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RBC Capital Markets, LLC
December 1, 2015
RBC Capital Markets US Equity Top Picks List RBC Capital Markets’ Equity Research Department is pleased to present the US Equity Top Picks List update for December 2015. The Top Picks List consists of the Top Pick-rated US equities as chosen by individual analysts in the RBC Capital Markets Global Equity Research Department. A Top Pick-rated stock represents an analyst’s best idea in the sector and is expected to provide significant absolute total return over 12 months with a favorable risk-reward ratio. The list is revised on an ongoing basis as stocks are upgraded and downgraded throughout the year and a published update is released on a monthly basis, detailing the companies rated as Top Pick and highlighting any changes over the past month. Please refer to specific company research for the investment thesis for each stock included in the Top Picks List as well as a discussion of valuation and risks. As always, we encourage you to reach out to our team to continue the dialogue regarding their investment ideas.
All values in US dollars unless otherwise noted. Priced as of market close on November 30, 2015 ET.
For Required Non-U.S. Analyst Conflicts Disclosures, see page 18.
Benchmark Price Returns:
Monthly Year-to- Since Inception
(November 2015) Date (Dec. 31, 2011)
S&P 500 Index .................................................................................................... +0.1% +1.0% +65.4%
RBC Capital Markets US Equity Top Picks List – Mean ..................................... +3.8% +3.5% +84.5%
RBC Capital Markets US Equity Top Picks List
Current Return Implied
Price Date Added Opening Price Closing Price Since Upside to
Company Ticker Analyst Rating Target to Top Picks When Added1 (11/30/15) Added Target
Air Lease Corporation AL Jason Arnold Top Pick $70 Aug 04, 2014 $36.05 $33.63 -6.7% 108.1%
Amphenol Corporation APH Amit Daryanani Top Pick $60 Dec 21, 2011 $22.25 $55.05 147.4% 9.0%
Aramark ARMK Gary Bisbee Top Pick $38 Dec 22, 2014 $29.80 $32.62 9.5% 16.5%
Boston Properties, Inc. BXP Michael Carroll Top Pick $155 Jan 05, 2015 $131.85 $124.99 -5.2% 24.0%
Brookdale Senior Living Inc. BKD Frank Morgan Top Pick $37 May 19, 2014 $31.58 $22.48 -28.8% 64.6%
CBS Corp. CBS David Bank Top Pick $64 Mar 14, 2012 $31.64 $50.48 59.5% 26.8%
Discover Financial Services DFS Jason Arnold Top Pick $69 Aug 12, 2011 $23.80 $56.76 138.5% 21.6%
Endo International Plc ENDP Randall Stanicky Top Pick $91 Jul 17, 2015 $86.47 $61.48 -28.9% 48.0%
Jarden Corp. JAH Nik Modi Top Pick $60 Nov 03, 2015 $47.41 $46.68 -1.5% 28.5%
Louisiana-Pacific Corporation LPX Paul C. Quinn Top Pick $22 Nov 04, 2015 $17.35 $18.40 6.1% 19.6%
LyondellBasell Industries NV LYB Arun Viswanathan Top Pick $120 Oct 08, 2014 $99.49 $95.82 -3.7% 25.2%
Marathon Petroleum Corp. MPC Brad Heffern Top Pick $66 Oct 01, 2014 $42.47 $58.41 37.5% 13.0%
PNC Financial Services Group Inc. PNC Gerard Cassidy Top Pick $105 Feb 03, 2010 $54.17 $95.51 76.3% 9.9%
Raytheon Company RTN Robert Stallard Top Pick $133 Sep 17, 2015 $107.32 $124.03 15.6% 7.2%
Ryder System, Inc. R John Barnes Top Pick $89 Dec 14, 2012 $49.25 $65.96 33.9% 34.9%
ServiceNow, Inc. NOW Matthew Hedberg Top Pick $90 Dec 15, 2014 $62.75 $87.01 38.7% 3.4%
Voya Financial Inc. VOYA Eric Berg Top Pick $53 Jun 12, 2013 $27.50 $40.70 48.0% 30.2%
WebMD Health Corp. WBMD David Francis Top Pick $60 Feb 13, 2014 $44.45 $45.49 2.3% 31.9%
Whirlpool Corporation WHR Robert Wetenhall Top Pick $201 Sep 15, 2015 $164.10 $162.52 -1.0% 23.7%
Yum! Brands, Inc. YUM David Palmer Top Pick $87 Jan 07, 2014 $76.89 $72.51 -5.7% 20.0%
Notes: For coverage transfers, date added to Top Picks given by first publication date or initiation of current analyst. 1 Opening price given by first open following upgrade: for publication between 12am and 9:30am ET, same day opening price; for publication between 4pm and 12am ET, following day opening price. Performance returns do not take into account relevant costs, including commissions and interest charges or other applicable expenses that may be associated with transactions in these Equity Top Picks. Past performance is not, and should not be viewed as, an indicator of future performance. Source: RBC Capital Markets estimates, Thomson Financial
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December 1, 2015 2
This Month’s Additions to and Deletions from the US Equity Top Picks List
Exhibit 1: This Month’s Additions to RBC Capital Markets US Equity Top Picks List
Company Ticker Analyst
Current
Rating
Current
Price
Target
Date Added
to Top Picks
Opening Price
When Added1
Implied %
to Target
Louisiana-Pacific Corporation LPX Paul C. Quinn Top Pick $22 Nov 04, 2015 $17.35 26.8%
Exhibit 2: This Month’s Deletions from RBC Capital Markets US Equity Top Picks List
None
Note: All prices in USD. 1 Opening price given by first open following upgrade: for publication between 12am and 9:30am ET, same day opening price. 2 Closing price represents last close prior to downgrade from Top Pick. Source: RBC Capital Markets estimates, Thomson Financial
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December 1, 2015 3
Investment Summaries Below, we provide an investment summary of each of our analysts’ Top Picks as well as a link to the latest company-specific research.
Air Lease Corporation (NYSE: AL) Jason Arnold (Analyst)
(415) 633-8594
Our Top Pick rating on Air Lease Corp is driven by the following key fundamental factors, along with the currently very attractive valuation of just 6.3x 2016E pre-tax EPS:
Leading Aircraft Lessor: Air Lease is well positioned as a leader in the aircraft leasing sector, with a sizable and growing fleet of new and in-favor aircraft leased to global airlines. Purchasing new aircraft in volume as AL does provides the advantage of attaining best price on high-demand equipment vs. peers—$124B of new aircraft financing is needed globally in 2015, which is expected to grow at a 6%+ CAGR. Outstanding management team furthers our outlook.
Growing Portfolio and EPS Outlook: Anticipating continued portfolio expansion on aircraft deliveries to support continued strong revenue expansion and robust 15%+ EPS upside. Additionally, we expect the company’s Blackbird JV to add significant fee revenue to the story prospectively, adding to growth and diversity of revenue.
Highest ROE and Lowest Leverage in Sector: Upper-teens ROE anticipated as well—above peers and well above most financial companies, while leverage is below peers at just 2.6x D/E. Significant excess cash flow generation, which goes toward financing new aircraft and paying down borrowings.
Key Risk Factors: The aircraft lessor business model is very durable relative to the performance of airlines—global air travel demand is critical rather than airline profitability. Risk stems primarily from significant macro factors impacting commercial air travel demand globally, or dramatic interest rate market volatility. We think that share valuation is so modest that risk here is more than priced in.
AL note, 11-06-2015
Amphenol Corporation (NYSE: APH) Amit Daryanani (Analyst)
(415) 633-8659
Ability to Sustain More than 10% Revenue Growth Long-Term: We think APH can outgrow end markets via share gains and acquisitions over multiple years. In CY15, APH should benefit from the recently acquired Sensor businesses, expanding its TAM of $52B by ~$21B (40%). Our current FY16 revenue estimate is conservative and implies mid-single-digit growth. Growth has been driven by a combination of better end-market mix and an impressive M&A strategy.
Differentiated and Attractive M&A Model: A core part of Amphenol’s success has been its impressive M&A strategy, acquiring more than 50 companies during the last decade. M&A contributed an average of 4% to annual revenue growth over the last five years, and APH’s track record of extracting synergies from prior acquisitions gives us confidence that the firm
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December 1, 2015 4
can improve the margin profile of acquired companies, which could enable sustained beats and raises through CY15.
Impressive OPEX Controls Drive Double-Digit EPS Growth. Amphenol’s operating structure and discipline remain substantially better and more resilient than peers (operating margins averaged 19% over the last 10 years). APH’s ability to maintain 25% incrementals through the cycle via reduction in SG&A and commodity procurement, in addition to stock repurchases, should drive EPS growth above revenue growth over time.
Capital Allocation Remains Healthy: Given the company‘s under-levered balance sheet, ample liquidity, and solid free cash flow generation capabilities (~90% of net income), we believe APH can continue to utilize its cash toward bolt-on M&A. We think free cash flow should be first earmarked toward acquisitions. Excluding acquisitions, we believe the company will strategically repurchase stock and maintain its dividend.
Risks: Key risks involve the level of end-market demand, pricing, the pace of new product introductions, the ability to generate free cash flow, lower production costs, and the ability to identify and to integrate attractive acquisition candidates.
APH note, 10-21-2015
Aramark (NYSE: ARMK) Gary Bisbee (Analyst)
(212) 299-9842
Aramark is a leading global provider of outsourced food services/catering and facilities services across a diverse set of end-markets. It operates in 22 countries but remains concentrated in North America, which generates ~80% of revenue and ~85% of profits.
We see ARMK well positioned to outperform and rate the stock Top Pick. We remain confident in its operational improvement story, like its North American focus, find valuation reasonable, and believe that positive estimate revisions over time are likely. We expect low-teens or better Y/Y EPS growth in the next few years and see room for ~1x or so valuation expansion, which should combine to drive strong share price returns. Key points:
Good (and stable) business model. Aramark generates healthy and consistent cash flows and solid financial returns. It has a high-quality and diversified client base and good visibility through long-term contracts, ~95% client retention, and repeatable revenue. It has also proven more defensive than average, with revenue and profits falling at half the market rate in the 2008–2009 recession.
Large and underpenetrated market. Aramark estimates that the global market for its services is ~$900 billion. This implies just a ~2% market share, and the five largest players have <10%. With an increasing trend toward outsourcing and the larger players garnering a disproportionate share of new business, growth potential is solid.
“Transform” initiatives still in the early innings. Aramark had a leadership transition in early 2012 and has implemented a plan to drive improved growth and margins. We believe significant opportunity remains to drive margins through labor and food cost efficiencies and to boost revenue growth through better merchandising and sales investments. We see a long runway of opportunity remaining and expect these strategies to be successful.
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December 1, 2015 5
Margin upside likely in FY16–FY17. While Aramark currently targets 20 bps of annual margin expansion, competitor Compass Group produced four years of ~45 bps after implementing a similar plan in 2007. Aramark delivered 31 bps in FY14 and 23 bps in FY15 (although FY15 was affected by short-term investments and contract start-up costs partially offset efficiency efforts). However, we believe that upside vs. the 20 bps plan is possible if not likely in FY16 and beyond as improvement initiatives mature and investments normalize.
ARMK note, 11-19-2015
Boston Properties, Inc. (NYSE: BXP) Michael Carroll (Analyst)
(440) 715-2649
Boston Properties (NYSE: BXP) is an office REIT that primarily owns class A CBD and suburban properties in Boston, New York, San Francisco, and Washington, D.C. The company is one of the large REITs within the industry and has an equity market capitalization of $19.9 billion. We believe the shares will outperform peers over the next 12 months.
Potential catalysts
Growing presence in San Francisco is a major plus. San Francisco remains the strongest office market in the country. Although the company’s current concentration of NOI in this market is 11.5%, three major developments under way are likely to drive substantial cash flow growth.
Leasing activity appears healthy across the portfolio. The company is benefiting from a landlord’s market, and it has been able to turn in solid leasing results with net cash lease spreads near 8.0% in the most recent quarter. However, we note that the company is in the process of completing several strategic transactions that will likely impact results in the near term.
The development business is substantial. A core competency for this company is office development. Given its presence in key markets across the US, any hints of additional new development are likely to be perceived positively by the market.
Strong balance sheet allows quick reaction to opportunities. Whether buying assets on the open market, buying partner interests, or adding new development spend, Boston Properties’ low-levered balance sheet and access to capital enable the company to move quickly on new opportunities. We expect more of those to surface through the remainder of the year.
Risks to our thesis
Employment gains in the US fail to materialize.
Large development projects do not gather substantial initial tenant interest.
Acquisition opportunities do not meet our expectations.
A sudden or sharp increase in interest rates.
BXP note, 11-03-2015
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December 1, 2015 6
Brookdale Senior Living Inc. (NYSE: BKD) Frank Morgan (Analyst)
(615) 372-1331
The senior housing / assisted living industry is a “pure play” on the aging of the US population, with minimal exposure to government reimbursement, and while the current economic backdrop is impacting move-in rates and occupancy, capacity growth has virtually stalled.
We believe there is significant operating leverage in the existing portfolio, as an uptick in the residential housing market or general consumer confidence could help to improve occupancy, which would carry high incremental margins and significant leverage.
Bed expansion projects, acquisitions, and the continued roll-out of ancillary services to its existing asset base are sources of high-return, low-risk growth.
While leverage is high relative to other industries, the customer base is very “sticky”, with long length of stays, and therefore generates very stable cash flows. Following recent improvement in its liquidity, Brookdale is better positioned for capital-intensive acquisitive growth again.
BKD note, 11-06-2015
CBS Corp. (NYSE: CBS) David Bank (Analyst)
(212) 858-7333
CBS remains the closest thing to a large-cap pure-play content story, in an environment of increasing content value (including traditional syndication, OTT, retrans/reverse comp). The stock is benefiting from financial engineering (e.g., REIT conversion) and capital returns. Longer-term, CBS should see multiple expansion as the post-Outdoor revenue mix has become ~50% advertising. We continue to be comfortable that visibility in earnings remains solid due to syndication pipeline, digital distribution deals, and retrans/reverse comp ramp.
RBC’s view versus consensus
Many investors view CBS as a highly macro-sensitive business model given the current revenue mix from advertising. We view short-term trends in advertising as very stable given our channel checks. Longer-term, we believe Network TV advertising is surprisingly stable (the last ad medium to be cut in a slowdown and the least substitutable versus digital).
We see long-term visibility into the monetization of CBS’s premium content, via both traditional linear syndication and online video SVOD, for years to come.
Potential catalysts
Further upside from OTT and traditional syndication monetization.
Higher debt leverage and returns of capital to shareholders.
Risks to thesis
There is greater macro sensitivity versus peers (given Local radio and TV in the mix).
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December 1, 2015 7
While we think hit-driven risks to Entertainment revenue are counterbalanced by visible retrans consent and syndication revenue streams, we acknowledge that a material ratings decline over an extended period of time could drive multiple compression.
CBS note, 11-04-2015
Discover Financial Services (NYSE: DFS) Jason Arnold (Analyst)
(415) 633-8594
Discover remains our Top Pick among card issuers, as we believe the company is well positioned for growth, taking market share in both the lending and network components of its business, and should continue to earn high-teens+ ROE and 8%+ EPS expansion.
Growth Outlook Remains Favorable: Loan growth is appealing vs. other financial company peers—card loans are expected to exceed the company’s targeted 3–5% growth target, with strong performance in cards as well as student lending and other loans. Other lending categories are expected to grow at 10%+.
Network Acceptance Bolsters Model: We anticipate increased acceptance/brand awareness (now ~98% merchant acceptance) supporting wallet share growth, along with selective new account adds. Discover appears to be accelerating here vs. peers, with the recent attainment of top card company in the JD Power survey.
Credit Unlikely to Rise Sharply Near-Term: Discover’s credit performance remains very favorable, supporting performance ahead. Charge-offs remain in the low-2% range, which we do not foresee rising sharply unless there is a meaningful uptick in US unemployment rates. We expect loan growth benefits to more than outpace credit costs in the model.
Excess Capital Position Robust – Share Buybacks: The company’s Tier 1 common equity ratio under the Basel III advanced approach is 14.3%, well above regulatory requirements as well as the company’s conservative targeted 11% level. We expect growth and share buybacks (3–5%+ of float annually) to be key uses of the strong excess capital position over time.
Key Risk Factors: Key risk factors to the business achieving our expectations are material credit performance erosion (4% or higher near-term on charge-offs) and inability to grow loans due to low industry demand or dramatically higher competition. As an offset, valuation remains modest, so shares are not pricing in excess optimism here, in our view.
DFS note, 10-21-2015
Endo International Plc (NASDAQ: ENDP) Randall Stanicky (Analyst)
(212) 618-3266
Our Top Pick rating on ENDP is based on a favorable risk/reward from a combination of solid base business trends, aggressive cost management, and likely accretion from ongoing M&A. ENDP has reinvented itself under its new CEO and a core part of our thesis has to do with what we think is an under-appreciated organic growth story that we see forming in 2016+, one that should be able to take valuation higher as it becomes better understood.
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December 1, 2015 8
(1) We see a 2016 growth inflection coming at ENDP. The company is moving past its major headwinds on key products, which comprised 38% of revenue in 2013 but should be only <10% in 2016E on a much more diversified business following the AUXL and Par deals.
(2) We see several levers that can help ENDP to grow the bottom line in the mid-teens. We anticipate an acceleration in organic growth helped by recently acquired products and the Par generics platform.
(3) Continued M&A should drive both EPS and potentially the growth profile higher. While we could see a pause in large-scale M&A following the announced Par deal, we continue to believe that M&A is a core part of ENDP’s strategy.
Potential catalysts to focus on: (1) early 2016 BELBUCA launch; (2) potential for additional smaller M&A or business development deals; and (3) potential for a pick-up in generic approval activity.
Risks to our thesis: (1) failure to identify and deliver on additional accretive M&A; (2) greater hit to competition on key products; (3) greater financing costs for additional M&A; (4) slow uptake for Auxilium branded products; and (5) Par integration.
ENDP note, 11-17-2015
Jarden Corp. (NYSE: JAH) Nik Modi (Analyst)
(212) 905-5993
Investment thesis: We rate Jarden shares Top Pick with a $60 price target. Despite being one of the best-performing stocks under our current consumer staples coverage, JAH continues to trade at a steep discount to its consumer staples peers. In fact, at ~15x our CY16E EPS, JAH is one of the cheapest names under our entire Consumers Staples coverage—a factor we attribute to misperception that the company’s complex (seemingly unrelated) brand portfolio is too exposed to changes in weather and the economy to deliver any degree of consistency. However, we point out the company’s revenue and EPS delivery has been as consistent as they come (e.g., consumer staples-like financial delivery).
We attribute this staples-like financial delivery to a few principal drivers:
Best-in-class management
Disciplined (and shareholder-friendly) capital allocation
Its “Big Fish business model”, with relative market share advantages in its largest businesses
Within this context, we believe JAH shares should trade more in line with HPC peers at 20x CY16 estimates.
Potential catalyst: Yankee Candle, Waddington, and Jostens integration
Over the last two years, Jarden has completed three $1.3+ billion deals (Yankee Candle, Waddington, and Jostens), which it is currently in the process of integrating. Each quarter, we expect management to update us on the integration of these businesses along with newly identified cost savings and cross-selling opportunities. We believe that through leveraging of one another along with Jarden’s existing platform, each of these businesses can achieve long-run, sustainable mid-single-digit top-line growth.
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December 1, 2015 9
Risks to our thesis
Weakness in global macros, primarily in North America and increasingly in Asia, Europe, and Latin America
Failure to successfully integrate new acquisitions
Promotional activity from competitors and reductions in Jarden’s brand investment may limit top-line growth
Volatility in weather conditions given the seasonal nature of Jarden’s businesses
Failure to maintain and expand relationships with key retail customers
JAH note, 11-20-2015
Louisiana-Pacific Corporation (NYSE: LPX) Paul C. Quinn (Analyst) – RBC Dominion Securities Inc.
(604) 257-7048
We rate Louisiana-Pacific shares Top Pick, as we believe they are being unfairly discounted by an overly conservative OSB outlook and weak Q315 results.
We expect the US housing market to continue improving at a more rapid pace since it picked up steam in Q215, resulting in improved demand for the company’s core products.
LP has strengthened its balance sheet, cut costs, and improved operations since suffering very poor results through the housing downturn.
LP has decreased the margin gap with its largest competitor over the last two years or so, as it focuses on cutting overhead costs and running fewer assets more efficiently.
LPX note, 11-04-2015
LyondellBasell Industries NV (NYSE: LYB) Arun Viswanathan (Analyst)
(212) 301-1611
North American ethylene margins to remain structurally advantaged for the next three to five years. With more than 70% of its feedslate mix in ethane and its net long exposure to ethylene, LYB is one of the largest beneficiaries of these rising ethylene margins (each $0.01/lb margin change is $110MM in annual EBITDA and $0.15 in annual EPS).
Low-risk brownfield ethylene growth outstrips industry. LYB is adding more than 20% capacity through 2017 (~2.4B lbs) to its 2013 North American production base of 9.9B lbs. Importantly, all of these projects are lower-risk brownfield expansions and LYB should be less subject to the cost overruns, long (>6 month) start-up delays, and labor shortages that many of the greenfield projects from other producers in the Gulf may face.
Cyclical recovery could provide more than $2B of additional EBITDA upside. Although we are not including it in our forecasts, we estimate that a cyclical recovery in Asian and European operating rates to 90%+ could lead to an additional $0.10–0.15/lb of ethylene price upside (typical mid-cycle to peak increase).
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Value return to exceed peers. LYB remains in the enviable position of choosing how to spend more than $3B in annual FCF generation. In addition to growth projects and dividends, LYB plans to return up to 10% of its market cap in buybacks in 2015, which would be the largest value return in our chemicals coverage.
Potential catalysts
Raw material movement – oil, natural gas liquids, gasoline, and oil derivatives.
Ethylene and Polyethylene pricing announcements – daily and weekly
Start-up of LYB capacity additions – mid 2015 through 2017.
Potential risks
Cyclical demand for its products
Commodity price volatility – oil below $50/bbl for a prolonged period is the main risk in our view
European exposure
New capacity by competitors
Ethane exports become viable, reducing oversupply of ethane
LYB note, 10-23-2015
Marathon Petroleum Corporation (NYSE: MPC) Brad Heffern (Analyst)
(512) 708-6311
We like Marathon Petroleum for its leverage to both the Gulf Coast and Midwest refining markets, which we think gives the company a unique combination of cheap inland crude supplies and access to waterborne export markets. We also think Marathon is well positioned to take advantage of growth in condensate production coming from the Utica shale play, on both the refining and midstream sides of the business. In our opinion, Marathon’s retail business, Speedway, is the most attractive retail franchise in our coverage universe. We see significant opportunities for Marathon to grow the Speedway business, especially given the recent acquisition of Hess’s retail business. Marathon’s cash returns have been the highest among its peer group over the last several years, and while we do expect these to slow slightly, we still expect cash returns to be very generous going forward.
Potential catalysts
Completion of MPLX/MWE deal: We see MPLX’s acquisition of MWE as highly accretive for MPC, so a closing of the deal would be positive.
Synergies from the Hess retail acquisition: A large part of the rationale for Marathon’s acquisition of the Hess retail business was operational improvements that Marathon could make to the business. Marathon could get a boost as these improvements are seen in earnings.
Increasing Utica condensate production: A significant amount of Marathon’s growth capex has gone toward expanding processing capacity for Utica condensate, so visible production growth in the play would be important.
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December 1, 2015 11
Risks to our thesis
An economic downturn in the US: An economic downturn in the US would likely affect product demand and refiner profitability, although we think Marathon’s large Midwest margins would insulate the company.
Weakness in product export markets: MPC is somewhat reliant on product exports from the Gulf Coast to keep throughput levels high. Weakness in global export demand, particularly from Latin America, could be a headwind.
Lack of significant growth in the Utica: Marathon is currently making significant investments to process condensate coming out of the Utica shale. If production from the play disappoints, this could be negative for Marathon.
MPC note, 10-29-2015
PNC Financial Services Group Inc. (NYSE: PNC) Gerard Cassidy (Analyst)
(207) 780-1554
We rate PNC shares Top Pick for the following reasons:
Well positioned for rising interest rates: The company’s interest rate sensitivity analysis in its 3Q15 10-Q filing shows that a 100 basis point gradual parallel shift in interest rates over the next 12 months would result in a 2.7% increase in net interest income. The benefit to net interest income in the second year from a 100 basis point gradual parallel shift in interest rates over the preceding 12 months would be a 6.4% increase in net interest income.
Underserved, higher-growth markets: PNC believes it can “fill out” its presence in the Southeast and gain market share, as it believes that banking clients in this area were underserved under the RBC Bank (USA) banner.
Well-balanced business mix highly tied to an improving economy: Most of PNC’s business is focused on traditional banking, with a commercial/consumer loan breakout of ~64%/36%. An improving economy should lead to solid loan growth.
High level of recurring fee revenues: Recurring fee income makes up approximately 46% of PNC’s total revenues. Generally, the top-performing banks have recurring fee income levels of 40–50% or higher.
Opportunity for new CEO to cut costs: Bill Demchack has brought PNC’s efficiency ratio down to the low-60% range by closing redundant branches and focusing on alternative banking channels. Currently, 45% of deposits are transacted through non-teller channels. We believe these channels could eventually exceed 50%.
Strong capital: The company’s Basel III common equity tier 1 (CET1) ratio of 10.1% at 3Q15 well exceeds the 8.5% level that we believe the company needs to run a conservative but highly profitable bank. The company was approved to repurchase $2.875 billion in common shares for the CCAR 2015 cycle, of which $0.6 billion was completed in 3Q15.
PNC note, 11-05-2015
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December 1, 2015 12
Raytheon Company (NYSE: RTN) Robert Stallard (Analyst) – RBC Europe Limited
(212) 905-2928
Export story: Raytheon is the US defense prime most exposed to the growing international market, by a wide margin. International revenue represents 30%+ of its total revenues versus roughly 10–15% for the rest of the defense primes. Raytheon enjoys a high mix of international work given its portfolio of air and missile defense systems approved for export to US allies in NATO and the Middle East.
US defense outlook improving: The US defense budget seems to have troughed, with a potential return to growth coming through in the FY16 process. As money comes back into the DoD, we expect funding to be focused on higher-priority areas such as electronics and high-priority services.
Let’s go cyber: Raytheon has diversified into civil cyber with the acquisition of most of Websense, which is now structured as a JV, including some of RTN’s existing cyber assets. Although the purchase price was high, this business should contribute with strong EBITDA growth going forward.
Margin expansion, pension, and buybacks—a familiar theme: Raytheon, like its defense peers, has done an impressive job of growing margin in the face of top-line pressure. Although its ability to continue growing margin at this pace becomes more challenging, its focus on returning free cash to shareholders through dividends and share repurchases is in little doubt. The share buybacks, combined with a pension tailwind, likely means that Raytheon should be able to grow underlying EPS in the face of top-line declines.
RTN note, 10-23-2015
Ryder System, Inc. (NYSE: R) John Barnes (Analyst)
(804) 782-4020
We rate Ryder Top Pick. Our investment thesis is based on the following key points:
Lease renewal cycle should reduce the age of the lease fleet considerably, driving material margin improvement and earnings growth. We continue to expect material margin expansion and earnings growth driven by a reduction in the age of the lease fleet over the next few years. This aspect of our thesis is unchanged and is already beginning to play out. We continue to see the age of the lease fleet moving steadily lower as R cycles the lingering effects of the 2007 pre-buy and lease extension phase. As a result, we see the FMS margin improving by 50–75 bps annually over each of the next few years.
A bounce in truck order activity suggests that more material lease fleet growth could develop over the near term. As we noted above, we are not expecting much earnings contribution from fleet growth over the next several years, which is consistent with our outlook for demand across our coverage universe. However, medium (Class 5–7) and heavy duty (Class 8) order trends have improved considerably. As a result, we believe that there could be some upside to fleet growth expectations.
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December 1, 2015 13
Development of new lines of business should drive EPS higher in this cycle. R continues to explore how it can further leverage its nationwide network of service and repair facilities by providing these services to a new customer base. We believe the company will be able to achieve success in this venture, as it can offer maintenance service at a lower price than an operator would be able to find at a dealer or independent service shop. Right now, these operations contribute a negligible amount to revenue and earnings, but we do see this business growing over time, due in large part to R’s dominant position in the market and reputation for providing a high level of service. Even though we believe this line of business will likely remain rather small in relation to the whole company, we point out that each dollar of revenue and profit generated by this business is incremental and should help push EPS to new highs.
We would likely become less constructive on the stock if the following were to occur:
A further weakening in demand for commercial rental or used vehicles, which would lead to further pressure on earnings.
A slowdown in demand for new lease vehicles due to weaker economic growth or changes in regulations.
Any change in regulations that cause maintenance expense to rise more quickly than we expect.
R note, 10-22-2015
ServiceNow, Inc. (NYSE: NOW) Matthew Hedberg (Analyst)
(612) 313-1293
Founded in 2004 by Fred Luddy, ServiceNow is an enterprise IT cloud company that delivers SaaS-based applications to automate and standardize IT business processes. We are bullish on the company’s ability to take share in the IT Service Management (ITSM) market as ServiceNow becomes the “ERP for IT”. Its technology centers on a suite of applications built on a proprietary platform that automates workflow, processes, and integration related business activities. Customers deploy their services to create a single system of record for IT, which reduces costs and streamlines operations. Moving beyond IT, ServiceNow could become the platform for the enterprise as customers and partners write custom SaaS applications for HR, finance, facilities, legal, procurement, etc., on its platform.
Key points
Above-market growth opportunity by taking share from legacy IT vendors
Growth strategy = land + expand + retain
Classic platform play as ServiceNow expands beyond IT
Improved monetization through updated packaging
Seasoned management team, many of which came from Data Domain, which was sold to EMC in 2009
Opportunity for long-term margin expansion
Potential investment catalysts
Results could come in above expectations
More robust IT spending for 2015
Improved up-sells from the “à la carte” pricing model
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New products/services such as ServiceWatch, Application Exchange, Analytics, Codeless App Creator, etc.
Investment risks
The economic environment remains volatile
Scaling the business to $4B in revenue vs. the move from $100M to $1B
Premium valuation
NOW note, 10-22-2015
Voya Financial Inc. (NYSE: VOYA) Eric Berg (Analyst)
(212) 618-7593
We believe Voya Financial management has a clear road map on how it would increase Voya’s ROE to 14% by the end of 2018, through a combination of growth, margin, and capital initiatives. Our confidence stems from several factors:
Management committed to freeing up capital within existing businesses. We think it is very likely that Voya is exploring options for reinsurance deals within its individual life insurance and annuity businesses to free up capital. Furthermore, we think Voya could explore options to sell legacy blocks of annuity businesses in order to permanently put them behind. Management also wants to continue the withdrawal from the variable annuity business, likely through updated accelerated annuitization programs, we believe.
A clear, shareholder-oriented goal, and tactics to achieve it. The new leadership team has articulated tactics to achieve a shareholder-oriented goal. The goal: To convert Voya Financial from a marketing- and top-line-oriented company to a truly shareholder-oriented company focused on achieving a 14% ROE by 2018.
Management has a record of prior success and has proper incentives. We’re encouraged by the fact that the new leadership team at Voya Financial had a demonstrated record of success prior to joining ING U.S. and has shareholder-aligned incentives.
Competitive risk. We consider this the No. 1 risk to Voya Financial’s achieving our price target; our earnings projections for this company contemplate in some instances strong growth in businesses that are extremely competitive, such as tax-deferred savings programs for educational systems and other non-profits.
Policyholder behavior risk related to Voya Financial’s closed block of variable annuities. Voya Financial acknowledges that it continues to face earnings risk and therefore risk to its balance sheet from its closed block of variable annuities. These are nearly 500,000 annuity contracts, written largely between 2004 and 2008, that contain substantial stock-market guarantees.
VOYA note, 11-04-2015
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WebMD Health Corp. (NASDAQ: WBMD) David Francis (Analyst)
(615) 372-1337
WebMD is the dominant, trusted brand in digital content for healthcare consumers and physicians. With the dawn of the era of consumerism in healthcare, we believe WebMD is poised to become the “Google” of the CHIT market.
Dominant brand in digital health. WebMD is the dominant source of digital content for consumers and physicians in the health care market. As the trusted partner for such content, the company has multiple revenue engines on its powerful digital platform.
The “hub” of connectivity between consumers, payers, and providers. The value that WebMD creates in drawing both consumers and providers into its content and connectivity services creates substantial opportunities to bring efficiencies to the clinical process, provide better care, and improve the care experience for all stakeholders.
Positioned at center of $50 billion CHIT market. With the emergence of the healthcare consumer as a more powerful economic player in the health care market, WebMD is strategically positioned at the very center of the new HCIT Superstructure that will support the rapidly evolving health care market.
Stock attractively priced with CHIT optionality. Trading at 9x our 2016 EBITDA and 8x 2017 EBITDA estimates, WBMD is attractively priced based on the current business, providing investors with optionality on the burgeoning Consumer Health IT market opportunity. We continue to rate WBMD our Top Pick in the HCIT/CHIT.
Potential catalysts
New advertising partners coming to the platform.
New CHIT solutions to drive additional revenue.
Specialty pharmaceutical expansion requiring the company’s targeted engagement capabilities and acquisitions.
Risks factors
Investment spending necessary to take advantage of rapidly expanding market opportunities may stifle earnings growth.
Slower than expected growth of CHIT market.
Recurrence of marketing budget reductions at pharmaceutical and medical products companies.
WBMD note, 11-04-2015
Whirlpool Corporation (NYSE: WHR) Robert Wetenhall (Analyst)
(212) 618-3251
Favorable competitive dynamics in North America: The North American segment (42% market share) stands to benefit from the emergence of a functioning duopoly following Electrolux’s (16% share) previously announced acquisition of GE Appliances (20% share). Recent pricing trends have been subdued (FY08–FY14 CAGR: 0.0%) in response to soft
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demand and intense competitive pressures. The emergence of a duopoly, however, represents a potential tailwind for pricing.
Improving North American demand trends: The North American segment (51% of FY15E revenues) stands to benefit from favorable macroeconomic trends in the US (>85% of NA segment revenues) that should result in stronger demand. Lower unemployment and modest wage inflation should lead to a sustained increase in consumer spending, which supports our view that appliance demand will likely increase by mid-single-digit levels in each of the next few years.
Large international growth opportunities: International markets (55% of FY15E sales), which are characterized by low levels of appliance penetration, should decline this year by LSD levels due primarily to a sharp contraction in Latin American demand, before considering the unfavorable impact of FX headwinds. In contrast to a more developed economy such as the US (79% penetration), emerging markets in LatAm (42%), China (36%), MEA (36%), and India (16%) are ideal candidates for higher levels of appliance penetration over the long term.
Robust free cash flow profile: Favorable trends in North America and sizable acquisition synergies should result in FCF climbing from $619 MM (FY15E) to $1.2 BN.
Key risks to our price target include – (1) softer demand; (2) FX headwinds; (3) raw material inflation; and (4) limited visibility into EPS performance.
WHR note, 11-17-2015
Yum! Brands, Inc. (NYSE: YUM) David Palmer (Analyst)
(212) 905-5998
Although the China division continues to struggle, we believe upside from the spin more than offsets a slower than expected pace of recovery. With the spin, we believe investors will also come to appreciate Yum! Brands’ sum of the parts value, which appears low-cost compared to peers, particularly when considering Yum! Brands’ improved global franchise businesses. Our price target implies peer multiples for the global franchised business and a 6x forward EV/EBITDA multiple for Yum! China (35% of profit).
We believe the market fundamentally undervalues Yum’s non-China business for the following reasons: (1) KFC, Pizza Hut, and Taco Bell are highly franchised global businesses with minimal exposure to input costs. (2) These brands have vast and international unit growth opportunities. (3) KFC and to a lesser extent Pizza Hut have a high geographic mix of faster-growth emerging markets (ex. China). (4) Yum US is on stable footing with Taco Bell and KFC, while Pizza Hut US remains an opportunity for improvement. In our sum-of-the-parts (China split/franchising) analysis we assume that the new Yum! Brands takes on five turns of debt—used for share repurchase—and we assign a blended multiple of 14.5x EBITDA for the company’s three global franchised brands.
China recovery at a measured pace: While Pizza Hut’s China issues appear to be largely company/ brand-specific, we believe KFC China is on the path to recovery (albeit at a slower than expected pace). Near-term, we believe Pizza Hut’s China issues are fundamentally fixable under the new leadership of Micky Pant with better execution that includes compelling value offerings to create more balanced growth. We also believe Yum! China is taking important steps to minimize food safety risk in the future.
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Risks to our investment thesis
Potential risks include but are not limited to: (1) high valuation; (2) slowing economic activity; (3) food safety and quality; (4) highly competitive fast food segment; (5) food and labor inflation; (6) obesity concerns and government regulation; and (7) foreign currency risk.
YUM note, 10-21-2015
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Required disclosures Non-U.S. analyst disclosure Paul C. Quinn (i) is not registered/qualified as a research analyst with the NYSE and/or FINRA and (ii) may not be an associated person of the RBC Capital Markets, LLC and therefore may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account.
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