by Scott Krisiloff, CIO, Avondale Asset Management
Although sentiment has been very positive this year, the hard data hasn’t tracked the optimism, at least not yet. Some of the comments on this week’s earnings calls seemed to reflect the fact that this still isn’t a robust environment. Weakness in auto manufacturing is particularly concerning since auto production is typically a late cycle indicator. It’s also disappointing that two consumer products companies called the quarter “challenging.” Consumer weakness is another leading indicator of broader weakness.
Still, there’s no sign of a significant change in the economy and optimism usually leads to stronger hard data. The Fed has been tightening though and that can also portend a shift. This also could just have been an off week.
The Macro Outlook:
This quarter may have been more challenging than advertised
“this indeed was another challenging quarter and as I think we all know, the industry continues to face global market volatility and we have seen a further slowdown in consumer demand in several key markets, most especially the U.S. Southeast Asia and South Pacific.” —Colgate CEO Ian Cook (Packaged Goods)
“while I remain optimistic about our long-term future, the near-term environment has become more challenging than maybe we saw at the beginning of the year. So category growth has slowed broadly in lots of places over the last year or so, and we expect that growth will pick back up over time, but that pickup may not happen quickly.” —Kimberly Clark CEO Thomas Falk (Packaged Goods)
Manufacturing has been slow to recover
“I think the outlook is actually stable…in the U.S. and the progress is directionally good, but the speed is not that what we would like of course.” —Manpower CEO Jonas Prising (Temp Staffing)
Auto production is weakening
“auto weakening is taking place. There’s no doubt that it’s plateaued…There’s no doubt in my mind that there’s some weakening going to be occurring. It’s only to the effect.” —Nucor CEO John Ferriola (Steel)
But companies are sticking to their guidance
“The improvement has been a bit uneven, it’s not happening in a straight line. That said…everybody is standing by their guidance for the third quarter. Where generally speaking the United States included, things are getting a little better.” —Robert Half CEO Harold Messmer (Temp Staffing)
Union Pacific is expecting improvement in 3Q
“volume, we think is going to be our friend certainly in the third quarter improving from the second quarter. And we’ll just have to see how the numbers play out.” —Union Pacific CFO Rob Knight (Railroad)
There’s no sign of a significant change
“however you wanted to describe it, an eroding plateau…we don’t see anything in terms of the economy, the health of the consumer, housing, oil…that would suggest that over the next two…years, that there’s any kind of significant collapse or dramatic change. We do think it’s going to decline. We think it will be a soft gradual decline” —Ford CEO James Hackett (Autos)
But could there be a shift “relatively soon”?
“The Committee expects to begin implementing its balance sheet normalization program relatively soon, provided that the economy evolves broadly as anticipated” —FOMC Statement
International:
There’s optimism in Europe, particularly France
“While we continue to be cautious on the UK and as they prepare to exit the EU, we are optimistic about the overall outlook for Europe…We also see…a great deal of optimism in France, as President Macron has a clear mandate for reforms including labor market reform which should benefit that economy and stimulate better employment growth.” —Manpower CEO Jonas Prising (Temp Staffing)
Germany is also very strong
“Germany, by definition, which is a big engine in Europe is doing well in the manufacturing side. And our business in Europe, if you look upon the portfolio, Industrial business is very strong.” —3M CEO Inge Thulin (Industrials)
There may even be signs of inflation in Europe
“Europe service, inflation is starting to at least be talked a little bit, even though at very small levels. But for many years, there was no discussion of inflation at all. And now at least there is some talk about potentially a little bit of inflation coming through” —United Technologies CFO Akhil Jori (Elevators)
Caterpillar was positive on construction in China
“Construction in China and gas compression in North America were highlights.” —Caterpillar CEO James Umpleby (Construction Equipment)
Financials:
Industries are changing faster than banks can keep up
“one of the things that I don’t think banks do that well…on things like Uber story is pull way up across all of our lending businesses and ask what is the impact given that industry after industry is being revolutionized…if we just go and make one loan at a time…we could wake up and have a lot of rude surprises like we did in the taxi kind of business.” —Capital One CEO Richard Fairbank (Bank)
Consumer:
The Whole Foods purchase validated omni-channel
“you think about omni-channel and the advantages that brings, and you look at the recent purchase of Whole Foods, and you scratch your head and say why did that happen, I think if you start to envision how omni-channel could play an important role in e-commerce. You could see an unfolding scenario that says there can be successful pure players and successful omni-channel players. And maybe it all gravitates towards omni-channel at some point.” —Stanley, Black and Decker CEO James Loree (Tools)
The retail industry still needs to restructure
“I think there’s a fundamental need to rationalize. People want to get larger to fight online and to fight Amazon and retail specifically. And there’ll be restructurings as well. Now the last time I was asked this, this would retail step in for energy? And the answer is I don’t believe it’s going to be as big an opportunity as energy. Energy was a very, very large user of capital in the leverage world…but a lot of those are smaller companies who are just kind of closing stores and shutting down” —Moelis & Co CEO Ken Moelis (Investment Bank)
Consumers buy more premium brands online
“What we observe on eCommerce thus far is that the consumer is actually — tends to buy more premium and even if they’re not buying the premium brands, they tend to buy in multiples. So, in fact the eCommerce behavior is favorable to us from a consumption point of view” —Colgate CEO Ian Cook (Packaged Goods)
Technology:
Data and AI are now the core currency of businesses
“The core currency of any business going forward will be the ability to convert their data into AI that drives competitive advantage.” —Microsoft CEO Satya Nadella (Enterprise Tech)
Technology is ultimately just a tool
“Ensure Tech has become sort of the flavor of the day to a certain extent. Having said this…when the day is all done these are just tools and ultimately how effective they are, how helpful they are will be determined by the people who are using them and the expertise that they have” —WR Berkley CEO Robert Berkley (Insurance)
The average Youtube viewer watches for 60 minutes per day
“YouTube now has 1.5 billion monthly viewers and people watch on average 60 minutes a day on their phones and tablets.” —Alphabet CEO Sundar Pichai (Internet)
Facebook has 2 billion monthly users (there are 3.7 billion internet users)
“This quarter we reached an important milestone for our community. 2 billion people now use Facebook every month, and more than 1.3 billion people use it daily.” —Facebook CEO Mark Zuckerberg (Social Network)
Comcast says there’s still room for growth in broadband
” growth…there is significant runway ahead of broadband. And the key to me when you look at this is the upside of the opportunity. We’re sitting at 45% penetration right now. So there’s growth just there. The overall market is growing with only 75% of households subscribing to Internet access” —Comcast EVP David Watson (Cable)
Healthcare:
Birthrates around the world have been disappointing
“So we had kind of projected 2016 was going to be a flat birthrate year. In the second quarter, we got the final fourth quarter numbers that showed it down 2% for the fourth quarter, which brought the full year down 1%…Korea’s birthrate…was down 7%, which is a pretty big, big drop…we don’t really understand it at a deep enough consumer insight level…But a broad trend is that Millennials are having their children a little later.” —Kimberly Clark CEO Thomas Falk (Packaged Goods)
Small hospitals need to get bigger by selling into health systems
“We’re seeing more opportunities in the marketplace now. I think as many health systems, again, went through the positive environment from 2015 and early 2016, and now we’re seeing some volume pressures. They’re looking, I think, to be part of the bigger system….we’re pleased to see the pipeline more robust than it has been in recent years” —HCA CEO Milton Johnson (Hospitals)
Scale is an advantage in most industries
“The broad story remains the same that it has been domestically, which is larger players taking share from smaller players…I still believe that the longer-term story is the competitive advantage that scale brings to the larger players versus the smaller players.” —Dominos CEO J. Patrick Doyle (Pizza)
Industrials:
Construction activity is still well below its prior peak
“if we use 2007 as kind of the peak market, I would say we’re somewhere around 65% of where we were back in 2007. So it’s getting better. It’s continuing to improve… we are still hoping for some news on our infrastructure build, which would prolong the cycle.” —Nucor CEO John Ferriola (Steel)
Infrastructure spend is missing
“what has, I’d say, disappointed for the last several years has been a lack of growth in infrastructure investment, which is really, I think, the area that looks prime to need some more investment and some more growth.” —Caterpillar CEO James Umpleby (Construction Equipment)
Waxy corn will be DuPont’s first CRISPR-developed product
“our CRISPR strategy, I would say, is something that is still emerging. We’ve clearly identified a few early targets. We talked about our waxy corn program….So it will be our first commercial product. We’d expect that by the end of the decade. We’re beginning to work on a few other diseases that we think CRISPR could help us control.” —DuPont EVP James Collins (Chemicals)
Materials, Energy:
OPEC is trying to rein in supply
“The OPEC Gulf countries and Russia…remain fully committed to sound and consistent stewardship of their resource base…These countries are…actively supporting the rebalancing of the global oil market by taking a procative role in moderating the current production levels” —Schlumberger CEO Paul Kibsgaard (Oil Service)
But US equity investors are preventing recovery
“U.S. equity investors…are encouraging, enabling and rewarding short term production growth in spite of marginal project economics…In this market the pursuit of equity appreciation outweighs the lack of free cash flow, net income and return on capital employed for both E&P companies and the service industry…their pursuit of short term equity returns from the U.S…is actually preventing the recovery of the oil market” —Schlumberger CEO Paul Kibsgaard (Oil Service)
This wont last forever
“I think if we stay in a $45 to $50 environment. You are going to have a number of the private operators probably lay down some rigs. So we wouldn’t be surprised if we saw a contraction in the rig count by maybe 50 to 100 rigs by the end of the year…They can’t continue to outspend their free cash flow because in our view the equity markets and the debt markets will be much tighter this time around than maybe year or year and half ago” —Core Labs CEO Dave Demshur (Oil Service)
But don’t bet against wildcatters’ animal spirits
“I said several quarters ago the customer and animal spirits back and they are with a vengeance and they are now running free to North America. Here is my last piece of wisdom for you. Do not bet against the animal spirits that our North America customers embody. I never have and I never will because that is the bet that you will lose.” —Halliburton CEO Dave Lesar (Oil Service)
There’s a lot of capital sloshing around the world
“there is a lot of capital that’s being raised and has been raised. And in general, there is just a whole lot capital sloshing around the world, looking for returns. ” —Blackstone COO Tony James (Private Equity)
Full transcripts can be found at www.seekingalpha.com
Copyright © Avondale Asset Management
