Valuentum Exclusive Analysis for the Discerning Investor

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Image Shown: In this article we cover a variety of companies that reported earnings in May 2020.

By Callum Turcan

As we get deeper into 2020, more companies have reported earnings that covered how they performed during the early days of the ongoing coronavirus (‘COVID-19’) pandemic on both a financial and operational basis.

In alphabetical order by ticker: DE, LOW, NVDA, TGT

Deere & Company

On May 22, Deere & Company (DE) reported second quarter earnings for fiscal 2020 (period ended May 3, 2020) that saw the net sales at its equipment division fall by almost 20% year-over-year while revenues at its financial services division fell by almost 2% year-over-year. The company expects its worldwide ‘agriculture and turf equipment’ sales to fall 10-15% in fiscal 2020 on an annual basis while its worldwide ‘construction and forestry equipment’ sales are forecasted to drop by 30-40% in fiscal 2020, highlighting the very serious headwinds facing industrial equipment manufacturers and the industrial sector at-large due to the ongoing pandemic. Foreign currency headwinds are also a factor (which depressed Deere’s fiscal second quarter revenues), as the US dollar has been relatively strong of late.

Deere acknowledged that the sharp forecasted drop in its equipment sales would seriously pressure its operating margins going forward. The firm expects to generate $1.9 billion - $2.3 billion in net operating cash flow this fiscal year and intends to continue investing in its core business operations while being cognizant of the fact that Deere needs to maintain solid investment-grade credit ratings. Maintaining Deere’s quarterly dividend continues to be the goal, at least as things stand today, and share repurchases are at the bottom of the company’s capital allocation priorities. Shares of DE are trading below the low end of our fair value estimate range as of this writing, as investors are growing increasingly worried about its outlook.

Back in March 2020, we wrote a note (link here) highlighting how Caterpillar Inc (CAT) was experiencing significantly weaker demand for its industrial equipment due to the pandemic, indicating these headwinds stretch far beyond just Deere. When Caterpillar reported its first-quarter 2020 earnings in late-April, the firm’s ‘Machinery, Energy & Transportation’ segment sales dropped by 22% year-over-year. Caterpillar’s financing wing also reported a year-over-year decline in its revenues, though that decline was far more modest at just below 3%. On a final note, we caution that the enormous financing arms of Deere and Caterpillar could become a major burden should borrowers come under immense financial distress (government action could help alleviate problems here, but that isn’t a given).

Lowe’s Companies

On May 20, Lowe’s Companies Inc (LOW) reported first-quarter earnings for fiscal 2020 (period ended May 1, 2020) that saw its GAAP net sales rise by almost 11% year-over-year while its cost of sales rose a little over 8%, as Lowe’s was successful at pushing through meaningful price increases. Like many other retailers, Lowe’s provided bonuses to its frontline workers to reward them during these challenging times. That saw the company’s SG&A expenses shift higher by almost 9% year-over-year, though strong top-line performance still enabled the home improvement retailer’s GAAP operating margin to rise by over 210 basis points as its GAAP operating income rose by almost 41% last fiscal quarter.

Going forward, the sharp slowdown in economic activity in the US could potentially weigh on the company’s ability to continue outperforming in the near term. Reduced consumer spending power as it relates to the firm’s do-it-yourself (‘DIY’) customer base is one concern; another is the potential impact subdued economic activity will have on construction activity, particularly as it relates to residential and some commercial construction activities. That said, new home construction has fallen far short of household formation in the US over the past decade (see more here), indicating there’s a very real need for greater amounts of new home construction starts and residential construction activity overall.

Lowe’s noted that its DIY customer base helped drive strong comparable store sales growth last fiscal quarter, assisted by strength from its pro sales as well, as highlighted by management during the firm’s latest quarterly conference call (emphasis added):

“For the first quarter, we delivered strong sales growth with total company comp sales growing 11.2%. Our U.S. home improvement comp was 12.3% due to strong demand from both DIY and pro customers. Overall demand strengthened as we moved through the quarter and that sales momentum has continued into the month of May.

For the quarter, DIY comps slightly outpaced pro comp, and the uptick in DIY demand was partly driven by the arrival of spring weather in many western and southern geographies, as well as a customer mindset that was heavily concentrated on the home. We saw broad-based project activity ranging from outdoor landscaping and other beautification projects to essential indoor repair and maintenance work and long-deferred home projects, the to-do list that customers hadn’t previously tackled given their busy schedules.

Comp sales for pro were strong, supported by our focus on retail fundamentals, including job lot quantities, more flexible delivery, and the improved service model that we put in place in 2019. As you would expect, we saw increased demand in COVID-related product such as cleaning supplies and appliances like refrigerators and freezers.” --- Marvin Ellison, CEO of Lowe’s

It appears that many US households decided to pass the time through DIY home improvement and repair projects while being quarantined at home due to stay-at-home orders.

Lowe’s exited the fiscal first quarter with $6.0 billion in cash and cash equivalents on hand plus an additional $0.2 billion in short-term investments and $0.3 billion in long-term investments. Stacked up against $1.6 billion in short-term debt and $20.2 billion in long-term debt, Lowe’s carries a hefty net debt load. Partially for that reason, Lowe’s suspended its share repurchasing program last fiscal quarter and does not expect to resume share buybacks anytime soon.

The company has continued to make good on its quarterly dividend of $0.55 per share. As of this writing, Lowe’s is trading in the upper bound of our fair value estimate range, indicating shares of LOW are fairly valued given the retailer’s strong performance of late and its promising long-term outlook (given the need for more new home construction in the US).

Nvidia

On May 21, Nvidia Corporation (NVDA) reported first quarter earnings for fiscal 2021 (period ended April 26, 2020) that saw its GAAP revenues surge upwards 39% year-over-year. The chipmaker reported explosive growth at its data center operations where sales rose by 80% year-over-year, and going forward, the launch of its NVIDIA A100 GPU (which is now in full production according to a May 2020 press release) that runs on its new Ampere architecture supports its outlook in this space. Additionally, a day after the end of its fiscal first quarter, Nvidia closed on the purchase of Mellanox (a big data center company focused on networking infrastructure) through an all-cash deal valued at ~$7 billion.

At the end of Nvidia’s latest fiscal quarter, the firm carried $16.4 billion in cash and cash equivalents on hand versus $7.0 billion in long-term debt. Please note that this picture will change somewhat after Nvidia’s Mellanox acquisition is reflected in its financial statements; however, Nvidia should still be in a position to retain its net cash balance. We strongly appreciate Nvidia’s focus on maintaining a net cash balance as that puts the firm in a much better position to ride out Black Swan events like COVID-19. Nvidia generated ~$0.75 billion in free cash flow during the fiscal first quarter which easily covered $0.1 billion in dividend payments during this period.

Please note that due to the Mellanox deal, Nvidia hasn’t been repurchasing a meaningful amount of its stock of late under its share buyback program. The firm “is evaluating the  timing of resuming share repurchases and will remain nimble based on market conditions” and “is currently authorized to repurchase up to $7.24 billion in shares through December 2022” which could be funded (at least in part) through future free cash flows. Nvidia “remains committed to paying its quarterly dividend” which is relatively small given that the firm prefers to reinvest cash back into the business, keep ample amounts of cash on hand, and repurchase its outstanding stock when prudent.

Shares of Nvidia are trading far above the top-end of our fair value estimate range as of this writing, however, when we roll over and update our models covering this space there’s a good chance the fair value estimate for shares of NVDA will be revised higher.

Target

On May 20, Target Corporation (TGT) reported first-quarter earnings for fiscal 2020 (period ended May 2, 2020) that saw its GAAP total revenues jump over 11% year-over-year, aided by surging demand for same-day delivery services. Target’s past investments in its digital infrastructure, grocery pickup operations, and home delivery options played an enormous role in supporting its sales growth. Please note that back in December 2017, Target announced it was acquiring Shipt for $550 million in cash to provide its customers with a truly competitive same-day and home delivery option (and to try and catch up with the competition).

In the fiscal first quarter, Target’s comparable store sales growth clocked in at 10.8% year-over-year, largely due to its digital sales rising by 141% as its in-store comparable sales were up just 0.9% year-over-year. Comparable store sales of its same-day delivery services (‘Order Pick Up, Drive Up and Shipt’) were up 278% year-over-year, and furthermore, management noted that Target saw its comparable store digital sales growth increase dramatically from February 2020 to April 2020 (meaning this side of the business appears to have a lot of momentum going forward). Digital sales channels generated over 15% of Target’s total sales last fiscal quarter, more than double year-ago levels.

Aggressive operating expense increases led to Target’s GAAP operating income dropping by almost 59% year-over-year in the fiscal first quarter, as the firm made major investments in both its workers and in worker safety (pay increases, bonuses, and enhanced paid leave along with safety measures like sneeze guards). While that ate into its margins, Target was able to grow its market share “across all five of its core merchandise categories” which speaks favorably to its financial performance going forward. Rewarding workers during difficult times such as these can lead to reduced employee turnover and better operational performance.

Target suspended its share repurchase program in March 2020 to preserve its financial position but has continued to pay out its quarterly dividend of $0.66 per share. At the end of its fiscal first quarter, Target had $4.6 billion in cash and cash equivalents on hand versus $0.2 billion in short-term debt and $14.1 billion in long-term debt. Shares of TGT are trading in the upper bound of our fair value estimate range as of this writing, indicating that shares appear fairly valued given its strong financial and operational performance of late, though we caution that Target’s net debt load will be a major hinderance to its financial flexibility going forward.

Concluding Thoughts

Companies that are selling goods in high demand, whether that be the tools and equipment needed for home improvement projects, components for data centers or consumer staples products, are doing much better than those selling industrial equipment. Demand for goods for home improvement products and residential construction activity has held up well so far, though things may get bumpy as we get deeper into 2020.

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Agricultural Equipment Industry – AGCO CAT CNHI DE MTW

Broad Line Semiconductor Industry – AMD AVGO FSLR INTC TXN

Communications Equipment Industry – CSCO JNPR KN NOK SMCI

Dollar Store and Department Store Industries – KSS M JWN BIG DG DLTR PSMT

Food Retailing Industry – CASY COST CVS KR SYY TGT WBA WMT

Integrated Circuits Industry – ADI MCHP MRVL NVDA SWKS TSM XLNX

Semiconductor Equipment Industry – AMAT CREE IPGP KLAC LRCX MKSI SNPS TER

Specialty Retailers Industry – AAN BBBY BBY GME HD LOW LL ODP SHW TSCO WSM

Related: SPY

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Callum Turcan does not own shares in any of the securities mentioned above. Cisco Systems Inc (CSCO), Dollar General Corporation (DG), and Intel Corporation (INTC) are all included in Valuentum’s simulated Best Ideas Newsletter portfolio. Cisco Systems Inc and Intel Corporation are both included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.