discipline is revealed and revenue growth trends improve.  Management remains quite confident in in its growth opportunities and feels that Search and Cloud are doing well against a tough macro environment.  Management also indicated that headcount growth would slow in the next quarter but remain elevated against revenue trends.  Northlake still sees GOOG as a good long-term growth investment with a great balance sheet.  Capital and expense discipline have improved markedly over the years but presently are out of balance with macro-pressured revenue growth.  It may take a few quarters for trends to turn and investor confidence to improve.  We are willing to wait given current valuation of the shares is just 10X EBITDA, below the historical average.  Moving back to an average multiple of 12X on depressed 2023 estimates gets the stock back to $125.  If revenue growth and operating margins are showing improvement later in 2023, estimates for 2024 should show double-digit growth which can drive the shares substantially above $125.  It will take patience and a better economy, but patience will be rewarded from current prices.

Meta Platforms (META): META shares are plunging following the company’s 3Q22 earnings report that included initial guidance for operating expenses and capital spending for 2023.  The stock is down 22% as we write to $100, a level last seen at the start of 2016.  In our recent write-ups on META, we have noted that the top line was under pressure but had the possibility to stabilize in late 2022 and 2023.  We also noted that the company was reigning in expenses to help protect earnings against below budget revenue trends.  3Q22 showed hope for stabilization in the top line with reported revenue and engagement, while qualitative 4Q22 guidance was mostly in line with recently lowered expectations.  Heading into the quarter, investors expected another signal that expenses were being budgeted cautiously given macro, competitive, and privacy headwinds.  This turned out to be far from the case.  Stunningly, management plans for operating expense and capital spending in 2023 to each be $10 billion higher.  This budgeting is crushing for earnings and free cash flow.  Ahead of the report, 2023 consensus EPS and free cash flow were $10.75 and $20 billion.  New EPS estimates range from $6.50 to $8.00 and free cash flow is $10 billion.  In 2021, the company was at nearly twice these levels.  Just maintaining expense and capex guidance would have led to a forecast just below prior consensus. Not surprisingly, the conference call went very poorly.  We listen to a few dozen calls each quarter, and this META call was about as bad as we can ever remember.  Management seemed unfocused and did not provide detailed answers to many questions, instead often just repeating that it had confidence in the core business and ability to grow again as metaverse investments stop growing and the core business benefits from continuing investment of operating expenses and capital spending.  We concluded last quarter’s META blog by noting, “Simply put, the shares are valued as though META is going the way of MySpace and AOL, a much too drastic scenario.”  Today’s plunge in META shares reflects concern that the company may be facing an existential crisis.  Investors clearly do not believe that current strategy is going to reinvigorate the company.  Management’s willingness to accelerate spending against uncertain revenue growth could be read as reflecting internal concern of that existential crisis. Northlake generally will not invest where we do not believe management is industry-leading.  Right now, for META, that is hard to believe.  However, the company still maintains a massive and highly effective advertising reach.  Arguably, the best in the world besides Google search. We may admit defeat and sell the shares, but we want to let the dust settle first and evaluate in a less emotional, lower volatility environment.

Comcast (CMCSA): CMCSA reported a better quarter with no new negative surprises for the first time this year.  This is an encouraging sign that could lead to a material recovery in the shares over the next several months. The company is not out of the woods given the competitive dynamic in broadband and secular decline in the linear cable and broadcast businesses.  However, management continues to do a good job, remains transparent, and has improved focus on shareholder friendly capital allocation in lieu of the company’s history as an acquirer of assets.  The share buyback in 3Q22 was aggressive, and on the conference call management noted that acquisitions are not necessary and less attractive given a higher cost of capital.  In 3Q22, revenue, EBITDA, free cash flow, and broadband subscribers all exceeded consensus.  The company added 14,000 new broadband subs and saw broadband ARPU rise about 4%.  This is encouraging after a string of subscriber misses.  The ability of the company to sustain price increases on broadband amid a heated competitive environment while subscriber growth is expected to stay minimal is critical to maintaining financial strength that supports shareholder friendly capital allocation.  Management also reiterated its capital spending plan against concerns that it would have to spend more to sustain subscriber levels against increasing fiber and fixed wireless competition.  Comcast shares trade at just 6X 2022 and 2023 EBITDA, a discount to Verizon and AT&T despite a still faster growth profile, a better balance sheet, and more free cash flow.  The better quarter and accelerated share buyback give Comcast and the cable industry a window to rebuild investor confidence, leading to slight multiple expansion due to stability in financial and operational performance.  A target in the low $40s is plausible but we may exit in the mid to upper $30s.

T Mobile USA (TMUS): The TMUS story is developing exactly as we hoped when he purchased the shares in February.  The stock is up almost 25% in a lousy market as each milestone we had hoped for has been achieved.  3Q22 earnings were the third consecutive beat and raise quarter in subscriber and financial growth.  Synergies from the Sprint acquisition are exceeding initial estimates.  Integration of the Sprint network came in ahead of schedule and is now complete.  The benefit of gaining Sprint’s mid band spectrum has made TMUS the leader in 5G just as consumers are upgrading phones.  Expansion into rural and business markets is proceeding and TMUS market share has a lot of room to rise.  Free cash flow is on target and set to explode in 2023 as costs to obtain synergies disappear and cost savings fully kick in.  One thing we did not anticipate was that the timing of closing the Sprint deal allowed TMUS to lock in long-term contracts on many costs, thus allowing inflation of operating expenses to be minimal.  Management delivered the promised share buyback two quarters ahead of schedule and is already aggressively buying back stock.  The strength in TMUS shares shows that investors have recognized all the good news, but we still think there is room for more upside as growth looks secure as the wireless industry benefits from 5G, and the share buyback kicks in to dramatically shrink shares outstanding and perhaps the float if Deutsch Telecom continues to hold its large stake.  TMUS is emerging as the wireless industry leader and deserves its premium valuation with a couple more years of highly visible elevated growth.  We think there is another 20% plus upside.

Apple (AAPL): AAPL reported a solid quarter against mixed signals coming into the report.  Guidance for the December quarter was cautious but still showed growth near estimates despite even harsher U.S. dollar strength impacts.  Surprisingly, to Northlake, the shares jumped about 8% in response.  We saw nothing in the report that was concerning but neither did we see anything that was materially better than expected.  However, after Alphabet, Meta, and Amazon reported earlier in the week with clear disappointments and weak guidance, Apple stood out for the resilience of its reported results and forward guidance.  It seems like AAPL’s core business is only being impacted by macro whereas the other tech leaders face issues beyond macro (Amazon: overbuilt cost structure, Meta: excessive operating expense and capital spending and weakening competitive position, Alphabet: weakness at YouTube from Apple privacy changes).  Since AAPL shares are not that expensive at a low 20s P-E multiple, resilience is good enough for investors and treated as a positive surprise.  Key for the next move in the shares will be the outlook for growth in 2023.  Macro is definitely a headwind impacting services growth the most.  iPhone still has upside from the transition to 5G phones.  Mac needs to digest an unusually strong quarter led by filling the channel that lacked inventory.  Overall, the stability of AAPL’s business, its well defended competitive position, and the strength of free cash flow and the balance sheet makes the shares a good investment for the current tricky macro environment.  We do not see a lot of upside, but we are happy to continue holding an overweighted position.

VICI Properties (VICI): VICI had another boring quarter in terms of financial results.  That is exactly what Northlake loves about VICI! The business mode is simple:  the company collects rent from high-quality tenants on the casino properties it owns in Las Vegas and regional gaming markets.  The pandemic shutdown of casinos battle tested the model as not a single VICI lessee missed a rent payment.  This is very comforting ahead of a possible recession.  VICI is essentially an alternative source of financing to casinos and experiential real estate and it is becoming a more attractive alternative as high yield credit markets have tightened making VICI a low-cost alternative.  This is keeping the pipeline of projects full which builds on inflation-protected growth in current rents.  While another quarter of mid-single-digit growth in revenue and earnings provides little fodder for analysis, VICI’s proven management team is executing on its growth strategy and taking advantage of the current environment.  In casino financing, the company announced it would buy another regional gaming property in Maryland.  VICI was also active as it diversifies into experiential real estate with new agreements with Great Wolf (family resorts), Canyon Ranch (spa and wellness), and Cabot (golf).  Shareholders are benefiting directly from the consistent performance as management announced an 8% dividend increase.  Mid-single-digit core growth plus acquisitions should provide 8-10% earnings and cash flow growth which when coupled with the current 5% dividend yield provides a low-risk, mid-teens total return for VICI shareholders.

IBM, GOOG, META, CMCSA, TMUS, AAPL, and VICI 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 One – IBM, WMT, GOOG, TMUS, META, CMCSA, VICI, AAPL, SONY

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IBM (IBM): IBM reported mostly solid 2Q22 results, but the stock fell victim to its strong performance from earlier this year.  Ahead of the report, the shares were nearly unchanged against a 20-30% decline for major stock market averages.  This strong performance raised expectations for IBM, and a good report with a few small flaws led to a sell-off of nearly 10% in the following days.  We still find the story attractive, underlined by another quarter of mid-single-digit constant-currency revenue growth and a forecast for more of the same in the second half of the year.  This sales strength is occurring against a weakening economic backdrop, including concerns about enterprise spending on technology – a key sector for IBM.  The flaws in the quarter were related to disappointing guidance from the impact of the strong U.S. dollar on revenue, free cash flow, and margins.  We expect similar guidance from other leading technology and internet stocks reporting earnings over the next two weeks.  The fact that IBM traded down on macro issues out of management’s control that are also impacting the company’s peers is why we think the shares are a victim of their year-to-date success.  Northlake’s bull thesis on IBM is built upon a return to growth that eventually flows through consistently to profit margins and free cash flow.  2Q22 might not have been good enough for short-term traders, but we are sticking with our long-term thesis and enjoying a 5% dividend yield and significantly discounted P-E ratio while we wait for the return to growth story to play out.

Walmart (WMT): WMT updated its guidance for 2022 ahead of its formal earnings report on August 16th.  As is usually the case when companies preannounce, the news was not good.  Management lowered the earnings outlook for 2022 by more than 10% due to the impact of shifting consumer spending habits.  The shares fell about 10% in response, giving up the gains since Northlake purchased the shares for clients with individual stocks.  The stock has rebounded somewhat and now sits about 7% lower.  Interestingly, WMT raised its sales forecast even as it slashed the earnings outlook.  Customers continue to spend but the basket is now filled with inflation-elevated groceries with little contribution from general merchandise.  General merchandise has higher margins, so the shift is dilutive to earnings.  Furthermore, to help clear unsold merchandise, particularly in apparel, management is aggressively marking down prices.  The combination of these factors is why the earnings hit is so steep despite rising sales.  Assuming WMT gets back on track in the next 6 to 12 months, the new guidance essentially costs the company one year of earnings growth against our investment thesis.  We do not believe our investment thesis has been delayed by a full year, however.  Management took strong action with markdowns and indicated that other than apparel, inventories were in good shape.  We think the shares can start working well again once there is a signal that demand trends are stabilizing.  Given our outlook that any recession will not be severe, this could occur later this year.  While we wait, the initial rebound off the post guidance lows supports our idea that WMT shares offer both defensive and offensive characteristics, a good combination in an uncertain economic and stock market climate.  We stand by our target of $150 for WMT shares.

Alphabet (GOOG/GOOGL): GOOG reported mixed results for 2Q22, but the shares rallied significantly.  Revenues were in line with expectations, while operating income and EPS fell slightly short.  Investor reaction was notably positive after major earnings misses from Snap and Walmart raised the prospect that GOOG might suffer similarly.  Instead, results indicated stability beyond the macroeconomic concerns that are impacting almost all companies.  Management cautioned investors about a continued deceleration in growth over the balance of 2022.  However, these comments were not notably different from the 1Q22 report three months ago when the shares were about 20% higher.  In other words, the stock reflected a worse report and outlook.  Search and Cloud continue to hold up well, while YouTube and the Play Store have seen a greater slowdown.  Analysts believe that Search is less impacted by Apple’s privacy initiatives.  Search is also further down the buying funnel and has more exposure to still-rebounding services like travel.  YouTube advertising is an early-cycle business and more sensitive to initial advertiser cutbacks in response to changing consumer buying habits.  The Play Store has exposure to discretionary consumer purchases that might be losing share to higher inflation-driven spending on staples like gas and food.  The Play Store also reduced fees, which management noted had a material impact.  GOOG still faces challenges from the uncertain macro environment that could hurt revenue and profit margins.  However, we believe the shares already reflect a conservative outlook trading at less than 20X forward earnings and less than 11X EBITDA.  Both metrics are below historical averages for GOOG shares.  At the long run average of 12X 2023 EBITDA, we see the shares worth nearly $140.  Using a conservative 10X multiple still provides 6% upside to $120.  Notably, management spent the most ever in a quarter on share buybacks in 2Q22 suggesting confidence in the outlook and supporting Northlake’s view that the stock is undervalued.

T-Mobile USA (TMUS): TMUS continues to reward our decision to swap from AT&T earlier this year.  The company reported another strong quarter and increased guidance for all important metrics including subscriber additions, revenue, EBITDA, and free cash flow.  The stock has performed very well, up from $121 when we purchased at the end of February to the current $140.  This is great performance in a very difficult market environment, even more so when considering poor performance at wireless and cable peers.  TMUS is not only executing on its merger with Sprint, but it continues to gain market share in wireless and now has a multiyear growth driver with fixed wireless broadband which at a minimum can reduce churn with current customers.  TMUS has been a share gainer for years.  The Sprint acquisition is key to sustaining the growth profile for the next several years.  TMUS gained a massive amount of mid-band spectrum from Sprint.  In fact, the value of that spectrum is probably as important as the former Sprint subscribers.  TMUS is able today to offer 5G speeds at capacity across most of the US at very competitive prices versus AT&T and Verizon.  With Sprint synergies kicking in and cost to capture falling off, TMUS is poised to see already high free cash flow nearly double in 2023.  Growth in EBTIDA plus debt reduction has the balance sheet at investment grade status.  This sets up one more big catalyst: commencement of a massive share buyback.  Depending on how TMUS majority owner Deutsche Telecom participates in the buyback, TMUS will either repurchase a material portion or virtually all its public float in the next several years.  We expect the buyback to be announced by year end.  Near-term, TMUS shares have additional upside to about $150, but we expect the benefit of the buyback can dramatically accelerate upside as the share count shrinks looking out to 2024 and beyond.  We try to keep our price targets based on the year ahead and show patience based on our long-term investment thesis.

Meta Platforms (META): META, formerly known as Facebook, reported roughly in line 2Q results against the dramatically lower guidance the company issued three months ago.  Unfortunately, despite many indications from anecdotal evidence that revenue trends improved over the last couple of months, the company again lowered top line guidance.  The new guidance is about 10% below consensus expectations.  The hit to earnings is not nearly so severe as the company also announced another $3 billion cut to its operating expense guidance.  This is the second pullback in in the 2022 expense budget this year, so management is at least being responsive to unexpectedly weak revenue trends.  Key to the near and long-term outlook for META shares is how much of the revenue disappointments are secular versus transient.  Encouragingly, management noted that engagement with the company’s apps, including Facebook and Instagram, continues to grow, albeit at very modest levels.  Nonetheless, with all the controversy the company has faced, sustaining engagement is a good sign and increases the potential that revenue growth will again emerge late this year and in 2023.  Beyond macroeconomic challenges from a weaker economy and advertising market and the stronger dollar, the company faces two primary issues: ongoing impacts from Apple’s (and soon Google’s) decision to offer opt-out tracking on mobile devices, and the rise of Tik Tok as competitor in social media.  The privacy initiatives have been hurting growth for several quarters, and despite lapping the initial impacts, the headwind remains significant.  META lost much of its ability to individually target users, which in turn lowered the effectiveness of its advertising.  In response, advertisers are either spending less overall or paying lower prices to reach META’s users.  Tik Tok appears to have broken the barrier with advertisers and is taking an increasing share of a smaller pool of economic and privacy-impacted advertising dollars.  META shares are very inexpensive, but the company needs to reassert topline growth to get the stock moving upward.  In order to be as conservative as possible, we looked at META valuation on a GAAP basis which ignores material non-cash charges based on stock-based compensation.  We also lowered our target EBITDA multiple to 10X, a level at which traditional media companies traded at in the years before the pandemic.  This conservative approach leads to a target of $190, up 21% from current levels.  Should revenue growth resume in the next six to nine months, less conservative valuation approaches could easily justify a stock well above $200.  We believe META still is one of the most effective and cost-efficient places for advertisers to spend money.  This should eventually lead to resumed growth, so we are sticking with the stock despite the hurricane force headwinds.  Simply put, the shares are valued as though META is going the way of MySpace and AOL, a much too drastic scenario.

Comcast (CMCSA): CMCSA posted another quarter of good financial performance and deteriorating cable fundamentals.  Entertainment properties at NBCU performed well with the exception of continuing losses for the company’s Peacock streaming service.  Overall, Comcast reported 5% revenue growth, 10% EBITDA growth, and 20% EPS growth.  On their own, these would be considered great results.  However, the slowdown in cable broadband subscribers stole the show even though the segment showed 4% growth in revenue and 5% growth in EBITDA.  This pattern of strong financial results amid slowing broadband subscriber growth has been in place for the past year.  The difference this quarter is that for the first time ever Comcast had no growth in broadband subscribers.  Historically low household moving activity continues to have a big impact as the pool of potential subscribers remains small.  Churn among broadband subscribers for cable or fiber connections is typically quite low.  For several quarters, investors have been concerned about increasing competition as AT&T, Verizon, and other telcos are aggressively expanding their fiber networks.  In addition, T-Mobile and Verizon are aggressively promoting fixed wireless broadband that runs on their LTE and 5G networks.  There remains debate about the speed and capacity of these networks but for the time being T-Mobile is adding over 500,000 subscribers a quarter with Verizon adding another 200,000.  It does not seem these subscribers are leaving cable broadband but there is little doubt they are further reducing the pool of potential subscribers.  Comcast shares are down about 10% in response to the earnings report, giving up recent gains.  We have been extremely patient with Comcast shares based on their low valuation and strong financial results.  With risk rising that financial growth will slow as Comcast has to compete harder to add and maintain subscribers, a recovery in valuation seems less likely.  The stock trades at a premium to AT&T and a small discount to T-Mobile.  We believe the 10% sell off is overdone against the positive financial results and strong balance sheet.  We are leaning toward selling Comcast but think a modest recovery could occur and offer a better exit point.

VICI Properties (VICI): VICI reported a typically boring quarter in line with analyst estimates other than some timing differences.  Boring is exactly why we like VICI!  The company is a REIT offering triple net leases to casino owners.  VICI owns most of the properties operated by MGM and Caesars, and is paid rent under long-term leases with inflation escalators.  Results for MGM, Caesars, and other casino owners can be sensitive to economic activity but are rarely if ever weak enough to warrant concern that VICI will not be paid.  2020 was a great test for VICI’s business model as most casinos were closed for extended periods due to pandemic restrictions.  VICI never missed receiving a rent check.  This proof of concept has contributed to the strong performance for VICI shares.  Investors are now willing to pay a higher multiple of earnings given credit concerns have been laid to rest.  This is important currently given the impact a recession could have on casino visitation.  VICI completed several large acquisitions in the last few years and is now one of the largest REITs of any type.  Looking ahead, management expects to complete more smaller deals and expand to “experiential” properties such as golf course developments, professional sport training facilities, or other real estate intensive leisure businesses.  Between rent escalators, expansions of current properties by their operators, and modest-sized acquisition activity, VICI can grow by 7-9% per year.  The current dividend provides a yield of 4.3% and should grow in line with earnings.  In a world full of uncertainty on economics, politics, and war, VICI’s consistent, predictable results and double-digit annual total return potential are especially attractive.

Apple (AAPL): AAPL reported mixed 3Q22 results that showed resilience against the macroeconomic factors that have tripped up many other companies.  Guidance for the September quarter was a little soft with management calling out the potential for reduced consumer spending.  The primary area of concern on the conference call related to slowing growth in the company’s services business.  Growth in the June quarter was 12%, the lowest since before the pandemic.  Management noted that further deceleration should be expected in the September quarter.  Services represent about 20% of company revenues and carry a gross margin over 70% compared to mid-30s for products.  iPhone is still the most important product at around 50% of revenues, and trends remain solid even with low to mid-single-digit growth.  Offsetting macroeconomic concerns, Apple seems to be past the headwind from supply chain constraints.  The impact in the June quarter was below the low end of management guidance and there was not a specific call out for the current quarter.  Apple shares remain near fully valued but as we have explained, we are willing to hold on given the overall quality of company.  The June quarter and guidance commentary were excellent examples of Apple’s quality.  Apple continues to gain share in iPhones and Services and build a larger installed base that can drive future earnings growth and share price upside.  As long-term investors, that is worth showing patience.

Sony Corporation (SONY): SONY reported better than expected 1Q22 earnings but guided down full-year operating income and operating cash flow forecasts.  Two factors are at work on the guidance.  On an operating basis, the company lowered its forecast for the Gaming segment due to weak first-party software, slowing engagement with live services, and continued investment in software development.  A smaller operating impact was noted for Image Sensors where the company noted weakness in Chinese smartphone sales.  Interestingly, Apple reported better than expected sales of iPhones in China.  Operating cash flow is more severely impacted based on working capital and non-operating foreign exchange accounting.  More generally, SONY adopted a more cautious forecast due to management’s weak outlook for the economy.  Games and Image Sensors were again the focus, while Pictures, Music, and Financial Services are expected to be less impacted.  Along with these cautious economic comments, management noted that they are prepared to move into a recessionary mindset if necessary.  All these comments should take into account that the company has a very conservative mindset consistent with Japanese culture.  We like SONY’s conservative nature, especially in such uncertain times.  We also like their willingness to continue to invest in their growth businesses where we see substantial long-term upside.  It may take a better quarter to get the stock moving upward again.  We are willing to wait given a history of strong management operating and strategic execution and a well thought out strategy for the company’s global leadership in video games, music, filmed entertainment, and image sensors.  Long-term upside to $120 or more remains our forecast.

IBM, WMT, GOOG/GOOGL, TMUS, META, CMCSA, VICI, AAPL, and SONY 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 One – IBM, GOOG, SONY, ATVI, TMUS

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Due to Steve’s travel schedule, we are going to try something new this quarter with our quarterly blog updates on individual stocks held widely in Northlake accounts.  Rather than publish a separate commentary on each stock, we are going to produce two or three updates with each containing comments on several stocks.  This will result in less detailed written analysis, so we request that you pass along feedback on the format for this quarter’s updates.  We always aim to please clients and are fully flexible and happy to adjust our various communications.

So far, we have had earnings reports from IBM (IBM), Alphabet (GOOG/GOOGL), Sony (SONY), and T Mobile USA (TMUS).  Before we provide commentary on these reports, we want to discuss the current market environment and its impact on the reactions to the current round of reports and long-term price targets.

The market has been in a corrective phase that has accelerated in the past week.  Major stock market averages are down between 10% and 20% so far this year.  Looking at our screens every day, we can state confidently that the averages understate the damage. Breadth has been terrible and outside of energy, commodities, and some consumer staples, we are in a bear market.  Many widely held stocks are down between 30% and 70% over the past six months.

Our initial 2022 stock market outlook stated that we expected a below average year, and thought there was greater chance for a significant decline than material upside.  Unfortunately, so far, the downside has developed.  We correctly anticipated the market would struggle with the shift in monetary policy at the Federal Reserve and global central banks.  Even before the war in Ukraine, the Fed appeared to be tightening policy faster than expected creating negative sentiment among investors.  The war accelerated inflation and in response the Fed is now tightening aggressively.  On a big picture basis, this has led to a compression in the overall stock market multiple from about 21 times to 19 times 2022 estimated earnings.  Future earnings are less valuable when discounted at higher current and projected interest rates.  Investors also have less confidence in economic growth and earnings projections as they are beginning to fear a recession.  These factors lead to lower P-E ratios or other valuation metrics and can also lead to lower earnings estimates.

Alphabet (GOOG) shares peaked around $3,000 and the company is expected to have earnings of $125 per share in 2022.  A 2 multiple point drop in GOOG’s P-E ratio is worth $250.  The shares are down about $700.  What accounts for the other $450 decline?  It is not lower earnings as GOOG estimates have barely changed even with the negative reaction to yesterday’s earnings reports discussed more below.  Instead, higher interest rates heavily impact growth stocks where future earnings are discounted many years ahead.

Facebook (FB) shares are down about 50% from 2021 all-time highs, much worse than GOOG.  The same factors hurting GOOG shares flow directly to FB – market and growth stock multiple compression.  FB also has hit a tough patch in growth with earnings estimates for 2022 falling about 30% due to lower projected revenues and higher costs.  FB shares not only saw multiple compression, but the lower multiple is on a much smaller level of earnings.

With this as background let’s look at the companies that have reported thus far.

IBM (IBM):  IBM reported a second consecutive strong quarter, once again surprising on the upside for revenue growth.  As recently as Thanksgiving, IBM shares traded at just 11 times 2022 estimated earnings, barely half of the average stock’s multiple.  The depressed valuation was due to years, even decades, where the company barely grew and lost market share as it missed the technology transitions underway.  We identified IBM as undervalued following the company’s acquisition of Red Hat which we thought would serve as the foundation for the company to start growing again within markets for cloud computing, consulting, and software.  IBM continues to maintain a large installed base of corporate clients.  Now, rather than lose market share, the company can offer its own products and services that not only replace lost legacy revenues but create new growth potential.  A new CEO who was the main proponent of the Red Hat acquisition and the spin off of a declining business unit adds to the IBM story.  The company is just beginning to build investor confidence in forecasted mid-single-digit revenue growth.  The company exceeded this level in 1Q22 and raised revenue guidance for 2022 to the top end of its prior range.  Margins and free cash flow are still seeing a little pressure but should follow if revenue trends are sustained.  If investors gain confidence in these measures, IBM’s multiple can expand.  It already has with the shares up over 20% from Thanksgiving and up about 2% this year against significant declines for the market and many other technology stocks.  We still think the shares can reach $160 based on a P-E of just 15 times 2023 earnings estimates.  Keep in mind the stock has a dividend yield of 5% and Northlake clients received a special dividend worth over $5 per share in the spin off completed earlier this year.

Alphabet (GOOG/GOOGL):  GOOG shares are down another 3% after reporting 1Q22 results but have rebounded from a decline of about 6%.  The earnings report was fairly good.  Revenues, operating income, and EPS all at least matched estimates adjusted for unusual or one-time factors like a write-off in the company’s investment portfolio.  The company’s largest business in Search grew 27%, a remarkable rate for a business so big.  Factors troubling other digital adverting companies like Apple’s privacy changes and macroeconomics have had little impact on Search so far.  YouTube has struggled and fell short of estimates for the second straight quarter.  It is not clear what is causing the slowdown at YouTube, with growth having declined from the upper 20% range to the mid-teens.  Investors are very concerned by the YouTube shortfall, and this is the primary reason for the stock’s decline in response to the earnings.  Two other factors are hurting the shares.  First, expense growth is set to accelerate as the company begins to invest in growth opportunities.  COVID held back these investment initiatives.  Second, revenue growth faces its most difficult comparison in 2Q22 vs a gain of 62% in 2021.  Overall growth at GOOG will be in the mid-teens next quarter.  Growth stocks always struggle when revenue decelerates. Despite the near-term investor concerns, Northlake remains bullish on GOOG.  The stock trades at a P-E of 19, about equal to the market but even mid-teens growth is two to three times the average stock.  We value GOOG shares on EBITDA.  Previously, we used a multiple of 15X.  If we lower that to 12X in light of the overall market multiple compression and the added pressure applied to growth stocks, we get a target of $2,925, up 25% from current levels.  GOOG remains one of our favorite stocks.

Sony (SONY):  SONY reported good results but has since seen its shares crushed from around $120 to $85.  Two factors are at work.  First, the yen has collapsed vs the dollar, declining by almost 20%.  This pressures SONY’s yen-reported results and dollar-equivalent trading price in Tokyo.  Second, Microsoft’s pending acquisition of Activison Blizzard is perceived as a threat to Sony’s industry-leading PlayStation video game platform and tightly integrated PlayStation network and first party published games.  We recently added SONY shares to build larger positions in many client accounts.  We see little threat to PlayStation given Microsoft’s incentives and likely regulatory concessions to get the deal approved.  SONY’s other business units including filmed entertainment, image sensors, and music are all performing well.  The yen-based dislocation in the shares has created exceptional long-term value.  Our previous target was $155.  We have barely touched our yen-based estimates but the weakness vs the dollar lowers our target to $127, up almost 50%.  Ultimately, we expect the yen to strengthen, providing further upside.

Activision Blizzard (ATVI):  We are holding ATVI shares anticipating that Microsoft’s acquisition of the shares at $95 will be approved in 2023.  ATVI’s earnings are really struggling with a sharp slowing in growth for its Call of Duty and World of Warcraft franchises.  King mobile games continue to exceed expectations.  Earnings estimates have fallen sharply and the shares would probably trade in the $40 to $50 range vs current levels in the upper $70s without the Microsoft takeover.  One positive is that current game development is back on track with major games in both key franchises coming later this year and throughout 2023.  Despite the poor results and weak 2022 earnings expectations, we are holding ATVI shares due to our view the acquisition will be approved.

T Mobile USA (TMUS):  TMUS 1Q22 results and outlook were a bright spot in a thus far bleak reporting season for telecom, media, and technology.  Results exceeded expectations for subscriber, revenue, and income growth.  Free cash flow matched investor estimates.  Management raised guidance for all important financial and subscriber estimates.  The integration of Sprint is just about complete and, as promised, results are accelerating. Concerns remain about the potential for slowing growth in wireless telephony, but TMUS is well insulated in that it happens to be a share gainer vs. AT&T and Verizon.  A major catalyst lies ahead when the company announces the start of a massive, multiyear stock buyback program.  We are maintaining our $150 target for TMUS, based on 2023 estimates that represent full realization of Sprint synergies.  The share buyback adds a lot of upside leverage to the stock price as we look long-term to 2024 and beyond.

IBM, GOOG/GOOGL, ATVI, TMUS, and SONY 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.