Sony (SONY): SONY had mixed news with its 3Q23 report.  Earnings were basically in line with or slightly ahead of expectations.  However, guidance was mixed, including initial insight into the year ahead that begins on April 1^st.  Capital allocation provided a positive surprise with the announcement of the spinoff of the company’s financial services business.  We remain positive on SONY on a long-term basis based upon the company’s attractive business mix (video games, filmed entertainment, and image sensors), smart strategic and financial management, and continued movement to more shareholder-friendly corporate cultures in Japan.

The primary issue in the latest earnings report that led the shares to sell off is a weak forecast for video games.  SONY cut its guidance for PlayStation 5 sales and noted a lack of major first-party and third-party video game releases in 2024.  The two issues are probably related.  A bearish take is the industry is maturing sooner than expected.  We think a significant part of the muted 2024 outlook relates to the release of Grand Theft Auto 6 in 2025.  We also note that SONY management consistently guides conservatively often including one-time expenses that most U.S. companies ignore.  Away from video games, the outlook is consistent with growth expectations.  Regarding the financial services spinoff, this will occur next year in the form of a stock dividend to shareholders.  Sony Financial Group is a good business but does not fit well with the rest of the company that is focused around entertainment delivered across TVs, theaters, mobile phones, gaming consoles, and PCs.  We expect the financial services business to get a valuation that is accretive to SONY’s current stock price.  Until the outlook for 2024 has stabilized, we expect SONY shares could struggle to recover.  We remain patient given the cheap valuation, attractive long-term growth prospects, strong management, and financial strength.

Walmart (WMT): WMT continues to perform very well on a fundamental basis.  4Q23 results and 2024 guidance exceeded estimates as several diversified growth strategies remain effective.  We continue to like the combination of offense and defense offered by WMT shares.  Management appears to agree as the Board raised the dividend 9%, the largest increase in ten years.  WMT’s growth strategy is built around being a retail technology leader and aggressively managing the core store-based business.  Technology-driven businesses in advertising, third-party fulfillment, and ecommerce are driving the top line at much higher margins than the company average.  As these businesses gain share of the top line, margins will continue to expand and operating income will grow faster than sales.  Store level business is also performing well albeit at slower growth rates.  WMT is gaining market share with its value leadership in a tough environment for consumers.  Higher income shoppers continue to build at WMT as they seek value in inflated groceries and respond to the company’s ecommerce efforts.  Traditional expense control remains a lever to pull. After several years of investments in labor, those expenses are flattening.  Another strategy helping growth is an accelerating pace of store remodels.  Retailers usually get a boost from remodels which drive customer satisfaction and take advantage of data driven insights in customer behavior.  Finally, WMT has invested heavily in supply chain engineering.  Those investments improve stocked shelves, reduce discounting, and increase efficiency driving profit margins and reducing working capital.  Our only complaint at WMT is that the stock carries a historically high P-E ratio.  We believe it is deserved and rooms remains for further multiple expansion.  Our WMT mantra is 25 times $8 in EPS in 2025 for a $200 target pre-split. After the recent 3-for-1 stock split, our new target is $67.

Home Depot (HD): After an initial move lower, HD shares have moved to a new 52-week high and within striking distance of the COVID, stay-at-home fueled all-time high from December 2021.  Interestingly, the latest move higher came after the company reported mixed results for 4Q23 and issued guidance calling for no growth in revenues or earnings in 2024.  Both 4Q23 and 2024 guidance were light compared to analyst expectations total sales, comparable store sales, and EPS.  Profit margins held up well against expectations as HD is managing the company assuming an ongoing tough sales environment.  Two factors are headwinds for HD: COVID pull-forward of home spending and higher interest rates.  On the conference call, management stated that the COVID impact is nearly over and lower rates from the Fed later this year could move home improvement spending back to 3-4% annual growth.  Guidance does not appear to include any pickup in 2024, however.  This is one reason the stock reversed and moved higher as investors think the outlook is conservative.  Furthermore, management remains very confident that HD will continue to gain market share.  This means top line can get back to mid-single-digit growth which is enough to drive profit margin gains and free cash flow leading to double-digit growth in earnings.  In Wall Street parlance, HD is endorsing its long-term growth algorithm at a time when the industry is under pressure. Northlake believes EPS growth should pick up in 2H24, ahead of management expectations and accelerate in 2025.  We also believe that COVID had a secular impact on home improvement that could allow industry spending to be elevated beyond the pre-COVID 3-4% rate.  HD is not as sensitive to mortgage rates as most believe, due to a large percentage of homeowners with fixed mortgage rates. Lower rates will still provide a boost, especially for large projects completed by professional contractors.  We believe HD is close to a pivot point for resumed growth that will lead the shares to reach a new all-time high over $400 and continue to outperform over the long haul.

Positives include lapping increases in interest rates, lapping lumber deflation, and lapping significant pressure on home turnover, while negatives include slowing consume spending growth, continued shift away from consumer spending on home improvement after the COVID boost, elevated interest rates relative to pre-pandemic, and project downsizing/deferral. Management thinks the industry declines at a low single-digit rate in 2024 and is neutral on any short-term recoveries in housing. Management thinks higher rates will last through 1H24. If rates get cut in 2H24, there is a timing impact for home improvement as it will take time for existing home sales to pick up. HD also thinks the company can generate positive comps without existing home sales improving.

VICI Properties (VICI): VICI wrapped up a strong 2023 with its normally predictable quarterly report.  AFFO (EPS for REITs) grew 12%.  Guidance for 2024 is for slower growth of just 4% but appears conservative since it takes into account recently issued shares to finance transactions that have yet to close.  Furthermore, it includes no new investments.  VICI has steadily grown its asset base with many small transactions and impossible to forecast larger transactions.  The conference call was devoted to two topics: future growth in casinos and new growth avenues in experiential real estate.  For casinos, management noted that several larger properties in Las Vegas will be undergoing upgrades or expansion.  In addition, new casinos are opening in Illinois, New York, and Virginia, while states like Texas and Georgia are trying to pass legislation to allow casinos.  These projects can be worth billions of dollars to VICI.  Experiential real estate is a new avenue for VICI that presently represents about 10% of the rent the company collects.  VICI has provided financing so far to waterparks, golf resorts, bowling centers, family recreation centers, and wellness centers.  VICI’s tenants are mostly well-established private companies, but investors have less insight into their growth plans and financial strength.  VICI expects to earn higher returns on capital to compensate.  Experiential real estate is much less regulated than casinos which allows VICI and their tenants to drive growth more easily.  We have noted in many prior VICI updates that we believe the management team is among the best in any industry we follow.  We have full confidence that any risks associated with the diversification strategy are well considered.  VICI shares yield 5.5%, so the stock can produce a double digital annual total return even with modest mid-single-digit growth.  It will probably take lower interest rates to get the stock moving, but we are happy to wait. We expect the long-term CAGR in total return to be comfortably above 10%.  A good reward for a conservative, low-volatility business model.

Nexstar Media Group (NXST): Following a difficult stretch for traditional media company stocks, especially local TV broadcasters, NXST proved once again that it sits atop the pack of its secularly challenged industry.  NXST reported better than expected 4Q23 earnings, wrapping up a strong year.  Guidance for 2024 was a little shy of the consensus analyst estimate but directly rebutted many of the concerns raised by peers who had reported the previous week.  Most importantly, NXST indicated that the net fees it receives from distributors like cable companies and pays to TV networks like CBS and NBC are still growing nicely with a better-than-feared forecast for 2024 and 2025.  These fees comprise over half of NXST’s revenue and are perceived to be under threat as households move from traditional cable TV to streaming services that usually do not offer local TV stations.  NXST also indicated that political advertising revenues should reach a record this year.  A couple of smaller TV station groups indicated that net distribution fees and political advertising would be disappointing this year.  The other major revenue stream at NXST is advertising on its stations.  Trends here could be better, especially in national advertising and the company’s stations in the largest cities.  Fortunately, NXST’s ad forecast was only a minor disappointment.  Another thing that sets NXST apart from other local broadcasters and traditional media companies like Warner Brothers Discovery and Paramount is that NXST maintains a strong balance sheet.  With modest levels of debt, NXST can use the high free cash flow endemic to local TV ownership to reward shareholders.  The company boosted its dividend 25% earlier this year and steadily buys back a material amount of its shares.  With the 2024 outlook de-risked, NXST shares should rally back toward all-time highs near $200.  NXST has been a great investment for Northlake clients, up 10 times initial purchases.  We do have concerns about the long-term secular outlook, however.  Hopefully, we are correct that the good outlook will drive the stock higher this year.  Presently, we expect to be sellers on the next move up but our views are subject to change as developments in the television industry are moving fast.

SONY, WMT, HD, VICI, and NXST 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.