StockInvestorSM focuses on the activities of portfolios of Morningstar, Inc. that are invested in accordance with the Tortoise and Hare strategies. These portfolios are managed by Morningstar Investment Management LLC, a registered investment adviser, which manages other client portfolios using these strategies.
Please see new analyst notes and updates below from Morningstar Research Services for Adobe ADBE, Autodesk ADSK, Berkshire Hathaway BRK.B, Charles Schwab SCHW, and Sanofi SNY.
Also, I'll be out of the office next week, so we won't be sending a weekly update next Friday. As the following Friday (April 7) is a market holiday, the next weekly update will be sent on Thursday, April 6th and will include any analyst notes/updates published next week.
Best wishes,
David Harrell,
Editor, Morningstar StockInvestor
Adobe Announces Slew of Innovations and Goes All-in on Generative AI at Summit; FVE Remains $425
by Dan Romanoff, CPA | Morningstar Research Services LLC | 3-21-23
Adobe hosted its Summit customer experience event accompanied by a tome of press releases and capped it off with a Q&A session for the investor community. In broad strokes, the firm announced an array of innovations to both the Adobe Experience Manager and Adobe Experience Cloud, highlighted by its new Firefly family of generative artificial intelligence, or AI, models. After viewing some short demos of product capabilities, we came away impressed and believe that wide-moat Adobe has widened its lead in both content creation and customer experience. Unfortunately for Adobe, we think some of the other announcements from today's event will be overshadowed by Firefly. We are maintaining our fair value estimate of $425 per share.
In connection with the event, Adobe released its beta version of its first Firefly models, which we are eager to try out firsthand. After years of discussion surrounding AI more broadly, we are surprised by the pace of AI introduction, integration, and proliferation that is finally washing over our software coverage. The ability to describe a piece of graphical content using natural language text, have Firefly create the image, and then being able to further edit it on the fly with either further natural language prompts or by using the myriad of Adobe's tools within Creative Cloud is impressive. These capabilities will obviously allow for a step-function in user efficiency. Pricing and general availability information are forthcoming for Firefly, but the possibilities skew our bias positively from a financial perspective.
Taking AI-generated content and being able to move it through an automated workflow using additional AI capabilities throughout Adobe's portfolio is also a significant development that incorporates a variety of the company's other announcements from today's events. For example, using Firefly to create content, and then automatically move from Creative Cloud to the Digital Experience suite to create marketing campaigns.
Autodesk's Investor Day Confirms Our Confidence in Its Long-Term Growth; Shares Attractive
by Julie Bhusal Sharma | Morningstar Research Services LLC | 3-22-23
On March 22, Autodesk hosted its investor day, spelling out how its market has plenty of drivers for future growth -- from adoption of building information modeling, or BIM, to leveraging machine learning. Since we have been a firm believer in these growth avenues for Autodesk and its ability to monetize them, our model remains unchanged. However, we think this is still an opportune time to remind investors that the stock is trading in attractive 4-star territory given our $230 fair value estimate. We think this is a rare opportunity for long-term investors, as we think the stock boasts a wide moat and more often than not trades at a premium valuation because of its quality.
Of note in the investor day was that Autodesk maintained its fiscal 2024 guidance despite increasing uncertainty arising from potential instability within the banking system. As a reminder, Autodesk expects fiscal 2024 revenue to be between $5.36 billion and $5.46 billion with a non-GAAP operating margin of near 36%. However, we do not find the reiteration of guidance surprising, as we think Autodesk's wide moat comes from switching costs stemming from the essential nature of Autodesk's solutions -- making it difficult for users to switch off of the software. In fact, Autodesk highlighted healthy revenue trends across its businesses, including 115% to 120% retention within its construction cloud, which we believe is an indicator of such strong switching costs.
Beyond a firm reiteration of guidance was news of impressive progress in newer revenue streams helping drive Autodesk's eventual $100 billion total addressable market. For instance, we were happy to hear that Autodesk is only weeks away from receiving FedRamp approval on its construction cloud offerings, which will give the company the ability to sell cloud offerings to the government -- not just on-premise ones. This is a big step because we believe it will make It easier for Autodesk to take more of the $382 billion U.S. construction market.
Altogether, a recurring theme was digitization of workloads and smarter flows of data between stakeholders involved in anything from a building's lifecycle to the creation of a movie. We believe Autodesk is wisely executing upon these trends by prioritizing interoperability -- an important trait, in our view, because it improves customer experience. With BIM being an example of smarter data flow between stakeholders, we were pleased to hear of continued adoption of BIM processes, including Germany and Japan enacting BIM policies this year. In addition, the most saturated global market still only at about 40% penetration -- leaving significant opportunity ahead.
Another Banking Crisis, Another Call to Buffett
by Greggory Warren, CFA | Morningstar Research Services LLC | 3-19-23
We were not too surprised to see stories pop up over the weekend about Warren Buffett, CEO of wide-moat Berkshire Hathaway, being in conversations with the Biden administration about the banking crisis, as well as reports from the major news outlets that a large number of private jets have made their way to Omaha this weekend. In just the past 10 days, we've seen the U.S. regulators step in and backstop depositors at two failing banks, Silicon Valley Bank and Signature Bank. The Swiss government stepped in to shore up Credit Suisse, and the U.S. regulators are working with 11 banks (including wide-moat JPMorgan Chase) to shore up First Republic Bank by placing $30 billion of their own funds in deposits at the struggling institution.
Even with all that, First Republic sank another 33.0% on Friday, with the SPDR Regional Banking ETF down 6.0%, the SPDR S&P Bank ETF down 5.6%, and the SPDR Financial Select Sector ETF down 3.3%. Since the start of the year, First Republic shares have lost 81.1% of their value, while the SPDR Regional Banking ETF, the SPDR S&P Bank ETF, and the SPDR Financial Select Sector ETF have declined 21.3%, 16.1%, and 6.4%, respectively. So, stories that the Biden administration and the U.S. regulators are looking at all possible means for supporting the banks and calming the markets should come as no surprise.
As for Buffett and Berkshire, on multiple occasions over the past two decades we have seen firms seek out capital from Berkshire on the belief that the "Buffett Seal of Approval" that came with that capital injection would reduce the pressure on their shares. This was most evident during the 2008−09 financial crisis, when Berkshire tapped into the strength of its balance sheet, its large excess cash balances, and the value that struggling firms (and their investors) placed on having Buffett's approval attached to their businesses and/or actions to extract large rents from those that lined up at the Bank of Berkshire.
In particular, on the financial services side of things, we saw narrow-moat Goldman Sachs, two days after it became a bank holding company in September 2008, announce a private offering to Berkshire Hathaway whereby the insurer would purchase $5 billion worth of 10% perpetual preferred stock issued by Goldman (with the investment bank retaining the option to buy back the preferred shares for $5 billion plus a one-time dividend of $500 million). As part of the deal, Berkshire also received warrants (expiring in 2013) to purchase 43.5 million of Goldman's common shares for $5 billion (or $115 per share). This became a strong show of support for Goldman at a time when the markets were in chaos primarily because Buffett has shunned investments in the investment banks following his own experience with scandal-ridden Salomon Brothers in the early 1990s.
Berkshire stepped up again in early September 2011 when wide-moat Bank of America reached out for a lifeline that had the insurer investing $5 billion in 6% Perpetual Preferred Stock, as well as receiving warrants to purchase 700 million common shares for $5 billion (or $7.14 per Share). The investment was seen as a huge vote of confidence in Bank of America, which has been plagued by mounting legal costs stemming from the 2008-09 financial crisis, as well as doubts about the strength of its capital base, sending the company's shares soaring off their recent lows. Buffett's seal of approval also helped other banks, which had been weighed down by weakness in the overall stock market, fears of a slowing U.S. economy, and concerns about their exposure to Europe's sovereign debt crisis, see a recovery in their share prices.
With all of that in mind, we would expect any action on the part of Berkshire-Buffett in the near term, with regards to the U.S. regional banks, to involve the same kind of capital injection (and Buffett seal of approval). This would be in exchange for high-coupon preferred stock (which is more tax efficient for an insurer) and warrants to buy common stock if anything happens at all. As such, that lifeline will not come cheap for those interested in going that route. What we do not expect to see is Berkshire stepping in and buying a bank. The firm has shown no interest in holding more than a 10%-15% stake in a U.S. bank primarily because ownership above that threshold comes with reporting requirements and oversight from the regulators that Berkshire is not all that interested in adhering to.
Charles Schwab Update: Decreasing FVE to $70, as We Forecast Lower Net Interest Income
by Michael Wong, CFA, CPA | Morningstar Research Services LLC | 3-19-23
We're reducing our fair value estimate for Charles Schwab to $70 per share from $87. Our fair value estimate implies a price/2024 earnings multiple of about 20 times and price/book multiple of about 5 times. $70 is currently our best assessment of the company's long-term intrinsic value. That said, new data regarding how the financial sector and Charles Schwab were affected by the events surrounding Silicon Valley Bank could materially change our valuation in the following months. We made many adjustments to our prior model with the most impactful changes being a large increase in usage of high-cost, short-term debt in the near term and more client cash being held in lower revenue-yielding money market funds instead of more profitable banking deposits.
We assess that wide-moat Charles Schwab has enough access to cash and capital to weather the storm in the financial sector that was unleashed after the collapse of Silicon Valley Bank. The company has access to the Federal Reserve's Bank Term Funding Program that can provide the firm upward of $200 billion of cash to deal with potential deposit withdrawals from clients. It also had about $40 billion of cash on its balance sheet at the end of 2022, over $50 million of cash inflows projected in 2023 according to our calculations, and other sources of liquidity.
On the regulatory capital front, Charles Schwab had a very healthy common equity Tier 1 capital ratio of 21.9% and a 7.2% Tier 1 leverage ratio at the end of 2022. It's true that the company's capital ratios would look worse if they included unrealized losses on securities holdings. However, Schwab shouldn't ever have to change those unrealized losses into realized losses by selling the securities, because it has so much access to cash. The unrealized losses are also related to the high interest rate environment (they're not losses from bad credit quality), and most of the unrealized losses should reduce to $0 when the fixed income securities mature.
Providing a bit more detail into our calculations, Schwab should have around $300 billion of available cash from its balance sheet and the Fed's Bank Term Funding Program. Over the course of 2023, Schwab should have around $25 billion of securities maturing, around another $22.5 billion of principal payments on securities, $4 billion of net income, around $1 billion of non-cash expenses reflected in net income, and we assumed that 2.5% of net new client assets (around $10 billion) will flow into deposits.
The range of possible needed borrowing from the Fed and Federal Home Loan Bank, or FHLBank, to replace deposits to prevent the selling of available-for-sale securities at a loss is difficult to handicap. We're estimating an average of about $100 billion for 2023, $20 billion in 2024, and close to $0 in 2025. The borrowing from the Fed and FHLBank keeps the securities portfolio roughly stable while deposits decrease by about $100 billion. Our assumption of a $100 billion decrease in deposits is from assuming an accelerated and higher degree of cash sorting to money market funds than we had previously modeled.
The near-term increase in high-cost, short-term borrowing causes revenue to decline around 15% in 2023, while the repayment of the high-cost funding and assuming some flow back into deposits leads to 15% to 20% net revenue growth from 2024 through 2026. The amount of high-cost funding is a significant driver of our near-term earnings forecast, while the change in deposits is a larger driver of our long-term valuation for Charles Schwab. Our thoughts on both of these metrics could materially change in the coming months, as Charles Schwab discloses information and we see how the overall environment evolves.
Sanofi and Regeneron Report Positive COPD Data, Raising Dupixent's Peak Sales Potential
by Karen Andersen, CFA | Morningstar Research Services LLC | 3-23-23
The efficacy of Sanofi and Regeneron's Dupixent appears to have extended to another inflammatory disease, as the phase 3 Boreas trial—focused on former or current smokers with type 2 inflammation and chronic obstructive pulmonary disease—has shown a statistically significant benefit for the drug on top of standard care by multiple measures. We now assume an 80% probability of approval in 2025, with potential sales peaking in 2029 around $2 billion in this indication; this puts our overall Dupixent peak sales estimate north of EUR 18 billion. This contributes to our Sanofi fair value estimate increase to EUR 113/$61 per share from EUR 110/$57. We would have included a low-single-digit increase in our Regeneron fair value estimate with this news, but we've also trimmed Eylea's sales in our model in 2028 and beyond to account for potential Medicare negotiation for the firm's high-dose version of the drug (on track to launch in 2023). We think Dupixent remains an important part of Sanofi's wide moat and Regeneron's narrow moat.
We had previously assumed that Dupixent sales could peak near EUR 17 billion before potential Medicare negotiation in 2030 and patent expiration in 2031. We expect Sanofi and Regeneron to file for approval in COPD in 2024 with data from the Boreas trial and the similar Notus trial, which is expected to read out next year. There are 500,000 people in the United States, Europe, and Japan with type 2 COPD.
Adding Dupixent to standard care not only reduced moderate to severe acute exacerbations of COPD by 30% relative to placebo, but it also led to improvements in lung function and quality of life. Safety data was solid, further supported by years of use of Dupixent in other indications. Because COPD has been notoriously difficult to treat and multiple other biologic treatments for asthma, like Astra's Fasenra and GSK's Nucala, have so far failed to see a benefit in COPD, we had not included COPD in our model for Dupixent. While new Fasenra and Nucala trials should have data over the next couple of years in the more targeted type 2 inflammation group, their different mechanism of action from Dupixent means that uncertainty around these programs is still much higher, in our view, paving the way for Dupixent sales in COPD.
Regeneron and Sanofi are also studying IL-33 antibody itepekimab in another type of COPD in former smokers, with data expected in 2025. We see the IL-33 program as higher-risk, given its prior failure in a broader group of current and former smokers, and there are also several other IL-33 programs at competitors like Roche and AstraZeneca that should generate phase 3 data on similar timelines. Therefore, we don't include significant revenue for this program in our forecasts.
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