Activision Blizzard (ATVI): ATVI reported strong 2Q23 results well ahead of analyst consensus.  A good launch for the latest Diablo game, ongoing strength in King mobile games, and steady results for Call of Duty and World of Warcraft led to the positive quarter.  Analyst estimates moved up for 2023 but less for 2024.  The more important news from ATVI concerned a dramatically increased likelihood that Microsoft will complete its takeover the of the company at $95 per share in cash before November.  Microsoft won its court case vs the US government which was attempting to block the merger on antitrust grounds.  The only remaining regulatory approval needed is from the UK, which rejected the deal earlier this year.  However, Microsoft offered new concessions and is negotiating with the UK regulatory authorities who have noted an immanent completion date for their renewed merger review.  Analysts now expect the deal to close with 95% certainty and ATVI shares have moved up to $92 reflecting the high likelihood of closing.  Interestingly, with another strong quarter of earnings, we now see fair value for ATVI shares be $85-$90 in a deal break scenario.  Microsoft is a getting a good deal but we are extremely happy to sell Northlake’s ATVI shares at $95.  Initial purchases for clients go back to 2014 when we paid just over $20 per share.  ATVI encountered several periods of extreme downside volatility where we held strong.  ATVI validates our patient approach to quality companies offering long-term earnings and cash flow growth.

Apple (AAPL): AAPL reported slight upside to EPS on a very small shortfall in revenue.  The stock has reacted poorly due to the revenue shortfall and guidance for the September quarter that implies another period of negative revenue growth.  EPS grew in the June quarter due to tight cost controls and higher gross margins, driven by a mix shift in revenue towards Services. EPS is forecasted to grow again in the September quarter. In fact, Services revenues showed the best growth in a couple of years as trends accelerated with the continued growth of AAPL’s installed base of iPhones, iPads, Macs, Watches, and AirPods.  Apple Pay, Apple Music, and the App Store led the way for Services growth.  AAPL’s net income this quarter was slightly less than the September quarter of 2021.  EPS are higher thanks to share repurchases, but trailing 12 months EPS are unchanged since the end of 2021.  Despite the lack of net income growth, the stock has performed well thanks to growth in high-margin Services revenues and a large and steady share buyback program. Accelerated hardware sales – especially iPhones – is needed for the stock to move meaningfully higher.  This may prove difficult given iPhone market share in the U.S. is nearly saturated.  Fortunately, emerging markets like China and India continue to offer market share opportunities for Apple in markets with less smartphone penetration.  Analysts project renewed EPS growth in 2024 built upon continued growth in Services and a recovery in iPhone growth.  The new Vision Pro mixed-reality headset is a wild card with low expectations given the extremely expensive price point for the first-generation device.  We have been through these periods before with Apple and remained patient due to the company’s superior cost management and capital allocation.  Those things remain in place so we shall continue to be patient.  AAPL positions in client accounts are heavily overweighted, so if you see a small sale of part of your shares, it is just portfolio management to keep risk and rewarded balanced and diversification maintained.

Nexstar (NXST): NXST reported 2Q23 earnings that were slightly ahead of consensus estimates and company guidance for revenue, EBITDA, and free cash flow. Nonetheless, the shares sold off on the day of the report and again the next day, dropping about 10%. The problem is that NXST management did not affirm its previously issued guidance for 2023/2024. NXST guides on two-year averages due to the massive impact of political advertising in even years. Queried extensively about this on the quarterly conference call, management noted that with a more than month-long blackout with DirecTV due a carriage fee dispute, it was inappropriate to comment or update guidance. Blackouts are a regular occurrence for NXST and other TV broadcasters. Often, they occur in the summer when there is not a lot of original TV shows or a heavy sports calendar. The blackouts are usually resolved by the start of the NFL and college football seasons in early September. NXST noted that it is in active negotiations with DirecTV and expressed confidence that a deal would be reached. As streaming becomes a more prevalent way to watch TV, including local channels and sports, there is always a risk that a major TV provider like DirecTV will choose to drop local channels. Local channels are consistently the most watched, and surveys show they are highly valued by viewers for their local news. Thus, we think it highly unlikely that DirecTV risks a blackout that lasts much longer. Ultimately, NXST will get paid and any guidance update should prove minor. That said, the story at NXST is changing as the company is maxed out on local TV ownership and is shifting to developing properties with national reach like the CW Network and NewsNation. NewsNation is going well but has taken longer than initially planned. The CW strategy has evolved and management is willing to spend on content which creates risk in the current environment for traditional TV. There is also risk that management acquires additional national TV assets. NXST could be a buyer of ABC and the ABC large market TV stations owned by Disney which are apparently for sale. NXST is a volatile stock and is up about 10X from our initial purchases. We have held through other periods of controversy because we believe management is among the best we have ever encountered. The secular challenges to the TV business raise the stake but for now we are willing to trust management and expect a settlement with DirecTV, better advertising trends over the next year, and the surge in political advertising in 2024 that drives free cash flow and shareholder friendly capital allocation. Based on current estimates, we think the shares can trade back to $200.

Sony (SONY):SONY reported slightly better than expected earnings while maintaining guidance. There were some gives and takes in the report and guidance that has created downward volatility but Northlake is not concerned that there is a change in the bullish long-term investment thesis. Three items seem to be bothering investors: a weaker quarter of PS5 sales, a downgrade in the outlook for image sensors due to weak smartphone sales in the US and China (called out by Apple), and the Hollywood strikes. None of these issues should prove lasting, so we are surprised the stock has declined 5% since the earnings report. Management addressed each issue. PS5 full-year sales guidance is maintained with a new promotional push planned for the rest of the year that was always in the budget. Image sensors should rebound as inventory is well controlled and the new set of phones set to be introduced should improve demand. The strikes are a problem and cannot be forecast but at least in the short term they pull forward free cash flow. It is also important to note is that management repeatedly mentioned “conservative” when discussing their updated outlook. Further, despite some near-term headwinds, guidance for the current year was maintained. We remain positive on SONY being aggressive in its strategic planning and capital allocation. The shares trade at a sharp discount to peers in video games, music, entertainment, and semiconductors. More aggressive management, including the support of the Japanese government to drive shareholder value throughout Japan’s largely conglomerate corporations, should close the valuation gap over time. The upcoming separation of SONY’s financial services business is a good example.

Disney (DIS):DIS has had a rough go in the last 12 months but things might be looking better. Operating income returned to growth in 3Q23 and management forecasted renewed growth ahead including in the current quarter. Cost cutting, lower content spending, and greatly reduced losses on streaming should drive growth in operating income, free cash flow, and earnings per share. Management showed confidence by indicating a dividend would be reinstated soon and share buybacks are likely in a year or two. Returning CEO Bob Iger is establishing a clearer vision for Disney. Streaming is shifting to a profit focus with price increases and ad-supported tiers. Iger is willing to sell the non-sports linear businesses including ABC, TV stations, and cable networks. ESPN will stay part of Disney but the company is looking for outside investors to support the transition to streaming. Parks will continue to get fresh investment including two new cruise ships. The film and TV studios have produced a series of underperforming content, but Iger’s shift in focus from distribution to content creators in the corporate structure and culture should resolve this issue given the company’s premier franchises and track record. According to J.P. Morgan, DIS should produce $15B in operating cash flow this year. By 2026, there should be a $5B favorable swing in streaming from a $2B loss to a $3B profit at which point streaming margins will only be half of what Netflix produces. The traditional linear TV businesses are in steady decline and will see profits fall by up to $2B or 30% over the next three years. Parks remains a growth business and should have $2B higher profits at a mid-to upper single digit growth rate. Put it all together compared to depressed 2023 levels, profits should grow by 50% in the next three years with EPS growing faster, from near $4.00 to almost $7.00. Struggles over the last few years have DIS in the penalty box, so despite the favorable outlook, DIS is a show-me story. We think the just-reported quarter marks the bottom and the turn upward will be evident in the next few quarters. DIS shares offer substantial upside to over $100.

Home Depot (HD): HD reported better-than-expected 2Q23 earnings with some positive signs that the digestion period from heavy customer spending during COVID is nearing an end.  Same store sales, total revenues, profit margins, and earnings per share all exceed analyst estimates.  As we have often noted, HD management is quite conservative when it comes to guidance, so consensus estimates were cautiously positioned.  July was the strongest month of the quarter with same store sales near unchanged.  However, management guided for a low single-digit decline for 3Q.  Traffic has improved, which is important, as the benefit of inflation is shifting to disinflation.  Investors generally prefer traffic-driven growth.  Working against a resumption of growth off the higher post-COVID base is that consumers and contractor pros are doing smaller projects.  The news on profit margins was good, with HD no longer suffering supply chain inefficiencies and operating expenses under strict control of management.  In fact, management outlined meaningful cuts in operating expenses for 2024.  Analyst earnings estimates for 2023 held steady with a slight uptick in 2024.  HD shares have recovered nicely since reaching 2023 lows in the spring.  The shares trade at 20X next year’s earnings, a slight discount to their historical average.  With COVID impacts receding and earnings estimate revisions moving from negative to positive, HD shares should continue to recover.  Our long-term thesis for consistent growth built around a secular shift to spending on the home is intact.

Walmart (WMT): WMT reported better than expected 2Q24 (fiscal year ends in January) with revenue, same store sales, and profit margins all materially ahead of consensus estimates.  WMT is executing very well on both its core store level business and its ecommerce and advertising business.  Two highlights in the quarter were 24% growth in ecommerce revenue and expanding operating margins.  WMT is gaining market share at the store level and in ecommerce through sharp pricing in a pressured consumer environment, an uptick in higher income households shopping in store and online, and an ongoing mix shift toward grocery, healthcare, and wellness products where WMT offers superior selection.  Despite the good quarter, WMT shares have traded down in a weak market since the report.  The only negative in the quarter was 3Q24 guidance for slower sales growth and a step back in margin expansion.  Sales growth may slow on tough comparisons from high gasoline prices a year ago (Sam’s is a major seller of gasoline).  When management announced that they would grow operating income faster than sales (i.e., margin expansion), they noted it would not be linear every quarter.  Northlake remains bullish on WMT with FY25 (essentially 2024) EPS estimates rising to almost $7.  The year ahead P-E of 22X remains attractive given market share increases and margin expansion.

ATVI, AAPL, NXST, SONY, DIS, HD, and WMT are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.