Company Notes Digest 7.26.13

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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

US Outlook

Steven Schwarzman thinks that the market is overreacting on rising rates:

“It appears that markets persistently overreacted initially to the Fed’s indication on when and how it march for tapering its bond purchase program…it’s clearly being micro managed by the fed to not really hurt an economic recovery.” ($BX)

TD Ameritrade sees a mini rotation rather than a great rotation:

“There are signs we are in the early stages of a rotation, with investors moving out of bond funds and into equities. But I would call it a mini rotation, as opposed to the great rotation at this point.” ($AMTD)

In the real economy, there were a few signs of a weak US consumer:

UPS sees customers trading down:

“Customers around the world continue to put greater emphasis on cost, rather than time in transit, trading down in the UPS product portfolio.” ($UPS)

Restaurants saw slowdown in June/July:

“what we do know is that there was a pullback to some extent [in the US in June and July], and it does seem to be impacting the informal eating out industry a little bit more so than broader retail.” ($MCD)

Pawn shops are seeing customers unwilling to lever up:

“anecdotally, I keep hearing from our store managers around the country that our customers are self-regulating to a large degree. While we have an opportunity on the value of their collateral to loan more money…A lot of customers are taking a lot less. Again, they’re trying to regulate their budgets and make sure they come back and pick the items up.” ($CSH)

Businesses showing signs that they are ready to invest though:

Now that credit costs have come down, banks have more cash to invest in operations:

“we’ve decided to go ahead and launch a major upgrade to our core loan and deposit systems and accounting systems. We’ve been studying this for probably a couple of years now…And we have pulled the trigger to go forward on those projects…We believe that much of the incremental costs can be offset by reduced so-called environmental costs, such as credit-related noninterest expenses and regulatory assessments and FDIC premiums and the like.” ($ZION)

Meanwhile trucking companies, which are sitting on aging fleets, may be ready to unleash pent up demand:

“There’s really an excellent utilization by fleets. Fleets are making reasonable money, some are making record results…I think people are saying, “These vehicles are getting old now, not only age but also in terms of miles.” And they’re excited by the benefits they see on our new vehicles. So I think it’s — the foundation is getting strengthened, and I think it will translate into improved sales over time.” ($PCAR)

Additional investment could come from a renewed focus on more local supply chains:

“More international trade is being conducted regionally, and supply chains are becoming more efficient, so the need for the fastest express options may not grow quite as strong in the future.” ($UPS)

Good ‘ole congress still can’t get its act straight, but no need to focus on that for now:

“Congress and the administration continue to work toward a compromise on the fiscal ’14 budget and are not there yet….barring some type of grand bargain, the defense budget ultimately will need to be reconciled with the cap spelled out in the Budget Control Act of 2011, which is about $50 billion lower than the currently proposed levels.” ($RTN)

International Outlook

McDonalds says don’t jump the gun thinking things are rosy in Europe:

“First of the all European economy, I can give you a perspective. All of us travel quite a bit to our markets…the economists may be a bit ahead of themselves…You’ve got markets – I was recently in Portugal and Ireland, you got markets, some markets may have bottomed out. I would tell you some of the larger markets are still having some challenges” ($MCD)

Amazon’s positivity on Spain is certainly an outlier:

“In terms of Spain, we’re very excited about what we see. It’s growing very fast. We’re in investment mode and it’s an exciting geography for us” ($AMZN)

On the whole it seems comments on China remain more positive than negative:

“within China, fundamental copper demand is really strong. It’s growing at 8% to 10% a year.” ($FCX)

“We grew orders in a number of key sectors and geographies, including China…we see positive signs out of China, while India remains a challenge” ($ABB)

“I’m not [a believer] that China will implode and drag the world down in to a massive black hole.” ($CAT)

An optimistic view of the Chinese slowdown is that the leadership transition created uncertainty, but that uncertainty is resolving itself:

“If you go back then maybe 1.5 years ago, we’re talking about how [electric train component] orders dried up because of the uncertainty around the transportation secretary, the leadership that was going on in China, whatever. We see that gradually improving.” ($ABB)

Egypt not completely shutdown:

[in Egypt] “obviously it’s not going and hitting on all cylinders at this point in time. The customers have dialed back a little bit…the ability to move around in the desert has been somewhat hampered, especially the ability to move explosives around and obviously, explosives are key to our business in terms of completing the wells. And so, that’s just made the logistics of doing our operations there a little bit more difficult. But it hasn’t been shutdown but it clearly has been ratcheted back” ($HAL)

Gold

There are real supply and demand dynamics in the Gold market. However, the current price isn’t low enough to stoke jewelry demand yet:

“I’m not hearing a lot of anecdotal things that people have come in and say, ‘Oh, we noticed the price of gold has dropped $300 an ounce or we’re in here to buy things.'” ($CSH)

The average person was taking advantage of high prices to unload gold rather than buy more:

“I think we went through 2000 — and late ’10 and 2011, early 2012, where, if you look at our business, and I think it existed throughout the country, people were unloading a lot of excess gold. And I think that game is over, to a large degree” ($CSH)

Financials

Even if you think that rates wont rise until 2015 or 2016, its time to get ready now:

“We do have a view on when rates start to rise…the current forecast would be late ’15, early ’16 But to be in the right position at that time, you would want to shorten duration from where it is today and you want to build up your float balances such that you have lots of flexibility to manage through a rising rate environment and take advantage and build your earning power at that point.” ($AMTD)

Zions Bancorp sees rational pricing except where the big guys are playing. (Is this a sign of irrationality or advantage of low cost of capital?)

“The pricing on smaller loans, although down in the last 6 months, has been much more stable than the pricing of larger credits…We have missed out on a number of larger deals because we won’t match the pricing that some of the bigger banks are throwing out there on those deals.” ($ZION)

Five years later, markets still aren’t liquid enough for the most toxic securities from the crisis:

“I don’t think the market is liquid enough yet that we’re likely to sell material amounts [of our Trust preferred CDOs] unless we see further improvement.” ($ZION)

Small and Mid sized banks continue to pare their CRE portfolios. Headwind to prices?:

“we’ve been — I think we’ve been very clear about this, too. We’ve made a strategic decision in this company not to let the CRE portfolio grow back to anything like the proportion of the total portfolio that was in circa 2006 and ’07.” ($ZION)

Blackstone isn’t concerned about real estate prices though, they’re huge buyers:

“we started buying very large amounts of real estate really about three years ago in real scale and we’ve been the largest purchaser in the world with vastly exceeding, vastly, multiples than anyone else.” ($BX)

They argue that if rates rise it will be in a good economy, so asset values will be fine:

“So as the economy goes up and as the real estate market intrinsically gets stronger and with construction so limited of new construction, I would expect spreads as base rates go up spreads come in a little bit and can cushion the blow of higher treasury rates if that happens.” ($BX)

Insurance is another industry heavily affected by changing interest rates:

There are puts and takes to book value and investment income:

“Book value in the quarter declined 2.3% due to rise in interest rates…Given we are fundamentally buy-and-hold fixed-income investors, this is, in essence, an accelerated recognition of a loss that would have amortized in overtime anyway, as our bonds mature…The flip side, of course, is that our reinvestment rate has improved by about 60 basis points for a portfolio of similar distribution, and this will benefit our income over years to come.” ($ACE)

Low investment yields are having a positive effect on pricing:

“if you look at the economic model of an insurance company, much of the rate increases people have been seeking stem from their concerns having to do from loss activity. And the impact, which is even more leveraged of investment income declining, is likely to force people to raise rates even beyond what they had done to date” ($WRB)

But hedge-funds playing baby Buffett are keeping pressure on reinsurance prices:

“there’s more capital chasing, to some degree, less business on the reinsurance side, and it always comes back in any market economy and with any industry. It’s that old supply-demand thing, and that’s what you got going on…you see alternate capital coming in capital markets, in addition to traditional players” ($ACE)

Speaking of Buffett, interesting commentary on Berkshire in insurance markets:

“Berkshire is going to write at a profit…He’s going to write the business where he thinks he can make money. And nobody should be afraid of that competition. He’s going to give good service, give good capacity. And he’s going to want to share the market, and he’s going to do it through those basis. But he’s not going to be a price cutter. Some people have entered the business to buy their share. I think Berkshire, by and large, is going to try and do it in other ways using their capacity, their credit and their ability to put large lines down.” ($WRB)

Insurance companies have developed better insights on risk thanks to more data and technology.  Can we say the same about capital markets?

“they’re much better data over the years in the last cycle. And because of math and computer power, and technology has changed it that way, and given their insight, they’re making different kinds of decisions about how to hold retentions, how to think about exposure. And they retain much more, many do than they did in the past.” ($ACE)

Blackstone thinks it may have a new way to get retail money into hedge funds:

“we will be rolling out a product, we can’t really talk about distribution partner and all that yet, you’ll hear from us in the future but it’s a product that we’re really excited about…essentially for retail investors, it will give them access to some of the leading hedge fund managers but still preserve their ability to have daily liquidity and daily marks.” ($BX)

Pension funds are struggling to meet return objectives:

“[analyst comment] Northrop mentioned that the impact of higher rates had an adverse impact on their return on assets [in their pension plan] year to date. They were only up 50 bps through the end of June….[Raytheon response] For us, I would say more than on a year to date basis, but as of just a couple of days ago, we were just under 8% return on assets [in the pension plan]” ($RTN)

Which Blackstone thinks is a good reason for money to continue flowing to “alternatives”

“no matter how you mix those…you get a low single-digit return if you are a big institution, that just doesn’t get there, if you are a pension fund that doesn’t pay for your liabilities. So that’s why they are shifting to alternatives.” ($BX)

Consumer

McDonalds is a proponent of everyday value vs. discounting:

“one thing we do see in the broader industry is we’re seeing a lot of discounting, price discounting rather than consistent value platforms which we have around the globe and we’ve put in place and we’re going to maintain that consistency because it’s important to consumers.” ($MCD)

Omnichannel retail is all the rage:

“We’re really excited about helping brick and mortar retailers provide an omnichannel experience for their consumers that obviously merges the online with the brick and mortar. We’re finding that there’s a lot of customers out there, consumers, that want to order online and ship to store.” ($UPS)

Creating an international brand in sporting goods is a local effort:

“Sporting goods doesn’t exist as cleanly as it does here in the majority in the rest of the world. So having to be a lot more thoughtful and a lot more creative. And it means we’re not taking one playbook into the new markets that we’re attacking or going into” ($UA)

Cleats are a lower margin shoe category, but integral to building an authentic brand:

“our mix today still is heavily weighted towards cleated versus non-cleated relative to a lot of other players out there. Obviously, that cleated side of our business is really, really important to our overall Footwear business from an authenticity perspective and credibility perspective, but it does come at the lowest of low margins in Footwear.” ($UA)

Juxtaposition of an old media company and a new media company:

Gannett has an established sales organization selling ad space in a shrinking medium:

“our biggest news for the quarter, our pending acquisition of Belo Corp…will both complement and accelerate our ongoing transformation…Gannett and Belo combined will be the largest owner/operator in terms of number of TV stations…as the [health insurance] exchanges come to market…there is clearly some tremendous media buys” ($GCI)

Facebook’s current challenge is to establish a sales organization in a growing medium:

“I think as you think about different industries using the power of online marketing, we see different levels of adoption but I’m a believer that over time this is where people are spending their time and any marketer who’s trying to reach people is going to spend their resources there as well…We are expanding both our direct selling efforts both to sales teams and online as well as the third parties we work with.” ($FB)

Technology

UPS highlighted that we are seeing a trough in the consumer tech innovation cycle:

“Over the last few quarters, there’s been a trough in the innovation cycle. Demand for new high tech products traditionally drives express small package and air freight out of Asia.” ($UPS)

Apple would beg to differ:

“We are on track to have a very busy fall. I would like to leave it there and go into more detail on October.” ($AAPL)

And thinks that the high end smartphone market still has room to run:

“I don’t subscribe to the common view that the higher end if you will the smartphone market is at it’s peak.” ($AAPL)

Amazon says it is focused on maximizing free cash flow. I’m not sure that Amazon knows what the definition of free cash flow is:

“what we will do is, we want to make sure that we try to maximize free cash flow, that’s something that we’ve always said. So, our strategy hasn’t changed, our outlook hasn’t changed in that regard.” ($AMZN)

There are some major physical capital expenses to building an internet business:

“The increase in capital expenditures reflects additional investments in support of continued business growth consisting of investments in technology, infrastructure including Amazon Web Services and additional capacity to support our fulfillment operations.” ($AMZN)

But costs have always come down over time:

“the cost of the equipment itself and the datacenters and over time Moore’s Law and other things and competition in the market have helped us to really be able to bring down the cost for each unit of equipment we use. And then…over time I think Facebook has impressively succeeded at making the hardware we use more efficient and the software that we run on it more efficient in terms of how much compute power that is needs.” ($FB)

Things sound pretty bleak at Zynga:

“With regards to the quarter, audience and bookings continue to decline, and we’re losing share on both web and mobile.” ($ZNGA)

At least they know what to focus on:

“In the long term, the best way to drive profitability is to grow the top line.” ($ZNGA)

Materials, Industrials, Energy

As drilling efficiency improves, rig count is no longer the most important metric to gauge activity:

“I think the people that are analyzing our industry have got to move away from rig count. They’ve got to move away from well count and really look at sort of horizontal footage drilled…pad sizes are getting much larger and that just drives more efficiency and more service intensity.” ($HAL)

Valero sees the WTI-Brent spread widening back out:

“what we have seen with WTI coming in so tight [to brent]…we expect that discount will open up again…we expect WTI discount to go back out to $7” ($VLO)

For now, there’s still activity in the mining industry, but spending is focused on maintaining production, not growing it:

“it shouldn’t be a mystery that we see some pressure from mining. But,… things that have to do with productivity or just the efficiency that you want to drive in ore body inside of a mine, we still feel pretty good about our tender backlog in that area” ($ABB)

Miscellaneous Nuggets of Wisdom

Insurance is not a business for optimists:

“anyone who’s has been in the casualty business for any reasonable length of time, it’s not a business for optimists, and you understand that the good news comes early and the bad news comes late” ($ACE)

It’s easy for financial analysts to forget the real operational challenges to executing a business plan:

“I know it takes you guys a second to update your model, but it actually take years to get permit and construction and do all these things and to spend the money.” ($VLO)

Quote of the week goes to Kevin Plank at Under Armour.  It can take decades to grow a business the right way, and that’s ok.

“The one thing about International and probably lessons learned over the last 17 or 18 years was that anything just takes time. And I think a longer view is what we need to approach any of these markets. I use the story of Japan a lot in sort of articulating how long it takes us, 8 years from 0 to $35 million, and then it was year 9 that they went from $35 million to $72 million and I think the tipping point really occurred…even with larger scale, larger size, well, resources, the things that we have today going for us, it still comes back to an investment, and it’s a prudent model…it’s not going to happen in 2 or 3 years. And if we get lucky and the market catches fire, great, but it’s going to take 6, 8 and 10 years and we’re sitting here telling you that we expect to be around for that much time and more. And we’re going to make the investments that’ll help us be great and be a local brand.”