Image Source: Brandon Martin-Anderson
The past few weeks have been difficult ones for the newsletter portfolios.
Sure, we’ve had some great reports from Hasbro (HAS) and Union Pacific (UNP), but the broad performance of some of our high-profile holdings hasn’t been what we’ve grown accustomed to. We’ve been concerned about the market’s “fluff” for some time, but equities have been racing ahead in any case, mostly in light of expectations for ongoing delays in continued contractionary monetary policy by the Fed, so the sluggish reports weren’t exactly what we were looking for to end the week. On Friday, April 22, we were “hit” with three rather glum quarterly reports from Microsoft (MSFT), Google – now known as Alphabet (GOOG, GOOGL), and Visa (V), all holdings in either the Best Ideas Newsletter portfolio, Dividend Growth Newsletter portfolio or both, together casting a shadow over an otherwise “feel good” Friday.
Microsoft Generates Free Cash Flow Margin of ~40%; Stock Sells Off
Even though Microsoft’s stock has run up 50% since the beginning of 2014, while paying a nice and growing dividend along the way, we can’t help but feel like we have disappointed members in some way with its stock selling off after its quarterly report, released April 22. We know stocks don’t go straight up all of the time, but that’s not to say that we don’t want them to. Microsoft’s revenue slipped ~5.5% while operating income dropped ~20% as earnings per share tumbled to $0.47 on a diluted basis in the quarter ending March 31, 2016, or the company’s third quarter of fiscal 2016. The performance came in shy of consensus.
Microsoft’s cash flow from operations, however, advanced nicely in the period, to ~$10.4 billion from $9.6 billion in the year-ago quarter, though capital outlays nudged up by ~$1 billion on a year-over-year basis, translating into relatively flat free cash flow performance of ~$8.1 billion — still an amazing 39% of reported revenue in the period though. Net cash on the balance sheet stood at $59.2 billion, or ~14% of its market capitalization at the end of the period. We’re not worried about Microsoft in the slightest, and we think the ho-hum report may actually serve to ignite a pace of dividend growth that we’ve yet to witness at the tech giant. Dividend growth investors might be very pleased by such developments, especially as any capital return will be backed heavily by the company’s phenomenal free cash flow generation.
Alphabet (Google) Grows Constant-Currency Revenue 23%; Shares Drop
Yet another sinking feeling it has been to watch a sell-off in shares of Alphabet following its quarterly report, released April 21, which showed a 23% constant-currency jump in revenue during the period ending March 31, 2016. Not only was the increase in revenue impressive on a standalone basis, but both the pace of reported revenue and constant-currency revenue accelerated from the year-ago period, 17% versus 12% and 23% versus 17%, respectively. GAAP and non-GAAP operating and net income also advanced nicely in the quarter, and the company’s ‘Other Bets’ operating loss was rather contained at ~$800 million. The market wanted more as both the top line and bottom line came in lower than the consensus estimate, and we believe the sell-off is an overreaction.
For one, Alphabet’s balance sheet health is tremendous as it holds nearly $68 billion of net cash on the books, or about ~13%-14% of its market capitalization, similar to the magnitude of top-rated credit Microsoft. During the period, net cash provided by operating activities leapt to $7.66 billion from $6.72 billion, while capital expenditures dropped modestly ($2.4 billion from $2.9 billion), helping to drive Alphabet’s free cash flow to $5.23 billion, up from the $3.8 billion. The free cash flow generated in the quarter ending March 31, 2016 was nearly 26% of revenue, revealing Alphabet’s top-notch ability to translate a dollar in revenue to a dollar in free cash flow while still investing heavily in new initiatives. We won’t see Alphabet’s undervalued equity truly power higher until the executive team announces a capital return program, something it has hinted at in the past, “Google Shows Why It Has Been a Best Idea (July 2015).”
We continue to be patient with this undervalued, cash-generating powerhouse in any case.
Visa Targets Mid-60s Operating Margin; $7 Billion in Free Cash Flow for 2016; Shares Pull Back
With Visa up over 40% since the beginning of 2014, it’s difficult for us to imagine being disappointed, but somehow in light of Microsoft’s and Alphabet’s reports today, it added to the downbeat nature of the day. Visa’s net operating revenue in the fiscal second quarter, released April 21, advanced 9% on a constant-dollar basis, while payments volume growth, on a constant dollar basis, jumped 12% over the prior-year mark of $1.3 trillion. Transactions processed by VisaNet leapt 9% in the quarter, while reported operating income advanced to $2.43 billion from $2.28 billion in the year-ago period. Cash flow from operations edged up modestly during the first six months of the fiscal year with Visa hauling in $2.57 billion in free cash flow.
Management raised a few concerns in its press release though: “The continued headwinds of the strong U.S. dollar, lower oil prices, and an uneven global economy are driving continued weak cross-border spend…we see weakness in China, Brazil, and oil based economies…Since we are not seeing any material improvements in economic trends, we are cautious as we head into the second half of fiscal 2016.” From our perspective, the executive suite may be deemphasizing the secular trend toward a cashless society in pointing to global cyclical tendencies, and while management is saying one thing, its financial targets are saying something completely different. How can one not like expectations for annual net revenue to grow 7%-8% for the year on an operating margin in the mid-60s with a target for free cash flow of ~$7 billion? We continue to view Visa as a long-term opportunity, and we’re sticking with shares.