The C-Suite Speaks: Inventories Destocked?
Each week our team at Avondale Asset Management reads dozens of transcripts from earnings calls and presentations as part of our investment process. Below is a weekly post which contains some of the most important quotes about the economy and industry trends from those transcripts.
An industrial recession typically ends when excess inventories have been depleted. We are probably not there yet, but we’re getting closer. That’s a good sign for the second half of 2016, but tightening conditions in capital markets could create problems of their own.
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The Macro Outlook
Industrial companies have been in recession for four quarters now.
“We are now basically in our fourth quarter of the recession . . . I see at least one more quarter, maybe another quarter.” — Emerson chairman and CEO David Farr (Industrial Components)
Eventually they will hit bottom. The question is when.
“This too will bottom. We have lived through a bunch of these. It just our view that we’re not going to see that end in ’16.” — Eaton chairman and CEO Alexander Cutler (Diversified Industrial)
Inventory depletion typically creates a bottom for manufacturers.
Where are we in the inventory cycle? It’s difficult to say.
“Destocking has always been difficult for us to see the magnitude. . . . I would expect destocking to continue through the next quarter. And beyond that, I couldn’t comment.” — Kennametal president, CEO, and director Donald Nolan (Machine Tools)
Inventory to sales data is still high.
“The US inventory sales ratio has come down slightly but it still remains elevated, certainly indicating we got continued overhang of inventories in the economy. And customers are obviously attempting to work them down.” — UPS EVP and chief commercial officer Alan Gershenhorn (Delivery)
A lot of companies are starting to sound more optimistic though.
Microchip was one of the first companies to enter the downturn and may be one of the first out.
“We believe that our business has stabilized and that the majority of the inventory correction is behind us. . . . The December quarter marks the bottom for us for this correction.” — Microchip Technology president, chairman of the board, and CEO Steve Sanghi (Semiconductors)
LyondellBasell’s CEO noted that inventories are low and we’re approaching a seasonal uptick in demand.
“My sense is inventory is very low. . . . Coming into a March, April, May timeframe, it will bring a seasonal uptick in demand, likely inventory restocking.” — LyondellBasell chairman and CEO Bhavesh Patel (Plastics)
Emerson’s CEO said the inventory downward draft is probably over with.
“I would say what my knowledge is right now: Inventory levels within the channel including ourselves, our levels are pretty good levels, low. . . . I don’t see much of a downward draft on that now. I think it’s pretty well over with, probably very minor downward draft.” — Emerson chairman and CEO David Farr (Industrial Components)
Eaton said that everyone’s in a protective crouch these days.
“I think people have got their hatches battened down tight and they too are trying to live through a period of time when growth is less than they’d hoped it might be a couple of years ago.” — Eaton chairman and CEO Alexander Cutler (Diversified Industrial)
End markets are shaky though.
Praxair’s CFO doesn’t expect much to improve.
“When I look around at the current industrial state of the world, I don’t see many things getting better, and a few are getting a little worse. The combination of excess supply and reduced demand continues to put strain on several industrial end markets.” — Praxair SVP and CFO Matt White (Industrial Gasses)
Eaton is not counting on a sustained recovery in the latter half of the year.
“I don’t think we’re seeing anything at this point that causes us to think that markets are better than what we’re forecasting here. . . . As we put the plans together this fall, we are not counting on an economic rebound in the second half.” — Eaton Chairman and CEO Alexander Cutler (Diversified Industrial)
Sysco mentioned “deflation” 40 times on their conference call.
“We currently believe that deflation headwinds will persist for at least the remainder of the fiscal year. . . . Deflation impacts the P&L. . . . The reality is it’s not a great environment because you end up with fewer dollars to pay your expenses with.” — Sysco president and CEO William DeLaney (Food Distributor)
At best, it’s an anemic situation.
“There’s no doubt it’s a slow growth environment.” — Honeywell chairman and CEO David Cote (Conglomerate)
“We do think that we are in this frustratingly slow environment that can often cause people to use the recession word, but I think that’s almost more of a kind of an emotional issues than it is a factual basis” — Eaton chairman and CEO Alexander Cutler (Diversified Industrial)
And it’s a long year.
“There is so much time between now and the fourth quarter.” — Eaton Chairman and CEO Alexander Cutler (Diversified Industrial)
International
Consumer-focused sectors are relatively strong in China.
“Consumer-related industries are still performing well in China as we continue to see good demand for things like transportation fuels, food, health care, environmental solutions, and plastics.” — Praxair SVP and CFO Matt White (Industrial Gasses)
But consumer spending is definitely being affected.
“Domestic spending is certainly impacted in China. I was in China last week and you could see it there.” — Mastercard president and CEO Ajaypal Banga (Payment Processing)
“Our China chocolate fourth quarter net sales results were less than our expectations. . . . Category performance is being impacted by macro economic issues and the related impact it’s having on consumer-shopping behavior and confidence.” — The Hershey Company chairman, president, and CEO John Bilbrey (Chocolate)
Industrial markets are very weak.
“Industry demand for medium- and heavy-duty trucks in China decreased by 24% for the full year as the industrial economy slowed.” — Cummins chairman and CEO Thomas Linebarger (Truck Engines)
The Chinese are looking to shut down steel production equivalent to total US capacity.
“Clearly, you have a situation of excess capacity across most infrastructure supporting industries, like steel, glass, and cement . . . the premier recently here announced their goal to take out about 100 million to 150 million ton a year capacity. And just to put that in perspective, that’s like the entire capacity of the United States.” — Praxair SVP and CEO Matt White (Industrial Gasses)
The weakness in China is in secondary cities.
“Our view is that customers in lower tier cities have been more significantly impacted by the softening economy, particularly around the industrial cities, which have been more heavily affected by China’s slowing export trade.” — Yum! CFO Pat Grismer (Restaurants)
“The services and technology companies are tending to focus in the largest cities. . . . demand for retail, logistics and office space in those major cities actually being quite robust. Where there’s stress in China is in the peripheral tier-two cities and in the tier-three cities where the industrial base was focused and where you see a clear decline in activity.” — Jones Lang LaSalle president and CEO Colin Dyer (Commercial Real Estate Broker)
AGCO’s CEO had some very negative things to say about the governments of Brazil and Venezuela.
“The government in Brazil is in very bad shape. They don’t know what they are doing, they don’t have a strategy, they are corrupt, and this is damaging not only our business but business in general. . . . I think Venezuela is close to complete bankruptcy. The political system doesn’t work at all. You can’t travel there without being killed. So that’s really, really a very, very difficult market.” — AGCO chairman, president, and CEO Richenhagen (Farm Equipment)
Financials
Capital markets look increasingly tight.
Widening spreads have affected companies’ ability to issue debt.
“In total, global bond issuance declined 26%. . . . In January, we saw a continuation of that trend. . . . Where we see spreads going, there’s a lot of volatility right now. We think that also plays into it, people’s appetite for going out. It’s not really related to the base rate. It’s related to the spread.” — McGraw-Hill president and CEO Douglas Peterson (Ratings Agency)
Volatility is likely to impact M&A activity this year.
“The volatile market conditions at the start of this year could affect our 2016 performance. . . . In our M&A business, while we’re off to a good start, it’ll be several months before we know whether volatility has affected deal announcements for the year.” — Lazard chairman and CEO Ken Jacobs (Investment Bank)
There has been some slackening in demand at the top end for real estate.
“What we did see is something of a cooling in demand at the high-end, in particular, our investment sales markets, a bit more selective purchasing, buyers not chasing risk as much as they might have done earlier in the cycle.” — Jones Lang LaSalle president and CEO Colin Dyer (Commercial Real Estate)
It’s not much of a seller’s market these days.
“I think your point is spot-on. I think it’s a terrible market to be trying to sell most assets out there, particularly obviously oil-related assets. And that’s why I’ve been pretty circumspect around asset sales.” — Chevron chairman and CEO John Watson (Integrated Oil)
Sellers want higher prices than buyers are willing to pay.
“Sellers’ expectations of price have continued to kind of push upwards whilst buyers’ willingness to pay those continuing increased prices have become slightly more hesitant.” — Jones Lang LaSalle president and CEO Colin Dyer (Commercial Real Estate)
“We have seen a couple of things where the pricing was so over the moon for the outset or the location that they had to back up and ask for a different bid or lower bid. But those are properties that, in my mind, it’s like somebody says they are going to sell you a Volkswagen Bug for $80,000. You are probably not going to get a lot of bids. So there is some of that.” — Kilroy chairman, president, and CEO John Kilroy (Office REIT)
“I would tell you on the — on down — in down cycles, having been through a few, it’s really hard to get the bid and the ask to converge on the way down.” — National Oilwell Varco president, chairman, and EO Clay Williams (Oil Service)
Venture capital (VC) investors are marking down portfolio positions.
“I personally spend a lot of time . . . with the VCs, the angel investors. . . . And a lot of those folks . . . there are some people that have been burnt, where the company went from $4 billion to $10 billion, $6 billion, or whatever it might be. Feel bad for those investors.” — Kilroy chairman, president, and CEO John Kilroy (Commercial REIT)
If capital markets freeze, some early stage companies are probably not going to survive.
“Some companies will fail and deserve to fail. Let’s just be honest about this. The nature of technology is that it rapidly evolves, or even creates a revolution in it, and sometimes that obsoletes some other things.” — Kilroy chairman, president, and CEO John Kilroy (Commercial REIT)
Many poor performing retailers weren’t able to survive the fourth quarter.
“We did experience in ’15 a number of bankruptcies of kind of the really poor performing retailers. There was clearly a slowdown in retail sales in the back half of the year. And then when you couple that with the tourism issue, you couple that with the normal weather, I mean, it was, so to speak, a perfect storm, and it took a lot of retailers out.” — Simon Property Group chairman and CEO David Simon (Mall REIT)
Consumer
There are signs of continued strength in labor markets.
“We are simultaneously dealing with pickier clients and pickier candidates. Candidates are getting more counteroffers. Candidates are getting competing offers. Candidates are turning down offers that our clients give them.” — Robert Half vice chairman, president, and CFO M. Keith Waddell (Staffing)
Casual dining gets hit harder by macro pressure than quick service.
“We’ve seen this not just in China, but outside that, casual dining is impacted by macro. . . . It always has a bigger impact on casual dining when macros are volatile and changing than it does on the QSR [quick-service restaurant] business.” — Yum! CEO Greg Creed (Restaurants)
The edges of a grocery store are growing much faster than the center.
“It’s the perimeter of the store where you are seeing a tremendous amount of growth versus the center of the store. . . . And listen, whether it’s Whole Foods or other retailers, they don’t want the center of the store to die. So they are all looking for innovation and working with us on innovation there.” — Hain Celestial chairman, president, and CEO Irwin Simon (Consumer Packaged Goods)
UPS delivered in excess of 612 million packages during the holidays.
“Certainly, it was a solid peak season. We delivered more than 612 million packages over the peak period. It’s the most in the company history, up about 7%.” — UPS EVP and chief commercial officer Alan Gershenhorn (Delivery)
Peak shipping demand is so high that Amazon has had to build its own infrastructure to accommodate it.
“What we’ve found is in order to serve — properly serve our customers at peak. We’ve needed to add more of our own logistics to supplement our existing partners. That’s not meant to replace them. And those carriers are just not — no longer able to handle all of our capacity that we need at peak. They have been and continue to be great partners. And we look forward to working with them in the future. It’s just we’ve had to add some resources on our own.” — Amazon CFO Brian Olsavsky (E-Commerce)
Chipotle said it may take a year or more to recover from its food safety issues.
“When we looked at other events, other companies that have gone through something like this, the recovery typically takes four or five quarters or so.” — Chipotle CFO John Hartung (Restaurants)
Technology
Alphabet says that it has made great advances in artificial intelligence (AI).
“On AI, we are obviously seeing incredible progress in this field. We make great strides. . . . It’s always tough to predict what happens over a five-year time frame, but I do see us making significant strides. Even a year ago, I wouldn’t have predicted that we would be in a strong position to mount a serious challenge to the world champion in Go this year. Looking at the pace of progress, I think we will have AI in a form in which it benefits a lot of users in the coming years, but I still think it’s early days, and there’s a long-term investment for us.” —Google CEO Sundar Pichai (Internet)
Companies are seeking cyber-security in the cloud.
“Security is now a major driver of the cloud adoption. As threats become more frequent and sophisticated, Azure’s unique technology, like machine-learning, empower customers to adapt to these new realities.” — Microsoft CEO Satya Nadella (Technology)
Marissa Mayer is on the defensive.
“In a turnaround, you must literally turn around declining revenue and get it to grow.” — Yahoo CEO Marissa Mayer (Internet)
Health Care
Aetna said that it has “serious concerns” about the sustainability of public health insurance exchanges.
“We continue to have serious concerns about the sustainability of the public exchanges. Specifically, we remain concerned about the overall stability of the risk pool, including enforcement of standards related to special election period enrollment, where CMS has made some recent changes, but more needs to be done.” — Aetna chairman and CEO Mark Bertolini (Health Insurance)
Industrials
Investors are worried about auto sales, but production is expected to stay high.
“We understand the concern that people in the investment community have with respect to where we are in the cycle and what production schedules look like. We see none. We’ve seen absolutely no change in production schedules from when we gave guidance originally a month ago. . . . We’ve seen no change.” — Delphi Automotive president and CEO Kevin Clark (Auto Parts)
The auto industry has been known to overproduce before though and dealers usually end up suffering.
“We’ve taken steps to begin to bring our inventories in line. . . . But even after we do that, if the industry overproduces and keeps inventory at a high level, that means the overall environment is still very difficult.” — AutoNation CEO Mike Jackson (Auto Dealer)
There has also been concern about the aerospace industry, but Eaton was positive.
“A lot of discussion over the last couple of weeks about what’s happening in the commercial aerospace activity. . . . We continue to see that outlook being strong as we move into 2016 and 2017.” — Eaton chairman and CEO Alexander Cutler (Diversified Industrial)
Honeywell also pointed out that flight hours are still growing.
“If you take a look at what’s happening in the aerospace industry, the biggest thing for us is that flight hours increase. And flight hours last year were up 4% or 5%. They’re likely to be up 4% to 6% again this year.” — Honeywell CEO David Cote (Conglomerate)
PACCAR was upbeat about prospects for truck production in North America.
“2016 will be another good year for the US and Canadian Class 8 industry truck market. . . . Cancellation activity in our operations are very normal. There’s nothing unusual that is happening in that arena. And in terms of where we’re at in the cycle, I think that’s to be determined. The economic fundamentals are positive, and we see that we’re going to track what the demand is, and we think the demand is going to be a good market for 2016.” — PACCAR CEO Ronald Armstrong (Truck Manufacturer)
Materials, Energy
Companies in the oil sector are becoming more sensible.
“It has been challenging and sometimes frustrating to reach agreement with potential sellers. But as the downturn lengthens, everybody in this space is becoming a lot more realistic.” — National Oilwell Varco president, chairman, and CEO Clay Williams (Oil Service)
This environment could last for longer than anyone expected.
“We do think the current environment that we’re in will probably be protracted. . . . Until we see events stabilize and we see oil prices . . . take on a new supply/demand dynamic than is currently in the market or anticipated in the near future, we will continue to be a very cautious investor.” — Anadarko EVP Darrell Hollek (Oil Exploration and Production)
The oil industry may not recover until 2017.
“We are looking at a situation, in my opinion, in the oil and gas marketplaces, that will not recover until well past middle of ’17, maybe late ’17.” — Emerson chairman and CEO David Farr (Industrial Components)
Hedging is no longer attractive in this environment.
“At $30 and $2, just to use big round numbers, I don’t think any company has got a motivation to hedge until it’s probably a negative cost of replacement. So I’m not sure we or anybody else would find ourselves motivated to lock in prices that are lower than the marginal cost in order to develop.” — Anadarko chairman, president, and CEO R.A. Walker (Oil Exploration and Production)
Rating agencies are likely preparing to downgrade oil companies.
“The rating agencies need to do what the rating agencies need to d, and they have conservative oil price scenarios out there, and I think that’s understandable. . . . If a downgrade does occur, and I think they’ve been moving in that direction . . . we would not be the only one that that would happen to. I don’t see it materially impacting our cost of funds or materially impacting our ability to secure financing.” — Chevron vice president and CFO Patricia Yarrington (Integrated Oil)
Companies are cutting spending where they can, including dividends.
“I mean, the dividend, it is costing us about $550 million a year currently. Obviously, there are other things we could do with that cash in the current environment. . . . I certainly do not expect us to eliminate the dividend. . . . I don’t think that’s an appropriate step, but the current yield is certainly higher than we would have targeted in a much higher stock price environment.” — Anadarko CFO Bob Gwin (Oil Exploration and Production)
“We have decided to reduce our quarterly dividend by 34%. We believe this level, which represents a payout ratio of close to 100% of 2016 earnings, remains highly competitive, but also protecting the long-term financial health and financial flexibility of the company. ” — Potash president and CEO Jochen Tilk (Fertilizer)
Miscellaneous Nuggets of Wisdom
Never enter into a deal that you don’t feel like you can walk away from.
“The way we look at it is, we don’t look at any of the acquisition that [it] is a must for us. We have not preceded any of the past acquisitions we have done with the eye towards that it’s an acquisition that we must do. We have done them because we found them. We were able to get them either at a reasonable price or we’re able to build a model where it would make sense. But you’ve seen us walk away from acquisition, like we’ve walked away from CSL. We walked away from many, many other that did not come in the public domain.” — Microchip Technology chairman, president, and CEO Steve Sanghi (Semiconductors)
Full transcripts can be found at Seeking Alpha.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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