Talkin Profits: Economic Outlook, Earnings, Business Performance ?
Now we're going to shift the focus back onto business performance but come at it top-down by starting with the macro-issues of profitability and asking what the economic outlook means for business performance and earnings outlooks. After the page-break you'll find some readings on those topics, general business conditions and some specific players (WMT, SBUX, Kraft, Whole Foods) that illustrate many of the points. Before we get into the meat however we'd like to share some of the morning's headlines which reinforce the arguments about a slowing economy and the deteriorating earnings outlooks. MUCH more importantly however these are the headlines from places like the WSJ and Bloomberg. Here's the first central question: what happens when it dawns on businesses and investors that the V-shaped recovery is history ? And that '09 is not looking much better ?
1. Economists Expect 2008's Second Half To Be Worse Than First The U.S. economy is poised for an unpleasant finish to 2008, amid a consumer-spending slowdown and a weakening global economy. The emerging pattern is the reverse of what most forecasts showed at the beginning of the year.
2. OECD Forecasts Sharper Slowdown for G-7 The world's leading developed economies are set to slow more sharply in the months ahead, according to the OECD's indicators of future activity.
3. Predicting What's Next Gets Harder Investors often expect the stock market to behave like a crystal ball. Lately it has made a better rearview mirror. For decades, turns in the stock market typically led earnings by roughly six months. But during the past decade or so, stocks have moved roughly in tandem with, and occasionally lagged, the trajectory of profits…
4. Is the Market Still a Future Indicator? At this point, you would have thought the Efficient Market Hypothesis would have died a quite death. The most fascinating aspect of this is the opportunity for anyone in the market to identify inefficiencies. Discover where the market has a non random error -- we've called it Variant Perception over the years -- and you have a potentially enormous money making opportunity.
Those headlines pretty well capture the arguments we've been making for some time, are based on similar analysis and point to a lot of other folks seeing the tipping point being crossed. And as Barry Ritholz points out in his post on the Deficient Market Hypothesis "you have an ....opportunity" ....if you make the right choices of course :) ! Speaking of which the next central question is what happens when the analysts figure out that their earnings outlooks need to go in the trash ? And the markets absorb those revisions ? How long will all that take to percolate ? Somewhere in there may lie some of Barry's opportunities.
We'll leave you to skim thru the readings which beef up these arguments but will note that the blue-highlighted titles are URL's - in other words you can click thru to get to the underlying story or post if you like. Now let's jump into parsing out the profit analysis
Corporate Profits: First Pass
Let's start with a fairly simple look by using the St. Louis Fed's FREDII data graphing tool to look back at YoY changes in corporate profits to 1980. Part of the point here is that you aren't reliant on the MSM but courtesy of the Fed can take some pretty deep dives yourself. It may take a bit to learn the tool and data sources, and maybe a bit more to learn what the data's telling you, but generating current analysis eventually takes a few minutes. Also btw just clicking on any graphic or chart will bring up an enlarged version for closer examination.
Take a careful look here and there are several things to notice. First off the timing, patterns and business cycle relationships are exactly what one would expect. The economy drives profits, no if, ands or buts. With some aberrations that are important. The blue line is "real company" after-tax profits on the right scale and it's volatile. But that scale wouldn't be so distorted except for the huge jump since '00. Before that those profits were cycling around a trend, which turned down in the '90s. Notice also that the drop in this decade is steep, now near-zero and below and appears headed lower.
Corporate Profits: Pass II
Let's take another pass at the data courtesy of Northern Trust's econ department and zoom in a bit, albeit with slightly different data on profits coupled with some inflation data.
First off notice that QtQ profits have been negative and dropping since Q406. Wonder where those buybacks and earnings reports are coming from ? You should. We do know it certainly didn't go into hiring or capex. And therefore won't either !
What about margins ? Well when the ratio between the good CPI and the finished consumer goods PPI is dropping like a rock that tells us there's no pricing power whatsoever. It also tells us that profits have been under enormous and growing pressures for some time. And when it accelerates those pressures worsen. Now what do you think about future profit prospects ? Worse and worse we hope ! :)
Corporate Profits: Pass III
Now let's take final pass at the big picture so you can get the full "slowly-boiling-frog" environment. The rather busy chart below shows corporate profits from 1979 from the national accounts. The UL shows the absolute number stacked up and if it looks like the Finance industry has been wallowing at the trough you'd be right. The UR shows profits as a % of GDP. We see three major structural trends that will govern things in the future. First off profits for non-financial companies were steady until this decade when they started liquidating their futures. Second, it looks like Financial companies went thru a major structural jump-shift and grabbed off more of GDP and, in the LR chart which shows % share of total profits, that's confirmed. And we now know what that was based on and how solid it was. Hm.....not promising. Remember the broken business models and wonder how that'll play out. And third, it looks like foreign profits (Rest-of-World or ROW) showed a steady rise until later in this decade when they took a big jump. That's born out in the LL chart which shows YoY% chanages, which btw, are both steady and pretty much mirror the business cycle. Note that very recently ROW profits are showing a non-cyclic jump. Brave new world indeed.
Business Readings
U.S. Economic & Interest Rate Outlook: Base Case vs Checkmate (NT): On a year-over-year basis, U.S. nonfinancial corporation profits generated from domestic operations have been contracting since the fourth quarter of 2006 (see Chart 19). With our forecast of contracting real GDP growth in the second half of this year followed by a muted recovery in 2009, unit sales growth for nonfinancial corporations is likely to be weak. Because of soft final demand, we believe that profit margins also will be squeezed as businesses find it difficult to pass on their higher commodity prices to consumers. This has been the case so far as the ratio of the Consumer Price Index (CPI) for goods to the Producer Price Index (PPI) for finished consumer goods has been falling (see Chart 20).
And the Winner, er, Loser Is... Portfolio.com readers speak: Who is the least trustworthy C.E.O. on Wall Street? John Thain has been thumped recently for having apparently reversed course on some initially reassuring comments he made about Merrill Lynch's capital position. But he's hardly alone in having been overly optimistic amid the mortgage meltdown, as Portfolio.com writer Megan Barnett recently documented. That raised the question of which financial-services C.E.O. is saddled with the widest credibility gap these days. So we asked our readers to vote. By that measure Thain came out fairly well, perhaps because Merrill is still in business and Thain still has his job. Readers said the least trustworthy executive is Alan Schwartz, who was unfortunate enough to be in the corner office at Bear Stearns when the C.D.O.'s hit the fan there in March. Close behind: Martin Sullivan, formerly chief executive of American International Group, who famously calculated the chances of AIG posting a loss as "close to zero" -- a few months before AIG posted losses of $13 billion. Thain came in sixth place of our nine nominees, a few basis points behind Dick Fuld at Lehman Brothers.
Big Differences In Earnings and Analysts' Estimates What's the value of analyst estimates? Look at the enormous differences between actual earnings and analyst estimates for a couple of recent companies: GM (NYSE: gm) loss: $11.21 Estimate loss:: $2.62 Merrill (NYSE: mer) loss: $4.97 Estimate loss: $1.91 These aren't the only ones: there are dozens of other examples in financials, autos, airlines and home builders where we have seen misses not of a few pennies, but of orders of magnitude. The problems: 1) poor visibility: these industries are seeing business deteriorate on almost a daily basis 2) poor communication and data sharing: many companies provide little if any guidance and share a little information as possible, leaving analysts to either develop their own sources or remain at the mercy of the company 3) poor quality of analysts: the best analysts have left the sell side and now work for the buy side. The remaining sellside analysts, as a group, are of lesser quality.
Shipping Costs Start to Crimp Globalization The world economy has become so integrated that shoppers find relatively few T-shirts and sneakers in Wal-Mart and Target carrying a “Made in the U.S.A.” label. But globalization may be losing some of the inexorable economic power it had for much of the past quarter-century, even as it faces fresh challenges as a political ideology. Cheap oil, the lubricant of quick, inexpensive transportation links across the world, may not return anytime soon, upsetting the logic of diffuse global supply chains that treat geography as a footnote in the pursuit of lower wages. Rising concern about global warming, the reaction against lost jobs in rich countries, worries about food safety and security, and the collapse of world trade talks in Geneva last week also signal that political and environmental concerns may make the calculus of globalization far more complex.
Commodity costs crimp Kodak turnaround Surging commodity prices are complicating Kodak’s (EK) recovery plan. The Rochester, N.Y., photo company posted a second-quarter profit that missed Wall Street’s estimates, as profit margins narrowed under the pressure of year-over-year increases in silver, aluminum, petroleum-based and other raw material costs. Kodak also said it expects its full-year profit to come in at the low end of its earlier forecast, and reduced its 2008 cash generation target.
Players
Las Vegas's Gambling Slump Shows How Starbucks Expansion Bubble Lost Air The Starbucks index is pointing down in Las Vegas. The Nevada city's gambling-driven growth in the 1990s proved irresistible to Starbucks Corp., the world's largest coffee-shop chain. Las Vegas, which had no Starbucks outlets before 1995, has about 155 now, according to the store locator on the company's Web site. Starbucks, stung by a slowdown in sales as strapped consumers shy away from $4 lattes, is staging the biggest retreat in its 37-year history, closing 600 of 11,168 U.S. company-owned and licensed stores. Las Vegas is taking the biggest hit, losing 16 of the once-trendy cafes, including in North Las Vegas, or 10 percent of its total. Los Angeles will lose just two of about 56 and New York City 10 of more than 200. The closings ordered by Chief Executive Officer Howard Schultz, 55, will cost as many as 12,000 jobs in the U.S. The company had 172,000 jobs as of last September. Rising gasoline and food prices, increased unemployment and the housing slump have shackled Starbucks. The company said in April that U.S. sales in stores open at least 13 months, a standard retail industry measure of performance, declined for the third straight quarter. Starbucks swings to loss on store closure costs
Why Starbucks lost its mojo Pundits and analysts blamed stock prices, the mortgage crisis, competition from McDonald's and Dunkin Donuts, along with real estate blunders, like putting stores on opposite corners of the same intersection. But they had it mostly wrong. This economic logic was too narrow and not culturally informed enough to explain Starbucks' fall. The company thrived throughout the past 15 years by giving middle-class Americans exactly what they thought they wanted – and this wasn't really about coffee. It was about creating a product that allowed doctors and lawyers, IT specialists and travel writers, and then their imitators, to portray themselves as they wanted to be seen. That's how products work in the world we live in. We buy things to announce something about ourselves. For the most part, the products that sell the best are the ones that communicate most effectively. That's what Starbucks did with their coffee. Really, then, they sold not coffee but elevated status. Just by buying the coffee and speaking the company's made-up lingua franca, you became a cup-carrying member of the upper class. And that made Starbucks, overpriced as it was, an affordable form of statusmaking.
Whole Foods Looks for a Fresh Image in Lean Times Whole Foods Market is on a mission to revise its gold-plated image as consumers pull back on discretionary spending in a troubled economy. The company was once a Wall Street darling, but its sales growth was cooling even before the economy turned. Since peaking at the beginning of 2006, its stock has dropped more than 70 percent. Now, in a sign of the times, the company is offering deeper discounts, adding lower-priced store brands and emphasizing value in its advertising. It is even inviting customers to show up for budget- focused store tours like those led by Mr. Hebb, a Whole Foods employee. But the budget claims are no easy sell at a store that long ago earned the nickname Whole Paycheck. Told of the company’s budget pitch by a reporter, some Whole Foods customers said they had not noticed cheaper prices; a few laughed.
Walter Robb, the company’s co-president, acknowledged that Whole Foods was fighting strong consumer perceptions about the chain’s prices, and he added that some of that was deserved. But he said the company had made a strong effort to challenge its competitors on price. Whole Foods’ makeover comes amid a tumultuous time in the grocery industry, as customers struggling to pay for higher-priced fuel and food are trading down to lesser products and discount-oriented stores. A July survey by TNS Retail Forward, of Columbus, Ohio, found that 20 percent of shoppers have changed where they buy groceries and household essentials because of the economy. The biggest beneficiaries have been dollar stores and discount grocers like Aldi and Save-a-Lot, which offer a limited selection at extreme discounts.
Wal-Mart Stores Inc.'s run as this year's best-performing Dow Jones Industrial Average company may end after the world's largest retailer said sales growth will slow this month. Wal-Mart declined 6.3 percent yesterday, the steepest drop since 2002, after it said sales in stores open at least a year may rise as little as 1 percent, which would be the smallest gain in five months. The company said most shoppers had spent the U.S. tax rebates that spurred sales. Wal-Mart had climbed 28 percent this year before yesterday, compared with the 30-company Dow's 14 percent drop. After yesterday's decline, Bentonville, Arkansas-based Wal-Mart had a gain of 20 percent, just ahead of International Business Machines Corp.'s 19 percent increase. Spending of tax rebate checks, part of the government's attempt to rejuvenate the economy, helped produce Wal-Mart's biggest same-store sales gains of the year in May, with a 3.9 percent increase, and June, with a 5.8 percent jump. The company lured shoppers battered by soaring gasoline and food costs with $4 prescriptions and discounts on groceries and flat-screen televisions as steep as 30 percent. Total sales in the first half of the fiscal year that started Feb. 1 climbed 9.6 percent. Total sales in July increased 9.4 percent. ``We are seeing the end of a catalyst,'' Lauri Brunner, a Minneapolis-based analyst for Thrivent Asset Management, said yesterday in a Bloomberg Radio interview. Thrivent manages $73.2 billion in assets, with 1.5 million Wal-Mart shares through June.