4th Quarter, 2018

The revenue and earnings growth of 17% and over 21% achieved by your companies during the fourth quarter of last year were exceptionally good. The comparable figures for the S&P companies were 7.3% and 13%. Although this impressive growth benefits from changes in the US tax code, it also was increased by sizeable revenue and profit growth obtained by your companies’ managers. They successfully drove decision-making down through their organizations to enable managers in direct contact with customers to exercise greater discretion when responding to expressed customer concerns. When this encouragement of initiative works, it helps build customer loyalty, revenue and profits.

The prices of our stocks are, as always, influenced by economic and geopolitical forces which currently are more changeable than the norm. That’s in part due to our president’s confrontational manner but also reflects political changes in the leadership of the governments of our allies and adversaries throughout the world. An important unknowable is the outcome of trade negotiations between the US and China which could become more manageable with a provisional agreement incorporating terms for considering modifications of tariffs or quotas based on the differences in experience versus expectations. Resolution of intellectual property issues always is a more complex and difficult issue than other trade issues and often takes longer to resolve than the time it takes for engineers to take the technology on to its next iteration.


Mettler-Toledo’s fourth quarter revenue of $817 million grew 8% in local currencies over the fourth quarter of 2017. 2018 revenue rose 6% to $2.93 billion. Foreign currency translation reduced revenue growth in US dollars by three percentage points during the quarter and added two percentage points to revenue growth for the year. Fourth quarter revenue for the Laboratory and Industrial businesses grew 7% and 10%, respectively, with all geographies contributing to this growth. Revenue in China rose 12%, the ninth consecutive quarter of double-digit revenue growth. Sales of laboratory instruments and core industrial products, primarily scales for production lines, to pharma, chemical and food companies now account for about two-thirds of sales in China. The global shift in focus to these industries away from discrete manufacturing, such as materials, plastics and electronic components, gives CEO Olivier Filliol confidence that Mettler-Toledo will have good growth in 2019 even if the global economy slows.

Mettler’s pricing and productivity initiatives along with good control of SG&A expense contributed to fourth quarter earnings per share growth of 15% to $6.85. The company achieved this earnings growth with a $4 million, or 15%, increase in R&D expense and a five-percentage point headwind from unfavorable foreign exchange rates and tariffs. Earnings per share for the year was $20.32, an increase of 16%. Mettler-Toledo’s stock price has risen 24% since the beginning of the year.


Visa’s fiscal first quarter revenue of $5.5 billion and earnings of $1.30 per share rose 13% and 21%, respectively, over the same period a year ago. Global payments volume of $2.2 trillion increased 11% in constant dollars. Payments volume of $109 billion in Central Europe, the Middle East and Africa and $108 billion in Latin America rose 17% and 22%, respectively. Payments volume of $980 billion in the U.S. and $434 billion in Western Europe rose 11% and 9%, respectively. Cross-border volume, which drives 27% of Visa’s gross revenue, increased 7%, a step down from the 10% growth achieved in the fiscal fourth quarter. The decline in the cross-border growth rate was caused in part by economic weakness in the EU, which slowed the growth of intra-Europe transactions, and by the strengthening of the U.S. dollar relative to other currencies. The stronger dollar reduced commerce from Canada, Latin America, China, Australia and Europe into the U.S. During the U.S. holiday shopping season, e-commerce spending grew 16.5%, three times faster than in-person shopping, and rose to one third of total retail spending. Visa’s 43% share of e-commerce payment processing is more than twice its share of in-person payment processing. In 2018, economic growth and the continued electronification of payments helped Visa’s U.S. payments volume across credit, debit and prepaid cards rise 11% to $3.7 trillion, or 60.1% of all U.S. card spending. Its share of U.S. credit card processing rose for the eighth consecutive year to 53.2%. Visa’s total return since January 1 is 17%.


On March 7, Costco reported operating results for its fiscal second quarter, a 12-week period ending February 17, 2019.  Revenue of $35.4 billion and earnings per share of $2.01 rose 7.3% and 26.4%, respectively, over the comparable period a year ago. Earnings grew faster than sales because lower gas prices and stable costs of Costco’s core items including grocery, apparel, electronics and appliances helped increase Costco’s gross margin by 30 basis points, or 0.30%, to 11.29%. A basis point of gross margin improvement translated to an additional $3.5 million of operating income in the quarter. A 4.9% rise in member visits and 1.8% increase in average member spending per visit increased sales at Costco warehouses open more than a year by 6.7% globally. In the U.S., where Costco operates 535 of its 770 warehouses, same store sales rose 7.2%. Satisfied Costco members renewed at a rate of 90.7% in the U.S. and 88.3% worldwide, increases of 0.6 and 1.0 percentage points over a year ago, driving a 7.3% increase in membership fee income to $768 million. In the first 24 weeks of fiscal 2019, Costco’s revenue of $70.5 billion rose 8.7% and earnings per share of $3.74 increased 23.0%.

Sales of Costco’s Kirkland Signature brand products account for 28% of total sales and rose to over $39 billion in fiscal 2018 from $35 billion in the prior year. Kirkland Signature revenue alone exceeds the global revenues of Coca-Cola, Macy’s, Starbucks and McDonald’s. These high-quality private label products, which range from gas, clothing, grocery, and household and pet supplies to mattresses and even a 72 lb. wheel of Parmigiano Reggiano for $899.99, are often manufactured by the national brands, such as Starbucks-roasted Kirkland coffee beans. Operating efficiencies, such as minimal marketing expense and manufacturers’ volume discounts, enable Costco to sell Kirkland Signature products at least 20% below the price of equivalent branded products. The total return on Costco shares is 16% since January 1.

Automatic Data Processing

ADP’s strong fiscal second quarter and increased earnings forecast for the year propelled its stock 18% higher since January 1.  Revenue of $3.5 billion and adjusted earnings of $1.34 per share rose 8% and 30%, respectively, from the same period a year ago.  ADP continues to streamline its operations while enhancing the client experience.  The good execution of these initiatives can be seen in ADP’s higher operating margins and the increase in client satisfaction scores to record levels.  ADP continues to invest to provide its customers with better information and analytics via the ADP DataCloud.  It empowers front-line managers and key decision makers by enabling them to benchmark their workforce against ADP’s broader client base which contains aggregated and anonymized information on 30 million US workers.  To further strengthen the services provided to accountants, ADP announced expanded integration with Intuit Quickbooks to give CPAs the ability to see their clients’ payroll reports and tax forms in one place which facilitates tax filing and reporting.

ADP’s PEO service revenues rose 15% with the number of employees paid up 9% from the prior year to 545,000.  During the quarter, new business bookings increased 1% while the number of employees on existing client payrolls increased 2.3%.  ADP’s interest earned on funds held for clients increased 21% to $129 million as the average balance increased 5% to $23.6 billion and the average interest yield increased 30 basis points from a year ago to 2.2%.


CME delivered another quarter of excellent results to cap an extraordinary year which led to a total return of 32% on the stock during 2018.  Revenues of $1.2 billion and $4.3 billion rose 37% and 18% for the fourth quarter and full year, respectively, while adjusted earnings of $1.77 and $6.82 per share rose 58% and 43%, respectively.  These strong results come from volume growth and cost control.  For the full year 2018 average daily volume was up 18%.  During the past two years CME’s revenue has grown by $580 million while adjusted expenses increased by only $55 million, resulting in over 90¢ of every incremental dollar of revenue falling to operating profit.  The NEX Group acquisition closed in early November and added $134 million to fourth quarter and full year revenue.  CME will migrate NEX Group’s BrokerTec and EBS trading platforms to CME’s Globex trading platform beginning in 2020 and 2021, respectively.  BrokerTec and EBS are industry leading platforms for cash trading of fixed income securities and foreign exchange among dealers.

During the fourth quarter 2018 CME’s average daily volume (ADV) was 20.8 million future and option contracts, up 31% from a year ago and representing the second highest quarterly ADV ever.  Global growth was strong with growth in ADV from Asia up 45% and Europe up 16%.  Equity index and interest rate futures and options drove total volume growth increases of 71% and 37%, respectively.  During the first two months of 2019, volumes declined 6% and 30% in January and February, respectively. It is not unusual to see a pause in volume growth after an exceptional quarter with elevated volatility.  CME’s total return is minus 9% since January 1.  CME continues to invest in its core business by developing new products and services to address customer needs.  CME Secured Overnight Financing Rate (SOFR) futures launched in May.  SOFR, an alternative to Libor (the London interbank offered rate) is based on transactions in the Treasury repurchase market where investors and banks borrow or loan Treasuries overnight.  Since launch, SOFR futures have traded 1.6 million contracts representing $3 trillion notional value.  Global participation has reached 105 firms including banks, buyside firms and proprietary trading firms.


Google’s advertising business continues to drive rapid growth at Alphabet. Revenue from ads delivered on mobile Google searches, YouTube and desktop Google searches contributed most to Google’s fourth quarter advertising revenue growth of 20%. Alphabet’s earnings of $12.77 per share increased 31% and total revenue rose 22% to $39.3 billion, of which ad revenue comprised 83%. In 2018, advertising revenue of $116.3 billion grew 22%, two percentage points faster than ad revenue growth in 2017 and propelled Alphabet’s total annual revenue to $136.8 billion and earnings per share to $43.70, increases of 23% and 22%, respectively. These strong results derive from management’s continued investment in Alphabet’s core advertising business, including new ad tools for advertisers. YouTube’s direct response video ad offering, TrueView for Action, is YouTube’s first video ad format specifically designed to drive viewers to advertisers’ websites. Launched in March 2018, TrueView for Action enables advertisers to create video ads with a customizable 15-character “call-to-action” banner that invites the viewer to navigate to the advertiser’s site. TrueView for Action also gives advertisers the ability to measure their conversion rate, the rate at which viewers visit the advertiser’s site, and take an action such as signing up for a service or buying a product. Advertisers have primarily used YouTube to increase brand awareness, however Google’s investments in machine learning and ad targeting have made sales and lead generation through YouTube more effective and less costly for advertisers. Since TrueView for Action’s launch, over 30% of the advertisers who have used it were first-time video ad buyers. Alphabet shares have risen 14% since January 1.

Ecolab, Inc.

Ecolab’s fourth quarter sales of $3.7 billion rose 6% in constant currency over the same period a year ago with price increases and volume growth each contributing three percentage points to the growth. Unfavorable foreign currency translation reduced growth in US. dollars to 3%. Gross margin declined 0.9 percentage points to 41.2% as growth in raw material costs outpaced good price realization and improved manufacturing productivity. Higher sales volume and cost-savings programs more than offset investments in the business which led to a 1.2 percentage point decline in SG&A expense for the quarter. Operating income rose 7% to $630 million while the operating margin expanded 0.2 percentage points to 16.0%. Earnings per share of $1.54 were 12% higher than earnings per share of $1.38 reported a year ago. Full-year revenue of $14.9 billion and earnings per share of $5.25 rose 6% and 12%, respectively, over 2017. All results exclude the impact of foreign currency translation, acquisitions and divestitures, special items and discrete tax effects.

On February 5, 2019, Ecolab announced that it was spinning off its WellChem and Oilfield Chemicals businesses into a new publicly-traded company. As ExxonMobil and Chevron increase their investment in unconventional oilfields in the U.S. (mainly in the Permian basin), the Upstream business has changed from one where Ecolab provided technical service and bespoke chemistry to smaller exploration & production companies who benefitted from the company’s technical knowledge to solely providing chemicals specified by technical specialists at the supermajors. As the Upstream business becomes more of a specialty chemical business, it becomes less like the businesses that Ecolab runs. In addition, large chemical companies and chemical distributors are entering the business. The Upstream business had revenue of $2.4 billion and operating income of $170 million in 2018. The Downstream business is a better fit with Ecolab’s current businesses. About half of its product sales use the company’s water technologies, and it remains a service business with high recurring revenue. The cyclical nature of the business also aligns it with Ecolab’s other industrial businesses. Ecolab expects the spin-off to be completed by the middle of 2020. The Energy business is fully integrated into Ecolab’s global financial reporting and supply chain systems. It will take time to separate the Upstream business from both systems and create the systems and infrastructure for the business to operate as a public company. The total return on Ecolab’s stock is 18%.


On February 25, 2019, Wabtec announced the completion of its merger with GE Transportation and reported fourth quarter and full year results. Fourth quarter and full year 2018 revenues of $1.1 billion and $4.4 billion rose 4% and 12%, respectively, from the prior year. Adjusted earnings, which exclude expenses for the GE Transportation merger, restructuring, litigation and pension settlements, and the effects of tax law changes in India, were 97¢ and $3.81 per share, lifting earnings 8% and 11%, respectively, above 2017’s results. Significantly, Wabtec’s cash flow from operations, which was a disappointing $70 million during the third quarter, rose to $277 million during the fourth quarter and was significantly higher than management’s initial forecast of $150 million. The combined operations of Wabtec and GE Transportation are projected to exceed $9 billion in revenue in 2019 with cash flow from operations reaching $710 to $740 million, although the contribution from GE Transportation is only for ten months.

The merger combines Wabtec’s Positive Train Control with GE’s rail network optimization services to provide customers the ability to move to Precision Scheduled Railroading and increasingly automated operations. GE Transportation, the leading manufacturer of diesel locomotives, brings Wabtec a $19 billion backlog of orders which includes orders for 1,000 new locomotives and $13 billion of service and aftermarket overhaul/modernization contracts on its installed customer base of 17,000 locomotives. This highly profitable aftermarket service revenue comprised 65% of GE Transportation’s 2018 revenues of $3.9 billion. Its 2018 locomotive deliveries were only 272. The acquisition results in GE shareholders owning 24.3% of Wabtec which they can and are selling while GE will own common stock and convertible preferred stock which together amount to a 24.9% interest in Wabtec. GE and its shareholders received 49.2% of shares in Wabtec.  The agreement requires GE to have sold all of its Wabtec shares by February 25, 2022. An initial sale of at least 10 million shares must occur before mid-August. Wabtec’s stock price has risen 2% since January.

IDEXX Laboratories

IDEXX Laboratories’ fourth quarter revenue of $547 million rose 10% in constant currency over the same period a year ago. Revenue for the full year rose 12% to $2.21 billion. Companion Animal Group recurring diagnostic revenue, which includes instrument consumables, reference lab services and rapid assay tests, grew 13% in both periods to $402 million and $1.65 billion, respectively. It accounted for 75% of IDEXX’s revenue during both periods with 55% from in-clinic offerings and 45% from the reference labs. IDEXX invested $118 million in research and development last year to develop new diagnostic tests and software to run the in-clinic instruments and new cloud-based services to help vet clinics to manage their practices. This steady stream of innovation increases the value of the instruments over time. It contributes to IDEXX’s very high retention rates, 21% global growth in premium instrument placements in 2018 and 19% annual growth in instrument consumables. Earnings per share for the quarter and the year of 98¢ and $4.26 rose 40% and 36%, respectively.

The company’s newest in-clinic tests, SDMA (early-stage kidney disease) and SediVue Dx urine sediment analyses each contributed two percentage points to revenue growth during the quarter. Over 58% of vets in the U.S. use SDMA regularly in their clinics and about 64% of the clinics worldwide that have a Catalyst chemistry analyzer have purchased the test. This strong adoption has led to over 1 million SDMA tests run in-clinic since its launch last year in addition to 19 million tests run in reference labs since 2015. IDEXX tracks test usage with its VetLab Station, a proprietary system that connects all the in-clinic instruments and a clinic’s practice management software system to IDEXX. Vets use it to order in-clinic and reference lab tests. IDEXX’s Smart Service software tracks test usage to ensure that the clinic captures the charges. Smart Service provides software updates through the cloud and helps clinics manage their consumables inventories. It also tracks SediVue tests which vets purchase by the run. IDEXX has continued to improve SediVue’s performance by using machine learning to improve the algorithm that identifies bacteria, blood cells and other components of medical interest in the urine sample. Neural Network 1.0 used a database of 450,000 images to create this algorithm. Later this month, IDEXX will launch Neural Network 4.0 which uses a database of 175 million images generated from 2.5 million samples. The update also includes two new parameters that assess liver function and blood disease in sick pets. All 6,000 SediVue owners worldwide will benefit from the improvements in this software release. IDEXX Laboratories’ stock price has risen 16% since the beginning of the year.

Varian Medical Systems

Varian Medical Systems’ fiscal first quarter revenue grew 9% over a year ago to $741 million. Earnings per share of $1.06 were unchanged from last year but include a 10¢ per share impact from the China – U.S. tariffs. On December 24, 2018, Varian received notice that its Halcyon radiation therapy systems, which are manufactured in China, will be exempt from U.S. tariffs. While the impact of this exemption on the company’s net income is small, Varian hopes that the Chinese government will reciprocate by removing tariffs from TrueBeam systems sold in China. This action would increase fiscal year 2019 revenue by $48 million. Oncology Systems revenue of $702 million rose 8% over the fiscal first quarter of 2018 with systems, software and service contributing to the growth. Recurring revenue from software and services now accounts for about 55% of revenue. Orders for the quarter were up 16% over the same period a year ago and trailing twelve-month orders are up 11%. This strong growth outpaced market growth for radiation system orders which Varian estimates grew at 9% over the same time period.

Varian received approval to sell Halcyon systems in China on November 28, 2018. The company launched Halcyon and showcased its cancer treatment portfolio at its China Users Meeting in January 2019. 1,300 radiation oncology professionals attended the meeting and 8,800 clinicians participated via webcast. China is Varian’s second largest market after the U.S and is driven by government investment in cancer treatment. In October, the Chinese government announced a quota of 188 Category A licenses for radiation systems that cost more than $3.5 million, such as Varian’s EDGE radiosurgery system, and 1,208 Category B licenses which includes the company’s TrueBeam and Halcyon systems. The additional licenses will help Varian increase its presence in China because it has been winning over 50% of government tenders. The need for these systems is great. Approximately 4.5 million new cancer cases are diagnosed in China each year, compared to 1.7 million in the U.S. Fewer than 25% of cancer patients in China receive radiation therapy compared to 50% to 60% in the U.S. or Western Europe. Varian Medical Systems’ stock price is up 19% since January 1.

Johnson & Johnson

Johnson & Johnson’s fourth quarter revenue of $20.4 billion rose 3.3% in constant currency over the same period a year ago. Full-year revenue grew 6.3% to $81.6 billion. Acquisitions and divestitures lifted revenue for the quarter and the year by 2.0 and 1.2 percentage points, respectively. Adjusted earnings per share for the quarter and for the year of $1.97 and $8.18 rose 16.1% and 10.4% in constant currency. These results exclude purchased intangible assets and non-recurring items in both periods. 2018 Pharmaceutical sales of $40.7 billion rose 11.8%, with sales of Actelion’s drugs contributing 3.4 percentage points to sales growth. 2018 Medical Device sales rose 1.1% to $27.0 billion. The sale of LifeScan, J&J’s glucose measurement business, reduced sales by 1.4 percentage points. Excluding acquisitions and divestitures, 2018 sales rose 2.6%. Orthopaedics’ full-year revenue of $8.9 billion declined 2.5% over 2017. Sales growth in its hips and trauma businesses were offset by declines in the knee and spine businesses. J&J’s global effort to improve the commercial effectiveness of these businesses is working. Orthopaedics’ revenue grew 0.5% in the fourth quarter. Revenue for Knees rose 0.2% and Spine sales, which include a 4.5% drop in price, fell only 1%. Spine sales were down 5% for the year.

The Consumer business posted 2018 revenue of $13.8 billion, an increase of 3.2% excluding the impact of acquisitions and divestitures. Sales of Beauty and OTC products grew 4.4% each and accounted for 61% of sales. Oral care sales of $1.56 billion rose 1.5% for the year and 4.4% during the fourth quarter driven by the performance of products like LISTERINE READY! TABS, quick dissolving, chewable tablets, which use a technology developed by the pharma business. The product creates a new occasion for the use of mouthwash – on-the-go. You chew the pill, swish the liquid in your mouth for 30 seconds and swallow it. J&J launched the product in the U.S., U.K. and Canada with extensive sampling in 2018. It was the number one new release on Amazon during the fourth quarter of 2018.

On December 14, 2018 Reuters published an article claiming that J&J knew that the talc used in its baby powder contained asbestos and failed to inform consumers and medical authorities. The company’s stock price fell 10% that day. The article selectively quoted documents that had already been submitted as part of the discovery process for the existing talc litigation cases, all of which J&J has either won in jury trials or on appeal. J&J issued a detailed rebuttal to the article on December 17th and posted thousands of original documents on its web site. The company resumed production of cosmetic talc in its two plants in India last week after government-sanctioned testing found no asbestos in the product. Regulatory authorities in Singapore, Thailand, Saudi Arabia, Jordan, Kuwait and Egypt have also confirmed its purity. The total return on Johnson & Johnson’s stock is 7% since the beginning of the year.

Air Lease Corporation

Air Lease’s fourth quarter and full year 2018 revenues of $450 million and $1.7 billion rose 13% and 11%, respectively, from the prior year.  Adjusted earnings per share of $1.65 and $6.20 for the same periods increased 3% and 4%, respectively, as the company sold fewer aircraft in 2018, realizing less gain.  During the year, Air Lease sold 15 aircraft realizing gains of $28.5 million while it sold 31 aircraft in 2017, realizing $38.5 million in gains.  The company ended the year with 275 owned and 61 managed aircraft, increases of 13% and 22%, respectively.  The average age of its owned fleet is 3.8 years and the average remaining lease term is 6.8 years, unchanged from a year ago.  Air Lease mitigates airline customer risk through geographic diversification and by managing customer concentration.  At year end, Air Lease counted 94 airlines as customers in 56 countries.  European customers represent 29.9% of aircraft value, Asia (excluding China) 24.5%, China 17% (down from 20.5% a year ago), the Middle East and Africa 12.4%, the Americas 11.7%, and Pacific, Australia and New Zealand 4.5%.  Of the 372 aircraft on order with Boeing and Airbus through 2024, all 78 scheduled for delivery in 2019 are placed with airlines and 69 of the 83 aircraft scheduled for delivery in 2020 are placed.  These committed forward lease placements provide significant visibility and incorporate interest rate adjusters to protect Air Lease in the event that interest rates rise between placement and delivery.  Air Lease’s total return is 12% since the beginning of the year.

Red Hat

On January 16, 2019, Red Hat’s shareholders approved the $34 billion merger with IBM. At IBM’s Think 2019 conference held from February 12 – 15, an equity analyst noted that Red Hat’s executives and employees who were at the meeting were enthusiastic about the deal and appeared committed to stay after the deal closes later this year. Red Hat’s stock price is up 4% since the beginning of the year. We expect the deal to close during the second half of the year and encourage you to consider using your Red Hat shares to make charitable gifts before June 30, 2019.

Red Hat reported its fiscal third quarter 2019 results on December 17, 2018. Revenue of $847 million grew 13% over the same period a year ago with 8% growth in subscription revenue from Red Hat Enterprise Linux (RHEL) and 28% growth in subscription revenue for Application development and emerging technologies to $534 million and $207 million, respectively. On-demand RHEL use in the cloud rose 25% year-over-year to an annual run rate of $300 million. Red Hat closed more than 100 deals over $1 million during the quarter and renewed its top 25 deals with increases of more than 20%. The sales force’s success in winning new business lifted the backlog 22% to $3.5 billion.

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Capital Counsel’s investment strategy combines disciplined fundamental analysis with patient execution. We hope this letter helps you understand that stock selection is at the core of our investment strategy. We seek to invest in profitable well-managed companies that generate recurring free cash flow. These companies should possess strong balance sheets and earn attractive rates of return on shareholders’ capital. We know the companies and their proven execution focused managers well. They deal with problems openly and effectively, and have incentives aligned with shareholders. We evaluate the company, as an informed private buyer might, to determine the value of the business based upon its ability to generate free cash flow. We manage concentrated portfolios which have provided our clients with good long-term results. The financial strength of the companies held in client portfolios has lessened the drop experienced when markets decline.

Client portfolio holdings may change, and stocks of companies noted may or may not be held by one or more client portfolios from time to time. Investors should not consider references to individual securities as an endorsement or recommendation to purchase or sell such securities. Transactions in such securities may be made which seemingly contradict the references to them for a variety of reasons, including but not limited to, liquidity to meet redemptions or overall client portfolio rebalancing. Investing in the stock market involves gains and losses and may not be suitable for all investors. Investment return and principal value of an investment will fluctuate.