Global equities scorecard: Part 2

The fourth-quarter results are in for five more stocks in our global equity portfolio.

As fourth-quarter earnings season in the US enters full swing, many of our Eureka International stocks are releasing results – with most exceeding expectations.

We took a look at Intuitive Surgical, Schlumberger, Xilinx and Facebook last week. You can read about our updated forecasts and valuations for the stocks here.

This week, in our two-part review, we investigate the other five stocks who have reported: Amazon, Google, Harley-Davidson, Dow Chemical and Gilead Sciences. Amazon has been the star, with investor sentiment recovering after a disappointing 2014 as the e-commerce company shows better profitability by moderating its heavy investments.

Amazon (NASDAQ)

After several disappointing quarters and a 20 per cent decline in the stock price, Amazon “delivered the goods” (to use a terrible pun), and not with a drone!

The company posted an 18 per cent year-on-year revenue gain and net income of 45 cents per share. The street was expecting only 17 cents per share.

The stock rallied 14 per cent, a remarkable move given the size of the company.

Drilling down into the results and the earnings call, the company reported some impressive margin metrics with a three-year high North American operating rate of 5.4 per cent and gross margins rising over the previous quarter, driven by third party seller and fulfilment service growth. Third parties using FBA (Amazon fulfilment services) rose 65 per cent.

Prime memberships rose 53 per cent during the year in spite of a $US20 price hike. Prime members spend on average $US1,500 per annum – more than twice that of regular Amazon customers.

For the full year, revenues increased 20 per cent to $US89 billion and operating cash flow rose 25 per cent to $US6.84 billion. No other US retailer has those metrics.

During the conference call, chief financial officer Tom Szkutak said that the company in the next quarter would begin to break out Amazon Web Services (AWS) revenues, so investors can get a better sense of the scale (and profitability) of one of the most dominant cloud computing businesses today which is growing at 20 per cent per annum – another positive for investors and overall sentiment.

We’ve made no changes in our forecasts to revenue, earnings, or price target of $US400 yet, although a number of Wall Street analysts have done so. Another great quarter or two like this will result in a number of upgrades, including mine.

The basic investment thesis put forth in our “buy” piece on December 15, 2014 was that Amazon would play a bit of “catch up” in early 2015 as strong results from fourth-quarter 2014 sales, better profitability from a moderation of heavy investments, and  more clarity regarding the Amazon Web Services would improve investor sentiment toward the stock.

Well, that has eventuated, in part anyway. Amazon can be profitable. Stay tuned. Stay invested.

Google (NASDAQ)

Google reported fourth-quarter results a bit below consensus on both revenues and earnings. A large number of unusual charges that weighed on profitability and foreign exchange were certainly a headwind. However, revenue growth accelerated nicely for core areas such as paid clicks and sites.

On the earnings call, management also addressed rising investor concerns with respect to accelerating operating expenses and capital expenditure growth, noting that 2014 was a year of significant investment and that the company will carefully monitor expenses and look to invest for growth in a more disciplined manner going forward.

Management also provided some data points with respect to YouTube and Programmatic, noting that YouTube watch time is up 50 per cent year-on-year and that mobile revenue on the platform more than doubled, while DoubleClick saw volumes increase two-fold in 2014.

The market liked the commentary and Google shares jumped 4.8 per cent.

More specifically, core earnings per share (EPS) and revenues grew 15 per cent year-on-year to $US6.88 per share and $US18.10 billion respectively. Operating income declined slightly to $US4.4 billion, impacted by an increase in R&D and spending on sales, marketing and general expenses.

Aggregate paid clicks grew 14 per cent year-on-year. Management also provided some positive metrics on YouTube, stating that it now has over 1 billion users. Mobile revenue has increased over 100 per cent year-on-year and the company announced a series of new ad formats specifically for mobile screens.

The main investment case for Google rests on the company successfully monetising its transition from desktop to mobile ads and the expansion of YouTube. Like with Amazon, a bit more discipline over investment spending would be helpful. These quarterly results show the company is moving in the right direction.

There’s no change to our revenue estimates or target price of $US647.

Harley-Davidson (NYSE: HOG)

Harley-Davidson’s full-year 2014 EPS increased 18.3 per cent to $US3.88 compared to EPS of $US3.28 in 2013. Net income was $US844.6 million on consolidated revenue of $US6.23 billion. For the fourth quarter of 2014, EPS increased 2.9 per cent year-over-year to 35 cents, which was two cents better than expectations.

Fourth-quarter net income was $US74.5 million on revenues of $US1.20 billion, which was a bit below expectations. Harley’s fourth quarter tends to be a bit smaller (less than 16 per cent of total sales) and more volatile, due to seasonality and dealers looking to the Spring driving season.

US consumers tend not to buy Harleys going into winter when you put your bike in the garage in October and bring it out again in March or April.

Still, dealers worldwide sold 47,149 new Harley-Davidson motorcycles in the fourth quarter of 2014, up 2.8 per cent compared to 45,875 motorcycles in the quarter the year before. In the US 26,957 new Harley-Davidson motorcycles in were sold in the quarter, a decline of 1.6 per cent.

In international, 20,192 Harley-Davidsons were sold, up 9.2 per cent on the previous year. International is increasing in importance for Harley as over 40 per cent of total sales are outside the US and growing at a much faster rate. The new lightweight, inexpensive “Street” range is a natural for Harley’s overseas markets.

Geographically, unit sales were up 14.2 per cent in the Asia Pacific region, 8.7 per cent in Europe, the Middle East and Africa and 4.7 per cent in Latin America.

Guidance was pretty much as expected with the company flagging shipments of 282,000 to 287,000 motorcycles worldwide in 2015, an approximate 4-6 per cent increase. The company expects a full-year 2015 operating margin of approximately 18-19 per cent for the Motorcycles segment. The company sees capital expenditures of $240 million to $260 million for the year.

To be candid, there was nothing in the earnings release to be particularly excited about, or concerned about, for that matter. It’s pretty well “steady as she goes” as the new model line (Rushmore and Road King) continues to gain traction and the “Street” models make market inroads globally. Harley is a high quality company with an undemanding valuation.

We’ve made no change in earnings, revenues or target price of $US74

Dow Chemical (NYSE: DOW)

Dow Chemical had a solid fourth quarter and FY14, beating earnings and revenue expectations significantly.

For the year, Dow generated EPS of $3.11, compared to $2.48 in 2013 – an increase of 25 per cent. The company reported fourth-quarter EPS of 85 cents, outpacing consensus estimates of 69 cents by a wide margin.

Volumes rose 4 per cent year-on-year, accelerating from the 2 per cent in the third quarter, led by the agriculture and performance materials businesses. As we expected, margins expanded in most businesses due to lower oil based cost inputs. Foreign exchange, as with most multinationals, impacted total revenues by 2 per cent and will certainly be a factor in 2015 as the US dollar goes from strength to strength.

Comments from chief executive Andrew Liveris were, of course, positive:

“We are delivering on the commitments we have made – even as we ramped up the pace of investment in our long-term growth projects. In addition, we announced two significant transactions in the quarter in our drive toward delivering our target of $US7 billion to $US8.5 billion of released value through aggressive portfolio management measures. Collectively, these achievements underscore Dow’s fundamental drive to maximize shareholder value-creation at every turn.”

No specific financial guidance was given for 2015, but Liveris was upbeat: “Against the backdrop of ongoing macroeconomic, currency and energy market uncertainty, we continue to see positive underlying demand fundamentals. Dow is well positioned to continue to optimize returns in this environment,” he said.

Dow is a global company with, as we say in the industry, “a lot of moving parts” (six large discrete business segments) that are exposed to global economies, currencies, and commodity prices. The investment case for Dow is based on a massive self-help restructuring program, better operating efficiencies, and achieving real scale in growth segments.

Our thesis is intact but, given global uncertainties, the development is unlikely to be linear. Dow is for patient long-term investors.

We’ve made no change in revenue assumptions or to our target price of $US65.

Gilead Sciences (NASDAQ: GILD)

Gilead announced fourth-quarter 2014 results on February 4, 2015 that were significantly ahead of consensus estimates.

The company earned $US2.43 per share, beating consensus of $US2.22. Revenues came in at $US7.3 billion for the quarter, up 137 per cent year-on-year (that’s not a misprint), 580 million ahead of street estimates of $US6.74 billion.

Sales of Gilead’s two key HCV (hepatitis C) drugs, Solvaldi and Harvoni, were the main drivers of growth in the quarter, realising $US3.84 billion in sales.

The company also announced a 15 billion share buyback (on top of a current 5 billion program) and will start paying a dividend of 43 cents per share each quarter. Gilead generated $US12.8 billion of cash in 2014.

Gilead guided to product sales of $US26-27 billion in 2015, somewhat short of analyst’s projections of $US28.5 billion. In spite of the blowout earnings numbers, the market’s reaction was negative and the shares traded down 8 per cent the next day.

I don’t have a problem with companies offering “conservative” guidance. It’s better to guide up later in the year. Gilead has a history of measured guidance.

The reduced 2015 number does, however, bring up another concern: discounting and competition from AbbVie and Merck’s new products. Gilead surprised the market by announcing discounts of up to 46 per cent for the blended HepC regimen, partially I suspect due to more public payers, but also in response to the new market players. Most likely the result will be higher volumes at lower prices and improved access to the patient population – so not a disaster. Lower prices are not positive for new entrants.

The bottom line is as follows:

  • Gilead is incredibly cheap, trading at 10.9 times 2015 EPS (the S&P is at 17.3 times 2015 EPS) and still has a 20 per cent EPS compound annual growth rate (CAGR) through 2014-2016.
  • Gilead’s HCV treatment remains best in class. There is some competition, but the market is sizable enough for all three. The FDA just rescinded Merck’s “Breakthrough Therapy Status” due the availability of Gilead’s Harvoni, pushing the launch of this competitive regimen into 2016.
  • The market is ignoring the long-term growth potential outside the US. Despite lower prices versus the US, Europe is ripe with opportunity. European governments are establishing dedicated funds for HCV treatment, including Great Britain ($US236 million) as well as Italy, France and Germany ($US230-$285 million each)
  • In the fourth quarter of 2014, Gilead said that just 32,000 patients were under treatment in the EU. The US will have 250,000 under treatment in 2015 (up 80 per cent from 2014) from a similar population sample. There are at least 3.5 million people in the US with HCV.
  • There is no change to our thesis that the HCV market will be bigger and more lucrative than currently anticipated and Gilead will maintain its dominance with a global market share of over 60 per cent.

I would be an aggressive buyer of the shares at current levels. We’ve made no change in estimates, earnings or target price of $US136.

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