Weekend Update #177

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This week was another big week for earnings, led by Amazon, Apple, and AMD. Although earnings results were mostly mixed, the market responded positively, partially driven by economic data, leading to over 1% gains in the S&P 500 and Nasdaq exchanges.

On Wednesday, the Federal Reserve held rates at the current range of 5.25% to 5.50%, as expected. The Committee did vote to slow the pace of balance sheet reductions as it prepares to reduce quantitative tightening. However, Powell also stated that further progress on reducing inflation would be needed before considering cutting rates. Investors responded positively as Fed Chair Powell said it was “unlikely” the Fed would hike rates as its next step, despite recent inflation data coming in higher than expected.

On Friday, nonfarm payrolls showed the US added just 175,000 jobs in April, the smallest gain in six months and well below estimates of 240,000. Average hourly earnings also came in lower than forecasts, rising 3.9% year-over-year. As a result, treasuries surged and traders pulled forward the pricing of the first Fed rate cut to September from November.

This week was filled with numerous earnings reports, a slew of economic data and Federal Reserve Chair Jerome Powell’s speech on the current state of the economy. Needless to say, the flurry of reports created a lot of action in our holdings. Overall, we had many holdings that reported first quarter earnings inline with our estimates. Some of these had share price reactions as we would have expected, although several stocks moved away from us based on management guidance following the earnings releases. Through all of his information flow, Fund One ended the week up 0.53% and inline with the S&P 500 which was up 0.55%.

The cohort with the most significant price appreciation for the week included many of our pharmaceutical and biotech holdings. Moderna was the best performer for the week, up almost 15%. They reported better than expected earnings but our analyst attributes most of the share price appreciation to management's ability to control costs without hampering innovation. Speaking of innovation, we remain optimistic that investors will continue to recognize Moderna not only for its COVID-19 vaccines but also for its next wave of nRNA drugs to treat a wider spectrum of illnesses and disease from the flu to cancer - yes, cancer.

Just as Tesla last week, short-position Apple reported closely inline with our estimates but moved against us after management remarks. Despite both companies reporting lackluster results, investors pushed shares higher on the back of management promises for a brighter future. In the case of Tesla last week, Elon Musk pointed to a quicker than expected roll-out of lower priced vehicles and somehow investors were quick to look over the 9% decline in revenue.. The stock continued to push higher again this week. Similarly, despite iPhone sales being down 10.5%, Tim Cook announced a massive share buyback program coupled with news that China was not as bad as feared. His upbeat delivery of a positive forecast, despite a mediocre reality, caused shares to go higher. Even incorporating the CEOs’ upbeat forecasts, we feel that both companies are expensive relative to expected growth rates so we’re maintaining our short positions.

Executive Summary

Apple shares are at risk of trading lower through the remainder of 2023 as the company continues to see weakness on various fronts, including iPhone, iPad, and Accessories, all of which saw double-digit year-over-year declines. Q3 FY2024 guidance wasn’t all that strong, either, with management speaking to total revenue growth in the “low single digits” and gross margin compression of about 50 basis points. The most positive piece of news from their latest earnings release was their announcement of a $110 billion share repurchase program, which the market rewarded with a 6% share price increase the following day. It is concerning, however, that Apple continues to experience anemic year-over-year revenue growth despite the release of the Vision Pro, and with management saying capex levels will remain the same, it seems unlikely Apple will experience a growth reacceleration anytime soon.

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Executive Summary

The primary takeaway from the earnings call was that Texas Instruments is driving a slow, but steady, inflection off of the bottom in its core growth markets; industrial and automotive. Generally, analysts should be pleased with the second half recovery timeline being maintained, after estimates exiting last year pushed back a 2Q/3Q timeline and the stock should maintain its valuation premium as the company exits a cyclical trough with a stronger margin profile.

In the quarter, TI reported revenue of $3.661 billion, above consensus estimates of $3.608 billion and slightly above BLUE ROOM estimates for $3.659 billion. GAAP gross profit margin of 57.2% was above the 56.5% street estimate, and slightly below BLUE ROOM’s 57.5% estimate. GAAP EPS was $1.20 and non-GAAP EPS was $1.14, which compares to consensus estimates of $1.07 GAAP and $1.11 non-GAAP, beat both measures. BLUE ROOM forecasted $1.14 for both GAAP and non-GAAP EPS.

On a sequential basis, the industrial sales channel was down in the “upper-single digits”, automotive fell mid-single digits, personal electronics fell mid-teens, comms. equipment decreased 25.0%, and enterprise systems declined “mid-teens”. On a year-on-year basis, industrial fell 25%, automotive fell around 3%, personal electronics declined in the single digits, comms. equipment was down ~50.0% and enterprise systems was down “mid-teens”.

For the second quarter of 2025, TI beat consensus estimates for topline sales, coming in at $3.800 billion (at the midpoint), above the street’s $3.776 billion and BLUE ROOM’s $3.715 billion. On earnings, TI fell 2c short of the consensus expectation of $1.17 and BLUE ROOM’s $1.17. The better than expected 1Q revenue and the higher 2Q guidance provides a lift to our FY forecast, especially with the validation of an inflation post-2H 2024. Our FY2024 revenue forecast increased to $16.126 billion from $15.989 billion.

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Executive Summary

Coinbase generated $1.6 billion in revenue, beating estimates of $1.3 billion, driven by a 103% sequential increase in Transaction revenue. Services revenue grew 36% quarter-over-quarter as a result of higher crypto prices and new products gaining traction. The company grew adjusted EBITDA to $1.0 billion, compared to an estimated $608 million, and produced a diluted GAAP EPS of $4.40 ($1.80 excluding one-time accounting adjustments), compared to consensus estimate of $1.15 per share. Since the launch of the Bitcoin ETFs and Ethereum’s Shapella upgrade, the company has seen a significant increase in activity both in retail and institutional. COIN shares are poised to continue higher in 2024 as Coinbase grows its international presence and new products take shape.

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Executive Summary

Trimble delivered a beat on revenue and adjusted EPS expectations in Q1 2024 as all three segments performed ahead of expectations. Annualized recurring revenue continues to surpass revenue growth at 14% YoY organic growth in Q1 2024 vs. 8% YoY organic growth of revenue, so the Connect & Scale strategic shift toward higher software mix is especially driving strength. Full year 2024 guidance was reaffirmed despite foreign currency moves. Some of the outperformance in Q1 came from hardware and term license revenue previously expected in Q2 2024, so the outlook for H1 2024 remains consistent, and organic revenue growth in H2 2024 will be consistent with H1. Trimble expects 11-13% YoY organic ARR growth and total revenue growth of 4-7% YoY for FY 2024, despite some macro weakness in Europe and Asia Pacific. FY 2024 adjusted operating margin guidance of 24-25% is in line with 2023 at 24.61%. Trimble is expecting continued ARR growth over the next 3-year timeframe, driven by the Scale & Connect strategy, which will shift the mix toward software and drive continued margin expansion.

In the Architects, Engineers, Construction, Owners (AECO) segment, Connect & Scale is driving 18% YoY organic revenue growth and 18% organic ARR growth and had record Q1 ACV bookings. Favorable market conditions with reshoring of manufacturing, EV & battery plants, data centers, and renewable energy projects all are helping to drive growth in the core segment, despite softening macro conditions.

Management says the Field Systems segment is thought of as “industrial IoT” to connect physical and digital worlds moving toward hybrid models of hardware and software, with organic ARR growing 14% YoY in Q1 2024. Management says excavator technology remains low-single digit penetration, so they feel there is further opportunity for expansion among existing installed base.

Transportation & Logistics delivered bookings growth despite a freight recession in Europe, specifically with AI driven product releases in autonomous procurement and autonomous quotation outpacing overall growth.

The other notable announcement of the quarter is Trimble’s EY auditors deemed that neither EY or Trimble had sufficient documentation of internal controls related to IT and revenue for systems and processes. Despite the positive decision by EY at the time of filing, that changed over the previous weeks and the Q1 2024 10-Q filing will be delayed and 2023 10-K will be amended. EY hasn’t withdrawn their FY 2023 audit opinion, but the amendments will take time (around 1 month). This announcement seems to be driving weakness in trading, as well as the fact that Q1 2024 revenue strength was more of a pull-forward from prior Q2 2024 expectations than a step up for full year expectations. It seems to me that Trimble is managing macroeconomic challenges very well with some of the structural business shifts toward software and bundled offerings.

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Executive Summary
Moderna shares are poised to trade flat-to-up following a better than expected (though still minimal with respect to FY2024 impact) first quarter earnings. Despite posting stronger than expected topline revenue, Moderna maintained its FY24 guidance, but shifted the timing of when revenue is to be realized. On the cost efficiency front, Moderna notably decreased its operating expenses. From 1Q23 to 1Q24, Moderna reduced operating expenses by $795M due to increased efficiency on the SG&A side and improved focus on the R&D side. This all adds a level of confidence in the company’s plan to breakeven by 2026. The company posted no operational updates that were previously unknown.

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Executive Summary

Shutterstock shares are poised to grow through 2024 as the company continues working towards a return to growth in its Content business and drives an ongoing explosion of growth in its Data, Distribution and Services business. Shutterstock beat on the top and bottom line and raised guidance for those respective items, and also announced an acquisition of Envato, a leader in digital creative assets and templates, for $245 million in cash funded by a $375 million credit facility. The company stated it plans to continue to pay dividends, repurchase shares, and is open to making further accretive acquisitions that align with its strategic objectives.

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Executive Summary

Despite weak performance in the quarter, Regeneron stock finished this week +8.36% after cannibalization headwinds of the EYLEA HD introduction was slightly offset by strong growth in Dupixent and Libtayo. Total EYLEA sales in the U.S. fell short of analyst estimates, coming in at $1.202 billion versus $1.372 expected. Globally, EYLEA and EYLEA HD fell 1.0% YoY. Despite the weaker envoriment for the anti-VEGF product, EYLEA HD sales were $200 million in the quarter (+64% QoQ). We believe that rapid adoption of the 8 mg dose will drive sequential increases in sales in each quarter through the remainder of the year after the product achieved its permanent J-code. Dupixent and Libtayo also continue to show strong revenue gains, with Dupixent leading share in new-to-market products in 80% of its indications and growing 24% YoY (globally), and Libtayo making headway in its approved indications and growing 45% YoY. Regeneron also has two sBLAs submitted for Dupixent and two other BLAs submitted for linvoseltamab and odrenextamab, with target action dates all before Fall 2024.

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Executive Summary

Schrödinger reported software revenue in line with consensus with a slight beat on net income expectations for Q1, but the company reported just $3.2 million in Q1 2024 drug discovery revenue vs. consensus of $8.1 million. Despite the revenue miss, largely driven by the greater-than-expected drug discovery recalibration in Q1 2023, Schrödinger maintains previous guidance set forward in Q4 2023:

Software revenue growth is expected to range from 6% to 13%
Drug discovery revenue is expected to range from $30 million to $35 million
Software gross margin is expected to be similar to software gross margin for the full year 2023
Operating expense growth in 2024 is expected to range from 8% to 12%
Cash used for operating activities in 2024 is expected to be above cash used for operating activities in 2023

The company also provided software revenue guidance of $31-33 million for Q2 2024 vs. consensus at $32.6 million and my estimate of $35.3 million.

Taken together, the assumption guidance sets forward is software revenue will ramp sharply at the end of the year. Q1 2024 sales plus Q2 2024 guidance would imply Q4 2024 software revenue increases 129% QoQ to get to the low end of 6% YoY growth for FY 2024 and a 163% QoQ increase to get to the high end of 13% YoY growth. That leaves a lot of weight on contracts signed in the back half of this year, but without a shift in full year guidance, it implies Schrödinger’s confidence in those signings remain through discussions through the first 4 months of the year.

Schrödinger management’s commentary on the earnings call reinforced confidence in the full year outlook with several drivers and highlighted underlying momentum that will get the company to the necessary triple-digit QoQ increases in software revenue in Q4 within the guidance range.

On the software side, ACV is still not being disclosed quarterly, but CFO Geoff Porges said ACV remains at a growth rate much higher than software revenue in Q1 2024 and is on track with the high growth rates they had messaged last quarter. This gives confidence in my modeled estimate of $176.6 million FY 2024 revenue prior to the call, as the mix between On-Prem software multi-year renewals and customers choosing Hosted software skewed toward lower revenue recognition in the quarter despite high ACV growth. Second, management noted a higher volume of early-stage biotech companies coming to Schrödinger to have conversations about software usage — a new a positive trend for Q1 while the headwind of existing biotech customer usage has not further deteriorated — which Geoff Porges also signaled as one path to getting to the higher end of the 13% YoY revenue growth range. Material science customers also continue to sign contracts and step up contract values, with the scientific research in the Gates collaboration so far specifically surprising them to the upside with “significant rewards” in the future if they continue to trend toward breakthroughs in battery technology.

On the expense side, efficiencies showed up in the numbers this quarter with better-than-expected net loss despite the revenue lumpiness, and Geoff Porges indicated the company has reached full scale of both software R&D spend as well as early-stage drug discovery spend. This bodes well for the profitability outlook, as they have identified that Schrödinger can continue to achieve the same level of software platform breakthroughs as well as a fully scaled discovery pipeline churn with relatively similar spend levels that we see now. This should be a true turning point for the financials as overall operating leverage is set to increase. Management also maintains the outlook for gross margin expansion to play out over time.

On the drug discovery progress, the announcement of BMS’s return of the SOS1 inhibitor Karen Akinsanya discussed as a result of a recent acquisition of BMS’s that included a SOS1 inhibitor further into development. Although it cuts off more of the potential milestone revenue from Schrödinger’s future financials, we’ve seen similar steps taken by Eli Lilly this year to favor late-stage assets over promising early-stage compounds, and Schrödinger continues to have confidence in the potential of the now-wholly-owned asset from data generated to-date. Offsetting the news of the asset return, Schrödinger announced the Wee1/Myt1 SGR-3515 had its IND cleared by the FDA, with Phase 1 clinical trials beginning in Q3 2024. MALT1 & CDC7 programs remain on track to deliver data in the year-end 2024 to early 2025 timeframe. Investor excitement is also building around NLRP3 & PRMT5 programs, with one of which set to submit an IND in 2025.

The key takeaway from the call is that the underlying momentum remains on track with opportunities for further upside as the year progresses, but another lumpy revenue print with some quarter-specific factors is still dominating trading after-market, with SDGR shares only edging slightly higher to $23.35 (-7.6%) following the commentary.

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FOMC Statement
May 1, 2024
2:00 p.m. EDT

Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have remained strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated. In recent months, there has been a lack of further progress toward the Committee’s 2 percent inflation objective.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. The Committee judges that the risks to achieving its employment and inflation goals have moved toward better balance over the past year. The economic outlook is uncertain, and the Committee remains highly attentive to inflation risks.

In support of its goals, the Committee decided to maintain the target range for the federal funds rate at 5-¼ to 5-½ percent. In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities. Beginning in June, the Committee will slow the pace of decline of its securities holdings by reducing the monthly redemption cap on Treasury securities from $60 billion to $25 billion. The Committee will maintain the monthly redemption cap on agency debt and agency mortgage-backed securities at $35 billion and will reinvest any principal payments in excess of this cap into Treasury securities. The Committee is strongly committed to returning inflation to its 2 percent objective.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee's assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Thomas l. Barkin; Michael S. Barr; Raphael W. Bostic; Michelle W. Bowan; Lisa D. Cook; Mary C. Daly; Phillip N. Jefferson; Adriana D. Kugler, Loretta J. Mester; and Christopher J. Waller.

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Executive Summary

Caterpillar posted a beat on EPS and operating margin consensus expectations for Q1 2024 while missing on revenue estimates and guiding to a year-over-year decline in Q2 2024 sales with dealer inventories expected to decline in line with seasonal trends. Additional guidance assumes price realization will remain favorable year-over-year in Q2 2024 but lower expected volume will mean that adjusted operating margin will step down from Q1 2024 levels (22.2%) to be flat with Q2 2023 (21.3%). Full year guidance was reiterated for FY 2024 sales to be similar to the FY 2023 level, but guidance excluded the previous commentary to “Expect price realization to modestly exceed manufacturing costs for the full year”. While price continues to be favorable in H1 2024, it is expected to become an unfavorable trend in H2 2024 along with more absorption of costs messaged on the earnings call.

Dealer inventories are anticipated to act as a headwind to both Q2 2024 and FY 2024 year-over-year, which has historically been a major indicator of Caterpillar’s sales trends and is producing a headwind to volume in the outlook. Construction Industries and the Europe geography were two points of greater-than-expected weakness seen in the quarter, while Energy & Transportation exceeded expectations due to strong demand for reciprocating engines, power generation, and turbines. Capital discipline among customers is also a slight headwind to sales broadly in FY 2024.

Management noted that Q1 2024 was another quarter of strong operating performance. Caterpillar is seeing robust demand in E&T as well as bright spots in Resource Industries outside of Europe. North America demand should remain healthy in Construction Industries. Large mining trucks are still growing, and they are optimistic that the continuing energy transition will support mining equipment demand to produce more commodities. In addition, Caterpillar returned $5.1 billion in dividends and repurchases in Q1 2024.

Overall, Caterpillar reinforced the outlook from the previous quarter of continuing strength throughout FY 2024, especially in the North American market. However, concerns about Construction Industries coming from weakness in Europe as well as the headwinds of lapping strong pricing and dealer inventory in 2023 have brought a new source of concern for CAT shares that had been up 23% YTD prior to the call. At the open, CAT shares are trading down to $334.00 (-8.1%) on uncertainty about how strength can continue into H2 2024, especially given the weak macro data from this morning.

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Executive Summary

Amazon shares are poised to fluctuate through the remainder of 2024. Although online stores and retail subscription services fell slightly short of expectations in Q1, third party seller performance was in line with expectations while that of physical stores was better-than-expected. Additionally, AWS and advertising experienced double-digit growth, driven by an uptick in AI-related workloads and improvements in relevancy and measurement capabilities, respectively. Amazon expects to significantly increase its capex spend beyond the $48 billion level it saw in 2023, and although it beat on the top and bottom line in the quarter, the midpoints of its revenue and operating income guidance ranges were slightly below Street consensus estimates.

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Executive Summary

AGCO missed slightly on revenue expectations in Q1 2024, driven by greater-than-expected weakness in North America (-21.0% YoY) and South America (-39.8% YoY), but the geographic weakness was offset by greater than expected sales in Europe & Middle East (+1.5% YoY) as well as better-than-expected operating efficiency. The net result in Q1 2024 was in-line net income performance compared to consensus estimates. In North America, continually softening demand led to declines in hay equipment, mid-range tractor, and combines. In South America, softer demand and under-production of retail drove declines in tractors and combines. In Europe/Middle East, growth in Germany and France and higher demand for high-horsepower tractors drove the geographic strength. Asia/Pacific/Africa saw sales down 15.5%, driven by softening demand, especially in China and Australia.

Despite the environment of softening demand, AGCO raised its FY 2024 adj. operating margin target to 11.3% (from 11.0%) while also increasing expected engineering expense to +3% YoY (from ~flat initially). FY 2024 revenue guidance saw a slight decline to $13.5 billion (from $13.6 billion), so the expected contribution of $300 million in sales from Trimble PTx through the rest of the year and the expectation that the ag environment will not worsen materially from here is driving relative strength within the ag industry. AGCO’s FY 2024 sales are expected to be down -6.4% YoY from the revised guidance, compared to Deere & Company’s forecast for its Production & Precision Ag segment to be down 20% YoY. This implies that gross margins will also see slight expansion to 26.6% in FY 2024 from 26.2% last year, while adj. operating margin is forecast to be down to 11.3% in 2024 from 12.0% in 2023.

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Executive Summary

On a GAAP basis the company failed to beat and raise against consensus estimates, causing analysts to scrutinize AMD’s equity value against its growth prospects in the Data Center AI accelerator market. The after-hours trade took the stock lower by roughly 5.0% on the initial release, but fell lower to -6.94% after management increased its GPU SAM by only $500 million. Our internal expectation was for >$1.0 billion QoQ after management increased its SAM by $1.5 billion last quarter. Overall, however, the quarter had some puts and takes that could make the quarter and guidance neutral relative to our expectations prior to the release.

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Executive Summary

Eli Lilly missed slightly on consensus revenue estimates, driven mainly by Trulicity ($1.456 billion vs. $1.667 billion estimate) and Mounjaro ($1.807 billion vs. $2.091 billion, while also beating slightly on net income estimates, but the key of the market reaction is commentary in the earnings release — Lilly raised their confidence in production capacity expansion for Mounjaro and Zepbound in the second half of the year. This signal is key for Lilly’s FY 2024 trajectory and trading is benefiting with LLY shares. Zepbound was a key positive surprise as well in Q1 2024 with $517 million in sales vs. consensus at $391 million and my estimate of $504 million. Albeit still early in just the second quarter since launch, this sets up Zepbound revenue at a much higher launch rate than Mounjaro (while total prescriptions are tracking relatively in line with Mounjaro’s launch) due to better pricing dynamics.

Interestingly, we are seeing GLP-1s cannabalize Trulicity at the same time that Mounjaro is supply-constrained, so it’s a possibility that with the tight supply, there was more uptake of Ozempic in Q1 2024 than share going to Lilly. The really bright spot is the increased expectation for supply growth in H2 2024 led Lilly to raise the guidance range by $2 billion to $42.4-43.6 billion for FY 2024 vs. consensus at $41.4 billion — despite the Mounjaro miss and lower contribution from other products. So, the net impact should be a stronger H2 2024 product ramp, with especially higher growth estimates for Mounjaro and Zepbound in H2 2024. Adjusted EPS FY 2024 guidance was also raised from the initial $12.20-12.70 to the updated $13.50-14.00 range, which beats consensus of $12.44 for the year — implying Eli Lilly is focused on finding operating efficiencies still early in the GLP-1 launch phase and that will be positive for the near-term outlook.

“The company continues to expand manufacturing capacity, with the most significant production increases in 2024 expected in the second half of the year… [Guidance is] primarily driven by the strong performance of Mounjaro and Zepbound and greater visibility into the company's production expansion for the remainder of the year.”

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