Category: Research

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Global stocks Shares

Lower Copaxone Sales, US Generic Competition, Unfavorable Exchange Rates Weigh on Teva’s Results

Business Strategy & Outlook: 

Israel-based Teva Pharmaceutical is one of the largest global generic drug manufacturers, with a significant presence in the United States and in Western Europe. Generic drug manufacturers with large exposure to the U.S. have fared very poorly compared with the overall market over the past few years due to factors that resulted in a highly deflationary generic drug price environment. To combat further margin deterioration, the largest, most capable manufacturers have invested more heavily in development and marketing of complex generics and biosimilars, which face much less competition and price erosion than small-molecule generics. 

Founded in 1901, Teva was a small wholesale drug business in Jerusalem that converted into a local drug manufacturer during World War II with the rise in demand. The company consolidated the market in 1960 to create the largest drugmaker; it later expanded into Europe and the U.S. and then into generics in 1984 with the passage of the Hatch-Waxman Act. In the following 30 years, Teva completed roughly 30 acquisitions to further its position as the largest global generic manufacturer with roughly 90 manufacturing and research and development facilities worldwide. Despite efforts to curb margin deterioration by eliminating unprofitable drugs in the portfolio, Teva’s top and bottom lines have been negatively affected by a 70% decline in sales for its largest specialty drug, Copaxone, following generic entry and competition from new therapies. At its peak in 2013, Copaxone generated $4.3 billion in sales and contributed one fifth of total company revenue. While the company’s specialty drug pipeline is deep and consists of several novel biologic products and biosimilars, the growth is expected to be anemic over the next few years with slow generic revenue growth and a further decline in Copaxone sales. The company forecasts $750 million in Copaxone revenue in 2022.

Financial Strengths:

As of year-end 2021, Teva holds net debt of $20.9 billion, with $1.4 billion due in 2022, $2.1 billion due in 2023, and $2.0 billion due in 2024. The company’s $2 billion in cash and free cash flow generated from operations gives us some assurance that Teva should meet its obligations in the near term. Legal risk from ongoing litigation related to opioids, price-fixing, and Copaxone is also a risk to liquidity over the next several years. The base assumption calls for $2 billion in a cash settlement paid over a period of 15 years.

Bulls Say:

  • As a leading global generic manufacturer, Teva enjoys economies of scale over its smaller peers.
  • Teva’s specialty portfolio represents one fifth of sales and diversifies the company from generic drug deflation risk.
  • Teva’s biosimilar for Humira is anticipated to launch in the U.S. in 2023, which should bolster specialty segment sales.

Company Description: 

Based in Israel, Teva is one of the world’s largest generic drug manufacturers, with over 3,500 products marketed in over 60 countries. While a majority of its revenue is attributed to prescription generic drugs, Teva develops and markets its own branded specialty and biopharmaceutical products, primarily in the U.S. and in Europe. The company’s branded portfolio generates one fifth of total revenue and consists of patented therapies targeting central nervous system conditions (Austedo, Ajovy, Copaxone), oncology (Bendeka/Treanda), and respiratory conditions (ProAir, Qvar). While global competition has facilitated the commodification of small-molecule generic drugs, Teva’s portfolio rationalization has resulted in less overall price erosion versus peers.

(Source: Morningstar)

DISCLAIMER for General Advice: (This document is for general advice only).

This document is provided by Laverne Securities Pty Ltd T/as Laverne Investing. Laverne Securities Pty Ltd, CAR 001269781 of Laverne Capital Pty Ltd AFSL No. 482937.

The material in this document may contain general advice or recommendations which, while believed to be accurate at the time of publication, are not appropriate for all persons or accounts. This document does not purport to contain all the information that a prospective investor may require.  The material contained in this document does not take into consideration an investor’s objectives, financial situation or needs. Before acting on the advice, investors should consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation, and needs. The material contained in this document is for sales purposes. The material contained in this document is for information purposes only and is not an offer, solicitation or recommendation with respect to the subscription for, purchase or sale of securities or financial products and neither or anything in it shall form the basis of any contract or commitment. This document should not be regarded by recipients as a substitute for the exercise of their own judgment and recipients should seek independent advice.

The material in this document has been obtained from sources believed to be true but neither Laverne and Banyan Tree nor its associates make any recommendation or warranty concerning the accuracy or reliability or completeness of the information or the performance of the companies referred to in this document. Past performance is not indicative of future performance. Any opinions and or recommendations expressed in this material are subject to change without notice and, Laverne and Banyan Tree are not under any obligation to update or keep current the information contained herein. References made to third parties are based on information believed to be reliable but are not guaranteed as being accurate.

Laverne and Banyan Tree and its respective officers may have an interest in the securities or derivatives of any entities referred to in this material. Laverne and Banyan Tree do and seek to do business with companies that are the subject of its research reports. The analyst(s) hereby certify that all the views expressed in this report accurately reflect their personal views about the subject investment theme and/or company securities.

Although every attempt has been made to verify the accuracy of the information contained in the document, liability for any errors or omissions (except any statutory liability which cannot be excluded) is specifically excluded by Laverne and Banyan Tree, its associates, officers, directors, employees, and agents.  Except for any liability which cannot be excluded, Laverne and Banyan Tree, its directors, employees and agents accept no liability or responsibility for any loss or damage of any kind, direct or indirect, arising out of the use of all or any part of this material.  Recipients of this document agree in advance that Laverne and Banyan Tree are not liable to recipients in any matters whatsoever otherwise; recipients should disregard, destroy or delete this document. All information is correct at the time of publication. Laverne and Banyan Tree do not guarantee reliability and accuracy of the material contained in this document and are not liable for any unintentional errors in the document.

The securities of any company(ies) mentioned in this document may not be eligible for sale in all jurisdictions or to all categories of investors. This document is provided to the recipient only and is not to be distributed to third parties without the prior consent of Laverne and Banyan Tree.

Categories
Global stocks Shares

Vehicle Repair Demand Continues to Strengthen, Benefiting LKQ’s Q1 Results

Business Strategy & Outlook

LKQ is the top alternative vehicle-parts provider to repair shops in North America and Europe. The company has built scale-driven cost advantages in its business. Customers value LKQ’s consistent parts availability across a wide range of products and quick delivery. LKQ helps customers complete repairs faster, boosting productivity. The company’s strong distribution network will support its ability to keep order fulfilment rates high in both aftermarket and salvage products.

The company’s strategy focuses on being a one-stop shop for repair professionals, ranging from salvage products to aftermarket and remanufactured parts. LKQ’s parts are a strong alternative to original equipment manufacturers’ parts, exhibiting high quality in comparison. While insurance companies aren’t usually direct customers, they do have sway over which parts are used in vehicle repairs. LKQ’s alternative parts allows insurance companies to reduce their cost base while also reducing the cycle time for repairs. Historically, the company has used acquisitions to build up its capabilities and footprint, but that has changed over the past few years. LKQ has shifted its focus to integrating its businesses and improving its cost structure, and it will aim to make smaller tuck-in acquisitions as opposed to larger deals.

 LKQ is well positioned to compete as electric vehicle adoption increases. The shift to EVs will present new revenue opportunities for the company. In both hybrid and full-electric vehicles, new parts will be needed to keep vehicles on the road. For example, to see increased demand for battery-related parts and a need for remanufactured or refurbished batteries.

LKQ has exposure to end markets with attractive tailwinds. The demand for repair work will be strong in the near term, largely due to vehicle owners taking in their cars for overdue servicing (delayed by the COVID-19 pandemic). The high average age of vehicles will also support demand for repair work.

Financial Strengths

LKQ maintains a sound balance sheet. Its debt balance stood at $2.8 billion in 2021, down from $3.7 billion in 2019. LKQ’s management team has been focused on strengthening the balance sheet over the past few years. The company’s net leverage position (net debt/EBITDA) has steadily improved, declining from nearly 3 times to under 2 times in 2021. This resulted in LKQ reaching investment-grade status.

In terms of liquidity, the company will be on solid footing over the long term. In 2021, LKQ had a cash balance of nearly $300 million, but this will likely increase over the forecast, given the company’s shift in its acquisition strategy. In the past, LKQ was more willing to acquire companies to expand its capabilities and footprint. Going forward, the company will focus on small tuck-ins, freeing up more cash to reinvest in its business, repurchase shares and grow its dividend. A stronger cash position will help LKQ quickly react to a changing operating environment as well as meet any near-term debt obligations (no major maturities until 2024). The comfort in LKQ’s ability to access $1.2 billion in credit facilities. LKQ’s solid balance sheet gives management the financial flexibility to run a balanced capital allocation strategy going forward that mostly favours organic growth and also returns cash to shareholders.

 LKQ can generate solid free cash flow throughout the economic cycle. The company to generate over $1 billion in free cash flow in midcycle year, supporting its ability to return free cash flow to shareholders through share repurchases and dividends. Additionally, free cash flow growth over the next decade will be supported by improving EBITDA margins in LKQ’s Europe business, which to be in the low-double-digit range over the next five years.

Bulls Say

  • Growth in miles driven increases the wear and tear on vehicles, requiring more maintenance and repair work to keep them on the road, benefiting LKQ.
  • LKQ’s collision business could see rising demand from increasing auto claims as more drivers return to the road following the COVID-19 pandemic.
  • Increasing adoption of hybrid vehicles presents new revenue opportunities for LKQ, such as new battery related parts, in addition to its ICE-related parts.

Company Description

LKQ is a leading global distributor of non-OEM automotive parts. Initially formed in 1998 as a consolidator of auto salvage operations in the United States, it has since greatly expanded its scope to include distribution of new mechanical and collision parts, specialty auto equipment, and remanufactured and recycled parts in both Europe and North America. It still maintains its auto salvage business and owns over 70 LKQ pick-your-part junkyards. Separate from the self-service business, LKQ purchases over 300,000 salvage automobiles annually that are used to extract parts for resale. Globally, LKQ maintains approximately 1,700 facilities.

(Source: Morningstar)

DISCLAIMER for General Advice: (This document is for general advice only).

This document is provided by Laverne Securities Pty Ltd T/as Laverne Investing. Laverne Securities Pty Ltd, CAR 001269781 of Laverne Capital Pty Ltd AFSL No. 482937.

The material in this document may contain general advice or recommendations which, while believed to be accurate at the time of publication, are not appropriate for all persons or accounts. This document does not purport to contain all the information that a prospective investor may require.  The material contained in this document does not take into consideration an investor’s objectives, financial situation or needs. Before acting on the advice, investors should consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation, and needs. The material contained in this document is for sales purposes. The material contained in this document is for information purposes only and is not an offer, solicitation or recommendation with respect to the subscription for, purchase or sale of securities or financial products and neither or anything in it shall form the basis of any contract or commitment. This document should not be regarded by recipients as a substitute for the exercise of their own judgment and recipients should seek independent advice.

The material in this document has been obtained from sources believed to be true but neither Laverne and Banyan Tree nor its associates make any recommendation or warranty concerning the accuracy or reliability or completeness of the information or the performance of the companies referred to in this document. Past performance is not indicative of future performance. Any opinions and or recommendations expressed in this material are subject to change without notice and, Laverne and Banyan Tree are not under any obligation to update or keep current the information contained herein. References made to third parties are based on information believed to be reliable but are not guaranteed as being accurate.

Laverne and Banyan Tree and its respective officers may have an interest in the securities or derivatives of any entities referred to in this material. Laverne and Banyan Tree do and seek to do business with companies that are the subject of its research reports. The analyst(s) hereby certify that all the views expressed in this report accurately reflect their personal views about the subject investment theme and/or company securities.

Although every attempt has been made to verify the accuracy of the information contained in the document, liability for any errors or omissions (except any statutory liability which cannot be excluded) is specifically excluded by Laverne and Banyan Tree, its associates, officers, directors, employees, and agents.  Except for any liability which cannot be excluded, Laverne and Banyan Tree, its directors, employees and agents accept no liability or responsibility for any loss or damage of any kind, direct or indirect, arising out of the use of all or any part of this material.  Recipients of this document agree in advance that Laverne and Banyan Tree are not liable to recipients in any matters whatsoever otherwise; recipients should disregard, destroy or delete this document. All information is correct at the time of publication. Laverne and Banyan Tree do not guarantee reliability and accuracy of the material contained in this document and are not liable for any unintentional errors in the document.

The securities of any company(ies) mentioned in this document may not be eligible for sale in all jurisdictions or to all categories of investors. This document is provided to the recipient only and is not to be distributed to third parties without the prior consent of Laverne and Banyan Tree.

Categories
ETFs ETFs

BlackRock iShares Enhanced Cash ETF: A diversified Portfolio of higher-yielding high Quality Short-term Money Market Instrument.

Investment Objective

The Fund seeks, by employing a passive investment strategy, to outperform the S&P/ASX Bank Bill Index (before fees and expenses). It offers the ability to achieve potentially enhanced regular income with a diversified portfolio of higher-yielding high quality short-term money market instruments, including floating rate notes. It is truly liquid and only holds instruments that can be easily sold to meet investor requirements.

Investment Strategy

The Fund seeks to achieve its objective by employing a passive investment strategy that aims to outperform the performance of the S&P/ASX Bank Bill Index (referred to in this section 6 of the PDS as the Index).   Given the synthetic nature of Index constituents (refer to section 6.4 of this PDS, titled “About the Index” for further information) it is not possible to implement an investment strategy that looks to construct a portfolio of Index constituents. Instead, the Fund’s conservatively managed passive investment strategy will construct a portfolio of money market and fixed income securities that typically provide higher yield without significant increase in default and interest rate risk. Securities will be selected with consideration to the security’s rating, sector, maturity, liquidity, and underlying credit fundamentals. 

The Fund will be managed using a buy and hold investment philosophy, similar to other passive investment strategies, with full daily portfolio transparency. A sampling methodology has been selected as the most appropriate investment technique, as it keeps trading costs to a minimum and provides the necessary flexibility to deliver investment returns that either meet or at times may exceed Index returns. Any outperformance of the Index will not be a result of active trading nor the investment expertise of the individual fund manager(s) in selecting particular investment securities that it considers will perform better relative to other securities. Rather, returns above the Index would typically result from prudent risk mitigation and diversification measures, including: 

► issuer diversification, for example, rather than having issuer concentration to the four major Australian banks, diversification can be achieved by investing in similarly rated authorised deposit taking institutions (ADIs) who issue securities at a margin above the benchmark BBSW rates (the rates provided by the major Australian banks) ‐ the overarching investment consideration is prudent risk management and credit risk mitigation and not active security selection by the individual fund manager(s) based on perceived credit quality, as the credit quality is the same; and 
► investment of up to 20% in Floating Rate Notes (FRNs) which earn a higher yield relative to very short‐term “cash‐like” securities ‐ these investments will be “buy and hold” and not actively traded, the overarching investment rationale for holding these securities is to further diversify credit risk in the portfolio. The Fund is also expected to attract additional returns from attractive interest rates on Australian dollar cash deposits. The interest rate on cash deposits will most likely exceed the 24-hour Cash Rate that is used as a price input into the Index return calculation, as BlackRock has long

established commercial relationships with several Australian ADIs, which allows cash to be placed on deposit at commercial rates. 

Cash deposits are not actively traded; rather allocations will be based on issuer concentration limits, therefore further diversifying the portfolio.   

Trading within the Fund is only expected to meet client flows or the reinvestment of maturating securities and not as a result of active security selection. The credit quality, liquidity risk and maturity profile of the Fund will be continuously monitored and adjusted with reference to the Index. Additionally, investments of the Fund are required to have a long‐term credit rating of BBB or higher or a short‐term credit rating of A2 or higher by S&P Ratings or an equivalent rating from Moody’s. Further details of the Fund’s investment strategy, including investment parameters, is set out in the Fund’s Investment Guidelines, which is available upon request. Given the Fund is unable to implement a traditional full replication or optimisation passive investment strategy, the Fund may at times incur greater tracking error than other ETFs (refer to the section of this PDS titled “Fund risks” for further information on the risks associated with investing in the Fund).

Performance: 

Asset Allocation:

People:

About the Index:

The Index offers short‐term exposure to Australian dollar‐ denominated bank bills with maturity profiles of up to 91 days.   Unlike traditional equity and fixed income indexes, the constituents of which are shares and bonds respectively, the Index consists of synthetic “securities” that cannot be purchased and sold. The constituents of the Index are a series of 13 hypothetical weekly bills, ranging from one‐week to 91 days in maturity that are interpolated using the 24-Hour Cash Rate and the 30‐Day, 60‐Day and 90‐Day Bank Bill Swap rates (BBSW). The credit worthiness of the bills included in the Index is deemed that of prime banks, i.e., the major four Australian banks. The 13 rates are derived from the four rate types described above and applied to each of the 13 hypothetical bills. As the Index progresses to the next weekly rebalancing date the term to maturity of each bill, and the Index as a whole, reduces daily until the shortest bill matures. The face value of this bill is then reinvested in a new bill with a term to maturity of 13 weeks and the term to maturity of the Index increases by approximately seven days. The total amount received on maturity, that is the face value, is reinvested in the discounted value of a new 91‐day bill. The Index is maintained so that maturing bills are reinvested in the discounted value of a new 91‐day bill on the day the cash is received (each Tuesday).

About the Fund:

Ishares Enhanced Cash ETF (ISEC) offers the ability to achieve capital preservation and potentially enhanced regular income with a diversified portfolio of higher-yielding high quality short-term money market instruments, including floating rate notes. The fund Achieve capital preservation and maximise regular current income with a diversified portfolio of higher-yielding high quality short-term money market instruments, including floating rate notes.

DISCLAIMER for General Advice: (This document is for general advice only).

This document is provided by Laverne Securities Pty Ltd T/as Laverne Investing. Laverne Securities Pty Ltd, CAR 001269781 of Laverne Capital Pty Ltd AFSL No. 482937.

The material in this document may contain general advice or recommendations which, while believed to be accurate at the time of publication, are not appropriate for all persons or accounts. This document does not purport to contain all the information that a prospective investor may require.  The material contained in this document does not take into consideration an investor’s objectives, financial situation or needs. Before acting on the advice, investors should consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation, and needs. The material contained in this document is for sales purposes. The material contained in this document is for information purposes only and is not an offer, solicitation or recommendation with respect to the subscription for, purchase or sale of securities or financial products and neither or anything in it shall form the basis of any contract or commitment. This document should not be regarded by recipients as a substitute for the exercise of their own judgment and recipients should seek independent advice.

The material in this document has been obtained from sources believed to be true but neither Laverne and Banyan Tree nor its associates make any recommendation or warranty concerning the accuracy or reliability or completeness of the information or the performance of the companies referred to in this document. Past performance is not indicative of future performance. Any opinions and or recommendations expressed in this material are subject to change without notice and, Laverne and Banyan Tree are not under any obligation to update or keep current the information contained herein. References made to third parties are based on information believed to be reliable but are not guaranteed as being accurate.

Laverne and Banyan Tree and its respective officers may have an interest in the securities or derivatives of any entities referred to in this material. Laverne and Banyan Tree do and seek to do business with companies that are the subject of its research reports. The analyst(s) hereby certify that all the views expressed in this report accurately reflect their personal views about the subject investment theme and/or company securities.

Although every attempt has been made to verify the accuracy of the information contained in the document, liability for any errors or omissions (except any statutory liability which cannot be excluded) is specifically excluded by Laverne and Banyan Tree, its associates, officers, directors, employees, and agents.  Except for any liability which cannot be excluded, Laverne and Banyan Tree, its directors, employees and agents accept no liability or responsibility for any loss or damage of any kind, direct or indirect, arising out of the use of all or any part of this material.  Recipients of this document agree in advance that Laverne and Banyan Tree are not liable to recipients in any matters whatsoever otherwise; recipients should disregard, destroy or delete this document. All information is correct at the time of publication. Laverne and Banyan Tree do not guarantee reliability and accuracy of the material contained in this document and is not liable for any unintentional errors in the document.

The securities of any company(ies) mentioned in this document may not be eligible for sale in all jurisdictions or to all categories of investors. This document is provided to the recipient only and is not to be distributed to third parties without the prior consent of Laverne and Banyan Tree.

Categories
Global stocks Shares

CS: History of Poor Risk Management Drives Discounted Valuation

Business Strategy & Outlook: 

Credit Suisse’s true underlying profitability has been masked for the better part of a decade by multiple restructuring charges and the cost of running down a legacy book of unprofitable assets. The new management team at the helm of Credit Suisse hoped that it addressed all issues during 2020, but new problematic exposures continue to crop up. This suggests a deeper risk management malaise at Credit Suisse. Credit Suisse has some very good, profitable, and generally asset-light business with good long-term secular growth prospects–especially in wealth management/private banking and the Swiss universal bank. The discount that the market has imposed on the rating of Credit Suisse relative to UBS and its other peers should, however, remain in place until Credit Suisse can convince investors that it has addressed its risk management deficiencies. 

Credit Suisse will have to report several quarters of results free from the large non-recurring items that have historically marred its results. There is a strong long-term secular trend that sees the wealth of high-net-worth individuals and families growing ahead of global nominal GDP. The ultra-high net worth and family office segment, where Credit Suisse has focused most of its attention, is a particularly attractive segment. The threat of digital disintermediation is reduced and the need for bespoke solutions and strong relationship between banker and client remains. The current negative interest rate environment obscures the benefits of Credit Suisse’s very strong deposit franchise that provides it with ample surplus liquidity. Currently, this is damaging to Credit Suisse’s net interest income–it needs to invest its excess liquidity in short-term risk-free assets that currently pays no or negative interest. Credit Suisse has, however, starting passing on these costs to selected clients.

Financial Strengths:

Credit Suisse has a common equity Tier 1 ratio of 14.4% currently, ahead of its own internal capital target of a 14% common equity Tier 1 ratio. This is comfortably ahead of its regulatory minimum capital requirement of 10%. However, Credit Suisse’s leveraged ratio of 4.2% is more of a constraint, with a regulatory minimum requirement of 3.5% and an internal target of 4.5%. Credit Suisse intends to pay out 25% of its earnings as a dividend and it has not announced new share buybacks.

Both Credit Suisse’s liquidity coverage ratio and its net stable funding ratio are comfortably above 100%, which indicates sound liquidity. These ratios, while helpful, do not fully capture the quality of a bank’s funding. One should also consider the structure of a bank’s funding–where the relatively lower importance of wholesale deposits in Credit Suisse’s funding mix is a clear positive. However, private banking/wealth management clients will typically be more sophisticated than the average retail banking client and therefore more likely to withdraw funds in times of stress. The private banking deposits are as sticky as general retail deposits, although they remains stickier than wholesale funding.

Bulls Say:

  • Credit Suisse looks set to emulate UBS and transform its business model into a wealth manager with a complementary investment bank, which would increase profitability and reduce earnings volatility.
  • Credit Suisse has run down a massive book of EUR 126 billion to EUR 45 billion over the past four years, incurring pretax losses of EUR 16 billion in the process. This has obscured the performance and profitability of the core business.
  • Credit Suisse generates the bulk of its earnings in stable and low-risk private banking/wealth management and Swiss commercial banking.

Company Description:

Credit Suisse runs a global wealth management business, a global investment bank and is one of the two dominant Swiss retail and commercial banks. Geographically its business is tilted toward Europe and the Asia-Pacific.

(Source: Morningstar)

DISCLAIMER for General Advice: (This document is for general advice only).

This document is provided by Laverne Securities Pty Ltd T/as Laverne Investing. Laverne Securities Pty Ltd, CAR 001269781 of Laverne Capital Pty Ltd AFSL No. 482937.

The material in this document may contain general advice or recommendations which, while believed to be accurate at the time of publication, are not appropriate for all persons or accounts. This document does not purport to contain all the information that a prospective investor may require.  The material contained in this document does not take into consideration an investor’s objectives, financial situation or needs. Before acting on the advice, investors should consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation, and needs. The material contained in this document is for sales purposes. The material contained in this document is for information purposes only and is not an offer, solicitation or recommendation with respect to the subscription for, purchase or sale of securities or financial products and neither or anything in it shall form the basis of any contract or commitment. This document should not be regarded by recipients as a substitute for the exercise of their own judgment and recipients should seek independent advice.

The material in this document has been obtained from sources believed to be true but neither Laverne and Banyan Tree nor its associates make any recommendation or warranty concerning the accuracy or reliability or completeness of the information or the performance of the companies referred to in this document. Past performance is not indicative of future performance. Any opinions and or recommendations expressed in this material are subject to change without notice and, Laverne and Banyan Tree are not under any obligation to update or keep current the information contained herein. References made to third parties are based on information believed to be reliable but are not guaranteed as being accurate.

Laverne and Banyan Tree and its respective officers may have an interest in the securities or derivatives of any entities referred to in this material. Laverne and Banyan Tree do and seek to do business with companies that are the subject of its research reports. The analyst(s) hereby certify that all the views expressed in this report accurately reflect their personal views about the subject investment theme and/or company securities.

Although every attempt has been made to verify the accuracy of the information contained in the document, liability for any errors or omissions (except any statutory liability which cannot be excluded) is specifically excluded by Laverne and Banyan Tree, its associates, officers, directors, employees, and agents.  Except for any liability which cannot be excluded, Laverne and Banyan Tree, its directors, employees and agents accept no liability or responsibility for any loss or damage of any kind, direct or indirect, arising out of the use of all or any part of this material.  Recipients of this document agree in advance that Laverne and Banyan Tree are not liable to recipients in any matters whatsoever otherwise; recipients should disregard, destroy or delete this document. All information is correct at the time of publication. Laverne and Banyan Tree do not guarantee reliability and accuracy of the material contained in this document and are not liable for any unintentional errors in the document.

The securities of any company(ies) mentioned in this document may not be eligible for sale in all jurisdictions or to all categories of investors. This document is provided to the recipient only and is not to be distributed to third parties without the prior consent of Laverne and Banyan Tree.

Categories
LICs LICs

Blackstone Remains the Go-To Firm in the Alternative Asset Management Segment

Business Strategy & Outlook:

Blackstone has built a solid position in the alternative asset-management industry, utilizing its reputation, broad product portfolio, investment performance track record and cadre of dedicated professionals to not only raise massive amounts of capital but maintain the reputation it has built for itself as a “go-to firm” for institutional and high-net-worth investors looking for exposure to alternative assets. Unlike the more traditional asset managers, who have had to rely on investor inaction (driven by either good fund performance or investor inertia/uncertainty) to keep annual redemption rates low, the products offered by alternative asset managers can have lockup periods attached to them, which prevent investors from redeeming part or all of their investment for a prolonged period of time. 

Blackstone is one of the world’s largest alternative asset managers with $880.9 billion in total assets under management, including $650.0 billion in fee-earning assets under management, at the end of 2021. The company’s portfolio is broadly diversified across four business segments–private equity (24% of fee-earning AUM and 32% of base management fees), real estate (34% and 39%), credit & insurance (30% and 16%), and hedge fund solutions (11% and 13%) –and it primarily serves clients in the institutional channel. With customer demand for alternatives increasing, and investors in alternative assets attempting to limit the number of providers they use, large-scale players like Blackstone are well positioned to gather and retain assets for their funds. That said, investors in Blackstone are betting that the company’s outstanding investment track record and fundraising capabilities will continue into the future. While the confidence in the firm’s ability to earn excess returns over the next 10 years, it will become increasingly difficult for the company to do so longer-term as increased competition from peers (including more traditional asset managers like BlackRock), continued pressure on fees, and a general maturation of the segment (from a solid period of above average growth due to shifting investor demand for alternatives) weigh on results.

Financial Strengths:

Blackstone’s business model depends heavily on having fully functioning credit and equity markets that will allow its investment funds to not only arrange financing for leveraged buyouts and/or additional debt issuances for the companies and properties it oversees but cash out of them once their investment has run its course. While the company saved itself a lot of headaches during the collapse of the credit and equity markets during the 2008-09 financial crisis by having relatively little debt on its own books, debt levels crept up to less-than-ideal levels during 2010-19. Given that asset managers like Blackstone have a high degree of revenue cyclicality and operating leverage, and are generally asset light, they should not maintain more than low to moderate levels of financial leverage. 

The company entered 2022 with $7.6 billion in longer-term debt (on a principal basis) on its books, with 60% of that total coming due during 2030-50. The company also has a $2.25 billion revolving credit facility (which expires in November 2025) but had no outstanding balances at the end of January 2022. Blackstone should enter 2023 with a debt/total capital ratio of 44%, debt/EBITDA (by our calculations) at 1.1 times, and interest coverage of more than 30 times. On the distribution front, share repurchases have been rare over the past decade, with the company repurchasing (net of issuances) just over $3 billion of stock (most of which was bought back in the past four calendar years). Dividend payments, meanwhile, exceeded $25 billion during 2012-21 and are expected to account for 85% of distributable earnings annually going forward.

Bulls Say:

  • Blackstone, with $650 billion in fee-earning AUM at the end of 2021, is a “go-to firm” for institutional and high-net-worth investors looking for exposure to alternative assets.
  • The company’s ever-increasing scale, diversified product offerings, long track record of investment performance and strong client relationships position the firm to perform well in a variety of market conditions.
  • Customer demand for alternatives has been increasing, with institutional investors in the category limiting the number of providers they use—both positives for Blackstone’s business model.

Company Description:

Blackstone is one of the world’s largest alternative asset managers with $880.9 billion in total asset under management, including $650.0 billion in fee-earning asset under management, at the end of 2021. The company has four core business segments: private equity (24% of fee-earning AUM, and 32% of base management fees, during 2021); real estate (34% and 39%); credit & insurance (30% and 16%); and hedge fund solutions (12% and 13%). While the firm primarily serves institutional investors (87% of AUM), it does serve clients in the high-net-worth channel (13%). Blackstone operates through 25 offices located in the Americas (8), Europe and the Middle East (9), and the Asia-Pacific region (8).

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
ETFs ETFs

iShares S&P 500 ETF: Seamless Execution at an Unmatched Fee

Approach

IVV tracks the S&P 500, a free-float, market-cap-weighted benchmark composed of large-cap US equities. Constituents are determined by a set of criteria and an index committee. The minimum market cap for companies in the index is about USD 5 billion. A slight quality tilt exists because of its conservative eligibility requirements pertaining to unprofitable companies and recent IPOs. Moving away from the cross-listing structure in September 2018, IVV now invests directly into a US-listed version of the strategy. Although it lacks exposure to small and mid-caps, the constituents of this index account for about 80% of the total market cap of the US stock market. Portfolio turnover is expected to be very low, in line with the underlying index. IVV distributes quarterly. IShares can reinvest dividends. Also, the underlying US-listed version engages in securities lending, adding some incremental returns to the Australian vehicle’s overall performance. In terms of its portfolio role, the ETF can be used as a core international equity holding, although it should be paired with an ex US equity offering for full global exposure.

Portfolio

The ETF mirrors the composition of the large-cap market, allowing the market to dictate its stock and sector weightings. This allows the ETF to harness the market’s collective view about the relative value of each stock and keeps turnover low, which is among the lowest in the category. As of 28 Feb 2022, the strategy’s top 10 holdings account for about 28% of the total assets, and the largest holding (Apple) accounts for 6.9% of assets, which effectively diversifies firm-specific risk. Information technology has been the largest sector exposure within the index (25.6% as of 28 Feb 2022), reflecting the dominance of tech stocks over the US large-cap space; however, it is underweight compared with the category average.

 The strategy is slightly underweight in technology, consumer cyclical, and communication services and overweight in financial services and healthcare compared with the average rival. The strategy has substantial indirect global exposure given the significant stakes it holds in several multinational companies. With a large chunk of the underlying companies’ asset-weighted revenue generated outside of the US, this feature adds to the geographic diversification of the ETF. The strategy is large-cap-focused with no small and mid-caps within its constituents. 

People

We are impressed with the management team and believe BlackRock’s vast resources give it an advantage. Day-to-day management of the Australia-domiciled ETF is shouldered by Derek Dei and his team located in Hong Kong. The team is responsible for overseeing more than 60 index funds and ETFs operating in the Asia Pacific region. However, the underlying US-listed ETF is managed by Alan Mason and his team of four portfolio managers based out of the US. Mason is the longest-tenured member of the team and has served as a portfolio manager at the firm since 1991. Greg Savage deals with multi-asset strategies, Jennifer Hsui monitors emerging-markets funds, Rachel Aguirre has responsibility for the institutional developed-markets and US funds, and Amy Whitelaw oversees North America and Latin America ETFs.

 These managers interact with a wider team of traders and managers around the globe to execute the fund’s day-to-day operations. The impact of personnel turnover is minimal when it does occur. Most of the portfolio management process is automated, and portfolio managers primarily review and approve trades prior to and after execution. The team employs BlackRock’s Aladdin platform to deliver much of its portfolio management tasks. Global trading desks allow traders to conduct foreign transactions in a cost-effective manner, and the team has maintained tight index tracking

Performance 

VV seeks to deliver the risk/reward profile of the US large-cap equity market via tracking one of the most popular indexes, the S&P 500. In the process, it sets a high hurdle for active managers to beat. BlackRock employs its sophisticated portfolio management systems and trading capabilities to emulate the risk/reward profile characteristics of the S&P 500, achieving low tracking error against the index. Over the trailing 10 years through 28 Feb 2022, the ETF has outperformed the category average by 67 basis points per year, with lower volatility. Much of this outperformance can be attributed to the strategy’s cost advantage; lower-thanaverage cash drag; and more favorable stock exposure in the technology, utilities, consumer cyclical, and consumer defensive sectors compared with the category average. IVV has held up as well as most of its peers during downturns since inception, despite its lower-than-average cash balance. Most actively managed strategies in the category keep larger cash balances on hand to meet redemptions, helping out during bear markets.

About Fund:

As the uptake for US large-cap equities increases, particularly through the passive route, iShares S&P 500 ETF IVV continues to be a very good investment on the back of seamless execution at an unmatched fee. The strategy is expected to outperform its peers over the long term and remains the clear choice for investors to gain US exposure. The underlying benchmark, the S&P 500, is a market-cap-weighted index of the largest 500 companies in the United States. Thus, it offers giant- to mid-cap exposure, covering about 80% of the free-float-adjusted market capitalisation of the US equity market. This results in a well-diversified index, at the stock and sector levels. As such, passive strategies that track the S&P 500 stand as above-average options in a market segment where active managers have generally struggled to outperform. Consisting of highly liquid stocks, material stock-specific valuation information is quickly incorporated into stock prices. 

From an Australian perspective, IVV gives exposure to a broad portfolio of some of the world’s most noteworthy companies, including sectors that are underrepresented in Australia, such as technology and healthcare. The S&P 500’s correlation to Australian equities has come down in recent years, effectively adding to diversification for Australian equities exposure. This vehicle invests into the US-listed version, which engages in securities lending to garner some incremental returns.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
ETFs ETFs

Magellan High Conviction ETF: A Highly Intense Strategy Reshuffles Its Leadership

Approach

This exchange-traded fund is the listed entry point for the unlisted Magellan High Conviction, after converting from a closed-end structure in August 2021. Magellan believes sustainable competitive advantages enable companies to earn lasting returns above their cost of capital. Concentrating on financial services, consumer franchises, IT, healthcare, industrials, and infrastructure trims the universe to about 4,000 names. Quantitative and qualitative screening cuts this down to about 200 stocks. These filters exclude measures incorporating current market prices, although Magellan seeks firms that have enduring competitive advantages, lucrative reinvestment potential, low agency risk, and low business risk to facilitate predictable cash flows. Relying mainly on discounted cash flow techniques, analysts elongate the model’s duration for wide-moat stocks and vice versa. 

Targets must be discounted sufficiently to intrinsic value to give a margin of safety. Stocks are ranked along qualitative and valuation dimensions, from which Magellan constructs an ultraconcentrated portfolio of eight to 12 of the best ideas. Unlike the Magellan Global strategy, there are no hard limits on the portfolio’s “combined risk ratio” (a proprietary risk measure based on historic stock beta and drawdown risk). The portfolio can hold up to 50% cash, which aims to provide protection in a falling market. From November 2020, the portfolio has unhedged currency exposure, having previously been actively hedged based on the managers’ views. Magellan publishes an intraday net asset value on its website to help price discovery. It is calculated using live prices and foreign exchange movements but doesn’t use futures, so it might be a lagging indicator in highly volatile markets. The vehicle targets a spread of 7 basis points on either side, but they can widen notably during volatile periods.

Portfolio

Magellan ignores index weightings when building this ultraconcentrated portfolio of eight to 12 companies. Historically, the manager has tilted towards consumer-related and technology sectors while steering clear of commodities. By its nature, sector concentration is large, and as at January 2022, 62% of the portfolio was exposed to information technology and Internet and e-commerce, while consumer discretionary and financials names accounted for less than 10% each. The manager’s preference for giant-cap multinationals with strong franchise value also leads to a strong bias towards North America. At year-end 2021, the portfolio held only three stocks outside of the United States, with Chinese ecommerce giant Alibaba the portfolio’s smallest holding. 

However, the managers carefully assess the portfolio’s underlying earnings exposure by geography, and on this basis European and emerging-markets ex-China exposure was around 32%. No single position can exceed 20% of the portfolio, and no more than four stocks can be weighted at over 12.5% each. The portfolio can hold up to 50% cash. At the end of 2021, the cash position was 5%. Turnover ranges between 30% and 40% and is lumpy given that a single stock initial purchase or exit represents a sizable trade. Given the strategy’s high level of concentration, it is suitable as a supporting player, composing only part of a more broadly diversified portfolio.

People

CIO Hamish Douglass co-founded Magellan and has been this strategy’s key decision-maker. In February 2022, he announced an indefinite leave of absence due to medical reasons, forcing a new lead portfolio manager. The firm called on Douglass’ co-founder Chris Mackay to step into the lead role as replacement. Mackay was Magellan’s CIO from 2006 inception to 2012, before choosing to focus on managing the listed MFF Capital Investments. At the same time, former head of research Nikki Thomas rejoined Magellan as comanager on the flagship strategy, after departing in 2017 following the decision to cease development of the non-US strategy she managed. Thomas had a four-year stint comanaging Alphinity’s global equities strategy. In early 2018, Chris Wheldon rejoined the group as assistant portfolio manager, concentrating on the High Conviction strategy as comanager. He had previously spent eight years at Magellan working as an analyst in the franchises team and as head of the industrials team, before a stint at US-based Davis Advisors. 

There is the backing of a strong team of investors and analysts, however. This includes Dom Giuliano, who was promoted to deputy CIO in December 2014, and Gerald Stack, who oversees the team as head of investments and is chair of the investment committee. Similarly, portfolio managers Chris Wheldon, Arvid Streimann, and Stefan Marcionetti have experience as a sounding board to Douglass at the portfolio level. 

Performance 

Magellan High Conviction unlisted fund has delivered performance slightly below benchmark and category average since its inception in July 2013 to January 2021. Significant underperformance over 2020 and 2021 has undone the strategy’s respectable track record. Measured over all rolling three-year periods, it outpaced the benchmark over 75% of the time during its history. The returns have also exceeded the manager’s target absolute return of 10% per year. Indeed, 2016 was a setback when positioning into Brexit, then the Trump reflation rally, saw the fund lag the market. This underperformance was more than made up for in 2017 by almost 10% outperformance, driven by holdings in Apple and Facebook. 

The year 2018 was more volatile, but the strategy still managed to achieve a positive return of 3.4% and beat out the benchmark. Notably, however, it lagged the flagship Magellan Global strategy by around 6.4% as the latter’s more-diversified portfolio did better during the more volatile periods of the year. The portfolio kept pace in 2019’s strongly rising market, with many of its tech holdings appreciating significantly. But the strategy’s punchy approach fell significantly behind the index throughout a volatile 2020 market. Active currency hedging also detracted value over the year to October. Fortunes weren’t any better in 2021, trailing the benchmark by a similarly wide margin, as volatility returned to technology names and Alibaba sold-off heavily.

About Fund:

The Magellan High Conviction Trust seeks to invest in outstanding companies at attractive prices, while exercising a deep understanding of the macroeconomic environment to manage investment risk. This vehicle is the listed entry point for the unlisted Magellan High Conviction. CIO Hamish Douglass announced a medical leave of absence from Magellan in February 2022, leaving a big void to fill. His indefinite absence exposes Magellan’s lack of succession planning across the investment team and the broader business. The firm has had to step outside the immediate team, albeit to somewhat familiar faces. Magellan co-founder Chris Mackay returns to the fold as lead manager; he had relinquished the CIO role in 2012 to focus on managing MFF Capital Investments. Portfolio manager Chris Wheldon provides some continuity, having been comanager alongside Douglass since rejoining the firm in 2018 after a stint at a USbased manager. 

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Shares Small Cap

Upon U.S. federal legalization, Tilray to own 21% of the U.S. multistate operator

Business Strategy and Outlook

Tilray cultivates and sells cannabis in Canada and exports into the global medical market. It also sells CBD products in the U.S. The company is the result of legacy Aphria acquiring legacy Tilray in a reverse merger and renaming itself Tilray in 2021. Canada legalized recreational cannabis in October 2018. Since then, recreational sales have come to represent an increasingly larger portion of sales for producers. The Canadian market is overly crowded with producers, so Tilray faces stiff competition to develop consumer brands that can lead to meaningful pricing power. Buoyed by attractive deal terms, Tilray’s acquisition of HEXO’s senior secured convertible notes could potentially help drive necessary market consolidation.

Legacy Aphria had an extensive international distribution business, which generated the majority of its net revenue, a far larger portion than many of its Canadian cannabis peers. Legacy Tilray had also entered the global medical market. With both companies’ international capabilities intact, Tilray looks well positioned. The global market looks lucrative given higher realized prices and growing acceptance of the medical benefits of cannabis. Exporters must pass strict regulations to enter markets, which protects early entrants. It is foreseen, roughly 15% average annual growth through 2030 for the global medicinal market excluding Canada and the U.S.

In 2020, legacy Aphria acquired SweetWater, a U.S. craft brewery. Legacy Tilray previously acquired Manitoba Harvest to distribute CBD products in the U.S. It finally secured a toehold into U.S. THC when it acquired some of MedMen’s outstanding convertible notes. Upon U.S. federal legalization, Tilray would own 21% of the U.S. multistate operator. Furthermore, Tilray paid a great price while also getting downside protection as a debtholder. It is held, the U.S. offers the fastest growth of any market globally. However, the regulatory environment is murky with individual states legalizing cannabis while it remains illegal federally. It is alleged federal law will eventually be changed to allow states to choose the legality of cannabis within their borders

Financial Strength

At the end of its third fiscal quarter 2022, Tilray had about $710 million in total debt, excluding lease liabilities. This compares to market capitalization of about $4 billion.In addition, Tilray had about $279 million in cash, which will allow it to fund future operations and investments. Management has been deliberate with its SG&A spending given the slow rollouts and regulatory challenges the Canadian market has faced. Legacy Aphria was the first major Canadian producer to reach positive EBITDA, with legacy Tilray reaching positive EBITDA in the quarter immediately preceding its acquisition. However, the combined company continues to generate negative free cash flow to the firm, which pressures its financial health.The proposed deal to purchase $211 million in HEXO senior secured convertible notes is unlikely to add any pressure to Tilray’s financial health.With most of its development costs completed, it is anticipated Tilray will have moderate capital needs in the coming years. As such, it is held, debt/adjusted EBITDA to decline. It is alleged Tilray is unlikely to require significant raises of outside capital. In September 2021, the company received shareholder approval for increasing its authorized shares in order to rely on equity for future acquisitions. This bodes well for keeping its financial health strong.

Bulls Say’s

  • Legacy Aphria’s acquisition of Legacy Tilray created a giant with leading Canadian market share, expanded international capabilities, and U.S. CBD and beer operations.
  • Tilray’s management focuses on strategic SG&A spending and running a lean business model, benefiting its financial health in the early growth stage industry.
  • Tilray management’s careful approach to expansion has allowed it to reach profitability faster than any of its Canadian peers.

Company Profile

Tilray is a Canadian producer that cultivates and sells medical and recreational cannabis. In 2021, legacy Aphria acquired legacy Tilray in a reverse merger and renamed itself Tilray. The bulk of its sales are in Canada and in the international medical cannabis export market. U.S. exposure consists of CBD products through Manitoba Harvest and beer through SweetWater.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks Shares

Carnival’s Return to Profitability in Sight Despite Omicron and Geopolitical Speed Bumps

Business Strategy & Outlook:

Carnival remains the largest company in the cruise industry, with nine global brands and 91 ships at 2021 fiscal year-end. The global cruise market has historically been underpenetrated, offering cruise companies a long-term demand opportunity. Additionally, in recent years, the repositioning and deployment of ships to faster-growing and under-represented regions like Asia-Pacific had helped balance the supply in high-capacity regions like the Caribbean and Mediterranean, aiding pricing. However, global travel has waned as a result of COVID-19, which has the potential to spark longer-term secular shifts in consumer behavior, challenging the economic performance of Carnival over an extended horizon. As consumers have slowly resumed cruising since the summer of 2021 (after a year-plus no-sail halt), the cruise operators will have to continue to reassure passengers of both the safety and value propositions of cruising. 

On the yield side, the Carnival is expected to see some pricing pressure as future cruise credits continue to be redeemed through 2022, a headwind partially mitigated by the return of capacity via full deployment of the fleet. And on the cost side, higher spend to maintain tighter cleanliness and health protocols should keep expenses inflated. Aggravating profits will be staggered reintroduction of the fleet through the first half of 2022, crimping near-term profitability and ceding previously obtained scale benefits. As of March 22, 2022, 75% of capacity was already deployed and the entire fleet should be sailing by the important summer season. These persistent concerns, in turn, should lead to average returns on invested capital including goodwill, that are set to languish below our 10.4% weighted average cost of capital estimate until 2026, which supports our no-moat rating. While Carnival has carved out a broad offering across demographics, the product still has to compete with other land-based vacations and discretionary spending for share of wallet. It could be harder to capture the same percentage of spending over the near term given the perceived risk of cruising, heightened by persistent media attention.

Financial Strengths:

Carnival has secured adequate liquidity to survive a slow resumption of domestic cruising, with around $7 billion in cash and investments at the end of February 2022. This should cover the company’s cash burn rate through the end of the redeployment ramp-up, which had run around $500 million or more in recent months due to higher ship startup costs. The company has raised significant levels of debt since the onset of the pandemic with $35 billion in total debt, up from around $12 billion at the end of 2019. The company has less than $3 billion in short term and $2 billion in long-term debt coming due over the next year (as of Feb. 28, 2022).

The company is focused on reducing debt service as soon as reasonably possible in order to reduce future interest expense. It has also actively pursued the extension of maturities, limiting the cash demand on debt service over the near term.  Carnival has just over one year’s worth of liquidity to operate successfully in a no-revenue environment. There is no anticipation on an imminent credit crunch in the near term, even with no associated revenue (which the company has successfully resumed capturing), as long as capital markets continue to function properly. Additionally, in order to free up cash to support operating expenses, Carnival eliminated its dividend in 2020 ($1.4 billion in 2019). Another $3 billion in current customer deposits were on the balance sheet, offering working capital that can be utilized to run the business and indicating demand for cruising still exists. And capital markets remain open to financing, with the company announcing a $500 million at-the-market equity raise at the end of January 2022, indicating access to cash is still plentiful.

Bulls Say:

  • As Carnival deploys its fleet, passenger counts and yields could rise at a faster pace than we currently anticipate as capacity limitations are repealed.
  • A more efficient fleet composition (after pruning 19 ships at the onset of the pandemic) may benefit the cost structure to a greater degree than initially expected, as sailings fully resume.
  • The nascent Asia-Pacific market should remain promising post-COVID-19, as the four largest operators had capacity for nearly 4 million passengers in 2020, which provides an opportunity for long-term growth with a new consumer.

Company Description:

Carnival is the largest global cruise company, with 91 ships in its fleet at the end of fiscal 2021, with all of its capacity set to be redeployed by summer 2022. Its portfolio of brands includes Carnival Cruise Lines, Holland America, Princess Cruises, and Seabourn in North America; P&O Cruises and Cunard Line in the United Kingdom; Aida in Germany; Costa Cruises in Southern Europe; and P&O Cruises in Australia. Carnival also owns Holland America Princess Alaska Tours in Alaska and the Canadian Yukon. Carnival’s brands attracted about 13 million guests in 2019, prior to COVID-19.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks Shares

Narrow-Moat Nordstrom Poised for a Turnaround as Its Strategic Plans Take Hold

Business Strategy & Outlook:

Nordstrom continues to be a top operator in the competitive U.S. apparel market. The firm has, cultivated a loyal customer base on its reputation for differentiated products and service and has built a narrow moat based on an intangible brand asset. While the company was unprofitable in 2020 because of the COVID-19 crisis, its profitability returned in 2021, and its brand intangible asset is intact. Despite a rocky couple of years, the Nordstrom’s full-price and Rack off-price stores have competitive advantages over other apparel retailers.

Nordstrom is responding well to changes in its market. The company has about 100 full-price stores, with nearly all of them in desirable Class A malls (sales per square foot above $500) or major urban centers. This is viewed as an advantage, as some lower-tier malls are unlikely to survive. Moreover, Nordstrom has a presence in discount retail with Rack (about 250 stores) and significant e-commerce (42% of its sales in 2021). Still, the firm’s full-price business is vulnerable to weakening physical retail, and Rack competes with firms like no-moat Poshmark and narrow-moats TJX and Ross.

Nordstrom unveiled a new strategic plan, Closer to You, in early 2021 that emphasizes e-commerce, growth in key cities (through Local and other initiatives), and a broader off-price offering. Among

the merchandising changes, Nordstrom intends to increase its private-label sales (to 20% of sales from 10% now) and greatly expand the number of items offered through partnerships (to 30% from 5% now). The firm set medium-term targets of annual revenue of $16 billion-$18 billion, operating margins above 6%, annual operating cash flow of more than $1 billion, and returns on invested capital in the low teens. Nordstrom will consistently generate more than $1 billion in operating cash flow, achieve ROICs in the teens, and reach $16 billion in annual revenue in 2024. However, they will trend higher, the operating margins will be slightly below 6% in the long run due to intense competition, but this could change if some of the new initiatives are more successful than expected.

Financial Strengths:

The Nordstrom is in good financial shape and will overcome the virus-related downturn in its business. The firm closed 2021 with more than $300 million in cash and $800 million available on its revolving credit facility. Although it also had $2.9 billion in long-term debt, most of this debt does not mature until after 2025. Nordstrom had net debt/EBITDA of a reasonable 2.5 times at the end of 2021. Nordstrom generated $200 million in free cash flow to equity in 2021, but this amount to rise through reductions in operating expenses, working capital management, and moderate capital expenditures. As per forecast an annual average of about $840 million in free cash flow to equity over the next decade. As Nordstrom’s results have improved, it has resumed cash returns to shareholders. In 2021, about $250 million in share repurchases and dividends totaling $0.76/share (23% payout ratio). Also, to conserve cash, Nordstrom has suspended its dividends and share repurchases (used more than $400 million combined in cash in 2019), but to anticipate both will resume in 2022. Over the next decade, the buybacks of about $340 million per year and an average dividend payout ratio of about 23%. Nordstrom’s capital expenditures were quite elevated prior to 2020. Its store count has increased from 292 at the end of 2014 to about 360 today as more than 60 Rack stores have opened

since 2014 and the company has expanded into Canada and New York City. Nordstrom has estimated its total investment in Canada and New York at $1.1 billion for 2014-19. The estimated Nordstrom’s yearly capital expenditures will average about $650 million over the next decade, well below 2019’s $935 million. 

Bulls Say:

  • ONordstrom’s online sales exceeded $6 billion in 2021, making it one of the largest e-commerce firms in the U.S.
  • ONordstrom suspended dividends and share repurchases   when the pandemic hit but has resumed cash returns to shareholders. The projected annual combined dividends and share purchase above $400 million over the next five years.
  • ONordstrom serves an affluent customer base in its full line stores, which separates it from the many midlevel retailers in malls. Most of its stores are in productive malls that are not expected to close.

Company Description:

Nordstrom is a fashion retailer that operates approximately 100 department stores in the U.S. and Canada and approximately 250 off-price Nordstrom Rack stores. The company also operates both full- and off-price e-commerce sites. Nordstrom’s largest merchandise categories are women’s apparel (28% of 2021 sales), shoes (25% of 2021 sales), men’s apparel (14% of 2021 sales) and women’s accessories (14% of 2021 sales). Nordstrom, which traces its history to a shoe store opened in Seattle in 1901, continues to be partially owned and managed by members of the Nordstrom family.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.