Reporting season update

Note: All figures in USD unless otherwise stated. Results referring to percentage changes (increases/decreases) relate to the previous corresponding period (pcp) e.g. Q4 FY23 results are compared to those of Q4 FY22

Apple Inc (AAPL: US)5

Share price 8/6/23: US$180.57

Result Q2 FY23

Revenue US$94.8b, down 3% on the pcp.

Underlying EPS US$1.52, flat compared to the pcp

• One notable highlight was the 2% growth in iPhone revenue even as the broader industry contracted almost 15% according to some estimates.

• Its iPad and Mac offerings struggled relatively speaking with revenue in both declining more than expected. Management highlighted the difficulty in comparison due to stronger demand fuelled by coronavirus pandemic stimulus.

• The Services business (which includes advertising and App Store revenues) continued to perform well with 5.5% growth in revenue. The wearables business (including products such as the Apple Watch) saw sales decline 1%, albeit still above consensus expectations.

Key points

• On the capital front the company announced its authorisation of $US90b in share buybacks and dividends with its dividend also being raised 4% to US 24c per share.

• Flat earnings amidst declines in some large tech peers saw the business outperform consensus expectations for the quarter. Guidance on forward performance remains elusive however with the gyrations in customer demand and in supply conditions seeing management decline to issue a more detailed outlook for forward performance.

• During the quarter Apple also emerged victorious from its lawsuit with Epic Games on a range of grounds. The key part though is ensuring the App Store fee structure and control remain intact which should support continued growth in its Services business.

• The quality of Apple’s hardware and services franchise remains undiminished in our view with the business retaining much of the revenue and earnings it reaped during the pandemic The business remains much larger than it was in previous spells of economic weakness, and we are monitoring closely to see how impacts overall performance will be given the constraints that higher interest rates are posing for household spending. Thus far the performance has remained strong with high cash generation supporting dividend growth and continued share buybacks which should underpin client returns.

• Apple has remained a safe haven for investors to start 2023 notwithstanding the disappointing expectations of a 2.5% decline in earnings for FY23 before a bounce back in subsequent years. This demand has supported the share price but leaves the valuation more challenged notwithstanding the quality of the business.

• The development of ancillary business lines such as services and advertising are playing an important role in continued top line growth. These can lead to macroeconomic exposure (e.g. advertising demand tends to be procyclical) but also improve profitability given Apple is advertising within its ecosystem that sees other ad providers either locked out entirely or paying a premium for access to its customer base.

• A key part of the Apple thesis has been the increased disclosure of its services segment. This showcases its high and growing profitability with investors willing to pay more for these kinds of recurring earnings streams. An ongoing commitment to strong capital returns to shareholders should serve it in good stead.

Abbott Laboratories (ABT: US)1

Share price 8/6/23: US$100.78

Result Q1 FY23

Revenue $US9.75b, down 18.1% on the pcp.

Underlying EPS $US1.03, a decrease of 40.5% on the pcp.

• Abbott added support to Johnson & Johnson’s remarks over a recovery in elective surgery volumes with management noting that most delayed, nonurgent medical procedures had now resumed, supporting demand for its core medical device business.

• COVID testing sales have fallen more than expected as it is seen as a less pressing public health concern with revenue guidance for COVID tests being lowered to $US1.5b, down from US$2b.

Key points

• The growth in its non-CVOID core business including medical devices is expected to more than offset this decline with the company retaining its profit outlook of $US4.30 to US$4.50 per share for FY23.

• Adjusted earnings per share of $US1.03 per share was 4% higher than consensus estimates of $US0.99.

• The company announced US Food and Drug Administration (FDA) approval of Navitor, its next generation aortic valve implant for people who at high risk for surgical intervention. In other product related news its FreeStyle Libre glucose monitoring system also gained FDA clearance allowing for entrenchment with leading insulin pump manufacturers and improving healthcare for diabetes sufferers.

• We saw confirmation that COVID-19 testing sales are falling with higher-thanexpected deceleration during the quarter

• The long-mooted recovery in elective surgery volumes is paying dividends however with 10% growth in the underlying business in spite of the COVID-19 headwinds.

Our comments

• The guidance for FY23 EPS of US$4.40 (on a midpoint basis) has been maintained and represents a strong overall story. The business had a “sugar hit” from COVID-19 testing sales which are now rapidly declining as the world moves past the pandemic. The development in other business lines is progressing well and should be supportive of strong earnings growth (and dividend growth) over the medium term.

• The company declared its 397th consecutive quarterly dividend and has increased its dividend for 51 consecutive years, highlighting its growth over time and the quality of its operations to continue paying dividends through several recessions over that period.

• Despite headwinds from weaker COVID testing sales, the business remains well-positioned for strong growth over time and investors will benefit from both this and a regular, increasing dividend presenting an attractive total return versus the broader market in our view.

Adobe (ADBE: US)1

Share price 8/6/23: US$439.03

Result Q1 FY23

Revenue $US4.65b, up 9.2% on the pcp.

Underlying EPS $US3.80, an increase of 12.8% on the pcp

• Both revenue and earnings surprised on the upside with revenue growth of 9% slightly above consensus forecasts and underlying earnings per share beating estimates by 3.3%.

• Management guided to underlying EPS of US$3.75 to US$3.80 on US$4.75b to US$4.78b in revenue for Q2 FY23. It also upgraded guidance for FY23 EPS to a midpoint estimate of $US15.45 (up from US$15.30)

• As with other multinationals foreign exchange movements were a big driver of outcomes financially. Revenue grew 9% in the quarter but stripping out currency changes growth was actually 13% implying a 4% headwind from currency movements.

• An additional 5 million shares were repurchased during the quarter helping to bolster earnings per share growth.

• Business segments saw broad-based strength with Digital Media, Creative and Document Cloud growing revenue 9%, 8% and 13% respectively. Stripping out currency change impacts see these growth rates ratchet higher to 14%, 13% and 16% respectively.

• Adobe’s $US20b acquisition of Figma is also facing additional regulatory challenges with UK regulator CMA launching an initial inquiry. This follows on similar initial assessment in both the European Union and US. None of these have translated into a definitive rejection with management still guiding towards completion by the end of 2023.

• The core Adobe business has picked up momentum with upgrades on the back of this stronger performance seeing the business re-rate from ~20x forward EPS to ~24x since the start of the year.

• Its breadth of tools makes it well-suited to the rise of new or more popular forms of media for creatives and the building ARR book (a further US$410m added for Digital Media alone in Q1 and US$420m expected in Q2) suggest it retains stickiness amongst users.

Our comments

• In summary, the core business is continuing to execute well in balancing profitability while spending for growth and should be able to compound earnings growth above the broader market in the medium term.

• Scrutiny turns to the Figma deal and the near-term overhang on investor sentiment than might occur if it is successfully challenged by regulators. We would expect the deal has reasonable prospects for success given the differences between the two businesses and the relative immaturity of Figma limiting the market share impact should the transaction proceed.

American Water Works (AWK: US)1

Share price 8/6/23: US$147.12

Result Q1 FY23

Revenue $US0.94b, up 11.4% on the pcp

Underlying EPS $US0.91, an increase of 4.6% on the pcp.

Key points

• Management affirmed its EPS range of US$4.72 to US$4.82 with higher revenues from investments in its existing asset base as well as acquisitions

Our comments expected to underpin the growth trajectory. They also increased the quarterly dividend by 8% consistent with the long-term growth target of 7-9%.

• As part of their strategic plan for the next 5 years (to 2027) the business successfully raised US$1.7b in new equity which helps to deleverage the business in the near term and provides flexibility for new organic investments or acquisitions.

• The core Regulated Business segment grew revenue 10.5% to US$860m in Q1. This was largely driven from a mix of higher utility rates as well as cost recovery for incremental capital spending and acquisitions.

• Acquisitions continue to provide new customers with 1,400 added in the March quarter. The plan with these inorganic opportunities is to gradually transition customers to the applicable American Water rates. A further 1.3m customer connections are in the existing pipeline of opportunities to help fuel the company’s 2023-2027 targets of both earnings and dividend growth of 7-9% p.a.

• Rate reviews (regulatory proceedings to increase water rates for consumers and recover operating and capital spending costs) continue to represent an important driver of revenue and overall profitability. A combination of these and additional infrastructure charges helped drive a US$279m in revenue for the first quarter. Current pending proceedings could add a further US$144m if successfully granted.

• American Water continues to execute well at a fundamental level consistent with long term targets for both dividend and earnings growth.

• The value of its water infrastructure assets including embedded inflation protections has been showcased even in a tougher interest rate regime for the US.

• One near-term risk may be share price sensitivity to further interest rate hikes but infrastructure assets unlike global real estate have proven to be far more resilient in terms of the price investors have been willing to play. The critical value of their assets coupled with the ability to increase prices in line with inflation quickly has been a key driver of the divergence.

Alphabet Inc. (GOOGL: US)1

Share price 8/6/23: US$122.14

Result Q1 FY23

Revenue $US58.07b, up 3.7% on the pcp.

Underlying EPS $US1.17, a decrease of 5% on the pcp.

• Google continued to show signs of greater sensitivity to the global economy with weaker demand and growth in operating expenses translating into missing consensus expectations for earnings (6.3% below) in the March quarter.

• Unfavourable currency movements remained a notable drag with 6% revenue growth for the year to March in constant currency terms, implying a headwind of 2.3%

• Management reacted to investor concerns over cost discipline with $US2.6b in charges incurred to fund workforce reductions (~US2b) as well as a reduced office footprint (~US$0.6b)

• Google Cloud performance remained a positive with an operating profit reported for the Marcher quarter. This was flattered somewhat by a large reduction in depreciation costs as the company extended the estimated useful life of servers and other network equipment. It was also supported by increased operating leverage (fixed costs being spread over a larger revenue base) with sales growing 28.1% for the year to March.

Key /points

• The overall revenue trend in Cloud is still decelerating however (28% in March vs 32% in December) from admittedly high levels suggesting that while customer demand remains present it has still been softening across the industry. Quarter-on-quarter growth to illustrate this point was only 2.1% and management comments suggested more cost-conscious spending plans by customers given the uncertain economic environment

• Alphabet has drawn investor concern over the public interest in Microsoft partner OpenAI’s ChatGPT bot and the competitive threat it might pose with integration in Microsoft offerings such as its Bing search engine. This is a situation we are continuing to monitor but note limited signs of this occurring to date with Google’s distribution advantages (e.g. default on Apple devices) remaining a sizeable competitive edge

• Management provided some additional insight into the use of artificial intelligence (AI) across its business and assisting Cloud customers with its Generative AI offering. Alphabet has secured availability of Nvidia’s new L4 Tensor Core GPU for Cloud customers ahead of other providers.

• The Alphabet group has shown signs of sensitivity to global economic conditions particularly in advertising demand which is unsurprising given the scale of its market position and the weaker economic backdrop globally.

• Google Cloud remains a source of longer-term revenue growth and profitability with an operating profit delivered for the first time this quarter

Our comments

• The quality of the franchise particularly its core Search business remains intact in our view with its distribution advantage key to combating novel threats such as AI-based solutions.

• Cost management efforts are showing some signs that management is finally addressing investor concerns on this front. There is considerably more scope available here to improve business profitability in our view and more may need to be conducted to improve investor sentiment.

Johnson & Johnson (JNJ: US)

Share price 8/6/23: US$160.26

Result Q1 FY23

Revenue $US24.75b, up 5.6% on the pcp (up 9.0% in constant currency terms).

Underlying EPS

$US2.368, up 0.4% on the pcp (up 3.0% in constant currency terms)

• A stronger US dollar dragged on international business performance, similar to other American multinationals with worldwide sales growth of 5.6%. Adjusting for currency fluctuations however revenue rose 9% over the period.

• International sales were still a source of weakness even after adjusting for currency due to more anaemic growth from Asia-Pacific and Africa regional sales (only growing 4.1%)

• March quarter profitability was ahead of consensus expectations by $0.18, boosted by a recovery in medical procedures and better-than-expected sales from its pharmaceuticals division (its COVID-19 vaccine and Stelara treatment).

• On the positive front, management upgraded its guidance relative to the January position.

• Underlying sales growth (assuming constant currency among other less material adjustments) is now projected to be 4.5%-5.5%, up from a range of 4%-5% with underlying EPS also upgraded by 0.5% from $10.40-$10.60 to $10.50-$10.60.

• Ongoing lawsuits over the company’s legacy talc products continue to persist with the latest manoeuvre being another attempt to use bankruptcy proceedings to resolve claims. This saw the company take a larger charge to provision for a total of $US8.9b in settlements. The hope is that this subsequent attempt at settlement will decisively conclude the claims.

• Finally, the company saw its Consumer Health division spun off as a new listed entity, Kenvue, in early May ensuring J&J is a focused medical device and pharmaceutical business.

• The business has shown the benefits of its diversified operations in being able to navigate a difficult macroeconomic backdrop and eke out earnings growth.

Our comments

• Our opinion on JNJ as a mature but growing business at a reasonable valuation remains intact. The Kenvue spinoff should bring greater attention on its core franchises and, ideally, support a higher valuation over the longer term as the business moves past both the boons (COVID-19 vaccine) and banes (higher input costs) of the pandemic period in recent years.

• The re-emergence of the legacy talc concerns is an issue that we are monitoring closely given its potential to distract and weigh on investor sentiment until it is adequately resolved.

Microsoft Corporation (MSFT: US)1

Share price 8/6/23: US$325.26

Result Q3 FY23

Revenue $US52.86b, up 7.1% on the pcp

Underlying EPS $US2.45, an increase of 10.4% on the pcp

Key points

• We saw signs of US dollar strength challenges as with other multinational businesses. In constant currency terms revenue grew 10% overall implying a currency drag of 2.9% for the period. Likewise, with underlying EPS if one accounts for currency impact the result was an increase of 14% suggesting a currency drag of almost 4%

Our comments

• Cloud revenue was $US28.5b overall, up 22% (25% in constant currency terms) with highlights including Azure growth of 27% (31% in constant currency terms).

• Sources of business weakness were notable in consumer facing products with Office Consumer seeing revenues rise only 1% (up 4% in constant currency terms) and likewise in personal computing which fell 9% (a 7% decline in constant currency terms).

• Results topped consensus forecasts overall with underlying EPS of $US2.45 versus expectations of $US2.23 while Azure growth of 27% was also above expectations of 26.6%. The result was also supported by stronger than expected demand in its productivity segment (which includes LinkedIn advertising revenues and Office software sales) that saw revenues top estimated by $US0.5b.

• Microsoft is still performing strongly in underlying terms particularly with its cloud business. The signs of sensitivity to the broader economy have persisted since the September quarter with personal computing one obvious point of weakness.

• US dollar strength has also continued as a near-term headwind expecting to detract 2% from revenue growth for the next quarter.

• The bid for US gaming giant Activision continues although opposition by UK authorities may stifle the bid as Microsoft is appealing the veto by British regulator CMA with a verdict due for August or September this year.

• Our overall thesis on the business remains intact with the shift to cloud offering a path to continued earnings growth (even with the slowdown a 27% expansion of Azure revenue is enviable for a business of this size and reach). It also offers returns on capital at a premium to the broader market and a reasonable valuation and remains compelling as an investment in our view.

• Two points of concern abide however, notably valuation and deceleration in its cloud business. On valuation surging interest in OpenAI’s ChatGPT tool have benefitted the company’s share price as people speculate on the potential productivity and other business gains from take-up of ChatGPT-powered solutions This is seeing shares re-rate materially higher and trade near the top of its 10-year range at almost 30x estimated EPS for FY24. This increases risk of a correction should the business disappoint lofty expectations.

• Secondly cloud revenue whilst growing at an enviable rate has been decelerating. While the business has benefited from a structural transition towards cloud solutions the tougher economic environment could see further declines in business IT spend that may see growth decelerate or outright decline.

Nestle

Share price 8/6/23: CHF 107.00

Result Q1 FY23

Revenue CHF 23.47b, up 5.5% on the pcp

• Overall revenue growth was impacted heavily by foreign exchange movements, a drag of 4%, while net acquisitions were a minor support, adding 0.3% for the quarter.

Key points

• Organic sales growth was 9.3% for the first quarter of FY23. This was split between a 0.5% decline in real internal growth (RIG, a volume measure) and 9.8% of pricing growth

• Organic growth remained broad-based across both developed (+8.6%, with price hikes, +9.7%, offsetting RIG declines, -1%) and emerging markets (+10.3%, a combination of pricing, +10%, and RIG, +0.3%, effects).

Our comments

• RIG declined 0.5% in Q1, an improvement on the 2.6% drop for Q4 FY22. Demand elasticity has remained subdued with limited signs of consumers downtrading to substitute products according to management. The decline in RIG was also driven partly by capacity constraints and portfolio optimisation efforts (removing higher growing but lower margin products).

• Portfolio optimisation efforts continue with a focus on higher growth and margin products.

• Management confirmed its FY23 outlook for organic sales growth of 6%-8% and an underlying trading operating profit margin of 17% to 17.5%. It also expected underlying EPS to growth between 6% and 10% in constant currency terms.

• Nestle continues to exert strong pricing power, leveraging the power of its brands with fractionally positive volume growth despite the scale of its price hikes

• The business has performed well, given its global scope, in largely containing inflationary pressures in its cost base and also passing on increases to end consumers.

• The resilience of organic growth is still being tested with developed markets weak on a volume basis. The concern is whether consumers is the wake of higher inflation and interest rates globally will continue to tolerate higher prices or pivot into substitute goods. To date the quality of its product set appears to be doing well and allowing the business to sidestep the choice of sacrificing margin by discounting to drive volume growth.

• Overall, the business remains well-placed to continue generating high single digit earnings growth without being overly troubled by inflationary challenges and returning capital back to shareholders in the form of dividends and buybacks.

• One point of concern remains the valuation front which we continue to monitor as we are conscious of not wanting to overpay for a low-growing (but safer) business in the current environment of elevated inflation and interest rates given the potential for a valuation derating if results disappoint. This has moderated with price weakness in the past quarter.

Universal Music Group (UMG: EU)1

Share price 8/6/23: €19.15

Result Q1 FY23

Revenue €2.45b, up 11.5% on the pcp

Underlying EBITDA €0.52b, an increase of 14.7% on the pcp.

• UMG saw top line revenue rise 11.5% for the year to March 2024 or 9.3% in constant currency terms.

• The result was driven by strength in its Recorded Music and Music Publishing businesses.

Key points

• The Recorded Music result was driven by growth in subscription revenue, up 12.7% with physical revenue (CD and DVD sales in Japan and stronger vinyl sales growth) also a surprise, up 32.1%.

• Music Publishing was driven by strength in digital revenue due to streaming and subscription sales growth.

• Adjusted EBITDA (a profitability measure) rose 14.7% or 13% in constant currency terms with Adjusted EBITDA margin expanding 0.6% to 21.3%.

• A new competitive threat emerged during the quarter, namely AI-generated music. The company is looking to block AI platforms from training their models

Our comments on songs that UM holds copyright over. The worry is that this technology could be utilised to recreate melodies or even artists’ voices sidestepping the industry entirely. This is a new space legally and it remains uncertain how authorities will react going forward. It is likely, in our view, to see some form of new regulation given the potential negative impacts on the sector, both artists and record labels, in the alternative scenario (giving AI solutions free rein).

• Our thesis of Universal Music as a diversified record label able to extract value from different facets of the music industry ranging from live events to streaming (e.g. Apple Music, Spotify) offerings as it benefits from its extensive catalogue of music rights The bounce back in earnings from live events offers an added near-term bonus as a pandemic recovery story as well

• Universal Music will continue to be capital intensive to an extent as it needs to find and develop new artists to bolster its music catalogue. We would also expect some royalty acquisitions over time where the company sees the value in being opportunistic in adding new music royalties as part of its stable.

• AI presents a new potential danger. We believe that some level of compromise will be achieve however given the real detriment that a zero regulations scenario would have for artists as well. In that sense we see it as somewhat analogous to the risk posed by online piracy until the industry found viable options in established platforms such as Spotify, Apple Music and social media.

Union Pacific Corporation (UNP: US)1

Share price 8/6/23: US$200.99

Result Q1 FY23

Revenue $US6.1b, up 4.1% on the pcp

Underlying EPS $US2.67, an increase of 3.9% on the pcp

• Operating revenue growth was driven by higher fuel surcharge revenue and core pricing increases that were partly offset by a negative business mix and volume declines, the latter was down 1%

• Net income was $US1.6b for the quarter and boosted by a one-time real estate transaction.

Key points

• Cost control remains challenged with the overall operating ratio (a measure of operating expenses relative to revenues) falling 2.7% as hikes in wages and other input costs, a 4.6% deterioration, were partly offset by a 1.9% gain from falling fuel prices.

• Management maintained its full year guidance for carloads to exceed US industrial production growth (current forecast of -0.7%, declining slightly more than the -0.5% forecast in January) and pricing growth in excess of inflation.

• Our overall view on the business remains intact

• Arguably more than some other businesses it has seen meaningful challenges from supply chain disruptions, higher labour costs and energy prices.

Our comments

• It has however demonstrated the quality of its moat with pricing power a key lever in countering these impacts and passing them on to the end customer instead of absorbing through lower profit margins. This has been tested more recently but we expect over time that productivity initiatives and the easing of supply chain challenges will support business results going forward. Management guidance for pricing increases in excess of inflation are also illustrative of that pricing power in action.

• Valuation should also be less of a drag going forward with the business trading at 16.3x next year’s consensus earnings forecast, mildly below its longer-term average

• We continue to see Union Pacific as an inflation-protected annuity stream over the longer-term with revenue stability that should support our portfolio with its defensive nature.

Share price 8/6/23: US$223.05

Result Q2 FY23

Revenue $US7.985b, up 11.1% on the pcp.

Underlying EPS

$US2.09, an increase of 16.8% on the pcp

• Visa saw a strong result in Q2 with strength broad-based as all segments saw revenue growth with International Transactions remaining the most material at +24% against the prior corresponding period (down from +29% in the previous quarter). Key to this was a continued recovery in cross-border travel which resulted in cross border volume growth climbing 24%

• The business returned $US2.2b to shareholders in buybacks with a further $US11.8b available for share repurchases.

Key points

• Despite the more negative macroeconomic backdrop payment volumes have held up more generally with a 10% increase excluding currency impacts while processed transactions grew more strongly at 12%.

• Higher wage costs (up 24%) was a notable driver of operating expense growth (up 11%). This was due to an increase in headcount over the past year but is expected to decline in the coming quarters (slowing by 2% - 3% next quarter) with management also flagging its flexibility to reduce staffing if economic conditions deteriorate.

• Looking forward management expects a boost from Chinese travel improving transaction volumes while higher interest rates are also supporting growth in non-operating income (mainly interest on cash balances) that will likely more than offset interest expenses.

• Visa continues to play a role in global commerce as a key payments processor with its duopoly with Mastercard remaining intact.

Our comments

• Travel volumes are a notable boost to overall sales and as travel demand continues to recover it remains a useful upside catalyst in the near-term albeit one whose impact should slow in the coming quarters.

• The business has seen margin expansion more recently in line with the boost in underlying consumer spending further justifying our position as a high-quality exposure to global commerce with strong growth prospects going forward

By Cameron Curko, Head of Macroeconomics & Strategy | Pitcher Partners Sydney Wealth Management +61 2 9228 2415 cameron.curko@pitcher.com.au

This view is general advice only and does not take into account your personal circumstances or finances. If you have further questions, we encourage you to consult with your adviser.