Weekend Update #124
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.
U.S. equity markets rose this week as earnings from big tech, including Microsoft, Alphabet, Meta, and Amazon, on average surprised to the upside and aided the earnings outlook for this year. Equity sentiment was positive despite mounting concerns over First Republic Bank after they explored a divestiture of $50 to $100 billion in assets and additional headcount reductions announced by Deutsche Bank.
In economic news for the week, Consumer Confidence in April and GDP in Q1 were weaker than expected whereas the Personal Consumption Expenditures Price Index, Employment Cost Index, and University of Michigan Inflation Expectations all came in higher than expected. Despite these indicators being directionally opposed to the Federal Reserve’s fight against inflation right before the FOMC’s interest rate decision on May 3rd, the impact to equity markets seemed relatively muted this week.
Other significant events this week included Bed Bath & Beyond’s Chapter 11 bankruptcy filing, UK regulators’ decision to veto Microsoft’s acquisition of Activision Blizzard, and House Speaker Kevin McCarthy’s submission of a bill to raise the national debt limit by $1.5 trillion.
Friday’s Close (Weekly Performance)
S&P 500 4,169.48 (+0.87%)
Nasdaq 12,226.58 (+1.28%)
Dow Jones 34,098.16. (+0.86%)
Thank you Blue Room Analyst JARED FENLEY.
Lance Fritz — Chairman, President and CEO
Good morning, everyone, and welcome to Union Pacific's First Quarter Earnings Conference Call. With me today in Omaha are Kenny Rocker, Executive Vice President of Marketing and Sales; Eric Gehringer, Executive Vice President of Operations; and Jennifer Hamann, our Chief Financial Officer. The story of the past quarter for Union Pacific is one of resiliency—battling heavy snow, Arctic temperatures, flooding and tornadoes, the team maintained service levels and exited the quarter on a positive trajectory. Persevering through those harsh conditions, our employees delivered for our customers, which demonstrates again that our people are the foundation for the great things that lie ahead.
Turning to the first quarter results. This morning, Union Pacific is reporting 2023 First Quarter net income of $1.6 billion or $2.67 per share. This compares to First Quarter 2022 results of $1.6 billion or $2.57 per share. Our first quarter operating ratio of 62.1% deteriorated 270 basis points versus 2022 driven by excess costs, inflation and lower volumes.
A series of weather events throughout the quarter had a real impact on our ability to capture demand, especially within our coal business as well as added cost to the network. Through those events, our service products showed greater and greater resiliency, quickly rebounding each time as we were better positioned with crew resources to support our customers. And with April month-to-date, freight car velocity is about 200 miles per day. We are operating a network that is positioned for consistent and reliable service. While a more difficult start to the year than expected, it doesn't reduce our expectations for 2023. As you'll hear from the team, all of our goals are still in front of us.
ANALYST TAKEAWAYS
Pinterest fell over 13% in after-hours trading despite the company reporting better than expected revenue and adjusted profits. Global MAUs have rebounded nicely from the lull last year, and engagement trends continue to be robust as Pinterest sees the benefits of platform innovation. MAUs ended the quarter at 463 million, up 7.0% from a year ago. Mobile app users, which account for 80% of impressions and revenue, grew 16% globally with N. American mobile users growth of 7%. Pinterest is having noticeable success with GenZ users, an area of concern for investors last year when TikTok carved out a large share of the demographic’s screen time.
Key Takeaways
Deliveries
Executives maintained guidance for 1.8 million annual vehicle sales, and will aim for 2 million on the upside
Company is focused on building more volume and a larger fleet rather than less volume and higher margins, with the expectation that the vehicle to be able to generate meaningful and significant revenues from its autonomy
150M+ miles driven via FSDbeta, and growing exponentially. This is a data advantage that no one else has, and Tesla is focused on improving the neural network training function
Company plans to expand vehicle delivery to new countries, and even if they are not individually huge markets, a meaningful size can be reached by combining them
Cybertruck — Continuous construction of the CT alpha version on the pilot line; completing the installation of the volume production line at Giga Texas, and expecting to have delivery event in Q3
If geopolitical problems do not erupt after the storm, team expects a rebound in demand in the spring of next year (2024)
Costs/Margins
One-time items added to margin pressure this quarter (about 50 bps) - warranty adjustments of old Model S/X, and increased deferred revenue for certain Autopilot features as the company transition technologies
Per unit cost for Austin and Berlin improved. However, these factories still provide a margin headwind and will likely continue to do so until full scale production is reached
4680 cell production grew 50% Q/Q and accomplished a 25% reduction in COGS over the quarter --> on track to achieve steady-state cost targets over the next 12 months
Logistics is becoming more favorable and supply chain team has done a great job on logistics optimization and taking advantage of reduced spot rates where possible
The price of lithium has fallen significantly --> this will have more impact in the second quarter, and will have a greater impact going into the second half
50% equipment installation and 75% utility installation in a new cathode production building in Texas
“The length of the supply chain matters also because what we’re talking about is very far upstream. So by the time it makes sense that that battery ends up in the car, it will be several months.”
Costs were partially offset by manufacturing credits earned as part of the IRA
Consumer sentiment was little changed this month at 63.5, inching up less than two index points from March.
Buying conditions for durables improved 11% — primarily on the basis of easing perceptions of unaffordability.
Despite the increasingly negative news on business conditions heard by consumers, their short and long-run economic outlook improved modestly from last month. These improvements were balanced by worsening assessments of personal finances due to higher expenses, reflecting the ongoing pain stemming from continued high prices.
The median expectation for one-year inflation (blue line) increased to 4.6%.
The median expectation for long-term inflation (green line) increased to 3.0%.
Year-ahead inflation expectations rose to 4.6% this month, up from 3.6% in March. These expectations have vacillated month-to-month since the beginning of the year. Uncertainty over short-run inflation expectations rose this month, and thus the volatility in expected year-ahead inflation is likely to continue.
Long-run inflation expectations inched up to 3.0% but remained remarkably stable, staying within the narrow 2.9-3.1% range for 20 of the last 21 months.
Earnings Call Summary
Quarter results:
Consolidated revenue of $69.8 billion, up 3% year-over year, or 6% in constant currency
Operating income of $17.4 billion, down 13%, with operating margin of 25%
Alphabet had a good quarter, beating overall expectations with Search displaying resilience in a challenging economic environment.
While Network saw slight advertiser pullback, YouTube saw stabilization with strong growth in subscription revenue.
While seeing some slight slow down in growth, Google Cloud achieved its first profitable quarter, with additional AI improvements on the horizon.
Q1 expenses were affected by 3 factors:
Charges relating to workforce and office space reductions,
Adjustments to the estimated useful lives of servers and network equipment,
Changes in timing of annual employee stock-based compensation awards.
Q2 headwind from exchange rate is expected to lessen, based on current spot rates.
Alphabet announced a multi-year effort to create savings, particularly by improving machine utilization, managing their real estate portfolio, investing in their infrastructure, etc… which may lead to a temporary increase in capital expenditures.
They also announced a combination of their Brain Team in Google Research with DeepMind to create Google DeepMind, with the goal to accelerate safe and impactful AI innovation.
Q2 2023 Outlook
Total MAUs: 530 million (above BR estimate of 515 million)
Total Premium Subscribers: 217 million (in-line with BR estimate of 217 million)
Total Revenue: €3.2 billion (below BR estimate of €3.3 billion)
Gross Margin: 25.5% (in-line with BR estimate of 25.5%)
Operating Profit/Loss: (€129) million (above BR estimate of (€163) billion)
Highlights
Spotify slightly outperformed on premium revenue while underperforming on ad-supported revenue. Apparently the quarter was choppy with momentum going into Q2, but they’ve seen this trend before so “it’s too early to say” what Q2 will look like. That being said, this is the first Q1 in Spotify’s history they have surpassed €300 million in ad revenue. Growth in operating expenses was slower than forecast thanks to less marketing spend than plan. Spotify sees continued momentum in MAU and premium subscriber growth in Q2 2023 and gross margin of roughly 25.5% as the company continues to implement operating efficiency improvements and look at areas such as real estate optimization.
Earnings Release Commentary
Caterpillar Inc. announced Q1 2023 sales and revenues of $15.9 billion, a 17% increase compared with $13.6 billion in Q1 2022. The increase was primarily due to favorable price realization and higher sales volume.
Operating profit margin was 17.2% for Q1 2023, compared with 13.7% for Q1 2022. Adjusted operating profit margin was 21.1% for Q1 2023, compared with 13.7% for Q1 2022. Q1 2023 profit per share was $3.74, compared with Q1 2022 profit per share of $2.86. Adjusted profit per share in Q1 2023 was $4.91, compared with Q1 2022 adjusted profit per share of $2.88. In the first quarter of 2023 and 2022, adjusted operating profit margin and adjusted profit per share excluded restructuring costs. Q1 2023 restructuring costs included the impact of the divestiture of the company’s Longwall business.
For the three months ended March 31, 2023, enterprise operating cash flow was $1.6 billion, and the company ended Q1 with $6.8 billion of enterprise cash. In the quarter, the company paid dividends of $0.6 billion and repurchased $0.4 billion of Caterpillar common stock.
“I’d like to thank our global team for their strong operational performance while serving healthy demand during the first quarter. We achieved double-digit top-line growth and record adjusted profit per share while generating strong ME&T free cash flow,” said Jim Umpleby, Chairman and CEO. “Our team remains focused on supporting our customers as we execute our strategy for long-term profitable growth.”
Q3 2023 Financial Highlights
Total Revenue: $52.9 billion, +7% YoY (+10% in constant currency)
Operating Income: $22.4 billion, +10% YoY (+15% in constant currency)
Net income: $18.3 billion, +9% YoY (+14% in constant currency)
Diluted EPS: $2.45, +10% YoY (+14% in constant currency)
Revenue in Productivity and Business Processes: $17.5 billion, +11% YoY (+15% in constant currency)
Revenue in Intelligent Cloud: $22.1 billion, +16% YoY (+19% in constant currency)
Revenue in More Personal Computing: $13.3 billion, –9% YoY (–7% in constant currency)
Q4 2023 Financial Estimates
Total Revenue: $54.85 — $55.85 billion
COGS: $16.8 — $17.0 billion
Operating Income: $22.75 – $23.75 billion
Net income: $18.65 – $19.50 billion
Diluted EPS: $2.52 – $2.62
Revenue in Productivity and Business Processes: $17.9 – $18.2 billion
Revenue in Intelligent Cloud: $23.6 – $23.9 billion
Revenue in More Personal Computing: $13.35 – $13.75 billion
ANALYST TAKEAWAYS
TXN reports revenue slightly below expectations missing by ~$180 million. Top investor concerns seem to be 1.) loss of market share of about 2% since the end of the pandemic, 2.) sequential margin attrition since 1Q22, and 3.) inventory levels elevated/growing while revenue growth rate turns negative.
According to TXN, the market share loss is attributable to frontloading supply in the beginning of the pandemic (AKA ramping up supply while others lightened the manufacturing load). In effect, TXN conveyed that the growth in market share was above trend and the decline of 2% is a return to the average.
TXN’s inventory days target range is 130 - 200+, and the current elevated trend is indicative of the company seeking to be as available for customer orders as possible, implying the expectation of a rebound sometime between 2H23 and 2H24. This position, however, is eating into the gross profit profile, only slightly offset by CHIPS Act Tax credits, which are accruing quarterly somewhere between 100 and 150 million USD per quarter.
Key Takeaways
Industry Outlook
The macro environment remained challenged in Q1 with the total U.S. advertising market down 7.4% Y/Y
Traditional TV advertising declined 12.7% Y/Y, and traditional TV ad scatter was down 20% YoY
Smart TV unit sales in the U.S. were up in Q1, driven in part by lower TV panel prices and freight costs
Traditional TV hours fell 10% year-on-year, while Roku streaming hours grew 20%
Financial services and media and entertainment remained pressured, verticals such as travel and health and wellness improved.
The advertising market in Q2 is expected to be down at a similar rate Y/Y to Q1
Platform
Average streaming hours per active account per day reached a record high of 3.9 hours, which is roughly half of the average U.S. household TV viewing, leaving significant opportunity for future growth
Streaming hours that originated from Roku home screen menu doubled Y/Y
Streaming hours were up 65% year-over-year on the Roku Channel, and remained a top five channel by reach and engagement on the Roku platform
Platform margins declined due to weakness in the ad scatter market, along with a greater mix away from M&E
Premium subscriptions business grew at 3X the speed of the ad subscriptions on the platform
Roku is developing more and deeper relationships with third-party platforms, including retail media networks, demand-side platforms, and other partners. We have begun to access new parts of advertiser budgets with several large clients that have specific DSP needs by making certain ad inventory more accessible
NewFronts coming up next week — Tuesday, May 2nd
The ad scatter market started to really materially slowdown midway through Q2’22, so there will be easier comps going into the back half of the 2023
BLUE ROOM Earnings Analysis
Snap’s Q1 misses on revenue, ARPU, and adjusted EBITDA overshadowed beats on EPS and free cash flow in the initial reaction to earnings. SNAP traded after hours at $8.78 (-16.4%) following the earnings release but prior to the earnings call. Geographically, North America drove the revenue miss with North America ARPU falling 18% YoY to $6.37.
Some highlights from the quarter include: time spent watching content grew globally, and time spent watching Spotlight content grew 170% year-over-year. Time spent watching creators’ Stories grew 100% year-over-year. All while DAUs grew 15% to 383 million. Engagement on the platform is clearly not the issue for Snap this quarter.
Advertising revenue growth from retail, CPG, travel, and restaurants all outperformed in the quarter — attributed to these verticals having implemented deeper integrations with Snapchat or having adopted their measurement solutions.
Global impression volume grew 10% YoY while eCPM declined 18% year-over-year, reflecting increased engagement among users on the platform and increased inventory along with decreased advertiser demand. Brand-oriented revenue was down 12% YoY and direct response revenue was down 9% YoY, reflecting a broad shift of spend away from Snapchat despite the cheaper CPMs and increased user engagement.
No official revenue or adjusted EBITDA guidance was given for Q2 2023.
Reading through the Q1 2023 Investor Letter, this may be one of the most important insights into a potential upcoming rebound in revenue:
“Revenue grew by 21% month-over-month in March of 2023 — well ahead of 13% in the prior year when the business was impacted by the onset of the conflict in Ukraine — and approximately in line with 22% month-over-month growth in March of 2021. It remains early in this transition period for our DR platform, but we are cautiously optimistic that the sequential growth we observed in the final month of Q1 may be indicative of greater platform stability following the initial impact of the changes made in January.”
FY 2023 Guidance:
Revenue: $31.2-31.7 billion (increased from $30.3-30.8 billion previously)
EPS: $8.18-8.38 (increased from $7.90-8.10 previously)
Non-GAAP EPS: $8.65-8.85 (increased from $8.35-8.55 previously)
Gross Margin: 77% (unchanged from 77% previously)
Non-GAAP Gross Margin: 79% (unchanged from 79% previously)
Operating Margin: 26% (unchanged from 26% previously)
Non-GAAP Operating Margin: 29% (unchanged from 29% previously)
Acquired IPR&D: $105 million
Other Expense: $(200)-(100) million (unchanged from $(200)-(100) million previously)
Tax Rate: ~13% (unchanged from ~13% previously)
Earnings Summary
Net sales of $127.4 billion represented a year-over-year acceleration of 9.4% relative to the previous quarter’s 8.6% increase
In AWS, net sales were $21.4 billion, up 16% year-over-year, which exceeded analyst expectations, but this also represents a slow-down from the previous quarter’s 20% year-over-year growth rate, and the company went on to say “we are seeing these optimizations [euphemism for customer cost-cutting] continue into the second quarter with April revenue growth rates about 500 basis points lower than what we saw in Q1 [11% implied year-over-year growth]”
Advertising revenues were $9.5 billion in Q1 2032, a 20.7% increase, representing an acceleration from the previous quarter’s 18.9% year-over-year change
Drivers includes sponsored product and brand offerings
Amazon’s large audience and machine learning capabilities ensure customers see relevant ads and brands reach the appropriate demographics
Worldwide operating income came in at $4.8 billion, a 30% year-over-year increase and above the top-line of the company’s guidance of $4.0 billion
The operating income was negatively affected by an estimated employee severance charge of approximately $470 million in Q1, including $270 million related to AWS
The company has built on progress they made through 2022 in improving productivity in their fulfillment network through continued process and tech improvements, exiting Q4 with a good labor balance
Labor availability has stabilized and inventory supply chain challenges have moderated; they’ve been able to transition their U.S. fulfillment network to a regionalized model
Amazon reported $3.2 billion in net income in Q1, which includes a pretax valuation loss of $467 million included in non-operating expenses from their common stock investment in Rivian Automotive
For the full year 2023, they expect capital investments to be lower than their $59 billion investment level in 2022 primarily driven by an expected year-over-year decrease in fulfillment network investments
They are continuing to invest infrastructure to support AWS customer needs, including investments to support Large Language Models and Generative AI
“This past year has seen us do a fair bit of cost streamlining…we took a deep look across the company and asked ourselves whether we had conviction about each initiative’s long-term potential to drive enough revenue, operating income, free cash flow and ROIC.”
CFO Outlook Commentary:
We expect Q2 2023 total revenue to be in the range of $29.5-32 billion. Our guidance assumes foreign currency headwinds will be less than 1% to year-over-year total revenue growth in the second quarter, based on current exchange rates.
We anticipate our full-year 2023 total expenses will be in the range of $86-90 billion, updated from our prior outlook provided in March. This outlook includes $3-5 billion of restructuring costs related to facilities consolidation charges and severance and other personnel costs. We continue to expect Reality Labs operating losses to increase year-over-year in 2023.
We expect capital expenditures to be in the range of $30-33 billion, unchanged from our prior estimate. This outlook reflects our ongoing build-out of AI capacity to support ads, Feed, and Reels, along with an increased investment in capacity for our generative AI initiatives.
Absent any changes to U.S. tax law, we expect our full year 2023 tax rate percentage to be around 20%.
In addition, we continue to monitor ongoing regulatory developments. We expect the Irish Data Protection Commission (IDPC) to issue a decision in May in its previously disclosed inquiry relating to transatlantic data transfers of Facebook EU/EEA user data, including a suspension order for such transfers and a fine. Our ongoing consultations with policymakers on both sides of the Atlantic continue to indicate that the proposed new EU-U.S. Data Privacy Framework will be fully implemented before the deadline for suspension of such transfers, but we cannot exclude the possibility that it will not be completed in time. We will also evaluate whether and to what extent the IDPC decision could otherwise impact our data processing operations even after a new data privacy framework is in force.
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