Practical analysis for investment professionals
22 March 2016

The C-Suite Speaks: Hotel California

The C-Suite Speaks: Hotel California

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 as well as other forums.


The US Federal Reserve decided not to raise rates last week even though unemployment and inflation both appear to be at stable levels and downside risks seem to have diminished in recent weeks. If the Fed doesn’t feel comfortable raising rates above 0.25% in the current conditions, will we ever leave this low rate environment?

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The Macro Outlook

The Fed is data dependent.

“The committee makes its decisions on a meeting-by-meeting basis and does not and need not decide on a likely future path for the federal funds rate.” — Fed chair Janet Yellen (Central Bank)

The Fed believes that the economy is near full employment.

“Given that the economy is now close to our maximum employment objective . . .” — Fed chair Janet Yellen (Central Bank)

The Fed still anticipates inflation increasing.

“The committee continues to feel that we are on a course where the economy is improving and inflation is moving back up.” — Fed chair Janet Yellen (Central Bank)

Risks to the outlook have also decreased in the past several weeks.

“Let me say that, in recent weeks, I think the committee certainly thinks that risks to the outlook have diminished.” — Fed chair Janet Yellen (Central Bank)

But the Fed opted to maintain an accommodative policy stance anyway.

“Our decision to keep this accommodative policy stance reflects both our assessment of the economic outlook and the risks associated with that outlook.” — Fed chair Janet Yellen (Central Bank)

“Welcome to the Hotel California.”

“We believe that when the Fed started quantitative easing, it entered Hotel California. As the classic Eagles song concludes, ‘You can check out any time you like, but you can never leave.'” — Alleghany (Y) president and CEO Weston Hicks, CFA (Insurance)

The economy does appear to be in decent shape.

“The economy I think in general is doing fairly well. . . . I think in general consumers are feeling okay. And I think . . . that’s contributing to our business certainly. The weather also being positive over the last six months around the country probably has helped consumer psyche and our business also.” — McDonald’s (MCD) EVP and CFO Kevin Ozan (Fast Food)

Consumer spending hasn’t improved that much, but it hasn’t deteriorated either.

“We do the thing called spending pulse, which is a method of getting from our card spend . . . It’s not better, it’s not dramatically worse . . . it’s kind of similar. It’s moving along, bouncing along there.” — MasterCard (MA) president and CEO Ajay Banga (Payments)

CLARCOR’s sales into agricultural markets were less negative than expected.

“Better than expected financial performance was assisted by higher than expected sales of fuel filtration products into the ag and construction equipment markets. Although sales in these markets declined 17% from last year’s first quarter, we . . . had expected sales to drop 25% to 30%.” — CLARCOR (CLC) VP and CFO David Fallon (Industrial Components)

FactSet didn’t see financial service companies pull back on spending.

“Market volatility gets people thinking and pausing a little bit, but we haven’t seen a dramatic shift in the spending.” — FactSet Research Systems (FDS) EVP Scott Miller (Financial Database)

Remember though that February data was helped by mild weather and the leap year.

“I note that February sales performance benefited from a favorable comparison. . . . February 2015 was impacted by the full or partial closure of 60 branches and distribution centers across the country. . . . For February 2015, the estimated weather represented an approximately 200 basis points sales growth headwind. This headwind did not repeat in 2016.” — HD Supply (HDS) VP and CFO Evan Levitt (Industrial Distributor)

“February was a decent month but [you have to] discount the leap year one day, because one day is 2%–3% of sales, so you take that down.” — MasterCard (MA) president and CEO Ajay Banga (Payments)

International

Fred Smith says that free trade is a great thing.

“The thought that trade has not been a great thing for the world and America is absolutely belied by facts. . . . To lump in all trade with the trade practices of a couple of trading partners is like putting leaches on you and bleeding the way they used to do during the old days. . . . The benefits of trade are always dispersed . . . which makes everyone’s standard of living better whereas the pain is always localized.” — FedEx (FDX) chairman, president, and CEO Fred Smith (Logistics)

China may have a hard time moving to a consumer-driven economy.

“China’s demographic profile, massive debt overhang, and underdeveloped social safety net will make the transition to a consumer-driven, services-intensive economy difficult.” — Alleghany (Y) president and CEO Weston Hicks, CFA (Insurance)

The fast food industry has gotten more competitive in China.

“Yes, it has gotten more competitive. And again, I think a lot of it is the local Chinese QSRs [quick-service restaurants]. You have a lot of street vendors there that are competitors. There is a lot of choices there and a lot of low-cost food choices that make competition there difficult and competitive. And it has gotten more competitive over the last couple years, I think is fair to say.” — McDonald’s (MCD) EVP and CFO Kevin Ozan (Fast Food)

JA Solar is shipping solar modules to countries around Asia.

“By geography, Asia continued to drive our growth, but we are seeing traction in new regions. . . . For instance, we shipped 180 megawatts into the Philippines. . . . We are also growing in other regions . . . such as Thailand, India, and Australia.” — JA Solar president Jian Xie (Solar Panels)

Financials

The Fed’s dot plots are not intended to be a plan for future policy.

“I would like to underscore, however, that the participants’ projections for the federal funds rate, including the median path, are not a ‘plan’ for future policy. Policy is not on a preset course.” — Fed chair Janet Yellen (Central Bank)

The Fed is not contemplating negative rates.

“We’re prepared to respond if things transpire differently. But we are not spending time actively debating and considering things we could do for additional accommodation and certainly not actively considering negative rates. We are looking at the experience in other countries, and I guess, I would judge, they seem to have mixed effects, you know, some positive and some negative things.” — Fed chair Janet Yellen (Central Bank)

The Fed doesn’t see any evidence that core inflation is experiencing a prolonged increase.

“[We] haven’t yet concluded that we have seen any significant uptick that will be lasting . . . in core inflation . . . that would include both the fact that recent inflation readings have been on the high side.” — Fed chair Janet Yellen (Central Bank)

MasterCard noted that its e-commerce price index went up a little though, which is new.

“Price indices are moving around, e-commerce price index actually went up a little bit in [February], which is a new thing.” — MasterCard (MA) president and CEO Ajay Banga (Payments)

Oil prices are now rising and declines are getting lapped.

“Fuel prices are ticking up a little bit and so that could possibly work against us on a year-over-year basis, so we’re watching that very carefully.” — FedEx (FDX) EVP and CFO Alan Graf, Jr. (Logistics)

Labor costs are increasing too.

“We are also investing in higher labor cost, which I think we can’t underestimate, and we are not alone here. I don’t know if other retailers have talked about it, but everybody is facing this. As the world is moving more to e-commerce, getting distribution center talent, good talent, is getting more and more competitive. So, that is a reality that all retailers are facing right now, and so we are investing in that as well.” — Williams-Sonoma (WSM) EVP and CFO Julie Whalen (Home Goods)

Consumer

The promotional retail environment isn’t going away.

“And also we believe the promotional environment will not recede and that no matter how you package a discount, a discount is a discount.” — Williams-Sonoma (WSM) president and CEO Laura Alber (Home Goods)

Retailers must delicately balance market share and margins.

“We took aggressive action to drive the top line over the holidays, with a focus on growing market share. . . . Our promotional activity . . . came at a cost of substantially lower margin and earnings for the quarter. . . . We were disappointed with the margin erosion we experienced this holiday, but we gained new marketing insights.” — DSW (DSW) VP and CFO Mary Meixelsperger (Offprice Shoes)

More non-traditional goods are being bought online.

“We are seeing a significant increase in non-traditional items now being purchased online — mattresses to new swing sets and big screen TVs, just to name a few.” — FedEx (FDX) EVP T. Mike Glenn (Logistics)

Technology

An important iPhone supplier saw accelerating softness in its mobility business.

“So we started seeing some softness in our Greenpoint business in the late January early February timeframe, and I think that’s because of our position in supply chain. So we started seeing the softness in January and it really accelerated in February.” — Jabil Circuit (JBL) CEO Mark Mondello (Electronics Manufacturer)

The softness was apparently bad enough that the CEO felt the need to reiterate that “mobile devices are here to stay.”

“Mobile devices are here to stay. They monitor and control an infinite number of connected devices as well as connect all of us in our daily lives. Apple remains dominant in this space and we’re fully committed to serving their brand.” — Jabil Circuit (JBL) CEO Mark Mondello (Electronics Manufacturer)

Oracle gave a good explanation of what a company is paying for in the cloud.

“You should think about it as if our customers move to the cloud. That means that they not only, of course, pay us for the software, but we also offer them a service where we own the hardware and we manage and we do all the labor. And so even though they end up paying us more than they would have historically, just for a support license, a support fee. . . they themselves, [our] customers, end up spending a lot less in total because of the massive economies of scale we have in running the Oracle database for them that they would not have on their own.” — Oracle (ORCL) CEO Mark Hurd (Enterprise Software)

Health Care

Valeant’s business hasn’t been “operating on all cylinders.”

“So, in summary, our business is not operating on all cylinders, but we and I are committed to get it back on track. We have a set of terrific products and brands and a loyal set of physicians, patients, and customers. Through both revenue enhancement and cost reduction, we are confident that we can and, again, will be able to begin to deliver the cash flows our shareholders and debt holders are accustomed to. . . . In terms of management credibility, we have to earn it.” — Valeant (VRX) CEO J. Michael Pearson (Pharmaceuticals)

Biopharmaceuticals are hard to produce.

“Now the good news for us is [biopharmaceuticals] are extremely difficult in manufacturing. . . .These are huge complex molecules that are, in fact, manufactured by cell and are fermented. The cells have to be engineered to produce the right protein, they have to be fed, and then you have to filter out the final product. And that’s our business.” — GE Life Sciences (GE) president and CEO Kieran Murphy (Conglomerate)

Industrials

There will likely be a successful third competitor in the aerospace sector at some point.

“I don’t think there is any question that we will see a successful third party in the market. I think it is a question of when and I think it will probably be later, rather than sooner . . . I think at this point Embraer is choosing to compete just below us. The CSeries is trying to take Boeing and Airbus head on and that is not working too well for them. But I think China and some of those other countries have great potential because of the demand in those markets, and the fact is that I think they will invest over the long term to be successful. So we know that new competition is coming. We know that there will be a successful third competitor.” — Boeing (BA) VP Randy Tinseth (Aerospace)

Fred Smith argued that people who think Amazon can build its own delivery network misunderstand the economic drivers of the delivery business.

“The essential thing in the delivery business is route density and revenue per delivery stop. And that is why . . . in all likelihood, the primary deliverers of e-commerce shipments for the foreseeable future will be UPS, the US Postal Service, and FedEx, because input costs . . . are trumped by the delivery density and the revenue per stop characteristics of the big carriers. . . . We have the capability to pick up, transport, and deliver an item from 95% of the human beings on the planet . . . within one to two business days. . . . So that’s known as Metcalfe’s law. . . . It’s that misunderstanding that the drivers are network density and revenue per delivery stop that has led to a lot of the misunderstanding about the future evolution of the markets.” — FedEx (FDX) chairman, president, and CEO Fred Smith (Logistics)

Materials, Energy

Small oil service companies are so starved for work that some are offering their services for free.

“Current industry conditions are as difficult as any faced by Total Energy since we commenced operations in 1997. Price competition has been fierce with some competitors literally offering certain of their equipment and service for free in order to secure what little work there is. We cannot and will not compete with free.” — Total Energy Services (TOT.TO) president and CEO Daniel Halyk (Oil Service)

Weak customers have become credit risks.

“We’ve turned down work where we’ve not been willing to accept the credit risk. . . . The worst thing than not getting a job is getting it and not getting paid.” — Total Energy Services (TOT.TO) president and CEO Daniel Halyk (Oil Service)

Miscellaneous Nuggets of Wisdom

When entering rough waters, batten down the hatches.

“We are sometimes asked why we are deleveraging at this point, with interest rates so low. The answer is when heading into stormy seas it makes sense to batten down the hatches. We believe that financial flexibility and corporate resiliency will be more valuable in 2016 and beyond.” — Alleghany (Y) president and CEO Weston Hicks, CFA (Insurance)

The way that you act when times are toughest is what defines your character.

“We’re not quitters. The easy thing to do is quit and we don’t quit. . . . We bring our cost structure down and then we hunker down. . . . [When] you’ve supported a small community during a pretty rough time, they remember who paid their property taxes during the rough times. They remember who supported the community, employed the locals. And I can tell you, number one, the community defends you. And number two, it’s pretty easy to find people to work for you relatively speaking. And so we take that commitment very serious. And we’ve never shut a branch down and we’ve hunkered down and gone through some pretty tough times. And we’re proud of that. That’s something that defines our culture.” — Total Energy Services (TOT.TO) president and CEO Daniel Halyk (Oil Service)

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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.

Image credit: ©iStockphoto.com/Rolf_52

About the Author(s)
Scott Krisiloff, CFA

Scott Krisiloff, CFA, is the CEO of Avondale Asset Management, an independent investment advisory firm located in Los Angeles. Krisiloff is the author of the firm's blog, Company Notes.

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