Weekend Update #112
Welcome to Blue Room's Weekend Update. Each week, we're sharing what companies we're researching and the what, the who and the how that we think makes the companies interesting and unique. This roundup is brought to you weekly by a group of interns, creative minds, artists and investors who believe that through best in class investing along with the democratization of financial education we can do great things together. Enjoy, Explore and Share.
Equities generally continued their rebound this week, rallying through the FOMC press conference, earnings, and economic data. The S&P 500 closed the week at 4,136.48 (+1.62%), the Dow Jones Industrial Average closed at 33,926.01 (-0.15%), and the Nasdaq Composite closed at 12,006.96 (+3.31%).
The FOMC concluded its first meeting of 2023 on Wednesday, raising interest rates by 25 basis points and bringing the Federal Funds target rate to 4.50-4.75%. Jerome Powell hosted a press conference following the decision, in which his comments were interpreted very dovishly as the Fed Chair refused to push back on the stock market’s strong uptrend over the past few months. As market participants put more hope on the U.S. achieving a soft landing and that the Fed is nearing the end of its hiking cycle, equities continued a strong rally following the conference.
In economic data for the week, the Employment Cost Index decelerated faster than expected as the index fell to 1.0% in Q4 2022. Consumer Confidence Index posted a surprise decline in January to 107.1 as expectations for the 6-month outlook on the U.S. economy deteriorated. ADP Employment Change showed larger-than-expected job additions at 180,000 in January. ISM Manufacturing showed a worse-than-expected contraction at 47.4. JOLTS Job Openings unexpectedly rose by over 500,000 jobs to 11.0 million job openings in December — bringing the job openings to unemployed Americans ratio to a near-high of 1.9. BLS Nonfarm Payroll data on Friday confirmed the hot ADP report with 517,000 job additions in January — far above the 188,000 estimate. The Unemployment Rate continued its downward trend to a historic low at 3.4%, aided by the Labor Force Participation Rate’s rebound to 62.4%.
Key earnings events for the week included Meta’s biggest one-day gain (+23.3%) since 2013 following a positive quarter and a disciplined expense outlook. This is in contrast to Snap’s earnings disappointment as brand advertising decline caused weakness in revenue despite strong user engagement trends. Ford also missed expectations as management cited issues with operations. Spotify shares jumped as good userbase additions and a positive outlook on additions inspired hope. Amazon’s advertising unit continued to grow but that was overshadowed by a cloud slowdown. Google foreshadowed further job cuts to come and showed weakness in search ads. Apple reported its first year-over-year revenue decline since 2019 as iPhone and Mac sales disappointed.
Friday’s Close (Weekly Performance)
S&P 500 4,136.48 (+1.62%)
Nasdaq. 12,006.96 (+3.31%)
Dow Jones 33,926.01 (-0.15%)
Thank you Blue Room Analyst JARED FENLEY and NICK PEART
Q2 FY2023 March Quarter Outlook
“Given the continued uncertainty around the world in the near-term, we are not providing revenue guidance, but we’re sharing some directional insights based on the assumption that the macroeconomic outlook and COVID-related impacts to our business do not worsen from what we are projecting today for the current quarter.
We expect our March quarter year-over-year revenue performance to be similar to the December quarter. This represents an acceleration in our underlying year-over-year business performance as the December quarter benefited from an extra week. Foreign exchange will continue to be a headwind and we expect a negative year-over-year impact of 5 percentage points.
For Services, we expect revenue to grow year-over-year. While continuing to face macroeconomic headwinds in areas such as digital advertising and mobile gaming
For iPhone, we expect our March quarter year-over-year revenue performance to accelerate relative to the December quarter year-over-year revenue performance
For Mac and iPad, we expect revenue for both product categories to decline double-digits year-over-year because of challenging compares and macroeconomic headwinds.”
Gross Margin: 43.5% - 44.5%
OpEx: $13.7 and 13.9 billion
OI&E: $(100) million, excluding any potential impact from the mark-to-market of minority investments
Tax Rate: ~16.0%
Given the above guide for the March quarter, Apple stands to generate diluted EPS of $1.47, a step down from the recently-announced Q1 figure if $1.88. On a trailing twelve-month basis this would represent $5.83 EPS per share yielding a P/E multiple of 26.5. The forward P/E multiples would be 26.0x for 2024 and 25.0x for 2025, respectively.
The key factors affecting Apple’s earnings were foreign exchange headwinds, COVID-19-related challenges impacting their supply chain, and macroeconomic uncertainty. Management felt confident they would have met revenue expectations had it not been for the supply chain disruptions and asserted their production levels are now where they need to be.
The crypto market rallied in January to reclaim the $1 trillion market cap mark after plunging in the aftermath of the FTX/Alameda fallout. The FTX contagion has been more contained than originally feared with only a few large firms (BlockFi, Genesis, and Gemini) significantly impacted. In addition to investors gaining more confidence to re-enter the market, the rally was primarily fueled by increased optimism for a soft landing in the United States, along with a supply squeeze of top crypto assets. The DXY US Dollar index has also shown USD reached its lowest point since May 2022 which has also been helping support crypto prices denominated in USD. The Fed also continues to slow its interest rate hikes, raising the federal funds rate 25 bps in its most recent meeting. Supply of long-term Bitcoin holders have reached all-time highs, while Ethereum’s Merge to proof-of-stake has resulted in supply being deflationary since September.
Eli Lilly & Co. posted strong Q4 growth in core products at 21% year-over-year, which drove Q4 2022 performance largely in line with expectations. A decreased tax rate projection for Q4 and FY 2023 aided earnings this quarter as well as the earnings outlook for 2023.
Strength in Verzenio sales drove growth in the oncology segment and offset the rapid decline in COVID-19 antibody sales following the removal of authorization in the U.S. for its sale.
The TRAILBLAZER-ALZ 2 Phase 3 study will read out mid-year 2023 and be a decisive factor in approval and reimbursement for the Alzheimer’s drug — which could reach sales up to $20 billion per year. A tirzepatide expanded indication to obesity will also be a critical point for the company as projections for peak sales show the drug could bring in $50 to $100 million per year. This figure compares to net 2022 Medicare spending of $755 billion and gross 2022 Medicare spending of $982 billion.
BLUE ROOM Earnings Analysis
Snap Inc. continued a disappointing string of earnings results as North American ARPU came in very weak. Positive digital advertising trends throughout Q4 did not apply to Snap Inc. as brand advertisers continued to pull back from the platform and direct response advertisers continued to struggle with relatively lower ROAS on the platform due to iOS privacy changes.
Ripping the bandaid off, Snapchat implemented a set of sweeping tweaks to its ad platform at the start of 2023, providing improvements in conversions rates for advertisers. However, in the short run, these positive changes introduce more ad supply than there is advertising demand as the company waits for 3rd party tracking metrics to catch onto the benefit of these changes. Guiding to a -10% to -2% year-over-year revenue decline in Q1 2023 added uncertainty to the outlook of how the upcoming year will be impacted by tightening financial conditions.
Q1 2023 Guidance
Total Revenue: $121.0—$126.0 billion (approximately in-line with consensus estimate of $125.5 billion)
This implies a range of year-over-year growth of 3.9%—8.2% over Q1 2022’s $116.4 billion figure, a deceleration from Q4 2022’s 8.6% growth rate
Operating Income: $0.0—$4.0 billion (below consensus estimate of $5.9 billion)
This implies an operating margin range of 0%—3.2%. For context, operating margin in 2020, 2021, and 2022 was 5.9%, 5.3% and 2.4%, respectively. Operating margin has declined three consecutive quarters, from 3.2% in Q1 2022 to 1.8% in Q4 2022
If this guide were to materialize, the implied diluted EPS for the period would be ($0.01) in the bear case, and would represent a trailing twelve-month EPS of $0.09. In this scenario, the 2023 forward P/E of Amazon would be 105.5x.
The earnings call comprised several key themes, including macroeconomic uncertainty, belt tightening on the part of the retail consumer as well as the enterprise AWS customer. To wit, when asked about an AWS forecast for the remainder of 2023, the company responded the outlook was too uncertain to do so, but did reveal that through January, Amazon is seeing mid-teens year-over-year revenue growth for AWS, which is a deceleration from the 20.2% they saw in the fourth quarter of 2022, which itself is a deceleration from the 40% figure the company saw in Q4 of 2021.
Meta Platforms surprised consensus estimates to the upside by 1.6% on Q4 2022 revenue — driven by some consolidation among advertising spend benefiting Instagram and Facebook as well as a better-than-expected foreign currency tailwind. Earnings missed estimates due to restructuring charges of $3.76 billion for the Family of Apps and $440 million for the Reality Labs segments — meaning diluted EPS would have been $3.00 aside from those charges.
Revenue guidance for Q1 2023 came in line with consensus estimates at the midpoint, but the large forecasting range of -7% to +2% year-over-year growth reflects significant uncertainty over advertising spending trends over even just the next 2 months. So far, Blue Room’s channel checks indicate digital advertising has been surprisingly weak quarter-to-date.
Management’s commentary on the earnings call strengthened confidence in Meta’s ability to manage expenses and prepare for a more “mature” phase of the company’s growth. Mark Zuckerberg also highlighted the next wave of investment in innovation being in generative AI and built excitement around the potential to further reduce reliance on human capital costs with such investments.
Should first-quarter advertising spend on Meta trend to the high end of the guided range, typical advertising revenue seasonality would imply FY 2023 revenue of about $122 billion, in line with revised consensus estimates. Including cost savings measures implemented by Meta, that could result in relatively flat operating profit for the full year at $29 billion. On the other hand, should total revenue trend lower to -7% year-over-year growth, that might mark an important warning sign that below-trend economic growth can result in further advertising weakness, risking flat FY 2023 revenue growth. In that scenario, Meta operating profit in 2023 could decrease 23% year-over-year to $22 billion — falling quite short of current consensus estimates at $32.3 billion.
Q1 2023 Outlook
Total MAUs: 500 million (above BR estimate of 492 million)
Total Premium Subscribers: 207 million
Total Revenue: €3.1 billion
Gross Margin: 24.9%
Operating Profit/Loss: (€194) million
Highlights
Ended 2022 with strong Q4 performance as nearly all of their KPIs surpassed guidance; including MAUs, subscriber growth and revenue growth
Gross Margin exceeded guidance due primarily to lower investment spending and broad-based music favorability
Free Cash Flow was negative in the quarter; however full year Free Cash Flow remained positive and they expect this trend to continue moving forward on a full-year basis
Premium revenue growth was led by subscriber gains; ad-supported revenue growth was led by podcasting
Gross Margin of 25.3% in Q4 reflected continued growth in Marketplace activity offset by new podcast content and product investments
Operating loss of (€231) million and Operating Expense growth reflected higher personnel costs primarily due to headcount growth and higher advertising costs
Music advertising revenue grew mid single digits year-over-year, reflecting double-digit growth in impressions sold, partially offset by softer pricing due to the current macroeconomic environment; podcast revenue grew in the mid 30% range, reflecting healthy double-digit growth in impressions sold and pricing; the Spotify Audience Network saw healthy double-digit quarter-over-quarter growth in participating publishers, shows and advertisers
Key drivers: reported margin beat: 25.3% vs 24.5% expected; “We think Q1 will be the low point in terms of gross margin for the year, with gross margin improving throughout 2023…with hopefully a nice trajectory heading out of 2023.”
“I think you can expect to see a meaningful improvement in Operating Loss in ‘23 relative to ‘22. Exactly when we’ll break even, we haven’t said yet, but we feel like we’re on a good path, and we feel like we are in a good position right now to have that speed and efficiency that we want to have in 2023.”
Essentially 2022 was an investment year and 2023, the company believes, will be the year they start to reap benefits from said investments (the investments have been in relation to improving engagement, users, subscribers)
Past, Present, and Future
Since the Lincoln administration signed our national bank charter No. 24 in 1863, we’ve drawn on our financial strength to serve customers. This has been especially evident in times of need, such as during the COVID-19 pandemic. Our response by the end of 2020 included a $20 million premium pay program for our employees, relief assistance and 108,000 Small Business Administration Paycheck Protection Program (PPP) loans for our customers, and $30 million in expedited charitable contributions for our communities. As a result, we’re proud to have been named the most essential bank amid the pandemic in a ranking by The Harris Poll.
We also recognize that this past year has fundamentally changed banking by accelerating the shift to digital products and services. We’re positioned well for this future, having launched new tools — like the U.S. Bank Smart Assistant — to complement our 26-state branch footprint.
Key Highlights
Although UPS expected volume levels to decline from last year, they did so but more than they had anticipated due to macroeconomic conditions
Q4 2022 revenue was $27 billion, down 2.7% from last year
Operating profit was $3.8 billion, a decrease of 3.3%
Consolidated operating margin was 14.1%; US margin expanded to 12.8%
FY 2022 revenue was $100.3 billion, missing their target by 2%
Almost all of the miss was due to a stronger dollar than originally anticipated
Operating profit of $13.9 billion; operating margin of 13.8% (higher than last year)
Free cash flow of $9 billion; diluted EPS of $12.94, a YoY increase of 6.7%
Their healthcare portfolio appears to be their high-growth segment; reached $9.2 billion in revenue in 2022 and they expect it to generate over $10 billion in 2023
The company worked on efficiency gains through implementation of their total service plan which improved on-time network and productivity; e.g., hours deployed in the U.S. dropped 5.3% which was greater than their decrease in volume & eliminated 1,500 trailer loads per day
Average daily volume was down 3.8% versus the same period last year, with about half the decrease coming from their largest customer (Amazon)
In December, volume fell short of expectations, reflecting consumer spending cutbacks at the height of the holiday season
B2C average daily volume was down 3% while B2B average daily volume was down 5.2% YoY
The latter was driven by declines in retail and industry sectors that are more sensitive to rising interest rates, like manufacturing and distribution
Q2 2023 Shareholder Letter
This past quarter we significantly outperformed our expectations for Connected Fitness subs, Connected Fitness Unit (CFU) orders, CFU deliveries, hardware revenue, subscription revenue, and Total Revenue, Adjusted EBITDA, and Free Cash Flow.
Nine months ago, we reported FCF of $(747) million. This quarter, we reported FCF of $(94) million. But strip out the costs of paying suppliers to settle obligations for parts we don't need, and we generated positive FCF of approximately $8 million in Q2. If you’ve been wondering whether or not Peloton can make an epic comeback, this quarter's results show the changes we’re making are working.
Despite seasonally strong hardware sales, for the third consecutive quarter, we generated more revenue from subscriptions than we did from hardware sales. This trend is gross margin accretive because subscription gross margins significantly exceed hardware gross margins. If this trend continues, which seems likely since we sell more hardware in Q2 than any other quarter of the fiscal year, it represents a structural shift toward improving gross margins in the business.
This was by far our best quarterly performance in my twelve months with Peloton. Most of the executive team is also relatively new to Peloton and new to their teams. Given what we’ve already accomplished, imagine what’s possible once the team finds its groove.
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These materials do not purport to be all-inclusive or to contain all the information that a prospective investor may desire in considering an investment. These materials are intended merely for preliminary discussion only and may not be relied upon for making any investment decision. Any discussion or information contained in this presentation does not serve as a receipt of, or as a substitute for, personalized investment advice from Blueroom or your advisor.
This publication does not constitute an offer to sell or a solicitation to buy any securities in any fund, market sector, strategy or any other product. Investing is speculative and involves substantial risks (including, the risk of loss of the investor’s entire investment). Past performance is not indicative of future results, and there can be no assurance that the future performance of any specific investment, investment strategy, or product will be profitable.
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