Walking Through Earnings Season
We are mid earnings season and generally, at this time, we take a moment to explain “how the season is going”. Usually, this involves a bunch of data and some tables. This time, Fang Zhou, CFA who works on our Large Cap equity and International portfolios, offered to provide his view from the trenches. Fang, like all of our analysts, dives deep into the companies during the reporting period, going through financial statements and listening and talking to management of the companies that we own and follow. Please find his thoughts below:
I always find it is difficult to explain to friends when they ask what is “earning season”. Terms such as organic growth, margin, capital expenditure, free cash flow, and share repurchase are not intuitive. So, I believe that talking about what I have learned from the companies during the earnings period and connecting the dots to how the businesses are affecting each other is easier to understand. It is also interesting to see how things are correlated.
- It all starts with the banks, who are generating great profits thanks to the rise of interest rates. The management of the US big four (JPMorgan, Citi, Bank of America, and Wells Fargo) shared the same comments: consumer spending remains robust and credit & debit card spending grew approximately 10% year over year (YoY). However, consumer spending habits have shifted away from products toward services.
- Then the retail players from Walmart, Staples, and Amazon to P&G, collectively noted that shoppers are buying less and, as a result, the companies are working to reduce the inventories that built up during the pandemic, owing to the concern of ongoing supply chain disruptions.
- After that, management from transportation companies like J.B. Hunt (trucking), and Union Pacific (rail) commented that they are experiencing double-digit decline in volumes. However, they continue to invest in technology to drive efficiency gains. FedEx completed a pilot project of its smart facility, which enables RFID technology in their network. The chips in the RFID label enable the company to reduce their misload ratio by more than half. We also heard the same comment from UPS with its use of RFID’s in shipping labels, which makes us very confident in our investments in warehouse and industrial automation companies.
- Later, the chip companies The CEO of ASML talked about the demand for lithography machines remaining solid. Their book-to-bill ratio stands well above 1.0x. While there’s weakness in chips related to the PC market, as mentioned by TSMC, (recall consumers have shifted their purchase from products to services) the demand related to IoT, data centers, etc. continues to be resilient.
- Then, the Giga Tech companies host their calls. While Microsoft sees the same weakness in PC, its Cloud business continues to expand at a rate of over 20% YoY, despite it already having a run rate of $20bn in revenue per quarter. Similar strengths appeared in other Cloud players like Amazon and Google. Together with Meta, Google is committed to investing billions of dollars in data center (recall TSMC’s comment), despite the internet giant facing short-term headwinds in their ads business, as people are going out to spend less time at home watching YouTube.
- With consumers getting out and back to travel, United Airlines reported the best third-quarter performances in history. However, the CEO called out a capacity shortage in the crew, pilots, and planes and told investors that it might take additional 2-3 years for Boeing and Airbus to get their production rate back to the pre-pandemic level. Boeing blamed engine shortages as the primary issue that drags their manufacturing recovery. The engine makers like CFM and Pratt & Whitney say they are struggling to meet demand as their suppliers couldn’t deliver because engine parts suppliers like Precision Castparts laid off 40% of workers during the pandemic and found the labor market to be tight and longer to train.
- Moving to the job market, the CEO of ADP, one of the largest payroll software providers, noted that “demand for labor remains solid”.
This means that” earnings season is yet to finish. We will formally call it closed in early December when the Canadian banks report but in the interim we expect shoppers to see bigger discounts from the stores, students to see more laptops on sale, and travelers could find flying still not as easy as pre-pandemic. We believe that the important take away from the above is that these are all operating companies, working hard to adjust their businesses to generate value for their shareholders (i.e. us!) and this is what we are invested in. With a real business, you try to understand how it is connected to your everyday life, rather than focus on the changing market quoted price of what a stock chart looks like. This is how we fundamentally invest our collective capital.
National Instrument 31-103 requires registered firms to disclose information that a reasonable investor would expect to know, including any material conflicts with the firm or its representatives. Doug Johnson and/or Pathfinder Asset Management Limited are an insider of companies periodically mentioned in this report. Please visit www.paml.ca for full disclosures.
*All returns are time weighted and net of investment management fees. Returns from the Pathfinder Partners’ Fund and Partners’ Real Return Plus Fund are presented based on the masters series of each fund. The Pathfinder Core: Equity Portfolio and The Pathfinder Core: High Income Portfolio are live accounts. These are actual accounts owned by the Pathfinder Chairman (Equity) and client (High Income) which contain no legacy positions, cash flows or other Pathfinder investment mandates or products. Monthly inception dates for each fund and portfolio are as follows: Pathfinder Core: Equity Portfolio (January 2011), Pathfinder Core: High Income Portfolio (October 2012) Partners’ Fund (April 2011), Partners’ Real Return Plus Fund (April, 2013), and Partners’ Core Plus Fund (November 2014).
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