It may be our ears were playing tricks on us, but we believe we heard yesterday (8/15/19) “you’re supposed to do your buying when there’s blood in the streets.” While this line pays homage to Baron Rothschild, an 18th century British nobleman and member of the famous Rothschild banking family, who reportedly said, “Buy when there is blood in the street, even if it is your own” you can understand our incredulity at the statement because, from where we sit, the only blood in the streets that we see is from the cellar-dwelling O’s following their 16th straight loss to the Bronx Bombers! It’s true the market’s action has gotten quite a choppy and difficult of late, but there’s no blood.
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In August Individual Med Adv enrollment increased 7.7% y/y and Group Med Adv enrollment increased 7.5% y/y, producing total y/y Med Adv growth of 7.6% – 8.4% ex. MN market which declined y/y due to the ongoing cost plan conversion. 65.1% of total Med Adv enrollment of 22.7M lives were in our covered co’s vs 61.6% of 21.1M lives a year ago.
With this note we are updating our models for MCO / Drug Retail coverage post 2Q19 results. We are also updating our price targets across our coverage universe to reflect 1) revised earnings est laid out in this note and 2) current S&P multiple of 16.25x (previously used 16.0x). Please see links to all updated models and new PT build-up on page 2 for further details. We continue to rate the MCO group Market Perform with top picks remaining ANTM, HUM and UNH.
We are introducing quarterly 2020 estimates for our airline coverage and adding FY22 estimates. We’re still negative on the airline sector (market underweight) because of compounding underlying capacity growth but we’re upgrading LUV from PP to OP ($57 TP) on a flight to quality concept. When airlines don’t demonstrate capacity discipline on an aggregate basis we tend to have a positive bias towards aggressive share winners with good CASMx trends and strong brand affinity. That is probably LUV in 2020.
While investors were clearly bracing for a rough Q2, it was still strikingly bad. 13 of 15 U.S. suppliers reduced full-year guidance. We gathered cautionary commentary on pricing, R&D reimbursements, low incremental/high decremental margins, and diminished ability to extract annual cost savings from Tier 2 suppliers. The average supplier saw earnings decline by 8.9% YOY in Q2. Since April 1, the average supplier shares are down 15% and 2019 / 2020 estimates have come down by 8% / 9%. And this isn’t yet recessionary. The US SAAR is still around 17 mln and Western European demand is still near peak levels.
We are updating estimates and PTs for UHS, DVA, and THC to reflect our revised estimates / EBITDA bridges post Q2 results. See summary of changes and our commentary by company on pages 4-9. We maintain our Outperform ratings on HCA, UHS, DVA and Peer Perform for THC.
SPTN reported 2Q19 earnings on Wednesday 8/14 after the market close (preliminary headline results were released on 8/12). On 8/12, SPTN also announced a leadership transition, naming its former CEO (and current Chairman of the Board) Dennis Eidson as interim CEO (replacing Dave Staples). SPTN’s revenue and profitability growth remains subdued, while the pricing environment, in our opinion, is likely to get tougher before it gets better (see our Midweek Musings – Here We Go Again…). Supply chain costs continue to come in higher than anticipated and the Military business profitability continues to diminish. If the new leadership team at SPTN is able to address and overcome some of these challenges in the next few months, the company could see an improvement in its margin profile. That said, balancing the company-specific issues and a tough industry climate with a valuation that appears to be reasonable, we remain Peer Perform rated on the equity.
In times of uncertainty, lean into field fundamentals (and valuation). There were two key, but distinct negative takeaways from last week’s 2Q19 result. First, fleet profitability retreated, and the N-T utilization outlook softened. Second, the company announced an Audit Committee review of potential controls deficiencies, which discovered that “incorrect expenses” were filed by the CEO/CFO (albeit in amount of a G&A rounding error). We understand the selloff, as investors remain in “wait and see” mode regarding audit findings. Rather than retrench to this holding pattern, we are leaning into field fundamentals, and believe that valuation (now below equipment replacement) encapsulates the audit overhang. We reiterate OP, and lower our YE19 PT to $27 (from $33) based on 5.5x our FY20 EBITDA.
This week, we reintroduce our volatility charts and here we highlight the inverse correlation between volatility and valuation. We also touch on GE and the fresh, old claims around its accounting.
Walmart U.S. continues to impress, putting up a strong U.S. comp of 2.8% while leveraging operating expenses. The momentum the company has in the U.S. business allows it to further invest in its growth, whether through price and/or convenience. Our research suggests that this does appear to be the case, as the company seems to be implementing a fresh round of price investment (see our Midweek note Here We Go Again…), particularly in food. Taking a step back on why we remain Underperform rated, the overall company’s earnings and ROIC continues to be subdued by losses from international investments (Flipkart), and while it is still too early to tell, our research does suggest that Amazon’s move to one-day delivery and reacceleration in North America could lead to a potential slowing of sales for WMT, or necessitate further investments in distribution infrastructure. Coupling these risks with an equity that is trading well above its historic valuation leaves us Underperform rated, though we are raising our target price to $105. (from $95).