Category: Sectors

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Technology Stocks

Charter Claims More Than 70% Of Internet Access Market Across Territory

Business Strategy and Outlook

It is impressive, Charter’s aggressive effort to drive customer penetration by limiting price increases, improving customer service, and expanding its offerings to appeal to a variety of preferences. It is likely the firm will successfully navigate growing competition from the phone companies, though growth will likely slow in the coming years. Charter’s aggression extends to its capital structure, where heavy share repurchases have bolster shareholder returns but have also kept debt leverage high, which will likely add volatility to the share price and could limit financial flexibility. 

Charter’s cable networks have provided a significant competitive advantage versus its primary competitors–phone companies like AT&T–as high-quality Internet access has become a staple utility. It is anticipated the firm now claims about 70% of the Internet access market across the territories it serves, up about 9 percentage points over the past five years and still marching higher. Charter has been able to upgrade its network to meet consumer demand for faster speeds at modest incremental cost while the phone companies have largely ignored their networks across big chunks of the country. Phone companies, notably AT&T, are starting to increase fiber network investment, which is projected will hit Charter at the margin–the firm has faced less fiber competition than its major cable peers. However, it is held Charter will remain a strong competitor even when faced with improved rival networks. 

Wireless technology has emerged as a potential new competitor to fixed-line Internet access. Analyst’s sceptical of wireless’ ability to meet network capacity on a wide scale for the foreseeable future. Also, it is likely dense fixed-line networks like Charter’s will play an increasingly important role in powering wireless networks in the future. Charter also faces declining demand for traditional television services, but here again it isn’t seized investors should be concerned. The amount of profit the firm earns from television service has been declining for several years. Internet access, now the bedrock of Charter’s customer relationships, delivers the vast majority of cash flow today.

Financial Strength

Charter operates under a fairly heavy debt load, with net leverage standing at 4.6 times EBITDA, by analysts’ calculation, a level that has held steady in recent quarters. Charter’s management team has run with a net leverage target of 4.0-4.5 times EBITDA over the past several years, typical of firms under the influence of Liberty and John Malone. By the firm’s calculation, net leverage was 4.4 times EBITDA at the end of 2021. This debt level is higher than its peer Comcast, which has typically targeted net leverage of around 2.0-2.5 times EBITDA. On the other hand, Charter’s leverage is more modest than Altice USA’s at roughly 5.5 times EBITDA. Charter typically directs free cash flow and the proceeds from incremental borrowing to fund share repurchases as a means of keeping leverage within its target range as EBITDA grows. The firm believes that it could reduce leverage quickly if its borrowing costs or business outlook change materially in the future. The firm generated free cash flow of about $8.7 billion in 2021 and spent $17.7 billion repurchasing shares and partnership units held by Advance/Newhouse. As a result, net debt increased to $91 billion from $82 billion at the start of the year. Importantly, free cash flow will face headwinds in the coming years as Charter begins paying federal taxes, which are likely to be meaningful starting in 2022. Charter has actively managed its debt load in recent years, trimming interest rates and pushing out maturities. About $7.5 billion of debt comes due through 2024 and its weighted average maturity stands at about 14 years at an average cost of 4.5%.

Bulls Say’s

  • Like its cable peers, Charter’s networks provide a platform to easily meet customers’ growing bandwidth demands, which should drive market share gains and strong recurring cash flow. 
  • As the second-largest U.S. cable company, Charter has the scale to efficiently adapt to changes hitting the telecom industry. The firm will be a force in the wireless industry eventually. 
  • Holding prices down to drive market share gains will pay huge dividends down the road, pushing costs lower and cementing Charter’s competitive position.

Company Profile 

Charter is the product of the 2016 merger of three cable companies, each with a decades-long history in the business: Legacy Charter, Time Warner Cable, and Bright House Networks. The firm now holds networks capable of providing television, Internet access, and phone services to roughly 54 million U.S. homes and businesses, around 40% of the country. Across this footprint, Charter serves 29 million residential and 2 million commercial customer accounts under the Spectrum brand, making it the second-largest U.S. cable company behind Comcast. The firm also owns, in whole or in part, sports and news networks, including Spectrum SportsNet (long-term local rights to Los Angeles Lakers games), SportsNet LA (Los Angeles Dodgers), SportsNet New York (New York Mets), and Spectrum News NY1 

(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
Small Cap

New Breakfast Lineup Driving Impressive Growth for Narrow Moat Hostess

Business diagram on financial report with coins

Business Strategy and Outlook

Although the previous owners of the Hostess brand filed for bankruptcy in 2004 and 2012, we contend it was due not to a lack of brand equity but rather highly inefficient manufacturing and distribution systems, a powerful unionized workforce, and a high debt load. In the four years preceding the pandemic, Hostess averaged 6.4% organic growth, materially outpacing the sweet baked goods category. Market share gains were driven by regained shelf space that was lost during its 2012-13 hiatus, expansion into new channels (enabled by its differentiated direct-to-warehouse delivery system), and expanded breakfast and value brand offerings.

Hostess has created significant shareholder value via its disciplined acquisition strategy. Although the 2018 Cloverhill acquisition initially depressed margins, the business is now generating healthy profits, and the deal provided a breakfast platform and access to the club channel, where the firm is expanding the Hostess brand. 

Financial Strength

Although previous owners of the brand filed bankruptcy in 2004 and 2012, that Hostess Brands is a much different company now, having shed the highly inefficient manufacturing and distribution systems, powerful unionized workforce, and high debt load responsible for the insolvencies. The current company is an entirely new entity. After the 2012 bankruptcy, investors purchased only the brand rights and recipes from the bankruptcy court, freeing them of employee benefits and other labor obligations that had weighed down the company. The new company has a highly efficient cost structure and operates with a cost-effective direct-to-warehouse model, whereas the predecessor firm operated with a more expensive direct-store-delivery model.

That said, the firm targets a 3-4 times net debt/adjusted EBITDA, a bit higher than most packaged-food companies, given its plan to expand into adjacent categories via acquisitions. As of September 2021, the ratio stood at 3.3 times. But the firm generates an impressive amount of free cash flow. Hostess’ free cash flow as a percentage of sales should average 12% over the next five years, comparable to most packaged food companies. 

Bulls Say’s 

  • The firm’s DTW distribution model allows it to penetrate channels previously not accessible (channels difficult for the firm’s DSD competitors to access), providing attractive, untapped growth opportunities. 
  • Hostess’ acquisitions in the breakfast and cookie segments provide it with a great foundation to expand into adjacent categories. 
  • The Hostess brand has exhibited impressive staying power throughout its 100-year history, outlasting many nutritional and diet fads, and we think the firm’s commitment to invest behind further innovation should ensure this persists.

Company Profile 

Hostess Brands is the second-largest U.S. provider of sweet baked goods under the Hostess, Voortman, and Dolly Madison group of brands, including Twinkies, Cupcakes, Ding Dongs, Ho Hos, Donettes, and Zingers. In 2018, Hostess expanded its breakfast offerings with the purchase of Aryzta’s breakfast assets (the Cloverhill business), including a branded business and private-label deals, and in 2020 entered the cookie category via the Voortman tie-up. Although its roots stem from the 1919 launch of the Hostess Cupcake, the company filed for bankruptcy in 2012. Investors purchased the brands and restarted production in 2013, followed by a 2016 initial public offering. Most products are sold in the U.S., although third parties distribute some product to Mexico, the United Kingdom, and Canada. 

(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

Dr. Reddy’s Continues to Weather Generic Drug Erosion in Core Markets

Business Strategy and Outlook

Dr. Reddy’s Laboratories is a global pharmaceutical company based in Hyderabad, India. It manufactures and markets generic drugs and active pharmaceutical ingredients in markets across the world, but predominantly in the United States, India, and Eastern Europe. Indian pharmaceutical manufacturers have seen success over the past decade in penetrating the U.S. market, where regulatory hurdles are lower than in Western Europe. With competition on price in a commodified space, the entry of low-cost manufacturers has facilitated a deflationary price environment for generic drugs since 2015, putting substantial pressure on the margins of established manufacturers. Conversely, in India and other countries with lower generics adoption, so-called “branded” generics have seen notable success. 

Generic manufacturers have taken different approaches to combat margin pressure over the past few years. While some manufacturers have addressed competition by rationalizing their U.S. portfolio and discontinuing low-margin or unprofitable drugs, Dr. Reddy’s has remained focused on expanding its U.S. market share. While its U.S. portfolio has experienced marginally higher deflation compared with peers, its pipeline is increasingly leaning toward injectables and other complex generics that command higher margins and exhibit relatively more price stability.

Financial Strength

Overall, Dr. Reddy’s reported a relatively uneventful third quarter, with higher revenue across the board largely due to new product launches and market share gain. The company’s revenue grew 8% to INR 53.2 billion ($715 million) on a year-over-year basis driven by new product launches and higher sales volumes in the global generics business. North America generics, which represents the largest share of company revenue (35%), was positively affected during the quarter by launches for four new products but negatively impacted by erosion within in generic drug portfolio. On a sequential basis, revenue fell 8%, largely due to price erosion in generics and reduction of volume of COVID-19-related products.

As of the fourth calendar quarter of 2021, Dr. Reddy’s holds gross debt of INR 28 billion ($370 million), which is more than offset by the cash on the company’s balance sheet. With very low leverage, the company faces little liquidity risk. This compares favorably with other global generic manufacturers like Teva and Viatris, which are saddled with high leverage as a result of an aggressive acquisition strategy over the past decade. The company pays an annual dividend of $0.34 per share, which translates to a dividend yield of under 1%.

Bulls Say’s 

  • Dr. Reddy’s low-labor-cost operations based in India and vertical integration likely provide a low-cost edge. 
  • In the U.S. and Russia, Dr. Reddy’s has grown quickly in OTC generics, which is an attractive segment of the market with slightly higher barriers to entry than conventional retail pharmacy drugs. 
  • Dr. Reddy’s strong branded generic presence in emerging markets provides significant growth opportunities with less price competition than typically seen in developed markets.

Company Profile 

Headquartered in India, Dr. Reddy’s Laboratories develops and manufactures generic pharmaceutical products sold across the world. The company specializes in low-cost, easy-to-produce small-molecule generic drugs and active pharmaceutical ingredients. Its drug portfolio in recent years has included biosimilar drug launches in select emerging markets and has shifted toward injectables and more complex generic products. Geographically, the company’s sales are well dispersed across North America, India, and other emerging markets. 

(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

Demand for Construction Equipment Continue to Flourish, Benefiting Caterpillar

Business Strategy and Outlook

Caterpillar will continue to be the leader in the global heavy machinery market, providing customers an extensive product portfolio consisting of construction, mining, energy, and transportation products. For nearly a century, the company has been a trusted manufacturer of mission-critical heavy machinery, which has led to its position as one of the world’s most valuable brands. Caterpillar’s strong brand is underpinned by its high-quality, extremely reliable, and efficient products. Customers also value Caterpillar’s ability to lower the total cost of ownership. 

The company’s strategy focuses on employing operational excellence in its production process, expanding customer offerings, and providing value-added services to customers. Since 2014, Caterpillar has taken steps to reduce structural costs and its fixed asset base by implementing cost management initiatives and by either closing or consolidating numerous facilities, reducing its manufacturing floorspace considerably. Over the past decade, the company has continually released new products and upgraded existing product models to drive greater machine efficiency. Customers also rely on the services that Caterpillar provides, for example, machine maintenance and access to its proprietary aftermarket parts. Furthermore, its digital applications help customers interact with dealers, manage their fleet, and track machine performance to determine when maintenance is needed. 

Caterpillar has exposure to end markets that have attractive tailwinds. On the construction side, the company will benefit from legislation aimed at increasing infrastructure spending in the U.S. The country’s road conditions are in poor condition, which has led to pent-up road construction demand. In energy, the improvement in the price of oil since COVID-19 lows will encourage exploration and production companies to increase oil and gas capital expenditures, leading to increased sales of Caterpillar’s oil-well-servicing products. That said, it is believed mining markets will have limited upside, as fixed-asset investment growth in China starts to slow, likely capping commodity price upside.

Financial Strength

Caterpillar maintains a sound balance sheet. On the industrial side, the net debt/adjusted EBTIDA ratio was relatively low at the end of 2021, coming in at 0.2. Total outstanding debt, including both short- and long-term debt was $9.8 billion. Caterpillar’s strong balance sheet gives management the financial flexibility to run a balanced capital allocation strategy going forward that mostly favours organic growth and returns cash to shareholders. In terms of liquidity, the company can meet its near-term debt obligations given its strong cash balance. The company’s cash position as of year-end 2021 stood at $8.4 billion on its industrial balance sheet. It is comforting to find comfort in Caterpillar’s ability to tap into available lines of credit to meet any short-term needs. Caterpillar has access to $10.9 billion in credit facilities for the consolidated business (including financial services), of which, $2.9 billion is available to the industrial business. Caterpillar’s focus on operational excellence in its industrial operations and improved cost base has put the company on better footing when it comes to free cash flow generation throughout the economic cycle. The company can generate $6 billion in free cash flow in our midcycle year, supporting its ability to return nearly all its free cash flow to shareholders through dividends and share repurchases. The captive finance arm holds considerably more debt than the industrial business, but this is reasonable, given its status as a lender to both customers and dealers. Total debt stood at $28 billion in 2021, along with $27 billion in finance receivables and $826 million in cash. In our view, Caterpillar enjoys a strong financial position supported by a clean balance sheet and strong free cash flow prospects.

Bulls Say’s

  • Increased infrastructure spending in the U.S. and emerging markets will lead to more construction equipment purchases, substantially boosting Caterpillar’s sales growth. 
  • Higher fixed-asset investment growth in China strengthens support for increased investment in mining capital expenditures, benefiting Caterpillar. 
  • A continued recovery from the temporary demand shock in oil prices will lead to increased oil and gas capital expenditures, leading to more engine, transmission, and pump sales for Caterpillar.

Company Profile 

Caterpillar is an iconic manufacturer of heavy equipment, power solutions, and locomotives. It is currently the world’s largest manufacturer of heavy equipment with over 13% market share in 2021. The company is divided into four reportable segments: construction industries, resource industries, energy and transportation, and Caterpillar Financial Services. Its products are available through a dealer network that covers the globe with over 2,000 branches maintained by 168 dealers. Caterpillar Financial Services provides retail financing for machinery and engines to its customers, in addition to wholesale financing for dealers, which increases the likelihood of Caterpillar product sales.

(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
Funds Funds

JPMorgan U.S. Large Cap Core Plus Fund performing well with solid philosophy and consistently applied bottom-up process

Process:

The strategy rests on a solid philosophy and a clearly designed and consistently applied bottom-up process. The ability to leverage the analysts’ insights through both long and short positions makes it distinctive, though small active bets make us somewhat cautious regarding its alpha potential. The strategy aims to capture temporarily mispriced opportunities through consistent use of the analysts’ long-term valuation forecasts. Those derive from an in-house dividend-discount model that is fed by the team’s earnings, cash flow, and growth-rate estimates. The analysts rank stocks in each industry based on their estimated fair value. The managers incorporate these rankings into their stock-picking, expressing modest sector preferences based on their macroeconomic view.

Portfolio:

This benchmark-aware and highly diversified fund held 289 stock positions per end of November 2021, of which 124 are shorts. The long leg of the fund is conservatively managed, with modest bets versus the Russell 1000 Index and an active share of 55%-60%. NXP Semiconductors, Alphabet, and Amazon.com were the largest active positions in the portfolio, with an overweight of around 200 basis points. Rivian was bought in 2021 for risk-management considerations to offset the underweight of Tesla, which the managers never held. Most stocks that are sold short in the 30/30 extension carry a weight of less than 25 basis points.

People:

Growing confidence in the two experienced portfolio managers and the large and seasoned analyst team supporting them leads to an upgrade of the People Pillar rating to Above Average from Average. Susan Bao is an experienced and long-tenured manager on this strategy and is well-versed in the firm’s hallmark investment process. Bao and Luddy have also managed this 130/30 strategy together since the start of the U.S.-domiciled vehicle in 2005 and since 2007 on its offshore counterpart. Steven Lee succeeded Luddy in 2018. Lee brings close to three decades of experience, but most of it was gained as an analyst. Since 2014, he has managed JPMorgan US Research Enhanced Equity, the firm’s analyst-driven long-short strategy, which serves as the blueprint for this strategy’s 30/30 extension. Although portfolio management is collegial, Bao concentrates on consumer, financials, and healthcare, while Lee is the lead for industrial/commodities, technology, and utilities/telecom. While their collaboration is still relatively short, it has already proved fruitful, and the managers have demonstrated their ability to generate alpha from both long and short ideas provided by the analyst team.

Performance:

It has outperformed the Russell 1000 Index on a total return and alpha basis since inception and over shorter time horizons. Since Susan Bao and Steven Lee have comanaged the strategy, a more relevant period to consider, the strategy also outperformed its average peer and the index. However, results were a bit mixed during that period, with a disappointing performance in 2018 offset by successful stock-picking predominantly in 2020 and 2021. The strategy had a good year in 2021, as stock selection in the long-leg and in the market-neutral component contributed positively. Positions in semiconductors, banks, and energy helped.

Table Description automatically generated

(Source: Morningstar)

Price:

It’s critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar category’s costliest quintile. Such high fees stack the odds heavily against investors. Based on our assessment of the fund’s People, Process and Parent pillars in the context of these fees, we don’t think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Neutral.


(Source: Morningstar)                                                                     (Source: Morningstar)

About Funds:

A growing conviction in the duo that manages JPMorgan U.S. Large Cap Core Plus and its Luxembourg resided sibling JPM U.S. Select Equity Plus, and the considerable resources they have effectively utilised, lead to an upgrade of the strategy’s People Pillar rating to Above Average from Average. The strategy looks sensible and is designed to fully exploit the analyst recommendations by taking long positions in top-ranked companies while shorting stocks disliked by the analysts. Classic fundamental bottom-up research should give the fund an informational advantage. The portfolio is quite diversified, holding 250-350 stocks in total with modest deviations from the category index in the long leg. The 30/30 extension is broadly sector-, style-, and beta-neutral. Here the managers are cognizant of the risks of shorting stocks, where they select stocks on company-specific grounds or as part of a secular theme. For example, the team prefers semiconductors, digital advertising, and e-commerce offset by shorts in legacy hardware, media, and network providers. Short exposure generally stands at 20%-30%, with the portfolio’s net exposure to the market kept at 100%. The strategy’s performance since inception, which still has some relevance given Bao’s involvement, has been outstanding. 

(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
Funds Funds Research Sectors

JPMorgan U.S. Large Cap Core Plus Fund performing well with solid philosophy and consistently applied bottom-up process

Process:

The strategy rests on a solid philosophy and a clearly designed and consistently applied bottom-up process. The ability to leverage the analysts’ insights through both long and short positions makes it distinctive, though small active bets make us somewhat cautious regarding its alpha potential. The strategy aims to capture temporarily mispriced opportunities through consistent use of the analysts’ long-term valuation forecasts. Those derive from an in-house dividend-discount model that is fed by the team’s earnings, cash flow, and growth-rate estimates. The analysts rank stocks in each industry based on their estimated fair value. The managers incorporate these rankings into their stock-picking, expressing modest sector preferences based on their macroeconomic view.

Portfolio:

This benchmark-aware and highly diversified fund held 289 stock positions per end of November 2021, of which 124 are shorts. The long leg of the fund is conservatively managed, with modest bets versus the Russell 1000 Index and an active share of 55%-60%. NXP Semiconductors, Alphabet, and Amazon.com were the largest active positions in the portfolio, with an overweight of around 200 basis points. Rivian was bought in 2021 for risk-management considerations to offset the underweight of Tesla, which the managers never held. Most stocks that are sold short in the 30/30 extension carry a weight of less than 25 basis points.

People:

Growing confidence in the two experienced portfolio managers and the large and seasoned analyst team supporting them leads to an upgrade of the People Pillar rating to Above Average from Average. Susan Bao is an experienced and long-tenured manager on this strategy and is well-versed in the firm’s hallmark investment process. Bao and Luddy have also managed this 130/30 strategy together since the start of the U.S.-domiciled vehicle in 2005 and since 2007 on its offshore counterpart. Steven Lee succeeded Luddy in 2018. Lee brings close to three decades of experience, but most of it was gained as an analyst. Since 2014, he has managed JPMorgan US Research Enhanced Equity, the firm’s analyst-driven long-short strategy, which serves as the blueprint for this strategy’s 30/30 extension. Although portfolio management is collegial, Bao concentrates on consumer, financials, and healthcare, while Lee is the lead for industrial/commodities, technology, and utilities/telecom. While their collaboration is still relatively short, it has already proved fruitful, and the managers have demonstrated their ability to generate alpha from both long and short ideas provided by the analyst team.

Performance:

It has outperformed the Russell 1000 Index on a total return and alpha basis since inception and over shorter time horizons. Since Susan Bao and Steven Lee have comanaged the strategy, a more relevant period to consider, the strategy also outperformed its average peer and the index. However, results were a bit mixed during that period, with a disappointing performance in 2018 offset by successful stock-picking predominantly in 2020 and 2021. The strategy had a good year in 2021, as stock selection in the long-leg and in the market-neutral component contributed positively. Positions in semiconductors, banks, and energy helped.

Table Description automatically generated

(Source: Morningstar)

Price:

It’s critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar category’s costliest quintile. Such high fees stack the odds heavily against investors. Based on our assessment of the fund’s People, Process and Parent pillars in the context of these fees, we don’t think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Neutral.


(Source: Morningstar)                                                                     (Source: Morningstar)

About Funds:

A growing conviction in the duo that manages JPMorgan U.S. Large Cap Core Plus and its Luxembourg resided sibling JPM U.S. Select Equity Plus, and the considerable resources they have effectively utilised, lead to an upgrade of the strategy’s People Pillar rating to Above Average from Average. The strategy looks sensible and is designed to fully exploit the analyst recommendations by taking long positions in top-ranked companies while shorting stocks disliked by the analysts. Classic fundamental bottom-up research should give the fund an informational advantage. The portfolio is quite diversified, holding 250-350 stocks in total with modest deviations from the category index in the long leg. The 30/30 extension is broadly sector-, style-, and beta-neutral. Here the managers are cognizant of the risks of shorting stocks, where they select stocks on company-specific grounds or as part of a secular theme. For example, the team prefers semiconductors, digital advertising, and e-commerce offset by shorts in legacy hardware, media, and network providers. Short exposure generally stands at 20%-30%, with the portfolio’s net exposure to the market kept at 100%. The strategy’s performance since inception, which still has some relevance given Bao’s involvement, has been outstanding. 

(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

Improved near-term outlook for Eastman; shares slightly undervalued

Business Strategy and Outlook:

Through acquisition and internal development, Eastman owns a solid portfolio of specialty chemicals. Eastman’s specialty chemicals include plastics and components used in safety glass, window tinting, and specialty plastics, which offer a solid growth profile. To increase its specialty portfolio, the firm invests roughly 4% of sales from its additives and functional products and advanced materials segments into research and development, which is in line with its specialty chemical peers. Eastman is well positioned to meet growing demand for auto window interlayers, including heads-up displays, and specialty plastics.

Eastman also holds a solid position in acetate tow, which is primarily used to make cigarette filters. The acetate tow industry has experienced falling prices due to overcapacity in China over the past several years. However, a handful of players dominates the industry, a factor that led to disciplined capacity shutdowns by all of the major companies during the industry downturn. To offset some of the decline, Eastman has been investing in capacity for other uses for its fibers, including fabrics and apparel.

Financial Strength:

Eastman is in good financial health. As of Dec. 31, 2021, Eastman carried around $4.7 billion in net debt on its balance sheet. Management reported net debt/adjusted EBITDA was a little less than 2.2 times. With strong free cash flow generation and the sale of its adhesive resins portfolio for $1 billion in cash in 2022, it is assumed that Eastman will have no trouble meeting its financial obligations, including dividends. Assuming no major acquisitions are made, the company will be able to maintain leverage ratios within management’s long-term target of 2.0-2.5 times over a number of years. However, the cyclical nature of the chemicals business could cause coverage ratios to fluctuate from year to year.

Bulls Say:

  • Eastman is well positioned to meet evolving chemical demands in auto window interlayers and tires through its best-in-class patented products. 
  • Eastman’s investments in plants that use sustainable based feedstocks, including recycled chemicals and wood pulp, should benefit from growing demand for specialty plastics made from these feedstocks. 
  • As Eastman continues to develop new patented products, it should expand its specialty chemicals business, which generates higher margins and commands some degree of pricing power.

Company Profile:

Established in 1920 to produce chemicals for Eastman Kodak, Eastman Chemical has grown into a global specialty chemical with manufacturing sites around the world. The company generates the majority of its sales outside of the United States, with a strong presence in Asian markets. During the past several years, Eastman has sold noncore businesses, choosing to focus on higher-margin specialty product offerings.

(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

Celanese shares fall as company reports strong 2021 results; shares fairly valued

Business Strategy and Outlook:

Celanese is the world’s largest producer of acetic acid and its chemical derivatives, including vinyl acetate monomer and emulsions. These products are used in the company’s specialized end products and also sold externally. Celanese produces the chemical in its core acetyl chain segment (roughly 70% of 2021 EBITDA), which primarily serves the automotive, cigarette, coatings, building and construction, and medical end markets. It produces acetic acid from carbon monoxide and methanol, a natural gas derivative. Celanese produces its own methanol at its Clear Lake, Texas, plant, which benefits from access to low-cost U.S. natural gas. The company recently announced that it will expand acetic acid production capacity at Clear Lake by roughly 50%, which should benefit segment margins thanks to lower average unit production costs

The engineered materials segment (around 25% of 2021 EBITDA) produces specialty polymers for a wide variety of end markets. The automotive industry accounts for the largest portion at around one third of segment revenue; other key end markets include construction and medical devices. This segment uses acetic acid, methanol, and ethylene to produce specialty polymers. Celanese and other specialty polymer producers have benefited in recent years from automakers light weighting vehicles, or replacing small metal pieces with lighter plastic pieces. Celanese should also benefit from increasing electric vehicle and hybrid adoption, as the company makes battery separator components.

Financial Strength:

Celanese is currently in excellent financial health. As of Dec. 31, 2021, the company had around $4 billion in debt and $0.5 billion in cash. Celanese is undergoing a portfolio transformation, exiting legacy joint venture deals and acquiring new assets to increase its engineered materials portfolio, such as the Santoprene business from ExxonMobil, which resulted in slightly higher debt. However, it is generally expected that the company’s balance sheet and leverage ratios to remain healthy as Celanese should generate enough free cash flow to meet its financial obligations. The cyclical nature of the chemicals business could cause coverage ratios to fluctuate from year to year. However, Celanese should still generate positive free cash flow well in excess of dividends.

Bulls Say:

  • Celanese built out its core acetic acid production facilities at a significantly lower capital cost per ton than its competitors thanks to the scale of its facilities (1.8 million tons versus average 0.5 million tons).
  • Celanese should benefit from producing an increasing proportion of its acetic acid in the U.S. to take advantage of low-cost natural gas. 
  • The engineered materials auto business should grow more quickly than global auto production because of greater use of these products in each vehicle.

Company Profile:

Celanese is one of the world’s largest producers of acetic acid and its downstream derivative chemicals, which are used in various end markets, including coatings and adhesives. The company also produces specialty polymers used in the automotive, electronics, medical, and consumer end markets as well as cellulose derivatives used in cigarette filters.

(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
Dividend Stocks Philosophy Technical Picks

Synchrony’s Partnership Base Remains Highly Concentrated, Top 5 Partnership Stretches more than 50% Revenue

Business Strategy and Outlook

Synchrony partners with retailers and medical providers to offer promotional financing as well as private label and co-branded general-purpose credit cards. The company’s promotional financing and instalment loans offered through its Home and Auto segment and its CareCredit program have performed well, and receivables have been relatively resilient in the current cycle. The company’s private-label and cobranded credit cards, co-marketed through partnerships with retailers, have faced more headwinds both before and during the pandemic, and credit card receivables outstanding are well below their 2018 peak. 

The company has also had to contend with the loss of Walmart in 2018 and then Gap in 2021. These were significant blows, as the Walmart credit card program was about 13% of Synchrony’s receivables at the time and the Gap credit card program was about 5%. The bank’s partnership base remains highly concentrated, with its top five partnerships accounting for nearly 50% of its revenue. The firm will likely continue to be forced to choose between revenue growth and margins as it is pressured at the negotiating table by its merchant partners.

Synchrony is also facing elevated repayment rates on the company’s cards as consumers have used fiscal stimulus money to pay down debt. This has caused the company’s loan receivables balance to stagnate and pushed down gross interest yields on the company’s credit cards. Repayment rates will likely normalize over time, as the impact of fiscal stimulus and loan forbearance fades, but in the short-term Synchrony’s net interest income will face headwinds. 

The future for Synchrony is not completely bleak. New credit card programs with Venmo and Walgreens give avenues for Synchrony to restart loan growth. The company also has several successful digital retailers as partners, such as PayPal and Amazon, which will offset the damage from Synchrony’s partners in the brick-and-mortar retail space. Additionally, high repayment rates on the company’s credit cards have pushed credit costs well below historical levels, and the company has been able to release the reserves it built up during the pandemic and accelerate share repurchases.

Financial Strength

Synchrony’s financial strength allowed it to navigate a difficult economic situation in 2020 without much stress being placed on the firm. The company’s sale of its Walmart portfolio to Capital One in late 2019 came at a fortuitous time, as it removed a credit-challenged account and created an influx of additional liquidity as the company entered 2020. Additionally, during the pandemic, decreased retail sales led to portfolio runoff and lower credit card receivables. While this is undoubtedly a negative for revenue generation, it did reduce the leverage of the bank and the company has been placed in a situation where it is seeking to manage the size of its deposit base to avoid becoming overfunded. 

The consequence of these events is clearly negative for the company’s income statement, as seen by Synchrony’s earnings results during 2020 and its low net interest growth since then. However, the balance sheet benefited and low receivable growth as well as low net charge-offs have allowed the firm to easily maintain that strength. The bank’s common equity Tier 1 ratio stands at 15.6%. With the bank’s allowance for bad loans at more than 10.76% of existing receivables, it is not foreseen Synchrony encountering any capital issues and there is likely room for continued shareholder returns. Even if credit conditions deteriorate or the firm sees additional retailer bankruptcies, the company is well positioned to manage it. The bank should have plenty of flexibility to respond to competitive threats and to invest in its business despite the uncertainties of the current economic cycle.

 Bulls Say’s

  • Synchrony enjoys long term contracts with several successful digital retailers such as Amazon and PayPal. These partnerships provide Synchrony with a source of receivable growth in a difficult environment for brick-and-mortar retailers. 
  • Synchrony continues to win new credit card programs, with credit cards for Venmo and Verizon being launched in 2020. 
  • The company’s credit cards present a compelling value for its retail partners. Struggling retailer will continue to be drawn to the incremental sales and revenue Synchrony’s credit cards provide.

Company Profile 

Synchrony Financial, originally a spin-off of GE Capital’s retail financing business, is the largest provider of private-label credit cards in the United States by both outstanding receivables and purchasing volume. Synchrony partners with other firms to market its credit products in their physical stores as well as on their websites and mobile applications. Synchrony operates through three segments: retail card (private-label and co-branded general-purpose credit cards), payment solutions (promotional financing for large ticket purchases), and CareCredit (financing for elective healthcare procedures). 

(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
Technology Stocks

Cerner to Be Acquired by Oracle for $95 Per Share in 2022

Business Strategy and Outlook

Cerner is a leading healthcare IT-services provider, offering an electronic health record platform to hospitals and health networks. Along with rival Epic, a privately owned peer, the two represent more than half of acute care EHR market share. While the market for acute care EHR is mature and offers little growth, the firm has been able to expand into other areas, such as ambulatory (outpatient) care and secure clients in the federal space, notably with the Department of Defense and Department of Veterans Affairs. Additionally, Cerner has started to cross-sell incremental analytics services to fortify retention rates. Incremental services are largely recurring in nature and include analytics, telehealth, and IT outsourcing.

Beyond EHR, Cerner has been investing in areas of strategic growth, in particular population health management and data-as-a-service, where it can use its domain expertise and intangible assets stemming from provider and patient data in other offerings. Cerner’s HealtheIntent is a cloud-based vendor-agnostic population health management tool that can aggregate and reconcile EHR data from any vendor and other sources (PBMs, insurance companies), for individuals across the continuum of care to create a longitudinal health record that can then score and predict risks to improve outcomes and lower costs for patients. The platform has approximately 200 clients and has been steadily growing in recent years. Cerner is also developing a data business, organically through utilizing the company’s leading market share and depth of EMR data and inorganically through tuck-ins acquisitions. In early 2021, Cerner acquired Kantar Health for $375 million, a life sciences research company providing real world evidence, data, and analytics for life science companies.

Cerner to be Acquired by Oracle in All-Cash Deal; Shares Valued at $95 20

 On Dec. 20, Oracle and Cerner jointly announced an agreement for Oracle to acquire Cerner through an all-cash deal, valuing Cerner at $95 per share. The deal is expected to close in 2022, rewarding Cerner shareholders with a 20% premium over the company’s market valuation earlier last week. The deal values Cerner at a 46% premium to our $65 fair value estimate. Morningstar analysts have a very high degree of certainty the transaction will go through without any regulatory pushback, as the combination of the two companies is unlikely to stir antitrust controversy. Morningstar analysts are raising the fair value estimate for Cerner to $92 per share, reflecting the sale price discounted half-a-year at the weighted average cost of capital.

Financial Strength 

Cerner has a standard level of financial strength. Revenue is growing steadily as the rollout of Cerner’s EHR platform at the DoD and VA commence, and incremental services to existing customers and international expansion add to the muted growth of the mature domestic EHR market. Non-GAAP margins are already solid, and we believe they are likely to expand further with the active rationalization of services with lower profitability and cost-saving initiatives. As of fiscal 2020, the company had over $1 billion in cash, equivalents, and investments, offset by roughly $1.3 billion in debt, resulting in a net debt position of approximately $300 million. Cerner initiated a quarterly dividend of $0.18 per share in mid-2019, which it subsequently raised to $0.22 per share at the end of 2020.

Bulls Say

  • Cerner has been able to maintain a leading market share in the acute care EHR market due to high switching costs. 
  • Despite the maturity of the domestic EHR market, Cerner’s federal contracts provide modest revenue growth through 2028. 
  • Cerner’s leading EHR market share gives the company valuable RWE that can be packaged and sold to pharma companies, payers, and providers in a data offering.

Company Profile

Cerner is a leading supplier of healthcare information technology solutions and tech-enabled services. The company is a long-standing market leader in the electronic health record industry, and along with rival Epic Systems corners a majority of the market for acute care EHR within health systems. The company is guided by the mission of the founding partners to provide seamless medical records across all healthcare providers to improve outcomes. Beyond medical records, the company offers a wide range of technology that supports the clinical, financial, and operational needs of healthcare facilities

(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.