Company Notes Digest 9.8.17

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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.

September is a light month for earnings but a busy month for investor conferences. This week tech companies spoke at a Citi conference and Consumer companies spoke at a Barclays conference. The two conferences actually dovetailed nicely considering that technology is currently up-ending the consumer products industry.

The EVP of Johnson and Johnson’s consumer products division did a great job of summarizing the immense challenges facing the industry and features heavily in this week’s post. He argues that historical barriers to entry are crumbling and that data is the new barrier to entry. It’s an interesting thesis, and only time will tell if it’s the right one, but it explains why companies are scrambling to use machine learning to make sense of the data that they have access to. One might wonder though, if old-line companies are leveraging tech companies’ cloud and engineers to unlock insights into their data, who’s data is it anyways?

On the macro front, there is clearly underlying inflation creeping into the system. Commodity costs are rising, but companies don’t feel they have the pricing power to pass cost increases on to their customers quite yet.

The Macro Outlook:

Commodity costs are rising but companies don’t have pricing power

“[we] continue to see competitive pricing in a challenging commodities environment…when you compare year-over-year…DRAM cost will be roughly double…but we continue to expect to see a very difficult pricing environment. We are not anticipating that easing up in the near term. So that would provide some pressure ” —HP Enterprise CFO Tim Stonesifer (IT)

“The flow of imported steel into the US has dramatically slowed due to duties and the threat of additional counter availing duties by the current administration. The result is an increase in the cost of this product with a limited ability to pass the increase onto the come customer, due to the competitive environment.” —HD Supply CFO Evan Levitt (Industrial Distributor)

Currency is becoming a tailwind

“if rates stay where they are today and hold, then that would certainly provide some tailwinds for us. Now we’ll have to see what happens at the beginning of the year, but as I said, if they hold where they are today, that should provide some uplift.” —HP Enterprise CFO Tim Stonesifer (IT)

The political environment could still rattle the economy

“I am still a believer…that if there is not real legislative progress other than extending a debt limit by 3 months to give relief down to the people in Texas they needed, but if there is not real legislative progress the sense that I get is that it will be a different conversation” —Korn/Ferry CEO Gary Burnison (Executive Recruiting)

International:

Britain is challenged from Brexit

“I think when Brexit was first announced, we did see a pause in the demand in the UK market…customers were trying to decide do they want to build their next datacenter in the UK or should they be building that datacenter someplace else in Europe. I think we are still feeling some after-effects from Brexit, because it’s not clear exactly how this is all going to work. So I would say, the UK market is a bit challenged for us.” —HP Enterprise CEO Meg Whitman (IT)

Consumer:

The head of J&J’s consumer division laid out the problems facing consumer products companies:

Competitive advantages are being dismantled

“the reality is that the pace of change in our industry is truly accelerating…If you look at our last few decades in this industry, there were a series of barriers for entry or sources of competitive advantage that were well established but those are becoming less and less unique.” —Johnson and Johnson EVP Jorge Mesquita (Healthcare)

It’s hard to have a monopoly on talent

“It used to be that companies like ours would acquire the best talent through our recruiting human resources mechanism, but it’s never been easier for you to source great talent across the world on demand.” —Johnson and Johnson EVP Jorge Mesquita (Healthcare)

It’s never been easier to build a brand

“Our ability to build and nurture brands, brand building competencies used to be again a source of competitive advantage but the reality is it’s very easy for you to start building a business, building a brand from scratch and you really don’t need a ton of money to get a community of active users that support you.” —Johnson and Johnson EVP Jorge Mesquita (Healthcare)

It’s not hard to access global manufacturing expertise

“Large scale manufacturing assets used also to be a source of competitive advantage. But the reality is if you want to compete in this industry, you can access high quality contract manufacturing work any place in the world.” —Johnson and Johnson EVP Jorge Mesquita (Healthcare)

Retailer relationships are no longer a moat

“Retailer relationships used to be also a source of advantage and a barrier for entry, but as you all know, new companies can now sell directly to consumers profitably in most markets. And then financial firepower for companies like J&J is not as critical as it used to be because new startup entrants can access capital relatively easy through VCs.” —Johnson and Johnson EVP Jorge Mesquita (Healthcare)

The disruption is digitally enabled

“So this disruption that is happening is digitally enabled and is changing the face of our industry. You see these new players coming into our category and at the heart of this disruption, there is a new consumer centric paradigm and that’s challenging completely the cost of goods scale and the value scale as we know it and its forcing a change in both the retail and the media landscape.” —Johnson and Johnson EVP Jorge Mesquita (Healthcare)

Small companies are succeeding because they stay close to the consumer and have digital DNA

“small players are the ones that are gaining share and majority of large companies are losing market share…they are really committed to breakthrough innovation by staying really close to consumers and customers and staying on top of consumer trend. They see where the product is going and they are designing to what that emerging consumer need is. They are focused on building digital first brands that have a clear purpose and a reason for being that resonates with millennial consumers. They capitalize on the rise of emerging channels. They don’t just play in the legacy channels but they figure out what are the new shopping behaviors, new emerging channel trends and they disproportionately drive growth in those channels. They are hyper efficient. Normally have very lean cost structures, flat organizations, no bureaucracy and as a result they move very fast. Speed is a great currency for them.” —Johnson and Johnson EVP Jorge Mesquita (Healthcare)

Big companies are becoming value added VCs

“the innovators are launching hundreds of new products every year. But once they’re successful, they all have the same kind of issues, issues like buying, procurement, like selling, distributing, manufacturing and capital. And so, we have a venture group that we started about ten years ago and, basically, it goes out to all the entrepreneurs and says, instead of going to private equity to get money, why don’t we work with you, we’ll invest in you and we’ll help you. And we’ll help you take your idea, solve some of the issues you might have, and we can see how you can be a part of what we’re doing and we can help you achieve your dreams as an entrepreneur…All of that allowing us to kind of source external innovation, so that when you take a healthy core, build strong, new businesses, and then bring all the next businesses in, it gives you a sustainable top line.” —Coca Cola EVP Sandy Douglas (Beverage)

Data is the new barrier to entry

“And what we’re seeing now is there is a new playbook emerging, a new how-to-win playbook that is really characterized by an asset light infrastructure. And the control of the consumer relationship, via the acquisition of the…data that allows for you to have a highly personalized iterative on demand consumer experience. And the ownership of this relationship with consumers and associated ecosystem that comes with it is now the new playbook. It is now the greatest new source of competitive advantage.” —Johnson and Johnson EVP Jorge Mesquita (Healthcare)

Technology:

Every business is becoming a data business

“Cloud was originally a place for startups, a place for surplus capacity, sort of a cost savings thing. And now with every business becoming a data business, the Cloud, people are moving to the Cloud to be secure and they’re moving to the Cloud to gain competitive advantage.” —Google SVP Diane Greene (Cloud)

Companies are data mining for business intelligence

“I think the big driver for server demand…is simply there are massive amounts of data that have been collected that have sat unused for a long time and you now have people using more and more and more of that data to try to form business insights and business intelligence…So, AI is an important trend…this is a trend that will sustain demand we believe on a going forward basis.” —Micron CFO Ernie Maddock (Digital)

Alert to NVDA investors. Google is building its own chips for machine learning.

“we have a lot of GPUs in Google Cloud, and we work very well with NVIDIA. And the TPU…for the big data machine learning, training and using the models, we saw an opportunity to build a custom chip that would give an order of magnitude performance advantage, which actually saves us a lot of money and also lets us do a better job on the machine learning because you could turn things around so quickly.” —Google SVP Diane Greene (Cloud)

Miscellaneous Nuggets of Wisdom:

Not all market share is good

“As the CFO, I get quite nervous about having a goal of market share, because you could go out and buy a lot of bad units. And you could high-five on the market share. So, it’s important that it’s profitable and then it’s then consistent with our strategy.” —HP CFO Cathie Lesjak (PCs)

The more you try the more likely you are to succeed

“we did a pretty exhaustive study to try to figure out how we could become more innovative. And the net is that there are a lot of things going on in innovation, but the one thing that had the highest correlation with success was the number of at-bats. It wasn’t the super brainy process. It wasn’t the eight-page request for authorization form that was better than another. It was, you had the general idea of what you’re trying to do and where the consumer is going and you create the opportunity for lots of tries. And the only way we could figure how to do that was to get other people to try and then to give us the chance to help them make the more likely winners succeed. But even then, the more likely winners don’t all win.” —Coca Cola EVP Sandy Douglas (Beverage)

Full transcripts can be found at www.seekingalpha.com