What CEO's Said This Week: Inventories Destocked?
by Scott Krisiloff, CIO, Avondale Asset Management
Each week we read 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. Click here to receive these posts weekly via email.
This Weekās Post: Inventories Destocked?
An industrial recession typically ends when excess inventories have been depleted. Weāre probably not there yet, but weāre getting closer. Thatās a good sign for the second half of 2016, but tightening conditions in capital markets could create problems of their own.
The Macro Outlook:
Industrial companies have been in recession for four quarters now
āwe are now basically in our fourth quarter of the recessionā¦I see at least one more quarter, maybe another quarter.ā āEmerson CEO David Farr (Industrial Components)
Eventually they will hit bottom, the question is when
āThis too will bottom weāve lived through a bunch of these. It just our view that weāre not going to see that end in ā16ā³ āEaton CEO Sandy Cutler (Diversified Industrial)
Inventory depletion typically creates a bottom for manufacturers
Where are we in the inventory cycle? Itās difficult to say
āDestocking has always been difficult for us to see, the magnitudeā¦I would expect destocking to continue through the next quarter. And beyond that, I couldnāt comment.ā āKennametal CEO Donald Nolan (Machine Tools)
Inventory data is still elevated
āthe U.S. 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.ā āUPS EVP 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
āWe believe that our business has stabilized and that the majority of the inventory correction is behind usā¦the December quarter marks the bottom for us for this correction.ā āMicrochip CEO Steve Sanghi (Semiconductors)
LyondellBasellās CEO noted that inventories are low and weāre approaching a seasonal uptick in demand
āmy sense is inventory is very lowā¦coming into a March, April, May timeframe, it will bring a seasonal uptick in demand, likely inventory restocking.ā āLyondellBasell CEO Bhavesh Patel (Plastics)
Emersonās CEO said the inventory downward draft is probably over with
āI would say what my knowledge is right now, inventory levels within the channel including ourselves, our levels that, they are pretty good levels, lowā¦I donāt see much of a downward draft on that now. I think itās pretty well over with, probably very minor downward draft.ā āEmerson Electric CEO David Farr (Industrial Components)
Eaton said that people have got their hatches buttoned down tight
āI think people have got their hatches buttoned down tight and they too are trying to live through a period of time when growth is less than theyād hoped it might be a couple of years agoā āEaton CEO Sandy Cutler (Diversified Industrial)
End markets are shaky though
Praxairās CFO doesnāt see many things getting better
āWhen I look around at the current industrial state of the world, I donāt 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.ā āPraxair CFO Matt White (Industrial Gasses)
Eaton is not counting on an economic rebound in the second half
āI donāt think weāre seeing anything at this point that causes us to think that markets are better than what weāre forecasting hereā¦as we put the plans together this fall were not counting on an economic rebound in the second half.ā āEaton CEO Sandy Cutler (Diversified Industrial)
Sysco mentioned ādeflationā 40 times on their conference call
āwe currently believe that deflation headwinds will persist for at least the remainder of the fiscal yearā¦deflation impacts the P&Lā¦the reality is, itās not a great environment because you end up with fewer dollars to pay your expenses with.ā āSysco CEO William DeLaney (Food Distributor)
At best, itās a slow growth environment
āthereās no doubt, itās a slow growth environment.ā āHoneywell CEO David Cote (Conglomerate)
āWe do think that we are in this frustratingly slow environment that can often cause people to use the recession word, but I think thatās almost a more of a kind of an emotional issues than it is a the factual basisā āEaton CEO Sandy Cutler (Diversified Industrial)
And itās a long year
āthere is so much time between now and the fourth quarterā āEaton CEO Sandy Cutler (Diversified Industrial)
International:
Consumer related industries are relatively strong in China
āConsumer related industries are still performing well in China, as we continue to see good demand for things like transportation fuels, food, healthcare, environmental solutions and plastics.ā āPraxair CFO Matt White (Industrial Gasses)
But consumer spending is definitely being impacted
āDomestic spending is certainly impacted in China. I was in China last week and you could see it there.ā āMastercard CEO Ajay Banga (Payment Processing)
āOur China Chocolate fourth quarter net sales results were less than our expectationsā¦category performance is being impacted by macro economic issues and the related impact itās having on consumer shopping behavior and confidence.ā āHershey CEO John Bilbrey (Chocolate)
Industrial markets are very weak
āIndustry demand for medium and heavy duty trucks in China decreased by 24% for the full year as the industrial economy slowed.ā āCummins CEO Thomas Linebarger (Truck Engines)
The Chinese are looking to shut down steel capacity equal to US output
āClearly, you have a situation of excess capacity across most infrastructure supporting industries, like steel, glass and cementā¦the Premier recently here announced their goal to take out about 100 million to 150 million tonnes a year capacity. And just to put that in perspective, thatās like the entire capacity of the United States.ā āPraxair CFO Matt White (Industrial Gasses)
The weakness in China is in lower tier cities
āOur 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 Chinaās slowing export trade.ā āYum! CEO Greg Creed (Restaurants)
āthe services and technology companies are tending to focus in the largest citiesā¦demand for retail, logistics and office space in those major cities actually being quite robust. Where thereās 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.ā āJones Lang LaSalle (Commercial Real Estate Broker)
AGCOās CEO had some very negative things to say about Brazil and Venezuelaās governments
āthe government in Brazil is in very bad shape. They donāt know what they are doing, they donāt have a strategy, they are corrupt, and this damaging not only our business but business in generalā¦ I think Venezuela is close to complete bankruptcy, the political system doesnāt work at all, you canāt travel there without being killed. So thatās really, really a very, very difficult market.ā āAGCO CEO Martin Richenhagen (Farm Equipment)
Financials:
Capital markets look increasingly tight
Widening spreads have affected companiesā ability to issue debt
āIn total, global bond issuance declined 26%ā¦In January, we saw a continuation of that trendā¦where we see spreads going, thereās a lot of volatility right now. We think that also plays into it, peopleās appetite for going out. Itās not really related to the base rate. Itās related to the spread.ā āMcGraw Hill CEO Douglas Peterson (Ratings Agency)
Volatility is likely to affect M&A activity this year
āthe volatile market conditions at the start of this year could affect our 2016 performanceā¦In our M&A business, while weāre off to a good start, itāll be several months before we know whether volatility has affected deal announcements for the year.ā āLazard CEO Ken Jacobs (Investment Bank)
There has been some cooling in demand at the high end for real estate
āWhat 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.ā āJones Lang LaSalle CEO Colin Dyer (Commercial Real Estate)
Itās a terrible environment to sell assets out there
āI think your point is spot-on. I think itās a terrible market to be trying to sell most assets out there, particularly obviously oil-related assets. And thatās why Iāve been pretty circumspect around asset sales.ā āChevron CEO John Watson (Integrated Oil)
Sellers are expecting to receive higher prices than buyers are willing to pay
āsellersā expectations of price have continued to kind of push upwards whilst buyersā willingness to pay those continuing increased prices have become slightly more hesitant.ā āJones Lang LaSalle CEO Colin Dyer (Commercial Real Estate)
āWe have seen a couple of things where the pricing was so over the moon for the outset or the location that they had to backup and ask for a different bid or lower bid. But those are properties, that in my mind ā its like ā 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.ā āKilroy CEO John Kilroy (Office REIT)
āI would tell you on the ā on down ā in down cycles, having been through a few, itās really hard to get the bid and the ask to converge on the way down.ā āNational Oilwell Varco CEO Clay Williams (Oil Service)
VC investors are marking down portfolio positions
āI personally spend a lot of timeā¦with the VCs, the angel investorsā¦and a lot of those folksā¦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.ā āKilroy CEO John Kilroy (Commercial REIT)
If capital markets freeze some early stage companies are probably not going to survive
āSome companies will fail and deserve to fail, letās just be honest about this. The nature of technology is that, it rapidly evolves or even increase the revolution, and sometimes that obsoletes some other things.ā āKilroy CEO John Kilroy (Commercial REIT)
Many poor performing retailers werenāt able to survive the fourth quarter
āwe did experience in ā15 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.ā āSimon Property Group CEO David Simon (Mall REIT)
Consumer:
There are signs of continued strength in labor markets
āweāre 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.ā āRobert Half CFO Keith Waddell (Staffing)
Casual dining gets hit harder by macro pressure than Quick Service
āweāve seen this not just in China, but outside that casual dining is impacted by macroā¦it always has a bigger impact on casual dining when macros are volatile and changing than it does on the QSR business..ā āYum! CEO Greg Creed (Restaurants)
The perimeter of a grocery store is growing much faster than the center of the store
āitās the perimeter of the store where you are seeing a tremendous amount of growth versus the center of the storeā¦listen, whether itās Whole Foods or other retailers, they donāt want the center of the store to die. So they are all looking for innovation and working with us on innovation there.ā āHain Celestial CEO Irwin Simon (Consumer Packaged Goods)
UPS delivered 612 million packages during the holidays
ācertainly, it was a solid peak season. We delivered more than 612 million packages over the peak period. Itās the most in the company history, up about 7%.ā āUPS EVP Alan Gershenhorn (Delivery)
Peak shipping demand is so high that Amazon has needed to build its own infrastructure to accommodate it
āwhat weāve found is in order to serve ā properly serve our customers at peak. Weāve needed to add more of our own logistics to supplement our existing partners. Thatās not meant to replace them. And those carriers are just not ā 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. Itās just weāve had to add some resources on our ownā āAmazon CFO Brian Olsavsky (E-Commerce)
Chipotle said it may take 4 or 5 quarters to recover from its food safety issues
āWhen we looked at other events, other companies that have gone through something like this, the recovery typically takes four or five quarters or so.ā āChipotle CFO John Hartung (Restaurants)
Technology:
Alphabet says that it has made great strides in AI
āOn AI, we are obviously seeing incredible progress in this field. We make great stridesā¦Itās always tough to predict what happens over a five-year timeframe, but I do see us making significant strides. Even a year ago, I wouldnāt have predicted that we would be in a strong position to mount a serious challenge to the world champion in Go this year. So 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 itās early days, and thereās a long-term investment for us.ā āGoogle CEO Sundar Pichai (Internet)
Companies are seeking cyber-security in the cloud
āSecurity is now a major driver of the cloud adoption. As threats become more frequent and sophisticated, Azureās unique technology like machine learning empower customers to adapt to these new realities.ā āMicrosoft CEO Satya Nadella (Technology)
Marissa Mayer is on the defensive
āIn a turnaround, you must literally turn around declining revenue and get it to grow.ā āYahoo CEO Marissa Mayer (Internet)
Healthcare:
Aetna said that is has āserious concernsā about the sustainability of public health insurance exchanges
āwe 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.ā āAetna CEO Mark Bertolini (Health Insurance)
Industrials:
The investment community is concerned about auto sales, but production is expected to stay high
āwe 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. I mean weāve seen absolutely no change in production schedules from when we gave guidance originally a month agoā¦weāve seen no change.ā āDelphi Automotive CEO Kevin Clark (Auto Parts)
The auto industry has been known to overproduce before though and dealers usually end up suffering
āWeāve taken steps to begin to bring in our inventories. But even if we do that if the industry overproduces and keeps inventory at a high level that means the overall environment is still very difficult.ā āAutonation CEO Mike Jackson (Auto Dealer)
There has also been concern about the aerospace industry, but Eaton was positive
āA lot of discussion over the last couple of weeks about whatās happening in the commercial aerospace activityā¦we continue to see that outlook being strong as we move into 2016 and 2017.ā āEaton CEO Sandy Cutler (Diversified Industrial)
Honeywell also pointed out that flight hours are still increasing
āif you take a look at whatās 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%. Theyāre likely to be up 4% to 6% again this year.ā āHoneywell CEO David Cote (Conglomerate)
PACCAR was upbeat about prospects for truck production in North America
ā2016 will be another good year for the U.S. and Canadian Class 8 industry truck marketā¦Cancellation activity in our operations are very normal. Thereās nothing unusual that is happening in that arena. And in terms of where weāre at in the cycle, I think thatās to be determined. The economic fundamentals are positive, and we see that weāre going to track what the demand is, and we think the demand is going to be a good market for 2016.ā āPACCAR CEO Ronald Armstrong (Truck Manufacturer)
Materials, Energy:
Companies in the oil space are becoming more realistic
āIt 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.ā āNational Oilwell Varco CEO Clay Williams (Oil Service)
This environment could last for longer than anyone expected
āwe do think the current environment that weāre in will probably be protractedā¦until we see events stabilize and we see oil pricesā¦take on a new supply-demand dynamic than itās currently in the market or anticipated in the near future, we will continue to be a very cautious investor in this environment.ā āAnadarko CEO R. A. Walker (Oil E&P)
The oil industry may not recover until 2017
āWe are looking at a situation, in my opinion in the oil and gas marketplaces, that will not recover until well past middle of ā17, maybe late ā17.ā āEmerson Electric CEO David Farr (Industrial Components)
Hedging is no longer attractive in this environment
āat $30 and $2, just to use big round numbers, I donāt think any company has got a motivation to hedge until itās probably a negative cost of replacement. So Iām 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.ā āAnadarko CEO R. A. Walker (Oil E&P)
Rating Agencies are likely preparing to downgrade oil companies
āthe rating agencies need to do what the rating agencies need to do and they have conservative oil price scenarios out there and I think thatās understandableā¦if a downgrade does occur, and I think theyāre moving in that directionā¦we would not be the only one that that would happen to. I donāt see it materially impacting our cost of funds or materially impacting our ability to secure financing.ā āChevron CFO Patricia Yarrington (Integrated Oil)
Companies are cutting spending where they can, including dividends
āI 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 environmentā¦I certainly do not expect us to eliminate the dividendā¦I donāt think thatās an appropriate step, but the current yield is certainly higher than we would have targeted in a much higher stock price environment.ā āAnadarko CEO R. A. Walker (Oil E&P)
āWe 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. ā āPotash CEO Jochen Tilk (Fertilizer)
Miscellaneous Nuggets of Wisdom:
Never enter into a deal that you donāt feel like you can walk away from
āThe way we look at it is, we donāt look at any of the acquisition that is a must for us. We have not preceded any of the past acquisitions we have done with the eye towards that itās 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 weāre able to build a model where it would make sense but youāve seen us walk away from acquisition, like weāve walked away from CSL, we walked away from many, many other that did not come in the public domain.ā āMicrochip CEO Steve Sanghi (Semiconductors)
Full transcripts can be found at www.seekingalpha.com
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