Global stocks: Markets recover

Some of our international picks are doing exceedingly well. Others present opportunities to be an aggressive buyer.

After being overseas for three weeks, it’s comforting to see markets and stock prices recovering to levels not seen since early July. The recent correction, while scary at times, has proved to be just that – a correction and not the beginning of a prolonged downturn in global equity markets.

We are also in the thick of third quarter earnings reports which hopefully will form the basis for the next leg of equity market appreciation. Some of our companies are doing exceedingly well.


In 3Q15 Amazon, to coin a popular phrase, “blew the numbers away (again)” exceeding expectations both on the top and bottom line. The company issued 4Q15 guidance well ahead of forecasts.

Upside was driven by all three segments – North American and International Retail sales accelerated sequentially and Amazon Web Services (AWS) growth of 78 per cent Y/Y was impressive to say the least, as this business continues to attract key customers such as General Electric, Netflix, and BMW. Also, AWS operating margins came in surprisingly strong at 25 per cent and North American retail margins continue to expand, driven in part by an increasing adoption of Prime.

Amazon generated $US25 billion of revenues in the quarter representing a Y/Y growth rate of 30 per cent. Earnings were $0.17/share, another surprise profit, well above the consensus estimate of a -$0.13 loss! (What are all those bright spark Wall Street analysts doing?)

Management’s 4Q15 sales guidance of $US33.5bn-$US36bn suggests a continuation of the strong trends seen in 3Q, and it may in fact prove too conservative. As you would expect the fourth quarter tends to the strongest for the company and I expect Amazon will have a very solid holiday season.

Amazon continues to be one of our favourite stocks and continues to disrupt the retail/online retail space (just ask Walmart!). Since we recommended AMZN on December 15, 2014, the shares have gained 100 per cent (see Prime time for Amazon).

I continue to be a buyer but given the recent strong move ( 20 per cent over the last 30 days), would suggest accumulating on market weakness.

For subscribers interested in Amazon, I would suggest perusing the vast US website (not the Australian one, selection is limited) and viewing the enormous scale of goods on offer not to mention the prices and delivery times.


Google, sorry I mean “Alphabet”, reported strong 3Q results, with accelerating net revenue growth and margins that exceeded expectations. Management cited growth of Mobile Search as a key highlight of the revenue beat, driven by improvements in mobile ad formats and delivery. The company also announced a $US5bn share repurchase program, providing the clarity around Alphabet’s capital allocation policies that investors have been waiting for.

Net revenue of $US18.7bn (up 13 per cent Y/Y but up 22 per cent in constant FX) beat estimates on the strength of websites revenue, which benefitted from the growth of mobile search and also from YouTube. Paid click growth accelerated to 35 per cent. Earnings per share (EPS) of $US7.35 handily beat consensus expectations of $US7.21.

The quarter also marked the earnings call debut for Google CEO Sundar Pichai, who provided detail on some of the company’s core initiatives – search, Google Apps, AI, the Android platform and YouTube.

I expect analyst estimates to be upgraded as the mobile-driven beat should help negate the bear thesis that the core search business does not transition well to mobile. The share repurchase announcement together with lower-than-expected capex indicates a more disciplined approach to capital and expenses (courtesy of CFO Ruth Porat) which is a good thing.

Moreover, the move to segment reporting in January will allow investors to value Alphabet on a sum-of-the-parts basis and ascribe some value to the Google X businesses. That should provide an additional catalyst for shares.

Just as a reminder, we recommended Google on December 22, 2014 at $US520 (see Searching for value in Google). Since then the shares have gained 35 per cent significantly outperforming the market but are still 13 per cent below our target price of $US800.00.

Intuitive Surgical

Intuitive Surgical yet again reported strong results, as 3Q 2015 revenues and EPS came in well above estimates. As per our original thesis, robust procedure growth, international expansion and improving margins are the primary growth drivers for the company.

For the third consecutive quarter, procedure growth ( 15 per cent) came in above expectations as general surgery (hernia and colorectal) and international strength continue to provide a strong tailwind, while prostate volumes remain stable.

Reported 3Q revenues of $US590m came in well above expectations primarily driven by robust procedure growth, with the company posting a sequential uptick from what was already a strong 2Q ( 14 per cent).

System placements continue to increase with the next generation Xi system representing the vast majority of shipments (77 per cent vs 64 per cent in 2Q), as the market continues to migrate towards the higher-end system.

During the quarter, the company shipped 117 da Vinci systems, including 90 Xi systems, which was a Y/Y increase from 111 systems in 3Q14. The Y/Y growth in systems was primarily due to strength in the US market with 80 systems delivered.

Worldwide annual procedures grew a robust 28 per cent y/y led by Asia, with management attributing the international outperformance to strong trends in kidney procedures and malignant hysterectomies, along with continued strength in prostatectomies (dVP).

Guidance is still going up with annual procedure growth increased yet again. Management is now calling for growth of 13-14 per cent vs 11-13 per cent previously.

We recommended Intuitive Surgical on August 4, 2014 at $US453.17 (see Intuitive Surgical: Buying into robotics). Since then it has traded as high as $US550 and is currently trading at $US500, some 20 per cent below our target price of $US600.00. No competition and a very solid long-term story in robotic surgery. What’s not to like with ISRG?


Billings of $US85m easily beat expectations, helped again by $US5m in early renewals, broad-based demand, and Targeted Attack Protection (TAP). Office 365 security solutions were also highlighted as continued source of demand.

Normalised for early renewals and FX, billings grew 38 per cent Y/Y. Duration adjusted billings were 69 per cent Y/Y as duration was 15 months. Very solid.

Revenues came in at $US69m (37 per cent Y/Y) vs the Street’s $US66m. Targeted Attack Protection (TAP) products continue to grow 100 per cent Y/Y for the 8th consecutive quarter, with TAP now integrated with MobileIron and AirWatch.

Operating margins of –1.4 per cent were above the Street’s –5 per cent estimate driven by top-line beat and gross margin expansion. PFPT continues to reinvest some of the upside, though the Street seems to be factoring this into numbers. Upside in margin led to higher than expected EPS of –$US0.06 vs the Street’s –$US0.12. Collections were once again very strong, resulting in OCF of $US24m (Street $US11m) resulting in FCFE of $US16m.

Management continued its streak of “beat and raise” as expected, with strong demand and stable to improving sales productivity as drivers. Q4 billings guidance of $US90m-$US92m is nicely ahead of the street’s $US87m and probably too low.

FCF for Q4 is expected to be flat. Initial FY16 guidance is 29-30 per cent revenue growth (3 per cent FX headwind) with billings slightly higher. FCF for FY16 of $US28-$US32m is up 58 per cent Y/Y (based on $US19m guide) but looks very conservative.

Proofpoint is a recent recommendation (20 July 2015) and along with FireEye (an earlier recommendation) is absolutely one of the best ways to play the cybersecurity theme.

Proofpoint continues to lead security peers in growth. With benign competition and strong demand for preventing email-borne malware, I continue to believe billings growth will remain above street/guidance levels for some time. Our target price is $US80, some 25 per cent above current levels. (See also Proofpoint proves its worth, July 20, 2015.)

Dow Chemical

Dow Chemical’s numbers were well received and the stock was up 7.3 per cent in the “premarket” after beating Q3 earnings estimates, raising its dividend and announcing plans to accelerate its stock buyback program.

Dow reported EPS of $US0.82 for 3Q 2015, significantly higher than the consensus estimate of $US0.69. The company flagged broad-based outperformances across multiple business segments and healthy volume growth ( 2 per cent Y/Y overall, China 12 per cent).

Dow also said Q3 revenues fell 16 per cent Y/Y to $US12bn, citing lower pricing and unfavourable currency moves; Dow generates some two-thirds of its revenue outside the US, so the stronger US dollar has impacted recent results.

Q3 volume rose 2 per cent, with gains in most operating segments, excluding Agricultural Sciences, Performance Plastics (up 5 per cent) and Infrastructure Solutions and Consumer Solutions (both up 2 per cent).

Dow is also increasing its quarterly dividend 10 per cent to $0.46/share and will speed up its $US5bn share buyback program by repurchasing $US1bn worth of stock in Q4 and the remainder in 2016.

Dow also announced it will review strategic options for its Dow AgroSciences business to "focus on creating new synergies in a consolidating agricultural market".

Dow is planning to reduce stakes in two Kuwaiti joint ventures, cutting its stake in the MEGlobal JV by year-end and receiving pre-tax proceeds of $US1.5bn, and reduce its interest in the Greater EQUATE JV by mid-2016.

More importantly, management committed to no major M&A or new capex in the next five years, with $US1bn productivity gains targeted between 2015-17 and 20 per cent achieved YTD, so the transformation of its portfolio should continue unabated.

At $US50.00, Dow Chemical is a great choice for a conservative investor who is looking for a high quality, well managed global company that will benefit by a strengthening US economy and a macro recovery globally.

Dow is trading at 13.5 x 2016 EPS with a 3.6 per cent yield and in spite of a recent 25 per cent rally off its recent (correction induced) August lows there is a considerable amount of upside left. (See also Dow Chemical rouses into action.)

Harley Davidson

Harley’s results were disappointing, posting weaker-than-expected 3Q results, with retail sales, shipments, and EPS below expectations. Management also lowered 2015 guidance, which many investors had already anticipated. Additionally, Harley announced that it will make additional demand-driving investments in marketing and product development as the company expects the heightened competitive environment to continue for the foreseeable future.

Globally, 3Q retail sales declined -1.4 per cent (vs -1.4 per cent in 2Q), as retail sales in the U.S. were down -2.5 per cent vs down -0.7 per cent in 2Q although international sales were up 0.9 per cent vs down -2.7 per cent in 2Q. Shipments of 53.5k were below consensus (55.5k) and guidance of 54k to 59k. 3Q EPS of US69c also was below Street estimates of US78c.

Management lowered annual shipment guidance to flat to down 2 per cent Y/Y (or 265k to 270k bikes) vs prior guidance of up 2 per cent to up 4 per cent (or 276k to 281k bikes). 4Q shipment guidance of 47k to 52k (down roughly 0.3 per cent to up 10.3 per cent) came in below the low-end of last quarter’s implied guidance. Further, HOG now expects a motorcycle operating margin of approximately 16 per cent to 17 per cent vs prior guidance of 18 per cent to 19 per cent. (This is still pretty high for essentially a “manufacturing” company.)

In 2016, HOG will increase its investment in customer-facing marketing by approximately 65 per cent Y/Y and in new product development by 35 per cent. Combined, these changes represent roughly $US70m in additional investment to spruik demand in 2016. Management intends to fund this by reallocating existing spending. HOG also expects to incur a one-time expense of about $US30m to $US35m in 4Q related to this initiative.

Clearly Harley is a stock for patient investors but I’m not ready to throw in the towel – yet!

Harley’s valuation is compelling trading at 11.6 X 2016 EPS. That’s a huge discount to the market and its peers (Polaris etc) for such an iconic brand. Historically (since 1987) HOG has traded at an average forward multiple of 16.4 X.

A good deal of the shortfalls in Harley’s revenues and competitors pricing pressure have been FX induced. I expect this to moderate over time. Most of the shortfalls are also relatively small in nature, that is, low single digits for sales, shipments and guidance. Some have also resulted from product shortages which should be rectified over the next few quarters.

Harley’s significant stock buyback ($US600m in 4Q 2015 and $US1.5bn in 2016) should support the shares as management gets things back on track.

The recently signed Trans-Pacific Partnership could turn out to be a nice tailwind going forward as it will lower tariff barriers for Harley’s products in a number of high-growth, motorcycle friendly countries such as Malaysia, Korea, Vietnam and Indonesia. According to CEO Matt Levatich in a recent Bloomberg interview, the company plans to open more than 200 stores in these countries by 2020.

I would be an aggressive buyer of HOG especially under $US50.00. (See also Harley-Davidson rumbles to life, November 3, 2014.)

In order to better understand these earnings reports, I urge Eureka Report subscribers to review the initial write up on each of these companies, linked above.

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