Morningstar morning note recap. See Morningstar for full report.
EOG Resources EOG reported first-quarter results May 4 with total production that came in toward the high end of company guidance but below our expectations. Excluding volumes from Canadian operations divested in late 2014, total production grew 8% year over year to 590 thousand barrels oil equivalent per day. Under the same basis, crude oil and condensate volumes grew 16% year over year, with gains largely attributed to the Delaware Basin and South Texas Eagle Ford. Our $75 fair value estimate and narrow economic moat rating are unchanged. In the Eagle Ford, EOG is expanding high-density completions to cover about 95% o f wells drilled in 2015. The redesigned completion method has markedly improved well productivity, as indicated by 90-day cumulative production from 47 wells that is tracking on average 23% higher than comparable low-density wells. EOG has also realized greater efficiencies through service cost reductions and improved drilling cycle times, with well costs currently averaging $200,000 below 2015 budget. In the Delaware Basin, EOG has entered full development mode in the Second Bone Spring Sand play, while testing additional targets including the Leonard Shale and Wolfcamp. In the Second Bone Spring, using pad drilling and self-sourced sand has resulted in well costs that currently average $500,000 below 2015 budget. In the Wolfcamp, early results from wells targeting the oil window appear economically similar to other core areas. For the entire note, click here.
Mark Hanson, CFA
Luxottica's LUX first-quarter results and leverage on the operating line underlines our narrow moat rating. We continue to think that the company holds significant competitive advantages, including brands and intangible assets, and its scale and distribution network. Results have been aided on both the top line and the operating income line by foreign exchange due to the weak euro. But even on a currency neutral basis sales growth was above the company's initial outlook for a mid-single-digits sales increase, and even after factoring in the moderating effect of exchange rates as 2015 progresses, the firm is sticking to its goal of creating net income growth of twice the sales growth. A number of other visible improvements from the sun season orders in a recovering Europe, success of the Michael Kors license launch, and better prescription-retail sales growth driven by both execution but also the stronger United States macroeconomy, have given investors comfort that strong results should continue. Shares, however, have been driven up to levels significantly above our EUR 42 fair value estimate, and although we continue to like the company's growth prospects and believe in the sustainability of its competitive advantages, we believe investing at current prices gives away too much upside in the risk/reward balance. In the quarter, sales were up sharply on a reported basis, growing 22% to over EUR 2.2 billion (including adjusting for an accounting change worth 2%).
We like the strategic rationale behind Health Care REIT's HCN divestiture of its joint-venture ownership in seven life sciences buildings in Cambridge, MA. However, the slightly positive financial impact of the deal is not material enough to adjust our $69 fair value estimate for this narrow-moat health-care real estate investment trust ahead of its first-quarter earnings release, expected on May 8. At year-end 2014, Health Care REIT received just 1.4% of net operating income from these properties. Nonetheless, we like the firm's stated plan to repurpose the sales proceeds (of roughly $400 million) into other health-care properties. Although life sciences properties' outlook has generally improved recently with the bullish environment surrounding new drug development, troublesome pockets persist in life sciences space markets. Health Care REIT itself reported a 17% decline in same-store net operating income at its life sciences portfolio in its latest quarter, due to vacancy created by a large tenant. This vacancy has been re-leased, and it looks like the reported 5% cap rate on the deal includes rent from the incoming tenant. Nonetheless, we find this pricing favorable to Health Care REIT. So we like Health Care REIT's decision to sell at a favorable price some assets we view as less desirable to reinvest the proceeds in more attractive health-care properties. For the entire note, click here.
Todd Lukasik, CFA
We plan to maintain our $80 fair value estimate for narrow-moat office landlord Vornado Realty Trust VNO following solid first-quarter results. Our reckoning of adjusted EBITDA of $311 million came in near our expectations, while portfolio operating results were mixed. Strength continued in Vornado's New York City properties, which dominate its portfolio, while its Washington, D.C., portfolio continues its struggles related to the leasing challenges in the area. In New York, internal growth (as captured by the change in same-store, cash-based EBITDA) was 5.5%, driven by a slight improvement in occupancy, rent escalators on in-place leases, and an impressive 18% cash-based re-leasing spread. In Washington, D.C., however, internal growth was negative 5.5%, due mainly to pressure on rents. Vornado did achieve slightly higher occupancy in Washington, D.C., but at the cost of higher-than-normal spending on capitalized tenant improvements and leasing commissions related to filling vacancy. This may continue until a more normalized level of occupancy is reached. Given the relatively larger impact its New York portfolio has on results, we estimate overall internal growth in the quarter was near 3%, a solid result for its portfolio in the current environment and near our long-term expectation.
Todd Lukasik, CFA
Telefonica Deutschland reported solid first-quarter results, and we are likely to increase our fair value estimate slightly. There is no change to our moat rating. Revenue increased 2.9% year over year versus our full-year projection of a slight decline. The main difference was a strong quarter of handset sales that jumped 28.8%, although we don't think this level of volume growth is sustainable. The impressive part to us is that handset sales generally have low margins, but despite these strong handset sales the firm's margins held up well. Telefonica's adjusted EBITDA margin was 19.9% versus our full-year projection of 20.3%, but the first quarter historically has lower margins. The firm is doing a good job of cutting costs after the acquisition of E-Plus and is ahead of our projections. Telefonica announced it will sell 301 stores to Drillisch in the second half of the year and has reached agreements with the workers council for reducing its staff by 1600 people by 2018, with about half this year. We have already modeled significant margin expansion over the next several years as cost cutting kicks in from the acquisition, but it appears that some of that will occur sooner than we projected. The company is also doing well on the revenue side. The handset sales were helped by adding 141,000 wireless subscribers during the quarter, taking the base to 42.2 million. This was partially offset by a 10.9% revenue decline from the fixed-line business. For the entire note, click here.
Allan C. Nichols, CFA
Concho Resources CXO reported first-quarter results May 4 that came in ahead of expectations, as production increased 30% year over year to 132 thousand barrels of oil equivalent per day. Over the same period, Concho's oil production grew 38%, driven primarily by drilling activity across its 420,000 net acre position in the Delaware Basin. In the northern Delaware Basin, strong well results were reported from 42 horizontal wells with at least 30 days of production, with 30-day IP rates averaging 891 boe/d and 73% oil content. Ongoing delineation efforts to assess the potential for multizone development in the basin exhibited promising results, as three Avalon Shale wells with at least 30 days of production delivered 30-day IP rates averaging 1,586 boe/d and 77% oil content. Concho realized significant service cost savings and improved efficiencies during the first quarter, including improved drilling cycle times and lower cost per lateral foot. This, in conjunction with quarterly drilling results that exceeded expectations, has led Concho to improve its 2015 outlook through increased production guidance and lower forecast spending. Total production growth is now expected to be 18%-22%, up from previous guidance of 16%-20%. Concho believes it can achieve this growth on lower capital spending and modestly reduced its budget to $1.8 billion-$2 billion from $2 billion. For the entire note, click here.
Mark Hanson, CFA
Cimarex Energy XEC reported first-quarter results on Monday that came in ahead of expectations, as production climbed 28% year over year to 947 million cubic feet of gas equivalent per day. The company had guided to a midpoint production estimate of 930 Mmcfe/d. Growth was led primarily by Permian Basin volumes, climbing 41% from the first quarter of 2014. A higher proportion of oil volumes from Mid-Continent activity shifted Cimarex's production mix to 53% liquids compared with 52% in the same period last year. Cimarex invested about $210 million in the Permian Basin and completed 30 net wells during the first quarter. The company reported robust results from seven long-lateral Wolfcamp D wells on production in Culberson County, with 30-day peak initial production averaging 2,378 boe/d. These extended-lateral wells offer superior returns compared with previous designs. Cimarex has allocated 36% of its 2015 budget to the Wolfcamp area and will concentrate activity primarily on long-lateral wells and new spacing pilots. In the Second Bone Spring--where Cimarex completed 12 wells during the period--the utilization of an upsized frac completion design from nine to 15 stages has improved 180-day cumulative production by an average of 64%. In the Mid-Continent, Cimarex spent roughly $95 million and completed 3 net wells during the first quarter. Mid-Continent activity will mainly be focused on the Cana-Woodford area in 2015. For the entire note, click here.
Mark Hanson, CFA
We are reaffirming our CAD 37 fair value estimate and narrow economic moat and stable moat trend ratings after Fortis reported first-quarter ongoing operating earnings of $0.65 per share, compared with $0.68 in the year-ago period. Management is now focused on building organic growth opportunities, a stark change from the company's acquisitive path. We applaud this strategic shift as the company has an attractive lineup of growth opportunities supporting management's five-year, $9 billion capital plan. In the quarter, the company's Waneta hydroelectric facility entered into service and will begin contributing to earnings in the second quarter. Additional opportunities at the Tilbury and Woodfibre LNG project should support 7.5% annual rate base growth. Management plans to wrap up its strategic review of the no-moat Fortis Properties unit in the second quarter. During the first quarter, the company received some key regulatory decisions. In Fortis Alberta, the company received support for the majority of its capital programs through its capital tracker. Its allowed return on equity fell to 8.30% from 8.75% for 2013-15, but we continue to appreciate the constructive Alberta regulatory environment. Future decisions related to its cost of capital for trackers will be key to determining constructiveness. At Central Hudson, the company entered into a joint settlement agreement for proposed rates with a 9.0% allowed return on equity. For the entire note, click here.
Andrew Bischof, CFA
Ingram Micro IM reported an in-line first quarter, and management's second-quarter outlook was as anticipated. We are impressed by management's commitment to step up the corporate margin profile, but we continue to stand behind our no-moat rating. Shares are trading at a roughly 14% discount to our fair value estimate of $30 per share. Revenues increased 2.5% year over year to $10.6 billion and came in marginally higher than our expectations. On a constant-currency basis, revenue was up 10%, based on growth across the board. Asia-Pacific and Latin America, notably, saw robust demand from all countries and reported sales growth (in dollar terms) of 11% and 18%, respectively. Adjusted operating margin was flat at 1.18%, as improvements in Asia-Pacific and Latin America were offset by contracting margins in the North America and Europe segments. While the Europe segment was negatively affected by foreign-exchange headwinds, the North America segment was affected by gross-margin pressure in its mobility business, on account of higher Verizon channel sales and weak pricing dynamics for returned handsets. Adjusted EPS of $0.43 was flat year over year. During the quarter, Ingram Micro generated $37 million in free cash flow and announced that it will resume share buybacks. The company has roughly $124 million remaining under its existing $400 million authorization.