- Posted by Scott Krisiloff, December 5th, 2013 at 11:25 am
With a little over three weeks left in the year, the S&P 500 is on pace to put up its second straight year of double digit gains. Below is a look at how the index has fared in the years following those double digit gains. The data isn’t particularly encouraging for 2014.
This will be the 12th time since 1957 that the index has risen by double digits in consecutive years. In the third year immediately following, the index has averaged only a 2.9% return. The average is buoyed by the late 90s though, when the S&P followed two good years with three more huge years, which formed a once in a generation (hopefully) equity bubble. If you set aside those three years, the index averaged a 4.8% loss and was negative 6 out of 9 times. In those nine years the index never put up a 3rd year of double digit gains.
If you look at the Dow to extend the data set, there were 12 times before 1957 that equities had two consecutive double digit gains, including two “three-peats”*. In the 12 years that followed those consecutive gains, the Dow averaged a -5.8% return. Excluding the three-peat years, the Dow was negative 7 out of 10 times.
*come’n get me Pat Riley
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Late Cycle Sector Performance
Scott Krisiloff, December 4th, 2013 at 7:22 am
No one knows what’s in store for 2014, but given the average length of an economic expansion, if we’re not already in the late phases of this economic cycle, then we’re probably at least getting close to seeing a setting economic sun.
To help chart the path from here, below is the relative sector performance in the late innings of the 90′s expansion and the mid-00′s expansion. The dates selected aren’t particularly scientific, but were meant to capture both the late phases of expansion and early phases of contraction–a window that might be similar to what we see over the next 18 months.
The performance doesn’t match up perfectly, but there are some ways that the relative performance of the sectors seems to rhyme. In each cycle, the “problem child” had already started to see significant deterioration during this window. In ’00-01 tech under-performed the S&P by 31%, and in ’07-08 financials were lagging by a similar amount.
Although it didn’t underperform, consumer discretionary did lag its peers in ’00-01 and was the worst sector outside of financials in ’07-08. Meanwhile, energy was at the front of the pack at the end of both cycles.
10-K Tuesdays: Steve Madden
Scott Krisiloff, December 3rd, 2013 at 7:13 am
We are taking a look at Steve Madden $SHOO this week, a name that popped up in Avondale’s proprietary quantitative value screen. The screen looks at historical financial data to potentially identify high quality companies trading at low valuations. The screen is an important part of Avondale’s investment process, but this post should not be taken as an investment recommendation.
Market Cap: $2.59 B
Revenue: $1.23 B
EBIT: $179 M
Gross Margin: 37%
Operating Margin: 14.6%
Cash: $168 m
Notes from 10-K
design, source, market and sell fashion-forward name brand and private label footwear for women, men and children and name brand and private label fashion handbags and accessories and license our trademarks for use in connection with the manufacture, marketing and sale of various products of our licensees.
Our business is comprised of five distinct segments: Wholesale Footwear, Wholesale Accessories, Retail, First Cost and Licensing.
Wholesale Footwear Segment(64% of Revs, 31% GM, 13% OM):
Our Wholesale Footwear segment includes the following brands: Steve Madden Women’s, Madden Girl, Steve Madden Men’s, Steven, Betsey Johnson shoes, Olsenboye (under license), Stevies, Superga (under license), Elizabeth and James (under license), Madden, Report, l.e.i. (under license), and includes our private label and International businesses.
We currently sell to over 4,400 doors of 15 department stores throughout the United States and Canada. Our major accounts include Macy’s, Nordstrom, Bloomingdale’s, Dillard’s and Lord & Taylor.
We currently sell to specialty store locations throughout the United States. Our major specialty store accounts include DSW, Famous Footwear and Journeys.
Wholesale Accessory segment (20% of revs, 36% GM, 17% OM):
Our Wholesale Accessories segment includes Steve Madden, Steven by Steve Madden, Big Buddha, Betseyville, Betsey Johnson, Cejon and, through license agreements, Daisy Fuentes® and Olsenboye® accessories brands and includes our private label business.
Retail Segment (16% of Revs, 62% GM, 14% OM):
109 retail stores including 91 Steve Madden full price stores, eleven Steve Madden outlet stores, two Steven stores, one Report store, one Superga store and three e-commerce websites
In 2012, our retail stores generated annual sales in excess of $890 per square foot
A typical Steve Madden store is approximately 1,400 to 1,600 square feet and is located in a mall or street location that we expect will attract the highest concentration of our core demographic, style-conscious customer base.
$188 m lease obligations
Our stores are also a marketing tool that allows us to strengthen brand recognition and to showcase selected items from our full line of branded and licensed products.
We operate three Internet website stores
First Cost Segment (7.8m op income):
The First Cost segment represents activities of a wholly owned subsidiary of the Company that earns commissions for serving as a buying agent for footwear products under private labels and licensed brands (such as Candie’s®) for many of the large mass-market merchandisers, shoe chains and other mid-tier retailers. As a buying agent, we utilize our expertise and our relationships with shoe manufacturers to facilitate the production of private label shoes to our customers’ specifications
our First Cost segment serves as a buying agent for the procurement of women’s, men’s and children’s footwear for large retailers, including Kohl’s, K-Mart, Sears and Bakers.
Licensing (7.6m op income):
We license our Steve Madden® and Steven by Steve Madden® trademarks for use in connection with the manufacture, marketing and sale of sunglasses, eyewear, outerwear, bedding, hosiery and women’s fashion apparel, jewelry and luggage.
We believe that our future success will substantially depend on our ability to continue to anticipate and react to changing consumer demands in a timely manner. To meet this objective, we have developed what we believe is an unparalleled design process that allows us to recognize and respond quickly to changing consumer demands. Our design team strives to create designs which it believes fit our image, reflect current or future trends and can be manufactured in a timely and cost-effective manner. Most new Steve Madden products are tested in select Steve Madden retail stores. Based on these tests, among other things, management selects the Steve Madden products that are then offered for wholesale and retail distribution nationwide
We believe that our design and testing process and flexible sourcing models provide the Steve Madden brand with a significant competitive advantage allowing us to mitigate the risk of incurring costs associated with the production and distribution of less desirable designs.
We do not own or operate manufacturing facilities; rather, we use agents and our own sourcing office to source our products from independently owned manufacturers in China, Mexico, Brazil, Taiwan, Italy and India.
Our products are available in many countries and territories worldwide via several retail selling and distribution agreements.
We compete with specialty shoe and accessory companies as well as companies with diversified footwear product lines, such as Nine West, Jessica Simpson, Guess, Ugg and Aldo.
We believe effective advertising and marketing, favorable brand image, fashionable styling, high quality, value and fast manufacturing turnaround are the most important competitive factors and intend to continue to employ these elements as we develop our products.
Principal marketing activities include product placements in lifestyle and fashion magazines, personal appearances by our founder and Creative and Design Chief, Steve Madden, and in-store promotions.
Noteworthy Risks: Constantly Changing Fashion Trends and Consumer Demands. Consolidation Among Retailers. The trend-focused nature of the fashion industry and the rapid changes in customer preferences leave us vulnerable to an increased risk of inventory obsolescence.
On January 3, 2012, the Company and its Creative and Design Chief, Steven Madden, entered into an amendment, dated as of December 31, 2011, to Mr. Madden’s then existing employment agreement with the Company. The amended agreement, which extends the term of Mr. Madden’s employment through December 31, 2023, provides for a base salary of approximately $5,416,000 in 2012, approximately $7,417,000 in 2013, approximately $9,667,000 in 2014, approximately $11,917,000 in 2015 and approximately $10,698,000 per annum for the period between January 1, 2016 through the expiration of the term of employment…
Back of the Envelope Math
Retail Segment Math
$191 m in sales from 109 locations => implies $1.75 m per location
$92 m in operating expense => implies $844 k op-ex per store
$890 sales per square foot => $554 gross profit per sqft => $122 operating profit per sqft
$890 sales per square foot => implies 214 k square feet total retail space
Wholesale Segment math
$1,035 m total revs in 4,400 doors (at department stores) => less than $235 k in sales per location (variable based on number of specialty locations) => if you assume 80% of wholesale revs were generated at department stores then 188k per location.
If SHOO generates the same sales/sqft at a wholesale location as it does in one of its retail stores, that implies that SHOO has 1.1 m sqft of selling space at wholesale, and is allocated somewhere less than 264 sqft of selling space per department store.
Valuation based on estimated sqft
EV = $2.4 B
Estimated Sqft of selling space ~ 1.3 m sqft
=> Currently valued at $1,846 EV per square foot (take with grain of salt–very, very rough estimate)
=> if SHOO continues to generate $122 in op inc per sqft, and you assume that it trades at a LT EBIT multiple of 9x, then $2.4 B EV implies 2.2 m sqft of selling space.
Fundamental Comparison Large Cap vs. Small Cap
Scott Krisiloff, December 2nd, 2013 at 12:19 pm
The S&P 500 may be up 26.5% this year, but that huge gain pales in comparison to the S&P 600 small cap index, which is up 35.9% in 2013. Like its large cap cousin, the small cap index’s rise has been driven by multiple expansion. In fact, looking at the earnings multiple, the Small Cap index trades at a significant premium to the Large cap index. Below is some fundamental data to help break down why that’s the case.
Perhaps not too surprisingly, Large Cap companies tend to generate higher margins than small cap companies, but generally at a lower growth rate. The exception in this data is that over the last 10 years, the median large cap company has grown earnings faster than the median small cap company.
In terms of valuation, the PE multiple may overstate the small cap premium somewhat since the median large cap company has a higher P/S multiple than the median small cap company. One could argue that this is justified though, since equity shareholders are paying for earnings, not sales.
Source: Compustat Data, Avondale
Note that these are median metrics for the indexes, not market cap weighted (as the published index data would be). That’s why the valuation metrics may be different than what you’ve seen elsewhere. The median PE ratio of the S&P 500 may be worth its own post.
Second Bull Market Phase Now Matches the First
Scott Krisiloff, November 26th, 2013 at 3:17 pm
Earlier this year I wrote that this bull market may be younger than people were giving it credit for because the 21% drawdown in 2011 may have technically reset the count. The reasoning was that instead of a 1,466 day rally (at that point) we were really only on day 528, which is not that long considering that the average bull market lasts 915 days.
Well, that may have been true at the time, but as time has gone on, the second phase of this bull market has gotten older in its own right. In fact, at 784 days since October 3, 2011, the second phase of this bull has now equaled the duration of the first phase, which lasted from March 9, 2009 until May 2, 2011. The S&P has almost gained the same number of points too: 675 in this phase vs. 694 in the first.
If you combine the whole stretch it’s now been 1,723 days since the March 2009 low, which means that there have only been two bull markets in history* that have lasted materially longer than this one. This bull could, of course, go on to match those advances, but if the initial phase of the bull couldn’t go longer than 784 days without a big drawdown, what are the odds that the second phase does? If the second phase were to last the duration of an average bull (915 days) it would peak in April of next year.
*bull market data via Bespoke; however, the 1974 rally may be a misprint in that data.
10-K Tuesdays: CF Industries
Scott Krisiloff, November 26th, 2013 at 2:13 pm
We are taking a look at CF Industries this week, a name that popped up in Avondale’s proprietary quantitative value screen. The screen looks at historical financial data to potentially identify high quality companies trading at low valuations. The screen is an important part of Avondale’s investment process, but this post should not be taken as an investment recommendation.
Market Cap: $12.2 B
Revenue: $6.1 B
Gross Profit: $3.1 B
EBIT: $2.95 B
D&A: $420 M
Net Income: $1.8 B
Cash: $2.3 B
Total Assets: $10.1 B
Debt: $1.6 B
Notes from the 10-K (Filed 2/27/13)
We are one of the largest manufacturers and distributors of nitrogen and phosphate fertilizer products in the world.
two business segments:
1) nitrogen segment (13 m tons, $2.9 B gross profit): ammonia, granular urea, urea ammonium nitrate solution, or UAN, and ammonium nitrate, or AN
2) phosphate segment (2 m tons, $200 m gross profit): diammonium phosphate, or DAP, and monoammonium phosphate, or MAP
five nitrogen fertilizer manufacturing facilities
75.3% interest in Terra Nitrogen Company, L.P.
a 66% economic interest in the largest nitrogen fertilizer complex in Canada
one of the largest integrated ammonium phosphate fertilizer complexes in the United States
recently constructed phosphate rock mine
an extensive system of terminals and associated transportation equipment
joint venture investments that we account for under the equity method
founded in 1946 as a fertilizer brokerage operation by a group of regional agricultural cooperatives.
operated as a traditional manufacturing and supply cooperative until 2002, when we adopted a new business model that established financial performance as our principal objective, rather than assured supply to our owners.
2005, we completed our initial public offering
2010, we acquired Terra Industries Inc. (Terra), a leading North American producer and marketer of nitrogen fertilizer products for a purchase price of $4.6 billion
We operate seven nitrogen fertilizer production facilities in North America… the combined production capacity of these seven facilities represented approximately 39%, 34%, 47% and 22% of North American ammonia, granular urea, UAN and ammonium nitrate production capacity, respectively. Each of our nitrogen fertilizer production facilities in North America has on-site storage to provide flexibility to manage the flow of outbound shipments without impacting production.
Sales and Production Data
Implied capacity utilization: Gross ammonia: 87.5%, UAN: 92.6%, Urea: 93.3%, AN: 48.9%
Total cost of sales in our nitrogen segment averaged approximately $168 per ton
Expenditures on natural gas, including realized gains and losses, comprised approximately 39% of the total cost of sales for our nitrogen fertilizer products in 2012 down from 45% in 2011. Natural gas costs represented a higher percentage of cash production costs (total production costs less depreciation and amortization)
A $1.00 per MMBtu change in the price of natural gas would change the cost to produce a ton of ammonia, granular urea and UAN (32%) by approximately $33, $22 and $14, respectively
The Donaldsonville nitrogen fertilizer complex is the largest nitrogen fertilizer production facility in North America. It has five world-scale ammonia plants, four urea plants, three nitric acid plants and two UAN plants.
Our nitrogen fertilizer production facilities have access to multiple transportation modes by which we ship fertilizer to terminals, warehouses and customers…truck and rail…The North American waterway system is also used extensively…also have access to pipelines for the transportation of ammonia.
In our nitrogen segment, our primary North American-based competitors include Agrium and Koch Nitrogen. There is also significant competition from products sourced from other regions of the world, including some with lower natural gas costs.
Implied capacity utilization: 99.5% of the mine, 90.8% of sulfuric acid, 92.4% of Phosphoric acid, 90.1% of DAP/MAP
Phosphate segment cost of sales averaged $397
Our Plant City phosphate fertilizer complex is one of the largest phosphate fertilizer facilities in North America. At one million tons per year, its phosphoric acid capacity represents approximately 10% of the total U.S. capacity.
All of Plant City’s phosphoric acid is converted into ammonium phosphates (DAP and MAP), representing approximately 13% of U.S. capacity for ammonium phosphate fertilizer products in 2012.
Phosphate rock is the basic nutrient source for phosphate fertilizers. Approximately 3.5 tons of phosphate rock are needed to produce one ton of P2O5
Plant City phosphate fertilizer complex typically consumes in excess of three million tons of rock annually.
As of December 31, 2012, our Hardee rock mine had 76.9 m tons total reserves.
Sulfur is used to produce sulfuric acid, which is combined with phosphate rock to produce phosphoric acid. Approximately three quarters of a long ton of sulfur is needed to produce one ton of P2O5. Our Plant City phosphate fertilizer complex uses approximately 800,000 long tons of sulfur annually when operating at capacity. We obtain molten sulfur from several domestic and foreign producers under contracts of varied duration. In 2012, Martin Sulphur, our largest molten sulfur supplier, supplied approximately 61% of the molten sulfur used at Plant City
In our phosphate segment, our primary North American-based competitors include Agrium, Mosaic, Potash Corp. and Simplot. The domestic phosphate industry is tied to the global market through its position as the world’s largest exporter of DAP/MAP.
The principal customers for our nitrogen and phosphate fertilizers are cooperatives and independent fertilizer distributors. CHS Inc. was our largest customer in 2012 and accounted for ten percent of our consolidated net sales. Sales are generated by our internal marketing and sales force.
In the fourth quarter of 2012, we announced plans to invest $1.7 billion in an expansion project at our Port Neal, Iowa facility which is projected to be completed by 2016. When completed, this project will increase our annual capacity of ammonia by approximately 0.8 million tons and granular urea by approximately 1.3 million tons.
In November 2012, we announced plans to construct new ammonia and urea/UAN plants at our Donaldsonville, Louisiana complex and new ammonia and urea plants at our Port Neal, Iowa complex. Our Board of Directors authorized expenditures of $3.8 billion for these projects. In combination, these two new facilities will be able to produce 2.1 million tons of gross ammonia per year and upgraded products ranging from 2.0 to 2.7 million tons of granular urea per year and up to 1.8 million tons of UAN 32% solution per year, depending on product mix. The $3.8 billion cost estimate includes: engineering and design; equipment procurement; construction; associated infrastructure including natural gas connections, power supply; and product storage and handling systems.
approximately $886.0 million of our consolidated cash and cash equivalents balance of $2.3 billion was held by our Canadian subsidiaries
we had $1.6 billion of senior notes outstanding in two series of $800 million each. The first series carries an interest rate of 6.875% and is due in the aggregate in 2018. The second series carries an interest rate of 7.125% and is due in the aggregate in 2020.
We manage the risk of changes in natural gas prices primarily through the use of derivative financial instruments covering periods of generally less than 18 months. The derivative instruments that we use currently are natural gas swaps and options.
Back of the Envelope Math
Total average selling price per ton: $393
Cost of sales per ton: $168, 39% of cost is natural gas => implies $102.5 in fixed cost per ton
Costs increase by ~$23/ton for $1 increase in price of nat gas => Implies ~$193 cost per ton at $4.50 nat gas
Hold selling price constant, 14.2m tons of capacity yield $5.5 B annual rev => $2.8 B gross profit at $4.50 nat gas
Nitrogen price sensitivity (bearish fertilizer price scenario):
Assume LT gross margin falls to 20%, costs at $193 per ton ($4.50 gas) => implies selling price per ton of $241
=> $241 price per ton yields $48 gross profit per ton => $48 gross profit per ton yields $681 m gross profit on 14.2 m tons of capacity
Company disclosed two capex projects:
$1.7 B in capex for 2.1 million tons of incremental capacity => $809 per ton
$3.8B in capex for 6.3 million tons of incremental capacity => $622 per ton
At midpoint capex per ton ($715), 14.2 m tons worth $10.2 B
Value of company’s phosphate rock reserves:
20 years of reserves: 76m tons of rock => 22 m tons of Phosphoric acid => 44m tons DAP/MAP => $21.7 B rev => $4.3 B gross profit over 20 years at current margins
Value Relative to Current Price:
Company currently trades at 12.2 B market cap. What is that discounting?
17 m tons of fertilizer capacity across whole business (nitrogen & phosphate) => implies $717 per ton of capacity
If you assume that company sells for 10x normalized EBIT, normalized EBIT would be ~$1.2 B, which is equal to $70 in operating profit per ton of capacity. If you assume $198 cost per ton, back into long term average fertilizer price per ton in $268 range, 26% operating margin.
S&P 500 Up 60% of the Time in 2013
Scott Krisiloff, November 25th, 2013 at 2:31 pm
As a follow up to a post that I first wrote back in May, below is a chart of the percent of days that the S&P closed positive by year going back to 1957. The index has risen on 6 out of 10 trading days this year, which is the third best winning percentage in the history of the index. Only 1995 and 1958 had better years that this one, which also happen to be the two best years in $SPX history. In 1995 and 1958 the index was up 34% and 38% respectively.
In order to match those years’ winning percentage, the S&P could only fall on three days between now and the end of the year. It would be quite a streak, and if it were to happen the index would likely reach a 30% gain for 2013.
For reference, the S&P’s average daily “winning percentage” going back to 1957 is 52.8%. The worst year ever was 1974 when the index only rose on 41.2% of days.
Company Notes Digest 11.22.13
Scott Krisiloff, November 22nd, 2013 at 8:16 pm
A digest of some of the top insights that I’ve gathered from this week’s earnings calls. Full notes can be found here.
The Macro Outlook
Retailers are preparing for war:
“more retailers are planning to open earlier than prior years on Thanksgiving Day, and there are 6 fewer shopping days in 2013 between Thanksgiving and Christmas. More importantly, a number of retailers have reported disappointing results over the past few quarters. We believe all of these factors combined will create the most intensely competitive and promotional holiday selling period in recent years.” ($ROST)
And there will be blood:
“it all depends how severe and bloody it gets…once the games begin, there’s not a lot any of us can really do” ($ROST)
The question is–will the consumer show? There are some signs that the consumer is running out of gas:
Glenn Murphy senses some fatigue:
“my view is there’s a little bit of fatigue out there when it comes to consumers. So the question is, are we disappointed in the consumer sentiment? Or are we, I’m just being honest, as an industry, have we really not been that innovative in order to give the consumers a value proposition that doesn’t look like wallpaper day in day out?” ($GPS)
And Ross says a slowdown is creating a good environment for buying closeout inventory:
“It’s a very good buying market. Okay. And yes, there’s a lot of opportunities…as business slows down…the supply lines obviously were not geared for that slowdown. So there was excess supply.” ($ROST)
But Housing is still a bright spot:
“Housing is a bright spot in our economy. As such, we are forecasting our fourth quarter sales and earnings to be stronger than our plan.” ($HD)
And the consumer is bifurcated. There are “haves” for every “have not”:
“We’re also seeing more bifurcation among consumers between those choosing higher-priced value-added products and those moving down the value stream to save money.” ($TSN)
Sometimes the only thing you have in business is faith:
“I’ve always had faith in the consumer. I’m just a glass half-full person. I just believe the consumer is more tailwinds than there are headwinds. And I think they’re going to come out and buy.” ($GPS)
Companies may start having trouble cost-cutting their way to earnings growth:
“There are really 3 things that have driven our operating margin over the last 2 years…I think that in each of those areas there might be some incremental upside. At this point, I think it’ll be fairly small, but there’ll be some incremental upside. So really most of the benefit from here on is from sales leverage.” ($ROST)
“I don’t think that the 15% growth number is going to be driven by cost-cutting. We’re just not going to save ourselves into the 15% growth” ($JEC)
When it comes to inflation, looks like I’m still waiting for Godot:
“is there deflation in the apparel business? Well, if you look at NPD, they’d say no. But is it a business that has heavy inflation? The answer is also no.” ($GPS)
State and Local Governments are starting to spend again on infrastructure:
“there’s a lot of states, a lot of municipalities that are…starting to spend to improve their facilities and do highways and do bridges and do transit systems that they haven’t been able to spend for quite some time” ($JEC)
Commodity price stabilization in 3Q may have been an illusion driven by Chinese stockpiling:
“I would suspect for a small part of what we saw in [dry bulk] rates [was that the Chinese] were taking advantage of the low price of iron ore or relatively low price of iron ore…to build up their stocks…So what we have here is a speculative purchase we feel of the commodity by people who can afford to speculate…and it was both in quantities that affected the market and would have affected any markets…because of the ferocity with which its appeared” ($DSX)
Somebody is getting aggressive financing auto loans (America’s Car Mart is a used car dealership catering to subprime-ish customers):
“Analyst Q: this influx of securitized lenders in the marketplace, could you compare and contrast it to the last time we saw this, which I believe and correct me if I am wrong was kind of like the ‘04, ‘05 and ’06 time periods. Is this substantially similar or do you see differences between this current environment and the last time we saw this type of competitive flex?
Management A: Yes, I would say it is definitely more significant than it was before. I think some of the deals and offerings we hear are more aggressive than that time period. And actually, it seems to be sustained longer this time than it was before…Yes, it’s definitely more aggressive than I think we saw the last time.” ($CRMT)
Retailers are bracing for a heavily promotional environment. Those that have a clear sense of identity will fare better:
Ross is consistent in its low price message:
“our marketing strategy and our marketing message has been very consistent over the years. The message is really that we offer the best value in apparel and home fashions all the time. There’s no gimmicks, no spin, just a straightforward message. And we found that, that works pretty well with our customers. They understand the message. And when they come to the store, we kind of deliver on that message. So no real change in terms of the — just the every day value message that we’re providing for the customer.” ($ROST)
Urban Outfitters prefers to differentiate itself in other ways. Promotions may even turn off Urban’s customers:
“We’re very much a believer in selling our product at regular price and creating an experience that differentiates and gives the customer a reason to come see us versus simply utilizing price to get them in the door. That remains our strategy…My experience is most of the customers that we try to serve, they’ll not particularly like promotional activities.” ($URBN)
Gap reminds us that relying on promotions isn’t going to cut it in the long run:
“If the definition of winning is having a similar promotion on a similar category week in, week out, I think people are going to do that. I think they’re going to struggle going forward to the point where the consumer is looking for an event, they’re looking for something exciting. At the end of the day, we’re in the fashion business…Maybe in my past life, just purely playing a discount or price card might have been effective, but not in this business” ($GPS)
Ross and JC Penney agree that when things get promotional, it’s time to get conservative:
“when we position ourselves relatively cautiously, when we keep our inventories tight, our expenses tight that actually if it’s a promotional environment we can do okay, and we can hit our guidance. And actually if it turns out we’re wrong, we’ve shown that we’re pretty good at chasing business. And we hope the sales trend is stronger…we run our inventories tighter. That’s what we do in off pricing…this is what we’ve done whenever we have felt the environment would be tricky, tricky being more promotional. We’ve tighten things up and got more conservative, and it’s just served us very well.” ($ROST)
You can always find a way to chase sales later:
“if you overplan the sales, you end up having too high an expense and too much inventory. If you’re a bit cautious with the plan, you can always find a way to leverage the expense and to find additional volume by selling more regular price and promotional price and less at clearance. Those are time true approaches to running a retail business.” ($JCP)
Ross and JCP also reflect on consumer buying patterns:
“the third quarter is tricky. As the quarter goes on, there are few reasons for the customer to shop until the weather turns cold” ($ROST)
“customers only come to department stores six to 12 times a year unlike a weekly shopping experience at a big box discounter, so it takes a while for the customer to realize we’re back in business, that we have the aesthetic they’re looking for, the lifestyle that they’re used to, the price promotion that they enjoy.” ($JCP)
Speaking of JCP, they took a step towards silencing critics in 3Q:
Margins were weak, but management argues mostly because of non-recurring items:
“there’s still several margin components that are weighing us down, the biggest of which is, of course, the discontinuation of some categories and negotiating with various partners to get out of things that didn’t resonate with the customer. These are nonrecurring, and frankly, once they’re out of the arithmetic of margin, we feel quite confident…There’s no other hidden component of gross margin, and that’s why we’re so confident about the fact that they will return to our traditional levels.” ($JCP)
And were emphatic on a couple of rumors:
They’re not giving merchandise away:
“I would like to point out, since there’s a lot of people saying that we are “giving the merchandise away”, there’s no remarkable difference between the margins we’re attaining on promotional markdowns through our major events than there was in 2011. So that’s just not a fact, and we’re quite comfortable with our promotional markdowns, promotional strategy.” ($JCP)
And they have the support of their vendors:
“our suppliers and vendors. Their support for us remains strong, and contrary to inaccurate reports, has not wavered over the past several months…Our suppliers are more than eager to help us when we ask for help.” ($JCP)
They sound pretty excited:
“The positive energy in our stores is inspiring…our teams are feeling it. Our supplier partners are feeling it, our associates at the store level are really excited about the fact that they see customers they haven’t seen for a while, and we’re consistently getting feedback that our stores look as good as they’ve ever looked” ($JCP)
Social media is particularly effective for companies that have always marketed by word of mouth:
“We have been experimenting and investing in social media over the last couple of years. We found historically that word of mouth is actually the best marketing that we have, and we found social media is a good vehicle to sort of promote word of mouth. So we’ve been doing a number of things in that space” ($ROST)
Materials, Industrials, Energy
For Dry Bulk Shippers the pain never ends:
“unfortunately the recent optimism in the market created a further problem which is going to prolong the agony and the problem of the market not picking up. So we are of the opinion that the market is not going to show any signs of recovery for the next three to six months and maybe we will see market deteriorating further” ($DSX)
Private Equity has injected fresh capital into the market complicating the situation:
“every cycle, you get somebody investing capital and usually delaying a recovery…in the 80’s the nationalized fleet in the containership trade in the 90s we saw the tax schemes from Germany, in the form of the KG structures. Now we’re seeing private equity funds.” ($DSX)
Diana thinks we’re close to a bottom now, but it’s going to be a weaker recovery:
“this happens near of the trough of the market. so the chances of these investments being profitable are far higher than other…[but] The recovery when it comes, its going to be later and weaker than it could otherwise be without this infusion of capital.” ($DSX)
Jacobs is seeing a greater number of small construction projects replace a small number of big projects:
“I would characterize today’s marketplace as compared to 4 or 5 years ago, what you’re referring to, the 1 big project, I think, you’re thinking of, those aren’t necessarily out there. But there’s a large volume of projects that are sort of just a little bit below that, maybe half that size in size. A large number as opposed to before where there were a few of those really big ones, but only a few.” ($JEC)
Counterintuitively, when it comes to oil sands non-traditional money is apparently a good sign:
“different clients than you might normally think about that are looking at investments as well in the oil sands business in addition to the traditional big energy companies, which, again, adds to my confidence that the overall viability of the oil sands business over the medium and long term is very strong…when you see nontypical investors, it’s usually a good indication of an ongoing, solid capital base. And when the nontypical investors start to run away, things tend to turn down” ($JEC)
Jacobs sees under investment by utilities, and wants to make an acquisition in the space:
“our view of the [utility] market is that it’s another area where there are long-term demands for investment that are being under-met at this point in time…So we think the power business is a business that Jacobs should be in…but we’re really going to have to make an acquisition to make it happen. We’re not going to be able to bootstrap that business.” ($JEC)
So it used its earnings call as a company wanted ad:
“so that’s why I made a point of mentioning the power business as an area of acquisition so you’d know where our thinking is, but also so people who are in that business listening on this call will know we’re interested.” ($JEC)
The world will probably plant less corn next year, leaving the door open for higher prices if there are unfavorable growing conditions:
“there is already talk about among U.S. farmers looking ahead to the 2014 planting season, about adjusting corn acreage down by about 4% in favor of soybeans…Looking at South America, Informa is forecasting a cut in planted corn area of about 10% in Brazil and of about 30% in Argentina…If 2014 brings unfavorable growing conditions in any part of the world, the U.S., Brazil, and Argentina in particular, corn stock fees [ph] would fall, suggesting the commodity prices would stabilize.” ($DE)
Miscellaneous Nuggets of Wisdom
Equity investments should produce 8-9% returns over time, even if you’re buying dry bulk ships:
“if you buy at the right time and you sell at the right time as well or if you keep your investment throughout tight, you are going to make something lie 8% to 9%. This is our position and having to run a company for the longest term” ($DSX)
Smart companies aren’t that interest rate sensitive when making long term plans:
“I would have to say that most of our clients are looking at their investment as long term, and short-term interest rates aren’t a big factor in their decision to invest. That might be true of smaller players. But when you look at big oil, big mining and minerals, big chemicals, big pharma, any of the major customers in this regard, I don’t think they are deceived by short-term interest rates as a key criteria for their investment decisions. So I don’t expect a nominal or reasonable rise in interest rates to have a materially negative impact on new investment.” ($JEC)
If you listen to your customer, she’ll tell you what you need to do:
“we listen pretty carefully to the customer. The customer will tell us exactly what they want in the store, and they’ll be able to help us on where it should be displayed.” ($JCP)
An Alternative to Shiller CAPE
Scott Krisiloff, November 21st, 2013 at 5:47 pm
Even though value investors love to use the Shiller Cyclically Adjusted PE (CAPE) to justify the market’s overvaluation, the metric has some obvious shortcomings. The most relevant one is that it is biased towards overstating the earnings multiple. That’s because the Shiller PE takes a simple average of 10 years worth of earnings. Assuming that the economy grows, this will give a depressed view of earnings power because the average relies heavily on old earnings. CAPE does try to correct for this issue by adjusting for inflation. But while this is better than nothing, it still under-represents growth and has a propensity to diagnose an overvalued market (especially in periods of weak inflation).
Below is an alternative long term valuation metric (I’ll call it the KAPE), which averages ROE rather than earnings. I think that this does a better job of capturing growth because the ROE metric captures elements of growth on its own. It measures how well a company managed a given pool of capital in each time period whether that pool is growing or shrinking. By averaging the ROE, the company’s past performance can then be compared to current valuation using a price to book multiple.
Mathematically the equation is:
You can see the reason why you use the current price to book ratio is that this cancels out the “book value” element of the final metric, leaving you with a more simplified Price to Earnings Power multiple, the Krisiloff PE, or KAPE.
The chart below compares the KAPE to the Shiller PE for the S&P 500. It mostly tells the same story, but with a little less volatility. Unfortunately I couldn’t find book value data pre-1990 to give a longer term comparison. If anyone can find long term historical book value data on a major index, please let me know.
When Momentum Stocks Break
Scott Krisiloff, November 20th, 2013 at 11:16 am
Tesla is now down 38% from its peak and appears to be suffering the same fate as many other momentum stocks before it. In order to help chart what $TSLA’s decline could look like, below is a list of the number of weeks that it took 11 other broken momentum stocks to lose 50% of their value from their peak.
It took these stocks 12 weeks on average to lose half of their value. If Tesla matches that pace it could be below $100 by mid December. On average, these stocks lost 91% of their value before their declines were over and the average duration of decline from peak to trough was 100 weeks (about 2 years).
Of course for every example here there is probably another example of a momentum stock that appeared to break but then recovered. Chipotle and Monster Beverage are two that come to mind that came close to 50% declines before recovering. Indeed, several of the stocks on this list (Netflix for example) have recovered quite a bit from their drawdowns. In the end though, valuation always wins.
Scott Krisiloff, CFA is Chief Investment Officer of Avondale Asset Management, a Los Angeles based investment firm, which manages investment accounts for individuals and institutions More.
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