Weekend Update #94
Welcome to Blue Room's Weekend Update. Each week, we're sharing what companies we're researching and the what, the who and the how that we think makes the companies interesting and unique. This roundup is brought to you weekly by a group of interns, creative minds, artists and investors who believe that through best in class investing along with the democratization of financial education we can do great things together. Enjoy, Explore and Share.
Friday market close marked the end of what has been a tumultuous quarter not just for stocks, but capital markets broadly. The 10- and 2- year yields reached levels not seen since 2008/2009 during the financial crisis, and the yield curve between the two has remained inverted since early July. FOMC rate decisions have sent yields rocketing higher, bonds notably lower, effectively sapping the liquidity in both equity and debt markets. The S&P 500 Index is lower 5.27% this quarter and down 9.61% in September.
Several FOMC members shared their thoughts on the state of the domestic economy this week. Hawkish commentary from the Fed’s Vice Chair Lael Brainard warned against retreating from inflation too soon and Atlanta Fed President Bostic contended that the 4.25 to 4.5 range is where the Fed should target its end of year rate. This was slightly offset earlier this week with Chicago Federal Reserve President, Charles Evans, positing that the U.S. central bank may be raising rates too quickly, believing that the economy can avoid a painful recession.
This week the S&P 500 finished lower by 3.02% at 3,585.62, the Nasdaq Composite index finished 3.66% lower at 10.575.62, while the Dow Jones Industrial Average closed this week down 2.69% to 28,725.51.
Economic data continues to support a strong American economy despite slowing growth with new consumer confidence, new home sales, personal income and personal spending all up m/m. GDP annualized q/q showed another quarter of negative growth.
Turning to the global macro, Russian president Vladimir Putin signed an official proclamation that currently occupied Ukrainian territories have been “officially” annexed. The move by the Russian leader was condemned by the United States, which subsequently issued new sanctions in response. Ukraine has formally applied for fast-track NATO membership. The move by Russia demonstrates that Putin has no intention of letting the war end any time soon, which does not bode well for energy and other commodity prices.
Thank you Blue Room Analyst IAN CARTER.
The third quarter has demonstrated a big shift as streaming services accelerated its market share gains over the summer. Despite a rough macroeconomic outlook, consumers, producers and advertisers alike are transitioning more and more to streaming. To symbolize the turning point, Amazon’s Prime Video became the exclusive host for Thursday Night Football — the first time ever an NFL game was not on a broadcast or cable channel. Netflix, the only streaming company in the green for September, has also been gaining momentum as reports surface that it is accelerating the timeline for its ad-tier launch.
The University of Michigan Consumer Sentiment Index increased slightly to 58.6 in September, up from 58.2 in August but falling from the preliminary September reading of 59.5.
Consumer sentiment confirmed the preliminary reading earlier this month and was essentially unchanged from the month prior, at less than one index point above August. Buying conditions for durables and the one-year economic outlook continued lifting from the extremely low readings earlier in the summer, but these gains were largely offset by modest declines in the long-run outlook for business conditions.
Headwinds:
Nike saw positive sales growth (non-currency adjusted) 3.58% y/y offset by cost of sales including inventory markdowns particularly in North America, cost of freight, increased challenges related to the zero-COVID policy in China. Operating expense headwinds included wage related expenses that grew 12.0% y/y the main contributor to a 280 bps decline in operating margin. Inventory increased 44.0% in the face of markdowns, indicating slower demand. Inventory days increased to 129, on a GAAP cost of sales basis.
Tailwinds:
Revenue growth still strong led by North America segment up 13.0% y/y on top of 15.0% growth in 1Q22 last year.
Inventory bubbles should be transitory and reflect mostly (roughly 65.0%) North American regions. This issue could be offset by the upcoming holiday season, where consumers may seek premium brands at value prices as gifts.
Demand shows strength in NIKE Direct channels led by NIKE Digital and certain high margin product releases like the Travis Scott AJ1 selling out in the West and the GT Cut & AlphaFly Next selling out in Greater China region.
Key Takeaways
Macro environment
Executives feel good about both revenue, given the current backlog, and the pipeline, which is growing double-digits
One caveat is that companies are looking two and three times before they sign off
Churn has been at record lows since prioritizing its focus to enterprise customers which have better stickiness and retention
FX continues to be a large headwind, with 35% of the business being international. The biggest parts of that portfolio are in Euro and Pound which have weakened significantly against the dollar since the beginning of the year
Financials
Did not change bottom line guidance despite absorbing 90 new people from Zephyr acquisition
Subscription gross margin currently runs at 80% non-gaap with the potential to improve 2+ points in the next couple years
McElhatton expressed optimism about reaching 25-30% growth and a 10-15% operating margin by FY’25
Zuora plans to continue running its professional services business near breakeven
Growth Outlook
Growth drivers are coming from Zuora’s Revenue and Collect products which are easier to land new customers than Billing which is a much bigger overhaul for companies to implement
Bookings growth for Revenue is nearly 100% quarter-over-quarter
The acquisition of Zephr will provide revenue opportunities on the subscriber experience side which allows Zuora to offer a holistic approach to the entire subscription journey
Zephr’s technology will allow clients to track users, implement paywalls, push upsells, and use AI for better autocollecting
Competition
Zuora’s main differentiator is its multi-product portfolio. There are no other competitors that can really offer the full end-to-end monetization platform with 40 different way to monetize recurring revenue out of the box
Competition is primarily coming from ERP and CRM players — but their functionality is too basic
Zuora does not see much competition on the lower end since turning its focus to enterprise customers. Once smaller companies scale, they realize they need a dedicated solution and end up coming to Zuora
Biggest headwind is not losing to other competitors, it’s companies trying to build internal infrastructure before ultimately switching over to a revenue and billing service when they reach scale
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EDUARDO SARABIA
VISITS BLUE ROOM HQ
BY ELI HAYNES
DIRECTOR OF IR
& BLUE ROOM ANALYST
Blue Room’s ethos behind our investment and commitment to the arts is no better highlighted than by our fearless and adventurous leader for our Guadalajara Art Project, Eduardo Sarabia. Eduardo embodies the values we seek to foster through our exposure to the arts by constantly innovating, exploring, and helping his community. His work, and his leadership in the art project, consistently interweave a strong sense of wonder, exploration, and connection that, in this case, stretches imaginations across borders.
Born in L.A. to Mexican immigrants, he has since relocated to his parents’ native country and has been based in Guadalajara since 2003. Since establishing roots in Guadalajara, Sarabia was able to attract top-level local talent and quickly assembled a team that has created an inspired and flourishing space in the heart of the city designed to empower local artists in the community. Please click here to read more about Eduardo’s personal journey, and the processes and events that led to the creation of what is now a haven for artists in Guadalajara.
Last week, we had the pleasure of hosting Eduardo in the Blue Room HQ, where he gave a presentation to the team updating us on his progress down in Guadalajara. Moreover, Eduardo was able to share the inspiration and vision behind much of his recent artwork, along with epic tales of precarious travels involving Quetzal feathers, international galleries, eclectic cars, and spiritual quests in the jungle.
Not to knock the colorful and dynamic corridors of Bloomberg Terminal, but Eduardo’s stories, art, and demeanor served to stretch our imaginations in different ways — ways that we’d like to think perhaps complement a more data-driven approach to investing and help keep us innovating, exploring, and learning. It’s evident that Eduardo loves what he does, and the joy, passion, and creativity he depicts in his artwork — which is displayed throughout the office — inspires us to be equally passionate and caring about what we’re up to in the HQ. We’re always excited when Eduardo comes into the office because, as Salvador Dali put it, “a true artist is not one who is inspired, but one who inspires others.” Needless to say, Eduardo’s easygoing and adventurous presence was a reminder to all of us at the HQ to remain bold and kind and curious and creative; which served as a reinforcement of why we love the arts.
Micron’s earnings report was a mixed bag of performance metrics with a very strong full-year improvement, slightly offset by an incredibly weak fourth quarter. We look to see the company continue to grow market share in the high-growth, stable margin businesses in Data Center and Graphics, Automotive, Network, and Industrial segments for cloud/AI end applications. It is clear now that we are in the beginning of a down market, which may find a faster rebound than that of previous cycles with Federal intervention. This is supported by the announcement of capital expenses focused on factory development of leading edge technologies, with the first factory to be constructed in Boise. We conservatively expect the first half of Micron’s fiscal year to be much weaker on a y/y basis as this fourth quarter, bouncing back only in the fourth quarter, as data center supply becomes less rigid, customer inventories detox, and bit demand returns to outsized growth in support of support global data growth trends.
HEADWINDS:
Fiscal Q1 revenue much lower than our expectations, with Q2 likely to be within a similar range. Q2 is especially worrisome as the combination of higher bit-shipments q/q and weak DRAM and NAND pricing leading to flat sequential revenue growth. In other words, Micron does not expect a recovery in memory pricing until at least the second half of next year.
Days of inventory are likely to remain elevated in the first half of this year as well, meaning 1-beta DRAM and 232 layer NAND next-gen memory solution revenue will be pushed back several quarters. Negative 1Q23 FCF is also deconstructive for entering the stock near-term. The company is looking to reduce near-term CapEx, keep expenses to a minimum and manage working capital in face of elevated inventory.
The outlook for the next six months was highly discouraging with Micron expecting $4.25b in revenue, at the midpoint, GM of 26.0%, and operating expenses of $1.0b. Micron estimated EPS of $0.04 at the midpoint is much weaker than prior market expectations of 55c.
TAILWINDS:
Market share growth is positive, with AI and data center SSDs.
As investors we like the company’s intent of returning 100% of free cash flow via share repurchases and dividends. The strong performance for the year allowed the company to return 90.0% of FCF to investors over the year.
Although inventories were shocked by the rapid quarterly decline in demand (DIOs increased 27 days on a GAAP basis), the company is limiting current capacity to weather near-term demand volatility.
The balance sheet still displays net cash, while debt levels are well within reasonable bounds.
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