Analysis

Offshore

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By Desmond Esakov

05 AUGUST 2022

Illinois Tool Works

Q2 2022

  • Illinois   Tool Works, the highly specialised manufacturer of industrial products and   equipment, reported a solid set of Q2 results which topped analysts’   estimates. Q2 2022 revenue came in at $4.0 billion, an increase of 10%   year-on-year (9% on an organic basis) and $20 million ahead of estimates.

  • EPS declined by 3.3% to $2.37 per share but was ahead of estimates   $2.22. Operating income increased by 4% to $923 million although the   operating margin declined to 23% from 24.3% in Q2 2021, as inflationary pressures   weighed on the business.

  • Return on invested capital, although impressive at 27.8%, was down   from 30.8% reported in the corresponding period in 2021.

  • ITW operates through seven segments namely Automotive, Food   Equipment, Test & Measurement and Electronics, Welding, Polymers &   Fluids, Construction Products and Specialty Products. Six of the seven   segments in Q2 delivered positive organic growth, led by   Food Equipment, up 25%, followed by Welding (+22%) and Construction Products   (+155%).

  • Despite the tough operating environment, management still projects a 7% to 10% increase in organic revenue for 2022. More impressively, management is guiding for a slight uptick in operating margins and stable returns on invested capital.

  • Although ITW is by no means an exciting business, it is highly profitable and conservatively run. The company has been in business for over 100 years and has increased its dividend for over 50 consecutive years, making it part of the Dividend Aristocrat club. The Dividend Aristocrats is a select group of companies which have managed to increase dividend payments for at least 25 years consecutively. This steady performance has also seen the company comfortably outperform the S&P 500 index over the long run. Since 1990, ITW has generated a compound annual growth (CAGR) rate of 13.6% versus the S&P 500’s 10.3%. Given this conservative management style, as well as management’s continuing drive to improve margins and returns, ITW is held in both our global managed portfolios and the Cratos BCI Worldwide Flexible Fund.

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By Ron Klipin

05 AUGUST 2022

CVS Health

Q2 2022

  • CVS   Health posted second quarter results which reflected a strong set of   financials, beating consensus estimates.

  • Non-GAAP Earnings Per Share (EPS) of $2.40 beat consensus by $0.22,   with revenue growth of 11% year-on-year TO $80.64 Bn, also beat estimates.

  • The cherry on top was a powerful 2022 full-year guidance, raising   the EPS range to between $8.40 to $8.60, from between $8.20 to $8.60.

  • · In addition, it raised cash flow from operations forecasts for the   year to $12.5bn to $13.5 bn, from between $12 bn to $13bn. This is a tribute   to management execution, and the diversity of the operating business model.

  • The three verticals (the pharmaceutical side, the healthcare   insurance business and retail stores) are synergistic, with health-care   benefits membership of 24.4m, which saw adjusted operating income grow 13.4%.

  • This represents around 38.50% of group operating income and is   expected to be the major driver for future, aided by its walk-in clinics.

  • The group has been proactive in the closure of unprofitable retail stores, with the focus on online retail sales and on further expanding into primary health care services. This should deepen its business operating model, to assist it in staving-off competition from the likes of Amazon, which is looking to enter the health care markets. My clients are invested CVS Health shares in the segregated portfolios which I manage.

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By Lee Kern

05 AUGUST 2022

Under Armour

Q1 2023

  • Athletics   apparel maker Under Armour reported results for the first fiscal quarter of   2023 which were mostly in line with expectations. Revenue was buoyed by   higher prices, but remained flat at $1.35 billion (up 2% on a currency   neutral basis) compared to the prior year as increased promotional activity   and currency headwinds impacted margins. The  gross margins declined 280   basis points to 46.7%.

  • Geographically, North American revenue was flat year over year at   $909 million, while international revenue declined 3.3% to $431 million (but   was up 1.5% on a currency neutral basis). The international segment was   dragged lower by an 8% decrease in sales in the Asia-Pacific region.

  • · Full-year earnings forecasts were revised lower. The sportswear   company now expects earnings per share for the full year to come in between   61 cents and 67 cents, down from earlier guidance of between 79 cents and 84   cents. It also lowered its gross margin forecasts 375 to 425 basis points   lower (from the previous range of 150 to 200 basis points down).

  • Under Armour defended its discounting in light of the inflationary   environment. Net income before adjustments came in at $7.68 million, or 2   cents per share.

  • The company has been bogged down in a legal dispute over a cancelled   apparel contract with UCLA for $67.49 million - and reported $10 million in   legal expenses (or a 2 cents impact on EPS) tied to that ongoing litigation.   Kevin Plank, Under Armour founder and executive chairman, also said the   company would choose a new CEO by the end of the year. Interim CEO Colin   Browne has been in the role since Patrick Frisk stepped down in June.

  • Nike, according to Piper Sandler, has been the number one favourite apparel brand among teens for the past 10 years. Nike's Jordan brand notched record sales last quarter, and its AF1 is the most-purchased shoe of 2020. Under Armour are now trying their hand at a Nike-Michael Jordan-style marketing tie-up, with NBA basketball star Stephen Curry, to try and revive the beleaguered business and recapture market share. Under Armour has struggled to compete, even with celebrity product placements in blockbusters like Disney’s Avengers movies, where Captain America donned their gear. We will keep an eye on Under Armour’s turnaround but own shares of Nike instead in the Cratos BCI Worldwide Equity Fund.

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By Ron Klipin

29 JULY 2022

Coca-Cola

Q2 2022

Coca–Cola surprised the market, beating market       estimates on both earnings and revenue in Q2. Organic revenue       increased 16%, while net revenue increased 12% as currency headwinds       weighed on the top line.

This multinational giant has a beverage       basket portfolio in excess of 200 brands, achieving exceptional financial       results, on the back of strong pricing power, and has also benefited from       product diversification. It has achieved robust results despite       challenging operating conditions, such as spiraling inflation, supply       side impediments and weak global markets.

· Product innovation has proved to be a       major plus factor, with a move into low sugar beverages, health drinks,       energy sports drinks, and Vitamin Waters amid the relatively new beverage       innovations.

Operating margins were maintained through       strong top-line growth, offsetting higher operating costs and marketing       spend, which was scaled up to create global brand campaigns.

Coke's nutrition juices, dairy, coffee and       tea also showed good growth as did hydration beverages, also benefiting       from a recovery in away-from-home channels, with an opening up of global       economies. The group gained additional market share in most categories.

The cherry on the top was the strong       guidance, with the company expecting to deliver full-year organic revenue       growth of 12-13%, up from its previous guidance of 7%-8%.

Coke is a high-quality share, which I hold       in our segregated portfolios. I have recently added to the position as I believe this is not only a defensive investment but should also reward       shareholders with increasing dividends.

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By Desmond Esakov

29 JULY 2022

Diageo Plc

Q4 2022

Global   alcoholic beverage group Diageo reported results for the year ended 30 June,   with organic net sales surging 21%. The increase was on the back of an 11%   increase in prices and a 10% increase in volumes. The revenue print was also   well above consensus of 17%. In the current environment, Diageo is one of a   handful of companies that have been able to raise prices & still grow   volumes. Remarkably volume and price growth were achieved across all regions,   highlighting the quality of Diageo’s brands.

The two largest regions, Europe and North America, saw volume growth of 20% and 3% respectively with the Latin America & Caribbean region reporting the largest sales growth of 43%.

Diageo reported an 18.2% increase in operating profit to £4.4 billion although the operating margin decreased by 77bps to 28.5%. Significantly, return on invested capital increased by 331bps to 16.8%. 

Adjusted EPS increased 23% to 151.9p which was ahead of the consensus expectation of 142.8 p with the company raising the dividend by 5% to 46.82p per share. 

With brands such as Johnnie Walker, Baileys, Guinness and Don Julio, Diageo is undoubtedly a high-quality company. In our view, these brands provide a substantial moat which should allow the company to continue generating shareholder value as it has done for decades. We remain long-term shareholders in the Cratos BCI Worldwide Flexible Fund as well as global portfolios despite the relatively elevated PE multiple of around 25x.

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By Ron Klipin

22 JULY 2022

Bank of America

Q2 2022

  • Bank of America reported its second quarter earnings, which were a mixed bag,   just missing GAAP EPS of $0.73 by a paltry $0.02, whilst revenue of $22.7bn   reflected a decline of only $90m.

  • This was due to conservative provisions for credit losses of $523m   as the US Federal Reserve tightens its regulatory stance, in the light of   high levels of inflation.

  • BOA’s major area of operations is centered in US, relative to its   multi-national US peers, and is weighted towards US retail banking. The Bank   has a lower cost deposit franchise model which is benefiting from rising   interest rates.

  • This should be positive for further increases in Net Interest Income   (NII), after reporting growth of 22% year over year on the back of strong   loan growth and higher interest rates. This should bode well for the bank for   the remainder of 2022 as highlighted by management.

  • Investment Banking profits, which declined 6% year over year from   the supernormal profit levels in the past year, did not impact on the group   to the same degree as its competitors were affected.

  • Despite shares having their worst first half in decades, Wealth   Management revenues grew by 7% year over year resulting in higher margin   recurring revenue streams.

  • Bank of America, which is the second-largest holding in Berkshire   Hathaway’s investment portfolio (after Apple shares) is on an attractive PE   of 10x, and a dividend yield of 2.7%. The share price has declined by 27% in   2022, to around $32.00 per share, which makes for a good entry point.

  • The high quality of its lending book, more than adequate capital   reserves, plus an experienced management that have rewarded shareholders with   dividend hikes and share buy backs, are major positive factors for the group.   Bank of America declared a quarterly dividend of $0.22, up 4.8%, reflecting a   confident outlook for 2022, despite the challenging macroeconomic environment.

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By Lee Kern

22 JULY 2022

Johnson & Johnson

Q2 2022

  • Johnson   & Johnson, the drug giant, posted better-than expected results  for the fiscal second quarter thanks to the strength of its pharmaceutical   unit.

  • Total sales for the group rose 3% to $24.02 billion, with almost   half of the sales coming from outside the US.

  • Segmentally, the pharmaceutical business (J&J’s largest   division) continued to perform well due to sales of cancer drug Darzalex and   Crohn’s disease drug Stelara. Sales of Stelara rose 14.3% to $2.60 billion in   Q2, while Darzalex revenues increased 40% to $1.99 billion. The pharma   division in total grew 6.7% year-over-year to $13.3 billion. J&J's   Covid-19 vaccine brought in $544 million in sales in the quarter but the drug   suffered from a poor uptake and weak demand.

  • The medical devices unit saw sales fall 1.1% in the period to $6.90   billion, as a result of lockdowns in China.

  • And the consumer health division, responsible for band-aids, mouth   wash, decongestants and skin care products, also saw sales fall 1.3% to $3.8   billion.

  • On an adjusted basis, Johnson & Johnson earned $2.59 per share.   However, due the strength of the US dollar, it has cut its full-year adjusted   profit estimates to between $10.00 to $10.10 per share, compared with prior   forecasts of between $10.15 to $10.35.

  • Johnson & Johnson is a high-quality business which is in the S&P500 Dividend Aristocrats Index. This index is composed of companies which have not only consistently paid a dividend to shareholders for at least 25 years but must have also annually increased the size of its payouts. Not only that, it is also a Dividend King - an even more exclusive group of stocks, with 50+ years of consecutive dividend increases.

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By Ron Klipin

15 JULY 2022

JP Morgan Chase & Co.

Q2 2022

  • JPMorgan Chase & Co. second   quarter results were disappointing, with GAAP EPS of $2.76,   which were $0,13 below market estimates. Revenue of $30.7bn also missed   market estimates by $1.12bn, which resulted in the company suspending share   buy backs.

  • The reason for this suspension was due to the need to build   additional net reserves by $428m and $657m and further provisions in times of   economic uncertainty, following the Federal Reserve Banks’ tightening of   regulatory requirements.

  • Jamie Diamond, the long standing, and highly experienced group CEO,   who has a proven track record, believes that business credit metrics in the   USA are still in good shape.

  • JPM has had an exemplary track record of delivery through challenges   brought about by changes in the business cycles.

  • The group has raised its net income guidance from $53bn to $56bn in   2022, due to the positive impact of rising interest rates, with expenses   maintained at $76bn to $77bn, despite additional expenditure on IT which   should bring about further efficiencies as well as increasing headcount of   skilled operatives.

  • The decline in profits comes off a high base where investment   banking fees were elevated due to buoyant activity in the IPO equity markets,   with substantial deal flow activity.

  • The company has a strong balance sheet, despite economic headwinds,   and a diversified business model and revenue streams, which should enable it   to deliver sustainable returns through most economic and regulatory operating   conditions.

  • Dividends have been maintained at $1.00 per share resulting in an   attractive dividend yield of 3.60%, and a PE for the current year of 8x to   10x at the current share price. The return on equity (ROE) was a relatively   impressive 13%.

  • JP Morgan, the largest US bank, encompasses consumer, commercial and   investment banking, which should prove to be defensive in the current   challenging economic environment, and has been conservative in setting aside   funds for loan losses. The share price has declined by 33% this year, and now   appears attractive for long term patient investors.

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By Lee Kern

15 JULY 2022

Pepsico

Q2 2022

  • The   snack and beverage giant Pepsico reported   better-than-expected sales and profits despite higher   freight and commodity costs biting into margins in the second fiscal quarter   of 2022.

  • Revenue was up 5.2% to $20.23 billion. Organic revenue, which strips   out the impact of acquisitions and disposals, climbed an impresssive 13%.   Pepsi recored a $1.17 billion write off from the Russia-Ukraine conflict, and   said it had paused sales in Russia except for essentials like baby formula.

  • Frito-Lay North America grew market share with organic revenue   rising 14% on the back of higher sales of Cheetos and Doritos. However,   volumes, which excludes pricing and forex movements, declined 2%.

  • Quaker Foods North America saw revenue jump 18% thanks to   double-digit sales growth in rice, pasta, oatmeal and cookies - and Pepsico   Beverage North America grew revenues 9% as Gatorade, Aquafina and Lifewtr   experienced double-digit growth in the quarter.

  • Outside of its primary market, Latin America experienced organic   revenue growth of 22%, with volumes of food and beverages up 6% and 9%   respectively.

  • Africa, Middle East and South Asia; and Asia Pacific, Australia and   the New Zealand and China Region saw revenue climb a tepid 6% and 3%   respectively.

  • Europe was far less sanguine as revenue fell 8% in the period, with   volumes of food and beverages tumbling around 8%.

  • Pepsi earned net income of $1.43 billion, down 40% year over year,   or $1.03 per share.

  • The soda King is expecting costs to continue to creep upward in the   second half of the year and will keep raising prices, reducing product sizes   and quanitites (like the number of chips in a packet) to manage rising   expenses. It expects organic revenue growth of 10%, up from its previous   forecast of 8%. It’s also estimating core   constant currency earnings per share growth of 8%.

  • Pepsico is a pedigree business and consistent dividend payer. It can   be found the S&P500 Dividend Aristocrats Index. This index is composed of   companies which have not only consistently payed a dividend to shareholders   for at least 25 years but must have also annually increased the size of its   payouts. We are confident that Pepsico will be resilient enough to weather   the current macroeconomic and geopolitical volatility and headwinds it faces.   We hold the stock in managed portfolios and in the Cratos BCI Worldwide Equity Fund.

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By Ron Klipin

08 JULY 2022

Ford

Q2 Sales Update

  • An update by Ford Motor Company reflected a   decline in sales for the current quarter against a backdrop of supply chain   issues, with the semiconductor chip market remaining tight.

  • A volatile and uncertain macroeconomic environment, due to a spike in inflation   and rising interest rates, were other factors impacting consumer spend.

  • However,   an uptick in demand in June, resulted in Ford’s market share in the US   increasing to 12.9%, outperforming other automotive players in the industry.

  • This   was driven by strong demand for electric vehicles, such as the F150 Lightning   pick-up truck, which made its debut in May 2022, with an order book   stretching into 2023.

  • This   new model electric truck was the best-selling pick-up in June, with SUV   automobiles accounting for the majority of US sales.

  • New   model innovation, such as the Bronco Sports brand and the Mustang E vehicles   have also resulted in stronger brand recognition, particularly in the US   market which is the largest and most profitable for the group.

  • Ford’s   strategy to grow its Battery Electric market share, which is highly profitable   relative to the sale of combustion vehicle engines, will take time to achieve   with the company undergoing a major transformation.

  • Fitch,   the credit ratings agency, recently upgraded Ford to a positive outlook, with   its signally sufficient cash reserves enabling the company to invest in the   electric vehicle industry.

  • Ford will present its results later this month (27th July) and   appears to be in a turnaround mode. At a current price of $11.65 per share,   this represents a fair value. Investors should wait for the results before   making any investment decisions.

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By Lee Kern

08 JULY 2022

Levi Strauss & Co.

Q2 2022

  • Levi   Strauss, the maker of iconic denim jeans, reported better than expected revenue and profit for   the fiscal second quarter of 2022 as office staff returning to work opted for   a more relaxed dress code.

  • Revenue   increased 15% y/y to $1.47 billion. Both Levi’s Direct-to-Consumer channel   and Wholesale business performed well, increasing revenues 16% and 15%   respectively from Q2 2021. Digital sales continued to grow, up another 3%   this quarter, and now comprising 20% of revenues, after 75% growth in the   same quarter a year ago. Its other brands, Beyond Yoga and Dockers grew   revenue 56% y/y.

  • Geographically,   sales were up 17% in the Americas, 3% in Europe and 16% in Asia from the year   ago period. Declines in sales of value denim brands sold at Amazon, Target   and Walmart were more than offset by its core business. However, Chief   executive Chip Bergh said there is evidence that the more value conscious   consumer is starting to feel the squeeze.

  • Expenses   climbed 21% y/y which it largely attributed to the war in the Ukraine. Gross   margins remained flat and adjusted EBIT margins improved to 9.9% from 9.0% a   year earlier. Levi’s made a profit of $50 million, or 12 cents a share, down   23% y/y. It finished the period with cash and cash equivalents of $602   million and maintained its guidance for the full year.

  • While we prefer shares of Nike, which we own in managed client portfolios and the Cratos BCI Worldwide Flexible Fund, we must point out the phenomenal turnaround and performance of Levi’s since CEO and President Chip Bergh joined the company from P&G in 2011. This is nicely illustrated below in the graphics from the company’s investor day presentation.

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By Lee Kern

01 JULY 2022

Nike

Q4 2022

  • Nike reported better than-expected results for the fiscal fourth quarter despite continued lockdowns and factory closures in China. However, the athletics apparel and sneaker giant warned of longer shipping times and higher transportation costs persisting. 

  • For the fiscal fourth quarter, revenue declined by 1% year over year to $12.23 billion. Over the past few years Nike’s strategy has been to sell directly to consumers to take advantage of better margins. Direct sales grew 7% to $4.8 billion in the period but its wholesale business (to resellers) saw sales fall 7% to $6.8 billion. Digital sales now make up 25% of revenue from a pre-pandemic figure of around 10%.

  • The company’s largest market is North America, which experienced a 5% decline in sales to $5.11 billion. In China, Nike’s second biggest market, operations were impacted by stay-at-home orders which saw sales tumble 19% from a year ago to $1.56 billion. Net income for the fourth quarter fell 4.6% to $1.44 billion, or 90 cents per share. Nike exited its Russian operations in the period and the board authorized a new four-year, $18 billion stock buyback program replacing the current $15 billion program.

  • Demand for Nike’s products has been robust for the last three quarters, with production now surpassing pre-pandemic levels. A potential supply chain normalization should allow it to capitalize on this excess demand. Unfortunately, this comes at a time when consumers face inflationary headwinds to their discretionary spend as well as the risk of the global economy slipping into a recession (which may see shoppers trade down to lower-priced brands). Nike is paying around five times the pre-pandemic container rate to ship between Asia and the U.S. and transit times are two weeks longer than before the pandemic. It said inventory buildup (up 23% year over year to $8.4 billion) was the result of such supply chain disruptions.

  • The company expects first-quarter revenue to be marginally higher on the prior year and anticipates full-year revenue to increase by low double-digits (on a currency-neutral basis). Nike has factored into its forecasts higher product and ocean transport costs, as well as markdowns and supply chain investments. With sports events taking place again, the soccer world cup later this year, and travellers needing sneakers, demand should remain resilient for Nike in spite of the gloomy economic outlook. This is a great business with high quality earnings. But it remains relatively expensive at these levels. We hold the stock in managed portfolios as well the Cratos BCI Worldwide Equity Fund.