THE DOW JONES BUSINESS AND FINANCIAL WEEKLY …
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THE DOW JONES BUSINESS AND FINANCIAL WEEKLY
JANUARY 18, 2019
ROUNDTABLE
¡°Cadence
Design
Systems and
Synopsys are
positioned to
grow and add
more tools
over
time, and
¡°Cadence
have
an
Design
incredibly
Systems and
wide
moat.are
¡±
Synopsys
Todd
Ahlsten
positioned
to
Disney and 4 Other Stock Picks
From a Parnassus Fund Manager
Barron¡¯s recently held its 2019 Roundtable, a gathering of 10 of Wall Street¡¯s smartest investors. Here
are the stock picks of Todd Ahlsten, lead portfolio
manager of Parnassus Core Equity Fund at Parnassus Investments in San Francisco.
Barron¡¯s: Welcome aboard, Todd. Are you
warmed up?
Todd Ahlsten: I¡¯m warmed up. By way of introduction, I have been at Parnassus for 24 years.
My Parnassus Core Equity fund [ticker: PRBLX]
co-manager Ben Allen and I look for wide-moat
businesses that are durable, have pricing power,
and can prosper under a wide range of economic
circumstances. We also want companies that have
increasing importance to the economy and can
solve complex problems, which adds to their value.
We want seasoned management teams with skin
in the game, and companies with good corporate
governance, and we want to buy them when their
stocks are undervalued. Finally, we are ESG investors [focused on environmental, social, and
governance issues]. We seek outstanding corporate
citizens that favor diversity in management, are
good stewards of the environment, and are attractive places to work.
I grew up in the business covering the semiconductor industry, and my first two picks are in electronic design automation, or EDA. These companies
sell the tools to help design semiconductor systems.
Cadence Design Systems [CDNS] has a $12 billion
market cap, and Synopsys [SNPS] has a $13 billion
market cap. What we love about the industry is that,
over time, design is only going to get more complex.
Not only do these companies have a core set of customers growing revenue by the mid-single-digits,
but they are acquiring new customers. EDA tools
account for about 10% of semiconductor R&D spending. Cadence and Synopsys are positioned to grow
and add more tools over time, and have an incredibly
wide moat. Chip design is getting harder and more
complex, and only a few companies can provide EDA
tools. In addition, both companies are run by good
executives. Lip-Bu Tan has headed Cadence since
2009. He has integrity and empathy, and employee
retention is high. Aart de Geus was a founder of
Synopsys.
What are your expectations for the stocks?
Ahlsten: We see Cadence revenue growing by
roughly 8% a year, and the bottom line, by at least
10% a year. Operating profit margins exceed 29%
and can move up to into the 30s. Our timeline for
an investment initially is three years. Cadence is
currently in the low $40s and our three-year price
target is $61, based on a multiple of 25 times our
$2.44 earnings per share estimate for 2021. Synopsys trades at a slightly lower multiple of roughly 22
times earnings. Again, we see high-single-digit topline growth, and operating margins that are rising
from 22% this year to 26% in the fiscal year ending
in October 2021. In the next three years, the stock,
now in the mid-$80s, could trade up to $125, or 22
times estimated earnings of $5.60. Both Cadence and
Synopsys have almost no debt.
Cadence is strong in the analog and customizing
markets, whereas Synopsys is strong in the digital
intellectual property design market. Both are putting
their tools in the cloud, and increasing their number
of customers. Research and development in this industry almost never faces significant cuts. If you don¡¯t
design next-generation products, you die. To walk
down memory lane, the industry has consolidated in
the past 25 years, down to only three large players¡ª
the third is a unit of Siemens [SIE.Germany]. The
survivors are making semiconductors and systems
more energy-efficient, so there¡¯s a nice ESG story
here, too. Some of us talked at lunch about how capital
spending at Facebook [FB], Microsoft [MSFT], and
Google [part of Alphabet ; GOOGL] is going through
the roof. These EDA companies give them more efficiency in semiconductor use.
grow and add
more tools
over time, and
have an
incredibly
wide moat.¡±
Todd Ahlsten
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Scott Black: If quantum computing takes
off, will these companies have the design
capacity necessary?
Ahlsten: That is a good question, but it is
outside our investment time horizon.
Next, we talked this morning about our
economic outlook. We see 1.5%-2% economic growth this year, and a wider range
of outcomes for earnings due to tariffs
and a slowing economy, but we still expect high-quality companies to compound
wealth. Cerner [CERN], a supplier of
health-care information technology, is our
third pick. It facilitates electronic medical
record-keeping [EMR]. The passage of
Obamacare was a major growth opportunity for the company, as it mandated a lot
of electronic record-keeping. The stock
went from roughly $20 to $75 from 2010 to
2015. We see continued opportunities for
the company to grow. We expect Cerner to
grow revenue by 7%-8% a year in the next
three years, and earnings by 11% annually.
Profit margins could grow by 30 to 45 basis
points [a basis point is 1/100th of a percentage point] a year. In the past several years,
operating margins have expanded to 24%
from 19%.
Cerner has front-loaded spending on
a large Veterans Administration contract,
which has depressed margins. So far, it
hasn¡¯t recognized revenue on it, but will
do so over the next 10 years. EMR is
becoming more important to patient outcomes, and we see partnerships with big
data-solutions providers like
[AMZN] and Google. Those companies are
great at crunching data, but Cerner owns
that last mile. The industry is a duopoly;
Epic [EPOR] is the other player. We like
that structure. Cerner is a $17 billion-market-cap opportunity to invest in health-care
IT. The balance sheet is pristine, with $300
million of net cash.
William Priest: The company has fairly
new CEO. He has been absent and hasn¡¯t
given any guidance to speak of.
Ahlsten: We had lunch with Brent Schafer,
the new CEO. We found him thoughtful.
Unlike a lot of new CEOs who make a major proclamation in their first 100 days, he
is taking time to understand the company
and talk to the sales force. Going into next
year, we¡¯ll get a lot more clarity on the
VA contract. EMR is a sticky business.
Whether GDP grows by 1% or 3% this
year, we estimate that Cerner can grow
the top line by 7% and expand profit margins. The company owns a lot of real estate
in Kansas City, Mo., and there is room to
rationalize costs. Cerner is a charitable
company and a good place to work, and has
a good reputation in Kansas City, which we
call the Silicon Prairie.
My fourth name is the old Praxair, now
known as Linde [LIN]. The company has
a fantastic global franchise. We like the
oligopoly structure of the industrial gas
industry. Industrial gases address climate
change because they reduce manufacturing
emissions in a lot of industries, including
metals production, mining, and energy.
Linde also has a unit that produces films
for solar panels. It fits our ESG mandate in
several ways. Praxair merged with Linde
in October 2018. The combined company
has roughly $30 billion of revenue, and operating margins of around 27.5%. We see
margins heading to 32.5% in the next three
to four years. The merger could realize
more than $1 billion of synergies. The stock
is trading for $156. We expect it to trade
for 11 times 2022 estimated enterprise
value to Ebitda [earnings before interest,
taxes, depreciation, and amortization], to
yield a price target around $202. The dividend yield is 2%. A recession would be a
risk to the markets that Linde serves, but
we don¡¯t see a recession around the corner.
In any case, the business is supersticky
and holds up well even when the economy
turns down. Linde has pricing power, due
to long-term take-or-pay contracts.
Priest: I would echo almost everything
Todd has said. Chemicals and energy are
19% of revenue, manufacturing is 18%,
health care is 17%, metals and glass are
13%, food and beverage is 7%, electronics
is 7%, and other is 19%. The CEO is outstanding.
Ahlsten: I also like Walt Disney [DIS].
Scott did a fantastic job of walking through
the thesis. The company has the best entertainment content in the world. It is undervalued, partly due to concerns about
subscriber losses at ESPN and the market disruption caused by Netflix [NFLX].
Without these issues, you don¡¯t buy a great
business at 15 times earnings. We think
Disney could earn $8 a share in 2022 and
fetch a price/earnings multiple north of 20,
which would put the stock at $160 a share.
By then, CEO Robert Iger¡¯s investments
in streaming media will bear fruit, and the
moat will widen. Disney is also a good and
charitable corporate citizen.
Nicely done. Thank you, Todd.
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