Gravitas: The Weighing Machine

February 09, 2024 | Michael Newton


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The Newton Group Insights

Benjamin Graham said: “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” It means that in the short run, the market votes on which firms are popular and sends stock prices up and down accordingly. But in the long run, the market has to assess the underlying fundamentals of a company to give its true weight, or value.

I was amazed when I saw these results from a blog post by Albert Bridge Capital:

  • Nvidia: It now has a $1.7 trillion market cap. And in the last five years, the stock is up about 1,700%. Guess what else is up about 1,700%? Nvidia’s earnings estimates.
  • Meta: Over the past seven years it has bounced around a lot but still has generated nearly 260% returns. And forward earnings projections? They’re up 280%.
  • Google: We can stretch things further back, and look at Google over the past 14 years (earnings up 885%, stock up 980%)
  • Amazon: during the same period earnings up nearly 2,500%, stock up about 2,800%
  • Microsoft: If we analyze Microsoft over the past 22 years. Forward earnings projections have increased 1,150%. The stock is up just over 1,200%.
  • Netflix: About 18 years ago, analysts were forecasting that Netflix would generate 11 cents of earnings in the coming 2006 year. Here in 2024, they are forecasting a whopping $17 of earnings in the coming year. That is an EPS increase of 14,889%. And how about the stock? Well it is up a staggering 14,882%.

Astonishing how accurate the earnings fitted to stock performance. Eventually it is the fundamentals that matter. The market is a weighing machine. Admittedly, some of these examples above are very long-term, but even when we self-select with some of the biggest, most exciting, long-term winners out there, and ignore the losers (of which there are many), it is still clearly apparent that it is the fundamentals that matter most.

Should you have any questions or concerns, please feel free to reach out.

Portfolio Notes

(+) indicates a positive development, (-) indicates negative, and (~) indicates neutral

(-) Alibaba (BABA-US) The Chinese e-commerce giant declined after it posted quarterly revenue that missed analyst estimates — 260.35 billion Chinese yuan ($36.6 billion) versus 262.07 billion yuan expected consensus — and hiked its share buyback program by $25 billion. We believe Alibaba’s lackluster earnings growth in the Dec-23 quarter result is a financial reflection of its newly sharpened strategy (i.e. focusing on core business and de-emphasizing/monetizing the non-core business). We expect similar weak earnings growth will persist in the next few quarters as the company continues to execute the strategy. On the other hand, the share buyback program upsizing by another US$25b offers a clearer outlook of a yield to shareholders at 7% per annum over the next 3 years, based on the current market cap. Such a clear outlook on yield to shareholders offers downside protection to the stock price, in our view. Owned in Opportunity Portfolio.

(-) Amgen (AMGN-US) stock suffered a few bad days over concerns that its weight loss therapy investigations overshadowed quarterly results that showed a surge in revenue on the back of its acquisition of Horizon Therapeutics. They reported Q4 2023 adjusted earnings per share of $4.71 on revenue of $8.2B. Analysts had expected earnings of $4.59 per share on revenue of $8.1B. Amgen's quarterly revenue surged 20% year over year. AMGN continues to execute on growth of base business, boosted by Horizon-acquired assets (e.g. Tepezza). Owned in Cash Flow and US Portfolios.

(sold) BCE (BCE-T) We exited Bell this week in the Core Portfolio only. The big surprise for BCE came with free cash flow guidance, which is expected to decline between 3% and 11%. By contrast, the Street was forecasting a 19% increase, a massive difference. Some of the items driving the FCF decline include an incremental $350 million in severance payments driven by a 9% workforce reduction, as well as a $300 million working capital hit. The implied F24 dividend payout ratio ranges from 120%-130% on a reported basis. After deducting capital lease payments, the payout ratio further increases to 155%-174%. Against this backdrop, BCE still raised the dividend by 3%, which makes no sense to us. Some chatter had BCE cutting its dividend, so now we are even more confused with this dividend increase. Because The Core is at its heart a growth portfolio, we sold shares. Still owned in Cash Flow Portfolio.

(new) C4 Therapeutics (CCC-US) is a clinical-stage biotech company developing protein degraders for the treatment of cancer and neurological disorders. RBC believes that the available clinical data has proven that targeted protein degradation (TPD) has a place in modern medicine for the treatment of various diseases. Time will only tell how robust this technology is able to achieve convincing clinical data to lock in regulatory approval and broad adoption among a

patient community. C4 has significant platform potential given ability to develop both mono functional and bifunctional degraders. A focus on validated targets helps de-risk development, while three collaborations (Roche, Biogen, Calico) provide external validation and non-dilutive financing. Finally, famed hedge fund manager Steven Cohen of Point72 (and New York Mets Owner) has been accumulating shares. New position in Opportunity Portfolio.

(-) Cameco Corporation (CCO-T) reported a healthy Q4, with results and guidance in line with expectations. Uranium sales were higher than RBCCM forecasts and realized sales prices were also slightly higher, as the price for physical uranium continued to tick higher in the quarter. On guidance, uranium production came in below RBCCM estimates, but sales estimates are above. Longer-term, Westinghouse compound annual growth rate guidance is estimated at 6-10%, which RBCCM thinks will be well received by the market as it confirms expectations for growth above the previous guidance of 3.6%. All in all, a good quarter for CCO but given the run the stock has had, we were not surprised to see a pullback. Owned in Core and Opportunity Portfolio.

(+) Caterpillar (CAT-US) reached all-time highs after the heavy machinery maker easily beat Q4 EPS expectations. Although higher interest rates kept a lid on equipment sales volume, the company effectively mitigated the decline through price increases across its product lineup. Furthermore, higher interest provided a boost to its Financial Products business, which generated a company-best revenue growth rate of 15% in Q4 to $981 mln. The standout performer was Energy & Transportation. Fueled by robust oil and gas drilling activity in the U.S., revenue increased by 12% to $7.7 billion due to strong demand for gas compressors and other equipment used for drilling rigs. The main takeaway is that CAT's upside earnings performance and better-than-feared outlook for FY24, is easing fears that higher interest rates and macroeconomic headwinds - especially in China - are putting a major dent in demand for heavy construction and industrial equipment. Owned in US Portfolio.

(new) Centrus Energy (LEU-US) were trading higher after the release of fourth-quarter financial results that showed earnings per share rose from the year-ago period. They reported fourth-quarter earnings per share of $3.58 on revenue of $103.6 million. In the year-ago period, the company reported EPS of $1.32 on revenue of $126.2 million. The company also reported 2023 full year net income of $84.4 million, above the $52.2 million reported in 2022. Centrus supplies nuclear fuel components and services for the nuclear power industry. New Position in Opportunity Portfolio.

(+) Chipotle (CMG-US) was nicely higher following a healthy EPS beat with its Q4 report last night. CMG also beat on revenues and posted nice comparable growth. It wraps up a successful 2023, wherein CMG delivered strong transaction growth, surpassed $3 million in AUVs (average revenue per restaurant), digital sales represented 37% of total sales and CMG formed its first international partnership to open locations in the Middle East. The company opened a record number of new restaurants in 2023 (271, 88% with Chipotlanes), including a record 121 new restaurants in Q4, of which 110 had a Chipotlane. CMG expects to open 285-350 new restaurants in 2024 with 80+% having a Chipotlane. However, CMG concedes that it continues to see developers delaying projects due to macro pressures and high interest rates along with permitting, inspection, and utility installation delays. Owned in US Portfolio.

(+) Eli Lilly (LLY-US) The pharma giant handily beat analyst expectations with its Q4 earnings report. LLY recorded its third consecutive double-digit EPS beat while revenue grew a robust 28.1% yr/yr to $9.35 bln. Much of the growth was driven by higher selling prices for its drugs. Growth was particularly strong in the US, fueled by weight loss drugs, particularly Mounjaro. The stock has been on a strong upward trend for most of the past year. Investors are excited about its exposure to GLP-1 obesity drugs and the recent approval of Zepbound only adds to that excitement. That has been helping to propel the stock higher. We are not seeing a big reaction this week as we suspect a good result was priced in already. Owned in Core, ESG+ and US Portfolios.

(~) Enbridge (ENB-T) reported EBITDA and distributable cash flow that was in-line to modestly ahead relative to consensus expectations. On the flip side, earnings came in slightly below. All-in, we would characterize this quarter was relatively in-line. The company also reiterated its F24 guide. Shares are trading at ~16.2x forward P/E, a notch below its 5-year average of ~17.3x. At this point in time, ENB is purely an income play from our perspective with a yield of ~8% and a payout of ~69% on 2024e DCF. Capital appreciation will likely be capped until we see progress on the integration from the utility assets. Owned in Cash Flow Portfolio.

(new) Ferrari (RACE-US) The success of new launches of vehicles like the Roma and the Purosangue should enable Ferrari to penetrate new demographics and the substantial Chinese luxury auto market. Finally, Ferrari is likely to dramatically expand its production. It has the capacity to make 15,000 vehicles but currently makes only13,000. Ferrari is a luxury stock. Ferrari’s EBITDA margins, stock price movements, and customer base are more similar to those of luxury stocks than auto OEMs. More than 40% of Ferrari owners already have at least one Ferrari and customers are largely in the growing UHNW (ultra-high net worth) and millionaire segment, similar to high-end luxury products. Furthermore, like some luxury brands, Ferrari has pricing power and loyalty, especially given the aura of exclusivity that it has garnered among its customers. Demand for Ferrari’s PHEV products is strong, and the company is able to price its EVs higher. Moreover, we expect the company to leverage EV technology to enhance the product—acceleration, handling etc. Finally, Ferrari is open to using partners instead of going it solo on EVs. As such, we expect capital allocation to be prudent. New position in Opportunity Portfolio.

(+) Linde PLC (LIN-US) reported Q4 results which beat consensus expectation on both a top and bottom-line basis. Despite flat volume growth in the quarter, the company continues to drive solid operating profit growth which exceeded consensus expectations through pricing and productivity. While Q1 EPS guidance fell below consensus expectations likely due to economic headwinds, FY EPS guidance of $15.25-$15.65 falls in line with consensus expectation at the midpoint. LIN is a high-quality company with a strong track record of delivering consistent growth and profitability in an attractive oligopolistic industry. Owned in Opportunity Portfolio.

(new) Madrigal Pharmaceuticals (MDGL-US) is an emerging biotechnology company with one of the most advanced pipeline candidates for nonalcoholic steatohepatitis, or NASH, a massive market with high unmet need. NASH is a common but serious liver disorder linked to obesity and diabetes, with limited treatment options. Liver fat buildup leads to fibrosis, the thickening and scarring of liver tissue, which could progress to cirrhosis, liver failure, heart disease, and death. The stakes in NASH are high, with a crowded pipeline contending for a slice of the $30 billion-plus market opportunity. We believe the potential segmentation of the NASH market will support multiple therapies and combinations, with later-stage NASH presenting a more lucrative opportunity. Shares have been volatile as Eli Lilly continues to make progress in the same area. Lilly also announced positive results from a study of tirzepatide, the chemical backbone behind Zepbound and diabetes drug Mounjaro, in a liver disease called metabolic dysfunction-associated MASH. After a year, 74% of patients who received tirzepatide showed no signs of MASH and their liver fibrosis didn't worsen. Just 13% of placebo recipients hit the same marks. The news suggests GLP-1 drugs, like tirzepatide, could play a part in treating MASH, formerly known as nonalcoholic steatohepatitis, or NASH. The size of the potential market and nature of the disease provide ample opportunity for multiple winners among companies developing (MASH) therapeutics,. New position in Opportunity Portfolio.

(-) McDonald (MCD-US) traded lower despite reporting another nice EPS beat. However, revenue was a bit light, which means this was MCD's first top line miss since 2Q22. Also, the comps were a bit disappointing. MCD concedes that it is operating in a challenging environment, and it expects these headwinds will continue in 2024. Elevated prices and muted consumer confidence are causing consumers to continue to be more discriminating with their dollars. MCD sees lower income consumers as being impacted the most. They are choosing to eat at home. MCD is not seeing much change among its middle- and high-income customers. MCD continues to gain share with those groups. As inflation has come down, MCD's pricing is coming down broadly in line with inflation. Recently, on TikTok, it’s a common refrain for McDonald’s customers to say the company has gone too far, charging more than $3 for a single hash brown in some locations. That is partly why MCD is guiding to more normalized +3-4% comps in 2024. MCD is still the powerhouse in fast food and we think it will remain resilient in 2024. Owned in Cash Flow and US Portfolios.

(new) Palantir Technologies (PLTR-US) surged after issuing a bullish FY24 revenue outlook, eclipsing rather tame numbers from Q4, including earnings and revs matching analyst forecasts and downbeat Q1 revenue guidance. However, an encouraging FY24 revenue estimate was not the only highlight from the quarter. The AI-based data analytics software developer surpassed $1.0 bln in commercial revs over the past 12 months for the first time, completed more AIP training seminars than initially expected, and forecasted a reacceleration of its U.S. government business this year. The 32% jump in PLTR's total commercial business outpaced the 11% growth in government revenue, carrying its overall top-line growth of 19.6% yr/yr to $608.35 million. New Position in Opportunity Portfolio.

(+)Shopify (SHOP-US) just rolled out another price hike for merchants. Merchants with Shopify’s Plus plan will see their monthly payment jump from $2,000 to $2,500 a month. Plus, the company quietly announced a new program where it will buy Google and Meta ads on behalf of its merchants. It’s the first time Shopify has provided full marketing services for its merchants. Owned in Core and ESG+ Portfolios.

(new) Spotify (SPOT-US) ended its fiscal year on a high note with 4Q23 results showing healthy subscriber growth and meaningful improvements on the bottom-line due to price increases and cost-cutting measures, including workforce reductions. The leading audio company is making good on its promise to improve its profitability and it expects those improvements to kick into a higher gear in FY24. Following growth of 16% last quarter, premium subscribers were up by 15% in Q4 to 236 million, beating its guidance by 1.0 million subscribers. The main takeaway is that after years of sizeable losses, SPOT finally seems to be turning a corner as it prioritizes profits. Owned in Opportunity Portfolio.

(+) TELUS (T-T) reported a great set of results, with revenue and adj. EBITDA in line, and impressive free cash flow of $590M vs. cons. $324MM. Despite commentary out of the peers on gaining market share, there is no evidence of that in this quarter for T, as subscriber growth was strong across all metrics with no dents in terms of recent trends. Furthermore, management commented on growth accelerating at Telus International, Telus Health, and Telus Ag. Although not huge contributors, their performance affects sentiment as we saw last year, and some momentum this year would be good for sentiment at T. Bottom line, relative to a more difficult operating environment and certainly in the wake of BCE’s results, this was a solid quarter. Although we are not pounding the table on any telcos at this time given fair valuation, we do continue to prefer T given its declining capex and industry leading NAV/dividend growth. Owned in Core and Cash Flow Portfolios.

(+) TransDigm (TDG-US) beats top-line and bottom-line estimates; updates FY24 outlook. !1 Non-GAAP EPS of $7.16 beats by $0.76. Revenue of $1.79B (+27.9% Y/Y) beats by $110M. TransDigm also provided a 16.4% jump in revenue guidance. TransDigm is a leading global designer, producer and supplier of highly engineered aircraft components, systems and subsystems for use on nearly all commercial and military aircraft in service today. Owned in Core and US Portfolios.

(+) Uber (UBER-US) reported its first annual operating profit, marking an “inflection point” in the tumultuous history of the ride-sharing company and sending its shares to fresh highs. Uber earned 66 cents per share and saw $9.94 billion in revenue, while analysts expected 17 cents and $9.76 billion. We think UBER's Q4 highlighted a business looking like its operating on all cylinders with strong growth, ramping profitability, significant FCF generation and is now set up for new LT targets and an inaugural capital return outlook at next week's investor day. Scale-fueled structural advantages continue to instruct our bullish views here where we believe the space remains under penetrated overall, the company is driving strong frequency improvements, new delivery vertical growth is continuing to ramp and we believe advertising has significant headroom to be an outsized margin expansion contributor from here. We like the company's scale-fueled structural advantage versus other smaller players and view it as a compounding growth story, with an increasing eye on FCF generation and capital return as it becomes part of the index. Owned in Core, ESG+, US and Opportunity Portfolio.

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“Government is like a baby: an alimentary canal with a big appetite at one end and no sense of responsibility at the other.”

– Ronald Reagan