Morning Note: Market news and updates from Alphabet, Visa, and Reckitt.

Market News

US markets closed the session in mildly negative territory. The Dow Jones Industrial Average closed down 0.14% while the Nasdaq Composite was -0.06% lower.  European markets also open down across the board.  The FTSE 100 is currently trading 0.4% lower at 8,127. Yields were little changed, and gold traded modestly higher at $2,414 an ounce.

Deutsche Bank suffered its first quarterly loss in four years as trading slowed and it booked a charge tied to a legacy issue at its Postbank retail unit. Revenue from buying and selling fixed-income securities and currencies declined about 3%, trailing the average 5% gain at the biggest Wall Street banks. At BNP Paribas, profit rose on surging equities trading revenue. UniCredit raised its full-year net revenue and capital generation targets. Santander reported record earnings.

The start of the Magnificent Seven earnings was underwhelming, dragging stocks lower.  Tesla slumped post-market after profit missed for a fourth quarter and it delayed its Robotaxi event to October.  Alphabet (see below) slipped as Sundar Pichai signalled patience will be needed to see results from AI investments.

Kamala Harris leads Donald Trump 44% to 42%, a Reuters/Ipsos poll showed. Trump said he’s willing to debate Harris. Joe Biden will address the nation today.  Trump filed a complaint claiming that the transfer of Biden’s $96m campaign war chest to Harris violates the law.  Elon Musk said on X that he’s making donations to a Trump super PAC but at lower levels than the previously reported $45m a month.

Blackstone is doubling down on opportunities in its international credit business. Global head of credit & insurance Gilles Dellaert said “there’s a lot more to do for us in Europe and in Asia.”

Source: Bloomberg

Company News

Last night, Alphabet released quarterly results which were slightly better than market expectations. However, the shares were marked down by a couple of percent in after-hours trading as the company highlighted ongoing elevated capital spend.

Alphabet is the public holding company for Google, one of the world’s most recognised and widely used brands. In addition to the core search engine, the group owns digital video platform YouTube, Google Cloud, web browser Chrome, mobile operating system Android, Gmail, Google Maps, Fitbit, and autonomous driving company Waymo, among others.

The group has a strong track record of innovation, leaving it well placed to capitalise on a wide variety of technological themes, such as digital media, e-commerce, video advertising, the cloud, the internet of things, driverless cars, and artificial intelligence. We believe the shift to internet-connected devices and streamed TV means the growth of advertising dollars on Google Search and YouTube has much further to run. Machine learning capabilities should also help advertisers get higher return on investment and encourage them to continue to allocate their advertising budgets to Google.

The company has six products with more than two billion users each and another nine with more than 500m users, most of which we believe are far from being fully monetised. The group’s structure allows it to own a portfolio of businesses with different time horizons, while its broad offering provides a competitive edge. Capital allocation is strong and spread across internal R&D, accretive M&A, and massive shareholder returns.

In the three months to 30 June 2024, revenue grew by 15% on a constant currency basis to $84.7bn, a touch ahead of the consensus forecast of $84.2bn. The main drivers were ongoing strength in Search and momentum in Cloud, while YouTube was a little disappointing.

The group reports its results across three segments: Google Services, Google Cloud, and Other Bets. Google Services is the largest division (87% of revenue), generates revenue primarily from digital advertising and the sale of apps, digital content products, hardware, and YouTube subscription fees. During Q2, Google Services revenue grew by 12% to $73.9bn.

Google Search (which accounts for 75% of ad revenue) increased by 14%. Advertising from Google Network Members’ websites (12% of ad revenue) fell by 5%. The group separates out YouTube, which accounted for 13% of ad revenue in the quarter and grew by 13%.

Other sales within the Services division (known as Google Subscriptions, Platforms, and Devices) include Play, content products, hardware, service, licensing fees, Nest, and YouTube’s non-advertising revenue. They grew by 14% in the quarter to $9.3bn.

Traffic acquisition costs (TAC) are the fees Google pays to other companies (such as Apple) to carry its search service and adverts (i.e., cost of sales). During Q2 they grew by 7% and currently account for 20.7% of advertising revenue.

Google Cloud includes Google’s infrastructure and data analytics platforms, collaboration tools, and other services for enterprise customers. Fee revenue comes from Google Cloud Platform services and Google Workspace collaboration tools. In Q2, Cloud grew by 29% to $10.3bn, vs the 28% growth rate in the previous quarter, with growth driven by AI adoption. Although the group continues to invest to grow the cloud business, the division’s quarterly profit grew from $395m to $1,172m, well above expectations.

The group’s Other Bets division (less than 1% of revenue), which is effectively an incubator fund for new products and technologies, made a quarterly loss of $1,134m. The group continues to wind down non-priority projects.

Alphabet continues to ‘durably engineer’ its cost base to support its investment in long-term growth opportunities, most importantly AI. Spending on data centres to support its AI plans is forecast to jump this year. The number of employees fell by 1% year-on-year, while actions are being taken to optimise global office space and use AI to increase business productivity.

In the latest quarter, group costs and expenses increased at a slower rate than revenue (+9%). As a result, margins expanded from 29.3% to 32.4%. EPS grew by 31% in the quarter to $1.89, versus the consensus forecast of $1.85.

Capital expenditure rose from $6.9bn to $13.2bn over the quarter and the company warned spending will remain close to that level for the rest of the year as it continues to pour money into AI products.

Free cash flow generation was strong ($13.5bn in the quarter), despite ongoing spend on R&D and capex, while its huge cash pile (including marketable securities and long-term debt) stands at $101bn. This has allowed the group to significantly increase its returns to shareholders. During the latest quarter, the company bought back $15.6bn of its shares.

Back in April, the group also approved the initiation of a cash dividend programme and declared a dividend of $0.20 per share that will be paid in September. Looking forward, the company intends to pay quarterly cash dividends. This is positive news and puts the company on an equal footing with Microsoft and Apple in the minds of investors looking for yield.

Regulators are increasingly focused on the depth and form of user data that are collected and used to target ads. As a result, political/regulatory risk remains elevated, with the potential for large fines, forced changes to business practices, or a break-up. However, we believe any action could be years away.

AI remains a hot topic. We believe the Alphabet is well placed – the company has been incorporating AI functionality into its search capabilities and other products for years and is expected to launch a steady stream of innovation in the future. Furthermore, Google’s position in cloud services – it is one of the big three public providers – leaves it well placed to provide the infrastructure and computing power needed by AI, while the group’s user scale and usage frequency supports a wealth of data, providing another competitive advantage. However, the introduction of Gemini, the group’s most advanced AI model, which is capable of more sophisticated reasoning and understanding information with a greater degree of nuance than its prior technology, has been faced some issues. This has raised concerns regarding execution and company’s ability to compete in an area of technology that Google itself pioneered. The group’s latest quarterly results are helpful in this regard. In addition, at its annual developer conference in May, the group announced a number of new products, including Trillium, its 6th generation TPU (Tensor Processing Unit), a type of AI semiconductor.

Looking forward, although the economic outlook will remain somewhat of a headwind in the near term, the group is facing easing year-on-year comparatives in 2024. Alphabet continues to trade on a valuation (18x ex-cash) below most of the other tech majors and at a level we believe is very attractive for a company exposed to several areas of long-term secular growth.

Source: Bloomberg

Yesterday evening, Visa released results for the three months to 30 June 2024, the third quarter of its FY2024 financial year. The figures were pretty much in line with the market forecast and the guidance for FY2024 was confirmed. The shares were marked down by 3% in after-hours trading post the announcement.

Visa is the world’s largest electronic payments network. It connects 14,500 financial institutions, 130m merchant locations, and 4.3bn cards. Visa is not a bank; it doesn’t lend or take on credit risk. It doesn’t issue cards or place the terminals at the merchant locations. Instead, the company earns a small fee from more than 200bn transactions processed on its network to generate annual revenue of more than $32bn.

The company is benefiting from the ongoing shift from cash and cheques (which still amounts to c. $18tn, growing at 2% p.a.) to electronic means of payment, and the growth of online retail, contactless, and mobile payment systems. In emerging markets, a lack of physical communication infrastructure traditionally provided a barrier to payments growth, but that has been removed by the emergence of mobile phone technology and a government focus on digitalising cash to reduce the black economy.

We believe the industry is at an inflection point in terms of sales growth driven by the global proliferation of smart devices which provide a way to pay and to be paid. In 2023, the company grew its acceptance locations by 17% as mobile phones and other devices became payment terminals.

During the latest quarter, Visa enjoyed solid trading with its key business drivers relatively stable. On the analysts’ call, the CFO highlighted that in the US, while growth in the high spend consumer segment remained stable compared to prior quarters, the company saw a slight moderation in the lower spend consumer segment.

This generated growth in payments volume (+8% in constant currency) and processed transactions (+10% to 59.3bn). Cross-border volume growth (which includes a lot of e-commerce) remained strong (+14%). The group enjoyed continued growth across its new flows, where the long-term revenue opportunity is estimated at 10x the size of existing consumer payments. Visa’s largest 265 clients now use an average of 22 of Visa’s value-added services products, such as cybersecurity, fraud, data analytics, and AI, all of which enhance the group’s competitive advantage. During the quarter, Visa expanded its partnerships with many clients around the world and announced several new innovations.

Earlier in the year, the group announced the issue of its 10 billionth token – a technology that replaces sensitive personal data with a cryptographic key that conceals sensitive payment data. Currently, almost a third of all transactions processed by Visa use tokens. The company also revealed that Visa tokens have generated more than $40bn in incremental e-commerce revenue for businesses globally and saved $650m in fraud in the last year.

Net revenue grew by 10% on a constant currency basis, to $8.9bn, in line with the market expectation and just about meeting the company guidance for low double-digit growth. Revenue was made up of service revenue (based on prior-quarters payment volume, +8% to $4.0bn); data processing (+9% to $4.5bn); international transaction revenue (+9% to $3.2bn); and other revenue (+31% to $780m). Client incentives, a contra-revenue item, were up 11% to $3.5bn.

Operating expenses were up 12% on a constant currency basis, primarily driven by increases in general and administrative, personnel and marketing expenses. Adjusted EPS was up 13% on a constant currency basis, to $2.42, versus the market expectation of $2.42 and company guidance for high end of low double-digit growth.

During the quarter, the group generated $4.7bn of free cash flow. The group’s balance sheet remains strong, with cash, cash equivalents, and available-for-sale investment securities of $19.7bn at the end of June. The main capital allocation priority is to invest to grow the business, both organically and via acquisition.

Visa also has an ongoing commitment to return excess cash to shareholders. The group has a record of strong dividend growth, with the latest quarterly payout raised by 16% to $0.52. During the quarter, the company also bought back $4.8bn of its stock, leaving $18.9bn of remaining authorisation for shares repurchases.

On the regulatory front, Visa has a long-term track record of coping with change. Most recently, in March, after nearly 20 years of litigation, Visa (and Mastercard) announced it has agreed to a landmark settlement with US merchants, more than 90% of which are small businesses, lowering credit interchange rates and capping those rates until 2030. However, in June, the Eastern District of New York court denied this motion providing the prospect of more onerous settlement terms.

Overall, we believe the long-term growth prospects for Visa remain very attractive, more so given the acceleration in recent years in the shift to e-commerce, tap-to-pay, and new digital payments, and in the number of acceptance points at SMEs. In addition, the broad application of digital payments by businesses and government provides a huge market opportunity.

The group has reiterated its guidance for the financial year to 30 September 2024: low double-digit revenue growth on a constant dollar basis and low teens EPS growth. The company still expects the year to be more second-half weighted due to tough year-on-year comparatives. For the current quarter, the company expects to generate low double-digit revenue growth and high end of low double-digit EPS growth.

In the near term, while some short-term uncertainty persists, the group remains confident in its ability to execute its strategy and expand Visa’s role at the ‘centre of money movement’. Persistent inflation and the ongoing shift to digital payments also provide a tailwind to growth, although a slowdown in overall consumer spending could be a drag on volumes. Spending across the network is very diversified, be it credit/debit, overseas/ domestic, discretionary/non-discretionary spend, and low/high ticket spend.  However, the company has previously said that if we do go into a recession, Visa is now stronger in debit – the card of choice in tougher times – than it was in the 2008/09 financial crisis. The group also highlights that if there is a recession, they have plenty of flexibility on costs and client incentives. Note that half of the group marketing spend is variable.

Source: Bloomberg

Reckitt has today released first-half results which were broadly in line with expectations and guidance for the full-year has been nudged down for exceptional reasons. The company has also announced a strategic review of the business which will see it focus on a smaller number of core brands. A new share buyback programme has been announced. In response, the shares are up 3% in early trading.

Reckitt is a global leader in health, nutrition, and hygiene. Trusted brands, such as Dettol and Lysol, are well placed to benefit from the shift to healthier and more hygienic lifestyles, particularly in emerging markets. To help ease the pressure on state-funded healthcare systems, we expect to see a transition to self-care and growth of over the counter (OTC) brands such as Mucinex, Nurofen, and Gaviscon, all of which are owned by Reckitt. A greater focus on immunity, mental health, and overall well-being is expected to drive growth of the group’s preventative treatments, such as vitamins, minerals, and supplements (VMS).

Following a thorough review of the group’s portfolio set out in October 2023 by new CEO Kris Licht, Reckitt has today announced a set of actions to significantly sharpen its portfolio and simplify its organisation for accelerated growth and value creation.

·       Reckitt will focus on a portfolio of market-leading, high margin Powerbrands, including Mucinex, Strepsils, Gaviscon, Nurofen, Lysol, Dettol, Harpic, Finish, Vanish, Durex, and Veet. Over the last five years this portfolio has delivered a 7% net revenue CAGR and a gross margin of 61% in 2023. The portfolio will also include likely future Powerbrands including Move Free and Biofreeze, and important local brands such as Lemsip, Airborne, KY, Veja, Jik, Tempra, and Jontex.

·       The company will seek to exit its portfolio of leading home care brands that are no longer core including Air Wick, Mortein, Calgon, and Cillit Bang by the end of 2025 and will consider all options to maximise shareholder value.

·       The Mead Johnson Nutrition business, with brands including Enfamil and Nutramigen, is now non-core and Reckitt will consider all strategic options to maximise shareholder value.

·       Reckitt will move to a simpler and more effective organisation with fewer management layers operated through three geographies: North America, Europe, and Emerging Markets.

·       Finally, the company will expand and accelerate its existing fixed cost optimisation initiative to unlock cost efficiencies and deliver at least a 300bps reduction in fixed costs by the end of 2027 to achieve a fixed-cost base of 19%.

However, in the near term the company (and the shares) has struggled because of a string of operational issues, compliance problems in the Middle East, and a negative legal outcome in the US. Last week, the group disclosed that its Nutrition sales will likely be affected in the short term by tornado damage to its Indiana warehouse, albeit impact on earnings is expected to be limited given the insurance in place.

Back to the results for the first half of 2024. During the period, reported revenue fell by 3.7% to £7,167m, including a currency headwind (-4.2%) and the impact of disposals (-0.3%). Stripping out these impacts, LFL growth was 0.8%, with Q2 flat.

Price/mix grew by 2.1% as the group benefitted from strong carry-over pricing from 2023 as it sought to pass on higher input costs. Pushing price increases through was made easier by strong product innovation, with consumers trading up to premium innovations. Volume fell by 1.3%.

By division, Hygiene grew by 4.5% in LFL terms to £3,060m, despite a more competitive market environment. Health was up 1.3% to £2.941m, held back by softness in seasonal OTC brands. Nutrition fell by 9.0% to £1,166m as the North America business continued to rebase due to lapping of the prior-year competitor supply issue, in addition to the voluntary recall of Nutramigen.

The adjusted gross margin rose by 120 basis points to 60.6%, driven by pricing and productivity efficiencies which more than offset inflation. Adjusted operating margin fell by 30bps to 23.5%. Adjusted EPS fell by 6.8% to 161.3p.

Free cash flow generation grew by 8.3% to £821m, while financial gearing ended the period at 2.2x net debt to adjusted EBITDA, a touch above the target of ‘below 2x’.

The company recently completed its £1bn share buyback following an acceleration of the programme in light of the share price fall and to reflect the Board’s confidence in the continued strong free cashflow generation of the business. With today’s results, the company has announced a further increase in returns through an increase in the interim dividend (up 5% to 80.5p) and another £1bn share buyback programme to complete over the next 12 months.

The group has nudged down its guidance for 2024 due to the short-term disruption to its Nutrition business, which performed above expectations in H1, due to the Mount Vernon tornado. Net revenue growth is now expected to be 1%-3% (vs. 2%-4% previously). Revenue growth is still expected to accelerate in H2 and Reckitt continues to target operating profit growth ahead of net revenue growth (i.e. a slight margin increase).

Source: Bloomberg