Practical analysis for investment professionals
13 September 2016

The C-Suite Speaks: Back to School

Posted In: Economics

The C-Suite Speaks: Back to School

The kids are back to school in the United States and so is Wall Street. Earnings season is over, but September is a busy month for conferences. Those companies presenting at conferences last week tended to have relatively upbeat things to say about the economy.

Will positive commentary outweigh soft economic data when the US Federal Reserve meets in September? No one at the Fed has ruled out a rate hike quite yet.

The Macro Outlook

Expectations for the consumer are pretty much the same, and will probably stay that way.

“We haven’t seen a meaningful change in the consumer. I think the consumer generally is okay. There [are] things that are working in his favor, whether it’s interest rates, fuel prices, unemployment rate. . . . I think there’s still probably a little bit of hesitancy and that stems even back from ’09 and ’10 when people remember a tougher time. . . . You continue to see a little bit of that.” — Walmart EVP and CFO Brett Biggs (Sam’s Club)

Industrial CEOs are starting to feel that the future is slightly less uncertain. 

“I use the word ‘encouraged’ because it’s been a tough slog for the last 18 months. and it’s been a walk down that has been tough to get through. And I think as I look forward, the range of possible outcomes has certainly narrowed significantly for our company. And so the encouragement is that while I’m not ready to call bottom, I am encouraged by the fact that we’re a little bit more predictable than we have been at any time in the last 18 months.” — Donaldson Company director, president, and CEO Tod Carpenter (Industrial Components)

Inventory destocking is no longer so big a concern.

“Overall, we still believe the impact from destocking is becoming less significant. However, there is still enough variability in week-to-week ordering to suggest that both off- and on-road customers have yet to find a stable bottom.” — Donaldson Company director, president, and CEO Tod Carpenter (Industrial Components)

Cleaning up inventories is not a simple process though.

“It’s simply taking longer to right the supply chain, to work the inventory flow through the entire supply chain, including much of this is import merchandise. So, it’s coming from overseas, takes time to bring it over from Asia, receive it into the country, bring it to the distribution centers, receive it into our large distribution centers, and then distribute throughout our network. That does take time. It’s taking more time than we thought.” — HD Supply SVP and CFO Evan Levitt (Industrial Distributor)

But many industries have worked through their excess merchandise.

“We think that inventories have actually been pretty well managed. . . . We don’t see any excess inventory that would create a sort of negative overhang in the environment that we’re seeing right now.” — Micron Technology VP and CFO Ernie Maddock (Memory Chips)

Leaner inventories coupled with stronger demand leads to pricing power.

“We are experiencing the ASP [average selling price] improvement in the spot market as well as the contract markets. We’ve seen some nice stabilization in the PC sector and the other markets continue to be robust. The mobile market is robust, graphics, servers. So we’re coming into a good period here.” — Micron Technology VP and CFO Ernie Maddock (Memory Chips)

Wage inflation is above 2% and the decline in food prices is moderating.

“I think given the wage pressure, it’s probably slightly above the 2%. . . . I mean, labor is — as Brian mentioned, we’re anticipating between 4% and 4.5% in the second half, within that range also in the first half. So it’s a little more and [with] some reduced reduction in cost of sales on the food side, the margin side gets a little harder.” — Dave & Buster’s director and CEO Stephen King (Restaurant)

Will the Fed raise rates this month?

“I’m ready to talk about it. . . . Knowing what I know today, if the economy in the next few weeks performs consistent with my sense of the economy, then I think we ought to have a serious discussion at the September meeting. So I in no way rule out September and look to December or look to even the November meeting.” — Atlanta Federal Reserve Bank president Dennis Lockhart (Central Bank)

There’s no sign that the European Central Bank (ECB) will be raising rates any time soon.

“Based on our regular economic and monetary analyses, we decided to keep the key ECB interest rates unchanged. We continue to expect them to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases. . . . Monthly asset purchases of €80 billion are intended to run until the end of March 2017 or beyond, if necessary.” — European Central Bank (ECB) president Mario Draghi (Central Bank)

International

UK manufacturing stands to benefit from the weaker pound.

“[Jaguar Land Rover’s] revenue: More than 80% comes outside the UK, from Europe, China, US, and other markets. We do source about 40%–50% of our components from EU. Therefore, if we take a combination of these, JLR over time would benefit from a continued weaker pound as a result of Brexit.” — Tata Motors CFO C. Ramakrishnan (Automobiles)

Latin America is weathering a storm of low commodity prices.

“There are a few glimmer spots — I won’t call them bright spots — I’ll call them glimmering spots. But Brazil, for example, has stopped declining in activity and is doing what it can to make their reserves work in the current economy.” — Halliburton president Jeff Miller (Oil Service)

Financials

The Fed is conscious of the consequences of low rates on the financial industry.

“There could be institutional damage over time with negative interest rates. . . . One is real damage to the financial system. . . . Even in our low-rate environment in the United States, we are seeing some of those institutions really express a lot of stress. . . . When you go to negative interest rates . . . in theory, at least, you can really do some damage to some important industries.” — Atlanta Federal Reserve Bank president Dennis Lockhart (Central Bank)

Smaller institutions are hurt more than larger ones.

“If you take a big bank like Deutsche Bank, you have the ability to withstand negative interest rates much longer, as we have a diversified business with asset management fees, transaction fees, trading businesses. And they are less affected or not affected. But our core banking business is. And at these margins with deposits, you will make losses. Because the money is parked at the central bank, you can’t use it elsewhere. For a simpler, more monoline bank that is taking deposits and lending it to clients, mortgages or consumer finance, it is more difficult. They have to charge more on the asset side for lending. Because you can’t really charge retail customers a fee or much of a fee for making deposits.” — Deutsche Bank CEO John Cryan (Bank)

For pure deposits, it is hard to charge a fee.

“I think banks will have to absorb that cost for taking deposits and try making up for some of the costs in charging a little bit more for lending. And that is the reason why I think the transmission mechanism with negative interest rates isn’t working.” — Deutsche Bank CEO John Cryan (Bank)

Consumer

Streaming music is the fastest growing revenue source.

“I would like to emphasize the rapid development of subscription services, which were chosen by 68 million subscribers worldwide in 2015 compared to 41 million in 2014. . . . 30% of Spotify’s 100 million customers have already switched to subscription streaming. Apple Music, launched last year, now has 13 million paying subscribers.” — Vivendi CEO Arnaud de Puyfontaine (Media)

Technology

The manufacturers of automated driving systems will be liable in the event of accidents.

“In cases where there is an automated driving system on the car, that system we see as being designated as the driver, and if there is an incident where the driver is deemed to be at fault, then the manufacturer of that automated driving system — that would be their responsibility.” — General Motors executive chief engineer, Chevrolet, Pam Fletcher (Automobiles)

5G will support a flood of wireless data from new devices.

“I think 5G is going to see a transformation of the client environment. It’s going to move beyond just the simple definition of smartphones and connected PCs and move towards an environment where we’re talking about connected cars, robots, drones, connected factories, and connected homes. And that environment is going to see an explosion of data in the client environment for megabytes per hour and gigabytes per day, to more like gigabytes per hour and hundreds if not thousands of gigabytes per month, for example, in the case of a connected car or connected factory.” — Intel Client and Internet of Things president Venkata Renduchintala (Semiconductors)

There’s plenty of demand for virtual reality but not enough supply.

“VR [Virtual Reality] is suffering from . . . a low production that is not meeting demand. But we see tremendous traffic when we run these events in our stores. And another element of just how much demand there is: We had the quickest sellout of pre-orders in our history the last time we were able to put up PS VR for preorder. We were out literally in five minutes.” — GameStop COO Tony Bartel (Video Game Retail)

Materials, Energy

Halliburton feels that the oil industry is rising from the wreckage.

“I think the headline reads, ‘On the Road to Recovery.” You have to look hard, but if you look at the headline, you’ll see, ‘On the Road to Recovery.’ But at the same time, I would describe this as sorting through the wreckage of the worst downturn that we’ve ever seen. We see the after-effects just about everywhere that we look.” — Halliburton president Jeff Miller (Oil Service)

Unemployment in the oil sector is at record highs.

“There have been more than 350,000 layoffs in the industry, mostly weighted toward oilfield services, some companies laying off as much as 80% of their workforce. At Halliburton we’ve laid off about 40% of our workforce. Bankruptcies and restructuring are quite commonplace today, and capex has been radically reduced and asset sales are now strategy.” — Halliburton president Jeff Miller (Oil Service)

Each week the team at Avondale Asset Management reads dozens of transcripts from earnings calls and presentations as part of its investment process. If you find these posts useful, click here to receive them every week via email.

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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/billnoll

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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